This entry includes 9 subentries:
Banking Acts of 1933 and 1935
Banking Crisis of 1933
Banks State Banks
The fundamental functions of a commercial bank during the past two centuries have been making loans, receiving deposits, and lending credit either in the form of bank notes or of "created" deposits. The banks in which people keep their checking accounts are commercial banks.
There were no commercial banks in colonial times, although there were loan offices or land banks that made loans on real estate security with limited issues of legal tender notes. In 1781 Robert Morris founded the first commercial bank in the United States—the Bank of North America. It greatly assisted the financing of the closing stages of the American Revolution. By 1800, there were twenty-eight state-chartered banks, and by 1811 there were eighty-eight.
Alexander Hamilton's financial program included a central bank to serve as a financial agent of the treasury, provide a depository for public money, and act as a regulator of the currency. Accordingly, the first Bank of the United States was founded 25 February 1791. Its $10 million capital and favored relationship with the government aroused much anxiety, especially among Jeffersonians. The bank's sound but unpopular policy of promptly returning bank notes for redemption in specie (money in coin) and refusing those of non-specie-paying banks—together with a political feud—was largely responsible for the narrow defeat of a bill to recharter it in 1811. Between 1811 and 1816, both people and government were dependent on state banks. Nearly all but the New England banks suspended specie payments in September 1814 because of the War of 1812 and their own unregulated credit expansion.
The country soon recognized the need for a new central bank, and Congress established the second Bank of the United States on 10 April 1816. Its $35 million capitalization and favored relationship with the Treasury likewise aroused anxiety. Instead of repairing the overexpanded credit situation that it inherited, it aggravated it by generous lending policies, which precipitated the panic of 1819, in which it barely saved itself and generated wide-spread ill will.
Thereafter, under Nicholas Biddle, the central bank was well run. As had its predecessor, it required other banks to redeem their notes in specie, but most of the banks had come to accept that policy, for they appreciated the services and the stability provided by the second bank. The bank's downfall grew out of President Andrew Jack-son's prejudice against banks and monopolies, the memory of the bank's role in the 1819 panic, and most of all, Biddle's decision to let rechartering be a main issue in the 1832 presidential election. Many persons otherwise friendly to the bank, faced with a choice of Jackson or the bank, chose Jackson. He vetoed the recharter. After 26 September 1833, the government placed all its deposits with politically selected state banks until it set up the Independent Treasury System in the 1840s. Between 1830 and 1837, the number of banks, bank note circulation, and bank loans all about tripled. Without the second bank to regulate them, the banks overextended themselves in lending to speculators in land. The panic of 1837 resulted in a suspension of specie payments, many failures, and a depression that lasted until 1844.
Between 1833 and 1863, the country was without an adequate regulator of bank currency. In some states, the laws were very strict or forbade banking, whereas in others the rules were lax. Banks made many long-term loans and resorted to many subterfuges to avoid redeeming their notes in specie. Almost everywhere, bank tellers and merchants had to consult weekly publications known as Bank Note Reporters for the current discount on bank notes, and turn to the latest Bank Note Detectors to distinguish the hundreds of counterfeits and notes of failed banks. This situation constituted an added business risk and necessitated somewhat higher markups on merchandise. In this bleak era of banking, however, there were some bright spots. These were the Suffolk Banking System of Massachusetts (1819–1863); the moderately successful Safety Fund system (1829–1866) and Free Banking (1838–1866) systems of New York; the Indiana (1834–1865), Ohio (1845–1866), and Iowa (1858–1865) systems; and the Louisiana Banking System (1842–1862). Inefficient and corrupt as some of the banking was before the Civil War, the nation's expanding economy found it an improvement over the system on which the eighteenth-century economy had depended.
Secretary of the Treasury Salmon P. Chase began agitating for an improved banking system in 1861. On 25 February 1863, Congress passed the National Banking Act, which created the National Banking System. Its head officer was the comptroller of currency. It was based on several recent reforms, especially the Free Banking System's principle of bond-backed notes. Nonetheless, the reserve requirements for bank notes were high, and the law forbade real estate loans and branch banking, had stiff organization requirements, and imposed burdensome taxes. State banks at first saw little reason to join, but, in 1865, Congress levied a prohibitive 10 percent tax on their bank notes, which drove most of these banks into the new system. The use of checks had been increasing in popularity in the more settled regions long before the Civil War, and, by 1853, the total of bank deposits exceeded that of bank notes. After 1865 the desire of both state and national banks to avoid the various new restrictions on bank notes doubtless speeded up the shift to this more convenient form of bank credit. Since state banks were less restricted, their number increased again until it passed that of national banks in 1894. Most large banks were national, however.
The National Banking System constituted a substantial improvement over the pre–Civil War hodgepodge of banking systems. Still, it had three major faults. The first was the perverse elasticity of the bond-secured bank notes, the supply of which did not vary in accordance with the needs of business. The second was the decentralization of bank deposit reserves. There were three classes of national banks: the lesser ones kept part of their reserves in their own vaults and deposited the rest at interest with the larger national banks. These national banks in turn lent a considerable part of the funds on the call money market to finance stock speculation. In times of uncertainty, the lesser banks demanded their outside reserves, call money rates soared, security prices tobogganed, and runs on deposits ruined many banks. The third major fault was that there was no central bank to take measures to forestall such crises or to lend to deserving banks in times of distress.
In 1873, 1884, 1893, and 1907, panics highlighted the faults of the National Banking System. Improvised use of clearinghouse certificates in interbank settlements some-what relieved money shortages in the first three cases, whereas "voluntary" bank assessments collected and lent by a committee headed by J. P. Morgan gave relief in 1907. In 1908 Congress passed the Aldrich-Vreeland Act to investigate foreign central banking systems and suggest reforms, and to permit emergency bank note issues. The Owen-Glass Act of 1913 superimposed a central banking system on the existing national banking system. It required all national banks to "join" the new system, which meant to buy stock in it immediately equal to 3 percent of their capital and surplus, thus providing the funds with which to set up the Federal Reserve System. State banks might also join by meeting specified requirements, but, by the end of 1916, only thirty-four had done so. A majority of the nation's banks have always remained outside the Federal Reserve System, although the larger banks have usually been members. The Federal Reserve System largely corrected the faults to which the National Banking System had fallen prey. Admittedly, the Federal Reserve had its faults and did not live up to expectations. Nevertheless, the nation's commercial banks had a policy-directing head and a refuge in distress to a greater degree than they had ever had before. Thus ended the need for the Independent Treasury System, which finally wound up its affairs in 1921.
Only a few national banks gave up their charters for state ones in order to avoid joining the Federal Reserve System. However, during World War I, many state banks became members of the system. All banks helped sell Liberty bonds and bought short-term Treasuries between bond drives, which was one reason for a more than doubling of the money supply and also of the price level from 1914 to 1920. A major contributing factor for these doublings was the sharp reduction in reserves required under the new Federal Reserve System as compared with the pre-1914 National Banking System.
By 1921 there were 31,076 banks, the all-time peak. Every year, local crop failures, other disasters, or simply bad management wiped out several hundred banks. By 1929 the number of banks had declined to 25,568. Admittedly, mergers eliminated a few names, and the growth of branch, group, or chain banking provided stability in some areas. Nevertheless, the 1920s are most notable for stock market speculation. Several large banks had a part in this speculation, chiefly through their investment affiliates. The role of investment adviser gave banks great prestige until the panic of 1929, when widespread disillusionment from losses and scandals brought them discredit.
The 1930s witnessed many reforms growing out of the more than 9,000 bank failures between 1930 and 1933 and capped by the nationwide bank moratorium of 6–9 March 1933. To reform the commercial and central banking systems, as well as to restore confidence in them, Congress passed two major banking laws between 1933 and 1935. These laws gave the Federal Reserve System firmer control over the banking system. They also set up the Federal Deposit Insurance Corporation to insure bank deposits, and soon all but a few hundred small banks belonged to it. That move greatly reduced the number of bank failures. Other changes included banning investment affiliates, prohibiting banks from paying interest on demand deposits, loosening restrictions against national banks' having branches and making real estate loans, and giving the Federal Reserve Board the authority to raise member bank legal reserve requirements against deposits. As a result of the Depression, the supply of commercial loans dwindled, and interest rates fell sharply. Consequently, banks invested more in federal government obligations, built up excess reserves, and imposed service charges on checking accounts. The 1933–1934 devaluation of the dollar, which stimulated large imports of gold, was another cause of those excess reserves.
During World War II, the banks again helped sell war bonds. They also converted their excess reserves into government obligations and dramatically increased their own holdings of these. Demand deposits more than doubled. Owing to bank holdings of government obligations and to Federal Reserve commitments to the treasury, the Federal Reserve had lost its power to curb bank-credit expansion. Price levels nearly doubled during the 1940s.
In the Federal Reserve-treasury "accord" of March 1951, the Federal Reserve System regained its freedom to curb credit expansion, and thereafter interest rates crept upward. That development improved bank profits and led banks to reduce somewhat their holdings of federal government obligations. Term loans to industry and real estate loans increased. Banks also encountered stiff competition from rapidly growing rivals, such as savings and loan associations and personal finance companies. On 28 July 1959, Congress eliminated the difference between reserve city banks and central reserve city banks for member banks. The new law kept the same reserve requirements against demand deposits, but it permitted banks to count cash in their vaults as part of their legal reserves.
Interest rates rose spectacularly all during the 1960s and then dropped sharply in 1971, only to rise once more to 12 percent in mid-1974. Whereas consumer prices had gone up 23 percent during the 1950s, they rose 31 percent during the 1960s—especially toward the end of the decade as budget deficits mounted—and climbed another 24 percent by mid-1974. Money supply figures played a major role in determining Federal Reserve credit policy from 1960 on.
Money once consisted largely of hard coin. With the coming of commercial banks, it came also to include bank notes and demand deposits. The difference, however, between these and various forms of "near money"—time deposits, savings and loan association deposits, and federal government E and H bonds—is slight. Credit cards carry the confusion a step further. How does one add up the buying power of money, near money, and credit cards? As new forms of credit became more like money, it was increasingly difficult for the Federal Reserve to regulate the supply of credit and prevent booms.
Since 1970 banking and finance have undergone nothing less than a revolution. The structure of the industry in the mid-1990s bore little resemblance to that established in the 1930s in the aftermath of the bank failures of the Great Depression. In the 1970s and 1980s, what had been a fractured system by design became a single market, domestically and internationally. New Deal banking legislation of the Depression era stemmed from the belief that integration of the banking system had allowed problems in one geographical area or part of the financial system to spread to the entire system. Regulators sought, therefore, to prevent money from flowing between different geographical areas and between different functional segments. These measures ruled out many of the traditional techniques of risk management through diversification and pooling. As a substitute, the government guaranteed bank deposits through the Federal Deposit Insurance Corporation and the Federal Savings and Loan Insurance Corporation.
In retrospect, it is easy to see why the segmented system broke down. It was inevitable that the price of money would vary across different segments of the system. It was also inevitable that borrowers in a high-interest area would seek access to a neighboring low-interest area—and vice versa for lenders. The only question is why it took so long for the pursuit of self-interest to break down regulatory barriers. Price divergence by itself perhaps was not a strong enough incentive. Rationing of credit during tight credit periods probably was the cause of most innovation. Necessity, not profit alone, seems to have been the cause of financial innovation.
Once communication between segments of the system opened, mere price divergence was sufficient to cause flows of funds. The microelectronics revolution enhanced flows, as it became easier to identify and exploit profit opportunities. Technological advances sped up the process of market unification by lowering transaction costs and widening opportunities. The most important consequence of the unification of segmented credit markets was a diminished role for banks. Premium borrowers found they could tap the national money market directly by issuing commercial paper, thus obtaining funds more cheaply than banks could provide. In 1972 money-market mutual funds began offering shares in a pool of money-market assets as a substitute for bank deposits. Thus, banks faced competition in both lending and deposit-taking—competition generally not subject to the myriad regulatory controls facing banks.
Consolidation of banking became inevitable as its functions eroded. The crisis of the savings and loan industry was the most visible symptom of this erosion. Savings and loans associations (S&Ls) had emerged to funnel household savings to residential mortgages, which they did until the high interest rates of the inflationary 1970s caused massive capital losses on long-term mortgages and rendered many S&Ls insolvent by 1980. Attempts to re-gain solvency by lending cash from the sale of existing mortgages to borrowers willing to pay high interest only worsened the crisis, because high-yield loans turned out to be high risk. The mechanisms invented to facilitate mortgage sales undermined S&Ls in the longer term as it became possible for specialized mortgage bankers to make mortgage loans and sell them without any need for the expensive deposit side of the traditional S&L business.
Throughout the 1970s and 1980s, regulators met each evasion of a regulatory obstacle with further relaxation of the rules. The Depository Institutions Deregulation and Monetary Control Act (1980) recognized the array of competitors for bank business by expanding the authority of the Federal Reserve System over the new entrants and relaxing regulation of banks. Pressed by a borrowers' lobby seeking access to low-cost funds and a depositors' lobby seeking access to high money-market returns, regulators saw little choice but capitulation. Mistakes occurred, notably the provision in the 1980 act that extended deposit insurance coverage to $100,000, a provision that greatly increased the cost of the eventual S&L bailout. The provision found its justification in the need to attract money to banks. The mistake was in not recognizing that the world had changed and that the entire raison d'être of the industry was disappearing.
Long-term corporate finance underwent a revolution comparable to that in banking. During the prosperous 1950s and 1960s, corporations shied away from debt and preferred to keep debt-equity ratios low and to rely on ample internal funds for investment. The high cost of issuing bonds—a consequence of the uncompetitive system of investment banking—reinforced this preference. Usually, financial intermediaries held the bonds that corporations did issue. Individual owners, not institutions, mainly held corporate equities. In the 1970s and 1980s, corporations came to rely on external funds, so that debt-equity ratios rose substantially and interest payments absorbed a much greater part of earnings. The increased importance of external finance was itself a source of innovation as corporations sought ways to reduce the cost of debt service. Equally important was increased reliance on institutional investors as purchasers of securities. When private individuals were the main holders of equities, the brokerage business was uncompetitive and fees were high, but institutional investors used their clout to reduce the costs of buying and selling. Market forces became much more important in finance, just as in banking.
Institutional investors shifted portfolio strategies toward equities, in part to enhance returns to meet pension liabilities after the Employment Retirement Income Security Act (1974) required full funding of future liabilities. Giving new attention to maximizing investment returns, the institutional investors became students of the new theories of rational investment decision championed by academic economists. The capital asset pricing model developed in the 1960s became the framework that institutional investors most used to make asset allocations.
The microelectronics revolution was even more important for finance than for banking. Indeed, it would have been impossible to implement the pricing model without high-speed, inexpensive computation to calculate optimal portfolio weightings across the thousands of traded equities. One may argue that computational technology did not really cause the transformation of finance and that increased attention of institutional investors was bound to cause a transformation in any event. Both the speed and extent of transformation would have been impossible, however, without advances in computational and communications technologies.
Bodenhorn, Howard N. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. Cambridge: Cambridge University Press, 2000.
Gilbart, James William. The History of Banking in America. London: Routledge/Thoemmes Press, 1996.
Mehrling, Perry. The Money Interest and the Public Interest: American Monetary Thought, 1920–1970. Cambridge, Mass.: Harvard University Press, 1997.
Timberlake, Richard H. The Origins of Central Banking in the United States. Cambridge, Mass.: Harvard University Press, 1978.
Wicker, Elmus. Banking Panics of the Gilded Age. Cambridge, Mass: Cambridge University Press, 2000.
Wright, Robert E. Origins of Commercial Banking in America, 1750–1800. Lanham, Md.: Rowman and Littlefield, 2001.
Perry G.Mehrling/a. e.
See alsoBank of America ; Bank of the United States ; Clearinghouses ; Credit Cards ; Credit Unions ; Federal Reserve System ; Financial Panics ; Financial Services Industry ; Savings and Loan Associations .
American financial history to 1934 was characterized by numerous bank failures, because the majority of banks were local enterprises, not regional or national institutions with numerous branches. Lax state government regulations and inadequate examinations permitted many banks to pursue unsound practices. With most financial eggs in local economic baskets, it took only a serious crop failure or a business recession to precipitate dozens or even hundreds of bank failures. On the whole, state-chartered banks had a particularly poor record.
Early Bank Failures
Early-nineteenth-century banks were troubled by a currency shortage and the resulting inability to redeem their notes in specie. States later imposed penalties in those circumstances, but such an inability did not automatically signify failure. The first bank to fail was the Farmers' Exchange Bank of Glocester, R.I., in 1809. The statistics of bank failures between 1789 and 1863 are inadequate, but the losses were unquestionably large. John Jay Knox estimated that the losses to noteholders were 5 percent per annum, and bank notes were the chief money used by the general public. Not until after 1853 did banks' deposit liabilities exceed their note liabilities. Between 1830 and 1860, weekly news sheets called bank note reporters gave the latest discount quoted on the notes of weak and closed banks. All businesses had to allow for worthless bank notes. Although some states—such as New York in 1829 and 1838, Louisiana in 1842, and Indiana in 1834—established sound banking systems, banking as a whole was characterized by frequent failures.
The establishment of the National Banking System in 1863 introduced needed regulations for national (i.e., nationally chartered) banks. These were larger and more numerous than state banks until 1894, but even their record left much to be desired. Between 1864 and 1913—a period that saw the number of banks rise from 1,532 to 26,664—515 national banks were suspended, and only two years passed without at least one suspension. State banks suffered 2,491 collapses during the same period. The worst year was the panic year of 1893, with almost five hundred bank failures. The establishment of the Federal Reserve System in 1913 did little to improve the record of national banks. Although all banks were required to join the new system, 825 banks failed between 1914 and 1929, and an additional 1,947 failed by the end of 1933. During the same twenty years there were 12,714 state bank failures. By 1933 there were 14,771 banks in the United States, half as many as in 1920, and most of that half had disappeared by the failure route. During the 1920s, Canada, employing a branch banking system, had only one failure. Half a dozen states had experimented with deposit insurance plans without success. Apparently the situation needed the attention of the federal government.
The bank holocaust of the early 1930s—9,106 bank failures in four years, 1,947 of them national banks—culminating in President Franklin D. Roosevelt's executive order declaring a nationwide bank moratorium in March 1933, at last produced the needed drastic reforms. In 1933 Congress passed the Glass-Steagall Act, which forbade Federal Reserve member banks to pay interest on demand deposits, and founded the Federal Deposit Insurance Corporation (FDIC). In an effort to protect bank deposits from rapid swings in the market, the Glass-Steagall Banking Act of 1933 forced banks to decide between deposit safeholding and investment. Executives of security firms, for example, were prohibited from sitting as trustees of commercial banks.
The FDIC raised its initial capital by selling two kinds of stock. Class A stock (paying dividends) came from assessing every insured bank 0.5 percent of its total deposits—half paid in full, half subject to call. All member banks of the Federal Reserve System had to be insured. Federal Reserve Banks had to buy Class B stock (paying no dividends) with 0.5 percent of their surplus—half payable immediately, half subject to call. In addition, any bank desiring to be insured paid .083 percent of its average deposits annually. The FDIC first insured each depositor in a bank up to $2,500; in mid-1934 Congress put the figure at $5,000; on 21 September 1950, the maximum became $10,000; on 16 October 1966, the limit went to $15,000; on 23 December 1969, to $20,000; and on 27 November 1974, to $40,000. At the end of 1971 the FDIC was insuring 98.6 percent of all commercial banks and fully protecting 99 percent of all depositors. However, it was protecting only about 64 percent of all deposits, with savings deposits protected at a high percentage but business deposits at only about 55 percent. By the mid-1970s the FDIC was examining more than 50 percent of the banks in the nation, which accounted for about 20 percent of banking assets. It did not usually examine member banks of the Federal Reserve System, which were the larger banks. There was a degree of rivalry between the large and small banks, and the FDIC was viewed as the friend of the smaller banks.
Whereas in the 1920s banks failed at an average rate of about six hundred a year, during the first nine years of the FDIC (1934–1942) there were 487 bank closings because of financial difficulties, mostly of insured banks; 387 of these received disbursements from the FDIC. During the years from 1943 to 1972, the average number of closings dropped to five per year. From 1934 to 1971 the corporation made disbursements in 496 cases involving 1.8 million accounts, representing $1.215 billion in total deposits. The FDIC in 1973 had $5.4 billion in assets. Through this protection, people were spared that traumatic experience of past generations, a "run on the bank" and the loss of a large part of their savings. For example, in 1974 the $5 billion Franklin National Bank of New York, twentieth in size in the nation, failed. It was the largest failure in American banking history. The FDIC, the Federal Reserve, and the comptroller of the currency arranged the sale of most of the bank's holdings, and no depositor lost a cent.
The 1980s and the Savings and Loan Debacle
The widespread bank failures of the 1980s—more than sixteen hundred FDIC-insured banks were closed or received financial assistance between 1980 and 1994—revealed major weaknesses in the federal deposit insurance system. In the 1970s, mounting defense and social welfare costs, rising oil prices, and the collapse of American manufacturing vitality in certain key industries (especially steel and electronics) produced spiraling inflation and a depressed securities market. Securities investments proved central to the economic recovery of the 1980s, as corporations cut costs through mergers, takeovers, and leveraged buyouts. The shifting corporate terrain created new opportunities for high-risk, high-yield investments known as "junk bonds." The managers of the newly deregulated savings and loan (S&L) institutions, eager for better returns, invested heavily in these and other investments—in particular, a booming commercial real estate market. When the real estate bubble burst, followed by a series of insider-trading indictments of Wall Street financiers and revelations of corruption at the highest levels of the S&L industry, hundreds of the S&Ls collapsed. In 1988 the Federal Home Loan Bank Board began the process of selling off the defunct remains of 222 saving and loans. Congress passed sweeping legislation the following year that authorized a massive government bailout and imposed strict new regulatory laws on the S&L industry. The cost of the cleanup to U.S. taxpayers was $132 billion.
In addition to the S&L crisis, the overall trend within the banking industry during the 1980s was toward weaker performance ratios, declining profitability, and a quick increase in loan charge-offs, all of which placed an unusual strain on banks. Seeking stability in increased size, the banking industry responded with a wave of consolidations and mergers. This was possible in large part because Congress relaxed restrictions on branch banking in an effort to give the industry flexibility in its attempts to adjust to the changing economy. Deregulation also made it easier for banks to engage in risky behavior, however, contributing to a steep increase in bank failures when loans and investments went bad in the volatile economic climate. Legislators found themselves torn among the need to deregulate banks, the need to prevent failures, and the need to recapitalize deposit insurance funds, which had suffered a huge loss during the decade. In general, they responded by giving stronger tools to regulators but narrowly circumscribing the discretion of regulators to use those tools.
During the 1990s, the globalization of the banking industry meant that instability abroad would have rapid repercussions in American financial markets; this, along with banks' growing reliance on computer systems, presented uncertain challenges to the stability of domestic banks in the final years of the twentieth century. As the economy boomed in the second half of the decade, however, the performance of the banking industry improved remarkably, and the number of bank failures rapidly declined. Although it was unclear whether the industry had entered a new period of stability or was merely benefiting from the improved economic context, the unsettling rise in bank failures of the 1980s seemed to have been contained.
Calavita, Kitty, Henry N. Pontell, and Robert H. Tillman. Big Money Crime: Fraud and Politics in the Savings and Loan Crisis. Berkeley: University of California Press, 1997.
Dillistin, William H. Bank Note Reporters and Counterfeit Detectors, 1826–1866. New York: American Numismatic Society, 1949.
Lee, Alston, Wayne Grove, and David Wheelock. "Why Do Banks Fail? Evidence from the 1920s." Explorations in Economic History (October 1994): 409–431.
Thies, Clifford, and Daniel Gerlowski. "Bank Capital and Bank Failure, 1921–1932: Testing the White Hypothesis." Journal of Economic History (1993): 908–914.
Walton, Gary M., ed. Regulatory Change in an Atmosphere of Crisis: Current Implications of the Roosevelt Years. New York: Academic Press, 1979.
Donald L.Kemmerer/a. r.; c. w.
Banking Acts of 1933 and 1935
The Banking Act of 1933, approved on 16 June and known also as the Glass-Steagall Act, contained three groups of provisions designed to restore stability to and confidence in the banking system. The first group of provisions increased the power of the Federal Reserve Board to control credit. The second group separated commercial and investment banking functions by prohibiting commercial banks from operating investment affiliates and by prohibiting investment banking houses from carrying on a deposit banking business. (These provisions were repealed by the Gramm-Leach-Bliley Act of 1999, also known as the Banking Modernization Bill.) The third group of provisions dealt with commercial banks and included a provision providing for the insurance of bank deposits under the supervision of the Federal Deposit Insurance Corporation (FDIC). (Creation of the FDIC is one of the New Deal's most important legacies and probably prevented a large-scale banking collapse in the early 1980s.)
The Banking Act of 1935, approved on 23 August, further increased government control over currency and credit. Title I amended the deposit insurance provisions of the Banking Act of 1933, and Title III contained a series of technical amendments to the banking laws governing the operations of the commercial banks. The most important of the act's three titles was Title II, which drastically reorganized the Federal Reserve Board and centralized control of the money market in its hands. The act authorized the president to appoint the seven members of the newly named "Board of Governors of the Federal Reserve System" for fourteen-year terms. It also increased and centralized the board's powers over discount and open market operations of the Reserve banks and materially broadened the discount base.
Dawley, Alan. Struggles for Justice: Social Responsibility and the Liberal State. Cambridge, Mass.: Harvard University Press, 1991.
Leuchtenburg, William E. Franklin D. Roosevelt and the New Deal, 1932–1940. New York: Harper and Row, 1963.
McElvaine, Robert S. The Great Depression: America 1929–1941. Rev. ed. New York: Times Books, 1993.
Frederick A.Bradford/c. p.
See alsoNew Deal .
Banking Crisis of 1933
The outcome of both the large number of bank failures during 1931–1932 and the wave of hoarding which swept the country in response, markedly weakened the banking structure. Attempts by the Reconstruction Finance Corporation to avoid disaster were in large measure nullified by the publication of the names of banks that had borrowed from it, a procedure not calculated to restore confidence to frightened depositors.
Banking difficulties in Michigan finally caused Governor William A. Comstock to declare a bank "holiday" in that state on 14 February 1933. Alarm quickly spread to neighboring states. Banking moratoria were declared in four other states by the end of February and in seventeen additional states during the first three days of March. Finally, on 4 March 1933, on his first day in office, President Franklin D. Roosevelt closed banks in the remaining states.
The situation was serious, and prompt action was imperative. Congress, called in special session by the president, passed the Emergency Banking Relief Act of 1933 on 9 March, thus providing machinery for reopening the banks. Under this act, only sound banks were to be reopened, while those of questionable soundness were to be placed in the hands of conservators and opened later if conditions permitted. The national bank moratorium was extended a few days to permit the provisions of the act to be put into effect. Sound banks reopened on 13–15 March. By the latter date, banks controlling about 90 percent of the banking resources of the country were again in operation, and the banking crisis of 1933 was at an end.
Dawley, Alan. Struggles for Justice: Social Responsibility and the Liberal State. Cambridge, Mass.: Harvard University Press, 1991.
Kennedy, Susan Estabrook. The Banking Crisis of 1933. Lexington: University Press of Kentucky, 1973.
McElvaine, Robert S. The Great Depression: America, 1929–1941. Rev. ed. New York: Times Books, 1993.
Frederick A.Bradford/c. p.
See alsoGlass-Steagall Act ; andvol. 9:Fireside Chat on the Bank Crisis .
The Export-Import Bank of the United States (Ex-Im Bank) is the official export credit agency (ECA) of the United States. Its purpose is to match officially supported foreign competition and to address export financing needs that are unmet by the private sector in order to maximize American exports. Currently, Ex-Im Bank performs this function through direct loans or guarantees of commercial loans to foreign buyers of American exports, working capital guarantees for United States exporters, and export credit insurance. In 2001 it made $871 million in direct loans, $6.1 billion in loan guarantees, and $2.3 billion in export credit insurance.
Franklin D. Roosevelt established the first Ex-Im Bank by executive order. It was chartered on 12 February 1934 as an instrument of his foreign policy and to promote economic recovery from the Great Depression by providing financing for moribund foreign trade. The bank's initial purpose was to facilitate trade with the Soviet Union after the United States extended diplomatic recognition. A second Ex-Im Bank was chartered in March to facilitate trade with a new government in Cuba, but its charter was quickly changed to allow it to finance trade with all countries except the Soviet Union. In June 1935, when it became apparent that government-supported trade with the Soviet Union would not materialize, the two banks were merged. Until 1945 Ex-Im Bank financed its operations by the sale of Reconstruction Finance Corporation stock to the Treasury Department. It primarily financed the foreign purchase of American exports of transportation equipment and agricultural products to Latin America. Ex-Im Bank also supported American exports used in infrastructure projects in strategic nations such as Haiti and Brazil, where Nazi influence was increasing, or in China, which was at war with Japan. These activities led Congress in 1939 to impose a dollar limit on the total loans the agency could have outstanding at any given time. Such congressional limits remain a feature of the bank's operations. The limit as of 2002 was $75 billion.
During World War II Ex-Im Bank's activities were largely confined to Latin America and financing American exports for projects that related to infrastructure and production of strategic materials. Subsequently, Congress passed the Export-Import Bank Act of 1945. It established Ex-Im Bank as an independent agency, with a bipartisan, appointed board of directors, including a chair, confirmed by the Senate. Capital was $1 billion in stock purchased by the Treasury, and Ex-Im Bank had authority to borrow up to $2.5 billion from the Treasury to finance its operations. In 1947 Congress required periodic rechartering of all federal corporations, including Ex-Im Bank. Since that time, Congress has used the process periodically to increase the bank's outstanding loan ceiling. Finally, the 1945 act mandated that Ex-Im Bank not compete with the private sector and that it make only those loans with a "reasonable assurance of repayment," principles that had already become part of the bank's institutional culture.
Immediately after the end of World War II and the termination of the lend-lease program that provided strategic materials to Allied countries, Ex-Im Bank made over $2 billion in loans to Western European nations for purchases of American exports. This pre–Marshall Plan assistance was crucial to European recovery. However, the generous repayment terms dictated by foreign policy considerations were a matter of consternation to many at Ex-Im Bank. After the start-up of the Marshall Plan, the bank was again able to focus on its traditional customers in Latin America. During the 1950s, loans to finance the purchase of American exports by Asian governments increased.
From the end of the 1950s through the early 1970s, the United States incurred substantial international balance-of-payment and budget deficits. Exporter and government pressure on Ex-Im Bank to enhance its assistance to American exporters increased as foreign ECAs became more aggressive supporters of their exporters. By 1971 Congress mandated that Ex-Im Bank's assistance to American exporters and foreign purchasers of American exports be competitive with those of other ECAs. After 1961 the bank increasingly leveraged its assistance to exporters by creating and expanding partnerships with the private sector. It guaranteed loans made by private institutions and underwrote export credit insurance in conjunction with an expansion of its traditional direct loan program. These operations increasingly financed the foreign purchase of new American technologies such as jet aircraft, nuclear power, and communications equipment. Beginning in 1963 Congress specifically authorized annual limits on Ex-Im Bank loan and guarantee activity in addition to its traditional approval of its annual administrative budget.
Increasing federal deficits, the oil price rise, and the end to fixed exchange rates in 1973 brought major changes to Ex-Im Bank's environment. Some critics thought that the end to fixed rates undermined the rationale for Ex-Im Bank's promotional activities. Critics from a variety of political perspectives noted that assistance to exporters was overwhelmingly bestowed on a few firms that exported large capital goods such as aircraft, power generation equipment, and construction machinery. In a period of tight federal budgets, critics also wondered just how effective were Ex-Im Bank's increasing subsidies in creating new export sales.
The high interest rates of the 1970s and intensified competition from foreign ECAs created major financial problems for Ex-lm Bank by the early 1980s. The "spread" between its high cost of borrowing from the Treasury and the lower rates it had to give foreign purchasers of American exports to keep U.S. exports competitive created huge losses and undermined the bank's balance sheet. By the early 1980s the debt crisis in the developing world dramatically reduced demand for foreign trade finance but increased the amount of underperforming or nonperforming loans or guarantees on Ex-Im Bank's books.
Ex-Im Bank's and the Treasury Department's response to the bank's worsening finances was slow in developing, but by the 1990s it had achieved success. Beginning in 1978, a series of increasingly stringent understandings about the terms of international export finance and their enforcement were developed through the Organization for Economic Cooperation and Development. The long-term impact has been to reduce export subsidies in international trade. During the 1980s Ex-Im Bank improved its risk assessment mechanisms and adjusted its fee structure. In 1989 the bank established a nonspecific loss reserve for nonperforming assets in its loan portfolio. Legislation enacted by Congress in 1990 provided a continuing appropriation for nonperforming assets, and by 2000 Ex-Im Bank received an annual appropriation of approximately $1 billion to cover the assessed risk of its ongoing activities. During the 1990s the privatization of state enterprises worldwide, the capital needs of the former Soviet Bloc, and the continued reluctance of private institutions to commit to export finance in many such markets led to dramatic increases in Ex-Im Bank loan guarantee activity.
Adams, Frederick C. Economic Diplomacy: The Export-Import Bank and American Foreign Policy, 1934–1939. Columbia: University of Missouri Press, 1976.
Becker, William H., and William M. McClenahan. The Market, the State, and the Export-Import Bank of the United States, 1934–2000. New York: Cambridge University Press, 2003.
Hufbauer, Gary Clyde, and Rita M. Rodriguez, eds. The Ex-Im Bank in the Twenty-first Century: A New Approach. Washington, D.C.: Institute for International Economics, 2001.
Hillman, Jordan Jay. The Export-Import Bank at Work: Promotional Financing in the Public Sector. Westport, Conn.: Quorum Books, 1982.
Rodriguez, Rita M., ed. The Export-Import Bank at Fifty: The International Environment and the Institution's Role. Lexington, Mass: Lexington Books, 1987.
Investment banks are not banks in the strictest sense of the term. Unlike financial intermediaries (of which commercial banks are the most well-known), investment banks do not themselves acquire funds from savers (lenders) in order to provide those funds to investors (borrowers). Instead, these institutions facilitate the flows of funds from savers to corporations (or government agencies) that wish to raise capital. (This function should be distinguished from the resale of existing securities, a process that is simplified by the existence of organized secondary markets such as the New York Stock Exchange.)
Investment banks work through a process called under-writing. Usually acting in a group or syndicate, the bankers first advise the borrower on what sort of security to use to raise the required funds, the options being equity (stocks) or debt (bonds). Next, the underwriting syndicate itself purchases the new issue from the firm or the government borrower. Finally, networks of agents (brokers) associated with the investment banks sell the bonds or stocks to the ultimate lenders, who might be either individuals or large institutional investors such as life insurance companies and pension funds. If the syndicate has correctly judged the market for these new financial instruments, it will profit from the spread between the price it paid for the new issue and the price at which the syndicate was able to sell the issue. This is the investment banker's return for assuming the risk of marketing the borrower's securities.
Investment banks thus help provide capital for large borrowers, most of whom do not have the necessary expertise to negotiate and market their own financial liabilities. The history and evolution of investment banking in the United States is one of the interplay of three factors: need (the demand for large amounts of capital); opportunity (the supply of available funds); and constraints (the limitations placed on investment bankers by regulators). Despite years of change in environment and practice, however, many of the names of twenty-first century investment banks include those of the proprietors or partners of private investment banks in the nineteenth century. Among these are Morgan, Kidder Peabody, Goldman Sachs, and Kuhn Loeb.
Investment banks were rare in the pre–Civil War period. American business and government had not yet put large capital demands on the economy, so that the small, short-term loans typical of commercial banks sufficed for most enterprises. The few large borrowers called upon loan contractors, who—using personal wealth—bought up securities to resell them at a profit. Stephen Girard and John Jacob Astor acted as loan contractors in the early 1800s, but most American borrowers relied upon the experience of European firms such as London's Rothschild family and the Baring Brothers. Later, as bigger commercial banks were formed in the 1830s, some (such as the United States Bank of Philadelphia, headed by Nicholas Biddle) became involved in buying up new securities for resale to the public.
Civil War Finance
It was not until 1860 that investment banking began its rise to prominence in American financial markets. Between the Civil War and World War I, the supply of funds changed. Instead of a few very wealthy Americans, savings were more widely distributed among individuals at home and abroad. More importantly, demand for funds shifted away from relatively small, commerce-based firms and toward government, public utilities, and industry, whose capital requirements far outstripped the ability of commercial banks to meet them. These changes put investment banks at the forefront of financing the large projects that transformed the American economy in the latter part of the nineteenth century.
Unable to sell all of the federal government's Civil War–generated bond issue in 1861, Secretary of the Treasury Salmon Chase called upon Jay Cooke, who earlier that year had had some success organizing the first syndicate of banks for the purpose of underwriting a large Pennsylvania state bond issue. Cooke, relying upon a far-flung domestic network of commission salesmen, distributed the issue and in 1870 formed a syndicate to refinance the $1.5 billion federal debt. (These two innovations—the distribution network and the syndicate—have characterized much of investment banking ever since.) Other early investment banking houses were involved in distributing the federal debt, including Kuhn Loeb and Goldman Sachs.
The House of Morgan
Cooke was also involved, although less successfully, in financing the other great borrower at the time, the railroads. The scope of railroad building in the 1860s and 1870s—stretching from the Midwest to the Pacific Coast—required vast new amounts of capital. Much of it was raised in Europe, where more funds were available. It was in this arena that the Morgans, arguably the best-known banking family in the country, got their start. Junius Morgan began the dynasty as an agent of the George Peabody Company, selling American railroad securities in London before the Civil War. In 1880, his son, J. P. (Pierpont) Morgan, organized a syndicate that sold a $40 million bond issue for the Northern Pacific Railroad, the largest American railroad bond transaction up to that time.
The activities of Morgan and his son, J. P. (Jack) Morgan, reflect the development of investment banking in the twentieth century. As the railroads forged an increasingly competitive national market, some manufacturing businesses saw the key to profitability in merging into larger, consolidated enterprises; other firms concluded that the key to survival was to reorganize and re-structure. The result was a merger wave at the turn of the century, with both consolidation and reorganization (or, in modern terms, mergers and acquisitions) becoming a primary activity of investment banking. In 1892, for example, J. P. Morgan Company (along with another Yankee firm, Lee Higginson) negotiated and financed the merger of Edison General Electric and Thomson-Houston into the General Electric Company. In 1906, Goldman Sachs underwrote both the consolidation of the United Cigar Company and the expansion of Sears, Roebuck and Company. (The latter was the first instance of an investment bank underwriting the securities of a retail firm—a business that, unlike railroads or manufacturing, had few large physical assets that creditors could liquidate in the event of bankruptcy.)
At about the same time, the United States began exporting capital, particularly to countries needing to fund wars. American investment bankers underwrote the British National War Loan of 1900 (for the Boer War) and Japanese bonds used to finance the Russo-Japanese War of 1904 and 1905. Funding for the allied effort in World War I came from the $500 million Anglo-French loan of 1915, which J. P. Morgan marketed.
While the U.S. government seemed to approve of investment bankers' international role, those bankers' domestic reputation was not as favorable. As a result of their intimate knowledge of industrial structure, many investment bankers in the early 1900s became directors of the corporations whose financial needs they had serviced. This intersection of industry and finance gave rise to worries that economic power was being centralized in what was called a "money trust." After an investigation in 1912 by the Pujo Committee of the U.S. House of Representatives, numerous recommendations were made for federal laws to limit the influence, and increase the federal oversight, of large private investment banking houses such as J. P. Morgan, Kuhn Loeb, and Kidder Peabody. Although none of these recommendations were adopted, the committee's hearings were a warning to the investment banking community that it no longer could expect to function outside regulatory purview.
Nineteenth-century regulation had already limited commercial banks' ability to engage in investment banking. Underwriting was a risky venture, and many regulators believed that an institution that held the public's deposits should not be allowed to use those deposits in what were considered highly speculative activities. Consequently, the National Banking Act of 1864 strictly limited the ability of federally chartered banks to deal in securities other than some government bonds (such as the popular Liberty Bonds issued in World War I). But during the 1920s, profits available from underwriting ran as high as 20 percent as the stock market boom raised both the demand for capital and the supply of small investors' funds. Commercial bankers knew that their established base of borrowers (firms) and savers (depositors) put them in a unique position to deal in securities and regain some of their market share. Thus, banks circumvented federal regulations by establishing state-chartered affiliates that could legally engage in all types of investment banking. Several large commercial bank–investment bank combinations were formed before the Great Depression, including National City Bank–National City Company and Chase National Bank–Chase Securities Company.
By 1930, commercial banks were underwriting half of all new securities issues, but the stock market crash of 1929 (and the bank failures that followed) put the regulatory spotlight back on this activity. Although modern economic research has found no connection between commercial bank failures and the securities business of those banks, Congress passed the Banking Act of 1933 (Glass-Steagall Act) that, in effect, put a fire wall between commercial and investment banks. Commercial banks were required to sever all ties to securities affiliates, and private bankers were forced to choose between engaging in commercial banking or in investment banking. A number of banks soon sheared off their investment banking activities into wholly separate firms. Thus, at the beginning of the twenty-first century, there were investment banks with names like Morgan Stanley, the progeny of J. P. Morgan, and First Boston Corporation, an offshoot of First National Bank of Boston. (In an interesting replay of the Pujo hearings, an antitrust suit was brought in 1947 against seventeen of these investment banks. United States v. Morgan was concluded in 1953, when Judge Harold Medina ruled that these investment banks were not engaged in anticompetitive behavior.)
As part of the financial shake-up of the 1930s, regulation of investment banks increased. Probably the most powerful regulatory measure was the Securities Act of 1933, which required that investment bankers practice "due diligence" and make full disclosure before publicly marketing any security. Such oversight was lessened, however, if new issues were distributed in a "private placement" with a large investor who, it was thought, could assess the risks of a new issue itself. The number of these placements rose rapidly in the late 1930s, but it cannot be determined whether this was the result of investment bankers' attempts to circumvent disclosure laws or the natural outcome of the rise in large institutional investors such as life insurance companies and pension plans.
Modern Investment Banking
Fifty years after the New Deal, some of the financial structures built in response to the Great Depression began to be dismantled. This was, in part, the result of rapid innovation in financial markets (including the money market mutual fund) and unusual variations in inflation and interest rates. At the same time, scholars questioned the received 1930s wisdom that investment and commercial banking should never be mixed, and experts in international finance claimed that universal banking (as practiced in countries such as Germany) seemed to be an efficient and relatively safe way to mobilize capital. As a result, new laws passed in the 1980s blurred the distinctions between commercial banks and savings and loan banks and between commercial banks and investment banks.
At the turn of the twenty-first century, Glass-Steagall still technically reserves securities underwriting to the investment bankers. But commercial bankers were testing this fire wall, and some predicted that the separation of American investment and commercial banks would soon be a thing of the past, perhaps returning, full circle, to the world of late-nineteenth-century financial capitalism.
Benston, George J. The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered. New York: Oxford University Press, 1990.
Calomiris, Charles W. U.S. Bank Regulation in Historical Perspective. New York: Cambridge University Press, 2000.
Carosso, Vincent P. Investment Banking in America: A History. Cambridge, Mass.: Harvard University Press, 1970.
Chernow, Ron. The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance. New York: Atlantic Monthly Press, 1990.
Endlich, Lisa. Goldman Sachs: The Culture of Success. New York: Knopf, 1999.
Hayes, Samuel L., III, and Philip M. Hubbard. Investment Banking: A Tale of Three Cities. Boston: Harvard Business School Press, 1990.
Peach, W. Nelson. The Security Affiliates of National Banks. Baltimore: Johns Hopkins University Press, 1941.
Redlich, Fritz. The Molding of American Banking. New York: Johnson Reprint, 1968.
Sobel, Robert. The Life and Times of Dillon Read. New York: Dutton, 1991.
White, Eugene Nelson. The Regulation and Reform of the American Banking System, 1900–1929. Princeton, N.J.: Princeton University Press, 1983.
The term "private banks" is misleading in American financial history. Virtually all of the banks in the United States were privately owned—even the First and Second Banks of the United States, the nation's "national" banks, sold 80 percent of their stock to private individuals. Apart from a few state-chartered banks owned exclusively by the state governments (the Bank of the State of Alabama and the Bank of the State of Arkansas, for example), all of the financial institutions in the United States were privately held. The confusion arose in the chartering process. If states chartered the banks, they were usually referred to as "state banks," even though they were not owned by the states. Alongside these chartered banks, however, existed another set of privately owned banks called "private banks." The chief difference between the two lay not in ownership, but in the authority to issue bank notes, which was a prerogative strictly reserved for those banks receiving state charters.
Private bankers ranged from large-scale semibanks to individual lenders. The numbers of known private bankers only scratch the surface of the large number of businesses engaging in the banking trade. Some of the larger nonchartered banks even established early branches, called "agencies," across state lines. They provided an important contribution to the chartered banks by lending on personal character and by possessing information about local borrowers that would not be available to more formal businesses. Private bankers also escaped regulation imposed on traditional banks, largely because they did not deal with note issue—the issue that most greatly concerned the public about banks until, perhaps, the 1850s. "Private banking" continued well into the early twentieth century.
Helderman, Leonard C. National and State Banks. Boston: Houghton Mifflin, 1931.
Schweikart, Larry. "Private Bankers in the Antebellum South." Southern Studies 25 (Summer 1986): 125–134.
———. "U.S. Commercial Banking: A Historiographical Survey," Business History Review 65 (Autumn 1991): 606–661.
Smith, Alice E. George Smith's Money: A Scottish Investor in America. Madison: State Historical Society of Wisconsin, 1966.
Sylla, Richard. "Forgotten Men of Money: Private Bankers in Early U.S. History." Journal of Economic History 29 (March 1969): 173–188.
The broad category of savings institutions is made up of several types of legal structures, including savings banks, building and loan associations, and savings and loan associations. Two of the most distinctive features of savings institutions are their mutual ownership structures and operation as cooperative credit institutions, which exempt them from income taxes paid by commercial banks and other for-profit financial intermediaries.
Savings banks originated in Europe. The first ones in the Western Hemisphere were the Philadelphia Saving Fund Society (opened 1816, chartered 1819) and the Provident Institution for Savings in Boston (chartered 1816). The concept of savings banks originated in the philanthropic motives of the wealthy, who wished to loan funds to creditworthy poor who exhibited the discipline of thrift through their savings behavior. Although savings banks provided a safe haven for small accounts, it is doubtful that these banks made many loans to the poor.
Rapid Expansion in the Nineteenth Century
Early savings banks were immediately popular. During their first twenty years of development in the United States, savings bank deposits grew to some $11 million. The popularity of savings banks resulted in part from their reputation for safety. They avoided runs by enforcing by laws that restricted payments to depositors for up to sixty days. As a result of these provisions, no savings banks failed in the panic of 1819. Around nine hundred commercial banks failed in the panic of 1837, but only a handful of savings banks met that fate.
Most savings banks also survived the subsequent panics of the nineteenth century. In the panic of 1873, some eighteen out of more than five hundred savings banks in existence suspended operations nationwide. Losses to savings bank depositors are thought to have been relatively insignificant across most of the nineteenth century. Between 1819 and 1854 no savings banks failed in the state of New York. Between 1816 and 1874, a period that includes the panic of 1873, total losses to savings bank customers in Massachusetts totaled only $75,000 on a savings bank deposit base of $750 million. As a result of their safety, savings banks' popularity surged and by 1890, 4.3 million depositors held $1.5 billion in savings banks across the nation.
The panic of 1893, however, slowed savings bank growth. Through the latter half of the nineteenth century, the class of acceptable investments for savings banks was broadened. By 1890, savings banks were invested in a wide array of assets, including government and state securities and corporate equities and bonds. Moreover, some savings banks began establishing themselves as joint-stock rather than mutual institutions. The combination of these two developments began to blur the distinction between investments of savings banks and commercial banks. Again, in 1893 most savings banks avoided failure by enforcing by laws that restricted payments to depositors. But consumer and business confidence was low and the economic disruption long. As a result, savings bank growth fell off considerably during and after the 1893 panic, although they soon recovered.
Competition, Federal Regulation, and the Democratization of Credit
In 1903 the comptroller of the currency ruled that national banks could hold savings balances. Hence, following the panic of 1907 concern for depositor safety grew in all sectors of the financial services industry. This concern, along with substantial heterogeneity in savings institutions in general and savings bank investments and operations in particular, led to the establishment of the postal savings system in 1910 as a direct competitor to existing savings institutions.
The postal savings system provided a safe haven for commercial bank depositors during the Great Depression. However, savings bank depositors experienced far fewer losses than commercial bank depositors during this period because of their diversification and their by laws allowing the restriction of payments.
New Deal legislation contained many provisions for depositor safety, including an expansion of federal authority over savings banks and building and loan associations. Prior to the 1930s, all savings banks were chartered and regulated by the states in which they operated. The New Deal established federal authority under the Federal Home Loan Bank Board for chartering and regulating savings banks and savings and loans. The creation of the Federal Deposit Insurance Corporation (FDIC) in 1933 and the expansion of the network of savings institutions are undoubtedly related to the demise of the postal savings system in the 1950s.
Savings banks and related institutions are thought to have contributed substantially to the democratization of credit in the United States during the twentieth century. Mortgage lending by these institutions led to widespread home and property ownership. Moreover, nonmortgage savings bank lending was the basis for the development of Morris Plan lending, an early form of consumer finance. Pioneered by Morris Plan Company in 1914, small, short-term (less than one year) loans were made to individuals who repaid them in fifty weekly installments. The loans became extremely popular, and by 1917 Morris Plan loans totaled more than $14.5 million to over 115,000 borrowers.
Although savings banks and savings and loans (and their predecessors, building and loan associations) were cooperative credit institutions, historically the institutions differed in some important ways. Savings and loans (and building and loan associations) concentrated primarily on residential mortgages, while savings banks operated as more diversified institutions. In the twenty years following World War II mortgages were favorable investments, so the difference between savings bank and savings and loan operations was insignificant. However, during late 1966 and 1967 savings banks were able to invest in corporate securities in the absence of mortgage loan demand, while savings and loans were not.
Decline and Resurgence
Many savings banks converted from mutual to joint-stock ownership during the 1980s. Facing new profit pressures from shareholders, the newly converted savings banks adopted portfolios similar to those of savings and loans. When sharply increased interest rates and the fundamental maturity mismatch between short-term deposits and long-term mortgages led to protracted difficulties in the savings and loan industry, many of these newly converted savings banks failed. Although lax supervision led to the replacement of the regulator of both savings and loans and savings banks (the Federal Home Loan Bank Board) with a completely new regulator (the Office of Thrift Supervision), savings bank deposits were insured by the FDIC and thus were not affected by the failure of the Federal Savings and Loan Insurance Corporation.
Although the popularity of savings institutions (including savings banks) waned in comparison with commercial banks following the crisis of the 1980s, savings institutions experienced a resurgence during the 1990s because of competitive loan and deposit rates, their mutual ownership structure and resulting tax advantages, and the broad array of financial services they may offer under contemporary banking law.
Alter, George, Claudia Goldin, and Elyce Rotella. "The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth Century." Journal of Economic History 54 (1994): 753–767.
Davis, Lance Edwin, and Peter Lester Payne. "From Benevolence to Business: The Story of Two Savings Banks." Business History Review 32 (1958): 386–406.
Olmstead, Alan L. "Investment Constraints and New York City Mutual Savings Bank Financing of Antebellum Development." Journal of Economic History 32 (1972): 811–840.
Sherman, Franklin J. Modern Story of Mutual Savings Banks: A Narrative of Their Growth and Development from the Inception to the Present Day. New York: J. J. Little and Ives, 1934.
Welfling, Weldon. Mutual Savings Banks: The Evolution of a Financial Intermediary. Cleveland, Ohio: Press of Case Western Reserve University, 1968.
White, Lawrence J. The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. New York: Oxford University Press, 1991.
State investment in banks was common before the panic of 1837. The idea behind it was that bank profits would lead to the abolition of taxes. This idea had its roots in the early eighteenth century, when colonies used the interest earned from loans made through loan offices and land banks as revenue to pay the expenses (chiefly administrative salaries) of the provincial governments. For example, between about 1724 and 1754, such income paid most of the cost of New Jersey's government.
In the nineteenth century the state was sometimes the sole owner of a bank, as in South Carolina, but more commonly it was a partial owner, as in Indiana. In some cases the ventures were profitable; in others they were disastrous. In Illinois, where the state owned $3.6 million in stock, the bank's failure forced the state to divorce its interests in 1843. In Mississippi, Arkansas, and Florida, where the investment was nearly $12 million, the result was repudiation of a debt that was never paid. In Louisiana, where the bonds issued to aid banks amounted to $19 million, there was a collapse followed by reform under the Specie Reserve System of 1842.
Among the successful state-owned banks, the State Bank of Missouri was the most important. It continued operation through the panics of 1837 and 1857, and in 1862, when it entered the national system as a private bank, the state sold its stock for a premium. The State Bank of Indiana survived the panics and emerged in 1857, when its charter expired, with a net profit to the state of more than $2 million. The Bank of the State of South Carolina also withstood the panics and continued through the Civil War as one of the strongest financial institutions in the nation.
In the aftermath of the public distrust of banks after the panic of 1819, the political struggle with Andrew Jackson over renewing the charter of the second Bank of the United States, and especially after the panic of 1837, states were presented with three banking options. Some chose to forbid banking altogether—seven of thirty-one states exercised this option in 1852. Others, such as Indiana, Missouri, and Ohio, made banking a state monopoly, or at least set up a state-owned bank. Some indecisive states tried one solution, then another; Iowa, for example, went from prohibition to state banking. The majority—including New York, Michigan, and Louisiana—elected to regulate banking more closely.
With the passage of the July 1865 amendment to the National Banking Act, which imposed a 10 percent tax on state bank notes after 1 July 1866 to force all state banks to join the national banking system, state-owned banks disappeared. State-chartered banks found a way around the law by encouraging borrowers to use check currency.
Hammond, Bray. Banks and Politics in America, from the Revolution to the Civil War. Princeton, N.J.: Princeton University Press, 1957.
Helderman, Leonard C. National and State Banks: A Study of Their Origins. Boston: Houghton Mifflin, 1931.
Sylla, Richard, John B. Legler, and John Joseph Wallis. "Banks and State Public Finance in the New Republic: The United States, 1790–1860." Journal of Economic History (June 1987): 391–403.
Donald L.Kemmerer/a. r.; c. w.
Ethics in Government Act (1978)
Ethics in Government Act (1978)
Robert G. Vaughn
The Ethics in Government Act of 1978 (P.L. 95-521, 92 Stat. 1824) addressed the constitutional crisis surrounding the Watergate break-in and the resignation of President Richard M. Nixon. These events prompted calls for ethics and openness in government. In response, the act established certain rules of conduct for former federal employees. These rules were designed to reduce corruption and prevent the improper use of knowledge gained while in the government's employ. The two most significant provisions of the law (1) require public officials and higher-ranking civil servants to make public financial disclosures and (2) prohibit certain activities by federal employees after their government employment ends. In addition, the act imposed limits on gifts and honoraria (payments at a set price for speeches or other services) and created new administrative procedures for enforcing ethics provisions.
At the time of enactment, several states already had public financial disclosure laws, and the act drew in part on these laws. In the name of ethics and openness, it also sought to correct the existing disclosure system for federal officials, which relied only on internal reporting within each agency. In 1974 the General Accounting Office, an investigative arm of Congress, had cast doubt on the effectiveness of that disclosure system, and Congress was responding to these criticisms.
Who Must Report? Within the executive branch, the act requires reporting by the president and vice president, all employees whose positions are classified at GS-16 (a classification for a federal civil service pay rate) or above, higher-ranking military officers, and administrative law judges. The reporting requirement also applies to members of Congress, federal judges, certain employees of the judiciary, and certain officers and employees of Congress.
What Must They Report? People covered by the act must report income derived from various sources, gifts, assets and liabilities, including some transactions, and certain positions held in businesses and in nonprofit organizations. Gifts of food, lodging, transportation, and entertainment are to be reported if gifts from any individual in a calendar year total $250 or more. Other gifts must be reported if gifts from any individual in a calendar year total $100 or more.
Income derived from dividends, interest, rent, and capital gains exceeding $100 must be reported but only in nine broad categories of value, from not more that $1,000 to greater than $5 million. As to other forms of income, the employee must report the source, type, amount, and value of income exceeding $200.
Assets and liabilities are reported within broad categories of value and include both real and personal property. The act does not require the reporting of the value of a personal residence not used for the production of income, provides a $1,000 exception, and excludes savings accounts and certificates of deposit totaling $5,000 or less. The employee must report all transactions, including a description, date, and value involving the purchase, sale, or exchange of real property, stocks, bonds, or commodity futures. Excluded is any transaction between the employee and the employee's spouse or children as well as the transfer, purchase, or sale of a personal residence.
An employee covered by the act must report the names of anyone who paid the employee compensation in excess of $5,000 in any of the two calendar years before a report is first filed. The employee must also include a brief description of the services performed. An employee must also disclose all positions held as an officer, trustee, director, partner, employee, representative, proprietor, or consultant of any corporation, firm, or business, including nonprofit organizations.
Protection of Privacy. The act seeks to ensure that reporting requirements will not compromise personal privacy or create opportunities for abuse of the financial information. Although the interests of spouses must be reported, the act creates several exemptions that reduce the effect of the reporting requirements on spouses. In addition, an agency must evaluate an employee's report before disclosure and indicate if no conflicts of interest were found. The custodian of the reports must destroy them after six years, and penalties are imposed for use of the reports for unlawful purposes or for commercial purposes, such as solicitation.
Before passage of the act, the federal criminal code placed limitations on the postemployment activities of federal employees. One such restriction barred appearances by former employees of an agency in certain proceedings conducted by that agency. The act added prohibitions on communications by former employees with their agencies.
Communications. Today, these restrictions create a lifetime bar against communications, including submission of memoranda, letters, and telephone calls, to an employee of the United States "in connection with a particular matter involving a specific party or parties, in which [the former employee] participated personally and substantially as an employee." The matter must be one in which the United States is "a party or has a direct and substantial interest." This prohibition seeks to prevent a former employee from "switching sides" by representing a party in a matter in which the former employee had previously worked as a government employee. For example, an employee representing the U.S. government in a particular matter should not be allowed to leave government service and soon after begin to represent in the same matter a private party whose interests may be antagonistic to those of the government. The appearance of impropriety is simply too great. It applies to appearances before the agency and communications with it but not to "behind the scenes" assistance given to others representing a party in the same matter. An employee might also be able to avoid this prohibition by disqualifying herself from the particular matter while still a government employee. A disqualification would have to remove the employee from all involvement in the matter.
A two-year prohibition applies in similar circumstances to communications by former employees regarding matters that they know or should know were actually pending under their official responsibility within a one-year period prior to leaving government employment. This prohibition addresses the improper use after leaving a job of knowledge that was gained while on the job. Employees have official responsibility for many matters in which they do not participate personally or substantially. Because the prohibition covers more matters with which employees have a more limited connection, it is of shorter duration. Because the prohibition applies to every particular matter that an employee oversees or reviews as part of their official responsibilities, an employee can not disqualify themselves without significantly impairing their performance as a government employee. Therefore disqualification will not remove the matter from those official responsibilities and will not affect the application of the prohibition. Like the other restrictions on communication, this prohibition seeks to prevent a former employee from "switching sides" by representing a party in a matter for which the former employee had official responsibility as a government employee, and does not apply to "behind the scenes" assistance given to others representing a party in the matter.
Modifications. The act originally prohibited a broader range of communications, including the prohibition of some "behind the scenes" communications, but concerns about the breadth of the prohibitions led to modifications. As a result, these restrictions now apply only to actions in which former employees communicate with an agency on behalf of a third party. The prohibition seeks to prevent an appearance that government decisions have been unduly influenced by former employees.
Senior Personnel. A prohibition on the postemployment activities of senior and very senior government personnel extends to other activities involving representing a third party. Senior employees, paid at the highest executive levels, may not, on behalf of any person, attempt to influence, through communication to or appearance before, the employee's former agency. This prohibition does not require that the matter on which official action is sought is one in which the former senior employee participated personally or substantially or was within the former employee's official responsibilities. It prohibits any representation of another person regarding any matter, including rule making or policy matters pending before the former senior employee's agency. The matter need not have been pending before the agency while the senior employee worked for the federal government. The Office of Government Ethics may waive these restrictions in certain limited circumstances, and some exceptions apply.
A similar prohibition regarding cabinet-level officials and a few employees paid at the level of deputy secretaries of cabinet departments extends beyond the agency for which the former employee worked and includes representation before the highest-ranking government officials in other agencies. The Office of Government Ethics may not waive this prohibition, although some limited exceptions apply.
Honoraria. Under the act, federal employees may not receive honoraria for speeches and writings directly related to official duties or paid because of the status of the recipient as a government employee. The act also restricts certain types of outside employment by government employees.
The Office of Government Ethics, established by the act, has responsibility for interpreting the act's provisions. The Office is treated as a separate agency within the executive branch. It has issued both regulations and advisory opinions that further define the prohibitions contained in the statute, and it has played an important role in clarifying them. The director of the Office of Government Ethics may seek to discipline an employee, and individual government agencies may take administrative action in some situations. The act permits civil as well as criminal enforcement of its prohibitions. The attorney general may seek civil penalties and injunctions against violation of these restrictions.
As part of a system of regulations including presidential executive orders, the Ethics in Government Act remains an important part of the legal regulation of public service ethics in the federal government. In Congress and the courts as well, it is a component of other ethical provisions imposed by rule and by statute.
Roberts, Robert. "Regulatory Bias and Conflict of Interest Regulation." In Handbook of Regulation and Administrative Law. Ed. David H. Rosenbloom and Richard D. Schwartz. New York: Marcel Dekker, 1994.
Vaughn, Robert G. Conflict of Interest Regulation in the Federal Executive Branch. Lexington, MA: Lexington Books, 1979.
Effects of Nixon's Resignation
In the aftermath of the Watergate scandal, in which President Richard Nixon resigned rather than face impeachment for crimes committed by his administration, numerous reforms were instituted to protect the public interest from official malfeasance. These included campaign finance regulations, conflict-of-interest guidelines, safeguards on the freedom of information, and improved privacy laws. Candidates for public office came under increased scrutiny for both their public and private lives, and public interest groups such as Common Cause greatly increased their membership rolls. While Watergate was neither the first nor the last presidential scandal of shocking proportions, it did mark a milestone in the growth of public cynicism about elected officials.