What is a private banker? Or rather, since the species
has more or less disappeared, what was a private banker? Private
bankers, to American banking historians, were individuals and
organizations that engaged in the business of banking without first
obtaining a permit to do so from governmental authorities. As a
consequence, the private banker often was free to practice the banking
trade with little or no governmental regulation. That was one of the
private banker's principal advantages. But it also became a leading
reason for the private banker's undoing and eventual disappearance from
the economic scene.
Today, when nearly every U.S. (and foreign) bank
operates under a license from, and is regulated by, one or more
governments, the idea that the provision of banking services could be
left to market forces might strike many people as somewhat bizarre and
perhaps even dangerous. Nonetheless, this idea was central to the
development of the banks and banking systems of England and continental
Europe during much of the seventeenth, eighteenth, and nineteenth
centuries. The celebrated Rothschilds, for example, were private
bankers, and so were all the banks of England - except the Bank of
England - until the second quarter of the nineteenth century.
Prominent U.S. Private Bankers
Given the new world's roots in the old, it is not
surprising that the idea and the practice of unlicensed, unregulated
banking would migrate to the United States. Indeed, a number of the
leading figures and financial institutions in U.S. history were private
bankers and banks. Alexander Hamilton was instrumental in founding the
Bank of New York as a private bank in 1784, although less than a decade
later the bank applied for and received a charter from the state of New
York. This venerable American institution still carries on its business
from its headquarters at 48 Wall Street. Across the street, at 59 Wall
Street, is Brown Brothers Harriman & Co., the only remaining private
bank of any size in the United States; it is the exception that probes
the rule that banks ought to be licensed corporations. This bank began
its career in Philadelphia in 1818 as the Merchant Bank of Brown
Brothers, with representative branches in Baltimore and London. It moved
its headquarters to New York in 1825.
At 60 Wall Street, next to the Bank of New York, are
the headquarters of J. P. Morgan & Company. The Morgan bank is now a
corporation, but it was a private bank during the time of its legendary
founder, John Pierpont Morgan (1837-1913), and it remained so long after
his passing. Another noted private bank was the Bank of Stephen Girard
in Philadelphia. Girard, possibly the wealthiest American of his era,
operated this bank from 1812 until his death in 1831. Girard's bank took
over the building of the first federal Bank of the United States after
that institution passed out of existence in 1812. The structure still
stands as a prominent feature of Independence National Historical Park
in Philadelphia.
Extent of Private Banking
Most of America's private bankers were not as large or
as prominent as the ones identified here. But they were quite numerous
in U.S. history, especially in the early decades. In 1856, U.S. Treasury
Secretary James Guthrie reported to Congress on a survey of the extent
of private banking as compared with that of licensed, that is,
"chartered" state banks. Guthrie found the capital of private bankers to
be at least $118 million, which was more than a third of the capital of
the state--chartered banks. He went on to note, "The combined capital in
chartered and un-chartered banks being over $460,000,000, proves that
banking is a favorite as well as a profitable business, and does not
need chartered privileges to generate or protect it."1 My own
work on U.S. banking history in antebellum times led to an estimate of
more than 700 private bankers operating in the country by the
mid-1850s.2 If the estimate is close to accurate, about one
American bank in three was a private bank at the time.
Even then, however, private banking had entered a
protracted period of relative decline that would in time lead to its
virtual disappearance. Secretary Guthrie's statement to Congress that
banking did not require "chartered privileges to generate or protect it"
probably indicated that even by 1856 most people thought otherwise. Why?
Private Banking and the Public Interest
There are, it seems, two possible sets of answers to
the question of why banks ought to be licensed and regulated by
governmental authorities. One involves public interest arguments. If
banks are not licensed by government, then there is a greater
probability that scoundrels and crooks will enter the banking business.
And without continuing governmental oversight by government-appointed
bank examiners, such bankers would mismanage or even abscond with the
funds entrusted to them by the public. Since each bank is a component of
the banking and monetary system, a few such "bad" bankers could
undermine, even destroy, the whole system, which is built on confidence.
These are microeconomic considerations. But they have
obvious macroeconomic implications. A "crisis of confidence" in banking
could cause a monetary collapse and plunge the economy into depression.
At the other extreme, unregulated banks might flood the economy with
money in the form of bank notes and deposits created by making excessive
loans. Unsustainable inflation would result before the arrival of the
inevitable collapse. To prevent either extreme of too little or too much
money from happening, the argument goes, governments must regulate banks
to provide just the right amount of money for sustainable,
non-inflationary economic growth.
There are problems with these public-interest
arguments. It is not evident, for example, why customers would deal
with, or allow themselves to be victimized by, scoundrels and crooks in
banking more than in other businesses that are unlicensed and
unregulated. Moreover, it is amply evident from history, even quite
recent history, that governmental licensing and regulation have
prevented neither individual bank frauds and failures nor depressions
and inflations. But here I shall only mention these still vigorously
debated issues without further exploring them. The so-called
public-interest arguments in fact had little to do with the decline of
private banking.
The Political Economy of Banking
The decline of private banking had far more to do with
the self-interest of both government officials and the non-private banks
they licensed and regulated than with the public interest. The United
States of the 1780s and 1790s was both capital poor compared to the West
European countries and free of the English laws that required banks to
be entities with unlimited liability and no more than six partners. In
these circumstances, most early U.S. banks were institutions chartered
by state legislatures as limited liability corporations. Attracted by
limited liability, their owner--shareholders clubbed together their
limited liquid funds to start the banks, through which they then made
loans to each other and to non-owner customers. In return for their
charters representing governmental authorization to provide banking
services, the banks agreed to make loans to, and perform other services
for, the states that granted them their charters. The states especially
liked this arrangement after the adoption of the U.S. Constitution, for
that document prohibited them from continuing the century-old practices
of colonial, and then state, governments of issuing fiat paper money.
Because of the Constitution, the states could no longer pay their bills
by printing state paper money, but they could still charter banks that
issued money.
The earliest state-chartered banks were thought of by
legislators, shareholders, bankers, and the general public as public
utilities. They were given exclusive privileges, namely monopolies of
banking in their towns, in return for providing financial services to
the state and the public. As the American economy grew and prospered,
these state-chartered banking monopolies became highly profitable.
Inevitably, new banks sought to enter the field to get their piece of
the action, whereas those already in the field sought to keep out the
would-be entrants. Resolution of these conflicting politico-economic
pressures took several decades. The ultimate result in the leading
commercial and industrial states was an American version of "free
banking," which meant relatively free entry into banking provided the
bank agreed to follow rules and regulations prescribed by state
governments.
State legislatures and individual legislators thrived
on the early American procedure of chartering banks individually by
specific legislative acts. The grant of a bank charter gave the grantees
a lucrative set of privileges not possessed by others. Bank charters
therefore had economic value. The states and the legislators were not
oblivious to this fact. They responded to it by charging the banks for
their charters. These charges sometimes took the form of bonus payments
to the states when charters were granted or renewed. They also took the
form of bank stock issued to state governments on favorable terms so
that the states could share in bank profits. Other types of charges
included special taxes placed on banks and of state directives to the
banks to finance out of bank resources certain institutions (such as
schools) that the states deemed worthwhile.3 These were
above-the-board payments the states could demand of the banks in return
for grants of charter privileges. They were popular because they kept
down taxes on individuals. In addition, there were under-the-table
payments to individual legislators for seeing that some banks received
charters and that others did not. In state capitals, because of all
these payments for privileges, bank chartering and state politics more
or less became extensions of each other.
Enter the Private Banker
On account of all the political considerations involved
in bank chartering, the number of chartered banks grew more slowly than
it might have, given public demands for banking services. And for good
reason. Charter values, and hence the payments that states and
individual politicians could extract from banks, were greatly enhanced
by restricting entry into banking. Restrictive chartering practices
created a yawning gap for the private bankers. A demand for banking
services was there, and growing. The chartered banks, the states'
creatures, were not meeting the demand for politico-economic reasons
that had little to do with economic efficiency. And nothing, at least
for a brief time, prevented individuals and partnerships from plying the
trade of banking without a license, just as private bankers long had
done in England and Europe.
We do not know how many private bank-ers entered the
field. Their numbers must have been large, however, at least large
enough to annoy both the chartered banks and the state legislatures. The
former had paid for their charters; the latter had received the
payments. Unauthorized competition in banking threatened to undermine
this neat political arrangement.
Hence, between 1799 and 1818, no fewer than eleven
states and the District of Columbia enacted laws to restrict private
banking. The larger states, where private banking likely was most
vigorous, acted on more than one occasion. New York passed four acts to
restrain private banking between 1804 and 1818, Pennsylvania three, and
Virginia two.4 The typical restraining act either banned
private bankers from issuing their own bank notes, which was the primary
method of providing bank credit at the time, or it laid a prohibitive
tax on such note issues.
Such legislation served two politico-economic purposes.
It reduced or eliminated competition for existing chartered banks,
thereby raising the value of bank charters and the payments the states
could extract for granting them. And it drove many private banks into
applying for charters, so that they, too, would have to pay the tolls
levied for governmental authorization to engage in banking.
Nonetheless, private banking persisted in the United
States for decades, Privacy and minimal regulation were among its
advantages, but the main reason for its persistence was that the states,
and later the federal government, dragged their heels in chartering
enough banks to satisfy the demand for banking services. American state
governments and public officials were not inept in their slowness to
charter banks. Both they and the banks already in the field had a
financial interest in restricting banking development. That this
interest was different from, and even inimical to, the real public
interest was a small consolation to the private bankers. They were
harassed by restraining acts and eventually driven out of banking or
into "authorized" banking on terms set by government.
An Implication for Our Time
Although the private banker, with few exceptions,
passed long ago from the economic scene, the history of U.S. private
banking sheds light on quite recent events. In September 1994, the 103rd
Congress enacted legislation to allow interstate banking. Thus, early in
the third century of the republic, American banks at last obtained the
freedom to do what flour millers, meat packers, and clothing
manufacturers could always do, namely market their products throughout
the country.
Why did it take so long? The fundamental reason, I
think, is that in U.S. political economy banking is the last bastion of
states' rights. Banking is the one area of regulated economic life in
which the federal government almost always has deferred to the
preferences of the states.
Federal deference to states' rights is unusual in
American history. The Constitution transferred substantial but limited
economic powers from the states to the federal government. During the
first century of the republic, Congress and the federal courts used
those powers to prevent the states from interfering with the emergence
of a nationwide free trade area. And during the second century of the
republic, right up to the present, the federal government further
weakened states' rights through federal laws, regulations, programs, and
mandates that, for good or ill, increased the political and financial
clout of the government in Washington relative to the governments of the
states.
Given this record, how did the states manage until 1994
to resist the federal juggenaut and maintain their power to regulate
their own chartered banks as well as federally chartered banks operating
within their boundaries, and to keep out banks chartered by other
states? No doubt many reasons could be given. But underlying all of them
must be this: Banking became the last bastion of states' rights because
it was the first bastion of states' rights to matter in
government-regulated economic life.
Early in U.S. history, the financial inter-ests of
state governments and politicians became substantially wedded to the
inter-ests of the banks they had chartered. Because banking was the
first great corporate interest to be regulated in our history, state
governments and banks together were able to resist encroachments into
their terrain by outsiders in ways that later corporate interests, less
regulated and less intimately tied to state financial interests, were
not. Private bankers as a class were only one of the trespassers on the
intertwined interests of the state-chartered banks and the state
gov-ernments that chartered them. The first and second Banks of the
United States established by the federal government were like- wise
trespassers. Like the private bankers, the two federal banks were beaten
down and, in 1812 and 1836, eliminated by powerful coalitions of state
banks and state govern-ments. In most areas the federal government
discovered ways to override parochial state interests, but in banking it
was itself overrid-den. Hence, the federal government learned the hard
way to accommodate itself to state interests in banking, for a longer
time than made much sense. The fragmented U.S. banking system, which
continues to look peculiar when compared with the banking systems of
other countries, is a result of the defeats suffered by both private
bankers and the federal government in the early decades of the
republic's history.
At the time of the original publication, Dr. Sylla was
Henry Kaufman Professor of the History of Financial Institutions and
Markets and Professor of Economics at the Stern School of Business,
New York University, and a Research Associate of the National Bureau
of Economic Research.
1. U.S. Secretary of the Treasury, "Report on Banks,"
(1856), 34th Congress, Ist Session, House Executive Document No. 102, p.
1.
2. Richard Sylla, "Forgotten Men of Money: Private
Bankers in Early U.S. History," Journal of Economic History 36, March
1976, pp. 173-88.
3. Richard Sylla, 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 48, June 1987, pp.
391-403, and John Joseph Wallis, Richard E. Sylla, and John B. Legler,
"The Interaction of Taxation and Regulation in Nineteenth Century U.S.
Banking," in Claudia Goldin and Gary D. Libecap, eds., The Regulated
Economy: A Historical Approach to Political Economy (Chicago: University
of Chicago Press, 1994), pp. 121-44.
4. Sylla, "Forgotten Men of Money," p. 182.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
April 1995, Vol. 34, No. 4.
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