State Banks, Capitalism, Politics

State Banking in Early America: A New Economic History

Howard Bodenhorn, 2003

A second book by Bodenhorn! I must really like this guy. 

I do, actually, although I have some issues with economic history which limited this book's usefulness to me. A big part of the motivation for this book seemed to have been Bodenhorn’s desire to refute the “historical justification” provided by the two classic histories of banking (Redlich’s The Molding of American Banking Hammond’s Banks and Politics from the Revolution to the Civil War), for central banking in general and for the broadening of the Federal Reserve’s powers after the Great Depression in particular. The other claim Bodenhorn made was that no one has really done an economic history of American banking, applying and testing state of the art economic theories against historical evidence. Both reasons highlighted interesting issues: why do we write history, and how best can we communicate historical insights to the public?

Bodenhorn’s approach and goals were a bit different from mine. I typically want to communicate with a broad audience and talk about the past in ways that interest them and are relevant to their lives in the present. He wanted to influence a wider range of scholars than economic history monographs normally reach, but I think it’s safe to say his focus was still very much on an academic readership. That is not to say economic historians have no thought of influencing the present. Bodenhorn regularly cited Ben Bernanke’s published work, which might illustrate the way most economic historians seek to influence the present: from the top, down. That’s completely legitimate -- it just doesn’t happen to be the way I want to do history. But that’s political, not purely academic. My academic objection had to do with the relevance and legitimacy of applying contemporary economic models to historical data.

I’m old. I did SPSS on punch-cards and fed them into a CDC Cyber 60 mainframe at UMass in the 80s. I think I appreciate the ways regression and simple econometric techniques can be used to answer historical questions.  But I’m also aware of the assumptions piled on assumptions that make up any complicated economic theory.  This is something economists are comfortable with (any econ grad student knows  dozens of jokes about economists and assumptions) and outsiders are more-or-less unaware of -- and I think it’s one of the factors that compromises the usefulness of economic models as explanations in history. The other is, what does an economic model actually model? Once it gets out of the hands of the economists, is it descriptive or normative? Does it point to the individual decisions of people, and if so, does it assume they’re “rational allocators” or does it allow for complexity and irrationality? Or does it point vaguely toward some generalized “historical force” that we’d say was old-fashioned teleology, if it didn’t come with the shiny new authorization of economic theory?

Maybe my bottom line objection, though, is that economic narratives just don’t excite me that much. I can’t see the people in them. So a lot of State Banking in Early America wasn’t particularly useful to me. But some of it was interesting and some of it ended up being useful to set up the economic-historiographical baseline that my narrative of upstate New York departed from in Peppermint Kings.

Bodenhorn’s basic contention was that states with “more banking facilities in 1830 experienced greater rates of growth up to 1860” and that more liberal banking regulations facilitated the growth of banks in these places (New York being the most notable one). One of the key economic roles of banks, that they had a particular advantage in, was “in gathering and processing information on the likelihood of success for at least some entrepreneurial projects.” This focus expanded slightly on his earlier discussion of banks as funnels for accumulated wealth, but he did not abandon that role either. Bodenhorn expanded on the strict definition of free banking, to make it an example of “decentralized federalism,” reflecting “the workings of early American Madisonian polity, in which state governments ceded as little power to the federal government as seemed possible” He accepted Naomi Lamoreaux’s description of New England banks as the “financial arms” of “extended kinship networks of artisans, traders, and manufacturers,” as well as her claim that “younger men who promoted banks in the 1830s” did so partly because they had been left out of the game by their elders, but quickly caught up to them in wealth and power. Even with the proliferation of free banks, however, “most banks fell into the hands of a few shareholders” because “stock ownership was beyond the means of most early nineteenth-century Americans”.

Lamoreaux and Glaisek had argued that “banks became ‘vehicles of mobility,‘ [through which] young entrepreneurs, strapped for cash, could establish a bank based on stock notes and provide credit primarily to themselves.” The period they were talking about was earlier and the demographics more urban-mercantile, but I wonder if this type of sentiment was still felt or remembered in the 1840s-50s, when my subjects started making regular trips to New York City? These are the types of questions this type of book was silent on -- but at least it opened the door and pointed me in a direction I could explore. That was really helpful.

Bodenhorn’s discussion of whether early banks followed a strict real-bills doctrine was interesting, because although he was more interested in what the bankers did, their actions shed light on what they may have thought. While I’m not all that interested in whether bankers conformed to a Schumperterian model, I am interested in what they thought they ought to be doing. Bodenhorn described providing working capital to “bridge the gap between seedtime and harvest, between the purchase of raw materials and the sale of the finished product” as “passive.” This approach, he said, limited the role of banks to providing “just enough credit to meet the ‘needs of trade’ and no more.” So it was not the growth-enabling transfer of capital he was looking for. But it’s interesting to me -- and I think it becomes even more interesting if the bankers are actually the people involved in getting in the harvest or creating the product. Thinking of bankers as actors themselves rather than as completely detached third parties seems more realistic to me (especially in smaller rural markets), and much more interesting.

Another really helpful thing this book did was describe in detail some of the mechanics of early banking, giving me a bit of a crash-course in terminology and functions. “Banknotes”, Bodenhorn said, were “noninterest-bearing promissory notes payable on demand at par at the issuing bank or authorized agency”. They differed from bills of exchange in that bills were usually redeemed somewhere else, and then the redeeming bank (or merchant) returned them to the issuing bank for payment.  “Nineteenth-century banks,” Bodenhorn said, “extended credit not so much by loans as by discounts. If a merchant presented a banker with a $100 note payable in 30 days, he received $99.50 in funds if the note carried a 6 percent interest charge. In 30 days, he repaid $100.” This is interesting, because the bankers weren’t extending general-purpose credit; they were underwriting specific transactions. It gets even more interesting, I found in my own research, if the merchant doesn’t repay the $100 after 30 days!

Notes were further divided into “single-name paper,” which carried just the drawer’s name, and “double-name paper,” which carried the names of, for example, the merchant and his supplier. Bills of exchange were “double-name” and the even safer ones were “documentary bills” which carried an attached bill of lading. Both the named parties were liable for repaying the amount, which made these notes safer. Dishonored notes or “clean bills” (those with no attached collateral) would be taken to a local judge or notary, who “recorded it as ‘protested’ for nonpayment and then notified all endorsers...that they stood potentially liable.” This also meant that protests could damage a merchant’s relationship with his trade partners as well as his creditors (assuming they weren’t the same people).

“The sheer complexity of these transactions,” Bodenhorn said, “and the apparent ease with which they were carried out, demonstrates that early American financial markets were more sophisticated than often believed.” This is the exciting part! Especially because these sophisticated, complex transactions connected mercantile centers like New York and Boston with “peripheral” farmers and millers as far away as the western frontier, and it wasn’t a one-way affair. The sophistication was present (and needed) on both sides!

Describing New York’s Safety Fund, Bodenhorn noted that around 1830, “New York’s per capita income was only about 84 percent of the national average” and about two thirds of New Yorkers worked on farms. Two of the events central to the early part of my story in Peppermint Kings, the failure of the Wayne County Bank (which had “a reputation of being managed in such a way as to produce large profits for its shareholders”) and of the Bank of Lyons were central events in the demise of the Safety Fund. The Bank of Lyons expired with about $81,000 in circulation in 1842 and the Safety Fund paid a balance of $89,000 (see also Bodenhorn’s 1996 article, “Zombie Banks...”). Free Banking, which had been enacted in New York in 1838 and gradually replaced the Safety Fund, required deposits of bonds or mortgages equalling the amount of circulating notes printed for the bank by the comptroller in Albany. The original 1838 Act also required a specie reserve, but this was later repealed. This meant that someone who could scrape together (or borrow from his rich uncle, as Hiram Hotchkiss did) $100,000 worth of government bonds or mortgages could become a banker (the minimum was soon reduced to $50,000). The uncle would still collect the interest on the securities, so his only expense was the risk his nephew would fail or defraud him. In this sense, starting a bank could represent a very large loan that could be monetized without actually being “spent.” Bodenhorn said this money supply was inelastic and resulted in “a general underissue of notes” relative to chartered bank issues, but I disagree. Chartered banks were limited by the requirement that they hold specie reserves, so they were by definition “money center” banks in mercantile cities (because that was where the gold was). And, possibly more importantly, velocity is money supply. If my notes are circulating through the economy twice as fast as yours, that’s the same as me having twice as many of them.

Free banking, Bodenhorn said, was “an unanticipated outcome of the bank war”. He noted, however, that the Equal Rights Party (aka the Loco-Focos) “opposed the privilege and corruption associated with corporate banking and championed the elimination of all banks.” When the Whigs took over in New York, they called their banks “associations” and issued “circulating notes”. Was this a distinction without a difference, or did it point to a subtle shift in ideas about what banking was for in New York state? The big innovation of free banking, Bodenhorn concluded, was “free incorporation” (his emphasis). “New York’s free banking law made incorporation a routine administrative function rather than a legislative function.” This was definitely a big, ominous change in the American economy, and it’s interesting that free banking contributed to it. But I still think there’s something potentially more interesting, lurking behind this story, which may have something to do with the New York Whigs. This pretty much ended, of course, when the Whigs became Republicans and eliminated State Banking.