[Richard Painter, guest-blogging, March 26, 2009 at 2:48pm] Trackbacks
The First Bank of the United States:

Thanks to MarkField for pointing out my error — the Bank's charter did not expire in 1808, although I believe 1811 not 1812 is the correct year and I have inserted 1811 in my earlier post.

In my post, I was careful to refer to "the" allegations of corruption, which were accusations of insider trading and conflict of interest by speculators and Members of Congress dealing in federal and state government bonds. It is true that the First Bank — unlike the Second — was otherwise operated in a relatively clean manner. This did not matter. Jeffersonians hated the bank and hated Hamilton and everything he stood for, and the scandal from speculation in government bonds had tarnished the Bank along with the rest of Hamilton's economic agenda. Sound economics perhaps the Federalists had, but without ethics at the outset, sound economic policy may go nowhere.

The Second Bank was set up after the War of 1812 when the government realized that without a Bank it could have difficulty raising money, particularly compared with England. This Bank was indeed "ethically challenged" for much of its existence (including Bank President Nicholas Biddle's payoffs for Senator Daniel Webster). President Jackson was able to use these and other allegations against the Bank to shut it down as well.

The United States did not get another government bank until the Federal Reserve was established in 1913. When a Wall Street bailout was required in 1907, J.P. Morgan & Co. had to work with the Treasury Department to get the job done. The Bank of England had been around since 1694, a 220 year head start on the United States. Business ethics and government ethics I believe were part of our national bank story or lack of one for so long.

England of course had its own experience with the combination of bad business ethics and bad government ethics, the South Sea Bubble of 1720. Many Members of Parliament were trading in the stock — and enacting bills to promote the Company — before it crashed. The King's mistress was stock jobbing as well, although I am not sure that similar access to inside information was given to the Queen.

The result was the Bubble Act, which restricted use of limited liability for transferable shares for over a century (the Act's actual impact on England's economy is a matter of debate as it was relatively easy for London solicitors to figure out a way around the Act). Once again, the reaction to ethics scandals in government and business, particularly when the two are combined, can be bad economic policy or bad regulation. Legislators, rushing to cover their posteriors, may take rash action.

More on all of this is in my Chicago legal history lecture, available on SSRN.

More recently, we had Enron and Worldcom in 2001 and 2002, and more recently the Wall Street meltdown. The rest of the story speaks for itself.

Richard Painter

James Gibson (mail):
The information I have goes with the 1811 expiration for the first bank of the United States. The building that the bank was housed in is still in existence in Philadelphia. Created and run until 1795 by Hamilton, its problems were due mostly to the actual inexperience of Hamilton as treasury secretary. Most people don't realize that it was Hamilton in ability to understand what the economy was like outside of the major American cities that prompted the Whiskey rebellion in the early 1790s. Later Congresses learned from this and the need to allow rural Americans to pay their government fees in something other then coin money (as documented by the Claiborne letters were a shipment of rifles to be sold to the men of Mississippi were paid for by the men in Bales of cotton). In this regard Obama's comparison of Geithner to Hamilton just makes me cringe.

As for the second bank, what prompted its creation was the huge national debt the country had after the war of 1812. American was fiscally sound until the conflict began, but by 1814 they didn't even have the money to pay volunteers to the Army and were increasing the amount of land given as a recruitment bounty to entice recruits. The fact the bank was just thrown together to get the nation out of a crisis, set the foundation for the later corruption that president Jackson fought.
3.26.2009 3:26pm
"insider trading and conflict of interest by speculators and Members of Congress dealing in federal and state government bonds."

A long time ago I read that these activities were pefectly legal at the time even though they were unethical.
3.26.2009 4:49pm
J. Aldridge:
Don't forget State Banks ... these were more efficent in operation and not politically motivated like the 2nd National Bank was. Bank of Iowa would put today's Federal Reserve to shame.
3.26.2009 6:25pm
michael (mail) (www):
and so this is the second bowl
3.26.2009 6:42pm
MarkField (mail):

Don't forget State Banks ... these were more efficent in operation and not politically motivated like the 2nd National Bank was. Bank of Iowa would put today's Federal Reserve to shame.

While a few of the state banks operated properly, the majority were a disaster, often used for political purposes by the legislatures. While I don't know about IA, IL was notorious for its bankruptcy and for the overall failure of the state finances. Not that these were all the fault of the bank -- the legislature contributed more than its fair share.
3.26.2009 6:51pm
Perseus (mail):
In this regard Obama's comparison of Geithner to Hamilton just makes me cringe.

Agreed. Like the Whiskey Boys, Geithner is a tax evader.
3.26.2009 9:49pm
MarkField (mail):
While Hamilton certainly recommended the whiskey tax, he didn't impose it by himself. If you want to blame anyone for it, blame Congress. And Washington who signed it.
3.26.2009 10:52pm
corneille1640 (mail):

Don't forget State Banks ... these were more efficent in operation and not politically motivated like the 2nd National Bank was.

Maybe they were on balance more efficient, at least I'll say so for the sake of argument. But I find it hard to believe that the creation of a state bank during the early republic would not be "politically motivated." A special act by a state legislature would have been required because this was before the era of general incorporation laws. At least, such is my understanding. At any rate, the Bank of the US was so controversial, it's hard to believe that state banks in that environment were not in at least some senses "politically motivated."
3.27.2009 10:18am
JohnKT (mail):
I've never understood why a central bank is so contentious an issue, and one I never heard about until I read the Cantos of Ezra Pound, of all people, an esoteric work of an esoteric writer. You'd think that so contentious an issue would at least be mentioned in my college history textbooks, if not high school, but nope, not a word.

I have recently read Chernow's biography of Hamilton, so I have a better idea of the degree of contention, but I still don't understand the politics. Naively, it is nothing but good sense to have a strong central bank, and not a fractionated one like our Federal Reserve.

Would the VC mind educating me on the politics? Remember please my background is literature, not politics and finance.
3.27.2009 6:09pm
Rich Rostrom (mail):
One should note that the "South Sea Bubble" wasn't just one "joint-stock company", but dozens. Once the mania started, everyone and his brother started forming companies and selling shares, and everyone, his brother, and all their cousins lined up to buy.

The memory of the Bubble lasted a long time. In 1889 (170 years later), Gilbert and Sullivan's "Duke of Plaza-Toro" sang

I sit, by selection,
Upon the direction
Of several Companies bubble!

As soon as they're floated
I'm freely bank-noted;
I'm pretty well paid for my trouble!

Of course the practice of recruiting distinguished figureheads to serve as directors of bogus enterprises is all in the past. Well, aside from a few cases like Rahm Emanuel (Fannie Mae), Richard Holbrooke (AIG)...
3.28.2009 12:13am
corneille1640 (mail):

Part of the politics had to do with the proper interpretation of the constitution. Nowhere does the constitution explicitly give the federal government the power to charter a private bank. Hamilton et al. suggested the power was implied in the constitution.

Some of the reasons for controversy: the bank (the first bank of the US, 1791-1811) was a symbol of Hamilton's broader policy of establishing a "funded debt' that would make regular interest payments to holders of US securities. The opponents of the bank alleged that the funded debt therefore used tax money to create wealth for a class of wealthy bondholders who did not do "honest" labor. The bank, which was supposed to "manage" this funded debt, was a convenient target.

For both the first and second banks of the US, another point of controversy was the alleged "special privileges" chartering of the bank conferred on bank officers. In some ways, the bank operated as a quasi-government institution: its bank notes to some extent operated as a type of paper currency, and the size of the bank made it powerful enough to set interest rates that other, state banks had to follow. Still, the bank was technically a private institution. The use of banknotes as currency--I'm not sure how widely these notes were so used--also raised the specter of a "dishonest" monetary system. The opponents to this monetary system believed that it was more "honest" to base a nation's currency on specie (gold and/or silver) instead of merely the faith and credit of the US, via a private, chartered corporation.

Also, the control the bank allegedly exercised over the economy made it a target in times of economic hardship. In 1819, a financial panic was blamed (rightly or wrongly) on the machinations of the bank of the United States.

I should point out that I'm painting things with a very broad brush, and if I get it wrong, I stand to be corrected. But I hope this helps.
3.28.2009 11:07am
JohnKT (mail):
corneille1640 responded to my query about the politics against a central bank, and asked if his post helps me.

Yes, it does somewhat. I feel though that there should be a lot more said.

What about the economic interests of the time? Weren't most of us farmers who didn't much like banks, while manufacturers whom I suppose found banks useful, were not that powerful politically yet?

And if the rise of industry led indirectly to more banking, why do we still not have a real central bank, especially since small freeholder farming is dead and gone?

If this subject bores VC readers, please say so and I'll stop.
3.30.2009 8:29am

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