The banking system was forming in the United States during the long period of time, while the Federal Reserve system was established. Mostly, banks were created in order to finance the war, but they also obtained an authority in currency issuing.
Brittan started to collect more and more from its colonies, that is why the United States had a particular interest in the separation process.
The first bank, as a first financial institution was founded in 1782, in Pennsylvania state and was called a Bank of North America. It was the first bank that received deposits and issued its own banknotes.
Robert Morris, one of the founders of the United States, was a founder of the institution. Bank was formed in order to support American Revolutionary War. At the same time, Morris had received significant inflow from France, in order to finance banking activity. France strongly supported the United States in terms of army, finance, and consumption as they saw an opportunity to undermine British power.
Some of the founding father were strongly against the formation of the “central” banking system, as in this case partially it was financed by foreigners and they were afraid of such a big conglomeration of power that could hold a private interest, as the First Bank was not controlled in any way by the United States government.
Others had a positive view of the perspective of the centralized banking system, as it would be able to help the United States in the process of developing from British colony to an individual country. Morris also had undertaken a various number of reforms including the reduction of the civil list, lowering of government expenditures using competitive bidding for contracts, tightening accounting procedures and ensuring the support in money supply to the States.
However, Morris’s Bank was strongly criticized and blamed in favoritism to foreigners and unfair policies against less corrupt state banks. The charter to operate was repealed in 1785.
Alexander Hamilton also played an important role in the process of formation of the centralized banking system. He had established a national bank, the First Bank if the United States. He also took the lead in the funding of the states’ debts by the Federal government. He established a system of tariffs and friendly trade relationships with Britain.
His bank was founded in 1791 in order to serve as a repository for federal funds and as a tax agent for the government. That financial institution was formed by the model of the Bank of England and was different compared to today’s central banks. As before, the bank was partially owned by foreigners. It also had rights to issue around 20% of market currency.
As expected, some of the founding fathers were afraid of a conglomeration of power controlled by foreign parties. Thomas Jefferson used to see an engine for speculation, corruption and financial manipulation in centralized banking system presented that time.
Bank had rights to operate during 20 years’ time and were not extended by state authorities.
During the War of 1812, the United States government greatly increased its debt, while without a centralized Bank, it had to deposit its tax revenues in state banks. As a consequence, state banks started to issue more currency in terms of banknotes, increasing the amount of money in the market, in circulation, which had led to increased inflation, as paper money and coins become less valuable. Later on, a suspension of specie payments followed, which had led to a Panic of 1819.
Some started to create banks in order to provide banknotes to owners in order to speculate later on in land prices. Those banks haven’t used to have depositors, and even haven’t needed to have them as they were not created due to capital investment possibilities or needs, not in order to provide help in process of obtaining land by farmers, but simply to provide more printed money in terms of cash to its owners. Eventually, a bank, as an institution, could be easily created, no specific requirement was needed, without capital with only one goal – support an owner with printed cash in order he would be able to speculate on the land market. Which is presented as a house of cards.
Hence, the Second Bank of the United States was created in 1816 for a 20 years term. It was modeled after the Bank created by Mr. Hamilton but was a private institution. It did receive tax collections and revenues from government land sales paid government bills. This version of the Bank also had an opportunity to sold government bonds when there was a need.
The Second Bank of the United States had storages of species (gold and silver) as it redeemed its banknotes and those of the state banks in specie. After the redemption process, the Second Bank of the United States became a creditor to other, small banks. At the same time, the Second Bank of the United States had the power to force payments from state banks in species, which it did. State banks were stressed and their owners started to call in loans to farmers and land speculation, which had led to its insolvency, which had led to an economic depreciation and deflation.
Many were concerned that the Second Bank of the United States was a private institution that had huge impact and control over the country’s money supply and the entity was managed by a private board of directors rather than by an elected official, who could follow their private interest, but country’s.
Around this period of time, Wall Street became more important in the financial system and it also not used to tolerate powerful privately-owned financial organization with headquarters placed in Philadelphia.
President at that time was Andrew Jackson. He was also anxious about the Second Bank of the United States that had big power and influence on the economy as a whole. He was also afraid of owners, as they were simply a group people that had strong special interest in political terms.
An entity, in this case, the Bank, had a possibility to simply ruin another state bank by presenting its banknotes for redemption.
President Jackson, during his time in charge, had stopped the sale of federal land and had issued the Specie Circular, which required government land to be repaid in species. Western land speculators went bankrupt as they were not able to repay their payables regarding the government.
No of banknotes in the market became numerous, while gold and silver coins were removed from circulation, which had led to the Financial Panic of 1837.
After 20 years term, the Second Bank of the United Stated charter had expired and were not prolonged, but the Bank used to operate as a state bank for another five years.
After another attempt at the centralized system creation, a free banking era was widely distributed. This part of the political movement was led by the Jacksonian Democrats in order to reduce agglomerates of power in the market between financial intuitions.
By the way, even though this period of time is called as free banking era, it did not mean that no rules were introduced. The Bank could be created with no charter issued, but the state used to regulate reserve requirements, interest rates on loans and deposits and so on. Banks could issue banknotes against species.
Banks started to find other ways, as an example, Banks started to hold only a part of reserves in order to meet the expected redemptions during the day. This could lead to a banking crisis if many customers would decide to withdraw cash from the bank at the same time.
Free entry on the market also increased some incentives for fraud and risk. Politics that time was strictly opposite of large banks. But on the other hand, if an owner should introduce add-in capital in order to operate under a franchise or brand name – that kind of market would be more stable compared to the system with a large number of small banks.
After introducing the Banking Act in 1863, besides the process of providing loans in the Civil War, several provisions were introduced. From that point, a national bank could be created, but it had to have higher reserves compared to state banks. A controller was created in order to supervise the banking sector. A goal of uniformed national currency was created, national banks were required to accept each other at par value.
In order to finance the War, banks were obliged to invest in Treasury securities, raising markets liquidity.
Even though some controls were introduced (see above the list), there were still two problems remained in the banking industry.
The first problem was the requirement to back up money with treasuries, while those treasuries have fluctuated – banks had to recall investments and borrowing from other parties.
The second problem was connected with seasonal liquidity spikes, as an example, a farmer income could depend on the season, as he could have no profit in winter, but high sales in autumn which could be connected like higher withdraws during planting and deposits during sales.
During the Banking Crisis, or in other worlds Panic, od 1907, Wall Street was turned to J.P. Morgan with the help request. A crisis threatened to slow down an economy and bring the depreciation. And consequently, Morgan did succeed in helping the economy. After the state realized that it had owned the economic survival to a private entity, particularly to a private bank, forced the government to introduce necessary legislation of order to create a central bank and Federal Reserve system.
A National Monetary Commission was formed in order to observe how banking system was working in Europe. Commission brought some thoughts merging British and German banking systems, but also improving those systems in some way by introducing some other rules observed in other countries.
The power of the Federal Reserve system was developed slowly during the time. It was created as a big reserve that had right to create money and should prevent the downward trend of withdrawals. At the Beginning of the World War First, the Federal Reserve System issued military bonds and therefore became the main retailer of the war.
After the War, the government decided to give rights to the Federal Reserve System in the order it would be able to take control over the money supply by creating or destroying money.
During the Second World War the capacity of the Federal Reserve System was increased by capital, particularly gold and silver that were transported from Europe in order to buy some military staff from the United States, or in order to keep species in safer place than Europe at that time as the territory of the United States were not drawn into the War.
After the war, the Fed was able to erase some of the bad memories of depression, keeping interest rates low.
The monetary policy of the Federal Reserve has not changed radically for the rest of the 20th century, but in the 1970s it was conducted by the Congress to effectively promote the goals of maximum employment, stable prices, and moderate long-term interest rates.
Without a Central Bank to provide oversight of banking and finance, the expanding banking system suffered from some major problems, even as it supplied the country with loans to finance economic growth.
One big problem was financial instability.
A huge number of banks failed during the process of formation. Another huge part became insolvent when borrowers defaulted on their loan payments. The banking crises led to business depressions with high unemployment.
Historically, the Federal Reserve monetary policy has been governed by a dual mandate: first, to maintain stable prices, and second, to achieve full employment. The Fed has generally relied on interest rate policy to pursue these goals.
As we know from recent experience, the Federal Reserve System did not eliminate banking crises. But crises were less frequent than when there was no central bank. Indeed, there have been only two major banking crises in ninety-six years, 1930–1933 and 2007–2009.
Today, the Federal Reserve system is tasked with managing the United States monetary policy, regulating bank holding companies and other member banks, and monitoring systemic risk.