Section 2: The Development of US Banking Money and Banking Section 2: The Development of US Banking

Objectives Describe how banking developed in the United States Identify the banking institutions that operate in the United States

Development of US Banking Origins 19th Century 20th Century First bank of the US 1791-1811 Second bank of the US 1816-1836 Federal reserve system (1913), true central bank, national currency Privately owned Wildcat banking-state banks, little regulation, multiple currencies National bank Tight regulation begins during the Great Depression, FDIC protects depositors Helped control currency 1860s-greenbacks, system of national banks, currency backed by US bonds Opposed by Antifederalists Deregulation contributes to S&L crisis in 1980 1900-gold standard

Origins of Banking Modern banking arose in Italy People would store valuables at the bank Fractional Reserve Banking Practice of holding only a fraction of the money deposited in the bank and lending the rest

Alexander Hamilton Leading Federalist Proposed chartering a privately owned national bank to put the government on a sound financial footing Bank issue national currency and help control the money supply

Colonial American Banks Similar practices as Italy Not nearly as secure If merchant’s business failed Lost all of their deposits/savings After Revolutionary War many state banks were established (State Banks) banks chartered or licensed, by state governments were established Issue of instability and disorder Currency lent out was not necessarily linked to reserves of gold or silver held by the bank

First Bank of the US Hamilton proposed national bank “Men often oppose a thing merely because they have had no agency in planning it, or because it may have been planned by those whom they dislike.” -Hamilton First Bank of the US Hamilton proposed national bank Bank issue a national currency Help control money supply by refusing to accept currency not backed by gold of silver Lend money to federal government, state banks, and businesses First national bank chartered in 1791 Achieved financial goals set by Hamilton Opponents claimed bank policies restricted economic growth Congress refused to renew charter in 1811

Questions How did Italian merchants begin the practice of fractional reserve banking? They lent money that was deposited with them because not all deposits were reclaimed at once Why was currency that not backed by gold or silver a cause of financial instability? There was nothing to give the money value

Without a central bank… Government encountered issues funding the War of 1812 State banks soon returned to issuing currency not backed by gold or silver Increase in money supply led to inflation

19th Century Developments Second bank of US chartered in 1816 Greater financial resources Made money supply more stable President Andrew Jackson vetoed renewal of its charter in 1832 Wildcat Banking No federal oversight of bank industry State banks issued its own paper currency bank notes Passed free banking laws Banks located in remote areas to discourage people from redeeming bank notes Remote locations and questionable quality of bank notes= wildcat banks Bank run financial panics and economic instability

19th century-Struggle for Stability Difficult to finance its operations during Civil War without national currency and a federal bank 1st solution issue a new currency backed by government bonds Greenbacks US Bank notes printed with green ink 1863, National Banking Act, provided for a national currency backed by US Treasury bonds and regulated the minimum amount of capital required for national banks as well as the amount of reserves to back the currency National banks, banks chartered by the national government 1900, adoption of gold standard National currency and gold standard brought stability to banking system Money was now uniform, backed by something of intrinsic value, and limited by the supply of gold

Question: How did the National Bank Act of 1863 attempt to eliminate the problems caused by wildcat banking It set strict standards for national banks and provided for a national currency backed by government bonds to replace the state bank notes

Activity Wildcat Banking Students will be placed into 3 groups representing bankers, businesses, and consumers. Each group will discuss the ways banking practices in the era of wildcat banking affected them WRITE THEM DOWN Each banker needs to create currency using colored paper or a design with the name of the bank on it Also list some rules for the customers Students will role-play scenarios showing how banks caused difficulties for businesses and consumers (problems with acceptability, redemption –decline in value of bank notes- and bank runs Discuss how the role-plays showed the problems with wildcat banking

Rubric Points Wildcat Banking Presentation of Information 4 Excellent Clear and creative 3 Good Mostly clear and creative 2 Fair Sometimes clear and creative 1 Poor Sketchy

20th Century Developments Combination of national banks and a national currency linked to the gold standard initially brought stability Still suffered from periods of inflation, recession, and financial panic Economic instability due to lack of a central decision making institution that could manage the money supply in a flexible way to meet the needs of a changing economy

A New Central Bank 1913, Congress passed the Federal Reserve Act established the Federal Reserve System (central bank) Provides financial services to the federal government Makes loans to banks that serve the public Issue Federal Reserve notes as the national currency Regulates money supply to ensure that money retains its purchasing power

The Great Depression and New Deal Banks failed due to bank runs FDR New Deal Banking Act of 1933, instituted reforms such as regulating interest rates that banks could pay and prohibiting banks from selling stocks FDIC provided federal insurance so that if a bank failed, people would no longer lose their money Ultimately this increased the regulation of banking in the US

Deregulation and S&L Crisis 1980 and 1982 Congress passed laws that lifted government limits on savings interest rates S&Ls able to operate like commercial banks Deregulation encouraged S&Ls to take more risks in the types of loans they made S&Ls failed and lost depositor’s money Congress agreed to fund S&L industry’s restructuring came out of taxpayer’s pockets

Question How are the First Bank of the United States and the Federal Reserve different? First Bank single bank with no direct control of state banks and their currency Federal Reserve system of regional banks, which issues the only legal currency

Financial Institutions in the US Bank refers to financial institutions Ultimately it is a business there to earn a profit Government regulates… How much money the owner of a bank will invest The size of the reserves a bank holds The ways that loans may be made

Commercial Banks Oldest form of banking privately owned Initially established to provide loans to businesses All national commercial banks belong to the Federal Reserve System 16% of State-chartered banks join the FDIC

Savings Institutions Savings and Loan associations began in the US in the 1830s Originally chartered by individual states as mutual societies for 2 reasons: 1. to take savings deposits 2. to provide home mortgage loans Also provide other services like commercial banks Many savings institutions financed through the sale of stock Insured under a specific fund of the FDIC as part of the reforms that followed the S&L crisis of the 1980s

Credit Unions Credit Unions are cooperative savings and lending institutions (more like early S&Ls) Offer savings and checking accounts, but specialize in mortgages and auto loans First credit union chartered in 1909 Federal Credit Union Act of 1934 created a system of federally chartered credit unions Major difference between credit union and other financial institutions… Membership requirements Cooperative, nonprofit organizations owned by and operated for members

Question Which type of bank described above has the largest percentage of its institutions chartered by the federal government? Why might this solution have developed? Credit Unions, 61% Credit Unions had a shorter history of being chartered by states before the Federal Credit Union Act passed in 1934