# Regulation and Instability in U.S. Commercial Banking ## Metadata * Author: [Jill M. Hendrickson](https://www.amazon.comundefined) * ASIN: B009ABY6IM * Reference: https://www.amazon.com/dp/B009ABY6IM * [Kindle link](kindle://book?action=open&asin=B009ABY6IM) ## Highlights Philosopher George Santayana is famous for, among other things, his observation: “He who does not know history is fated to repeat it”. Unless we understand the origins of contemporary problems in banking, public policy remedies are apt to be rather naïve. — location: [496](kindle://book?action=open&asin=B009ABY6IM&location=496) ^ref-28132 --- the market process provides the opportunity to mobilize knowledge and to open doors of discovery to new opportunities. That is, the market process creates knowledge. If one looks at the world through the Austrian lens, regulation cannot be a harmless, stabilizing force. On the contrary, regulation interrupts the market process as well as the discovery, incentives, and competition of that process. At the same time, the state does not possess the knowledge necessary to make stabilizing and efficient regulation because such knowledge comes from the very process it is interrupting. However, even though government regulation drastically alters the market path, the entrepreneur still adjusts and continues to search for new and profitable opportunities. It is this continuous motion of the market, even while regulated, that makes regulation destabilizing because while regulation is static the market is not. — location: [530](kindle://book?action=open&asin=B009ABY6IM&location=530) ^ref-23557 --- the very reason the banks were small was because of chartering restrictions that gave state regulators incentive to limit the number of banks by extracting rents from the banker. At the same time, the banker then had incentive to limit entry (i.e. limit competition) and paid off state regulators to minimize the number of charters granted. — location: [659](kindle://book?action=open&asin=B009ABY6IM&location=659) ^ref-6533 --- The passage of two important banks acts in 1863 and 1864 that created national banks was motivated, in large part, as a means of generating revenue for the federal government and had little to do with creating a healthy banking system. — location: [666](kindle://book?action=open&asin=B009ABY6IM&location=666) ^ref-63596 --- After the Great Depression, regulators placed a limit on the interest rate that banks could pay to attract deposits. Certainly this minimized competition between bankers and also limited the cost of obtaining deposits. However, regulators also placed a ceiling on the interest rate the banker could charge on certain types of loans thereby limiting revenue opportunities. — location: [720](kindle://book?action=open&asin=B009ABY6IM&location=720) ^ref-5919 --- The large number of banks is the product of chartering and asset restrictions as well as limits on branch banking. The small size of many of these banks also reflects limits on branching and regulation such as the tax on bank capital and deposit insurance. — location: [730](kindle://book?action=open&asin=B009ABY6IM&location=730) ^ref-550 --- more recent scholarship has increasingly shown that there is a positive relationship between bank competition and stability and not necessarily a trade-off between the two.13 For example, Carlson and Mitchener (2009) find that, during the Great Depression, banks that were exposed to new competition, due to branch entry, improved their efficiency and profits to remain viable. — location: [744](kindle://book?action=open&asin=B009ABY6IM&location=744) ^ref-52186 --- recent scholarship finds that when banking markets are opened to more free entry, portfolio risk declines, efficiency improves and loan losses decrease.15 These findings suggest competition in banking is stabilizing despite deposit insurance. — location: [757](kindle://book?action=open&asin=B009ABY6IM&location=757) ^ref-19208 --- some scholars argue that the system protected the public against unsound banks through its discipline.49 The Suffolk Banking System brought about stability without the coercion of government. Rather, a voluntary cooperative agreement between bankers created a successful payments system. — location: [1216](kindle://book?action=open&asin=B009ABY6IM&location=1216) ^ref-40456 --- the demise of the Suffolk System ultimately became inevitable with the passage of the 1865 Revenue Act which essentially put an end to state banknotes. — location: [1223](kindle://book?action=open&asin=B009ABY6IM&location=1223) ^ref-10625 --- the private banker established a substantial presence in antebellum America. The catalyst for the growth in private banking occurred with the crisis of 1837 which destroyed many state chartered banks, thereby opening the door for private bank entry.62 The rise in the number also corresponds to the repeal of some restraining acts and the advent of free banking.63 — location: [1290](kindle://book?action=open&asin=B009ABY6IM&location=1290) ^ref-64684 --- Bodenhorn (1997) provides a detailed and data rich account of a small private banker from Virginia; Thomas Branch & Sons. He finds that Branch & Sons tended to lend to younger entrepreneurs who were just embarking on their commercial careers and generally these borrowers had fewer accumulated assets than commercial bank borrowers. Thus, if the Branch & Sons operation is characteristic of antebellum private banking in general, it is clear that private bankers were crucial in the intermediation process, particularly for younger entrepreneurs. — location: [1299](kindle://book?action=open&asin=B009ABY6IM&location=1299) ^ref-3523 Key point for why disregulated, reree barking was so important. --- Most of the state regulation of private banking came in the form of restraining acts which, at one extreme, prohibited private banking and, at the other, forbid the institutions from issuing notes.65 By 1820, 19 of the 24 Union states passed restraining acts. It appears as though the impetus behind these acts was, in part, state bankers lobbying to keep competition at bay. — location: [1308](kindle://book?action=open&asin=B009ABY6IM&location=1308) ^ref-13677 --- the enterprising banker simply found ways around the restraints. For example, some private bankers continued to issue notes, they simply called the notes something else. — location: [1313](kindle://book?action=open&asin=B009ABY6IM&location=1313) ^ref-49596 --- Careful analysis of the Bank’s balance sheets indicate that during its first two months of operation, December 1791 and January 1792, the Bank issued notes in excess of $886,000 and made loans of $2,675,441.69 As it turns out, many of these were very short-term loans (30 days) often made to market speculators, including Duer.70 This path of rapid money expansion was abruptly abandoned in early February as Bank officials worried about the quality of their notes and the extent of market speculation. In February and early March close to $625,000 in loans were called in or not renewed. Evidence suggests that to pay for these loans most borrowers were forced into selling their securities. This liquidation, in turn, led to falling stock prices and the crisis of 1792. Thus, the First Bank’s erratic policy of injecting liquidity followed by an abrupt reversal of policy led to the stock market sell-off and ensuing crisis. — location: [1341](kindle://book?action=open&asin=B009ABY6IM&location=1341) ^ref-27178 --- there was only one small window in which banking, throughout its entire history, was not subject to federal regulation. This window is the 27 years after the demise of the Second Bank of the United States and before the 1864 National Bank Act. In this period, regulation was left entirely to the states, many of whom responded by setting up free banking laws and systems. During the remaining years, banks were regulated by both state and federal authorities. — location: [1442](kindle://book?action=open&asin=B009ABY6IM&location=1442) ^ref-46768 --- Branching restrictions also make a bank vulnerable on the liability side of its balance sheet. Like the assets, the liabilities of a unit bank cannot be too diversified which, in turn, magnifies the possibility of runs and gives banks a more narrow base from which to draw deposits. — location: [1475](kindle://book?action=open&asin=B009ABY6IM&location=1475) ^ref-40043 --- there were fewer failures and specie suspensions in those states with established branch systems. — location: [1481](kindle://book?action=open&asin=B009ABY6IM&location=1481) ^ref-10239 --- statistical evidence does not bear out the long held belief that fraudulent, or wildcat, banking dominated the free banking era. Thus, the statistical evidence indicates that regulation, in the form of bond collateral requirements, contributed to most free bank failures. — location: [1576](kindle://book?action=open&asin=B009ABY6IM&location=1576) ^ref-56952 --- Looking at the correlation between periods of falling debt prices and the incidence of failures, the scholars find a high correlation. Indeed, they find that approximately 80 percent of all bank closings during the free banking era occurred during periods of substantial declining bond prices. Further, the declining bond prices were linked to the fiscal condition of the issuing state. For example, the fall in the price of Indiana bonds in the early 1840s was tied to fears that the state was going to default on the bond issue. — location: [1627](kindle://book?action=open&asin=B009ABY6IM&location=1627) ^ref-6681 --- Notice that the states with the most instability with free banking, Michigan and Minnesota, did not allow branching while states with the most free banking success, notably New York, did allow branching. — location: [1639](kindle://book?action=open&asin=B009ABY6IM&location=1639) ^ref-2857 --- Four bank institutions were born in antebellum America beginning with state chartered and private banks followed by two experiments with federal banking and ending with the free banking era. — location: [1650](kindle://book?action=open&asin=B009ABY6IM&location=1650) ^ref-22084 --- membership was not compulsory for all banking institutions which resulted in serious adverse selection problems.38 By 1931, all of the deposit insurance schemes had failed or ceased operation due to mounting bank failures and insufficient funds. — location: [1959](kindle://book?action=open&asin=B009ABY6IM&location=1959) ^ref-49670 --- the state banks were used as scapegoats because the Treasury needed someone to blame for inflationary pressures and for the wartime financial policy of issuing greenbacks and selling bonds to national banks.63 — location: [2163](kindle://book?action=open&asin=B009ABY6IM&location=2163) ^ref-63238 --- The folly of the 1865 Revenue Act is that the federal government, at that time, clearly misunderstood the functioning of commercial banks. Because the banks were relying heavily on deposits rather than banknotes as a source of funds, the Act was ultimately ineffective. — location: [2169](kindle://book?action=open&asin=B009ABY6IM&location=2169) ^ref-21975 ---