The Historical US Concern With Banking Concentration
Executive Summary
- It is little discussed in the modern era regarding the long history of the US of banking concentration.
Introduction
Concerns around banking concentration have been a long-term issue of many leaders in US history.
This is explained in the following quotation.
Although Jefferson and Jackson may have been wrong in their solutions, they were prophetic in their fears. They worried that money tended to flow where there was more money and banks that became too large and powerful would only lend where profits were highest and thus create inequalities. But they miscalculated that keeping banks geographically dispersed could preclude centralized banking power. The modern world has made that solution insufficient. There is no doubt Thomas Jefferson would have been just as uncomfortable with our current bifurcated nationwide banking systems (one for the rich and one for the poor) as he was with a big-city banking monopoly that left out poor rural farms. The point was that the rich and poor should operate in credit markets governed by the same rules; banks must not have the power to anoint winners and losers. The fight for equality in banking, which started before the ink dried on the Constitution, ended sometime in the last few decades as deregulation did away with most meaningful attempts to restrict bank power. What eventually happened was predictable: banks became large and powerful and stopped serving a large sector of the population. Instead of bank wars or even bank skirmishes, politicians pushed laws favoring bank profitability and efficiency over public needs. Any suggestion that banks should be forced to lend to less profitable borrowers was seen as a government intrusion into a private market. And because our politicians have gone from fighting the centripetal force of bank power to helping it along, the accumulated power of banks has become harder to dislodge. Banks disowned their “state institution” past and clothed themselves in the language of the market. This was the whole point of three decades of deregulation—to free banks from state-imposed restrictions and separate them from the state so that they could compete in the market like other businesses. But in the banking business, deregulation turned out to be a one-sided deal. Banks enjoyed significant profits in the deregulated banking market for decades, but when the market turned on them, the federal government swooped in to save them.
Source: How the Other Half Banks
https://www.amazon.com/How-Other-Half-Banks-Exploitation/dp/0674286065
The Risk Imposed by Banks
Whereas in the Middle Ages the key threat to banks was sovereign failure, today, as Andrew Haldane, director at the Bank of England, explains, “Perhaps the biggest risk to the sovereign comes from the banks. Causality is reversed.” One lesson of the recent global crisis is that fragility in a large and complex banking sector has the potential to sink nations. The implications of that shift affect how we should think about banking policy. The nature of the bank/government relationship changed significantly throughout various phases of U.S. history, but the general contours of the social contract remained roughly the same. Banks were supported as long as they enabled the strength of the democracy and would be restricted if they came to present a threat to democracy. For hundreds of years, this country’s leaders were afraid of excessive bank power and the inequalities of access it would inevitably produce. Many presidents and lawmakers fought and resisted the natural tendency of banks to grow large and powerful and favor the profitable few over the many. Then they stopped fighting. And what was always feared came to pass.
Source: How the Other Half Banks
All of this is why the US economy has been financialized. This financialization places the overall economy at the control of the private banking interests and emphasizes industrial capitalism, which is what was previously the strategy of the United States.
The opposition to concentrated banking interests was so strong that Thomas Jefferson opposed the creation of a central bank, as the following quotation explains.
Jefferson and the rural farmers of the American colonies feared that a robust centralized banking system would amass wealth and power in cities, away from farmers. He also feared that banks would provide too much credit, which would destroy the agrarian principles of hard work and thrift. Jefferson, who derided banks as being “more dangerous than standing armies,” was not alone in his disdain. Banks and bankers were cast as villains flaunting easy money and debt; farmers were the protagonists whose work made the economy possible. In 1811, former president John Adams wrote: “Our whole banking system I ever abhorred, I continue to abhor, and shall die abhorring.” Similarly, in 1833, William Gouge, a Treasury official and economic advisor to Andrew Jackson, described banks and their outsized power as “the principal cause of social evil in the United States.” These sentiments were rooted in the traditional Protestant and agrarian principles of thrift and self-reliance, as well as a distrust of artificial power derived from the concentrated control of money. The American republic was a distinct break from the Old World social order, and one of its central premises was that every person, regardless of social rank or accumulated wealth, would enjoy “equality of opportunity.” One historian explains that as long as the “channels of ascent and descent were kept open it would be impossible for artificial aristocrats or overgrown rich men to maintain themselves for long.”
Source: How the Other Half Banks
It should be noted that these quotations are barely mentioned on discussions of the founding fathers. It almost appears as if none of the founding fathers had anything negative to say about concentrated banking interests, and as if none of the debates and discussions they had, had anything to do with banking.
This concern is explained in the following quotation.
Many saw excessive bank power through accumulated capital as a formidable threat and expressed fears that banks would amass political power and influence and wield it to thwart the budding democracy. William Findley described banks as “artificial creature[s] endowed with powers not possessed by human beings and incompatible with the principles of a democratic social order.… ‘This institution, having no principle but that of avarice, which dries and shrivels up all the manly, all the generous feelings of the human soul, will never be varied in its object and if continued will accomplish its end, viz., to engross all the wealth, power and influence of the state.’ ”The growing economy needed those with money, which had been accumulated in the Old World, to lend in order to support new ventures. This formative tension between protecting the principles of democracy and enabling a burgeoning laissez-faire spirit of limitless prosperity shaped the evolution of the social contract. The fear of too much bank power led the government to keep banks under strict supervision. Banks were given state charters and allowed to lend with heavy restrictions as well as charters requiring them to honor a distinctively public mission.
Source: How the Other Half Banks
This has of course come to pass. All of the major banks and most of the smaller banks meet this definition of “no other principle than avarice.”
One of the features which were designed to restrict the concentration of financial power in banks was that banking charters were temporary. This is explained in the following quotation.
In particular, early state laws attempted to keep banks small and short-lived, in keeping with widely held fears of concentrated economic power. The state of New York, for example, issued all of its banks charters with an expiration date. Legislatures renewed the charters subject to conditions or more commonly, denied requests for charter extensions to keep banks from amassing too much power or market share. In addition, state law imposed participation requirements to prevent privately controlled banks from being dominated by a few individuals or economic interests. One historian asserts: “In practice state legislatures viewed banking corporations as instrumentalities of the state, established to serve various public purposes as well as the private interests of stockholders and borrowers.” In Schaake v. Dolley, the Kansas Supreme Court explained that banking is not “a matter of private concern only, like the business of the merchant, and for all purposes of legislative regulation and control it may be said to be ‘affected with a public interest.’ ” The court made it clear that banking needs to be distinguished from “ordinary private business” because of its “public nature.” Because banks received “public patronage,” a state bank was “a trustee of the fiscal affairs of the people and of the state.” The most important charter impositions, and the most long-lasting, were prohibitions on bank size and location. Unit banking, wherein a single bank operates in a single region, was the norm in U.S. banking for almost two centuries. Most banks did not open branches outside a state, or even within a state in many cases, for much of U.S. banking history.
Source: How the Other Half Banks
This shows how at this time the US government sought to keep banks on a “tight leech.” Also, unlike today, it was openly expressed that banks are not like other businesses.
Limitations on Bank Branching
A unit bank is when a bank operates only one branch. Branching is when a bank is allowed multiple branches. There was previously all manner of limitations on bank branching, including the ability to the only bank within one state. Over time these restrictions were loosened as bankers increasingly took over the regulations of banks.
This is explained in the following quotation.
A coalition of community bankers warned against national bank branching, stating: “[Such branching would] create a brood of two hundred or three hundred great central banks, with 10,000 to 15,000 branches in large cities as well as small, and as such branches would have no capital and only figure-head management, individualism in management would cease, local taxes [would] be evaded, [there would be] no home distribution of profits, local progress [would be] retarded, in short, the great central banks would skim the cream from the whole country to enrich [their own] exchequers.” These rules were anticompetitive and held banks hostage to a single region’s credit markets. The situation was not only inefficient but also unstable. If the region in which a bank was forced to concentrate its resources suffered bad weather or a local disaster, the bank would sink. And many did. Banking crises and failures were chronic during this era. Nonetheless, these restrictions remained because rural farmers needed and wanted the lower rates for credit that unit banking uniquely enabled. And the state, through chartering laws and restrictions, made it so. During the era of state-chartered banking, some states experimented with unregulated banking. This phase, called “free banking” or “wildcat banking,” lasted from 1837 to 1862 and is considered a disaster by most scholars. This short experiment with free banking stands as the only example since the 1600s of any banking system worldwide operating without government support. Not every state allowed free banking, but those that did saw bank charters explode because anyone could charter a bank. But no one trusted these banks. Many of them would pop up in desolate areas for the sole purpose of not having to redeem the bank notes they had issued, thus earning the name “wildcat” banks. The banks that existed during free banking lasted an average of five years, and half of them failed. The turbulence and constant bank failures were unsustainable, and the period ended relatively quickly. The Union’s financial emergency during the Civil War was the impetus that finally begat national banking. The Union needed credit to fund an expensive and protracted war, and because of the magnitude of the crisis, President Lincoln and Treasury secretary Salmon Chase were finally able to overcome agrarian opposition. But Congress had written Jacksonian opposition to national banking into laws prohibiting the Treasury from participating in nationwide monetary policy, and so to finance the war, the federal government had to depend entirely on private state bankers in New York, Boston, and Philadelphia. This dependence on private loans significantly restrained federal spending. President Lincoln and Secretary Chase needed much more than what they could borrow from these banks. The way to loosen credit would be to establish a national paper currency so that the federal government could fund itself, allowing the federal government to print and sell “greenbacks” to banks and raise the money it needed.
National banks could not branch within any state that did not allow such nor could any bank branch outside of its state. The banks were also only to engage in traditional banking activities, such as lending and deposit-taking, and were to steer clear of the territory covered by Wall Street investment banks, such as underwriting, trading in stocks or private bonds, or merchant banking. These acts served as the template for later restrictions on state banks’ activities as well.
Source: How the Other Half Banks
Jefferson supported a public banking option, something that never came to fruition unless one includes the medium duration US post office banking that existed in the US from 1911 to 1967. This is explained in the following quotation.
Over the past several decades, nearly all of the government and industry initiatives aimed at financial inclusion have focused on community efforts to bank the poor—Jefferson’s localism still runs deep in banking politics. However, the problem of access is fundamentally different today than it was historically. Disparities in access are not regional but based almost purely on income. Banks, local or otherwise, do not lend to the poor due to one straightforward economic reason: they can make more profits elsewhere. Any effort to bank the poor must recognize that centralized, national, and large banks won a decisive victory over small community banks. Alexander Hamilton rightly believed that government-controlled central banking was essential to coordinating a modern economy. But Thomas Jefferson was also right that permitting banking power to accumulate in the hands of the few does so at the expense of the many. The dilemma of living in a Hamiltonian banking world without addressing the Jeffersonian nightmare of inequality has led to the current crisis of the unbanked. But there is a Hamiltonian solution to Jeffersonian fears: a public option in banking—a central bank for the poor. The core function of the central bank, or Federal Reserve, is to infuse liquidity into troubled banks so that they can withstand a temporary credit crunch and get back on their feet. A public option would provide the same short-term credit help to individuals so that they, too, can withstand a personal credit crunch and get back on their feet. Indeed, in the modern banking landscape, only a large, liquid lender is able to lower the costs of lending to the poor.
Source: How the Other Half Banks
As Bank of America was growing, the community banks of America were dying. When most people discuss this trend of mergers and consolidations in the banking industry, they focus on the resulting Too-Big-to-Fail banks that have come to dominate the industry. But these banks were built using an already existing checkerboard of community banks across the country. Each bank that Bank of America purchased originally started as a small community bank before being turned into a megabank branch or closed in the name of efficiency and replaced by an ATM machine. Market forces have always applied to banks, but the tight-margin, high-stakes nationwide banking market is new. The full range of intensely competitive market forces have applied to banks to a much greater degree during the last thirty years—with the clear exception of the largest banks, which are too big to fail. Community banks’ struggles to stay profitable, however, emanate not only from market principles, but also, more recently, from regulatory pressure. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) regulatory regime, a response to the 2008 financial crisis, primarily purported to address the risks in the large-bank sector. Most scholars and industry observers claim that the act falls short of true reform for the large banks. But when applied to small banks, Dodd-Frank is overkill. Dodd-Frank has placed added rules on community banks, which claim that they are “too small to comply.” Community banks claim that its onerous regulatory demands create compliance costs that are reducing their already small margins. Large banks can absorb these costs and have large compliance departments to deal with the regulatory mandates. Small banks are spending limited resources to comply with these laws, which are mismatched to the risks their industry faces.
Source: How the Other Half Banks