Money and Banking

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

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

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

4. 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

5. 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

6. 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

7. “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

8. 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

9. Without a central bank… • Government encountered issues funding the War of 1812 • State banks soon returned to issuing currency notbacked by gold or silver • Increase in money supply led to inflation

10. 19thCentury 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

11. 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

12. 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

13. 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

14. Rubric

15. 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

16. 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

17. The Great Depression and New Deal • Great Depression 1929 • 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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