13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (4 page)

When it came to the basic economic issues, Hamilton was right. Economic development in the early United States depended heavily on the creation of a well-functioning financial system, as shown by modern scholars such as Richard Sylla and Peter Rousseau.
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The United States in the 1780s “lacked nearly all the elements of a modern financial system, [but] by the 1820s had a financial system that was innovative, large and perhaps the equal of any in the world.”
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This was due not only to the Bank of the United States, but also to other financial reforms implemented by Hamilton, such as his careful management of cash flows into and out of the Treasury while keeping money on deposit with “approved banks,” as well as his highly influential reports to Congress on credit and manufacturing.
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Hamilton successfully argued that the federal government should assume the debts incurred by the individual states during the American Revolution, thereby setting the valuable precedent that the United States would always pay its debts.
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In Ron Chernow’s words, “Hamilton did not create America’s market economy so much as foster the culture and legal setting in which it flourished.”
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The result was a stable and relatively favorable environment for banking. The United States had only three banks in 1789, but twenty-eight banks were chartered in the 1790s and another seventy-three in the first decade of the 1800s.
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Bank shareholders had limited liability, a real innovation at the time (in England before the 1850s, only the Bank of England had limited liability) that helped attract entrepreneurs and money.
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By 1825, when the United States and the United Kingdom had roughly the same population (11.1 million and 12.9 million, respectively), the United States had nearly 2.5 times the amount of bank capital as the United Kingdom.
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The United States also rapidly developed a healthy equity market that was able to attract capital from around the world. Already by 1803, more than half of all U.S. securities were held by European investors.
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By 1825, there were 232 listed securities in the United States (in New York, Philadelphia, Boston, Baltimore, and Charleston combined), approaching the 320 securities listed in England, and the level of equity market capitalization was similar in both countries. Many of the companies listed in American stock markets represented the leading sectors of the modern economy, including insurance, transportation, utilities, and manufacturing.
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The abundance of both bank capital and equity financing meant that there was plenty of money available to invest in new and expanding businesses—initially concentrated in New England, but soon spreading to the rest of the country.
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A modern financial system became even more important with the spread of the Industrial Revolution early in the nineteenth century, which neither Jefferson nor even Hamilton foresaw. At the time of their debates, the Industrial Revolution was decidedly small-scale and largely confined to England. But the progressive application of technology to the production of goods would vastly raise the potential output of the American economy and permanently change its place in the world. Because industrialization required investments in new technology, it also required credit. Jefferson’s small-scale farms may have represented a democratic political ideal (at least for those fortunate enough to own those farms and not be slaves working on them), but long-run prosperity required large-scale commerce and industry, both of which required banks. In retrospect, Jefferson’s economic positions seem either cranky and uninformed or motivated by his distaste for the Northern commercial interests that he correctly predicted would benefit from a strong central government and eventually undermine Southern plantation (and slave) owners such as himself.
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But while Hamilton may have been right about the economics, that was not Jefferson’s primary concern. His fear of large financial institutions had nothing to do with the efficient allocation of capital and everything to do with power. Jefferson correctly discerned that banks’ crucial economic functions—mediating financial transactions and creating and managing the supply of credit—could give them both economic and political power. In the 1790s, Jefferson was particularly worried that the Bank of the United States could gain leverage over the federal government as its major creditor and payment agent, and could pick economic winners and losers through its decisions to grant or withhold credit. Over the past two hundred years, financial institutions and markets have only become more intertwined with the day-to-day functioning of the economy, to the point where large companies depend on the short-term credit they use to manage their cash flow as much as they depend on electricity. In Jefferson’s eyes, the increasing importance of finance to society would only give banks even more power—power that could be used to benefit the bankers themselves, or in extreme cases could even threaten to undermine American democracy.

In matters of economic policy, we tend as a nation to lean toward Hamilton. As President Calvin Coolidge said in 1925, “[The American people] are profoundly concerned with producing, buying, selling, investing and prospering in the world.”
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And for most of American history, that has served us relatively well. The United States would not have the largest economy in the world without a financial sector that has, most of the time, funneled capital toward the investments in new technology and processes that are critical to long-term productivity growth.

However, our Hamiltonian inclinations—to seek out efficiency, to celebrate bigness, and to look favorably on anything that makes money—have been kept at least partially in check by the legacy of Jefferson. Although Jefferson lost the battle over the Bank of the United States (and his worst fears did not materialize), the cause of restraining concentrated economic or financial power was taken up by three of his most important successors. In the 1830s, Andrew Jackson’s showdown with the Second Bank of the United States set back the development of a concentrated financial sector. At the beginning of the twentieth century, the crusade against the industrial trusts begun by Theodore Roosevelt ultimately left intact the powerful private banks symbolized by J.P. Morgan; but during the Great Depression of the 1930s, Franklin Delano Roosevelt was finally able to break up the largest banks and constrain their risky activities. While they did not achieve all of their aims, the Jeffersonian tradition represented by these presidents has served as a counterweight to Hamilton’s influence, helping prevent a powerful and unfettered financial system from undermining broader prosperity. The American financial system has oscillated between concentration and fragmentation; but over the long term, it helped give us unrivaled prosperity without undermining our democratic system—at least not yet. Today, as we face the largest and most concentrated financial sector in our nation’s history, Jefferson’s legacy again demands our attention.

JEFFERSON’S REVENGE

Jefferson’s fear of big banks was something close to an obsession for the seventh president of the United States, Andrew Jackson. “Old Hickory,” like Jefferson, favored the ideal of an agrarian republic and distrusted big-city bankers.
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Just as important, he believed in presidential power, and he saw a major national bank as a rival that needed to be dealt with.

After its charter expired in 1811, legislation to recharter the Bank of the United States narrowly failed. However, the economic dislocation caused by the War of 1812 and the resulting chaos in the financial system convinced politicians of the need for a national bank. Congress passed legislation creating the Second Bank of the United States, which was signed by President James Madison, and the bank went into operation with a twenty-year charter in 1816.
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By the time Jackson was elected president in 1828, the Second Bank functioned as an “important administrative agency of the government”
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—regulating the money supply, handling the day-to-day financial operations of the U.S. government, issuing bank notes, and providing credit for both federal authorities and private sector clients (including prominent politicians). Under the management of Nicholas Biddle, it supported the development of the American capital markets and helped coordinate a banking system that primarily operated at the state or local level.
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Jackson, however, opposed the Second Bank on both economic and political grounds. He hated paper money and believed only in the hardest of hard money—gold and silver. Paper money, he thought, allowed banks and bankers to distort the economy at the expense of common people. In addition, the Second Bank’s monopoly over government finances gave Biddle and his friends power (and profits) that, he felt, rightfully belonged to the executive branch. The president was particularly enraged that Biddle used his economic power to curry favor with Congress, influencing elected representatives to support his aims; almost every prominent person supporting Biddle was also substantially in his debt (including some of the leading politicians of the day, such as Daniel Webster and Henry Clay).
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As Jackson’s secretary Nicholas Trist put it, echoing Jefferson, “Independently of its misdeeds, the mere
power,—
the bare existence of such a power—is a thing irreconcilable with the nature and spirit of our institutions.”
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The “Bank War” began when Biddle and his ally, Henry Clay, attempted to renew the Second Bank’s charter in 1832, four years before it expired, in part to create a political issue that Clay could use in his campaign to become president.
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In order to gain support, Biddle directed the Bank to expand its lending in a bid for popularity.
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Congress voted to renew the Bank’s charter, but Jackson vetoed the renewal. His veto message mixed together a rebuke to the Supreme Court (which had finally resolved the Jefferson-Hamilton debate over the constitutionality of the Bank of the United States in favor of Hamilton), an attack on paper money (“Congress have established a mint to coin money.… The money so coined, with its value so regulated, and such foreign coins as Congress may adopt are the only currency known to the Constitution”), a defense of states’ rights, and a swipe at the economic elites (“It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes.”)
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In private, Jackson was more personal: “The Bank,” he said to Martin Van Buren (his running mate in 1832), “is trying to kill me,
but I will kill it
.”
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The veto held up when Jackson defeated Clay in the 1832 presidential election. Biddle did not go quietly, however. When Jackson began transferring the federal government’s deposits out of the Second Bank to his favored “pet banks,” the Second Bank demanded payment on bills issued by state banks and reduced its loans by over $5 million, contracting the money supply and causing interest rates to double to 12 percent. Biddle hoped, by damaging the economy, to stir up opposition to Jackson; in the process, he showed that Jackson had not been wrong to fear the power of a major bank to distort the economy for its own purposes.
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Eliminating the most efficient commercial bank in the United States was probably not a textbook example of sound macroeconomic management, especially according to today’s textbook. Jackson’s veto most likely slowed the development of an integrated payments and credit system such as those seen in more advanced parts of Europe.
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Without a major national bank or a central bank with the ability to stabilize the financial system, the U.S. economy also suffered through severe business cycles through the rest of the nineteenth century.

However, the primary importance of the Bank War was not economic, but political.
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Although Jackson’s economic grounds for opposing a new charter may have been weak, the Second Bank’s behavior showed the political danger presented by a powerful private bank. Biddle was able to bribe, cajole, or otherwise pressure congressmen into taking his side against the president. Not all of the Bank’s supporters were in it for the money. But as the war raged, Daniel Webster wrote to Biddle, “I believe my retainer has not been renewed or
refreshed
as usual. If it be wished that my relation to the Bank should be continued, it may be well to send me the usual retainers.”
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More ominously, at least as interpreted by Jackson’s supporters, Biddle had attempted to hold the economy hostage to his political ends, first expanding credit in order to gain political support and then withholding it (and triggering a recession) in order to punish Jackson.
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This was exactly what Jefferson had feared.