from the Richmond Fed
— this post authored by Robert L. Hetzel and Gary Richardson
Our nation’s founding fathers debated whether the United States should have a national bank. In 1791, Congress chartered the first Bank of the United States to handle the financial needs of the federal government and the credit and coinage of the nation. The charter expired after 20 years. Five years later, in 1816, Congress chartered a second Bank of the United States, whose charter also expired after two decades.
When its charter expired, Congress failed to override President Jackson’s veto of its rechartering. Congress could not agree on a successor because of disagreement about the government’s role in money, banking, and financial regulation and about the states-rights issue of the desirability of a bank with nationwide powers (Jaremski and Rousseau, forthcoming; Timberlake 1993).
The Fed was founded in response to periodic banking crises and the recurrent financial instability that plagued the United States in the 19th century (Sprague 1910; Wicker 2000). The precipitating crisis emerged in 1907 with a severe financial panic that spread from the money-center of Manhattan throughout the nation. Congress took the first step toward reform in 1908 when it passed the Aldrich-Vreeland Act, which created the National Monetary Commission. The commission studied the monetary and banking systems of leading countries in Europe. Its final report focused on flaws in the dual-banking system with its federal and state chartering of banks. The letter transmitting the final report to Congress summarized 17 “principal defects in our banking system” (National Monetary Commission 1912, 6).
Thirteen of the 17 related to the fragility of the financial system. The first defect was the immobility of cash reserves in times of trouble. The fifth was the lack of an organization larger than a city clearing house that could coordinate actions “to prevent panics or avert calamitous disturbances affecting the country at large.” The sixth was the lack of a lender of last resort, particularly one that could cover the entire country or shift reserves from one place to another to prevent “disastrous disruptions” of the payments system. The seventh was the lack of a lender of last resort that could deal effectively with international gold and currency flows during financial crises. The eighth through 12th pointed to the illiquidity of financial assets, particularly short-term commercial paper, in times of crisis and even during periods of normal seasonal flows. Most of these points related to risks posed by financial panics when in the absence of a lender of last resort commercial banks could not access reserves, sell assets, cooperate effectively, or counteract interregional and international flows.
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Source: https://www.richmondfed.org/-/media /richmondfedorg/ publications/ research/ working_papers/ 2016/ pdf/ wp16-01.pdf
