President of a young country in need of a banking system, George Washington signed legislation passed by Congress in 1791 creating the First Bank of the United States — an effort at creating a central bank whose charter would need to be renewed every 20 years.
The driving force behind the creation of the First Bank was Alexander Hamilton, treasury secretary under Washington. In the post-revolutionary period, Hamilton was arguably the biggest booster of the young industrial revolution model of economic development, which had begun in Great Britain. He initially thought the First Bank might perform some functions of a commercial bank, like lending to businesses.
The Federal Government’s Fiscal Agent
Getting the First Bank of the United States up and running was no easy task for Hamilton. The opposition thought the bank would increase federal power too much. Prominent politicians like Thomas Jefferson and James Madison were leery of that possibility. Jefferson, for example, saw the future of the United States as more pastoral rather than industrial, arguing that the bank was unconstitutional.
Hamilton believed the bank was needed to stabilize and bolster the new nation's creditworthiness; to improve the handling of the financial business of the new federal government under the newly enacted constitution; and to make it easier for the federal government to raise funds through bond sales.
A central bank of the United States was also needed so that the federal government could assume the Revolutionary War debts, pay off those debts, and bring about a national currency.
The vast majority of banks in the U.S. at the time were chartered by states and were only allowed to have branches in that state.
Congress chartered The First Bank of the United States in 1791. But the First Bank did not perform the functions of a modern central bank. It did not set monetary policy, regulate private banks, hold banks' reserves, or act as a lender of last resort. It was national insofar as it was allowed to have branches in multiple states and lend money to the U.S. government. The vast majority of banks in the U.S. at the time were chartered by states and were only allowed to have branches in that state.
Second Bank of the United States: 1816-1836
By and large, the First Bank of the United States was considered a success, and a prominent group of businessmen in 1815 — four years after the bank’s charter was supposed to have been renewed — appealed to Congress to create a Second Bank of the United States. President James Madison had opposed the creation of the first bank but agreed the bank should be renewed, mainly because he thought it was needed to help fund the fight against the British in the War of 1812.
But in 1814, when peace talks with Britain seemed to be going well, Madison temporarily withdrew his support for the bank. When peace came in 1815, Congress was initially opposed to renewing the bank’s charter. But the federal government’s financial position had deteriorated — to such an extent that some state-chartered banks stopped accepting federal notes. Finally, in April 1816, Madison relented and signed legislation creating the Second Bank of the United States.
President Andrew Jackson, like Madison and Jefferson before him, was suspicious of the Bank of the United States, and banks in general. When Congress voted to renew the bank's charter early, in 1832, Jackson vetoed the legislation.
One of the reasons Jackson was so suspicious of the banks was personal. A land deal he had done more than two decades prior to his presidency hadn’t gone well. Jackson had accepted a banknote — essentially currency — in exchange for land. When the issuers of the note went bankrupt, Jackson was left holding worthless paper.
Jackson also thought the Bank of the United States was essentially unconstitutional, trampling on state’s rights. He also felt the bank put too much power in the hands of too few people and operated too far outside the jurisdiction of Congress.
The fact that Congress did not have enough votes to override Jackson’s veto was one key reason the bank’s charter was not renewed. But another key event that all but assured the bank’s demise was that Jackson made a decision to move the federal government’s deposits from the Bank of the United States to state-chartered banks, greatly restricting the Bank of United States’ ability to do business.
Unfortunately, another attempt at central bank creation wasn't made until after the turn of the 19th century. In the interim, there were no less than 8 banking panics in the years after the Civil War and into the very early 20th century.
One result of all these panics was that in the 1890s there was more and more thought being given to reforming the U.S. banking system.
Back then, as now, New York was the nation’s financial center, and many of the panics — 1884, 1890, 1899, 1901, and 1908 — stayed confined to New York and its environs. Other panics, for example, those in 1873, 1893, and 1907, were more serious and went nationwide.
In the panics of 1884 and 1890, the New York Clearing House, through which financial institutions cleared trades, attempted to act like a central bank by pooling the reserves of its clients and providing liquidity where needed. It successfully stopped some runs on banks in those years.
Economist Elmus Wicker, who made a specialty of studying panics of the late 19th century, said the actions by the New York Clearing House in the 1884 and 1890 panics went further than European central banks of the time, taking highly aggressive steps to quell the crises.
One result of all these panics was that in the 1890s, there was more and more thought given to making reforms to the U.S. banking system. For example, after the 1894 panic, the American Bankers Association, the secretary of the Treasury, and the comptroller of the currency all proposed banking reform legislation.
Creation of the Federal Reserve
The impetus behind the creation of the Federal Reserve was a series of events that sparked runs on banks in New York. The federal government did not have a functioning central bank to bail out those banks.
The panic of 1907, showed that one man had more power in financial markets than the United States government, an untenable situation.
Ultimately, famed financier J.P. Morgan provided the funds that were needed to end what came to be called The Panic of 1907. But the crisis showed that one man had more power in financial markets than the United States government, an untenable situation.
In 1911, Congress set up a committee to examine the creation of a modern central bank. The Federal Reserve opened for business in 1913 and since has played a key role in financial market stability.