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The Panics of the National Banking Era and the Creation and Early Form of the Federal Reserve System David Mitchell Economics 4 ! The common occurrences of banking panics in the United States prior to the creation of the Federal Reserve System had some similar qualities that slowly changed the views on banking regulation. However the panics of !"#$ and the incipient panics of !""% and !"&' did little to galvani(e a force large enough to implement a central bank or lender of last resort in the United States. )t was not until the *anic of !&'# and the special circumstances that surround it that convinced many there needed to be a central bank for the stability of the financial and banking system. +nce created the Federal Reserve System did not look e,actly like the Federal Reserve we know today. The form the Federal Reserve took in its infancy was much more decentrali(ed than what we see today. The *anic of !"#$ and the incipient panics of !""% and !"&' did very little to change attitudes on banking regulation. The *anic of !"#$ had its origins not in the United States but in -urope.! .hile much more severe than the banking disturbances later seen in !""% and !"&' it was still less serious than the *anics of !"&$ and !&'#. The /ew 0ork 1learing House was the main lender of last resort in the United States during this period. )t responded to this banking panic by issuing loan certificates and pooling or equali(ing the reserves of its member institutions to stem bank runs and the panic in general. The clearinghouse also suspended cash payments a move not made in !""% and !"&'. )t is generally well regarded that the private2sector response in the *anic
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.icker Banking Panics of the Gilded Age !3.

6 of !"#$ was sufficient and restored confidence to the banking system. The private2sector response to the disturbances of !""% and !"&' were even better. The /ew 0ork 1learing House was very prompt on issuing loan certificates to halt the spreading of the financial stringency. 4ank failures were very few in number and the disturbance largely was contained in /ew 0ork and did not spread much into the interior. There did not seem to be a need for an official lender of last resort or central bank. The responses of private2 sector institutions were seen as satisfactory. The ne,t panic the United States faced was much more severe and was differed from earlier panics in one ma5or way. The *anic of !"&$ had its origins in the interior of the banking system. Since the member banks of the /ew 0ork 1learing House were not directly affected the clearinghouse was much slower in its response than they were in !"#$ !""% and !"&'.6 7ttitudes among bankers in /ew 0ork had also changed in such that the banks did see it as their responsibility to shore up interior banks.$ )t was also during this period that the battle over the free coinage of silver was really gaining momentum. The attention of those who would support a formal lender of last resort was drawn to this battle. This is not surprising as the most pressing problem to people especially farmers and those in the west during this period was the severe deflation and economic depression being e,perienced in the United States. The distraction of free silver coinage would be mortally wounded with the defeat of .illiam 8ennings 4ryant in the presidential election of !"&3 and vanquished completely with the passage of the 9old Standard 7ct in !&''.

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$ +ne panic in particular was the ma5or tipping point for the creation of a formal lender of last resort. The *anic of !&'# was truly unique among the /ational 4anking -ra panics. )n the years leading up the panic trust companies had started to play a much larger role in the financial system of the United States. )n fact -lmus .icker refers to it as the Trust 1ompany *anic of !&'#.% The /ew 0ork 1learing House did not and technically could not help alleviate the panic in financial markets. The clearinghouse had raised the minimum the cash reserve ratio a trust company must maintain to be a member. The ratio had risen from #.:; in !&'$ up to !:; by 8une !&'%.: This caused the ma5ority of the trust companies in /ew 0ork to withdraw their membership from the clearinghouse. .hen the panic struck the trust company market and runs began on some of the largest trusts of the time namely the <nickerbocker Trust 1ompany the /ew 0ork 1learing House could not step an issue loan certificates to the trust companies. =oans and deposits actually rose at /ew 0ork banks at the e,pense of the trust companies because depositors were fleeing to safety.3 Trust companies were a ma5or source of risk to financial markets and the *anic of !&'# proved that it could severely disrupt the financial system. .ith only a few of the trusts in /ew 0ork members of the /ew 0ork 1learing House there was no way to stop the turmoil if it originated from trusts. Trust companies posed a systemic risk to the financial system and they were outside the emergency loan provision capabilities of the /ew 0ork 1learing House. This risk was what swayed the influential /ew 0ork banker>s opinion of a central bank and they

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% actively supported early efforts to establish one.# 7fter contentious political debate *resident .oodrow .ilson signed the Federal Reserve 7ct into law on December 6$ !&!$. The act called for establishment of Federal Reserve 4anks provide a currency that was elastic afford a means of rediscounting commercial paper and establish better supervision of banking." 7n inelastic currency is a commonly referred to contributor to the creation of the Federal Reserve System and this is certainly true. )t however it did not significantly sway attitudes that a formal lender of last resort was needed. The panic caused by trust companies did sway attitudes towards a central bank. -ven though the /ew 0ork banks started pushing for central bank they would not get everything they wanted in a central bank. Democrats sei(ed control of 1ongress in !&!6 and it was them who had final say over the creation of the Federal Reserve. The Federal Reserve System in its early form was quite different than what we are used to with our centrali(ed modern Federal Reserve. The Federal Reserve System initially had twelve regional reserve banks that operated autonomously much more so than they do today. 4anks could become members of the reserve banks by buying stock of the their respective regional bank. 7fter buying into the regional bank the Federal Reserve then provided them 3; annual return on the value of their stock.& 7lso the Federal Reserve was first and foremost subordinate to the gold standard which the United States adhered to. The principal function it was created to perform was aiding
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United States. 1ongress @Federal Reserve 7ct.B Studenski and <rooss Financial History of the United States 6:"C63'.

: member banks when they were short liquidity. ?any of the later instruments used by the Federal Reserve to manipulate the banking system were still in a state of infancy or thought to be of no use. Two of these instruments that were neglected early were fle,ible reserve requirements and the most important function of today>s Federal Reserve open market operations.!' -ven as the government was attempting to iron out the kinks of the system it still greatly improved than the one before the adoption of the Federal Reserve 7ct. The new system helped alleviate the problem of an inelastic currency ended the pyramiding of reserves and increased the efficiency of check clearing. 7lso by becoming the primary fiscal agent of the Treasury it centrali(ed control of the discount rate and gold stock which could be used in times of crisis.!!

References

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Studenski and <rooss Financial History of the United States 63!. Studenski and <rooss Financial History of the United States 63'.

3 ?oen 8on R. and -llis .. Tallman. @.hy Didn>t the United States -stablish a 1entral 4ank until after the *anic of !&'#EB Federal Reserve Bank of Atlanta !&&& no. !3. .orking *aper Series G/ovember !&&&HA $!. ?oen 8on and -llis .. Tallman. @The 4ank *anic of !&'#A The Role of Trust 1ompanies.B Journal of Economic History :6 no. $ GSeptember !&&6HA 3!!C$'. Studenski *aul and Herman -dward <rooss. Financial History of the United States Fiscal! "onetary! Banking! and #ariff! $ncluding Financial Administration and State and %ocal Finance. /ew 0orkA ?c9raw2Hill !&3$. Federal Reserve 7ctA *ublic =aw 3$2%$ 3$d 1ongress H.R. #"$# *ub. =. /o. 3$2%$ $" Statutes at =arge 6:! G!&!$H. httpAfraser.stlouisfed.orgIpublicationIEpidJ&33 .icker -lmus. Banking Panics of the Gilded Age. /ew 0orkA 1ambridge University *ress 6'''.