All Commentary
Saturday, April 1, 1995

The Forgotten Private Banker

How Did Unlicensed, Unregulated Banking Give Way to Today's System?

Dr. Sylla is Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics at the Stern School of Business, New York University, and a Research Associate of the National Bureau Of Economic Research.

What is a private banker? Or rather, since the species has more or less disappeared, what was a private banker? Private bankers, to American banking historians, were individuals and organizations that engaged in the business of banking without first obtaining a permit to do so from governmental authorities. As a consequence, the private banker often was free to practice the banking trade with little or no governmental regulation. That was one of the private banker’s principal advantages. But it also became a leading reason for the private banker’s undoing and eventual disappearance from the economic scene.

Today, when nearly every U.S. (and foreign) bank operates under a license from, and is regulated by, one or more governments, the idea that the provision of banking services could be left to market forces might strike many people as somewhat bizarre and perhaps even dangerous. Nonetheless, this idea was central to the development of the banks and banking systems of England and continental Europe during much of the seventeenth, eighteenth, and nineteenth centuries. The celebrated Rothschilds, for example, were private bankers, and so were all the banks of England–except the Bank of England–until the second quarter of the nineteenth century.

Prominent U.S. Private Bankers

Given the new world’s roots in the old, it is not surprising that the idea and the practice of unlicensed, unregulated banking would migrate to the United States. Indeed, a number of the leading figures and financial institutions in U.S. history were private bankers and banks. Alexander Hamilton was instrumental in founding the Bank of New York as a private bank in 1784, although less than a decade later the bank applied for and received a charter from the state of New York. This venerable American institution still carries on its business from its headquarters at 48 Wall Street. Across the street, at 59 Wall Street, is Brown Brothers Harriman & Co., the only remaining private bank of any size in the United States; it is the exception that probes the rule that banks ought to be licensed corporations. This bank began its career in Philadelphia in 1818 as the Merchant Bank of Brown Brothers, with representative branches in Baltimore and London. It moved its headquarters to New York in 1825.

At 60 Wall Street, next to the Bank of New York, are the headquarters of J. P. Morgan & Company. The Morgan bank is now a corporation, but it was a private bank during the time of its legendary founder, John Pierpont Morgan (1837-1913), and it remained so long after his passing. Another noted private bank was the Bank of Stephen Girard in Philadelphia. Girard, possibly the wealthiest American of his era, operated this bank from 1812 until his death in 1831. Girard’s bank took over the building of the first federal bank of the United States after that institution passed out of existence in 1812. The structure still stands as a prominent feature of Independence National Historical Park in Philadelphia.

Extent of Private Banking

Most of America’s private bankers were not as large or as prominent as the ones identified here. But they were quite numerous in U.S. history, especially in the early decades. In 1856, U.S. Treasury Secretary James Guthrie reported to Congress on a survey of the extent of private banking as compared with that of licensed, that is, “chartered” state banks. Guthrie found the capital of private bankers to be at least $118 million, which was more than a third of the capital of the state-chartered banks. He went on to note, “The combined capital in chartered and unchartered banks being over $460,000,000, proves that banking is a favorite as well as a profitable business, and does not need chartered privileges to generate or protect it.”[1] My own work on U.S. banking history in antebellum times led to an estimate of more than 700 private bankers operating in the country by the mid-1850s.[2] If the estimate is close to accurate, about one American bank in three was a private bank at the time.

Even then, however, private banking had entered a protracted period of relative decline that would in time lead to its virtual disappearance. Secretary Guthrie’s statement to Congress that banking did not require “chartered privileges to generate or protect it” probably indicated that even by 1856 most people thought otherwise. Why?

Private Banking and the Public Interest

There are, it seems, two possible sets of answers to the question of why banks ought to be licensed and regulated by governmental authorities. One involves public interest arguments. If banks are not licensed by government, then there is a greater probability that scoundrels and crooks will enter the banking business. And without continuing governmental oversight by government-appointed bank examiners, such bankers would mismanage or even abscond with the funds entrusted to them by the public. Since each bank is a component of the banking and monetary system, a few such “bad” bankers could undermine, even destroy, the whole system, which is built on confidence.

These are microeconomic considerations. But they have obvious macroeconomic implications. A “crisis of confidence” in banking could cause a monetary collapse and plunge the economy into depression. At the other extreme, unregulated banks might flood the economy with money in the form of bank notes and deposits created by making excessive loans. Unsustainable inflation would result before the arrival of the inevitable collapse. To prevent either extreme of too little or too much money from happening, the argument goes, governments must regulate banks to provide just the right amount of money for sustainable, noninflationary economic growth.

There are problems with these public-interest arguments. It is not evident, for example, why customers would deal with, or allow themselves to be victimized by, scoundrels and crooks in banking more than in other businesses that are unlicensed and unregulated. Moreover, it is amply evident from history, even quite recent history, that governmental licensing and regulation have prevented neither individual bank frauds and failures nor depressions and inflations. But here I shall only mention these still vigorously debated issues without further exploring them. The so-called public-interest arguments in fact had little to do with the decline of private banking.

The Political Economy of Banking

The decline of private banking had far more to do with the self-interest of both government officials and the non-private banks they licensed and regulated than with the public interest. The United States of the 1780s and 1790s was both capital poor compared to the West European countries and free of the English laws that required banks to be entities with unlimited liability and no more than six partners. In these circumstances, most early U.S. banks were institutions chartered by state legislatures as limited liability corporations. Attracted by limited liability, their owner-shareholders clubbed together their limited liquid funds to start the banks, through which they then made loans to each other and to non-owner customers. In return for their charters representing governmental authorization to provide banking services, the banks agreed to make loans to, and perform other services for, the states that granted them their charters. The states especially liked this arrangement after the adoption of the U.S.Constitution, for that document prohibited them from continuing the century-old practices of colonial, and then state, governments of issuing fiat paper money. Because of the Constitution, the states could no longer pay their bills by printing state paper money, but they could still charter banks that issued money.

The earliest state-chartered banks were thought of by legislators, shareholders, bankers, and the general public as public utilities. They were given exclusive privileges, namely monopolies of banking in their towns, in return for providing financial services to the state and the public. As the American economy grew and prospered, these state-chartered banking monopolies became highly profitable. Inevitably, new banks sought to enter the field to get their piece of the action, whereas those already in the field sought to keep out the would-be entrants. Resolution of these conflicting politico-economic pressures took several decades. The ultimate result in the leading commercial and industrial states was an American version of “free banking,” which meant relatively free entry into banking provided the bank agreed to follow rules and regulations prescribed by state governments.

State legislatures and individual legislators thrived on the early American procedure of chartering banks individually by specific legislative acts. The grant of a bank charter gave the grantees a lucrative set of privileges not possessed by others. Bank charters therefore had economic value. The states and the legislators were not oblivious to this fact. They responded to it by charging the banks for their charters. These charges sometimes took the form of bonus payments to the states when charters were granted or renewed. They also took the form of bank stock issued to state governments on favorable terms so that the states could share in bank profits. Other types of charges included special taxes placed on banks and of state directives to the banks to finance out of bank resources certain institutions (such as schools) that the states deemed worthwhile.[3] These were above-the-board payments the states could demand of the banks in return for grants of charter privileges. They were popular because they kept down taxes on individuals. In addition, there were under-the-table payments to individual legislators for seeing that some banks received charters and that others did not. In state capitals, because of all these payments for privileges, bank chartering and state politics more or less became extensions of each other.

Enter the Private Banker

On account of all the political considerations involved in bank chartering, the number of chartered banks grew more slowly than it might have, given public demands for banking services. And for good reason. Charter values, and hence the payments that states and individual politicians could extract from banks, were greatly enhanced by restricting entry into banking. Restrictive chartering practices created a yawning gap for the private bankers. A demand for banking services was there, and growing. The chartered banks, the states’ creatures, were not meeting the demand for politico-economic reasons that had little to do with economic efficiency. And nothing, at least for a brief time, prevented individuals and partnerships from plying the trade of banking without a license, just as private bankers long had done in England and Europe.

We do not know how many private bankers entered the field. Their numbers must have been large, however, at least large enough to annoy both the chartered banks and the state legislatures. The former had paid for their charters; the latter had received the payments. Unauthorized competition in banking threatened to undermine this neat political arrangement.

Hence, between 1799 and 1818, no fewer than eleven states and the District of Columbia enacted laws to restrict private banking. The larger states, where private banking likely was most vigorous, acted on more than one occasion. New York passed four acts to restrain private banking between 1804 and 1818, Pennsylvania three, and Virginia two.[4] The typical restraining act either banned private bankers from issuing their own bank notes, which was the primary method of providing bank credit at the time, or it laid a prohibitive tax on such note issues.

Such legislation served two politico-economic purposes. It reduced or eliminated competition for existing chartered banks, thereby raising the value of bank charters and the payments the states could extract for granting them. And it drove many private banks into applying for charters, so that they, too, would have to pay the tolls levied for governmental authorization to engage in banking.

Nonetheless, private banking persisted in the United States for decades. Privacy and minimal regulation were among its advantages, but the main reason for its persistence was that the states, and later the federal government, dragged their heels in chartering enough banks to satisfy the demand for banking services. American state governments and public officials were not inept in their slowness to charter banks. Both they and the banks already in the field had a financial interest in restricting banking development. That this interest was different from, and even inimical to, the real public interest was a small consolation to the private bankers. They were harassed by restraining acts and eventually driven out of banking or into “authorized” banking on terms set by government.

An Implication for Our Time

Although the private banker, with few exceptions, passed long ago from the economic scene, the history of U.S. private banking sheds light on quite recent events. In September 1994, the 103rd Congress enacted legislation to allow interstate banking. Thus, early in the third century of the republic, American banks at last obtained the freedom to do what flour millers, meat packers, and clothing manufacturers could always do, namely market their products throughout the country.

Why did it take so long? The fundamental reason, I think, is that in U.S. political economy banking is the last bastion of states’ rights. Banking is the one area of regulated economic life in which the federal government almost always has deferred to the preferences of the states.

Federal deference to states’ rights is unusual in American history. The Constitution transferred substantial but limited economic powers from the states to the federal government. During the first century of the republic, Congress and the federal courts used those powers to prevent the states from interfering with the emergence of a nationwide free trade area. And during the second century of the republic, right up to the present, the federal government further weakened states’ rights through federal laws, regulations, programs, and mandates that, for good or ill, increased the political and financial clout of the government in Washington relative to the governments of the states.

Given this record, how did the states manage until 1994 to resist the federal juggernaut and maintain their power to regulate their own chartered banks as well as federally chartered banks operating within their boundaries, and to keep out banks chartered by other states? No doubt many reasons could be given. But underlying all of them must be this: Banking became the last bastion of states’ rights because it was the first bastion of states’ rights to matter in govemment-regulated economic life.

Early in U.S. history, the financial interests of state governments and politicians became substantially wedded to the interests of the banks they had chartered. Because banking was the first great corporate interest to be regulated in our history, state governments and banks together were able to resist encroachments into their terrain by outsiders in ways that later corporate interests, less regulated and less intimately tied to state financial interests, were not. Private bankers as a class were only one of the trespassers on the intertwined interests of the state-chartered banks and the state governments that chartered them. The first and second Banks of the United States established by the federal government were likewise trespassers. Like the private bankers, the two federal banks were beaten down and, in 1812 and 1836, eliminated by powerful coalitions of state banks and state governments. In most areas the federal government discovered ways to override parochial state interests, but in banking it was itself overridden. Hence, the federal government learned the hard way to accommodate itself to state interests in banking, for a longer time than made much sense. The fragmented U.S. banking system, which continues to look peculiar when compared with the banking systems of other countries, is a result of the defeats suffered by both private bankers and the federal government in the early decades of the republic’s history.

1.   U.S. Secretary of the Treasury, “Report on Banks,” (1856), 34th Congress, 1st Session, House Executive Document No. 102, p. 1.

2.   Richard Sylla, “Forgotten Men of Money: Private Bankers in Early U.S. History,” Journal of Economic History 36, March 1976, pp. 173-88.

3.   Richard Sylla, John B. Legler, and John Joseph Wallis, “Banks and State Public Finance in the New Republic; The United States, 1790-1860,” Journal of Economic History 48, June 1987, pp. 391-403, and John Joseph Wallis, Richard E. Sylla, and John B. Legler, “The Interaction of Taxation and Regulation in Nineteenth Century U.S. Banking,” in Claudia Goldin and Gary D. Libecap, eds., The Regulated Economy: A Historical Approach to Political Economy (Chicago: University of Chicago Press, 1994), pp. 121-44.

4.   Sylla, “Forgotten Men of Money,” p. 182.