The
r ounding
Father
American
Financial
Disaster
How Thomas Jefferson s hatred of money
men spawned an unruly regulatory and
banking system and led to our current crisis
By John Steele Gordon
i
• í«
NO ONE DOUBTS THAT THOMAS JEFFERSON was a
genius who deserves his place on Mount Rushmore. His words in
the Declaration of Independence still express what this country has
been ahout for 232 years: life, liherty and the pursuit of happiness.
But he wasn't a saint.
He was an aristocrat who despised and
feared aristocracy, a lover of liberty who
lived off the labor of slaves, an intellectual
who had more interest in theory than facts.
He cleverly devised the world's first decimal currency—a dollar divided into 100
cents—but never tried to understand the
mechanisms that are necessary to keep that
currency functioning reliably in the real
world, because he hated banks.
We have been paying a high price for
Jefferson's disdain ever since. His hatred of
"money men" and commerce led to an
unruly banking and regulatory system prone
to periodic and catastrophic breakdowns.
Today America has more banks than all the
world combined and a fragmented fmancial
regulatory system that adds to the chaos.
The seeds of our present-day financial
crisis were sown during Jefferson's epic
battles with the first secretary of the
Treasury, Alexander Hamilton, who was
every bit his intellectual equal. Jefferson
was an elitist, the scion of one of the richest families in Virginia whose earliest
memory was of being carried on a pillow
by a slave. Hamilton, orphaned hefore he
Jefferson's dictum that institutions must "keep
pace with the times" is etched in stone at his
Washington, D.C., memorial. But the chaos aeated by his hatred of banks still haunts America.
IBflAHIM/GETTV IMAGES
Jefferson set America on a course to
bank failure, a chaotic money supply
and a boom-and-bust cycle
was 10, ^ e w up working in a trading house in St. Croix in
the West Indies, where he learned the rough-and-tumble of
the marketplace first hand.
Jefferson and Hamilton clashed over the massive leftover
war debts from the Revolution, an unstable money supply and
whether the countr>- needed a central bank. At first, Hamilton
won, and got the young republic on a sound financial footing
by establishing a coherent, disciplined banking system. But
Jefferson and his allies eventually destroyed Hamilton's system
and set America on a course to bank fraud and failure, a chaotic money supply and a boom-and-bust cycle that has resulted
in major financial crises about every 20 vears.
Alexander Hamilton
was not honored
with a monument,
but a statue of him
stands watch outside
the Treasury building
in Washington, D.C.
AMERICA'S FIRST FINANCIAL PANIC occurred in
1792. A classic stock bubble had been growing for montbs.
Rising securities prices induced dreams of unbounded wealth
acquired with no effort, and speculation became bold. Then the
bubble burst. Securities values plummeted, real estate prices
piunged, credit dried up and unemployment increased. Many of
the most prominent players in the financial community became
bankrupt, and some were carted off to jail. "Ever>ihing is afloat
and destroyed," lamented one New York merchant, who noted
that "shopkeepers, widows, orphans, butchers, cartmen, g ^ deners and market women" had lost their savings.
As tbe man in charge of America's financial system, Hamilton
was appalled by tbe reckless speculation. "Tis time," be wrote just
before the bubble broke, "there should be a line of separation
between honest men ôc knaves, between respectable stockholders
and dealers in tbe funds and mere unprincipled gamblers."
Hamilton tried to confine the damage to speculators and
keep it from spreading to tbe financial system. He ordered tbe
Treasury to buy up hundreds of thousands of dollars in federal
securities, pumping liquidité' into the market, and urged banks
not to call in loans. He allowed merchants who owed duties on
goods tbey bad imported, many of whom bad been hurt by tbe
crash, to pay them with notes due in 45 days.
It worked, New York City- quickly recovered and the growing prosperity of the 1790s continued in tbe country as a
whole. Meanwhile, Jefferson was calculating: Losses totaled
about $5 million, a sum he thougbt equal to tbe value of all
New York City real estate at the time. He thus saw the panic
as the equivalent of a natural disaster, one that ruined those
who deserved it—speculators. He was indifferent, at best, to
the damage infiicted on the rest of the population.
JEFFERSON ENVISIONED A COUNTRY where farmers
who owned and worked their own land would be the dominant
force in tbe economy and politics. He feared tbe establishment
of an aristocracy, whether that aristocracy was based on land
holdings, like the nobility in England, or based on trade and
industry, like tbe burgbers wbo dominated tbe Netherlands.
And he believed that a strong national banking and financial
system might tend to help such a plutocracy.
When Hamilton was appointed Treasury secretary by
President George Washington in 1789, he was under no illusion
about the manipulative beha\âor of some men of commerce. But
he was convinced that tightly regulated money markets and
banks would cause the entire economy, including yeoman farmers, to prosper. Jefferson opposed him ever>- step of the way.
The debt left over from tbe Revolution was in arrears and
paper bills, called "continentals," bad depreciated drastically.
o ŒE SNPDER'PHOIO P
The First Bank of the
United States, rendered
in a 1799 colored line
engraving, was housed
in Philadelphia, the
temporary capital of
the fledgling republic.
In 1987 the building
was made a National
Historic Landmark.
Hamilton wanted to refund the debt and retire the paper money
by issuing bonds. Jefferson and James Madison, then a leader of
the House of Representatives, thought that only the original
holders of the debt should be paid full value. Speculators who
had bought up much of it, looking to make a profit when it was
redeemed, should get no more than they had paid.
Hamilton knew that determining the original owners of
the bonds would be difficult, if not impossible. And he realized that once government acquired the power to pick and
choose whom it owed money and how much, politics would
dominate the process and make government securities less
attractive. Hamilton was anxious to establish a well-funded
national debt to allow the government to borrow easily in
times of emergency. He also knew that the new federal
bonds could serve as capital and reserve funds for banks.
Congress backed Hamilton, rather than Jefferson and
Madison, and the new bonds sold.
Hamilton also wanted the national government to assume
the Revolutionär}' War debts of states. This was more controversial. Not surprisingly, states that hgd largely paid off their
debts—Virginia among them—were against it. So to get his
bill passed by Congress, Hamilton had to trade a big political
chip. He went to Jefferson and Madison, both Virginians, and
offered to throw his weight behind establishing the nation's
new capital on the Potomac, rather than in New York. They
agreed and the bill passed.
The third part of Hamilton's program was critical; establishing a Bank of the United States, modeled on the Bank of
England. It would be chartered by the federal government, with
shares traded publicl)-. The government would own 20 percent,
and have 20 percent of the seats on the board, It would also have
the right to inspect the books at any time.
Jefferson vehemently opposed the bank. He worried that it
would not only have the power to increase or lessen the money
supply, but could play havoc with the economy in general.
Hamilton's plans called for a $10 million capitalization. The
combined capital of the three state banks in existence was only
THE GRANGER COLLECTION, NY. HIGMT WEIDEH HISTOW» GBOUP «RCHIVE
$2 million. By deciding whether to accept the bank notes of
state banks, the Bank of the United States could hold tremendous power over state banks. That was exactly what Hamilton
had in mind to create a reliable money supply.
"I have ever been the enemy of banks, " Jefferson wrote
vears later to John Adams. "My zeal against those institutions was so warm and open at the establishment of the
Bank of the United States that I was derided as a maniac by
FOUNDING FEUD
*A bank is an
essential instrument
in the obtaining
of loans to
government'
Alexander Hamilton
*This institution
is one of the most
deadly hostiles
existing, against
the principles
and form of our
government'
Thomas Jefferson
APRIL 2009 AMERICAN HISTORY 33
the tribe of bank-mongers, who were seeking to filch from
the public their swindling and barren gains."
President Washington ultimately sided with Hamilton and
signed a bill chartering the Bank of the United States—for a
period of 20 years. Its stock, offered in 1791, was snapped up in
two hours by investors.
HAMILTON'S SYSTEM PROVED a remarkable success.
When the Constitution was adopted in 1787, the United States
was in financial turmoil, unable to pay its debts or even the
interest on them. The money supply was a hodgepodge of nearworthless bank notes and foreign coins, credit was hard to
obtain and capital was scarce. By the time Hamilton ftnished his
six-year term as Treasury secretary in 1795, American bonds
were selling at a premium in Europe, the financial system and
money supply were stable, and the economy was growing.
None of this prompted Jefferson to change his mind about
banking. All he could see were "the immense sums [that]
were...filched from the poor and ignorant." When the
Jeffersonians rose to power in the following years, they destroyed
Hamilton's system and created a fragmented banking arrangement with a money supply loosely controlled by states. In 1811
the charter of the Bank of the United States was not renewed.
The War of 1812 nearly ended in disaster because of the government's inability to borrow, so a second Bank of the United
States was established in 1816. It got oft to a shaky start and
failed to exercise much control over state banks. Andrew
Jackson, a Jeffersonian, idUed it when its charter expired in 1836.
Meanwhile, bank failures and a chaotic money supply
became as American as apple pie. Half the banks founded
between 1810 and 1820 failed by 1825. Half those founded in
the 1830s were bankrupt by 1845. By the 1850s, there were
A Short History of America's Panic-Prone Banking System
1791-1831
CENTRAL BANKING ERA
Alexander Hamilton, America's first
Treasury secretary, pushed for the
establishment of a central bank
to regulate the nation's money
supply. The bank was welcomed by
Northern merchants but viewed
as a threat to states' rights
by Thomas Jefferson and
other Southerriers.
depression. Out of 850 banks
nationwide, 343 close entirely
and 52 suffer partial failure.
1857 Panic caused by failure of a
life insurance firm leads to depression
that lasts until the Civil War
1860 & 1861 Two incipient
panics confined to New York.
1862 President Abraham Lincoln
issues $450 million in greenbacks
to pay troops.
1863-1913
NATIONAL BANKING ERA
National Banking Acts of 1863 and
1864 establish a federal system for
chartering banks, impose a tax on
state bank notes and créale the
Office of the Comptroller of the
Currency. Federal bonds bought by
banks finance Union war effort.
1866 Treasury tighteris money
supply by retiring greenbacks.
1873 U.S. goes off silver standard.
1791 First Bank of the United
States receives 20-yeaf charter.
1792 Wall Street's First Crash:
Treasury pumps money into the
market and New York recovers.
1811 First Bank charter expires
and Jeffersonians hlock renewal.
1816 Catastrophic problems funding War of 1812 prompts President
James Madison to back creation of
Second Bank of the United States.
1819 Nationwide bank panic and
depression caused by abrupt
decline in international trade,
1836-62
FREE BANKING ERA
President Andrew Jackson kills the
Second Bank of the United States
in 1836, launching era with no unified currency. State-regulated
banks circulate more than 10,000
bank notes. Half the banks founded
in the 1830s fail by 1845.
1837 Panic caused by rampant
speculation leads to five years of
34 AMERICAN HISTORY APRIL 2009
In an 1836 lithograph by caricaturist Henry R. Robinson, President Andrew Jackson battles
the Second Bank of the United States, which he denounced as a "hydra of corruption."
THE QRAW3ER COLLECT1OÍ«. NV
When hard times began to stalk rural America in
the 1920s, the number of pOOrly regulated
country banks had grov^^n to 30,000 '
more than 7,000 varieties of valid bank notes in circulation as
well as more than 5,500 fraudulent and counterfeit notes.
Publishers did a brisk business selling "bank note detectors" to
tell merchants and bankers which were fraudulent.
The lack of a central bank that could exercise control over
interest rates also made the United States prone to bigger
booms and bigger busts than other countries. In 1837, the year
after the Second Bank of the United States went out of
business, the country experienced its first catastrophic financial
panic, heralding the onset of the longest and one of the deep-
1873 Panic: Bankruptcy of
Jay Cooke and Company, a
major financier of railroads,
leads to 101 bank failures and
six-year depression.
1876 U.S. Silver Commission
investigates manipulation
of money supply and advises
reinstatement of greenbacks
and silver dollars.
1886 Two-thirds of money
supply is called in by banks, and
bank loans are suspended.
1893 Panic caused by shaky railroad financing and a run on gold
leads to failure of more than 50
banks and a major depression.
1907 Panic: A national run on
banks is contained when J.P.
Morgan organizes consortium of
New York financiers to act like a
central bank and shore up system.
1913-present
FEDERAL RESERVE
SYSTEM ERA
Federal Reserve Act of 1913 creates
12 regional banks and the Federal
Reserve Board. Federal Reserve
notes replace national bank notes.
1929 Stock market aash: 659 of
24,633 banks nationwide fail.
1930 Nationwide panic results in
1,350 bank failures.
1931 Two nationwide panics
result in 2,293 bank failures.
1932 Nationwide panic results in
1,453 failures.
1933 President Franklin 0.
Roosevelt closes banks until the
Office of the Comptroller of tbe
Currency clears them or forces
their liquidation. 4,000 banks fail.
Banking Act of 1933 increases
controls over credit and creates
Federal Deposit Insurance
Corporation (FDIC).
1951 Accord between Treasury
and Federal Reserve frees tbe Fed
from obligation to peg interest
rates to government debt and
enhances its ability to conduct
independent monetary policy.
1980-present
DEREGULATION ERA
Deregulation and Monetary
Control Act of 1980 forces all
banks to abide by Federal
Reserve's rules; allows banks to
merge; allows savings and loans
to offer checking accounts.
1982 Depository Institutions Act:
Savings and loans allowed to
make risky commercial loans and
real estate investments.
1980--85 More than 500 savings
and loans close when they can't
compete with money market
funds from investment banks.
1986-95 Half of 3,234
savings and loans close, leaving
federal insurers wirti $160 billion
in bad loans.
1987 Stock market crash: Quick
action by Fed limits financial fallout.
1998 Congress allows interstate
banking; banks start consolidations.
2008 Panic and market crash triggered by subprime mortgage crisis.
est depressions in American history. Banks failed by the hundreds. In 1857 another panic swept through the economy,
causing a depression that only ended with the Civil War.
EVER SINCE THE JEFFERSONIAN dismantling of
Hamilton's fmancial system, crisis has driven sporadic efforts
at reform. In 1863 the need to fmance the Civil War prompted
Congress to pass the National Banking Act, offering federal
charters to banks that invested two-thirds of their capital in
U.S. Treasury securities. The banks were allowed to issue
notes, but only of a uniform design and backed 100 percent
by federal bonds. Meanwhile, tbe government imposed a 10
percent tax on all other bank notes, effectively driving state
banks out of the business of printing their own currency. For
the first time since Hamilton, the country had a uniform and
dependable paper money supply.
While the national charter system was distinctly
Hamiltonian, the new national banks were not allowed to
branch across state lines. Moreover, the fmancial system grew
even more fractious as state banks continued to proliferate
after the Civil War. Many banks in the West and the South
lacked sufficient capital to meet national charter requirements.
And in many states, thanks to tbe Jeftersonian inheritance,
branch banking of any sort was prohibited.
The Panic of 1907, when tbe New York Stock Exchange
fell 50 percent from its peak the pre\nous year, was contained
only when J.P. Morgan acted as a central banker and organized the major New York banks to shore up the banking system and increase liquidity. Tbat prompted the creation in
1913 of the Federal Reserve System. But the chronic fear of
an overly powerful bank had a large influence on its design.
Instead of one central bank, headquartered in New York as
Wall Street wanted, there were 12 quasi-private regional
banks, located in cities across the country from Boston to San
Francisco. A Federal Reserve Board, comprised of public officials, met in Washington. But each bank was essentially independent and coordination among tbem was limited.
Tbe consequences were not long in coming. American
farmers had prospered during World War I, but hard times
began to stalk rural America in the 1920s. By then the
number of poorly regulated country banks had grown to
30,000. After tbe 1929 stock market crash and the onset of
the Great Depression, a tidal wave of bank failure rolled over
the economy, and there was little tbe Federal Reserve could do
about it. There were 1,350 bank failures in 1930, 2,293 in
1931, and 1,453 in 1932. Only President Franklin Roosevelt's
dramatic bank boHday prevented a general collapse of tbe
American banking system in 1933.
APRIL 2009 AMERICAN HISTORY 35
6 The system's fundamental problems are in large part
fear of central banking and strong federal
Snow higfilights the downcast faces of men in a Depression-era breadline depicted at the Franklin D. Roosevelt Memorial in Washington, D.C.
Roosevelt said the government should provide "at least as much assistance to the little fellow as it is now giving the large banks."
36 AMERICAN HISTORY APRIL 2009
A«T/QETTY IMAGES
a legacy of Jefferson's
regulation 9
Once again, crisis drove reform. This time, the Federal
Reserve was reorganized into a unified system, wdth the real
power held by the board of governors in Washington headed by
a chairman appointed by the president. The Federal Deposit
Insurance Corporation was founded to insure deposits.
But the banking system was still fragmented, with national
banks, investment banks, state banks, trust companies and savings and loan associations. Banldng regulation also remained
fragmented, with regulators sometimes acting at cross-purposes.
When the post-World War II economic boom began to
unravel in the late 1960s and the 1970s, the banking system
once more entered a crisis. The country experienced hoth stagnant growth and the highest peacetime inflation in history.
Among the hardest hit were the vast number of small savings
and loan associations. The interest those associations could pay
on deposits was limited by law, and they could not compete
•with money market funds offered by investment banks.
In a Hamiltonian banldng system, the obsolescent savings
and loans would have been liquidated or forced to merge with
larger, stronger banks. Instead Congress responded to their
calls for help with quick fixes. The result was disaster. Most
went broke in the late 1980s. Depositors' money, which was
insured, cost the government about $160 billion.
In 1998 Congress allowed interstate banking for the first
time, which set off a wave of consolidation in tbe hanking
industry. But even today there are more than 8,500 hanks of
various types nationwide, and the regulatory system remains
fragmented and ineffective.
Neither Jefferson nor Hamilton would recognize the modern financial world, vvdth its instant global communications,
vast wealth widely distributed, and money represented by bits
in interlocking computer networks. But the fundamental problems in the system are in large part a legacy of Jefferson's fear
of central hanking and strong federal regulation.
The current crisis—like the Civil War, the panic of 1907,
the Great Depression and the savings and loan collapse—provides another opportunity for basic reform. What is called for
is wbat Hamilton sought at the birth of the republic: a unified
banking system of large, diversified, well-capitalized institutions under the control of a unified, coherent regulatory system
free of undue political influence. That means fmally putting to
rest Thomas Jefferson's fear of banks and money men. Fewer
tban 2 percent of American families now live on farms. Nearly
70 percent own their homes, more than 60 percent own securities, and everyone has a direct self-interest in the prosperity
of Wall Street. In a very real sense, we are all money men now.Q
John Steele Gordon writes on business and
financial history. His most recent book on
American economics ¿t An Empire of Wealth.
APRIL 2009 AMERICAN HISTORY 37