Saturday, January 31, 2009

How NYC Became the World's Banking Capital







Banking and PoliticsFont size

As Old As the Republic

By Gary Tilzer

Many economists are now blaming the deregulation of the banking industry by congress as the cause of the nation’s economic crisis. It is important to understand that the intimate relationship between politics and banking policy is not new, nor is its economic influence now unique. Since the nation's beginnings banking regulations have been intimately connected to politics, and the politics of banking is a high stakes game not well understood by the public. It is clearly not understood by today's elected officials who have destroyed Wall Street and the economy of New York City. A review of New York's economic history and banking policy from 1784 to the Civil War clearly shows that banks and banking policy were central to the state's economic development (and closely entwined with politics). It also shows that intelligent banking policy can further economic development while bad policy inevitably causes economic havoc.

In New York City, the intimate relationship between banks and politics began when the Bank of New York was chartered in 1784. Founded by Alexander Hamilton, the bank was the only one in the City until 1799. Hamilton used the bank for his political ambitions as it furthered his Federalist Party and the conservative economic polices it espoused. Merchants who disagreed with Hamilton's political point of view ran the risk of having their loans called in at election time.
The Federalist chartering of the First Bank of the United States in 1791 had a profound effect on the economy. It also increased the influence of the wealthy in the politics of the 1790's. Just as important to NY was the chartering in 1799 of the Bank of Manhattan by Aaron Burr. It was the City's second major bank and a direct rival to the Bank of New York and its Federalist policies. The bank was chartered to bring water to the City, in an effort to reduce the perils of the Yellow Fever epidemics.

The Bank of Manhattan ultimately became instrumental in the rise of Tammany Hall as a political force and was also an important factor in the election of Thomas Jefferson in 1800. In fact, Jefferson's election had the effect of breaking the Federalist's control of New York's commercial, financial and political institutions. The number of banks rose from 28 in 1800 to 89 in 1811. By 1816 it was up to 250. Since the only currency other than gold and silver was bank notes, a banking charter literally meant having a license to print money. The circulation of more notes from newly chartered banks enlarged the monetary supply, creating capital for an expanding economy - all of which was important to the City's economic growth. The capital for building the Erie Canal came from New York City's banks. In fact, the largest initial purchaser of Erie Bonds was the Bank for Saving of New York institutions. The state completion of the canal in 1825 was the watershed event in New York's rise as the world's premier financial center.

Nationally, banking policy had an even more profound effect on politics and the country than it did at the state level. Hamilton's First National Bank was rechartered as the Second Bank of the U.S. in 1816 by President Madison on the grounds that it was the only hope for restoring U.S. currency after the War of 1812. Both the First and Second Banks of the U.S. were private banks, privately owned and had exclusive rights to federal deposits, and thusly functioned like the Federal Reserve - controlling the money supply and the flow of credit. The Second Bank continued to push both conservative policy and politics.

President Andrew Jackson like all traditional Jeffersonian Democrats, opposed large, centrally controlled financial institutions. Thus Jackson and his supporters charged that the Second Bank was a tool of the moneyed aristocracy and was intent on oppressing working people. Jackson's veto of the Second Bank's recharter became a major issue in the 1832 election. Support from the working classes including Tammany Hall helped lead Jackson to re-election. Jackson's veto of the recharter and the subsequent withdrawal of federal deposits had broad repercussions. One effect was to shift the financial center of the country from Philadelphia to New York, where it remains to this day. A second and more far-reaching effect was to cause the Bank of the United States to contract the nation's money supply, causing widespread economic panic and a depression.

In contrast to federal banking policy, New York's policy was much more far-sighted and intelligent. The Erie Canal was financially successful beyond its most enthusiastic bankers' wildest expectations. The $7 million borrowed to build the canal was quickly repaid and shrewdly deposited, unlocking banks with a view to furthering economic development across the state. Additionally, in 1839, New York set up the Safety Deposit Fund which all state banks were forced to join. The fund insured depositors against bank failures and fund officials had the right to review the solvency of New York's Banks. This was the forerunner of the Federal Deposit Insurance Corporation, and generally of state and federal banking regulations and legislation - the subject of today's controversy. These state regulations played a prominent role in the state's rise as the nation's financial center and in the prosperity this city has enjoyed until now.
The history has broad implications for the current debate over banking regulations and debate over nationalizing the nation's banking system. The large amounts of money at stake, combined with the high cost of modern political campaigns, must also raise questions about the potential influence of bank money in politics. Banking policy is much too important to be left in the hands of bankers and politicians - it must be understood and debated by the community as a whole.

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