The Mystery of Banking

Party became even more Jacksonian, more ardently dedicated to
hard money, than ever before. The Democrats strived during the
1840s and 1850s, for the outlawing of all fractional reserve bank
paper. Battles were fought during the late 1840s, at constitutional
conventions of many western states, in which the Jacksonians
would succeed in outlawing such banking, only to find the Whigs
repealing the prohibition a few years later. Trying to find some
way to overcome the general revulsion against banks, the Whigs
adopted the concept of 
free banking
, which had been enacted in
New York and Michigan in the late 1830s. Spreading outward
from New York, the free banking concept triumphed in 15 states
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Central Banking in the United States II
215
by the early 1850s. On the eve of the Civil War, 18 out of the 33
states in the U.S. had adopted free banking laws.
9
It must be emphasized that free banking before the Civil War
was scarcely the same as the economic concept of free banking we
have set forth earlier. Genuine free banking, as we have noted,
exists where entry into the banking business is totally free, where
banks are neither subsidized nor controlled, and where at the first
sign of failure to redeem in specie, the bank is forced to declare
insolvency and close its doors. 
Free banking before the Civil War, however, was very differ-
ent. Vera C. Smith has gone so far as to call the banking system
before the Civil War, “decentralization without freedom,” and
Hugh Rockoff labeled free banking as the “antithesis of laissez-
faire banking laws.”
10
We have already seen that general suspen-
sions of specie payments were periodically allowed whenever the
banks overexpanded and got into trouble; the last such episode
before the Civil War being in the Panic of 1857. It is true that
under free banking incorporation was more liberal, since any
bank meeting the legal regulations could be incorporated auto-
matically without having to lobby for a special legislative charter.
But the banks were subject to a myriad of regulations, including
edicts by state banking commissioners, along with high minimum
capital requirements which greatly restricted entry into the bank-
ing business. The most pernicious aspect of free banking was that
the expansion of bank notes and deposits was tied directly to the
amount of state government bonds which the bank had invested
in and posted as security with the state. In effect, then, state gov-
ernment bonds became the reserve base upon which the banks
9
Hugh Rockoff, 
The Free Banking Era: A Re-Examination
(New York:
Arno Press, 1975), pp. 3–4.
10
Vera C. Smith, 
The Rationale of Central Banking
(London: P.S. King
& Son, 1936), p. 36, also ibid., pp. 148–49, Hugh Rockoff, “Varieties of
Banking and Regional Economic Development in the United States,
1840–1860,” 
Journal of Economic History
35 (March 1975): 162, quoted
in Hummel, “Jacksonians,” p. 157.
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The Mystery of Banking
11
Bray Hammond, 
Banks and Politics in America: From the Revolution
to the Civil War
(Princeton, N.J.: Princeton University Press, 1957), p. 627.
On the neglected story of the Jacksonians versus their opponents on the
state level after 1839, see William G. Shade, 
Banks or No Banks: The Money
Issue in Western Politics, 1832–1865
(Detroit: Wayne State University Press,
1972); Herbert Ershkowitz and William Shade, “Consensus or Conflict?
Political Behavior in the State Legislatures During the Jacksonian Era,”