The National Banking System (1863-1913) was the monetary structure of the United States before the founding of the Federal Reserve in 1913 and was created by the National Banking Acts, originally called the National Currency Acts, of 1863 and 1864 in the midst of the Civil War. It significantly changed the country's financial landscape compared to the previous era of "free banking" (1837-61). Most importantly, it standardized the country's currency by replacing state bank notes with national bank notes and created a multitiered credit structure where reserves were ultimately concentrated in a handful of bankers' banks. It also created a comptroller of the currency who had the power to charter and regulate the new national banks and established federal management of national banks' reserve requirements (Timberlake 1993, 86-87; Rockoff 2000, 651-52; White 2013, 8-10). These new changes to the country's monetary and banking environment created a quasi-centralized banking system wherein reserves were concentrated in a few banks, which in many ways portended the changes brought about by the Federal Reserve Act of 1913. However, less frequently described are the unique set of circumstances and the particular motivations of individuals that allowed for the creation and survival of the system during the Civil War. An account that develops the motives behind the forces of both the 1863 and 1864 acts and integrates them into a coherent narrative has not yet been explicitly described.
Although Secretary of the Treasury Salmon P. Chase is generally credited with proposing the system to Congress in 1863 and being one of its most dedicated supporters, Chase would not have had nearly the success he did if it were not for his financial and familial connections with Philadelphia investment banker Jay Cooke of Cooke & Co. Jay and his helpful brother, Washington lobbyist Henry Cooke, were indispensable in getting the act passed by means of their crucial lobbying to Congress in the winter of 1863. They did so not merely out of patriotic love for their country and desire to change the country's financial system but also out of the wish to gain financial benefits. In particular, Jay Cooke, who became the main seller of Union bonds in 1862 through his connections with Chase, believed he could more easily sell the federal debt under the new monetary arrangement because national banks had to purchase federal bonds if they wanted to issue national bank notes.
Although Jay Cooke enthusiastically sponsored the 1863 act, many others, including the prestigious banks in New York City, did not, and it was only through Cooke's organizing of several national banks that the system was able to survive in its formative months. These prestigious banks were against it mainly because of their earlier troubles with Secretary Chase over financing the war, they did not see the benefits of issuing national bank notes, and, most importantly, they would lose a significant portion of their business by no longer acting as bankers' banks for banks in other large cities, who before the act was passed were allowed to keep part of their reserves in the form of bank deposits in New York City under existing state banking laws. Therefore, in order for the structure to obtain nationwide acceptance, it had to be favorable in New York City, and, as a result, an amendment to the act was crafted in 1864 to motivate them to join. The most important enticement allowed national banks in other large cities to count as part of their reserves any deposits they held at national banks in New York City, which created the familiar three-tiered banking structure of country banks in small cities, reserve city banks in large cities, and central-reserve city banks in New York City. In the end, reserves were concentrated mostly in newly formed bankers' banks in New York City, which partially led to the creation of an unstable banking system.
The Chase-Cooke connection and Cooke's motivation behind promoting the 1863 act have been previously described in varying detail by economic historians, including Henrietta Larson (1936), Robert Sharkey ( 1967), Bray Hammond (1970), Heather Richardson (1997), Murray Rothbard ( 2005), and Samuel DeCanio (2015). However, these authors do not explicitly separate the 1863 act from the 1864 act and the primary motivation behind the latter to entice New York City banks to join the National Banking System. Only David Gische (1979) has done so, with later complementary analyses by John James and David Weiman (2011) as well as by Matthew Jaremski (2013), who studies primarily the system's effects on the country's bank credit structure. And only Gische's and James and Weiman's works very briefly mention the Chase-Cooke connection. The purpose of this paper is to provide an in-depth narrative of the origins and special-interest motivations behind the National Banking Act, its amendment in 1864, and its creation of a quasi-centralized banking system centered in New York City national banks.
I begin by discussing how Jay Cooke became the main subscriber of Union bonds through his personal link with Secretary Chase and how this important connection was formed. Next I examine the passage of the 1863 act and explain how the Cookes were crucial to both its passage and its early implementation. Then I discuss the 1864 amendment and show how its main motivation was to entice New York City banks to join the system. I close by showing how this system created a new group of elite banks who specialized in managing other national banks' deposits.
The Civil War and Secretary Chase's Bond Drives: The Rise of Jay Cooke
Contrary to military opinions and unfortunately for the American public, the American Civil War from April 12, 1861, to May 9, 1865, was a long and costly war. The burden of trying to finance the conflict would fall primarily on the newly appointed U.S. secretary of the treasury, Salmon P. Chase. A hard-money Jacksonian Democrat from Ohio, Chase switched to the Republican Party due to the slavery issue. He had previously served as a U.S senator from 1849 to 1855 before becoming governor of Ohio until 1860, when he briefly returned to the Senate until he was appointed secretary of the treasury on March 6,1861 (Gische 1979, 32; Burch 1981, 20; James and Weiman 2011, 343). With tax revenue not enough and the printing of unbacked money not yet politically feasible, Chase was forced to finance the war by selling bonds.
Chase had problems, however, selling the necessary amount of bonds to conservative bankers in major financial centers in 1861. Conflict arose between him and the bankers when he refused to sell the bonds below par because of the high interest rate and the damage it would bring to the government's credit, whereas the bankers wanted to buy them at the prevailing market price. The conflict escalated further when in August 1861 Chase negotiated a $150 million bond loan from leading banks in New York City, Philadelphia, and Boston, with the majority bought by New York City. The banks agreed to buy the bonds in three installments of $50 million each in August, October, and December. However, Chase, following the rules of the hard- money Independent Treasury Act of 1846, wanted the banks to pay for the bonds in specie and to boost confidence in the government and its war effort, but the banks wanted to pay in bank credit. The banks eventually complied: after the first round of bond sales, the government obtained the specie it wanted, and the banks recovered their specie when they sold the bonds. However, after the third installment was bought in November, ahead of schedule, the price of the bonds sharply fell. The banks, not eager to sell bonds at what they perceived to be lower prices than they could obtain in the future, did not sell them to the public and consequently did not recoup specie reserves. Word soon reached the public, who panicked upon hearing that the banks did not have enough specie to satisfy a sufficient amount of withdrawals. Runs occurred on the banks in late December, and the New York City bankers suspended specie payments, with the rest of the banks in the country and the Treasury following suit. The suspension would take the United States off the gold standard until 1879 (Larson 1936, 110-13; Kindahl 1961, 31; Gische 1979, 32-33; Bensel 1990, 244-47).
On January 11, 1862, the major New York City bankers met with Chase and other prominent government officials and pleaded for a suspension of the Independent Treasury Act, the use of state banks as public depositories for government specie, acceptance of the sale of bonds below par, and heavier taxation to pay for the burgeoning government debt. When Chase adamantly refused to do these things, the New York bankers ended their cooperation, and Chase had to turn to other sources to finance the war. One of these sources was the printing press, and on February 25 the Legal Tender Act was passed, which allowed the issue of $150 million in paper- money greenbacks and further issues later on, totaling $449 million in greenbacks (Gische 1979, 33-34; Friedman and Schwartz 1993, 24). (1) However, the majority of the war was still financed by bond issues, and with this method of financing the prominent wartime activities of Jay Cooke began.
Jay Cooke was a Philadelphia investment banker who had family connections with Secretary Chase. Cooke's father, Eleutheros, served in both the Ohio and U.S. House of Representatives and shared speaking platforms with Chase, and his brother, Henry, was the editor and owner of the Ohio State Journal, a major Republican newspaper that brought Henry into close contact with Chase. Chase befriended Henry Cooke and appreciated the newspaper for the support it had given him and the future support it might give him in his various political endeavors, including the Republican nomination for president in 1860 (which he lost to Lincoln), an...