NATIONAL BANK CHARTERS
A. Joyce Furfero, Ph.D., J.D.
3 Jul 2004
Article 1, Section 8 provides that Congress shall have the power
"to make all laws which shall be necessary and proper for carrying into execution the foregoing powers, and all other powers vested by this constitution in the government of the United States, or in any department or officer thereof."The foregoing powers of Article 1, Section 8 include the power
1. To lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defence and general welfare of the United States; but all duties, imposts and excises shall be uniform throughout the United States:Yet, despite all of these fiscal and monetary powers, the Constitution does not provide explicitly for the chartering of banks by the federal government.
One issue, which arose fairly early in United States history, was whether or not the federal government had the power to charter a bank. The Constitution was silent on the matter. Unfortunately, the finances of the new government were in chaos. Millions of dollars in Revolutionary War debt had to be repaid and the new government had no specie with which to repay it.
Politically, the country was divided into two groups. The Federalists, headed by Alexander Hamilton, advocated a strong central government. They subscribed to the view that "if a power is not expressly prohibited to the federal government in the Constitution, then it is allowed." The Anti-Federalists, headed by Thomas Jefferson, advocated a weak central government. The Anti-Federalists believed strongly in the sovereignty of the states. They subscribed to the view that "if a power is not expressly granted to the federal government in the Constitution, then it is denied."
In 1791, over the protests of the Anti-Federalists, Congress established the First Bank of the United States. The bank was the idea of Alexander Hamilton, who believed that a national bank could aid the new government in the administration of its public finances by facilitating the collection of taxes, by making loans to the Treasury, and by issuing a uniform currency. Hamilton's proposal called for the government to supply $2 million of the initial authorized capital and for private interests to subscribe to another $8 million in authorized capital. One-fourth of the private interest was to be paid in specie to ensure adequate reserves. The plan also called for private management with government oversight. The government oversight would prevent the private management from running amok, and the private management would prevent legal suspensions of specie in the face of imagined exigencies. To appease the Anti-Federalist interests, the bank was chartered with a limited life of 20 years.
By all measures, the First Bank of the United States was an unqualified success. It efficiently managed tax collections, government disbursements, and foreign exchange, and by issuing 20% of all notes in circulation, it provided a uniform currency for all transactions with the government. Although the bank was originally chartered to be a commercial bank, it soon became a central bank. As the federal government repaid its war debt, the bank accepted more and more state bank notes. This permitted the bank to regulate national credit. When the bank wanted to restrain credit, it redeemed the notes it received promptly, thereby forcing other banks to keep greater specie reserves to meet the redemptions. When the bank wanted to stimulate credit, it showed forbearance. It complemented this strategy by decreasing or increasing its own level of loans, as the case required, and because it controlled so much specie (by 1811 it held fully 50% of all bank-held specie) this had a great added effect.
Needless to say, the bank's activities made it few friends among state bankers or the new political establishment in Washington. In 1803, Thomas Jefferson became President and the Republicans (the former Anti-Federalists) took over Congress. Jefferson managed to foster a great dislike for the bank. He ignored it and delegated all financial responsibility to his Treasury Secretary, Albert Gallatin, who deposited Treasury proceeds in state-chartered banks. Although the next President, James Madison, who succeeded Jefferson in 1811, was in favor of the bank, he failed to garner sufficient support in the Republican-controlled Congress for the charter's renewal. Moreover, the bank's directors were politically inept. They did not feel it their duty to lobby for the bank. And, the bank's shareholders were overwhelmingly foreign. They believed that prudence dictated silence.3 The bank, located in Philadelphia, was subsequently bought by Stephen Girard and operated as a private banking firm housed in the same building by the same staff.
Then the War of 1812 erupted. The federal government had to rely on the state-chartered banks to help finance the War. When the British raided Washington in 1814, and the state-chartered banks had problems paying out specie, they suspended specie redemption. In the absence of a federal regulator, the banks ran down their specie and over-issued notes. Bank notes in circulation became the equivalent of interest-free, indefinite loans from the public to the banks. Predictably, prices rose, the bank notes depreciated in value, and they traded at all sorts of discounts from par, depending on location and identity of the issuing bank. Commerce suffered, and the federal government, forced to accept depreciated state bank notes as payment for taxes, defaulted on some of its own bonds. The federal government's debt depreciated as well and the Treasury had a very hard time finding buyers for new bonds. These chaotic conditions stimulated renewed calls for a national bank.
In 1816, Congress established the Second Bank of the United States. The Second Bank, like its predecessor, was chartered for 20 years. At its inception, renewal seemed almost inevitable. However, the Second Bank was not nearly so successful as the First Bank. First of all, the economy floundered throughout most of the 1820s. Farm prices dropped, farmers failed to repay loans, state banks ran short of specie, they called loans, businesses could not repay immediately, the money supply contracted further, people had difficulty finding specie or Treasury bonds with which to pay taxes, and the economy languished. Second, the original directors of the Second Bank were incompetent or worse. All sorts of financial chicanery, insider loans, and outright frauds occurred in the bank and its branches. The worst abuses occurred at the Baltimore branch, where the cashier, James McCulloch, lent himself half a million dollars on no collateral as part of a fraudulent conspiracy that eventually cost more than $1.5 million.
Prior to the discovery of these misdeeds, however, Mr. McCulloch and his Baltimore branch became the focus of a major constitutional battle. In an attempt to force its closure, state governments had exacted punitive taxes from the various branches of the Second Bank. Mr. McCulloch refused to pay the Maryland tax.
The case, McCulloch v. Maryland, 17 U.S. 316 (1819), eventually reached the United States Supreme Court, where Chief Justice John Marshall sustained the power of Congress to charter a bank under the "necessary and proper" clause. He noted that the word "necessary" does not mean "indispensible." Rather it means "convenient" or "in furtherance of." He explained how the chartering of a national bank was a necessary and proper adjunct to the federal government's fiscal and monetary powers. He rejected Maryland's authority to tax a bank so chartered. Marshall reasoned that if a state could tax the bank or its branches, then the bank could not survive as a national institution. Today, the case is remembered more for its sweeping interpretation of the commerce clause.