Hamilton's First Bank of the United States, Schemes and Mind Maps of Law

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Hamilton’s First Bank of the United States Jesús Fernández-Villaverde1 February 4, 2022 1University of Pennsylvania The Bank of England The Bank of England • Modern central banking starts when the Bank of England opens on July 30, 1694 (some predecessors in Italy, Dutch Republic, and Sweden). • Its creation is closely related with the institutional changes brought by the Glorious Revolution of 1688. • Its initial business is to fund the government with £1.2 million during the War of the Grand Alliance (1688-1697). • It does so by printing paper notes rather than in specie. • Thus, the Bank of England is an engine of credit from the start. 3 4 The Bank of England and public debt • Later, the Bank of England lent to the government either directly or through the purchase of government debt (discounting). • The Bank helped establishing credible commitment on the part of the government by originating most of the loans. • It thus provided oversight of the government, especially with respect to payment of interest on the debt. • Eventually, the Bank started managing the government debt directly as well as a range of government securities. • By 1770s, the Bank handled 3/4 of the government debt for a fee and held about £11.7 million. 5 8 Hamilton’s plan The financial situation in 1789 • The U.S. financial conditions are dire: 1. Customs duties generate a mere $162,000 and country is in default on Revolutionary War debt. 2. No national currency. 3. No national bank. 4. Poorly developed financial markets and banking system. 9 Hamilton’s intellectual background • Hamilton is well read in the economics of the time and is very familiar with the history of banking: Venetian, Dutch, and British. • Probably related with his early life experience in St. Croix and New York City. • Hamilton began on his plans for the U.S. financial system around 1779. • By then, Hamilton is already anticipating a Constitutional Convention to reform the Articles of Confederation. “The tendency of a National Bank is to increase public and private credit. The former gives power to the state for the protection of its rights and interests, and the latter facilitates and extends the operations of commerce among individuals. Industry is increased, commodities are multiplied, agriculture and manufactures flourish, and herein consists of the true wealth and prosperity of a state.” Letter to Robert Morris (1781). 12 13 A central bank for the United States • Hamilton anticipates that the Bank of the United States would be privately chartered, funded by a combination of foreign debt and domestic equity. • The government would be a part owner, receiving a share of profits and the Bank would loan money to the government, facilitating the development of a market in public debt and bolstering the public finances. • The Bank would issues notes and these notes would be redeemable in specie, thus stabilizing the value of currency. • Notably the Bank would not be a monopoly. “Most commercial nations have found it necessary to institute banks and they have proved to be the happiest engines that ever were invented for advancing trade.” Letter to Robert Morris (1781). • Hamilton goes on to publish 6 essays on his ideas in a New York newspaper in 1781 under the title “The Continentalist.” 14 Implementation, I • Congress approves the Bank and, on February 25, 1791, Washington signs the “bank bill” into law. • Stock is oversubscribed by July, 1791 and operations start on December 12, 1791. • Headquarters in Philadelphia. Hamilton chooses Philadelphia, in part, to keep power in the North. • The Bank opens branches in Boston, New York, Baltimore, and Charleston the following year. 17 18 Implementation, II • States copy the idea and 17 state Banks are chartered between 1791-1795 bringing the total to 20 by 1795 and to 28 by 1800. • Soon, we have a national banking network. • Securities markets expand with exchanges in New York, Boston, Philadelphia, Charleston, and Baltimore. • New financial sector helps spur U.S. economic growth to the 1-1.5% range. Specially, New England and New York. • 20 years chart. It expires in 1811 and it is not renewed. Why? 19 The initial public offering, II • Speculative bubble erupts and then prices crash, resulting in a short-lived financial panic before the Bank even opened its doors. • By early August, the share price or right to own the stock had increased 10 fold to $250, implying a fully paid share was worth $625, for a one-month profit of over 50%. • Prices for a piece of scrip (the right to a share) topped out at around $325 on August 11th fueled by notions that the return on the stock could reach 12% per year. • Bank of New York curtails loans to speculators and a panic sets in with prices plummeting to $110 on August 15th. • Hamilton quells the plummeting by directing the Bank of New York to purchase stock, and in September purchases more. • This measure stops the free-fall in the share price and it fluctuates between $130-$170 over the rest of the year. 21 Organization • 25 directors elected by shareholders: 1. 7 face reelection each year. 2. Determine salaries of the officers and clerks. 3. Supervise the supply of bank notes. 4. Approve loan applications. 5. Appoint the Bank President. • Thomas Willing elected unanimously. Already President of the Bank of North America and partner in Willing and Morris. Strong Federalist, former judge of the Pennsylvania Supreme Court, and perhaps wealthiest person in Philadelphia. • Semi-annual dividends. • Cap on property held of $15 million. 22 23 Banks, Personal Connections, and Economic Development in Industrial New England 26 The Panic of 1792 • Initially, the First Bank floods the market with credit, but changes course in February 1792. • This change causes a stock market crash, the first in U.S. history. • The largest speculator was William Duer, whose financial company failed in March, paralyzing credit markets. • Old friend of Hamilton: invited to work on The Federalist and in the Treasury, related also through the Society for Establishing Useful Manufactures. • Once again Hamilton order the Treasury to purchase securities and branches of the Bank are opened during the panic. 27 Gcer 28 Bum and bust, I • The First Bank floods market in January 1792: $964,000 in first 2 weeks of operation. • Bank of New York stops accepting notes on January 26th. • Did the First Bank curtail lending in February? 1. The next existing balance sheet that survived is March 9, 1792. The Bank did not renew almost 25% of the 30 day discounts from the end of January until March ($625,000 in loans called in). 2. There is evidence that the First Bank started curtailing issuance in mid-February (letters of the times). • Why? The First Bank realizes that it has been too aggressive, causing its notes to trade at a discount in Boston and for Bank of New York to stop accepting its paper. Anything but a secure medium of exchange. 31 Bum and bust, II • Spectre of paper being returned for specie. Between the end of January and March 9th, almost $270,000 of notes returned. • Specie is flowing out too quickly. • Additionally, branches were set to open in 2 months and $500,000 in seed money is needed for each branch. • The First Bank needs to curtail the expansion of credit. • Curtailment appears to be happening in Boston at the Massachusetts Bank and at Bank of New York, but it appears their actions were rather small compared to First Bank. They are much smaller in size. • Fortunately, the 1792 financial panic did not lead to a recession. Similar to black Friday in October 1987, when market tumbled more than 25% with no discernible economic effect. 32 Bum and bust, III • The 4 branches open during the crisis. Local boards elected by the main board. The last to open is in Baltimore in June. • Hamilton stems the crisis by injecting liquidity into financial markets in March. He also secures a new loan from the Dutch of 3 million florins, which calms fears. • New York branch adds liquidity as well. And, in Philadelphia, First Bank resumes discounting to merchants in May following a large infusion from the Treasury in mid-April. • It is possible that Hamilton coordinated the events. • Safe principles would guide the Bank over the next 20 years. • The financial machinations draw the ire of Jefferson and he and Madison attack Hamilton viciously. “take up your pen, select the most striking heresy and cut [Hamilton] to pieces in the face of the public”(Jefferson to Madison) 33 36 Additional borrowing • Additionally, the loan is used to cover government shortfalls at the time and to build a fleet to send against the Barbary pirates. But costs of Whiskey rebellion so large that shipbuilding put on hold. • Hamilton borrows another $2 million to cover the payment on the initial loans, and the Bank raises the funds by issuing $2 million in 6% bonds. • In total, the Bank lends $5.5 million to the government during 1794 and 1795. • This comes at the cost of issuing less private loans to private busininess. • Evidence of “crowding out” comes from the decline in private deposits as these are drawn down to pay for existing loans. • As well, the proportion of loans granted fell drastically, in Baltimore by as much as 2/3 (goes from $1.22 of loans requested for each dollar lent to $2.03 requested for each dollar lent). 37 The First Bank as a central bank • To be a central bank, there needs to be a banking system. • At First Bank’s inception, there are only 3 other banks: Bank of New York, Bank of North America, and the Bank of Massachusetts. • By 1811, there are 88 banks. U.S. moves to a fairly developed financial system in a very short time. • The First Bank takes on a supervisory role by reigning in state banks that it believed were over issuing notes. It would gather up state bank notes and tender them for specie, thus constraining further issuance. • Boston branch president (1807): “We are charged with doing injury to other Banks by draining them of their specie and retaining it by limitation of our discounts.” • So sacrificing its own profits to ensure stability of banking system. • However, the First Bank does not act as a lender of last resort by lending to other banks in a crisis. 38 Overlaps between the First Bank and the Treasury, II • Lending to Banks is an activity of the Treasury, which demands adequate security that its loans will be repaid. • During yellow fever epidemic in New York in 1798, the Treasury made sure there was adequate liquidity by discounting acceptable paper. • Treasury also boosts deposits to First Bank during the shortfall in specie during 1804, so that the Bank does not have to curtail lending. • So, it is basically the Treasury that acts as the central bank using the First Bank as its instrument. 41 An economic assessment • Government pays off $1.2 million of the public debt by selling off much of its Bank stock. Thereafter, the debt is repaid gradually. • Bank lasts for 20 years and the charter is not renewed during the Madison administration. • By then, the U.S. has a well established financial system that developed in a remarkably fast manner. • The First Bank is integral part of that development. • Some of that is due to its tremendous size. Capitalized at $10 million, which dwarfs the total capital of the $3 million of the five banks already in existence. • When it closed in 1811, it had as much specie in its vaults as all the other 89 banks combined. • While not a full fledged central bank, the First Bank takes on responsibilities that are associated with central banking. • Hamilton’s blue print for the economy turns out to be extraordinarily successful. 42 The political economy of the First Bank Enumerated vs. general powers • In the U.S. Constitution, there are: 1. Enumerated powers: those powers expressly listed. 2. General powers: those given to the government to serve the general welfare of the people. General Welfare Clause, Article I, Section 8 “The Congress shall have Power 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;” The Necessary and Proper Clause, Article I, Section 8 “The Congress shall have 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.” 45 Jefferson’s arguments • Jefferson dislikes all corporations. • Also, he argues: Opinion on the Constitutionality of a National Bank, 1791 “...the foundations of the Constitution [was] laid on this ground that ‘all powers not delegated to the US by the Constitution, nor prohibited by it to the states are reserved for the states or the people.’ [10th amendment]. To take a single step beyond the boundaries drawn around the powers of Congress, is to take possession of a boundless field of power no longer susceptible of any definition.” • Radically opposed to the idea: suggests to governor Henry Lee of Virginia (the father of Robert E. Lee) that anyone recognized the Bank in Virginia is guilty of high treason and should suffer death. 46 Madison’s arguments, I • Madison insists that Hamilton wants to use the government to establish the national bank as a corporation, a power that falls outside of Article 1, Section 8, as a power granted directly to Congress. • Attorney General Randolph tells President Washington that he agrees with Madison’s reasoning. • Thus, Washington asks Madison to draft a veto in case he decides against the Bank. • Madison bases it on the Constitution not warranting the Act: the Constitution is a grant of particular powers and the “necessary and proper” clause should not be considered as granting powers other than those consistent with “the incidentality to an express authority.” • “necessary and proper” can not mean unlimited discretion. At a minimum, a measure that comes within the meaning of a clause and “to means necessary to the end and incidental to the nature of specified powers.” • The Bank bill is not a borrowing of money or a levy of taxes, but the exercise of a power not enumerated. • It is not possible to discover within the Constitution a power to incorporate a Bank. Indeed the power of incorporation was rejected at the Convention. 47 Federalist 44, II (Madison) Had the convention taken the first method of adopting the second article of Confederation, it is evident that the new Congress would be continually exposed, as their predecessors have been, to the alternative of construing the term “EXPRESSLY” with so much rigor, as to disarm the government of all real authority whatever, or with so much latitude as to destroy altogether the force of the restriction. It would be easy to show, if it were necessary, that no important power, delegated by the articles of Confederation, has been or can be executed by Congress, without recurring more or less to the doctrine of CONSTRUCTION or IMPLICATION. As the powers delegated under the new system are more extensive, the government which is to administer it would find itself still more distressed with the alternative of betraying the public interests by doing nothing, or of violating the Constitution by exercising powers indispensably necessary and proper, but, at the same time, not EXPRESSLY granted. Had the convention attempted a positive enumeration of the powers necessary and proper for carrying their other powers into effect, the attempt would have involved a complete digest of laws on every subject to which the Constitution relates; accommodated too, not only to the existing state of things, but to all the possible changes which futurity may produce; for in every new application of a general power, the PARTICULAR POWERS, which are the means of attaining the OBJECT of the general power, must always necessarily vary with that object, and be often properly varied whilst the object remains the same. 50 Federalist 44, III (Madison) Had they attempted to enumerate the particular powers or means not necessary or proper for carrying the general powers into execution, the task would have been no less chimerical; and would have been liable to this further objection, that every defect in the enumeration would have been equivalent to a positive grant of authority. If, to avoid this consequence, they had attempted a partial enumeration of the exceptions, and described the residue by the general terms, NOT NECESSARY OR PROPER, it must have happened that the enumeration would comprehend a few of the excepted powers only; that these would be such as would be least likely to be assumed or tolerated, because the enumeration would of course select such as would be least necessary or proper; and that the unnecessary and improper powers included in the residuum, would be less forcibly excepted, than if no partial enumeration had been made. Had the Constitution been silent on this head, there can be no doubt that all the particular powers requisite as means of executing the general powers would have resulted to the government, by unavoidable implication. 51 Federalist 44, IV (Madison) No axiom is more clearly established in law, or in reason, than that wherever the end is required, the means are authorized; wherever a general power to do a thing is given, every particular power necessary for doing it is included. Had this last method, therefore, been pursued by the convention, every objection now urged against their plan would remain in all its plausibility; and the real inconveniency would be incurred of not removing a pretext which may be seized on critical occasions for drawing into question the essential powers of the Union. If it be asked what is to be the consequence, in case the Congress shall misconstrue this part of the Constitution, and exercise powers not warranted by its true meaning, I answer, the same as if they should misconstrue or enlarge any other power vested in them; as if the general power had been reduced to particulars, and any one of these were to be violated; the same, in short, as if the State legislatures should violate the irrespective constitutional authorities. In the first instance, the success of the usurpation will depend on the executive and judiciary departments, which are to expound and give effect to the legislative acts; and in the last resort a remedy must be obtained from the people who can, by the election of more faithful representatives, annul the acts of the usurpers. 52 Hamilton’s reply, II • Hamilton bases his argument on the fiscal policy nature of the Bank; it will help with the collection of taxes through printing notes redeemable in specie and that can be used to pay taxes, it will help with the payment of the debt, and it will aid raising future debt when necessary. “The power which can create the Supreme law of the land, in any case, is doubtless sovereign as to such case. This general & indisputable question puts at once an end to the abstract question – Whether the United States have power to erect a corporation.” • Basically, Hamilton is arguing that any power is available if not prohibited by the Constitution. This is a very elastic interpretation. “It has been questioned by some, whether the Act of Congress, for establishing the Bank of the United States, is Constitutional; but if it is a useful means for carrying into effect any of the powers specifically vested in the government of the United States, and does not infringe the rights of any individual state or persons, on what principle can it be unconstitutional.” 55 Who was right? • The dispute has an economic and a legal component. • Giving a monopoly as the government’s fiscal agent would give the Bank an enormous advantage over competitors. • The U.S. after Jackson and prior to the Federal Reserve Act has no national bank, yet has remarkable economic success and carries out its fiscal policies without significant difficulty. • Southerners’ misgiving were, therefore, not totally unfounded. • However, at the time there was not a sophisticated financial system in the U.S. so an institution like the First Bank would have been more useful than at later dates, when there existed a well developed private banking system. • What about the constitutional issue? 56 The Supreme Court and the National Bank • Washington signs the bill on February, 25, only after being convinced it is constitutional. • Washington initially viewed the veto power as one to be used only when a law passed by Congress was unconstitutional, not for reasons concerning his agreement with the legislation. • Judicial review will not come to the fore until Marbury v. Madison (1803). • However, we can uncover how the Marshall Court would have ruled by looking at his decision in McCulloch v. Maryland (1819). 57 Mark R. Killenbeck WROTE L GORE (eta Leti Tem McCulloch v. Maryland (1819), I • Maryland decides to tax the Second Bank of the United States’ notes. • Recall that the Second Bank is a fiscal agent of the Treasury. • Can a state tax an agency of the U.S. government? • Maryland argues yes because the laws to be authorized are to be “necessary and proper” for the purpose, not “necessary or proper”. • In Maryland’s view, convenience is not a justification, but must be “indispensably requisite.” • Maryland’s decision is ruled unconstitutional by the court 7-0 (only 7 justices at the time), with John Marshall’s writing the decision. 61 McCulloch v. Maryland (1819), II • Marshall’s opinion is, in some places, almost word for word what Hamilton wrote almost 30 years prior. • Marshall rejects Maryland’s argument and indicates that convenience is a justification. Necessary implies that any means that accomplish the end are allowable. Does not mean absolutely necessary, a phrase that appears in Article 1, Section 10. • The legislature must be able to “avail itself of experience, to exercise its reason, and to accommodate its legislation to circumstances.” • Marshall fears that the national government will fail without being able to exert discretion, and that discretion will not undermine the enumerated powers as Madison had argued earlier. 62 Current interpretations, I • How would some current originalists approach the reasoning in this decision? • At the time “necessary” was defined as 1. needful; indispensably requisite. 2. Not free; fatal; impelled by fate. 3. Conclusive; decisive by inevitable consequence”. • Maryland’s argument applies this meaning. It does not imply convenient or useful. • But the Constitution also contains the term “absolutely necessary” perhaps implying that “necessary” does not imply indispensable when used by itself. As well in Article 11, Section 3 the words “necessary and expedient” are used further indicating that necessary is not synonymous with indispensable. • But if necessary is synonymous with expedient, why use it all in necessary and expedient. 65 Current interpretations, II • George Mason introduces the article II language at the 11th hour with an amendment, so not a lot of thought was given to the phrase. It was also clear from earlier statements by Mason at the Convention that he equated necessary with indispensable. • It is interesting that Madison himself rejected that necessary meant indispensably necessary because “very few acts of the legislature could be proved essentially necessary to the absolute existence of government.” • Madison urged that the words be “understood so as to permit the adoption of measures the best calculated to attain the ends of government, and produce the greatest quantum of public utility.” • Thus, as was argued by Hamilton, necessity should not be so strict that no statute can pass, nor so lenient that any statute can pass. An appropriate level of scrutiny is required. 66 Current interpretations, III • Many current constitutional scholars may be interpreting Marshall’s opinion in too open ended a way. Certainly, his 1803 opinion in United States v. Fisher is open ended, but in McCulloch he is more circumspect. • “The means chosen must be “plainly” adapted to the end, not merely conducive to it; tenuous connections to granted powers will not pass muster. It must in addition be “appropriate,” which implies some supervision of the reasonableness of the means...“ • It must not be a “mere pretext ... for the accomplishment of objects not entrusted to the government.” It must be consistent with the spirit as well as the letter of the Constitution. • However, in McCulloch, Marshall does make much effort to provide the scrutiny that would justify the Bank. 67