ECON CH 10-2 BANKING HISTORY

LAST: FIRST:

PERIOD:

Study the introduction to this unit. Explain what you are expected to learn from this unit.
Study the vocabulary words and look for them in the questions that follow

a.	Federal Reserve System	h.	member bank
b.	Alexander Hamilton	i.	national bank
c.	Federal Reserve note	j.	greenback
d.	bank run	k.	Thomas Jefferson
e.	Great Depression	l.	gold standard
f.	bank	m.	Federal Deposit Insurance Corporation (FDIC)
g.	central bank

a monetary system in which paper money and coins are equal to the value of a certain amount of gold

an institution for receiving, keeping, and lending money

bank that can lend to other banks in times of need

widespread panic in which great numbers of people try to redeem their paper money

the national currency we use today in the United States

the government agency that insures customer deposits if a bank fails

10.

the nation’s central banking system

11.

bank that belongs to the Federal Reserve System

12.

a bank chartered, or licensed, by the national government

13.

paper currency issued during the Civil War

14.

the severe economic decline that began in 1929 and lasted for more than a decade

Chances are there is at least one bank? —
an institution for receiving, keeping,
and lending money? —near your home.
That’s because banks have become a fact of
everyday life in the United States. This was
not always the case, however. American
banking as we know it today has developed
over the course of the nation’s history to
meet the needs of a growing and changing
population.

American Banking
Before the Civil War

During the first part of our nation’s
history, banks were very informal businesses
that merchants managed in addition to their regular trade. For example, a merchant who sold cloth, grain, or other goods might allow customers to deposit money. He would then
charge a small fee to keep the money safe.
He would also charge a fee if a customer
wanted to take out a loan. These informal
banks were not completely safe, however.
If a merchant went out of business or was
untrustworthy, customers could lose all of
their savings.

15.

Before the Civil War banks were

a.	Formal institutions chartered by the states	c.	informal institutions
b.	Formal institutions chartered by the U.S. government	d.	under tight government control

Two Views of Banking

After the American Revolution, the leaders
of the new nation agreed that one of their
main goals must be to establish a safe,
stable banking system. Such a system was
important for increasing trade with other
countries and ensuring the economic
growth of the new United States. The
nation? ’s leaders did not, however, agree on
how that goal should be accomplished.
Their debate on banking during the 1780s
and 1790s was part of a larger political
debate about the role of government in the
young country.

As you may remember from your study
of American history, the Federalists
believed that the country needed a strong
central government to establish economic
and social order. The Anti-federalists
favored leaving most powers in the hands
of the states. These two groups viewed the
country ’s banking needs quite differently.

The Federalists, led by Alexander
Hamilton, believed that a centralized
banking system was necessary for the
United States to develop healthy industries
and trade. When President Washington
appointed Hamilton as Secretary of the
Treasury in 1789, Hamilton proposed a
national bank (a bank chartered, or licensed,
by the national government) that could
issue a single currency for the entire nation,
manage the federal government ’s funds,
and monitor other banks throughout the
country.

The Anti-federalists, however, led by
Thomas Jefferson, supported a decentralized
banking system. In this system, the
states would establish and regulate all
banks within their borders.

16.

Why did the early colonial leaders believe we needed a strong banking system?

a.	For foreign trade and growth of the nation	c.	So the people would have a place to borrow money for automobiles
b.	So farmers would have a place to put their wealth	d.	Without a banking system there would be no ATM’s

17.

During the post Revolutionary War years the two political groups were the Federalists and Anti-Federalists. Which statement below is true?

a.	The Federalists wanted strong state governments while the Anti-Federalists wanted a strong national government	c.	The Federalists and Anti-Federalists both wanted strong state governments over the national governments
b.	The Federalists and Anti-Federalists both favored a strong national government	d.	The Federalists wanted a strong national government and the Anti-Federalists wanted strong state governments

18.

Alexander Hamilton wanted a _____ banking system and Thomas Jefferson wanted a _____ banking system

a.	European - American	c.	centralized - decentralized
b.	American - European	d.	decentralized - centralized

19.

Which Colonial learder proposed a strong national bank and a single currency?

a.	Washington	c.	Jefferson
b.	Hamilton	d.	Hancock

Alexander Hamilton	Thomas Jefferson
The First Bank of the United States At first, the Federalists were successful in creating a strong central bank. In 1791, Congress set up the Bank of the United States, granting it a twenty-year charter, or license to operate. The United States Treasury used the Bank for the following purposes: • to hold the money that the government collected in taxes • to help the government carry out its powers to tax, borrow money in the public interest, and regulate interstate and foreign commerce • to issue representative money in the form of bank notes, which were backed by gold and silver • to ensure that state-chartered banks held sufficient gold and silver to exchange for bank notes should the demand arise	The Bank succeeded in bringing order and stability to American banking. Many people worried, however, that the Bank would lend only to wealthy people and large businesses. They feared that ordinary people who needed to borrow money to maintain or expand their farms and small businesses would be refused loans. In addition, Jefferson and other Antifederalists pointed out that the Constitution does not explicitly give Congress the power to create a national bank. Therefore, they argued, the creation of a national bank was unconstitutional. When Alexander Hamilton died in a famous duel with Vice President Aaron Burr in 1804, the Bank lost its main backer. The Bank functioned only until 1811, when its charter ran out.

20.

Which of the choices below was NOT a purpose for the first National Bank?

a.	Hold government tax money	d.	To make sure there was enough gold and silver to back state banks
b.	make sure farmers had a place to borrow money	e.	Help the government exercise its taxing and borrowing responsibility
c.	To issue representative money

21.

What was the constitutional objection that Jefferson had against the national bank?

a.	There were not enough branches to service the entire country	c.	The constitution did not provide enumerated or specific power to the government to create a national bank
b.	Only rich people had access to loans	d.	There was no provision for it in the Bill of Rights

22.

Who killed Alexander Hamilton, Secretary of the Treasury?

a.	The Vice President	c.	Thomas Jefferson
b.	A jealous husband	d.	The President

Chaos in American Banking Once the Bank’s charter expired, state banks (banks chartered by state governments) began issuing bank notes that they could not back with specie, or gold and silver coins. The states also chartered many banks without considering whether these banks would be stable and creditworthy. Without any kind of supervision or regulation, financial confusion resulted.	Prices rose rapidly. Neither merchants nor customers had confidence in the value of the paper money in circulation. Different banks issued different currencies, and bankers always faced the temptation to print more money than they had gold and silver to back. Merchants had to keep lists of which notes were redeemable by gold and silver and which were not.

23.

What happened after the national bank closed in 1811?

a.	The states relied on a single form of currency	c.	The states assumed responsibility for an orderly banking system
b.	The states made sure they had enough gold and silver on hand to back the currency.	d.	The financial system fell into chaos

The Second Bank of the United States

To eliminate this financial chaos, Congress
chartered the Second Bank of the United
States in 1816. Like the first Bank, the
Second Bank was limited to a twenty-year
charter. The Second Bank slowly managed
to rebuild the public ’s confidence in a
national banking system, although many
people, including President Andrew
Jackson, continued to oppose the idea.

Nicholas Biddle, the Second Bank ’s president starting in 1823, was responsible for
restoring stability. If Biddle thought that a
particular state bank was issuing bank
notes without enough reserves (that is,
gold and silver to back them), he would
surprise the bank with a great number of
its notes all at once, asking for gold or silver in return. Some state banks, caught without the necessary reserves, went out of business. Others quickly learned to limit how many notes they issued.

Despite the difficulties arising from decentralized banking, many people continued to distrust the federal government ’s banking power. In addition, although the Supreme Court had ruled a national bank constitutional in 1819, the same groups who had opposed the first Bank also opposed the Second Bank. Finally, President Jackson ’s extreme distrust of the Second Bank led him to veto the renewal of the Bank in 1832.

24.

What did the Supreme Court rule concerning the Second National Bank?

a.	It was beyond the authority of the Supreme Court to rule on the bank	c.	It was constitutional
b.	There was no need for a national bank	d.	It was unconstitutional

25.

What effect did Nicholas Biddle and the second national bank have on the financial system?

a.	It created more chaos	c.	It had no effect on public confidence
b.	It brought order and stability	d.	It was a threat to the national government

26.

How did President Andrew Jackson feel about the second national bank?

a.	He had no opinion one way or another	c.	He had full faith and confidence in it
b.	He used it to provide money to poor farmers and shop keepers	d.	he distrusted it and failed to renew its charter

The Free Banking Era

The fall of the Second Bank once again triggered a period dominated by state-chartered banks. For this reason, the
period between 1837 and 1863 is known as the Free Banking, or “Wildcat, ” Era. Between 1830 and 1837 alone, the number of state-chartered banks nearly tripled. As you might expect, the sheer number of banks and currencies gave rise to a variety of problems.

1. Bank runs and panics State-chartered
banks often did not keep enough gold and silver to back the paper money that they issued. Customers found it increasingly
difficult to exchange their paper money for gold and silver, setting off bank runs. These were widespread panics in which great numbers of people tried to redeem their paper money at once. Many banks failed as a result, and public confidence plummeted. An especially
severe panic occurred in 1837.

2.Wildcat banks Some banks were located
on the edges of settled areas. They were
called “wildcat banks ” because people
joked that only wildcats lived in such remote areas. Wildcat banks had a high rate of failure.

3. Fraud A few banks engaged in out-andout
fraud, or cheating. They issued bank notes, collected gold and silver money from customers who bought the notes, and then disappeared. Anyone who had bought the notes lost their money.

4. Many different currencies State-chartered
banks —as well as cities, private banks,
railroads, stores, churches, and individuals —
were allowed to issue currency. Notes of the same denominations often had different values, so that a dollar issued by the “City of Atlanta ” was not necessarily worth the same as a dollar issued by the “City of New York. ” Many notes were counterfeits, or worthless
imitations of real notes.

27.

What caused the “Free Banking, or Wildcat Era,” in banking between 1837 and 1863.

a.	The close of the second national bank	c.	The death of Aaron Burr
b.	Th strength and stability of a national bank	d.	Not enough state chartered banks

28.

What was the result of the state run Free Banking Era?

a.	Bank runs because there was not enough gold and silver to back the money	d.	Banks located in distant areas
b.	fraud and corruption	e.	All of these were results of the Free Banking Era
c.	multiple currnecies of different values

The Later 1800s

By 1860, an estimated 8,000 different
banks were circulating currency. To add to
the confusion, the federal government
played no role in providing paper currency
or regulating reserves of gold or silver. The
Civil War, which erupted in 1861, made
existing problems worse.

Currency in the North and South

During the Civil War, both the Union and
Confederacy needed to raise money to
finance their military efforts. In 1861, the
United States Treasury issued its first paper
currency since the Continental. The official
name of the currency was “demand notes,”
but they were called “greenbacks ” because they were printed with green ink.

In the South, the Confederacy issued
currency backed by cotton, hoping that a
Confederate victory would ensure the
currency ’s value. As the Confederate
economy suffered under the strain of the
war, however, Confederate notes became
worthless.

29.

What role did the federal government play in the banking system in 1860?

a.	little or none	c.	laws that required gold and silver to back the currency
b.	tight regulation of the currency	d.	a limit on the powr of the state banks

30.

During the Civil War the Notrh issued paper money called, “greenbacks.” What did the South use to back the currency that it issued?

a.	tobacco	c.	gold
b.	cotton	d.	silver

Banking in the Early Twentieth Century

Reforms such as the creation of a single
national currency and the gold standard
helped stabilize American banking. They
did not, however, provide for a central
decision-making authority. Such an
authority could help banks provide funds
for growth and manage the money supply
based on what the economy needed.

Continuing problems in the nation’s
banking system resulted in the Panic of
1907. Because they lacked adequate
reserves, many banks had to stop
exchanging gold for paper money. Several
long-standing New York banks failed, and
many people lost their jobs because businesses did not have access to money for
investing in future projects. Clearly, the
economy needed a central banking system
so that the country could avoid such panics
in the future. As a result of the 1907 crisis,
the government made plans to reinstate a
central bank.

31.

What did teh creation of a single currency backed by gold have on the American banking system.

a.	It brought chaos to the system	c.	It brought stability and confidence
b.	It caused the states to revolt	d.	It had no effect on the system

32.

What did the federal government do in reaction to the banking panic of 1907?

a.	It did nothing	c.	It made sure that businesses had enough loan money to expand business
b.	It made plans for a new national bank	d.	It instituted the FDIC

33.

The history of American banking shows a series of shifts between stability and instability.
What does the chart suggest about the role of government in banking during the twentieth century?

a.	It shows that the individual states do a better job of running the banking system than the federal government	c.	It shows that the government has no role to play in the banking system
b.	It shows the weakness of Capitalism and the strength of Socialism	d.	It points out the need for the government to take an active role in the nations banking system

The Federal Reserve System
Passed in late 1913, the Federal Reserve
Act established the Federal Reserve System. The Federal Reserve System, or Fed, served as the nation ’s first true central bank, or bank that can lend to other banks in time of need. It reorganized the federal banking
system as follows:

• Member banks The system created up
to twelve regional Federal Reserve Banks
throughout the country. All banks chartered
by the national government were
required to become members of the Fed.
The Federal Reserve Banks were the
central banks for their districts. Member
banks —banks that belong to the Fed —
stored some of their cash reserves at the
Federal Reserve Bank in their district.

• Federal Reserve Board All of the
Federal Reserve Banks were supervised
by a Federal Reserve Board appointed by
the President of the United States.

• Short-term loans Each of the regional
Federal Reserve Banks allowed member banks to borrow money to meet shortterm
demands. This helped to prevent
bank failures that occurred when large
numbers of depositors withdrew funds
during a panic.

• Federal Reserve notes The system also
created the national currency we use
today in the United States —Federal
Reserve notes. This allowed the Federal
Reserve to increase and decrease the
amount of money in circulation
according to business needs.
You will read more about the role of the
Federal Reserve and how the system works
today in Chapter 16.

34.

What is the name of the banking system we operate under today?

a.	Third National Bank	c.	Federal Reserve System
b.	North Island Federal Credit Union	d.	U.S. National Bank

35.

All new federally charterd banks

a.	can join a state banking system or federal banking system	c.	can decide for themses which banking regulations they want to follow
b.	have to issue credit cards	d.	are required to belong to one of the 12 regional federal reserve banks

36.

Who supervises the Federal Reserve Banks?

a.	a Board of Directors appointed by the President	c.	a banking czar appointed by the President
b.	a Board of Directors appointed by the Congress	d.	the Congress of the United State

37.

How does the Federal Reserve Bank provide stability to the member banks

a.	It makes sure they follow the laws concerning the handicapped.	c.	It lends them money in time of need so they will not fail
b.	It requires the states to provide tax money when the member banks need it	d.	it transfers gold to the member banks

38.

What does it say at the top of every paper currency bill you might hold in your pocket?

a.	Chucky Cheese Note	c.	Silver Cirtiticate
b.	Federal Reserve Note	d.	Gold Cirtificate

39.

Who increases or decreases the amount of money in circulation in the United States?

a.	your local bank	c.	the Congress
b.	the mint	d.	the Federal Reserve Bank

Banking and the Great Depression

The Fed helped to restore confidence in the
nation’s banking system. It was unable,
however, to prevent the terrifying Great
Depression—the severe economic decline
that began in 1929 and lasted more than a
decade.

During the 1920s, banks loaned large
sums of money to many high-risk businesses.
Many of these businesses proved
unable to pay back their loans. Farmers
were also unable to pay back loans due to
crop failures and hard times on the
nation’s farms. In addition, the 1929 stock
market crash resulted in widespread bank
runs as nervous depositors rushed to
withdraw their money. The combination
of unpaid loans and bank runs resulted in
the failure of thousands of banks across
the country.

40.

What caused the failure of thousands of banks during the Great Depression of 1929?

a.	tight Federal Reserve regulations	c.	the policies of Franklin D. Roosevelt
b.	unpaind loans and bank panics	d.	the policies of Richard Nixon

41.

What is a bank run?

a.	Lots of people attempt to withdraw their money from the bank at the same time	c.	Running to the bank to cash a check or use the ATM
b.	Running the economy with banks	d.	A marathon sponsored by a bank

Banking Reforms

After becoming President in 1933, Franklin
D. Roosevelt acted to restore public confidence in the nation’s banking system. On March 5, 1933, Roosevelt declared a
national “bank holiday ” and closed the
nation’s banks. Within a matter of days,
sound banks began to reopen. The “bank
holiday” was not a time of festivities, as the
name implies, but a desperate last resort to
restore trust in the nation’s financial system.

Later in 1933, Congress passed the act
that established the Federal Deposit Insurance Corporation (FDIC). The FDIC insures customer deposits if a bank fails. At first, FDIC insurance covered losses up to
$2,500. Today the amount insured has
risen to $100,000 per account.

In addition, federal legislation passed
during the Great Depression severely
restricted individuals ’ ability to redeem
dollars for gold. Eventually, currency
became fiat money backed only by the
government ’s decree that establishes its
value. In this way, the Federal Reserve
could maintain a money supply at adequate
levels to support a growing economy.

42.

What was the bank holiday declaird by FDR during the Great Depression?

a.	Banks had to close during the Christmas holiday season	c.	Banks were required to give their employees holiday leaves of absence
b.	The banks closed for a period of time to prevent any further “runs on the banks.”	d.	Banks had to close during FDR’s birthday

43.

What was the FDIC

a.	Federal Directory Insurance Corporation	c.	A guarantee to depositors that the bank held gold reserves for every dollar on deposit
b.	Insurance the banks provided so that depositors would not loose their money in case of a panic	d.	A guarantee to depositors that the bank would not lend out their money

Banking in the Later Twentieth Century

As a result of the many bank failures of the
Great Depression, banks were closely regulated from 1933 through the 1960s.
Restrictions included the interest rates
banks could pay depositors and the rates
that banks could charge consumers for
loans. Banks could also lend money only to
customers who had a history of paying
back loans on time.

By the 1970s, banks were eager for relief
from federal regulation. In the late 1970s
and 1980s, Congress passed laws to
deregulate several industries. Deregulation is the removal, or relaxation, of government
restrictions on business. Unfortunately,
this deregulation contributed to a crisis
in a class of banks known as Savings and
Loans (S&Ls).

Tight controls were re-imposed by Congress on the banking industry which led to an even greater crisis in 2008. Congress required the banks to make home loans to people who could not afford to pay their loans. When people started to default on their home loans the government had to rescue the banks with trillions of dollars called the “Bail out.”

The arguement of tight or loose controls of the banking industry continues to this day.

44.

Why did the Congress impose tight controls on the banking industry after 1933?

a.	Because the banks refused to make loans to ordinary citizens	c.	Because the banks were not making enough profits
b.	Because the banks were becoming too big	d.	Becuse of the many bank failures during the Great Depression

45.

Based on the readings above, which statement is true?

a.	Whether or not the banking industry should have more or less government control is an ongoing question and debate.	c.	Government never makes the right decisions regarding the banking industry.
b.	Government always makes the right decisions regarding the banking industry.	d.	The country would be better off without banks.

The Savings and Loan Crisis

Deregulation was one cause of the S&L crisis. High interest rates, inadequate capital, and fraud were others.

1. Deregulation S&Ls had previously
been protected by government regulation.
S&Ls were unprepared for competition
after deregulation.

2. High interest rates During the 1970s,
S&Ls had made long-term loans at low
rates. By the 1980s, interest rates had
skyrocketed. This meant that S&Ls had
to pay out high interest rates to their
depositors. At the same time, however,
they were receiving low rates on the
money they had loaned out in the 1970s.

3. Bad loans Risky loans made in the early
1980s hit the S&L industry especially hard, forcing many out of business, as the
graph on page 176 of Chapter 7 shows.

4. Fraud A few financially important
institutions fraudulently made large
loans to businesses that had little chance
of succeeding. When these businesses
failed, a tremendous drain was put on the
reserves of the FSLIC, the federal agency
that insured S&Ls.

In 1989, Congress passed the Financial
Institutions Reform, Recovery, and
Enforcement Act (FIRREA). This Act
essentially abolished the independence
of the savings and loan industry and
transferred insurance responsibilities to
the FDIC.

Recent Trends

In 1999, in some of the most sweeping
legislation since the Great Depression,
Congress repealed the 1933 Glass-
Steagall Act. This action paved the way
for banks to sell financial assets such as
stocks and bonds while establishing new
privacy rules for customer data. In
addition, the 1990s and 2000s saw a
growing trend toward bank mergers. You
can read more about these mergers in the
Case Study on page 265.

46.

What did the Glass-Steagall Act allow the banks to do? (pick two)

a.	It allowed banks to merge into larger banks	c.	It allowed the banks to give away appliances, such as toasters, if people would open an account.
b.	It allowed the banks to sell stocks and bonds as well as provide the traditional banking services.	d.	It allowed the banks to stay open on Sundays

47.

The savings and loan crisis of the late 1980’s caused many savings and loan institutions to fail. A savings and loan instution is similar to a bank. Which statement below is true about the S&L crisis?

a.	Deregulation was the only reason for teh S&L crisis.	c.	The Great Depression caused the S&L crisis.`
b.	There were many, not one, reason for the S&L crisis.	d.	President Nixon was responsible for the S&L crisis.