Real and Pseudo Free Banking

wildcat banking
Old West Bank by Gravityx9, modified, CC 2.0 license

wildcat bankingLike certain weeds and infectious diseases, some myths about banking seem beyond human powers of eradication.

I was reminded of this recently by a Facebook correspondent’s reply to my recent post on “Hayek and Free Banking.” “We had free banking in the US from 1830 until 1862,” he wrote. “It didn't work out too well.” “During the Wildcat Era,” he added, “banks were unregulated and failed by the hundreds.”

Imagine the effect my critic must have anticipated — the crushing blow his revelations would surely deal to my cherished beliefs.  Upon reading his words, my eyes widen; my jaw goes slack.  Can this really be so?, I ask myself?   I read the ominous sentences again, more slowly, sub-vocalizing.  Beads of sweat gather across my brow.  Then, pursing my lips, my eyes downcast, I turn my head, first left, then right, then left again.  If only I had known!  All these years…no one ever…I mean, how was I supposed…it never occurred to me… DARNITALL! Why didn’t I think of looking at the U.S. experience before shooting my mouth off about free banking?

Well, that isn't what happened.  "What cheek this fellow has!" was more like it.  (OK, it wasn't exactly that, either.)  Of course I’ve looked into the U.S. record.  So has Larry White.  And Kevin Dowd.  And every other dues-paying member of the Modern Free Banking School.  We’ve looked into it, and we’ve found nothing there to change our minds concerning the advantages of freedom in banking.

So what about all those "unregulated" wildcats?  First of all, there’s never been a time in U.S. history when banking was truly unregulated, or anything close.  Up until 1837, just getting permission to open a bank was a hard slog, when it wasn’t altogether impossible.  Here’s Richard Hildreth’s tongue-in-cheek description of how one went about becoming a banker back in 1837:

The first thing is, to get a charter.  One from the General Government, with exclusive privileges, and a clause prohibiting the grant of any other bank, is esteemed best of all.  But such a charter is a non-such not easy to be got.[1]

Next best is a State Bank, in which the state government takes a portion of the stock, with a clause, if possible, prohibiting the grant of any other bank within the state. But if such a bank is not to be had, a bare charter, without any exclusive privileges, should be thankfully accepted.

It is very desirable however, that no other bank should be permitted in the county, city, town or village, in which the new bank is established; and all existing banks, are to join together upon all occasions, in a solemn protest against the creation of any new banks, declaring with one voice, that the multiplication of small banks, — which, by way of emphasis, may be denounced, as “little peddling shaving shops,” — is ruinous to the country, produces a scarcity of money, &c. &c. &c.

In order to obtain a charter, it is necessary to be on good terms with the legislature applied to.  Obstinate opposers may be silenced by the promise of a certain number of shares in the stock, — which shares, if very obstinate, they must be allowed to keep without paying for.

This being properly prepared, a petition is to be presented to the legislature, representing that in the town of ——–, the public good requires the establishment of a bank. … The bank is to be asked for, solely on public grounds; not a whisper about the profits the petitioners expect to make by it.

If the petition is coolly received, it may be well to revise the private list of stock-holders, and to add the names of several of the legislators. …

If nothing better can be done, employ some influential politician to procure a charter for you, and buy him out at a premium.[2]

When Hildreth wrote, around 600 U.S. banks were in business. That may seem like plenty.  But the fact that the vast majority of these were in the northeast, and that hardly any had branches, meant that most U.S. communities still had no banks at all.  In most territories and states west of the Mississippi, becoming a banker wasn't just difficult: it was illegal.

1837 was also, however, the year in which Michigan passed a “free banking” law, becoming the first of thirteen states that would pass similar laws over the course of the next two decades.  The laws provided for something akin to a general incorporation procedure for banks, making it unnecessary for state legislators to vote on specific bank bills, and to that extent improved upon the former bank-by-bank charter or “spoils” system.  But despite the name, which suggested, if not completely unregulated banking,  at least the sort of lightly-regulated banking for which Scotland was then famous, the laws didn’t even come close to allowing American banks the freedoms that their  Scottish counterparts enjoyed.  Indeed, the restrictions imposed on U.S. "free" banks proved so onerous that the laws don't even appear to have achieved a substantial overall easing of entry into the banking business.[3]

Two rules, common to all U.S. free banking laws, were to have especially important consequences. The first denied U.S. “free” banks the right to establish branches—something their Scottish counterparts were famous for doing, and that even some chartered U.S. banks could and did do.  The other required them to secure their notes using specific securities, which were to be lodged for safekeeping with state banking authorities.  U.S. “free” banks were not free, in other words, to decide how to employ the funds represented by their notes, which were in those days a more important source of bank funding than bank deposits.  Such “bond deposit” requirements were also unknown in the Scottish system.

So U.S. “free” banks were hardly “unregulated.”  They did, however, “fail by the hundreds”– 2.42 hundred, to be precise, which was no small portion of the total.  The question is, why did so many American "free" banks fail?  Was it because they weren't regulated enough?  No sir: it was because they were over-regulated: the free banking laws of several states forced banks to invest in very risky securities — and especially in risky state government bonds — while the rule against branching limited their ability to diversify around this risk, especially by relying more on deposits than on notes.  It was owing to these restrictive components of U.S.-style free banking that scads of American free banks ended up going bust.

And that's not just one kooky free banker's opinion: it’s the opinion of every competent monetary historian who has looked into the matter.[4]  According to Matt Jaremski, whose 2010 Vanderbilt U. dissertation is the most careful study to date, the bond-deposit requirements of antebellum free-banking laws “seem to be the underlying cause of the free banking system’s [sic] high failure rate relative to the charter banking system.  While bond price declines were significantly correlated with free bank failures, they were not correlated with the failure rate of charter banks.”  Moreover, it wasn’t the general level of bond prices that mattered, but only the prices of specific securities that banks were legally obliged to purchase.

And “wildcat” banking?  It’s no coincidence that that expression appears to have first gained currency, so to speak, in Michigan in the 1830s, where it was used to refer to some of the more disreputable banks established under that state's original free banking law.[5]  That law proved such a fiasco that it was repealed just two years later, after inflicting heavy losses on innocent note holders.[6]  The law appears to have encouraged more than a few bankers to throw large quantities of their notes onto the market, while situating their banks as remotely as possible, the better to avoid pesky redemption requests.  But here, as with U.S. free bank failures generally, regulations were to blame.  It just so happened that the securities banks were encouraged to hold under Michigan’s law were especially lousy, consisting as they did “either of bonds and mortgages upon real estate within this state or in bonds executed by resident freeholders of the state.”[7]  Call it the Wild West version of Community Reinvestment.

Notwithstanding what happened in Michigan, and all the attention it received, “wildcat” banking, understood to mean banking of the fly-by-night sort, was actually quite rare.  In Wisconsin, Indiana, and Illinois, whose free banking laws also proved disastrous, it was unimportant, if not altogether unknown; even in Michigan itself it doesn't seem to have survived the first free-banking law.[8]  Indeed, the all-around record of U.S.-style free banking improved significantly as the Civil War approached.  Even banknote discounts — another consequence of unit banking that has been wrongly treated as a necessary consequence of having multiple banks of issue — had become almost trivial by the early 1860s.  According to my own research, someone who, in October 1863, was foolish enough to purchase every non-Confederate banknote in the country for its full face value, in order to sell the notes to a broker in either Chicago or New York, would have suffered a loss on that transaction of less than one percent of his or her investment.[9]  That's less than the cost merchants incur today when they accept credit cards, or what people typically pay to withdraw cash from an ATM that doesn't belong to their own bank.

The best reason I can think of for the persistence of the myth of rampant wildcat banking is simply that stories about it makes for more titillating reading than ones about the mass of less colorful, if no less unfortunate, free-bank failures.  Wildcat banking is to the history of banking what the O.K. Corral and Wild Bill Hickok are to the history of the far west.

Somewhat harder to account for is the fact that, in America at least, “free banking” has come to refer exclusively to the antebellum U.S. episodes (as well as to a similar — and mercifully short-lived — Canadian experiment).  The expression was, after all, appropriated by U.S. state legislators for the sake of its appealing connotations, after having been in use for some time overseas, where it and its equivalents (“la liberté des banques,” “bankfreiheit,” etc.) continued to stand for genuinely unregulated banking, or something close to it.  Sheer parochialism is, I'm afraid, partly to blame: many authorities on American banking, whether economists, historians, or economic historians, appear to be unfamiliar with European writings on free banking, or with the banking systems those writings regard as exemplary.

The limited interest that even some of the more painstaking authorities on U.S. style “free” banking have shown in free banking of the other sort seems to me a shame.  After all, what could be more informative than to compare, say, Michigan's experience with Scotland's, so as to gain a better understanding of the consequences of laissez-faire banking on the one hand and of certain departures from laissez faire on the other?  By failing, not only to make such comparisons,  but (in some cases) to even recognize non-U.S.-style free banking and the literature concerning it, such experts have unwittingly encouraged people to confuse U.S.-style "free banking" with the real McCoy.


[1] Thanks to Andrew Jackson’s efforts, the Charter of the 2nd Bank of the United States had been allowed to expire the year before.

[2] Richard Hildreth, The History of Banks (Boston: Hilliard, Gray & Company, 1837), pp. 97-8.

[3] See Kenneth Ng, “Free Banking Laws and Barriers to Entry in Banking, 1838-1860.”  Journal of Economic History 48 (4) (December 1988).  Since the Scottish system was itself essentially a "charter" system, entry into it was also strictly limited.  Limited entry was, indeed, the most important of several departures of pre-1845 Scottish banking was genuine laissez faire.

[4] See, among other works, Hugh Rockoff, The Free Banking Era: A Reexamination (New York: Arno press, 1975); Arthur J. Rolnick and Warren E. Weber, "The Causes of Free Bank Failures: A Detailed Examination,"  Journal of Monetary Economics 14 (3) (November 1984); Gerald P. Dwyer, "Wildcat Banking, Banking Panics, and Free Banking in the United States," Federal Reserve Bank of Atlanta Economic Review, December 1996; Howard Bodenhorn, State Banking in Early America: A New Economic History (New York: Oxford University Press, 2003); and Matthew S. Jaremski, "Free Banking: A Reassessment Using Bank-Level Data" (PhD Dissertation, Vanderbilt University, August 2010).

[5] Dwyer, p. 1.

[6] Michigan took another, more successful stab at free banking in 1857.

[7] Dwyer, p. 6.

[8] Ibid., pp. 9-10, and the studies mentioned therein.

[9] See my article, "The Suppression of State Banknotes." Economic Inquiry 38 (4) (October 2000).

  • vikingvista

    Superb post.

  • Andrew_FL

    Another explanation could be that the focus on US "experience" is part of a larger persistent myth of the US having begun it's existence as a capitalist's paradise and largely remained so to the present day.

    To suggest, for instance, that modern day economic problems could be cause by government regulation, is to be met with the incredulous response that that cannot be, Reagan and Bush eliminated what little regulation our wild west country ever had!

    • George Selgin

      I'm quite certain that you are correct, Andrew. Thanks for the observation.

  • Mathieu Bédard

    Interestingly enough, Massachusetts had a system somewhat closer to real free banking, in that entry was relatively painless and state-level regulation minimal. It also adopted pseudo-free-banking laws, like most States, but obtaining a regular charter was so easy that nearly all news bank creations during the free banking era used the regular, non-Free-Banking-Laws channel. It experienced a much more reasonable number of bank failures.

    • George Selgin

      I agree, Mathieu. Also, in New England, as you know very well, the Suffolk System — the first U.S. clearinghouse system — helped to overcome some of the shortcomings of unit banking, even managing to achieve par circulation of banknotes throughout the region by the mid- 1820s. This was freedom in banking proving, not only that it could work well on its own terms, but that it could overcome to some extent the destructive effects of misguided regulatory restraints.

  • lintondf
    • George Selgin

      Thanks. I will fix the link

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  • Nick_Rowe

    Good post George.

    "(as well as to a similar — and mercifully short-lived — Canadian experiment)."

    I don't remember hearing about that one. Can you point me somewhere, or give me the short version for historical dummies?

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  • csissoko

    Thank you for an interesting and insightful post. It stimulated some questions that I pose below:

    Perhaps it would be useful to make clear that what you mean by "free" in Scotland is that aside from the three oldest banks, all banks had to have unlimited liability (until sometime after 1878). So you could form a bank, but you couldn't incorporate it. The U.S. regulation you are criticizing was designed (admittedly often poorly designed) to prevent limited liability banks from simply being frauds.

    In fact, are you sure that the issue of notes by an unchartered, unlimited liability entity was illegal in all states? (I really don't know.) Is it possible that your ideal of free banking was competing with the limited liability (and regulated) model that would be adopted by the end of the 19th century — and was already losing the competition?

    But more importantly if you are advocating unregulated banking, are you also advocating prohibiting the use of the corporate form by banks. Does the latter count as regulation or lack of regulation?

    • George Selgin

      Thanks for these questions, csissoko. In Scotland free entry into banking was indeed limited to unlimited liability firms, and that was perhaps the main departure there from ideal free banking. But it isn't clear that the entry barrier was binding because, for many years after it was at last relaxed in 1862, none of the Scottish unlimited liability banks chose to convert to limited liability. (Several did so after 1887). I do not, however, view corporate or unlimited liability status itself as a form of regulatory intervention, though I understand that this is a matter of some debate.

    • Michael Matt

      The various states went about outlawing unincorporated note-issue banking through different restraining acts over the course of the late 18th and early 19th century, with the earliest in Virgina in the 1780's and the latest in Mississippi in 1840. Usually, states that lacked restraining acts up to a certain time would not have many banks to begin with, with those few that existed pursuing charters anyway because of the benefits of limited liability and others accruing to the corporate form. A restraining act would then come about because the early movers would push for brakes to competition from other unincorporated banks.

      The majority of the developed states that would have had a need for banks had outlawed unincorporated banking (either in general or in terms of note-issue) by about 1820. The most developed areas (New England, New York, Pennsylvania) got there first, either before 1800 (in the case of New England) or by 1810 (New York and Pennsylvania). The US never really had a shot at real, unregulated free banking because, by the time banking was a going concern, the people with the power an influence to start molding banking law to their own needs realized how important banking was going to be — and thus both how profitable it could be to them and how vital a well functioning banking system would be to the country.

      The US has had a really screwed up banking history and history with money in general, ranging from the money-draining policies of the British Empire during the colonial era to the deep, intimate involvement of every level of government in money and banking from the earliest days of independence.

      • George Selgin

        Thank you for these most helpful observations, Matt.

        • Michael Matt

          Not a problem Dr., I've been an avid follower of your work and the work of your colleagues for years, so I'm always happy to share what my own research has turned up.

      • csissoko

        Thank you for that thorough discussion. Do you of any good sources on this material?

        • George Selgin

          See chapter 2 in the 2nd edition of Larry White's Free Banking in Britain, and the papers by Carr and Mathewson cited therein:

          • csissoko

            Thank you. I am familiar with those sources, but am not entirely in agreement with their interpretation of some facts. John D. Turner has recently published a book on the role that unlimited and extended liability played in stabilizing the British banking system.

          • George Selgin

            Thank you for alerting me to Turner's work.

        • Michael Matt

          The specific citation on when various states passed restraining acts comes 'Evolution of the Legal Framework for Government Regulation of Commercial Banking' by Roger S White. As far as I'm aware it's a publication of the Business History Conference, easy to Google if you're interested in more. The overview of US history in banking regulation is gleaned from reading the works of both our esteemed hosts in the Modern Free Banking School and US history more broadly (especially in the pre-Fed era, when banking was occasionally a major political issue).

          I can't really think of one, good resource for US banking history, especially in the period in question. I'm just starting to crawl through Mr. Jaremski's dissertation and it looks good so far, although it doesn't really dig deeply into the pre-'free banking' era banking that occurred, especially in New England where it was successful and relatively free in practice.

          If you're interested in reading more detail on banking in New England, a Google search for 'Suffolk System' should turn up good material to dig through.

          • csissoko

            Thank you. The Roger White source is excellent, and I was completely unaware of its existence.

          • Michael Matt

            We have the great fortune to live in a time when there is more pertinent information available on most any given subject than we could ever be really aware of. While the general public and a good deal of the economic and economic history professions seem to be unaware of the details of banking regulation in American history (thus the misunderstandings you get, even amongst what are supposed to be experts, about the 'free banking' era), not everyone has been so misinformed in the 150 years since the National Banking Acts and many of these surprisingly well informed people have nothing to do with and no knowledge of the Modern Free Banking School personages.

            It's amongst these people that you'll find some of the most fascinating details. Our hosts here have provided decades worth of laudable scholarly research, but there is always more to be found and I feel like some of it is outside even their domain of knowledge, which makes it all the more interesting to lay persons like myself.

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  • Diyaree Ismael

    Thank you for the post it's really interesting, reading this I remembered another article I read about free banking and this quote came to mind
    “If we want to have money, it must be something that cannot be increased with a profit by anybody, whether government or a citizen. The worst failures of money, the worst things done to money were not done by criminals but by governments, which very often ought to be considered, by and large, as ignoramuses but not as criminals.”

    —Ludwig von Mises,

    I have a question though, I noticed that you didn't mention/go over how free banks can issue currency and the possibilities that entails I'd really like to hear your opinion about that.