How Thomas Jefferson’s hatred of money men spawned an unruly regulatory and banking system and led to our current crisis.
No one doubts that Thomas Jefferson was a genius who deserves his place on Mount Rushmore. His words in the Declaration of Independence still express what this country has been about for 232 years: life, liberty and the pursuit of happiness. But he wasn’t a saint. He was an aristocrat who despised and feared aristocracy, a lover of liberty who lived off the labor of slaves, an intellectual who had more interest in theory than facts. He cleverly devised the world’s first decimal currency—a dollar divided into 100 cents—but never tried to understand the mechanisms that are necessary to keep that currency functioning reliably in the real world, because he hated banks.
We have been paying a high price for Jefferson’s disdain ever since. His hatred of “money men” and commerce led to an unruly banking and regulatory system prone to periodic and catastrophic breakdowns. Today America has more banks than all the world combined and a fragmented financial regulatory system that adds to the chaos.
The seeds of our present-day financial crisis were sown during Jefferson’s epic battles with the first secretary of the Treasury, Alexander Hamilton, who was every bit his intellectual equal. Jefferson was an elitist, the scion of one of the richest families in Virginia whose earliest memory was of being carried on a pillow by a slave. Hamilton, orphaned before he was 10, grew up working in a trading house in St. Croix in the West Indies, where he learned the rough-and-tumble of the marketplace first hand.
Jefferson and Hamilton clashed over the massive leftover war debts from the Revolution, an unstable money supply and whether the country needed a central bank. At first, Hamilton won, and got the young republic on a sound financial footing by establishing a coherent, disciplined banking system. But Jefferson and his allies eventually destroyed Hamilton’s system and set America on a course to bank fraud and failure, a chaotic money supply and a boom-and-bust cycle that has resulted in major financial crises about every 20 years.
America’s first financial panic occurred in 1792. A classic stock bubble had been growing for months. Rising securities prices induced dreams of unbounded wealth acquired with no effort, and speculation became bold. Then the bubble burst. Securities values plummeted, real estate prices plunged, credit dried up and unemployment increased. Many of the most prominent players in the financial community became bankrupt, and some were carted off to jail. “Everything is afloat and destroyed,” lamented one New York merchant, who noted that “shopkeepers, widows, orphans, butchers, cartmen, gardeners and market women” had lost their savings.
As the man in charge of America’s financial system, Hamilton was appalled by the reckless speculation.“’Tis time,” he wrote just before the bubble broke, “there should be a line of separation between honest men & knaves, between respectable stockholders and dealers in the funds and mere unprincipled gamblers.”
Hamilton tried to confine the damage to speculators and keep it from spreading to the financial system. He ordered the Treasury to buy up hundreds of thousands of dollars in federal securities, pumping liquidity into the market, and urged banks not to call in loans. He allowed merchants who owed duties on goods they had imported, many of whom had been hurt by the crash, to pay them with notes due in 45 days.
It worked. New York City quickly recovered and the growing prosperity of the 1790s continued in the country as a whole. Meanwhile, Jefferson was calculating: Losses totaled about $5 million, a sum he thought equal to the value of all New York City real estate at the time. He thus saw the panic as the equivalent of a natural disaster, one that ruined those who deserved it—speculators. He was indifferent, at best, to the damage inflicted on the rest of the population.
Jefferson envisioned a country where farmers who owned and worked their own land would be the dominant force in the economy and politics. He feared the establishment of an aristocracy, whether that aristocracy was based on land holdings, like the nobility in England, or based on trade and industry, like the burghers who dominated the Netherlands. And he believed that a strong national banking and financial system might tend to help such a plutocracy.
When Hamilton was appointed Treasury secretary by President George Washington in 1789, he was under no illusion about the manipulative behavior of some men of commerce. But he was convinced that tightly regulated money markets and banks would cause the entire economy, including yeoman farmers, to prosper. Jefferson opposed him every step of the way.
The debt left over from the Revolution was in arrears and paper bills, called “continentals,” had depreciated drastically. Hamilton wanted to refund the debt and retire the paper money by issuing bonds. Jefferson and James Madison, then a leader of the House of Representatives, thought that only the original holders of the debt should be paid full value. Speculators who had bought up much of it, looking to make a profit when it was redeemed, should get no more than they had paid.
Hamilton knew that determining the original owners of the bonds would be difficult, if not impossible. And he realized that once government acquired the power to pick and choose whom it owed money and how much, politics would dominate the process and make government securities less attractive. Hamilton was anxious to establish a well-funded national debt to allow the government to borrow easily in times of emergency. He also knew that the new federal bonds could serve as capital and reserve funds for banks. Congress backed Hamilton, rather than Jefferson and Madison, and the new bonds sold.
Hamilton also wanted the national government to assume the Revolutionary War debts of states. This was more controversial. Not surprisingly, states that had largely paid off their debts—Virginia among them—were against it. So to get his bill passed by Congress, Hamilton had to trade a big political chip. He went to Jefferson and Madison, both Virginians, and offered to throw his weight behind establishing the nation’s new capital on the Potomac, rather than in New York. They agreed and the bill passed.
The third part of Hamilton’s program was critical: establishing a Bank of the United States, modeled on the Bank of England. It would be chartered by the federal government, with shares traded publicly. The government would own 20 percent, and have 20 percent of the seats on the board. It would also have the right to inspect the books at any time.
Jefferson vehemently opposed the bank. He worried that it would not only have the power to increase or lessen the money supply, but could play havoc with the economy in general. Hamilton’s plans called for a $10 million capitalization. The combined capital of the three state banks in existence was only $2 million. By deciding whether to accept the bank notes of state banks, the Bank of the United States could hold tremendous power over state banks. That was exactly what Hamilton had in mind to create a reliable money supply.
“I have ever been the enemy of banks, ” Jefferson wrote years later to John Adams. “My zeal against those institutions was so warm and open at the establishment of the Bank of the United States that I was derided as a maniac by the tribe of bank-mongers, who were seeking to filch from the public their swindling and barren gains.”
President Washington ultimately sided with Hamilton and signed a bill chartering the Bank of the United States—for a period of 20 years. Its stock, offered in 1791, was snapped up in two hours by investors.
Hamilton’s system proved a remarkable success. When the Constitution was adopted in 1787, the United States was in financial turmoil, unable to pay its debts or even the interest on them. The money supply was a hodgepodge of near-worthless bank notes and foreign coins, credit was hard to obtain and capital was scarce. By the time Hamilton finished his six-year term as Treasury secretary in 1795, American bonds were selling at a premium in Europe, the financial system and money supply were stable, and the economy was growing.
None of this prompted Jefferson to change his mind about banking. All he could see were “the immense sums [that] were…filched from the poor and ignorant.” When the Jeffersonians rose to power in the following years, they destroyed Hamilton’s system and created a fragmented banking arrangement with a money supply loosely controlled by states. In 1811 the charter of the Bank of the United States was not renewed. The War of 1812 nearly ended in disaster because of the government’s inability to borrow, so a second Bank of the United States was established in 1816. It got off to a shaky start and failed to exercise much control over state banks. Andrew Jackson, a Jeffersonian, killed it when its charter expired in 1836.
Meanwhile, bank failures and a chaotic money supply became as American as apple pie. Half the banks founded between 1810 and 1820 failed by 1825. Half those founded in the 1830s were bankrupt by 1845. By the 1850s, there were more than 7,000 varieties of valid bank notes in circulation as well as more than 5,500 fraudulent and counterfeit notes. Publishers did a brisk business selling “bank note detectors” to tell merchants and bankers which were fraudulent.
The lack of a central bank that could exercise control over interest rates also made the United States prone to bigger booms and bigger busts than other countries. In 1837, the year after the Second Bank of the United States went out of business, the country experienced its first catastrophic financial panic, heralding the onset of the longest and one of the deepest depressions in American history. Banks failed by the hundreds. In 1857 another panic swept through the economy, causing a depression that only ended with the Civil War.
Ever since the Jeffersonian dismantling of Hamilton’s financial system, crisis has driven sporadic efforts at reform. In 1863 the need to finance the Civil War prompted Congress to pass the National Banking Act, offering federal charters to banks that invested two-thirds of their capital in U.S. Treasury securities. The banks were allowed to issue notes, but only of a uniform design and backed 100 percent by federal bonds. Meanwhile, the government imposed a 10 percent tax on all other bank notes, effectively driving state banks out of the business of printing their own currency. For the first time since Hamilton, the country had a uniform and dependable paper money supply.
While the national charter system was distinctly Hamiltonian, the new national banks were not allowed to branch across state lines. Moreover, the financial system grew even more fractious as state banks continued to proliferate after the Civil War. Many banks in the West and the South lacked sufficient capital to meet national charter requirements. And in many states, thanks to the Jeffersonian inheritance, branch banking of any sort was prohibited.
The Panic of 1907, when the New York Stock Exchange fell 50 percent from its peak the previous year, was contained only when J.P. Morgan acted as a central banker and organized the major New York banks to shore up the banking system and increase liquidity. That prompted the creation in 1913 of the Federal Reserve System. But the chronic fear of an overly powerful bank had a large influence on its design. Instead of one central bank, headquartered in New York as Wall Street wanted, there were 12 quasi-private regional banks, located in cities across the country from Boston to San Francisco. A Federal Reserve Board, comprised of public officials, met in Washington. But each bank was essentially independent and coordination among them was limited.
The consequences were not long in coming. American farmers had prospered during World War I, but hard times began to stalk rural America in the 1920s. By then the number of poorly regulated country banks had grown to 30,000. After the 1929 stock market crash and the onset of the Great Depression, a tidal wave of bank failure rolled over the economy, and there was little the Federal Reserve could do about it. There were 1,350 bank failures in 1930, 2,293 in 1931, and 1,453 in 1932. Only President Franklin Roosevelt’s dramatic bank holiday prevented a general collapse of the American banking system in 1933.
Once again, crisis drove reform. This time, the Federal Reserve was reorganized into a unified system, with the real power held by the board of governors in Washington headed by a chairman appointed by the president. The Federal Deposit Insurance Corporation was founded to insure deposits.
But the banking system was still fragmented, with national banks, investment banks, state banks, trust companies and savings and loan associations. Banking regulation also remained fragmented, with regulators sometimes acting at cross-purposes.
When the post–World War II economic boom began to unravel in the late 1960s and the 1970s, the banking system once more entered a crisis. The country experienced both stagnant growth and the highest peacetime inflation in history. Among the hardest hit were the vast number of small savings and loan associations. The interest those associations could pay on deposits was limited by law, and they could not compete with money market funds offered by investment banks.
In a Hamiltonian banking system, the obsolescent savings and loans would have been liquidated or forced to merge with larger, stronger banks. Instead Congress responded to their calls for help with quick fixes. The result was disaster. Most went broke in the late 1980s. Depositors’ money, which was insured, cost the government about $160 billion.
In 1998 Congress allowed interstate banking for the first time, which set off a wave of consolidation in the banking industry. But even today there are more than 8,500 banks of various types nationwide, and the regulatory system remains fragmented and ineffective. Neither Jefferson nor Hamilton would recognize the modern financial world, with its instant global communications, vast wealth widely distributed, and money represented by bits in interlocking computer networks. But the fundamental problems in the system are in large part a legacy of Jefferson’s fear of central banking and strong federal regulation.
The current crisis—like the Civil War, the panic of 1907, the Great Depression and the savings and loan collapse—provides another opportunity for basic reform. What is called for is what Hamilton sought at the birth of the republic: a unified banking system of large, diversified, well-capitalized institutions under the control of a unified, coherent regulatory system free of undue political influence. That means finally putting to rest Thomas Jefferson’s fear of banks and money men. Fewer than 2 percent of American families now live on farms. Nearly 70 percent own their homes, more than 60 percent own securities, and everyone has a direct self-interest in the prosperity of Wall Street. In a very real sense, we are all money men now.
John Steele Gordon writes on business and financial history. His most recent book on American economics is An Empire of Wealth.
Originally published in the April 2009 issue of American History. To subscribe, click here.
