Safety Fund System

Last updated

The Safety Fund System was one of many banking systems created after the failure of the Second Bank of the United States and before a national banking system was established. Other notable systems include the Suffolk System, the free banking system, and the Forstall System. [1] The Safety Fund System was the nation's first experiment in bank liability insurance. [2] It was enacted by the New York legislature in 1829 and it began to fail following the Panic of 1837. [1]

Contents

Background

Throughout the antebellum period, there were several attempts to establish appropriate banking controls by employing different systems. These different experiments helped the banking industry decide which kinds of regulations worked and which ones did not. The number of banks increased from 327 to 1,562 during this time and total loans increased from just over $55.1 million to $691.9 million. Bank supplied credit also increased at an average annual rate of 6.3 percent. [2] The financial sector was increasing rapidly and the government saw fit to place regulations on the banks. Most of these regulations were at the state level because of the Federalist views held by the Jackson administration. [2]

Policies

Officially passed under the Safety Fund Act in 1829, the system required banks to hold at least 3 percent of capital stock as reserves. Prior to the Act, New York banks were notoriously corrupt and bank customers had no protection from losses they would occur. [1] These reserves were held in a common fund with all the banks of New York and were to be used to pay all debts of failed banks except capital stock. Banks were also subject to inspections to ensure proper compliance with new banking regulations. [1]

Downfall

After the Panic of 1837, the Safety Fund System was nearly bankrupt. The stress put on the system by the Panic eventually caused it to fail as deflation soared because the banks of New York began to only accept specie. Upon its initial passing, lawmakers did not realize the impact this insurance could have. [1] The promise of reimbursement caused the system to break down under the burden of numerous bank failures from 1840–1842. [1] This paved the way for the free banking system.

Effects

The idea of bank liability insurance that was first implemented in the Safety Fund System is still prevalent in the United States banking system today. The Federal Deposit Insurance Corporation was created to ensure that banks are following the precedent of holding reserves. The Safety Fund System was extremely influential in the advancement of banking in the United States and its effects are still seen today.

See also

Notes

  1. 1 2 3 4 5 6 Holdsworth, John Thom (1971). "Lessons of State Banking before the Civil War". Proceedings of the Academy of Political Science. 30 (3): 23–36. doi:10.2307/1173279. JSTOR   1173279.
  2. 1 2 3 Bodenhorn, Howard (March 26, 2008). "Antebellum Banking in the United States". In Whaples, Robert (ed.). EH.Net Encyclopedia.

Further reading

Related Research Articles

<span class="mw-page-title-main">Federal Deposit Insurance Corporation</span> US government agency providing deposit insurance

The Federal Deposit Insurance Corporation (FDIC) is a United States government corporation supplying deposit insurance to depositors in American commercial banks and savings banks. The FDIC was created by the Banking Act of 1933, enacted during the Great Depression to restore trust in the American banking system. More than one-third of banks failed in the years before the FDIC's creation, and bank runs were common. The insurance limit was initially US$2,500 per ownership category, and this has been increased several times over the years. Since the enactment of the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, the FDIC insures deposits in member banks up to $250,000 per ownership category. FDIC insurance is backed by the full faith and credit of the government of the United States, and according to the FDIC, "since its start in 1933 no depositor has ever lost a penny of FDIC-insured funds".

<span class="mw-page-title-main">Banking in the United States</span> Overview of the U.S. financial system

In the United States, banking began by the 1780s along with the country's founding and has developed into highly influential and complex system of banking and financial services. Anchored by New York City and Wall Street, it is centered on various financial services namely private banking, asset management, and deposit security.

<span class="mw-page-title-main">Panic of 1837</span> 19th-century United States financial crisis

The Panic of 1837 was a financial crisis in the United States that touched off a major depression, which lasted until the mid-1840s. Profits, prices, and wages went down, westward expansion was stalled, unemployment went up, and pessimism abounded.

The Panic of 1819 was the first widespread and durable financial crisis in the United States that slowed westward expansion in the Cotton Belt and was followed by a general collapse of the American economy that persisted through 1821. The Panic heralded the transition of the nation from its colonial commercial status with Europe toward an independent economy.

<span class="mw-page-title-main">Bank run</span> Mass withdrawal of money from banks

A bank run or run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may fail in the near future. In other words, it is when, in a fractional-reserve banking system, numerous customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent. When they transfer funds to another institution, it may be characterized as a capital flight. As a bank run progresses, it may become a self-fulfilling prophecy: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy. To combat a bank run, a bank may acquire more cash from other banks or from the central bank, or limit the amount of cash customers may withdraw, either by a imposing a hard limit or by scheduling quick deliveries of cash, encouraging high-return term deposits to reduce on-demand withdrawals or suspending withdrawals altogether.

<span class="mw-page-title-main">Savings and loan crisis</span> US financial crisis from 1986 to 1995

The savings and loan crisis of the 1980s and 1990s was the failure of 32% of savings and loan associations (S&Ls) in the United States from 1986 to 1995. An S&L or "thrift" is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members.

This history of central banking in the United States encompasses various bank regulations, from early wildcat banking practices through the present Federal Reserve System.

<span class="mw-page-title-main">Free banking</span> Economic system

Free banking is a monetary arrangement where banks are free to issue their own paper currency (banknotes) while also subject to no special regulations beyond those applicable to most enterprises.

<span class="mw-page-title-main">1933 Banking Act</span> 1933 U.S. banking reform; established the Federal Deposit Insurance Corporation (FDIC)

The Banking Act of 1933 was a statute enacted by the United States Congress that established the Federal Deposit Insurance Corporation (FDIC) and imposed various other banking reforms. The entire law is often referred to as the Glass–Steagall Act, after its Congressional sponsors, Senator Carter Glass (D) of Virginia, and Representative Henry B. Steagall (D) of Alabama. The term "Glass–Steagall Act," however, is most often used to refer to four provisions of the Banking Act of 1933 that limited commercial bank securities activities and affiliations between commercial banks and securities firms. That limited meaning of the term is described in the article on Glass–Steagall Legislation.

<span class="mw-page-title-main">Financial crisis</span> Situation in which financial assets suddenly lose a large part of their nominal value

A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults. Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy.

The Independent Treasury was the system for managing the money supply of the United States federal government through the U.S. Treasury and its sub-treasuries, independently of the national banking and financial systems. It was created on August 6, 1846 by the 29th Congress, with the enactment of the Independent Treasury Act of 1846. It was expanded with the creation of the national banking system in 1863. It functioned until the early 20th century, when the Federal Reserve System replaced it. During this time, the Treasury took over an ever-larger number of functions of a central bank and the U.S. Treasury Department came to be the major force in the U.S. money market.

<span class="mw-page-title-main">Financial Institutions Reform, Recovery, and Enforcement Act of 1989</span>

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), is a United States federal law enacted in the wake of the savings and loan crisis of the 1980s.

<span class="mw-page-title-main">Too big to fail</span> Concept in economics

"Too big to fail" (TBTF) is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected that their failure would be disastrous to the greater economic system, and therefore should be supported by government when they face potential failure. The colloquial term "too big to fail" was popularized by U.S. Congressman Stewart McKinney in a 1984 Congressional hearing, discussing the Federal Deposit Insurance Corporation's intervention with Continental Illinois. The term had previously been used occasionally in the press, and similar thinking had motivated earlier bank bailouts.

The shadow banking system is a term for the collection of non-bank financial intermediaries (NBFIs) that provide services similar to traditional commercial banks but outside normal banking regulations. Examples of NBFIs include hedge funds, insurance firms, pawn shops, cashier's check issuers, check cashing locations, payday lending, currency exchanges, and microloan organizations. The phrase "shadow banking" is regarded by some as pejorative, and the term "market-based finance" has been proposed as an alternative.

<span class="mw-page-title-main">Bank failure</span> Insolvency or illiquidity of a bank

A bank failure occurs when a bank is unable to meet its obligations to its depositors or other creditors because it has become insolvent or too illiquid to meet its liabilities. A bank usually fails economically when the market value of its assets declines to a value that is less than the market value of its liabilities. The insolvent bank either borrows from other solvent banks or sells its assets at a lower price than its market value to generate liquid money to pay its depositors on demand. The inability of the solvent banks to lend liquid money to the insolvent bank creates a bank panic among the depositors as more depositors try to take out cash deposits from the bank. As such, the bank is unable to fulfill the demands of all of its depositors on time. A bank may be taken over by the regulating government agency if its shareholders' equity are below the regulatory minimum.

The Panic of 1930 was a financial crisis that occurred in the United States which led to a severe decline in the money supply during a period of declining economic activity. A series of bank failures from agricultural areas during this time period sparked panic among depositors which led to widespread bank runs across the country.

The Panic of 1826 was a financial crisis built upon fraudulent financial practices from the management of various firms. The height of the panic occurred during July 1826 when six of the sixty-seven companies publicly traded on the New York Stock Exchange abruptly failed. Within the coming months, twelve more NYSE firms would also fail. The panic sparked New York State to bring in extensive legislation seeking to regulate financial companies and protect investor interests. These regulations, legislation, and precedents like the shareholder derivative precedent were some of the first ever enacted in America and provided the basis for today's financial regulations after the panic of 2008.

This article details the history of banking in the United States. Banking in the United States is regulated by both the federal and state governments.

State defaults in the 1840s were defaults by U.S. states that took place in Arkansas, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi, Pennsylvania, and the territory of Florida. The end of an inflationary period from 1834 to 1839 and the Panic of 1837 led to a tightening of credit lending from the Bank of England. By 1841, nineteen of the twenty-six U.S. states and two of the three territories had issued bonds and incurred state debt. Of these, the aforementioned states and territory were forced to default on payments. Four states ultimately repudiated all or part of their debts, and three went through substantial renegotiations.

The Forstall System was a banking system developed by Edmund J. Forstall in 1842 and used until the end of the Civil War. After the Panic of 1837, banks underwent two main reformations. New York adapted a free banking system while Louisiana set up a banking system with specie reserve requirements. The Forstall System propelled Louisiana to economic maturity with its sound and credible banking system. It has been called one of the building blocks of the modern financial system still in place today.