Banking is probably the most highly regulated industry in America, especially after the 2008 “financial crisis.” Peter Conti-Brown and Sean Vanatta have produced the first comprehensive account of how our system came to be. This may be the best book ever written about bank regulation. For those inclined to say “That’s like being the tallest building in Topeka, Kansas,” the absence of competition is significant. Banking has been conspicuously missing from scholarship on the administrative state. The founders of the field (James Landis, Leonard White) and its reformers (the Brownlow and other commissions) all but ignored it. Banking has also been virtually exempt from the antitrust laws. Conti-Brown teaches finance and economics at the Wharton School and is a fellow at the Brookings Institution; Vanatta teaches financial history at the University of Glasgow. In this deeply researched and admirably written work, they aim to put banking back into the picture.
The narrative stream is a repeated history of vacillations between the private-profit and the public-welfare (as in “safe and sound” banking practices) sides of banking, which have made the industry a quasi-public utility. The authors properly accentuate the danger of “internalized benefits and externalized costs” in finance. Everyone became familiar with this kind of “heads the bankers win, tails the public loses” problem in the 2008 bailouts, and more recently in the Silicon Valley Bank rescue. American history displays a long train of political clashes over banking: Jefferson v. Hamilton, Jackson v. Marshall, Salmon P. Chase v. himself, Bryan v. McKinley, Woodrow Wilson and Louis Brandeis v. “the money trust,” and the Roosevelts v. the “malefactors of great wealth.” Today, we have Elizabeth Warren v. “the big banks” and Trump v. Powell. Each conflict tends to augment the regulatory superstructure, which the authors call “institutional layering.”
It may be hard not to laugh at the authors’ ingenuous conclusion, that “bank supervision is not some sleek, efficient machine ordained by farsighted legislators.” Bank regulation is “not simply a teleological march toward ever-greater perfection.” Indeed. Our regulatory structure looks more like a Rube Goldberg design or the Ptolemaic solar system before the Scientific Revolution than Hegel’s “divine idea as it exists on earth.” One can only wonder why it took these experienced scholars so long to arrive at their “theoretical conceit that history is contingent and unpredictable.”
The Civil War national bank system did more than just provide a national currency. Its most important function was to monetize the enormous federal debt that accompanied the Civil War.
The origins of America’s exceptional banking system lie in our constitutional history, principally in the confusion of “money” and “banking.” The Constitution gives Congress the power “to coin money, regulate the value thereof,” and some other money-related powers like taxing and borrowing. It forbids the states to “coin money; emit bills of credit; make any thing but gold and silver coin a tender in payment of debts.” It says nothing about banking. This, of course, was the basis of the first great interpretive controversy in American constitutional history, between Jefferson and Hamilton over the First Bank of the United States (BUS). This bank, and its successor, were supposed to provide a uniform and stable national currency, which everyone agreed was a legitimate congressional function. (Nobody but hard-core libertarians seems to have said that Congress could or should not exercise its money power—to leave it dormant, like the bankruptcy power or much of the commerce power.) The banks’ involvement with private business—with banking—is what raised hackles. Opponents complained that Congress had delegated its monetary power to the Bank, with virtually no strings attached. The constitutional debate was a close one. Washington sided with Hamilton against Jefferson and Madison, and the latter two came to accept the Bank. John Marshall endorsed it, but Jackson reopened the controversy and killed the Second BUS. If Congress had created a Third BUS, as Henry Clay and the Whigs wanted, it is likely that the Taney Court would have reversed McCulloch v. Maryland and struck it down.
Instead, after Jackson killed the Second BUS, the country entered the “free banking era.” States liberally permitted bank incorporation (via “free banking” laws) and began to experiment with regulatory devices like examination and note insurance. Despite the constitutional prohibition, states did make banknotes legal tender. In the inaugural term of the Taney Court, Briscoe v. Bank of Kentucky (1837) reversed a Marshall Court precedent and effectively allowed the states to usurp the national monetary power. This period is often depicted as the chaotic era of “wildcat banking,” but historians like Richard Timberlake have defended it. The authors point out that banks in this period were primarily “regulated” by market competition (30). The US did not go all the way to the radically libertarian Locofoco ideal of “the separation of bank and state,” but we’ve never been closer.
The Civil War ended the state-centered bank era. Congress enacted several “National Currency Acts” during the war. They did not create a third national bank, but extended the state free-banking model nationwide, and made the notes of national banks the national currency. The lack of a uniform currency offended the nationalism of the Secretary of the Treasury, Salmon P. Chase. He hoped that all the state banks would join the national system, but they did not. Congress had to impose a prohibitive tax to drive state banknotes out of circulation. The Court upheld this unusual use of the taxing power, which was really a corrective to the antebellum usurpation of the money power by the states, permitted in Briscoe. By this time, the larger issue of the constitutionality of a national bank seemed to be settled; a predominantly Republican federal bench was not likely to dispute it. No longer able to issue notes, the state banks adopted a demand-deposit or checking account system, and by the end of the century, the number of state banks had increased twentyfold and outnumbered national banks three to one. The US has maintained a uniquely bifurcated or “dual” banking system ever since, with a large number of both state and national banks.
The Civil War national bank system did more than just provide a national currency, though. Its most important function was to monetize the enormous federal debt that accompanied the Civil War. National banks had to purchase federal bonds to back the notes they issued. The National Currency Acts also created the first “independent regulatory commission,” the Office of the Comptroller of the Currency (OCC). Congress gave the OCC the mandate to examine the national banks, made its funding independent of annual appropriations, and for the first time imposed a restraint on the president’s power to remove an officer.
Conti-Brown and Vanatta try to make the case that the OCC is part of the “missing century of administrative law” depicted by Jerry Mashaw and the “revisionists,” featuring permissive legislative delegation, robust administrative discretion, and judicial deference. (The Steamboat Inspection Service is the poster child of this allegedly lost world.) This is hard to sustain. The OCC kept within its statutory lane, and hardly anyone complained that it went beyond ensuring compliance with the law to telling bankers how to conduct their business. Comptroller James McCulloch’s Instructions and Suggestions is hardly akin to the Department of Education’s “Dear Colleagues” letters on school gender-affirmation policy, as the authors suggest. It looks more like the OCC became less active in the late nineteenth century, in keeping with the abatement of most of the Civil War-era statist expansions. This is why almost nobody today outside of the banking industry has ever heard of the OCC, and why the Interstate Commerce Commission is considered the first IRC. As Leonard White observed, in his monumental history of the origins of federal administration, “An old timer in Washington looking backward from the vantage point of the late 1890s would have found the government establishment bigger but not much different from its essential nature in 1870.”
The OCC hardly affected the money supply at all. (Curiously, the authors do not address the forays of the Gilded Age Treasury Department into de facto central banking.) Congress retained the monetary power, which was often at the center of national political debate—the Sherman Silver Purchase Act and its repeal, the Legal Tender Act and the Greenback parties, the 1896 “battle of the standards.” The shortcomings of the national banking system—the period panics due to the “inelastic” bank note system (note issue was limited by the amount of federal debt the banks held)—led to the creation of the Fed in 1913. The new central more than overcompensated in providing elasticity. Where the US saw deflation of about 40 percent from the Founding until 1913, we have had an inflation of 3,200 percent since then.
This was the beginning of the wholesale delegation of the monetary power to the bureaucrats. The Fed also failed to impose a coherent national banking system and failed to manage the economic crises of 1921 and 1929. But Franklin D. Roosevelt and Congress only gave the Fed more power. This is the hallmark of bureaucratic expansion: attributing regulatory failure to market failure and using it as the grounds for more regulation. The New Dealers also put into place the last twentieth-century piece of national bank regulation, the Federal Deposit Insurance Corporation. The 1935 Banking Act marks the real debut of bank regulation in the modern administrative state. The OCC continued, though overshadowed by the Fed and FDIC. The authors liken it to the “panda’s thumb,” a vestigial, redundant curiosity.
The authors note that each institutional addition became a power unto itself, “rendering efforts to remove this authority or abolish them as fruitless as they are regular. This is not due merely to the exercise of bureaucratic power, nor is it evidence of the (contested) idea that Congress creates but never abolishes federal bureaus.” Actually, it is. The bank regulation story confirms Publius’ warning in Federalist #44 that “one legislative interference is but the first link of a long chain of repetitions, every subsequent interference being naturally produced by the effects of the preceding.” Often this is because one round of regulation produces harmful economic effects that lead entrepreneurs to devise ways around the existing system (“shadow banking” institutions, which Hugh Rockoff has shown to be on the scene of almost all of our financial crises), or for political entrepreneurs to call for deregulation or reregulation.
We see regulatory pathology in the generation after the New Deal banking reforms. The mid-twentieth-century US came very close to a nationalized banking system. Jesse Jones, the head of the Reconstruction Finance Corporation ([RFC] the bailout ladle for banks, railroads, and municipalities “too big to fail,” a First World War and Hoover administration holdover that did expire, though not until 1957), warned the American Bankers Association in 1933 to get behind the New Deal or be nationalized. By 1935, the RFC owned stock in half of American banks, and one-third of all bank capital. By World War II, federal bonds constituted 57 percent of all bank assets; another 19 percent were guaranteed loans to government contractors. The “animal spirits” of the financial world were torpid. Postwar banking was all but risk-free. This was the era of so-called “3-6-3 banking”—borrow at 3 percent, lend at 6, and be on the golf course by 3. As the authors observe, “the banking industry’s corporatist system of public and private risk management had perhaps succeeded too well in dampening excitement and entrepreneurial risk.” This surely had dampening economic consequences. The postwar years were not an “era of unprecedented growth,” but rather lackluster compared with the late nineteenth or late twentieth centuries.
We see regulatory pathology in the generation after the New Deal banking reforms. The mid-twentieth century US came very close to a nationalized banking system.
The modest deregulation movement of the 1970s came late to the banking industry. Conti-Brown and Vanatta tell the engaging story of James Saxon, JFK’s Comptroller’s and his fruitless effort to “get the country moving again.” In 1970, Treasury official Roy Englert (who just passed away at the age of 102) lamented that Congress was moving in the other direction, adding “one restraint after another,” especially for consumer protection and civil rights. Many took the Savings and Loan collapse of the 1980s as a cautionary tale against deregulation, but it rather reinforces the story of self-generating government interventions. The Fed fed rampant inflation at the turn of the ’80s and devastated the S&L industry; inept congressional and regulatory responses compounded the demise. Real reform came with the Gramm-Leach-Bliley Act of 1999, which became the scapegoat for the 2008 “financial crisis,” begetting the next round of re-regulation, with the Dodd-Frank Act and the Consumer Financial Protection Bureau, an independent agency within the independent Fed.
It’s said that the Fed’s job is to take away the punchbowl when the party starts to get too lively. (Nobody accuses the OCC of being such a killjoy—it’s never invited to the monetary party.) Conti-Brown and Vanatta might be said to do the same, with the post-1960s story relegated to a brief chapter on “Expansion of Residual Risk: Bank Supervision for Antidiscrimination, Consumer Protection, and Community Reinvestment.” One would like to hear the story of how the “new social regulation” came to banking, and the role of “woke banking” on the subprime mortgage implosion in the last financial crisis. It would be good, as well, to hear of the contribution of “government-sponsored entities” like Fannie Mae and Freddie Mac and SEC-anointed accreditors, and of the “regulatory capture” by bank lobbyists and their congressional confederates. But that is more than enough material for another volume, particularly when technological change has produced so many “shadow banking” alternatives (how many of the iGen and now Gen-Alphas have ever darkened the foyer of an actual brick-and-mortar bank?) and even money alternatives (do we need an Office of the Comptroller of the Cryptocurrency?). In the meantime, we have this helpful account of how the financial industry fits into what Gary Lawson calls “the rise and rise of the administrative state.”
