A (Very) Brief History of U.S. Central Banking

Hamilton is hot on Broadway, but his Central Bank idea was not so much. Find out why.

Rob Hajduch, Principal Credit Analyst

While the Federal Reserve's ubiquitous presence in the financial press (especially around quarterly meetings) allows us to take it for granted as a government institution, it is relatively young compared to other Federal agencies. In fact, the current central bank represents the third incarnation of central banking in the United States, sharing commonalities with its predecessors in being conceived following national emergencies.

The first central bank incarnation was the Bank of the United States (known as First Bank), created in 1791 in Philadelphia at the behest of Alexander Hamilton (theater fans have recently become quite familiar with his story). The bank's charter incorporated three functions: 1) consolidate and settle the Revolutionary War debt of the 13 colonies, 2) act as the Federal government's fiscal agent, and 3) issue uniform nationally accepted paper currency. The bank's creation was controversial from the beginning, with opposition focused on perceived concentration of economic power and the bank's privately sourced initial capital being largely taken from foreigners. As a compromise, the founding fathers agreed the bank's charter would expire after 20 years and could only be renewed by an Act of Congress. To facilitate its role in the collection of Federal tax revenue (primarily in the form of tariffs...ever hear of those?), eight branches were opened in major port cities, and the First Bank quickly emerged as the largest corporation in the country.

Although the First Bank was a financial success, opposition to its existence never subsided and Congress allowed its charter to expire in 1811. Timing for the First Bank's demise proved ironically inopportune as the U.S. and the British Empire again were at war in 1812, following which the Federal government found itself under another crushing debt burden. In 1816 the next Bank of the United States (Second Bank) was created by Congress with similar charter goals and longevity, but with a construct and capitalization that proved even more controversial than those of its predecessor. Like the First Bank, political opposition haunted the Second Bank over the length of its charter and the Jackson Administration allowed it to expire in 1836.

The U.S. economy operated without any form of a central bank over the ensuing seven-plus decades, during which there were four systemic financial crises, culminating in the Panic of 1907 triggered by the collapse of the Knickerbocker Trust Company that echoed eerily and loudly in the 2008 Lehman Brothers bankruptcy.  The 1907 panic served as the final catalyst to form our current Federal Reserve System, adding the "lender of last resort" function in 1913.   

Sources:

stlouisfed.org

federalreserveeducation.org

history.com