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  • Corey Voorman

Wildcat Banking

Independently issued and un-collateralized currencies are nothing new. In fact, the ideas that under-pin the recent “crypto-revolution” are not novel and appear repeatedly in history. An excellent historical example of this is what became known as the Free Banking Era which lasted in the United Stated from 1837-1864. Prior to this period, there were two previous attempts to establish a central bank for the United States. After the second rebuff of a planned federal bank, the onus for banking regulation was placed into the hands of the states. This resulted in a tumultuous and failure ridden spree of currency creation rife with fraud and bank runs.

The term Wildcat banking (deemed wild-catting) is alleged to have originated in Michigan in 1837 shortly after the state was founded. The banks, many times specious were placed so far out in the country that wild animals were said to have outnumbered people. Many states granted charters to banks individually upon legislative approval whereas Michigan allowed for the creation of a bank with a charter granted almost solely based on collateral. The required collateral to start a bank was 50,000 dollars. Once a bank’s collateral requirements were met and backed by state bonds, the newly minted bank’s lending endeavors could begin. Though certain states free banking experiment was successful, due to panics and collateral shortages and counterfeiting, many ended in disaster. To further complicate the free banking environment a secondary market rapidly developed for the bank notes which traded on the New York Stock Exchange. This secondary market encouraged arbitrage and speculation. The free banks were often at a high risk of a banking runs as many banks only held enough specie (bullion) or state government bonds to honor only a few days’ worth of redemptions. When a panic occurred such as the panic of 1857, many banking clients who tried to redeem their local bank notes were left with worthless paper, if they weren’t first in line.

One common problem for certain states was the ability for bank notes to be redeemed as collateral at par or face value. For example, a 100 dollar note issued from the Bank of Bellevue in Nebraska could circulate to Farmers Bank of Sandstone in Barry Michigan and be redeemed for 100 dollars of collateral even though the bank note was trading at 90 dollars at a discount in the secondary market. This meant that 10 dollars of extra collateral was created. Accidental distortions or errors in banking during this period were the most benign of issues plaguing banking at this time. Many examples of outright fraud happened when Wild-Catting bankers would create a bank, over extend their lending then pack up and leave town folding the bank as they left. To combat this issue, there were inspectors in many banks who would redeem currency at a rate based on the perceived legitimacy of the note. These so-called inspectors, would assess the credit quality by observing the wear on the note, if it was dirty and appeared circulated, there was a higher chance that it would not be deemed worthless. In addition, a brief exposure to a light source would show how many holes were created by pins used to hold the currencies as they circulated from bank to bank.

What ended the free banking era? A few different factors contributed to its demise. The final blow to free banking was the National Banking Act of 1963 which was followed by heavy taxes on state bank notes. During the free banking period, many banks lasted less than a year and it was estimated that up to 1/3 of all currency traded was defunct or fraudulent. The ethos of the free banking period should resonate strongly with the current crypto phenomena. Many regulators have been considering regulating crypto exchanges as banks, and mandating federal collateral back the different currencies. Regulation, followed by heavy taxes, could bring the crypto era to a similar end as the free banking era.

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