Banking in the United States Around the War of 1812
United States
Establishment of the Bank of the United States did not represent a legal obstruction to the growth of other banks. While the Constitution prohibited state governments from participating in banking directly, it did not forbid them from chartering private ones. By 1810, state governments had chartered nearly 90 banks.
The Bank of the United States exerted a substantial influence on state banks. By favoring only those that were well-funded in its dealings and regularly presenting the notes of other banks for redemption, it somewhat restrained the tendency toward speculative practices and over issue of notes by country banks. While this did not resolve the fundamental problem of the bank credit system, it did limit it to some degree.
A bill renewing the bank's 20-year charter was defeated by a single vote, and it was forced to close. State governments continued granting charters to fill the void and one of the most inflationary periods in the nation's history followed. Banking practices became more and more irresponsible.
The War of 1812 turned the developing financial crisis into a gravely serious one. Congress was reluctant to levy taxes to pay for the war. Instead, it borrowed heavily from the banks. State banks accommodated congressional demand for war funding by creating a volume of paper currency, bills of credit, that defied the banks' ability to honor these obligations in money. The state banks were repeating the same mistake the Continental Congress had made when issuing the Continentals!
Bank notes in circulation rose from $ 28 million in 1811 to $ 68 million in 1816 as the number of banks rose from 90 to 250. The value of the notes, which depended solely on the confidence of the noteholder in the issuing bank, began depreciating. Within three years of the closing of the Bank of the United States, confidence had deteriorated to such an extent that banks across most of the country stopped redeeming their notes in money.
To rein in this behavior and to reduce the number of notes in circulation, Congress authorized the charter of a "second" Bank of the United States.
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