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The Development of the National Money Market, 1893-1911

Published online by Cambridge University Press:  11 May 2010

John A. James
John A. James
Affiliation:
University of Virginia
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Abstract

In this article the convergence of U.S. interregional interest rates in the late nineteenth century is examined and two major hypotheses are tested in the framework of a bank portfolio selection model based on the capital-asset-pricing model. Both the spread of the commercial paper market and the lowering of entry barriers through the reduction of national bank minimum capital requirements are rejected as principal explanations. The erosion of local monopoly power is shown to have been of central importance, and this development was due to the growth of state rather than national banks.

Type
Articles
Information
The Journal of Economic History , Volume 36 , Issue 4 , December 1976 , pp. 878 - 897
Copyright
Copyright © The Economic History Association 1976

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References

1 Davis, Lance E., “The Investment Market, 1870-1914: The Evolution of a National Market,” Journal of Economic History, 25 (Sept. 1965), 360–65CrossRefGoogle Scholar.

2 East—Maine, N.H., Vt., Mass., R.I., Conn., N.J., Pa., Del., Md., D.C. South—Va., W.Va., N.C., S.C., Ga., Fla., Ala., Miss., La., Tex., Ark., Tenn., Ky. Midwest—Ohio, Ind., Ill., Mich., Wis., Minn., Iowa, Mo., Kans., Nebr., N. Dak., S. Dak. West—Colo., Wyo., Mont., Idaho, Nev., Utah, N. Mex., Ariz., Calif., Oreg., Wash., Okla. The regional interest rate series are weighted averages of the average rate on loans and discounts of country national banks by state, the weights being the relative size of the loan and discount portfolio.

3 For a discussion of the derivation of the local interest rates, see John A. James, “Banking Market Structure, Risk, and the Pattern of Local Interest Rates in the United States, 1893-1911,” Review of Economics and Statistics, forthcoming.

Although constructed from the same sources, earnings statements and balance sheets of national banks in the annual reports of the U.S. Comptroller of the Currency, the series here appear to be more accurate than those of Smiley, although the comparison is difficult since their construction is not explicitly reported. For one thing, these series are semiannual, rather than annual. The Smiley series is actually a rate of return on private earning assets, including items such as stocks and bonds, which are separated out of the series here; similarly, here losses are extracted from the reported Losses and Premiums account. Moreover, a correction is made for the growth of the loan portfolio in the derivation here, in order to avoid biasing the computed rates downward. Smiley, Gene, “Interest Rate Movement in the United States, 1888-1913,” Journal of Economic History, 35 (Sept. 1975), p. 595CrossRefGoogle Scholar.

4 A similar story is found by examining interest rate movements of the more disaggregated regions reported by the Comptroller of the Currency. The gap between North Central and New England states narrows significantly over the late 1890's, being virtually eliminated by 1900. The differential between the Great Plains and Mountain states and New England narrows by almost two percentage points, or 40 percent, while that between the Mountain and Pacific states and New England falls around one percentage point, or about 25 percent.

5 , Smiley, “Interest Rate Movement,” p. 600Google Scholar.

6 Rather than the coefficient of variation, a more appropriate, although ad hoc, indicator of the rate of convergence would involve some measure of the diminishing differentials between other regions and the East. The square root of the average of squared differentials of other regions with the East,

is presented here for five year intervals over the period below.

The rate of convergence is not uniform, to be sure, but the trend over the period is clearly toward narrowing differentials with eastern rates. Moreover, the rate of convergence slows after 1900, as Davis also finds.

7 Richard Keehn in his study rejecting the Sylla hypothesis attributed the decline in differentials to declines in transfer costs between markets due to technological improvements in transportation and communication. Domestic exchange rates may be taken as a measure of the transfer costs of funds. Even in the 1830's, a period before significant advances in transportation and communication, the highest quoted exchange rate was lower than the western-eastern and southern-eastern differentials over 1888-1911. Those quoted in Bradstreet's in the late nineteenth century were substantially smaller yet. Consequently transfer costs could account for only a small part of the total observed differential.

Jeffrey Williamson emphasizes demand rather than supply factors in explaining the movement of the differentials. A relative decline in the demand for funds in the Midwest in the late nineteenth century caused rates there to decline relative to eastern rates and after the turn of the century an increase in demand for funds there led to a relative rise in rates. Thus, the explanation for capital market integration is found in real forces exogenous to the capital market. However, this explanation is limited to the Midwest and does not account for the movement of western and southern differentials. Keehn, Richard, “Federal Bank Policy, Bank Market Structure, and Bank Performance: Wisconsin, 1863-1914,” Business History Review, 48 (Spring 1974), 1–27.CrossRefGoogle ScholarWilliamson, Jeffrey G., Late Nineteenth-Century American Development (Cambridge: Cambridge University Press, 1975), pp. 130–32Google Scholar.

8 , Davis, “The Investment Market, 1870-1914,” pp. 370–73Google Scholar.

9 Sylla, Richard, “The United States, 1863-1913,” in Cameron, Rondo, ed., Banking and Economic Development (New York: Oxford University Press, 1972), p. 258Google Scholar.

10 Sylla, Richard, “Federal Policy, Banking Market Structure, and Capital Mobilization in the United States, 1863-1913,” Journal of Economic History, 29 (Dec. 1969), p. 685CrossRefGoogle Scholar.

11 Ibid., pp. 664-70.

12 Smiley has considered these two hypotheses by an inspection of the data, but not within a well-defined theoretical model. , Smiley, “Interest Rate Movement,” pp. 607–10Google Scholar.

13 For the derivation see John A. James, “Portfolio Selection with an Imperfectly Competitive Asset Market,” Journal of Financial and Quantitative Analysis, forthcoming.

Several features of nineteenth-century banking greatly simplified the portfolio problem. The benign influence of the real bills doctrine ensured that loans were short-term and thus eliminated the term structure problem. Moreover, liquidity constraints do not seem to have been considered.

The assumption of risk aversion in the mean-variance model seems to be a reasonable one. There is no evidence of a well-developed market in bank stock, so it may be assumed that banks were generally closely held by the entrepreneur, who is usually taken to be risk-averse. The Sylla and Keehn models of bank behavior, on the other hand, portray banks as firms, equating marginal revenues and marginal costs on assets; such a characterization misses the essence of choice among varying risks in portfolio selection. James, John A., “The Evolution of the National Money Market, 1888-1911,” unpublished MIT Ph.D. thesis, 1974, pp. 301–7Google Scholar.

14 For detailed information about the transformation of the theoretical risk-return relationship into estimable form, construction of the variables, and regression results see James, “Banking Market Structure.”

15 Stigler, George, “Imperfections in the Capital Market,” Journal of Political Economy, 75 (June 1967), 288CrossRefGoogle Scholar.

16 Smiley suggests that his finding of no interest rate convergence over this period may have been due to an increase in risk aversion of bankers, although risk is not explicitly measured. , Smiley, “Interest Rate Movement,” pp. 600–5Google Scholar.

17 The estimated coefficients from a simple regression of the VAR series by state on a time trend were regressed in turn on regional dummies.

Even though the groupings are not significant, the magnitudes of the coefficients across regions are consistent with out expectations, the smallest decline being in the East, then the Midwest, the South, and finally the West with the largest decline.

18 In a cross-section time series regression for reserve cities, however, the estimated VAR coefficient was significantly positive and of substantial magnitude, perhaps indicating that closer market integration among cities allowed banks to reduce risk. For the complete regression results see James, “Banking Market Structure.”

19 , Davis, “The Investmen t Market, 1870-1914,” p. 372.Google Scholar

20 Greef, Albert O., The Commercial Paper House in the United States (Cambridge: Harvard University Press, 1938), p. 39.Google Scholar

21 Smiley suggests that the expansion of the commercial paper market over the period 1907-1909 may have led to interest rate convergence, but does not explicitly test the proposition. , Smiley, “Interest Rate Movement,” pp. 607–9Google Scholar.

22 , Greef, The Commenced Paper House in the United States, p. 48Google Scholar.

23 For identification of the starting date of commercial paper sales in various cities see Greef, p. 39. Phillips, Chester A., Bank Credit, (New York: Macmillan Co., 1920), p. 135Google Scholar.

24 This case is strengthened by examining more finely drawn regions. For example, it was noted that country banks in the Great Plains began buying paper around 1900: however, there also wer e substantial declines in interregional differentials before 1900.

25 In the South and Midwest, for example, virtually every state has a negatively signed and significant M P coefficient. For th e complete list of estimated regression coefficients see James, “Banking Market Structure.”

26 For the simulated magnitudes see , James, “The Evolution of the National Money Market, 1888-1911,” p. 542Google Scholar.

27 The increase in the rate of formation of both state and national banks after 1900 suggests that they were affected by some common influence such as the business cycle. If lowered legal barriers to entry in th e National Banking Act had bee n the principal influence, no influence on the formation of state banks should be observed. If anything, th e rate of state bank formation should have decreased with the lowering of national bank capital requirements.

28 For example, in Texas where state banks wer e still forbidden, thirty-four new national banks were organized over the same period. In Iowa, wher e the state minimum capital requiremen t was $25,000, the same as the national one, thirty-two new national banks were organized. Cooke, Thornton, “The Effect of th e Ne w Currency Law on Banking in th e West,” Quarterly Journal of Economics, 15 (Feb. 1901), 278–80CrossRefGoogle Scholar.

29 All-Bank Statistics, p. 32.

30 Barnett, George E., State Banks and Trust Companies since the Passage of the National-Bank Act (Washington: Government Printing Office, 1911), p. 202Google Scholar.

31 Padgett, A. E., “The Multiplication of Banks,” Proceedings of the South Carolina Bankers' Association, 1908, p. 126Google Scholar.

32 Preston, Howard H., History of Banking in Iowa (Iowa City: State Historical Society of Iowa, 1922), p. 354Google Scholar.

33 “Country Credit Methods, “Proceedings of the Maryland Bankers' Association, 1914, p. 47.

34 Hinchman, T. H., Banks and Banking in Michigan (Detroit: M. Graham, 1887), p. 170Google Scholar.

35 Friedman, Milton and Schwartz, Anna, A Monetary History of the United States (Princeton: Princeton University Press, 1963), p. 122.Google Scholar On the other hand, state banks might not have bee n severely handicapped by the loss of the privilege of note issue even relatively early in the I post-bellum period. In 1881, the earliest observation date, checks rather than currency constituted over 70 percent of total receipts of national banks in all rural regions except th e Pacific states. U.S. Comptroller of the Currency, Annual Report, 1881 (Washington: Government I Printing Office, 1881), pp. 17–19.Google Scholar

36 , Keehn, “Federal Bank Policy,” p. 27.Google Scholar

37 Private banks, unincorporated banks not generally subject to state regulations, should also be mentioned. On the whole they were quite small and provided banking facilities in very small towns which could not support a larger bank. For example, in Wisconsin in 1890 one-third of private banks had capital of less than $5,000 and two-thirds had capital of less than $15,000. How could any bank possess monopoly power as long as private banks could be established with no minimum capital? Apparently private banks were not perfect substitutes for chartered banks. The public seemed to put a premium on soundness and felt more comfortable with chartered banks as a result. Nevertheless, private banks did to some extent act as an offset to high capital requirements. In the period immediately after the Civil War private banks grew very rapidly, providing alternatives to the relatively difficult-to-establish national banks; later, in the 1880's, state banks became viable alternatives to national ones, and the growth of private banks essentially stopped. Andersen, Theodore A., A Century of Banking in Wisconsin (Madison: State Historical Society of Wisconsin, 1954), pp. 62–63Google Scholar.

38 In 1909 only four states had no minimum capital requirements for state banks—Arizona, Arkansas, South Carolina, and Tennessee. In these states state banks were organized under the I business incorporation law and like other corporations the size of capital was at the discretion of 1 the incorporators. Barnett, State Banks, p. 36.

39 Cooke, Thornton, “Distribution of Small Banks in the West,” Quarterly Journal of Economics, 12 (Oct. 1897), 71CrossRefGoogle Scholar.

40 , Barnett, State Banks, pp. 23, 32Google Scholar.

41 Dailey, Dan M., “The Development of Banking in Chicago before 1890,” (unpublished fh.D. dissertation, Northwestern University, 1934), pp. 309, 355Google Scholar.

42 , Barnett, State Banks, p. 31.Google ScholarHelderman, Leonard C., National and State Banks (Boston: Houghton Mifflin Co., 1931) pp. 161–62Google Scholar.

43 This conclusion is consistent with RockofTs suggestion that free banking laws improved the allocation of bank capital in the antebellum period. Rockoff, Hugh, “The Free Banking Era: A Reexamination,” Journal of Money, Credit, and Banking, 6 (May 1974), 157–63CrossRefGoogle Scholar.

44 The Davis hypothesis emphasizing the spread of the commercial paper market postulates a I net flow of funds from East to West, while, on the other hand, Sylla emphasizes the flow from I the countryside to the cities through the mechanism of bankers' balances. It can be shown that [unless the eastern interregional balance of trade surplus was enormous, close to $1 billion per year over the period 1900-1910, the direction of short-term capital flow must have been from Vest to East, a result consistent with the observations of contemporaries concerning the oncentration of funds in New York through the system of bankers' balances and also consistent vith the function of New York as a financial intermediary. The Market Power hypothesis fits buite well with this picture of capital flows, but the Institutional Change hypothesis does not. , James. “The Evolution of the National Money Market, 1888-1911,” pp. 200–12Google Scholar.