Insider Lending [ePub]

by Naomi R. Lamoreaux

Although I thought I had earlier gotten the gist of Lamoreaux's argument about insider lending from her Journal of Economic History article on Banks and Kinship (1986), this book adds an entirely new level of insight and evidence, and demonstrates how antebellum American banking was different from everything we think of as banking today.

First, Lamoreaux shows that banks usually weren't organized and capitalized so that people could make money making loans to other people. Quite the opposite in fact, banks were largely organized so that people could have a source of loans for their own enterprises. A bunch of individuals, usually associated with a family, would buy some stock in a new bank and ask the state for a charter, after which they would solicit funds (mainly capital (ie stock)) from others, and then they would, as directors of the new bank, approve loans to their own businesses. This wasn't regarded as corrupt, but as the very essence of banking itself. Outsiders invested in a bank knowing that it was a way to invest in that family's business, which in New England often meant textile concerns. These people invested long-term in bank stocks because they thought the bank itself should invest long-term in the director's companies. Deposits and notes were regarded as inherently suspect, since a run could force a sudden unwinding of long-term assets, and thus were kept to a minimum. Today many banks have leverage ratios of 33 to 1, borrowed money to invested. In New England it wasn't uncommon for banks to have 2 to 1 ratios, in REVERSE, mostly capital to borrowed funds. As Lamoreaux says, they were more investment clubs than what we would think of as commercial banks.

The book also shows how these banks transformed into more modern enterprises. The panic of 1837 and the Jacksonian reaction against insider banking caused some diminution of insider lending, and some laws that restricted such practices, but it was largely the decline in profitability of banks after 1873 that caused them to expand borrowed funds versus capital, thus making deposits more central in their balance sheets, thus making short-term commercial lending more common. Lamoreaux even has pictures showing how the friendly open-atmosphere of early banking rooms, with low walls and open desks, was transformed into later banking rooms with cages for the tellers, demonstrating a new-found division between "customer" and "banker," when previously these positions were almost synonymous.

So this is a useful and impressive look at how modern American banking came to be, and why.



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