-issue. Several States adopted the practice of giving notes a prior lien on assets. Another measure adopted was that of double liabllity which made bank shareholders liable for the debts of the bank to an amount equal to their respective holdings of shares over and above the amount of capital actually invested by them in the bank. The most ambitious scheme was the New York Safety-Fund system. This was a system of compulsory insurance of banks against unmet liabilities. The banks paid contributions to a fund to be allocated to the paying out of the liabilities of insolvent banks where they exceeded their assets. There was, of course, a tendency under this scheme to subsidise weak institutions at the expense of the stronger and more prudently managed ones, especially as the insurance premium was not assessed on the basis of actuarial risks, but was merely computed as a percentage on the capital of the bank. It also had the further unhealthy effect of weakening the public scrutiny over the issues of particular banks, and many of the banks were tempted by this fact itself to risk bigger issues. Between 1840 and 1842 eleven of the safety-fund banks failed, the fund was exhausted, and the solvent banks had to be called upon for increased contributions. Future contributions were also mortgaged in advance for charges in respect of an issue of State bonds made to replenish the fund. After the bankruptcy of the fund in 1842, it was made security for notes only and no longer for deposits as well, but it still proved inadequate.
We have already observed that the banking business in the United States, or at least over the greater part of it, was in the first half century of its growth by no means open to free entry. But from 1838 onwards there was a change of policy in several of the States which made it possible for banks to set up without having to obtain a charter. The new policy was inaugurated by New York in 1838 in a so-called Free-banking Law. Under this law it was made permissible for any person or association to issue notes, provided they had deposited with the Comptroller the equivalent amount in the form of certain securities. All stocks of the United States and those of States approved by the Comptroller were eligible, and, in addition, certain bonds and mortgages on real estate. Should a bank default on its notes, the Comptroller would sell the collateral securities in order to redeem them. The first effect of the newly granted freedom was a wild dash to establish banks.
Immediately on the passage of the bill arrangements were made for the formation of over a hundred and thirty new banks; about half of these had actually started business a year later and nearly half of them had gone out of business after another three years. The idea in the minds of many of the bank organisers seems to have been that if their notes were secured, nobody would ever demand their redemption. Many of them set up solely for the purpose of issuing notes, but in 1848 the State passed legislation requiring banks to undertake discount and deposit business as well as note circulation.
The bond deposit system had the effect of tying up bank investment in certain lines, usually Federal or State bonds. Mortgage and other real estate business soon proved to be too illiquid to provide backing for notes. It also had the rather peculiar effect of making the amount of the note circulation depend on the prices of Federal and State bonds. It meant also that while banks, constituted on other lines, could realise their assets in order either to get funds for redeeming their notes or to decrease the amount of notes in circulation, the bond deposit banks had very little chance of doing this, because their capital was tied up in Government securities which they were not free to sell until they had first reduced their note circulation, a feature which put them at a considerable disadvantage in comparison with the chartered banks. Moreover, the system was by no means a perfect guarantee of note redemption, because when a bank failed, many State stocks could be disp