e 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 disposed of only at a discount.
Parallel with the beginnings of this movement in favour of a greater measure of competition, there took place in some other States foundations of State monopolies. Early in the nineteenth century Indiana and Illinois had prohibited banks unless the State should judge fit to establish one out of its own funds. The Bank of Indiana and the Bank of Ohio, founded in 1834 and 1845, respectively, were both State monopolies. Illinois followed the New York free banking plan in 1851, and Indiana and Wisconsin did the same a little later.
The improvement that took place in American banking in the twenty years preceding the Civil War was especially noticeable in the eastern region. The banking system was by no means perfect at this period, but except for the international crisis of 1857, when suspensions of specie payments
were general over most of the United States, the situation was far steadier than ever before. It is very probable that this improvement was not attributable to any considerable extent to State regulations relating to bond deposit guarantees for notes. In fact, the State authorities seem to have become, after a time, rather lax in the enforcement of the law, and the State Comptroller was usually satisfied if the bank had in its own possession the prescribed assets and was prepared to present them for his examination when he paid the bank visits on certain days. This gave scope for a system of window-dressing by which the banks passed round the same block of securities for exhibit on the appropriate days. The law was thereby rendered ineffective. Much the greater weight is to be attached to the more rigid enforcement of specie payments between banks by frequent exchange of notes, due in great part to the spread of the Suffolk system and to the institution of the New York clearing-house.
The Civil War provided the occasion for a radical change in the banking system of the whole country. The banks in the South gave their support to the secession and ceased remittances to the North, 