William Gouge
An Inquiry

Of the Formation of Bank Capitals.

When the uninitiated hear of Banks having capitals of 500,000 or of 1,000,000 dollars, they suppose that these institutions had at their commencement, or some time after, real money to this amount.  It is a very natural supposition;  but not a true one.  The Banks create their own capitals in the same manner that they create the money they lend to the people.

The usual method of proceeding is as follows: An act is passed by the Legislature to authorize the establishment of a Bank, and certain persons, called Commissioners, are appointed to receive subscriptions.  It is provided in the act that the amount subscribed shall be paid in instalments of five or ten dollars in specie, or the notes of specie-paying Banks, and that after one or two instalments shall have been paid in, the Bank shall commence operations.  The first instalment, which we shall suppose to be five dollars on a share, enables the Bank to purchase desks and a counter, and to pay for engraving and printing its notes.  It has then the necessary apparatus for commencing operations, and has, perhaps, a specie fund in reserve of three or four dollars for each share of stock, to meet contingencies.

It then begins to discount notes and circulate paper.  The spare cash of those who have dealings with it, are deposited in its vaults.  This fund enables it to extend its operations.  As the Bank notes will serve the purposes of trade in the neighborhood, the specie is sent to distant places to procure commodities.  This leaves open a new channel for the circulation of paper: and the Bank increases the amount of its issues.  Then comes the time for paying the second, third, or fourth instalment.  The Bank makes a call on the stockholders.  Some of them hypothecate their stock, that is, pledge it to the Bank, and with the means obtained from the Bank itself pay in their proportion.  Others have obtained the means by discounts of accommodation notes, without any hypothecation of stock.  Some few pay in real money: but they generally pay in the notes of the Bank itself, or of similar institutions.

It is by this kind of hocus-pocus that Bank capitals are formed.  After the first instalment is paid, the Bank by its own operations, facilitates the paying of the others.

The Bank of Pennsylvania and that of the United States have more pretensions than most others to solidity of capital.  It was provided in their charters, that a portion of their instalments should be paid in Government stock.  This is not a convenient form for loanable capital, which, it might be supposed, is what Banks should possess.  But the peculiar profits of Banks are derived from credit and circulation, and they want no more real capital of any kind than is necessary to support their credit.

It is difficult to say in what the capitals of the other Banks ever consisted, unless it be in what it consists at present – in the promissory notes of individuals.  Now, the Banks did not obtain these promissory notes by lending real money of their own, for they had it not to lend.  They obtained these promissory notes of the stockholders, by giving in exchange for them the promissory notes of the Bank.  Thus Bank capitals are formed by exchanging one kind of promises to pay for another kind of promises to pay.

This mode of forming Bank capitals, with the stock notes of the subscribers, is not peculiar to Banks of the second and third order.  The Banks of the most approved standing have formed their capitals in the same way.

The nominal capital of the old Bank of the United States, was ten millions of dollars.  One-fifth part of this, or two millions of dollars, was subscribed by the National Government;  but the National Government having no money to pay its subscription, professed to borrow from the Bank.  And the Bank having no money to lend, passed a credit of two millions in its books to the Government on which it paid six per cent.  The Government, in its turn, received the dividends on 5,000 shares of stock of 400 dollars each at par value.

The residue of the capital, or eight millions, was subscribed by individuals, and was to be paid, three-fourths in six per cent. stock, and one-fourth in specie, in four six monthly instalments of five hundred thousand dollars each.  "No more," says Dr. Erick Bollman, "or little more than the first instalment, can ever be considered as having been received by the Bank actually in hard money."[10]

The capital of the present Bank of the United States was fixed by its charter at thirty-five millions, of which Government subscribed seven;  but Government having, as in the former instance, no money, the Bank granted it a credit to this amount.

The remaining twenty-eight millions of stock were subscribed for by individuals.  On each share of the stock, they were, agreeably to the terms of charter, to pay five dollars in gold or silver coin at the time of subscribing;  at the expiration of six months the further sum of ten dollars: and at the expiration of twelve months, the further sum of ten dollars.  At each of those three periods, twenty-five dollars more were to be paid, on each share, either in United States stock, or in gold and silver coin, at the option of the subscribers.

No more or very little more, than the first instalment of five dollars on each share, was paid in gold or silver coin.  The Directors, indeed, proceeded on the principle that no more was necessary.  "It is clear," says one of them, "that having commenced business, and put its paper in circulation, it (the Bank) could not enforce the specie part of the second and third instalments of the capital, in new acquisitions of specie. * * * * The Directors acted wisely in discounting the notes of the stockholders, payable in specie, sixty days after date, for the payment of the second instalment."[11]

It is contended by the founders of these institutions, that this mode of forming Bank stock, is perfectly correct.  If it is, stock may be created to almost any amount.  The Bank risks nothing, and does not increase its circulation;  for the notes which it pays out at one counter in discounting stock notes, are paid in at another counter in subscriptions.  The subscribers pay a certain sum to the Bank as borrowers: but they receive back the same amount as stockholders.

The whole business, is nothing but a paper transaction between the Bank and its stockholders.  Many of the present owners of stock have paid their hundred dollars' worth of property, or perhaps given an advance of twenty per cent. for the shares they hold: but what they paid, never went to form the capitals of the Banks.  They paid it to the original subscribers or to those who bought script from the original subscribers.


10   Paragraphs on Banks, Philadelphia, 1811.  Dr. Bollman was a zealous advocate for the renewal of the charter of the Bank.

11   A Friendly Monitor, Philadelphia, published December 15,1819, and re-published September 17, 1822.

Of Speculations in Bank Stock, and of other Stock Jobbing.

It is well worthy of remark, that, though the Banks derive as much profit as private capitalists, from so much of their capital as is invested in real estate and public securities, however they may have got that capital, and however they may have formed it: and though they derive from 12 to 18 per cent. from so much of their capital as is employed in discounting, they do not, on an average, divide more than six per cent.  When the proposal was made to form a "safety fund," by a tax on the Banks, the proprietors of stock in the city Banks of New York objected to it as a great hardship, alleging that they had not, for a series of years, received more than 5½ per cent. per annum.  The heavy expenses of these institutions in the payment of Presidents, Cashiers, and Clerks, and the heavy losses that are necessarily sustained when corporate interest superintends the business of lending, are the reasons that the stock holders get much less than the people pay.  Such being the fact, the anxiety to establish new Banks might create surprise, if we did not know that the object of the projectors of such institutions is not to lend money, but to make money.  People who have money, can lend it without the intervention of Boards of Directors.  They can lend it more securely, and watch over it more easily.  But a new Bank will afford to some favored gentleman a snug birth as President for life, and to another an equally snug birth as Cashier.  Poor cousins can be very conveniently provided for by giving them clerkships.  To some, the new Bank will afford facilities for borrowing;  to others, it will afford facilities for lending – at two or three per cent. a month.  To those who are to be Directors, it will impart additional consequence in society, and give great advantages over their neighbors in business.  Others hope to make fortunes by speculations in the script.  To further all these objects, nothing is necessary but a charter from the Legislature, and the means of paying the first instalment.  By the convenient contrivance of stock notes, the stock of the Bank can be completed.  The circulation and deposits will prove a certain source of revenue.

When a charter is granted, the speculators evince great anxiety to possess the stock, and thereby create an idea that it is something very valuable.  In New York, their practice is to subscribe a much greater amount than the nominal capital, and then clamor for a pro rata division.  In the case of the Broome County Bank, the capital of which was fixed at 100,000 dollars, the subscriptions amounted to eight millions.  In Pennsylvania, where subscriptions are not received beyond the amount of nominal capital, draymen and other able-bodied persons are hired by the speculators to get the script for them.  They struggle at the windows with so much violence, as to give and receive severe personal injury.  The most disgraceful riots that occur in Philadelphia, are those which are produced by the opening of the books of subscription for a new Bank.

These doings have their effect on simple-minded people;  and, from the prospect of large profits, they prefer Bank stock to land and houses.  The founders of the Bank kindly spare them some of the script at an advance of five or ten per cent., retaining only enough to keep the control of the institution in their own hands.

Even those who are not simple-minded, do not hesitate to buy the script at an advance, for they hope to sell it at an additional advance.  They know that the price of Bank stock in the market is regulated principally by the rate of dividends, and that few make inquiry into the solidity of these institutions, or have, indeed, the means of ascertaining whether, on the winding up of affairs, they can pay fifty cents in a dollar.

From the peculiar nature of their operations, Banks may sustain their credit, and continue to make high dividends, even when nearly all their capital is gone.  In one instance, in Philadelphia, a sum equal to the whole capital of a Bank, was actually taken from it by some of its clerks and their coadjutors out of doors, without the Directors knowing any thing about it.  The Bank continued its operations as before, supported by its deposits and its circulation.  Its stock sold as high in the market as ever.  When the defalcation was discovered, the credit of the Bank received a shock.  But the Directors called in one or two additional instalments, and the Bank recovered its credit.  Its stock is now much above par.

On common gambling principles, speculations in Bank stock are, perhaps, as eligible as speculations in any thing else.  But it may be made a question, if executors, guardians, and trustees, act with sound judgment, when they, merely for the sake of facility of management, invest the property entrusted to their care in stocks of this description.  The ability of a Bank to pay any thing to the purchasers of its shares, depends on the ability of the original subscribers to pay their stock notes and accommodation notes, and on the ability of borrowers to pay their promissory notes.  This ability depends on various contingencies, all which ought to be duly considered by those who contemplate making permanent investments of the funds in their hands.

In making temporary investments, there is less risk.  "The house is crazy," says the weary traveller to himself, "and must fall;  but not to-night.  I may therefore venture to sleep in it."  When it has no profits, the Bank may make dividends on its capital, and the fact be concealed from all but the Directors.  If its stock should fall in the market, it may be raised again by a few pretended sales, effected through the instrumentality of brokers.

Sometimes the funds of a Bank are employed in purchasing its stock, and then, if the price offered be sufficiently high, those who have the management contrive to sell their own shares.  In 1826, four thousand eight hundred and eighty-three shares of the Franklin Bank of New York, were bought up with the funds of the Bank, at an advance of 62,850 dollars.  When an investigation was made of the affairs of the Bank, in 1828, it was found there was not enough left to pay the remaining stockholders 50 cents in a dollar.

When a Bank gets into difficulties, it sometimes sustains itself for a period, and affords its agents a considerable chance of profit, by allowing them to have its notes at a discount, on condition of their putting them in circulation in distant places.  On an investigation of the affairs of the State Bank at Trenton, in 1825, it was proved that one of its agents had sold bills of the Bank to the amount of 18,500 dollars, at an average discount of 37½ per cent.  The very day before the Bank stopped payment, its notes were quoted in the Philadelphia Price Current, at only 1½ per cent. discount.

Every now and then the speculators find it convenient to break a Bank.  This enables them to purchase up the notes at a discount, and therewith pay what they owe to the Bank.  "There are instances," says Mr. Gallatin, "in which the stockholders, by paying for their shares in their own notes, and afterwards redeeming their notes with the stock in their name, suffered no loss;  and this fell exclusively on the holders of Bank notes and depositors."

In the New York American, for June 1825, the following account is given of a mode of operation which was adopted by the knowing ones of that city.

"The mode of proceeding is simple and not expensive, and acquires strength by its own action.  We will illustrate it by a case.  It is desired to get possession of Insurance Company A, for example.  The stock bears a premium in the market, say of five per cent.  Enough money is raised among the contributors to pay the premium;  and the residue is borrowed from other individuals or companies, on a pledge of the stock A, at par.  The original advance of the combination is thus small, and they are thence enabled to be operating in the stock of many Companies at once, till, having acquired a control in the several concerns, they turn out all the old administrators, put in their own men, and then go to work again with renewed energy, and means increased by the whole amount of the capitals they have thus acquired the control of.  By artful management, assiduous puffing, magnificent predictions, and supplies of stock skilfully curtailed as the demand increases – any one of the stocks thus owned, may be blown up to an absurd rate – and spared as a favor to the public, until the Managers have sold all out, and realized their profits, leaving the new purchasers to come in and assist at the bursting of the bubble."

The Editor of another New York paper, the Inquirer, said in June, 1826, that certain men had, "by their bonds, rags, and hypothecation of stock, managed to control a nominal capital of nearly four millions of dollars in different institutions, and I do not believe" said he, "the whole confederacy is worth 100,000 dollars."

The same editor afterwards gave a list of thirty-four Banking, Insurance, and other companies, all which, he asserted, were under the control of a certain gang of stock jobbers.

If a Legislature will only grant charters enough, the speculators will have no difficulty in providing a full "assortment" of stocks – Banking, Insurance, and of every other description that may be wanted to suit all the varieties of taste to be found in men and women who have money to part with.  If they have one Bank under control, they can use that as a means of putting half a dozen other Corporations into active business.  So, the Northern Bank of Pennsylvania was set agoing by means of a certificate for thirty-five thousand dollars said to be deposited in one of the New York Banks: and so, the Sutton Bank of Massachusetts was put in operation by means of 50,000 dollars in specie, borrowed for one day from the City Bank of Boston.

Several of the kind of doings described in this chapter, are regarded with horror by Banks which have reputations to sustain.  But, in a view of the whole system, it is necessary to take them into consideration.  The aggregate of loss sustained by simple-minded people, through such doings, is enormous.

Another way of making money through the medium of incorporated paper-money Banks, is by dealing in Government stocks.  Voltaire gives us some insight into this, in one of his letters from Ferney, in Switzerland.

"Here I am," he says, "living in a way suited to my habits, and caring but little for to-morrow;  for I have a friend, a Director in the Bank of France, who writes to me whenever money is to be made in the public funds.  Some times he writes to me desiring me to sell, because the Bank is going to withdraw its notes: at other times, he bids me to buy, for we are going to issue a quantity of notes;  and so, through the kindness of my friend, I always make money, though living two hundred miles from Paris."