Free banking’ in Michigan (1837)

Michigan was the first state actually to pass a ‘free banking’ law. As in New York, there was considerable dissatisfaction with the existing ‘monopoly’ in banking, and a ‘free banking’ law was passed in March 1837 modelled on a bill that was still before the New York legislature. Hammond (1948:6) reports that 40 banks were set up very quickly after the passage of the new law and all were in liquidation within a year, while Knox (1903:735) reports that 42 banks were in liquidation and only 6 banks—2 chartered banks and 4 ‘free banks’—still remained in operation by the end of 1839. The ‘free banking’ act itself was suspended in 1838, and it was subsequently repealed in 1839 and declared unconstitutional in 1844. What had happened? The most important factor behind the failures appears to be a suspension law that resulted from a special legislative session in June 1837–three months after the ‘free banking’ law—that authorized all banks in the state to stop specie payments. This law effectively removed the discipline against overissue—if banks’ notes are convertible, then a bank is limited in its ability to issue notes by the legal requirement that it redeem them on demand for specie. The suspension law removed that requirement and thereby eliminated any effective check on the note issue. As Rockoff put it,

a unique situation was set up in which a group of men could issue bank notes with practically no risk to themselves. Few free banks had been started up to this time, but now the rush to start began in earnest, and in fact, nearly all the Michigan wildcats lived their brief lives during the period of general suspension. (Rockoff 1975a: 95)

Far from telling us much about ‘free banking’ as such—recall that ‘free banking’ laws required that banks maintain convertibility—the Michigan experience thus appears to tell us more about the dangers of suspension laws. Yet the Michigan experience, ironically, had a profound impact on later generations’ perceptions of ‘free banking’, and 1837 Michigan was remembered when the successes of ‘free banking’ in New York and other states were all but forgotten. Many of the colourful stories about ‘wild-cat’ banking that were later regarded as the natural outcome of ‘free banking’ stem from episodes in late 1830s Michigan. With convertibility suspended, banks had no need to keep reserves other than to satisfy the bank commissioners, and the famous episodes of barrels of nails covered with coins and of specie being moved around the country to fool the commissioners were perhaps only to be expected.