Policymakers have been quick to compare cryptocurrencies to historical wildcat banks. SEC Chair Gary Gensler argues that stablecoins are similar to wildcat banks, which he says resulted from the lack of federal bank regulation prior to the National Bank Act. Stablecoins are cryptocurrencies with a fixed exchange rate against a major currency, such as the US dollar. To do this, stablecoin issuers must hold enough liquid reserves to convert the stablecoins at the promised conversion rate. Gensler questions the “long-term viability for cryptocurrencies,” the Wall Street Journal reports, “underscoring the importance of protecting investors in the market and bringing it under regulatory oversight.”
Senator Elizabeth Warren has expressed a similar view:
In the 19th century, “wildcat notes” were issued by banks without any underlying assets. And eventually, the banks that issued these notes failed and public confidence in the banking system was undermined. The federal government stepped in, taxed these notes out of existence and developed a national currency instead. And that’s why we’ve had the stability of a national currency.
So, in theory, a digital currency issued and backed by a central bank could provide the advantages of cryptocurrency without those risks. The Federal Reserve, a trusted institution, could provide a digital version of cash to the public that is secure, stable, and accepted everywhere.
The unregulated private sector failed to produce reliable claims in the past, she says; the government should step in to remedy the perceived shortcomings of privately-issued cryptocurrencies, as it did with its historical antecedents.
There’s just one problem with this narrative: it is inconsistent with the historical record. The US experience does not show the dangers posed by an unregulated banking system. To the contrary, it clearly demonstrates the perils of poor regulation. Policymakers are learning the wrong lessons from history.
For starters, wildcat banking was incredibly rare. Gensler and Warren perpetuate the myth that the banking system was flooded with wildcat banks, issuing banknotes convertible into gold or silver without the sufficient reserves to honor those promises and absconding with their ill-gotten gains before noteholders wised up; and that this practice was not brought to an end until federal regulators stepped in. In fact, wildcat banking was limited to just a few states and lasted just a few years.
“The events in Michigan are spectacular,” Jerry Dwyer writes in an examination of the period, “but besides not lasting very long themselves, they also did not persist in the sense that they did not reappear in other states. In 1838, while Michigan was suffering through its debacle, New York passed the free banking law that its legislature had been debating for several years. New York’s free banking system is widely regarded as notably successful.”
Dwyer presents the losses to New York free bank noteholders from 1842 to 1863.
The annual loss rates on New York notes were relatively high in the 1840s—4 percent in 1842, 0.2 percent in 1844, and 0.4 percent in 1848—and then never again as high as 0.1 percent. Noteholders’ loss rates of less than 0.1 percent in later years are not obviously more than their losses from inadvertently destroying or misplacing notes.
Perhaps 4 percent seems extraordinary. But it is not much higher than standard merchant terminal fees incurred to make payments today.
Dwyer also presents the losses to those holding notes from those New York free banks that failed.
For a few years, noteholders’ loss rates on these banks’ notes are relatively high. Nonetheless, loss rates on failed banks’ notes show the same pattern of declining losses over time as do noteholders’ loss rates on all notes. The highest loss rate is 42 percent in 1842, within the range of estimated loss rates for Michigan a few years earlier. In the 1840s, the annual average loss rate is 9.8 percent; in the 1850s, it is 3.7 percent; and in the four years of the 1860s, it is 0.1 percent. Although the loss rate borne by those who held failed banks’ notes sometimes is substantial, even this loss rate decreases over time.
Even when a bank failed, therefore, its noteholders typically suffered little.
None of this is to deny that there were very real problems in the historical US banking system. US banks were notoriously unstable. But that instability was not due to unregulated wildcat banks. Rather, it followed quite naturally from terrible state-level regulations.
Prior to the National Bank Act, banks were chartered at the state level. They were not permitted to open branches across state lines. Many states went further still, preventing branch banking within the state. As a result, the US banking system was characterized by a large number of small, under-diversified unit banks. These local banks were overexposed to their small local economies. Local shocks––like bad weather, which reduced agricultural yields––took a terrible toll on their balance sheets. And, in many cases, these unit banks failed.
State banks were also prevented from backing their banknotes with the assets of their choice. Instead, they were often required to hold low-quality state treasury bonds, which provided an attractive source of credit to states but endangered the solvency of the issuing banks. And, even in cases where they were permitted to hold federal bonds, the dwindling supply of such bonds following the Civil War constrained note issues and made it incredibly difficult to meet seasonal demand for notes.
George Selgin contrasts the US banking system with that of Canada at the same time, which lacked the burdensome restrictions described above.
Canadian banks, unlike their U.S. counterparts, were free to issue notes on the same general assets that supported their deposit liabilities. They were as a result perfectly capable of accommodating both secular and seasonal changes in the demand for currency.
The problem, in other words, wasn’t a lack of regulations. Rather, it was the existence of terrible regulations!
Finally, the claim that the federal government clearly improved matters with the introduction of the National Bank Act appears to be out of sync with the historical record, as well. The National Bank Act did not permit banks to branch across state lines. Rather, it enforced unit banking on the entire country! Nor did it permit banks to back their claims with whatever assets they desired. Perhaps that is why relatively few banks swapped their state charters for national charters when initially given the opportunity––and didn’t do so until a sizable tax was levied on state bank notes.
The National Bank Act could have offered a better alternative. But it didn’t. Instead, it strong-armed banks into going along with an even worse alternative.
Perhaps the cryptocurrency market would benefit from regulatory oversight. But the regulators are certainly wrong to base their case on the historical experience of the US. The lesson they should learn from history is that regulation can be detrimental.