Financial History 139 (Fall 2021) - Page 37

Collection of the Museum of American Finance
$ 5 note from the Citizens Bank of Louisiana , circa 1850s . commercial paper ” in order to cover twothirds of its deposit liabilities , with others made for “ accommodations for the furtherance of agriculture and industry .” In spite of such adoptions in the hope of maintaining some measure of fiscal prudence , his tenure as president was limited . The directors purportedly wanted to make credit more readily available in the wake of the Panic of 1837 .
By the late 1830s and into the 1840s , Forstall ’ s reform efforts began to bear fruit . Gaining the attention of the legislature he offered a testimony entitled “ Report on the Banking Situation of the Monied Institutions of New Orleans .” Proposed in 1837 , Forstall advised the state legislature that , in part , the “ Real Bills ” theory of commercial lending be applied to state banks . By the early 19th century , “ Real Bills ,” also known as the “ Commercial Loan ” theory , had become an underlying criteria in the debate on how domestic banks should manage their loan portfolios .
Essentially , Real Bills assumed that if short-term commercial loans of no more than 90 days were underwritten for the purposes of financing inventory , banks would not have to worry about increasing the money supply and contributing to inflation . In effect , loans would be self-liquidating . Though not universally accepted as a rule of thumb in academic circles , nor practiced by contemporary bankers since inflation has been shown to increase the number of loans
in circulation , the doctrine occupied banking theory up until the early 20th century .
Throughout this period , Louisiana ’ s banks relied to a great extent on European investors as a source of capital . By the 1830s , however , the flow of European ( especially British ) investment accelerated , allowing for the establishment of 12 new banks within the state between 1831 and 1837 . These institutions were capitalized from $ 1 – 14 million and had total paid-in capital estimated at $ 39.9 million by 1837 .
Many of these banks were considered “ improvement companies ,” often functioning in their day-to-day activities much like banks . Unlike property banks , they operated like commercial banks , financing capital projects such as canals , railroads and hotels . However , their excessive lending practices ( particularly in real estate ), coupled with a national business contraction in 1839 , made their vulnerability evident . Consequently , as a means of maintaining their fiscal stability , by decade ’ s end the state legislature began directly funding these improvement companies .
Forstall ’ s experience with Citizens Bank and his prior associations made him particularly aware of how property banks functioned and why regulation at the state level might improve their solvency . Although generally not as cavalier in their lending decisions as were many of the improvement companies / banks , the property banks sometimes had inadequate specie reserves , thus contributing to their liability exposure . As to their financing , property banks were capitalized not through stock issuance but from mortgages pledged by the owners of commodities : cotton , sugarcane and rice , for example . In turn , these securities were used as collateral for loans when banks needed to borrow funds .
Similar in the composition and promotion of modern-day Mortgage Backed Securities ( MBS ) issued by Fannie Mae and Freddie Mac , the collateralized debt allowed the property bank ’ s managers to borrow against the mortgages they held . The funds were then used to generate capital . What ’ s more , Forstall had some hands-on experience in this practice , having actively participated in the marketing of such securities in Europe during his prior affiliation with Union Bank . As asserted by banking historian Irene Neu , such banks could expand credit and capital in areas — particularly for agricultural purposes — scarce in loan origination and investment funds .
As mentioned , during his brief association as a board member with Citizens until 1843 , Forstall promoted banking reform . In his 1837 report to the legislature , he advanced the ideas put forth at Citizens , namely that “ fundamental rules ” should govern bank management . In part , his testimony noted that specie reserves ought to back up both notes in circulation and deposits ; furthermore , loans would be restricted to those that “ sustained their liabilities to advances
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