The New York Free Banking Era: Deregulation or Reregulation?

The deregulation of the banking market is a frequently debated policy issue. Proponents of deregulation claim that free market forces would improve market efficiency. The basis for their argument is grounded in the work and tenets of Adam Smith. Deregulation opponents claim that a bank market left unfettered would disrupt the financial market; bank mismanagement, failures, and panics would pervade the market and cause distrust of the banking system . Opponents of deregulation derive their beliefs from actual historical experiences rather than theory . Many opponents point to a period of American banking history, called the Free Banking Era (1838-1863), in which banks entered the market without government sanction. The traditional accounts depict a period of financial chaos; wildcat\u27 banking, large noteholder losses, counterfeit banknotes and bank failures were commonplace. Opponents contend that the turmoil during the free banking period could again occur if the banking market were deregulated. The arguments put forth by opponents can be contested on two grounds. First, several recent studies have shown that wildcat banking, large noteholder losses and bank failures were limited to a few states. The evidence also indicates that noteholders of failed banks were usually compensated for their holdings. Second, the opponents have erroneously equated the free banking period with a period of free competition . Although potential entrants were free to enter without government sanction, the free banks were subject to numerous constraints and were under close scrutiny by the state and the public. In fact, a preliminary investigation of the New York banking laws (one of the free banking states) shows that the banking laws prior to the free banking period were more lenient than the free banking laws. Based on the New York evidence, one may contend that the free banking laws reregulated rather than deregulated the banking market