Strong Managers, Weak Owners: The Political Roots of American Corporate Finance

By Mark J. Roe | Go to book overview

CHAPTER 5
Banks

WHEN FINANCIAL RESTRICTIONS are mentioned, the New Deal laws of the 1930s come to mind, and the Glass-Steagall Act, which separated commercial banks from investment banks, comes to the forefront. But the most serious restrictions on financial institutions predated the New Deal and were in place at the end of the nineteenth century for banks and shortly after the beginning of the twentieth century for insurers. Until the rise of mutual funds and pensions in recent decades, banks and insurers were the key financial institutions.

At the end of the nineteenth century, when large-scale industry became technologically feasible, the key financial intermediary was the bank. Where would the new national industries go for financing? They had economies of scale, a continent-wide market, and political stability. But they needed financing. While some large-scale industries were financed internally from retained earnings, others, the railroads in particular, needed outside capital. Even those industries that grew by retaining earnings needed external financing to cement the consolidations during the end-of-the-century merger wave.1 Banks, however, were incapable of easily financing the new largescale industry because “[f]or much of its history, the United States has had a banking system like no other in the industrialized world. Since the early 1800s, the U.S. banking system has been highly fragmented, consisting of numerous small banks without extensive branch systems.”2 American federalism fostered fragmented banking, as each state chartered and protected its own banks, excluding branches from other states' banks and often preventing their own single-location banks from branching. Although during the Civil War, the United States did set up what were called national banks, the National Bank Act of 1864 was interpreted as confining each to a single location. In 1895, President Cleveland endorsed proposals to allow national banks to branch, but the well-organized unit bankers, which each operated from a single location, killed the proposals. Instead, capital requirements were lowered for rural national banks; many were established, enlarging the antibranching banker constituency of small, weak local banks

____________________
1
Alfred D. Chandler, Jr., The Visible Hand—The Managerial Revolution in American Business 373 (1977).
2
Robert T. Clair and Paula K. Tucker, Interstate Banking and the Federal Reserve: A Historical Perspective, Federal Reserve Bank of Dallas, Economic Review, Nov. 1989, at 1.

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