Free Bank Failures: Risky Bonds versus Undiversified Portfolios

Authors


  • I would like to thank Peter Rousseau, Jeremy Atack, Howard Bodenhorn, William Collins, Bob Driskill, Neil Canaday, and John James for their comments on various drafts, as well as Robert DeYoung and the two referees for their insightful suggestions. I would also like to thank Warren Weber for giving me access to his antebellum databases and Vanderbilt University for financial support.

Abstract

Almost 30% of the 872 banks established under the Free Banking System (1837–62) are considered failures, unable to reimburse noteholders for the full value of their bank notes upon closure. Lacking sufficient data, economists have focused on one of two general failure explanations: poor regulation design or undiversified bank portfolios. I test both explanations within hazard functions using Warren Weber's annual balance sheet data for almost every antebellum bank. My results suggest that free banking's bond-secured note issue was the underlying problem, but individual banks could have avoided failure by diversifying their assets with loans and controlling their circulation.

Ancillary