of the banking sector . They introduced the Bank Act of 1871 and adopted a uniform banking system that allowed for the chartering of banks with federal oversight . Ultimately , central control of the banking system came to fruition for both countries ; however , their paths were very different .
Differing Attitudes Toward Moral Hazard
The presence of moral hazard in the United States became increasingly apparent in the response to bank failures in the 19th century . Until the National Bank Act was passed during the Civil War , the American system was comprised exclusively of state-chartered banks , which created a lack of uniformity and inconsistent standards . In Canada , the opposite was true and the banks in the different colonies — e . g . Nova Scotia , Upper Canada — all had a broader mandate and a branch banking system .
This time period was characterized by a series of crises , starting in 1837 . The crises normally were the result of declining land prices , after a period of rapidly increasing prices and instability in the railroad / railway industry . In 1837 , there was the additional factor of President Andrew Jackson vetoing the re-chartering of the Second Bank of the United States . In the aftermath of the Panic of 1837 , Congress established the Independent Treasury System in an effort to separate federal funds from private banks . Although this was a signal of a hands-off approach which was meant to curb moral hazard by incentivizing banks to maintain sound practices , it would not be possible to maintain this approach forever .
Further crises occurred in 1857 and 1873 and led to further intervention . Even before the 1837 crisis , certain states adopted a system of deposit insurance , led by New York State in 1829 . Between 1831 and 1858 , five additional states adopted insurance programs : Vermont , Indiana , Michigan , Ohio and Iowa . Regulation varied from state to state ; Indiana was recognized as having the best regulation . The arrival of “ free banking ” and the passage of the National Bank Act of 1863 during the Civil War led to the temporary end of the state sponsored insurance programs .
A total of 150 proposals for deposit insurance or guaranty were made in Congress between 1886 and the establishment of the Federal Deposit Insurance Corporation in
1933 . Although not adopted , the early proposals signaled a shift in sentiment regarding government responsibility in the banking sector . The proposals suggest the early development of moral hazard as deposit security was no longer viewed as the sole responsibility of the bank .
As deposits became more important to banks than notes , eight states once again adopted deposit insurance . Between 1907 and 1917 , the seven states running north from the Gulf of Mexico to Canada , plus Washington , did so .
Things were different in Canada . When the new country finally adopted a Bank Act in the early 1870s , it emphasized soundness in the banking system from the time of chartering ( capital requirements , limits on bank liability and double liability for shareholders , as well as the unique Canadian provision of decennial reviews of the Bank Act and the banks ). The legislation made clear that the banking industry — not the Canadian government — was responsible for any failures .
The bias to bank responsibility rather than government responsibility can be seen in the creation of the Canadian Bankers Association ( CBA ) in 1890 after the decennial Bank Act review . Cooperation of individual banks was facilitated and encouraged . A decade later , the CBA ’ s powers were enhanced and they became the regulatory agency of banking for more than the next two decades .
Evidence of the Canadian government not exposing itself to moral hazard can be found in the half century after confederation . During that period , 25 banks failed . The elimination of weaker banks or their amalgamation with more stable institutions was seen as a progressive move towards greater efficiency . The four major banks developed a two-fold strategy of organic growth and growth by acquisition of smaller , weaker banks . This is not dissimilar to what occurred in California , the only state with the same tendency towards larger and fewer banks as in Canada , but with better regulation in California .
The 1907 Crisis — More Differences
Intervention sets a precedent for more intervention and embeds moral hazard into the banking system . The aftermath of the Panic of 1907 influenced the way financial crises would be addressed in the United States . When J . P . Morgan saved the Street in 1907 , it was the last entirely private bailout during a major financial crisis , and it was followed by the introduction of the Aldrich-Vreeland Act , which allowed banks to issue emergency currency as a replacement for gold . Granting banks the ability to bypass gold convertibility and issue emergency currency in times of crisis embedded moral hazard deeper in the American financial system , as banks realized they no longer had to follow the rules of the game . Instead , in times of crisis there would be new rules .
In 1910 , a meeting took place at Jekyll Island , Georgia , in which several influential bankers and financial leaders , including Senate Finance Committee Chairman Nelson Aldrich , met in secrecy at the Jekyll Island Club . This meeting led to the establishment of the Federal Reserve System . Several proposals were debated including the introduction of a lender of last resort , regulated member banks and a more elastic currency . The banking leaders could benefit from the introduction of a lender of last resort , as they would have the ability to take risk without bearing full responsibility .
In further response to the Panic of 1907 , in 1913 the Federal Reserve Act was introduced , and 12 regional banks became responsible for the reserves and liquidity of member banks . The introduction of the Federal Reserve Act and the Aldrich- Vreeland Act set precedent that in the wake of a crisis , the government would be there with plans of further intervention . As the lender of last resort , the Federal Reserve Bank established a set of circumstances in which intervention was necessary . As soon as a lender of last resort exists , banks no longer believe they will be left to their own devices in times of crisis and will adjust risk tolerance accordingly . The establishment of the Federal Reserve cemented moral hazard into the American financial system .
Canada was also hit by financial stringency in 1907 , but not as hard as the United States (– 7.8 % in GDP per capita in Canada vs – 9.8 % in the US ). Canada ’ s saviour was not a J . P . Morgan-type figure , but rather the Federal Minister of Finance , W . S . Fielding . His solution to the problem of limits on bank note circulation was to increase their circulation for a specific period of time in order to provide the required liquidity during harvest season . This “ gentle intervention ” was all that
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