Financial History Issue 128 (Winter 2019) | Page 31

issued notes used for currency. Merchants, the general public and other banks com- monly accepted these notes as payment for goods and private debts. They would later present them to the bank having issued the note in exchange for “specie.” After the War of 1812, financially sound banks in Boston competed with rural insti- tutions in the circulation of bank notes. However, many banks outside of Bos- ton proved fiscally unsound, often lacking adequate specie reserves in support of their notes. Sometimes the excess cur- rency in circulation resulted in inflation, an accidental but unfortunate occurrence. In the hope of strengthening the position of banks in the area and reducing the like- lihood of economic instability in New Eng- land, the Suffolk Bank implemented prac- tices uncommon to most other banks. For instance, it required deposits of non-inter- est paying certificates and subjected banks holding specie to unannounced, on the spot redemption calls. Suffolk also, given its monopoly status, stifled the growth of competitors in the New England area. The bank’s position as a pillar of sta- bility within the New England economy stemmed from its creation of the “Suffolk System.” The “system,” developed in 1825, functioned as a consortium of Massachu- setts banks, led by Suffolk, which cleared bank notes for the purpose of settling pay- ments owed to banks who had advanced gold and silver to their clients. Until then, bank notes issued by depository institu- tions outside of Boston (“country banks”) were often so numerous that they some- times posed a great deal of risk to city banks when presented for clearance. The larger the number of notes in circulation, the less purchasing power they afforded— leaving the clearing agent holding bank paper of diminished value. Further, these notes were often “discounted” in that they were only accepted by clearing agents below face value. Discounting protected the clearing agents because, sometimes, country banks would not pay clearing agents the full (face) value of the notes. Recognizing the risks associated with redemption borne primarily by Boston’s banks, Suffolk addressed a letter to the managers of the city’s banks in 1824. The memo cautioned that “…bills thus removed from circulation are replaced by a worse description of paper.” Furthermore, if banks continued clearing out of town notes, they “must be attended with some risk.” By 1825, most of these banks under- stood their individual risk exposure and decided to join together under the “Suf- folk System.” The agreement stipulated that rural banks would have to redeem all notes at par value, with the Suffolk Bank and its members reserving the right to discount based on risk of non-payment. A rural institution could, however, forfeit a redemption call if it held $2,000 on deposit at the Suffolk Bank. As support of Suffolk’s policies became known, rural banks joined the system; over time, the bank functioned as the collection agent for banks spanning from New York to Maine. Many of these institu- tions became “correspondent members,” as their clearing services were provided under Suffolk. In addition, those banks keeping all of their deposits with Suffolk had the prerequisite balance requirement for specie redemption waived. From its inception in 1825, until it eventually suc- cumbed to competition in note clearing by 1858, the Suffolk System asserted a monopoly in the clearing of notes and, to some degree, accumulation of deposits within the region. In practice, the bank functioned very much like a monopoly. The price or fee charged to rural banks included network services for correspondents. This encom- passed 2.5–3% of their paid-in-capital (funds in excess of a bank investors’ con- tribution). Similar to a monopoly, this rate more than offset the cost of Suffolk’s note clearance expenditures while substantially covering its marginal cost of operation— the additional cost incurred for clearing each note. Furthermore, those banks with less than $100,000 in capital deposits were required to maintain a $2,000 reserve and keep a redemption account with Suffolk. How might Suffolk have justified such charges? Possibly the allowance for price discrimination, or charging different users various prices (a practice commonly utilized by monopolies), could explain the scheme. Boston’s banks collectively had a total capital position estimated at $18,180,000 in October of 1846, 58% of all Massachusetts’s bank capital at the time. Accordingly, their asset position might have rationalized why Suffolk charged higher fees to less adequately capitalized banks. The demand for Suffolk’s clear- ing services—given banks had no other substitute clearing agent—may have also been a factor. Banks declining to join the system faced threats and intimidation. The Worcester Bank of Massachusetts refused to join Suffolk and kept its deposits with the New England Bank of Boston. Using its monopoly power, Suffolk accumulated over $38,000 in the bank’s notes—half of its circulation—and demanded specie redemption. Although the bank agreed to Suffolk’s demands, it did not act promptly enough to placate the Suffolk Bank. Suc- cessfully, Suffolk’s agent had Worcester’s property attached. Other critics opined that Boston gained an unfair trade advan- tage over the region due to the draw of bank notes and specie. Still, proponents of Suffolk emphasized that the flow of notes to Boston was the effect of the city’s growth, not the cause of it. By the early 1830s the waning influ- ence of the Second Bank of the United States, as an alternative to Suffolk in note redemption (somewhat self-inflicted by the political jousting match engaged in between its director and then President Andrew Jackson), increased the volume of redemptions handled by the bank. Cor- respondent banks, too, began to apply for more credit; Suffolk started limiting overdrafts to $10,000, a conservative level for the time. By 1833, overdrawn accounts greater than or equal to $16,000 required pay- ment in specie by Monday, if not received by Saturday. “On the spot” redemptions where Suffolk agents would demand immediate payment in specie also became common. Describing the hegemony of Suffolk over its members, The Bankers’ Magazine and State Financial Register commented in August 1846: “A bank there www.MoAF.org  |  Winter 2019  |  FINANCIAL HISTORY  29