What Are Pet Banks? Definition and Historical Impact
Uncover the definition and historical impact of 19th-century "pet banks," revealing their role in shaping early American finance and politics.
The early 19th century in the United States saw significant financial transformation and political debate regarding banking. During this era, a unique type of financial institution emerged, influencing economic stability and political discourse.
Defining Pet Banks
“Pet banks” was a term that arose in the 1830s to describe state banks chosen by the U.S. Department of the Treasury to receive federal government funds. The term itself was derogatory, implying favoritism and political patronage in the selection process. These banks became depositories for federal revenues following a significant shift in national financial policy around 1833, when federal deposits were transferred from the Second Bank of the United States.
The designation of these state banks was a direct consequence of a political struggle over the national banking system. Critics argued that the chosen state banks were not selected based on financial soundness alone, but rather on their loyalty to the political administration. This perception of political alignment and preferential treatment gave rise to the “pet” moniker. The establishment of these banks signaled a departure from a more centralized banking system towards a decentralized one, distributing federal funds across numerous state-chartered institutions.
Establishment and Characteristics
The establishment of pet banks was a direct result of President Andrew Jackson’s campaign against the Second Bank of the United States. Jackson viewed the national bank as an unconstitutional and elitist institution that concentrated too much financial power. After his re-election in 1832, Jackson ordered the removal of federal deposits from the Second Bank and their transfer to selected state banks. This action was met with resistance, with some Treasury secretaries resigning rather than carrying out the order.
The criteria for selecting these state banks were often influenced by political connections rather than strict financial stability. Initially, a small number of state banks received these deposits, but by the end of 1833, the number had grown to 23. By 1836, the number expanded to as many as 91 such institutions. These state-chartered banks operated without the centralized oversight that the Second Bank of the United States had provided.
The operational characteristics of these pet banks differed significantly from a national bank. Freed from the regulatory influence of the Second Bank, many state banks expanded their lending practices and increased the issuance of paper currency. Their notes, often not fully backed by gold or silver reserves, fluctuated greatly in value. This environment contributed to a rapid increase in the overall money supply and credit availability across the country. The lack of uniform regulation among these numerous state banks meant that banking practices varied widely, with some engaging in highly speculative ventures.
Economic and Political Outcomes
The influx of federal deposits into numerous state banks, combined with lax regulation, led to significant economic and political consequences. The increased money supply and easy credit fueled rampant speculation, particularly in public lands. Land sales surged as individuals and companies borrowed heavily to purchase western territories, anticipating quick profits. This speculative bubble was a direct outcome of the expanded lending capacity of the pet banks.
The excessive issuance of paper money by these state banks contributed to a period of considerable inflation. Prices for goods and services rose, diminishing the purchasing power of the currency. The value of bank notes varied widely, causing instability in commercial transactions. This environment of unchecked credit expansion and rising prices created an unsustainable economic situation.
The Panic of 1837, a severe economic depression, began shortly after Martin Van Buren took office. A key factor was the Specie Circular of 1836, an executive order by Jackson that required all public land purchases to be made with gold or silver coin. This policy, intended to curb speculation, instead triggered a demand for hard currency that many pet banks could not meet, as their paper notes were not adequately backed by specie reserves.
The inability of banks to redeem their paper currency for specie led to widespread bank failures and the suspension of specie payments. Over 40% of all banks failed, businesses closed, and unemployment rose. This economic downturn led to significant public outcry and political fallout. While various factors contributed to the Panic of 1837, the actions related to the pet banks, including the unchecked expansion of credit and currency, are widely recognized as a major catalyst for the crisis.