Banks and Kinship
07/10/2010 18:22
Lamoreaux, N. R. (1986). "Banks, Kinship, and Economic Development: The New England Case." The Journal of Economic History 46(3): 647-667.
Lamoreaux challenges “scholars [who] have seen the persistence of traditional social institutions, and especially kinship-oriented business, as major impediments to economic development.” (666) Using an approach that looks somewhat like the Zeitlin/Ratcliff Chilean kinship-network argument of Landlords and Capitalists (albeit with a positive spin), Lamoreaux argues that “Early banks in New England functioned not as commercial banks in the modern sense but as the financial arms of extended kinship networks.” (647)
“Scholars who have explored the relationship between banks and economic development have assessed the banking system in terms of what theoretically are its two major functions: to provide an adequate money supply and to serve as an intermediary between savers and investors.” I’d add one more function, which I think was behind Rockoff’s approach: as an intermediary to safeguard and insulate urban investors’ wealth (money stock) from direct contact with rural entrepreneur/borrowers (money flow). But I completely buy her argument that it’s the personal connections and kinship groups that are key here.
In 1800 there were 17 state-chartered banks in New England, with capital totaling $5.50 million. By 1850, this number had increased to 300, and the capital available for loan to $62.87 million. Ten years later, 505 New England banks controlled $123.56 million. (chart, 651) Capital during this period came to banks not primarily through deposits, but through investment, as first the founders and later a wider range of local people bought shares. Lamoreaux disagrees with Rockoff: even if initial capital “was largely fictitous...deposited only to satisfy legal requirements and then immediately withdrawn in the form of loans...sales of new shares to outsiders gradually transformed capital stock to a legitimate source of funds. (653-4) This may be true, but does it avoid the point that by getting in cheaply and then controlling subsequent paid-in capital, bank owners gained an incredible degree of economic power?
In the long run, institutional investors like insurance companies, savings associations, and trustees of large estates contributed the majority of bank capital. In many cases, these institutions were part of the same kin networks that initially owned, and continued to run the banks. “Members of kinship groups generally held large blocks of their banks’ stock at the time of formation.” (655) The percentage of bank stock held by the initial owners tended to decrease as the banks grew, but “the groups often retained their dominant positions on the banks’ boards of directors...because other stockholders rarely took an interest in the institutions’ affairs.” (655-6) And these same “kinship groups...often dominated the boards of the institutional investors that purchased their banks’ stock.” (657)
The role of these banks (despite the public-service rhetoric they employed to get their corporate charters during the early period, when incorporation implied quasi-governmental public status) was to “become engines to supply insiders with capital.” (657) “Even a prudent businessman,” Lamoreaux says, “might find himself in financial difficulty.” (658) The panic of 1837 and depression of 1839 had certainly proven that point. An emergency might force him to “convert illiquid assets into cash to pay off debts.” A friendly bank could “prevent distress sales of assets by accepting notes to balance accounts.” (659) After spending so much of his time in New York City, observing this process, is it any surprise that my upstate merchant started his own bank? Especially since, in the words of the 1854 Bankers Magazine, “where business is constantly and rapidly expanding, the younger class of business men who are entitled to bank facilities, equally with their older brethren, cannot have their wants fairly supplied without the occasional establishment of new banks. The old circle of customers use the existing banks to the extent of their capacity, and keep their door shut against the new men.” (663)
This raises questions that were apparently understood by bankers in the 1850s. Lamoreaux answers that “although the system of group-dominated banking doubtless resulted in some degree of favoritism in credit markets, the situation was remarkably fluid. Up-and-coming groups were able to build financial empires that rivaled those of the oldest, most established merchant families in the region.” (664) But even with no barriers to entry, is this what we’d call a “credit market?”
One thing that does seem certain, though, is that these banks facilitated a particular type of economic development. “Could kinship groups have tapped the community’s savings without their aid?” Lamoreaux asks. “The market for securities of manufacturing corporations in early nineteenth-century New England was extremely narrow,” she says. Even the Boston Associates failed to raise enough capital, and were forced to borrow. “The market for bank securities was much wider...because the diversified enterprises of the kinship groups permitted them to pay high and steady dividends and thereby draw out the community’s savings in a way that most individual ventures could never have done.” (665) “Without banks,” she concludes, “kinship groups would have been forced to depend largely on their own resources to finance investment.” (666)
Even if New England’s financial system allowed relatively free entry into banking, and banks allowed a slightly wider public to participate in a diversified portfolio of investments that would otherwise have been restricted to the very rich, was the concentration of economic activity in the hands of these “kinship groups” a good thing? Lamoreaux mentions in the first few pages of her article that lawsuits across New England challenged the “insider” ways in which these chartered corporations behaved. Even banking commissioners admitted “an almost uniform departure from the original design of banks in this respect.” (651) Although it involves counterhistorical speculation, it might be useful to ask what alternatives there may have been to simply accepting the inevitability that “kinship groups” should gain access to the “community’s savings” to finance business ventures for their individual benefit. To what degree is this a free choice, made by empowered individuals (investors and later depositors) acting in their own best interests, and to what degree is the public’s range of choices limited by laws and social conventions that allow incorporation, interlocking control, and that regulate the terms and conditions of credit? (along these lines, do usury laws actually benefit established banks, by lowering the incentive for individuals to loan money to each other at higher -- risk-appropriate -- rates of interest?)
Lamoreaux challenges “scholars [who] have seen the persistence of traditional social institutions, and especially kinship-oriented business, as major impediments to economic development.” (666) Using an approach that looks somewhat like the Zeitlin/Ratcliff Chilean kinship-network argument of Landlords and Capitalists (albeit with a positive spin), Lamoreaux argues that “Early banks in New England functioned not as commercial banks in the modern sense but as the financial arms of extended kinship networks.” (647)
“Scholars who have explored the relationship between banks and economic development have assessed the banking system in terms of what theoretically are its two major functions: to provide an adequate money supply and to serve as an intermediary between savers and investors.” I’d add one more function, which I think was behind Rockoff’s approach: as an intermediary to safeguard and insulate urban investors’ wealth (money stock) from direct contact with rural entrepreneur/borrowers (money flow). But I completely buy her argument that it’s the personal connections and kinship groups that are key here.
In 1800 there were 17 state-chartered banks in New England, with capital totaling $5.50 million. By 1850, this number had increased to 300, and the capital available for loan to $62.87 million. Ten years later, 505 New England banks controlled $123.56 million. (chart, 651) Capital during this period came to banks not primarily through deposits, but through investment, as first the founders and later a wider range of local people bought shares. Lamoreaux disagrees with Rockoff: even if initial capital “was largely fictitous...deposited only to satisfy legal requirements and then immediately withdrawn in the form of loans...sales of new shares to outsiders gradually transformed capital stock to a legitimate source of funds. (653-4) This may be true, but does it avoid the point that by getting in cheaply and then controlling subsequent paid-in capital, bank owners gained an incredible degree of economic power?
In the long run, institutional investors like insurance companies, savings associations, and trustees of large estates contributed the majority of bank capital. In many cases, these institutions were part of the same kin networks that initially owned, and continued to run the banks. “Members of kinship groups generally held large blocks of their banks’ stock at the time of formation.” (655) The percentage of bank stock held by the initial owners tended to decrease as the banks grew, but “the groups often retained their dominant positions on the banks’ boards of directors...because other stockholders rarely took an interest in the institutions’ affairs.” (655-6) And these same “kinship groups...often dominated the boards of the institutional investors that purchased their banks’ stock.” (657)
The role of these banks (despite the public-service rhetoric they employed to get their corporate charters during the early period, when incorporation implied quasi-governmental public status) was to “become engines to supply insiders with capital.” (657) “Even a prudent businessman,” Lamoreaux says, “might find himself in financial difficulty.” (658) The panic of 1837 and depression of 1839 had certainly proven that point. An emergency might force him to “convert illiquid assets into cash to pay off debts.” A friendly bank could “prevent distress sales of assets by accepting notes to balance accounts.” (659) After spending so much of his time in New York City, observing this process, is it any surprise that my upstate merchant started his own bank? Especially since, in the words of the 1854 Bankers Magazine, “where business is constantly and rapidly expanding, the younger class of business men who are entitled to bank facilities, equally with their older brethren, cannot have their wants fairly supplied without the occasional establishment of new banks. The old circle of customers use the existing banks to the extent of their capacity, and keep their door shut against the new men.” (663)
This raises questions that were apparently understood by bankers in the 1850s. Lamoreaux answers that “although the system of group-dominated banking doubtless resulted in some degree of favoritism in credit markets, the situation was remarkably fluid. Up-and-coming groups were able to build financial empires that rivaled those of the oldest, most established merchant families in the region.” (664) But even with no barriers to entry, is this what we’d call a “credit market?”
One thing that does seem certain, though, is that these banks facilitated a particular type of economic development. “Could kinship groups have tapped the community’s savings without their aid?” Lamoreaux asks. “The market for securities of manufacturing corporations in early nineteenth-century New England was extremely narrow,” she says. Even the Boston Associates failed to raise enough capital, and were forced to borrow. “The market for bank securities was much wider...because the diversified enterprises of the kinship groups permitted them to pay high and steady dividends and thereby draw out the community’s savings in a way that most individual ventures could never have done.” (665) “Without banks,” she concludes, “kinship groups would have been forced to depend largely on their own resources to finance investment.” (666)
Even if New England’s financial system allowed relatively free entry into banking, and banks allowed a slightly wider public to participate in a diversified portfolio of investments that would otherwise have been restricted to the very rich, was the concentration of economic activity in the hands of these “kinship groups” a good thing? Lamoreaux mentions in the first few pages of her article that lawsuits across New England challenged the “insider” ways in which these chartered corporations behaved. Even banking commissioners admitted “an almost uniform departure from the original design of banks in this respect.” (651) Although it involves counterhistorical speculation, it might be useful to ask what alternatives there may have been to simply accepting the inevitability that “kinship groups” should gain access to the “community’s savings” to finance business ventures for their individual benefit. To what degree is this a free choice, made by empowered individuals (investors and later depositors) acting in their own best interests, and to what degree is the public’s range of choices limited by laws and social conventions that allow incorporation, interlocking control, and that regulate the terms and conditions of credit? (along these lines, do usury laws actually benefit established banks, by lowering the incentive for individuals to loan money to each other at higher -- risk-appropriate -- rates of interest?)
