By John Steele GordonThe road to hell is notoriously paved with good intentions and for banking that goes double. There is no better example of that than the Freedman’s Bank that was chartered by the federal government in 1865 to provide banking services to the newly freed slaves.
While slaves seldom saw cash, many blacks had joined the Union army and received both signing bonuses and wages (although they were paid less than white soldiers). Many thought that they would soon be fleeced out of their hard-earned money, and a New Yorker named John W. Alvord convened a meeting of 22 prominent New Yorkers to discuss creating a bank where blacks could safely keep their money.
The group got Sen. Charles Sumner to propose a bill to establish a Freedman’s Savings and Trust Company to be headquartered in Washington, D.C. Passed in the rush before adjournment in March of 1865, the charter was a very broad one. It was the only bank in the country allowed to branch across state lines. Nor was it subject to oversight by the Comptroller of the Currency as other nationally chartered banks were. John Alvord was named the bank’s president. Unfortunately, Alvord was not a banker; he was a clergyman.
By the 1870s, the bank had 38 branches in 16 states. But there had been problems from the beginning. No capital had been subscribed, so the bank had to be entirely financed out of deposits. And while there were many depositors, most them had very small accounts. And it is just a fact of banking that accounts tend to cost about the same to service whatever the size of the account.
At that time, the banking rule of thumb was that expenses should be no more than 0.5 percent of deposits. But at the Freedman’s Bank, they were closer to 5 percent. With the U.S. Treasury bonds the bank was required to invest in paying about 6 percent interest, there was very little money left over to pay dividends.
Because of the high expenses, there was not enough money to pay competent help. Many employees, while well-intentioned, simply did not know what they were doing. One bookkeeper certified the bank’s book balances as “correct. E & OE.” Later asked what that meant he said that it stood for “errors and omissions excepted.”
A second big problem was that there was little supervision at the top. The Freedman’s Bank, in theory, was governed by a board of trustees with 50 prominent men serving on it. But they paid little attention to the bank or its officers. William Cullen Bryant, the distinguished poet and editor, for example, never attended a single meeting of the board.
The officers and a three-man finance committee were effectively in charge with no one looking over their shoulders, a never-fail recipe for disaster. Because of the high expenses, they lobbied Congress to expand what the bank could lend on to include real estate, the most illiquid of all investments. Congress passed it with little debate, requiring only that the value of the real estate collateral had to be at least twice the size of the loan. But the value of real estate is highly subjective until a sale is made. They were also allowed to lend on such collateral as railroad bonds, often the junk securities of the day.
With the financial panic of 1873, the end game began. Depositors began withdrawing their money and the bank soon collapsed. Most of the depositors never saw a dime of their money. So an institution whose whole purpose had been to safeguard the money of the country’s poorest ended up destroying it.