CHAPTER IX. OF THE CREATION OF BANKS WITHOUT CAPITALS, OR OF FRAUDULENT BANKS.

THE term fraudulent bank is intended to be applied to a bank commenced without capital, or what is the same thing, a bank, the stock of which is held by persons who have not the means of paying for it, and who have consequently been obliged to hypothecate it to the bank as collateral security for stock notes discounted to meet the instalments as severally called for. The mode by which such a bank may be established without capital is this:—

Books are opened to receive subscriptions to the capital stock, each share of which is to be $100, of which $5 per share is to be paid at the time of subscribing. The capital is to consist of 1000 shares, equal to $100,000. The stock is taken, not by capitalists, as a mode of investment, but by persons who subscribe as a matter of speculation, with the view of selling out at a profit. The first instalment, amounting to $5000 being paid in, the directors are chosen from amongst these very speculators, who are expected to make the payment of the ensuing instalments come easy to themselves and their constituents. A second instalment of $10 is called for, but as the holders of the stock have no more money to pay in, they offer notes for discount, and pledge their stock to the bank as collateral security. The third, fourth, fifth, and all subsequent instalments are paid in a similar manner by stock notes; and, finally, the stock-holders obtain an additional discount for the original $5 per share paid in, which may have been originally borrowed, and thus we have a bank with a nominal capital of $100,000, but possessing not one dollar of real capital.

Such a bank, however, in its operations thus far, must be a losing concern. The expenses of management would compel the stockholders to pay in discounts more than they would receive in dividends, and the next step of the directors would of course be, to issue bank notes in exchange for the promissory notes of individuals. In the first instance they would probably discount their own notes or the notes of other stockholders, in which case, if the notes of the bank could be got into circulation, which experience shows they could be, if the directors were adroit and active, the borrowers of them would be enabled to command the capital of other people, to carry on business with. It is, perhaps, not probable that many of the banks of the United States have been entirely established upon this principle, but no small number of them have been partially so, and it must be evident that so far as any part of the capital of a bank has been loaned to a stockholder upon the hypothecation of his stock, he not being entitled to credit upon his mere personal security, so far the capital of the bank is diminished, and so far the public are deprived of the security which the nominal amount of the capital promises to afford.

The same deficiency of security might exist in case there were two banks established upon similar principles, and the stock of each was pledged with the other by two speculating sets of holders who changed position.

The following account of banks established in part upon this fraudulent principle is extracted from a report made to the legislature of North Carolina, during the session of 1828–29:—

“The legislature having laid down, in the charters of the several banks, certain fundamental articles for the government thereof, the committee assumed these articles as the basis of their investigations, and proceeded accordingly to inquire, in the first place, whether the stock of the several banks had been raised in the manner required by their charters. The evidence received by the committee on this point, shows that the charters of the banks were disregarded and violated in the very creation of their capital.

“The charter of the Bank of Cape Fear, enacted in 1804, authorised that corporation to raise a capital stock of $250,000; and the charter of the Newbern Bank, enacted in the same year, authorised that bank to raise a capital stock of $200,000; both charters directing the capital to be paid by the stockholders in gold or silver. The undersigned have received no evidence as to the mode in which these banks got into operation. It would seem, however, that they contemplated, at the outset, an evasion of the provisions of their charters. It is in evidence to the undersigned, that soon after they went into operation, they contrived to get possession of nearly all the paper money which had been issued on the faith of the state, which being at the time a legal tender, enabled them to evade demands for specie, which they did, by thrusting this ragged paper at those who presented their notes for specie. In 1807, $25,000 was added to the capital stock of each of these banks; in 1814, their charters were extended, and they were authorised to increase their respective capitals to $800,000 each, viz., the Newbern Bank was authorised to raise an addition to its stock of $575,000, and the Bank of Cape Fear, an addition of $525,000. It is in evidence to the undersigned, that the whole of this additional stock was manufactured by the banks themselves, and that, in many instances, favored individuals were permitted to acquire stock by subscribing their names, and putting their notes into bank, without advancing a single dollar of actual capital. It follows, that the whole amount of the interest drawn from the people, on the loans made on this fictitious capital, was a foul and illegal extortion. The effect of the transaction was the same as if the pretended stockholders had individually executed their notes of hand, without interest, to the amount of the notes which they issued from the bank, and exchanged them with the people for their notes, bearing interest and renewable every ninety days. Taking the issues made on this fabricated capital to be in proportion with those made on the former capital, they must have put into circulation, on the faith of the assumed stock, between three and four millions of notes; and thus, a parcel of individuals, under the name of stockholders, but who, in fact, held no stock, contrived to exchange their notes, without interest, to the amount of three or four millions, for the notes of the people, bearing an interest of more than six per cent.; and while the property of the people was pledged for the payment of the notes they had given to the stockholders, there was not. a dollar or an atom of property pledged to them for the payment of the notes they had received from the stockholders; so that for the use of their notes, which, intrinsically, were of no value at all, the stockholders of these two banks have drawn from the people, by way of interest, something like $200,000 annually.”