american banks versus british banks -- 8/7/15

Today's selection -- from American Economic History by Jonathan Hughes and Louis P. Cain. The fragmentation of the American banking industry into thousands of small banks, which was the legacy of the early prohibition of interstate banking, led to the emergence of giant investment banks like J. P. Morgan, and Brown Brothers, Harriman:

"Lance Davis [of the California Institute of Technology] noticed an interesting difference between American and British experience with respect to the linkage between industrial and financial development. As we have seen, in the late nineteenth and early twentieth centuries, U.S. industrialists participated in a great merger movement during which 'giant enterprises' emerged. The same was not true in banking, which proliferated by replication -- more and more, hundreds, thousands, of small banks. By 1900 or so, the United States had huge industrial corporations and a plethora of small commercial banks. The opposite was true in Great Britain. The British characteristically did not merge industrial firms into large organizations, but they did amalgamate their commercial banks into a small number of giant banks with numerous branches nationwide and worldwide.

Office formerly owned by J.P. Morgan & Co. located at the southeast corner of Wall Street and Broad Street

"Davis, a student of finance in both countries, noted the crucial link -- investment banking. The American investment banker specialized in placing stocks and bonds in the hands of investors, including the thousands of small commercial banks. In Britain, small industrialists in a secondary city such as Wolverhampton or Sheffield could go to their local branch of Lloyds, Barclays, or the Westminster Bank for all their financial needs. The bank's local branch offices could draw upon the mobilized capital of a giant system. In this way, British industrialists could raise the capital for expansion without surrendering their individual firms to amalgamation. Consequently, Britain's industrial structure consisted largely of small, family firms.

"The American industrial firm in similar circumstances had no such local capital source. To raise the capital, the American firm had to create an intangible asset that could be traded elsewhere, in a major center, for capital funds. It created such intangible assets, stocks and bonds, to finance activities such as mergers. American industrialists had access to big money, but not to small. The specialized agencies for such capital-raising industrial reorganizations were the investment banking firms located in the financial centers who did business under names like J. P. Morgan, Brown Brothers, Harriman, KuhnLoeb, and Kidder-Peabody.

"People like Pierpont Morgan and Jakob Schiff made their careers in investment banking by merging and reorganizing railroads, mining companies, and manufacturers into firms whose prospects were bright enough for their financial paper to be marketable. Transactions costs were reduced by this intermediation. It was widely believed that the result was reduced competition in industries so organized. Thus, the American investment banking industry, logically following the Davis thesis, grew up with the American manufacturing industry and the transportation network. Big firms were made by investment bankers, and investment banking grew on the proceeds of organizing big firms. In fact, Pierpont Morgan typically insisted upon placing a 'Morgan man' on the board of directors of each of his great financial reorganizations to maintain the ties.

"The process can be illustrated with a single man: Andrew Carnegie. In the late 1860s, Carnegie, then a Pennsylvania Railroad official, had gone to London to raise money. It could not be done in the United States. In 1900, when Carnegie decided to sell out, he wrote his price, more than $400 million, on a piece of paper, and handed it to his boy-wonder executive, Charles Schwab, who delivered it to Pierpont Morgan. Schwab reported that Morgan merely glanced at the paper and said, 'I'll take it.' The result was the biggest industrial merger in history to date. United States Steel, which had two-thirds of the industry's ingot capacity, $550 million of common stock, $550 million of preferred stock, and $304 million in bonds. The American capital market, by then centered in Wall Street, had come into its own with investment bankers like Morgan filling the pilot role. It all happened in a single lifetime, in the business career of a single person, such as Carnegie or Morgan. Institutional adaptation, in this case to the remorseless fragmentation of American commercial banking, produced both high finance and big business. So Davis argues, and history seems to support him.


Jonathan Hughes and Louis P. Cain


American Economic History (8th Edition) (Pearson Series in Economics)




Copyright 2011, 2007, 2003 Pearson Education


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