which in the following two decades was emulated by many other states. the nature of free banking and the states ’ experience with this approach to regulation have been the subject of profound misconceptions. specifically, many seem to believe that free banking was banking free from government regulation and that the result was a series of debacles. they conclude that - 3the experience with free banking demonstrates that market forces cannot effectively constrain bank risktaking. in fact, the “ free ” in free banking meant free entry under the terms of a general law of incorporation rather than through a specific legislative act. the public, especially in new york, had become painfully aware that the restrictions on entry in the chartered system were producing a number of adverse effects. for one thing, in the absence of competition, access to bank credit was perceived to have become politicized - - banks ’ boards of directors seemed to regard those who shared their political convictions as the most creditworthy borrowers. in addition, because a bank charter promised monopoly profits, bank promoters were willing to pay handsomely for the privilege and legislators apparently eagerly accepted payment, often in the form of allocations of bank stock at below - market prices. if free banking was not actually as free as commonly perceived, it also was not nearly as unstable. the perception of the free banking era as an era of “ wildcat " banking marked by financial instability and, in particular, by widespread significant losses to noteholders also turns out to be wide of the mark. recent scholarship has demonstrated that free bank failures were not as common and resulting losses to noteholders were not as severe as earlier historians had claimed. in addition, failure rates and loss rates differed significantly across states, suggesting that whatever instability was experienced was not inherent in free banking per se. in particular, widely cited losses to holders of notes issued by free banks in indiana, illinois, and wisconsin appear to have resulted from banks in these states being forced to hold portfolios of risky state bonds that were not well - diversified, were not especially liquid, and too often defaulted. it was, in short, state regulation that caused the high failure rates. during the free banking era private market regulation also matured in several respects. particularly after the panic of 1837, the public was acutely aware of the possibility that banks would prove unable to redeem their notes. discounting of bank notes was widespread. indeed, between 1838 and the civil war quite a few note brokers began to publish monthly or bi

mr. greenspan looks at the evolution of banking in a market economy remarks by the chairman of the board of the us federal reserve system, dr. alan greenspan, at the annual conference of the association of private enterprise education, in arlington, virginia on 12 / 4 / 97. i am quite pleased and gratified to receive the adam smith award this evening. having been a bank regulator for ten years, i need something to remind me that the world operates just fine with a minimum of us. fortunately, i have never lost sight of the fact that government regulation can undermine the effectiveness of private market regulation and can itself be ineffective in protecting the public interest. it is most important to recognize that no market is ever truly unregulated in that the selfinterest of participants generates private market regulation. counterparties thoroughly scrutinize each other, often requiring collateral and special legal protections ; self - regulated clearing houses and exchanges set margins and capital requirements to protect the interests of the members. thus, the real question is not whether a market should be regulated. rather, it is whether government intervention strengthens or weakens private regulation, and at what cost. at worst, the introduction of government rules may actually weaken the effectiveness of regulation if government regulation is itself ineffective or, more importantly, undermines incentives for private market regulation. regulation by government unavoidably involves some element of perverse incentives. if private market participants believe that government is protecting their interests, their own efforts to do so will diminish. no doubt the potential effectiveness of private market regulation and the potential ineffectiveness of government intervention is well understood by those attending this conference on zero - based government. however, i am sure that you will not be taken aback to hear that many here in washington are skeptical of market self - regulation and seem inclined to believe that more government regulation, especially in the case of banking, necessarily means better regulation. to a significant degree, attitudes toward banking regulation have been shaped by a perception of the history of american banking as plagued by repeated market failures that ended only with the enactment of comprehensive federal regulation. the historical record, however, is currently undergoing a healthy reevaluation. in my remarks this evening i shall touch on the evolution of the american banking system, focusing especially on the pre - civil war period, when government regulation was less comprehensive and less intrusive and interfered less with the operation of market forces. a recent growing body of research supports the view that during that