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Can we learn something from how a nearly laissez-faire economic system would deal with a banking crisis? Of course. One reform I would make if I were President would be to eliminate the unlimited liability of ownership of financial firms (and firms in some other sectors), and perhaps subject their corporate charters to renewal every 10-20 years. Why?

You might wish to learn a little about the failure of the Ayr Bank in Scotland in 1772, just 3 years after it opened. Kevin Dowd tells the story in his article, “The Establishment of Central Banking” of how management of the bank engaged in reckless expansion of its loan business, and quickly found itself in serious difficulty.

It remained solvent for a time by borrowing from London banks, but it was never able to repay its debts, and went bankrupt soon thereafter. The public suffered no losses from the failure, and all the creditors were paid off in full. Any inconvenience the public might have suffered was reduced by the policy of competing free banks (the Bank of Scotland and the Royald Bank of Scotland) to accept the notes of Ayr Bank at par; they did this to attract more deposits and to put more of their own notes into circulation. The collapse of Ayr Bank inflicted serious losses on the bank’s proprietors (who were liable for all debts) and on some smaller banks that had circulated its bills, but the major banks and the public suffered little to nothing. Such were the effects of the most serious bank collapse during the “free” banking period.

Reading this article, or Vera Smith’s, The Rationale of Central Banking, will provide a lot more background on how free systems evolve, and how they handled panics far worse than we are seeing today. Needless to say, the public was not fleeced in the name of “stability” nor were irresponsible parties rewarded for their bad behavior. Quite the opposite on both fronts.

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