A Case Study in Banknote Pricing During Financial Chaos: The Illinois Experience During the First Summer of the Civil War

Abstract

This case study of the Illinois banking market shows how the private market managed the crisis in the banknote market during the first year of the Civil War. Banknotes backed by southern bonds started their decline with the election of Lincoln causing their values to fall below par. The Illinois legislature acted swiftly to shore up the banking system, but the start of the Civil War upended the market. A series of private market agreements failed to stabilize prices at face value leading to chaos in the banknote market resulting in fluctuating prices for different banks. The Wright Bros., a private banker, took the lead by publishing weekly banknote prices of over 100 banks during a 20-week period. The discounts on banknotes were significant and the evidence suggests that the banknotes were not efficiently priced. Banknote prices were not very sensitive to the market value of the bonds securing banknotes. While Wright Bros. did set prices based, in part, on the market value of the bonds, market and bank-specific risks and the reputation of the bank were the major factors differentiating prices.