The Warburgs

by Ron Chernow

  In late January 1913, Glass told Wilson that he had met with small-town Western bankers and they had “concluded that they could not carry out Mr. Warburg’s purpose of ‘battering the committee into a repudiation of the Democratic platform.’ …”22 The first draft of his central bank bill provided for at least fifteen regional banks, but also a Federal Reserve Commission in Washington, with mostly public appointees. Again it departed from Paul’s plan more in nuance than in essential outline.

  Paul became involved in actually drafting the Federal Reserve Act through Wilson’s closest adviser, Colonel House, who formed a back channel to Wall Street. In late April, President Wilson gave House the first digest of the secret Glass bill, which House handed to Paul for quick analysis. Glass later said Paul was hostile, whereas Paul preferred to style himself a sympathetic critic. To make them less provincial, Paul wanted to reduce the number of district reserve banks. House widely circulated Paul’s unsigned critique within the administration. In late May, Paul sailed to Europe on a liner with House, who got his reactions to various draft bills, then approvingly wired them to Wilson. To placate the populists and Senator Robert L. Owen, chairman of the Senate Banking Committee, Wilson settled for a bill in June that provided for regional reserve banks, supervised by a Washington reserve board under presidential control. With all seven board members to be appointed by the President, Paul feared the new Reserve Board would be “hopelessly political.”23

  Even though the Glass-Owen bill was being debated in Washington, Paul stuck to his annual ritual of spending the summer in Europe and he kept up a correspondence with Colonel House. He already believed opponents were plagiarizing his ideas. “I have been in the international banking business for 27 years,” he told House. “I have preached the gospel of reform on the lines now adopted at a time when Mr. Owen and Glass had not begun to study the alphabet of banking.”24 That his rivals had denied him credit would become a leitmotif in Paul’s later years.

  When he returned to the United States that fall, he met several times with Glass and discussed the banking bill at length with Senator Owen on a train from the capital to New York. Paul sometimes sounded a melodramatic note of alarm about the bill’s defects. After meeting several senators in November, for instance, he complained to Sir Ernest Cassel, “I am mortified by the suicidal stubbornness with which sound suggestions have been swept aside so far.”25 Such hyperbole tended to divert attention from his basic sympathy for the measure and was later misconstrued as opposition.

  On December 23, 1913, Wilson signed the Federal Reserve Act. Although he feared the prescribed minimum of eight reserve banks would make the system weak and unwieldy, Paul regarded the legislation as a spectacular triumph. “The passage of the Federal Reserve Act was a signal achievement and one for which the Democratic party could justly claim great credit,” he wrote.26 It embittered him that Glass and other belated converts portrayed the bankers as all opposed to the bill. For six years after the 1907 Panic, in fact, bankers had developed ideas that were then packaged into bills by Democratic politicians. In one critical respect, however, Paul’s opponents were absolutely correct: He had dissented sharply on the issue of political control and feared White House domination of the new system.

  The final act compromised on the seven-member Federal Reserve Board. It would include the treasury secretary, the comptroller of the currency, and five presidential appointees, of whom at least two would need banking experience. This last provision paved the way for Paul’s own appointment to the board.

  It is hard to parcel out credit for the Federal Reserve System, which went through such an extended gestation period. Many contemporaries cited Paul as its father. As The New York Times wrote, “In actual fact he had a more legitimate title to that distinction than any other American citizen.”27 Edwin R. A. Seligman, the Columbia University economist, said, “it may be stated without fear of contradiction that in its fundamental feats the Federal Reserve Act is the work of Mr. Warburg more than any other man in the country.”28 Paul had introduced the principle of mobilizing scattered reserves and the rediscount policy. In the late 1920s, Paul undertook a massive history of the Fed, in which he took withering exception to Glass’s statement that the Federal Reserve Act bore no resemblance to the Aldrich Bill. Laying the two bills side by side, he showed they were “surprisingly akin.”29 The Aldrich Plan had provided for a more centralized system and greater banker control. Otherwise it was clearly a brother, though not an identical twin, of the Federal Reserve System.

  This controversy over the Fed’s authorship would pose a terrible dilemma for Paul. He hated show-offs and exhibitionists and especially detested the way Bernard Baruch paraded his political influence. Yet it grated upon his sense of injustice that he was denied credit. As his son said, “another man might either have asserted himself or let it go. He couldn’t quite do either. He was an extremely just and gentle sort of man.”30 The issue dripped bitter poison into his mind.

  Before enactment of the Federal Reserve Act, Paul had a cordial visit with Carter Glass at the Raleigh Hotel in Washington. Out of the blue, Glass shocked Paul by asking whether he would consider a seat on the new board. As Paul recalled, “I took the question more or less as a joke or, at the most, as a compliment, and told him that I did not think the President would be at all likely to submit the name of a man associated with one of the leading Wall Street firms.”31 Paul had a bit of time to grow accustomed to the idea. The day Wilson signed the bill, Paul wrote Glass a congratulatory letter. Then Glass reiterated, “I take leave to suggest that you might well give serious consideration to the rather personal question that I put to you in my room at the Raleigh when you were last here.”32 Paul foresaw the dilemma that would confront him: He might have to help administer a Fed whose flaws he had so persistently exposed. When Wilson offered Paul the post by letter, he accepted “by return of mail and without any reservation,” as he said.33 His appointment pacified a leery Wall Street.

  In joining the Fed, Paul had to surrender lucrative partnerships at Kuhn, Loeb and M. M. Warburg as well as directorships at the B&O Railroad, Westinghouse Electric, and Wells Fargo Express. Aware of the prestige involved, Schiff also felt it part of his patriotic duty to let Paul go. Paul exchanged an income estimated at $500,000 a year for one pegged at $12,000. At the time he became a top American financial official, Paul had never even cast a vote: He became a citizen in 1911 and was in Europe on election day in 1912.

  To the American public, he was a faceless figure. When one newspaper asked for his picture, he declined: “I have never yet had my picture in the newspapers and am rather proud of this record. Therefore you will pardon me for not breaking it now.”34 Paul’s sense of public relations was faulty: He was behaving with the discretion appropriate for a private banker. Luckily, he had many more admirers than detractors. When one Midwest editor heard of Paul’s nomination, he asked the head of a local bank, “We have just received a flash from Washington that a man named Paul M. Warburg is slated for the Federal Reserve Board. Who is he?” “Paul M. Warburg,” said the bank president, “is the best-informed banker in the United States.”35

  If Wall Street hailed Paul as a paragon of banking, the populist press unleashed a torrent of violent criticism. As the Philadelphia North American said of Paul, “of all the financiers in the United States, there is none, we believe, whose nomination to the federal reserve board would be more offensive to the principle that credit should be freed from sinister influences.…”36 Believing the new board had too many bankers, Senate Progressives seized on the chance to resurrect the Money Trust campaign against Kuhn, Loeb. The press zeroed in on Edward H. Harriman’s railroad empire, with Schiff as his financial agent. Some papers saw a nefarious Kuhn, Loeb plot to overtake the house of Morgan, others a Warburg plot. As The New York Times reported, “The opponents of Mr. Warburg also say he is actively connected with the Hamburg banking house of Max Warburg,” which would “give one of the powerful banking houses of Europe an
unfair advantage.”37 At a time of tremendous xenophobia in America, the prejudice directed against Paul was often blatant. Congressman Joe Eagle said he opposed Paul’s nomination because “he is a Jew, a German, a banker and an alien.”38 Under attack for the composite identity that had made him so uniquely valuable in American finance, Paul faced a typically Warburgian dilemma.

  Board nominees required approval by the Senate Banking Committee. Paul agreed to testify if all nominees were treated alike. In early July 1914, three “popular” nominees sailed through without questioning, while Paul and Thomas D. Jones of International Harvester faced rougher sledding. Senator Joseph Bristow of Kansas commented acidly that Jones and Warburg, instead of being Fed nominees, should be “candidates for punishments for unlawful acts in violation of the Sherman law and other criminal statutes.”39 The committee voted against Jones and delayed Paul’s confirmation, deciding to single him out for questioning. Stung by this patent bias, Paul dug in his heels and refused to appear, informing the committee pointedly that he wouldn’t respond to humiliating, discriminatory behavior.40 All of his native stubbornness flared up.

  For the next four weeks, controversy stalled his nomination. Wilson, Treasury Secretary McAdoo, and Nebraska Senator Gilbert M. Hitchcock, acting chair of the Senate Banking Committee, pleaded with Paul to relent. The more insulted he felt, the more intransigent his dignity, which had lent him heroic stature in business circles, became. Paul telephoned McAdoo, bluntly stating that he wouldn’t testify. On July 3, he wrote to Wilson and asked him to withdraw his name, saying the committee had placed upon his nomination “the stamp of suspicion and doubt.”41 Refusing to drop Paul’s nomination, Wilson courageously converted it into a test of party loyalty. He felt he had to show the business community that the Democratic party wasn’t hostile to it. As The Wall Street Journal said, “Not many bankers have had the distinction of having a President of the United States take up the cudgels in their behalf—and in a fight with the mighty Senate of the United States at that.”42 Paul’s files show that Wilson prodded him to testify, telling him that “I could not in entire respect for the Senate request it to act upon your nomination in the present circumstances.”43

  The senators felt their own dignity offended, and a political stalemate ensued. In late July, Paul met with Senator Hitchcock on Long Island. Taking a conciliatory approach, Hitchcock said the committee meant no disrespect and had no plans to heckle him and reminded Paul that he wasn’t a well-known personality. A small minuet of mutual apology ensued. Paul voluntarily gave Hitchcock answers to questions posed by the committee. Afterward, Paul told Wilson that he would meet with the committee behind closed doors. It would be a discussion, not a formal hearing, and without a stenographer present.44

  Paul’s appearance before the committee provided another lacerating lesson in Washington chicanery. He told the senators he wanted to “show that a Wall Street man does deserve the country’s confidence in carrying on these things.”45 Senator Bristow remained unconvinced. For a day and a half, he grilled Paul so narrowly about Kuhn, Loeb that Paul snapped, “I think that my firm is not up as a nominee for membership of the Federal Reserve Board.”46 Paul denied being a Rothschild agent in America, noting that August Belmont & Co. performed that service. He surprised the committee by saying that while he was a Republican, he had contributed to Wilson’s campaign after Teddy Roosevelt entered the race. Brother Felix, he added, had supported Taft.

  Paul acquitted himself ably and honorably, and the Banking Committee and full Senate confirmed his recommendation. Yet he was psychologically bloodied by the contest. Sensitive and a bit priggish, he was easily disillusioned. He felt superior to the congressmen who had tried to skewer him and derived no pleasure from his victory. When Colonel House said the controversy acquainted a wider public with his signal merits, Paul replied dryly, “While you may be right that the notoriety that I received may help me in some parts of the country, I sincerely wish it had never come to me. Personally I rather resented it.”47

  On August 10, 1914, Paul Warburg took the oath of office and began to serve on the Federal Reserve Board. One reason he had compromised about appearing before the committee was the outbreak of World War I on August 1. The issue of his German birth and recent citizenship—which had seemed so abstract and distant when first raised—would now haunt him for the next four years. The extraordinary good fortune that had catapulted him into early prominence would seem to abandon him without mercy. During his tenure in office, the Federal Reserve System—the financial instrument he had so carefully honed—would prove a weapon in the fight against his beloved Germany. By a terrible trick of fate, he and Max ascended to leading positions in American and German finance right on the eve of World War I.

  CHAPTER 11

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  The Endangered German

  Max Warburg attained eminence in the heyday of imperial intrigue, when statesmen picked countries ripe for exploitation on unfurled maps and bankers served their will. Private bankers were ideal channels for such covert action because they didn’t answer to shareholders or publish balance sheets. They also prized intelligence and operated with sphinxlike discretion that mimicked diplomatic activity. The involvement of Jewish bankers in often sub-rosa colonial activity fed popular fantasies that they ran a secret empire, when, in fact, they operated under the strict guidance of the German Foreign Office. Like other private bankers, Jewish bankers mixed business and politics in a way that made them liable to a later political backlash.

  On the eve of World War I, Jewish bankers enjoyed such official favor as to make their later persecution the more perplexing to them. Some analysts have suggested that these Jews, still insecure at bottom, financed colonial expansion to certify their patriotism and to curry favor with the kaiser.1 If so, their talents were abundantly exploited. Service to the imperial state lashed them to Germany’s presumed mission in the world.

  Max believed unhesitatingly that bankers should advance the overseas interests of their governments. Noting how his British counterparts stimulated an economic rebound from the Boer War, he observed in his bank’s 1904 report, “This shrewd merger of finance and politics didn’t occur equally well in Germany.”2 A liberal imperialist who thought Germany needed colonies to sustain a booming economy and population, he wished to extend German power by peaceful settlement, not by military domination. A close friend of Colonial Secretary Bernhard Dernburg, Max boasted that no German bank more steadfastly supported colonial enterprises than his own.3 At Dernburg’s prompting, he cofounded the Colonial Institute in Hamburg to train Germans to run the country’s colonies. As an institute adviser, he stressed that these pioneers must preserve their German identity in exotic settings. He also helped to cofound—then twice rescued from bankruptcy—a Tropical Hygiene Institute.

  Max’s colonial work strengthened his ebullient, enterprising presence in official Berlin. If his judgment was later badly clouded by patriotism, we must note that his early success was premised on government patronage. It was during its period of colonial involvement that M. M. Warburg & Co. leaped into the first rank of world banking, its balance sheet expanding from assets of 46 million marks in 1900, to 127 million marks in 1914.

  Germany was infused with a sense of manifest destiny about overseas development. Bismarck had displayed only grudging interest in colonies, regarding them as economic burdens that might spark friction with England and France. In contrast, Wilhelm II wanted to compete for colonies and bumptiously asserted German interests. With truculent pride and notable self-pity, German leaders deplored the discrepancy between their robust domestic economy and the relative paucity of their overseas holdings. As latecomers to imperial adventure, they tried to compensate by boldly exploiting opportunities to make inroads against the French and British.

  In 1904, Max joined a Deutsche Bank loan to the Imperial Ottoman Empire to bankroll the Baghdad railway. The next year, the Foreign Office lured him into tangled Liberian intrigue. After spurni
ng loans from French and British banks to avoid submission to their governments, Monrovia appealed to Germany. Working with Paul at Kuhn, Loeb, Max organized an international loan for Liberia to thwart England and guarantee a market for German goods, a loan so successful that most Liberian commerce ended up in German hands.4 By 1907, M. M. Warburg & Co. tied for first place in securities issues among German banks, sharing top honors with the globe-straddling Deutsche Bank.

  As the great powers jockeyed for influence in Asia and Africa, they formed syndicates with other creditor countries to regulate the competition. The elaborate cartel for China included Germany. By the late 1890s, HAPAG ran freight service there, and major Chinese ports swarmed with German merchants. In 1909, U.S. president William Howard Taft insisted that American banks join in financing Chinese railways. With Jacob Schiff and Paul Warburg participating in the American group, Max was recruited by the German Foreign Office to ensure German-American harmony. He later said, “We succeeded through our good offices, in constant contact with Washington and the Wilhelmstrasse, in achieving an understanding between America and Germany.”5 Max relished such a middleman role, which proved that international bankers could transcend national differences—a fond Warburg belief.

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  Alice and Max Warburg in their confident, pre-Nazi prime.