America's Bank: The Epic Struggle to Create the Federal Reserve
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ALSO BY ROGER LOWENSTEIN
The End of Wall Street
While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis
Origins of the Crash: The Great Bubble and Its Undoing
When Genius Failed: The Rise and Fall of Long-Term Capital Management
Buffett: The Making of an American Capitalist
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Copyright © 2015 by Roger Lowenstein
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Photograph credits:
Courtesy of the Rhode Island Historical Society: Insert image 1; Library of Congress, Prints and Photographs Division: 2, 10, 11, 14, 18; Library of Congress, Harris & Ewing Collection: 3; courtesy of the Jekyll Island Museum Archives: 4, 9, 12, 13; Citi Center for Culture/Heritage Collection: 5; courtesy of the Woodrow Wilson Presidential Library, Staunton, Virginia: 6, 15, 19, 20; Museum of American Finance: 7, 8; Library of Congress, National Photo Company Collection: 16; Library of Congress, Bain Collection: 17
ISBN 978-1-101-61412-9
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TO JUDY, ALWAYS
We do not think it fair that men . . . should raise the cry of a central bank or summon the ghost of Andrew Jackson.
—NELSON ALDRICH
CONTENTS
ALSO BY ROGER LOWENSTEIN
TITLE PAGE
COPYRIGHT
DEDICATION
EPIGRAPH
INTRODUCTION
PART ONE
THE ROAD TO JEKYL ISLAND
ONE: THE FORBIDDEN WORDS
TWO: PRIVILEGED BANKER, SELF-MADE SENATOR
THREE: JITTERS ON WALL STREET
FOUR: PANIC
FIVE: THE CROSSING
SIX: PROGRESSIVISM
SEVEN: JEKYL ISLAND
PART TWO
THE LEGISLATIVE ARENA
EIGHT: INTO THE CRUCIBLE
NINE: THE GREAT CAMPAIGN
TEN: WOODROW’S MIRACLE
ELEVEN: THE PRINCETON DEPOT
TWELVE: THE “SLIME OF BRYANISM”
THIRTEEN: “THE IMPOSSIBLE HAS HAPPENED”
FOURTEEN: EPILOGUE
PHOTOGRAPHS
ACKNOWLEDGMENTS
NOTES
INDEX
INTRODUCTION
SO PERVASIVE IS ITS INFLUENCE that Americans today can scarcely imagine a world without the Federal Reserve. To begin with, the Fed—America’s central bank—issues the Federal Reserve notes that we call “money.” It sets the short-term interest rate that affects the market for mortgages, car loans, corporate debt, and even the level of the stock market. It manages, sometimes adroitly and sometimes wantingly, the supply of credit whose ebb and flow alternately buoys and batters business. It supervises—or it is supposed to supervise—the nation’s banks. And as Americans were vividly reminded during the meltdown of 2008, the Federal Reserve acts as the lender of last resort, providing loans to banks when credit shuts down.
Barely a century ago, the Fed did not exist. Every other industrialized nation had such a central bank to oversee its banking system and to assure stability, yet America’s financial system—if system one can call it—was antiquated, disorganized, and deficient. The United States boasted the world’s largest economy, its vast territory was ribboned with railroad tracks and telephone wires, its cities were bursting with factories churning out iron and steel. Yet, almost as if history had missed a turn, its banks were disconnected and isolated, left to prosper or flounder (or fail) according to the reserves of each individual institution. As Paul Warburg, one of the heroes of this story, was to observe with his trademark acuity, America’s banks resembled less an army commanded by a central staff than they did an inchoate legion of disjointed and disunited infantry. It was hardly surprising that throughout the latter half of the nineteenth century and into the early twentieth, the United States—alone among the industrial powers—suffered a continual spate of financial panics, bank runs, money shortages, and, indeed, full-blown depressions.
This book tells the story of how, culminating in the days before Christmas 1913, the Federal Reserve came to be. It was not a gentle or an easy birth, nor was it swift. To Americans of the early twentieth century, especially farmers, the prospect of a central bank threatened the comfortable Jeffersonian principle of small government. To a people for whom local autonomy was sacrosanct, the notion of a powerful bank, joined to the even more powerful federal government, was deeply unnerving. Opposition to central authority had animated the minutemen at Lexington and Concord, and the battle to establish the Fed resembled a second American revolution—a financial revolution.
America had, of course, experimented with central banking early in its history. After the War of Independence, a military success but a financial disaster, the government was saddled with debt. When in due course the Constitution was ratified, providing a greater degree of political unity, Alexander Hamilton proposed a financial equivalent, a Bank of the United States, modeled after the Bank of England. Thomas Jefferson was mightily opposed, as were his many followers. Nonetheless, President Washington was persuaded, as was a majority of Congress, and in 1791, the Bank, headquartered in Philadelphia, opened for business.
To modern eyes, the Bank was a strange beast, 20 percent owned by the government and 80 percent by private investors. It was authorized to hold the government’s deposits but not, specifically, to be the nation’s monetary steward or to perform other functions of a central bank. Nonetheless, the Bank began to play this role. In particular, it strengthened the previously shoddy credit of the federal government. The twenty years of its initial charter were generally prosperous, and the number of private banks, which received charters from the states, swelled from five to more than one hundred.
But the Bank was doomed by the rise of the anti-federalists, both in the White House, in the person of James Madison, and in Congress. Rechartering failed by one vote in each chamber. Thus, in 1811, America was returned to a condition of monetary innocence, or laissez-faire, money again being the business of individual banks in the states, each of which issued notes according to its respective powers. Inflation followed, and when the government’s credit became overtaxed by the War of 1812, banks suspended operations, causing Madison to rethink matters. In 1816, Congress, now with Madison’s endorsement, chartered the Second Bank of the United States.
The Second Bank, though endowed with more capital, was in most respects a replica of the first. It succeeded at restraining the state banks from issuing too many notes, thus keeping a lid on inflation. It worked to mute excesses in the business cycle. And the Bank’s notes were widely accepted as a common currency, no small thing for a nation pushing across an unsettled continent. But the Second Bank met a fate no better than the first. Although Congress approved its recharter, the margin was not sufficient to override the determined veto of Andrew Jackson. In 1836, the national bank was, for the second time, a
llowed to expire. Once again, the country experienced an inflation, this time followed by a severe depression. In 1841, Congress chartered a third bank. President John Tyler, a southerner preoccupied with states’ rights, vetoed it. And there, for some seven decades, matters rested.
Given the two Banks’ overall effective records (and allowing for some stumbles by each), the question must be asked: Why such a haste to abolish them? Despite their success, many Americans regarded the Banks with profound suspicion. Alexis de Tocqueville, the French political thinker who toured Jacksonian America, noticed in his travels through what was still a frontier society a pair of seemingly inconsistent facts. The notes of the Second Bank were valued equally “on the edge of the wilderness” as they were in Philadelphia, testifying to the people’s general regard for its credit; nonetheless, the Bank had become the “object of intense hatred.” De Tocqueville’s diagnosis was that “Americans are obviously preoccupied by one great fear,” which he identified as fear of a tyrannical government or, as he put it, of “centralization.” De Tocqueville was plainly bewildered. To him—to most any Frenchman—the Bank of France seemed a natural outgrowth of the national government, no less French than the Court of Versailles. But in America, such a bank did not seem natural. It reawakened Americans’ primal anxieties, the colonials’ fear that their hard-won liberties would be crushed by a far-off king.
Even after independence, the pattern of settlement—the way that the frontier continually pushed westward—ensured that a perpetual class of outsiders would resent and resist the power structure in the East and especially the Northeast. For the opposition to central banking was always a matter of geography as much as anything else. In the vote to establish the first Bank in the House of Representatives, only three congressmen from southern states voted in favor; only one from the North was opposed. It was no accident that Jackson, the slayer of the Second Bank, was a rough-hewn soldier and Indian fighter, the first president not from the Eastern Seaboard.
Many early Americans were not merely suspicious of a federal bank; they were suspicious of any big bank, a prejudice that loomed especially large in rural areas. To merchants and city dwellers, banks were a boon, but farmers and debtors (often the same people) resented being hostage to banks, especially large metropolitan banks. And most of America, for a very long time, was rural: when Jackson was elected president, only one of fifteen Americans lived in cities.
Although Europe also had agrarian traditions, farmers in Europe lived in villages. They were surrounded by neighbors, accustomed to interdependence. In America, farmers were dispersed and isolated. They relied less on labor (which was scarcer) and more on capital—which is to say, they relied on banks. It has been wittily suggested, not without cause, that American farmers hated banks because they needed loans. Jefferson in particular was suspicious of finance, a profession he considered ethically tainted. It is worth noting that Jefferson never visited a town until he was almost eighteen. Jackson similarly frowned on financiers. He squashed the Second Bank largely because, he felt, it was a tool of eastern elites.*
Jackson’s heritage was remarkably enduring. Even generations later, the reformers who sought to establish the Fed could not admit to favoring a “central bank”—the very phrase was forbidden. Rhode Island senator Nelson W. Aldrich, the first legislator in the twentieth century to draft a bill for a national bank, felt as though he were doing battle not just with the populists and anti-bank agitators of his own time but also, as he phrased it, with “the ghost of Andrew Jackson.”
Before Congress could consider legislation, the public had to be persuaded of or at least exposed to the idea of establishing a unifying financial institution. In the first part of our story, bankers and others launch a campaign to win over influential citizens in business, universities, and the press. The reformers were a mixed bag—economists, bankers, idealists bent on modernizing the system, and, as well, Wall Street financiers with the more self-serving ambition of enhancing profits.
New York bankers wanted a central bank in part because they wanted to assume a greater role on the world stage. The America of the late nineteenth century was an industrial powerhouse but a financial also-ran. The U.S. dollar was a second-rate currency; incredibly, the dollar was quoted in fewer currency markets than the relatively puny Italian lira or Austrian schilling. In monetary terms, America remained a stepchild of the Bank of England, whose interest-rate maneuvers could, and often did, plunge Wall Street into recession. Financial independence required a more resilient currency, and one whose supply was regulated not in London or in Paris but in America itself.
But what sort of bank would issue this currency and what rules would it live by? These questions had preoccupied Americans since the Civil War. They fought—unceasingly—over whether the money supply should be pegged to the country’s gold reserve, or to silver, or to some other standard. Bankers of the Gilded Age were worried about inflation, as bankers always are; however, for strapped American farmers, money was in chronic undersupply. Farmers, industrialists, bankers, consumers, workers, all had conflicting interests. What became clear to all—after a disastrous panic in 1907, when the banks literally ran out of money—was that the prevailing system in which each bank stood on its own did not work.
The system’s inadequacy was seen most clearly by a newcomer, Paul Warburg, a German expatriate. He was stunned by the primitive condition of American banking and relentlessly lobbied his fellow financiers to embrace reforms modeled on the central banks of Europe. As Warburg acclimated to his adopted country, he recognized the need to cultivate the political establishment, then thoroughly Republican, and recruited the powerful Senator Aldrich to his cause.
Aldrich, however, was unprepared for the progressive tide that was reshaping American politics. Social activism was on the rise and Americans—not unlike in our own time—resented the widening gap between rich and poor, evident in the palatial mansions of railroad tycoons and industrial barons. The progressive movement was an effort to balance the scales. Since progressives were all for modernization, they should have looked favorably on proposals for a central bank, but progressives were innately wary of bankers—even of reform-minded bankers. And they deeply mistrusted Senator Aldrich, who had acquired his great wealth in shady, backroom dealings with monopolists. Aldrich was so out of favor that he opted to abscond from public view, along with a band of Wall Street advisers, and rewrite the nation’s banking laws in secret. Aldrich’s clandestine effort, a stranger-than-fiction mission to a remote Georgia island, would forever link the Fed’s founding to the wildest claims of conspiracy theorists and cranks.
In the second part of the story, as Warburg’s proposals are painstakingly translated into legislation, bankers pass the baton to politicians. No sooner did this process start than, in 1912, the electorate installed the Democrats in Congress. The Democrats were hostile to a central bank. After all, they were the party of Andrew Jackson. Moreover, they were concentrated in the West and South and naturally feared that a central bank would enhance the power of the big banks in New York. But the Democrats could scarcely overlook the pressure for reform that was sweeping the country. Moreover, the Democratic president-elect, Woodrow Wilson, was a good way evolved from his small-government predecessors. Though hardly a New Deal–style activist, Wilson was more willing to balance concern for individual freedom with a desire to promote national unity and the overall health of society. On the specific issue of central banking, Wilson—a student of American government—was favorably disposed.
The task of reconciling banking reform with the party’s states’-rights traditions fell, improbably, to a southern congressman—the Virginian Carter Glass. A child of the Civil War, a rebel in his bones, Glass was ambitious enough to see that modernizing banking could be his ticket to a place in the national spotlight. But he had to devise a program that did not run afoul of his party’s prejudices.
Prodded by Wilson, pressured by Warburg and
by Main Street bankers, Glass advanced a bill that, in its way, mimicked the constitutional experiment in federalism. The Federal Reserve would be unlike the central banks of Europe—for it would not be one bank but twelve. Power would be shared between the center and the periphery, between the federal government and the private banks that it was designed to serve. If the establishment of the Fed constituted a landmark moment, when the direction of society veered from laissez-faire toward government control, it was nonetheless intended to be a compromise.
Glass’s aim was to reconcile a set of overlapping tensions—between local and federal authority, between private and public interest, between farmers and merchants, as well as between small-town bankers, big-city banks, and Wall Street. His aim was to pool the nation’s banking reserves, in accord with the principle of collective security, without creating a powerful monster that violated American traditions and the prevailing sentiment against large banks. What he and the other founders could not have envisioned was the degree to which these tensions would persist. Indeed, in the political climate of today, it is doubtful whether the Federal Reserve Act could be passed. A century later, opposition to the federal government, such as in the Tea Party wing of the Republican Party, is as impassioned as ever. In 1913, Glass had to overcome the fear that a central bank would become a tool of Wall Street; in the aftermath of the 2008 crisis, when the Fed and the Treasury provided bailouts or credit to the biggest banks, such fears run rampant. And just as opponents of the Fed’s establishment protested that it would lead to inflation, the modern Fed’s sustained policy of near-zero percent interest rates has prompted critics to warn that a dangerous inflation looms ever nearer. More generally, in an America still nursing its wounds from the financial crisis, both its central bank and its prominent private banks have become objects of vitriol and mistrust. Truly, the battle for the Fed in 1913 foretells our differences today.