America's Bank: The Epic Struggle to Create the Federal Reserve

by Roger Lowenstein

Check clearing was a good example. Each bank maintained a battalion of clerks to process checks and handle communications with other banks, a process that was unwieldy and at times comically inefficient. Its salient feature was a lack of coordination, in particular between banks across city and state boundaries—manifest in the seemingly simple task of routing checks to their bank of origin. A contemporary writer demonstrated the waste in the system by tracing the path of a single check for $43.56, drawn by Woodward Brothers, a general store in Sag Harbor, New York, on eastern Long Island, on its account at the local Peconic Bank and paid to Berry, Lohman & Rasch, a wholesale grocer in Hoboken, New Jersey. The check was deposited in the Second National Bank of Hoboken, which sent it along to a New York bank, which—not having a regular correspondent in Sag Harbor—bundled it with other checks to their Boston correspondent. The latter, inexplicably, transferred the nomadic debit to the First National Bank of Tonawanda, New York, near Niagara Falls. The Tonawanda bank, realizing the check had wandered off course, shipped it to a bank in Albany, which endeavored to get it nearer to home and relayed it to the First National Bank of Port Jefferson, only sixty miles from its point of issue. Alas, the check took another detour, to the Far Rockaway Bank, thence to the Chase National, the weary check’s second visit to New York City. After two more stops, it was returned to the Peconic and duly laid to rest. As the writer concluded, “Once started, the poor check gets pushed along from station to station.” In an economy humming with iron ore furnaces and factories, such methods were laughably archaic. In nearly every other field, combination and economy of scale were the watchwords. Industries were rapidly congealing into trusts (more than two hundred trusts were created from 1898 to 1904) and, largely in response to these giant combines, labor was recruiting workers into nationally affiliated unions. The country was knit by rail tracks and telegraph wires; electrification was advancing apace.

  Only banking, or so it seemed, remained so fractured and so atomized. Even adjusting for the size of its population, America had far more banks than other countries. Most of its banks were small, rural affairs, and two-thirds were chartered by individual states rather than by Washington. Such state banks, although uninhibited by the considerable burdens of the National Banking Act, were, of course, prohibited from issuing National Bank Notes. This meant that the “national” currency was accessible to only a minority of the country’s banks. As Warburg summarized this confusing picture, “there existed as many disconnected banking systems as there were States.” Larger cities, it is true, had clearinghouses (local associations to provide banking functions such as check clearing and emergency liquidity), but clearinghouses were not universal, and their capacity was limited, and beyond the municipal level no collective machinery for banking existed.

  Warburg frequently unburdened himself to Schiff as they walked downtown to the new Kuhn, Loeb skyscraper, a twenty-two-story token to modernity in the financial district. Schiff repeatedly insisted that, for cultural and historical reasons, America was not yet ready for a central bank. As Warburg acclimated to his new country, he came to better appreciate the political obstacles. Increasingly, his frustrations centered on the person who had the power (had he chosen to use it) to legislate reform: Senator Aldrich.

  Aldrich, partly to mollify bankers, did offer his own currency bill, but it was less a reform measure than a reaffirmation of the status quo. In truth, the present arrangement suited him. High tariffs (which Aldrich largely dictated) enriched the Treasury and were used to buoy the banks in time of need. To Aldrich, the tariff, the gold standard, and National Banking constituted a sacred trinity best preserved intact. His one innovation was to suggest that railroad bonds be deemed acceptable collateral for government deposits in the national banks. This enraged progressives, who saw it as a plot to drive up the value of railroad securities, and thus make federal banking policy subservient to the interests of corporations.

  In the marriage of business and government, Aldrich felt no discomfort. Like many politicians of the Gilded Age, he genuinely believed that society benefited when its elected leaders were guided by men of wealth. A card-playing companion of J. P. Morgan, he treated his own lack of a fortune as a providential error, one to be duly rectified. In fact, in the early 1890s, he had flirted with leaving the Senate; however, a Rhode Island business tycoon, Marsden J. Perry, offered him a way to stay in Congress and still maintain the lavish lifestyle that he, Abby, and their eight children had come to enjoy. Perry made Aldrich a partner in a plan to consolidate and electrify the state’s trolleys; critically, the millions in capital needed to fund the modernization were provided by the Sugar Trust. Buoyed by this investment, Aldrich soon had a personal fortune that ran into the millions, and he could attend to his legislative work without the distraction of material concerns.*

  Aldrich saw nothing wrong in such a convenient partnership with sugar—the industry over which he held so much power. He would have said that his votes for sugar tariffs were votes of conscience. His links to the business elite were further sealed by the marriage of his daughter Abby, in 1901, to John D. Rockefeller Jr. In a perceptive senior thesis submitted at Harvard six decades later, Michael Rockefeller, the senator’s great-grandson, would write that “it became easy for Aldrich to conceive of legislation as being primarily a problem of consultation with the economic aristocracy followed by the application of personal authority.”*

  Aldrich generally ignored public criticism, believing that the Rhode Island machine shielded him from the vicissitudes of politics. But he was foolish to be so cavalier about his reputation. The American public was developing an appetite for scandal; journalists such as Ida Tarbell were writing hard-hitting articles exposing corruption in politics and unscrupulous behavior in business. American magazines had previously catered to a literary audience, but scandal sold better, and with technological innovations such as glazed paper made from wood pulp, publishers were able to cut prices and reach a mass audience. Many articles focused on the gross inequities in American society—the squalor of tenement living as opposed to the gilded lives of the ultrarich.

  Predictably, Aldrich became a target. In 1905, William Randolph Hearst’s Cosmopolitan commissioned David Graham Phillips, a well-known novelist, to write a series of exposés, published the next year under the overwrought title “The Treason of the Senate.” The second installment—“Aldrich, the Head of It All”—vilified Aldrich as “the chief exploiter of the American people.” Phillips’s prose was so soaked in innuendo and overstatement that President Roosevelt objected. He likened Phillips to the mythical collector of filth in The Pilgrim’s Progress, who could “look no way but downward, with a muck-rake in his hand.” Thus “muckraking” was officially christened. Critics also thought the attacks on Aldrich were unfair. Whether the reading public was so discriminating is impossible to say. But Phillips’s larger point—that Aldrich typified a Congress too cozy with corporate interests and too distant from the people—was correct.

  The “Treason” series weakened Aldrich’s political moorings by stirring cries for the popular election of senators. More important was the context of such articles. If the populists of the 1890s spoke to farmers, the muckrakers engaged a more urban constituency who had been put off by Bryan but who were, nonetheless, disturbed at the seeming unfairness in American society. Progressives, as these reformers came to be called, tended to be liberal-leaning city dwellers, such as lawyers and educators. While the populist and progressive movements had areas of overlap, progressivism was more focused on labor than on agriculture, more drawn to government and less fixated on laissez-faire. Progressives tapped into the unease that Americans felt over the rapid transformations wrought by industry, immigration, and technological change. The automobile was one change; education was another. From the Civil War to 1900, the number of high schools nationwide rose from several hundred to six thousand. In comparison with the America of the recent past, more people lived in cities; more worked at f
actories; more knew people who had been born overseas. The extreme concentration of wealth was also new. Millionaires had once been unheard of; now America had 3,800 of them. Newest of all were the giant industrial combinations supplanting local businesses. If the arbiter of society once had been a small-town lawyer or banker, now it was—or seemed to be—a huge corporation, a trust.

  Theodore Roosevelt, although wealthy himself, championed progressive causes, whereas he would never have identified with a mob of farmers. Woodrow Wilson, now the president of Princeton University, who was attracting attention in Democratic political circles, shared many of the same ideals.

  The question of which way progressives would lean on banking reform was complicated. Progressives applauded using the tools of social science to prescribe solutions to the problems of the day. Warburg’s meticulous dissection of the banking system was consistent with that approach. On the other hand, progressives were skeptical of Big Business and of Wall Street. People in the movement did not trust banks—big banks especially—and they did not trust Senator Aldrich.

  CHAPTER THREE

  JITTERS ON WALL STREET

  There is just as true patriotism to be found in Wall Street as there is anywhere else in this country.

  —FRANK A. VANDERLIP

  WITH CONGRESS STALLED and bankers in the heartland far from committed to reform, Wall Street began to agitate for a central bank. The spark was a prophecy delivered by Jacob Schiff, Warburg’s older partner and a respected Wall Street sage.

  Early in 1906, Schiff issued a warning to the New York Chamber of Commerce. “I do not like to play the role of Cassandra,” the bearded financier solemnly began, but if the financial system was not reformed soon, he averred, “we will get a panic in this country compared with which those which have preceded it will look like child’s play.”

  Schiff feared that America’s prosperity was endangered by its rickety banking system and its shallow money market. Treasury Secretary Leslie Shaw had tried to paper over these deficits by nimbly moving funds around, but Schiff did not need to remind his audience what had occurred the previous autumn, when Shaw had removed $100 million from commercial banks, redeploying these funds into the government’s Panama Canal project. On Wall Street, short-term interest rates briefly soared from 10 percent to an intolerable 125 percent, as if New York City were some remote financial backwater. In a more mature system, such volatility would be unthinkable. It grated on Schiff that New York, which had a new subway line admired around the world and opulent hotels on a par with those in Paris, had to suffer a financial system that was a holdover from the Civil War. “I say that is a disgrace to a civilized community,” Schiff proclaimed.

  The chamber was so alarmed it formed a committee to study America’s much maligned currency. Significantly, the primary chore of writing the committee report was assigned to Frank A. Vanderlip, one of a coterie of younger bankers who, propitiously, did not share his elders’ attachment to the hidebound National Banking system. Vanderlip had a diverse background, having worked in Washington and the Midwest as well as Wall Street. He was inquiring and ambitious, the sort of businessman whom Paul Warburg had been hoping to interest in reform.

  Vanderlip had grown up on an Illinois farm and begun his career as a reporter, specializing in financial news. He was an enterprising journalist, cultivating high-level sources, and in 1897 he moved to the Treasury as assistant to Secretary Lyman Gage. In Washington, he rubbed shoulders with Theodore Roosevelt, then the assistant secretary of the Navy, whom he judged to be an egotistical warmonger. When the Spanish-American War broke out, Vanderlip arranged for the sale of war bonds and became familiar with scores of bankers, including James Stillman, the highly successful though reclusive president of National City Bank (and the gentleman who had curtly dismissed Warburg’s memorandum on a central bank).

  Impressed with Vanderlip’s quickness, in 1901 Stillman offered Van-derlip a position as vice president. Immediately, he began to groom him as a successor. Notwithstanding that Stillman lorded over his staff—each morning at his house on East Seventy-second Street, servants ferried four eggs on a tray upstairs and anxiously awaited the master’s judgment—he took to Vanderlip as if he were a son. The two went motoring on Sundays, and the ordinarily delphic banker shared with Vanderlip the secrets of the business, which Stillman had built by developing a roster of prized clients, including William Rockefeller of Standard Oil and a host of other magnates. Fusing a traditional loan business with underwriting, Stillman had made City the largest bank in the United States. Meticulous in manner and impeccably dressed, he did all he could to mold Vanderlip into a worthy heir, which included providing his protégé with a mansion on the Hudson, fully furnished (in the English style), and sponsoring him for membership in the right Republican clubs.

  Despite their closeness, Vanderlip did not share his mentor’s hostility toward monetary reform. Stillman regarded financial panics as natural and worthy rituals that cleansed the market of excesses that he himself studiously avoided (National City was fondly known as “Stillman’s money trap,” an homage to his prudence). Vanderlip, nearly twenty years his junior, took a more pragmatic view, judging that America’s lack of a lender of last resort was needlessly holding back its progress. Even though the U.S. economy had grown to be the world’s largest, with 40 percent of total banking capital, it remained a stepsister in international finance. National banks were not even authorized to operate foreign branches, much to Vanderlip’s frustration.* And owing to the lack of confidence in American markets, short-term interest rates were higher and more volatile than they were in the United Kingdom (this amounted to a penalty paid by American businesses and other borrowers). Nor was the dollar used in settling international balances. To the mortification of financiers such as Vanderlip and Schiff, merchants in Philadelphia buying goods in China or South America had to settle their transactions in Paris, London, or Berlin. Wall Street was tired of paying tribute. And as long as the United States was visited by periodic panics and money stringencies, there was little chance that the dollar would overtake the pound as an international currency.

  Vanderlip, who was forty-one when he set to writing the chamber of commerce report, quietly handsome with narrow eyes behind thin spectacles, had no doubt that this state of affairs could be rectified if the government were to assume a more active role. His report bristles with the frustration of a metropolitan banker whose lofty ambitions in high finance were checked by the prosaic demands of the countryside. The harvests and the marketing of the crops, he complained, had strained the banks, which were “unable to make use of their credit, but are obliged to take lawful money from their reserves and send it into the harvest fields.”

  Vanderlip blamed the same culprit as did Warburg—the stifling requirements of the National Banking Act, which, in particular, put a crimp on circulation. The law imposed particular burdens on rural areas. In the cities, people had bank accounts and were accustomed to writing personal checks, which were simply an unregulated form of money. On the farm, people relied on bank notes—but the note supply was, of course, highly constrained. Vanderlip’s aim was to fashion a more flexible supply—not more money on average, but a greater elasticity in either direction. For this, he proposed a central bank “of issue” (that is, with note-issuing powers) that would deal only with banks; it would be controlled by a board of governors appointed, at least in part, by the president of the United States. This is a fair description of the eventual Federal Reserve Act.

  But Vanderlip’s prescience in one respect failed him. Although he included, as a fail-safe, an alternate, less draconian reform, he naïvely assumed that what New York bankers advised, the rest of the country would gladly endorse. Having talked to bankers in the interior, Vanderlip was convinced, as he put it with stunning lack of sensitivity, that “a majority of the bankers of the United States appreciate the necessity for a variable and elastic element in the currency and will hearti
ly co-operate with the bankers of New York City.” Sounding even more elitist, he lauded the day, not long in coming he must have imagined, when “the lawful money reserves of banks in financial centers would no longer be depleted in the autumn in order that harvest hands in Kansas, Nebraska and Dakota might receive their wages.”

  If the onetime farm boy had difficulty empathizing with Dakota harvest hands, it reflected Wall Street’s widening distance from the rest of the country—even from other bankers. As American industry assumed corporate form, many companies established headquarters in New York and turned to banks to finance growth. Leading financial institutions in the city were gradually morphing into investment banks, peddling securities, trading bonds, and dabbling in foreign exchange. This was a momentous evolution, presaging a culture of finance that was wholly foreign to ordinary Americans. Thomas F. Woodlock, editor of The Wall Street Journal, observed that “New York bankers are, with few exceptions, steeped in the atmosphere of the stock-market business, and the ticker takes a good deal of their attention.”

  Sensitive to attitudes west of the Hudson River, Schiff tried to soften Vanderlip’s recommendations when he again addressed the chamber, in November 1906. “If you go away from New York City and discuss this subject of a central bank,” Schiff began, replicating the admonishments he had delivered to Warburg, “if you . . . discuss it with the people of this country all the way across its three thousand miles, you will find grave distrust in the proposition.” The American people, he explained,

  at the time of Andrew Jackson, and more so today, do not want to centralize power. They do not want to increase the power of government. . . . They do not want to have this mass of deposits, which the government would have to keep in this bank, controlled by a few people. They are afraid of the political power it would give and of the consequences.