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

by Roger Lowenstein

  After dinner they would remove to a more comfortable setting for a digestif and a cigar, with Davison grabbing the plushest chair. They worked well into the evening, Aldrich set the pace and he was indefatigable. Naturally at home in an exclusive setting, he strove to craft a plan on a latticework of detail. Clearly, he favored a central bank, but his ideas on how to structure it were not at all crystallized, and many questions had to be resolved: Who would put up the capital and own this bank? Who would run it and how would they be chosen?

  Warburg favored a stronger government role than Aldrich did, to assure the public that Wall Street would not be in charge. Warburg also preferred a federal structure, as in his “United Reserve Bank” plan—again, to mollify the public. However, Aldrich had his heart set on a central bank like the ones he had seen in Europe.

  Over the long days of work, tension arose between the two strongest-willed figures, Warburg and Aldrich. The senator disliked the tenacity with which Warburg pressed his points. Often Aldrich cut him off in midsentence, though he might later return to Warburg’s point, cloaking it as his own. Warburg felt so passionately about reform that, when silenced, he could not help but smolder.

  The pair reached an impasse over the structure of reserves—the building blocks, as it were, of the system they were creating. The point may seem a technical one, but it bears a moment’s thought, for the entire edifice of the new central bank would hinge on how these reserves were defined. If a bank were to deposit assets at the central bank, it would be credited with a reserve—on this much all were agreed. But if the bank, say, traded a loan for a note of this new central institution, would these notes, deposited in a bank’s own vault, also count as reserves?

  Warburg insisted that they should (as, indeed, the modern Federal Reserve recognizes). The note, after all, represented a promise from the central bank—it was an asset no less than a deposit was. To Warburg, the integrity of the entire system hinged on this point. Aldrich disagreed. Warburg’s conception, he believed, countenanced a dangerous inflation (the more reserves a bank possessed, the greater the volume it could issue in loans).

  In all of his previous plans, Warburg had devoted intense thought to the issue of inflation. Since the central bank notes would circulate as money, the danger of excessive circulation was clear. Therefore, he devised an elaborate set of rules governing which sorts of paper would be eligible to be exchanged for notes. In simplest form, he proposed that notes be exchanged only for short-term paper (such as commercial paper) of the most reliable character, generally loans endorsed by banks. He thought this system, modeled on Germany’s, would foster an elastic currency but also guard against abuse. Nonetheless, he could not convince Aldrich, or any of the others, on the question of reserves. Warburg and Aldrich had a heated exchange and came to the point of falling out.

  When the session adjourned that night, Davison led Warburg for a walk in the island darkness, with Warburg numbly repeating, “The notes must count as reserves.” “Paul,” Davison interjected, “you cannot force Mr. Nelson [Aldrich]. If you try to, you will lose him. Drop the matter for the time being, and see whether you can take it up again later on.” Even though Davison had no expertise in monetary matters, his calming presence and human understanding proved just as valuable.

  Thanksgiving fell toward the week’s end; the group feasted on wild turkey and oyster stuffing. With the basic points of the reform plan settled, at least for the moment, the conspirators opted to take a day off for a duck shoot. The party took out a boat, with Davison drolly attired in khaki hunting clothes and moccasins. No ducks were found.

  The final, crucial task was to sculpt their oral discussions into a written blueprint. Warburg declined the job of draftsman, fearing that his style and language would be recognized and that the plan would be condemned as the Wall Street concoction that it was. The task went to Vanderlip, who wrote in a newspaperman’s popular style, and whose views were close to Warburg’s.

  Aldrich prevailed on the issue of reserves, but the general outline was faithful to Warburg’s idea of a federal structure. In many ways, what came to be known as the Aldrich Plan resembled Warburg’s “United Reserve Bank,” although the name was changed to “Reserve Association of the United States.” Essentially, it was a plan to pool reserves and create a new elastic currency, a Reserve Association note, backed by a gold reserve, that would supplant the old National Bank Notes.

  Both Aldrich and the bankers recognized the danger that their creation would be seen as a central bank, and thus did everything they could to avoid that dreaded appellation. That meant building in safeguards against domination by either the government or Wall Street. To mollify fears that the plan would be seen as radical, Aldrich built on the familiar tapestry of the local clearinghouses, standardizing their form and knitting them into a cohesive nationwide organization.

  Each participating bank would belong to a local association, which would act as a more stable form of clearinghouse. The local associations would, in turn, send representatives to a district branch—with fifteen branches spanning the country. At the apex of the pyramid stood the Reserve Association in Washington.

  Governance in the association was to be strictly democratic, with boards at each level (local, district, and national) elected by members. While larger banks would own more shares (subscriptions were set at 20 percent of capital), the overall scheme was egalitarian. A system of one bank/one vote prevailed, so that no cabal of banks—not even of the biggest banks—could hope to assert control.* The only plum for the big New York banks was that the rules would be liberalized to let national banks do business overseas. For Vanderlip, hungrily eyeing international expansion, this was a major coup.

  The Aldrich Plan was deliberately tailored to American traditions; it was democratic in governance and federal in structure. But it was not a central bank like those in Europe. As Warburg was to write, “It was strictly a bankers’ bank.”

  To avert the impression of a threatening colossus, the district branches would act as the operating units. They would hold the reserves of member banks and issue the new currency, through a process known as “discounting.” In contrast to the existing arbitrary regime, in which the volume of currency depended on investment in government bonds, the circulation now would have an organic relationship to ordinary banking activity. In brief, member banks would go to their respective branches and exchange short-term loans such as commercial paper, suitably endorsed, for reserve notes—the new paper money. The branches also would handle routine functions such as check clearing.

  The Reserve Association in Washington would control policy and oversee the branches (including when one region needed emergency reserves from another). In conception, Aldrich envisioned a single bank visible to the community in the guise of its fifteen operating branches. Importantly, Washington would set a single interest rate for the entire country. Warburg had wanted each district to set its own rate, but Aldrich, who felt that a uniform rate would seem fairer, overrode him.

  To avoid the suspicion that the association would favor political factions or their friends, bankers—not government—would be in control. The President would choose the Reserve Association governor from a list provided by its directors. However, thirty-nine of the forty-five directors were either bankers or industry representatives chosen by bankers; only six were government appointees (and even they were a grudging concession, forced on Aldrich by the politically sensitive Warburg).

  Although Aldrich recognized that the public had a vital interest in banking, he was adamant that the Reserve Association avoid the possibility of political influence, which, as he saw it, was the critical weakness of the Second Bank in the time of Jackson. He rationalized the near-exclusion of the public by casting monetary policy as merely a banking problem. “These are business questions,” he said. “They are not political questions.” To further keep the ghost of Jackson at bay, the association’s powers would be lim
ited. It could buy and sell securities on the open market (much like the eventual Federal Reserve), but it could not be a banker to the community at large, such as by taking deposits. It would serve the banks, not compete with them. It could not even compel individual banks to join (membership would be voluntary, reflecting the drafters’ laissez-faire bias).

  Just as the association would be protected against power grabs by politicians, it would also be immune to exploitation by banks, or so the drafters believed. Association dividends paid to member banks were capped at 5 percent, with a portion of the profits directed to the Treasury.* Thus, while bankers were in control, they could not expect more than a reasonable return.

  It was an inventive and thoughtful plan, honestly wrought. Aldrich, who had been so wedded to the old currency based on government bonds, showed courage in supporting a new currency based on private loans. The chief deficit of the plan was that it looked backward, to the era of private bankers. The drafters could not quite envision that, in the twentieth century, progressivism and like movements around the world would insist on public control of financial institutions.

  As they were leaving the island, the collaborators resolved to seek the support of Wall Street’s old guard. Aldrich would talk to J. P. Morgan and George Baker; Vanderlip would consult with James Stillman. The real work would be persuading bankers away from the Eastern Seaboard.

  Warburg suggested they also organize a league of businessmen to promote reform. Aldrich thought this preposterous. “If you can do that, God bless you!” he said mockingly. The others had a hearty laugh. Once again, Warburg seethed. But despite the tension between them, the week had enhanced his respect for Aldrich—who for all his tendency to dominate was willing to do the hard work of understanding the issues.

  The group disbanded quietly, in agreement over the blueprint despite many points of friction. Vanderlip considered the episode a high point of his life. Writing Stillman the next day—a violation of his secrecy oath—Vanderlip declared, “I am back from Jekyl Island, and have had as keenly interesting a time as I can remember ever to have had.”

  Given the total makeover of Congress, now tilted toward progressives, Vanderlip was not optimistic on the Plan’s immediate prospects. Nonetheless, he predicted that eventually “something along these general lines will be enacted.” Using Stillman and Vanderlip’s private code for Aldrich, Vanderlip added, “Zivil was greatly pleased with the result of the conference, and desires to keep in very constant touch.”

  Aside from a couple of vague allusions, the Jekyl conspirators did not refer to the trip in subsequent correspondence. Although they would continue working together, the trip itself disappeared from view. Six years later, in 1916, the journalist B. C. Forbes (then laying plans for Forbes magazine) mentioned the bare fact of the trip in Leslie’s Weekly. But his article received scant notice, and the secret was essentially preserved. Even as late as the late 1920s, when Warburg was writing an account of the Federal Reserve’s origins, he said only that he had been “invited to join a small group of men who, at Senator Aldrich’s request, were to take part in a several days’ conference with him, to discuss the form that the new banking bill should take.” He added in a footnote, “Though eighteen years have since gone by, I do not feel free to give a description of this most interesting conference concerning which Senator Aldrich pledged all participants to secrecy.” However, in 1930, an authorized biography of Aldrich finally revealed a few details.

  Thanks to its secrecy and its glittering cast, the cloak-and-dagger retreat would give rise to legions of conspiracy theories. For gold bugs, anti–Federal Reserve zealots, and flat-out cranks, the 1910 escapade would come to assume mythic significance. Over the decades, its suspicious character seemed only to grow larger. In 1952, Eustace Mullins, a Holocaust denier and conspiracy theorist nonpareil, described the “secret meetings of the international bankers” as a conclave of the Rothschild family linked backward in time to Hamilton and forward to Winston Churchill, Franklin D. Roosevelt, and Joseph Stalin. Mullins was inspired to probe into the central bank during a hospital visit to the fascist sympathizer Ezra Pound and devoted his career to a lunatic blend of anti-Fed and anti-Semitic diatribes. Some years later, G. Edward Griffin transformed paranoid theories into a lucrative cottage industry. A onetime writer for the John Birch Society and for Alabama governor George Wallace, and the author of a previous book espousing a miracle cancer cure, in 1994 Griffin penned The Creature from Jekyll Island. This book, which became a steady seller, argued that the bankers who came to the island in 1910 did so to establish a cartel, with the aim of suppressing competition in banking and confiscating the people’s wealth.

  For such writers, Jekyl became a metaphor for central banking, supposedly an international plot to bury civilization in debts. Since central bank notes are a form of obligation, each dollar issued by the Federal Reserve, each pound minted by the Bank of England, was, it was alleged, an added enslavement. A leitmotif in such arguments was that debt itself was pernicious, and in fact a strain of credit-phobia persists in America to this day. In 2010, the centenary of the Aldrich mission, Jekyll Island* was host to a conference at which a contemporary naysayer claimed that the Federal Reserve was nothing but a confidence game. These arguments against money and credit have gained wide—at times fanatical—adherence, perhaps not surprisingly, since many financial disasters are accompanied by waves of debt failures.

  Credit has often been abused or overused, but it is hard to imagine a society advancing beyond the most primitive stage without some means of exchange between those possessing surplus funds and those in deficit. Otherwise, money would sit idly in the vaults of the rich. People could try to borrow from rich people directly, but most people’s personal credit, and even that of most firms, is limited to a relatively small circle of acquaintances. This is the gap filled by banks. As Vanderlip put it to Carter Glass, “the main business of a bank is to exchange its credit for the credit of its customers.” The point of a central bank was to be a banker to banks, to use its credit to supplement that of each individual institution.

  The bankers who journeyed to Jekyl Island had no notion of monopoly. They wanted a more resilient banking system. They espoused greater cooperation, but it was for the purpose of collective security as opposed to, say, fixing interest rates. They certainly thought Aldrich’s “Reserve Association” would redound to their institutions’ benefits. Confidence in the credit system could only help their bottom lines. More specifically, Vanderlip’s correspondence makes emphatically clear that he was eager for National City to expand overseas, and a central bank would further such efforts. Vanderlip, himself a former Treasury official, envisioned the U.S. government as potentially a helpful partner to international banks just as, say, planters in Central America might hope to call, now and then, on the U.S. Marines. However, the bankers accompanying Aldrich did not envision, or want, a government central bank. They generally held to a laissez-faire view that private credit was more dependable than government debt—and therefore, that “money” should consist of private, rather than government, notes. They were interested in a system of self-regulation for banks. They wanted a framework in which banking reserves could be pooled—centralized or at least regionalized—and this, they believed, would indisputably be to the greater society’s good.

  While sequestered on the island, the bankers spoke with bitterness at having to steal about as though they were criminals. In their own minds, and in any fair rendering, they were attempting to achieve a worthy public reform. They were conspirators, but patriotic conspirators.

  Once home, they orchestrated a two-pronged attack. Aldrich reached out to leading bankers in the West. Meanwhile, Warburg surgically inserted himself into the deliberations of various commercial groups who were debating monetary reform. Coaxing these bodies toward a position consistent with the Aldrich Plan involved a nimble pirouette—because Warburg, of course, could not reveal that he knew
what the Plan was going to say. Thus, he was anxious for Aldrich to go public.

  Barely had he been home a week than Warburg bombarded Aldrich with seven pages of suggestions as the senator prepared a final draft. He also wrote to Andrew, whom Warburg frequently used as an alternate channel to communicate with Aldrich, relaying his impatience. Warburg had been made head of the New York Chamber of Commerce’s monetary committee—an influential group—and he was especially eager for Aldrich to divulge his plan so that Warburg could openly recommend it to the committee. “Will you please find out from Mr. N [Aldrich] what he wants me to do and what he intends to do,” Warburg asked Andrew, barely concealing his frustration. “I have not called together my committee up till now, but I cannot delay that very much longer.” As usual, Warburg supplied a carrot as well as a stick. “Not a day passes,” he exclaimed, “without some new evidence that the Central bank is wanted.”

  Aldrich briefed his colleagues on the Monetary Commission without breathing a word of the trip to Jekyl. But a whisper of great tidings was in the air. During December, Warburg was introduced to Taft. “Warburg,” the rotund President said good-naturedly, “I hear all kinds of things that Senator Aldrich is doing. What, really, is going on?” At such moments Warburg felt his foreign roots keenly. While replying evasively to the President, he could not help but wonder about the strange workings of the American political system, in which the head of state was forced to inquire of a rank outsider about events within his own party.