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

by Roger Lowenstein

  Willis immediately began to revise the plan to include a capstone and to reflect other points discussed at Princeton, and he and Glass mounted a campaign to win the support of bankers. The pair focused not on Wall Street but on the (mostly midwestern) bankers who dominated the councils of the American Bankers Association—and, through it, the small-town bankers who were influential across the country. A prime target was Barton Hepburn, the chairman and retired president of the Chase National Bank. Although presiding over a New York institution, Hepburn, who had been born on a farm and was chairman of the ABA’s currency commission, carried weight with bankers whose support Glass considered vital, such as George Reynolds and James Forgan of Chicago and the St. Louis banker Festus J. Wade.

  Chicago bankers had warmed toward the central bank idea, but they remained mistrustful of any plan that smacked of New York dominance. Even though they were open to a regional approach, they had come to appreciate the Warburg argument for centralization. Willis’s talks with Hepburn resembled a minuet, in which Willis probed to see how much decentralization Hepburn and his colleagues would tolerate, and Hepburn delicately pushed back. Forgan, the leader of the Chicago faction, was particularly insistent that control be centralized.

  Glass used his subcommittee hearings to persuade the industry that its best—probably only—hope for reform was to rally behind him. Willis later called the hearings an exercise in “testing public opinion,” which is exactly what they were not. Glass and Willis did not even disclose they had written a draft, presumably so that witnesses would not be tempted to offer criticisms. Rather, they stage-managed the proceedings to mold public opinion. As early as December 31, 1912, Willis assured Glass that both Hepburn and Warburg were “in good humor toward the hearings” and disposed “to assist by giving moderate and reasonable testimony.”

  Hepburn led off, and while he admitted a preference for the Aldrich Plan, he generously allowed that “no one would claim that the Aldrich bill is the last word of wisdom.” This was the “reasonable” middle ground that Glass aimed to exploit. Bankers had their own reasons for rejecting a European-style central bank—namely, central banks in Europe did business with ordinary customers. American bankers were afraid of the competition from a central bank (when their self-interest was threatened, staid commercial bankers could sound downright populist).

  However, the bankers also rejected the Bryan alternatives of government fiat money or federal deposit guarantees. Bryan’s approach represented a contrary philosophy—rather than a strong network of private banks, a strong hand of government. The bankers feared that either of Bryan’s remedies would lead to inflation. Their pushback was useful to Glass, who shied away from either extreme and who needed leverage to resist the committee members loyal to Bryan.

  The one witness who did not play along was Warburg. He had come too far to muzzle his convictions now. Warburg testified that a regional system would perpetuate the flaws in the existing order. He vividly recounted to the subcommittee his horror at the money shortages when he first arrived in New York, in 1902. Now emboldened by his status as a U.S. citizen, he accused his adopted country of ignoring what worked in banking elsewhere. The country’s most pressing need, he said, was to centralize reserves—without which the currency would never be truly elastic. “Elastic currency” was a buzzword among Americans of the day; Warburg used it knowing that it resonated, but went on to define it in vivid terms. America, he noted, was hostage to the “stupid condition” whereby each of the country’s seventy-five hundred national banks had to freeze a quarter of its funds “and put them into a safe-deposit box, where they are of no use.”

  Glass attempted to frame Warburg as an absolutist.

  THE CHAIRMAN: Would you say that we should do nothing if we can not at this time get a central reserve association?

  Warburg refused to accept Glass’s all-or-nothing formulation, but he pointed out that in a system with multiple reserve banks, those in New York and Chicago would surely dominate—precisely the outcome Glass wanted to avoid. And Warburg doubted that regional banks would cooperate with one another any more than individual clearinghouses had in 1907. Nonetheless, he tried to offer the subcommittee a face-saving compromise by insisting it could achieve a centralization of reserves without establishing, in formal terms, a “central bank.”

  THE CHAIRMAN: That is what you are trying to arrive at, the centralization of reserves?

  WARBURG: It is not that I am trying to arrive at it, Mr. Chairman. It is to my mind—and I have studied this thing very, very carefully for a great many years—the only way, the fundamental way, in which every other country in the world has been treating this.

  Victor Morawetz provided a counterweight to Warburg, offering a cogent case for regional reserves. Presumably, regional banks would respond more nimbly to local credit conditions, particularly in an era when distances loomed so large. And as Morawetz pointed out, the individual banks could always be merged later.

  Glass repeatedly trotted out the Democratic Party platform restrictions, which he said “confronted” the subcommittee and “precluded” it from pursuing a central bank. He referred to the party’s “traditional hostility” to central banking as though it were a perhaps-regrettable—but unbreakable—chain about his neck; this was also the tone of his memoir, in which he referred to the memory of Jackson, who had abolished the Second Bank, as a ghost that “stalked” and “haunted” him. Because these arguments did not address the substance, they raised the question of why a central bank so terrified Glass. Although he shared with Bryan a vague aversion to bigness, it is hard not to think that Glass’s primary concerns were political.

  They were, in any case, effective. The hearings convinced bankers, as Warburg put it, that “no scheme would be considered seriously by Mr. Glass and his colleagues unless it embraced the regional reserve bank principle.” Prominent bankers such as Hepburn and Wade, and even Forgan, agreed to back a regional framework, even though they intended to keep pushing to make the individual parts cohesive.

  Warburg recast his latest plan so that it comprised four regional banks (many fewer than in Glass’s plan), mutually responsible for one another. This version was delivered to Henry Morgenthau, and also to Willis, who shared its thesis with Glass. Warburg’s point was that with too many banks, the system would suffer a lack of coordination and, in the weaker regions, a lack of capital.* But a quartet of closely knit banks could preserve the principle of collective security. “The tantalizing puzzle,” Warburg offered, was how to unify the system for the purposes of fluidity of reserves while nonetheless endowing the individual banks with sufficient independence—“otherwise they will be nothing but [glorified] safe-deposit vaults.” Although Warburg’s criticisms were constructive, Glass didn’t trust him as he did other bankers, perhaps because the perfectionist Warburg was so difficult to satisfy; he suspected that Warburg’s true purpose was resurrecting the Aldrich Plan. Warburg returned the favor, regarding Glass as a mere politician who did not have the business mind of Aldrich.

  Wilson was eager to have a bill when he took office (presidents in that era were inaugurated on March 4). Willis completed a draft on January 15. As the hearings progressed, he continued to tinker with it, still taking extraordinary precautions to keep its provisions secret. In one series of letters, Willis painstakingly queried of Glass how many people should be allowed to see the draft; agonized over whether to exclude James Laughlin, who was still advising him; and finally suggested they show the bill only to a small group in executive session after which they would “call in all copies.” In their way, Glass and Willis were as conspiratorial as the bankers on Jekyl Island. Laughlin desperately sought to procure a copy, but now that Glass had the ear of Wilson, he no longer needed Laughlin. At the end of January, Glass presented Wilson with a formal draft, this time at the governor’s office in Trenton. At this meeting, Wilson endorsed Glass’s basic regional design. Laughlin miserably conclud
ed he had been left “outside the breastworks.”

  The document Glass took to New Jersey had been softened to mollify bankers; for instance, deposit guarantees were out and the Reserve Banks were limited to taking deposits from other banks, not from ordinary citizens. Thus, the Trenton plan envisioned a “banker’s bank.” Nonetheless, the Reserve Banks were permitted to conduct open market operations such as buying bonds, later to become a favorite tool of Ben Bernanke. Contrary to what bankers sought, membership was to be compulsory, and Glass blithely ignored Warburg’s admonition to reduce the number of Reserve Banks—Glass specified “not less than fifteen.”

  In other respects, the Trenton draft bore a striking resemblance to the much renounced Aldrich Plan. Both bills proposed a new currency backed by bank assets and a gold reserve. Each envisioned a new institution (or multiple institutions) to hold bank reserves, governed by local boards of bankers and a supreme board in Washington. Where Glass wanted fifteen or more banks, Aldrich envisioned fifteen branches. And notwithstanding the frequent charge that the Aldrich Plan was elitist, the bills were similar in providing for democratic governance and local representation.

  The bills were also similar in scope. Each proposed a new agency to become the fiscal arm of the United State government. Each set up a system of bank examinations and check clearing. Willis even mimicked the Aldrich bill’s phraseology.

  Of course, the plans also differed in important respects. The biggest was that Aldrich and Warburg had conceived of “branches” around the country subservient to a central organ. Glass was proposing regional “banks” with greater local independence—although arguably, this was a matter of degree. Another distinction was that Glass-Willis compelled the banks to shift their reserves to the new Reserve Banks, ending the perilous “pyramiding” of reserves from the farm to the city to New York. Aldrich, not wanting to offend his banker colleagues, had been mum on this important point.

  As the Glass legislation evolved, other significant differences would emerge. Willis would contend in his memoir that the Federal Reserve Act was the product of many bills and ideas from which its authors selected, revised, sifted, and so forth. It is true that few transformative ideas emerge from thin air; nonetheless, Willis was on shaky ground in asserting that the Act “was not derived from, or modeled after, or influenced even in the most remote way by other bills or proposals currently put forward.” In fact, the Aldrich Plan was its direct and recognizable forebear. But for political reasons, as well as the desire to inflate their own roles, Glass and Willis each felt compelled to disown the connection to Aldrich.

  • • •

  AS INAUGURATION DAY NEARED, Wilson agonized over whether to give a cabinet role to Bryan; ultimately, he reckoned that Bryan would pose less trouble inside the tent than out. The Commoner was given State—a relief to bankers, whose worst nightmare would have been to see Bryan at the Treasury. Colonel House, who had great influence on the selections, discouraged the inclusion of another corporate critic—Louis Brandeis—probably because Wilson clearly admired Brandeis, and House saw him as a threat. With reluctance, Wilson acquiesced. (House cannily turned down a cabinet role for himself, preferring the offscreen role of adviser at large.)

  The most important slot for banking legislation was Treasury. At the suggestion of House, Wilson made an inspired choice—William Gibbs McAdoo, a businessman and one of the managers of Wilson’s campaign. A southerner—as were over half of Wilson’s choices—McAdoo was born in Georgia, into “bitter poverty” during the Civil War. His family moved to Tennessee, where McAdoo studied law, set up a practice, and invested his meager resources in a venture to electrify streetcar lines in Knoxville (the industry that had led to Nelson Aldrich’s fortune). When the venture failed, he moved to New York. With few resources, and six young children to feed, he attempted to resurrect an abandoned project to dig a rail tunnel under the Hudson River, linking New Jersey and Manhattan. The project faced high hurdles, engineering and financial; improbably, McAdoo succeeded. (The tunnels today serve the heavily trafficked PATH trains to midtown and downtown New York.) Although Morgan provided financing, McAdoo was not a Wall Street insider, and his battles with bankers left him with a jaundiced view of the financial world. He fancied himself a public-service-minded executive and adopted the motto “The public be pleased” (a clever inversion on the infamous saying of the railroad tycoon William Vanderbilt, “The public be damned”). McAdoo’s slogan was certainly calculated to further his political ambitions. But he backed it by operating clean, well-lit cars, instituting a box for customer complaints, and—unusually for that era—paying equal wages to women.

  As a businessman reformer and a southerner to boot, McAdoo was perfect for Wilson. The country had been governed by Republicans for so long that business was unsettled by the prospect of a Democrat; McAdoo was a Democrat whom business could tolerate, while also clearly aligned with progressive ideals. He firmly believed that government should have a say over the economy—not leave it to the moguls with whom he had formerly crossed swords. Wiry with a dark complexion, derby hat, and black suit, he moved with quickness and vitality and, unlike the president-elect, preferred action to theorizing.

  Wilson decided to begin his legislative assault with the tariff, a simpler issue than banking reform. Shortly before he took office, the Sixteenth Amendment (sanctioning an income tax) was ratified; this provided a further rationale for tariff cuts, since Wilson could now seek to replace lost tariff revenue with taxes. However, tariff cuts were a partisan cause, pleasing to the South but perceived as anti-business. Wilson did not want to be seen as a “southern” president. Putting a progressive gloss on his agenda, he made a point, in an address in January to the Southern Society of New York, of rejecting sectionalism.

  Partly for this reason, the Democrats were eager to move on banking reform, which appealed to businesses irrespective of geography. Wilson saw the Glass bill as a program to benefit banking customers, not just the narrow universe of banks. His goal was to unshackle business by establishing new centers of credit. Wilson was also licking his chops over the prospect of bringing Wall Street to heel; he imagined that if the Glass bill was enacted, the new Reserve Banks would level the influence of the New York financial houses. According to Joseph Tumulty, soon to be Wilson’s White House secretary, the president-elect said he wanted “to take away from certain financial interests in the country the power they had unjustly exercised of ‘hazing’ the Democratic Party at every Presidential election.”

  As if another rationale were needed, days before the inauguration Samuel Untermyer submitted the final report of the Money Trust investigation. It was a scorching indictment of the old-boy network that dominated American finance. Untermyer’s relentless cross-examinations and eye-catching charts had documented the web of interlocking directorships that knit Wall Street and corporate America. (Frank Vanderlip testified, to his embarrassment, that he held directorships in thirty-five corporations.) Just as damning, Untermyer proved that competition in securities was a farce. None other than George Baker, Morgan’s friend, supplied the crucial testimony.

  UNTERMYER: Have you ever competed for any securities with Morgan & Co. in the last five years?

  BAKER: I do not know that we have competed with them.

  UNTERMYER: You divide with them, do you not? You give them a part of the issues when you have it?

  BAKER: We are very apt to.

  UNTERMYER: And if they take a security, they give you a part of the issue, do they not?

  BAKER: Yes.

  Untermyer affirmed that a Money Trust did exist—assuming, he wrote in the report’s most quoted section, that the term was taken to mean a “well-defined identity and community of interest between a few leaders of finance which has . . . resulted in a vast and growing concentration of control of money and credit in the hands of a comparatively few men.” Untermyer identified J. P. Morgan, James Stillman, and George Baker as
the “inner circle.” To his credit, he admitted that no conspiracy had been found—no price-fixing or plot. It was enough to say that the Money Trust existed—Wilson and the Democrats rightly regarded even the potential for abuse as serious.

  Public revulsion was nearly uniform; even The Wall Street Journal grudgingly acknowledged that concentration on Wall Street was excessive. The hearings, as much as anything, convinced progressives that banking reform demanded immediate action. The increasingly influential Brandeis further galvanized public opinion with a widely read series, “Breaking the Money Trust,”* which was published in Harper’s Weekly as Congress debated the Glass bill.

  Surprisingly few observers noticed that Untermyer’s description of a trust applied more to securities than to ordinary banking. America, after all, had twenty-five thousand individual banks—roughly half of them founded since 1900. Nor was the industry particularly profitable; net earnings of the national banks totaled only $161 million (about $3.8 billion in today’s money), and a return on assets of less than 2 percent. Moreover, banks in New York City held a smaller share of the country’s banking resources in 1912 than they had in 1900. It is true that within New York, assets were more concentrated than previously, and that the boards of the biggest banks were decidedly cozy. But on balance, conventional banking did not exhibit the cartel pattern of Wall Street. In this sense, the “Money Trust” was merely a convenient label to sell reform to the public.

  Untermyer was on more substantive ground when he attacked the lopsided distribution of power to marshal reserves in a crisis. Regarding the market turmoil of 1907, he bore in on R. H. Thomas, the retired president of the New York Stock Exchange: