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

by Roger Lowenstein

  If Warburg’s view was predictably double-edged, Frank Vanderlip’s was maddeningly inconsistent. In midsummer, heading into an uncertain harvest, the head of America’s largest bank had publicly warned Glass that the bill’s weaknesses were such that it would be better not to have a bill at all; in the fall, as money market conditions eased, his mood improved. By late September, Vanderlip was confessing to James Stillman, “The more consideration I give to the currency bill, the more I am inclined to believe that we need not be frightened [of it].”

  With bankers’ opinions scattered and shifting, the industry could do little to break the impasse in the Senate Banking Committee. Inevitably, the responsibility defaulted to the President. Ellen Wilson had remained in Cornish through the Indian summer, and in that era, when long-distance telephoning was a luxury, even the First Family communicated via the mail. Wilson tried to reassure his fretful wife not to worry about the bill or its effect on him—“Don’t be anxious about me,” read one typical passage. Ellen, often depressed, disregarded him and inquired about the flood of worrisome news stories. Wilson was more candid with his friend Mary Peck, to whom he wrote in late September, “The struggle goes on down here without intermission. Why it should be a struggle is hard (cynicism put on one side) to say.” Frustrated by the committee’s refusal to act, the idealistic Wilson wondered why “public men” should have to be led “to what all the country knows to be their duty.”

  Once again, he moved on the tariff first. The President leaned full bore on the Senate, which (remarkably) approved more drastic cuts than the House. On October 3, using two gold pens, Wilson signed the Revenue Act of 1913, sharply reducing tariff rates from the Aldrich tariff of 1909. The measure also instituted an income tax of 1 percent above $4,000 and steeper rates on higher incomes. Secretary of Agriculture David Houston could scarcely believe it. “A progressive income tax!” he noted with astonishment. “I did not much think we should live to see these things.” Vanderlip offered the jaundiced, and accurate, prophecy that the income tax would be “extremely annoying. The machinery of collection will make it as unpopular as the tax itself.”

  A cornerstone in the progressive agenda, the income tax was a harbinger of the coming era of big government. However, to Americans of the day, few of whom reached the threshold of taxation, the tariff cuts seemed more epochal.* For Wilson, who had always regarded the tariff as a burden on ordinary citizens to benefit northern manufacturers, the legislation fulfilled a long-standing dream. Yet the reform, he felt, would not be complete until Congress also reformed the banking system. Even at the White House signing ceremony, the President was mindful of unfinished business. “So I feel tonight,” he offered poetically, “like a man who is lodging happily in the inn which lies half way along the journey.”

  Intent on cracking the whip over the Banking Committee, Wilson tabled plans for an extended vacation with Ellen in New Hampshire and put off a visit to Panama, where the American canal was nearing completion. Nor, he insisted, would he allow Congress to recess before the Senate dealt with Glass-Owen. Congress was still in the “special session” that had started in the spring. The regular session would begin on December 1. Wilson was adamant that the Senate give him a proper banking bill before that date, so he could then shift his focus to antitrust reform. But the opposition would not be quieted.

  When the ABA held its annual convention in Boston, on October 8, some two thousand delegates ratified the criticisms drafted in Chicago and denounced Glass-Owen as “socialistic.” A week later, Senator Nelson Aldrich emerged from the obscurity of his retirement and savaged the bill as a triumph of “Bryanism.” Wilson could ignore Aldrich but the President was furious at the ABA. His mounting stack of mail—which he eagerly showed to visitors—was running heavily in support of the legislation. Both the Merchants’ Association of New York and the U.S. Chamber of Commerce endorsed Glass-Owen early in October, suggesting that business was also on board. Wilson believed that the banks were trying to “poison” an otherwise favorable climate. Even though his suspicions had an element of truth, the industry was neither so united nor so calculating. America had more than 25,000 banks of various classes—some were opposed, some criticized Glass-Owen in the hope of landing a better deal, and some supported it.

  Wilson next threatened to take the bill to a party caucus, essentially forcing the measure on Democrats in the Senate as he had in the House. However, given the strong opposition from Democratic senators, that step was problematic.* It also would guarantee the enmity of every Republican. The President then floated, as a trial balloon, the possibility of squeezing the refusenik senators by campaigning directly in their home states. But he realized he could not afford to alienate the Senate. He protested, a bit too loudly, to the Washington Post, “I never said any such thing. It is contrary to both my thought and character.”

  With the administration momentarily flummoxed, Treasury Secretary McAdoo invited Owen, the Senate Banking Committee chairman, aboard a revenue cutter, one of the armed ships then operated by the Treasury Department to enforce customs duties. Over two days, they anchored on the Potomac and talked strategy. On October 16, after the secretary had regrouped with his boss, Wilson unveiled a softer approach, inviting O’Gorman, Reed, and Hitchcock to separate conclaves at the White House.

  Each of the three holdouts was a first-term senator with distinct reasons for defying the President. Hitchcock was a Nebraska rival to Bryan and the publisher of the influential Omaha World-Herald. He was fiercely independent, having abandoned the Republican Party of his father (who had also been a U.S. senator). He was not a man to bow to a president, and as a director of several Nebraska banks, Hitchcock genuinely preferred a central bank to the dozen Reserve Banks in Glass-Owen. O’Gorman’s resistance was a matter of politics. A former New York judge, O’Gorman was an ally of Tammany Hall and eager to deliver the clubhouse its share of federal appointments. Wilson had seemingly slighted his need for patronage and was disdainful toward the machine, which had set O’Gorman against him. Reed, a former mayor of Kansas City, was opposed to Glass-Owen from the other political extreme—that is, he hewed to the Jacksonian tradition of opposition to any form of banking combination. Reed was a skillful speaker and a hard drinker who despised Wilson’s self-righteousness. He styled himself a maverick but was contentious for its own sake, a point suggested by H. L. Mencken’s later tribute: “The stature of such a man as Reed is not to be counted by his successes. The important thing is that he fights.”

  After the three renegades left the White House, Reed told reporters that for Glass-Owen to win the committee’s support it would have to undergo drastic alteration. However, the tone of the resistance softened. Over the next several days, Reed and O’Gorman each delivered more encouraging remarks (Hitchcock was immovable). Wilson offered an olive branch by suggesting that he might be willing to compromise with proponents of a central bank by modestly reducing the number of Reserve Banks.

  This more hopeful climate was shattered in less than an hour. On October 23, Vanderlip, the impulsive steward of National City Bank, appeared before the committee and dropped the equivalent of a bomb by proposing a radically different plan.

  The genesis of Vanderlip’s proposal was an appearance at the committee earlier in October. It is notable that, in his first testimony, although he found fault with various technical features of the bill, such as the vagueness of its definition of the powers of the Federal Reserve Board, he was supportive overall. He testified that the legislation would rechannel into ordinary commerce millions of dollars that were currently tied up in the stock market; moreover, he stated that the new Reserve Banks, with their ability to manipulate interest rates, would give the United States newfound power to discourage the flight of gold. Privately, he expressed himself more forcefully and more candidly: the prospect of lower reserve requirements, he wrote unblushingly to Stillman, would liberate National City from having to tie up so much of its capital, and
thus permit it to aggressively expand. While Vanderlip’s public testimony was more circumspect, it jarred some of the members into rethinking the legislation. In an illuminating exchange, Joseph Bristow, a Kansas progressive, asked whether he would advise amending Glass-Owen so that farm mortgages could be discounted for reserve notes. Positively not, Vanderlip replied, elaborating that it was a mistake to think of banks as (merely) creditors. “Banks,” he averred, “are the great debtors of the country.” To be sure of satisfying their depositors, their assets had to be in liquid form. This is why the bill stipulated ninety-day commercial loans as eligible for discount. Mortgages, being the least liquid paper, could not be readily converted into cash. Vanderlip’s insight was validated nearly a century later: modern investment bankers created an entire industry out of converting mortgages into tradable and supposedly liquid securities, but during the 2008 meltdown, these wizards discovered that mortgages were not so liquid as they had imagined. Committee members in 1913 could not have known that, but Vanderlip’s superior understanding left them dazzled.

  After the hearing, O’Gorman and Hitchcock approached Vanderlip with the germ of an idea: Would he consider drawing up a new plan with a unitary central bank, owned by the government? The point of such a plan would be to appeal, simultaneously, to two political extremes. Democrats, progressives, and other traditional opponents of a central bank might be able to stomach such a body if control rested in public hands, and bankers might be willing to yield on control if the country were to create a centralized institution, on a par with those in Europe.

  Vanderlip’s initial reaction was dubious—he did not think credit decisions should be left to the government. However, he agreed to consider it. After mulling the idea for a couple of days, he heartily embraced it. Like others before him, he seems to have become seduced by the prospect of authoring a banking reform, and let vanity cloud his judgment. In any case, he eagerly wrote to Stillman on October 10, “If the legislation is perfected along the lines that I now feel confident it can be, the City Bank will for the first time begin to reap true benefit from its great capital.”

  Vanderlip then called Harry Davison, the congenial Morgan banker who had proved so useful on Jekyl Island (Warburg, who was about to board a liner home from Hamburg, was unavailable), and also Ben Strong, one of the more incisive thinkers in the industry. Very quickly, and with a hint of renewed conspiracy, the trio got to work. Vanderlip reported to Stillman:

  They came to my rooms in the Plaza and we deserted all meetings or telephone calls. The result was the creation of a plan that seemed to us of very great value; one that would meet every economic principle, that could be accepted by bankers, so far as control is concerned, and that still was ingenious enough to have met the tenets of the Democratic Party and the political exigencies of the day.

  Vanderlip’s optimism was misplaced. The Democratic Party platform, of course, proscribed the establishment of a central bank. Also, by eliminating the Reserve Banks, the plan would do away with the one organizational layer that was to have been run by bankers—a change unlikely to appeal to the industry.

  Nevertheless, Vanderlip, now intoxicated by his mission, eagerly decamped for Washington, his two confreres in tow. They put up at the Army and Navy Club, where Senator O’Gorman resided. Vanderlip corralled O’Gorman, telling him he had the requested plan. However, the senator denied having asked for a plan. Presumably, he had had second thoughts about confronting the President so publicly. He suggested that Vanderlip present the plan as his own.

  So, a fortnight after his first appearance, the National City president returned to the committee room. He now proposed a central bank with twelve branches, wholly controlled by the federal government and (to appeal to progressives) its stock held by the public. The bait for bankers was that the plan included fewer compulsory features and, of course, it was more centralized. Vanderlip’s most sensible idea was to drop the three cabinet officials from the Reserve Board, which would then be composed of seven members nominated by the president, upon the “advice and consent” of the Senate—and for terms of fourteen years rather than eight. These changes would lessen the president’s control, tending to a less political and more professional body.

  Republicans and the three renegade Democrats immediately endorsed his plan. No one on the committee seemed to notice that Vanderlip’s proposal represented a complete about-face from his previous, fervent denunciations of government control.* No matter, the Vanderlip plan suddenly had eight votes on the Banking Committee, versus four for Glass-Owen.

  Vanderlip now wrote to Wilson, immodestly suggesting that his plan was “quite along the lines of your own thoughts, as I understand them.” He offered to call on the President, along with Davison and Strong, “to more fully explain” it.

  Wilson was stunned. There was no chance, he knew, that the House would endorse a central bank. The Democrats remained the party of Jackson. Moreover, the process was too far along to contemplate such a drastic revision. The President had completely lost patience with the big banks, and his reply was curt:

  I am at a loss to understand how you can have come to think of the bank plan which you proposed to the [committee] yesterday as “being along the lines of my own thought.” It is so far from being along the lines of my thought in this matter that it would be quite useless for me to discuss it with you and Mr. Davison and Mr. Strong.

  Wilson reaffirmed his support for all the essentials of Glass-Owen and summoned the Senate Democratic leaders to the White House. His message was succinct: he would not let bankers dictate policy. Not for the first time, Vanderlip had overplayed his hand.*

  Because the committee was unwilling to report a central bank against the wishes of the President, the members met in daily session, testing proposals to see if anything stuck. The Republicans voted in a block, so the rebellious Democrats acted as swing votes. Owen tried to cobble together a majority, and Wilson coordinated with Senate leaders, but they were clearly on the defensive. At the end of October, they suffered a defeat when the committee cut the number of Reserve Banks to only four (specifying New York, Chicago, St. Louis, and San Francisco). This was a fair-sized step toward a central bank, and unacceptable to Wilson or to Democrats in the House, since it would rob the system of its federal character. Similarly, the committee, over Owen and Wilson’s objections, swung toward the Vanderlip notion of offering stock in the Reserve Banks to the public rather than to banks.

  Wilson agreed to drop the secretary of agriculture and the comptroller of the currency from the Reserve Board but insisted that the Treasury secretary remain. This reflected the President’s desire to have McAdoo, a trusted confidant (he then was courting Wilson’s youngest daughter, who was a quarter of a century younger), oversee the Fed once it got going.

  The President saw the contest as a power struggle from which retreat would be disastrous. In his prior career as an academician, he had admired the way leaders in the British Parliament commanded loyalty from the party; the American chief executive, he believed, was entitled to no less. He tended to react personally to disagreement, and having made up his mind, he viewed dissension from Democrats as disloyal.

  Outside the halls of Congress, support for the administration bill continued to grow. Many bankers, fearful that the chaos in the Senate Banking Committee could leave the country with no reform at all, rallied to Glass-Owen. Wade, the St. Louis banker who in September had called the bill “repulsive,” now did a complete flip. He was sure, he wrote reassuringly to Wilson, that the American people would not support a central bank. Glass-Owen was the only shot. Soon after, Glass debated Vanderlip at the Hotel Astor in New York, a gala event before eleven hundred people “gay with fashion and beauty.” Glass seemed to get the better of it. Vanderlip trashed the bill and pouted over the President’s refusal to see him; Glass’s defense of a regional system resonated with the high-toned crowd, many of whom were bankers.

  Wilson and Glas
s got a further boost on election day: Democratic victories in New Jersey, Maryland, and Massachusetts were seen as a ratification of the first-year president. Just as important, New York City’s Democratic slate—handpicked by Tammany—was trounced. This weakened Senator O’Gorman’s base, lessening his inclination to challenge the President. Indeed, O’Gorman immediately began to vote on the administration’s side in the committee. Reed also began to waver. If O’Gorman was intimidated from further opposition, Link suggested, Reed was satisfied with his. Quietly, he abandoned the fight. Just days after the November 4 balloting, the committee (with the help of one Republican) reversed its previous action reducing the number of reserve banks.

  Only Hitchcock continued to hold out. The senator bridled at Wilson’s efforts to meddle in the committee and refused to be either persuaded or pushed. Hitchcock’s implacable stance left the committee, in mid-November, firmly deadlocked at 6 votes to 6. The panel ruptured, its two factions now convening separately.

  Vanderlip went on a speaking tour and boldly predicted that no legislation would be enacted until 1914, when he hoped a consensus would favor his plan. While he distanced himself from the Glass-Owen camp, Warburg, having just returned from Europe, avidly engaged the committee. Predictably, his energies were focused on making Glass-Owen more centralized by eliminating some of the Reserve Banks. Warburg’s evolving concern reflected his appreciation of the still vast distances that separated American cities in the era before commercial aviation. He envisioned that a dozen Reserve Banks would be uncoordinated and, in some cases, undercapitalized. (The total capital of all national banks was only $1 billion, heavily concentrated in the Northeast.) Moreover, Washington itself was a provincial capital and anything but a commercial center. Warburg favored establishing pillars of banking in a few major cities rather than entrust the system to, as he put it, “a set of men who are out of touch with the daily business of the county, and situated at Washington.”