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

by Roger Lowenstein

  The Fed’s framers had assumed that the new institution would take its place, with other central banks, in a world in which exchange rates and capital flows were regulated and kept reasonably stable by international gold movements. But after World War I, with Europe hobbled by debts (and in Germany’s case, reparations), this system broke down. Europe’s insolvency put America under a severe strain.

  Strong attempted to navigate these turbulent monetary seas, but his death in 1928 left the Fed without a capable hand at the tiller. The next year, Warburg, who monitored the Fed like an anxious parent, criticized the agency’s weakened leadership for letting stock market operators seize the reins of money creation. He warned that if their “orgies of unrestrained speculation” were permitted to spread—that is, if credit continued to flow to the stock market and to other speculative assets—it would lead to a general depression throughout the country. Three years later, during the depths of the Great Depression, the sixty-four-year-old Warburg died in New York City. The Fed would face the tempestuous 1930s without the cream of its founding generation, and without anyone else of equal caliber.

  The other sojourners to Jekyl Island were, by then, gone from the scene. Harry Davison had remained the dominant partner at Morgan’s, but shifted his focus after the war to philanthropic ideas for reconstruction and relief. In 1922 he succumbed, his grace intact, to a lethal brain tumor. During the war, Piatt Andrew went to Europe and organized an ambulance squadron, the American Field Service, to serve with French divisions at the front. He was awarded the Croix de Guerre from France. In 1920, he was elected to Congress, where he later became a staunch enemy of the New Deal, but the professor was never again influential in banking. Frank Vanderlip, ever the eager international financier, seized on the Federal Reserve Act to build a vast network of overseas lending offices. But he fell out with James Stillman, who did not approve of National City’s expansion, especially when the Russian Revolution led to losses. After the war, Vanderlip became passionately interested in European recovery schemes, to the displeasure of the bank’s directors, who replaced him with Stillman’s son. Two years before his death in 1937, Vanderlip published a memoir in which he recalled the week on Jekyl Island as “the highest pitch of intellectual awareness that I have ever experienced.”

  Nelson Aldrich did not shake his bitterness that Glass’s bill, rather than his, was embraced by the public and enacted by Congress. He clung to his belief that banks should be supervised by bankers—not by government. Improbably, he was hoping for a Republican revival and new legislation when, in April 1915, he died, leaving an estate worth approximately $16 million. Aldrich’s heirs, as if shadowed by the patriarch’s sullied reputation, were more self-conscious aristocrats. His daughter, Abby Aldrich Rockefeller, became a noted collector. Far more progressive than her father, she helped to found the Museum of Modern Art. Her son Nelson, a liberal Republican, was a big-spending governor of New York and vice president of the United States; another of the senator’s grandsons, David Rockefeller, chief executive of Chase Manhattan, was the quintessential banker in the postwar era, when globe-trotting bankers were willing, and subject, partners to government.

  William McAdoo married Wilson’s daughter Eleanor, in a White House ceremony, in the spring of 1914. Since Wilson was counting on McAdoo to shape the Federal Reserve, he refused to accept his son-in-law’s offer to resign. After the war, the ambitious McAdoo left the government and ran, unsuccessfully, for president.

  Colonel House accompanied Wilson to Paris in 1918 to represent the United States in the peace negotiations at Versailles. His eagerness to accede to French and Italian demands, at a time when Wilson was ailing, led to a rift. The two men were never friends again.

  Historians regard Woodrow Wilson’s first term as one of the most successful ever, and the Federal Reserve Act as its crowning achievement. Wilson’s fear that early success would be followed by controversy proved prophetic. In 1916, widowed and already happily remarried, he narrowly won reelection, campaigning on the slogan “He kept us out of war.” A month into his second term, America joined the fight. Full of postwar ideals, Wilson negotiated the Treaty of Versailles and earnestly sought its approval by the Senate. Then he suffered a debilitating stroke. Senator James Reed, beaten by Wilson during the Federal Reserve legislation, helped to thwart his dream of an American-led League of Nations—a bitter disappointment. Wilson died in 1924.

  Carter Glass, who as a junior representative had studied banking in his hotel room at nights, became a Senate authority on finance. He sponsored an amendment to create the Securities and Exchange Commission as a stand-alone agency rather than, as had been proposed, part of the Federal Trade Commission. Thus, he played a pivotal role in the three major financial reforms—the Fed, the SEC, and the Glass-Steagall Act—of the twentieth century. Within the upper chamber, he oversaw the Banking Act of 1935, which strengthened the Reserve Board—the little “capstone” that had once appalled him. The 1935 act divorced the board from the executive branch, removing the Treasury secretary and the comptroller of the currency from the directors’ table, and lengthened terms to fourteen years (all as Vanderlip had proposed in 1913). Otherwise, Glass was a persistent thorn in the New Deal’s side. He remained committed to states’ rights and helped to block federal efforts to lift the poll tax. When he died in 1946, he was the last member of Congress born in the antebellum South. The New York Times eulogized, “He is generally regarded as the father of the Federal Reserve Act.”

  For as long as they lived, the framers fought bitterly over this assessment. Eight of the founding generation wrote memoirs or accounts of the creation of the Federal Reserve. Owen and Glass got into a nasty scrap over who was entitled to the lion’s share of the credit for the bill’s passage. Owen hit the press first, with a slim volume in 1919. He later denounced the Fed, which he said had become a tool of the big banks. Glass was less bothered by Owen than by Charles Seymour, a Yale professor who got access to the files of Colonel House, from which he stitched a sensational narrative, The Intimate Papers of Colonel House, exaggerating House’s role in the Fed’s enactment. Glass’s own memoir, An Adventure in Constructive Finance, published in 1927, devoted nearly fifty pages to refuting Seymour, whose book he termed “an amusing fiction,” and which he did not find amusing at all.

  Glass’s account was highly self-serving, unctuously praising Wilson as the unerring helmsman and leaving no doubt that the honor of realizing Wilson’s program had belonged to Glass. By overstating Wilson’s role, Glass was able to ignore those who had preceded Wilson—and who had preceded Glass. Parker Willis, who wrote an exhaustive, 1,750-page history of the bill, took a more expansive approach, although he also concentrated on the period after he and Glass had begun to draft a bill. Neither Glass nor Willis cited Victor Morawetz—a stinging omission, since Morawetz had been the first to propose a regional banking plan. Even more unkindly, Willis all but ignored his former professor, James Laughlin, to whom he had eagerly turned for advice when he was sketching out a plan in 1912. Willis’s comment on the plan that Laughlin had helpfully supplied when Willis and Glass were preparing to see Wilson was especially uncharitable. “This bill,” he coldly informed posterity, “when received by Mr. Glass was filed with numerous other bills . . . transmitted to the Committee and received the same consideration.”

  Willis reserved his greatest animus for the Aldrich Plan and for its intellectual author, Warburg. Unlike Glass, who came to appreciate the German-born banker despite their disagreements, Willis resented Warburg’s reputation for brilliance and lobbied to keep him off the Reserve Board. In his book, Willis ungraciously characterized Warburg’s role as “simply that of a critic . . . and a critic whose recommendations were not adopted”—a narrow and highly misleading synopsis. Willis also claimed that of all the antecedent bills from which the Federal Reserve Act borrowed, it was least indebted to the Aldrich Plan. Willis managed to make this topsy-turvy assertion even whil
e acknowledging that in drafting the Act, he had made “use of such features of the Aldrich bill as were considered to be desirable or even in various places the use of language drawn from or modeled after the language implied in the Aldrich bill.” In other words, he had copied from it.

  Willis’s book did not provoke a response, at least immediately, but Glass’s did. Samuel Untermyer, whose feud with Glass had never been repaired, quickly responded to excerpts of An Adventure in Constructive Finance with all of his old vinegar, calling it an “interesting work of imagination.” Untermyer said Glass had slighted the contribution of Owen (not a disinterested comment, since he, Untermyer, had worked with Owen in the spring of 1913). Moreover, Untermyer claimed that the Reserve Act was “the direct outcome of the disclosures of the dangerous concentration of the control of money and credits by the Pujo investigating Committee”—of which, of course, Untermyer had been counsel. In other words, Untermyer’s investigation led to the Federal Reserve Act.

  Warburg claimed that Glass’s book inspired him to write his two-volume tome on the Fed’s enactment and early years, The Federal Reserve System. Warburg probably would have written it anyway, but Glass’s book, which Warburg privately referred to as “vicious,” gave Warburg his purpose: he wanted to add historical perspective and balance to the Glass narrative of a Democratic Congress legislating over the will of Republicans and of truculent bankers. Warburg saw the Act—which was the work of Democrats—as the culmination of many previous proposals, including by Republicans and by bankers such as himself. He wanted the Federal Reserve to be seen as one of America’s great monuments—“like the old cathedrals of Europe”—whose preservation would require a national and shared commitment. When Warburg was writing, in the late 1920s, America had lived with the Fed for less than twenty years. If the agency were to survive—by no means assured then, and perhaps not today—it was imperative, he wrote, that it have bipartisan support, and therefore, that it be seen “not as the work of a single party,” but as the product of years of work by people across the spectrum.

  To rebut the notion that financiers had been antagonistic to reform, Warburg emphasized the role of bankers and economists who had instigated the reform discussions arising out of the 1907 Panic. Even in 1913, he rightly pointed out, bankers were hardly the uniformly hostile lobby that Glass depicted, the savage critiques of the American Bankers Association notwithstanding. Most of all, Warburg sought to establish a place of honor for the Aldrich Plan. While Glass portrayed the Aldrich Plan as a counterreform intended to institutionalize the Money Trust and block any genuine reforms, Warburg presented it as an evolutionary step that, in conjunction with the Citizens’ League publicity campaign, prepared the public for eventual legislation.

  Warburg’s book was also self-serving, and his sarcasm betrayed his dislike of Willis and of Glass. However, he presented his case as perhaps only he could, methodically setting forth the Aldrich bill and, on facing pages, the Reserve Act. This “juxtaposition of texts,” which stretched to over two hundred pages including explanatory comment, demonstrated, even to Glass’s admirers, that the Aldrich bill was the nearest ancestor to the Glass-Owen bill. Milton Friedman and Anna Schwartz would call the bills “identical in many details” and “very similar in general structure.” It is doubtful that the Reserve Act would have passed without Wilson’s leadership or Glass’s tenacity, but it would have looked quite different without the Aldrich bill, which itself sprang from Congress’s idea (in hindsight, an inspired one) of creating a commission to study reform. The Aldrich trip to Europe was vital because the models for central banking came from Europe. Warburg supplied the intellectual rigor. Having traced the failings of American banking to the country’s phobia of centralization, he labored unceasingly to cure it. Warburg was the anti-Jackson. But as Warburg acknowledged, there were many theorists and contributors besides himself. Asked once about the identity of the Fed’s “father,” he replied that he didn’t know, but that judging from the number of men who claimed the honor, “its mother must have been a most immoral woman.”

  As the joke implied, the Fed’s parentage was mixed. It drew from both American traditions, Hamiltonian and Jacksonian. Some said the banks got all they wanted—that, in effect, the Money Trust won out. But they did not get control of the Reseve Board, and that was a very great concession. For National City to submit to Washington, in so many particulars and regulatory details, was more than it had ever done before. Control was to be shared—private or quasi-private banks but a government board. Similarly, the organization was split—Federal on top, regional below. The character of the money was also a compromise. The essential bargain was to respect the federalist character of American politics while overcoming its fierce resistance to centralization.

  The Federal Reserve Act did not guarantee sound monetary policy any more than the establishment of Congress could guarantee good laws. Policy would be the burden of those in power—as disputatious today as in 1913. However, the Act unified the banking system, which unquestionably made it stronger. It created an institution for regulating the money supply, a difficult task but a necessary one for societies too advanced to depend on the vagaries of mining gold. It provided flexibility to respond to financial shocks and economic headwinds and thus made the system more resilient. It was an imperfect bill—nonetheless, after a decade of debate, division, panic, study, conspiracy, party platforms, elections, and legislative work, it was a highly worthy achievement.

  From the time he entered the Senate in 1881, Nelson W. Aldrich was a bastion of conservatism and a stout defender of the decentralized Civil War banking structure. His cool exterior masked a melancholy nature and a yearning to leave his mark.

  Senator Nelson W. Aldrich. Unknown, n.d. Albumen print photograph. Graphics. Anonymous. RHI X17 141.

  William Jennings Bryan, depicted soon after his stirring “cross of gold” speech at the 1896 Democratic convention, lost the election but won the support of farmers and working-class Americans who thought the banking system favored the wealthy. Wall Street regarded him with contempt.

  Carter Glass, the son of a Confederate soldier reared on the gospel of states’ rights, was determined to reform the banking system without creating a dread “central bank.”

  The young financier Paul Warburg moved to America in 1902 and joined his in-laws’ firm on Wall Street. He was horrified by the primitive condition of American banking and passionately crusaded for a system of centralized reserves like the one he had left behind in Germany.

  The onetime farm boy Frank Vanderlip, heir apparent at National City Bank of New York, was upset that reserves were siphoned off to the countryside at harvest season, depleting metropolitan areas of funds. He agreed with Warburg that America needed a central bank.

  Although Democrats opposed a national bank, the young president of Princeton University, Woodrow Wilson, had written favorably of Alexander Hamilton’s original experiment and was sympathetic to the cause of reform.

  During the Panic of 1907, one man—J. P. Morgan, shown beside an ornamental vase in his library—fulfilled the role of “lender of last resort,” which in other nations was played by the central bank

  Even Morgan’s efforts were not enough, as this scene from the Panic of 1907 demonstrates. Despite the efforts of Morgan and his colleagues to organize loans, banks around the country ran out of money and had to circulate scrip.

  In 1908, the Harvard professor Piatt Andrew (shown at his home in Gloucester, Massachusetts) guided Aldrich and other members of the National Monetary Commission on a tour of Europe, studying central banking operations in London, Berlin, and Paris.

  In Europe, Aldrich did an about-face and became convinced of the need for a central bank.

  The rising progressive movement trained its sights on one villain in particular: Nelson Aldrich. In this political cartoon, typical of the era, Aldrich is depicted as a spider trapping needed reform efforts in its web.
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  Desperate to enact a reform while the Republicans still held power, Aldrich absconded to remote Jekyll Island in Georgia with Piatt Andrew and three leading Wall Street bankers. Working in absolute secrecy in this still-standing clubhouse, the conspirators drafted the Aldrich Plan.

  During the week at Jekyll Island, tension simmered between Aldrich and Warburg. The light touch of Henry P. (Harry) Davison cooled them down.

  By the time William Howard Taft succeeded his good friend Theodore Roosevelt as president, the growing strain in their relationship was visible in their mutually stiff poses. Roosevelt’s ultimate break with Taft cleaved the Republican Party in two and dealt a fatal blow to the Aldrich Plan.

  The political operator Edward M. House, known by the honorific “Colonel,” dedicated himself to making Wilson president. His first task was winning the endorsement of William Jennings Bryan.

  Inauguration day, March 4, 1913. Wilson pledged to reform the banking system, but he reassured bankers that he would “restore” rather than “destroy.”

  Treasury Secretary William G. McAdoo—businessman, progressive, and southerner—epitomized the new administration. He boldly proposed his own banking plan, putting Glass’s Federal Reserve bill in jeopardy.