A History of Money and Banking in the United States: The Colonial Era to World War II

by Murray N. Rothbard

  The defeat of the Democrats in November was a referendum on World War I, its aftermath, and the inflation and rationing of wartime, rather than against Houston, but Meyer used the victory to step up attacks on Secretary Houston. Organizing a nationwide campaign of demagogy, stressing especially the plight of the cotton farmer, Meyer personalized his assault on Houston’s stalwart laissez-faire views. Combining hyperbole with alliteration, Meyer roasted Houston before the Joint Agricultural Committee of Congress. Meyer thundered,

  History records no precedent... for the wholesale sacrifices imposed upon the civilized world by the Secretary’s [Houston’s] present policies for the purpose of maintaining the petty platitudes of the outworn political economy which he professes.33

  Congress duly passed the measure to revive the export lending of the WFC. When Wilson followed Houston’s advice to veto the measure, asking Houston himself to write the veto message in December, Congress easily overrode the veto.

  During the interregnum, Meyer and his friends angled for top jobs for him with the new Harding administration, but with Treasury and commerce closed off, Meyer turned down the post of assistant secretary of commerce under Herbert Hoover, correctly expecting Congress to re-enact the WFC. The new president duly reappointed Meyer to be head of the revived WFC, refurbished as an agricultural export aid bureau. In fact, exports were largely forgotten as the WFC was transformed into a simple agricultural relief agency. Under Meyer’s aegis, and supported by Harding, Congress passed the Agricultural Credits Act of 1921, which increased the maximum authorized credits by the War Finance Corporation to $1 billion, and permitted it to lend directly to farmers’ cooperatives and foreign importers, as well as exporters.

  Meyer plunged in with a will, heavily financing farm coops, enabling them to buy and store crops, thereby raising farm prices, and presaging the more directly governmental farm price support policies of the Hoover and Roosevelt administrations. The WFC’s first loan was to Aaron Sapiro’s Staple Cotton Cooperative Association. Sapiro was a high-priced young attorney for several California farm co-ops who concocted grandiose plans for voluntary price-raising cartels in cotton, wheat, tobacco, and other crops, all of which turned out to be failures.34 By the summer of 1923, the WFC had loaned $172 million to farm co-ops and another $182 million to rural banks, which in turn loaned money to farmers. The WFC, working closely with farm bloc leaders, appointed a Corn Belt Advisory Committee of farm leaders to pressure Midwestern rural bankers into lending more heavily to farmers in that region.

  With banks providing a steady flow of short-term farm loans, and a vast Federal Farm Loan system, established in July 1916, supplying plentiful mortgage loans, the farm bloc still felt a gap in unsubsidized intermediate-term credit. Meyer and the co-op interests duly introduced a bill into Congress calling for a system of privately capitalized agricultural credit corporations, with the Federal Reserve empowered to extend credits and support these corporations. But the farm bloc, supported by Secretary of Commerce Hoover and Secretary of Agriculture Henry C. Wallace, went further, backing a competing bill establishing a large governmentally capitalized system of Federal Intermediate Credit Banks, patterned after the Federal Reserve System and governed by the Federal Farm Loan Board (FFLB), which had already been established to run the Farm Loan System. Congress passed both bills in one Agricultural Credits Act of 1923 in the summer of that year, but the Meyer system was in effect a dead letter; how could a privately financed albeit subsidized credit system compete with one financed by the U.S. Treasury?

  With WFC duties now assumed by the new Federal Intermediate Credit system, Eugene Meyer allowed the War Finance Corporation’s authority to make loans expire at the end of 1924. The WFC lingered on with no duties for five years, until Congress finally liquidated it in 1929. Meyer was cheerful about its demise, however, because he was able to use the virtually defunct post to meddle in, and eventually take over, the now-powerful Federal Farm Loan Board (FFLB). Meyer assumed control of the FFLB in March 1927, and continued to run it until the advent of the Hoover administration two years later.35 His lengthy record in charge of inflationary government lending, in addition to his service in helping swing the New York Republican delegation to Hoover at the Republican convention of 1928, made Eugene Meyer eminently qualified to be Hoover’s new governor of the Federal Reserve Board in the autumn of 1930.

  MEYER IN THE HOOVER ADMINISTRATION

  In the midst of a German and the American bank crises, and a growing depression, Eugene Meyer battled the totally Morgan-run New York Fed for dominance over the Federal Reserve System. The Morgans were even more interested than Meyer in bailing out the European banking systems. In late June 1931, the New York Fed agreed to participate with the Bank of England, the Bank of France, and the Bank for International Settlements in a $100 million loan to try to bail out the German Reichsbank. Soon the Germans were asking for $500 million more to save their banking system. While Harrison was sympathetic, Meyer and the other bankers felt this was too much of a long-term commitment. The German government then asked the Fed, not only for the extra loan, but also for a reassuring statement—clearly mendacious—hailing the “fundamental soundness” of the German economy. Happening to be in New York in the midst of this German crisis on the weekend of July 12, Meyer found out by accident of a secret meeting at the New York Fed on the crisis with the top Morgan people in the administration, including Morgan partners Russell Leffingwell and S. Parker Gilbert; Albert Wiggin, head of the Morgan-run Chase National Bank; Acting Treasury Secretary Ogden Mills; Owen D. Young, chairman of the Morgan-run General Electric, and from the New York Fed, Governor George Harrison and Deputy Governor W. Randolph Burgess. The meeting had already persuaded President Hoover to issue a statement of sympathy for the German situation. Meyer, at this point, went ballistic, insisting that the president’s statement, backed by a meeting of top banking worthies, would be taken by the Germans as well as everyone else as a “moral commitment to help the Germans,” which would either lead to a disastrous blank-check support for German finance, or would make matters worse when that support was repudiated. Meyer also insisted that only the Federal Reserve Board in Washington could legally commit the Fed to such action. By his last-minute intervention, Meyer was fortunately able to block the Morgan cabal from getting Hoover to make the public endorsement. The following week, Hoover, aided by veteran Morgan-oriented lawyer and Secretary of State Henry L. Stimson, agitated again for direct loans to Germany, but Meyer was able to confine Hoover to engineering a Meyer-approved big power “standstill agreement” by which banks throughout the major countries of the world would continue to hold German and other Central European short-term debts without trying to get out of German marks and other shaky currencies of that region.

  Generally, Meyer was able to overrule Harrison. Thus, when gold flowed out of U.S. banks after Britain’s disastrous abandonment of the gold standard in late September, Meyer was able to force Harrison—wedded to cheap money—to raise the New York Fed’s discount rate from 1.5 percent to 3.5 percent in October, thereby reversing the gold drain by raising market confidence in the dollar.36

  By early September 1931, even before Britain’s abandonment of the gold standard, President Hoover, Eugene Meyer, and the nation’s financial establishment all agreed that America required a massive infusion of more money and credit, under the direction of the federal government. There was one difference: whereas Meyer and the bankers wanted a revival of the War Finance Corporation for government to pour in the new money directly, Hoover first wanted to try a dab of his characteristic government-business partnership to encourage private bankers to contribute the necessary hundreds of millions of dollars to a federal agency. Hoover set up his National Credit Corporation (NCC) to attract $500 million from the banks in order to shore up shaky individual banks. But when the National Credit Corporation was only able to raise $150 million, Hoover quickly and cheerfully threw in the towel, and by the end of November, agreed to introduce a
bill into Congress to revive the old WFC and expand it for peacetime uses into a new Reconstruction Finance Corporation (RFC).37

  The RFC bill, which sailed through Congress by late January 1932, provided for the Treasury to pour $500 million of capital into the Reconstruction Finance Corporation, which was empowered to issue securities up to an additional $1.5 billion. The RFC could make loans to banks and financial institutions of all types. The theory was that, ensured of freedom from failing, the timid banks would be emboldened to lend massively to business and industry, the money supply would dramatically rise, and prosperity would return. This was the doctrine trumpeted by President Hoover, Meyer, Mills, and Undersecretary of the Treasury Arthur A. Ballantine, a partner of the law firm headed by longtime Morgan attorney Elihu Root. Unsurprisingly, the representatives of groups expecting a massive infusion of federal money—commercial banks, savings banks, life insurance companies, and building and loan (in later years, savings and loan) associations—testifying before Congress “all praised the [RFC] bill in glowing terms, claiming that it was essential to the survival of the money market.” In addition, the RFC was empowered to lend money to railroads, in order to relieve their indebtedness and revivify the railroad bond market. The railroad representatives were also delighted with the bill.

  Hoover’s original bill was even more sweeping, also allowing the RFC to make business loans to “bona fide institutions,” but the Senate Democrats, suspicious of excessive executive power over business, killed this proposal. The Senate Democrats also reportedly extracted a promise from Hoover to make the beloved Eugene Meyer chairman of the new RFC. Meyer, doing double duty as governor of the Federal Reserve Board and head of the RFC, was now the most powerful single economic and financial force in the federal government.

  The RFC, at the Democrats’ insistence, was to have a board of directors consisting of four Republicans and three Democrats. Three of the Republicans were the ex officio heads of the Federal Reserve Board (Chairman Meyer), the secretary of the Treasury (Ogden Mills, who had replaced Mellon in January), and of the Federal Farm Loan Board (Paul Bestor, Meyer’s protégé and successor). The fourth Republican appointee was former Vice President Charles G. Dawes, a Chicago railroad man in the Morgan ambit.

  The RFC was not only patterned after the old War Finance Corporation in philosophy, but also aped its organizational structure and took over many of the WFC’s actual personnel. The general counsel, and the three top examiners, of the WFC happily took up their old posts, while the first secretary of the RFC was George Cooksey, a former director of the WFC who had been a member of that outfit’s remarkably leisurely liquidation committee from 1929 until he assumed his new position in the RFC. Like the War Finance Corporation, the RFC established eight divisions, as well as 33 local loan agencies.

  Each of these loan agencies established an advisory committee consisting of the leading local bankers to scrutinize and pass on loan applications. This arrangement placed tremendous political and financial power into the hands of local bankers armed with federal power. Moreover, the Reconstruction Finance Corporation was not required to reveal the names of borrowers or the amounts of its loans to Congress or to the public. A tremendous political and economic power was thus placed in the RFC and bankers associated with it. Even progressive Senator George Norris of Nebraska lamented that he had never envisioned “putting the government into business as far as this bill would put it.”

  Hoover and his associates rationalized this power as being a temporary necessity to handle an emergency, supposedly much like World War I, when the prototype of the RFC had been established. Thus, Hoover repeatedly spoke of fighting the depression as the equivalent of fighting a war:

  We are engaged in a fight upon a hundred fronts just as positive, just as definite, and requiring just as greatly the moral courage, the organized action, the unity of strength, and the sense of devotion in every community as in war.

  Eugene Meyer spoke repeatedly in military metaphors, and Secretary Mills spoke of the “great war against depression... being fought on many fronts,” especially the “long battle... to carry our financial structure through the worldwide collapse.”

  And so too did business and financial leaders rationalize their hasty embrace of collectivism in the Reconstruction Finance Corporation. An illuminating article in the Magazine of Wall Street, summarizing the congressional debate over the RFC bill, noted that big business, “always complaining of public intervention in economic matters,” was now beating the drums for intervention, the RFC being supported by big bankers, industrialists, and railroad presidents. The article added:

  The answer made by representatives of business to the charge of socialism is that in all great emergencies, war for example, governments have always thrown themselves into the breach, because only they can organize and mobilize the whole strength of the nation. In war every country becomes practically a dictatorship and every man’s resources are at its command; the country is now in an equally great emergency.38

  The RFC certainly paid off for these favored business groups. The excuse for the secrecy was that public confidence would be weakened if the identity of the shaky business or bank receiving RFC loans became widely known. But of course these institutions, precisely because they were in weak and unsound shape, deserved to lose public confidence, and the sooner the better both for the public and for the health of the economy, which required the rapid liquidation of unsound investments and institutions. During the first five months of operation, from February to June 1932, the RFC made $1 billion of loans, of which 60 percent went to banks and 25 percent to railroads. The theory was that railroad bonds must be protected, since many of these securities were held by savings banks and insurance companies, alleged agents of the small investor. In practice, the bulk of these RFC railroad loans went to repaying debt. About a third of these loans went to repaying railroad debts to banks. Thus, one of the first RFC loans was $5.75 million to the Missouri Pacific Railroad to repay its debt to J.P. Morgan and Company, and an $8 million loan to the B and O Railroad to repay its debt to Kuhn, Loeb and Company. One of the main enthusiasts for this policy was Eugene Meyer, who touted it as “promoting recovery” by “putting more money into the banks.” It certainly did the latter, at the expense of the taxpayers and of propping up inefficient banks and businesses. The loan to Missouri Pacific was a particularly egregious case, for as soon as Missouri Pacific performed its task of repaying its debt to Morgan, it was gently allowed to go into bankruptcy.

  Another consequence of RFC bailout loans to railroads was to accelerate the socialization of the railroad industry, since the RFC, as a large-scale creditor, was able to place government directors on the board of the railroads reorganized after bank-ruptcy.39

  While the Democrats in Congress had their way after August in forcing the RFC to report to Congress on its loans, President Hoover had his way in finally persuading Congress to transform the RFC into a bold, “positive” agency empowered to make new loans, to engage in capital loans, to finance sales of agriculture at home and abroad, and to make loans to states and cities, instead of being merely an agency defending indebted banks and railroads. This amendment to the RFC Act, the Emergency Relief and Construction Act of 1932, passed Congress at the end of July, and increased the RFC’s authorized capital to $3.4 billion. Eugene Meyer, suffering from exhaustion, persuaded Hoover to include, in the amended bill, the separation of the ex officio members from the RFC. But Meyer’s double-duty work was greatly appreciated by Felix Frankfurter, soon to be one of the major gurus of the Roosevelt New Deal. Frankfurter telegraphed Meyer’s wife that “Gene... has been the only brave and effective leader in [the Hoover] administration in dealing with depression.”40

  Free-market financial writer John T. Flynn had a very different assessment of the year of the Hoover-Meyer Reconstruction Finance Corporation. Flynn pointed out that RFC loans only prolonged the depression by maintaining the level of debt. Income “must be freed for purchasing b
y the extinguishment of excessive debts.... Any attempt to... save the weaker debtors necessarily prolongs the depression.” Railroads should not be hampered from going into the “inevitable curative process” of bankruptcy.41

  In the meantime, Eugene Meyer was promoting more inflationary damage as governor of the Federal Reserve. Meyer managed to persuade both Hoover and Virginia conservative Carter Glass, leading Democrat on the Senate Banking Committee, to push through the Glass-Steagall Act at the end of February, which allowed the Fed to use U.S. government securities in addition to gold as collateral for Federal Reserve notes, which were of course still redeemable in gold.42 This act enabled the Federal Reserve to greatly expand credit and to lower interest rates. The Fed promptly went into an enormous binge of buying government securities, unprecedented at the time. The Fed purchased $1.1 billion of government securities from the end of February to the end of July, raising its holdings to $1.8 billion. Part of the reason for these vast open market operations was to help finance the then-huge federal deficit of $3 billion during fiscal year 1932.