The Creation of the Federal Reserve—1907 to 1913
The second of the currency war antecedents was the creation of the Federal Reserve System in 1913. That story has antecedents of its own, and for those one must look back even further, to the Panic of 1907. This panic began amid a failed attempt by several New York banks, including one of its largest, the Knickerbocker Trust, to corner the copper market. When Knickerbocker’s involvement in the scheme came to light, a classic run on the bank commenced. If the Knickerbocker revelations had occurred in calmer markets, they might not have triggered such a panicked response, but the market was already nervous and volatile after massive losses caused by the 1906 San Francisco earthquake.
The failure of the Knickerbocker Trust was just the beginning of a more general loss of confidence, which led to another stock market crash, even further bank runs, and finally a full-scale liquidity crisis and threat to the stability of the financial system as a whole. This threat was stemmed only by collective action of the leading bankers of the day in the form of a private financial rescue organized by J. P. Morgan. In one of the most famous episodes in U.S. financial history, Morgan summoned the financiers to his town house in the Murray Hill neighborhood of Manhattan and would not allow them to leave until they had hammered out a rescue plan involving specific financial commitments by each one intended to calm the markets. The plan worked, but not before massive financial losses and dislocations had been sustained.
The immediate result of the Panic of 1907 was a determination by the bankers involved in the rescue that the United States needed a central bank— a government-established bank with the ability to issue newly created funds to bail out the private banking system when called upon. The bankers wanted a government-sponsored facility that could lend them unlimited amounts of cash against a broad range of collateral. The bankers realized that J. P. Morgan would not always be around to provide leadership, and some future panic could call for solutions that exceeded even the resources and talents of the great Morgan himself. A central bank to act as an unlimited lender of last resort to private banks was needed before the next panic arose.
America had a long history of antipathy to central banks. There had been two efforts at something like a central bank in U.S. history prior to 1913. The first of these, the Bank of the United States, was chartered by Congress at the urging of Alexander Hamilton in 1791, but its charter expired in 1811 during the presidency of James Madison and a bill to recharter the bank failed by a single vote. Five years later, Madison steered the chartering of a Second Bank of the United States through Congress. But this second charter had a limited life of twenty years and would be up for renewal in 1836.
When the time for renewal came, the Second Bank ran into opposition not only in Congress but from the White House. President Andrew Jackson had based part of his 1832 presidential campaign on a platform of abolishing the bank. After a contentious national debate, which included Jackson pulling all
U.S. Treasury deposits out of the Second Bank of the United States and placing them in state-chartered banks, the rechartering did pass Congress. Jackson vetoed it, and the charter was not renewed.
The political opposition to both national banks was based on a general distrust of concentrated financial power and a belief that the issuance of national banknotes contributed to asset bubbles that were inflated away by easy bank credit. From 1836 to 1913, an almost eighty-year period of unprecedented prosperity, innovation and strong economic growth, the United States had no central bank.
Now, literally in the rubble of the 1906 San Francisco earthquake and the financial rubble of the Panic of 1907, a concerted effort began to create a new central bank. Given the popular distrust of the idea of central banking, the bank sponsors, led by representatives of J. P. Morgan, John D. Rockefeller, Jr., and Jacob H. Schiff of the Wall Street firm Kuhn, Loeb & Company, knew that an education campaign to build popular support would need to be conducted. Their political patron, Senator Nelson W. Aldrich, Republican of Rhode Island, who was head of the Senate Finance Committee, sponsored legislation in 1908 creating the National Monetary Commission. Over the next several years, the National Monetary Commission was the platform for numerous research studies, sponsored events, speeches and affiliations with prestigious professional associations of economists and political scientists, all with a view to promoting the idea of a powerful central bank.
In September 1909, President William H. Taft publicly urged the country to consider supporting a central bank. That same month, the Wall Street Journal launched a series of editorials favoring the central bank under the heading “A Central Bank of Issue.” By the summer of the following year, the popular and political foundations had been laid and it was now time to move toward a concrete plan for the new bank. What followed was one of the most bizarre episodes in the history of finance. Senator Aldrich was to be the primary sponsor of the legislation setting up the bank, but it would have to be drafted in accordance with a plan that satisfied the wishes of New York bankers still reeling from the Panic of 1907 and still searching for a lender of last resort to bail them out the next time a panic arose. A committee of bankers was needed to draft the plan for the central bank.
In November 1910, Aldrich convened a meeting to be attended by himself, several Wall Street bankers and Abram Piatt Andrew, the recently appointed assistant secretary of the Treasury. The bankers included Paul Warburg of Kuhn, Loeb; Frank A. Vanderlip of the Rockefeller-controlled National City Bank of New York; Charles D. Norton of the Morgan-controlled First National Bank of New York; and Henry P. Davison, the most senior and powerful partner at J. P. Morgan & Company after Morgan himself. Andrew was a Harvard economist who would act as technical adviser to this carefully balanced group of Morgan and Rockefeller interests.
Aldrich instructed his delegation to meet under cover of darkness at an isolated railway siding in Hoboken, New Jersey, where a private railroad car would be waiting. The men were told to come singly and to avoid reporters at all costs. Once aboard the train, they used first names only so that porters could not identify them to friends or reporters once they left the train; some of the men adopted code names as an extra layer of security. After traveling for two days, they arrived in Brunswick, Georgia, along the Atlantic coast about halfway between Savannah and Jacksonville, Florida. From there they took a launch to Jekyll Island and checked into the exclusive Jekyll Island Club, partly owned by J. P. Morgan. The group worked for over a week to hammer out the Aldrich bill, which would become the blueprint for the Federal Reserve System.
It still took over three years to pass the Federal Reserve Act, the formal name given to the Aldrich bill based on the Jekyll Island plan. The Federal Reserve Act finally passed with large majorities on December 23, 1913, and went into effect in November 1914.
The Federal Reserve Act of 1913 contained many features promoted by Aldrich and Warburg designed to overcome traditional objections to a U.S. central bank. The new entity would not be called a central bank but rather the Federal Reserve System. It would not be a single entity but rather a collection of regional reserve banks guided by a Federal Reserve Board whose members would not be picked by bankers but rather by the president and subject to Senate confirmation.
On the whole, it looked decentralized and under the control of democratically elected officials. Inside the plan, however, was a de facto mechanism much more in line with the true intent of the Aldrich party on Jekyll Island. Actual monetary policy, conducted through open market operations, would be dominated by the Federal Reserve Bank of New York since New York was the location of the major banks and dealers with whom the Fed would do business. The Federal Reserve Bank of New York was run by a board of directors and governor, not selected by politicians but selected by its stockholders, who were dominated by the large New York banks. The result was a “Fed within the Fed,” run by the New York banks and amenable to their goals, including easy credit for bailouts as needed.
Some of these features were changed by subsequent legislation in the 1930s, which centralized power in the Board of Governors of the Federal Reserve in Washington, D.C., where it resides today. In more recent years the board has been dominated not by bankers but by academic economists and lawyers who ironically seem even more favorably disposed toward easy money and bailouts than the bankers. Yet, at least through the 1920s, the Fed “system” was dominated by the New York Fed under the firm hand of its first governor, Benjamin Strong, who ran the bank from 1914 until he died in 1928. Strong was a protégé of Morgan partner Henry Davison as well as of J.
- Morgan himself. Thus the circle of Morgan influence on the new central bank of the United States was complete.
History has its echoes. Decades after the Jekyll Island meeting, Frank Vanderlip’s National City Bank and Charles Norton’s First National Bank merged to become the First National City Bank of New York, which later shortened its name to Citibank. In 2008, Citibank was the recipient of the largest bank bailout in history, conducted by the U.S. Federal Reserve. The foundation laid by Vanderlip and Norton and their associates on Jekyll Island in 1910 would prove durable enough to bail out their respective banks almost one hundred years later exactly as intended.
