Read America's Bank: The Epic Struggle to Create the Federal Reserve Online
Authors: Roger Lowenstein
Early in July, Glass and McAdoo attempted, once again, to mollify the bankers. The government’s 2 percent bonds mysteriously began to trade lower, to a point where banks, which held some
$700 million of these bonds
, were threatened with serious losses. Banks had purchased these bonds so that, under the National Banking Act, they would be entitled to circulate bank notes. McAdoo and Glass sympathized with the banks, feeling that since the government now was changing the rules, bondholders should be protected. Evidently—to judge from the bonds’ cascading prices—the recent changes to the bill had not done the trick. In short order, the bill was further amended, seemingly guaranteeing the bonds’ value.
However, the bonds continued to plummet
. McAdoo smelled a rat. Never very trusting of Wall Street, the onetime tunnel financier hotly accused New York bankers of conspiring to artificially drive down prices to frighten country banks and turn them against the bill.
Such a conspiracy was unlikely, but the ill will between Wall Street and the administration was not so easily repaired. In a public letter, Vanderlip threatened that if the legislation retained its noxious element of federal control,
the country’s seventy-five hundred national banks
would feel free to recharter as state banks (for whom membership was voluntary), take their $11 billion in assets, and defect from the National Banking system. The threat to desert the new Federal Reserve—even before it was created—was a gun to the head. But if Vanderlip imagined that either McAdoo or Glass might back down, he was deluded. It was a measure of his remove that even while threatening to undermine the system, Vanderlip affected a haughty air of noblesse oblige, insisting that only businessmen—not public officials—should be trusted to look after the public interest. “
There must, in fact, be
a central bank and that is what the proposed measure
creates,” Vanderlip said curtly. “The objection is not to the powers granted but to the hands in which they are placed.”
While McAdoo and Glass were sparring with banks, House Democrats began to savage the bill for being too kind to bankers. Wilson at first underestimated the threat. However, in mid-July, he confided to Ellen, who was spending her maiden summer as First Lady at an artists’ colony in Cornish, New Hampshire, “
We have a difficult Banking
and Currency Committee to deal with in the House.” Actually, it was more serious than that. Rural Democratic congressmen from the West and South, known as “agrarians,” were much like the populist agitators of the nineteenth century. Rather than use silver-backed money to inflate commodity prices, the latest crop of populists wanted to channel more bank loans directly to farmers, who still
made up some 30 percent
of the U.S. population. Although the Glass-Owen bill
specifically included bank loans
to agriculture as being eligible for Federal Reserve discounts, the agrarians were wary of leaving the process up to bankers. They also feared that the new central bank would become too cozy toward member banks, and even, in an emergency, protect the banks from losses. (This fear would look prescient during the financial crisis of 2008.) However, agrarians were not opposed to government protection—they simply wanted it extended toward farmers rather than banks.
The spiritual leader of the agrarians
was Robert Henry, a Texas Democrat who was chairman of the House Rules Committee. Henry was an engaging talker, who traded on his reputation for being close to Bryan and commanded loyalty among backcountry members of the Banking Committee. Henry insisted that the Federal Reserve Board should include a bona fide farmworker as well as a representative of organized labor. To bankers, this was worse than a board of politicians. Even more troubling to the orthodoxy, Henry challenged the basis of the new Federal Reserve notes. Mistrusting bankers, Henry disliked any sort of currency that was based on bank assets. He wanted the bill amended so that agricultural assets (such as
warehouse receipts) would become the basis of money. This new money would be loaned, on generous terms, to farmers.
On July 23, the agrarians on the Banking Committee broke into open rebellion, proposing a controversial amendment to ban interlocking directorates (preventing any director from serving on the board of more than one national bank). The amendment was extraneous to monetary reform, and though it was sound from a corporate-governance perspective, in the context of the Glass-Owen legislation it was a volatile distraction. Knowing that it would extinguish whatever support still remained among bankers, Glass opposed it. The amendment was adopted over his protest. With his committee, and his bill, in crisis, fireworks erupted. James Ragsdale, a South Carolina ally of Henry, proposed
a series of amendments
to fundamentally alter the bill. The most eye-catching would direct the Reserve Banks to issue $700 million worth of loans divided among three new classes of United States currency (each to a powerful interest group): $300 million for ordinary business loans, $200 million for state projects such as bridges and roads, and $200 million to corn, cotton, and wheat farmers. In other words, bank credit was to be apportioned by the U.S. Congress. Bankers, who had considered this to be their job, were naturally appalled. The amendments, apparently inspired by Henry, were, according to the shocked editors of the
Times,
“
quite beyond the pale of discussion
.” It was unclear whether Henry had the support of Bryan, which he seemed to be reckoning on. But plainly, Glass had lost control of the Banking Committee. Wilson would need to step in again.
“THE IMPOSSIBLE HAS HAPPENED”
Fleeing from the evils
of Wall Street and a private monopoly, we rush headlong and pell-mell into the arms of a great public monopoly.
—R
EPRESENTATIVE
T
HOMAS
W. H
ARDWICK
,
on the Glass-Owen bill
—W
OODROW
W
ILSON
TO
E
LLEN
W
ILSON
,
September 19, 1913, the day following House passage
O
VER
LATE
J
ULY
AND
A
UGUST
, Wilson was buffeted by a series of difficult challenges. As his biographer Arthur Link put it, “
During that epochal summer
of 1913 Wilson and his advisers moved from crisis to crisis.” The revolution in Mexico had spun out of control, with the strongman General Victoriano Huerta seizing dictatorial
powers and various rivals mounting armed attacks. The insecurity along the border, as well as the threat to American citizens and business interests, thrust the President into his first international crisis. Over the summer, he recalled America’s ambassador, appointed a new envoy, and gave his first address on foreign policy, proclaiming of the turmoil to the south, “
Those conditions touch us very nearly
.” Wilson was meanwhile struggling to push tariff reform to a vote in the Senate, its last lap before enactment. The measure included an income tax—the first ever in peacetime.
On Glass-Owen, the President was occupied at two levels: fending off threats from bankers and dealing with the revolt in the House Banking Committee. The latter in particular upset him. Intraparty strife was the virus that had undone Taft, and Wilson was determined not to give factionalism any quarter. He worked closely with Carter Glass, who provided the President with a list of nine troublesome committee members, asking Wilson to call them (
that he complied is suggested
by the check marks the President made beside each name). Wilson also insisted,
in his public comments
, that Glass-Owen would be approved without any significant changes. Although news reports were often pessimistic, the President reassured his wife, Ellen, “
Discount what you see
in the papers.” He went on to explain, “It happens, by very hard luck, that practically
all
the men likely to oppose and give trouble, whether in the House or in the Senate, are on the committees now handling the matter. When once it is out of their hands, I believe that we shall have comparatively plain sailing.”
The agrarians, led by Robert Henry, sought to fundamentally alter the bill, and Wilson’s leadership was critical in overcoming them. He summoned several congressmen to the Oval Office, cajoling, imploring, and pressuring them to fall in line. A master of parliamentary process, the President calculated that the legislation would fare better in the full House than in the Banking Committee. Glass, therefore, moved it to a caucus of the House Democrats, where a favorable reception was considered likely. Once the caucus approved the
measure, it would become binding on every Democrat in the House. Also at Wilson’s prompting,
Glass obtained a gag order
on the fractious members of his committee.
However, the caucus deliberations, which had been expected to last only several days,
dragged on for most of August
. Henry was not a member of the Banking Committee, but in the caucus he had free rein.
Henry charged that the bill
was a redo of the Aldrich Plan of 1910 (which, in large part, it was) and that it violated the legacy of Jackson. More to the point, he quoted a speech by Bryan, when the Commoner had been in Congress, in opposition to then President Cleveland. The powerful implication was that Bryan also sided with Henry against the President now. Since Henry’s chief demands—to substitute a more expansive currency, and to ban interlocking boards—were issues that Bryan had championed for most of his career, the threat was entirely credible.
Although the caucus debate was mostly superficial, it touched on the issue that had vexed Americans throughout their history: What is the proper basis of money? In modern times, the Fed influences the money supply by buying and selling Treasury securities (buying securities will add to the money supply). A member bank can also borrow from the discount window of the local Federal Reserve Bank by pledging many of the forms of collateral (such as its loans to customers) envisioned in 1913. However, the discount window is used on a limited basis—mainly when banks need liquidity to cover a shortfall. The 2008 financial crisis was a prime example, when banks—as envisioned by Paul Warburg—did pledge commercial paper, as well as other assets, to get loans from the Fed. But the ordinary channel through which banks get stacks of dollars to distribute to customers has evolved. Generally, banks request currency from their Reserve Bank, in return for which the Fed debits the account that each bank maintains at the Fed. Once again, during the financial crisis and its aftermath, the Fed made use of an improvised avenue for creating liquidity—directly purchasing assets such as Treasury bonds and
certain mortgage-backed securities. These moves were controversial; at the margin, the determination of what sort of paper is worthy of being converted into “money” remains a matter of judgment and, to some extent, arbitrary.
The principle of the Glass-Owen bill was that the new Federal Reserve Banks would make this determination by deciding which bank loans to “discount,” or exchange for reserve notes—that is, for money. The guidelines in the bill were favorable to commerce; for instance, Reserve Banks were authorized to discount commercial paper as well as bills of trade based on imports and exports.
Henry objected that the legislation “
should be fair to the farmer
and allow him to have money based on his assets upon the same terms.” The point was hardly trivial. People held all sorts of financial assets—bills of lading, merchant IOUs, and so forth. Those that could be converted into currency would obviously be in a privileged position. Although the legislation permitted banks to convert agricultural loans to reserve notes, Henry continued to insist that farm assets—a warehouse receipt for grain, say—should be convertible directly into money. His proposal surely would have led to inflation. However, it’s well to note that monetary arrangements are always man-made contrivances; none can claim perfection much less divine inspiration. Paul Volcker, the Fed chief during most of the 1980s, attempted to run policy by counting the total of money in circulation; he soon forsook this approach, known as “monetarism,” because no useful definition of money existed.
Glass-Owen simply represented one of the better approaches of its day. The mechanism for converting bank loans into currency appealed to bankers because it seemed to place the new central bank in a passive position; the Fed would mint reserve notes only if, and as, banks presented it with acceptable commercial paper.
*
But there was
plenty of room for argument over just
which paper should be “acceptable
.” Moreover, the legislation was slightly contradictory. On the one hand, it set a practical limit on how many notes the Reserve Banks could issue, by establishing rules on what sort of bank assets they could exchange for notes. On the other hand, the bill required the Reserve Banks to limit the circulation of notes to a set proportion of their gold (and to redeem their notes for gold on demand); this established an alternate set of monetary brakes. In effect, the legislation created two, not always consistent, limits on the circulation.
Wilson, of course, did not involve himself in questions of theory. His priority was to furnish a more “elastic” currency and to make the credit system more resilient by knitting the banks into a unified whole. The President’s other expressed goal, to “democratize” banking, was mostly rhetoric.
When the bill was in caucus,
Bryan asked Wilson to add
language to placate the agrarians. Glass objected that “
a lot of bunk
was being handed out to the farmer.” Nonetheless, he allowed a phrase to be inserted stating explicitly that the act did not prohibit banks from discounting paper “
secured by staple agricultural products
, or other goods, wares, or merchandise.” It is doubtful that this clause changed any of the substance. It certainly did not satisfy Henry, who continued to push for radical changes.
Adding to the legislation’s difficulties, Senator Robert Owen, who was overly impressed by monetary critics and cranks, gave out in an interview that he no longer advocated a regional reserve system—which, as the
Times
noted, “is the essence of the bill that bears his name.” Owen may well have been influenced by the budding rebellion in the House. In any case, Wilson summoned Owen to the White House on August 20 (the day the senator’s comments were published), jerking him back into line. Even though
Owen’s apostasy
was quickly aborted, it was alarming on account of his closeness with Bryan. Glass concluded that only Bryan could get the bill unstuck. Soon, an opportunity presented itself.
On August 22, Henry addressed the House caucus, demanding that it support the ban on interlocking boards. Glass was ready for him. With a theatrical flourish, the bantam chairman retrieved from his pocket a letter that, he revealed—glancing at Henry—had been addressed to him from the secretary of state.
Glass began to read
. In the letter, Bryan noted that he had long advocated a ban on interlocking directorates. However, he said, “care must be taken not to overload a good measure with amendments, however good those amendments may be in themselves.” Bryan went on in that statesmanlike vein, asserting that the bill was correct with regard to the few principal points that mattered. As for the rest, he authorized Glass to say that he, Bryan, stood entirely with the President—“I am with him on all the details.”
Witnesses said the Democrats broke into cheers. Glass, never a gracious winner, recorded for posterity that Henry turned “
white with anger
.” In any case, Henry was beaten. Wilson promised to address the issue of bank directors in a subsequent antitrust measure.
*
Although the caucus tarried for another week,
it overwhelmingly approved
Glass-Owen, with only minor changes.
Just as the caucus deliberations were reaching a climax, the currency commission of the American Bankers Association held a parley in Chicago and unanimously recommended
a set of draconian amendments
—without which, they strongly implied, support for the bill would be withheld.
*
The ringleader was James Forgan, who called Glass-Owen “unworkable” and crossed a line by tarring Glass, personally, as “incompetent.” This was so strong that Forgan was forced
to issue an apology. More important, the ABA’s aggressive tactics backfired.
Its supposedly “unanimous” vote
, it developed, had been secured by railroading the two hundred bankers present and stifling dissent. Many of the bankers,
led by George Reynolds
, thought it would be wiser to negotiate with the administration and had urged a more conciliatory stance. An even wider chasm separated the big banks in Chicago, who dominated the proceedings, from smaller country banks. For instance, the ABA demanded that bankers be given a voice on the Federal Reserve Board;
country bankers, fearful of their urban
brethren, preferred to have oversight by the government. And despite the ABA’s advocacy of a single central bank, rural bankers liked the idea of a regional network.
Word of the industry’s divisions leaked to the Wilson administration. As Treasury Secretary McAdoo confided to Colonel House, “
The action of the banks
at Chicago, although upon the surface unanimous, was . . . far from reflecting the real sentiments of that meeting. I am advised that fully half of those present in their hearts favored the bill.”
McAdoo was further buoyed
by evidence that, outside the banking fraternity, Glass-Owen was increasingly popular. The publisher of the influential
Charlotte Daily Observer
figured that Glass-Owen, if enacted, would “
distribute the money
over the whole U.S. much more equally.” In North Carolina, he approvingly predicted, it would spare cotton millers from having to go to New York for money. The
U.S. Chamber of Commerce conducted
a field study in eleven states west of the Missouri River and reported “a strong desire” on the part of businesspeople for Congress to act. Based on such reports and on
his own contacts with bankers
and others, McAdoo felt confident enough to reject the Chicago manifesto out of hand. Parker Willis similarly urged Glass to ignore the ABA, whose conference he judged a “fiasco.”
In the second week of September, Glass brought the bill to the House floor. Sensing that the members remained uncomfortable with the prospect of creating a powerful federal agency,
Glass downplayed
the legislation’s impact. For the most part, he maintained, the bill would merely reassign powers that had long been exercised by the secretary of the Treasury and the comptroller of the currency. The Reserve Board, he suggested, would function as an “
altruistic institution
. . . with powers such as no man would dare misuse.” This was remarkably naïve. Frank Mondell, a Republican from Wyoming, was more perceptive—or more candid—in recognizing the bill’s landmark character. “
Not only is its power
, authority, and control vast,” he warned of the prospective Fed, “but it is of a character which in practical operation would tend to increase and centralize.”
Charles Lindbergh, another Republican opponent
from the heartland, violently criticized the bill—among other reasons, for authorizing the Fed to operate overseas in support of foreign trade. Lindbergh’s nativism was striking, since his constituents in Minnesota depended on exports and the congressman himself was an immigrant. But xenophobia had been a hallmark of monetary populists since the early days of the republic. It did not die easily. A generation later, when the United States was facing a mortal threat from Nazi Germany, Lindbergh’s aviator son would urge America to stay out of “foreign” wars.