America's Bank: The Epic Struggle to Create the Federal Reserve (6 page)

The “Treason” series weakened Aldrich’s political moorings by stirring cries for the popular election of senators. More important was the context of such articles. If the populists of the 1890s spoke to farmers, the muckrakers engaged a more urban constituency who had been put off by Bryan but who were, nonetheless, disturbed at the seeming unfairness in American society. Progressives, as these reformers came to be called, tended to be liberal-leaning city dwellers, such as lawyers and educators. While the populist and progressive movements had areas of overlap, progressivism was more focused on labor than on agriculture, more drawn to government and less fixated on laissez-faire. Progressives tapped into the unease that Americans felt over the rapid transformations wrought by industry, immigration, and technological change. The automobile was one change; education was another. From the Civil War to 1900, the number of high schools nationwide rose from several hundred to six thousand. In comparison with the America of the recent past, more people lived in cities; more worked at factories; more knew people who had been born overseas. The extreme concentration of wealth was also new. Millionaires had once been unheard of; now
America had 3,800 of them
. Newest of all were the giant industrial combinations supplanting local businesses. If the arbiter of society once had been a small-town lawyer or banker, now it was—or seemed to be—a huge corporation, a trust.

Theodore Roosevelt, although wealthy himself, championed progressive causes, whereas he would never have identified with a mob of farmers. Woodrow Wilson, now the president of Princeton University, who was attracting attention in Democratic political circles, shared many of the same ideals.

The question of which way progressives would lean on banking reform was complicated. Progressives applauded using the tools of social science to prescribe solutions to the problems of the day. Warburg’s meticulous dissection of the banking system was consistent with that approach. On the other hand, progressives were skeptical of Big Business and of Wall Street. People in the movement did not trust banks—big banks especially—and they did not trust Senator Aldrich.

JITTERS ON WALL STREET

There is just as true patriotism
to be found in Wall Street as there is anywhere else in this country.

—F
RANK
A. V
ANDERLIP

W
ITH
C
ONGRESS
STALLED
and bankers in the heartland far from committed to reform, Wall Street began to agitate for a central bank. The spark was a prophecy delivered by Jacob Schiff, Warburg’s older partner and a respected Wall Street sage.

Early in 1906, Schiff issued a warning to the New York Chamber of Commerce. “I do not like to play the role of Cassandra,” the bearded financier solemnly began, but if the financial system was not reformed soon, he averred, “we will get a panic in this country compared with which those which have preceded it will look like child’s play.”

Schiff feared that America’s prosperity
was endangered by its rickety banking system and its shallow money market. Treasury Secretary Leslie Shaw had tried to paper over these deficits by nimbly moving
funds around, but Schiff did not need to remind his audience what had occurred the previous autumn, when Shaw had removed $100 million from commercial banks, redeploying these funds into the government’s Panama Canal project. On Wall Street, short-term interest rates briefly soared from 10 percent to an intolerable 125 percent, as if New York City were some remote financial backwater. In a more mature system, such volatility would be unthinkable. It grated on Schiff that New York, which had a new subway line admired around the world and opulent hotels on a par with those in Paris, had to suffer a financial system that was a holdover from the Civil War. “I say that is a disgrace to a civilized community,” Schiff proclaimed.

The chamber was so alarmed it formed a committee to study America’s much maligned currency. Significantly, the primary chore of writing the committee report was assigned to Frank A. Vanderlip, one of a coterie of younger bankers who, propitiously, did not share his elders’ attachment to
the hidebound National Banking system
. Vanderlip had a diverse background, having worked in Washington and the Midwest as well as Wall Street. He was inquiring and ambitious, the sort of businessman whom Paul Warburg had been hoping to interest in reform.

Vanderlip had grown up
on an Illinois farm and begun his career as a reporter, specializing in financial news. He was an enterprising journalist, cultivating high-level sources, and in 1897 he moved to the Treasury as assistant to Secretary Lyman Gage. In Washington, he rubbed shoulders with Theodore Roosevelt, then the assistant secretary of the Navy, whom he judged to be an egotistical warmonger. When the Spanish-American War broke out, Vanderlip arranged for the sale of war bonds and became familiar with scores of bankers, including James Stillman, the highly successful though reclusive president of National City Bank (and the gentleman who had curtly dismissed Warburg’s memorandum on a central bank).

Impressed with Vanderlip’s quickness, in 1901 Stillman offered Van-derlip a position as vice president. Immediately, he began to groom
him as a successor. Notwithstanding that Stillman lorded over his staff—each morning at his house on East Seventy-second Street, servants
ferried four eggs
on a tray upstairs and anxiously awaited the master’s judgment—he took to Vanderlip as if he were a son. The two went motoring on Sundays, and the ordinarily delphic banker shared with Vanderlip the secrets of the business, which Stillman had built by developing a roster of prized clients, including William Rockefeller of Standard Oil and a host of other magnates. Fusing a traditional loan business with underwriting, Stillman had made City the largest bank in the United States. Meticulous in manner and impeccably dressed, he did all he could to mold Vanderlip into a worthy heir, which included providing his protégé with a mansion on the Hudson, fully furnished (in the English style), and sponsoring him for membership in the right Republican clubs.

Despite their closeness, Vanderlip did not share his mentor’s hostility toward monetary reform. Stillman regarded financial panics as natural and worthy rituals that cleansed the market of excesses that he himself studiously avoided (National City was fondly known as “Stillman’s money trap,” an homage to his prudence). Vanderlip, nearly twenty years his junior, took a more pragmatic view, judging that America’s lack of a lender of last resort was needlessly holding back its progress.
Even though the U.S. economy had grown
to be the world’s largest, with 40 percent of total banking capital, it remained a stepsister in international finance. National banks were not even authorized to operate foreign branches, much to Vanderlip’s frustration.
*
And owing to the lack of confidence in American markets, short-term interest rates were higher and more volatile than they were in the United Kingdom (this amounted to a penalty paid by American businesses and other borrowers). Nor was the dollar used in
settling international balances. To the mortification of financiers such as Vanderlip and Schiff, merchants in Philadelphia buying goods in China or South America had to settle their transactions in Paris, London, or Berlin. Wall Street was tired of paying tribute. And as long as the United States was visited by periodic panics and money stringencies, there was little chance that
the dollar would overtake the pound
as an international currency.

Vanderlip, who was forty-one when he set to writing the chamber of commerce report, quietly handsome with narrow eyes behind thin spectacles, had no doubt that this state of affairs could be rectified if the government were to assume a more active role. His report bristles with the frustration of a metropolitan banker whose lofty ambitions in high finance were checked by the prosaic demands of the countryside. The harvests and the marketing of the crops, he complained, had strained the banks, which were “
unable to make use of their credit
, but are obliged to take lawful money from their reserves and send it into the harvest fields.”

Vanderlip blamed the same culprit as did Warburg—the stifling requirements of the National Banking Act, which, in particular, put a crimp on circulation. The law imposed particular burdens on rural areas. In the cities, people had bank accounts and were accustomed to writing personal checks, which were simply an unregulated form of money. On the farm, people relied on bank notes—but the note supply was, of course, highly constrained. Vanderlip’s aim was to fashion a more flexible supply—not more money on average, but a greater elasticity in either direction. For this, he proposed a central bank “of issue” (that is, with note-issuing powers) that would deal only with banks; it would be controlled by a board of governors appointed, at least in part, by the president of the United States. This is a fair description of the eventual Federal Reserve Act.

But Vanderlip’s prescience in one respect failed him. Although he included, as a fail-safe, an alternate, less draconian reform, he naïvely assumed that what New York bankers advised, the rest of the country
would gladly endorse. Having talked to bankers in the interior, Vanderlip was convinced, as he put it with stunning lack of sensitivity, that “
a majority of the bankers
of the United States appreciate the necessity for a variable and elastic element in the currency and will heartily co-operate with the bankers of New York City.” Sounding even more elitist, he lauded the day, not long in coming he must have imagined, when “the lawful money reserves of banks in financial centers would no longer be depleted in the autumn in order that harvest hands in Kansas, Nebraska and Dakota might receive their wages.”

If the onetime farm boy had difficulty empathizing with Dakota harvest hands, it reflected Wall Street’s widening distance from the rest of the country—even from other bankers. As American industry assumed corporate form, many companies established headquarters in New York and turned to banks to finance growth. Leading financial institutions in the city were gradually morphing into investment banks, peddling securities, trading bonds, and dabbling in foreign exchange. This was a momentous evolution, presaging a culture of finance that was wholly foreign to ordinary Americans. Thomas F. Woodlock, editor of
The Wall Street Journal,
observed that “
New York bankers are, with few exceptions
, steeped in the atmosphere of the stock-market business, and the ticker takes a good deal of their attention.”

Sensitive to attitudes west of the Hudson River, Schiff tried to soften Vanderlip’s recommendations when he again addressed the chamber, in November 1906. “
If you go away from New York City
and discuss this subject of a central bank,” Schiff began, replicating the admonishments he had delivered to Warburg, “if you . . . discuss it with the people of this country all the way across its three thousand miles, you will find grave distrust in the proposition.” The American people, he explained,

at the time of Andrew Jackson, and more so today, do not want to centralize power. They do not want to increase the power of
government. . . . They do not want to have this mass of deposits, which the government would have to keep in this bank, controlled by a few people. They are afraid of the political power it would give and of the consequences.

The chamber of commerce approved the Vanderlip report (without the softening suggested by Schiff) the same day. The group’s boldness perhaps was spurred by the urgency of events. Money markets had experienced unusual turmoil that year, exacerbated by a devastating earthquake in San Francisco that caused three thousand deaths and destroyed most of the city. The quake set off a transatlantic movement of gold that destabilized world markets. In that era, financial calamities were shadowed by the physical movement of bullion. Foreign insurers had to pay claims on San Francisco policies, and banking capital, unavailable at home, had to be imported. Gold shipments were the most practical means of supplying it. Nine days after the quake, on April 27, Vanderlip reported to Stillman, who was spending considerable time in Paris, where he resided in a gray-green mansion on rue Rembrandt, “
The immediate effect has been
the transfer of a very large amount of gold to San Francisco.”

Just as Paul Warburg had predicted, in the absence of a government bank, National City’s preeminent position thrust on it much of the responsibility of dealing with the disaster. For the moment, Stillman’s money trap was up to the task. One week later, Vanderlip reassured his mentor,

The drain which California
has put upon us gives indication of being at an end. Shipments there ceased two or three days ago. The total withdrawals of funds by California banks from New York and other centers will considerably exceed $30,000,000. . . . We have arranged to import $2,500,000 more gold which brings the total of the City Bank’s importation, as I am cabling you, up to $31,000,000.

But money markets remained turbulent.
In April and three times later
that year, reserves in the New York banks fell into deficiency. Legally, this prevented them from extending new loans. What the banks needed was someone to supply them with additional reserves.

Leslie Shaw did his utmost to facilitate gold imports—including providing
a short-term loan of $10 million
to National City. The Treasury secretary boasted that thanks to his efforts more than six carloads of gold, “largely in bars,” were imported from Europe, Australia, and South Africa. Moreover, he widened the practice of depositing and withdrawing government funds at strategic moments. It is worth listening to Shaw’s recounting of the languid summer of 1906, when

granaries and warehouses were empty
, freight cars stood on sidetracks, business men fished in mountain streams or rested at vacation resorts. Meanwhile the banks were comfortably well supplied with money, and interest rates were low. Everything seemed serene . . . except to those who recognized that in this latitude crops mature in the fall.

Taking precautions, Shaw withdrew $60 million from national banks, lest it be used as tinder for stock speculation, and temporarily “locked it up.” Then, as cooler nights brought the approach of autumn,

business men returned to their desks
fresh for more intense activities. Crops began to mature, granaries and warehouses began to fill, freight cars were put in commission, checks and drafts were drawn in multiplied number and in multiplied amounts, while the people naturally carried in their pockets more ready cash than at other seasons. The strain inevitable [
sic
] began to develop. Interior banks [those in the country] called their loans. . . .

With credit now in short supply, Shaw restored a portion of the funds previously withdrawn, “
with great benefit
,” he judged, “to the business interests of the country.”

Shaw was not trying to increase the money stock, only to smooth the seasonal fluctuations—a modest goal by the standards of today.
The total funds at his disposal
were also modest. But his actions were seen as radical by his peers. It did not help matters that
fully 11 percent
of the government’s bank balances were parked with a single bank—National City. A Chicago banker, incensed over Shaw’s close relations with City (which was also the bank to Standard Oil), fumed that the public “
had begun to smell kerosene
on his wardrobe.”
The Nation
charged Shaw with aiding “
a ring of powerful Wall Street speculators
.” A similar charge had been leveled in the 1790s at Treasury Secretary Alexander Hamilton and, indeed, would be brought against the Federal Reserve during the financial crisis of 2008. It is a truism of capitalism that if money is injected into the system, no matter the intent, some of it will end up benefiting well-connected financiers. Shaw had at least tried to sprinkle his deposits around the country according to demand—in Boston, Louisville, Kansas City, New Orleans, Minneapolis, Buffalo, Omaha, and other cities—but the money ended up where interest rates were highest: in New York. “Money,” he dolefully observed, “is almost as liquid as water and
finds its level about as quickly
.”