America's Bank: The Epic Struggle to Create the Federal Reserve (9 page)

One more nuanced analyst was Woodrow Wilson. Formerly an economics lecturer, the university president was as unsettled as were many Americans by Wall Street’s risk taking and by the concentration of Wall Street power. Bankers, he insisted, should be “
statesmen”—leaders in society
—rather than mere profiteers. Wilson was dismayed by corporate greed and wrongdoing, which he believed to be widespread, yet he acknowledged there was nothing in the Constitution that forbid “accumulation” by business. The only way to reconcile the conflict between human avarice and the general welfare, he suggested in an interview in the
Times
soon after the Panic, was to put society on a moral footing. Where Wilson differed from many progressives was that he was willing to recognize morality, or at least civic purpose, in men of business and finance. He saluted Morgan, albeit with the air of a high-minded professor looking down on the Wall Street scrum. “I am glad to see,” Wilson said puckishly, “that in the midst of all
this turmoil of undefined wickedness
, Mr. Morgan’s name has not been among the celebrities. He seems to have kept his hands clean and his reputation clear of any dishonor.” But not even Wilson thought morals alone could do the trick. Currency reform was long overdue, he said: “The European currency system is far better than our own.”

Reform was suddenly the rage. Proposals poured into Congress. Over the winter of 1907–1908,
Columbia University sponsored
a series of lectures by prominent bankers, including Vanderlip, Perkins, and Barton Hepburn. The symposium was organized by Edwin Seligman, the professor who had prodded Warburg to publish, and who
now persuaded him to appear, for the first time, on an American stage.
Warburg unapologetically advised
that America’s system was inferior to those in Europe. In fact, he said, it suffered in comparison with that of the ancient Babylonians. Warburg made the trenchant distinction that banks in Europe, being “fully protected” by balances with their central banks, could lend freely in times of distress, whereas, during the recent American panic, as if in some topsy-turvy universe, “the banks, instead of disbursing their cash, begin to accumulate and actually to hoard currency.” The Columbia lectures, which were published in book form,
introduced the arguments for centralization to a wider public
.

However, the Warburg view remained a minority one. Even most bankers were fixated on an asset currency—the idea floated at the Indianapolis convention for a currency based on individual bank loans. Because this would further fracture the country’s money, it was the opposite of what Warburg hoped to accomplish. He recognized that the political climate was hostile to a complete remake of the system; therefore, he craftily styled his newest plan
a “modified” central bank
. His “modified” bank was an attempt to split the difference—in effect, it was
an umbrella organization of clearinghouses
that would issue currency and provide a unified source of support for banks, even if it was less than a full central bank. The fear of arousing popular opposition tilted him toward a federal structure, a pattern that would recur down to the very day of the Fed’s enactment.

Although Warburg’s arguments appealed to a handful of journalists and professors, he had no audience where it counted—in Congress. As a German national, Warburg had no entrée on Capitol Hill, where the asset currency notion held sway. Frustrated at being ignored, Warburg harbored a particular resentment of Senator Aldrich, who wielded the power in the upper chamber and who, as Warburg understood it, would
never permit the system to truly change
.

Aldrich, now sixty-six
, had spent a quarter century defending the status quo in money, tariffs, and railroad regulation. He was
enamored of the system of National Bank Notes secured by government bonds, and his usual contribution to the subject of reform had been to propose more such bank notes. He had little appreciation for the system’s vulnerability, and much less had he foreseen the recent trouble. He had gone on his annual sojourn to Europe in the spring of 1907 and returned to Warwick, the magnificent estate he was building on Narragansett Bay, in July, in time to supervise the installation of a greenhouse with a multitude of orchids. His enjoyment of such labors was cut short by the sudden collapse of the banking system. The magnitude of the Panic jolted him. At a minimum, Aldrich realized that, for political reasons, legislation would be necessary. The Republicans could not face the electorate in 1908 without having enacted a reform. He also experienced, if not full-fledged doubt, a stirring of curiosity about what had gone wrong.

With banking conditions returning to normal, in late December the senator made inquiries on Wall Street, and found his way to Kuhn, Loeb. His ostensible purpose was narrow: he wanted to question Jacob Schiff about the law under which Germany issued government bills. Schiff called in a colleague who, he said, was better informed: Paul Warburg.
Gazing on Aldrich for the first time
, Warburg was struck by the sharp nose, the piercing eyes, the high color framed by the bushy eyebrows and mustache, and, above all, the “strong and clear forehead, the head erect upon the broad shoulders.” In spite of his resentment, Warburg could not resist trying to engage the senator. The conversation became broader; Warburg ventured into the forbidden territory of centralization. Perhaps to quiet this simmering volcano, Aldrich said that Warburg could send him material for further reading. As Aldrich departed, Warburg mused to himself, “There goes currency reform.”

Schiff advised that it would be a grave mistake
to write to Aldrich. Warburg ignored him. The next day, he sent the senator a copy of his “A Plan for a Modified Central Bank.”
Four days later
he wrote to him again. Now that the volcano was uncapped, there was no
restraining it. “
Did not the last panic
show that we are suffering from too much decentralization of our banking system and from the absolute impossibility of securing any concerted action as to the free use of our reserves?” the banker demanded. He continued with a diatribe pleading for order, coherence, centrality—all the traits he found lacking in banking in his adopted home.

Senator Aldrich did not reply.

THE CROSSING

This central reserve, or whatever name
we may give to it, must be a sacred institution, run for the public weal.

—P
AUL
W
ARBURG

Well timed reform alone averts revolution
.

—T
HEODORE
R
OOSEVELT
,
citing Turgot

I
N
THE
YEAR
FOLLOWING
the Panic of 1907,
Congress crafted a legislative response
that was, for the most part, disappointing. It had not thought to study the Panic; its legislation was guided by politics. But almost as an afterthought, Congress did move the ball forward. Before the year was out, an American delegation led by Nelson Aldrich would fan out across Europe for the purpose of understanding just how banking on the Continent differed from that in America. Aldrich himself made a remarkable swing toward reform. Somewhere between the old bookshops in London and the
elegant hotels of Paris, the senator, perhaps for the first time since his youth, became inspired by the classical models of Europe. His transformation was nothing short of startling. After Aldrich’s return, Paul Warburg began to think that serious monetary reform just might be possible. Realizing he had become hooked on his mission in the New World, Warburg took the decisive step of applying for American citizenship.

But 1908 did not start auspiciously
for reformers. The two chambers of Congress—each of them, like the White House, in Republican hands—wrangled over distinct bills, Aldrich being the author of the Senate version and Representative Charles Fowler, the champion of asset currency, leading the way in the House. Neither bill had the ambition or scope that a meltdown such as the Panic of 1907 demanded. Warburg sent a congressman a copy of his “modified” central bank plan, hoping Fowler would introduce it. The gambit went nowhere. Central banking was too hot to handle even had the members favored it, which most did not.

The Aldrich bill proposed
, controversially, to let banks issue notes backed by their investments in railroad bonds. This gift to the railroads (similar to an earlier Aldrich proposal) betrayed his peculiar knack for inflaming the popular will against him. Railroads were widely resented, as much for the sumptuous mansions in Newport where industry barons summered as for their allegedly unfair rates. Western senators would not abide a favor to the rails, and the provision was stricken. That still left Congress splintered. Since Aldrich could not get his plum for the rails, he favored the status quo: currency based on government bonds. The House bill authorized currency supported by individual bank loans—precisely what La Salle Street had long demanded. Late in May, George Perkins updated J. P. Morgan, who was in London, on “the final failure” of the bill, adding, “
We are all thoroughly disgusted
over the condition of things in Washington.”

But Congress fashioned a compromise after all, an odd slice of
legislative sausage known as the Aldrich-Vreeland Act. The law, adopted at the end of May, authorized banks to form local currency associations and, with the approval of the Treasury secretary, to issue additional National Bank Notes in an emergency.
*
There was little enthusiasm
for the bill among bankers, and none among the public. Warburg feared that Aldrich-Vreeland, which did little for his cherished idea of centralizing reserves, would defuse support for genuine reform. In short, it might be worse than nothing. The saving grace was that the law would expire in 1914. Thus it was a stopgap, not a solution. To underline the point, the law provided for the establishment of a National Monetary Commission, consisting of eighteen members of Congress, to study the defects in America’s banking system and offer an enduring remedy. In this circuitous way, the bill offered possibility.

Aldrich was named the commission chairman; many assumed he would use the post to bury reform for good. On the Senate floor, however, he let slip the suggestion of bolder purpose, as if envisioning the potential for crafting a legacy as he entered the twilight of his career. “
Thoughtful students of economic history
,” Aldrich noted, in a clear allusion to Warburg, “who are led by the experience and practice of other commercial nations . . . favor some plan for a central bank of issue.” Although Aldrich gave himself political cover by insisting that America was not yet ready, he expressed a belief that, eventually, the country would adopt such a plan. This was a major concession.

Given carte blanche to do as little
or as much with the commission as he chose, Aldrich ordered a vast research effort, which led to the publication of a shelf of books covering the monetary history and
practices of nations around the world. It was a boon to the obscure field of financial history, as the financial historian James Grant would cheekily point out, and a few volumes, such as Oliver Sprague’s
History
of Crises Under the National Banking System,
are studied to this day. If most of the commission’s work would ultimately gather dust, Aldrich sensed that an ambitious project required a proper foundation, a bibliographic heft, to be treated with the requisite gravitas.

From the beginning, Aldrich treated his fellow commissioners as ciphers. Few had either banking experience or clout on the Hill. Aldrich controlled the meeting agendas as well as press statements, which were studiously bland and designed to keep the commission out of election-year news.
Aldrich did seek help
—just not from the other commissioners. At the suggestion of Charles William Eliot, the long-standing president of Harvard University, Aldrich hired Piatt Andrew, the economics professor, as his assistant and in-house expert. Aldrich also sought the advice of J. P. Morgan, who urged that Aldrich enlist the services of the banker Harry Davison.

Morgan had been so impressed
by Davison’s efforts during the Panic that he sought permission, over a friendly dinner with George Baker, head of the First National, to lure Davison to Morgan’s. The move did not occur until the end of 1908, but Aldrich was fully aware that the Monetary Commission was taking on an adviser who answered to the most powerful man on Wall Street. Aldrich, of course, saw nothing wrong with government and business joining forces. Perkins, a less-than-discreet Morgan executive, let fly in a cable to the boss: “
It is understood Davison
is to represent our views and will be particularly close to Senator Aldrich.”

Such a communiqué, had it become public, would have destroyed the commission before it even got started. It is worth noting that, even while one Morgan lieutenant (Davison) was teaming up with Aldrich, another (Perkins)
was furiously lobbying Congress to weaken
the antitrust law, imploring the administration for gentle regulatory
treatment of select Morgan clients, and overseeing a collusive effort by rival railroad executives to jack up freight rates. Lending a trusted man to a public commission was wholly congruent with how moguls of the era operated. Quiet alliance with the government was always preferable to noisy confrontation.

Although the Monetary Commission was bipartisan, the likelihood of its having an impact, Aldrich knew, hinged on whether the Republicans could keep control of the White House. In June, the Republicans nominated William Howard Taft, the secretary of war and a close friend of the President (the forty-nine-year-old Roosevelt had voluntarily, and mystifyingly, opted to retire). Taft publicly supported the commission and sent Aldrich a flattering note, expressing his eagerness to meet with “
the levelest headed man in the country
.”

Three weeks later, the Democrats nominated William Jennings Bryan. A great orator though a twice-failed candidate, Bryan had no use for a commission run by Aldrich. At any rate, the Democrats backed a very different banking reform—deposit insurance. Oklahoma, a newly admitted state, had enacted deposit insurance the previous December, with the aim of discouraging bank runs. This solution dismayed orthodox bankers, who feared that insurance would serve as an invitation to reckless banking. If depositors had no reason to seek out well-managed banks, what would motivate bankers to discipline their lending? James Laughlin, author of the 1897 Indianapolis report, reacted as did many experts—with haughty disapproval. Deposit insurance, Laughlin said, was a vain attempt to “
make men good by law
. It is purely populistic or socialistic.” He said depositors should rely instead on the “skill, integrity” and “good management” of banks.

Coming so soon after the Panic, Laughlin’s evocation of bankers’ professionalism sounded much as it would a century later—laughably naïve. Deposit insurance was popular with voters and came to be adopted, over the next year, in Kansas, Nebraska, and Texas, and in
ensuing years in a handful of other states.
*
Taft denounced the Oklahoma plan
, but as the presidential campaign progressed, he wisely backed away from the issue. Republicans needed their own monetary strategy; their hopes came to rest, entirely, on Aldrich’s broad shoulders.

Aldrich told the press his aim
was only the modest one of refining the Aldrich-Vreeland Act. This is scarcely credible, since within weeks he was plotting a lengthy fact-finding mission to Europe. Meeting at the recently opened Plaza Hotel in New York, the commission duly seconded his plan. Eight of the members would make the ocean crossing.

Passage was booked on the German-built
Kronprinzessin Cecillie,
departing New York for England on August 4.
Aldrich reserved a $260 suite
for his wife, Abby, and himself and a lower berth for Mathilda Schonberg, listed on the shipping manifest as their maid, for $82.50. (
Davison had sailed ahead
to arrange appointments with European bankers, with Morgan providing introductions.)
Aldrich exhaustively prepared
for the inquiry. Liberated from the mesh of daily politics, he reveled in the opportunity to practice statecraft as a purely intellectual challenge. The senator was so eager for the project to be seen as creditable that
he took unusual precautions
to guard his reputation, insisting that his adult children in London not reside at his hotel, lest he be accused of palming off family expenses on the taxpayers.

At Aldrich’s suggestion,
Professor Andrew brought banking textbooks
for the voyage to tutor his fellow commissioners. They could scarcely have asked for a better teacher.
Andrew hailed from La Porte
, Indiana, where his father, a Civil War veteran turned local banker, had a proud record of never having foreclosed on a mortgage. Piatt
had fully imbibed his father’s conservative banking ethos. An incisive if not an original thinker, he had sparkled in academia and was no stranger to men of influence and privilege.
At Princeton he had studied
under Woodrow Wilson and at Harvard he was
teacher to the young Franklin D. Roosevelt
, with whom he went riding in the environs of Cambridge.

Economics in the Gilded Age
was a liberal discipline, not the forbidding maze of mathematics it later became. Andrew thought of banking as a Renaissance pursuit, intellectually on a par with the Ibsen and Shakespeare plays he attended in Cambridge, the operas of Paderewski, and stimulating lectures by the likes of the Arctic explorer Lieutenant Robert Peary. A devotee of the outdoor life, somewhat in the model of the Harvard graduate Theodore Roosevelt, Andrew skated on Hammond Pond and engaged in strenuous running and swimming. He loved his home in Gloucester on the sea and found Harvard difficult to leave. But the thirty-five-year-old bachelor had a romantic spirit. “These autumn days are too lovely—warm and fragrant,” reads a typical diary entry. The prospect of a European adventure thrilled him. Moreover, banking theory was just that—theory. Here was a chance to translate ideas into action, at the princely government salary of $3,000. With a palpable sense of excitement, he wrote in his diary, “My new life begins.”

Central banking in Europe, as Andrew no doubt informed his pupils, had begun with the Riksbank, created to make loans to the King of Sweden in 1668. The Bank of England was established a generation later, in 1694, by private capitalists, also as a banker to the throne, which had been impoverished by an ongoing war with France. Over time,
the Bank of England acquired
other functions, such as issuing notes, acting as the government’s fiscal agent, determining interest rates, protecting the nation’s gold reserve and the value of the pound, and recognizing an (implicit) duty as lender of last resort. The process of becoming a public institution was gradual and, judged by modern standards, incomplete. In 1908 the Bank of England
remained private, a servant to the state but not of it. The important point to the Americans was that the Bank’s directors recognized the need, in times of crises, to resist what is every banker’s natural instinct to tighten credit. The only workable option when all others were hoarding funds was for the Bank to be an open spigot.
In the famous phrase of Walter Bagehot
, the Victorian-era journalist, the central bank “must lend to merchants, to minor bankers, to ‘this man and that man.’” The Bank would insist on good collateral but, make no mistake, it would “lend freely.”

Many central banks (by the early 1900s, there were
roughly twenty in all
) had been organized in response to a war or another inflationary episode. The Bank of France was chartered in 1800 as an antidote to the financial turmoil of the French Revolution. The early American experience was similar. The first Bank of the United States was created to mop up debts from the Revolutionary War, and the Second Bank after the War of 1812. They improved America’s credit, but the special privileges they enjoyed fostered resentment—from Andrew Jackson in particular. In that light, it should be recalled that corporations were often chartered with special privileges. Parliament granted the Bank of England the exclusive right to circulate notes, just as it had given the East India Company a monopoly on tea. Over time, the privileges were matched with responsibilities. The various bankers to the state morphed from primarily profit-seeking institutions into ones that, while still shareholder owned, acknowledged a first duty to the public. Except, of course, America’s Banks didn’t evolve. Congress let them expire.