Warburg was the third of five sons, heirs to the Hamburg banking firm M. M. Warburg, which traced its origins to the time of Napoleon. He was introspective and shy, and he harbored a melancholy whose physical manifestation was a thick mustache inevitably characterized as “drooping.” If his younger brothers, Felix and Fritz, were bons vivants, and Max, the second, was a headstrong banker, Paul had the soul of a poet, and the intellectual fire of the eldest brother, Aby, who became a prominent art historian. As the family biographer, Ron Chernow, noted, Paul seemed to make money without really caring for it. However, his training uniquely prepared him to be an authority in international finance.
After graduating from a European gymnasium at eighteen, Paul entered the family bank, spent two years in London, in a variety of jobs, and moved to Paris and to a bank specializing in foreign trade. After a year in Hamburg, the young banker was dispatched on a world study tour, commencing by train to Genoa, where he embarked on a sail-bearing steamer to Suez, followed by a luxurious British liner to India. After stops in Singapore, Saigon, Hong Kong, and Japan, he returned home via Vancouver and the United States. The trip burnished his appreciation of the role of central banking in ensuring market stability. Overall, his field study had lasted seven years.
By 1895, though still only twenty-seven, Warburg was basically running the family bank. In that same year, he married Nina Loeb, the daughter of an American financier. Like Paul, Nina hailed from a tribe of German-Jewish bankers who lavished attention on their children’s education, musical training, and cultural upbringing in preparation for lives of wealth and civic involvement. Like him, as well, she carried a sadness, the result of an accident when she fell from a cart, injuring a leg and ending her dream of a career in ballet. The couple settled in Hamburg, crossing to America for summers, but Nina’s ailing parents yearned for their daughter to be nearer, and in 1902, the thirty-four-year-old Paul bowed to the inevitable and moved his family to New York, where he joined his in-laws’ firm, Kuhn, Loeb & Company.
Warburg was shocked by the primitiveness of American finance. Whereas banks in Germany functioned with near-military cohesiveness, banking in America, he concluded, suffered from an ethos of extreme individualism. As credit tightened, each bank pulled its loans, thereby accentuating the scarcity for all the rest. In 1903, soon after the plunge on Wall Street, Warburg let on to Jacob Schiff, his brother-in-law and the senior partner at Kuhn, Loeb, that he had penned some thoughts on the defects of American banking and how to cure them. The key problem that Warburg outlined was the lack of a central reserve. In effect, each of the country’s approximately fifteen thousand banks stood watch over its own cache of gold, which neutralized what could have been a potent collective reserve. Another problem was the lack of a liquid market in so-called bills of trade—pieces of paper representing loans that were endorsed by banks. In Europe, banks could sell, or “discount,” such loans to the central bank, freeing up reserves so they could issue more loans; by contrast, such loans were illiquid and inert in America. The final defect was the lack of an elastic currency. Warburg believed that each of these problems could be met by a single remedy—a central bank such as existed in his homeland.
Although his English was flawed, Warburg wielded an unusually lucid and forceful pen. The act of writing seemed to liberate him, transforming the self-effacing, studiously correct gentleman into a passionate and persuasive advocate. Schiff read Warburg’s paper and agreed with the substance of it. However, Schiff said, Warburg had misread the psychology of the American people, who would “never” accept any institution resembling a central bank. He warned his junior partner not to share his paper with others. A generation older than Warburg, Schiff had immigrated to the United States after the Civil War and become one of the country’s leading railroad financiers. No doubt he feared that Warburg would alienate local bankers by lecturing them on the shortcomings of their own system. But, as a teaching exercise for his protégé, he offered to show the paper, on a confidential basis, to two well-placed friends. One was Edward H. Harriman, a railroad tycoon and Schiff’s sometime ally in business. The other was James A. Stillman, president of the National City Bank and one of the preeminent bankers in New York. Harriman read Warburg’s memorandum and dismissively told Schiff that Old World institutions couldn’t be replicated in America.
A day or two later, Warburg looked up from his desk and found Stillman looming over him. Stillman was a man of legendary laconicism, highly eccentric. He was silent now, looking at Warburg through half-closed, heavy eyes.
Finally, adopting a tone of gentle sarcasm, Stillman spoke: “How is the great international financier?” He added, somewhat defensively, “Warburg, don’t you think the City Bank has done pretty well?”
Warburg agreed that it had—very well indeed.
“Why then not leave things alone?”
Warburg hesitated before daring to reply. “Your bank is so big and so powerful, Mr. Stillman, that when the next panic comes, you will wish your responsibilities were smaller.”
Stillman—no longer quite so friendly—huffed that Warburg had it all wrong. America’s banking system, far from being inferior to those in Europe, actually represented an improvement. Indeed, had not America tried a central bank during the Jackson era and discarded it?
Warburg put his paper on a shelf. For the moment, he had plenty else to do, learning the ins and outs of railroad finance and corporate mergers.
• • •
VARIOUS OTHER BANKERS—heirs to the Indianapolis convention—carried on the fight for reform. However, unlike Warburg, they favored establishing an asset currency, a decentralized scheme based on each individual bank’s loans. Charles Fowler, chairman of the House Committee on Banking and Currency, introduced a bill to the bankers’ liking, but the legislation was stillborn. For one thing, the issue was rather too technical for President Roosevelt, who preferred to expend his energies on social problems on which he could act as the nation’s moral leader. Moreover, the existing National Banking system had a fierce defender in the Senate, who stubbornly and consistently blocked reform.
Nelson W. Aldrich, chairman of the Senate Finance Committee, was arguably the most influential figure in Congress at the turn of the century. In this time of Republican hegemony, his word went practically unchallenged; so great was his authority that newspapers called him the “general manager of the United States.” Strongly identified with business interests, Aldrich resisted popular efforts to regulate industry and railroads, or to protect labor. The decades since the Civil War had seen America transformed by the Industrial Revolution, and Aldrich viewed the task of government as essentially ensuring that American business would continue its upward course. In banking as in other fields, he reflexively defended the status quo. However, late in life, Aldrich would experience a stunning conversion to Warburg’s cause. He then became the first ardent champion of a central bank in a position of power.
Unlike Warburg, Aldrich was of humble background. Born in 1841 in a farmhouse in the tiny town of Foster, Rhode Island, Aldrich had high aspirations tempered by a steely pragmatism. During the Civil War, he showed no appetite for glory, much less for risking his hide. Assigned to guard Washington, D.C., he was enthralled by the sight of the Capitol—“its splendid white marble staircase,” in particular—but contracted a fever and was promptly discharged. It was not that Aldrich lacked ambition; rather, his ambition was centered on his material advancement. His father, a skilled machinist who was learned in Rhode Island history, had been checked in his career by periodic drinking binges. Not unlike Carter Glass, Aldrich felt acutely his father’s failure to advance in the world and harbored a deep yearning to succeed. As a young man, he fell in love with an independent woman of some means, Abigail P. T. Chapman, who rebuffed him. Rejection furnished Aldrich with an urgent motive to raise his station, a worldly zeal that persisted even after he had won her hand, for Aldrich was to write his young wife, “
I grow sick with the thought that I am to remain one of that herd of ‘dumb, driven cattle’ which makes up the mass of men.”
By dint of tireless work, Aldrich elevated himself from the position of clerk at a wholesale grocer in Providence to junior partner. He also engaged in the lively debates in the local lyceum—such public lecture halls were a fixture in American towns of that era—on issues ranging from the tariff to the currency. Although he was hardly rich, he identified with the propertied class, and coveted Old World objets as though aristocracy were his natural entitlement. While still a young man, he began acquiring land on Narragansett Bay, where the state’s blue-blood families traditionally vacationed and where he himself one day would build a ninety-nine-room Renaissance château, with three sides majestically facing the sea.
Abby tried to moderate his ambition; early in their marriage, as if fighting a premonition, she expressed her “most earnest and cherished hope” that her husband might leave “an unstained record, without one single blemish.” His own inner torment nearly derailed his career. In 1872, racked by insomnia, stomach pains, and mental exhaustion, Aldrich set off on a rambling tour of Europe, and though the couple had recently lost a child, his depression seemed driven by a deeper, more personal malady of the soul. He ventured from the South of France to Naples and Rome, where he gazed upon the Colosseum. Somewhere amid the paintings and palazzi, according to Jerome L. Sternstein, author of an unpublished narrative of Aldrich’s early life, he rediscovered purpose, “a basis for his commitment to worldly success.” As he wrote to Abby, “If I am deeply impressed with the insignificance and unimportance of man’s life, I also feel what a grand thing it is to live and how much a man may accomplish even in this short and transitory existence.” He returned, after a journey of five months, determined to placate the bruised sensibilities of his abandoned-feeling wife and—more than ever—to claim an august place in the affairs of men.
In the 1870s, Aldrich was elected to the city council in Providence; thanks to his close relations with local businesspeople, he also became a director of a small bank. Meanwhile, he advanced to the statehouse and then to the House of Representatives. Aldrich had no ken for dramatic speechifying. He did not give interviews, much less engage in Lincolnesque yarn spinning, and when a joke was told he smiled rather than laughed out loud. Unabashedly elitist, he had an aversion to crowds; the common touch was never his. But what Aldrich lacked in charisma or warmth was offset by his capacity to coolly analyze the facts. Over six feet tall, with a flowing handlebar mustache, he dressed in well-tailored suits and black bow ties and was a man of presence and intelligence. Rarely did he debate in public; the cloakroom, the back corridor, was where his work was done. A reporter with the New York Tribune noted the “side whiskers close cut” and the “brilliant dark eyes which he fastens closely upon the person with whom he is conversing.” Another journalist described him, more succinctly, as “a blindness to inessentials masquerading as a human being!” Aldrich simply comprehended the issues, down to their intricate details, better than did his adversaries.
In 1881, the Rhode Island legislative bosses elevated Aldrich to the U.S. Senate. Now forty, he held a seat that was less subject to democratic challenges than it might have seemed. Rhode Island restricted the franchise to property owners and native-born citizens willing to pay a poll tax. Even when the franchise was broadened, the legislature was gerrymandered in favor of small Republican towns, shielding Aldrich from the swelling ranks of immigrants, who voted Democratic.
When he arrived in the Senate, the hot issue was the tariff. Contemporary Americans can scarcely grasp how controversial the tariff was throughout the nineteenth century. After the Civil War, business had persuaded Congress to erect a complex schedule of duties to protect textiles, manufactured products, machine tools, commodities such as sugar, and a host of other goods from imports. America was still an emergent economy, its businesses less efficient than those of Great Britain and other European states. Even as America’s competitive disadvantage dissipated—that is, as the economic basis for the tariff vanished—northern manufacturers, through some combination of fearfulness and greed, supported the maintenance of high tariffs with near-religious fervor. At the same time, residents of farm states, who were consumers of industrial goods, resented having to pay more for such items. Geographically, therefore, the tariff debate mimicked that of silver, with agricultural regions fiercely resenting the tariff as an eastern, and Republican, policy prejudicial to their interests.
Aldrich immersed himself in reading on this dense topic, and had 170 volumes shipped to his home in Washington (he had a fondness for his books, mostly dry tomes). He read on both sides of the tariff issue, including Adam Smith, who in the late eighteenth century expounded the classical view that “the general liberty of trade” increased the average prosperity of all. This fine theory did not sway Aldrich, who at ground level observed that the tariff was a blessing for Rhode Island, which had the highest concentration of industry of any state in the union. Always practical in his thinking, the new senator judged that the tariff was vital not only to the manufacturers in his state but also to the “comfortable homes” and “material prosperity” of its ordinary citizens. In other words, he saw in the tariff a nineteenth-century version of trickle-down, in which factory owners insulated from overseas competition reaped higher profits and paid more lucrative wages. Aldrich did not have to be arm-wrestled into hearing out his business constituents; he avidly sought their opinion and genuinely trusted their expertise. He bonded, in particular, with the Sugar Trust, the colossus that in the late nineteenth century monopolized the sugar-refining industry. Aldrich was friends with Theodore Havemeyer, a member of the stupendously wealthy family that ran the Sugar Trust, and the owner of a mansion in Newport, Rhode Island. And the senator faithfully legislated in the Trust’s interests, at times securing to the penny the tariff rate that Havemeyer requested.
On currency questions, Aldrich lined up against silver and was instrumental in 1896 in persuading William McKinley to run on a gold platform. Nonetheless, during his first two decades in the Senate, Aldrich was only intermittently involved in banking. It was the money shortages of the early twentieth century that shifted his focus. After the market break that also attracted Warburg’s attention, bankers desperate to halt the never-ending succession of stringencies called on Aldrich to fashion some sort of new currency to enlarge the total in circulation and relieve the stress. Aldrich, grounded in the conservatism of the era, had no wish to dabble with the currency. He feared that supplying a new currency, by enhancing the total money supply, would likely cause inflation. Barton Hepburn, the former comptroller and now president of the Chase National Bank, urged him to support reform, to which Aldrich replied, “Our currency is as good as gold. Why not let it alone?” (Hepburn rejoined that the currency was both as good and as bad as gold, namely “quite inelastic.”)
To appreciate the extent to which Aldrich was a roadblock to reform, one has to realize how influential he was not only within the Senate but with Theodore Roosevelt. Although the two did not see eye to eye on popular issues such as trust-busting, labor reform, and railroads, Roosevelt valued Aldrich’s intelligence and superior financial sense. What’s more, he had to deal with Aldrich’s hold on the Finance Committee. As Roosevelt confessed to the crusading journalist Lincoln Steffens, “Aldrich is a great man to me; not personally but as the leader of the Senate. He is a king pin in my game. Sure I bow to Aldrich. . . . I’m just a president, and he has seen lots of presidents.”
The President did bow to Aldrich. Behind closed doors, Roosevelt had promised Hepburn that if the American Bankers Association were to propose legislation for an asset currency, Roosevelt “would adopt it as his own.” When a bill was submitted, he failed to do anything of the kind. When Hepburn sought an explanation, the Rough Rider admitted that he had cut a deal with Aldrich, as well as with Joe Cannon, the Speaker of the House, under which the legislato
rs “let” the President have his way with “certain reforms,” probably including railroad rate regulation, and kept currency and the tariff for themselves. And when Roosevelt ran for another term in 1904, currency reform was on hold.
Meanwhile, Paul Warburg continued to study the banking regime that Aldrich stoutly defended, and his critique of it deepened. Warburg found fault, in particular, with the system’s rigid rules for bank reserves. The National Banking Act required banks in New York to keep a reserve equal to 25 percent of their deposits locked in their vaults, with similar restrictions applying to other banks.* This “stupid condition,” Warburg concluded, immobilized the country’s assets, just as if an army were required to garrison its troops in thousands of scattered barracks rather than be allowed to shift them to the front and concentrate them where they were needed most. “To a person trained under the central banking system of European countries,” he would write, “such conditions seemed bewildering and strange.”
In various other ways, Warburg judged that the American system, adequate perhaps for an agrarian society, was unsuited to the fast-growing industrial and commercial economy of the early 1900s. In Europe, a bank holding short-term loans could sell this paper in a liquid secondary market. (This was true both for the bills of trade mentioned earlier, which were issued by banks, and for commercial paper, which consisted of promissory notes issued by merchants and other businesses.) As a result, Europe’s credit markets were fungible and highly liquid, similar to the stock market. In the United States, a bank that held such paper was stuck with a fixed, immobile asset. The lack of trading could not but be a drag on business. America needed a banking system, Warburg wrote, that was up to handling “a lively and intimate daily exchange.” As business grew, the system’s shortcomings were bound to surface.
America's Bank: The Epic Struggle to Create the Federal Reserve Page 4