America's Bank: The Epic Struggle to Create the Federal Reserve

by Roger Lowenstein

  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.

  Aldrich focused on the big three of European banking—England, Germany, and France. Each of their central banks was owned by private shareholders and held the national reserve, but in important ways they differed. The Bank of France possessed far more gold—more, in fact, than the other two combined. Also, the French bank was controlled by the state; England’s was defiantly independent. Surprisingly, directors of the latter were wealthy merchants rather than bankers. In Germany, management was in the hands of trained professionals—experts such as Warburg. The German chancellor held supreme power over the Reichsbank but rarely used it.

  The Aldrich mission docked at Plymouth, England,
on August 10, 1908, and was welcomed to dinner at Morgan’s London home, with Lord Rothschild present. Morgan lost no time in requesting a favor, complaining to Aldrich that the tariff on importing art was interfering with his plan to donate European treasures to the Metropolitan Museum in New York. Interviews at the Bank of England got off to a slow start. The commission group was unwieldy; the Americans struck their hosts as naïve and unprepared. Matters improved after a few days, when two commissioners returned home and several of the others struck out on their own. From then on, Aldrich worked with a core group including Andrew and Davison. Knowing he would need the support of western bankers, Aldrich also enlisted George Reynolds, a former Iowa store clerk and head of the Continental National Bank of Chicago, who cut short a vacation in Italy to join them. (In turn-of-the-century America, Chicago was still considered “western.”) Davison took the lead in interrogating foreign bankers and leavened the sessions with his playfulness and wit.

  The resilience of British banking made a strong impression on Aldrich. Commercial banks kept very little cash; they didn’t feel the need. Even the Bank of England had relatively little gold, but faith in the institution obviated the need for more. The Americans could not help but notice how the monetary landscape was inverted from their own: the United States had far more bullion, but confidence in the national currency was greater in England. Also, as a businessman with investments in Mexico and Africa, Aldrich appreciated the ease with which British merchants financed trade. After their interview sessions, Aldrich and Andrew went rummaging through London bookstores, Aldrich liberally buying economics books for the library he was planning for Warwick. He also hunted down a print of Sir Robert Peel, the British prime minister responsible for the 1844 law that gave the Bank of England the exclusive right to issue notes. Why did Aldrich want a picture of Peel? Andrew had the strong sense that the senator had discovered his purpose; he wanted to become America’s Robert Peel.

  At the end of August, the group ventured to Berlin, where Andrew and Davison took in the Turkish baths, Andrew went to a production of the Strauss opera Salome, and more rounds of interviews commenced. Then they took a train to Paris. In the City of Light, Aldrich gazed wistfully at a dispatch written by Napoleon, just after the battle of Austerlitz, in which the general advised that the Bank of France was as critical to the Republic as were his victories in battle. The Aldrich group dined with James Stillman, the most distinguished American banker in Paris, who suggested that Aldrich gather some trusted bankers at Warwick and draw up a plan in secret. The next day, Andrew and the Davisons motored out to the country château of the U.S. ambassador.

  At each central bank, the Americans were given to feel like the representatives of a primitive system, one barely above contempt. Their astonishment at what they heard was palpable (the interviews in Germany and France were assisted by an interpreter). The Europeans portrayed their institutions as effortlessly superseding parochial or private interests; their policies seemed universally accepted. The interviews, of course, took place at the apogee of the social harmony of prewar Europe. Had Aldrich gone to Europe in the 1920s, much less in the 1930s, the picture would not have been so harmonious.

  Davison and Aldrich pressed their hosts on the question of reserves: Who held them? What were the requirements? What were the rules regarding the holding of cash? The Europeans’ consistent response, phrased in varying ways, was that the confidence reposed in their centralized systems obviated the need for the rigid regulations of American banking. London bankers could not relate to the American fetish with “elasticity.” How then, the Americans wondered, did the Bank of England adjust the currency supply to meet demand? A Bank official, rather a delphic one, said this occurred “automatically.” (He meant that as bills of trade were discounted—that is, accepted by the Bank England in return for its notes—Bank notes entered circulation.) At the Reichsbank, the mechanics of discounting were gone over in detail. Exchanging bankers’ loans for notes of the Reichsbank was a critical function, an official explained: “We could not stop it.” On form, once a central bank was established, the other banks adapted—became dependent. The German continued, “If we did [stop] it would bring about the greatest panic that we ever experienced.”

  It was in France where the visitors were truly humbled. Davison explained that, in the United States, “the question of the proper relation between cash in hand and liabilities is considered very important.” What, he inquired, was the rule in France: What portion of deposits were backed by cash reserves?

  M. Pallain, the governor of the Bank of France, shook his head with a weary sigh. “I think you pay more attention to the quantity [of reserves] than to the quality.”

  But surely France had laws, regulations, some stipulation governing the proper proportion?

  “Non.” The reserve requirements so dear to America, Pallain replied, were insignificant in France, “on account of the facilities offered by the Bank of France for the rapid conversion, in a crisis,” of portfolio assets into ready money.

  The Americans persisted: What, they demanded, determined the fluctuations in the volume of notes? Pallain, despairing of his ability to explain the power of a central reserve to these stubborn Yanks, waxed philosophical. “It is the sun,” he said, “or it would perhaps be more correct to say, the alternating seasons.”

  The problem that Aldrich had come to investigate did not, on this side of the Atlantic, appear to exist. Throughout fifty-eight meetings with central bankers as well as with diplomats, editors, and local financiers, the overriding sense was one of internal coherence—of a system that worked. At the very least, Europe employed its reserves while America largely squandered its own. George Reynolds, the Chicago banker, maintained it was in Berlin, in the luxurious lobby of the Hotel Adlon, on a sofa behind the bend of the stairway facing its giant marble columns, where Aldrich “converted” to the central bank idea. At any rate, when he docked in New York on October 20, after an absence of fully eleven weeks, Aldrich was a changed man.

  The November elections bolstered his sense of possibility. In the presidential contest, Taft trounced Bryan, whose appeal was confined to the South and a sprinkling of states in the West. The outgoing Roosevelt helpfully announced that he would get out of the way and leave the limelight to his successor—specifically by going on safari in Africa. Just as important, the Republicans won commanding majorities in both the House and the Senate. Aldrich’s timing could not have been better.

  That fall, the Monetary Commission held a hearing at the Metropolitan Club of New York, a perfect opportunity for Aldrich to unveil his agenda. The interregnum between election and inauguration was traditionally a period for showcasing new ideas. But Aldrich revealed nothing. Paul Warburg, invited to present his thoughts, noticed that some of the other commissioners looked downright drowsy—almost comatose. After the session, though, Aldrich summoned the banker.

  “Mr. Warburg,” he began, “I like your ideas. I have only one fault to find with them.”

  Warburg, momentarily stunned, asked about the fault.

  Aldrich shot back, “You are too timid about it. You say we cannot have a central bank, and I say we can.”

  As Warburg was to recall in poignant terms, “It is easy to imagine, but hard to describe, the mixed feelings of joy and bewilderment into which this remark threw me, for suddenly I found our roles reversed.” Whereas previously the banker despaired of persuading Aldrich of the merit of a central bank, now he feared that Aldrich would jeopardize the project by being too ambitious. Warburg explained that a bank with broad powers, such as existed in Europe, was politically impossible due to Americans’ deep-seated prejudices against federal power. They debated the point, without resolution. Their difference notwithstanding, Warburg left elated. “For the first time,” he would write, “I felt confident that genuine banking reform was within grasp of the United States.”

  Warburg jumped into the fray with his trademark
energy. In the short space of a couple of months, he wrote an essay on the discount system in Europe, read a paper on central banking before the American Economic Association, and joined the currency committee of the Merchants’ Association of New York. Business groups were becoming interested in currency reform because the panic had wreaked such havoc on trade. Even though the Merchants’ Association did not favor central banking, Warburg became a fifth column, relentlessly indoctrinating the other members. “Many an afternoon and night I sat with them,” Warburg was to write, “struggling to win them over to the gospel of centralized reserves.”

  Aldrich, meanwhile, began telling friends he would not run for another term in 1910, and that he would focus, during the time left to him in office, on monetary reform. He had visions of a central bank as the crowning work of his career—a monument to his decades in the Senate. The truth about his decision to retire was more complicated. Vilified for opposing progressive causes, and tarnished in the public eye ever since the “Treason of the Senate” exposé in Cosmopolitan, the senator was growing weary of divisive battles. The ugly political cartoons (invariably showing corporate money slushing in his pockets) had taken a toll. A perceptive reporter observed that, despite Aldrich’s image of implacability, “he doesn’t like being pilloried continually in newspapers and cartoons as a corporation Senator, the representative of ‘special interests.’”

  Aldrich intended to devote a full two years to crafting a bill. He wanted to work at a safe remove from politics, studying banking as if it were a purely academic or technical subject. The commission certainly had plenty to do; it had to hire writers and gather facts and figures on banking and money in each of forty-six states and overseas. Such information was difficult to obtain; New York’s banking department did not even have a spare copy of the state’s banking laws.

  Nonetheless, Aldrich should have set a brisker pace; politics is always a question of seizing the hour. He believed he could legislate at leisure, but he misjudged the gathering strength of progressives, who were pushing for reforms such as an income tax, direct election of senators, labor protections, corporate regulation, and (taking dead aim at Aldrich) reduction of the tariff. These forces were challenging Aldrich’s dominion in the Senate and redefining the national agenda. Aldrich overlooked the need to engage the public, even on what he hoped would become his capstone achievement. In a stopover in Milwaukee, soon after he returned from Europe, his response to a reporter’s question about his commission work ran to seven words: “Really, gentlemen, I have nothing to say.”