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

by Roger Lowenstein

  CHAPTER THIRTEEN

  “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.

  —REPRESENTATIVE THOMAS W. HARDWICK, on the Glass-Owen bill

  Isn’t it wonderful?

  —WOODROW WILSON TO ELLEN WILSON, September 19, 1913, the day following House passage

  OVER LATE JULY AND AUGUST, 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 th
e 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.

  Owing to the Democrats’ large majority, the debate in the House was brief. The Republicans tried to distract the chamber by proposing an amendment endorsing the gold standard (which the legislation had left untouched). As expected, some of the Democrats became aroused by the mention of the Republican metal and wanted to substitute “coin” for “gold,” to include a place for silver. Fearing a tempest, Glass called Bryan. The Commoner had no interest in revisiting old crusades and advised that silver was “irrelevant.” On September 18, the gold standard amendment was approved. Hours later, Glass-Owen passed by a thumping vote of 285–85. All but three Democrats voted in favor.

  Glass could not have done it without Bryan, and Bryan, surely the least likely man to champion a central bank, had cooperated only due to Wilson’s dogged courtship and careful compromising. Willis ascribed the credit “almost exclusively to the unswerving determination of the President.” Wilson was elated. He wrote to his “own darling,” Ellen, that he was overjoyed to see the bill pass “by so splendid a majority.”

  Nevertheless, the outlook in the Senate was problematic. Local control was less of a concern in the upper chamber, and many senators agreed with the ABA that twelve Reserve Banks were well too many. The Republicans on the Banking Committee favored a more centralized approach and so did two of the Democrats—Gilbert Hitchcock of Nebraska and James O’Gorman of New York. Another Democrat, James Reed of Missouri, was a demagogue and reflexively oppositional. Without those three, the Democrats’ 7–5 majority on the committee would shrink to a 4–8 minority.

  In contrast to the brisk proceedings in the House, the Senate committee scheduled extensive hearings, with a witness list that was stacked with fault-finding bankers. Forgan was the lead witness; he insisted that Congress ditch Glass-Owen for a single bank. Festus Wade, objecting to the bill’s compulsory features, was even harsher. “To many of us, and I admit I am one, this bill is repulsive,” the banker said. As such views were known, the purpose of the hearings was less to inform than to sow discord and delay.

  Owen, who was not an effective chair, sought to cut the proceedings short, but the Democratic holdouts ganged up with the minority and the hearings dragged on. The list of witnesses included a hardware executive from Duluth, a lumber merchant from Minneapolis, a smattering of economists and lawyers, and a parade of bankers. The quarrelsome senators brazenly led their witnesses and tried to elicit negative comments. Despite their efforts, a rich diversity of viewpoints emerged. A telling exchange occurred between Senator Hitchcock and Thomas McRae, a country banker from Prescott, Arkansas, whose tiny institution boasted capital and surplus of a mere $150,000. McRae, like other Arkansas bankers, was accustomed to spreading his reserves among banks in New York, St. Louis, and Little Rock. Under Glass-Owen, McRae would be forced to shift his reserves to the nearest Federal Reserve Bank. Hitchcock, emphasizin
g the bill’s coercive character, tried to goad him into denouncing it. McRae did not bite.

  HITCHCOCK: You have the power to control it. Do you want all that wiped out, to have all your eggs put in one basket and no assurance that your paper will be discounted when you present it?

  MCRAE: Your question assumes that the place where I can now present my paper will have plenty of money to accommodate me. This was not true in 1907.

  McRae testified that, given the ever present threat of a panic, prudence required him to operate with an overabundance of cash. The cotton farmers in Prescott did their borrowing from March through the summer; when the loan season peaked, McRae generally put $2 million in the safe, just to have on hand. The money, in other words, sat idle. “The purpose of this bill,” McRae volunteered, lecturing the senator, “is to require public funds of the United States to be kept in circulation.”

  But country bankers, with their deeply held suspicions of centralized banking, did have concerns. They were unhappy at being made to invest their capital in the Federal Reserve when dividends would be capped at 5 percent—less than they typically earned on loans. And they feared that under the new system, the cumbersome process for clearing checks would be overhauled, rationalizing a business on which they earned tidy fees.

  Wall Street’s view of the bill was ambiguous. Bankers were vocal with a few key criticisms but favored the bill’s guiding principle of concentrating reserves. And they tended to be less oppositional in private. Warburg was a prime example. Appalled by the populist rhetoric of politicians, he adamantly opposed putting the banks under political control. In an article published just before he returned from Switzerland, Warburg fulminated that “in our country, with every untrained amateur a candidate for any office . . . a political management would prove fatal.” Yet Warburg’s criticisms, relayed from his mountain lair in Europe via Colonel House, were always intended to improve the Glass-Owen legislation—not to forestall it. Reform had been his idea, and he remained an avid supporter.