The United States Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913.
Central banking prior to the Federal Reserve The Federal Reserve System is the third central banking system in United States history. The First Bank of the United States (1791–1811) and the Second Bank of the United States (1817–1836) each had a 20-year charter. Both banks issued currency, made commercial loans, accepted deposits, purchased securities, maintained multiple branches and acted as fiscal agents for the U.S. Treasury. The U.S. Federal Government was required to purchase 20% of the bank capital stock shares and to appoint 20% of the board members (directors) of each of those first two banks "of the United States." Therefore, each bank's majority control was placed squarely in the hands of wealthy investors who purchased the remaining 80% of the stock. These banks were opposed by state-chartered banks, who saw them as very large competitors, and by many who insisted that they were in reality banking cartels compelling the common person to maintain and support them. President Andrew Jackson vetoed legislation to renew the Second Bank of the United States, starting a period of free banking. Jackson staked the legislative success of his second presidential term on the issue of central banking. "Every monopoly and all exclusive privileges are granted at the expense of the public, which ought to receive a fair equivalent. The many millions which this act proposes to bestow on the stockholders of the existing bank must come directly or indirectly out of the earnings of the American people," Jackson said in 1832.Andrew Jackson, "Veto Message, Washington, July 10, 1832," in Richardson, ed., Messages and Papers of the Presidents, II, 576–591. Jackson's second term in office ended in March 1837 without the Second Bank of the United States' charter being renewed.
In 1863, as a means to help finance the Civil War, a system of national banks was instituted by the National Currency Act. The banks each had the power to issue standardized national bank notes based on United States bonds held by the bank. The Act was totally revised in 1864 and later named the National-Bank Act, or National Banking Act, as it is popularly known. The administration of the new national banking system was vested in the newly created Office of the Comptroller of the Currency and its chief administrator, the Comptroller of the Currency. This federal agency, which still exists today, examines and supervises all banks chartered nationally and is a part of the U.S. Treasury Department.
The Federal Reserve Act, 1913
National bank currency was considered inelastic because it was based on the fluctuating value of U.S. Treasury bonds. If Treasury bond prices declined, a national bank had to reduce the amount of currency it had in circulation by either refusing to make new loans or by calling in loans it had made already. The related liquidity problem was largely caused by an immobile, pyramidal reserve system, in which nationally chartered rural/agriculture-based banks were required to set aside their reserves in federal reserve city banks, which were required to have reserves in central city banks. Rural banks exploited their reserves during the planting season to finance full plantings. Then, during harvest season, they used profits from loan interest payments to restore and grow their reserves. A national bank whose reserves were being drained would replace them by selling stocks and bonds, borrowing from a clearing house, or calling in loans. With little private deposit insurance and no federal deposit insurance, if a bank was rumored to be having liquidity problems, this might cause many people to withdraw their funds. Because of the crescendo effect (repeated situations of moral distress) of banks that lent more than their assets could cover, the United States economy experienced a series of financial panics during the last quarter of the 19th century and the beginning of the 20th century.
The National Monetary Commission, 1907-1913 Prior to a particularly severe panic in 1907, there was a motivation for renewed demands for banking and currency reform. The following year, Congress enacted the Aldrich–Vreeland Act, which provided for an emergency currency and established the National Monetary Commission to study banking and currency reform.
The chief of the bipartisan National Monetary Commission was Nelson Aldrich, a financial expert and Senate Republican leader. Aldrich set up two commissions – one to study the American monetary system in depth and the other, headed by Aldrich, to study and report on the European central-banking systems.
Aldrich went to Europe opposed to centralized banking but, after viewing Germany's banking system, he came away believing that a centralized bank was better than the government-issued bond system that he had previously supported. Centralized banking was met with much opposition from politicians, who were suspicious of a central bank and who charged that Aldrich was biased due to his close ties to wealthy bankers such as J.P. Morgan and his daughter's marriage to John D. Rockefeller Jr.
In 1910, Aldrich and executives representing the banks of J.P. Morgan, Rockefeller, and Kuhn, Loeb & Co., secluded themselves for ten days at Jekyll Island, Georgia. The executives included Frank A. Vanderlip, president of the National City Bank of New York, associated with the Rockefellers; Henry Davison, senior partner of J.P. Morgan Company; Charles D. Norton, president of the First National Bank of New York; and Col. Edward M. House, who would later become President Woodrow Wilson's closest adviser and founder of the Council on Foreign Relations. There, Paul Warburg of Kuhn, Loeb, & Co. directed the proceedings and wrote the primary features of what would be called the Aldrich Plan. Warburg would later write that "The matter of a uniform discount rate (interest rate) was discussed and settled at Jekyll Island." Vanderlip wrote in his 1935 autobiography From Farmboy to Financier: Excerpts at
Despite my views about the value to society of greater publicity for the affairs of corporations, there was an occasion, near the close of 1910, when I was as secretive, indeed, as furtive as any conspirator. None of us who participated felt that we were conspirators; on the contrary we felt we were engaged in a patriotic work. We were trying to plan a mechanism that would correct the weaknesses of our banking system as revealed under the strains and pressures of the panic of 1907. I do not feel it is any exaggeration to speak of our secret expedition to Jekyl Island as the occasion of the actual conception of what eventually became the Federal Reserve System. ... Discovery, we knew, simply must not happen, or else all our time and effort would be wasted. If it were to be exposed publicly that our particular group had gotten together and written a banking bill, that bill would have no chance whatever of passage by Congress. Yet, who was there in Congress who might have drafted a sound piece of legislation dealing with the purely banking problem with which we were concerned?
Despite meeting in secret, from both the public and the government, the importance of the Jekyll Island meeting was revealed three years after the Federal Reserve Act was passed, when journalist Bertie Charles Forbes in 1916 wrote an article about the "hunting trip".Leslie's Weekly, Oct. 19, 1916, p. 423. Collected in
The 1911–12 Republican plan was proposed by Aldrich to solve the banking dilemma, a goal which was supported by the American Bankers' Association. The plan provided for one great central bank, the National Reserve Association, with a capital of at least $100 million and with 15 branches in various sections. The branches were to be controlled by the member banks on a basis of their capitalization. The National Reserve Association would issue currency, based on gold and commercial paper, that would be the liability of the bank and not of the government. The Association would also carry a portion of member banks' reserves, determine discount reserves, buy and sell on the open market, and hold the deposits of the federal government. The branches and businessmen of each of the 15 districts would elect thirty out of the 39 members of the board of directors of the National Reserve Association.Link, Arthur. Wilson and the Progressive Era New York: Harper, (1954) pp. 44–45
Aldrich fought for a private monopoly with little government influence, but conceded that the government should be represented on the board of directors. Aldrich then presented what was commonly called the "Aldrich Plan" – which called for establishment of a "National Reserve Association" – to the National Monetary Commission. Most Republicans and Wall Street bankers favored the Aldrich Plan, but it lacked enough support in the bipartisan Congress to pass.
Because the bill was introduced by Aldrich, who was considered by southern and western states the epitome of the "Eastern establishment", the bill received little support. It was derided by southerners and westerners who believed that wealthy families and large corporations ran the country and would thus run the proposed National Reserve Association. The National Board of Trade appointed Warburg as head of a committee to persuade Americans to support the plan. The committee set up offices in the then-45 states and distributed printed materials about the proposed central bank. The Nebraskan populist and frequent Democratic presidential candidate William Jennings Bryan said of the plan: "Big financiers are back of the Aldrich currency scheme." He asserted that if it passed, big bankers would "then be in complete control of everything through the control of our national finances."
There was also Republican opposition to the Aldrich Plan. Republican Sen. Robert M. La Follette and Rep. Charles Lindbergh Sr. both spoke out against the favoritism that they contended the bill granted to Wall Street. "The Aldrich Plan is the Wall Street Plan ... I have alleged that there is a 'Money Trust'", said Lindbergh. "The Aldrich plan is a scheme plainly in the interest of the Trust". In response, Rep. Arsène Pujo, a Democrat from Louisiana, obtained congressional authorization to form and chair a subcommittee (the Pujo Committee) within the House Committee Banking Committee, to conduct investigative hearings on the alleged "Money Trust". The hearings continued for a full year and were led by the subcommittee's counsel, Democratic lawyer Samuel Untermyer, who later also assisted in drafting the Federal Reserve Act. The "Pujo hearings" convinced much of the populace that America's money largely rested in the hands of a select few on Wall Street. The Subcommittee issued a report saying:
If by a 'money trust' is meant an established and well-defined identity and community of interest between a few leaders of finance ... which has resulted in a vast and growing concentration of control of money and credit in the hands of a comparatively few men ... the condition thus described exists in this country today ... To us the peril is manifest ... When we find ... the same man a director in a half dozen or more banks and trust companies all located in the same section of the same city, doing the same class of business and with a like set of associates similarly situated all belonging to the same group and representing the same class of interests, all further pretense of competition is useless. ...