How Populist Outrage Gave Birth to the Federal Reserve: Echoes

This week marked the 104th anniversary of the night that ultimately gave birth to the Federal Reserve.

On Nov. 2, 1907, John Pierpont Morgan assembled the presidents of several prominent trust companies in the library of his Fifth Avenue mansion. The illiquidity of their firms had caused what is known today as the Panic of 1907. Morgan forced those rich and powerful men to wait and worry, and by the next morning he had strong-armed them into an agreement that ended the crisis.

It wasn't the first time that Morgan, a private citizen, had come to the rescue of the financial community. And the reaction among the public, and at all levels of government, was a mixture of shame and anger. In response, Congress created a central bank six years later, on Dec. 23, 1913.

Today, as its 100th anniversary approaches, many followers of both the Tea Party and Occupy Wall Street movements are calling to "End the Fed." The rich irony here isn't that reactionaries and radicals are in agreement on something; after all, they are both passionately populist. The irony is that it was populist outrage and calls for reform that created the Fed in the first place.

The U.S. had what amounted to a central bank in its early days. The First Bank of the United States received its 20-year charter in 1791, part and parcel of Treasury Secretary Alexander Hamilton's efforts to put the young republic on a sound financial footing. Those efforts included federal assumption of the states' war debts, and were opposed vociferously by Thomas Jefferson and his allies.

It has often been observed that Americans are children of Jefferson living in Hamilton's nation, and that is most obvious in the almost continuous debate over central banking.

Populist sentiment prevailed when the charter for the First Bank of the United States wasn't renewed in 1811. The timing couldn't have been worse: The War of 1812 soon left Washington, international trade and the economy all in ashes.

To bring some order to the chaos, the Second Bank of the United States was chartered in 1816, but its renewal was vetoed in 1836 by Andrew Jackson, a president possibly even more anti-bank than Jefferson.

The next year, J.P. Morgan was born in Hartford, Connecticut.

The three decades from the demise of the second central bank to the point where the Lincoln administration began printing greenbacks to finance the Civil War were known as the years in the wilderness for American finance. Banks printed their own notes -- and let the buyer beware. Bank runs and panics were a common fact of life.

Even with the terrible economic conditions we've seen in the past few years, it's difficult today to comprehend the precarious state of business and personal finance in those days. Not only was there no central bank to restrain economic swings, there was no deposit insurance and no social safety nets. Banks were chronically undercapitalized and went bust with alarming frequency. There was no recourse for depositors. Farms and shops were foreclosed, families put on the street.

In 1907, the economy had been showing multiple signs of distress. As with our recent troubles, the natural ebbs and flows of the economy were amplified and made dangerous by excessive speculation, irresponsible lending and financial engineering run amok. By one account, half the bank loans in New York City were backed only by securities as collateral.

Returning to New York at the time from an Episcopal Church convention in Richmond, Virginia, the 70-year-old, semi-retired Morgan reluctantly entered the fray.

On Oct. 21, copper prices collapsed and an attempt to corner the market by mining magnate F. Augustus Heinze and notorious banker Charles W. Morse failed. Charles T. Barney was president of Knickerbocker Trust Co., the third-largest in New York. He had backed previous ventures by Heinze and Morse, but declined to back the copper play. Nevertheless, when the attempted corner failed, Barney's long association with the pair led the trust's board to force him out. Depositors ran on Knickerbocker, and it failed the next day.

Heinze was indicted, but not convicted. Morse went to federal prison. Barney shot himself.

Bank runs, stock volatility, bankruptcies and wild rumors began caroming around financial markets. Morgan tried to instill calm while practicing triage. Operations like Knickerbocker that were too far gone were left to die. Banks, brokerages and businesses that were fundamentally sound but in distress were supported.

Morgan wasn't necessarily acting out of the goodness of his heart. In the end, the last shaky outfits standing were a few trust banks and the brokerage of Moore & Schley, which controlled Tennessee Coal & Iron. Morgan, who had founded U.S. Steel -- the first $1 billion company in the world -- in 1901, wanted Tennessee Coal in his fold. His Faustian bargain: Moore & Schley would sell Tennessee Coal to U.S. Steel for $45 million, enough money to stay solvent. In return, the healthier trusts would create a $25 million pool to support the weaker ones.

Morgan locked the principals in his library to settle the deal, sometimes taking one or another aside for some added cajoling. The climax came when he confronted the last holdout -- Edward King, president of Union Trust Co. -- at around 5 a.m. on Nov. 3. Morgan pointed to the agreement on the table and said, "Here is the place, King, and here's the pen."

President Theodore Roosevelt, legendary trust-buster, was wise enough to allow the shotgun wedding of Tennessee Coal to U.S. Steel for the greater good. Two weeks later, Oklahoma would be admitted as the 46th state -- the expansion of the nation could not be hobbled, and if Morgan got a fire-sale price for Tennessee Coal, that could be considered his fee for services rendered.

But such a price would never be paid again.

In 1908, Republican Senator Nelson Aldrich of Rhode Island convened a special banking commission devoted to creating a central bank that would respond to such crises in the future. He noted wryly that "we many not always have Morgan." Indeed, the financier died March 31, 1913.

Nine months later, The Glass-Owen bill establishing the Federal Reserve system was adopted and signed into law.

(Gregory D. L. Morris is a member of the editorial board of the Museum of American Finance, a Smithsonian affiliate, and a contributor to the Echoes blog. The opinions expressed are his own.)


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