The Fed’s Century of Power Started With a Fateful Meeting

Roger Lowenstein is writing a book on the origins of the Federal Reserve System.
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On Dec. 26, 1912, Representative Carter Glass visited New Jersey Governor Woodrow Wilson at his home in Princeton. The snows were piled high, and Wilson, the president-elect, was in bed with a cold.

Although he had canceled other appointments, Wilson insisted on seeing Glass -- who, he knew, was bringing a legislative proposal for a new system of coordinating bank reserves. Then as now, the U.S. had recently experienced a financial panic, and many argued that the monetary system was largely to blame.

Unlike every nation in Europe, the U.S. lacked a central bank, a legacy of the country’s fierce mistrust of large financial institutions. Only a week earlier, America’s most prominent banker, J.P. Morgan, had been hauled before a congressional committee -- much like the Dimons and Blankfeins in our time -- and grilled over his supposed control of the financial system. Suspicion of big banks was especially prevalent in the rural South and West, as it had been since the time of President Andrew Jackson.

Concentrated Power

Glass, who represented a Virginia farm district, was heir to that mistrust. Reared during Reconstruction, Glass had a sectional aversion to Wall Street and embraced the Democratic Party view that banking was too concentrated and too powerful. Wall Street, begging to differ, favored the creation of a body that would further concentrate the nation’s credit and make it available during a crisis.

Each side had a point. Although the Gilded Age had witnessed ferocious development of railroads and manufacturing, American banking was still primitive, better suited to the era of the Pony Express. Put simply, the U.S. had thousands of banks but no banking system. Rural banks placed their surplus cash with city banks, and city banks stored their cash in vaults in New York. The New York banks, lacking a good alternative, loaned their money on call to the stock market.

The result was predictable. At the first sign of trouble, the entire chain buckled. When farmers needed cash, telegraph wires vibrated with news of rural distress, and city banks called their loans. Even a whiff of such disquiet in the hinterland was enough to incite panic in the stock market, whose own credit was perched on the most precarious link in the chain. In the Panic of 1907, the banks had gone to Morgan for a rescue, but the economy was growing beyond the powers of an individual private banker.

Glass, a pugnacious redhead (and later author of the Glass-Steagall Act) was intent on ending the practice under which the country’s cash was deposited with New York bankers. This form of centralization, popularly (if misleadingly) dubbed the “money monopoly” or the “money trust,” was his primary villain. As his train steamed into Princeton -- the track had been cleared by a horse-drawn plow -- Glass focused on how he could persuade Wilson to reform the system without establishing a “central bank.”

Glass was accompanied by H. Parker Willis, a journalist moonlighting as his legislative aide. The two traveled by carriage from the station to a little house on Cleveland Lane, where an aged butler answered their knock and escorted them past a blazing fire to Wilson’s chamber. The gaunt, square-jawed Wilson -- not the most robust of men even when in good health -- was propped on pillows.

Receptive Hearing

Wilson had been governor for only two years, previous to which he had been an eminent scholar and the president of Princeton University. He was anything but a financial expert, and on the campaign trail he had echoed his party’s anti-banking chorus, declaring, “The money trust is no myth; it is no imaginary thing.” Like other Americans, Wilson was upset by the rush of big companies to merge into giant trusts. Financial conglomerates were the most complex, and thus the most frightening, of all. Although he and Glass were barely acquainted, Wilson was a fellow Virginian, and Glass had reason to expect a receptive hearing.

Wilson’s identification with banking critics was a recent thing, however, and his views were still evolving. He had, in fact, been drafted into politics by businessmen who hoped he might present a moderate, pro-business counterweight to the Populists, who were then dominant in the Democratic Party. Moreover, as the author of a popular history of the U.S., Wilson had written sympathetically of America’s two earlier, short-lived central banks. “The supporters of the Second Bank,” Wilson had written, “were in a measure justified in claiming that for such a purpose the very government itself had been set up.”

The plan that Glass and Willis presented to Wilson was a model of decentralization. It envisioned local reserve banks spread about the country -- perhaps 20 or more. These would each be entrusted with the cash reserves of the banks in their territory, and would be expected to lend to them in times of distress. The reserve banks would report to the U.S. Comptroller of the Currency, but they would essentially be independent organs -- owned by private banks and managed by private bankers.

When Wilson’s visitors were done, the president-elect was silent for a moment. Then he spoke. “It needs a capstone,” Wilson said -- an “altruistic” body that would sit above the reserve banks, supervise their activities, and direct policy. Wilson hadn’t worked out the details, but he sensed that Glass’s collection of independent banks was inconsistent with the constitutional premise of checks and balances. No single official could manage such a vast banking network.

‘Keep Quiet’

That Glass was unhappy with Wilson’s suggestion may be deduced from the letter he wrote days later to Willis, in which he voiced his suspicion that Wilson had been lobbied by bankers pushing a “dangerous centralization.” Glass was correct; Wall Street had lobbied Wilson. Judging that Wilson might yet bend, Glass wrote, “We shall have to keep quiet on this point for the present.”

To this astonishing suggestion that they work around the designs of the future president, Willis replied, more thoughtfully, that Wilson’s idea of a “capstone” ultimately raised “the problem of whether this mechanism should be simply a mechanism of ‘control’ or ‘oversight’ or whether it shall be an actual means of doing business.”

Where would the power to set interest rates, intervene in markets and affect policy reside -- with the reserve banks or with the capstone in Washington?

In 1912, prejudice against central banks sparked a bitter legislative debate, which threatened to doom the entire project. But on Dec. 23, 1913, a year after the two Virginians met, Glass’s proposal was enacted as the Federal Reserve Act. Although the Fed was initially hampered by its regional character, Wilson’s “capstone” -- the Federal Reserve Board -- in time would evolve into a full-blown and forceful central bank. However, fear of the Fed’s authority would re-emerge in each generation, often promoted by demagogues and girded by the most fantastic of conspiracy theories.

A century after that fateful meeting, the power of Glass’s regional banks has atrophied, while Wilson’s capstone, thanks to its central structure and authority, has sufficient command of reserves to backstop the financial system. Its leadership, over time, has been variously competent or flawed, but at least until the arrival of the next J.P. Morgan, it is the necessary lender of last resort.

(Roger Lowenstein is the author of “When Genius Failed: The Rise and Fall of Long-Term Capital Management” and is writing a book about the origins of the Federal Reserve system. The opinions expressed are his own.)

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