Hindsight: The Federal Reserve’s Framers Would Be Shocked

ONE hundred years ago today, President Woodrow Wilson went before Congress and demanded that it “act now” to create the Federal Reserve System. His proposal set off a fierce debate. One of the plan’s most strident critics, Representative Charles A. Lindbergh Sr., the father of the aviator, predicted that the Federal Reserve Act would establish “the most gigantic trust on earth,” and that the Fed would become an economic dictator or, as he put it, an “invisible government by the money power.”

Had the congressman witnessed Ben S. Bernanke’s news conference last week, he surely would have felt vindicated. Investors, traders and ordinary citizens listened with rapt attention as Mr. Bernanke, the Fed chairman, spoke of his timetable for scaling down stimulative bond purchases. “If things are worse, we will do more,” he said of the nation’s economy. “If things are better, we will do less.”

In 1913, few of the framers of the Fed anticipated that the institution would do anything of the sort. The preamble to the act specified three purposes: to furnish “an elastic currency,” to provide a market for commercial paper so that banks would have more liquidity, and to improve supervision of banks. Regulating the economy was not among them.

The framers saw that the banking system needed reform, but they were sorely divided about how to go about it. Wall Street wanted a strong central bank — preferably under private control. Populists like William Jennings Bryan, Wilson’s secretary of state, insisted that banks answer to the public. But many people from the farm belt, like Lindbergh, were opposed to any powerful financial agency.

The backdrop to the legislation was that the United States, in the late 19th century, suffered frequent financial panics. In 1907, banks ran out of cash and the panic snowballed into a depression. The nation had no central reserve — no agency that, in a crisis, could allocate credit where needed. All it had was J.P. Morgan Sr., who arranged for a private loan syndicate. That was not enough, and, anyway, in the spring of 1913 Morgan died. Leading financiers, like Paul Warburg, a German immigrant who wanted to replicate the Reichsbank in his adopted home, thought the United States needed some coordinating agency. They thought that the system was too decentralized.

Many ordinary Americans disagreed. They thought banking was too centralized already, and that credit shortages were the fault of uncompetitive practices on Wall Street. Over the winter of 1912-13, Congress staged sensational hearings to unmask the “money trust” — a supposed conspiracy among the biggest banks. The hearings did not uncover evidence tying credit shortages to collusive behavior. They did establish that Wall Street tycoons were overly clubby with one another — especially in the distribution of securities — and not exactly beacons of free competition.

The Democrats, who won control of Congress in 1912, promised in their platform to free the country “from control or domination by what is known as the money trust.” What’s more, they specifically opposed the creation of a “central bank,” which the delegates saw as a stalking horse for the money trust.

THUS, supporters of the Federal Reserve legislation faced a delicate problem: how to fashion a centralizing agency and not run afoul of the strong popular sentiment against centralization.

Representative Carter Glass of Virginia, the chief sponsor of the Federal Reserve Act, embodied this dichotomy. Before 1913, his claim to fame was helping to draft a state constitution that had disenfranchised African-Americans. He was an ardent champion of states’ rights. Like most Southern Democrats, he wanted to restrain federal authority — in banking as well as in race relations. Laissez-faire Democrats since Jefferson and Jackson had opposed central banks, and Glass embraced that tradition. But he recognized a need for banking reform, and wanted a more elastic currency to avert money panics and moderate depressions.

His solution was to propose privately owned regional reserve banks that would be new centers of banking strength, away from Wall Street. Wilson horrified him by insisting that a Reserve Board sit atop the individual banks. To Glass, this federalist design looked too much like a central bank.

Then Wilson horrified Wall Street by insisting that Reserve Board members be named by the president, rather than by banks. “History and experience unmistakably show that governments are not good bankers,” hissed The New York Times, which typically toed the Wall Street line. The Washington Post accused Wilson of engineering “a colossal political machine.”

Facing Congress on June 23, Wilson touched a popular chord when he said banks should be “the instruments, not the masters, of business.” But he also said that “our banking laws must mobilize reserves.” This had been Warburg’s main goal — to pool banking reserves so they could be tapped as needed.

Historians still debate what the Fed’s framers intended because many details were left vague, and the Fed evolved over time. When the act was signed, in December 1913, few anticipated that the Federal Reserve Board would become so central to the economy, though it did have authority over interest rates. And Glass pledged that the new agency would be restrained by the requirements of the gold standard — which the nation eventually abandoned.

The current Fed would dismay the framers. Glass would be shocked at the power of Mr. Bernanke. Warburg might applaud the Fed’s efforts to temper a recession, while frowning on its printing of “fiat money.”

For some of the same reasons, “end the Fed” is a rallying cry among Tea Partyers, and among critics with a fondness for the gold standard. Representative Kevin Brady, a Texas Republican who is chairman of the Joint Economic Committee, has marked the Fed’s centennial by calling for a commission “to examine the United States monetary policy” and “evaluate alternative monetary regimes.”

The trenchant question is whether nostalgia for “originalism” is a useful guide to policy. Wilson knew well that the Second Bank of the United States — a 19th-century precursor to the Fed — had been left to die, at the insistence of President Andrew Jackson. But Wilson was trying to govern for the present, not to placate his party’s ghosts. Congress today should receive reform proposals in the same spirit.

Roger Lowenstein is writing a history of the Federal Reserve.

Article source: http://www.nytimes.com/2013/06/23/business/the-federal-reserves-framers-would-be-shocked.html?partner=rss&emc=rss