Chapter Two - Banking Reform 1907-1913

The gold-driven prosperity of the early 1900s did not validate the nation's hapless financial structure. European banking experts had long been appalled by its irrationality and lack of central control. Unlike other industrial nations, the United States had no central bank to ease the effect of economic shocks or to prevent them, by creating or depleting bank reserves. In 1907, the point was driven home with frightening clarity.

In 1873 and again in 1893, clearing-house associations in New York, St. Louis, Philadelphia and other major cities had issued clearing-house loan certificates when money dried up. Banks who were members could pledge illiquid securities in return for certificates that could be used to settle imbalances with other banks. Weak banks with a lot of bad paper could not qualify, but sound banks top-heavy with long-term loans were saved from short-term starvation. In 1907, the New York Clearing House issued $101 million in certificates and $256 million was the national total. The St. Louis Association made $11 million in certificates available to its members, and none of them failed. Nationally, bank failures barely exceeded the figures for "normal" years and did not outnumber new banks created.

After the breathing spell afforded by payment restrictions, banks furnished cash on demand to depositors in January 1908, and within a few weeks, depositors regained confidence. In February, they began to return currency to the banks. Contemporaries viewed the events of 1907 as a relatively mild contraction that became severe because of the bankers' panic and the restriction of payments. Later scholars have questioned this description, but it was widely agreed at the time that changes in the financial system were urgently needed to prevent a recurrence.[2] Many bankers hoped that the corrections would not be too drastic. Some favored creating a central currency reserve to meet emergencies, which would not be touched in ordinary times. During the panic, Cortelyou had used Treasury funds in this way, but he had too little cash available to stave off the restriction of payments.

Another proposal would have empowered national banks to supplement their government bond-backed notes with notes backed by cash in vault and deposits in reserve (or central reserve) city banks. This requirement, using the same assets employed to back deposits, would have solved the inelasticity problem. There was also support among bankers for a banker-controlled central bank such as that advocated by Frank A. Vanderlip of the National City Bank of New York. Vanderlip had gathered support from several leading New York businessmen for his plan, but few congressmen liked it. Agrarians and most Midwestern bankers saw too much Wall Street in the scheme.[3]

William Jennings Bryan, waging his third presidential campaign in 1908, made an issue of federally guaranteed bank deposits. This idea, which he had first advocated in 1894, was popular not only with farmers but with country bankers in the Midwest. Worried supporters of Republican nominee William Howard Taft reported in August that country bankers thought a federal guarantee would free them from the dictation of the East and New York in currency matters. Larger bankers, in the East especially, hated the idea because it would involve the government in banking, a dangerous precedent which carried the potential of taxing all banks to finance the guarantees.

After considering its options, Congress in 1908 enacted the Aldrich-Vreeland bill, which had two major features. The first, a stopgap measure, authorized emergency currency which could be issued by any group of 10 national banks, individually sound and with a combined capital and surplus of at least $5 million. This currency was available to any member of the association in amounts up to 75 percent of its commercial paper held by the association or up to 90 percent of the value of its holdings of approved state and federal bonds. The act's second provision, largely a device to avoid decisive action, established a National Monetary Commission composed of nine senators and nine representatives.

Senator Nelson W. Aldrich of Rhode Island was named chairman of the commission, which guaranteed the hostility of Democrats and insurgent Republicans such as Robert W. La Follette of Wisconsin to anything it might recommend. Aldrich, a former banker, was allied with the House of Morgan; he had written the Gold Standard Act of 1900, and he was the Senate's leading protectionist. He was as obnoxious to Democrats and insurgents as Bryan was to conservatives.

After touring Europe to study its banking systems and techniques, Aldrich and the other commissioners returned convinced that the United States should have a central bank controlled by bankers and issuing notes based on commercial paper. This was a surprising reversal for Aldrich, who previously had opposed any significant changes in the existing system, believing that only bond-related notes should be issued. The commission made no immediate proposal for legislation, knowing that an extensive campaign would be required to educate bankers and the public, especially after the Democrats gained control of the House of Representatives in 1910.

Various proposals for reform were under discussion by banking groups in 1909. The American Bankers' Association in 1906 had endorsed a system of regional clearing houses through which banks could issue notes secured by bonds and guaranteed by a fund derived from a tax on the notes when issued. This plan had been drafted by a currency commission of the ABA headed by A. Barton Hepburn of the Chase National Bank but dominated by Midwestern bankers who resented New York's financial hegemony. Western growth and the proliferation of banks had eroded some of Wall Street's dominance, and Chicago and St. Louis bankers liked the trend.[4]

Charles H. Huttig, president of the Third National Bank, and Festus J. Wade, president of the Mercantile Trust Company, represented St. Louis on the currency commission. They were prominent members of the banker and businessmen's group, conservative Democrats and some Republicans, who united politically behind the "good-government" Democratic Mayor Rolla Wells (1901-1909). Their detractors called them the "Big Cinch," a testament to their economic and political domination of the city. Huttig was a director of the Mercantile Trust, the St. Louis and Suburban Railroad, and the Laclede Gaslight Company. For years a leader in the ABA, he became its president in 1912 (the ABA itself had been organized in 1876 at the suggestion of St. Louis banker James T. Howenstein).[5]

Festus J. Wade, a brilliant, driving achiever, had an unusual background for a St. Louis banker. His family had come from Ireland to St. Louis in 1860, when he was a year old. Wade began working when he was 11 years old and had a dozen jobs from waterboy on a construction crew to driver for John Scullin and James Campbell's Northwestern horsecar line before he was 23, when he became secretary of the St. Louis Agricultural and Mechanical Fair Association. After studying part-time at a business college for four years, he entered a real estate partnership in 1893, where he was an immediate success. In 1899, he founded the Mercantile Trust Company, with considerable help from Scullin, the president of Scullin Steel, and Campbell, the organizer and principal stockholder of the four-city North American Utilities Company. Almost immediately the Mercantile Trust was second only to Julius Walsh's Mississippi Valley Trust Company among Missouri's banking houses. Wade took it from there, and by 1907 Mercantile had absorbed three of its competitors, including the large Missouri Lincoln Trust Company, and soon it had outdistanced all of its Missouri rivals.[6]

Wades formidable reputation was enhanced by such feats as forcing the St. Louis Terminal Railway monopoly to admit the Rock Island Railroad to its ranks, and blocking for several years, with Mayor Wells and on behalf of the railroads, the construction of a municipal free bridge across the Mississippi. His directorships included the Big Four Railroad Company, the Metropolitan Life Insurance Company, the St. Louis and San Francisco Railroad, and not surprisingly, the Scullin Steel Company and North American Utilities. During the formative period of the Federal Reserve legislation, Wade was in frequent contact with the other leading bankers and politicians involved.[7]

Banking reform acquired a regional look in 1909. Maurice Muehleman and Theodore Gilman of New York both published regional plans, but Victor Morawetz, a noted railroad attorney with ties to the House of Morgan, made the greatest impact in an address to the American Political Science Association. He suggested that since a European-style central bank was politically impossible and perhaps inappropriate in the American federal system, properly distributed sectional banks under a central board would serve as well. Morawetz did not care whether the board was private, governmental or mixed.[8]

The NRA differed in important ways from European central banks. It would deal only with the government or its members, except in bond or specie purchases, and it could not pay interest on deposits. It would fix the discount rate, uniform in all regions, and change it when appropriate, and issue notes against bonds and rediscounted paper representing commercial and industrial transactions (real bills). Notes drawn to carry stocks, bonds or other investments were not eligible for rediscount. It would also replace national bank notes with its own notes, thus substituting an elastic for an inelastic currency. Though the branches chose their own boards, most important policy decisions were to be made by the central board. The level discount rate mandated in the plan denied the regionalism the NRA's framers so frequently stressed. But in the election of the central board's directors by the branch boards and in the provision that no more than four directors could be elected from one region, the regional principle was observed.

In May 1911, the currency commission of the American Bankers' Association (including St. Louisans Huttig and Wade) endorsed the Aldrich plan after insisting that banks be allowed to count the NRA's notes as reserves.[16] Paul Warburg had been busy all spring, orchestrating the formation of support groups to help make the case for the plan to Congress. On January 18, 1911, a "Businessman's Monetary Conference" adopted a resolution (written by Warburg) endorsing the Aldrich plan, and a few weeks later the "National Citizens' League for the Promotion of a Sound Banking System" opened for business. The League was as free of Wall Street appearance as possible. Professor Laughlin was its chairman, Chicago was its headquarters, merchants and manufacturers rather than bankers were on its board, and none of its officers were from New York. The league did not formally endorse the Aldrich Plan, but some of its members stumped the country for it, speaking to businessmen's groups. Wall Street bankers stayed out of the limelight, publishing no endorsements and making no speeches. Many local business groups and 29 of the 46 state banking associations announced their support. Speeches and promotional literature stressed decentralization and guaranteed that there would be no more panics.[17]

Reflecting skepticism among businessmen, the National Association of Manufacturers would not endorse the Aldrich plan. Daniel Tompkins, a former NAM president, who led the opposition, called it an invention of "Aldrich, the Standard Oil Company, and the Steel Trust."[18] Theodore Roosevelt, who ordinarily avoided the subject of banking but who was ready to throw his hat in the presidential ring again, privately opposed it. President Taft pronounced it good, but he doubted that it would ever pass the Democratic Congress. Congressman E. B. Vreeland urged prompt action, warning that Progressive or Democratic "radicals" might beat Aldrich to the punch with a government-dominated banking system. Warburg shared his impatience; state banks were multiplying prodigiously and he hoped the reform would encourage large national banks with branches at the state banks' expense.[19]

Dissension struck the Citizens' League in 1911. Its president, J. Laurence Laughlin, had opposed the concession on reserves exacted by the ABA's currency commission, and in July, writing to Paul Warburg, he charged that no bill with Aldrich's name on it would ever get through Congress. Warburg immediately shut off the New York funds that supported the league, and Laughlin backed off, going so far as to persuade Roosevelt not to oppose the plan publicly. Then in November, the Aldrich Plan seemingly scored its biggest victory, the endorsement of the American Bankers' Association. But as its price, the ABA had required a fateful concession: the power to remove the governor of the NRA was transferred from the president to the system's board of directors, thus removing the last trace of government control from the Aldrich Plan.[20] William Jennings Bryan noted that "big financiers" were backing Aldrich's "currency scheme"; its passage would give them control of everything. President Taft drove another stake into the heart of the plan in his December message, protesting all the while that he favored it. After endorsing it, he added: "there must be some form of governmental supervision and ultimate control."[21]

President Taft, who had offended Wall Street with his vigorous anti-trust prosecutions-he had violated the detente reached by Roosevelt and J.P Morgan-got no help from the large bankers in the campaign. Both Roosevelt, whose views were well-known, and Wilson, whose views were not, opposed anti-trust prosecutions simply because a business combination was large; it had to have misused its power (the rule of reason). George Perkins, a Morgan partner, had been Roosevelt's closest adviser for years, and the third-party ticket got the majority of financial-center support. But Wilson also did well; Jacob Schiff was one of his largest contributors. As predicted, Wilson won the presidency in an electoral landslide and the Democrats controlled both houses of Congress.

Wilson's position on banking reform, if any, was not publicly known. He had stuck to generalities during the campaign, going no further than supporting the Democratic platform, which rejected the Aldrich plan and central banking while endorsing reform in principle. The Progressives had been more direct, denouncing the Aldrich Plan and stealing Bryan's thunder with "currency is fundamentally a government function . . . {it) should be protected from domination or manipulation by Wall Street."[23]

Paradoxically, these revelations stirred up demand for legislation to bring the big bankers into line, the same bankers who had been behind the drive for banking reform all along. Central-bank reformers wasted no time; they wanted a banking system and they wanted the right kind. Colonel E.M. House, who was to be Wilson's White House chief-of-staff, was eager to oblige. He consulted with Paul Warburg and J. P. Morgan, Jr. long before inauguration day. In view of Jacob Schiff's campaign support for Wilson, it was not surprising that House and Warburg got together, nor was it surprising that House persistently advocated the Aldrich plan, with a gloss on it to conceal its origins. Carter Glass, who became chairman of the House banking committee in the new Congress, resented the Colonel's efforts to influence the President's views on banking legislation. He claimed that House had no idea why he favored a central bank, but it seems likely that the Colonel had a very good idea after he talked with Warburg.[25]

Glass's currency subcommittee had begun its work before the 1912 elections, and it was to begin its hearings in January 1913. Glass had been a small city Virginia newspaper editor before his election to Congress, and neither he nor the other members of the subcommittee knew very much about banking systems. President Wilson was not an expert either, but he was more knowledgeable than the committee or its chairman. He had taught economics for 10 years and was well acquainted with the writings of Walter Bagehot and W. Stanley Jevons on central banking.[26]

To help the committee's "intelligent amateurs," as Glass called them, he hired H. Parker Willis, associate editor of the New York Journal of Commerce as the committee's banking expert. Willis, a professional economist, was a close friend and protégé of J. Laurence Laughlin, his former professor at the University of Chicago. Naturally, Willis was a real bills exponent, and through his extensive writings for the National Citizens' League, he was identified with the principles of the Aldrich bill. Chairman Glass opposed the central-bank feature of chat ill-fated proposal, but he too favored private control of the system. As the plan evolved, it became clear that there was little difference in the thinking of the framers of the first draft (Willis, Laughlin, and Glass) and Paul Warburg.[27]

After preparing memoranda on various proposed banking systems during the summer of 1912, Willis, with Glass's consent, invited Laughlin to draft an outline for the committee's benefit. By this time, the three men knew that a regional approach was essential. Clearly, they were indebted to Victor Morawetz for the basic structure of their developing system, but none of the three ever acknowledged the debt. Laughlin submitted several plans, and by October, according to Willis, a rough draft of the Glass bill was completed, considerably influenced by Laughlin's contributions. It called for an unspecified number of regional reserve banks (apparently they had 15 to 20 in mind), calculated to eliminate the concentration of reserves in New York City. National banks would be required to be stockholding members of their reserve banks, and their existing reserves would be transferred to those banks immediately. The reserve banks would issue federal reserve notes with a gold and liquid paper cover (real bills); they would rediscount commercial paper for member banks, setting their own discount rates, and they would displace the subtreasuries as fiscal agents of the government. They would be jointly liable, required to shift funds from one to the other when needed. The Comptroller of the Currency would supervise the system.[28]

Carter Glass did not share much with the Bryan wing of his party, but he agreed with them that the National Banking System was badly flawed because it concentrated reserves in Wall Street, where banks invested them in the lucrative call money market, thereby feeding stock market speculation. For Glass, the worst feature of this sequence was the high interest rates in New York chat lured funds from country banks that should have been invested at home. On one occasion, he suggested to the president-elect that the bill might prohibit banks from paying interest on deposits from other banks. Wilson liked the idea, but he pointed out that, if included, it would endanger the entire reform bill.

For the same reason, Glass was against a central bank that would concentrate reserves. Consequently, joint liability was of key importance. Funds would be dispersed over the country, but the regional banks together would hold a pool of reserves. Glass would have the best of both worlds: a system that would function as a central bank in emergencies without geographical concentration of its resources.[29] Festus Wade of St. Louis, an early partisan of the Aldrich plan, speaking for the American Bankers' Association, told Glass after the details of the plan were known that it did not matter what the system was called, "it will be a central bank in the last analysis."[30]

On December 26, 1912, Glass and Willis took their secret draft to Woodrow Wilson, who was in bed with a cold at his home in Princeton, New Jersey. According to Glass, Wilson had insisted on their coming despite his illness because he wanted "speedy and sweeping" currency reform. Wilson had lashed out at the Money Trust in his "New Freedom" campaign addresses, charging that it crushed smaller businesses whenever it found them inconvenient, and he was not hostile to central banking. But he knew that an out-and-out central bank, identified as such, would not be politically feasible. When Glass and Willis described their plan, he told them they were on the right track, but then he startled them by advocating a "capstone," a presidentially appointed "altruistic" board of control which would supervise the regional reserve banks and set policy for the system.[31]

Neither of Wilson's guests disagreed openly, but they were uncomfortable. The capstone would replace the Comptroller of the Currency as the supervising authority and it would make policy for the system, which they had intended to be in the hands of bankers. Glass thought somebody had gotten to Wilson, presumably an advocate of the Aldrich plan, but that seems unlikely. A government board of control would suit Bryan and the Progressives more than the bankers. Thereafter, Glass had to direct his efforts toward obtaining banker representation on the central board.

Willis and Glass went to work immediately after the conference, revising their draft bill and preparing for the committee hearings which were to begin on January 7, 1913. During the next few weeks Wilson and his aides met with several major bankers, including Paul Warburg and A. Barton Hepburn, chairman of the board of the Chase National Bank. Warburg and Hepburn said they would cooperate, Warburg even suggesting during his committee testimony that there were other roads to an effective banking system than the Aldrich plan. Unlike other prominent Wall Street bankers, Hepburn had for years been active in the leadership of the American Bankers' Association, and his views were closer to those of the Midwest bankers than to his New York peers. At the hearings, Warburg, Hepburn, George Reynolds of Chicago and Festus Wade of St. Louis pleased Glass by avoiding specific plans, simply voicing support for regional reserve banks, commercial paper cover for notes, elastic credit and cooperation among regional banks. Despite Warburg's apparent friendliness, Glass never trusted him, believing that he was conspiring to revive the Aldrich plan. Throughout the hearings, witnesses and minority committee members attempted to get a central reserve bank on the agenda, despite Glass's pointing out that both the Democratic and Progressive campaign platforms repudiated the idea.[32]

After giving their testimony, Wade, Reynolds, Hepburn and other bankers met privately and agreed to support a regional plan and try to persuade others to do the same, reserving the privilege to make suggestions for improvements. Glass appreciated this and corresponded frequently with Wade thereafter. At times the Reynolds-Wade group's "improvements" tested the supersensitive Glass's patience. In exasperation he told Wade in early July that, since he had made several changes requested by "you and your associates;" the bill should be supported "by men of your type:" Glass described Wade to Secretary of the Treasury William McAdoo as "the fiercest, but frankest of the adverse banking group;" and on another occasion, "a belligerent without guile."[33]

On January 30, Glass handed Wilson a revised draft of the reform bill. It called for 15 or more regional reserve banks, each controlled by a board elected by its member banks. Over the system, there was to be a Federal Reserve Commission consisting of two representatives of each regional bank, three members appointed by the President, the Secretary of the Treasury, the Secretary of Agriculture and Comptroller of the Currency-unless more districts were added, 36 members in all. To supervise the operations of the regional banks, there would be a Federal Reserve Board, Wilson's "capstone." The Board would have nine members, three elected by the banker members of the Commission plus the six public members of the Commission. The Board was to report to the Commission at the latter's quarterly meetings on the activities of the regional banks. The lines of responsibility between the two bodies were not clearly defined in the draft bill, but it was apparent that the Board would have the more active role. According to Glass, Wilson was enthusiastic about the draft, which, except for the above, varied little from the earlier version.[34]

With Wilson's go-ahead to encourage them, Glass and Willis hid themselves away to rewrite what they believed would be the final draft of the administration's bill. They completed it by the first of May and circulated it among the president's close associates. But rough water lay just ahead. Secretary of State Bryan, still the hero of millions of Democrats, and Senator Robert L. Owen of Oklahoma, chairman of the Senate Banking Committee on the one side and the major bankers on the other, were dissatisfied, for different reasons and about different sections of the bill. Not only was Owen a Bryanite, he was irritated by Glass's secrecy. As the Virginian's senate counterpart, he had reasonably expected to be consulted on, or at least informed about, the bill while it was in preparation. Bryan's disquiet was potentially devastating.

Why the experienced Glass had not anticipated the depth of Bryan's opposition is hard to understand. Perhaps he was misled by the secretary's silence in the cabinet and in the columns of his family's publication, The Commoner, on currency questions. Bryan wanted to be loyal to the president, and he had instructed his brother Charles not to publish anything on the topic until Wilson's position was known. When the details of the Glass bill were released, he was shocked. Except for the absence of a central reserve bank and the public majority on the Federal Reserve Board, admittedly significant differences, the Glass bill looked a lot like the Aldrich bill. In a private session with the President on May 19, the agrarian Achilles warned that if certain features of the plan were not removed he would use his influence in Congress and the country to defeat it. He was against banker dominance of the regional boards and the Commission, banker membership on the Federal Reserve Board, and asset-backed bank notes instead of government notes. He reminded the president later, through Wilson's aide Joseph Tumulty, that only government notes would be consistent with recent Democratic platforms.[35]

Meanwhile, Senator Owen had prepared a reform bill of his own, providing for eight regional reserve banks under the supervision of a National Currency Board of seven members, all presidential appointees. Two-thirds of the reserve bank directors would be elected by member banks and one-third appointed by the president of the United States. Currency would consist of U .S. notes redeemable in gold, issued to the reserve banks on the security of their assets, including commercial paper in their vaults. To check inflation, the banks would pay interest on the notes issued to them. Because demand for these notes would fluctuate with credit needs, they would provide an elastic currency, replacing national bank notes. In other respects, the Owen bill resembled the Glass bill.[36] Bryan preferred the Owen bill, and so did Samuel Untermyer, the Pujo Committee counsel who kept pressing for transfer of banking and currency legislation from Glass's committee to his own.