Blueprint for reform: how to draft it?

Excerpt from Reflections from History:
The Minneapolis Federal Reserve Bank


Clarence W. Nelson
February 1973

Was it fear? Fear was a part of it.

There was stubborn independence, too, and apprehension over control of their destinies—control, as they saw it, by “The East,” by “Big Money” interests. Strong currents of feeling from the people of the Northwest region contributed to the ideas and the politics of national monetary reform that eventually became word of law in the Federal Reserve Act of 1913.

To be sure, there were other, weightier voices. Throughout America's South and West, men shared the fear of “Wall Street domination.” But nowhere did feelings run more strongly than in the northern great plains—a land opened by homesteading, rooted in the soil, yet dependent on a seemingly indifferent “East” for its financing and its markets. Here was sired a distinctive “prairie politics” that found voice in the Populist movement with its own sprung-from-the-soil remedies for money ills.

Reform there would be. And the Northwest would lend its own special flavor to the national consensus. The time was early 1908. Ahead lay a six-year period of debate—a debate, you might say, over “architecture.” If either doubt or lethargy existed earlier over the need for reform of the monetary system, they were shaken loose by the Panic of 1907. From that point through 1913, study, debate, and a growing popular insistence ruled that a new financial superstructure would soon be built. Farmer, banker, businessman, and politician—all agreed. The only question now—and for the next six years—was what design for reform should Congress adopt.

The need for a change

Many defects marred the nation's monetary system as the 20th century began; some of them were obvious to almost everyone, others were understood only by a relatively few financial experts. One of the obvious flaws was that currency—that is, hand-to- hand, pocket money—was incapable of expanding in volume to meet the fluctuating needs of agriculture and commerce. “Inelastic,” they called it. This was obvious to people of the Northwest, because periodically they found that banks could not convert their deposits into cash, forcing them to resort to scrip or to barter. Harvest-season shortages of cash continually vexed farmers, and at times they had to pay “premium” to get currency.

“Pyramided reserves” was another flaw that even the lay observer could appreciate. A small, farm-community bank in North Dakota, for example, ordinarily kept only a part of its reserve funds as cash in its vaults, the remainder being deposited, say, in larger Twin Cities banks. Twin Cities banks, in turn, kept reserves in Chicago banks; and the Chicago banks, New York. Sudden, unusual demands for cash could quickly shift pressures for cash from the outlying countryside through the financial centers and focus them on New York where the reserve funds of the nation tended to concentrate. This reserve arrangement worked well enough in good times, but it was a ready-made system for transmitting financial panic in times of low confidence—and it had so operated at least once a decade since the time of the Civil War.

Then, too, in New York the excess funds usually ended up in the stock market in the form of “call loans,” which meant technically they could be gotten back by the banks on a moment's notice. The trouble was that often the borrower was speculating and in the process had all his own money, plus the borrowed money, in stock. When “calls” had to be made in large volume and the borrowers tried to get cash by selling stock, then prices dipped—or plunged—in a cumulative wave of forced selling. In this way, “runs” on banks in the hinterland were sometimes translated into stock market crashes in New York.

There was another problem. More often than not, a bank that had been closed by a “run” of withdrawals was basically in sound shape; at least it held a portfolio of perfectly good assets, even though it had no place to turn to get temporary cash for them. Or, if the assets were “callable” loans or “marketable” securities, any attempt by the bank to turn them into cash under crisis conditions only abetted chaos in the banking system.

These were but a few of the recognized ills of the extant system. Congressional study during this period distinguished seventeen such defects, many of which played a part in the Panic of 1907. This crisis started, somewhat differently from most of its predecessors, by rumors of insolvency followed by panicky withdrawals from a few big banks in the New York money market. But the jitteriness spread quickly, and runs were soon made on banks in distant farming areas. The effects of these runs, in turn, converged back on New York. The result: complete collapse of the nation's banking system and the forced bankruptcy of many businesses. Although major panics had occurred before (1873, 1884, 1893), the Panic of 1907 turned out to be the one that catalyzed reform efforts.

Efforts in Congress

An aroused Congress passed the Aldrich-Vreeland Act on May 30, 1908. This Act accomplished some minor patchwork by providing emergency sources of currency. Much more important, it established a bipartisan Congressional committee, the National Monetary Commission, under the chairmanship of Republican Senator Nelson Aldrich of Rhode Island, which was instructed to:

...inquire into and report to Congress at the earliest date practicable, what changes are necessary or desirable in the monetary system of the United States or in the laws relating to banking and currency...

The Commission's study was broad, thorough, and lengthy; a final report was not issued until January 1912. Its many findings and recommendations formed the main fabric of two Congressional proposals for remedial action. Senator Aldrich himself introduced the first proposal in January 1911 carefully based on the committee's work. His bill—the Aldrich plan for a “National Reserve Association”—nevertheless had two fatal flaws: its “architecture” and its “politics.”

The Aldrich plan provided for voluntary, regional associations of banks, and also a national supervisory body to be elected largely by bankers. The associations were granted various powers, among them to mobilize reserves of the banking system, and to issue currency based on commercial need. The plan was built upon expert advice and was well-geared to remedy essentially all the ills diagnosed by the Commission. The plan's regional emphasis appealed to the deep sectional feelings, such as those existing in the Northwest. On the whole the plan had the support of bankers, since their membership was voluntary and since they were given elected representation in the associations.

But the whole arrangement was too “banker-oriented” to gain grass roots acceptance. For example, Republican Congressman Charles A. Lindbergh of Minnesota, member of the House Committee on Banking and Currency (and father of the famous aviator), spoke critically of the Aldrich plan, charging that the reserve associations would fall into the hands of the so-called “Money Trust.” Others objected outright to the lack of direct government control over the proposed financial superstructure.

As though these substantive features weren't obstacle enough, the fact that the bill bore the name of Republican Senator Aldrich further doomed it to defeat. The Democratic party had gained control of the House of Representatives in the 62nd Congress (1911-1913), and partly as a result the Aldrich proposal was never brought to a vote. Then, with the elections of November 1912, when Woodrow Wilson and a Democratic Senate were swept into power, it became clear that in order to pass in the 63rd Congress any reform measure would have to be authored by Democrats. The Democratic platform of 1912 had declared: “We oppose the so-called Aldrich Bill or the establishment of a central bank . ..”

In this context, then, the key figure became Carter Glass, Democratic Representative from Virginia's 6th district and newly-appointed chairman of the House Banking and Currency Committee. By the time election results were posted, Glass had outlined a preliminary draft of a reform bill, which he then discussed with President-elect Wilson in December. In the next half year successive revisions incorporated the results of (1) hearings by the Committee during January-February 1913, (2) detailed review by Glass, Secretary of Treasury McAdoo, and Committee expert H. Parker Willis, and (3) compromise with the insistence on government control demanded by William Jennings Bryan, then Secretary of State in the Wilson cabinet. The end-product of all this jostling was a monetary reform bill introduced into the House on June 26, 1913, as H.R. 6454, popularly called the Owen-Glass Bill in deference to the fact that an identical companion bill was introduced in the Senate by Democratic Senator Robert L. Owen of Oklahoma.

The Owen-Glass proposal to establish a Federal Reserve System of regional reserve banks differed in some important respects from the Aldrich plan, although there were many basic similarities. Some of the differences—notably the introduction of a fully government-appointed board to supervise the system from Washington, and the provision for compulsory membership for banks with national charters—aroused strong opposition from bankers. But these measures gathered broader support from some of the factions that had opposed the Aldrich plan.

As first introduced the plan had a great many technical defects. So its various provisions were debated at length in Congress and in Committee on technical as well as political grounds through summer and fall of 1913. Glass rewrote the bill and introduced it into the House (as H.R. 7837) on August 29. Though never fully purged of technical flaws, the much revised Owen-Glass proposal, with some last minute compromises between Senate (Owen) and House (Glass) versions, became the blueprint for reform that Congress finally and officially approved.

Role of the National Citizens' League

In January 1911, against the background of three years of the National Monetary Commission study, and publication of the Aldrich proposal, a group of businessmen meeting at a Conference of the National Board of Trade in Washington resolved to promote monetary reform in an organized way and on a national scale. That businessmen should have taken direct initiative in the matter of monetary reform is not at all strange. Panics typically exacted great toll from businesses. The Board of Trade appointed a seven-man committee under the chairmanship of Paul M. Warburg of New York, and the work of setting up an organization began immediately.

The committee knew it could not locate the headquarters for such an organization in New York, or any eastern city for that matter, because suspicion of eastern influence was so strong that the West and the South would give a New York based operation no support. So the committee chose Chicago where, after a series of discussions, its members persuaded a group of Chicago businessmen to organize the National Citizens' League for Promotion of a Sound Banking System. The League was promptly organized with John V. Farwell as president and was fully ready for work by June 1911.

The League's objectives were to arouse interest in banking reform and to carry on a nationwide campaign to inform people about the issues. And while League members favored the principles of the Aldrich plan, they declined officially to endorse its details. As it turned out, the League helped pave the way for the plan of reform that finally emerged from Congress in December 1913.

The League's work was accomplished through state committees that were quickly set up in most states. Many businessmen from the Northwest stepped into voluntary posts on the committees and devoted themselves for two or more years to establishing their state organizations, arranging for meetings, seminars and speakers, and distributing educational material throughout the entire Northwest.

The Minnesota state committee, headed by John H. Rich, a businessman from Red Wing, had its headquarters in the Goodhue County National Bank of Red Wing. Mr. Rich, with his assistant, Curtis L. Mosher (“on loan” from the Northern Pacific railroad), proceeded to organize one of the most active and effective chapters of the League in the country. Norman B. Holter, operator of the Holter Hardware company at Helena, was Mr. Rich's counterpart in Montana; L. B. Hanna, Fargo, banker and Congressman at large from North Dakota, headed the North Dakota chapter; and T. Henry Foster of John Morrell & Company, Sioux Falls, led the South Dakota organization. As we shall see many of these dedicated and determined leaders in the League's campaign for monetary reform ultimately became directors or officers in the Federal Reserve Bank of Minneapolis.

Perhaps the most telling episode of the League's work occurred in early 1913. At that point it appeared to the League that growing momentum for reform might falter under the incoming Wilson administration. True, President-elect Wilson had conferred with Carter Glass on the matter in December 1912. Yet, revision of the tariff was the main objective set for the special session of Congress which the President-elect had announced for April 1, and he had not committed himself publicly on the question of whether monetary reform would also be pushed.

During the pre-inaugural period the League continually exhorted its members to make their desires for monetary reform known in Washington. For example, in the February 1, 1913, issue of the League's monthly newsletter, Banking Reform, a bold-print, front-page editorial charged all members:

Congress is wavering over the question of banking reform. The Democratic leaders are undecided whether to bring in a currency bill at the special session in the Spring or defer action until the regular session next December ...

President-elect Wilson has been quoted as holding the view that public sentiment as to banking reform has not yet crystallized.

Write to Mr. Wilson if you know him. If you don't know him, it is a good way to get acquainted.

The National Citizens' League has 10,000 members and a million friends. If every member of the League and every friend of banking reform does his duty, Congress will have substantive evidence that the business world is not indifferent...

Now is the time to act.

Shortly after the inauguration, John Farwell and a delegation from the National Citizens' League met with the President and inferred from their discussion that Wilson was in no hurry to introduce monetary reform measures in the spring program. Wilson reportedly was not aware of sufficiently widespread popular demand for reform to justify him in taking personal interest at that time. The League's delegation promptly wired the Chicago headquarters to call its state organizations into action. Response from members quickly followed. Telegrams poured into the White House by the bushel basket—reportedly some 27,000 messages within about three days. The President was impressed. “Call off your members,” wired Presidential Secretary Tumulty to the Chicago headquarters of the League, “The President has all the evidence he needs.” Assured of the great public demand for monetary reform, President Wilson became “a firm and unwavering friend of banking reform legislation” and gave strongest backing to efforts to speed complete legislation.

Thus the League was able to proclaim in the final issue of Banking Reform, October 1, 1913:

With the introduction of the Glass bill the work of the National Citizens' League practically ended. It was deemed wise by the Executive Committee to continue until there was more definite assurance of the intentions of the Wilson administration to push the cause of banking reform to an early conclusion. These assurances have been made both definite and emphatic. The time when an adequate bill will be passed cannot be set, but there is no doubt that it is near...

The Owen-Glass Bill, as finally revised, passed Congress on December 23, 1913 and that same day was signed into law by President Wilson.

Blueprint for a monetary “superstructure”

The question of what changes were necessary or desirable in the monetary system began the era of debate in 1908. The answer that closed the era (but certainly not the debate) was given by Congress in 1913 when the revised Owen-Glass Bill became Public Act No. 43 of the 63rd Congress—the Federal Reserve Act:

An act to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking In the United States, and for other purposes.

The Act was a blueprint for a great many important changes. In fact, no other modern nation had ever undertaken through democratic processes such complete and broad reform of its financial system. Many defects in the plans still would have to be worked out, but, on the whole, the Act was widely heralded as a remarkable achievement.

We shall single out three basic elements of design of the new system, first, because they were so fundamental to the architecture as it was drawn in 1913, and second, because in the reasons for their ultimate abandonment we shall see unfolding the evolution of a new architecture—and that is the theme of our story.

(1) With respect to structure: the Act called for several regional reserve banks, empowered to operate more or less autonomously within their own areas.

(2) With respect to control: the Act compromised between private and government control by providing: (a) at the regional level, a board of directors of each Federal Reserve Bank, a majority of whom would be elected by (and presumably responsive to) the member banks of the region, and (b) at the national level, a government-appointed supervisory body. The national supervisory body would, in turn, have a directly-appointed representative on the board of directors of each of the regional banks. Policy-making was to be in large measure at the initiative of the regional boards of directors.

(3) With respect to function: the amount of reserve bank credit extended to member commercial banks would rise and fall almost automatically, its volume correctly attuned to the needs of the economy because only legitimate “productive” borrowing at commercial banks by their farm and business customers would serve as the basis for extending reserve credit. Furthermore, the mechanism for providing reserve bank credit - the rediscounting process—was to operate in a thoroughly decentralized manner in response to actions taken by the individual commercial bank.

The blueprint still had technical gaps and defects, but many of these could only be filled in or remedied with time and experience. Whatever the flaws, by the final week of 1913 the nation had drawn its plans—“a uniquely American solution to an American problem”—and was ready to grapple with the job of organizing the regional reserve system. The country's regional reserve banks, including the Federal Reserve Bank of Minneapolis, were about to enter the scene.