Whitehouse is staff assistant in the Office of the Secretary at
the Board of Governors in Washington, D.C. He has written and lectured
extensively on the early history of the Federal Reserve System and
In paying tribute recently to Henry Wallich, late member of the Federal
Reserve Board of Governors, Bankers Magazine noted that Wallich was
a successor, in more than one respect, to Paul Warburg. Both of these
board members were emigrants from Germanyand from the higher circles
of German and European finance. Warburg, a member of the first Federal
Reserve Board, like Wallich, was a staunch advocate of sound finance.
Both, having witnessed the strengths and weaknesses of the European
banking system during economic debacles as younger men, brought their
experience to the United States committed to putting those lessons to
It's been said that Governor Wallich's speeches and essays represent
one of the best financial histories of our time. The same can certainly
be said of Warburg's writings, speeches and testimony for the period after
the turn of the century. His life's work constitutes perhaps the best
history of the development of central banking in the United States and
mirrors its controversies, struggles and the final accomplishment.
It's seems fitting then, in this 75th anniversary year of the Federal
Reserve System, to look at the life of Warburg, one of the System's architects
and staunchest proponents.
Warburg's Early Banking Experience
Paul Warburg was born in Hamburg in 1868. The offspring of a prominent
German banking family, he had been trained in banking in the European
financial capitals. After attending the university, at age 18 he began
his career in London where for two years he worked for a banking and discounting
firm, followed by a short stint with a London stockbroker. After that
he moved to France and gained additional experience at the Russian bank
for foreign trade, which had an agency in Paris. He then traveled to India,
China and Japan before returning to Hamburg to become a partner in M.M.
Warburg & Co., the family banking firm.
Warburg's father had fully expected that Paul would take charge of his
family's banking business along with his brothers Aby and Max, but in
1895 Warburg married an American citizen, Nina Loeb, an accomplished violinist,
and began to live part of the year in New York. Six years later, at age
34, he left Germany, took up permanent residency in the United States,
and accepted a position as a partner at his father-in-law's firm, Kuhn,
Loeb and Co.one of Wall Street's most important and respected banking
houses. While adapting quickly to his new business, he still viewed the
United States through the eyes of a European banker and was literally
shocked at what he considered the primitive status of banking and financial
In the early 1900s, the nation was suffering from periodic liquidity
crises. These crises or "panics" occurred because the banking system was
fettered with a rigid amount of currency that could not meet unusual demands,
and a system of reserves that pyramided up to New York. During these panics
businessmen and farmers were unable to obtain credit to finance inventories
and the production and transportation of crops. The crises spread across
the country and converged upon Wall Street, resulting in plunges in the
stock market, a large number of bank and business failures, and a further
shortage of currency.
Such phenomena deeply affected Warburg, a small unassuming man whose
most obvious physical characteristic was a large drooping mustache that
gave him more the appearance of a tenor in a barbershop quartet than an
important international banker.
While small in stature, however, he was hardly tame or timid in his
professional assessment of conditions then prevailing in his new country.
"The United States," he said, "is at about the same point that had been
reached by Europe at the time of the Medicis." Witnessing first-hand a
period of high interest rates "where call money went up to 25 and
100 percent," he felt compelled to "write an article on the subject then
and there for [his] own benefit."
Warburg thought it a bit presumptuous to attempt to educate a country
to which he was so new a resident, so when advised by an associate to
put the paper aside, he did so and attended to duties at his firm. However,
when the same conditions arose in the beginning of 1907, he could hold
his tongue no longer, and he began to circulate his writings for the benefit
of others as well.
The Panic of 1907
Early in 1907, New York Times Annual Financial Review published Warburg's
first official reform plan, entitled "A Plan for a Modified Central Bank,"
in which he outlined remedies that he thought might avert panics, like
the great one that would occur later that year. Furthermore, he identified
what he saw as the "evils" of the system in the United States the
"decentralization of reserves and the immobilization of [commercial] paper."
To remedy this, he advocated the development of an American discount market
and a European-style commercial paper. This system was based partly on
a concept known as the "real bills" doctrine, which maintained that the
money supply should vary with the short-term "legitimate" needs of business
and commerce. By allowing banks to borrow only against short-term loans,
the real bills doctrine, in theory, provided liquidity through the discounting
(or selling) of loans and at the same time restricted the ability of a
central bank to expand the supply of money. Warburg also proposed the
creation of a "central reserve" or central bank that would hold the reserve
funds of member banks so that collective funds could be made available
to a bank in need of liquidity. Both the discounting and reserve concept,
he contended, would help make money and credit more elastic and keep interest
The Panic of 1907 hit full stride in October. The crash was of such
severity that it immediately helped focus public awareness on the problems
with the monetary and banking system. Although the issue of a central
bank was unpopular because of its connotations of powerful central authority,
Congress was now forced to act. The Aldrich-Vreeland Act, passed by Congress
in May 1908, provided for the issuance of emergency currency and created
a bipartisan National Monetary Commission to study central banking and
other alternatives for monetary and banking reform. Warburg would serve
this committee and, through his efforts for the commission, achieve an
influence on subsequent proposals for reform.
Warburg Meets Sen. Aldrich
Sen. Nelson Aldrich of Rhode Island, chairman of the Senate Finance Committee,
was appointed head of the National Monetary Commission. He divided the
commission into two groups: one would study the US banking system and
compile a report, and the other, headed by the senator himself, would
travel to Europe and study the central banking systems in London, Paris
Aldrich was a known advocate of the extant bond-backed currency arrangement,
which provided that bank notes could only be issued by national banks
on the basis of the amount of US government bonds that were held to back
them. However, the 67-year-old Aldrich, who was considered the most influential
figure in Congress on financial matters, was committed to exploring new
ideas for reform. In 1908, he announced that he would not seek office
again and instead would devote his full attention to the currency and
Meanwhile, Warburg began to enlarge his circle of professional contacts
and have his voice heard throughout the country. However, the German banker
still didn't have the ear of the man who mattered most Aldrich.
Aldrich first met Warburg by chance when the senator was preparing for
the European trip and visited Kuhn, Loeb and Co. to gather preliminary
material about the German banking system. Following that meeting, the
German native began writing to Aldrich outlining his proposals, but Aldrich
was cool to Warburg's plan and deferred his correspondence to A. Piatt
Andrew, a Harvard professor whom Aldrich had appointed official secretary
of the National Monetary Commission. As new ideas on banking reform began
to crystallize for the senator, Andrew brought the work of Warburg to
the senator's attention again and soon Andrew was corresponding with Warburg
on behalf of the senator. Warburg was asked to write a study on the "discounting
of commercial bills" for the National Monetary Commission, and became
an unofficial advisor to the group. However, the banker and the senator
still were at loggerheads on the question of what shape the central bank
should take in the United States, and on the issue of discounting commercial
In his monograph, "The Discount System in Europe," Warburg declared
that the effective utilization of the discount policy was one of the most
impressive victories for central banks in Europe during the Panic of 1907.
The only structure that is safe, he concluded, is one that provides for
effective concentration of cash reserves and their freest use in case
of need, enabling banks, when necessary, to turn into cash a maximum of
their assets with a minimum disturbance to general conditions. He noted
further that a central bank is able to guard the cash reserve of the country
and accommodate nonreserve banks by accepting prime security, like bank-accepted
Warburg, in the meantime, continued his campaign on other fronts. He
had followed his first New York Times article with a speech at Columbia
University on "American and European Banking Methods and Banking Legislation
Compared," and privately published a new, more complete proposal for a
US banking system, entitled "A Modified Plan for a Central Bank."
In May 1908, the New York Times gave his revised plan prominent coverage.
Primarily, Warburg continued to emphasize that the United States must
finally develop some sort of central bank system, giving the country an
elastic currency based on modern commercial bills payable in gold: a system
similar in principle, if not exactly alike in form, to those of the important
European central banks. He believed that "no measure that bases currency
on a long term basis like the Aldrich-Vreeland Emergency Currency bill,
(which allowed banks in regional currency associations to use their aggregate
bank balances as the basis for the issuance of currency) can be acceptable."
Also, he stressed that issuing notes "must be centralized into a few organs,
or if feasible, into one organ to ensure effective expansion and contraction
of reserves." The tireless reformer further stated that no central bank
could be effective that "vests the powers of a central bank in political
officers alone. That power clearly defined, ought to be vested in political
officers and businessmen combined, in a way that would render impossible
any political or financial abuse." Any hasty decisions on the composition
of the directors of a central bank, he said, could stand in the way of
the creation of such an organization. Better that those practical and
political questions could be worked out after careful consideration.
The idea of an "elastic currency," which would expand to meet the legitimate
needs of business and commerce, was not new. In fact, Warburg himself
claimed no originality for the idea, but through his writings, speeches
and counsel to others he began to have a greater impact than anyone else.
Warburg did, however, succeed in injecting two new ideas into the discussion:
first, shifting of emphasis from the currency problem to the reserve problem;
and second, advocacy of the principle of rediscounting a new kind of commercial
These ideas were starting to be discussed more seriously throughout
the country, and other individuals involved in the banking and currency
reform movement began to take note. With both the building momentum of
other banking reform advocacy groups and Aldrich's own exposure to the
efficient and effective central banking system in Europe, the senator
finally opened to these other ideas.
The debate on central banking reform was still in full swing several
years after the 1907 Panic. Indeed, it began to heat up, with the American
Bankers Association standing opposed to "any form of central bank yet
suggested by legislators." Meanwhile, Warburg, Aldrich and several other
prominent figures intensified their efforts and began to form an alliance
that was to last over the coming crucial years of the banking reform movement.
Aldrich Reconsiders His Position
The European interviews of the National Monetary Commission had a profound
influence upon Aldrich. He had a clear plan for reform when he returned
from Europe, radically different from his original beliefs. The change
in the senator's thinking was so drastic that Aldrich's biographer explained
it as an epiphany, saying, "Aldrich was converted on the road to Damascus."
When Aldrich and the National Monetary Commission returned from Europe
in the fall of 1908, Aldrich asked Warburg to present his own ideas and
answer questions regarding the European interviews at a meeting at New
York's Metropolitan Club.
After Warburg's Metropolitan Club testimony, Aldrich pulled the banker
aside and told him that he liked his plan for reform but he was being
too timid about it. Warburg was surprised to learn that Aldrich, who before
his European travels had not favored centralization and had advocated
a national currency backed by government bonds, had changed his thinking
and envisioned a European-type central bank for the United States. While
Warburg now warned the senator against attempts to establish a full-scale
central bank in the European sensebelieving it politically unrealistic
he was nonetheless encouraged.
A particular key feature of the European systems persuaded the senator
to reconsider his thinking. According to commission member Sen. Theodore
Burton, the concept of currency backed by commercial assets began to take
hold in Aldrich's mind in London, and the interviews in Berlin finally
convinced him. Commission Assistant George Reynolds concurred, noting
that "the experience and practice of German bankers in meeting the needs
of commerce in their country demonstrated to Aldrich the validity of the
use of commercial assets as a basis for currency. The idea, formerly so
obscure, came home to him in great force from its demonstration in a non-political,
While Aldrich's conversion was a welcome one to Warburg and other progressive
reformers, the very concept of a European-style central bank was still
an anathema to a great many bankers and politicians. Bankers wanted reform
that would make the banking system more efficient and better coordinated
but were fearful of government interference in the management of a central
bank. While Reynolds, as president of the American Bankers Association,
had traveled to Europe and had become an intimate of Aldrich, his association
was not supportive of reform. Moreover, many politicians believed that
the geographic size of the United States and its diverse business conditions
warranted a different banking system than those existing in Europe. Complicating
the matter further was the fact that any plan to which Aldrich attached
himself was sure to be attacked by Democrats and others who believed the
senator had only the interest of eastern businessmen and bankers in mind.
Aldrich had close ties with J. P. Morgan and other important bankers,
and his eldest daughter's marriage to John D. Rockefeller Jr. did not
help to dispel this suspicion.
The Jekyll Island Expedition
One evening in early November 1910, Warburg and a small party of men from
New York quietly boarded Sen. Aldrich's private railway car, ostensibly
for a trip south to an exclusive hunting club on an island off the coast
In addition to Warburg and Aldrich, the others, all highly regarded
in the New York banking community, were: Frank Vanderlip, president of
National City Bank; Harry P. Davison, a J.P. Morgan partner; Benjamin
Strong, vice president of Banker's Trust Co.; and A. Piatt Andrew, former
secretary of the National Monetary Commission and now assistant secretary
of the Treasury. The real purpose of this historic "duck hunt" was to
formulate a plan for US banking and currency reform that Aldrich could
present to Congress.
Even Warburg at first questioned the motives of this gathering, not
knowing if he was included because the group knew what he preached and
was interested in what he had to offer, or if he was to be involved as
a conspirator in order to be muzzled. He soon saw that the Jekyll Island
conference was pulled together because, as Warburg later wrote, Aldrich
was "bewildered at all that he had absorbed abroad and he was faced with
the difficult task of writing a highly technical bill while being harassed
by the daily grind of his parliamentary duties."
The group was secluded on Jekyll Island for about 10 days. All the participants
came to the conference with strong views on the subject and did not agree
on the exact shape a US central bank should take. Vanderlip noted: "Of
course we knew that what we simply had to have was a more elastic currency
through a bank that would hold the reserves of all banks." But there were
many other questions that needed to be answered. If it was to be a central
bank, how was it to be owned: by the banks, by the government, or jointly?
Should there be a number of institutions or only one? Should the rate
of interest be the same for the whole nation, or would it be higher in
a community that was expanding too fast and lower in another that was
lagging? In what open market operations should the bank be engaged?
Warburg realized that he had not been able to persuade the senator that
if a central banking organization was to be created, it had to be a modified
scheme based on the European models. In fact, Warburg, "the best equipped
man there in the academic sense," according to Vanderlip, "was so intense
... and apparently felt a little antagonism towards Aldrich," so that
there were some moments of strain that had to be eased by the others.
Aldrich had his mind set on a European-style central bank, "a model he
seemed loath to abandon," according to Warburg, and the senator strongly
believed that the proposed central bank should be kept out of politics.
Warburg and the others felt that whatever the theoretical justification
for such a central bank, American conditions would require some sort of
compromise and that concessions should be made considering government
influence and representation. Aldrich, yielding somewhat, allowed that
the government should be represented on the board of directors and have
full knowledge of the bank's affairs, but a majority of the directors
were to be chosen, directly or indirectly, by the members of the association.
Warburg also didn't agree with Aldrich's position on note issuance,
conditions of membership of state banks and trust companies, or on the
need for a uniform discount rate. Aldrich insisted, however, that a central
bank should maintain a uniform rate of discount throughout the United
States. He thought such a measure politically wise because it would refute
the charges that other "great financial centres" would attempt to establish
favorable rates for themselves in different regions to the disadvantage
of other localities in the country.
Eventually all of the individuals at the Jekyll Island conference had
to modify their views on a central bank plan. Nonetheless, Aldrich got
out of the conference just what he intendeda banking scheme that
rested upon a consensus of opinion representing the best-informed bankers
of this country.
The banking bill the group brought north, which came to be known as
the "Aldrich Plan," called for the establishment of a central bank in
Washington, to be named the "National Reserve Association," meaning a
central reserve organization with an elastic note issue based on gold
and commercial paper. The association was to have 15 branches at geographically
strategic locations throughout the country. The bank was to serve as fiscal
agent for the US government and, by mobilizing the reserves of its member
banks, become a lender of last resort to the American banking system.
The association as a whole was to serve as a bank of rediscount, that
is, it was empowered to discount a second time commercial paper that members
of the association had already discounted. By rediscounting, the association
could issue new money that might stay in circulation so long as the paper
for which it was issued was not redeemed.
No one person was responsible for the final draft bill that was written.
It was a record of their composite views. Yet Vanderlip regarded Warburg
as having made significant and important contributions to the final result:
"As a philosophical student of banking he was first among us at that time."
Warburg was satisfied that the Aldrich Plan was not a central bank in
the European sense. "It was strictly a bankers' bank with branches under
the control of separate directorates having supervision over the rediscount
operations with member banks," he said.
Warburg viewed the result of the Jekyll Island meeting as pivotal: "The
period during which nonpolitical thought held the leadership in the banking
reform movement may be considered as having ended with this conference."
Up until then, bank reform had been an educational campaign carried on
by individuals and groups; but at that point, the movement assumed a national
character. Warburg saw Senator Aldrich as being the standard-bearer of
a political proposal for a central bank. Said Warburg: "From then on until
the final passage of the Federal Reserve Act, the generalship was in the
hands of political leaders, while the role of banking reformers was to
aid the movement by educational campaigns and, at the same time, to do
their utmost to prevent fundamental parts of the nonpolitical plan from
being disfigured by concessions born of political expediency." Aldrich
presented his draft plan to the public in January 1911. One year later,
on Jan. 19, 1912, the National Monetary Commission presented its report
and endorsed the Aldrich Plan.
The Final Campaign
Warburg playfully described himself as a "fanatic" for what he considered
sound finance. He was also pragmatic and sensitive to political realities,
however. Thus he tempered his approach to a central bank in the United
States, and his campaign over the next several years reflected that position.
When he saw the roadblocks that lay ahead with Aldrich attempting to sell
his plan to a greater part of the country, Warburg began a formal educational
campaign to assist. Warburg believed that "beyond doubt, unless public
opinion all over the United States could be educated and mobilized, any
sound banking reform plan was doomed to fail."
The National Board of Trade appointed Warburg the head of a seven-man
committee to set up a national group to promote reform. The group was
called The National Citizens League For the Promotion of Sound Banking.
It accomplished much of what it set out to do: establishing effective
organizations in 45 states, printing a vast amount of educational materials
for the businessman and layman alike, and publishing essays in pamphlets
and articles in newspapers. Warburg also continued to publish in important
journals and lecture before influential groups, doing all he could to
help promote sound banking principles and convince larger audiences of
the urgency for reform.
The Final Plan The Federal Reserve Act
Before the Aldrich Plan could be enacted into law, the Democrats won the
White House and took control of the Congress in 1912. The Democratic position
called for a divisional reserve bank system, with a number of reserve
banks or central banking cities. Nevertheless, President Woodrow Wilson
believed that the Aldrich Plan was "60-70 percent correct." As a result,
the plan became the basis for constructing the Federal Reserve bill, which
began to take shape in Congress with the presentation of a bill proposed
by Sen. Robert Latham Owen in May 1913.
When the Aldrich bill was rejected and the Democrats began to rework
the banking bill, the group of bankers that had worked so hard in support
of the Aldrich Plan began to split apart, and many of those bankers refused
to consider an alternative plan. Warburg was more conciliatory and remained
in contact with prominent Democrats, including Carter Glass, chairman
of the House banking committee, and H. Parker Willis, the committee expert,
and continued to write and speak on the new legislation. Warburg's reserve
and discounting concepts were embraced in the Federal Reserve plan, though
the central bank gradually abandoned the emphasis on discounting in favor
of open market operations as the major monetary policy tool. Nonetheless,
his efforts in educating the country, bringing sound banking techniques
to the forefront of debate, were of tremendous importance in final preparation
and passage of the Federal Reserve Act.
Warburg's career didn't end with passage of the Federal Reserve Act. In
a sense, the close of this chapter marked the beginning of his next important
role as a central banker. He was to wield a tremendous influence on the
development of the System he worked so hard to help establish. In spite
of vehement opposition from many Democrats and populists, President Wilson
asked Warburg to become a member of the first Federal Reserve Board.
It appears President Wilson made a wise decision. Once Warburg was appointed
to the board, Secretary of the Treasury William McAdoo, who often clashed
with Warburg over policy matters, explained Warburg's appointment this
way: "It was thought that his technical knowledge in international finance
would be useful. It was useful, in some respects it was invaluable." Benjamin
Strong, governor of the Federal Reserve Bank of New York, went even further
in his estimation of Warburg. Although Warburg was appointed as a member
of the board (not as the chairman or vice chairman), Strong called Warburg
"the real head of the board in Washington, so far as knowledge and ability
But the fact that he was at all chosen to serve on the board seems to
have been as much a surprise to the European-born banker as to those who
took issue with his nomination. Indeed, he first declined the appointment
because of the "rampant prejudice in this country against a Wall Street
man," and balked at testifying before the Senate banking committee because
other nominees had not been asked to do so. However, when World War I
erupted in Europe, Warburg decided to waive all personal considerations
"in deference to the president's urgent request and in view of the present
urgency which render desirable the promptest organization of the Federal
Reserve Board," and appeared before a largely antagonistic committee.
With Warburg before them, rather than take advantage of his vast knowledge
in central banking to learn how the country would adapt to this new system,
the senators chose instead to question the banker on Kuhn, Loeb and Co.'s
"money trust" connections. Thus, one of the best opportunities for history
to record Warburg's extemporaneous impressions on the final Glass-Owen
Federal Reserve bill was lost. But when Warburg was questioned as to his
motives for making the sacrifice financial and otherwise
to become a member of the Federal Reserve Board, the nominee's answer
was characteristically to the point:
"When President Wilson asked me [again] whether I would take this [on]
and make the sacrifice ... I felt that I had no right to decline it; and
I will be glad to make the sacrifice, because I think there is a wonderful
opportunity for bringing a great piece of constructive work into successful
operation, and it appeals to me to do that."