America’s Money Machine

11.

Advent of Storm

HISTORY ALLOWED THE ADMINISTRATION Seven months to construct its new financial ark before the deluge of the First World War. The immediate task was purely political—where to locate the regional reserve banks provided by the Act. The Reserve Bank Organization Committee, which meant, in short, Secretary of the Treasury William Gibbs McAdoo and Secretary of Agriculture David F. Houston,1 was provided with $100,000 for its investigations.

The two officials fitted out a special car, organized a corps of secretaries, and right after the New Year began a country wide tour to study the advantages and disadvantages of each proposed reserve center. Hearings were held in eighteen cities and concluded on February 18. Over two hundred cities requested that their claims be heard. Certain decisions were foreordained. The influence of New York City would be cut down by lopping off New England and creating a reserve bank in Boston and another in Philadelphia. Pittsburghers, led by Andrew Mellon, 2 protested loudly at being neglected, urging the importance of their city as the center of the steel industry. Baltimore was disappointed to lose out to Richmond, Va., but this was inevitable considering Carter Glass’s origins.

For thirty-seven American cities, however, the principal preoccupation was their claims to be selected as a reserve city. The Committee stretched its authority to the maximum and chose twelve, and announced its decision on April 2. New Orleans was passed over in favor of Dallas; the Committee ignored the claims of Senator Owen’s home state and chose Kansas City instead of Oklahoma City, at the same time passing over Denver and Omaha. The twelve cities selected were: New York, Boston, Philadelphia, Richmond, Atlanta, Chicago, Cleveland, St. Louis, Dallas, Kansas City, San Francisco, and Minneapolis.

Meantime, another issue arose over appointments to the governing board of the new institution. McAdoo, as Secretary of the Treasury, and John Skelton Williams, as Comptroller of the Currency, were ex officio members. On May 4, it was reported that the President would propose the following for membership: Richard Olney of Boston, Attorney General and Secretary of State in the second Cleveland Administration, and now seventy-eight years old; the New York banker Paul M. Warburg; Adolph Caspar Miller of Berkeley, California, forty-eight years old, educator and economist and at the time assistant to the Secretary of the Interior; W. P. G. Harding, president of the First National Bank of Birmingham, Alabama; and Harry A. Wheeler, a Chicago banker and former president of the U. S. Chamber of Commerce.

Olney, however, declined the appointment because of his age, and Wilson found it expedient to make other changes in his list. He nominated instead Thomas C.Jones, head of the International Harvester Company—who immediately became a controversial figure because of his association with what had come under attack as a monopoly of farm machinery manufacture—and Charles S. Hamlin, a Boston attorney.

The Senate Banking and Currency Committee, after some reservations regarding his connections with the Boston and Maine railway, accepted Hamlin, and it also made no obstacle to confirming Harding and Miller, but it wanted to examine Jones and Warburg—Warburg because of his banking connections with the railway industry, but more because of his strong views on central banking theory.

Warburg was promptly offended that the Committee had not required the other nominees to appear before it, and declined to present himself. President Wilson, equally offended at what he regarded as an impertinence on the part of the Senate, raised his hackles and announced his intention of forcing acceptance of his nominees.

Jones, however, willingly appeared and made a spirited denial of his alleged disqualifications; the Committee nevertheless withheld confirmation. Wilson demanded the confirmation; the Committee remained obdurate, and finally broke with the President by rejecting the nomination July 9.

Wilson was now more determined than ever to obtain confirmation of both Jones and Warburg. At the same time Warburg, now more sensitive than ever, continued to decline to appear before the Committee.

While this was going on, the press reported the front page news that the heir to the Austrian throne had been assassinated in an obscure city of Eastern Europe, in the realm of the little kingdom of Serbia, where he had been making a state visit. Condolences were sent by the German government to the Emperor Franz Joseph on the death of his nephew, but the German Emperor, Kaiser Wilhelm, after it had been announced that he would go to Vienna to comfort his neighbor and war ally, made excuses to remain in Berlin. This allayed any uneasiness over the possible political consequences of the tragedy, and the affair passed over to the inside pages of the American press, or was ignored in favor of the three-cornered tussle over Warburg’s nomination

Amid the declarations and cross-declarations of war among Russia, Austria, Germany, and France, Paul M. Warburg was confirmed as the seventh member of the Federal Reserve Board, along with Frederic O. Delano (whom Wilson had named in place of Jones), and on August 10 they took the oath of office. The President designated Hamlin as governor and Delano as vice governor of the board.

It was not until October 25, however, that the Secretary of the Treasury, in accordance with the law, was able to announce the formal establishment of the Federal Reserve System. The effective date for the opening of business and for the application of the new reserve requirements was November 16, 1914. Two days before this the Comptroller of the Currency had signed the charters of the twelve reserve banks, and two weeks earlier (November 2) the initial installment of one-sixth of the capital subscription to the banks had become payable.

In the light of the terrible financial catastrophe and debacle of 1933, the consequences of which are still with us, charity requires that such statements be read as another of the fond delusions into which mankind is periodically led by an incurable optimism or an inner necessity for hope.

The full statement, which sets forth some of the more modest gains in banking and currency practice, is as follows:

Among the principal direct benefits which the new act confers are these:

First, it supplies a circulating medium absolutely safe, which will command its face value in all parts of the country, and which is sufficiently elastic to meet readily the periodical demands for additional currency, incident to the movement of the crops, also responding promptly to increased industrial or commercial activity, while retiring from use automatically when the legitimate demands for it have ceased. Under the operation of this law such financial and commercial crises, or “panics,” as this country experienced in 1873, in 1893, and again in 1907, with their attendant misfortunes and prostrations, seem to be mathematically impossible.

Second, it provides effectually and scientifically for the mobilization of bank reserves in the 12 Federal reserve districts, where these funds are not only available for the member banks of each respective district, but, under wise and well-guarded provisions of the law, the surplus moneys of any one district become available for the legitimate needs of any other districts which may require them.

Third, it eliminates the indirect tax of many millions of dollars annually upon the commerce and industry of the country, heretofore imposed in the shape of collection or “exchange” charges on checks, and inaugurates a system of clearances by which it is expected that every check or draft on any member bank in any one of the 12 Federal reserve districts can be collected ultimately free of the exchange charges heretofore exacted and may be charged on the books of the Federal Reserve bank to the account of the bank upon which drawn, in most cases, within 24 hours or less after it is deposited with a member bank. This provision renders available many hundreds of millions of dollars heretofore carried in transit in the mails in expensive and tedious processes of collection, sometimes absolutely useless during weeks when much needed, held in transit moving from point to point.

Fourth, it furnishes a discount system by which every well-managed member bank may have the opportunity of converting into money by rediscounting, to such extent as may be necessary or desirable, all commercial paper having not more than three months to run which it may have taken in the ordinary course of its business. The new law removes, so far as borrowing money from a Federal Reserve bank is concerned, the limitation which prevented a national bank from borrowing an amount in excess of 100 per cent of its capital. The significance of this release may be appreciated when it is realized that some national banks have deposits amounting to 10 times their capital or more. The ability to borrow only an amount equal to capital would be wholly insufficient, in many cases, to enable banks to meet the demands which arise from unexpected runs, or in financial crises, or other extraordinary demands.

It removes from prosperous and well-managed banks penalties hitherto imposed on their very prosperity and success.

It relieves the well-managed bank from the limitations of original capital invested and gives it the legitimate advantages of its own enterprise and the business it has built up and actually does.

Fifth, by making it possible for any well-managed bank to convert its assets readily into cash to meet unexpected contingencies or runs, the necessity for the large reserves heretofore required ceases. It is estimated that by this reduction in the reserve requirements alone more than four hundred millions of dollars of money or credits heretofore held in reserves and inert, will become available for commercial purposes and the legitimate demands of business.

Sixth, the new law also makes it possible for national banks to lend money on improved, unencumbered farm property, thus enabling farmers, the most numerous and in many respects most important portion of our population to participate directly in the beneficent provisions of the new law.

Seventh, the new law provides that national banks may establish branches in foreign countries, these branches to be under the jurisdiction and subject to the rules, regulations, and examinations of the comptroller’s office. These branch banks should be material aids in building up our foreign commerce.

Eighth, the former system of paying national bank examiners by fee is abolished; and the examinations of all member banks, both National and State, are now placed upon a basis which necessarily will insure a thoroughness and efficiency hitherto impossible.

Under the provisions of the new law the failure of efficiently and honestly managed banks is practically impossible and a closer watch can be kept on member banks. Opportunities for a more thorough and complete examination are furnished for each particular bank. These facts should reduce the dangers from dishonest and incompetent management to a minimum. It is hoped that national-bank failures can hereafter be virtually eliminated.

Ninth, the establishment of a system of bank acceptances and an open market for commercial paper, which, it is believed, will aid and facilitate this country in obtaining a larger share of international trade and of the world’s commerce.

 

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3The Comptroller of the Currency was also a member, but he kept to a passive role.

4Head of the Mellon National Bank, and later to become “the greatest Secretary of the Treasury since Alexander Hamilton.”

• 1*The Comptroller of the Currency was also a member, but he kept to a passive role.
• 2†Head of the Mellon National Bank, and later to become “the greatest Secretary of the Treasury since Alexander Hamilton.”
• 3HISTORY ALLOWED THE ADMINISTRATION Seven months to construct its new financial ark before the deluge of the First World War. The immediate task was purely political—where to locate the regional reserve banks provided by the Act. The Reserve Bank Organization Committee, which meant, in short, Secretary of the Treasury William Gibbs McAdoo and Secretary of Agriculture David F. Houston,* was provided with $100,000 for its investigations.
• 4The two officials fitted out a special car, organized a corps of secretaries, and right after the New Year began a country wide tour to study the advantages and disadvantages of each proposed reserve center. Hearings were held in eighteen cities and concluded on February 18. Over two hundred cities requested that their claims be heard. Certain decisions were foreordained. The influence of New York City would be cut down by lopping off New England and creating a reserve bank in Boston and another in Philadelphia. Pittsburghers, led by Andrew Mellon, † protested loudly at being neglected, urging the importance of their city as the center of the steel industry. Baltimore was disappointed to lose out to Richmond, Va., but this was inevitable considering Carter Glass’s origins.