The Origins of the Federal Reserve System: Part One

Woodrow Wilson signed into law the Federal Reserve Act on December 23, 1913, thus creating the Federal Reserve System with its twelve banks and board of governors that is so familiar today.

As the debate swirls around who will be named the next Federal Reserve Chair, I wanted to take a look back at the Federal Reserve System’s origins in a short series here on the blog. Perhaps unsurprisingly given the polarizing views in Congress today regarding the leadership of the Fed (and even the Fed itself!), there was heated debate over a century ago about the Federal Reserve System’s creation.

A Jacksonian Disinterest

One of the main functions of a central bank is to serve as the bank’s bank. It manages the money supply and interest rates, and serve as a lender of last resort in times of need, i.e. lending when there is a crisis so that a bank run would not result in disaster. (See this clip from It’s a Wonderful Life for cinematic interpretation of a bank run).

The first two central banks of the United States were the aptly named First Bank of the United States and the Second Bank of the United States. The Second Bank of the United States had a twenty-year charter set to expire in 1836. Its renewal became a point of contention in partisan politics. President Andrew Jackson, siding with the banking industry which preferred decreased regulation and increased profits, used his veto power and refused to renew the charter for the Second Bank. The charter expired, and the country was left without a central bank function for over 75 years.

The continuous cycle of panics that followed made sure to underscore that the banking system in the United States was fractured and could not sustain itself in times of crisis. A larger authority to assist banks was needed, but the political hurdles were daunting.

The Catalyst

The Panic of 1907 put things into perspective.  Starting first in the stock market, the crisis spread to banks and businesses around the county. The panic was so severe that wealthy private bankers such as J.P. Morgan deposited personal funds in banks to keep them open (Ahamed, 53 -54).

Prior to the Panic of 1907, banking legislation was either suppressed or ignored in Congress. As H. Parker Willis noted in 1912, “For years after the Civil War such questions as the tariff, the currency, banking, bond issues and the like, were vehicles for the expression of fanatical and partisan views” (p. 870). And both parties, Republican and Democratic, were guilty; much like today, the partisan divide on many issues  was extremely bitter and contentious.

With central banking in particular, there existed a lingering wariness about its role and effects on the American banking system leftover from the Jackson era.  As a political battle, any move toward a creation of a central banking system would not be an easy sell.

The Panic of 1907 and its aftermath forced political action. In 1908, Congress passed the Aldrich-Vreeland Act to allow national banks to issue emergency currency in response to crises. The Act also established the National Monetary Commission to study central banking and “report to Congress…what changes are necessary or desirable in the monetary system of the United States” (Dewald, p. 931). The central banking issue was reopened.

Oddly, the Republican Senator Nelson W. Aldrich, often accused of stalling banking legislation in the past and known for rubbing shoulders with the banking elite, would chair the National Monetary Commission.

Continue to Part Two

Further Reading

Ahamed, Liaquat. Lords of Finance: Bankers Who Broke the World. New York, Penguin Books (2009).

Dewald, William. “The National Monetary Commission – A Look Back.” Journal of Money, Credit and Banking. Vol. 4, No. 4 (November, 1972), pp. 930-956.

Fancher, E. R. “The Establishment and Scope of Branches of Federal Reserve Banks – Its Purpose and Work.” Annals of the American Academy of Political and Social Science. Vol. 99 ( January, 1922), pp. 135 – 142.

Willis, H. Parker. “The Banking Question in Congress.” Journal of Political Economy. Vol. 20, No. 9 (November, 1912), pp. 869 -885.

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