Nelson Aldrich versus Carter Glass—Part 2

Burghers of Calais (Rodin) in deep doo-doo
Original story here

(Part 1)

After the passage of the Federal Reserve Act (FRA; Dec 1913), the Federal Reserve System continued to evolve.¹  Meanwhile, a lot of bitter debates raged about a surmised lost opportunity, a potential for the true liberator of the economy from "the money trust."  I was interested in understanding the circumstances under which key decisions were made, and the controversies surrounding them.

Paul Warburg is my main source; he contributed to the design of the Federal Reserve System (FRS), but his preferred version was the Aldrich Bill, which was not the one that passed.  The one that passed was drafted by Senators Carter Glass (of Glass-Steagall fame) and Robert L. Owen, assisted by Dr. H. Parker Willis.²  Willis and Glass are mainly interested in presenting the existing FRA and resultant FRS as a natural development of necessity; as a consequence, they aren't really interested in acknowledging a quarrel with either Senator Aldrich or anyone else.  On the other hand, Warburg was determined to challenge the final composition of the system as a fundamental departure from the "Money Trust" drawn up by Aldrich. Why?

The Aldrich Bill was proposed in January 1912, but abandoned.  A few months later, Congress had hearings on the alleged "Money Trust," claiming that an elite group of bankers was rationing credit to enrich themselves and control the commerce of the country.   This was not an astonishing claim; trusts were a common form of industrial organization used to consolidate control of multiple firms into the hands of a single entity, for purposes of controlling prices and output.  Trusts could create a de facto monopoly out of scores of independent firms, with no obvious evidence.   Nothing seemed more likely than the idea that the financiers who organized trusts for steel, oil, sugar, tobacco, and so on, would devise one for themselves.³

The one problem was that the usual method of cartelizing Usonian enterprise, the trust, relied on trustees representing multiple shareholders from multiple firms—allowing many shareholders from many firms to make decisions as a single unit.  This didn't work with investment banking, which consisted of partnerships who borrowed money, not managers of a share-issuing corporation. It also didn't work with the commercial banks, who were supposed to follow rules systematically.   A more plausible scenario was that banks had interlocking directorates that allowed them to defeat prudential regulations and to shut out market entry in business sectors they wanted to protect.

However, the entity proposed in 1912 and its derivative, the Federal Reserve, was in fact an actual, non-metaphorical trust of trusts of commercial banking entities.  The banks would be shareholders in a new entity, the 12 district banks, and the 12 district banks would have a group of trustees in Washington.   My impression is that the Aldrich plan was very similar to the status quo before 1907 but for a plan to coordinate the supply of reserves.  This meant creating a network of banks whose nodes—and reserve-holders—were state-mandated but under private-sector control.  What Aldrich wanted was a fire department for the banks, and his innovations were entirely in line with the bankers' framing of the problem: a collection of tools, including uniform guidelines for bankers' acceptances and banknotes, and a cohort of banks whose sole purpose was to systematically pool reserves over a large area.

(The previous period of US banking, 1863-1908, is usually known as the National Bank Act period.  It provided for what would ultimately be three cities as "central reserve cities," whose banks were endowed with certain duties and privileges that were supposed to pool reserves and ensure the ready availability thereof in the event of a panic.  In addition to the three central reserve cities, another 16 cities were "reserve cities" who served as middle nodes in the system.  Champ (2007), p.9 explains how this system failed to protect bank liquidity during panics.)

The Glass-Owen Bill which was passed was heavily influenced by the Aldrich Bill, a point that Warburg makes many times, especially in the section where he compares the two bills on facing pages.  One big difference, in Warburg's mind, is that the districts were not merely branches of a national reserve "association" (one single mutual bank for banks), but now, multiple actual banks.^4, 5

Another big difference was that the Aldrich Bill, under advisement by Warburg, included a comprehensive scheme for centralizing reserves of the entire banking system to protect legitimate bank assets anywhere.  Banks were required to store all reserves with the National Reserve Association.  Warburg was disappointed in particular that FRB notes were accorded a lower class status to gold or "lawful money," i.e., circulating media that is legally permissible as bank reserves.  However, the original FRA was subsequently amended to treat notes of the FRB as lawful money identical in (domestic) status to gold certificates and US notes ("Greenbacks").

From the point of view of bank skeptics, this meant two things: one, the FRS would ultimately standardize policy to make it far more difficult to circulate gold as an alternative to FRS notes (since banks were no longer compelled to maintain gold reserves to supply in exchange for FRS notes).  Two, the Federal Reserve banks won a virtual monopoly—after 1971, an actual monopoly—on the issue of banknotes.  This, and the "money-trust" character of the Fed's organization, made it a sitting duck for populist denunciation.

So I return now to the question: why did the 63rd Congress, with its distinctly Progressive orientation, create a monetary authority so seemingly like a money trust?  One answer lies in the lack of viable alternatives: the old system was decentralized to the point that a totally unofficial figure like J.P. Morgan, or someone like him, could have hypothetically brought about the failure of currency-issuing banks he didn't like.  The surviving banks would then have truly been able to issue currency or quasi-currencies ad libitum, since antagonist banks could have been induced to suffer runs. The mechanism for doing so was, if not widely understood by the financial press, widely accepted as existing "somewhere out there." I don't know how to hack an electric power grid and shut it down, but I know it can be done.

(I don't want to defame Morgan, but a person with his power and his combination of motives could very readily have ruined banks underwriting rival industrial concerns. Morgan's line of work was issuing securities for a huge array of industrial interests, including Standard Oil, US Steel, and the United Fruit Company.  These firms benefited hugely as a result of the Morgan financial empire: the network of Morgan banks allowed them to raise capital for their pharaonic ventures.  In order to win struggles for market control, they also benefited when their rivals—when their rivals' underwriter—could not raise adequate capital.)

The scary thing, to me, about financial power is when it can be exercised in a granular way.  If one entity can ruin companies it finds inconvenient, that's more disturbing than its potential to, say, issue so much money it causes inflation; you don't usually expect airline pilots to want to wreck the airplane they're flying, although they definitely could do it.  But you do worry that a college professor could sexually harass students in his class.

That left collective management of the market for money and credit. At the micro level, the only strategy was to apply regulations consistently to the banks.  In time, this would be extended to monitoring the orders management gave to employees within banks themselves, e.g., the creation of firewalls between different lines of business.  At the macro level, this meant policy coordination to fight panics.

Finally, the designers of the Fed determined that the trust at the very top had to be institutionally divorced from the Federal Reserve banks, the equivalent of the sub-trustees in my "trust-of-trusts" characterization.  The District banks would be agents of the money trust, notionally served by the Board (or topmost layer of trustees); but those trustees would be appointed by the public and answerable to it.

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NOTES

1. See Addendum IV, Amendments between 15 August to 5 April 1918 (Warburg, 1930, I.p.520).  One major change was that responsibility for admitting new members to the FRS was transferred to the Federal Reserve Board (rather than district banks).


2. Dr. Willis (1920) published a book that is wholly online and explains his decisions. So did Senator Glass (1927), which I tracked down and read, but it's mainly a political memoir and not terribly useful.Willis's book is mostly a bare-bones description of the system's experience during WW1 (which, for the USA, was April 1917 to November 1918). But compare Willis (1920, p.25ff) with Warburg (1930, I.p.310ff).  Senator Nelson W. Aldrich died in 1915.


3. Brandeis (1914) Chapter 2: "How the Combiners Combine" and Chapter 3: "Interlocking Directorates." The book is in the public domain and hosted many places for free, but the online editions don't have page numbers.  Brandeis's answer was interlocking directorates, a residue of underwriting issues of stock for a company.


4. I remain fairly confident that Aldrich's scheme was inspired by a minimal fix to the National Banking Scheme, with the goal of an actual, non-metaphorical trust for banks.  I also think the Owen-Glass Plan was intended as a counterpoint to the Aldich Plan, in large measure to answer populist objections to centralization of the banking sector.  But I want to acknowledge countervailing evidence to my hypothesis.
   
   Warburg (1930, I.36) mentions discussions with O.M.W. Sprague (whose entire book is linked below) and a Mr. Victor Morawetz, who both were opposed to the idea of any sort of central bank,  Both changed their minds after talking with Warburg; Morawetz, a corporate lawyer who often represented J.P. Morgan's industrial interests, now favored a system of regional banks.  This may have been because Morawetz was concerned about public reception to a central bank, rather than because n regional banks would have been especially sound.


5. For the claim that the Aldrich scheme would have been a single bank posing as an "association," see Warburg (1930, I.64).   "Banking association" is the older legal term for what is more commonly known as a "mutual bank," or bank owned by its depositors.  Elsewhere (I.p.744), Warburg expresses strong regret that the political conditions require regionalism, and pushes back against a claim that regionalism is a peculiar virtue.  In fact , he thinks that regionalism has to be protected against its own tendencies.

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SOURCES 🙵 ADDITIONAL READING

Nelson W. Aldrich Papers, Library of Congress

Louis Brandeis, Other People's Money—and How the Bankers Use It, New York: Frederick Stokes, 1914

Major B. Foster, Banking (Vol. XVI of Modern Business series), Alexander Hamilton Institute (1919)

Bruce Champ, "The National Banking System: A Brief History" (PDF), Federal Reserve Bank of Cleveland, Working Paper 7-23 (Dec 2007)

Carter Glass, An Adventure in Constructive Finance, Doubleday, Page 🙵 Co. (1927)

Allan H. Meltzer, A History of the Federal Reserve, Vol I: 1913-1951, University of Chicago Press (2004)

O.M.W. Sprague, History of crises under the national banking system (complete text online), National Banking Commission (1910)

Paul M. Warburg, Federal Reserve System: Its Origin and Growth (complete text online), MacMillan (1930)

Henry P. Willis, The Federal Reserve System,  Chicago: Blackstone Institute (1920).  Willis provides an alternative explanation of the FRA.