History of the Federal Reserve System

from its creation to the present.

Central banking in the United States prior to the Federal Reserve

The Federal Reserve System is the third central banking system in the United States' history. The First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-1836) each had 20-year charters, and both issued currency, made commercial loans, accepted deposits, purchased securities, had multiple branches, and acted as fiscal agents for the U.S. Treasury.cite web |url=http://www.bos.frb.org/about/pubs/begin.pdf |title= Historical Beginnings ... The Federal Reserve |author= Johnson, Roger T. |publisher= Federal Reserve Bank of Boston] In both banks the Federal Government was required to purchase 20% of the bank's capital stock and appoint 20% of the directors. Thus majority control was in the hands of private investors who purchased the rest of the stock. The banks were opposed by state-chartered banks, who saw them as very large competitors, and by many who understood them to be banking cartels which compelled to them servitude of the common man. President Andrew Jackson vetoed legislation to renew the Second Bank of the United States, starting a period of free banking. Jackson staked his second term on the issue of central banking stating, "Every monopoly and all exclusive privileges are granted at the expense of the public, which ought to receive a fair equivalent. The many millions which this act proposes to bestow on the stockholders of the existing bank must come directly or indirectly out of the earnings of the American people." [Andrew Jackson, "Veto Message, Washington, July 10, 1832," in Richardson, ed., Messages and Papers of the Presidents, II, 576-591.]

In 1863, as a means to help finance the Civil War, a system of national banks was instituted by the National Currency Act. The banks each had the power to issue standardized national bank notes based on United States bonds held by the bank. The Act was totally revised in 1864 and later named as the National-Bank Act, or National Banking Act, as it is popularly known. The administration of the new national banking system was vested in the newly created Office of the Comptroller of the Currency and its chief administrator, the Comptroller of the Currency. The Office, which still exists today, examines and supervises all banks chartered nationally and is a part of the U.S. Treasury Department.

The Federal Reserve Act

The early national banking system lacked liquidity.cite web |url= http://odur.let.rug.nl/~usa/E/usbank/bank00.htm|title= A Brief History of Central Banking in the United States |author= Flaherty, Edward|work= |publisher= University of Groningen, Netherlands] National bank currency was considered inelastic because it was based on the fluctuating value of U.S. Treasury bonds rather than the growing desire for easy credit. If Treasury bond prices declined, a national bank had to reduce the amount of currency it had in circulation by either refusing to make new loans or by calling in loans it had made already. The related liquidity problem was largely caused by an immobile, pyramidal reserve system, in which nationally chartered country banks were required to set aside their reserves in reserve city banks, which in turn were required to have reserves in central city banks. During planting season country banks needed to call in their reserves, and during the harvest season they would add to their reserves. A national bank whose reserves were being drained would replace its reserves by selling stocks and bonds, by borrowing from a clearing house or by calling in loans. As there was little in the way of deposit insurance, if a bank was rumored to be having liquidity problems then this might cause many people to remove their funds from the bank. Because of the crescendo effect of banks which lent more than their assets could cover, during the last quarter of the 19th century and the beginning of the 20th century, the United States economy went through a series of financial panics.

The National Monetary Commission

A particularly severe panic in 1907 provided the motivation for renewed demands for banking and currency reform.cite web |url= http://links.jstor.org/sici?sici=0002-7162(190803)31%3C8%3ATPO1AS%3E2.0.CO%3B2-7|title= The Panic of 1907 and Some of Its Lessons |author= Herrick, Myron|date=1908-03|work= |publisher= Annals of the American Academy of Political and Social Science] The following year Congress enacted the Aldrich-Vreeland Act which provided for an emergency currency and established the National Monetary Commission to study banking and currency reform.cite web |url= http://www.minneapolisfed.org/pubs/region/89-05/reg895d.cfm|title= Paul Warburg's Crusade to Establish a Central Bank in the United States |author= Whithouse, Michael|date=1989-05|work= |publisher= Minnesota Federal Reserve]

The chief of the bipartisan National Monetary Commission was financial expert and Senate Republican leader Nelson Aldrich. Aldrich set up two commissions — one to study the American monetary system in depth and the other, headed by Aldrich himself, to study the European central-banking systems and report on them. Aldrich went to Europe opposed to centralized banking, but after viewing Germany's banking system came away believing that a centralized bank was better than the government-issued bond system that he had previously supported. Centralized banking was met with much opposition from politicians, who were suspicious of a central bank and who charged that Aldrich was biased due to his close ties to wealthy bankers such as J.P. Morgan and his daughter's marriage to John D. Rockefeller, Jr. In 1910, Aldrich and executives representing the banks of J.P. Morgan, Rockefeller, and Kuhn, Loeb & Co., secluded themselves for 10 days at Jekyll Island, Georgia. The executives included Frank A. Vanderlip, president of the National City Bank of New York, associated with the Rockefellers; Henry Davison, senior partner of J.P. Morgan Company; Charles D. Norton, president of the First National Bank of New York; and Col. Edward House, who would later become President Woodrow Wilson's closest adviser and founder of the Council on Foreign Relations.cite web |url= http://www.cooperativeindividualism.org/aier_on_conspiracy_04.html|title= America's Unknown Enemy: Beyond Conspiracy |publisher= American Institute of Economic Research] There, Paul Warburg of Kuhn, Loeb, & Co. directed the proceedings and wrote the primary features of what would be called the Aldrich Plan. Warburg would later write that "The matter of a uniform discount rate (interest rate) was discussed and settled at Jekyll Island." Vanderlip wrote in his 1935 autobiography "From Farmboy to Financier" :

I was as secretive, indeed I was as furtive as any conspirator. Discovery, we knew, simply must not happen, or else all our time and effort would have been wasted. If it were to be exposed that our particular group had got together and written a banking bill, that bill would have no chance whatever of passage by Congress…I do not feel it is any exaggeration to speak of our secret expedition to Jekyll Island as the occasion of the actual conception of what eventually became the Federal Reserve System.”

Despite meeting in secret, from both the public and the government, the importance of the Jekyll Island meeting was revealed three years after the Federal Reserve Act was passed; when journalist Bertie Charles Forbes wrote an article about the "hunting trip" in 1916.

The 1911-12 Republican plan was proposed by Senator Aldrich to solve the banking dilemma, this was supported by the American Bankers’ Association. It provided for one great central bank, the National Reserve Association, with a capital of at least $100 million and with fifteen branches in various sections. The branches were to be controlled by the member banks on a basis of their capitalization. The National Reserve Association would issue currency, based on gold and commercial paper, that would be the liability of the bank and not of the government. It would also carry a portion of member banks’ reserves, determine discount reserves, buy and sell on the open market, and hold the deposits of the federal government. The branches and businessmen of each of the fifteen districts would elect thirty out of the thirty-nine members of the board of directors of the National Reserve Association. [Link, Arthur. "Wilson and the Progressive Era" New York: Harper, (1954) pp 44-45]

Aldrich fought for a private monopoly with little government influence, but conceded that the government should be represented on the Board of Directors. Aldrich then presented what was commonly called the "Aldrich Plan" -- which called for establishment of a "National Reserve Association" -- to the National Monetary Commission. Most Republicans and Wall Street bankers favored the Aldrich Plan, but it lacked enough support in the bipartisan Congress to pass.cite web |url= http://www.minneapolisfed.org/pubs/region/88-08/reg888a.cfm|title= Born of a panic: Forming the Federal Reserve System |date=1988-08 |publisher= Minnesota Federal Reserve]

Because the bill was introduced by Aldrich, considered the epitome of the "Eastern establishment", the bill received little support and was derided by southerners and westerners who believed that wealthy families and large corporations ran the country and would thus run the proposed National Reserve Association. The National Board of Trade appointed Warburg as head of a committee to persuade Americans to support the plan. The committee set up offices in the then-45 states and distributed printed materials about the central bank. The Nebraskan populist and frequent Democratic presidential candidate William Jennings Bryan said of the plan: "Big financiers are back of the Aldrich currency scheme." He asserted that if it passed, big bankers would "then be in complete control of everything through the control of our national finances."cite web |url= http://www.bos.frb.org/about/pubs/begin.pdf|title= Historical Beginnings… The Federal Reserve|author= Johnson, Roger|date=1999-12 |publisher= Federal Reserve Bank of Boston] .

There was also Republican opposition to the Aldrich Plan. Republican Sen. Robert M. LaFollette and Rep. Charles Lindbergh Sr. both spoke out against the favoritism that they contended the bill granted to Wall Street. "The Aldrich Plan is the Wall Street Plan…I have alleged that there is a 'Money Trust'", said Lindbergh. "The Aldrich plan is a scheme plainly in the interest of the Trust". In response, Rep. Arsène Pujo, a Democrat from Oklahoma, obtained congressional authorization to form and chair a subcommittee (the Pujo Committee) within the House Committee Banking Committee, to conduct investigative hearings on the alleged "Money Trust." The hearings continued for a full year and were led by the Subcommittee's counsel, Democratic lawyer Samuel Untermyer, who later also assisted in preparing the Federal Reserve Act. The "Pujo hearings" cite web |url= http://www.public.asu.edu/~icprv/courses/hst315/secret315/biographies/Prog/Pujo,%20Arsene%20PROG.txt |title=Pujo, Arsene, a brief biography] convinced much of the populace that America's money largely rested in the hands of a select few on Wall Street. The Subcommittee issued a report saying: [cite web |url=http://college.hmco.com/polisci/wilson/am_gov/7e/students/portfolio/1913pujo_b.html |title=U.S. Congress, Excerpts from the Report of the Committee Appointed to Investigate the Concentration of Money and Credit, House Report No. 1593, 3 vols. (Washington, D.C., 1913), III: pp. 55-56, 89, 129, 140.]

"If by a 'money trust' is meant an established and well-defined identity and community of interest between a few leaders of finance…which has resulted in a vast and growing concentration of control of money and credit in the hands of a comparatively few men…the condition thus described exists in this country today...To us the peril is manifest...When we find...the same man a director in a half dozen or more banks and trust companies all located in the same section of the same city, doing the same class of business and with a like set of associates similarly situated all belonging to the same group and representing the same class of interests, all further pretense of competition is useless.... "

Seen as a "Money Trust" plan, the Aldrich Plan was opposed by the Democratic Party as was stated in its 1912 campaign platform, but the platform also supported a revision of banking laws that would protect the public from financial panics and "the domination of what is known as the "Money Trust." During the 1912 election the Democractic Party took control of the Presidency and both chambers of Congress. The newly elected President, Woodrow Wilson,was committed to banking and currency reform, but it took a great deal of his political influence to get an acceptable plan passed as the Federal Reserve Act in 1913. Wilson thought the Aldrich plan was perhaps "60-70% correct". When Virginia Rep. Carter Glass, chairman of the House Committee on Banking and Currency, presented his bill to President-elect Wilson, Wilson said that the plan must be amended to contain a Federal Reserve Board appointed by the executive branch to maintain control over the bankers.

After Wilson presented the bill to Congress, a group of Democratic congressmen revolted, led by Representative Robert Henry of Texas, demanding that the "Money Trust" be destroyed before it could undertake major currency reforms. They particularly objected to the idea of regional banks having to operate without the implicit government protections that large, so-called money-center banks would enjoy. The group almost succeeded in killing the bill, but were mollified by Wilson's promises to propose antitrust legislation after the bill had passed and by Bryan's support of the bill.

The enactment of the Federal Reserve Act

After months of hearings, amendments, and debates the Federal Reserve Act passed Congress on a Sunday two days before Christmas when most of Congress was on vacation. Years later, regarding the bill he signed into law, Wilson said, “I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world." [ "Repeal the Federal Reserve Banks" by Rev. Casimir Frank

Gierut] Most every Democrats in support of and most Republicans against it. As noted in a paper by the American Institute of Economic Research:

In its final form, the Federal Reserve Act represented a compromise among three political groups. Most Republicans (and the Wall Street bankers) favored the Aldrich Plan that came out of Jekyll Island. Progressive Democrats demanded a reserve system and currency supply owned and controlled by the Government in order to counter the "money trust" and destroy the existing concentration of credit resources in Wall Street. Conservative Democrats proposed a decentralized reserve system, owned and controlled privately but free of Wall Street domination. No group got exactly what it wanted. But the Aldrich plan more nearly represented the compromise position between the two Democrat extremes, and it was closest to the final legislation passed.

Frank Vanderlip, one of the Jekyll Island attendees and the President of National City Bank, wrote in his autobiography:

"Although the Aldrich Federal Reserve Plan was defeated when it bore the name Aldrich, nevertheless its essential points were all contained in the plan that was finally adopted."

Ironically, in October 1913, two months before the enactment of the Federal Reserve Act, Frank Vanderlip proposed before the Senate Banking Committee his own competing plan to the Federal Reserve System, one with a single central bank controlled by the Federal government, which almost derailed the legislation then being considered and already passed by the U.S. House of Representatives.cite web |url=http://query.nytimes.com/mem/archive-free/pdf?res=9901E5DC1E3BE633A25756C2A9669D946296D6CF|title= Wilson Upholds Glass Money Bill; But Senators Think His Statement Offers a Loophole for His Accepting Vanderlip Plan |date=October 25, 1913 |publisher= New York Times] Aldrich himself stated strong opposition to the currency plan passed by the House.cite web |url=http://query.nytimes.com/gst/abstract.html?res=9500E7DC133FE633A25755C1A9669D946296D6CF|title= Aldrich Sees Bryan Back of Money Bill; Socialist, Unconstitutional Measure, Says Ex-Senator |date=October 18, 1913 |publisher=New York Times]

However, the former point was also made by Republican Representative Charles Lindbergh Sr. of Minnesota, one of the most vocal opponents of the bill, who on the day the House agreed to the Federal Reserve Act told his colleagues:

"But the Federal reserve board have no power whatever to regulate the rates of interest that bankers may charge borrowers of money. This is the Aldrich bill in disguise, the difference being that by this bill the Government issues the money, whereas by the Aldrich bill the issue was controlled by the banks...Wall Street will control the money as easily through this bill as they have heretofore."(Congressional Record, v. 51, page 1447, Dec. 22, 1913)

Republican Congressman Victor Murdock of Kansas, who voted for the bill, told Congress on that same day:

"I do not blind myself to the fact that this measure will not be effectual as a remedy for a great national evil – the concentrated control of credit...The Money Trust has not passed [died] ...You rejected the specific remedies of the Pujo committee, chief among them, the prohibition of interlocking directorates. He [your enemy] will not cease fighting...at some half-baked enactment...You struck a weak half-blow, and time will show that you have lost. You could have struck a full blow and you would have won." (Congressional Record, v. 51, pages 1443-44, Dec. 22, 1913)

In order to get the Federal Reserve Act passed, Wilson needed the support of populist William Jennings Bryan, who was credited with ensuring Wilson's nomination by dramatically throwing his support Wilson's way at the 1912 Democratic convention. Wilson appointed Bryan as his Secretary of State. Bryan served as leader of the agrarian wing of the party and had argued for unlimited coinage of silver in his "Cross of Gold Speech" at the 1896 Democratic convention.cite web |url= http://www.minneapolisfed.org/pubs/region/97-12/glass-bio.cfm|title= Carter Glass: A Brief Biography |author= Page, Dave|date=1997-12|publisher= Minnesota Federal Reserve] Bryan and the agrarians wanted a government-owned central bank which could print paper money whenever Congress wanted, and thought the plan gave bankers too much power to print the government's currency. Wilson sought the advice of prominent lawyer Louis Brandeis to make the plan more amenable to the agrarian wing of the party; Brandeis agreed with Bryan. Wilson convinced them that because Federal Reserve notes were obligations of the government and because the President would appoint the members of the Federal Reserve Board, the plan fit their demands. However, Bryan soon became disillusioned with the system. In the November 1923 issue of "Hearst's Magazine" Bryan wrote that "The Federal Reserve Bank that should have been the farmer's greatest protection has become his greatest foe."

Southerners and westerners learned from Wilson that the system was decentralized into 12 districts and surely would weaken New York and strengthen the hinterlands. Sen. Robert Owen of Oklahoma eventually relented to speak in favor of the bill, arguing that the nation's currency was already under too much control by New York elites, whom he alleged had singlehandedly conspired to cause the 1907 Panic.

Large bankers thought the legislation gave the government too much control over markets and private business dealings. The "New York Times" called the Act the "Oklahoma idea, the Nebraska idea"-- referring to Owen and Bryan's involvement.

However, several Congressmen, including Owen, Lindbergh, LaFollette, and Murdock claimed that the New York bankers feigned their disapproval of the bill in hopes of inducing Congress to pass it. The day before the bill was passed, Murdock told Congress:

"You allowed the special interests by pretended dissatisfaction with the measure to bring about a sham battle, and the sham battle was for the purpose of diverting you people from the real remedy, and they diverted you. The Wall Street bluff has worked." (Congressional Record, 12/22/1913)

When President Wilson signed the Federal Reserve Act on December 23, 1913, he said he felt grateful for having had a part "in completing a work ... of lasting benefit for the country," cite web |url= http://query.nytimes.com/gst/abstract.html?res=9B04E3DB173DE633A25757C2A9649D946296D6CF|title= Wilson Signs Currency Bill| publisher= New York Times, December 24, 1913] knowing that it took a great deal of compromise and expenditure of his own politcal capital to get it enacted. This was in keeping with the general plan of action he made in his First Inaugural Address on March 4, 1913, in which he stated:

We shall deal with our economic system as it is and as it may be modified, not as it might be if we had a clean sheet of paper to write upon; and step-by-step we shall make it what it should be, in the spirit of those who question their own wisdom and seek counsel and knowledge, not shallow self-satisfaction or the excitement of excursions we can not tell.cite web |url= http://www.civicwebs.com/cwvlib/constitutions/usa/e_wilson_1st_inaug_address.htm|title= President Wilson's First Inaugural Address|publisher= Civic Webs Virtual Library]

While a system of 12 regional banks was designed so as not to give eastern bankers too much influence over the new bank, in practice, the Federal Reserve Bank of New York became "first among equals". The New York Fed, for example, is solely responsible for conducting open market operations, at the direction of the Federal Open Market Committee.cite web |url= http://www.house.gov/jec/fed/fed/fed-impt.htm|title= The Importance of the Federal Reserve |author= Keleher, Robert|date=1997-03|work= Joint Economic Committee |publisher= US House of Representatives] Democratic Congressman Carter Glass sponsored and wrote the eventual legislation, and his home state capital of Richmond, Virginia, was made a district headquarters. Democratic Senator James A. Reed of Missouri obtained two districts for his state. [ [http://stlouisfed.org/publications/foregone/chapter_three.htm A Foregone Conclusion: The Founding of the Federal Reserve Bank of St. Louis by James Neal Primm - stlouisfed.org - Retrieved January 1, 2007] ] However, the 1914 report of the Federal Reserve Organization Committee, which clearly laid out the ratiionale for their decisions on establishing Reserve Bank districts in 1914, showed that it was based almost entirely upon current correspondent banking relationships.cite web |url=http://fraser.stlouisfed.org/historicaldocs/rboc/download/31338/ReserveBankDecision1914.pdf |title= Decision of the Reserve Bank Organization Committee Determining the Federal Reserve Districts and the Location of Federal Reserve Banks under the Federal Reserve Act approved December 23, 1913 |author= Reserve Bank Organization Committee |date= April 14, 1914 |publisher= U.S. Government Printing Office] To quell Elihu Root's objections to possible inflation, the passed bill included provisions that the bank must hold at least 40% of its outstanding loans in gold. (In later years, to stimulate short-term economic activity, Congress would amend the act to allow more discretion in the amount of gold that must be redeemed by the Bank.) Critics of the time (later joined by economist Milton Friedman) suggested that Glass's legislation was almost entirely based on the Aldrich Plan that had been derided as giving too much power to elite bankers. Glass denied copying Aldrich's plan. In 1922, he told Congress, "no greater misconception was ever projected in this Senate Chamber."

Wilson named Warburg and other prominent experts to direct the new system, which began operations in 1915 and played a major role in financing the Allied and American war efforts. [Arthur Link, "Wilson: The New Freedom"; pp. 199-240 (1956).] Warburg at first refused the appointment, citing America's opposition to a "Wall Street man", but when World War I broke out he accepted. He was the only appointee asked to appear before the Senate, whose members questioned him about his interests in the central bank and his ties to Kuhn, Loeb, & Co.'s "money trusts".

Accord of 1951 between the Federal Reserve and the Treasury Department

Post Bretton-Woods era

In July 1979, Paul Volcker was nominated, by President Carter, as Chairman of the Federal Reserve Board amid roaring inflation. He tightened the money supply, and by 1986 inflation had fallen sharply.cite web |url= http://www.nationalreview.com/nrof_bartlett/bartlett200406140846.asp|title= Warriors Against Inflation |author= Bartlett, Bruce|date=2004-06-14 |publisher= "National Review"] In October 1979 the Federal Reserve announced a policy of "targeting" money aggregates and bank reserves in its struggle with double-digit inflation. ["Source: A Monetary Chronology of the United States, American Institute for Economic Research, July 2006"]

In January 1987, with retail inflation at only 1%, the Federal Reserve announced it was no longer going to use money-supply aggregates, such as M2, as guidelines for controlling inflation, even though this method had been in use from 1979, apparently with great success. Before 1980, interest rates were used as guidelines; inflation was severe. The Fed complained that the aggregates were confusing. Volcker was chairman until August 1987, whereupon Alan Greenspan assumed the mantle, seven months after monetary aggregate policy had changed. [A Monetary Chronology of the United States, American Institute for Economic Research, July 2006]

2001 Recession to Present

From early 2001 to mid 2003 the Federal Reserve lowered its interest rates 13 times, from 6.25 to 1.00%, to fight recession. In November 2002, rates were cut to 1.75, and many interest rates went below the inflation rate. On June 25, 2003, the federal funds rate was lowered to 1.00%, its lowest nominal rate since July, 1958, when the overnight rate averaged 0.68%. Starting at the end of June 2004, the Federal Reserve System raised the target interest rate and then continued to do so 17 straight times.

In March 2006, the Federal Reserve ceased to make public M3, arguably the most reliable means of measuring the money supply. Their statement declared that the costs of collecting this data outweighed the benefits. M3 includes all of M2 (which includes M1) plus large-denomination ($100,000 +) time deposits, balances in institutional money funds, repurchase liabilities issued by depository institutions, and Eurodollars held by U.S. residents at foreign branches of U.S. banks as well as at all banks in the United Kingdom and Canada. M3 had increased past 9% in the three months prior to the move, and a total 17% inflation in the past year.

2008 subprime mortgage crisis

Due to a credit crunch caused by the sub-prime mortgage crisis in September 2007, the Federal Reserve began cutting the federal funds rate. The Fed cut by .25% after its December 11, 2007 meeting and disappointed many individual investors who expected a higher rate cut: the Dow Jones Industrial Average dropped by nearly 300 points at its close that day. The Fed slashed the rate 0.75% in an emergency action on January 22, 2008 to assist in reversing a significant market slide influenced by weakening international markets. The Dow Jones Industrial Average initially fell nearly 4% (465 points) at the start of trading and then rebounded to a more tolerable 1.06% (128 point) loss. On January 30, 2008, eight days after the 75 points decrease, the Fed lowered its rate again, this time by 50 points. [cite news|author=Michael M. Grynbaum and John Holusha|title=Fed Cuts Rate 0.75% and Stocks Swing|url= http://www.nytimes.com/2008/01/22/business/23cnd-fed.html |work=The New York Times|publisher=The New York Times Company|date=2008-01-22 |accessdate=2008-01-22]

Key laws affecting the Federal Reserve

Key laws affecting the Federal Reserve have been:ebook: The Federal Reserve - Purposes and Functions:http://www.federalreserve.gov/pf/pf.htm:for info on government regulations, see pages 13 and 14. Addressing bank panics on page 83. Implementation of monetary policy on page 12 and 36. Board and reserve banks responsibility on page 12. Key laws affecting the federal reserve on page 11. Monetary policy uncertainties on pages 18-19.]
*Banking Act of 1935
*Employment Act of 1946
*Federal Reserve-Treasury Department Accord of 1951
*Bank Holding Company Act of 1956 and the amendments of 1970
*Federal Reserve Reform Act of 1977
*International Banking Act of 1978
*Full Employment and Balanced Growth Act (1978)
*Depository Institutions Deregulation and Monetary Control Act (1980)
*Financial Institutions Reform, Recovery and Enforcement Act of 1989
*Federal Deposit Insurance Corporation Improvement Act of 1991
*Gramm-Leach-Bliley Act (1999)

References