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How Wall Street created the Federal Reserve

December 06, 2013 11:34 IST

In 1910 the who's who of Wall Street met in total secrecy in an American town to work towards the first draft of the bill that would finally give the United States a central bank.

The clock had just struck 10 pm on the night of November 22, 1910. The New Jersey railway station was largely empty. The coach at the end of the platform was the private railway car of Senator Aldrich and was often seen at New York and New Jersey railway stations. But this was no ordinary journey. Aldrich would be travelling with six other people, who had all been instructed to arrive separately at the station and avoid the press at any cost. Even after they had boarded the train they had to address each other by their first names, so that the service personnel on the train did not know who they were.

Travelling with Aldrich that night were: (a) Benjamin Strong, head of JP Morgan’s Bankers Trust Company, (b) Henry P Davison, a senior partner in the JP Morgan Company, (c) Charles D Norton, president of JP Morgan-run First National Bank, (d) Abraham Piatt Andrew, an economist and an Assistant Treasury Secretary of the United States, (e) Paul M Warburg, a partner in Kuhn, Loeb & Co, a Wall Street investment bank which was very close to the Rothschild banking dynasty of Europe, and (f) Frank A Vanderlip, president of the National City Bank of New York, one of the most powerful banks at that point of time and seen to be aligned with John D. Rockefeller.

This top-secret meeting of the who’s who of Wall Street was supposed to last for one week at an exclusive retreat, the Jekyll Island Club, on Jekyll Island, Georgia. The facilities for the meeting had been organised by JP Morgan himself. Morgan was a member as well as a co-owner of the club.

After travelling for two days, they reached their destination. When news got around in the small town of Brunswick where they had alighted to get to JekyllIsland, the press that landed up was told by Davison that he had got his guests along for the simple amusement of duck hunting. At the resort, the normal full-time staff had been given nine days off and carefully screened staff had been brought along for the occasion. All this was done to ensure that word of the meeting did not get out.

The agenda of the meeting was to draft the central-bank bill for the United States. After it had been drafted, Aldrich would put this up in the Congress for discussion. But, what was interesting were the loyalties of the men who had come along to JekyllIsland to draft the bill. Davison, Norton, and Strong were clearly aligned to JP Morgan. Vanderlip and Aldrich were close to Rockefeller. The Treasury Secretary Andrews had his feet in both the camps. And that left Warburg, who represented the interests of one of the biggest investment banks of Wall Street, with close links to the Rothschilds of Europe.

So, we had a team full of people from the Wall Street working toward the first draft of the bill that would finally give the United States a central bank. One of the things suggested and adopted was not to use the word central bank anywhere. The phrase central bank evoked too much power being concentrated in the hands of a few, which would not be a good move politically.

Senator Aldrich wanted to adopt one of the better European banking systems straight away, but gradually, he saw some sense in Warburg’s system of multiple central banks. The central bank was to be called the National Reserve Association and would have 15 regional reserve associations.

Aldrich presented the proposal made by this group of seven at the JekyllIsland to the National Monetary Commission a few months later, in January 1911. The idea of regional banks gained much support, because it was believed that this would bring down the financial importance of the city of New York.

But when the Aldrich bill, as it came to be known, reached the Congress, it was attacked by committees in both the houses. Despite the attempts made by the group of seven to make the bill look like something very important for the overall American economy, its Wall Street leanings were not so well-hidden.

Given these reasons, the House Banking and Currency Committee assigned a subcommittee under the leadership of Carter Glass, a newspaper publisher and a representative from Virginia. Glass believed in totally autonomous regional banks and did not like the idea of any central coordinating agency. This sounded even more radical to the ears of Woodrow Wilson, who had just become president and was sure that neither the public nor the US Congress would approve any plan in which the government had little or no control over the central bank.

Hence, a proposal for a central authority with seven members was included. The central-banking system would be called the Federal Reserve System, and in line with that the central authority would be called the Federal Reserve Board. The board would consist of seven members, including the treasury secretary, the comptroller of currency and five members appointed by president, of which two needed to have prior experience in banking or finance. These appointments would have to be approved by the Senate.

The bill was passed by the House of Representatives, one of the two houses of the American Congress on September 18, 1913. After that, it came up for discussion in the Senate, the other house. The bill passed by the House of Representatives had a provision for a series of central banks around the country, not less than 12 in number. The Senate changed it to not less than eight but not more than 12 in number.

With these changes, the Senate passed the bill on December 17, 1913. President Wilson signed the Federal Reserve Act on December 23, 1913 and the 12 Reserve Banks opened on November 16, 1914.

When Carter Glass took control of what was to become the Federal Reserve Act, he appointed economist Henry Parker Willis as his administrative assistant.

Willis wrote a paper a few months after the Federal Reserve Act saw the light of day. In this paper, he said that the Act in its final form was not drawn from any single source.

But that does not seem to be the case. As the Federal Reserve of Minneapolis (one of the 12 central banks formed after the Act was passed) points out in an article on its website: ‘The eventual Federal Reserve Act ... was similar to the earlier plan launched by Senator Aldrich.’ The only difference being that the private banks and Wall Street were not given as much control of the system as was originally envisaged.

But who is to say that they were not happy with what they got. In fact, one thing they obviously would have known all along is that the bill would not be passed exactly like they had presented it through Aldrich. Changes would be proposed and made as the bill would be discussed in great detail in both the houses of the Congress. Given this, at some level, it made sense for them to have enough provisions in the bill which would be knocked down anyway. This would give a feeling to the politicians that they had done away with the more controversial provisions of the Act.

Wall Street soon realised that even though the Federal Reserve Board would be controlled by the government in Washington, it would not be difficult for them to infiltrate the other central banks with their own men. Each central bank would have nine directors. Of this, three would be appointed by the Federal Reserve Board. Of this, two would need to have banking experience. The remaining six directors would be elected by the member banks. These would be banks of the region which had chosen to become a part of the Federal Reserve System and hence were called member banks.

Reprinted with permission from Easy Money, Evolution of Money from Robinson Crusoe to the First World War, by Vivek Kaul. Consulting Editor, 2013 / 300 pages / Paperback: Rs 395 (9788132113423) / SAGE Response