Wall Street vs. Main Street

It’s amazing how little politicians know. What they say often amounts to half-truths: yes, there is some truth in what they’re saying, but as is often the case there is another side to the story. Consider 2008, when the international banking system was on the verge of collapse. Accusations were flying thick and fast in Congress. Washington politicians were looking for a scapegoat and pointing fingers at the Federal Reserve, which was scrambling to save financial institutions that could be saved. Politicians who thought they knew better railed at the Fed for rescuing Wall Street while Main Street languished. What they said was half true.

The Federal Reserve has 12 locations spread throughout the country, but truth be told a surprising number of Washington politicians didn’t know exactly what they did. During the crisis, these 12 Federal Reserve branches were busy rescuing banks in their region. In other words, they were rescuing Main Street. The presidents of the 12 regional Federal Reserve banks are hands-on bankers who know their communities well. Indeed, they have more experience in the kinds of interactions of which retail politics is made than many Washington politicians. They know their communities, speak at the local chamber of commerce, and meet with business leaders and local bankers. Richard Fisher was one such president who had his office at the Dallas Fed. Imagine his surprise when a congressman stormed into his office spewing anger at the Federal Reserve for rescuing big Wall Street banks. Little did the congressman know that Fisher personally approved every discount-window loan the Dallas Fed made—even during the crisis, when the lending hit $9 billion a night—and as it happened, the day before, the discount window had extended credit to a bank in the congressman’s district.

“I just lent $10,000 to a bank in your district last night,” Fisher said. The congressman was dumbfounded: he had no idea the Fed was so deeply involved in the routine operations of local banks. Few congressman did. However much Congress may have wanted to punish the Fed for its actions during the crisis, the task of regulating trillion-dollar banks is too complicated to hand over to just anyone. The Federal Reserve, as lawmakers discovered, did know what they were doing and were in fact helping banks throughout the U.S. And the result? Instead of reducing the Fed’s authority, on July 21, 2010, Congress passed a law to increase the Fed’s power.

What do we really know about the Federal Reserve? We know Treasury Secretary Alexander Hamilton created an early version of the Fed, called the Bank of the United States, or B.U.S. for short. Twenty-some years later President James Madison renewed the B.U.S. charter. Twenty years after that, President Andrew Jackson famously destroyed B.U.S., and the longest recession in our nation’s history ensued. Indeed, without a National Bank—a.k.a., lender of last resort—the nation’s economy convulsed badly every twenty years or so thereafter. Each time it did, fortunes were wiped out overnight, state banks closed by the thousands, businesses by the tens of thousands shut their doors, and workers by the hundreds of thousands were put out on the streets. In 1907, faced with another recession, J.P. Morgan stepped in as a lender of last resort to prevent yet another run on banks. It was then that a few enlightened Washington politicians met secretly with a few enlightened Wall Street bankers and decided it was time to reinstate the National Bank. The week-long meeting took place on an island in a rural part of Georgia, at a private hunting and fishing lodge known as the Jykell Island Club.

THE JYKELL ISLAND CLUB

“If men were angels, no government would be necessary,” James Madison famously wrote. The same could be said of bankers: if bankers were angels, there would be no need of a national bank. The creation of the Federal Reserve is the subject of “America’s Bank” by Robert Lowenstein. The underlying theme is trust, as in, Who do you trust? Since the beginning of the American republic, Americans trusted neither governments nor banks, particularly central governments and central banks, such as ruled the British Empire from London and governed the affairs of the American colonies—until ties were severed by the American Revolution. After the Revolution, the original 13 states struggled politically and financially until the enactment of the Federal government in 1789 and the establishment of B.U.S. in 1791. Both functioned exceedingly well, so much so that Thomas Jefferson feared a new London-style monarchy was in the making on American soil. He ran for president to stop it.

Jefferson was determined to reduce the size of the federal government and do away with B.U.S.. In spite of Jefferson’s antipathy, the national bank proved handy as a means of paying for the Louisiana Purchase, and to finance the army and rebuild the navy during the War of 1812. B.U.S. served the government and the nation well until the presidency of Andrew Jackson. By then, the bank had become the object of intense hatred by Jackson and his vocal constituency of Southern slaveholders and Northern farmers who elected him president. De Tocqueville, touring America at the time, was plainly bewildered. To him, as to most Frenchmen, the Bank of France seemed a natural outgrowth of the French national government. But in the U.S. the central bank reawakened Americans’ primal anxieties, the colonials’ fear that their hard-won liberties would be crushed underfoot by a far-off monarch and his scheming money men. Without a second thought, Jackson destroyed B.U.S. and was hailed as a hero for the next 80 years, despite a series of financial panics, bank runs, money shortages, and full-blown depressions that might have been averted or lessened had there been a lender of last resort. Without B.U.S., Lincoln financed the Union war effort by selling government bonds and issuing fiat money—unsecured “greenback dollars” that failed to hold their value.

In 1907, after a particularly nasty panic that was arrested only by the deep pockets of J.P. Morgan, opinion began to change. Two politicians and four Wall Street bankers decided it was time to do something about it. At midnight and in disguise, they secretly boarded a train for a rural island off the coast of Georgia, to the secluded Jykell Island Club. The politicians were a U.S. Senator (Nelson Aldrich), and an assistant Secretary of the Treasury (A. Piatt Andrew). The Bankers were Henry Davidson (J.P. Morgan and Company), Paul M. Warburg (Kuhn, Loeb and Company), Benjamin Strong (Bankers Trust of New York), and Frank A. Vanderlip (National City Bank).

Why a secret meeting? Because Senator Aldrich—the head of a joint Congressional committee studying the bank issue—needed help. If it were known that he was calling on Wall Street bankers to help him prepare his report and write his bill, it would be fatal to the outcome. After all, everyone knew bankers couldn't be trusted. Yet these particular bankers were well educated, convinced change was necessary, and possessed the very insider information Senator Aldrich needed to write an effective bill. What they worked out closely approximated what would become the Federal Reserve System. A spate of obstacles lay in the bill’s passage, including famed populist William Jennings Bryant (a noted bank basher and Jacksonian Democrat), a nation of Americans still opposed to a central bank, bankers in general, as well as newspapers and politicians—in effect, nearly everyone. But things were changing. Progressivism was on the rise, antitrust laws were in force, women were campaigning for the vote, and a bill for the direct election of U.S. Senators was before Congress. While opposition to a national bank remained strong, everyone believed something needed to be done to prevent another financial meltdown.

Enter Woodrow Wilson. Wilson was a Democrat and a good friend of William Jennings Bryan. Unbeknownst to Bryan, Wilson favored a central bank. Despite being a member of the party of Jefferson and Jackson, Wilson thought highly of Alexander Hamilton, the founder of the Bank of the United States. He labeled Hamilton as “one of the greatest figures in our history.” And Jefferson? “A great man, but not a great American.” At the time Wilson wrote these words, he was the president of Princeton University. By the time Congress was looking into the possibility of resurrecting the national bank, Wilson was governor of New Jersey. In 1912, he ran for president. With the much-needed support of Williams Jennings Bryan (coupled with division within the Republican Party), Wilson was elected president. He appointed Bryan Secretary of State and gradually brought him around to supporting the bank. Congress, meanwhile, was having trouble hatching out a bank bill that would pass in both houses of Congress. They were about to adjourn for the summer when Wilson intervened. Exercising his power as president, he ordered Congress to stay in session until they had a bill ready for his signature. All that long, hot summer and into the fall Congress wrestled with the bill, considering input from a variety of sources, including President Wilson himself. Two days before Christmas, Congress finished its work and presented the bill for the president’s signature, which he duly signed into law.

According to Vanderlip, the Federal Reserve Bill, despite undergoing a variety of back-and-forth changes, ended up looking very much like the original bill that had been drafted on Jykell Island. The Federal Reserve would be comprised of a central bank in New York City and 12 branches spread across the country. There would be a seven-member Federal Reserve Board appointed by the President and approved by the Senate. The Board would oversee the district banks, generally regulate the banking system and set national monetary policy. Each of the 12 branches would have its own board of directors. There would be a single national currency of paper money, backed by one of the 12 branch banks and redeemable in gold.

There is one other thing to know. At the time, most Americans did very little banking. They paid cash for everything, not in paper money but in coins issued by the U.S mint, the larger ones minted in gold: $2.5 Quarter Eagles, $5 Half-Eagles, $10 Eagles, and $20 Double Eagles. The only credit available was the type extended by the local dry goods store. People generally kept their money under the mattress, especially in times of recession. Banks were the domain of business.

There is more to Lowenstein’s book, especially about the wild and woolly days of state banks and paper money in all its forms prior to the creation of Federal Reserve System. Prior to the Fed, any financial strain placed on the American banking system—such as it was—would often lead to recession. Prior to the Fed, the American economy had nothing behind it to prevent a recession, which is tantamount to walking a high wire without a net.

Final note: this week it was announced that Alexander Hamilton’s face on the $10 bill is secure, thanks to a legion of Hamilton admirers who petitioned the Fed coupled with the overwhelming success of the Broadway musical “Hamilton.” It did seem ironic in the extreme that the Fed would replace Hamilton’s image on the $10 instead of Andrew Jackson’s on the $20. Jackson despised paper money and bankers, and destroyed the forerunner of the Fed—B.U.S. Now, at last, the Fed has gotten it right. Hamilton’s image stays on the $10 bill, and Jackson’s image on the $20 is replaced with that of Harriet Tubman. Ms. Tubman was an African-American abolitionist, humanitarian, and, during the American Civil War, a Union spy. Born into slavery, Tubman escaped and subsequently made some thirteen missions to rescue approximately seventy enslaved families and friends, using the network of antislavery activists and safe houses known as the Underground Railroad. In the post-war era she was an active participant in the struggle for women's suffrage.

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