Early 1900's: The Creation of the Federal Reserve System
In 1907, a severe financial panic jolted Wall Street and forced several banks into failure. This panic, however, did not trigger a broad financial collapse. Yet the simultaneous occurrence of general prosperity with a crisis in the nation's financial centers persuaded many Americans that their banking structure was sadly out of date and in need of major reform.
In 1908, the Congress created the National Monetary Commission. This Commission, led by Nelson W. Aldrich and composed of members of the House of Representatives and the Senate, was charged with making a comprehensive study of the necessary and desirable changes to the banking system of the United States. The resulting plan called for a National Reserve Association, which would be dominated by the banking industry. This plan was treated with great skepticism and received very little public support.
In 1912, the House Banking and Currency Committee held hearings to examine the control of the banking and financial resources of the nation. The Committee concluded that America's banking and financial system were in the hands of a "money trust." The Committee's report defined a "money trust" as "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 public's awareness of a monopoly on the banking system was crucial in leading to America's financial reform.
Another key event leading to America's financial reform was the election of Woodrow Wilson as President in 1912. Wilson and his Secretary of State William Jennings Bryan, forcefully opposed "any plan which concentrates control in the hands of the banks."
On December 26, 1912, the Glass-Willis proposal was submitted to President-elect Wilson. Instead of suggesting the creation of a central bank, the proposal called for the creation of twenty or more privately controlled regional reserve banks, which would hold a portion of member banks' reserves, perform other central banking functions and issue currency against commercial assets and gold. Wilson approved of this idea, but also insisted upon the creation of a central board to control and coordinate the work of the regional reserve banks.
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The Federal Reserve Act of 1913
The Federal Reserve Act presented by Congressman Carter Glass and Senator Robert L. Owen incorporated modifications by Woodrow Wilson and allowed for a regional Federal Reserve System, operating under a supervisory board in Washington, D.C. Congress approved the Act, and President Wilson signed it into law on December 23, 1913. The Act, "Provided for the establishment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.
The Act provided for a Reserve Bank Organization Committee that would designate no less than eight but no more than twelve cities to be Federal Reserve cities, and would then divide the nation into districts, each district to contain one Federal Reserve City.
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The Dilemma of the New York Fed
The controversies evident in the writing of the Federal Reserve Act were carried over into the selection of the Federal Reserve cities. New York was at the center of this controversy. There was no doubt that New York would receive a Federal Reserve Bank, but the size of the bank to be established there was a highly contentious issue. The city's foremost financiers, such as J.P Morgan, argued that the New York Fed should be of commanding importance, so that it would receive due recognition from the central banks of Europe. The New York Fed that the financiers desired would have approximately half of the capitalization of the entire system.
However, many throughout the country feared that a Federal Reserve Bank of such magnitude would dwarf everything else in the system and would accord far too much power to the New York District. Treasury Secretary William McAdoo and Agriculture Secretary David F. Houston shared this opinion and a belief that the European central banks should deal with the Federal Reserve System as a whole, rather than with just one of its parts.
On April 2, 1914, the Reserve Bank Organization Committee announced its decision, and twelve Federal Reserve banks were established to cover various districts throughout the country. Those opposed to the establishment of an overwhelmingly powerful New York Fed prevailed in their desire that its scope and influence should be limited. Initially, this bank's influence was restricted to New York State. Nonetheless, with over $20,000,000 in capital stock, the New York Bank had nearly four times the capitalization of the smallest banks in the system, such as Atlanta and Minneapolis. As a result, it was impossible to prevent the New York Fed from being the largest and most dominant bank in the system. However, it was considerably smaller than the New York banking community had wanted.
