Look, the Federal Reserve is bogus. Everybody on Fintwit knows this. I now know this too. Most people don’t even know what the Fed does, but those that do, are outraged. Last year I had no idea what they did, even though I listened to over 100 Planet Money podcasts on the financial crisis and have an undergraduate English degree. Let’s do some English major math to see how clueless we are about the Fed.
According to the census, there are about 200 million Americans ages 25 to 65 and over. Approximately 30% have bachelor’s degrees, which gives us 60 million. At least half of all bachelor’s degrees are dogshit, giving us 30 million. Conservatively, half of the people who went to college are also morons, which leaves 15 million people with the bare bones intellectual capacity to even attempt to understand the Fed. That’s about 5% of the population. What’s even more intriguing is that about 6% of Americans are millionaires. Given that Fed policy seems to disproportionately benefit the rich, those two numbers have an uncanny astrological alignment.
What’s more, that miniscule 5% comprehension rate means that the mass of our democratic mob has no business forming an opinion on what these greedy bankers do in smoke-filled rooms on Epstein’s Island. How is that sensible, when we’re all forced to carry dollars? I can’t answer that. What I can do is try my best to give an English major’s account of a complex financial institution.
Let’s start with a quotation aperitif. Senator Nelson Aldrich, villain and hero of the story, started life out modestly. Wikipedia reports that “his [family] passed through generations of declining circumstances.” Shortly after being spurned by a well-to-do woman, Aldrich wrote, “I grow sick with the thought that I am to remain one of that herd of dumb driven cattle which makes up the mass of men” (America’s Bank Page 34. All page numbers refer to the book). I grow sick with the same thought, and you should too. Onward to enlightenment, so we can be talkative driven cattle at the very least.
Now, to the fed.
Backasswards Bank Balkanization, Freedom Style
Early American banks were a mess. These were chartered by states, were unlimited, and could mint their own currency. Please imagine that. If you went from Cleveland to Pittsburgh you would have needed at least two currencies. Since you had on a Browns jersey, however, you didn’t trust the Pittsburgh Steelercoin and demanded a 10% premium to make the exchange. The Raping Roethlisberger Steelmakers Bank, on the other hand, accused your fair city of seignorage and demanded a 10% discount to exchange your currency! Imagine trying to conduct interstate business with all of this madness.
Later, the National Banking Acts of 1863 and 1864 reduced circulating currencies to seven, but set up a Ponzi scheme of banking reserves. The law allowed three tiers of banks: local, city, and central reserve, which were St. Louis, Chicago, and New York. Local banks could hold reserves in their vaults and receive no interest, or deposit them up the pyramid to the city, who would then deposit them to the central reserve, who would then lend to Wall Street for extra interest. Meanwhile, no local or city banks had any reserves. Lowenstein explains that “the problem was most acute in the fall, when farmers needed cash to move the crops. Farmhands had to be hired, horses fed, machinery operated, shipping procured. The agrarian economy, as it were, sprung to life and required bundles of cash. This imbalanced the relative currency demands of city and farm, resulting in regular shortages” (15). Imagine a banking panic literally every fall.
The two most convincing arguments in favor of the Fed then, seem to be providing a fungible currency and an elastic money supply. Strangely, neither of these is mentioned in the Fed’s mandate.
Panics, and Bailouts, and Critical Readings of Balance Sheets? Oh My!
The precipitating crisis for the creation of the fed was the Panic of 1907. During this panic, J.P. Morgan corralled a handful of other bankers and they provided liquidity, bailed out some banks, and bought out an insolvent public company. In short, they were the Fed. J.P. Morgan, maligned throughout his career and trampled during the Pujo hearings, comes off as a prudent gentleman. Seeing the current reckless firehose approach of the 2020 Fed, I think many finance and Fintwit bigwigs would be happy to have Morgan, rather than Powell, at the helm.
With that in mind, I’d like to resuscitate Morgan’s reputation. When Morgan bailed out the entire financial system, as well as the city of New York, was this because he was “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money?” No, although muckrackers said essentially the same thing about him for decades.
Instead of unfairly maligning an historical figure who certainly made some money because of lax corporate law at the time, I’d prefer to put him into context, as Lowenstein does very astutely. Morgan’s “signature projects, such as consolidating bankrupt railroads and organizing trusts” he writes, “always served the goal of greater order in commercial life. That his deal making tended to replace cutthroat competition with more gentlemanly collusion, and to augment profits, is without a doubt. Morgan’s business arrangements were based on his deep-seated preference for stability and his loathing for the chaos that capitalism often produces” (71-72). The Fed seems to enjoy stability and certainly loathes chaos. If they didn’t, Warren Buffet would own hundreds of cruise ships, airplanes, and hotels right now. Instead, you and I own junk bonds of those now defunct but still-walking-among-us companies.
A key event in the turmoil of 1907 really pissed off the public. Trusts were an important catalyst in the crisis. They “existed outside the regulated ecosystem of National Banking—not unlike the way, in a future generation, special off-balance-sheet vehicles would help commercial banks to circumvent the rules…and while a dollar in the national banks was backed, on average, by 25 cents of cash in the till, each dollar in the trusts was supported by only 6 cents” (62). 94% leverage. Not bad.
One trust, Moore and Schley, was insolvent and had a significant position in the Tennessee Coal, Iron & Railway Company. Morgan, seeing that the failure of the trust would lead to panic selling that would inevitably collapse the TCIRC, found a buyer to prevent this. Unfortunately, the buyer was the monopolistic U.S. Steel, on whose board J.P. Morgan sat. More details here.
Critics, in the vein of Taibbi, would accuse Morgan of having actually created the panic in order to make the deal happen. Senator Robert M. La Follette, “a Wisconsin progressive and enemy of corporate power, charged that ‘a group of financiers who withhold and dispense prosperity’ had ‘deliberately brought on the late panic to serve their own ends’” (72). My take is that if J.P. Morgan had lived in Omaha and ate McDonald’s for breakfast every day, the whole country would have applauded his move. Morgan preferred yachts and shaking his stick at photographers though, so no such love was forthcoming.
Here’s the last I’ll say in glorifying J.P. Morgan’s reputation. At the beginning of the 1907 panic, a crowd rushed on the Trust Company of America to withdraw all of their deposits. Benjamin Strong, future Fed chairman, went to inspect their books, returned, and reported “that although Trust of America’s surplus had vanished, it remained solvent. Calmly, Morgan said, ‘This, then, is the place to stop this trouble’” (64).
This may seem shocking, but Morgan actually inspected the books of companies before throwing trillions of bailout dollars at them. Morgan, ever the Scrooge and rapacious capitalist, evidently believed that certain unscrupulous firms perhaps deserved to fail, regardless of their size. Driven by this ethos, he actually withheld rescue funds from some other overleveraged outfits whose board members had speculated recklessly and failed to reserve the capital necessary to withstand a rough patch. Morgan, one of many hard-money evangelists proselytizing throughout America’s Bank, put up his own capital* in his firm’s loans and bailouts. Today, I’m told, the Fed is robbing future wealth from unborn Americans in order to save undercapitalized and overleveraged bloated clown car cruise ships. Who’s the bigger scoundrel?
The Ghost of Andrew Jackson
My favorite motif from America’s Bank is the phrase “the ghost of Andrew Jackson.” Jackson slayed the Second Bank of the United States and embodied many Americans’ disdain for any centralized power. His ghost haunted the American psyche and spooked the discussions around centralizing power in a bank. Reading his arguments 100 years later, I’m struck by how accurately Jackson voiced the arguments of today’s ardent Bitcoiners. Jacob Schiff, prominent banker and minor player in the story, explains “the American people…at the time of Andrew Jackson, and more so today, do not want to centralize power. They do not want to increase the power of government…They do not want to have this mass of deposits, which the government would have to keep in this bank, controlled by a few people. They are afraid of the political power it would give and of the consequences” (51). It’s hard to say those Americans were wrong.
Moving forward to the story of the Fed’s establishment, we meet Senator Nelson Aldrich, the legislative architect of the Fed. Throughout his career, Aldrich enriched himself by taking ownership stakes in businesses that benefitted from his support of a high tariff. Receiving gifts from corporations of large bundles of shares was technically not illegal, but was certainly against the letter of the law and is shockingly immoral to our modern sensibility. Politicians shouldn’t receive direct donations from their corporate supporters; they should receive them like gentlemen, through Super PACs.
Despite Aldrich’s scurrilous and self-enriching dealings with corporations, he seems to have been genuinely dedicated to creating a central bank that would supplant J.P. Morgan as the lender of last resort in the event of another panic. Lowenstein suggests numerous times that Aldrich saw a central bank as his swan song that could redeem his legacy. In 1914 Congress approved a National Monetary Commission “to study the defects in American’s banking system and offer an enduring remedy,” making Aldrich the chairman. Had Aldrich intended to continue to line his pockets, he would have called J.P. Morgan for a reform blueprint, or used his control of the Senate to kill this progressive reforming impulse. He did not. Instead he sought the tutelage of Piatt Andrew, an economics professor and assistant secretary of the Treasury, and commissioned a trip to Europe to study their three main central banks in England, Germany, and France.
Lowenstein details the pains Aldrich took to avoid tainting the committee’s reputation. Regarding the trip itself, “The senator was so eager for the project to be seen as creditable that he…[insisted] that his adult children in London not reside at his hotel, lest he be accused of palming off family expenses on the taxpayers (82). Further, “Although Aldrich recognized that the public had a vital interest in banking, he was adamant that the Reserve Association avoid the possibility of political influence, which, as he saw it, was the critical weakness of the Second Bank in the time of Jackson” (114). Lastly, Lowenstein offers this in praise of Aldrich’s integrity as it relates to the initial draft: “It was an inventive and thoughtful plan, honestly wrought. Aldrich, who had been so wedded to the old currency based on government bonds, showed courage in supporting a new currency based on private loans” (115).
Jekyll and Hyde
The last stain I’d like to get out of the Fed’s shirt is the conspiracy theory surrounding how a cabal of bankers met on Jekyll Island and hatched a plan to enslave the universe via quantitative easing and overnight repo rates. Aldrich’s team certainly met on a remote Island and hatched a plan for the Federal Reserve. This plan was never enacted into law. The final two thirds of this book is dedicated to how Congress adulterated the Jekyll Island plan over the next few years and turned it into a Frankenstein’s monster of compromise and pork. One of the high points of Lowenstein’s history is his takedown of these lunatic theories. His take, in full:
“Thanks to its secrecy and its glittering cast, the cloak-and-dagger retreat would give rise to legions of conspiracy theories. For gold bugs, anti-Federal Reserve zealots, and flat-out cranks, the 1910 escapade would come to assume mythic significance. Over the decades, its suspicious character seemed only to grow larger. In 1952, Eustace Mullins, a Holocaust denier and conspiracy theorist nonpareil, described the ‘secret meetings of the international bankers’ as a conclave of the Rothschild family linked backward in time to Hamilton and forward to Winston Churchill, Franklin D. Roosevelt, and Joseph Stalin. Mullins was inspired to probe into the central bank during a hospital visit to the fascist sympathizer Ezra Pound and devoted his career to a lunatic blend of anti-Fed and anti-Semitic diatribes. Some years later, G. Edward Griffin transformed paranoid theories into a lucrative cottage industry. A onetime writer for the John Birch Society and for Alabama governor George Wallace, and the author of a previous book espousing a miracle cancer cure, in 1994 Griffin penned The Creature from Jekyll Island. This book, which became a steady seller, argued that the bankers who came to the island in 1910 did so to establish a cartel, with the aim of suppressing competition in banking and confiscating the people’s wealth” (117).
Any comment that includes the phrase “the international bankers” should immediately make you question the intellectual capacity of the person who said it. Couple that with the John Birch Society and George Wallace, and we should have enough evidence to trust that Griffin’s attempt at history is specious, laughable, and probably disgusting. I was ashamed to hear Robert Kiyosaki mention this book in a recent interview on the Pomp Podcast. the John Birch Society may be unknown today, but was the QAnon of the middle century. In his early bid for governor of California, Reagan had to all but denounce alleged ties to this group to be palatable to the broad electorate.
Democracy and the Adulteration of Good Ideas
The fate of the Fed went through two administrations: it started with a Republican controlled Senate and White House under William Howard Taft and would eventually be enacted by a Democratic controlled House and Senate, and signed by Woodrow Wilson, a Democratic President. To think an Aldrich-crafted, J.P. Morgan and Jewish banker approved, perfidious Jekyll Island plan would survive the political changes of the 1913 election is absurd. Additionally, the increasingly progressive Democrats would exert considerable leverage to revise the various banking plans to get us to the Compromise Fed that would eventually be signed into law.
Woodrow Wilson took the banking reform baton from now retired Senator Aldrich. He wrangled with Carter Glass, William Jennings Bryan, banking lobbyists, and Progressives, and eventually the Act passed along party lines.
I leave you to read about the protracted negotiations in various committees for yourself. The political wrangling needed to pass the final bill does not interest me all that much, nor do the minutiae of the various drafts of the bill. Suffice it to say that the Fed is a complex amalgamation of conflicting ideas due to the concessions inevitable in a bill that was the culmination of 20 years of debate. The Fed is a complex and contradictory institution, at times accretive, at times adaptive, at times eschewing all precedent to meet the demands of an increasingly complex financial system, including purchasing bonds, mortgage-backed securities, and keeping interest rates at or near 0 for over a decade.
Lowenstein takes us to the finish: “Asked once about the identity of the Fed’s ‘father,’ [Paul Warburg] replied that he didn’t know, but that judging from the number of men who claimed the honor, ‘its mother must have been a most immoral woman.’ As the joke implied, the Fed’s parentage was mixed. It drew from both American traditions, Hamiltonian and Jacksonian…The Federal Reserve Act did not guarantee sound monetary policy any more than the establishment of Congress could guarantee good laws. Policy would be the burden of those in power—as disputatious today as in 1913. However, the Act unified the banking system, which unquestionably made it stronger. It created an institution for regulating the money supply, a difficult task but a necessary one for societies too advanced to depend on the vagaries of mining gold. It provided flexibility to respond to financial shocks and economic headwinds and thus made the system more resilient. It was an imperfect bill—nonetheless, after a decade of debate, division, panic, study, conspiracy, party platforms, elections, and legislative work, it was a highly worthy achievement” (270).
*Yes, by this phrase, I literally mean that J.P. Morgan, when he issued a loan to a large company or foreign government, actually put up capital from J.P. Morgan’s own bank account. J.P. Morgan, then, was very circumspect and even more prudent when assessing the credibility of a borrower. I’d reckon he would not have been in the subprime mortgage CDO game.