The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed

Published by EH.NET (August 2006)

Elmus Wicker, The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed. Columbus, OH: Ohio State University Press, 2005. xii + 120 pp. $35 (cloth), ISBN: 0-8142-1000-7.

Reviewed for EH.NET by Ellis W. Tallman, Federal Reserve Bank of Atlanta.

Elmus Wicker has written another important book for understanding a crucial portion of the complex economic history of the United States’s banking system. The book describes the evolution of the banking reform debate that took place between 1894 and 1913 in newspapers, magazines, and political discourse, documenting the sharp turns it took along with changes in the key reform proposals from the most influential reformers. The book ends with Wicker suggesting that the creation of the Fed may have been accidental. Although the conclusion is debatable, the book will likely motivate further research on the banking reform movement and should appeal particularly to the specialist in the monetary history of the United States.

The core of the book centers on how the banking reform debate evolved from the initial asset-based currency proposals arising from the interior banks toward the central bank-like plans (mainly from the New York City banking interests) that culminated in the passage of the Federal Reserve Act. Wicker presents essential details on various banking reform proposals, the key participants, and the main tenets of the reforms and he makes it clear that the path toward the establishment of a central banking entity was circuitous.

For the context of banking reform, it helps to provide a brief synopsis of the cornerstone events spurring the debate. During the Banking Crisis of 1893, the New York City national banks left interior banks to fend for themselves by restricting convertibility of deposits into currency. Under existing banking legislation, banks outside New York City could not increase their currency supply when demand required it, but instead relied on their reserves on deposit at New York City national banks. In reform proposals, the banks outside New York City wanted to reduce their dependence on New York City national banks when emergency cash needs arose. Asset-based currency provisions would reduce that dependence. New York City bankers opposed asset-based currency proposals, instead supporting (though half-heartedly) central bank proposals. These positions held generally prior to the Panic of 1907.

In a brief book, each chapter takes on a mission and Chapter 3, entitled “The Quest for an Asset-Based Currency, 1894-1908” argues that initial banking reform proposals aimed to repair the flaws of the National Banking System: seasonal money market stringency and banking panics. The initial reform proposals wrangled with “inelasticity of the currency,” that is, the failure of currency (note issuance from banks especially) to respond to changes in demand, most notably, the seasonal demands from the agricultural cycle. The book provides a complete analysis of proposals and reform movements, and the descriptions retain a thematic continuity to the title. The Baltimore Plan in 1894 was conceived by bankers in the Baltimore Clearing House who then presented a proposal for currency reform at the American Bankers’ Association annual convention. Wicker presents the detailed asset-based currency proposal of the Baltimore Plan, emphasizing that the plan was not uniformly supported by reformers with similar views. For example, J. Laurence Laughlin, chairman of the Department of Economics at the University of Chicago, perceived that the key constraint in a banking panic was access to credit, which was not going to be fixed by additional currency. Laughlin’s subsequent participation in the Indianapolis Monetary Commission in 1897 links together the discussion of the two reform movements, making clear that the latter reform gained from the work of the Baltimore Plan. The Indianapolis Monetary Commission had as its goal the appointment of a National Monetary Commission, much like the one commissioned in the Aldrich-Vreeland Act of 1908.

Wicker describes several other less well known reform proposals that deserve notice. Among the other banking reform proposals, the Pratt Bill of 1903 would have authorized each clearinghouse with the right to issue currency on the collateral of its general assets, thereby offering asset-based currency only through the clearinghouses rather than individual banks. This innovative element was similar to the portion of the Aldrich-Vreeland Act that allowed clearinghouses the authority to issue “emergency currency.”

The New York Chamber of Commerce Report in 1906 proposed a banking reform that promoted the establishment of a European-style central bank. Arising from New York City business leaders, the proposal provides a key contrast to the proposals from outside New York City. Frank Vanderlip, an executive at National City Bank in New York City, participated in the effort, although he apparently was unconvinced by the final draft of the proposal. It was a notable outlier among the reform proposals prior to the Panic of 1907.

The book leaves two key questions relatively unanswered. First, Wicker asks how it was that the Midwestern, interior banking forces that initiated the serious effort toward reform lost the leadership of the banking reform movement to Wall Street bankers. Without that leadership, the interior banking interests had limited influence on the shape and content to the banking reform legislation. I think that the book understates the effect that the Panic of 1907 had on the banking reform debate. Wicker describes the Columbia University Lectures, a set of prepared lectures held in New York City on banking and financial market reform presented by a list of distinguished bankers, scholars, and public servants. The motivation for the lecture series arose from the aftermath of the Panic of 1907, which had affected New York City banks and financial markets most intensely. As a result, New York City banking interests had a heightened interest in the banking reform debate. The influence of the Wall Street bankers on the reform proposals in 1908 and afterward changed the contents of the banking reform debate. Separately, Wicker argues that bank reform shifted toward the creation of a central bank and lost its focus on panic prevention. This loss of focus in the banking reform movement on its initial motivation is not fully developed in the book, and offers some opportunities for additional inquiries.

The second question that the book raises but then does not fully answer refers to the change in the perspective on banking reform of the central political character of the book, Nelson Aldrich, Senator from Rhode Island and Chairman of the Senate Banking Committee. The text describes how Aldrich left the United States to visit European central banks; at the time of his departure, Aldrich believed in the efficacy of currency reform, perhaps some form of asset-based currency legislation. Upon his return, though, Aldrich was an advocate of establishing a central bank in the United States. The discussion leaves the reader asking “why did he change his mind?” It is left for further research to uncover whether there was an event or particular observation that led Aldrich to change his mind. The address by Aldrich in the National Monetary Commission (Volume XX) emphasizes the absence of large-scale credit disruptions in Europe over the period in which the United States faced several serious crises, but there is no revelation of what caused his notable change of view.

The description of the infamous Jekyll Island cabal and its role in the conception and creation of the Aldrich Bill offers perhaps the most accessible content for the general interest reader. Wicker describes the key personalities, their views, and their role in the creative process. The participants of Jekyll Island meeting were Nelson Aldrich, Henry P. Davison (a partner of J.P. Morgan and Co.), A. Piatt Andrew (a Harvard economics professor on leave as Assistant Treasury Secretary), Frank Vanderlip (second in command to James Stillman at National City Bank), and Paul Warburg (an investment banker from Kuhn-Loeb). Wicker emphasizes the absence of Benjamin Strong from the list of participants, and provides ample source material to underline that fact. Otherwise, the discussion of the Aldrich Bill is concise and accurate to set up a comparison with the Owen-Glass Bill that was eventually passed as legislation for the creation of the Federal Reserve System.

The discussion of the Glass Bill examines an overlooked antecedent in the Muhleman Plan. Apparently, it is one of three proposals that H. Parker Willis, assistant to Carter Glass and often referred to as a central figure in the drafting of the Glass Bill, summarized for the Glass subcommittee. Wicker also describes Victor Morawetz’s plan for regional reserve banks, in which the each district has considerable autonomy, a notable difference from the Aldrich Bill. Regional district autonomy was adapted to the Glass Bill.

The book spends substantial text highlighting the differences and similarities of the Aldrich and Glass-Owen Bills. The differences were huge, despite the obvious benefit that the Owen-Glass Bill received from the Aldrich Bill as blueprint. The Aldrich Bill left the National Reserve Association as an entity run by bankers with some political oversight, whereas the Owen-Glass Bill reversed the roles. In terms of currency, the Aldrich Bill maintained currency as bank issue, whereas the Owen-Glass Bill made currency an obligation of the U.S. Treasury. With respect to the regional structure and districts, the Aldrich Bill was somewhat more centralized than the Owen-Glass Bill. The autonomy of the district banks in the Owen-Glass Bill contrasted with the Aldrich Bill proposal, and in retrospect, such autonomy likely hindered coordination within the Federal Reserve System during the Great Depression. The similarities of the two bills provide backdrop for another central theme of the book.

The subtitle of the book is Nelson Aldrich and the Origins of the Fed and the author makes no secret of his intention to acknowledge the debt owed to Nelson Aldrich for the successful passage of the Federal Reserve Act. The point is well-argued, well-worth making, and it is simple. Nelson Aldrich participated in the investigation of other central banks, he was crucial in guiding the momentum for banking reform toward the establishment of a central bank, and he coordinated the writing of the Aldrich Bill, which was an important blueprint for the Owen-Glass Bill. Aldrich was able to push the debate far enough to allow discussion of an institution that could be referred to as a central bank. For seven preceding decades in the United States, there was innate aversion to any proposal for a central bank. The contribution of Aldrich to the success of the Owen-Glass Bill, both in its content and in its passage, seems unmistakable.

The contribution of this book is more than a summary of central points on bank reform proposals and their shortcomings. Instead, it offers a comprehensive yet concise analysis of the great American debate on banking reform. The book should become required reading for those interested in U.S. monetary and financial history, as a synopsis of the banking reform proposals as well as the development and passage of the Federal Reserve Act.

Ellis W. Tallman is Vice President in the Macro Policy Group of the Research Department at the Federal Reserve Bank of Atlanta. His research interests in economic history focus on financial crises and specifically on the Panic of 1907 in the United States. He and his frequent co-author Jon Moen are completing a manuscript of a book examining the economic arguments that supported the movement to establish a central bank in the United States in the early twentieth century.