‘America’s Bank, ’ by Roger Lowenstein: Note for a Lecture, "E Pluribus Unum? What Keeps the United States United"

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Image from, with caption: Map of the twelve Federal Reserve Districts, with the twelve Federal Reserve Districts enumerated in black circles and the twelve Federal Reserve Banks marked as black squares. Branches within each district are marked as red circles. The Washington, D.C. headquarters is marked with a star enclosed in a black circle.

‘America’s Bank,’ by Roger Lowenstein
By ROBERT E. RUBIN OCT. 19, 2015

Most Americans know the story of that hot Philadelphia summer in 1787 when
prolonged debate led to the creation of the United States Constitution to
overcome the inadequacies of the Articles of Confederation. Disagreements
about the extent of federal power and the design of our democratic institutions
were resolved through long arguments and, ultimately, principled
compromises.

Few Americans, on the other hand, are familiar with the analogous history
of periodic financial crises and economic duress throughout the 19th and early
20th centuries that gave rise to the creation of an effective American central
banking system. Decades of fervent debate finally led to the enactment of the
Federal Reserve Act in 1913. That is the story Roger Lowenstein tells, vividly
and compellingly, in “America’s Bank.” It should be required reading for
anyone who is engaged in, or interested in, the actions of the modern Fed, and
the continuing debates about those actions and about its governance.

The remarkable tale of the politics, disagreements, decisions and crises
that culminated in the Federal Reserve Act is the core of the book. But
Lowenstein, the author of several works on economics and finance, builds off
it to describe the history of the era, the rise of the Progressive movement, the
compromises and machinations that were critical to Congressional passage
and the key figures in the drama of creating the Federal Reserve System.

Lowenstein depicts the end of the 19th century and the early part of the
20th as a time of profound transformation. The transition from a
predominantly agricultural nation toward an industrial economy parallels the
transition we are undergoing today to an information economy. From new
technologies and growing global integration, to the stark contrast between the
wages and working conditions of many American workers and the vast wealth
accrued by a few, the forces then driving change created policy challenges of
great consequence, just as today’s changes do.

Lowenstein highlights the similarity between the arguments then and now
over the structure of our financial system: the governance and powers of a
central bank, its relationship with private financial institutions, the
appropriate scope of Congressional oversight and much else. Then as now,
these debates took place against a social and political backdrop that is
particular to our country’s history — wariness of central government;
antagonism toward banks; and the divergent interests of farmers, merchants,
manufacturers and financiers in widely different regions. And Lowenstein’s
account of financial crises before the establishment of the Fed powerfully
demonstrates that it is imperative for the Federal Reserve System to maintain
its effectiveness and independence from politics.

The decades leading up to the Fed’s creation were punctuated by repeated
financial crises, culminating in the ferocious panic of 1907. The shortage of
cash was so great that, as Lowenstein puts it, the nation seemed to be
“reverting toward barter.” These disruptions may have been severe and
frequent, but they were largely problems of liquidity, not episodes of
widespread insolvency. Lowenstein explains how harvest season routinely
produced financial turmoil. Without a centralized mechanism to adjust the
supply of currency or to lend to solvent banks experiencing liquidity pressures,
the demand for money to pay workers and to finance the purchase of
agricultural goods drove interest rates up and reduced the availability of
credit. This stifled growth precisely when it should have been accommodated.

More broadly, Lowenstein contrasts the relative stability of the major
European economies with American financial instability during the period. He
shows that the United States needed what Europe had, but we lacked: a central
banking arrangement that could mobilize reserves across the entire system, to
serve as lender of last resort to solvent banks and to provide an “elastic
currency” that could be expanded when demand for currency increased or
contracted when times became too frothy. Interestingly, managing aggregate
demand in the economy through monetary policy — the principal focus of the
Fed in recent decades — didn’t develop in practice until after World War II.

The panic of 1907 involved not only sweeping bank failures, but the
collapse of non­bank trusts, the shadow banking system of the day, like the
venerable Knickerbocker Trust Company on Fifth Avenue. As with so much
else in Lowenstein’s history, these trust company failures foreshadowed a
serious contemporary challenge: regulating shadow banking institutions and
activities that are growing rapidly because they are not subject to the
heightened constraints on banks.

Lowenstein also gives us striking portraits of key figures, well known and
unknown, involved in the creation of our central bank. William Jennings
Bryan, remembered as a commanding figure in the Democratic Party and the
Populist movement, exercised great statesmanship in abandoning his
longstanding opposition to a central bank; he provided crucial support for the
passage of the Federal Reserve Act. President Woodrow Wilson, whom many
remember as an austere former academic who ultimately lost his battle for the
League of Nations, is portrayed in the book as having almost Lyndon Johnson-like legislative skills, cajoling, pressuring and corralling members of Congress
to support legislation. Among the legislators who figure prominently in
Lowenstein’s large cast of characters are Senator Nelson Aldrich of Rhode
Island, the powerful chairman of the Senate Finance Committee, and
Representative Carter Glass of Virginia, who led the charge in the House. And
the immigrant financier Paul Warburg, virtually forgotten today, who for
decades was an advocate of an effective central banking system, emerges as
one of the book’s heroes.

Lowenstein’s history makes clear just how critical the exercise of practical
politics and the willingness to compromise were. The first Congress of
Wilson’s presidency enacted a host of groundbreaking measures unimaginable
in today’s political environment: a progressive income tax; the direct election
of senators; tariff reduction; the Clayton Antitrust Act; and, of course, the
Federal Reserve Act, which Lowenstein labels the “crowning achievement” of
Wilson’s presidency.

The Federal Reserve System, as Lowenstein observes, has, like our
Constitution, been a living organism. Its powers, while grounded in its original
functions, have been adapted to meet the evolving needs of our financial
system and economy. And while “America’s Bank” concludes with the
establishment of the Fed, it alludes to how the creative adaptation of the Fed’s
original powers was critical in dealing with the 2008 financial crisis.

The Fed’s effectiveness, Lowenstein notes, ultimately depends on human
judgment. During the early years of the Great Depression, for example, instead
of using its lender­-of­-last­-resort powers, the Fed stood by while roughly 40
percent of America’s banks failed. And these bank failures contributed greatly
to the severity and duration of the Depression. Then, in the 1970s, the Fed
again stood by as inflation rose to a peacetime high until Paul Volcker was
appointed chairman and took strong measures to restore stability.

Protecting the independence of the Fed from political influence was built
into its creation and, as Lowenstein demonstrates, is critical to the effective
use of its powers, to its credibility and to the credibility of our markets. All that
is vital, both because of the inherent cyclicality of economies and because of
the never-­ending need to prevent — and, when necessary, mitigate — financial
disruptions. It’s true that the Federal Reserve has sometimes exercised poor
judgment. What is clear, however, is that a number of the reforms currently
being proposed in Congress could undermine the system’s effectiveness by
adversely affecting the Fed’s independence from Congressional political
influence and reducing its policy­-making flexibility.

“America’s Bank” provides a dire warning against such actions. And
thanks to Lowenstein, the largely untold story of the great financial debates of
the 19th and early 20th centuries, together with the creation of our Federal
Reserve System, can now take their rightful place in the history of American
democracy and the evolution of the United States into a global financial power.

AMERICA’S BANK
The Epic Struggle to Create the Federal Reserve
By Roger Lowenstein