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America's Bank: The Epic Struggle to Create the Federal Reserve
By Roger Lowenstein
Fed Power: How Finance Wins
By Lawrence R. Jacobs and Desmond King
Oxford University Press
The periods after the destructive financial crises of the past century have traditionally been periods of reform; as a response, more democratic control was brought over money. Yet no such fundamental change has occurred in the wake of the financial crisis of 2008. This lack of movement has led to confusion and reaction, and academics are now trying to tease out the history and politics of how change happened before, and how it might happen again.
There were cries for changes in the aftermath of the devastating 1907 financial crisis. However, the path from an idea of reform to the Federal Reserve Act of 1913 is a complicated one, now told in Roger Lowenstein’s America’s Bank: The Epic Struggle to Create the Federal Reserve. Even that new system could not prevent the Great Depression. What was needed was a full assault on the gold standard and a complete reworking of what money meant. This swift and successful campaign is outlined in historian Eric Rauchway’s The Money Makers: How Roosevelt and Keynes Ended the Depression, Defeated Fascism, and Secured a Prosperous Peace.
We don’t face a depression, but instead a Great Recession, one where the deep political dynamics of the Federal Reserve play a central role. These forces are examined in Fed Power: How Finance Wins, by political scientists Lawrence R. Jacobs and Desmond King. The recent chaos has put the Federal Reserve and monetary policy under a public spotlight in a way it hasn’t seen in decades. The debates over the bailouts, engineered by the Fed, dominated the beginning of Barack Obama’s presidency, and debates over whether the Fed has learned anything, or is even capable of providing sustained prosperity and full employment, dominate the end.
This moment, one where conservative presidential candidates can run for office on bringing back the gold standard, is dangerous. Yet the long arc of history is encouraging for liberals, and the challenges now are an opportunity. At each earlier step, money and banking came under greater democratic control. Money itself used to be scarce, until the state made it elastic and able to respond to the economy. The “barbarous relic” of the gold standard, in John Maynard Keynes’s famous phrase, was destroyed. Continuing this arc is essential for prosperity in the 21st century.
Banking was contentious from the founding of our country. President Andrew Jackson’s successful war against the Second Bank of the United States during the 1830s made establishing any type of central bank a political nonstarter for nearly a century. While trying to move the Federal Reserve Act that he sponsored through the Senate, southern Democrat Carter Glass would later write in his memoir, “the ghost of Andrew Jackson stalked before my face in the daytime and haunted my couch for nights.”
BY THE SECOND HALF of the 19th century, as Roger Lowenstein writes in America’s Bank, “the United States was an industrializing nation with a banking system stuck in frontier times.” Thousands of banks, each with their own currencies and reserves, compounded the problems. The central problem was that “the system suffered a serious deficit: it consistently failed to generate enough money.” The price of money rose rapidly in the late 19th century because money was scarce, leading to crippling deflation. America was going to need a central bank going forward.
The crisis of 1907 was the breaking point. A group of bankers, economists, and a few politicians gathered informally at first, working to build a consensus plan that they could try to pass. This group finally met at Jekyll Island in 1910, led by Senator Nelson Aldrich. The meeting, which has become the focus of conspiracy theorists ever since, created the Aldrich Plan, designed to create a central bank, controlled by private finance, that could pool deposits and fight off panics.
This plan immediately walked into the buzz saw of the 1912 presidential election and subsequent Woodrow Wilson administration. Lowenstein does a wonderful job explaining how even the more carefully constructed policy must be navigated through an endless maze of hearings, interest groups, and politicians. The wide cast of bankers, progressive reformers, populist agitators, muckrakers, and conservative Democrats, each wanting to push and pull reform in their own way, is still easy to imagine today.
At the core, however, were philosophical and political splits. Populists, led by William Jennings Bryan, saw banking as a public trust, where dollars backed by the government should be the dominant currency. He, like Wilson, wanted public supervision over the system. More-conservative supporters of central banking wanted private control; Wall Street wanted the biggest banks to have the most say, while midsized banks wanted regional control.
This book connects the creation of the central bank to the crosscurrent of European ideas that characterized, in historian Daniel Rodgers’s phrasing, the “Atlantic Crossings” of the Progressive Era. The Progressive movement itself was complicated and contradictory, and the Federal Reserve’s initial structure should be understood as a work of compromise. The Federal Reserve system would be based in regional banks to ensure that Wall Street didn’t dominate it. However, there would be public accountability through a Federal Reserve Board centered at the federal level.
Though Lowenstein’s sympathies are rightfully with the people trying to make this work, he can be too dismissive of those worried about the power of the financial sector. The Pujo Commission, for instance, established to investigate Wall Street, is treated with a more skeptical tone than it deserves. William Jennings Bryan’s ideas are too easily dismissed—the abuses of Wall Street alongside the desire for a gold standard helped lead to the Great Depression.
PEOPLE MAY REMEMBER that in his 1933 inaugural address, Franklin Delano Roosevelt told us “that the only thing we have to fear is fear itself.” What they might not remember is that Roosevelt also described “an adequate but sound” currency as one of his core “lines of attack” against the Great Depression. Adequate was key there; putting it first, above sound, was a clear signal that Roosevelt would no longer let the supply of gold determine the amount of currency in circulation. Two days after that address, Roosevelt suspended the convertibility of money into gold, effectively taking us off the gold standard.
The story of how this happened is told in excellent detail by Eric Rauchway’s The Money Makers. Rauchway provides both the particulars and an entertaining story about the connection between the high-level monetary ideas of Roosevelt and Keynes, and how they acted on them. The first “fireside chat” features Roosevelt arguing that there is something “more important than gold, and that is the confidence of the people themselves,” and the economy has never been the same since.
That it is portrayed as a clear decision consistently executed puts Rauchway’s account at odds with much of the recent New Deal scholarship. Historians tend to focus on the flailing and contradictory nature of what the New Deal wanted to accomplish with its economic policy. Economist Alvin Hansen stating that he doesn’t “know what the basic principle of the New Deal is” in 1940, and the more generous “chaos of experimentation” formulation of the historian Richard Hofstadter, tends to characterize the literature on New Deal economic policy.
Worse, tomes on the New Deal often spend a few sentences on this crucial decision to go off the gold standard, focusing more on government spending. When people looked to the New Deal to deal with the Great Recession, what to do about money was sorely lacking in public discussion. Rauchway provides a useful corrective here, showing that the major decisions weren’t an accident, but a conscious decision emanating from political commitments that would continue in the postwar order built at Bretton Woods.
SINCE THEN, THE Federal Reserve’s control over banking regulation and the money supply has been taken for granted. And since then, it’s amassed a significant amount of institutional power. In Fed Power: How Finance Wins, Lawrence R. Jacobs and Desmond King use the tools of political science to examine the Federal Reserve as an institution. They find a “mutant institution of government” that is too comfortable with Wall Street and too detached from accountability and transparency to function well.
Jacobs and King seek to displace a type of common-sense wisdom that has gained strength among policymakers, one where the bailouts worked, the United States is doing well compared with Europe and especially in the wake of a financial crisis, and reform has been more than sufficient to the task at hand. At times, to fight this wisdom that lacks any nuance or concerns, they themselves push too hard on the Federal Reserve. But their analysis shows the strengths and limitations of liberal criticisms of the Federal Reserve at this moment.
Jacobs and King argue that the democratic accountability of the Federal Reserve has suffered because of the bailouts. And it’s completely true that the Federal Reserve pushed their powers beyond what anyone had expected, extending loans to all kinds of financial institutions to quell the panic. But by the end, both Congress and two presidents signed off on the bailouts through the passage of the Troubled Asset Relief Program. Obama’s Treasury secretary and a Democratic Senate were the ones who didn’t stop bonuses from being paid to failed bankers. The institutional failure goes well beyond the specifics of the Federal Reserve.
Jacobs and King argue that much of the weak recovery for Main Street was the result of the Federal Reserve being too close to banks. Yet the failures of mortgage refinancing and modification programs directly fell on the Treasury Department. There was more than sufficient room to think boldly there, and the Obama administration failed to act on it. The Federal Reserve was able to get 30-year-mortgage interest rates down to very low numbers; if the administration was interested in fixing the housing crisis, the Fed was already there to help.
Yet there’s a very important initiative Jacobs and King point to as a solution to their concerns: the way Canada regulates its banking system. Canada has large, universal banks, banks much larger than ours in terms of GDP. Yet they haven’t had the problems the United States has had, because their banking regulators are independent of their monetary authority. By separating the two, and having the banking regulators much more accountable, we can tame the financial sector.
There’s a lot to be impressed with in this approach. Certainly the Federal Deposit Insurance Corporation has been aggressive in pushing for financial reform, much more than the Federal Reserve in the wake of the passage of the Dodd-Frank Act. Since it is responsible for covering costs of bank failures through its insurance system, the FDIC’s incentives to be a strict regulator are well aligned. Certainly the pre-crisis era also showed that fragmentation of regulators leads to a regulatory race to the bottom and a less coherent regime.
However, we should be careful about terms of accountability. The notion that the Federal Reserve had been “captured” by financial interests before the crisis is a major theme of the book. This argument is important, yet it deserves pushback. Congress and leaders of both political parties had been creating a deregulatory environment for decades before the crisis, pushing for a presumption of deference to the financial sector. Elected officials took actions on this, such as firing individuals and cutting budgets of places seeking to check the financial sector, while passing laws and appointing people favorable to this project. That regulators took a hands-off approach shows the administrative state as responsive to and following democratic oversight and accountability, not removed from it.
Many of the features of financial reform play on this very concern. The Consumer Financial Protection Bureau, for instance, was deliberately funded in a way to prevent Congress from being able to tamper with its funding for political gain. The Federal Reserve absorbed new responsibilities on similar grounds, given the independence it is granted. Political scientists will need to think of the right ways for regulators to be accountable going forward, so that oversight helps, rather than hinders, their essential mission.
Indeed, the correct focus for Federal Reserve accountability is less the specific things they do and more whether they are achieving their goals. Much of the demand for accountability has been focused on the specific instruments they are using, such as the large-scale purchasing of long-term financial instruments called quantitative easing. Why not focus more on the Fed’s inability to bring about full employment? With that as the clear focus of accountability, it is easier to focus on the tools necessary to achieve it.
Those instruments are not clear yet. They could be as simple as the Federal Reserve simply giving people money to make up for persistently weak economic recoveries. Economists often joke that the Federal Reserve should just throw money out of a helicopter as a means of boosting the economy if they have no other tools available. Why not make a version of that a reality, with the Federal Reserve directly giving people freshly printed money when the economy is weak? Perhaps the Fed could be directly funding infrastructure and necessary investments? If jobless recessions continue to be the norm, such actions have to move to the center of discussion. Though many would think these ideas silly, history tells us that such an expansion in what we think of as possible is both appropriate and necessary in the wake of our devastating crisis.