How Big Banks Created a Fed to Serve Their Own Interests

Editor's Note: The debate over the subsidies giant banks enjoy from their "too big to fail" status has proliferated in the aftermath of the financial crisis. According to All the Presidents' Bankers: The Hidden Alliances that Drive American Power (Nation Books, 2014), top banks' ties to Washington have endowed them with unique advantages for many decades. The following passage, taken from "Chapter One: The Early 1910s: Post-Panic Creature and Party Posturing," outlines the influence of leading bankers, including J.P. Morgan, during the creation of the Federal Reserve - and the lengths to which government officials went to cover it up.

First of two parts; part two is here.

After the Panic of 1907, bankers and politicians alike sought a more stable banking system, though for different reasons. Despite J. P. Morgan's ability to harness backing from the Treasury Department when he needed it (and vice versa), he desired a more permanent solution to financial emergencies. The rest of the big bankers concurred. But they wanted such a mechanism to be established on their terms.

In Washington, Republicans and Democrats both concluded that excessive reliance on bankers to stabilize the financial system in times of turbulence was too high a risk to their own influence over the country, and possibly damaging to America's status in the world. The axiom that the group that controlled the money controlled the country remained true. But with the nation struggling economically, such a condition had political implications and had to be navigated accordingly.

William Howard Taft knew this when he campaigned on a vow to continue Teddy Roosevelt's reform policies, including the trust-busting activities Roosevelt had set in motion. Though his own background was largely blue-blooded and warm toward the financiers, he knew the population blamed the bankers for their problems and that the Democrats would capitalize on those suspicions if he didn't balance his support for business interests with empathy for the public. The tactic worked. In the presidential election of 1908 Taft won handily over populist Democrat William Jennings Bryan, even as the country was experiencing a post-Panic recession.

Congress established the bipartisan National Monetary Commission to develop a banking reform proposal and study the problems underlying the panic and alternative foreign central banking systems, for analytical and competitive purposes. The commission had no populist bent; it was headed by Senator Nelson Aldrich and largely made up of men sympathetic to bankers and their lawyers.

During the summer of 1908, Aldrich and some subcommittee members journeyed to Europe. Their official mandate was to study the operations of European central banks for background information with which to fashion some sort of central bank for the United States. Unofficially, Aldrich and the bankers wanted to strengthen America's economic position relative to its European counterparts-that would require establishing a means to further consolidate or centralize a method of creating currency in downturns, or for other purposes, as the European central banks could. Aldrich was expected to provide a summary of his findings and draft a currency bill that fall. Yet when he and his men returned, they did not bring home a fully formed strategy for a U.S. equivalent to the English and French central banks that would both create a stronger national currency and support the desires of the bankers. Also, constructing the first central bank in the United States required a fair bit of maneuvering; the idea did not yet have broad bipartisan or popular support. With elections looming, it was risky to push for a system that might be deemed unacceptable or too bank-centric by voters who didn't understand that this was already the premise of the Aldrich-Vreeland Act. There was a recession going on, after all, and public opinion equated this matter as residue from the Panic of 1907.

Aldrich tapped his Wall Street friends to advise him further. The world stood at a financial crossroads: the most powerful and capital-rich U.S. bankers could realistically consider the possibility of competing with European bankers for the first time, just as the United States itself could now consider competing with Europe. It would be advantageous for the U.S. government and for Wall Street to establish a strong central bank that would strengthen the U.S. currency to aid both factions in that quest for international power. The only question was: How would this central bank be fashioned? How would it be controlled, and who would have the most influence over it-actually or at least with respect to the public eye? The solution would require constructing an entity that worked for both the president and the bankers, politically and practically.

In the summer of 1910 Aldrich selected National City Bank president James Stillman to accompany him on yet another fact-finding mission to Europe. Stillman had ties to two of the most powerful families in the United States. His daughter was married to William Rockefeller's son, William Goodsell Rockefeller, and he worked in a banking alliance with both J. P. Morgan and William Rockefeller.

For Frank Vanderlip, a founding father of the original plan for the Federal Reserve System, who was serving as vice president of the National City Bank at the time, "the beginning of the adventure" came in the form of a letter from Stillman, his boss and mentor, while Stillman was traveling in Paris with Aldrich. Stillman said that he had "just had a long conference" with "Zivil" (their code name for Aldrich), who was "keen to get to work on banking and currency revision." Zivil was upset that Vanderlip and Henry Davison (a senior partner at J. P. Morgan) had not been able to join him and Stillman in Europe that summer, where he felt the group would have had "plenty of time for our discussions and been free from interruptions." Stillman told Vanderlip to "make everything else subservient," to give his "whole time and thought to a thorough consideration of the subject."

Retaining secrecy was crucial for Aldrich and the bankers, not just because the plan would have to come across as free from banker input to get passed in Congress, but also because these men were in effect formulating a financial avenue to propel America's financiers to a more dominant global position. If the notion of private bankers influencing a central bank was unpalatable to the public, the idea of private bankers constructing America's path to achieve global power would be impossible to get approved.

Central banks were a key to establishing national superpowers in world trade through the issuance of centralized bank notes and loans to banks. If the United States was going to compete on a global platform, it would need a unified currency backed by one centralized entity. This would render the dollar, and hence the United States, stronger politically and financially.

The challenge was convincing the political elite and the U.S. population that a strong central bank and currency meant a strong America. Three years after a major banker-induced panic, this had to be traversed with caution. As a former reporter, Vanderlip considered some degree of financial transparency to be beneficial; it could potentially reduce instances of rumor-incited panics. But, he noted, "there was an occasion near the close of 1910, when I was as secretive - indeed, as furtive - as any conspirator. . . . I do not feel it is any exaggeration to speak of our secret expedition to Jekyll Island as the occasion of the actual conception of what eventually became the Federal Reserve System."

Vanderlip characterized the secrecy surrounding deliberations over the creation of the Federal Reserve System as reflecting the manner in which the banking titans of the time operated. "None of the big men of Wall Street could tolerate the thought of publicity when I arrived there," he later wrote. "Baker, Morgan, Stillman, habitually avoided journalists." As such, the Federal Reserve plan would be penned clandestinely, and these men would not be present together when it was formulated.

Nomi Prins is a journalist and senior fellow at Demos, and author of five previous books, including "Other People's Money" and "It Takes a Pillage." Alex Amend of Demos provided additional research for this excerpt.