The Fed: Why Was It Created?

In 1873 President Andrew Dickson White of Cornell University refused permission to the Cornell football players to meet Michigan at Cleveland by stating "I will not permit 30 men to travel 400 miles to agitate a bag of wind" (from The Encyclopedia of American Facts and Dates - 6th edition).  President White seems to have possessed an ample ability to clearly express his decisions, and apparently he had no great regard for the sport of football, which at that time bore a close resemblance to today's game of soccer.  However, it is possible that fiscal prudence also freighted his decision-making, as the same source states that the "Panic of 1873" was triggered by the failure of the great banking house of Jay Cooke & Company on September 18 of that year.

The Panic resulted in a Depression.  The Encyclopedia of American Facts and Dates tells us that 5000 businesses failed during that time.  Think of that as seeing a headline a year or so after the Lehman Brothers bankruptcy in September 2008 yelling out "40,000 business failures!" since the nation's population in 2008 was about 8 times what it was in 1873.  (The US Census of 1870 recorded a population of about 38.5 million, and the US Census Bureau's population clock shows a current US population of about 312 million, for an approximate population ratio of 1 to 8.)  My guess is that the 5000 failures were among businesses that were of substantial size for the time, since the actual enumeration of very small businesses is a 20th century development.  So the 40,000 contemporary businesses would probably be from among those that are primarily larger than sole proprietorships or individuals acting as service companies or affiliates of much larger companies.



Two other similar banking panics followed in later years, and two prior ones preceded it.  The Reader's Companion to American History (Houghton Mifflin Company, 1991) identifies American banking panics in the years 1819, 1837, 1873, 1893 and 1907.  This is like having the equivalent--for the time--of a Bear Stearns and a Lehman Brothers failure occurring together every 20 years or less!  Each of these panics was followed by economic depressions of increasing severity--not surprising, considering the continually increasing size and complexity of the country.

The Reader's Companion to American History concludes a biographical sketch of the banker J. Pierpont Morgan by saying:  "In 1907, when a banking panic threatened to spin out of control, Morgan took command, rallied the other bankers, and restored confidence.  This panic led to the creation of the Federal Reserve System in 1913. . ."

Notwithstanding the dramatic flourishes of the biographical sketch, the nation's history of periodic banking panics, followed by the individual hardships of economic depressions, was cause for a desire on the part of the nation's "movers and shakers" to develop a different way of managing the country's banking system.  Perhaps some of them even hoped that "different" would be "better" in some way, too; almost certainly, the bankers hoped that it would be "better" for them.

In normal business fashion, these bankers probably marshaled arguments and evidence which were placed in front of the politicians and government leaders to convince them that the end result would also be "better" for the country as a whole.

Leaving aside for the purposes of this writing any value judgments of these arguments and supporting evidence, the case was made to  President Wilson and a supportive Congress--as described in the previous posting--and the Federal Reserve Act became the law of the land late in 1913.  J.P. Morgan probably saw little, if any, personal gain from whatever beneficial effects accrued to the banks of the time, as he died within days of the President's signing of the law.

And that is why the Fed was created.