On had a lot to do with New York

On December 23rd, 1913 the Federal Reserve was created. Prior to this congress discussed their concerns about the banking system in the United States. Many Americans were fearful that the banking system was not stable, and that they would later worry about the liquidity of their assets. The ways the US banking system was operating was very antiquated. So they took initiative to write reforms on how the banking system can improve ie. have a central bank. In 1913 they came up with the Federal Reserve Act of 1913 to address the political and social concerns of the US Banking system. Today the Federal Reserve is the United States central bank, and works to conduct the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. They also promote the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad. The FED promotes the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole and fosters payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments. Lastly, the FED promotes consumer protection and community development through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations. (Structure of the Federal Reserve System). 1907 Banking Panic Many historians believe that the panic of 1907 was what spurred the formation of the Federal Reserve, being the first world wide crisis of the twentieth century. This panic had a lot to do with New York City trust companies. “Trust companies were state-chartered intermediaries that competed with banks for deposits,”(Moen) but they were not a central part of the payments system as banks were. These trusts held a lower percentage of cash reserves, relative to its deposits. Since trust company accounts were demandable in cash, trusts, like banks were susceptible to runs. Even though they had a smaller role in the payment transactions system, trusts were very important to the financial system, because they made large loans in New York equity markets including the NYSE.    Trusts did not require collateral for the loans, which then had to be repaid by the end of the day, so these brokers used these loans to buy securities either for themselves or for their clients. These securities were then used as collateral for a “call loan” which is an an overnight loan that facilitated stock purchases from a nationally chartered bank. The gains from the call loan were used to pay back the initial loans from the trust. Because the law prohibited nationally chartered commercial banks from making uncollateralized loans and did not guarantee the payment of checks written by brokers on accounts without sufficient funds, these trusts were crucial. However in October, the clearing house was able to newsbreak that the president of Knickerbocker Trust, Charles Barney, was an associate of Morse which was another trust that failed, this then sparked a running on Knickerbocker.  Then the National bank of commerce extended credit to Knickerbocker to cover those withdrawals. The bank then asked for a loan from the New York Clearing House, but this was denied, because its resources were reserved for the support of its member institutions and Knickerbocker were not members. After that a request for aid was made to J.P. Morgan, but they also refused to aid the trust. The National Bank of Commerce then announced that it would no longer act as Knickerbocker’s clearing agent, after that the run on Knickerbocker increased and depositors had withdrawn nearly $8 million. This spurred a full on financial crisis in New York. This spread to many trusts in America and hurt them greatly. After that Morgan decided to then give aid as well as the New York clearing house, however depositors were still fearful of this and withdrew money even after that. When Knickerbocker closed, on October 22, the annualized rate went from “9.5% to 70% then to 100% two days later (Moen). At some points, there were no credit offers at that rate. The New York Stock Exchange remained open largely due to the actions of Morgan, who solicited cash from large financial and industrial institutions and then had it delivered directly to the loan post at the exchange to support the few brokers who were willing to extend credit.This panic and withdrawal of deposits at the trust companies signaled systematic panic, or widespread belief that people needed to withdraw all their money from financial institutions, which caused a “credit crunch” for these financial institutions. This shows that overnight panics can be the initial catalyst for longer economic downturns. The panic of 1907 shows further links between financial distress and failure among financial intermediaries specifically trust companies, and the poor performance of the nonfinancial firms that depended on them for loans and other financial services. This shows that there needed to be some form of a central bank to help mitigate these panics. More importantly the panic of 1907 had many severe effects, “industrial output fell 17% in 1908, and real GNP fell by 12%” (Moen). Monetary Commission “Congress responded by adopting the Aldrich-Vreeland Act of 1908, which provided for a cumbersome system of emergency currency and, more important, for the appointment of a National Monetary Commission to study the problem and report to Congress” (Link, 1956: 200). They took an extensive report to study why the economy crashed like this, and how it could be stopped or solved. This helped to address whether it was a money and finance problem or was it a national banking problem. This report underscores the reorganization of the national banking system that set off one of the liveliest controversies of the time.A partner in the investment firm of Kuhn, Loeb & Company provided for the establishment of one great central bank, the National Reserve Association, with a capital of a minimum of $100,000,000 and with fifteen branches, controlled by banks with members in them, in various sections of the country. “The National Reserve Association would carry a portion of member banks’ reserves, determine discount rates, buy and sell on the open market, receive the deposits of the federal government, and, most important, issue currency based upon gold and commercial paper, currency that would be the liability of the Reserve Association and not of the government”(Link, 1956: 201). The reserve association would finally be governed by a board of officials, who were chief bankers and businessmen. At the “Democrats at the Baltimore convention in 1912,  promised financial reform and opposed the establishment of any kind of central bank. Republicans, however were more explicit in their condemnation of the Aldrich plan” (Link, 1956: 201). The Progressive platform of 1912 denounced the plan and thought that, “the issue of currency is fundamentally a government function and the control should be lodged with the government and should be protected from domination or manipulation by Wall Street or any special interests” (Link, 1956: 201). In 1912 preliminary discussions of proposed banking legislation had begun. Willis had completed a tentative draft of a bill by the end of October in 1912. This would create a decentralized, privately controlled reserve system, in which the objective will be to eliminate the credit concentration on Wall Street, by having rivals to overcome them. This would create more of a separation so that all the wealth is not held within one sector of the economy.  Having a true central bank was probably the best option at this point. However, even though a central bank is economically desirable, it was bound to upset some groups politically.