America's Bank: The Epic Struggle to Create the Federal Reserve (8 page)

Morgan’s centrality was so critical that the
Times
reported, worryingly, when he caught a mild cold, which was blamed on exposure to night air. Briefly, this private man was the toast of the town. Floor traders on the stock exchange burst into an ovation in jubilant thanks for his efforts.
Grateful tributes streamed in to
23 Wall Street, some from far-flung correspondents. The letters, which pinned to Morgan’s chest the medal of savior, raised the question of his role in the economic system and whether it could be relied upon in the future. Jacob Schiff bluntly declared, “You stand between us and financial chaos.” A handwritten note from a banker in Memphis asserted that it was the general impression that “the safety and welfare of the financial structure of this country depends almost entirely upon you.”

But Morgan was edging into retirement, as were Stillman and Baker. They would not be around forever. And Morgan’s efforts, however laborious, were not enough.
New York’s trusts lost
a remarkable (and devastating) 48 percent of their deposits. Even worse, at the end of October the New York Clearing House was forced to take the drastic step of authorizing banks to settle accounts with one another
via certificates—paper substitutes for money—rather than with cash. The Panic had now reached epic proportions. The Clearing House “loan certificates” were backed by loans of the member banks. They were IOUs—promises to pay cash when cash became available. They were a form of invented money.

With panic spreading, clearinghouses
and bank associations in scores of other cities minted their own versions of clearinghouse money. Some were elaborately engraved to give the appearance of normal currency. The certificates were intended to be used only among banks, so that cash could be preserved for ordinary depositors. In a crude way, they added to the money supply—later a function of the Federal Reserve. However, in more than a score of cities
banks were forced to hand out
loan certificates not just to their fellow banks, but to ordinary depositors.

Many railroads, mining companies
, and shopkeepers paid workers with bank checks instead of with cash; those that didn’t had little choice but to suspend operations. In Birmingham, Alabama, banks distributed checks signed by their cashiers in denominations as small as one dollar to local employers—who used this scrip to pay their workers. Retail establishments generally accepted such paper, since that was all that many customers had.

By mid-November, approximately half
of the country’s larger cities were using loan certificates “or other substitutes for legal money,” according to a survey conducted just after the Panic by Harvard’s Professor Piatt Andrew. Loan certificates had been used in previous panics, but never so extensively. In some smaller towns where no clearinghouse existed, the local bankers improvised, setting up a temporary committee, as it were, on the front porch. Bankers tried to reassure the public, noting that certificates were backed by “approved securities.” Some added piquant details. In Portland, Oregon, the clearinghouse boasted that banks had deposited notes secured by “wheat, grain, canned fish, lumber . . . and other marketable products.” Monetary exchange was reverting toward barter.

Andrew estimated that
$500 million of cash substitutes
of one form or another were circulated nationwide. And in two-thirds of cities with populations above 25,000, banks suspended cash withdrawals “
to a greater or less degree
.” For example, in
Council Bluffs
, Iowa, a limit was imposed of $10 per customer; in Atlanta, $50 per day and $100 per week. Banks in Providence, Rhode Island, adopted a convenient policy of “discretion,” vetting withdrawals case by case. Although such actions had scant legal footing, officials not only looked the other way,
in many states they encouraged banks
, for their own protection, to curtail teller operations. Bank holidays were proclaimed in a handful of states, with California’s enduring until late December. Small wonder that Andrew termed it “
the most extensive and prolonged breakdown
” of the credit system since the Civil War.

Even though clearinghouse certificates provided a measure of relief, they were generally recognized only in their city of issue, which was a serious drawback. A New York banker lamented that “
drafts on Philadelphia, Boston
and other banks sent for collection are being returned on the plea that momentarily it is impossible to remit New York exchange. Each city issuing its own Clearing House certificates . . . builds a Chinese wall against other centres.” Through November and much of December, the United State monetary system devolved toward the polyglot moneys of the early nineteenth century, when itinerant peddlers did business with different moneys state to state and territory to territory.

Money, in fact, traded at a premium. Those who needed cash were forced to write checks for more than 100 percent of the desired sum. Money lost its normal, fungible characteristic—it was worth more in one place than in another. Brokers placed ads offering to buy and sell currency at premiums, the size of which was in constant flux. Out-of-town exchange was often unavailable at any price.

Even the suggestion that banks
were short of cash frightened depositors—many of whom withdrew funds while they still could. In New York, there was a run on the rental of
safe-deposit boxes
.
Nationwide, bank deposits
plunged by $350 million
, much of which ended up stashed in bedroom dressers and kitchen drawers.

However, hoarding by individuals
did not cause as much harm as hoarding by banks. As Secretary Cortelyou noted, “
It is said that many of our people
have hoarded money. This is undoubtedly true, but so have many of the banks.” Country banks pulled deposits from reserve cities; middle-tier banks in such cities yanked money from New York, Chicago, and St. Louis. Country bankers were not without reason for taking precautions. Some found their deposits at reserve city banks to be temporarily frozen. James E. Ferguson, a bank president in Temple, Texas, got a telegram from his reserve city bank announcing that it would not ship currency, because the reserve bank, in turn, had been frozen by New York. As Ferguson later told a congressional committee, “
We were broke with a pocket full of money
.” It did not take many such experiences for small-town bankers to start hoarding currency.

Banks in San Antonio, Indianapolis, Wichita, and Portland
bolstered their reserves
to 35 percent of deposits, well above the 25 percent required. Banks in Galveston, Texas, went to 49 percent, a veritable fortress of financial redundancy, and a bank in Indiana bragged it had a cash reserve of 67 percent—a good portion of which,
Vanderlip sourly surmised
, had been pulled from vaults in New York. The surplus reserves represented, in effect, the banking system’s wasted resources. In contrast, New York banks at least tried to supply liquidity by assuming the loans of failing trusts—and in so doing, ran their reserves to
well below the legal minimum
.

Charges and countercharges flew
; the question of blame became impossible to untangle. Did country bankers needlessly hoard reserves, as Vanderlip believed, or did New York’s risk taking leave the country exposed? Each accusation was correct. And while many out-of-town banks thought only of stuffing their vaults, they had every right to protect their own institutions.

The problem was that the system
inspired a competition for
reserves, so that much of the country’s banking capital, though substantial
in the aggregate,
was never put to use. Reserves were disaggregated bank by bank and city by city. This rendered them sterile. Warburg likened the system to
a town without a fire department
in which each family maintained a pail of water to quench blazes in its own house.

The contrast with Europe could not have been starker. In the British system, the Bank of England performed the job of “leaning into the wind”—that is, lending funds when funds were otherwise scarce. Not coincidentally,
Britain had not experienced a banking suspension
since the time of the Napoleonic wars.
America had been scorched
by five severe banking crises, in addition to more than twenty lesser panics, in little more than a generation. As the writer Richard Timberlake put it, “
All institutions had to run
with the wind; none could lean into it.”

Quickly on the heels of the Panic
, the economic contraction deepened. As bank reserves dwindled, banks were forced to curtail loans. The stock market plunged approximately 40 percent. Iron and steel production was severely reduced. Many factories shuttered or went part-time due to the lack of currency for wages. The severity of the depression astonished businesspeople, not least because it had struck during a period of prosperity. The country’s railroads had been profitable, its farmers rich.

Such chaos in the midst of plenty convincingly demonstrated, at least to bankers such as Warburg, that the system had to be redesigned. Morgan’s heroics notwithstanding, America’s finances were too complex to rely on a single banker or group of bankers. What Strong had witnessed on the pavement outside the Knickerbocker led him and other Wall Street bankers to strongly endorse reform.

Morgan was disinclined to join a crusade; however, Stillman, burdened by the responsibility of propping up failing banks, experienced a change of heart. Several weeks into the Panic, he ventured the short distance to the offices of Kuhn, Loeb. Unannounced, he made his
way to the émigré banker he had first met four years earlier. He found him there, as he was before.

“Warburg,” he barked, “where is your paper?”

“
Too late now, Mr Stillman
,” Warburg replied sadly. “What has to be done cannot be done in a hurry. If reform is to be secured, it will take years of educational work to bring it about.”

Soon after this encounter, Warburg reignited the public debate with a letter to the
Times
in which he argued that only “
a modern central bank
” could cure America’s ills. By “modern,” Warburg meant “European”—that is, managed by private bankers. Warburg was mistrustful of American democracy, which was too popular (or populist) for his ordered Germanic tastes. He feared leaving banking in the hands of politicians and proposed a central bank governed by “our best trained business men.” Progressives, on the other hand, saw banking as a public trust. To farmers, westerners, and others, the Panic was proof that Wall Street and business in general were unworthy of such a trust. Critics tartly observed that even in their rescue efforts, Morgan and other bankers were seeking a profit. The farther from the Hudson River one traveled, the less benign their motives looked.

One episode in particular soured
the public on Wall Street. At the beginning of November, Moore & Schley, one of the most prominent brokers on the stock exchange, was suddenly threatened with bankruptcy. Since Moore & Schley owed money to banks up and down the Eastern Seaboard, Morgan had reason to fear that its failure would spark fresh waves of panic. The solution he hit upon was to unload a major asset of Moore & Schley, its holding of stock in Tennessee Coal, Iron & Railroad Company. The difficulty was that the natural buyer for Tennessee, and the one to whom Morgan turned, was the giant U.S. Steel Corporation. Morgan had a personal attachment to U.S. Steel, a prized client, which he had organized in 1901 to consolidate (some said monopolize) the steel industry. And although the sale of Tennessee achieved his aim of averting a major brokerage
failure, this solution was not as disinterested as Morgan’s other rescues. Also, U.S. Steel obtained, on an expedited basis, a personal assurance from President Roosevelt that the acquisition would not be attacked on antitrust grounds. Thus, the deal reeked of political favoritism as well.

The fairest conclusion was that private industrialists should not be entrusted with the degree of power wielded by Morgan (the deal itself, given the severity of the crisis and the lack of other buyers, was probably in the public interest). However, Morgan’s standing with the public suffered. Some critics asserted that Morgan had contrived the entire panic. Senator Robert M. La Follette, a Wisconsin progressive and enemy of corporate power, charged that a “
group of financiers who withhold
and dispense prosperity” had “deliberately brought on the late panic, to serve their own ends.” The President, who respected Morgan, wrote disapprovingly to his brother-in-law that the public had “passed thru the period of unreasoning trust and optimism into
unreasoning
dis
trust and pessimism
.” (Such cycles are not unknown today.) People were so shocked by the repeated scandals and by the “trickery and dishonesty in high places,” Roosevelt wrote, “they have begun to be afraid that every bank really has something rotten in it.”

Since the time of Jackson, anti-banker hysteria had been a predictable American response to financial turmoil. Wall Street was often depicted as scheming and conspiratorial and, indeed, omniscient and all-powerful. Barely had the Panic ended when Alfred Owen Crozier, a prominent Ohio attorney and critic of Wall Street, penned
The Magnet,
a novel that depicted the Wall Street “machine” as an “
inscrutable and mysterious power
” that serves “its invisible master, undetected, with . . . infallible accuracy.” Crozier was outflanked by the better-known Upton Sinclair, whose 1908 novel
The Money Changers
featured a Morgan-like figure who deliberately orchestrates a panic. The view of Morgan as inciting a crisis was a gross misreading of the man. His signature projects, such as consolidating
bankrupt railroads and organizing trusts, always served the goal of greater order in commercial life. That his deal making tended to replace cutthroat competition with more gentlemanly collusion, and to augment profits, is without a doubt. Morgan’s business arrangements were based on his deep-seated preference for stability and his loathing for the chaos that capitalism often produces. In 1907, Morgan had done his level best to forestall the chaos, and it was not enough.