A Locked Door, A Secret Meeting And The Birth Of The Fed

by Robert Smith and Jacob Goldstein
December 23, 2013 3:43 AM


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J.P. Morgan: Not a pussycat. Hulton Archive/Getty Images

In 1907, the U.S. economy was in the grip of a financial crisis. Unemployment was up. The stock market was down.

People started panicking. They were lining up overnight to pull their money out of healthy banks This can be deadly for an economy: Healthy banks have to shut down, businesses can't get credit, they lay people off, and the economy gets worse.

At the time, the U.S. government had no way to deal with the panic. There was no institution that could step in to stop the run on healthy banks. So the job of stopping the panic fell to one man: J.P. Morgan (of J.P. Morgan fame).

He summoned dozens of the leading financiers in New York to his private library on Madison Ave, and essentially ordered them to contribute to a $25 million pool that would be used to backstop the system. Then he locked them in and made them stay there through the night, until they all agreed to his plan.

The plan worked — it essentially ended the Panic of 1907.

But some powerful people in Washington wondered: what about the next panic? Do we really want the fate of the U.S. economy to hinge on one rich guy in New York?

One person in particular decided this was a problem: Senator Nelson Aldrich, chairman of the Senate finance committee. Aldrich knew there was something America could do so that it would no longer have to rely on one guy to end panics. The U.S. could create a central bank.

This was not a new invention. Countries in Europe already had central banks. And, during panics, the central banks basically did what J.P. Morgan did in the U.S.: Act as lenders of last resort for healthy banks. When depositors were lined up out the door yelling for their money, banks that were basically sound could borrow from the central bank.

But just consider that name: central bank. Throughout American history, both of those words — "central" and "bank" — had been deeply unpopular. The thought of a bunch of rich bankers in New York controlling a powerful central bank did not inspire confidence.

Still, Aldrich realized he needed bankers' help to draw up a plan for a central bank. So he came up with a plan to gather in secret.

He told a handful of New York bankers to come on a given night, one by one, to a train station in New Jersey. There they would find a private rail car hitched to the back of a southbound train. To conceal their identities, Aldrich told the bankers to come dressed as duck hunters and to address each other only by first name.

The train headed south, and the bankers got off in Georgia. They spent the next week holed up in a private club at a place called Jekyll Island. (Apparently, the name didn't sound as sketchy then as it does today.)

At Jekyll Island, Aldrich and the bankers came up with a plan. They knew many Americans thought a central bank could become too powerful, too influential in the economy. So they came up with a classic, American workaround: The decided the U.S. should create lots of little central banks, scattered all around the country.

The plan they came up with still had a long way to go. It got shot down the first time in Congress. The plan for a central bank was debated, changed significantly, renamed. But the basic idea held up. And on December 23rd, 1913 President Woodrow Wilson signed the Federal Reserve Act into law.

Creating the Fed didn't solve the nation's economic problems. In fact, a few decades after the Fed was created, its policies made the Great Depression worse. And the Fed has changed significantly over the course of a century. But even after all those changes, there are still a dozen Federal Reserve banks scattered around the country in cities like Dallas, Richmond and, of course, New York.


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Mervyn King Warns of 1930's Depression

Time magazine names Bernanke 'Person of the Year'

Photo(Courtesy) http://www.washingtonpost.com/wp-dyn/content/article/2009/12/16/AR2009121600758.html?hpid=moreheadlines

Wed Dec 16, 2009 10:17am EST

By Mark Felsenthal

WASHINGTON, Dec 16 (Reuters) - Federal Reserve Chairman Ben Bernanke was named Person of the Year by Time magazine on Wednesday, a highly visible show of support at a time he seeks to beat back proposals that would erode the central bank's authority and independence.

Time credited Bernanke with creative leadership that ensured 2009 would be a year of recovery, however weak, rather than a catastrophic second Great Depression.

"The recession was the story of the year. Without Ben Bernanke ... it would have been a lot worse," Time managing editor Richard Stengel said in a statement.

"We've rarely had such a perfect revision of the cliche that those who do not learn from history are doomed to repeat it. Bernanke didn't just learn from history; he wrote it himself and was damned if he was going to repeat it."

Time's selection of Bernanke, an expert on the Depression, is sure to be noticed on Capitol Hill, where Fed-bashing has been the norm in recent weeks.

It comes a day ahead of a vote in the Senate Banking Committee on his nomination to a second term. His first four-year term as Fed chief expires on January 31.

Congress is considering proposals that would strip the Fed, which was due to close out a two-day policy meeting on Wednesday, of its regulatory authority over major banks and expose its interest rate decisions to audits.

One criticism that has been leveled at the Fed and the Obama administration is that despite efforts to prop up the financial system with billions of taxpayers' dollars, banks still show a reluctance to lend.

In an interview with Time, Bernanke said banks have been stabilized, but he conceded that lending remains too weak to support a healthy recovery.

"We have told the banks very clearly that we want them to make loans to creditworthy borrowers, where there are borrowers who can repay the loans," Bernanke said.

After a "near-death experience," banks are wary of taking on the kind of risk that led to the crisis, although they have rebuilt capital, he said.

Bernanke and his colleagues lowered overnight interest rates to near zero a year ago and have pumped more than a trillion dollars into the financial system to overcome the crisis.

Now, Bernanke said it was time to put in place reforms to ward off future crises. "We need to have extensive reform in the private sector, in the public sector, to eliminate these risks in the future," he said.

The Fed, along with the administration and Congress, still has a lot to do to get the economy back to stability and start creating jobs again, he said.

"Even though the recession may be technically over, in a sense that the economy is growing, it's going to feel like a recession for some time, because unemployment remains very high, about 10 percent," he said.

He also said that Congress and the administration need to develop "a credible medium term ... strategy for fiscal policy."

The Obama administration had proposed making the Fed the lead regulatory policing the financial sector for 'systemic" risks. Bernanke said the Fed had never proposed that it be responsible for regulating the entire financial system, although he argued no other agency has its expertise.

"We have a wide range of expertise that makes us the natural supervisor for these large, complex firms," he said.

Banks have yet to broadly understand the need for more restraint on pay after they were bailed out with taxpayer money, he said.

The Fed instituted policies "which we'll be enforcing on banks" that require them to structure pay in ways that align it with performance and discourage excessive risk taking, he said.

"We are going to be looking at that as part of our supervision of banks," he said. (Additional reporting by Ciara Linnane; Editing by Padraic Cassidy)

Source:http://www.reuters.com/article/idUSN1617297020091216

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The path to another Depression

By John Silveira

Those who cannot remember the past are condemned to repeat it.
— George Santayana, 1863-1952

In 1921, we had a severe depression. It’s no longer part of America’s collective consciousness because it only lasted about a year and was followed by a time of then-unprecedented prosperity that we remember as the Roaring 20s. In 1930 another depression began. That one lasted over a decade and only “ended” because World War II broke out.

What caused one to pass so quickly and the other to drag on until it left a scar on the American psyche?

In the depression of 1921, the government did nothing.
In the Great Depression of the 1930s, the government did everything.
Typically, what happens in a recession/depression is that people lose jobs, prices and wages fall, weak businesses fail. But when wages fall far enough, companies are able to hire again. As prices fall, workers are able to make purchases again. As the weak businesses fail, the strong businesses rise to the top and some of the businesses that went bankrupt are bought by new owners and have another chance to succeed.

Hoover and Roosevelt

There are two myths from the Great Depression: Contrary to popular belief, (1) Herbert Hoover was not a “do-nothing” president, and (2) Franklin Delano Roosevelt did not get us out of the Depression while saving capitalism. Both were interventionist presidents who monkeyed with what is basically a natural business cycle. Both tried to artificially keep the economy afloat and failed to let the problems that caused the Great Depression correct themselves. And both are responsible for it getting so bad.

For four years under Hoover the Depression deepened because he tried to rig the economy. What’s ironic is that, when FDR ran for the presidency in 1932, he ran on a platform of conservative economics. He claimed the reason Hoover couldn’t “save” the economy was because he was too interventionist. His vice presidential running mate, John Nance Garner, even went so far as to accuse Hoover of leading the country down the path of socialism.

Of course, when he took office FDR out-Hoovered Hoover; many economists, looking back from today, have said FDR could have ended that depression in a year had he not thrown out his campaign promises. But he did and the Great Depression dragged on for another eight long years of his first two terms—until World War II broke out and sent the nation and the rest of the world through yet another upheaval.

Those same economists feel the Great Depression lasted so long because it was the first depression politicians meddled in. By 1937 FDR was at wit’s end trying to figure out why the Depression was deepening despite his efforts. In fact, in 1937 we had a depression-within-a-depression. It’s likely both presidents went to their graves and never understood what they had done.

What were those ineffective programs the two presidents employed that prolonged the Great Depression?

Among his acts, Hoover bullied and cajoled businesses into not cutting wages. He raised tax rates. He signed protectionist policies, such as the Smoot-Hawley Tariff Act. The result was that businesses couldn’t afford to hire more employees and our trading partners retaliated with their own tariffs, which put obstacles in the way of American businesses so they couldn’t sell overseas.

What is forgotten today is that when FDR took office, most of his programs were, as Rexford Tugwell, a member of FDR’s “Brain Trust” said, expansions of what Hoover had instituted.

FDR sponsored “make-work” programs instead of real work programs. Thus, instead of helping businesses create jobs that create wealth—and it’s wealth that creates other jobs and prosperity— FDR had us build roads and bridges and plant trees. I know, we need roads and bridges and trees, but the country was no longer making consumer goods. (If public works spending, including building roads, monuments, and even military buildups are the way to create prosperity, the Soviet Union would have been the richest country in the world, and if promoting the manufacture of consumer goods were bad, Japan would be the poorest.)

Like Hoover, FDR artificially tried to keep wages up. He even instituted the first national minimum wage law and created a wage-floor that, on the surface, appeared to guarantee a living wage. In reality, it prevented many businesses, already on the brink of failure, from hiring the out-of-work. Without being able to hire more workers, production lines stagnated, and with both production and profits falling, businesses were caught in a loop that prolonged and deepened the Great Depression. Neither Hoover nor FDR nor FDR’s “Brain Trust” advisors appeared to understand that high wages do not create prosperity. It’s the other way around: prosperity creates high wages.

FDR, even more so than Hoover, also attempted to keep prices up. FDR and his advisors thought this was how to keep businesses running, even those that should have failed. For example, to keep farm prices up he went so far as to institute programs where farmers cut production, and farm products were even destroyed to create artificial scarcity—while Americans were starving.

Both presidents also taxed the very people who could create real jobs, jobs that produce more wealth and allow even more people to be employed. They were the kinds of jobs that would have ended the Great Depression. But much of that money, removed from company coffers all over the nation, was instead put into the “make-work” programs that created little or nothing and ensured the Depression would continue.

Bush and Obama

Today, President Obama is saying his stimulus packages are going to be used to build infrastructure. He also has Vice President Joseph Biden overseeing policy to create “green” jobs. These are all “make-work” jobs, instead of real jobs, just as FDR created make-work jobs in the 1930s.

The President also wants to place higher taxes on the so-called “rich,” the people who actually create jobs. In his words, these taxes are to “spread the wealth around.” The problem is that many of these people are small business owners, exactly the people we need to create real jobs to pull us out of this slump. And just as FDR’s taxes took money out of the economy and destroyed jobs, so will Obama’s, and he is going find himself inadvertently spreading poverty and misery around instead.

What may be worse is that today Washington is also trying to keep alive businesses that should be allowed to fail. A case in point is the “Big Three” automakers of Ford, GM, and Chrysler. Bankruptcy is the antidote for what ails them. Let them go under. They’re not going to go away. What will happen is that new owners will buy up the assets and start from scratch. More importantly, bankruptcy will allow the automakers to repudiate their debts.

Which debts? Politicians rarely discuss one of the two big reasons the auto industry is in trouble: Unions. Today, American automakers labor under the burden of wages, pensions, and health plans essentially extorted during wage and benefit negotiations in the auto industry’s boon times when automakers could simply pass the increased costs onto consumers. The other big reason Detroit is in trouble is because Congress believes it should dictate the kinds of cars automakers sell, rather than letting the consumer—the guy who actually spends the money—decide. By way of example, Congress and the Environmental Protection Agency have mandated “fleet-average mileage” rules for car manufacturers. So, for each SUV Americans are willing to buy, and on which the automakers make a profit, they must also make smaller cars that Americans simply won’t buy, and on which car makers lose money. Hence, GM’s Saturn, Chrysler’s PT Cruiser, and other small car disasters that have befallen Detroit.

Worse yet is that to “fight” global warming the President has also promised that he will start shifting our economy to “renewable” sources. With the exception of hydropower, almost all of the renewable sources are less efficient and more expensive than conventional sources. No rational person can think that less efficient and more expensive power sources are going to help turn the economy around.

With our government blithely putting more and more obstacles in the way, don’t expect the recent downturn to abate. There’s the distinct possibility we’re going to slump right into the depression we’ve all been fearing. Some economists are saying that because the politicians are getting in the way of letting these problems correct themselves, just as they did in the ‘30s, this downturn could surpass that of the Great Depression and last 10 to 15 years.

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Source: http://www.backwoodshome.com/articles2/silveira117lw.html

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