ers of the Federal Reserve Board.
Michael A. Whitehouse
Whitehouse is staff assistant in the Office of the Secretary at the Board of Governors in Washington, D.C. He has written and lectured extensively on the early history of the Federal Reserve System and U.S. banking.
In paying tribute recently to Henry Wallich, late member of the Federal Reserve Board of Governors, Bankers Magazine noted that Wallich was a successor, in more than one respect, to Paul Warburg. Both of these board members were emigrants from Germany—and from the higher circles of German and European finance. Warburg, a member of the first Federal Reserve Board, like Wallich, was a staunch advocate of sound finance. Both, having witnessed the strengths and weaknesses of the European banking system during economic debacles as younger men, brought their experience to the United States committed to putting those lessons to use.
It’s been said that Governor Wallich’s speeches and essays represent one of the best financial histories of our time. The same can certainly be said of Warburg’s writings, speeches and testimony for the period after the turn of the century. His life’s work constitutes perhaps the best history of the development of central banking in the United States and mirrors its controversies, struggles and the final accomplishment.
It’s seems fitting then, in this 75th anniversary year of the Federal Reserve System, to look at the life of Warburg, one of the System’s architects and staunchest proponents.
Warburg’s Early Banking Experience
Paul Warburg was born in Hamburg in 1868. The offspring of a prominent German banking family, he had been trained in banking in the European financial capitals. After attending the university, at age 18 he began his career in London where for two years he worked for a banking and discounting firm, followed by a short stint with a London stockbroker. After that he moved to France and gained additional experience at the Russian bank for foreign trade, which had an agency in Paris. He then traveled to India, China and Japan before returning to Hamburg to become a partner in M.M. Warburg & Co., the family banking firm.
Warburg’s father had fully expected that Paul would take charge of his family’s banking business along with his brothers Aby and Max, but in 1895 Warburg married an American citizen, Nina Loeb, an accomplished violinist, and began to live part of the year in New York. Six years later, at age 34, he left Germany, took up permanent residency in the United States, and accepted a position as a partner at his father-in-law’s firm, Kuhn, Loeb and Co.—one of Wall Street’s most important and respected banking houses. While adapting quickly to his new business, he still viewed the United States through the eyes of a European banker and was literally shocked at what he considered the primitive status of banking and financial affairs.
In the early 1900s, the nation was suffering from periodic liquidity crises. These crises or “panics” occurred because the banking system was fettered with a rigid amount of currency that could not meet unusual demands, and a system of reserves that pyramided up to New York. During these panics businessmen and farmers were unable to obtain credit to finance inventories and the production and transportation of crops. The crises spread across the country and converged upon Wall Street, resulting in plunges in the stock market, a large number of bank and business failures, and a further shortage of currency.
Such phenomena deeply affected Warburg, a small unassuming man whose most obvious physical characteristic was a large drooping mustache that gave him more the appearance of a tenor in a barbershop quartet than an important international banker.
While small in stature, however, he was hardly tame or timid in his professional assessment of conditions then prevailing in his new country. “The United States,” he said, “is at about the same point that had been reached by Europe at the time of the Medicis.” Witnessing first-hand a period of high interest rates — “where call money went up to 25 and 100 percent,” he felt compelled to “write an article on the subject then and there for [his] own benefit.”
Warburg thought it a bit presumptuous to attempt to educate a country to which he was so new a resident, so when advised by an associate to put the paper aside, he did so and attended to duties at his firm. However, when the same conditions arose in the beginning of 1907, he could hold his tongue no longer, and he began to circulate his writings for the benefit of others as well.
The Panic of 1907
Early in 1907, New York Times Annual Financial Review published Warburg’s first official reform plan, entitled “A Plan for a Modified Central Bank,” in which he outlined remedies that he thought might avert panics, like the great one that would occur later that year. Furthermore, he identified what he saw as the “evils” of the system in the United States — the “decentralization of reserves and the immobilization of [commercial] paper.” To remedy this, he advocated the development of an American discount market and a European-style commercial paper. This system was based partly on a concept known as the “real bills” doctrine, which maintained that the money supply should vary with the short-term “legitimate” needs of business and commerce. By allowing banks to borrow only against short-term loans, the real bills doctrine, in theory, provided liquidity through the discounting (or selling) of loans and at the same time restricted the ability of a central bank to expand the supply of money. Warburg also proposed the creation of a “central reserve” or central bank that would hold the reserve funds of member banks so that collective funds could be made available to a bank in need of liquidity. Both the discounting and reserve concept, he contended, would help make money and credit more elastic and keep interest rates stable.
The Panic of 1907 hit full stride in October. The crash was of such severity that it immediately helped focus public awareness on the problems with the monetary and banking system. Although the issue of a central bank was unpopular because of its connotations of powerful central authority, Congress was now forced to act. The Aldrich-Vreeland Act, passed by Congress in May 1908, provided for the issuance of emergency currency and created a bipartisan National Monetary Commission to study central banking and other alternatives for monetary and banking reform. Warburg would serve this committee and, through his efforts for the commission, achieve an influence on subsequent proposals for reform.
Warburg Meets Sen. Aldrich
Sen. Nelson Aldrich of Rhode Island, chairman of the Senate Finance Committee, was appointed head of the National Monetary Commission. He divided the commission into two groups: one would study the US banking system and compile a report, and the other, headed by the senator himself, would travel to Europe and study the central banking systems in London, Paris and Berlin.
Aldrich was a known advocate of the extant bond-backed currency arrangement, which provided that bank notes could only be issued by national banks on the basis of the amount of US government bonds that were held to back them. However, the 67-year-old Aldrich, who was considered the most influential figure in Congress on financial matters, was committed to exploring new ideas for reform. In 1908, he announced that he would not seek office again and instead would devote his full attention to the currency and banking question.
Meanwhile, Warburg began to enlarge his circle of professional contacts and have his voice heard throughout the country. However, the German banker still didn’t have the ear of the man who mattered most — Aldrich.
Aldrich first met Warburg by chance when the senator was preparing for the European trip and visited Kuhn, Loeb and Co. to gather preliminary material about the German banking system. Following that meeting, the German native began writing to Aldrich outlining his proposals, but Aldrich was cool to Warburg’s plan and deferred his correspondence to A. Piatt Andrew, a Harvard professor whom Aldrich had appointed official secretary of the National Monetary Commission. As new ideas on banking reform began to crystallize for the senator, Andrew brought the work of Warburg to the senator’s attention again and soon Andrew was corresponding with Warburg on behalf of the senator. Warburg was asked to write a study on the “discounting of commercial bills” for the National Monetary Commission, and became an unofficial advisor to the group. However, the banker and the senator still were at loggerheads on the question of what shape the central bank should take in the United States, and on the issue of discounting commercial paper.
In his monograph, “The Discount System in Europe,” Warburg declared that the effective utilization of the discount policy was one of the most impressive victories for central banks in Europe during the Panic of 1907. The only structure that is safe, he concluded, is one that provides for effective concentration of cash reserves and their freest use in case of need, enabling banks, when necessary, to turn into cash a maximum of their assets with a minimum disturbance to general conditions. He noted further that a central bank is able to guard the cash reserve of the country and accommodate nonreserve banks by accepting prime security, like bank-accepted bills.
Warburg, in the meantime, continued his campaign on other fronts. He had followed his first New York Times article with a speech at Columbia University on “American and European Banking Methods and Banking Legislation Compared,” and privately published a new, more complete proposal for a US banking system, entitled “A Modified Plan for a Central Bank.”
In May 1908, the New York Times gave his revised plan prominent coverage. Primarily, Warburg continued to emphasize that the United States must finally develop some sort of central bank system, giving the country an elastic currency based on modern commercial bills payable in gold: a system similar in principle, if not exactly alike in form, to those of the important European central banks. He believed that “no measure that bases currency on a long term basis like the Aldrich-Vreeland Emergency Currency bill, (which allowed banks in regional currency associations to use their aggregate bank balances as the basis for the issuance of currency) can be acceptable.” Also, he stressed that issuing notes “must be centralized into a few organs, or if feasible, into one organ to ensure effective expansion and contraction of reserves.” The tireless reformer further stated that no central bank could be effective that “vests the powers of a central bank in political officers alone. That power clearly defined, ought to be vested in political officers and businessmen combined, in a way that would render impossible any political or financial abuse.” Any hasty decisions on the composition of the directors of a central bank, he said, could stand in the way of the creation of such an organization. Better that those practical and political questions could be worked out after careful consideration.
The idea of an “elastic currency,” which would expand to meet the legitimate needs of business and commerce, was not new. In fact, Warburg himself claimed no originality for the idea, but through his writings, speeches and counsel to others he began to have a greater impact than anyone else. Warburg did, however, succeed in injecting two new ideas into the discussion: first, shifting of emphasis from the currency problem to the reserve problem; and second, advocacy of the principle of rediscounting a new kind of commercial paper.
These ideas were starting to be discussed more seriously throughout the country, and other individuals involved in the banking and currency reform movement began to take note. With both the building momentum of other banking reform advocacy groups and Aldrich’s own exposure to the efficient and effective central banking system in Europe, the senator finally opened to these other ideas.
The debate on central banking reform was still in full swing several years after the 1907 Panic. Indeed, it began to heat up, with the American Bankers Association standing opposed to “any form of central bank yet suggested by legislators.” Meanwhile, Warburg, Aldrich and several other prominent figures intensified their efforts and began to form an alliance that was to last over the coming crucial years of the banking reform movement.
Aldrich Reconsiders His Position
The European interviews of the National Monetary Commission had a profound influence upon Aldrich. He had a clear plan for reform when he returned from Europe, radically different from his original beliefs. The change in the senator’s thinking was so drastic that Aldrich’s biographer explained it as an epiphany, saying, “Aldrich was converted on the road to Damascus.”
When Aldrich and the National Monetary Commission returned from Europe in the fall of 1908, Aldrich asked Warburg to present his own ideas and answer questions regarding the European interviews at a meeting at New York’s Metropolitan Club.
After Warburg’s Metropolitan Club testimony, Aldrich pulled the banker aside and told him that he liked his plan for reform but he was being too timid about it. Warburg was surprised to learn that Aldrich, who before his European travels had not favored centralization and had advocated a national currency backed by government bonds, had changed his thinking and envisioned a European-type central bank for the United States. While Warburg now warned the senator against attempts to establish a full-scale central bank in the European sense—believing it politically unrealistic— he was nonetheless encouraged.
A particular key feature of the European systems persuaded the senator to reconsider his thinking. According to commission member Sen. Theodore Burton, the concept of currency backed by commercial assets began to take hold in Aldrich’s mind in London, and the interviews in Berlin finally convinced him. Commission Assistant George Reynolds concurred, noting that “the experience and practice of German bankers in meeting the needs of commerce in their country demonstrated to Aldrich the validity of the use of commercial assets as a basis for currency. The idea, formerly so obscure, came home to him in great force from its demonstration in a non-political, practical atmosphere.”
While Aldrich’s conversion was a welcome one to Warburg and other progressive reformers, the very concept of a European-style central bank was still an anathema to a great many bankers and politicians. Bankers wanted reform that would make the banking system more efficient and better coordinated but were fearful of government interference in the management of a central bank. While Reynolds, as president of the American Bankers Association, had traveled to Europe and had become an intimate of Aldrich, his association was not supportive of reform. Moreover, many politicians believed that the geographic size of the United States and its diverse business conditions warranted a different banking system than those existing in Europe. Complicating the matter further was the fact that any plan to which Aldrich attached himself was sure to be attacked by Democrats and others who believed the senator had only the interest of eastern businessmen and bankers in mind. Aldrich had close ties with J. P. Morgan and other important bankers, and his eldest daughter’s marriage to John D. Rockefeller Jr. did not help to dispel this suspicion.
The Jekyll Island Expedition
One evening in early November 1910, Warburg and a small party of men from New York quietly boarded Sen. Aldrich’s private railway car, ostensibly for a trip south to an exclusive hunting club on an island off the coast of Georgia.
In addition to Warburg and Aldrich, the others, all highly regarded in the New York banking community, were: Frank Vanderlip, president of National City Bank; Harry P. Davison, a J.P. Morgan partner; Benjamin Strong, vice president of Banker’s Trust Co.; and A. Piatt Andrew, former secretary of the National Monetary Commission and now assistant secretary of the Treasury. The real purpose of this historic “duck hunt” was to formulate a plan for US banking and currency reform that Aldrich could present to Congress.
Even Warburg at first questioned the motives of this gathering, not knowing if he was included because the group knew what he preached and was interested in what he had to offer, or if he was to be involved as a conspirator in order to be muzzled. He soon saw that the Jekyll Island conference was pulled together because, as Warburg later wrote, Aldrich was “bewildered at all that he had absorbed abroad and he was faced with the difficult task of writing a highly technical bill while being harassed by the daily grind of his parliamentary duties.”
The group was secluded on Jekyll Island for about 10 days. All the participants came to the conference with strong views on the subject and did not agree on the exact shape a US central bank should take. Vanderlip noted: “Of course we knew that what we simply had to have was a more elastic currency through a bank that would hold the reserves of all banks.” But there were many other questions that needed to be answered. If it was to be a central bank, how was it to be owned: by the banks, by the government, or jointly? Should there be a number of institutions or only one? Should the rate of interest be the same for the whole nation, or would it be higher in a community that was expanding too fast and lower in another that was lagging? In what open market operations should the bank be engaged?
Warburg realized that he had not been able to persuade the senator that if a central banking organization was to be created, it had to be a modified scheme based on the European models. In fact, Warburg, “the best equipped man there in the academic sense,” according to Vanderlip, “was so intense … and apparently felt a little antagonism towards Aldrich,” so that there were some moments of strain that had to be eased by the others. Aldrich had his mind set on a European-style central bank, “a model he seemed loath to abandon,” according to Warburg, and the senator strongly believed that the proposed central bank should be kept out of politics. Warburg and the others felt that whatever the theoretical justification for such a central bank, American conditions would require some sort of compromise and that concessions should be made considering government influence and representation. Aldrich, yielding somewhat, allowed that the government should be represented on the board of directors and have full knowledge of the bank’s affairs, but a majority of the directors were to be chosen, directly or indirectly, by the members of the association.
Warburg also didn’t agree with Aldrich’s position on note issuance, conditions of membership of state banks and trust companies, or on the need for a uniform discount rate. Aldrich insisted, however, that a central bank should maintain a uniform rate of discount throughout the United States. He thought such a measure politically wise because it would refute the charges that other “great financial centres” would attempt to establish favorable rates for themselves in different regions to the disadvantage of other localities in the country.
Eventually all of the individuals at the Jekyll Island conference had to modify their views on a central bank plan. Nonetheless, Aldrich got out of the conference just what he intended—a banking scheme that rested upon a consensus of opinion representing the best-informed bankers of this country.
The banking bill the group brought north, which came to be known as the “Aldrich Plan,” called for the establishment of a central bank in Washington, to be named the “National Reserve Association,” meaning a central reserve organization with an elastic note issue based on gold and commercial paper. The association was to have 15 branches at geographically strategic locations throughout the country. The bank was to serve as fiscal agent for the US government and, by mobilizing the reserves of its member banks, become a lender of last resort to the American banking system. The association as a whole was to serve as a bank of rediscount, that is, it was empowered to discount a second time commercial paper that members of the association had already discounted. By rediscounting, the association could issue new money that might stay in circulation so long as the paper for which it was issued was not redeemed.
No one person was responsible for the final draft bill that was written. It was a record of their composite views. Yet Vanderlip regarded Warburg as having made significant and important contributions to the final result: “As a philosophical student of banking he was first among us at that time.” Warburg was satisfied that the Aldrich Plan was not a central bank in the European sense. “It was strictly a bankers’ bank with branches under the control of separate directorates having supervision over the rediscount operations with member banks,” he said.
Warburg viewed the result of the Jekyll Island meeting as pivotal: “The period during which nonpolitical thought held the leadership in the banking reform movement may be considered as having ended with this conference.” Up until then, bank reform had been an educational campaign carried on by individuals and groups; but at that point, the movement assumed a national character. Warburg saw Senator Aldrich as being the standard-bearer of a political proposal for a central bank. Said Warburg: “From then on until the final passage of the Federal Reserve Act, the generalship was in the hands of political leaders, while the role of banking reformers was to aid the movement by educational campaigns and, at the same time, to do their utmost to prevent fundamental parts of the nonpolitical plan from being disfigured by concessions born of political expediency.” Aldrich presented his draft plan to the public in January 1911. One year later, on Jan. 19, 1912, the National Monetary Commission presented its report and endorsed the Aldrich Plan.
The Final Campaign
Warburg playfully described himself as a “fanatic” for what he considered sound finance. He was also pragmatic and sensitive to political realities, however. Thus he tempered his approach to a central bank in the United States, and his campaign over the next several years reflected that position. When he saw the roadblocks that lay ahead with Aldrich attempting to sell his plan to a greater part of the country, Warburg began a formal educational campaign to assist. Warburg believed that “beyond doubt, unless public opinion all over the United States could be educated and mobilized, any sound banking reform plan was doomed to fail.”
The National Board of Trade appointed Warburg the head of a seven-man committee to set up a national group to promote reform. The group was called The National Citizens League For the Promotion of Sound Banking. It accomplished much of what it set out to do: establishing effective organizations in 45 states, printing a vast amount of educational materials for the businessman and layman alike, and publishing essays in pamphlets and articles in newspapers. Warburg also continued to publish in important journals and lecture before influential groups, doing all he could to help promote sound banking principles and convince larger audiences of the urgency for reform.
The Final Plan — The Federal Reserve Act
Before the Aldrich Plan could be enacted into law, the Democrats won the White House and took control of the Congress in 1912. The Democratic position called for a divisional reserve bank system, with a number of reserve banks or central banking cities. Nevertheless, President Woodrow Wilson believed that the Aldrich Plan was “60-70 percent correct.” As a result, the plan became the basis for constructing the Federal Reserve bill, which began to take shape in Congress with the presentation of a bill proposed by Sen. Robert Latham Owen in May 1913.
When the Aldrich bill was rejected and the Democrats began to rework the banking bill, the group of bankers that had worked so hard in support of the Aldrich Plan began to split apart, and many of those bankers refused to consider an alternative plan. Warburg was more conciliatory and remained in contact with prominent Democrats, including Carter Glass, chairman of the House banking committee, and H. Parker Willis, the committee expert, and continued to write and speak on the new legislation. Warburg’s reserve and discounting concepts were embraced in the Federal Reserve plan, though the central bank gradually abandoned the emphasis on discounting in favor of open market operations as the major monetary policy tool. Nonetheless, his efforts in educating the country, bringing sound banking techniques to the forefront of debate, were of tremendous importance in final preparation and passage of the Federal Reserve Act.
Warburg’s career didn’t end with passage of the Federal Reserve Act. In a sense, the close of this chapter marked the beginning of his next important role as a central banker. He was to wield a tremendous influence on the development of the System he worked so hard to help establish. In spite of vehement opposition from many Democrats and populists, President Wilson asked Warburg to become a member of the first Federal Reserve Board.
It appears President Wilson made a wise decision. Once Warburg was appointed to the board, Secretary of the Treasury William McAdoo, who often clashed with Warburg over policy matters, explained Warburg’s appointment this way: “It was thought that his technical knowledge in international finance would be useful. It was useful, in some respects it was invaluable.” Benjamin Strong, governor of the Federal Reserve Bank of New York, went even further in his estimation of Warburg. Although Warburg was appointed as a member of the board (not as the chairman or vice chairman), Strong called Warburg “the real head of the board in Washington, so far as knowledge and ability goes.”
But the fact that he was at all chosen to serve on the board seems to have been as much a surprise to the European-born banker as to those who took issue with his nomination. Indeed, he first declined the appointment because of the “rampant prejudice in this country against a Wall Street man,” and balked at testifying before the Senate banking committee because other nominees had not been asked to do so. However, when World War I erupted in Europe, Warburg decided to waive all personal considerations “in deference to the president’s urgent request and in view of the present urgency which render desirable the promptest organization of the Federal Reserve Board,” and appeared before a largely antagonistic committee.
With Warburg before them, rather than take advantage of his vast knowledge in central banking to learn how the country would adapt to this new system, the senators chose instead to question the banker on Kuhn, Loeb and Co.’s “money trust” connections. Thus, one of the best opportunities for history to record Warburg’s extemporaneous impressions on the final Glass-Owen Federal Reserve bill was lost. But when Warburg was questioned as to his motives for making the sacrifice — financial and otherwise — to become a member of the Federal Reserve Board, the nominee’s answer was characteristically to the point:
“When President Wilson asked me [again] whether I would take this [on] and make the sacrifice … I felt that I had no right to decline it; and I will be glad to make the sacrifice, because I think there is a wonderful opportunity for bringing a great piece of constructive work into successful operation, and it appeals to me to do that.”