Paul Moritz Warburg, a German-Jewish immigrant who was one of the founding fathers of the U.S. Federal Reserve, had a fervent wish that his creation would be seen as one of America’s great monuments — “like the old cathedrals of Europe.”
Warburg’s dream that “the Fed” would become a cherished American institution has never looked more in doubt. The Federal Reserve, which was enacted by Congress in 1913 and set up shop the following year, is today an institution under siege. More surprising perhaps is that the Fed is refighting partisan and ideological battles that Warburg and the other founders thought they had settled a century ago.
Congress today is rife with bills to restrict the Fed’s independence or subject its decisions on monetary policy to real-time Congressional review. (This would require Janet Yellen and the other Federal Open Market Committee members to conduct deliberations on interest rates in open political theater.) Another bill, by Congressman Kevin Brady (R-Texas), would charter a commission to study the Fed and recommend an overhaul.
Congress’s ire stems largely from libertarians who disdain the Fed as a meddling Washington bureaucracy. Rand Paul and Ted Cruz, if either lands in the White House, clearly intend to downsize the Fed’s charter. But on the left, Sen. Elizabeth Warren (D-Mass.) has co-sponsored a bill to prevent the Fed, in some future financial crisis, from administering the remedies it pursued in 2008–09, including propping up the markets for credit cards and auto loans vital to households. Sen. Warren has criticized the Fed for being too cozy with banks; apparently her anger at banks trumps her well-advertised empathy for consumers.
Anger at Washington? Anger at banks? Warburg once wrote, in despair of ever launching a central bank, that an “abhorrence of both extremes” — that is, of Washington and of Wall Street — “had led to an almost fanatic conviction” in favor of extreme decentralization.
Warburg was born into a wealthy banking family, proprietors of M.M. Warburg, in Hamburg in 1868. The third of five brothers, he was groomed to run the bank, yet found the details of commerce tedious, and was repelled by the coarser elements of banking, such as stock speculation. Introspective and brooding, he became active in a local commercial court and in the city council — evidence of his latent interest in politics.
In 1895, Warburg married Nina Loeb, scion of the Kuhn, Loeb banking family in New York. They settled in Hamburg, but Nina yearned to be near her parents. In 1902 they relocated to New York, with Warburg joining his in-laws’ firm. Warburg was stunned by the primitive condition of American banking. Not long after he arrived, interest rates in New York’s chaotic money market soared to 100 percent. “I was not here but three weeks,” Warburg said, “before I was trying to explain to myself the roots of the evil.”
Warburg quickly concluded that the fault lay in America’s lack of a central bank. Most other industrialized nations had a central bank, which acted as a storehouse of reserves (or surplus credit) for the entire nation. In addition, the central bank acted as a lender of last resort, supplying liquidity in times of stress.
In America, by contrast, each bank was responsible for its own reserve. In times of financial stress, each bank — seeking to protect itself — would pull back on credit, accentuating the general scarcity, causing interest rates to soar. Money shortages and panics were common; depressions were not infrequent.
After his arrival, Warburg wrote a paper, calling for a central bank similar to the one in his native Germany. Jacob Schiff, Warburg’s brother-in-law and senior partner at Kuhn, Loeb, showed the paper to James Stillman, head of National City, the country’s biggest bank.
A few days later, Stillman paid Warburg a visit. They had a testy exchange. Warburg said that in the next panic Stillman would regret the lack of a central bank; Stillman left in a huff. Schiff warned Warburg not to show his paper to anyone else. The American people, Schiff explained, “do not want to centralize power. They do not want to have this mass of deposits controlled by a few people.”
Warburg had stumbled upon the original American conflict, debated first by Hamilton and Jefferson, of federalism versus anti-federalism. Indeed, the young republic twice experimented with a national bank, and even though each attempt was successful, each of these banks was abandoned. President Andrew Jackson, who abolished the Second Bank, personified the mistrust, common among rural Americans, of government banks. He thought the Second Bank was a tool of moneyed elites (just as populists today accuse the Fed of favoring Wall Street). Alexis de Tocqueville, who visited the U.S. during Jackson’s reign, was baffled. He wrote that Americans were “obsessed” with a fear of “centralization.”
For Warburg, overcoming this obsession became a crusade. He wrote numerous papers urging adoption of a central bank. To him, America’s banking system resembled a town in which each household had a backyard well but lacked a general water supply. It would not suffice for putting out fires.
In 1907, just as Warburg had predicted, a panic virtually shut down the banking system. Hundreds of banks were unable to repay deposits; the country was plunged into a depression. In the middle of the panic, Stillman returned. “Warburg,” he barked, “where is your paper?”
Actual legislation was still years away. Warburg became a U.S. citizen, and played a major behind-the-scenes role in drafting legislation. In one stranger-than-fiction episode, he and two other bankers were invited by an influential U.S. senator to Jekyll Island, off the Georgia coast, for a secret drafting session. Though his status as a foreigner, and a Jew, made him suspect in the eyes of many of his peers, Warburg’s brilliance gradually won him acceptance. He was nominated by President Woodrow Wilson to be a governor on the Federal Reserve Board, and was a power in the system in its first years. When America entered the European war against Germany, however, his position became awkward. President Wilson accepted his resignation — a blow from which Warburg never recovered.
After his death in 1932, the Fed became a frequent target of anti-Semites, bank haters and conspiracy theorists. Its opponents today are more mainstream. But they are still ideologically motivated. Had the Fed failed to rescue the financial system in 2008, their ire would be understandable — but it did not fail. Similarly, were the Fed inflicting hardship on Americans with onerous interest rates, the anger would be comprehensible. But interest rates are low, while inflation has remained quiescent and the dollar strong. The Fed is instead being punished for success.
Americans, as before, are suspicious of large financial bodies, especially government ones. Warburg would recognize and regret this suspicion. As he wrote of the Fed, “I feel for it, in a sense, as I would for my child.”
Roger Lowenstein is the author of “America’s Bank: The Epic Struggle To Create the Federal Reserve” (Penguin, 2015).