Federal Reserve System Research Paper

Federal Reserve System Research Paper

The Federal Reserve System is the central banking system of the United States, and just like the Eiffel tower it wasn’t built over night. The first step to this system was the foundation that, in this case, was the first central bank of the United States. The First Central Bank of the United States is considered a success by economic historians. Initially introduced by Alexander Hamilton, the First Bank was granted a twenty-year charter by Congress; in spite of the opposition of the Jeffersonian who thought that it represented the dominance of mercantile over agrarian interests, and an unconstitutional use of federal power. Treasury Secretary Albert Gallatin commented that the Bank was "wisely and skillfully managed." The Bank was also profitable, earning most of its income through substantial loans to both government and private business, but it won the enmity of entrepreneurs and state banks; that argued its fiscal caution was constraining economic development. Additionally, others were troubled by the fact that two-thirds of bank stock was held by British interests. Thomas Jefferson, in the debate over the Re-charter of the Bank Bill in 1809, said “If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks…will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” These critics, working with agrarian opponents of the bank, succeeded in preventing renewal of the charter in 1811, and the First Bank went out of operation.  

Soon after, the country found that not having a bank placed a toll on financing the War of 1812. After much interest in a central bank, in 1816, the Second Bank of the United States was created with old and new principles. The Second Bank’s initial years were difficult, and many felt that its mismanagement helped bring on the panic of 1819.

Many people were so enraged with the Second Bank, that there were two attempts to have it struck down as unconstitutional. In the case McCulloch v. Maryland in 1819 the Supreme Court voted 9-0 to uphold the Second Bank as constitutional. Chief Justice Marshall wrote ^[1]"After the most deliberate consideration, it is the unanimous and decided opinion of this court that the act to incorporate the Bank of the United States is a law made in pursuance of the Constitution, and is part of the supreme law of the land" (Hixson, 117).  It wasn’t until Nicholas Biddle became the Bank's president in 1823 did it begin to function, move, and grow as planned. By the time the Bank had regained some control of the money supply and restored some financial stability to the country in 1828, Andrew Jackson, an anti-Bank candidate, had been elected President. Although the Second Bank was not a campaign issue by 1832, four years before the Bank's charter was to expire, political divisions over the Bank had already formed. Pro-Bank members of Congress produced a renewal bill for the Bank's charter, but Jackson vetoed it. In his veto message Jackson wrote:

^[2]“A bank of the United States is in many respects convenient for the Government and for the people. Entertaining this opinion, and deeply impressed with the belief that some of the powers and privileges possessed by the existing bank are unauthorized by the Constitution, subversive of the rights of the States, and dangerous to the liberties of the people, I felt it my duty...to call to the attention of Congress to the practicability of organizing an institution combining its advantages and obviating these objections. I sincerely regret that in the act before me I can perceive none of those modifications of the bank charter which are necessary, in my opinion, to make it compatible with justice, with sound policy, or with the Constitution of our country.” (Ibid, 14-15).

Jackson was not opposed to the idea of central banking, but to the Second Bank in particular. No other bill to renew the Bank's charter was presented to Jackson, and so the Second Bank of the United States expired in 1836.

 ^[3]The National Bank Act of 1863 was designed to create a national banking system, float federal war loans, and establish a national currency. Congress passed the act to help resolve the financial crisis that emerged during the early days of the American Civil War (1861–1865). The fight with the South was expensive and there was no effective tax program produced to finance the war. In order to bring financial stability to the nation and fund the war effort, the National Bank Act of 1863 was introduced to the Senate in January of that year. A Republican congressman from Pennsylvania, Thaddeus Stevens (1792–1868), opposed the act; Secretary of the Treasury Salmon Chase (1808–73), aided by Senator John Sherman (1823–1900) of Ohio, promoted it. The bill was approved in the Senate by a close vote of 23 to 21, and the House passed the legislation in February. The National Bank Act improved, but did not solve the nation's financial problems. This continued until the Panic of 1907, also known as the 1907 Bankers' Panic; a United States financial crisis that took place over a three-week period starting in mid-October, when the New York Stock Exchange fell almost 50% from its peak the previous year. A company called United Copper Company soared past $62 per share on October 14, 1907. Two days later, it closed at $15 per share, and the owner, F. Augustus Heinze, was well on his way to financial ruin.

In 1913, President Wilson, a Democrat, signed the Federal Reserve Act, also known at the time as the Currency Bill or the Owen-Glass Act. With Woodrow Wilson winning the presidential election and Democrats holding control of both houses, the banking community, which had strongly backed the Aldrich plan, became anxious about what plan the new administration would propose. The House of Representatives passed the Federal Reserve Act by a vote of 298 to 60. The Senate also passed the measure 43 to 25. In both parts of Congress, it was the anti-banker Democrats that overwhelmingly supported the Act, while for the most part the pro-banker Republicans opposed it. The bill called for a system of eight to twelve mostly autonomous regional Reserve Banks that would be owned by commercial banks and whose actions would be coordinated by a committee appointed by the President. The Federal Reserve System would then become a privately owned banking system that was operated in the public interest. Although bankers would oversee the twelve Banks, the Federal Reserve Board would supervise them to ensure the public interest; members of the Board included the Secretary of the Treasury, the Comptroller of the Currency, and other officials appointed by the President. While Woodrow Wilson signed the 1913 Federal Reserve Act, a few years later he wrote: