13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (43 page)

71.
For the history of the Fed, see Milton Friedman and Anna Jacobson Schwartz,
A Monetary History of the United States, 1867–1960
(Princeton: Princeton University Press, 1963); and Alan H. Meltzer,
A History of the Federal Reserve, Volume 1, 1913–1951
(Chicago: University of Chicago Press, 2003). For the political compromise that created the Federal Reserve, see David Wessel,
In Fed We Trust: Ben Bernanke’s War on the Great Panic
(New York: Crown Business, 2009), 36–38.

72.
A version of this idea is central to the historical account in Kindleberger,
Manias, Panics, and Crashes, supra
note 61.

73.
Quoted in Urofsky,
Louis Brandeis, supra
note 66, at 346.

74.
This was not a new view, but it had previously been held only by “populists” or “progressives” who were not generally part of the mainstream consensus. See, e.g., Michael McGerr,
A Fierce Discontent: The Rise and Fall of the Progressive Movement in America, 1870–1920
(Oxford: Oxford University Press, 2005).

75.
David M. Kennedy,
Over Here: The First World War and American Society
(Oxford: Oxford University Press, 2004), chapter 2.

76.
Ironically, the origins of the “laissez-faire” philosophy lay in opposition to big business and monopoly power based on state charters and other restrictions on free entry. From the late nineteenth century there was an active debate in the United States about the extent to which this doctrine was still relevant; see Lawrence E. Mitchell,
The Speculation Economy: How Finance Triumphed over Industry
(San Francisco: Berrett-Koehler, 2008). By 1920 “laissez faire” rhetoric was a mainstay of big business, for example as represented by Andrew Mellon and Herbert Hoover, as part of its resistance to regulation (as represented by Brandeis). See David Cannadine,
Mellon: An American Life
(New York: Vintage, 2008); McCraw,
Prophets of Regulation, supra
note 50; and Urofsky,
Louis Brandeis, supra
note 66.

77.
Calvin Coolidge, “The Press Under a Free Government,”
supra
note 21.

78.
Cannadine,
Mellon, supra
note 76; Hofstadter,
American Political Tradition, supra
note 20, at chapter 11. Harding is quoted in Cannadine,
Mellon,
at 277.

79.
McCraw,
Prophets of Regulation, supra
note 50, at chapters 4 and 5.

80.
Jerry W. Markham,
A Financial History of the United States, Volume II: From J. P. Morgan to the Institutional Investor (1900–1970)
(Armonk, NY: M. E. Sharpe, 2002), chapter 4. Deposit-taking commercial banks were allowed to promote securities; Charles E. Mitchell rose to prominence at National City Bank doing just that—on a salary of $25,000 a year, Mitchell’s bonuses pushed his total compensation to $3.5 million between 1927 and 1929. Ibid. at 117. The McFadden Act of 1926 “codified the existing practice of buying and selling ‘investment’ securities by national banks.” Ibid. at 113.

81.
J. K. Galbraith,
The Great Crash, 1929
(New York: Mariner, 2009); Charles R. Geisst,
Wall Street: A History from Its Beginnings to the Fall of Enron
(Oxford: Oxford University Press, 2004).

82.
The operation of the gold standard meant that the Fed adjusted interest rates to reflect flows of gold in and out of the country; monetary policy was affected more by developments in major European trading nations than by concerns about speculative bubbles. The broader economic philosophy was: stay on gold, let the private sector sort out its own problems, and all will be well. For more details, see Barry Eichengreen,
Golden Fetters: The Gold Standard and the Great Depression, 1919–1939
(New York: Oxford University Press, 1992); Lester V. Chandler,
Benjamin Strong: Central Banker
(Washington: Brookings Institution Press, 1958); and Liaquat Ahamed,
Lords of Finance: The Bankers Who Broke the World
(New York: Penguin, 2009).

83.
Galbraith,
The Great Crash, supra
note 81; Kindleberger,
Manias, Panics, and Crashes, supra
note 61.

84.
Quoted in William Greider,
Secrets of the Temple: How the Federal Reserve Runs the Country
(New York: Simon & Schuster, 1987), 65.

85.
The definitive source for interest rates is Sidney Homer and Richard Sylla,
A History of Interest Rates,
fourth edition (Hoboken, NJ: Wiley, 2005). Friedman and Schwartz argue that even the tightening in 1928 was a mistake. Friedman and Schwartz,
Monetary History, supra
note 71. See also Ben S. Bernanke, “Money, Gold, and the Great Depression” (H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, VA, March 2, 2004), available at
http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/
default.htm
.

86.
Ahamed,
Lords of Finance, supra
note 82; Chandler,
Benjamin Strong, supra
note 82.

87.
The Fed was weak by modern standards, but it was not without some power—see William L. Silber,
When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy
(Princeton: Princeton University Press, 2007).

88.
There was an active debate within the Federal Reserve system, with the New York Fed (which had more autonomy than today) favoring tighter conditions for credit, while the board in Washington preferred to keep the boom going. Meltzer,
History of the Federal Reserve, supra
note 71; Friedman and Schwartz,
Monetary History, supra
note 71; Ahamed,
Lords of Finance, supra
note 82; Cannadine,
Mellon, supra
note 76.

89.
Quoted in Ahamed,
Lords of Finance, supra
note 82, at 360; Harrison was at odds with the Federal Reserve Board, but still lent over $100 million into the market. Ibid. at 358–59. He also persuaded the board to cut interest rates from November, but other members of the Fed Board were reluctant to go further. Ibid. at 365, 369.

90.
Ibid. at chapter 20.

91.
Friedman and Schwartz stressed the importance of a decline in the money supply. Friedman and Schwartz,
Monetary History, supra
note 71. Bernanke argued that the real problem was the failure of banks, as these had local information about borrowers that disappeared when they collapsed. Bernanke, “Non-Monetary Effects,”
supra
note 62. See also Alan H. Meltzer,
History of the Federal Reserve, supra
note 71, at chapter 5. The major bank failures began in late 1930 with the Bank of the United States (no relation to the U.S. government). For the full dynamics of the bank failures, see Elmus Wicker,
The Banking Panics of the Great Depression
(Cambridge: Cambridge University Press, 1996).

92.
Within New York, the largest banks (e.g., J.P. Morgan, Chase, National City) rescued other large banks (e.g., Kidder Peabody) but declined to save the less prominent Bank of the United States at the end of 1930; this helped trigger wider runs on banks. Ahamed,
Lords of Finance, supra
note 82, at 387–88.

93.
Eichengreen,
Golden Fetters, supra
note 82; Peter Temin,
Lessons from the Great Depression
(Cambridge: MIT Press, 1989). Chang-Tai Hsieh and Christina D. Romer are skeptical, at least with regard to the monetary expansion in 1932. Chang-Tai Hsieh and Christina Romer, “Was the Federal Reserve Constrained by the Gold Standard During the Great Depression? Evidence from the 1932 Open Market Purchase Program,”
Journal of Economic History
66 (2006): 140–76, at 172. On the debate over the cause of the Great Depression, see also Peter Temin,
Did Monetary Forces Cause the Great Depression?
(New York: W. W. Norton, 1976); Charles H. Feinstein, Peter Temin, and Gianni Toniolo,
The World Economy Between the World Wars
(Oxford: Oxford University Press, 2008); and Christina D. Romer, “Great Depression,” in
Encyclopedia Britannica
(2003), available at
http://elsa.berkeley.edu/~cromer/great_depression.pdf
. Besides the theories that the Depression resulted from mistakes by the Federal Reserve and that it was caused by the international gold standard, another explanation is that the international community was unable to deal with shocks in Europe. Ahamed,
Lords of Finance, supra
note 82. Alternatively, the federal government may have simply lacked the capacity to counteract the contraction in the private sector, since federal government spending was only 2.5 percent of GDP before the 1929 crash.

94.
National City Bank, for example, paid high bonuses tied to selling risky stock. More generally, the prudential standards in banking were lax; Markham,
Financial History,
Volume II,
supra
note 80.

95.
Geisst,
Wall Street, supra
note 81, at 214–15, 224–25.

96.
On the relationship between private sector banks and the Federal Reserve and regulation more generally, see John T. Woolley,
Monetary Politics: The Federal Reserve and the Politics of Monetary Policy
(Cambridge: Cambridge University Press, 1984), chapter 4. On the history of Federal Reserve politics, see Greider,
Secrets of the Temple, supra
note 84
.

97.
H. W. Brands,
Traitor to His Class: The Privileged Life and Radical Presidency of Franklin Delano Roosevelt
(New York: Anchor, 2008), 431.

98.
Quotations in this paragraph are from ibid. at 450; a slightly later but similar statement is quoted in David M. Kennedy,
Freedom from Fear: The American People in Depression and War, 1929–1945
(Oxford: Oxford University Press, 1999), 282. Roosevelt did not mention Jackson’s mistreatment of American Indians. See, e.g., H. W. Brands,
Andrew Jackson: His Life and Times
(New York: Anchor, 2005); Remini,
Life of Andrew Jackson, supra
note 34.

99.
Arthur M. Schlesinger, Jr.,
The Coming of the New Deal: 1933–1935
(Boston: Mariner, 2003), 444.

100.
Carnell et al.,
Law of Banking, supra
note 8, at 17.

101.
Ibid. at 20.

102.
Allen N. Berger, Richard J. Herring, and Giorgio P. Szego, “The Role of Capital in Financial Institutions,”
Journal of Banking and Finance
19 (1995): 393–430. Double liability existed in some states, and for nationally chartered banks from the National Banking Act of 1863, and only ended with the Banking Acts of 1933 and 1935. Anthony Saunders and Berry Wilson, “Contingent Liability in Banking: Useful Policy for Developing Countries?” (Policy Research Working Paper 1538, World Bank, November 1995). Comparable data are not available prior to 1850.

103.
The figure is from David Moss, “An Ounce of Prevention: Financial Regulation, Moral Hazard, and the End of ‘Too Big to Fail,’ ”
Harvard Magazine,
September–October 2009, available at
http://harvardmagazine.com/2009/09/financial-risk-management-plan
. Data are from Bureau of the Census,
Historical Statistics of the United States: Colonial Times to 1970, Part 2
(Washington: U.S. Government Printing Office, 1975), Series X-741; Federal Deposit Insurance Corporation, “Failures and Assistance Transactions,”
Historical Statistics on Banking,
available at
http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=30
.

104.
Leading independent students of central banking argue that thin equity layers make sense only when there is tight regulation. See, e.g., Charles Goodhart, “Financial Crisis and the Future of the Financial System” (paper presented at the 100th BRE Bank–CASE Seminar, Warsaw, Poland, January 22, 2009).

105.
See G. J. Bentson,
The Separation of Commercial and Investment Banking
(London: Macmillan, 1990); and Alexander Tabarrok, “The Separation of Commercial and Investment Banking: The Morgans vs. the Rockefellers,”
The Quarterly Journal of Austrian Economics
1 (1998): 1–18.