FEDERAL RESERVE ACT OF 1913

On December 23, 1913, President Woodrow Wilson (1913–1921) signed the Federal Reserve Act, and thereby created the Federal Reserve System. The Federal Reserve Act was intended to prevent a national financial crises and promote economic stability. The legislation established a national system for governmental regulation of currency supply and federal distribution of currency to banks. The Act also relocated supervision of the banking system from the private sector to the federal government. After years of popular national opposition to the federal government's involvement in the banking system, the passage of the Federal Reserve Act was a turning point. The Act represented a recognition that banking and currency would remain unstable without a unifying regulatory system at the national level.

Opposition to a federal banking system dated back to the United States' beginnings. The newly formed United States was largely agrarian, with little banking experience and a deep distrust of any central government activity. Nevertheless, many congressional members believed that a banking system was crucial to the fledgling nation's economic development. Under leadership of the first Secretary of the Treasury, Alexander Hamilton (1755–1804), Congress established the First Bank of the United States in 1791. However the First Bank (and its successor the Second Bank, established in 1816) fell prey to fears that the federal government's power was excessive at the states' expense. As the nation expanded a stampede ensued to establish state banks under numerous state laws. These banks wildly vacillated between freely issuing bank notes and lending money, to tightening down on the money supply. Bank failures and loss of depositors' savings were widespread.

Not until the nation was faced with the financial demands of the American Civil War (1861–1865) did the government attempt to intervene in the financial sector again. Congress passed National Bank Acts in 1863 and 1864. The acts created a system of privately owned banks called "national" banks because they were chartered and regulated by the federal government. The national banks issued a uniform currency nationwide, but the national bank system was not equipped to meet the money supply needs of a rapidly expanding economy.

A series of devastating cash panics between 1873 and 1907 focused public attention on the need for more extensive banking and monetary reform. The Aldrich Vreeland Act of 1908 provided temporary issues of emergency currency. In 1910 the National Monetary Commission began extensive investigations of the banking system, laying the groundwork for the system's reform. After much Congressional debate and compromise, the Glass-Owen bill—the Federal Reserve Act—was passed and signed into law in 1913.

Careful to avoid the label "central bank," the Federal Reserve Act diffused bank supervision by creating 12 Federal Reserve Districts. Each district had a Federal Reserve Bank and a Federal Reserve Board to oversee and coordinate operation for the entire system. To ensure that commercial bankers throughout the country would have a voice, the Federal Advisory Council was established and composed of twelve members, one from each Federal Reserve district and elected by member banks of that District.

All national banks had to belong to the entire system. Member banks also included a small number of state-chartered banks that were willing and qualified to join. The required investment of each member bank was six percent of its capital. Each member bank received an annual dividend of six percent of the amount it invested in the Reserve Bank.

Passage of the Federal Reserve Act began a long organizing process. Section 10 of the act charged the Federal Reserve Board with establishing a centralized banking system to meet the challenging and changing needs of the U.S. economy. The board, based in Washington, D.C., consisted of seven members serving 10-year terms. The board members were: the Secretary of the Treasury, the Comptroller of the Currency, and five members appointed by the President of the United States with consent of the Senate. In order to avoid potential domination by any region, the act specified that no more than one of the five appointed members could be from any one Federal Reserve District. To eliminate partisan pressures the framers of the act intended that the appointees be public figures who could not financially benefit from board decisions. The act also required that at least two board members be knowledgeable in banking and finance so that the commercial and financial needs of the nation were addressed according to scientific principles. To insulate the board from the legislative branch, all expenses were paid from Reserve Bank earnings rather than congressional appropriations. Once they were appointed, board members were neither directly responsible to the president nor to any other branch of the federal government.

The Federal Reserve Board was charged with establishing and overseeing the twelve Reserve Banks. In addition, the board would examine the accounts, books, and affairs of reserve and member banks, and review discount rates (the rate charged to member banks for loans from Reserve Banks) set by each Reserve Bank. The Federal Reserve Board was also charged with oversight of currency circulation. This included regulating the amount of gold reserves held against Federal Reserve notes (paper money), supervising the issue and retirement of notes, serving as a central clearinghouse for checks, and executing various supervisory and regulatory functions pertaining to Reserve Banks.

Conflicts arose between the Federal Reserve System and U.S. Treasury. The Banking Act of 1935 diffused the discord by removing the Treasury Secretary and Comptroller of the Currency from the Federal Reserve Board. All seven board positions became presidential appointees. The 1935 act also established the Federal Open Market Committee (FOMC), a group consisting of the seven board members and five of the twelve Reserve bank presidents. For over fifty years the powerful FOMC held complete control over the country's money supply.

By the end of the twentieth century the Federal Reserve System remained largely an independent agency of the government. At that time the system controlled the flow of money and credit in three ways. First the Federal Reserve System conducted open-market sales or purchases of government securities; second, the system raised or lowered the discount rate. Finally the Federal Reserve System changed reserve requirements— the percentages of deposits that a member bank must hold as currency in their vaults or as deposits in their district Federal Reserve Bank. The Federal Reserve System continued to grow and undergo adjustments, assuring economic stability in the United States.

See also: Bank of the United States (first), Bank of the United States (second), Woodrow Wilson

FURTHER READING

Broz, J. Lawrence. The International Origins of the Federal Reserve System. Ithaca, NY: Cornell University Press, 1997.

McCulley, Richard T. Banks and Politics During the Progressive Era: The Origins of the Federal Reserve System, 1897–1913. New York: Garland Publishing, 1992.

Timberlake, Richard H., Jr. The Origins of Central Banking in the United States. Cambridge, MA: Harvard University Press, 1978.

Toma, Mark. Competition and Monopoly in the Federal Reserve System, 1914–1951: A Microeconomics Approach to Monetary History. New York: Cambridge University Press, 1997.

West, Robert C. Banking Reform and the Federal Reserve, 1863–1923. Ithaca, NY: Cornell University Press, 1977.

[the struggle that produced the federal reserve act] is not merely a chapter in financial history; it is also an account of the first battle in a campaign for safe and scientific banking. h. parker willis, first secretary of the federal reserve board, 1923