Boom, Bust and the Decline of the Anti-Federalists

The US Regulatory Environment Part 3.1
Boom Bust and the Decline of the Anti-Federalists_HEADER
BELLIN author pictureAuthor: BELLIN

When I began writing about the financial regulators I wanted to give a resource that could be referenced. However, the more I delved into them, the more I realized that there was a gap in the narrative established in our last post on US regulation. The anti-federalists had instilled a powerful ideology on the US, and while their influence can still be seen by the American distaste for federal regulation, it has nowhere near the clout that it did in the period leading up to 1930.  So, in this post I’m going to extend the narrative established in the last post and show how the regulators were a response to the instability born from the ideologies behind the anti-federalists.

In our last post we introduced the idea of checks and the regulatory environment they came from. We traced the anti-federalists like Thomas Jefferson and their notorious mistrust of banking – but more so, of centralized banking, and centralization as a whole. This post we want to talk about that strange period of American history between 1863 and 1942 where the anti-federalist ideology’s grip on American economic politics loosened, and it all starts with the National Bank Act.

The National Bank Act

The National Bank Act marked a tremendous change in American regulation. Following the free banking era, the call to regulate and control banks became loud enough to promote a major shift in regulatory style. This created a period of stability and security that had not been seen since the years of the First and Second banks.

The growing American industrialism resulted in a surge of demand for capital in the late 19th century, and a boom in new banks. With them came the industrial banks that served to fund the expansion of the railroads, America’s booming mining operations, and the development of the new American industry.

In the period following, the American financial system was in disarray. Like at the start of the century, major financial panics occurred in 1873 and 1893. These panics caused a serious push for financial regulation reform.

The Wall Street Panic

Then in 1907 the American financial system changed forever with an event known as The Wall Street Panic. A cabal with plans to corner the United Copper Company’s stock failed. The banks that had funded the cabal suffered substantial losses. This hurt depositor faith, resulting in larger withdrawals. These bank runs quickly spread to associated banks and financial institutions, eventually resulting in the collapse of one of New York’s largest trust institution: the Knickerbocker Trust Company.

JP Morgan is said to have pulled the financial system back from the brink, convincing New York’s bankers to pledge funds to shore up depositories. He also loaned great sums of his own money to smaller banks to keep them afloat.  The day was saved, but what about the next time? And what if, next time, there was no JP Morgan? The system needed a lender of last resort.

The Federal Reserve

One year later Congress established a commission to investigate the crisis and propose solutions, and at its head: senator Nelson Aldrich. Then in an event that inspired some of the most popular American conspiracy theories, Nelson Aldrich, Frank Canderlip (National City – now Citibank), Henry Davison (Morgan Bank), and Paul Warburg (Kuhn, Loeb Investments) met on the infamous Jekyll island to discuss how they would formulate banking reforms, and plans to institute a centralized bank.

The truth is, the meeting needed to be secret. Anti-Wall Street sentiment following the crashes of the early 20th century left America fearful of anything that included them. If the commission were seen as taking input from Wall Street, it could be potentially disastrous.

The result was the Aldrich Plan: a system of 15 regional central banks that would be known as the National Reserve Association. The regional banks that made up the members would be controlled individually and nationally by bankers – a prospect that did not sit well with the reigning US government.

Woodrow Wilson had warned against the “money trusts” and “a concentration of control of credit” as early as in his acceptance speech. The government would not accept bankers at the helm of US institutions. The Aldrich Plan failed.

However, while the plan itself failed, the ideas behind it found their way into the Owen-Glass Act, which would come to be known as the Federal Reserve Act. It would produce a system of eight to twelve autonomous Reserve Banks owned regionally, but coordinated by an appointed Federal Reserve Board.  All national banks were required to join the system. It also created Federal Reserve notes, adding elasticity to the American currency system. The Federal Reserve Act was signed into law on December 23rd 1913, and the Fed was born.

The Great Depression and the end of the fear of centralization

Then there was the Great Depression and with it the worst systemic banking crisis of the 20th century. The depression met head on with a collapse of the financial system, and by 1933 what little faith the American people still had in banks was gone. 28 states closed ALL financial institutions, resulting in a declared “national banking holiday” where all financial institutions were closed for seven business days.

The collapse hit hard. By its height, the unemployment rate was 25%, the stock market had declined 75%, and sentiment of the American public had turned. Bank runs were common, and anti-bank sentiment was high.

On the 22nd of January 1932, Congress chartered the Reconstruction Finance Corporation, authorized to extend loans to all financial institutions, including state-chartered banks without links to the Fed.

The next month, the Banking Act of 1932 expanded the Fed’s power to loan funds.

In 1933 Franklin D. Roosevelt and the Democratic Party took the White House. They took immediate steps to reform the American financial system and curb the Great Depression. Over the next 8 years the US congress would transform the US regulatory environment. Among these were:

  • 1933 – A revision of The Banking Act of 1932 creating what it is known today as “Glass-Stegall”. It would, among many things, put a hard separation between commercial and investment banks and establish the Federal Deposit Insurance Corporation.
  • 1933 – The Emergency Banking Act which let sound banks reopen under supervision of the treasury and established a structure of loans if need be. This re-opened three-quarters of the Federal Reserve System within three days, and relaxed fears about banking – flooding the system with gold and deposits.
  • 1934 – The Securities Exchange Act established the Securities and Exchange Commission (SEC), and further regulated secondary trading of securities.
  • 1934 – The Federal Credit Union Act, creating the Bureau of Federal Credit Unions. This would eventually become the National Credit Union Administration.
  • 1934 – The National Housing Act of 1934 was passed, insuring deposits in savings and loans.
  • 1936 – The Commodity Exchange Act passes, creating CFTC.
  • 1940 – The Investment Company Act (or Company Act, or ‘40 Act) passes, regulating mutual funds and closed-end funds.
  • 1940 – The Investment Advisor Act, to monitor and regulate the activities of investment advisers. It is administered by the SEC.

There’s disagreement about whether Roosevelt’s policies were a success, but what cannot be denied was that the regulation enacted in the 1930s ended 90 years of panics – the bank runs stopped. No major crisis would hit the United States economy until the 1980s.

The fear of Wall Street’s power over the previous 30 years had led to a political environment where the anti-federalist fear of centralization had turned full circle. The US government now not only accepted central control, the policies of FDR’s Democrats seemed to embrace it. The ideologies born of Jefferson’s ideals had subsided in favor of greater federal governance.

Next up: next week we look at the regulators as they exist today, what each does, and the role they play in your business.

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