Throughout most of , Glass and Willis labored over a central bank proposal, and by December , they presented Wilson with what would become, with some modifications, the Federal Reserve Act. From December to December , the Glass-Willis proposal was hotly debated, molded and reshaped. By December 23, , when President Woodrow Wilson signed the Federal Reserve Act into law, it stood as a classic example of compromise—a decentralized central bank that balanced the competing interests of private banks and populist sentiment.
Before the new central bank could begin operations, the Reserve Bank Operating Committee, comprised of Treasury Secretary William McAdoo, Secretary of Agriculture David Houston, and Comptroller of the Currency John Skelton Williams, had the arduous task of building a working institution around the bare bones of the new law. But, by November 16, , the 12 cities chosen as sites for regional Reserve Banks were open for business, just as hostilities in Europe erupted into World War I. When World War I broke out in mid, U.
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Through this mechanism, the United States aided the flow of trade goods to Europe, indirectly helping to finance the war until , when the United States officially declared war on Germany and financing our own war effort became paramount. Following World War I, Benjamin Strong, head of the New York Fed from to his death in , recognized that gold no longer served as the central factor in controlling credit.
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During the s, the Fed began using open market operations as a monetary policy tool. During his tenure, Strong also elevated the stature of the Fed by promoting relations with other central banks, especially the Bank of England.
During the s, Virginia Representative Carter Glass warned that stock market speculation would lead to dire consequences. In October , his predictions seemed to be realized when the stock market crashed, and the nation fell into the worst depression in its history. Many people blamed the Fed for failing to stem speculative lending that led to the crash, and some also argued that inadequate understanding of monetary economics kept the Fed from pursuing policies that could have lessened the depth of the Depression.
In reaction to the Great Depression, Congress passed the Banking Act of , better known as the Glass-Steagall Act, calling for the separation of commercial and investment banking and requiring use of government securities as collateral for Federal Reserve notes.
The Act also established the Federal Deposit Insurance Corporation FDIC , placed open market operations under the Fed and required bank holding companies to be examined by the Fed, a practice that was to have profound future implications, as holding companies became a prevalent structure for banks over time. Also, as part of the massive reforms taking place, Roosevelt recalled all gold and silver certificates, effectively ending the gold and any other metallic standard. In the Bank Holding Company Act named the Fed as the regulator of bank holding companies owning more than one bank, and in the Humphrey-Hawkins Act required the Fed chairman to report to Congress twice annually on monetary policy goals and objectives.
It did so at the request of the Treasury to allow the federal government to engage in cheaper debt financing of the war. To maintain the pegged rate, the Fed was forced to give up control of the size of its portfolio as well as the money stock. Conflict between the Treasury and the Fed came to the fore when the Treasury directed the central bank to maintain the peg after the start of the Korean War in President Harry Truman and Secretary of the Treasury John Snyder were both strong supporters of the low interest rate peg.
The President felt that it was his duty to protect patriotic citizens by not lowering the value of the bonds that they had purchased during the war.
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Unlike Truman and Snyder, the Federal Reserve was focused on the need to contain inflationary pressures in the economy caused by the intensification of the Korean War. Many on the Board of Governors, including Marriner Eccles, understood that the forced obligation to maintain the low peg on interest rates produced an excessive monetary expansion that caused inflation.
After a fierce debate between the Fed and the Treasury for control over interest rates and U. This eliminated the obligation of the Fed to monetize the debt of the Treasury at a fixed rate and became essential to the independence of central banking and how monetary policy is pursued by the Federal Reserve today.
The s saw inflation skyrocket as producer and consumer prices rose, oil prices soared and the federal deficit more than doubled. The Monetary Control Act of required the Fed to price its financial services competitively against private sector providers and to establish reserve requirements for all eligible financial institutions.
The act marks the beginning of a period of modern banking industry reforms. Following its passage, interstate banking proliferated, and banks began offering interest-paying accounts and instruments to attract customers from brokerage firms. Barriers to insurance activities, however, proved more difficult to circumvent. Nonetheless, momentum for change was steady, and by the Gramm-Leach-Bliley Act was passed, in essence, overturning the Glass-Steagall Act of and allowing banks to offer a menu of financial services, including investment banking and insurance.
Two months after Alan Greenspan took office as the Fed chairman, the stock market crashed on October 19, In response to the bursting of the s stock market bubble in the early years of the decade, the Fed lowered interest rates rapidly. After the bank holiday , the public showed vast support for insurance, partly in the hope of recovering some of the losses and partly because many blamed Wall Street and big bankers for the Depression. Although Glass had opposed deposit insurance for years, he changed his mind and urged Roosevelt to accept it.
No state bank was eligible for membership in the Federal Reserve System until it became a stockholder of the FDIC, and thereby became an insured institution, with required membership by national banks and voluntary membership by state banks. Deposit insurance is still viewed as a great success, although the problem of moral hazard and adverse selection came up again during banking failures of the s.
In response, Congress passed legislation that strengthened capital requirements and required banks with less capital to close. The act had a large impact on the Federal Reserve. Prior to the passage of the act, there were no restrictions on the right of a bank officer of a member bank to borrow from that bank. Excessive loans to bank officers and directors became a concern to bank regulators. In response, the act prohibited Federal Reserve member bank loans to their executive officers and required the repayment of outstanding loans.
In addition, the act introduced what later became known as Regulation Q, which mandated that interest could not be paid on checking accounts and gave the Federal Reserve authority to establish ceilings on the interest that could be paid on other kinds of deposits. The prohibition of interest-bearing demand accounts has been effectively repealed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of Beginning July 21, , financial institutions became allowed, but not required, to offer interest-bearing demand accounts.
Glass and Steagall also cosponsored the Banking Act of , which was also commonly referred to as the Glass-Steagall Act prior to the passage of the Banking Act of Federal Reserve Bank of St.
The National-Bank ACT as Amended, the Federal Reserve ACT and Other Laws Relating to National Banks
Friedman, Milton and Anna J. A Monetary History of the United States Princeton: Princeton University Press, Meltzer, Allan. A History of the Federal Reserve Volume 1: Chicago: University of Chicago Press, Preston, Howard H. Shughart II, William. Silber, William.
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Endnotes 1 Glass and Steagall also cosponsored the Banking Act of , which was also commonly referred to as the Glass-Steagall Act prior to the passage of the Banking Act of Bibliography Federal Reserve Bank of St.