After the banking panic of 1907, appealing to wealthy financiers was no longer a solution for the United States. Timing chosen to create the Fed, today the most influential financial institution.
This institution has already existed for 111 years. The United States Federal Reserve (or Fed) was created in 1913, to stabilize their financial system after years of turmoil and frequent banking crises. The most notable is the panic of 1907 where massive bank withdrawals threatened the economy.
To understand the origin of this institution, we must go back to the end of the 18th century. It was in 1791 that Alexander Hamilton, American financier and politician, created the First Bank of the United States. This initial central bank plays a crucial role in the financial management of the government but it disappears after twenty years. Its absence leaves room for a mainly regional banking system, without federal coherence, where each state bank issues its own currency.
History repeats itself with the creation of the Second Bank of the United States in 1816. Its objective: to put an end to the galloping inflation which hit the country after the war.
Panic of 1907: the trigger
The Civil War saw a new attempt to consolidate the banking system but without a central bank, the challenge remained until the end of the 19th century. During this period, the government sometimes had to call on private financiers, such as John Pierpont Morgan, to weather economic crises.
In 1895, JP Morgan came to the aid of the American Treasury. Even more, he prevented New York from going bankrupt in 1907, during the banking panic. Trigger of the crisis: the fall of the Knickerbocker Trust, a bank specializing in wealth management. Thousands of depositors are demanding repayment of their investments at Knickerbocker.
What followed was a fall in the American stock market of almost 50% in one year. Faced with a crisis of confidence, only a stable and well-organized financial system can provide an effective solution.
Preventing future financial disasters
Just after the crisis, on May 30, 1908, the National Monetary Commission was created. Chaired by Senator Nelson W. Aldrich, this commission is tasked with proposing improvements to the American monetary system. It was not until 1912 that the conclusions of this commission reached Congress. The election of Woodrow Wilson in 1912 actually put the project on track.
The commission’s recommendations lay the foundation for the Federal Reserve Act. The latter was adopted by Congress on December 23, 1913 and signed into law by President Woodrow Wilson on December 29 of the same year.
Three monetary policy objectives are defined by the United States Congress in the Owen-Glass Act: full employment, price stability, and moderate long-term interest rates. The first two factors are often referred to as the Fed’s “dual objective” or “dual mandate.”
