The Creation of the Federal Reserve

​The Federal Reserve functions as the central bank of the United States. Headquartered in Washington, DC, the Federal Reserve is a complex federal agency led by a Board of Governors and consisting of 12 Federal Reserve Banks throughout the US. The agency was established via the passage of the Federal Reserve Act of 1913, which outlined a more reliable and resilient national monetary system. The Federal Reserve Act was authored and authorized in response to several economic challenges facing the nation.

Many of the issues that led to the creation of the Federal Reserve had existed since America's founding. Numerous pundits and policymakers had raised the issue before 1913. However, reforming the national banking system was a daunting task, complicated by the competing interests of political parties, government agencies, and private interest groups.

America's banking system was decentralized prior to the Civil War, with most banks operating under state charters. Around this time, only two of the country's banks had federal government charters. These banks were viewed as controversial government installations by proponents of states' rights and limited federal influence, including Thomas Jefferson. As a result, these banks, both carrying the name Bank of the United States, were shut down.

Over the next several decades, public opinion of the national banking system remained largely negative. The Civil War and the Reconstruction period provided opportunities to reassess banking operations in the United States. In response, the government enacted a series of National Banking Acts, which established federal charters for banks, although these charters differed from those used before the Civil War. A key difference was that the newly chartered federal banks were entirely privately owned and operated.

Both the public and the US government initially espoused nothing but antipathy towards the new federally chartered banks. This mistrust manifested additional prohibitions, making it difficult for federal banks to remain competitive with banks operating with state charters. However, the rise of thousands of single-office banks, called unit banks, resulted in widespread instability, as most offices struggled to grow to a size that allowed for efficient banking operations. When paired with the relative inelasticity of the US currency of the day, unit banking resulted in a national system of banks that were vulnerable to many financial crises.

Once again, political leaders found themselves trying to overhaul a banking system while balancing the competing needs of large metropolitan banks and smaller offices in rural areas, as well as the longstanding conflict between states' rights advocates and those promoting the benefits of federal banking regulations.

A political solution was eventually found after the Panic of 1907, when in December 1913, Congress passed, and President Woodrow Wilson signed the Federal Reserve Act. Opponents finally reached an agreement, the Federal Reserve Act of 1913, following the Panic of 1907. The panic occurred during a three-week period when the New York Stock Exchange plunged 50 percent below its 1906 peak. A wave of bankruptcies hit state banks throughout the nation.

A series of lesser financial crises followed, prompting Senator Nelson W. Aldrich to lead an investigation into the national banking system. His efforts led directly to the creation of the Federal Reserve System.

KC Kronbach

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