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Sunday, June 23, 2013

Consolidation From 1913: The Federal Reserve, Megabanks, and the U.S. Government

In 1911, the U.S. Supreme Court ruled that federal anti-trust law required the break-up of Rockefeller’s mammoth Standard Oil Company, which had replaced ruinous competition with coordination in the American refining industry. The ruling’s impact was truncated because each of the resulting companies had the same ownership; the existing trust certificates were simply exchanged for shares in each company. The respective managements even remained in the same office building in New York City. In effect, the court had mandated oligopolistic collusion and still more restraint of trade. Undaunted, the elderly Rockefeller worked on his golf game.
One hundred years later, the U.S. Treasury and the Federal Reserve were still striving to salvage the economy from a near direct-hit in September 2008. The Fed’s massive bond-buying program of some $7 trillion would dwarf the $750 billion in the democratically-enacted TARP (Troubled Assets Relief Program) funds. In 2010, Congress had passed the Dodd-Frank Act, which was designed to solve the problem of banks and other companies being too big to fail without actually breaking any up. Not surprisingly, by 2013 it had become apparent that systemic risk was still much too high. The government that had broken up Rockefeller’s mighty managerial machine had apparently lost its spunk for breaking up enterprises, at least those whose very existence involves an intolerable amount of systemic risk to the economy as a whole.  
A century earlier, in 1913 to be exact, the sixteenth amendment to the U.S. Constitution was ratified, making a federal income tax constitutional. Congress promptly passed the Revenue Act of 1913, which reinstituted the federal income tax and lowered tariffs. The assumption was that the revenue from the income tax would make up for the decrease from the lower tariffs. As the graph below indicates, the income taxes would do more than compensate for reduced tariff revenue. The ratification of the amendment and the passage of the Revenue Act laid the groundwork for an expansion in the fiscal role of the federal government. In the constitutional convention, some delegates had been concerned that a federal income tax would “crowd out” the states as they seek to raise more revenue for domestic purposes.
 
Also in 1913, exactly a century before the Federal Reserve’s board wrestled with whether to reduce the central bank’s bond-buying program, a fiscal stimulus to reduce unemployment, the bill establishing the central bank became law. Charles Lindberg, the father of the famous flyer, predicted from his seat in the U.S. House of Representatives that the Act would establish “the most gigantic trust on earth” that would be an “invisible government by the money power.”[1] At the time, it was assumed that the gold standard would provide sufficient constraint. This assumption would go flat in 1973 with Nixon’s termination of the Bretton Woods agreement. By 2013, the premise of the Act, which specifies three purposes for the Fed: “to furnish ‘an elastic currency,’ to provide a market for commercial paper so that banks would have more liquidity, and to improve supervision of banks,” had been superseded to a degree that would have stunned even the advocates of the original bill.[2]
Speaking before Congress on June 23, 1913, President Wilson said banks should be “the instruments, not the masters, of business.”[3] William Jennings Bryan, the U.S. Secretary of State, went one step further in insisting that banks answer to the public rather than to themselves or business.[4] A century later, was the Fed buying trillions in dollars of bonds to help the banks, whose executives had gone largely unscathed in terms of bonuses, or the public? If the latter, shouldn’t the Congress and the elected U.S. president have played more of a decisive role by legislating the program?
The democracy deficit in the Fed’s increasing “job description” is not the only danger, however. Not even democracy can be relied on to safeguard the checks and balances afforded by federalism or even federalism itself. Simply in being such a consolidated power at the U.S. level, the Federal Reserve further consolidates power as it expands its fiscal power. Federalism pays the price not only directly, but also in that the Fed is prohibited by federal law from buying the bonds of heavily-indebted state governments. That is to say, the Federal Reserve can come to the aid of the U.S. Treasury as well as large consolidated banks, while the state governments are on their own. The bias here favors further consolidation at the expense of federalism.
Europeans have been much more sensitive to the impact of the European Central Bank’s expansive bond-buying program on the E.U.’s federal system. Even though the ECB would be purchasing the bonds of indebted state governments, the centralization in the purchasing and the associated fiscal redistribution delayed agreement on the program. In 1913 as the Federal Reserve legislation was going through Congress, federalism was not sufficiently considered, and thus protected. Paul Warburg, a financier who had immigrated from Germany to New York, thought the banking system was too decentralized in the United States. Oblivious to the American federal mindset that still treated the federal level of government as properly assuming empire-level powers such as defense and regulating commerce between the republics, he wanted to replicate the Reichsbank of his native state for the United States as a whole.[5]
Avoiding that political category mistake, Rep. Carter Glass, the chief sponsor of the Federal Reserve Act, “wanted to restrain federal authority” even in banking and yet he “wanted a more elastic currency to avert money panics and moderate depressions” through banking reform.[6] He proposed privately-owned regional reserve banks and referred to Wilson’s proposal “that a Reserve Board sit atop” those banks as a federalist design at odds with the rights of the states.[7] That the resulting Act was more along Wilson’s lines suggests that the federalism was not sufficiently consulted in the legislative process, which was not coincidentally entirely at the U.S. level. That is to say, federal-level officials established a central bank that would operate to the advantage of that level. Also in 1913, the seventeenth amendment, by which U.S. senators would no longer be elected by their respective state legislatures, was ratified; the state governments would henceforth had even less wherewithal at the federal level to thwart encroachments by the U.S. Government.
In conclusion, a consolidating trend favoring both big business and the U.S. Government at the expense of the states can be discerned from legislation passed in 1913. The consolidation of banking power in a few megabanks like Citigroup and JPMorgan and of political power in the U.S. Government evident in 2013 can thus be viewed as having historical underpinnings.  


1. Robert Lowenstein, “The Federal Reserve’s Framers Would be Shocked,” The New York Times, June 22, 2013.
2. Ibid.
3. Ibid.
4. Ibid.
5. Ibid.
6. Ibid.
7. Ibid.