to be appointed by the president. It also mandated up to twelve regional or “district” (as the Fed refers to them) Fed banks, each to be owned by the private banks in their districts, each to be run by a “governor.” It was a classic American balancing between centralization and decentralization, but the legislation provided no clear division of responsibilities between the board in Washington and the regional Fed banks, a feature that would prove troublesome before and during the Great Depression.
Three Wilson appointees — the secretaries of the Treasury and agriculture and the comptroller of the currency — spent months drawing boundaries and designating headquarters of twelve regional Federal Reserve banks, a politically delicate exercise that, among other things, gave Missouri two Fed banks, one in Kansas City and the other in St. Louis. The memory of the regional fights was so lasting that the boundaries have never been adjusted to reflect the westward movement of the population, leaving only two banks, in Dallas and San Francisco, west of Kansas City.
Benjamin Strong, the Morgan lieutenant, had campaigned against the compromise legislation as too decentralized and too fragmented. With some reluctance, he became president of the Federal Reserve Bank of New York and the most powerful player in the system. “He regarded the twelve reserve banks as eleven too many,” Carnegie Mellon economist Allan Meltzer wrote in his voluminous history of the Fed, a sentiment that Strong’s successors at the New York Fed shared, Geithner especially.
The institution was still in its adolescence when it confronted and failed its biggest test: misstep after misstep on the Fed’s part turned a bad late-1920s recession into the Great Depression, an indictment made by Nobel laureate Milton Friedman and collaborator Anna Schwartz, and later expanded by Ben Bernanke in his years as an academic.
In the preface to a collection of his essays on the Depression, Bernanke described those years as “an incredibly dramatic episode — an era of stock market crashes, bread lines, bank runs, and wild currency speculation, with the storm clouds of war gathering ominously in the background all the while. Fascinating, and often tragic, characters abound during this period, from hapless policy makers trying to make sense of events for which their experiencehad not prepared them to ordinary people coping heroically with the effects of the economic catastrophe.” The words might have applied accurately to the early twenty-first century.
“[M]uch of the worldwide monetary contraction of the early 1930s,” he wrote, “was … the largely unintended result of an interaction of poorly designed institutions, short-sighted policy-making, and unfavorable political and economic preconditions.” The Depression occurred because the government stood by as the financial system imploded. “That went on for three and a half years without any significant action,” Bernanke said. “The banks failed. The stock market crashed, other credit markets stopped functioning, foreign exchange markets stopped functioning and that collapse of the financial system, together with the deflation and monetary policy, was the basic reason why the Depression was as severe as it was.”
The bottom line — that the Depression was largely the Fed’s fault — dominated Bernanke’s thinking throughout the Great Panic. He was determined that no future scholar would convict
him
of similar timidity or complacency in the face of a financial crisis. As Bernanke put it in his book of essays, “To understand the Great Depression is the Holy Grail of macroeconomics.” That Holy Grail has been the driving force of his entire professional life.
W HO’S IN C HARGE?
Critics of the Fed’s ineptitude in the late 1920s and early 1930s point to an absence of enlightened, strong leadership at the top. Friedman and Schwartz argued that the Depression would have been avoided had
Three Wilson appointees — the secretaries of the Treasury and agriculture and the comptroller of the currency — spent months drawing boundaries and designating headquarters of twelve regional Federal Reserve banks, a politically delicate exercise that, among other things, gave Missouri two Fed banks, one in Kansas City and the other in St. Louis. The memory of the regional fights was so lasting that the boundaries have never been adjusted to reflect the westward movement of the population, leaving only two banks, in Dallas and San Francisco, west of Kansas City.
Benjamin Strong, the Morgan lieutenant, had campaigned against the compromise legislation as too decentralized and too fragmented. With some reluctance, he became president of the Federal Reserve Bank of New York and the most powerful player in the system. “He regarded the twelve reserve banks as eleven too many,” Carnegie Mellon economist Allan Meltzer wrote in his voluminous history of the Fed, a sentiment that Strong’s successors at the New York Fed shared, Geithner especially.
The institution was still in its adolescence when it confronted and failed its biggest test: misstep after misstep on the Fed’s part turned a bad late-1920s recession into the Great Depression, an indictment made by Nobel laureate Milton Friedman and collaborator Anna Schwartz, and later expanded by Ben Bernanke in his years as an academic.
In the preface to a collection of his essays on the Depression, Bernanke described those years as “an incredibly dramatic episode — an era of stock market crashes, bread lines, bank runs, and wild currency speculation, with the storm clouds of war gathering ominously in the background all the while. Fascinating, and often tragic, characters abound during this period, from hapless policy makers trying to make sense of events for which their experiencehad not prepared them to ordinary people coping heroically with the effects of the economic catastrophe.” The words might have applied accurately to the early twenty-first century.
“[M]uch of the worldwide monetary contraction of the early 1930s,” he wrote, “was … the largely unintended result of an interaction of poorly designed institutions, short-sighted policy-making, and unfavorable political and economic preconditions.” The Depression occurred because the government stood by as the financial system imploded. “That went on for three and a half years without any significant action,” Bernanke said. “The banks failed. The stock market crashed, other credit markets stopped functioning, foreign exchange markets stopped functioning and that collapse of the financial system, together with the deflation and monetary policy, was the basic reason why the Depression was as severe as it was.”
The bottom line — that the Depression was largely the Fed’s fault — dominated Bernanke’s thinking throughout the Great Panic. He was determined that no future scholar would convict
him
of similar timidity or complacency in the face of a financial crisis. As Bernanke put it in his book of essays, “To understand the Great Depression is the Holy Grail of macroeconomics.” That Holy Grail has been the driving force of his entire professional life.
W HO’S IN C HARGE?
Critics of the Fed’s ineptitude in the late 1920s and early 1930s point to an absence of enlightened, strong leadership at the top. Friedman and Schwartz argued that the Depression would have been avoided had
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