The Development of the Federal Reserve Essay

This essay has a total of 1186 words and 5 pages.

The Development of the Federal Reserve

To guard against this possibility, bankers prior to the establishment of the Federal
Reserve would establish lines of credit with larger banks. In the event of a run, the
smaller bank would draw on the line of credit. The larger banks, or central banks, to keep
shady small-time operators out of business, evaluated the line of credit. Nobody would
invest serious money to a small bank not protected against a run by a larger partner.
However, the system was not perfect. In times of panic, large numbers of depositors would
demand to withdraw their money. Only the largest Wall Street banks, with millions of
dollars in reserve, could guard against this. Stories of bank
runs- tales of people running to withdraw all their cash from their accounts- may seem
dramatic, almost theatrical to people today. But to people living in an economically
unstable society, like the early twentieth century, they were an expected occurrence. The
banks were independent rivals, the amount of currency in circulation was fixed, and there
was no element of trust between the depositor and the bank.

The banks, in an attempt to avoid bank runs, were hoarding their money. However in order
to hoard the money, they did not lend any out, bringing the economy to a standstill. The
credit system of the country had ceased to operate, and thousands of firms went into
bankruptcy. Something had to be done that would provide for a flexible amount of currency
as well as provide cohesion between banks across the United States. A large regulated
bank, like the Federal Reserve could make this happen. The Federal Reserve Act of 1913
helped to establish banks as a united force working for the people instead of independent
agencies working against each other. By providing a flexible amount of currency, banks did
not have to hoard their money in fear of a bank run. Because of this, there was no
competitive edge to see who could keep the most currency on hand and a more expansionary
economy was possible.

The evolution of the Federal Reserve did not begin on December 23, 1913 with the passage
of the Federal Reserve Act. Rather, it began with the Banking Panic of 1907, the most
severe of the four national banking panics that had occurred in the precious thirty-four
years. During this time several large corporations and stock brokerages went bankrupt that
summer. Stock prices fell, causing traders to withdraw money from banks to cover their
losses. There was a recession looming nationwide. It was a terrible situation that needed
help or it could keep deteriorating and produce a panic far worse than any previous
panics. J.P. Morgan, the legendary
founder of one of Wall Street's largest investment banks, swung into action to meet the
crisis. He assembled a team of bank and trust executives who met around the clock in
Morgan's library every day for three weeks. The men had every incentive to act forcefully.
Their own businesses and vast fortunes were on the line. Under Morgan's direction, the
team redirected money from strong to weak banks, secured further lines of credit overseas,
and bought stock in distressed but still sound corporations. Within a few weeks the panic
passed, with only minimal effects on the country.
Morgan did not receive the thanks of a grateful nation. A House of
Representatives committee investigated Morgan. Morgan, it turned out, had profited by his
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