So...What Exactly Is the Fed?

I have a sixteen-year-old son that plays high school football, is a college football fanatic, and is in three or four fantasy football leagues. In short, football is his life. So, when said son comes to me and asks, “Hey Dad, what the heck is the Fed,” it’s either a sign of the approaching apocalypse or perhaps, maybe, something is actually filtering through in school besides football practice. Being a glass is half full kind of guy I opted for the latter.

“The Fed is an abbreviation for the Federal Reserve System,” I told him, “And is the bank for banks.” “Why do banks need a bank,” he asked. Recognizing the opportunity to share some of my world with him, and knowing I would probably make him regret having initiated the conversation by providing him with too much information, I forged ahead nonetheless with an impromptu history lesson.

At the end of our discussion, I asked if he had a better idea of what the Fed was, and to my surprise he said yes, but what he really found interesting was the history he was never taught. “You know what Dad; you should write another book, or maybe do a series in IQ Trends.” Wow, I never saw that coming. So, here you go, and I hope you find it interesting too.

Okay, so here is this brand-new country with no credit history, no financial infrastructure, and a lot of debt. Not exactly the opportunity lenders or investors are interested in. Rough. That was the United States in its infancy, a financial hot mess.  

Alexander Hamilton, the first Secretary of the Treasury, had a plan in mind for things that had to be created or fixed such as a central bank, a federal mint, national credit, and a federal excise tax. There was also the issue of the “continentals.” To finance the American Revolution, the Continental Congress printed the new nation's first paper money. Known as "continentals," the fiat money notes were printed to the point that they led to inflation, which, at first, was relatively mild. As the war progressed, however, inflation began to accelerate at a rapid pace. Eventually, the public lost faith in the notes, and the phrase "Not worth a continental" came to mean "utterly worthless."  

The Bank of the United States was established by Congress in 1791 with a twenty-year charter. It was the largest corporation in the country and was dominated by big banking and money interests. The bank had supporters, but what we today would call the lobbying class was uncomfortable with the idea of a large and powerful bank and opposed it. When the bank’s charter expired in 1811 Congress refused to renew it by one vote. Congress made another attempt in 1816 with the second Bank of the United States, but that bank met the same fate in 1836 when President Andrew Jackson vetoed a renewal of its charter.  

Although the United States was less than fifty years old, the territory it occupied was vast, and growing. Like today, what was important to one region was not necessarily important, or desirable, in another region. The North had a greater industrial base. The South was more textile and agricultural oriented. The ever-expanding West had more ranching and farming. Accordingly, these different regions had differing needs for credit, and believed there were imbalances in how credit was managed and distributed among the different regions. In short, it was difficult to agree on a banking system that was seen as fair and equitable to all. As is typical when politics are involved, without consensus, or compromise, the result remains the status quo. 

After the second Bank of the United States was closed, State-chartered banks and unchartered “free banks” took hold during this period, issuing their own notes, redeemable in gold or their own currency. Some businesses would accept money from one bank, but not another. About 30,000 different bank notes (paper money) were in circulation. Because there were so many kinds of money, fraud was very common. About one-third of paper money used in this “free banking” era was counterfeit.  

In any rapid growth phase, whether it is a company or a country, problems typically get addressed piecemeal in a reactive rather than proactive manner. By example, during the Civil War, the National Banking Act of 1863 was passed, providing for nationally chartered banks, whose circulating notes had to be backed by U.S. government securities, which established the first uniform structure of a national currency. 

Although there was some measure of currency stability, bank runs and financial panics continued and the country experienced a series of financial dilemmas, with major crises in 1839, 1857, 1873, 1893, and finally in 1907. The banking panic of 1893 triggered the worst depression the United States had ever seen, and the economy stabilized only after the intervention of banking legend J.P. Morgan.  

The Panic of 1907 was triggered by, wait for it, speculation on Wall Street that crashed and burned. Inflation-adjusted gross national product declined by 12 percent, more than two times the decline recorded during the Great Recession of 2007 to 2009. J.P. Morgan was instrumental, once again, in bringing the panic to an end, and after the panic ended there was wide agreement that reform was needed, but the arguments about what kind of monetary policy and financial system the nation would adopt that had been going on for over a hundred years remained.  

Who was doing the arguing? The list is broad, but it included farmers, labor, business owners of all sizes, small town bankers, big city bankers, government bureaucrats, blah, blah, quack. Clearly a diverse group with diverse interests from diverse regions of a still growing country.  

One group was in favor of a central bank like the Bank of England, with centralized power and was owned and operated by the banking system. Others wanted a banking system that was controlled by the federal government in D.C. Another group didn’t trust any system that was controlled by the government or the big New York banks and wanted a regional system without any centralized control. Lastly, some did not want a central bank period.  

Factually, Congress passed the Federal Reserve Banking Act, and President Woodrow Wilson signed it into law on December 23, 1913. How the Federal Reserve Act actually became law is where the history books differ, and with many things historical there is some intrigue, murkiness, and of course allegations of shenanigans that brought this impasse to an end. What is true, false, or somewhere in between depends on which side of the aisle your bread gets buttered.  

Congress, as it does, reacts only after the fact, but at least post 1907 it got engaged. Senator Nelson Aldrich, the Senate Finance Committee chair, was instrumental in getting the Aldrich-Vreeland Act of 1908 passed, which allowed for the issuing of emergency currency during a banking crisis. The Act also created a national Monetary Commission to identify a long-term solution to the nation’s banking and financial problems. As a Senator from New York, the Aldrich led commission developed a banker-controlled plan, go figure. The progressives, led by populist William Jennings Bryant, preferred a central bank that was controlled by the public instead of bankers. Clearly, as today, there were major trust issues in the salons of power.  

In 1910 Aldrich and five others met on Jekyll Island off the coast of Georgia to work on another plan to reform the banking system. In 1912 Woodrow Wilson, a Democrat, was elected president, and the plan developed by Aldrich, a Republican, was shelved. But wait, there’s more. 

Wilson was not a financial or banking expert, so he sought the advice of the incoming chair of the House Banking and Finance Committee, Rep. Carter Glass from Virginia, and from H. Parker Willis, formerly a professor of economics at Washington and Lee University, who was the committee’s expert advisor. Over the course of 1912 Glass and Willis, with input from Aldrich and his Jekyll Island crew, delivered a plan to Wilson that would become, with some modifications, the Federal Reserve Act.  

follow us on LinkedIn 

Newsletter Performance


We love to hear from our subscribers so reach out any time. Kelley will answer your emails and calls personally. Send to


Download Agreement Forms