The recent troubles involving investment banks, J.P. Morgan and the Federal Reserve are not understood by most people in the media, on Wall Street, in the banking industry, at
colleges or by private investors. There has been more wrong information and wrong comments about what recently
transpired than I can recall ever hearing about any similar event in the past 40 years. I want you to understand the full information needed to fully grasp the meaning of what has been going on. So here goes:

The root causes of recent problems have been visible since last August. Then in September the Fed held its annual
gathering of financial leaders at Jackson Hole, Wyoming. Axel Weber, president of Germany’s Central Bank, told the
gathering that: “The current turmoil in the financial markets has all the characteristics of a classic banking crisis, but one that is taking place outside of the traditional banking sector.”
A review of the gathering by Knishna Guha appeared in the London Financial Times. It included these observations:
“Some Federal Reserve policymakers privately see comparisons between the current distress in credit markets
and the bank runs of the 19th and early 20th Century, in which savers lost confidence in banks and demanded their
money back, creating a spiraling liquidity crisis for institutions that had invested this money in longer-term assets. The scenario ultimately led to the creation of the Federal Reserve System as a lender of last resort. However, the tools that modern central banks possess to address liquidity problems can only address such runs inside the traditional banking system, and do not directly touch the NON-BANK FINANCIAL SECTOR which has been hardest hit by the current credit crisis. Mr. Weber’s analysis highlights the dilemma facing central banks, which cannot channel funds directly to the non-bank financial sector.” (End quotes,)
The Federal Reserve System does in fact have powers to lend money to the non-bank financial sector. Dr. Ben Bernanke had discovered them years ago while reading the fine-print of the 1913 enabling Act for the Fed.
BEFORE I GO INTO HIS ACTIONS, I THINK IT IS NECESSARY TO GO BACK IN HISTORY TO EXAMINE BRIEFLY THE FACTS THAT LED THE PRIVATE BANKING INDUSTRY AND THE CONGRESS TO CREATE TODAY’S FEDERAL
RESERVE SYSTEM, WITH ALL OF ITS POWERS.
Place yourself back in time, to New York City on October 21, 1907. Another of the periodic runs on
banks that had plagued the U.S. since before the Civil War had just been digested and apparently stopped by a
committee of Bankers, led as usual by J. Pierpont Morgan.mind to a task few if any dared oppose him. Late that day,
a brilliant young banker named Benjamin Strong, whom Morgan had borrowed for the occasion from Banker’s Trust
Co., reported back to him that the books of Knickerbocker Trust – the key player in the dangerous run unfolding –
were in such poor shape that Strong could not tell whether Morgan should move to save that Trust Company.
But Strong had learned that the directors of the Knickerbocker Trust had assembled that evening at one of
the city’s premier restaurants, and had left the door of their private dining room wide open. Observers had gathered at the open door to listen as the directors loudly bragged about their wild speculative gambles, using depositors’ money. Word of this dinner party spread fast in New York City. By the time the Knickerbocker Trust opened its doors the next morning, double-wide lines of depositors waiting to withdraw their money spread out for blocks in two directions. The Trust directors, in panic, made a phone call to Pierpont Morgan, begging for cash loans so they could stay open. He told them he would not help them. And he didn’t. It took just three hours of a run to snuff out the life of that huge Trust Company.
Trusts had once been the most conservative of financial institutions. They were not banks and really had no claim
for support by banks. But on that day, Strong and Morgan discovered that there were interlocking directorships between Trusts and Banks. That was only the beginning. The trusts had become deeply involved in new kinds of investment schemes involving gigantic leverage, something previouslynot customary in the banking world. The downside risk uncovered by Morgan was frightening to all whom he let in on it. He kept the news away from the New York Times, which was poking around the fringes of the story and running front-page articles. He was afraid panic could quickly spread like an out-of-control forest fire and threaten to destroy the U.S. banking system.
So Morgan chose the soundest Trust Companies and immediately set in motion a rescue operation. He pledged
millions of dollars to guarantee their deposits, but in return he extracted a promise that they would get out of any
speculative ventures and not go into new ones. At first the news of his actions only frightened more people into rushing to get their money out of their bank accounts. Morgan put out a call for assistance. John D. Rockefeller responded with millions. So did President Theodore Roosevelt, who directed the Treasury Secretary to draw down the government’s stock of small bills and deliver them to Morgan. But the Panic refused to end. The Rockefeller cash was soon gone and so was the Treasury’s supply of bills. Morgan dipped deeper into his own pockets (he had a
fortune worth $400 million) and he successfully talked other bankers into supporting every Trust Company that Benjamin Strong decided was a good risk. The runs broke out here and there for a number of weeks. The amounts withdrawn kept getting smaller. The stock market was rising again (It had crashed to a low on the day the Knickerbocker Trust went broke). And by March of 1908 the Panic was fully and finally over. But the nation’s financial structure had been threatened in ways never seen before. Private Bankers and Congressmen began to hold discreet meetings to discuss creation of a lender of last resort — a new bank that could save the system from collapse in an emergency.
They all knew two things: One, the new bank would have to be very powerful in order to replace the great Pierpont
Morgan, who had been protecting America for years but was no longer a young man. It would have to be granted
substantial day-to-day power to regulate, control and even issue money. But the larger overall power and control was to be left in the hands of Congress. That is because the founding American constitution placed full and total power over money in the hands of the Congress and ONLY the Congress. This government-chartered private bank would have to be empowered as a lender of last resort, which meant that it had to be allowed to create money. That feature was missing in 1907 and had been desperately needed. And two, it would have to be a private bank sheltered under the protection of the federal government but still mostly independent of the government and especially beyond the reach of the Treasury and the President. That is one fear that had been in America from its founding days. And so the Federal Reserve System was conceived.
It was to be decentralized, another American feature. There would be twelve regional Federal Reserve Banks, each independent in most ways but tied into an interlocking system.The New York Fed was to be given the most power and the President of the New York Fed would in fact preside over the system. (Benjamin Strong was given that job and title, and served until an illness took his life at a young age in 1928, leaving the Fed leaderless as it stumbled into the Great Depression. Without Strong’s steady hand, Wall Street in 1929 had broken out into an orgy of speculative lending and borrowing, with tragic results. It has to remind you of the way, under the permissive Greenspan, Wall Street firms – especially non-bank investment banks – left their traditional roles and traded with gigantic leverage on their own account, and everyone plunged into speculative devices unknown only a half-dozen years earlier.)
The final touch in 1913 was purely American. The twelve private regional Feds were to be owned by the commercial banks in their territory. The boards of directors to be divided into three groups. The first was to be chosen from the biggest banks in each district. That would mean that in Texas Oil Money might dominate. In the Midwest it would be farming. In the Northeast it could be financial affairs. There were two more groups of directors, with small banks having directors’ seats reserved for them. The Congress set up a small Board of Governors in Washington, led by a Chairman. That Board was not considered important in 1913, the year the Fed opened for business. One year later, World War One broke out in Europe and Washington began a climb in power that has carried us to the situation today. Ironically Dr. Ben Bernanke, as chairman of the Board of Governors in Washington, is a big fan of Benjamin Strong, and through Strong and now Bernanke the anti-speculative, anti-leveraged finance ideals of Pierpont Morgan still live,
That is why Bernanke dared act as boldly and decisively as he did when he had J.P. Morgan acquire Bear Stearns. Just as the Trust Companies were not banks, neither are investment banks. And just as Strong discovered that an interlocking series of directorships meant that the collapse of one bank in 1907 could pull down the whole banking system, so too did Bernanke come to realize that derivatives had sent Bear Stearns tentacles reaching out to so many banks and investment banks in America, Europe and Asia that were they allowed to fail the bankruptcy court might be forced to take actions that threatened the whole Western World.
In stepping into the world of Investment Banking, which Congress may now add to his regulatory domain, Bernanke
was able to send the word out across the country – he would protect them against their enemies who wanted them
to fail, but in return they had to pull back from the long list of dangerous speculative activities that had been growing
fast in the years of Greenspan. Thus I feel the bottom is in place - marked by the closing of Bear Stearns, and
very soon we will witness a new Age of solid growth in America, possibly led by the most conservative finances
since the 1950’s.