IF THERE WERE ANY DOUBT as to the primacy of human psychology as a force in the economic universe, one need only look at the first few days of the Franklin Roosevelt administration for proof. On Saturday, March 4, as millions listened on the radio, Roosevelt gave one of the handful of inaugural addresses that have been remembered beyond the day it was given. Its very first paragraph gave us a phrase that instantly became part of the American political fabric. “So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.” The speech had a near magical effect on the American people. In the first week the White House received 450,000 letter and cards. Hoover had needed one clerk to handle the White House mail; Roosevelt would need seventy.
The next day he summoned Congress into special session for the following Thursday, issued an executive order—under the dubious authority of the Trading with the Enemy Act passed during the First World War—closing all the nation’s banks until after Congress met, and convened an emergency meeting of major bankers. The Treasury Department, still largely staffed by Hoover’s men, and the bankers worked feverishly in the next few days to prepare the Emergency Banking Relief Act.
On Wednesday, March 8, Roosevelt called his first press conference, and 125 reporters crowded into the Oval Office. At the end of his prepared remarks the reporters—for perhaps the only time in history—broke into spontaneous applause. The American people, including reporters, wanted FDR to succeed, and in no small degree because of that, he did.
The banking bill was presented to the House at one o’clock on Thursday and passed, unread, by acclamation thirty-eight minutes later. The Senate passed it with only seven dissenting votes (all from rural states), and the president signed it into law at 8:36 that evening.
The act authorized what Roosevelt had already done and conferred on him vast new powers to regulate the banking system and foreign exchange in the future. It set Monday, March 13, as the day for banks declared sound to reopen. On Sunday, March 12, he gave the first of his fireside chats. In a voice that was both aristocratic and avuncular, didactic and soothing, he told his vast audience that when the banks began to reopen the next day, it would be “safer to keep your money in a reopened bank than under the mattress.”
The people believed him, and the next day money and gold began to flow back into the banking system. The heart of the American economy began to beat again. Raymond Moley, with justifiable pride, reported that “capitalism was saved in eight days.”
THE CONSTITUTION of the Roman Republic, its citizens fearful of executive authority after the overthrow of the kings, had divided it between two consuls, who served for a year and alternated daily in command of both the government and the army. But the Romans realized that, in an emergency, such a system wouldn’t work. And so the constitution allowed, when necessary, for one man to hold absolute power for six months. The term for this temporary official was dictator.
For the first three months after his inauguration—the so-called Hundred Days—Franklin Roosevelt was the American dictator, in the very best sense of that term.
The record of legislation passed and signed into law is simply astonishing.
By definition, a depression is a period of economic contraction, and Roosevelt’s Hundred Days brought the contraction that had begun in early 1929 to a close. As the American people, thanks to the force of the president’s personality, his swift moves, and his unquenchable optimism, began to have renewed faith in the economy and in the country, recovery began. The year 1933 would prove to be one of the best years of the twentieth century on Wall Street, although, of course, rebounding from a disastrously low base. The Dow that year rose almost 60 percent, and some brokerage firms even began hiring again.
The country was a very long way from prosperity, but, still, the upward path was soon unmistakable. The GNP was a mere $55.6 billion in 1933, its lowest since 1916, without taking inflation into account. The next year it was $65.1 billion. By 1937 it was $90.5 billion. The money supply and wholesale prices also increased at the rate of 10 to 12 percent annually in the four years following early 1933. Unemployment, however, stayed stubbornly high, dropping only to 14.3 percent in 1937. Much of the renewed economic activity was performed by employees who had been working part-time in what were supposed to be full-time jobs, delaying the need to hire new workers.
(One often overlooked, but highly favorable consequence of the persistent unemployment in the 1930s was the fact that children tended to stay in school longer. The number of people receiving high school diplomas almost doubled in the 1930s, while those receiving college degrees increased by 50 percent. In 1940 some 8.1 percent of twenty-three-year-olds received bachelor’s degrees.)
NOWHERE DID THE EARLY NEW DEAL have a greater effect on the American economy than in banking, the one sector that had come closest to utter destruction as the depression had deepened. The Glass-Steagall Act greatly strengthened the Federal Reserve’s control over the nation’s banking system, making many more banks, such as savings banks, eligible for membership. It also gave the Federal Reserve the power to control speculation on Wall Street by setting margin requirements.
In 1935 the Federal Reserve Act further increased and centralized the powers of the Federal Reserve. The heads of the regional Federal Reserve banks, who had been called “governor”—the title of power in central banking—were restyled presidents, and the Federal Reserve Board in Washington became the Board of Governors, where the main power has resided ever since. Each of its members was appointed to a fourteen-year term and its chairman appointed from among them for four years. To ensure independence from politics—which Alexander Hamilton had recognized as necessary 150 years earlier—the members of the Board of Governors could not be removed except for cause.
Open market operations, a major tool for regulating the banking system and interest rates, were centralized in the Federal Open Market Committee in Washington rather than being handled by the twelve regional banks. This committee consisted of the seven members of the Board of Governors and five members appointed by the regional Federal Reserve banks, one being always appointed by the New York Federal Reserve. The Federal Reserve was also empowered to set reserve requirements for member banks, another powerful tool to control interest rates and the money supply.
For the first time in ninety-nine years, since President Andrew Jackson had destroyed the Second Bank of the United States, the country had a fully functioning and empowered central bank. The country had paid dearly for the lack of one in those years, not least because the country had been unable to develop much expertise in the arcane specialty of central banking.
The Glass-Steagall Act also established the Federal Bank Deposit Insurance Corporation (FDIC), which guaranteed the deposits of banks that joined the system (only banks that were members of the Federal Reserve were required to join) up to $5,000 per account. At a stroke, the bank run, a recurring nightmare in the American economy since the first one in 1809, became a thing of the past. Roosevelt had worried about the “moral hazard” created by a system that relieved bankers of the worry that their depositors’ assets would be wiped out. But he decided that eliminating bank runs was worth it. There has not been a significant American bank run since, but events long after his death would prove that Roosevelt had been right to worry.
Glass-Steagall greatly strengthened national banks by permitting them to branch within the states where they were headquartered, if that state permitted branch banking. This allowed these banks to diversify over a larger area and thus not be so subject to purely local economic fluctuations, such as a major layoff by a large local employer. Unfortunately the reform did not go far enough, and interstate branching was still not permitted, limiting the size and resources of banks.
But Glass-Steagall also greatly weakened the largest and strongest banks by forcing those that had both a deposit and an investment business to choose one or the other. J. P. Morgan and Company, for instance, remained a depository bank and spun off Morgan, Stanley, and Company.
As corporations had grown in size and profitability in the early decades of the twentieth century, they became much less dependent on the Wall Street banks to finance expansion and acquisitions, using instead their own retained profits and the commercial paper market. So Morgan no longer possessed the overwhelming influence in the American economy that it had had at the turn of the twentieth century. But Glass-Steagall weakened Morgan and similar banks much further.
The separation of deposit and investment functions into noninter-locking companies was required because having the two businesses under the same management was thought to create an inevitable conflict of interest that had exacerbated the banking crisis of the early 1930s. In fact, the evidence for this was slight, and within a couple of years even Senator Carter Glass, the father of the bill (and, indeed, the father of the Federal Reserve System itself twenty years earlier), recognized that this separation had been a mistake.
The iron law that it is far easier to pass a bill than to repeal one, however, held, and it would be more than sixty years before this part of Glass-Steagall would finally be reversed in an utterly different economic universe than that which had brought it into existence. And only then would banks finally be allowed to have branches in more than one state.
After the reforms of the early 1930s the American banking system would prove to be stable and able to meet the needs of the country. But it would remain the most Byzantine in the world, with many overlapping regulatory agencies at both the state and federal levels. It would also continue to have more banks. Despite thousands of mergers, there would still be more than seven thousand independently chartered banks in the United States in the year 2003, more than the rest of the developed world put together.
WALL STREET CHANGED PROFOUNDLY as well in these years, although it put up far more resistance than did the banking industry. The resistance was led by Richard Whitney, the hero of Black Thursday, who became president of the New York Stock Exchange in his own right in 1930. A series of congressional hearings, remembered by the name of the lead counsel, Ferdinand J. Pecora, had revealed much that was indefensible with the way the Street had operated.
The New York Stock Exchange was a private organization owned by its seat holders. Although the exchange had also long been a vital mechanism in the country’s financial system, it still operated solely for the benefit of those seat holders. Specialists, who were exchange members who maintained orderly markets in the various listed stocks, were in a privileged position to know what those stocks were likely to do in the near future. Floor traders were also members, but ones who traded only for their own accounts. Because they had access to the trading floor, they too had what amounted nearly to insider information. The specialists and the floor traders throughout the boom years of the 1920s manipulated stocks by forming pools—“took them in hand,” in the phrase of the day—to fleece the outsiders.
As long as stocks boomed in general, there was little sentiment to reform the ways of the exchange. But after the crash, the pressure to reform grew exponentially as more and more abuses came to light. Many on Wall Street welcomed and even worked for reform, especially the brokers who did a regular retail business and were thus dependent on the goodwill of the public.
Those who benefited from the status quo, such as the specialists and major speculators, of course, resisted it ferociously. The situation in the early 1930s was very similar to the situation in the immediate post–Civil War era. Richard Whitney, the leader of the so-called Old Guard, proclaimed that “the exchange is a perfect institution.” But even he tacitly admitted it wasn’t a perfect institution when he introduced several reforms, including forbidding specialists from taking options in stocks in which they made a market, and giving insider information to friends.
Roosevelt intended much more thorough reform than that, and in 1934 Congress established the Securities and Exchange Commission to oversee the industry. His first chairman of the SEC was Joseph P. Kennedy, a highly counterintuitive choice, seeing as Kennedy had been one of the most successful and ruthless of the Roaring Twenties speculators. Newsweek magazine wrote acidly at the time that “Mr. Kennedy, former speculator and pool operator, will now curb speculation and prohibit pools.” The Senate, leery of appointing a fox to safeguard the henhouse, delayed his confirmation for six months while it waited to see how Kennedy would perform.
Kennedy was far too smart—and too rich—to try to profit from his position, and he did such a good job of getting the SEC on its feet that the Senate confirmed him with neither discussion nor dissent. Kennedy, who certainly knew where the bodies were buried regarding Wall Street shenanigans, nevertheless regarded his most important task to be ending the so-called strike of capital, the reluctance of the major underwriting banks, badly shell-shocked, to underwrite anything, regardless of how sound the deal.
Kennedy resigned after sixteen months, and it fell to the third chairman, William O. Douglas (later a justice of the Supreme Court for more than thirty years), to bring fundamental reforms to Wall Street. He would have the entirely unintended help of Richard Whitney. Whitney had retired from the office of president of the New York Stock Exchange in 1935, but he remained on the board of governors and was, by far, the best known broker on Wall Street. “I mean the stock exchange to millions of people,” he told his successor as president.
Whitney lived lavishly, with a town house on East Seventy-second Street; a large farm in New Jersey, where he often foxhunted—one of the most expensive sports one can pursue on land—and numerous club memberships. He was spending about $5,000 a month at a time when the average annual per capita income was about $700. Unfortunately, he couldn’t afford it. His brokerage firm, while it numbered the Morgan bank among its clients (which conferred great prestige but not much business), actually earned very little, and his investments had all lost money. He maintained himself by borrowing from friends and acquaintances, especially his older brother, George Whitney, who was a partner of J. P. Morgan and Company.
When that didn’t suffice, he began dipping into the accounts of his clients, his clubs, even his wife’s trust fund. As embezzlements usually do, his fell apart, and on March 7, 1938, the New York Stock Exchange interrupted trading to announce that Richard Whitney and Company had been suspended, for “Conduct contrary to just and equitable principles of trade.”
The Wall Street establishment was shocked beyond measure. “Wall Street could hardly have been more embarrassed,” wrote The Nation, a leftist political journal, gleefully, “if J. P. Morgan had been caught helping himself to the collection plate at the Cathedral of St. John the Divine.”
Six thousand people turned out in Grand Central Terminal on April 12 to watch Richard Whitney, in handcuffs, board the train that took him to Sing-Sing prison. William O. Douglas, meanwhile, moved swiftly to take advantage of the utter disarray of the Wall Street Old Guard. Before the end of the year, the stock exchange had a new constitution, one that took its public responsibilities into account. The president became a paid employee, not a member. Firms had to submit to much more intrusive audits, and members could not buy stock on margin if they did business with the public. The permissible ratio of debt to capital was lowered, making brokerage firms more stable and able to survive marked downturns in the market.
Even more important, short sales could now only be made on an uptick—that is, at a higher price than the previous sale. This ended one of the principal means by which bear raids had so roiled the market in the 1920s and helped lessen the severity of panics such as the market had known in 1929. By the end of the 1930s Wall Street was ready to take advantage of the revolution in stock trading that would happen in the next decade.
THE SUPREME COURT would invalidate much of what came to be called the First New Deal, but a fundamental shift had nonetheless taken place in American politics. For one thing, the Democratic Party, under the leadership of one of the ablest American politicians of his or any day, became the majority party. In the sixty-two years after the election of 1932, the Democrats would control the House of Representatives for all but four years, in 1947–48 and again in 1953–54. After the 1936 election—when Roosevelt, in the greatest landslide in American history up to that time, carried forty-six states—the Republican Party would have only sixteen senators and eighty-nine representatives in Congress.
The amount of GNP that flowed annually through the federal government began a steady rise. Government outlays in 1929 had been about 3 percent of GNP. In 1940 they were more than 9 percent. The national debt, meanwhile, had swelled from 16 percent of GNP to more than 50 percent, by far the greatest peacetime increase up to that point. The effect has been to make the federal government’s budget a sort of fiscal flywheel, providing economic energy to the system in times of slack demand and preventing a self-reinforcing downward spiral such as occurred in the early 1930s. Unemployment since the Second World War has only once, and then briefly, risen above 10 percent.
And national fiscal priorities had changed both fundamentally and permanently. Before the onslaught of the Great Depression, balancing the budget and paying down the debt had been the most important fiscal responsibilities of the federal government. After 1933, preventing a new Great Depression became the most important responsibility, in some ways the only one. Further, government came to be perceived as, at least, the provider of last resort of the essentials of an adequate standard of living.
This meant, inevitably, that government influence on the economy would increase as well. The national debt would never again be substantially reduced in dollar terms (although it would vary greatly as a percentage of GNP). And the annual budget, which had been in surplus two-thirds of the time before 1933, would be in surplus only 16 percent of the time after that date.
Most of all, while many of the New Deal programs were unsuccessful and many of its economic principles shortsighted, in its totality it was an enormous success. The country since the New Deal has been a far richer, far more economically secure, far more just society. It has been one that has proved to offer far more opportunity for all and produce far more wealth as a consequence. There has never been a serious political effort to reverse the New Deal, although its worst ideas—such as the cartelization of much of the American economy—were discarded and much of it has been reformed, for democracy is a process of endless reform.
In a very real sense—to paraphrase Richard Nixon—we are all New Dealers now.
When the Supreme Court threw out most of the early New Deal (some of whose programs, notably the NRA, had not been working well anyway) the Roosevelt administration, ever pragmatic, tried new programs. In 1935 it initiated what came to be called the Second New Deal. This called for Social Security, further banking reform, more extensive works programs (including the WPA), higher taxes on high incomes and inheritances (including a so-called wealth tax on estates more than $50 million—a threshold only a handful of families met), and strong protections for organized labor to make it easier for unions to organize workers.
This revolutionized the American workplace, especially in manufacturing, which was then the heart of the American economy. The reform of labor relations in this country had begun, as so much else attributed exclusively to the New Deal, under Herbert Hoover. The Norris–La Guardia Act of 1932 made “yellow dog” contracts—in which workers had to agree not to join a union—unenforceable and forbade injunctions against strikes and picketing. But organized labor had been badly hit by the depression. In 1933 the membership in the AFL was only 2.3 million, about what it had been at the turn of the century.
In 1935 the National Labor Relations Act (usually known as the Wagner Act, after its chief congressional sponsor, Senator Robert F. Wagner of New York) was passed. It has often been called the Magna Carta of American organized labor. It guaranteed the right of workers to join a union of their choice and to bargain collectively with their employers. Further, it included a long list of “unfair labor practices” that companies were forbidden to engage in (but, significantly, did not name any practices that unions were forbidden to engage in). It established the National Labor Relations Board to police the labor marketplace and supervise elections. Most major industrial states soon passed laws modeled on the Wagner Act.
American government, long almost instinctively on the side of management, had now swung decisively behind labor. While there was violence as plant after plant was organized, it was far less deadly than the labor violence of the late nineteenth century. Even the aged Henry Ford, essentially a man of the nineteenth century and long adamantly opposed to unionization, had no choice but to bargain with Walter Reuther and the Automobile Workers Union in 1939.
In the six years following passage of the act, union membership more than doubled. By the early 1950s unions would represent about 35 percent of the American workforce. Membership in the craft unions of the AFL advanced greatly, but the greatest gains were among unskilled and semiskilled workers who most needed unions to protect their interests. The Congress of Industrial Organizations (CIO), established as an independent labor organization under the leadership of John L. Lewis of the Mineworkers Union in 1937, had 2.7 million members by 1941.
Another crucial part of the Second New Deal was the move to bring electricity to vast areas of the country that did not have it. The cost of providing electricity to a given area—in terms of building generating capacity and running lines—is nearly the same whether that area is densely or scarcely populated. Thus if the population density is below a certain level, it is simply prohibitively expensive on a per-capita basis for utilities to provide service. The spread of cable television in more recent decades had exactly the same spotty distribution for precisely the same economic reasons.
Because private enterprise could not bring electricity to much of the countryside, Roosevelt established the Rural Electrification Administration to do so. It worked to form publicly owned, nonprofit, electrical cooperatives to provide power to areas that did not have it. When the REA was formed in 1935, only two farms in ten in the United States had electricity. Just a little more than a decade later, eight in ten did. This not only greatly increased the economic productivity of these farms (and increased the flow of workers from farming to other sectors of the economy), but equally increased the quality of life in rural areas and brought the inhabitants into much closer contact with the nation as a whole through such means as radio and the telephone, whose wires could be strung on the same poles as the electric wires.
IN 1937 THE FEDERAL RESERVE, using its newly granted power, began to increase bank reserve requirements sharply for various technical reasons. At the same time, the Roosevelt administration began to cut public works spending to help bring the budget closer into balance. The result was a new depression. Unemployment soared back up to 19 percent the following year, while GNP dropped 6.3 percent. It was the first time in the history of the American economy, and the last time, so far, that the peak of the business cycle was lower than the previous peak had been, as the height in 1937 was well below the peak in 1929.
While technically the economy had been in recovery for four years, in popular parlance the word depression was applied to the whole decade of the 1930s. So economists dubbed this new depression within a depression a “recession.” This has been the term for economic downturns ever since, and the word depression is now usually capitalized and refers exclusively to the uniquely dark days of the 1930s.
Recovery began again in 1938, but unemployment remained stubbornly high, being at 14.6 percent as late as 1940. In the end it was not the New Deal that cured what ailed the American economy. It was war. The dreadful peace devised at Versailles in 1919 turned out not to have been a peace at all, but merely a twenty-year truce, an interlude between the worst war in human history and one that would be far, far worse in terms of lives lost and treasure squandered.
And as with the first great war of the blood-drenched twentieth century, when the bombs stopped falling, geopolitical power would have been radically redistributed in favor of the United States.