The Young Fed: The Banking Crises of the 1920s and the Making of a Lender of Last Resort

by Mark Carlson

A new history of crisis responses in the central bank’s formative years.


The long-standing description of the Federal Reserve as a “lender of last resort” refers to the central bank’s emergency liquidity provision for financial entities in periods of crisis. As Mark Carlson shows, this function was foundational to how the Fed was designed but has, at times, proven challenging to implement. The Young Fed examines the origins of the Federal Reserve’s emergency liquidity provision which, along with the setting of monetary policy, has become a critical responsibility.


Focusing on the Fed’s response to the financial crises of the 1920s, Carlson documents the formative deliberations of central bank policymakers regarding how to assist banks experiencing distress; the lessons that were learned; and how those lessons shaped subsequent policies. Carlson depicts an early Fed that experimented with a variety of approaches to crises, ranging from bold spectacles featuring cash-filled armored cars to behind-the-scenes interventions to prevent inducing panics or bank runs. The Young Fed weaves previously unpublished material from the Fed archives into a watershed work in American economic a deeply sourced account of how the world’s most important central bank became a lender of last resort.

Genres: Economics, History

240 pages, Hardcover

Published January 23, 2025

About the author

Mark R. Carlson is Founder, President, CEO, and co-owner of Mental Health Systems (MHS), Minnesota. He is also Vice-President of the Dialectical Behavior Therapy National Certification and Accreditation Association (DBTNCAA) and Adjunct Professor in Psychology at Argosy University, Twin Cities. He served as the Clinical Director of multiple clinics before leaving to found MHS.

Reviews

[Robert Morris · Rating 3 out of 5]

Well, it is a little dry. But it does exactly what it says it will do. Economist Mark Carlson has assembled a useful if not exactly pulse-pounding set of case studies on some of the early activities of the Federal Reserve. The US central bank was only founded in 1913. It then quickly had to face the dislocations of World War I, and the economic boom the war inspired in the United States. That agricultural bonanza led to a bust in the early 1920s as peace time Europe got back to farming.

So the activity that this book focuses on, actions to save struggling financial institutions, was the Federal Reserve's first attempt to carry out one of its central functions, acting as the lender of last resort. When a bank runs into trouble, especially in the two decades when there was a Federal Reserve but no FDIC, the Federal Reserve had to decide whether or not to save a troubled bank, and how far to go in trying to save it. Carlson goes into the careful calculations the Fed's bank examiners had to make, judgement calls on the management, the kinds of assets the bank has, whether the bank is insolvent or just temporarily illiquid. Carlson's case studies also illustrate how outside factors mattered. A bank that might not be worth saving elsewhere, might gain Fed funding if it was systemically important to some industry or city's well-being.

Carlson also lays out some of the technical details of Fed financing, and well as illustrating the way that the Fed's approaches changed over the course of the decade. Fascinating details crop up, like the feuds of Benjamin Strong, the head of the New York Federal Reserve, the Fed's most powerful figure for its first 15 years, and the fact that Cuba was firmly enough under the US's thumb in the 1920s that the Fed operated there as freely as it did in the Midwest. The book is generally not full of fireworks though. It's straightforward, and well explained. I appreciated how simply Carlson laid out financial details that had heretofore struck me as somewhat arcane, like the discount window and collateral.

The book is also a great example the importance of maintaining archives, and the value of bureaucracy. Much of the book, and I believe all of the case studies, are drawn from a set of surveys Fed headquarters sent out to the regional Fed banks towards the end of the 1920s. Some far-seeing bureaucrat thought to ask the questions, and diligent officials at many of the regional banks sent back thoughtful, lengthy responses. A century later, if the survey hadn't been sent, and hadn't been preserved, we'd know very little about the decision-making of the early Federal Reserve. The author of this book should also be praised for recognizing the value of those surveys.

The book won't light you on fire, but if you're interested in the topic, it's perfect.

[Brad Eastman · Rating 3 out of 5]

Mr. Carlson had a very interesting idea, just not executed very well. Mr. Carlson looks at banking crises in the early 20th century and asks how did the local Federal Reserve Banks react. He does not really look at monetary policy set by the Federal Reserve Board in Washington DC, rather he looks at the individual member banks and asks what went into their considerations as they acted as a lender of last resort for the banks in their districts. In the early 1920s, America was still largely an agricultural economy. After World War I, agricultural prices crashed and the farmers who owed money to banks backed by their crops began to struggle to repay. Mr. Carlson looks at individual case studies of banks in trouble and why and how the Federal Reserve Banks reacted or why they chose not to react.

Why is this story important? First, very little history focuses on the day-to-day mechanics of the Federal Reserve member banks and the very central role they play in the economy. We assume that the Federal Reserve System is a monolith. Monetary policy is set in Washington and banking rules are set in Washington, but the individual member banks have to determine which banks to lend to and which to let fail. Mr. Carlson focuses on this later point. In addition to setting monetary policy, the Federal Reserve system is the lender of last resort, lending to banks suffering from liquidity issues, but not solvency issues. The problem is liquidity issues and solvency issues look a lot alike. Additionally, the difference between a liquidity issue and a solvency issue can depend how a crop performs months down the line.

The lessons learned by the Federal Reserve Banks in the early 1920s greatly affected their response to the collapse of the stock market at the end of the decade -not always in a good way. The same tools beginning to be developed in the 1920s were used throughout the next 100 years by the Federal Reserve System to address periodic crises.

I loved the topic. I just did not find the writing particularly captivating.

[Frank · Rating 3 out of 5]

If you think it would be difficult to write an interesting book about the early history of the Federal Reserve, your opinion would be verified by the book "The Young Fed." The book reads very much like a text, except most texts contain more facts and are more interesting. This book should be reserved only for the most serious students of the Federal Reserve, and the rest of us should read The Wall Street Journal. It's more interesting and contains more fact. Granted that "The Young Fed" amply describes what the early Federal Reserve was up against in its infancy to maintain a banking system devoid of drama. The one lesson the reader can take away from this book is that it must have been beyond difficult to maintain the banking system before the Federal Reserve without numerous bank failures. It strains the imagination to conjure up what must have taken the place of the Fed. Read this book if you are a serious student of banking system of the United States. All others stay clear.

[Frank Stein · Rating 5 out of 5]

One of the essential lessons from this book is that "it was ever thus." As early as the 1920s, when the agricultural crisis in America led to a slew of bank failures, the Fed attempted to bail out, or, as they would say, support banks in critical condition. Few if any were clear examples of bailing out banks known to be failures, but many extended discounts to banks known to be on the edge, using questionable collateral, for the sake of keeping banks opened in places that needed them. The banking situation of the "community" reverberates constantly in these stories. Sometimes the Fed banks used "currency fund" or piles of currency transported in with authority to rediscount rapidly, or just show it to depositors. In Kansas City the Fed bank president mounted a chair and told depositors he was convinced of the soundness of the bank and that he would try to keep it open. In a banking crisis in El Paso the FRB Dallas agreed to deposit $500,000 in a City National Bank, that had been pushed to by an insolvent bank by the Texas Guaranty Fund, but that it would have a full assesment of existing shareholders and that questionable paper would be offered to collect (it later wrote off $100,000 of its claims). In the end, by 1925 the Federal Reserve banks were losing over 1 million dollars a year on bad loans, while others thought the Fed had taken too much precedence over depositors and taken collateral from them after a failure. In 1925 a report by H. Parker Willis said the Fed's general lending policies had excerbated losses to depositors. The next year a Fed analysis found its discounting had encouraged too much risk-taking and they pulled back on such support in its 1926 Annual Report, which mentioned it tried to limit continous borrowing.

The book also excels at explaining the general practices of the Fed and the banking system in this period. For instance, about five percent of paper offered in some Reserve Banks for discount were rejected, and generally discounted loans were overcollaterialized by about 60 percent. Sometimes they would ask for discounts to be endorsed by bank directors. In troubled situations the Fed banks could discount far more than a banks capital and surplus.

This is a dedicated piece of historical investigative work that should shape our understanding of the early Federal Reserve and of the history of American financial bailouts.

[Mindy Carlson · Rating 5 out of 5]

An excellent history of the founding of The Federal Reserve system that even a normal person can understand. Very well researched with fun anecdotes.