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The sale price of an acceptance is always less than the value of the underlying contracts; otherwise no one would buy them. The difference represents the potential profit to the buyer. It is expressed as a percentage and is called the 'rate' of discount—or, in this case, rediscount. But the rate given by the seller must be lower than what he expects to earn with the money he receives, otherwise he will be better off not selling.
Although bankers' acceptances were commonly traded in
Europe, they were not popular in the United States. Before the Federal Reserve Act was passed, national banks had been prohibited from purchasing them. A market, therefore, had to be created.
The Fed accomplished this by setting the discount rate on acceptances so low that underwriters would have been foolish not to take advantage of it. At a very low discount, they could acquire short-term funds which then could be invested at a higher rate of return. Thus, acceptances quickly became plentiful on the open market in the United States.
But who would want to buy them at a low return? No one, of course. So, to create that market, not only did the Federal Reserve set the discount rate artificially low, it also pledged to buy all of the acceptances that were offered. The Fed, therefore, became the principal buyer of these securities. Banks also came into the market as buyers, but only because they knew that, at any time they wanted to sell, the Fed was pledged to buy.
Since the money was being created out of nothing, the cost did not really matter, nor did the low profit potential. The Fed's goal was not to make a profit on investment. It was to increase the nation's money supply.
WARBURG AND FRIENDS MAKE A LITTLE PROFIT
The man who benefited most from this artificially created market was none other than Paul Warburg, a partner with Kuhn, Loeb and Co. Warburg was in attendance at the Jekyll Island meeting at which the Federal Reserve System was conceived. He was considered by all to have been the master theoretician who led the others in their deliberations. He was one of the most influential voices in the public debates that followed. He had been appointed as one of the first members of the Federal Reserve Board and later became its Vice Governor until outbreak of war, at which time he resigned because of publicity regarding his connections with 482
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German banking. He was a director of American I.G. Chemical Corp. and Agfa Ansco, Inc., firms that were controlled by l.G.
Farben, the infamous German cartel that, only a few years later, would sponsor the rise to power of Adolph Hitler. He was also a director of the CFR (Council on Foreign Relations). It should not be surprising, therefore, to learn that he was able to position himself at the center of the huge cash flow resulting from the Fed's purchase of acceptances.
Warburg was the founder and Chairman of the International Acceptance Bank of New York, the world's largest acceptance bank. He was also a director of several smaller 'competitors,'
including the prestigious Westinghouse Acceptance Bank. He was founder and Chairman of the American Acceptance Council.
Warburg was the acceptance market in America. But he was not without friends who also swam in the river of money. Men who controlled America's largest financial institutions became directors or officers of the various acceptance banks. The list of companies that became part of the interlocking directorate included Kuhn, Loeb and Co.; New York Trust Co.; Bank of Manhattan Trust Co.; American Trust Co.; New York Title and Mortgage Co.; Chase National Bank; Metropolitan Life Insurance Co.; American Express Co.; the Carnegie Corp.; Guaranty Trust Co.; Mutual Life Insurance Co.; the Equitable Life Assurance Society of New York; and the First National Banks of Boston, St. Louis, and Los Angeles, to name just a few. The world of acceptance banking was the private domain of the financial elite of Wall Street.
Behind the American image, however, was a full partnership with investors from Europe. Total capital of the IAB's American shareholders was $276 million compared with $271 million from foreign investors. A significant portion of that was divided between the Warburgs in Germany and the Rothschilds in England.
Just how large and free-flowing was that river of acceptance money? In 1929, it was 1.7 trillion-dollars wide. Throughout the 1920s, it was over half of all the new money created by the Federal Reserve—greater than all the other purchases on the open market 1. For a detailed account of this episode, see Part Two of the author's book,
2. Larry Schweikart, ed.
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plus all the loans to all the banks standing in line at the discount window.1
The monetary scientists who created the Federal Reserve, and their close business associates, were well- rewarded for their efforts.
Profit-taking by insiders, however, is not the issue. Far more important is the fact that the consequence of this self-serving mechanism was the massive expansion of the money supply that made the Great Depression inevitable. And that is the topic which impelled us to look at acceptances in the first place.
CONGRESS SUSPICIOUS BUT AFRAID TO TINKER
By 1920, suspicions and resentment were growing in the halls of Congress. Politicians were not getting their share. It is possible that many of them failed to realize that, as partners in the scheme, they were entitled to a share. Nevertheless, they were dazzled by banker language and accounting tricks and were afraid to tinker with the System lest they accidentally push the wrong button.
Watching with amusement from London was Fabian Socialist
