In 1873, Walter Bagehot articulated what remains the most important duty of a central bank: lender of last resort. In a crisis, he insisted, it should lend generously against any and all sound collateral, albeit at a high rate of interest. In so doing, it could guarantee that any solvent institution could meet demands upon it, stemming a financial panic. As is usually the case, defining the principle was easier than implementing it. In his book The Young Fed, Mark Carlson describes how in the 1920s the Federal Reserve, then less than a decade old, performed this duty.

Though remembered in the US as an age of prosperity, the 1920s saw an unprecedented number of bank failures. Only the worst years of financial panic in the nineteenth century saw as many banks go under as did during an average year of the Roaring Twenties. The problem centered among small, rural banks hurt by the sharp drop in the price of agricultural commodities in the early 1920s. Falling prices after years of high ones created severe economic hardship in the South and on the Great Plains, largely because farmers had borrowed heavily when prices were good, and banks in these regions suffered as farmers defaulted on their debts.

The architects of the Federal Reserve created it in 1913 precisely to deal with such problems. As a new institution, it had few precedents on which to draw, and though the experience of the central banks of other countries provided some guidance, the extreme decentralization of the American financial system created special challenges. The country had a vast network of small, rural banks, each tightly tied to its local economy. Most were not members of the Federal Reserve System and relied on correspondent banks, somewhat larger urban institutions, for clearing services and credit when under pressure. Relying on the records of the regional federal reserve banks, Carlson presents a variety of case studies of banks that, in extremis, turned to the Fed for help.

Using these case studies, Carlson describes the pressures on the Fed and the considerations that shaped its policy. The Fed could extend credit to members and, through them, to nonmembers (sometimes) by purchasing or “rediscounting” loans, but it had considerable discretion. When approached by a bank facing a drain of money, the Fed asked itself a series of questions: Was the bank in question solvent (good assets larger than deposits)? Was its management honest and competent? Were at least some in the community willing to invest new money if necessary? Did a risk of contagion exist—might the collapse of one bank take others with it, particularly a network of correspondents? Would the collapse of an institution leave a community without any banks? Carlson concludes that, on the whole, the Federal Reserve did a good job. Though unable to save every troubled institution, it almost always secured at least an “orderly liquidation” that avoided panic.

The author examines a few subjects that will be new even to most historians of the Federal Reserve. In the 1920s, the Fed would sometimes dispatch a large volume of cash to a distant point at which trouble threatened, not loaning it to any specific bank but simply warehousing it in the vault of one. The idea was to reassure depositors that the Fed had cash ready to put into any troubled bank if necessary—a tactic that often worked. Bad loans sometimes involved the Fed in operations in which it had little expertise and less interest. The Dallas Federal Reserve Bank had a staff of twenty to manage the cattle it possessed after the default of borrowers who had used the animals as collateral. Perhaps the most interesting part of this book comes at the end, when Carlson notes that by the late 1920s, the Fed had concluded that its rescue operations had been too generous and shifted to a more cautious policy toward troubled banks. This judgment reflected both the ultimate failure of a significant number of the banks that the Fed had assisted as well as the administrative challenges involved in helping troubled institutions. Coming on the eve of the worst financial crisis in the nation’s history, this change was problematic, to put it kindly.

The Young Fed has a tight focus. It does not deal with international finance, monetary policy broadly defined, or the high politics of the Federal Reserve System. What it does, however, it does well. Mark Carlson has produced a solid volume on the “lender of last resort” that students of central banking will find valuable.