Full text of Statements and Speeches of Thomas B. McCabe : The Significance of Membership in the Federal Reserve System : Address at the annual meeting of the Stockholders of the Federal Reserve Bank of Boston

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THE SIGNIFICANCE OF MEMBERSHIP 3N THE
FEDERAL RESERVE SYSTEM*
Tliis annual meeting of the Stockholders of the
Boston Federal Reserve Bank is a distinctly New
England custom. It is so favorably known throughout the Federal Reserve System that I was very
happy to accept the cordial invitation of your Chairman and my good friend, Albert Creighton, to
come here and participate in your discussions.
During the six months that I have been in my
present position I have visited and attended meetings in seven of the twelve Federal Reserve districts.
I expect to visit three districts within the next
month. During most of my business career it was
my practice to make frequent trips throughout the
country, for no man can follow the progress of his
business except on the firing line. When I was
Foreign Liquidation Commissioner in 1945 and
1946, I traveled 56,000 miles during a period of six
months in order to obtain firsthand information
about what was taking place in various countries
of the world. My associates say that whenever I
receive a call to go to a Federal Reserve district
I am off on the run like an old firehorse who has
heard the gong again. I have always relied to a
great extent on personal contact with the people
who are in daily touch with operating problems
before making decisions.
Of course it is no hardship for me to come to
New England, because I truly love this country.
My family goes to Maine for most of each summer
and I generally find plenty of excuses to join them.
I want to commend you Stockholders for your
record in exercising one of the most important responsibilities of the member banks to the System—
the election of six of the nine directors of the regional Federal Reserve Bank and, through them,
the selection and guidance of its management. Each
Board of Directors also elects a member of the
Federal Advisory Council, a most important body
in the development of Federal Reserve policy.
The Boston Bank has been noted for its distinguished presidents. One of them, Ralph Flanders,
your good friend and mine, was drafted by the
\Address3y Thomas B. McCabe, Chairman, Board of Governors of the Federal Reserve System, at the annual meeting of
the Stockholders of the Federal Reserve Bank of Boston, on
October 26, 1948.
NOVEMBER




1948

citizens of Vermont to go to the United States
Senate. Your latest president, Laurcnce Whittemore, has just been selected to run one of your great
railroads. T w o former governors of the Federal
Reserve Board, W . P. G. Harding and Roy Young,
who is now president of one of your leading banks,
also typify the high character and ability of your
past presidents. It is a tribute to j o u r Board of
Directors that these men were chosA for such positions and is the finest indicator of the public's high
regard for the Boston Bank. Although the loss of
good men creates temporary difficulties of ^placement because it seems that in each instance they are
indispensable, yet broadly speaking, there is compensation in the loss of some of our good men to
the community because these ex-officers are helpful
in giving the various segments of our economy a
better understanding of the nation's monetary and
credit policies, of which there is a grave lack of
understanding.
When I implore you to value your stockholder's
responsibility highly and discharge it with all the
ability at your command, I do so from experience
and deep conviction. As you know, I was on the
Board of the Philadelphia Bank for more than ten
years before taking this assignment. Our Philadelphia directors were of invaluable aid not only in
executive personnel matters but in advising the
Bank on policies and procedure and in keeping it
close to current economic and banking problems.
The directors of the twelve Banks, with their
branch directors, are a representative cross-section
of the leaders in finance, commerce, and agriculture
of their respective regions. Since going to Washington, I have found the directors' advice and judgment, expressed both directly and through their
various officers and members of the Advisory Council, of the greatest help.
As a result of my experience, I cannot urge you
too strongly to continue your vigilance in selecting
and electing the most outstanding leaders. Some
of the Banks have followed the principle of rotation in order to acquaint more of their leaders with
the problems of the System.
This meeting affords an excellent opportunity to
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T H E SIGNIFICANCE O F M E M B E R S H I P I N T H E FEDERAL RESERVE SYSTEM
discuss the significance of membership i n the Federal Reserve System. Two-thirds of all commercial
banks in N e w England, holding four-fifths of demand deposits, are members. Holders of 63 per cent
of the demand deposits of State banks have voluntarily chosen to become members. Those percentages speak for themselves and indicate pretty general belief i n the importance of membership. I t is
especially noteworthy, I think, in this area of traditional Yankee shrewdness.
As you men know, two of the earliest constructive plans to stabilize banking by cooperative effort
were made i n N e w England. I refer to the Suffolk
System and the Bank of Mutual Redemption.
These two were voluntary steps toward the establishment of more effective control over the issuance
of money. So you might say that the seeds of the
Federal Reserve System germinated right here.
This System is a unique creation i n the history
of central banking. A l l economic societies, except
the most primitive, have some f o r m of money. I n
highly productive societies such as ours, organized
around personal enterprise and initiative, money
w i l l not manage itself. A positive provision for the
proper exercise of the central banking function is
therefore inescapable. T h e problem of how to organize central banking functions, however, has no
easy solution. Many experiments have been tried.
Although central banking is a public function just
as the administration of justice is a public function,
experience has proved that central banks should be
organized independently of the Executive and of
the Treasury, just as Courts of L a w are organized
independently of the Executive and of the Department of Justice.
I n Europe the solution to this difficulty long
took the f o r m of privately-owned central banks,
operating under special charters from the sovereign.
This type of organization has tended to insure
relative freedom to central banks from political
encroachment but it has left them vulnerable to
accusations that they were operated for private
advantage, at the expense of the public interest.
Recently, the pendulum has swung away from
this pattern in many countries. I n order to accent
the public nature of the functions which central
banks perform and the public responsibilities w i t h
which they are entrusted, some governments have
purchased the privately-held shares of their central
banks and have made them wholly publicly-owned
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institutions. These central banks are still organized,
however, as completely separate institutions.
T h e truth is that central banks must function
solely in the public interest. I n doing this effectively they must of course maintain close contact
and cooperation both w i t h the private financial
community and w i t h the Executive, including particularly the Treasury. Whatever their form of
organization, they cannot escape this dual role.
T h e financial history of the United States before
the creation of the Federal Reserve System illustrates repeatedly the difficulties of this problem.
T h e First and Second Banks of the United States
represented attempts to organize the central banki n g function i n this country by chartering a
privately-managed single central bank. I n both
cases, this type t)f organization proved politically
vulnerable. I t was politically suspect because the
management was •entirely i n private hands and
because the central bank, due to its eastern location,
was felt to be out of touch w i t h conditions nearer
the frontiers. Both banks were allowed to lapse
without regard to the effects such action would
have on the financial stability of the country..
These attempts taught one lesson that has conditioned our banking and financial structure ever
since, namely, that the American people are determined to avoid centralized financial power
whether it is public or private. I t is i n response
to this determination that our dual banking system
has evolved w i t h its emphasis on individual unit
banks. I t is also because of this inherent characteristic of our people that the banks of this country
operated for nearly three generations under the
constant overhanging threat of recurrent money
panic. The passage of the Federal Reserve Act
put an end to this danger, and w i t h its provisions
for decentralization of power, organized the function of central banking in an ingenious combination of public and private management. I am
thoroughly convinced that the authors of the Federal Reserve Act gave us a monumental piece
of legislation—a system tailor-made for the economic expansion of our country. The System
might be compared to a great pyramid w i t h its
base in the grass roots of our economy, and its
apex i n the Board of Governors. T h e breadth
and strength of the pyramid is i n its base, w i t h
the member banks and the Reserve Banks as
elevations in the slope toward the top.
FEDERAL RESERVE BULLETIN

T H E SIGNIFICANCE O F M E M B E R S H I P I N T H E FEDERAL RESERVE SYSTEM
The history of the Federal Reserve is singularly
free of political bias. Although i n the light of
hindsight there may not be agreement that the
System has always done the right thing at the
right time, there is general agreement that partisanship has had no place i n its operations. For this,
again much credit must be given to the framers
of the Federal Reserve Act, who were meticulous
in their efforts to safeguard the System from the
pressure of special interests or partisan groups.
The operation of the System is also free from
profit motivation. Whether the Federal Reserve
earns income over and above expenses has no influence on its policies. As you know, at present
our earnings are large. Last year 90 per cent
of the System's net earnings were turned over
to the Treasury.
The System is thus free of the two influences
which might distract it from acting w i t h impartial,
studied judgment on matters of monetary and
credit policy, solely i n the public interest.
I n addition to this great continuing responsibility for nonpolitical, nonprofit administration of
money i n the public interest, the System is the
lender of last resort, w i t h vast powers to extend
credit in time of need. Its powers i n this respect
have been greatly liberalized, so that the Reserve
Banks may now lend on all sound assets of member
banks.
Our banking and credit economy consists of
an incredibly complex structure of interlocked
assets and liabilities. N o bank can operate that
cannot convert its assets quickly into cash when
depositors' use of funds results i n a drain. O u r
markets are so organized that in normal times
this conversion can take place i n enormous magnitude without resort to the Reserve Bank. I n periods
of financial strain, however, there is no alternative
but recourse to the Reserve System. This recourse
to funds is always available to a member bank,
w i t h f u l l assurance that the Federal Reserve
w i l l be in a position to meet its requirements,
whatever they may be. Membership from this
point of view may be thought of as that of a
contributing member to a local volunteer fire
company. So long as enough neighbors contribute,
the protection w i l l be adequate. O f course, in case
of a conflagration noncontributors can also receive
service. This is somewhat inequitable but is
both humane and necessary to.prevent spreading
NOVEMBER 1948




of the danger to the whole community. However,
i n the existence and majority support of the
organization there lies great security,
I don't need to tell this audience of the day-to-day
tangible advantages of Federal Reserve membership. These include the supplying of coin and
currency as needed, collection of checks, collection
of noncash items, telegraphic transfers of funds,
safekeeping of securities, purchase and sale of
government securities, and examinations conducted
in a helpful and practical spirit. I t is the policy
of the System constantly to improve all of these
operations. Your suggestions as to improvement
of any of these operations w i l l J>e appreciated.
One of the primary objectives of the Federal
Reserve System when it was organized was
to improve methods of check clearing*and collection
in this country. A great effort has been made
to obtain this objective w i t h the m i n i m u m
of disturbance to correspondent and interbank
relationships.
I k n o w you also value highly the research
services of the Federal Reserve, not only the regular services, but special studies such as the
exhaustive one by Alfred Neal of the Boston Bank,
which points out that the N e w England economy is
far from static, as some sob-sisters would have you
believe. O n the contrary, it is still growing and has
excellent opportunities for much further growth.
M y first over-all impression of the System gave
me a wholesome respect for the highly professionalized work of the research organizations of the
banks and the Washington staff. Many of you
have cooperated w i t h the members of the research
group and I know you w i l l agree w i t h me that
the end product has established a new level
of professional competence i n this field. W e
must strive to increase their effectiveness still
further. They supply the yardsticks of the present
and are our eyes for the future.
Membership makes possible the performance
of these services. You and I know, however,
that members are subject to certain limitations
relative to nonmembers. Members are prohibited
from charging exchange on checks, are required
to have larger capital to maintain out-of-town
branches, are subject to greater restrictions on
investments and loans of member banks, and on
holding companies and interlocking directorates;
are required to carry deposit insurance, and must
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T H E SIGNIFICANCE O F M E M B E R S H I P I N T H E FEDERAL RESERVE SYSTEM
carry large reserves w i t h the Federal Reserve Banks.
These limitations have been developed out of
experience, especially i n periods of banking difficulty, and are i n the interests of sound banking.
By far the most serious and burdensome to you
at this time is the requirement on reserves.
Because of the large gold inflow of the 1930's
and the legacies of war finance in the 1940's,
reserves have had to be substantially increased.
I t has been said that the recent increase of
reserve requirements was politically inspired. That
allegation does not deserve the dignity of a denial.
T h e increase was one of the moves that we, in our
best judgment, felt was necessary to restrain the
growth of the money supply.
I fully realize that this instrument of monetary
management has definite shortcomings.
I t is
neither as flexible nor as selective as we would like.
Especially, it is unfair under present conditions
because it restricts the commercial banking system
while leaving unfettered other segments of the
credit structure which have access to the Federal
Reserve System through sales of Government
securities. I t is also unfair i n that the increases
have not been made applicable to all nonmember
banks. Some states, however, have been quick
to respond to the action of the Federal Reserve
by raising their requirements.
Quite naturally, a member banker may ask,
" W h y am I the goat when so many - of my competitors go Scot-free?" There is no question but
that many other agencies, public as well as private,
are extending credit freely. But, gentlemen, we of
the Federal Reserve have a grave responsibility to
curb the rapid expansion of credit in the area i n
which we operate. As a member of the Board of
Governors I could not be true to myself or my
oath of office unless I fulfilled my responsibilities.
You as members of the System also have a responsibility. I f we live in a community where there are
other citizens who do not accept their civic responsibilities, that does not excuse us from doing our
duty. You who live i n N e w England and carry the
burden of a N e w England conscience w i l l understand me, I am sure.

spite of it loans at commercial banks have increased
over 6 billion dollars in the year ending June 1948.
I n addition, commercial banks' holdings of securities, other than Governments, have increased over
700 million dollars during this period. This expansion of credit occurred at banks located in all sections of the country and at banks of all sizes, but
particularly i n rural areas and small cities.
One of the principal reasons for the increase in
reserve requirements was to immobilize the reserves
which have been created in the banking system
during very recent months as a result of sales of
Government bonds to the Federal Reserve from
nonbank portfolios. Since June these purchases
have been far i n excess of the recent increase i n
reserve requirements. I n other words, this action
has not reduced either the earning assets or the
lending power of ^Jie member banks as a whole
below what they were as late as midyear. I n the
meantime, the moves of Treasury and the Federal
Reserve to raise short-term interest rates have had
the incidental effect of increasing the earning power
of bank assets. I fully appreciate, however, that
i n some individual cases the reserve increase has
worked a temporary hardship and it w i l l take expert management to adjust to the situation.
As I see it, reserves are each bank's contribution
to an effective national monetary policy. I t is unfortunate that this contribution is not made equally
by all, for the benefits are enjoyed by all. I do not
see that any threat to our dual banking system is
involved i n the request that reserve requirements
apply equally to member and nonmember banks.
I am heartily i n favor of the dual banking system,
as I stated at the Louisville meeting of the National
Association of Supervisors of State Banks. But I do
think that i n respect to a credit control instrument
as powerful as reserves and one so vitally affecting
the earning assets of banks, some degree of uniformity of application is essential to the strength
and soundness of banking in this country. I do not
feel that the need for preserving the respective authorities and jurisdictions of the State and national
authorities in this matter presents any great difficulty. I am confident that it could be worked out
I have frequently stressed that this inflation w i l l satisfactorily in consultation w i t h the State banking
not be cured by the action of any one agency. T h e authorities.
There are many i n this audience, I know, who
cooperative action of the American Bankers Association to persuade their members to restrain un- would like me to say something about the support
necessary lending has been very laudable, but in of Government bonds which made it possible for
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FEDERAL RESERVE BULLETIN

T H E SIGNIFICANCE OF M E M B E R S H I P I N T H E FEDERAL RESERVE SYSTEM
nonbank bond sales to swell commercial bank
reserves.
I w i l l here repeat what I told the Mouse Banking
and Currency Committee on August second, and said
again i n a talk just a month ago at Philadelphia:
It is my view that the System is obligated to
maintain a market for Government securities
and to assure orderly conditions in that market,
not primarily because of an implied commitment
to wartime investors that their savings would be
protected, nor to aid the Treasury in refunding
maturing debt, but because of the widespread
repercussions that would ensue throughout the
economy if the vast holdings of the public debt
were felt to be of unstable value.
When you consider that the public debt is one
and a half times all other debt i n the country combined, it seems obvious to me that the market for
the Government debt securities must be one where
investors can deal at all times w i t h confidence. I
remain of the conviction that for the foreseeable
future the support program should be continued.
This conviction is shared by all the members of the
Board of Governors, the members of the Federal
Open Market Committee, and by the Treasury. I t
is also supported by the weight of financial opinion
i n the country.
I n the last twenty years monetary influences have
assumed new prominence i n the eyes of the people.
Whether this is because such influences have indeed
become more prominent or because the public, made
more economically sophisticated by education, has
come to realize the true significance, I w i l l leave to
the theorists. Suffice it to say that the boom of the
late 20's, the disastrous collapse, war financing, the
huge public debt, and our present inflation have
all focused the attention of the public on the importance of money and credit.
So far I have dealt w i t h the Federal Reserve System i n its relation w i t h its members i n the past.
I n conclusion, let us turn the telescope toward the
future. Admittedly, the horizon is low and the
readings are very obscure. W e can see, on the one
hand, great promise for the American economy.

NOVEMBER 1948




Never has it had the potential that it has today.
Our external relations, however, our place i n the
world environment that is emerging, indicate responsibilities beyond the power of man to evaluate.
What w i l l be the role of the Federal Reserve System,
of the Board of Governors, of the twelve Federal
Reserve Banks, and of the member banks i n that
future?
This much we can surely say, at present. T h e
Board of Governors in Washington w i l l continue to
bear the major responsibility for the broad formulation of monetary and credit policies, adapted to the
necessities of our domestic and foreign economic relations. T h e twelve Federal Reserve Banks, each
i n its region, w i l l continue to bear*the major operating responsibilities. They are the eyes, the ears,
the hands of the System, adapting their operations
to the regional requirements of our economy. They
are also our principal advisers, providing wise counsel for System policies. They are staffed by an
exceptionally competent group of individuals of
the highest professional caliber. W e must vigorously strive to raise the caliber even higher. You,
who are in charge of the member banks, w i l l continue to be primarily responsible for the ultimate
decisions that make an enterprise system operate.
Specifically, you determine who is financed and for
how much.
T h e responsibilites of you, the Reserve Banks,
and the Board of Governors are inextricably bound
together. N o one of them can be performed successfully without parallel performance by the
other two. Personally, however, I feel that your
role is the most indispensable of all. N o t least
is your part i n shaping the business leadership i n
this country. W h e n you exercise your individual
credit judgment, you really decide who, among all
the applicants for credit, w i l l be financed. I n maki n g that decision i n the past you have played a
part i n providing this country w i t h the virile, enterprising, economic leadership for which it is famous.
May you continue to play your role w i t h wisdom,
for i n the days to come the world w i l l need that
leadership as never before.

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