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X-9219

May 21, 1935.
Honorable James Couzens
United States Senate
Washington, D* C.
Dear Senator Couzens:
You asked me the other day what procedure I would have folloxved in
1928 and 1929 had the Banking Bill of 1935 been in effect at that time
and had I been Governor of the Federal Reserve Board. It is always' difficult to state what one would have done in different circumstances, and
I presume that what you meant was not what I myself would have done in
the circumstances, but what powers this bill would confer on the Board
that it did not have at that time that would have been helpful in preventing the excesses of 1928 and 1929•
As I stated in the hearing, the Banking Bill of 1935 is not primarily
proposed for the purpose of meeting a situation such as existed in 1928
and 1929• Provisions that would have strengthened the Board's power to
meet such a situation are contained in the Banking Act of 1933, which was
the direct outcome of a Senate resolution and investigation occasioned by
the stock market excesses during that period* The Securities Act and the
establishment of the Securities and Exchange Commission were also the results of investigations by the Senate Committee into abuses in the capital
market and on the Stock Exchange.
Conditions in 1928 and 1929 represented the culmination of developments during the entire post-war period. Interest rates were falling
steadily from 1920 to the end of 1927, owing partly to the great inflow
of gold from abroad; business was generally active; there were large
profits earned by certain corporations, particularly by the larger corporations with monopolistic advantages. Opportunities for floating securities at profitable rates were exceptionally good, with the consequence that many corporations built up large cash reserves beyond their
immediate needs, and this money was available for temporary employment in
the stock market when the demand for brokers' loans increased.
Speculative activity on the stock market had become pronounced in
1924 and had continued to be large with fluctuations from that time to the
autumn of 1929. In 1927 an easy money policy, adopted primarily for the
purpose of helping England remain on the gold standard and helping France
and other countries to return to the gold standard, v/as followed by an
additional spurt in the stock market• During 1928 the Federal Reserve




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System raised discount rates and sold Government securities, but this had
relatively little effect on speculation.
In 1929 the Federal Reserve System had only a small volume of Government securities left and member bank indebtedness was large. The question
that arose was whether the discount rates should be raised- Some of the
Reserve banks recommended such advances, but the Federal Reserve Board felt
that there was nothing in the business situation that required restraint;
that, in fact, there was a recession in building activity and that advances
in discount rates would be undesirable because they would probably not
deter speculators, but would have a bad effect on business activity. The
Board, therefore, adopted a policy of trying to reach member banks directly
by curtailing Federal Reserve credit extended to banks that had a large
volume of loans in the stock market* This policy was only partially successful in restraining speculation, partly because under the then existing
law the Reserve banks could only deal with member banks who were actually
in debt at the Federal Reserve banks • This enabled banks with large stock
exchange accounts to buy Federal funds from other banks and thus to acquire
reserve funds without borrowing directly from the Reserve banks* Control
of speculative loans was difficult under these conditions. Furthermore,
there was little or no growth in the volume of bank credit in 1S28 and
1929 • Loans by member banks to brokers and member bank deposits did not
increase. The speculative demand for credit in the market was met largely
by the loaning of surplus funds owned by corporations*
It is impossible at this time to say what could have been done to
remedy the situation, certainly at so late a date as 1928 and 1S29. It is
to be hoped that with security issues and stock exchange practices under
regulation by the Securities and Exchange Commission, with authority in
the Federal Reserve Board to regulate margin requirements on collateral
loans, both for brokers and for banks, with loans by corporations to
brokers prohibited, and with the additional powers of control over speculative activity by member banks contained in the Banking Act of 1933, the
Federal Reserve System will be in a much stronger position to prevent the
development of an unsound situation such as the one that culminated in
the stock market debacle of 1929.
The Banking Bill of 1935 is not directed towards preventing stock
market abuses, which, as has just been said, have been dea?tt with by other
legislation. This bill is concorned with improving the machinery of the
Federal Reserve System and with centralizing in the Federal Reserve Board
responsibility for all the instruments of monetary policy, najnely, discount
rates, open-market operations, and changes in reserve requirements* It
was not in 1929 that the powers contained in this bill would have been
valuable, but in 1931. At that time, when England went off the gold
standard and there was a heavy drain on gold in this country and a drastic
deflation in business and in bank credit, the System would have been in a




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X-9219

much stronger position to adopt a vigorous open market policy if this
bill had been in effect. As things were at that time the System could
not buy Government securities freely because they were not eligible as
collateral for Federal Reserve notes and the Reserve banks had an inadequate
supply of commercial paper eligible for that purpose. It was not until
the passage of the Glass-Steagall Act at the end of February 1932 that
the System was able to pursue a vigorous open market policy. This
obstacle to an easing policy at a critical time will be removed by the
proposed bill.
Moreover, if banks had been able to borrow on their sound assets
from the Reserve banks during the depression, as they would have been had
this bill been in effect, much liquidation would have been avoided.
The bill would also increase the ability of the Federal Reserve
Board to cope with such a situation by placing on it the full responsibility for open market policy, so that it could adopt and carry out such a
policy on the basis of its conception of the national interest without
being delayed by negotiations with the individual Reserve banks, which
under existing law not only have the sole power of initiating open market
policy but also have the power of refusing to participate in such a policy
when it is adopted.
The situation in 1931 and the early part of 1932 illustrates how
the present bill would have helped at a time when deflation was in
progress. Another purpose of the bill is to strengthen the Federal Reserve System's power to counteract inflation, if it should get under m y
in the future. With the large volume of excess reserves at member banks
at the present time and the likelihood of further increases in these reserves through gold imports, silver purchases, the use of the stabilization
fund, and through possible currency issues under the bonus bill or otherwise, there are possibilities of further increases of the reserves of member banks without corresponding growth in security holdings of the Federal
Reserve banks that would be available to sell in the market for the purpose
of absorbing member bank reserves. The proposed bill would improve the
position of the Federal Reserve System in such a situation by concentrating
the open market power in the hands of the Federal Reserve Board, which
could act promptly and decisively without possibility of delay or inability
to agree on a policy. It would also give the Board the power to increase
member bank reserve requirements without the necessity of declaring an
emergency or obtaining permission from the President, who ought not to
have this responsibility.
The fact that the proposed bill prescribes as an objective of monetary
policy the maintenance of business stability would also strengthen the
Board's power to act because an inflationary boom is not consistent with
business stability.




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Honorable James Couzens, -

It is for these reasons that I feel that the proposed bill would
strengthen the power of the. Board to act promptly both in a period of inflation and in a period of deflation. With the powers contained in this
bill, together -with the provisions of the Banking Act of 1933 and the
Securities Exchange Act, I believe that the Federal Reserve System would
be in a much stronger position to moderate booms and depressions and
would be better able to contribute to business stability in so far as
this can be done within the scope of monetary action.
I hope that this is a satisfactory answer to your question. I have
not dwelt on other phases of the bill because these matters are not directly in line with your question and have been discussed in my testimony.




Very truly yours,
(Signed) M. S. Eccles
M. S. Eccles
Governor