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COPl August 4, 194-8 Tot Board of Governors Fromi SUBJECT* Mr. Vest Constitutional power of Congress as to reserves of nonmember banks. When Chairman McCabe was testifying before the House Banking and Currency Committee on August 2, 1948, he was requested to have a memorandum prepared on the constitutional power of Congress to make reserve requirements applicable to nonmember banks* Ve have prepared such a memorandum and I have submitted a copy to the House Banking and Currency Conmittee. A copy i s attached for the Board1 s informa- tion. G.B.V. Attachment P W R OF CONGRESS T REQUIRE B N S WHICH ARE H T O E O AK O M M E S OF THE FEDERAL RESERVE SYSTEM TO MAINTAIN E BR CERTAIN RESERVES As a measure to aid in protecting interstate commerce and the nation1s monetary, banking and financial structure against the dangers arising from further inflationary pressures, i t has been proposed that Congress enact legislation requiring a l l commercial banks to maintain certain reserves in the form of balances with Federal Reserve Banks. This proposal encompasses banks which are not members*as well as those which are members of the Federal Reserve System because, as has been pointed out, the proposal would be both ineffective and unfair i f the reserve requirements in question were made applicable only to those banks that happen to be members of the Federal Reserve System. A question has been raised as to the authority of Congress to enact such legislation requiring nonmember banks to comply with such reserve requirements, and the purpose of this memorandum is to show in brief compass the clear authority which Congress has in the matter. Previous Legislation Applicable to Nonmember Banks Before discussing the legal considerations and the decisions of the Federal courts which clearly sustain this authority on the part of Congress, i t should be pointed out that Congress has heretofore enacted legislation which subjects bonks to certain requirements regardless of whether or not they are members of the Federal Reserve System. In the Banking Act of 1933> Congress included a provision -2(section 21 of that Act) which provides that i t shall be unlawful for any person engaged in underwriting securities to engage at the same time in receiving deposits. In other words, banks were required by that Act to give up any underwriting business in which they were then engaged. That provision applied to a l l persons engaged in the banking business, regardless of whether or not members of the Federal Reserve System. Likewise in 1934-, in the Securities Exchange Act of that year, Congress authorized the Board of Governors of the Federal Reserve System to issue regulations prescribing the amount of credit which could be extended for the purpose of purchasing or carrying registered stocks, and the Board, pursuant to that authority, has for years had in effect a regulation which applies to a l l banks, whether or not members of the Federal Reserve System. More- over, i t goes without saying that Congress could, as a condition of insurance of deposits of banks by the Federal Deposit Insurance Corporation, make any reserve or other requirements of such banks which i t deemed appropriate. But as w i l l be demonstrated below, the decisions make clear the power of Congress to enact the proposed legislation regardless of whether the banks affected by i t are insured by the FDIC or are members of the Federal Reserve System. The f i r s t part of the discussion which follows relates to the power of Congress to take the proposed action under its authority over interstate commerce, and this power alone is f u l l y sufficient to authorize the proposed legislation. In addition, however, there is discussed the authority of Congress to take this action in order to protect the banking system which Congress has established and in order to protect the nation1s monetary system* A l l these grounds arc related, but i t is convenient to consider -3them separately. Authority of Congress Power over Interstate Commerce. - The power of Congress to enact the legislation in question is sustained by the plenary authority granted to Congress by Section 8 of Article I of the Constitution, "To regulate Commerce with foreign Nations, and among the several States, * * * l f , and tfTo make a l l Laws which shall be necessary and proper for carrying into Execution the foregoing Powers * * *. tf p. XXXIX, 1946 Ed.) (U. S. Code* That banking—whether chartered by the Federal or State governments—is an activity within the reach of this Congressional authority has been decided specifically by court decisions under both the National Labor Relations Act and the Fair Labor Standards Act which, of course, were enacted in pursuance of the "commerce power". In National Labor Relations Board v. Bank of America National Trust & Savings Association. 130 F(2d) 624 (C.C.A. 9th, 1942), a petition for enforcement of a Board order based on violations of the National Labor Relations Act, the Bank contended in defense that i t was not "engaged in commerce" and that its operations did not "affect commerce" within the meaning and intendment of that Act. In sustaining the order and, therefore, overruling the Bank's contentions, the Court reviewed the Bank's activities, including, among others, the financing of business operations, both interstate and intrastate in character; the collection of commercial paper, much of which mm J^, mm covered interstate shipments of goodsj the interstate transfers of funds? and the facilitation of the sale and shipment of goods in the channels of commerce through the discounting of trade acceptances, the issuance of letters of credit, bank drafts, etc* The Court said that the Bank!s operations had an "undeniable effect * * * upon commerce among tho States,11 lending "vital support to the commercial l i f e of the nation*11 Furthermore, the Court said that the Bank was "itself directly and every hour of tho business day engaged in interstate activities not describablo otherwise than as commcrco * * * *within tho meaning of the Constitution*." Tho United States Supremo Court doniod certiorari and rehearing (318 U.S, 791-792? 319 U,S. 782).. A similar caso is that of Bozant v. ftank of N w York* 156 o F(2d) 787 (C.C*A* 2d, 1946), which hold that tho Bank was subject to the Fair Labor Standards Act becauso of tho relationship of tho Bank's activities to interstate commorco. Tho cipso relationship of credit activities to interstate commorco is further illustrated by United States v# General Motors Corporation* 121 F(2d) 376 (C.C*A* 7th, 1941), cert, and rohoaring den. 314 U. S* 579, 618, 710, holding that tho local r e t a i l and wholesale financing of products moving in interstate commorco is a matter within tho power of Congress undor tho "commorco power" as expressed in the Federal anti-trust laws. - 5 The above decisions demonstrate f u l l y the application to banking of the principle, established by the courts in dealing with other but analogous situations, that the regulation of commerce may extend properly to the regulation of a l l aspects of commerce and of a l l instrumentalities upon which the carrying on of commerce depends. This general principle was reiterated in United States v. Darby. 312 U.S. 100, 11S (1940) > wherein the Court, in holding a local manufacturer subject to the Fair Labor Standards Act, said that f,Tho powor of Congress over interstate commerce * * * extends to those activities intrastate which so affocts interstate commorco or the oxorcise of the power of Congress ovor i t as to make rogulation of thorn appropriate moans to the attainment of a legitimate end, tho oxorciso of the granted power of Congress to regulate interstate commerce.11 For earlier examples, i t has long since boon settled that stockyards, although engaged in dealing locally in livestock, arc subject to Federal control, because they arc essential cogs in tho machinery of interstate commorce. 25S U.S. 4-95 (1922). Stafford v. Wallace» The same is time of a local grain exchange. Board of Trade of City of Chicago v. Olson. 262 U.Sf 1 (1923) • The issuance of fraudulent b i l l s of lading i s punishable undor Federal statute, although they covor no interstate shipment. Forger. 250 U. S. 199 (1919)• United States v. Indeed, the Supreme Court has frequently rejected arguments which, by the application of "artificial 1 1 or "mechanical" concepts, would disregard the "economic continuity" of either individual or collective processes or activity and, hence, ignoring actuality, seek to limit or impair the Constitutional powor of Congress over interstate - 6 commerce. Mandevllle Island Farms. Inc. 68 S# Ct. 996 (1948) • v. American Crystal Sugar Co.. Seo also United States v. Sullivan. 68 S. Ct. 331 (194S). While no useful purpose would bo served by referring to the many court decisions cumulative of the foregoing, no discussion of tho "commerce power11 would be complete without mention of United States v. South-Eastern Underwriters Association. 322 U.S. 533 (1944), holding that the business of insurance, notwithstanding local regulation, constitutes commerco and, hence, is subject to tho Federal anti-trust laws. Sec also Pair v. Mutual Life Insurance Co. of N w York. 17 L.W. 2035 (CfC.A#, 2d, e July 8, 1948), holding that "insurance policies are goods produced for commerce11 within the coverage of the Fair Labor Standards Act; and Smolowe v. Delendo Corporation. 136 F (2d) 231 (C.C.A., 2d, 1943), cert den. 320 U.S. 751, holding that, as "private sales11 on national security exchanges affect stock quotations thereon, such sales are not purely intrastate activities, but are subject to Congressional regulation as interstate commerce under the Securities Exchange Act of 1934* In conclusion on this point may be noted Wickard v. Filburn. 317 U.S. I l l (1942), in which the Court sustained as validly within the "commerce power" of Congress, tho whoat marketing quota and attendant penalty provisions of the Agricultural Adjustment Act of 1938, as amended, although the facts boforo tho Court involved whoat not intended in any part for commerce but wholly for consumption on the farm where grown. In so holding, the Court observed that tho general schemo of the Act was "to control the volume" of whoat ^moving in interstate and foreign commerco in order to avoid surpluses and shortages and the consequent ~ 7~ abnormally low or high,wheat pricos and obstructions to commorcc*" In overruling tho argument that the Act was unconstitutional as an interference with local matters, "production" and "consumption11, which, at most, would have only an w indirect" offeet on interstate commerce, tho Court said: "But even i f appelleets activity be local and though i t may not be regarded as commerce., i t m y s t i l l , whatever its nature, be reached by Congress i f i t exerts a substantial economic effect on interstate commorco, and this irrospoctivo of whether such offoct is what might at samo earlier timo have boon defined as 1 direct 1 or ^ d i r e c t * * * That appellee^ own contribution to tho demand for wheat may bo t r i v i a l by itself is not enough to romovo him from tho scope of federal regulation whore, as horo, his contribution, taken together with that of many others similarly situated, is far from t r i v i a l * * * * * Congress nay properly havo considered that wheat consumed on tho farm whore grown, i f wholly outside tho schomo of regulation, would havo a substantial effcct in defeating and obstructing its purpose to stinulato trado therein * * *." Tho Wickard caso is particularly apposite to tho question horo# I f i t is constitutional to rogtflato as intorstato commorco wheat grown locally and in a "trivial 11 amount for homo consumption, as hold in tho .Wickard caso, so also is local banking subject to such regulation ovon though, in a given caso, i t might bo considered to bo of equally "trivial" proportions in intorstato commorco. Horo, as in tho legislation involved thoro, Congress may properly considor that any such banking, no loss than local farming, i f l o f t outsido tho schomo of regulation, "would have a substantial offoct in defeating and obstructing" its lawful purpose and, thoroforo, apply its rcgu^ lation to a l l banks, largo and small aliko, and whothor nonnembors or members of tho Federal Rcscrvo System# -8Protection of the Banking and Monetary Systems. - Although, as indicated above, the "commerce power" is ample authorization for the proposed legislation, the Congress also has authority for such action under its power to protect the banking system and the nation1 s monetary system. The authority of Congress to protect the national banking system and the Federal Reserve System has been reaffirmed many times since the famous case of McCullech v. Maryland, U Wheat (U.S.) 316 (1819), which held that a bank chartered ty Congress could not be taxed fcy a State because such taxation would interfere with the power of Congress. In that case, Chief Justice Marshall stated (p. 426) the basic doctrine that ffa power to create implies a power to preserve11. The authority of Congress to authorize national banks to act in certain circumstances as trustees, executors and administrators, as against the contention thet such action infringed State authority, was sustained in First National Bank v. Union Trust Co.. 244 U. S. 416 (1917), on the ground thet Congress could lawfully authorize national banks to act in such capacities in order to enable them tc compete with State corporations having such power. And, in State of Missouri v. Duncan. 265 U.S. 17 (1924), the Court held, in effect, that, although the local law did not authorize national banks to act as executors, a State probate court could not discriminate against national banks by refusing to appoint them executors and thereby deprive such banks of "their power to compete that Congress is authorized to sustain." The banks to which Congress can lawfully extend protection, however, need not be Federally chartered. Thus, in Westfall v. United States. 274. -9U. S. 256 (1927), a defendant was indicted for aiding and procuring a branch manager of a member bank of the Federal Reserve System to misapply bank funds in violation of Federal statute. The application of the statute to the defendant, although not e bank official, was sustained on the ground that i t was proper to prevent the weakening of the System. The authority of Congress similarly to protect nonmember banks whose deposits are insured ty the Federal Deposit Insurance Corporation also has been upheld. v* Doherty United States. 94 F* (2d) 495 (C.C.A., 8th, 1938) and Weir v. United States, 92 F. (2d) 634 (C.C.A., 7th, 1937), cert. den. 302 U. S. 761. The authority of Congress to protect the nation1s monetary system was long ago held to authorize measures far more sweeping than the legislative proposal in question. Veazie Bank v. Fenno, 8 Wall (U.S.) 533 (1869), sustained a 10 per cent Federal tax imposed on the circulating notes of State banks. Although clearly recognizing that the tax was intended to, and did, bring to an end the practice of State banks of issuing such notes, the Court stated the monetary authority for such action as follows; "Having undertaken to provide a currency for the whole country, i t can not be questioned that Congress may, constitutionally, secure the benefit of i t to the people by appropriate legislation. To this end, * * * Congress may restrain, by suitable enactments, the circulation as money of any notes net issued under its own authority." I t w i l l be noted that the statute sustained by the court in the Veazie ftank case singled out State banks and applied the burden -10of the control exclusively to them. That statute, by comparison, illustrates the far milder effect which the present proposal would have on State banks. Instead of laying special burdens on State banks as was done in the Veazie Bank case, the present proposal would merely have a l l banks, member and nonmember alike, conform to the requirements which would be ineffective and unfair i f applied only to members of the Federal Reserve System., and which are necessary for aid in the protection of interstate commerce and the banking and monetary systems established by Congress. The Congressional powers to protect the banking and monetary systems are, of course * clearly related. They stem not only from several specific provisions of the Constitution but from a blending thereof and from its general purposes. Norman v. B. & 0. R.R. Co. 294 U* S. 240 (1935) is one of many cases illustrating the broad sweep of those powers. There the Court sustained the power of Congress to strike down tfgold clausesw not only in contracts made by individuals . but also in contracts of States and their subdivisions. The Court not only quoted with approval from the Veazie Bank case> above} but clearly stated and reaffirmed the comprehensive character of such powers: "The Constitution fronts to the Congress power coin money* regulate the value thereof> and of foreign coin. 1 Art. I , sec. 8, par. 5* But the Court in the legal tender cases [12 Wall. 457] did fTo -11not derive from that express grant alone the f u l l authoritj' of the Congress in relation to the currency. The Court found the source of that authority in a l l the related powers conferred upon the Congress and appropriated to achieve 'the great objects for which the government wns framed,1 — f a national government5 with sovereign powers.1 McCulloch v» Maryland, 4 Wheat. 316, 404-407; Knox v. Leof supra, pp. 532, 536j Juilllard v. Greoaan, supra, p. 438* The broad and comprehensive national authority over the subjects of revenue, finance and currency is derived from the aggregate of the powers granted to the Congress, embracing the powers to lay and collect taxes, to borrow money, to regulate commerce with foreign nations and among the several States, to coin money, regulate the value thereof* and of foreign coin, and fix the standards of weights and measures, and the added express power ! to make a l l laws which shall be necessary and proper for carrying into execution1 the other enumerated powers." Clearly the legislative proposal in question, which would operate prospectively and which would be merely regulatory rather than prohibitory* is nothing like as drastic as the Congressional action sustained by the court in theflormatiand Veazie Bank cases. Thus, i f tho Congressional power can be lawfully used as demonstrated by th^se cases to adjust matters of v i t a l national interest;, thero can be no room for doubt as to the validity of tho Congressional action now proposed. Submitted by George B. Vestf General Counsel* Board of Governors of the Federal Reservo System. August 4> 1948.