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Form i / . 1 1
'R 3

BOARD • F GDVERNDRS
• F THE

FEDERAL

RESERVE

SYSTEM

C Jfice Correspondence
To

Chairman EccXes

From

Date

March 30f 1933

Subject:

M r , Smead




At the Board meeting on Tuesday, March 22, Governor Ransom
asked that our memorandum with respect to Section 2(c) of the
Patman Bill be revised so that it could, if the Board chose, be
used in connection with the hearings on the Bill, and that as
revised it include a statement with respect to Federal Reserve
notes.

A copy of the memorandum, as revised, is attached.

Attachment.

March 29, 1938
COMMENTS WITH RESPECT TO SECTION 2(c) OF THE PATMAN BILL, HR 7230

Section 2(c) of the Patman Bill provides that "After all necessary
expenses have been paid or provided for, the net earnings of the Federal
Reserve banks shall be covered into the Treasury as miscellaneous receipts"•
Section 7 of the Federal Reserve Act as amended requires that all net earnings of the Federal Reserve banks after the payment of dividends shall be
paid into the surplus funds of the banks•
The reasons for the proposed change in the Law, it is assumed, are
based on the assumption that
(1) the net earnings of the Federal Reserve banks, after the
payment of dividends, are substantial,
(2) the United States Government will have no claim on such
net earnings if they are not paid to the Government
currently each year, and
(3) the surplus of the Federal Reserve banks is adequate in
relation to their liabilities.
Net earnings of Federal Reserve banks*

During the period of the

world war and for a few years thereafter member banks were borrowing very
large amounts from the Federal Reserve banks, and as a consequence the
earnings of the Federal Reserve banks were exceptionally large.
time Federal Reserve banks paid a franchise tax.

At that

The franchise tax pay-

ments for the calendar years 1920 and 1921 amounted to over $120,000,000#
For the eighteen year period from the organization of the Federal Reserve banks
in 19114 to the end of 1932 total franchise tax payments amounted to $li|9#138,300,




2
The requirement for the payment of a franchise tax was repealed by the Banking Act of 1933»

The surplus accounts of the Federal Reserve banks were

built up in large part during the World War and early post World War periods
when the earnings of the Reserve banks were relatively large.
The Federal Reserve Act, as amended on March 3* 1919* provided that
all of the net earnings of a Federal Reserve bank remaining after the payment of dividends, including those for the calendar year 1918* should be
paid into a surplus fund until it amounted to 100 percent of subscribed
capital and that thereafter 10 percent of such net earnings should be paid
into the surplus and the remainder paid to the United States as a franchise
tax.

This provision of the Law was again modified by the Banking Act of

1933* to provide that all of the net earnings of a Federal Reserve bank,
after payment of the 6 percent dividend provided by law, should be paid into
its surplus fund*

At the seme time, however, Congress required the Federal

Reserve banks to use one-half of their surplus to purchase stock in the
Federal Deposit Insurance Corporation, on which they receive no dividends.
In other words, one-half of the surplus of the Federal Reserve banks was
appropriated by Congress for the purpose of furnishing the Federal Deposit
Insurance Corporation with a part of its capital funds.
The net earnings of the Federal Reserve banks available for transfer to surplus during recent years have been relatively small, amounting
to $2,616,352 in 1937* to $352,5214 in 1936, and to #607*ij22 in 1935*

In

some years the Federal Reserve banks, after payment of dividends, have had
deficits in net earnings which were charged to surplus.
Since the Federal Reserve banks were organized in 191^4 their total
earnings have amounted to $l,2ljl,000,000. Of this amount $610,000,000 has




boon utilized to cover costs of operation, $33*000,000 has been set aside
as reserves for contingencies and the balance of $598*000,000 has been used
as follows:
Payment of 6 percent dividend on
capital stock, as required b y
Section 7 of the Act

$162,000,000

Payment of franchise tax to the
United States Government

1149,000,000

Contribution to the capital stock of
the Federal Deposit Insurance Corp.

139*000,000

Balance in surplus accounts

II48,000,000

Of the not earnings of the Federal Reserve banks since their organization, L\B percent has gone to the Treasury as franchise taxes and to the
Federal Deposit Insurance Corporation as a contribution to its capital
funds, 27 percent has gone to member banks in payment of the 6 percent dividend required by statute, and 25 percent remains as surplus.
Governments right to surplus. With respect to the second assumption
mentioned above, Congress has the right at any time to legislate with respect to the surplus funds of the Federal Reserve banks.

If at any time

Congress should consider the surplus of the Federal Reserve banks more than
adequate, in the light of their liabilities and responsibilities, it could
appropriate a portion thereof for such purposes as it saw fit#

As stated above,

Congress did in 1933 appropriate one-half of the surplus of the Federal Reserve
banks to be used as a part of the capital funds of the Federal Deposit
Insurance Corporation. While the Federal Reserve banks technically own stock
in the Federal Deposi t Insurance Corporation, they are not permitted under the
law to receive any dividends on such stock.




Under present law member banks are entitled to a 6 percent cumulative
dividend on their paid-in subscription to the capital stock of the Federal
Reserve banks.

No further distribution to member banks of the net earnings

of the Federal Reserve banks is possible under existing law.

In case of

liquidation of a Federal Reserve bank the Law provides that its surplus shall
be paid to and become the property of the United States•
The acquisition by the Government of the capital stock of the Federal
Reserve banks, as provided in Section 2(a) of the Patman Bill* would necessitate an initial expenditure of Government funds in the amount of approximately
$133,000,000 for the cost of such stock, and in view of the fact that the
public indebtedness of the Government presumably would be increased by a
corresponding amount, the net income derived by the Government from the ownership of such stock would be limited to the difference between the interest
cost to the Government of money borrowed by it and the annual dividends received from the Federal Reserve banks.

The annual 6 percent dividend payable

to member banks in accordance with Section 7 of the Federal Reserve Act amounts
to about $8,000,000, and if the cost to the Government of borrowed money be
considered to be say 2-l/2 percent per annum on the basis of long term bonds
the net profit which would accrue to the Government from its investment of
$133*000,000 in the capital stock of the Federal Reserve banks would be less
than #5,000,000 per annum.

Should Congress decide to reduce the dividend on

Federal Reserve bank stock this profit would be largely eliminated.
Adequacy of surplus of Federal Reserve banks.

The Federal Reserve banks

now have deposit and note liabilities of about $1 1,960,000,OjQ© and surplus
accounts aggregating $11*7*739*000, the surplus accounts amounting to about 1.2
porcent of deposit and note liabilities *




-

5

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Operations of the Federal Reserve banks must under the law be governed
with a view to accommodating commerce and business and with regard to their
bearing upon the general credit situation of the country.

If the Federal

Reserve banks are to servo the productive enterprises of the country adequately
they must at times take unusual risks.

Furthermore, the Federal Reserve banks

should be in a position, if necessary in the public interest, to operate over
substantial periods with income insufficient to cover expenses.

In the

circumstances, it is important that the Federal Reserve banks have adequate
surplus out of which to defray such expenses and losses.

The present surplus

of 1.2 pcrcent of liabilities may prove inadequate for these purposes and
should be increased from time to time as the earnings of the Federal Reserve
banks permit.
Federal Reserve notes.

It is frequently stated that the Federal Re-

serve banks obtain Federal Reserve notes from the United States Treasury for
the cost of printing, and that they place large volumes of such notes in
circulation and thus obtain substantial profits which should belong to the
Government.

It is important, therefore, to review the factors that determine

the volume of Federal Reserve notes in circulation, what the Federal Reserve
banks hovo to do to get them and the costs connected with the supplying of
currency to the public.
The amount of money in circulation at a given time represents what
the public collectively wants, since currency always moves out of the Federal
Reserve banks when the demand for it increases and returns to them when the
demand subsides.

This is what is meant by an elastic currency. When cur-

rency is needed, the public obtains it from the local banks, and the latter




-

6

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obtain it from the Federal Reserve banks* When it is not needed, the public
deposits it in the local banks, and the local banks in turn redeposit it in
the Federal Reserve banks*

The Federal Reserve banks may be regarded as

reservoirs from which additional currency is drawn when the public requires it
and to which currency not required by the public is returned.

The Federal

Reserve banks have no way of keeping in circulation a larger amount of currency than the public requires, or reducing the amount of currency that the
public needs to finance its current operations.
The demand for currency is determined by various conditions.

A certain

minimum is required for day-to-day cash expenditures of individuals; a certain
minimum is required for payrolls.

There are times when personal expenditures

rise, as during holidays, and there are times when payrolls rise, as during
harvest.

Certain individuals, businesses, and communities have their own

periods when they need more or need less cash than ordinarily.

The net effect

of all of these factors is a normal and regularly repeated cycle of demand
for currency year after year —

slack after the first of January, when retail

trade falls off following tho h&lIdays, larger during the succeeding spring
months, when payrolls increase and outdoor industries become active, slack
again in mid-summer5and steadily increasing during autumn and early winter to
the regular peak in December.
In addition to this regular annual cycle, the amount of currency also
responds to increases and decreases in the volume of retail trade and of payrolls as the amount of business done by the country increases or decreases.
There have been times also vhen the demand for currency was greatly increased
as in the period preceding the banking holiday in 1933*




In the course of a

-

7

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few weeks at that critical time the Federal Reserve banks furnished the
public with as much as $2,000,000,000 of additional currency*
For more than twenty years the Federal Reserve banks have fully met
the normal demands of the country for currency; they have also fully met
peak demands both in times of prosperity and in times of depression, and they
have made it possible for the volume of currency to decline automatically
when the public demand for it declined.
Machinery of note issue.

Before a Federal Reserve bank can obtain

Federal Reserve notes it must deposit as security with the local representative of the Government, known as the Federal Reserve agent, collateral at
least equal in amount to the notes to be issued.
by law, may consist of the following assets only:

This collateral, as provided
(l) promissory notes,

drafts, bills of exchange, or acceptances, usually referred to as "eligible
p?*perff; (2) gold certificates on hand or due from the United States Treasury;
and (3) until June 30, 1939* United States Government securities bought in the
open market.

In addition to being secured by the pledge of specific col-

lateral, Federal Reserve notes are a first lien on all the assets of the
issuing Federal Reserve bank, and a

0 percent reserve in gold certificates

must be maintained against them#
As of March 16, 1938, the Federal Reserve banks had obtained
$lj.,l}ij0,000,000 of Federal Roserve notes from the Federal Reserve agents, of
which i}L\, 125*000,000 wore in circulation, constituting about two-thirds of the
total of $6,330,000,000 of money in circulation, and $315,000,000 were held in
the vaults of the Federal Reserve banks•
notes was as follows:




The collateral held against these

Gold certificates on hand and duo from U.S. Treasury

$14*533*000,000

10,000, 000

7*000*000
550*000,000
Gold certificates are receipts which are issued to the Federal Reserve banks
by the United States Treasury for gold deposited with it by the Federal Reserve banks in compliance with the Gold Reserve Act of 193^4* which required all
monetary gold in the United States to be delivered to the Treasury.

The Fed-

eral Reserve banks do not have the right to pay out those gold certificates.
As indicated, the Federal Reserve banks have pledged $14*533*000,000 of these
certificates against $l4,l|l40,000,000 of their own notes in circulation.

Federal

Reserve notes, therefore, at present are virtually substitutes for gold held
by the United States Treasury.

So long as the Federal Reserve banks pledge

one dollar in gold certificates against each dollar of Federal Reserve notes
in circulation they cannot obtain a profit by issuing Federal Reserve notes.
Moreover* all costs connected with the printing, shipping and redemption of
Federal Reserve notes are borne by the Federal Reserve banks. As will be noted
from page 10 of this memorandum, it cost the Federal Reserve banks nearly
$6,000,000 during 1937 to obtain currency from the Treasury and supply it to
member banks and through them to the general public.
Expenses of Federal Reserve banks.

The expenses of the Federal Re-

serve banks were incurred in rendering the services and performing the functions
required by the Federal Reserve Act. As stated above, they furnish the public
with an adequate, safe and elastic currency; they collect largo volumes of
checks and other items payable upon presentation for member banks; they provide
rediscount facilities for member banks; and perform fiscal agency, custodianship, and depositary services for the Treasury and other Government agencies.




~

9

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In carrying out those and other important functions the Federal Reserve banks
have endeavored to be of as much servico to their member banks, and through
them to commerce, industry, agriculture, and the public in general, and to the
United States Government, as is consistent with the efficient and economical
operation of the System.
All compensation provided by the boards of directors of the Federal
Reserve banks for directors, officers or employees is subject to the approval
of the Board of Governors.

The Board of Governors requires each Federal Re-

serve bank to submit periodically detailed reports of its expenses and of
salaries paid each officer and employee.

The reports of expenses are re-

viewed and summaries thereof are furnished the Foderal Reserve banks in order
that their costs may be compared.
Shortly after the present Board took office on February 1, 1936* it
instituted a survey of the organization at each Federal Reserve bank and as
a result thereof many economies were effected, among which were the placing
of the chairmanships at the Federal Reserve banks on an honorary basis and
the fixing of the compensation of the Chairmen on the same basis as that of
any other director in lieu of annual salaries of from $20,000 to $50*000,

as

had been the previous practice. Wherever it is found that certain operations
can be handled more economically without sacrificing efficiency prompt steps
are taken to effect the economies.
There has been a gradual reduction in the unit costs reported for
the principal operating units of the Federal Reserve banks.

For example, in

the Country Checks--Outgo ing unit, which is the largest single operating unit
in the Federal Reserve banks, the average cost of handling a thousand items




was $3*65

10

-

years ago as compared with $2*59 in 1936 and |2.61|. in 1937*

With a few exceptions, the unit cost in the Country Checks-Outgoing unit
for each of the past ten years has been lower than that reported in the
immediately preceding year as may be noted from the following tabulation:
Cost per thousand items in the Country Checks-Outgoing unit
1928
1929
1930
1931
1932

02*65
3*35
3*35
3*23
3*30

1933
193k
1935
1936
1937

$3
3*05
2.88
2.59
2.61*

The reductions in operating costs reported for the Country Checks-Outgoing
unit are due principally to improved methods of procedure.
The costs of performing the various services rendered by the Federal
Reserve banks during 1937 are set forth below in summary form.
EXPENSES OF FEDERAL RESERVE SYSTEM, YEAR 1937
Currency and Coin
The cost of receiving and handling
2*257*889,000 pieces of currency and
2*730,387*000 pieces of coin, including
shipping charges to and from member
banks was

$14,11*9*671

Assessments by the Treasury Dept. to cover
the cost of printing new Federal Reserve
currency, the cost of issuing such currency
at the Reserve banks, and the cost of redeeming Federal Reserve currency unfit for
circulation, including shipping charges,
amounted to ••••..•.•••.••*•.#•••.••••.•••
Total ..............




01,787,036
05*936,707

11

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Cheek Clearing and Collection
Handling and collecting 926,792,000 checks
and 6,705*!-il3 maturing notes, drafts,
coupons, etc. cost

•«.«••••

$3*802,889

Loans, Rediscounts and Investments and Safekeeping
Making discounts and advances to member
banks; handling applications for advances
to industry for working capital under
Section 13b of the Federal Reserve Act;
maintaining credit information, holding
in safekeeping and servicing about
Oil, 000, 000,000 of securities for member
banks and purchasing and selling Government securities for member banks cost ••••

01*366,258

Fiscal Agency, Custodianship, and Depositary
Receiving, proving, and paying 127,823*053
Government checks and coupons, including
work relief checks, and maintaining the
general account cf the Treasury of the
United States, etc. cost
Fiscal Agency work for the U* S# Treasury
Dept. comprising principally the issue,




$1,125,^02

12
redemption, and exchange of 3*892,00i|
pieces of securities cost

$1,380,352

Total

02,505,751*

Reimbursed by Treasury Dept

&L,63ii,363

Not cost

0871,391

Services performed for various Government
agencies such as the Reconstruction Finance
Corporation, Federal Farm Mortgage Corporation, Federal Land Banks, Federal Intermediate Credit Banks, Federal Emergency
Administration of Public Works, and the
Federal Home Loan Banks and Home Owners f
Loan Corporation cost

$2,231,11*2

Reimbursed by Government Agencies •••
Net cost

2,20i4,Ij26
$26,716

Accounting
This function, which includes the maintenance of the general books, member and
Federal Reserve bank accounts, etc*, and
the making of transfers of funds for the
account of member banks, cost
Banking House and Furniture and Equipment
Cost of operation of banking houses,
including payment of taxes, the salaries




§1,579,520

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13

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of janitors, elevator operators, etc.,
less deductions for income received from
rented space, etc. ••.••..•••••...•••••.

$2,612,685

Reserves set aside for depreciation
on banking houses •••.••••..«•«•.•
Furniture and equipment, net cost
Total

1,297*859
233*290

§k>ih3>Q3k

Bank examination
Cost of examining state member banks
and of analyzing condition and examination reports of National and State member
banks, etc.• amounted to ••••••••••«•«•*•

§1,101,800

Expenses of the Board of Governors
Assessments for expenses of the Board of
Governors of the Federal Reserve System.•

01,71+8,379

Statistical and Analytical
Preparing and publishing monthly reviews
of credit, business and agricultural conditions; and obtaining and assembling
various statistical data, etc. cost ••»«•<

Bank

01480,028

Relations

Bank relations work; visiting member and
ncnmembor banks, conferences, etc* cost •••




0195*00*4

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Ik

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Personnel and Service
Maintenance of filing, mailing and personnel
departments; vaults and telephone sorvice;
purchasing supplies and equipment; equipment
repairs; page sorvice, etc., cost ••....••.••

02,29lu23l4

Protection
Salaries of special officers and watchmen,
and the cost of other protective services
amounted to

932

Postage and Insurance
Postage on ordinary mail; insurance on
equipment and supplies; premiums on
employees1 fidelity bonds, bankers blanket
bonds, etc., cost ..

0l# 321^298

Auditing
Maintaining general audits of the Federal
Reserve banks and branches cost ....•»«•••

v552,62J

Legal
The employment of counsel and other legal
expenses cost

§190,086

General Overhead
General overhead and supervisory expenses,
including directors' fees and other miscellaneous expenses, amounted to




Total Net Expenses ....

01,685,101
$28,263*800