Full text of Marriner S. Eccles Papers : Memorandum to Mr. Eccles, Box 78, Folder 13, Item 9

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Form 7« R. 131

BOARD OF GO V ERN ORS
□ F THE

FEDERAL RESERVE SYSTEM

Office Correspondence

Date November 8. 19A.0

To________Mr. Eccles______________

Subject:_Mr. Evans1 proposal

From______Mr. Morrill1s office_____

_______________________________

In accordance with a request from the Division of
Research and Statistics, kindly mark '’Confidential” Exhibit C
"Proposals to Control Bank Reserves" by Victor M. Longstreet,
attached to the memorandum dated November 6 from Mr. Goldenweiser.




November 6 , 1940
TOt

Board of Governors

FROM*

E. A, Goldenweiser

SUBJECT*

Mr. Evans’ proposal

Mr. John Evans* President of the First National Bank of
Denver, has submitted to the Board of Governors and to the Treasury
Department copies of the attached memorandum, dated May 7, 1940, en­
titled The Banks and Government Bonds (Exhibit A, attached). This
memorandum outlines a plan providing for (1) oash redemption of
Government securities held by member banks and (2) additional member
bank reserve requirements in the form of Government bonds,
Also attaohed arc two memoranda that analyze the main fea­
tures of this plan. The one entitled A Plan to Stabilize Prices of
Bank-heId Government Bonds (Exhibit B, attached) deals primarily with
the cash redemption features of the proposal. The conclusion of this
memorandum is that, although the plan would unquestionably accomplish
its main aim of reducing the risk of prioe declines in Government
securities, it would do so by requiring the Government to pay a rela­
tively high long-term intorest rate on what would be in effeot a
short-term or demand investment. It would also operate in favor of
one particular class of bondholders, namely, the banks.
The memorandum entitled Proposals to Control Bank Reserves
(Exhibit C, attached) discusses on pages 11-12 that part of the pro­
posal which requires banks to hold Government securities equivalent
to a certain percentage of their deposits, This appears to have been
first proposed by Lawrenoe Seltzer of Wayne University, formerly with
the Treasury Department, In our correspondence with Mr, Seltzer, he
has agreed that the operation of this plan as a check to credit ex­
pansion would be fundamentally the same as the so-called "oeiling
reserve plan” . The "reserve-bond plan" of Mr, Seltzer and Mr, Evans
is of neoessity muoh more oomplioated than the "oeiling reserve plan"
discussed on pages 7-9, involving as it does the additional provisions
affecting the bond market, bank earnings. Treasury financing, etc.




a.

(COPY)

EXHIBIT

A

THE BANKS AND GOVERNMENT BONDS
A SUGGESTED SOLUTION FOR A MENACING SITUATION
Memorandum in reference to United States Government
bonds now owned by the Federal Reserve System and
its member banks and suggestions ooncorning a refund­
ing and change in form thereof ■which would appoar to
be in the interest of tho Treasury, the Federal
Reserve System, tho member banks, the Federal Deposit
Insurance Corporation and the public genorally
whoso money is deposited in the member banks.

May 7th, 1940*

As of Docember 31st, last, the Federal Reserve System itself and all
member banks held, respectively, 2*5 and 11«2 billions of direct obligations
of tho Unitod States Government*
billions of bonds and

In addition thereto, member banks held 3*1

notes guarantoed by tho

Unitod States Government,

2*7 billions of tho obligations of states and their political subdivisions
and 3*0 billions of other securities*
These vast aggregates totaling 22.5 billions have, when considered as
a whole, been acquired

within the banking system at extremely high market

levels and at excessively low yields.
(inasmuch as many individual banks may have purchased certain of
their securities prior to the advent of extreme easy money, this
statement may be challenged by those banks andshould be verified
by a factual study of actual reports on file of examination of all
member banks by the National Bank aid Federal Reserve Examiners)*
The net working capital of all member banks (i.e*, gross capital less
capital permanently tied up in bank premises, furniture and fixtures and
other non-convertible items) is approximately 4*4 billions*

(This total in­

cludes a substantial amount of preferred stock owned by the Government and
not as yet redeemed)*
The United States Government, in public estimation, substaatially
guarantees the safety of deposits in member banks through its Federal
♦(Since this memorandum was prepared statistics have become available
as of June 30,1940, and should be inserted* The substitution of lator

figures would but magnify the problem*)


»

2*»

Deposit Insurance Corporation.
In 1920 when the total Government debt was loss than 25 billions of
dollars, Fourth 4-l/4$ Liberty Loan bonds sold in the middle 80* s, approximat­
ing a Q% yield to maturity and in the same year tho Government offered one
year cortifioatos at 6% interest* Tho not yield of Federal obligations has
recently ranged between loss than Ofo for the shortest maturities and
for the longest maturities* Tho return on tho latter has fallen to this
level from 4^2 in 1932 in the face of the fact that tho national debt has
substantially doubled sinco that date*
An advaneo in tho yield on a 10 to 15 year bond selling on a 2§?S
bas'ds to even a 4$ basis would cause its market value to decrease approximate­
ly 15$. A

15% deoroase in the investment aooount of all member banks would

wipe out approximately two-thirds of their net capital* This net capital must
also absorb all losses arising from some 14 billions of loans*
In particular reference to the Government securities now owned by
member bonks, during tho past several years the carrying value of these bonds
has in offoot been steadily written up through tho process

of

selling one

issue for profit and buying another at the same market level and often of
substantially the same maturity* Early issues of highor coupon rates have
been paid off and issues of progressively lower coupon rates have taken
their places* Thus tho present carrying values will approximate the exist­
ing extremely high markot values*
It has been conclusively demonstrated that the market for Govern­
ment securities promptly disappears whenever any goneral selling movement
occurs except insofar as the Fodoral Reserve System is willing to support
a declining markot and by so doing further incroase the Systom investment
in Government socuritios which is already in exooss of 20$ of the reserve



d ep o sits o f i t s member banks*

THE EXISTING HOLDINGS OF 11*2 BILLIONS OF DIRECT UNITED STATES
GOVERNMENT SECURITIES CONSTITUTE 23% OF THE AGGREGATE DEPOSITS OF ALL
MEMBER BANKS*
In view of the dangers inherent in the situation above outlined, I
would recommend for the serious consideration of the Federal authorities that 1* The Treasury issue and sell at par to the Federal Reserve System
account and to all member banks, indebtedness of the United States Govern­
ment in the form of consols of no maturity in the aggregate amount of 13*7
billions, all for the purpose of refunding tho System account of 2*5 billions
and the member banks' aocount of 11*2 billions, i.e., their prosent holdings
of direct Unitod Statos Government securities* In payment for oonsols at
par the Treasury to accept from tho System account and from momber banks
cash and/or their present holdings of direct United Statos Government secur­
ities at the average daily opening market value of each issue so tendered
for a reasonable period immediately preceding the conversion, or from the
offering date on issues sold within that period* The said consols to be
subject to call at par by the Troasury proportionately from all holders and
until called to bear a rate of interest substantially equal to the present
yield of tho System portfolio, i*o*„ 1-3/4$* Tho ownership of oonsols to be
restricted to tho Federal Reserve System and its member banks*
2* Concurrently with (l) above the legal reserve requirements of all
momber banks to bo increased by an average of 23$, which increased reserves
shall be held in United States Government oonsols* The said increase
averaging 23% shall bo proportioned in tho same manner and to the same
rolativo degree as cash reserves are now proportioned between Central Reserve
City banks, Reserve City banks, and country banks, and between demand and
time deposits as follows *



DEMAM)

DEPOSITS

Central Ros* Res«City Country
City Banks
Banks
Banks

TIME DEPOSITS

AVERAGE

All Banks

All Banks

Required cash
reserve «•*•>•#
Required consol
reserve **••••

22-3/4$

17|$

12JS

s£

13$

40

$

31 $

2l£

_9£

231

Total

62-3/4$

48§$

*to

*r-1

36$

•** *•

3* The System aooount to purchase from each nembor bank daily at par
all consols hold in oxcess of reservos required to bo so held and to sell
daily at par consols to each member bank sufficient to fill reserves required
to be so held* Since consols would be held in safe-keeping by Federal Re­
serve banks, ownership could bo transferred from one member bank to another
by book entry*
4* The Treasury to redeem consols at par when total outstanding ex­
ceeds 2*5 billion (System account) plus tho required reserves of all member
banks to be held in consols (i*o*, in case of a shrinkage in tho total of all
deposits in member banks)*
5* The Treasury may at its option soil additional consols at par to
the System when total outstanding is less than 2*5 billions (System account)
plus tho above required rosorvos of all member banks to be hold in consols
(i*e*, in case of an increase in the total of all deposits in member banks«)
In case tho Treasury failed to avail itself of said option tho reservos of
member banks required to be held in consols shall bo automatically proportion­
ately so reduced*
Under a Rational omorgoncy and possibly in any ovont for
flexibility, it is possiblo that tho Secretary of tho Treasury
and tho Board of Governors of tho Federal Reserve Systom, act­
ing jointly, should have some discretion, but in any ovent
within definite fixed limits, to incroaso tho consol reserves
above 23$ (being tho $ of member bank deposits now invested in
tho diroct obligations of Government*) On tho one hand, tho
Treasury has full authority to redeem consols* It is obvious
that if tho Treasury and the Board of Governors, acting jointly.



had th© authority to incroaso tho average oonsol resorvo abovo
the existing 23$ average to an average of 25$, it would give
the Government a further call upon tho deposits of the public
in member banks of approximately 1 billion dollars*
6* At such time as the Treasury is retiring the national debt and
at its option calls proportionately from all holders all or any part of its
then outstanding consols, reducing the total of 2*5 billions (System acoount)
plus the above required reserves of all member banks to be held in consols,
to a lesser total, the reserves of member banks required to be held in
consols shall first and to that extent be automatically proportionately so
reduced and thereafter applied to reduce the System account*
7* The aggregate of consols held within the System in its own and
member bank accounts shall not exceed a total whioh is not covered, as are
all other member bank reserves, by 35$ in gold or lawful money*
8* Total gold or lawful money required to be held in vaults of
System or subject to its sole order would then be as follows:
40$ to cover circulation
of 4*9 billions

1 2*

35$ to oover member banks*
cash reserves

+ 4.

35$ to oover member banks*
consol reserve
Total gold or lawful money
required by System

¿10 •

Total gold now held by
Federal Reserve System

¿L6*

9. Member banks desiring to do so would be permitted to hold any
other United States Government securities but at free market risk in
addition to their required reserves in consols*
This procedure should bo desirable from tho Treasury viewpoint be­
cause it will 


1* Effect a permanent refunding of 32$ of tho total Federal debt
without increasing the total thereof outstanding excopt as offset by sub­
sequent saving in interest*
2* Reduce prosent cost of interest to the Treasury on 11*2 billions
of direct debt owned by member banks*
(This statement should bo verified from reports of Examiners*
It is believed that the average coupon rate of member bank
holdings exceeds that of tho System account).
3* Stabilize tho market for all Government issues by removing the
constant throat of bank selling of bonds hold against demand deposit lia­
bilities. Other holders of balance of publics debt such as life insurance
companies, corporations, trusts, savings and other individuals aro generally
investors of term funds not subject to mass withdrawal and therefore more
stable holders. Balance of public debt so held as more permanent investment
reduced to ¿28*5 billions.
4* Natural investment level of premier security of world could bo
better maintained when freed from threat of mass selling from banks*
5* Protect the deposits of the publio and particularly the Federal
Deposit Insurance Corporation guarantee.
This procedure should be desirable from the Central Bank or System
viewpoint because it will 1* Increase purely monetary and credit controls*
2* Increase reserve requirements substantially without adversely
affecting cash loan or other investment position of member banks as a whole
(Note that the increased requirements of smaller and country banks are
much less than of large banks in Reserve cities* See table on page 4.)
3* Will nit decrease existing System revenue*
4* Remove member bank speculation in Government bonds - switching,
gambling on conversion rights,



etc*

5* Remove necessity of supporting markets on totals of 42 billions
of United States Government securities to protect 11#2 \ 2*5 or 13»7 billions
held within the Federal Reserve System*
6* Further justify present gold acquisition policy by requiring that
gold be held by Federal Reserve System to secure all reserves of member banks*
7* Bost promote interests of agriculture and industry and overy othor
objective of the Federal Reserve System by centering attention on ways and
means protecting the member banks and hence the money of the public on
deposit therein.
This procedure should be desirable from the individual member bank
viewpoint because it will 1* Eliminate the danger of capital impairment due to market fluctua­
tion of existing Government securities which are at times "frozen" and
unsalable•
2* Eliminate the possibility of market manipulation by large holders
at

expense of small holders.
3* Assure moderate earnings on reasonable proportion of required

reserves*
4* Divert banking attention to banking needs of public and away from
speculative interest in Government bond markets*
This procedure should be desirable from the public viewpoint because
it will 1* Better protect the money of the American people in member banks,
restoring the principle of diversification of risk in all forms of loans
and investments which are




subject to market fluctuation and risk, when

made with depositors* money largely subject to demand.
2* Increase the courage and confidence of bank management and«
free of the threat of oapital impairment,

encourage freer lending*

3* Avoid further dangerous and destructive extremes of easy money
and tond to arrest the diminishing returns on oapital*




*• 9 -

Condition of All Member Banks
In Billions of Dollars
12/30/39
Loans

14. )
Capital
)
Surplus &
State and Munioipal Bonds
2.7)19.7)
Undivided
5*5
)
)
Profits
Other Securities
3.0)
)
)22.8 Demand Deposits 28,2)
U.S.Gov’t.Securities - Direct 11.2
)
)
Demand Interbank 8.5) 37.4
)
U.S.Gov’t.Securities-Guaranteed 3*1 3.1)
)
Domand Foreign
. 8)
Federal Reserve Cash - Required 6*4)
Time Deposits
11.7)
)ll.6)
) 11.8
5.2)
)
Excess
Time Interbank
)
.1 )
Vault
.8)
)19.7
)
)Cash
49.2
Other Banks
5.5) 8.1)
)
)
In process of collection
1.
8)
Miscellaneous assets
(Bank premises, bank furniture
and fixtures, etc.)

1.1

54.8

54.8

U.S.Gov’ts.(direct) of 11.2 are 23$ of member bank deposits?
11 " ”
in System account are 2*5 additional yielding avg. of 1.72$
Federal Reserve notes in circulation are 4.9 40$ *2.0
Member Bank deposits with Federal are
11.6 35$ ■ 4.0
Gold & lawful money now required by
'" '
System
6.0
Gold now held by System
16.0
Excess Reserves 5,2 Correspondents* balances excessive by 1.8
Loams & other investments of 22.8 could rise 30$ before banks would have
to rediscount.
19.7 cash + 11*2 Direct Gov*ts. ■ 30.9 of Cash & Direct Gov*ts. or 63$ of
total member bank deposits.
Capital Ratio

1. Net capital-gross capital of 5.5 less misc. bank
premises, etc., of 1.1, or 4.4
Should not be
2. Loans 14.+ State & Munic.Bds. 2.7+othor bonds 3*0+U.S.
between capital &
guaranteed* s 3.1«22.8«loans & investments placed at
deposits but between
risk by member bank management (excluding U.S.
net capital & money
Direct)
at risk
4.4) 22.8 as 1» 5.2