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November 25, 19S8, MEMORANDUM: TO - The President FROM - Chairman £ccles Meed for banking legislation In March, 1935, you declared a National Emergency. It should be terminated before your term expires. let it cannot be safely terminated until a banking system has been created which can withstand the impact of changing economic conditions, and a coordination of Federal banking supervision has been established that will be capable of exerting its influence towards the control of an inflation or towards cushioning a deflation when either of these conditions becomes dangerous to the national economy. The Administration1s courageous and effective actions in dealing with the stoat acute banking collapse in history have evoked universal commendation* The restoration of confidence in the banks and the subsequent recovery, however, have tended to obscure the fact that our b&nking systes regains fundamental' ly unsound. It has been dealt with on an emergency basis* It needs now to be dealt with on © broader, sore permanent basis of reconstruction so that it can function effectively as an integral part of the Government's mechanisms for coping not only with potential future emergencies of inflation or deflation but also with an emergency that sight be created by the international situation, The effective organisation of the banking system is a basic and essential part of &ny eoaprehensive program of preparedness* The system is not now so organised. Responsibilities and authority are scattered among various agencies; there is much overlapping, duplication, conflicting jurisdiction; there is lack of uniformity both in practices and in policies so that, as for example in connection with the Msdnistrstion's easy money policy, efforts of the Treasury and of the Reserve System to carry out that policy tend to be frustrated because some of the agencies pursue contrary practices or policies; the system is characterised by numerous paralysing discriminations a© between member banks of the Reserve System, insured banks and State banks not under Federal supervisionj enforcement of sound banking standards and the Government's ability to carry out national policy in the public interest become a mockery when banks may at will escape supervision toy the Federal authorities, this makes for the Bcompetition in laxity11 which hes long been e blot on the American banking Because of the ssultipllcation since 1929 of Federal agencies either with supervisory or lending powers, or both, the situation has become even more unsatisfactory, and the need for reorganisation, consolidation and simplification the more urgent, in excellent precedent is to be found in the Administration1 s bringing together under the Farm Credit Administration of the scattered authorities that previously were divided aoong the Federal Farm Board, the Federal Farm Loan Board, the Reconstruction Finance Corporation, the Department of Agriculture and the Treasury Department. As the President declared, this reorganisation of the farm credit powers was "to eliminate overlapping, prevent duplication, settle conflicting jurisdictions—in short, to provide a aore efficient, logical and consolidated credit service for the farmers at low cost." The s&me general reasons apply with even greater force to the banking situation today. Another precedent is to be found in the Administration's merging in the Hone Loen Bank Board supervision of the operations of the Home Owners1 Loan Corporation, the Home Loan Bank System, the Federal Savings and Loan Associations and the Federal Savings and Loan Insurance Corporation. In striking contrast, the attached chart portrays the disorganized, complex and irrational structure of the Federal banking agencies. Beyond these conspicuous structural defects, however, the banking system is in no position today to withstand another severe inflationary or deflationary crisis, and the Federal authorities are without adequate seen* of exerting a control over the vest and volatile credit reservoirs, swollen by the fortuitous inflows of foreign capital and gold, nor has the banking system any adequate ae&ns of protecting the domestic economy from these foreign movements. If the Federal Reserve System, with its nation-wide organisation, extensive equipment and trained personnel, has any basic justification for existence it Is to exert an influence towards greater economic stability and to mitigate speculative credit excesses and inflationary or deflationary extremes. let while the Congress has vested the Reserve System with certain powers to cope with such credit developments, those powers today are wholly inadequate, and the Reserve System Is placed in the untenable position of having a tremendous responsibility which it Is incapable of discharging because of lack of adequate powers and divided and conflicting banking authorities scattered among Federal and State jurisdictions. la the past five years there has been an addition of seven blllioa dollars to the stonetary gold stock of the country, resulting principally froa a flight of capital from Europe. On the baais ©f r«s@rv@i created lagr t M s gold ther© eould ^ & credit expansion that would wreck our economic machine, let th«r# is no p&mr in smj agw&oy of (kjT©ms@nt to take aetlos to control these reserves, except the power of the Treasury to do so 1^- laereasing the publle debt. This ia .politically difficult and w>ald result in a ris© ia th© coat of barrowing. If the Treasury had to borrow a constantly iaereasiag amount for the purpose of sterilizing present excessive gold stocks, as well as future inflows, the result would fee an inereass® in the interest cost not only on the amount borrowed for tills purpose but also on all borrowing that the Treasury had to undertake, Soae method other then this wist be de-vised for discouraging the inflow of foreign eapital and gold m& for controlling the effeats on our eeoaoay of the gold that has already eom® to this eountry and that oay come in the future. It is also highly desirable to discontinue purchases of silver which likewise further increase the excess reserves of the banking system, the silver program is an unnecessary and useless one for monetary and credit purposes end serves solely as & subsidy to silver producers* That the silver policy is not even politically justifiable is indicated by the attached resolutions of the American Ilining Congress* Results of present organization of federal authorities Sot only does the present set-up foster inefficiency, but it leads to disputes over authority and results in the frustration of monetary mid credit policies by actions of supervisory agencies, is a recent example, at the President's request last spring & conference of the Federal banking agencies was called under the leadership of the Secretary of the Treasury for the purpose of better coordination of bank examination policy. After extended discussion and compromise, an agreement was finally reached, coupling with it a modification of the Comptroller1s Regulation. Sympathetic and understanding administration is necessary to carry out the purpose and spirit of the agreement in practice. Such administration is not to be expected when there are wide differences of interpretation and application of the terns of an agreement representing a coa- promise of widely divergent views* Outworn examining practices have not only frustrated Administration policy which the Treasury and Federal Reserve have sought to carry out, but have served to accentuate deflation on the downswing and to encourage over-expansion end speculation on the upswing. Congress has recognised by legislation and the Reserve authorities are endeavoring to follow the principle of taking monetary action so as to reduce the violence of both inflation and deflation. Both the Administration and the Reserve authorities have consistently followed an easy money policy designed to encourage bank lending and investment so as to stimulate business, which, in turn, would relieve the Government of a corresponding aaount of public borrowing* The effect of these policies and actions is largely nullified when bank examiners following outworn aethode entirely unrelated to monetary policy, criticise the banks for making the kind of loans which are required by the communities in which they operate* Old-fashioned bank examination aethods, still being pursued| attempt to force banks to liquidate on the downswing, thereby accentuating deflation and undermining the banks1 loans and investments. This not only discourages the banks from making new loans at the very time the Government is attempting to encourage thea to do so, but it places additional burdens upon the Federal budget by requiring the Government to set up Federal agencies to supply the credit which the banking system is thus discouraged from supplying, and to expand the supply of money and put it into circulation through relief and other programs because of the deficiency resulting froa bank liquidation and the failure of private credit to expand. The time for improving the quality of bank assets is under boom conditions. That is when banks sake loans and investments that later get thea into trouble* However, this is the very time when bank examination policy falls to discourage unsound loans and investments because it persists in measuring value by the artificial yardstick of ticker quotations, which are likely to be as unrepresentative of true worth in a speculative period as they are when all prices are abnormally I have set forth the foregoing at soae length not only as an example of conflicting policies, due to the existing diffusion of authority, but because this case particularly reflects the necessity for close coordination of bank examination and investment policy with Government monetary policy. Authority over aonetary policy is largely useless unless such authority is closely integrated with bank examination and investment policy. In principle, authority ove-r all these functions should b@ vested In on© agency, but, in any case, should be vested in closely coordinated The situation calls for action at ^his session of Congress These prohleas should not be left for consideration later than this winter inasmuch as a year from now the country will be on the eve of a presidential election. The banking holiday should be terminated before that time. To leave the situation until after 1940 would involve a delay that sight prove disastrous in the face of future speculative and inflationary potentialities and taking into account world conditions together with the exposure of our credit systea to foreign influences. To let the situation drift would not only indicate unawareness or unwillingness to face it, but would give the opposition an opportunity to make an issue of it in the 1940 campaign. If the Administration were to put the responsibility ap to Congress at this session, not only would there be no - xo opportunity to make such a case against this Administration, but responsibility for future consequences would be upon the shoulders of the Congress. The procedure It would be desirable if the President in his message to Congress would in a paragraph or two indicate in a general way the need for further constructive banking legislation to enable the banking system to deal store effectively with the present situation and future developments. Then, in its annual report to Congress, the Board of Governors, it see»® to ate, should sake & reasonably coaplete statement of the existing conditions and express willingness to appear before Congress, if called, to advise on appropriate legislation. Or, should the Board for any reason mot see its way clear to sake such & report, then the Chairman at least should do so. this course seems to me to be far preferable at this time to attempting to bring about an agree&ent among Federal banking agencies upon a specific piece of legislation, which would be regarded as an Administration bill and would be almost certain to be attacked on partisan grounds* Moreover, as you are aware, the members of Congress are jealous of their pre- -11 - rog&tives sad resastful at h&^lng any on® ®g@i*ey prsae&t nad«4rled legisl&tioaa for passage. If the President Congress to asiaert this prerogative and to uork oat legislation, hostil© owmbars of Congress would not be able to the responaiblllty, and all afe^eles tat©r«§sted In legislation would hs^® aa ©qtxatl ©pportimlt^ to prmumt tbalr vl@ws» If legislation result®# the eredlt would redound to the Administration. Wh@r«s&sf if Congress falls to act after having be«s r^u@st©d to do to, the amis will b# oa tb« m mi the groups that blocked action* Instead of leaving is«ae far the Republieaiis to mk% mich o£ In 1940 and whiah tlu» Deaocr&ts would find It difficult to laake a defanse, those responsible for blocking the legislation will be oa the of X feeliew that :So»gress mmM be willing to initiate a progra® bringing about a serg@r of Federal basking ^iperrisory agancio^ that would largely avoid conflicting jurisdictions and effect a much better set-up of the Federal agencies. the Comptroller of the Currency its almost entirely today an ©x&jsiaing agency for national bBak»# the other functions - It « ©f the office being minor. The Federal Reserve System examines State member banks. The Federal Deposit Insurance Corporation examines State insured banks that are nonfaesabers. It would seem to me to be politically feasible to obtain legislation which would merge the examining functions of the Comptroller*s office and of the Federal Reserve System with the Federal Deposit Insurance Corporation, whereas any other method of complete consolidation of these functions would, in sy opinion, be impossible to obtain from Congress. This would be logical because all of the banks now examined by the various Federal agencies are insured banks* This would place in one agency all Federal examination, supervisory and chartering functions, while there should be consolidated in the Reserve System all of the regulatory functions, thus eliminating the numerous discriminations now existing between member banks and nomaember banks. Attached is a memorandum shot&Bg the laany existing discriminatory provisions of law. If this were done, it would be important, however, to have ex&ssin&tions, chartering, supervision of trust departments, and other supervisory functions carried on with d o s e - 13 - coordination with the Federal Reserve. To bring tills about, I would suggest, if called upon to testify, that the Chairman of the FDIC be appointed to the vacancy now existing on the Board of Governors and that the Chairaan of the Board of Governors be put on the FDIC to fill the vacancy on that Board which would result froa aerging the office of Comptroller* I would suggest that the third aesber of the FDIC be designated by the Secretary of the Treasury to represent his on the FDIC Board and to »erre at his pleasure* The effect of this would be to have on the FDIC Board two out of three members who are also aeabers of the Federal Reserve Board* This would afford an excellent opportunity to work out a harmonious and cooperative program of relations and of Integrating examination with monetary policy. In the new Federal Reserve Building there is considerable available space and there is also an adjoining vacant building lot for future expansion of all the offices required by such a merger. This joint housing would, in turn, eliminate duplication of statistical and other functions* I atention the foregoing possible solution of the organisation problem, but should sose better set-up be devised, or should you prefer soae other course, I would naturally wish - 14 - to defer to your judgment. % ova guiding view is merely that the present set-up is unsound and impractical, and I as not wedded to any one solution but only to the necessity of getting &om® solution. The aost practicable compromise, X think, would be the plan suggested, calling upon both the Seserve Systaa and the Comptroller1s office to give up their examining functions to the FDIC, then coordinating the FDIC and the Reserve Board so that policies, now and in the past repeatedly in conflict, aay be haraonized. An important part of this pattern, I think, would be to do away with the existing legal berriers to membership in the Reserve System, and, in fact, to scrap altogether the restrictive membership requirements, by blanketing all insured banks into the Systea and requiring that they carry their reserves with the Reserve banks, at the same time, of course, being entitled to all of the privileges of the Reserve System. One provision that I favor, which would, in ay judgaent, nake this proposal sore attractive to the insured banks, would be that they be relieved of paying insurance assessments on the funds they carried with the Reserve banks as reserves* This would also have the desirable effect of tending against the - 15 - over-concentration of correspondent batik balances In the large money centers, chiefly la Hew York. It would have an incidental effect of serving to put a bottom of l/l2th of 1 per cent oa Interest rates. I would also recommend, if asked, that the Federal Reserve Syatea be completely fre&H from private banker influence and made unequivocally a public body. While the truth is that the Systes is not banker dominated, it has been much criticised by Patm&n, Coughlin and others because private bankers are oa the boards of the twelve Federal Reserve banks and because meaber banks hold stock in the Federal Reserve banks, on which stock they receive a 6 per cent dividend, a rate that is out of line with current returns. I, accordingly, would recommend that bankers be removed from the directorates of the Federal Reserve banks; that such directorates consist of three representatives of commerce, agriculture and industry who would be elected by the banksj that three others representative of the public interest be appointed, as now, by the Board of Governors, and that a seventh director be chosen either from among or by State bank supervisory authorities. This would reduce the number of directors from - 16 - nine, a® at present, to seven, and would giv@ the Board an equal number with those elected by the banks, while the State banking authorities would be represented by the seventh member. I would also recoaaend that the Reserve bank stock be dome away with entirely, as It is sot necessary. I would suggest that the Reserve Spates be permitted to Accumulate in its capital account out of earnings a sufficient amount to offset the loss of capital due to paying off the stock, but all earnings in excess of such amount to be paid into the Treasury each year as a franchise tax, These two changes would reiaove two principal, though exaggerated, complaints against the present set-up of the System. It is also important that the Reserve System be given increased power to deal with foreign balances, particularly those of foreign governments and foreign central banks. Likewise, the Reserve System should have restored to it the power to buy Treasury bills directly froa the Treasury as can be done by ef&ry other central bank in the world. There are various other recosssendations I would sake, if called upon, which X feel would strengthen and simplify the existing banking system, but the foregoing are the principal and aost important ones. - 17 - It would b© very helpful to se to feel that I had your moral support in connection with remedying the banking situ&tion at this tine* I would not want to make reeoameiidations contrary to your wishes, if I should be asked to testify before Congress. The steps X have outlined would9 I think, meet with m minimum of political resistance, while accomplishing desirable results. Retention of Reserve System Since no laodern economy can get along without a central banking organisation, I have assumed the continuance of the Reserve System in any plan of reorganisation, the Ee~ serve System, created nearly a quarter of a century ago, performs numerous essential functions for the banking system, and If abolished would have to be replaced, by some other system to perfors the sane functions. The Reserve System has an extensive physical plant, consisting of the 12 Federal Reserve banks with their 24 branches and agencies, located in principal cities throughout the country, and the Board of Governors in Washington occupying a recently constructed building with aiapl© facilities to accoaaodate all existing Federal banking functions, and with aaterial savings in the elimination of duplication. All of this represents a large investment in property. In addition, the He- - 18 - serve System has a continuing and trained personnel both in the field and in Washington. The Board of Governors of six members now—seven required by lav-—has its own trained staff of lawyers, ax&ainers, statisticians, economists* etc., the personnel 1 B Washington numbering more than 550. Under the law the Board is a continuing agency, and it is able to contribute that expertness which follows from continuous service. It is able to devote its full time and resources to the single purpose of dealing with banking and monetary matters. The present Board was selected entirely by this Administration. It is one, there- fore, in which the President can have confidence. Under existing circumstances, the Board is in the unenviable position of lacking authority to discharge the responsibilities iaposed upon it by law, and I question whether the Board can hold or continue to attract the services of public-spirited sen if this situation is not remedied. Speaking for ayself, I would not wish to continue in the Chairmanship of a System which in the minds of the public and of Congress is charged with great responsibility for exercising controls over doaestic credit and monetary conditions, - 19 - when, in fact, as it exist© today, the System's powers and authority are largely limited to the performance of raechanical functions. In conclusion Without venturing to speak for otber sembers of the Board, I, as the Chaira&n, find myself in the situation where I would be opes to the charge of failing in my public duty, and I feel that I would he equally remiss in my obligation to the President, if I were to let the iapression stand that I felt that the banking situation was safe, and that no steps needed to be taken to safeguard it against the dangers ahead. My tera expires & year from February, and I have no right choice, it seeas to me, except to bring to your attention well in advance of the end of ay tera the necessity for remedial action before the problems become acute, and there is a flare back of eritleisa. Otherwise I would be justly charged ©ither with not knowing the facts or withholding them for some reason. While ay reappointaent, a year from February, may be out of the question for other reasons, in any ceae, as I view it, 1 should not put the President in the position of considering for reappointaent an official who had so far failed - 20 - in the discharge of the reaponsibilitiea of his office. I think It is clear thet, as Chairman of the Board, 1 have a responsibility to bring these general considerations to your attention so that, If you consider it appropriate to do so, y<m ®&y Include in your message the request that the Congress take cognisance of the situation with a view to proTiding the necessary remedies end safeguards. Thereby, I feel, the Administration will aaye done its part, and the responsibility for action will be clearly upon the Congress, Attachments.
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