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February 8, 1935


The chief purposes of the proposals for changes in our banking laws,
in so far as they relate to the Federal Reserve System, are the following:

To accelerate the rate of economic recovery*


To make our banking and monetary system, which was designed
under the conditions prevailing prior . o the World War, more
responsive to our present and future economic needs*


To prevent a recurrence of conditions that led to the collapse
of our entire bankingstructure in the spring of 1933.

The banking system of this country has been put to a severe test and has
not stood that test. It has not been able to stand up under the strain of
the depression or to lend effective support in the fight against it. On the
contrary, the banking system has proved to be an element of weakness in our
economic structure that has aggravated and prolonged the worst phases of the

And it still impedes the rate of recovery*

The explanation of this is not to be found only in the excesses and
abuses that characterized our banking practices in the recent past, nor in
the present relative inertia of the banking system, nor by an assumption that
bankers are less eager than other men to hasten the progress of recovery*
The fact that the banking system has proved to be inadequate is to be explained,
in large part, by the fact that our banking structure has remained essentially
unchanged throughout an epoch of far-reaching economic changes both in this
country and in the world at large*

The principal measures contemplated in the proposed legislation,
therefore, are designed to remedy deficiencies now inherent in the
banking structure itself. In this connection it is proposed to make
the Federal Reserve System, which is the cornerstone of the banting
structure, more responsive to our national economic needs. It is also
proposed to make our commercial banks better adapted to meeting the
credit requirements of Industry, commerce, and agriculture, under the
changes that have taken place in our economic system since most of our
present banking laws were enacted.
Underlying the proposed changes in the banking laws are fundamental
economic and monetary considerations, the widespread influence of which
has not been adequately understood.

In fact, the lack of an adequate

understanding of these fundamental considerations was an important
factor in bringing about the disastrous collapse of our economy which
culminated in the closing of all the banks in the spring of 1933.
Fluctuations in production and employment, and in the national
income, are conditioned upon changes in the available supply of cash
And deposit currency, and upon the rate and character of monetary expenditures. The effect of an increased rate of spending may be modified by
decreasing the supply of money, and Intensified by increasing the supply
of money. Experience shows that, without conscious control, the supply
of money tends to expand when the rate of spending increases and to
contract when the rate of spending diminishes.
During the depression the supply of money did not expand and thus
moderate the effect of decreased rates of spending, but contracted
rapidly and tfo intensified the depression.

This is one part of the

economy in which automatic adjustments tend to have an intensifying


rather than a moderating effect. If the monetary mechanism is to be
used as an instrument for the promotion of business stability, conscious
control and management are essential.
At the present stage of economic developments, main reliance for
bringing about a rise in the national income must be placed upon increased governmental and private expenditures. The most important role
of monetary control at the moment, therefore, is assuring that adequate
support is available whenever needed for promoting and accelerating
Two supremely important duties are likely to devolve upon the
reserve administration in the future. The first is assuring that a
recovery does not result in an undesirable inflation. The second is
assuring that a recovery is not followed by a depression. If recovery
is allowed to develop into inflation, it is certain ultimately to lead to
another depression. To regain prosperity without excesses, and thereafter to maintain business stability, are the two immediate objectives
of monetary policy.
In order that the reserve administration may endeavor, with some
prospect of success, to render prompt support for emergency financing
in case of need, to prevent the recovery from getting out of hand, and
to prevent the recurrence of disastrous depressions in the future, it
is essential that the authority of the Federal Reserve Board be strengthened. As matters now stand, the Board is charged with responsibility for
monetary developments in this country, but lacks the clear and explicit
authority for determining the country*s monetary policies.


An essential step in giving the Board this authority is to give
it a controlling influence over the System9 s open-market operations9
for these are by far the most important instrument of Reserve policy.
By these operations reserves may be given to or taken away from member
banks; and it is on these reserves that deposits are based*

It is not

too much to say that the power to control open-market operations is the
power to control the expansion and contraction of bank credit, and thus
in large measure to control the country1s supply of money.
In the present administrative organization, the power to initiate
open-market policy rests with the twelve Federal Reserve banks, which
act jointly through the Federal Open Market Committee established by the
Banking Act of 1933#The Federal Reserve Board has no representation on
this Committee. It is given only the power to approve or disapprove
open-market policies recommended by the Committee, and to prescribe the
regulations under which the open-market operations are to be carried out*
However much the Board may desire an energetic buying and selling policy
it has no authority under the law to initiate such a policy.
On the other hand, the ability of the Open Market Committee to give
effeet to policies that it recommends is dependent both on the approval
of the Board and on the willingness of t$re Reserve banks individually to
participate in the operations.
It is difficult to conceive of a legal arrangement more calculated
to result in conflict, obstruction, and delay. The fact that it may not
have done so in the past is manifestly not an adequate reason for perpetuating diffusion of authority in a matter so vital to the nation1 s economic

-5Under the existing arrangement, 128 persons are in various degrees
ultimately responsible for determining open-market operations and other
System policies*

These persons are the 8 members of the Federal Reserve

Board, the 12 Governors of the Federal Reserve banks, and the 108 directors
of the Reserve banks*

There is no reason to suppose that such an unwiddy

organization will in the future be any more effective in bringing about
business stability than it has been in the past*

Furthermore, a complete

stalemate resulting from a cleavage of opinion between the Board and the
Reserve banks is always possible.
The need is obviously for concentration of authority and responsibility for open-market operations in a small cozomittee representing a
national point of view and having a majority of its members chosen from
the Federal Reserve Board*

This is provided for in the proposed legisla-

tion without in any way impairing the autonomy of the Federal Reserve
banks in matters of local or regional concern*
Another anomaly in the present administrative organization of the
Federal Reserve System is the arrangement in respect of the Reserve bank
Governors. The Governors are the principal executive officers of the
Reserve banks, and their positions are of major importance in the System;
yet they are not even mentioned in the Federal Reserve Act, nor is their
appointment subject to the approval of the Federal Reserve Board.

It is,

therefore, proposed to recognize the office of Governor in the law, to
combine this office with that of Chairman of the Board of Directors, and
to make the appointment subject to the approval of the Federal Reserve


To facilitate the carrying out of national policies, it is
proposed to remove certain of the restrictions that are now imposed
on the Federal Reserve System by the Federal Reserve Act, but that
experience has shown to be detrimental and impracticable. These restrictions are largely predicated on conditions that prevailed when
the Federal Reserve Act was adopted in 1913, and were wisely imposed
on a system that was new and untried; but in the course of time the
circumstances that gave rise to them have diminished in importance
or greatly altered.
A conspicuous example in this respect is the rigid definition
of the kinds of paper that the Federal Reserve banks are permitted
to discount. Changes in the country1s economic life, notably in the
methods of financing business enterprise, have materially reduced the
volume of short-term, self-liquidating paper of the classes to which
the discount privileges of the Reserve banks are largely restricted
by law. In times of stress, therefore, when the help of the Federal
Reserve System has been most urgently needed, many banks, though holding
sound assets in their portfolios, have been devoid of the particular
kinds available under the law for borrowing at the Reserve banks.
The undue severity of the limitations on eligible paper was
finally recognized, and they were removed temporarily by emergency
legislation; but this action was not taken until much harm had been
done to the business of the country and unwarranted hardship and loss
suffered by bank depositors. Furthermore, there is at present considerable evidence that these limitations are proving an impediment to


recovery. New loans of a type that commercial banks have customarily
made in the past are now refused, not beeause the applicants do
not possess sound assets, but because the sound assets that they do
possess are technically ineligible for rediscount*

There is also

still a tendency among vany banks to remove from their portfolios
paper that cannot be immediately liquefied by recourse to the Federal
Reserve banks.
For these reasons it is proposed that the legal limitations on
eligibility be removed and authority be given to the Federal Reserve
Board to determine by regulation the character of paper that shall be
eligible for discount at the Reserve banks*
Another of the proposed changes in the Federal Reserve Act
would dispense with the requirement for segregation of collateral
behind Federal Reserve notes, without in any way altering the present
requirement of 40 per cent reserve of gold certificates. When there
was a foreign drain on the country's gold in 1931-1932, the requirement for segregation of collateral caused serious difficulty by
tyingi?) gold over and above the 40 per cent required reserve. The
situation was met for the emergency by p emit ting the pledge of
United States Government obligations as collateral against Federal
Reserve notes; but the authority of the Reserve banks in this matter
is only temporary.
Since Federal Reserve notes are prior liens on all the assets
of the issuing Reserve bank, and are in addition obligations of the
United States Government, the requirement for segregation of collateral
serves no useful purpose and adds nothing to the safety of the notes.


It has been erroneously asserted that to dispense with the
requirement for segregation would give the Reserve banks power to
issue notes without adequate backing. This is not the case. The
Reserve basks have two principal classes of liabilities: deposits
and notes. Back of these, in addition to gold and lawful money,
are the Reserve banksf bills and securities*

Either notes or

deposits can be increased through the acquisition by the Reserve
banks of an acceptable asset. Their total can be increased in no
other way.

It is at the time the asset is acquired that the determina-

tion is made that it is good enough to be held by the Federal Reserve
bank; and this determination is made without reference to whether
the asset iw ultimately to become backing for a deposit liability
or f«rr a note liability.

The deposits of the Federal Reserve banks

are the reserves back of all deposits of member banks. Assets that
are good enough to constitute the backing for deposits of the Reserve
banks are also good enough to back Federal Reserve notes.
Furthermore, a holder of a deposit with a Federal Reserve bank
has the right to withdraw it in notes at any time, and consequently
the Federal Reserve bank should be in a position to use the asset
acquired at the time the deposit was created as backing for the notes
into which this deposit is convertible.
Neither the elasticity of our currency supply nor the safety
kf Federal Reserve currency is in any way affected by the proposed
change in the law. Its only practical effect is to eliminate the
cumbersome and useless requirement that certain specific collateral
be segregated, and hold at considerable expense and in a privileged


position, as backing exclusively for Federal Reserve notes.
The proposals relating directly to member banks of the Federal
Reserve System are few in number, but vital to speeding recovery.
Their purpose is to make it more feasible for banks to meet the
present requirements of mortgage borrowers and to participate more
aggressively in a revival of activity and employment in the construction industry*

The changes proposed would authorize banks to use a

larger proportion of their assets for mortgage loans than is permitted by existing law, to lend up to 75 per cent of the property
value and for a term up to twenty years on properly amortized first
mortgages, and to make such loans without regard to the local geographical limits to which the existing law confines them.
These changes would put an end to restrictions in the existing
las that practical experience has plainly shown to be injurious to
banks and mortgage borrowers alike*

The effect of these proposed

changes would enable commercial banks to take an effective part in
the reopening of the mortgage market, and to give their unstinted
support, in a manner not now possible for them, to that branch of
industry in which the opportunity for meeting both a social and an
economic need is now greatest*