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Confidential draft

March 17, 1958

The fundamental objective of H.R.7203 is to establish a mechanism that
would control the volume of money with a view to maintaining a fixed price
Monetary objectives
The Board of Governors of the Federal Reserve System has given constant
study to the problem of objectives of monetary policy. Under date of July 30,
1937, the Board issued a statement expressing the conclusion that economic
stability, rather than price stability should be the general objective of
public policy, because stability of the price level does not necessarily
prevent serious economic maladjustment. It stated that in its judgment the
Reserve System's duty, in addition to working toward the maintenance of sound
banking conditions, is to exert its influence toward maintaining a flow of
funds conducive to as full a use of the country1 s productive resources as can
be continuously sustained. The Board also stated its belief that efforts of
all the departments of the Government should be directed toward the achievement of this broader objective, and that neither monetary stability nor price
stability can be achieved by monetary means alone.
Federal Resejrve System operates in the public interest
In proi)osing a reorganization of the Federal Reserve System, the author
of the bill contends that it has not been operated in the public interest;
that it has been dominated by bankers; that it has been conducted in the

Page 2
selfish interests of a small group, and that it has made large profits at the
expense of the community*

The Board of Governors does not believe that any of

these assertions can be sustained by the record.
Ownership of stock by member banks does not enable the bankers to control
the Federal Reserve System. It is more nearly in the nature of a compulsory
capital contribution than stock ownership. Although the member banks elect
two-thirds of the directors of the Reserve banks, the large banks elect only
two out of nine directors.

The small banks elect two, the medium-sized banks

elect two and the Board of Governors in Washington appoints three.

Only a

third of the directors can be bankers and all directors and officers are subject to removal by the Board of Governors.

The appointment of all Presidents

and First Vice Presidents and the salaries of all officers and employees are
subject to approval by the Board in Washington.
Complete authority over all matters of major national policy, such as the
determination of discount rates, reserve requirements, margin requirements on
security loans, and maximum rates of interest to be paid on time deposits is
vested in the Board of Governors. Authority over open market operations is
vested in an open market committee consisting of seven members of the Board of
Governors and five members elected by the Reserve banks. Not only has the
Board a majority of the committee, but the other members are subject to the
Board's approval in their positions as presidents of the Reserve banks.
It is clear, therefore, that in matters with which the bill is primarily
concerned the System is dominated, not by banks, but by the Board of Governors,
a governmental body whose members are appointed by the President and confirmed
by the Senate.

Page 3

Federal Reserve banks not operated for profit
During the twenty-three years of its existence the Federal Reserve System
has earned approximately one and a quarter billions of dollars, of which
one-half has been used for operating expenses incurred largely in performing
public services, such as the clearing and collection of checks, the supplying
of currency to the banks and to the public, the performance of many duties
for the United States Government, and in furnishing rediscount facilities for
the member banks.
Of the six hundred million dollars of earnings above expenses, approximately one-fourth has been paid to the Government as franchise tax, nearly
one-fourth has been turned over to the Federal Deposit Insurance Corporation
as capital, one-fourth has been paid as the statutory dividends to member
banks, and the remainder is held in a surplus account which in case of
liquidation becomes the property of the Government.
Member banks contribute 3 per cent of their capital and surplus to the
capital of the Reserve banks and receive not more than 6 per cent annually
on this amount.

In addition, member banks are required to keep balances with

the Reserve banks amounting on the average to 16 per cent of the member banks'
deposits and receive no return on these balances. A member bank having a
capital and surplus of |100,000 contributes $3,000 to the Reserve bank*s
capital and receives annual dividends of #180, or at a rate of less than twotenths of 1 per cent on its own capital and surplus.

Page 4

The System "was established and is operated in the public interest and
dominated by public officials; it performs a service that saves the people
of the country far more than the cost of the System, and it makes no profits
for any private interest other than the amount paid annually to stockholders
at a fixed rate, which has been prescribed and can be changed by Congress.
ProT>osals would not improve banking system
Proposals in the bill for reorganizing the Reserve System would transfer
ownership of the stock in the Federal Reserve banks to the Government and
would have all the directors of the Reserve banks appointed by the President
and approved by the Senate • It would enlarge the membership of the Board of
Governors to fifteen, including three ex-officio members -- the Secretary of
the Treasury, the Comptroller of the Currency, and the Chairman of the Federal
Deposit Insurance Corporation*
A Board of Governors of fifteen members proposed in tho bill would be too
unwieldy to function promptly and effectively. Appointment of Reserve bank
directors by the President would tend to introduce party politics into the
System, and would make it more difficult for it to perform its duties

The proposal in the bill to offer all the privileges of member-

ship to nonmember banks so long as they choose to keep their reserves in a
Federal Reserve bank would remove all incentive to become members of the System.
It would enable all banks to profit by the services of the System so long as
it suited them, without contributing anything to its strength or complying
with its regulations, and to withdraw their reserves when to maintain them
would seem to be burdensome•

It would make futile the proposed enlargement

Page 5

of the power to increase reserve requirements.

It would remove all incentive

to membership and would make it impossible for the System to discharge its
responsibility for maintaining sound credit conditions.
Distinction between monetary and fiscal authorities should be maintained
The primary function of the Treasury is to collect taxes, borrow money,
and provide funds for the various agencies of the Government in accordance
with Congressional appropriations. The primary function of the Federal Reserve
System is to influence the flow of money and to contribute to the soundness of
the banking situation.

The ultimate objectives of both agencies are the same,

namely, to serve the public interest, but their points of view and experience,
and their approach to current problems may at times be different.

The main-

tenance of an organization for the regulation of credit separate from the
fiscal arm of the Government has been found advantageous in most countries of
the world, and its abandonment, which is proposed in the bill, would, in this
Board1 s opinion, be a backward step.
Local autonomy in local matters should be preserved
Since its establishment in 1914, the Federal Reserve System has undergone
many changes in the direction of increased control by the Board of Governors.
With the passage of the Banking Act of 1935 this control has been greatly
strengthened in so far as national policies are concerned.

In regard to

local matters, the maintenance of local autonomy under general supervision
and close Government regulation is advantageous in a country like the United
States, consisting of various regions with diverse economic interests. The

Page 6

maintenance of locally elected directors on Federal Reserve bank boards is
of great advantage in creating local pride and local interest in the System
and in inspiring the business community with confidence in its management.
This would be largely destroyed if the appointments of local directors were
handled entirely from Washington.

There would also be the danger that partisan

political considerations would enter into the appointments and the directors
and through them the personnel of the banks might became subject to political

There is nothing that would be more destructive than this of the

ability of the System to render a disinterested public service to all classes
of the community.
To sum up, the Board is convinced that improvement in our banking system
is urgently needed but sees nothing in this bill that would tend in this

The Board believes that the main objective of the bill is not

practicable; and is convinced that the evils which the bill proposes to correct
do not exist; that the organization which it proposes to establish would result
in less satisfactory service to the country, and that its enactment would be a
retrogression and not a forward step in the development of the banking system
in the public interest.


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

Section 7 of the present Act requires that all net earnings of

the Federal Reserve banks after the payment of dividends shall be transferred
to surplus.
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.
No one of the above assumptions is valid.
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*

At that time Federal Reserve banks paid a franchise

tax, the franchise tax payments amounting to over §120*000,000 for the calendar
years 1920 and 1921, as compared with total franchise taxes of $1149,138,300,
for the period from the organization of the Federal Reserve banks to the end
of 1932 after which the requirement for the payment of a franchise tax was

It was also during this period that the Federal Reserve banks




added substantial amounts to their surplus accounts.

The Federal Reserve

Actj 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 amounts 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% dividend provided by law,
shall be paid into its surplus fund. At the same 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 $352,521* in 1936, and to $607,1422 in 1935-


some years the Federal Reserve banks have had deficits in net earnings after
payment of dividends which were charged to surplus.
With respect to the second assumption mentioned above, Congress
has the right at any time to legislate vdth 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 Deposit Insurance Corporation, they are not
permitted under the Lav to receive any dividends on such stock.
Under present lav/ member banks are entitled to a 6 percent
cumulative dividend on their paid-in subscription to capital stock of
the Federal Reserve banks. Ho 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 bo 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
Fatman Bill, would necessitate an initial expenditure of Government
funds in the amount of approximately $133*000,000 for tho cost of
such stock, and, in view of the fact that tho public indebtedness of
tho Government presumably would be increased by a corresponding
amount, the net income derived by the Government from the ownership
of such stock would bo limited to the difference between the interest
cost to tho Government of money borrowed by it and the annual divi-

donds of tho Fodoral Rosorvo banks

The annual 6 percent dividend

payable to member banks in accordance with Section 7 of tho Federal
Reserve Act amounts to about 07,800,000, and if the cost to tho
Government of borrowed money bo considered to bo soy 2-l/2 percent
per annum on the basis of long term bonds tho not profit which would
accrue to the Government from its investment of vl33*000,000 in the
capital stock of tho Federal Reserve banks would be loss than
$5,000,000 per annum
With respect to the adequacy of the surplus, the Federal
Reserve banks now have deposit and note liabilities of about
^11,960,000,000 and surplus accounts aggregating $1^8*739*000, the
surplus accounts amounting to about 1.2 percent of deposit and note
If tho operations of tho Federal Rosorvo banks are to
be governed with a view to accommodating comerce and business and
with regard to their bearing upon tho general credit situation of the
country as required by statute, tho Federal Reserve banks cannot
function with a profit motive in view. Moreover, if they are to discharge effectively their statutory responsibilities, they must
have adequate surplus funds to permit them to operate at a loss, if
necessary, over substantial periods*

Present surplus funds,

amounting to 1#2 percent of liabilities are certainly not excessive


and could easily provo inadequate particularly as there are no present
prospects for substantial increases therein.
Since the Federal Reserve banks vera organized in 19lh their
total earnings have amounted to $1,2141,000*000. Of this amount
$610,000,000 has been utilized to cover costs of operation, 133*000,000
has been sot aside as reserves for contingencies and the balance of
1598,000,000 has been used as follows:
Payment of 6 percent dividend on
capital stock, as required by
Section 7 of the Act


Payment of franchise tax to tho
United States Government


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


Balance in surplus accounts

II48, 000, 000

It will be noted from the above that of tho net earnings of
1598,000,000 of the Federal Reserve banks since thoir organization, I48
percent has gene to tho Treasury as franchise taxes and to the Fedoral
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.



Tho expenses of tho Federal Reserve banks were incurred
in rendering tho services and performing tho functions required by the
Federal Reserve Act* One of tho purposes of tho Federal Reserve System,
as stated in the preamble of the Act, is to furnish an elastic currency,
and in order to do so Soction 16 of tho Act authorizes the Federal Reserve
banks to issue Federal Reserve notes*

In accordance with tho provisions

of tho Act the Federal Reserve banks furnish member banks and through
them the public with the currency needed for carrying on the country's
business; they collect large volumes of checks and other items payable
upon presentation for member banks; they provide rediscount facilities
for member banks; and perform fiscal agency, depositary and custodianship
services for the Treasury and a large number of Government agencies. In
carrying out these and other important functions tho Federal Reserve banks
have endeavored to be cf as much sorvice to their member banks, and through
them to commerce, industry, agriculture, and tho public in general, and to
the United States Government* as is consistent with tho efficient and
economical operation of tho 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.

In discharging this responsibility

the Board gives individual consideration to the salary of each officer in
every Federal Reserve bank, and has provided a classification plan whereby

all of the non-official positions in each Federal Reserve bank are classified
and a maximum salary provided for each#

The Board of Governors also requires

each Federal Reserve bank to submit periodically detailed reports of its
expenses and of salaries paid eachtffficerand employee.

The reports of

expenses are tabulated by the Board's staff and summaries thereof are
furnished each Federal Reserve bank in order that it may compare its costs
with similar costs at other Federal Reserve banks.
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 their compensation 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-Outgoing unit, which is the largest single
operating unit in the Federal Reserve banks, the average cost of handling
a thousand items was §3*65 ten years ago as compared with $2.59 in 1936 and
in 1937. With a few exceptions, the unit cost in the Country ChecksOutgoing 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


8 -

Cost por thousand items in tho Country Chocks-Outgoing unit




Tho reductions in operating costs reported for the Country Checks-Outgoing
unit are due to improved methods of procedure.

A survey of the Country

Checks unit at all Federal Reserve "banks has recently been completed by
members of the Board's staff.

Since the ner Board took office members

of its staff have also made field surveys of the Bank Examination, Auditing
and Legal Departments at the Federal Reserve banks * On occasions when the
unit costs of some particular bank appear to be out of line special field
surveys are made.

For example, last month a special survey was made of a

certain operating unit at two banks where there was a substantial variation
in unit costs and suggestions were made to the bank reporting tho higher cost.
The costs of performing tho various services rendered by the
Federal Reserve banks during 1937 are set forth below in summary form.

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




Assessment 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 .•...«


Check Clearing and Collection
Handling and collecting 926,792,000 checks
and 6,705,i4l3 maturing notes, drafts,
coupons, etc. cost


Loans, Rediscounts and Investments
The cost of making 13,571 discounts and
advances to member banks; of handling 388
applications for advances to industry for working capital under Section 13b of the Federal
Reserve Act; of maintaining credit information,
of holding in safekeeping and servicing about
$14*000,000,000 of securities for member banks
ana purchasing and selling Government
securities for member bahlcs cost





Fiscal Agency, Custodianship and Depositary
Receiving, proving, and paying 127*823,063
Government checks and coupons, including
work relief checks; maintaining the general
account of the Treasury of the United
States, etc. cost


Fiscal Agency work for the U. S, Treasury
Dept. comprising principality the issue,
redemption, and exchange of 3*982,751
pieces of securities cost
Reimbursed by Treasury Dept.


Net cost


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 tho
Federal Home Loan Banks and Homo Owners*
Loan Corporation amounted to
Reimbursed by Government Agencies

Not cost


- 11
This function, which includes tho 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
of janitors, elevator operators, etc.,
less deductions for income received from
rented space, etc., was • ....


Reserves set aside for depreciation
on banking houses
Furniture and equipment, net cost



Bank examination
The cost of examining state member banks
and incidental work in connection therewith


Expenses of the Board of Governors
Assessments for expenses of tho Board of
Governors of the Federal Reserve System




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



Bank relations work; visiting member and nonmember banks, conferences, etc. cost


Personnel and Service
The maintenance of personnel records, the
purchasing of supplies and equipment, telephone service, filing, mailing, etc., cost





The salaries of special officers and watchmen, and the cost of other protective
services amounted to •....••
Postage and Insurance
The cost of postage on ordinary mail;,
insurance on equipment and supplies, etc.;
the cost of employees1 fidelity bonds,
bankers blanket bond, etc., amounted to

yl, 3214,298

13 Auditing
Maintaining general audits of the Federal
Reserve banks and branches cost


The employment of counsel and other legal
expenses cost


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

Total Net Expenses ........