The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
.ARTICLE l3Y DOCTOR WILLIS NEW YORK WORLD Sunday, February 17, 1929. BRIEF .ANALYSIS The Federal Reserve System was never designed to check or prevent speculation carried on with individual funds. Purpose of Federal Reserve System was merely to take the barik reserves of the country out of the speculative market. The Reserve J;.Ct transferred the required reserves to the Federal reserve banks and further provided that loans of the Federal reserve banks should never be made for the purpose of carrying speculative transactions. The Federal it indirectly provided for permitting member banks to the city batiks for loan on Reserve Act not only did not attack speculation; it by reducing amount of required reserves and continue to deposit their surplus reserve with collateral if the owners of it so desired. The Federal Reserve Act exempted United States obligations from the prohibition against loans for carrying securities; in other words, it allowed borrowers to get funds from reserve banks for the purpose of buying and carrying United States bonds and certificates. The reason for this exception was shown in the World War, the reserve banks being an indispensable adjunct in the placing of Government bonds. The special interests induced Congress to permit Federal reserve batiks to loan on the direct notes of member bariks with Government bonds as collateral. Administrative rulings and practice under this new provision made it almost mandatory for a reserve bank to do so. This was a long step in advance of the permission granted in the Act to loan for the purpose of carrying United States securities. This put the reserve banks in the position of being obliged to loan with United States bonds as collateral, without inquiring what the purpose of the loan was, - that is to say, to loan indirectly for the purpose of speculation in ether securities. Although promise was made to repeal this immediately after the war was over the same special interests sought to protect it and it has remained on the statute books. Thus the batik reserves of the country have more than ever gone back into the market • .Lf :170 -2- X-6243 At a recent date the reserve banks were carrying about $720,000,000 of certificates or loans secured by such Government obligations. The Res~rve Act provided for the bankers' acceptance as a means of obtaining suitable interest bearing instruments in which the surplus reserves of the member batiks could be invested should they prefer not to loan on call. It was supposed that, as in Great Britain, batiks desiring to be in a liquid condition would put their surplus reserves into bankers' acceptances and then when needing funds get tl:em by selling these acceptances to reserve batiks. The member banks have never carried any considerable amount of such acceptances but have sold them direct to the reserve batiks which have to carry the entire b,-.rden of the acceptance market from the very beginning. At a recent date member banks were holding only about $25,000,000 out of the total of $1,284,000,000 of acceptances outstanding of which the reserve bariks held for their own and for~ign accounts about $800,000,000. The c~edit obtained by acceptance financing has admittedly in many instances gone directly into the stock market and thus the surplus re- serves of the country, as well as the basic reserves themselves, have been put back into the service from which the Reserve Act had sought to draw them. ) The remedy for a bad practice is always the complete cessation of that practice. This may not be possible as an immediate step but it must be begun and systematically carried forward. REMEDIES: 1. Reserve banks should absolutely stop supporting the market for Treasury certificates under re-purchase agreements. 2. They ought to stop lending to members on the direct notes of such mer:.bers collateraled by Governme\nt obligations. Cites recent loan to member bank of over $100,000,000 on its direct notes collateraled by Government securities. 3. The reserve bariks Should rid themselves of all save a very moderate holding of Government certificates. 4. They should hold no Government bonds whatever. 5. They should refuse to buy acceptances except when they represent a fractional part of a general' body of paper of the sort which is being carr.Ud 'by the member banks as a way of investing surplus reserves and thereby keeping themselves liquid. 6. Reserve banks should do what they never have done, - resort to -3- direct de~lings in two-name paper regardless of the endorsement of member batiks, - a practice widely carried on by European central batiks. The above changes would result in re-establishing the liquidity of reserve banks and in doing what the original Act intended to do, - keep the rsserve funds of the count~y out of the stock market. ~ne Federal Reserve Act never had any quarrel with legitimate speculation but on the contrary provided for the release of funds which could be used if desired to take care of it. Speculation is a part of the industrial and financial structure of the United States and performs a useful economic service. It cannot be well dispensed with under ~::·1 present economic order. It ought to be liberally financed. It is, ha.ever, constantly tending to invade other fields. At the present time the stock market is taking the place of the banks in many particulars. A new type of financing by the issue of stocks and bonds rather than through commercial batik loans has come into vogue. The number of enterprises listed on the Stock Exchange has immensely increased. The New York Stock Exchange is serving vastly more than a speculative purpose; it has become a medium of current industrial and business finance. The excess in the use of credit for brokers' loans and collateral loans is shown by the fact that the Stock Exchange calls upon New York banks for total loans of $3,000,000,000 at a time when the entire short-term loans of the London Clearing House baruts, as estimated by Mr. McKenna, are less than $750,000,000 of which probably less than half is devoted to genuinely speculative transactions. · The above, of course, is what the Federal Reserve Board had reference to in its recent statement. The statement referred to the lack of any duty on the part of reserve batiks as regards speculation; it would have been better had it referred positively to their actual duty to keep batik reserves out of speculation. Whatever the form.of expression employed, the real meaning was the same, in that an unusual share of the country's resources had become involved in supporting a kind of transaction which, even though beneficial in itself when kept within limits, may, like anything else, be exaggerated and rendered dangerous. It does not help the present situation to point out what our banking system ought to have done several years ago,· or to note the errors which were made during and after the war and to point the way to long range reform. -4This situation is one of emergency, - nothing less. It is not necessary to figure the possibility of a collalJSe of values or an old fashioned panic, or a series of bank failures. As a matter of fact, these conditions may present themselves as they did after 1920. They may not appear at all, and yet·the harm of present conditions may ;t.anifest itself in other ways that are quite as serious i f slower in operation and less spectacular. It may manifest itself in one way or another, and the question is how to bring about a better situation, - a situation from which it is possible to raake a start towards better conditions. TWO R!Jt:iEDIES SUGGESTED: 1. Obtain an agreement that no greater amount of credit should be used for Stock Exchange purposes than is now employed. This is perfectly feasible. It was done during the war through the money pool and the equivalent was done many times before the war to arrest or prevent panic and disastrous chro1ges in security values. The effect of it would be to cut off at once the constant growth in stock market transactions which calls for an ever growing volume of credit and which permits more and more people all over the country to become involved in a speculative maelstrom. 2. To make this effective it might be accomplished by an agreement amont: the is.suing houses of the city to slow down, or perhaps for a time suspend further new issues except where such transactions are necessary. This was effectively resorted to during the war through the Capital Issues Committee. In a moderate way it has been pursued at different times since then for the purpose of preventing a condition of indigestion from becoming acute in the bond market. One reason for the constantly mounting total of brokers' loans is the vast amount of loans used to finance iss•-:e houses and syndicates and in enabling them to carry large volumes of securities that have not been sold to the public. WHAT C.Alr THE RESERVE SYSTEM 00? Let us see what it has done. 1., It has raised its acceptance rates in the effort to liquidate its portfolio of acceptances. ...-"~ rt:llo-.,1 t;•r:l ....;5- Govern~ent X-6243 ...L t 1 :; 2. It has shown a little more reluctance towards supporting the security market. 3. It has slightly raised its discount rates (last summer). 4. The Eoard has lately issued a warning statement. 5. Certain western reserve banks have informed their members they will not rediscount for any member who sends funds out of the district for speculative· purposes. All the above are good as far as they go. They have not been applied early enough but have been used reluctantly and s.lo\vly as conditions had developed which were really beyond control. It has been suggested that the reserve bank should refuse further credit to borrowing banks who are lending in the stock market. That would merely bring on a crash which would aggravate existing conditions. The local reserve bank by reason of past blunders is more responsible than any otherinstitutionsfor what is occurring in the market today, It cannot stand from under by merely repudiating its responsibility, - as the Reserve System .tried to do without success in 1920. Wise and strong handling of the local reserve bank could and would produce results very much greater than any that have been obtained thus far by the policies already described. It is too late to obtain the desired effect by the conventional methods, especially in view of the bur.den we have assumed in connection with our joint effort to sustain the Eank of England in maintaining the gold standard policy. It is an unfortunate outcome of 15 years experience. in centnal banking, - for now we must find some way of correcting conditions on old fashioned 1 ines.
@FedFRASER