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CQPY ~ " FEDERAL RESERVE BAM OF ST. LOUIS X—6438 December 2, 1929. Mr. Walter Wyatt, General Counsel, Federal Reserve Board, Washington, D. C. Dear Mr. Wyatt: I am enclosing copy of my suggestions to Governor Martin on the inquiry contained in Governor Harding's l e t t e r . (1) - I cannot find any legal obstacles which would preclude the taking of such c o l l a t e r a l in special cases, (2) - i cannot find anything in the wording of the amendments which would prohibit the taking of such c o l l a t e r a l ; (3) - In the face of the vote on the Weed resolution, i t cannot be said that i t was the intent that our recommendation should include such a prohibition; (4) - Each bank was l e f t free to take or not take such collateral and not violate the intent of the policy recommended. In our discussions, I think a l l of us had in mind member banks only, since the EARLY case arose out of a member bank case, and, the decision in the STORING case we were considering general collateral of a member bank with the Reserve bank. However, Regulation ' J 1 applies alike to member and non-member par banks, and, in my discussion in the report to Governor Martin, I have considered both classes as included. I think I can see clearly why Mr. Weed's suggestion could be followed in his and other similarly situated d i s t r i c t s but could not be s a f e l y adopted in other d i s t r i c t s like ours; and, whilst the adoption of such a policy in one d i s t r i c t - when not followed in another - might cause the l a t t e r some embarrassment in a particular case in explaining why when i t had the same right i t had not taken the same precaution. Nevertheless, I do not believe one d i s t r i c t should be prohibited from taking the collateral because some other d i s t r i c t did feel j u s t i f i e d in so doing. In addition to the foregoing reasons for not taking the collateral in the 8th D i s t r i c t , we have MISSOURI and ARKANSAS by j u d i c i a l decisions, KENTUCKY by p r a c t i c e , and, INDIANA'by Statute, allowing preference on trans i t items in the case of State banks, so that the loss to the owners of t r a n s i t items in this District has been a negligible quantity. Therefore, I would not like to recommend that we adopt a policy in this D i s t r i c t of taking such c o l l a t e r a l . Very truly yours, (S) Jas. G. McConkey, Counsel. FEDERAL RESERVE BA1IK OF ST. LOUIS COPY X-6438-1 November 15, 1929. Mr. Wm. Mc C. Martin, Governor, Federal Reserve Bank of St. Louis, St. Louis, Missouri. Dear Mr. Martin: EE:- Interpretation of Conference Policy re Check Collection Topic for Governors' Conference. Attached is. copy of a l e t t e r X - 6 4 0 9 - T d from Governor Harding of the Federal Reserve tank of Boston to Governor Young of the Federal Reserve Board relative to the Board's l e t t e r X - 6 3 8 9 attached hereto, and, copy of a l e t t e r X - 5 4 0 9 - 6 from the Board's Counsel to Counsel of the Federal reserve banks. Governor Harding inquires whether the policy outlined in the Board' l e t t e r would prohibit banks making special arrangements in special cases to take colla teral to insure the payment of t r a n s i t items, p a r t i c u l a r r e f e r ence being made to paragraph 4 of Section V of Regulation *J* as amended, and, which i s as follows: "(4) Checks received by a Federal reserve bank on i t s member or non-member clearing banks rrill ordinarily be forwarded or presented direct to such banks and such banks will b'e required to remit or pay therefor at par in cash, by bank d r a f t s acceptable to the collecting Federal reserve bank, by telegraphic transfers of bank credits acceptable to the collecting Federal reserve banks, or by authorizing the collecting Federal reserve bank to charge t h e i r reserve accounts or clearing accounts." At the Conference of Counsel, we had before us the EARLY case involving the right to charge a t any time the member banks 1 account with the unremitted for cash l e t t e r s , and, STORING vs. FIRST NATIONAL BAM of MINNEAPOLIS case involving the right to use the general c o l l a t e r a l furnished by the closed member to pay unremitted for cash l e t t e r s . After a general discussion, i t was found that Counsel for four of the Reserve banks favored the following of the rule as laid down in these cases - this plan was (for convenience) designated Policy A. Counsel for the"other eight Reserve banks objected to this plan, and, offered another plan designated Policy B. With this division before us, the following Resolution was offered: "RESOLVED, That i t be the sense of this conference that uniformity among a l l the Federal reserve banks in the treatment of reserve balances, collateral accounts and the cash surrender value of capital stock in relation to outstanding cash items, i s desirable and that whether the policy outlined by Messrs. Ueland and Wallace on the one hand or the policy outlined by Mr. Stroud on the other hand be adopted, — 2 *• X-6458-1 FEDERAL RESERVE BAH OF ST. LOUIS the action of a l l of the Federal reserve "banks in relation to the matter under discussion should "be of one accord." Mr. Logan moved, as an amendment to the Resolution, that a l l of the Resolution a f t e r the word "desirable" he eliminated. The amendment was unanimously carried. (Page 2 of the Minutes.) Policy B. favored hy Counsel for eight of the Federal reserve "banks was then presented, and, a f t e r a general discussion resulting in some changes in i t s verb age, Mr. Agnew moved i t s adoption. Mr. Weed, of Boston, moved as a substitute that a reservation be included therein giving the right to any Federal reserve bank in special or exceptional cases to charge unremitted for cash l e t t e r s to collateral taken for that specific purpose. Mr. Weed's motion was lost by a three to five vote of the eight Counsel favoring Policy B. Mr. Agnew's original motion then carried by a vote of eight to four - Messrs. Weed, Logan and Stroud explaining that they voted for Policy B plan with the understanding that the report of the Committee was not intended to carry with i t any implication that a Federal reserve bank might not in special cases make arrangements to insure the payment of t r a n s i t items. Counsel for Philadelphia, Richmond, Chicago and Minneapolis not voting - presumably for the reason that they were not in accord with Policy B with or without the"reservation. The real question before the Conference u n t i l Mr. Weed's substitute motion was confined to the advisability of using any of the member banks' reserve, capital stock or general collateral for the payment of t r a n s i t items. Mr. Weed's substitute motion raised the question of the right of the Reserve banks to take special collateral in partiou l a r cases to insure the payment of transit items, and, while Mr. Weed's substitute motion lost by a vote of 3 to 5, nevertheless, Policy B plan, as recommended, was adopted as expressing the views of the majority, with the explanation of the three favoring the Weed substitute that they voted for the report with the •understanding that the report of the Committee i s not intended to carry any implication that a Federal reserve bank may not make special arrangements to insure the payment of transit items in special cases. I t would, therefore, follow that no implication against taking collateral in a special case was intended when Policy B was adopted as representing the views of those voting in favor of the policy. Sirther, i t i s reasonable to assume that if the four Counsel who favored policy A had voted they would have joined the three on the reservation clause, making a total of seven of the twelve Counsel favoring such a reservation, the motion to adopt Policy B without the reservation would have lost by a vote of five to seven. Therefore, Policy B as recommended by the Conference of Counsel approved by the Conference of Governors and adopted by the Board was not intended to prohibit a Reserve bank in a special case to take collateral to insure the payment of transit items. - 3 - X-6438-1 EBDEBAL RESERVE BANK OF ST. LOUIS ADVISABILITY OF TAKIITG SUCH COLLATERAL. Now as to the advisability of taking special collateral to insure the payment of t r a n s i t items, this raises a more d i f f i c u l t question than the interpretation of the meaning intended in Paragraph 4 of the Regulation. I can find no legal obstacle to a Federal reserve "bank in i t s agency r e l a t i o n taking such collateral to insure the payment of t r a n s i t items, and, whilst a uniformity in a l l Reserve "banks i s des i r a b l e , nevertheless, when we attempt to formulate a plan to govern a l l d i s t r i c t s a l i k e , and, wherein the controlling factors in the several d i s t r i c t s are so unlike in many respects, a uniform ruling to be followed seems impracticable. For example, in the Boston and Me? York or other thickly populated d i s t r i c t s where the member and the non-member clearing banks and the non-member par banks to which items must be sent through the mails, the banks are larger and stronger than in the sparcely s e t t l e d a g r i c u l t u r a l d i s t r i c t s and the instances are fewer where they would have to t&lce such protection to secure the payment of t r a n s i t items. Whereas, in the agricultural d i s t r i c t s , we have a much larger number of small member, non-member clearing banks, and par banks, a l l in about the same but none too liquid condition, and, i f we required c o l l a t e r a l from one, to be consistent, we would have to call for the collateral from a much greater percentage of such banks than would Reserve banks in the more thickly populated d i s t r i c t s , and, doubtless, these requirements would lesson the number of our par non-member banks. Further, in the Boston and New York and other thickly settled d i s t r i c t s , p r a c t i c a l l y a l l the banks are located in towns on main mail routes and within a short time schedule from the Reserve banks. Consequently, i t would seldom occur that there would be more than one cash l e t t e r sent out before the returns from the previous cash l e t t e r s had been received. Therefore, the amount of collateral to be required would be less than i t would be in a sparcely s e t t l e d agricultural dist r i c t where a large number of the banks are located in the country, or in small towns off the main tiiail routes and where we have 3 to 5 day points, and, frequently, 3 or 4 cash l e t t e r s will have been sent out before the receipt of the remittance for the previous cash l e t t e r s could be received; consequently, the amount of collateral necessary would be out of proportion to the banks' a b i l i t y to furnish i t , and, i f demanded, might place a small, liquid, solvent bank in a very embarrassing position. - 4 - X-6438-1 FEDERAL RESERVE BAM OF ST. LOUIS Farther, i t has "been our observation that when a member bank reaches a condition where i t i s getting into the danger zone, and we would feel j u s t i f i e d in asking for collateral to protect the cash l e t t e r s , i t already has under rediscount with us p r a c t i c a l l y a l l i t s e l i g i b l e paper, and, i f i t s rediscounts with us i s as ;mch as i t s capital and surplus i t has deposited with us as extra collateral to secure i t s dis-*count obligations and with i t s correspondent banks on advances made, p r a c t i c a l l y a l l i t s liquid and most of i t s slow paper so that the only c o l l a t e r a l these small banks could supoly would be of very doubtful value, and, i f re were to require the banks to put up with us liquid c o l l a t e r a l s u f f i c i e n t to protect the average outstanding cash l e t t e r s , we would, in a great many cases, be taking from the bank the only class of paper on which i t could secure advances s u f f i c i e n t to carry i t over a d i s t r e s s period, and, might thereby, be a party in some cases to forcing an otherwise solvent bank into liquidation. Taking the foregoing reasons into consideration, I do not believe i t would be desirable to follow such a procedure in the Eighth D i s t r i c t however desirable i t might be in some of the other districts. Very truly yours, (S) Jas. G. McConkey, Counsel. COPY X-6438-a LAW OFFICE U3LA2TO AND UELAilD 401 New York Life Building, Minneapolis. November 22, 1929. Governor W. B. Geery : Oar comments on Governor Harding's l e t t e r of October 19th to Governor Young, and Mr. Wyatt's l e t t e r of November 7th, both dealing with the recent amendment to Regulation J follow: 1. Governor Harding states that a Federal reserve bank in collecting checks as agent may be, as a practical matter, under compulsion to forward checks to drawee banks in dubious circumstances. He urges that i n such cases the Federal reserve bank i s at l i b e r t y to protect i t s e l f as agent and i t s principals ( the owners of the checks) by taking c o l l a t e r a l . This argument from practical necessity was advanced at the j o i n t meeting of governors and counsel in support of the view (which has now been put on the shelf) that the Federal reserve clearing houses should furnish as much security as practicable to the owAers- of checks. 2. The f i r s t question i s , can the right asserted by Governor Harding be reconciled with the recent amendment of paragraph 6 of Section V of Regulation J? I t i s argued that Regulation J in i t s present form does not prohibit a Federal reserve bank from taking c o l l a t e r a l in such cases. This argument may be paraphrased thus : A Federal reserve bank collects checks as agent. The reserve account, the Federal reserve stock, and the coll a t e r a l held by the Federal reserve bank in i t s own right cannot be held as security for the l i a b i l i t y of drawee banks to remit for or return checks to the Federal reserve bank. W. B. Gr&ery 2. Nov. 22, 1929. X—6438—a That much i s s e t t l e d by the amendment to Regulation J . But notwithstanding that amendment a Federal reserve bank may i n a s p e c i f i c case require and take collateral to secure l i a b i l i t i e s running to the Federal reserve bank as a collection agent for the owners of the checks. 3. In order to test the v a l i d i t y of this argument we will suppose such "a s p e c i f i c case". A drawee bank suspends payment with- out remitting for or returning checks forwarded to i t by a Federal reserve bank. But the Federal reserve bank has taken a pledge of Liberty Bonds to secure such a remittance. Paragraph 5 of Section V of Regulation J as amended reads in p a r t : "neither the owner or holder of any such checks shall have any right of recourse upon, i n t e r e s t payment from, any fund, reserve, c o l l a t e r a l , or property of the drawee in the possession of the reserve bank." *** in, or other Federal Now in the face of this very plain English can the owners of the checks assert successfully that they are secured by the Liberty Bonds? In our opinion, they cannot. 4. I t i s obviously the language of the Regulation and not the language employed in the majority resolution of counsel which will control the action of the courts. Hence a Federal reserve bank would hardly be j u s t i f i e d in proceeding contrary to the meaning of the Regulation in reliance upon language used or reservations made a t the conference of counsel. But i f i t were, how could i t have been intend- ed by the majority of counsel that the rights of security which the Federal Reserve Bank of Minneapolis had been asserting for years on behalf of i t s principals were i l l e g a l preferences (see paragraph 6 of the majority r e p o r t ) , whereas the security which the Federal Reserve Hov. 22, 1929. W. 33. G-eery 3. X-6438-a Bank of Boston, now proposes to take is not only proper "but i t s tak«* . ing commendable? The right asserted by Governor Harding i s not, in our opinion, consistent with the majority resolution adopted a t the conference of counsel. 5. If Governor Harding's views are concurred in by the Board the language of Paragraph 6 of Section V of Regulation J could be revised, before i t takes e f f e c t on January 1, 1930, so as to give the Federal reserve banks the desired l a t i t u d e . To our minds the only question i s whether this revision i s advisable. $6 this con- nection we quote from our l e t t e r written to Mr. Wyatt under date of May 1, 1929: "If Regulation J i s to be amended so as to make l i a b i l i t i e s f o r unremitted for t r a n s i t items unsecured l i a b i l i t i e s , but !?ith the option to the Federal reserve banks to take s e c u r i t i e s in special cases, then we hope that the exceptional cases in which securities may be taken will be defined with as great accuracy as possible. In the l i g h t of i t s own experience the Minneapolis bank would probably want to go as f a r in this direction as an honest interpretation of Regulation J would permit.® • If in special instances a Federal reserve bank can exact security from a drawee bank, there i s no legal reason which we are aware of way that security may not consist of any of the drawee bank's a s s e t s . The security may be in the form of a pledge of bonds or customer's notes. But i t may equally be in the form of a secondary lien on c o l l a t e r a l which the Federal reserve bank already holds in i t s own r i g h t , or, i f you please, a secondary lien on the reserve balance at the time of suspension. We do not see why Governor Harding's bank could not exact one kind of security just as properly as i t could W. B. Geery 4. another. Nov* 22, 1929. X—6438—a Indeed i t would be less of a "burden on the drawee bank i f i t were permitted to hypothecate assets already in the hands of i t s Federal reserve bank, than to require i t to deposit two separate and d i s t i n c t funds to be held as c o l l a t e r a l by the reserve bank, one fund as security for obligations to "the reserve bank in i t s own r i g h t , the other as security for the principals of the reserve bank. In the l a t t e r case the drawee bank would have- to part with a greater amount of s e c u r i t i e s . We understand Mr. Wyatt to suggest that any arrangement by which the same c o l l a t e r a l i s taken to secure indebtedness owing to the Federal reserve bank in i t s own right and a t the same time to protect i t against losses in i t s capacity as a collection agent would produce confusion or conflict between the s e l f i s h i n t e r e s t s of a Federal reserve bank and i t s duties as a collection agent. We doubt whether this i s so, but i f i t were, the same objection may be made to the proposal to permit a Federal reserve bank to create two d i s t i n c t collateral funds. The question could always a r i s e , why was ae much collateral placed in the " b i l l s payable" envelope and so l i t t l e in the "collection agent" envelope, etc. etc. 6. Accordingly i f Regulation J were amended so as to permit a Federal reserve bank to take security "in special cases", Federal reserve banks would find themselves limited only by the embarrassing question of what i s "a special case". What i s a special case? A conservative o f f i c e r of a Federal reserve bank would probably consider that every bank which was not in an impregnable financial posi- W. B. Greery - #5 Nov." 22, 1929. X-6438-a tion was a special case. 7. With the right open to a Federal reserve hank to take security for their principals under special circumstances, we think a court might fasten on this as a "basis for l i a b i l i t y on the part of a reserve hank i s a case where security might have been, hut was not, taken. If the e f f e c t of Regulation J should he that security may be taken in exceptional cases, then an obligation to act in the exceptional- case might well arise out of the fiduciary relationship which everyone concedes the Federal reserve banks occupy to their depositors. Hence an exception ot reservation in Regulation J would create doubt and uncertainty, instead of clarifying the extent of the duty owed by the Federal reserve banks to their depositors, which everyone a t the conference seemed to agree was the principal objective to be attained. A Federal reserve bank dannot foresee in advance how much checks received by i t for collection on a given bank will aggregate at any one time. Taking collateral would be tantamount to a declaration by the reserve bank that i t considered the drawee bank unsafe. This would prove embarrassing i f the checks received on that bank exceeded the amount or value of the c o l l a t e r a l . Likewise taking col lateral in special instances would, we anticipate, give r i s e to charges of favoritism and discrimination on the part of the reserve bank, a l l of which would be unpleasant even though untrue. As a uniform policy has now been adopted by the conference of Governors and approved by the Federal Reserve Board, our conclusions are as follows: * 269 W. B. Geery - #6 ITov, 22, 1929. X-6438-a (1) I t i s our opinion that that policy as now expressed in Paragraph 6 of section V of Regulation J does not permit a Federal reserve bank acting as a collection agent to take c o l l a t e r a l in special cases, (2) I t i s our opinion that as long as this uniform policy i s maintained i t would create confusion and uncertainty a,s to the legal r i g h t s , duties, and l i a b i l i t i e s of the Federal reserve to make ex~ ceptions or reservations which would permit taking collateral in special cases. (Signed) (Signed) A. Ueland Counsel. Sigurd Ueland • Assistant Counsel.)
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