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X-6737 2 7 8 TE13 DISCOUNT BATE CONTROVERSY BETWEEN THE FEDERAL ±C2ERVE BOARD and THEffSEEBALRESERVE BANK OF NSW YORK — M o v e nib e r , 1930. The Federal Reserve Bank of New York, i n i t s Annual Report f o r the year 1929, s t a t e d : "For a number of weeks from February to May, 1929, the D i r e c t o r s of the Federal Reserve Bank of New York voted an i n c r e a s e i n the discount r a t e from 5$ to 6$. This i n c r e a s e was not approved by the Board,/' Annual Report, Page 6. -2- The above statement makes c l e a r the e r r o r of the p r e v a i l i n g view t h a t the discount r a t e controversy l a s t e d from February 14, 1929, - the date of the f i r s t a p p l i c a t i o n for i n c r e a s e i n discount r a t e s , to August 9, 1929, the d a t e of the Board's approval of the i n c r e a s e from 5$ to 6 f o . The controversy began on February 14, 1929, b u t p r a c t i c a l l y ended on May 31, 1929. On May 22, 1929, Governor Harrison and Chairman McGarrah t o l d the Board t h a t while they s t i l l d e s i r e d an i n c r e a s e to 6$, they found t h a t / the member banks, under d i r e c t p r e s s u r e , feared to i n c r e a s e t h e i r borrowings, and t h a t they wanted to encourage them to borrow to meet the growing demand f o r commercial l o a n s . 16 Diary 76 ( 6 9 ) . Furthermore, on May 31, 1929, Chairman McGarrah wrote to the Federal Reserve Board t h a t the control of c r e d i t without i n c r e a s i n g discount r a t e s X-6737 — 2 "~ ( d i r e c t p r e s s u r e ) had created u n c e r t a i n t y ; t h a t agreement upon a program t o remove u n c e r t a i n t y was f a r more important than the discount r a t e ; t h a t i n view of recent changes i n the "business and c r e d i t s i t u a t i o n , h i s d i r e c t o r s b e l i e v e d t h a t a r a t e change now without a mutually s a t i s f a c t o r y program, might only aggravate e x i s t i n g tendencies; t h a t i t may soon he necessary to e s t a b l i s h a l e s s r e s t r i c t e d discount p o l i c y i n order t h a t the member banks may more f r e e l y borrow f o r the proper conduct of t h e i r b u s i n e s s ; t h a t the Federal r e s e r v e bank should be prepared to i n c r e a s e i t s p o r t f o l i o i f and when any r e a l need of doing so becomes a p p a r e n t . 195 - 65. On June 5, 1929, Mr. Mitchell came b e f o r e the Board and urged a more l i b e r a l discount p o l i c y and an easing of c o n d i t i o n s by purchase of b i l l s and Government s e c u r i t i e s , leaving the discount r a t e a t 5$, to be i n c r e a s e d only i f s p e c u l a t i o n should r e v i v e , 16 Diary 99, 100 (198). The Federal Reserve Board, as h e r e i n a f t e r pointed out, on June 12, 1929, expressed a w i l l i n g n e s s to suspend d i r e c t a c t i o n i n view of t h e need of more Federal r e s e r v e c r e d i t , t h e 5$ r a t e , however, to be continued for the p r e s e n t , a t l e a s t . 16 Diary 108, 109 (76). -3I t i s the purpose of t h i s a r t i c l e to examine i n t o the f a c t s connected with t h i s controversy, and the divergence of opinion between t h e Board and the Federal Reserve Bank, of Hew York as to the proper Federal r e s e r v e policy* X-6737 -4- - 3 -i The annexed t a b l e shows the discount and acceptance "buying r a t e s of the Federal Reserve Bank of Hew York p r i o r to and since the controversy: Discount Rates 1927 August 5 Acceptance Buying Bates 60 to 90 days 1927 August 5 3J1 1928 May 18 J u l y 13 1929 3-3/8% H 33-?/44 4H S/°. 1929 November 1 November 15 January 4 January 21 February 15 March 21 March 25 July 12 August 9 October 25 November 1 November 15 November 22 6% W> February 11 February 24 March 5 March 6 March 11 March 14 March 19 March 20 May 1 • May 2 — 3-gi& 31o i—1 CO CD 2hi 11 l June 20 5-l7W 5# June 5 June 20 J u l y 21 3fi 3-5/8i 3l-< 3-3/8^ 31< H May 2 5-] 5-3/8% 5M 1930 February 7 March 14 jJJL <2 August 9 1930 M- 1928 January 27 February 3 March 30 A p r i l 13 May 18 J u l y 13 J u l y 20 February 3 2 8 0 3i 2-7/8$ — 2-5/8# 2¥k m 2I 1 - 7 / 8 to X-6737 -5- 2 8 1 4: The following shows the important dates i n connection with the controversy: 1928. September 28: The Federal Advisory Council opposed any i n c r e a s e in rates. November 22; The Federal Advisory Council opposed any i n c r e a s e i n r a t e s because of i n j u r y to business* 1929. January 19: Dr. Miller t o l d Board the Federal Reserve System was d r i f t i n g and t h a t r a t e i n c r e a s e was necessary to e f f e c t a curbing of s p e c u l a t i o n ; t h a t the r e a l l y courageous way would be a p u b l i c announcement t h a t c r e d i t i n the f u t u r e would be a v a i l a b l e a t reasonable r a t e s for a g r i c u l t u r e and business* but t h a t the Board would watch the r i s e i n discounts and prevent seepage i n t o Wall S t r e e t . 15 Diary 129, 130 (152). January 21: Dr» M i l l e r introduced a d r a f t of a l e t t e r to a l l Federal r e s e r v e banks suggesting d i r e c t p r e s s u r e on the member banks* 15 Diary 150 (152). January 25: Chairman McG-arrah informed the Board t h a t h i s d i r e c t o r s were considering i s s u i n g a p u b l i c warning to corporations which were loaning i n Wall S t r e e t t h a t they were i n j u r i n g the Federal Reserve System, and i n t h i s warning to i n clude an i n t i m a t i o n that the c o l l a t e r a l behind these loans might prove not to be l i q u i d . 15 Diary 134 (152). January 25: Chairman McG-arrah o b j e c t e d to the proposed l e t t e r to the Federal reserve banks on ground t h a t i t would be cons t r u e d as a blow a t the stock market. 15 Diary 134 (153). February 2; Dr. M i l l e r ' s motion was passed, some changes having been made in the l e t t e r . 15 Diary 143, 144 (154). X-5737 - 5 - 1929 ( C o n t ' d . ) . February 2: The executive o f f i c e r s of the Federal Reserve Bank of ITew York favored an i n c r e a s e i n discount r a t e s but t h e r e was o b j e c t i o n i n the Board of D i r e c t o r s . 15 Diary 143 (44). February 5: The Board sent l e t t e r s to a l l Federal r e s e r v e banks p o i n t ing out the seepage of Federal r e s e r v e c r e d i t i n t o s p e c u l a t i v e channels and asked how they kept informed of the use made of the proceeds of r e d i s c o u n t s , the methods employed to r e g u l a t e the abuse and how e f f e c t i v e the methods had been. . 187 107. February 5: : Governor Harrison informs the Board t h a t an i n c r e a s e i n discount r a t e s i a necessary; t h a t d i r e c t a c t i o n as to banks "out of l i n e " had proved a f a i l u r e . 15 Diary 149, 150, 151, 154 (46) February 7: P u b l i c warning of Federal Reserve Board r e l e a s e d to p r e s s . , This w i l l be r e f e r r e d to in some d e t a i l l a t e r . 187 - 113. Governor Harrison informs Board t h a t h i s d i r e c t o r s a r e considering an i n c r e a s e i n discount r a t e s . 15 Diary ISO (47). February 11: The New York d i r e c t o r s met but took no a c t i o n as to i n c r e a s i n g discount r a t e s . 15 Diary 165 ( 4 8 ) . February 14: The Federal Reserve Bank of Mew York a p p l i e d f o r approval of an i n c r e a s e t o 6$ on condition t h a t the Board immediately a c t on t h e same. This was the f i r s t a p p l i c a t i o n f o r an increase,. I t was disapproved by the Board, as a l s o were s i m i l a r a p p l i c a t i o n s made March 3, March 21, March 28, A p r i l 4, A p r i l 18, April 25, May 9, May 16, and May 23. 2 8 3 X-3737 1929. ( C o n t ' d . ) February 15: The Federal Advisory Council met and approved the Board's warning published February 7, but advised the Board to go f u r t h e r and obtain the cooperation of member banks to prevent the d i v e r s i o n of Federal r e s e r v e c r e d i t to "loans on s e c u r i t i e s " g e n e r a l l y , - meaning customers security loans. 15 Diary 173, 174 (51). The Federal Advisory Council f u r t h e r advised the Board not to approve any i n c r e a s e of discount r a t e s u n t i l the Board's e f f o r t s along the l i n e s of d i r e c t p r e s s u r e had been exhausted. The Council, when making i t s recommendations, did not know of the a c t i o n of the Federal Reserve Bank of Hew York i n recommending an i n c r e a s e i n discount r a t e s the day b e f o r e . 15 Diary 175, 176 (52). March 21: Governor Young suggests a conference as to discount r a t e s with t h e Hew York d i r e c t o r s . Governor Harrison r e p l i e d Yes but discount r a t e s must f i r s t be i n c r e a s e d . A p r i l 4: The Governors Conference, accepting the d e s i r e of Boston, New York, and Chicago f o r an i n c r e a s e to &fo, favored a r a t e not l e s s than bf> f o r the other Federal reserve banks. 16 Diary 15 (58). April 19: The Federal Advisory Council reverses i i s recommendation of February 15 and advises an i n c r e a s e a t Mew York to 6$. May 1: Report of Committee on r e c e n t economic changes. Rather " b u l l i s h " i n i t s optimism. Fothing much to worry about. The degree of progress in recent years i n s p i r e s us with high hope. May 17: The Federal Reserve Bank of Cleveland passes a r e s o l u t i o n favoring an i n c r e a s e i n the Hew York discount r a t e to 6$ to curb s p e c u l a t i o n . 16 Diary 64 (97)'. 1929. ( C o n t ' d . ) May 21: The Federal Advisory Council re commends an i n crease to Sfo. 16 Diary 15 (58). 16 Diary 25 (91). May 22: May 29: Governor Young p o i n t s out t h a t Federal Reserve Bank of Hew York has not mentioned an i n c r e a s e i n buying r a t e s for acceptances i n connection •with an i n c r e a s e of discount r a t e s ; t h a t with a 5fo discount r a t e , acceptance r a t e s remaining a t 5 a c c e p t a n c e s would flow i n t o the Fede r a l Reserve Bank. New York suggests a conference of a l l Federal r e s e r v e hanks as n a t i o n a l questions a r e i n volved. x6 Diary 91 (92). May 31: Chairman McGarrah w r i t e s Board asking i t to take up a program f o r encouraging member "banks to i n c r e a s e t h e i r borrowings. 195 - 81. June 3: D i r e c t o r Mitchell of Hew York t o l d the Board t h a t the market should he eased by buying b i l l s or Government s e c u r i t i e s ; t h a t the discount r a t e should remain a t 5$ and t h a t a more l i b e r a l discount p o l i c y should be adopted. 16 Diary 100 (74). June 12: The Federal Reserve Board, a f t e r a conference between i t s Committee and the d i r e c t o r s of the Federal Reserve Bank of Hew York, s e n t a l e t t e r to Chairman McGarrah i n d i c a t i n g a w i l l i n g ness to suspend d i r e c t p r e s s u r e , except as to a few f l a g r a n t cases of continuous borrowing, X-6757 1929. ( C o n t ' d . ) June 12: ( C o n t ' d ) . the 5jo r a t e , however, to continue f o r the p r e s e n t . 16 Diary 108, 109 ( 5 4 ) . J u l y 16: D i r e c t o r Mitchell t o l d Dr. Miller t h a t an easing p o l i c y was a b s o l u t e l y necessary, although he s a i d t h a t Governor Harrison s t i l l favored an i n c r e a s e i n the discount r a t e * 1C Diary 132 (199). August 2i Governor Harrison came "before the Board and favored an easing p o l i c y through purchases of M i l ? , Government s e c u r i t i e s , or "both i f necessary. While he a l s o asked f o r an i n c r e a s e i n discount r a t e s to 6fo, he s t a t e d t h a t t h i s would merely a c t as a "barrage which would make the acceptance "buying r a t e (then 5 ^ ) lower than the discount r a t e , thus i n c r e a s i n g the flow of acceptances i n t o the Federal r e s e r v e "bank and would, a t t h e same time* induce the member banks to use p a r t , a t l e a s t , of the money received from the s a l e of acceptances f o r r e d u c t i o n of t h e i r r e d i s c o u n t s . 16 Diary 149 (80). August 7: The Governors, i n conference, favored an easing p o l i c y as recommended by Governor Harrison, but through purchase of acceptances r a t h e r than Government s e c u r i t i e s , and approved h i s suggestion of an i n c r e a s e to a t Hew York but on the unders t a n d i n g and t h e i r assurance t h a t the 5'jo r a t e would be maintained a t the other Federal r e s e r v e banks. 16 Diary 152, 155 (81). August 8; The Board approved the p o l i c y as o u t l i n e d by the Governors. 16 Diary 153 ( 8 1 ) . August 8: The Board approved a r e d u c t i o n of the buying r a t e on acceptances from 5^ to 5-1/8$; X-6737 -5— — 9 — Having o u t l i n e d the important dates involved, v/e can now consider the d i f f e r e n c e as to discount p o l i c y which arose between the Federal Reserve Board and the Federal Be serve Bank of Hew York, The Board had anxiously observed the wave of s e c u r j t y s p e c u l a t i o n sweeping ever t h e country, and during the year 1928 three i n c r e a s e s of discount r a t e s and three i n c r e a s e s of acceptance buying r a t e s had been approved, v i z : - i n discount r a t e s , to 4$ on February 3, to 4 o n May 18, and 5$ on J u l y 13, while acceptance buying r a t e s had been s e v e r a l times i n c r e a s e d , being 4 o n J u l y 25, 1928. In 1929 acceptance buying r a t e s were incre ase d from 4 o n 4 , to January fa on March 25. Between February 15, 1928 and February 13, 1929, the System had sold 231 m i l l i o n s , n e t , of Government s e c u r i t i e s , and money i n c i r c u l a t i o n had been reduced 16 m i l l i o n s . -7~ Between J u l y 13, 1928, - the date of the e s t a b l i s h m e n t of the 5$ r a t e a t New York, - and February 14, 1929, - the date of the f i r s t a p p l i c a t i o n of New York f o r an i n c r e a s e to 6$, a p e r i o d of seven months, no change i n the discount r a t e was suggested by the Federal Reserve Bank of Mew York. I t w i l l be i n t e r e s t i n g to consider the course of Federal r e s e r v e c r e d i t during t h i s p e r i o d of seven months. X-S7C7 - f 2 8 10 - As above p o i n t e d out, "between January 1 and J u l y IS, 1929, t h e r e had been t h r e e i n c r e a s e s i n discount r a t e s , and the System had sold about 400 m i l l i o n s of Government s e c u r i t i e s , under a Federal r e s e r v e p o l i c y of firming conditions, approved by the Federal Advisory Council, the Open Market Committee, and by the Beard# On August IS, 1929, the Federal Reserve Bank of How York r e p r e s e n t e d to the Board t h a t seasonal requirements might produce some c r e d i t s t r a i n which might r e a c t on business and commerce, and the Board s t a t e d t h a t i n such event i t would permit easing of the market by b i l l purchases, and t h a t i t would f u r t h e r , i f a b s o l u t e l y necessary, permit the purchase of Government s e c u r i t i e s up to the l i m i t of 100 m i l l i o n s . The Federal Reserve Bank of Hew York net the seasonal c r e d i t demand, as a u t h o r i z e d by the Federal Reserve Board, by the purchase of acceptances, s u b s t a n t i a l l y no Government s e c u r i t i e s being bought. I t was c l e a r l y under- s t o o d , however, t h a t Federal r e s e r v e p o l i c y p e r m i t t e d these acceptance purchases merely f o r the purpose of meeting c r e d i t s t r a i n , should such strain arise. As a f a c t , however, the Federal Reserve Bank of Hew York a c t i n g f o r the other banks as w e l l , between J u l y and November, 1928, i n c r e a s e d t h e i r holdings of acceptances by 286 m i l l i o n d o l l a r s . That t h i s amount was f a r beyond any p o s s i o l e need of increased c r e d i t , i s shown by the f a c t t h a t l a r g e l y out of the proceeds of these s a l e s the member banks not only met a l l seasonal c r e d i t demands, but a c t u a l l y paid off about 193 m i l l i o n s of t h e i r r e d i s c o u n t s • As a r e s u l t of these purchases, helped i n small X-6737 ^ — 11 — degree "by gold imports r a t e s on "bills and on commercial paper, as well as customers r a t e s , a c t u a l l y declined, c o n t r a r y to the u s u a l seasonal trend# Member "bank reserve "balances i n c r e a s e d 28 m i l l i o n s , and loans on s e c u r i t i e s of reporting member ba;:ks i n c r e a s e d 127 millions* There -rould seem to be no p o s s i b l e doubt "but t h a t t h i s l i b e r a l p u r chase of t i l l s i n excess of c r e d i t needs wv,s a f a c t o r ' n the r e v i v a l of s p e c u l a t i o n and i n the growth of "brokers l o a n s . JLs a f a c t , the p u r - chase of acceptances had been on such a l i b e r a l s c a l e t h a t the Federal r e s e r v e banks h e l d f o r t h e i r own account. and f o r account of t h e i r f o r e i g n correspondents, about two-thirds of the t o t a l volume of outstanding acceptances. The above f a c t s are brought out c l e a r l y i n the Annual Heport of the Board f o r 1928* F u r t h e r , during t h i s period from June to November. 1928, s t o c k p r i c e s increased from an average based on 1926 f i g u r e s , of 150.5 to 192,1; stock s a l e s i n c r e a s e d from 11,6 m i l l i o n s to 23.3 m i l l i o n s ; brokers loans of the New York banks i n c r e a s e d : (a) f o r own account 176 m i l l i o n s , (b) f o r other banks 205 m i l l i o n s ; (c) "for others" i n c r e a s e d 488 m i l l i o n s the t o t a l i n c r e a s e of a l l these loans being 870 m i l l i o n s . There i s annexed hereto a t a b l e showing the course of Federal r e serve c r e d i t from J u l y to November, 1928, giving both i t s composition and the r e l a t i v e f a c t o r s f o r i n c r e a s e and decrease; X-S737 - 12 - Federal Reserve Credit. J u l y to November, 1928. Composition Discounts Acceptances U. S. -Securities Other F.H. c r e d i t Total I n c r e a s e - 193 285 4. 25 + 4 315 * + 193 122 Factors For i n c r e a s e Money i n c i r c u l a t i o n Unemployed c a p i t a l funds Non-member "bank d e p o s i t s Member "bank r e s e r v e s For decrease + 114 + 21 + 2 j. J- 28 165 Treasury funds Monetary gold + 5 •* 38 .+ 43 » 122 Increases F. B. c r e d i t i n c r e a s e Monetary gold " Treasury currency 122 38 5 Deductions Member bank r e s e r v e balancus_ Money i n c i r c u l a t i o n Unemployed c a p i t a l funds ITon-member bank d e p o s i t s 28 137 114 23 21 2 2 The e f f e c t of t h e s e acceptance purchases was to n u l l i f y the e f f e c t of the i n c r e a s e of the discount r a t e to 5$ made on J u l y 13, 1928, and to change Federal reserve p o l i c y from one of firming to one of easing the market. X-5737 - I S - The above i s confirmed by Deputy Governor Burgess of the Fede r a l Reserve Bank of iIe-7 York, who s t a t e d i n an address b e f o r e the American Acceptance Council, December 11, 1928: "The Talcing by the Federal ..-•••serve banks of b i l l s o f f e r e d involved p u t t i n g i n t o the money market something l i k e 100 nr.llions of d o l l a r s more than s e a sonal c r e d i t needs r e q u i r e d , which was used by the member banks to l i q u i d a t e p a r t of t h e i r indebtedness, and t h i s tended, i n conjunction with gold imports, to ease s l i g h t l y the money s i t u a t i o n . " I t i s i n t e r e s t i n g to note t h a t on December 15, 1928, Dr. Miller introduced a r e s o l u t i o n favoring higher acceptance buying r a t e s . This r e s o l u t i o n , however, f a i l e d , but was voted f o r by Dr. M i l l e r , P i a t t , and C.S.H. 15 Diary 115 (149). Such was the s i t u a t i o n c o n f r o n t i n g the Federal Reserve Board a t the beginning of January, 1929, I t found t h a t i t s f i r m i n g p o l i c y , agreed upon by the Federal Advisory Council and the Open Market Committee, had i n f a c t been changed by the Federal Reserve Bank of Hew York i n t o an easing p o l i c y . Federal r e s e r v e c r e d i t outstanding i n January, 1929, was some 226 m i l l i o n s g r e a t e r than i n January, 1928. There was danger t h a t the customary l i q u i d a t i o n a f t e r the f i r s t of the year might not take p l a c e and t h a t Federal reserve c r e d i t outstanding would X-6737 - 14 i n c r e a s e i n 1929 r a t h e r than decrease, j u s t as i t i n c r e a s e d •between January and May, 1928. In t h i s connection i t should "be j o i n t e d out t h a t f o r the year ending June 30, 1929, 1,114 ba^ks were "borrowing f o r 80fo or more of the time. 135 - 143. The problem confronting the Board was how to b ring ah out a reasonable l i q u i d a t i o n of Federal r e s e r v e c r e d i t s i t h o u t , a t the same time, i n j u r i n g a g r i c u l t u r e and "business. A f t e r most c a r e f u l c o n s i d e r a t i o n , the Federal Reserve Board determined to keep the p r e s e n t 5^ r a t e unchanged Vat to t r y to reduce outstanding Federal r e s e r v e c r e d i t "by b r i n g i n g d i r e c t p r e s s u r e , through the Federal r e s e r v e banks, upon the member banks to b r i n g about a reasonable l i q u i d a t i o n of t h e i r s p e c u l a t i v e l o a n s , or a t l e a s t not to i n c r e a s e them, and to t h i s end reduce, or a t l e a s t not i n c r e a s e , t h e i r borrowings from the Federal r e s e r v e bank to support t h e i r r e q u i r e d r e s e r v e s a g a i n s t d e p o s i t s a r i s i n g out of these s p e c u l a t i v e l o a n s . On February 2, 1929, the Board sent a l e t t e r to a l l Federal r e serve banks c a l l i n g a t t e n t i o n to the seepage of Federal r e s e r v e c r e d i t i n t o the s e c u r i t y markets and a l s o r e l e a s e d f o r February 7, 1929, a p u b l i c statement k n o w as the Board's "warning", which w i l l be considered in d e t a i l l a t e r . -8- Before considering the r e s u l t s obtained from the e x e r c i s e of d i r e c t - 15p r e s s u r e , with a s t a b l e 5fo discount r a t e , i t w i l l "be advisable to consider the grounds upon which the Federal Reserve Bank of New York based i t s r e p e a t e d r e q u e s t s f o r an increase of the discount r a t e , and the reasons prompting the Board to disapprove the i n c r e a s e . The Federal Reserve Bank of New York, as above shown, f i r s t asked f o r an i n c r e a s e to &j> on February 14, 1929, and the Board disapproved the i n c r e a s e a s a l s o nine other a p p l i c a t i o n s f o r a s i m i l a r i n c r e a s e , the l a s t r e f u s a l being on May 23, 1929. I n considering the f i r s t a p p l i c a t i o n , the Board, was hampered by the f a c t t h a t the Federal Reserve Bank had given the Board no o f f i c i a l explanation of the reasons prompting i t to ask the i n c r e a s e . I t should be remembered t h a t , on October 5, 1928, the Board asked the Federal r e s e r v e banks when forwarding a p p l i c a t i o n s f o r changes i n r a t e s , to give the reasons f o r such changes, b u t t h a t on October 25, 1928, Chairman McGarrah r e p l i e d t h a t the Bank would be g l a d to f u r n i s h the Board with the main f a c t s p r e s e n t e d to the d i r e c t o r s a t t h e time of a change in the r e d i s c o u n t r a t e , but beyond t h i s i t would be i m p r a c t i c a b l e to go, owing to the d i f f i c u l t i e s of attempting to express the reasons which have a c t u a t e d the d i f f e r e n t d i r e c t o r s i n voting t o change the r a t e . the a p p l i c a t i o n of February 14, 1929, was made over the telephone by Governor H a r r i s o n , and the Board voted to t a b l e i t pending an answer of the Bank to the Board's warning l e t t e r r e l e a s e d February 7* F i n a l l y the Board reconsidered i t s vote and advised Governor Harrison t h a t i t would take the a p p l i c a t i o n under review and take no a c t i o n on t h a t day. X-6737 2 9 3 •m l £ w Governor Harrison then t o l d Governor Young t h a t he had not given him the a c t u a l v o t e ; t h a t i t was i n f a c t c o n d i t i o n a l on a c t i o n "by the Board on t h a t day; and that h i s d i r e c t s . " , could not leave u n t i l the Board rendered i t s d e c i s i o n . F i n a l l y the Board unanimously voted to disapprove the a p p l i c a t i o n . 15 Diary 168 to 170 ( 5 0 ) . The disapproval was based a s well on the condition imposed by the Federal Reserve Bank of immediate d e c i s i o n by the Board as upon the m e r i t s of the a p p l i c a t i o n . The Board f e l t t h a t i t would not be p o s s i b l e to e x e r c i s e i t s duty of review and determination unon a telephonic r e q u e s t , giving no o f f i c i a l reasons f o r the change and conditioned on immediate d e c i s i o n of the Board. Governor Young, however, explained to Governor Harrison t h a t the a p p l i c a t i o n involved n a t i o n a l as well as l o c a l c o n s i d e r a t i o n s ; t h a t i f the New York r a t e was increased to 6$, every Federal r e s e r v e bank e a s t of t h e M i s s i s s i p p i River and very p o s s i b l y the o t h e r Federal r e s e r v e banks a l s o would have to make a s i m i l a r i n c r e a s e , and t h a t a m a j o r i t y of the Board f e l t t h a t such a c t i o n might s e r i o u s l y a f f c c t a g r i c u l t u r e and commerce, and f u r t h e r , t h a t the Board could not decide t h i s important question o f f hand, on the day of the a p p l i c a t i o n , i n the absence of any o f f i c i a l statement of reasons. 15 Diary 158 (248). On February 27, 1929, Governor Young i n response to a request of the Board on February 14th f i l e d with the Board a memorandum s t a t i n g the reasons given by the Board to the Federal Reserve Bank of Hew York, f o r d i s a p p r o v a l of the a p p l i c a t i o n , which memorandum was given by him to D i r e c t o r Mitchell of the Federal Reserve Bank of Hew York. X-5757 - 17 - 3 9 4 These reasons i n substance r/ere: 1. S u f f i c i e n t time lias not elapsed to determine the e f f e c t of the Board's warning published Feb. 7, 1929. 2. The r e p l i e s received from nearby Federal reserve banks i n d i c a t e t h a t r a t e i n c r e a s e s should not be begun now. 3. The danger of increased r a t e s encouraging gold imports. 4. The Federal Reserve Bank of Hew York has f u r n i s h e d the Board with s t a t i s t i c s , but has given i t no reasons f o r wishing the i n c r e a s e , and the Board d e s i r e s reasons. 5. Before consenting to an i n c r e a s e , the Board d e s i r e s to know to what l i m i t s the Federal r e s e r v e banks are p r e p a r e d to go i n the event of the i n c r e a s e to not being e f f e c t i v e , 5. The Board d e s i r e s the advice of the Federal Advisory Council now i n s e s s i o n , b e f o r e proceeding on a r a t e i n c r e a s e program. This memorandum was placed i n the Minutes of February 14th, which were not approved u n t i l February 27th. The second a p p l i c a t i o n f o r i n c r e a s e was an informal one, Governor Young advising the w r i t e r on Sunday, March 3rd, t h a t Governor Harrison had t o l d him t h a t h i s d i r e c t o r s e a r n e s t l y hoped f o r a u t h o r i t y to i n c r e a s e to 6sfi the next day, as they f e a r e d a runaway market. This a p p l i c a t i o n a l s o f a i l e d but the "runaway market" did not appear. 1 15 Diary 184, 185 ( 5 4 ) , The t h i r d a p p l i c a t i o n was f i l e d on March 21, 1929. I t imposed the same c o n d i t i o n of ininediate a c t i o n by the Board. I t was p o i n t e d out in the Board t h a t the f i g u r e s r e v e a l e d a general d e c l i n e of Federal reserve c r e d i t , which, a p a r t from the p r e v a i l i n g s p e c u l a t i o n would p o i n t to the d e s i r a b i l i t y of lower r a t h e r than h i g h e r discount r a t e s . $-6737 .<295 «• 18 «* The Board disapproved the a p p l i c a t i o n with only one d i s s e n t i n g v o t e . 15 Diary 196, 197* (56) . The fourtii a p p l i c a t i o n f o r i n c r e a s e was made on March 28, 1929. Board disapproved by a vote of 7 to 1. The 16 Diary 4 (57). The f i f t h a p p l i c a t i o n was made on April 4, 1929, and was disapproved by the Board. On A p r i l 9, 1929, Governor Harrison i n a l e t t e r to the Board, gave f o r the f i r s t time an o f f i c i a l statement of the reasons of h i s Bank f o r d e s i r i n g an i n c r e a s e . The reasons given i n substance were t h a t s p e c u l a t i v e a c t i v i t y had i n c r e a s e d i n t e r e s t r a t e s g e n e r a l l y i n the United S t a t e s to the i n j u r y of b u s i n e s s and e s p e c i a l l y of b u i l d i n g c o n s t r u c t i o n ; t h a t these high r a t e s had prevented the f l o t a t i o n of f o r e i g n s e c u r i t i e s i n t h i s country; t h a t they were reducing the purchasing power of Europe and t h r e a t e n i n g our export t r a d e , and t h a t the high c a l l loan r a t e s were drawing gold from Europe to be i n v e s t e d i n the c a l l loan market. The s i x t h a p p l i c a t i o n was made on A p r i l 18, 1929. I t was p o i n t e d out i n the Board t h a t some of the reasons given f o r the i n c r e a s e , - n e c e s s i t y f o r the easing of i n t e r e s t r a t e s , d i f f i c u l t y of p l a c i n g f o r e i g n loans i n the United S t a t e s , the consequent f a l l i n g o f f i n our export t r a d e , e t c . , were the very reasons advanced i n 1917 f o r lowering discount r a t e s . I t was a l s o p o i n t e d out t h a t the Hew York Bank a p p a r e n t l y f e l t that h i g h e r discount r a t e s would b r i n g about lower c a l l loan r a t e s , but the opinion was expressed t h a t higher discount r a t e s would c o n s t i t u t e a f i r m %-6737 % 9 G - ia foundation f o r h i g h e r r a t h e r than lower c a l l loan r a t e s . The Board disapproved the application.. 15 Diary 22, 23 ( 6 0 ) . The seventh a p p l i c a t i o n was made on April 25, 1929, and tnc Board disapproved. 15 Diary 38 ( 6 3 ) . The eighth a p p l i c a t i o n was made on May 9, 1929, the chief reason given by the Itew York Bank "being a d e s i r e to b r i n g the Federal r e s e r v e r a t e s i n t o proper r e l a t i o n with market r a t e s . I t was p o i n t e d out t h a t a 6fo r a t e was not needed to r e s t o r e the former r e l a t i o n of r a t e s , — t h a t a r a t e of 5^fo would accomplish t h i s . The Board disapproved. IS Diary 51 (63). The n i n t h a p p l i c a t i o n was made on May 16, 1929. I t was p o i n t e d out i n the Board t h a t Federal r e s e r v e c r e d i t o u t s t a n d i n g was r a p i d l y f a l l i n g ; t h a t a r a t e of 5|-^ would be s u f f i c i e n t to r e s t o r e the old r e l a t i o n of r a t e s . The Board disapproved. 15 Diary 56 (54). The t e n t h and l a s t a p p l i c a t i o n f o r increased r a t e s was made on May 23, 1929. Federal r e s e r v e c r e d i t outstanding had been reduced so m a t e r i a l l y t h a t t h e r e was some evidence that an a d d i t i o n a l amount, perhaps a hundred m i l l i o n d o l l a r s , was needed f o r the purposes of a g r i c u l t u r e and b u s i n e s s . While the Board disapproved the a p p l i c a t i o n , t h e r e was some discussion of a p o s s i b l e c o m p r o m i s e , a lowering of acceptance r a t e s coupled with a 6$ discount r a t e to act as a kind of "Lombard" r a t e . 15 Diary 78 ( 6 9 ) . X-6737 — 20 — From t h i s time on, the n e c e s s i t y of an i n c r e a s e d rate was p r a c t i c a l l y dropped from c o n s i d e r a t i o n , and on May 51, 1929, Chairman McGarrah, as above p o i n t e d out, advised the Board t h a t h i s d i r e c t o r s d e s i r e d to take up a program of encouraging the "banks to borrow. 195 - 85. The advance i n the discount r a t e to 6$ on August 9, was, as already p o i n t e d out, a p a r t of a program f o r easing the money market through lower acceptance r a t e s . 16 Diary 149 (80). During the d i s c u s s i o n s above o u t l i n e d , in which Governor Harrison gave reasons f o r i n c r e a s i n g discount r a t e s , the c o n d i t i o n s were r a p i d l y changing. Federal reserve c r e d i t outstanding, as shown by t o t a l b i l l s and s e c u r i t i e s of the New York Bank were s t e a d i l y decreasing, while i t s r e s e r v e r a t i o was a s s t e a d i l y i n c r e a s i n g , as shown in the following t a b l e : Federal Reserve Bank of New York. Total B i l l s and S e c u r i t i e s He serve Ratio 1929. 1929. * January 2. 709.8 January 70.4$ February. 6 325 February 78.6 March 6 349.9 March 79. April 3 238 April 79.2 May 1 328.3 May 81.1 June 5 253.6 June 79.1 The Board was thus asked to i n c r e a s e discount r a t e s under conditions of f a l l i n g Federal r e s e r v e c r e d i t and i n c r e a s i n g r e s e r v e r a t i o s which, according to the canons of banking p r a c t i c e c a l l e d f o r lower r a t h e r than higher rates! . 298 V 1-6737 -9- SI •* I t h a s "been g e n e r a l l y s u p p o s e d b y t h e p u b l i c t h a t t h e i s s u e "between the Federal Reserve Board and the Federal Reserve Bank of New York was simply whether the discount r a t e should or should not he i n c r e a s e d from 5$ to 6 fom This s u p p o s i t i o n i s a b s o l u t e l y erroneous. Ho one was hold enough to p r e d i c t with any confidence t h a t a mere i n c r e a s e to 6fo would s u f f i c e . The r e a l i s s u e was whether t h e 5$ r a t e should he maintained coupled with d i r e c t p r e s s u r e on the member banks to l i q u i d a t e reasonably, or a t l e a s t not to i n c r e a s e t h e i r s p e c u l a t i v e loans, o r , on the other hand, as claimed by the New York Bank, whether the Board should approve a p o l i c y of r e p e a t e d i n c r e a s e of r a t e s , beginning only a t 6$ and continuing to i n c r e a s e u n t i l the " s i t u a t i o n should be c o r r e c t e d " , t h a t i s , u n t i l the New York Stock market should be r a d i c a l l y d e f l a t e d . An a p p r e c i a t i o n of t h i s f a c t i s necessary to a complete understanding of the r e a l i s s u e between the Board and the Federal Reserve Bank of New York. That such was the r e a l i s s u e w i l l be apparent from reading the l e t t e r s e n t by Governor Harrison to the Federal Reserve Board dated A p r i l 9, 1929, i n which he used the following language i n j u s t i f y i n g the d e s i r e of h i s d i r e c t o r s f o r i n c r e ase d rates; "The r a t e i n c r e a s e would have the f u r t h e r r e s u l t of giving d e f i n i t e p u b l i c n o t i c e to the country t h a t the Reserve System i s ready to supplement and support a l l i t s other e f f o r t s by an a f f i r m a t i v e r a t e p o l i c y . "Public r e a l i z a t i o n t h a t the discount r a t e would be employed i n c i s i v e l y and r e p e a t e d l y , i f n e c e s s a r y , would x 6737 - 299 - 22g r e a t l y s t r e n g t h e n the e f f e c t i v e n e s s of the System's p o l i c y , and. i n i t s e l f h a s t e n the time when the System might lend i t s i n f l u e n c e towards e a s i e r money c o n d i t i o n s , " ( I t a l i c s mine). 195 - 45. Governor Harrison s e v e r a l times t o l d the Board t h a t i f the &fo r a t e did not " c o r r e c t the s i t u a t i o n " recourse mast be had to f u r t h e r i n c r e a s e s . February 5, 1929. 15 Diary 149 to 151 ( 4 5 ) . May 22, 1929. 16 Diary 74, 75 (68). Chairman McGarrah a l s o t o l d the Board t h a t i f 6fo did not " c o r r e c t the s i t u a t i o n " he would favor an i n c r e a s e to 7$, 8'jo or even h i g h e r . April 24, 1929, 16 Diary 37 (62). May 23, 1929, 16 Diary 74, 75 (68). Mr. Warburg, i n h i s book, "The Federal Reserve System," e n t e r t a i n e d the same views. . 1 - 513. 16 Diary 66 to 70 (257). I t i s i n t e r e s t i n g i n t h i s connection to note the e d i t o r i a l i n the Manchester Guardian Commercial on March 4, 1929: "There appeared to be some slender hope t h a t the Federal Reserve a u t h o r i t i e s were meditating a c t i o n d r a s t i c enough to p r e c i p i t a t e the c r i s i s i n Wall S t r e e t , which, i n the opinion of most monetary s t u d e n t s , must come sooner or later." 189 - 155 ( 5 ) . -10- Such was the i s s u e between the Federal Reserve Board and the Federal Reserve Bank of Hew York. The ilew York Bank wanted quick, r a d i c a l d e f l a t i o n of the stock market, through r a p i d i n c r e a s e s i n discount r a t e s . Chairman McGarrah admitted t h a t i f the p o l i c y of i n c i s i v e , repeated i n c r e a s e s did not quickly " c o r r e c t the s i t u a t i o n " the r e s u l t would be ~ 23 f r a u g h t with s e r i o u s danger to a g r i c u l t u r e and commerce# The Federal Reserve Board f e l t t h a t the way to solve the problem was to keep the discount r a t e s t a b l e a t bfo as a p r o t e c t i o n to b u s i n e s s , but to cut off Federal r e s e r v e c r e d i t from seeping i n t o Wall S t r e e t by d i r e c t p r e s s u r e upon the member banks to reduce, or a t l e a s t not i n c r e a s e , speculative loans. I f the Board had yielded to the d e s i r e of the Few York d i r e c t o r s and had entered upon a p o l i c y of repeated i n c r e a s e s of discount r a t e s , the crash i n the Hew York stock market which took p l a c e i n October, 1929, might have taken place i n May or June, 1929, but the r e s u l t a n t i n j u r y to bus in e s s would have been, i n a l l p r o b a b i l i t y , d i s a s t r o u s in the extreme* The m a j o r i t y of the Board f e l t , however, as above s t a t e d , t h a t the p r e s e n t f e v e r of s p e c u l a t i o n could not be curbed through the discount r a t e by any i n c r e a s e s h o r t of such extremes as would produce a cataclysm i n the market ,• which, as above s t a t e d , would i n j u r e business as much as or even more than i t would i n j u r e the stock market,, -*11-* That the discount r a t e i s i n e f f e c t i v e in curbing a s p e c u l a t i v e mania when once u n d e r l a y , i s the opinion of many bankers and economists. For example Mr. James Alexander, a t a meeting of the Federal Advisory Council on September 28, 1928, s t a t e d t h a t s p e c u l a t i o n could not e f f e c t i v e l y be c o n t r o l l e d by discount r a t e s , and favored a r e d u c t i o n of r a t e s to 4 15 Diary 33, 34, 35 ( 5 ) . - 24 P r o f e s s o r Hawtry, of London, t o l d the w r i t e r the same, adding t h a t i n h i s opinion our discount r a t e s vrere too high, and were merely i n j u r i n g b u s i n e s s . January 22, 1929, 15 Diary 131 (43). Mr. Harry A. Wheeler, a prominent Chicago "banker, t e l e g r a p h ed the Board on A p r i l 2, 1929, opposing f u r t h e r increase i n d i s count r a t e s , and s t a t i n g t h a t any i n c r e a s e would add to the heavy burden imposed on the commercial loan group whose r a t e s have been i n c r e a s e d i n f u l l p r o p o r t i o n to rediscount i n c r e a s e s , without e x e r c i s i n g any permanent r e s t r a i n i n g i n f l u e n c e upon market o p e r a t i o n s . 190 - 31. On March 23, 1929, the London S t a t i s t c r i t i c i s e d Governor Young's address b e f o r e the Commercial Club, C i n c i n n a t i , on March 16, 1929, s t a t i n g t h a t i t revealed a complete bankruptcy of i d e a s on the s u b j e c t of c r e d i t c o n t r o l ; t h a t the obvious remedy f o r t h e unhealthy c r e d i t s i t u a t i o n i n the United S t a t e s would be to lower money r a t e s so a s to cause a r e f l e x i n the i n t e r n a t i o n a l movement of short—term funds and to encourage lending abroad on the l a r g e s t s c a l e compatible with s a f e t y and profit. On May 3, 1929, the United S t a t e s Chamber of Commerce opposed an i n c r e a s e of discount r a t e s s o l e l y f o r the purpose of curbing s p e c u l a t i o n . 191 - 32. X-6737 - 25 On May 11, 1929, the London Economist s t a t e d : "The f i n a l l e s s o n i s perhaps the most imp o r t a n t . I t i s t h a t when stock p r i c e s are r a p i d l y r i s i n g , high money r a t e s are only an i n e f f e c t i v e d e t e r r e n t which p e n a l i z e s the innocent without t r o u b l i n g the g u i l t y . "The only remedy a g a i n s t rampant speculat i o n i s to cut off funds a l t o g e t h e r . " 193 - 79 (3) (221). On May 14, 1929, the New York Journal of Commerce s t a t e d t h a t the Federal Reserve System has no r i g h t to t r y to curb s p e c u l a t i o n through d r a s t i c i n c r e a s e s of discount r a t e s ; t h a t a l l t h a t has been r e q u i r e d of i t a t any time has been t h a t i t should keep i t s own funds, the r e s e r v e s of the deposit banks, out of the s p e c u l a t i v e market. 191 - 113. On May 23, 1929, the Manchester Guardian Commercial exp r e s s e d the b e l i e f t h a t i n c r e a s e d discount r a t e s would not curb s p e c u l a t i o n . 192 - 147 ( 2 ) . On May 25, 1929, the London S t a t i s t s t a t e d t h a t the banking a u t h o r i t i e s i n the United S t a t e s apparently want a business depression to curb s p e c u l a t i o n . 192 - 147. The w r i t e r b e l i e v e s t h a t the s p e c u l a t o r s would have heaved a s i g h of r e l i e f a t an i n c r e a s e in the discount r a t e to 6$, i n the hope t h a t then the d i r e c t p r e s s u r e , so embarrass- X-6737 — 26 — • ing to t h e i r movements, would be removed, and t h a t they would be enabled to obtain a l l the money they d e s i r e d under the 6$ Federal r e s e r v e r a t e . a 6rate, To these s p e c u l a t o r s the w r i t e r b e l i e v e s , would have been "easy money" as compared with the 5$ r a t e and i t s s t r i n g e n t d i r ect pressure. The Board a c t e d on the above theory with the o b j e c t of c u t t i n g o f f , by d i r e c t p r e s s u r e , the seepage of Federal r e s e r v e funds i n t o the s e c u r i t i e s market, as w i l l be shown later. That the s p e c u l a t i v e mania, i n s p i t e of the Board 1 s e f f o r t s , was fed from "loans f o r others" was a f a c t over which the Federal Reserve Board had no e f f e c t i v e c o n t r o l . I t must not be f o r g o t t e n t h a t the Federal Reserve System in t r y i n g to curb s p e c u l a t i o n through discount r a t e s , can a c t only by i n c r e a s i n g discount r a t e s on comrmercial paper; i t can not discount paper secured by stock collateral. Suppose the a u t h o r i t i e s of a town were to announce t h a t they had determined to put an end to the l o s s of l i f e by r e c k l e s s automobile d r i v i n g by i n c i s i v e and r a p i d i n c r e a s e s i n the p r i c e of g a s o l i n e ! X-6737 - 2V - Or suppose a Father were to c h a s t i s e h i s only son teecause an i n t o x i c a t e d man was carousing i n the s t r e e t ! The reply would c e r t a i n l y tee made t h a t nothing s h o r t of d i r e c t a c t i o n a g a i n s t the automobiles or a g a i n s t the i n t o x i c a t e d man i n the s t r e e t would s u f f i c e to c o r r e c t the e v i l ! The m a j o r i t y of the Board took the p o s i t i o n t h a t a g r i c u l t u r e and b u s i n e s s were e n t i t l e d to lower r a t h e r than higher r a t e s ; t h a t the r a t e s p a i d tey them had been m a t e r i a l l y i ncre ase d a l r e a d y by d i v e r s i o n of funds i n t o s p e c u l a t i v e channels, and t h a t to impose upon a g r i c u l t u r a l and commercial paper f u r t h e r crushing blows i n the shape of r a p i d i n c r e a s e s of discount r a t e s would be a serious i n j u r y to them and a f r u i t l e s s method of attempting to curb s p e c u l a t i v e loans, and e s p e c i a l l y the bank loans " f o r o t h e r s " , - which had become the chief cause of t h e trouble. —12— The Board having reached the conclusion t h a t the 5% r a t e should be kept s t a b l e f o r the p r o t e c t i o n of b u s i n e s s , and t h a t seepage of Federal r e s e r v e c r e d i t i n t o s p e c u l a t i v e channels should be prevented by other means, on February 7, 1929 i s s u e d a p u b l i c statement which came t o be known as the Board's "warning" and a c t i o n taken under i t as " d i r e c t a c t i on". This warning and the use of d i r e c t p r e s s u r e was by no means a new idea. I t was discussed i n the Board i n October 1922 when Chairman P e r r i n of the Federal Reserve Bank of San Francisco explained how the X-6737 305 - 28 - Federal Reserve Banks of Cleveland and San Francisco daring the war p e r i o d had s u c c e s s f u l l y employed i t , keeping the discount r a t e s t a b l e at 6<f> while the Federal Reserve Bank of New York had a 7$ r a t e . 194 - 97. I t was used a l s o "by the Federal Reserve Bank of New York i n October, 1925 b u t i n a d i f f e r e n t manner, as w i l l l a t e r be shown, frtira t h a t now advocated by the Federal Reserve Board. 194 - 97 ( 2 ) . The Federal Reserve Bank of P h i l a d e l p h i a used i t a l s o i n 1925. 194 - 97 ( 2 ) . Dr. Miller p o i n t e d out the danger from t h e seepage of Federal r e serve c r e d i t i n t o s p e c u l a t i v e channels i n an address a t Boston i n November, 1925. 194 - 103. On J u l y 27, 1927, the Governors Conference recommended d i r e c t a c t i o n to p r e v e n t s p e c u l a t i v e excess following the r a t e reduction to 3 | 14 Diary 16, 17 ( 5 9 ) . The danger was f r e q u e n t l y p o i n t e d out by the Board i n i t s Annual Reports from 1925 to 1928, and i n the Federal Reserve B u l l e t i n s . 194 - 103. The n e c e s s i t y f o r i t s p r e s e n t use was emphasized by the f a c t t h a t , e a r l y i n 1928, c e r t a i n ITew York member banks had borrowed from the Fede r a l Reserve Bank, on t h e i r c o l l a t e r a l n o t e s , many m i l l i o n s of d o l l a r s which they loaned on the stock exchange vdth g r e a t p r o f i t to themselves. 194 - 97 ( 3 ) . On ITovemeer 22, 1928, the Federal Advisory Council recommended i t to p r e v e n t seepage of Federal r e s e r v e c r e d i t i n t o the c a l l loan market. 186 - 2 1 X—6737 - 29- - • On February 14, 1929, the Federal Advisory Council advised i t s ext e n s i o n to loans of member banks to t h e i r customers. 188 - 60, 67, 70, 78. I t i s true t h a t on April 5, 1929, and again on May 21, 1929, the Federal Advisory Council reversed i t s recommendation of February 14, 1929, and advised an i n c r e a s e of discount r a t e s to 6*f> as asked f o r by Hew York, on the ground t h a t d i r e c t p r e s s u r e had not succeeded i n curbing s p e c u l a t i v e l o a n s . 15 Diary 15 (58). 15 Diary 25 (91). As a f a c t , however, on May 31, 1929, j u s t ten days a f t e r t h i s l a s t recommendation of the Federal Advisory Council, Chairman McG-arrah adv i s e d the Federal Reserve Board t h a t the Sew York d i r e c t o r s wished to consider a program f o r easing money conditions and encouraging banks to borrow! 195 - 85. I f the Federal Advisory Council had delayed i t s recommendation f o r a 6lo r a t e f o r t e n days, i t i n a l l human p r o b a b i l i t y would never have made i t l -15!The Board, i n i t s p u b l i c warning of February 7, 1929, p o i n t e d out t h a t during the year 1928 the System had encountered i n t e r f e r e n c e b e cause of the a b s o r p t i o n of Federal reserve c r e d i t i n s p e c u l a t i v e s e c u r i t y loans; t h a t the volume of s p e c u l a t i v e c r e d i t was s t i l l growing and t h a t t h i s e f f e c t , coupled with gold e x p o r t s , had brought about an advance of from Vp to l-g-yo i n the cost of commercial c r e d i t ; t h a t i t became the duty of the Board to i n q u i r e i n t o t h e s e conditions and to take s u i t a b l e f\ X-6737 ^ j -w - SO measures to c o r r e c t them* which i n the immediate s i t u a t i o n meant to r e s t r a i n the u s e , e i t h e r d i r e c t l y or i n d i r e c t l y * of Federal r e s e r v e c r e d i t f a c i l i t i e s i n a i d of the growth of s p e c u l a t i v e c r e d i t . The r e f e r e n c e i n t h i s warning to the Board's l e t t e r of February 2, 1929, to the Federal reserve "banks, led many to b e l i e v e , i n c l u d i n g the Federal Reserve Bank of New York (16 Diary 93 ( 7 2 ) ) , <- t h a t the Board 1 s warning meant t h a t as a matter of law, under the Federal Re*, serve Act, no member bank a t any time could l a w f u l l y rediscount e l i g i b l e paper i n order to r e p l e n i s h i t s r e s e r v e s to s u s t a i n d e p o s i t s a r i s i n g out of s p e c u l a t i v e l o a n s . The w r i t e r b e l i e v e s no such r u l i n g of law was intended but merely a r u l e of sound banking p r a c t i c e under the rabid s p e c u l a t i o n then rampant. This would seem t o be c l e a r from the following quotation from the warning: " • • • • which, i n the immediate s i t u a t i o n , means to r e s t r a i n the u s e , d i r e c t l y or i n d i r e c t l y , of Federal r e s e r v e c r e d i t f a c i l i t i e s i n a i d of the growth of s p e c u l a t i v e c r e d i t . n ( I t a l i c s mine) • -14We can now consider the e f f e c t of d i r e c t p r e s s u r e , which l a s t e d , as above p o i n t e d out, from February 7, 1929, to about June 9, 1929, To understand i t s e f f e c t i t w i l l be advisable to consider the periods j u s t b e f o r e i t went i n t o e f f e c t , and the l a t e r p e r i o d s ending with the stock market c o l l a p s e of October, 1929. These p e r i o d s may be divided as follows: 1. January, 1928 to January, 1929• 2. February, 1928 to February, 1929* 308 X-6737 *» 31 — 3. February 9, 1929, to June 8, 1929. (This i s the period of direct pressure.) June 8, 1929 to Au™ast 9, 1929. 4. 5. August, 1929 to October, 1529. This includes the increase i n discount r a t e s to 6fa, approved August S, 1929, FEDERAL RESERVE SYSTEM The Federal Reserve f i g u r e s a r e weekly averages. The Member bank f i g u r e s a r e f o r weekly statement d a t e s . 1. January. 1928 ~ January. 1929. Gold F.R. :Dis- :Accep-:U.S. se-:Mem. b k . j S e c . : Comm. ; I n v e s t - : I m - :Ex- : Curr, i n credit:counts:tances:curities:reserves:loans:loans:ments :ports:ports: circulation 4239 -37 : f503 : 4104 : -364 ; ^796:^333 : - 2 4 )ruary. 4245 4391 442 -208 - -12 4924 i i'ecrua]ry. 482 : 251 : -19 S, : 246 : : : -33 i -45 3. Direjet Actio:i . F e b n iary 9,. 1929 - June 8. 1929. -193 4140 -361 4444 - 68 -300 -262 173 429 42 465 31 453 S* jgust ]10. 1929, le 8. 19%5. — Ai 4 62 4 81 - 24 4 5 5. 4 41 -186 4234 - 20 4518:4189 4 31 Aw?ust. 192<3. 4 io - -242 0ctob<3r. 1929, - 2 8 i 253 -134 (From f i g u r e s f u r n i s h e d by Dr. Goldenweiser) 199 - 57. Let us now comment on these periods and examine the course of Federal reserve c r e d i t f o r the Federal Reserve System. Period 1. January 1928 to January 1929. Federal r e s e r v e c r e d i t outstanding i n c r e a s e d 239 m i l l i o n s caused l a r g e l y "by gold exports of 250 m i l l i o n s n e t . During t h i s period s e c u r i t y loans i n c r e a s e d 796 m i l l i o n s of d o l l a r s , i n s p i t e of the gold exports and the d e c l i n e of 19 m i l l i o n s i n money i n c i r c u l a t i o n . Period 2. February, 1928 to February, 1929. Federal r e s e r v e c r e d i t i n c r e a s e d 245 m i l l i o n s l a r g e l y through gold e x p o r t s , while s e c u r i t y loans i n c r e a s e d 924 m i l l i o n s . Period 3. February 9, 1929 to June 8, 1929. This was the p e r i o d of d i r e c t a c t i o n , a l s o of a s e r i e s of i n c r e a s e s i n buying r a t e s on acceptances a t the Federal Reserve Bank of ITew York, and of i n c r e a s e s in discount r a t e s by f o u r Western Federal reserve banks to bring them i n t o l i n e with the 5fo r a t e a t the other banks. During t h i s period there was a f a l l i n g - o f f of $300,000,000 i n the acceptance holdings of Federal reserve, banks and of $44,000,000 i n holdings of United S t a t e s s e c u r i t i e s , while discounts of member banks i n c r e a s e d $144,000,000, so t h a t t o t a l reserve bank c r e d i t outstanding declined by $193,000,000. This decrease i n reserve bank c r e d i t , d e s p i t e an i n c r e a s e of $29,000,000 i n the amount of money i n c i r c u l a t i o n , accompanied an importation of $173,000,000 of gold and a decline of $68*000,000 i n member bank r e s e r v e balances. During t h i s p e r i o d there was a r e duction of $361,000,000 i n s e c u r i t y loans and of $262,000,000 i n investments of r e p o r t i n g member banks accompanied by an i n c r e a s e of $444,000,000 i n a l l o t h e r , l a r g e l y commercial, loans. During t h i s p e r i o d , however, loans " f o r others" incre ase d 313 millions. I t may be contended t h a t these decreases in r e s e r v e bank c r e d i t were brought about more l a r g e l y by the decrease in acceptance holdings of 300 m i l l i o n s which more than o f f s e t the i n c r e a s e in gold imports of 173 m i l l i o n s . X-67S7 - 33 I t should be remembered, however, t h a t the s h u t t i n g o f f of the flow of acceptances by increased purchasing r a t e s had been in e f f e c t b e f o r e d i r e c t p r e s s u r e was put i n e f f e c t by the Federal Reserve Board# On January 4, 1929, the Federal Reserve Bank of New York i n c r e a s e d i t s buying r a t e s on acceptances from 4|-fo to 4^$ wi thout even a s k i n g a u t h o r i t y from the Federal Reserve Board, and on January 21st i t i n creased these r a t e s to 5fo. This a c t i o n i n s h u t t i n g off the flow of acceptances threw a g r e a t l y i n c r e a s e d s t r a i n f o r rediscounts on the Federal r e s e r v e banks. The Federal Reserve Board, by d i r e c t p r e s s u r e , headed off t h i s i n c r e a s e d demand f o r r e d i s c o u n t s and kept i t down to 140 m i l l i o n s , notwithstanding a 344 m i l l i o n decline i n the System's holdings of a c ceptances and Government s e c u r i t i e s . Had i t not been f o r the d i r e c t p r e s s u r e , i t i s f a i r to assume t h a t under the rampant s p e c u l a t i v e mania, the member banks would have redis— counted very much more than t h i s i n c r e a s e of 140 m i l l i o n s , and t h a t the gold imports of 173 m i l l i o n s would have a l s o served i n m a t e r i a l degree to support f u r t h e r expansion. I t should be remembered a l s o t h a t while member bank r e s e r v e s decreased 68 m i l l i o n s , commercial loans increased 444 m i l l i o n s a g a i n s t an i n c r e a s e of only 82 m i l l i o n s in the preceding p e r i o d . Period 4. June 8, 1929 to August 9, 1929. Early i n June the a p p l i c a t i o n of d i r e c t a c t i o n was suspended, l a r g e l y because i t was f e l t that the heavy c r e d i t and currency requirements around the end of the f i s c a l year should be met by the banks m thout h e s i t a t i o n and without a f e e l i n g t h a t they were going c o n t r a r y to Federal r e s e r v e X-6737 - 34 p o l i c y . That the System had decided upon a p o l i c y of r e l a t i v e ease became g e n e r a l l y known, and t h i s l e d to a r e v i v a l of s p e c u l a t i v e a c t i v i t y . Between June 5 and August 7 there was a growth of $518,000,000 i n s e c u r i t y loans of r e p o r t i n g member "banks, and of $736,000,000 i n b r o k e r s 1 l o a n s . S e c u r i t y p r i c e s advanced about 14 per c e n t . The growth i n Federal r e s e r v e bank c r e d i t , however, during the p e r i o d was l i m i t e d to $62,000,000,. owing i n p a r t to the f a c t t h a t there was an inflow of $42,000,000 of gold from abroad. A p a r t of t h i s i n c r e a s e i n r e serve funds was i n c i d e n t to the issuance of the new-size currency, money i n c i r c u l a t i o n i n c r e a s i n g by $65,000,000 during the p e r i o d . Member bank r e serve balances a l s o showed a growth of $31,000,000* P e r i o d 5. August 10, 1929, to October 12, 1S29. On August 9 the discount r a t e a t the Federal Reserve Bank of Hew York was i n c r e ase d from 5 to 6 p e r cent and a t the same time the buying r a t e on acceptances was reduced from 5 - 1 / 4 to 5 - 1 / 8 p e r c e n t . This r e s u l t e d i n a r e v e r s a l of e a r l i e r conditions by making i t cheaper f o r the banks to obtain r e s e r v e bank c r e d i t by the s a l e of acceptances r a t h e r than by the d i s count of e l i g i b l e p a p e r . By the second week i n October borrowings of the Federal r e s e r v e banks had d e c l i n e d $186,000,000, while acceptance holdings of the Federal r e s e r v e banks had i n c r e a s e d $234,000,000, the net change i n Federal reserve bank c r e d i t o u t standing being an i n c r e a s e of $41,000,000. The d e c l i n e i n member bank indebtedness r e s u l t e d i n a d i s t i n c t easing of conditions i n the money market. S e c u r i t y loans of member banks d e c l i n e d somewhat during t h i s p e r i o d , but there was a very r a p i d i n crease i n s p e c u l a t i v e a c t i v i t y and i n b r o k e r s ' l o a n s , supplied mostly by non-banking l e n d e r s . ... X-673? 3 1 2 — 35 **• A s i m i l a r comparison f o r the Federal Reserve Bank of New York follows; ( i n m i l l i o n s of d o l l a r s ) Federal r e s e r v e f i g u r e s are weekly averages. Member bank f i g u r e s a r e f o r weekly statement d a t e s . F. R. bank credit Bills | d i s - | Accepcounted \ tances \ U. S. securities Reporting member banks i n New Member York City bank r e Investserve b a l - i S e c u r i t y Commercial ments loans ances | loans p e r i o d 1 . January 7. 1928 to January 5. 1929. 4 226 4 243 4 64 - 80 - 23 4 344 4 90 4 37 16 4 21 Period 2 . February 11. 1928 to February 9. 1929. i 39 4 78 4 10 - 51 4 2 4 320 4 Period 3 . Direct Action, February 9, 1929 to June 8, 1929. - 78 4 1 - 89 4 2 - Period 4 . June 8, 1929 + 193 4 168 4 19 7 - 179 4 257 - 78 4 82 - 90 4 108 - 29 to August 10, 1929. 4 12 9 4 283 Period 5. August 10, 1929 to October 12, 1929. - 161 - 216 4 60 - 19 4 15 - 125 An i n s p e c t i o n of the above t a b l e s s a t i s f i e s the w r i t e r t h a t the d i r e c t p r e s s u r e imposed during the 3rd p e r i o d was s u c c e s s f u l i n p r e v e n t ing the seepage of Federal reserve c r e d i t i n t o s p e c u l a t i v e channels. This i s borne out by the f a c t t h a t on May 22, 1929, Chairman MoG-arrah and Governor Harrison t o l d the Board t h a t d i r e c t p r e s s u r e had made the banks a f r a i d to borrow a t a l l and t h a t they wanted to encourage X-6737 «• 3 6 *" the "banks to borrow to meet the necessary demand soon to come f o r comm e r c i a l needs. 16 Diary 75, 76, 77 (179). The Manchester Guardian, on May 215, 1929, s t a t e d t h a t d i r e c t a c t i o n had reduced Federal reserve c r e d i t used f o r s p e c u l a t i o n , hut not the amount of c r e d i t absorbed i n s p e c u l a t i v e loans, the l a t t e r e v i d e n t l y r e f e r r i n g to loans " f o r o t h e r s " . 192 - 147 ( 2 ) . I t would appear a l s o t h a t even i n the two succeeding periods ending i n the collapse of October, 1929, the cause of the rampant s p e c u l a t i v e a c t i v i t y was l a r g e l y a t t r i b u t a b l e to the flow of funds i n t o the c a l l loan market from c o r p o r a t i o n s u s i n g the banks to p l a c e t h e i r l o a n s . The following t a b l e " a l l b r i n g t h i s out g r a p h i c a l l y : Brokers 1 Loans Reporting Member Banks, New York City. Chm Account and Out of Town Banks 1929 February June August October 5 5 14 9 3048 2350 2775 2772 "For Others" 2621 2934 3178 3941 Total 5669 5284 5952 6713 Comparing February 5 with October 9, we f i n d t h a t the loans by New York banks f o r t h e i r own account and t h a t of out of town banks declined 270 m i l l i o n s , while the New York banks loans " f o r others" i n c r e a s e d 1320 millions. -15While during the p e r i o d of d i r e c t p r e s s u r e there was a v e r y s a t i s f a c t o r y decrease i n t o t a l s p e c u l a t i v e (including brokers) l o a n s , yet 814 X-6737 - £7t h e s e c u r i t y l o a n s to customers a s d i s t i n c t f r o m "brokers d i d n o t d e c r e a s e , "but on t h e c o n t r a r y i n c r e a s e d , a s t h e f o l l o w i n g t a b l e w i l l show? A l l Weekly Reporting Member Banks. Loans on S e c u r i t i e s . To Brokers and Dealers In New York City 1929 February 6 June 5 To Customers Outside of Hew York City 1771 1122 -649 816 808 - 8 4971 52 57 -*296 -16- Out of t h i s i n c r e a s e i n customers loans, there arose another d i f f e r e n c e between the Federal Reserve Board and the Federal Reserve Bank of New York, - wholly a p a r t from the d i f f e r e n c e as t o discount r a t e s . 16 Diary p . 1. On May 1, 1929, the Federal Reserve Board wrote Chairman McGarrah e n c l o s i n g a l i s t of c e r t a i n banks i n New York City which had been f r e q u e n t or continuous borrowers and which were s t i l l c a r r y i n g a considerable volume of s e c u r i t y l o a n s , and asked him to i n q u i r e of these banks why they had not a d j u s t e d t h e i r p o s i t i o n . 195 - 67 ( 5 ) . On May 10, Mr. McGarrah r e p l i e d s t a t i n g that the Board was l a y i n g down a new t e s t of abuse of. Federal r e s e r v e c r e d i t by t h i s l e t t e r ; t h a t the Federal r e s e r v e bank can not determine whether member banks s e c u r i t y loans to customers a r e s p e c u l a t i v e or not; t h a t the Federal r e s e r v e bank has no lawful r i g h t to r e f u s e to discount e l i g i b l e paper on the ground t h a t the proceeds a r e to be used to s u s t a i n such s e c u r i t y loans; t h a t X-6737 315 *»3S: - such r e f u s a l would be a r a t i o n i n g of c r e d i t and b r i n g about a condition the Federal reserve bank could not a f f o r d to r i s k , and i n conclusion he r e i t e r a t e d h i s b e l i e f t h a t such loans could be t r e a t e d only through the use of the discount r a t e . 195 - 63. Governor Harrison had p r e v i o u s l y , on February 6, 1929, taken the same p o s i t i o n . 15 Diary 158 (115). This p o s i t i o n of the Federal Reserve Bank of Hew York was not i n accord with the recommendation of the Federal Advisory Council on FeT>. r u a r y 15, 1929, as shown above. Nor does i t accord with the p o s i t i o n taken by Mr. George M. Reynolds, a prominent banker of Chicago, who, i n a l e t t e r to Governor McDougal dated March 2, 1929, s a i d : 11 1 s h a l l i n s i s t upon our people doing more than t r y i n g to s i t on the l i d to prevent f u r t h e r expansion, because I am now of the opinion t h a t nothing s h o r t of a vigorous e f f o r t f o r c i n g l i q u i d a t i o n of many l a r g e l i n e s of c r e d i t w i l l accomplish our purpose "The people seem to have l o s t t h e i r heads over stock gambling, and the time has come when those who are i n r e s p o n i b l e p o s i t i o n s w i l l have to take the b u l l by the horns and f o r c e them to do something which they w i l l not l i k e . With s a l e s of over s i x m i l l i o n shares of stock yesterday, i t i s c l e a r l y shown t h a t the p u b l i c has not p r o f i t e d by the advice of the Federal Reserve Board, and I think we have now reached the p o i n t where i t i s a m a t t e r f o r each i n d i v i d u a l bank to get i n t o the game v i g o r o u s l y and do whatever i s necessary to a t l e a s t f o r c e a reduction i n the amount of money t h a t i s borrowed a g a i n s t s t o c k exchange collateral." As opposed to t h e above views of the Federal Advisory Council and Mr. Reynolds, the Federal Reserve Bank of Few York from the f i r s t took the p o s i t i o n not only t h a t d i r e c t p r e s s u r e should be s t r i c t l y confined X-673? i o O. ™ 39 — to banks which were "borrowing more than the mass of "banks of t h e i r gene r a l c l a s s , "but a l s o t h a t customers loans could not "be considered "by Federal r e s e r v e "banks i n passing upon a p p l i c a t i o n s f o r r e d i s c o u n t s . On February 5, 1929, Governor Harrison squarely made such a s t a t e ment. 15 Diary 154 (114). On February 21, 1929, Chairman McGarrah r e p e a t e d the s t a t e m e n t . 195 - 67. On.May 29, 1929, both Governor Harrison and Chairman McGarrah took the p o s i t i o n t h a t d i r e c t p r e s s u r e should not be used to curb customers speculative loans. 16 Diary 76 (55). On June 5, 1929, Governor Harrison repeated the statement, c o r r e c t ing Mr. M i t c h e l l , one of h i s d i r e c t o r s , who went f u r t h e r i n h i s view of the power of the Federal reserve bank. 16 Diary 101, 102 (155). I t i s unnecessary to s t a t e t h a t the Board never advised the d i r e c t r e f u s a l of r e d i s c o u n t s to any bank, although i t c l e a r l y i s within the power of the Federal reserve bank to do so, as our General Counsel, Mr. Wyatt, and Hon. Newton Baker, our Special Counsel, have advised the Board. What the Board intended was t o have the Federal reserve bank examine i n t o the s e c u r i t y loans being made by a member bank which i s a f r e q u e n t or continuous borrower from the Federal r e s e r v e bank, and i f i t considered such loans out of l i n e with i t s commercial loans or excessive g e n e r a l l y under p r e s e n t c o n d i t i o n s , to warn the bank t h a t i t mast p r o t e c t the i n t e r e s t s of i t s depositors and of the p u b l i c by e x e r c i s i n g a more X-6K7 31 - '40 - reasonable use of Federal reserve c r e d i t obtained by r e d i a c o u n t i n g . The m a j o r i t y of the Board b e l i e v e d t h a t a mere suggestion along these l i n e s would, i n the v a s t m a j o r i t y of c a s e s , be s u f f i c i e n t with«» oat the n e c e s s i t y of the Federal r e s e r v e bank u s i n g i t s r e s e r v e d power of r e f u s i n g r e d i s c o u n t s a l t o g e t h e r . The p o s i t i o n of the Federal Reserve Bank of New York i n the matter i s i n accord with the f e e l i n g of many bankers t h a t a good customer, keep* ing a good balance, i s e n t i t l e d to a l l the money he may d e s i r e i f he i s w i l l i n g to pay the discount r a t e f i x e d by the bank, and t h a t the use of the discount r a t e i s the only method of curbing the good customers des i r e f o r money. In ordinary times the above r u l e of p r a c t i c e might pass without c r i t i c i s m , but i n e x t r a o r d i n a r y times of s p e c u l a t i v e mania i t must be p o i n t e d out t h a t the r u l e i s not c o n s i s t e n t with sound Federal r e s e r v e banking p r i n c i p l e s . The r e p l y i s c o n s t a n t l y made t h a t i f a bank r e f u s e d a loan under such circumstances the customer w i l l withdraw h i s account and g e t the money he d e s i r e s from some competing bank not so s o l i c i t o u s f o r the i n t e r e s t of i t s d e p o s i t o r s or of the p u b l i c . This may ce t r u e i n i n d i v i d u a l cases but could be guarded a g a i n s t by agreement among the p r i n c i p a l banks of the c i t y , or of the country, to j o i n i n curbing wild s p e c u l a t i o n , and then the customer would f i n d t h a t a l l the competing banks are following the same r u l e and t h a t he can g a i n nothing by withdrawing h i s account. X-6737 3 1 8 - 41Such a conference was repeatedly urged upon the o f f i c e r s of t h e Federal Reserve Bank of ITew York "by the w r i t e r . The suggestion was l a t e r approved by Mr. P o t t e r , of the Guaranty Trust Company of ITew York, "but so f a r as the w r i t e r knows, was never carried out, Feb. 14, 1929, 15 Diary 172 ( 9 7 ) . -17— An i n t e r e s t i n g l i g h t was thrown on the r e s p o n s i b i l i t y of bankers i n times of s p e c u l a t i v e manias, by Governor Young, i n an address del i v e r e d a t Old Point Comfort, Va., on May 7, 1930, in which the Governor said: "We bankers have a r e s p o n s i b i l i t y beyond our own balance s h e e t s f o r the general course o f . e v e n t s . " "We must look beyond the s a f e t y of the c o l l a t e r a l o f f e r e d us f o r a loan to the s a f e t y of the aggregate volume of c o l l a t e r a l t h a t we know i s being o f f e r e d f o r loans a t a l l the banks." "When we see an unhealthy development g e t t i n g under way we mast not only p r o t e c t our own immediate i n s t i t u t i o n , but must take a broader view with r e f e r e n c e to the i n t e r e s t s of the e n t i r e community." "In other c o u n t r i e s , where banking development has been l o n g e r , and banking concentration has proceeded f a r t h e r , c e r t a i n methods of c o n t r o l have been developed." "A customer i n England i s not granted u n l i m i t e d c r e d i t on the b a s i s of s e c u r i t y o f f e r e d as c o l l a t e r a l ; he i s granted a l i n e of c r e d i t i n accordance with h i s c r e d i t standing and the requirements of h i s b u s i n e s s , and he can not e a s i l y exceed t h a t l i n e no matter how much c o l l a t e r a l he may be able to o f f e r . " "I am not prepared to recommend to you t h i s or any other s p e c i f i c course of a c t i o n , but I do f e e l j u s t i f i e d i n c a l l i n g your a t t e n t i o n ^ t o our j o i n t r e s p o n s i b i l i t i e s and to suggest t h a t what we need i s cooperative a c t i o n in the development of sound banking t r a d i t i o n s , which alone w i l l give assurance to the country of a l a s t i n g s t a b i l i t y of i t s f i n a n c i a l organization.% X-6737 ~ 48 ~ 11 To such cooperation I pledge my wholehearted support• n -18- The w r i t e r b e l i e v e s t h a t the a c t i o n of the Federal Reserve Board i n re cues t i n g the Federal reserve hanks during t h i s p e r i o d of mad s p e c u l a t i o n to take up with member hanks applying f o r r e d i s c o u n t s the matter of t h e i r customers s p e c u l a t i v e s e c u r i t y l o a n s , i s not only i n accordance with law, but a l s o i s i n accord with the p r i n c i p l e s of sound banking, and t h a t i f t h i s i n qui ry had been more g e n e r a l l y made, conditions might not have been as bad i n the F a l l of 1929 as they i n f a c t were. Although Chairman McGarrah and Governor Harrison c h a r a c t e r i z e d such a procedure as 11 c r e d i t r a t i o n i n g " l i k e l y to r e s u l t i n a p p a l l i n g con- sequences, the w r i t e r b e l i e v e s t h a t s u f f i c i e n t evidence has a l r e a d y been d i s c l o s e d of the a p p a l l i n g consequences of l a c k of such i n q u i r y as would warrant the conclusion that such i n q u i r y , whether c h a r a c t e r i z e d as c r e d i t r a t i o n i n g or by some other name, would have been f o r the g r e a t e s t good of the g r e a t e s t number of our people. -19Before c l o s i n g t h i s a r t i c l e i t may be well to consider the a t t i t u d e of bankers, economists, and the p r e s s , towards the Board 1 s warning and the operations conducted under i t from time to time as i t p r o g r e s s e d . The following are among those who expressed approval: American Bankers Association April 29, 1929. Anderson, B. M. Feb. 13, 1929. Mar. 22, 1929. 193 - 67 ( 3 ) . 188 - 48. 190 - 69. o^O *•6737 - 43 - The following a r e among those who expressed approval (Cont'd#) Ayres, Leonard Feb. 1 5 , 1 9 2 9 . 188 - 68. Becker and Co. Feb. 13, 1929. 1 8 8 - 5 1 (2). Bendell, E. C. Feb. 13, 1929. 1 8 8 - 5 1 (2). Feb. 7, 1929. A p r i l 5, 1929. May 16, May 23, June 28, 187 190 191 192 193 Boston T r a n s c r i p t F i n a n c i a l column - 125. 50. 144. 34. 65, 70. On May.23, i t s t a t e d t h a t d i r e c t p r e s s u r e had proved as e f f e c t i v e as discount ratfe i n c r e a s e s . Brookmeyer Economic Service Dulles, John Foster Equitable Trust Co. J u l y 9, 1929. 193 - 120. April 30, 1929, 191 - 20. Mr. Austin Dec. 13, 1929. 199 - 25. Lawrence, David D i r e c t p r e s s u r e has succeeded and Federal Reserve Board w i l l now suspend i t . June 3, 1929. 192 - 92. Explains warning. June 5, 1929. 192 - 102. Lisman Digest P o i n t s out t h a t low discount r a t e s do not n e c e s s a r i l y mean e a s i l y a v a i l a b l e money. J u l y , 1930. 205 - 65. London Economist The events of the p a s t year have seen the beginnings of a new technique, which, i f maintained and developed, may succeed i n r a t i o n i n g the s p e c u l a t o r without i n j u r i n g the t r a d e r . May 11, 1929. 193 - 77. New R e p u b l i c Feb. 20, 1929. April 9, 1929. 198 - 112. 190 - 63. 321 ; > 44 • The following a r e among those who expressed approval (0o»t*4») New York Post Feb. 8, 1929. 188 - 5. Hew York Herald-Tribune Feb. 8, 1929. 187 - 134. 188 - 5 ( 2 ) , New York Telegram Nov. 25, 1929. 198 - 88. Hew York Times New York World Feb. 8, 1929. 187 - 152, Feb. 11, 1929. 188 - 10 F i n a n c i a l column. Mar. 20, 1929. 189 - 88. Mar. 28, 1929. 189 - 142. Apr. 6, 1929. 190 - 48. May 20, 1929. 192 - 12 F i n a n c i a l column. Sept. 13, 1929. The 6$ r a t e has f a i l e d to d i r e c t funds from the stock market-. The Board may have to resume d i r e c t p r e s s u r e . 195 - 118. See a l s o i n f r a - C r i t i c i s m s Feb. 7, 1929. 187 - 118, 129, 130. Feb. 8, 1929. 188 - 5 ( 5 ) . Feb. 9, 1929. 188 - 1. Apr. 13, 1929; Publishes i n t e r v i e w s mostly approving. 190 - 80. May 23, 1929: The Board h e s i t a t e s to p e n a l i z e business but seeks to check d i v e r s i o n of c r e d i t i n t o s p e c u l a t i v e channels. 192 - 36. May 26, 1929: People who once a t t a c k e d the Board f o r i t s t i g h t money p o l i c y , now a t t a c k i t f o r i t s disapproval of i n c r e a s e d d i s count r a t e s . 192 - 70. J u l y 31, 1929. 194 - 14. Aug. 12, 1929. 194 - 98. Nov. 19, 1929. 198 - 56. See a l s o - Criticisms Newark News Nov. 24, 1929. 198 - 46. P h i l a d e l p h i a Evening B u l l e t i n A g r e a t v i c t o r y f o r the Federal Reserve Board. June 7, 1929. 192 - 122. X-6737 3 2 3 - 45 •« The following are among those who expressed approval (Cont'd*) >• Rogers, Will Suggests t h a t the people may discover t h a t the Federal Reserve Board ;oay be working in the i n t e r e s t of the millions. May 24, 1929. 192 - 34. Rukeyser (Mew York Ameri can) Feb. 11, 1929. 188 - 37 ( 2 ) . Oct. 7, 1929; Board nas m i t i g a t e d violence of trade c y c l e . 196 - 100. J u l y 31, 1950: P r a i s e s Gov. Young's address a t Old Point Comfort, Va., p o i n t i n g cut to member "banks t h e i r duty and respons i b i l i t y for controlling speculative loans. 206 - 30. Sprague, F. K. Approves but d i l a t o r y . Feb.. 15, 1929. 138 - 51 ( 2 ) . 87. Stern Feb. 18, 1929. 183 — Temple, A. K. Mar. 27, 1929. 190 Apr. 24, 1929. 190 - 69. 27. 189 - 69. United S t a t e s Chamber of Commerce May 4, 1929. 191 - 59, 91 Yanderpoel May 16, 1929. 191 - 150. Walmseley April 7, 1929. 190 - 52. Washington Post Feb. 9, 1929. 188 April 6, 1929. 190 Trust Companies Washington S t a r Feb. 1929. Feb. 16, 1929. 168 — — 4. 47. - 76. — Whaley^-Saton Service Mar. 25, 1929. 189 — 130. S u c c e s s f u l i n most d i s t r i c t s but not i n a l l . 10 (3) June 29, 1929. 193 Wheeler, H. A. A p r i l 2, 1929. 190 — 31. 5-6737! i -20- . UiW'j - 46 » There follow some c r i t i c a l comments or a r t i c l e s which appeared from time to t i m e ; JLyres, Leonard Board d e f e a t e d i n i t s s t r u g g l e to c o n t r o l ^he c r e d i t situation. J u l y 16, 1929. 193 - 145. Boston. Herald Board f a i l e d . Boston >?ews Bureau Adve r s e coninen t . Aug. 10, 1929. 194 - 55. A p r i l 6, 1929. 190 - 56. Commons, P r o f . Federal Reserve Board may have gp ne a f t e r the s t o c k market too h a r d . Feb. 14, 1929. 188 - 57. Dorant, W. C. Attacks Federal Reserve Board. Feb. 28, 1929. Apr. 2, 1929. Aug. 10, 1929. 189 - 4. 190 - 30. 194 - 68. Harvard Economic Service P r e d i c t s the warning vrill f a i l u n l e s s coupled with h i g h e r discount r a t e s , which, however, i t admits w i l l i n j u r e business. Feb. 19, 1929. 188 - 105. Lawrence, David U n c e r t a i n t y of Board's p o l i c y c r i t i c i s e d "by many. June 11, 1929. 192 - 141. London Times Adverse comment. Savors of p o l i t i c s . May 25, 1929. .Manchester Guardian Commercial Adverse comment. Mar. 28, 1929. 192 - 147. 193 - 5 7 . Hew York Herald-Tribune The cfo r a t e s u b s t i t u t e d f o r v a c i l l a t i o n , t h r e a t s , and cajollery. Aug. 9, 1929. 194 - 90. X-6737 •w 47 W C r i t i c a l a r t i c l e s which appeared from time t o time ( C o n t ' d . ) New York Herald-Tribune ( C o n t ' d . ) Defense "by Federal Reserve Board i n i t s Annual Report f o r 1929 agreed to by few. April 24, 1930. 202 - 130. Gov. Young not r e s p o n s i b l e f o r d i r e c t p r e s s u r e . Aug. 28, 1930. 206 - 88, Hew York J o u r n a l of Commerce Adverse c r i t i c i s m Feb. 8, 1929. Feb. 9, 1929. Apr. 6, 1929. 187 - 140. 188 - 3, 5. 190 - 44. See - W i l l i s , H. P. Board guided by p o l i t i c a l f e a r s . May 24, 1929. May 25, 1929. 192 - 45. 192 - 147. By approving 6$ r a t e the Board has changed i t s p o l i c y . Aug. 5, 1929. 194 - 30. The Board's defense of d i r e c t a c t i o n p u t s i t i n a ridiculous position. April 28, 1929. 202 - 140. The Board's c r e d i t c o n t r o l i n 1929 was a mockery. Aug. 29, 1930. 206 - 90. New York Post The p r e - p a n i c a c t i o n of the Board was i n e f f e c t i v e because of the Board's p e r s o n n e l . Sept. 5, 1 9 3 0 c 2 0 6 - 1 1 4 . New York Sun Charges p o l i t i c s . Feb. 14, 1929. 188 - 87. Criticises. Aug. 29, 1929. 195 - 19. Board t r i e d to shut off c r e d i t a l t o g e t h e r . The Federal Reserve Bank of New York saved the country from p a n i c . April 24, 1930. 202 - 130. The Board has learned from experience the importance of following sound banking p r i n c i p l e and the need of r e s p e c t i n g the d e c i s i o n s of the r e g i o n a l banks. Sept. 2, 1930. 206 - 104. 33: X-673f C r i t i c a l a r t i c l e s which appeared from time to time (Cont'd.) See - Schneider, F New York Times C r i t i c i s e s Board f o r not following advice of Federal Advisory Council to approve i n c r e a s e t o 6$. May 23, 1929. 192 - 31. C r i t i c i s e s Board's r e l u c t a n c e to p e n a l i z e "business, which, i t says, has a l r e a d y been p e n a l i z e d . June 6, 1929. 192 - 110. F i n a n c i a l column says t h a t Board's approval of the 6$ r a t e r e p r e s e n t s a change of p o l i c y . Aug. 12, 1929. 192 - 110. A matter of dispute how f a r Board f e l l s h o r t of the neo.ds of the occasion. Purpose and a c t i o n to safeguard the c r e d i t s t r u c t u r e was c o r r e c t . Board did not a c t with s u f f i c i e n t promptness or decisiveness. Allowed i n t e r n a l d i v i s i o n to b e t r a y i t s e l f . R e l i e d on persuasion or reasoning when p a s t experience i n d i c a t e d that the time had passed f o r anything b u t peremptory a c t i o n or, a t l e a s t , d e f i n i t e warning which could not be misunderstood. Lack of e f f e c t i v e l e a d e r s h i p . Sept. 6, 1950. Hew York World. Right but tardy Feb. 8, 1929. 206 - 110. 188 - 5 Delayed firming p o l i c y too long. Board has l o s t control of money market. April 3, 1929. 190 - 32. E i g h t , but not determined enough. April 15, 1929. 190 - 72. P r e s t i g e of Board i n j u r e d by i t s v a c i l l a t i n g course. Aug. 12, 1929. 194 - 98. Richmond P r e s s Criticizes. 187 - 151. * 3 - 46- C r i t i c a l a r t i c l e s which appeared from time t o time (Cont'd.) Rulceyser (New York American) Has proved f r u i t l e s s * Feb. 11, 1929. 188 - 37 ( 2 ) . Schneider, F. J r . (New York Sun) In J u l y , 1929, Mr. Schneider, a f t e r p r a i s i n g the easy money p o l i c y of t h e System i n 1927, c r i t i c i z e d s e v e r e l y the f i r m i n g p o l i c y of 1928 and 1929, s t a t i n g t h a t the e x t e n t of the s e c u r i t y s p e c u l a t i o n had been exaggerated, and t h a t the System should not be unduly d i s t r a c t e d by emotional r e a c t i o n s r a i s e d by the stock market and b r o k e r s loans controversies. 194 - 73. On December 31, 1929, Mr. Schneider took the p o s i t i o n t h a t the F e d e r a l Reserve Bank of New York was r i g h t , and the Federal Reserve Board wrong in the discount c o n t r o v e r s y . He e v i d e n t l y assumed t h a t the i s s u e was between a 5 or a 6$ d i s c o u n t r a t e , f o r i n the a r t i c l e above mentioned he s p e c i f i c a l l y condemned any attempt t o b r e a k the s t o c k market by r a p i d i n c r e a s e s i n d i s c o u n t r a t e s , not knowing e v i d e n t l y t h a t t h a t was the then p o l i c y of the Federal Reserve Bank of New York. 199 - 70. Seligman, P r o f . Holds Board p a r t l y r e s p o n s i b l e f o r the crash of October, 1929, because of r e f u s a l to approve i n c r e a s e of d i s c o u n t rates. Nov. 26, 1929. 198 - 96. S h i v e l e y , E. A. Criticizes. Feb. 8, 1929, Simmons, E. W. W. Criticizes Address. Chicago Stock Exchange. . , May 14, 1929, Sprague, F. K. Dilatory. Feb. 13, 1929. 188 - 51 ( 2 ) . 191 - 112. 188 - 51 ( 2 ) . Rates should have been i n c r e a s e d long ago. Mar. 12, 1929. 189 - 79. . , X-6737 - p 50 - C r i t i c a l a r t i c l e s which appeared from time to time (Cont'd*) Sprague, P r o f . 0. M» W, Warning had "but l i t t l e e f f e c t . May, 1929. Stem Board has f a i l e d . Stokes, 3 . C. Attacks. 193 - 3 1 . Feb. 28, 1929. Mar. 1, 1929. 189 - 6. 189 - 19. Mar. 23, 1929. June 18, 1929. 189 — 104. 193 - 32. S u l l i v a n , Mark Washington 'believes Board has not succeeded. Aug. 16, 1929. 194 - 102. Truth Criticises. Wall S t r e e t Journal Criticises. Williams, Langbourne Attacks W i l l i s , H. P . Criticises North American Review April 17, 1929. 193 - 41. May £, 1929. Aug. 29, 1930. 191 - 58. 206 - 90. A p r i l , 1929. May 10, 1929. 190 - 28. 191 - 118 A p r i l , 1929. 190 - 107 192 - 49. Withers, H a r t l e y Mr. Withers "believes t h a t discount r a t e s should have been i n c r e a s e d and quotes from Mr. B u r g e s s ' s book to the e f f e c t t h a t the Federal Reserve System d e a l s with c r e d i t q u a n t i t a t i v e l y and not q u a l i t a t i v e l y ; t h a t i t s i n f l u e n c e i s upon the t o t a l amount of c r e d i t i n u s e , . not i n i t s employment, and that i t can not r e s t r i c t l o a n s on the Stock Exchange. Let u s examine the above quotation from Mr. B u r g e s s ' s book. Is i t t r u e t h a t the Federal Reserve System's power over discounts i s q u a n t i t a t i v e only and not q u a l i t a t i v e ? I s i t f u r t h e r true t h a t the X-67S7 - 61 q u a n t i t a t i v e power can be e x e r c i s e d only through changes i n d i s c o u n t rates? In one s e n s e , c e r t a i n l y , the Federal Reserve System i s . the most q u a l i t a t i v e system i n the world, f o r the reason t h a t u n t i l a t l e a s t the amendment of 1917, the Federal r e s e r v e banks could d i s c o u n t only a c e r t a i n q u a l i t y of p a p e r , - t h a t i s , s e l f - l i q u i d a t i n g a g r i c u l t u r a l and • commercial p a p e r . So a l s o the amendment of 1917 was a q u a l i t a t i v e amendment f o r i t p e r m i t t e d advances to member banks on t h e i r n o t e s c o l l a t e r a l s by Government bonds. Mr. Burgess, i n h i s book, however, mast mean t h a t once the p a p e r o f f e r e d has p a s s e d the q u a l i t a t i v e t e s t , the Federal Reserve System can only c o n t r o l the amount, and t h a t only through changes i n the d i s c o u n t r a t e , no m a t t e r to what uses the bank may apnly the proceeds of the r e discount. I f t h i s p o s i t i o n i s c o r r e c t , i t must follow t h a t i n a time of ramp a n t s p e c u l a t i o n , whether i n commodities, r e a l e s t a t e , or s e c u r i t i e s , the Federal r e s e r v e bank can e x e r c i s e no c o n t r o l i n the p u b l i c i n t e r e s t except through changes i n the d i s c o u n t r a t e , and t h a t a bank o f f e r i n g e l i g i b l e paper has an a b s o l u t e r i g h t to discount i t , r e g a r d l e s s of the amount or of t h e use which i t expects to make of the p r o c e e d s , p r o v i d i n g i t i s w i l l i n g to pay the o f f i c i a l d i s c o u n t r a t e . To take such a p o s i t i o n , however, i s to i g n o r e the Federal Reserve A c t , which s t a t e s t h a t a Federal r e s e r v e bank may d i s c o u n t , and n o t X-6737 — > 82 — that i t shall discount. I t i s c l e a r t h a t a Federal r e s e r v e hank i n i t s d i s c r e t i o n may d e c l i n e to discount a l t o g e t h e r . Such a p o s i t i o n , moreover, would "be a t variance with the p r a c t i c e of the Federal Reserve Bank of Hew York which has always claimed and e x e r c i s e d the r i g h t of i n q u i r y i n t o the loan p r a c t i c e s of tanks "borrowing more than o t h e r "banks of t h e i r c l a s s , and of warning them t h a t a c o n t i n u a t i o n of such p r a c t i c e may r e s u l t i n a r e f u s a l to rediscount t h e i r paper. (See l e t t e r of Chairman McGarrah to the Board dated February 21, 1929. 195 - 67.) While the Federal r e s e r v e "bank, to "bo s u r e , e x e r c i s e s here a q u a n t i t a t i v e power, i t i s c e r t a i n l y "based on q u a l i t a t i v e c o n s i d e r a t i o n s . The "bank i s d i r e c t e d to reduce the amount of i t s borrowings, and i n order t o do t h i s , i t may determine the p a r t i c u l a r means by which t h i s r e d u c t i o n i s brought about, whether by reduction of investments, or s e c u r i t y or other l o a n s . Can i t be, however, t h a t when a l l banks of a given class are engaged i n feeding the s p e c u l a t i v e movement to the i n j u r y of a g r i c u l t u r e and b u s i n e s s , the Federal reserve bank has no power to examine i n t o t h e i r loan p r a c t i c e s and d i r e c t a r e d u c t i o n of t h e i r borrowings? I f the answer i s i n the n e g a t i v e , i t w i l l p l a c e the Federal r e s e r v e banks i n a p o s i t i o n of impotence never intended by the framers of the Federal Reserve Act. Let us suppose t h a t a town were to e r e c t a r e s e r v o i r to h o l d water f o r i r r i g a t i o n purposes, with a r i g h t granted by the l e g i s l a t u r e to X-6737 3 - 53 s e l l the water a t i t s d i s c r e t i o n and to f i x the p r i c e , l e t us further suppose t h a t the owners of farms talcing t h i s water were d i v e r t i n g i t f o r w a s t e f u l purposes other than i r r i g a t i o n . Let us f u r t h e r suppose t h a t the town has n o t i f i e d these owners t h a t t h i s p r a c t i c e mast "be stopped, and t h a t the r e p l y r a s made t h a t i n the case of one owner d i v e r t i n g more water f o r such w a s t e f u l p u r poses than the general c l a s s of owners, the town would have power as regards t h a t one owner, hut i n a case where a l l the owners a r e inkp r o p e r l y d i v e r t i n g the water, the town would "be powerless. Certainly- scant a t t e n t i o n would he given to such a claim, and s i m i l a r l y scant c o n s i d e r a t i o n should he given to a s i m i l a r claim of impotence i n the Federal reserve hanks. I t would not be necessary f o r the Federal reserve "banks to p i c k out any p a r t i c u l a r s p e c u l a t i v e loan and order i t to "be l i q u i d a t e d . The Federal r e s e r v e "bank could simply -yarn the bank t h a t the amount of i t s borrowing was excessive because of i t s loan p r a c t i c e s , leaving to the bank the t a s k of a d j u s t i n g i t s p o s i t i o n . Altho"ugh t h i s power of the Federal reserve bank p r i m a r i l y i s a q u a n t i t a t i v e power, yet the d e c i s i o n may be based l a r g e l y on q u a l i t a t i v e c o n s i d e r a t i o n s , and t h i s would seem to be c l e a r l y w i t h i n the power of the Federal Reserve System. -21- 2he g i s t of the above c r i t i c i s m s seems to be t h a t the Board p e r s i s t e d i n i t s p o l i c y of d i r e c t p r e s s u r e not only from February 7, 1929, X-6737 ' 54- to June, 1929, b u t f a r t h e r u n t i l August 9, 1929, when i t r e v e r s e d i t s e l f and. approved a 6$ discount r a t e asked f o r by the Federal Reserve . Bank of New York) t h a t t h i s r e v e r s a l of p o l i c y Was reached only aftdfr long delay and i n d e c i s i o n ; and f i n a l l y t h a t the f a i l u r e to approve the i n c r e a s e d r a t e s asked f o r by the Federal Reserve Bank of Hew York e a r l i e r , p l a c e s upon the Board some r e s p o n s i b i l i t y , a t l e a s t , f o r the market crash of October, 1929. The answer to these c r i t i c i s m s has already been p o i n t e d out b u t can be r e p e a t e d ; 1. The d i r e c t p r e s s u r e p o l i c y was suspended e a r l y i n June, 1929, when the Board and the Federal Reserve Benk of Hew York agreed t h a t b e cause of changes i n the business and c r e d i t s i t u a t i o n the problem had been changed i n t o one providing f o r an i n c r e a s e of Federal r e s e r v e c r e d i t , and i n c r e a s e d borrowings by the banks. This change of p o l i c y was not p u b l i c l y announced e i t h e r by the Board or by the Federal Reserve Bank of New York for f e a r of i t s e f f e c t on the stock market. I t did, however, leak out and was mentioned by Mr. David Lawrence i n an a r t i c l e published on June 5, 1929. From what source Mr. Lawrence derived t h i s information, the w r i t e r has no knowledge 2. The i n c r e a s e in discount r a t e s to 6% approved by the Board on August 9, 1929, had nothing to do with the Board's p o l i c y of d i r e c t p r e s s u r e , which, a s above s t a t e d , had been suspended e a r l y i n June. On the c o n t r a r y , t h i s i n c r e a s e , as explained by Governor H a r r i s o n , and p o i n t e d out e a r l i e r i n t h i s a r t i c l e , was merely a " b a r r a g e " , t o use X 3 3 2 X-6737 - 65 Governor H a r r i s o n ' s exact language, i n connection with a program f o r easing money c o n d i t i o n s . 3. So f a r from being timid and v a c i l l a t i n g i n i t s p o l i c y of d i r e c t a c t i o n , the Board on February 7, 1929, acted d e c i s i v e l y and "boldly and kept d i r e c t a c t i o n i n force u n t i l the object sought by i t , - p r e v e n t i o n of d i v e r s i o n of Federal reserve c r e d i t i n t o s p e c u l a t i v e channels, - had been accomplished, Federal r e s e r v e c r e d i t outstanding having been reduced under d i r e c t p r e s s u r e , about 193 m i l l i o n s of d o l l a r s . 4. So s u c c e s s f u l was t h i s p o l i c y t h a t , as b e f o r e pointed o u t , Governor Harrison and Chairman McGarrah informed the Board on May 22, 1929, t h a t under the i n f l u e n c e of d i r e c t p r e s s u r e the member banks were a f r a i d to i n c r e a s e t h e i r borrowings and t h a t i t had become neoe s s a r y to encourage then; to borrow from the Federal reserve banks to sup-oly the growing demand f o r commercial c r e d i t s J 15 Diary 75 (69). 5. The f u r t h e r charge of r e s p o n s i b i l i t y f o r tho crash i n the stock market i n October. 1929, because of r e f u s a l to approve i n c r e a s e s i n discount r a t e s asked f o r by the Federal Reserve Bank between February 14 and May 23, 1929, seems to me, as h e r e i n a f t e r s t a t e d , tantamount to a s t a t e m e n t t h a t t h e s t o c k m a r k e t c r a s h w h i c h came i n O c t o b e r c o u l d h a v e b e e n a v e r t e d b y a n i n c i s i v e d i s c o u n t r a t e p o l i c y i n A j p r i l o r May, w h i c h , / . i however, would hayb produced the c r a s h a t t h a t e a r l i e r period# Looking back to the period between February 4 and kay <*<-•, 19x9, the Board had b e f o r e i t the demonstrated f a c t t h a t i t s p o l i c y of d i r e c t a c t i o n had k e p t Federal r e s e r v e c r e d i t away from the s p e c u l a t i v e market; t h a t 8% X-6737 ~ 56 — commercial loans were i n c r e a s i n g , while s e c u r i t y loans were d e c r e a s i n g . I t a l s o had "before-it the r e p o r t of the Committee on r e c e n t economic changes which was g e n e r a l l y i n t e r p r e t e d as a " b u l l i s h " r e p o r t . I t stated g e n e r a l l y t h a t there was nothing much to worry ahout, and t h a t i n a t t a c k i n g the problems b e f o r e the Committee the degree of progre ss i n r e c e n t years i n s p i r e d i t with high hope. Can i t be contended t h a t under such conditions a p u b l i c Board would d e l i b e r a t e l y have attempted to smash the stock market by cataclysmic i n c r e a s e s of r a t e s on commercial paper? I do not b e l i e v e any p u b l i c board i n the United S t a t e s , whether composed of bankers or economists would, under these circumstances, whatever i t s courage and wisdom, have made such an attempt. Mr. Edie has p o i n t e d out i n an address b e f o r e the Academy of P o l i t i c a l Science January, 1930, t h a t the ordinary law of supply and demand does not apply i n time of rampant s p e c u l a t i o n ; t h a t i n such times higher p r i c e s do not check demand b u t a c t as an a l c o h o l i c s t i m u l a n t to f u r t h e r extremes of demand. The w r i t e r b e l i e v e s t h i s i s as true of money or c r e d i t as of cornmodi t i e s , and t h a t i n c r e a s e i n discount r a t e s during such p e r i o d s l o s e s i t s f o r c e as a r e g u l a t o r of demand f o r money; t h a t the only way to r e g u l a t e demand i n such cases would be such i n c i s i v e and extreme advances i n discount r a t e s t h a t money or c r e d i t would p r a c t i c a l l y cease to be obtainable a t any p r i c e . X-6737 - 57 Mr. Edie admits t h a t a gradual slow process of i n c r e a s i n g r a t e s would have a s t u n t i n g e f f e c t on business, but t h a t a sharp and s v / i f t advance i n r a t e s would check f a l s e i n f l a t i o n i n s e c u r i t y markets without p a r a l y z i n g b u s i n e s s . This i s tantamount to saying t h a t i f t h e Federal Reserve System, i n May or June, had suddenly and i n c i s i v e l y and r e p e a t e d l y r a i s e d r a t e s high enough to smash the stock market, business would not have been i n j u r e d . know the e f f e c t on b u s i n e s s of the crash i n October. We a l l I f the Federal Reserve System had d e l i b e r a t e l y brought about t h i s crash i n May or June, by s t a r t l i n g i n c r e a s e s i n discount r a t e s , there would seem to be l i t t l e ground, i n the w r i t e r ' s opinion, f o r b e l i e f t h a t business would have taken i t any d i f f e r e n t l y i n May or June than i t did i n f a c t i n October. -•22— Mr. Warburg, i n h i s book e n t i t l e d "The Federal Reserve System" gives a review of the discount r a t e controversy. Vol. 1, pages 500 to 517. He says t h a t the Board's warning was bravely expressed i n the beginning, but t h a t i t had only a temporary e f f e c t , as the Board b e came i n a r t i c u l a t e ; t h a t the Board agreed to advance r a t e s to &f> only i n August, a t l e a s t h a l f a year, i f not a y e a r , too l a t e ; t h a t the Board's attempt a t loan contraction without adequate i n c r e a s e of d i s count r a t e ^ proved an impracticable and w a s t e f u l experiment. X-6737 - 58 Mr. Warburg s t a t e s t h a t loans " f o r other" a r e "beyond the d i r e c t c o n t r o l of the Federal Reserve System, but s t a t e s t h a t he made a suggestion which would tend to b r i n g down these l o a n s , namely; The How York Clearing House Committee, a c t i n g under the auspices of the Federal Reserve System, could have sent f o r a stock exchange Comr- m i t t e e , and have i n v i t e d them to aslc every stock exchange firm w i t h i n a given time to reduce i t s borrowings , - whatever they might be, - by a given small percentage; t h a t i f t h i s had been done, the top of the market would have been reached then and t h e r e , and l i q u i d a t i o n g r a d u a l l y would have s e t i n ; t h a t i f the Federal Reserve System and the Clearing House banks had d e f i n i t e l y agreed on such a p l a n , the stock exchanges would have been f o r c e d to f a l l i n t o l i n e , f o r no matter how l a r g e a volume of funds stock exchange firms were r e c e i v i n g from "others" they would have r e a l i z e d t h a t , i n the f i n a l a n a l y s i s , they were depending upon the s t r e n g t h and good w i l l of the Hew York banks. Mr. Warburg says he d e f i n i t e l y urged t h i s i n the f i r s t days of A p r i l , 1929, but t h a t while everybody seemed to agree on i t s d e s i r a b i l i t y and p r a c t i c a b i l i t y , i t proved impossible to carry i t into e f f e c t ; t h a t the X-673? *. 5S ~ Reserve System f e a r e d to expose i t s e l f to the charge of d e a l i n g , even i n d i r e c t l y , with the stock exchanges, and the c l e a r i n g house banks were l o a t h to undertake so unpopular a s t e p , so long as Federal reserve d i s count r a t e s were not i n c r e a s e d to 6^« Mr. Warburg f u r t h e r s t a t e s t h a t with the Board u n w i l l i n g a t that time to permit the i n c r e a s e to which four months l a t e r i t agreed, i t i s not s u r p r i s i n g t h a t the proposal f e l l through. No such suggestion r a s ever made to the Federal Reserve Board, and i t mast have been made, i f a t a l l , to the Federal Reserve Bank of Hew York. Governor Harrison once r e f e r r e d t o such a suggestion without r e - v e a l i n g i t s source and he s t a t e d t h a t he p e r s o n a l l y was opposed to i t . March 22, 1929. 15 Diary 199 (57). Mr. Warburg c r i t i c i z e s the Board f o r i t s d i s i n c l i n a t i o n to i n j u r e bus in e s s by i n c r e a s i n g discount r a t e s , and adds t h a t with quick and determined i n c r e a s e s , i n c i s i v e enough to bring about l i q u i d a t i o n , the period of high money r a t e s would probably have been so b r i e f t h a t b u s i n e s s might h a r d l y have been a f f e c t e d by i t . Mr. Warburg concludes by t h i s i n t e r e s t i n g s t a t e m e n t : "This does not mean, however, t h a t a Federal Reserve bank should not be f r e e to a c t according to i t s own d i s c r e t i o n i f a member bank were to use Federal reserve c r e d i t excessively or too continuously, or i n a manner harmful to the c o u n t r y ' s i n t e r e s t . " Mr. Warburg f a l l s i n t o the p r e v a i l i n g e r r o r by assuming t h a t t h i s controversy l a s t e d from February 7th, the date of the i s s u e of the warning, to August 9 t h , the d a t e of the approval of the 6$ discount r a t e . As above X-6737 - •, 60 • shown, from the e a r l y days of June to August 9, the problem "before the Board and the Hew York Bank was how to induce the member "banks to increase t h e i r "borrowings, and not "by means of discount r a t e s to reduce these "borrowings. He f u r t h e r approves the p o s i t i o n of the New York Bank that i n c i s i v e , r e p e a t e d i n c r e a s e s of discount r a t e s should "be used to " c o r r e c t the s i t u a t i o n " , t h a t i s , to l i q u i d a t e r a d i c a l l y the Hew York stock exchange loans. This, as "before s t : t e d , i s tantamount to saying t h a t the stock market crash which came i n October could have been a v e r t e d by an i n c i s i v e discount r a t e p o l i c y i n April or May which would have produced the crash a t t h a t e a r l i e r p e r i o d , - as p o i n t e d out above by the Manchester Guardian. The Federal Eeserve Board, however, f e l t t h a t under d i r e c t p r e s s u r e a gradual l i q u i d a t i o n cculd have been secured without the n e c e s s i t y of the Board's going out of i t s way to smash the stock im r k e t . Such gradual l i q u i d a t i o n took p l a c e during the p e r i o d of d i r e c t p r e s s u r e , but was i n t e r f e r e d with by an i n c r e a s i n g demand f o r commercial c r e d i t . The w r i t e r b e l i e v e s t h a t i f the Federal Reserve Board had smashed the s t o c k market by i n c i s i v e discount r a t e i n c r e a s e s , i t would c e r t a i n l y have p u t an end to any i n c r e a s e d demand f o r commercial c r e d i t , and t h a t such a c t i o n would have been an impetus to the slow d e c l i n e even then apparent i n commerce and b u s i n e s s , terminating i n the p r e s e n t b u s i n e s s d e p r e s s i o n . Mr. Warburg's statement t h a t d i r e c t a c t i o n was a w a s t e f u l experiment, would seem to be answered by the course of Federal reserve c r e d i t during the p e r i o d when d i r e c t p r e s s u r e was b e i n g a p p l i e d . His suggestion of co~ X«6737 o p e r a t i o n b e t w e e n t h e Mew York S t o c k Exchange a n d t h e F e d e r a l E e s e r v e System was, as above s t a t e d , never p r e s e n t e d to the Federal Reserve Board. Assuming, however, t h a t he p r e s e n t e d i t to the Federal Reserve Bank of Hew York, and the reference» above quoted, to Governor Harrison's s t a t e m e n t would seem to i n d i c a t e t h a t he may have, i t i s easy to see how the o f f i c i a l s would have regarded i t as c r e d i t r a t i o n i n g , to which, as above shown, they were a b s o l u t e l y opposed. I t should be remembered t h a t Mr. P o t t e r of the Guaranty Trust Company, and a l s o t h e w r i t e r , suggested cooperation between the Federal r e serve bank and the l e a d i n g banks, with a view to e x e r c i s i n g c o n t r o l over the s p e c u l a t i v e customers' loans of these banks. I t i s believed that such cooperation might have brought about the r e s u l t s Mr. Warburg hoped f o r from a conference between tne System and the iTevr York Stock Exchange. His f i n a l statement of approval of a c t i o n by the Federal r e s e r v e bank i n the case of banks u s i n g Federal r e s e r v e c r e d i t e x c e s s i v e l y or too cont i n u o u s l y , or i n a manner harmful to the cotintry's i n t e r e s t , can only be accepted as an approval of the Board's p o s i t i o n taken i n i t s warning a g a i n s t f r e q u e n t or continuous borrowing. Hon. R u s s e l l l ^ f f i n g w e l l , f o r m e r l y A s s i s t a n t S e c r e t a r y of the Treasury, i n a r e c e n t review of Mr. Warburg 1 s book, c r i t i c i s e s the Federal Reserve Board f o r attempting by d i r e c t a c t i o n GO make money dear f o r t h e s p e c u l a t o r , and, a t t h e same time, cheap f o r the b u s i n e s s man. He r e p e a t s the statement i n Mr. B u r g e s s ' s book t h a t the Federal Reserve System can c o n t r o l the amount but not the d i s t r i b u t i o n of X-S737 62 — Federal r e s e r v e c r e d i t . 'This statement I have a l r e a d y answered i n this article. Mr. L e f f i n g w e l l f u r t h e r holds the Board r e s p o n s i b l e f o r the f r e n z i e d "bull" market i n the f i r s t e i g h t or nine months of 1929, and a l s o f o r the stock market crash i n October, 1929. Here he f a l l s i n t o the p r e v a i l i n g e r r o r t h a t the Board's controversy with the ITew York Bank l a s t e d from February to August, while, as a matter of f a c t , as above shown, the Federal Beserve Board p o l i c y a f t e r June 1 s t was a common p o l i c y subscribed to both by the Federal Eeserve Board and the Federal Eeserve Bank of New York. He s t a t e s t h a t d i r e c t a c t i o n was a f a i l u r e , but I f e e l t h a t he has not c r i t i c a l l y examined the f a c t s , and has not discovered t h a t during the s h o r t p e r i o d of fro;:i February 14 to June 1, i n which d i r e c t a c t i o n was i n f o r c e , commercial loans g r e a t l y i n c r e a s e d , while s e c u r i t y loans g r e a t l y diminished, and i o d e r a l r e s e r v e c r e d i t was reduced about 193 m i l l i o n s of d o l l a r s . He holds the Board r e s p o n s i b l e f o r the f r e n z i e d "bull" market during t h i s p e r i o d . D i r e c t a c t i o n unquestionably did have a profound e f f e c t on the c a l l loan market, but what would have been the e f f e c t on t h i s market i f the Board in February had entered upon a cataclysmic i n c r e a s e i n discount r a t e s which r o u l d have p r a c t i c a l l y made i t impossible to obtain money or c r e d i t a t any r a t e , and which would have smashed the stock market? Mr. L e f f i n g w e l l presumably would have favored smashing the stock market : 340 X-S737 — 63 — i n February, 1924, as he i s on record i n t h i s a r t i c l e a s f a v o r i n g t h e Hew York Bank's p o l i c y , but the e f f e c t on the c a l l loan market of such an o p e r a t i o n , a s I have s a i d , he f a i l s to p o i n t o u t . -23In conclusion, i t may he asked whether the m a j o r i t y of the Board, i n supporting a s t a b l e 5^ r a t e with d i r e c t p r e s s u r e , intended to l a y down t h i s as a permanent p o l i c y to the exclusion of incre ase d discount r a t e s h e r e a f t e r to curb s p e c u l a t i v e a c t i v i t y . To such an i n q u i r y , an u n q u a l i f i e d l y negative answer mast be given. The Board always has aiiu always w i l l f o o l f r e e to use the discount r a t e to p r o t e c t a g r i c u l t u r e rnd commerce from i n j u r y from any s p e c u l a t i v e exc e s s , e i t h e r i n the stock market or i n the commodity or r e a l e s t a t e market. For example, discount r a t e s -jere i n c r e a s e d to curb s p e c u l a t i v e a c t i v i t y in the e a r l y months of 192", i n the f a l l of 1924, in the beginning of 1925, i n the autumn of 1925, in the summer and f a l l of 1926, i n the f a l l of 1927, and i n 1923, 189 - 127 191 - S3. When, however, i t appears, as in the concrete case, t h a t a s p e c u l a t i v e orgy has s e t i n , i t may t o necessary to revive d i r e c t a c t i o n and p r e s s u r e upon a l l s p e c u l a t i v e l o m s , with or without i n c r e a s e s of discount r a t e s , whether to brokers or customers, or b o t h . Direct a c t i o n or p r e s s u r e , i n s h o r t , i s a means and not an end i n i t s e l f , to be used i n connection with or independently of i n c r e a s e d discount r a t e s , as the b e s t judgment of the Federal Reserve System s h a l l determine.
@FedFRASER