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X-622 First Draft W.F. 6* H* S I Hs # In conformity with the requirements of Section 10 of the Federal Reserve Acty the fourth annual report of the operations of the Federal Reserve Board for the ca3endar year ended December 31, 191V, is submitted herewith: The outstanding feature of the year has been, of course, the entry of the United States 3nto the war. The declaration by Congress of a state of war, on April 6th, had been preceded by a period extending over many months of unprecedented activity and expansion m practically all lines of business and industry, tempered, however, in the minds of thought ful men, by uncertainty and apprehension as to the ultimate adjustment of international relationships. The Board had seen, for a long time, that / / the feverish conditions brought about by tjie rap*d change *n our position from a debtor to a creditor nation, by the great influx of gold into the country, and by the large foreign Credits negotiated here, rendered it imperative that the Federal Reserve system should be strengthened and brought to the highest state of efficiency, in order that it might perform the most effective service in either one of two events which seemed likely to transpire — the conclusion of a general peace in Europe, or the entry of the United States itself into the war. In the event of peace, a radical readjustment was to be expected, and there would have been a slov7ing down of those industries which were engaged m supplying war material, a consequent heavy falling off in our exports, accompanied, in SI 0 8 -2- ■ all probability, by a strong demand upon us for gold* . and on the other hand, in the case of our own belligerency, it was foreseen that there would be a greatly increased denand for all articles necessary for the equipment and maintenance of our own military and .naval establishments, much laxger credits to the countries associated with us in the war, and an inevitable cessation of gold shipments to us by those countries. For these reasons, the Board felt that it should in either event, during this period of uncertainty, undertake to preserve the liquid character of the assets of the Federal Reserve banks, to discourage any undue expansion of credits, and to reduce to very moderate proportions the holdings of the batiks in such investments as bonds and warrants which had been ta&La: primarily for the sake of income. Early in the year, therefore, the Board began to carry out these policies and the end of March found the Federal Reserve banks in a very strong position, with assets unusually liquid. While some of the banks had purcl&sed and were holding government bonds, the aggregate amounted to less than five per cent of their total resources. Holdings of municipal warrants, which at times had been freely purchased by some of the banks also, had been reduced to a comparatively small amount. In order better to provide for the strengthening of our banking structure, for the conservation of our gold supply, and for the regula tion of its outflow, the Board in January suggested some amendments to the Federal Reserve act which were designed to make membership in the X623 -3 - system more attractive to the state banks and trust companies, and to modify reserve requirements in such a way as to increase the gold holdings of the Federal Reserve banks and to make their gold more available as a basis for note issues* These amendments finally became law on June 21st and will be discussed more fuliiy in other parto of this report* In anti cipation of these changes and of future contingencies, the Board determined upon the preparation and distribution of a much lazier volume of Federal Reserve notes, and during the months of January and February placed ad ditional orders with the Bureau of Engraving and Printing, through the Comptroller of the Currency, for more than $900,000,000 of these notes, and arranged also that the stock of notes on hand should no longer he v reduced through withdrawals for current needs, but that as drawn upon by the Federal Reserve banks new orders . n equal amount should be placed I automatically. In order to insure immediate availability, ample supplies of notes were placed at the subtreasuries for delivery to the Federal Reserve agents as required. The precautions taken have been, justified by events and an ample supply of Federal Reserve notes has been available throughout the year. When a state of war was declared on April 6th, the reserve position of the Federal Reserve banks was exceptionally strong. ' Gold in the Federal Reserve banks and with Federal Reserve agents amounted to $943,552,000; the reserve against notes was 101.2$ and against deposits 76.5$, the combined reserve against deposits and notes ■ X-6 23 V ■ —d— Investments in government bonds and municipal warrants had been reduced to #51 ,836, COO and -purchases of acceptances were in smaller volume. FEDERAL RESERVE BANK& AS FISCAL AGENTS OF THE UNITED STATES. The entry of the country Into war resulted almost immediately in the assignment to the Federal Reserve banks of new and exceedingly im portant duties. Section 15 of the Federal Reserve Act provides in fart that the banks when required by the Secretary of the Treasury shall act as fiscal agents of the United States. This function had hither to been a negligible one, byt on May 2nd the Secretary of the Treasury made public the details of theffxst bond issue, known as the Liberty loan of 1917v and at the same time l e announced that each Federal Re i serve bank would be constituted a central agency in it3 own distridt for the organization of a bond campaign, for receiving subscriptions and payments, making deliveries and managing the necessary details. The K v i g were also charged by the Secretary of the Treasury with the duty air of placing the successive issues of short time Treasury certificates which have been offered, and of rddeeming them at maturity. These new duties have brought the banks into more intimate contact with the Treasury and have also increased enormously their operating problems. It has been necessary for them to add to their working space and to more than double their clerical staffs. They have rendered especially valuable service In the prompt flotation of the various issues of Treasury \f j X-623 3141 -5 - certificates of Indebtedness which, running for short periods only in an,ticipatlon of receipts from the long term bonds, were placed with banks rather than with the investing public* The first issue of $50,COO,000 offered under the provisions of the Act of March 3, 1917 in anticipation of income tax receipts accruing on June 30th, was offered before rates for mo2iey had advanoed, and at the request of the Secretary of the Treasury, the Federal Reserve banks them selves subscribed for the entire issue, at the rate of 2% per annum* This constituted their first direct service to the government in its war financing* This issue however, was only a beginning* by an offering of $250,000,000, at ^ It was following on April 25th, which was quickly distributed by the Federal Reserve banks among the member.* and nonmember banks of their respective districts. This process has been repeated on eleven subsequent occasions, four Issues having been made in anticipation Oao of the first Liberty loan of $2,000,000.which was closed on June 15th, A while six were anticipatory of the second Liberty loan, subscriptions to which closed on November 28th. The last issue or $700,000/000, in • \ anticipation of taxes due next June, has a longer time to r..n than the others and being intended prin&rily for the convenience of those who will have taxes to pay on account of incomes and excess profits, appealed more particularly to corporations and investors than other issues, which went mainly to banks* Subscriptions are now being received by the Federal Reserve banks for a new offering of the same character. In his annual report to Congress the Secretary of the Treasury i -6- expressed his appreciation of the services rendered by the Federal Reserve banks as fiscal agents by stating that "The Federal Reserve system has been of incalculable value during this period cf war financing on the most ex tensive scale ever undertaken by any nation in the history of the world. It would have been impossible to carry through th93e unprecedented financing operations under our old barJrlrg system. The effective machinery af forded by the Federal Reserve banks has p e m i t t e d the government to ex ecute its plans without a tremor of disturbance. GresLt credit is due the twelve Federal. Reserve banks for their broad grasp of the situation and their intelligent and comprehensive cooperationc" He added that the oxganizations which they have perfected have contributed greatly to the phenomenal success of the Liberty leans. The Federal Reserve banks have from the first met with a prompt and hearty response from the member and nonmember banks in their respective districts, both in th9 flotation of Treasury certificates and of the Liberty bonds. The Treasury has relieved pressure upon the market by permitting the Federal Reserve banks to distribute the proceeds of the £jle of certificates and bonds among the national banks subscribing, but • the term of these deposits has necessarily been short, and as a consider able lapse of time is required for the redistribution of these funds throughout the country through normal trade and banking channels, the greatest measure of relief has been afforded through rediscounts of member banks with the Federal. Reserve banks. These transactions have involved . no loss of gold, this being obviated by a substantial expansion of Federal Reserve note issues. X-623 i" : -7-» DISCOUNT POLICY. Upon the Federal Reserve Board has fallen the responsibility of directing the policies of the system so as to Insure prompt accommodation to banks whose customers required assistance in making their payments for bonds, as well as to banks which bought bonds for their own account. It was important that there be no disturbance in the money market and that Interest rates should be stable and as free as possible from fluctuation. The Board accordingly, before the subscriptions to the first Liberty bond issue were closed, and in anticipation of the amendments which became law on June 21st, established a preferential-fate of disoount for notes of fsember banks secured b y government obligations, whether certificates or bonds, firing a lower rate than that borne b y the securities themselves, 3§$ for notes maturing up to 90 days. As a further means of relief, the Board authorized Federal Reserve banks to discount for nonmember banks, * upon the endorsement of a member bank, notes secured by government se curities, whether made by the nonmember banks themselves or by their cus tomers, when the proceeds were to be used for carrying Treasury certifi cates or United States bonds. These measures involved modifications in discount schedules and rates, which may be enumerated as follows: (1) The establishment of a rate of Z% per annum for the discount at Federal Reserve banks of notes of menber banks running not longer than 15 days secured by Treasury certificates of indebtedness, which certifi cates had been issued at rates varying from 3 to (2) per annum. The establishment of a rate of discount at. Federal Reserve banks of 3§$ per annum for customers’ notes running up to 90 days, with X-623 -8 - the endorsement of member banket when such notes had been made for the purpose of obtaining funds for the purchase of government bonds and were secured by government obligations* (3) . She authorization of Federal Reserve banks to rediscount for member banks, on behalf of nonmcmbar banks, notes of nonmember banks or their customers, secured by government obligations, for the purpose of obtaining funds with which to purchase United States bonds or notes* (4) The establishment of a one day rate of from 2 to 4 $ at the Federal Reserve banks in the principal financial centers, New Yolk Vi • particularly, for the purpose of restoring to the market funds temporarily withdrawn through government loan operations* (5 ] M -The authorization of Federal Reserve barite to discount notes made by nonmember banks with the erdorsemsit of a member bank, on con dition that such notes, running not longer than 90 days, should be redis counted only up to July 15th and that they should be accompanied by an affidavit that the proceeds thereof had been used for the purchase of government bonds by the banks er their customers* /7as given " ' A general assurance / savings banks and trust companies that the Board desired in every way to cooperate with them in avoiding strin gency and that the Federal Reserve banks were prepared to extend through member banks every reasonable accommodation not inconsistent with law, for the purpose cf relieving any strain which might result from with drawals of deposits for purchases of government securities. The rediscount policy of the Board, which was intended to assist X-623 -9 - those desiring to subscribe for the first Liberty loan by assuming banking accommodation pending the payment in full of their subscriptions, was amply justified by results. As nearly as can be ascertained, scarcely more than $300,000,000 of the loan ./as actually subscribed by banks for their own account, and of this amount a very large part was quickly trans ferred to private investors who had not originally subscribed for or been allotted all the bonds they desired to obtain. The amount of rediscounts aj Federal B.eser/e banks of notes secured by government obligations reached its maximum of $82,950,000 on June 22nd, one week after the closing of subscriptions for the loan, but these notes were paidkoff so rapidly that the total of such rediscounts had on August 17th, fallen to $11,051,000. Reports from all sections of the country indicate that only a comparatively small percentage of the first issue of Liberty bonds is now being carried. upon a long term instalment basis, and that as a rule both barks and private investors were able, within a few weeks* to pay for the securities which they agreed to take. EFFECT OF ADDITIONAL LOANS. The services rendered by the Federal Reserve banks during the second Liberty loan oampgign, which began on October .1st and ended on October 27th, were even more marked than in the first instance. The experience which had been gained on the former occasion, the fact that more time had been afforded for organization, a better understanding by the people of the merits of government bonds as an investment, and a general awakening to a sense of patriotic duty, all combined to bring about the X-6 23 vigorous cooperation of the public generally. The arrangements pre viously made to accommodate the hanks and their customers who desired to subscribe to government bonds, remained effective, and there were no changes in discount rates, notwithstanding the advance, of one-half of one per cent, in the rate of interest carried by the bonds themselves, until the close of November and the middle of December, whan general advances of one-half of one per cent in rates of Federal Reserve banks ware made. The organisation of the liberty loan committee and the arrangement* for publicity and for soliciting subscriptions, had been greatly improved under the leadership of the Federal Reserve bank in each district, and t the result wqs gratifying In a corresponding^ degree. The fadt that the •second loan, as offered to the public, was fifty per cent greater than the ^firbt, while actual subscriptions received were in an even greater pro‘ . po3ption,Anaturaily. increased tfery substantially the operations of the Federal Reserve banks in discounting paper secured by government obliga tions. The total of such paper discounted at the Federal Reserve banks As was the case with the first loan however,, there were constant transtors to investors, and on <*&&& JL& of this character had been reduced to the total amount X S j . $**■/' 0 0 c? Ekperience during the year with these operations a n d an analysis of the consequent changes in the banking situation, demonstrate how greatly the entry of the United States into the war has increased the responsibility X-6 23 -1 1 - of the Federal Reserve system In its relations to the Treasury and to the public* Not only have new duties devolved upon the Federal Reserve system, but it has been made more directly responsible for the soundness of the banking position* The Federal Reserve Board is, of course, not concerned with the financial policy of the government except in so far as the Sec retary of the Treasury may choc-F.e to call upon its members for service in. an advisory capacity* The Board, however* is charged by the Federal Re serve Act with the exercise of a general supervision over Federal Reserve banks, which, in their function; as fiscal agents of the government, are responsible for banking technique of government borrowing, as well a3 for the execution of policies determining the extent and manner of backing participation in public leans* This responsibility is one which, during the past year* has rested heavily upon the members cf t e . Board, and rtilch hthey cannot evade or transfer* ■ « 1 • The Board feels that the duties which it is called upon to perform are at all times impressed with the highest quaJ.iti.es of trusteeship, and in times of emergency like the present, are vested, if it be possible, with an added solemnity. it seems net improper to suggest that those charged with the supervision of bazfks should at this time advise a : ' caution the :., banks of the country in the interest of the public welfare, with the view of developing and applying methods which are best adapted to withdrawing from private employment and diverting to public service the vast sums which national necessity demands and which Congress, by its enactments, has authorized the Secretary of the Treasury to borrow or to raise by taxation. In its final analysis, war financing means the furnishing to our government X-623 ■ ( of supplies or services for its own use or for the assistance of those governments which are associated with us in the war. These services and supplies are necessary for the winning of the war, and it is just as im portant that the government secure them as it is that it should procure the funds or credits with whi>h to. pay for them. In some respects the American people have not as yet cooperated to a sufficient degree, not . * > - because of any lack of patriotism, but because they have not yet been adequately impressed with the 2mp era Live necessity for the ir complete and constant cooperation. . fact that the issue — in their hands. They have hot yet been thoroughly aroused to the success or failure — - our future as a nation, lies A great campaign cf education, nation-wj.de ir. scope, lies ahead of us, and in this campaign the banks of the country have an opportunity to render great service by const!tutlng themselves the leaders of public sentiment. Each bank, in its own community ought to make the people understand clearly that the amount of goods, or supplies which can be produced is limited, and that in conservation and in the avoidance of waste, as well as by increased production of food stuffs, cotton, wool, lumber, iron and steel products, and all other supplies necessary in the conduct of the war, the people who remain at home have the best op portunity of serving their country. These necessary supplies should be furnished in sufficient quantities and in the shortest possible time, for time is .a vital factor. It is of course essential to economize in the use of those things yhioh are required by the government, but by re stricting the use of those things which are not required by the government, material may be released which can be used in other ways or shipped to 3119 ■13- other countries. As an ill-as oration it may be pointed out that if every family in the United States would use fewer clothes than they would in ordinary times, cotton and woolen goods to the value of millions of dol lars could be made available for export, and the proceeds could be used in making purchases of copper in Mexico, hides and wool in Argentina, and of nitrates in Chile. By consuming a smaller amount of goods additional money is saved, which can be used by the people in payirg for the war loans of the government> Decreased demand for goods by individuals and pur chases of government bonds out of savings rather than by excessive borrow ing from banks, will tend to retard a further xise in prices and t o re strict expansion of banking credits which necessarily contribute to the rise of prices. The government is the principal customer for .farm products and for mauufaebured articles and there need be no fear of any falling off in demand for staple articles of all kinds as the result of Individual economies. Since the beginning of the war, and more especially since the entry of this country into the v/ar, deposits in banks have increased enormously, b.:t it should be remembered that loans and discounts and investments have increased in an even greater degree, ^sp^gold holdings in three years have Increased more than a billion dollars and are now larger than those of any other country, but at the same time par percentage of gold reserves against deposits and note issu&3 has decreased. These conditions are not unusual in times of war, and to a certain extent they cannot be prevented, but the banks of the country should make it their business to keep these tendencies under control and to- prevent too rapid a n expansion of credits X-6 2 3 n* « . 14- as far as possible, without placing in jeopardy the supreme object of our national effort r*- the w5m'.ng of the war* Bab we «should realize that in the accomplishment of this purposo, the conservation of our economic and financial strength is ju3u as important as the augmentation of our military power, and that upcn +bis conservation our military strength de pends* Nothing mas b be need which can be dispensed with* There mast be a conservation of credit as well as goods, and credit, generally speak ing, should not be used except where it Js required for the common welfare, as in planning crops, the manufacture of necessary articles, or in such construction work as nay be essential in bringing about in creased production* Contraction of ordinaxy lines of credit js necessary to make room for the credits required by the goveTireu!# for ihe purchase of supplies essei-tjal for wa^ purposes. It is hoped that the banks of the coimtzy will cooperate along these lines and that they will teach the d o c r n n e of serving and saving* Shis is not the time for the purchase and sale of 3usuries or for carrying large stocks of any kind. There should be fewer and plainer goods carried 1*1 stock, for their is no unlimited supply of goods or of credit* This is a time for all establishments, large and small, to reduce inventories, thereby freeing goods and banking credit* It should be urged upon state, city and county authorities, that this is not the time for municipalities to engage in construction work, except perhaps in cases where such work is necessary for the public health, and that instead of engaging in new under takings, they should rather consider cancelling existing contiacts in order X -6 2 3 -15to release men and nftterdal, thereby avoiding competition with the govern ment for man power and for the savings of the people* It is, of course, inevitable that the war activities of the govern ment will tend, to oaose a farther rapid growth of deposits and loans in banks, and in order to keep our credit structure strong it is necessary that the banks should exert their influence and lend their energies to a more general absorption of government loans by savings, to a contraction of private credits wherever practicable without causing hardship. We most look to the future, and prepare unceasingly for further demands which the forests nay be made upon us. The products of the fields,/the mines, and the manufacturing establishments of in the nature of luxuries. the country are not, generally speaking, They can, as a rule, be classed as necessaries, and with the outlook ahead of us there seems to be no possibility of over-production. It seems, therefore, that the banks of the country, from the standpoint of good business as well as from patriotism, should lend their funds and credits freely to those engaged in these productive enterprises, and their power to serve the country .In this w a y will be increased by the curtailment of unnecessary credits and b y the adoption by the people generally of a policy of common sense, k practical economy* The Board would call attention also) to the very great assistance which it is in the power of the Federal Reserve banks to give to their member banks by rediscounting paper growing out of agricultural, indus trial, and commercial transactions. The Federal Reserve Act as amended X-263 -16- last June provides that state banks admitted to membership may retain all of their statutory and charter powers. Thus state bank members are governed -by their own state laws and remain under the supervision of their state banking departments. Their Interest rates and the limitations upon their loans are determined entirely by state law* . There are not yet members but which ure eligible 2or membership * "v .- hundreds of good banks throughout the country/ and It seems proper to re fer here to a statement issued by the President of the United States on October 13th last In which he called attention to the fact that "the • . extent to which our countxy can wJ.thstand the financial strains for i/fc-ieh we must be prepared will depend very largely upon the strez^th and staying power of the Federal Reserve banks," and In which he urged the im portance of developing our banking power to the nB.xf.mow degree and of pro viding financial machinery adequate for the very great financial require ments imposed upon our country by reason of the war. He pointed out that all banks should cooperate in strengthening the position of the Federal Reserve system, thereby strengthening the nation's banking power, and urged upen every bank officer and director to consider the question of membership in the Federal Reserve.system as a "solemn obligation." Since the date of the President's statement the banking departments of nearly all of the states have ejcpressed approval of menbershlp in the Federal Reserve system on the part of the banks under their supervision, but the reserve requirements In a few states practically prohibit the co operation of state banks and trust companies w ith the Federal Reserve system, making it or them to become members as well as X-6 2 3 * -i *. -1 7 - impossible to exchange their Federal Reserve notes for gold* The Board would suggest to the banks in these states that efforts should be made to obtain such legislative action as may be necessary to enable them to co operate with the system, and that in those states where the legislatures will not meet for a year or more, the banks might feel justified in ask ing their governors to convene the legislature in special session. DISCOUNT RATES. The discount rates of the Federal Reserve banks have an important bearing upon the problems of government financing, and upon the condition of the banks of the country as a whole. Since the first adjustment of discount rates, effective shortly after the organization of the Federal • «*<Txt4»£ue Reserve banks, changes have been comparatively irijii 1n T . ufuif i I thjo m ^ - 'fa year 1917, money was in abundant s j ^ l y , and discount rates were low. The expectation ^ of some that the entry of the United States into the war would^cause w 7 In rates"rnJ intemjot, was not realized. ^ Market rates have, ■ &juMgffS, advanced substantially, fijk the process has be9n o gradual, and there were no changes ^ 4 ^ in the rates of Federal Reserve banks until the flotation of the first Liberty loan was well under way. Then, in order to facilitate the disposition of the ljbonds, the Beard Indicated to the Federal Reserve banks that it would be desirable to es tablish preferential rates in favor of notes secured by government X-G 23 -1 8 obllgatiens. With such paper, as with ordinary commercial paper, a distinction was made between short maturities and these running f cr a longer period. Accordingly, notes of member banks running net longer? than fifteen days, and secured, by government obligations, were in general, put upon a 3% basis, while 90 day obligations secured in the same way, were given a rate of 3j^S, these rates being about one-half of one per cent below the rates fixed f?r ordinary commercial paper of the same ma turities. ■ " Because ef the generous cooperation of many banks throughout the country in making advances to purchasers of government bonds at the same rate of interest as that carried by the securities, these bond purchasers have had the full advantagej ef the facilities afforded by Federal Re serve banks in the rediscount of their notes. A firmer tendency became apparent during the summer at some of the financial centers, and the 4jJ rate borne b y the second Liberty loan (one-half per cent more than the si ff • ' first) suggested the pragrftoty e‘ a'general advance of one-half of one ^ per cent in Federal Reserve discount rates. As already stated, this advance has been made, but the differential in favor of paper secured by government obligations is still maintained. The discount jchedules have been consolidated and simplified by reducing the number of separate classifications. In connection with the revision of rates, it was deemed proper to merge with the ordinary commercial rates the special rate which was made in the summer of 1915 for paper secured b y warehouse receipts for staple and readily marketable articles of a non-perishable character, known as X-623 -IS- commodity paper. The continuance of this rate, which had been na.de originally for the purpose of assisting the orderly maiketing of crops 'In order to avoid speculation and violent flsibctuafcions in prices, had become unnecessary because of the great advance in the price jjf agricultural products, and because/of price fdsisg^by the government. Changed conditions made it desirable that these products should move steadily to market, and it seemed best in the circumstances not to encourge their holding b y producers or middle men. Complete tables showing these changes in discount rates, are appended to this report, as Exhibit EFFECT OF THE A M E M M E H T S OF JPME 21ST. The amendments to the Federal Reserve Act which became law on June 21st last, were most opportune, as they added greatly to the ability of the i Federal Reserve system to assist in meeting the financial requirements of the government, and to exercise 'f- controlling influence in the money .t, raarke^, just at a time when mush larger demands were being made upon it because of war financing. The amendments were substantially those recommended by the Board in its last annual report, and they have opened two new and distinct avenues of added strength, - by making possible greatly increased holdings of gold in the Federal Reserve banks by permitting them to issue Federal Reserve notes in exchange for gold, and by inviting the full cooperation of state banks and trust companies, through more favorable conditions of membership* X-623 8 1 3t> - 20- The process of issuing notes has been simplified, and the discount power of the banks has been augmented without impairing their actual holdings of gold, by reason of their larger power to issue notes* While it may be true that the character of the Federal Reserve note as contem plated in the original act has been altered to' a certain extent, and that these notes may remain outstanding for longer periods of time than had been first intended, the flexible quality of the notes has not been impaired, nor dees a large issue of notes of necessity mean expansion of currency. The character of the Federal Reserve note is now best determined by the amount *f the gild reserve behind it. lihen it is issued against geld, it merely takes the place as a circulating medium ef the gold for which it was exchanged. As the geld reserve is reduced, commercial paper is deposited to preserve the security; and the note takes on more of the quality which it possessed under the original act, and when the rediscounts of the Federal Reserve banks are reduced, the paper securing the note issues isreturned to the makers, and the gold reserves are correspondingly increased, thereby giving outstanding'Federal Reserve notes more of the character of geld certificates. Amendments to the act have also changed the former reserve require-* ments for member banks by fixing them at 13$, 1©$, and 7$ for central reserve, reserve city, and country banks respectively, and have, at the same time, strengthened the position ©f the Federal Reserve banks them selves by requiring the maintenance with them of the member bqnks* entire reserves in collected funds, the amount^of vault cash to be carried by a pun* member bank being left to its discretion,as determined by actual needs.> This change, togethe r with the expiration of the time limit for the com ' X-623 . ' ' ' . - 21 - plete transfer of reserves ab required by the original act, involved the transfer of a lafge amount fif actual money to the Ffederal Reserve banks. - The termination of the period when fugds dep!?sited with banks in reserve cities might be counted as reserve for count-y banks., would hot;, for reasons ejqplalhed in thb Board's last annual report; have made necessary any material transfer of cash, btit the hew. fesefve requirements led to the shifting of about $250,000,000 and a corresponding increase in the cash holdings of Federal Reserve barks. Another amendment included in the act of.June 21st, permits nonmember banks to open for exchange or collection purposes, accounts with Federal Reserve banks, thereby availing themselves of the facilities of the check clearing and collection system. ; This change, at the outset,' increased still further the cash holdings of the Federal Reserve banks, as several large nontaember institutions opened accounts of this kind with Federal Reserve banks. Most of these institutions have, however, how become members, so that the balances held by nonmember banks are comparatively ■ " . . negligible, amounting bn December 31st to $______________ The^gain in actual cash by Federal Reserve banks, Jan may be best demonstrated by a comparison of their condition on. June 1st on the latter date the total was $1,421,382,000. MEMBERSHIP OF STATE BARKS. Second only in importance to the change in the reserve and note issue provisions of the law, must be.reckoned the amendment to Section 9, under ^ ■ 4 >/ j t - 623 31 s b -2 2 - which state banks and trust companies may become menbers of the Federal Reserve system and retain, at the same time, their full charter and statutory privileges. The Board has already given such assurance in its regulations relating to membership of state banks, but there had alu&ys been a question in the minds of many as to the validity and permanence of rhese regulations, in the absence of definite ' stUtutjUPy. authority. The action of Congress in c o n f i r m ! ^ what the Board had attempted to accomplish by regulation has given state barking institutions firm assurance that they may continue to carry on their business in substantially the same way as they have heretofore done, without fear of future changes in methods prescribed, and it has given them in addition the definite right to withrdraw from the system upon sir months’ notice, subject to conditions which they, regard as reasonable. The inducement to the state banks to become members of the system thus held out by theamendment to Section 9 of the Act \ was further strengthened by an opinion of the Attorney General of the United States rendered on September 10th, in which h e expressed the vuew that this amendment, in reserving to the state banks as members their full statutory a nd charter powers, released them from the restrictions of Section 8 of the Clayton Act, as to interlocking directors, to which they had been previously held to be subject, in common with the national banks* Just at a time when the principal obstacles which had previously stood in the way of the enlargement of the system b y state bank member ship were thus overcome by statute and bjrjsig^legal Interpretation, an additional incentive was given the 1 _ state banks and trust companies to apply for membership in the system b y reason of the- rapid development 1 X -6 23 -2 3 - of the government’s requirements in war financing, the patriotie desire to assist in meeting and supplying these needs, and an appreciation of the added safety to themselves resulting from menbershlp* Compelling reasons for membership in the system from a patriotic standpoint were brought to the attention of all the banks in a strong statement by the ■ » # President on October 13th, to which reference has already been made* Under all these influences many of the strongest state banks and trust companies in the United States have filed their applications and have been admitted to membership. 21st . / S 3 At the time of the passage of the Act on June .state banks and trust .companies were members of the system*, but on December 31st membership had been increased to . . The aggregate capital and surplus of the-member state banks and trust companies was on that date 4 tt o £ik <3*1tJlt ' erus* and aggregate resources « as compared with ->.^ j j _ on June 21st* y ?ft . and It is estimated that the manber- ship of the Federal Reserve system represents at this time about l of the total banking assets of the country. . Thus it- is evident that substantial progress has been made toward the complete unification of our • banking system. . A table showing the titles, dates of admission, capital and surplus, and aggregate resources of state bank^ members appears in the appendix. . CREDIT EXPANSION. ', Great as is the admitted power of the Federal Reserve system, equipped with its new resources and supported by the greater part of the banking uiousui'iircj ol^the country, there are nevertheless, limits to its m U f a * v C f r f u V W f M V j J e f r ildtJLeit X-623 ?"s < .0 ' ■ /'O . : -2 4 - capacity. Boring the past year there have been very naturally some ex pressions of anxiety on the part of the financial community as to ex pension of credits* The Board has fully recognized the dangers of overH[xpansion and has endeavored in every way not hurtful to war financing, to. prevent such a condition* The question as to how far expansion has drifted toward the danger point, despite concentration and careful use Of our banking resources, shorild be'carefully considered in the develop ment of a sound policy for the future* The .wllowing tabulation from combined statements of the twelve Federal Reserve batiks shows the changes | in the reserve position of the Federal Reserve system during the year, | the figures being as of December 31, IS 16, April 1, 1917, July 1, August 1, November 1, and December 31, 1917, the four dates last named re- \ fleeting I thechanges directly attributable to the flotation of the ■ . Liberty loans- J , (Inserttable) ' From.the foregoing it will be noted that the increase in the total invested funds grouped as earning assets., during the months intervening between the beginning and the close of the year 3.917 is about ^ Of this sum, *. }. . is represented by purchase or discount of ' commercial paper of the kinds made eligible under the tern®, of the Federal Reserve Act, the remaining & ^ '5< f £ O & a representing the dis-< ---- ------ — * c o u n t e r p u r c h a s e p y the banks o f ^ a p e r secured by government obligations', for the purpose of enabling buyers of bonds to. carry them during the < period necessary for the liquidation of their own obligations thus in- | * cur red. ■ ■ As will be seen from the table, the reduction in the reserve percentages of the Federal Reserve banks against notes and deposits was <tLh 'fentALtom*! ut^d****^ 3 fa ‘ , I | */,&, j X-6 2 3 -2 5 - most marked during the periods between April 1 to July 1 and between August 1 to November 1* During the month of July there was a notable strengthening of the reserve position and this condicion is also observed in a smaller degree between November 1 and Deoember 31* Taking the year as a whole, It will be no^ed that, although there has been a great increase in the total asseis of the system, there has been a reduction of gold and lawful money reserves ,from at the beginning* to at the end of the year, but it should not be overlooked that the figures fer December 31, 1917 represent the condition existing at a tlzae when the process of distributing the second Liberty loan was still uncompleted* The question whether the final distribution of the second Liberty loan and the resulting financial adjustments *would bring about as favorable a existed situation as that which Bftrtoforaft at the closing of the first loan, is still an open one, but indications are that there will be a larger amount of bonds left in the hands of the banks and that a correspondingly greater volume of rediscounts secured by government obligations may remain with the Federal Reserve banks than was the case at the close of the first Liberty lean. This condition will no doubt b e gradually improved, but the reduction in the volume ef d isdaunts will depend to a great extent upon the requirements of the government and the time which will elapse before the floating of a new bond issue becomes necessary. The position of the banks with respect to credit expansion is shown by the condensed statement of the deposits, loans, discounts, and investments •f the national banks as reported to the Comptroller of the Currency on November 20th 1917, as compared with corresponding figurgs on X -6 2 3 —26— 3 1 3*« November 17, 1917- Nov. 17. 1916 » Deposits, net on which reserve is computed L 7. f Nov. 20. 1917 oc& ^ Leans and discounts t /Of*##? United States bondsCjjJ 7*V- Other stocks, bonds, and securi ■ (a) including i r o a s m y certificates of indebtedness ' ' t It seems reasonable.to assume that while, during the year 1917/ there has been a lessoning of the fluidity and immediate avail ability of the country's banking resources, the change has really been moderate when there Is considered the extent of the requirements which _ i have been made upon our banking system* . It is evident also, from an analysis of the figures, that the decrease In reserve strength is liaj.iHy attributabl^jto commercial discounts but that it is directly the result of government financing and its unavoidable but necessary demands upon our J8£t355adL resources. It is estimated that the advance in commodity prices during the year 1917 ( d shown by the statements of the Department of Labor has been a b o u t __ __ which may be compared with a n estimated advance of about ^ from August 1, 1914 to December 31, 193.6. It is clear, however, .that so far as the year 1917 is concerned, the rise in prices must be attributed more to the relatively decreasing supply of neoessaiy commodities and a greatly increased demand for them because c^ f the war, than to expansion in the volume ef currency or bank credits. X-623 8 1?Vi «2 7 ~ Rising prices are an unavoidable out growth of a state of affairs through* out the world whereby a very large proporti&n cf artisans and laborers have been transferred from productive occupations into* unproductive and destructive wcrk, no longer performing their functions aa producers of raw materials and of canuTaotured articles, but at the same time increas ing their demands upon the remain ! j stoc’. of the available supplies* rg r . It seems, therefore, unjust to ascribe the rise in prices entirely to credit expansion or over-activity on the part of the banks * Nor can the increased volame cf the Federal. Reserve note Issues be regarded as . inflationary, for not cnly are these notes net available as legal re- . serve, in the vaults of member banks, but the withdrawal of gold and gold certificates from circulation which has resulted frein the efforts of the Board has naturalJy created a vacuum which could cnly be filled by additional issues of currency* It may be asserted with confidence # that any danger of undue expansion with which the country cay be confronted Is likely to manifest itself not in a n ever-Issue of circulating notes, but rather in the increase in bank deposits resulting from loans — creation of demand credits upon the books cf the banks. the The danger of currency inflation, the evils of which have been fe'JLt in all previous ' wars of long duration, has not, up to this time, been a menacing one in the United States* The fluid condition cf our banking resources and the • • should amount of free gold held b y Federal Reserve banks, are factors which ■ ■ be taken into account when the question of note issues is considered* PRIVATE A N D CORPORATE FINANCE. A feature ef the banking and financial situation which has been X-623 3134 -28- developing during the past year, and 1 9 whidh £he attention of the Beard has been frequently directed, is the position of firms and private c o o perations having short term obligations maturing in the near future, and who have been accustomed to procure banking accommodations upon terms which are now impossible* The action of the President in taking over control of the railroads and of their financing has apparently solved the most serious problem with which the country had been confronted, but there remains to be considered the requirements of various public utili ties corporations, as well as. of some of the larger concerns which have been accustomed to borrow heavily at banks for the purpose of carrying laige stocks or of providing themselves with working capital* The ef fect of public borrowing on a very large scale has been a withdrawal from the market of a large proportion of the funds available for short term loans, or for private investment on long term* While every effort has been made to transfer government obligations speedily and effectively 1 / . to private ownership, in order to withdraw them from the market, and to prevent their accumulating in. the portfolios of the banks, it is neverthe less true that during the process of distribution, large amounts are necessarily carried by the banks for their account, as well as for their customers* The influence thus exerted upon the loan and investment market is necessarily incidental to operations, of this kind* The resulting situation is more or less inconvenient for all who have been accustomed to resort to banks for loans on collateral, but it is particularly distressing to the 29- larger borrowers* She situation has been further complicated by the com* paratively large Volume of obligations of foreign governments which are being carried by the banks against short texm notes, resulting in a di minution of their percentage of liquid assets* Sheee conditions are reflected in the requests which the Board has for some time past received* from many quarters that the rediscount privilege be extended to papeS of a character and form which has not been regarded hitherto as eligible* Perhaps the most urgent request of this kind has been that the Board per mit Federal Reserve banks to discount notes or acceptances ^Llch have been placed upon the market under an agreement between the borrowers and their bankers, which provides for a considerable number of successive renewals* Had the Board permitted such paper to be rediscounted, Federal Reserve banks would have been burdened with paper which the makers would not expect to liquidate at maturity* She discount of paper based upon an agreement for repeated renewals is not consistent with the underlying principles of the Federal Reserve Act, and the Board has had no hesitation in stating that it does not regard paper subjedt to these agreements as a desirable investment for Federal Reserve banks* The Board's attitude - does not imply any doubt or question of the legitimacy of the purposes for which the funds were desired, or of the Inherent soundness of the paper itself, but rather that such transactions are not a kind which Federal Reserve barks may properly facilitate, as they should never overlook their obligation to preserve the liquid character of their, assets* Another proposition of a somewhat similar aharacter which contemplated the sale of acceptances designed to finance foreign purchases of goods in X-623 31 «i -3 0 - the United States, but whidh had no connection with any qpieoific trans action, was likewise brought to the attention of the Board during the month of November: and for reasons similar to those governing the case of the renewal paper, to \ i l h reference has Just been made* the Board rhc has found itself unable to look upon such acceptances as eligible for discount at Federal Reserve banks* Another case involving the eligibility of aooeptaneed secured by readily marketable commodities carried In ware houses, was also taken under consideration, and the Board reached the conclusion that acceptances of this kind might be eligible for discount or purohase by Federal Reserve banks, provided the goods were stored in a satisfactory manner, and unquestioned legai title of the property con veyed by the warehouse receiptsf l While this conclusion is in harmony with the letter of the Federal Reserve Act, it seems, nevertheless, that discounts of paper of this character should be scrutinized closely and that they should not be permitted in very large volume. The significance of .these prepositions is that there is pressure on the part of commercial and manufacturing .enterprises to gain access to the rediscount facilities of the Federal Reserve banks, and there Is evidently a disposition to obtain the privilege upon the terms of technical points of the law rather than its spirit* The policy of the Board, however, must invariably be to interpret and apply the law in accordance with its « manifest intent and underlying principles, with the end in view always . X-623 of safeguarding and naintainirg the liquid character of the assets of the Federal Reserve hanks/ T f s duty, always present, l a become inoperative ht is because of the fact that the entire reserves of the member bankb, so far as based upon legal requirements, are how, by the act. of June 21, 1917, carried on the books of the Federal Reserve banks* Upon these banks# and upon the Federal Reserve Board, therefore, falls the. responsibility for the maintenance of a liquid condition, and upon them will justly fall censure for any improper or imprudent use ef these reserve funds which are held under a trusteeship of the highest character. Therefore, in no circumstances, can the Beard admit thp eligibility of paper by whomsoever made which, in its essential character, fails to conform to sound banking principles and to the provisions of the Federal Reserve Act. In making this statement ef its attitude, however, the Board does not Ignore or overlook the very serious problems which new confront private enterprises of providing for their financial requirements. From statistics which have been obtained by the Beard, it is evident that there will mature during the year 1918, short term obligations aggregating a large amount, and the Board has no infermatipn, up to this time, as to arrangements for their liquidation or renewal. Reference has already been made te the position of the savings banks and other investment institutions In general* Undoubtedly some effective measure of relief is desirable and if made available will be of great benefit net only to those requiring funds for comparatively long periods, but would also improve indirectly the general banking situation. The X - 623 4 * -3 2 - reeulting problem Is 6ne which may perhaps come within the scope ef the Board's advisory Relationship,. but It Is not ope which can be dealt with by the Board in an administrative way* FRam a purely advisory standpoint, the Board would suggest the propriety of dealing with this situation through direct governmental aid in some form approved by the Secretary &f the Treasury* The Board is, moreover, of the opinion that any plan involving governmental aid is preferable to one which would be dependent upon the use / f the resources of the Federal Reserve banks* ? Such an expedient would be justified, If at all, only after all other means had failed, and as a final and desperate erStmae resort at a time of the most f urgent national, necessity* It is particularly recommended also, that any plan which may be adopted for the relief of those desiring long time accommodations upon security cf a non-liquid character, should not be made to depend for its success upon any access direct or indirect to the resources of the Federal Reserve banks, or upon the pewer to i3sue currency for the purpose of extending credits of this character* It ought to be possible to extend effective aid to those deserving it without jeopardizing our entire financial structure* CONSERVATION OF <GO£D. She entry cf the countiy into the war was accompanied almost Immediately by a cessation of the movement of gold to this country which had been continuous since the early months of the year 1915, and in fact the move ment had begin to slacken as early as November 1916* Foreign governments had found it convenient to liquidate their obligations due in other countries by purchase of bilia in our own markets, and while the aggregate X-623 -3 3 - trade balance has continued In favor of this country, the balance is against us In some cases. During the second quarter of the year there developed a strong tendency te withdraw gold by those neutrals whose supplies of raw materials had been drawn upon by our own government and by other govern ments associated with us in the war, and during the months of June, July, and August, our net loss of gold amounted to about $100,000,000. She movement of gold having already been restricted Inall of the belligerent u t c t f g countries, demands for it In settling International accounts, in afffi adjusting exchange rates, and in strengthening reserves, were naturally made In our own markets. As the movement began to assume larger pro portions, the President, on September 7th, issued an executive ordee, attached hereto as Exhibit . vesting In the Federal Reserve Beard, with the approval of the Secretary &f the Treasury, tM- duty of passing upon applications for shipment of coin, bullion, or currency. Acting In conjunction with a representative of the Treasury Department, the Board issued regulations covering the licensing of such shipments, and has since held dally sittings for t y purpose of considering applications. te It became manifest almost immediately that applications for peimission to export gold fell into a few distinct classifications. ■Applications for permission to ship gold, to European neutral countries have, except for a few days following the date of the cider, been invariably declined, f r o. obvious reasons which it does not seem necessaiy to enumerate. A dif ferent problem however, presented itself in the case of applications for shipmaits of gold to the Orient, to Mexico, and to South American countries which had been furnishing necessary raw materials. It was X-623 ■4 3- deemed Important to continue these trade relationships while reducing ship-i ments of gold to a minimum* For a short time large shipments were permitted to g > to India, but as a result ef negotiations between the o Treasury Department and representatives cf the British government, prevision has been made fpr rupee exchange resulting from shipments of silver, to be allotted by Federal Reserve banks to Importers according to their necessities. In a few cases shipments of gold are being permitted to South American, countries, although it is hoped that arrangements can be concluded at an early date which Will ebviate the necessity of making further shipments in any considerable volume. Issued a decree on September The Mexican government 27th which requires the payment of expert and import duties in gold, the return in gold of the full value of geld ores and bullion exported from Mexico, and the return in gold of 25$ of the value of silver ores exported. For a time it was necessary to per mit some shipments of gold for payroll purposes, in mining operations controlled by citizens of the United States, and where the products were brought into this country. More recently, however, it has been the policy of the Board to decline to permit exportation of gold to Mexico except for payment of duties, and for the return to Mexico of the value of metallic brought into this country. It has been ascertained that in many instances United States currency can be used in Mexico for payroll purposes, and that in cases where it cannot be used, Mexican gold can usually be purchased. The total amount of gold shipments to various countries which have been authorized since September 7th appears as Exhibit . Before the executive order was issued, considerable sums X-623 i 4j . • •35- of gpld had bean earmarked of the banks in New York City. or held In trust for Canadian banks by some The Board has deemed it proper to permit the exportation of this earmarked gold, and has also entered into an agreement with Canadian bankers whereby a total of $25,000,000 of gold may be released up to July 1, 1918. This action was deemed essential in order to finance the movement of Canadian orcps which were needed for export to European countries associated with us in the war, and its effect upon sentiment wa3 so favorable that ne part of the amount has so far 4 ' ’ been withdrawn, New York exchange in Canada having new advanced to a considerable premium. Foreign exchange rates have been abnormal throughout the year and in many of the countries which send us necessary material, American bills are at a heavy discount* The Board is making a close study of our trade relationships with neutral countries and has been fortunate in securing the services of Mr. Frederick 1. Kent, of New York as its foreign exchange adviser. (Statement by Kent) . (Make reference here to the new order which the President is expected to issue giving the Board authority to issue licenses in foreign exchange transactions.) CLEARING AND COLLECTION. The volume of checks handled b . the Federal Reserve batiks during the y year has increased enormously, although there has been no material addition to the number of nonmember banks which remit at paS to Federal Reserve banks. Section 13 of the Act was amended last June as recommended by . X—6 3 2. -<36. the Board, a* as to allow Federal Reserve banks to receive accounts for collection and exchange purposes from such nonmember banks and trust companies as may agree to remit to Federal Reserve banks at par for checks « drawn upon themselves and Which will, in addition, maintain balances with the Federal Reserve bank sufficient to offset the items in transit held for their account by the Federal Reserve bank. Comparatively few nen~ member banks have, however, availed themselves of this privilege, and the Federal Reserve banks are still unable to collect checks drawn on many nonmember banks except at heavy expense. An- effort was made, on behalf of some of the bank3 to amend the Act by providing for a standard! zed exchange charge not to exceed one-tenth, of one per cent, to be made by member banks against Federal Reserve banks for checks sent for collection. It was not successful, and the Act as finally amended provides that a member or nonmember balk may make reasonable charges, to be determined and regulated by the Federal Reserve Board, but in no case to exceed ten cents per hundred dollars or fraction thereof, based on the total of checks and drafts presented at any one time, for collection or payment of checks and drafts and remission therefor by exchange or otherwise; such charges shall be made against the Federal Reserve banks. but no The Attorney General has been requested to give his opinion as to whether this proviso applies to nonmember banks. kptx An affirmative opinion will make possible the establishment of an universal par clearing system, but if, on the contrary, it should be held that It applies to member banks only, the further development of the collection' system will neces sarily be slow. • It seems unfair that small member banks should be obliged t . remit at par while their nonmember bank competitors can continue o X-623 3143 -3 7 - to make their usual charges« The Board feels $hat all banking institutions should be obliged to remit at par or else that they should all be permitted to make reasonable charges* In order to complete as far as possible the clearing and collection system, and to rendeS all possible service to the banks and to their customers, the Board authorised the Federal Reserve banks on July 1st, to receive for collection for account of member banks nat . i n notes and ur.g bills, and miscellaneous drafts, subject to a moderate collection charge* Consequently, mamba? banks which were obliged to rely upon other banks for services of this kind, can now depend upon the Federal Reserve banks for such service. There has also been put int* operation by all Federal Reserve banks a system of transfer drafts, which enables any member bank to have its drafitj drawn upon t i Federal Reserve bank cf its i m dis le trict, paid immediately, without time allowance or deduction at any other Federal Reserve bank, adjustments between the respective Federal Reserve banks being made through the gold settlemait fund- In this way, any member bank has, under the proper and necessazy restrictions provided, the same exchange facilities it would have by carrying accounts in each of the twelve Federal reserve cities* GOID SETTLEMENT FUNLv The operation of this fund has been described, in former reports of the Board, and no extended commaiits upon it seem necessary at ■ this time. Under the act as amended additional safeguards have been thrown around the fund by permitting the Treasurer of the United States to carry a special account upon his bocks to the credit of the Federal Reserve Board as agent -3 8 - for the respective Federal Reserve banks and Federal-Reserve agents* Settlements are now made by warrant, signed by officials of the Board^t and the pzactlce of Issuing gold order certificates in denominations of $10,GOO, representing gold deposited with the Treasurer by federal Reserve banks, and which were held in the custody of the Federal Reserve Board pending transfers between the banks and the Treasury, has been discontinued* The operation of this fund, which Is in effect a clearing house between the twelve Federal Reserve banks, has been particularly useful during the past year by reason of the continuous transfers for very large amounts which have grown out of the sale of government bonds and Treasury certificates and the redistribution and disbursement of the funds real ized. Without such an arrangement, our own operations would have been accompanied with great expense and much Inconvenience, but by its aid, transfers have been instantaneous and automatic, and have been made with* out the inconvenience and expense which would have been unavoidable- had physical transfers or shipments of monsy been necessary* BRANCHS OF FEDERAL RSERVE BANKS. During the year, branches have been established at Omaha, by the Federal Reserve Bank of Kansas City, at Louisville by the Federal Reserve Bank of St* Louis, and at Portland, Oregon, Seattle and Spokane, Washing ton, by the Federal Reserve Bank of San Francisco, and are in satisfactory operation* The Board has, in addi tlen, authorized the establidiment of branches at Pittsburgh, and Cincinnati by the Federal Reserve Bank of Cleveland; at Detroit by the Federal Reserve Bank of Chicago; at Baltimore by the Federal Reserve Bank of Richmond, and at Denver by the Federal Reserve batik ef Kansas City® It Is expected that all ef tJiese branches will begin business during the months of January or February. Questions relating to the establishment and operation of branch banks' have been simplified by the amendment to Section 3 of the Federal Reserve Act. As originally enacted, this section provided that each Federal Reserve bank “shall establish branch banks" to be "operated by a beard of directors raider rulea and regulations approved by the Federal Reserve Beard," and provided also that there be seven directors and that should possess the same qualifications as directors of Federal Re serve banks* The Section as now amended provides that the Federal Reserve Board may pernlt or require any Federal Reserve bank to establish branches within Its district, and that such branches, subject to such rules and regulations as the Federal Reserve Board may prescribe, shall be operated under the supervision of a board of directors to consist of not more than seven or less than three directors, of whom a majority shall ef one shall be appointed by the Federal Reserve bank of the district, and the remaining directors by the Federal Reserve Board* . policy The ' of the Board in the establishment of these new branches, has been to recognise the unity a i paramount responsibility of the Fed rd eral. Reserve bank, while extending to the banks in the territoiy served by the branch full facilities* By avoiding duplications in bookkeeping, and by a consolidated control of accounts at the Federal Reserve b t k ai, it is believed that branches can be operated at a comparatively small expense* The branch of the Federal Reserve Bank of Atlanta, at New Orleans, date of the Board's last annual report, was the only one in which?! at the X-623 31^ -4 0 - operation, has, during the past year, again demonstrated its usefulness and has been , or soon will be, supplemented by the tei just referred to* INTERLOCKING DIRECTORATES. In its report for the year 1916, the Board gave full details of its work in the application of the previsions of Section 8 of the Clayton Lot and the Kern amendment thereto* During the year 1917, applications ^ were received for permission to serve as joint directors, and of this J $ number . ' have been granted, and ■ ■ have been refused. ■ FIDUCIARY POWERS. On June 11, 1917, the Supreme Court of the United States handed down its decision in the case of Bank vs Fellows? appealed from the ' Supreme court of Michigan, which was referred to in the Board's last annual report to Congress* The lswer court was reversed, and the court sustained the constitutionality of Section 11 (k| of the Federal Reserve Act which authorizes the Federal Reserve Board "to grant by special permit to national banks applying therefor when not in contravention of state or local law the right to act as trustee, executor, administrator, and registrar of stocks and bonds under such rules and regulations as the said Board may prescribe." The decision in this case is of far-reaching and vital importance to the Federal Reserve system in that it not only sustains the right of Congress to vest in national banks the powers enumerated in Section 11 (kb but recognizes the right of Congress to grant to such banks any and all powers that are necessary to enable them to meet the competition of corporations organized under state law. • * First National Bank of Bay City, v Grant Fellows, Attorney General, and others. X-623 Prior to this decision the Federal Reserve Bpard had granted permits • • * t i applicant banks except in those cases where the laws of the s.tate in which f the bank was located expfeAsly or by necessary Implication prohibited such banks from exercising these powers* The language of the court, in the decision handed down on June lith; was apparently susceptible of the inter pretation that these permits might be granted in any case in which the state laws permitted competing banks to exercise such powers. In view of its importance the matter was referred to the Attorney General who reached the conclusion that while Congress is fully.empowered to authorize the Board to grant permits under such circumstances, the Act as it now stands does not vest this authority in the Board* There are seme states, which authorize banks or trust companies created and organized under their own laws to exercise such powers but which expressly prohibit any other corpoiations from doing so. In order to coordinate the powers of national with state banks it is recommended that section 11 (k), should be amended so as to permit the granting of these powers to national banks in any case in which the competing coiporation organized under state laws are permitted t® exercise such powers. By direction of the Board its counsel, with the consent of the Court, took part in the proceedings both in the Supreme Court, of Michigan and on appeal before the Supreme Court of the United States. The Board has granted during the year 1917, 112 permits for the exercise of fiduciary powers, making a total to date of 481. . mHNIlKS AND EXPENSES. The rediscount demands which have been made upon the Federal Reserve banks during the past year, and the greater employment of their funds, have been reflected in very greatly increased earnings. The combined net earnings ‘ X— 623 >42— of the twelve banks for the year, were at the rata ef _____ % on the ag- / t / / // gregate capital, and the total net earnings f©r the entire year were . &-- • Section 7 of the aot provides that "afterall necessary expenses of a Federal Reserve bank have been paid ef provided for, the stockholders shall be entitled to receive an annual dividend tf si& per centum on the paid-in capital stock, which dividend shall be cumulative* After the aforesaid dividend claims have been fully met, all the net earnings shall be paid to the United States as a franchisee tax, except that one-half of such net earnings shall be paid into a surplus fund until it shall amount to forty per centum of the paid-in capital stock of such bank*1 1 The Board construes the foregoing as meaning that no contingent funds can be set up against future expenditures Or As a reserve for unforeseen losses, but that the surplus fund which, under the law, can accumulate until it readies forty per centum of the capital of the Federal Reserve bank, is intended to take care of all such contingencies. The Board has, however, advised the hanks that provision for apparent or temporary depreciation in securities should be made, before any sum is transferred to suiplus account or any payment is made to the United States government. It has also per- ' mitted banks to charge off furniture and fixture accounts in full, and a reasonable proportion of the cost of vaults. It has authorized the writ ing off of the amounts actually paid for the printing of Federal Reserve notes, whether the notes have been put in circulation by the bank or held by the Federal Reserve agent. It has also authorized those- banks which own their premises to write off five per cent of the total cost per annum as a depreciation allowance. The gross and net earnings of all the banks for the calendar year 1917, and the dividends declared by them from the date Digitizedof FRASER organization for their to the end of 1917, are shown in the following tables -4 3 - (Insert table — See page 13 annual report 1916) _ lr ' i . It will be seen frpm t j foregoing that the Federal Reserve Bank of je San Francisc^hasj^I^D^^^unulated dividends up to December- 31y 1916, that five others - the Federal Reserve banks of Philadelphia, Kansas City, Cleveland, and Dallas* have paid their accumulated dividends up°to June 30, 191?, and that six banks’ those of Boston* New York, Richmond, Atlanta, Chicago, and Minneapolis* have paid all accumulated dividends to the end of 1917.. These b t k ; after charging off their ex ais* penses and making the depreciation allowances, which have been previously described, have' set aside surplus funds and have paid equal amounts to the government as a franchise tax, making the total return to the govern ■‘ ment £ A ’ ' ' * ' ' f i The Board wishes to repeat the statements made in previous reports that the bahkA are'not operated piin&rlly tat profit, but in meeting the demands Which are exsected to be made upon them during the coming year their earnings will undoubtedly continue to be large. It is exp.acted t t a all accumulated dividends will be paid during the year, and that the iet excess to be paid to the government as a franchise tax, at the beginning sf 1919, will be very much greater than the payment which has just been made* ' administrative policies . Dyring the period sf organization and ef development which extenied tver the first two years of. the operation of the system, the Board deemed it advantageous t> obtain frequent suggestions from the officials ef the o Federal Reserve banks, and to have them confer with each other in order that £-623 3150 -44-* definite understandings might be reached, and uniform methods of operation determined upon* Many of the problems which had to be worked out were entirely new* and because of w5.de2y different conditions in the various districts, frequent consultations seemed necessary to ensure a better knowledge of administrative details* Thus frequent conferences with the Federal Reserve agents and governors of the banks9 were deemed advisable, In order to secure more speedily an effective organization. The banks had, however, by the end of the year 1916, become well established, and having had two years of actual experience to guide them in the future conduct of their business, these frequent conferences gave become no longer necessary« The Federal Advisory Council, composed of twelve members, chosen by and representative of the Federal Reserve hanks, has held, in conformity with the requirements of Section 4 of the Act, four meetings during the year,-thus, giving the Board at frequent intervals the benefit of its views as to the trend of the money na.rket, and the proper adjustment of discount rates. Members of the Council have reported also upon the general financial, agricultural, commercial and industrial conditions in their respective districts. There have been no meetings of the Federal Reserve agenua during the year, but the Board, in anticipation of the first Liberty bond campaign, held a meeting with the governors of the Federal Reserve banks in April, and requested them to confer with it, in Washington, again in November. The activities of the year have been so great as to require the constant presence of the executive officers at their banks. The Board now exercises broader administrative functions, and makes final decisions on all questions X-623 3151 -4 5 * of policy calling far prompt aoticn, without awaiting an ©xjportunity *9T consultation and development of opinion on matters of detail, as has been customary in the beginning* The'functions of the Board as the co-oidinat- ■ ing body for all the banks, and as the directors of the Federal Reserve are now system,// . well defined, and the line of distinction between the ■ local management of the banks and their operation as a system, has become more clearly marked. The Board has, on two occasions during the year, exercised its power of requiring Federal Reserve banks to mefce rediscounts for other Federal Reserve banks without submitting the questicn to their directors tfor determination. This has been dene for the Sake of greater ji■ jmrtfrgrev promptness and efficiency in securing the adjustments desired, j■■ . and not because there was any doubt about favorable action being taken upon the suggestions of the Board, as the banks have all responded promptly in cases where the Board has made its wishes known* RESERVE ' CITIES. (The Federal Reserve Act confers authority upon the Federal Reserve ' Board to add to the number of cities classified as reserve and central reserve citids, or to reclassify existing reserve and central reserve cities or to terminate their designation as such. As the reserves of member banks are new carried exclusively »*ith the Federal Reserve banks, the designation Of any city as a reserve city relates An only to the percentage of reserve ■ ■ h c must be carried by the member banks located therein. -rih The Board has retained the old classification of central reserve and reserve cities, and has also designated as reserve cities, making the banks therein subject to -4 6 - Xhe cities so designated all have a population in excess of 100y000 and are banking centers. Vithout this classification, the banks in those cities would have continued to carry the reserve prescribed for country banks * * 7%, and the Board deemed it equitable to bring their reserves up to the requirements of other cities of their class* The. three central reserve cities, under the old national banking laws - New York, Chicago, and St. Louis, have been continued in that classification, and the member banks of those cities are required to carry the, maximum reserve of 13$. Philadelphia and Boston, although important banking centers, and each having a greater .population than the city of St. Louis, continue to be classified .as reserve citites, and reserves of 10$ only are required of the banks located. therein. it is difficult to nake an equitable and uniform adjustment of reserves under the. present law, and the Board is making a careful study of the subject, with a view of recommending to Congress at a lat©9 date a change in the law which would provide for a differential in xssBZsauDKJt reserves to be carried in all towns and cities a^like upon certain classes of deposits, with a minimum for time deposits, a maximum Stet'harik deposits, and an intermSdiate figure, to be determined upon, for individual or commercial deposits subject to check. This is a matter however, which will require careful study and analysis, and the Board is not prepared as yet to make a recommendation for any change in the reserve requirements. SUGGESTIONS FOR AMENDMENTSi - xhe Board seed no occasion at this time for any sweeping changes in the ■ Act. . / - , ■ It would suggest* however, the following for the consideration of Congress: (1) : An amendment of Section 4 relating to the election of directors* The law provides that the member banks sisalX be classified into three general groups or divisions, each group to contain as nearly as may be one-*third of the aggregate number of member banks of the district, and to consist as nearly as possible of banks of small capitalization, and that each member bank shall elect by ballot a district reserve elector and shall certify his name to the chairman of the board of directors of the Federal Reserve bank of the district, who shall make lists of the district reserve electors thus named by banks in the three groups and shall transmit one list t . each elector in the group. o Each member bank is permitted to nominate to the chairman one candidate for a director of Class A and one candidate for director of Class B. Candidates so nominated are listed by the chairnan and a copy of the list is furnished by him to each electcr, who, within fifteen days after the receipt of the list certifies to the chairman a second or other choice of directors of Class A and Class B respectively, upon a preferential ballot. * Any candidate having a majority of all votes oast in the column of the first choice is declared elected and if no candidate have a majority of all the first choice votes, then there is added the votes cast by the electors for such candidates in the second choice column. Any candidate having a majority of the electors1 vote by adding together the first and second choices, is declared elected. Should no candidate have a majority X-623 3154 -4 8 i In this way, then the third ohoioe voted are added* This System, which is designed t c secure f representative beard of directors* is complicated and has f t resulted in many cased in the choice bi directors by a very small minority Of the banks. A majority bf the baziks has zieve$ since 1914 chosen a district elector and there seems tb be no reason why the directors of the banks should not be peimitted to authorise the President or Cashier Of the bank to bast the vote of the bank. The heard has ruled that electors ence chosen may continue to serve until their successors are elected, but since the first year the baziks have net as a rule participated fully in these elections, ■ * * ■ In the election held in December 1917 by the various greups in the respective districts, In nearly every case less than -one-half of the banks participated. In the New York district 84 votes were cast out of a total of 224; Richmond district 72 out of 172; In the Atlanta district 66 out of 140; the Chicago district 86 out of 360; 162; in in the St, Louis district 35 out ef in the Minneapolis district 45 out of 283; 15 cut of 201; In the in the Dallas district in the San Francisco district 71 out of 178; and in one instance the successful candidate was chosen by 15 votes out of a total of 201,' and in another by 28 votes out of 162, . The Board would suggest that this section be changed so as to simplify elections by pexmlttizig each bazik through its President or Cashier to cast ohe vote for director regardless of its capitalization, and by providing that ene additional vote may be cast by a bazik for each s2LQ» 0 0 9 ©f stock held by it j in the Federal Reserve bazik, the total number ef vjftes cast by any bazik not to exceed ten* It is also suggested that the baziks be permitted to elect three Class B directors, but ozily two Class A directors, and that one Class A director X-623 be appointed by the Board In addition to the three Class C directors now appointed by it* The member banks would still elect a majority of the Beard, five against four appointed by the Federal Reserve Board, which in being permitted to appoint the third Class A director, would have an ’ -f opportunity of rectifying any inequalities which might result from the election by the member banks* (2) . An amendment to Seotlcn 9 to permit state banks already in operation, having an aggregate capital and surplus of net less than $109,©00 to become members of the Federal Reserve system at the discretion of *the Federal Reserve Board* This section as it is now written requires that ns applying bank should be admitted to membership in a Federal Reserve bank unless it possesses a paid-up and unimpaired capital sufficient tc entitle it to become a national banking association in the place where it is situated under the provisions of the national bank Act. The attention of the Board has been directed, in many cases, to state banks otherwise, eligible fGr membership, which cannot apply because of this restriction, and which do net feel warranted in asking their stockholders to increase their capital to the requisite amount. There are several national .banks located in towns or cities whose population has been greatly increased by annexations or otherwise, which are how operating with a smaller capital than would be required of new banks in these cities, under charters granted before this increase in population took place, and the Board does not believe that any injustice would be done by modifying this section in the manner suggested so as to be applicableenly to existing banks. X-625 - 50 (3) ’ 3156 An amendment to Sect.Ion 9 to authorize mutual savings banks having no capital stack, te becenJe associate members of the Federal Reserve system under certain prescribed conditions* This was suggested by the • Board in its annual report for the year 1916, and its consideration at this tinte Seems mere important than was the case a year ago, as many savings . banks hbw have eligible paper 5n the form ef notes secured by obligations Of the United States. The principal beneficiaries would be the mutual savings banks of the. Eastern and New England states which cannot become members of the Federal Reserve system under the present law because of the lack of any provision enabling them to subscribe to capital stock in a Federal Reserve bank, as they have no capitalization of their own upon which a percentage could be based. The accommodation proposed limits mutual savings banks strictly to the discount of customers1 notes secured by notes or bonds of the United States maturing within thirty days, or of their own i promissory notes secured in like manner running not longer than fifteen days. (4) An amendment of Section 16 which now permits Federal Reserve notes to be issued in denominations ef $5, $10, $20, $50, and $100 only, so as to permit their issue in the larger denominations of $500, $1,003, $5,000, and $10,000. It is thought that such an amendment would tend to increase the geld holdings of the Federal Reserve banks, particularly those in the larger financial centers. The Federal Reserve banks receive gold at the present time chiefly from two sources* by registered mail or express from national or state banks, and over the counter in cases where now currency ia convenient denominations Is required for payrolls or for other purposes. . All avenues for loss of gold are now under control except X-623 fttfi -*51- direct withdrawals over the counter, and an analysis of counter transactions at some of the larger Federal Reserve banks discloses the fact that frvm $100,000 te $1,£00,000 of gold certificates are paid out every business day mainly because many member banks prefer te keep as part of their vault msney notes of large denominations which can now be furnished only in the form of gold certificates. (5) An amendment of Section 22. This is a penal section, not al together definite in its terms, and the Board is constantly receiving requests for a proper construction of it. It has, however, uniformly adhered to the view, that a section of this character can be construed duly by the courts, and has declined in all cases to express any opinion as to the liability vdiich might be incurred by any bank which acted upon an incorrect interpretation. As amended on June 21st this section permits transactions relating to the discount of notes, drafts, or bills cf exchange by a director with his cwn bank, upon the affirmative vote or written consent of at least a majority of the board of directors ef the bank; but there are other trans actions such as the purchase by directors of goods or property taken by the bank for debt, vhich might well be .permitted under the same conditions. It is not inconceivable that there may be occasions where a bank can best save * Itself from loss by being permitted to have a transaction ef this kind with one of its own directors. (6) An amendment to Section 25 to provide for the Federal incorperation of banking corporations whose stock is owned by national banks which operate under;the contrwl of the Federal Reserve banks aai which are engaged'solely in international and foreign banking. The present law permits any national X-623 v. » ' ~5&« • 1 . tank to Invest an amount not exceeding In the aggregate ten per centum of its paid In capital stock and surplus In the stock of one or mere hanks or cor porations chartered, or incorporated under the laws of the United States or any state thereof * and principally engaged in International or foreign bank ing, or banking In a dependency or insular possession of the United States* This language appears to indicate an intention by Congress- to permit in corporation under the laws of the United State&j and Several national banks have become stockholders in banks which have been organized under state laws for the purpose of carrying en a foreign banking business in accordance with the terms of this section. The arguments in favor ef Federal incorporation are: (1) The time will probably come when the conflict of the dual control exercised by the Federal Reserve Board and by the banking department of a state may be a matter of embarrassment or unduly restrict the activities ef the banking corporation* (2) Such a banking corporation* being essentially a national enter prise, whose stock ownership by national banks was authorized by an act of * Congress, is subjected to unfavorable comment by foreigners, in that it is incorporated under local rather than national laws* (7) An amendment to Sections 5208 and 5209 of the Revised Statutes. These are penal sections relating to the overcertification of checks, to embezzlement, abstraction or wilful misapplication of moneys, funds, or credits of national banks by officers, directors, agents, or employes of national banks, and to false entries in books, reports, or statements of national banks with intent to injure or defraud en the part of any officer, director, ' agent er employe of a national bank. It is suggested that these sections be 3159 X-623 -5 3 - , amended so as to apply to similar acts committed by officers, directors, agents, or employes of Federal Reserve banks and member banks. . ORGANISATION, STAFF* AND EXPENDITURES, There'have been no changes In the organization ot the Board during the past year. The growth cf the system and the expansion of the work of the - 4 Board have required some additions to its clerical and examining force. There have been some minor changes due mainly to the fact that several of the Board1s staff have engaged in military service, but the Board has thus far been able to fill their places satisfactorily. staff of the Board* There are now - on the The total cost of conducting its work during the year 1917, including printing of the Bulletin and salaries of members, ✓ ' was $______________ , which was defrayed by assessments levied upon the Federal Reserve banks amounting to .foranraoc _____ % of their capital* The volume of clearings through the g$ld settlement fund has greatly increased, the total during the year having amounted to 4________________ as compared with £ ___ during 1916. The cost of operating the gold settlement fund for the year 1917 was $___________ j i compared with £_______ ss in 1916, the net cost being_______ cents per ^1,000 as against ________ cents the previous year. The net balances, representing the change of ownership between the Federal- Reserve banks of gold held in the fund were 4 _____________ , which represents the amount of currency or coin which would, without the facilities of the gold settlement fund, have been transported between the banks. Further details relating to the operation > f the Federal Reserve banks and of # the system, will appear as exhibits in the appendix of this report, as will the annual reports of the Federal Reserve agents.
@FedFRASER