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.208
x.:...s2so
March 7. 1929.
TO:
The Federal Reserve Board
FR011::
Mr. Wyatt, General Counsel.
SUBJECT: Power of Board to enforce principles regarding proper use of credit
facilities of Federal Reserve System
laid down in Board's letter of February 2, 1929.
At the Board meeting on March 5th, I was requested liTo report
as. to Tihat powers the Board has under the Federal Reserve Act for
the enforcement, should it become
necess~ry,
of the principles re-
ga.rding the proper use of the credit facilities of the Federal Reserve System, laid down in the Board's letter of February 2nd to all
Federal .reserve banks. u
The following paragraphs of the Board's letter contain the statement of principles referred to:
"The Federal Reserve Act does not, in the op1mon
of the Federal Reserve Board, contemplate the use of
the resources of the Federal reserve bam~s for the creation or extension of speculative credit. A member bank
is not within its reasonable claims for rediscount facilities at its Federal reserve bank when it borrows
either for the purpose of making speculative loans or
for the purpose of maintaining speculative loans.
11 The Board has no disposition to assume authority to
interfere with the loan practices of me8ber banks so long
as they do not involve the Federal reserve banks. It has,
however, a grave responsibility whenever there is evidence
that member banks are maintaining speculative security
loans with the aid of Federal reserve credit. When such
is the case the Federal reserve baruc becomes either a contributing or a sustaining factor in the current volume of
speculative security credit. This is· not in harmony with
the intent of the Federal Reserve Act nor is it conducive
to the wholesome operation of the ba.mcing and credit system
of the country.n
It would appear, therefore,
th~t
the Board desires to be informed
as to the powers which it has under the Federal Reserve Act which could
0
X-·62 6"
'.9
. ~\h
-2-
...
be used to prevent member banks from using Federal reserve credit
for the purpose of making or maintaining speculative security
loans.
In view of the further remarks contained 'in the press state~
ment issued by the Board under date of February 5th (X-6233) and
lished on page
~3
pu~
of the Federal Reserve Bulletin for February, 1929,
to the effect tbat, ".the great and growing volume of speculative
credit has already produced some strain, which has reflected itself
in advances of from 1 to li per cent in the cost of credit for commercial use, 11
I assume that the Board does not wish to know what powers
it might exercise with a view
of
tightening the
6~neral
credit situa-
tion, such as the power to increase the rediscount rates or further
r.estrict the volume of open market investments of the Federal reserve
banks.
With this understanding, I shall endeavor to point out certain
powers which the Board possesses under the Federal Re.serve Act and
which might be exercised with a view of accomplishing
purposes.
~he
above
In suggesting these powers, however, it is my intention
merely to inform the Federal Reserve Board of its lawful rights;
and the 1:1ention of these rights is not intended as a suggestion
that they should be exercised.
The question whether these rights
ought to be exercised is a question of policy on which I intend
to express no opinion.OPUTION.·
(1)
Under Section 13 of the Federal Reserve Act, the Board
has ample power to prescribe such restrictions,
limita~ions
and regu-
>
X-6260
(1;A
,.::~J._
-3-
lations (;overning the rediscount of notes, drafts, bills of exchange
and bankers 1 acceptances, the making of advances to member banks on
their promissory notes, and the purchase of bills of exchange,
bankers' acceptances and government, State, and municipal securities (lncluding purchases under so-called repurchase agreements),
as may be necessary to prevent member banks from using the
credit resources of the Federal Reserve System for the purpose
of making or·maintaining speculative security loans.
(2)
Thus, the Board could,·if it deems it advisable, prescribe
a regulation forbidding any Federal reserve bank to rediscount any
paper for, make any loan or advance to, or purchase any bills of exchange, bankers' acceptances, or government, State, or municipal securities (under repurchase agreements or otherwise) from, any member
bank which at the time:
(1)
Has loans outstanding to brokers or deal-
ers in stocks, bonds or other investment securities; or (2) has unreasonably large amounts of speculative loans outstanding to customers secured by stocks, bonds, or other investment securities, or
the proceeds of which have been or are to be used for the
of carrying or
(3)
tr~ding
p~rpose
in stocks, bonds, or other investment securities.
The Board has ample power to enforce such a regulation by
suspending or' removing from office the officers and directors of
any Federal reserve bank which violates it.
(4)
The Board has no independent power under Section 4 of the
Federal Reserve Act to issue orders restricting or qualifying the
right of member banke to der.nand of their Federal reserve banks '•uch
.·.1'~
discounts, advancements, and accommodations as may be safely and
0.
X-6260
-4· reasonably made with due regard for the claims and demands of other
member banks".
(5)
This right of member banks, however, is expressly made sub-
ject to the exercise of such powers as the Federal Reserve Board has
under other provisions of the Federal Reserve Act, including the power
under Section 13 to prescribe restrictions, limitations and regulations
gpverning the discount and rediscount and the purchase and sale by any
Federal reserve bank of any bills receivable and of domestic and foreign
bills of exchange and of acceptances; and the Board could order a Federal reserve bank to cease violations of any such restrictions, li;nitations or regulations which it may have
(6)
prescribed.
The Board could, if it so desires,
~escribe
a special rate
(higher than the rediscount rate on indus.trial, commercial or agricultural
paper) for advances to member banks on their promissory notes secured by
bonds or notes of the Government of the United States.
DISCUSSION
Section 13 of the Federal Reserve Act contains the following provision:
"The discount and rediscount and the purchase
and s~le by any Federal reserve bank of a1~ bills
receivable and of domestic and foreign bills of
exchange, and of acceptances authorized by this
Act, shall be subject to such restrictions, limitations, and regulations as IDa¥ be imposed by the
Federal Reserve Board.u
This, in my opinion, confers upon the Federal Reserve Board
~le
power to prescribe such restrictions 1 limitations and regula-
tions governing the rediscount of notes, drafts and bills of exchange
X-6260
-5-
by Federal reserve banks, the making of advancements by Federal reserve banks to member banks on the promissory notes
.rr
such member
banks, and the purchase and sale of bankers' acceptances, bills of exchange, and Government, State and municipal securities under Section 14
(including the purchase of such bills, acceptances, and securities under
repurchase agreements) as may be necessary to prevent member banks from
using the credit resources of the Federal Reserve System for the purpose
of making or maintaining speculative loans.
The above quoted provision of Section 13 has heretofore been considered by this office and it has been found that it applies not. only
to rediscounts under Section 13 but also to purchases and sales at home
or abroad under Section 14.
(See my opinion of October 20, 1927 (X-4980),
pages 5 and 6, a copy of which is attached hereto.)
It also applies to
the making of advances to member banks on their promissory notes under
the seventh paragraph of Section 13 (See opinion of Mr. Vest dated June 21,
1928, (X-6124-a), a copy of which is attached hereto.
The question might be raised whether this paragraph pertains to the
rediscount of notes and "drafts" as well as bills of exchange and bankers'
acceptances, but it is clear that notes and "drafts" are included in
term "bills receivable".
fu
e
That 1erm has been held by the courts to include
promissory notes, bills of exchange or other instruments for the payment of money.
(See Words and Phrases, Bouvier's Law Dictionary, and
authorities cited therein.)
The term
a~d
11
bills receivable" would seem to ap:9ly also to bonds
notes of the United States and bills, notes, reVenue bonds and war-
rants issued by States, counties, districts, political subdivisions and
municipalities; since all such obligations are "instruments for the
X-6260
-6.,...
payment of money".
Even if the aboy:e-quoted paragraph in Section 13
does not apply to these classes of seQurities, however, the Board has
ample power under Section 14(b) to prescribe rules and regulations
governing the purchase of such securities.
The Board has power, therefore, to prescribe rules and
regulations governing practically every method by which a member bank
obtains credit accommodations from a Federal reserve bank, including not
only the rediscount of notes, drafts, bills of
exchan~e
and bankers' ac-
ceptances, but also borrowings by member banks from Federal reserve
banks on the promissory notes of such momber barucs and sales of bills
of exchange, bankers' acceptances and Government and municipal securities to Federal reserve banks
unde~
Section 14, including sales under
so-called "repurchase agreements".
The exercise of all these powers is by the above quoted
paragraph of Section 13 made subject to
11
such restrictions, Umi ta-
tions and regulations as may be imposed by the Federal Reserve Board."
There is no limitation in the law on the character of restrictions,
limitations and regulations which the Board may prescribe; and the matter is left to the discretion of the Federal Reserve Board, subject
only to the usual qualification that the restrictions, limitations
.·
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x... Gzso
and regulations prescribed by the Board must not be in oonfliet with other
provisions of the Federal Reserve Act and must not be arbitrary, capricious
or unreasonable.
Any restriction, limitatiOn, or regulation which is
reasonably calculated to carry out the purposes of the Federal Reserve .Act
and the policies which Congress had in mind when it enacted the Federal
Reserve Act would clearly be reasonabl-e and within the Board's power.
Certain of these purposes and policies were summarized a.s follows on page t3!3 of the Bbal'd • s Ann u ai Report for the year 1923:
lltt'he Federai reserve act has laid down as the broad
principle for the gUidance of the ]federal reserve banks and of
the Federal Reserve Board ih the discharge of their functions
with respect to the administration of the credit facilities
of the Federal reserve banks the principle of •accommodating
con~erce and business.•
(Sec. 14 of the Federal reserve act,
par,(d).) The act goes further. It gives a further indication of the meaning of the broad principle of accommodating
con~erce and business.
These further guides are to be found
in section 13 of tht;l Federal reserve act, where the purposes
for which Federal reserve credit may be provided are described
as 'agricultura.l, industrial, or commercial purposes'. It is
clear that the accommodation of commerce and business contemplated as providing the proper occasion for the use of the
credit facilities of the Federal reserve banks means the accommodation of agriculture, industry, and trade.- The extension
of credit for purposes •covering merely investments or
issued or drawn for the purpose of carrying or trading in
stocks, bonds, or other investment securities, exce-pt bonds
a."'ld notes of the Government of the United States, t is not permitted by the Federal reserve act. The Federal reserve system
is a system of productive credit. It is not a system of credit
for eit.her investment or speculative purposes. Qredit in
the service of agriculture, industry, and trade may be described comprehensively as credit for productive use. The
exclusion of the use of Federal reserve credit for speculative and investment purposes and its limitation to agri- ·
<(~:~al, industrial, or commercial purposes thus clearly
indf(J~tes the na.tu:r:e of the tests which are appropriate
as guides in the extension of Federal reserve credit.
:(,.'·,..-,,
..
2'15
X-6260
-8They clearly describe the nature or character of the purposes for which such credit and currency may be extended. The
qualitative tests ap~ropriate in.Federal reserve batik credit
admird.stratibn laid down by the act are' therefore, definite
and aniple • it
'
11
That this is an accurate statement of certain of the pur~oses
which Congrecs had in mind When i t enacted the Federal Reserve Act can be
.
,
conclusively d~monstrlited. by a ~+•view of the legislative history of the Act •
After ·defining the character of paper which is eligible for rediscount at Federa.i reser'1te batiks; Section 13 provides that:
Such definition shall not include notes, drafts or
bills covering merely investments or i13sued or drawn for
the purpose of carrying or trading in stocks, bonds or
other investment securities, except bonds and notes of the
Government of the United States. 11
11
The policy of this provision is indicated by the following
passages from the report of the Committee on Banking and Currency of the
House of Representatives on the original Federal Reserve Act ( H.R. Report
No. 69, 63rd Congress, 1st Session, pages ll, 19, 20, 48, 59, 62 and 63):
ESSENTIAL FEATURES OF REFORM.
"The other plans before the committee or examined by
it have likewise been found unsatisfactory-some for reasons
analogous to those which made the Aldrich bill unaccep-table,
others because of defective detail, erroneous principle,
or faulty construction. An effort was, however, made to
ascertain the constituent.elements of these measures ~~d of
the Aldrich bill, common to all, which should be recognized
and pr'ovided for in aey new plan because representing the
fundamentals of legislation. It is believed that these are
as follows:
11 1.
Establishment of a more nearly uniform rate of
discount throughout the United States, and thereby the furnishing of a certain kind of preventive against over expansion of credit which should be similar in all parts of
the country.
X-6260
-9nz • General eco:npp\y of te~etves in order that such reserves might be held ready for use in urotecting the banks of
any se.ction of the country and for enabling them to go on meeting their obligations instead of suspending payments, as so often
in the uast·.
"3. Furnishing of an elastic currency by the abolition
of the existing bond-secured note issue in whole or in part, and
the substitution of a freely issued and adequately protected
system of bank notes which should be available to all institutions which had the proper class of paper for presentation.
11 4.
Management and commercial use of the funds of
the Government which are now: isolated in the Treasury and subtreasuries in large amounts.
11 5.
General supervision of the banking business and
furnishing of stringent and careful oversight.
11
6.
Creation of market for connnercial :paper.
"Other objects are sought, incidentally, in these plans,
but they are not as basic as the chief purposes thus enumerated.
*
*
"TRANSFER OF RESERVES.
11Reference has been briefly made to the fact that the
committee's proposals provide for the transfer of bank reserves
from existing banks which hold them for others to the proposed
reserve banks. At present the national banking act recognizes
three systems of reserves:
*
*
*
*
"The original reason for creating this so-called 'pyramidal' system of reserves was that inasmuch as central banking
institutions were absent, and inasmuch as banks outside of
centers were obliged to keep exchange funds on deposit with
other banks in such centers, it was fair to allow exchange
balances with such centrally located banks to count as reserves inasmuch as they were presumably at all times available in cash. *
*
*
*
As matters have
developed, it has been vicious in the extreme. Coupled with the
inelasticity of the bank currency, the system has tended to create
periodical stringencies and periodical plethoras of funds.
Banks in the country districts unable to withdraw notes and
contract credit when they have seen f1 t to do so, because of
the rigidity of the bond-secured currency, have redepQsited
such fundswi.th other banks in reserve and central reserve
cities and have thus built up the balances which they were
entitled to keep there as a part of their reserves. Moreover,
r$ -·<~
~JY:)
X-6260 r:::,u~.- '
-1011 the :practice of thus :h3deposi ting funds having been once
established, it has been carried. to extreme lengths, and at
times has been decidedly injurious in its influence. The payment of interest on deposits by banks in the centers has been
used for the purpose of attracting to such banks funds which
otherwise would have gone to other centers or to other banks in
the sa~e centers or which would lkave been retained at home.
The funds thus redeposited, even when not at~racted by any artificial means, have of course constituted a demand liability, and
have been so regarded by the banks to which they were intrusted.
"!1 In conse-quence, such banks have sou,£,ht to fL1d the most
profitable means of employment for their resources and at the
same time to have them in such condition as would ~ermit their
prompt realization when demanded by the depositing banks whiCh put
the1~1 there.
T'ne resUlt has been an effort on the part of the
national banks, particularly in central reserve cities, to dispose of a substantial portiori of their funds in call loans protected by stock-exchaltge collateral as a rule. This was on the theory
that, inasmuch as listed stock-exchange securities could be
readil:r sold, call loans of this type were for -~)ractical purposes
equivalent to cash in hand. The theory is of course close enough
to the fact·s when an effort to realize is made by only one or few banks,
but is entirely erroneous whenever the attempt to withdraw deposits
is made by a number of baru~s si~ultaneously. At such times, the
banks in central reserve and reser..-e cities are wholly unable to
meet the demands that are brought to bear on them by country banks;
and the latter, realizing the difficulties of the case, seek to
protect themselves by an unnecessary accumulation of cash which they
draw from their correspoudents: thereby weakening the latter and
frequently strengthening the.asel ves to an undue degree. Under
such circumstances the reseT-vc:Js of the country, whic~ ought to
consti:!>U.te a readily avai1~:;,1e homogeneous fun'h__!eady for use in
~ direction where sudden necessities may de-relop, are in fact
scattered and entirely los~ their efficiency and.._~_tre~ owing
to their being diffuset through a great number of institutions
in rela~ively small amount and thereby rendered nearly unavailable. T:.i"lis evil has been met in times past by the suspension
of specie ?ayments by banks and by the substitution of unauthorized and extra-legal substitutes for currency in the form of
cashiers• checks, clearing-house certificates and other methods
of furnishing a medium of exchange. Needless to say such a
method of meeting the evilisthe worst kind of makeshift and
is qnlf somewhat better than actual disaster.
·
"HOLDING OF FU11)5 •
The comni t tee believes . that the only way to correct
this condition of affairs is to provide for the holding of
reserves by duly qualified institutions which shall act primarily
in the public interest and whose motives and conduct shall be so
absolutely well known and above suspicion as to inspire unquestioning confidence on the part of the community. It believes
11
~·
_,.
0\ •••
X-5260
-1111 that the reserve banks which it proposes to ~~rovide
for will afford such a t7pe·of institutions ru1d that they
may be made ·. ~· the effective means for the holding of
the liquid reserve· funds of the countr;y- to the extent
that the latter are not needed in the vaults of the banks
themselves. * * *
*
*
*
*
"Section 20 (i.e., section 19 of the Federal Reserve
Act) seeks to readjust the reserve requirements now provided
by the national banking act in such a way as to L~e them conform to the dictates of scientific banking, and to adjust
them to the provisions of the proposed bill. Tho following
1:1ain objects have been had in mind:
To abolish entirely the present system of redeposited or 'pyramided' reserves.
11 1.
11 2.
To establish a moderate required reserve actually to be held in cash in the vaults of the banks.
"3. To prescribe a secondary reserve to take the form
of a credit with the Federal reserve b~~s.
*
*
*
*
11 In outlining the general philosophy of the proposed barucing bill it was pointed out that the existing
systom of redeposited reserves ~ives rise to cheap money
for stock-exchange speculation in the centers while it fails to
-provide in times of panic a reserve upon which the country can
draw with assurance, because at such times &rock-exchange securities can not be easily liquidated,. so that call loans are unavailable as a resource, and the city banks in self-defense have
deemed themselves warranted in susnending s~ecie payments. It is
contended, however, that these difficulties and irregularities
of the existing system are me.a· blemishes upon the surfac¢ of
an otherwise desirable state of affairs, and that there is
coed and sufficient economic reason for maintaining the present
system of redeposited reserves at least in ~art. This claim
may be reduced to a series of propositions as follows;
11 1.
The redeposited reserves are placed with the
city banks not for stock speculation, out in larg~
measure at least to supply exchange funds upon which the
depositing banks may draw.
2. The redeposited balances must be kept with the
banks which now hold the~, bec~se the country banks look to
these city banks for accommodation and the latter .gauge the
amount of accommodation to be granted them by the size of the
balances.
11
X-6260
-12"3. The country ba1"lks, and in general all banks makthe redepoaits get a rate of interest thereon. They
are thus able to make use of a reserve which would otherwise
be 'deadJ 1 and which when held in cash or in the Federal reserve banks will yield them no revenue, the latter batiks being forbidden by the terms of the bill to ?8¥ interest on deposits.
ir~
"These contentions are worthy of careful study, because
they are widely urged.
...
*
*
*
...
11 ~e second point already noted has even less force
than the first. Not only does the proposed
bill urovide more extensive. facilities for rediscount
than have ever been known, but even if it didnot do so,
and even if, as alleged, there are many kinds and classes· of
security not elit;ible for rediscount under the bill which
country banks can use as a basis for accomffiodation only with
city banks, it would still remain true that this does not
afford any warrant for demanding the maintenance of the existi~g situation.* *
*
•
...
...
11 * * In view of the great difficulty of defining
'comrnercial :paper, r the actual definition of the same has
been left to the Federal reserve board in order that it
may adjt"..st the definition to the practices -prevailing
in different parts of the country in regard to the transaction
of business and the making of paper. For obvious reasons
it is forbidddn that any such paper shall be admitted to
rediscount if made for the purpose of carrying stocks or
bonds."
From this,
i~
is perfectly clear that one of the fundamental" purposes
of the Federal Reserve Act was to prevent the bank reserves of the country
from being tied up in speculative loans on stocks, bonds and other
investment securities.
It is obvious, therefore, that it would be en-
tirely in accordance with the purposes of the Federal Reserve Act and
the policy of Congress when it enacted the Federal Reserve
~ct
if the
Board should promulgate restrictions, limitations and regulations designed
to prevent member banks of the Federal Reserve System from using the
credit resources of the Federal Reserve System for the purpose of making
-13.,-
or maintaining loans, the proceeds of which are used for the purpose of
carryiDb or trading in stoCks, bonds or other investment securities.
It is true that the above-quoted provision of the Federal Reserve Act excluding loans of this character from the definition of eligible paper, does not itself prevent member
b~1]lt:s
from discounting el-
igible paper and using the proceeds to make loans on stocks, bonds and
other investment securities; but it is equally clear that the b11oad powers
of the Federal Reserve Board to prescribe restrictions,. limitations and
regulations governing theoperations of Federal reserve bankswere intended to enable the Board to meet just such contingencies and to prescribe such rules, regulations and restrictions as rdght be necessary to
supplement the express provisions of the Act and more fully to carry out
the broad purposes of the Act.
It has been
ar~ued
that it is not inconsistent with the provisions
of the FederalReserve Act for federal reserve
bruh~s
to make loans to, or
to rediscount eligible paper for, member banks which at the time have
surplus funds loaned to brokers or dealers in stocks, bonds and other
investme11t securities; because it is impossible to trace the proceeds of
any particular rediscount or advance to a
m~nber
bank and show that
the crodi t obtained from the Federal reserve bank is used for the purpose
of making or obtaining such loans.
is not a
tec~nical
While it may be true that this
violation of the Federal Reserve Act, it obviously
is contrary to the policy of the Act, as indicated by the above quotations from the Committee report; and i t clearly is within the BoaTd 1:s
power to prescribe such rules,
regulation~
an9. restrictions as may be nee-
-14essary to prevent any such evasion of the Gxpress provisions of the
Act.
II.
One of the most direc·t, appropriate and effective powers
which the :Soard could exorcise for the enforcement of the principles laid down in its letter of Fe.bruary 2, 1929, therefore, would
be to prescribe a regulation forbidding any Federal reserve bankto
rediscount any paper for, or to make any loans or advances to, or to
purchase any bills of exchange, bankers' .acceptances or Government,
State, or municipal securities (either outright or under repur-.
chase agreeoents) from, any member bank which at the time: (1) Has
loans outstanding to brokers or dealers in stocks, bonds or other
investment securities; or (2) Has unreasonably large ru:;ounts of specul.ative
loans outstanding to customers secured by stocks, bonds, or other
investment securities, or the proceeds of which have been or are to
be used for the purpose of carrying or trading in stocks, bonds, or
other investment securities.
!f the Board should decide to pronrolgate such a regulation,
it probably would find it necessary, for practical reasons,
to incorporate therein certain exceptions which would enable member
ba~s
embarrassed by sudden fluctuations in their reserves or their
reserve
requir~ments
to obtain temporary accommodations at the
Federal reserve bank until they eQUid liquidate their investments
in loa.ns to brokers or dealers in stocks, bonds or other investment
se·cu.ritie-s.
However, exceptions to cover this practical difficulty
can ba &ovised; and, if the :Soard desires to
~romulgate
such a regu-
X-6260
-15lation, I believe that a thoroughly practical
and workable regula-
tion can be drawn.
III.
~Dere
can be no doubt that the Board has ample power
to enforce such a regulation, or any other lawful regulation which
it mir:ht prescribe; since Section 11 (f) of the Federal Reserve
Act authorizes the Board,
11 To suspend or remove any officer or
director of any Federal reserve bacl~, the cause
of such removal to be forthwith communicated in
writing by the Fe·deral Reserve Board to the removed officer or director and to said bank".
This power to·
removal~is
subject only to the condition that
the Board communicate the cuase of such removal in writing to
the removed officer and to the Federal reserve bank.
The cause of
removal is not specified in the law but is left to the discretion
of the Rederal Reserve Board, the only limitation being that it
must be reasonable and not capricious or arbitrary.
Clearly, the willful violation of a lawful rebulation JJrescri bed by the' Federal Reserve :Board would be a reason able and valid c·ause for the removal of any officer or director
of any Federal reserve bank.
X-6260
('':'~c."'.\
The question .has been raised whethor' under the following
provision of Section 4 of the Federal Reserve Act, the Federal Reserve Board has power to order a particular Federal reserve barik
to ceaae or suspend the granling of any discounts, advancements or
acco1m~odations
to a particular member bank.
"Said board shall administer the affairs of
said bank fairly and impartially and without discrimination in favor of or against any member bank
or banks and shall, subject to the ~revisions of
law and the orders of the Federal Reserve Eoard,
extend to each member bank such discounts, advancements and accommodations as n~y be safely and reasonably made with due regard for the claims and demands
of other member banks."
In view of the importance of this question, I have made a careful study of the legislative history of this paragraph of the Federal
Reserve Act before undertaking to construe it.
A complete statement
of the legislative history of this paragraph, with lengthy quotations
from the debates in Congress, has been prepared by this office and
will be furnished to any member of the Board desiring to read it; but
I believe that a brief statement of the situation and one or two quotations from the debates will be sufficient for the purposes of this
opinion.
The above quoted paragraph was included in Section 4 of the Federal
Reserve Act as originally enacted and has never been amended.
It was
not discussed in the reports on the original Federal Reserve Act either
by the House Banking andCurrency Committee, by the Senate Committee, or
by the conferees.
{-;.
(.:';, r:,.j L.J
-16-
This paragraph, however, was not contained in the
-17bill when it passed·the House of Representatives, but was inserted
in the bill by the Senate Committee on
comp~omise
between
~arious
Baru~ing
& Currency as a
conflicting views.
It appears that certain Senators feared that the Federal re-
serve ba11ks would come under the domination of the larger member
banks and would discriminate against other member banks 4 It was
feared that, through such discrimination, some member baruts ndght
be denied credit aceommodations at the Federcl reserve banks when
it was badly needed in times of emergency; and, in order to prevent
such discrimination, it was proposed to
provide that,
11
~~end
the bill so as to
Each member bank:shall be entitled as a matter of
right to the rediscount of eligible paper to the full amount of its
capital stock upon the lowest current rate of discount . 11
This was
incorporated in an amendment proposed by Senator HitchcoCk and was
the subject of a bitter fight both in the committee and on the floor
of the Senate.
It was felt, however, that such a provision would be absolutely
contrary to accepted banki.ng practices and would be extremely dangerous and unsound; and finally the above-quoted paragraph was inserted
in the bill by the Senate Committee as a compromise.
Senator Shafroth
explained the matter as follows (Congressional Record for Dec. 13,
~913,
Vol. 51, Part 1, page 859):
Mr. SH.A:FROTH. 11 Mr. President, that clause was placed
in that paragraph largely for the reason that the
Hitchcock bill contained a provision for compulso~y
discounts, assetting that any member bank going with
paper to a Federal reserve bank should be entitled, as
()>
;,r:
f',..,t(•..-t)
-18- .
X-6.360
a matter of right, which it could enforce perhaps
by mandamus, to compel the Federal ~eserve bank to
discount that paper. We thought that was too extreme a provision; it was thoucht wise that there
might be conditions of the bank that would not justify
the discounting of its -p;;;per. For that reason we put
in a clause, which to a large extent is advisory ·to
them, but which, nevertheless, indieates the policy
that should be pursued by them in making these discounts
where they fairly can. 11
It ap-oears that this compromise was suggested by Senator Reed
of
r~:issouri
durin€; the meetings of the Senate Cor.arJ.i ttee on Banking
anC Currency .and that the above quoted paragra=)h was inserted in
Section 4 of the Federal Reserve Act at his suggestion.
Reed's
e~olanation
Senator
of the purpose and effect of this paragraph,
therefore, is entitled to great weight in construing it.
On :3ages 173 and 174 of the Congressional Record for December
4, 1Sl3, (Vol. 51, Part 1) Senator Reed
eA~1ained
this paragraph
as follows:
11 Mr. President, we did not stop at that point.
I· myself had the honor of offering an amendment prescribing
or defining the duties of these directors. It is as
follows:
11 The board of directors shall perform the
duties usually appertaining to the office of
directors of banking ass.ociations and all such
duties as are prescribed by law.
Sa,id board shall administer the affairs of
said bank fairly and impartially and without
discrimination in favor of or against any member
bank or baru~s. and shall, subject to the provisions
of law and the orders of the Federal Reserve Board,
extend to each member bank such discounts, advaj1Cements, and accommodations as may be safely and reasonably made with due regard for the claims and demands of other member ba1iks.
11
"Mr. President, the importance of that amendment lies
in the fact that for the first time it wrote into the bill
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X-6260
C)C't,{"
f(..l,<.;.;o
language which commanded the directors of the regional banks
to treat all member banks alike. It :9rohibits favoritisi:l;
it forbids discrimination; it gives to member banks the right
to demand impartial treatment. The me;~1ber bank is not left
to solicit favors; it may insist upon rights.
"Mr. President, the provisions I have just discussed might
be ineffectual if it were not for the fact that at the same time
we enlarged the powers of the Federal reserve board so that it can
compel regional banks to obey this mandate of the law. We conferred this power by providing in section 11, paragra?h J, as
follows: The Federal reserve board shall have power~It ~o
exercise general supervision over said Federal reserve
banks•
"When, therefore• we imposed the duty upon the directors of
the regional banks to treat all member banks fairly and impartial!~ and without discrimination, and gave the Federal reser~
board, which is appointed by the President of the United States,
authority to exercise general supervision over tha Federal reserve bank, we gave the Federal reserve board power and authority
to compel the Federal reserve banks to be impartial in their
dealings with member banks. The same authority empowers the
Federal reserve board to protect the public against wrongs sought
to be perpetrated by the reserve banks. The power conferred is
sufficient to accomplish these ends, and if it be wisely exercired.
there is but slight da~er of discrimination in favor of some
bank and against others; or in favor of one section of the country
and against another; or, I will add, the adoption of a policy by
regional banks which will be oppressive to the public.
Powers of Reserve Board Increased.
"The Federal reserve board, appointed by the President, is, by
the two amendments I have set out, given absolute comr;:and of the
system. It can make the regional directors perform their full
duty with fairness and impartiality to all.
11 We followed these amendments with others of equal importance.
We gave the reserve board the unrestricted right to reroove a~· of
the directors of a regional bank. Here is the language: 1 The
Federal Reserve Board shall have power to suspend or. remove any
officer or director of any Federal reserve bank, the cause of
such removal to be forthwith communicated in writing by the
Federal Reserve Board to the removed officer or director and to ·
s~id bank.'
The House bill only gave a restricted right of
removal."
* * * * * "'
"Putting together, then, these several provisions to which I
have adyerted, I believe we can say to the country with a clear
consciehce that while we have drawn these banks together into
this gre~t system, while we have given them a common stock ownership, while we have placed the control of the regional barnes in
the hands of the bankers, we have· at the same time so safeguarded
every avenue and so locked every door that the people may be
content. In the last analysis the Federal reserve board, appointed by the President and representing the entire country, has
-20-
complete and absolute !JOWer, and will control the entire
system an<i prevent discriminations, combinations, or other
wrongs.ii
In view of this explanation, it is quite clear that this
para[~raph
/
a1one was hot intended to confer additional power upon the
Federal Reserve Board but was intended to prescribe
a
rule governing
the amninistration of the affairs of the Federai reserve bank by the
board of directors of the Federal reserve barik.
to do two things:
(1)
This rule was intended
To prevent discrimination either in favor of or
against any member bank; and (2) To make it clear that member banks are
entitled as a matter of right to
commodations as
1-:1ay
11
such discounts, advancements and ac-
be safely and reasonably made with due regard for
the clair..1s and demands of other member banks. 11
It was contemplated that, if any Federal reserve bank should
discriri•inate against any member bank or should deny it such discounts,
advancements and accommodations as might be safely and reasonably made
with due regard to the claims and demands of other member banks, the
'
barut so discriminated against could appeal to the Federal Reserve Board
and the Board could order the Federal reserve bank to comply with the
law and. to cease such discrimination.
It was pointed out, however,
that such power was included in the Board's power under Section 11 (j)
to exercise general
~pervision
over the Federal reserve banks and
could be enforced by the exercise of the Board's power under Section
11 (f) to suspend or remove any officer or director of any Federal
reserve bank.
The power to exercise
ge~ral
supervision over the Federal
reserve bariks was inserted in Section 11 at the
sug5~stion
of Senator·
Reed, in or'der to enable the Board to enforce .the above quoted paragraph
-21-
of Section 4; and. this shows clearly that the provision of
Section 4 ···as not intended to confer arl'J independent power
upon the :Board.
}.:ore over I the fact that the Whole purpose of this paragraph was to make it clear that member banks are entitled to reasonable
credit accommodation from the Federal teserve batiks without discrimination is clearly inconsistent with the thought that the same paragraph
might :possibly confer power upon the Federal Reserve :Board to order
a Federal reserve bank to deny credit accommodations to a "9articular
member bank.
Such an order by the Federal Reserve :Board might amount
to the very kind of discrimination against individual banks which
this yaragraph was intended to prevent.
The words "subject to the provisions of law and the orders of
the Federal Reserve :Board" obviously were inserted in this paragraph
as a qualifying or saving clause similar to those found elsewhere in
the Act and must have been intended to have substantially the following
meaning: Subject to the provisions of law and to such orders, regulations,
etc., as the Federal Reserve :Board 1nay lawfully promulgate pursuant to
the power granted the :Board under other provisions of the Federal Reserve
Act.
I run of the opinion, therefore, that this language does not confer
any additional power on the_ Federal Reserve :Board and that any authority
which the :Board may have to issue orders qualifying the right of member
banks to credit accommodations from the Federal reserve banks must be
found elsewhere in the Act.
The clause "subject to the provisions of law and the orders of
---,_'·''
'
-22-
X-6260
the Federal Reserve l3oard11 , however. is important; since it makes the
right of
meJ~ber
banks to credit accommodations from the Federal reserve
banks subject to such rules, regulations and restrictions as the Federal Reserve Board may lawfully prescribe under authority granted elseWhere in the Act.
Thus, it makes this right of the member banks sub-
ject to such ±-estr:i.ctions, limitations and regulations as may be imposed by the Federal Reserve :Board under the paragraph of Section 13
discussed elsewhere in this opinion.
Although the paragraph of Section 4 of the Federal Reserve
Act discussed above does not itself confer ariy such power upon the
F-ederal Reserve Board, it is perfectly obvious that, if the Federal
Reserve Board should-prescribe a regulation forbidding any' Federal reserve bank· to rediscount any paper for, grant any loan to, or purchase any bills of exchange, bankers' acceptances or Government, State,
or municipal securities from, any member bank which at the time has
loans outstanding to brokers or dealers in stocks, bonds or other investment securities, the Board would have power to issue such orders
in specific cases as might be necessary to stop violations of this
regulation.
Thus• if such a regulation w.ere promulgated and the Board
should find that a particular Federal reserve bank is rediscounting
paper for, or making loans to_, a particular member bank which has loans
outstanding to brokers or dealers in stocks, bonds or other investment se-·
curities, the Board could, order the Federal reserve bank to cease re-
'.
X-6260
230
-23--
discounting paper for, or making loans to, such member bank; and, if the
Federal reserve bank should fail or refuse to comply with such
a~
order,
the Eoard could enforc~ its order by suspending or removing from office
the offending officers and directors of the Federal reserve bank •.
VI.
The question has been raised whether the Eoard could, if it so
desires, prescribe a special rate (higher than the rediscount rate on
industrial, cownercial or agricultural paper) for advances to member
banks on their
promissor~
notes secured by bonds or notes of the Government
of the United States,
While this does not have a direct bearing on the main question
discussed in this opinion, it has been suggested that it might have a very
practical and helpful effect on the main problem confronting the Board in
this connection.
Thus, it has been suggested by one member of the Board
that, in practice, most of the credit accormnodations obtained from the
Federal reserve banks by reserve city member banks which are at the same
time lending large sums to brokers and dealers in investment securities
are obtained in the form of advances on the promissory notes of such
member banks secured by bonds and notes of the Government of the United
States; that this practice might be checked if a higher rate of interest
shou~d
be prescribed for borrowings in this form; and that such a higher
'
rate of interest of
int~rest
would not increase the cost of credit to
cormnerce, industry and agriculture.
One mer.:ber of the Eoard, therefore,
requested me to cover this point in this opinion.
The power to make advances to member
baru~s
on their promis-
sory notes is conferred by the following paragraph of Section 13 of the
Federal Reserve Act:
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X-6260
Any Federal reserve bank may make advances
to its men:1bor banks on their :9romissory notes for
a period not exceedine; fifteen days at rates to be
established by such Federal -reserve ba.,1J:cs, subject
to the review and determination of the Fed,lral Reserve Board, lJrovided such prorJissory notes are
secured by such riotes, drafts, bills of exchange,
or bankers' acceptances as are eligible for rediscount or for purchase by Federal reserve ba11ks under
the yrovisions of this Act, or by the deposit or pledge
of bonds or notes of the United States."
11
It ivill be noted that this paragra-ph providec. that such
advances shall be made at rates to be established by such Federal
reserve ba.nks, subject to the review and determination of the
Federal Reserve Board.
It will be noted that the language here
used is very similar to that used in Section 14(d) pertaining to
other rates of discount to be charged by the Fedvral reserve banks
and that the qualifying clause "subject to review and determination
of the Federal Reserve Board" is precisely the same,
word for word,
in both sections.
The Attorney General of the United States has held that under
Section 14(d) the Federal Reserve Board "has the right under the
powers conferred by the Federal Reserve Act, to determine what
rates of discount should be charged from time to time by the Foderal reserve
b~,
to require such
and under their powers of review and supervision,
I'~tes
to be put into effect by such bank."
(32 Op.
Atty. Gen., p. 81.)
It is perfectly obvious that the Board has the same power with
respect to the rates at which Federal reserve banks may make advances
on the promissory notes of member banks under Section 13 as it has
over the rates of discount to be established under Section 14(d?.
It is well recognized that the Federal reserve banks may establish
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X-626G
and the Federal Reserve :Soard may approve, different rediscount
rates for different classes of paper; and it would seem that the
same power could be exercised in
armrovin~.
·or fixing the rates
at which advances will be made to member banks on their promissory
notes under Section 13.
phrase
11
While Section 13 does not contain the
for each class of paperll found in Section 14(d), it iB
significant that Section 13 uses the plural nrates 11 and does
not merely authorize the fixing oflla rate" at which Federal
reserve banks may make advances to member banks.
The fact that the subject is treated separately clearly
indicates that the promissory notes of member banks constitute a
separate class of paper; and it would seem obvious that this
class of pa:,r?er may be further subdivided into other C::basses according to the maturity bf the notea or the
security~
It would seem perfectly
ob~ious
c~acter
of collateral
tl1at member banks•
promincory notes aecured by Government bonds, which are not eligible for rediscount, are clearly in a different class from those
secured by agricultural, industrial and commercial paper, which
is eligible for rediscount.
I am of the opinion, therefore, tm t the :Soard could,
if it so desires, prescribe a special rate (higher than the rate
of discount on industrial, cqnmercial or agricultural paper) for
advances to member banks on their promissory notes secured by
bonds or notes of the Government of the United States.
R,espectfully,
Walter Wyatt
General Counsel.
SAD
\'IW
VD:S
@FedFRASER