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X-7085 148 February 10, 1932. C. S. Hamlin. Proposed S u b s t i t u t e f o r Section 3 of the g l a s s B i l l : S t r i k e out Sees. 3 and 9, and s u b s t i t u t e the f o l l o w i n g : Section 3 : In o r d e r to secure a more e f f e c t i v e supervision of t a n k i n g i n the i n t e r e s t of "bank d e p o s i t o r s and of the p u b l i c , the Federal Reserve Board may p r e s c r i b e r e g u l a t i o n s d e f i n i n g and r e g u l a t i n g the use of the c r e d i t f a c i l i t i e s of the Federal Reserve System within the l i m i t a t i o n s of t h i s Act as amended. Each Federal r e s e r v e "bank s h a l l keep i t s e l f informed of the loan and investment p o l i c i e s of i t s member hanks, and f o r t h i s purpose may c a l l upon such "banks from time to time f o r r e p o r t s . The Chairman of the Board of each Federal r e s e r v e bank s h a l l r e p o r t t o h i s bank and to the Federal Reserve Board any use made by a member bank of Federal r e s e r v e f a c i l i t i e s , d i r e c t l y or i n d i r e c t l y , in connection with any loans made by i t , whether commercial, s p e c u l a t i v e , r e a l e s t a t e , o r o t h e r w i s e , which i s undue or excessive under t h i s Act a s amended, and the r e g u l a t i o n s of the Federal Reserve Board. Each Federal r e s e r v e bank may, i n i t s d i s c r e t i o n , a f t e r due warning, suspend from the f u r t h e r use of Federal reserve p r i v i l e g e s any member bank abusing s a i d f a c i l i t i e s , a s above p r o v i d e d . I f , i n the judgment of the Federal Reserve Board, any Federal r e s e r v e bank f a i l s to take proper a c t i o n under t h i s p r o v i s i o n , the Board may, by an a f f i r m a t i v e vote of not l e s s than f i v e of i t s members, enforce t h i s p r o v i s i o n a g a i n s t any o f f e n d i n g member bank or banks. -1> X-7085 February 10, 1932. C. S. Hamlin. Proposed .Amendment Giving the f e d e r a l Reserve Banks and the Federal Reserve Board Power to Suspend Member Banks from Federal Reserve Bank Privileges: In reviewing the p e r i o d of s p e c u l a t i v e a c t i v i t y , beginning i n the f a l l of 1927 and continuing up to the crash of October, 1929, - one f a c t stands out i n bold r e l i e f , - the complete i n a b i l i t y of t h e member banks, of t h e i r own accord, to r e s t r a i n the wave of s p e c u l a t i o n which swept over the country. As r e g a r d s the Federal Reserve System, even the s a l e of 400 m i l l i o n s of Government s e c u r i t i e s , coupled with 3 i n c r e a s e s of discount r a t e s up to J u l y 13, 1928, f a i l e d to stem the t i d e . Between J u l y , 1928, and January, 1929, a t i d a l wave of loans ,r for o t h e r s " swept over t h e country p r o v i d i n g f u e l f o r the s p e c u l a t i v e f i r e . This wave would have overcome the i n f l u e n c e of any discount r a t e i n c r e a s e , u n l e s s of such a d r a s t i c n a t u r e t h a t i t would be impossible to borrow money on any t e r n s , which, of i t s e l f , would probably have turned s p e c u l a t i v e confidence i n t o f e a r , and would have p r e c i p i t a t e d i n May or June t h e c r i s i s which f i n a l l y came i n October. The Federal Reserve Bank of New York, however, b e l i e v e d t h a t the whole question was a r a t e q u e s t i o n , and asked the Board to agree upon an a f f i r m a t i v e r a t e i n c r e a s e p o l i c y which, c a r r i e d to the extreme, a s above s t a t e d , would probably have brought on i n May o r June the c r i s i s which took p l a c e i n October, 1929. The Federal Reserve Board i n s i s t e d on keeping the d i s c o u n t r a t e a t 5$ where i t had been p l a c e d i n J u l y , 1928, - and issued a warning to the banks X-706§ #3# to r e s t r a i n the growth of s p e c u l a t i v e a c t i v i t y . In o t h e r words, the Board took the p o s i t i o n t h a t the only e f f e c t i v e way to r e s t r a i n s p e c u l a t i o n was to cut o f f s p e c u l a t i v e c r e d i t , or a t l e a s t to stop i t s growth, l e a v i n g the discount r a t e where i t was, i n o r d e r to p r o t e c t b u s i n e s s , a g r i c u l t u r e , and commerce, which was even then s u f f e r i n g under e x i s t i n g r a t e s , as p o i n t e d out "by Governor Harrison i n h i s l e t t e r of ^ p r i l 9, 1929, to the Federal Reserve Board. That t h e question was not i n essence a r a t e q u e s t i o n , was shown c l e a r l y by the f a c t t h a t during the period of d i r e c t p r e s s u r e , from February 7 to about June 1, 1929, the t o t a l earning a s s e t s of the Federal Reserve Bank of New York s t e a d i l y d e c l i n e d , while i t s r e s e r v e r a t i o , a t t h e same time, s t e a d i l y i n c r e a s e d . Under ordinary canons of banking, t h i s condition would have suggested a reduction r a t h e r than an i n c r e a s e of discount r a t e s . The claim i s o f t e n made, however, t h a t the d i r e c t p r e s s u r e e x e r c i s e d by the Federal Reserve Board under the 5$ r a t e , was a f a i l u r e . How can t h i s be s a i d , when, during i t s o p e r a t i o n , t o t a l earning a s s e t s d e c l i n e d , and r e s e r v e r a t i o s i n c r e a s e d , t o t a l Federal r e s e r v e c r e d i t o u t s t a n d i n g having been reduced 193 m i l l i o n s ? The f a c t i s , t h a t d i r e c t p r e s s u r e went very f a r i n e l i m i n a t i n g the seepage of Federal r e s e r v e c r e d i t i n t o s p e c u l a t i v e a c t i v i t i e s . It certainly succeeded so f a r as b r o k e r s loans were concerned, which were reduced 649 millions. On the o t h e r hand, customers' s e c u r i t y l o a n s , as d i s t i n g u i s h e d from b r o k e r s l o a n s , i n c r e a s e d during t h a t p e r i o d from 4,971 to 5,267 m i l l i o n s , - an i n c r e a s e of 296 m i l l i o n s . Brokers loans and customers loans t o g e t h e r , however, showed a n e t decrease of about 361 m i l l i o n s during t h i s X-7085 •: -LcJJl period. I f the member "banks of the country had r e s t r a i n e d the growth of t h e i r customers s e c u r i t y l o a n s , a s well a s "brokers loans * the r e s u l t would have "been f a r b e t t e r . I t i s o f t e n s t a t e d t h a t i t i s impossible to know whether a customer 1 s s e c u r i t y loan i s one f o r s p e c u l a t i v e purposes or n o t . In t h i s connection, i t i s i n t e r e s t i n g to note t h a t Governor Harrison, in h i s l e t t e r t o t h e Board of A p r i l 9, 1929, used the following language? "A r a t e i n c r e a s e w i l l have a d i r e c t e f f e c t upon the p o s s i b l e use of Federal r e s e r v e c r e d i t f o r s p e c u l a t i v e purposes, because a l a r g e p a r t of t h e c r e d i t now g r a n t e d on the b a s i s of s e c u r i t i e s c o n s i s t s of loans by banks d i r e c t l y to t h e i r customers, a s d i s t i n g u i s h e d from loans to brokers on the open c a l l money market. Recent i n c r e a s e s f o r c r e d i t f o r s e c u r i t y o p e r a t i o n s have been almost e n t i r e l y i n t h i s form of l o a n . In t h i s d i s t r i c t , many such loans a r e being made a t r a t e s between £>§• and 6 ^ . " The member banks, however, were not w i l l i n g to impose r e s t r a i n t s on customers seeking to borrow f o r s p e c u l a t i v e purposes. On the c o n t r a r y , i t seems to have been an e s t a b l i s h e d banking p r a c t i c e , t h a t when a customer m a i n t a i n i n g a good b a l a n c e , and o f f e r i n g good s e c u r i t y , applied f o r accommod a t i o n f o r s p e c u l a t i v e purposes, he was given a l l he wanted, provided only he was w i l l i n g to pay the discount r a t e f i x e d by t h e bank. In times of s p e c u l a t i v e c r a z e , however, r a p i d l y i n c r e a s i n g stock p r i c e s and even i n c r e a s e d discount r a t e s seem to whet, r a t h e r than to reduce, wild s p e c u l a t i o n . i The above p r a c t i c e of bankers i s not i n accord with sound banking practice. I t d i s r e g a r d s the r i g h t s of d e p o s i t o r s , and i s a g a i n s t the p u b l i c interest. I f the Federal r e s e r v e banks had power, e x p l i c i t l y s t a t e d , to i n s i s t X-7085 :• 3L52 on r e d u c t i o n of member "bank customers s p e c u l a t i v e l o a n s , and had used t h a t power, the r e s u l t would have "been a much "better c o n t r o l of s p e c u l a t i v e activity. Even w i t h t h i s l i m i t a t i o n , however, d i r e c t p r e s s u r e was so s u c c e s s f u l t h a t , as above s t a t e d * during i t s o p e r a t i o n Federal r e s e r v e c r e d i t was reduced 193 m i l l i o n s , although during t h i s p e r i o d d i s c o u n t s of p a p e r , l a r g e l y commercial, i n c r e a s e d 444 m i l l i o n s , the r e s u l t i n g gain being brought about l a r g e l y by the r e d u c t i o n of t o t a l s e c u r i t y loans* "brokers and customers l o a n s , of 361 m i l l i o n s of d o l l a r s . D i r e c t p r e s s u r e under the 5$ r a t e during t h i s p e r i o d was, i n f a c t , so s u c c e s s f u l t h a t about June 1, the Federal Reserve Bank of New York s a i d t h a t the "banks needed c r e d i t f o r commercial purposes, but were a f r a i d to "borrow, and they "begged the Board to consider a p o l i c y of e a s i e r money. There seems to "be l i t t l e doubt t h a t , but f o r the loans " f o r o t h e r s " the d i r e c t p r e s s u r e e x e r c i s e d under the 5$ r a t e , would have brought about such a m a t e r i a l l i q u i d a t i o n of s p e c u l a t i v e c r e d i t t h a t the c r a s h which came in October, 1929, might have been a t l e a s t g r e a t l y minimized i n i t s effect. Such would a s s u r e d l y have been the r e s u l t , had t h e Federal r e s e r v e "banks "been given express power to suspend from the p r i v i l e g e s of the Federal r e s e r v e bank, member banks making undue use or abuse of i t s f a c i l i t i e s f o r s p e c u l a t i v e purposes. The Federal r e s e r v e banks, to be sure, have t h i s power now, a s we have been advised by Counsel, but i t i s not e x p l i c i t l y s t a t e d , and i t would be f a r b e t t e r to have t h i s power s t a t e d in express terms, so t h a t t h e r e can no longer be a doubt a s to i t . X-7085 153 The f e d e r a l Reserve Bank of Hew York, a t the h e a r i n g s "before the Glass Sab-committee, denied i t s power to examine i n t o the loan p r a c t i c e s of member banks, e s p e c i a l l y customers l o a n s , except p o s s i b l y where one bank might be out of l i n e w i t h o t h e r banks of the sane c l a s s , The duty of knowing the loan p o l i c i e s and p r a c t i c e s of the member banks should be d i r e c t l y imposed upon the Federal r e s e r v e banks, and they should be e x p l i c i t l y d i r e c t e d , i n case of abuse, to suspend the member bank from Federal r e s e r v e f a c i l i t i e s , so long a s the abuse c o n t i n u e s . I t i s i n t e r e s t i n g i n t h i s connection to note t h a t the Federal Advisory Council, on February 17, 1931, unanimously passed the f o l l o w i n g r e s o l u t i o n : "There should be imposed upon the Federal r e s e r v e banks the requirement to keep themselves informed of the q u a l i t y of the investments and l o a n s , and t h e p o l i c y of t h e management of a l l member b a n k s . n In t h i s connection, a l s o , i t i s i n t e r e s t i n g to note t h a t Mr. Owen D. Young, i n h i s testimony b e f o r e the Glass Sub-committee, a s contained i n the New York Times of February 5, 1931, s t a t e d unequivocally t h a t the Federal Reserve System should have c e r t a i n powers to see t h a t banking p r a c t i c e s i n i m i c a l to the s a f e t y of d e p o s i t o r s should not be indulged in by member banks; t h a t the Federal Reserve should have power to examine and d i s c i p l i n e a l l i t s member banks; t h a t the Federal reserve banks should have the power to l i m i t o r r e f u s e r e d i s c o u n t s even i f the paper i s e l i g i b l e , or suspend o t h e r p r i v i l e g e s of membership, i f the banking p r a c t i c e s of any p a r t i c u l a r Bank were, i n i t s judgment, unsound, and t h e r e f o r e s u b j e c t e d i t s d e p o s i t o r s to unreasonable r i s k , e i t h e r as t o l i q u i d i t y or s e c u r i t y ; t h a t in case t h e r e s e r v e bank e x e r c i s e s such power u n f a i r l y , an appeal might be taken t o the Federal Reserve Board; t h a t i f the unsound p r a c t i c e s were p e r s i s t e d i n , : 154 X-7085 the Federal Reserve Board, on complaint of any Federal r e s e r v e bank, might expel the t a n k from membership. Section 3 of the proposed Glass b i l l , i f l i t e r a l l y construed, would b a r a member bank from rediscount p r i v i l e g e s i f i t had a t the time a s i n g l e loan o u t s t a n d i n g based on stock exchange c o l l a t e r a l . Such was not the i n t e n t of the Federal Reserve Act a s o r i g i n a l l y e n a c t ed. The i n t e n t of t h a t Act was t h a t banks should confine themselves p r i m a r i - l y to commercial t r a n s a c t i o n s , but t h e r e was nothing in the Act f o r b i d d i n g a reasonable use of Federal r e s e r v e r e d i s c o u n t s f o r b u i l d i n g up r e s e r v e s a g a i n s t d e p o s i t l i a b i l i t i e s growing out in p a r t from l o a n s f o r purposes o t h e r than those s t r i c t l y commercial or a g r i c u l t u r a l . The whole question devolved upon a reasonable as opposed to an undue and unreasonable use of Federal r e s e r v e f a c i l i t i e s f o r s o - c a l l e d s p e c u l a t i v e purposes. That r e a s o n a b l e , a s opposed to undue u s e , i s t h e r e a l question, w i l l c l e a r l y appear from the f o l l o w i n g taken from a r t i c l e s and addresses of Dr. H. P . W i l l i s , who presumably was the author of t h a t p a r t of Section 3 of the Glass b i l l above r e f e r r e d t o : A n n a l i s t . Mov. 26. 1926: We long ago came to t h e conclusion t h a t the amount of funds advanced f o r stock market use should not be e x c e s s i v e . 28. The measure of t h a t excess has been found i n the degree to which such loans i n f r i n g e upon the r e s e r v e f u n d s of the a c t u a l d e p o s i t banks of the country. 28. Federal r e s e r v e c r e d i t r e p r e s e n t s the u l t i m a t e r e s e r v o i r of c r e d i t in the United S t a t e s , the source from which banking c r e d i t must e v e n t u a l l y be drawn. 31. -7* X-7085 11 i5 Magazine of Wall S t r e e t . Mav 7. 1937: Speculation or margin t r a d i n g should "be recognized, l e g i t i m a t i z e d , by every p r o p e r means, and l i b e r a l l y provided with f u n d s . 36. I t i s an e s s e n t i a l a d j u n c t to modern b u s i n e s s , which i s i n i t s e l f s p e c u l a t i v e in many of i t s branches. 36. The c e n t r a l "bank f u n c t i o n i s to determine e x a c t l y where the l i n e should "be drawn in g r a n t i n g of c r e d i t to v a r i o u s types of b u s i n e s s . 37. Duty of every c e n t r a l banking system to see to i t t h a t i t s p o l i c y p r e v e n t s an undue amount of the c o u n t r y ' s l i q u i d funds from being absorbed i n s p e c u l a t i o n . 37. Federal Reserve System should e x e r c i s e i t s a u t h o r i t y through a s a t i s f a c t o r y c o n t r o l of the money market, 37. D i s t r i c t of Columbia Bankers A s s o c i a t i o n . •Address. J a n . 24. 1929. (187-50 scrap book). Immediate problem i s to b r i n g about a readjustment i n our use of c r e d i t , which s h a l l r e s t o r e some p o r t i o n of i t now d i v e r t e d , to the channels where i t i s needed, a t the same time making a proper p r o v i s i o n f o r the l e g i t i m a t e requirements of s e c u r i t y o p e r a t i o n s . 51. ers !Eh.e p r i n c i p a l bank/ must undertake d e f i n i t e l y t o reduce t h e i r commitments i n p u r e l y s p e c u l a t i v e or t r a d i n g accounts to some f i g u r e taken a s b a s i c or normal. 51. New York World. A r t i c l e . Feb. 17. 1929: An undue share of the c o u n t r y ' s resources had been involved in supporting s p e c u l a t i v e t r a n s a c t i o n s , which, though b e n e f i c i a l when kept w i t h i n l i m i t s , may be exaggerated and rendered dangerous, 55. Necessary to o b t a i n an agreement t h a t no g r e a t e r amount of c r e d i t should be used f o r s t o c k exchange purposes than i s now employed. 56. The suggestion t h a t Federal r e s e r v e banks should r e f u s e f u r t h e r c r e d i t to borrower banks who are lending i n the s t o c k market would merely b r i n g on a crash which would aggravate e x i s t i n g c o n d i t i o n s . 57. In t h i s connection i t i s i n t e r e s t i n g to read what Governor Harrison s t a t e d d u r i n g the h e a r i n g s b e f o r e the Glass Sub-Committee: *.8*4 X-7085 Testimony of Governor Harrison. Hearings - 0-1 ass Sub-Cowni January 20. 1931: Governor Harrison: I t h i n k the Committee may wish to consider . . . whether the Federal Reserve System oan do something s h o r t of e x p e l l i n g a bank from membership in the System. Of course the a c t u a l expulsion, which becomes p u b l i c n o t i c e , w i l l , of i t s e l f , p r e c i p i t a t e the very t h i n g you want to avoid c l o s i n g the bank. Page 46. Query: Whether i t would be p o s s i b l e and proper - and I throw t h i s out as a suggestion to the Committee, - to give to the Federal Reserve Board or to the Federal r e s e r v e banks, the r i g h t to suspend a member bank from any or a l l of the p r i v i l e g e s of membership during a given p e r i o d i n the event t h a t the bank has n o t , in our judgment, conducted i t s e l f in the s a f e s t way f o r the d e p o s i t o r s . If t h a t could be done i n some f a s h i o n t h a t would not involve p u b l i c i t y , and would not then n e c e s s a r i l y i n v i t e what you a r c t r y i n g to avoid by e x p e l l i n g the bank from membership, which n e c e s s a r i l y becomes p u b l i c , i t would give u s a very much s t r o n g e r hand i n d e a l i n g w i t h a r e c a l c i t r a n t bank than we now have. The Chairman: You are speaking of member banks? Governor H a r r i s o n : Yes, of c o u r s e , only member banks, - and by r e c a l c i t r a n t banks, I do not mean a bank v i o l a t i n g the law, which i s i n a category of i t s own, but one which we b e l i e v e i s g e t t i n g i t s e l f i n t o a p o s i t i o n demanding more and more, or a b i g g e r and b i g g e r p r o p o r t i o n of our a s s e t s in l o a n s . I t h a s been a s s e r t e d t h a t we have the a u t h o r i t y of denying borrowing privileges. The Chairman: You have t h a t a u t h o r i t y complete. Governor H a r r i s o n : I t h i n k t h a t m y s e l f . I agree with you t h a t l e g a l l y we have. The only d i f f i c u l t y with the e x e r c i s e of t h a t s o r t of power, i s t h i s , t h a t a bank borrows from the Federal r e s e r v e bank not f o r the purpose of t a k i n g the money and applying i t to a p a r t i c u l a r loan, or to a p a r t i c u l a r p u r pose, but r a t h e r to make good an already e x i s t i n g d e f i c i e n c y i n i t s reserves. -9- X-^7085 Governor Harrison then explained the matter of Reserves against, deposit l i a b i l i t i e s , and s t a t e d the case of a bank which a t the end of the day f i n d s i t s e l f with a d e f i c i e n c y of 10 m i l l i o n d o l l a r s , and t h a t the bank comes with p e r f e c t l y e l i g i b l e paper and a sks the Federal r e s e r v e bank to give them 10 m i l l i o n d o l l a r s . We have two a l t e r n a t i v e s : - We can say, *Yes, you can have t h a t a t our discount r a t e because you have e l i g i b l e paper and need i t to r e p a i r your r e s e r v e s ' o r , i f we e x e r c i s e the a u t h o r i t y to r e f u s e to make t h a t l o a n , which r i g h t has been questioned by many people, the only t h i n g t h a t happens i s t h a t they a r e d e f i c i e n t in r e s e r v e s , and they borrow the money i n a way, by having a shortage in t h e i r r e s e r v e s , r a t h e r than by a s t r a i g h t loan. I t i s t r u e t h a t the shortage c a r r i e s with i t a h i g h e r r a t e , because they have t o pay a p e n a l t y on the d e f i c i e n c y , but t h a t i s not the sound way of t r y i n g to c o r r e c t the bank in i t s management, even i f we thought i t was wise, - t h a t i s , f o r c e them to be d e f i c i e n t . 47. My thought was t h a t i f t h e Committee could consider the p o s s i b i l i t y and p r o p r i e t y of g i v i n g to the r e s e r v e bank, s u b j e c t to the approval of the Federal Reserve Board, the r i g h t of suspension from any or a l l of the p r i v i l e g e s of membership so t h a t we can have the d e c i s i o n , in given circums t a n c e s , of what p r i v i l e g e s we w i l l deprive them, t h e r e would be no question about t h a t , and i t could be handled with such d e x t e r i t y t h a t i t would avoid c e r t a i n u n d e s i r a b l e consequences t h a t we might otherwise p r e c i p i t a t e . 47, 48. The Chairman: We c a n ' t conceive why you should say or t h i n k t h a t you have not con>p l e t e a u t h o r i t y to r e f u s e the rediscount p r i v i l e g e . Governor H a r r i s o n : When I was Counsel f o r the Federal Reserve Board, I gave an opinion to the e f f e c t t h a t we had complete a u t h o r i t y , and I have not changed my mind about i t . 48. The Chairman: I understood you to suggest t h a t t h e r e was good reason to oppose t h a t view. Governor Harrison: Ho. I merely meant to suggest t h a t I saw t h e p o i n t s t h a t some on the opposite s i d e r a i s e d . I do not agree with them. 48.
@FedFRASER