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CENTRAL BANKING
UNDER THE
FEDERAL RESERVE SYSTEM

THE MACMILLAN

COMPANY

N E W YORK • BOSTON • CHICAGO • DALLAS
ATLANTA • S A N FRANCISCO

MACMILLAN & CO., LIMITED
LONDON * BOMBAY • CALCUTTA
MELBOURNE

THE MACMILLAN COMPANY
OP CANADA, LIMITED
TORONTO

CENTRAL BANKING
UNDER THE
FEDERAL RESERVE SYSTEM
WITH SPECIAL CONSIDERATION OF THE
FEDERAL RESERVE BANK OF NEW YORK

LAWRENCE E. CLARK, PH. D.

NEW YOEK
THE MACMILLAN COMPANY

1935

1935,

BY THE MACMILLAN COMPANY
All rights reserved—no part of this book may be
reproduced in any form without permission in writing
from the publisher, except by a reviewer who wishes
to quote brief passages in connection with a review
written for inclusion in magazine or newspaper.

Set up and printed. Published January, 1935L

FEINTED IN THE XUnXED STATES OF AMXBICA

TO
MY FATHER AND MOTHER

PREFACE
In this book I have sought to provide an account of the
development of the Federal Reserve system during the
twenty years of its existence, laying particular stress upon
its operation in the capacity of a central banking institution.
The development of the system presents certain features
which are common to all the Federal Reserve banks. In
order to gain a clearer understanding, however, of the operation of central banking under the system, I have given more
detailed consideration to the Federal Reserve Bank of New
York because of the relative importance of its size and
power and the special significance which its policies and
operations have held for the people of the whole United
States. There are pointed out the relationships between
that Bank and the other Reserve banks and the Federal
Reserve Board, the failures and the achievements of the
Federal Reserve system, and conditions which have been
different from those intended in the Federal Reserve Act.
The prime purpose of a central banking institution is public
service. I endeavored, therefore, in the analytical phases of
this book, to judge from the point of view of the general
welfare.
The research work was carried on for the most part in the
library of Columbia University, the financial library of the
Federal Reserve Bank of New York, and in the economics
division of the New York Public Library. Government
publications, including the annual reports of the Federal
Reserve Board, the Federal Reserve Bulletins, and the hearings before the Banking and Currency Committees of the
United States Congress, and the publications of the Federal
Reserve banks constituted an underlying source of information. This material was supplemented by reference to
specialized works and correspondence with officials of the
Federal Reserve system.
I wish to make special acknowledgment to Professor

vii

viii

PREFACE

H. Parker Willis of Columbia University for valuable information and for his helpful criticism. Thanks are due to
Professors Benjamin H. Beckhart, James W. Angell, and
John Maurice Clark of Columbia University for their considerate reading of the book. It is, perhaps, unnecessary to
state that the author alone is responsible for the conclusions
expressed herein.
Finally, I desire to express my deep appreciation of the
aid of my wife, Gladys Rice Clark, who rendered much interested and efficient assistance at various stages during the
progress of the work.
LAWRENCE E. CLARK
N E W YORK CITY,

November, 1934,

CONTENTS
CHAPTER

I. T H E N A T I O N A L B A N K I N G S Y S T E M . . .
American Banking Development
Scattered and Pyramided Reserves
Concentration of Reserves in New York . . . .
Use of Reserves in Stock Speculation
Recurrent Financial Panics
Currency
Clearing and Collection
Discount Market and Domestic Exchange . . . .
Foreign Exchange and Foreign Trade Financing . .
Treasury Operations
Credit Control
IL ESTABLISHMENT OF T H E F E D E R A L R E SERVE SYSTEM
The Banking Reform Movement
The Aldrich Plan and the National Citizens League .
The Passage of the Federal Reserve Act
. . . .
How the Federal Reserve Act Differed from the Aldrich
Bill
The Federal Reserve Act and Central Banking
. .
A Central Banking System
HL THE PROBLEM OF DISTRICTING AND THE
LOCATION
OF
FEDERAL
RESERVE
BANKS
The Reserve Bank Organization Committee . . .
The Size of the New York District
New England's Claim for a Reserve Bank of Its Own .
The Size of the Boston District
. . . . . .
The Organization Committee's Methods and Principles
of Districting
The Districting Decision
Readjustment of District Lines
Effort to Reduce the Number of Federal Reserve
Districts
ix

PAGE

1
1
4
6
8
9
12
14
14
15
16
17

19
19
22
26
29
32
34

37
37
39
44
47
50
53
54
60

CONTENTS

CHAPTER

IV. E S T A B L I S H M E N T O F T H E F E D E R A L R E S E R V E B A N K OF N E W Y O R K
Incorporation .
Election of Directors
Appointment of Class C Directors
Selection of Executive Staff
The Problem of Opening the Federal Reserve Banks .
The Secretary of the Treasury Orders Opening
. .
The New York Reserve Bank Begins Operations . .
Work of the Preliminary Committee on Organization.
and the Washington Conference
Charter

PAGE

64
64
65
71
72
74
76
78
79
82

V. A D M I N I S T R A T I O N A N D C O N T R O L . . .
By-Laws
Method of Electing Directors
Service of and Interests Represented by Directors
.
Influence of Stockholders
Internal Organization
Management
The Federal Reserve Agent and Governor
. . .
Subordination of Federal Reserve Agent to Governor .
Representation of the Public
The Governors Council.
.

83
83
84
86
88
88
91
93
95
99
102

VI. F I N A N C E S
Sources of Funds
Total Earnings
Sources of Earnings
.
Expenses
Net Earnings and Dividends
Surplus
The Government's Share: Franchise Tax . . . .
Effort to Reduce Government's Share and Increase
That of Member Banks
Paying Interest on Reserves
The Interest Paying Proposals and Central Banking
Policy
Reasons for Reducing Government's Share
. . .
Effect of Banking Act of 1933
Returns to the Government

106
106
106
108
112
117
118
120

VII. OBSTACLES TO D E V E L O P M E N T A N D M E M BERSHIP
. . .
Antipathy of the Bankers . . . . .
. . .
Rival Plans for a Central Bank

123
124
127
128
130
131
134
134
136

CONTENTS
CHAPTER

xi
PAGE

Conflict between the Reserve Bank and the New York
Clearing House
Opposition to Clearing and Collection Functions . .
The Membership Problem
Efforts to Increase Membership during the War . .
Membership since the War
Group Banking and Membership
VIII. CENTRALIZATION OF OPEN
MARKET
POLICY OF THE RESERVE SYSTEM . .
The New York Bank as Agent for the Other Reserve
Banks
Origin of Central Control outside the Federal Reserve
Board
Considerations Leading to the Federal Reserve Board
Resolutions of 1923 . . . . . . . . .
The Open Market Investment Committee
. . .
Centralization of Open Market Powers in the New
York Reserve Bank
.
The Federal Reserve Board versus the Federal Reserve
Bank of New York
Formation of the Open Market Policy Conference
.
Effect of Banking Act of 1933

137
141
143
148
153
157
161
161
162
164
168
169
172
174
176

IX. CENTRAL
BANKING
FUNCTIONS—RESERVES AND GOLD .
Holder of the Reserves of Member Banks . . . .
Legal Reserve Requirements
Maintenance and Use of Reserve Balances . . .
Custody and Administration of the Nation's Gold
Reserve
Acquisition of Gold
Administration of Gold Reserve
Custody and Control of Gold Passes to the Treasury.
Regulation of Foreign Exchange . . . . .. .

189
189
193
194
196

X. CENTRAL BANKING FUNCTIONS—NOTE
ISSUE AND FISCAL
Note Issue
Federal Reserve Bank Notes
The Issue of Federal Reserve Notes
Security and Elasticity of Federal Reserve Notes .
Fiscal Agent of the Treasury . . . . . . .
Transfer of Functions to Reserve Banks
. . .
War Financing

200
200
200
202
203
208
208
210

181
183
183
187

xii

CONTENTS

CHAPTER

PAGE

Services Rendered the Government
Relations with the Treasury
. . . . . . .

214
215

XI. CENTRAL BANKING FUNCTIONS
AND
EMERGENCIES
Emergencies
The Post-War Period of Inflation and Depression .
The Depression of 1929-1933
The Bank Holiday
Credit Control .
Meaning of the Term "Credit Control"
. . .
Basis of Federal Reserve Control of Bank Credit .
Control over the Use of Credit

220
220
220
223
226
231
231
233
236

XII. C R E D I T CONTROL—RATES, OPEN M A R K E T
A N D LOAN O P E R A T I O N S
Discount and Acceptance Rates
Efficacy of Rate Changes
Development and Influence of Open Market Operations
Type and Effect of Open Market Operations . . .
Purchase of Paper Directly from Business Concerns .
Eligibility of Paper for Rediscount
Acceptability of Paper for Rediscount
Loans on Collateral
.

240
240
242
244
246
249
251
252
254

XIII. CREDIT CONTROL—DIRECT ACTION . \
260
Persuasion, Curtailment of Non-Essential Loans . . 260
Warnings
264
Conflict between the New York Reserve Bank and the
Federal Board
266
Efficacy of Warnings
268
Uses and Efficacy of Persuasion
270
Refusal to Discount Eligible Paper
273
Rationing of Credit
274
Enlargement of Federal Reserve Board's Authority . 276
XIV. CENTRAL SERVICE FUNCTIONS . . . .
Clearing and Collection
Domestic Exchange
Currency, Coin, and Gold Bullion
Bank Runs and Suspensions
Acceptances and Government Securities . . . .
Miscellaneous
. . .• .
Member Bank Relations Department

281
281
284
285
287
289
291
294

CONTENTS
CHAPTER

xiii
PAGE

The Buffalo Branch
Examination
X V . C E N T R A L I Z A T I O N OF F O R E I G N P O L I C Y OF
T H E RESERVE SYSTEM
Scope of Foreign Relations under the Federal Reserve
Act
Centralization of Foreign Relations in the New York
Reserve Bank
Banker for the Government in Foreign Transactions .
International Financial Relations
International Conferences of Central Bank Officials. .
The International Conference of 1927
Power of the New York Reserve Bank Abroad: Foreign
Recognition
Establishing Foreign Monetary Systems . . . .
Supporting the Gold Exchange Standard . . . .
X V I . COLLABORATION W I T H F O R E I G N C E N TRAL BANKS
Establishment of the Bank for International Settlements
New York Reserve Bank Identified as the Central
Bank of the United States
Relations with the Bank for International Settlements
Finance Loans to Central Banks
Other Inter-Central Bank Relations
Earmarking
Representing American Interests Abroad . . . .
Effect of Banking Act of 1933
X V I L C O N C E N T R A T I O N OF B A N K R E S E R V E S I N
N E W YORK
The Intention of the Federal Reserve Act . . . .
Inter-Bank Balances
Pyramiding of Reserves
Use of Bank Credit in Security Speculation:
Brokers' Loans
Reasons for Correspondent Banking and Concentration
in New York

294
298
301
301
302
304
307
309
312
314
317
320
322
322
325
327
333
335
338
340
344
346
346
349
352
353
360

X V I I I . B A N K I N G A N D M A R K E T R E L A T I O N S H I P S 371
Use of Central Reserve Credit in the Stock Market . 371
The New York Call Loan Market versus Other Money
Markets
375

xiv

CONTENTS

CHAPTER

PAGE

Relation of Reserve Banks to the Stock Market . . 380
The Federal Reserve Bank of New York as a Central
Bank
387
XIX. TWENTY YEARS OF T H E FEDERAL
SERVE SYSTEM

RE397

APPENDIX I. By-Laws of the Federal Reserve Bank
of New York
409
APPENDIX IL Directors of the Federal Reserve Bank
of New York . . . . Facing 412
BIBLIOGRAPHY

413

INDEX

421

TABLES
PAGE

1. Earnings of the Federal Reserve Bank of New York,
by Sources
2. Earnings of all Federal Reserve Banks, by Sources . .
3. Fiscal Agency Expenses of the Federal Reserve Bank of
New York, 1917-1931
4. Total and Net Earnings of the Federal Reserve Bank
of New York, and Disposition Made of Net Earnings
5. Total and Net Earnings of all Federal Reserve Banks,
and Disposition Made of Net Earnings
6. Member Banks in Second Federal Reserve District,
Changes in Membership
7. Member Bank Reserve Requirements under Original
Federal Reserve Act
8. Member Bank Reserve Requirements under Original
Federal Reserve Act (after 3 year period) . . . .
9. Member Bank Reserve Requirements under Amendment to Federal Reserve Act, June 21,1917 . . . .
10. Monetary Gold Stock and Gold Reserves
11. Certificates of Indebtedness, 1917-1919
12. Liberty Bonds, 1917-1919
13. Net Amount of Accommodation Received from or Extended to Other Federal Reserve Banks by the Federal
Reserve Bank of New York, 1920-1921
14. Actual and Adjusted Reserve Ratios of Federal Reserve
Banks, 1919-1921
15. National and State Bank Suspensions, 1921-1932
. .
16. Loans and Investments, All Member Banks, 1921-1929 .

109
Ill
113
114
116
158
182
184
186
190
212
213
222
223
403
405

ILLUSTRATIONS
FIGUBE

1.
2.
3.
4.

The Second Federal Reserve District
The Federal Reserve Districts, Bank and Branch Cities .
Organization of the Federal Reserve Bank of New York •
Organization of a Typical Function, Federal Reserve
Bank of New York, Cash Function

CENTRAL BANKING
UNDER THE
FEDERAL RESERVE SYSTEM

CHAPTER I
THE NATIONAL BANKING SYSTEM
American Banking Development
Previous to the establishment of the Federal Reserve
system in 1914 there developed in the United States a banking structure quite different from that of other countries.
There were forty-eight state governments, each one of which
had jurisdiction over its chartered banks. There was also a
group of national banks in each state under the jurisdiction
of the United States Government, forming what was known
as the national banking system. A dual banking network
thus existed embracing state banks on the one hand and
national banks on the other. Altogether the number of
commercial banks in these political jurisdictions totaled
over 25,000, in 1913, and there was no organic connection
between them.
The existence of these independent local unit banks was
largely due to the influence of the frontier life on the American people. The broad geographical expanse with its
frontier conditions made for individual initiative and selfreliance in economic and political affairs. As the settlement
of the large public domain proceeded westward and banks
were established to serve the needs of the people, this spirit
of independence manifested itself in the banking structure
of the nation and decentralization became the accepted
policy. The unpopularity of the First Bank of the United
States was followed in due course by hatred of the Second
Bank of the United States and the refusal to recharter it in
1836. The people had become suspicious of and antagonistic
toward any centralized banking institution or suggestion of
monopoly of credit.
Consequently banks were set up in each state independent
of the Federal Government and unconnected with banks in

CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

any other state.1 An extremely uncoordinated situation
developed in the nation's banking structure. Lacking a
"banking tradition" enforced by public opinion, as in England or Scotland, banks became either practically a law unto
themselves or were subject to weak legislation and control.
Unscrupulous individuals in the West and South inflicted
upon those pioneer communities the same faulty money
and banking practices from which the people of the Atlantic
seaboard states had suffered in colonial times and our early
national life, and which they had thrown off in considerable
measure after much sad experience. The kind of banking
which was carried on in this period prior to the Civil War
was dubbed wildcat banking, being characterized by deception, exploitation, uncertainty, and insecurity, and the
money put out was called wildcat currency. A multitude of
different kinds of money was in use. It circulated at various
rates of discount, some of it being worthless and nearly all
of doubtful value.
Owing to the financial exigencies of the Civil War, Congress passed on February 25, 1863, the National Bank Act
which was subjected to revision, and on June 3*1864, a substantially new law was enacted.2 The National Bank Act
provided for the chartering of national banks by the Federal
Government in any part of the Union and the issue of bank
notes of uniform value. It sought to aid the financing of the
Civil War by the sale to these banks of government bonds
bearing the circulation privilege as security for the national
bank notes. The Act resulted in the establishment of a
system of banks on a national scale, incorporated by the
same governmental authority, subject to the same laws and
regulatory control. The national banking system was
characterized by free banking, independent local unit banks
instead of large banks with branches, and fixed reserve
requirements.
The wildcat currency problem was solved by an Act of
1

See W. G. Stunner, History of Banking in the United States; John Jay
Knox, A History of Banking in the United States; Charles A. Conant, A
History of Modern Banks of Issue, Sixth Edition, chapter XIV.
2
See Knox, op. cit., chapters XIV and XV; Conant, op. cit., chapter XV.

THE NATIONAL BANKING SYSTEM

Congress, March 3, 1865, providing for a tax of 10 per cent
on the amount of the notes of state banking associations.
This tax made the issue of such notes unprofitable and
effectively put them out of circulation. As compared with
the present time relatively little deposit banking was
done prior to and during the Civil War period, the banks
relying upon the privilege of issuing notes for support. So
when the issue of state bank notes was suppressed by the
federal tax it was hoped that the state banks would liquidate and take out national charters. In fact it was stated
in Congress at the time the bank note tax measure was introduced that the intention was to have national banks
exclusively, a unified banking system. Many state institutions did take out national charters and others liquidated voluntarily or failed. Consequently their number
dwindled while, on the other hand, national banks multiplied.
The results of taxing the notes issued by state banks were
working out as anticipated when the use of bank checks in
business in place of bank notes began to assume major
proportions. This practice resulted in the rise of deposit
banking. As a consequence, about 1880, banking under a
state charter took a new lease on life. It again became
profitable to operate state banks and they rapidly increased
in number during the last quarter of the century* There
has continued to exist, therefore, this dual banking structure
with its competition between the National Government on
the one hand and the several state governments on the other
for incorporating banks.
The National Bank Act, setting as it did at the time relatively high standards, caused national banks to be considered
favorably by the people and served as a model for the enactment of new banking laws in various states in the following
years. Among the advantages of the Act probably the chief
were that it provided the country with bank note money of
uniform value and furnished the Government with a market
for its bonds. Although the advantages of the national
banking system over the chaotic conditions which had
prevailed prior to the Civil War were much appreciated by

CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the people, very early in the history of the system some
deficiencies appeared. These were, however, not generally
felt until the '80s. Aggravated by the depression of 1893 the
deficiencies became more pronounced and with their periodical recurrence in succeeding years they assumed major
importance.
The defects of American banking under the national
banking system as they finally developed may be classified
under the following subjects: scattered and pyramided
reserves, concentration of reserves in New York, use of
reserves in stock speculation, recurrent financial panics,
currency, clearing and collection, discount market and
domestic exchange, foreign exchange and foreign trade
financing, treasury operations, and credit control.
Scattered and Pyramided Reserves
Under the National Bank Act national banks were divided
into three classes, those in (1) central reserve cities, (2) reserve cities, and (3) other towns. National banks were required to keep a legal minimum reserve against their deposits and the amount of this required reserve which any
bank had to maintain was determined by this classification.
The requirements were as follows: National banks in the
central reserve cities, New York, Chicago, and St. Louis, had
to keep a reserve of 25 per cent in their own vaults. In reserve cities (about sixty of the larger cities) the minimum
was also 25 per cent but one-half of it could be kept with national banks in central reserve cities. For banks in other
places (usually referred to as country banks) the minimum
was 15 per cent, three-fifths of which could be kept with national banks in either central reserve or reserve cities.3
Some states followed the National Bank Act in its classification upon which they based a similar sliding scale of legal
reserve requirements and generally permitted their institu8
The reserve percentage required of the New York City banks was not
far from the reserves actually held by these banks before the National Bank
Act was passed. For a discussion of the fixing of these reserve requirements
in the National Bank Act, see M. G. Myers, The New York Money Market,
Vol. I, chapter XL

THE NATIONAL BANKING SYSTEM

tions to carry a larger proportion of the required reserves in
other banks. There developed extensive inter-bank balances
forming the basis of the correspondent banking system which
attained substantial proportions by the first decade of this
century. Banks in the smaller cities seized upon the opportunity to keep part of their reserves in the reserve and central
reserve cities. The reserve city banks in turn divided their
reserves between their own vaults and the banks in New
York, Chicago, and St. Louis. Thus the legal reserves of the
nation's banking organization were scattered among the
thousands of independent unit banks, both national and
state.4
The reserve arrangement of the national banking system
had certain inherent defects and worked badly. It resulted
in the pyramiding of reserves. Country banks, upon sending
checks to their reserve agents for collection, would count
them as legal reserve as soon as mailed. Reserve city banks,
upon sending the same checks to their reserve agents in the
central reserve cities, would likewise count them as legal
reserve as soon as mailed, and therefore before they were
collected. Thus some checks were counted twice as reserve
or even more times on account of circuitous routing. This
practice rendered a substantial amount of the legal reserves
fictitious in that they were not cash reserves but paper
reserves. For example, the national banks held, on October 2, 1913, $926,000,000 in cash and paper reserves of
$792,000,000 as against total deposits subject to reserve
requirements of $7,172,000,000. Thus their cash reserves
were about 12.8 per cent of their deposit liabilities.5 Although possessed of these defects, such a system was very
profitable for the country and reserve city banks. Under this
system that part of their reserves kept elsewhere could be
deposit credit instead of the lawful money which they had
to keep in their own vaults, and a certain amount of checks
could be counted twice as legal reserve. They therefore were
enabled to carry a larger amount of deposit liabilities and
make more loans.
* See below, p. 13.
5
Conway and Patterson, The Operation of the New Bank Act, p. 206.

6 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
Concentration of Reserves in New York

The reserves of banks generally over the United States
became deposit balances in other banks. Not only was the
full amount of the bank balance permitted to be counted as
legal reserve deposited but country and reserve city banks
deposited in their correspondent banks from 50 to 100 per
cent excess reserves.6 The reserves of the country banks in
the reserve city banks were redeposited by the latter in the
central reserve city banks. Bank reserves tended to concentrate, therefore, in the central reserve cities.7 By far the
greatest concentration was in New York City. Furthermore,
banks in the central reserve cities of St. Louis and Chicago
kept balances in the New York banks. New York City was
the great magnet which attracted bank reserves from all over
the country—from cities large and small.8 During seasonal
and cyclical disturbances as well as in more settled periods
bank deposits there were relatively preponderant. National
banks in New York City held approximately one-third of the
total inter-bank deposits of national banks and about seventenths of the total of the central reserve city national banks.9
The dominance of New York City at the time of the
organization of the Federal Reserve system is shown also
by the following:10 The amount on deposit from all banks
6
L. L. Watkins, Bankers Balances, p, 359; Hearings before the Committee
on Banking and Currency of the Senate, on H. R. 7837 (S. 2639), 63rd Congress, 1st Session, 1913, Vol. I, p. 825. (Hereafter cited as Senate Hearings
on the Federal Reserve Act, 1913.)
7
Central reserve city banks numbered less than 1 per cent (after 1908) of
national banks but held about one-half the inter-bank deposits of national
banks. For detailed statistics regarding inter-bank deposits prior to the Federal Reserve system see tables in Watkins, Bankers Balances, chapter II.
8
Hearings before a Subcommittee of the Committee on Banking and Currency of the House of Representatives, on H. R. 429 and 504, 62nd Congress,
1st Session, 1912, Exhibit 133, pp. 1192-1212, 1654-1660, 1981. (Hereafter
cited as Hearings in the Money Trust Investigation, 1912.)
9
Watkins, op. cat., p. 20.
It will be recalled that in 1913 there were over 25,000 banks in the country.
Out of 111 banks and trust companies in New York City, 30 had 19,015 bank
deposit accounts of out-of-town banks. And 10 banks out of the 30 had 15,483
bank deposit accounts. These 10 New York banks had 60 per cent of all deposits of all the state and national banks of the country. Senate Hearings on
the Federal Reserve Act, 1913, Vol. I, pp. 819 and 823.
10
Decision of the Reserve Bank Organization Committee, Table D, p. 14.

THE NATIONAL BANKING SYSTEM

and trust companies throughout the United States, February 14, 1914, in the national banks in New York City was
$742,386,939. The next nearest city was Chicago with
deposits of $278,824,567. Indicative of the extent to which
reserves were concentrated in New York is the following:
The reserve in the vaults of national banks in New York
City, consisting of specie and legal tender notes, on January 13, 1914, was $313,586,128. Chicago was second with
reserves of only $88,732,480. Further evidence of the
predominance of New York City as a financial center is
indicated by the following figures u of national banks as of
March 4, 1914.
Capital and surplus
Individual deposits
Loans and Discounts

New York
$ 248,505,000
771,724,999
1,082,272,650

Chicago
$ 69,050,000
211,558,247
335,820,233

All reporting banks 12—National, State, Savings and Loan,
and Trust Companies as of June 4, 1913.
Capital and surplus
Individual deposits
Loans and Discounts

New York
$ 563,221,701
2,866,351,069
2,306,503,682

Chicago
$151,882,559
682,498,992
690,799,087

The reasons for the preponderant concentration of bank
resources in New York City were several. It was necessary
to allow outside banks to keep reserves there in order to
facilitate the financing of domestic and foreign exchange
operations, as had been customary before the establishment
of the national banking system. The banks sold exchange on
New York to their customers on which they realized a profit.
Also in normal times the banks kept as little as possible of
primary reserves preferring to put the rest to work in other
banks drawing interest. The bank balances in New York
City ordinarily served as a convenient secondary reserve
in that they could be withdrawn promptly by the other banks
when needed in their own communities. They, therefore,
looked upon bank balances in New York as a good way
to "invest" part of their resources even though they could,
at times, have loaned all their funds at home, since such a
11

Ibid., Table E, p. 15.

Ibid., Table F, p. 16.

8 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

plan constituted a diversification of their assets. These
balances secured for them about 2 per cent interest and at
the same time they were usually liquid, being available to
them on call.
Another factor was that they wanted an established banking connection to serve as a source of borrowing. It gave the
banks a feeling of security that they would be " taken care
of" in times of seasonal or cyclical stringency or emergencies
of one kind or another. Furthermore, the New York banks
served the outside banks as collection agencies. They collected cash and non-cash items payable in various parts of the
country for their correspondent banks which service was
highly valued by the latter. With all of the above motives
for keeping deposits in the New York banks, such deposits
would at the same time count as reserve under the National
Bank Act and the laws of the various states. Thus while all
these advantages would be accruing to the outside banks
they would be satisfying their legal reserve requirements in
part with the very same bank deposits which superinduced
these advantages and on top of all that were enabled to
make more loans in their own localities.
Use of Reserves in Stock Speculation
In spite of the apparent advantages which the outside
banks gained by sending their reserves and surplus funds to
New York, the New York banks would have been unwilling
to accept them for deposit if they could not have found a
place to invest them. The reason for this was that the New
York City banks, like all the others, were governed by the
profit motive and therefore maintained their cash reserves
close to the legal minimum. Though they held to a very
large extent the ultimate bank reserves of the country they
did not assume central banking responsibility with regard to
them. To have had available excess reserves for a time of
credit stringency, they would have had to carry idle reserves
at other times, and this was incompatible with the competitive, profit-seeking economy which motivated their loan
and investment policies.
Opportunity in New York City was afforded the banks to

THE NATIONAL BANKING SYSTEM

make a profit on the bank balances by loaning them in the
call loan market. In New York City a securities market of
national proportions was centered. This market was financed
in large measure by call loans supplied by the banks under a
daily settlement system. More money could be loaned on
call in New York at a higher rate than elsewhere. This was
the chief outlet for bankers' balances in New York. And so
profitable was this outlet that not only were the New York
banks eager to have the deposits of outside banks but competition for them became so keen that they were willing to
offer 2 per cent interest to obtain them.
The outlying banks thus secured deposit balances in the
New York banks payable on demand and the latter converted these balances into call loans secured by stock exchange collateral.13 Furthermore, the concentration of
funds in New York City was augmented by the practice of
the banks in sending funds to their New York correspondents
not for keeping to their credit but to be loaned directly for
the stock market.14 The dominance of the New York City
banks in the field of stock exchange loans at the time of the
organization of the Federal Reserve system is evident from
the following facts:15 The total amount of bought paper
and stock exchange loans made by national banks in New
York City to non-customers throughout the United States,
January 13, 1914, was $263,803,618. The next nearest city
was Boston, the figure for which on the same date was
$47,402,893.
Recurrent Financial Panics
The ill effects of padding reserves and the concentration
of funds in New York, apparent in normal times, became
severe in times of pressure. The concentration of funds in
New York involved a seasonal movement of money between
New York and the interior. For example, in the fall and
winter funds flowed to New York and then in the spring and
13

Hearings in the Money Trust Investigation, 1912, pp. 952-963,1192-1212.
Report on the Money Trust Investigation, 62nd Congress, 3rd Session,
House Report No. 1593, p. 159; Senate Hearings on the Federal Reserve Act,
Vol. I, pp. 510 and 825.
15
Decision of the Reserve Bank Organization Committee, Table D, p. 14*
14

10 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

summer when the agricultural communities needed cash for
planting and harvesting the interior banks recalled funds.
This seasonal movement of money was not only economically
wasteful but resulted in wide interest rate fluctuations.16
The most serious phase of this concentration of funds in
New York was their use in the call loan market which resulted in a tendency to inflate stock prices. At times nearly
all the bank reserves of the nation were put to the service
of the stock market speculators. During the period of a
plethora of funds in New York, the banks' loans to brokers
"boosted" stock prices. Normally when outside banks requested their deposits, the New York banks called their
loans to brokers and sent them the funds. But as stock
prices rose their maintenance became ever more difficult
and the New York banks were increasingly reluctant to
part with funds which belonged to others. A substantial
decline in the reserves of the New York Clearing House
banks warned of approaching disaster.
At times when the credit situation was more or less
stringent the calling of loans had an unbalancing influence
in the money market and on stock exchange transactions
the effect of which was felt throughout the nation.17 Outlying banks which had secured a banking connection in
New York City in order to be able to borrow from it in an
emergency not only found they could not borrow but could
not get returned to them the very reserves which they had
previously sent to New York and which were supposed to
be payable on demand. There was no central bank which
16
See E. W. Kemmerer, Seasonal Variations in the Relative Demand for
Money and Capital in the United States, Senate Document 588, 61st Congress, 2nd Session, published by the National Monetary Commission.
17
Mr. Sol Wexler, a New Orleans banker, said, "the first radical reduction
in reserves exhibited itself in the New York bank statement, and that attracted
the attention of the whole country to the condition in New York. The moment
we all saw that condition, we had to draw our money out of New York in
order to intrench ourselves, and in doing so we further weakened New York,
so that we contributed in a sense to the acute condition that existed in New
York. Our country bank correspondents, when they found that we were
drawing our money out of New York with a view of strengthening ourselves,
turned around and drew it out of us to strengthen themselves. So that the
whole system broke down because of its inefficiency." Senate Hearings on the
Federal Reserve Act, 1913, Vol. I, p. 95.

THE NATIONAL BANKING SYSTEM

could regulate the money market and serve as a lender of
last resort for the New York banks as a whole. The outside
banks, not obtaining their New York balances, could not
finance the agricultural and business requirements of their
customers nor meet the claims of their depositors. Just at
crucial times when bank credit, in accordance with the central banking rule, should have been enlarged at increasingly
high rates to deserving applicants it was practically unobtainable at any price for anyone.18 Recurrently such financial panics made their appearance, characterized by nonredeemability of bank deposits, extremely high interest
rates, runs on banks and the refusal of credit to deserving
firms. A typical experience was that of the Boston banks
which, when the panic of 1907 occurred, had on deposit in
New York banks subject to check from $25,000,000 to
$30,000,000. When the Boston banks needed it and requested it "they could not get a cent of it." "The New
York banks said, 'We have got your money and we are
going to use it/ and they did." 19
Paradoxical as it is, the fact is that one of the reasons why
the outside banks wished to keep deposits in New York City
was that it gave them a feeling of security and that they
would be "taken care of" in time of need. And yet when the
time of greatest need came they could not be "taken care
of." The correspondent banking system with its concentration of bank reserves in New York City, resulting in their
feeding of stock speculation, made the commercial banking
system of the country dependent for its "liquidity" upon the
condition of the stock market—a situation not consonant
with commercial banking principles. In the absence of any
centralization of reserves confined to commercial banking
purposes it was a case of making the best of a bad situation
18
For a comprehensive survey of the operation of the national banking
system during crises, see O. M. W. Sprague, History of Crises under the
National Banking System, Senate Document 538, 61st Congress, 2nd Session,
published by the National Monetary Commission.
19
Testimony of William A. Gaston, President of the National Shawmut
Bank, Boston, Mass., before the Reserve Bank Organization Committee at
Boston, January 9, 1914: contained in the Stenographic Minutes of the Hearings before the Reserve Bank Organization Committee.

12 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

and hoping for the best to come. And when the whole banking structure broke down, in frantic efforts to relieve the
situation, in New York and some other cities, a form of bank
cooperation was resorted to through their clearing house
associations which involved the pooling of reserves and the
use of clearing house certificates.20 But these organizations
were primarily local in their efforts, were quite ineffectual
so far as general credit conditions were concerned, and were
disbanded in due course after each stringency.
Currency
The currency in use was inelastic. Most of the discussion
regarding inelasticity of the currency during the period of
banking reform agitation was directed against the inelasticity
of bank notes. But there was deposit currency, circulating
by means of checks, which was also inelastic. By inelasticity
is meant not that the currency could not be increased in
amount but that it could not be expanded and contracted
in accordance with the increase or decrease in the demand
for it.
There were in circulation in 1913 the following kinds of
paper money: gold certificates, silver certificates, United
1
States notes, Treasury notes of 1890,21 and national bank
notes. Of all the kinds of money in circulation the national
bank notes were the only ones which could be increased
without increasing the amount of monetary metal in the
hands of the Government. They were the only ones offering
any possibility of expansion along with expansion in business.
These notes were extremely inelastic, however, in that their
volume depended upon the amount available and the price
of United States Government bonds, against which they
were issued.
The amount of government bonds available for security
against the bank notes was limited by their use in protecting
public deposits and as an investment medium. Moreover,
20
See footnote 24 regarding clearing house certificates and the pooling of
reserves.
21
The Treasury had announced a policy of retiring the Treasury notes
of 1890 as rapidly as they were turned in and relatively few were in circulation.

THE NATIONAL BANKING SYSTEM

the banks were limited in the amount they could issue by
their capitalization. And even though the notes could be
obtained further inelasticity was present on account of the
delay involved in making them available. They not only
did not expand with the volume of trade but once issued
their contraction was very difficult. As a matter of fact the
volume of national bank notes commonly decreased when
business expanded.22
The deposit currency, which comprised a much greater
proportion of the medium of exchange than paper currency,
was inelastic because of the scattered reserves independently
controlled and the fixed percentage of reserve required by
law. There was no general organized pooling of reserves
from which particular banks could be served in time of
stringency. When these banks were "loaned up" they were
unable to relieve the credit strain in their communities.23
This inelasticity of both deposit and paper currency accentuated seasonal fluctuation in interest rates and widened the
amplitude of the business cycle.24
22
Report of Indianapolis Monetary Commission, 1898, pp. 224, 227, 231,
309; Report of National Monetary Commission, Jan. 9, 1912, Senate Document 243, 62nd Congress, 2nd Session.
23
See above discussion concerning the use of reserves in stock speculation
and recurrent financial panics.
54
In the larger cities the members of the clearing house associations sought
temporary relief from the inelastic currency and stringency through the issuance of certificates by the clearing houses. The first issue of these certificates
was by the New York Clearing House in 1860 and they were issued in New
York and other cities in every decade until the establishment of the Federal
Reserve system. Probably the first time that the New York banks cooperated
for the protection of their reserves in an emergency was not in 1860 but in
1814. Regarding this The Financial Age, Sept. 19, 1914, p. 477, says:
" A pamphlet issued by the bank of Manhattan Company states that the
banks of New York at the present time are confronted with practically the
same problems with which they had to contend just one hundred years ago,
or during the last year of the Napoleonic wars in Europe. It says:
" 'At the meeting of the General Committee on August 27, the spirit of cooperation among American bankers was evidenced in the following resolution:
" ' Resolved, that if any bank shall be called upon for a payment of specie
beyond its present ability to pay, every aid shall be given by the other institutions consistent with their own safety.
" ' At this same meeting the General Committee also prepared regulations
for the settlement of balances between banks to become effective September 1,
1814. The financial strain had evidently increased, and in spite of the strong
effort to maintain specie payments, they had been suspended. The regulations

14 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
Clearing and Collection

The clearing and collection practices of the national
banks were cumbersome and costly. In the settlement of
inter-sectional trade balances banks commonly exacted
collection and exchange charges, and where such were
exacted they were commonly passed on to the business public
directly or indirectly in higher interest charges. This was a
heavy burden on the business public; and to the extent that
the charges were absorbed by the banks they were an economic loss. In an effort to avoid paying these charges to
other banks, bankers adopted the practice of circuitous
routing of checks between correspondent banks aiming at
par collection. This not only involved waste and delay but
gave rise to a large volume of uncollected checks or float.
As pointed out above though the banks counted this float as
collected it in reality was a fictitious reserve. As such it was
subject to considerable risk and in crucial times it proved
to be irredeemable in cash. The absence of any centralized
clearing mechanism for handling inter-city or inter-sectional
claims necessitated heavy expense and trouble of shipping
gold and currency.25
Discount Market and Domestic Exchange
Under the national banking system there was no discount
market of national proportions.26 Due to the independent
are especially interesting. They make it evident that exactly 100 years ago
during our own war with Great Britain and the Napoleonic wars in Europe,
the New York banks found it necessary to work out an emergency system for
settling their daily balances. This, without doubt, was the precursor of the
system of Clearing House Loan Certificates, which, since the formation of
the New York Clearing House in 1853, has been used in several crises, and is
in effect at the present moment/ "
For a discussion of clearing house certificates and other practices of imparting a degree of elasticity to an inelastic currency see Sound Currency, Vol. II,
No. 6, Feb. 15,1895, and W. E. Spahr, The Clearing and Collection of Checks,
chapter V.
2fi
For details concerning the evils of the clearing and collection system see
H. Parker Willis, The Federal Reserve, pp. 228-230; and W. E. Spahr, The
Clearing and Collection of Checks, pp. 101-119.
26
L. M. Jacobs, Bank Acceptances, Senate Document 569, 61st Congress,
2nd Session, published by the National Monetary Commission; J. Laurence
Laughlin, Editor, Banking Reform, chapter VI.

THE NATIONAL BANKING SYSTEM

unit bank system and the legal restrictions to which national
banks were subject in the making of acceptances, the scope
of the operations of commercial banks was, as a rule, quite
naturally limited to their own communities. There was no
standard commercial paper or bank acceptance available for
the loans and investments of banks and this tended to cause
the concentration of reserves in New York City. Consequently, there was extreme variation in the cost of capital in
different parts of the country and lack of stability of interest
rates.
There was no organization capable of assuring the furnishing of domestic exchange from one part of the country to any
other part or able to prevent the disruption of the exchanges.
Domestic exchange operations required the physical shipment of quantities of currency and coin, which involved
much time, labor, expense, and the risks of transportation.
As in the case of foreign exchange, the shipment of gold, or
currency, was necessary in order to settle balances between
various sections of the country. Exchange on distant cities
was purchased at rates which fluctuated widely and constituted a burden on the business public.27
The above conditions associated with the lack of a national
discount market and the inadequate domestic exchange
medium superinduced financial difficulties in good times and
bad, hindered domestic trade and industrial financing, and
accentuated the ill effects of sectional as well as national
disturbances.
Foreign Exchange and Foreign Trade Financing
In the matter of foreign exchange and foreign trade
financing we were for the most part dependent upon the
London money market. Our foreign trade was largely
financed abroad. This was probably fundamentally due to
the fact that the United States was a debtor rather than a
creditor nation and such trade could be financed more
cheaply in London. But it was also due to the restrictions
against creating acceptances to which American banks were
f > F o r details concerning domestic exchange operations, see Ira B. Cross,
Domestic and Foreign Exchange, chapters I, II, and IIL

16 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

subject and the lack of foreign branches of American banks.
The situation called for an additional foreign exchange
operation which involved more expense and additional risk.
Furthermore, foreigners secured information which handicapped American business men in competition with them.
Although there was a money market in New York, it was
hardly an international one in the sense that the London
money market was because a substantial rise in the discount
rates of commercial banks did not succeed in attracting much
foreign capital. There was no power to exert a decisive
influence on gold movements by means of money rate
changes or the settling of international balances by offering
bankers* acceptances. Gold movements were too greatly
influenced by stock market speculation and the call loan
rate.28
Treasury Operations
Since 1846, when the Independent Treasury was established, the Government had been custodian of its own funds.
In the administration of these funds, the Government kept
its money apart from the banking organization, locked up in
its vaults in the Treasury building in Washington and in
several sub-treasuries scattered over the country. To the
extent that the Treasury deposited money in the banks, the
deposits were ordinarily governed by political considerations. The Treasury's practice of receiving payment in
cash for the most part and making its disbursements in cash
resulted in periodic withdrawals from the banks which upset
monetary and banking relationships. During periods of
stringency which, indeed, its own operations had helped to
produce, its effort to furnish relief tended to stimulate
speculation and made it more difficult for banks to maintain
their reserves. Unsatisfactory as was the experience of the
Federal Government in being its own fiscal agent in time of
peace, it made very difficult the collection and disbursement
of revenue in time of war. And its operations could generally
**See L. M. Jacobs, Bank Acceptances; J. Laurence Laughlin, Editor
Banking Reform, chapter XXII.
'

THE NATIONAL BANKING SYSTEM

be counted upon to accentuate fluctuation in interest rates
and unsettle business conditions,29
Credit Control
Credit control under the national banking system was an
impossibility. The thousands of independent unit banks
worked at cross purposes. The least "scare" would cause
each bank to strengthen its position by competing for the
available gold because there was no central agency which
would enable the banks to increase their reserves or secure
bank notes to meet the increased demands of their customers
for cash. No increase in the reserves of the commercial
banking system was possible except that arising from
domestic gold production or gold imports or perchance the
habits of the people resulting in the deposit of gold coin in
their banks. The contraction of bank credit was dependent
upon putting gold coin into circulation or exporting gold.
The independent bankers quite naturally developed correspondent bank relationships and these proved very insecure. There was no central bank or organization to
coordinate the policies of the commercial banks of the
country and to whom they might look for leadership in
good times as well as periods of adversity. Economic life
during the period of the national banking system became
ever more specialized and groups and sections of the country
became increasingly interdependent. In like manner international relations multiplied and became more complex.
The use of deposit credit far outstripped metallic and paper
money as a medium of exchange.
There was no institution which could survey lending
policies from a national point of view and control the total
amount of bank credit in use in relation to the gold base or
any other criteria. A central authority was lacking which
could regulate the flow of credit in and out of the money
markets and the flow of gold between countries, marshal
19
David Kinley, The Independent Treasury of the United States and ita
Relation to the Banks of the Country, Senate Document 587, 61st Congress,
2nd Session, published by the National Monetary Commission. See also The
New York Money Market, Vol. I, by M. G. Myers, chapters IX and XVII.

18 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the financial resources of the nation to make a united front
against a crisis whether it be one of war or business depression. In short there was no institution which was charged
with the duty of being responsible for general credit conditions. The lack of such an institution, of course, constituted a
vulnerable weakness of the national banking system. The
defects of the commercial banking structure were inherent
though they were patent more especially during crises. The
injurious effects of the evils of the national banking system
were not only inflicted upon the banks but in greater degree
upon everyone else, the public, the producers, and consumers.30
30

Concerning the injuries suffered by the people of the nation, Carter Glass
said: "While we may boast that no note holder has ever lost a dollar, and the
losses of depositors constitute an inconsiderable percentage of the total liabilities of the banks, nevertheless, the failure of the system in acute exigencies
has caused widespread business demoralization and almost universal distress.
Five times within the last 30 years financial catastrophe has overtaken the
country under this system; and it would be difficult to compute the enormous
losses sustained by all classes of society, by the banks immediately involved;
by the merchants whose credits were curtailed; by the industries whose shops
were closed; by the railroads whose cars were stopped; by the farmers whose
crops rotted in the fields; by the laborer who was deprived of his wage. The
system literally has no reserve force. The currency based upon the nation's
debt is absolutely unresponsive to the nation's business needs. The lack of
cooperation and coordination among the more than 7,300 national banks produces a curtailment of facilities at all periods of exceptional demand for credit.
This peculiar defect renders disaster inevitable." Speech in House of Representatives, Sept. 10, 1913. Congressional Record, Sept. 10, 1913, p. 4642.

CHAPTER II
ESTABLISHMENT OF THE FEDERAL RESERVE
SYSTEM
The Banking Reform Movement
During the panic of 1893 such serious attention began to
be paid to those defects of the banking system which had
become manifest that this panic may be said to mark the
beginning of the banking reform movement. At this time the
Baltimore Clearing House drew up a plan which was presented to the convention of the American Bankers Association in Baltimore in 1894. This plan, which became known
as the Baltimore plan, was modeled upon the Canadian
system of guaranteed note issue and was concerned with
making the paper money safer and more elastic.1 The bankers7 convention sponsored the plan and. gave it publicity.
In his report on the state of the finances, December, 1894,
the Secretary of the Treasury, Mr. Carlisle, also urged a
revision of our bank note issue.2 During the ensuing period the question of reform of the bank note issue was submerged in the controversy over the unlimited coinage of
silver.
A noteworthy step was taken in 1897 when the Indianapolis Monetary Commission, composed of bankers, business
men, and economists, investigated the situation and issued a
report.3 This report furnished the basis for a bill which was
introduced in the House on January 6, 1898. Doubtless
Congressional action was delayed on account of the SpanishAmerican War. The Monetary Commission had emphasized
1
For the essentials of the plan see J. Laurence Laughlin, Banking Progress,
p. 27. See also The Commercial and Financial Chronicle, Oct. 27, 1894,
pp. 718-720.
2
Annual Report of the Secretary of the Treasury, Dec. 3,1894, pp. LXVIILXXXIII.
3
Report of the Indianapolis Monetary Commission, 1898.
19

20 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the desirability of asset currency. When the Gold Standard
Act of 1900 was enacted some of the recommendations of the
Commission became the law, but the revision of the method
of issuing bank notes was not one of them. The prosperity
of the time resulted in a relaxation of interest in the subject
on the part of most of the banking and commercial people.
Scientific students of the subject, however, continued their
investigation and promotion of reform.
The effort for reform was generally known as the currency
reform movement. It was not, however, confined merely to
currency, which was popularly thought of as bank notes,
and its elasticity. It referred to many other phases of banking including banking organization and credit control.
"Currency reform" was a phrase which became more or less
traditional from the time of the Baltimore plan following the
panic of 1893 and covered the general revision of the banking structure of the country as it was discussed. Throughout
the entire reform movement including the period of debate
on the Federal Reserve Act itself, newspapers, magazines,
and scientific societies generally referred to the matter as
"currency reform." In its inception the movement had to
do with a revision of the issue of bank notes but about the
beginning of the century commonly involved a modification
of the whole banking structure. Indeed, previous to the
Gold Standard Act of 1900, Maurice L. Muhleman had
proposed a central bank of issue.4 It became evident that
mere currency reform was not enough but that what was
needed was a change in the organic structure of the banking
system.
Hence it developed that the inauguration of central banking in the United States, which had long been so unpopular
politically, was seriously urged at the beginning of the century by the younger school of economists. The change in
the nature of the so-called "currency reform" discussion
had progressed so far that by 1902 banking reform was
analyzed under the title of "The Demand for Centralized
Banking." This analysis by an authority who, a decade
later, was economic adviser of the House Banking and Cur4

Maurice L. Muhleman, Monetary and Banking Systems, p. 206.

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM

rency Committee in the formulation of the Federal Reserve
Act, contained a summary of the situation as follows:5
Until recently, most of those who have written on the subject
have been very certain that what the country needed was a better
equipment of small and branch banks. Most of the arguments on
currency reform dealt with this question at greater or less length,
apparently assuming that, should permission to establish branches
be conceded, a long step toward the improvement of currency
conditions would have been taken. The change in the trend of
the discussion may be outlined as follows:
1. It is now assumed or stated, by many writers and speakers that
the subdivision of banking capital has gone far enough, for the
time, at least.
2. It is argued that, whether or not the establishment of branches
should be permitted to institutions of large capitalization, this
innovation is not what we now need, but that the next step to be
taken is rather the coordination of the parts of the existing banking mechanism.
3. Stress is being laid upon the need for some central bank which
should consolidate the credit institutions of the country, and which,
according to some, should take over certain Treasury functions or
be entrusted with certain new functions, such as the exclusive
right to issue notes based on commercial assets.

The discussion regarding centralization encompassed a
number of ideas, but it was pointed out by Dr. Willis that
"in order to attain centralization in banking in the United
States it is necessary to introduce into our banking system
such changes as will result in satisfying two requirements,
concentration of reserves and concentration of control; and
that any changes which secure that result will ipso facto
introduce a centralized system of banking." 6
In the period between 1900 and the panic of 1907 a number of proposals for banking reform were offered. Some of
these were then or a little later introduced in Congress but
the reaction to them all was that they were premature or
unconvincing. The panic of 1907, however, was a powerful
impetus to the talk of revising our banking system. The
result was the passage of the Aldrich-Vreeland Act of
June 30, 1908.7 This Act provided for the issuance of a
6
H. Parker Willis, "The Demand for Centralized Banking," Sound Currency, Vol. IX, No. 1, March, 1902, pp. 1 and 2.
7
* Ibid., p. 6.
See J. Laurence Laughlin, Banking Progress, chapter IV.

22 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

temporary emergency currency8 and for the appointment of
the National Monetary Commission consisting of sixteen
members of both houses of Congress. The Commission was
charged to carry on an investigation of banking systems
and make a report to Congress with a view to the ultimate
adoption of a permanent reform measure. It made an extensive investigation of the regulations, principles, and practices offinancialinstitutions in the more important countries.
The results of its research were published in a series of many
volumes, which included the individual work of several
experts in their fields. The consequence was an equipment
of technical material of service in formulating a banking
system adapted to American conditions.9
The Aldrich Plan and the National Citizens League
Following the panic of 1907 there was more widespread
discussion of the questions at issue. The Secretary of the
Treasury, Leslie M. Shaw, said: "Financial panics in this
country have caused more mental and physical suffering
than all the plagues known to man/' 1 0 The country became
aroused to the need of reform. Many organizations, such as
scientific societies, forum clubs, chambers of commerce,
produce exchanges, merchants and bankers associations,
gave more or less attention to the subject.11 The National
Monetary Commission headed by Senator Aldrich was
scheduled to present its report "early in 1911 following the
congressional elections in the fall of 1910/' 12 But owing to
8
For details see the following: Report of the Comptroller of the Currency,
Dec. 6, 1915, pp. 44-45, 94r~101; J. Laurence Laughlin, Banking Progress,
chapter IV; H. J. Dodge, "The Aldrich-Vreeland Emergency Currency,"
The Annals of the Academy of Political and Social Science, January, 1922,
p. 49.
9
Report of the National Monetary Commission, Jan. 8,1912, Senate Document 243, 62nd Congress, 2nd Session. For details concerning the work of
the National Monetary Commission, see N. A. Weston, "The Studies of the
National Monetary Commission," The Annals of the American Academy of
Political and Social Science, January, 1922, p. 17.
10
Annual Report of the Secretary of the Treasury, Dec. 3, 1908.
11
Regarding the details of efforts at reform see Willis, The Federal Reserve,
chapters II and III; Willis, The Federal Reserve System, chapters I-VII;
Willis, "The Banking Question in Congress," The Journal of Political Economy, Vol. 20, November, 1912, pp. 869-885.
12
Congressional Record, Sept. 12,1913, p. 4824.

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM 23

the reverses suffered in the House of Representatives in the
1910 elections by the administration in power, Senator
Aldrich's report was delayed.13 The reason for the delay was
apparently not generally understood in Congress inasmuch
as there was considerable impatience and the Commission
was accused "of withholding its report for the purpose of
continuing salaries." i4 The report was postponed because it
was considered an inopportune time to present it since the
administration faced an unfriendly public and time was
needed to make a canvass of the new House of Representatives and "provide for their special advisement in financial
matters."
Rather than make the Monetary Commission report
public, it was decided to carry on first an "educational
campaign" among the people. For this purpose it was
determined to launch a new organization to undertake the
task of preparing the public for a ready acceptance of the
Aldrich bill for a central bank. In order that the impetus
of this campaign might appear to come spontaneously from
the business men of the country, the National Board of
Trade met in Washington, D. C, in January, 1911, to consider "currency reform." 15 Senator Aldrich reported the
first draft of his bill, intended for the National Monetary
Commission, to the Board of Trade, copies of it being already
in the hands of the delegates the day preceding the conference. On January 18, 1911, the Board of Trade authorized
the chairman "to appoint a committee to organize a 'Business Men's Monetary League' with headquarters in Chicago
and branches throughout the country, to conduct a comprehensive campaign of education in behalf of some kind of a
national reserve association." 16 In order to overcome prejudice against the efforts of the League, the backers of the
Aldrich plan decided that its headquarters should not be
located in New York City, and selected Chicago.17 This was
"Idem.
Idem.
16
J. Laurence Laughlin, The Federal Reserve Act: Its Origin and Problems,
p. 59; Congressional Record, Sept. 12, 1913, p. 4825.
16
Laughlin, Editor, Banking Reform, p. 419.
17
Laughlin, The Federal Reserve Act: Its Origin and Problems, p. 59.
u

24 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

considered by the chairman of the executive committee of
the League, Professor J. Laurence Laughlin, "good strategy." 18 They promised to give the Chicago organization
financial support if it undertook the task.19 Accordingly the
committee was appointed, met in Chicago on April 26, 1911,
and got the Chicago Association of Commerce to appoint a
group of men to organize the League.20 The organization
effected had a lengthy and imposing title and an extensive
program. It was called "The National Citizens League for
the Promotion of a Sound Banking System." The certificate
of incorporation which was granted June 6, 1911, reads,
"The object for which it is formed is to give organized
expression to the growing public sentiment in favor of, and
to carry on a campaign of education for, an improved banking system for the United States of America." 21 A nationwide campaign was conducted by the League from its
headquarters in Chicago designed to inform the public concerning the issues of banking with a view to securing favorable action by Congress.22
Senator Aldrich submitted his plan for a central bank,
which he termed a "plan for monetary reform," to the
Monetary Commission in January, 1911.23 Finally, after a
year's postponement and after being revised somewhat, it
was introduced in Congress on January 8, 1912, together
with the report of the Commission.24 It was called a bill
"to incorporate the National Reserve Association of the
United States " in order to avoid the idea that the institution
which it sought to establish was a central bank. The bill
was not favorably received and was not even reported out of
committee* Though the bill as such was not debated in
Congress there continued an energetic campaign for its
18

Idem.
»Idem.
20
Laughlin, Editor, Banking Reform, pp. 419-420.
21
" T h e Origin of t h e League," published b y t h e National Citizens League.
22
See A. D . Welton, " T h e Educational Campaign for Banking Reform,"
T h e Annals of the American Academy of Political and Social Science, January,
1922, p . 29; Laughlin, T h e Federal Reserve Act: I t s Origin a n d Problems,

PartL
23
24

Senate Document 784, 61st Congress, 3rd Session.
Senate Document 243, 62nd Congress, 2nd Session.

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM

adoption especially by New York bankers and the American
Bankers Association. The New York bankers, working with
the American Bankers Association, used the National
Citizens League as a vehicle for the promotion of the acceptance of their ideas among the country bankers and people
generally.25 An illustration of the cooperation between the
League and the New York bankers who were backing the
Aldrich plan of a central bank is furnished by the following
letter.26 This letter was sent out by the Chase National Bank
to its correspondents in the interior in the early part of
1912.
The Chase National Bank,
New York, February 21, 1912.
GENTLEMEN:

We enclose a letter from the National Citizens League, which
we have been asked to forward to you. The campaign of education which the League is conducting in favor of currency and banking reform is non-partisan in character and national in scope.
We believe it of direct importance to the business interests of the
country. The merchants interested in the work have felt that
while they regard themselves as responsible for the raising of
funds for the prosecution of the work, the country at large should
know that the banking interest is in sympathy with the work.
Any correspondence should be taken up with Mr. Isidor Straus,
treasurer, Broadway and Thirty-fourth Street, New York, and
any contributions made direct to him.
Yours sincerely,
A. H. WIGGIN, President

The League did not put forward a legislative proposal of
its own but it regarded the Aldrich bill favorably. It approved of its principles 27 and carried on an intensive effort
for their adoption. Indeed, it was understood at the time of
the annual convention of the American Bankers Association
25

The Commercial and Financial Chronicle, Bankers Convention Section,
Dec. 2, 1911, p. 109; Report of the Currency Commission of the American
Bankers Association, submitted to the American Bankers Convention at
Detroit, Sept. 10-13,1912, published in The Commercial and Financial Chronicle, Bankers Convention Section, Sept. 21, 1912; Congressional Record,
Sept. 12, 1913, p. 4824.
26
Congressional Record, Sept. 12, 1913, p. 4824. In connection with the
content of this letter, see the material in this chapter to which footnote 15 is
a reference.
27
Congressional Record, Sept. 12, 1913, p. 4824.

26 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

in November, 1911, that the convention vote for the Aldrich
bill was to be followed by an aggressive "campaign of education" under the auspices of the National Citizens League.28
The Passage of the Federal Reserve Act
In the meantime the political complexion of Congress
changed from Republican to Democratic. The banking
question was a vital issue 29 in the presidential campaign of
1912 which resulted in the election of Woodrow Wilson, the
candidate of the Democratic party. Wilson became President
March 4, 1913. He desired an immediate change in the
banking laws and set about to secure it. On June 23, 1913,
President Wilson delivered a special message on banking
reform to Congress in which he said:
We must act now, at whatever sacrifice to ourselves. It is a
duty which the circumstances forbid us to postpone. I should
be recreant to my deepest convictions of public obligation did I
not press it upon you with solemn and urgent insistence. And the
control of the system of banking and of issue which new laws are
to set up must be public, not private; must be vested in the Government itself, so that the banks may be the instruments, not the
masters, of business and of individual 30enterprise and initiative.
I have come to you to urge action now.
On June 26, 1913, Carter Glass, chairman of the Committee on Banking and Currency of the House, introduced a
bill, which had been in process of preparation by that Committee for some time, beginning in March, 1912. There
developed a conflict between those who favored the Aldrich
bill and those who favored the Glass bill.31 The Executive
28
The Commercial and Financial Chronicle, Bankers Convention Section,
Dec. 2, 1911, p. 109.
29
President William Howard Taft, the candidate of the Republican party,
in referring to the importance of banking reform declared: " I t is more important than the tariff, more important than conservation, more important than
the question of trusts and more important than any political legislation that
has been presented." Quoted in the Congressional Record, Sept. 10, 1913,
p. 4643.
30
The Commercial and Financial Chronicle, June 28, 1913, pp. 1806-1807.
31
For details concerning the legislative history of the Act, see Willis, "The
Federal Reserve Act in Congress," The Annals of the American Academy of
Political and Social Science, Vol. XCIX, January, 1922, p. 36; Willis, The
Federal Reserve System, chapters VII-XXIL

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM

Committee of the American Bankers Association had
approved the Aldrich bill, May 2, 1911. The American
Bankers Association at its annual meeting in New Orleans,
in November, 1911, voted unanimous approval of the
Aldrich plan in all its details.32 The bankers continued to
support that plan and when the Glass bill was proposed
they and those congressmen who went along with them
waged determined opposition to the enactment of the
Federal Reserve Act and a bitter fight ensued.
The Federal Reserve Act was opposed not only by bankers
but by various business organizations largely dominated by
the larger banking interests and by some writers on economic
and financial questions.33 The National Citizens League
which before had favored the Aldrich plan now came out
openly in condemnation of the Owen-Glass bill.34 In so far
as the real origin of the National Citizens League was found
in the purposes of the backers of the Aldrich plan to obtain
ultimate passage of the Aldrich bill, those backers failed to
achieve their purposes. The League did, however, render
very considerable service in providing the people with
technical material concerning the defects of the national
banking system and by informing them about banking and
currency problems of the day. It was the most ambitious
effort to mold public opinion made during the banking reform
period.
The fight for the Aldrich plan was not successful. This
plan 35 provided for a central bank called the National
Reserve Association of the United States with a head office
in Washington, D. C, and fifteen branches located in
financial centers. The charter was to run for fifty years.
Stock in the central bank was to be held by the banks. Control was vested in the banks and primarily in the larger
81
The Commercial and Financial Chronicle, Bankers Convention Section,
Dec. 2, 1911, pp. 109, 194; Sept. 21, 1912, p. 108.
83
Journals, magazines, and newspapers of the period are filled with opposition to the Act. Consult also The Commercial and Financial Chronicle,
Bankers Convention Section, Sept. 21, 1912, p. 148; Willis, The Federal Reserve System, chapters XIV-XVIIL
3
* The Financial Age, July 12, 1913, p. 53.
88
Senate Document, No. 243, 62nd Congress, 2nd Session, p. 43.

28 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

ones because voting rights were to be in proportion to the
capital stock owned by the banks. State banks as well as
national could purchase stock. It retained the reserve
requirements of the national banking system.
The National Monetary Commission or Aldrich plan was
rejected because it was generally believed that it meant too
great a centralization of power in the hands of the " financial
interests" of Wall Street. The feeling of the public was that
banking is so vitally connected with the welfare of all classes
in the country that it was unreasonable and unsafe to allow
a banking system to be controlled so largely by one class—
the bankers.36 It was felt that the banks handle other people's money and control the credit necessary for the success
of the business and agricultural classes and that the Aldrich
plan did not allow other interested parties and especially
the Government an adequate share in the management of the
system. Simultaneously with the Glass committee working
on the new bank act was the Pujo committee carrying on
the "Money Trust Investigation." A highly centralized
organization and control of financial power was brought to
light in this investigation.37 The fact that interests identified
with the so-called "Money Trust" were favorable to the
Aldrich plan and that these same interests were to be the
chief powers in the proposed organization, caused people to
be suspicious of the ulterior purposes of its backers and
fearful of the power of exploitation which they believed
would be handed over to this group if the Aldrich plan were
adopted.
The results of the "Money Trust" investigation accentuated the aversion to this type of central bank. Another
objection to the Aldrich bill was that, though the plan provided for branches in various cities of the country, it was
36
George 3VL Reynolds, president of the Continental and Commercial National Bank of Chicago at the time, said: " I believe the money power now
lies in the hands of a dozen men; and I plead guilty to being one, in the last
analysis, of those men." Hearings in the Money Trust Investigation, p. 1657.
37
Report of the committee appointed pursuant to House Resolutions 429
and 504 to investigate the Concentration of Control of Money and Credit,
submitted by Mr. Pujo, Feb. 28, 1913, House Report No. 1593, 62nd Congress, 3rd Session.

ESTABLISHMENT OF THE FEDERAL EESERVE SYSTEM 29

believed that they would not be sufficiently autonomous to
meet the needs of the diverse economic conditions in the
various regions, adopt a policy in the interests of each district, and serve the people effectively. Being merely branches
it was felt that they would be dominated by the central
bank which would mean the "financial interests" in New
York.38 Furthermore, it did not remedy the series of evils
involved in the reserve city deposit system. In short the
Aldrich central bank plan was patterned too much after the
European central banks and was defeated because it was not
adapted to American conditions, geographical and economic,
and was contrary to the American tradition of local autonomy and of opposition to centralized financial power in
private hands which had persisted from the days of the
Second Bank of the United States.
The bill which Carter Glass introduced on June 26, 1913
ran the gamut of conference and revision. With some few
modifications introduced by the Senate Committee headed
by Senator Owen, it was known as the Owen-Glass bill.
On December 23, 1913, the Federal Reserve Act was signed
by President Wilson and became the law.39 The Federal
Reserve Act differed from the Aldrich bill in several important particulars.
How the Federal Reserve Act Differed from the Aldrich Bill
1. The Aldrich bill provided for one central bank for the
whole United States with fifteen branches, all the gold
reserves of which would be in one place. The Federal Reserve
Act authorized a central banking system consisting in part of
several regional central or reserve banks, each with its own
gold reserve located in its own bank. It provided for branches
of each Federal Reserve bank.
2. The Aldrich bill provided for a uniform discount rate
the country over, opposing any differences as between
88
E. W. Kemmerer, "Banking Reform in the United States," American
Economic Review Supplement, Vol. Ill, March, 1913; E. W. Goodhue, ibid.,
p. 79; Speech of Senator Owen in United States Senate, Congressional Record,
Nov. 24, 1913, p. 5993; Willis, The Federal Reserve, pp. 82-83; Willis, The
Federal Reserve System, pp. 83-85.
39
Public Act, No. 43, 63rd Congress.

30 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

various sections. The Federal Reserve Act provided for
regional banks sufficiently autonomous so that they could
adjust themselves to the diverse economic conditions in
various sections of the country and adopt a policy in the
interests of each district, such as, for example, the important
policy regarding discount rates.
3. The Aldrich plan retained the old system of pyramided
reserves and proposed to leave undisturbed the great concentration of bank balances in New York. It made no provision
for centralization of legal reserves of members of the association. The Federal Reserve plan provided for centralized
legal reserves in the regional banks.
4. The Aldrich bill provided a plan whereby upon redissounting a member bank would receive the central bank
'egal tender notes which it could count as a part of its own
reserve. That plan would tend to prevent the contraction of
the notes and promote inflation by making them the basis
for the manufacture of bank credit. On the other hand, the
Federal Reserve Act provided that Federal Reserve notes
could not be counted as a part of the legal reserves of member
banks. Thus, under this Act, Federal Reserve notes could
not be made the basis for the creation of bank credit by
member banks and the contraction of the notes would be
facilitated. Whereas that provision of the Aldrich bill involved an expansion of the note issue, the Federal Reserve
Act provided for an elastic note issue.
5. Membership in the National Reserve Association was
made voluntary while the Federal Reserve Act required
national banks to be members of the Federal Reserve system
or forfeit their charters.
6. The Aldrich bill did not make specific provision for
remedying the old clearing and collection evils. The Federal
Reserve Act provided for eliminating such evils and requiring uniform and moderate exchange charges.
7. The Aldrich bill would have set up a reserve of the
central bank which would have been inactive since it was
not to be the basis for the regular clearing and collection of
items drawn against the banks. The Federal Reserve Act
on the other hand provided that the reserves of the Federal

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM 31

Reserve banks and the reserve deposits of member banks
in the Federal Reserve banks be active, that is, funds would
flow in and out of the Federal Reserve banks as a result
of the receipt and collection of claims upon other banks.
8. The central bank under the Aldrich bill was designed
to function as a bank for emergency relief to the members of
the association. In this respect, also, its reserve was to be
inactive. Credit was a kind of passive affair to be advanced
primarily to prevent a panic or to "help out" a hard pressed
bank. In the case of the Federal Reserve, while all emergency
requirements of the commercial banks were to be met, the
view of a central banking organization functioning actively
as a credit control institution in order to stabilize conditions
in the money market, to lessen the causes of the troubles
which had confronted the American banking system and to
prevent the emergencies from arising, was embodied in the
Federal Reserve Act. Moreover, credit was to be expanded
or contracted with a view to influencing general financial
conditions, or the superstructure of credit. There were
several provisions of the Federal Reserve Act designed to
facilitate these ends, the chief of which were the rediscounting clauses and those authorizing the broad open market
powers of the Federal Reserve banks including the purchase
of two-name commercial paper directly from the business
concerns.
9. Finally, in addition to all of these differences of principle and organization, there is the marked difference in the
controlling authority. The Aldrich bill would have set up a
central bank controlled by the bankers, exercising in turn
control over the credit its branches would receive. On the
contrary under the Federal Reserve Act there was established a central banking system with a Federal Reserve
Board composed entirely of United States Government
representatives as the central authority. It also provided
for substantial government representation on the boards of
directors of the Federal Reserve banks. Moreover, these
regional banks had immediate control of their own credit
policy but ultimate power and control over all of them was
vested in the government Federal Reserve Board.

32 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The differences indicate that in these fundamental provisions the Aldrich bill was the very antithesis of the Federal
Reserve Act.
The Federal Reserve Act and Central Banking
The Federal Reserve Act was the climax of a quartercentury of educational effort for the reformation of the banking system which began during the depression in 1893. The
framers of the Act deduced from American experience
principles and practices which were calculated to be useful
in removing the defects of the national banking system.
These, together with those of European countries, they
welded into a coherent whole in such a way as tofitAmerican
conditions and meet the requirements of the American
people. The general demand for an elastic currency, which
furnished the inception for the banking reform movement,
was met essentially by the requirements that legal reserves
be centralized, that they consist of deposit credit on the
books of regional Reserve banks, and that they be mobile.
In addition to furnishing elasticity to bank credit, these
requirements were also formulated to protect solvent banks
against runs on the part of depositors. The combining of
reserves was not an end in itself but a means to ends. The
idea of a central reserve is found in early American experience. It may be traced back to the New England Bank of
Boston 40 and then through the Suffolk banking system,41
wherein each member bank kept a reserve on deposit with
the Suffolk Bank in Boston for the purpose of redeeming its
bank notes at par.
Thereafter we find the reserve plan developing in the socalled correspondent banking system as it spread out over
the country, which, with the enactment of the National
Bank Act, was carried over in the national banking system.
Finally, the reserve principle was utilized for emergency
purposes by the local or district clearing house associations.42 But with the establishment of the Federal Reserve
40

Knox, A History of Banking in the United States, p. 365.
Ibid., pp. 365-368.
42
See chapter I, footnote 24, regarding the issue of clearing house certificates.
41

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM 33

system the principle of combining reserves to achieve certain
ends attained further development in our national economy.
Instead of being a temporary arrangement it was incorporated as a continuing factor in our banking organization;
and instead of serving a more or less local area, it was applied
to the whole United States. So far as the regional organization and centralization of legal reserves in several centers are
concerned, the framers of the Federal Reserve Act made an
ingenious adaptation to the banking sphere of a fundamental
aspect of the American constitutional system—a combination of local self-government and federal authority. Though,
of course, they did so for reasons pertinent to existing financial conditions and banking principles.
President Wilson played an effective part in the Reserve
Act 43 and credit to him for this banking reform measure
may be based on three counts:
1. His indomitable purpose to give the nation a new banking system and his demand for immediate legislation.
2. His political leadership, along with his understanding
and support of the Federal Reserve Act, which reconciled the
differences among various factions and secured the united
support of his party for the Act.
3. His requirement and unequivocal stand in the face of
determined opposition that the controlling authority of the
Federal Reserve system be entirely governmental, without
private representation.
43
Carter Glass, Introductory Statement of, in Willis, The Federal Reserve
System, p. ix.
At the conclusion of the signing of the Federal Reserve Act, President Wilson
said: "All great measures under our system of government are of necessity
party measures for the party of the majority is responsible for their origination
and passage, but this cannot be called a partisan measure." The Commercial
and Financial Chronicle, Dec. 27, 1913, p. 1866.
Charles S. Hamlin, the first governor of the Federal Reserve Board, in an
address before the New York Chamber of Commerce in 1914, referring to the
Federal Reserve Act, said: "Its underlying principles were not invented or
newly created, but are the result of years of discussion and study. I can say
this with confidence, however, that no selfish interests assisted at its birth.
I can further state that beyond those primarily responsible for its provisions . . . there looms up one figure more entitled to the credit for its provisions than any of the others, the President of the United States, Woodrow
Wilson." The Commercial and Financial Chronicle, Dec. 5, 1914, p. 1634.

34 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The purposes of the framers of the Federal Reserve Act
were several. Consideration will be given to these purposes
in succeeding chapters. According to the title of the Act,
their purposes were "to provide for the establishment of
Federal Reserve banks, to furnish an elastic currency, to
afford means of rediscounting commercial paper, to establish
a more effective supervision of banking in the United States,
and for other purposes." 44 The Federal Reserve Act was
designed to remove the defects of the national banking system from our economic life. As a constructive measure it
was designed to establish an institution to carry on the
functions of central banking. The institution which it set
up was not a central bank but it was a central banking system.
A Central Banking System
The central banking system established in 1914 consisted
of thirteen parts, the Federal Reserve Board and twelve
Federal Reserve or district central banks. There was also
authorized and set up a Federal Advisory Council as an
adjunct to the system. The Federal Advisory Council is an
organization composed of one representative from each
Federal Reserve district, elected by the board of directors
of the respective Reserve banks, and meets with the Federal
Reserve Board four times a year. It was designed to enable
the banking interests to give organized expression of their
views to the Federal Reserve Board, to call for information
about Federal Reserve problems, and make recommendations thereon. The Federal Reserve Board consists of eight45
members, including the Secretary of the Treasury and the
Comptroller of the Currency as ex-officio members, and six
appointed by the President of the United States. It is a
central board of directors of the banking system, not an
operating bank. The banking functions are exercised by the
Federal Reserve banks. Over these banks the central board
has had powers of examination and supervision, the veto
44

Public Act, No. 43, 63rd Congress, Dec. 23, 1913.
The Federal Reserve Act as amended June 3, 1922. The original Act
provided for seven members.
45

ESTABLISHMENT OF THE FEDERAL RESERVE SYSTEM 35

power over some of their important functions, and extensive
authority over their expenses and personnel.
From this point of view the Reserve banks are the head
banking offices of the Federal Board. While each Reserve
bank was to carry on actual banking operations and have a
certain control over affairs in its own district, the Federal
Board was to provide central coordination and management
so far as concerns the common interests of the Reserve banks
and monetary and banking policies national or international
in scope and influence. Thus the Act provided for governmental control over the commercial banking system of the
United States. Hence centralization of control was intended
and provided by means of the Federal Reserve Board.
The Act was intended to bring about a certain decentralization of banking resources so far as the nation was concerned; but to centralize legal reserves so far as each district
was concerned and to provide for the inter-district mobility
of them through centralized government control in the
Federal Reserve Board. Thus centralization of reserves was
introduced into our banking organization*
There is unity of reserves in each Federal Reserve district.
There is also unity of reserves in the nation, the Act providing that the Federal Reserve Board may require one Federal
Reserve bank to rediscount the paper held by another. The
Federal Reserve system may properly be called a central
banking system in that (1) the reserves are centralized in
each district and the Federal Reserve Board is a central
board coordinating and supervising the work of the Reserve
banks even to the extent of making the reserves of one
Federal Reserve district available for use in any and all other
districts; (2) so far as concerns policies affecting general economic conditions, national interests, or affairs of international scope are concerned, the Federal Reserve Board was
established as the central authority of control; and (3) the
system's policies are to be determined with a view to attaining various public ends rather than making profits.
From the point of view of the national economy the Act
did not provide for a single central bank. It provided for a
chain of Reserve banks each of which in conjunction with the

36 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Federal Reserve Board is the central bank of its district.
The intention of the framers of the Act was to make each
Reserve bank in the chain independent of the others and to
preclude the existence of any outstanding Reserve bank
which would overshadow the Federal Reserve system.
Though each district central bank in the chain was to be
independent of the authority of every other one, each bank
was to be under the authority of the Federal Reserve Board.
The Federal Reserve Board was made not only the higher
authority over each Reserve bank but a central controlling
authority of the Federal Reserve system.46
46
The passage of the Federal Reserve Act was the occasion for widespread
comment at the time both at home and abroad. Probably no banking act in
the history of this or any other country ever evoked such praise or condemnation or such international interest as the Federal Reserve Act. Examples of
such are these:
Doctor Richard Hauser, of the Deutsche Bank of Berlin, issued a statement
in which he said: "The American Act is one of the greatest undertakings that
has ever been attempted in the realm of banking, surpassing the English reform of Sir Robert Peel in 1844. . . . In no instance has such an aggregation
of capital had opened to it such new forms of opportunity. . . . It will depend
entirely upon whether the united regional banks, acting as a reserve power,
will be able to make adequate use of the unusual powers committed to them,
and also whether responsible men of integrity and efficiency are selected for
the management." Quoted by R. H. Treman, president of the New York
State Bankers Association, at New London, Conn., June 11, 1914. The Financial Age, June 19, 1914, p. 1040.
A prominent economist stated: "Next to the Declaration of Independence
and the Constitution of the United States, the Federal Reserve Banking Act
may prove to be the most important measure ever placed before the people
of the United States because upon its wise administration depends the good
or ill of one hundred million people in the material affairs." Quoted by R. H.
Treman, idem.

CHAPTER III
THE PROBLEM OF DISTRICTING AND THE
LOCATION OF FEDERAL RESERVE BANKS
The Reserve Bank Organization Committee
To effect the establishment of the new banking organization, the Federal Reserve Act provided for a committee to be
known as "The Reserve Bank Organization Committee,"
consisting of the Secretary of the Treasury, the Secretary of
Agriculture, and the Comptroller of the Currency. The
first problems which confronted this committee were those of
districting and the location of the Reserve banks. The
problem of districting was a new one in central banking.
European governments had no such problem and for two
reasons. Their central banks had evolved gradually from
commercial banks over a period of decades. Also, the size of
European states was so small that one central bank was
considered sufficient for their respective territories.
While the Federal Reserve Act was under discussion in
Congress, no provision was morefiercelyfought than the one
calling for a division of the United States into districts,
each with a Reserve bank of its own. This proposal was the
object of scorn and ridicule and it was pronounced " impossible.'/ The basis of the opposition was the anxiety of the
New York bankers who desired not to disturb the old
correspondent banking relationships and not to lessen the
concentration of funds in New York City. Also some of the
New York banks had ambitions to become central banks
themselves.1
The problem before the Organization Committee was one
of drawing the district lines in such a way that each Reserve
bank could carry on central banking functions. The Federal
Reserve Act directed this committee to "designate not less
1

Willis, The Federal Reserve System, p. 562. See chapter VII, pp. 136-137.
37

38 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

than eight nor more than twelve cities to be known as
Federal Reserve cities/' and to " divide the continental
United States, excluding Alaska, into districts, each district
to contain only one of such Federal Reserve cities.'7 The
districts were to be drawn "with due regard to the convenience and customary course of business" and their boundaries
were not required to be "coterminous with any state or
states." Pursuant to authority conferred in the Act, the
Organization Committee set to work immediately after the
passage of the Act. It secured the services of experts and
inaugurated a nation-wide survey preparatory to its determination of Reserve bank cities and district lines.
It was announced that hearings would be held in strategic
centers. A number of cities were anxious to be designated as
the headquarters of a Reserve bank and the Committee
sought to afford applicant cities every reasonable opportunity to furnish evidence to support their claims as locations
for Federal Reserve banks. New York was decided upon as
the city in which to commence the hearings. A member of
the Treasury department went in advance and made all
arrangements for the hearings such as securing the quarters
and scheduling the hour of appearance of the witnesses in
order to avoid congestion and conserve the time and interests
of those who wished to testify. Special invitations to appear
were extended to a representative list of persons, including
members of the clearing house, bankers of New York, Jersey
City, Newark, and various up-state cities and towns, and
representatives of commercial organizations. In addition the
Committee announced that it would listen to any other
banker or business man who wished to appear before the
Committee and make a statement.2 The hearings in New
York covered a period of three days, January 5, 6, 7, 1914.
There were present at all meetings, Secretaries McAdoo
and Houston who comprised a majority of the Reserve
Bank Organization Committee, and they were assisted by
Milton C. Elliot of the Treasury department, and Martin
Vogel, Assistant Treasurer of the United States, representing
the Government.
2

The New York Times, Jan. 2, 1914, p. 24.

DISTRICTING AND LOCATION OF THE RESERVE BANKS 39

The Size of the New York District

The Organization Committee set forth two questions, to
which the hearings 3 were to be addressed. These questions
were:
1. Should a Reserve bank be organized in New York, and
if so, why?
2. If a Reserve bank is organized in New York, what territory should such a bank serve?
In answer to the first question some concise facts were
given as follows:
"New York is by far the most important manufacturing city
in America, the value of its annual output being more than two
billion dollars, or one tenth of the product of the entire United
States in 1900.
"It has twenty-one separate industries the yearly output of
each of which is more than twenty million dollars.
"It has over 25,000 separate factories, employing over 700,000
operatives.
"One fourth of the population of the United States is located
within a radius of two hundred miles of this city.
"About 2 7 ^ % of the export and import business of the entire
United States is carried on through this port andfinancedby this
city.
"While 27J^% actually passes through the port of New York,
there is probably over 70% actually financed here. There is a
great deal of cotton movement in the South, and a great deal of
the business done through Baltimore, Boston, Philadelphia, and
other nearby ports that is practically financed through New York.
"About 60% of the bank clearings of the entire United States
are credited to New York banks.
"The mere statement of these figures, showing the extent of
New York's manufacturing, distributing, and export trade, shows
conclusively why a regional bank should be established here."
The Organization Committee was not disposed to question
these facts nor argue with any of the witnesses about the
claims of New York for a Reserve bank. It was recognized
3
Nearly all material in this chapter concerned with the hearings was secured
from the Stenographic Minutes of the hearings before the Reserve Bank Organization Committee. Use was also made of Senate Document 485, 63rd Congress, 2nd Session, 1914—Letter from the Reserve Bank Organization Committee transmitting the briefs and arguments presented to the Organization
Committee of the Federal Reserve Board relative to the location of Reserve
districts in the United States.

40 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

that New York was the largest manufacturing center, the
largest export and import center, and the financial center
of the country. In fact the hearings were conducted largely
upon the assumption that a Reserve bank would be located
in New York and the whole discussion revolved around the
question: How large an area should be attached to the New
York Bank? As to this question there was considerable
difference of opinion. The following proposals indicate the
range and diversity of opinion among the witnesses as to the
scope of the district attached to New York:
1. All territory north of the Potomac including all of Pennsylvania.
2. New York, New England, New Jersey, Delaware, and
Pennsylvania.
3. New York, New Jersey, New England, and Pennsylvania.
4. New York, New England, and northern New Jersey.
5. New York and all of New England.
6. The Metropolitan area of New York City, including Manhattan Island, Long Island, Westchester County in New York,
and in New Jersey, Bergen County contiguous to the Hudson
River, and Hudson and Essex Counties contiguous to New York
Bay.

In addition to these proposals there were some which did
not set forth definite boundary lines. One witness advocated
what he called the shoe-string plan. This plan involved a
division of the country into strips with a view to securing a
diversity of economic interests in each strip. He said that
the strips should run north and south for in this way they
would include the cotton states as well as the business
interests of the North. This witness also thought that it
was of no great importance how large an area was attached
to New York, because, "so far as diversity of interest is
concerned, New York is the United States in a variety of
aspects." 4 One enthusiast for equalizing the power of the
Reserve banks went so far as to propose that there should
be no Reserve bank located in New York but that Reserve
banks should be located in Boston and Philadelphia and the
4
Frank A. Vanderlip, president of the National City Bank of New York,
The New York Times, Jan. 6, 1914, p. 19.

DISTRICTING AND LOCATION OF THE RESERVE BANKS

dividing line between these two districts should be along
Broad Street of New York City.5 Another proposal of
similar type was that a Reserve bank be located in the
Wall Street district but its territory should be restricted to
that area south of about 14th Street. That part of Manhattan Island north of this together with some adjacent
territory should be allocated to a separate Reserve bank.
As is evident from the list of proposals, the area witnesses
thought the New York district should include ranged from
the very large, all the northeastern states, to the very small,
the metropolitan area of New York City, and even merely the
Wall Street district. Most of the discussion centered around
the question of whether the northeastern states should be
included in the territory assigned to the New York Bank or
whether other banks should be located at Philadelphia and
Boston, or either city. This was an important question
because upon it depended the size and power of the New
York Reserve Bank. This was so because of the way in which
the capital of the Reserve banks was to be obtained.
The Act provided that national banks shall subscribe to
the capital an amount equal to 6 per cent of their capital and
surplus, one-half of which or 3 per cent was to be paid within
a few months after the organization of the Reserve banks
and the other half upon the call of the Federal Reserve
Board. A few witnesses believed that a bank should be
located at Boston to serve all or most of New England, while
one thought that no harm would be done to New York if a
bank were established in Boston, yet he stated that Boston
would be better off as a part of the New York zone. A member of a commercial paper firm supported Boston. He
believed it made no difference to New York how small a
territory was attached to it. He said in effect that Boston is
the center of a manufacturing area and has a class of commercial paper peculiar to it. They understand it better than
anyone else. Ever since the Suffolk banking system was
established they have had very intimate relations with a
large number of banks in New England.
In opposition to the establishment of a Reserve bank in
5

The New York Times, Jan. 6, 1914, p. 19.

42 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Boston, a large bank advocate stated that the question of
knowing financial paper was not material because a branch
bank in Boston could be in touch with local conditions and
could learn the credit standings. The witness who suggested
that the district should include only the metropolitan area
of New York City believed that the territory attached to the
New York Bank should be concentrated as much as possible.
He advanced an individual reason for his opinion. He said
that if the capitalization of the New York Reserve Bank
were originally made unreasonably out of proportion to the
other banks, and under the power conferred by the Act, the
Federal Reserve Board should later decide to change the
districts and reduce the size of the New York Bank, it might
upset the layout and financial poise of the whole Federal
Reserve system. It was even suggested that it was not
necessary to have a Reserve bank in New York but that a
branch bank might be located there.
In the course of the three days' hearings the Organization
Committee listened to forty-eight witnesses. All but a very
few of these testified in favor of a large Reserve bank in
New York and emphasized the need for it. Most of the
witnesses wished to see New England placed in the New York
district. In support of the large bank idea the following
points were advanced:
1. New York has been looked upon as the financial center of
the United States from the beginning of the republic.
2. To create an institution which would command respect abroad.
While the New York Bank would be coordinated with the other
Reserve banks through the Federal Reserve Board, yet Europe
will look to particular Reserve banks for certain purposes, for
example, to the Chicago Reserve Bank in its grain business, the
New Orleans Bank in the cotton business and to the New York
Bank in its exchange and discount transactions.
3. To equip the New York Reserve Bank for dealing with the
clearing house banks. A strong bank is needed in New York to
overshadow the local New York banks in order to be in a position
to loan member banks in time of emergency. Larger banks are
not inclined to go to a small one for business. If the personal ambitions of member banks to overshadow are not curbed by the
power and size and strength of the Reserve banks, many of the
old diseases will be uncured.

DISTRICTING AND LOCATION OF THE RESERVE BANKS 43

4. The New York Bank should compare favorably in size with
the largest national banks in New York City.
5. " There are two banks here now with a $25,000,000 capital
and I wouldn't want to see a smaller Federal Reserve Bank."
6. Acceptances should be created in New York and it is believed
they will not be created in New York unless there is a great bank
in New York City which will give stability and certainty of a
market for all such paper at all times.
7. The New York Bank should be a large bank with at least
40 per cent of the banking resources of the system in order to develop an open discount market in the United States. It is not
thought possible to establish any such market elsewhere at first.
If the New York Bank were very strong, then discount or acceptance houses would become established and we would then have a
market with standardized commercial paper like they have abroad.
Parties would invest in commercial paper because there would be
almost a certainty that it could be sold at any moment.

One of those who urged the inclusion of all territory north
of the Potomac, including all of Pennsylvania, stated that
the capital of the New York Bank on a 3 per cent basis
would amount to $25,575,000. Secretary McAdoo asked if
this would not reduce the other seven or more banks to
puny institutions. Whereupon he was answered: "Better
have one strong bank and seven puny ones than to have
eight puny ones." 6 The president of one of the New York
City banks, in urging that the New York Bank be made a
large one, admitted this would mean that the others would
be small but said that was unavoidable " as the country did
not lend itself into eight districts." In estimating the size
of the New York Bank most of the witnesses rested their
calculations upon a 3 per cent basis as they felt that the
remaining 3 per cent would be called only in an emergency
and probably not in the immediate future. Secretary
McAdoo, however, was inclined to believe that the Federal
Reserve Board would call the second 3 per cent in connection
with the original organization. Secretary McAdoo figured
that on a 6 per cent basis, the aggregate capital of the eight
or more banks would be $106,000,000. If the New York
district took in all the territory which some of the witnesses
urged, the New York Reserve Bank would have 45 per cent
6

Charles A. Conant, Economist, The New York Times, Jan. 6, 1914, p. 19.

44 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

of this capital, leaving only $55,000,000 or $60,000,000 to
be divided between the seven or more other Reserve banks.
New England's Claim for a Reserve Bank of Its Own
Reports of the hearings in New York were received with
apprehension by interested parties in Boston. They had
learned that the emphasis in New York was upon a preponderant bank and in order to have that it would be
desirable to include New England. There was much opposition to this idea in New England so the hearings in Boston
centered around the question of whether Boston should be
attached to New York or have a Reserve bank of its own.
In opening the hearings in Boston, which were held on
January 9 and 10, Secretary McAdoo impressed upon the
witnesses the serious purpose of the committee. He said:
" I think there is an impression that only one bank will be
located in each district. Now that is true so far as the headquarters banks are concerned, but it is not true in another
aspect of the case. These banks are permitted to have
branches, and through that machinery it is expected that
these facilities will be placed at the disposal of all parts of the
district, so that the banks in every part of the respective
districts will be within easy reach either of the headquarters
bank or some one of its branches. Now we quite understand
the local pride which prompts the various cities to enter
into friendly contest for the headquarters of these banks.
At the same time, gentlemen, this is a broad and most
important economic problem. It is not a political problem,
it is an economic problem. This committee is not on a
political expedition. We are not on a junket. We are here
for business and we intend to deal with this proposition in a
strictly business fashion."
Notwithstanding the Secretary's admonition against
raising the question of pride, that factor was in evidence
more than once during the Boston hearings. One witness
said: " I have been a Boston merchant for forty years and
have a pride, a New England pride, a Massachusetts pride,
in Boston as a great financial and commercial center. I put
it in two words, fair play. We think fair play would give us a

DISTRICTING AND LOCATION OF THE RESERVE BANKS

regional bank in Boston, and we resent unfair discrimination." Another said the people of New England desired
their section to be regarded as a separate and homogeneous
unit with a Federal Reserve bank of its own for historical
and sentimental reasons. Nearly all of the witnesses, however, gave some economic reasons for their stand. The idea
advanced in New York of a preponderant bank there was
attacked with much vigor. Several points were made in
opposition to the idea.
As far as creating respect abroad and being able to establish effective relations with the central banks were concerned, it was argued that it is feasible for a small country
to borrow from a large one, but not a large country from a
small one, and that the banking resources of the United
States are greater than those of any European country.
Also, that it is not necessary for the New York Bank to do
any foreign exchange business and if it does not do any it is
immaterial whether the Bank is large or small, because it can
influence gold movements through affecting foreign exchange
rates by changing the discount rate.7 Others argued that the
strength of the system lay in the coordination of the Reserve
banks through the Federal Reserve Board rather than in
the size of any one bank; that it was not necessary to
have the New York Reserve Bank larger than any of its
member banks; and that to make the New York Reserve
Bank a preponderant one would mean a reduction in the
size and scope of operation of some of the others to a point
which would make their portfolio undiversified and reduce
their effectiveness.
The argument that the financial predominance of New
York required a very large bank was parried in various
ways. It was stated that while New York was subject to
financial strain such as the calling of brokers' loans, the
payment of commercial paper, and the withdrawal of bank
balances, after the Federal Reserve system is established,
New York would not be subject to so much strain because
exchange on other cities, for example, Chicago, St. Louis,
and Boston, would be just as good as exchange on New
7

O. M. W. Sprague, Harvard University.

46 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

York; also that commercial paper would not be payable in
New York to such an extent as before, and that call loans
would not be the most liquid assets a bank would hold and
therefore banks would not seek to secure additional funds
by calling brokers' loans.8
There was a strong feeling that Boston was entitled to a
Reserve bank of its own for more positive reasons- Statistics
were introduced to show that whereas New England comprised but 2 per cent of the area of the United States, it had
7 per cent of the population and 14 per cent of the "productive ability," that New England ranked first in savings per
capita, had the lowest discount rates in the country for
short-term maturities, and a regional bank in Boston could
maintain a comparatively low rate of discount, that Boston
was the third city in the United States and the fourth in
bank deposits. It was pointed out that New England was
the center of the cotton, woolen, and boot and shoe industries, producing more than half of the entire output of each
industry in the country. Considerable emphasis was laid
by several witnesses upon the particular character of these
industries and how they were related to the problem.
It was stated that New York does not know anything
about the credit requirements in the leather, shoe, and woolen
industries and very little about the cotton industry; that the
paper of these industries should be handled by people who
have the technical knowledge of these industries and their
related branches and are qualified to pass upon financial
paper arising out of these lines of business, and that if this
paper is handled by a Reserve bank in New York, "it will be
less well known, less wisely handled by them with reference
to the Reserve bank and with reference to the community."
The paper arising out of the operations of these industries
together with that offered in the towns, was purchased by
bankers in New England towns and there grew up a local
discount market in New England. It was argued that bankers in such towns as Salem, Lynn, and Portland did not
know and would not know in the future names appearing on
the acceptances and commercial paper in New York, while
8

Idem.

DISTRICTING AND LOCATION OF THE RESERVE BANKS

the names on the paper in Boston would be local and would
command local capital. In this connection it was also argued
that since familiarity with credit requirements in New England was desirable, that Boston should have a Reserve bank
because six of the nine directors would be chosen by the member banks of the district, whereas, if Boston were made a
branch of New York, the seven directors of the branch would
be chosen by the directors of the New York Reserve Bank.
This question of control was also considered important
from another angle when it was argued that the New York
Bank would be controlled by New York interests; and that
in time of need for currency, New England would want
currency at the same time as New York; but that in case of a
question as to who shall get it, New York will get it and not
New England because New York has control of the Reserve
Bank and not New England and New York is going to protect
New York first. Therefore New England people wished a regional bank of their own in Boston, built up with their own
resources and on which they could depend in case of trouble.
Previous to the establishment of the Federal Reserve system there had developed in several cities of the country a
system of collecting checks on banks in contiguous territory.
Such a system had developed in Boston and it was introduced to give force to the contention that Boston should
have a Reserve bank of its own. Under that system the
Boston Clearing House Association undertook to collect all
checks on banks in New England, giving the time and labor
free. If the bank remitted at par no charge was made, otherwise a charge was made corresponding to the charge made
by the bank. It was argued that this check collection system
covered all New England, bound it together and gave it an
entity that was real and that if a Reserve bank should be
established in Boston all of this practical experience could
be drawn upon, taken over without change, and could be
done better than another regional bank could do it.
The Size of the Boston District
|t The sentiment for a Reserve bank in Boston was very
strong and widespread. Bankers associations, clearing house

48 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

associations, chambers of commerce, real estate, trade, and
labor organizations in New England passed resolutions
petitioning the selection of Boston and presented them to the
Organization Committee. The difference of opinion at the
Boston hearings turned largely upon the question of whether
all of New England should be attached to the Boston Reserve
Bank and if not all, how much should be attached to New
York. A good share of the opinion held that New England
was a unit and should be treated as a unit and that a regional
bank in Boston should have as its territory the whole of
New England and not nine-tenths or any other fraction of it.
Some of the witnesses were inclined to consider the advisability of attaching outlying portions of New England, such as
Vermont and the western half of Massachusetts, to the
New York district.
Some banks in these parts of the country had been maintaining balances in Albany, Philadelphia, and New York
because of the free collection of their checks and it was
suggested in New York that to attach this territory to
New York would be merely maintaining existing banking
relationships. In answer to this it was stated that under the
Federal Reserve system with its par collection that question
is eliminated and it was argued that those banks would
return to Boston where they were originally and to which
they are naturally attached because of quicker service and
returns. That part of New York west of Massachusetts and
north of Albany it was also felt naturally belonged to Boston.
One witness went so far as to urge that not only the entire
area of New England be allocated to a Reserve bank in
Boston but that most of New York State be assigned to
Boston. He advocated dividing New York into two parts
with Wall Street as the dividing line and putting the whole
of New York State north of Wall Street with the Boston
district. Bankers who carried accounts in New York,
Albany, Philadelphia, and Chicago for collection purposes
testified that these were artificial relations and that under
the Federal Reserve system they would prefer to be connected with a regional bank in Boston. They felt that since
domestic collection and exchange charges would be elim-

DISTRICTING AND LOCATION OF THE RESERVE BANKS 49

mated, Boston exchange would be just as good as New York
exchange so no attention needed to be paid to the existing
methods of payments between sections of the country.
There was still more inclination to allow New Haven,
Hartford, and western Connecticut to be allocated to New
York. Hartford as represented by the Hartford Clearing
House and the Business Men's Association preferred to be
in the New York district. It was stated that most of Hartford exchange was in New York banks, only 15 per cent
being in Boston, and that business transactions were largely
carried on with New York. In answer to this it was argued
that if a branch of the Boston Bank were established at
Hartford all the banks in Connecticut would be as well
served if connected with Boston as they would be if connected with New York. On cross examination one witness
admitted that the clearing and collection features of the
Federal Reserve Act would have a very material effect in
relieving the situation so far as exchange is concerned.
Another witness argued that under the new clearing and
collection system, banks in this part of Connecticut would
be as well taken care of by effecting relations with Boston
banks as with New York banks, but if they so desired the
then existing ordinary correspondent relations with the
New York banks would not need to be changed. It would
be only in the matter of rediscounting that they would be
served by the Boston Bank.
A still smaller portion of Connecticut, the New York
suburban zone of western Connecticut, was considered.
The point of view of those who favored a 100 per cent
New England district for the Boston Bank may be represented by the following: "There must be great convenience
in observing state lines as far as possible, and it seems to
me that the inconvenience of western Connecticut is so
little, that it will be so little disturbed by hitching them on
to the regional bank here in Boston, that it had better be
done. It is only a matter of a little inconvenience and a little
sentiment. I do not think it is a matter of moment at all/ 19
In the course of the Boston hearings two of the witnesses
9

William A. Gaston, president of the National Shawmut Bank, Boston.

50 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

introduced plans for the districting which required that the
country be divided upon a basis of geographical lines, the
meridians of longitude and the parallels of latitude. It was
argued that the state boundary lines were political and
hence of an arbitrary nature and not suitable for standardizing statistical, financial, or any other kind of information
which is based upon the laws of science. The lines were to be
chosen at such a distance apart as would result in a division
of the country into about four hundred blocks and then
statistical information pertaining to the problem in hand was
to be secured for each block. The hearings were concluded
after the committee had listened to fifty witnesses.
The Organization Committee's Methods and Principles of Districting
During the week of January 12, 1914, the Reserve Bank
Organization Committee sat in Washington, D. C , to hear
the claims for Philadelphia, Pittsburgh, Baltimore, Wheeling, Richmond, and Washington. The Pittsburgh delegation
desired that Pittsburgh be made a Reserve bank city, but
failing that, they wished to be in a district with New York
as the Reserve bank city rather than Philadelphia. The
Philadelphia delegation urged that a Reserve bank be
located in their city and strongly opposed a great bank in
New York. They were inclined to Secretary McAdoo's view
that foreigners would look to the entire system for evidence
of strength rather than to any one Reserve bank. The hearings on the rival claims of the eastern cities were concluded
in Washington, D. C , on January 16. Following these,
hearings were held in thirteen cities scattered throughout
the country beginning at Chicago and ending at Cleveland.
On this circle tour the Committee had an office on wheels, a
steel railway car especially equipped for the purpose. In it
they lived most of the time and went over testimony and
correspondence received from Washington, D. C, regarding
the districting problem. In the meantime the Committee's
expert had received the testimony and documents and
prepared a scientific analysis of the districting problem.10
"Secretary McAdoo had appointed Dr. Willis to prepare individually a

DISTRICTING AND LOCATION OF THE RESERVE BANKS

He submitted a report to Secretary McAdoo's Committee
in which the following principles were set forth: n
The fundamental principles of a positive nature upon which
the process of districting should be carried out may now be laid
down.
(a) The Act calls for not less than eight nor more than twelve
districts; it leaves the choice of the number within these limits entirely open and to be decided without prejudice.
(b) The plain intent of the framers of the act was to establish
a number of different and independent institutions, each sufficiently
strong to care for itself without the necessity in normal times of
depending upon any other.
(c) The institutions to be created should, therefore, be reasonably similar to one another in size, without attempting to bring
about any artificial similarity, and should be located at such points
as will most nearly convenience the business of the country.
(d) The creation of any one large bank should be avoided,
meaning by large bank, a bank so preponderating in importance
as to make it ipso facto the most conspicuous and by far the
strongest element in the system; while at the same time it should
be sought to avoid the creation of two distinct classes of banks,
one consisting of large, powerful institutions, the other consisting
of smaller and weaker institutions likely to become dependent
upon the neighboring and stronger banks.
(e) While the law requires that a minimum capital of $4,000,000
shall be present in each and every district and while this requirement must be observed, there is no harm in approaching closely
to it or even in going below this limit so far as the banks are concerned, making up the deficiency by private or government subscription, if it be true that within a reasonably near future the
district will probably advance in wealth and capital so as to make
the establishment of such a bank desirable.
(f) Special study should be given both in establishing the districts and in establishing the point in each district where the
headquarters bank is to be situated, to the facilities and speed of
transportation both between such point and those at which other
districting plan. A total of about 5,000 pages of stenographic reports of the
hearings were filed. These together with documents and briefs were examined
by Dr. Willis and an analysis of the districting problem was prepared by him
which was used as a basis for the Organization Committee's report. This
analysis is published in" The Report of the Preliminary Committee on Organization to the Reserve Bank Organization Committee, pp. 6-17: Published
June 1, 1914, New York, for private circulation (Confidential, No. 243). It
may also be found in Willis, The Federal Reserve System, pp. 566-578.
11
Report to the Reserve Bank Organization Committee by the Preliminary
Committee on Organization, p. 12.

52 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
headquarters banks are located, and between such headquarters
point and the outlying portions of the district itself.

When the Reserve Bank Organization Committee returned
to Washington the middle of February it began the preparation of its report to Congress. On April 2, 1914, the Committee announced its decision.12 It selected twelve cities,
the maximum number possible under the Federal Reserve
Act for Federal Reserve banks: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis,
Minneapolis, Kansas City, Dallas, and San Francisco. The
Committee stated that every reasonable opportunity had
been afforded applicant cities to furnish evidence to support
their claims as locations for Federal Reserve banks. Representatives of more than two hundred cities were heard
and of these thirty-seven cities applied for a Federal Reserve
bank. The majority of the Organization Committee including its chairman, the Secretary of the Treasury, and the
Secretary of Agriculture were present at all hearings.
In addition many independent investigations were made
through the Treasury department and the preference of
each bank as to the location of the Federal Reserve bank
with which it desired to be connected was ascertained by an
independent card ballot addressed to each of the 7,475
national banks throughout the country which had formally
assented to the provisions of the Federal Reserve Act.13 The
Committee endeavored to follow state lines as closely as
practicable and deviated from them only wherever it was
considered convenient and advantageous for the districts
concerned.14 Many factors were considered by the Committee in the selection of the cities and the district lines,
prominent among which were:16
First. The ability of the member banks within the district to
provide the minimum capital of $4,000,000 required for the
12
Decision of the Reserve Bank Organization Committee Determining the
Federal Reserve Districts and the Location of Federal Reserve Banks. Government Printing Office, 1914
13
Ibid., p. 3.
14
Ibid., p. 4.
»Idem.

DISTRICTING AND LOCATION OF THE RESERVE BANKS

Federal Reserve bank, on the basis of 6 per cent of the capital
stock and surplus of member banks within the district.
Second. The mercantile, industrial, and financial connections
existing in each district and the relations between the various
portions of the district and the city selected for the location of the
Federal Reserve bank.
Third. The probable ability of the Federal Reserve bank in
each district, after organization and after the provisions of the
Federal Reserve Act shall have gone into effect, to meet the legitimate demands of business, whether normal or abnormal, in accordance with the spirit and provisions of the Federal Reserve Act.
Fourth. The fair and equitable division of the available capital for the Federal Reserve banks among the districts created.
Fifth. The general geographical situation of the district, transportation lines, and the facilities for speedy communication between the Federal Reserve bank and all portions of the district.
Sixth. The population, area and prevalent business activities
of the district, whether agricultural, manufacturing, mining or
commercial, its record of growth and development in the past,
and its prospects for the future.
The Districting Decision

The district allocated to the Reserve Bank in New York
City was designated the Second Federal Reserve District
and its boundary lines were made coterminous with those of
the state of New York. The land area of this district was
47,654 square miles and the population was 9,113,614.16
The New York district as originally formed was the second
smallest in area and the second largest in population. An
important factor responsible for the small geographical size
of the district was the desire to avoid the creation of a
relatively preponderant Federal Reserve bank in New York
City. Another factor was the proximity of the stock market.
The Committee wished to reduce the number of banks having direct contact with the Reserve bank operating in the
location of the securities market.
The contrast between geographical conditions in the
United States and abroad which in part warranted the
regional central bank plan, so fiercely opposed, is shown by
the following. The territory of continental United States is
an area greater than all of Europe, exclusive of Russia,
16

United States Census, 1910.

54 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

comprising 2,973,890 square miles as against 1,936,320
square miles for the latter. The three countries of Europe
especially interesting on account of their established central
banks are dwarfs compared with the United States. They
are the United Kingdom with 121,391 square miles, France
with 207,220 square miles, and Germany with 209,000 square
miles. In the Chicago Federal Reserve district alone there
were over 12,000,000 people, a number greater than the
combined population of Norway, Sweden, and Switzerland.
In the San Francisco district alone there could be put all
of Great Britain, France, Italy, and Germany and there
would still be left an area larger than all of New England
excepting the state of Maine.17
The analogy is not exactly comparable because of the
conflict of national entities abroad within a similar extensive
area; while in the United States, notwithstanding the extensive area, there is a unity of interests in the various sections
which go to make up our national life, and an economic interdependence among them. But, in addition to the immense
distances, as regards economic development and interests
and relative risk attaching to the commitment of capital,
there were, when the Federal Reserve system was established, marked differences as between widely separated
parts of the United States.
Readjustment of District Lines
Following the announcement of the Organization Committee's decision dissatisfaction was voiced by representatives of several cities and a number of banks over the country.18 While economic considerations for the most part
governed Secretary McAdoo's Committee, unfortunately
political pressure at certain points brought about some
serious errors in districting. The Committee chose the
Reserve bank cities first and then tried to fit a district
around them instead of the reverse. While in the case of
"Address of Charles S. Hamlin, governor of the Federal Reserve Board,
before the New York State Bankers Association, Saratoga Springs, N. Y.,
June 25, 1915.
18
Annual Report of the Federal Reserve Board for 1914, p. 5.

DISTRICTING AND LOCATION OF THE RESERVE BANKS

three or four cities, which were obviously proper locations,
this procedure was all right, when applied to the whole country it brought some unsatisfactory results.19
So far as the New York district was concerned the Organization Committee erred in not allocating northern New
Jersey and part of Connecticut to the New York Reserve
Bank. The Banking and Currency Committee of the New
Jersey Bankers Association had polled the banks in New
Jersey to determine of which Reserve bank each wished to
be a member in the event that Reserve banks were established at both New York and Philadelphia. The result was
that practically all of the banks north of Mercer and Ocean
Counties desired to be included in the New York district
and the balance in the Philadelphia district.20 This was
pointed out at the hearings in New York in January, 1914.
The banks in the northern part of New Jersey, with few
exceptions, have no direct rail communication with Philadelphia and their banking and trade channels all run to New
York City. Yet in spite of these facts the Organization
Committee assigned the banks in northern New Jersey to
the Philadelphia Reserve Bank.
The New Jersey bankers' Banking and Currency Committee quickly endeavored to have the assignment changed
but was told that under the law once the decision of the
Reserve Bank Organization Committee had been rendered
it was final and recourse would have to be to the Federal
Reserve Board. The Federal Reserve Act provided that
"the districts thus created may be readjusted and new
districts may from time to time be created by the Federal
Reserve Board, not to exceed twelve in all" and that the
decision of the Organization Committee "shall not be subject to review except by the Federal Reserve Board when
organized." The New Jersey banks chafed under this delay
19
Concerning some problems of districting in other parts of the country
and the selection of cities see Decision of the Reserve Bank Organization
Committee Determining the Federal Reserve Districts and the Location of
Federal Reserve Banks, Government Printing Office, 1914. This may also be
found in the Report of the Comptroller of the Currency, Dec. 7, 1914, Vol. I,
pp. 135-153; Willis, The Federal Reserve System, chapter XXIV.
20
The Financial Age, May 16, 1914, p. 827.

CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

and some of the larger national banks made advances to
secure state charters. The cashier of the First National
Bank of Jersey City is reported to have said: "I asked
Commissioner LaMonte if he would put anything in our
way if we decided that placing us in the Philadelphia district
had hurt banking in Jersey City and we decided we would
relinquish our national charter and take out a state charter.
He said there would be no trouble.21 . . . " A vice president
of the Hudson County National Bank of Jersey City is
reported to have said: "We have not actually applied for a
state charter, but there is a strong possibility of our doing so,
unless the Federal Reserve Board when it organizes heeds
our appeal and places us in the New York district. The
annexing of our banks to the Philadelphia district will prove
a matter of great inconvenience. I do not believe we would
experience any great difficulty in securing a state charter." 22
The members of the Federal Reserve Board took thenoath of office on August 10, 1914, but chose to postpone
consideration of the matter of readjusting district lines until
the Federal Reserve banks were established. It was considered best not to delay the opening of the Reserve banks
and the later strained conditions in finance and business
confirmed the soundness of the Board's judgment.23 On
September 26, 1914, the Banking and Currency Committee
of the New Jersey Bankers Association in behalf of the
member banks in northern New Jersey filed a petition. It
was signed by 123 out of the 132 national banks in the ten
northern counties and prayed that the territory in which
they were located be transferred from District No. 3, the
Philadelphia district, to District No. 2, the New York district. This petition was supported by a brief stating the
reasons why they wished the transfer to be made.24 The
21

Ibid., p. 856.
Idem.
Annual Report of the Federal Reserve Board, 1914, p. 5.
24
The following is a part of the brief: "The volume of checks drawn on any
particular city which are received on deposit by a bank show very accurately
the amount of business which is done by the community in which the bank is
located with the community on which the checks are drawn. Taking this
method as a basis, we find that the commercial business of northern New
Jersey with New York is fully ten times as much as the commercial business
22

DISTRICTING AND LOCATION OF THE RESERVE BANKS 57

Reserve banks were opened in November and when the
pressure of organizing the system was over attention was
given to the question of redistricting. Hearings on the
petition were held in Washington on January 20, 1915,
before the Federal Reserve Board. In technical opposition
to the New Jersey banks appeared the governor of the
Federal Reserve Bank of Philadelphia and the counsel of
that bank. On May 4, 1915, the Federal Reserve Board
of that section with Philadelphia, and throughout that section of the state the
ties, both commercial, financial, and social are almost entirely with New York
City. The industrial enterprises of northern New Jersey, especially those
located in the large cities of Hudson, Passaic, Essex, Union and Middlesex
counties, do a very much greater business with New York than with Philadelphia. Most of these concerns have offices in New York City, while but
few of them have offices in Philadelphia. We append tables showing the population and industrial importance of northern New Jersey.
"We are advised by the banks of northern New Jersey that of the checks
which they receive on deposit drawn on the cities of New York and Philadelphia from 85 per cent to almost 100 per cent are drawn on New York City,
and on account of the large volume and amount of these checks payable in
New York City it is essential that they be sent directly there in order to insure
prompt presentation and prompt notice in case of non-payment. It is impracticable to send these checks to New York by way of the Philadelphia Reserve
Bank. This very same question will arise in connection with the very heavy
volume of checks payable in northern New Jersey which are received on deposit by the New York City banks.
" An analysis of figures which were received by the Comptroller of the Currency from banks of northern New Jersey during the month of June last will
demonstrate the close relationship existing between New York City and
northern New Jersey, and will show that this relationship is much more active
and close than that existing between northern New Jersey and Philadelphia.
In taking these figures into consideration it must be borne in mind that the
Comptroller's figures separate New York City from New York State, but do
not separate Philadelphia from the State of Pennsylvania.
"We give below figures covering the month of June furnished by five representative institutions in Newark, New Jersey, showing the volume of checks
on Newark received from New York City and from Philadelphia, and the
currency shipments between Newark and New York, there being none with
Philadelphia:
On local banks, received from New York City
819,096,489
On local banks, received from Philadelphia
2,351,506
Currency shipments to and from New York City
2,034,000
"A considerable number of the banks in northern New Jersey at certain
times in the year purchase commercial paper. This is all purchased through
New York brokers, and is usually passed upon by New York banks before
being purchased.
"The relations existing between the banking institutions of northern New
Jersey and the banks of New York City have always been most intimate, and

58 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

approved the petition and passed a resolution transferring
the following counties in northern New Jersey from District No. 3 to District No. 2: Bergen, Essex, Hudson, Hunterdon, Middlesex, Monmouth, Morris, Passaic, Somerset,
Sussex, Union, and Warren.25 This readjustment became
effective July 1, 1915.26
In western Connecticut a similar disaffection developed
though a little later than in the case of the New Jersey
banks. On May 10, 1915, a group of fifty-two national
banks in Connecticut petitioned the Federal Reserve Board
that all that part of Connecticut west of the Connecticut
River be transferred from District No. 1, the Boston district, to the New York district. In support of the change the
banks said: "Ever since the beginning of the national banking system these banks have always transacted the majority
of their banking business with New York, which is thennatural center and to which mostly all business of a financial
nature as well as a commercial nature automatically flows.
To try, therefore, to change this natural flow and trend to
an artificial and forced point seems, if we may be allowed to
use the simile, like trying to make water flow up hill. If
left in the Boston district these banks can never derive the
benefits from the system which they ought to, because it
will be unnatural, inconvenient, and burdensome." The
banks contended that ten times as much business was done
with New York as with Boston.27 Further efforts to effect
this redistricting in Connecticut occurred in February, 1916,
when a committee representing banks located in Hartford,
Waterbury, New Haven, and Bridgeport (all in western
Connecticut) appeared before the Federal Reserve Board and
petitioned that they be transferred from the Boston to the
New York district. They presented statistics showing that
the transactions between that section of New Jersey and New York City are
carried on in a very large degree through personal contact, resulting in mutual
advantage. On account of this close relationship no artificial barriers should
be erected, and if erected, will prove injurious to the banks of northern New
Jersey." The Financial Age, Oct. 10, 1914, p. 60S.
25
Annual Report of the Federal Reserve Board, 1915, p. 114.
28
Ibid., p. 28.
27
The Commercial and Financial Chronicle, July 31, 1915, p. 335.

DISTRICTING AND LOCATION OF THE RESERVE BANKS

more of the business of the banks in western Connecticut
was transacted with New York than with Boston and argued
that trouble resulted from the necessity of being joined to
the Boston Reserve Bank.
Counsel for the Boston Reserve Bank opposed the change
sought and argued that it was essential that all available
sources of income be deflected to Boston and away from
New York, if it was the desire of the Board to prevent
centralization of capital in one Reserve bank city.28 Upon
consideration of the petition and the answer of the Federal
Reserve Bank of Boston the Federal Reserve Board stated,
"it appears to the Federal Reserve Board that the convenience and customary course of business and the best
interests of the Federal Reserve system will be served by a
readjustment of the geographical limits of Districts No. 1
and 2," and on February 29 voted to transfer the County of
Fairfield in Connecticut to District No. 2.29 The transfer
was made effective April 1, 1916.30 The petition of the
Connecticut banks in so far as it related to that part of
Connecticut west of the Connecticut River outside of Fairfield County was not granted and the banks in the cities
mentioned above are members of the Boston Reserve Bank.
Since the addition of Fairfield County, Connecticut, the
boundaries of the New York Federal Reserve district have
remained unchanged. A map of the district is shown on
page 60. This district at the present time constitutes an
area of 51,890 square miles, distributed as follows:31
The entire state of New York
Twelve counties in New Jersey
Fairfield County in Connecticut

47,654 square miles
3,605 square miles
631 square miles

The estimated population of the district is 16,622,000.32
As at the time of its original formation the district is still the
second smallest in area and the second largest in population,
the Philadelphia district being the smallest in area while the
Chicago district has the largest population.
28

The Commercial and Financial Chronicle, Feb. 19, 1916, p. 656.
Annual Report of the Federal Reserve Board, 1916, p. 124.
Ibid., p. 126.
31
Annual Report of the Federal Reserve Board, 1931, p. 286.
32
Annual Report of the Federal Reserve Board, 1933, p. 383.
29

60 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Effort to Reduce the Number of Federal Reserve Districts
While some of the original errors of judgment on the part
of the Organization Committee were thus later rectified by
the Federal Reserve Board, an effort to bring about a major
change in the districting plan of the Federal Reserve system
failed of fruition. This major change involved the elimination of several of the Federal Reserve districts and, of

SECTION or NEW YORK STATC ALLOCATES
TO THE BUFFALO BRANCH.
[•/T*«;| COUNTIES OF NEW JERSEY.

J U S l FAIRFIEUD COUNTY, CONNECTICUT.

FIG. 1.—The Second Federal Reserve District

course, their Federal Reserve banks, in the South and West.33
This was an effort initiated by the New York member of the
Federal Reserve Board who had formerly opposed the
regional Reserve bank plan of the Federal Reserve Act
when it was under discussion by Congress.
It will be recalled that the New York bankers especially
desired not to disturb the old correspondent banking rela33
Consult Willis, The Federal Reserve System, chapter XXIV; W. P. G.
Harding, The Formative Period of the Federal Reserve System, pp. 34r-38.

DISTRICTING AND LOCATION OF THE RESERVE BANKS

tionships of the national banking system. The alleged
authority for the change in the organization of the system
was based upon that part of section 2 of the Federal Reserve
Act which reads: "The districts thus created may be readjusted and new districts may from time to time be created
by the Federal Reserve Board, not to exceed twelve in all."
The Federal Reserve Board had been organized but a few
weeks when certain members of that body began to promote
a reduction in the number of Federal Reserve districts. The
discussion of this change increased to such an extent that
the Board finally resolved to appoint a special committee
of its members to consider the matter. The question was
referred to counsel. The Board's general counsel held
that the section of the Federal Reserve Act referred to did
not give the Board authority to reduce the number of Federal
Reserve districts.34 A special counsel employed by the
Board rendered a contrary decision.35 Finally, the AttorneyGeneral of the United States ruled that the Board had no
power to reduce the number of Federal Reserve districts
from the number of twelve 36 which was established by the
Reserve Bank Organization Committee nor to change the
present location of any Federal Reserve bank.37 The argument of the Attorney-General was to this effect: that the
Federal Reserve Board had no power under the Federal
Reserve Act to change any decisions of the Reserve Bank
Organization Committee unless the power to change a
certain decision was specifically conferred in the Act; that
the power to "readjust" districts created and to create new
ones did not mean the power to reduce; and that inasmuch
as the power to abolish certain districts or banks was not
affirmatively conferred, the Federal Reserve Board had
not the power to reduce the number of Federal Reserve
districts nor change the location of any of the Federal
Reserve banks. The Attorney-General's decision settled the
move to eliminate some of the Federal Reserve districts,
34

Federal Reserve Bulletin, Vol. II, 1916, p. 20.
Ibid., p. 25.
Federal Reserve Bulletin, Vol. I, 1915, p. 396.
37
Federal Reserve Bulletin, Vol. II, 1916, p. 207.

55
38

•"-"BOUNDARIES OF FEDERAL RESERVE DISTRICTS
——BOUNDARIES OF FEDERAL RESERVE. BRANCH TERfUTORtES
® FEDERAL RESERVE BANK CITIES
•
FEDERAL RESERVE BRANCH CITIES
O FEDERAL RESERVE DANK AGENCY

Fia. 2.—The Federal Reserve Districts, Bank and Branch Cities

DISTRICTING AND LOCATION OF THE RESERVE BANKS 63

no recurrence of any such effort having been made. Thus,
with the few minor changes in district lines, the pattern of
the Federal Reserve system assumed its present form about
the middle of 1916. The accompanying map shows the
twelve Federal Reserve districts and the location of the
Federal Reserve banks and their branches.

CHAPTER IV
ESTABLISHMENT OF THE FEDERAL RESERVE
BANK OF NEW YORK
Incorporation
New York City was designated as the location of a Federal Reserve Bank by the Reserve Bank Organization Committee on April 2, 1914. The Federal Reserve Act provided
that national banks must join the Federal Reserve system
or forfeit their national bank charters. The establishment
of the Reserve Bank was uncertain. It was an open question as to whether the large national banks in New York City
would join the Federal Reserve or forfeit their national
charters.1 The Federal Reserve Act stated that in case the
amount of the subscriptions to the capital stock of the
Reserve Bank was insufficient, stock would be offered to
the public at par. But the offering of stock for public subscription proved to be unnecessary. There were 477 national banks in the New York or Second Federal Reserve
District and every one of them accepted the provisions of
the Federal Reserve Act and announced its intention to
subscribe to the capital stock of the Federal Reserve Bank
of New York,
When the minimum amount of capital stock prescribed
by the Federal Reserve Act for the organization of any
Federal Reserve bank was subscribed, the Reserve Bank
Organization Committee designated five banks and notified
them on May 11, 1914, to execute the organization certificate of the Reserve Bank. The following banks were selected to effect the incorporation of the New York Reserve
Bank: National Commercial Bank, Albany; First National
Bank, Syracuse; Marine National Bank, Buffalo; National
Park Bank, New York City; Irving National Bank, New
1

The Commercial and Financial Chronicle, Dec. 27, 1913, p. 1854.
64

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

York City. Orders were dispatched to these banks asking
that a special meeting be called at once for the purpose of
passing a resolution sent to them authorizing its officers to
sign the organization certificate.2 Clothed with such authority representatives of the banks named met at the office
of the president of the New York Clearing House Association in New York City who held the certificate of incorporation as the agent of the Reserve Bank Organization Committee. They signed the certificate which was filed with the
Comptroller of the Currency on May 18, 1914. On this
date the Bank was incorporated and it marks the birth of
the Federal Reserve Bank of New York,3 possessed of the
powers conferred by law except that it could not transact
"any business other than such as was incidental and necessarily preliminary to its organization, until formally authorized by the Comptroller to begin the business of banking." 4
Election of Directors
The next step in the establishment of the Reserve Bank
was the election of directors. The election procedure was
laid down in the Federal Reserve Act and it devolved upon
the Organization Committee to initiate and supervise the
election. This Committee classified the member banks of
the district into three general groups, each group containing approximately one-third of the aggregate number of
the member banks of the district, and consisting of banks
of similar capitalization. Group No. 1 contained banks
having the largest capitalization, Group No. 2, banks of the
next largest capitalization and Group No. 3 was composed
of banks having the smallest capitalization. Of the nine
directors of the Reserve Bank the member banks were to
elect six. Three of these, called Class A directors, were to
be representative of the stockholding banks and three, called
Class B directors, were at the time of their election to be
"actively engaged in commerce, agriculture, or some other
industrial pursuit." The banks in each group were to elect
2

The Financial Age, May 16, 1914, p. 863.
Annual Report of the Federal Reserve Bank of New York, 1915, p. 7.
* Report of the Comptroller of the Currency, Dec. 7, 1914, Vol. I, p. 154.

66 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

one Class A director and one Class B director. To effect
this result each of the member banks was required to elect
a district reserve elector actually to cast the vote of his
bank. The purpose of electing district reserve electors was
"to obviate the necessity of convening the boards of the
various member banks in order to vote on the nominees." 5
When the Reserve Bank Organization Committee was
effecting the incorporation of the Reserve Bank, the Comptroller of the Currency in a message to the member banks
expressed the hope that the Organization Committee would
receive nominations for Class A and Class B directors and
the names of the district electors so that a vote could be
taken early in June. The Organization Committee made
every effort to expedite the election so that the board of directors of the Reserve Bank could be organized in ample
time to elect officers, select employees and banking quarters,
and place the banks in actual operation by August I.6 Developments occurred, however, which prevented such an
early opening of the Reserve Bank. The selection of the
Bank's directors became involved in a heated controversy.
Under date of May 6, 1914, the Organization Committee
sent a circular letter to all member banks relative to the
steps to be taken in electing the directors together with
forms upon which each member bank was to report to the
Committee the name of its elector and the names of its
nominees for Class A and Class B directors.7 The New York
City banks, however, were unwilling that this election should
proceed without effecting some control over the selection of
that body of men who would direct the Federal Reserve
Bank of New York. Accordingly a circular letter was sent
by A. IL Wiggin, president of the Chase National Bank
and chairman of the New York Clearing House Association,
to each of the member banks in the Second Federal Reserve
District. It invited their representatives to a separate conference for each group at the New York Clearing House to
fi
6

Annual Report of the Federal Reserve Board, 1914, p. 66.
The Financial Age, May 16, 1914, p. 863.
* Reserve Bank Organization Committee Circular 2, Annual Report of the
Federal Reserve Board, 1914, p. 65.

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

consider the matter of nominations.8 The plan was to frame
a "slate" at these conferences for directors of Classes A
and B. 9 It was so arranged that these group conferences
were not to be held at the same time but were to meet at
different times, Group 1 meeting first, then Group 2 followed by Group 3. The representatives of the largest banks,
those in Group 1, met on Tuesday, May 19, at the New York
Clearing House. At this meeting, A. Barton Hepburn of the
Chase National Bank of New York City was elected chairman and William Woodward of the Hanover National Bank
of New York City offered the following resolution which
was adopted: 10
" Resolved, that a committee of eight be appointed to recommend to the member banks names of suitable candidates for directors of Classes A and B of the New York Federal Reserve Bank,
and that said committee be asked to meet with similar committees
from Groups 2 and 3, if they be appointed; and further
"Resolved, that this group request Groups 2 and 3 to respectively appoint a similar committee, to meet with the committee
from Group 1, so that intelligent and beneficial discussion may be
had on this subject."
The representatives of banks in Group 2 met on Friday
8

Mr. Wiggin's letter to the banks of Group 2 follows: (The letters to Groups
1 and 3 were similar.)
"Gentlemen:
"The organization of the Federal Reserve Bank of this district is nearly completed so far as the Government is concerned, and presently the individual
banks will be called upon to perform the part devolved upon them by statute,
the election of a director representing the banking interests and also a director
representing the commercial, agricultural or other industrial interests of the
district.
" In order that there may be intelligent and concerted action, it is deemed
desirable that a preliminary conference be held.
" We suggest a meeting of the members of each group of this Federal Reserve
district in order that each and every bank may be given a voice in the proceedings and harmony and unity of action be secured. We are arranging for
a meeting of the members of Group 1 on May 19 and for Groups 2 and 3 on
May 22. We invite you to attend a meeting of Group 2 of this Federal Reserve
district at the Clearing House in this city on Friday, May 22, at 11 A. M., for
the purpose of a general discussion, interchange of views and the adoption of
a proper course of procedure. We very much hope that some one representing
your good institution will be present on this occasion." The Financial Age,
May 16, 1914, p. 843.
9
10
Idem.
The Financial Age, May 23, 1914, p. 883.

68 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

morning, May 22. At this meeting which was presided over
by Robert H. Treman, president of the Tompkins County
National Bank of Ithaca and president of the New York
State Bankers Association, Group 2 passed a resolution similar to the above.11 The proceedings at both of these meetings were harmonious. Everything apparently went according to schedule and the committees provided for by the
resolutions were appointed. Group 3, composed of banks
having a capital and surplus of $70,000 or less, had its meeting also on Friday but in the afternoon. Its session was prolonged, unharmonious, and at times took on the semblance
of open revolt.12 The meeting was opened by A. H. Wiggin,
president of one of the largest banks in Group 1, who, as
chairman of the New York Clearing House Association, had
invited the bankers to the conference.
Robert H. Treman who was chairman of the Group 2
meeting in the morning was also put up for chairman of
this Group 3 meeting. His sponsors finally succeeded in
electing him chairman of the group, after taking three
ballots, by a vote of 21 to 12. His election, however, evoked
bitter opposition because he was not a member of Group 3,
but belonged to Group 2 and had been elected chairman of
that group at the morning session. Finally, after more than
an hour's wrangling, Mr. Treman declined to serve as chairman and the group elected G. E. Merrill, cashier of the
First National Bank of East Aurora, chairman. A Group 3
committee was then appointed to meet with the other group
committees the following Tuesday.13 The joint meeting of
the three group committees on May 26, resulted, after
several hours of discussion in the unofficial nomination of
some candidates for directors of the Reserve Bank. The
candidates were nominated unanimously by the individual
committees and then approved unanimously at the joint
meeting. Groups 1 and 2 each nominated a candidate for
Class A, and two candidates for Class B. Group 3 nominated one candidate for Class A but no candidate for Class
B directors. At the time of the joint meeting it was understood that the Group 3 nominating committee would hold
11

Idem.

«Idem.

Idem.

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

another meeting shortly thereafter to nominate two business men for that class of directors.14 According to the statute a bank's nomination for a Class A director did not need
to be confined to a banker whose bank was classed in the
same group. But once the nominations were officially made
in the manner prescribed by law, a bank could vote only on
the candidates nominated by the banks in the group to
which it belonged.15
The purpose of this provision of the Federal Reserve Act
was to make the Class A and Class B directors representative of various groups of banks and their customers and
allow the smaller banks a better chance to have a voice in
the management of the Reserve Bank. The series of bankers'
caucuses initiated by the New York Clearing House banks
resulted in the unofficial nomination for Class A directors of
candidates all of whom were connected with Group 1, the
largest banks.
The Group 3 nominating committee held another meeting, as planned, in Albany on June 3, to nominate two business men for Class B directors. A spirited contest took place
at this meeting. Nearly two score of the bankers present
declined to accept the nominees of the regular nominating
committee for Group 3 at the New York City Conference.16
This group, called "insurgents," after having been ignored
by the "regulars/7 subsequently held a meeting of their
own and adopted the following resolution:
"Resolved, that this meeting recommend that a member for
Class A and Class B directors of Group 3, regional reserve bank
of New York, be a man representative of Group 3 and an officer
of a Group 3 bank or associated with the interests of a Group 3
bank in afinancialand business way."
In accordance with this resolution they then nominated a
candidate for Class A director and a candidate for Class B
director.17
Similar dissension arose among the Group 2 bankers. A
14

The Financial Age, May 30, 1914, p. 921.
Reserve Bank Organization Committee, Circular No. 2, May 6, 1914.
The Financial Age, June 6, 1914, p. 963.
"Idem.

15
16

70 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

number of these met at Utica on June 5 and nominated one
candidate for Class A director and one for Class B director.
This insurgent group also passed unanimously a resolution
favoring the selection of directors from Group 2 banks and
interests, and urging all the member banks of the group not
represented at the meeting to stand by this proposition.18
The so-called "insurgents" in Groups 2 and 3, while recognizing that their banks could legally nominate men affiliated
with Group 1 banks to serve as directors of the Reserve
Bank, held that Group 1 members could not satisfactorily
represent the interests of banks in Groups 2 and 3 and decried the "Wall Street domination" which had inspired the
first "regular" nominating conferences in New York City.
Regarding the insurgent movement, the point of view of
the New York City bankers was expressed by one of them
who said: "If you had the job of selecting a captain for
the Aquitania or the Vaterland, you would not pick out a
canal boat skipper." 19
During the month of June the contest for nominations
waxed hot. The chairman of the original nominating committees of each group sent a joint letter to each member
bank in the district urging the election of the "regular"
nominees for the board of directors, in opposition to the
recommendations of the "insurgents." On June 25 the Reserve Bank Organization Committee announced the names
of the candidates for directors which had been nominated
by the banks in the New York district.20 There were fifty
candidates, which evidenced the extent of the disapproval
of the efforts of the largest banks to "put through" candidates of their selection. On July 7 the member banks received from the Committee the ballots on which they voted.
But balloting proceeded slowly and as there were close contests for some positions the complete list of directors of the
Reserve Bank was not known until the first part of August.
Though the large banks were more successful in the election
13

Idem.
The Financial Age, June 13, 1914, p. 998.
20
The Financial Age, June 27, 1914, p. 1119. For an account of the contest
for nominations and the names of all the nominees, see The New York Times,
July 8, 1914, p. 6.
19

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

the work of the "insurgents'' bore fruit for them. Of the six
directors elected by the banks, four were those recommended by the original New York City conference nominating committees and two were so-called "insurgent"
nominees who were elected Class B directors representing
business interests.
Appointment of Class C Directors
With the election of the Class A and Class B directors by
the member banks, the appointment by the Federal Reserve
Board of three Class C directors representing the Government remained to complete the board of directors of the
new bank before it could begin active operations.21 One
of the first tasks of the Federal Reserve Board, which was
organized on August 10, was to select these directors, one
of whom was to be appointed Federal Reserve agent. The
Board attached particular importance 22 to this selection
21

The men who constituted the first board of directors of the Federal Reserve
Bank of New York were:
Group
Name
Residence
Class C
Pierre Jay,
New York City
NOTE: The group number
Federal Reserve Agent
refers to the classification of
the bank which nominated the
and Chairman of the
director. It doea not mean
Board of Directors
that the director in each case
was associated with a bank
Charles Starek,
New York City
belonging to that particular
Deputy Federal Reserve
group. Thus, every Class A
Agent and Vice Chairdirector was an officer of
banks in Group 1, that is, the
man of the Board of
group
comprising the largest
Directors
Lake George, N. Y.
George F. Peabody
Class A
New York City
William Woodward
Ithaca, N. Y.
Robert H. Treman
Buffalo, N. Y.
Franklin D. Locke
Class B
H. R. Towne
New York City
1
William B. Thompson
Yonkers, N. Y.
2
Leslie R. Palmer
Croton-on-Hudson, N. Y»
3
For a list of all the directors of the Federal Reserve Bank of New York,
showing occupation, tenure, etc., see Appendix II, facing p. 412.
22
Upon announcing its selection of government directors for the Federal
Reserve banks, the Federal Reserve Board issued the following statement:
"In selecting the directors the board has made the utmost efforts to weigh
and compare the merits of all those whose names were presented to it. It has
also inquired into the qualifications of all other suitable men as to whom it
could get information, to the end that in every case the best might be chosen.

72 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

and when it announced its appointments on October 1
they were greeted with considerable satisfaction.23
Selection of Executive Staff
The framers of the Federal Reserve Act had intentionally
omitted from the Act details regarding the internal organization of the Federal Reserve banks.24 The Federal Reserve Act provided that the board of directors of the Reserve Bank had power to appoint officers and employees not
otherwise provided for in the Act. But it also provided for
the appointment of one of the government directors as
Federal Reserve agent and outlined in considerable detail
his functions and duties. This provision for the Federal Reserve agent caused no little anxiety among bankers for a
while after the passage of the Act. They were fearful that
the Federal Reserve agent was either intended to be the
operating head of the Bank or would in some way be made
such.25 There was no such intention, however, on the part
of the framers of the Act, it being expected that each of the
Federal Reserve banks would have a practical banker as its
executive manager.26 The member banks desired that such
a head be chosen by them. The members of the Federal Reserve Board reached an understanding after consultation
with the framers of the Act that the Reserve banks should
have operating heads distinct from the Federal Reserve
agents and so notified the board of directors of the Bank.27
Members of the board have made special journeys for the purpose of investigating conditions in various Federal Reserve cities and of ascertaining facts
regarding those who were being considered by the Board. In other instances
persons have been invited to Washington for consultation.
" In each case the board has endeavored to assure itself that the man selected
is able to comply with the requirements of the Federal Reserve Act, is a man
of ability and has the confidence of the banking and business community in
which he is placed. So far as reasonably possible geographical considerations
have been taken into account in order that different portions of each district
might be represented on the board of directors." The Financial Age, Oct. 3,
1914, p. 555.
23
The New York Times, Oct. 2, 1914.
14
Willis, The Federal Reserve System, p. 687.
25
Ibid., p. 259.
26
Idem.
97
Annual Report of the Federal Reserve Board, 1914, p. 120.

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

The question of a proper title for the operating head engaged the attention of the Federal Reserve Board and it
wasfinallydecided that he was to be known as " governor." 28
The position and title of governor were not provided by
the Federal Reserve Board until October, 1914. However,
during the preceding spring when the election of directors
was on foot it is understood that various bankers in New
York had discussed the question whom they wanted to
manage the Reserve Bank in the city and undoubtedly
agreement among them had been reached regarding Mr. Benjamin Strong for the place. It is understood that this decision was well known to the member of the so-called "Wall
Street Group" of New York bankers, Mr. P. M. Warburg,
and that it was probably considered by him at the time
when he accepted appointment as a member of the Federal
Reserve Board. Mr. Warburg was heartily in sympathy
with the choice of Mr. Strong and it was well understood
that he would support it, as he did.
Shortly after completion on October 5, 1914, the board of
directors of the Reserve Bank held its first meeting in the
directors' room of the Bank of the Manhattan Company,
40 Wall Street, New York. This meeting, presided over by
Mr. Pierre Jay, chairman of the board and Federal Reserve
agent, resulted in the election, without controversy, of
Mr. Strong as governor of the New York Reserve Bank in
accordance with previous indications. Mr. Strong was at
the time president of the Bankers Trust Company but was
in a rather unhappy position in relation to his directors. As
a result he was in a duly receptive attitude for the new
position with the Reserve Bank at a salary of $30,000 in
lieu of the $50,000 he was then receiving as head of the
Bankers Trust Company. The several Federal Reserve
banks did not adopt an identical policy with reference to the
selection of a governor. Most of them, like the New York
Reserve Bank, went outside of their own boards of directors
for this official. The Federal Reserve Banks of Philadelphia,
28
Willis, The Federal Reserve System, p. 698. Later the Federal Reserve
Board bitterly regretted their attaching the title of "governor" to the operating officer of the Federal Reserve banks.

74 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Richmond, and Dallas, however, selected governors from
their own directors.
The Problem of Opening the Federal Reserve Banks
The Secretary of the Treasury was to set the date for
opening the Reserve banks according to the Federal Reserve Act. In May, 1914 it was the hope of Treasury department officials to place the banks in operation by August I.29 As late as the last of June they still thought it
possible to open the banks by this date.30 But with the
organization of the Federal Reserve Board itself delayed
until the 10th of August, such an early opening was impossible. By the time the Board was organized the European
War was in progress and conditions in the foreign exchange
and commodity markets were quite upset. These and foreign relations occupied the attention of the Administration
and tended to delay not only the formation of the Federal
Reserve Board but the establishment of the Federal Reserve
banks. But upon assuming office the question of opening
the banks occupied the attention of the members of the
Board and was discussed at many long conferences which
took place daily throughout the summer.
The opinion was frequently expressed that "the opening
of the Federal Reserve banks should be deferred until the
return of more normal conditions." 31 The Secretary of the
Treasury on the other hand was insistent upon opening the
banks at the earliest possible moment and most of the members of the Board had the same feeling about it. When Secretary McAdoo announced this intention the first week in
September, the bankers in New York City let it be known
that they considered it extremely hazardous to open the
Reserve banks as long as the European War lasted.32 Determined pressure was brought to bear upon Secretary of
the Treasury McAdoo to defer practically indefinitely the
29

The Financial Age, May 16, 1914, p. 863.
Financial Age, June 27, 1914, p. 1134.
W. P. G. Harding, The Formative Period of the Federal Reserve System,
p. 26.
32
The Financial Age, Sept. 5, 1914, p. 406; Sept. 12, 1914, p. 452.
30
The
31

ESTABLISHMENT OF THE NEW YORK RESERVE BANK 75

opening of the newfinancialinstitutions. When it became
evident that nearly all of the members of the Federal Reserve Board could not be dissuaded in their desire to have
the Federal Reserve system in condition to render effective
service to the country as quickly as possible, the next effort
of the opposition was to try to have the New York Reserve
Bank opened first and postpone to some indefinite date the
opening of the other Reserve banks.
The Federal Reserve Board invited the directors and
governors of all the Reserve banks to a meeting with the
Board in Washington, October 20-22, to consider the various problems confronting them. At this meeting Secretary
McAdoo was emphatic that he expected to have all the Reserve banks opened at the same time 33 and tentatively
named November 16 as the date. This brought forth considerable opposition from the directors and governors assembled, including those of the New York Bank, about half of
the convention opposing the opening. They also stated in
support of their stand that the member banks would be
weakened at that critical period by having gold withdrawn
from their vaults and placed with the Reserve banks. They
went so far as to declare that it would not be possible to
put the banks in operation at that time.34 What the opponents of the early opening of the banks failed to realize
was the greater strength which would accrue to the member
banks by uniting and depositing their gold with the Reserve
banks. In the face of this determined opposition, Secretary
McAdoo, however, asserted his independence and exercised
his prerogative. He decided definitely after the convention
was concluded that he would order the Federal Reserve banks
opened on November 16, believing that such was for the
general good of the country. His statement in part follows.35
The Federal Reserve Act imposes upon the Secretary of the
Treasury the duty of announcing, in such manner as he may elect,
the establishment of a Federal Reserve bank in any district. In
83

The Financial Age, Oct. 24, 1914, p. 663.
Willis, The Federal Reserve System, p. 645; The Financial Age, Oct. 24,
1914, p. 663.
36
The Financial Age, Oct. 31,1914, p. 850.
34

76 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
the discharge of that duty I have determined to announce on the
16th day of November, 1914, the establishment of the Federal
Reserve banks in all the Federal Reserve districts. On that date
the new reserve requirements for national banks, as prescribed
by the Act, will become operative.
I am compelled to this decision particularly because of the
emergent conditions in the South and the confident belief that
the prompt opening of the Reserve banks will be very helpful to
the cotton situation and to general business in all sections of the
country.
This conclusion has been reached after a thorough discussion
with my associates on the Federal Reserve Board, who are cooperating cordially with me, and also after full consideration of
the views expressed by the directors of the Federal Reserve banks
at their recent conference in Washington with the Federal Reserve Board. . . .
Those on the Board who had opposed the early opening
of the Reserve banks did not cooperate with the Secretary
and when he issued this announcement they assailed it as
an unwarranted assumption of authority. But they were in
the minority and when it was pointed out to them that the
Federal Reserve Act vested the power to determine the date
of opening in the Secretary of the Treasury they could do
nothing but let the judgment of Secretary McAdoo determine the issue.36
The Secretary of the Treasury Orders Opening
Secretary McAdoo's order for the opening was received at
the New York Reserve Bank on October 26 and was as
follows:37
PIERRE JAY,

Chairman Board of Directors,
Federal Reserve Bank, New York.
Please call a meeting of the directors of the Federal Reserve
Bank of your district and advise them that all necessary statutory
requirements having already been complied with by the several
Federal Reserve banks, the Comptroller of the Currency will
forward to each bank on or before November 16, 1914, the certificate authorizing such bank to commence business as prescribed
by section 4 of the Federal Reserve Act, and the Secretary of the
36
37

Willis, The Federal Reserve System, p. 645.
Annual Report of the Federal Reserve Bank of New York, 1915, p. 8.

ESTABLISHMENT OF THE NEW YORK RESERVE BANK 77
Treasury will, in conformity with section 19 of the Act, formally
announce the establishment of the Federal Reserve banks in each
of the Federal Reserve districts on the 16th day of November,
1914. Please also assure the directors that this department will
gladly extend to them every facility and all possible assistance in
opening the banks on that date and also assure them of my very
best wishes and of my earnest desire to cooperate with them in
every possible manner to render this great public service.
W. G. MCADOO,

Secretary of the Treasury.

The directors of the New York Reserve Bank assured
Secretary McAdoo of their desire to cooperate with his plan
in a telegram sent on October 28, which was as follows:3S
HON. W. G. MCADOO,

Secretary of the Treasury, Washington.
At the meeting of the directors of the Federal Reserve Bank of
New York today your telegrams of Monday to Gov. Strong and
myself were presented, and I was authorized to express to you the
entire concurrence of the board of directors in the telegraphic replies sent you on Monday by Gov. Strong and myself and to
thank you for your good wishes and offer of assistance and to
assure you of their desire to cooperate with your plan.
PIERRE JAY, Chairman.

Following the receipt of Secretary McAdoo's order,
Mr. Jay said that he and Mr. Strong would " cooperate
loyally" with Secretary McAdoo in the effort to open the
bank by November 16.39 There was a great deal to be done
in three weeks to accomplish that purpose. When the
request for the opening came on October 26, the New York
Reserve Bank may be said to have consisted of only the
board of directors, the Federal Reserve agent, and operating
head. Banking quarters had not been secured nor had a
staff been assembled. The Federal Reserve Board designated November 2 as the day on which member banks were
to pay the first installment on their subscribed capital stock.
By special arrangement this money was received at the
New York Clearing House with the assistance of a number
of men from the New York banks.40 While there were on
38

Idem.
The New York Times, Oct. 22, 1914.
40
Annual Report of the Federal Reserve Bank of New York, 1915, p. 9.
89

78 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

file over 2,000 applications for positions with the new institution, the officers did not attempt to select a permanent
staff in so short a time but secured the temporary services
of experienced officers and clerks detailed for the purpose
from the larger New York banks.41 Banking quarters were
leased at 62 Cedar Street and possession was taken on
Monday, November 9. During that week the officers and
clerks of the new Bank met daily for drill in the various
branches of the work. The certificates authorizing the
Federal Reserve banks to commence business, in accordance
with section 4 of the Federal Reserve Act, were signed by
the Comptroller of the Currency on November 14 and provided formal authority for the announced opening.42
The New York Bank Begins Operations
On schedule time on the morning of November 16 the
Federal Reserve Bank of New York commenced operations
with a staff of seven officers and eighty-five clerks.43 The
occasion was one of special interest and was recognized as
such by many prominent bankers of the district who came
and extended their felicitations to the officers and directors.
Representatives of the British Chancellor of the Exchequer 44
also called. The event was hailed as marking the beginning
of a new era, full of promise for greater financial stability.
Pursuant to a request from the Federal Reserve Board
member banks were engaged on the opening day in paying
the first installment on their reserves to the Reserve Bank.
In order to facilitate the work of counting the money the
banks generally cooperated with the Federal Reserve officials by sending gold certificates of the larger denominations.
The large New York City banks not only did this but also
paid their reserves so far as possible by orders on the New
41

Idem.

Report of the Comptroller of the Currency, Dec. 7, 1914, p. 163.
43
Annual Report of the Federal Reserve Bank of New York, 1915, p. 9. In
addition to Pierre Jay, chairman and Federal Reserve agent and Benjamin
Strong, governor, there were several offices temporarily filled. These were:
cashier, assistant cashier, secretary, assistant secretary, treasurer, credit manager, auditor, and chief accountant. The Financial Age, Nov. 21,1914, p. 945.
44
Sir George Paish and Basil P. Blackett.

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

York Clearing House which called for the payment of gold
or gold certificates already counted by the clearing house.
This procedure was also followed when the banks paid the
subscription on their capital stock. With a view to expeditious and efficient handling, payments were received at
three places, the Federal Reserve Bank, the New York
Clearing House, and the United States Sub-Treasury.45 On
this opening day applications for loans were received from
three banks apparently with a view to making " complimentary rediscounts." The first one of these was for over
$2,000,000 from the Chemical National Bank which had
previously asked for permission to make the first rediscount.
Its application was acted upon favorably and the bank was
given deposit credit.46 The other two were for relatively
small amounts and were not acted upon. After the close of
business the first balance sheet of the Federal Reserve Bank
of New York was mailed to the Federal Reserve Board.47
Upon advice of the Secretary of the Treasury the assistance of the United States Sub-Treasury in New York
City was assured. Its staff cooperated with the staff of the
Reserve Bank and its specialized equipment was placed at
the new Bank's disposal until such time as the latter had
suitable equipment of its own. Experienced money counters
from the sub-treasury assisted in counting the reserves
transferred from the member banks. Storage compartments
in the vaults of the United States Sub-Treasury building
on Wall Street were used by the Bank and by the Federal
Reserve agent. Federal Reserve currency unfit for circulation was prepared in the sub-treasury for its dispatch to
Washington. All gold coin received by the Reserve Bank
was weighed by the sub-treasury.48
Work of the Preliminary Committee on Organization and the
Washington Conference
The Federal Reserve Act set forth no details concerning
the organization of the Federal Reserve banks. For that
45

The New York Times, Nov. 17, 1914, p. 1.
The Financial Age, Nov. 21, 1914, p. 945.
47
Annual Report of the Federal Reserve Bank of New York, 1915, p. 9.
48
Ibid., pp. 10-11.
46

80 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

purpose the framers of the Act had made provision for the
Reserve Bank Organization Committee. This committee
decided to set up a subcommittee called the Preliminary
Committee on Organization. It appointed as chairman the
counsel of the House Banking and Currency Committee,
Dr. H. Parker Willis. The chairman then selected a group
of experts as members of the Preliminary Committee.49 Its
work consisted of an intensive analysis of the technical requirements of the Reserve banks involving organization and
accounting. The results of its efforts were gathered into an
exhaustive report50 accompanied by a complete set of forms
which covered such technical subjects as the organization
of the Federal Reserve banks, the accounting system, regulations regarding the issue and retirement of Federal Reserve
notes, the interpretation of commercial paper, by-laws for
the Board, the Reserve banks, and their branches, detailed
plans for putting the clearing provisions of the Federal
Reserve Act into effect, and regulations governing the
establishment of foreign branches.
Based upon this report, the Federal Reserve Board sent
to the officers and directors of the Federal Reserve banks
in October, 1914, circulars containing suggested by-laws, a
set-up for a uniform accounting system, and an analysis of
the organization and functions of the constituent elements
of the Federal Reserve system for study and discussion.51
Appreciating the benefit which would result from the cooperation of all the Reserve banks' directors and governors,
and from general similarity of aims and actions, the Board
then asked the banks to send representatives to a general
meeting which it determined to hold at Washington, October 20, 21, and 22.52 The purposes of the Board in calling
the convention were to discuss matters of common interest
49

The members of the Preliminary Committee on Organization were:
H. Parker Willis, chairman
Edmund D. Fisher
Ralph Dawson
Andrew A. Benton
Stephen H. Farnham
Joseph A. Broderick
O. Howard Wolfe
60
Report of the Preliminary Committee on Organization to the Reserve
Bank Organization Committee, June 1, 1914.
51
Annual Report of the Federal Reserve Board, 1914, pp. 74-165.
«Ibid., Exhibit H, p. 190.

ESTABLISHMENT OF THE NEW YORK RESERVE BANK

incident to the inauguration of a central banking system
for the United States. More particularly they may be
grouped in two classes: 1. Questions of system policy and
regulations to be issued by the Federal Reserve Board.
2. Subjects concerning the internal organization and operations of the Reserve banks. Along with the announcement
of the convention the Board sent a series of questions inviting suggestions and criticisms concerning the proposals
which had been sent the Reserve bank heads, which were
to be discussed at the convention.
The attendance was very gratifying to the Federal Reserve Board, about one hundred persons, including directors,
Federal Reserve agents, governors, and members of the
Preliminary Committee on Organization being present. The
delegates were divided into several committees each of which
was assigned a special subject for study and report.53 The
experts on the Preliminary Committee on Organization and
the members of the Federal Reserve Board were divided up
among the convention committees to aid in their work and
give them such information and advice as their previous
experience and work on the problems at hand had fitted
them. The subjects assigned to individual committees were
as follows:54
(a) Legal matters and procedure: by-laws, other legal points,
and the preparation of legal forms.
(b) Office quarters, equipment, and personnel: vault space,
organization of staff and matters affecting officers and directors,
including compensation of directors and members of the Federal
Advisory Council.
(c) Rediscount: definition of commercial paper and consideration of credit bureaus.
63

Circular No. 9, Federal Reserve Board, Annual Report of the Federal
Reserve Board, 1914, p. 165.
64
Idem. This circular gives the names of the members of the Federal Reserve
Board and the Preliminary Committee on Organization and the particular
committees to which they were assigned.
The members of the first Federal Reserve Board and their places of residence were as follows: William G. McAdoo (member ex-officio), New York;
John S. Williams (member ex-officio), Richmond, Va.; Charles S. Hamlin,
Boston; W. P. G. Harding, Birmingham; Frederick A. Delano, Chicago; Paul
M. Warburg, New York; and Adolph C. Miller, Berkeley, CaL

82 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
(d) Duties of Federal Reserve agents: auditing of Reserve
banks, note issues, the clearing of national currency.
(e) Accounting and statistics: books and forms, statements to
be forwarded to the Federal Reserve Board, etc.
(f) Domestic Exchange: transit and clearing.
(g) Bonding of Federal Reserve agents, members of their staff,
or other officers of Reserve banks.
(h) Mechanical devices for the keeping of accounts and statistical work.

All of the committees made reports upon these subjects
before the convention adjourned.55 These, for the most part,
followed the lines already set forth in detail in the preliminary report and were adopted by the convention in a rather
routine way.56 There was thus brought about a general
consensus of opinion which materially aided the early opening of the Federal Reserve banks and gave them a more
auspicious start. Such was the manner by which the Federal
Reserve Bank of New York and the other central banks
acquired the requisite information, regulations, plan of organization, and material, which enabled them to open
simultaneously on November 16, 1914, and inaugurate the
new era of central banking in the United States.
Charter
Under the original Federal Reserve Act, each Reserve
bank was granted a charter for twenty years. As the twentyyear period drew nearer to its close, concern was felt that
the development of the central banking system might be
arrested. It was believed that should consideration of charter
renewal be left until the end of the period, the succession
of the banks might become involved in a political controversy, such as occurred in the case of the First and Second
Banks of the United States, and their charters might automatically expire. Congress, therefore, by the Act of February 25, 1927, provided for indeterminate charters. As a
result the Reserve banks will continue to function unless
they are dissolved by an act of Congress or are required to
forfeit their franchises for violation of law,
66
All of these reports may be found in the Annual Report of the Federal
Reserve Board, 1914, pp. 167-178.
M
Willis, The Federal Reserve System, p. 639.

CHAPTER V
ADMINISTRATION AND CONTROL
By-Laws
The legal basis for the administration and control of the
Federal Reserve banks rests primarily upon the provisions
of the Federal Reserve Act and* then upon the Bank's bylaws. In section 4 of the Federal Reserve Act it was provided that the board of directors of each Federal Reserve
bank shall have power to prescribe by-laws "not inconsistent with law, regulating the manner in which its general
business may be conducted, and the privileges granted to
it by law may be exercised and enjoyed." The organizers
of the Federal Reserve system, however, did not wait for
the boards of directors of the Reserve banks to be organized and permit them to formulate by-laws for their respective banks in an uncorrelated fashion. This work was to be
done for them beforehand.
The Preliminary Committee on Organization first formulated a tentative set of by-laws.1 The Federal Reserve Board
then sent a tentative set to the directors of each Federal Reserve bank for their consideration with a view to bringing
about "a desirable uniformity" in the organization of the
Reserve banks.2 Suggestions were invited and were considered by the Committee on Legal Matters and Procedure
appointed at the Conference of Directors of Federal Reserve
banks with the Federal Reserve Board on October 20, 1914.
This Committee recommended a similar standard set of
by-laws 3 which was ratified by the convention with the
understanding that any Reserve bank could modify them to
1
Report to the Reserve Bank Organization Committee by the Preliminary
Committee on Organization, p. 22.
2
Circular No. 6, Federal Reserve Board, October 5, 1914, Annual Report
of the Federal Reserve Board, 1914, p. 74.
3
Circular No. 11, Federal Reserve Board, Annual Report of the Federal
Reserve Board, 1914, p. 167.

84 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

suit conditions peculiar to a district. It was substantially
this set of by-laws which the directors of the New York Reserve Bank originally adopted on October 28, 1914.4
Method of Electing Directors
The Federal Reserve Bank of New York is a corporation
having a charter from the United States Government. All
of its stock is owned by the member banks of its Federal
Reserve district. The member banks, as stockholders, have
voting privileges which entitle them to elect six out of the
nine directors of the Bank. For the purpose of voting for
directors, the Federal Reserve Board, in 1918, reclassified
the member banks in the New York district into three
groups, each group to consist as nearly as may be of banks
of similar capitalization. The previous requirement that
the groups were to consist also of approximately equal
numbers of banks had been eliminated. The Board's classification was as follows:5
Group 1. Banks having capital and surplus in excess of $1,999,000.
Group 2. Banks having capital and surplus not exceeding $1,999,000 and not below $201,000.
Group 3. Banks having capital and surplus below $201,000.

This classification is in effect at the present time but the
number of banks in the three groups differs widely. Group 3
contains the greatest number of banks. Group 2 is next with
about three-fourths the number in Group 3. The number in
the group of banks with the largest capitalization totals only
a small fraction of the number in each of the other two
groups.
In the matter of electing directors of the New York Reserve Bank, the procedure has been changed. While there
has been technical compliance with the Federal Reserve
Act, the practice has come to be something different from
that intended by the authors of the Act. The procedure now
* With a few minor amendments, these by-laws appear in the Annual Report
of the Federal Reserve Bank of New York, 1915, p. 57. Occasional amendments have been made to the by-laws to date. The by-laws in effect since
January 19, 1928, are in Appendix I, p. 409.
6
Annual Report of the Federal Reserve Bank of New York, 1918, p. 36.

ADMINISTRATION AND CONTROL

is this: The bankers' associations of the states served by
the Federal Reserve Bank of New York—New York, New
Jersey, and Connecticut, have cooperated to appoint a committee. When there is a vacancy on the board of directors
to be filled by the member banks, this committee canvasses
the situation and recommends some one to the member
banks for the nomination. Before this recommendation is
made it is ascertained whether the person so chosen will
serve on the board. It has been the custom to recommend
only one man for the nomination. Here begins the formal
compliance with the Federal Reserve Act. A number of
member banks of the group concerned send in the name of
the person recommended as the nominee. No other nominations are made.
There is no contest in the election, there being only one
candidate up for a vacancy. Some of the member banks then
go through the formality of filling out a ballot for this one
candidate and sending it to the Federal Reserve agent of
the Bank as provided in the Federal Reserve Act. Thus, it
is all a "cut and dried" matter, the banker-elected directors
of the Reserve Bank being already chosen in reality, though
not nominally, by this committee of the state bankers'
associations. When the recommendations for nominations
are made by the committee it has been announced that
the men so recommended would replace certain men on the
board of directors.6 It appears, therefore, that the real
power in determining who shall sit on the board as Class A
and Class B directors of the Reserve Bank resides in this
committee of the bankers' associations of the states in the
district.
As early as the second year of the Reserve Bank's history
member banks exhibited quite general indifference to their
voting privileges. And in the election held in December,
1917, only 84 banks cast their ballots out of a total of 224
in the group of banks then voting.7 In recent years, as then,
a large number of member banks have been neglecting to
6
The New York Times, Oct. 7,1932; New York World-Telegram, March 30,
1933. See also The New York Times, April 18, 1933.
7
Annual Report of the Federal Reserve Board, 1917, p. 31.

86 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

vote for directors. Under the present method of seating
directors, it is not strange that so many member banks fail
to exercise their franchise since voting for directors is now
only a perfunctory affair. Thus it is seen that, regarding the
plan of the Federal Reserve Act to bring about representative control of the Reserve banks by large and small banks
alike, the situation is quite different from that intended.
Concerning this, Dr. Willis says: "Small banks have voted
as large ones dictated; the grouping of banks for the election
of directors has been unsatisfactory and artificial; the public directors have been no more public than those chosen by
the banks." 8
Service of and Interests Represented by Directors
From the time of its establishment to December 31, 1933,
thirty-four men have served as directors of the Reserve
Bank of New York.9 Over half have come from New York
City. There have been several from elsewhere in New York
State, a few from New Jersey, but none from Connecticut,
only one county of that state being in the New York district. The period of service of the government directors
has been much longer than that of either of the other two
classes of directors while the Class A directors have shown
the greatest turnover. Of the directors elected by the banks,
those representing the banks have averaged a little over
four years service,10 and those representing business have
8

Journal of Commerce [New York], Jan. 24, 1927.
• Two new directors commenced service on January 1, 1934. For a list of
all the directors of the Federal Reserve Bank of New York, showing occupation, tenure, etc., see Appendix II, facing p. 412.
10
Special mention should be made of Mr. Robert H. Treman, president of
the Tompkins County National Bank of Ithaca, New York. His tenure constitutes a marked exception to that of the other Class A directors. Mr. Treman
served the Bank continuously from its establishment in 1914 to December 31,
1929, as a representative of the member banks. His term of service of more
than fifteen years was more than twice as long as that of any other Class A
director. It was also longer than that of any other director of the Bank. In
addition to being a director, he served as senior deputy governor for a period
of three years from 1916 to 1919. Moreover, during these years which included
the entire period of the nation's participation in the World War, Mr. Treman
was acting governor for one year when the governor was absent because of ill
health. From the beginning in 1914 to his retirement at the end of 1929 he

ADMINISTRATION AND CONTROL

averaged four and two-thirds years. But the government
directors, appointed t>y the Federal Reserve Board, have
served an average of seven and a half years.11
The occupations in which the thirty-six directors were
engaged prior to or during their connection with the Reserve
Bank are as follows:
Banking and finance
Manufacturing
Merchandising
Bank examining
Real estate
Public utilities
Mining

19
9
4
1
1
1
1

Of the eight men who have served as government directors,
three were engaged in banking, one was a national bank
examiner, one a financier, and three were chairmen of
boards of directors of manufacturing corporations. Of the
thirteen men who have been elected by the banks to represent "commerce, agriculture or some other industrial pursuit," six have been affiliated with manufacturing corporations, four with merchandising, and one each with mining,
real estate, and public utilities.
It will thus be noted that on the board of directors of the
New York Reserve Bank, in addition to the bankers of Class
A, industry and trade are widely represented. The lack of
influence of the agricultural interests in this district is evident from the fact that there has never been a director who
was representative of agricultural pursuits. There has been
some complaint that there has not been fair representation
of business interests as distinguished from banking interests
attended directors' meetings, coming from his home in Ithaca, nearly every
week and for a long time twice a week. (See Annual Report of the Federal
Reserve Bank of New York, 1929, p. 24.)
11
Another noteworthy exception to the usual length of service is that of
Pierre Jay. Mr. Jay was appointed a government director, chairman of the
board of directors and Federal Reserve agent at the time the Bank was organized. He served the Bank continuously in this capacity for more than twelve
years, from October, 1914, to December 31, 1926, when he resigned to accept
an appointment as American member of the Transfer Committee under the
Dawes Plan. (See Annual Report of the Federal Reserve Bank of New York,
1926, p. 34.)

88 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

in the Federal Reserve system. When the Senate Committee on Banking and Currency was investigating the national
and Federal Reserve banking systems in 1931, Owen D.
Young, who had been a director of the Bank since January.
1923, first as a Class B and then as a Class C director, gave
categorical answer to this question so far as the New York
Bank was concerned. He said there has been'' certainly ample
representation of the business interests as distinguished from
the banking interests" in the New York district.12
Influence of Stockholders
In the case of some of the Federal Reserve banks their
member banks have formed stockholders' associations which
hold annual meetings. These associations discuss their
mutual problems, have various committees at work, and
endeavor to influence the policy of their respective banks
and the Federal Reserve system. The situation as regards
the New York Reserve Bank is otherwise. The member
banks of the New York district have never had such an
organization. During its history, however, there have been
a few occasions when the officers of the Bank have held a
series of more or less formal conferences with member
bankers. In such cases the Bank invited the member bankers
in small geographical groups. Thus, a group at a time, as
those from one county or section, has met at the Bank and
opportunity was then offered for the presentation and discussion of the point of view of those member banks. In
determining the policy of the New York Reserve Bank, the
stockholders as a group exert no influence except indirectly
in the selection of two-thirds of the members of the Bank's
board of directors and then not in reality but only nominally.
Internal Organization
The committee of technical experts known as the Preliminary Committee on Organization laid the basis for the
12
Hearings before a Subcommittee of the Committee on Banking and Currency, United States Senate, 71st Congress, 3rd Session, pursuant to S. Res.
71,1931. (Hereafter cited as Hearings on Banking Systems, 1931.)

ADMINISTRATION AND CONTROL

internal organization of the Federal Reserve banks.13 The
Federal Reserve Board presented this committee's plan to
the directors of the Reserve banks in order as it stated "to
promote a desirable uniformity in the organization of the
Federal Reserve banks" and "as a basis for further discussion." 14 The Board recommended the adoption of a
uniform system of organization in all twelve Reserve banks
in so far as conditions would permit. In accordance with
the varied circumstances in the several districts, circumstances involving the nature of financial transactions and
the variable human element, substantially different systems
of organization have developed among the banks of the
system.
The internal development of the New York Reserve Bank
may be divided into two periods. The first extends from
the date of opening to September, 1919, and the second from
September, 1919, to date. In the first two months of its
existence, the temporary staff, which had been hastily
assembled to provide for the opening, was gradually replaced by a permanent staff. The work of the Bank was
divided among many departments, and all the operating
departments were centered in the office of cashier. This
first period, during which occurred the World War, involving sudden growth in the scope and volume of operations,
was one of rapid adjustment to meet new situations. It was
a period of experimentation consisting of almost continuous
shifting of personnel and departmental organization. There
was duplication of effort and lack of definite responsibility
and the form of organization proved to be of a temporary
character.15
In order to secure a more effective organization within
the Bank and to render more efficient service to all concerned, a new system was put into effect September 2, 1919.
Though some changes in departments and lines of control
have been made, the general plan of organization and man13

Report of Preliminary Committee on Organization to the Reserve Bank
Organization Committee.
14
Circular No. 8, Federal Reserve Board, Oct. 17, 1914.
18
Annual Reports of the Federal Reserve Bank of New York, 1915-1919.

As'lOfin'l

Mwager

DIT actor

„„.,„

Manager

FIG. 3.—Organization of the Federal Reserve Bank of New York

ADMINISTRATION AND CONTROL

agement then adopted is in effect at the present time. The
entire work of the Bank is divided along functional lines,
each function being under the immediate supervision of a
senior officer, with the title of controller.16 The controllers
are concerned with questions of policy. The responsibility
of each of them is subdivided into workable units. The
various functions are divided into departments presided
over by junior officers called managers, each of which is
responsible for the duties of operation or organization, as
the case may be, which attach to his department. In many
of the departments there are divisions each in the charge
of a chief. The division of control and the allocation of responsibility is in some cases carried still further for several
of the larger divisions are divided into sections each in the
charge of a supervisor.17
Management
The management of the Bank is carried on under the
supervision and control of its board of directors, the chairman of which is the Federal Reserve agent. This officer is
the appointee, and is legally constituted the official representative, of the Federal Reserve Board at the Bank. The
board of directors functions subject to the control vested
by law in the Federal Reserve Board. And while the directors appoint their managing officers the Federal Reserve
Board has power to remove any officer of the Bank so appointed. The board of directors meets once a week. For
the purpose of carrying out some of its functions, and to
act when it is not in session, the board of directors has an
executive committee. The directors have delegated to this
committee some important powers including that of passing
upon all discounts and advances.18 In general the executive
committee directs the business of the Bank subject to the
supervision and control of the board of directors, but its
work is for the most part turned over, or left, to the discretion of the governor. Responsible to the executive com16

See organization chart of the Bank, p. 90.
See organization chart of a typical function, p. 92.
18
See by-laws, Appendix I, p. 409.

Cash
Department

Manager

Cob & Bull Eon
Division

Money
Division

Cash Cuatodj
Dlli

C AwlBlfcnt Chief •
Supervisor

Cath Ptymenta

SuperrlBor

Certiflcatloufl
Autboililcs
ClcariLg Ilouee
Debits, Citdits
and Advkci
Office n Oath
£ Vtultod

General eupervlalon
of oounting and
sortlnjof ourrenuy
and ReoelvSog Teller

General superrlalon
of counting and
wrting of ourrenenr

Receipts of new
ourrenoT from U. 8.
Treasury and Federal
Itesarve Agent

Translers to vault
and PsjlDg DWlakn

General B i
of ctiuotlng and
Sorting ot ourrenqr
Cufltodjof Taulted
unoouAt&d ones and
twos
Tfunsfcre to vault
and from vault to
Counting Unit*

Paying
Receiving
Counting
& V T l

Examination! and
StltlStiCB

a. 4.—Organization of a Typical Function, Federal Reserve Bank of New York, Cash Function

ADMINISTRATION AND CONTROL

mittee and the board of directors is the governor who is
the operating officer of the Bank. The operating functions
are allocated to several deputy governors. The governor
has no functions under his special jurisdiction but controls
all these functions through his deputies.
The Federal Reserve Agent and Governor
The Federal Reserve agent is charged, in the Federal Reserve Act, with certain duties and responsibilities. He is
chairman of the board of directors and as such is the head of
the New York Reserve Bank and is responsible for leading in
the policies pursued by the Bank. He is also Federal Reserve
agent and as such he is to maintain a local office of the
Federal Reserve Board on the premises of the Bank and
be the Board's official representative. In this capacity he
is expected to be an official observer for the Board—a
guarantor for the conduct of the Bank and the performance
of functions conferred upon the Board by the Act. He is
to make regular reports to the Board and keep it informed
as to conditions in his district. As Federal Reserve agent
he also issues, for the Board, Federal Reserve notes to the
Reserve Bank and has charge of their withdrawal. Ancillary
to this function he has charge of passing upon the collateral
security tendered for the Federal Reserve notes and its
safekeeping. For the purpose of carrying out these functions several departments have been organized in the
Bank under the special jurisdiction of the Federal Reserve
agent. These are the departments of Note Issues, Reports, Member Bank Relations, Bank Examination, and
Auditing.
The title of governor is unknown to the Federal Reserve
Act. It was given to the operating officer of the Reserve
banks by the Federal Reserve Board under its general administrative powers upon the solicitation of one of their
number who urged that it would dignify the position and
make it more attractive to bankers of ability and fitness for
the position. The title of governor has been traditionally
held by the heads of several foreign central banks, noteworthy being the head of the Bank of England. But the

94 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

governor of the Federal Reserve Bank of New York is not
in the same position as the governor of the Bank of England.
The governor of the Bank of England is the chairman of
the board of directors and the head of that bank. The
chairman of the board of directors or chief executive officer
of the New York Reserve Bank is not the governor of the
Bank but an appointee of the Federal Reserve Board who
in addition to his appointment to the chairmanship is designated Federal Reserve agent. The governor of the Reserve Bank occupies a position de jure comparable to that
of the comptroller of the Bank of England or the senior
general manager of a Joint Stock Bank.
The board of directors of the Reserve Bank is charged
with the duty of directing the policy of the Bank and not,
of course, with the execution of that policy, except in so
far as it would be expected to know that the policy it formulates is carried out. Hence the chairman of the board of
directors and not the governor of the Bank may be expected
to lead in determining the policy of the Reserve Bank, not
only because he is a member of the policy determining body
but because he is the chairman of that body. Such was the
intention of the provisions of the Federal Reserve Act19
and such was the decision of the Federal Reserve Board at
the time of the establishment of the Federal Reserve banks.20
For the purpose of executing the policy of the Bank the
Federal Reserve Act provided that the board of directors
should appoint officers not otherwise provided for by the
Act. It did appoint an operating officer who is called governor. In the course of the development of the New York
Reserve Bank, the position of governor has become one of
greater importance and influence, whereas that of chairman
and Federal Reserve agent has declined.
19

Hearings on Banking Systems, 1931, pp. 292-293.
Regarding the question of the relative status of the chairman and operating
head, Dr. Willis said: " . . . after much discussion the Board finally resolved
to say to all inquirers that the distinction between the Federal Reserve agent
and the operating head of the bank was to be in a general way the distinction
between the maker of a policy or the developer of a general system of organization and the factor employed to carry it out." Willis, The Federal Reserve
System, p. 689.
20

ADMINISTRATION AND CONTROL

Subordination of Federal Reserve Agent to Governor

Let us review briefly some of the activities of the men
that have held these executive positions. The chairman and
Federal Reserve agent has worked for the most part quietly
in the Bank. His outside activities have been largely confined to addresses before bankers and other business groups
and civic organizations. On the other hand the governor,
in addition to such addresses, has been head of the Central
Liberty Loan Committee of the New York Federal Reserve
district during the war, head of the Open Market Investment
Committee of the Federal Reserve system, and representative of the Bank in the central bank conferences at home and
abroad with the heads of foreign central banks. During
the depression, there was held at Washington, D. C, in
August, 1932, the so-called National Conference of Business
and Industrial Committees, meeting upon the invitation of
President Hoover. This conference voted to create a central
committee to " bring Federal agencies and private business
into an immediate six-point campaign to expand credit and
spread employment." To this central committee were
named the chairman of the banking and industrial committees of each of the Federal Reserve districts and nine
other men, one of whom was the governor of the New York
Reserve Bank.21 Here was, officially at any rate, a Federal
government-initiated effort involving the cooperation of
government and private agencies, but the Federal Reserve
Bank official who was appointed a member of the central
committee was not the chairman and Federal Reserve agent
but the governor. Again, in 1932, the governor of the Bank
met with the governors of the other Federal Reserve banks
in Washington as often as three tunes in three months, and
was regarded as having not only discussed but planned policies involving his own Bank and the Federal Reserve
system.22
Besides all of these means by which the policy of the
Bank has been in the hands of the governor, the governor
has been the dominant factor in determining the policy of
21
22

The New York Times, Aug. 27, 1932.
The New York Times, July 16,1932.

96 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the Bank by shaping the policy of the board of directors.
How has this been possible since the governor is not a member of the board of directors? The stockholding member
banks naturally desired to control the policy of the Reserve
Bank through the office of governor. Benjamin Strong, the
first to hold the office at the Federal Reserve Bank of New
York, possessed a personality which supplied such leadership.
Soon after the Reserve Bank was established it became the
practice for the governor to sit with the board of directors in
their meetings for the purpose of attaining more harmony
and efficiency.23 Though the governor was not a member of
the board of directors and could not vote, this was not
necessary in order for him to furnish the leadership in developing the Bank's policy. The board of directors was not
only receptive but encouraged leadership on the governor's
part. It was the practice of the board of directors at their
weekly meetings to ask the governor if he had any recommendations to make concerning, for example, the vital
question of discount policy. If the governor recommended a
change, it was discussed by the directors.24
While it was intimated at the time of the appointment
of Benjamin Strong as governor of the Bank, that the Federal Reserve agent as chairman of the board of directors
would " exercise a dominating influence over the affairs of
that institution/' such was not the case. Mr. Jay as Federal
Reserve agent worked under the direction of Mr. Strong as
governor of the Bank. And while Mr. Strong was not a
member of the board of directors he sat with the board and
influenced its deliberations.25 This subordination of the office of chairman-Federal Reserve agent to the office of
governor, although contrary to the Federal Reserve Act, has
continued under Mr. Strong's successor, G. L. Harrison.26
23

Willis, The Federal Reserve System, p. 695.
Hearings on H. R. 11806 before the Committee on Banking and Currency
of the House of Representatives, 70th Congress, 1st Session, 1928, p. 14.
(Hereafter cited as Stabilization Hearings on H. R. 11806, 1928.)
25
See Financial Age, Oct. 10, 1916, p. 605, and Hearings before the Committee on Banking and Currency of the House of Representatives on H. R.
7895, 69th Congress, 1st Session, 1926, p. 859. (Hereafter cited as Stabilization Hearings on H. R. 7895, 1926.)
26
Hearings on Banking Systems, 1931, pp. 292-293.
24

ADMINISTRATION AND CONTROL

Another way by which the governor succeeded in dominating the policy of the Bank was through the executive committee of the board of directors of which he was the chairman.
There existed, then, the anomalous situation whereby the
directors' executive committee was headed by an officer who
was not a director. In this way, an unofficial alteration of
structure and control has come about in the organization
of the New York Reserve Bank. The executive committee,
as has been seen, was delegated important powers of policy
and control by the board of directors. The board of directors
accepted the leadership of the governor in matters of policy.
The fact that six of the nine members of the board of directors were elected by the member banks and that they
elected the governor made it possible for the governor to
assume the leadership rather than the chairman who was
an appointee of the Federal Reserve Board, representing
the Government.
On questions of policy affected with a public interest, involving a possible controversy between the government
directors on the one hand and the bank or private directors
on the other, the balance of power rests with the directors
chosen by the member banks. Fortified with this division
of legal corporate power in the board of directors, of which
the governor was undoubtedly aware, advantage was taken
of his position as operating officer of the Bank to increase
his authority and project the scope of his control over questions of general policy. In this situation there were two
courses open to the chairman and Federal Reserve agent.
He could make an issue of authority over certain matters
as they came up, or he could permit himself to become
subordinate to the governor. He chose the latter course.
There is no evidence to indicate that the chairman ever
made an issue of the matter of relative authority. But that
he has subordinated himself to the governor in the leadership of the Bank and problems of general policy is a matter
of record.
There were two other factors which tended to cause the
subordination of the chairman and Federal Reserve agent
to the governor of the Bank. These involved the corre-

98 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

spondence between the Federal Reserve Board and Bank
and the salaries. In the beginning the Federal Reserve
Board communicated with its representative at the Bank,
the Federal Reserve agent and chairman. But during its
first year the Board developed the practice, following the
complaint of governors of the Reserve banks, of sending a
duplicate communication to the governor, when it addressed
the agent. The next step was that the Board addressed the
governor of the Bank and sent a duplicate of the communication to its representative. And finally the Board communicated with the governor when any very important matter
was involved, sending less and less duplicates to the Federal
Reserve agent.27 The effect of all of this was the elevation
of the governor over the chairman-Federal Reserve agent.
So far as the salaries of the chairman-Federal Reserve
agent and the governor are concerned the original wide
divergence between them at once elevated the governor
above the Federal Reserve agent. Various observers at the
time considered such a difference in the salaries of the two
officers a serious mistake,28 some considering the salary of
the governor much too high relative to the salaries of the
members of the Federal Reserve Board. But bankers contended that it was necessary to offer a salary comparable to
those paid the officers of the commercial banks in New York
City in order to attract the kind of man to take the position
of governor. On the other hand, since the chairman-Federal
Reserve agent was a United States Government appointee,
his salary was obliged to bear a reasonable relation to the
salaries paid such officials in Washington. Thus the delicate
question of adjusting salaries was decided. The annual
salary of the chairman-Federal Reserve agent was set at
$16,000, while the governor was paid $30,000.
From this financial elevation of the governor to so much
higher a level of salary than the chairman-Federal Reserve
agent, it was an easy step to the feeling of subordination of
the office of the former to the latter. Both being officials
in the same institution and both being engaged in adminis27
28

Willis, The Federal Reserve System, pp. 699-700.
Ibid., p. 690.

ADMINISTRATION AND CONTROL

trative work, the fact that the governor received nearly
twice the salary paid the Federal Reserve agent could have
but one meaning to the banking community—that the
governor occupied the leading position in the Bank and was
the superior officer of the Federal Reserve agent. The
chairman, consequently, came to look upon himself as
assuming a secondary role in the Bank and acted accordingly.
During the course of the development of the Federal
Reserve system, the point of view which in the beginning
determined salaries of $16,000 and $30,000 for the chairmanFederal Reserve agent and governor respectively of the
New York Bank became modified. Not only was the salary
of the governor raised to $50,000 in 1919 but the divergence
in the relative financial position between the two was gradually lessened.29 Finally, in 1927, the salary of the chairmanFederal Reserve agent was raised to the same amount paid
to the governor, $50,000.
Representation of the Public
The Federal Reserve Board, which approved the increase
of the chairman's salary, issued a statement indicative of
the regard in which it held the office of chairman-Federal
Reserve agent at the New York Reserve Bank. Said the
Board:30
There is no more responsible or important position in the
Federal Reserve banks than that of chairman and Federal Re29
Official salaries of the chairman-Federal Reserve agent and governor of
the Federal Reserve Bank of New York, 1915 to 1933, are as follows:*

Federal ReFederal Re- i-l*"kTroi*n
/"Yi
Governor
serve Agent
serve Agent \J\} V el il\Jl
1915
$30,000
1925
$30,000
$50,000
$16,000
1916
16,000
30,000
1926
40,000
50,000
1917
20,000
30,000
1927
50,000
50,000
1918
20,000
30,000
1928
50,000
50,000
1919
30,000
50,000
1929
50,000
50,000
1920
30,000
50,000
1930
50,000
50,000
1921
30,000
50,000
1931
50,000
50,000
1922
30,000
50,000
1932
50,000
50,000
1923
30,000
50,000
1933
50,000
50,000
1924
30,000
50,000
* Compiled from the Annual Reports of the Federal Reserve Board.
30
Federal Reserve Board, statement released for publication, Feb. 10, 1927.

100 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
serve agent at the Federal Reserve Bank of New York. The chairman of the board is, in a special sense, the guarantor to the Federal Reserve Board and to the public of the good functioning of his
bank. In his capacity as Federal Reserve agent he is the official
representative of the Federal Reserve Board at his bank.

In its first annual report, the Federal Reserve Board had
stated that the Federal Reserve agent was "intended to be
a government representative and spend his time in furthering the interests of the public at large, a position he could
hardly preserve were he to become an active operating
officer, anxious to increase profits and advance given private interests." 31 So far as the law and the intentions of
the framers of the Federal Reserve Act are concerned, he
was to act in a dual capacity, being the government representative and the chief officer of the Bank. As the New
York Reserve Bank has developed, the conditions of administration and control have been different from those intended.
As we have seen, the governor has been the dominant factor in determining the policy of the Bank, and the chairmanFederal Reserve agent has been reduced chiefly to a figurehead presiding at meetings of the directors and custodian
of notes and collateral security.32 Furthermore, after his
salary was raised to the amount received by the governor,
the subordination in which the chairman was placed in the
beginning continued.
In his capacity as the representative of the Federal Reserve Board, again, the chairman has not been functioning
in the way that was intended.33 Although the $50,000 annual
31

Annual Report of the Federal Reserve Board, 1914, p. 121.
Consult also Willis, The Federal Reserve System, pp. 696-697; Hearings
on Banking Systems, 1931, pp. 292-293.
Dr. Adolph C. Miller, a member of the Federal Reserve Board from the
time of its organization in 1914 to date, stated before the House Banking and
Currency Committee that he was of the opinion that the position of chairmanFederal Reserve agent should be broken up into two positions—"one, chairman of the board of his bank, and the other, Federal Reserve agent—the
Federal Reserve agent to be a functionary in the bank, an agent of the Federal
Reserve Board on the premises of the bank for the issuing of notes, etc., but
not a director of the bank; the chairman to be the official representative of
the Board in its relations with the Reserve bank." Stabilization Hearings
on H. R. 7895, 1926, p. 859.
33
Stabilization Hearings on H. R. 7895, 1926, p. 859.
32

ADMINISTRATION AND CONTROL

101

salary which the Federal Reserve agent has received from
1927 evidences the regard in which the Board holds the
position, in actual practice, as a subordinate to the governor
of the Bank he has been more or less interested in the operation of the New York Reserve Bank as against general
policy and the point of view of the Federal Reserve Board.34
An outstanding instance of ill consideration of the public's
interest is afforded by the failure of a large member bank in
New York City in 1930.35 This involves one of the functions
of the Reserve Bank, that of the examination of member
banks, which had been specifically assigned to the Federal
Reserve agent. The management of the failed member bank
had been addicted to the practice of organizing real estate
security-holding affiliates. These security affiliates were engaged in buying up securities and speculating in the stock of
the bank itself. The bank commonly made loans to individuals and corporations on their notes, which merely represented real estate equities, and also on notes collateralled
with the stocks of real estate affiliates. Furthermore, the
bank issued new shares of its own stock coupled with shares
of stock in an affiliated securities corporation.
It was generally known in usually well-informed quarters
that these things were going on and that the condition of
the member bank was in bad shape.36 Chairman Case, the
Federal Reserve agent, declared that the officers of the
Reserve Bank had not had "full confidence" in the management of the member bank for a period of years.37 Presumably then, the Federal Reserve officers possessed at
least general knowledge of what was going on. And yet the
Federal Reserve agent, under his examination function,
34

Idem.
The member bank was the Bank of United States, a state bank chartered
by the state of New York. It had no connection with the Government of the
United States. It was unfortunate that it possessed the title it did. Such a
bank could not have used the name "United States" in its title if it had been
organized after a law enacted in 1926 regarding limitation on the use of the
words "Federal," "United States," or "Reserve." (Act approved May 24,
1926; 44 Stat., 628.)
36
Hearings on Banking Systems, 1931, p. 498. See also page 311 of these
hearings.
37
Ibid., p. 116.
35

102 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

did not find out in good season the non-liquid condition of
the bank's assets; or if he did know of this condition he did
not announce or publish his findings for the protection of
the public. The member bank subsequently failed causing
the loss of millions to depositors .and dire distress.38
The government directors, of which the chairman-Federal
Reserve agent is one, have been no more " public" than
those chosen by the banks.39 The Federal Reserve agent
has been for the most part an operating officer, a local
New York Reserve Bank official, interested in his particular
bank.40
Governors Council
About the time of the organization convention at Washington in October, 1914, there was formed the Governors
Council whose chairman was the governor of the Federal
Reserve Bank of New York. The council had a paid secretary who was also an officer of the New York Reserve Bank.
There has never been any published statement as to the
origin of the idea or of the actual organization of this council.
It has been supposed that the project originated with some
of the officers of the larger banks or with one of the original
members of the Federal Reserve Board.41 The first record
of such an organization is contained in the report of one of
the committees of the convention of officers and directors
of the Federal Reserve banks held at Washington in October,
1914.42 This report was by the committee on rediscount
which was the only committee on which the Board member
referred to sat. In its report under date of October 21, 1914,
the committee said:
38

At the time of closing the deposits amounted to about $160,000,000.
Cf. Journal of Commerce [New York], Jan. 24, 1927.
40
Before the Senate Committee on Banking and Currency, in 1928, Professor Willis commented thus: "We had supposed that the establishment of
the Reserve system had been to supervise our banking and make its action
more public spirited than it was under the old banking system; but the actual
working out shows how difficult it is for anyone to foresee the future. It has
not done it." Hearings before the Senate Committee on Banking and Currency on S. Res. 113,1928, pp. 24r-25. (Hereafter cited as Hearings on Brokers'
Loans, 1928.)
41
Willis, The Federal Reserve System, p. 703.
« Annual Report of the Federal Reserve Board, 1914, p. 171.
39

ADMINISTRATION AND CONTROL

103

It is believed wise that an executive council should be formed,
consisting of the twelve governors, with the deputy governors as
alternates, to which should be referred the matter of determining
the date and manner of undertaking, from time to time, such
additional functions as the following:
[Here follows a list of important powers devolving upon the
Federal Reserve Board by the Federal Reserve Act.]
In order that the very minimum of machinery may be employed
in the first days of operation it is thought that even (a) transfers
between member banks and (b) transfers between Federal Reserve banks should be deferred until the executive council43 suggested is satisfied that the necessary preliminaries have been
arranged for such transactions.44

Here we have the first intimation of this extra-legal organization, headed by the governor of the New York Reserve
Bank, setting itself up as practically a higher directing
authority than the Federal Reserve Board.
The first formal meeting of the Council of Governors took
place in Washington, December 10-12, 1914.45 The governor
of the New York Reserve Bank was elected head of the
council and also the head of a committee which functioned
in a sort of inter-regnum capacity.46 Thereupon, a cleavage
between this council and the Federal Reserve Board arose
concerning, fundamentally, the question of who should control the affairs of the Federal Reserve system—the managers
of the Federal Reserve banks or the Federal Reserve Board.
The Federal Reserve Board, or a majority of its membership, held that the Federal Reserve Act gave such control
to the Board. As an example of the peremptory attitude
of the governors, at their December, 1914, meeting, the
New York Reserve Bank reported that "it was decided to
continue for a few months the practice of receiving at par
checks on Federal Reserve banks in order to observe the
results of facilitating in this way the transfer of money
between the twelve Federal Reserve cities." 47
The attitude of the council and its members became more
43
44
45

Italics are the author's.
Annual Report of the Federal Reserve Board, 1914, pp. 171-172.
Annual Report of the Federal Reserve Bank of New York, 1915, p. 13.
46
The New York Times, Dec. 12, 1914, p. 8.
47
Annual Report of the Federal Reserve Bank of New York, 1915, p. 13.

104 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

and more domineering. Referred to as the "council," a concession to the feeling of the Federal Reserve Board was
made, beginning probably in 1916, when it was called the
Governors Conference or Conference of Governors.48 Under
this title the governors held four formal meetings each year
in 1916 and 1917. Very little ever got into the newspapers
about such meetings or the activities of the governors, but
they apparently worked consistently to undermine the
power of the government board. Their assumption of authority and refusal to carry out the instructions of the Federal
Reserve Board continued to such length, however, that
when Mr. Harding assumed office as governor of the Board,
he resolved to terminate the governors' assumption of extralegal authority. Governor Harding informed the Reserve
bank governors that the Board could not allow the meetings
of the Governors Conference to continue. Such a policy
was carried out during the period of Mr. Harding's governorship. The Federal Reserve Board could not prevent
the twelve governors of the Federal Reserve banks from
getting together and discussing their mutual problems and
there never had been any reason why it should do so.49 But
what it did feel was unauthorized was the formal organization of the managers of the Reserve banks and the assumption of powers of the Federal Reserve Board.50
The New York Reserve Bank governor was the dominant
figure of this group and he was usually made chairman of
the organization. The idea of a body of Reserve bank officials grouped around the New York Bank's official and not
subject to administrative or governmental control continued
to persist. In 1922 the governors demanded the right "to
meet officially when and where they would for the purpose
of independent deliberation, free of supervision [and presumably of the presence of any members] of the Federal
Reserve Board itself." 51 The policy decided upon at that
time was that the Board would summon the governors to
48
Willis, The Federal Reserve System, p. 705.
«Ibid., p. 707.
60
Hearings on Banking Systems, 1931, p. 157.
"Willis, op. cit, p. 708.

ADMINISTRATION AND CONTROL

105

Washington for recognized meetings at which would be
present one or more members of the Federal Reserve Board.52
This the Board has done and such meetings have been held
each year.
The Open Market Policy Conference,53 which was in
existence from March, 1930 to June, 1933, was composed
of representatives of all the Reserve banks and in practice
of their governors. The Open Market Policy Conference
did not supersede the Governors Conference. Both organizations consisted of the same body of men but acting in a
different capacity.54 In recent years, the so-called Governors Conference has met only upon the invitation of the
Board and it has come to be in effect a conference of governors with the Federal Reserve Board.55 While the
Governors Conference is not defunct it is responsible to the
Federal Reserve Board and it was stated by a member of
the Board that "its deliberations are mainly confined to
technical matters." 56 Thus the effort and apparent tendency
in the early years of the system to form a central body of
governors headed by the representative of the New York
Bank, which would act authoritatively, independent of the
Federal Reserve Board, and, therefore, practically supersede that central authority created by the Federal Reserve
Act, was unsuccessful.
62

Idem.
See chapter VIII, p. 174.
54
Hearings on Banking Systems, 1931, p. 157.
65
Idem.
56
Testimony of Adolph C. Miller, idem.

CHAPTER VI
FINANCES
Sources of Funds
The funds with which the Federal Reserve banks commenced business in November, 1914, were furnished entirely by the member banks. They were secured by the
sale of capital stock to the member banks and by the deposit of their reserves. The amount of the capital stock of
the Reserve banks depended upon the amount of the capital
and surplus of the member banks. Each member bank was
required to subscribe for capital stock of the Reserve Bank
in an amount equal to 6 per cent of its capital and surplus.
One-half of the subscribed amount had to be paid while
the remaining half was subject to the call of the Federal Reserve Board. The Board has never called for the second
half. The capital stock of a Reserve bank, therefore, increased or decreased with the increase or decrease in the
number of its member banks and their capital and surplus.
All reserves of the member banks were required (since
June, 1917) to be kept at the Federal Reserve banks and
there was a legal minimum for such reserves which consisted
of a percentage of the deposit liabilities of the member
banks. The Reserve banks also secured working capital by
accepting deposits of the United States Government, nonmember clearing banks, and foreign central banks. The Reserve banks have not accepted deposits from individuals or
business concerns. The bulk of the New York Reserve
Bank's deposits have been those of its member banks. In
addition to the above sources of funds, the Reserve banks increased their assets by profits which were transferred to surplus in due course according to statute.
Total Earnings
The first year earnings of the New York Reserve Bank
were merely nominal. They were not sufficient to cover all

106

FINANCES

107

the expenses. There was very little demand for loans in the
money markets. On the other hand, reduction in the reserve
requirements of member banks resulted in the availability
of a plethora of bank credit. Reserve banks did not wish to
compete with member banks in discounting bills in the open
market. In the second year, a slightly better record was
made but it was not until our participation in the World
War that earnings began to mount. Beginning in 1917,
they increased rapidly till they reached their peak for all
time in 1920 at $60,000,000. These large earnings reflected
the unusual fiscal operations of the Government in connection with financing the war. In 1921 the earnings were
about the same as for 1919 but for each of the following
years they have been markedly less. In the post-war years,
significant is the period of wild speculation in securities
which some were wont to call the "new era," the idea being
that new levels in stock prices were reached which would
not drop to former levels.
This era of stock speculation, which began in 1925 and
collapsed in October, 1929, reflects the increasing activity of
the New York Reserve Bank in the stock market by supplying funds to member banks and buying securities in the
open market. This activity of the Bank resulted in greatly
enlarged income. During this time the earnings of the
Bank increased from $10,000,000 in 1925 to $19,000,000 in
1929. The depression years of 1930 and 1931 showed a
great falling off in earnings, the Bank being unable to pay
dividends the latter year without drawing on its surplus.1
The large increase of earnings during 1932 and 1933 over
the previous two years, in spite of the continuing depression,
reflected the extra effort to stimulate business recovery by
forcing excess reserves upon member banks by buying
government securities.
During the decade of the 720s the earnings were materially
reduced below what they otherwise would have been because of the presence of the market for federal funds. This
market originated in 1921 with the sale by some member
banks in New York City of their excess balances at the
1

See Table 4, p. 114.

108 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Reserve Bank to member banks in debt at the Bank. Since
then the federal fund market has developed to a high degree.
The use of the federal fund market means that (1) banks in
debt to the Reserve Bank have been able to liquidate their
indebtedness by borrowing, for a day at a time, from commercial banks, and (2) banks with deficiencies in their
reserve accounts may make them up not by borrowing from
the Reserve Bank but by borrowing the excess Federal
Reserve balances of other banks. By this practice the
banks have brought about a curtailment of the earnings of
the Reserve Bank.
Sources of Earnings
The earnings of the Reserve banks have been derived
generally from interest on rediscounts and advances to
member banks and interest on securities and acceptances
purchased in the open market. A few miscellaneous sources
augmented these incomes slightly.2 During its first two
years, the New York Reserve Bank's loans and discounts
were so nearly zero that it adopted the policy of buying
municipal warrants and acceptances in order to meet expenses. During this period also, part of the Bank's income
consisted of "service charges/' that is, charges at one cent
per item made to member banks depositing checks with the
New York Reserve Bank for collection. Such charges,
however, were abandoned about the middle of 1918.
Interest on discounted bills, which include rediscounted
paper, has comprised the major part of the New York
Bank's earnings. A very large proportion, however, of the
earnings from this source was secured during the relatively
brief period of war-financing. The year 1930 witnessed a
sharp drop in such earnings and they continued at a low
level during the succeeding depression years, reflecting the
depressed activity of business and the fall in interest rates.
During the four years, 1930-1933, more than two-thirds of
the total earnings of the New York Bank were derived from
United States Government securities. This extremely high
2

See Tables 1 and 2, pp. 109, 111.

TABLE 1

EARNINGS OF THE FEDERAL RESERVE BANK OF NEW YORK, BY SOURCES *
(Before deduction of expenses)
Earnings
Year
1914-15
1916
1917
1918
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
Total

g
<o

Total
$

345,035
971,026
4,929,214
25,314,736
35,332,412
60,525,321
34,710,274
11,349,279
11,413,183
8,569,350
10,217,174
10,600,968
10,647,759
18,483,042
19,314,279
10,393,189
7,555,213
15,948,943
17,523,930
314,144,327

On
Discounted
Bills

On
Purchased
Bills

36,782
37,368
2,455,533
17,736,261
29,935,911
49,839,183
30,762,021
3,970,210
8,255,646
2,613,566
5,188,506
5,836,836
4,614,110
12,210,527
12,492,642
1,910,378
1,661,805
3,276,595
2,572,465
195,406,345

97,135
530,484
1,843,325
5,411,821
3,334,605
8,323,050
1,829,665
1,619,512
1,969,837
1,446,693
1,469,858
2,001,668
2,558,080
3,482,649
3,522,642
1,917,937
1,638,210
932,505
288,117
44,217,793

* Compiled from the Annual Reports of the Federal Reserve Board,

On U. S.
Government
Securities
$

81,645
378,668
1,561,839
1,888,497
1,975,649
1,955,970
5,227,488
1,087,251
4,165,856
2,984,698
2,379,546
2,960,563
2,421,172
2,459,163
5,895,425
3,613,854
11,157,507
14,255,732
66,450,523

Deficient
Reserve
Penalties
$ 18,565
27,192
36,405
141,664
63,804
49,738
40,800
24,974
33,422
45,386
28,680
46,009
96,076
. 27,066
17,425
44,367
19,476
761,049

From
Miscellaneous
Sources
$211,118
321,529
233,123
577,623
136,994
245,775
98,814
482,331
59,649
318,261
540,690
337,532
486,326
322,685
743,756
642,383
623,919
537,969
388,140
7,308,617

110 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

proportion of earnings from "governments" reflected the
Bank's effort to break the depression by pumping credit
into the market.
The figures given for earnings on discounted bills include
interest on the promissory notes of member banks secured
by eligible collateral. Although the bulk of such collateral
has consisted of government securities, officers of the Bank
have, on numerous occasions, stated that the member
banks had at the time of application for such loans an amount
of eligible commercial paper in their portfolios at least
equivalent to the amount of Federal Reserve credit applied
for. The extensive development of borrowing excess Federal
Reserve balances of other banks in lieu of borrowing from
the Reserve Bank has accounted for a curtailment of earnings on discounted bills.3
The significant proportions that open market operations
have assumed is evidenced in the fact that over one-third
of the total earnings has been derived from them. Earnings
from acceptances and United States Government securities
purchased in the open market have exceeded those from
loans and discounts in nine years—1914, 1916, 1922, 1924,
1927, and 1930 to 1933. In the case of the first two years the
Bank was trying to get on its feet, and in the absence of
scarcely any demand for rediscounts, endeavored to pay
expenses and meet dividend requirements by buying interestbearing securities. In 1922 the purchases were made with
the same ends in view. In 1924 and 1927 the Bank was
motivated by an "easy money" policy for a variety of reasons. During the four years of 1930 to 1933 the Bank
purchased heavily for the purpose of creating an upturn in
the security and commodity markets. While in the case of
single years and the entire period, as between Federal Reserve banks, there have been wide variations in the relative amounts of earnings derived from their various sources,
the figures for the Federal Reserve system are strikingly
similar to those of the Federal Reserve Bank of New
York.
* See above, pp. 107-108.

TABLE 2

EARNINGS OF ALL FEDERAL RESERVE BANKS, BY SOURCES*
(Before deduction of expenses)
Earnings
Year
1914-15
1916
1917
1918
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
Total

Total

On
Discounted
Bills

$ 2,173,252
5,217,998
16,128,339
67,584,417
102,380,583
181,296,711
122,865,866
50,498,699
50,708,566
38,340,449
41,800,706
47,599,595
43,024,484
64,052,860
70,955,496
36,424,044
29,701,279
50,018,817
49,487,318
1,070,259,479

$ 1,218,516
1,025,675
6,971,479
48,348,007
80,768,144
149,059,825
109,598,675
26,523,123
32,956,293
15,942,845
17,679,549
22,551,561
17,010,778
38,334,140
47,790,662
10,672,215
9,820,546
17,881,058
9,137,038
663,290,129

On
Purchased
Bills
$ 244,664
1,560,918
4,951,729
11,939,808
13,994,544
22,020,158
5,234,141
5,628,956
9,371,288
5,709,809
9,103,915
10,003,081
9,206,677
13,020,535
12,063,349
6,081,187
5,009,541
2,785,213
1,238,068
149,167,581

' Compiled from the Annual Reports of the Federal Reserve Board.

On U. S.
Government
Securities
$

171,831
1,106,860
2,367,989
3,828,782
5,761,300
7,140,615
6,253,854
16,682,463
7,444,089
14,712,593
12,783,001
12,589,119
14,206,174
10,827,702
8,163,486
17,273,331
12,428,297
26,923,568
37,529,872
218,194,926

Deficient
Reserve
Penalties
$

1,157
194,526
698,991
727,844
1,573,335
1,177,562
602,951
521,061
381,619
310,406
382,946
273,839
277,401
449,653
225,748
296,960
541,432
191,051
8,828,482

From
Miscellaneous
Sources
$ 538,241
1,523,388
1,642,616
2,768,829
1,128,751
1,502,778
601,634
1,061,206
415,835
1,593,583
1,923,835
2,072,888
2,327,016
1,593,082
2,488,346
2,171,563
2,145,935
1,887,546
1,391,289
30,778,361

112 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Expenses
The gross earnings of the Federal Reserve Bank were
applied to operating expenses, charges for depreciation on
buildings and reserve accounts, dividends, surplus, and the
United States Government franchise tax. The cost of operating the New York Reserve Bank the first year (1914-1915)
amounted to nearly $300,000. The Bank began its work as
fiscal agent and depositary of the United States on January 1, 1916.4 These duties involved relatively little effort
until the entry of the United States into the World War in
April, 1917, and so it was decided that their cost be absorbed
by the Bank. When the war-financing operations conducted
by the Bank necessitated greatly increased expenditures in
1917 its total current expenses began to mount. But the
Bank was reimbursed by the Treasury for practically all
direct expenses incurred in carrying on those functions during the war period and until June 30, 1921. Since that
date the Bank has been reimbursed for only those expenses
incurred directly in connection with the sale of new issues
of government securities.5
Another important factor in causing the large increase in
current expenses during the war was the expansion of free
services for member banks. Following the war the free
services continued to show a substantial increase. These
have been justified on the ground that they were a primary reason for the establishment of the Federal Reserve
system. It was expected that the member banks would receive substantial benefits in the form of services rather than
profits in return for the placing of their funds with the
Federal Reserve banks. Such services they received in addition to the protection afforded them against financial panics
or other emergencies. In 1920 the total expense for operations reached over $6,000,000 and since then has assumed
more or less constant proportions, having never fallen below that amount in any year.6 All of the expense items are
relatively small in comparison with the amount paid in
4

Annual Report of the Federal Reserve Bank of New York, 1916, p. 21.
•See Table 3, p. 113.
•See Table 4, p. 114.

113

FINANCES
TABLE 3

FISCAL AGENCY EXPENSES OF THE FEDERAL RESERVE
BANK OF NEW YORK, 1917-1931 *
Expenses
Absorbed by
F. R. Bank

Year

Total

Reimbursable
Expenses

1917
1918
1919
1920

$ 900,040
4,821,309
4,963,642
1,516,455

1921
1922
1923
1924

674,261
605,812
842,480
315,315

481,787
209,289
422,091
48,469

$ 192,474
396,523
420,389
266,846

1925
1926
1927
1928

233,494
189,339
246,255
189,983

18,544
15,190
111,777
88,809

214,950
174,149
134,478
101,174

1929
1930
1931

100,116
90,766
105,659

17,681
20,158
29,193

82,435
70,608
76,466

Total

15,794,926

13,664,434

2,130,492

* Source: Federal Reserve Board. Figures since 1931 were unavailable.

salaries. In 1931, for example, out of total current expenses
of six and a half million dollars, approximately two-thirds
was spent for salaries.
The volume of work which the Reserve Bank's staff performed bears little relation to the earnings. In 1923 the
Bank reported that the personnel engaged in lending operations constituted only about 5 per cent of its entire staff.7
It is the cash and collection functions which are responsible
for the major portion of the total expenses of operation.
Quite a substantial addition to current expenses before
net earnings are determined is the depreciation allowed on
the premises of the Reserve Bank. The purchase of a site
and the erection of a building were authorized by the board
of directors of the New York Reserve Bank in October, 1917,
7

Annual Report of the Federal Reserve Bank of New York, 1923, p. 13.

TABLE 4

TOTAL AND NET EARNINGS OF THE FEDERAL RESERVE BANK OF NEW YORK,
AND DISPOSITION MADE OF NET EARNINGS*
Earnings and Expenses
Year

1914-15
1916
1917
1918
£1919
&1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
Total

Total
Earnings
$

Disposition of Net Earnings

Current
Expenses

Net
Earnings

Dividends
Paid

$ 468,922
486,255
1,655,507
2,509,770
5,561,086
6,797,764
8,078,362
6,776,530
6,880,136
6,350,821
6,325,202
6,421,442
6,472,171
6,444,265
7,052,465
6,826,564
6,647,104
6,376,729
7,052,351
105,183,446

-$ -123,887
414,064
3,078,481
21,662,917
27,959,619
53,128,130
26,093,832
3,721,593
3,043,679
616,852
3,103,298
3,749,748
3,720,601
11,018,433
12,263,224
4,588,384
1,532,081
10,404,550
6,197,727
196,173,326

$ 127,113
1,942,819
1,195,026
1,291,047
1,477,096
1,608,721
1,652,138
1,749,239
1,796,530
1,888,196
2,100,191
2,327,355
2,743,725
3,544,314
4,013,779
3,891,599
3,562,030
3,509,873
40,420,791

* Compiled from Annual Reports of the Federal Reserve Board.

Transferred
to Surplus

$ 649,363
20,467,891
23,964,678
12,332,523
3,782,671
-1,397,603
129,444
-1,179,678
1,215,102
1,649,557
1,393,246
8,274,708
8,718,910
574,605
-2,359,518
6,842,520
2,687,854
87,746,273

Franchise Tax Profit ( + ) or
Paid to
(—) CarUnited States Loss
ried Forward
Government
$

649,363
2,703,894
39,318,511
20,702,440
3,467,058
1,164,996

68,006,262

$-123,887
+286,951
-163,064

FINANCES

115

In 1918 the Federal Reserve Board approved the purchase
of a plot of ground in the financial district of New York
City for the purpose.8 The war emergency and high costs
for labor and materials delayed the construction until 1921,
Up to that time the Bank had been quite handicapped on
account of lack of safe and adequate quarters. It then
occupied offices and vaults in six separate buildings.9 In
that year charges of waste of public money and extravagance
with regard to salaries and buildings of the Federal Reserve
banks led an investigation of the same to be made by the
United States Senate. The salaries and building program of
the Federal Reserve Bank of New York were particularly
the subject of attack but no action was taken on them by
Congress as a result of the investigation.10
The new building was occupied by the Bank in 1924 and
cost over $14,000,000.n The cost of the building was not
charged to current expenditures but was paid for out of the
Bank's capital. Hence its cost did not reduce annual earnings and the Government was not deprived of franchise
taxes because of it, except as depreciation or reserves were
deducted under the rulings of the Federal Reserve Board.
The Reserve banks may not hold real estate as an investment
nor loan on real estate paper, except that they may own
property necessary to their operations. Such assets being
non-liquid, are inappropriate for the requirements of central
banks. Even in the case of the Reserve bank buildings, the
Federal Reserve Board adopted a ruling at the time they
were being constructed requiring complete amortization by
the end of fifty years.12 Consequently, the New York Reserve
Bank charges off each year 2 per cent of the cost of its building. The Bank is possessed of a building that is worthy of its
responsibilities and central position in national and international finance and is admirably suited to its purposes now
and for many years to come.
8
9
10

Annual Report of the Federal Reserve Board, 1918, p. 346.
Senate Document No. 75. 67th Congress, 1st Session, 1921.
Idem.
11
Annual Report of the Federal Reserve Board, 1925, p. 122.
12
W. P. G. Harding, The Formative Period of the Federal Reserve System,
p. 250.

TABLE 5

TOTAL AND NET EARNINGS OF ALL FEDERAL RESERVE BANKS, AND
DISPOSITION MADE OF NET EARNINGS*
Disposition of Net Earnings

Earnings and Expenses
Year

1914-15
1916
1917
1918
£1919
St 1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
Total

Total
Earnings

Current
Expenses

Net
Earnings

$ 2,320,586
2,273,999
5,159,727
10,959,533
19,339,633
28,258,030
34,463,845
29,559,049
29,764,173
28,431,126
27,528,163
27,350,182
27,518,443
26,904,810
29,691,113
28,342,726
27,040,664
26,291,381
29,222,837
440,420,020

$ -141,459
2,750,998
9,579,607
52,716,310
78,367,504
149,294,774
82,087,225
16,497,736
12,711,286
3,718,180
9,449,066
16,611,745
13,048,249
32,122,021
36,402,741
7,988,182
2,972,066
22,314,244
7,957,407
556,447,882

Dividends
Paid
217,463
1,742,774
6,801,726
5,540,684
5,011,832
5,654,018
6,119,673
6,307,035
6,552,717
6,682,496
6,915,958
7,329,169
7,754,539
8,458,463
9,583,913
10,268,598
10,029,760
9,282,244
8,874,262
129,127,324

Franchise Tax
Paid to
United States
Government

Profit ( + ) or
Loss ( - ) Carried Forward

$ 1,134,234

$ -358,922
+1,008,224
+509,413
-1,158,715

• Compiled from Annual Reports of the Federal Reserve Board,

Transferred
to Surplus

$ 1,134,234
48,334,341
70,651,778
82,916,014
15,993,086
-659,904
2,545,513
-3,077,962
2,473,808
8,464,426
5,044,119
21,078,899
22,535,597
-2,297,724
-7,057,694
11,020,582
-916,855
278,182,258

2,703,894
60,724,742
59,974,466
10,850,605
3,613,056
113,646
59,300
818,150
249,591
2,584,659
4,283,231
17,308
2,011,418
149,138,300

t Franchise tax requirement repealed by Banking Act of 1933.

FINANCES

117

Net Earnings and Dividends

After current expenses have been paid, and charges for
depreciation on the buildings and reserves for various purposes set up, the balance constitutes net earnings available
for distribution. It is evident that the Reserve Bank has a
relatively large and more or less steady annual budget for
operating expenses and overhead costs which it is called
upon to meet in some way. Consequently, wide fluctuation
in total earnings means considerable variability in net
earnings.13 And this has been the situation during the
course of the Bank's history. Thus, during the first year
there were no net earnings, while in 1920 they amounted to
$53,000,000. If the years following 1921 be taken as perhaps
affording a more settled picture, it is noted that net earnings
have fluctuated widely between a low of $600,000 in 1924
and a high of $12,000,000 in 1929.
Disposition of net earnings is made according to law to
three sharers—the member banks, the Reserve Bank itself,
and the United States Government. The member banks have
first claim upon them, being entitled to dividends amounting
to 6 per cent of the capital stock of the Reserve Bank. The
dividends are cumulative and in 1917 back dividends were
paid covering the period when the Bank was getting started.
Since 1917 the total dividend payments increased each year
gradually until 1931.14 In case the net earnings are in any
year insufficient to meet this claim the Bank's surplus is
drawn upon to pay the dividends. Such withdrawals from
surplus were necessary in three years, 1922,1924, and 1931.
In 1931 the dividend claims fell off owing to a decline in the
number of member banks and a reduction of the capital
stock of the Reserve Bank.16 But in spite of the decline in
required dividends the net income was insufficient by over
$2,300,000 for meeting them in that year of the depression.
Hence this sum was drawn from surplus for the purpose.16
13
See Table 4, p. 114.
"Idem.
15
Idem.
16
Federal Reserve Bank of New York, 17th Annual Statement, Circular
No. 1081, Jan. 22, 1932.

118 FEDERAL BANKING UNDER FEDERAL RESERVE SYSTEM

Surplus
The original Federal Reserve Act provided that after the
dividend claims hhd been fully met, all the net earnings
would be paid to the United States as a franchise tax,
except that one-half of such net earnings would be paid into
a surplus fund until it amounted to 40 per cent of the paidin capital stock of a Reserve bank. The New York Reserve
Bank was the first to accumulate this surplus of 40 per
cent.17 And none of the other Reserve banks had accumulated the 40 per cent surplus before this requirement was
raised.18 By an amendment, approved March 3, 1919, the
terms of the distribution of earnings were changed by providing that the whole of such net earnings be paid into the
surplus fund until it amounted to 100 per cent of the subscribed capital stock of the Reserve banks, and that thereafter 10 per cent of such net earnings be paid into the surplus.
The purpose of requiring the accumulation of a larger
surplus was to secure better protection for the creditors of
the Reserve banks and to increase their strength generally
for their safety and the more effective carrying out of their
functions.19 An adequate surplus is needed to permit a
desirable divorcement between earnings and credit policy.
The restrictions upon national banks concerning the liabilities they may incur are more strict than those imposed upon
the Federal Reserve banks. National banks cannot legally
become liable for borrowed money (except to Federal Reserve
banks) in an amount greater than their capital stock, nor
can they issue national bank notes in excess of this amount.
In order to give essential elasticity to central bank operations, Federal Reserve banks were not made subject to
these restrictions.20
Furthermore, Federal Reserve notes, issued by the Federal
Reserve Board through the Federal Reserve banks, are a
17

Annual Report of the Federal Reserve Board, 1918, p. 28.
Idem. For the percentage of surplus to capital attained by the other
eleven Reserve banks see this reference.
19
Annual Report of the Federal Reserve Board, 1918, pp. 81-82.
80
Idem.
18

FINANCES

119

liability of the Reserve banks and ultimately of the United
States Government. It was considered, therefore, of much
importance to the United States as well as to the Reserve
banks that the surplus fund be increased. The deposit and
note liabilities of the Reserve banks had increased beyond
all original expectations on account of the war so that at
that time (1918) the capital and surplus of the Reserve
banks amounted to only 2 per cent of their total liabilities.21
In reporting upon the bill containing this amendment and
urging its passage as requested by the Federal Reserve
Board, it was stated that the New York Reserve Bank "has
obligations greater than has the Bank of England, and yet
the Bank of England has four times the capital of the Federal Reserve Bank of New York." 22 For these reasons the
higher surplus requirement provided a desirable soundness
in the financial set-up of the Reserve banks.
The accumulation of a larger surplus fund under the 1919
amendment was provided for in three ways: 1. The base
was higher, it being the subscribed capital stock instead of
the paid-in capital stock, the former amounting to twice
the sum of the latter. 2. The percentage was raised from
40 per cent to 100 per cent. 3. The surplus fund was not
limited by the amount of the capital stock and percentage
requirement but after the latter was met it could be enlarged
without limit by the addition of 10 per cent of the net
earnings. The amendment was made retroactive so far as
the year 1918 was concerned. As a result of that year's
operations over $20,000,000 was transferred to surplus.23
In 1919 an additional amount was transferred, so that by the
end of the year the Bank was able to report a total surplus
which not only surpassed the capital paid in but amounted
to 100 per cent of the subscribed capital stock.24 The
surplus fund continued to be at least 100 per cent of the
subscribed capital stock from 1919 to 1923 inclusive. At no
time since 1919 has the surplus been less than the paid-in
21
Congressional Record, 65th Congress, 3rd Session, Vol. 57, Part 2, p. 1156,
Jan. 9, 1919.
22
Statement of Senator Hitchcock, idem.
23
See Table 4, p. 114.
24
Annual R e p o r t of t h e Federal Reserve Board, 1919, p . 332.

120 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

capital. But since 1923 the surplus has declined relative to
the subscribed capital. At the end of 1931 the surplus
amounted to 171.0 per cent of the paid-in capital and only
85.5 per cent of the subscribed capital. In view of the fact
that nearly two and one-half million dollars was withdrawn from the surplus at the conclusion of operations for
1931,23 and since relatively large net earnings in the future
are highly problematical, the larger surplus requirement of
the Federal Reserve Act tends to provide a prudent strengthening of the financial position of the Reserve Bank.
Moreover, in the light of the experience of the depression
period there is reason for believing that even after the
100 per cent surplus requirement is reached, a larger share
of the net earnings of the Reserve banks should be retained
than the 10 per cent which was allotted to them. For in so far
as the Reserve banks accumulate a larger surplus fund in
prosperous years, such strength tends to enable them to
prosecute their central banking functions without regard to
profit-making motives. To this end the Banking Act of 1933
provided that the Government is to receive none of the net
earnings of a Federal Reserve bank but that all are to go into
its surplus fund.26 The recent period also emphasizes the
need of elimination of waste and inefficiency in the operation
of the Reserve.Bank in every particular. The credit of the
Reserve banks, their efficient management, and the carrying
out of a sound policy require the accumulation of a relatively
large surplus fund.
The Government's Share: Franchise Tax
Prior to the passage of the Banking Act of 1933, after the
dividends had been paid and the surplus requirements fulfilled, all net earnings were to be paid to the United States
Government. In only six years of the Bank's history has
anything been paid to the Government. But in these years,
1917 and 1919-1923, the Government received SB^OOO^OO.27
Such earnings could be used by the Secretary of the Treasury
26

See Table 4, p. 114.
Banking Act of 1933, section 4.
27
See Table 4, p. 114.
26

FINANCES

121

to supplement the gold reserve held against outstanding
United States notes or to reduce the outstanding bonded
indebtedness of the United States. The Federal Reserve Act
provided that the earnings receivable by the Government
were to be paid by the Reserve banks as a "franchise tax.7'
The justification for the tax was that the Federal Reserve
banks were given a monopoly of note issue. It is true that
national banks issue bank notes but they are not the socalled "asset currency" that Federal Reserve notes are or
were originally intended to be. Furthermore, the intention
of the Federal Reserve Act was that national bank notes
were to be gradually retired from circulation. This is another
of those things which was intended that has not occurred.
During the existence of the Federal Reserve system, the
Government has received from all the Federal Reserve banks
franchise taxes amounting to $147,000,000. Of this amount
the New York Reserve Bank has paid $68,000,000.28 Under
the Aldrieh-Vreeland Act, the Government taxed the members of the emergency currency associations upon the amount
of "emergency notes" they issued at rates of 5 to 10 per
cent. The New York Reserve Bank made a study of the
taxes it would have paid if the Government had taxed it at a
rate of 7 per cent on that portion of its Federal Reserve notes
not covered by gold during 1920. The Bank found that the
tax the Government would have received directly would have
approximated very closely the amount it actually did receive
as its share of the net earnings of the Bank for that year.29
Under the Federal Reserve Act the Federal Reserve
Board may charge the Reserve banks interest on the amount
of their Federal Reserve notes outstanding which are uncovered by gold.30 This interest could have been charged
while at the same time the Government was not only a
residual claimant to net earnings but actually received
them. But such interest or franchise tax has never been
28

Idem.
Annual Report of the Federal Reserve Bank of New York, 1920, p. 24;
Hearings before the Joint Commission of Agricultural Inquiry, 67th Congress,
1st Session, 1921, p. 719. (Hereafter cited as Hearings in the Agricultural
Inquiry, 1921.)
30
Federal Reserve Act, section 16.
29

122 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

levied by the Federal Reserve Board. Although the Government received no franchise tax in the form of net earnings
from the New York Reserve Bank for any year since 1923
the Federal Reserve Board has not charged interest on the
Federal Reserve notes it has issued to the New York Reserve
Bank since that year.
In addition to the distribution of earnings the Bank has
rendered valuable services for the Treasury.31 It was estimated that the Bank's expenses required on account of
operations for the United States Treasury department
were $650,000 in 1925 and that in general they would run
about $600,000 a year.32 And this did not include the cost of
certain services formerly rendered by the sub-treasury such
as handling gold and currency. So far as the fiscal agency
department's expenses are concerned, they are now largely
absorbed by the Bank. Table 3, page 113, shows the relative
amounts paid by the Treasury and absorbed by the Bank
for the years stated. Beginning with 1917 and continuing
until June 30, 1921, the Treasury reimbursed the Federal
Reserve banks for practically all direct expenses incurred by
them in the performance of their fiscal agency functions.
Since the latter date the Reserve banks have been reimbursed
for only those fiscal agency expenses which are incurred
directly in connection with the sale of new issues of government securities, the cost of conducting all other fiscal agency
operations and other government services being absorbed
by the Reserve banks.33 The major part of the Federal
Reserve system operations for the Treasury have been
handled by the New York Reserve Bank.34
The fiscal agency expenses of the New York Reserve
Bank have been greater proportionately than for the other
Reserve banks. This is because the Treasury has dealt
directly with this Bank, in effecting the distribution of its
issues to all the Reserve banks, rather than with each Reserve bank separately.35 The total fiscal agency expenses
31

See chapter X, pp. 214-215.
Stabilization Hearings on H. R. 7895, 1926, p. 488.
33
Ibid., p. 489.
34
Ibid., pp. 488-489.
88
Ibid., p. 278.
82

FINANCES

123

of the New York Reserve Bank from 1917 through 1931
comprised approximately 17 per cent of the current expenses
of the Bank for that period. The benefit to the Government
from the grant of a charter to the New York Reserve Bank
cannot, therefore, be determined solely by the amount of
the franchise tax received each year but consideration must
be given to the services the Bank renders for the Government, the costs of which are borne by the Bank. In addition to receiving from the New York Reserve Bank almost
half of the total amount of franchise taxes paid by all the
Federal Reserve banks, the Government and the people of
the United States have received no little benefit from the
work performed for them by the Federal Reserve Bank of
New York.
Effort to Reduce Government's Share and Increase That of Member Banks
The member banks generally have never been satisfied,
during the entire existence of the Federal Reserve system,
with the financial returns or services they have obtained as
a result of their membership in the system. They have had
the feeling that they were entitled to more than the limited
return of 6 per cent on their paid-in capital stock. And so
from the beginning they have constantly made an effort to
get more out of the Reserve banks, to make the Federal
Reserve system the means whereby they would make larger
profits. In various ways they have succeeded in that effort
by amendments to the Federal Reserve Act and through
the administration of the Reserve system.
In other respects they did not succeed. Consequently the
agitation to make the Federal Reserve more profitable to
the member banks, especially by reducing the Government's
share, continued. Various proposals were advanced and
promoted. Most prominent among these have been:
1- Pay interest on member bank balances with the Federal Reserve banks.
2. Revise the allotment of net earnings so that the Government gets less and the member banks receive more, by
(a) leaving the fixed dividend rate as it is and paying all or

124 CENTKAL BANKING UNDER FEDERAL RESERVE SYSTEM

a larger share of the surplus earnings to the member banks,
or (b) raising the fixed dividend rate above 6 per cent and
basing it on the member banks7 stock holdings, their reserve
balances, or a combination of both. For the past decade a
number of bills have been pending in Congress embodying
variants of these proposals.36
Paying Interest on Reserves
The plea of the banks for interest on their reserves in the
Federal Reserve banks was based upon the fact that they
customarily received interest on their balances in correspondent banks prior to the establishment of the Federal Reserve
system. They also pointed out that state non-member
banks in most states could satisfy part of their legal reserve
requirements with correspondent bank balances which
earned them interest. The Federal Reserve banks have not
been permitted to pay interest on member bank balances
for several reasons.
With due consideration to the claims of commercial banks
under the old national banking system, and in order to be
fair to them, the framers of the Federal Reserve Act, recognizing that a central bank could not properly pay interest
on reserve balances, provided that the national banks should
not lose the amount of interest on correspondent bank balances upon becoming members of the Federal Reserve
system. They did this by lowering the legal reserve percentage required. This gave the banks power to create
much more bank credit and so enhanced their earnings. It
has been calculated that this reduction of legal reserve has
more than offset any loss of interest on Federal Reserve
bank balances. So the claim that national banks were losing
interest on their reserves was not well taken because they
36
Probably the most representative voice among banking interests supporting a reduction of the Government's share in earnings has been the Economic Policy Commission of the American Bankers Association. The view
of this body may be found in its report of May 7, 1930. Another large organization, the Chamber of Commerce of the United States, has taken a stand
in agreement with the bankers favoring a reduction of the Government's
share. (See Report of its Banking and Currency Committee on the Federal
Reserve System, December, 1929, pp. 22-25. See also Auxiliary Statements
accompanying the committee report, December, 1929, pp. 121-124.)

FINANCES

125

were compensated for such loss at the start and again in
1917. But member banks have received still more than this
compensation for the loss of interest. In the first place, by
reason of the existence of the Reserve banks they have
been enabled to make more loans and investments because
they have been able to reduce relatively their idle vault
reserves.
Under the Federal Reserve system banks have been able
to get along with less cash on hand since it could be replenished quickly from the Reserve banks.37 The Federal Reserve Bank of New York cited one of its members as an
example.38 The amount of cash which this bank kept on
hand fluctuated widely on account of pay-roll requirements.
Prior to membership in the system the bank was obliged to
maintain vault reserves running as high as $500,000 in order
to avoid falling below the legal requirement for cash in
vault of $250,000. Their vault cash averaged about $350,000.
On the other hand, not long afterward, as a member bank
it conducted its business with from $125,000 to $300,000 of
vault cash which averaged about $200,000. This member
bank estimated that of a reserve balance of less than $400,000
required at the Federal Reserve Bank, about half could be
transferred from its vault and "therefore represented no
loss of interest whatsoever." Upon the basis of the proportionately greater reserves which could be carried safely at
the Reserve banks, the member banks built a superstructure of credit of many times that amount. Thus it is seen
that the Federal Reserve system has made possible considerable profit for the member banks because of its ability
to supply the banks with cash quickly.
Secondly, the member banks have been wont to call their
reserves "idle" and to say that they fulfill no purpose other
than meeting legal percentage requirements because they
receive no interest on them directly. Reserves that make
possible all the benefits to banks which flow from concentration and mobilization of reserves can hardly be called
57
See
38

Federal Reserve Bulletin, November, 1923, p. 1178.
Federal Reserve Bank of New York, Questions and Answers, September,
1919.

126 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

idle or serving no purposes other than legal percentage
requirements. Take for example, one use of reserves—their
use as clearing accounts. The Federal Reserve banks
handled, in 1931, over 864,000,000 checks totaling $248,000,000,000. The bulk of these were deposited by the member
banks which had reserve balances of only $2,268,500,000 39
to take care of that large volume of checks cleared and at
no expense to the member banks.
In the third place, through the more direct check collection system, funds become available and earnings begin
more quickly than before the Federal Reserve system. Thus
the member bank to which reference has just been made,
estimated a considerable saving. It figured that it sent out
daily about $200,000 in checks and drafts and that by using
the Federal Reserve system it received returns one day
sooner than it did through former collection channels. Its
saving was calculated as being equivalent to at least 2 per
cent interest on $200,000 and this was held to be a further
offset to the loss of interest on its deposits with the Reserve
Bank.40
Another form of compensation has been the saving on
shipments of cash between the member banks and the Reserve banks, which are made without cost to the former.
Member banks have also benefited by a number of other
free services. Still another offset is the gain they have made
on their rediscounting operations since they have ordinarily
borrowed from the Reserve banks at rates lower than those
charged by the correspondent banks. Finally, though the
reserves yield no interest directly and though the stockholders7 share of the Reserve bank earnings is limited, yet,
as a result of the centralization of reserves in the Federal
Reserve banks, the member banks may make, as indeed
they have made, substantial profits from loans extended
on the basis of their borrowings from the Reserve banks or
reserve balances credited to their accounts as a result of
open market operations.
39
Average reserve balance of all member banks on four call dates. Federal
Reserve Board Report, 1931, p. 96.
40
Federal Reserve Bank of New York, Questions and Answers, September,
1919.

FINANCES

127

As far as the state non-member banks getting interest on
reserves carried in correspondent banks is concerned, Federal Reserve policy may not properly take cognizance of
that. One of the purposes of the Federal Reserve banking
reform measure was to get away from that very thing.
Moreover, following the reduction of reserve percentages
in the Federal Reserve Act, the states have commonly enacted less strict reserve requirements with a view to making
the banking business more profitable for the state banks in
competition with national banks. For the Federal Reserve
to have still less strict reserve requirements with a view to
outdoing the state banks would reduce Federal Reserve
policy to an anomaly. It would mean the adoption of the
business point of view whereas Federal Reserve policy
should always be governed by the point of view of economics.
The Interest Paying Proposals and Central Banking Policy
Though member banks have been compensated for the
loss of interest on bank balances which they formerly received from their correspondent banks, that is not the real
reason why Federal Reserve banks have not paid and should
not pay interest on member bank reserve accounts. Such
compensation nullifies any possible charge to the effect that
the banks have not been treated fairly in the matter but
it does not touch the merits of the question at issue. The
real reason involves the functions of central banks. In
order to earn enough to pay interest on member bank
balances the Reserve banks would be required to make huge
profits compared to what they have been and are making.41
The forcing of such additional claims on income would
mean that they would be compelled to give primary consideration to profit-making and go after more business.
This would necessitate risks which a central bank is not
justified in undertaking. Thus a profit-making policy would
involve artificially low rates, extensive competition with
member banks, and the reckless thrusting aside of the true
objects of central banking policy. On the other hand the
41

Stabilization Hearings on H. R. 7895,1926, p. 558.

128 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

payment of such interest would tend to induce member
banks to borrow, stimulating unsound advances.
As a result of these considerations the reserves of the
Federal Reserve banks would be dissipated and unavailable
in time of need. Inflation in the financial and business organization and non-liquidity of Reserve bank assets would
result. The reserve power to exert a stabilizing influence
on business and financial conditions would be impaired.
Thus it is seen that in order to be in a position to adopt a
sound credit policy and make it an effective one, the Federal
Reserve banks must be unhampered by profit-making
motives.42 The question of whether the Reserve banks
should pay interest on member bank reserves is one to be
answered from the point of view of economics or national
welfare, rather than from the standpoint of business or the
commercial banks' desire for profit. And from this point
of view it is seen that interest on commercial bank reserves
would be incompatible with the central banking functions
of the Reserve banks.
Reasons for Reducing Government's Share
It will be recalled that after the payment of an annual
cumulative dividend of 6 per cent on the stockholdings of
member banks and accretions to the surplus, all the remainder of the net earnings went to the Government prior
to the enactment of the Banking Act of 1933. There had
been much discussion about effecting a different distribution
of earnings. Member banks favored a reduction or even an
elimination of the Government's share but were not in
agreement upon any particular plan for it.43 For the most
42
It is assumed that some earnings will result from the regular course of
their central banking operations. And such profits as are ancillary to their
central banking functions are not in question in this analysis. During their
history, the Reserve banks have made profits and in the ordinary course
of events it will continue to be so. It is reasonable to expect this in view
of the fact that the Reserve banks obtained their assets under no obligation
other than a cumulative dividend of 6 per cent on the capital stock payments
of member banks. None of the leading central banks pay interest on their
deposits. (See Kisch and Elkin, Central Banks, 1932 Edition, pp. 142-143.)
43
The payment of interest on reserves would reduce the Government's
share, though indirectly. The discussion at this point involved a decrease in

FINANCES

129

part, the member banks, while seeking the surplus net
earnings for themselves, did not openly oppose the payment
of a portion of them to the Government. However, in the
case of some of the bills which were introduced in Congress,
this pressure for reducing the Government's share expressed
itself in a form which allowed none of the earnings to the
Government and all of them to the stockholders.
Those who supported the proposal to increase member
bank earnings by reducing the Government's share argued
that the member banks are entitled to the bulk of the residual
earnings because they supply the funds which make those
earnings possible. They contribute all the capital stock and
furnish the bulk of the deposits. The deposits of the Government are comparatively small. Another point advanced
was that the Reserve bank earnings are derived mainly from
their operations with member banks. Furthermore, they
could point to the considerable amount of services which
the Reserve banks render the Government without charge
and which they have been doing from 1921. The costs of
the fiscal agency functions of the Reserve banks are now
largely absorbed by these banks. Thus the fiscal agency
expenditures of the Federal Reserve Bank of New York,
1921-1931, were $3,500,000.44 Of this amount, nearly twothirds was absorbed by the Bank.
In addition, the Reserve banks' expenses are greater by
reason of other services which they render the Government
but which are not ordinarily regarded as fiscal agency functions. These are (1) services rendered as depositary for the
Treasury, including the payment of government checks,
warrants and coupons, the transfer of funds, and (2) currency and coin operations formerly performed by the United
States Sub-Treasury. The substantial total amount expended
on account of government services may be considered practically a part of the returns accruing to the Government in
return for the privileges with which it has endowed the
Reserve banks. And finally it was held that more generous
the percentage of earnings allotted to the Government and may be thought of
as a reduction in the Government's share directly.
" See Table 3, p. 113.

130 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

distribution of earnings would increase the loyalty of member
banks and tend to draw more banks into the system and
hence strengthen it.45 These points were also emphasized
strongly by a committee of Reserve bank officers which reported to the joint conference of governors and Federal
Reserve agents with the Federal Reserve Board in 1924.46
Effect of Banking Act of 1933

The campaign for the payment of a larger share of net
earnings to the member banks proved to be unsuccessful.
The Banking Act of 1933 does not recognize the claims advanced for such a redistribution. A different apportionment
of earnings, giving member banks an additional percentage
dividend or share of earnings would bring about a tendency
to inflation inasmuch as there would be the desire on the
part of member banks for the Reserve banks to enlarge net
earnings so that they would get more profits from the central
banks. In so far as the Reserve banks would be under
pressure to make earnings, this would result in an overextension of Federal Reserve bank credit with a consequent
weakening of their reserves. Thus they would be going
contrary to their function as central banks which are expected to build up reserves when possible and conserve them
at all times. Refusal to increase the allotment to member
banks tends to prevent the Reserve bank directors from
adopting unsound credit policies with a view to profitmaking. Hence the limitation of shareholders' profits
to a minimum return on the capital investment is because
central banking policy is incompatible with the desire of
shareholders for increased profits and enlargement of Federal Reserve bank earnings.
Furthermore, the requirement in the new Act that after
the 6 per cent dividend claims have been fully met, "the
net earnings shall be paid into the surplus fund of the Federal
Reserve bank" will tend to increase the strength and efficiency of the Reserve banks. Their future earnings are un45
Report of Economic Policy Commission. American Bankers Association,
May 7, 1930, p. 12.
48
See below, p. 133.

FINANCES

131

certain. They may be nominal or there may be losses. To
take care of such in any year the present provision for the
distribution of earnings is so framed as to guard against the
adoption of an inflationary credit policy. The new Act increases the possibility of building up a competent surplus
and this surplus makes possible the adoption of a central
banking policy mainly irrespective of expenses, losses, or
profits. The need for a competent surplus, therefore, is
another reason for limiting dividends on Reserve bank stock.
Returns to the Government
The campaign for a reduction of the Government's share
did, however, result successfully. The reason why the Federal
Reserve Act provided that part of the net earnings of the
Reserve banks were to be paid to the Government is this:
The Government has granted them the distinct and profitable right of issuing paper money and creating bank deposit
credit based upon their holding the legal, ultimate gold reserves of the money and banking system. Such a right involved considerations of broad and fundamental social concern and in return therefor the Government is entitled to a
part of the profits of the Reserve banks. The share of net
earnings to the Government was viewed as a payment for a
right conferred, a kind of franchise tax, resting upon considerations of public policy. Another reason for a return to
the Government is that it stands behind the Reserve banks'
liability for their Federal Reserve notes, in that the Government is ultimately itself liable for the redemption of
these bank notes in gold. Under the Banking Act of 1933,
however, the Government will receive no more of the net
earnings of the Reserve banks.
Although no share of the profits of our central banks is
now distributed to the Government, it may secure a return
from the franchise it has granted the Federal Reserve banks
in ways other than by receiving a share of net earnings. As
stated above, in the first place, the Government has benefited by a number of free services rendered it by the Reserve
banks in lieu of monetary returns. Another form of franchise
tax is a tax on the note issue. The Federal Reserve Act

132 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

authorized the Federal Reserve Board to require the Reserve banks to pay interest on the amount of their Federal
Reserve notes outstanding uncovered by gold. But the
Federal Reserve banks have paid the Government no interest, or tax, on these bank notes, the Board not having
required them to do so. Any allotment of earnings which
the Government formerly received, may, therefore, be looked
upon as being in some portion in lieu of this tax on Federal
Reserve notes*
The plan of taxing Federal Reserve notes not covered by
gold has been officially discussed. In June, 1920, the Federal
Reserve Board advised the Reserve banks that they were
considering imposing the interest charge.47 The Board referred to the criticisms at that time against the large earnings
of the Federal Reserve banks and to the fact that it was
generally overlooked that the large earnings of the Reserve
banks are due to a great extent to their use of Federal Reserve notes.48 The opinion of the Federal Reserve Board,
however, was divided and no action was taken on the matter.
It finally decided not to impose the tax because it "did
not want to seem to be doing anything to restrict the circulation the business of the country demanded." 49
In discussing the subject before the House Banking and
Currency Committee, Governor Harding held that a specific
tax on the uncovered portion of the note issue would result
in relatively large returns to the Government when the
Reserve banks had large earnings because the latter were
due to a considerable extent to the issue of Federal Reserve
notes; while on the other hand in lean years the Government would receive little or nothing as a result of the tax.50
The taxing of Federal Reserve notes was considered as an
alternative to the former plan of government participation
47

Report of Committee to Consider Advantages of Tax on Circulation
over Government Participation in Profits, 1924.
48
Idem.
49
Hearings on Distribution of Profits of Federal Reserve Banks before the
House Committee on Banking and Currency, June 28, 1922, p. 6.
50
Idem. These hearings were on H. R. 12208, a bill which provided that
excess earnings, after allotting 10 per cent to surplus, be divided equally between the Government and the member banks.

FINANCES

133

in profits also by a Federal Reserve committee. The conclusions of the committee were (1) that the Federal Reserve
Board should tax the uncovered portion of the Federal
Reserve notes outstanding and (2) the Reserve bank earnings in excess of accretions to surplus should be divided
between the Government and the member banks "in either
a fifty-fifty or a sixty-forty proportion, the division among
the member banks being made in proportion to the average
reserve balances maintained." 51 Nothing came of these
recommendations.
51
Report of Committee to Consider Advantages of Tax on Circulation
over Government Participation in Profits, submitted to the conference of
governors and Federal Reserve agents with the Federal Reserve Board, 1924,
by George W. Norris, governor, Federal Reserve Bank of Philadelphia and
J. H. Case, deputy governor, Federal Reserve Bank of New York. See above,
pp. 123-124.

CHAPTER VII
OBSTACLES TO DEVELOPMENT AND
MEMBERSHIP
Antipathy of the Bankers
The Federal Reserve Bank of New York began its existence under circumstances of adverse nature. The World
War had created numerous problems requiring the attention of the Federal Reserve Board and not as much consideration could be given to the development qf the Federal
Reserve system as would otherwise have been the case. The
Aldrich-Vreeland emergency currency, the issue of which
began immediately after the advent of the World War in
the summer of 1914, involved problems of retirement along
with the formulation of Federal Reserve policy. The controversy which had developed during the progress of the
Federal Reserve Act in Congress between the bankers and
those sponsoring the Act made the process of developing the
Reserve banks subject to difficulties.
The efforts to obstruct the Reserve Bank itself began
with the effort to put off its opening indefinitely which was
discussed in chapter IV. The Federal Reserve system was
unique in that for the most part those who were entrusted
with the responsibilities of carrying out the provisions of
the Federal Reserve Act and managing the Federal Reserve
banks had opposed the establishment of the central banking
system provided by the Act. The activities of the Governors
Council* during the early years of the system interfered
with the process of developing the Reserve banks inasmuch
as it was an unauthorized body and its efforts included not
only interference with but even defiance of the legally constituted powers and orders of the Federal Reserve Board.2
1
2

See chapter V, p. 102.
Willis, The Federal Reserve System, pp. 70&-707.
134

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

135

The New York Reserve Bank had as its first governor one
who had opposed the passage of the Federal Reserve Act.3
Practically none of the banks in the district were sympathetic with the new banking system. The large New York
City banks assailed the Federal Reserve system because it
threatened their correspondent banking business. The outof-town banks were fearful lest they would lose the profits
derived from their exchange charges* One of the large New
York City banks refused to turn over its gold in payment of
its subscription on its capital stock when such payment
was due on November 2, 1914, and withheld it for some time
thereafter. The Reserve Bank did scarcely any rediscounting in its early days. The New York bankers were generally
opposed to it. At the beginning of the Reserve Bank's operations the bankers said that member banks in New York
City would continue to do most of the rediscounting for the
country banks 4 and they did so.5 And under the conditions
then existing the New York banks did not have occasion
to do much rediscounting themselves. The reduction in reserve requirements under the Federal Reserve Act had made
available to the member banks much more lending power.
The national banks, which in a sense entered the Federal
Reserve system involuntarily, were unfriendly to the central banking system. They talked persistently against the
system.6 They looked upon the Federal Reserve Bank not
only as an unprofitable venture for them but as an unnecessary expense.7 The smaller banks in the district, as well as
the large New York City banks, were apathetic and hostile
to the system and in keeping with this attitude most of the
member bank reserve accounts were dormant.8 One banker
in a small town in Putnam County, New York, in 1915,
charged off as a loss the amount of his bank's subscription
to the capital stock of the Federal Reserve Bank of New
3

Stabilization Hearings on H. R. 7895, 1926, p. 341.
The New York Times, Nov. 18, 1914.
6
Annual Report of the Federal Reserve Bank of New York, 1915, p. 35.
6
The Commercial and Financial Chronicle, May 29, 1915, p. 1791.
7
Idem; Annual Report of the Federal Reserve Bank of New York, 1915,
p. 35.
8
Annual Report of the Federal Reserve Bank of New York, 1915, p. 35.
4

136 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

York because he doubted that the Reserve Bank would
ever pay a dividend on it.9
While some bankers doubted that the Bank would be successful enough to pay dividends, others were fearful that it
would enlarge its loan and investment operations and deprive them of business. As a result efforts were made to
have the Reserve Bank's capital returned to the stockholders and a bill was introduced in Congress early in 1916
providing for the cancellation of the unpaid subscriptions
to the capital stock and the return to the member banks of
most of that already paid the Reserve banks.10 But these
efforts were frustrated. A number of member banks sent
anonymous letters to the New York Reserve Bank. They
contained extracts from section 9 of the Federal Reserve
Act, entitled " Failure to comply with Regulations/' with
certain words underlined. The Reserve Bank officials presumed that the letters were sent for the purpose of creating
prejudice against the Federal Reserve system.11
Rival Plans for a Central Bank
The old attitude of hostility to the Federal Reserve continued on the part of a substantial number of bankers and
became so pronounced that it brought forth some rival
plans. During the latter part of 1914 it was announced
that a plan, which had been under consideration for some
time, had been proposed to establish a central banking institution for the State of New York to be a rival of the Federal Reserve Bank of New York. Capital was to be supplied by the New York State banking institutions and the
proposed bank was to hold their reserves. The bank was to
perform functions similar to those authorized for the Federal Reserve banks. It was suggested that this bank might
be a rival not only of the Federal Reserve Bank of New York
but of all the Federal Reserve banks, because the proposed
9

American Bankers Association Journal, May, 1927, p. 801.
The Commercial and Financial Chronicle, Sept. 18, 1915, p. 888; April 8,
1916, p. 1309.
"Letter from Federal Reserve Bank of New York to member banks,
June 28, 1916.
10

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

137

bank would hold out the offer of rediscounting facilities not
only to banks in New York State but to banks all over the
country and on more attractive terms than the Federal Reserve could offer.12 This plan, however, was not carried out.
Another effort of similar type was undertaken. But this
time it was by a bank already organized with a successful
record behind it. For some years some of the larger New
York banks had had ambitions to become central banks
themselves.13 A definite effort in this direction was undertaken by the Guaranty Trust Company of New York.
When, in the spring of 1915, the Federal Reserve Bank of
New York announced the plan for the collection of checks
on member banks at par, the Guaranty Trust Company
solicited the non-member banks, in the State of New York
especially, to utilize their bank for clearing and collection
purposes.
In a letter to the banks the Guaranty Trust Company
made the proposal that the banks maintain reserves with
the Guaranty Trust Company which would collect their
checks free of charge.14 This bank offered to non-member
banks in the State of New York the right to print or stamp
on all of their checks the words, " Collectible at par through
the Guaranty Trust Company of New York"; and while the
Reserve Bank did not pay interest on reserve balances the
Guaranty Trust Company offered to pay 2 per cent. This
plan of the Guaranty Trust Company failed to assume substantial proportions beyond what was accomplished by the
larger New York banks as correspondent banking institutions.
Conflict between the Reserve Bank and the New York Clearing
House
One of the most serious obstacles to the development of
the New York Reserve Bank was the effort of the New York
12

The Financial Age, Dec. 19, 1914, p. 1100.
Willis, The Federal Keserve System, p. 562.
The Commercial and Financial Chronicle, April 24, 1915, p. 1407. The
letter is printed in full. The voluntary intra-district collection system of the
New York Reserve Bank was announced April 20, 1915. The letter of the
Guaranty Trust Company to the banks was dated April 3, 1915, but it was
not given out until after the Reserve Bank's circular (No. 22) was released.
13
14

138 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

City banks through their clearing house association to combat the spread of the clearing and collection system of the
Reserve Bank. On June 1, 1915, the voluntary mtra-district
collection system of the Reserve Bank became effective.15
The commercial banks countered by establishing an out-oftown check collection department in the New York Clearing
House which began to function on August 9, 1915.16 There
were, then, three systems in the field in New York City
for the out-of-town check collection business in its territory.
It was seriously proposed at the time that these three
systems continue, as if such a plan could be successful, and
it is interesting to note the basis upon which the field was
divided up among them. Thus said The Financial Age:
With the installation of the new department,17 New York will
have a transit system equal, if not superior, to any in the country.
The Federal Reserve Bank of New York, with its control of foreign exchange and administration of rediscounts, will be the international clearing house. The private system maintained by the
largest of the metropolitan trust companies will clear for state
banks and trust companies which are not members of the Federal
Reserve system. The Clearing House, finally, will collect for its
members, free of charge, all out-of-town checks drawn on banks
agreeing to remit upon presentation of mail items.18

The regulations adopted by the New York Clearing House
Association provided for the collection of checks on all banks
in the five states of New York, New Jersey, Connecticut,
Massachusetts, and Rhode Island which agreed to remit at
16
Annual Report of the Federal Reserve Bank of New York, 1915, p. 24.
Regarding this move of the New York Clearing House Association, The Financial Age said: "New York City had horse-drawn street cars years after the
small towns of the country had installed electric cars, but New York ultimately adopted the electric way. Now, spurred on by the competition of the
Federal Reserve Bank, the New York Clearing House Association, has, after
weary years of agitation, installed a department to serve as a collection agency
for country checks deposited with its members/* The Financial Age, July 24,
1915, p. 96.
18
Annual Report of the Federal Reserve Bank of New York, 1915, p. 25.
17
In reference to the new out-of-town check collection department of the
New York Clearing House.
18
The Financial Age, July 24, 1915, p. 96.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

139

par by draft on New York Clearing House banks or cash on
the day of the receipt of any items sent them. The Clearing
House of London had established a country clearing department in 1858 for the purpose of clearing checks in England
and Wales. In several cities in the United States, during
the latter part of the last century, there had been established
out-of-town collection departments in their clearing houses.19
That of Boston was especially noteworthy. The New York
Clearing House had not established such a department.
When the Federal Reserve system inaugurated its par
collection plan for out-of-town checks, the New York City
banks did not let the plan of the Federal Reserve develop
normally or efficiently. Instead they set up an out-of-town
clearing department in their own association to do what the
Federal Reserve system had already set up the machinery
for doing. There was thus brought about an obstruction
to the purpose and functioning of the Federal Reserve system. The establishment of that out-of-town collection department in the New York Clearing House, while in operation, rendered ineffective the accomplishment of the purposes
of the Federal Reserve Act as regards the elimination of the
clearing and collection evils of the national banking system.
In Boston the clearing house association of that city turned
over its work to the Federal Reserve Bank of Boston. When
compulsory collection was introduced by the Federal Reserve system in July, 1916, the Boston Reserve Bank took
over the entire equipment and staff of the Boston Clearing
House.20 The Boston Reserve Bank then did the clearing of
checks not only on the Boston banks but on all banks in
New England as well as on banks in other Federal Reserve
districts. In New York City, however, the New York Clearing House banks were not agreeable to such a course.
During these first years of the Reserve Bank's development, competition between the Clearing House and the
Federal Reserve system regarding this matter was keen.
It was a question whether the Federal Reserve Bank of New
York would have to yield to the New York Clearing House
19
20

W. E. Spahr, The Clearing and Collection of Checks, pp. 124-130.
Annual Report of the Federal Reserve Bank of Boston, 1916.

140 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

on this collection problem or the New York Clearing House
would yield to the Federal Reserve. The New York Clearing
House system for the collection of out-of-town checks comprised 347 members at the outset in August, 1915. By the
end of 1915 it had over 500 members and the volume of its
transactions was about twice as large as that of the collection system of the Reserve Bank.21 It then announced an
extension of its plan involving the five states above in that
it would receive items on any banks joining its system in
places from which mail reached New York overnight.22
In the course of development of the central banking organization, however, it turned out that the effort of the
New York Clearing House was withdrawn. The inauguration of compulsory par collection by the Federal Reserve
Board in 1916, provided a basis for the success of the Federal Reserve Bank's collection system. The establishment
of the compulsory system was followed by reductions of the
charges which New York Clearing House banks imposed
upon their customers for the collection of out-of-town checks.
The Reserve Bank's service charge of one cent per item for
collecting checks and cash items was eliminated in June,
1918.23 Another factor responsible for the supremacy of
the Reserve Bank was the increase in the number of banks
throughout the United States on which checks could be
collected by the Federal Reserve banks at par.24 Finally,
the New York Clearing House adopted an amendment to
its constitution, effective October 1, 1918, providing that
its members should neither pay a higher charge for the collection of checks on banks on the Federal Reserve par list
than would be incurred in collecting such items through the
Federal Reserve Bank, nor allow the paying bank to hold
back the remittance beyond the day on which the item is
received.25
- The result of the change in the constitution of the New
York Clearing House was to make it advantageous to mem21
Annual
22

Report of the Federal Reserve Bank of New York, 1915, p. 25.
Idem.
23
Annual Report of the Federal Reserve Board, 1918, p. 331.
24
Idem.
M
Idem.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

141

bers of the association to send to the Reserve Bank their
out-of-town items on banks which were on its par list.26
The Clearing House continued its out-of-town collection
department but a short time after the new regulation went
into effect—until November 15, 1918, when it was abandoned and its work was taken over by the Federal Reserve
Bank.27 With the removal of this obstacle the New York
Reserve Bank greatly increased the efficiency of its clearing
and collection functions and they assumed a degree of
effectiveness more nearly in accord with the purposes of a
clearance institution.
Opposition to Clearing and Collection Functions
The objections of both member and non-member banks
at every point in the development of the par collection system constituted difficulties which the Federal Reserve authorities had to overcome. When the voluntary intra-district
collection system was introduced June 1,1915, only 70 member banks in the district joined it. There were two primary
reasons why more of them did not join.28 First, the banks
had been accustomed to deducting exchange when remitting
for items drawn upon them and to join the Federal Reserve
par collection system meant that they would have to forego
this source of profit. Second, the system necessitated their
keeping larger reserves at the Reserve Bank and hence loss of
interest in order to avoid impairment of reserves resulting
from the practice of the Reserve Bank of charging directly
against the account of the paying bank.
The fact that so few banks joined the collection system
accentuated this impairment of reserves because the checks
against them could not be offset as much as would have
been the case had a larger number joined. Hence the impairment of reserves resulting from the introduction of this
voluntary collection system was both a cause and effect of
the smallness of the number of member banks which did
join. State banks were reluctant to join the Federal Re26

Idem.
Annual Report of the Federal Reserve Bank of New York, 1918, p. 21.
28
Annual Report of the Federal Reserve Bank of New York, 1915, p. 24.
27

142 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

serve system for these reasons as well as for others.29 This
factor, therefore, cut down the number of banks which
could be members of the voluntary collection system. When
the Federal Reserve Board ordered the inauguration of the
compulsory par collection system 30 on July 15, 1916, protests by the banks were vigorous and widespread.
When this step was under consideration the members of
Group VI of the New York State Bankers Association, in
convention assembled, passed a resolution urging amendments to the Federal Reserve Act repealing the provisions
on the collection of checks and ending further transfer of
reserves to the Federal Reserve banks*31 Later on in response to a request from the Reserve Bank 32 the up-state
bankers resolved not to sign an agreement calling for par
collection of checks on non-member banks.33 In order to
secure payment for checks at par the New York Reserve
Bank finally was obliged to resort to the presentation of
them by express company or other local agents at the counters of a number of paying banks. The introduction of
various other Federal Reserve services all met the same
obstruction from the larger city banks whenever those services were believed to reduce their province as correspondent
banks.34
During all of this period the Federal Reserve Board was
determined to carry out the provisions of the Federal Reserve Act and proceeded to develop the new powers and
functions of the Reserve banks with as much dispatch as
possible. Stimulated by the efforts of the Federal Reserve
Board, officers Pierre Jay and Benjamin Strong of the
Reserve Bank aided materially in effecting the firm establishment of the new banking system. By explanation of the
aims of the Federal Reserve clearing and collection pro29

See below, p p . 144^146.
The Commercial and Financial Chronicle, Feb. 19, 1916, p. 656.
Circular No. 1 (Series of 1916), Federal Reserve Board, May 1, 1916.
32
Circular, Federal Reserve Bank of New York, April 1, 1916.
33
The Commercial and Financial Chronicle, April 7, 1916, p. 1344.
84
Regarding obstacles to development of the Federal Reserve, see also
Willis, The Federal Reserve System, pp. 660-663 and chapters XXXVII
and XXXVIII.
30

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

143

gram, the benefits to be derived from it and from membership in the system, and by earnest, patient solicitation,
Messrs. Jay and Strong secured the cooperation of an ever
increasing number of member and non-member banks.
The Membership Problem
During the process of formulating the Federal Reserve
Act, it was urged that national bank membership in the
system be made voluntary. This proposal, however, was
rejected as being impractical, because of the danger that
the central banking system could not be established in that
way on account of the refusal of banks voluntarily to enter
the system. Compulsory membership for all national banks
was therefore imposed. The difficulties later encountered
in securing the cooperation of the banks in establishing the
system evidenced the wisdom of this decision. The Federal
Reserve Act as finally enacted provided for the voluntary
admission of state banks and trust companies to membership in the system.
The problem of the admission of state banks to membership was one which had been considered by the Reserve
Board practically from the opening of the central banks.35
A unified banking system in the United States was urged
by the Board during its first year. The central Board set
forth its views and inaugurated the system's effort to include the state banks in June, 1915. The following is quoted
from the Board's statement:36
A unified banking system, embracing in its membership the
well-managed banks of the country, small and large, state and
national, is the aim of the Federal Reserve Act. There can be
but one American credit system of nation-wide extent, and it
will fall short of satisfying the business judgment and expectation
of the country and fail of attaining its full potentialities if it rests
upon an incomplete foundation and leaves out of its membership
any considerable part of the banking strength of the country.
The original attitude of the state institutions, however,
was one of aloofness. In that formative period, prior to the
36
30

Federal Reserve Bulletin, July 1, 1915, p. 117.
Ibid., p. 145.

144 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

entrance of the United States into the World War, the state
banks generally preferred not to join the system until benefits accruing to them from membership were apparent and
the effects of the operation of the system became manifest.37 The banking requirements under the state laws of
New York, New Jersey, and Connecticut, the states included in the Second Federal Reserve District, were less
strict than those imposed by the Federal Reserve Act. The
central banking act had not been on the statute books four
months before New York State passed a banking act devised to offset any net advantage which the Federal Act
may have offered to state institutions joining the central
banking system.38 The New York law sought to make it
more attractive to state institutions to remain outside the
Federal Reserve system. This new statute not only extended
to state institutions some advantages which they would
have gained by entering the Federal Reserve system, but
gave some privileges which would have been sacrificed if
they had joined the Federal Reserve-39
Furthermore, the state institutions feared membership
would involve double reports and examination and double
governmental regulation and control. They also feared the
authority of the Federal Reserve Board and their attitude
was expressed in the words of one banker who said "we do
not want them to come in and tell us how we shall run our
business." 40 They also wished to see how the national banks
fared under the new system before joining. This attitude
was intensified by the feeling that, once in, they could not
withdraw from membership as easily as could a national
37
Annual Report of the Federal Reserve Board, 1914, p. 20; Annual Report of the Federal Reserve Bank of New York, 1915, p. 37; The Financial
Age, May 23, 1914, p. 892; The New York Times, July 10, 1914, p. 2; The
Commercial and Financial Chronicle, May 1, 1915, p. 1479; The Financial
Age Supplement, July 3, 1915, p. 1135. See Table 6, p. 158. Consult also Willis,
The Federal Reserve System, chapter XXXVII.
38
The Report of the Federal Reserve Committee on Branch, Group and
Chain Banking, as yet unpublished, contains a detailed treatment of the competition between national and state banks in the United States and its ill effects.
39
The New York Times, April 19, 1914, Section IX, p. 11.
40
E. C. MacDougal, president, Bank of Buffalo, address before New York
State Bankers Association, Saratoga Springs, N. Y., June 24, 1915: Financial
Age Supplement, July 3, 1915, p. 1135.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

145

bank. In an address before the New York State Bankers
Association in the summer of 1915, the governor of the New
York Reserve Bank pointed out three objections which
state bankers had to membership.41
1. The elimination of the "padded" reserves practice.
2. The possible duplication of reserves, or necessity for
excess reserve balances, for collection purposes.
3. The loss of revenue from exchange charges.
It may be asked why a state bank should keep duplicate
reserves with its correspondent bank after joining the system. In answer to this Mr. Strong pointed out that a bank
felt it must continue to carry balances, which drew 2 per
cent interest, with its old correspondent in order to have the
following services performed:42
1. The collection of all checks drawn on non-member
banks and on points outside of the district, which the Reserve
Bank is not now able to handle.
2. The checking, purchase, and collection of commercial
paper.
3. Investigation, purchase, custody, and sale of bonds.
4. Making general inquiry regarding banks and other
credits.
5. Loaning surplus funds on collateral security on the New
York Stock Exchange.
6. The collection of notes.
Early in 1916, the chairman of the New York Reserve
Bank stated that there were four major reasons which kept
state banks in the district from joining the system.43 They
were:
1. The failure of the Reserve Bank, as yet, to pay dividends.
2. The certain loss of interest on reserve deposits.
41
The Financial Age Supplement, July 3,1915, p. 1123, address of Benjamin
Strong.
42
The Financial Age Supplement, July 3, 1915, p. 1135.
,^ 43 Address of Pierre Jay at Watertown, N. Y.y April 17, 1916, on "The
Country Banker and the Federal Reserve System,"

146 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

3. The adjustments made necessary by the development
of the collection system.
4. The probable loss of the revenue many country banks
now secure by deducting exchange when remitting for checks
drawn upon them.
During the pre-war period, the officers of the New York
Reserve Bank and members of the Federal Reserve Board
were engaged in "missionary" efforts among the state institutions. By holding conferences with them, by writing, and
by addressing various gatherings, they endeavored to answer
their reasons for not joining surveyed above and to convert
the non-member banks to membership in the system. So
far as obtaining immediate results was concerned their
efforts were practically in vain.
When the Federal Reserve Bank of New York opened in
November, 1914, it had no state institutions as members.
In 1915 only one such joined, and up to August, 1917, there
was only one more. It is of interest, therefore, to note the
ideas which actuated these two banks in joining and thus
"breaking new ground" in adopting a policy quite at variance with that of the state institutions. The Broadway
Trust Company, New York City> was the first state institution to become a member bank, joining the system in the
summer of 1915. At that time its president said:
To be sure, our State Bank laws as regards trust companies
provide for lower reserves, the reserve law requiring 3% higher
reserves (18%) and all of it, ultimately, in cash or on deposit with
the Reserve Bank without interest. I doubt, however, that many
state banks or trust companies will feel comfortable standing alone
on their own feet with lower reserves than the national banks
which have the Reserve Bank to lean against. Besides, the reports
of state institutions show that they have uniformly declined to
avail themselves of the lower reserve privilege.
As a member bank, the acceptance provision will be restricted,
inasmuch as the total amount outstanding will be limited to onehalf of the capital and surplus, or with special permission, to
100% of such amount. While, perhaps, it may be argued that
this is too low a limit, if there is any virtue at all in restrictive
legislation concerning bank commitments, our present State law,
in my opinion, allows too much latitude in this respect. I do not
understand, from reading the Reserve Law, that a state bank

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP 147
may not make domestic acceptances as well as foreign, if the total
be within the lawful limit, but in any event, at the present time
and with our present business customs, domestic acceptances are
of no great help.
The question of real estate loans is left rather open, the provision being to the effect that they must not be made to such an extent as to render the assets of the institution unduly non-liquid,
that is, beyond the point of safety. This surely jibes with common
sense, and any institution which will base its refusal to join the
system on this account will present a dubious argument. In the
case of trust companies, their capital stock is by law non-liquid,
and may not even be kept in gold dollars in its vault, but must be
permanently tied up in certain high-class bonds or mortgages.
This gives them a capacity for loans on real estate which, in my
opinion, should be sufficient, as I cannot agree that it is good sense
to loan deposits which are repayable on demand, in non-liquid
securities of this kind.
The one objection which seems at this time to be well founded
is concerning the attractiveness of the capital stock of the Federal
Reserve Bank as an investment. I have always regretted that the
dividend was made cumulative. The New York Federal Reserve
Bank is not at present earning its dividend of 6%, but its organization expenses have been heavy, and it has so far invested only
about 10% of its assets. I am told that if 20% were invested, even
at present low rates, its dividend would be covered, as is already
the case in other of the Reserve banks, where the demand has
been heavier, that is, Atlanta, Dallas, and Richmond. It seems
likely that these latter banks will before long be coming to the
New York Bank for rediscounts, in which case the dividend will
be in sight.
It is hardly necessary to mention the principal great benefit of
membership to member banks and their customers. This is the
right of such member banks to convert, through the Reserve banks,
their commercial assets into cash or credit. It seems to me that
if this right is not appreciated by the state institutions, it will be
by their customers.
My own feeling has been from the start that the Broadway
Trust Company should join the system, as its banking business is
practically all commercial and its assets of 44the character which
are acceptable under the Reserve Bank Law.

In the summer of 1916, a second state institution became
a member bank. This was the Corn Exchange Bank of
44

F. G. Lee, quoted in The Commercial and Financial Chronicle, June 12,
1915, p. 1979.

148 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

New York which is still a member of the system. It issued
the following statement:
This bank has applied for admission to the Federal Reserve
system and we have been admitted upon terms which we consider
favorable. Our status as a State bank is maintained with all the
principal privileges we now enjoy.
Whatever feeling of disapproval and distrust of the system we
may have had has been put aside in the larger view that the
Federal Reserve system has come to stay, and it becomes a duty
not to oppose it, but to cooperate to its improvement.
This we believe can best be done by a full membership, and our
motive in joining is to contribute our share to its resources and to
associate ourselves with other leading banks of the country in
developing the system.
We have been pleased with the courtesy and cooperation with
which we have been met by the Federal
Reserve Board and the
Federal Reserve Bank of this district.45
Efforts to Increase Membership during the War
The entrance of America into the World War furnished a
powerful stimulus to the efforts to enlist state banks as
members. Among those who took a prominent part in this
campaign were: officials of the United States Government,
officials of the Federal Reserve system, the Council of
National Defense, State Councils of Defense, the American
Bankers Association, the New York Superintendent of
Banks, and the President of the Association of State Banks
of the State of New York. Much of the membership campaign effort was based upon an appeal to patriotism and
often assumed a war-like color. Typical of such are the
following:
William G. McAdoo, Secretary of the Treasury said:
The time may come when the financial resources of the country will not be commensurate with the national purpose, if the
nation remains half state bank and half national bank in its organization. The state banks will find greater security for themselves, if disaster should threaten, if they are members of the
Federal Reserve system; and the Federal Reserve system itself
will be irresistibly strong if the state banks unite with the national banks in making them an extremely useful national instru48

The Commercial and Financial Chronicle, July 8, 1916, p. 107.

^OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

149

ment. I commend this question to your earnest and patriotic
consideration, with the sincere hope that love of our common
country should surmount every other consideration, and bring
about this supremely desirable result.46

President Wilson issued a statement October 13, 1917,
which was sent by the Federal Reserve Board to all banks
urging immediate consideration. The President said:
May I not, therefore, urge upon the officers and directors of
all non-member state banks and trust companies which have the
required amount of capital and surplus to make them eligible for
membership, to unite with the Federal Reserve system now and
thereby contribute their share to the consolidated gold reserves
of the country? I feel sure that as member banks they will aid to
a greater degree than is possible otherwise in promoting the national welfare, and that at the same time, by securing for themselves the advantages offered by the Federal Reserve system, they
will best serve their own interest and the interest of their customers.
I believe that cooperation on the part of the banks is a patriotic
duty at this time, and that membership in the Federal Reserve
system is a distinct and significant evidence of patriotism.47
An officer of the Federal Reserve Bank of New York set
forth in a letter the following argument:
The Federal Reserve Act has now been amended in such a
way as to remove any disadvantages except the loss of interest on
balances kept with the Federal Reserve Bank, and of this loss,
much if not all, can be offset by making use of the discount, collection and other facilities of the Reserve Bank. . . .
I asked you to consider membership solely as a war measure and
a national necessity. We are in a great war, and are only just beginning to visualize through the great battles now raging in
France, the great sacrifices our allies are calling upon us to make.
We are also in a period of great credit expansion. The Federal
Reserve system is the only credit reservoir in the country. The
commercial banks and trust companies, of themselves, have but
little additional credit making power. They rely, whether members or not, upon the Federal Reserve system for the constantly
growing credit they are obliged to extend to the Government and
to their customers. They look to this great cooperative system to
provide 100 per cent of all the additional credit which must be
created, yet only about 65 per cent of the banking resources of
the country have as yet been willing to contribute their propor48
The Commercial and Financial Chronicle, May 12, 1917, p. 1834.
47
Federal Reserve Bulletin, Nov. 1,1917, p. 828.

150 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
tionate share to the common reservoir, upon which, whether contributors or not, they must rely, not only for their daily needs
but for their ultimate safety as well. At the most critical period
in the world's history, America's financial system should have,
not 65 per cent but 100 per cent of the financial resources of the
country standing solidly behind it. It should gather to itself
every ounce of financial strength in order to unhesitatingly give
to our Government and our industries the financial support they
require, however vast it may be. For the Federal Reserve system
to be able to give to the Government only two-thirds of the support it may require, because the other third of the banks are reluctant to make some little sacrifice of current earnings, is a situation to which I am sure you would not wish to be contributory;
yet it is exactly the situation in which we find ourselves today.
Will not you and your fellow directors be good enough to consider the matter, not solely as trustees for your stockholders, in
which capacity you may shrink from incurring a slight diminution of earnings, but primarily as trustees of the banking resources
accumulated by your community, and of one of the integral parts
of the Government's war machinery? Were it possible to explain
the matter to your stockholders and your community, could there
be any doubt of the overwhelming sentiment which would be found
to exist in favor of having your bank contribute its share to the
agency created to stand back of the Government and of the whole
industrial fabric of the country at this time of crisis?
Will not you and your directors allow your bank to step forward, as a million of our young men have already done, and volunteer for the country's service? And will you not also please
read to your directors again President Wilson's letter of October 13,
1917? If any further evidence of the need for prompt consolidation of our banking resources were needed,
the events of the past
fortnight in France have furnished it.48

Pierre Jay, Federal Reserve agent of the Federal Reserve
Bank of New York said:
But assuming that there would often be some loss, what would
the loss amount to? Under no circumstances would it be so large
as to affect a conservative dividend policy. Under no circumstances
would it more than slightly retard the growth of surplus. Can we
stop to consider such a trifling loss when civilization is hanging
in the balance and thousands of American and allied soldiers are
cheerfully giving up their lives for the cause? Must not our one
thought be, " What can we do, what service can we perform, to
48

From the library of the Federal Reserve Bank of New York.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

151

help win the war? " For if we do not win it, profits and losses, dividends and surplus, will be of very little consequence.49

The patriotic appeal to state banks to join immediately
following the declaration of war did not bear fruit. Not a
single state bank became a member of the Federal Reserve
Bank of New York until after amendments 50 to the Federal
Reserve Act in June, 1917, which made membership more
profitable to them. By these amendments, most of the objections to membership were removed, and some of the regulations which the Federal Reserve Board had promulgated
were given the force of statutory law much to the satisfaction
of the state institutions.51 State banks and trust companies
could become members of the Federal Reserve system and
"retain at the same time their full charter and statutory
privileges." 52 Further inducement to join was offered by a
decision of the Attorney-General of the United States,
September 10, 1917, that this retention by the state banks
of their charter rights released them from the restrictions
of section 8 of the Clayton Act as to interlocking directorates
which had previously been applied to all member banks.53
Changes in the New York State banking laws also were
effected in May, 1917, which were calculated to facilitate
membership in the system and to make such membership
more profitable for the state institutions. Accordingly, it was
prescribed that any part of the "reserves on hand," that is
the cash in the vault, in excess of 4 per cent of the deposits
in the case of the commercial banks and in excess of 3 per
cent of the deposits in the case of the trust companies, could
be deposited in the Federal Reserve Bank. Furthermore,
banks and trust companies were permitted to include Federal
Reserve notes in their legal reserves by withdrawing the
prohibition against their inclusion.54 New Jersey and Con49

Trust Companies Magazine, April, 1918, p. 310.
Public Act, No. 25, 65th Congress, June 21, 1917.
Annual Report of the Federal Reserve Board, 1917, p. 13; GuarantyTrust Company, pamphlet entitled " Reasons for Entering the Federal Reserve
System/7 Oct. 4, 1917.
52
Annual Report of the Federal Reserve Board, 1917, p. 13.
58
Ibid., p. 14.
64
The Commercial and Financial Chronicle, May 19, 1917, p. 1975.
60

152 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

necticut also passed laws permitting Federal Reserve notes
to be counted as part of the legal reserves of state institutions.56
The first addition to the New York Reserve Bank's
membership in 1917 was that of a country bank on August 1.
This was followed by that of another country bank in
September, and the Guaranty Trust Company of New York
City in October. Following the lead of the Guaranty, the
largest state institution in New York City, most of the
others in the city joined and a number from elsewhere in the
district.56 Altogether the membership of state institutions
increased by 44 in 1917 and 56 in 1918. In no other year in
the history of the Reserve Bank have the admissions of state
banks approached these in number.57 Besides the amendments and the Attorney-General's decision of 1917 other
considerations were factors in enlarging the membership
during the war years.
There was the pressure of public opinion and the patriotic
motive of helping the Government finance the war. The
Federal Reserve agent of the New York Reserve Bank
attached especial importance to the element of patriotism,58
although not one state bank responded to the appeal to
country until after the war amendments to the Reserve Act,
enabling greater banking profits to be made by joining, were
passed. The weight of the following factors in causing a
group of state institutions to join the Federal Reserve system was probably determining: making profits growing out
of the rediscounting of war paper and the deposit of government funds, the value of being able to advertize—"Member
of the Federal Reserve System/7 the amendment to section 22 of the Federal Reserve Act relating to transactions
between member banks and their officers or directors,59 and
55
The Commercial and Financial Chronicle, Aug. 25, 1917, p. 740. Though
national banks could not count Federal Reserve notes as part of their legal
reserve, they could keep in their vaults as much currency in Federal Reserve
notes as they wished.
M
Annual Report of the Federal Reserve Bank of New York, 1917, p. 28.
67
See Table 6, p. 158.
58
Annual Report of the Federal Reserve Bank of New York, 1917, p. 28.
69
Annual Report of the Federal Reserve Board, 1918, p. 81.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

153

the feeling of safety due to possible need of drawing upon
the resources of the Federal Reserve on account of the
increased demands for credit and uncertain conditions as a
result of the war.
In 1918, the United States Council of State Banking
Associations suggested to the Federal Reserve Board an
amendment to the Federal Reserve Act enabling certain
classes of savings banks to become members of the Federal
Reserve system.60 The savings banks were especially desirous
of membership at that time in order to obtain a share of the
business of handling war loans and obtaining government
deposits growing out of them. The proposal to admit savings
banks continued to be talked of in certain quarters. Finally,
mutual savings banks, Morris Plan banks, and " other
incorporated banking institutions engaged in similar business" were made eligible to membership under the liberalizing provisions of the Banking Act of 1933.
Membership since the War
In spite of the campaign of patriotism and legal changes
making membership more profitable, there were approximately 200 eligible state banks and trust companies in the
New York district at the end of 1918, which were nonmembers. Twice as many eligible state institutions were
outside the system as were in it.61 Hence the question of
state bank membership remained after the war. It has been
the object of discussion ever since then and is still a problem.62 Early in 1919, the New York State laws were amended
in such a way as to reduce the percentage of reserve which a
state institution, becoming a member of the Federal Reserve
system is required to carry, and to make it no longer necessary for such institutions to carry a required percentage of
their deposits in cash in vault.63 The effect of these changes
upon membership in the New York Reserve Bank was inappreciable.
60

Federal Reserve Bulletin, January, 1919, p. 50.
See Table 6, p. 158.
See chapter VI, p. 123, concerning efforts to reduce the Government's
share.
63
Federal Reserve Bank of New York, Circular No. 159, April 5, 1919.
61
62

154 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

In response to a congressional inquiry on membership in
the Federal Reserve system in 1923 the New York Reserve
Bank reported to the Federal Reserve Board on this question as follows:64
The reasons given by non-member banks in this district for
not joining the Federal Reserve system may be summarized as
follows, in the order of their importance:
1. Cost, because of the loss of interest on balances, inability to
count cash in vault as reserve, and limited dividends.
2. Ability to secure benefits from correspondents without membership, and disinclination to sever these relationships.
3. State laws, prescribing reserve requirements at variance with
the requirements prescribed by the Federal Reserve system.
4. Inconvenience of further examination and supervision.

While the consideration of cost was most often encountered
by the Reserve Bank as an obstacle to joining, yet it found
that in most cases very little or no additional expense was
borne by state institutions which were members.65 On this
point the Bank reported:66
It does not appear, generally speaking, that membership has
resulted in reduced profits to state banks whether through loss of
interest on reserve balances formerly kept with city correspondents, or through loss of exchange on checks. Where earnings have
been reduced in one direction they have been increased in others.
The special services afforded by the system and the earmark of
security which membership gives is usually regarded as ample
compensation for any added expense incurred.

The situation is that membership may subject the state
banks to certain losses which are more or less tangible
whereas the benefits are in large part intangible or less easily
calculated. But few country bankers have had a costaccounting system which enabled them to accurately determine the cost of membership.67 While the benefits of membership may enable the country state banker to operate more
64
Inquiry on membership in the Federal Reserve system, Joint Hearings
before the Committee on Banking and Currency of the United States Congress pursuant to Public Act No. 503,1923, p. 51. (Hereafter cited as Hearings
M
on Membership, 1923.)
Idem.
5
« Idem.
* Idem.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

155

effectively or profitably, they probably require more effort
on his part and a higher degree of managerial ability. And
while the benefits are quite easily obscured, such losses as
interest on balances, inability to count cash in vault as
reserve, and limited dividends are very patent to him.
It will be noted that among the reasons given for not
joining the Federal Reserve Bank of New York, the loss of
exchange charges does not appear. By 1923 the loss of exchange charges was not a deterrent to membership in that
district because all non-member banks had made arrangements to pay their checks at par.68 The Federal Reserve
banks now absorb the costs which banks formerly claimed
were the basis of their exchange charges. Hence such charges
can no longer be defended and their loss by the banks cannot be legitimately advanced as a reason for not joining the
system.
In its report to the Federal Reserve Board the Bank
listed four methods of encouraging membership in the
Federal Reserve system.69 They were:
1. To compel membership by Federal law and undergo the
test of the courts on the question of constitutionality.70
68

Ibid., p. 52.
Ibid., pp. 53-54.
When the banking reform law was under discussion, unified banking was
proposed by W. P. G. Harding (later a governor of the Federal Reserve Board)
in 1913, at which time he said: "In my opinion there should be, if possible,
government supervision of state banks as well as national banks, and as all
commercial banks do a collection and exchange business, it is therefore probable that they are doing an interstate business which would subject them to
Federal supervision." (Willis, The Federal Reserve System, p. 443.) It was
also urged by Senator J. T. Shafroth before the Senate Banking and Currency
Committee. (Senate Hearings on the Federal Reserve Act, 1913, Vol. I, p. 960.)
The Federal Reserve Board, in 1915, declared unified banking to be the aim
of the Federal Reserve Act and urged its attainment. During the existence
of the Federal Reserve system it has been proposed several times in Congress
to force state banks into the Federal Reserve under the taxing power of the
Federal Government. Unified banking has in recent years come to be widely
discussed as a result of the investigation of the banking situation conducted
by the Senate Banking and Currency Committee in 1931. (See Hearings on
Banking Systems, 1931, p. 366.)
In March, 1932, the Federal Reserve Board was requested by the Senate
Committee on Banking and Currency "to suggest a constitutional method of
creating a unified banking system in the United States." In a lengthy analysis
of this subject the Board's General Counsel concluded that "Congress has
69

156 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

2. To secure uniformity of reserve requirements for banks,
both state and national.
3. To educate systematically all eligible non-member banks
upon the value of membership, appealing both to their self-interest
and to their public spirit.
4. To make membership more attractive financially.

The last named of these plans, making membership more
attractive financially, would remove the chief obstacle to
increasing the membership of state banks in the system, so
far as the New York Reserve district is concerned.71
The desirability of bringing more state banks within the
Federal Reserve organization rests upon several considerations. In the first place, the services and benefits of the
Federal Reserve system would be brought directly to a
greater number of communities, particularly those in the
rural sections. This would mean that the ability of state
banks to adjust themselves to changing economic conditions would tend to be increased. Enlarged membership
would also increase the amount of bank credit under the
authority of the Federal Reserve system and hence tend to
increase the effectiveness of Federal Reserve credit control
policies. Furthermore, the number of member banks in
the system is not likely to remain constant but is likely to
increase or decrease. A long continued decrease in membership would seriously impair, on the one hand, wide distribution of benefits of the Federal Reserve system, and, on
the other hand, the inherent financial resources necessary
to render such benefits.
A clearer understanding of the course of membership may
be obtained by reference to the analysis of changes in memthe power under the Constitution to restrict the business of receiving deposits
subject to withdrawal by check to national banks." (See Federal Reserve
Bulletin for March, 1933, pp. 166-186, for the complete opinion.) The New
York State Banking Board, presided over by the State Superintendent of
Banking, adopted resolutions in March, 1933, deploring the competitive
establishment of unit banks between Federal and state authorities, and memorialized Congress in favor of requiring, as soon as practicable, compulsory
membership in the Federal Reserve system of all banks and trust companies
in the state. (See Congressional Record [unbound edition], March 31, 1933,
p. 1067.)
71
Hearings on Membership, 1923, p. 54. See chapter VI, p. 123, concerning
plans to make membership more profitable for member banks.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

157

bership as shown in Table 6, page 158. The number of member banks of the New York Reserve Bank at the end of each
year showed an increase to and including 1928 when the
peak was reached with a total of 938 banks. Beginning in
1929 the membership declined each year. The organization
of new national banks was responsible for a greater number
of additions to membership during the history of the Bank
than the admission of state banks. Exclusive of 1915 when
there was the group transfer of banks from another Reserve
district, the war and post-war years, 1917-1920, accounted
for more additions than occurred during any other period
of equal length.
Losses to membership were most numerous during the
depression years of 1931 and 1933. Mergers between member
banks accounted for over half of the total losses. Suspension
and insolvency were responsible for the next largest number
of losses. Other losses included those occasioned by voluntary liquidation, absorption of a member bank by a nonmember bank, the conversion of a national bank to a state
bank, and the withdrawal of state member banks.
Group Banking and Membership
The comparatively recent development of group banking
raises the question of its effect upon membership in the
Federal Reserve system. The outstanding group banking
system in the Second Federal Reserve district has been the
Marine Midland Corporation, with headquarters in Buffalo,
which comprised72 twenty-two banks widely scattered over
the State of New York. Although it has been the policy of
the officers of this group not to cause the banks affiliated
with it to withdraw from the Federal Reserve,73 it appears
that they look with more favor upon having their larger
banks belong to the Federal Reserve, leaving the smaller
ones to be "taken care of" by correspondent banks. The
president of the Marine Midland Corporation in testifying
72

February, 1933.
Hearings before the Committee on Banking and Currency, House of
Representatives, 71st Congress, 2nd Session, under EL Res. 141, on Branch,
Chain, and Group Banking, 1930, Vol. II, Part 9, pp. 1250-1251. (Hereafter
cited as Hearings on Branch, Chain, and Group Banking, 1930.)
73

158 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
TABLE 6

MEMBER BANKS IN SECOND FEDERAL RESERVE DISTRICT
CHANGES IN MEMBERSHIP*
19I4f
MEMBERSHIP, FIRST OF YEAH
ADDITIONS

Organization of national bank
Conversion of non-member to national
Admission of state bank and trust
companyResumption following suspension
Transferred from Third Federal ReBerve District (national banks)
Transferred from First Federal Reserve District (national banks)
Other additions
Total additions

480

1918

1919

1920

1921

613

622

670

723

753

784

1915 1916 1917
479

0
0

1
1

1
0

44
0

56
0

20
0

18
0

3
1

131

0
0
0

0
0

15
0

0
0

141

0
0
0
0
0
0
1

3
1
0
2
0
0
1

2
3
0
3
8
0
0

1
0
0
1
6
0
0

5
0
0
0
0
0
0

3
3
0
2
1
0
0

14
1
0
1
2
3
0

12
0
1
0
0
2
0

LOSSES

Merger between member banks
Voluntary liquidations
Suspension and insolvencyAbsorption, member by non-member
Conversion, national to non-member
Withdrawal, state member
Other losses
Total losses^
N E T CHANGE
MEMBERSHIP, END OF YEAR

National
State bank and trust company
Percentage of national banka
Percentage of state banks and trust
companies

8
1
16
7
-1
+134 +9 +48
670
613 622
479
624
479
612 620
0
2
1
46
99.8 99.7 93.1
100.0
0.0

0.2

0.3

6.9

+53

+30

+31

+11

723 753
784 795
622
631
650
662
122
134
133
101
86.0 83.8 82.9 83.3
14.0

16.2

17.1

16.7

* Data for the years 1915-1927, 1929 compiled from Annual Reports of Federal Reserve
Board. Data for the years 1928, 1930-1933 compiled from Annual Reports of the Federal
Reserve Bank of New York.
t From date of opening, November 16, 1914.

before the House Banking and Currency Committee of
Congress in 1930 said:74
Mr. Dunbar (Member of the committee). Do you encourage
your substation banks to become members of the Federal Reserve
system?
Mr. Rand. We have not changed the banks that have gone into
our group. If they are members of the Federal Reserve, we want
them to remain members of the Federal Reserve. So far, we have
not adopted a policy. I should say, however, our policy is to have
our large banks, particularly, members of the Federal Reserve
system.
Mr. Dunbar. Why should not the smaller banks be members?
74
George F. Rand, idem.

OBSTACLES TO DEVELOPMENT AND MEMBERSHIP

159

TABLE 6—Continued

MEMBER BANKS IN SECOND FEDERAL RESERVE DISTRICT
CHANGES IN MEMBERSHIP— Continued
1922

1923

1924

1925

1926

1927

1928

1929

1930

1931

1932

1933

795

803

835

855

880

913

937

938

931

914

841

827

16 a

327

9
2

5
1

8
0

16
0

9
0

4
0

3
0

8
0

3
4

242
10

8
1

Total

131

0
0

15
0

751

7
1
0
1
0
0
0

12
0
0
0
1
2
0

12
0
0
2
5
0
0

16
0
0
0
1
0
0

22
0
0
2
0
0
0

30
0

20
0
4
3
0
2
0

32
0
44
4
0
3
0

S
1
11

223
13
94
31
32
14
17

19
17
IS
13
9
15
+8 +32 +20 +25 +33 +24

937
771
166

938
775
163

13
1
1
1
2
0
0

803
667
136

835
692
143

2
2
1
2
2
0

855
711
144

880
734
146

913
750
163

0
5
4
0
0

2
0
0
0

0
31
1
0
0
15»>

424
83
22
54
29
—.7 -17 -73 -14 -20 +327
c
807
931 914 841 827
769 759 699 684 650
162 155 142 143 157
39

83.1

82.9

83.2

83.4

82.1

82.3

82.6

83.0

83.1

82.7

80.5

16.9

17.1

16.8

16.6

17.9

17.7

17.4

17.0

16.9

17.3

19.5

Organized to succeed 13 banks under conservators, 2 licensed banks, and 1 bank in
receivership.
b
Includes 2 national banks whose successor banks were chartered in January, 1934.
c
Includes 50 unlicensed banks.

Mr. Rand. Well, we allow our banking boards a very large
degree of local autonomy and where the board of directors of the
local bank wish to become a member of the Federal Reserve system, we encourage it and sometimes they have not wished to
become a member of the Federal Reserve system and we have not
interfered with the local autonomy that they cherish.

Experience has been too limited and it is too early to be
certain, however, as to the effect of the group banking movement upon the membership, resources, and control of the
Federal Reserve system. But those who are interested in
protecting and developing the nation's central banking
system have felt that group banking constitutes a threat

160 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to the financial integrity and public control of the system.
Consequently they took such measures as were deemed
necessary to safeguard the Federal Reserve and incorporated
them in the Banking Act of 1933.75 Where two or more
banks are associated with the same holding company affiliate, this Act limits the participation in Federal Reserve
nominations and elections to one of them.76
75
76

Public Act, No. 66, 73rd Congress, June 16, 1933.
Banking Act of 1933, section 3(b).

CHAPTER VIII
CENTRALIZATION OF OPEN MARKET POLICY
OF THE RESERVE SYSTEM
The New York Bank as Agent for Other Reserve Banks
The Federal Reserve Act authorized the Reserve banks
to engage in open market operations under rules and regulations prescribed by the Federal Reserve Board.1 In the
very first stages of Federal Reserve open market development the New York Reserve Bank began to act as agent
for the other Reserve banks in the purchase of open market
paper in the principal money market of the country.2 It
was on the last day of 1914 that the New York Bank engaged in its first open market operation when it arranged
to purchase a block of New York City warrants. Following
this transaction other Reserve banks asked the New York
Bank to act for them in the purchase of warrants.3 At the
second meeting of the Governors Council held in Washington, January 20 to 23, 1915, the other Reserve banks appointed the New York Reserve Bank their agent in purchasing paper eligible under section 14 of the Federal Reserve
Act.4 From the first year of its existence the New York
Bank has held balances of the other Reserve banks and
these have been used to fulfill its agency function in purchasing securities for the several Reserve banks. In addition the New York Bank has sold acceptances purchased
for its own account to the other Reserve banks.5
One way by which the operation of the other Reserve
banks has been governed by the policy of the New York
Bank is shown, for example, in this: Bank acceptances
from all over the country have tended to flow to the dealers
1

Federal Reserve Act, section 14.
Annual Report of the Federal Reserve Bank of New York, 1915, p. 20.
Idem.
4
Idem.
5
Annual Reports of the Federal Reserve Bank of New York.
161
2
3

162 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

in New York. In order to maintain a market for the acceptances and enable the dealers to continue in business the
New York Bank has made heavy purchases of them. As a
result its reserves ran low and in order to replenish them,
it became necessary, with the approval of the Federal Reserve Board, to sell some of the acceptances purchased to
the other Reserve banks.6 The other Reserve banks having
surplus funds have generally cooperated with the New York
Bank in this procedure and have not been compelled to do
so by the Federal Reserve Board.
While purchases of various classes of paper were made by
each Reserve bank independently of the others in their local
markets, the several Reserve banks were more or less affected
by what the New York Bank did in the principal money
market. Each regional bank ordinarily bought the kind of
paper it chose and at such times and in such amounts as
suited its individual purposes. The paper purchased consisted of municipal warrants, acceptances, and government
securities. There was no formal organization of Reserve
bank representatives directing open market operations in
the early years unless the Governors Council be considered
as such along with its other work.
In so far as the generally independent open market practice was modified, it was largely in respect to the agency
function which the Reserve bank governors had delegated
to the New York Reserve Bank and the dominant power
exercised by the New York Bank, operating in the principal
money market, to which the other Reserve banks were subject. From 1915 to 1923, the part played by the Federal
Reserve Board in these open market operations consisted
almost entirely in formulating regulations concerning the
eligibility of various kinds of credit instruments for purchase by the Reserve banks.
Origin of Central Control outside the Federal Reserve Board
Following the crisis of 1920 there was a general liquidation of credit which included a repayment of member bank
«Annual Report of the Federal Reserve Board, 1919, p. 7; 1920, pp. 49,
51.

CENTRALIZATION OF OPEN MARKET POLICY

163

borrowings to the Reserve banks.7 As a result the volume
of discounted paper in the portfolios of the Reserve banks
was very low during the first part of 1922. With a view to
increasing their earnings some of the Reserve banks purchased considerable amounts of government securities on
their own initiative and for their own account.8 This buying
of securities gave the Federal Reserve Board and the Treasury some concern. It was evident to them that the open
market buying was not because the market needed more
money but because the Reserve banks were inspired by the
profit motive.9 The Reserve banks were bidding against
each other and in the actual execution of the orders it was
seen that their operations affected the price of government
securities in such a way as to arouse the criticism of the
Treasury. Moreover, the Reserve banks being the fiscal
agents of the Treasury, it did not seem proper that they
should be working at cross purposes with the Treasury or
interfere with its plans. It was the governors of the Reserve
banks who took the initiative in improving this situation.
In order to effect some coordination (1) between the open
market operations of the several Reserve banks and (2) in
their operations in the capacity of fiscal agents for the
Treasury, there was appointed at the May, 1922 meeting
of governors, a small committee. The committee was composed of the governors of the New York, Boston, Philadelphia, and Chicago Reserve banks. The governor of the
New York Bank was chairman of the committee. At first
the committee's work consisted merely in the execution of
orders from the several Reserve banks for the purchase and
sale of securities in an orderly way in the open market.10
It was, indeed, a central committee for the execution of
open market orders. Its organization marked the first step
toward the centralization of the open market credit policy
of the Reserve banks.
It was not long, however, before the central committee
7

Annual Report of the Federal Reserve Board, 1923, p. 13.
Idem; Stabilization Hearings on H. R, 7895, 1926, p. 863.
9
Stabilization Hearings on H. R. 7895, 1926, p. 863.
10
Ibid, p. 310.
8

164 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

under the leadership of the New York Reserve Bank assumed increased authority. It is worthy of note that such
enlargement of power was undertaken not upon the recommendation or authority of the Federal Reserve Board, but
upon the authority of the Governors Conference. Mr. Strong,
governor of the New York Reserve Bank, reported that at
the meeting of the Governors Conference in October, 1922,
the governors voted to give the new central open market
committee power to make recommendations to the Reserve
banks regarding purchases and sales of government securities.11 Commencing in October, 1922, the central open
market committee changed its functions in accordance with
the decision of the governors. It no longer merely executed
orders for the purchase and sale of securities for system
account but recommended an open market policy to the
separate Reserve banks.
Thus the second step in the centralization of open market
operations was taken. This consisted in the assumption by
this central open market committee of powers reserved to
the Federal Reserve banks and the Federal Reserve Board.
These powers involved the central control of open market
policy and the determination of a Federal Reserve system
credit policy by the Federal Reserve Board. This very
important credit policy function was now to be undertaken
by this governors' committee.
Considerations Leading to the Federal Reserve Board Resolutions
of 1923

The importance of open market operations lies in their
effects on rates of interest, the volume of member bank
credit and general credit conditions. They have commonly
been used to prepare the market for Reserve bank rediscount
rate changes. The purchase of open market items places
the member banks in the possession of funds, which, in case
they are indebted to the Federal Reserve banks, they may
use to liquidate such indebtedness. The sale of items in the
open market reduces the member bank reserves and may
11

Idem.

CENTRALIZATION OF OPEN MARKET POLICY

165

result in increased borrowings from the Reserve bank. Local
money markets not having been established in each of the
Federal Reserve bank cities, when the Reserve banks, in
1922, purchased independently the acceptances and government securities, they bought them for the most part in
New York, the leading money market of the country.
Consequent upon the independent purchases it was observed that the payments in New York resulted in a reduction of the indebtedness of the New York banks to the
Reserve Bank in New York. This was in accordance with
experience abroad where it has become a well-recognized
principle that when the central bank puts cash into the
money market the indebtedness of the banks to the central
bank tends to be correspondingly less. But this result did not
follow in certain other Federal Reserve districts. Following
such independent purchases it was noted that the borrowings
of member banks outside the larger money centers were
not correspondingly reduced.12 A similar difference occurred
in the case of open market sales. Following their sales of
securities in the latter part of 1922 and the early part of
1923, the borrowings of the New York member banks at
their Reserve Bank tended to increase. On the other hand
at the same time it was noted that the member banks' indebtedness at their respective Reserve banks outside the
money centers was not proportionately increased.13
From the time the first central open market committee
of governors was organized (May, 1922) the Federal Reserve
Board gave particular attention to the problem and investigated the whole open market situation. Not only did the ill
effects and inconsistencies stated above receive its attention, but also the Board's relation to the question of control
over the open market policy and operations of the Reserve
banks. The result was that the Board took an important
step to assert its authority over these operations in a set
of resolutions approved on March 22, 1923. These are as
follows:14
12

Annual Report of the Federal Reserve Board, 1923, p. 15.
Idem.
14
Stabilization Hearings on H. R. 7895, 1926, pp. 864-865.
13

166 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
Whereas the Federal Reserve Board, under the powers given
it in sections 13 and 14 of the Federal Reserve Act, has authority
to limit and otherwise determine the securities and investments
purchased by Federal Reserve banks; and
Whereas the Federal Reserve Board has never prescribed any
limitation upon open-market purchases by Federal Reserve banks;
and
Whereas the amount, time, character, and manner of such purchases may exercise an important influence upon the money market; and
Whereas an open-market investment policy for the 12 banks
composing the Federal Reserve system is necessary in the interest
of the maintenance of a good relationship between the discount
and purchase operations of the Federal Reserve banks and the
general money market; and
Whereas heavy investments in United States securities, particularly short-dated certificate issues, have occasioned embarrassment to the Treasury in ascertaining the true condition of the
money and investment markets from time to time:
Therefore be it
Resolved, That the Federal Reserve Board, in exercise of its
powers under the Federal Reserve Act, lay down and adopt the
following principles with respect to open-market investment operations of the Federal Reserve banks, to wit:
(1) That the time, manner, character, and volume of openmarket investments purchased by Federal Reserve banks be
governed with primary regard to the accommodation of commerce
and business and to the effect of such purchases or sales on the
general credit situation.
(2) That in making the selection of open-market purchases
careful regard be always given to the bearing of purchases of
United States Government securities, especially the short-dated
issues, upon the market for such securities, and that open-market
purchases be primarily commercial investments, except that Treasury certificates be dealt in, as at present, under so-called "repurchase" agreements; Be it
Further resolved, That on and after April 1, 1923, the present
Committee of Governors on Centralized Execution of Purchases
and Sales of Government Securities be discontinued and be superseded by a new committee known as the Open-Market Investment
Committee for the Federal Reserve System, said committee to
consist of five representatives from the Reserve banks and to be
under the general supervision of the Federal Reserve Board; and
that it be the duty of this committee to devise and recommend
plans for the purchase, sale, and distribution of the open-market
purchases of the Federal Reserve banks in accordance with the

CENTRALIZATION OF OPEN MARKET POLICY

167

above principles and such regulations as may from time to time
be laid down by the Federal Reserve Board.

Thus, for the first time there was formulated a set of
general principles to govern the open market operations.
The Board then also first proclaimed its authority to control
them as against the governors led by the New York Bank.
In accordance with these resolutions the central open market
committee of four governors was dissolved and a new committee was organized composed of five representatives from
the Reserve banks. The Board designated the banks of
New York, Boston, Philadelphia, Cleveland, and Chicago
to select representatives and left it to the banks as to whether
they would appoint governors or Federal Reserve agents.16
Governors were chosen in each case and the personnel of
the new committee was the same as the one it superseded
with the exception that the governor of the Cleveland Bank
was added. The Board labeled the new committee the Open
Market Investment Committee and empowered it to supervise open market operations for the system under the Board's
direction.
As stated by Dr. A. C. Miller, "the theory underlying
this whole thing was to put the open market operations
substantially on the same basis as prescribed for discount
operations by the Federal Reserve Act itself." 16 That is
true so far as the relation of the Federal Reserve Board to
these two types of central bank operations is concerned. It
marked the third step in the development of this phase of
centralization.
A fourth step in the centralization of open market operations occurred in the fall of 1923. This was the establishment
of a Federal Reserve system open market investment
account.17 The system account was set up and operated by
the New York Bank under the general supervision of the
Open Market Investment Committee. Changes in holdings
in this account were to be subject to the approval of the
Reserve Board.
15

Ibid., p. 865.
Idem.
17
W. R. Burgess, The Reserve Banks and the Money Market, p. 218.

168 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
The Open Market Investment Committee

The understanding was that this new Open Market Investment Committee could make recommendations regarding credit policy to the Reserve banks and order purchases
and sales in accordance therewith but that whatever it did
was subject to the approval of the Federal Reserve Board
even to fixing the acceptance rates.18 How did this new
arrangement work out? The formal procedure worked in
this way: The committee determined its policy. In cases
where it was "legally necessary7' such policy was submitted
to the Federal Reserve Board for approval.19 It was then
submitted to the individual Reserve banks who had the
option of participation. The regional banks nearly always
cooperated. There was no public announcement of the
policy and the committee proceeded to carry it out.
The central committee's policy was that bankers' acceptances and short-term United States securities be purchased
almost exclusively. There has been one large discount
market in the country and that is in New York. Though
the committee requested some acceptances be purchased in
local discount markets, the bulk of them were bought in
New York. The New York Reserve Bank fixed the buying
rate on acceptances in the national New York discount
market. The rate fixed would determine approximately
the amount of acceptances the Bank would buy, since it
determined the amount offered, and the Bank took those
offered. As rapidly as they came in they were divided by
the New York Bank. Some went to the credit of foreign
banks. In this case the other Reserve banks participated in
a contingent liability on account of a written blanket guarantee of payment at maturity.20 The rest were divided
among the Reserve banks in certain proportions, related to
assets, which werefixedfrom time to time by the central committee with the approval of the respective regional banks.21
18

Stabilization Hearings on H. R. 7895, 1926, pp. 865-866.
Ibid., p. 312.
20
As to the percentage participation in this business on the part of the
separate Reserve banks, see Hearings on Banking Systems, 1931, pp. 883-884.
21
Stabilization Hearings on H. R. 7895, 1926. p. 316; Hearings on Banking
Systems, 1931, p. 92.
19

CENTRALIZATION OF OPEN MARKET POLICY

169

The decisions in the Federal Reserve system regarding the
purchase of foreign bills of exchange have been made by the
New York Reserve Bank. Such bills have been purchased
by that Bank and allotted to the other Reserve banks on a
pro rata basis.22
There has been one large government securities market
and that too is in New York. United States Government
securities were purchased by the New York Reserve Bank
for system account and apportioned in accordance with
agreed percentages to the other Reserve banks.23 Notice
of the purchase was given to all Reserve banks and none was
obliged to participate in the purchase until it had been
submitted to and approved by that bank.24 However, in
case the committee decided that a certain amount should
be purchased, and it was approved by the Federal Reserve
Board, but one of the Reserve banks did not take its share,
the New York Bank would commonly take it anyway.
In the case of distributing new issues of treasury securities, the individual Reserve banks did not deal with the
Treasury. The governor of the New York Reserve Bank
dealt with the Treasury directly, in consultation with the
other governors on the committee, and then apportioned the
securities by agreement among the Reserve banks.25 The
holdings of government securities by the several Reserve
banks since the opening of the system account have largely
reflected increases and decreases of totals in that account.
Centralization of Open Market Powers in the New York Bank
While we speak of the Open Market Investment Committee as doing something, in practice open market operations were handled for the most part by the New York
Reserve Bank. Technically the committee did some things
but they were usually motivated and actually accomplished
by the head and driving force of the committee, the governor
of the New York Reserve Bank. It was he who submitted
22

Hearings on Banking Systems, 1931, pp. 91, 92.
Stabilization Hearings on H. R. 7895, 1926, p. 327.
Idem.
25
Ibid., p. 278.
23
24

170 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

his ideas with which the committee's meetings were introduced.26 The protection of the central committee was
afforded the New York Reserve Bank by having the committee make formal recommendations to the Federal Reserve
Board.27 Since the market for acceptances and government
securities centers in New York, the New York representative
had closest contact with the problems involved and ordinarily would be expected to have the most definite convictions concerning them. As a result the views and attitude
of the New York Bank carried the greatest weight with the
committee.28 So while technically responsibility for some
part of the open market operations rested with the committee, since the head of the committee was the governor
of the New York Bank, the New York Bank largely controlled the Open Market Investment Committee*
Dr. A. C. Miller of the Federal Reserve Board, in testifying
before a congressional committee of inquiry, significantly
answered a question concerning the method by which the
policy of the five members of the committee was determined.
He was asked: "A majority of those five determines?" Dr.
Miller replied: "Well, it may sometimes be a majority of
one. It may be that one is the majority." 29 The open market
policy of the Federal Reserve system, in so far as we can
speak of a system policy, which was carried through, for
example, from 1923 to 1929, was the policy sponsored by the
New York Reserve Bank.
Particular responsibility for "system" policy has been
felt by the officers of the New York Bank upon those occasions when they have undertaken to analyze and defend it.
From other Reserve banks also has come recognition of the
New York Bank's power in handling the very important
credit operations under the open market section of the
Federal Reserve Act. In answering questions submitted by
the Senate Banking and Currency Committee concerning
various phases of open market operations, the other Reserve
28

Hearings on Banking Systems, 1931, p. 801.
Stabilization Hearings on H. R. 7895, 1926, p. 762.
28
See Stabilization Hearings on H. R. 11806, 1928, p. 126.
29
Ibid., p. 191.
27

CENTRALIZATION OF OPEN MARKET POLICY

171

banks made repeated statements to the effect that the
answers regarding them would be covered by the New York
Bank.
Recognition of the leadership of the New York Bank in
the Federal Reserve system as against the other Reserve
banks and, indeed, the Federal Reserve Board, has also
come from abroad. When English interests in 1927 desired
a low rate policy at the New York Reserve Bank and it was
forthcoming, they also desired that it be made fully effective
by putting low rates in force at the other Reserve banks.
When this issue was forced upon the Chicago Reserve Bank,
through the Federal Reserve Board, the independence
asserted by the Chicago Bank induced the scorn and alarm
of London bankers.30 But solace was found in the fact that
after all the New York Reserve Bank's policy was what
counted. The chairman of the board of a prominent banking
corporation in London said:
Any way, the real power of a Reserve bank is its open market
policy and fortunately this is in the hands of an open market committee. Since New York is your only money market of importance,
New York dominates this committee and so dominates the whole
Federal Reserve system. The Chicago crowd cannot help themselves. They can be made to fall into line with
the policy of the
New York Bank whether they want to or not.31
Furthermore, a more important and absolute control of
open market credit policy of the Federal Reserve system was
exercised by the New York Bank in the determination of the
buying rate on acceptances. While the function of the central
open market committee was mainly to regulate the time and
amount of purchases and sales, the New York Reserve Bank
fixed the acceptance rate which governed the bulk of the
Reserve banks' purchases directly in regard to time as well
as amount and indirectly affected the small balance of purchases of acceptances. It should be noted that the Open
Market Investment Committee did not buy acceptances or
government securities nor did it sell them to the Reserve
80
Lionel D. Edie, "British Bankers Resent Mid-West Activities in Reserve
System/' Chicago Journal of Commerce, Nov. 6, 1928.
31
Idem.

172 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

banks. Open market purchases and sales of acceptances and
government securities for "system account" have been
made by the New York Reserve Bank.
The extent to which such acceptances and securities were
held by the New York Bank and the amounts allotted to
the other Reserve banks were brought out by the Senate
Committee on Banking and Currency in its investigation of
the Federal Reserve system.32 The amount of acceptances
which were bought was not actually determined by the
Open Market Investment Committee. It was determined
by the Federal Reserve Bank of New York through its
fixing of the buying rate on acceptances. And the amount
of acceptances purchased by the New York Bank governed
the amount that would ordinarily be taken by the other
Reserve banks since each took a proportionate share of them.
Thus it is seen how the New York Reserve Bank practically
controlled the situation. The centralization of the open
market powers of the Federal Reserve system was effected
to a high degree in the New York Reserve Bank.
The Federal Reserve Board versus The Federal Reserve Bank
of New York
As stated above, the resolutions passed by the Federal
Reserve Board, March 22, 1923, constituted an effort of the
Board to assert its authority over the open market policy of
the system. The degree of authority granted by the Federal
Reserve Act to the Board over open market powers of the
Reserve banks was not as explicitly stated as it was with
regard to its jurisdiction over rediscounting powers. And
32

See Hearings on Banking Systems, 1931, Part VII. On page 893 is shown
the amounts of acceptances purchased by the New York Reserve Bank for
the Federal Reserve system, the amount held by the New York Bank and the
amount allotted to the other Reserve banks. On pages 886-892 and 894r-898
are shown the amounts of acceptances acquired by the other Reserve banks
in consequence of allotments by the Open Market Investment Committee.
On pages 824-840 are shown the amounts of United States securities purchased
through the Open Market Investment Committee, and independently, and
held by the separate Reserve banks. The New York Reserve Bank set up a
special investment account, allotments from which were directed by the Open
Market Investment Committee, and purchases of United States securities by
the Reserve banks were ordinarily made through the New York Reserve Bank.

CENTRALIZATION OF OPEN MARKET POLICY

173

members of the Board have believed that it was a reasonable
question as to the extent of its open market authority.33
The Board, however, held that it was entitled to such comparable authority and undertook to declare rather complete
control over the open market powers of the Reserve banks
in its edict of 1923, including the right to limit the purchases
of the Reserve banks.
On the other hand the Reserve banks did not concede the
right of the Board to regulate open market operations in the
same way as lending operations. Some of the banks questioned the Board's authority to approve their open market
purchases.34 There were indications that if the Board declined to approve purchases "the board of directors of the
Reserve Bank would go ahead on their own account and
operate in the open market." 3& Regarding such an action
Dr. Miller made this prophetic statement in 1926: "that
would be fatal." His judgment was vindicated by the extensive open market purchases in 1927, which were inspired
largely by the New York Reserve Bank.36 These purchases
led to the excessive securities speculation preceding the
stock market crash of October, 1929, and, in his judgment,
resulted in one of the most costly errors of banking policy
in any country in 75 years.37
Technically, the recommendations and conclusions of the
Open Market Investment Committee were referred to the
Federal Reserve Board, and approved, modified, or disapproved before being put into operation.38 But during the
investigation conducted by the Senate Banking and Currency Committee into the operation of the Federal Reserve
system, in 1931, it developed that the open market operations were never "very adequately" under the control of
the Reserve Board until quite recently.39 As the Open
33
See Stabilization Hearings on H. R. 7895, 1926, pp. 866-867, and Stabilization Hearings on H. R. 11806, 1928, p. 403.
34
Stabilization Hearings on H. R. 7895, 1926, p. 866.
35
Idem.
3S
Hearings on Banking Systems, 1931, p. 132. See chapter XIV, section on
The International Conference of 1927.
37
Hearings on Banking Systems, 1931, p. 134.
38
Stabilization Hearings on H. R. 11806, 1928, p. 127.
39
Hearings on Banking Systems, 1931, pp. 129, 158.

174 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Market Investment Committee developed it operated, in
effect, as a central bank.
The resources of the twelve regional banks were considered
as a unit and under the nominal centralized control of the
Committee, were "put into the pot" in the central money
market of the country. When the open market policy of
the New York Reserve Bank functioned in such a way as
to neutralize any intended effect of rediscount rate changes
over which the Reserve Board had more definite control,
the power of the New York Bank over banking and credit
in the country was brought into bold relief. The influence
of the so-called outside Reserve banks was trifling.40 The
extensive "easy money" policy of 1927 in the open market
was in reality a central bank operation. According to a
member of the Federal Reserve Board who went through
that period, "it could hardly have been more so if we had
had but one bank." 41
Formation of the Open Market Policy Conference
The disastrous consequences of the 1927 "easy money"
program to aid Europe caused the outside Reserve banks to
be more solicitous about the use of their resources. Largely
due to their feeling, the old Open Market Investment Committee was dissolved by action of the Federal Reserve
Board, March 25, 1930, and a new committee was constituted.42 The character and size of the committee were
changed. This committee included representatives from each
of the twelve Reserve banks and was officially known as the
Open Market Policy Conference. Given the right to designate any representative of the Reserve banks they chose,
the boards of directors appointed their governors in every
case.
»Ibid., p. 140.
41
Idem.
42
Idem. The effects of that "easy money" policy are pointed out in treating various topics. Particularly, see pp. 173, 269, 377, 385. Cf., in general, the
following: Harold L. Reed, Federal Reserve Policy, 1921-1930, chapter IV;
Charles O. Hardy, Credit Policies of the Federal Reserve System, Part I,
chapters V-VIII; The New York Money Market, Vol. IV, Part I by B. H.
Beckhart. *

CENTRALIZATION OF OPEN MARKET POLICY

175

The following constitution of the Open Market Policy
Conference shows the form of its organization and includes
the general principles which governed its functions:43
(1) The Open Market Investment Committee, as at present
constituted, is hereby discontinued and a new committee, voluntary in character, to be known as the Open Market Policy Conference is set up in its place.
(2) The Open Market Policy Conference shall consist of a representative from each Federal Reserve bank, designated by the
board of directors of the bank.
(3) The Conference shall meet with the Federal Reserve Board
upon the call of the governor of the Federal Reserve Board or the
chairman of the executive committee, after consultation with the
governor of the Federal Reserve Board.
(4) The function of the Open Market Policy Conference shall be
to consider, develop, and recommend policies and plans with regard to open market operations.
(5) The time, character, and volume of purchases and sales
shall be governed with the view of accommodating commerce and
business and with regard to their bearing upon the credit situation.
(6) The conclusions and/or recommendations of the Open
Market Policy Conference, when approved by the Federal Reserve Board, shall be submitted to each Federal Reserve bank for
determination as to whether it will participate in any purchases
or sales recommended; any Federal Reserve bank dissenting from
the proposed policy shall be expected to acquaint the Federal Reserve Board and the chairman of the executive committee with
the reasons for its dissent.
(7) An executive committee of five shall be selected from and
by the members of the conference for a term of one year, with full
power to act in the execution of the policies adopted by the Open
Market Policy Conference and approved by the Federal Reserve
Board, and to hold meetings with the Board as frequently as may
be desirable.
(8) Each Federal Reserve bank participating in the Open Market Policy Conference shall be considered as waiving none of its
rights under the Federal Reserve Act; each Federal Reserve bank
shall have the right at its option to retire as a member of the
Open Market Policy Conference, but each bank while a member of
the Conference shall respect its Conference obligations.

It will be seen from this statement that the purposes of
the Federal Reserve Board in revamping the open market
situation were several:
43

Hearings on Banking Systems, 1931, p. 158.

176 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

{ 1. To assure the several Reserve banks more autonomy
over the control of their respective resources in the exercise
of Federal Reserve open market policy.
2. To curtail the control exercised by the New York Reserve Bank.
3. To make the Federal Reserve Board the central controlling authority over open market powers.
4. For the effective use of the Board's power, to provide
the administrative machinery for applying it.
5. A reaffirmation of the general aims to govern open
market policy.
In order to execute the policies adopted by the Open
Market Policy Conference, an executive committee was
formed. This was composed of the governors of the five
Reserve banks in the northeastern part of the United
States—New York, Boston, Philadelphia, Cleveland, and
Chicago. As far as the extent of its operations is concerned,
the San Francisco Bank would properly have been represented on the committee, but.it is too remote to make it
practicable for anyone from there to function effectively on
it. It was held that such an executive committee should be
in close contact with the money market and would be
obliged to hold meetings with the Federal Reserve Board as
frequently as desirable.
Effect of Banking Act of 1933
Further and more definite control by the Federal Reserve
Board over the open market operations of the system was
provided in the Banking Act of 1933. Also official statutory
recognition was given to the organization of an additional
institution to carry out more effectively the open market
provisions of the Federal Reserve Act. Under the new
Banking Act there was created the Federal Open Market
Committee composed of a representative from each Federal
Reserve bank. The organization of the new Federal Open
Market Committee and its relation to the Federal Reserve
Board are set forth in the Act as follows:44
44

Banking Act of 1933, section 8.

CENTRALIZATION OF OPEN MARKET POLICY

177

(a) There is hereby created a Federal Open Market Committee
(hereinafter referred to as the " committee ")» which shall consist of
as many members as there are Federal Reserve districts. Each
Federal Reserve bank by its board of directors shall annually
select one member of said committee. The meetings of said committee shall be held at Washington, District of Columbia, at least
four times each year, upon the call of the governor of the Federal
Reserve Board or at the request of any three members of the committee, and, in the discretion of the Board, may be attended by
the members of the Board.
(b) No Federal Reserve bank shall engage in open-market
operations under section 14 of this Act except in accordance with
regulations adopted by the Federal Reserve Board. The Board
shall consider, adopt, and transmit to the committee and to the
several Federal Reserve banks regulations relating to the openmarket transactions of such banks and the relations of the Federal
Reserve system with foreign central or other foreign banks.
(c) The time, character, and volume of all purchases and sales
of paper described in section 14 of this Act as eligible for openmarket operations shall be governed with a view to accommodating commerce and business and with regard to their bearing upon
the general credit situation of the country.
(d) If any Federal Reserve bank shall decide not to participate
in open-market operations recommended and approved as provided in paragraph (b) hereof, it shall file with the chairman of the
committee within thirty days a notice of its decision, and transmit
a copy thereof to the Federal Reserve Board.

In these provisions the framers of the Act, in effect, ratified
the purposes of the Federal Reserve Board in adopting the
open market procedure as of March, 1930. The present statutes, however, supplement that code of procedure, strengthen
the hands of the Board in its control over open market operations, and tend to give the several Reserve banks more voice
in formulating a system open market policy. It will be noted
that the new law does not state the functions of the Federal
Open Market Committee. It therefore devolved upon the
Reserve Board to define the Committee's functions under the
authority of paragraph (b) which empowers the Board to lay
down the conditions under which open market operations may
be carried on. In these new regulations the Committee's functions are prescribed by the Board.45 It is the duty of the Com48
Federal Reserve Board Regulations M, Series of 1933, Federal Reserve
Bulletin, August, 1933, p. 502.

178 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

mittee "to consider the needs of commerce and business, the
general credit situation of the country, and such other matters as may be called to its attention by the Federal Reserve
Board or by any member of the committee and to formulate
and submit to the Federal Reserve Board for its action recommendations in writing concerning the open market policy
of the Federal Reserve system."
The final authority concerning open market policy is now
unequivocally stated to reside in the Federal Reserve Board.
The Open Market Committee is given the power to formulate general open market policy which it recommends to the
Reserve Board. But no policy may be effective or be executed except when and to the extent approved beforehand
by the Reserve Board. For the purpose of carrying out the
Board's open market policies the Board prescribed an
executive committee such as had evolved in practice in
former years. The executive committee consists of five
members and is elected annually by the Federal Open Market
Committee from its own membership. The present Open
Market Committee is composed of governors. Its executive
committee consists of the representatives from the Reserve
banks of New York, Boston, Philadelphia, Chicago, and
Cleveland. As in the case of former open market committees
the New York Bank's governor is the chairman of the system
committee and its executive committee.
In carrying out the Reserve Board's policies, it is the
duty of the executive committee to purchase and sell government securities and other obligations, and to allocate
among the participating Reserve banks the total purchases
held for their account, and to adjust such allocation from
time to time to meet the changing needs of the respective
Reserve banks. The executive committee is required to
make such allocations with a view primarily of (a) enabling
each Federal Reserve bank to maintain a suitable reserve
position, and (b) equalizing as far as practicable the net
earning position of the Federal Reserve banks.
Further centralization of open market operations in the
hands of the Reserve Board is evidenced by a number of
other requirements, the more important of which are:

CENTRALIZATION OF OPEN MARKET POLICY

179

(1) No Federal Reserve bank may purchase or sell government securities except in accordance with an open
market policy approved by the Reserve Board and in effect
at the time.
(2) In case a Reserve bank wishes to purchase or sell
government securities for certain specific purposes, for its
own account, it must first obtain the consent of the Reserve
Board.
(3) The Reserve Board has the right in its own discretion
to require the sale of any government securities purchased
by an individual Reserve bank as in (2).
(4) Purchases and sales of obligations other than government securities must be in accordance with regulations of the
Board appropriate thereto and must be reported daily to the
Board.
(5) Rates of interest or discount on acceptances and bills
of exchange must be in accordance with schedules approved
by the Board.
(6) No obligations payable in foreign currency shall be
purchased without the consent of the Federal Reserve
Board.
(7) No Federal Reserve bank may engage in the purchase
or sale of cable transfers for its own account without first obtaining the approval of the Board/6
(8) No Federal Reserve bank shall engage in any open
market transactions which are not of the customary character, which do not occur in the ordinary course of business,
which are engaged in for the purpose of affecting general
credit conditions or which may have a material effect upon
general credit conditions, except with the approval of the
Federal Reserve Board: Provided, however, that any Federal
Reserve bank may purchase obligations for the purpose of
affording relief in a situation involving specific banking institutions in its district.
Some autonomy of the several Reserve banks, however,
is assured under the new law and regulations. A Federal
Reserve bank is not legally compelled to participate in the
48
An exception to this applies to the Federal Reserve Bank of Atlanta,
which may purchase and sell cable transfers through its Havana agency.

180 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

system open market operations determined by the Board.
It may file notice with the Board, within a reasonable time,
of its decision not to participate. But in the absence of
filing such notice a Reserve bank is deemed to have agreed
to participate in any particular system operations and is
expected to cooperate fully in carrying out the system policy.
Independent buying or selling of government securities,
apart from system open market policy, is granted to any
Federal Reserve bank (1) in an emergency when it is necessary to afford relief involving specific banking institutions
in its district; and (2) for other specific purposes for its own
account, if consent is first obtained of the Federal Reserve
Board. Finally, regarding open market operations in other
than government securities, a degree of independent dealing
is permitted each Reserve bank, when such dealing has no
material effect upon general credit conditions.47
Thus, on the whole, the new open market requirements
preserve the regional principle when operations are of local
concern or influence; but when they may affect general
credit conditions, then the Federal Reserve Board has jurisdiction over them as the nation's central controlling authority. In the organization of the Federal Open Market
Committee, all the Reserve banks are put upon an equal
footing so far as legal representation is concerned. The
power of the Reserve Board to control open market policy
and transactions is definitely enlarged and strengthened.
The new statutes, therefore, are calculated to increase the
tendency of recent years to make Federal Reserve open
market operations more a result of system policy rather
than the policy of the Federal Reserve Bank of New York.
47
Even these transactions, however, must be conducted under the regulations of the Board, and potentially, at any rate, the Board has a high degree
of control over them.

CHAPTER IX
CENTRAL BANKING FUNCTIONSRESERVES AND GOLD
Central banks are located in each of the principal countries
of the world today, many of them having sprung into existence since the World War.1 A study of them reveals that
they do not function on exactly the same basis.2 There are
many differences in organization and methods of operation.
Under these conditions there have been voiced various definitions of a central bank, evidencing the differences of
opinion as to what really are its functions. There is, however, the traditional experience of a few European central
banks led by the forerunner of them all, the Bank of England,3 and out of this experience has come a body of literature
dealing with the operations of central banks and the principles of their administration.
In establishing the central banking system of the United
States the framers of the Federal Reserve Act drew upon
American and foreign experience. The central banking
functions which we shall consider are the functions which
were recognized in the Federal Reserve Act and are evidenced
by its provisions. These functions may be classified under a
few main heads as follows: holder of the reserves of member
banks, custody and administration of the nation's gold
reserve, regulation of foreign exchange, note issue, fiscal
agent of the Government, and credit control.
1

Regarding the development of central banks and banking throughout the
world, 1918-1928, see Introduction by H. Parker Willis in Foreign Banking
Systems, Willis and Beckhart, Editors.
2
See Kisch and Elkin, Central Banks.
8
The Bank of England is not the first of existing central banks of issue
founded. It is the second, the Bank of Sweden having been founded earlier.
But the Bank of England is the forerunner of all central banks for the reason
that it first adopted central banking functions, doing so in the second quarter
of the 19th century.
181

182 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
TABLE 7

MEMBER BANK RESERVE REQUIREMENTS UNDER ORIGINAL
FEDERAL RESERVE ACT
Total Legal
Distribution of Reserve
Reserve Required: (From Date of Establish
Percentage of Deposits ment of Reserve Bank)
Time
Banks Demand
Deposits Deposits
With Its
In Own
(Payable (Payable
Reserve
Vault
within
after
Bank
30 Days) 30 Days)
Central
18%
6/18
7/18
5%
Reserve
city
banks

Balance

Balance in own
vault or in its
Federal Reserve
bank, at option
of member bank

Reserve
city
banks

15%

For first
For first 12
36 months months—
3/15, to be
thereafter increased by
5/15
1/15
each
succeeding
six months
until total
is 6/15

For
first
36
months balance in
own vault, or its
Federal Reserve
bank, or with
national banks in
reserve or central
reserve
cities.
Thereafter
balance to be kept
in own vault, or
with its Federal
Reserve bank, or
in both, at option
of member bank

Country
banks

12%

For first
36 months
—5/12,
thereafter
4/12

For
first
36
months, balance
m own vault, or
with its Federal
Reserve bank, or
with
national
Danks in reserve
or central reserve
cities.
Thereafter balance to
3e kept in own
vault, or with its
Federal Reserve
sank, or in both,
at
option
of
member bank

For first 12
months—
2/12, to be
increased by
1/12
each
succeeding
six months
until total
is 5/12

RESERVES AND GOLD

183

Holder of the Reserves of Member Banks

Legal Reserve Requirements

A sine qua non of central banking is the concentration of
reserves. The holding of the reserves of other banks is a
condition precedent to other central banking functions.
The Federal Reserve Act prescribed the transfer of part of
the legal reserves of national banks and member state banks.
This meant the shifting of reserves from their correspondent
banks in the reserve and central reserve cities to the Federal
Reserve banks. The requirements of the original Act are
shown in Table 7.
Three significant points in connection with the original
requirements are (1) the reduction of legal reserve percentages, (2) the gradual transfer of reserves, and (3) the
optional placement of reserves. The original Reserve Act
reduced considerably the legal reserves which had been required under the National Bank Act.4 This reduction was
effected in two ways. The reserve percentages were lowered
and deposits were classified into demand and time. The
reserve percentage required for time deposits, those payable
after thirty days, was made much less than for demand
deposits. The reduction of reserve requirements was considered justified because of the greater efficiency of centralized as compared with scattered reserves, and also as a
compensation to the banks for the non-payment of interest
on their reserve balances with the Federal Reserve banks.
The reserve percentage requirements at the close of a threeyear period from the date of opening of the Reserve banks
were to be as shown in Table 8.
It was decided to effect the transfer of reserves from the
correspondent banks to the Federal Reserve banks gradually
over a period of three years rather than all at once. The
reason for this as given in the report of the House Committee
on Banking and Currency in 1913 was: "A period of three
years is granted during which the deposits of country banks
may be kept with the present correspondent banks in order
that the latter may not be unduly embarrassed by sudden
* See chapter I, p. 4

184 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
TABLE 8

MEMBER BANK RESERVE REQUIREMENTS UNDER ORIGINAL
FEDERAL RESERVE ACT
(After 3 year period)

Banks

Total Legal
Reserve Required:
Percentage of Deposits
Demand

Time

Own
Vault

Federal
Reserve
Bank

Proportion
in Own
Vault or
Federal
Reserve
Bank

18%

6/18

7/18

5/18

15%

5/15

6/15

4/15

12%

4/12

5/12

3/12

Central Reserve
city banks
Reserve city
banks
Country banks

Proportion in

withdrawals while the new reserve banks will not be as
suddenly compelled to provide for using a very large quantity
of funds.''5
The original Act also provided that part of the legal reserves were to be kept in the bank's own vault and part
could be kept at the option of the bank, after the preliminary
three year period, in either its vault or in the Reserve bank
of its district. The theory of the Reserve Act was that "in
times when Reserve banks needed greater strength they
would so alter their policy and adjust their rates as to attract
this variable element of reserves to their own vaults, while
at times when credit could properly be relaxed they would
repel it and thus transfer to member banks the responsibility
for enlargements of the volume of credit in the market,
enabling them to proceed regardless of Reserve bank
policy." 6 But owing to the intervention of the war the
Act was amended so as to centralize member bank reserves
100 per cent in the Reserve banks, thus making possible a
larger expansion of credit for war purposes. The war amendments to the Act having remained on the statute books, it
was not possible to test the original theory of distribution
of reserves.
fi
Willis, The Federal Reserve System, p. 290. See also statement of
Mr.
Glass, Congressional Record, Sept. 10, 1913, p. 4648.
6
Willis, op. cit., p. 1179.

RESERVES AND GOLD

185

As the possibility of American participation in the war
increased, the Government was desirous of impounding the
member banks7 gold in the Reserve banks as a basis for
war financing.7 An amendment to the Reserve Act, September 7, 1916, was directed to this end. It gave the Federal
Reserve Board authority to permit member banks to carry
in their Reserve banks any portion of their reserves which
had been required to be held in their own vaults. Pursuant
to this amendment the New York Reserve Bank in a communication to its member banks said:8
The permission thus given offers an opportunity to all member banks both to be relieved of the responsibility for unused funds
held in individual vaults, and to strengthen their reserves with
their Federal Reserve banks. It should also tend to encourage
the concentrating of the reserves of each district with the Federal
Reserve bank where they will serve as a proper basis for elasticity
when demands for currency are made and will, of course, be immediately available in case of emergency.

A number of member banks in the New York district
availed themselves of the option and deposited all their
legal reserves in the Reserve Bank. After our entry into
the war, a final step was taken under the amendment of
June 21, 1917, in accordance with which all legal reserves
must be kept in the respective Federal Reserve banks. At
the same time the proportion of reserve to deposits was
reduced thereby permitting greater expansion of the superstructure of credit. Since then the reserves required, all of
which have consisted merely of balances at the Federal
Reserve bank, have been as shown in Table 9.
The reserve percentage requirements which have been in
effect from June 21, 1917, are subject to variation under the
terms of the Agricultural Emergency Relief Act, approved
May 12, 1933.9 This act provides that "the Federal Reserve Board, upon the affirmative vote of not less than five
of its members and with the approval of the President,
7

In this connection it is interesting to recall the persistent opposition on
the part of the New York bankers to the opening of the Federal Reserve
banks until the return of "more normal" conditions. (See chapter IV, p. 74.)
8
The Federal Reserve Bank of New York, Circular No. 57, Nov. 20, 1916.
9
Public Act, No. 10, 73rd Congress.

186 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
TABLE 9

MEMBER BANK RESERVE REQUIREMENTS UNDER
AMENDMENT TO FEDERAL RESERVE ACT,
JUNE 21, 1917
Banks
Central Reserve city banks
Reserve city banks
Country banks

Total Legal Reserve Required:
Percentage of Deposits
Demand

Time

13%
10%

3%
3%
3%

may declare that an emergency exists by reason of credit
expansion, and may by regulation during such emergency
increase or decrease from time to time, in its discretion, the
reserve balances required to be maintained against either
demand or time deposits." This statute supplements the
provision already in the Federal Reserve Act, which was
intended to increase elasticity of currency under the Federal
Reserve system.
As provided in the original Federal Reserve Act, the
Federal Reserve Board may suspend the reserve percentages stipulated in the Act practically indefinitely subject
to a certain graduated tax.10 Such suspension of reserve,
requirements, in effect a reduction of them, has never occurred. The new authority granted the Board with the
approval of the President under the Act of May 12, 1933,
permits the reserve percentage requirements to be reduced
without the levying of a tax. Thus an additional means
for relieving any stringency of credit or currency is delegated to the central banking Board. Moreover, the new
provision permits an outright reduction of legal reserves
and not merely a suspension. But the new law goes further.
It increases the powers of the Federal Reserve Board in
controlling credit in that the constituted authorities may
increase the legal reserve percentages as well as decrease
them.11
10

Federal Reserve Act, section ll(c).
See chapter XIII, p. 276, section on Enlargement of Federal Reserve
Board's Authority.
11

RESERVES AND GOLD

187

Maintenance and Use of Reserve Balances

The legal reserves of the commercial banks were originally
deposited in the Reserve banks almost entirely in the form
of gold. Since then any form of money or bank credit acceptable to the Reserve banks has been receivable to apply
on reserve accounts. Deposits are received by mail, telegraph, or through the window of the receiving teller; or
deposits are created by borrowing.
These deposit credits in the Reserve banks, then, have
served member banks as satisfying the legal reserve percentage requirements. In addition, such member bank reserve balances have constituted a central reserve against
the deposits in non-member banks. The reason for this is
that non-member banks have been required to maintain
legal reserves in the form of deposit balances with member
banks, and against such bankers' balances member banks
were obliged to have a reserve the same as against other
deposits. The member bank reserve balances in the Federal
Reserve banks, therefore, have been the basis directly or
indirectly of the nation's bank credit.
The member bank reserve balances have been active.
They have been used as a basis for the nation-wide clearing
and collection system. Federal Reserve banks have effected
the transfer of reserves between commercial banks as settling
agent for the clearing balances of the banks. In this capacity
the Reserve banks have held deposit balances of non-member
banks as well as of member banks.
From the beginning member banks have adopted the
policy of carrying no excess reserves at the Federal Reserve
bank, since no interest is paid on them. Member banks,
therefore, have tended to keep their Reserve bank balances
down to the legal minimum. As a result of dealings with its
Reserve bank a member bank's reserve account fluctuated
in amount. If the reserve went below the legal requirements,
the member bank would have a penalty to pay. If the
reserve went above, the member bank would lose the interest it could obtain by having that excess on deposit in its
correspondent bank. The New York Reserve Bank, therefore, in its first year inaugurated the practice of cooperating

188 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

with its member banks in their effort to maintain their reserve accounts in accordance with the law and yet not lose
interest on the excess. It was done in this way. The member banks arranged with their New York correspondents to
transfer to the Reserve Bank, at the latter's request, sufficient
funds as needed to offset amounts charged. On the other
hand the Reserve Bank deposited any excess balances, built
up through the operation of the collection system, with the
member bank's New York correspondents.12
Member banks have also built up their reserve balances
by (1) depositing cash or cash items, (2) the sale of acceptances and securities, (3) rediscounting eligible paper, and
(4) borrowing on their own promissory notes collateralled
by United States Government securities or eligible paper.
Beginning with the war period in 1917, when such a method
of borrowing was authorized, and ever since, member bank
reserves have been built up chiefly on the basis of government securities.13
The New York Reserve Bank has aided its member
banks in this by holding in custody government securities
belonging to them. Member banks have kept themselves
well supplied with "governments.'' They thus have been
able to replenish any deficiency of reserves very easily and
quickly by borrowing on them. Consequently they have
felt no need to keep any surplus reserves. The intention of
the Federal Reserve Act was that member bank reserves
were to be built up by the rediscounting of commercial
paper. But much the smaller proportion of them has been
obtained in this way, particularly by the member banks in
the New York Federal Reserve district.
With the reduction of reserve percentage requirements
and the adoption of a class of time deposits carrying a much
lower percentage as compared with demand deposits, the
way was open for a tremendous expansion of the superstructure of credit. In addition to federal legislation during war
time making for greater expansion of credit, such expansion
12

Federal Reserve Bank of New York, letter to member banks, July 3,
1915.
13
See The New York Money Market, Vol. IV, p. 385.

RESERVES AND GOLD

189

was considerably augmented by a practice of commercial
banks. This involved the shifting of demand deposit accounts to time deposit accounts which went on particularly
in the decade of the J20s. By this process the banks were
able greatly to increase their loans and investments since
they were required to carry only 3 per cent reserve against
time deposits in lieu of 13, 10, or 7 per cent against demand
deposits.
Another practice of the banks, however, tended to reduce
their Reserve bank balances. This was the sale of " federal
funds." In this case one bank sells its surplus reserves to
another bank in the same or another Federal Reserve district. Thus the bank buying the funds obviates borrowing
from its own Reserve bank. In this way the reserve base
for the superstructure of credit has been less than it otherwise would have been. The sale of federal funds has been
most extensive in New York where the federal funds market
has attained a high degree of development.
It was due to the desire to have no excess reserves that
the market for federal funds originated. Banks with surplus reserves on a particular day have commonly loaned
them for a day to other banks which found themselves
short. While the market for federal funds has aided an
individual bank to operate very close to its minimum reserve requirements, it has been the ability of member banks
to replenish their legal reserves by borrowing from the
Reserve Bank which has been fundamentally responsible
for the general realization of the no-surplus-reserve policy.
Custody and Administration of the Nation's Gold Reserve
Acquisition of Gold

About two-thirds of the gold stock supporting the nation's
monetary and banking structure was held by the Federal
Reserve system, as shown in Table 10. The sources of the
system's holdings of gold were (1) payment of subscriptions
to capital stock of the Federal Reserve banks, (2) deposit
of required reserves of member banks, (3) receipts resulting
from regular banking operations, and (4) special efforts to
acquire gold. The Federal Reserve Act required member

TABLE 10

MONETARY GOLD STOCK AND GOLD RESERVES
(End of year amounts in thousands of dollars)

Year

Total Monetary
Gold Stock in
United States *

Gold Reserve of
Federal Reserve
System t

Proportion of
Total Monetary
Gold Stock Held
by Federal
Reserve System

Gold Reserve of
Federal Reserve
"Rftnlr nf
jj&nK oi

New York*

Proportion of Federal Reserve System
Gold Reserve Held
by Federal Reserve
Bank of New York

1914
$ 241,321
13.3%
$ 91,350
$1,813,005
37.9%
1915
2,312,061
542,413
23.5%
264,146
48.6%
1916
2,842,804
736,236
25.9%
287,145
38.9%
1917
3,155,009
1,674,405
609,697
36.4%
53.1%
1918
3,159,915
2,092,062
66.2%
624,959
29.9%
26.6%
1919
2,944,127
2,062,845
70.1%
549,162
23.0%
1920
2,925,750
2,062,786
70.5%
473,412
1921
3,660,301
2,874,995
78.6%
1,081,204
37.6%
5
1922
3,928,816
3,047,393
77.6%
956,784
31.4%
o
1923
4,243,869
3,080,032
72.6%
871,495
28.3%
32.7%
1924
4,499,481
2,936,533
65.3%
959,602
34.4%
1925
4,399,425
2,701,315
61.4%
928,965
1926
4,492,060
2,818,539
62.7%
961,552
34.1%
1927
4,379,268
2,733,187
62.4%
868,601
31.8%
1928
4,141,421
2,584,232
62.4%
716,698
27.7%
1929
4,283,923
2,857,051
66.7%
749,860
26.2%
1930
4,593,488
2,941,219
64.0%
1,007,122
34.2%
1931
4,460,099
2,988,892
67.0%
843,738
28.2%
1932
4,513,001
3,150,671
69.8%
1,016,087
32.2%
1933
4,322,599
3,568,976
82.6%
938,402
26.3%
• Gold coin and bullion (including foreign coin) held by United Statea Treasury and Federal Reserve banks (including gold held under earmark abroad)
and United Statea gold in circulation. Sources: Annual Report of the Director of the Mint for thefiscalyear ended June 30,1933, p. 76; Circulation Statement of United Statea Money, Dec. 31, 1933.
t Prior to the June 21, 1917 amendment to the Federal Reserve Act, gold held to the credit of the Federal Reserve agents waH not included in the gold
reserves of the Federal Reserve banks. Since this amendment they have been included. Thefiguresgiven as representing the gold reserves held by the
Federal Reserve system and by the Federal Reserve Bank of New York for the years, 1914, 1915» and 1916, include the gold held by the Federal Reserve agents. Source: Compiled from the Annual Reports of the Federal Reserve Board.
X Source: Compiled from the Annual Reports of the Federal Reserve Board.

RESERVES AND GOLD

191

banks to pay for the capital stock of their respective Reserve banks in gold or gold certificates. Accordingly, the New
York Bank acquired itsfirstgold reserve, receiving one of three
installments before it opened in 1914.14
The reserves of member banks were not required to be
paid in gold or gold certificates. However, in the Second
Federal Reserve District, as a result of solicitation by the
Federal Reserve Board and the New York Bank, a large
proportion were transferred to the Reserve Bank in the
form of gold or gold certificates.15 In the course of its regular banking operations the New York Bank acquired gold
(1) through the Gold Settlement Fund as a result of " favorable" balances accruing to it on account of inter-Federal
Reserve district transactions and (2) from the member
banks in its own district who deposited their gold holdings.
Since the early period of the Reserve system member banks
generally preferred not to keep gold in their own vaults and
nearly all imports of gold consigned to New York banks
were sent to the Reserve Bank. The gold kept in the vaults
of the member banks could not be counted by them as reserve. By turning it over to the Reserve Bank they augmented their reserves or converted it into the wanted denominations of currency. Moreover, whenever the banks
needed gold it was made available to them in any amount
for transfer at home or abroad.
Special efforts to acquire gold were employed during the
World War before the United States entered it and after
the declaration of war. Prior to our entry into the war relatively large gold imports greatly increased the gold holdings
of the commercial banks. It was felt by Federal Reserve
authorities that this large stock of gold might be the basis
of unwise credit inflation. Therefore, member banks were
urged to turn it over to the Reserve banks where it would
14
Federal Reserve Bank of New York, Circulars Nos. 1, la, 15, and 21;
Annual Report of the Federal Reserve Bank of New York, p. 9.
15
Annual Report of the Federal Reserve Bank of New York, 1915, p. 11;
Federal Reserve Bank of New York, Circulars Nos. 57 and 74; The New York
Times, Nov. 17, 1914; Federal Reserve Bank of New York, letter to banks
in the Second Federal Reserve District, Aug. 10, 1917, published in the Federal Reserve Bulletin, September, 1917, p. 659.

192 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

be under centralized control. It was pointed out that later
on, when possibly an outflow of gold would be required,
such a movement could be effected with less disturbance to
banking and business conditions.
During the period of American participation in the war,
the efforts to impound gold in the Reserve banks were
pushed vigorously. In a series of communications in 1917 to
all member and non-member banks in the district, including
trust companies and savings banks, the New York Reserve
Bank urged them to send in gold and gold certificates. It
stated that the purpose in thus impounding the gold was to
strengthen the base upon which the credit power of the
central banking system rested so that we might be placed
in the strongest possible position forfinancingthe war.
Several things were done to facilitate the impounding of
gold in the Reserve banks. The war amendments to the
Federal Reserve Act of June, 1917, included one which required all member bank legal reserves to consist of deposit
credit on the books of the Federal Reserve banks. All the
states with territory in the New York Federal Reserve district revised their banking laws so as to permit their state
banks to use Federal Reserve notes to satisfy their legal
reserve requirements. Then the New York Reserve Bank
pointed out that Federal Reserve notes were available to
all national banks for vault money, and to all state banks in
the district for legal reserves and asked their cooperation in
strengthening the banking system by exchanging their gold
and gold certificates for Federal Reserve notes.
The Reserve Bank offered some inducements to stimulate
cooperation on the part of the banks in its Federal Reserve
district. It paid the transportation charges on the shipments of gold and gold certificates and, if they desired currency, the Bank paid the cost of shipping them Federal
Reserve notes.16 Ordinarily the Bank received gold coin
subject to the usual limit of tolerance, but from November,
1917, it received for a limited time gold coin at its face
value.17 The Federal Reserve Board urged that gold be not
16

Annual Report of the Federal Reserve Bank of New York, 1917, p. 21.
"Federal Reserve Bank of New York, letter to banks in the district,

RESERVES AND GOLD

193

used for Christmas gifts in 1917 and the New York Bank
asked its member banks to avoid payments of gold for gift
purposes, offering them new paper money instead to meet
this demand of their customers. The gold impounding campaign resulted in greatly enlarged gold reserves in the
Reserve Bank.
Administration of Gold Reserve

Under the Gold Standard Act of 1900, the Secretary of
the Treasury was charged with the duty of maintaining
the parity of all forms of money with gold. Since the establishment of the Federal Reserve system the responsibility
for the maintenance of monetary convertibility into the
standard of value devolved for the most part upon the Federal Reserve system. Especially was this the case since the
accumulation of most of the gold in the Reserve banks during the war. The Federal Reserve banks were empowered
to aid the Secretary of the Treasury in maintaining the gold
standard and keeping all forms of money at parity with gold.
Of the total gold holdings of the Federal Reserve system
about one-third was held by the New York Reserve Bank,
leaving the remainder to be divided among the other eleven
Reserve banks*18 Nearly all gold imports and exports of the
United States were handled by the financial institutions in
New York City. In so far as bank rates in the United States
have affected international gold movements, it has been
the discount rate of the New York Reserve Bank which
has been instrumental in regulating gold movements between America and foreign countries. That Bank carried
on the function of conserving and protecting the ultimate
gold reserve of the nation's financial system in order that
the gold stock should be adequate to meet. any demands
which might be made upon it.19 In so doing the New York
Nov. 2,1917; Annual Report of the Federal Reserve Bank of New York, 1917,
p. 21.
18
See Table 10, p. 190.
19
Protection in this sense refers to the prevention of undue foreign drains
of gold. It means that taking into consideration domestic and foreign claims,
the New York Reserve Bank performed the function of "managing" gold
for the American people, according to the judgment of those in control of that
Reserve Bank.

194 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Bank has been the major factor in managing the gold standard in this country.20
The Federal Reserve Bank of New York, on occasion, endeavored to conserve and protect the nation's gold reserve
by raising its discount rate, by open market operations,21
and by its currency policy. By the latter is meant the type
of currency which it decides to pay out in response to a
demand for currency. At times the Bank has sought to
gather in the gold certificates in circulation and, at other
times, to pay them out instead of Federal Reserve notes.22
In the latter case gold was impounded in Washington by
the Treasury department and did not appear on the Federal
Reserve statements. Thus (1) this impounded gold was
further removed from accessibility as a basis for credit,
(2) it was made to appear from a reading only of the Federal
Reserve statements that the nation's gold stock was less,
and (3) the Federal Reserve ratio was reduced.
The Federal Reserve banks helped materially in maintaining the parity of all forms of money with gold. To accomplish this they exchanged gold for all moneys, coined
or issued. Moreover, the Reserve banks maintained the
ready convertibility of bank credit into gold. Bank deposits
formerly represented a potential demand for gold. The
amount of gold, relative to total deposits, requested for use
within the United States was ordinarily extremely small.
However, when public confidence in the national and state
banks waned, many people resorted to hoarding gold. Gold
was demanded for bank deposits and supplied by the Reserve banks in substantial amounts. Until the government
decrees of 1933, the parity of all forms of money with gold
was maintained by our central banks. And in this work, such
maintenance meant the convertibility of bank credit as well
as money into gold.
Custody and Control of Gold Passes to the Treasury

As the confidence of the people in banks sank to a low
ebb in 1932 and the early part of 1933, gold hoarding as20

See also chapters XV and XVI.
See following section on Regulation of Foreign Exchange.
53
See Stabilization Hearings on H. R. 7895, 1926, pp. 906-907,

RESERVES AND GOLD

195

sumed serious proportions. Consequently the Government issued executive orders prohibiting the paying out, earmarking,
and exporting of gold coin, bullion, and certificates. The first
such prohibition was contained in the President's proclamation of March 6, 1933, declaring a bank holiday.23 There followed from time to time other executive orders further tightening the ban and defining certain exceptions thereto.
Another step in the Government's control of the gold
stock involved the turning over of the gold in circulation to
the Government. Under the Emergency Banking Act of
March 9, 1933,24 the Secretary of the Treasury was empowered in his discretion, to require any and all individuals
and organizations to deliver gold coin, gold bullion, and gold
certificates owned by them to the Treasurer of the United
States. The Secretary of the Treasury issued an order to this
effect under date of December 28, 1933-25 All persons subject
to the jurisdiction of the United States were ordered to deliver
such gold and were reimbursed in other kinds of money. Some
exceptions were permitted under this Treasury order, including the gold owned by the Federal Reserve banks.
There was some discussion over the question whether
the Government had the right to take over the gold owned
by the Federal Reserve banks. President Roosevelt held
that such power had already been vested in the Government under the Emergency Banking Act, but desired specific authority from Congress for this purpose. The final
step by the Government, therefore, in securing ownership
and control of the monetary gold stoqk, involved an enabling act, known as the Gold Reserve Act of 1934, which
was passed by Congress and became the law on January 30,
1934.26 The purposes of the Act as stated in its preamble
are: "To protect the currency system of the United States,
to provide for the better use of the monetary gold stock of
the United States, and for other purposes."
With the enactment of the Gold Reserve Act all title and
claims of the Federal Reserve Board, the Federal Reserve
23

Federal Reserve Bulletin, March, 1933, p. 113.
* Public Act, No. 1, 73rd Congress, section 3.
Federal Reserve Bulletin, January, 1934, p. 9.
26
Public Act, No. 87, 73rd Congress.
2

196 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

banks, and the Federal Reserve agents in and to all gold
coin and bullion were vested in the United States Government.27 Payment therefor was made by crediting the accounts of the above authorities on the books of the Treasury,
For balances in such accounts the Treasury has paid gold certificates.
The result is that gold, which formerly composed the
bulk of the legal reserves of the American central banks has
been transferred to the United States Government mints,
assay offices, and the Treasury building in Washington,
D, C. Deposited in those places, it is now stored in vaults
and is under the custody and control of the Treasury department. In lieu of the gold coin and gold bullion, Federal
Reserve banks now hold gold certificates as reserve for
their note and deposit liabilities. Gold is still the basis of
our money and credit system but the several forms of money
and credit are no longer redeemable in gold. The custody
and administration of the monetary gold stock of the United
States, which the Federal Reserve system and primarily the
Federal Reserve Bank of New York controlled for almost
twenty years, have passed to the Treasury.
Regulation of Foreign Exchange
Closely related to the protection of gold reserves has been
the regulation of foreign exchange rates. During two periods
27
The Gold Reserve Act also included a prescription concerning the revaluation of the gold dollar. The Act of May 12, 1933 had granted authority
to the President to revalue the dollar. The Gold Reserve Act provided that in
case the President should reduce the weight of the gold dollar, this weight
should not exceed 60 per cent of the old weight.
On January 31, 1934, the President issued a proclamation fixing the weight
of the gold dollar at 155/2i grains nine-tenths fine, or at 59.06 per cent of the
former weight of 25.8 grains. (See Federal Reserve Bulletin, February, 1934,
pp. 61-70.) This devaluation of the gold dollar resulted in an increase in
value, amounting to $2,808,000,000, in the United States Government's stock
of monetary gold. Reflecting primarily the devaluation of gold, the total
stock of monetary gold of the Government, which was $4,033,000,000 on
January 31,1934, became $7,438,000,000 at the end of February, 1934.
Effective February 1, 1934, the United States Treasury undertook to purchase all gold offered at $35 an ounce, compared with the old statutory price
of $20.67 an ounce, and to sell gold for export to foreign central banks whenever our exchange rates with gold-standard currencies reach the gold export
point.

RESERVES AND GOLD

197

in its history the Federal Reserve Bank of New York was
largely relieved of this responsibility by action of the United
States Government in declaring an embargo on gold. The
first period was during the World War and the second commenced in March, 1933.
At the time of the first gold embargo foreign exchange
dealings were regulated by an agency of the Federal Reserve
Board set up in New York City in the quarters of the New
York Reserve Bank. At the time of the second embargo
such transactions were regulated by an agency of the United
States Treasury department, also located in the building of
the New York Reserve Bank. During both of these periods
the Federal Government agencies worked in close collaboration with the Reserve Bank. At all other times when gold
movements were subject to the influence of central banking
policy, the New York Reserve Bank largely did the regulating of them so far as any impulse emanating from this
country is concerned.28
Central banks have had a responsibility to a certain
degree for foreign exchange rates because of the bearing of
these rates on international gold movements and in order
to lessen the risks involved in negotiating foreign trade contracts. Such banks, including the Federal Reserve Bank
of New York, have been accustomed to hold foreign-currency
bills for three purposes—to put surplus funds at interest,
to stabilize interest rates in the home market, and as a
secondary reserve, utilizing them abroad in lieu of gold
when the exchange rates on a foreign market approached
the gold exporting point. The influence of the New York
Reserve Bank on foreign exchange rates has been expressed
not only indirectly through discount rate changes and open
market operations, but directly through dealings in the
foreign exchange market. The Bank has endeavored to
stabilize rates of exchange by buying and selling futures.
When foreign exchange rates were normally weak, it has
commonly purchased bills of exchange.
The Reserve Bank's problem has been not so much the
28
See Stabilization Hearings on H. R. 7895, 1926, p. 502, and Hearings on
Banking Systems, 1931, pp. 91, 899-903.

198 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

prevention of unfavorable rates of exchange as the supporting of weak foreign exchanges, which have generally
ruled throughout its existence. Thus, for example, the
New York Bank enlarged its purchases of bills stated in
foreign currencies in 1927, 1929, and 1930, at a time when
the foreign exchanges were weak and gold was likely to be
sent to the United States. The Bank explained the reasons
for its purchases in these years as follows:29
We sought to support exchange by our purchases and thereby
not only prevent the withdrawal of further amounts of gold
from Europe but also, by improving the position of the foreign
exchanges, to enhance or stabilize Europe's power to buy our exports. In fact our efforts to support exchange were undertaken in
the autumn during our heaviest export season when the foreign
exchanges are normally under pressure, and these operations were
liquidated when the seasonal strain had passed, our goods had
been moved, and the position of the foreign exchanges had improved.

The decision in the Federal Reserve system as to whether
or not bills stated in foreign currencies shall be purchased
has been determined by the board of directors of the New
York Reserve Bank.30 None of the foreign-currency bills
were acquired by the Open Market Investment Committee.31
The New York Bank has purchased foreign-currency bills
from central banks of foreign countries. Such purchases of
foreign exchange have been allotted on a pro rata basis by
the New York Bank to the other Reserve banks. So far as
the control of foreign exchange is concerned the Federal
Reserve Bank of New York has been the central bank for
the United States.
The great inflow of gold following the war and growing
out of the war conditions resulted in unusually large hold29
Hearings on
30
Ibid, p. 91.
31

Banking Systems, 1931, p. 901.

Idem.
Under the Federal Beserve Act as amended by the Banking Act of 1933,
the Federal Reserve Board issued regulations which take away from the
New York Bank authority over purchases of bills stated in foreign currencies.
The requirements now are that no obligations payable in foreign currency
shall be purchased without the consent of the Federal Reserve Board. [Federal Reserve Board, Regulation M. Series of 1933, Section VII, (2).]

RESERVES AND GOLD

199

ings of gold which have continued. The problem of the
Reserve Bank in protecting the nation from foreign drains
of gold has been comparatively easy. The Bank has given
more attention to the matter of redistributing the gold held
here to foreign countries. But whether to retard the inflow
of gold or to send it abroad, the efforts of the Bank to control
international gold movements have met with most limited
permanent success. Owing to the intervention of the war,
nothing comparable to the degree of success in controlling
gold movements which may have been expected has been
possible.

CHAPTER X
CENTRAL BANKING FUNCTIONSNOTE ISSUE AND FISCAL
Note Issue
Federal Reserve Bank Notes

A primary function of a central banking institution is to
enable the banks of the country upon request to convert
their assets into money. In order to maintain the liquidity
of the banking system the Reserve banks were given the
power of creating central bank credit in the form of bank
notes. The Federal Reserve Act provided for the issuance
of two kinds of central bank notes or paper money, Federal
Reserve bank notes and Federal Reserve notes. They were
to be issued under different terms and conditions but the
authorization of the two types of currency had a common
point of origin. It lay in the purpose of the Act to substitute an elastic note issue backed by commercial paper for
the bond-secured national bank notes.
The intention was to retire the national bank notes. In
order to facilitate their retirement, and to avoid any loss
to national banks in the process and undue contraction of
the nation's media of exchange, the Act authorized the
Federal Reserve banks to issue what it called Federal Reserve bank notes.1 These notes were to be issued and
redeemed under the same terms and conditions as national
bank notes except that the total which any Reserve bank
could issue was not limited by the amount of its capital
stock. The Federal Reserve Board has no authority over
the issue of Federal Reserve bank notes.
National bank notes have not been retired as intended
largely because of the opposition of national banks which
desired to retain them for advertising purposes. Consequently, relative to other kinds of money, a small amount of
1

Federal Reserve Act, section 18.

200

NOTE ISSUES AND FISCAL AGENCY

201

Federal Reserve bank notes has been issued. During two
periods, however, there were important increases in the issue
of these notes. But in both periods the unusual enlargement
of the Federal Reserve bank note circulation was for other
purposes. The first increase was due to a foreign emergency
which involved one of our allies during the war.2 A domestic
emergency, the banking crisis of 1933, was responsible for
another substantial issue of Federal Reserve bank notes.
During the Banking Holiday, March 6 to 14, the Bank
Conservation Act was passed, March 9, 1933.3 Under this
Act Federal Reserve bank notes became an "emergency
currency." In addition to United States bonds, merely
miscellaneous collateral acquired by a Federal Reserve bank
could be pledged with the Treasurer of the United States
as backing for them. They could be issued in unlimited
amounts without any gold reserve. Each Reserve bank has
control over their issue except that such issuance is subject
to any regulations which the Secretary of the Treasury may
prescribe.
The issue of Federal Reserve bank notes upon the security
of miscellaneous collateral is limited to the period of the
emergency recognized by the President by proclamation of
March 6, 1933. After the President has declared by proclamation that this emergency has terminated, Federal
Reserve bank notes must be backed, as formerly, by government bonds bearing the circulation privilege. A considerable
volume of this type of Federal Reserve bank notes was
issued during the national banking emergency throughout
1933.4 Consequently, Federal Reserve bank notes, which
2
The Pittman Act, approved April 23, 1918, authorized the issuance of
Federal Reserve bank notes to replace silver dollars which were melted to
provide bullion for foreign use, especially to enable Great Britain to relieve
an acute financial crisis in India. (See Annual Report of the Federal Reserve
Board, 1918, pp. 77-79; W. P. G. Harding, The Formative Period of the Federal Reserve System, pp. 121-122.) At this time the amount of Federal Reserve bank notes in circulation rose from about 9 million dollars in April, 1918,
to a maximum of over 209 millions in December, 1920. (See Annual Report
of the Federal Reserve Board, 1927, Table 22.) From 1921 the amount of
these notes in circulation gradually declined until they reached a low of less
than 3 million dollars in February, 1933.
3
Public Act No. 1, 73rd Congress.
4
During this emergency the amount of Federal Reserve bank notes in cir-

202 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

were originally planned gradually to replace national bank
notes and to be eliminated ultimately from our monetary
system, have assumed new significance as emergency currency.
The Issue of Federal Reserve Notes

The real elasticity in our hand-to-hand medium of exchange was to be obtained, during the period of substitution
of Federal Reserve bank notes for national bank notes and
thereafter, by the currency designated Federal Reserve
notes. Federal Reserve notes are. a combination of government and bank notes. Legally, they are government notes
since, under the Federal Reserve Act (1) the United States
Government is ultimately liable for their redemption and
(2) its agency, the Federal Reserve Board, technically issues
the notes to the Reserve banks through its representatives,
the Federal Reserve agents located at the Reserve banks,
or it may refuse to issue any notes requisitioned. The ultimate authority having the power and responsibility of determining the amount of Federal Reserve note issue is the
Reserve Board.
But Federal Reserve notes are also, legally, bank notes,
inasmuch as the Federal Reserve Act makes them a first
lien on all the assets of the Reserve bank issuing them.
Since the amendment to the Reserve Act of June, 1917,
each Reserve bank has included among its liabilities all its
Federal Reserve notes in actual circulation. From the point
of view of banking principles, Federal Reserve notes are
bank notes issued by the Reserve banks. The Federal Reserve Act so treats them when it authorizes the Federal
Board to charge interest on a Reserve bank's " outstanding
Federal Reserve notes." But here again, this power possessed by the Federal Reserve Board is capable of being a
substantial factor in the credit policy of the Federal Reserve
system. From the point of view of banking principles, therefore, the central banking Board may also be an important
dilation increased from about 3 million dollars in February, 1933, to a maximum of 208 millions in December, 1933. Since then there has been a steady
decline in the volume of these notes outstanding.

NOTE ISSUES AND FISCAL AGENCY

203

influence in determining the note issue policy of the Reserve
banks.
Practically, however, the Federal Reserve banks have
issued Federal Reserve notes. The position of the Federal
Board in the matter has been passive.6 Its power of note
issue has not been acted upon.6 The Reserve Act gives the
Board the right "to grant in whole or in part, or to reject
entirely the application of any Federal Reserve bank for
Federal Reserve notes." 7 But the Board has never refused
the application of any Reserve bank for such notes. Each
Reserve bank has determined the time and the amount of
each issue of its own notes. Besides, the Reserve Board has
never levied an interest charge on a Reserve bank's outstanding Federal Reserve notes. Furthermore, each Reserve
bank has decided the terms of note issue. It has decided
which type of collateral, among several kinds of eligible
collateral, served as security back of the notes. Finally,
each Reserve bank has also determined the relative amounts
of this collateral on the one hand as compared with gold on
the other with which the notes have been backed. Thus, in
the exercise of the note issue function the Reserve banks
almost solely have determined questions of money, credit,
and banking policy. The note issue function has been in
the hands of the Reserve banks and not the Federal Board.
Federal Reserve notes, therefore, regardless of any divided
statutory authority, have been in effect bank notes. Although the Reserve banks were not given a monopoly of
note issue, they were granted a power of note issue superior
to that enjoyed by the national banks.
Security and Elasticity of Federal Reserve Notes

Since the elastic element of our monetary system was to
be supplied by the Federal Reserve notes, the intention of
the Federal Reserve Act was that they were to be issued
only against short-time self-liquidating paper. The original
6

See Annual Report of the Federal Reserve Board, 1921, pp. 96-98.
Of course there is excepted the sheer mechanical sense of acquiescing in
the demands of the banks for notes and issuing them to the Federal Reserve
banks.
7
Federal Reserve Act, section 16.
6

204 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Act provided that the Reserve bank would receive Federal
Reserve notes from the Federal Reserve agent upon turning
over to him promissory notes and acceptances eligible for
rediscount and amounting to 100 per cent of the value of
the currency received. Against these Federal Reserve notes
the Reserve bank was required to keep a reserve in gold of
40 per cent, thus making the total security behind them
140 per cent. The amount of Federal Reserve notes in circulation, therefore, was to fluctuate with the amount of
commercial paper presented at the Reserve banks which
would vary in accordance with the volume of business
transactions.
Very early the practice of the New York Reserve Bank
came to vary from the intention of the Federal Reserve
Act. The Act provided that the Federal Reserve agent
would issue to the Reserve bank currency only in exchange
for an equivalent amount of commercial paper. In 1915
the Federal Reserve Board and the New York Bank desired to impound gold. After the Bank had handed commercial paper to the Federal Reserve agent and received
Federal Reserve notes it began the practice of turning gold
and gold certificates over to the Federal Reserve agent and
receiving back a like amount of commercial paper held by
the agent.8 This practice was continued in 1916 and 1917
and was known as "reversing the pump." 9 It was defended
by the Bank on the ground that it would strengthen its gold
position and its ability to assist member banks and other
Federal Reserve banks; also, that it would tend to prevent
unwise expansion of credit which might occur if the commercial banks had control of the gold in their own vaults.10
Thus in reality the Reserve Bank was engaged in the practice
of exchanging Federal Reserve notes for gold.
8
Annual Report of the Federal Reserve Bank of New York, 1915, pp. 1819. The Bank did this under the authority of section 16 of the Federal Reserve
Act, which provided that it could reduce its liability for outstanding Federal
Reserve notes at any time "by depositing with the Federal Reserve agent,
its Federal Reserve notes, gold, gold certificates, or lawful money of the United
States."
9
Annual Report of the Federal Reserve Bank of New York, 1916, p. 16;
1917, pp. 18-19.
10
Annual Report of the Federal Reserve Bank of New York, 1915, p. 18.

NOTE ISSUES AND FISCAL AGENCY

205

The issue of Federal Reserve notes became a function of
the gold policy of the Bank. This new currency became, in
effect, gold certificates. By June, 1917, all outstanding
Federal Reserve notes of the New York Bank were secured
dollar for dollar by gold or gold certificates.11 This was
contrary to the intention of the framers of the Federal
Reserve Act, which was that the gold deposited with the
Federal Reserve agent was to furnish a basis for the redemption of Federal Reserve notes, and was not for the purpose
of releasing commercial paper which could then be used as
a basis for the issue of more notes.12 However, in order to
make possible a greater expansion of credit for war purposes, the practice was legalized by Congress under the Act
of June 21, 1917. Gold held by the Federal Reserve agent
as collateral for Federal Reserve notes was to be counted as
part of the gold the Reserve bank was required to maintain
as a reserve against its Federal Reserve notes in actual circulation. The effect of this amending act was to reduce the
security back of Federal Reserve notes from 140 per cent to
100 per cent. Of this 100 per cent security at least 40 per
cent was required to be a gold reserve but it could consist
entirely of gold. In time of extensive gold holdings the New
York Bank has enlarged the proportion of gold back of
Federal Reserve notes. At other times when the Federal
Reserve ratio has become low, the Bank has placed more
eligible paper and less gold back of them.
Another amending act affecting the terms of note issue
was that of September 7, 1916. In the first place, under
this amendment, Federal Reserve notes could be issued upon
the security of bills of exchange and bankers' acceptances
rediscounted or purchased under the terms of the Reserve
Act. During the war many of the acceptances held by the
New York Bank were non-liquid. They were based upon
supplies in storage, goods which had been destroyed or used
in unproductive ways in war, and frequent renewals under
a system of revolving credits.13 Since the war the Bank
11

Annual Report of the Federal Reserve Bank of New York, 1917, p. 20.
Willis and Steiner, Federal Reserve Banking Practice, p. 122.
13
See Willis, The Federal Reserve System, chapter XLIV.
12

206 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

has held acceptances which were non-liquid, representing
goods not in the process of sale.14 It has, therefore, been
possible for the Bank to issue Federal Reserve notes representing such non-liquid assets.
A second provision of the amendment of 1916 was that
the Reserve banks could make advances to member banks
on their own promissory notes secured by United States
Government securities. The New York Bank established
the policy early in 1915 of complete interchangeability between deposit credits and Federal Reserve notes. While
the member banks' collateralled notes could not be held by
the Federal Reserve agent as security for the Federal Reserve currency, member banks could take the proceeds of
their borrowings in the form of Federal Reserve notes. This
they have done. Since 1916, therefore, Federal Reserve
notes have been issued indirectly upon the basis of United
States Government bonds.
Authority to issue currency directly upon the basis of
United States Government securities was given the Reserve
banks as an emergency measure for a period of one year in
the so-called Glass-Steagall Act of February 27, 1932.15
Following the passage of this act it was possible for the
Reserve banks to purchase government securities in amounts
sufficient to enable the member banks to meet not only the
domestic demand for currency but the foreign demand for
gold, and at the same time to reduce their indebtedness to
the Reserve bank and to accumulate a considerable volume
of excess reserves.16
The Federal Reserve Board stated that the Glass-Steagall
Act had been a helpful factor in a disturbed situation and
also of service to individual member banks in a number of
instances.17 The Board went so far as to suggest the enactment of certain sections 18 in permanent form, but in any
14

H. Parker Willis, "American Banking during 1930," The Banker, London,
February, 1931, p. 155. See also Hearings on Banking Systems, 1931, pp. 212,
503, 852; Beckhart, The New York Money Market, Vol. Ill, pp. 325, 326, 330,
360-366.
15
Public Act, No. 44, 72nd Congress.
16
Federal Reserve Bulletin, February, 1933, p. 60.
17
Ibid., p. 96.
u
In addition to the note-issue section, a section in the Glass-Steagall Act

NOTE ISSUES AND FISCAL AGENCY

207

event recommended extension of such authority for at least
a year beyond March 3, 1933.19 Congress acted favorably
upon the recommendation, extending certain provisions of
the Glass-Steagall Act to March 3, 1934, including the one
on the issuance of Federal Reserve notes.20
As the time for the expiration of the extension period
for the issuance of Federal Reserve notes directly against
United States Government obligations drew near (March 3,
1934), the Senate passed a bill providing for the continued
extension of this privilege.21 This bill passed the House but
not without a delay and was not approved by the President
until the afternoon of March 5, 1934. Consequently, for
more than twenty-four hours, about $400,000,000 of Federal Reserve notes in circulation among the people were
unsecured.22 No action was taken because of this technical
lapse, however, since the Federal Reserve Act prescribes
no penalty in case the Federal Reserve agent and Reserve
banks do not maintain the required security back of all
Federal Reserve notes in circulation.
The act approved March 5, 1934 23 extended the emergency privilege of issuing Federal Reserve notes for one
year, that is, until March 3, 1935 or until the expiration of
such additional period not exceeding two years as the President may prescribe. The issue of Federal Reserve notes
directly against United States Government indebtedness,
therefore, is authorized at least until March 3, 1935 and,
should the President so decide, until March 3, 1937. Under
the Glass-Steagall Act and its extensions, the Reserve Bank
issued Federal Reserve notes merely by segregating and
pledging some of its government securities. Thus the Reserve
authorized the Federal Reserve banks, in exceptional and exigent circumstances, to make advances to member banks having a capital of not exceeding
$5,000,000 against paper that would otherwise not be eligible for discount,
in case these banks lacked an adequate supply of eligible paper. These were
the sections which were extended for a period of one year, that is to March 3,
1934.
19
Federal Reserve Bulletin, February, 1933, p. 97.
20
Public Act, No. 326, 72nd Congress.
21
S. 2766, Congressional Record (unbound edition), Feb. 28, 1934, p. 3451.
22
It happened that March 3, 1934 was on a Saturday.
23
Public Act, No. 115, 73rd Congress.

208 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Bank has become an agency for doing directly what it has
long done indirectly, viz., converting the public debt into
paper money.
Federal Reserve notes have generally been issued on the
basis of gold and United States Government securities and
not upon self-liquidating credit instruments. Moreover,
the note issue policy of the New York Bank cannot be ascertained merely by a study of the fluctuations in the issue of
Federal Reserve notes. Gold certificates have been paid out
in lieu of Federal Reserve notes to meet changes in the
demand for currency. Although per se an inelastic currency, gold certificates have formed an integral part of the
function of the Bank in providing an elastic currency.24
This has been possible because of the unusually large stock
of monetary gold in this country. So far as the function of
note issue is concerned, the idea incorporated in the original Federal Reserve Act, of providing the United States
with an asset currency varying with the needs of trade,
has, in practice, largely disappeared.25
Fiscal Agent of the Treasury
Transfer of Functions to Reserve Banks

In order to remedy the evils associated with the Independent Treasury system, it was provided in the Federal
Reserve Act that the Reserve banks could be depositaries
of the Government and serve as its fiscal agents. The
authority was not mandatory but permissive, to be exercised at the discretion of the Secretary of the Treasury.
The acquirement of fiscal agency functions on the part of
the Reserve banks came about gradually. Prior to the
24

See Stabilization Hearings on H. R. 7895, 1926, pp. 906-907.
The following figures show the collateral held by the Federal Reserve
agents against Federal Reserve notes issued (all banks) as of the dates stated:
Nov. 30, 1933
Aug. 31, 1934
Federal Reserve notes issued
$3,264,891,000
83,397,104,000
25

Gold
Eligible paper
U. S. Gov't securities
Total collateral
* Gold certificates exclusively.

2,618,254,000
96,276,000
597,600,000

3,133,656,000*
12,685,000
294,000,000

3,312,130,000

3,440,341,000

NOTE ISSUES AND FISCAL AGENCY

209

adoption of the Act the duties connected with the receipt,
holding, and disbursement of funds and with floating government loans nominally devolved upon the Treasury department which utilized, in addition to its own facilities,
those of national banks. The transfer of these functions
to the Reserve banks was not begun until they had overcome some problems of organization.26
National banks, for the most part, performed such functions for the Government until January 1, 1916. On this
date the duties of fiscal agent commenced with the transfer to the Reserve banks of government funds on deposit
in national banks in cities where was located a Federal Reserve bank.27 The United States sub-treasuries continued
to hold large sums of government deposits.28 During 1916
and 1917, up to the entrance of the United States into the
World War, the operations of the New York Reserve Bank
were limited to accepting for deposit the receipts of government collectors of customs and internal revenues and paying
checks and warrants drawn upon the Treasurer of the United
States and coupons of United States bonds.29
Immediately following the declaration of war the Reserve
banks were charged with the important fiscal agency function of floating loans for the Government. As a result the
services of the New York Reserve Bank were enlarged to
include the following:30
36
Letter of Secretary McAdoo to the Federal Reserve Board, Nov. 23»
1915, designating the Federal Reserve banks fiscal agents of the Government
commencing January 1, 1916, Federal Reserve Bulletin, December, 1915,
p. 395.
27
Idem; Annual Report of the Federal Reserve Bank of New York, 1916,
p. 21; Annual Report of the Federal Reserve Board, 1915, p. 6.
28
Federal Reserve Bulletin, February, 1917, p. 112.
29
Annual Report of the Federal Reserve Bank of New York, 1916, p. 21;
1917, pp. 2&-30. In 1916 the sub-treasuries and their relation to the Federal
Reserve banks was the subject of investigation by the Secretary of the Treasury. The question was whether the sub-treasuries should be discontinued
and their duties turned over to the Reserve banks. In his report to Congress,
Secretary McAdoo advised against the discontinuance at that time of any or
all the sub-treasuries and the transfer of their duties to the Reserve banks. A
list of the duties and functions exercised by the sub-treasuries at that time is
contained in the report. Federal Reserve Bulletin, February, 1917, pp. 110112.
30
Annual Report of the Federal Reserve Bank of New York, 1917, p. 30.

210 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

1. The sale and redemption of certificates of indebtedness.
2. The sale and delivery of Liberty bonds, the payment of
coupons thereon, the exchange of bonds of small denomination for bonds of large denomination, and vice versa, and the
conversion of bonds of one issue into bonds of another issue.
3. The administration of deposits of the United States
Government in depositary banks in its district resulting
from sales of certificates and bonds, and the examination,
approval, and custody of the securities pledged to secure
such deposits.
4. The sale of war-savings stamps and thrift stamps.
War Financing
The World War necessitated the raising of hitherto unprecedented sums. The decision of the government authorities to finance it for the most part by borrowing or credit
inflation, rather than by current taxation, imposed a heavy
burden upon the banking organization for funds. Successive issues of Liberty bonds were floated. The Secretary
of the Treasury asked the Reserve banks to assume the
duties incident to federal borrowing in their respective districts.31 As a result each Reserve bank became a central
agency for the organization of bond-selling campaigns
among the banks and the general public. The Reserve banks
handled the routine matters of receiving payments for subscriptions, making deliveries, exchanges, and redemptions.
They also sold numerous issues of treasury certificates of
indebtedness in anticipation of bond issues and tax receipts.
These short-time issues were utilized advantageously in
enabling the Government to absorb accumulated savings
81
Concerning the war finance policies and operations of the Federal Reserve
system, see the following for the years 1917, 1918, and 1919: Annual Reports
of the Federal Reserve Board, the Federal Reserve banks, and the Secretary
of the Treasury; and the Federal Reserve Bulletins. Consult also the following:
Willis, The Federal Reserve System, chapters XLVII-LVII; Jacob Hollander,
War Borrowing; B. H. Beckhart, The Discount Policy of the Federal Reserve
System, chapters VI and VII; J. M. Chapman, Fiscal Functions of the Federal Reserve Banks, chapter V; Wm. A. Brown, Jr., The New York Money
Market, Vol. IV, chapters XIV-XVI; Federal Reserve Bank of New York,
Current Operations of the Federal Reserve Bank of New York as Fiscal Agent
of the United States, May 20, 1919.

NOTE ISSUES AND FISCAL AGENCY

211

gradually without undue disturbance to the money market.
The certificates also enabled purchasers to anticipate their
payments on account of Liberty bond subscriptions and
taxes.
The central banks made direct investments in government securities and loans to member banks, and indirectly
to non-member banks, collateralled by the securities. Popular subscription campaigns were carried on among the
people. Business organizations, large and small, and individuals in all sorts of circumstances were urged to subscribe
for bonds. If they could not buy them outright they were
urged to borrow and buy. To facilitate the sale of the bonds
and certificates by the borrowing process, the Reserve banks
loaned to member banks at interest rates substantially
equal to or less than the rates carried by the government
bond and certificate issues and also at preferential rates on
such war finance paper as compared with commercial paper.
The commercial banks thus advanced credit to purchasers
of the security issues and in turn borrowed from the Reserve
banks.
The result was an enormous manufacture of bank credit
to serve the Government. Several amendments of the Federal Reserve Act, in 1917, made possible this expansion of
purchasing power. The chief factors making for a greater
expansibility of bank credit as a result of the amendments
were: reduction in the reserve percentage requirements of
member banks, member bank legal reserves consisted only
of Federal Reserve bank balances, issuance of Federal
Reserve notes in exchange for gold, and the increased advantages to state banks of membership in the system. The
Government was dependent upon the facilities of the Federal Reserve banks and it was due to the existence of the
central banking system that the Government was able to
secure so easily the purchasing power to finance the war.
Its work as fiscal agent for the Government brought the
New York Reserve Bank in close contact with every bank
in the district, member and non-member alike.32 Although
32
Annual Report of the Federal Reserve Bank of New York, 1918, p. 24.
See also chapter VII, section on Efforts to Increase Membership during the War.

212 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the Bank could not discount directly for non-member banks,
it purchased treasury certificates of indebtedness from them
whenever necessary under an agreement on their part to
repurchase the same within 15 days.33 The Bank, also,
under the authority of the Federal Reserve Board, rediscounted for member banks the paper of non-member banks
when it was given to purchase Liberty bonds or certificates
of indebtedness. This relieved pressure not only on member
but non-member banks.34
The successful distribution of the war bond issues among
the American people is one of the outstanding achievements
in the fiscal history of the United States. The head of the
central organization which was charged with the sale of
Liberty bonds in the Second Federal Reserve District was
the governor of the New York Reserve Bank, Benjamin
Strong. The major part which the New York Reserve Bank
played in financing the war is shown in Tables 11 and 12.
Over two-fifths of all the certificates of indebtedness sold
in the United States during the war years was sold by the
New York Bank in its Federal Reserve district. About
30 per cent of all the Liberty bonds issued were sold through
the New York Reserve Bank.
TABLE 11

CERTIFICATES OF INDEBTEDNESS, 1917-1919

Year

Total Sales in
the United States

Amount Sold through
the Federal Reserve
Bank of New York in
the Second Federal
Reserve District *

Proportion of
Total Sales,
Sold in Second
(New York) Federal
Reserve District

1917
1918
1919

$ 3,880,570,000
10,742,094,000
11,246,820,500

$ 2,422,075,500
4,091,260,000
4,506,155,500

62.4%
38.1%
40.1%

$25,869,484,500

$11,019,491,000

42.6%

* Annual Report of the Federal Reserve Bank of New York, 1920, p. 55.
33
Annual
84

Report of the Federal Reserve Bank of New York, 1918, p. 24.
Annual Report of the Federal Reserve Bank of New York, 1917, p. 27;
1918, p. 24.

213

NOTE ISSUES AND FISCAL AGENCY
TABLE 12

LIBERTY BONDS, 1917-1919

Title

Total Amount
Issued

First Liberty
Loan
$ 1,989,453,550
Second LibertyLoan
3,807,865,000
Third Liberty
Loan
4,175,650,050
Fourth Liberty
Loan
6,964,581,100
Victory Liberty
Loan
4,495,373,000
$21,432,922,700

Amount Sold
through the
Proportion of
Federal Reserve
Total Sales,
Bank of New York
Sold in Second
(New York) Federal
in the Second
Reserve District
Federal Reserve
District *
$ 617,831,650

31.1%

1,164,366,950

30.6%

1,115,243,650

26.7%

2,044,901,750

29.4%

1,317,646,600

29.3%
29.2%

§56,259,990,600

* Annual Report of the Federal Reserve Bank of New York, 1919, p. 44.

The government financing requirements necessitated not
only billions of dollars but occasioned severe shifts of funds.
The shifting of funds was bound to create a temporary demand for credit by various commercial banks. The Reserve
banks, however, supplied the required amount of funds
and the elasticity in the credit structure which was needed,
by their rediscounting and open market operations. Thus
the Reserve system aided the banks in meeting the war
emergency by providing credit expansion, relieving the
pressure on the money market, and equilibrating the credit
flow which was disrupted on account of temporary shifts of
funds. Although the Government placed a heavy responsibility upon the Reserve banks, it was one which they discharged admirably. It was the organization and credit
facilities of the Federal Reserve system together with able
leadership, which made possible the meeting of the Government's unprecedented financial requirements and its
military victory with the Allies.35
35
By means of the Federal Reserve system the United States Government
obtained the funds to finance not only its own military and naval operations

214 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Services Rendered the Government
The growth in the fiscal agency operations of the Federal
Reserve banks during the years 1917 to 1920 and the efficiency with which they were conducted made unnecessary
the services of nine sub-treasuries.36 Congress, therefore,
approved an act, May 29, 1920, providing for their discontinuance on or before July 1, 1921.37 The Secretary of
the Treasury was authorized to transfer any or all of their
duties to the Treasurer of the United States, the mints,
assay offices, or Federal Reserve banks. In accordance
therewith, the sub-treasuries were discontinued and the
Federal Reserve banks took over the following duties previously exercised by them:38
The receipt of gold coin and standard silver dollars for exchange.
The receipt of United States notes, Treasury notes, gold and
silver certificates, and subsidiary and minor silver coins for redemption.
The exchange of various forms and issues of money.
The cancellation and shipment to Washington of currency unfit for circulation and the laundering of soiled currency which permits of this process.
The receipt from United States depositary banks of their surplus deposits of internal revenue, customs, money-order, postal,
and other government funds.
The receipt of deposits of postal savings funds, post-office funds,
money-order funds, deposits on account of the 5 per cent fund for
the redemption of national bank notes, deposits of interest on
public deposits, and deposits of funds by government disbursing
officers.
The payment of United States coupons.
The payment of checks39and warrants drawn against the Treasurer of the United States.
but the billions of dollars which it loaned to allied European countries as
well for such purposes.
38
The United States sub-treasury system was authorized by the Act of
August 6, 1846. In 1920 there were nine sub-treasuries located in the cities
of Boston, New York, Philadelphia, Baltimore, Cincinnati, Chicago, St. Louis,
New Orleans, and San Francisco.
87
Annual Report of the Federal Reserve Board, 1920, p. 72.
w
Ibid., pp. 72-73.
49
Although the Federal Reserve banks are required like the sub-treasuries
were, to pay all United States Government checks, in practice, whether the
New York Reserve Bank pays them depends upon who presents them. While
paying government checks arriving from commercial banks in the clearing

NOTE ISSUES AND FISCAL AGENCY

215

The receipt of funds for transfer to other points through Federal
Reserve banks or branches located therein.

The Treasury department retained the function of custodian of reserve and trust funds consisting of gold coin
and bullion and standard silver dollars securing gold and
silver certificates respectively and held as reserve against
United States notes. This function was to be discharged
by the Treasurer of the United States, the mints, and assay
offices, while to the Treasurer of the United States alone
was reserved the duty of issuing gold order certificates on
gold deposits.40
In addition to the above operations of the sub-treasury,
the Reserve banks have assumed the following services for
the Government: sale and delivery of newly issued government obligations, redemption of securities called for payment or matured, denominational exchanges, interchanges
of coupon and registered bonds, exchange of temporary for
permanent bonds, conversions, transfers of ownership, purchase and sale of securities for Treasury account, maintenance and withdrawal of government deposit accounts
with depositary banks, custody of securities for the Treasury, holding on deposit the general funds of the Treasury,
collection of checks and non-cash items for Treasury account, and transfer of government funds and securities.41
Relations with the Treasury
Since the Reserve banks are the fiscal agents of the
Treasury, their policies have necessarily been affected by
the program of the Treasury. Because the Secretary of the
and collection process, the Bank's policy has been not to pay government
checks presented by individuals at the paying teller's window, except in certain selected cases. The Reserve Bank's paying teller, in 1931, upon declining
to cash a government check issued by the Veteran's Administration to a World
War veteran, told him to take his government check to his grocery store for
payment.
40
Annual Report of the Federal Reserve Board, 1920, pp. 72-73.
41
As fiscal agent of the United States the Reserve banks deal not merely
with member banks but with all commercial banks in their respective districts. For a detailed discussion of these services for the Government, see
John M. Chapman, The Fiscal Functions of the Federal Reserve Banks and
Willis and Steiner, Federal Reserve Banking Practice, chapters XXI and
XXII.

216 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Treasury and an appointee of his, the Comptroller of the
Currency, are members of the Federal Reserve Board, it
has been easier for the Treasury to get what it wanted than
would otherwise have been the case. On the whole a high
degree of cooperation has characterized the relations between the Reserve banks and the Treasury. There has been
"a constant disposition not to work at cross-purposes, but
to let the Treasury's program, whenever it is practicable,
work in with the Federal Reserve's." 42
From the commencement of the fiscal agency function on
the part of the Reserve system, the bulk of the Treasury's
business has been handled by the New York Bank. The
war-time Secretary, William G. McAdoo, found that he
could handle many matters more efficiently through the
New York Bank and he tended to deal directly with it
rather than with the Federal Reserve Board or the other
Reserve banks.43 As Professor Willis has stated: "Thus it
often happened that important policies were initiated and
put into effect without previous consultation with the Reserve Board, which received information only when the
policies had been determined upon, and occasionally at a
later date." 44 During the long regime of Secretary Mellon
the policy of dealing directly with the New York Bank
continued and the Treasury depended upon that Bank in its
dealings with the money market.45 Although the Government maintains accounts with all of the twelve central Reserve banks, its principal account has been with the New
York Bank. That Bank has purchased and distributed far
greater amounts of United States certificates, notes, and
bonds than any of the other Reserve banks.
In accordance with its policy of working directly with
the New York Reserve Bank, the Treasury has furnished
the Bank information regarding its forthcoming operations.46
The information included data about government security
42

A. C. Miller, Stabilization Hearings on H. R. 11806, 1928, p. 264.
See Willis, The Federal Reserve System, pp. 1210-1212.
Ibid., p. 1210.
H. Parker Willis, "A Turning Point in American Banking," The Banker,
London, December, 1928, p. 252.
46
Stabilization Hearings on H. R. 7895, 1926, p. 1003.
43

44
45

NOTE ISSUES AND FISCAL AGENCY

217

issues and tax payments. With this advance information
the New York Bank made plans to prevent disturbances in
the money market and stabilize general credit conditions.
The nature and extent of the cooperation between the
New York Bank and the Treasury may be illustrated by
what occurs on the quarterly tax dates. At each of these
dates, the 15th of March, June, September, and December,
the Treasury receives income tax payments, redeems maturing obligations, pays interest on a portion of its debt, and
usually issues new certificates, notes, or bonds.
On account of the large number of income tax checks and
their geographical distribution, it takes several days to
effect their collection. The disbursements of the Treasury
on the quarterly tax day are, therefore, usually in excess of
its receipts and balances on deposit in banks, which balances the Treasury transfers to the Federal Reserve Bank.
This situation results in (1) an overdraft of the Treasury at
the Reserve Bank and (2) excess member bank reserve
balances. To cover the overdraft the Treasury has followed
the practice of obtaining funds temporarily from the Reserve Bank on a special certificate of indebtedness maturing in one day. Then, from day to day, as the income tax
checks have been collected the Treasury replaced the certificates of indebtedness by successive certificates of smaller
amounts until, after a few days, the whole sum was retired.47
The excess member bank reserve balances created a
problem in that they tended to " flood" the market. Consequently the Reserve Bank has intervened to reduce these
member bank reserve balances. For this purpose several
methods have been used by the Bank, viz., the sale of participations in the one-day treasury certificates of indebtedness to member banks, open market sales of government
securities, and the non-replacing, or postponement of re47

Cf. Annual Report of the Federal Reserve Board, 1929, p. 71.
By means of the treasury bill adopted in 1929 the Treasury has been in a
position to prevent the size of the overdraft in the first place from being as
large as otherwise. The reason for this is that the maturity of the bill may be
made to fall not on the quarterly tax date but on one or more days following
it, thus making the Treasury's tax receipts and disbursements coincide more
closely.

218 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

placing, of maturing government securities or acceptances
in its portfolio.48 The difficulty of excess reserves in this
situation has also been mitigated at times by action of the
member banks in balancing an accumulated deficiency in
the reserve account for a period ending on the tax day, and
by the reduction of their indebtedness at the Reserve Bank.49
Through the cooperation between the New York Reserve
Bank and the Treasury the quarterly turnover of funds has
been handled in such a way as to stabilize money market
conditions and smooth out short-time interest rates.50
As was the case during the war when the Reserve banks
supported the Treasury by discounting paper collateralled
with government obligations, since the war, in good times
and bad, the Reserve banks have practically made a market
for government securities. They have bought those not
taken by others and thus have aided the Treasury in realizing its financial policies. The Government has been moti48
W. R.
49
Idem.
50

Burgess, The Reserve Banks and the Money Market, p. 101;

The total volume of operations for Treasury account, for example, on
March 15, 1927, was nearly $2,000,000,000. A detailed account of the quarterly tax day transactions at that time is given in the Federal Reserve Bulletin,
April 1, 1927, pp. 249-250.
Transactions of this general character have taken place at most of the
Federal Reserve banks on each tax date. The largest part of them, however,
has occurred in New York, since it is there that most of the Treasury disbursements have been made to holders of United States Government securities.
In addition to the financial institutions there having funds to invest, the
New York money market has not only been the center for the investment of
large amounts of out-of-town funds, but many short-term government securities originally purchased in other districts have tended to gravitate to the
central money market.
In order to provide for current expenditures in quarterly periods following
the tax dates, and to prevent a periodical contraction of credit in the money
market, a system of special depositary banks has been used. This involves
the sale of treasury certificates of indebtedness to the depositary banks which
pay for them by giving the Government deposit credit, resulting in no strain
on the money market. In recent years although the use of the treasury bill
has supplemented and modified this practice, it has not superseded the special
depositary system. By the sale of treasury bills the Government can secure
cash or Federal Reserve funds at any time during a quarter period. Consequently the Treasury does not need to accumulate on the tax dates sufficient
bank deposits in the depositaries to carry it through the quarter periods. (See
Annual Report of the Secretary of the Treasury, 1920, pp. 171-173; John M.
Chapman, The Fiscal Functions of the Federal Reserve Banks, chapterVIIL)

NOTE ISSUES AND FISCAL AGENCY

219

vated chiefly with the idea of borrowing at low interest rates
in spite of all other considerations and the economic effects
of such a policy. The result has been the maintenance of a
large proportion of practically permanent debt in shorttime form and the filling up of the portfolios of our central
banks with government obligations.
In these fiscal agency operations of the Federal Reserve
system the New York Reserve Bank has been the point of
immediate contact with the Treasury and as such it has
practically apportioned the purchases of government obligations among the other Reserve banks.51 During the war
the Treasury centralized its banking business in the hands
of the New York Reserve Bank.52 At that time the Federal
Government made the New York Bank its representative
in foreign transactions and that Bank also became the agent
of the other Reserve banks in dealings with foreign parties.
The Treasury policy begun during the war to centralize
its financing in the New York Reserve Bank has continued
and makes that Bank the special fiscal agent of the United
States Government.
61

See chapter VIII.
See chapter XV, section on Banker for the Government in Foreign Transactions.
62

CHAPTER XI
CENTRAL BANKING FUNCTIONS AND
EMERGENCIES
Emergencies
The Post-War Period of Inflation and Depression

Emergencies of the type which gave rise to the pre-Federal
Reserve banking reform movement have arisen several
times during the existence of the Reserve system. They
occurred during the post-war period of inflation and depression and the recent depression beginning in October, 1929.
Confronted with these emergencies the Reserve banks functioned as lenders of last resort. They brought into play
their various powers and demonstrated their capacity for
operating as a coordinated central banking system. In
those trying periods the weightiest burdens rested on the
officials of the New York Reserve Bank. In meeting them
that Bank performed central banking functions of far greater
diversity and complexity than any of the other Reserve
banks.
The steady rise in commodity prices from 1915 culminated
in the spring of 1920, when in May the index number stood
at 247. At no time during the period of the rise and never
before in peace times had prices and bank credit increased at
such a rapid rate as during the twelve months preceding the
decline.1 In the ensuing months there occurred in America
the most precipitous decline of the price level the country
ever experienced, the low point being registered in January,
1922, with an index number of 138.
During this post-war period of inflation and deflation
there were exceptional movements of funds in connection
with the fiscal operations of the Treasury, seasonal requirements for the movement of crops and the purchase of raw
1

Annual Report of the Federal Reserve Bank of New York, 1920, p. 7.
220

CENTEAL BANKING AND EMERGENCIES

221

materials by industries. All of this resulted in very large
demands upon the Federal Reserve and banks all over the
country drew heavily on their New York correspondents.
The New York City banks were called upon to meet not
only the demands of their local customers but out-of-town
business concerns as well. They loaned large sums to mercantile, manufacturing, and other customers in all parts of
the country. The loans they made to their correspondent
banks were even greater than they were before the regional
central banks were established, being the largest on record.2
The heavy demands for central bank credit bore, therefore, exceptionally on the New York Reserve Bank, which
met them by rediscounting and open market purchases.
As expected by the framers of the Federal Reserve Act
the demand for bank credit proceeded at an uneven rate in
the several Federal Reserve districts. But during this postwar period of extreme speculation and price changes, the
Federal Reserve system functioned as a unit in supplying
credit to banks wherever needed. The Federal Reserve
Board adopted the policy of equalizing as far as practicable
the reserve position of the central banks. The Reserve banks
not only served their respective districts but other districts
as well. By the latter part of 1919 the demand for Federal
Reserve credit in some districts was so great as to result in
the Federal Reserve ratios of the Reserve banks falling below the legal minimum percentage in the absence of interdistrict rediscounting. This situation continued during the
depression years of 1920 and 1921.
The New York Reserve Bank, during the post-war period,
appeared at times as a lender to the other Reserve banks and
at times as a borrower. When the member banks in the
New York district made such heavy demands for credit
upon the Reserve Bank that they could not be met without
a suspension of the reserve percentage requirements, resulting in the imposition of a penalty rate, the Bank rediscounted
some of its paper with the other Reserve banks. When the
Reserve banks in other districts experienced a similar situation, and the New York Reserve Bank's reserve position
2

Ibid., p. 10.

222 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

permitted, the Bank rediscounted the paper of the other
Reserve banks. The net amount of accommodation received from or extended to other Federal Reserve banks by
the New York Bank for 1920 and 1921 is shown in Table 13.
Actual and adjusted reserve percentages of each Reserve
bank in connection with this inter-Federal Reserve bank
accommodation is shown in Table 14.
TABLE 13

NET AMOUNT OF ACCOMMODATION RECEIVED FROM OR
EXTENDED TO OTHER FEDERAL RESERVE BANKS BY THE
FEDERAL RESERVE BANK OF NEW YORK, 1920-1921 *
Date
Federal Reserve
Date
Federal Reserve
1920
Bank of New York
1921
Bank of New York
-51,827
Jan. 20
-75,649
Jan. 31
Feb. 27
-55,308
Feb. 28
-22,654
March 26
-34,096
March 31
513
April 30
April 30
+92,683
+16,950
May 31
May 28
+82,054
+27,020
June 25
+56,567
June 30
+38,024
July 30
+ 6,474
July 30
+37,530
Aug. 27
-40,923
Aug. 31
+34,768
Sept. 24
-13,404
Sept. 30
+26,933
Oct. 29
-61,362
Oct. 31
+18,328
Nov. 26
-24,502
Nov. 30
+ 4,324
Dec. 30
- 6,917
Dec. 31
* End-of-month holdings in thousands of dollars. Plus sign indicates net
accommodation extended; minus sign, net accommodation received. Annual
Report of the Federal Reserve Board, 1921, p. 45.

While the Federal Reserve Board is empowered to require Federal Reserve banks to rediscount the discounted
paper of other Federal Reserve banks, there was no compulsion exercised during this emergency. The Reserve banks
cooperated with the Board so that all such transactions
were effected voluntarily in response to the Board's wishes.3
The operations were effected quickly over the Federal Reserve private telegraphic lines and settled for daily through
the Gold Settlement Fund in Washington. Thus central
bank credit was shifted to and fro to whatever district
needed and the Federal Reserve banks became in effect a
single reservoir of credit under the direction of the Federal
Reserve Board.
3

Annual Report of the Federal Reserve Board, 1919, p. 5; 1920, p. 48.

CENTRAL BANKING AND EMERGENCIES

223

TABLE 14

ACTUAL AND ADJUSTED RESERVE RATIOS OF FEDERAL
RESERVE BANKS, 1919-1921*
Federal
Reserve Bank
Boston
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas CityDallas
San Francisco
System

1919
1920
1921
Actual Adjusted Actual Adjusted Actual Adjusted
per Cent per Cent per Cent per Cent per Cent per Cent
44.0
24.3
59.5
79.4
55.3
76.3
40.0
36.2
40.0
39.5
83.6
84.0
40.8
32.7
54.2
58.7
74.6
74.6
46.3
49.4
59.1
75.9
74.8
74.9
40.9
43.5
45.4
40.3
43.7
41.1
52.8
55.2
40.7
24.8
40.5
35.9
50.6
58.8
40.4
40.4
74.2
74.2
46.5
60.5
44.5
44.5
63.5
63.5
39.4
39.4
39.8
27.7
47.3
47.3
43.1
41.3
41.4
25.2
48.6
48.6
49.4
77.0
41.8
17.5
39.3
35.7
54.9
59.3
49.3
51.1
79.3
79.3
45.4
45.4
72.7
72.7
44.8
44.8

* Compiled from annual reports of the Federal Reserve Board. Percentages
are based on end-of-year figures except in the case of 1921 where they are
based on figures for the last day of November, the last month during which
inter-Federal Reserve bank accommodation occurred.
The percentages are the ratio of total reserves to combined note and net
deposit liabilities for 1919 and 1920; ratio of total reserves to combined note
and total deposit liabilities for 1921.
"Actual" reserve ratios are those based on the reserves actually owned by
the bank.
"Adjusted" reserve ratios sue those based on its reserves before inter-bank
borrowing or lending. The adjusted ratio is an index of the ability of a Reserve
bank to loan to others or its need to borrow from them.

The Depression of 1929-1933

During the depression of the early thirties there were four
critical emergencies which afford outstanding examples of
the way the New York Reserve Bank has functioned as a
central bank in times of stress. Each of these crises possessed
differences which required different treatment. The first
one occurred on the heels of the cataclysmic drop of security
prices. Lenders all over the country—banks, corporations,
firms, and individuals became alarmed. They called their
brokers' loans and withdrew in the short space of two weeks
over $2,000,000,000 from the New York money market. A
money panic was impending as a consequence of the secu-

224 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

rity panic.4 The commercial banks in New York, in order
to stop the panic, replaced the loans called by additional
loans themselves, in such amounts as were necessary, to
brokers and directly to customers.
The banks were able to do this because of the existence of
the Reserve Bank which met this emergency promptly and
placed at the disposal of member banks whatever sums were
needed. The Bank extended credit in two ways, about half
by lending and the other half by the purchase of government securities.5 Its action prevented threatened runs, a
money panic, and bank failures in New York. In this case
the demand on the part of the member banks was primarily
for an increase in their reserve balances at the Federal Reserve Bank.
The second emergency was in December, 1930. By this
time public opinion had become reconciled to the presence
of a severe depression, although false prophets continually
proclaimed its end and minimized its gravity. The solvency
of industrial concerns and banks was questioned. A wave of
bank failures spread over the country. Against this background a climax was afforded by the failure of two banks in
the nation's financial center, in the shadow of the Federal
Reserve Bank of New York, the largest one of which was a
member bank. These banks had so overloaded themselves
with real estate and other non-liquid assets that they could
not meet the demands of their depositors for cash. Depositors in some other banks in the same general localities of
the city became uneasy and withdrew unusually large
amounts. These banks in turn called upon the Reserve Bank
for currency to meet these excessive demands.
Moreover, the leading banks in the city were fearful lest
they would be attacked with a run and obtained abnormal
amounts of cash from the Reserve Bank. At this same time
there was the usual maximum seasonal demand for currency
for holiday purposes. As a result of this combination of
4
Dr. Adolph C. Miller of the Federal Reserve Board, in his testimony
before the Senate Banking and Currency Committee in January, 1931, stated:
"No banking system in the world has ever been subjected to the pressure and
the test that the New York banks were in the last part of 1929."
5
Annual Report of the Federal Reserve Bank of New York, 1929, p. 8.

CENTRAL BANKING AND EMERGENCIES

225

circumstances the New York Reserve Bank was subjected
to an extraordinary emergency demand for currency. It
met this emergency completely. In one week alone, ending
December 13, the Bank supplied over $170,000,000 in cash
to its member banks.6 The Reserve Bank provided the
requisite elasticity to the currency in this crisis in two ways,
by loans and by purchases of government securities and
bankers' acceptances.7 This crisis differed from the previous
one, then, in that it involved a demand for cash instead of
for Reserve bank deposits.
The third critical emergency was in the fall of 1931. A
serious credit and gold crisis arose in several European
countries in the summer of 1931. This was followed by the
suspension of the gold standard in Britain in September.
There was a scramble for gold which culminated in the
so-called "run on the dollar." Several central banks which
had funds on deposit in the United States or invested here
began, the latter part of September, withdrawing their
claims in gold. These withdrawals reached the proportions
of a "drain." Never in the history of the United States and
probably of any country had so much been lost in such a
short time. Approximately $725,000,000 of gold was withdrawn by foreign banks in a little over a month by earmarking and exporting.8 The domestic situation was characterized by failures and uncertainty in business and the
number of bank failures was unparalleled in the history of
the country.
The gravity of the situation expressed itself in the withdrawal of bank deposits throughout the country and the
hoarding of currency. There was an acceleration of currency
hoarding in October and at the same time some withdrawal
of bank balances in New York by the interior banks. There
were, therefore, the foreign drain of gold, currency hoarding,
and the withdrawal of bankers' balances, all three of which
converged at the same time on the large member banks in
New York. The "Wall Street" banks in turn called upon
6
7
8

Annual Report of the Federal Reserve Bank of New York, 1930, p. 8.
Ibid., p. 9.
Annual Report of the Federal Reserve Bank of New York, 1931, p. 13.

226

CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the Federal Reserve Bank of New York to meet the crisis.
This the Bank did successfully. As in the case of the two
previous crises, the Bank furnished the necessary relief by
lending and by purchasing securities. But, whereas, in the
case of the first crisis, the member banks desired reserves,
and in the second, money, in this emergency both reserves
and money in large sums were required to meet their extraordinary demands.
The Bank Holiday
The last of these critical emergencies occurred in February and March of 1933. It proved to be, perhaps, the most
severe banking crisis in American history. The new year,
1933, opened with more than three years of depression behind it. Business stagnation, unemployment, and low prices
weakened the so-called liquid assets of the banks so that a
considerable part of them became illiquid. Also, the banks,
generally speaking, were waterlogged with non-liquid securities—real estate mortgages, government bonds, and stocks.
These things added to several thousand bank failures had
undermined confidence in the remaining banks. This lack
of confidence expressed itself in the hoarding of currency
and even of gold. The "money in circulation" was rising
and the banks were being drained of their cash.
This was the situation when without warning early in the
morning of February 14, the governor of Michigan proclaimed a banking holiday effective in his state for eight
days. The immediately aggravating situation in Michigan
was the frozen condition of some Detroit banks' assets. The
Michigan moratorium gave an impetus to hoarding and
resulted in a scramble for cash which became natipn-wide.
Unable to obtain sufficient cash in Michigan, business and
financial interests there sought to secure it from other states.
Banks in other states were, therefore, subjected to two additional pressures. There were the demands to supply cash to
connections in Michigan and the increased withdrawals of
bank deposits on the part of people stricken with new fear.
When such large numbers of depositors withdrew, the banks
were unable to meet these demands for cash. Hence the

CENTRAL BANKING AND EMERGENCIES

227

bankers appealed to the state governments to come to their
rescue. This the states did by declaring moratoria on banking operations or restrictions against withdrawals.
The Michigan banking holiday started a succession of
state moratoria which did not cease until every state in the
Union had invoked some kind of restriction on banking
operations. Beginning with Indiana on February 23, there
followed intervention by three states in February.9 By
March 4, all the rest of the states had joined the movement.10
Uneasiness over the banking situation was not confined to
our own country. During this crisis foreign central banks
withdrew substantial amounts in gold mostly through earmarking operations at the Federal Reserve Bank of New
York. Foreign demands continued in increasing amounts
during February and early in March attained record
proportions.11
The vast banking debacle placed a heavy burden on the
Federal Reserve banks but particularly the New York
Reserve Bank. Funds began moving out of New York the
latter part of January in consequence of sales of securities
in the New York market by parties in other districts. In
February, interior banks made heavy withdrawals of their
New York correspondent bank balances. This movement
was particularly induced by the Michigan bank holiday
followed by similar restrictions in other states. The New
York Reserve Bank served not only its own member banks
but those in other districts as well. Thus, during the Michigan moratorium, when banking operations were suspended,
and large amounts of cash were sought with which to carry
on business and for payroll purposes, a considerable part
of the funds sought were supplied by the New York Reserve
Bank.12
The funds transferred by the Reserve Bank were for the
account of commercial customers of its member banks and
to meet the demands of the interior banks for the return of
9

Federal Reserve Bank of New York, Monthly Review, April 1, 1933, p. 1.
Idem; New York Herald Tribune, March 5, 1933.
11
Federal Reserve Bank of New York, Monthly Review, March 1, 1933,
p. 1; April 1, 1933, p. 2; The New York Times, March 4, 1933.
12
Federal Reserve Bank of New York, Monthly Review, March 1,1933, p. 1.
10

228 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

their New York balances. Most of the transfer of funds
from the Reserve Bank was effected through the Federal
Reserve wire transfer system, and the currency was supplied
by the Detroit Branch of the Federal Reserve Bank of
Chicago. But here was a situation where the New York
Reserve Bank functioned not only to supply funds to the
banks in other Federal Reserve districts but to send them
cash from its own vaults as well. Part of the funds transferred consisted of actual currency shipped directly from
the New York Reserve Bank to communities in Michigan.13
Member banks in all districts withdrew from the Reserve
banks in a period of a little more than three weeks, February 8 to March 3, over $1,700,000,000, the major part of
which was withdrawn in the last week.14 New York City
banks alone gave up bank balances of their correspondents
amounting to nearly $800,000,000 in order to help meet the
increasing demands of the crisis. Simultaneously with the
heavy drafts on the New York banks from the interior,
foreign central banks withdrew large sums in gold. All of
these demands converged upon the New York Reserve Bank.
The Bank met the calls by supplying currency, largely
Federal Reserve notes, for domestic use and gold to meet
the foreign demand.
When member bank reserves were depleted, the Reserve
Bank replenished them and continued to aid the banks by
loans and by purchasing government securities and acceptances in the open market and directly from the banks. The
extent of the nation-wide crisis is evidenced by the reduction
in excess gold reserves of the Federal Reserve banks. From
a high point of $1,500,000,000 in January, they declined to
a little over $400,000,000.15 The decline was due to pressure
from both ends. Gold was withdrawn from the Reserve
banks for foreign account and for domestic hoarding. On
the other hand, to meet the exceptional demand for currency, increasing quantities of Federal Reserve notes were
issued, which necessitated more gold reserve.
13

Idem.
"Federal Reserve Bank of New York, Monthly Review, April 1, 1933,
P- 2.
is idem.

CENTRAL BANKING AND EMERGENCIES

229

The pressure on the gold reserves of the system fell most
heavily on the New York Reserve Bank. It was meeting
not only the demands of banks in the Second Federal Reserve District, but in addition large demands from the districts of other Reserve banks. Its reserve ratio declined to
near the legal minimum. In order to maintain its reserve
position the Bank rediscounted a considerable amount of
its paper with other Reserve banks and also sold government securities to them.16 The amount of paper which the
New York Reserve Bank rediscounted with other Reserve
banks during this crisis as shown by its weekly statements
was, on March 8, $210,000,000; on March 15, $143,800,000.17
By March 22, this indebtedness to other Reserve banks had
been liquidated. The extent to which the Bank drew upon
other Reserve banks during this crisis by shifting government securities is indicated by the following reduction in
its holdings.
(In millions of dollars)
725
February 21
March
1
620
3
515
15
555
22
625
29
700
Auril
5
725

By March 4, a Saturday, every state had placed extraordinary restrictions upon banking operations. The resources
of the Federal Reserve system were rapidly being depleted,
business was disrupted, and fears of an economic collapse
were heard from responsible quarters. On this date, also, a
new administration assumed charge in Washington. The
incoming president, Franklin D. Roosevelt, immediately
attacked the banking crisis and issued a proclamation before
business hours on the morning of Monday, March 6, which
brought it to a head. The President's order declared a na16
17

Ibid., p. 26.
According to information supplied directly to the writer by an assistant
Federal Reserve agent of the New York Reserve Bank, these figures represent the rediscounts of the New York Reserve Bank with other Reserve banks
in 1933.

230 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

tional bank holiday, suspending all banking transactions
including those of Federal Reserve banks.18
The national bank holiday terminated the draining of
gold and currency from the banking system pending analysis
and legislation making possible the opening of banks at the
end of the suspension period without the probability of
closing due to runs. Such legislation was quickly drawn up
and the Emergency Bank Act was enacted March 9, 1933.
On March 13, the Federal Reserve banks opened for business, after being closed to normal transactions for one week.
Member banks also began to reopen on March 13. They
were allowed to resume business as rapidly as they obtained
licenses to function under the new regulations of the Secretary of the Treasury.19
The Emergency Bank Act and the Treasury regulations
sufficed to restore confidence to a degree which brought
about a return flow of currency to the banks. The restrictions against paying out gold and currency for hoarding
were continued. Of the gold which had been hoarded a
large proportion was returned to the Federal Reserve banks
following an order of the Federal Reserve Board calling for
a list of "gold hoarders" and threats of publishing such a
list.20 The excess gold reserves of the Federal Reserve Bank
of New York and the other Reserve banks mounted and
this nation-wide banking collapse passed.
Granted the occurrence of emergencies, the Reserve
system has been of considerable aid to the banks and the
public. Indeed, the central banking system has been a
tower of strength. The effectiveness of its service in coping
with emergencies, whether of local, community concern or
of wide and even national moment has been inestimable.
Through the exercise of its central banking functions, except for the complete collapse as represented by the national
bank holiday, the Federal Reserve system has, at any rate,
proven its capacity as an emergency banking system.
18

Federal Reserve Bulletin, March, 1933, pp. 113-114.
Federal Reserve Bulletin, March, 1933.
Ibid., pp. 130-131; Federal Reserve Bank of New York, Monthly Review,
April 1, 1933, p. 29.
19
20

CENTRAL BANKING AND EMERGENCIES

231

The intention of the Federal Reserve Act, however, was
that the Federal Reserve system was to be not merely an
emergency banking system, but was to do what it could to
prevent emergencies from arising. In no small measure the
emergencies during the existence of the Reserve system
have arisen because of the lack of exercise and improper
use of its central banking powers embodied in the function
of credit control.
Credit Control
Meaning of the Term "Credit Control"

By credit control, as the term is used herein, it is not to
be inferred that central banks can decide upon a goal of a
certain price level, and by a deliberate policy bring this
result to pass. It was not to be expected that the Federal
Reserve system could, or has the power completely to stabilize general credit conditions and prices. The Reserve
banks could not prevent oscillations in business activity
and employment under the existing economic system in
which prices largely determine the direction of economic
activity.
There are a number of factors affecting the price level
with which the Federal Reserve banks have no contact and
others over which they have no authority and no power to
influence. The Reserve banks have been linked to the commercial banking structure, but about two-thirds of the
number of commercial banks holding one-third of the banking resources have not been members of the Federal Reserve
system. There are many financial institutions not dealing
in commercial bank credit but whose operations vitally
affect the amount of credit used in exchange. The United
States Government has immense powers of influencing
credit through its fiscal and monetary policies and its ability
to shift its deposits between Federal Reserve banks and
commercial banks.
Furthermore, the TnminmiTn gold reserve requirements of
the Federal Reserve Act would make impossible the stabilization of the price level under all conditions. There are
also changes in the factors affecting the production of goods

232 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

and even their distribution, not only national but international in scope. Such changes Federal Reserve authorities cannot determine in advance nor offset once they have occurred.
Yet the influence of such factors on prices is fundamental.
The intention of the Federal Reserve Act was that the
Reserve system should influence general credit and banking
conditions, and that through sound policies and practices
a direction should be given to financial and business operations resulting in a safer and more stable economic order.
The Reserve banks were charged with the function of maintaining the liquidity of bank assets. As the author uses the
term, credit control refers to the power of the Reserve system to adopt policies which tend to bring about these ends.
There are several means by which the Reserve banks may
influence the credit structure. Credit control deals with
the means and powers possessed by these central banks by
which they may regulate the quantity and quality of Federal Reserve credit outstanding and the uses to which member banks put this credit. By control is not meant complete
dominion over credit and its effect on prices. Influence and
regulation are the essence of credit control in modern central banking.
It is evident from a study of the Federal Reserve Act
that its purpose was not only to establish a permanent
organization which should render necessary aid in emergencies but that the central banks should carry out a policy
calculated to prevent emergencies from arising. As the
Federal Reserve Board said in its first annual report concerning the function of a Reserve bank: "Its duty plainly
is not to await emergencies but by anticipation, to do what
it can to prevent them." 21
In the contemporary system of production of wealth,
money and credit are fundamental factors. The quantity
and quality of bank credit, and the time and manner of its
injection into the economic system are of paramount influence and public concern. The fountain head of the national
credit economy has been our central banking system. The
Reserve banks have supplied the base for the superstructure
21

Annual Report of the Federal Reserve Board, 1914, p. 17.

CENTRAL BANKING AND EMERGENCIES

233

of credit—the country's purchasing power. Through their
policies they have determined in some measure the direction of economic activity by supplying the reserves of credit
with which to carry it on, leaving the composite result to
the kaleidoscopic play of vast economic and other forces.
The operations of the Reserve banks have exerted considerable influence upon general economic conditions. What
has been the influence of central banking policy with regard
to the various means of credit control? Has the management done what it could to prevent emergencies from arising? Have the policies tended (1) to prevent abuse of the
central banking reserves of our economic system, and (2)
to assure the liquidity of bank assets? Or have they, in
short, stimulated the creation of unsound credit and thereby contributed to economic distress?
In determining the answers to these questions, we shall
be primarily concerned with the New York Reserve Bank.
This is for the reason that the New York Bank operates in
the primary money market of America and has dealt with
credit in the mass. Its problems have been national and
international in scope and influence. We shall survey the
operations respecting the instruments of credit control and
note the tendency of each one in order to see what have
been the effects of the policies adopted by the directing
heads of the New York Reserve Bank.
Basis of Federal Reserve Control of Bank Credit

Federal Reserve banks are primarily bankers' banks.
Not only was little dealing directly with the public authorized in the Federal Reserve Act, but the Reserve banks
have engaged in still less. The Act authorized the Reserve
banks to deal directly with the business public under the
open market powers. The Reserve banks could buy twoname paper from business concerns and through such contact have a direct influence on the cost of credit. The
central banks have, however, refrained from using this instrument of control, probably the most effective instrument which they had to use.22
22

See chapter XII, pp. 247-248.

234 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

In so far as the Federal Reserve system has had power to
influence the quantity and quality of bank credit used as
a medium of exchange, nearly all of such power has been
exercised indirectly through the member banks. The connection with member banks, the basis of Federal Reserve
credit control as it has been practiced, lies in the fact that
the Federal Reserve banks hold the required reserves of
member banks in the form of deposit credit; and at times
it is necessary for member banks to borrow from the Reserve
banks in order to maintain legal reserves, to secure gold for
exporting, and to obtain currency for their customers. The
cost of such borrowing influences the price and volume of
total bank credit in use. Also, the probability of not being
able to borrow from the Reserve banks because of the use
made of credit would tend to restrict credit for such use.
The basis of Federal Reserve control of credit, therefore,
centers in the member banks7 reserve accounts.
Refusing to buy commercial paper, the New York Reserve
Bank purchased bankers' acceptances and government
securities. Moreover, in its open market acceptance operations the Bank confined its dealings to the largest finance
companies. The responsibility for open market purchases
has been primarily that of the Reserve Bank rather than
the institutions with whom it dealt in the open market.
The reasons for this are (1) the Reserve Bank has been the
active factor in the purchase of government securities,
(2) the Bank hasfixedthe acceptance rate which determined
whether acceptance houses would sell the bills to the Reserve Bank, and (3) the Bank has had the power to refuse
to purchase all acceptances which did not arise out of bona
fide short-term commercial transactions.
The open market purchases of acceptances and govern- •
ment securities increased member bank legal reserves. Upon
the basis of the enlarged legal reserves, member banks expanded the superstructure of credit. Thus, by limiting the
amount of its open market purchases the New York Bank
could have prevented to that extent an expansion of bank
credit. Because of the lack of authority held by Reserve
banks over the use member banks make of central bank

CENTRAL BANKING AND EMERGENCIES

235

credit once obtained, the importance of directing a Reserve
bank in such a way that member bank legal reserves are
not increased by the purchase of non-liquid acceptances
becomes evident. Consequently, through its open market
powers a Reserve bank not only has possessed some control
of the quantity, but of the quality of bank credit outstanding
as well.
Regardless of the use made of the proceeds of member
bank loans and investments, whether they go into manufacturing, merchandising, real estate, or dealing in securities,
the resulting increase in member bank deposits concerns
a Federal Reserve bank. This is for the reason that when
the loans and investments of member banks increase their
deposits increase. A larger amount of deposits necessitates
more reserves at a Reserve bank. Since member banks
commonly keep practically no excess reserves, they seek
to borrow from a Reserve bank as the lender of last resort.
If a Reserve bank declines to grant a loan to a member
bank the latter must take up some of its loans or liquidate
some of its investments.
Consequently the influence of the Reserve bank upon
the extension of member bank credit and the use to which
it is put lies in part in this: that member banks can calculate
approximately their needs for more Federal Reserve credit
as a result of increasing their loans and investments by a
certain amount. As to whether they will increase them by
a certain volume and in a certain field of business depends
upon the credit policy of a Reserve bank at the time, such
as is expressed, for example, through its rates, its open
market operations and its attitude regarding the quality
of the credit extended. A central bank restrictive policy
either as regards total volume or the enlarging of a certain
class of loans would tend to check member bank loans and
investments.
In so far as member banks are confronted with a restrictive
policy resulting in higher interest rates or being turned down
at the central bank for any legitimate reason, they would
tend not to make some loans in the first place. Ultimately,
therefore, upon the decisions of the Federal Reserve officials

236 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

affecting the accumulation of member bank balances in the
Federal Reserve banks rests the superstructure of credit;
and through their credit policy the central banks can exercise considerable influence upon this superstructure. Because the use of credit in any field involves the central
Reserve banks as stated, and may affect general economic
conditions, the Reserve banks are obligated to prevent an
expansion of credit resulting in inflation in any markets and
to conserve their resources for the maintenance of a sound
banking structure and the benefit of the whole community.
Control over the Use of Credit

The ability of a Federal Reserve bank to control the use
made of member bank balances or bank credit based upon
them has been relatively limited. This has been especially so
because of the practice of member bank borrowing on
promissory notes collateralled with government securities.
However, a Reserve bank has some power over the use of
bank credit. This power is considerable as between broad
categories of credit, such as credit used for working capital
versus that used for fixed capital purposes, and credit used
for trade financing versus that used for carrying or trading
in securities.
A Federal Reserve bank has no voice in the matter of
passing upon particular applications for loans at the member
banks and thus controlling the use of bank credit. But it
does have some authority in this matter. A Reserve bank's
authority lies in these respects:
1. Under its powers of examination and supervision it is
the duty of a Reserve bank to see that member bank loans
to customers are made according to law.
2. Under the open market powers a Reserve bank is
authorized to analyze the quality of acceptances offered it.
An insistence upon an underlying transaction of short-term
commercial character in every case would tend to result in
the creation of a larger proportion of liquid acceptances.
3. It is incumbent upon a Reserve bank to see to it that
Federal Reserve credit is not used for purposes of speculation or investment. The intention of the Reserve Act was

CENTRAL BANKING AND EMERGENCIES

237

that member banks may not utilize Federal Reserve credit
as a basis for carrying or trading in securities.23 In so far as
member banks are indebted to a Reserve bank, while at the
same time they have outstanding speculative or investment
loans,24 Federal Reserve credit is being used as a basis for
such loans, because (1) the deposits resulting from such
loans require Reserve bank balances to support them, and
(2), generally speaking, without such borrowings from the
central bank, such loans could not be carried, unless other
legitimate demands for commercial bank credit were restricted. The Federal Reserve Board in its communications 25 of early February, 1929, sought the cooperation of
the directors and officers of the Reserve banks to carry out
the intention of the Reserve Act in this respect.
4. Whether the member banks are indebted to a Reserve
bank or not, there is a moral obligation resting upon the
directors and officers of the central banks to furnish leadership to the banking institutions of the country. Indeed this
moral obligation is one not only implied from the nature of
the Reserve system's duties, but it is specifically stated in
the sub-title of the Federal Reserve Act that the Federal
Reserve system is "to establish a more effective supervision
of banking in the United States." As quasi-public institutions, the Reserve banks were obligated to do what they
could to maintain the liquidity of the member banks for the
safety of the depositors and hence the general community.
In order to confine bank credit to legitimate channels and
carry on an intelligent credit policy, knowledge of the use
member banks make of Federal Reserve credit is necessary.
A prerequisite, therefore, is that member banks themselves
know the purposes for which they (member banks) loan
"money." As a result of a questionnaire sent by the Senate
Banking and Currency Committee to banks and security
affiliates it was found that various loaning officers had determined, even down to fractions of 1 per cent, the purposes
23
Refers to securities other than United States Government issues. Federal
Reserve Act, section 13.
24
Loans used for the purpose of carrying or trading in securities other than
United States Government securities.
25
See chapter XIII, pp. 265-266.

238 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

for which their respective loans were made.26 Hence member
banks have known the use they make of Federal Reserve
credit.
The New York Reserve Bank officers and directors in
turn have known the use member banks have made of
Federal Reserve credit. An official of the Bank stated before the House Committee on Banking and Currency that
they had means of "knowing fully" the operations of the
member banks.27 Information as to how bank credit is used
by member banks is obtained from reports of the examiners
and from the staff of the member bank relations department.28 From each of the New York City banks the Reserve
Bank has received a daily report containing a statement
of its deposits and brokers7 loans. It also has received
weekly reports of condition of about 800 reporting member banks in the principal cities throughout the United
States which indicate the loans secured by stocks and
bonds.
The New York Reserve Bank has not only been in "constant contact" with officers of the borrowing banks but in
the case of such banks its practice has been to gather detailed information about them.29 In the event of an application for a loan the credit department of the Bank has carried
on the practice of gathering pertinent information regarding
the condition of the borrowing bank which was submitted
to the officers and executive committee. In the case of the
New York City banks such information included the amount
of its loans on the stock exchange and whether they were
increasing or decreasing. The governor of the Bank testified
before the Joint Commission on Agricultural Inquiry that
the Federal Reserve officials could tell "pretty generally"
whether or not Federal Reserve funds were being applied
for the purpose of loaning on the stock exchange.30
28

Hearings on Banking Systems, 1931, pp. 266-267, 1010-1013.
W. Randolph Burgess, Stabilization Hearings on H. R. 7895, 1926, p. 967.
28
Stabilization Hearings on H. R. 7895, 1926, p. 969.
29
Benjamin Strong, governor of the Federal Reserve Bank of New York,
Hearings in the Agricultural Inquiry, 1921, VoL II, pp. 709-710. See also
Hearings on Banking Systems, 1931, pp. 722-723.
30
Hearings in the Agricultural Inquiry, 1921, p; 710.
27

CENTRAL BANKING AND EMERGENCIES

239

For the purpose of exercising the function of credit control, various means have been at the disposal of Federal
Reserve officials. These means are discount and acceptance
rates, open market operations, practice regarding rediscounts
and advances, practice regarding acceptability, warnings,
persuasion, refusal to rediscount or advance loans on
"eligible" paper, and rationing of credit.

CHAPTER XII
CREDIT CONTROI^-RATES, OPEN MARKET AND
LOAN OPERATIONS
Discount and Acceptance Rates
The various means of credit control and the uses the
Federal Reserve Bank of New York has made of them have
particular significance. The importance of the New York
Reserve Bank in this respect is due to the location of the
national and international money markets of the United
States in New York City; and also to the centralization of
the open market policy of the Reserve system in that Reserve
Bank.1 The various divisions of the general money market
in New York are the most sensitive in the country. Thus,
discount rate changes have been made more often by the
New York Bank than by any of the other Reserve banks.2
Under the Federal Reserve Act the Reserve banks are
charged with the duty of establishing from time to time
discount rates on each class of paper subject to the review
and determination of the Federal Reserve Board. In the
beginning the New York Bank had a system of variation in
rates according to the type and maturity of paper discounted. In general paper with longer maturities bore
higher interest rates, and in practice this meant that agricultural and live-stock paper carried higher rates. This
policy continued until June 16, 1921. After this date, at
any one time, the Bank charged the same discount rates
on all classes and maturities of discounted paper. During
the war the Bank discounted paper secured by United States
Treasury notes, certificates of indebtedness, or Liberty bonds
at lower rates than they loaned on other paper. Within
1

See chapter VIII.
Discount Rates of the Federal Reserve Banks, 1914r-1921, Government
Printing Office, Washington, 1922; Annual Reports of the Federal Reserve
Board, 1922 to date.
2

240

RATES, OPEN MARKET AND LOAN OPERATIONS

241

this class of "bond-secured" paper, beginning with May 22,
1917, discount rates varied for different maturities. This
variation continued to February 5, 1921. Since this date
such paper, regardless of its type or maturity, has been discounted by the Reserve Bank at any one time at the same
rate. The Bank has also since then charged member banks
the same rate of interest when they borrowed on their own
promissory notes collateralled by government securities or
eligible paper as when they rediscounted commercial paper.
As a means of more effectively controlling credit by means
of the discount rate, upon the recommendation of the Federal
Reserve Board, an amendment to the Federal Reserve Act
was approved April 13, 1920. It permitted the Reserve
banks with the approval of the Federal Board to establish
progressive rates of discount. The progressive rates were
assessed against amounts discounted for member banks in
excess of their "basic" or "normal" lines, the latter being
determined by each Reserve bank uniformly for its member
banks.3 The New York Bank did not put this plan into
effect. Progressive rates were, however, established by the
Reserve banks at Kansas City, Dallas, St. Louis, and
Atlanta. After a brief trial they were abandoned by August,
1921, as being a no more effective means of control than
some other plans while at the same time arousing much ill
feeling.4
On the whole it has been the policy of the New York Bank
to exert a restraining influence when business and speculative
activity appeared to be excessive, and to remove restraints
at times of business depression "in the hope that this policy
might aid in avoiding the extremes of business expansion
and contraction and encourage greater business stability." 5
In accordance with this policy the Bank has made increases
and reductions in its discount rates and its buying rates for
acceptances.
During the period of war financing, however, this policy
was shelved in favor of one suited to the requirements of
3
Annual Report of the
4
Ibid., p. 59; Hearings
B

Federal Reserve Board, 1920, p. 58.
on Banking Systems, 1931, pp. 787-789.
Hearings on Banking Systems, 1931, p. 761.

242 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the emergency as determined practically by the United
States Treasury department. From shortly after the beginning of the war in 1917 until the end of the year 1919
Federal Reserve discount rates were fixed at artificially low
levels with a view to facilitating the Treasury's fiscal program. In order to supply the Government with sufficient
funds, preferential rates were established for bond and
certificate-secured paper as compared with commercial
paper, and a differential was set in favor of the rate on such
bond and certificate-secured paper as compared with the
interest rate borne by these government obligations.
The New York Bank has generally altered the discount
rates and acceptance rates together, raising them to restrict
expansion and lowering them during periods of decline and
depression. One important exception to this practice, however, was in August, 1929, when the discount rate and the
acceptance rate were changed in opposition to each other.
At that time of wild speculation and serious inflation in
securities the New York Bank raised its discount rate but
lowered its acceptance rate.6
Efficacy of Rate Changes
Since the banks have gained access to a large proportion
of Federal Reserve credit through the bankers' acceptance
market, the acceptance rate has been an important influence on the superstructure of credit. The New York Bank
has stood ready to purchase acceptances offered it at the
established buying rate for acceptances.7 It has not gone
into the market and bid for acceptances when purchasing
for Federal Reserve account.8 On the whole its acceptance
6

Annual Report of the Federal Reserve Bank of New York, 1929, p. 7.
The Bank's purchases, however, depended upon the size of the financial
house offering the acceptances to the Bank. In practice this has meant that
the New York Reserve Bank stood ready to purchase bankers' acceptances
from concerns offering them if those concerns were large enough. See below,
p. 248.
8
When buying for the account of foreign central banks the Reserve Bank
does go into the market to seek acceptances. Although some of the acceptances
purchased without going into the market, may be, and on occasion have been,
credited to the accounts of foreign central banks.
Federal Reserve officials have made a distinction between the Bank's
7

RATES, OPEN MARKET AND LOAN OPERATIONS

243

rates, which have been primarily the rates for the Federal
Reserve system, have been artificially low.9 This low acceptance rate has tended to enlarge bank credit unduly and to
result not only in "frozen credits" in the portfolios of commercial banks but in non-liquid assets in the Federal Reserve
Bank itself.10 The Bank has not discriminated in the buying
rate for acceptances on the basis of the self-liquidating or
non-self-liquidating nature of the transaction from which
the acceptance arose.11 The acceptance rates have varied
only on the basis of length of maturity of the bills.
So far as the discount rate is concerned no discriminatory
rates against particular member banks have been in effect
in the New York district. The same discount rate has applied
to all banks for the same paper at the same time. But by
taking the discount rate in connection with the acceptance
rate it has been possible for some banks to obtain Federal
Reserve credit cheaper than other banks. In particular
the group of large banks in New York City engaged in
making acceptances and in contact with the acceptance
dealers have been the beneficiaries as compared with the
other banks in the district. This advantage possessed by
the New York City banks was rather strikingly emphasized
at the time of the undue expansion of bank credit based on
securities in 1929 when the acceptance rate was lowered
while at the same time the other banks which handled relatively few acceptances were penalized with a higher discount rate.
The Federal Reserve Bank of New York has stated that
in general increased discount rates have tended to check
"taking the initiative" in the case of buying government securities and occupying a passive r61e in the case of buying acceptances, likening the latter to the
rediscounting operations of member banks. There is a vital difference, however, between acceptance purchases and rediscounting in their effects on the
superstructure of credit, which is the important consideration in this connection so far as the management of central banks is concerned. For a discussion of the differences between the Reserve Bank's acceptance buying and
its rediscounting in their economic effects, see Beckhart, The New York Money
Market, Vol. Ill, pp. 448^50.
9
See Beckhart, The New York Money Market, Vol. Ill, pp. 410-411.
10
See below, pp. 248-249.
11
Hearings on Banking Systems, 1931, p. 920.

244 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

credit expansion and lower rates have tended to encourage
it.12 There is a tendency in the New York district on the
part of member banks to transfer increases in discount
rates to their customers.13 This is particularly marked in
the financial centers.14 In addition to the effect of a greater
or less cost of bank credit, discount rate changes have a
psychological influence which makes them a potent factor
in credit control management.15 In fact, unless a member
bank is borrowing from the Federal Reserve bank practically the only effect of a change in the central bank discount rate is psychological. In actual practice, however,
discount rate changes have been relatively ineffective.16
The New York Reserve Bank admitted in effect that its
discount rate changes were made too late and the increases
were not large enough.17 Furthermore, the Reserve Bank's
practice of lending on the basis of government securities
largely prevented its discount and acceptance rate changes
from having whatever salutary effect they otherwise would
have had.
Development and Influence of Open Market Operations
So far as the relation of Federal Reserve credit to the
superstructure of credit is concerned, it was intended in the
original Federal Reserve Act that open market operations
were to be secondary to rediscounting eligible paper for the
banks. During the early years of the system the Reserve
banks made relatively few purchases in the open market
as compared with later years; although the volume of purchases prior to our entrance into the war was larger than
the volume of rediscounts. Such open market purchases
as were made prior to 1922 were for the purpose of providing
the Reserve banks with earning assets to defray expenses,
stimulating the development of an acceptance market, and
18
13

Ibid., p. 776.
Ibid., p. 770.
" Idem.
11
Idem; Beckhart, The New York Money Market, Vol. IV, p. 19.
"Willis, The Federal Reserve System, pp. 1516-1518; Beckhart, op. cit.,
p. 19.
17
Hearings on Banking Systems, 1931, p. 766.

RATES, OPEN MARKET AND LOAN OPERATIONS

245

meeting technical difficulties in the money market. The
element of credit control during this period was not a consideration.
As the system has developed since 1922, the purchases
and sales of acceptances and government securities have
superseded in importance rediscounting operations. But
the significance of this change is considerably enhanced
by reason of the fact that during this period open market
operations came to be an acknowledged instrument of credit
control. Open market operations have practically submerged rediscounting transactions and have become the
most powerful factor influencing credit conditions.18
Open market operations are potentially and have been a
powerful influence upon credit conditions because by its
own decision the Reserve Bank increases or decreases member bank reserves upon which the superstructure of credit
is based. By purchases the Bank increased those reserves
and by sales it decreased them. The purchases especially
have affected fundamental changes because once the credit
superstructure expanded it has been f ound difficult to bring
about its contraction by sales without disturbing repercussions in the nation's economic system. Sales of securities
on the part of the Reserve Bank, therefore, have usually
resulted in increased member bank borrowings. Member
banks have increased borrowings in order to maintain their
reserves, thereby sustaining the enlarged volume of bank
credit superinduced by Reserve Bank open market purchases.
A Federal Reserve bank is not required to buy acceptances offered it. The Federal Reserve Board in a ruling
regarding bankers' acceptances in 1921 said:19
It should be remembered, however, that there is no obligation
upon a Federal Reserve bank to purchase paper offered it, even
18
See testimony of Dr. A. C. Miller, member of the Federal Reserve Board,
before the Senate Committee on Banking and Currency, ibid., pp. 128-132,
150. Several useful studies on Federal Reserve policy have appeared in recent
years. One of these, by S. E. Harris, was not availed of by the author inasmuch
as this manuscript was completed before that work came into circulation.
Dr. Harris has presented, however, a comprehensive treatment of the history
of open market operations, particularly in Volume I, Part II.
19
Federal Reserve Bulletin, June, 1921, p. 699.

246 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

though the paper is technically eligible as a matter of law. The
Federal Reserve banks have discretionary power, just like any
other bank, to decline to purchase paper whenever for any reason
that course seems advisable.
And yet on occasion it has been announced in advance
that the Reserve Bank would buy a certain amount of
acceptances in the following months—a practice inimical
to the proper use of central bank reserves. Such an announcement is an open invitation to all sorts of abuses. It
means that the Reserve Bank commits itself to the purchase of acceptances regardless not only of whether the
acceptances offered meet sound credit tests, but of whether
some future factor may make the purchase of some acceptances unwarranted.
From the standpoint of credit control, open market operations are complementary to discount policy. On the whole
these operations have ostensibly been used in conjunction
with discount rates to force the banks to fall in line with
Federal Reserve policy. The New York Bank has made
purchases and sales in the open market in order to compel
member banks to put into effect a rate and lending policy
desired by it.20 When the Reserve Bank desired to make
credit easier it bought acceptances and government securities, thereby increasing member bank reserves. When it
desired to tighten rates it sold securities, thereby taking
funds out of the member bank reserve account.
Type and Effect of Open Market Operations
Although the New York Reserve Bank, by its open market
operations, has been particularly successful in preventing
short-time disturbances in the money market, smoothing out
extremes in interest rates, and in meeting emergencies, the
Bank's operations have been scarcely, if at all, successful
in the field of credit control. Open market operations have
20

The technique of open market operations and the methods used by the
Bank to prepare the way for rate changes were described by Mr. Strong,
governor of the Bank, before the House Committee on Banking and Currency
in 1926 (see Stabilization Hearings on H. R. 7895, 1926*—particularly pp. 307,
330-338) and in the answers to Questionnaire No. 9 (open market operations)
published in Hearings on Banking Systems, 1931, pp. 794-840.

RATES, OPEN MARKET AND LOAN OPERATIONS

247

commonly preceded changes in the Bank's discount rate
and have been supposed to make the latter more effective.
Such operations have been so extensive at times that they
have resulted in excess member bank reserve balances
which contributed to inflation in various markets. Because
of the difficulties of effecting a substantial contraction of
bank credit, the enlargement of legal reserves in the first
place was an important factor in making the open market
operations of the Bank ineffectual as an instrument of
credit control.
The inefficacy of the Reserve Bank's open market operations has also been due to several other considerations. In
the first draft of section 14 of the Reserve Act it had been
provided that the Reserve banks could buy direct from
individuals, firms, or corporations notes, drafts, and bills
of exchange of the kind which the Act made eligible for
rediscount.21 Opposition to the purchase of notes directly
from the maker, however, resulted in the deletion of this
power from the Act as enacted. But the framers did succeed in getting into the Act authority for the Reserve banks
to buy in the open market not only bankers' acceptances
but bills of exchange directly from business concerns. The
Federal Reserve Board early formulated rules governing
such purchases and advised the Reserve banks concerning
their procedure in effecting such transactions.
The policy of the New York Reserve Bank, however,
has been to make no purchases of bills of exchange directly
from business concerns. These have, at all times, had to
go through an intermediary banking institution. Its refusal
to apply this traditional central bank power has been defended on the ground that intermediary discount houses
needed to be encouraged in order to develop a strong discount
market. However, while a strong discount market would
strengthen the financial situation, the direct purchase of
two-name paper upon occasion need not preclude the development of a healthy discount market. Moreover, there
cannot be a strong discount market unless the general credit
milieu in which it operates is sound. The first and primary
" Willis, The Federal Reserve System, p. 1037.

248 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

consideration, therefore, is to have the mechanism at hand
to bring the proper influence to bear at the proper time upon
general credit conditions to the end that these may be
sound and hold the confidence of the public. The Federal
Reserve Act provided the mechanism to a degree but the
New York Reserve Bank refused to make use of it as intended.
As operated the New York Reserve Bank has had no
direct influence on the cost of credit. Its open market operations have been practically confined to bankers' acceptances
and government securities. It has been inclined to do nothing whatever to develop the commercial paper market.
The older central banks, on the other hand, such as the Bank
of England and the Bank of France, have made their rate
changes effective by direct dealings with the public in commercial paper. In the United States, however, the New York
Reserve Bank has not dealt directly in commercial paper
even at times when it wished to make its credit policy effective. The Bank has not purchased bills of exchange from
business men without the endorsement of a member bank
in those cases in which indirect action through the commercial banks was too slow or lacked sufficient influence. This
unwillingness of the Bank to put into effect the open market provision of the Act has been an important factor in
the failure of its open market operations at strategic times
to have the effect desired and the failure of its credit policy
in general.
There have been other factors responsible for the unfavorable effect of the Reserve Bank's open market operations on credit conditions. One of these is its policy of dealing in bankers' acceptances only with the large firms. It
has been the practice of the Bank not to buy bankers' acceptances from any dealer whose capital was less than
$l,000,000.22 The consideration in point, however, in determining the financial responsibility element in the credit
standing of an acceptance dealer is not the amount of his
capital but the ratio of his net worth to his liability on
acceptances.
This practice of dealing only with a few big firms has pre22

Hearings on Banking Systems, 1931, p. 93.

RATES, OPEN MARKET AND LOAN OPERATIONS

249

vented the Bank's credit policy from exerting as wide or
strong influence as otherwise would have been the case.
Moreover, it has prevented the benefits of the Federal Reserve system from being widely distributed without discrimination to all entitled to them, with adequate credit
standing, as was intended by the Reserve Act.
Another factor in the Bank's open market operations
exerting an unfavorable influence has been its apparently indifferent attitude regarding the liquidity of acceptances.
The Reserve Bank has purchased quantities of acceptances
during its existence which were really non-liquid when
subjected to the true tests for such paper. Various abuses
crept into bankers' acceptances resulting in inflation and a
weakening of the banking structure.23 The chief respects in
which the acceptances were non-liquid were that they were
based upon unsold commodities and they were renewed
either by the same bank or under a system whereby a group
of banks in effect renewed each other's acceptances. Furthermore, the Reserve Bank's excessive purchases of government securities at times prior to 1929 resulted in inflationary effects in the stock market.24
Purchase of Paper Directly from Business Concerns
A break in the traditional policy of the Reserve banks of
purchasing no paper directly from individuals or business
concerns was made as an emergency measure during the
recent depression. The Federal Reserve Act was amended
by an emergency act of July 21, 1932.25 The amendment
empowered the Federal Reserve Board to authorize the Reserve banks, in certain circumstances, to discount for individuals, partnerships, or corporations notes, drafts, and
bills of exchange of the kinds and maturities made eligible
23

Concerning abuses in the use of the acceptance, see Federal Reserve Bank
of Richmond, Letter No. 13, pp. 166-167; Willis, The Federal Reserve System, chapter XLIV and pp. 1449-1451; Beckhart, Discount Policy of the
Federal Reserve System, pp. 238-240, 442-449; Journal of Commerce [New
York], Jan. 2, 1929; Hearings on Banking Systems, 1931, pp. 433^63, 841882; Beckhart, The New York Money Market, Vol. Ill, pp. 320-326, 360-366.
24
See Journal of Commerce [New York], Jan. 2, 1929.
26
Public Act, No. 302, 72nd Congress, section 210.

250 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

for discount for member banks. No such purchase could be
made, however, unless a Reserve bank obtained evidence
that the applicant was "unable to secure adequate credit
accommodations from other banking institutions."
There had been an excessive number of bank failures in
the country, all the banks in many communities having
closed. There was also a good deal of dissatisfaction at the
time regarding the attitude of the bankers who were hesitant about making loans during the period of falling prices.
Apparently the complete absence of banking facilities in
some towns together with the critical attitude toward new
loans were responsible for enlarging the lending powers of
the Reserve banks to include direct loans to the public.
Under the amendment, the New York Reserve Bank, in
1932, authorized thirteen direct loans to business organizations totaling $1,292,500, and made advances thereon.26
As stated above the Reserve Bank had already possessed
the right to deal directly with business men under its open
market powers ever since its establishment, but had not thus
dealt. The 1932 amendment merely added another method
of direct contact with the ultimate users of bank credit,
that of discounting their notes, although under conditions
such as to make it almost impossible for any business to
actually obtain such loans from the Reserve banks. The
terms of the 1932 statute were such that if a business applicant could secure Federal Reserve credit under it, he could
probably secure it from a commercial bank as well. Nevertheless, the Reserve Bank did make contact with business
organizations under this emergency amendment and not
under its long unused open market powers. As a gesture,
perhaps, the New York Bank did deal directly with business men in several cases.
The importance of this step does not turn upon the number and dollar value of the direct transactions, relatively
small as they were. The principle of this contact of the
New York Reserve Bank with the business public is significant in effecting a departure from the Bank's traditional
policy of dealing only with an intermediary financial insti28

Annual Report of the Federal Reserve Bank of New York, 1932, p. 24.

RATES, OPEN MARKET AND LOAN OPERATIONS

251

tution. Amendments to the Reserve Act, to all intents and
purposes incorporated for merely an emergency period, have
characteristically taken their place among itsfixtures.Further
authority, under which Federal Reserve banks may make
direct loans to individuals, partnerships, and corporations
engaged in business, has been prescribed by Congress in the
acts of March 9, 1933 and June 19, 1934-27
Eligibility of Paper for Rediscount
One mechanism for regulating the quantity and quality
of credit is that of the rediscounting process. This involves
the application of eligibility tests to the items offered for
rediscount. The Federal Reserve Board began at the outset to lay down the requirements of eligibility of customers'
paper for rediscount at the Reserve banks within the limits
prescribed in the Reserve Act. The Board's fundamental
requirements, set forth in November, 1914, were designed
to raise the quality of paper carried in the average bank's
portfolio.
In general the requirements sought to eliminate from the
banks much paper that had been responsible for bank suspensions in that it was not based on commercial transactions and was non-collectible at specified dates. Paper of
the commercial banking type was to be substituted in the
future for such paper as was carried of the investment type.
Furthermore, regulations were drawn to insure that the
Federal Reserve banks would hold only liquid commercial
paper. These requirements were received coldly by the
American banking community* It had carried on more
liberal credit practices for many years and vigorously opposed the adoption of exacting methods. Consequently the
restrictions were modified from time to time to accord more
with existing practices.28
In various subsequent regulations the Board has determined the kinds of transactions which could be made the
basis for securing central bank credit by the rediseounting
27

Public Act No. 1 and Public Act No. 417, 73rd Congress.
See Federal Reserve Board Circular No. 13, Nov. 10,1914 and Willis, The
Federal Reserve System, chapter XLIL
28

252 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

process. Within the limits of eligibility set by the Board,
the Reserve banks have interpreted the regulations and
applied the rules and credit tests to specific items offered by
the banks.29 The eligibility, therefore, of any particular item
offered by a member bank for rediscount was in the final
analysis a matter of judgment of its Reserve bank.
The creation of Reserve bank credit then, has depended
upon the degree of strictness with which the eligibility rules
were applied by the several Reserve banks. The New York
Reserve Bank has been liberal in passing upon the eligibility
of paper.30 It has been the practice of the Bank to consider
all items offered for rediscount as being eligible unless obviously technically ineligible.31
Acceptability of Paper for Rediscount
The Federal Reserve Act, however, does not require a
Reserve bank to discount all offerings of even eligible paper.
It merely says that it may discount such paper.32 Whether
the Reserve Bank will discount a particular item offered
depends upon the acceptability of that item as well as upon
its eligibility. The Act further states:
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 authorized by
this Act, shall be subject to such restrictions, limitations, and regulations as may be imposed by the Federal Reserve Board.33
Supplementing the permissive discounting provision of
the Act, the Board has recognized the distinction between
eligibility and acceptability in one of its regulations pertaining to the discount of promissory notes. This contained
the proviso reading:
Unless the statement of the borrower clearly indicates that
29
For a comprehensive treatise on eligibility requirements, theory and
practice, consult Willis and Steiner, Federal Reserve Banking Practice, chapters VII-XIV.
30
Hearings on Banking Systems, 1931, p. 732.
31
Idem.
32
Federal Reserve Act, section 13.
33
Idem.

RATES, OPEN MARKET AND LOAN OPERATIONS

253

such note is both eligible from the legal standpoint and acceptable
from a credit standpoint. . . ,34

Again, in the Digest of Rulings of the Federal Reserve
Board (1928 Edition) the Board states:
Even though paper may be eligible for rediscount, a Federal
Reserve bank is under no obligation to rediscount it, but may accept it or refuse it as it is considered desirable from a credit standpoint. 35

Since the paper offered by a member bank may be undesirable from a credit standpoint, various credit tests have
been applied to the paper by the Reserve Bank to determine its acceptability. These are the borrower's financial
standing, his ability to pay, his general business record and
reputation, and the value of the endorsement of the offering member bank.36 Unfavorable factors developed as a
34

Regulations of the Federal Reserve Board, Regulation A, section IV,
Series of 1928.
36
Federal Reserve Board, Digest of Rulings, 1928 Edition, p. 28.
36
Hearings on Banking Systems, 1931, p. 710. The practice of the New
York Reserve Bank in passing upon items offered for rediscount was given in
reply to questions put by the Senate Committee on Banking and Currency as
follows:
"The credit tests employed by us to determine the acceptability of paper
offered for rediscount by member banks are substantially as follows:
"Our first and main reliance is on the indorsement of the borrowing member
bank, and we are constantly scrutinizing the value of each bank's indorsement. In addition paper offered by the bank must meet certain tests. ^
"A statement of the borrower is obtained in all cases where the obligation
amounts to $5,000 or more, and in some instances for less amounts. Reports
of commercial agencies covering financial standing, history, and trade reputation of borrowers are obtained on all items of $1,000 and over, and information is given for all items by the borrowing bank as to business and net worth
of the borrower, and use of the proceeds of the note. It is also our custom to
obtain information by direct checking with banks and others on names where
such a course appears necessary.
"Our credit files are maintained in a manner similar to those of large commercial banks. The net worth of the borrower relative to his debt is taken into
consideration and the ratio of quick assets to current liabilities is regarded as
an important factor. The borrower's history in active business and the trend
indicated by the comparison of statements over a number of years are also
considered important.
"We have found it necessary, in passing upon acceptability of paper, to
recognize in dealing with individual banks that generally they cannot offer for
discount paper of a better quality than their community produces. This is

254 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

result of these tests have caused the Bank to turn down
eligible paper. But whether because of ineligibility or nonacceptability the amount of paper which the New York
Bank has rejected has been a very small proportion of the
total paper offered for rediscount by its member banks.37
It is possible for some control over bank credit to be exercised by varying the strictness or liberality with which the
credit tests of acceptability are applied. However, as far as
its policy is concerned, the Bank states that it does not
raise acceptability requirements at a time when it is following restrictive credit policies.38
Loans on Collateral
The intention of the original Federal Reserve Act was to
loan on paper on its own strength. This has been modified
in two ways: (1) by the administrative practice of requiring excess collateral from borrowing banks, and (2) by the
amendment to the Act of September 7, 1916, authorizing a
Reserve bank to make advances to a member bank on its
promissory note secured by eligible paper or United States
Government obligations. The New York Bank has always
required a margin of collateral in a limited number of cases.39
In such cases borrowings have been handled "in the form of
a collateral note secured by eligible paper equaling at least
the amount of the note and also by a margin of additional
paper or collateral which need not necessarily be of eligible
character." 40 This practice follows that developed by the
large commercial banks in making collateral loans to their
"country" correspondents. These banks have been accustomed to require a substantial margin of collateral even
especially so in the case of the smaller banks." Hearings on Banking Systems,
1931, p. 710.
Consult these hearings, page 732, for further details regarding the rejection
of paper.
" T h e amount rejected on account of ineligibility and non-acceptability
combined for each of the four years, 1927-1930, was less than one per cent.
Hearings on Banking Systems, 1931, p. 732.
38
Ibid., p. 711.
39
Ibid., p. 712. Concerning the problem of requiring excess collateral see
also the same hearings, pp. 103-106.
«Ibid., p. 712.

RATES, OPEN MARKET AND LOAN OPERATIONS

255

though the borrowing bank put up securities which were
quickly salable in the open market.
The position of the New York Reserve Bank in defense
of requiring a margin of collateral has been the prescription
in the Federal Reserve Act that loans shall be " safely and
reasonably made," 41 or in other words that loans shall be
made in such manner as to assure, as far as possible, that
repayment in full will be made.42 The Bank stated that it
felt impelled in many instances to make loans where surrounding conditions were such as to indicate some possibility
of loss; and that in such cases the requirement of excess collateral was an effort to have the grant of credit fall in the
category of loans which "may be safely and reasonably
made." 43
Conditions where a loan to the member bank was not
considered unquestionably safe and yet the New York Bank
adjudged that its member bank was entitled to a loan upon
putting up excess collateral, were outlined by the Bank as
follows: 44
(1) Impaired value of the member bank's indorsement, due to
depreciation in its securities account, losses in loans, or other losses
which reduce the ratio that its capital funds bear to its liabilities.
It is sometimes necessary to extend accommodation to a bank
during the period in which steps are being taken by its directors
to bring about restoration of the capital account.
(2) Variation in the dependence to be placed on the judgment of
the member bank as to the goodness of loans it has made. The
paper in different banks may be equally eligible from a legal view
point and apparently acceptable from a credit standpoint, but
the loss experience of a particular member bank may have been
such as to indicate that its paper will show a considerably larger
proportion of loss than that of other and better-managed institutions.
41
42

Federal Reserve Act, section 4.

Hearings on Banking Systems, 1931, p. 714.
Idem.
44
Ibid., pp. 714r-715.
In 1926, the governor of the Bank testified before the House Banking and
Currency Committee that the practice of the Bank was not to take additional
collateral in the case of a discount but that such margins were required in
the case of 15 day advances in some instances. Stabilization Hearings on
H. R. 7895, 1926, p. 544.
43

256 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
(3) The character of the business of the community may be
such as to give rise to paper of poor average grade, even though
legally eligible and apparently good. In situations of this kind a
large volume of the bankers' paper can not be classified either as
certainly good or as bad, but required some middle classification.
To reject a considerable portion of this would probably be unfair
to the member bank, especially as the reserve bank is obliged to
form its opinion largely upon the data obtained at secondhand,
and does not have the opportunity to have personal contact with
borrowers or to observe the daily course of their business as reflected in their current bank account. Ordinarily in cases of this
middle classification the member bank's indorsement is quite adequate to make the loan safe, but if the value of that indorsement
is impaired for any reason, a margin of collateral becomes important.
(4) Emergency conditions: When a bank is undergoing a run,
it is only with great difficulty that it can assemble paper and prepare applications for rediscount rapidly enough to meet the needs
of the situation. The difficulty of selecting paper of an acceptable
character at such a time is great and to pass upon several thousand
items quickly enough to give the needed credit to the member
bank is almost impossible for a reserve bank, especially in cases of
paper of a borrower whose statement has never before been on
file with the Federal reserve bank. In such a case the member
bank may meet the situation and receive the needed accommodation by offering a margin on its paper, perhaps using for the purpose of margin, paper or other collateral not of eligible character.
(5) It is necessary to recognize in taking commercial paper from
a member bank which is in possible danger of being closed by a
run, that in the event of such closing the collectibility of the paper
of its customers would be very much impaired, and that many
notes which might be paid if the bank were to continue as a going
institution might be partially or wholly uncollectible in the event
of its closing.
The practice of the Reserve Bank of making loans on
excess collateral on member bank rediscounted paper undoubtedly did "protect" the paper. The Bank reported
that it had lost no money on its loans to member banks.
In case of doubt as to the safety of the rediscounted paper,
the Reserve Bank would have the collateral anyway. Also,
the loans on collateral have "relieved" certain banks. However, the tendency of such a practice is to lessen the degree
of care with which commercial paper is examined by the
Reserve Bank before it is rediscounted. Consequently

RATES, OPEN MARKET AND LOAN OPERATIONS

257

member banks do not need to exercise the care they otherwise would in making self-liquidating loans. Frozen assets
therefore accumulate.
Although lending on excess collateral may help out a
hard-pressed bank under any of the above conditions, and
while such lending may make the loans unquestionably
"safe," and undoubtedly protects a Reserve bank, on the
other hand it tends to prevent the proper control of credit.
Safeguards, such as the close scrutiny of commercial paper
and insistence upon the "commercial" character of the
underlying transaction tend to be relaxed in favor of " ample security." The consequence is that bank assets become
less liquid than they otherwise would be.
Member bank borrowing on Treasury obligations, begun
during the war, continued on a large scale during the decade
of the '20s. The Treasury policy of constant refunding of
short-term issues at low rates provided bankers with relatively unlimited access to the resources of the central banks.
Regardless of whether a member bank held in its portfolio
commercial paper,45 eligible and acceptable for rediscounting, it could always be assured of drawing on the resources
of its Reserve bank if it possessed government securities.
Moreover, even though member banks did have eligible
paper, they usually borrowed on their own notes collateralled
with government securities rather than rediscount the commercial paper because it was more convenient to do so.
The New York Reserve Bank stated that "in practically
all cases where government bonds are owned, borrowing will
be against them before resorting to the use of eligible paper,
purely as a matter of convenience." 46
The New York Reserve Bank also favored the policy of
making advances to member banks on their collateralled
notes. The Bank has constantly defended this practice as
against the testing of commercial credit which it was supposed to do if it was to function in such a way as to maintain the real liquidity and soundness of the banking struc45

Referring to commercial, industrial, or agricultural paper, within the
meaning of the Federal Reserve Act.
« Hearings on Banking Systems, 1931, p. 780.

258 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

ture. By this type of lending Federal Reserve officials
have relieved themselves of much responsibility. They saw
that the government securities behind the member bank
notes totaled a certain amount. Such a practice requires
far less ability than one which imposes a real credit analysis
of specific items of commercial paper. Furthermore, as
administered by the New York Reserve Bank the practice
resulted in virtually transferring control over the use of
Federal Reserve credit to the commercial bankers who
utilized United States Government securities for " profitmaking " purposes primarily, rather than for the accommodation of commerce, agriculture, and industry.
Whether the proceeds are used for commercial, speculative,
or investment purposes, borrowing from the central bank on
the basis of government securities is questionable because
such securities are of a semi-permanent nature. The policy
of making advances collateralled by government securities
breaks the close connection between the volume of trade
to be financed and the extension of Reserve bank credit.
Another defect of the policy was that it interfered with the
ability of the Reserve Bank officials to determine the use of
credit and regulate it. This is due to the fact that the member bank promissory notes afforded no evidence on their
face as to the use to which the proceeds of the loans would
be put. Again the result was less assurance that bank
assets had the liquidity needed for the bank's deposit liabilities.
The original Federal Reserve Act provided for the rediscounting of commercial paper by having the Reserve banks
carefully examine each item offered by the member banks
and decline paper which was not self-liquidating and which
did not represent commercial as distinguished from investment transactions. These methods which have prevailed of
obtaining Federal Reserve credit in ways other than by the
rediscounting of short-term self-liquidating paper have rendered more difficult the problem of credit control. The
reason for the difficulty is that the practices have removed
the direct checks to the unwarranted expansion and use of
bank credit involved in the rediscounting of eligible paper

RATES, OPEN MARKET AND LOAN OPERATIONS

259

upon the basis of its individual worth. The extent to which
the New York Reserve Bank has discounted paper secured
by collateral47 instead of relying upon the inherent soundness of the paper itself because of its self-liquidating character indicates how far the Bank has departed from the ideas
of the framers of the Federal Reserve Act and the tenets of
central banking.
47
See The New York Money Market, Vol. IV, by Beckhart, Smith, and
Brown, p. 385, for the ratio of discounts secured by government obligations
to total bills discounted, Federal Reserve Bank of New York and the Federal
Reserve System. This percentage has been considerably larger for the New
York Bank than for all the Reserve banks combined.

CHAPTER XIII
CREDIT CONTROL—DIRECT ACTION
Persuasion, Curtailment of Non-Essential Loans
Supplementary efforts to control the volume and use of
member bank credit and Federal Reserve funds have been
adopted. These efforts have included persuasion, warnings,
and the refusal to rediscount. It has been the policy of the
New York Bank almost throughout its existence to use
persuasion * as a means of credit control.2 During the war
and post-war period (1918-1920) the Bank was not able
to regulate credit to its satisfaction by discount rate increases owing to the requirements of the Treasury. It therefore resorted to direct action.
The war period involved an effort on the part of Federal
Reserve authorities to conserve credit for purposes which
were calculated to strengthen the Government in prosecuting the war. The Federal Board, by every means within
its power, endeavored to impress upon the Reserve and
member banks the need of rationing credit.3 An important
medium was the Board's monthly bulletin in which it persistently espoused the attainment of these goals. In the
April 1918 issue, the Board made a broad distinction between necessary and unnecessary productive activities; and
urged that all unnecessary credits be curtailed and that
credit be conserved for the use of the Government.4 In
July the Board addressed a letter to the Reserve banks
asking their support in the campaign, and another letter
to all the banks of the country calling upon them to exercise "a reasonable discretion to restrict credits which are
1

Sometimes called "moral suasion."
Hearings on Banking Systems, 1931, p. 724.
3
Federal Reserve Bulletin, June, 1918, p. 485.
* Federal Reserve Bulletin, April, 1918, pp. 260-262.
260
2

DIRECT ACTION

261

clearly not needed for the prosecution of the war nor for
the health and necessary comfort of the people." 5
In accordance with the request from the Board, the directors of the New York Bank undertook to further the program in every practicable way. They passed a resolution
directing the officers of the Bank to express to the banking
institutions of the district the importance and necessity of
conserving credit:
By endeavoring to secure such gradual reduction as may be
practicable of loans now carried for non-productive or nondistributive purposes.
By gradually reducing the amount of credit granted for purposes
not clearly necessary for the prosecution of the war or the health
and necessary comfort of the people, and
By educating borrowers of all classes to keep their demands
for credit down to the very minimum.6

In a letter to all banks in its district, non-member as well
as member, the Bank urged the realization of these ends.7
Again during the post-war period of inflation the Federal
Board and the New York Reserve Bank endeavored to
control credit by persuasive measures. The campaign was
carried on by informal conversations with bankers, correspondence8 and through publications—the Federal Reserve
Bulletin and the monthly reviews of the various Reserve
banks. A policy of deflation was begun in the fall of 1919
and continued through the early months of 1920 with a
view to reducing the volume of bank credit outstanding
and prices.9 The credit restriction policy was rather sugB
Copies of these letters may be found in the Federal Reserve Bulletin,
August, 1918, pp. 685-687.
• The Commercial and Financial Chronicle, Aug. 10, 1918, p. 552.
7
A copy of this letter may be found in the Agricultural Inquiry Hearings,
1921, Part 13, pp. 766, 767. To assist the banks in furthering the program the
Reserve Bank prepared two statements for banks to use in enlisting the cooperation of their customers. One statement was for a bank to send alone to
a customer. The other statement was to be sent with a letter from the Bank.
Thousands of these statements were distributed to the banks and by them to
their customers. Copies of them may also be found in the Agricultural Inquiry Hearings, 1921, Part 13, pp. 768, 769.
8
Federal Reserve Bulletin, February, 1920, p. 116.
•See Federal Reserve Bulletins, October, 1919-May, 1920; Federal Reserve Bank of New York, Reports on Business Conditions, October, 1919May, 1920.

262 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

gestive at first but gradually increased in forcefulness and
involved the rationing of credit on the part of the commercial banks.
The first positive step in the deflation process in the New
York district was begun by the New York Bank in January,
1920. It then summoned the heads of several member
banks and insisted that they cut down their customers'
loans and reduce their indebtedness at the Reserve Bank.10
The campaign was pushed in its monthly report on business
conditions reaching a climax in May, 1920. In its April
(1920) bulletin the Bank stated that the Federal Reserve
banks and each one of the 30,000 banks of the country
"have a special duty and responsibility towards present
conditions which they cannot neglect." It held that primary responsibility rested on each banker to do his share
by exercising a stricter control of the credit he creates.
In answer to the question: "What can the banker do among
his customers to exercise a stricter control of credit?" the
Bank made the following suggestions: n
1. Care should be exercised in granting credit to customers
whose capital has not been increased proportionately with the
increased liabilities of the present day, and who are not setting
aside ample reserves against depreciation.
2. A distinction should be made between loans for the purpose
of speculating in commodities, securities and real estate on the
one hand, and loans for the production and distribution of necessary goods on the other.
3. Avoid loans for the production and distribution of unnecessary goods or for the purpose of carrying stocks of luxuries and
expensive grades of goods as such "merely increase the temptation to extravagant living; while loans to individuals to purchase
such articles seem wholly undefensible."
4. Business should not be extended for the sake of increased
volume of profits. In particular, do not expand plants and equipment but use those existing by installing labor-saving devices or
by night work to get larger production without extensions.
5. If extensions of plants and equipment are adjudged necessary they should be financed as far as practicable through conservation of profits.
10

The Commercial and Financial Chronicle, Jan. 24, 1920, p. 317.
"Federal Reserve Bank of New York, Report on Business Conditions,
April 30, 1920, pp. 1-4.

DIRECT ACTION

263

6. Urge borrowers to pay their debts, reduce present excessive
and extravagant consumption, foster systematic saving and sensible spending.
7. Take a more firm and determined stand to prevent further
expansion and inaugurate a gradual and orderly restriction of
credit,

While the campaign to get the banks to ration credit in
the New York Reserve district as well as through the country had some effect,12 on the whole, its results were most
disappointing and must be considered a failure.13 There
were several reasons for the failure of the campaign for
credit rationing. In the first place, bankers found it difficult to distinguish between essential and non-essential uses
of credit.14 Opinion was quite diverse concerning the meaning of the term "essential" and doubtless tended to vary
according to the particular interests demanding accommodation at the banks. Also, such a voluntary system depended for its success upon practically all business enterprises having to resort to the banks for financing. Since
there were many enterprises of an unessential type which
were self-financing and did not rely upon the banks, the
method employed did not reach them and was not uniform.15
Finally, the nature of our banking organization was such
as to preclude the success of a vigorous rationing program.
With thousands of independent banks, most of which were
not members of the Federal Reserve system, closely bound
up with the economic and social life of their respective
communities, any sincere effort to apply the principle of
rationing to a customer was likely to meet with defeat.
Any one banker in a community would naturally hesitate
12
See Federal Reserve Bulletin, August, 1918, p. 685; September, 1918,
p. 802; B. M. Anderson, Jr., Effects of the War on Money, Credit and Banking
in France and the United States, p. 191. Consult also the Federal Reserve
Bulletins, January to May, 1920.
13
Governor W. P. G. Harding of the Federal Reserve Board, in the Commercial and Financial Chronicle, Sept. 25, 1920, p. 1229; Dr. A. C. Miller of
the Federal Reserve Board, in the American Economic Review, June, 1921,
p. 189; Federal Reserve Bulletin, October, 1918, p. 923.
14
Federal Reserve Bulletin, August, 1918, p. 689.
u
Federal Reserve Bulletin, October, 1918, p. 923.

264 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to refuse credit on the ground of its being non-essential for
fear of losing a customer's business to his competitor. A
rationing plan of this type would have had a much better
chance of success in a country of relatively few banks with
branches.
Warnings
Both the Federal Reserve Board and the New York
Reserve Bank have issued warnings. The first public warning was issued by the Board in October, 1915.16 It concerned the unwarranted use of Federal Reserve credit for
speculative loans. In the latter part of 1916 the Board issued
another warning with a view to restraining the banks from
buying foreign securities.17 In 1917 the Board called attention to a plethora of net gold imports and the dangers of
the continuous and rapid growth of loans and deposits.18
While the war was on in 1918 it warned against granting
unnecessary credits and urged the conservation of credit
for war purposes.19 During the post-war period of speculation and inflation counsel and warnings were repeatedly
given by the Board.20 It pointed out the dangers existing
in the situation and that Federal Reserve funds were not
intended for speculative purposes.21 At this time the New
York Bank also urged the liquidation of the war investments of the banks and warned member banks that the
rediscounting privilege should be exercised only to meet
emergency or seasonal conditions.22 It pointed out that at
other times they were not to borrow for the purpose of
18
W. P. G. Harding, governor of the Federal Reserve Board, quoted by
H. P. Willis in The Federal Reserve System, p. 1335.
"Federal Reserve Bulletin, December, 1916, p. 661; The Commercial and
Financial Chronicle, Dec. 2, 1916, p. 2029.
18
The Commercial and Financial Chronicle, Feb. 17, 1917, p. 614.
19
Federal Reserve Bulletin, April, 1918, pp. 260, 261.
20
Dr. A. C. Miller, " Federal Reserve Policy," American Economic Review,
June, 1921, p. 189.
21
The Commercial and Financial Chronicle, June 7, 1919, p. 2285; June 14,
1919, p. 2390; July 12, 1919, pp. 102, 130; Federal Reserve Bulletin, June,
1919, pp. 523, 524; July, 1919, p. 617; October, 1919, p. 910; December, 1919,
pp. 1107-1109.
22
Federal Reserve Bank of New York, Report on Business Conditions,
Nov. 20, 1919, p. 1.

DIRECT ACTION

265

making a profit over the discount rate 23 and that a reduction of their indebtedness to the Reserve Bank was a condition precedent to the restoration of normal times.24
Warnings were not issued by the Bank during the period
of securities inflation and speculation, 1925-1929. The tone
of its Monthly Review was different from what it was at
the time of the previous inflation. During the "new era"
regime it reported facts and statistics regarding rate changes,
brokers7 loans, and movements of funds in its bulletin. But
the New York Reserve Bank did not sound warnings as it
had done while the post-war boom was on. The Federal
Reserve Board did, however, issue a warning rather late in
this "new era," February, 1929, against the use of Federal
Reserve credit, directly or indirectly in stock speculation.
In a public statement the Board sounded perhaps the most
emphatic warning it ever issued, declaring in part that:
The Federal Reserve Board neither assumes the right nor has
it any disposition to set itself up as an arbiter of security speculation or values. It is, however, its business to see to it that the
Federal Reserve banks function as effectively as conditions will
permit. When it finds that conditions are arising which obstruct
Federal Reserve banks in the effective discharge of their function
of so managing the credit facilities of the Federal Reserve system
as to accommodate commerce and business, it is its duty to inquire into them and to take such measures as may be deemed
suitable and effective in the circumstances to correct them; which,
in the immediate situation, means to restrain the use, either directly or indirectly, of Federal Reserve
credit facilities in aid of
the growth of speculative credit.25

With this statement was included a letter which it had
addressed to the Federal Reserve banks a few days before,
giving further warning against the use of Federal Reserve
credit for the purpose of maintaining loans on the stock
exchange. It read in part as follows:
23

Idem.
Federal Reserve Bank of New York, Report on Business Conditions,
Dec. 20, 1919, p. 1.
25
Federal Reserve Bulletin, February, 1929, pp. 93, 94. See also Federal
Reserve Bulletin, March, 1929, pp. 175-178; Annual Report of the Federal
Reserve Board, 1929, pp. 1-4.
24

266 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The resources of the Federal Reserve system are ample for
meeting the growth of the country's commercial needs for credit,
provided they are competently administered and protected against
seepage into uses not contemplated by the Federal Reserve Act.
The Federal Reserve Act does not, in the opinion of the Federal
Reserve Board, contemplate the use of the resources of the Federal Reserve banks 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.
The Board has no disposition to assume authority to interfere
with the loan practices of member 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 bank 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 banking and credit system of the
country.26
Conflict between the New York Reserve Bank and the Federal
Board

The use of Federal Reserve credit in stock speculation
brought forth a divergence in policy between the New York
Bank and the central Board. The Board addressed a letter
to the New York Reserve Bank, February 2, 1929, asking
what they had done to stop Federal Reserve credit from
going into speculative channels.27 The Board's warning
referred to above was made public on February 7th. The
Federal Reserve agent of the Bank, Gates W. McGarrah,
replied on February 21st to the effect that it had endeavored
to get any banks which were "out of line" with other banks
to readjust their position but that such a policy was not
very effective in controlling the total amount of credit.
26
Federal Reserve Bulletin, February, 1929, p. 94. In its Annual Report
for 1928 which was published after these warnings, the Board called attention
to the danger resulting from the increase of loans on securities and stressed
the responsibility of the Federal Reserve system for limiting the use of Federal Reserve credit in the security markets. Annual Report of the Federal
Reserve Board, 1928, pp. 7, 8.
27
Hearings on Banking Systems, 1931, p. 170.

DIRECT ACTION

267

The Board, however, believed that it was the duty of the
Reserve Bank to apply pressure to all banks of a group
which were borrowing from the Reserve Bank and at the
same time loaning money on the stock exchange just as
much as when one bank got out of line by borrowing a little
more than other banks.28
Accordingly, the Board sent another letter to the Federal
Reserve agent of the New York Bank, May 1,1929. In that
letter the Board sent a list of New York City banks which
were borrowing continuously or frequently, and which were
also carrying quite a large volume of security loans, including brokers7 loans and customers' loans.29 The Board requested the Federal Reserve agent to take up the matter
with those banks and ask them why they had not adjusted
their position in accordance with the Board's warning and
why such adjustment was not in accordance with the public
interest.30 The Reserve Bank declined to comply with the
request of the Board to apply such pressure to the member
banks.31 In explaining the refusal, Federal Reserve Agent
McGarrah told the Board that it was laying down a new
procedure to test the abuse of Federal Reserve credit; that
it implied the right of a bank to borrow on eligible paper
was prejudiced by the fact that that bank is loaning on securities, whereas the banks have a right to loan on securities.32
Following this reply of the New York Bank, the Reserve
Board practically let the matter rest. The Federal Reserve
M
28 Idem.
Idem.
81
Ibid., p. 171.
Idem.
32
Idem.
Mr. McGarrah, himself, while chairman and Federal Reserve agent, was
connected with stock market operations in a private capacity. He was, in
1929, a director in a corporation called the Shennar Corporation. The Shermar Corporation was one of six personal corporations formed by Albert H.
Wiggin, head of the Chase National Bank, to lessen payment of personal
income taxes. Two of these corporations, the Shermar and the Murlyn, developed a short position of 42,506 shares in the stock of the Chase National Bank
and were forced to borrow $6,588,430 from the Chase National Bank to cover
that position. This is a specific example of a member bank's stock market
loans during this period under question. It also shows a connection which
the chairman and Federal Reserve agent of the Federal Reserve Bank of
New York personally had with it. Hearings before the Senate Committee
on Banking and Currency, Oct. 31, 1933, published in The New York Times,
Nov. 1, 1933.
M

268 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Act prescribed that the board of directors of a Reserve bank
was to make discounts and advances to member banks
"subject to the provisions of law and the orders of the Federal Reserve Board." 33 An issue between a Reserve bank
and the Board had never been forced to such an extent as
to result in a judicial interpretation of the word "orders"
in this section. In this case of the use of Reserve credit for
stock speculation the Federal Board did not press its stand
upon the Reserve Bank. The Board chose not to issue an
order compelling the Reserve Bank to do what it sought to
have the Bank do by the method of recommendation or
exhortation. The central controlling authority had interpreted the Reserve Act one way and the New York Bank
had interpreted it another way. Apparently the Board felt
that it had made its position clear regarding the restrictions
in the Act upon the use of Federal Reserve credit and the
consequences of the then existing situation. The Board did
not force the issue. Consequently, the position taken by the
New York Bank in its interpretation of the Reserve Act
continued to prevail and to furnish support for the connection between Federal Reserve credit and stock market
speculation.
Efficacy of Warnings
The efficacy of warnings as an instrument of credit control
has been very slight. While at times they no doubt have
exerted a restraining influence the forces making for expansion have proved too powerful for warnings without any
teeth in them to be effective. During the post-war period
the checking of inflation by increases in the discount rate
was impracticable because of the requirements of the Treasury in putting over its government financing program.34
Relying, therefore, upon direct action, the warnings which
were given proved to be "only a transitory expedient and
were given only momentary attention by many banks." 35
33

Federal Reserve Act, section 4.
Annual report of the Federal Reserve Board, 1919, p. 3; The Commercial
and Financial Chronicle, June 14, 1919, p. 2390.
35
Annual Report of the Federal Reserve Board, 1929, p. 12.
Concerning the experience with this type of credit control, Governor Hard34

DIRECT ACTION

269

In the case of the "new era" regime the easy money policy
of the New York Bank in 1927 was followed by an unwarranted use of Federal Reserve credit in a wild orgy of
speculation in stocks*
Although discount rates were used as an instrument of
control the rate increases were tardy and in insufficient
"doses" in the early stages of expansion.36 After inflation
in securities had proceeded to great heights, the call money
rate became king and the Federal Reserve discount rate
became secondary and relatively an impotent weapon.37
This was the stage that was reached when in 1929 the
Federal Reserve Board decided that the time had gone by
when discount rate increases could be effective against
securities speculation and could be made without hurting
commerce and agriculture.38 In this situation it adopted
the policy of direct pressure and issued its warning of
February 7th.39
While it may be that the Board's warning restricted the
ing of the Federal Reserve Board said in 1920: "As I have already pointed
out, a thorough test was made last year of the theory that the credit situation
could be controlled without advancing discount rates, but it was found that
control could not be effected by an appeal to reason alone/' The Commercial
and Financial Chronicle, Sept. 25, 1920, p. 1229.
Again, Dr. A. C. Miller of the Board said: "Direct action, so-called, as a
method of control was not succeeding. The expansion of credit and the rise
of prices went on apace. Speculation flourished." American Economic Review, June, 1921, p. 189.
36
Hearings on Banking Systems, 1931, pp. 141,142.
37
Ibid., pp. 141-144.
58
Ibid., pp. 142, 143.
At the time of the Board's public warning (February 7, 1929) the New York
Reserve Bank discount rate had not been raised since July 13, 1928, upon
which date it reached 5 per cent. Under the Federal Reserve Act discount
rate changes are proposed by the Reserve banks to the Federal Reserve Board
for determination. Dr. A. C. Miller of the Board testified before the Senate
Committee on Banking and Currency as follows: "The rate was raised by the
New York Bank to 5 per cent on the 13th day of July, 1928. It was not until
the 14th of February, 1929, or seven months later and one week after the
Board issued a public statement to the country with respect to credit conditions, in which was emphasized the dangers inherent in the extraordinary
growth in the volume of speculative security credit, that the Federal Reserve
Bank moved. It was not until after the Board issued that statement, that the
first proposal to raise the rate to 6 per cent was made to the Board." Hearings
on Banking Systems, 1931, p. 142.
39
See also pp. 265-266.

270 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

use of bank credit for trading in or carrying securities below
what it otherwise would have been, actually, brokers'
borrowings increased after the edict to greater heights than
ever before and stock prices advanced.40 The Board endeavored to follow up its warning by dealing with the New
York Reserve Bank. Its effort, however, to get that Bank
to put restrictive measures on the banks, which were using
Federal Reserve credit to support their stock market
operations, failed.
Uses and Efficacy of Persuasion
The campaign carried on by the New York Bank during
the war and post-war years indicates the length to which the
Bank went in its effort to control not only commercial banks'
lending policies but even the financing policies of business
concerns and the economic life of consumers. It was a farreaching use of the persuasion method of control on the
part of a central bank to bring about rationing of credit
and deflation. It is a phase of control to which the Bank
did not resort during the "new era/7 1925-1929, with its
over-expansion, inflated stock prices, and mania of installment buying.
Concerning the effectiveness of the use of persuasion as
a method of control, the New York Bank stated that "we
believe it is impracticable to use moral suasion as an effective
part of a program designed generally to restrict or control
expansion in or use of Federal Reserve credit" and "we
do not believe it is possible for Federal Reserve banks by
moral suasion or other means to prevent credit from being
used for speculative or investment purposes as distinguished
from other purposes." 41 In defense of its stand the Bank
explained the difficulties with the use of persuasion as
follows:42
The first difficulty is that a principal cause of member-bank
borrowings is a loss of deposits which is not connected with loans
40

For a comprehensive analysis of various phases of Federal Reserve policy
during this period see The New York Money Market, Vol. IV, chapters IVVIII, by Dr. Beckhart.
41
Hearings on Banking Systems, 1931, p. 725.
42
Idem.

DIRECT ACTION

271

currently made. In most cases the bank which actually borrows
at the reserve bank is not the institution which originally makes
the extension of credit resulting in an additional demand for Federal reserve credit. The second difficulty in the use of moral suasion
is that it is a personal appeal, the effectiveness of which depends
largely upon the human characteristics of the person appealed
to. Some bankers are exceedingly anxious to cooperate with the
reserve bank and are willing to sacrifice all other considerations to
an accomplishment of that purpose. Others resent any suggestions as to how they should run their own business and are but
little affected by anything less than the most drastic methods.
The great majority of bankers range all the way in between these
extremes. It is not possible to present a case to any considerable
number of bankers in such a manner as to secure anything approaching uniformity. Moral suasion, if effective, is bound to
lead to discrimination, as it merely drives business from the cooperative bank to another less cooperative one. No matter how
clear or explicit the expression of policy may be, whether it is
communicated by circular letter or by individual contact, the
different bankers to whom it is addressed will give it various interpretations, which are likely to be affected by the interests or
supposed interests of their respective banks or customers. There
is no doubt that much can be done by direct contacts with bank
officers, and in cases where the individual bank is borrowing in a
manner which requires special treatment the method of direct
contact must necessarily be employed. It is a slow operation and,
when many banks are to be dealt with, it does not produce results
nearly so promptly, effectively, or equitably as does a change in
rate. The reasons for a change in rate may not be thoroughly
understood by the member banks, but their reaction to it is sufficiently uniform to bring about prompt movement in the direction
in which the rate should operate.

The method of persuasion has been used by the New
York Bank to influence individual banks with some degree
of success.43 Where an individual bank, for one reason or
another, appeared to be borrowing either in amounts or for
a length of time out of proportion to other banks similarly
situated or doing a similar type of business, pressure has
been applied to that bank to get it to reduce its indebtedness
to the Reserve bank.44 This method has also been employed
in the case of banks which were using Reserve bank credit
as a substitute for capital or were borrowing merely for
43

Ibid., p. 724.
* Ibid., pp. 170, 724.

272 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

profit.45 Its policy has been not to urge a bank to liquidate
its Federal Reserve indebtedness because it was using the
credit in a certain way but because its borrowings were out
of line with banks in the same community.46 Neither has
the New York Bank endeavored to persuade its member
banks generally or a group of banks in a community not to
use Federal Reserve credit for speculative or investment
purposes.47
There are certain difficulties in determining the use a
member bank makes of the proceeds of any specific loan.48
This is because Federal Reserve credit obtained by whatever means goes into a common pool—the member bank
reserve account—which furnishes the basis for a member
bank's expansion of loans and deposits as a whole. However, when a member bank makes loans to stock exchange
brokers resulting in an increase in deposits and thus necessitating increased borrowings from the Reserve Bank, Federal Reserve credit is used to support the trading or carrying
of securities. This is contrary to the intent of the Federal
Reserve Act.49 And yet, as we have seen, the officials of the
New York Reserve Bank have known and are in a position
to know the general uses to which member banks put funds
borrowed from the Reserve Bank.50
Persuasion as a means of credit control has not been successful. The Federal Board's effort to get the New York
Reserve Bank to persuade banks supporting stock exchange
loans with Federal Reserve funds to reduce the former was a
failure. The Reserve Bank did not loan directly on stock
exchange paper. What happened was that the stock exchange was supplied indirectly with Federal Reserve funds
«Idem.
46
Ibid., pp. 72, 724.
«Ibid., pp. 71, 72, 171.
48
The New York Reserve Bank has supplied a rather detailed statement
of these difficulties. See Hearings on Banking Systems, 1931, pp. 715-718.
49
The Federal Reserve Act did not prohibit member banks from making
investment or stock exchange loans. The prohibition in the Act relates only
to their eligibility as a basis for Federal Reserve credit. (See Federal Reserve
Act, section 13. See also speech of Senator Glass in the United States Senate,
Congressional Record [unbound edition], May 10, 1932, p. 10197.)
60
See chapter XI, p. 238.

DIRECT ACTION

273

with which it could not be supplied directly. The Federal
Reserve Act was nullified largely by Reserve bank lending
to banks on their promissory notes collateralled by government securities and by open market purchases.51
Refusal to Discount Eligible Paper
Experience has shown that the particular form in which
member banks acquire Federal Reserve funds in no way
determines their eventual use.52 There is a way, however,
in which the Bank could have prevented an unwarranted
use of the ultimate reserves of the commercial banking
system if it had chosen to do so. That way is by refusing to
discount eligible paper or make advances upon the same
when those reserves were used for that purpose.
As previously stated, the Federal Reserve Act prescribes
that a Reserve bank may discount or make advances. It
does not say it shall or must do so.53 This provision of the
Act gives the Reserve banks a means of exercising a qualitative control over credit. It enables them to restrict the
diversion of Federal Reserve credit into channels not recognized by the Federal Reserve Act. The use of such a method
would not result in tightening money for commerce and
agriculture. Some of the interior Reserve banks did exercise
their authority to decline such an extension of Federal
Reserve credit on eligible paper. When they found a member
bank was increasing its loans on call they refused to discount
any paper for that bank except perhaps for a day or two at
a time.54 But the New York Reserve Bank did not refuse
61
See chapter XII, pp. 244-249, 254-259.
82
Hearings on "Ranking Systems, 1931, p. 718.
53

See chapter XI, section on Acceptability for Rediscount.
The general counsel to the Federal Reserve Board and its special counsel,
Hon. Newton D. Baker, advised the Board that a Federal Reserve bank has
the power to refuse discounts. (Hearings on Banking Systems, 1931, p. 177.)
The United States Circuit Court of Appeals for the Second Circuit, in a decision rendered in 1929, stated in effect that it is lawful for a Federal Reserve
bank to decline to rediscount eligible paper since such power, under the terms
of the Federal Reserve Act, is wholly permissive. (Re: Frank G. Raichle v.
Federal Reserve Bank of New York, Annual Report of the Federal Reserve
Board, 1929, pp. 35, 36; Federal Reserve Bulletin, August, 1929.)
64
H. Parker Willis, "A Turning Point in American Banking," The Banker,
London, December, 1928, p. 255.

274 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to discount for member banks on the ground that they were
using Federal Reserve resources for stock market purposes.
If it declined the discount of any paper presented by one of
its member banks it was upon some other ground such as
being "out of line" with banks similarly situated.55 The
logical position in which the New York Bank is thus placed
is this: if one bank in a community was "heavily in" the
brokers7 loan market, it would be appropriate to support it
with Federal Reserve credit if the other banks in the community would get in just as deep, or if they had drawn upon the
central bank's reserves to support stock exchange trading
in about the same degree. The management of the New
York Reserve Bank operated in accordance with this policy.
Rationing of Credit
Rationing of credit is another possible method of control.
The Federal Reserve Act makes no mention of it nor has
any policy of the Federal Board or the New York Bank
been particularly "advertised" as such. The efforts of the
Federal Reserve Board to prevent the absorption of Federal
Reserve funds into the stock market do not comprise rationing since the Board was only endeavoring to prevent the
use of reserves in ways it considered illegal under the Federal
Reserve Act. Rationing of credit is applicable only to the
conversion of credit instruments into exchange media
within the limits set by the Act.
As the author uses the term credit rationing involves an
effort toward some social end which effort is determined by
a high authority and imposed from the top down.56 It means
that the central banking authorities have a plan, apart from
the normal acceptability requirements, in accordance with
which they prevent bank credit from going into restricted
channels, and facilitate the placing of such credit in lines of
which they approve. Thus if several pieces of eligible paper
65

Hearings on Banking Systems, 1931, p. 52.
In a broad sense there is a rationing of credit in the application of credit
tests to paper in determining its acceptability for rediscount. But such a procedure is merely the practice of banking in according with sound principles.
The procedure here described is something different and is defined as credit
rationing.
66

DIBECT ACTION

275

are offered a Reserve bank, it might choose the underlying
transaction or the type of business it will make the basis
of a loan and deny it in the case of another. Or again, the
Reserve bank might decide upon the amount of credit it
will lend and deny credit in excess of this amount to other
applicants.
For this purpose the Reserve bank might establish a
quota for a firm, an industry, or a trade division and turn
down applications in excess of this quota. Central banks
are especially fitted to influence the degree of development
of any manufacturing industry in so far as that industry
obtains its working capital from the banks rather than from
the investment market. The central banks are the institutions which possess, or are in a position to possess, a composite record of the status of each industry in the country.
Ungoverned by the profit motive and with a comprehensive
picture of the "position77 of an industry before it, the central
banking authority may "ration77 credit, and thereby exert
its influence toward a balanced economic system.
The nearest approach to credit rationing on the part of
the New York Reserve Bank was the campaign in which it
engaged during the war and post-war period of prosperity
to prevent the creation of bank credit for unnecessary purposes.57 This effort was directed to getting the banks and
business concerns to avoid the original creation of credit
for non-essential and speculative purposes.58 The Reserve
Bank did not announce that it would engage in or did engage
in the practice of credit rationing and presumably it did not
do so. There was opportunity for the Bank to do some
rationing of credit itself when passing upon eligible paper
57
68

See above, p. 260.
The Federal Reserve Bank of Atlanta, however, did adopt credit rationing of quite limited scope. It sought to restrict the use of Federal Reserve
credit in financing the purchase of "strictly pleasure or passenger automobiles"
by refusing to discount paper arising out of such transactions. Although the
automobile industry was in an over-expanded condition, and the Atlanta
Reserve Bank sought to lessen such a condition, nevertheless, this slight effort
at credit rationing was not successful. Pressure from the automobile manufacturers who had cars to sell on the installment plan soon compelled the
abandonment of this policy. The Commercial and Financial Chronicle, May
22, 1920, p. 2142.

276 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to determine its acceptability. But the reasons it has given
for judging paper non-acceptable have been other than those
it enjoined upon the member banks during the war and
post-war era concerned. What the Federal Reserve did
was to use the method of persuasion to get the member and
non-member banks to practice credit rationing. There is
reason to believe that the New York Bank itself has never
used rationing as a method of credit control.
Enlargement of Federal Reserve Board's Authority
The relative ineffectiveness of the Federal Reserve system
to control general credit conditions led to the introduction
in the United States Senate, early in 1930, of a resolution
calling for a survey of the national and Federal Reserve
banking systems.59 Pursuant thereto a subcommittee of the
Senate Committee on Banking and Currency conducted
extensive hearings in Washington in 1931. The hearings
covered a wide range of contemporary banking problems,
but particular emphasis was placed upon the use of Federal
Reserve facilities for trading in and carrying speculative
securities.60
In the course of the months following the hearings, the
chairman of the Committee, Senator Glass, introduced
several bills in an effort to secure remedial legislation by
Congress. The object of the bills was to bring about the
practice on the part of the Federal Reserve Bank of New
York and of the Reserve system in accordance not only
with the intention, but, in some instances, the literal wording of the Federal Reserve Act. In the House, Representative Steagall, chairman of the Banking and Currency Committee also worked for banking legislation. Thwarted in his
efforts time after time, it was not until June 16, 1933, that
Senator Glass was able to procure the enactment of a new
banking reform bill. This, the Banking Act of 1933, is of
M

Senate Resolution No. 71, 71st Congress, 2nd Session, April, 1930.
Upon the conclusion of the hearings, the banking expert for the committee,
Professor IL Parker Willis, prepared a comprehensive report and summary of
his findings in regard to bank security loans and investments, brokers' loans
and security affiliates. This report was published as an appendix, Part VII,
of the Hearings on Banking Systems, 1931.
60

DIRECT ACTION

277

particular significance in this treatise because of its provisions relating to credit control.
It will be recalled that the Federal Reserve Act had imposed upon the Reserve banks the duty of seeing to it that
Federal Reserve credit was not used for stock market purposes. This, as has been pointed out, the New York Reserve
Bank failed to do with the resulting disastrous effects. We
have seen, with particular reference to the New York Bank,
that the various means of credit control and the administration of them proved ineffective. Consequently the
Banking Act of 1933 sought to strengthen the Federal
Reserve Act with a view to safeguarding the credit structure
from being weakened by the use of banking reserves for
stock speculation. Several provisions in the reform measure
of 1933 are for the purpose of restricting the use of bank
credit in the investment and speculation markets and
effecting greater control over the chief medium of exchange,
bank credit.
Section 4 of the Federal Reserve Act formerly read that
the board of directors of a Reserve bank shall, subject to
the provisions of law and the orders of the Federal Reserve
Board, extend such credit to member banks as may be
safely and reasonably made with due regard for the claims
and demands of other member banks. In section 13 of the
Federal Reserve Act dealing with the powers of the Reserve
banks, one of the provisions of law was that a Reserve bank
may make discounts and advances to member banks. Under
these sections, as was pointed out, some Reserve banks have
refused to approve applications for credit and judicial authority has held that the power of rediscount was not mandatory but merely permissive. Nevertheless, the framers of
the Act of 1933 apparently wished to reenforce the power
of a Reserve bank to refuse a member bank credit by stating
in section 4 that the board of directors may (instead of shall)
extend such credit to member banks in the manner stated.61
Any credit so extended to member banks shall be with
due regard for the maintenance of sound credit conditions.62
To attain this end the Federal Reserve Board is empowered
61

Banking Act of 1933, section 3.

Idem.

278 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to issue further regulations; and each Federal Reserve bank
is specifically directed to keep itself informed of the general
character and amount of the loans and investments of
member banks with a view to ascertaining whether undue
use is being made of bank credit for the speculative carrying
or trading in securities, real estate, or commodities, or for
any other purpose inconsistent with the maintenance of
sound credit conditions.63 In this connection the right of a
Reserve bank to refuse credit accommodation is specifically
mentioned, for the new Act says: "in determining whether
to grant or refuse advances, rediscounts or other credit
accommodations, the Federal Reserve bank shall give
consideration to such information." 64
The powers of the Federal Reserve Board are considerably
enlarged. The Board, under the new Act, not only has greater
control over the several Reserve banks, but at several points
its authority extends directly to the individual member
banks and includes control over their loan policies. It is
empowered tofixfrom time to time for each Federal Reserve
district the percentage of individual bank capital and surplus
which may be represented by loans secured by stock or bond
collateral with a view to preventing the undue use of bank
loans for the speculative carrying of securities.65 The Board
may also direct any member bank to refrain from further
increase of its security loans for any period up to one year
under penalty of suspension of all rediscount privileges at
its Reserve bank.66 Moreover, if in the judgment of the
Board, any member bank is making undue use of bank
credit for any purpose inconsistent with the maintenance
of sound credit conditions, the Board may suspend such
bank from the use of the credit facilities of the Federal
Reserve system and may terminate such suspension or
renew it from time to time.67 Still more power to affect
63

Idem.
Idem. Italics are the author's.
Ibid., section 7.
This power may be exercised only upon the affirmative vote of not less
than
six of its members.
66
Idem.
97
Ibid., section 3.
64
85

DIRECT ACTION

279

credit conditions is granted the Board by the EmergencyAct of May 12, 1933. Under this Act the Board is given
the right under certain conditions to increase or decrease
from time to time the reserve balances required to be maintained against either demand or time deposits.68
The abuse of Federal Reserve credit by the practice of
borrowing on promissory notes, collateralled especially with
government securities, can now be prevented by alert
Federal Reserve officers. Warnings may be a more effective
instrument of credit control for in the future they will have
"teeth in them." Should an occasion arise similar to that
in 1929, when the Federal Reserve Board was prevented
from making its warnings effective by lack of cooperation
on the part of the responsible authorities of the New York
Reserve Bank, control over an offending member bank
automatically resides in the Federal Reserve Board. It is
provided that if any member bank to which an advance 69
has been made shall, during the life or continuance of such
advance, and despite an official warning of the Reserve
bank of the district or of the Federal Reserve Board to the
contrary, increase its outstanding " investment or stock
market loans," 70 such advance shall be deemed immediately
due and payable, and such member bank shall be ineligible
as a borrower on its promissory note for such period as the
Federal Reserve Board shall determine.71 Here again the
authority of the Federal Reserve Board extends directly to
the individual bank.
In other ways the member bank is brought under the
direct jurisdiction of the Federal Board. The new banking
68
Public
69

Act No. 10, 73rd Congress, section 46.
This prescription applies to all advances on the promissory notes of a
member bank whether such notes are collateralled by government securities
or eligible paper.
70
The author uses this term to cover the lengthy legal description of the
different kinds of loans to which this statute applies. For the technical description of the prescribed loans, see Banking Act of 1933, section 9.
71
Banking Act of 1933, section 9.
There is one exception to this which states that: "No temporary carrying
or clearance loans made solely for the purpose of facilitating the purchase or
delivery of securities offered for public subscription shall be included in the
loans referred to in this paragraph."

280 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

act gives the Board power to remove from office, under
certain conditions, any bank director or officer found to
have engaged in "unsafe or unsound practices" in the
management of a member bank.72 This provision may have
a tendency to improve general credit conditions in that it
is calculated to cause bank directors and officers to exert
greater care over the creation of bank credit. It is also the
duty of the Board to fix the rate of interest from time to
time which member banks may pay on time deposits, thereby
giving the Board another means of influencing member bank
credit and general credit conditions.73
The extent to which open market policy and operations,
and foreign transactions, with their vital influence on general
credit conditions, have been brought under the control of
the Federal Reserve Board is discussed in other chapters.74
We there see in what respects the credit control powers of
the Reserve banks and the Board have been clarified and
strengthened. Thus it is apparent in view of the extensive
and plenary powers, bearing upon the control of credit,
delegated to the Board that the Federal Reserve system
is now entering upon a new phase of its development.
We may witness the expansion and use not only of Federal
Reserve bank credit but of member bank credit regulated
to a substantial degree by the Board. Since specific means
for enforcing its authority have been granted the Board, it
is possible that the various methods of credit control available to the central banking system will attain a greater
degree of effectiveness than in the past.
72
Ibid., section 30.
"Ibid., section ll(b).
The Act prohibits a member bank from paying any interest on any deposit
payable
on demand. [Section 11 (b).]
74
See chapters VIII and XVI.

CHAPTER XIV
CENTRAL SERVICE FUNCTIONS
Clearing and Collection
In addition to the central banking functions there are
several other functions which have been performed by the
Federal Reserve banks* These the author designates central service functions. Clearing and collection are, perhaps,
the most outstanding central service functions of the Reserve banks. While not necessary to the performance of
central banking functions, the Federal Reserve's clearance
operations have been a valuable aid in furnishing the central banking authorities with information concerning the
movement of funds between various sections. Consequently,
the clearing and collection system has been useful in the
determination of Federal Reserve credit policies.
A Reserve bank clears and collects for banks in its Federal Reserve district cash claims, consisting mostly of checks
drawn against each other. This service has been rendered
not only for member banks but, in addition, for so-called
non-member clearing banks.1 In the case of member banks
their reserve accounts are used to effect the settlement of
claims. In the case of non-member clearing banks, deposits
are kept at the Reserve banks for that purpose. A Reserve
bank also effects the clearing and collection for banks in
its district of their claims against banks in all other Federal
Reserve districts. For this purpose the Gold Settlement
Fund in Washington, operated by the Federal Reserve
Board, is used.
The banks of any one Federal Reserve district send checks
directly to their Federal Reserve bank and also to the other
Reserve banks in the case of checks drawn on banks in other
Federal Reserve districts. A bank receives credit at par
for each check it deposits either immediately or after a de1

See also chapter VII, p. 14L

281

282 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

ferred period. The length of the deferred period amounts
to one, two, or more days, according to a graduated time
schedule*2 The time schedule is based upon the time usually
required for the mail to reach the bank upon which the check
is drawn, and for that bank to make payment at its own
Federal Reserve bank. This direct routing of checks together with the settlement of inter-Federal Reserve bank
balances by telegraphic advice through the Gold Settlement Fund have been most beneficial. The new methods
have done away with circuitous routing of checks, saved
much labor and time, and have largely eliminated the float
so troublesome during the national banking system era.
Also, the par collection system has removed a heavy toll
of exchange charges from the commercial and industrial
interests of the country.3
Valuable services in facilitating the local clearing and
collection of bank claims are also rendered by the New York
Reserve Bank. Balances at the New York Clearing House
are settled by book entries at the Federal Reserve Bank,
thus making it unnecessary to transfer large amounts of
money through the streets. The clearing house associations
of several other cities in the district also use the Reserve
Bank to settle the balances arising from their operations.
Settlements are effected by debit and credit entries in the
books of the Federal Reserve Bank of New York upon the
receipt of telegraphic advice from the clearing house associations. In this way the costly and risky movement of cash
through city streets is eliminated or, if drafts were used, a
large amount of float and labor is avoided and one or more
days are saved in time required for collection. Furthermore, the new method of settlement has resulted in providing the banks with legal reserve funds instead of a check
drawn on some other commercial bank.
2

Federal Reserve Bank of New York, Time Schedule Circular.
For detailed treatment of clearing and collection under the Federal Reserve system, see: Federal Reserve Bank of Richmond, Letters, Nos. 4, 5, 6, 7,
and 8, March-October, 1922; W. E. Spahr, The Clearing and Collection of
Checks, chapters VI, VII, VIII, and XIII; Willis and Steiner, Federal Reserve
Banking Practice, chapter XX; T. C. Jones, Clearings and Collections—
Foreign and Domestic, chapter V,
3

CENTRAL SERVICE FUNCTIONS

283

The local clearing association has been expanded in the
district to embrace the county. Following the example of
the Northern New Jersey Clearing House Association organized in 1920, a number of county clearing house associations
have been established and are in operation.4 The members
of one of these associations send checks drawn on the others
direct to them, simultaneously advising the Reserve Bank
by telegraph of the amounts. The Bank then clears the
aggregate of the claims by making appropriate entries on
its books. This arrangement has effected the saving of at
least two days in the time required for collecting these items
and avoids the necessity of mailing checks to and from the
Reserve Bank or correspondent bank. All of the above
clearing and collection services are rendered without cost
to member banks.5
In view of the limited dividend on capital stock of the
Reserve Bank and the non-payment of interest on reserve
balances it has been the policy of the Bank to be liberal in
rendering services to member banks. Non-cash items are
also collected for member banks. These consist of notes,
drafts, and maturing bonds and coupons. The collection of
these items is handled for member banks without charge
except such charges as collecting banks may make are
passed on to the banks depositing the claims.
During the war the Bank engaged in a foreign collection
service for American banks.6 At that time insurance rates
were abnormally high on shipments of securities across the
Atlantic. The New York Reserve Bank made special arrangements with the Bank of England and the British
Treasury. Coupons on all British Government securities
payable in London and maturing British Treasury securities
payable in London were accepted and paid by the New York
* See Annual Reports of the Federal Reserve Bank of New York, 1920,
1921, 1922, 1923.
6
During the first few years of its existence, the Bank levied against member
banks what it called a "service charge" of one cent per item on checks deposited with it for collection. The charge was imposed to cover the cost of
collecting checks. (Annual Report of the Federal Reserve Bank of New York,
1915, p. 9.) These service charges were, however, abandoned on June 15,
1918. Annual Report of the Federal Reserve Bank of New York, 1918, p. 7.
6
Federal Reserve Bank of New York, Circulars 107, 135, 298, and 461.

284 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Reserve Bank. This service was announced July 6, 1918,
and continued until June 30, 1922.7
Domestic Exchange
In addition to the domestic transfer of funds through the
collection of checks, the Reserve system has effected a remarkable improvement in furnishing domestic exchange.
The Reserve banks have transferred funds to and from
their member banks by mail or telegraph between any cities
or towns in the country.8 By the use of drafts and telegraph
orders any member bank in the country may obtain through
its Federal Reserve bank an exchange service comparable
to what it would secure if it had an account in each of the
twelve Federal Reserve banks.
The Federal Reserve system has served non-member
clearing banks in the same manner. Funds are transferred
only upon the request of the member or non-member clearing banks. However, other banks which are correspondents
of either member or non-member clearing banks also,
through them, have the privilege of utilizing the facilities
of the Reserve system. But the value of the Reserve system
in supplying domestic exchange is not confined to the banks.
Business organizations as well benefit from the system.
Though the Reserve banks will not deal with business concerns and make transfers to them directly, the latter may
have funds transferred to other business concerns or banks
by getting their banks to do it for them.
7

In discontinuing this service the New York Reserve Bank said:
"As the conditions which led to the adoption of these arrangements no
longer exist, and as adequate facilities for the encashment of coupons from
British Government securities are now available through ordinary channels,
there is no longer any necessity for our continuing this special service. For
your information it may be said that there is a market for the sale of these
coupons for cash in New York, and they may be readily disposed of in that
way, or they may be collected through those banks and bankers which deal
in foreign exchange." Federal Reserve Bank of New York, Circular 461,
May 23, 1922.
8
Federal Reserve Bank of New York, "Transferring Funds under the
Federal Reserve System/' Monthly Review, June 1, 1921; Federal Reserve
Bank of Richmond, "Federal Reserve Exchange," Letter No. 17, September,
1924, and "Telegraphic Transfers," Letter No- 19, July, 1926. Consult also:
Ira B. Cross, Domestic and Foreign Exchange, chapter III; W. E. Spahr, The
Clearing and Collection of Checks, pp. 206-217.

CENTRAL SERVICE FUNCTIONS

285

All drafts sent by mail are payable upon presentation at
par for immediate credit. The total transfers by mail have
been insignificant in amount, most of them having been
made by telegraph. The settlements between Federal Reserve banks are effected by telegraphic advice through the
Gold Settlement Fund operated by the Federal Reserve
Board. For this service the Federal Reserve system leases
a network of private telegraphic wires, under its own control and operated in its own offices, the messages being
usually in code. Any excess reserves of a member at the
New York Reserve Bank may be made immediately available to any other Federal Reserve bank or member bank in
the New York or any other Federal Reserve district. Transfers within New York City take place also by messenger
and through the clearing house.
Telegraphic transfers have brought about the immediate
transfer of funds at par. Moreover, this telegraph service
is rendered free of charge to the banks. Physical shipments
have been practically reduced to the supplying of currency
and coin to member banks for use as till money, and the
return of any excess till money to the Reserve banks. Domestic exchange has thus been made available in every part
of the United States and without the payment of any premium.9 A trying inconvenience and a large financial burden
has been taken from the banks and business of the country.
Currency, Coin, and Gold Bullion
Commercial banks ordinarily keep enough vault money
on hand to take care of only their minimum requirements.
But every day there are some banks requiring additional
cash, or in need of exchanging unclean and mutilated notes
or of securing other kinds or denominations. The Reserve
banks have met these needs of the member banks for currency and coin. When member banks have wanted gold
bullion for export purposes the New York Reserve Bank
9

When the Reserve banks first transferred funds for business concerns they
did it gratis. Later on such transfers became so extensive that the Federal
Reserve leased telegraph lines became over-crowded and the Reserve banks
charged for the telegraph service on behalf of business concerns.

286 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

has supplied it, subject to any restrictions imposed by the
American Government during a period of embargo. The
Bank has supplied demands for currency for the most part
by issuing Federal Reserve notes. But it also furnishes all
the other kinds of money in circulation, paper and metallic.
The member banks have been supplied in good times and
bad and so have been enabled to meet the needs of business.
No bank in the United States has failed because it could
not convert its balances at the Reserve bank into cash, or
indeed its balances in the commercial banks in New York.
The latter have always been able to obtain funds from the
New York Reserve Bank for the purpose of supplying the
needs of their bank clients. Moreover, any bank having
satisfactory paper could always obtain accommodation for
legitimate purposes or get currency to pay depositors who
wanted money, except during the bank holiday. The banks
do not need to borrow in order to obtain circulation from
the Reserve banks as it may be charged against their balances in excess of the amount required for the reserve. The
danger of a run on a solvent bank is minimized since, if
there are no excess reserves, the bank may acquire them
by borrowing or selling some of its assets, provided, of course,
that what it has to offer is acceptable.
A service for the conversion of Canadian paper money
into United States currency was begun in April, 1930.10
Formerly, the discount in the United States on Canadian
currency brought in by travelers frequently ranged as high
as 10 per cent and sometimes 20 per cent at places remote
from the border. This situation gave rise to some feeling
in Canada, especially since United States currency was
generally accepted at par in Canada. Such high discounts
were regarded as excessive by the Federal Reserve Board
and arrangements were made to lower them to the banks
so that they could lower them to merchants receiving Canadian currency. Member banks may include Canadian currency, properly segregated, with their shipments of United
States currency to the Reserve bank. Upon receipt the
Reserve bank converts it into United States funds and
10

Federal Reserve Bank of New York, Circular No. 973.

CENTRAL SERVICE FUNCTIONS

287

credits the proceeds to the member bank's reserve account.11
The Federal Reserve banks absorb the cost of shipping the
Canadian currency from the member banks to their respective Federal Reserve banks. But they deduct an allowance
to cover the actual exchange charges, and insurance and
shipping charges, if any, from the Federal Reserve banks
to the points of conversion into United States currency.
For three years the average cost of converting Canadian
currency into United States funds, including both exchange
and shipping charges, averaged less than 1 per cent.
Bank Runs and Suspensions
Although the Federal Reserve system has minimized the
danger of bank runs there have been occasions when bank
runs or suspensions have threatened and the Reserve banks
have been of service. One such occasion was in a foreign
country but the Reserve system was involved because of
the interests of member banks there. Confidence in the
banks in Cuba, in 1926, was seriously impaired and widespread runs had started in various parts of the island. The
New York Reserve Bank figured in this, being of much
service not only to New York City member banks but to
another part of the United States and a foreign country as
well.
Member banks in New York City had a number of
branches in Cuba and wished to send currency to them.
The currency, amounting to some $27,000,000, was sent
to those branches through the New York Reserve Bank.12
The Bank transferred the funds to the Federal Reserve
Bank at Atlanta by telegraph. The Atlanta Bank shipped
the actual cash, Federal Reserve notes, by a special train
and boat to Cuba. As a result the bank depositors in Cuba
were paid, the alarm subsided and the runs stopped. The
arrangements and arrival of the currency in Cuba were all
effected between the time of closing the banks on Saturday
and their opening Monday morning. The transaction re11

In April, 1930, such conversion was effected by sale in New York at the
current market rate. Federal Reserve Bank of New York, Circular No. 973.
12
Stabilization Hearings on H. R. 7895, 1926, pp. 477-478.

288 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

suited in a depletion of the New York member banks' reserve accounts of $33,000,000,13 which they made up by
borrowing from their Reserve Bank. The New York Reserve
Bank again enters the picture. The shipment of $27,000,000
of Federal Reserve notes so reduced the cash resources of
the Atlanta Reserve Bank that it had to replenish them.
The New York Reserve Bank supplied the funds by buying
$14,000,000 worth of securities from the Atlanta Reserve
Bank, payment and receipt being effected by debit and
credit entries on the books of the Gold Settlement Fund.14
So far as its out-of-town member banks are concerned,
the New York Reserve Bank has been of service in a wide
variety of troubles. Information regarding the financial
condition of the banks comes to the notice of the Bank in
various ways: through the official bank examinations, bank*
ing operations with them, visitations of the Bank's officers
and members of the staff of the Member Bank Relations
Department, and particular reports concerning some unfavorable development or unfortunate occurrence. There
have been many cases of banks being weakened by heavy
withdrawals where the Reserve Bank has rendered immediate service which had an undoubted effect in restoring
confidence and ending the withdrawals.15 This was accomplished by the advice and cooperation of the Reserve Bank's
officers and the bank examiners, the extending of credit and
the sending of an ample supply of currency. When the
New York Bank has received word of a run on a member
bank it has sent a man with currency by the first train.16
In some other Federal Reserve districts, the central banks
have used airplanes and motor cars to speed money to distressed banks.17 During an influenza epidemic all the officers
of one bank and nearly all its clerks and directors were
stricken with influenza. The Reserve Bank sent a force of
13

Tliis was the amount the New York Reserve Bank telegraphed to the
Atlanta Reserve Bank for the account of the banks that ordered the currency
shipped to Cuba. Ibid., p. 478*
14
Idem.
15
Annual Report of the Federal Reserve Bank of New York, 1920, p. 45.
16
Stabilization Hearings on H. R. 7895, 1926, p. 480.
"Idem.

CENTRAL SERVICE FUNCTIONS

289

men to run that bank until its staff recovered. Bank buildings have burned down and bank vaults would not open.
In such cases the Reserve Bank rushed money to them to
keep them going.18
Acceptances and Government Securities
Other central service functions rendered by the Reserve
banks involve acceptances and government securities. The
New York Reserve Bank offers a special acceptance service
to its member banks. When a member bank's reserve balance is above the legal requirement the Reserve Bank will
buy interest-bearing acceptances. It has purchased for the
banks acceptances on their order either for particular bills
or for an approximate amount of bills of certain maturities.
In the latter case the acceptances have been such as the
Bank has purchased for its own account, three-name paper
bearing a bank endorsement other than that of the acceptor.
The acceptances have been held in the custody of the Bank,
sold when desired, collections made on them at maturity or
disposed of in other ways as directed. These services are
rendered without charge. The Bank has thus made it easy
for members to keep their funds profitably employed at
all times in acceptances.
Government obligations are also bought and sold pursuant to definite instructions from member banks. Bonds
and certificates of one issue are converted into those of another. The Bank supplies all banks in the Federal Reserve
district with descriptions of new issues and receives subscriptions for the same. It will transfer certain types of
United States Government securities for and to a member
bank by means of the wire transfer system—no physical
shipment of them being necessary. For this purpose, the
Reserve Bank has had on hand a supply of unissued government securities. If a certificate of indebtedness is sold in
San Francisco for delivery to a party in New York it may
be turned in at the Federal Reserve Bank of San Francisco
and canceled there. Upon receipt of a code telegram the
18

Ibid., p. 547.

290 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

New York Reserve Bank will deliver a new one in New York
and thus save the risk and expense of shipment across the
country.19 This process is accomplished with the aid of the
Commissioner of Public Debt at Washington, D. C. During
the war and post-war years the Bank collected coupons on
British Government securities and matured British Treasury
bills and war expenditures certificates.20
Another service is that of safekeeping of securities. This
is limited to securities owned by member banks. The country banks particularly find the custody service convenient
and economical because (1) the securities are already at
the Bank in case they wish to use them as collateral for borrowing and, (2) sales may be made to the Reserve Bank or
others and funds received more quickly. Commencing in
July, 1929, the Bank's security service was perfected as a
result of becoming a clearing non-member of the Stock
Clearing Corporation of the New York Stock Exchange.21
The Bank furnishes quotations and it will give advice upon
request. While most of the securities involved are government, the security service has not been confined exclusively
to treasury issues.
The Reserve Bank now effects receipts and deliveries of
stocks for the account of member banks through this corporation at the Stock Exchange. The system involves principles and methods similar to those utilized in the clearing
of checks. The corporation conducts a central delivery department and the clearing institutions make settlement by
paying or receiving the net balance due to or from the Stock
Clearing Corporation. As a result of a careful study of the
matter by the Reserve Bank it was determined that this
system provided substantial improvement in service to
member banks from the standpoint of both safety and convenience.22 The delivery and settlement of non-clearing
stocks, bonds, curb and over-the-counter stock are not.
included in this new system.
19

Ibid., pp. 540, 896-897.
See above, p. 283.
21
Federal Reserve Bank of New York, Circular No. 922.
22
Idem.

CENTRAL SERVICE FUNCTIONS

291

Miscellaneous

When the Federal Reserve collection system was being
introduced many member banks in the district did not join
it because they were reluctant to give up exchange charges
from which they had customarily derived a substantial
income. In order to secure their cooperation and assist
them in making a rational decision, the New York Reserve
Bank experts made studies of the income, expenses, and
methods of a number of typical member banks in the district for the purpose of seeing what economies might be
effected or additional sources of income developed and by
what methods.23 As a result of the analyses, the expense of
which was borne by the Bank, it developed a method for
analyzing depositors' accounts adapted to the average
bank's business, by the use of which the net profit or loss
arising from each account could be determined.24
The Reserve Bank recommended and urged upon member
banks methods of offsetting any losses arising through the
use of the Federal Reserve collection system. It advised
that each depositor's account be put on a paying basis by
(a) maintaining a compensating balance, (b) paying a regular monthly charge for the bank's service, or (c) paying a
definite amount for each check used.25 It also pointed out
the possibility of increasing earnings by withdrawing and
loaning at home funds they had formerly kept with collecting banks.26 Furthermore, the Bank sent to a number of
country banks a junior officer who explained methods of
analyzing deposit accounts and generally discussed with
the bankers the changes recommended.27
The Bank has encouraged the practice of requiring financial statements in order to establish higher standards of
banking. In order to assist member banks to assemble and
maintain credit information relating to borrowers it distributed four types of forms to member banks, one for each
23
Federal Reserve Bank of N e w York, letter t o member banks, April 20,
1915.
24
Federal Reserve Bank of New York, Analysis of Depositors' Accounts.
25
Federal Reserve Bank of New York, Circular No. 46*
26
Annual Report of the Federal Reserve Bank of New York, 1916, p. 22.
27
Idem.

292 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

of the following classes of borrowers: corporations, firms,
farmers or live-stock dealers, and merchants, manufacturers,
or other individuals.28
The Bank makes for its member national banks all deposits required of them on account of the 5 per cent redemption fund held by the Treasurer of the United States for
redeeming national bank notes. The deposits are finally
effected by the Treasury department in Washington by
making transfers from the gold redemption fund of the Bank
against Federal Reserve notes, the Treasury having custody
of both redemption funds.29
Member banks were supplied with a method for analyzing
their reserve accounts by the use of which the required
reserve and the available reserve balance for each day could
be determined.30 Information concerning principles and
methods of exercising new functions which the Federal
Reserve Act conferred upon the Reserve Bank and commercial banks has been freely given, such, for example, as
the trust and acceptance functions. Beginning with October 28, 1914, the Bank has issued over one thousand
circulars to its members and sometimes all banks in its
district, pertaining to matters of common interest and concern. Circular No. 2, October 31, 1914, said:
This circular is sent to member banks in accordance with the
desire of the directors of the Federal Reserve Bank of New York
that they should be kept fully informed from time to time of the
steps which have been taken in its organization and of all matters
of general interest to them in connection with its operation and
policies.
Now and then, also, pamphlets of an informative or scientific character have been distributed gratis to its member
banks. 31 One pamphlet, "Better Banking/' which was
28

Federal Reserve Bank of New York, Circular No. 29.
Annual Report of the Federal Reserve Board, 1922, p. 28.
30
Federal Reserve Bank of New York, Circular No. 207.
31
Examples of such have been: Current Operations of the Federal Reserve
Bank of New York as Fiscal Agent of the United States; Organization Manual
of the Federal Reserve Bank of New York; The Ratio of Bank Capital to
Deposits; Recommendations of the Bureau of Standards of the United States
Department of Commerce as to the Standardization of the Size and Arrangement of Bank Checks and Other Forms; Laws Affecting the Federal Reserve
29

CENTRAL SERVICE FUNCTIONS

293

descriptive of banking operations under the Federal Reserve
system, was offered to member banks at one cent a copy to
cover the cost of publication. The banks distributed it to
their customers, usually with the name of the member bank
printed on the cover.32 The Bank has published a monthly
bulletin of information and statistics called "Monthly
Review of Credit and Business Conditions/' which is distributed to member banks and others interested. It was
first issued in September, 1919, but prior to tHis a bulletin
called " General Business Conditions," was issued from
January 2, 1918 to August 15, 1919. The latter bulletin
was the outgrowth of a monthly report which the Federal
Reserve agent sent to the Federal Reserve Board, commencing in 1915. The current bulletin has contained a monthly
summary of monetary, banking, and business developments
based upon statistical analysis and personal inquiry. The
New York Reserve Bank's monthly review is received not
only by its member banks but by banks and other interested
parties all over the United States and the world.33
On the tenth floor of its building in the financial district,
at Liberty and Nassau Streets, special rooms are provided
for the use of member bankers. These rooms have been the
scene not only of "routine" and informal meetings of
bankers but of "star-chamber" sessions lasting most of the
night when financial problems of extraordinary consequence
were argued. Occasionally special series of formal conferences have been held at the invitation of the Bank for
the purpose of realizing greater cooperation in the policies
and operations of the Federal Reserve system.34
Officers of the Bank have, throughout its history, customarily attended bankers' conventions and group meetings
not only in the New York district but in other districts and
have commonly addressed such gatherings.
and Regulations of the Federal Reserve Board; Report of the Committee on
Bank Reserves of the Federal Reserve System.
32
Up to the end of 1922, the number of copies purchased from the New York
Reserve Bank was 667,000. Annual Report of the Federal Reserve Bank of
New York, 1922, p. 32.
33
The monthly circulation of the bulletin has been as high as 42,000.
34
Annual Reports of the Federal Reserve Bank of New York, 1919, p. 28;
1921, p. 30; 1925, p. 18.

294 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Member Bank Relations Department

When the pressure of operations involved in financing the
war subsided a concentrated effort was made by the officers
of the New York Bank to establish personal relations with
officers of member banks* When the functional organization was effected in 1919, a new department was installed,
the Member Bank Relations Department,35 devoted distinctly to this service. Early in 1919 a special representative of the Bank was delegated to visit member banks,
make personal contacts with their officers, explain the services of the Reserve Bank and the rules and regulations of
the Federal Reserve Board, discuss their problems and
point out how the Reserve Bank could help in solving them.
This service proved to be so beneficial that when the Member Bank Relations Department was organized, several
men were assigned to it for such work. Ever since then this
department has had a number of traveling representatives
who have spent practically their entire time going about
over the Second Federal Reserve District, calling upon the
officers of banks, instructing them and advising with them.
It has been the policy to visit every member bank in the
district at least once a year. A record has been kept on each
bank of all matters qoming up between it and the Reserve
Bank during the year. When the call on the bank was made
these have been discussed.36 While most of this work has
been with member banks many non-member banks have
been visited and a similar service has been rendered them
so far as their status permitted.37 Altogether, thousands of
visits have been made. The work of this department has
aided the banks materially in utilizing to a fuller extent the
opportunities offered by the Federal Reserve system.
The Buffalo Branch
The member banks in New York City have advantages
which the country banks in the district are not in a position
35
Annual
36

Report of the Federal Reserve Bank of New York, 1919, p. 28.
Stabilization Hearings on H. R. 7895, 1926, p. 560.
For example, in the month of April, 1930, representatives of the Reserve
Bank made 379 visits to banks, 259 to member banks and 120 to non-member
banks.
37

CENTRAL SERVICE FUNCTIONS

295

to enjoy. Their checks and other claims can be cleared and
collected more quickly, thus making Reserve bank credit
available to them for use sooner. They can secure currency
more quickly. Hence they can have more funds drawing
interest because they do not have to have as much vault
cash with which to conduct their daily business. They also
have greater protection against runs and therefore a feeling
of greater safety, and more peace of mind, in the knowledge
that the Federal Reserve Bank is "right across the street."
Furthermore, the officers of the New York City member
banks are in a position to maintain close personal contact
with the Federal Reserve Bank officials. They, therefore,
may effect a greater coordination of their policies and receive
such benefits of information and counsel as may be secured
in conversation with them, all of which should be conducive
to a more enlightened conduct of their affairs.
It was to make available to all member banks in a district more complete and satisfactory service, comparable
to that enjoyed by the banks in Federal Reserve bank cities,
that the Federal Reserve Act provided for the establishment of branches of Federal Reserve banks.38 In the New
York Federal Reserve district the matter of opening a
branch to serve the western counties of New York* State
proceeded in an unhurried manner. It was not until May,
1919, that a branch of the Federal Reserve Bank of New
York was opened for business in the city of Buffalo.39 The
ten western counties of the State were assigned to the Buffalo Branch.40
There are, in a general way, two types of Federal Reserve
branches. There are those which act more or less independently under the direction of their boards of directors, and
carry on nearly all the functions exercised by the Federal
Reserve banks. The others are quite confined in their operations, and either do not carry on some of the more important Reserve bank functions or exercise them only on specific authority from, or for the account of their Reserve
88
Federal
39
Annual
40

Reserve Act, section 3.
Report of the Federal Reserve Bank of New York, 1919, p. 39.
See chapter III, p. 60.

296 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

bank.41 The Buffalo Branch is in the former group. It carries
the reserve accounts of the member banks located in its territory and the clearing accounts of non-member banks. Eligible paper presented by member banks is discounted by and
carried on the books of the Branch, subject to review, however, by the Reserve Bank. The Branch clears and collects
checks, drafts, and other cash items collectible at par through
a Federal Reserve bank, and receives for collection and
credit, on its own books or on the books of the Reserve
Bank, maturing bills, notes, coupons, acceptances, and bill
of lading drafts.
The Branch also makes telegraphic transfers of funds for
the account of member and clearing non-member banks and
participates directly in the daily clearing through the Gold
Settlement Fund. It maintains custody services as (1) collateral pledged as security for rediscounts and member
banks' collateral notes, (2) collateral pledged by member
banks as security for government deposits, (3) securities
held for the account of the fiscal agency department, United
States Treasury, and (4) securities held in safekeeping for
member banks. A supply of currency and coin is kept to
meet the requirements of banks in its territory. As far as its
relations with the Treasury are concerned, government deposits are received and transmitted to the New York Bank,
government checks and coupons are paid, government obligations are exchanged and those matured are redeemed, and
subscriptions are received for certificates of indebtedness and
Treasury notes. In the matter of open market operations
the Branch is restricted. Acceptances and United States
Government securities are not purchased in the open market
except upon specific instructions from New York and when
so purchased are carried on the books of the New York Bank.
The Federal Reserve Board has pointed out the impracticability of establishing branches in relatively large cities
merely to gratify civic pride.42 It has also been reluctant to
increase the number of branches for the reason that "they
41
There are now 25 branches and 2 agencies of Federal Reserve banks in
operation. Most of them are of the first type mentioned.
42
Annual Report of the Federal Reserve Board, 1919, p. 39.

CENTRAL SERVICE FUNCTIONS

297

add materially to operating costs." 43 On this question the
Board commented thus:
Most of the branches now in operation were established during or immediately following the war period when there seemed
to be very good reasons for going to the expense of maintaining
branches in the cities in which they were established. There is
some doubt now, however, as to whether or not the greater promptness with which member banks in certain Federal Reserve branch
cities may now avail themselves of the services of the Federal Reserve bank is of sufficient importance to warrant the additional cost
to the Federal Reserve bank of maintaining the local branch. It
may be necessary, therefore, at some time in the future to give serious consideration to the advisability of 44discontinuing certain of
the existing Federal Reserve branch banks.

While there has been no effort to discontinue the Buffalo
Branch, there is reason to believe that as long as the territory of the Second Federal Reserve District remains substantially as at present, the New York Reserve Bank will
not have more than the one branch. Early in its history
the Federal Reserve Board adopted the policy of having
the Federal Reserve banks pay all costs involved in shipping
money to and from the member banks, thus bringing about
much greater equalization of Federal Reserve advantages
as between banks. Since the establishment of the Buffalo
Branch, any bank in the district may be reached from its
respective central service point, New York City or Buffalo,
over night. The increasing costs of maintaining on a business basis any additional branches in the district tend to
prevent their establishment.
So far as inequalities due to differences in location are
concerned, the work of the Buffalo Branch has been of considerable service in bringing about a greater equalization of
benefits among all banks in the district. The extent of the
advantages enjoyed by member banks in New York City
over out-of-town banks, referred to above, would be much
greater were it not for the branch in western New York. It
has been the policy of the Federal Reserve Board to consider the Federal Reserve districts as units and to hold the
43

Annual Report of the Federal Reserve Board, 1922, p. 26.
«Idem.

298 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Reserve banks to full responsibility for all operations in
their respective districts.45
Examination
The original Federal Reserve Act required at least two
examinations each calendar year of every member bank,
state as well as national, to be made under the direction of
the Comptroller of the Currency, and the submission of
reports of condition and of the payment of dividends to
that officer.46 It also provided, however, that the Federal
Reserve Board might authorize an examination of state
member banks by state authorities accepted as satisfying
the requirements. Furthermore, the member banks were
subject to such additional special examinations as the Federal Reserve Bank or Federal Reserve Board saw fit to make.
The state institutions did not like the idea of being under
the jurisdiction of the Comptroller of the Currency or the
Federal Reserve Board in such matters and this was one of
the factors which made them reluctant to join the Federal
Reserve system. Hence in the Act of June 21, 1917, was
included an amendment providing that while the examinations are subject to the direction and approval of the Federal Reserve Board, "whenever the directors of the Federal
Reserve Bank shall approve the examinations made by the
state authorities, such examinations and the reports thereof
may be accepted in lieu of examinations made by examiners
selected or approved by the Federal Reserve Board/7 This
Act also provided that reports of condition and the payment of dividends be made to the Federal Reserve Bank.
These are the legal requirements in effect at the present
time.
As far as national banks are concerned close cooperation
has been maintained between the Reserve Bank examiners
and the national bank examiners for the New York Federal
Reserve district,47 who, in fact, have their offices in the
building of the Federal Reserve Bank of New York. The
45

Annual Report of the Federal Reserve Board, 1917, p. 25.
Federal Reserve Act, 1913, sections 9 and 21.
43
Annual Reports of the Federal Reserve Bank of New York.
46

CENTRAL SERVICE FUNCTIONS

299

Reserve Bank examiners have examined some national
banks independently and have participated in examinations
jointly conducted with representatives of the office of the
Comptroller of the Currency. Copies of the reports of examinations by national bank examiners have been furnished
the Bank.
The Reserve Bank examination department has worked
in close cooperation with the state banking commissioners.
The Bank has generally accepted an examination report of
a state institution made by the respective banking department of the states of New York, New Jersey, or Connecticut. The reports have usually been approved without
supplementing them with an independent investigation of
its own. In some cases, however, the reports have been
supplemented by the work of the Reserve Bank's own examiners. Special examinations have been made by the Bank
of state institutions applying for membership. In the case
of the regular periodical examinations, the Reserve Bank
may conduct and often has conducted joint examinations
with the state bank examiners.
The conflicting examination authorities of the state banking departments on the one hand and the national bank
examiner's office on the other have been a disturbing factor
in the successful development of the Federal Reserve Bank's
examination function. Some progress has probably been
made by the Reserve Bank in bringing about standards more
uniform as between the state and national authorities so far
as the technical examination is concerned. But this is of
secondary importance since the state and national laws
upon which the respective examinations are based are different and therefore result in competition between state
and national banking interests for a lowering of banking
standards.
As was pointed out in a previous chapter 48 the Federal
Reserve agent has had charge of the Reserve Bank's examination function. He is "on the ground" and it had been
supposed would be in a particularly advantageous position
to look out for the interests of depositors in member banks.
48

See chapter V.

300 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The agent has had authority to make credit investigations
and special examinations. Although he has subjected some
member state banks to this authority, the conditions surrounding one of the largest American bank failures 49 in
history in New York City indicate that there was much
to be desired in protecting depositors through the examination function.
49

See chapter V, pp. 101-102.

CHAPTER XV
CENTRALIZATION OF FOREIGN POLICY
OF THE RESERVE SYSTEM
Scope of Foreign Relations under the Federal Reserve Act
Authority for American contact with foreign financial
institutions was prescribed in the Federal Reserve Act. The
original Act empowered every Federal Reserve bank to
carry on certain transactions with banks in foreign countries or to engage in business itself abroad by means of its
own agencies or branches.1 The Act is specific as to what
kind of business the Reserve banks may do and authorizes
three modes of carrying on such business. They are:
1. Maintain banking accounts in foreign countries.
2* Appoint correspondents in foreign countries.
3. Establish agencies 2 in foreign countries.
The Act also states that such foreign relationships may
be undertaken only "with the consent of the Federal Reserve Board/' Early in the history of the Federal Reserve
system the question of establishing branches of the Reserve
banks abroad was discussed. The Board decided, in 1916,
not to establish any such branches for several reasons,
largely involving the opposition of the larger banks doing a
foreign trade financing business.3 No such agencies have
been established other than a minor one of quite limited
scope operated jointly by the Federal Reserve Banks of
Boston and Atlanta in Havana, Cuba, opened in 1923.4
The policy of the Federal Reserve has been distinctly ad1
2

Section 14.
The term "agency" means an office of a Reserve bank or banks. It may
be thought of ordinarily as a branch. But in section 14 it is technically differentiated from the term "branch" as used in section 25 of the Federal Reserve Act in reference to branches of national banks. Willis, The Federal
Reserve System, p. 1234.
s
See Willis, op. cit., chapter LIV.
4
See Annual Report of the Federal Reserve Board, 1923, p. 45.
301

302 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

verse to extending its operations by opening branch agencies
in the foreign field. This has left foreign contacts to be made
in the other two ways, opening accounts and appointing
correspondents. By an amendment approved September 7,
1916, authority was given for a Federal Reserve bank, with
the consent of the Federal Reserve Board, to open and
maintain banking accounts for foreign correspondents or
agencies.
Centralization of Foreign Relations in the New York Reserve
Bank
During the latter part of 1916 the relations of the United
States Government with European governments became
quite delicate. It was considered desirable in government
circles in view of the war and the probability of our own
participation in it to be prepared for eventualities. Accordingly the Federal Reserve Board was solicitous about the
inauguration of correspondent relations between the Reserve
system and the Bank of England. For reasons which have
never been made public, the Federal Reserve Board chose
not to carry on the correspondence relative to this central
banking relationship but directed the New York Reserve
Bank to conduct the negotiations with the Bank of England.5
Following an announcement that a large issue of British
Treasury bills was about to be offered in this country, the
Federal Reserve Board made a lengthy pronouncement
warning American banks against becoming non-liquid by
buying foreign war securities.6 This was taken in some quarters to mean that Washington had "broken" with Britain.
President Wilson was desirous of maintaining a neutral
position and an announcement of the new agency relationship with the Bank of England was therefore quickly made
by the chairman of the Federal Reserve Board, Secretary
McAdoo, with a view, for one thing, of offsetting any unwarranted effects of the British Treasury bill episode.7 In its
6
Willis, The Federal Reserve System, p. 1100.
• Federal Reserve Bulletin, Bee. 1, 1916, p. 661.
7
Willis, op. tit, p. 1101.

CENTRALIZATION OF FOREIGN POLICY

303

Federal Reserve Bulletin
for January 1, 1917, the Federal
Reserve Board stated:8
The Board has had under consideration for some time the advisability of authorizing the Federal Reserve banks to establish
one or more correspondents or agencies in Europe and under date
of December 20, 1916, passed a resolution approving the application of the Federal Reserve Bank of New York for authority to
establish an agency with the Bank of England.
m.

The United States, having declared war on the central
powers on April 6, 1917, our central banking system found
itself in a position to quickly bring to a head the international banking relationships. The first such relationship
was concluded May 3, 1917 between the Federal Reserve
Bank of New York and the Bank of England. It was formal
in character and was reduced to a written agreement, ratified by the directors of the two banks, which covered in
detail the nature of their operations and made "a close,
effective and complete agency." The written agreement
provided that the Bank of England would act as correspondent and agent in England of the Federal Reserve Bank
of New York and the Reserve Bank of New York would
act as correspondent and agent in America of the Bank of
England.9
The understanding at the time was that the New York
Reserve Bank would act on behalf of the other Reserve
banks and that whatever services were needed by them
would be handled by and through the Federal Reserve Bank
of New York. The Federal Reserve Board had announced
that other Reserve banks might participate in the agency
relationship that would govern the New York Reserve
Bank.10 Unequivocal authority for such relationship was
later contained in the so-called war amendments to the
Federal Reserve Act of June 21, 1917.u Pursuant to the
reciprocal arrangements entered into with the Bank of
England, the New York Reserve Bank, in June, 1917, paid
for the account of some English banks a loan of $52,500,000
8

Federal Reserve Bulletin, Jan. 1, 1917, p. 4.
Annual Report of the Federal Reserve Bank of New York, 1917, p. 29.
10
Federal Reserve Bulletin, Jan. 1, 1917, p. 5.
11
Public Act, No. 25, 65th Congress, section 6.
9

304 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

with interest, maturing in New York; and received in return
gold sovereigns of equivalent value from the Bank of England and held in the Bank of England earmarked for the
account of the Federal Reserve Bank of New York. This
transaction marked the beginning of the relationships of
the Federal Reserve system with central banks abroad.
The other Federal Reserve banks were allotted "shares"
in the transaction to the amount of about $34,000,000,12
but they held no gold in London. The Bank of England
held the gold to the credit of the New York Reserve Bank
and the latter held balances to the credit of the other Federal Reserve banks. Various types of transactions between
the New York Reserve Bank and central banks, throughout
the history of the Federal Reserve system, have given rise
to central bank balances where the New York Reserve
Bank has acted as the agent of the other Federal Reserve
banks. But the principle of the New York Bank's acting as
the agent for all Reserve banks and allotting them participation in its foreign business finds its first application in
this war-time transaction with the Bank of England.
In this case it will be noted that the Federal Reserve
Board authorized the relationship in advance, while the
negotiations were carried on by the governor of the New
York Reserve Bank and the details of the written agreement
were ratified by the boards of directors of the two banks
concerned.13 Following this transaction most of the foreign
loans of the Federal Reserve system have been arranged
by the New York Reserve Bank and then subsequently
were made known to the Federal Reserve Board,14 while
so far as the other Reserve banks are concerned they "were
informed that they would be expected to contribute in proportion to their assets." 15
Banker for the Government in Foreign Transactions
The early foreign relations of the Federal Reserve Bank
of New York involved transactions growing out of the war
"Annual Report of the Federal Reserve Bank of New York, 1917, p. 29.
13
Annual Report of the Federal Reserve Bank of New York, 1918, p. 29J
14
Congressional Record (unbound edition), Feb. 10, 1930, p. 3.
15
Idem.

CENTRALIZATION OF FOREIGN POLICY

305

and some of these were closely linked with the United States
Government for which that Bank served as banker. The
Bank accepted in return for its payment of a loan maturing
in New York, in June, 1917, sovereigns of equivalent value
earmarked in the Bank of England. Part of this gold was
turned over to the Treasury department for the use of the
United States Government or its allies in Europe.16 To
secure payment for wheat and other commodities sold to
Europe in 1918, the Treasury department requested the
Bank to open an account with the Netherlands Bank. Payment for these exports was effected by crediting the account
of the New York Reserve Bank in guilders 17 and the proceeds were used to effect disbursements for the War department. The Sveriges Eiksbank of Stockholm and the Norges
Bank of Christiania also opened accounts in favor of the
New York Reserve Bank in 1918 for similar purposes.18
During the war the foreign exchanges between the United
States and South American countries were demoralized.
Pursuant to an arrangement between the United States and
Argentine governments, the Federal Reserve Bank of New
York and the Banco de la Nacion appointed each other
correspondents. The New York Bank " undertook to receive
deposits not exceeding $100,000,000 exportable in gold coin
after the proclamation of peace and the deposit of over
$16,000,000 of gold coin" earmarked in New York.19 The
purpose of the arrangement, the stabilization of exchange
between the countries involved, was fulfilled. The United
States made analogous agreements with the governments
of Bolivia and Peru as a result of which the New York
Reserve Bank served as banker to the Government in ways
similar to that in which it served with Argentina.20
The foreign exchange relations between the United States
and India were also demoralized. A comprehensive arrangement was made between the United States and the British
Government whereby the latter supplied the New York
Reserve Bank with sufficient rupee exchange each month
16
Annual
17
18

Report of the Federal Reserve Bank of New York, 1918, p. 29.
19
Idem.
Idem.
M
Ibid., p. 30.
Idem; 1919, p. 32.

306 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to enable importers in America to pay for goods from India.21
Operations under the arrangement were from November,
1917 to May, 1919. In this period the New York Bank
received a total credit of over 200 million rupees and sold
all of it to our importers, resulting in a satisfactory stabilization of exchange rates on India.22
Another service rendered the Government by the New
York Reserve Bank involved several central banking features—acquiring gold abroad, earmarking and increasing
our gold reserves, and acting as agent for the other Reserve
banks. The German Government in 1919 purchased foodstuffs in the United States from the United States Grain
Corporation and paid for them in gold amounting approximately to 730,000,000 marks. The marks were deposited
in the National Bank of Belgium, Brussels, and the Netherlands Bank, Amsterdam. The United States Grain Corporation secured payment for the sales at the bullion value
of the marks from the New York Reserve Bank and the
latter took claim to the gold marks. At the request of the
New York Reserve Bank, the Bank of England transferred
the gold marks from the continent to London where they
were assayed and converted into bars. The gold was earmarked by the English bank for the account of the Federal
Reserve Bank of New York which added it to its gold reserves. The New York Bank acted as agent of the other
Reserve banks and prorated the gold among them, thus
increasing the reserves of all the regional banks.23
Still another type of foreign transaction for the Government was with the Bank of Spain. The Treasury department had issued certificates of indebtedness in connection
with a large Spanish peseta credit. The New York Reserve
Bank opened an account in 1919 with the Bank of Spain to
receive therein the pesetas which it purchased as fiscal
agent of the United States to retire the peseta certificates
of indebtedness.24
21

Annual Report of the Federal Reserve Bank of New York, 1919, p. 32.
Idem.
Ibid., pp. 33-34; 1920, p. 48.
24
Annual Report of the Federal Reserve Bank of New York, 1919, p. 32.
22

CENTRALIZATION OF FOREIGN POLICY

307

The New York Reserve Bank also facilitated the work of
the Reparation Commission. This work assumed such large
proportions that during 1921 and 1922 the Bank's transactions with the Bank of England, the Bank of France, and
the Bank of Belgium, related principally to reparations payments handled on behalf of the Reparation Commission.25
During the war and early post-war years the transactions
of the Federal Reserve Bank of New York with foreign
central banks were generally such as grew out of the war
conditions. They concerned the stabilization of rates of
exchange, gold transfers, government finance, and reparations. In this period the Bank laid the basis for its worldwide network of foreign banking connections and its position as representative of the Federal Reserve system abroad.
It established banking contacts with the central banks or
banks of issue of fourteen countries 26 and the Government
of the United Kingdom.
International Financial Relations
Prior to the World War the American banking system
had relatively few contacts with foreign banking systems.
Such direct relations as existed were those of a few of the
largest banks which had branches or accounts with correspondents abroad, the function of which was the financing
of foreign trade. Although several of the leading commercial nations had central banks, they dealt very little with
each other, while American banks had practically no relations with them. Nevertheless, the world-wide ramifications of American trade and finance had become quite entangled with those of other nations. In reality, therefore,
the United States had become a member of an economic
organization of nations which carried on international
trade for many years based on the gold standard. This
organization was a partnership of nations and though not
25
Annual Report of the Federal Reserve Bank of New York, 1921, p. 33;
1922, p. 34.
26
They were the banks of: England, Italy, France, Japan, Philippines,
Netherlands, Sweden, Norway, Argentina, Bolivia, Peru, Java, Spain, and
Belgium.

308 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

formally organized as such, still was bound together not
only by an infinite variety of customs and conventions of
long standing, but by a network of legal contracts. It has
indeed been a sort of financial "League of Nations."
The war interrupted normal foreign financial relations
but it did not destroy the operation of the international
network of finance. International financial relationships
increased during and following the war. The monetary and
banking systems of nations were interdependent to a greater
extent than ever before. To the pre-war entanglements had
been added problems of currency inflation, monetary standards, foreign exchange, war claims, internal and external
indebtedness, and heightened tariff barriers. The decade
of the '20s opened with the European countries off the gold
standard. All of these things vitally involved the nations
concerned and particularly their banking systems.
European statesmen devoted their attention to these
problems of reconstruction. In an effort to solve their common problems the European powers held a conference at
Genoa, Italy, in April, 1922.w Particular attention was
given to the problem of achieving stability of their money
and credit systems. The conference resolved that the essential requisite for the economic reconstruction of Europe
was the achievement by each country of stability in the
value of its currency, and advocated the restoration of the
gold standard. Furthermore, it advocated the establishment of a central bank in every country where none existed.
In due course a number were established and the central
banks of the various countries were made the fountain head
of rehabilitation and the means for connecting the money
and credit mechanism of each country with such mechanisms
of the others.
In this financial "League of Nations" one nation cannot
take any major action concerning its standard of value,
prices, credit policy, or trade, without affecting the others
in the " league." The problem of money, or the regulation
of its value, transcends the boundaries of national sov27
See Report of the Genoa Financial Commission, Federal Reserve Bulletin,
June, 1922, p. 67.

CENTRALIZATION OF FOREIGN POLICY

309

ereignty. The control of credit within any one country is
an international problem. That money markets in the
leading commercial countries have been closely connected
with each other is evidenced by the movement of interest
rates in these markets. As C. H. Kisch has pointed out,
the rates in leading money markets have, especially since
the World War, tended to move together.28 Each nation
has, therefore, an interest in what the others do in these
lines. However, in this country before the war, there was no
bank or institution which could present a unified financial
policy in international affairs representative of the entire nation. Fortunately, the passage of the Federal Reserve Act
provided for a central banking organization in time to render
service during the critical war period and laid the basis for
presenting a national front abroad. This service, as we have
seen, was rendered by the New York Reserve Bank.
International Conferences of Central Bank Officials
An outstanding development in international relations in
the '20s was the conferences of officials of central banks.
The American {<representative" in these conferences, unauthorized by the Federal Reserve Board, was the governor
of the Federal Reserve Bank of New York. The governors
of the New York Bank and the Bank of England got together
first. Beginning in 1920, Montagu Norman, governor of
the Bank of England, made annual trips to America to
confer with the governor of the New York Reserve Bank.
Likewise that Reserve Bank official has made periodical
trips abroad for such conferences, sometimes twice a year.
There was made available to him a desk and a private secretary in the Bank of England.29 Gradually as the scope of
28
C. H. Kisch, "The Part Played by Central Banks in International Affairs/'
The Royal Institute of International Affairs Journal, May, 1930, p. 368.
Mr. Kisch cited for example, changes in the rates of different central banks
in 1929. Tracing them, he found that between January 1, 1929, and October
31,1929, there were 21 changes upward against 2 reductions. Between November 2, 1929, and December 31, 1929, there were 17 changes, all of which were
downward. Says Mr. Kisch: "The succession of a period of an upward drive
by a period of general descent exemplifies the international link of which I
have been speaking."
29
Congressional Record (unbound edition), Feb. 10, 1930, p. 3526.

310 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

their conferences widened they commonly included the
heads of the Bank of France and the Reichsbank.
Notwithstanding that these conferences assumed great
significance in the eyes of the financial community, they
were shrouded in secrecy. It might have been presumed,
under the existing conditions, that the central bank heads
would discuss such fundamental issues as gold reserves and
the restoration of monetary standards. However, they
characteristically remained silent as to the real purpose of
their meetings. Not only was the public not informed as
to the nature of the conferences, but their proceedings were
not even reported to the Federal Reserve Board.
The central bank heads stoutly maintained that in these
conferences they were concerned with no topics of importance or of general interest. Their foreign trips were
described as being for the purpose of " taking a vacation/7
"visiting with friends/' and to "see my pals." "Courtesy
visits/' "courtesy greetings/' "visits with old friends" were
other phrases they employed to describe these collaborations abroad. In 1926, Governor Strong of the New York
Reserve Bank and Governor Norman of the Bank of England were in France and held conferences with Governor
Moreau of the Bank of France. An Associated Press dispatch from Nice, France, stated: "Mr. Strong and Mr. Norman are spending hours daily together, although the American banker asserts they are studying rural life, not
finance." 30
As an example of the way in which the New York
Reserve Bank, rather than the Federal Reserve Board, carried
on foreign negotiations for the Federal Reserve system the
following dispatch from Paris to the New York Times under
date of November 11, 1930, may be cited:
European banking circles are looking forward to the visit of
George L. Harrison, governor of the Federal Reserve Bank of
New York, who reached England tonight aboard the Mauretania,
if for no other reason than for the opportunity it will afford for
obtaining authoritative American opinion regarding the position
30

Journal of Commerce [New York], July 21, 1926.

CENTRALIZATION OF FOREIGN POLICY

311

of Washington in the event that reconsideration of Germany's
war obligations becomes necessary.
Mr. Harrison has come to Europe to confer with heads of the
State Banks of Great Britain, France, and Germany, and in some
well-informed quarters his journey has been associated with new
arrangements for war debts and
reparations as a preliminary to
an international trade revival.31

On the occasion of this trip to Europe, in November,
1930, the governor of the New York Bank reported his
mission as involving only matters of "pure routine" and as
"a regular business trip," giving no indication as to the
subject matter of his conference abroad.32 Foreign officials,
however, were more informative than the Reserve Bank
governor and indicated that the central bank conferences
involved not routine matters but issues of vast importance
to the American people. Their statements purported to
show that the New York Federal Reserve official was discussing with them matters involving the lending of the
resources of the Federal Reserve system abroad and the
sending to Europe of the ultimate gold reserves of the American banking system. Thus said Andr6 Tardieu, Premier
of France, before the American Club in Paris:
Our two countries are in a position to take together the leadership in a great movement for the betterment of world conditions;
for reconstruction and peace. We have that responsibility, being
the world's two biggest gold holders, and we share that duty.
We can do something separately. We can do infinitely more together and in association with others.
Recently I had the pleasure of conferring with George L. Harrison, governor of the Federal Reserve Bank of New York, on means
of action, and in the coming months you who do business here between our two countries and with the rest of the world may see us
working in accord together along what we believe to be the right
road toward a new and better prosperity.33

And a high official of the Bank of France said that as a
result of Governor Harrison's visit, relations between the
Bank of France and the Federal Reserve Bank of New York
had become very close and that the arrangements they had
31
32
83

The New York Times, Nov. 12, 1930.
The New York Times, Nov. 13, 1930; Dec. 3, 1930.
The New York Times, Nov. 28, 1930.

312

CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

consummated concerned the conditions under which loans
would be made and where.34
In the summer of 1931, Governor Norman left England
"quite unexpectedly for Quebec, ostensibly for his health."
While there the governor of the New York Reserve Bank
journeyed to Quebec and conferred with the English banker.
Shortly after Governor Norman's return home, Britain
went off the gold standard.35 Greater secrecy even than
usual surrounded the conference of the governors of the
Bank of England and the Federal Reserve Bank of New
York in August, 1932. On this occasion Governor Norman
landed at Boston. He traveled under the name of " Professor
Clarence Skinner" and the ship's personnel was instructed
not to reveal the banker's identity.36 On his trip to New
York, aside from a visit to Governor Harrison's office in
the New York Reserve Bank, Governor Norman spent
nearly all of his time in the residential apartment of Governor Harrison.37 After returning to London, the general
court of the Bank of England moved a "vote of thanks"
to Governor Norman. At this meeting of the general court
a stockholder of the Bank of England is reported to have
said: "His recent trip to the United States sowed a seed
which, in the future, will bear fruit, not only for Britain,
but also for the rest of the world." 38 And yet on the occasion of this trip he was reported to have come to the United
States only for a "vacation jaunt." It should be noted
also that his only contact with the Federal Reserve system
was with the governor of the New York Reserve Bank and
not the Federal Reserve Board.
The International Conference of 1927
Perhaps the most noteworthy occasion of the extent to
which the foreign relations of the Federal Reserve system
have been in the hands of the New York Reserve Bank and
the secrecy of such operations is furnished by the summer
34

The New York
New York
Idem.
37
The New York
38
The New York
35
The
38

Times, Dec. 3, 1930.
Times, Aug. 21, 1932.
Times, Aug. 30, 1932.
Times, Sept. 24, 1932.

CENTRALIZATION OF FOREIGN POLICY

313

conference of foreign central bank heads with the governor
of the New York Bank in 1927. This conference was composed of representatives of the Bank of England, the Reichsbank, the Bank of France, and the Federal Reserve Bank
of New York. It was the first one at which representatives
of all these central banks were brought together. The members of this conference practically agreed upon a general
reduction in discount rates and that the Federal Reserve
rates were to be lower than those of the foreign central
banks.39
Following the conference this plan was put into effect as
a result of which almost $600,000,000 of gold was exported
by mid-summer of 1928, the largest international gold movement in peace-time history. The purpose of the easy money
policy was to help Europe, especially Great Britain, but
that this way was taken to do it was probably influenced
by the desire of a group who wanted Federal Reserve credit
at low cost which would enable them to make profits in
securities speculation.40 In this international arrangement
involving the Federal Reserve system, the Federal Reserve
Board was not a party.
It was the governor of the New York Reserve Bank who
undertook to confer with the foreign central bank heads,
to speak for the Federal Reserve system, and to commit
the banking resources of America to their service. The
Federal Reserve Board met the foreign central bank officials
only socially and then through the courtesy of the governor
of the New York Bank.41 This meeting was at a luncheon
given by the governor of the Federal Reserve Board and
the question of discount rates was not discussed.42 On the
other hand vital and far-reaching foreign relations of the
Federal Reserve system including relative discount rates
were discussed at the central banking conference, the meet39
Stabilization
40

Hearings on H. R. 11806, 1928, pp. 217, 318.
H. Parker Willis, "The Discount Rate Controversy in the United States,"
The Banker, London, November, 1927, pp. 408-416; H. Parker Willis,
"The Failure of the Federal Reserve," North American Review, May, 1929,
pp. 547-556.
41
Stabilization Hearings on H. R. 11806, 1928, pp. 217, 405.
«Idem.

314 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

ings of which were held at the Federal Reserve Bank of
New York and the Long Island estates of Ogden Mills and
Mrs. Ruth Pratt.43
It was Governor Strong of the New York Bank who issued
a formal statement at the time regarding this international
conference of central bank officials. The scope of the foreign
affairs discussed by them as well as the non-relation of the
Federal Reserve Board thereto may be seen from his statement which, in part, was as follows:
During the past week their time has been devoted mainly to
exchange of views regarding financial and economic matters, the
policies of the banks of issue and like subjects which are of concern to these institutions. These subjects naturally include the
relationship of their respective rates of discount, the question of
the so-called gold exchange standard, which has had so extensive a
development since the war; the expensive shipments of gold,
which necessarily affect the reserves of the banks of issue; the
purchasing power of gold, and various proposals to promote closer
cooperation.
Yesterday was spent in Washington in order to make calls of
courtesy upon members of the Federal Reserve Board and to attend a luncheon given by the Board,
at which the officers of the
Treasury department were present.44
Power of the New York Reserve Bank Abroad: Foreign Recognition

Consequent upon the 1927 international central bankers'
conference and the adoption of the easy money policy on the
part of the New York Bank, a similar policy was initiated at
several other Reserve banks. The Chicago Reserve Bank
was among those Reserve banks which refused. Whereupon,
following pressure from the New York Reserve Bank or its
governor, a low discount rate was forced on the Chicago
Bank by the Federal Reserve Board. As a consequence
there was considerable controversy throughout the country
about the management of the rate policy. Chicago bankers
frequently voiced their convictions to the effect that the
Federal Reserve discount rates were being practically
43
44

Current History, October, 1932, p. 27.
The New York Times, July 9, 1927.

CENTRALIZATION OF FOREIGN POLICY

315

dictated by the Bank of England.45 And Governor Norris of
the Federal Reserve Bank of Philadelphia stated in public
substantially that it had been necessary to lower rates in
America in order to avoid hurting business in Great Britain
and some other European countries.
The Chicago Tribune called for the resignation of Governor Strong of the New York Bank. It based its demand
upon the ground that he had been attempting to control
discount rates in the interest of Great Britain. Apropos to
this matter the British thought very highly of Governor
Strong and appreciated what he did for them. Thus, for
example, one of their leadingfinancialjournals, The Banker,
said editorially:
London has recently been honored with the presence of
Mr. Benjamin Strong, governor of the Federal Reserve Bank of
New York. The United States contains no better friend of England than this great banker. While mindful of the proper interests of his own country, he has been a generous friend of England,
and we owe much to the energy and skillfulness he has given to the
service of England. This work is not well known to the public,
but those who have had the opportunity of appreciating his efforts will not contradict the assertion that his name should be
associated with46 that of Mr. Page as a friend of England in her
greatest need.
Writing in 1927, Hon. Philip Snowden said:
When Mr. Norman was elected governor he effected a great
but unseen revolution. He gave his whole time to the governorship, he established relations with the heads of the central banks
of the world—particularly with the Federal Reserve Bank of
New York; and he gradually evolved a policy of cooperation between the central banks of the world for the reconstruction of
Europe. • . . The magnificent support given to Great Britain
by the Federal Reserve Bank of New York owes much to the great
friendship between Mr. Norman and Mr. Strong. In these days
of immense impersonal business the comradeship of two great
bankers in the beneficent work of international reconstruction is
indeed remarkable.
In using, as he has done, the great opportunities which his
position as governor of the Bank has provided to promote inter« See also chapter VIII, p. 171.
« The Banker, London, June 1, 1926, p. 403.

316 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

national goodwill, Mr. Norman has set an example to all who are
engaged in commerce and finance, of how chivalry47and comradeship may be combined with business management.

Following the effects of the collaboration of Governor
Norman of the Bank of England with the governor of the
Federal Reserve Bank in New York, The Banker, in its
issue of November, 1928, complimented Mr. Strong as being
"one of the best friends England ever had" and said that he
had "served Europe much better than those who owe both
their birth and fortune to it." 48
Similar recognition of the authority and power of the
New York Reserve Bank in foreign affairs in place of the
Federal Reserve Board has been expressed also in Germany
and France. As examples of such the following may be
quoted:
Mr. Benjamin Strong, governor of the Federal Reserve Bank
of New York and the leading head of the American bank of issue
system, did not allow prices to sink further but caused them to
rise somewhat. In other words, he has made gold—the whole
world's currency basis, 49
which is managed by the United States,
cheaper and not dearer.
The Bank of France rendered a public homage to American
collaboration in a communication in 1928. "The gold which the
Bank has bought since August, 1926, whether in public in the
form of moneys, or whether in ingots in foreign markets, and particularly in the American market, is afinishedoperation, thanks to
the facilities it has met, notably in the Federal Reserve Bank of New
York, whose friendly collaboration deserves to be underlined."50

It has been the officials of the New York Reserve Bank
who have represented the Federal Reserve system in its
foreign relations. As a result of these international central
bankers' conferences, there have evolved "agreements on
discount rates, international credits among central banks,
and secret understandings of one sort or another."
47
The Right Hon. Philip Snowden, M. P., "The Bank of England and
European Reconstruction," The Banker, London, May, 1927, pp. 376-381.
48
The Banker, London, November, 1928, p. 141.
49
Frankfurter Zeitung, Dec. 25, 1927.
60
Revue Des Deux Mondes, February, 1929.

CENTRALIZATION OF FOREIGN POLICY

317

Establishing Foreign Monetary Systems

Perhaps the most important use of the New York Reserve
Bank's power was the agreements it made with central
banks to enable them to restore the gold standard in their
respective countries.51 The forerunner of all these and
by far the outstanding one was that with the Bank of England in 1925.52 According to this arrangement the New
York Bank undertook to sell gold on credit to the Bank of
England from time to time during the following two years,
but not to exceed $200,000,000 at any one time.53 In other
words the New York Bank contracted to furnish the Bank
of England gold up to a total value at any one time of
$200,000,000. The Bank of England could then ship the
gold out of the United States, earmark it in the Reserve
Bank's vault, or use it to make payments in this country.
The gold was to be paid for by deposit credit on the books
of the Bank of England. The purpose of the agreement was
to stabilize sterling exchange by enabling the Bank of England to meet a foreign demand for gold without reducing its
own reserves, or enabling it to replenish its reserves by drawing gold from the Reserve Bank or earmarking it at the
Reserve Bank.
The contract was negotiated by Governor Strong of the
New York Bank and Governor Norman of the Bank of
England.64 The New York Bank made arrangements with all
the other Reserve banks whereby the latter shared pro rata
in this contingent liability transaction.55 The liability of the
61
Of the many countries which went off the gold standard during the war,
the United States was the first to return to it. The American Government
removed gold export restrictions in 1919.
52
Concerning the restoration of the gold standard in Great Britain in 1925,
see Federal Reserve Bulletin, June, 1925, pp. 369-373. Britain's return to
gold in 1925 meant not the free coinage of gold or the issuance of a certain
amount of paper currency on a certain gold reserve, but that its international
trade went on a gold standard basis. It remained on this basis until September,
1931, when it suspended gold payments on foreign trade balances. Britain's
monetary standard from 1925 to 1931 may be designated the "gold bullion
standard."
53
Federal Reserve Bulletin, June, 1925, pp. 371-373; Annual Report of the
Federal Reserve Bank of New York, 1925, pp. 9-11; Annual Report of the
Federal Reserve Board, 1925, pp. 10-14.
64
66
Stabilisation Hearings on H. R. 7895, 1926, p. 512.
Ibid., p. 497.

318 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

other Reserve banks ran to the New York Reserve Bank
and not to the Bank of England.56 In connection with
the contract between the New York Bank and the English
bank, J. P. Morgan and Company made a contract with the
British Government whereby the banking house would
loan the latter $100,000,000 of gold if desired. Should
the credit have been used, the gold which Morgan and
Company agreed to supply the British Government would
have had to come from the gold reserves of the Federal
Reserve system just the same as in the case of the Reserve
Bank's obligation to the Bank of England.57 In case Great
Britain needed the gold it was understood that the officials
of the Reserve Bank and the Morgan Company would
collaborate and decide which credit would be drawn upon.58
The Bank of England did not buy any gold under this
contract or use any part of the credit so promised.69 Likewise none of the Morgan credit was used.
The New York Reserve Bank effected loan agreements
along similar lines with other central banks in order to
stabilize their currencies in relation to gold. While some
loans secured by gold were made by the Bank, the loan
contracts usually took the form of agreements to purchase
prime commercial bills up to a maximum amount from the
central banks if they desired to sell them. The central banks
which the New York Reserve Bank aided to stabilize their
66

Ibid., pp. 269, 270.
Ibid., p. 512.
Ibid., p. 497.
fi9
There was a great deal of criticism against this arrangement between the
New York Reserve Bank and the Bank of England in the United States at
the time. Its legality was seriously questioned. Among others considerable
concern was felt by the members of the Federal Reserve Board and the officers
of the other eleven Federal Reserve banks. (See Congressional Record [unbound edition], Feb. 10, 1930, p. 3525.) The criticisms of the agreement were
to the effect that (1) it was a binding prearrangement which left the initiative
with the Bank of England but did not permit of the freedom of action as to
time and amount contemplated by the Federal Reserve Act, and (2) it authorized revolving credits the final maturity of which was longer than was permitted for eligible paper. The arrangement was investigated by the House
Committee on Banking and Currency and was then defended by Governor
Strong of the Reserve Bank. (See Stabilization Hearings on H. R. 7895, 1926,
pp. 494^512.)
67

CENTRALIZATION OF FOREIGN POLICY

319

currencies and the extent of the Bank's liability thereunder
were:60
Bank of England (1925)
National Bank of Belgium (1926)
Bank of Poland (1927)
Bank of Italy (1927)
National Bank of Roumania (1929)

$200,000,000
10,000,000
5,250,000
15,000,000
4,500,000

Although the central banks in Great Britain, Belgium, and
Roumania did not use any of the credits guaranteed, the
fact that financial assistance of the central banking system
of the United States was contracted for and was available
should the need arise undoubtedly was an element of considerable support in enabling those countries to achieve
stabilization and obviating such a need.
Besides these guaranteed credits and loans the Reserve
Bank cooperated with foreign central banks to aid them in
restoring the gold standard through its discount and open
market policies. In 1924 and 1927 the Bank lowered discount and open market rates and made extensive open market purchases. Its easy money policy in these periods tended
to result in the sale of foreign securities in this country and
exchange rates favorable to foreign countries. The checking
of gold imports and the increasing of gold exports were
desired and these results ensued at the time.61 The support
of foreign efforts to return to gold was stated to be a vital
factor in motivating the New York Bank's easy money
policy in both of these periods.62 While the work of reorganizing the foreign disarranged monetary systems was
materially aided by the resources of our central banking
system, the impetus of American participation was supplied
by the New York Reserve Bank.
60

Annual Reports of the Federal Reserve Bank of New York, 1925-1929.
The United States was overwhelmingly a creditor nation. While the
efforts of the Reserve Bank to redistribute the gold stock held in the United
States did succeed to some extent immediately, they were in the long run
largely ineffective in the face of the forces determining gold movements. The
long time result was net imports into the United States.
62
Hearings on Banking Systems, 1931, pp. 762-763, 816-817.
61

320 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
Supporting the Gold Exchange Standard

The New York Reserve Bank did not enable foreign
countries to return to a gold standard of the kind that was
practiced before the war, that is, one where there were no
restrictions on gold exports or imports, convertibility of all
kinds of money and of bank credit into gold, and no opposition to hand-to-hand circulation. But it did enable them to
establish a variant of the gold standard—the gold exchange
standard. Under this standard central banks invested a
considerable part of their resources in liquid foreign assets.
These foreign assets constituted a part of their operating
reserves and in many cases were counted as part of their
legal reserves.63 Such assets consisted of deposit balances,
bills of exchange on foreign countries, foreign bank notes,
short-term investments in foreign markets—including acceptances, treasury bills, and loans on stock exchange collateral.
Of the total holdings of foreign assets by central banks,
there was reason to believe that the proportion held in the
United States was large.64 Countries set their monetary
units at a certain relationship to the dollar and endeavored
to keep them there through the operation of the foreign
exchange mechanism. This involved the accumulation of
dollar balances which the statutes of many European and
South American countries permitted their central banks to
count as a part of their legal reserves.65 Foreign balances
were accumulated in America and served this purpose.66
They were subject to conversion into gold on demand. This
conversion was followed by actual withdrawal for export or
earmarking. In either case the gold reserves of the Reserve
system were depleted. Concerning this subject the Federal
Reserve Board had the following to say:67
63

Federal Reserve Bulletin, June, 1927, p . 392.
There was no way to determine this proportion closely, but the Federal
Reserve Board, in 1927, held that perhaps as much as $1,000,000,000 of the
operating reserves of foreign central banks was in dollar exchange. Federal
Reserve Bulletin, June, 1927, p. 392.
65
Federal Reserve Bulletin, April, 1925, p. 234. For a summary of the
legal reserve requirements of many central banks, see Federal Reserve Bulletin, June, 1927, p. 394.
66
Stabilization Hearings on H. R. 7895, 1926, p. 452.
67
Federal Reserve Bulletin, June, 1927, pp. 392-393.
64

CENTRALIZATION OF FOREIGN POLICY

321

In view of the strong reserve position of the Federal Reserve
banks and of the American policy of placing no legal or practical
restrictions on gold withdrawals, so that balances with banks in
the United States are convertible at any time into exportable gold,
dollar exchange is considered throughout the world as equivalent
to gold. To build up the volume of dollar exchange at their command has been the policy of many central banks, which find it
safe, convenient, and profitable to keep a portion of their reserves
productively employed in the United States, rather than to keep
them unproductive in the form of gold in vault.

The gold reserves of our central banking system, therefore,
served as the base not only for our own money and credit in
use but
for the monetary systems of foreign countries as
well.68
In the operation of the gold exchange standard, although
the gold reserves of all the Reserve banks were subject to
such use, it was the New York Bank which felt the immediate
responsibility. The actual policies and processes by which
the gold exchange standard was supported were executed by
that Bank. The Bank administered foreign balances and
invested them pursuant to instructions from abroad. It
met the demands for gold on the part of foreign interests
whether for earmarking or exporting. The New York Bank,
therefore, had the important duty of adjusting its policies
with reference not only to the domestic situation, but to
foreign conditions, the policies of foreign central banks,
the large volume of short-term balances located here and
their withdrawal in gold.69 Thus in supporting the gold
exchange standard as well as in other international transactions, the foreign policy of the Federal Reserve system was
practically centralized in the New York Reserve Bank.
68
The gold exchange standard did not last long. Since 1929 European
nations have been returning not to gold but to a paper basis. Monetary relationships in Europe have again become disarranged. Concerning the gold
exchange standard and its failure, see Federal Reserve Bulletin, June, 1927,
pp. 391-394; Willis, "The Breakdown of the Gold Exchange Standard and Its
Financial Imperialism," The Annalist, Oct. 16, 1931, p. 626. See also a discussion of the gold exchange standard by Feliks Mlynarski in his book, Gold and
Central Banks, chapter V.
69
Thus in its Annual Report for 1925, the New York Reserve Bank stated
that it was its intention "to exchange information fully" with the Bank of
England.

CHAPTER XVI
COLLABORATION WITH FOREIGN CENTRAL
BANKS
Establishment of the Bank for International Settlements
The Federal Reserve Bank of New York and its officials
were engaged in the post-war foreign relationships growing
out of reparations and in the establishment of the Bank for
International Settlements. The Reserve Bank maintained
an account for the Agent General for reparation payments.
A director of the Bank, Owen D. Young, was the man most
immediately responsible for the formulation of the so-called
Dawes plan, in 1924, for the settlement of reparations. The
chairman and Federal Reserve agent of the Bank assisted
Mr. Young in Europe in setting up the administration for
the Dawes plan. An assistant Federal Reserve agent went
to Europe in 1924 and served as economic adviser to the
Transfer Committee and later as finance director, Office for
Reparation Payments. At the end of 1926, the chairman,
Pierre Jay, resigned to go to Berlin to be the American
member of the Transfer Committee under the Dawes plan.
Finally, his successor, Gates W. McGarrah, held a position
in the Reichsbank of Germany as American member of the
council while he was chairman of the board and Federal
Reserve agent of the Reserve Bank.
The Dawes plan, though it proved useful in some respects,
was found to work unsatisfactorily particularly with regard
to its transfer provisions. Hence the allied governments
reached a decision in Geneva in September, 1928, to set up
a committee of independent experts whose duty was to draw
up "proposals for a complete and final settlement of the
reparation problem." The experts from the respective allied
countries were chosen and in addition two from the United
States, the latter being appointed by the Reparation Com-

322

COLLABORATION WITH FOREIGN CENTRAL BANKS

323

mission conjointly with the German Government. One of
the two experts from America was Owen D. Young, who
was a director and deputy chairman of the Federal Reserve
Bank of New York and the other was J. Pierpont Morgan,
the head of J. P. Morgan and Company of New York.1 The
committee of experts held its first regular meeting in Paris,
February 11, 1929, and continued in session for seventeen
weeks. The deputy chairman of the New York Reserve
Bank was chairman of the Experts' Committee. The Reserve Bank was also represented at the Paris conference by
its assistant Federal Reserve agent who rendered some
technical service.2
During the Committee's deliberations early reports of the
preliminary drafts of the new plan had indicated the creation of an International Bank and the inclusion of the Federal Reserve Bank of New York as one of the central banks
to set up and run it. Also the press reported that the assistant Federal Reserve agent while in Paris made a flat statement as follows:
The Federal Reserve Bank will act as correspondent to the
new establishment as it does for other central banks, which will
avoid the necessity of special American legislation. The Federal
Reserve Bank will make important deposits of gold in the International Bank abroad and will receive in New York deposits of
gold from it.3

As a result of the early reports and this statement, which
the official later denied making, the concern felt in many
quarters over the foreign activity of the Federal Reserve
Bank of New York and the involvement of the Federal
Reserve system with the new Bank for International Settlements, the administration in Washington announced its
position with regard to the matter. It was stated informally
that President Hoover was "opposed to the United States
acting through the Federal Reserve system in any manner"
1
Two alternates were also in attendance—Thomas N. Perkins and T. W.
Lamont, the latter being associated with Mr. Morgan as a partner in J. P.
Morgan and Company.
2
W. Randolph Burgess.
3
The New York Herald Tribune, May 17, 1929; Congressional Record
(unbound edition), Feb. 10, 1930, p. 3528.

324 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

in setting up the Bank for International Settlements.4 The
Secretary of State, in response to a Senate inquiry, issued
a formal statement of the Government's policy in which
he said:
. . . this Government does not desire to have any American
official, directly or indirectly, participate in the collection of German reparations through the agency of this bank (Bank for International Settlements) or otherwise . . . it will not permit any
officials of the Federal Reserve system either to serve themselves
or to select American representatives as members of the proposed
International Bank. 5

This opposition to Federal Reserve participation in the
Bank for International Settlements was reaffirmed by the
Secretary the next month.6
The State department's restrictions upon Federal Reserve
participation in the Bank for International Settlements
aroused discussion in both houses of Congress concerning
the connections of the Federal Reserve with the foreign
bank. Senator Glass contended that the Secretary of State
was without authority to determine the relation of the Federal Reserve to the new International Bank and the Senate
passed a resolution asking for information concerning the
activity of the State department in such matters.7 Following a reply from the President,8 Senator Glass introduced
another resolution calling upon the State department to
refrain from such intervention in the affairs of the Federal
Reserve system,9 control over which was expressly vested
in its own officers. The resolution was finally passed by the
Senate on February 26, 1931.10
Notwithstanding the traditional attitude of the United
States Government against mixing in the collection of reparations, it was expected that approximately two-thirds of
the German reparation payments into the International
4

The New York Times, May 15, 1929.
The New York Times, May 17, 1929.
The New York Times, June 27, 1929.
7
Congressional Record, June 16, 1930, p. 11,265. The right of the State
department to "sanction" foreign loans was also involved.
8
Senate Document 187, 71st Congress, 2nd Session.
9
Congressional Record, June 25, 1930, p. 12,076.
10
Congressional Record, Feb. 26, 1931, p. 6103.
5

COLLABORATION WITH FOREIGN CENTRAL BANKS

325

Bank would go indirectly to America in settlement of war
debts.11 It was reported that Mr. Young favored representation of the Federal Reserve system in the International
Bank.12 But in accordance with the pronouncement of the
United States Government, the report of the Experts' Committee, of which he was chairman, omitted mentioning the
Federal Reserve system or any component part of it, save
in one place in connection with the " special advisory committee " of the Bank for International Settlements.13
New York Reserve Bank Identified as the Central Bank of the
United States
The Experts* Report, or as it was generally called, the
Young plan, involved as its central factor the formation of
the Bank for International Settlements. This bank has
two sets of functions. Its primary and obligatory functions
are "to receive and disburse reparation payments, effect
transfers in certain contingencies, and handle deliveries in
kind as long as they are made." The secondary and permissive functions are such as enable it "to act as a bank for
other central banks." 14 Although the Young plan did not
definitely provide for the association of the Federal Reserve
Bank of New York with foreign central banks in the formation of the International Bank, it did provide alternative
arrangements which involved the New York Reserve Bank.
If the Reserve Bank or its governor could not participate
in any of the undertakings, provision was made for representatives of his to serve, whereby, in the words of one of
the alternate members of the Experts' Committee, "the
same end is intended to be attained." 15
Such alternative provisions were incorporated into the
statutes of the Bank for International Settlements concluded at the Hague conference in January, 1930. These
statutes set forth the relation of the central banks, of the
countries whose nationals were members of the Experts'
11
The
12

New York Times, June 8, 1929.
The New York Times, July 5, 1929.
"Experts' Report, Part VIII(E).
14
Federal Reserve Bulletin, July, 1929, pp. 461-462.
16
T. W. Lamont, The New York Times, July 5, 1929.

326 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Committee, to the organization, direction, and operations
of the Bank for International Settlements. The Federal
Reserve Board is not mentioned in the International Bank's
statutes, but the Federal Reserve Bank of New York is
clearly indicated in them by defining the term " central
bank." They read:
For the purposes of these statutes:—
Central bank means the bank in any country to which has been
entrusted the duty of regulating the volume of currency and credit
in that country; or, where a banking system has been so entrusted,
the bank forming part of such system which is situated and operating in the principal financial market of that country. 16

Since the principal financial market of the United States
is in New York, the New York Reserve Bank is identified
as the central bank of the United States. The International
Bank is empowered to transact business with the central
banks of the world and the Federal Reserve Bank of New
York and to operate in the New York money market. Furthermore, the Federal Reserve Bank of New York is given
in the statutes the power of veto over operations of the
International Bank in this financial market. Thus on any
questions involving the interests of the United States, the
New York Reserve Bank has the power of decision under
this plan.
As has been seen, officials of the New York Reserve Bank
were vital factors in the formal development in Europe of
the plan for the International Bank which had been worked
out largely in the Federal Reserve Bank of New York.17
Officials of the Reserve Bank continued to be prime factors
in the establishment and management of the International
Bank. The organization committee constituted under the
Young plan, to put the bank project into effect, had as its
chairman a director of the Reserve Bank.18 The chairman
of the board of directors and Federal Reserve agent of the
New York Reserve Bank, Gates W. McGarrah, had been
16

Article 58, (1).
Hearings before a Subcommittee of the Senate Committee on Banking
and Currency on Nomination of Eugene Meyer to be a Member of the Federal Reserve Board, 71st Congress, 3rd Session, 1931, p. 309.
18
Jackson E. Reynolds, president of the First National Bank of New York.
17

COLLABORATION WITH FOREIGN CENTRAL BANKS

327

determined upon as an American director of the International Bank, and, it was generally understood, as its
president. He accordingly resigned in February, 1930, to
accept an appointment as one of the two American directors of the International Bank and was elected and served
as its first president. According to well-known European
bankers, an American head for the bank was chosen because
of the hope that he would be able "to secure a more friendly
attitude on the part of the United States toward reparations and perhaps toward the softening of our debt contracts with the allied governments." 19
Relations with the Bank for International Settlements
The New York Reserve Bank not only participated in the
establishment of the International Bank but has operated in
close communication with it. That Bank " detailed members
of its staff to work in connection with the operations of the
International Bank and to keep it advised" of what went
on in Basle.20 In the summer of 1931, a seven-power conference of ministers in London arranged that the Bank for
International Settlements would set up a committee,
nominated by the governors of the central banks interested,
to inquire into the financial crisis in Germany.21 In consequence, Governor Harrison of the New York Bank nominated Albert H. Wiggin, chairman of the governing board
of the Chase National Bank, who represented American
interests abroad in the matter of "frozen" German acceptance credits. In accordance with specific provisions in the
Experts7 Report (the Young plan) when the question of fulfillment of Germany's obligations arose in the fall of 1931,
the governor of the New York Reserve Bank was requested
by the president of the International Bank to nominate an
American member of the Special Advisory Committee provided for in the Young plan. Accordingly, Governor Harrison nominated Mr. Walter W. Stewart, chairman of the
board of directors of a New York banking house,22 who
19
Journal
20

of Commerce [New York], editorial, April 24, 1930.
Journal of Commerce [New York], editorial, June 28, 1930.
21
The New York Times, July 31, 1931.
22
Case, Pomeroy and Company, Inc.

328 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

served in that capacity.23 It is evident from the above facts
that if the requests of the Washington Government can be
said to have been observed, they were observed only in the
most attenuated and technical sense.
Although established under the auspices of the leading
central banks and the Federal Reserve Bank of New York,24
since the policy of the United States Government would not
permit the Federal Reserve banks to buy stock of the
International Bank, funds from the United States were
supplied by a banking group headed by J. P. Morgan and
Company, the First National Bank of New York, and the
First National Bank of Chicago. These three institutions
guaranteed the subscription of one-seventh of the bank's
entire capital and subscribed for 16,000 shares, which were
subsequently distributed to at least one hundred American
banks.25
The investment of the American banks in the stock of the
Bank for International Settlements was not based upon our
Federal authority. While there is no prohibition in the
National Bank Act against the purchase of stock in a
foreign bank, national banks have not been authorized by
law or by regulation of the Comptroller of the Currency to
invest in shares of stock of foreign banks; and the courts
have held the purchase of such stock to be ultra vires except
as specifically authorized by statute. The basis for the
affiliation of the American banks with the International
Bank is found in the preamble of its charter.26 The control
23

Annual Report of the Federal Reserve Bank of New York, 1931, p. 24.
The Federal Reserve Bank of New York acting unofficially.
The Banker, London, November, 1931, pp. 143-146.
25
Agreements Concluded at the Hague Conference, January, 1930: Constituent Charter of the Bank for International Settlements, Preamble: " Whereas
the powers signatory to the Hague Agreement of January, 1930, have adopted
a Plan which contemplates the founding by the central Banks of Belgium,
France, Germany, Great Britain, Italy and Japan and by a financial institution of the United States of America of an International Bank to be called
the Bank for International Settlements:
" And whereas the said central banks and a banking group including Messrs.
J. P. Morgan and Company, of New York, the First National Bank of New
York, New York and the First National Bank of Chicago, Chicago have
undertaken to found the said Bank and have guaranteed or arranged for the
guarantee of the subscription of its authorized capital amounting to five
24

COLLABORATION WITH FOREIGN CENTRAL BANKS

329

of the International Bank is not vested in the shareholders
but in the governors of the central banks of the countries
involved or their representatives, the latter applying to the
New York Reserve Bank. The fact that the three American
.banks and not the Federal Reserve Bank of New York are
affiliated with the foreign central banks in the enterprise
does not mean that the Federal Reserve Bank of New York
or the Federal Reserve system has not become financially
involved in the International Bank.
The three banks comprising the group which guaranteed
the subscription for America's allotment of stock in the
International Bank would be obliged to obtain the gold to
fulfill their contract from the Federal Reserve because they
do not carry substantial amounts of gold for such purposes.
It is not reasonable to suppose that the officers of the American banks would have undertaken to affix their signatures
to the charter if they had not been assured of not only the
moral but the financial support of the Federal Reserve Bank
of New York. As Lord Melchett of England said in 1929:
It will be impossible to make a success of either the scheme
of reparation payments or still more the Bank for International
Settlements, unless the financial power of the United States,
frankly, fully, and wholeheartedly comes to its assistance. 27

Furthermore, J. P. Morgan and Company have been the
fiscal agents in this country of foreign governments and
have had "close working agreements" with the Federal
Reserve Bank of New York.28 Also it will be recalled that
of the two American members of the conference in Paris
which drew up the plan for the International Bank, one was
a director and deputy chairman of the Federal Reserve
Bank of New York, who was chairman of the conference, and
the other was J. P. Morgan.
Direct correspondent and financial relations between the
Federal Reserve Bank of New York and the Bank for International Settlements have been carried on from the time
hundred million Swiss Francs equal to 145,161,290.32 grains, fine gold, divided into 200,000 shares."
27
Congressional Record (unbound edition), Feb. 10, 1930, p. 3528.
28
Ibid., p. 3527.

330 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

of the establishment of the latter institution. The Bank for
International Settlements opened for business at Basle,
Switzerland, in May, 1930, and at this time the New York
Reserve Bank opened an account in New York in its favor.29
The relations of the Reserve Bank in New York to the
International Bank have been comparable to its relations
with foreign central banks. The International Bank's
account has been "subject to the same general terms and
conditions as the accounts received from foreign central
banks of issue." 30 The New York Reserve Bank has performed services for it such as investing its funds in bankers'
acceptances and short-term United States Government
securities, earmarking gold, keeping securities, making collections, paying checks, and transferring funds.
In accordance with the statutes of the Bank for International Settlements, financial operations in the New York
money market have been subject to the veto of the New
York Reserve Bank in order that the International Bank's
operations here may not conflict with the credit policy of the
Reserve Bank. In practice this has meant that all of the
International Bank's operations in any financial market in
the United States have been subject to the authority of the
New York Reserve Bank. The reason for this is that the
dollar funds the International Bank has employed in the
United States have been handled in the first instance through
its account with the New York Reserve Bank.31 In this way
the New York Reserve Bank has been "in a position to
understand the nature and volume" of the International
Bank's operations in the United States and hence to exercise
its veto rights under the International Bank's statutes. The
relations between the two banks were considerably enlarged
in 1931. In that year the Reserve Bank made deposits in
the International Bank. It also extended loans to the
International Bank for its (the International Bank's) own
account and as intermediary for several central banks.32
n

Annual Report of the Federal Reserve Bank of New York, 1930, p. 22.
Idem.
31
Ibid., p. 23.
32
Annual Report of the Federal Reserve Bank of New York, 1931, pp. 2230

COLLABORATION WITH FOREIGN CENTRAL BANKS

331

The reports from Paris at the time of the conference of
experts in 1929 as to the part the Federal Reserve system,
and more particularly the Federal Reserve Bank of New
York, was to play in the Bank for International Settlements
have been amply confirmed. Subsequent events have shown
the extent to which the experts from America and the
representatives of the New York Reserve Bank during the
conferences, although acting in an "unofficial" capacity,
knew whereof they spoke and planned to have the New York
Reserve Bank place the reserves of the Federal Reserve
system at the disposal of the Bank for International Settlements. Since the opening of the International Bank, the
lending of these reserves and the financial relations of the
New York Reserve Bank with it have been undertaken
under the authority of section 14 of the Federal Reserve
Act, the section under which the Bank has been carrying
on its relations with central banks. No announcement by
governmental authority or the Federal Reserve Board has
been made specifying the part the Federal Reserve banks
are to play in relation to the International Bank or the use
which they might make of the nation's banking reserves for
the International Bank and its constituent central banks.
Although the Bank for International Settlements is not a
central bank, the New York Reserve Bank has carried on
with it financial relations of substantially the same character
as it has carried on with foreign central banks.33 So far as
the relation of our central banking system to the Bank for
International Settlements is concerned, the Federal Reserve
Bank of New York has been the means of contact and
actually the institution which has wielded the power. The
New York Reserve Bank and its officials, and no other
Reserve bank, have been engaged directly in operations
with the International Bank. Moreover, policies underlying
these operations have been determined by the New York
Bank and not by the Federal Reserve Board, the Board
acquiescing in whatever was done by the Reserve Bank.
In the discussions attending the formation of the Bank
for Internationa] Settlements, it was urged that a good
33

Hearings on Banking Systems, 1931, p. 94.

332 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

reason for setting it up was that it would serve as a convenient meeting place for the heads of central banks. They
could meet oftener, more regularly and privately, and under
more favorable circumstances. It was said that "personal
contacts" could be developed which would be valuable
aids in the settlement of international problems involving
gold, loans, and monetary standards. Such problems not
only involve political considerations but monetary and banking policies national in scope. It was over just such affairs
that the Federal Reserve Board was given jurisdiction in the
Federal Reserve Act. The statutes of the International
Bank, however, make no mention of the Federal Reserve
Board, but deal with central banks, and by definition, the
term "central bank" is made to apply to the Federal Reserve
Bank of New York for the United States.
While the settlement of reparations provided the original
reason for the establishment of the International Bank, this
function very early in its existence became of minor importance. In as short a time as nine months from the opening
its president said that the bank's activity in connection with
the German reparation payments has become the smaller side
of the work, that the latter has become a routine " trust company" operation, and that ''nearly the whole thought and
energy of the bank are devoted to other financial fields." 34
In other words, the functions of the bank in its relations
with the central banks of the world became paramount. In
carrying out these functions the International Bank provides
a recognized common meeting place where the central bank
heads may gather and exchange views on monetary and
banking policies, stabilization of exchange rates and prices;
may reconcile their different points of view and coordinate
their policies.
The statutes of the International Bank were prepared so
that no legislative sanctions are required and it is free from
the supervision of national governments. These statutes
give the International Bank authority to engage in a number of kinds of transactions with central banks, some of
34
Address of Gates W. McGarrah before the American Club of Paris,
Feb. 12, 1931, The Banker, London, April, 1931, p. 21.

COLLABORATION WITH FOREIGN CENTRAL BANKS

333

which the Federal Reserve banks have not been empowered
to carry on under the Reserve Act. This is the type of foreign
institution with which the New York Reserve Bank has
carried on financial relations as "the central bank of the
United States." These relations with the International
Bank have been a continuance and expansion of the previous
activity of the New York Bank as the representative of the
Federal Reserve system and American financial interests in
the international sphere.
Finance Loans to Central Banks
It was evident, in 1928, that large acceptance credits
were being drawn to finance the movement and storage of
unsold goods in central Europe and were purchased by the
New York Reserve Bank.35 Although the Reserve Bank is
expected to buy only prime commercial bills, these acceptances were in reality finance bills. Such acceptances continued to be made and purchased by the Bank in succeeding
years. Having taken them in the first instance the New
York Bank then parceled them out to the other Reserve
banks, thus involving the resources of the Federal Reserve
system in these non-liquid assets. Such acceptance credits
especially followed the inability to market long-term bonds
in the United States.36
When the European financial situation became very
strained in 1931 on account of the banking crisis in Germany
36
H. Parker Willis, "American Banking and the German Collapse/' The
Banker, London, September, 1931, p. 227.
36
Several Federal Reserve banks reported that such curtailment of capital
exports to central Europe through 1929 was a cause of the increase in acceptances arising from foreign storage and equipment. (See Hearings on Banking
Systems, 1931, pp. 859-860.)
"German banks and for that matter other European institutions, finding
their clients unable to float new obligations in this market, have obtained
from bankers acceptance credits which they have used to cover the carrying
of cotton, copper, flour and other staples in foreign warehouses. They have
also been inclined to lean upon the American market for money with which
to finance trade between themselves and other (non-American) countries. It
has been a good deal cheaper for a German bank to finance the trade with
Russia by the use of paper floated in the American market, than it has been
for a bank in Nebraska to finance the trade between that State and the Eastern
states." Journal of Commerce [New York], editorial, July 17, 1930.

334 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the Executive Committee of the New York Reserve Bank
held an all-day meeting at which members of J. P. Morgan
and Company were in attendance.37 At this meeting "it
was decided that the Federal Reserve would follow the lead
of the World Bank" in this crisis.38 What was the lead of
the "World Bank"? The board of directors of the Bank
for International Settlements issued a statement to the
effect that it had decided "in agreement with the other
institutions concerned, to renew its participation in the
rediscount credit previously accorded to the Reichsbank." 39
As a result the New York Reserve Bank made loans to the
German Reichsbank by purchasing reichsmark acceptances
in which all the other regional Reserve banks participated.40
In connection with the "frozen" assets of certain European central banks, the New York Bank made other special
loans in that year to the central banks in Austria, Hungary,
and Great Britain.41 The amounts of the New York Reserve
Bank loans to foreign central banks in 1931 were:
National Bank of Austria
National Bank of Hungary
German Reichsbank
Bank of England

$ 1,083,000
5,000,000
25,000,000
125,000,000

As the loans were made the Reserve Bank gave a deposit
credit on its books to the foreign central bank, which in
turn gave the Reserve Bank a deposit of the same amount.
The Reserve Bank then turned over the deposits to various
American banks and ordered its own deposits abroad invested in "prime commercial bills" of the currency of the
borrowing central bank.42 These bills were endorsed or
guaranteed by the respective foreign central banks and it
37
The New
88
Idem.
39

York Times, July 14, 1931.

Idem.
Annual Report of the Federal Reserve Bank of New York, 1931, p. 23.
41
See Annual Report of the Federal Reserve Bank of New York, 19317
p. 22; Federal Reserve Bulletin, August, 1931, p. 435; The New York Times,
Aug. 2, 1931; Federal Reserve Bank of New York, Monthly Review for July,
August, September, October, and November, 1931.
42
Annual Report of the Federal Reserve Bank of New York, 1931, p. 22;
New York Herald Tribune, Sept. 13, 1931.
40

COLLABORATION WITH FOREIGN CENTRAL BANKS

335

was agreed that ultimate repayment of the loans would be
made in gold if necessary.43 The bulk of these loans,
$125,000,000, went to the Bank of England. The purpose
behind this loan, in which the Bank of France joined, was
to relieve the pressure on sterling exchange. But what it
amounted to was that the Bank of England shifted the
burden of some of the "frozen" German credits from London
to Paris and the Federal Reserve system.
Some of the "accommodation" which the New York
Reserve Bank extended to European banks has not been
repaid when due. The non-payment corroborated the lack
of the commercial nature of such transactions to which
these Federal Reserve operations were supposed to be confined and revealed their real "finance" character. In the
case of foreign acceptances or loans held by the Reserve
banks which were not paid at maturity, the New York Bank
has followed the practice of renewing them.
Other Inter-Central Bank Relations
The New York Reserve Bank has had no regular business dealings with foreign commercial banks. It has confined its foreign relations to central banks and the Bank
for International Settlements. The Reserve Bank has never
sought a foreign account in its history.44 The opening of its
accounts with central banks has resulted from steps initiated
by the foreign state banks of issue involved. After the
Reserve Bank has investigated the foreign institution and
approved of it the account has been opened.
Foreign central banks have not extended any loans or
guaranteed credits to the New York Bank or any other
Reserve bank. The Federal Reserve system's position has
been so strong that no foreign aid was needed. It has always
been a case of the American central banking organization
lending to European institutions. The New York Reserve
Bank has maintained deposit balances in foreign central
banks and the latter have kept balances at the Reserve
Bank. The Bank's deposits abroad have been quite nominal
43
44

Annual Report of the Federal Reserve Bank of New York, 1931, p. 22.
Hearings on Banking Systems, 1931, p. 92.

336 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

whereas foreign deposits in the Reserve Bank were relatively large. The reason for this difference is that the accumulation of central bank balances here was part of the program of foreign countries to stabilize their currencies, in
doing which they set their monetary units at a certain relationship to the dollar.
Many of the foreign balances in the United States have
been gold exchange balances which, under the laws of foreign countries, central banks have been authorized to count
as part of their legal reserves.45 But whether legal reserves
or not all the different accounts were in reality actual reserves
of the central banks. In this respect they were practically
the same as the member bank reserves in the Federal Reserve banks. The New York Bank considered them gold
balances and undertook to pay their owners gold on demand.
Therefore, foreign central bank deposits in the Reserve
Bank have been kept in liquid form, either book credits or
short-term paper. In the case of foreign deposits held by
the commercial banks, and for which they were called upon
to supply gold, the banks would get it from the Reserve
Bank as the only holder of gold in considerable amounts.46
Definite written agreements have been concluded between
the New York Reserve Bank and foreign central banks outlining what each bank is expected to do for the other bank
in the purchase of acceptances in their respective markets.47
As to the foreign-currency bills, the Bank has purchased
these only through the central bank of the currency in
45

Stabilization Hearings on H . R. 7895, 1926, p . 452. See Annual Report
of the Federal Reserve Board, 1926, p. 16.
46
Foreign short-term balances in America assumed very large proportions
in the decade of the 720s. There are several reasons for this. Foremost among
them was the universal confidence in the American dollar. The United States
was on the gold standard and held an unprecedented stock of monetary gold.
Its currency was relatively stable and foreigners could withdraw their balances
in gold at any time. In contrast to this the economic conditions of many other
countries were unsettled and their monetary systems disarranged. Furthermore, the billions of dollars loaned to foreign parties tended to increase foreign
balances here; while at the same time a developing acceptance market and a
stimulated stock market attracted surplus foreign funds. (For a detailed statistical analysis of foreign funds in the American market, see The New York
Money Market, Vol. II, chapter XII, by James G. Smith.)
47
Hearings on Banking Systems, 1931, p. 94.

COLLABORATION WITH FOREIGN CENTRAL BANKS

337

question.48 All the arrangements and the purchasing of
acceptances for foreign account have been effected by the
New York Reserve Bank on behalf of the Reserve system.
As the agent of foreign central banks in the American market, the New York Bank has guaranteed the payment at
maturity of purchased acceptances. So in effect the holding
of acceptances for foreign account had the status of a guaranteed deposit. The Reserve Bank has not endorsed the
acceptances. The guarantee has been in the form of a blanket
agreement under which the Reserve banks assume liability,
each according to its allotment of bills purchased, for their
payment at maturity. For its service of buying and guaranteeing the acceptances, the Bank charges a small commission.49
The cooperation of our central banking system with that
of Great Britain has been effected by conferences between
the governors of the New York Reserve Bank and the Bank
of England. In the intervals between conferences the New
York Bank has kept in close touch with London. Further
cooperation between these two leading central banks has
been achieved by their weekly exchange of cables concerning conditions in the money markets in New York and
London, including advance notice of impending interest
rate changes.50
Although the Reserve Bank pays no interest on its foreign
deposits, it will invest them for its correspondent central
banks. Pursuant to directions from abroad, the Bank has
rendered this service, purchasing bankers' acceptances and
short-term treasury issues.61 Other services, which may
be considered in lieu of interest, have included the safekeeping and sale of securities, the purchase, sale, and earmarking of gold, the collection of checks and non-cash
items, the domestic transfer of funds by mail or telegraph,
and the payment of checks and drafts drawn on the Reserve
banks.
48
Ibid., p. 91.
43
Ibid., p. 885. The commission charged has been one-eighth
60
Stabilization Hearings on H. It. 7895, 1926, p. 975.
61

See Hearings on Banking Systems, 1931, pp. 883-885.

of 1 per cent.

338 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
Earmarking

The practice of the New York Eeserve Bank of earmarking gold for central banks, which commenced during the
war, assumed huge proportions since 1924.52 By this practice the gold was segregated in separate vaults of the Reserve
Bank, but ownership of the metal passed to the central
bank concerned. In the form of gold bars (bullion), foreign
gold coin, or United States gold coin, duly identified, it was
held subject to the orders of the central bank whose property it was.
The importance of earmarking lies chiefly in its effect
on the central reserves. When the New York Bank earmarked gold for the account of foreign central banks the
reserves of our central banking system were reduced by the
amount of gold earmarked, just as though the gold were
exported. The opposite practice is known as " release from
earmark." When a foreign central bank ordered its gold
released from earmark it has usually been for the purpose
of shipping it out of the country; and the exportation of it
has followed*53 However, this is not a necessary consequence
and has not always been the case. When the gold released
was not exported, it again became the property of the Reserve Bank and enlarged its reserves just as though gold
were imported.
By the practice of earmarking, unheard of among central
banks before the war, the New York Bank has settled some
international balances in gold without shipping gold. Such
settlements were effected by transferring on its books claims
to the gold earmarked. When the New York Bank has
come into possession of gold abroad it has sometimes had
it earmarked there, largely in order to save the expense of
"Annual Report of the Federal Reserve Board, 1932, p. 97. Here are
shown figures on earmarked gold beginning with 1916. Some of the gold
held in New York under earmark has at times been the property of member
banks, but inasmuch as the earmarking of this gold has commonly been at
the instance of foreign correspondents of these banks, the amount has been
considered, on occasion, as part of the gold earmarked for foreign account.
Federal Reserve Bulletin, December, 1927, p. 801.
63
Department of Commerce, The Balance of International Payments in
the United States, 1928, p. 52.

COLLABORATION WITH FOREIGN CENTRAL BANKS

339

shipping to the United States gold that might later require
reshipment.54 Gold thus held abroad by the Bank was
counted as legal reserve prior to February 4, 1921, but
since then it has not been so counted.55
At the conclusion of the World War the Federal Reserve
Board envisaged an international gold clearance fund.56
It had been cheered by the success of the Gold Settlement
Fund which it operated for the Reserve banks in the United
States, scattered as they are widely across a continent. It
therefore announced its readiness " to undertake negotiations
looking to the establishment of an international gold exchange fund." It suggested that it would probably be
necessary in the beginning to confine affiliations with the
fund to the United States, the entente allies, and to a few
of the leading neutral nations, but thought it conceivable
that all civilized nations might eventually be participants.
Foreign interests did not take up the idea, no doubt
because of the uncertainty of availability of each nation's
gold in the event of war, and it has lain dormant. However,
by the New York Bank's earmarking operations, foreign
nations entrusted their gold to the custody of an American
institution. The Bank has in effect operated an "international gold exchange fund" of limited scope. A number of
foreign central banks having accounts at the Federal Reserve
Bank of New York availed themselves of this service.57
Not all of the earmarking of gold for foreign account by
the Federal Reserve system was done by the Federal Reserve
Bank of New York. The New York Reserve Bank, however,
did carry on almost the entire volume of such gold transactions. At the western port on the Pacific coast, the Federal
Reserve Bank of San Francisco did no earmarking of gold for
foreign account. The Federal Reserve Bank of Boston
engaged in some earmarking operations, but that Reserve
54

5&
Idem.
Federal Reserve Bulletin, December, 1927, p. 801.
Annual Report of the Federal Reserve Board, 1918, p. 35.
Another significant development involving international gold clearing
is the Bank for International Settlements. It has avoided gold movements
between countries in some cases by debit and credit entries on its books, thus
operating an international gold clearance fund on a limited scale, but with
possibilities of considerable expansion.
fi8
57

340 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Bank had few transactions of that character.58 The President's proclamation of March 6,1933, and succeeding Executive orders of that year prevented the earmarking of gold
as well as the exporting of it.
Representing American Interests Abroad
Representation of the Federal Reserve system in foreign
financial affairs, was begun during the World War, and, as
we have seen, the New York Reserve Bank then commenced
functioning in this capacity. The breakdown of European
monetary systems during the military conflict resulted in a
need for their restoration. In the work of reconstruction and
central banking development since the war the New York
Reserve Bank became the American institution which
determined the Federal Reserve system's foreign policy and
wielded the power in international affairs. In the course of
its history, the New York Reserve Bank has had relations
with the central banks of no less than 37 countries 59 and
the Bank for International Settlements. Foreign central
banks and the New York Reserve Bank have made agreements among themselves by which credits have been shifted,
and gold reserves supporting the bank deposits have been
shunted to and fro, determining the capacity of the Reserve
and foreign banks to expand and contract the superstructure
of credit.
63
For a few months during the years 1925, 1930, and 1931, at the request
of one of its member banks, the Boston Reserve Bank earmarked gold for a
foreign customer of that member bank (a South American government) in
relatively small amounts varying from $600,000 to $7,500,000.—Letters from
the Federal Reserve Bank of Boston.
69
These countries are:
Argentina
Finland
Peru
Australia
France
Philippine Islands
Austria
Germany
Poland
Belgium
Greece
Portugal
Bolivia
Holland
Roumania
Bulgaria
Hungary
South Africa
Chile
Italy
Spain
Columbia
Japan
Sweden
Czechoslovakia
Java
Switzerland
Danzig
Latvia
United Kingdom
Denmark
Lithuania
Uruguay
Ecuador
Nicaragua
Yugoslavia
Norway

COLLABORATION WITH FOREIGN CENTRAL BANKS

341

The foreign business the Reserve banks have done has
been almost entirely that which has been dependent upon
the engagements of the New York Eeserve Bank with the
foreign banks. The written agreements and oral understandings, expressed or implied, into which the New York
Reserve Bank has entered with foreign central banks have
in actual practice bound the other Reserve banks as well.
In nearly all cases where accounts have been carried, the
New York Bank has acted as the agent for the other Reserve
banks.60 In the business of dealing in acceptances and
securities, the papers have been kept in the New York Bank
while the balances were divided among the other Reserve
banks, which shared in them proportionately.61
Governors of the New York Reserve Bank have held
conferences with foreign central bank heads which were not
authorized by the Federal Reserve Board.62 These officers
have gone abroad and conducted negotiations in such a
manner as to cause Europeans to infer that they represented
the Federal Reserve system. Indeed, Governor Strong, in
testifying before the United States Joint Commission of
Agricultural Inquiry in 1921, referred to himself as "speaking for the Federal Reserve system/' 63 Mr. Strong and
Mr. Montagu Norman, governor of the Bank of England,
went to Berlin in July, 1925, and held a conference with
Mr. Hjalmar Schacht, president of the Reichsbank.64 The
particular purpose of the conference was not announced as
it was said to be of a private nature. Following the conference
it was reported that the Messrs. Strong and Norman informed Mr. Schacht that they were "satisfied" and "they
could recommend German investments in America."65
Though the central bankers7 conferences in which officials of
the New York Bank have participated have had no real official
status, they have tended to create false impressions abroad
60
Stabilization Hearings on H. It. 7895, 1926, p. 313.
61
Idem; Hearings on Banking Systems, 1931, p. 92.
62
Stabilization Hearings on H. R. 11806, 1928, p. 319.
63

Hearings before the Joint Commission of Agricultural Inquiry, 67th
Congress, 1st Session, 1921, Vol. II, Part 13, p. 788.
64
Deutsche Tageszeitung, July 10, 1925.
65
The Commercial and Financial Chronicle, July 18, 1925.

342 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

as to the capacity of the New York Bank's officers to speak
for the system.
Although the Federal Reserve Board is not a bank and
cannot engage in banking practice, the policy of the Federal
Reserve system regarding foreign relations and the supervision of operations thereunder were the functions de jure
of the central Board. In the course of central banking
development, however, in so far as the Board has had any
contact with central banks it has been indirect. The contacts have been made in the first instance by the New York
Bank and have been maintained by it. The Board has had
incomplete information regarding these negotiations and
policies conducted on behalf of the Federal Reserve system.
And when the Board has been informed it has generally
been informed only through the New York Reserve Bank.
The views of many well informed persons were expressed
by a prominent Chicago banker.66 In testifying before the
Senate Banking and Currency Committee, the Chicago
banker said he did not believe the Federal Reserve Board
had had supervision over the foreign relations of the Federal
Reserve system.67
In the international field the New York Reserve Bank
has not only handled the banking functions for all the
Federal Reserve banks but has carried on as well the functions which, under the Reserve Act, devolved upon the
Federal Reserve Board. The extent to which international
relations of the Federal Reserve system have been in the
hands of the New York Reserve Bank is seen in the farreaching and disastrous 1927 easy money policy of the
Federal Reserve system which was consequent upon the conference of central bankers in this country with the governor of the New York Bank. This policy was not the result of
any deliberations of the foreign officials with the Federal Reserve Board. The foreign central bank heads met the Board
members only socially through the courtesy of the governor
of the Reserve Bank.
Another significant policy was the making of finance loans
66
57

The late Melvin W. Traylor.
Hearings on Banking Systems, 1931, p. 411.

COLLABORATION WITH FOREIGN CENTRAL BANKS

343

to European central banks in 1931. In this case there are
evidenced the following conditions as to the way in which
the central banking system of the United States has developed: 6S
1. That the foreign operations of the Federal Reserve
system were handled by the Reserve Bank in New York for
all the other Reserve banks.
2. That the disposition of the reserves of all the district
Reserve banks was determined not only by the New York
Reserve Bank but by the Bank for International Settlements in Basle, Switzerland.
3. That the disposition of the reserves of district Reserve
banks for foreign use was determined not by the Federal
Reserve Board but by the New York Reserve Bank.
4. That the decision in the New York Reserve Bank was
made not by the board of directors, but the Executive Committee, presided over by the governor of the Bank.
5. That partners of a private international banking house
joined the sessions of the Executive Committee of the New
York Reserve Bank and that the official decision of the
Reserve Bank was determined during such collaboration.
6. That the New York Reserve Bank in collaboration
with a private international banking house, not the Federal
Reserve Board, determined the policy to be followed by the
Federal Reserve system.
Public purposes were proclaimed by the New York Reserve
Bank in its effort to reestablish monetary systems in Europe.
Under a regime of economic interdependence among nations,
maintenance of monetary and business stability in foreign
countries tends to promote domestic stability. Another
public motive of the Bank's transactions to facilitate the
establishment of monetary standards was the conservation
of the world's monetary gold stock. On account of a decline
in gold production cooperation among central banks was
considered essential in order to support the superstructure of
credit and aid world price stability.
In addition to public motives the cooperation of the
New York Reserve Bank with foreign central banks has been
68

See above, pp. 333-335.

344 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

undertaken apparently on account of private motives.
Private motives are seen in the case of the "easy money"
policy of 1927, and the finance loans to foreign central banks
in 1931. The former satisfied those stock market and affiliatedfinancialinterests who wanted cheap Federal Reserve
credit to promote speculation; and also aided New York
financial groups in floating huge amounts of foreign securities
in the United States. The finance loans of 1931 aided New
York banks which held quantities of "frozen" German acceptances. The course of the New York Reserve Bank's
policy during the above period in conjunction with the
happenings in the stock market and the flotation of foreign
securities would seem to indicate that private motives predominated.
Effect of Banking Act of 1933
Pursuant to the recommendations of the Senate Banking
and Currency Committee, provisions for reenforcing the
authority of the Federal Reserve Board over the system's
foreign contacts and operations were incorporated into the
Banking Act of 1933.69 The Federal Reserve Act as amended
by the new statute now provides that it is the duty of the
Federal Reserve Board to exercise special supervision over
all relationships and transactions of any kind entered into
by any Federal Reserve bank with any foreign bank or
banker, or with any group of foreign banks or bankers.
The Board is authorized to prescribe limitations and
regulations governing the foreign transactions of a Reserve
bank. An officer or representative of a Reserve bank may
not conduct negotiations of any kind with officers or representatives of any foreign bank or banker without first
obtaining the permission of the Federal Reserve Board.
Furthermore, the Board is given the right, in its discretion,
to be represented in any conference or negotiations by its
own appointees. Finally, a full report of all conferences or
negotiations, and all understandings or agreements arrived
at or transactions agreed upon, and all other material facts
appertaining to such conferences or negotiations, shall be
69

Banking Act of 1933, section 10; Federal Reserve Act, section 14(g).

COLLABORATION WITH FOREIGN CENTRAL BANKS

345

filed with the Federal Reserve Board in writing by a duly
authorized officer of each Federal Reserve bank which shall
have participated in such conferences or negotiations.70
The new statutes indicate that Congress has charged the
Federal Reserve Board with unequivocal and complete
authority and direction over the foreign relationships of our
central banking system or any component part of it. There is
no limit to the extent to which the Board may exercise control over any foreign policy or transaction involving a Federal Reserve bank* The present law affects particularly the
power exercised by the officials of the New York Reserve
Bank in the past in collaborating with foreign central banks
and bankers and steering foreign relations involving Federal
Reserve policy along lines desired or determined by them
(the officials of the New York Bank). Now that Congress
has placed in the hands of the Federal Reserve Board complete authority, it remains to be seen whether the Board will
control the foreign relationships of the Federal Reserve
banks or whether these relationships will be largely controlled as in the past by the New York Reserve Bank.
70
With a view to carrying out these new requirements, the Board has issued
regulations governing the relations of the Federal Reserve system with foreign
banks and bankers. See Regulations N, Series of 1933, published in Federal
Reserve Bulletin, August, 1933, p. 505.

CHAPTER XVII
CONCENTRATION OF BANK RESERVES
IN NEW YORK
The Intention of the Federal Reserve Act
Of all the evil conditions existing under the national
banking system none were so persistently and vehemently
denounced as the concentration of bank reserves in New
York and their use in the call loan market for the financing
of trading in securities. This entanglement of commercial
banking reserves with the speculation and investment markets was attacked as the prime and pressing evil of banking and business. The financial breakdowns, money panics,
bank runs, and even business crises which had befallen
the American economic system were held to have found
their inception in this alliance of the banks with stock speculation.
The remedy, therefore, for the dire consequences with
which the people were periodically visited was sought by
breaking the connection between bank reserves and the stock
market. This was an overwhelming motive in the minds
of some of the leaders in the banking reform movement.
Those who sponsored the Federal Reserve Act expected
that the organization and requirements for its operation
which they prescribed would prevent the concentration of
bank reserves in New York and their use in the stock market.
The following statements indicate their ideas and expectations :
In the belief that the present reserve system is antiquated
and unsatisfactory, that the massing of funds in New York and
other financial centers of which so much has been said in recent
years, is largely due to the present reserve requirements of national banks, and that in order to get the real benefit from the system of rediscount which has been proposed as a remedy for many
existing evils, it is necessary to base such system upon an actual

346

CONCENTRATION OF RESERVES IN NEW YORK

347

control of reserves, provision has been made for recasting the present bank reserve system.1 (From a digest of the first draft of
the Glass bill furnished by Mr. Glass to the President.)
Upon these precise lines the bill is cast. Guided by the lamp
of experience, taking note of the fact that, in time of emergency,
clearing house associations in the great money centers, and even
in smaller communities, repeatedly succeeded in arresting financial
disaster, the House Banking and Currency Committee conceived
the idea that regional organizations of individual banks throughout the country might effectually prevent disaster. Hence, the
fundamental idea of the bill now presented is the creation of a2
new class of banks to be known as Federal Reserve banks.
(Carter Glass)
The whole fight of the great bankers is to drive us from our
firm resolve to break down the artificial connection between the
banking business of this country and the stock speculative operations at the money centers. The Monetary Commission, with
more discretion than courage, absolutely evaded the problem;
but the Banking and Currency Committee of the House has gone
to the very root of this gigantic evil and in this bill proposes to
cut the cancer out. Under existing law we have permitted banks
to pyramid credit upon credit and to call these credits reserves.
It is a misnomer; they are not reserves. And when financial
troubles come and the country banks call for their money with
which to pay their creditors they find it all invested in stockgambling operations. There is suspension of payment and the
whole system breaks down under the strain, causing widespread
confusion and almost inconceivable damage.
The avowed purpose of this bill is to cure this evil; to withdraw
the reserve funds of the country from the congested money centers and to make them readily available for business uses in the
various sections of the country to which they belong.3 (Carter
Glass)
The purposes of this great measure are:
First. To insure the stability of our commerce, of our manufacturing enterprises, of our industries, and the safety of our merchants and manufacturers and business men generally.
Second. To make available effective commercial credit for individuals engaged in manufacture, in commerce, in finance, and
in business to the extent of their just deserts.
Third. To put an end to the pyramiding of the bank reserves of the
country and the use of such reserves for gambling purposes on the
stock exchange.
1
2
3

Willis, The Federal Reserve System, p. 174.
Congressional Record, Sept. 10, 1913, p. 4643.
Ibid., p. 4648.

348 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Fourth. To keep constantly employed the productive energies of
the nation.4 (Robert L. Owen)
Mr. President, one of the most far-reaching results which will
follow will be the abatement of the nuisance of the national menace of the stock-gambling operations in this country, because this
measure proposes to gradually withdraw these reserves, which
have heretofore
been pyramided in the three great central reserve
cities.5 (Robert L. Owen)
These typical expressions at the time of the establishment of the Federal Reserve system evidence the understanding of the situation and the intention of the Federal
Reserve Act on the part of the proponents of the new central reserve organization. The projected Federal Reserve
system possessed certain features upon which the sponsors
of the Reserve Act relied in order to achieve the objects
which they sought. The new organization was to comprise
a number of regional central banks to hold the reserves of
the member commercial banks* Reserves, therefore, were
to be withdrawn from the correspondent banks in the "reserve " and "central reserve cities" and placed in the Federal
Reserve banks. Accommodation to banks for seasonal
requirements or other times of emergency was to be met by
resort to the Federal Reserve banks rather than the correspondent banks.
Furthermore, the Federal Reserve system was to be a
commercial banking system rather than a stock market or
investment banking system.6 Liquid paper arising from
current commercial transactions rather than notes secured
by stock exchange collateral or merely investments was to
be the principal asset of the member banks as a group.
After the current requirements of its own community were
taken care of, the average bank was to "invest" its avail4

Congressional Record, Nov. 24, 1913, p. 5994.
Ibid., p. 5998.
In keeping with the intention and spirit of the Federal Reserve Act, the
first governor of the Federal Reserve Board, Charles S. Hamlin, delivered an
address before the American Bankers Association in 1914, in which he said:
"The assets of these Federal Reserve banks, and the government deposits
which may be made in them, will be pledged to strictly commercial uses and
cannot be used for speculative purposes." The Commercial and Financial
Chronicle, American Bankers Association Convention Section, Oct. 24, 1914,
p. 87.
6

CONCENTRATION OF RESERVES IN NEW YORK

349

able funds in acceptances or commercial paper rather than
the call loan market or stock exchange paper. Finally, the
central bank method of testing and liquifying commercial
credit was to be by the rediscounting of commercial paper
rather than by lending on collateral. Paper drawn for the
purpose of carrying or trading in business securities was forbidden rediscount at the central banks.
The Federal Reserve Act did not prohibit banks from
carrying balances with correspondent banks. But the Act
was drafted with a view to preventing the concentration of
bank reserves in New York. Under the regional plan interior banks were to be related to the Federal Reserve bank
in their district rather than to the correspondent banks in
New York. It was presumed that inter-bank balances would
dwindle to small proportions. Reserve city bankers feared
that such would be the case. It was particularly supposed
that balances would not be concentrated in New York,
which belief induced the extreme hostility of the New York
bankers to the Reserve Act.
The chief provisions of the Act by which the subjugation
of the correspondent banking system was to be accomplished
were these: Capital subscriptions to the Reserve banks were
prescribed for all member banks. Bank balances, in correspondent banks after three years, could not count as legal
reserve. Legal reserves had to be centralized in the regional
central banks. Lastly, clearing and collection functions
were to be performed by the Federal Reserve banks.
Inter-Bank Balances
Efforts were constantly made in the early years of the
Reserve system to extend and improve clearing and collection operations and thereby relieve member banks of the
necessity for keeping deposits in correspondent banks.
Nevertheless, in spite of the provisions of the Reserve Act
and the development of a nation-wide clearance system,
banks still kept large balances in other banks and these
balances have been especially concentrated in New York.7
7

For a statistical treatment of inter-bank balances since the establishment

350 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The amount of bank deposits from other banks has in
fact been much larger than it was in 1914. The following
statement from Watkins, Bankers' Balances, emphasizes
the continued importance of inter-bank deposits:8
In 1914 the 26,765 banks of the country reported deposits held
for the account of banks and maintained with banks amounting
to 2,705 and 2,873 million, respectively. By 1926 the total number
of banks had increased to 28,146, the amount due to banks to
4,297 million, and that due from banks to 4,031 million.

Some member banks have held more deposits of other
banks than deposits of individuals, firms, and corporations
combined. Not only as a whole but for all classes of banks
the amount of inter-bank balances has reached higher
levels since the establishment of the Federal Reserve system.9
Although member banks are required to maintain their
reserves in the form of deposits in the Federal Reserve
banks, their deposits in correspondent banks have been
near the level of non-member bank deposits in correspondent banks.10 But what is more significant, member banks
have on the whole had deposits in correspondent banks
which closely approximated their Reserve bank balances.11
If country member banks alone are considered, they, during
certain years, maintained deposits with correspondents
exceeding their Federal Reserve balances by from 27 per
cent to 51 per cent.12
The bankers' balances held by member banks located in
the Federal Reserve bank cities have generally been in
excess of the reserves of the twelve Reserve banks.13 The
continued vitality of correspondent banking relationships
of the Federal Reserve system, see L. L. Watkins, Bankers' Balances, chapter
IV; The New York Money Market, Vol. II, chapter X, by James G. Smith.
8
Watkins, op. cit., p. 50.
9
Ibid., chapter IV. See also The New York Money Market, Vol. H, pp. 203210. Bankers' balances relative to total deposits of all national banks, from
1900 to 1930, declined. Bankers' balances relative to total deposits of all
national banks, and of all member banks, from 1915 to 1930, declined, while
those of state member banks increased.
10
12
Watkins, op. cit., pp. 99-100.
Idem.
11
Ibid., p. 100.
"Idem.

CONCENTRATION OF RESERVES IN NEW YORK

351

is further evidenced by the fact that aggregate bankers'
deposits held by all member banks have exceeded their
reserves with the Federal Reserve banks by from 65 per
cent to nearly 100 per cent.14 In the case of the New York
City member banks, the chief point of concentration, the
deposits of their bank clients were far in excess of their own
reserve balances in the New York Reserve Bank—as much
as 96 per cent more in 1924.15
The dominance of New York City as the holder of bank
balances has not been lessened by the development of the
central banking system. Indicative of the concentration of
funds is the bank deposits of national banks in various cities.
The bankers7 deposits in the national banks of New York
City, in 1926, were 939 million dollars. The city next in
importance in this respect was Chicago which had 276 millions of such deposits.16 Although Chicago has gained substantially in importance, since 1914, as a correspondent
banking center, still the concentration of bankers7 balances
there is relatively small in comparison with the concentration in New York.
Again, as a result of a statistical study in 1932, the continued importance of New York as a center for the concentration of bankers7 deposits was shown.17 The concentration in the form of bankers' deposits relative to total deposits
is slightly less than it was before the Federal Reserve system
in all sections of the country. Nevertheless, New York City
is not only just as important a point of concentration of
bankers7 balances relative to other centers as it was before
the Reserve system, but slightly more so. Moreover, the
New York City bants have gained as depositaries for funds
of banks throughout the country as a whole. Whereas other
financial centers have gained in importance for their surrounding territory, particularly Chicago for the Middle
West, New York City has become more important as a
national depositary center than before the Reserve system.18
14
Idem.
1B
Idem.
16
Ibid, p.
17
18

57. The figures are those at the midsummer report dates.
The New York Money Market, Vol. II, chapter X, by James G. Smith.
Idem.

352 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM
Pyramiding of Reserves

It will be recalled that under the national banking system,
the New York City national banks had to keep a 25 per cent
gold reserve 19 against their deposits. Since part of such
deposits consisted of the legal reserves of banks all over the
country, the 25 per cent gold reserve of the New York banks
was at that time practically the ultimate reserve of the
country's banking system. As was pointed out above, a
substantial part of the legal reserves of non-member banks
has been scattered in city correspondent banks as before
the Federal Reserve system, and the concentration of such
reserves in New York has continued. It was estimated in
1932 that approximately 20 per cent of the bankers' balances
in New York City at that time was constituted of legal
reserves of non-member banks.20
In so far as the bankers' balances in the New York banks
have consisted of the reserves of non-member state banks
throughout the country, the ultimate reserve of the nonmember banks under the Federal Reserve system has been
located also in New York City. This ultimate reserve has
been the 35 per cent gold reserve 21 held by the Federal
Reserve Bank of New York against its member bank reserve
account. Moreover, this gold reserve has also been in practice an ultimate reserve against interior member bank
deposits in the New York City banks. Although these
balances in New York could no longer be counted as legal
reserves, the depositing member banks looked upon them
as reserves. The New York Reserve Bank's gold supported
the huge amount of these secondary reserves from all sections of the country. The secondary reserves were treated
as the equivalent of cash and in fact were withdrawn whenever desired without any trouble.
The pyramiding of reserves, therefore, has continued
under the Federal Reserve system. It has worked in this
way: Reserve deposits have been kept by interior non19
Considered here as a gold reserve because it was essentially gold although
some so-called "lawful money" was included.
20
The New York Money Market, Vol. II, p. 276.
21
Including some lawful money.

CONCENTRATION OF RESERVES IN NEW YORK

353

member "country" banks with "approved reserve agents"
(correspondent banks) in Chicago, St. Louis, and other
"reserve cities/' and against such deposits the reserve agents
in those cities have in turn maintained deposit balances with
the New York City banks. Against the deposits of interior
banks held in New York City member banks, the latter,
in turn, have had to keep a reserve of 13 per cent, not in
gold but in the form of deposit credit, in the New York
Federal Reserve Bank. Thus we have had an integratedchain bank-credit structure wherein bank credit served as a
reserve for other bank credit.22
As our banking has developed under the Federal Reserve
system, pyramiding of reserves has not only not been eliminated, but the degree of pyramiding has actually increased.
The old method of redeposited reserves with their concentration in New York has remained practically unchanged.
Whereas under the national banking system, the New York
City banks had to keep a 25 per cent gold reserve against
their deposits, under the Federal Reserve system, they have
had to keep only 13 per cent reserve against such deposits,
and that not of gold, but of deposit credit in the Federal
Reserve Bank. Upon the basis of this 13 per cent reserve,
which itself was capable of a huge increase until the ratio of
the Reserve Bank's gold to its deposits amounted to 35 per
cent, it has been possible to effect the tremendous expansion
in the superstructure of credit which has taken place by
means of the central banking system.
Use of Bank Credit in Security Speculation: Brokers' Loans
With the continued dominance of New York City as a
concentration point of the nation's bank reserves, legal and
secondary, their use in financing speculation on the stock
exchange has persisted. Large amounts of bank funds from
interior banks have continued to be available to the "Wall
Street" banks to loan at the money desk of the stock exchange. A direct relationship has generally existed between
the brokers' loans of the New York City banks for their own
22
For a statistical survey of deposit credit pyramiding, see The New York
Money Market, Vol. II, pp. 195-201.

354 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

account and the due-to-banks.23 At times this relationship
has been so close, as through the years 1926, 1927, 1928, and
1929, as to point to the conclusion that it has not been
fortuitous.
The holding of deposits of interior banks in the New York
City banks is only one form of concentration of bank resources in New York. Interior banks also send their funds
to New York to be loaned directly on the stock exchange by
the New York banks acting as their agents. This form of
concentration in New York is reflected in brokers7 loans for
the account of out-of-town banks.24 There was a huge
increase in brokers' loans for the account of correspondents
and out-of-town banks during the existence of the Reserve
system, which increase reached its climax in 1929.25
From the beginning of the Reserve system to October,
1929, there was a general rise in all classes of brokers7 loans.26
Such classes include loans made by the New York City banks
for their own account, loans made by these banks for the
account of out-of-town domestic banks, and loans for the
account of " others." 27 The chairman of the House Banking
and Currency Committee stated, in 1926, that the classes of
brokers' loans of the New York City banks, those for their
own account and for the account of out-of-town correspondents, which were $500,000,000 in 1913, had increased to
seven times that amount.28 The significant fact is that not
23
24

See Beckhart, The New York Money Market, Vol. Ill, pp. 148-153.
Prior to 1926, there was no separate classification of loans for the account
of out-of-town banks. The New York banks classified brokers' loans according
to loans for their own account and loans for the account of "correspondents."
Loans for "correspondents" represented, at the time of the establishment of
the Reserve system, chiefly loans for out-of-town bank clients of the New
York banks. Beginning in January, 1926, the loans to brokers, which the
New York banks made as agents for their clients, were classified into loans
for out-of-town banks (meaning domestic banks) and loans for " others.*'
The loans for "others" came to occupy an increasingly important r61e, even
exceeding the other two classes in amount.
26
See Beckhart, op. cit, pp. 81, 145, 159.
38
Ibid., Part I.
27
"Others" refers to domestic and foreign corporations or firms, investment trusts, individuals, and foreign banks,
28
Stabilization Hearings on H. R. 7895, 1926, p. 976. See also Hearings on
Banking Systems, 1931, Appendix, Part VII, pp. 1020-1029.
During this period since 1913, the level of prices was higher than formerly.

CONCENTRATION OF RESERVES IN NEW YORK

355

only has the use of bank reserves for speculation not been
lessened but that a much larger proportion of the nation's
banking resources has gone into stock speculation and
corporation security loans since the establishment of the
Reserve system.29
It must not be supposed that the New York banks were
responsible only for the brokers7 loans made for their own
account. These banks were also largely responsible for the
loans for the account of the out-of-town banks and for the
"others." Their responsibility presents several aspects. The
New York banks sought this business from the banks and
business concerns throughout the country. A business concern or a bank that had "surplus" funds would be approached by a New York bank and asked to transfer their
account to that bank. Suppose the amount was $3,000,000.
As an inducement to making the transfer, the bank would
say, "We will lend $2,000,000 of that on the call market if
you will keep the other million on deposit with us." 30
The development of the brokers7 loan business was due
There was also a general growth in industry and trade and a n increase in t h e
number of listed shares. Both of these factors would require a greater number
of dollars t o effect the turnover of a given volume of transactions. T h e question of whether the increase of bank credit in the New York security market,
or t h e increase of b a n k credit which went into corporation securities generally,
was o u t of proportion t o t h e country's industrial development is capable of
only approximate determination if a t all a n d is not involved in this discussion.
T h e subject a t h a n d concerns the use of the nation's liquid banking resources
in stock speculation or investment operations.
29
See Brokers' Loans Hearings, 1928, pp. 1, 2, a n d 33; and appendix of the
Hearings on Banking Systems, 1931, P a r t V I L
T h e peak of brokers' loans b y the reporting New York City member banks
was reached on October 2, 1929 when they totaled 86,804,000,000. This
a m o u n t was subdivided as follows: For own account, $1,071,000,000; for outof-town banks, $1,826,000,000; for others, $3,907,000,000. T h e total consisted chiefly of demand loans, t h a t is loans on call. T h e figures were: time
loans $362,000,000; call loans, $6,442,000,000. Annual Report of the Federal
Reserve Board, 1929, p . 119.
E v e n more than t h e total of brokers 7 loans given above was used in financing
trading o n t h e N e w York Stock Exchange. T h e Stock Exchange reports
brokers' borrowings, which include, in addition t o loans m a d e b y t h e N e w
York banks, loans b y private banks, brokers, foreign banking agencies, etc.
T h e peak of brokers' borrowings as reported b y t h e N e w York Stock Exchange
was $8,549,000,000 on September 30, 1929. Annual Report of t h e Federal
Reserve Board, 1929, p . 120.
30
Hearings on Branch, Chain, and Group Banking, 1930, p. 723.

356 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to the activity of the New York banks in going to business
concerns and out-of-town banks and soliciting their funds to
lend in the call money market at high rates.31 These organizations cannot get into the call money market directly. A
Chicago banker, for example, cannot lend in the New York
brokers' loan market without going through a New York
bank. The mechanism of the market is such that all of these
brokers' loans must be made by or through a New York
bank.32 The New York banks connected American banks
and other lenders with the stock market and received a
commission for making such loans.
In the case of loans for the account of others, the New
York banks' responsibility embraced more than soliciting
the funds and acting as agents for the placing of these loans
in the stock market. As a result of an investigation made
for the Senate Banking and Currency Committee in 1931,
the sources of brokers' loans for the account of " others"
was determined.33 The figures were obtained from seven
large New York banks, as of the date when the largest volume
of such funds was handled in 1929. These amounts accounted
for approximately two-thirds of the total loans for uothers"
and were considered typical of the distribution of this class
of brokers' loans. It was found that business corporations
supplied 58 per cent of the total shown by the seven banks
and investment trusts 8 per cent. Domestic corporations,
therefore, furnished two-thirds of the loans for "others."
These domestic corporations obtained funds with the
consent and assistance of the banks. The bankers were
substantially interested in the investment trusts and actually
owned outright their security affiliates. Many of the security
affiliates were heavy lenders in the stock market. The flotation of securities of the corporations and investment trusts
was financed by the banks directly or through afiiliates.34
31

Practically all of the brokers' loans which the New York banks made for
the account of out-of-town banks and others were call loans. The small proportion of time loans made were for the New York banks' own accounts.
32
The bank may be a private bank as well as an incorporated one.
33
See Hearings on Banking Systems, 1931, Appendix, Part VII, p. 1024.
34
See H. Parker Willis, " American Banking and Investment Trust Problems," The Banker, London, January, 1928.

CONCENTRATION OF RESERVES IN NEW YORK

357

The commercial banks purchased relatively large amounts
of corporation securities for their own account. In addition to purchases, the banks supplied funds to the security affiliates and investment banking houses by making
collateral loans. By these methods the banks "carried"
the securities until they could be sold to the public.
The "money" loaned on the stock exchange by the
"others" did not come entirely from the earnings of the
corporations or the proceeds of sales of securities to investors.35 Bank credit furnished some part of the funds in the
first place for such loans. The creation of bank credit
financed part of the brokers' loans of the "others" in these
ways: (1) corporation securities had been purchased by the
banks with bank credit, (2) the "others" had borrowed
funds from the banks which were loaned on the exchange,
and (3) the purchasers of securities, from the "others"
which made the loans, had borrowed to pay for them. To
the extent that these means had enabled the "others" to
make brokers7 loans, the funds so loaned did not consist of
savings but were the result of the creation of bank credit.
The New York banks were responsible for their loans to
brokers for the account of outside banks and "others" in
that they solicited bank and corporation deposits and
stimulated speculation by promising a reward through loaning the funds on call at a profitable rate. Further responsibility attaches to the New York banks because they furnished
in part the funds which the "others" used in turn to loan
through the banks, and assumed a sort of contingent liability
with regard to them which in fact became real.
As a result of the New York bankers' activity, loans for
the account of "others" assumed increasing importance in
the total of brokers' loans during the "new era" period
preceding the stock market crash in October, 1929. They
reached higher totals than the other two classes of loans
combined, comprising nearly 60 per cent of the total of
brokers' loans.36 The New York banks made a handsome
35

The New York Money Market, Vol. IV, Part I, p. 104, by B. H. Beckhart.
See Annual Keport of the Federal Reserve Board, 1929, p. 119 and Beckhart, The New York Money Marke , Vol. Ill, p. 81.
In order to restrict the use of bank credit in the stock market, the Banking
36

358 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

income out of the system for they secured a commission or
interest when they supplied corporations with funds, and
again when they loaned these funds in the stock market for a
commission. With the corporations and investment trusts
loaning the proceeds of their financing on call through the
medium of the banks, bank credit further fed the stock
market boom*
The sponsors of the Federal Reserve Act expected that the
new statutes and central banking organization would lessen
the attractiveness of the call money market in New York.
It was anticipated that the amount of credit available to the
New York banks for lending on the stock exchange would be
curtailed. Brokers7 loans, made as they are by the commercial banks and used for securities speculation or for the carrying of unsold stocks and bonds, reflect the use of bank credit
in such speculative operations. The record of the years
shows how far the intention of the Federal Reserve Act
failed of realization.
The only call money market in the country of national
importance is the one in New York. Moreover, the Federal
Reserve system has made the New York call money market
more attractive than it ever was before the establishment of
the central banking system.37 Distance from New York was
no barrier nor was the size of the bank a deterring factor.
Even the banks in the Pacific coast section and the small
country banks have been sending funds to loan on call in
Wall Street.38 The effect of sending funds from the country's
banks to New York was to cause the local banks to turn to
their respective Federal Reserve banks and borrow.39 The
Act of 1933 decreed that: "No member bank shall act as the medium or agent
of any non-banking corporation, partnership, association, business trust, or
individual in making loans on the security of stocks, bonds, and other investment securities to brokers or dealers in stocks, bonds, and other investment
securities." [Banking Act of 1933, Section 11 (a).] This statute strikes at the
brokers' loans which the New York banks made for the account of others.
37
Concerning the reason for this, see chapter XVIII, section on New York
Call Loan Market versus Other Money Markets.
88
See the following: Stabilization Hearings on H. R. 7895, 1926, pp. 680,
881; Hearings on Branch, Chain, and Group Banking, 1930, pp. 119-122;
Hearings on Banking Systems, 1931, pp. 337-338; Monthly Review of the
Federal Reserve Bank of New York, March 1, 1933, p. 34.
^Hearings on Branch, Chain, and Group Banking, 1930, pp. 119-122.

CONCENTRATION OF RESERVES IN NEW YORK

359

banks borrowed from their Reserve banks at a low rate and
loaned money in New York on the stock exchange at a high
rate.40
Not only have surplus bank funds been sent to New York
to loan on the stock exchange, but even bank credit which
was needed to meet the requirements of the banks' local
customers. Thus the chairman of the House Banking and
Currency Committee stated: 41
I called that to the attention of a banker friend of mine from
the central west the other day, a section of the country which
claims it greatly needs additional banking facilities to take care of
the needs of farmers. He confessed to me that he was probably
guilty in that respect, because during the period referred to 42 his
bank was loaning on call at New York to the extent of a million
dollars.
A Federal Intermediate Credit Bank in a private statement reported the following:43
Again, local funds for short-term loans to farmers seem to be
particularly scarce at this time. During 1929 such loans were scarce,
because the banks could more profitably employ their funds in the call

market, but today the scarcity seems to be real. More and more
we arefindingthat the Federal Land Bank is about the only source
of new money for many farm borrowers.

Hon. Francis Seiberling of Ohio, member of the House
Banking and Currency Committee, stated that he knew
that such lending in the New York call money market
was sometimes substituted for loans to commercial or industrial enterprises, which otherwise would have been made.44
Further corroboration of the sucking of needed commercial credit into the speculative call loan market was
given by the Comptroller of the Currency. The Comptroller, whose position as head of the examination function
of national banks enabled him to know, testified before the
40

Idem.

41
Stabilization Hearings
42
The year 1925.
43

on H* R. 7895, 1926, p. 881.

Quoted by IL Parker Willis in an article entitled "Restoring Bank Liquidity in the United States/' The Banker, London, March, 1930, p. 411.' The
italics are those of the present writer.
44
Hearings on Branch, Chain, and Group Banking, 1930, p. 726.

360 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Senate Banking and Currency Committee in 1931 as
follows:45
The Chairman (Senator Carter Glass). Does it not frequently
happen that a commercial bank fails to accommodate its commercial customers in order that they may use the funds for call loans?
The Comptroller of the Currency (Hon. J. W. Pole). I have no
doubt there are cases of that.
The preservation of the resources of the banks for paying
depositors and meeting industrial, agricultural, and commercial requirements, which the Federal Reserve banks
were designed to serve, therefore, has been prejudiced by
the concentration of bank funds in New York and their use
in stock speculation, just as before the Federal Reserve
system. Banks in all sections of the country have continued
sending funds to New York. In the first place, these banks
sent funds to the New York banks for the interest obtained
on their deposit balances, which balances the New York
banks in turn loaned on the stock exchange. Secondly, the
outlying banks loaned directly in the New York call money
market at a higher rate using the New York banks as their
agents. In the third place, the banks then borrowed from
their Federal Reserve bank at a low rate and loaned in the
New York call money market at a profit. Finally, some
interior banks even curtailed needed accommodation to
commerce, agriculture, and industry in order to make a
greater profit by loaning on call in the New York stock
market.46
Reasons for Correspondent Ranking and Concentration in New
York
There are a number of considerations which account for
the continued existence of the correspondent banking system, for a greater expansion of bank credit, and for the predominant concentration of bank reserves in New York City
providing credit for stock speculation. The Federal Reserve
45

Hearings on Banking Systems, 1931, p. 13.
Concentration of bank resources in New York was also encouraged and
aided by the management of the Federal Reserve banks with respect to their
rate and acceptance policies. (See chapter XVIII, p. 375, section on The New
York Call Loan Market versus Other Money Markets.)
46

CONCENTRATION OF RESERVES IN NEW YORK

361

Act did not require all bankers* balances to be kept on deposit in the Reserve banks but only the legal reserves. The
Act reduced the legal reserve percentage requirements of
national banks. In addition, deposits were classified into
demand and time with the latter requiring a much smaller
percentage than the former. This reduction in required
reserves left a margin between the old and new reserve percentages from the start to seek employment or be deposited
wherever the member banks chose.
A further reduction in legal reserve percentages for both
demand and time deposits, in 1917, made available to member banks still more reserves which would be deposited in
correspondent banks. In that year also all member bank
reserves were required to consist of deposit balances in the
Federal Reserve banks. The member banks transferred the
portion of reserves held by them to the Reserve banks in
part in the form of gold and lawful money and such transfers made possible further enlargement of bank credit.
During the existence of the Reserve system several influences have been at work which have had the same effect on
the amount of actual reserves which member banks held as
a lowering of the legal percentages. One of these is the rulings
of the Comptroller of the Currency and the Federal Reserve
Board. In every instance such rulings were in the direction
of reducing reserve requirements, thus making for an expansion of bank credit and reserve balances.47 Another factor
was the issuance of Federal Reserve notes in exchange for
gold. This practice which was begun in 1915, as an administrative variation from the law, was legalized in 1917. The
revised procedure of issuing notes made possible a considerable expansion of bank credit.48 Also the unprecedented
gold imports swelled member bank reserves far above what
they otherwise would have been; and the gold in conjunction with the lowered reserve requirements greatly multiplied the expansibility of bank credit.
In addition the banks had "extra" reserves to deposit
where they chose because of a shifting of demand deposits
47
48

Stabilization Hearings on H. R. 7895, 1926, p. 371.
See chapter X, pp. 204-205.

362 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

to time deposits. The reserve percentage for time deposits
was lowered in 1917 from 5 per cent to 3 per cent and there
has been no reduction since then. But many banks got their
customers to shift their demand accounts to a time basis.
This practice went on continuously after 1917 and had the
effect of enlarging the actual reserves. Time deposits increased much more rapidly than demand deposits.49 The importance of this shift was shown as a result of an inquiry made
by the Federal Reserve Bank of New York. It was held that
about 55 per cent of the increase in bank deposits that occurred during nine years was represented by an increase in
time deposits which required only a 3 per cent reserve.60
Finally, the average banker was less inclined to assume
responsibility for the strength of his own position. He
tended to cut his vault cash and surplus legal reserve balance to the minimum and depend upon the central bank
when in need of funds. The need of a bank to keep an excess
reserve and till money was removed because of (1) the
reduction of money in circulation by the increased use of
deposit currency, (2) the smooth working of the Reserve
system in effecting transfers of funds and clearances, (3)
the increased velocity of circulation of money and credit,
and (4) the ability to borrow and secure cash quickly,
facilitated especially by the wire transfer system.51 Thus
*9See B. M. Anderson, Jr., "Bank Expansion vs. Savings," The Chase
Economic Bulletin, June 25, 1928, pp. 12-16.
60
Stabilization Hearings on H. R. 7895, 1926, pp. 370-371.
In a statement before the House Banking and Currency Committee,
Mr. Strong, governor of the Federal Reserve Bank of New York, said: "Nobody can tell to what extent, because of the inducement of a larger profit to
the member bank in getting accounts transferred from a regular checking
account to some form of time deposit requiring but 3 per cent reserve, how
much of the really check deposit balances of the banks of the country are in
fact being carried on a 3 per cent reserve. That is a material reduction in the
reserve of the banking structure. It would require a very careful analysis of
just how each bank classifies these accounts and what kind of contracts it
makes with its depositors to get a correct understanding of this, but there is
a subtle and very important change that has taken place in the banking structure." Stabilization Hearings on H. R. 7895, 1926, p. 371.
51
Concerning the circulation of money under the Federal Reserve system,
Dr. A. C. Miller of the Federal Reserve Board testified before the House Banking and Currency Committee as follows:
Dr. Miller. There is no country in the world, probably, where the rapidity

CONCENTRATION OF RESERVES IN NEW YORK

363

the very existence and operation of the Reserve system
itself tended to reduce the actual amount of reserves required and to enlarge correspondent bank balances.
Another explanation of reserve balances in correspondent
banks is found in the nature of American banking. Because
of the dual banking organization it has been possible for the
forty-eight state governments to determine where the legal
reserves of their respective state banks could be kept. Under
state banking laws, non-member state bank reserves either
were required to be held or might be held in other banks.52
In nearly all cases the statutes of these states permitted
deposits in the New York City banks to be counted in the
required reserves.
In the case of state banks which were members of the
Federal Reserve system, they were obliged to conform to
the reserve requirements for national or member banks.
But most of the state banks—thousands of them—were outside the Reserve system. These non-member state banks
have been keeping some or all of their legal reserves in correspondent banks, or "approved reserve agents," as the
state statutes and banking regulations commonly refer to
them. Thus the correspondent banking system has continued to perform the function of reserve depositaries for
non-member banks, just as it did for all banks before the
Federal Reserve system.
Following the passage of the Federal Reserve Act, there
of turnover of money is as great as it has become in the United States under
the Reserve system.
The Chairman. Velocity, I think it is commonly referred to.
Dr. Miller. Velocity, or, as I would prefer to call it, efficiency of performance
of the monetary unit of value under the operation of the Federal Reserve
system. The American dollar has become an efficiency marvel. Currency,
we will say, is retired from circulation in San Francisco today. Tomorrow it
is loaned on call in New York City. This means that the San Francisco member bank gets credit in its reserve account with the Federal Reserve Bank of
San Francisco on the day it deposits redundant currency, immediately arranges
for a transfer wire to New York, and it is out on call tomorrow. Stabilization
Hearings on H. R. 11806, 1928, p. 175.
62
For the provisions of state laws relating to reserve requirements of state
banks, see the following Federal Reserve Bulletins: Vol. Ill, p. 768 (October,
1917); Vol. X, p. 154 (March, 1924); Vol. XIV, p. 778 (November, 1928); VoL
XVI, p. 570 (September, 1930).

364 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

was a lowering of reserve percentage requirements, but the
proportionate amount that state laws permitted state banks
to carry with correspondents remained approximately the
same.53 Besides, state laws permitted state banks to include
Federal Reserve notes in their legal reserves. All of these
factors tended to release more funds available for transfer
to New York. In addition to the legal and secondary reserves
of non-member state banks, the secondary reserves of
national banks and state member banks continued, under
the Federal Reserve system, to be deposited in correspondent
banks, chiefly in New York.
One reason why banks kept reserves on deposit in correspondent banks and not in the Federal Reserve banks has
been the rate of interest paid on deposits by the commercial banks.54 The New York correspondent banks have
competed with those of other cities for the holding of the
reserve balances, legal and auxiliary, of the interior banks.55
In this competition the New York banks have continued
to hold the dominant position as we have seen. The chief
magnet in New York has been the stock market with its
financial tributary, the call loan market. Because of this
speculative market, the New York banks have been able to
provide a highly profitable outlet for bankers' balances and
to pay an attractive rate of interest on them, just as before
the Federal Reserve system. American banks have seen fit
not to resist the temptation to send their reserves to New
York for the interest paid by the " Wall Street" banks.
The city correspondent banks have also rendered a number of services to their bank clients, some of which could not
"See Annual Report of the Federal Reserve Board, 1915, pp. 104-113;Federal Reserve Bulletin, March, 1924, pp. 154-181.
64
This motive for the maintenance of deposit concentration in New York
and other reserve city banks was considerably lessened by the Banking Act
of 1933. This act [Section 11 (b)] prohibited any member bank from paying
any interest on demand deposits, with certain exceptions applicable to foreign
countries, mutual savings banks, and public deposits. Nearly all the correspondent banks in New York, Chicago, and other reserve cities are member
banks. So this new law tends to curtail the amount of bankers' balances in
correspondent banks. And as for time deposits, the same act [Section 11 (b)]
charges the Federal Reserve Board to limit by regulation the rate of interest
which member banks may pay on such deposits.
55
See Stabilization Hearings on H. R. 11806, 1928, p. 128.

CONCENTRATION OF RESERVES IN NEW YORK

365

be obtained from the Federal Reserve banks. The most
important service which interior banks have obtained from
city correspondents in New York and other centers is loans.
Non-member banks have not been permitted to borrow
from Federal Reserve banks except for a brief period during
and immediately following the World War. Consequently
they have relied upon their city correspondents for loans.
Some member banks in certain seasons of the year have
made more loans to correspondent banks than they made
to their local customers. A number of city banks, especially
in New York but in other cities also, have done a large
volume of such business with their correspondents. Although
not lenders of last resort, they have been virtually banks of
rediscount, performing this function for their correspondents
as Federal Reserve banks have done for their members.
Perhaps the most striking aspect in which correspondent
banking relationships have been different from that intended
by the framers of the Federal Reserve Act is the borrowing by member banks from their city correspondent banks.
The volume of such loans has been considerable when compared to the volume of member bank borrowings from the
Federal Reserve banks.56 The correspondent banking relationship has been particularly attractive to banks because
they could borrow from the city banks on paper of types
collateralled with corporation securities, which were ineligible
for discount at a Federal Reserve bank.57
m
The continued importance of correspondent bank loans to banks which
were members of the Federal Reserve system is shown by the following examples: On December 31, 1929, ''country" member banks had bills payable
with the Federal Reserve banks amounting to $137,000,000, and with correspondent banks amounting to $105,000,000. (Federal Reserve Bulletin,
March, 1930, p. 136). On September 30, 1932, "reserve city" member banks
had bills payable and rediscounts with Federal Reserve banks amounting to
$76,000,000 and with correspondent banks amounting to $93,000,000. Federal Reserve Bulletin, December, 1932, p. 782.
See also The New York Money Market, Vol. II, pp. 222-227, 238-240.
67
Thus one country bank borrowed $100,000 from the Chase National Bank
in New York instead of the Federal Reserve Bank of New York. The country
bank could borrow from the Chase National Bank at the same rate as that
charged by the Reserve Bank or sometimes a little higher, and particularly,
it borrowed on railroad bonds or other securities on which it could not borrow
from the Federal Reserve Bank. Hearings on Brokers* Loans, 1928, p. 87.

366 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Throughout the existence of the Reserve system, American banks, member and non-member alike, have borrowed
from their correspondents in New York.58 In order to obtain
loans, the interior banks were required to build up a "borrowing equity/7 as the New York banks called it; that is
they had to keep a satisfactory amount on deposit in order
to borrow the desired amounts.59 New York City banks
have usually required their correspondent bank clients to
keep a minimum balance equal to about 20 per cent of the
bank's borrowings. Some of the large New York banks,
such as the Chase National which held balances from over
7,000 banks, were in an especially favorable position to loan
to their correspondents funds which the latter, considered
as a group, had deposited. But if the New York banks
lacked sufficient funds to meet the needs of their bank
clients over the country, they borrowed from the Federal
Reserve Bank of New York and thus supplied the credit.
Another service which attracted bank deposits to New
York is that of safekeeping of securities. The custody service of the Federal Reserve banks has extended only to
member banks and has embraced only securities owned by
the member banks. The New York commercial banks, in
addition to such services, have held for safekeeping the
securities of non-member banks and those of the customers
68
Hearings on Branch, Chain, and Group Banking, 1930, pp. 1892-1893;
Hearings on Banking Systems, 1931, p. 269.
69
The relationship between the bank balances with a New York correspondent bank and its loans to bank clients is illustrated by the experience of
the Chase National Bank of New York in 1920 and 1921. The following figures relate to fifty-nine state and national banks, among the thousands which
kept deposit balances with the Chase bank. The fifty-nine banks were located
in the South from coast to coast and in the West from Canada to Mexico as
far east as the Mississippi Valley including a few in Ohio and Indiana. Banks
in the larger centers were not selected. Otherwise the fifty-nine banks were
reported to have been picked at random. (Hearings on Branch, Chain, and
Group Banking, 1930, p. 1893.)

January, 1920
September, 1920
October, 1920
November, 1920
December, 1920
January, 1921

Balances
81,426,400
1,215,800
1,221,200
1,091,800
754,200
759,200

Loans
$ 459,200
1,057,500
1,677,800
1,346,400
801,500
951,300

CONCENTRATION OF RESERVES IN NEW YORK

367

(individuals, firms, and corporations) of member and nonmember banks. Interior banks, member and non-member
alike, have, for two chief reasons, found it advantageous to
have a New York correspondent bank connection to obtain
this service.
With such a connection interior banks have been enabled
to borrow almost instantly. By telephone or telegraph they
have arranged with their city correspondents to credit their
accounts with a certain amount, using securities in custody
as collateral.60 Secondly, by having the securities held in
New York, interior banks and their customers have been
able to sell them in the national security market whenever
they wished. When the securities were sold the proceeds
were made immediately available to them if desired by telegraphic transfer.
The New York City banks have rendered a number of
other services for their correspondent banks in connection
with the investment of their funds. They made inquiry
regarding the advisability of various credits and drew upon
their extensive statistical and credit departments to furnish
information to the interior banks. Upon request "investment counsel" was given concerning the purchase and sale
of securities. Interior banks have preferred to buy and sell
securities, especially unlisted issues, through their New York
correspondent bank rather than to deal directly with a
broker.61 The New York banks allotted their clients participation in new security issues and acceptance financing
and purchased for their account acceptances and commercial paper. They facilitated the investment of secondary
reserves in commercial paper by analyzing its worth and
collecting it at maturity. Brokers' loans on the stock exchange also were handled for interior banks in record breaking amounts as was noted above. The New York banks held
M
See Hearings on Brokers' Loans, 1928, p. 87.
Where a member bank had government securities in custody at a Reserve
bank, it was able to borrow with similar convenience and dispatch. But in
the case of member banks rediscounting with their Federal Reserve bank, it
was necessary to gather the desired amount of eligible paper and send it to the
Reserve bank.
61
In so doing the New York bank's own broker handled the transactions.

368 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

the collateral and handled all details about these loans for
the interior banks. Finally, the New York banks collected
interest coupons and credited the accounts of the correspondent banks. These "investment services" have been
of considerable influence in maintaining balances in the
New York correspondent banks.
Certain aspects associated with the development of the
clearing and collection system have also made it advantageous for banks to carry balances with correspondent banks
in New York and other reserve cities. Non-member banks
which decline to remit in acceptable funds to Federal Reserve banks and operate on a non-par collection basis, cannot use the Federal Reserve system as a collection agency.
The number of banks which have preferred to deal with
city correspondents for clearance purposes has comprised
most of the non-member banks. By using city correspondent
banks, the interior banks have in most cases been given
immediate or earlier credit than was given by the Federal
Reserve banks. The New York City banks have been giving
immediate credit.62 Interior banks have also been permitted
to send transit items in batches instead of sorting them
according to the time collection schedule and keeping thengeneral ledgers on a deferred account basis.63 Again, some
collections are more simply and quickly effected by means
of inter-bank debits and credits than by putting them
through the Federal Reserve clearance system.64 Furthermore, in the case of those non-member banks which have
refused to remit at par, banks chiefly in the South and West,
they have also derived a profit in exchange charges.
The Federal Reserve system has largely done away with
the need of maintaining city bank balances to furnish domestic exchange. However, owing particularly to the dual
banking structure with thousands of non-member state
banks, and a substantial part of them not remitting at par,
62

See Watkins, Bankers' Balances, pp. 137-139;
While the large New York banks have given their correspondents immediate credit, they have not been willing that the Federal Reserve banks
give immediate credit.
" F o r some examples of such action, see The New York Money Market,
Vol. II, pp. 234-237;
83

CONCENTRATION OF RESERVES IN NEW YORK

369

domestic exchange on banks in New York, Chicago, and
other reserve cities has continued to be supplied to some
extent. As far as foreign exchange is concerned the need
of foreign balances has been lessened by the development
of the American acceptance market. Nevertheless, during
the existence of the Federal Reserve system, hundreds of
millions of dollars have been required annually for payments
abroad.
The Federal Reserve banks have not established branches
abroad on which interior banks could buy foreign exchange.
Such facilities not having been established, the Reserve banks
have done very little to supply foreign exchange. Not being
able to secure exchange from the Reserve banks, the interior
banks have continued to secure it from their correspondent
banks in the larger centers which banks have depended
chiefly upon foreign banks. The bulk of foreign exchange
has been sold by the New York City member banks. In
order to obtain this exchange for their customers and the
counsel and service that have accompanied it, the interior
member as well as non-member banks have maintained
balances in New York.
In the case of a member bank, it need not have kept a
balance with a correspondent bank. The member bank
could have paid for the exchange with a check on its Federal
Reserve bank. But member banks have found it more convenient and more profitable to maintain a balance with the
correspondent bank furnishing the exchange and to pay by
having this account debited. By this method it has also
been possible at times to render service to customers more
quickly. The correspondent banking system has owed its
existence during the Federal Reserve period in part, therefor, to the city banks' facilities for supplying domestic and
foreign exchange.65
65
In the hearings before the Senate Banking and Currency Committee in
1928, it was brought out by a member of the Federal Reserve Board that the
New York City bankers served their correspondent bankers also by buying
them theatre tickets and entertaining them in various ways when they went
to New York. Hearings on Brokers' Loans, 1928, p. 87.
The publisher of a mid-western banking journal conducted a survey concerning the relative merits of the correspondent banking system and the
Federal Reserve system. About 2,000 questionnaires were answered. In reply

370 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The various considerations discussed above have tended
to maintain the usefulness of correspondent banks, in spite
of the Federal Reserve banks, to member as well as nonmember banks, and to continue the predominant concentration of bank reserves in New York City. A few of the
New York banks developed financial connections national
and world-wide in scope. Particularly on account of their
contact and experience with foreign trade financing and
the national and international security markets, they have
offered to American banks profitable employment of reserves and valuable services. The New York institutions
have provided a broad correspondent banking service which
smaller banks in other cities have not been in a position to
equal.
to the question: What is the most unusual service a correspondent bank ever
rendered you? some answers were: Offered to do our Christmas shopping;
secured costumes for a home talent play; acted as detective in locating a man
we were looking for; secured theater and athletic tickets we couldn't hope to
get. The New York Herald Tribune, March 7, 1928.
See also Hearings on Branch, Chain, and Group Banking, 1930, pp. 18901891.

CHAPTER XVIII
BANKING AND MARKET RELATIONSHIPS
Use of Central Reserve Credit in the Stock Market
The Federal Reserve Act was enacted with a view to keeping the central reserves of our banking system out of the investment security market. Federal Reserve banks were
denied the right to purchase industrial, railroad, or public
utility stocks and bonds. The Act also prohibited the
regional central banks from rediscounting commercial paper
collateralled with corporation securities.
Federal Reserve credit was to be kept out not merely of
the so-called speculative security market, but of the capital
market in general. That is why the statute read'' carrying or
trading in stocks, bonds, or other investment securities" *
instead of saying "speculative operations" or "speculative
securities." It had been expected not only that the resources
of the Federal Reserve banks would not be loaned on stock
market collateral, but that our central banks would be managed in such a way that no central reserve credit would be
used even indirectly in financing trading on the stock exchange.
The original Federal Reserve Act contained no prohibition
against the use of the central reserves for investment and
speculation operations when the use of such reserves was
obtained by borrowing on member bank promissory notes
with government securities as collateral. An obvious reason
for this was the fact that borrowing on member bank promissory notes was not permitted. The only way a member bank
could borrow under the original Act was by rediscounting
eligible paper.
It is true that under the original Act customers7 notes
were permitted to be rediscounted by member banks at a
1

Federal Reserve Act, section 13.

371

372 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Reserve bank when such notes were given for the purpose of
carrying or trading in United States Government securities.
But at the time the Federal Reserve Act was enacted, the
Federal Government debt was small, indeed insignificant as
compared to what it later became. It was, therefore, probably assumed that the limitation of obtaining central reserve
credit supporting investment operations to only those in
United States Government securities was practically tantamount to prevention of the use of central bank reserves for
investment or speculation operations in stock market
securities. Otherwise, it will be recalled, rediscounts were
restricted to paper arising out of agricultural, commercial,
or industrial transactions. Moreover, the Act contained
specific prohibition against obtaining central reserve credit
in order to carry or trade in corporation securities.
Indeed, when Senator Glass was presiding over the investigation of the operation of our banking system in 1931,
he informed the governor of the New York Reserve Bank
of the attitude of those who, in 1913, sponsored the Federal
Reserve Act as follows:2
As a matter of fact, you could not lend them on bonds at all
if, at that time the proponents of the Act had ever had any conception of the fact that there would be billions of dollars of outstanding United States bonds. You know when the Act was passed
there was less than $1,000,000,000 of outstanding United States
bonds and they were rapidly disappearing. We never would have
included the right to use United States bonds as collateral for
those purposes, but for the fact that they were at that time rapidly
disappearing.

The World War and the amendment to the Reserve Act
of September 7, 1916, furnished a turn of events which
fundamentally altered the character of the banking system.
This was the amendment which permitted member banks to
borrow on their promissory notes collateralled by government securities. By possessing "governments" the banks
have been able to gain access to Federal Reserve credit
regardless of what kind of paper they held. The incentive
for possessing short-time liquid commercial paper as a basis
2

Hearings on Banking Systems, 1931, p. 53.

BANKING AND MARKET RELATIONSHIPS

373

for rediscounting was removed. Consequently, Federal
Reserve credit was drawn upon to sustain an ever-increasing
volume of bank loans on the stock exchange and customers'
security loans, largely by borrowing on government securities.
In addition to borrowing on government bonds, Federal
Reserve credit was used to finance security trading indirectly in another way. To some extent the banks rediscounted eligible commercial paper and used the proceeds
for loans in the security market.3 A number of times during
congressional hearings bankers have admitted that Federal
Reserve credit was used in stock market speculation. It was
brought out in one of such hearings during the questioning
of the president of the National City Bank of New York 4
that this bank had borrowed from the Federal Reserve Bank
for the purpose of loaning on the stock exchange. The bank
head defended the practice and held that the Federal Reserve
banks were established for that purpose.5
The president of the National City Bank declared:
"Frankly in the conduct of our bank I have never felt quite
happy unless we have a volume of about $100,000,000 of
demand street loans." 6 Then he pointed out the relationship
between the call loan operations of the National City Bank,
during 1929 and 1930, and its borrowings from the Federal
Reserve Bank of New York during that period.7 At times
during the "new era," the National City Bank had borrowings from the Reserve Bank of considerably more than
$100,000,000 and had over $250,000,000 loaned on the stock
exchange.
During the investigation of the banking situation conducted by the Senate Banking and Currency Committee in
1931, the head of the Chase National Bank,8 the largest of
the New York banks at that time, did not deny that member
* Ibid., pp. 289, 303.
* Charles E. Mitchell.
See Hearings on Branch, Chain, and Group Banking, 1930, p. 1999.
Hearings on Banking Systems, 1931, p. 289.
7
Idem. For a chart showing this relationship, see same hearings, opposite
p. 322.
8
Albert H. Wiggin;
6
6

374 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

banks used Federal Reserve credit for stock market purposes. In fact he held that he did not see how the Federal
Government could prevent a member bank from borrowing
"money" from a Federal Reserve bank in order to lend on
the stock exchange.9 The bulk of borrowing from the Reserve
banks has been by means of member bank promissory notes
collateralled with United States Government securities.10
This method of borrowing has been particularly predominant
in securing central reserve credit from the Federal Reserve
Bank of New York.
Federal Reserve funds were drawn into the stock market in
large volume, particularly in 1919 and the first few months
in 1920, and during the "new era," 1925-1929. The use of
Federal Reserve credit in security speculation during the
post-war period gave Federal Reserve officials considerable
concern. In reporting a conference of the Federal Reserve
Board and governors of the Reserve banks regarding such
use, in the fall of 1919, the press had the following to say as
to the conclusions of the Board on the subject: n
Never again will the credit facilities of the Federal Reserve
banks be used for speculative purposes to the same extent as
marked the operations of the banks in the New York district
during the past month.
This resolution on the part of the Federal Reserve Board apparently has been stamped upon the minds of the governors of the
twelve Federal Reserve banks, who have been in session here for
the past few days. It has been made clear that the Board officials
firmly believe that more of the Federal Reserve credit facilities
in the New York district were being used for stock market operations than for carrying on of bona fide business transactions. It
has been made clear also that there could not be a repetition of
this situation without general business suffering, and it has been
made emphatic that in no event will this be permitted to occur.

The far greater extent to which the reserves of the central
banks were used for stock market speculation during the
period immediately preceding the crash of October, 1929,
furnishes ironical comment on conditions in the operation of
9

Hearings on Banking Systems, 1931, p. 185.
For chart showing borrowings, see The New York Money Market,
Vol. IV, p. 322.
11
The Commercial and Financial Chronicle, Nov. 22, 1919, p. 1933.
10

BANKING AND MARKET RELATIONSHIPS

375

our banking system which can scarcely be equaled in American history.
The New York Call Loan Market versus Other Money Markets
It was pointed out in the preceding chapter how the bank
reserves came to be available, why they were deposited in
correspondent banks, and why they concentrated in New
York City. Federal Reserve policy with respect to interest
rates and acceptances also tended to draw funds to New
York and to play into the hands of the stock market interests.
The belief had been held that the call loan market would
lose its attractiveness because stock-exchange paper was
ineligible for rediscount at the Federal Reserve banks. It
was expected that banks would discriminate against the
loans collateralled by securities and in favor of paper arising
out of current business transactions. By possessing a portfolio of the latter paper the banks were to be in a position
to convert their assets into cash at the Reserve banks at any
time or restore or enlarge their legal reserves if necessary.
The provision in the Federal Reserve Act granting acceptance powers to national banks was designed to furnish an
"investment" for banks which would compete successfully
with the call loan. In lieu of brokers' loans, the framers of
the Federal Reserve Act had expected that secondary reserves would be invested in commercial paper and bankers'
acceptances, which investment would be facilitated by the
development of local money markets. It had been intended
that each of the Federal Reserve banks was to have its own
funds which were to be kept in its district. The growth of
local money markets centering around the regional central
banks, however, was inhibited by influences tending to draw
funds to New York and to concentrate the acceptance business in that city.
The bulk of the bankers' acceptance business has been
centralized in New York City. The fact that New York
has been the outstanding foreign trade port of the United
States contributed a good deal to the centralization of the
acceptance business in that city. However, probably more
of this acceptance business originating in other commercial

376 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

centers would have been retained there (1) if the Federal
Reserve Bank of New York had not rendered the liberal
fostering care that it did, and (2) if other Federal Reserve
officials had not cooperated in a special effort to centralize
acceptance financing in New York.12
In an effort to develop the New York discount market,
the Federal Reserve Bank of New York kept its buying rate
for acceptances relatively low. This encouraged resort to the
acceptance method of financing on the part of borrowers.
Drawers of acceptances all over the country sent them to
New York. The low rates of the New York Reserve Bank,
its policy of buying freely, and its resale agreement system,13
in effect a secured loan to acceptance dealers, made a profit
for the dealers and aided them in carrying the acceptances.14
A tendency toward uniformity of discount rates among the
different Federal Reserve banks has been fostered by the
administration of the Reserve system. Particularly, since the
war there has been a greater similarity among these rates
than was probably warranted by the economic development
of the respective regions. In fact at times the same discount rate has been in effect at all twelve of the Federal
Reserve banks, whereas the actual interest charges paid by
customers on their bank loans varied considerably among the
different Federal Reserve districts. The effect of this tendency toward interest rate uniformity which has been promoted was to shift funds from the various parts of the country to New York and its stock market.15 The reason for this
effect is that money tends toflowaway from the place where
12
See
13

Annual Report of the Federal Reserve Board, 1920, p. 49.
For details concerning the resale agreements of the Federal Reserve banks,
see Beckhart, The New York Money Market, Vol. Ill, pp. 380-407.
14
The bulk of resale agreements "are entered into with the Federal Reserve
Bank of New York. There the dealers carry from 50 to 65 per cent of such
portfolios as they maintain, on the basis of resale agreements." The New York
Money Market, Vol. Ill, p. 389.
16
See Stabilization Hearings on H. R. 11806, 1928, p. 129.
An influence in the Federal Reserve rate structure is the market for federal
funds. Banks in one Federal Reserve district can circumvent their Federal
Reserve discount rate by buying federal funds in another district where the
rate is lower. The effect of such a practice is toward a uniform rate structure.
(See B. C. Turner, The Federal Fund Market, pp. 81-84; Hearings on Banking
Systems, 1931, p. 96.)

BANKING AND MARKET RELATIONSHIPS

377

the official interest rate is below the economic rate. Uniform
bank rates in the various Federal Reserve districts mean in
effect a higher rate in New York and money is attracted
there.
The other Reserve banks have, on the whole, kept their
acceptance buying rates at or nearly as low as the buying
rates of the New York Reserve Bank. There has been a
tendency toward uniformity of acceptance rates just as
there has in the case of discount rates.16 Banking interests
in New York City have desired this. Likewise there has been
strong pressure on their Reserve banks from the borrowers
in other Federal Reserve districts to offer credit at as low
rates as was being obtained by borrowers in the New York
district.17
The policies of both the New York Reserve Bank and the
other Reserve banks considered together, therefore worked
to the same end, viz., the concentration of funds and the
centralization of the bankers' acceptance business in New
York. Thus when acceptances could not be had from their
local institutions, the other Reserve banks again resorted to
New York and purchased them from or through the New
York Reserve Bank. The spare funds of the regional central banks were thus not kept "at home" but were sent to
New York for investment in bankers' acceptances.18 In
this way the central banking reserves of the interior Reserve
banks percolated into the stock market via the bank acceptance route.
The abnormally low Federal Reserve buying rates and
lax policy regarding the quality of acceptances placed quantities of central reserve credit at the disposal of the New
York banks. This made it possible for those banks to loan
many times such amounts of central reserve credit in the
stock market. Security speculation was stimulated resulting
in a rise in the call loan rate which in turn further attracted
16
Since 1924 there has been a high degree of uniformity of acceptance rates
at the Federal Reserve banks. See The New York Money Market, Vol. Ill,
pp. 442-444.
17
Hearings on Banking Systems, 1931, p. 778.
18
See Annual Report of the Federal Reserve Board, 1919, p. 6; Federal
Reserve Bulletin, August, 1925, p. 527.

378 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

more funds to New York to be loaned on the stock exchange.
Thus the management of the bankers' acceptance market
tended to make the New York call loan market more important than it was before the Federal Reserve system.
The influence of the Federal Reserve Board and the
Reserve banks, through their particular support of the
bankers' acceptance market, worked against the development of the commercial paper market. The low acceptance
rates and buying policy together with the use of domestic
acceptances 19 tended to result in financing by means of
acceptances rather than commercial paper. Furthermore,
the abundance of bank credit created and supplied for
stock speculation at low cost stimulated the financing of
trade by security issues instead of by commercial paper
loans. Well-known companies which previously had obtained working capital through the sale of their promissory
notes in the commercial paper market replaced this type
of financing with the sale of securities. As a result the volume of commercial paper distributed through the market
has been largely reduced.20
The paternalistic support accorded the bankers' acceptance market by low buying rates and the other means mentioned, while necessary in the beginning, was too long continued by the Reserve banks to permit the establishment
of a sound acceptance market to date. A real acceptance
market, one not primarily inherent in the Federal Reserve
banks, has been prevented by the central bank policy.21
The influence of the low acceptance buying rates was to
cause the demand for acceptances to come chiefly from the
Reserve banks. At the same time the low rates had the
correlative effect of increasing directly and indirectly the
relative profitableness of call loans. American banks usually
19
The original Federal Reserve Act did not authorize domestic acceptance
credits. For a discussion of the reasons for not authorizing them, see Beckhart, The New York Money Market, Vol. Ill, pp. 261-264. Acceptance
privileges were extended to domestic transactions by the amendment of September 7, 1916, concerning which see the same volume, pp. 267-269.
20
Hearings on Banking Systems, 1931, p. 862.
21
Cf. in general, Beckhart, The New York Money Market, Vol. Ill, chapter
XIII.

BANKING AND MARKET RELATIONSHIPS

379

found the yield so low as to warrant not investing their
funds in acceptances.
The Federal Reserve system has, however, brought about
the establishment of an incipient discount market on a
national scale, centering in New York City. In a few cities
of financial importance, particularly Boston, Chicago, and
San Francisco, there has been a limited development of local
markets. But, on the whole, the establishment of local
discount markets has been retarded.22
Under our central banking system, in any time of crucial
strain involving a widespread withdrawal of bank balances
or brokers' loans, the New York banks have always been
able to meet the situation.23 The "Wall Street" banks have,
throughout the existence of the Federal Reserve system,
returned "cash" to their correspondents and other lenders
in the call money market whenever requested. These New
York banks have been able to get the "cash" because of
the presence of the Federal Reserve Bank "around the
corner." But the banks did not have to hold bona fide commercial paper such as the Federal Reserve Act made the
basis for tapping central bank resources.
When American banks and the "others" called their
brokers' loans, the New York banks borrowed from the
Reserve Bank on government securities or were relieved by
the Bank's purchase of "governments" and acceptances
in the open market. It was chiefly by these methods that
the New York Reserve Bank rendered the call loans from
all over the country liquid at times of emergency. By reason
of the existence of the Federal Reserve system, therefore,
there has been a lender of last resort in the New York money
market which has provided an elasticity to bank credit,
a liquidity to call loans, not possible under the old national
32
For a variety of economic and technical reasons for the centralization of
the acceptance business and the lack of establishment of local discount markets, see Hearings on Banking Systems, 1931, pp. 849-852. See also The New
York Money Market, Vol. Ill, pp. 330-346.
Cf. in general, Facts and Figures Relating to the American Money Market,
American Acceptance Council, 1931.
23
The period of the Bank Holiday, by Executive Order of the President,
may be considered in a sense an exception. See p. 405.

380 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

banking system. The activities of the New York Reserve
Bank in counteracting influences in the money market and
stabilizing short-time credit conditions have resulted in
making call loan rates more stable than before 1914. Hence
banks have been more certain of a satisfactory return on
their placements in call loans.
The facilities of the Federal Reserve system, then, made
call loans more attractive than before its establishment.
These loans not only still offered a return on available and
idle funds but much of the time the highest returns as between alternate uses. Moreover, under the Reserve system,
call loans possessed the added allurement that they were
safer and more liquid.24 Consequently American banks
tended to put their secondary reserves in the New York
call money market rather than into bankers' acceptances
or commercial paper.
Relation of Reserve Banks to the Stock Market
It was not the function of our central banks to regulate
trading on the stock exchanges. Their duty was to prevent
the ultimate reserves of the commercial banking system
from going into speculative and investment channels. Moreover, there was reason for the Federal Reserve authorities
to take cognizance of the use made of the member banks'
own resources in determining central bank rate, open market,
and loan policies. This is because the large amount of bank
credit used in financing security trading influenced both
directly and indirectly industrial, agricultural, and commercial conditions.
We shall here review the contact which the Federal Reserve system has had with the stock market. The Reserve
banks in the larger cities, particularly New York, have more
or less aided and abetted trading in securities. Their opera24

The liquidity referred to is from the point of view of the interior banks
and the "others." The stock-exchange call loans have not been liquid per se.
The reason for this is that they were shifted about in the market among different lenders, under the stimulus of credit expansions, rather than being
liquidated by the passage of securities to the ultimate investor. Their immediate and apparent liquidity was in reality derived from dependence on the
Federal Reserve system.

BANKING AND MARKET RELATIONSHIPS

381

tions have mainly had to do with supplying the required
funds and adjusting rates whenever the stock market situation seemed to require or permit.
Loan rates in the call money market are fixed by the
supply of and demand for such funds. The rates are not
fixed, however, by the forces of free competition but are
controlled. The supply of money loaned at the " money
desk" of the New York Stock Exchange has been controlled
by those chiefly interested in loaning bank credit. The
money committee of the New York Stock Exchange has
on various occasions advised the administration of the
New York Reserve Bank of "the state of the money situation, and what they think the rate ought to be." 25 The
officials of that Reserve Bank have collaborated with the
money committee of the New York Stock Exchange in
determining the rate on call loans.26
The method of the New York Reserve Bank in giving
effect to this collaboration has been to furnish any funds
needed in order to enable the "money crowd" to make its
loans and the banks to adjust their reserve position.27 It
has been common practice for the "Wall Street" banks to
borrow from the New York Reserve Bank for the purpose
of regulating the call loan rate.28 This was done with the
knowledge of the board of directors of the Reserve Bank.
A result of the Federal Reserve system has been that,
through the cooperation of the New York Reserve Bank
with the stock exchange authorities, it has tended to stabilize call loan rates. Although such rates have occasionally
reached high levels, these have never compared to the
heights which they attained during the pre-Federal Reserve
period.29 At the same time, however, the New York Reserve
2fi
2S

Hearings on Banking Systems, 1931, p. 95.
Hearings on Banking Systems, 1931, p. 26; Stabilization Hearings on H. R.
7895, 1926, pp. 355-356. Concerning the technique of fixing call loan rates,
see The New York Money Market, Vol. Ill, chapter II, by B. H. Beckhart.
27
Stabilization Hearings on H. R. 7895, 1926, pp. 355-356.
28
Hearings on Banking Systems, 1931, p. 95.
29
The success of the use of Federal Reserve credit in the stock market so
far as lowering and stabilizing the call loan rate is concerned, is evidenced by
a comparison between the call loan rates before 1914 and those since the establishment of the Federal Reserve system. Some of the very high call loan rates

382 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Bank has been operated in such a manner as to enlarge and
maintain brokers' loans at an inflated figure.
While the stabilization of short-time rates in the money
market is commendable, the stabilization of call loan rates
is secondary in importance for economic welfare to the prevention of inflation in the stock market. If it is a case of
not stabilizing call rates by means of Federal Reserve credit
or of supplying Federal Reserve credit which would enable
speculation to inflate the prices of securities to ever higher
levels, call rates had better not be stabilized. For, if as a
result of the lack of stabilization the check to security inflation comes sooner than otherwise, inflation does not proceed so far; the reaction to more reasonable prices is not so
great; and therefore the subsequent losses and damage to
the community are not so severe.
Stock market speculation and inflation in securities during the "new era" resulted from an easy money policy initiated by the New York Reserve Bank which made money
abundant and cheap in the national security market.30 As
a result of all the ways by which the reserve requirements
were lowered or actual reserves relative to existing deposits
were increased, it was possible to create the expansive superstructure of bank credit used in security speculation.31
prior to 1914 were the following: 1890, 186 per cent; 1892, 40 per cent; 1893,
74 per cent; 1895, 100 per cent; 1896, 127 per cent; 1899, 186 per cent; 1901,
75 per cent; 1905,125 per cent; 1906, 60 per cent; 1907,125 per cent. (Hearings
in Agricultural Inquiry, 1921, p. 541.) Under the Federal Reserve system 30
per cent was the highest rate for call money and this rate prevailed for one
day only. Moreover, call money rates have rarely gone over 10 per cent.
These rates are on a per annum basis. (Consult also The New York Money
Market, Vol. IV, pp. 511-518, by James G. Smith.)
30
Stabilization Hearings on H. R. 11806, 1928, p. 189.
Numerous predictions and warnings that inflation and collapse would follow
the Federal Reserve easy money policy of 1927 were expressed by Dr. H.
Parker Willis. His forecasts of the resulting economic disaster were voiced
not merely in 1929 when the security inflation was about to collapse but immediately upon the inauguration of the central bank policy in mid-year 1927.
See The Journal of Commerce [New York], 1927, 1928, and 1929, editorial
pages.
Dr. B. M. Anderson, Jr., in a treatise entitled: "Some Major Forces in the
International Money Market," expressed disapproval of the 1927 credit
policy. See The Chase Economic Bulletin, Oct. 29, 1927, pp. 24r-25.
31
See chapter XVII, section on Reasons for Correspondent Banking and
Concentration in New York.

BANKING AND MARKET RELATIONSHIPS

383

Federal Reserve credit was used indirectly in the stock
market as a result of two general Reserve bank operations,
loans to member banks and open market purchases. The
loans were made for the most part upon the member banks'
promissory notes collateralled with government securities.
By purchases of government securities and acceptances
the Reserve banks placed more reserves at the disposal of
member banks. This resulted whether the Reserve banks
purchased from the member banks or from private bankers
and dealers. Purchases from the private financial houses
and non-member banks were paid for in "federal funds/'
deposited in the banks and redeposited in the member bank
reserve accounts. Experience has shown that funds entering
the market by the Reserve system's open market purchases
went in the first instance into the stock exchange loan
account.32
Inasmuch as both the central money market and the
national security market are located in New York City,
particular responsibility for Federal Reserve policy devolved
upon the Federal Reserve Bank of New York. Having
stimulated security speculation in the first place by its easy
money policy, the New York Reserve Bank did little if
anything to restrain the use of central reserve credit for trading or carrying securities once this speculation gained momentum. On numerous occasions during the existence of the
Federal Reserve system, New York member banks have
borrowed from the Reserve Bank in order to keep from
withdrawing stock exchange loans.
Whenever interior banks and the "others'' called their
brokers7 loans, the New York Reserve Bank aided "Wall
Street" banks in supporting the stock market.33 In fact
these member banks have had assurance that they could
go to the New York Reserve Bank and get whatever funds
were necessary to take care of the withdrawal of interior
funds loaned on the stock exchange.34 In addition, that
32
Stabilization
33

Hearings on H. R. 11806, 1928, p. 362.
See chapter XI, section on Emergencies. Consult also The New York
Money Market, Vol. IV, chapter VIII, by B. H. Beckhart.
34
Stabilization Hearings on H. R. 11806, 1928, p. 231.

384 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Reserve Bank made loans to its member banks and substantial open market purchases at times when brokers'
loans were rising.
Private financial houses and non-member banks were
particularly aided by the policy of the Reserve Bank regarding the acceptance rate and the volume and quality
of acceptances purchased. But non-member as well as member banks obtained the use of Federal Reserve credit in
another way. This occurred as a result of borrowings from a
Reserve bank by member banks which made payments to
other banks which had loans on the stock exchange.
Accepting banks obtained some funds to loan in the stock
market by carrying their customers on an acceptance basis,
inasmuch as the New York Reserve Bank did not discriminate between speculative or " accommodation" acceptances and essentially liquid acceptances.35 In the spring of
1929 the New York Journal of Commerce reported in an
editorial the following:
According to practical bankers largely in the acceptance
business, the precaution surrounding the making of acceptances
has been much relaxed of late and during the past season perhaps
50 per cent of all acceptances were being made without very much
regard36to the liquidity or the character of the underlying transactions.

Furthermore, the practice of the New York Reserve Bank
of buying no paper direct from business concerns and of
buying acceptances only from financial houses which had
not less than $1,000,000 capital tended to lessen the commercial aspect of the Federal Reserve system and enhance
its use to interests affiliated with the stock market.
Differential discount rates according to the character and
duration of the paper, used in the early years of the Federal
Reserve system, were soon discontinued and were not in
use in the decade of the '20s. After putting the very low
discount rates into effect, when the speculative fervor
stimulated by the cheap money policy gained momentum,
the New York Reserve Bank then delayed the raising of
35
36

H. Parker Willis, The Banker, London, July, 1928, p. 22.
The Journal of Commerce [New York], May 23, 1929;

BANKING AND MARKET RELATIONSHIPS

385

rates until the inflationary movement was beyond control.
Moreover, that Reserve Bank did not decline to rediscount
eligible paper when an applying member bank had loans on
the stock exchange. And finally, the efforts of the Federal
Reserve Board to get the New York Reserve Bank to apply a
method of persuasion to the "Wall Street" banks did not
elicit the cooperation of that Reserve Bank.37
The depression of the early '30s was due in no small degree
to the orgy of speculation and inflation in the stock market
which preceded it. The enormous expansion of bank credit
used in security trading went hand in hand with successive
levels of higher stock prices, paper profits, and the enlargement of production capacity and output. The ensuing
stock market collapse resulted in a loss to the community
which was estimated at $58,000,000,000.38 When stock
prices fell, the purchaser of stocks with bank credit could
not liquidate his loan at a profit by the resale of the stock
in the market. Consequently he was obliged to save to pay
off his bank or broker's loan.
This effort to pay for stocks whose inflated market value
had vanished meant that the purchasers could not continue
to spend as they had for goods. The debts of those who held
inflated stocks when the crash came in October, 1929, curtailed purchasing power enormously. The demand for goods
fell off throwing employees out of work. The reduction of
purchasing power then was accelerated by the resulting
unemployment. Thus the pressure to liquidate loans based
on the inflated security prices helped bring on business
stagnation and intensified the depression. In so far as the
depression was due to this train of events, the Federal
Reserve banks, and particularly the New York Bank, contributed much to its severity, inasmuch as by their policies
they stimulated the security inflation and over-expansion in
certain industries.
Although the establishment of our central banking system
37

See chapter XIII, section on Conflict between the New York Reserve
Bank and the Federal Board.
38
Some estimates ran even higher than that figure. Hearings on Branch,
Chain, and Group Banking, 1930, p. 726.

386 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

had been intended to reduce the use of bank credit in the
stock market, it has not done so. Moreover, the expectations
which had been practically universally entertained at the
time Congress passed the Federal Reserve Act, that no part
of the central bank reserves would get into not merely the
so-called "speculative" loans but even security loans, have
not been realized. The operation of the Reserve banks, controlled by directors elected by the member banks whom
they served, resulted in supplying at low cost abundant central reserve credit for speculation and "carrying" securities.
While member banks have not been able to turn stock
exchange securities over to a Reserve bank and thus replenish
their legal reserves and extend more credit to the stock
market, such being illegal, they have secured these reserves
by other means. The practice of sending interior Reserve
bank funds to New York for investment in acceptances
worked hand in hand with the practice of loaning to member
banks on their security-collateralled notes in furnishing
funds for the stock market. In supplying banks with central
reserve credit virtually in exchange for government securities, the Reserve banks did not analyze the financial
statements of business concerns. The expansion of bank
credit went on apace practically unrestrained by the checks
of central banking controls.
Member banks obtained quantities of legal reserves with
ease without placing upon the central bank the obligation of
testing commercial credit. In the banking process these
reserves were multiplied many times. The superstructure of
credit was enlarged, resulting in rampant security speculation and over-expansion in industry. Credit money does not
grow nor create itself. Some one must create it and push it
along. This was done by those who controlled it, the bankers, under the impetus of the profit motive.
Instead, then, of devoting central reserve credit solely to
the uses of commercial banking, it was used indirectly in
financing trading on the stock exchange. Such use, as
previously pointed out, has been contrary to the intent and
spirit of the Federal Reserve Act.39 The Federal Reserve
39

The intended commercial banking character of the Federal Reserve sys-

BANKING AND MARKET RELATIONSHIPS

387

system has been an adjunct of the investment banking and
speculativefinanceinterests. So close and extensive has this
affiliation been that the maintenance of genuine liquidity of
Federal Reserve assets has been submerged. The American
central banking organization has been to a considerable
degree an investment banking system.
The Federal Reserve Bank of New York as a Central Bank
In adopting the Federal Reserve plan of having a chain of
central banks instead of one central bank for the United
States, Congress sought to diminish the power of the New
York banking group relative to the rest of the banking
organization. It purposed to avoid the creation of a central
banking system wherein one Reserve bank would be preponderantly larger than any of the others. There was to be
more or less equality among the various Reserve banks.
Consequently the districting of the United States was carried
out in such a way as to lessen the relative size and influence
of the Federal Reserve Bank of New York. Territory
thought by some to belong to New York was allocated to
other districts. The geographical area attached to the
New York Bank was confined to the State of New York and
eleven counties in two adjacent states.40
Although legally constituted as a district or regional
central bank, so far as the Reserve banks are concerned the
New York Bank has exerted the chief influence upon American banking and economic conditions and our international
relationships. A major reason for the country-wide scope of
its influence has been the continuation of the correspondent
tern was recognized by a governor of one of the Reserve banks. George W.
Norris, governor of the Federal Reserve Bank of Philadelphia, gave a talk
before the monthly luncheon of the Philadelphia Association of Security Salesmen in February, 1930. In discussing the October, 1929 stock market panic,
he pointed out to the salesmen the connection of the Federal Reserve system
with the capital market at that time. Mr. Norris said that "the Federal Reserve Bank of New York stepped in and within twenty-four hours bought
§150,000,000 of government bonds and in other ways gave assistance. It was
courageous action and you received a benefit from the Federal Reserve system that it was not intended you should have/' The New York Evening
Post, Feb. 20, 1930.
*° See chapter III.

388 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

banking system. Whereas member banks were related to the
Reserve banks of their respective districts, such relationship
did not preclude affiliations with banks in thefinancialcenters. Thousands of banks located in all the Federal Reserve
districts, member as well as non-member, have continued
to deal with the New York City banks. Indeed, the correspondent banking relations of the New York banks became
more extensive and national in scope during the existence
of the Federal Reserve system than before its establishment.
The Federal Reserve system has helped to maintain and
make more efficient the correspondent banking relationships. On occasion excess balances of out-of-town banks
have piled up in the New York member banks which in turn
resulted in surplus balances at the Reserve Bank. The
New York Reserve Bank has indeed looked upon these
balances as being actually owned by banks in other Federal
Reserve districts.41 At other times the New York Reserve
Bank has extended any credit required on account of the
withdrawal of brokers' loans or deposits from the interior,
and, furthermore, has supported the New York banks in
their loans to banks in all Federal Reserve districts. The
balances which correspondent banks have kept on deposit
in the New York banks have been considerably larger than
the reserve deposits kept by the New York banks with the
Federal Reserve Bank. Consequently even relatively moderate withdrawals of funds by outside correspondents have
frequently resulted in borrowing by the New York banks
from their Reserve Bank.
During particularly the two major depressions under the
Federal Reserve system, the New York Reserve Bank
worked in close cooperation in furnishing central bank credit
to the New York City banks which were lending to banks
and others in all Federal Reserve districts. During the postwar depression (1920-1922) the interior bank clients of the
New York banks felt the pressure of their district Reserve
banks, paid off their loans with them, and transferred those
41
See Federal Reserve Bank of New York, Monthly Review of Credit and
Business Conditions, March 1, 1933, p. 1.

BANKING AND MARKET RELATIONSHIPS

389

loans to their New York correspondents, in some cases using
the same collateral which they had pledged with the Federal Reserve banks.42 Consequently the burden of supporting such loans was transferred from the interior Reserve
banks to the Federal Reserve Bank of New York through
the medium of the New York correspondent banks. The
loans, during this depression of the early ;20s; by six of the
largest New York City banks to out-of-town correspondent
banks were larger than they had previously been, even
before the establishment of the Reserve system.43 As a
result the borrowings from* the New York Reserve Bank
were especially heavy.44
Again, during the depression of the early '30s the New York
Reserve Bank gave constant support to the entire banking
structure of the country by coming to the aid of its city
member banks whenever necessary.46 The governor of the
Reserve Bank held conferences with the heads of the "Wall
Street" banks at which the question of a more liberal credit
policy on the part of the New York banks toward correspondent banks throughout the country was considered.46
It was announced that "all deserving" interior banks were
being taken care of by the New York Clearing House banks
under the aggressive direction of the governor of the Federal
Reserve Bank.47
In line with the purpose of Congress to prevent the concentration of financial power by establishing the regional
42
Hearings in the Agricultural Inquiry, 1921, Part 13, p. 648. See also
these hearings, pp. 637-649.
«Ibid., p. 641.
44
The loans made by New York City banks, as of November 15, 1920, to
banks, railroads, public service corporations, and others outside of the Second
Federal Reserve District totaled $1,375,276,750; and their total borrowings
from the Federal Reserve Bank were $880,640,000. Hearings in the Agricultural Inquiry, 1921, Part 13, p. 641.
On February 14, 1921, the loans to banks, railroads, and corporations outside of New York State by the five New York City banks which were then
the largest borrowers at the Federal Reserve Bank, were $280,000,000 more
than their borrowings at the Reserve Bank. Hearings in the Agricultural
Inquiry, 1921, Part 13, p. 641.
45
See chapter XI, pp. 223-231.
46
The Commercial and Financial Chronicle, Oct. 17, 1931, p. 2550; The
New York Times, "Topics in Wall Street/' Oct. 17, 1931.
47
The Commercial and Financial Chronicle, Oct. 17, 1931, p. 2550.

390 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

central bank plan twenty years ago, just before the Federal
Reserve banks were opened, Woodrow Wilson said: 4S
No group of bankers anywhere can get control. No one part
of the country can concentrate the advantage and conveniences
of the system upon itself for its own selfish advantage. . . . I
think we are justified in speaking of this as democracy of credit.
However, as conditions have developed under the regional
central banks, it appears that New York banking interests
largely control the situation in much the same way as they
did before the Federal Reserve era. The head of the largest
bank in New York, with thousands of correspondent banks
in all Federal Reserve districts, reported that the Chase
National Bank would not extend credit to a correspondent
bank unless its statement was about what was wanted.49
The experience of a mid-western banker bears out the
testimony of this New York banker. A banker in Cedar
Rapids, Iowa,50 who had $3,000,000 of deposits in his bank
told (in August, 1927) of his subserviency to New York in
a statement reported as follows:51
At this moment I have $1,600,000 of that in New York. Part
of that is in bank balances and I am getting 1% per cent. Part of
it is invested in listed bonds, for which I am getting 4J^ per cent,
charging my farmer neighbor 7 per cent, and charging the best
business loans 6 per cent. I am doing that under this system because if I lend money to a farmer and he does not pay when it is
due, and we lose it or put it on the slow list, it is no longer rediscountable, and I am under suspicion, and in order to keep myself
in good standing according to the New York rules, I am forced to
run my bank that way.
It was reported that this situation as depicted by the
Cedar Rapids banker was typical of banks in other cities in
Iowa and was general throughout the state. 52 Again, a pro48
This statement is attributed to Wilson in a letter to Representative Underwood. Quoted by Pierre Jay, former chairman of the Federal Reserve
Bank of New York, in Trust Companies Magazine, March, 1926, p. 348.
49
Testimony of Albert H. Wiggin. Hearings on Banking Systems, 1931,
p. 186.
60
Located in the Seventh (Chicago) Federal Reserve District.
61
Hearings on Brokers' Loans. 1928. p. 56.
«Idem.

BANKING AND MARKET RELATIONSHIPS

391

fessor in a state university of the Middle West 53 gave further
evidence of the control exercised by the New York bankers
over the interior banks. He stated that the country banker
of Wisconsin put it in this way:64
We get our orders from New York. Either we are in a squeeze
and tighten up or in a position where we have to loosen up. If we
tighten up or loosen up we get orders from New York.
Following the investigation in 1931 by the Senate Banking and Currency Committee of the operation of the Federal
Reserve system, Senator Carter Glass declared that the
interior banks were practically forced under the guise of
"advice" to take billions of dollars of low-grade foreign
securities.55 The senator said that he had heard banker
after banker say that they had purchased certain investment securities from the big city banks "not because they
wanted them, not because they were confident that they
would be remunerative or that the facilities of their respective banks would justify their purchase, but because they
were indebted to the offering banks for accommodations
extended/' 66
On account of the subservience of the interior correspondent banks, then, to the "Wall Street" banks, the New York
Reserve Bank has been related to member and non-member
banks in all Federal Reserve districts. That Reserve Bank
has been in fact the lender of last resort to thousands of
banks throughout the country. Its credit policy has vitally
affected conditions in their communities. Consequently
the Federal Reserve Bank of New York has possessed special
significance as a national central bank.
The Federal Reserve Bank of New York has also served
in the capacity of a central bank for the country inasmuch
as its member banks have to an increasing degree financed
American industry and trade. Comparatively speaking,
before 1914, business concerns in the towns and cities dotting
the country satisfied their banking requirements from their
53

J o h n R . C o m m o n s , University of Wisconsin.
Stabilization Hearings on H. R. 7895, 1926, p. 1108.
65
Congressional Record (unbound edition), May 10, 1932, p. 10196.
«Ibid., p. 10204.
54

392 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

local banks. Since the establishment of the Federal Reserve
system, far reaching changes in business organization and
finance have taken place.
In view of the lack of branch banking and the extent to
which the combination movement has been carried, business
concerns have not been able to obtain satisfactory accommodation from local banks.57 Consequently companies
have tended to go to the large money centers in order to
satisfy their credit needs. Many corporations which formerly had their head offices elsewhere have grown so large
or have become units of holding companies, with the result
that they have found it desirable to establish their financial
headquarters in New York City.58 Whether they did their
financing by means of bank loans or by issuing securities,
they have been served by the large New York banks, and
hence the New York Reserve Bank.
Moreover, the New York Reserve Bank has served the
nation's business in another way. Whereas commercial
banks in other Federal Reserve districts made loans to companies situated in their own communities, the "Wall Street"
banks have business customers in every state in the Union.
These New York banks have made loans not only to local
companies but to railroads, public utilities, life insurance
companies, industrial and commercial corporations, throughout the country.59
57
Ibid., p. 10206; Hearings on Branch, Chain, and Group Banking, 1930,
p. 1566; Hearings on Banking System, 1931, p. 217.
The National Bank Act has prohibited bank loans to one business concern
or customer of more than 10 per cent of its capital and surplus.
58
See Stabilization Hearings on H. R. 7895, 1926, p. 1006; Hearings on
Branch, Chain, and Group Banking, 1930, pp. 1210-1214, 1322-1323; Annual
Report of the Federal Reserve Bank of New York, 1924, pp. 17-18.
69
Hearings in the Agricultural Inquiry, 1921, pp. 637-641, 648-649; Hearings on Branch, Chain, and Group Banking, 1930, p. 1566; Hearings on Banking Systems, 1931, p. 217.
In the fall of 1920, the borrowings of the New York banks from the Federal
Reserve Bank had increased enormously. In response to an inquiry from the
Federal Reserve Board as to the reason for such increase, the Reserve Bank
gave as one of the reasons the refusal of southern banks to handle cotton
paper. The Reserve Bank said: "In the case of Bank C additional funds have
been required to assist in the financing of cotton. The depression in the cotton
trade has caused many local banks to refuse to deal in cotton paper and the
big New York City banks, in consequence, have had to shoulder the burden."

BANKING AND MARKET RELATIONSHIPS

393

Hand in hand with the increase in the size of the business
organization and the meeting of its financial requirements
through the New York market has been the sending of
funds of local units of the combinations to New York and
other centers. Thus in analyzing the situation in Dayton,
Ohio, during the recent depression, ex-Governor Cox of
Ohio, as head of a city committee, found that the "major
disorder" common to all cities was "the sequence of a new
economic order." Governor Cox reported as follows:60
In the last twenty years the chain stores and the chain theatres
have developed, and there has been an intense centralization in
industry. Most of the chain stores and theatres deposit their
balances locally every day, and then immediately check them out
to large banks, principally in New York. . . . It is a slow process
of strangulation. New York in the last two or three years has had
so much money that it doesn't know what to do with it.

This analysis of the situation was accepted as representing
an accurate portrayal of conditions by New York bankers
in conference with representatives of the Dayton committee.61 It is further indicative of the extent to which
New York City has become a national financial center
through which the New York Reserve Bank's policies affect
the nation.
All the sub-divisions of the national money market—
the market for federal funds, call loan money market, discount market, commercial paper market, government bond
market, and the general securities market, center in New
York City. There has been a constant ebb andflowof funds
between New York and other parts of the country. There
is some movement of funds between other money markets,
Boston, Chicago, Cleveland, San Francisco, St. Louis,
Minneapolis, etc. But there has been a movement of funds
between New York and all other money markets.62 More60

The New York Times, Oct. 16, 1931, editorial page.
Idem.
62
Such movements have taken place with more or less regular recurrence.
There are weekly, monthly, quarterly, and seasonal movements. See The
New York Money Market, Vol. IV, Part III, by James G. Smith; Annual
Report of the Federal Reserve Bank of New York, 1924, pp. 16-21; Stabilization Hearings on H. R. 7895, 1926, pp. 443-449, 453-455, 969; Hearings on
Banking Systems, 1931, p. 86.
61

394 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

over, an operation in another market affected the " nerve
center" in New York City. There the stimulus was "offset"
by the New York Reserve Bank or allowed to work itself
out. In either case the result was promptly reflected more
or less throughout the country.
The New York money market has come to be more national in scope than it was before the establishment of the
Federal Reserve system. Being the central bank for all the
sub-divisions of the national money market, the New York
Reserve Bank has been in a position to influence the general
credit situation of the United States either by stimulating
or restraining that market. Concerning the movement of
funds between New York and other money markets and
the national aspects of the credit policy of the New York
Reserve Bank, Mr. Strong, governor of the Bank, commented as follows:63
The operation of the New York Bank in these respects, that
is, looking at the whole volume of credit, has to be conducted with
a close eye to our own position in our local market and equally
with consideration to the position of the whole system. We could

not tell, because of this vastflowof credit that takes place throughout the country, what to do in New York unless we knew what
was happening in every other districts

The New York Reserve Bank, then, has dealt with national
credit in the mass. Its discount rate policy has affected a
considerable volume of business of national companies
whose financing was handled in the New York market, as
well as the banking structure of the country and hence
other business which has tied up with that Reserve Bank
through the New York correspondent banks. Since Reserve
system open market operations were centralized in the
New York Bank, it practically determined whatever influence such operations had on the national economy. The
credit policy of the New York Reserve Bank, therefore,
has had a substantial influence on financial and business
conditions in all Federal Reserve districts, which influence
63

Stabilization Hearings on H. R. 7895, 1926, p. 455.

The italics are the author's.

BANKING AND MARKET RELATIONSHIPS

395

no other Reserve bank has held. This power of the NewYork Bank has been recognized many times during the
development of the Reserve system, when Federal Reserve
authorities have sought to change general business conditions by initiating a change in the discount rate and/or
open market policy of that Reserve Bank*
In addition to its national importance, the New York
money market has been the international money market
of the United States. It has been the principal financial
center of the western hemisphere. The Canadian banks
especially have made constant use of the New York money
market. The contact between Montreal and New York has
been almost as close and intimate as between Chicago and
New York. So close has been the relationship of the banks
of our northern neighbor to the American money market
that there was serious consideration on both sides of the
border of admitting the Canadian banks to membership
in the Federal Reserve system.65 Following the shift of the
United States during the war from a debtor to a creditor
nation, the power of this country in international finance
assumed commanding importance. New York became one
of the leading financial centers of the world and London
vied with it for the premier position.
During the decade of the '20s New York was in some
respects the leading money market of the world. Foreign
commercial banks and corporations sent funds to New York
and foreign central banks placed some of their reserves and
surplus funds in that financial center. These foreign shortterm funds sent for deposit and investment reached unprecedented sums. There was a constant demand for and
supply of exchange on New York in all parts of the world.
The New York market had the largest fund of gold available for banking operations; it did the largest amount of
international lending; it performed the functions of a free
gold market; and upon it rested the major burden of supporting the gold exchange standard of many nations. Currencies which were on the gold or gold exchange standard
65
Canada would thus become practically the thirteenth Federal Reserve
district.

396 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

were adjusted to the American dollar, which became the
chief arbiter of international prices.
On account of the interdependence among nations, in
carrying out the functions of central banks of modern times,
cooperation with other central banks developed. The central banks became the liaison offices of the banking systems
of the various countries. In this international collaboration
of central banks, the foreign policy of the Federal Reserve
system was centralized in the New York Reserve Bank. In
so far as the gold standard was managed in this country,
it was essentially done by that Reserve Bank. Furthermore,
the New York Reserve Bank has been the American central
bank in foreign exchange and in making commitments
abroad involving all of the Federal Reserve banks.

CHAPTER XIX
TWENTY YEARS OF THE FEDERAL RESERVE
SYSTEM
During the twenty years in which the Federal Reserve
system has been in operation, its major influence on our
national economy has, of course, been exerted through its
credit policy. Federal Reserve credit policy during this
period has been the composite result of several conflicting
interests. The effort of the Reserve Bank Organization
Committee to avoid the establishment of a Reserve bank in
New York which would be preponderant in size and importance as compared to any of the other Reserve banks
was not successful. The Federal Reserve Bank of New York
has been so large and has possessed such power and influence that none of the other regional central banks has been
at all comparable to the New York Bank in these respects.
So overwhelming has been the power of the New York
Reserve Bank, that the instrumentalities through which
Federal Reserve credit policy has been expressed may be
brought into a grouping of three—the Federal Reserve
Board, the Federal Reserve Bank of New York, and the
other, or interior, Federal Reserve banks. At times the
Federal Board has held the balance of power in the system
and at other times the New York Reserve Bank. But the
influence of the interior Reserve banks has always been
weak.1 On the whole there is reason to believe that the
Federal Reserve Bank of New York has been the dominant
1
The replies of the Federal Reserve banks to the questionnaire submitted
by the Senate Committee on Banking and Currency in 1931 disclosed that
some of the interior Reserve banks disagreed with the system open market
policy. If the interior Reserve banks had had more influence in determining
the open market policy, the economic distress experienced during the recent
depression would probably have been less severe, inasmuch as some part may
be traced to the open market purchases. (See Hearings on Banking Systems,
1931, Part VI, Questionnaires No. 9 and No. 10.)

397

398 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

instrumentality which has controlled the credit policy of
our central banking system.
i The Federal Reserve Bank of New York has been preponderant in size as compared to any of the regional central
banks. It has generally held about one-third of the total
central reserves of the system, while its deposits have reached
even a higher percentage, these being at times about onehalf of the deposits of all the Reserve banks combined. But
the relative influence of the New York Bank in the system
has been far greater than its proportionate size. Confined as
it was to a small geographical area,2 it has been much more
than a Reserve bank for the Second Federal Reserve District.
The chief reason for this is that the New York Reserve
Bank is located at the central money market. In affecting
all the sub-divisions of the national money market its operations have affected the entire United States. As a result of
the functioning of the commercial and financial organization, funds were drawn to New York from all districts. This
was accomplished through the medium of the regular transactions in various money markets, the correspondent banking
system, and the open market operations.3 Through the
medium of its local member banks, New York Reserve
Bank credit has found its way to all Federal Reserve districts. Given its strategic location and the influence of the
New York Reserve Bank's operations in the money market,
the fact that its resources were so much larger than those of
any other Reserve bank made its power all the greater and
the extent of its dominance all the more evident.
The Federal Reserve Bank of New York has been in some
respects a central bank for the larger proportion of the com2
The State of New York, one county in Connecticut, and ten counties in
New Jersey.
3
Open market operations were centralized in the Federal Reserve Bank of
New York. When acceptances appear among the assets of the individual
Federal Reserve banks, that does not mean that the Federal Reserve credit
thus released is available for the customers of the banks in their respective
districts. On the contrary that credit is largely lodged in New York. The
interior Reserve banks sent their funds to New York for investment in acceptances and securities. The funds so released became a part of the credit in the
New York money market which the "Wall Street" banks made available at
their discretion to their correspondent banks throughout the country.

TWENTY YEARS OF THE FEDERAL RESERVE SYSTEM 399

mercial banks (particularly the non-member) of the country. It has been the central bank for the stock market and
the various money markets. It has been the central bank
in the regulation of foreign exchange, and in the management of the gold standard. In the exercise of the central
banking function of credit control, the New York Bank's
policies have possessed the chief influence on our national
economy. The Bank has been the chief fiscal agent of the
United States. Treasury operations have largely been centralized in that Bank, which has then effected distributing
relationships with the other Reserve banks. Finally, the
New York Bank has been the institution which has wielded
the power in the foreign relationships of the central banking
system, practically supplanting the Federal Reserve Board
in this authority. Although the Federal Reserve Bank of
New York is not the central bank of the United States, it
has to a considerable degree served in the capacity of a
national central bank.
We have seen that during the development of central
banking under the Federal Reserve system a number of important achievements have been realized. Considerable
progress has been made in- the integration of the nation's
banks. The centralization of reserves in the Federal Reserve
banks and the coordination of the system under the Federal
Board have done much to bring together the independent
unit banks in a common service to the community. By the
concentration of bank reserves their ready elasticity was
effected, the old inelasticity of currency was abrogated, and
there resulted a mobility of bank credit, making it more
available to all parts of the country at any time. This united
strength of the banking organization has been brought to
the aid of individual communities and particular sections
in time of emergency.
The centralization of gold effected a great economy in its
use and aided substantially in a more efficient operation
of the gold standard. The gold base of the banking system
was brought under control so that the use of gold in the
settlement of domestic or international balances was obtained without injury to other parties and without sub-

400 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

jecting the entire banking organization of the country to a
breakdown. Moreover, on occasion, the Federal Reserve
system brought an effective influence to bear upon gold
movements. A complete control over gold movements in
the face of more powerful forces has not been realized.
Furthermore, our central banking system has enabled the
United States to present a unified banking front to foreign
countries for the first time in its history.
A beginning has been made in developing a national discount market. Through the use of the acceptance powers
and the purchases by the Reserve banks, the financing of
America's foreign trade has been accomplished at less cost
than formerly and on otherwise more favorable terms.
Unfortunately, however, serious abuses have been so common in the use of the bankers' acceptance as to leave much
room for improvement in this type of financing. The effort
to develop genuine local discount markets about each
Reserve bank has been retarded, although there has been
some progress toward the establishment of money markets
in a few other financial centers. The New York market
during this twenty-year period became not only a real international money market but one of commanding importance
in foreign affairs.
By the elimination of the Independent Treasury system
and placing the numerous functions of the sub-treasuries in
the hands of the Reserve banks, a desirable integration of
public finance with the banking system was accomplished.
Not only was a remarkable record made by the Federal
Reserve system in financing our participation in the World
War, but the collection and disbursement of government
revenue have been carried on with an economy and efficiency
far superior to conditions during the regime of the Independent Treasury. Although the Federal Reserve system has
greatly facilitated the work of the Treasury in serving as
itsfiscalagency, on the other hand the system's subservience
to the exigencies of Treasury finance has resulted in a
changed condition of the assets of American banks. The portfolios of both commercial and Reserve banks became waterlogged with government securities.

TWENTY YEARS OF THE FEDERAL RESERVE SYSTEM 401

The movement of funds to and from the various moneymarkets and the operations of the Treasury in time of
peace and war have been handled and "offset" so as to
prevent serious short-time disturbances in the credit system.
The extreme fluctuation in interest rates as a result of such
movements, particularly in the financial centers, has been
eliminated by " accommodation" from the Federal Reserve
banks. The operation of the central banking system has
resulted in a general lowering of interest charges and credit
has been supplied at more uniform rates to all sections of
the country than was the case in the pre-Federal Reserve
era.
The Federal Reserve system has achieved important
results in its clearing and collection functions. A national
clearance system through the Gold Settlement Fund has
been in successful operation. The benefits accruing from
the system have been that the shipments of gold to and fro
were avoided; there is a wider acceptability of checks, and
faster and cheaper collection; and the "float" has largely
been eliminated. The bulk of checks pass at par. The par
clearance plan together with the Federal Reserve telegraphic transfer system have relieved the business public
of the former heavy burden of exchange charges. Furthermore, by carrying on the clearance function the administrators of the Reserve system have obtained information
useful in the shaping of their credit policies.
The extent of Federal Reserve membership is not indicative of the benefits accruing to American banking inasmuch
as non-member state banks have received nearly as much
benefit as have member banks. Not one of the forty-eight
state banking systems has had any reserve credit power of
its own. The Federal Reserve banks have comprised the
only credit reservoir of the country. All the state banks
have depended ultimately upon the Federal Reserve system
and have looked to it to provide additional credit. The
contact of the non-member state banks with the Reserve
system has been chiefly through their correspondent banks
in the financial centers. In addition the non-members have
profited by (1) the discount market involving Reserve bank

402 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

purchase of the acceptances of state banks, (2) the rediscount, during the war financing period, of promissory notes
with member bank endorsement, and (3) the clearing and
collection services.4 Furthermore, in so far as the banking
structure was strengthened and general credit conditions
were made more stable by the Reserve system, the nonmember state banks have derived a benefit as part of the
milieu in which they operated.
The most disappointing results, perhaps, of banking
under the Federal Reserve system are to be found in the
record of bank failures. There were failures in thousands
of communities throughout the country in spite of the Federal Reserve banks. In many cases all the banks in a town
or city closed leaving the people without banking facilities
or compelling them to resort to banking by mail. Indeed
the twenty years of the Federal Reserve system witnessed
a period of bank failures without parallel.
Bank failures began to increase during the latter part of
1920 and from 1921 assumed alarming proportions. During
the years 1921-1932 over 10,000 national and state banks
with deposits of nearly $5,000,000,000 failed.5 The failures
during this twelve-year period represented about 36 per cent
of the total number of active national and state banks in
4
Although a substantial proportion (comprising mostly non-member but
including some member banks) of the total number of banks have been using
their city correspondent banks instead of the Federal Reserve banks as collection agencies, it has been due to the Federal Reserve system that the city
banks have been able to render the quicker and more efficient collection service and at less cost than under the old national banking system.
6
Report by the Federal Reserve Committee on Branch, Group, and Chain
Banking, volume on Bank Suspensions in the United States, 1892-1931. (In
mimeograph form.)
For the purpose of the study by this Federal Reserve Committee, a bank
was considered in suspension whenever its doors were closed to the public,
either temporarily or permanently, by supervisory authorities or by the bank's
board of directors on account of financial difficulties. Banks which were reopened or taken over by other institutions after closing were included as
suspensions.
Concerning the problem of bank failures, consult also Report of an Inquiry
into Contemporary Banking in the United States, by H. Parker Willis and
others, 7 volumes, 1925. Unpublished. (Onfile,Columbia University Library.)
The author uses the word failure as being synonymous with suspension in
this treatise.

TWENTY YEARS OF THE FEDERAL RESERVE SYSTEM

403

1920 and about 13 per cent of their total deposits at that
time. In no previous period of equal length since the establishment of the national banking system in 1863 has so
large a proportion of American banks failed. This was
about five times the number which suspended during the
previous twenty-nine years. The high mark was in 1931
when there was a total of 2,213 failures, or 10.5 per cent of
all banks in operation in that year.6 The number of suspensions during each of the twelve years and the losses to
depositors are shown in the following table :
TABLE 15

NATIONAL AND STATE BANK SUSPENSIONS
1921-1932 *
Year

Number

Gross Deposits

1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
Total

461
343
623
738
579
924
636
479
628
1,292
2,213
1,416
10,332

$ 163,299,000
89,274,000
146,347,000
202,423,000
159,904,000
250,434,000
194,992,000
139,400,000
222,931,000
821,834,000
1,669,075,000
698,382,000
4,758,295,000

* During the same period 476 private banks and 8 mutual savings banks
failed. Trust companies and stock savings banks are included among the
state banks. Bank Suspensions in the United States, 1892-1931, Table 1,
by the Federal Reserve Committee on Branch, Group, and Chain Banking.

The percentage of state bank failures during the period
was more than twice as high as that for national banks.
The closing of the banks, involving as previously stated
nearly $5,000,000,000 of deposits, caused heavy losses to
individuals, immobilized credits, forced liquidation, cur6

10.5 per cent stands as the high mark, as far back as reliable records go,
in the percentage of bank failures to active banks in a single year. In 1932
the proportion was also very high, the 1,416 failures accounting for 7.8 per
cent of all banks.

404 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

tailed credit, and reduced purchasing power, which accentuated the severity of the recent depression.7
The high percentage of bank failures under the Federal
Reserve system has, of course, not been due to the fact that
there was not a central bank where bank assets could be
converted into cash on demand to meet the claims of depositors, as was the case oftentimes under the old national
banking system. A chain of central banks stood ready as
lenders of last resort and were prepared to supply cash on
the basis of eligible paper. But a fundamental difficulty
was that so large a proportion of commercial banks did
not have the liquid assets to offer the Federal Reserve
banks. Their assets were "frozen7' and it is no part of the
function of central banks to accept anything but liquid
paper.
The increase in member bank reserve balances during
the decade of the 720s resulted in a deterioration in the quality of bank credit. The increase (actual and percentage) in
the several classes of bank assets is shown in Table 16. "All
other loans" were identified as mainly commercial loans.8
It is seen that this type of loan, which the Federal Reserve
system was designed to foster, remained practically constant throughout the period, whereas loans on securities
increased by more than 100 per cent and loans on urban
real estate by over 200 per cent.
The proportion of commercial banking resources devoted
to investments and security loans has increased since the
establishment of the Federal Reserve system. The past
decade, especially, witnessed a growing ratio of investment
assets and a declining ratio of self-liquidating assets to
demand liabilities. The principal asset of member banks
as a group has been investments, including bonds, loans
on stocks and bonds, and loans on real estate, instead of
7
According to estimates by the Comptroller of the Currency, in the nine
years preceding 1930, 7,264,957 depositors contributed to the total of more
than 81,700,000,000 of deposits in failed banks and no less than 114,000 shareholders suffered losses through these suspensions. During these nine years,
failed banks caused the enforced liquidation of approximately $2,000,000,000
of loans, chiefly small loans. Hearings on Branch, Chain, and Group Banking,
1930, p. 14.
s Hearings on Banking Systems, 1931, p. 137.

TWENTY YEARS OF THE FEDERAL RESERVE SYSTEM

405

TABLE 16

LOANS AND INVESTMENTS, ALL MEMBER BANKS *
(In millions of dollars)

1921
1922
1923
1924
1925
1926
1927
1928
1929

Investments

Loans on
Securities

6,002
7,017
7,757
7,963
8,863
9,123
9,818
10,758
10,052

p 4,400
: 4,500
4,950
c 5,350
6,718
7,321
8,156
9,068
110,095

Loans
on Urban
Real
Estate f
} 875
11,100
11,350
11,575
11,875
2,161
2,449
2,624
2,750

Actual Increase
1921-1929

4,050

5,695

1,875

Percentage Increase
1921-1929

67%

129%

214%

Total
All Other Loans and
Loans
Investments
12,844
24,121
11,565
24,182
12,450
26,507
12,279
27,167
12,062
29,518
12,579
31,184
12,333
32,756
12,611
35,061
12,814
35,711
§30

11,590

48%

* Source: Hearings on Banking Systems, 1931, p. 138.
f Real estate loans other than farm lands.
i Partly estimated.
§ Decrease.

short-term paper.9 Inasmuch as the maturity of bank assets
was not properly related to the demand claims of the depositors, banks were unable to pay money upon request and
consequently failed.
Under the Federal Reserve system, prior to 1933, the
general monetary stringencies of the type existing under
the old national banking system were averted. The Bank
Holiday of March, 1933, was more than a general panic.
It constituted a complete collapse. But even during the
anxious days preceding that episode the Federal Reserve
system did not fail to meet the needs of that emergency.
There is no reason to doubt that the Reserve banks met all
legitimate demands for credit based upon eligible paper.
9

Other assets of the investment type included a portion of bankers' acceptances, and installment finance paper. The apportionment of bank credit to
investment uses was shown in an extensive and detailed report submitted to
the Senate Banking and Currency Committee in 1931. (See Hearings on
Banking Systems, 1931, Appendix, Part VII.)

406 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

The trouble was that the banks considered as a group did
not have the right kind of paper. Moreover, no banking
system can stand up under a stampede to convert most of
the claims against it into gold and currency. Modern banking systems are not planned on that principle and cannot be
expected to function under it.
It is desirable, therefore, that the banking system be so
managed that the public shall not lose confidence in the
banks in the first place. Though the Federal Reserve system has seen that the legitimate business needs for credit
have been met, it has not succeeded in maintaining financial
stability in the community by preventing the creation of an
excessive amount of bank credit. The idea that the system
was essentially nothing more than an emergency organization has been dominant in the councils of its administration. Federal Reserve officials have looked upon it as an organization to "help out" hard pressed banks rather than as a
central banking institution to take the lead in the prevention
of inflation and undue speculation in various markets.
If the chief purpose of the Federal Reserve Act be, as has
often been held, the supplying of a means of credit control,
that purpose has fallen considerably short of reasonable
realization. The very concentration of reserves, in view of
the multiplication of bank credit upon the central reserve,
placed vast discretionary power in the hands of the Federal
Reserve officials. During the war they were allowed free
rein, indeed were requested by the Treasury department,
to expand credit freely; and this expansion was excused on
the ground of winning the war.
Following the war, during the decade of the J20s, with
reserves swollen by the inrush of gold from abroad, inflationary interests among bankers, and securities market promoters attained their objective and took the nation's gold
reserves into their service. The Federal Reserve system had
no remedial influence on the use of bank credit and central
reserves in security speculation and investment operations.
Considerable responsibility for the failure to alter what
was held, during the banking reform period, to be the prime
and pressing evil, rests upon Federal Reserve open market

TWENTY YEARS OF THE FEDERAL RESERVE SYSTEM 407

policy and the war amendment to the Federal Reserve Act
authorizing direct loans to member banks on the basis of
government securities. This type of lending largely replaced
the rediscounting of commercial paper and hence seriously
interfered with the capacity of the Reserve banks to regulate the creation of bank credit.
Federal Reserve control over the creation of bank credit
was also considerably impaired by the borrowing relationships between correspondent banks. Banks have known
that they could obtain funds from their city correspondents.
They have consequently continued to ask for and secure
them. Such correspondent lending has tended to weaken
the character of bank assets inasmuch as the banks were
not required to hold the quality of paper necessary for borrowing from a Federal Reserve bank. The continuance of
the correspondent borrowing relationships developed under
the old national banking system must, therefore, bear its
share of responsibility for the non-liquid condition of American bank portfolios and hence for bank failures. Furthermore, competition between the state banks on the one hand
and national banks on the other has tended to prevent the
raising of the standards of commercial banking.
The Federal Reserve system has not operated to relate
the expansion and contraction of bank credit to the needs
of industry and commerce. The elasticity of currency which
the Reserve system was expected to furnish has practically
meant expansion of the currency. Such elasticity of the currency as has occurred was brought about not so much by
the rediscounting of commercial paper, as was anticipated,
but by the existence of large holdings of gold in the Federal
Reserve banks and the presence of large quantities of United
States Government securities among the assets of member
banks. Furthermore, the Federal Reserve system has been
to a considerable degree an investment banking system and
thus not fulfilling the purposes of its establishment in serving commercial banking.
Throughout the existence of the Reserve system relatively
little commercial paper has been held as security for the
Federal Reserve notes. The intended elasticity of Federal

408 CENTRAL BANKING UNDER FEDERAL RESERVE SYSTEM

Reserve notes has been set aside in two ways, (1) by the
issuance of the bank notes upon the basis of gold, and (2) by
their issuance upon the basis of United States Government
securities, at first indirectly and later directly. In neither
case is there any necessary correlative connection between
the amount of bank notes issued and the volume of selfliquidating business transactions. Federal Reserve notes,
for the most part, have been in effect gold certificates, or
"bond-secured" notes which the Federal Reserve Act was
designed to abolish.
Nevertheless, with all of its shortcomings, there has been
attained during the twenty years of the Federal Reserve
system a degree of control over bank credit which was not
possible before 1914. Credit extension has not been left to
the free play of independent competitive banks. Progress
has been made in the regulation of credit within limits in
relation to chosen criteria. Considerations of general welfare have supplemented the profit motive so that banking
has been controlled to a greater extent than formerly from
a national point of view.
Money and credit, being fundamental factors in our
national economy, the quantity and quality of bank credit
and the time and manner of its creation are of paramount
influence and public concern. The central banking institution is in a position to aid considerably in regulating credit
for commerce and industry according to economic requirements and thereby to bring about a greater degree of stability
in American economic and social life.
However suited to conditions in the United States the
Federal Reserve system may be, a structure operating
through a system of checks and balances does not in itself
assure sound credit management. As our experience with
central banking under the Federal Reserve system has
shown, upon its wise administration depends the welfare of
the American people. Such an administrative task may be
aided by the development of understanding on the part of
the people, and the creation of an informed public opinion
which may intelligently serve to enforce sound central
banking policies.

APPENDIX I
BY-LAWS OF THE FEDERAL RESERVE BANK OF
NEW YORK*
ARTICLE L—DIRECTORS
Section 1. QUORUM.—A majority of the directors shall constitute a quorum for the transaction of business, but less than a
quorum may adjourn from time to time until a quorum is in
attendance.
Section 2. VACANCIES.—As soon as practicable after the occurrence of any vacancy in the membership of the board the chairman of the board shall take such steps as may be necessary to
cause such vacancy to be filled in the manner provided by law.
Section 3. MEETINGS.—There shall be a regular meeting of the
board every Thursday at 2 o'clock P.M., unless that day be a holiday when the meeting is to be held on the next business day, unless otherwise ordered by the board. The chairman of the board
may call a special meeting at any time and shall do so upon the
written request of any three directors or of the governor. Notice
of special meetings shall be given by mail or by telegraph. If given
by mail, such notice shall be mailed at least two days before the
date of the meeting. If given by telegraph, such notice shall be
dispatched at least twenty-four hours before the date of the
meeting. Notice of any meeting may be dispensed with if each of
the directors shall in writing or by telegraph waive such notice.
Section 4. POWERS.—The business of this bank shall be conducted under the supervision and control of its board of directors,
subject to the supervision vested by law in the Federal Reserve
Board. The board of directors shall appoint the officers and fix
their compensation.
The board may appoint counsel for the bank with such duties
and compensation as the board may determine.
Section 5. SPECIAL COMMITTEES.—Special business of the bank
may be referred from time to time to special committees, which
shall exercise such powers as the board may delegate to them.
* In effect January 1, 1929.
409

410

APPENDIX I

Section. 6. ORDER OF BUSINESS.—The board may from time
to time make such regulations as to order of business as may seem
to it desirable.
ARTICLE II.—EXECUTIVE COMMITTEE
Section 1. How CONSTITUTED.—There shall be an executive
committee consisting of the governor (or, in his absence, a deputy
governor), the chairman of the board of directors and three or
more directors chosen by the board, who shall serve during the
pleasure of the board or for termsfixedby it. Not less than three
members of the committee shall constitute a quorum for the transaction of business, and action by the committee shall be upon the
vote of a majority of those present at any meeting of the committee.
The committee shall have power to fix the time and place of
holding regular or special meetings and the method of giving notice thereof.
Minutes of all meetings of the executive committee shall be kept
by the secretary, or an assistant secretary, and such minutes shall
be submitted to the members of the board of directors at its next
succeeding meeting. Such minutes or a digest thereof shall be
read to the meeting if requested by any member of the board.
Section 2. POWERS.— Subject to the supervision and control of
the board of directors, as set forth in Article I, section 4, the executive committee shall have the following powers:
(a) To pass upon all discounts and advances.
(b) To apply for and provide for the security of such Federal
Reserve notes as may, in the judgment of the committee or of the
board, be necessary for the general requirements of the bank.
(c) To employ or to delegate to officers of the bank authority
to employ clerks and other subordinates and to define their duties
and to fix their compensation.
(d) To approve bonds furnished by the officers and employees
of the bank and to provide for their custody.
(e) To exercise such other powers as may be from time to time
delegated to such committee by the board of directors.
(f) In general, to direct the business of the bank, subject to the
supervision and control of the board of directors.
ARTICLE III.—OFFICERS
Section 1. The board of directors shall in January of each year
appoint a governor, one or more deputy governors, one or more

BY-LAWS OF FEDERAL RESERVE BANK OF NEW YORK 411
assistant deputy governors, one or more managers of departments
of the bank, a secretary, and a general auditor, and shall have
power at other times during the year whenever for any reason the
offices of governor, or deputy governor, or assistant deputy governor, or manager, or general auditor, or secretary, are vacant to
make appointments to fill such positions, and shall have power
from time to time to appoint such additional deputy governors,
assistant deputy governors, managers, and such other officers as
the board may determine to be necessary and appropriate for the
conduct of the business of the bank. The secretary may hold at
the same time the position of deputy governor, or assistant deputy
governor, or manager. The officers chosen by the board shall hold
office during the pleasure of the board.
Section 2. CHAIRMAN OF THE BOARD.—The chairman of the
board shall preside at all meetings thereof and shall perform such
other duties as the board may require.
Section 3. DEPUTY CHAIRMAN.—In the absence or disability of
the chairman, his powers shall be exercised and his duties performed by the deputy chairman.
In the absence of both the chairman and deputy chairman, the
third Class C director shall preside at meetings of the board.
Section 4. GOVERNOR.—Subject to the supervision and control
of the board of directors, the governor shall have general charge
and control of the business and affairs of the bank. He shall
have power to make any and all transfers of securities or other
property of the bank which may be authorized to be sold or transferred by the executive committee or by the board. The governor
shall have power to prescribe the duties of all subordinate officers
and agents of the bank where such duties are not specifically prescribed by law or by the board of directors or by the executive
committee or by the by-laws. The governor may suspend or remove any employee of the bank.
Section 5. DEPUTY GOVERNORS.—The duties of the deputy
governors shall be such as may from time to time be prescribed
by the governor, where such duties are not specifically prescribed
by the board of directors, or by the executive committee.
Section 6. ASSISTANT DEPUTY GOVERNORS.—The duties of the
assistant deputy governors shall be such as may from time to
time be prescribed by the governor, where such duties are not
specifically prescribed by the board of directors, or by the executive committee.

412

APPENDIX I

Section 7. MANAGERS.—The duties of the managers shall be
such as may from time to time be prescribed by the governor,
where such duties are not specifically prescribed by the board of
directors, or by the executive committee.
Section 8. SECRETARY.—The secretary or an assistant secretary shall keep the minutes of all meetings of the board and of
all committees thereof. He shall have custody of the seal of the
bank with power to affix same to certificates of stock of the bank,
to acknowledgements of assignments of registered bonds of the
United States, and to such instruments the execution of which
may from time to time be authorized by the board or by the
executive committee. The board of directors may, in the absence
or disability of the secretary, or upon other occasion when in the
discretion of the board greater convenience can be attained appoint a secretary pro tern, or empower one or more officers to
affix the seal of the bank to certificates of stock or other instruments. The secretary and the assistant secretary shall have such
other duties as may from time to time be prescribed by the governor, where such duties are not specifically prescribed by the
board of directors, or by the executive committee.
ARTICLE IV.—CERTIFICATES OF STOCK
All certificates of stock, or of payment of or on account of stock
subscriptions shall be signed by the governor or a deputy governor
and the secretary or an assistant secretary, or such other officers
as may be prescribed by the board, and shall be countersigned by
the Federal Reserve agent or an assistant Federal Reserve agent;
and such certificates shall bear the corporate seal.
ARTICLE V.—BUSINESS HOURS
The bank shall be open for business from 10 o'clock to 3 o'clock
on each week day except Saturday, on which day it shall be open
for business from 10 o'clock to 12 o'clock, and except that it shall
not be open for business on days or parts of days established as
legal holidays.
ARTICLE VL—AMENDMENTS
These by-laws may be amended at any regular meeting of the
board by a majority vote of the entire board: Provided, however,
that a copy of such amendment shall have been mailed to each
member at least five days prior to such meeting, unless waiver
thereof shall have been made in writing.

APPENDIX II
DIRECTORS OF THE FEDERAL RESERVE BANK OF NEW YORK
Of the nine directors of the Federal Reserve Bank of New York, the member banks voting in the three groups mentioned below elect six, of whom three may be bankers
and three must be actively engaged in commerce, agriculture or industry in the district. The remaining three are appointed by the Federal Reserve Board and they and
the three business-men directors may have no other banking connections while serving as directors.
Group 1, Banks having capital and surplus in excess of $1,999,000
Group 2, Banks having capital and surplus not exceeding $1,999,000 and not below $201,000
Group 3, Banks having capital and surplus below $201,000
Class
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
B
B
B
B
B
B
B
B
B
B
B
B
B
C
C
C
C
C
C
C
C
^Gro7

Director

Residence

Character of
Business

Business Firm or Affiliation

Tenure

Group *

To
December 31, 1918
December 31, 1924
December 31, 1930
December 31,1919
December 31,1922
December 31,1925
December 31,1929
December 31,1928
December 31,1931
December 31,1932
December 31,1933
March
15, 1933
December 31, 1935
December 31, 1937
December 31, 1936

1914
1, 1922
1, 1925
1914
1, 1920
1, 1923
1914
1, 1920
1, 1924
1, 1927
1,1933
3, 1933
1, 1934

December 31,1921
December 31,1924
December 31, 1933
December 31,1919
December 31,1922
January 13,1927
December 31,1919
April
28, 1923
December 31,1932
March
3, 1933
December 31,1935
December 31, 1937
December 31, 1936

October
1914
January 1, 1922
October
1914
October
1914
February 9, 1917
January 13, 1927

December 31,1921
December 31, 1936
December 31,1926
January 31,1917
December 31,1926
December 31, 1935
February 27,1930
December 31,1937

F. D. Locke
Charles Smith
Delmar Rimkle
William Woodward
Jas. S. Alexander
Gates W. McGarrah
R. H. Treman
J. E. Reynolds
C. K Mitchell
T. W. Stephens
David C. Warner
Albert H. Wiggin
Edward K. Mills
George W. Davison
Cecil R. Berry

Buffalo, N. Y.
Oneonta, N. Y.
Hoosick Falls, N. Y.
New York City
New York City
New York City
Ithaca, N. Y,
New York City
New York City
Montclair, N. J.
Endicott, N. Y.
New York City
Morristown, N. J.
New York City
Waverly, N. Y.

Vice Pres., Mfrs. & Traders National Bank
President, Citizens National Bank
President, Peoples National Bank
President, Hanover National Bank
President, National Bank of Commerce
Chairman, Mechanics & Metals National Bank
President, Tompkins County National Bank
President, First National Bank
President, National City Bank
President, Bank of Montclair
President, Endicott Trust Company
Chairman, Chase National Bank
President, Morristown Trust Company
Chairman, Central Hanover Bank and Trust Company
President, Citizens National Bank

Banking

3
3
3
1
1
1
2
1
1
2
3
1
2
1
3

From
October
1914
January 1,1919
January 1, 1925
October
1914
January 1, 1920
January 1, 1923
October
1914
January 1, 1926
January 1, 1929
January 1, 1930
January 1,1931
January 1, 1932
January 1, 1933
3, 1933
May
January 1,1934

L. R. Palmer
Frank L. Stevens
S. W. Reyburn
H. R. Towne
Chas. A. Stone
Owen D. Young
W. B. Thompson
R. H. Williams
T. K Whitmarsh
William H. Woodin
Walter C. Teagle
Thomas JV Watson
Robert T. Stevens

Croton-on-Hudson, N. Y.
North Hoosick, N. Y.
New York City
New York City
New York City
New York City
Yonkers, N. Y.
Madison, N. J.
New York City
New York City
New York City
New York City
Plainfield, N. J.

President, Croton Docks Company
President, Stevens & Thompson, Inc.
President, Associated Dry Goods Corporation
Chairman, Yale & Towne Manufacturing Company
President, American International Corporation
Chairman, General Electric Company
President, Inspiration Copper Company
Williams & Peters, New York
President, Francis H. Leggett & Company
President, American Car & Foundry Company
President, Standard Oil Company of New Jersey
President, International Business Machines Corporation
President, J. P. Stevens & Company, Inc.

Real Estate
Manufacturing
Merchandising
Manufacturing
Public Utilities
Manufacturing
Mining
Merchandising
Merchandising
Manufacturing
Manufacturing
Manufacturing
Merchandising

3
3
3
1
1
1
2
2
2
1
2
1
3

October
January
January
October
January
January
October
June
January
April
January
May
January

Lake George, N. Y.
Geo. F. Peabody
New York City
C. M. Woolley
New York City
Pierre Jay
New York City
Charles Starek
Plainfield, N. J.
W. L. Saunders
New York City
Owen D. Young
New York City
Gates W. McGarrah
Plainfield, N. J.
J. Herbert Case
p number refers to the group classification of the bank

Chairman, American Radiator Company
Chairman, Federal Reserve Bank of New York
National Bank Examiner
Chairman, IngersoU-Rand Company
Chairman, General Electric Company
Chairman, Federal Reserve Bank of New York
Chairman, Federal Reserve Bank of New York

Financier
Manufacturing
Banking
Bank Examiner
Manufacturing
Manufacturing
Banking
B

•"

which formally nominate! the director. It does not refer to the group classification of the bank with which the director is connected.

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Economic Review, Vol. XI, No. 2, June, 1921.
National Citizens League. The Origin of the League. Chicago,
1911.
The New York Times.
Read, L. M. The Story of Commercial Paper. R. G. Dun and
Company, New York, 1931.
Report of the Monetary Commission of the Indianapolis Convention. The University of Chicago Press, Chicago, 1898.
Report of Committee to Consider Advantages of Tax on Circulation over Government Participation in Profits. Submitted
to the Conference of governors and Federal Reserve agents
with the Federal Reserve Board. 1924.
Report of the Committee on Finance and Industry (Macmillan
Report). H.M. Stationery Office, London, 1931.
Report of the Gold Delegation of the League of Nations Financial
Committee. League of Nations, Geneva. World Peace
Foundation, Boston, 1932.
Snowden, Philip. "The Bank of England and European Reconstruction." The Banker, London, Vol. I l l , No. 16, May,
1927.
Sound Currency. A periodical published by the Sound Currency
Committee of the Reform Club in New York. 1891 and 18941905.
Weston, N. A. "The Studies of the National Monetary Commission." The Annals of the American Academy of Political and
Social Science, Vol. XCIX, No. 188, January, -1922.

420

BIBLIOGRAPHY

Willis, H. Parker. "The Banking Question in Congress." The
Journal of Political Economy, Vol. XX, No. 9, November,
1912.
. "The Federal Reserve Act in Congress." The Annals
of the American Academy of Political and Social Science,
Vol. XCIX, No. 188, January, 1922.
" The Discount
the United1927,
States."
The-.Banker,
London,Rate
Vol. Controversy
IV, No. 22, in
November,
"American Banking and Investment Trust Problems."
The Banker, London, Vol. V, No. 24, January, 1928.
"A Turning Point in American Banking." The Banker,
London, Vol. VIII, No. 35, December, 1928.
. "Restoring Bank Liquidity in the United States."
The Banker, London, Vol. XIII, No. 50, March, 1930.
"American Banking during 1930."
The Banker,
London, Vol. XVII, No. 61, February, 1931.
"American Banking and the German Collapse." The
Banker, London, Vol. XIX, No. 68, September, 1931.
"The Failure of the Federal Reserve." North American Review, Vol. 227, No. 5, May, 1929.
"The Breakdown of the Gold Exchange Standard and
Its Financial Imperialism." The Annalist, Vol. XXXIII,
No. 978, Oct. 16, 1931.
Willis, H. Parker and Others. Report of an Inquiry into Contemporary Banking in the United States. 7 Vols. 1925. Unpublished. (On file, Columbia University Library.)

INDEX
Acceptance market, development of, Atlanta Federal Reserve Bank:
and centralization in New York,
adopts credit rationing, 275n;
375-380
agency of, 301; service to banks in
Acceptance rates, 240-244; and conCuba, 287-289
centration of funds in New York, Austria, National Bank of, loan to,
375-380
334
Acceptances, bankers*, 349, 389n,
400: and government securities, Baker, Newton D., cited, 273n
289-290; abuses in use of, 243, 249, Banco de la Nacion, 305
333-335, 377, 384, 400; character Bank Conservation Act (emergency
act of March 9, 1933): issue of
of, held by New York Reserve
Federal Reserve bank notes under,
Bank, 205-206; re difference be201; passed during the bank
tween rediscounting and purchases
holiday, 230
of, 243n; Federal Reserve banks
not required to buy, 245-246; Bank credit: a reserve for other bank
credit, 352-353; control of, 231Federal Reserve policy re, and use
239, 276-280, 386; deterioration
of bank credit in stock market,
in quality of, 404-405; determina375-380; re kind of firms from
tion of use of, 238, 258, 272, 273;
which purchases were made, 234,
expansibility of, 353; factors mak242n, 248-249, 384; lack of standing
for expansibility of, during war,
ard, 15; New York Reserve Bank
211; influence of discount rate
makes market for, 162; purchase of,
changes on the cost of, 243-244,
for central banks, 336-337; purpose
248; maintaining parity of, with
of granting acceptance powers to
gold, 193-194; member bank renational banks, 375; services to
serve balances, the basis of, 187,
member banks re, 289; substituted
234, 236, 245; open market operafor long-term securities by Eurotions and availability of, 398n;
pean institutions, 333
relation of expansion of, to inflation
Acceptances, domestic, 378
and the depression, 382-387; relaAdministration and control, 83-105,
tion of expansion of, to needs, 407;
386
reason for central bank to consider
Agricultural Emergency Relief Act
use made of member, 380; reasons
of May 12, 1933, re changing legal
for expansion, 360-364, 406-407;
reserve requirements, 185-186
use of, in security speculation, 353Aldrich Bill: approved by American
360
Bankers Association, 27; how different from Federal Reserve Act, Bank failures, 286: and the examination function, 300; during early
29-32; introduced in Congress, 24
thirties, 224-227, 250; failure of a
Aldrich, Nelson W., plan of, 22member bank in New York City,
28
101-102; relation of Federal ReAldrich-Vreeland Act, 21-22: issue of
serve banks to, 402^07; services of
"emergency notes" under, 134;
Federal Reserve system re bank
provision re taxes on "emergency
runs and suspensions, 287-289;
notes/ 1 121
statistics, 403
American Bankers Association: approval of Aldrich Bill, 26-27; Bank for International Settlements:
and the Federal Reserve system,
Economic Policy Commission of,
322-335; capital stock of, 328n;
favors reduction of Government's
determines credit policy of Federal
share of earnings, 124n
Reserve system, 334, 343; estabAnderson, B. M., cited, 382n
421

422

INDEX

Iishment, 322-325, 328n; functions,
325, 332; meaning of the term
"central bank," in statutes of, 326;
operates international clearance
fund, 339n; purchase of stock of,
by American banks and authority
for, 328; services rendered for, by
New York Reserve Bank, 330;
statement of official of New York
Reserve Bank on relation to, 323
Bank holiday, 226-231,405
Bank of England, 119, 307: agreement of 1925, to loan to, 317-319;
arrangements for paying securities
in United States, 283-284; cooperation with Federal Reserve system,
321n, 337; direct dealing with public in commercial paper, 248; earmarks gold for New York Reserve
Bank, 305, 306; establishment of
agency relationship with, 302-304;
re exchanging information with
New York Reserve Bank, 321n;
Federal Reserve discount rates
held to be dictated by, 314-315;
forerunner of central banks, 181n;
loan to, of 1931, 334-335; position
of governor of, 94; relations with
governor of, 309-319; stockholder
of, cited, 312
Bank of France, 307: cited, 316; direct dealing with public in commercial paper, 248; relations with
New York Reserve Bank, 310-314,
316,335
Bank of Spain, 306
Bank of Sweden, 181n
Bank of the Manhattan Company,
73; cited, 13n
Banker, The (London), cited, 315
Bankers' balances: expectations re,
under Federal Reserve system,
349; loaned in call money market,
8-9; reasons for concentration of
in New York, 7-8, 354-357, 360370, 375-380; reasons for, under
Federal Reserve system, 360-370;
under Federal Reserve system,
349-354; used as a secondary
reserve, 7
Bankers in New York (also see New
York City banks): antipathy of,
to development of Federal Reserve
system, 134^142; control over
American banks by, 389-391; desire not to disturb correspondent
relationships, 60-61; endorse Aldrich plan of a central bank, 25;

oppose opening of Reserve banks,
74-75; urge a large Reserve bank
in New York, 4 2 ^ 3
Banking Act of 1933: distribution of
earnings of Reserve banks, 120,
130-131; foreign relations, 344345; group banking, 159-160; jurisdiction of Federal Reserve Board
extends directly to member banks,
276-280; member bank loans on
securities, 357n-358n; mutual savings banks, Morris Plan banks,
eligible to membership, 153; open
market operations, 176-180; use of
bank credit in securities operations,
276^280
Banking, American: defects of, under
National Bank Act, 4-18; development of, 1—k; government control of, 26, 28, 31, 33-36, 159-160
(also see Central authority of control); influence of units of Federal
Reserve system, 397-399; under
Federal Reserve system, 397-408
Banking Reform: and the Banking
Act of 1933, 276-277; preceding
enactment of Federal Reserve Act,
19-29, 32
Banks (also see Member banks, National banks, Non-member banks,
State banks): and emergencies,
220-231; assets, condition of, 400,
404^07; bank holiday, 226-231,
405; competition between state and
national banks, 127, 144, 153,
155n-156n, 299; correspondent
bank borrowing, 365-367; effort to
ration loans of, and difficulties,
260-264, 270-273; examination of,
298-300; integration of, under
Federal Reserve system, 399; interbank balances, 349-351; liquidity
of, dependent upon stock market,
11; purchase of stock of International Bank and authority for,
328; relation to security affiliates
and investment trusts in stock
speculation, 356-358; services rendered by city, to "country"
correspondents, 363-370; shifting
of demand deposits to time deposits, 189, 361-362; under Federal
Reserve system, to engage in
commercial banking, 348-349
Belgium, National Bank of, 306, 307;
loan contract with, 318-319
Blackett,BasilP.,78n
Boston: as a financial center, 9;

INDEX

423

experience of Boston banks with Call loan market, 346, 349, 363n,
New York banks in crisis, 11; re
364, 373: attractiveness of, under
location of a Reserve bank in, 44Federal Reserve system, 358-360,
50; money market in, 379
375, 378-380; banks borrow from
Federal Reserve banks to loan in,
Boston Clearing House Association,
358^360, 383; New York banks
139
solicit funds to loan in, 355-358;
Boston Federal Reserve Bank: and
use of, by banks, 8-9; versus other
earmarking of gold, 339-340;
money markets, 375-380
agency of, 301; designated for
representation on open market Call loan rates, 16: fixing of, 381382; prior to 1914, and under
committees, 167, 176, 178; re
Federal Reserve system, compared,
establishment of, 44-50; takes over
381n-382n; stabilization of, 381work of Boston Clearing House
382; supplant Federal Reserve
Association, 139
discount rate in influence, 269
Boston Federal Reserve District,
Call loans: bankers' balances used
hearings re, 44-50
for, 8-9; dominance of New York
Branches of Federal Reserve banks:
City banks re, 9; liquidity of,
foreign, 301, 369; location of, 62
379-380; use of Federal Reserve
British Government, 307: arrangecredit for, by National City Bank
ment with, to supply rupee exof New York, 373
change, 305-306; contract of 1925
with J. P. Morgan and Company, Canada: banks of, and membership
in Federal Reserve system, 395;
318; services of New York Reserve
conversion of paper money of, into
Bank re securities of, 283-284,
United States funds, 286-287
290
Broadway Trust Company, 146-147 Carlisle, J. G., cited, 19
Brokers' loans, 265, 267, 270, 272, Case, J. H., cited, 101, 133n
367-368, 375, 379: bank credit Central authority of control (also see
Federal Reserve Board), 17-18, 31,
created for, 357; Banking Act of
33-36, 176, 180, 276-280, 332, 342,
1933 on loans for "others," 357n344-345
358n; classification of, 354n; increase of, 354-355; relation of Central bank: ambition of some
New York banks, 37; lack of, 10New York Reserve Bank to, 38311, 17-18; meaning of the term
384; responsibility of New York
"central bank," in the statutes of
banks for, 355-358; sources of
the International Bank, 326; New
loans for "others," 356-358
York Reserve Bank in capacity
Buffalo Branch of the Federal Reof
a central bank of the United
serve Bank of New York: map
States, 387-399; not prescribed by
showing counties allocated to, 60;
Federal Reserve Act, 34-36; Open
nature of, and services to banks,
Market Investment Committee
294-298
operated as, 173-174; plan of
Burgess, W. R., 323
Senator Aldrich, 27-32; proposed,
Business organizations: direct loans
20; rival plans for, by New York
to, 233, 247-251; financial statebanks, 136-137; urged at beginments of, advised, 291-292, not
ning of the century, 20-21
analyzed, 386; financing of, 378,
391-394; investment services of Central bank policy, in relation to: acceptances, 246, 375-380; accumulaNew York banks for, 366-368;
tion of surplus, 118-120; credit conloaning funds of, in stock market,
trol (also see Credit control), 233,
355-358; New York banks loan to,
275; distribution of earnings of Rein all Federal Reserve districts,
serve banks, 118-433; lending on
388-389, 392; rationing of credit
government securities, 258; money
for, and regulation of, 262-264,
markets, 375-380; paying interest
274-276; relieved by par collecon member bank reserves, 127-128;
tion system, 282; transfer of funds
purchases of commercial paper difor, 284r-285
rectly
from business concerns, 247By-Laws, 83-84; of the New York
248; regulation of business enterReserve Bank, 409-412

424

INDEX

change, 198; of acceptance busiprise, 275; stock speculation, 371ness, 375-380; of credit control pow374, 382-387; testing commercial
ers, 276-280; of foreign relations,
credit, 386
301-345; of gold reserves, 399-400;
Central banking: administration of,
of open market policy, 161-180; of
and the public, 408; and the FedTreasury operations, 215-219
eral Reserve Act, 32-34; demand
for, at beginning of the century, Chamber of Commerce of the United
States, favors reduction of Gov20-21; development under Federnment's share of earnings, 124n
eral Reserve system, 397^-408;
responsibility lacking re ultimate Chase National Bank, 66: correspondent banking relationships,
bank reserves, 8
365n, 366; example of stock market
Central banking functions (also see
loans, 267n; head of, on borrowing
Credit control): and bank failures,
from Federal Reserve Bank to
404; and emergencies, 220-239;
lend on stock exchange, 373-374;
city correspondent banks, banks
letter to its correspondent banks, 25
of rediscount for non-member
Checks:
circuitous routing of, 5,
banks, 365-367; correspondent
282; clearing and collection of, 14,
bank system provides reserve de281-284; float, 14, 282; payment
positaries for non-member banks,
of Government checks, 214n
363-364; credit control, 231-280,
386; custody and administration of Chemical National Bank, 79
the nation's gold reserve, 189-196; Chicago: a central reserve city, 4, 6;
as a financial center, 7, 351; confiscal agent of the Treasury, 208centration of bankers' balances in,
219; holder of reserves of member
351; money market in, 379
banks, 183-189; note issue, 200208; purpose of Federal Reserve Chicago, First National Bank of: aid
of, in obtaining funds from AmeriAct, 34; regulation of foreign excan banks for International Bank,
change, 196VL99
328
Central banking system: characteristics of Federal Reserve system, Chicago Federal Reserve Bank: designated for representation on open
34r-36; development of Federal
market committees, 167, 176, 178;
Reserve system, 397-408; purpose
Detroit branch of, supplies curof Federal Reserve Act, 34, 387;
rency during crisis, 228; independrelation to national economy, 232ence of, induces scorn of London
233
bankers, 171; refuses to alter disCentral banks, 181: buying accepts
count rate, 314
ances for account of foreign, 242n,
336-337; dollar balances serve as Chicago Tribune, The, calls for resigreserves of, 320-321; establishnation of governor of New York
ment of, advocated at Genoa
Reserve Bank, 315
Conference, 1922, 309; finance Clearing and collection: based on
loans to, 333-335; foreign, withmember bank reserve balances,
draw balances in gold, 225, 227187; conflict between New York
228; international conferences of
Reserve Bank and New York
officials, 309-316, 341; of countries
Clearing House, 137-141; defects,
with which New York Reserve
14; immediate credit, 281-282,
Bank has had dealings, 340n; of
368; international clearance fund,
Europe, 37; relation of Federal
339; services of city correspondent
Reserve system to foreign, 301banks, 368-369; services to banks
345; relation to Bank for Internaand business, 281-285
tional Settlements, 322-333; re- Clearing house associations (also
lations with foreign, during the
see New York Clearing House):
World War, 304r-307; services
regional and county, 283; use
rendered foreign, by New York
Federal Reserve bank to settle
Reserve Bank, 335-337
balances, 282
Clearing
house certificates, use of,
Central reserve cities, 4
13n-14n
Central service functions, 281-300
Centralization: control of foreign ex- Cleveland Federal Reserve Bank,

INDEX
designated for representation on
open market committees, 167, 176,
178
Collection: benefits of, under Reserve
system, 126; plan of Guaranty
Trust Company of New York, 137
Commercial paper (also see Eligible
paper), 349: acceptability and rediscounting of, 252-253; and member bank borrowing, 110, 407;
banks rediscount and lend proceeds on stock exchange, 373; eligibility and redlscounting of, 251252, 407; eligible paper and collateral behind Federal Reserve
notes, 208, 407; Federal Reserve
banks refused to buy, 233-234,
248; lack of standard, 15; provision
in Federal Reserve Act on rediscounting of, 258, 371-372; rediscounting of, compared with open
market operations, 244r-245; tests
employed to determine acceptability of, 253n
Commercial paper market, development, 375-380
Commons, John R., cited, 391
Comptroller of the Currency: and
examination of banks, 298-299;
and opening of Federal Reserve
banks, 65, 78; member of Federal
Reserve Board, 34; no authority to
invest in stock of foreign banks
given by, 328
Concentration of funds in New York,
6-12, 346-370, 375-380, 398
Concentration of reserves in New
York, 6-12, 346-349, 352-353, 360
Connecticut: county in, attached to
New York District, 59, 60; transfer
of banks in, to New York District,
58-59
Corn Exchange Bank of New York,
147-148
Correspondent bank system: advantages of, to banks, 145; affected by
restriction against interest on demand deposits, 364n; and influence
of New York Reserve Bank, 387395; and open market operations,
398n; before passage of Federal
Reserve Act, 4-12; borrowing relationships and credit control, 407;
clearing and collection service,
402n; correspondent bank borrowing, 365-367, 388-392; defects, 17,
346-349; features of concentration
of funds in New York, 11; Federal

425

Reserve system held to threaten,
135; inter-bank balances, the basis
of, 5; inter-bank balances under
Federal Reserve system, 349-351;
New York bankers desire not to
disturb, 37; New York banks make
brokers' loans for correspondents,
353-360; New York Reserve Bank
supplies funds for, 286, 379, 383,
388^392; opposition of city banks
to introduction of Reserve bank
services, 142; provisions of Federal
Reserve Act which were to subjugate, 349; pyramiding of reserves,
352-353; reasons for, under Federal
Reserve system, 360-370; services
of city correspondent banks, 363370, 402n; services of New York
banks to correspondents during
emergencies, 221, 225, 227-228,
365-366, 379, 388-389; transfer of
reserves in correspondent banks to
Federal Reserve banks, 183-185,
188
Country banks, reserves of, under
National Bank Act, 4
Cox, James M., cited, 393
Credit (also see Bank credit): rationing of, 262-264, 274r-276; testing
commercial, 386
Credit control: and state banks in
Federal Reserve system, 156; basis
of Federal Reserve control of bank
credit, 233-236; clearing and collection, of aid in, 281; conflict between
the Federal Reserve Board and the
New York Reserve Bank, 266-268;
control over the use of credit, 236239; defects re, under old national
banking system, 17-18; determination of the use of bank credit, 237238, 258, 272, 273; efficacy of Federal Reserve, 406-408; factors related to inflation and depression
commencing in October, 1929, 382387; Federal Reserve Board s authority increased, 176-180, 186,
276-280, 344-345; Federal Reserve
Board's power re note issue, 202203; loans on collateral, 254r-259;
meaning of the term, 231-233;
national aspects of credit policy of
New York Reserve Bank, 233,39^399; persuasion, and curtailment
of non-essential loans, 260-264,
270-273; purchase of paper directly
from business concerns, 233-234,
247-251; rationing of credit, 262-

426

INDEX

264, 274-276; refusal to discount
eligible paper, 273-274; relation
of credit expansion to needs, 407;
requirements re acceptability of
paper, 252-254; requirements re
eligibility of paper, 251-252;
through open market operations,
161-180, 244-251; transfer of control over use of Federal Reserve
credit to commercial bankers, 258;
use of discount and acceptance
rates, 240-244; warnings, 264270
Crises (also see Panics, Emergencies):
and alliance of banks with stock
speculation, 346; bank holiday,
226-231; depression of 1929-1933,
223-231; post-war period, 220-223;
services of Federal Reserve system,
379
Cuba, Federal Reserve system serves
banks in, 287-288
Currency: deposit, 12-13; elasticity
of, increased, 186; experience under
Federal Reserve system, 208, 407408; hoarding, 225-226, 230; how
demand for elastic currency was
met, 32; inelasticity of, 12-13
Currency, coin, and gold bullion,
central service functions re, 285287
Currency policy, use of gold certificates instead of Federal Reserve
notes, 194, 208
"Currency Reform," meaning of the
term, 20
Dayton, Ohio, report on conditions
during depression in, 393
Delano, F. A., 81n
Deposits (also see Bankers' balances):
concentration of, in New York,
6-12; deposit currency, 12-13, 17;
interest on, 123-130, 280, 364n;
methods of putting depositors' accounts on paying basis, 291; shifting of demand, to time, 189, 361362; used as legal reserve, 4r-5
Depression: and alliance of banks
with stock speculation, 346; and
inflation during the "new era,"
382-387; aid of New York Reserve
Bank to banks and companies in
all Federal Reserve districts during,
388-389, 391-392; policy during,
107-110, 241; relation of Federal
Reserve policy and inflation to,
382-387, 397n; report on con-

ditions in Dayton, O.» during,
393
Directors: Class C, appointment of,
71; election of first, 65-71; executive committee of, 91, 97; list of
New York Reserve Bank, on insert
facing 412; method of electing,
84-86; service of and interests
represented by, 86-88
Discount Market (also see Acceptance
market): defects, 14-15; establishment of national, 379
Discount rates (also see Interest
rates), 240-244: and concentration
of funds in New York, 375-380;
efficacy of changes, 174, 242-244,
269, 384r-385; foreign aspects of
altering, 171, 309, 313-316, 319
Domestic exchange: defects, 15; supplied by city correspondent banks,
368-369; supplied by Federal Reserve system, 284-285
Earmarked gold, see Gold
Eligible paper (also see Commercial
paper): and collateral behind Federal Reserve notes, 208; distinction
between eligibility and acceptability, 252-253; loans on collateral of,
254—259; practice in rediscounting,
252-254, 407; refusal to discount,
273-274, 385; requirements for rediscounting, 251-252; tests employed to determine acceptability,
253n
Elliot, M. C , 38
Emergencies (also see Crises, Panics):
and central banking functions, 220239; Federal Reserve banks instead of correspondent banks, to
meet needs in, 348; rediscounting
privilege to be used for, 264; services of Federal Reserve system in,
287-289, 379, 388-389, 404^06
Emergency Act of May 12, 1933, 279
Examination of banks, 298-300
Federal Advisory Council, 34
Federal fund market, 107-108, 189,
376
Federal Open Market Committee,
176-180
Federal Reserve Act: and central
banking, 32-34; and Woodrow Wilson, 33; comment re, when enacted,
36n; Federal Reserve Board cited
re unified banking, 143; how it
differed from Aldrich Bill, 29-32;

INDEX
intent re call loan market, 358;
intent re use of bank reserves in
speculation, 346-349; intent re use
of Federal Reserve credit in speculation or security loans, 266, 272,
346-349, 358, 371-372, 386; nullified re use of Federal Reserve credit
in stock speculation, 272-273; opposition to, by bankers, 27, 349;
opposition to, by New York bankers, 37, 349; passage of, 26-29; provisions of, to subjugate correspondent bank system, 349; purposes of,
29-32, 34, 35, 346-349, 375, 387;
scope of foreign relations under,
301-302
Federal Reserve agent: and examination function, 299-300; and governor, 93-94; and issuance of
Federal Reserve notes, 202-206;
and stock market operations, 267n;
position and function of, 72, 93-94;
subordination of, to governor, 95-99
Federal Reserve bank notes, 200-202
Federal Reserve banks: and the Banking Act of 1933, 176-180, 276-280,
344—345; conversion of Canadian
money into United States funds,
286-287; custody and administration of the nation's gold reserve,
189-194; dealing directly with
public, 233, 247-251; discount and
acceptance rates, 240-244; Governors Council, 102-105; hold reserves of member banks, 183-189;
inter-Federal Reserve bank "accommodation," 221-223,229; member bank reserve balances in, basis
of nation's bank credit, a central
reserve against deposits in nonmember banks, 187; New York
Reserve Bank allots foreign-currency bills to, 198; New York
Reserve Bank begins to act as agent
for, 161-162; note issue of, 200-208;
open market operations and availability of bank credit, 398n; open
market operations of, dominated
by New York Reserve Bank, 168174; open market operations of,
under Banking Act of 1933, 176180; operation of, governed by
policy of New YorJs: Reserve Bank,
161-162; power of, in controlling
credit, 231-239; powers and functions of, 34-36; progressive rates,
241; rationing of credit and regulatioD of business enterprise, 262-264,

427

274-276; refusal to discount eligible
paper, 273; relation to bank failures, 402-407; relation to Federal
Reserve Board, 34-36; relations
with Bank for International Settlements, 322-335; relations with
foreign central banks, 301-345,396,
400; responsibility for open market
purchases, 234; service to banks in
Cuba, 287-288; services of, as fiscal
agents, 208-219; services of, during
emergencies, 220-231; services rendered United States Government,
122-123, 129, 209-210, 214-215;
transfer of gold to United States
Government, 194-196
Federal Reserve banks, establishment
and organization: administration
and control of,. 83-105, 386;
branches of, 294-298; by-laws,
83-84, of the New York Reserve
Bank, 409-412; charter, termination of, 82; executive staff, 72-74;
foreign branches and agencies, 301302, 369; hearings and decision
re establishment, 37-54; internal organization of, 79-82; location, 52, 62; obstacles to development and membership, 134-160;
officials meet with Federal Reserve
Board, 75, 80-82; opening of, opposed by bankers in New York,
74-75; Preh'minary Committee on
Organization, 79-82; problems re
opening, 74-82; Secretary of the
Treasury orders opening, 76-78;
stockholders, 88
Federal Reserve banks, finances,
106-133: capital stock, 106; deposits in, from whom accepted,
106; earnings, 106-111, 117-133,
sources of, table, 111, disposition
of, table, 116; expenses, 112-116,
122-123; profits, 128n; surplus,
118-120
Federal Reserve Board: cited re unified banking, 143, 155n; and examination function, 298-300; and
foreign transactions of Federal
Reserve svstem, 302-345; and International Bank, 326, 331-332,
342; and note issue, 202-204; and
representing American interests
abroad, 340-343; and securities
operations, under Banking Act of
1933, 276-280; and Treasury operations, 216; appointment of directors and officers of Reserve

428

INDEX

banks, 71-73; asserts authority
over open market operations, 165167, 175-176; authority over foreign relations, extended under
Banking Act of 1933, 344r-345; central authority of control, 34-36,
178-180, 276-280, 344-345; conflict with New York Reserve Bank
over use of Federal Reserve credit
in stock speculation, 265-270;
control of credit increased under
act of May 12, 1933, 185-186; control of open market operations
under Banking Act of 1933, 176180; direction of inter-Federal Reserve bank accommodation, 221222; re directors appointed by, 86,
91-102; enlargement of authority
over controlling credit, 176-180,
276-280, 344r-345; empowered to
authorize direct loans to public,
249-250; Federal Reserve agent as
representative of, 99-102; interference by Governors Council, 134;
jurisdiction of, extended directly to
member banks, 276-280; meeting
with directors and governors of Reserve banks, 75, 80-82; membership of, 34; on preventing emergencies, 232; on use of dollar exchange
by central banks, 321; opposition to authority of, by bankers,
144; origin of central control outside of, 162-164; powers and functions of, 34-36; readjustment of
district lines by, 54-63; relation to
Federal Reserve banks, 34-36; relation to Governors Council, 102105; resolution in 1919 re use of
Federal Reserve credit in stock
speculation, 374; resolutions of
1923 re open market operations,
164-167; urges rationing of credit,
260-261; uses persuasion and warnings to control credit, 260-270,272273; versus New York Reserve
Bank, 172-174
Federal Reserve districts: and location of Federal Reserve banks,
37-63, 387; decision, 53-54; effort
to reduce number of, 60-63; hearings on districting, 38-50; map, 62;
map of Second (New York) Federal
Reserve District, 60; methods and
principles of districting, 50-53; readjustment, 54r-63
Federal Reserve notes, 286, 361, 364:
gold certificates as reserve behind,

196; issuance of, 202-203; security
and elasticity of, 203-208, 407408; tax on, 120-123, 131-133;
used by national banks as cash in
vault, 152n; used by state banks
as part of legal reserves, 151-152
Federal Reserve system: acceptability of paper, 252-254; administration and control of, 83-105, 397;
and stabilization of prices, 231-232;
attractiveness of call loan market
under, 358-360, 375, 378-380;
benefits of, to non-member state
banks, 401—402; causes bankers to
cut excess reserves, 362-363; central service functions, 281-300;
centralization of foreign policy,
301-321; centralization of reserves
under, 32-33; characteristics of,
29-32, 34^36; clearing and collection, 281-285, 368, 402n; collaboration with foreign central banks,
322-345, 395-396; control of credit,
see Credit control; control of use
of credit in securities operations,
276-280; cooperation with Bank of
England, 337; credit policy, efficacy of, 406-408; credit policy,
relative influence as between central board and banks, 397-399; development of, re foreign transactions, 340-345;
development,
twenty years, 397-408; development opposed by banks, 134-142;
eligibility of paper and rediscounting, 251-252; establishment of, 1936; factors in expansion of bank
credit during war, 211; features of,
which were to achieve the objects
of banking reform, 348-^349; Federal Open Market Committee, 176180; Federal Reserve credit used in
stock speculation, 358-360; financing the World War, 210-213; gold
reserves of, a base for monetary
systems of foreign countries, 320321; gold reserves of, table, 190;
group banking and membership in,
157-160; inducements for state
banks to join, 146-152; investment
banking character of, 382-387,404r407; lending on collateral, 254-259;
loans to foreign central banks, 317319, 333-335; map of districts, 62;
non-member banks obtain use of
Federal Reserve credit for stock
market loans, 384; not to be merely
an emergency banking system, 231-

INDEX

429

232; open market investment com- Foreign Exchange: arrangement re
mittee, 166-174; open market operUnited States and India, 305-306;
ations, 244r-251; open market policy
defects, 15-16; dollar balances
conference, 174-176; open market
serve as reserves of foreign central
policy of, dominated by New York
banks, 320-321; New York ReReserve Bank, 168-174; operates a
serve Bank, the central bank re
control of, 198; purchase of, by
single reservoir of credit, 221-222,
New York Reserve Bank, 336-337;
229; opposition to clearing and colregulation of, 196-199; service of
lection functions, 136-143; origin
city correspondent banks, 369;
of central control outside the Fedstabilization of sterling and other
eral Reserve Board, 162-163; perrates of, 305-307, 317-319, 335;
suasion and curtailment of nonsupplying of, by Federal Reserve
essential loans, 260-264, 270-273;
banks, 369
profitableness of, to member banks,
124-126; public control of, and Foreign relations: control of Federal
Reserve, under Banking Act of
group banking, 159-160; pyramid1933, 344-345; foreign agencies of
ing of reserves under, 352-353;
Federal Reserve banks, 301-302;
rate and acceptance policy, and
foreign aspects of altering discount
stock speculation, 375-380; rationrates, 309, 313-316, 319; foreign
ing of credit, 274-276; reasons for
balances in United States, 320correspondent bank relations un321, 335-337; international charder, 360-370; refusing to discount
acter of New York Money Market,
eligible paper, 273-274; relation of
395-396; international financial repolicy to stock market collapse and
lations, 307-309, 395-396; New
depression, 382-387; relation to
York Reserve Bank begins to act
Bank for International Settlefor other Federal Reserve banks,
ments, 322-333; relation to na302-304; of Federal Reserve systional economy, 232-233.; relations
tem, 301-345; scope of, under
with the Treasury, 215-219, 400Federal Reserve Act, 301-302;
401; services of, during emerunified banking front in, 400
gencies, 220-231; warnings, 264r270; why a central banking sys- Foreign trade financing, 369, 400: defects, 15-16; example of cost of,
tem, 35; why state banks have
compared with domestic, 333n
refused to join, 141-147, 154155
Gaston, W. A., cited, 11, 49
Finances, 106-133
Germany, 316, 327, 333-335
Financial Age, cited, 138
Financial power, concentration of, 28, Glass, Carter, 26, 276,324; cited, 18n,
347, 372, 391
389-390
Financing of business organizations, Glass Bill, 26-27, 346-347
Glass-Steagall
Act, note issue under,
378, 391-394
206-207
Fiscal agency function: assumed by
New York Reserve Bank, 112; co- Gold: centralization and control of,
399-400; custody and control of, by
ordination with open market operaTreasury, 194^196; "earmarked,"
tions, 163; cost of, 112-113, 122explanation of, 338; earmarked for
123, 129; distribution of new issues
foreign central (banks, 227, 321,
of government securities, 169; in337-340; earmarking operations of
tegration of public finance with
the Federal Reserve system, 306,
banking system, 400-^01; paying
338-340; embargo, 197, 340; effort
United States Government checks,
to redistribute, 313, 319; for ex214n; relations with the Treasury,
port, 285-286, 338-340; hoarding,
215-219; services rendered the
228-230; international clearance
Government, 21^-215; transfer of
fund, 339; monetary gold stock and
functions to Reserve banks, 208gold reserves, table, 190; move210; war financing, 210-213
ments, 16,313,319,338-339; parity
Float, of checks, 14, 282
of all forms of money with, 193-494
Foreign branches of Federal Reserve
Gold dollar: and international prices,
banks, 301, 369

430

INDEX

395-396; devaluation of, 196n;
foreign confidence in, 336n
Gold exchange standard, 395: failure
of, 321n; Federal Reserve Board
on the use of dollar exchange by
central banks, 321; Federal Reserve system supports, 320-321,336
Gold Reserve Act of 1934: devaluation of the gold dollar under, 196n;
purposes of, 195; transfer of gold to
United States Government under,
195-196
Gold reserves (also see Reserves): acquisition of, by Reserve banks, 185,
189-193; administration of, by Reserve banks, 193-194; centralization and control of, 399-400; conservation of, 193-194; custody and
control of, by Treasury, 194-196;
subject to transfer to foreign countries, 311, 317-318, 320-321, 331,
336, 338^-339, 343; table, 190; used
in stock speculation, 406
Gold settlement fund, 191, 222, 281282, 285, 288, 339, 401
Gold standard: advocated at Genoa
Conference, 1922, 308; aid in restoration oi, abroad, 317-319; in
Great Britain, 317n; management
of, in United States, 193-194, 396,
399-400; nature of, before World
War, 320
Gold Standard Act of 1900, 20, 193
Governor: and Federal Reserve agent,
93-94; Bank of England, 94; position and title of, 72-73, 93; subordination of Federal Reserve
agent to, 95-99
Governors Council (or Governors
Conference), 102-105, 134, 161,
162, 164
Great Britain, 302, 313, 315, 317n,
318
Group banking, and membership,
157-160
Guaranty Trust Company of New
York: joins Federal Reserve system, 152; plan of, in opposition to
New York Reserve Bank, 137
Hamlin, Charles S., 81n; cited, 33n,
348n
Harding, W. P. G., 81n, 104; cited,
74, 155n, 268n-269n
Harris, S. E., 245n
Harrison, George L., 96,310-312, 327
Hauser, Richard, cited, 36n
Hitchcock, G. M., cited, 119

Hoover, Herbert C , 95, 323
Houston, D. R, 38
Hungary, National Bank of, loan to,
334
Independent Treasury, 16, 400
Indianapolis Monetary Commission,
19
Inflation: and Federal Reserve policy,
406-407; and stabilization of call
loan rates, 382; during the "new
era" and relation to depression,
382-387; effort to control, during
post-war period, 260-264, 268;
effort to control, during the "new
era," 265-270; Federal Reserve
banks to prevent, 236; in stock
market, 10, 249; resulting from
open market operations, 247, 249;
resulting from profit-making policy
of central banks, 127-128; postwar period of, 220-223
Interest: Banking Act of 1933 re interest on deposits, 280, 364n; payment of, on correspondent bank
balances, 124-125,364; payment of,
on member bank reserves, 123-130
Interest rates (also see Acceptance
rates, Call loan rates, Discount
rates), 13, 15, 401: and credit
control, 240-244; movement of,
in leading money markets, 309;
reducing fluctuations in, 217-218;
uniformity of, 375-380
International Bank, see Bank for
International Settlements
International financial relations, 307309, 395-396; power of United
States in, 395
Investment banking character of
Federal Reserve system, 380-387,
404^07
Investment trusts, relation to banks
in stock speculation, 356-358
Italy, Bank of, loan contract with,
318-319
Jay, Pierre, 71, 73, 76-78, 87n, 96,
142, 322; cited, 145-146, 150-151
Journal of Commerce, New York,
cited, 384
Kiseh, C. H., cited, 309n
Lamont, T. W., 323n
Laughlin, J. Laurence, cited, 23. 24
Lee, F. G., cited, 146-147
Liquidity: of acceptances, 243, 249,

INDEX
333-335, 384; of bank assets, 243,
400, 404r^07; of call loans, 379380; of Federal Reserve assets,
243, 333-335, 384, 387
Loans (also see Brokers' loans, Call
loans): and investments of member banks, statistics, 405; and
stock speculation, see Stock speculation; and testing commercial
credit, 386; advances on member
bank promissory notes, 254r-259;
correspondent bank, 365-367, 388392; curtailment of non-essential,
260-264, 270-273; determination of
use of, 237-238, 258, 272; effort to
ration, and difficulties, 260-264,
270-273; intended character of,
under Federal Reserve system,
348-349; 371-372; on collateral,
254r-259, 279, 349, 371-374, 386;
on eligible paper, 251-254, 407; on
government securities, 25^-259,
279, 371-373, 386; provision in
original Federal Reserve Act, 258,
371-372; requiring excess collateral,
254-259; to foreign central banks,
317-319, 333-335

431

188; indifference to voting privileges, 85-86; influence as stockholders, 88; keeping duplicate reserves with correspondent banks,
145; loans and investments, table,
405; member bank relations department, service to, 294; member
bank reserve balances reduced by
the sale of Federal funds, 189; opposition to clearing and collection
functions of the Federal Reserve
system, 141-143; penalties on account of deficient reserves, tables,
109, 111; reason for central bank
to consider use made of credit of,
380; reserve requirements of, tables,
182, 184, 186; services rendered by
Federal Reserve system to, 112,
142, 281-300
Membership in Federal Reserve system (also see State banks): and
group banking, 157-160; admission
of Canadian banks to, 395; changes
in Second Federal Reserve District,
table showing, 158-159; efforts to
increase, during the World War,
148-153; not indicative of benefits,
401-402; savings banks, Morris
Plan banks, etc., 153; since the
Marine Midland Corporation, 157World War, 153-157; the problem
159
of. 143-146, 153-157
McAdoo, Wm. G-, 81n, 302; cited, 38,
Michigan, banking crisis, 226-228
43*44, 50-52, 74-77, 148-149
Miller, A. C , 81n; cited, lOOn, 105n,
MacDougal, E. C , cited, 144
167, 170, 216, 269n, 362n-363n
McGarrah, Gates W., 266-267, 267n,
Mills, Ogden, 313-314
322, 326-327
Mitchell, C. E., cited, 373
Melchett, Lord, cited, 329
Member banks: and credit control, Money (also see Currency, Gold
dollar, Note issue): circulation of,
231-239; and emergencies, 220under Federal Reserve system,
231; and war financing, 210-213;
362n-363n; control of, 386, 408;
assets, condition of, 400, 404-406;
conversion of Canadian, into
borrowing from Federal Reserve
United
States funds, 286-287;
banks, 234, 238, 244, 245, 264currency policy, 194, 208; foreign
265, 267, 270-274, 277-279, 286,
monetary systems, establishing of.
358-360, 371-374, 379, 381-384,
317-319; gold, centralization and
386, 388-392; borrowing from Fedcontrol of, 399-400; monetary
eral Reserve banks for profit,
gold stock and gold reserves, table,
264-265, 271-272, 35&-360; bor190; parity of all forms of, with
rowing on government securities,
gold, 193-194; redeemability of
210-213, 254-259; brought under
money and credit in gold, 196; redirect jurisdiction of Federal Relation of American dollar and
serve Board, 276-280; control of
Federal Reserve system to foreign
Federal Reserve Bank, 96, 386;
monetary systems, 320-321; servcontrol over use of Federal Reices of Federal Reserve system in
serve credit, 258; effort to obtain a
supplying, to banks, 285-287;
larger share of earnings of Reserve
statutory price of gold, 196n; telebanks, 123-130; examination of,
graphic transfers, 284-285
101-102, 298-300; grouping of, Money
market: development of
84; how they obtained reserves,

432

INDEX

money markets, 375-380, 400;
importance of New York money
market under Federal Reserve
system, 393-396, 400; nature of
New York money market before
1914,16; New York Reserve Bank,
a central bank for sub-divisions of,
393*394; relation with foreign
markets, 309, 395; seasonal and
other movements of funds, 9-10,
393-394; stabilizing conditions in,
217-218, 401
"Money Trust," investigation of, 28
Moreau, Emile, 310
Morgan, J. P., 323, 329
Morgan, X P. and Company: aid of,
in obtaining funds from American
banks for International Bank, 328;
contract of 1925 with British
Government, 318; officers of, aid
in establishing Bank for International Settlements, 323; relations
of Federal Reserve system with,
318, 329, 334, 343
Muhleman, M. L., 20
National Bank Act: characteristics
of banks established under, 2; defects of banking under, 4^18, 346348; effects of, 3; enactment of, 2;
reserve requirements under, 4-5
National bank notes, 118, 121: inelasticity of, 12-13; retirement of,
200
National banking system, 1-18, 346349
National banks: classification of, 4;
competition with state banks, 127,
144,153,155n-156n, 299
National Citizens League, 22-26
National City Bank of New York,
borrowings from Federal Reserve
Bank and stock exchange loans, 373
National Monetary Commission. 2228
Netherlands Bank, 305
New England, claim for a Reserve
Bank of its own, 44-47
"New era," meaning of the term, 107
New Jersey: counties of, attached
to New York District, 58, 60;
transfer of banks in, to New York
District, 54-58
New York, First National Bank of:
aid of, in obtaining funds from
American banks for International
Bank, 328
New York City: a central reserve

city, 4; as a financial center, 6-9,
351, 390-395; concentration of
funds in, by business organizations,
391-393; concentration of reserves
and bankers' balances in, 346370, 375-380; re location of Federal
Reserve Bank in, 39; seasonal
movements of funds between New
York and interior, 9-10; securities
market in, 8-9
New York City banks (also see
Bankers in New York): and concentration of reserves, 352-353,
360-370, 375-380; advantages of,
as compared with other banks in
district, 294^-295; ambition to become central banks, 37; beneficiaries of cheap Federal Reserve
credit, 243; correspondent banking
relationships, 365n, 366, 388-395,
398n; handling of correspondent
banks' reserves duringfinancialpanics, 10-11; lacking in central banking responsibility, 8; obtain funds
from Reserve Bank for correspondent banks, 223-229, 286, 379,
388-392; oppose development of
Federal Reserve system, 134-142;
responsibility for brokers' loans,
355-358; services to correspondent
banks, 363-370; services to correspondent banks during emergencies, 221, 225, 227-228, 365-^66,
379; solicit banks and business
concerns for funds to lend in stock
market, 355-^56; using Federal
Reserve credit for stock speculation, 267,373-374,383
New York Clearing House Association: conflict with New York Reserve Bank, 137-141; settlement of
balances, 282; use of certificates
in crises, 13n
New York Federal Reserve Bank:
administration and control of, 83105, 386; Buffalo branch, 294-298;
building of, 113-115; by-laws of,
409-412; credit and discount department, 253n; directors (also see
Directors), list of, on insert facing
412; district of, 37-50, 53, 60, 387,
398; establishment, 64r-82; incorporation, 64-65; management,
91-102; member bank relations
department, 294; obstacles to development and membership, 134r160; opening of, 74-79; organization of, figure, 90; publications,

INDEX

433

292-293; stockholders, 88; selecnote issue, 203-206; paying governtion of executive staff, 72-74;
ment checks, 214n; relation to distypical function, figure, 92
tribution of new issues of securiNew York Federal Reserve Bank:
ties, 169; services rendered United
and Banking Act of 1933, 176-180,
States Government, 122-123, 129,
276-280, 344-345; and control of
209-210, 214-215, 304-307
credit, see Credit control; acquisi- New York Federal Reserve Bank,
tion of gold, 189-193; conflict with
foreign relations, 301-345: agreeFederal Reserve Board over use of
ment of 1925 to loan to Bank of
credit in stock speculation, 265England, 317-319; American inter270; conflict with New York Clearests abroad, handled by, 340-344;
ing House, 137-141; credit policy,
assumes agency function for Fednational aspects and relative ineral Reserve banks, 302-307;
fluence of, 394-399; determination
banker for the United States Govof the use of bank credit, 237-238;
ernment, 304r-307; cooperation with
Federal Reserve agent of, in relathe Bank of England, 321n, 337;
tion to stock market operations,
earmarking operations, 306, 338267n; gold reserve of, table, 190;
340; earmarks gold for foreign
gold reserve of, as an ultimate
central banks, 225, 227; establishreserve of the nation's banks, 352;
ment of agency relationship with
governor of, on credit policy, 394;
Bank of England, 302-304; loans
identified as the central bank of the
to foreign central banks, 317-319,
United States, 325-327; in the
333-335; motives of its policies,
capacity of a central bank of the
343-344; operates "international
United States, 387-399; intergold exchange fund," 339; relation
Federal Reserve bank "accommoof credit policy to sale of foreign
dation," 221-222, 229; manages
securities in United States, 319,
the gold standard, 193-194; policy
334; relations with the Bank of
re use of Federal Reserve credit in
France, 310-314, 316, 335; services
stock speculation, 264-274; rate
to banks in Cuba, 287-288; services
and acceptance policy and stock
to foreign central banks, 335-337;
speculation, 375-380; regulation
services to International Bank, 330
of foreign exchange, 196-199; rela- New York Federal Reserve Bank,
tion of policy to stock market
governor of: and Federal Reserve
collapse and depression, 382-387;
agent, 93-99; chairman of open
services of, during emergencies,
market committees, 163, 169, 178;
220-231; services to banks, 281engages in conferences with heads
300; size, power of, 41-47, 50-51,
of foreign central banks, 309-319,
168-174, 193-194, 198, 219, 233,
341; heads Governors Council, 102240, 307, 316, 326, 331, 340-345,
104; influence of, 95, 340-343; op387-389; supplies cash directly to
posed to Federal Reserve Act, 135
interior banks, 228: supplies funds New York Federal Reserve Bank,
to banks in other Federal Reserve
open market operations, 244-251:
districts through New York City
assumes agency function for Fedbanks, 221, 223-229, 286, 379, 388eral Reserve banks, 161-162; cen395; versus Federal Reserve Board,
tralization of open market powers
172-174
in, 169-172; character of acceptances held, 205-206; designated for
New York Federal Reserve Bank,
representation on open market
finances, 106-133: earnings, 106committees, 167, 176, 178; fixes
110, 114, 117-120; earnings and
buying rate on acceptances and
disposition made of them, table,
allots them to other Reserve banks,
114; earnings by sources, table, 109;
168-169, 171; responsibility for
expenses, 112-116; salaries, 98-101
open market purchases, 234; reNew York Federal Reserve Bank,
sponsibility
for system policy, 170fiscal agent of the United States,
171; sets up system account for, 167
208-219: assumes fiscal agency New
York Federal Reserve District,
function, 112; centralization of
387, 398: districting decision, 53Treasury operations in, 216-219;

434

INDEX

54; hearings re size of, 37-50, 53;
map, 60
New York Stock Exchange: cooperation of New York Reserve Bank
with, in fixing call loan rate, 381382; relation to New York Reserve
Bank in clearing securities, 290
Non-member banks (also see State
banks): and war financing, 210213; city correspondent banks,
banks of rediscount for, 365-367;
correspondent bank system provides reserve depositaries for, 363364; correspondent banks render
services to, 363-370; deposits in,
supported by member bank reserve
balances, 187: effort to control loan
policy of, 260-264; how benefited
by Federal Reserve system, 401402; New York Reserve Bank, a
central bank for, 398-399; obtain
use of Federal Reserve credit for
stock market loans, 384; opposition
to clearing and collection functions
of Federal Reserve system, 141143; paper of, rediscounted by
Reserve banks, 212; reserves of,
and their concentration, 352-353,
363-364; services of Federal Reserve system to, 281-286, 294,388,
401-402
Norges Bank, 305
Norman, Montagu, 309-317, 341
Norris, G. W., 133n; cited, 315, 387n
Note issue (also see Federal Reserve
bank notes, Federal Reserve notes,
National bank notes): central banking function of, 200-208; tax on,
120-123, 131-133; tax on state
bank notes, 3; under AldrichVreeland Act, 121
Open market operations (also see
Acceptances, bankers'): and availability of credit in Federal Reserve
districts, 398n; and correspondent
bank system, 398n; and earnings,
110; and nullification of Federal
Reserve Act, 272-273; and rediscounting transactions, 244-245;
centralization of open market
powers in New York Reserve Bank,
169-172; coordination with fiscal
agency function, 163; effect of
Banking Act of 1933, 176^-180;
Federal open market committee,
176-180; Federal Reserve Board
asserts authority over, 165-167;

Federal Reserve Board resolutions
of 1923, 164-167; Federal Reserve
Board versus Federal Reserve
Bank of New York, 172-174; importance and effects of, 164-165,
244-249, 398n; New York Reserve
Bank begins to act as agent for
other Federal Reserve banks, 161162; open market investment committee, 166-174; open market policy conference, 174^176; origin of
central control outside Federal
Reserve Board, 162-164; purchases,
Federal Reserve banks responsible
for, 234; purchase of paper directly
from business concerns, 233, 247251; relation to stock market, 379,
383-386; resale agreements, 376;
system account set up by New York
Reserve Bank, 167, 169; re the distinction between buying government securities and buying acceptances, 242n-243n
Open market policy, 110, 244-251:
Federal Reserve banks disagreed
on, 397n; limitations of, 248; New
York Reserve Bank responsible for
system policy, 170-171
Owen, Robert L., 29; cited, 347-348
Owen-Glass Bill, 27
Paish, Sir George,
78n
ttC,
tOIX
Panics (also see Crises, Emergencies):
financial, 9-12; security panic of
October, 1929, and aid of the Federal Reserve system, 223-224, 387n
Perkins, Thos. N., 323n
Philadelphia: connection of banks in
New Jersey with, 55-58; location of
a Reserve bank in, 40, 41, 50, 52
Philadelphia Federal Reserve Bank:
designated by Federal Reserve
Board for representation on open
market committees, 167, 176, 178;
governor of, on aid of Federal Reserve system to investment banking, 386n-387n; governor of, on
foreign aspects of altering discount
rates, 315
Pittman Act, issuance of Federal
Reserve bank notes under, 201
Pittsburgh, re location of in Philadelphia District, 50
Poland, Bank of, loan contract with,
318-319
Pole, J. W., cited, 360
Pratt, Mrs. Ruth, 313-314
Preliminary Committee on Organiza-

INDEX
tion: formulates by-laws, 83-84;
lays basis for internal organization,
8&-89; members of, 80n; re report
of, 51n; work of, 79-82
Prices, stabilization of, 231-232
Profits: and central banking functions, 118-120, 127-128, 386, 408;
and state bank membership during
World War, 151-152; banks restrict loans to commerce, agriculture, and industry, to make profits
in call loan market, 358-360; effort
of member banks to secure more
from Reserve banks, 123-130;
government securities used to obtain, 258; member bank borrowing
for, 264^265, 271-272, 358-360,
386; motive of, in banking, 5, 8-9,
386, 408; of Reserve banks, 128n;
profitableness of Federal Reserve
system to member banks, 124-126;
profitableness of security speculation to New York banks, 357-358
Public: and administration of central
banking, 408; attitude of bankers
toward Federal Reserve Board,
144; Federal Reserve bank dealing
directly with business, 233, 247251; group banking and public
control of Federal Reserve system,
159-160; lack of benefit from acceptance dealings, 248-249; representation of, 86, 97, 99-102
Rand, George F., testimony of, 158159
Rediscounting: and open market
operations, 244-245; intention of
original Federal Reserve Act re,
254, 258
Reichsbank: loan to, 334; represented
in international central bank conferences, 310, 313, 341
Reserve Bank Organization Committee: districting decision of, 5354; re establishment of Reserve
banks, 64r-66, 70; methods and
principles of districting, 50-53; organization and problem of, 37-38
Reserves (also see Gold reserves): and
the settlement of clearing balances,
281-282; bank credit a reserve for
other bank credit, 352-353; Banking Act of 1933 re use of, in
speculation, 276-280; basis of the
nation's bank credit, 187; centralization of, under Federal Reserve
system, 32-35; changes in legal

435

requirements and expansion of
credit, 360-363; concentration of, in
New York, 6-12, 346-349,352-353,
360; correspondent bank system
provides reserve depositaries for
non-member banks, 363-364; custody and administration of gold
reserves, 189-196; Federal Reserve
notes used for, by state banks, 151152; fictitious, 14; handling of excess, at time of quarterly tax payments, 217-218; holding reserves of
member banks, 183-189; how member banks obtained them, 188; intention of Federal Reserve Act re
concentration in New York and
use in speculation, 346-349; keeping duplicate reserves with correspondent banks, 145; legal and
secondary, deposited in city correspondent banks, 363-364; legal requirements, 183-186; legal reserve
requirements and maintenance of
balances in New York, 352-353,
360-364; maintenance and use of,
187-189; member bank reserve
accounts, basis of Federal Reserve
control of credit, 233-236; need of
excess, removed, 362; penalties on
deficient reserves, tables, 109, 111;
profitableness of requirements to
banks, 5, 124-127; pyramiding of,
4-5, 352-353; reasons for concentration of, in New York, 7-8,
360-370; requirements under National Bank Act, 4; re Reserve
banks paying interest on member
bank reserves, 123-130; reserve
principle, development of, 32-33;
sale of member bank surpluses, 189;
scattered, 4-5; secondary, investment of, 375, 380; secondary,
treated as cash, 352; transfer of
excess, 285; transfer to Federal
Reserve banks, opposed by a group
of the New York State Bankers
Association, 142; use of, in stock
speculation, 8-12, 346-349, 353360, 386
Reserves, of Federal Reserve banks:
effect of earmarking of gold upon,
306, 338; subject to transfer to
foreign countries, 311,317-318,320321,331,336,338-339,343; support
the nation's bank credit, 352-353;
table, 190; use in stock speculation,
358-360, 371-375, 386; use of, to
aid Great Britain, 318; used as

436

INDEX

base of foreign monetary systems,
320-321,336
Reserves of foreign central banks,
dollar exchange used as, 320-321,
336
Reynolds, George M., cited, 28n
Roosevelt, Franklin D.: and revaluation of gold dollar, 196n; and the
Gold Reserve Act of 1934,195-196;
orders bank holiday, 229-230
Roumania, National Bank of, loan
contract with, 318-319
St. Louis, a central reserve city, 4, 6
San Francisco Federal Reserve Bank,
176; and earmarking of gold, 339
Savings banks, and membership in
Federal Reserve system, 153
Schacht, Hjalmar, 341
Securities (also see United States
Government securities, Stock speculation): Federal Reserve Act re
lending on, 371-372, 386; Federal
Reserve Board warns banks against
buying foreign, 264, 302; Federal
Reserve credit used to finance
trading in, 372-374,380-387; flotation of, and stock speculation, 356358; paying British securities and
coupons, in United States, 283284; relation of credit policy of
New York Reserve Bank to sale of
foreign securities in United States,
319, 334; services of New York
City banks to correspondent banks
re, 366-368; services to member
banks re, 289-290; Strong and
Norman on recommending German
securities for sale in America, 341;
use of bankers' acceptances in
place of, by European institutions
in American market, 333
Security affiliates, relation to banks
in stock speculation, 356-358
Seiberling, Francis, cited, 359
Shafroth, J. TM cited, 155n
Shaw, Leslie M., cited, 22
Snowden, Philip, cited, 315
Speculation, see Stock speculation
Sprague, O. M. W., cited, 45, 46
State banks (also see Non-member
banks): competition with national
banks, 127, 144, 153, 155n-156n,
299; re desirability of, in Federal
Reserve system, 156; how benefited by Federal Reserve system,
401-402; inducements to join Federal Reserve system, 146-152;

legal reserve requirements and
maintenance of balances in New
York, 352-353, 363-364; reasons
for refusing to join Federal Reserve
system, 141-147, 154^155; tax on
note issues of, 3
Steagall, Henry B., 276
Stewart, Walter W., 327-328
Stock market: banks borrow from
Federal Reserve banks to loan in,
358-360, 372-375, 386; relation of
Federal Reserve banks to, 380387; use of Federal Reserve credit
in, 371-375
Stock speculation, 16: and earnings
of New York Reserve Bank, 107;
and rate policy, 375-380; availability of bank credit for, 360-370;
effort to restrict use of Federal
Reserve credit in, 264-274; Federal
Reserve Board's power to control
the use of bank credit in, under
Bunking Act of 1933, 276-280;
following open market purchases,
173, 249; intention of Federal
Reserve Act re use of reserves in,
346-349, 371-372; knowledge of
the use of bank credit in, 238; the
"new era," idea of, 107; use of
bank credit in, 353-360; use of
Federal Reserve credit in, 372375, 380-387, 406-407; use of reserves in, prior to 1914, 8-12; when
Federal Reserve credit is used for,
237, 272
Strong, Benjamin, 73, 77, 96, 142,
164, 309-310, 313-317, 341; cited,
145n, 362n, 394
Suffolk banking system, 32
Sveriges Riksbank, 305
Taft, William H., 26n
Tardieu, Andre*, cited, 311
Tax, franchise, 118, 120-123, 131133
Traylor, Melvin W., cited, 342
Treasury (also see United States
Government): defects in operations before 1914, 16-17; discount
rates adjusted to wishes of, 241242; location of sub-treasuries,
214n; operations under Federal
Reserve system, 400-401; paying
checks drawn on, 214n; Secretary
of, member of Federal Reserve
Board, 34; services rendered by
Reserve banks, 112, 122-123, 129,
209-210, 214-215, 304r-307; under-

INDEX
takes custody and control of gold.
194-196
Treman, R. H., 36n, 68, 71, 86n
Unified banking system, 3: Federal
Reserve Board urges it in 1915,
143; promotion and constitutionality of, 155n-156n; re state banks
in Federal Reserve system, 155-156
United States: international financial relations, 307-309; limitation
on use of the words "United
States," "Federal," or "Reserve,"
lOln; monetary gold stock, table,
190; New York Federal Reserve
Bank in capacity of a central bank
of the United States, 387-399;
power in international finance,
395; re presenting a unified financial policy abroad, 309, 344^345,
400; relation of financial power of,
to reparation payments and International Bank, 329
United States Government (also see
Treasury): attitude of bankers re
government control, 144; directors
representative of, 71-72, 86; Federal Reserve agent as representative of, 100; monetary gold stock
of, before and after devaluation of
gold dollar, 196n; New York Reserve Bank serves as banker for,
in foreign transactions, 304-307;
power of influencing credit, 231;'
re preventing borrowing from Federal Reserve Bank to lend on stock
exchange, 374; re relation of Federal Reserve system to International Bank, 323-325; share of, in
earnings of Reserve banks, 120124, 128-133; takes custody and
control of gold, 194-196; Woodrow

437

Wilson urges Government control of
banking systems and of issue, 26
United States Government securities:
distribution of, during World War,
210-213; earnings derived from, by
Reserve banks, 107-111; effect of
practice of lending on, 244; issuance of Federal Reserve notes on,
206-208; lending on, and nullification of Federal Reserve Act, 272273; market for, made by Federal
Reserve banks, 218-219; member
bank borrowing on, 210-213, 254259, 279, 371-374, 379; services to
member banks re, 289-290; use
of, for profit-making purposes by
commercial bankers, 258
Vanderlip, F. A., cited, 40
Vogel, Martin, 38
War financing: discount rate policy,
to aid, 241-242; facilitated by
change in basis of note issue, 205;
impounding of gold for purpose of,
185,191-193; rationing of credit, to
aid, 260-264; services of Federal
Reserve banks, 210-213
Warburg, P. M., 73, 81n
Watkins, L. L,, cited, 350
Wexler, Sol, cited, lOn
Wiggin, A. H., 66, 267n, 327; cited,
25, 67, 373-374, 390
Williams, John S., 81n
Willis, H. Parker, 20-21; 50-51; 80,
276n; cited, 21, 86, 94n, 102n, 184,
216, 382n
Wilson, Woodrow, 29, 33, 302; cited,
26, 33n, 149, 390
Woodward, Wm., 67, 71n
Young, Owen D., 322-325; cited, 88

Full text of Central Banking under the Federal Reserve System : With Special Consideration of the Federal Reserve Bank of New York

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