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Minutes of actions taken by the Board of Governors of the Federal Reserve System on Thursday, August 2, 1951. The Board met in the Board Room at 10:30 a.m. PRESENT: Mr. Szymczak, Chairman pro tern Mr. Evans Mr. Powell Mr. Carpenter, Secretary Mr. Vest, General Counsel Mr. Evans said that informal advice had been received from the -i4reau of the Budget that the President expected shortly to submit to the Congress a further statement with respect to the Defense ProAct Amendments of 1951, which became law on July 312 1951, and that, if the Board felt that the limitations imposed by the legislation "the authority over consumer instalment credit were of sufficient 1lliP°1‘tance to be commented on in such a statement, the Bureau of the EkIdget would like to have a draft of the material which the Board w°"'d like to have included in the statement. Mr. Evans outlined the brief statement which he felt should be submitted and, after some discussion, it was approved unanimously as follows with the understanding that it would be sent to the Budget Bureau tomorrow: " extent to which excessive expansion of consumer crediThet in adds to inflationary pressures is of genuine concern 4 time of rapidly expanding defense expenditures. The 8/2/51 -2- "limitations on instalment credit terms written into the flew legislation will badly cripple this means of curbing an inflationary expansion of such credit. "I am compelled to re-emphasize the view expressed in my midyear economic report to the Congress of July 23." Mr. Evans reported that Mr. Caldwell, Chairman of the Federal Reserve Bank of Kansas City, had telephoned to say that the Dank had been looking for an attorney to succeed Mr. Johns as Counsel, that a eati3factory man had been found but that he was a member of the Kansas 04Y Board of Election Commissioners, that his term as such a member would 114 expire for approximately 1-1/2 years, and that Mr. Caldwell wanted to kille1714hether it would be contrary to the policy of the Board with respect t°Officers and employees of Federal Reserve Banks holding political or 1111blic office if the attorney were permitted to complete his term while —4-ag as Counsel for the Bank. Mr. Caldwell commented, Mr. Evans said, that the Board of Election Commissioners was nonpartisan, that in the past he (1r• Caldwell) had served as a member, and that he saw no objection tO the continuation of membership until the expiration of the current term. In response to Mr. Evans' request, Mr. Vest reported that it eared from the statutes of the State of Missouri that membership on the tr 'ansas City Board of Election Commissioners carried a salary of 43av, Per annum, that the Commission was composed of two Republicans 41a t'No Democrats, and that among the duties of the Commission were the atile etion of judges and clerks of election, furnishing digests of election 8/2/51 _3_ laws, and the determination of election districts. In the ensuing discussion, it was agreed unanimously that while the Commission might be conceived as a nonpartisan organization for the primary purpose of insuring honest elections, the duties of the Commission would make it difficult to disassociate, in the minds of the public, membership on the Commission from partisan political activity and that therefore Mr. Vest should discuss the matter with Mr. Leedy, President of the Federal Reserve Bank of Kansas City, and if the duties of the Commission were as Mr. Vest had outlined them, Mr. Leedy should be advised that the attorney should not be appointed as Counsel for the Federal Reserve Bank of Kansas City unless he resigned as a member of the Board of Election Commissioners before assuming the duties of the new position. At this point Mr. Vest withdrew and the action stated with respect to each of the matters hereinafter referred to was taken by the Board: Memoranda dated July 24, 1951, from Mr. Williams, Assistant Di) Division of Research and Statistics, recommending increases in the basic annual salaries of the following employees in that Division, etfective August 51 1951: 41.1! L. Watts m arjorie C. Capps Title Draftsman Clerk-Stenographer Salary Increase To From $277 $2,675 2,530 2,650 Approved unanimously. al Memorandum dated July 30, 1951, from Mr. Sloan, Director, DiviExa minations, recommending: (1) That for a period of approximately one year beginning August 27, 1951, Mrs. Nancy R. Porter, currently 8/2/51 -4- Supervisor of the Recording and Stenographic Section in the Division of Examinations, be appointed a Special Assistant Federal Reserve Examiner and transferred to the field staff of examiners, with official headquarters in Washington, D. C., with no change in her present basic salary at the rate of $4,200 per annum, and with the understanding that at the expiration of the period of approximately one year, Mrs. Porter will return to her present position; (2) (3) 04) That for a period of approximately six months beginning August 27, 1951, Miss Frances Scott, currently Secretary to Mr. Sloan, Director, Division of Examinations, be appointed a Special Assistant Federal Reserve Examiner and transferred o the field staff of examiners, with official headquarters in Nashington, D. C., with no change in her present basic salary at the rate of $4,075 per annum, and with the underStanding that at the expiration of the period of approximately six months, Miss Scott will return to her present position; That Special Assistant Federal Reserve Examiners, during the time of their service with the Board's field staff of examiners, be allowed, in addition to per diem in lieu of subsistence, a special travel allowance of $40.00 per calendar month; That Special Assistant Federal Reserve Examiners traveling /th the Board's field staff of examiners be permitted to Ts o.L Pullman accommodations costing not more than the cost roomettes. Z By unanimous vote, Mrs. Nancy R. Porter was appointed a Special Assistant Federal Reserve Examiner to examine Federal Reserve Banks, for all purposes of the Federal Reserve Act and of all other Acts of Congress pertaining to examinations of such banks made by, for, or under the direction of the Board of Governors of the Federal Reserve System, and was designated as a Special Assistant Federal Reserve Examiner, for approximately one year beginning August 27, 1951, with official headquarters at Washington, D. C., and with basic salary at the rate of $4,200 per annum. 8/2/51 -5By unanimous vote, Miss Frances Scott was appointed a Special Assistant Federal Reserve Examiner to examine Federal Reserve Banks, for all purposes of the Federal Reserve Act and of all other Acts of Congress pertaining to examinations of such banks made by, for, or under the direction of the Board of Governors of the Federal Reserve System, and was designated as a Special Assistant Federal Reserve Examiner, for approximately six months beginning August 27, 1951, with official headquarters at Washington, D. C.) and with basic salary at the rate of $4,075 per annum. Unanimous approval also was given to recommendations (3) and (4) in Mr. Sloan's memorandum of July 30, 1951. Letter to the Presidents of all Federal Reserve Banks, reading 41114°110ws. "In its confidential letter of May 4, 1951, the Board relerred to the large defalcation in Syracuse, New York, and stated that it would be made the subject of further advice ell . details could be given. You will appreciate the fact coll;it dt=ents of this letter also should be considered t qhe matter was brought to the attention of the Board '11)11:11Governors on the morning of April 10, 1951, by the F.B.I., bA,!h had been brought into the case by the officers of the the e previous evening. The Federal Reserve Bank of New 1N' York was advised immediately and the Reserve Bank, in advised the State banking authorities. The Federal d°8it Insurance Corporation was also advised and took immeP alt ate action to provide depositor protection, if required, ne "°11gh it did not appear that any unusual action would be so ssarY. The State member bank involved had total reand capital accounts, respectively, of approximately 0 02 00 and 44,500,000. Its surplus and undivided profits ''' n apZO t Jflate1y equaled the gross amount of the apparent de"4-cation 1E188 . dnd It appeared that actual loss would be much 7 8/2/51 -6- "The Reserve Bank and the State banking authorities arranged to make a joint examination as of the close of business April 12, 1951. The report of that examination has been made available to the Board as well as other information which form the basis for this report. The nature of the irregularity and the amounts involved appear to have been determined. Actual loss is still subject to adjustment although it is believed to have been estimated With reasonable accuracy. It should be noted, however, that the two bookkeepers apparently involved have been indicted along with seventeen of the bank's customers and the trial procedure may produce further information OX' disclose the involvement of other individuals. "As stated in the Board's previous letter, the story is fantastic. It is alleged that the bank's head bookkeeper, named Klock, and his assistant, named Root, withheld from posting to individual ledger accounts checks having a total ! Taco value of $2,500,695 and juggled control figures to cover. N other officer or employee was found or is believed to be involved. The checks withheld affected more than 200 checking accounts and represented overdrafts in three accounts, among °thers, amounting to $1,567,300, 067,400 and $50,7001 re?Pectively. It was the involvement of outside parties and -the need for effecting recovery to best advantage from all T3urce5 that caused the withholding of information when the J.rr egularity was first disclosed. "Klock is reported to have given as his reason for withholding m -L checks the burden of the work involved in returning !"ecks, reporting and calling customers with respect to over'4refts, the correction of missorts, obtaining proper countersignature, etc., which had caused him to work overtime. His maniPulations apparently began in 1947. Prior to 1947 he is reed to have spent a lot of time at the bank after hours hneaning up his work. His wife complained of his absence from ip accused him of infidelity and divorced him in 1944 or tu" Sometime thereafter he remarried and, when his work at e bank again became heavy, he started withholding checks to working overtime and to prevent trouble at home. No 0th he er explanation was given and he stoutly maintained that h,received no payment from outside parties. It is noted, ,: swelrer, that the newspaper account of the indictment of the atY having the largest overdraft states that he was accused ti,,PaYing 'various sums' of money to Klock and Root at 'various —4 "in 1948, 1949, and 1950. r 4 q 8/2/51 "Root, who covered the condition when Klock was on vacation or away from the bank for any reason was a close friend of Klock and this friendship is the only explanation of his involvement. Hel also, denied any pecuniary consideration. 'The situation was brought to light by a certified Public accountant who audited the books of a customer and called the attention of an officer of the bank to the fact that two payroll checks of the customer, amounting to about $2,000 each and issued on different dates, had not been charged to the customer's account until 24 days after the date on which it was cashed in one instance and 66 days after in the other. While seeking to unravel this mystery, checks amounting to about $22,000 were found in flock's desk. Under questioning and pressure Klock finally produced checks having a face value of $2,398,864„ most of Which he had stored away at his home. "Some of the checks recovered appeared to have been withheld merely because of missorts or lack of proper countersignatures or similar reasons and were subject to charge to individual accounts having available balances. The following is a statement of the condition found: $2,500,695 Total ledger difference Amount for which no checks have 101031. been located to cover $2,398,864 Checks found Less checks paid In full (152 customers) $203,261 In part (10 customers) 339,361 136,100 Checks representing over$2,059,503 drafts The overdrafts were as follows: Interests of a local real estate operator An appliance and radio dealer A restaurant A dry cleaning and dyeing establishment Sundry customers: 33 accounts considered $ 31,671 collectible 74 accounts - loss conceded 34,054 $1_1567,322 367,385 50,742 8,329 6 725 ,0 9 03 "The bank was able to obtain control of the properties of the real estate operator involved and, largely from this source, eyti ; 8/2/51 "has effected substantial actual recoveries. Based upon apparently assured further recoveries and conservative valuations it is estimated that the net loss to the bank may amount to less than $200,000 after applying $650,000 surety coverage. The bank has excess valuation reserves to cover and capital accounts will not be disturbed. "It appears that the totals involved had been greatly increased since the bank had been last examined on May 17, 1950. Investigation by the examiners revealed the fact that the difference had been concealed at that time by debits to two large and active accounts, one in the amount of $722,629 and the other in the amount of $359,2141 a total of $1,081,843. The dollar amount of these debits, which were offset by blind postings a few days later, were not unusual in the accounts involved. Daily entries in each account were frequently as high as $1,000,000 and perusal of the ledger sheets would not have aroused suspicion. It was possible for the concealing entries to be made because Of the semi-delayed posting system used in the bank and it is assumed that the same method of concealment had been used at previous examinations. "The fact that the audit procedure in the bank was in'ffective is quite apparent. In the course of the examination it was developed that the so-called commercial ledger had not ,Elen proved to its control by the auditor for over six years. ) lt had been the practice of the auditor to prove a particular ,ledger to its control in the bookkeeping department occasionalbut he did not prove the controls to the general ledger. various needed improvements in audit procedure and control had been discussed with the management in previous years and the examiners were assured that the necessary improvements had been effected. It appears that the auditor failed to effect the procedure which the officers believed to be in Operation. "This case emphasizes the difficulties for examiners inherent in the system of delayed and semi-delayed posting Of individual ledgers which, as you know, has been sanctioned 03/' legislative action in 39 States and recognized in the 80ardt5 Regulation J. When examiners enter a bank to find a Portion of the items to be posted to the individual ledgers 1111Posted, almost insurmountable difficulty is encountered in Placing such ledgers under effective control. The major Problems should be obvious and will not be outlined in detail. 14rhils procedures may be followed which would approach complete 1 8/2/51 -9-. "Control in some instances, it is doubtful that absolute control could be effected in any instance by examiners. "In the case under consideration, the bank maintained 85 individual commercial and savings ledgers and the examination was started with 34 men who had to establish and maintain control of cash, securities, etc., as well as such control of individual ledgers and other records as was practicable. To have established reasonably effective control of individual ledgers operating under the semi-delayed Posting plan would have required at least two or, perhaps, three times the number of examiners. Another practical consideration in such circumstances is the effect upon the internal operations of the bank under examination. If examiners were available to apply the procedures necessary to effect reasonably satisfactory control the functioning of the bookkeeping department would be seriously delayed. "In the numerous cases, such as the one under consideration, where the examiner in charge is unable to establish an effective control of individual ledgers or other records, it would appear to be incumbent upon him tc investigate carefully the scope and effectiveness of the aUdit program in the bank and to satisfy himself that an "equate program is scheduled and, through examination of w°rkpapers, reports, etc., that such program is actually and efficiently maintained. In fact, it is felt that apPraisal of the adequacy and effectiveness of the system of audit and internal controls is one of the most important Tatters for consideration by the examiner. The procedure r,or determining the adequacy of audit and controls and for "termining the actual and proper functioning of the programs ostensibly in effect, as well as securing improvement and correction where needed, is the most pressing current Pr°blem for study by the supervisory authorities. fi "Copies of this letter are being forwarded to the Ofcers in Charge of Examinations at each Federal Reserve Bank." Approved unanimously. Memorandum dated July 301 19511 from Mr. Chase, Assistant Soliqtor / recommending that the Board's file in the case of Gould Investment Q°41Parky 1-kiverly Hills, California, a registrant under Regulation W, Cotlaunr tm Credit, be closed, inasmuch as Mr. Murray Goldman, sole owner fie" p. ,; 8/2/51 -10- of the company, allowed investigators for the Federal Reserve Bank °f San Francisco to inspect his books after a subpoena was served Upon him in accordanc e with the Board's order of May 8, 1951. Approved unanimously. Telegram to the Presidents of all Federal Reserve Banks and °fficers in charge of Federal Reserve Bank branches, reading as follows: "Certain Reserve Banks have asked what changes, if any, need to be made in the wording of the identification certificates for investigators under Regulations W and X by reason of extension of the Defense Production Act. We see no necessity for any change but suggest that if and when You reprint the identification certificate you add the Phrase 'as amended' after 'Defense Production Act of 19501." Approved unanimously. Letter to the Honorable Alexander Wiley, United States Senate, 1Vashineton, D. C., reading as follows: ur "This acknowledges your letter of July 11, 1951, to • GAY E. Noyes, Director of the Division of Selective Credit Regulation, which was accompanied by nine telegraphic protests about Regulation X, Real Estate Credit. I(3 nine telegrams, filed at Madison, Wisconsin, on July "around 6 p.m., were sent by the following: E.B.A. Sokoloski E. 0. Dahl 2017 South Park Street 3721 John Street Madison, Wisconsin Madison, Wisconsin T Jim Imhoff 2133 Oakridge Avenue Madison, Wisconsin Grant Kittle 708 Brittingham Place Madison, Wisconsin Harold Bewick 101 Vandusen Street Madison, Wisconsin Ivan Gregory 3301 Harvey Madison, Wisconsin 8/2/51 -11"B.F. Killian Schroeder Road Madison, Wisconsin Tom McGovern Route 4 Madison, Wisconsin C.J. Goucher 3300 Monona Drive Madison, Wisconsin "In view of the fact that all of the telegrams are generally of the same tenor, a uniform response to each would seem to provide the most satisfactory form of reply. Copies are enclosed for each of your correspondents. "Regulation X was issued under the authority of the Defense Production Act of 1950 and Executive Order No. 10161, and is designed to conserve materials and labor for the deff!nse effort and to restrain inflationary forces. In considering the terms prescribed by the regulation and the accompanying restrictions of the Federal Housing Administration and the Veterans Administration, the Board and the other G overnmental agencies concerned took great pains to establish requirements which would be as equitable as possible in their effect on the various income groups. As a result, we established, after prolonged study, down-payment requirements which start at 10 per cent for houses valued at $5,000 or less ( tIVeterans can buy a $6,000 house with a down payment of only a per cent) and increase gradually to 50 per cent for houses valued at more than $24,250. The regulation, therefore, is ProPortionately much more restrictive, as we think you will agr!ge it should be, on those persons buying more expensive ! sidences. If, however, the regulation is to be effective must be restrictive to some extent with respect to all d asses of persons; hence, some persons may be obliged to efer the purchase of a new house until they have accumulated reater savings, or perhaps buy an older or lower-priced 4°use. The Board, however, is deeply concerned that the ;TPact of the regulation be as equitable as possible, and ands ready to make whatever adjustments may be necessary 0 achieve this end. 'The Board has also consistently stated that the terms the regulation will be modified if it is demonstrated that arY are too restrictive. When Regulation X was issued, the veral governmental agencies responsible for curtailment of r, is al estate credit estimated that a volume of 850,000 housing tarts for 1951 would be consistent with the objectives of the T g j 8/2/51 -12- 'enabling legislation. This represented a 40 per cent reduction under the real estate boom year of 1950, but still compared favorably with other years since the war. Already more than 600,000 housing starts have been made in 1951 and) With nearly six months of the year still ahead, there is a reasonable presumption that the 850,000 goal may not only be reached, but may be exceeded. We would like to see the building industry produce as many houses in all price classes as would be consistent with the defense effort and non-inflationary prices. However, the Federal expenditures for defense and related activities are expected to rise precipitously and may account for as much as 20 per cent of total national output within a year. If renewed inflationary trends are to be controlled, therefore, public policy will need to limit private spending, especially such spending as is financed by borrowing. During the first four months of 1951 nonfarm mortgage recordings of $20,000 or less totaled $5,254,000,000, an increase of 19 per cent over 1950. Until the needs of the defense program have been taken care of and the dangers of further inflation have moderated, a general liberalization of real estate credit regulations would not seem to be desirable. th 4. "Despite all these considerations, we wish to assure you ,a- We believe the regulation should be as equitable as pos-Ible to all persons, and we are glad to give consideration O any proper means to accomplish this purpose. If we can Provide you with further information, we will be glad to do r. The copies of the telegrams you sent us are returned ne rewith." Z Approved unanimously.
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