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CONGRESS!
O„V,,|,„
/
: Session
SLNAiL
\ N o . 123, PT. 2
/
DOCUMENT
MONETARY POLICY AND THE MANAGEMENT OF THE PUBLIC DEBT
THEIR ROLE I N ACHIEVING PRICE
STABILITY AND HIGH-LEVEL
EMPLOYMENT
R E P L I E S TO Q U E S T I O N S A N D O T H E R M A T E R I A L FOR
T H E USE OF T H E S U B C O M M I T T E E O N G E N E R A L
CREDIT CONTROL A N D DEBT M A N A G E M E N T
PART 2
JOINT COMMITTEE ON THE ECONOMIC BEPORT
U N I T E D STATES
GOVERNMENT P R I N T I N G O F F I C E
98454
W A S H I N G T O N : 1952
JOINT COMMITTEE
ON T H E ECONOMIC
REPORT
(Created pursuant to sec. 5 (a) of Public L a w 304, 79th Cong.)
H O U S E OF REPRESENTATIVES
SENATE
J O S E P H C. O'MAHONEY, Wyoming, Cfha ir- E D W A R D J. H A R T , New Jersey, Vice
Chairman
man
W R I G H T P A T M A N , Texas
J O H N S P A R K M A N , Alabama
R I C H A R D B O L L I N G , Missouri
P A U L H . DOUGLAS, I l l i n o i s
C L I N T O N D. M c K I N N O N , California
W I L L I A M B E N T O N , Connecticut
JESSE P. WOLCOTT, Michigan
ROBERT A. T A F T , Ohio
C H R I S T I A N A. H E R T E R , Massachusetts
R A L P H E. F L A N D E R S , Vermont
A R T H U R V. W A T K I N S , U t a h
J. C A L E B BOGGS, Delaware
Director
G R O v e r W . E * rsLEY, Staff
JOHN
SUBCOMMITTEE
ON GENERAL
W . LEHMAN,
CREDIT
Clerk
CONTROL AND
DEBT
MANAGEMENT
W R I G H T P A T M A N , Texas, Chairman
P A U L H . DOUGLAS, I l l i n o i s
R I C H A R D B O L L I N G , Missouri
R A L P H E. F L A N D E R S , Vermont
JESSE P. WOLCOTT, Michigan
H E N R Y C . M U R P H Y , Economist
II
to the
Subcommittee
CONTENTS
Pafft
Chapter I V . Replies by Federal Reserve Bank Presidents
General statements
A. Ownership of the Federal Reserve Banks and their Relationship to
the Government
Question 1. Implications of ownership of Reserve bank stock
2. Ownership of Reserve bank surplus
3. Relation of Reserve banks to Government
4. Congressional policy directives to the Federal
Reserve System
B. Organization of the Federal Reserve Banks
Question 5. Managerial roles of presidents and boards of
directors
6. Election of class A and B directors
7. Appraisal of present methods of selecting directors-.
C. Distribution W i t h i n the Federal Reserye System of Authority on
Credit Policies
Question 8. Regional versus national credit policies
9. Roles of directors and presidents in credit policy
formulation
10. Historical development and significance of open
market operations
11. Allocation of authority over various credit control
instruments
12. Coordination of credit control instruments
D . General Credit and Monetary Policies
Question 13. Effects of rising yields of short-term Governments,
August 1950 to March 1951
14. Role of general credit policy in counteracting
inflation or deflation
15. Responsiveness of bank lending to credit policy
measures
16. Credit policy in relation to Treasury borrowing
17. Influence of interest rates on nonbank demand for
Government securities
18. Use of rediscounting privileges by member banks __
19. Effects of credit restriction on national defense and
standard of living
20. Role of bank supervision in furthering objectives of
Employment Act
21. Regulation of consumer credit
22. Regulation of real estate credit
23. Regulation of stock market credit
24. Feasibility of other selective credit regulations
25. The Voluntary Credit Restraint Program
26. Moral suasion as an instrument of credit control
27. Function of bank reserves and present reserve
requirements
28. Application of reserve requirements to nonmember
banks
29. Basing reserve requirements on type of deposit
30. Secondary reserve requirements
31. Ceiling reserve plans
32. Basing reserve requirements on assets rather than
liabilities
33. Statutory authority for, and usefulness of, credit
"rationing"
m
633
633
646
646
648
648
650
653
653
658
662
665
665
666
669
672
673
680
680
683
690
691
696
699
702
703
704
708
710
711
713
717
719
720
723
726
728
729
731
IV
CONTENTS
Chapter IV—Continued
E. The Banking Structure
737
Question 34. Adequacy of banking facilities
737
F. Availability of Capital for Small Business
787
Question 35. Availability of credit and capital to small business.
787
36. Effects of bank examination on lending to small
business
825
Appendix:
List of questions
834
Letter from the Directors of the Federal Reserve Bank of Boston
(with enclosure)
837
Chapter V. Reply by the Council of Economic Advisers
847
A. Congressional Policy Directives
847
Question 1. Emphasis of Employment Act on high-level employment and price stability
847
B. Formulation of Fiscal and Monetary Policy
848
Question 2. Role of the President i n the formulation of monetary
policy
848
3. Division of authority over credit control instruments
within the Federal Reserve System
851
C. Credit and Debt Management Policy
852
Question 4. Role of general credit policy in counteracting inflation or deflation
852
5. Responsiveness of bank lending to general credit controls
858, 861
6. Use of rediscounting privileges by member banks_ _ 862, 863
7. Economic effects of changes in interest rates since
August 1950
864
8. Appropriate roles of direct and credit controls under
differing circumstances
865
9. The Voluntary Credit Restraint Program
868
10. Statutory authority for, and usefulness of, credit
"rationing"
871
11. Effects of credit restriction on national defense and
standard of living
873
12. Role of bank supervision in furthering objectives of
Employment Act
875
13. Function of bank reserves and suggestions for
changes
875, 877
14. Insulation of public debt securities from effects of
general credit policies
878
15. Influence of interest rates on nonbank demand for
Government securities
879
16. Desirability of stable long-term Government bond
market
880
17. Compulsory sale of Government securities
886
18. Advisability of issuing a purchasing power bond
888
19. Advantages and disadvantages of marketable and
non-marketable securities
889
20. Recommended types of securities for Government
borrowing
891
D. Deposit Insurance
891
Question 21. Extension of coverage of deposit insurance
891
Separate note by M r . Clark
892
Appendix (list of questions)
894
Chapter V I . Reply by the Comptroller of the Currency
897
A. General Purposes of Office
897
Question 1. Functions and mode of operation
897
2. Nature and purpose of examination of banks
898
3. Congressional directives bearing upon economic
objectives
904
4. Weight given t o Employment Act in determining
policies
905
5. Role of bank examination in furthering objectives
of Employment Act
909
6. Other means by which Office promotes objective
of economic stability
910
7. Use of economic analysis in operation of Office
912
CONTENTS
Chapter VI—Continued
B. Relationship to the Government
Question 8. Relationship w i t h the Secretary of the Treasury..
9. Relationship w i t h the President
10. Relationship w i t h other Federal bank supervisory
agencies
11. Are reports to Congress on pending legislation submitted to the Bureau of the Budget?
12. Suggestions for legislation
C. Income and Expenses of the Comptroller's Office
Question 13. Annual income since 1933
14. Annual expenses since 1933
15. Budgetary procedure
16. Provision for audit
17. Expenses to influence public opinion on controversial matters
D. The Banking Structure
Question 18. Adequacy of banking facilities
19. Policy followed in acting on applications for new
national bank charters
20. Applications for national bank charters approved
and rejected
E. Availability of Capital for Small Business
Question 21. Availability of credit and capital to small business. _
22. Effects of bank examination on lending to small
business
Appendix (list of questions)
Chapter V I I . Reply by the Chairman of the Federal Deposit Insurance
Corporation
A. General Purposes of the Corporation
Question 1. Functions and mode of operation
2. Congressional directives bearing upon economic
objectives
3. Weight given to Employment Act in determining
policies
B. Organization of the Corporation and its Relationship to Government
Question 4. Responsibility to the President
5. Resolution of policy conflicts
6. Are reports to Congress on pending legislation submitted to the Bureau of the Budget?
7. Suggestions for legislation
C. Earnings and Expenses of the Corporation
Question 8. Annual earnings since date of organization
9. Annual expenses since date of organization
10. Analysis of expenses during past 5 years
11. Budgetary procedure
12. Provision for audit
13. Expenses to influence public opinion on controversial
matters
D . Deposit Insurance
Question 14. Data on number and amount of insured and uninsured deposits
15. Data on relation of Deposit Insurance Fund to
amount of deposits at risk
16. Alternative techniques available to protect depositors of failing banks
17. Number of banks and amount of liabilities handled
by each technique
18. Extension of coverage of deposit insurance
E. Bank Examination
Question 19. Role of bank supervision in furthering objectives of
Employment Act
F. Reserve Requirements
Question 20. Function of bank reserves and application of reserve
requirements to nonmember banks
G. The Banking Structure
Question 21. Adequacy of banking facilities
VH
Page
912
912
913
913
916
917
919
919
919
922
924
925
925
925
928
929
932
932
936
937
941
941
941
942
942
942
942
943
943
944
944
944
945
946
947
947
947
948
948
949
950
951
952
953
953
953
953
954
954
IV
CONTENTS
Page
Chapter VII—Continued
H . Availability of Capital for Small Business
954
Question 22. Availability of credit and capital to small business. _
954
23. Effects of bank examination on lending to small
< business
956
Appendix (list of questions)
956
Chapter V I I I . Reply by the Administrator of the Reconstruction Finance
Corporation
961
Question 1. Changes in availability of capital and credit to small
business
961
2. Economic role of capital and credit to small business
964
3. Suggestions for improving availability of capital and
credit to small business
964
4. Relation to present national emergency
965
Appendix:
List of questions
965
Reconstruction Finance Corporation—Loan authorizations to
business enterprises by calendar year
966
Chapter I X . Replies by State bank supervisors
967
Question 1. Role of bank supervision in furthering objective of economic stability
967
2. Extension of coverage of deposit insurance
973
3. Function of bank reserves and application of reserve requirements to nonmember banks
978
4. Adequacy of banking facilities
984
5. Policy followed in acting on applications for new Statebank charters
989
6. Applications for State-bank charters approved and rejected
995
7. Availability of credit to small business
997
8. Effects of bank examination on lending to small business. 1005
Appendix:
List of questions
1010
Persons replying
1011
Chapter X . Replies by economists
1013
Question 1. Effects of credit policies resulting in large and small
changes in interest rates
1013
2. Role of credit expansion in the postwar and post-Korean
booms; effectiveness of general and selective credit
controls
1043
3. Roles of direct controls, selective credit controls and
general credit restriction in restraining inflation under
differing circumstances
1066
4. Insulation of public debt securities from effects of general
credit policies
1081
5. Influence of interest rates on nonbank demand for Government securities
1092
6. Advisability of issuing a purchasing power bond
1097
7. Recommended types of securities for Government borrowing
1114
8. Compulsory sale of Government securities
1122
Appendix:
List of questions
1130
Persons replying
1131
C h a p t e r l X I . Replies by bankers
1133
Question 1. Lending policies since July 1950
1133
2. Investment policies since July 1950
1146
3. Factors contributing to changes in lending and investment policies
1148
4. Abandonment of par support of Government securities __ 1160
5. Function of bank reserves and application of reserve requirements to nonmember banks
1168
6. Secondary reserve requirements
1176
7. Extension of coverage of deposit insurance
1184
8. Role of bank supervision in furthering objective of economic stability
1192
9. Regulation of consumer and real estate credit
1199
10. Implications of ownership of Federal Reserve bank stock. 1205
CONTENTS
VH
Chapter XI—Continued
Appendix:
List of questions
Persons replying
Chapter X I I . Replies by life insurance company executives
Question 1. Investment policies from 1945 to June 1950
2. Changes i n investment policies since June 1950 and
reasons therefor
3. Company preferences for different types of Government
securities
Appendix:
List of questions
Persons replying
Pag»
Chapter X I I I . Replies by United States Government security dealers
Question 1. Response of customers to credit and debt management
moves since Korea
2. Effect of changes in credit policies on customer preferences
for different maturities of Government securities
3. Abandonment of par support of Government securities
4. Influence of interest rates on nonbank demand for Government securities
5. Recommended types of securities for Government borrowing
Appendix:
List of questions
Persons replying
Chapter X I V . Statement by Conference of University Economists
sponsored by the National Planning Association
Index
1251
Part I contains the replies by—
The Secretary of the Treasury.
The Chairman of the Board of Governors of the Federal Reserve
System.
The Chairman of the Federal Open Market Committee (in collaboration with the Vice Chairman).
1217
1219
1227
1228
1234
1244
1249
1249
1251
1270
1273
1279
1284
1294
1295
1297
1303
CHAPTER IV
R E P L I E S
B Y
P R E S I D E N T S
O F
T H E
F E D E R A L
R E S E R V E
B A N K S
INTRODUCTION
The presidents of the Federal Reserve banks were informed, when
the questionnaire p r i n t e d i n the appendix to this chapter was sent to
them, t h a t the questions, insofar as they referred to country-wide practices and conditions, m i g h t be answered j o i n t l y by the presidents i f they
so preferred—each president, of course, adding such supplement or
dissent as he desired. T h i s procedure was followed; each president
submitted,a.,set of j o i n t answers to most of the questions to which,
wKeFTie'considered i t appropriate, he aclcled his supplemental comments. Some of the presidents also submitted general statements,
"best presented as a whole. General statements by the presidents follow, and after them the j o i n t answers w i t h the i n d i v i d u a l comments
of the several presidents.
G E N E R A L S T A T E M E N T S BY FEDERAL RESERVE B A N K
PRESIDENTS
Joseph A. Erichsony Boston
W e want t o assure you of our willingness t o cooperate w i t h the
subcommittee i n any way t h a t w i l l be h e l p f u l t o its work. T h e subjects being investigated represent i m p o r t a n t parts of the Nation's
monetary, credit, and debt management problems. W e believe i t
w o u l d be w o r t h while f o r your subcommittee t o consider f u r t h e r the
question whether i t w o u l d be desirable sometime i n the near f u t u r e
to establish a National Monetary Commission to review a l l aspects
of the financial organization of the country, i n c l u d i n g all of its lendi n g and investing institutions, both public and private, the controls
to which they are subject, and the extent t o w h i c h a l l are contributing
to the objectives of the Employment A c t of 1946.
Allan Sproul, New York
T h i s letter and its attachment are m y answers to the questionnaire
w h i c h you sent me under cover of your letter of October 12, which
reached me on October 15. A s i n the case of a similar questionnaire
sent to the presidents of the Federal Reserve banks by a subcommittee
of the J o i n t Committee on the Economic Report i n August 1949, and
as suggested i n the heading of the questionnaire of the present subcommittee, I am using material prepared i n behalf of all of the presidents of the Federal Reserve banks to answer most of the questions
asked by the subcommittee, and to provide the background f o r my
i n d i v i d u a l comments.
T h i s method of answering the questionnaire recommends itself both
as a means of avoiding unnecessary duplication of effort, and as the
633
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT634
only practical way of meeting the t i m e schedule suggested by your
subcommittee. Even by adopting this time-saving method, however,
i t has been impossible t o prepare exhaustive answers to a list of 36
questions and many subquestions, covering a very wide range of economic theory and banking practice. Volumes could be w r i t t e n on these
questions w i t h o u t exhausting their possibilities f o r discussion and debate. T h e only practical alternative, when l i m i t e d t o 1 m o n t h f o r the
preparation of replies, is a series of short, sharp answers w h i c h t r y to
h i t the target of the inquiry. Obviously this method leaves out much
i n the way of analysis, and does not p e r m i t of necessary qualifications
and variations. The answers to the questions, therefore, must be taken
only as a summary of views, not as complete and inclusive expressions
of opinion.
T h i s observation and caveat leads me t o repeat w h a t I said i n a
letter to Senator Douglas (then chairman of a similar subcommittee)
under date of October 14, 1949:
* * * many of the problems you have raised deserve prolonged study and the
seasoning t h a t comes f r o m extended public discussion. I feel t h a t the national
interest would best be served i f a number of these could be reviewed a t length
by a special commission, set up to reexamine our entire monetary system i n a
manner comparable to the investigations of 1909 to 1912, which preceded the
original establishment of the Federal Reserve System.
I n m y opinion, a national monetai^ commission, made u p of men i n
public l i f e , i n private business, and i n academic chairs, is the best way
to b r i n g these problems under final review and provide the Congress
w i t h a comprehensive and seasoned report on w h i c h legislative changes
m i g h t be based.
M y general comments, supplementing the attached specific answers
to the questionnaire w h i c h you addressed to the presidents of the
Federal Eeserve banks, t r y to follow three or f o u r m a i n threads w h i c h
seem to me to r u n t h r o u g h the whole inquiry.
The first of these threads is the relation o f the Federal Eeserve System to the Government, or more p a r t i c u l a r l y to the executive branch
of the Government. This question was brought sharply t o the fore
by the public dispute between the Treasury and the Federal Eeserve
System i n late 1950 and early 1951. I t is not a new question, however;
i t was debated and decided i n favor of an independent Federal Eeserve
System at the time the Federal Eeserve A c t was passed i n 1913. I t
was a troublesome problem immediately after the F i r s t W o r l d W a r ,
and i t lias been a persistent problem d u r i n g the past dozen years since
the public debt began to occupy so large a place i n the whole debt structure of the country. Yet, whenever there have been major amendments t o the Federal Eeserve A c t the Congress has reaffirmed its origi n a l judgment on this important point.
I t h i n k the wisdom of those who created the Federal Eeserve System, i n establishing a buffer zone between the System and the executive
branch of the Government, has been demonstrated over the years, and
never more so than d u r i n g the regrettable dispute between the Treasu r y and the Federal Eeserve System last f a l l and winter. The execut i v e branch of the Government, no less than the Federal Eeserve System, needs a buffer zone to protect i t f r o m the pressures w h i c h w o u l d
converge upon i t i f i t had final authority and responsibility i n the
technical field of monetary and credit policy. T h i s is not to argue
that an independent Federal Eeserve System can have policies and a
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
635
p r o g r a m which r u n counter t o the national economic policy. T h a t
has never been the case, is not now, and never should be. I t does argue
f o r specialized competence acting under a general directive f r o m the
Congress w i t h i n the bounds of national economic policy as determined
by the Congress.
T h e core of the problem as i t has recently presented itself is the
coordination of debt management and credit policy. Debt management and credit policy cannot w o r k separately, b u t they can w o r k
badly or w e l l together. P u t t i n g the case f r o m the standpoint of the
Federal Eeserve System, their coordination requires recognition of
the fact t h a t there cannot be a purposeful credit policy unless the
Federal Eeserve System is able to pursue alternating programs of restraint, neutrality, and ease as the business and credit situation may
require, and to act p r o m p t l y w i t h each change i n the general situation.
I t requires recognition of the fact t h a t such programs must, as they
accomplish an increase or contraction i n the volume of credit and a
t i g h t e n i n g or loosening i n the availability of credit, affect interest
rates not only f o r private lenders and borrowers, b u t f o r Government
securities—the terms of Treasury offerings f o r new money and f o r
r e f u n d i n g issues must be affected. I t does not require t h a t the management of the public debt be made unnecessarily burdensome t o the
Treasury, nor t h a t the cost of servicing the debt, over time, necessarily
be increased, but i t does require t h a t Government b o r r o w i n g h o l d its
place i n the market instead of being floated on a stream of newly
created mtfney. Successful coordination of debt management and
credit policy depends on the sensitivity of the money and capital
markets, and the possibility of close and continuous contact w i t h a l l
areas of these markets, to make credit policy effective w i t h relatively
small changes i n credit availability and interest rates. I t depends on
the great g r o w t h t h a t has occurred i n the Federal debt, its widespread
distribution, and its importance i n the portfolios of the increasingly
i m p o r t a n t institutional investor, to make this sensitivity real and this
contact w i t h the money and capital markets pervasive. I n other words,
i t uses the facts as they exist to f u r t h e r the purposes of credit policy
and to combine i t w i t h effective debt management; i t does not t r y to
alter the facts.
T h i s does not require nor suggest a subordination of the Treasury
to the Federal Eeserve System as some have charged or implied. W h a t
is needed is to redress the balance i n their coordinate spheres. The
Treasury is one of the oldest branches of the Federal Government,
and the Secretary of the Treasury is one of the highest executive
officers of the Government and usually an intimate of the President.
I t has been n a t u r a l f o r succeeding Secretaries to assume, since the
relatively recent establishment of the Federal Eeserve System, t h a t
their responsibility and authority is exclusive i n cases where credit
policy and debt management overlap. I t should be possible, however,
to separate the Federal Eeserve System f r o m a host of advisers to
the Treasury, public and private, so that the Treasury and the System
could approach these overlapping problems as equals seeking solutions and, by mutual agreement, finding solutions w h i c h best fit the
needs of the economy of the country at the time.
Eecognizing that there s t i l l could be differences of opinion, the situat i o n suggests to some t h a t the Federal Eeserve System be brought
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT636
w i t h i n the executive branch of the Government, or t h a t the Chairman
of the B o a r d of Governors be made a member of the Cabinet, so t h a t
as a last resort conflicts m i g h t be resolved by the President. This
solution runs counter to the whole idea of a buffer zone between the
central b a n k i n g system and changing executive administrations, and
compounds the mistake of burdening the President w i t h too many
responsibilities i n fields where a t r a d i t i o n of technical competence
is necessary. I t w o u l d lead either to bottlenecks i n reaching decisions,
or to decisions actually made by staff members h a v i n g no direct respons i b i l i t y to the Congress or to the public. I t s practical effect would
probably be to place the Federal Reserve System under the domination
of the Treasury, or to place both the System and the Treasury under
the domination of something like the Council of Economic Advisers.
A more hopeful avenue to follow is the suggestion of your predecessor subcommittee (the Douglas committee) that Congress give a
general mandate to the Treasury and the Federal Reserve System
regarding the objectives of debt management and credit policy i n the
l i g h t of present-day conditions. These instructions, as the Douglas
committee said, need not and i n fact should not be detailed. They
would not challenge the p r i m a r y responsibility of the Treasury f o r
debt management. They should specify, however, as p a r t of the legislative f r a m e w o r k of debt management, that the Treasury have regard
f o r the structure of interest rates appropriate to the economic situation. The implication of such a directive, to me, w o u l d be t h a t the
Treasury could not, as a matter of r i g h t or of superior position, call
upon the Federal Reserve System to "make a market f o r its securities"
at rates which the System believed to be out of line w i t h the degree of
credit restraint considered necessary by the System. I recognize t h a t
there w o u l d continue to be differences of opinion about these matters,
and I realize t h a t you cannot legislate cooperation between people,
but the Congress, as final arbiter, m i g h t be able to provide a mandate
w h i c h would charge debt management as well as monetary management w i t h some responsibility f o r the objectives specified i n the
Employment A c t of 1946. The country cannot afford to keep money
cheap at all times and i n a l l circumstances, i f the counterpart of that
action is inflation, r i s i n g prices, and a progressive deterioration i n the
purchasing power of the dollar—including the purchasing power of
the dollars w h i c h the Government itself must spend and the purchasing
power of dollars invested by the public i n Government securities.
T h a t brings me t o what seems t o me to be a second m a i n thread of
y o u r i n q u i r y , a challenge t o b r i n g proof of the effectiveness of moderate changes i n the availability of credit (and the consequent changes
i n interest rates) i n counteracting inflation or deflation. Questions
i n this area cannot be answered categorically by recourse t o the record.
Y o u are always faced w i t h the problem of the facts and statistics
w h i c h are not there—the record of what w o u l d have happened i f no
action had been taken i n the field of credit policy. The fact is, of
course, t h a t at times too much emphasis and at times too l i t t l e emphasis
has been placed on the effectiveness of credit policy i n combating
inflation and deflation. General economic situations are made up o f
a whole complex of i n d i v i d u a l situations, and economic developments
are the resultant of a variety of economic forces. A l l t h a t should be
claimed f o r credit policy is that, combined w i t h other measures
w o r k i n g i n the same direction, such as fiscal policy, debt management,
MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT
637
and, i n extraordinary circumstances, direct controls, i t can contribute
to anti-inflationary or anti-deflationary forces.
I t is quite generally admitted, however, t h a t a severe policy of
credit restraint, and the resultant sharp increase i n interest rates, can
be effective (even by itself) i n combating inflation. Such a policy
works itself out i n terms of a sharp restriction of the money supply,
contraction of production, contraction of employment, and contract i o n of income. T h i s few would now advocate, but i t is not necessary
to j u m p f r o m rejecting the strong-arm use of the power of the purse
to complete rejection of monetary measures. T h e tendency of some
is, however, to claim or to suggest t h a t there is no point of effectiveness between such drastic use of credit power as is socially unacceptable, and such m i l d use as is w h o l l y ineffective, and even h a r m f u l i n
the vocabulary of those who t a l k about " w a d i n g t h r o u g h $250 b i l l i o n
of public debt" to get at & segment of the p r i v a t e debt. Such an
attitude, w h i c h denies t h a t there is any place between the extremes
where credit policy could be made effective, seems to me t o fly i n the
face of common sense. A n d common sense as well as fine-spun theoretical argument has its place i n the consideration of this economic
problem ( w h i c h is also a problem i n human reactions), i f the public
and the Congress are to understand what i t is a l l about.
"Certainly there are difficult problems t o be worked out, i n finding
the proper sphere of effectiveness of general credit policy under present conditions. B u t i f any are to be asked t o b r i n g proof of their
theories, i t should be those who are t r y i n g to discredit general credit
controls (or general credit controls which must operate w i t h i n a framew o r k of orderly conditions i n the Government security m a r k e t ) , and
who would place m a i n reliance on selective credit controls, or who
suggest recourses to old laws, directed to other purposes, to b r i n g about
r a t i o n i n g of bank credit to i n d i v i d u a l borrowers. T o quote f r o m a
recent issue of the L o n d o n Economist:
The proper reply to those who deny the effectiveness of (changing credit
availability and) interest rates is not, however, to cite instances in which they
would be effective; on the contrary, it is to point out that it is precisely because
no one can possibly know and catalog the manifold instances, and neatly classify
them in degrees of vulnerability, that the sifting function of a variable interest
rate cannot be duplicated by a planning mechanism. Such a mechanism, i f
operated by a physical licensing system of sufficiently great complexity, might
conceivably succeed in exerting a sufficient restraint upon total demand; but,
i f i t did succeed, i t would be at the cost of intolerable frictions, wastages, and
anomalies. A variable interest rate, like any other price mechanism, sifts automatically a virtually infinite number of marginal and near marginal demands,
and discriminatingly grades the remainder according to economic "priorities"
established naturally i n the market place. * * * [Matter i n parentheses
supplied.]
A t h i r d thread of i n q u i r y i n the various questionnaires relates to
the structure of the Federal Eeserve System and the allocation of
powers w i t h i n it. P r i v a t e participation i n the affairs of the Federal
Eeserve System seems to be called into question,, and an attempt seems
to be made to trace undue private influence upon the f o r m u l a t i o n of
national credit policy, t h r o u g h the directors and presidents of the
Federal Eeserve banks. T h i s aspect of the operations of the Federal
Eeserve System has been discussed i n the answers to sections A , B , and
C of the questionnaire addressed to me as president of the Federal
Eeserve B a n k of New Y o r k . I w o u l d emphasize what I believe t o be
the advantages of the present modest measure of private participation
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT638
i n the affairs of the Federal Eeserve System, and I w o u l d enlarge
upon the suggestion t h a t the responsibility f o r a l l of the m a j o r instruments of credit policy be placed i n the group now called the Federal
Open M a r k e t Committee. Here I can do no better t h a n repeat what
I said at the hearings of the Douglas committee i n December 1949:
This is a question on which men i n the System may differ, displaying a bias,
perhaps, t o w a r d the side they know best. As a Reserve bank president, i t is
probably n a t u r a l t h a t I should see advantages i n this proposal, w h i l e members
of the B o a r d of Governors may react against i t , as an intrusion upon their
authority. On this question, just as on the substantive questions of credit policy,
both views deserve a hearing. M y own view is t h a t we shall do w e l l to retain,
wherever we can, the regional characteristics of the System, both i n the matter
of decentralized operation and, more important, i n the matter of System national
policy. No one would deny the need f o r coordination of general credit policy,
but we now have, i n the Federal Open M a r k e t Committee, the statutory means
of achieving this w h i l e retaining some regional participation and responsibility.
T h i s committee is composed, as you know, of the seven members of the B o a r d
of Governors and five of the presidents of the Federal Reserve banks. Here are
brought together, under stautory auspices and w i t h statutory responsibilities,
men who are devoting their f u l l time to the problems of the Federal Reserve
System and who are i n touch w i t h governmental policies and private views and
opinions, i n Washington and throughout the country. I t is the best expression
w h i c h we have of the Federal character of the System, a character w h i c h is i n
tune w i t h o u r political organization, w i t h the continuously expressed intent of
the Congress, and w i t h the desires of our people.
A n d let me n a i l r i g h t here one or two arguments which have been advanced
on the other side. F i r s t , there is the argument t h a t the presidents on the
Federal Open Market Committee exercise authority w i t h o u t having responsibility.
I n the first place, as I have stated, membership on the Federal Open M a r k e t
Committee, and the duties and responsibilities of the committee are now fixed
by statute. Every man who accepts a place on t h a t committee derives his aut h o r i t y f r o m the Congress and assumes a responsibility to the Congress and,
through i t , to the public. These presidents are mostly men who have devoted
their lives to the Federal Reserve System—they are career men i n the public
service. * * * You do not plant honor and integrity i n a man by bringing
h i m to Washington and giving h i m an official position i n the Government.
Second, there is the argument by t h r e a t ; by posing a wholly unacceptable
solution as the only alternative to the giving of additional powers to the Federal
Open Market Committee. This is the argument t h a t i f you are going to give
additional powers to the committee, you should abolish the Board of Governors.
Such an argument seems to me to miss the whole point of the o r i g i n a l suggestion. The essential and unique characteristic of the Federal Open Market
Committee is i t s blend. The Board retains a l l of its existing duties, but
exercises its principal powers through m a j o r i t y membership i n the Federal Open
M a r k e t Committee. The presidents, w i t h their experience gained through carryi n g out policy i n the field, sit as m i n o r i t y members of the committee. A l l
participate i n policy-making discussions, and conflicting views are given the test
of thorough debate. You are protected f r o m being blown off your course by
either the political winds of Washington or the financial winds of W a l l Street.
*
*
*
*
*
*
*
T h i s is a case where the whole cannot adequately be replaced by either of
its parts. I n my view, we have developed through the Federal Open M a r k e t
Committee a unique contribution to the processes of democratic administration.
The System w i l l best meet its responsibilities i f this successful pioneering
experiment is expanded to embrace aU of the major policy determination of the
System.
A f o u r t h field of i n q u i r y embraced i n most of the questionnaires
sent out by your subcommittee, which seems a l i t t l e apart f r o m the
m a i n thread of investigation, is the availability of capital and credit
f o r small business. The implication here is t h a t small business has
not had adequate access to capital and credit and t h a t this has led to
a concentration of economic power and a lessening of the dynamic
character of our economy. The answers to questions 35 and 36 of
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
639
the questionnaire prepared i n behalf of the presidents of a l l of the
Federal Reserve banks t r y to separate m y t h f r o m fact i n this area,
and suggest t h a t while there may be some difficulty i n obtaining
capital f o r small business, i t cannot be held t h a t credit has generally
been lacking.
I t is m y own observation t h a t the difficulties of small business, to
the extent t h a t they may be distinguished f r o m the difficulties of b i g
business, do not o r d i n a r i l y arise f r o m a lack of credit. They arise
f r o m a lack of management ability, f r o m a lack of distribution and
sales skill, f r o m the keeping of inadequate records, f r o m a lack of
knowledge of cost accounting, and f r o m a lack of access to the stream
of research discoveries and technological developments w h i c h are so
conspicuous a p a r t of our economic progress. Attempts to supply
these lacks, where they can be supplied, through private i n i t i a t i v e or
public aid, have not gotten very f a r but, i n m y opinion, should be pursued f u r t h e r . A t the Federal Reserve B a n k of New Y o r k we are
actively pursuing this objective, w i t h g r a t i f y i n g results, i n our relations w i t h our small member banks, aiding them i n the setting up of
commercial and agricultural credit files, i n the handling of their
check operations, and prospectively w i t h some of their other problems
and procedures. I t w o u l d be a disservice to small business, i n my
opinion, to t r y to cure its ills by more liberal injections of credit. The
maladies of small business, w h i c h obviously suffers f r o m a h i g h b i r t h
and death rate, are not due to credit anemia.
I should like to close this letter w i t h a general observation. The
purpose of the i n q u i r y launched by your subcommittee is to contribute
to our knowledge of economic problems so t h a t we may v be better able
to make effective the policy of the Congress, w i t h respect to economic
stability, which is i m p l i c i t i n the Employment A c t of 1946.- Under
circumstances such as have existed d u r i n g most of the past 5 or 6
years, and such as s t i l l may exist d u r i n g the next year or t^vo, the
pursuit of economic stability has required resistance to inflationary
pressures i n our economy. T h e basic elements of an anti-inflation
program i n a country such as the U n i t e d States are not unknown.
They include:
1. A fiscal policy w h i c h demands a balanced cash budget or a
surplus, achieved b y —
(a) R i g i d p r u n i n g of Government expenditures, both c i v i l
and m i l i t a r y , to achieve the results demanded by the domestic
and international situation i n the most efficient manner;
(b) Taxes w h i c h so f a r as possible retain production incentives and keep consumer spending i n line w i t h available
supplies of goods and services.
2. A debt management policy w^hich—
(a) Competes f o r nonbank funds i n the market rather
than w a i t i n g f o r such funds to accumulate and become available at some predetermined level of interest rates;
(b) Aggressively seeks to channel directly into Government hands a substantial part of the savings w h i c h accumulate i n a period of f u l l employment, h i g h national income,
and relative scarcity of goods.
3. A credit policy or program w h i c h places restraint on the
availability of bank reserves and thus on the ability of the banki n g system to expand its loans and investments.
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT640
4. I n war or semiwar, when there are special m i l i t a r y demands
on the economy, certain direct controls to channel scarce materials
into the defense .production effort, and to check a wage-price
spiral f r o m developing or continuing. ( I f the wage-price controls have f o r m but not substance, and a f a r m price policy requires t h a t increases i n wages and industrial prices be matched
by rises i n f a r m support prices, you have b u i l t - i n inflation, not a
cneck rein.)
A l l of these things must be w o r k i n g i n the same direction and tow a r d the same end i f there is to be a chance of success i n combating
inflation i n an economy i n which the maintenance of a h i g h level
of employment and production is desirable and, i n fact, necessary. I f
we don't want to meet the tests of such a program, we don't really
want to avoid inflation. Credit measures alone can't do the job. I n flation can come about t h r o u g h the push of costs as well as the p u l l of
demand, even though the end result may be too much money chasing
too few goods. A n increasing money supply w h i c h merely permits
the business of the country to be carried on at a higher level of costs
may be more a symptom than a cause.
I hope t h a t the answers which I have given to your questionnaire,
and the views w h i c h I have expressed i n this letter, w i l l be of help to
your subcommittee i n the important study w h i c h i t has undertaken i n
behalf of the Joint.Committee on the Economic Report.
Alfred H. 'Williams,
Philadelphia
M y replies to the questions addressed to the presidents of the Federal
Reserve banks by the subcommittee of w h i c h you are chairman are
attached to this letter. The answers are identical w i t h those prepared
under the direction of a special committee of Federal Reserve bank
presidents, except as to No. 34 and the concluding paragraphs of Nos.
6, 35, and 36, w h i c h relate to the t h i r d Federal Reserve district and are
attached to the answers of the special committee.
I wish to supplement these answers to your specific questions w i t h
judgments on several of the basic issues raised by the range of questions
as a whole. I shall l i m i t these observations to f o u r such issues, as
follows:
1. The relationship between the Federal Government and the
Federal Reserve System as the central banking organization of the
country.
2. T h e internal functioning, of the System.
3. The roles of fiscal, debt management, and monetary policies
i n a competitive enterprise economy, w i t h particular emphasis
on the area f o r w h i c h the System has p r i m a r y responsibility:
namely, general and selective instruments of monetary policy.
4. The functions and availability of capital and credit, especially f o r small business.
1. The relationship between the Government and the Federal Reserve
System.—The Constitution of the U n i t e d States, based on the principle
of the separation of powers, vests i n the Congress the power to coin
money and regulate its valiie. The decision to place the regulation of
money i n the legislative branch was based on sound principles of government and on extensive experience i n many countries w i t h executive
control over money.
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C DEBT
641
The Congress, i n t u r n , has created the Federal Reserve System to
regulate the amount, availability, and cost of money and credit i n ways
that w i l l promote the purposes specified by the Congress. I n the Federal Reserve System the Congress created a central banking system
that is apart f r o m but not above the Government. I t provided safeguards to assure t h a t the System w o u l d operate i n the long-run public
interest and not, under the exigencies of the moment, f o r short-run
private or political advantage. The ultimate assurance t h a t the
System w i l l operate i n the long-run public interest arises f r o m the fact
that, as a creature of the Congress, i t is responsible to the Congress.
The question of m a k i n g the System responsible to the President
raises the much more basic issue of the separation of legislative powers f r o m executive powers. T h e President of the U n i t e d States, unlike
the prime minister i n parliamentary systems of government, is not
responsible to the Congress or the legislative branch of government.
The President has a fixed term and does not resign when he is unable
to secure a congressional or parliamentary m a j o r i t y . T h e basic issue,
therefore, is not whether the System should be independent in an
absolute sense, but whether i t should be responsible to the Legislature
or Congress on the one hand or the Executive or President on the
other. I believe our experience confirms the judgment of those who
d r a f t e d the Constitution and t h a t the System should continue to be
responsible to the Congress.
2. The internal fimctioning
of the Federal Reserve System.—The
f o r m a l structure under w h i c h i t operates is an i m p o r t a n t aspect of
any organization; but i t is only one of several aspects t h a t produce
a l i v i n g institution. Others are traditions and people. I n j u d g i n g
the competence of an i n s t i t u t i o n and the desirability of change, i t is
i m p o r t a n t to view the i n s t i t u t i o n as a whole and to recognize that a
change i n one aspect may produce p r o f o u n d changes i n other aspects.
A change i n organization, f o r example, w i l l affect the traditions and
the willingness of people to serve. Given changes i n organization
produce some effects t h a t are apparent or can be foreseen; but they
can—and often do—produce unforeseen effects t h a t are undesirable.
T h a t is w h y change merely f o r the sake of change or merely f o r the
purpose of creating a logically consistent organization structure
seldom proves desirable.
These general principles are relevant to the organization of the
Federal Reserve banks. I f we had no central banking system and
were now confronted w i t h the necessity of establishing Federal Reserve banks, we probably w o u l d not organize them precisely as the
existing Reserve banks are organized. A c t u a l l y the Reserve banks
have been operating f o r 37 years. A characteristic t h a t permeates
these banks is the t r a d i t i o n t h a t the public interest is paramount.
Directors, officers, and employees receive this t r a d i t i o n as they enter
the service of a Reserve bank. Over almost f o u r decades they have
enriched i t t h r o u g h t h e i r own service. I t is now deeply emt>edded.
A significant feature of this t r a d i t i o n is t h a t the Reserve banks have
developed i n the direction intended by the Congress when i t established them. A change i n methods of selecting directors or i n organization could i m p a i r this t r a d i t i o n significantly. I believe i t would be
a serious mistake to r u n t h a t risk i n the hope of achieving gains which,
even i f f u l l y realized, would concern appearance rather t h a n sub98454-—52—pt. 1 40
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT642
stance. I do not envision, however, t h a t any adverse consequences
w o u l d result f r o m placing final responsibility f o r a l l instruments of
credit control i n the Federal Open M a r k e t Committee, as is indicated
i n the answer to question 11. I agree also that the present allocation
of authorities has proved workable and satisfactory, and t h a t change
i n this particular is not urgent.
3. The role of general and selective monetary and credit policies.—
The f u t u r e of our dynamic competitive organization may w e l l depend on our a b i l i t y to achieve economic stability at h i g h levels of
employment and production. Since the subcommittee is concerned
w i t h debt management and monetary policies, m y observations w i l l
be directed p r i m a r i l y to these fields. I t is imperative to remember,
however, t h a t such stability cannot be achieved t h r o u g h these means
alone because i t is inherently a collective responsibility.
Since we have a money and credit economy, a heavy share of responsibility rests on the major agencies t h a t determine our fiscal, debt
management, and monetary policies: the Congress, the Treasury, and
the Federal Reserve System.
The Congress has responsibility f o r expenditures and receipts and
consequently also f o r the cash surplus or deficit of the Federal Government. I n a period of inflation, congressional action w h i c h produces a surplus contributes to stability and makes easier both the
Treasury's problem of managing the debt and the System's task of
restricting credit. A deficit, on the other hand, reinforces inflationary developments and aggravates the problems of both the Treasu r y and the System. The tax and expenditure structures also influence the volume and flow of expenditures and may contribute to
stability or aggravate instability.
T h e Treasury takes up where the Congress leaves off. I t has a basic
responsibility f o r managing the public debt and the Government's
cash balance. The terms established by the Treasury i n financing
the debt influence the willingness of investors t o buy and to h o l d
the securities and the flow of expenditures throughout the whole
economy. Unattractive terms stimulate expenditures and exert upw a r d pressures on prices of goods and services, i n c l u d i n g those purchased by the Government. T h e debt management policies of the
Treasury, therefore, have i m p o r t a n t influences on economic stability.
The Federal Reserve System has p r i m a r y responsibility f o r monet a r y policy. I t influences the flow of expenditures p r i m a r i l y t h r o u g h
the use of instruments w h i c h affect the supply, availability, and cost
of money. A p r o g r a m of monetary ease—increasing the supply and
availability and reducing the cost—tends t o encourage expenditures;
and a program of monetary restraint tends t o discourage spending.
Policies i n these three fields should be formulated w i t h reference
to developments i n the entire economy. A l t h o u g h Government financial operations d w a r f those of any other i n d i v i d u a l or institution,
even at currently projected m a x i m u m prospective levels, Government
expenditures w i l l be less than one quarter of total expenditures f o r
goods and services. W e should not, therefore, choose w h a t may appear i n the short r u n to be the easiest way t o meet the immediatel
needs of the Government when that choice w i l l i m p a i r the strength
of the entire country, i n c l u d i n g the Government, i n the long run.
Monetary policy influences the flow of expenditures p r i m a r i l y
through its effects on the amount, availability, and cost of money and
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
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643
reserves. Unless a central bank controls both the amount of assets
eligible as reserves a n d — i n a country such as ours w i t h many independent banks—reserve requirements, i t cannot impersonally and effectively control the volume of deposits and money. Impersonal
quantitative control, such as can be achieved only t h r o u g h the use
of general instruments, is an essential b u l w a r k to the maintenance of
free competitive enterprise, w h i c h is a basic objective of the E m p l o y ment A c t of 1946.
Open market operations, changes i n reserve requirements, and
changes i n discount rates place upon the market the function of allocating credit among competing uses. Use of these general instruments of monetary policy thus decentralizes this i m p o r t a n t function.
I n m y judgment, we cannot hope to m a i n t a i n a strong free competitive
enterprise system i f we concentrate i n the central bank the allocation
of credit t h r o u g h a complex system of rationing.
Use of the general instruments w i l l , of course, affect the cost of reserves and money. I t is tempting, therefore, to look t o w a r d the selective instruments as a means of avoiding this effect. Selective instruments directed t o w a r d the use of credit, however, are no substitute f o r general instruments directed t o w a r d the t o t a l amount of
money. I f the t o t a l amount of money is allowed to increase relative
to the demand at current prices, borrowers w i l l be able to meet r i s i n g
down payments and shortening maturities. Selective instruments are
relatively ineffective unless they are b u i l t on the solid foundation of
general instruments.
A t times, despite appropriate over-all control t h r o u g h general instrument, credit developments i n particular sectors may be getting
out of hand. Under these circumstances, selective instruments can
be h e l p f u l i n p r o m o t i n g economic stability. T h a t is their l i m i t e d but
i m p o r t a n t role. They are a supplement to, not a substitute f o r , open
market operations, changes i n reserve requirements, and changes i n
discount rates i n a free competitive economy.
4. The functions and availability
of capital and credit, especially
for small business.—A h i g h l y dynamic economy is inherently a mixture of i n d i v i d u a l successes and failures. I t is distinguished by a continuous flow of new ideas, new methods, new operations, new institutions. I t is difficult and at times impossible to say i n advance which
w i l l survive. Each survivor tends to make its competitors obsolete.
We cannot expect to m a i n t a i n this dynamic character i f we insist that
every new idea shall succeed and that every old one shall survive.
Capital and credit are an important aspect of this process. W e
shall weaken our system i f we provide ever-increasing amounts of
funds to those who cannot meet the competition of the market place.
T o do so would reduce first the profitability of the efficient and next
the incentive to efficiency itself. The small-business u n i t generally
competes w i t h other small businesses as well as w i t h large businesses.
T o retain t h r o u g h subsidy or otherwise the competition of the inefficient producer merely because he is small w i l l weaken the efficient
competitor, whether large or small.
The hope of profit motivates those who have funds to invest as well
as those who desire funds. Owners of funds are under strong incentives to select f r o m among their applicants those most l i k e l y to succeed. W i t h the advantage of hindsight, i t may be concluded that
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT644
mistakes are made. B u t some mistakes are inevitable. The real
question is whether a centralized agency w o u l d make fewer and smaller
mistakes t h a n are made under our present private decentralized system i n w h i c h profitability is the p r i m a r y m o t i v a t i n g force f o r those
w i t h funds and f o r those i n need of funds. I n m y judgment, the
probability is t h a t such an agency would make more and larger
mistakes.
I have made these comments because I want to make clear m y own
point o f view on some of the basic issues t h a t a l l of us wish to have
resolved i n the best interest of the entire country. U n f o r t u n a t e l y , a
basic philosophy is apt to be obscured i n answers to a list of particular
questions, i n c l u d i n g some t h a t are necessarily rather detailed. Since
m y general comments and the answers to specific questions prepared
by the System subcommittee are consistent, I have not made minor
changes i n phraseology.
C. E. Earhart, San Francisco
Generally speaking, the questions i n section D call f o r discussions of
the various instruments of monetary policy, w i t h reference to the roles
they play, and the effects they create, and their accomplishments and
shortcomings i n restraining inflation. I n any series of questions and
answers dealing w i t h a subject w h i c h has as many facets as monetary
and credit policy, i t is v i r t u a l l y inevitable t h a t problems are treated
somewhat piecemeal. L i m i t a t i o n s upon the effectiveness of a particular
credit control measure, and the disadvantages to some persons that
result i f the measure is effective, may be rather readily apparent.
A restrictive credit policy pursued by the Reserve System may well
result i n a rise i n the interest charge on the public debt; allow Government securities t o f a l l below par, thus b r i n g i n g losses to sellers of
Governments; oblige commercial banks to deny some of t h e i r customers
credit f o r ventures which hold promise of success; and even prevent a
particular i n d i v i d u a l , i n certain circumstances, f r o m b u y i n g a house,
an automobile, or a television set. These and similar readily apparent
consequences of credit controls are certainly not desirable f o r their own
sake. F o r instance, taxpayers may well object t a the first result,
investors to the second, businessmen to the t h i r d , and consumers to
the last. However, before concluding t h a t the policies w h i c h have such
apparent effects should not be followed, one should attempt to assess
the results i f another available course of action, or inaction, were to be
chosen instead. Sometimes the cure is worse than the disease, b u t at
other times, the disease is worse t h a n the cure.
W e should like to develop this point a l i t t l e f u r t h e r w i t h respect to
the situation w h i c h has probably provoked more discussion i n the
postwar period t h a n any other aspect of credit policy, namely, the
pegging of prices (or yields) of Government securities. A s l o n g as the
Federal Reserve System keeps a firm floor under Government security
prices and a ceiling on yields, i t appears t h a t Treasury b o r r o w i n g w i l l
be facilitated, r e f u n d i n g of m a t u r i n g issues w i l l be readily accomplished, the burden of interest payments on public debt w i l l not increase
relative to the t o t a l debt, and holders of Government securities w i l l
consider them as good as cash.
B u t i f i t is necessary to peg the Government security market (as
opposed to intervention to maintain an orderly m a r k e t ) , i t is because
Government securities have not been made sufficiently attractive to find
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I C
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buyers i n an unsupported market. Preference of investors f o r other
uses of their funds means t h a t the Federal Reserve System must buy
the unwanted Governments i n whatever amounts are being offered i n
the market at the pegged prices. The ultimate result is much the same
as i f the Reserve System had purchased directly f r o m the Treasury
these securities t h a t the market refused to accept or retain.
T h e unwillingness of Congress, both t o give the System more than
l i m i t e d authority to buy Government securities directly f r o m the
Treasury and to allow the Treasury to issue currency w i t h iio reserve
whatever i n lieu of borrowing, reflects its recognition of the undesirability of insulating Government b o r r o w i n g f r o m the test of the
market, except under temporary, emergency conditions. Y e t to peg
the Government security market short circuits market influence i n
essentially the same fashion.
The inflationary dangers of " p r i n t i n g press" money, and of direct
sale of securities by the Government to the central bank, have been
recognized by Congress and the public alike, but they are not quite so
apparent when securities reach the central bank through a supported
market. Y e t , as long as i t is pegging Government security prices and
m a i n t a i n i n g a fixed pattern of yields, the Federal Reserve System has
been a p t l y described as " a n engine of inflation." Pegging the market
makes Government securities as good as cash, to be sure, but as inflation
progresses and prices rise, cash itself becomes less and less desirable.
The taxpayer m i g h t find that the effect of price increases on Government expenditures f a r outweighs the saving i n interest charges; the
investor m i g h t find t h a t the reduction i n purchasing power of his
Government bonds is more serious than the capital losses he m i g h t
possibly have incurred through their sale before m a t u r i t y i n an unsupported m a r k e t ; the businessman m i g h t find that r i s i n g costs, uncertainty of supplies, and distorted markets have increased his difficulties of profitable operation; and the consumer m i g h t find t h a t r i s i n g
prices have swept a house, an automobile, or a television set well beyond
his reach.
I f the economy hopes to avoid the effects of inflation but does not
wish to bear the effects of restrictive open-market operations, i t m i g h t
rely on an extensive system of direct controls. Price and wage controls, r a t i o n i n g of commodities and credit, controls over i n d u s t r i a l
materials and end products, would a l l be needed to dam the pressure
upon prices.
The taxpayer then m i g h t find other restrictions even more i r r i t a t i n g
t h a n taxes; the investor m i g h t find himself compelled to h o l d Government securities; the businessman m i g h t find t h a t his output was
s t r i c t l y limited, either by r a w materials controls or by direct order
and t h a t his selling prices were strictly regulated; and the consumer
m i g h t find himself i n one queue after another.
T o substitute administrative decision f o r t h a t of the market
throughout the economy is feasible only f o r periods of serious and
temporary emergency when patriotism can insure reasonable compliance. Even i f they are effective, direct controls only postpone the
resumption of price increases, i f nothing is done to check the g r o w t h
of the money supply.
Unchecked inflation and a network of direct controls over economic
activities obviously have their unfavorable aspects, too. Whether or
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I Ct ) E B T646
not any attempt is made to check inflation, regardless of the kinds of
anti-inflation measures t h a t m i g h t be adopted, and regardless of how
much our productive capacity may be expanded, the fact remains t h a t
the men and materials being used to provide f o r our defense and our
foreign-aid p r o g r a m cannot contribute to current c i v i l i a n production,
and someone must forego the use of the goods and services they represent. T h a t fact is inescapable and is the reason t h a t the advantages
and disadvantages of open-market operations, selective credit regulations, or any other instrument of economic control, can only be evaluated w i t h reference to the advantages and disadvantages of other
courses of action.
R E P L I E S TO I N D I V I D U A L Q U E S T I O N S
A. O W N E R S H I P OF T H E FEDERAL RESERVE B A N K S A N D T H E I R R E L A T I O N S H I P
TO T H E GOVERNMENT
1. Describe the present arrangements w i t h respect to the ownership
of the stock of the Federal Reserve banks. W h a t are the implications, advantages, and disadvantages of this ownership as
compared w i t h ownership by the Federal Government?
Joint answer
Stock of the Federal Reserve banks is owned b y banks which are
members o f the Federal Reserve System, but their ownership of stock
is as much an obligation as a r i g h t . Member banks are a l l the national banks and the qualified State-chartered banks t h a t have been
admitted t o membership by the B o a r d of Governors of the Federal
Reserve System. Each member bank is required to subscribe to
stock of the Federal Reserve bank of its district i n a sum equal to
6 percent of its paid-up capital stock and surplus. Member banks
have been required to pay i n only one-half of their subscriptions, the
remaining one-half being subject to call by the B o a r d of Governors
of the Federal Reserve System.
Ownership o f stock does not i m p l y proprietary interest i n or the
control over policies and operations of the Reserve banks, and thus
differs essentially f r o m the case of ordinary commercial or i n d u s t r i a l
corporations or banks carried on f o r profit. I t implies, rather, private
provision of capital f o r , and membership in, one of a federated system
of regional banks w h i c h administer and help to formulate monetary
and credit policies w h i c h w i l l contribute to a sound and stable
economy.
Member banks are entitled to a cumulative dividend at a specified
rate on the stock they hold. Member banks have no other claim upon
the earnings of the Reserve bank. T h e stock cannot be transferred
or hypothecated. Each member bank, regardless of the number of
shares i t holds, has but one vote, which may be exercised only f o r
the election of directors of a Federal Reserve bank, according t o the
procedures described i n the answer to question 6. Member bank ownership of the stock of the Reserve banks was not intended t o place
control of the System's policies i n the hands of the member banks,
and has not, i n fact, done so.
T h e present stock ownership arrangement stimulates among member banks a greater interest i n Reserve bank affairs t h a n w o u l d exist
i n the absence of such ownership. I t helps t o secure effective co
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647
operation between private business and Government f o r the attainment of objectives i n the interest of the general public, at the same
time avoiding both political partisanship and narrow private interest.
T h e Federal Eeserve System has achieved much of its effectiveness
because of its regional organization and internal freedom f r o m domination by any particular group. I n the actual administration of the
12 banks, a unique combination is obtained t h r o u g h the positive contributions of able directors and experienced officers combined w i t h
effective supervision by a public body.
Because the Eeserve banks have many of the attributes of private
management while conducting operations i n the public interest, they
have been able to combine the advantages of businesslike efficiency
w i t h the s p i r i t of public service. Directors are w i l l i n g to serve because they feel t h a t they are elected or appointed on the basis of
a b i l i t y and reputation t o render service w i t h i n their field of competence; officers who have made a career of central banking have done
so both because they are attracted t o a public service i n s t i t u t i o n and
because they feel t h a t advancement f o r m e r i t and security f r o m arbit r a r y political preferment are available i n the Federal Eeserve banks.
The present stock ownership of the Federal Eeserve banks has cont r i b u t e d to a d i s t r i b u t i o n of powers commensurate w i t h the duties
to be performed. Some powers have been given to the central agency,
the B o a r d of Governors; some toj the regional banks; and some t o a
combination of the two. T h i s distribution of powers assures group
judgments, which provide variation i n emphasis, and decentralized
administration, w h i c h encourages initiative.
The advantages just cited are achieved by a type of stock ownership
w h i c h does not i m p l y control. Transfer of ownership to the Government w o u l d deprive the Federal Eeserve System of most of these
advantages. Government ownership, unlike private ownership, would
i m p l y control w h i c h w o u l d be unnecessarily centralized. Fears of
p o l i t i c a l interference w o u l d i m p a i r the cooperation w i t h banks and
business already achieved and w o u l d reduce the willingness of able
men to serve the Eeserve banks. These consequences of Government
ownership would be reflected i n a loss of efficiency i n operations of the
Eeserve banks and reduced effectiveness i n achieving the ultimate objectives of m a i n t a i n i n g business stability and h i g h levels of production
and employment.
T h e only disadvantage of private ownership of the stock, f r o m the
viewpoint of the Federal Eeserve System, is the occasional misconception to which i t gives rise. The p r i n c i p a l misconception is that the
policies of the System are or may be subject to private domination.
T h a t this is a misinterpretation is shown by the statements of fact contained i n this and subsequent answers. T h e method of dealing w i t h
this problem is to conduct a continuing program of public i n f o r m a t i o n
as to the role and f u n c t i o n i n g of the Federal Eeserve System. T h e
same misconception may have led some Members of Congress to supEose t h a t private ownership of the stock of Federal Eeserve banks
as made the policies of the System subject to undue influence by
private interests, and may consequently have been an obstacle to f u l l
support of the System, i n c l u d i n g legislative action as needed, i n the
efforts to carry out its responsibilities. I f t h a t is the case, congressional inquiries such as the present one should help to c l a r i f y the
situation.
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT648
Comment of R.R. Gilbert, Dallas
I n connection w i t h this answer, I t h i n k i t m i g h t be pointed out that,
although at the time of organization of the Federal Reserve System
the organization committees were permitted under certain l i m i t e d
restrictions to allot stock i n the Federal Reserve banks t o the U n i t e d
States to be p a i d f o r at par out of any money i n the Treasury not
otherwise appropriated, such authority was i n the nature of a "last
resort" provision.
I n fact, the act provides t h a t subscription to stock of the Federal
Reserve banks was intended to be l i m i t e d to national banks and other
member banks and t h a t only i f such subscriptions d i d not provide adequate capital could the organization committees t u r n to other sources
f o r such funds. Even then, however, i t was first provided t h a t addit i o n a l funds, i f needed, should be obtained through stock offered to the
public, and then, finally, i f t h a t secondary source d i d not provide adequate capital funds, stock was to be allotted to the Treasury as a last
resort device.
2. W h o , i n your opinion, owns the surplus of the Federal Reserve
banks ?
Joint answer
The surplus of the Federal Reserve banks belongs to the Federal
Reserve banks and not to their stockholders or to the U n i t e d States.
The surplus of a Federal Reserve bank protects its depositors and
other creditors, and so long as a Federal Reserve bank is a going concern its surplus should continue t o p e r f o r m this n o r m a l function.
Should a Federal Reserve bank be dissolved or go into liquidation, any
surplus remaining after payment of debts, dividends, k n d par value of
its stock becomes the property of the U n i t e d States.
3. D o you consider the Federal Reserve banks t o be p a r t of the U n i t e d
States Government ? P a r t of the private economy ? I f neither,
or p a r t l y one and p a r t l y the other, discuss their status.
Joint answer
A s distinguished f r o m the B o a r d of Governors of the Federal
Reserve System, Federal Reserve banks are not independent establishments of the Government. Federal Reserve banks are "instrumentalities" of the Federal Government. A s such, they act as agents of the
Government i n p e r f o r m i n g Government functions.
There are many kinds of Government instrumentalities. Distinctions may be d r a w n between such instrumentalities of the Government
as (a) private independent contractors w o r k i n g on Government contracts; (b) national banks, w h i c h are w h o l l y p r i v a t e l y owned and
controlled, and are operated f o r private p r o f i t ; (c) Federal Reserve
banks, a l l the stock of w h i c h is privately owned, a m a j o r i t y of the
directors of w h i c h are elected by such stockholders, and w h i c h are
operated (under the general supervision of the B o a r d of Governors of
the Federal Reserve System, an independent establishment of the Government) p r i m a r i l y f o r public and governmental purposes and not
at a l l f o r private p r o f i t ; and (d) the numerous corporations w h o l l y
owned and controlled by the Federal Government and operated entirely
f o r Federal governmental purposes, such as the Reconstruction
Finance Corporation.
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649
I n our opinion Federal Eeserve banks are p a r t i a l l y p a r t of the p r i vate economy and are p a r t of the functioning of the Government (although not technically a p a r t of the Government). Because they are
a p a r t of the functioning of Government the public interest is dominant
i n their policies. They thus carry out the o r i g i n a l intent f o r w h i c h
they were formed w h i c h was to function somewhere between private
enterprise and the Government itself (much closer to the Government
than are national banks, but not so close as are "Government
agencies"). W e believe t h a t i t was an essential p a r t of the intent of
Congress, i n enacting the Federal Reserve A c t , t h a t Federal Reserve
banks should thus be allied to the Government but not be a p a r t of the
Government itself.
Comment of Allan Sproul, Neio York:
[ M r . S p r o u l would substitute the f o l l o w i n g f o r the last paragraph
of the j o i n t answer.]
I n m y opinion Federal Reserve banks are not p a r t of the U n i t e d
States Government nor ar.e they w h o l l y a p a r t of the private economy.
Disregarding the p i t f a l l s of semantics, I would say t h a t i n discharging
their most i m p o r t a n t responsibilities—participation i n the formulat i o n and execution of monetary and credit policy—the Federal Reserve banks are p a r t of the functioning of Government. I n performi n g their duties as fiscal agent, they are instrumentalities of Government. I n the provision of such services as the clearing of checks,
they are p a r t of the private economy. I n the field of monetary and
credit policy, the Government or public interest is dominant and cont r o l l i n g as i t should be. I n the field of fiscal agency operations, the
Federal Reserve banks act as agents of a Government principal. I n
the field of check clearings, and similar operations, the private economy
is served i n the public interest.
I share the belief t h a t i t was the original intent of those who created
the Federal Reserve System, t h a t the Federal Reserve banks should
f u n c t i o n somewhere between private enterprise and the Government.
I believe t h a t i t has been the continuing intent of each succeeding
Congress t h a t the Federal Reserve banks should be allied to Government but not p a r t of Government. I- believe t h a t there has been and
is wisdom i n this segregation. I t has generally protected the Federal
Reserve banks f r o m partisan political pressure; i t has enabled the
Federal Reserve banks to repel the pressure of private interests; and
i t has provided the country w i t h a central banking system staffed by
men who have made central banking a career, and operated the Federal
Reserve banks according to standards of efficiency and service which
compare favorably w i t h the best i n Government undertakings and
private enterprise. I t is significant t h a t there have been no scandals,
no charges of influence peddling, no evidence of favors given and
received, i n connection w i t h the operations of the Federal Reserve
banks.
Comment of R. R. Gilbert, Dallas
A s f u r t h e r evidence i n support of the position t h a t the Federal
Reserve banks are not p a r t of the U n i t e d States Government, I believe
i t is significant t h a t the Congress does not appropriate Government
funds f o r use i n connection w i t h the System's operations; neither does
the System obtain funds f r o m the Government by borrowing. More-
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT650
over, funds required by the B o a r d of Governors of the System f o r
its operation are derived f r o m the Federal Reserve banks and not
f r o m the Government.
4. State the congressional policy directives a p p l y i n g t o the Federal
Reserve banks, c i t i n g appropriate statutes. I n what respects, i f
any, do you believe t h a t these directives should be altered?
Joint answer
T h e f o l l o w i n g are brief references t o statutory provisions w h i c h
i n our opinion may be regarded as congressional policy directives
a p p l y i n g to the Federal Reserve banks or to the Federal Open M a r k e t
Committee, upon which are five representatives of Federal Reserve
banks.
Paragraph 8 of section 4 of the Federal Reserve A c t provides that '
the board of directors of each Federal Reserve bank—
shall administer the affairs of said bank f a i r l y and i m p a r t i a l l y and w i t h o u t
discrimination i n f a v o r of or against any member bank or banks and may,
subject to the provisions of law and the orders of the Board of Governors of
the Federal Reserve System, extend to each member bank such discounts, advancements, and accommodations as may be safely and reasonably made w i t h
due regard f o r the claim^ and demands of other member banks, the maintenance
of sound credit conditions, and the accommodation of commerce, industry, and
agriculture.
I t f u r t h e r provides t h a t each Federal Reserve bank—
shall keep itself informed of the general character and amount of the loans
and investments of its member banks w i t h a view to ascertaining whether undue
use is being made of bank credit for the speculative carrying of or t r a d i n g i n
securities, real estate, or commodities, or for any other purpose inconsistent
w i t h the maintenance of sound credit conditions; and, i n determining whether
to grant or refuse advances, rediscounts, or other credit accommodations, the
Federal Reserve bank shall give consideration to such i n f o r m a t i o n ;
and t h a t (after report and recommendation by the chairman of the
Federal Reserve bank to the Board of Governors) :
Whenever, i n the judgment of the Board of Governors of the Federal Reserve
System, any member bank is making such undue use of bank credit, the Board
may, i n its discretion, after reasonable notice and an opportunity for a hearing,
suspend such bank f r o m the use of the credit facilities of the Federal Reserve
System and may terminate such suspension or may renew i t f r o m time to time.
Subdivision (b) of section 12A of the Federal Reserve A c t provides
t h a t no Federal Reserve bank shall engage or decline to engage i n
open market operations under section 14 of the Federal Reserve A c t
except i n accordance w i t h the direction of and regulations adopted
b y the Federal Open M a r k e t Committee; and subdivision (c) provides
t h a t the time, character, and volume of a l l purchases and sales of
paper described i n section 14 as eligible f o r open-market operations
shall be governed w i t h the view to accommodating commerce and business and w i t h regard to their bearing upon the general credit situation
of the country. Section 14 of the Federal Reserve A c t has the headi n g "Open-market operations" and authorizes Federal Reserve banks
subject to specified conditions and limitations to purchase and sell
cable transfers, bankers' acceptances, bills of exchange, direct and
guaranteed obligations of the U n i t e d States, bonds of the Federal
F a r m Mortgage Corporation, bonds issued under the provisions of the
Home Owners' L o a n A c t of 1933, obligations of States and other
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651
municipalities, obligations guaranteed by the U n i t e d States, acceptances of Federal intermediate credit banks and national agricultural
credit corporations. I n addition, Congress has directed i n section
14 ( d ) that the Federal Reserve banks shall establish discount rates
" w i t h a view of accommodating commerce and business."
A l t h o u g h some of the w o r d i n g of the first p a r t of paragraph 8 of
section 4 of the Federal Reserve A c t reflects concepts of the functioni n g of a central bank at the time the Federal Reserve System was
created, and m i g h t be changed i f i t were w r i t t e n now, we see no compelling need f o r revision of any of these directives. They serve the
purpose, and occasion no difficulties.
W h i l e the Employment A c t of 1946 contains no explicit directive to
the Federal Reserve banks, the stated objectives of that act guide the
consideration of Federal Reserve policy.
Comment of Ray M. Gidney, Cleveland
I t is not clear f r o m the question whether congressional policy directives a p p l y i n g to the Federal Reserve banks is intended by your
committee to refer only t o the extension of credit by the Federal
Reserve System as is apparently assumed i n the answers submitted
to the j o i n t reply. I believe t h a t there should be reference to congressional directives w h i c h give rise t o major activities of the Reserve
banks i n terms of numbers of employees and volume of daily transactions, and result i n Reserve banks p e r f o r m i n g services of great
value to banking, business, individuals, and the Nation.
The preamble of the Federal Reserve A c t states t h a t the purpose is
to " f u r n i s h an elastic currency" and section 16 gives detailed directions as to the issuance of Federal Reserve notes. U n d e r this directive, the Federal Reserve banks supply the currency of the country
and carry on huge d a i l y transactions i n doing so.
Section 16 of the Federal Reserve A c t provides:
Every Federal Reserve bank shall receive on deposit a t par f r o m member
banks or f r o m Federal Reserve banks checks and d r a f t s d r a w n upon any of its depositors, and when remitted by a Federal Reserve bank, checks and drafts drawn
by any depositor i n any other Federal Reserve bank or member bank upon funds
to the credit of said depositor i n said Reserve bank or member bank.
Under this directive and the broader authorization of section 13,
the Federal Reserve banks engage i n huge operations i n collecting and
clearing checks, an invaluable service to the people of the country.
Section 15 of the Federal Reserve A c t requires the Reserve banks to
act as depositaries and fiscal agents of the U n i t e d States upon the direction of the Secretary of the Treasury. T h i s requirement is the
basis f o r a very large, volume of services performed efficiently f o r the
U n i t e d States Government f o r which appropriate reimbursement is
made to the banks by the Treasury.
Note should also be taken of the purpose stated i n the preamble of
the act—
to estabUsh a more effective supervision of banking i n the United States—
and the provision of section 21 relative to the power of the B o a r d
of Governors of the Federal Reserve System and the Federal Reserve
banks t o conduct bank examinations of member banks.
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Delos 0. Johns, St. Louis
[ F o l l o w i n g are M r . Johns 5 comments on the j o i n t answers t o questions under section A . Ownership of the Federal Reserve Banks
and T h e i r Relationship t o the Government.]
M y opinion, w i t h respect to the replies to questions 1, 2, 8, and 4,
coincides w i t h t h a t expressed i n the j o i n t replies prepared under the
direction of a special committee of the presidents of the Federal
Reserve banks to these questions. I wish t o emphasize, hqwever,
certain points w i t h respect to these questions'. M y comment is general and relates mainly to questions 1 and 3.
The p r i m a r y responsibility of the Federal Reserve System is t o influence the supply, cost, and availability of credit w i t h a view to maint a i n i n g f u l l employment, stable values, and a r i s i n g standard of l i v i n g .
H i s t o r y w o u l d seem to indicate t h a t a central b a n k i n g i n s t i t u t i o n has
proved to be the best instrument yet devised f o r influencing the
monetary and credit conditions of a country i n the public interest.
The reasons, distilled f r o m experience, f o r separating i n some measure
Government's participation i n the f o r m u l a t i o n of monetary and credit
policy f r o m the political functions of Government are generally
understood. H i g h on the list of such reasons are the necessity to keep
monetary and credit policies flexible and responsive t o continuously
changing conditions, even t o the point of t r y i n g to foresee changes,
the necessity to preserve continuity and u n i t y i n these policies, and
the need t o m a i n t a i n nonpartisan objectivity i n their determination.
T h i s concept involves considerations w h i c h i n some respects resemble
those u n d e r l y i n g the separation of the j u d i c i a l branch f r o m the pol i t i c a l branches of Government.
T h i s is not to argue that the central bank should be so independent
of the several branches of Government as to destroy the u n i t y of
Government. I n a democracy, monetary policy cannot be made i n
disregard of the opinion of Government elected by the people. I n the
U n i t e d States where the monetary authority is responsibile to the
legislative branch, such obviously cannot long be the case. W h a t is
meant by independence on the p a r t of the central bank is its nonpartisan approach and its freedom to make appropriate decisions as
to national monetary and credit policy i n the l i g h t of broad economic
considerations. T h a t independence t o make policy is subject to broad
veto power on the p a r t of the legislative branch.
The principle of this k i n d of independence f o r the central bank
apparently was i n the minds of the framers of the act when the
System was begun almost 40 years ago. T h e American approach to
constitutionalism involves l a y i n g down certain broad principles and
then attempting t o w r i t e into law and b r i n g into practice certain
specific safeguards f o r those broad principles. T h e legal f o r m set
up f o r the central bank and subsequent modifications i n the f o r m were
designed to safeguard t h a t broad principle of independence.
A m o n g such safeguards are provisions f o r 14-year terms f o r the Governors, f o r stock ownership by the member banks, and other like
requirements. The regional characteristics of the System and the
forms of regional representation have been b u i l t into the act. A l l of
these steps and others were merely devices to insure the k i n d of independence i n the central bank t h a t the Congress' believed desirable.
Insurance t h a t the public interest w o u l d be served was provided by
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fixing responsibility of the Federal Reserve System to the Congress,
but i n such a way as to insure at the same t i m e the System's nonpartisan approach. These provisions' seem to have served their purposes p r e t t y well and I do not believe they should be changed.
I wish to emphasize the fact that, while the Federal Reserve banks
are not Government agencies i n the legal or technical sense, they are
regional elements i n the Federal Reserve System and as such are responsible to the Government t h r o u g h the direct responsibility of the
Board of Governors to the Congress. W i t h o u t question the System
i n its entirety is a public i n s t i t u t i o n operated i n the public interest
and responsible to the public.
B. ORGANIZATION OF T H E FEDERAL RESERVE BANKS
5. Describe the role of the presidents and the boards of directors of
the Federal Reserve banks and of the B o a r d of Governors i n the
management of the Reserve banks.
Joint answer
The Federal Reserve A c t provides t h a t each Federal Reserve bank
is to be controlled and supervised by its board of directors. Certain
actions of the bank boards, however, are subject to the control vested
by law i n the B o a r d of Governors of the Federal Reserve System.
T h e directors of a Reserve bank p e r f o r m the duties usually appert a i n i n g to the office of directors of banking associations and a l l such
duties as are prescribed by statute. The board of directors prescribes
the bylaws under w h i c h the bank's general business is conducted and
its privileges are exercised. I t has the responsibility of determining
the management policies of the bank. I t appoints the officers of the
bank, defines their duties, bonds, and i n some cases tenure, and, subject
to the approval of the B o a r d of Governors, fixes their compensation.
The president and first vice president are appointed w i t h the approval
of the Board of Governors f o r terms of 5 years. A l l appointees by
the board of directors are subject to dismissal. B y statute any officer
or director of the bank may be suspended or removed by the B o a r d
of Governors.
' The directors have a continuing responsibility f o r obtaining and
m a i n t a i n i n g management personnel of the necessary quality to make
possible efficient, progressive, and economical operations, careful analysis of information, and expert counsel f o r the board of directors, the
Board of Governors, and the Open M a r k e t Committee.
The directors have a special responsibility f o r m a i n t a i n i n g and
supervising the internal a u d i t i n g system of the Reserve bank. They
appoint the auditor who conducts an independent and continuous
audit of the accounts of the banks. The auditor reports directly to
the a u d i t i n g committee of each bank's board of directors. T h e directors share w i t h the B o a r d of Governors the responsibility f o r reviewing
annual budgets of the banks.
The chairman of the board of directors presides at a l l meetings, and
i n his absence his powers are executed and duties performed oy the
deputy chairman. The chairman of the board of directors is also
designated as Federal Reserve agent and as such has administrative
duties i n connection w i t h the issuance of Federal Reserve notes. The
chairman of the board is appointed by the B o a r d of Governors as
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT654
is the deputy chairman. The chairman is the official representative
of the B o a r d of Governors at the bank.
T h e board of directors or its executive committee meets at least f o r t n i g h t l y t o review banking and business conditions and t o pass upon
discounts and advances, discount rates, or any other matters r e q u i r i n g
consideration or action. ,
The directors of a Reserve bank share a broader public responsib i l i t y t h a n their counterparts i n the ordinary banking association.
T h i s responsibility extends beyond the banking field to the broad
interests of commerce, industry, agriculture, and the whole economy.
I n the conduct of the bank's affairs, the directors must administer
f a i r l y and i m p a r t i a l l y w i t h o u t discrimination i n favor of or against
any member bank or banks. Discount rates, although established
i n the first instance by the directors, take into account credit policies
of the System as a whole, and are subject to review and determination
by the B o a r d of Governors.
The Federal Reserve A c t requires t h a t each Federal Reserve bank
must keep itself informed on the general character and amount of
loans and investments of its members w i t h a view to ascertaining
whether undue use is being made of bank credit f o r speculative purposes or other purposes inconsistent w i t h the maintenance of sound
credit conditions. The board of directors is required t o give consideration to such i n f o r m a t i o n i n extending or refusing to extend
credit, and the chairman of the board must report to the B o a r d of
Governors cases of undue use of bank credit w i t h his recommendations. I n practice this is usually delegated to the internal management of the bank and is reviewed by the board of directors.
T h e president is the chief executive officer of the bank and actual
manager of the bank as a w o r k i n g mechanism, and he is directly i n
charge of the bulk of relationships between the bank and its members.
I n his absence, the first vice president acts i n his place. B o t h officers
i n their managerial duties are subject to the supervision and control
of the board of directors. A l l executive officers and a l l employees
are directly responsible to the president.
T h e president has general supervision and direction of policy of
the bank i n effectuating the regulations of the B o a r d of Governors
and the Open M a r k e t Committee on major matters of System policy,
and over the administration of these policies i n the district.
Officers responsible to the president exercise general supervision
over discounts, collections, clearings and transfers, examination of
State member banks, and, i f necessary, other member banks; apply
f o r Federal Reserve notes and provide the security to be pledged
against them as may be necessary f o r the general requirements of
the b a n k ; supervise the participation of the bank i n the open market
account, and manage personnel. They p e r f o r m fiscal agency functions f o r the Government; collect, assembl, and analyze pertinent
economic i n f o r m a t i o n and statistics; and carry out other duties of
an administrative and operating sort related to the business and
affairs of the bank.
T h e president communicates w i t h member banks on matters of
policy and administration affecting them and is also responsible f o r
developing ways and means of i m p r o v i n g services rendered to member banks, the banking community, and through them to the gen-
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
655
eral public. H e participates i n discussions at meetings of the president's conference held to exchange i n f o r m a t i o n and to coordinate, to
the necessary extent, the internal administration of the banks and
the application of policies. The presidents meeting j o i n t l y w i t h the
B o a r d of Governors help to formulate System policies and methods of
implementing them.
The B o a r d of Governors of the Federal Reserve System, as noted
above, has important powers concerning the internal administration
and operation of the Federal Reserve banks. Some of these powers
are direct, some of a supervisory nature, and others of a coordinating
character.
A m o n g the more i m p o r t a n t powers of the B o a r d of Governors concerned w i t h internal administration of the Reserve banks are the
following:
Examination of the Reserve banks.
A p p r o v a l of operating budgets.
A p p r o v a l of compensation of i n d i v i d u a l officers and the staff
salary classification system.
A p p o i n t m e n t of the class C directors, one of whom is designated
chairman and Federal Reserve agent.
A p p r o v a l of appointment of president and first vice president.
R i g h t to remove officers or directors of the banks f o r cause.
Review and determination of discount rates set by directors.
Definition of paper eligible f o r rediscount.
R i g h t to require inter-Reserve bank rediscounting.
P e r m i t or require establishment or closing of branches or
agencies.
R i g h t to w i t h h o l d issues of Federal Reserve notes.
R i g h t to impose interest charges on Federal Reserve notes.
A u t h o r i z a t i o n and approval of arrangements made and r i g h t
of participation i n transactions and relationships w i t h foreign
central banks and governments.
Setting the terms and conditions under which selective credit
control regulations and operating regulations are t o be administered.
Requiring Federal Reserve banks t o f o l l o w certain standard
practices i n dealing w i t h member banks.
I n i t i a t i n g , i n some instances, changes i n services offered member
banks.
A p p r o v a l of the appointments of the officer i n charge of examinations and of examiners.
The management of the Reserve banks thus is subject t o the influence
of both the local boards of directors and the central body, the B o a r d of
Governors. The method of organization of the Federal Reserve System, i n which some powers have been given to a central agency, some
to the regional banks, and some to a combination of the two, provides
room f o r i n i t i a t i v e and imagination i n the f o r m u l a t i o n and administ r a t i o n of System policies, and contributes t o w a r d a better understandi n g of System policies and problems.
Comment of Ray M. Gidney, Cleveland
I am i n agreement w i t h the j o i n t answer but w o u l d l i k e t o add to
the list of duties of directors the f o l l o w i n g :
1. A p p o i n t m e n t of f o u r of seven directors of branches.
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT656
2. Election of member and alternate member of the Federal
Open Market Committee as specified by law.
3. Appointment of industrial advisory committee to advise
the officers and directors on applications for industrial loans under
the provisions of section 13b.
4. Appointment of a member of the Federal Advisory Council.
5. Appointment of the chairmen of the boards of directors at
the branches.
6. Making of recommendations to the Board of Governors on
applications for fiduciary powers of national banks.
7. Making of recommendations to the Board of Governors on
applications for voting permits of holding company affiliates.
The agenda of two directors' meetings at this bank are attached with
the thought that they may give an idea of the duties, responsibilities,
and practices of the directors of the Federal Eeserve Bank of Cleveland as they are met with in the course of current operations. (Exhibits A and B.)
EXHIBIT
A
F E D E R A L R E S E R V E B A N K OF C L E V E L A N D — M E E T I N G OF B O A R D OF D I R E C T O R S ,
J A N U A R Y 11, 1951, 9 : 4 5 A . M .
ORDER O F B U S I N E S S
1. Executive session (directors).
(a) Appointment of officers.1
2. Minutes of meetings (summaries i n folders).
(a) Board of directors, December 14, 1950.
(b) Executive committee, December 28, 1950.
3. Report of chairman ( M r . B r a i n a r d ) .
(a) Announcements.
4. Resolution—retirement of Mr. A. Z. Baker ( M r . B r a i n a r d ) . 1
5. Appointments ( M r . B r a i n a r d ) .
(a) Executive committee for 1951.1
(b) Standing committees, board of directors, 1951.1
(c) Federal Open Market Committee, member and alternate, year beginn i n g March 1, 1951.1
(d) I n d u s t r i a l advisory committee, year beginning March 1, 1951.1
6. Correspondence f r o m Board of Governors ( M r . Gidney).
7. A n n u a l statement, 1950 (Mr. Gidney).
8. Report of the officers (Mr. Gidney).
9. Retirement plan, change of rate of contribution (Mr. Gidney). 1
10. Personnel matters ( M r . M o r r i s o n ) .
(a) Salary adjustments effective February 1, 1951.1
(b) Salary adjustments made December 1,1950, December 16,1950, and
January 1, 1951.1
(c) Changes i n salary-adjustment schedule effective January 1, 1951.1
id) Graduate schools of banking. 1
(e) Four-month leave of absence—31-year employee.1
( / ) Leaves of absence.
(g) Report of separation wages paid d u r i n g 1950.
(h) Report of operations of confidential funds, 1950.
( i ) Personnel report for 1950.
11. Report of audit review committee ( M r . B a i n e r ) .
12. Statement of investments ( M r . Fletcher).
(a) Loans and discounts.
(b) Regulation V and industrial loans.
13. Cincinnati branch, management agreement, Robert A. Cline, Inc. ( M r . Fulton). 1
14. Pittsburgh branch, lease of vault space ( M r . Kossin). 1
15. Preliminary comparison of expenses w i t h budget for 1950 ( M r . L a n i n g ) .
16. Assessment, Board of Governors' expenses ( M r . Laning). 1
1
Presented for action by directors.
MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT
17.
18.
19.
20.
21.
657
F i r e insurance, renewal of ( M r . Clouse).
Report on bank and public-relations activities ( M r . Clouse).
Report on open-market operations ( M r . Hostetler).
"Price control i n 1951" ( M r . Cutler).
Discount and interest rates ( M r . Gidney). 1
EXHIBIT
FEDERAL
RESERVE
BANK
OF
B
CLEVELAND—MEETING
SEPTEMBER 13, 1 9 5 1 — 9 : 3 0
A.
OF
BOARD
OF
DIRECTORS,
M.
1. Minutes of meetings (summaries i n folders).
(a) Board of directors, August 9,1951.1
(&) Executive committee, August 23,1951; September 6,1951.1
2. Report of chairman ( M r . B r a i n a r d ) .
(a) Announcements.
3. Correspondence f r o m Board of Governors ( M r . Gidney).
4. Report of the officers ( M r . Gidney).
5. Reports of committees.
(a) Personnel committee ( M r . V i r d e n ) .
(1) Salary adjustments. 1
(2) Leaves of absence.
(3) Employees, obligation reports.
(&) Budget committee ( M r . Bowlby).
(1) Expense budget 1952.1
(c) Research committee ( M r . S t i l w e l l ) .
6. Statement of investments ( M r . Fletcher).
(a) Loans and discounts. 1
(&) Advances and commitments under section 13b of the Federal Reserve Act. 1
(c) Foreign loan, Banque Centrale de la Republique de Turquie. 1
(tf) Regulation V loans.
7. Report on open market operations (Mr. Thompson)
8. Report of Pittsburgh branch chairman (Mr. Burchfleld).
9. Report of Cincinnati branch chairman ( M r . Cramer).
10. "Boom, Bust, or P h f f t " ( M r . Thompson).
11. Discount and interest rates ( M r . Gidney). 1
12. Remarks by Governor Powell.
13. Discussion of matters of public interest (directors).
14. Adjournment. 1
Comment of R.R. Gilbert, Dallas
A n additional important responsibility of the boards of directors
of the Federal Eeserve banks is their selection of a Federal advisory
councilman to represent their respective districts.
I believe that greater emphasis also should be given to the responsibility of the boards of directors of the Federal Eeserve banks with
respect to budgetary control of expenses than is given in the answer
to this question. The broad business and professional experience of
the directors is a very valuable asset to the System in connection with
the directors' study of the banks' budgets and control of expenditures,
as well as in many other respects. Budgetary views of the directors
are influenced to some extent by many of the same principles of conservative budgeting that are essential for the successful operation of
a private business. This tends to minimize waste and to promote efficiency in the Eeserve banks. Although final approval of the budgets
1
Presented for action by the directors.
98454-—52—pt. 1 40
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT658
of the Reserve banks rests with the Board of Governors of the System,
it should be emphasized that most careful and conservative consideration has been given by the banks' directors to the budgets before
submission to the Board of Governors.
6. State the qualifications required for election as class A and class B
directors of the Federal Reserve banks, and the method of electing
such directors. Include in your description both qualifications
and procedures prescribed by statute and those established by
customary usage, distinguishing between them when necessary.
Joint answer
Section 4 of the Federal Reserve Act provides that each Federal
Reserve bank shall be conducted under the supervision and control
of a board of directors consisting of nine members holding office for
3 years and divided into classes A, B, and C. Class A consists of three
members who are chosen by and are representative of the member
banks. Class B consists of three members chosen by the member banks
who at the time of their election are actively engaged in their district
in commerce, agriculture, or some industrial pursuit. Class C consists of three members appointed by the Board of Governors of the
Federal Reserve System.
No officer or director of a member bank is eligible to serve as a
class A director unless nominated and elected by banks which are
members of the same group as the member bank of which he is an
officer or director.
No director of class B may be an officer, director, or employee of
any bank. No director of class C may be an officer, director, employee, or stockholder of any bank. Thus the majority of each board
is made up of persons having no affiliation with banks.
Directors of class C at the time of their appointment must have been
residents of the district from which appointed for at least 2 years.
One of the class C directors is designated by the Board of Governors
as chairman and as Federal Reserve agent, and another class C director
is designated as deputy chairman. No Member of Congress may be
an officer or a director of a Federal Reserve bank.
The class A and B directors are elected according to a special plan
designed to prevent domination of the electoral procedure by any
group. The Board of Governors classifies the member banks of the
district into three general groups, each of which is designated by
number. Each group consists as nearly as m$y be of banks of similar
capitalization, and elects one class A and one class B director. Generally, group 1 contains the largest banks of the district, group 2
the middle-sized banks, and group 3 the smaller banks. Each member bank of the group then electing is permitted to nominate to the
chairman of the board of directors of the Federal Reserve bank of
the district one candidate for director of class A and one candidate
for director of class B. A list of the candidates so nominated is prepared, indicating by whom nominated, and a copy of this list is furnished to each member bank by the chairman within 15 days after
completion. Each member bank by a resolution of its board of directors or by amendments to its bylaws authorizes its president,
cashier, or some other officer to cast the vote of the member bank in
the elections of the class A and class B directors. Whenever two or
MONETARY POLICY AND MANAGEMENT OF PUBLIC
t)EBT
659
more member banks within the same Federal Eeserve district are
affiliated with the same holding company, participation by such member banks in any such nomination or election is confined to one of
such banks, which may be designated by the holding-company affiliate
for the purpose.
Within 15 days after receipt of the list of candidates, the duly authorized officer of a member bank of the group then electing certifies
to the chairman of the board of directors of the Federal Eeserve bank
of the district his first, second, and other choices for director of class A
and class B, respectively, upon a preferential ballot furnished by the
chairman. Each such officer makes a cross opposite the name of the
first, second, and other choices for a director of class A and for a
director of class B but cannot vote more than one choice for any one
candidate.
Any candidate having a majority of all votes cast in the column
of first choice is declared elected. I f no candidate has a majority
of all the votes in the first column, then the votes cast by the electors
for each of the candidates in the second column and the votes cast
for each of the candidates in the first column are added together.
The candidate then having a majority of the electors voting and the
highest number of combined votes is declared elected. I f no candidate has a majority of electors voting and the highest number of
votes when the first and second choices have been added, then the
votes cast in the third column for other choices are added together
in like manner, and the candidate then having the highest number of
votes is declared elected. A n immediate report of election is declared.
Vacancies that may occur in the several classes of directors of Fed-*
eral Eeserve banks may be filled in the manner provided for the original selection of such directors. Such directors hold office for the unexpired terms of their predecessors.
On three occasions the Board of Governors has ruled concerning
the eligibility of certain persons for election to a Eeserve bank board,
and the Attorney General has ruled in this connection on one occasion.
On December 23, 1915, the Federal Eeserve Board 1 adopted a resolution which read in part:
I t is the opinion of the Federal Reserve Board that persons holding political
or public office i n the service of the United States, or of any State, T e r r i t o r y ,
county, district, political subdivision, or municipality thereof, or acting as
members of political p a r t y committees, cannot, consistently w i t h the s p i r i t
and underlying principles of the Federal Reserve Act, serve as directors or
officers of Federal Reserve banks.
Under date of July 2,1925, the Federal Eeserve Board advised that
it had
reached the conclusion t h a t a person whose sole occupation is t h a t of officer of an
insurance company is not eligible f o r election as a class B director of a Federal
Reserve bank—
and, similarly, the Board ruled on October 18, 1939, that a person
whose sole occupation is that of president of a Federal savings and
loan association is not eligible for election and service as a class B
director.
1
Under sec. 203 (a) of the Banking Act of 1935, the Federal Reserve Board is now
known as the Board of Governors of the Federal Reserve System.
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT660
I n a letter dated March 4,1926, the Attorney General expressed the
opinion that mutual savings banks are banks within the meaning of
section 4 of the Federal Reserve Act prohibiting directors of class B
and class C from being officers, directors, or employees of any bank.
The Board of Governors has also ruled on the procedure of nominating and voting for directors. On October 27,1920, the Federal Reserve
Board declared that it is optional with the member banks whether they
shall nominate candidates for class A and class B directors, but under
the terms of the law it is mandatory for each member bank to empower
some officer to cast its vote in the election of directors.
I n some districts it has become the practice for member banks to
form committees whose purpose is to suggest nominees. I n other
districts committees of State bankers' associations may suggest candidates. I n still others the stockholding member banks have formed
associations, one of whose functions is to suggest nominees. I n some
districts, including the ninth, no such groups are formed for the
purpose of suggesting nominees, and in all districts any bank can make
nominations in accordance with the procedures outlined above.
Comment of JosephA. Erichson, Boston
I n the first Federal Reserve district the member banks have formed
the stockholders advisory committee, which has been in continuous
existence since 1923. This committee, composed of seven members,
is elected each year. Two members are elected by the member banks
present at the annual convention of the Massachusetts Bankers' Association, and one member each by the member banks present at the annual conventions of the State bankers' associations of the other five
New England States.
This committee annually appoints a committee on Reserve directors
of seven members each to present to member banks of the group participating in the regular election of class A and class B directors of
the bank to be held that year recommendations of one or more names
for the directors to be elected. Thus, one committee is appointed
for group 1 banks (capital and surplus of more than $1,800,000) in
the year in which group 1 banks elect a class A director or class B director, one for group 2 banks (capital and surplus of $400,000 to $1,800,000, both inclusive) in the year in which group 2 banks elect a class A
director or class B director, and one for group 3 banks (capital and
surplus of less than $400,000) in the year in which group 3 banks elect
a class A director or class B director. The membership of each committee on Reserve bank directors is made up of two members from
Massachusetts and one from each of the other New England States.
Similar recommendations are made by the appropriate group committee whenever special elections are held to fill vacancies occurring
in the class A and class B directorships.
Comment of Alfred H. Williams,
Philadelphia
I n the third Federal Reserve district a nominating advisory committee was created in 1923 to stimulate interest in the election of
directors and to recommend qualified persons for nomination. I n
operation, the committee is divided into three subcommittees, one for
each electoral group: Large, medium, and small member banks. Each
of the groups of the Pennsylvania Bankers Association having territory in this district, the Delaware Bankers Association, and the New
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
661
Jersey Bankers Association appoints one member to each of these
subcommittees. Prior to an election, the members of the appropriate
subcommittee canvass the member banks for suggestions as to possible
candidates. The subcommittee then meets to review the suggestions
and to recommend a candidate or candidates to the member banks in
its group. As its name implies, the functions of the committee are
purely advisory. Actual nominations are made by the member banks.
Comment of Hugh Leach, Richmond
There is no distinction between the qualifications required for election as class A and class B directors prescribed by statute and those
established by customary usage in the fifth Federal Reserve district.
However, a procedure peculiar to the district is followed in the nomination and election of such directors by the three general groups of
member banks prescribed by statute.
The fifth Federal Reserve district is composed of the States of
Maryland, Virginia, North Carolina, and South Carolina, all of West
Virginia except six counties in the northern panhandle, and the District of Columbia. Since the member banks in the district had to
elect six directors prior to the opening of the bank, they arranged to
hold a conference in Richmond of representative bankers from these
six geographical divisions on May 18, 1914, approximately 6 months
before the bank was opened. Representatives of 210 member banks
were present at the conference, at which it was decided to appoint a
committee of 18 (3 from each of the 6 geographical divisions) to consider the question of nominations and the adoption of some method to
insure a satisfactory distribution of representation among the 6 divisions. This committee recommended that one director be elected from
each of the six geographical divisions and that the nominees of group
1 banks be a class A director from Maryland and a class B director from
Virginia; of group 2 banks, a class A director from North Carolina
and a class B director from South Carolina; and of group 3 banks, a
class A director from West Virginia and a class B director from the
District of Columbia.
The recommendations of the committee were unanimously adopted
by the conference and it was ordered that the action of the conference
be formally reported to all member banks in the district. The agreement thus arrived at voluntarily by member banks of the district
before the Federal Reserve bank was opened has been adhered to
continuously from the beginning.
Comment of J.N. Peyton, Minneapolis
I n some districts it has become the practice for member banks to
form committees whose purpose is to suggest nominees. I n other
districts committees of State bankers' associations may suggest candidates. I n still others the stockholding member banks have formed
associations, one of whose functions is to suggest nominees. I n some
districts, including the Ninth, no such groups are formed for th<j
purpose of suggesting nominees and in all districts any bank can
make nominations in accordance with the procedures outlined above.
Comment of C. E. Earhart, San Francisco
I n connection with the concluding paragraph of the joint reply
there are no formal committees or associations of twelfth district
member banks that suggest candidates for director. Any consulta-
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT662
tions among banks that occur are informal and are initiated by banks
that may be interested in particular individuals as possible nominees.
7. Do you believe that all the directors of the Federal Eeserve banks
should be chosen as public representatives rather than as representatives of specified groups ? I f so, how should they be chosen ?
I f representation of specified groups is to be continued, do you
believe that labor should be added to the groups represented?
I f so, how should the labor representatives be chosen?
Joint answer
The class A and class B directors, although not designated or familiarly referred to as public representatives, are in fact such representatives. A l l classes of Eeserve bank directors may be considered and
consider themselves to be trustees of the public interest. The directors of the Federal Eeserve banks are chosen for their competence to
render a service to the Eeserve banks and through them to the public.
The unique character of the Federal Eeserve System in its operation
for the benefit of the whole economy imposes upon directors in each
class a special public responsibility which extends beyond the banking
field to the broad interests of all economic groups. The public nature
of the Eeserve System is well illustrated in its functions and services
and the absence of the profit motive, but with regard for maximum
efficiency, in its operations.
I n the case of class A directors who "are chosen by and are representative of" the member banks, their specialized professional experience and advice is helpful in connection with the improvement of technical operations and the overseeing and management of banking functions performed by the Eeserve banks. Their professional experience
and advice is helpful in judging the impact of broad policy decisions
affecting the supply and cost of money and credit. Their knowledge
of local conditions provides valuable sources of economic information
for guidance in making policy decisions, and their standing in their
communities provides local support for the Eeserve System and helps
to widen public understanding of the functions of the Federal Eeserve
System and of the purposes of its policy actions.
Class B directors are chosen from those actively engaged in their
districts in commerce, agriculture, or some other industrial pursuit.
Their point of view reflects that of the commercial bank customer
which complements and balances the point of view of the bankers
on matters apart from technical phases of operation. Just as the
class A directors may be expected to be familiar with the problems of
lenders, so the class B directors may be expected to be familiar with
the problems of borrowers. The class B directors, like those of class
A and class C, are a* local source of information about the System
and its function.
No group of banks can dominate the Federal Eeserve banks' boards
of directors. While each member bank has one vote for one class A
director and one vote for one class B director, irrespective of its size,
the group classification prevents small, medium, or large banks from
electing all six of the A and B directors and insures roughly equal
representation of banks of differing size.
Class C directors appointed by the Board of Governors are usually
men of standing in their communities—public-spirited individuals,
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
663
serving because of a sense of community responsibility. (The occupational groups from which the present directors have been drawn
are listed in the answer submitted by the Chairman of the Board of
Governors to question 9 addressed to him by the subcommittee.)
A t all Eeserve banks, a broad cross section of the public has always
been represented on the boards of directors. The distribution of representation of various groups has differed from district to district
but this has reflected the distinctive economic characteristics of the
districts. The word "representation" should not be construed to
mean that the directors come to meetings as the instructed delegates
of a constituency. I n fact, the tradition has become established that
in acceptance of a directorship the individual puts aside the narrow
interest of any one group and serves the public generally.
I n discharge of their statutory duties at the Eeserve banks, it is
essential that the banks' boards continue to include in their composition men experienced in the techniques of banking, both as lenders
and as borrowers and aware of the impacts of credit policy upon our
economy. The prescription for board composition at the present time
is diversified enough to reflect the public interest. I t would permit
the appointment by the Board of Governors of a labor man if that
were desirable on grounds other than occupational classification or
group representation alone. Further definition of occupational classifications, or repeal of present occupational designations, would risk
destruction of the present balance and might fail to recognize the
background against which the Eeserve banks operate, causing confusion and misunderstanding which would more than offset any theoretical gains.
The Federal Eeserve Act does not call for representation of organized groups as such on the boards of directors; rather, it is based on
the concept that those able to serve the Eeserve banks because of experience or training will aid in developing a more effective administration of the banks, and thus make the banks more useful instruments
to the community and to the Nation. Credit policy is determined
and finally made by the System's central bodies—the Federal Open
Market Committee and the Board of Governors. I t is the decisions
of these groups that influence monetary and credit conditions which
are of greatest importance to labor, capital, agriculture, and business,
rather than the decisions made by the individual Eeserve banks' boards
of directors. The interests of the public generally are now represented on the banks' boards and we do not favor a change designed
to encourage representation of the narrow interest of any particular
group.
Comment of C. E. Earhart, San Francisco
The joint replies, as set forth in section I , to questions 5 and 7 do
not describe the role of branch directors. Each of the four branches
of the Federal Eeserve Bank of San Francisco has a board of directors
consisting of five members; three branch directors are appointed by
the district board of directors at San Francisco and two by the Board
of Governors. One of the Board of Governors' appointees is designated by the district board as chairman of the branch board of directors. Chairmanship designations have usually been on an annual
rotation basis. While there are no occupational or other requirements
governing the appointment of branch directors, it is the practice of
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT664
this banks' directors to appoint bankers, and of the Board of Governors to appoint men in other fields who are not officers or directors
of commercial banks.
The benefits obtained from this composition of the branch board
are essentially the same as those discussed in the answer to question 7
with respect to class A and class C directors of Federal Reserve banks.
Through the branch boards, further participation is obtained in
System affairs by men of particular competence in the field of banking, and men, other than bankers, who are public-spirited men of
standing, all with intimate knowledge of business conditions in their
branch zone.
The role of the branch boards in management is to quite an extent
advisory. The officers of the bank and the San Francisco directors
obtain valued counsel and recommendations of branch boards on
various matters affecting the branches and on questions relating to
bank and System administration and policy. Thus, additional "grassroots" experience and advice are made available with respect to the
conduct of this bank and the System as a whole, on the one hand, and
additional local understanding of the System's purposes and functions
is obtained, on the other.
Delos G. Johns, St. Louis
[Mr. Johns submits the following comments on the joint answers to
questions under section B. The Organization of the Federal Reserve
Banks]
I concur completely in the joint replies of the special committee of
the presidents of the Federal Reserve banks to questions 5, 6, and 7.
I might point out that with respect to the eighth Federal Reserve
district, nominations for the bank-elected directors follow precisely
the provisions of the Federal Reserve Act. There are no formal committees of member banks or of State bankers' associations which exist
for the purpose of nominating directors for the St. Louis bank.
Nominations are made by informal and ad hoc groups of banks or
by individual banks as a desire to see a particular individual serve on
the bank board arises.
I might note further that it has become the practice in recent years
for St. Louis bank class A and B directors elected by the large banks
to serve no more than two terms. This is not an unchanging custom
but a matter for joint determination of the individual director and
the nominating and electing banks. There is no definite practice with
respect to length of service for the class A or B directors elected by
the medium-sized and small banks.
I wish to emphasize two points with respect to the boards of directors of the Federal Reserve Bank of St. Louis and its branches. I am
sure these comments apply equally to the directors of the other Reserve banks and branches. First, the men who have served and are
serving on the St. Louis bank board and the three branch boards have
been of unfailing help in providing judgment and counsel to the internal management of the bank and branches, fostering understanding of and good working relations for the Federal Reserve System in
the eighth Federal Reserve district, and providing helpful information and opinion as background for the St. Louis bank's participation
in the shaping of national monetary policy. There is little question
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in my mind that the management of the bank, the strength of the
Federal Reserve System in general, and the formulation of monetary
policy benefit from their presence.
The second point I wish to emphasize is brought out in the joint
reply to question 7. A l l of the members of the St. Louis bank or
branch boards serve as public members. They bring to the St. Louis
bank and branches wide experience in public affairs, intimate knowledge of district conditions, and, in the case of the bankers, specific
knowledge of technical credit problems. None of the directors serves
as the representative of a special group. An industrialist on our board
does not consider himself the representative of industrial interests
but rather as a director who is in a position to provide counsel with
respect to business-management practices and to the general course of
business developments. A farmer who serves on our board considers
himself as a director with a knowledge of agriculture but not as a
specially instructed representative of agriculture. The same is true
for the bankers. A l l of the class A and B directors are just as much
public members as are the class C directors.
As I see it, there is no reason why a labor man should not serve on a
Federal Reserve bank or branch board. However, he should serve as
a public member acquainted with labor problems, practices, and conditions, and not as an instructed representative of organized labor as
such.
c. DISTRIBUTION W I T H I N T H E FEDERAL RESERVE SYSTEM OF A U T H O R I T Y ON
CREDIT POLICIES
8. Discuss the extent to which it is possible to maintain regional credit
policies differing from national credit policies. Who is responsible for the formulation of such policies and what are the instrumentalities by which they can be maintained ?
Joint answer
The Federal Reserve System does not attempt to formulate and
maintain regional credit policies which differ from national credit
policies. Rather, it attempts to take regional considerations into
account in developing national policy and to adapt that policy to local
conditions.
I t is chiefly through the Federal Open Market Committee on which
five presidents of the Federal Reserve banks and the seven members of
the Board of Governors serve that national credit policy is formulated
and implemented. Thus is provided a body for centralized decisionmaking on credit policy in which is reflected the thinking of people
from all regions of the country. Diverse viewpoints and opinions are
brought together and welded into a national policy.
The application and adaptation of national policy to local conditions
is achieved in the Federal Reserve System through the presidents and
officers of the Federal Reserve banks and their boards of directors.
Examples may be found in the administration of loans to member
banks, the administration of consumer credit and real estate credit
regulations, direct or guaranteed loans to business, and guaranteed
loans to defense contractors. Additionally, the voluntary credit restraint program, which was developed largely under the aegis of the
Federal Reserve System, illustrates the feasibility of adapting gener-
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT666
alized guiding principles to local conditions. I n each of the areas
mentioned the Federal Reserve banks follow the over-all policy which
has been developed with their participation.
When the Federal Reserve System was started, regional differences
in credit policy were emphasized. The improvement in facilities
for transferring funds and the increasing interdependence of the
various districts brought about a gradual lessening of regional differences and the System's experience led to an increasing awareness
of the need for a more unified credit policy. The present System organization, which has evolved from experience, provides for the establishment of central banking policy on a national basis. A t the same
time it provides the means whereby the policy can be adapted or
modified to meet the needs of regional conditions. A t times there
may be local situations which may call for local action to restrain bank
financing of speculative or other unhealthy developments through
discount policy or bank supervisory policy, which situations can be
handled within the framework of general System policies. Similarly,
there may be special needs' for credit in particular localities which
likewise can be met by the regional Reserve banks within the over-all
policies of the System. The present organization provides the best
assurance that the existence of such needs will be quickly recognized.
The procedures followed in the formulation and administration of
Federal Reserve credit policy stand in sharp contrast with any centralized determination of policy in which participation of regional
representatives is absent and in which administration also is centralized.
The processes by which policy is determined, implemented, and administered under the Federal Reserve System are a unique embodiment of the political, economic, and social traditions built up in this
country.
9. Describe the role played by the boards of directors and the presidents of the Federal Reserve banks in the formulation of national
credit policy.
Joint answer
I n the determination of national credit policy the directors of the
Federal Reserve banks act directly and formally only on discount
rates, subject to review and determination by the Board of Governors, and on requests for opinions received from the Board of Governors. I n addition, they contribute informally or indirectly in the
formulation of the entire range of credit policy. They do so, from
time to time, by communicating with the Board of Governors, and
by expressing to the presidents of the Reserve banks their impressions and opinions on economic developments and on desirable credit
policy in the light of those developments.
The presidents thus have the benefit of the views of the boards
of directors' which they are able to utilize in developing their own
views which they present in the Federal Open Market Committee and
in discussions with the Board of Governors. They also have the
benefit of economic information and analysis furnished by the research departments of the Reserve banks, as well as the advice of
Reserve bank operating officers based on their direct experience in
administering credit policies.
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I t should be noted that the presidents as members of the Open
Market Committee do not go to meetings of the Committee with specific instructions from the boards of directors of the Federal Reserve
banks, for in that capacity the presidents act as individual members of
the committee. They do not reveal to their boards of directors policy
actions that are to be considered at forthcoming meetings of the committee, and they do not report to the directors concerning the decisions made by the Committee until those decisions are public information. Thus, although the informed judgments of the directors are
obtained concerning the broad characteristics of economic developments and the desirable direction of open market policy, and although
the directors are in a position to help broaden the public understanding of policy decisions taken, the directors are not given access to
confidential information about open market policy.
I t is in meetings of the Open Market Committee that lines of
thought from two directions converge to form national credit policy,
as far as the Federal Reserve System is concerned. The one flows
from banking, business, and the general public in the various regions
of the country through the presidents of the Reserve banks. The
other flows from the Board of Governors of the Federal Reserve
System. Each member of the Committee, with statutory responsibilities for the determination of national credit policies, brings* to the
deliberations of the Committee the sum total of his knowledge and
experience.
The Board of Governors before reaching decisions on important
matters usually consults with the presidents of the Reserve banks.
These consultations take place either informally, in meetings of the
Federal Open Market Committee, or in joint meetings' with the Conference of Presidents of the Federal Reserve Banks.
The procedures outlined indicate that the Open Market Committee is
supplied with regular and continuing sources of information from all
parts of the economy.
Comment of H.G Leedy, Kansas City
While the direct participation of the directors of the Federal Reserve banks in the determination of national credit policy is limited
to the establishment of discount rates subject to the approval of the
Board of Governors, the indirect contribution of their advice and
judgment in the determination of credit policy is of great importance.
By reason of their contacts with the various segments of the economy,
including banking, and their familiarity with economic developments
in their respective districts, they are in a position to make an important contribution to the System's economic knowledge and understanding. This capacity to effectively serve the Federal Reserve
System is greatly increased as a result of the fact that these directors
come from a wide variety of business, banking, agricultural, professional, and other pursuits, and are outstanding men in their respective
fields of endeavor.
From time to time, the Chairman of the Board of Governors requests
the views of members of the boards of directors on problems that are
under consideration by the Board. Moreover, the presidents of the
Reserve banks have the benefit of the views of the boards of directors,
including their impressions and opinions on economic developments
and on desirable credit policy in the light of those developments, which
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT668
the presidents are able to utilize in developing their personal analysis
and judgment on matters that come before them in the Federal Open
Market Committee and in joint meetings of the presidents' conference
with the Board of Governors.
The directors of the Federal Reserve banks also perform an important function in contributing to public understanding of Federal
Reserve policies in their districts and throughout the country. I t is
of considerable importance that bankers, businessmen, and others
should be informed regarding the problems to which Federal Reserve
actions relate and the reasons for the policies adopted. Over the
years, this should lead to a better appreciation of the role of appropriate central bank policies. I n order for directors of Federal Reserve banks to perform their various functions as successfully as they
have in the past, it is essential that capable and outstanding men be
attracted to these functions and continue to serve as directors of the
Reserve banks.
The presidents of the Federal Reserve banks have a part either
specifically or indirectly in the formulation of virtually the entire
range of credit policy. The specific role is that of serving on the
Federal Open Market Committee, in which capacity they not only
have a part in the determination of open market operations, but also
participate in the consideration of the use of the other instruments of
credit policy, which need to be coordinated with open market operations. As members of the Open Market Committee, the presidents
go to meetings of the committee without specific instructions from the
boards of directors of the Federal Reserve banks, for in that capacity
the presidents act as individual members of the committee. Although
the informed judgment of the directors is obtained concerning the
broad characteristics of economic developments and desirable direction
of national credit policy, and although the directors are in a position
to help broaden the public understanding of policy decisions taken,
the directors are not given access to confidential information about
open market policy.
I n addition to the participation in the formulation of national credit
policy through the Federal Open Market Committee, the presidents
also contribute indirectly in the formulation of that policy in many
other ways. Matters of credit policy pending before the Board of
Governors are discussed in joint meetings of the presidents' conference with the Board of Governors. Moreover, at other times, thel
Board requests the views of the presidents with respect to pending
decisions and enlists the aid of the presidents in assembling pertinent
economic information in their districts with respect to problems under
consideration. Furthermore, the presidents on their own initiative
pass on to the Board of Governors their views on credit policy
matters and pertinent information that reaches them through the
Reserve banks' research departments and operating officers and in a
multitude of informal ways.
Comment of R. R. Gilbert, Dallas
The answer to this question points out that the boards of directors of
the Federal Reserve banks contribute informally and indirectly in
the formulation of national credit policy by communicating with the
Board of Governors and by expressing to the presidents of the Reserve
banks their impressions and opinions on economic developments and
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desirable credit policy in the light of those developments. I n addition, it should be stated that the boards of directors of the Federal
Eeserve banks also communicate their impressions and opinions on
such economic matters and related credit policy questions to the Federal Advisory Council members of their respective districts. The
Federal Advisory Council members, thus, are in a better position to
discuss such questions and problems at their council meetings and to
perform their legal responsibility under the act at their periodic meetings with the Board of Governors of the Federal Eeserve System.
10. Trace the historical development of open-market operations covering both their significance as instruments of monetary and credit
policy, and the nature and composition of the bodies which have
successively had control over them.
Joint answer
The present role and administration of open-market operations as
an instrument of Federal Eeserve policy have been the result of a
process of gradual development. This development has taken place
in accordance with the changing credit situation and the increasing
recognition of the importance and use of open-market operations as
an instrument of central bank policy. The administration of these
operations as an instrument of Nation-wide credit policy under the
control of a single body developed as the money and capital markets
became increasingly national in scope and the Nation-wide effects of
open-market operations were more fully comprehended. During the
life of the Federal Eeserve System, their use has been adapted to the
changing character of the credit requirements of the economy.
To a considerable degree, the changes in the use of open-market
operations and in the control over them have taken place without special legislation, and some of the legislative actions taken have given
legal status to changes in policy and organization already in effect.
These changes, along with the legislative changes, have been the result
of the test of experience which has revealed both the strength and the
weakness of past decisions. The developments that have taken place
have been influenced by the problems that have arisen and the situations with which the System has been confronted.
I n contrast with present understanding, which recognizes openmarket operations as the most important single instrument of credit
control, the discount rate was considered the most important instrument in the early years of the Federal Eeserve System with openmarket operations not regarded as a major instrument of policy. The
use of open-market operations was viewed as essentially a local matter.
Although the Federal Eeserve Act empowered the Federal Eeserve
banks to buy and sell specified types of credit instruments in the open
market, it was originally expected that these transactions would be
carried out primarily to enable the Federal Eeserve banks to acquire
sufficient earnings on occasions when rediscounting by member banks
was small. The fact that open-market operations could be an effective
instrument of credit control was learned only gradually.
I n 1921 and 1922, the individual Federal Eeserve banks on their
own initiative and in order to build up their earnings began to buy
Government securities in the New York market. Since these investment operations tended to disturb the market and to affect the re
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT670
serve position of the member banks, it became evident that some degree of coordination was required. I n A p r i l 1922, therefore, the
Conference of Governors of Federal Reserve Banks (the predecessor
of the Conference of Presidents of Federal Reserve Banks) appointed
a Committee on Centralized Execution of Purchases and Sales of
Government Securities, consisting of the Governors of the Boston,
New York, Philadelphia, and Chicago banks, to buy and sell securities at the request of the Reserve banks and thereby to coordinate
these operations. I n October 1922, the committee also began to make
recommendations, purely on an advisory basis, as to policy.
The experiences of 1922 also led to a recognition of the importance
of open market operations as an instrument for making the discount
rate effective in general credit policy and of the need for coordination
of open market policy and discount rate policy to make credit control
effective. I n view of this need, the Federal Reserve Board discontinued the committee in A p r i l 1923, and supplanted it with an Open
Market Investment Committee, whose membership was identical with
that of the preceding Committee except for the addition of the Governor of the Federal Reserve Bank of Cleveland. A t that time, it was
agreed that the Federal Reserve banks would not carry out open
market operations on a significant scale without the approval of the
Board, and that all such operations would be governed "with primary
regard to the accommodation of commerce and business" and to their
effect "on the general credit situation." The individual Reserve
hanks retained the power to determine whether they would participate in open market operations, however. I n 1930, this committee
gave way without special legislation, as in the earlier instances, to the
Open Market Policy Conference consisting of the Governors of all
12 Federal Reserve banks. A n executive committee of five Governors
was established to act under authorization of the full committee.
Again, the decisions of the committee were subject to the approval
of the Federal Reserve Board, which also was authorized to call
meetings of the committee and to participate in its discussions.
The Banking Act of 1933 gave legislative status to the Committee
and changed its name to the Federal Open Market Committee. The
Federal Reserve banks were forbidden to engage in any open market
operations except in accordance with regulations of the Federal Reserve Board, but neither the Committee nor the Board was empowered
to require any Reserve bank to engage in such operations. However,
any Reserve bank not participating was required to state its objections
in writing. I n keeping with regulations already in effect, the law
provided that open market operations should be conducted—
w i t h a view to accommodating commerce and business and w i t h regard to their
bearing upon the general credit situation of the country.
Finally, the Banking Act of 1935, as amended in 1942, placed full
authority for open market operations in the hands of a reconstituted
Federal Open Market Committee, consisting of the seven members
of the Board of Governors, a representative (in practice the president) of the New York bank, and representatives (in practice the
presidents) of four other Reserve banks chosen in rotation annually.
The control ovetf open market operations has remained in the hands
of this body since that time. The Committee meets whenever required, but at least four times a year, and sets general policy. I t ap-
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points an executive committee (three members of the Board and two
presidents of Eeserve banks) which meets frequently and implements
the broad policy laid down by the full committee.
Thus the authority for open market operations has been placed
in the hands of a single body to act for the Federal Reserve System
as a unit. This body has been given authority to determine policy
and to engage in open market operations in accordance with that
policy, and the individual Reserve banks are prohibited from engaging in open market operations except in accordance with the Open
Market Committee's direction and regulations. These provisions are
based upon a recognition of the fact that open market operations are
of Nation-wide rather than local significance. While the organizational arrangement is in keeping with that recognition, it also recognizes the advantages of the combined views of the members of the
Board of Governors and of the presidents of the Federal Reserve
banks.
During the course of their evolution, Federal Reserve open market
operations have been undertaken With a number of different objectives.
Originally, as already noted, open market purchases were made primarily as investments and as a means of obtaining earnings for meeting expenses and dividends. I n the earlier years of the System's history, the importance of open market operations as an instrument of
national credit policy was not recognized. For a decade beginning
with 1923, open market operations were undertaken predominantly
as a means of influencing the volume of bank reserves and bank credit.
During the 1920's, these operations were used as an important part of
System policy directed to promoting credit restraint at times of apparently excessive business and speculative activity, and credit ease
at times of business depression. A common view was that open
market operations should be used primarily to make the discount rate
effective. I n the early 1930's, open market operations were conducted
with a view to establishing easier credit conditions in an effort to encourage bank credit expansion and economic recovery. This program
led to the virtual elimination of member bank indebtedness without
the credit expansion hoped for, and in 1932 and 1933, operations were
conducted for the express purpose of building up excess reserves. As
the large increase in the monetary gold stock contributed to an increasingly larger volume of excess reserves, the System did not again
undertake open market operations for the purpose of changing the
total volume of member bank reserves until the United States entered
World War I I , and the size of the Government security portfolios of
the Federal Reserve banks showed little change from 1934 to 1941.
With the growing importance of the public debt, increasing attention has been directed, in deciding upon open market operations, to
conditions in the market for Government securities. I n the spring
of 1937, for the first time, the Federal Reserve banks purchased longterm Government bonds specifically to limit their decline in price and
to maintain "orderly conditions" in the bond market. These purchases were undertaken in connection with the liquidation of Government securities by a limited number of banks, particularly in New
York City, which were adjusting to increases in the level of member
bank reserve requirements, and were not undertaken for the purpose
of affecting the total volume of member bank reserves. Purchases in
order to maintain orderly conditions in the market were again under-
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT672
taken at the time of the outbreak of war in Europe in September 1939,
the invasion of Norway, Denmark, and the Low Countries in the
spring of 1940, and the entry of the United States into the war in
December 1941, with offsetting sales during the intervening periods.
The purpose of these operations was not the maintenance of any particular level of prices or yields on Government securities but was
limited to the maintenance of orderly conditions in the market.
I n May 1942, however, this objective was carried further by the
initiation of a policy, in agreement with the Treasury, of maintaining
a fixed pattern of interest rates on Treasury obligations, whereby a
virtual price floor was placed under the entire structure of the public
debt. The objective of maintaining stability in the Government
securities market was to assure the ready financing of the war, to keep
down the cost of Treasury borrowing during the war, and to remove
the incentive for investors to delay purchases of Government securities in anticipation of higher yields. The System also had another
basic objective during the war, namely, the restriction of credit expansion within the limits permitted by the attainment of the first objective. However, the process of maintaining stability in the market
transferred the initiative in open market operations from the Federal
Eeserve System to the market and make it impossible for such operations to be used as an effective credit control device.
The objective of maintaining stability in the Government securities
market was continued into the postwar period, but the System also
necessarily continued to carry the responsibility for an effective credit
policy. So long as the System maintained a fixed pattern of rates in
the Government securities market, however, it was not in a position
to exercise effective control over the volume of reserve funds available
to the banking system. I n view of the strong inflationary pressures
that prevailed during much of the postwar period, the conflict between these two objectives became especially acute, and the System
undertook to restrict the extension of credit through open market
operations by endeavoring through sales and redemptions to offset
purchases in the segment of the market under pressure. Following
some earlier modifications beginning in 1947 in the policy of maintaining fixed prices in the Government securities market, that policy
was finally revised under the Treasury-Federal Eeserve accord of
March 1951, so that the System withdrew its intervention in the Government securities market except to the extent necessary to maintain
orderly conditions.
11. What is the rationale of the present assignment of authority over
open market operations to a body other than the Board of
Governors? Why should the allocation of responsibility for
open market policy differ from the allocations with respect to
discount rates and reserve requirements ? Do you consider these
differences desirable? Why, or why not?
Joint answer
The Federal Open Market Committee brings together, with statutory responsibilities for the exercise of the most important instrument
of credit policy—the direction of open market operations—men of
diversified background who are devoting their full time to the problems of the Federal Eeserve System and who are in touch not only
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with Government views in Washington but also with private views and
opinions throughout the country. The assignment of the authority
over open market operations to the Committee has been an evolutionary development.
The Federal Open Market Committee in its present form has worked
well for a number of years. I t provides a method for conducting
policy deliberations that is uniquely in tune with our political and
economic institutions. I t is a body in which Government is directly
represented through the Presidential appointees to the Board of
Governors, and regional interests and the lessons of experience "in
the field" are represented by the Eeserve bank presidents. I t is an
organization in which responsibility for the determination of reserve
requirements and approval of discount rates might properly be lodged.
The fact that the Federal Open Market Committee directs open
market operations, the Board of Governors fixes reserve requirements,
and the Eeserve banks establish discount rates subject to review and
determination of the Board of Governors, has not in practice constituted any serious difficulty. Changes in reserve requirements and
in discount rates are considered in relation to open market policy.
Since actions with respect to all instruments of credit control are
discussed by the Open Market Committee and since open market operations generally are recognized as the most important single instrument of Federal Eeserve policy, it may be expected that other policy
actions of the Board of Governors, or of the Eeserve banks, with the
concurrence of the Board of Governors, will not run counter to those
of the Open Market Committee.
I f any past actions taken with respect to reserve requirements or
discount rates appear to have been inconsistent with the direction of
open market operations in the same period, it should be recognized
that such apparent inconsistencies are not necessarily attributable to
faults in the organizational structure of the Federal Eeserve System.
This point is elaborated in the answer to the next question.
Although the present allocation of responsibility over the various
instruments of credit control has proved workable and satisfactory,
greater assurance of coordination in the use of those instruments in
the future could be achieved by placing the fixing of reserve requirements and the approving of discount rates in the hands of the Federal
Open Market Committee.
12. Can open-market policy, discount policy, and reserve requirement policy pursue different general objectives or should these
various instruments always be directed to a common policy?
When differences of viewpoint among different policy-determining groups must be compromised in order to adopt a common policy, what are the factors of strength and weakness in
the position of each of the parties to the compromise—i. e., the
Board of Governors, the Federal Eeserve bank president members of the Federal Open Market Committee, and the boards of
directors of the Federal Eeserve banks?
Joint answer
Open-market policy, discount policy, and reserve-requirement policy should be directed to a common objective. The public interest
98454—52—pt. 2
4
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT674
would usually be better served if all instruments of monetary control
were coordinated to facilitate greater availability of credit or to restrain monetary expansion, as the general condition of the economy
demands.
I f the various instruments of credit policy are directed toward
different objectives, the over-all effectiveness of credit policy is likely
to be impaired. For example, if open-market operations are directed
toward the maintenance of stable prices and interest rates for Government securities, the effectiveness of other actions, such as increases
in Eeserve bank discount rates or increases in member bank reserve
requirements designed to restrain credit expansion, is likely to be
greatly reduced. Under such circumstances, higher discount rates
would have only a psychological influence, if any, since there would
be little need for borrowing by member banks. Higher reserve requirements could easily be met by member banks through sales in
the market of Government securities which the Federal Eeserve System would have to buy in order to maintain the stability of the market, and the higher reserve requirements would thus have little effect
in deterring credit expansion.
I t is true that at times during recent years, the Federal Eeserve
System has employed the tools of monetary policy in a manner which
may have appeared inconsistent. For example, during the year beginning in November 1947, the System considered it necessary, in the
light of circumstances prevailing at that time, to maintain a stable
and orderly market for Government bonds even though the inflationary tendencies of the early postwar years were still apparent. As
a result, the System offset widespread selling of Government bonds by
banks and nonbank investors with purchases of bonds in amounts
sufficient to keep market prices slightly above par. A t the same time,
the Board of Governors on several occasions during 1948 (acting in
part under the temporarily enlarged authority granted it by the special session of Congress in August of that year) increased the percentage reserve requirements of member banks. W i t h the aid of
Treasury surpluses, it was possible largely to offset the effect on bank
reserves of the large-scale purchases of bonds through Treasury redemption of maturing securities held by the System and through
market sales of short-term securities by the System, but other factors,
such as gold inflows, provided the banks with additional reserves.
The increases in reserve requirements may have helped to immobilize
some of the additional reserves, but they also led to further bank
sales of Treasury securities which the Federal Eeserve System had
to absorb if the stability of the market was to be maintained. On
the whole, the actions taken during this period did not result in such
large additions to the lending power of the banks as has been commonly assumed, but neither did they constitute a fully effective program of restraining credit expansion as a means of combating inflationary tendencies.
To the extent that such actions by the Federal Eeserve System
appear to be inconsistent—in that one action tended to facilitate
monetary expansion, while others were directed toward restraint of
monetary expansion—it should be recognized that the apparent inconsistency was attributable to special circumstances prevailing at that
time. Large amounts of the war-expanded public debt were loosely
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held by investors who had become unaccustomed to the fluctuations
in interest rates and security prices that had been considered normal
in earlier years and tended to become alarmed over the possibility
of substantial declines in the value of their securities when heavy demands for capital and credit began to be reflected in an upward drift
in interest rates. Furthermore, many institutional investors who
preferred greater diversification of their investments, and saw the
prospect of obtaining higher yields from other types of investments,
sold Government bonds in substantial amounts. There was danger of
the development of panicky conditions in which acute weakness in the
security markets might have had serious repercussions in the general
business situation. Consequently, while the Federal Eeserve System
never abandoned its objective of restraining inflationary pressures to
the extent possible through credit action, it felt obliged to engage in
open market operations which would prevent serious disturbances and
would thus work toward a situation in which more normal use of the
instruments of credit policy might be possible in the future.
Actions taken under such circumstances, therefore, in no sense suggest any abandonment of belief in the desirability of coordination of
all the instruments of credit policy toward a common objective.
The second part of this question might seem to suggest that lack of
logical coordination in open market policy, discount policy, and
reserve requirement policy, or a lack of common direction in the use
of the various instruments of credit control, might be attributable to
differences of viewpoint among "policy determining groups" within
the Federal Eeserve System. These groups are named in the question,
i. e., the Board of Governors, the Eeserve bank president members
of the Federal Open Market Committee, and the boards of directors
of the Eeserve banks.
While the general credit powers are lodged with different bodies
within the System, that arrangement does not prevent a coordinated
use of those credit instruments. Inasmuch as they should be used
so as to complement each other, it is important that a forum be provided for the careful consideration of their coordinated use. This is
provided bv the Federal Open Market Committee, in which both the
members of the Board of Governors and the presidents of the Eeserve
banks are represented. The directors of the Eeserve banks do not
have a direct role in policy formulation in the Open Market Committee, but they do have an indirect part in the process of judging
the economic situation and appraising the factors influencing credit
policy. I t must clearly be stated that in the Open Market Committee,
where open market policy is determined, members of the committee
have not banded into groups. They have come into the meetings of
the committee as individuals, each with his opinion concerning the
actions which might most appropriately and effectively be taken.
They have come uninstructed and free to express their opinions, and
each has exerted an influence proportionate to his persuasiveness and
his ability to marshal facts supporting his opinions. Hence the factors of strength or weakness in the position of each party—each individual—depends on the strength or weakness of his position when
pitted against or compared with the strength or weakness of the
position taken by others. Past experience indicates that when there
is division of opinion within the Federal Open Market Committee,
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the division is likely to be between individual members of the committee, regardless of whether they are members of the Board of Governors or Reserve bank presidents, rather than between the Board
members as a group and the presidents as a group.
Comment of C. S. Young, Chicago
I n addition, it should be noted that oftentimes technical and temporary considerations require apparently conflicting operations on the
part of monetary authorities. The impact of some restrictive actions
must be cushioned and spread over time in order to avoid transient
market disruptions. Thus, the imposition of higher reserve requirements may be accompanied by a modest amount of Federal Reserve
purchases of Government securities during the few days immediately
preceding the effective date of the new requirements. Such action,
while providing fewer new bank reserves than are immobilized by
the new requirement, alleviates strain on the banking system and
pressure in the Government securities market which would otherwise
develop as banks in tight reserve positions attempt to acquire necessary additional reserves. I n succeeding days, as the new reserve positions of banks become more stabilized, some of the temporary reserves
supplied by Federal Reserve purchases of Government securities can
be absorbed by subsequent sales by the System. Within the framework
of one common policy, such partially compensatory operations are
frequently required in order that the degrees of credit ease or stringency introduced on any given day do not exceed the capacity of the
financial markets to absorb them.
Comment of J.N. Peyton,, Minneapolis
[Mr. Peyton would substitute the following for the first part of
the System answer.]
Open-market policy, discount policy, and reserve requirement policy
should not pursue different general objectives; they should rather be
directed to a common policy. Coordination in the use of the instruments of credit control is certainly desirable. The structural arrangement of the Federal Reserve System does not prevent such coordination
from being achieved. On occasion, there may appear to be a lack
of coordination in the use of the various instruments of credit control
even though they are directed toward a common policy, or the pursuit
of a coordinated use of the instruments may be difficult because of
considerations other than monetary policy.
The public interest would more likely be better served if all instruments of monetary control would be coordinated to effect over-all
monetary expansion or monetary contraction, as the general condition
of the economy demands. Such coordination of the uses of the various
instruments of monetary control—^ach complementing the others—
would provide the most effective implementation of general credit
policy.
I t may be pointed out that in past years the Federal Reserve System
at times has employed the tools of monetary policy in a manner which
may have appeared inconsistent—for example, the open-market operations have at times effected monetary expansion while at the same
time changes in reserve requirements have been used in an attempt to
effect monetary contraction, or that the one instrument has been used
in an attempt to offset the effects of the other. This was clearly the
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case in 1948 when the Federal Reserve, in accord with the Treasury,
deemed it an overriding objective that a stable and orderly market for
Government bonds should be maintained. I n pursuit of this objective
the System met widespread selling of bonds by banks and nonbank
investors with purchases in an amount sufficient to keep the market
prices of those bonds slightly above par. Recognizing that such purchases created commercial bank reserves, to the extent that they were
not offset by System sales and redemptions, it was decided by the
Board of Governors that reserve requirements should be raised in order
to immobilize at least a part of the reserve so created.
I f such actions by the Federal Reserve should be deemed inconsistent—that the one action worked in the direction of monetary expansion while the other worked toward monetary contraction or
toward offsetting expansion—it also should be recognized that the inconsistency was assignable to debt-management considerations rather
than to monetary-policy considerations. The pegging of Government
bond prices overrode appropriate monetary-policy considerations in
that such action forbade interest rates to perform freely an economic
function. As Chairman McCabe observed in his report to the Subcommittee on Monetary, Credit, and Fiscal Policies in 1949:
* * * To keep down the rate of interest by making credit freely available at
a time when capital demands exceed current savings has an inflationary result.
Conversely, to increase rates of interest and thereby discourage borrowing at a
time when business activity is low, 'is conducive to f u r t h e r contraction. Monet a r y policies should be flexibly adapted to the changing needs of the economy.
However, i n view of the large outstanding debt and its widespread distribution,
the Federal Reserve faces the dilemma of endeavoring to follow flexible monetary
policies w i t h o u t detracting f r o m the willingness of investors to be firm holders
of Government securities.
Delos G. Johns, St. Louis
[Mr. Johns offers the following comments on the joint answers to
questions under section C. Distribution Within the Federal Reserve
System of Authority on Credit Policies.]
The joint replies of the special committee of the presidents of the
Federal Reserve banks to questions 8 through 12 are generally satisfactory to me. The comment which follows represents no substantive
difference with those replies. I t relates to the section as a whole and
is not tied specifically to the individual questions.
One of the great strengths of the Federal Reserve System is found
in its regional characteristics. As is noted in my reply to question 35,
the eighth Federal Reserve district is a definite regional entity with
regional conditions and problems which differ in degree and in kind
from those of other regions. I n a nation as extensive as the United
States such differences may be expected. They reflect differences in
the amount and kind of basic resources, in population, and in the type
and extent of resource utilization.
I t is important to recognize that these regional variations exist and
important to take them into consideration in the formulation of national policies. This should not be taken to mean that national policies
should reflect merely narrow and selfish sectional interests; rather it
means that national policies should reflect realistic recognition of the
facts of regional differences so as to make those policies serve most
fully the purposes for which they are designed and hence the true
national interest. This principle, of course, underlies the federal form
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT678
of government we have chosen. Policies are formulated in the broad
national interest but they are formulated with the benefit of regional
representation and opinion. This approach implicitly recognizes that,
while national aggregates and national averages have meaning, policies based solely on such aggregates and averages without consideration for the regional deviations from them may well be at best inadequate, at worst harmful.
System policies are forged with due consideration for regional deviations from national averages. This helps prevent adoption of unsound or unworkable national policies and helps promote adoption of
policies that are sound and workable. The fact that there are 12
Eeserve districts and the fact that each bank and branch has directors
drawn from the particular district provides for full recognition of the
characteristics of the district, ^ach Eeserve bank president is in a
position to judge possible alternatives of national monetary policy with
due regard to the particular characteristics of his region. This makes
for adoption of national monetary policy that squares realistically
with actual conditions in the regions] rather than with a statistical
average of all regions, which average may or may not be meaningful.
A t the same time the Federal Eeserve banks and branches are in a
position to make the policy chosen best fit the characteristics of the
various regions, as indicated in the joint reply to question 8. Thus,
proper flexibility is assured and the adopted policy serves its purpose.
No Eeserve bank acting by itself can or would contravene the real
purpose of the national monetary policy, but it can provide for special
regional circumstances.
The desirability of the regional characteristics of the Federal Eeserve System thus seems clear. Much of the System's strength stems
from this factor. And the official record of the decisions and votes of
the Open-Market Committee demonstrates the fact that the regional
characteristics do not result in or reflect selfish sectionalism. Such
divisions as have occurred on open-market policy have not been commonly between the five bank representatives and the seven board
representatives as two distinct groups but between shifting groups,
each of which may contain both presidents and board members. The
differences reflect the individual committee members' analyses, interpretations, and viewpoints. I n actual practice, even on matters of
reserve-requirement policy, for which statutory authority rests solely
in the Board of Governors, and on discount policy, there is consultation between the presidents and the board, demonstrating full recognition of the principle of considering regional factors of difference and
also demonstrating the fact that regional representation is a source of
strength.
I n this connection I wish to emphasize strongly a point upon which
there seems to be considerable misunderstanding. The presidents of
the Federal Eeserve banks naturally are in close contact with the commercial bankers in their districts. This fact is interpreted by some
people as meaning that the presidents reflect commercial-banking
opinion and apparently that such opinion necessarily is at odds with
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the public interest. I n my opinion, the Eeserve bank presidents' views
are not unduly influenced by the commercial bankers he works with
daily. Eather, these intimate contacts provide him with a "feel" for
conditions as they exist in his district and enable him to make a greater
contribution to System policy consideration. Also, I do not believe
that commercial-banking opinion is necessarily at odds with the public
interest. I believe that it may well be as patriotic and as publicly
oriented as any other opinion. Furthermore, the very fact that the
presidents are in regular contact with commercial bankers gives them
better insight into the practical administrative problems of monetarypolicy implementation. Lack of such contact would seem more likely
to result in unrealistic approaches to policy formulation rather than
to more objectivity. The System has taken great pride in the fact
that it does not employ the "ivory tower" technique in formulating
policy, but that it seeks to obtain as much evidence and informed
opinion as possible before taking action.
Finally, I wish to note specifically my concurrence in the joint reply
to question 12, which points out that open-market policy, discount
policy, and reserve-requirement policy actually have not pursued different objectives, although superficial examination of the record might
lead to the belief that such had been the case at various times. Consequently, the fact that open-market-policy power is lodged in the
Open Market Committee, while reserve-requirement-policy power rests
with the Board of Governors, and discount-policy power with both
banks and Board, has not in practice led to action in one field deliberately offsetting action in another. I have already noted that the Board
ordinarily seeks the advice of the Eeserve bank presidents and staffs
prior to taking action with respect to reserve requirements. Discountrate changes are initiated at the Eeserve banks, but require approval
by the Board. Action in both fields ordinarily is discussed and considered at Open Market Committee meetings, and policies in practice
are coordinated.
I t might seem more logical to lodge all three policy powers with
the Open Market Committee, but there would seem to be no compelling
reason to do so on the basis of the record. However, in keeping with
the broad principle of constitutionalism, referred to in the discussion
of section A of the subcommittee questionnaire, if there is to be full
assurance for all time of proper recognition of regional differences
and of coordination of open-market, discount, and reserve-requirement
policies, the discount and reserve-requirement powers might well be
placed in the Open Market Committee. This step would follow the
general American approach in safeguarding a principle with specific
legislative action.
I n summary, my opinion with respect to the points raised in the
^
questionnaire agrees generally with
M y supplementary comment has
attempted to stress the strengths resulting from the regional characteristics of the System and to emphasize the fact that the distribution
of powers within the System reflects that regional strength and has
worked well in practice.
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D. GENERAL CREDIT AND MONETARY POLICIES
13. Analyze the effects of the rising yield upon short-term Governments between August 1950 and March 1951 from the standpoint
of (a) effect upon the volume of bank loans, (&) effect upon the
level of private interest rates and the differential between those
rates and the yield on Governments, (c) effect upon the market
prices and the volume of sales of long-term Governments, (d)
effect upon the policy of the Federal Reserve System to support
the long-term Governments.
Joint answer
The analysis of any segment of the historical record of credit control
must proceed from an explanation of the mechanism and the essential
principles of that control. For that reason, a reading of the reply to
this question might best follow a reading of the replies to all other
questions in section D on general credit and monetary policies. The
present question deals only with certain effects of a program of general
credit restraint, without embracing all aspects of that program.
While each of these selected aspects is important, it will also prove
desirable to summarize briefly the background of other developments
and the over-all effects of general credit restraint during the period
from August 1950 to March 1951, to which this question directs
attention.
During a period of emergency affecting the national security, credit
policy must consider the immediate interests of national defense as
well as its primary responsibility for a monetary policy which will
contribute to economic stability. For this reason, although the Federal Reserve System was prepared to implement a credit program designed to combat reviving inflationary pressures prior to the Korean
outbreak, the System withheld action on such a program and aimed
its policy along the lines of credit neutrality when the Secretary of
the Treasury asked the System to stand aside until the President had
presented a special message to Congress on the defense needs growing
out of the Korean hostilities, and until the Secretary himself had
determined the probable magnitude of early needs for additional
financing. By the middle of August 1950 both of the conditions set
forth by the Secretary had been clarified, and the civilian sector of
the economy was in the throes of a substantial boom, while defense
expenditures were scheduled at a rate which would not in itself contribute directly to inflationary pressure for some time to come. The
President had called for tax increases and restriction of credit to combat the inflationary tendencies in the private sector of the economy.
I n that setting, on August 18, the Board of Governors approved an
increase in the discount rate of the Federal Reserve Bank of New
York, and the Board and the Federal Open Market Committee announced that they were—
prepared to use a l l the means a t their command to restrain f u r t h e r expansion
of bank credit consistent w i t h the policy of maintaining orderly conditions i n
the Government securities market.
Unfortunately, on the same date, the Secretary of the Treasury announced that $13.5 billion of Treasury securities called or maturing
on September 15 and October 1 would be refunded through a shortterm offering identical in form and rate with similar offerings of
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June 1 and July 1 that had been announced before the Korean outbreak and the intensification of inflationary pressures which followed.
The Federal Reserve System then chose the only course which afforded an opportunity for compromise between a Treasury decision
that required an abundant supply of funds in the market and an overall governmental policy (cf. the President's message of July 19) calling for credit restraint. The System made no attempt to peg the
entire short-term market in line with the terms of the Treasury's offerings ; but it stood ready to purchase any of the outstanding securities
scheduled to mature on September 15 or October 1 at the higher prices
(lower yields) consistent with the Treasury's terms. The System,
in turn, sold other securities from its own portfolio at the relatively
lower prices (higher yields) consistent with market demand. The
results over the ensuing 7-week period were System purchases of
roughly $8 billion, offsetting sales (or redemptions) of roughly $7
billion, and a net rise of $1 billion in Federal Reserve credit. The
inflationary repercussions of this unfortunate lack of coordination
continued throughout the autumn and early winter. On November
22, the Treasury made an advance announcement of the terms for its
refunding operations of December 15, 1950, and January 1, 1951,
and the System was obliged to stabilize a wide segment of market
prices until after January 1. Thus, in effect, a large part of the System's effort to restrain credit over the 29-week period from the announcement of August 18, 1950, through the announcement of Treasury-System accord on March 4, 1951, was consumed in offsetting the
Federal Reserve credit released during the 13 weeks within this period
that Treasury refunding issues (other than bills) were before the
market. Despite these handicaps, however, the over-all growth of
the money supply (demand deposits and currency) during this period
amounted to only slightly more than 1 percent. Continuing gold
outflows throughout the period were a principal source of restraining
pressure on bank reserves; and an increase of member bank required
reserve percentages during January helped to reinforce the System's
efforts to exercise a restraining influence through open market operations during the relatively free interlude.
(a) The effect upon the volume of bank loans.—The effects of rising
yields on short-term Governments during this period were largely
counteracted by the System's purchases in support of Treasury refunding operations, and therefore did not prevent an unduly large loan
expansion. But the amount and the inflationary character of this expansion might have been considerably greater if two positive results
had not been achieved. First, rising yields enabled the Federal Reserve System, in effect, to sell such a large volume of short-term securities to the market that member banks were left with barely two-thirds
of a billion dollars of added reserves to use as a base for credit expansion (after allowing for the effect of the increase in the ratios of
required reserves) over the 29-week period as a whole. Second, because the member bank reserve base was thus limited, much of the
loan expansion which occurred in the banks wasfinancedthrough bank
sale of short-term Government securities to nonbank investors (mainly
business corporations)—and thus represented a shift of bank assets
without an expansion of the total credit and money supply. The total
loans of all commercial banks (for which estimated data are available
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only as of the end of each month, without breakdown as to type of
loan) rose $7.6 billion in the 7 months from August through February,
inclusive; their holdings of Government securities declined $6.2 billion.
For the same 7 months, total loans of the weekly reporting member
banks rose $5.9 billion; their business loans rose $4.8 billion; and their
holdings of Government securities declined $4.9 billion. Some of these
Government securities sold by the banks found their way to the Federal
Reserve banks, thus adding to reserves; but because short-term rates
were attractive to the market the combined Federal Reserve acquisitions from all sources were well below the amounts unloaded by the
banks.
(i) Effect upon the level of private interest rates and the differential between those rates and the yield on Governments.—When Federal Reserve credit is scarce, interest rates on all classes of credit tend
to rise. The resulting increase in yields on short-term Governments
may often precede increases in other yields, but such increases are
interrelated results of the general reduction of credit availability; one
increase is not necessarily the cause of the other. Over the 7-month
period, the issue rates on new Treasury bills (3 months) rose from 1.173
on August 17 to 1.406 on March 1, or not quite one-quarter of 1 percent.
The rise in Federal Reserve discount rates by one-fourth of 1 percent
on August 18 was matched almost immediately by all of the openmarket private money rates. I n general, shortLterm Government interest rates rose more slowly, and not so far, as the private short-term
rates over the 7-month period. Longer-term rates fluctuated moderately around a very slight rising yield trend. There was little change
in the differentials between Government bonds and other longer-term
issues. The causes and significance of these changing differentials are
discussed further under question 17.
(c) Effect upon the market prices and the volume of sales of longterm Governments.—To some extent, rising short-term rates contributed to expectations of somewhat higher long-term yields (i. e., lower
market prices), and may have encouraged some anticipatory sales of
Government bonds during these 7 months. But the major factor in
the bond sales was the steady unloading by insurance companies, savings banks, and other investors in order to obtain funds for other
commitments promising higher rates. They had been undertaking
larger commitments than could be met out of newly arising savings or
the repayment of past loans or investments. They did so because longterm Government securities themselves were being kept at an arbitrarily high price (low yield), in the face of mounting inflationary
pressures, and because they expected that support would continue to
make Government bonds virtually the equivalent of cash on demand—
available whenever the commitments came in to be met. The fact that
yields on most types of longer-term private securities or other outlets
for funds did not rise appreciably under these inflationary circumstances reflected the fact that easy access to freshly created credit
(through sales of Government securities to the System in a supported
market), kept the supply of long-term funds ciosely abreast of the
demand.
The rise of short-term rates did exert a counterinfluence, however.
Some of the sellers of long-term Government bonds, while continuing
their regular unloading programs, were persuaded by the growing
prospects of rate uncertainty to return some of the proceeds to the
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short-term market. I n addition, the rise in rates also attracted large
investment in short-term Government securities by other nonbank
investors. Thus, by meeting this demand through further sales of
short-term Governments, in the relatively attractive short-term
market, the Federal Reserve was able to offset to some extent the inflationary effects of its support of the long-term bond market.
(d) Effect upon the policy of the Federal Eeserve System to support the long-term Governments.—The System's policy of support,
which was focused upon the two longest-term bank-restricted bonds,
made it impossible for the System to achieve any sustained measure
of effective control over the credit supply through sales of Government bonds. A t times, within the anchor prices set for the longestterm bonds, the System could make some sales, as it had done to offset
the credit released in supporting the Treasury's June and July refinancing. But the volume of such potential sales was limited at all
events, and had been largely exhausted by August 18. Nonetheless,
the System continued supporting the long Governments throughout
this period, hoping to be able to more than offset the effects of such
support by sales of short-term securities at the more attractive yields
demanded by the market. By January and February of 1951, however, System purchases of the long-term bonds began to accelerate
under selling pressure. A final break was made away from arbitrary
support following the Treasury-System "accord" of March 4, 1951.
The gradual rise of short-term yields had not made possible enough
sales out of the System's short-term portfolio to offset the purchases of
bonds entailed by the support technique during a period of mounting
inflationary stress. The purposes of bond support through the long
"digestion" period following the great growth of long-term debt in
World War I I had already been largely served; and, as events proved,
the transition to unsupported long-term markets below par no longer
presented insurmountable problems. Since March and April of 1951
credit restraint has been reflected in the prices and yields of all classes
of Government securities, as well as throughout the long-term securities market.
Comment of R. R. Gilbert, Dallas
The answer to this question refers to the approval by the Board of
Governors on August 18 of an increase in the discount rate of the
Federal Reserve Bank of New York. I t should be added that the
Board of Governors approved increases in the discount rates of the
other Federal Reserve banks, with such increases becoming effective
between August 21 and August 25. By the 25th of August the
discount rate at all Federal Reserve banks was 1% percent.
14. Describe the mechanism by which a general tightening or easing
of credit, and the changes in interest rates which may result, is
expected to counteract inflation or deflation. Discuss the impact
on borrowers and lenders in both the short-term and long-term
credit markets and on spending and savings. Indicate the effect
on each of the broad categories of spending entering into gross
national product. What are the (actual or potential) capital
losses or gains that would be brought about by changes in interest rates ? To what extent is the effectiveness of a program of
credit restraint affected by or dependent upon expectations with
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respect to subsequent changes in interest rates ? Distinguish in
your discussion between small changes in rates and large changes
in rates.
Joint answer
The reply to this question will serve as an introduction to the replies
to other questions in section D on general credit and monetary policies. Those other replies develop in further detail the broad principles which are outlined here largely in terms of an inflationary
situation that necessitates a general tightening of credit. Centering
this reply on inflationary conditions should lend orderliness to the
presentation, and will also high-light the fact that credit policies are
most influential in curbing inflationary distortions before the economy
reaches a stage of crisis (and the subsequent collapse into depression).
Credit controls help to counteract inflation mainly by limiting those
volatile additions to aggregate demand that are financed with borrowed funds. They do not, of course, remove other causes of cyclical
disturbance, but credit-financed demand frequently accentuates disturbances set off by other causes. Consequently, effective credit controls must be an important part of any program aimed at limiting
cyclical swings and preserving a sustained high level of employment
and production. They cannot, however, be relied upon to offset or
conceal all other causes of cyclical disturbances.
I n an inflationary situation, no source of bank reserves should be
permitted to serve as a basis for an over-all expansion of credit or the
money supply in excess of the economy's physical capabilities at current prices. The volume of Federal Reserve credit must be restricted
to prevent an increase in bank reserves sufficient to support excessive
expansion of credit. Broadly speaking, that volume is largely controlled by changes in the Federal Reserve System's holdings of Government securities. Variations in Reserve bank discount rates and
discount policy also exert some influence, but their significance derives
largely from the reinforcement they supply to the System's openmarket operations in Government securities. Increases in the ratio
of required bank reserves may, for banks which are members of the
Federal Reserve System, help to immobilize Federal Reserve credit
already outstanding, but that will be the case only so long as banks
cannot readily meet the higher requirements by selling additional
Government securities to the Federal Reserve banks. Thus, so far
as anti-inflationary control over the volume and usability of Federal
Reserve credit is concerned, the key to effective action is the System's
open-market account.
The dependence of general credit control upon the System's ability
to operate in the Government security market is dictated by the debt
(i. e., the credit) structure of the economy. Because the Government
debt is now equal to one-half the total debt of the economy, and because
the wide distribution of the holding of that debt has been successfully
encouraged by developing a well-organized market for Government
securities (for which few, if any, parallels exist in other countries),
it is inevitable that general credit control must be exerted through the
Government security market.
Characteristically, under inflationary conditions, private demands
for credit increase beyond the supply of loanable funds arising from
current savings and the repayment of other debt. Lending institu-
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tions confronted by this large demand for funds attempt to liquidate
some of their other assets in order to satisfy this demand. Their usual
recourse is sales of those assets which represent the closest substitutes
for cash—that is, Government securities. I f sales are made to others
who have currently accumulated savings, or have funds arising from
debt repayment, the net effect is merely a transference of existing loanable funds without necessarily adding to inflationary pressures, although there may be an increase in the velocity of use of funds. But,
if the sales of Government securities are financed by an expansion of
bank credit, or especially by an expansion of Federal Reserve credit,
they will in most circumstances produce an excessive volume of credit
and intensify the upward pressure upon prices that results when aggregate demand exceeds (at current prices) the physical volume of goods
and services that the economy can produce. Under some inflationary
conditions, notably when the Treasury incurs a cash deficit, it is not
sufficient to check an expansion of private credit; a part of the current
flow of savings must actually be diverted away from private demands
to the Government, so that there will be no expansion in total credit,
Government and private. (See question No. 16.) Other conditions
requiring some direction of the use of currently investable funds, within the framework of general credit restraint, are described under questions 21 through 25.
Certainly the essence of credit control, as a check upon inflation in
existing circumstances, is use of the Federal Reserve open-market account to prevent "monetization" of the large outstanding public debt.
That must necessarily mean, at times, strict limitations on the volume
of System purchases and consequent reductions in the market prices of
Government securities. I t does not mean that the credit of the Government itself is impaired in any way. I t does mean that holders who
attempt to dispose of Government securities in a manner that will
produce an excess supply of new credit, instead of holding to maturity
when full repayment is assured, must expect to find their way impeded under inflationary conditions. For the small individual saver,
or for others who cannot be expected to take account of changing market prices, nonmarketable savings bonds are available in suitable
amounts at yields fixed arbitrarily above the yield levels that usually
prevail in the market. The impact of changing market prices is felt
by the banking institutions which provide the major proportion of the
Nation's over-all credit supply and by the large and informed institutional investors.
Credit control during an inflation is not, however, aimed specifically
at lowering the prices of Government securities, nor at raising interest
rates. The entire complex of the forces of market supply and demand
will determine what happens to prices and yields when the Federal
Reserve refuses to buy, or aggressively sells. But unless all Government securities are immobilized in the portfolios of all classes of lenders by compulsion, and additional supplies of cash resources do not
become available to the ba*nks from other sources, the pressure of an
excessive demand for credit upon a limited supply will unavoidably
force some reduction in prices on Government and other securities, and
a corresponding rise in interest rates. Generally speaking, interest
rates on shorter-term Government securities will have to rise far
enough to assure nonbank purchases of these securities in whatever
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volume the Treasury has put into the market. For longer-term securities, a rise of yields means larger capital losses in the event of sale than
a similar rise in shorter-term securities, and the attention of some holders will necessarily be focused upon the magnitude of those potential
losses. I n general, if the over-all credit volume is to be effectively
limited to economic requirements, market yields on longer-term securities will rise until potential capital losses become large enough to
discourage most sellers, or alternatively, until the lowered market
prices attract other buyers in sufficient volume to absorb all sales that
continue to be offered.
Because of the wide participation in the Government security
market, and because important groups of institutional lenders have
a preference for relatively riskless assets and have income requirements of an actuarial type that change relatively slowly, rather small
changes in yields (or capital gains or losses) will usually bring
about a balance in the market. As a general rule, short-term rates will
fluctuate more frequently, and over a wider range, than long-term
rates. However, no clear-cut assurance can be given as to the magnitude of the changes in interest rates which occur as a result of restraint upon credit expansion. This depends upon the demand for
credit as well as the reduction in the supply of credit available to
meet it. The choice is not between very small and very large changes
in rates; there may be an almost infinite number of gradations of
change as credit restraint is imposed. Recent experience indicates
that effective credit restraint can be accomplished without causing
more than relatively small changes, in existing circumstances, but
any commitment to that effect by the Federal Reserve System would
remove the element of uncertainty over rate movements that frequently serves as a useful substitute for further restraining action.
This uncertainty over rate changes is one aspect of expectations
that plays an important role in reinforcing the specific action taken
to restrain credit. Of course, if a general rise in rates is expected to
continue for a long period, some borrowers may try to avoid higher
borrowing costs later by borrowing more now; but lenders tend, under
these same circumstances, to become unwilling to lend except for relatively short periods; and all classes of investors become increasingly
interested in short-term Government securities as a temporary resting
place for their investable funds. By feeding this demand for shortterm securities, the Federal open-market account can actually
strengthen its hold on bank reserve positions. Government borrowing plans must also be adjusted to the investor responses growing out
of these expectations of rising rates, as will be further described
below.
The principal impact of credit tightening upon borrowers comes
through the limitations imposed on the availability of funds. As
lenders reject applications, borrowers are compelled to postpone or
scale down their plans. To be sure, some borrowers, particularly
those intending long-term capital investment, may take themselves
out of the market if rates rise above a point consistent with their
projections of costs and probable income, or if they think they may
be able to obtain the funds at lower cost (and perhaps carry out
their expenditure programs more economically) at a later time. Rising short-term rates, in an atmosphere of uncertainty over the pros-
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pects for particular businesses, may also deter borrowing for inventory expansion or for carrying additional trade receivables. These
are important effects; they occur on a significant scale; but by far
the most important influence upon borrowers is the difficulty of obtaining funds from lenders who feel they have become "loaned up."
There is an apparent, but not an actual, loophole in attempts to
restrain lenders who hold short-term Government securities. I t would
seem that they could obtain additional loanable funds merely by
allowing their holdings to run off at maturity, accepting cash instead
of the new issue. For any individual lender that is indeed possible
from time to time, but there are few lending institutions that have
such regular, frequent, and ample maturities that they can obtain
by that means all the additional funds they could use. Moreover, it
is not possible for all lenders unless the Federal Reserve System purchases enough of the refunding issues to supply the Treasury with
the cash to pay off the holders of maturing issues. I t is the Treasury's
inherent responsibility for combating inflation that it offer securities
which are acceptable to the prevailing market.
Another apparent difficulty concerns the implications of investor
expectations for Treasury financing operations, when interest rates
rise as a result of restricted credit availability. I n the face of rising
rates, investors may shrink away from any given Treasury offering,
and await the better yields to be expected shortly. I n that event, it
has been suggested, the Treasury might be forced to turn directly or
indirectly to the Federal Reserve banks, and thereby actually cause
the total volume of money and credit to expand. Paradoxically, it
would seem, rising market rates of interest would, in that event, have
caused a greater release of new credit than might have occurred if
bank money had been used to support prices (peg yields) in order to
attract a greater response by other investors to the Treasury's offering. There is" no doubt that this is a difficult problem. I t cannot be
resolved by a simple formula. But when it is met squarely by the
Treasury and the Federal Reserve acting together, it can be reduced
to a matter of skillful timing and studied selection of the terms for
Treasury issues. (See questions 13, 16, and 17.) Slight errors, or
miscalculations, sometimes occur. But on balance, although continuously pegged markets might on some occasions assure greater direct
response to an individual Treasury offering, the cumulative effect over
time would necessarily be a complete loss of control over credit availability since pegged markets can be maintained only by more or less
continuous support by the Federal Reserve System, which means the
extension of Federal Reserve credit at the option of "the market."
The effects of credit restraint upon savings and spending are clear
as to the direction of influence, discernible as to the relative magnitude
of their influence, but altogether unmeasurable in terms of statistical
aggregates because they act by preventing what might have been. So
far as savings are concerned, those of individuals are certainly stimulated (over what they might otherwise have been) by any appreciable
rise in the return on savings media that accompanies a general tightening of credit, but the over-all magnitude of this response is not likely
to be large. By far the greater impulse to individual saving results
from a steadying of general prices, for which credit restraint must
always divide responsibility with other measures. Business savings
tend to rise over what they might otherwise have been, in the aggre
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gate, as credit restraint reduces access to borrowed funds, and provides an incentive to rely more heavily on retained earnings as a
source of funds. A dampening of excessive consumer demand effects
business inventory policy and other business expenditures. Both
directly and indirectly this rise of business saving serves as a significant anti-inflationary factor.
W i t h respect to "the broad categories of spending entering into
gross national product," credit restraint exerts a wide range of direct
and indirect influences. Consumption expenditures are affected directly when general credit restrictions check the growth of credit for
the purchase of durable consumer goods; further price increases for
such goods become less likely; and, while output is likely to remain at
the peaks permitted by available materials in a period of heavy overall demand, consumers devote less of their current (or future) income
to such purchases. The real income of consumers is protected or enlarged by preventing a swollen money supply from inflating the entire
price structure. When there is general credit restraint, the dollar
volume of gross private domestic investment expenditures, like that
for consumer durables, will not be expanded by duplicating grants of
credit to competing investors, which cause them to bid up prices for the
inventories, equipment, plant, residential housing, or other construction that the economy is capable of producing. The ricocheting effects
of these price increases upon other costs, money wages, and the general
level of prices may thus also be avoided.
And it must be remembered that general credit controls are not
punitive; they are not imposed to cut the aggregate volume of available credit below the aggregate volume of goods and services that the
economy is physically able to produce for the civilian economy at
prevailing prices. They do tend to prevent excessive demands for
the same goods, financed by borrowed money. They leave the allocation of the limited credit supply to the operation of the price mechanism and the combined wisdom of the specialized lending institutions
of the economy which are best able to allocate credit among its most
economic uses—so long as the total volume of loanable funds which
they have to allocate is not so easily expansible as to remove the
necessity for selection among borrowers.
The other "broad categories" of spending are net foreign investment and Government purchases of goods and services. For both of
these the effects of credit restraint are indirect—the results of holding
prices lower than they would otherwise have been if money and credit
had continued to expand freely. I n the case of the Government, however, these indirect effects may be very substantial because credit restraint directly limits excessive demand for the wide range of investment goods which utilize the same types of materials that are embodied
in a large proportion of the goods purchased by the Government.
There is, no direct effect upon Government expenditures, since these
are determined by Congress and, in effect, have priority over all other
demands for goods and services; but the price tags on Government
purchases are held down.
As indicated at the outset, the reply to this question has been prepared, in terms of inflationary conditions. That approach seemed
appropriate both because the exposition of these broad principles
could be undertaken more systematically by tracing all of them
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through a single set of conditions, and also because credit control is
relatively more effective as a check upon inflationary tendencies than
as a stimulant during deflation. However, because changes in credit
availability may exert a very early effect upon most of the categories
of investment, it is also possible for a well-timed program of credit
ease to play a significant part in resisting a downturn during its early
stages, particularly if that downturn has resulted from a gradual
wearing out of expansionary forces rather than the precipitate curtailment associated with an economic crisis. The measures undertaken to check such a "sagging deflation" will be essentially the same
in character, although perhaps not in magnitude, as those undertaken
to stimulate recovery from severe depression. Consequently, a summary of those measures may provide a useful conclusion to this review
of the contracyclical effects of general credit control.
The stimulus toward recovery would, under most deflationary circumstances, be exerted initially by Federal Eeserve System purchases
of Government securities, or a lowering of required reserves, with a
consequent increase in excess reserves available for credit expansion.
Credit availability will be increased; interest rates may be expected to
decline. Having an opportunity for capital gains on longer-term securities, and with the prospect of lower yields on shorter-term money
market instruments, lenders will attempt to enlarge their longer-term
investments, particularly if they fear that yield levels may decline
still further. The flotation of new securities, particularly fixedinterest obligations, will be encouraged. Longer-term investment
projects that had been postponed during the period of limited credit
availability, and higher interest rates, may be revived. Lenders and
underwriting organizations will aggressively seek out new investment
opportunities. Industrial concerns may take advantage of the easy
credit conditions to borrow for the financing of receivables (credit
extensions to distributors), using this means to build up their own
sales outlets and indirectly to assist those outlets themselves, particularly smaller concerns or concerns of marginal creditworthiness. Retailers will be able to borrow readily in order to make credit sales to
consumers. As the interest costs of carrying inventory lessen, some
concerns may carry more diversified stocks to attract additional business. The construction of residential housing will be especially encouraged, because the segment of carrying costs represented by interest charges (which is normally a large proportion of the total) will
have been materially lowered. Similarly, the production and sale of
consumers' durable goods may be aided. Treasury borrowing costs
will probably decline.
I n these ways, and through a variety of associated psychological influences, a turn toward credit ease may help to check or onset undesirable deflationary tendencies. Although the "spur" effect of credit
ease may be less pronounced than the "bit" effect of credit restraint,
both have a necessary place in fulfilling the Nation's economic objectives—sustained high level production and employment, steady
growth, and rising living standards.
Comment of Hugh Leach, Richmond
As indicated in the joint answer, open-market operations can be the
most flexible and effective instrument of general credit control for use
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in tightening or easing bank credit. However, it should not be overlooked that the other quantitative credit-control instruments—reserve
requirements and discount rates—are an integral part of System
policy. Even though changes in reserve requirements are admittedly
a clumsy tool to be used sparingly and the effect of discount rate
changes is now largely psychological, these instruments can be of
considerable value under certain circumstances.
I t is true, of course, that an increase in requirements at a time when
member banks have few loans and heavy investments in Government
securities selling above cost will have little restraining effect on most
banks beyond reducing potential expansion on a given amount of excess reserves, because they can sell securities (at a profit) to the Federal Reserve System. H o w e w , the situation would be quite different
if the volume of outstanding loans was so large that many member
banks would find it difficult or impossible to adjust their reserve positions to additional requirements by offsetting sales of Government
securities. Under such conditions an increase in reserve requirements
would undoubtedly be restrictive. The restrictive effect would be increased at times when banks could sell Government securities only at
a loss.
Granting the current effect of discount rate changes as largely
"psychological," it has been clearly demonstrated in the postwar
period that discount rate increases do have an immediate effect (apart
from open-market operations) on the credit climate and short-term
money rates.
Comment of C. E. Earhart3 San Francisco
I f taken as a statement of general principle, we agree entirely with
the following sentence taken from the joint reply to question 14:
I n an inflationary situation, no source of bank reserves should be permitted
to serve as a basis for an over-all expansion of credit or the money supply in
excess of the economy's physical capabilities at current prices (second paragraph, first sentence).
This should not be taken to mean that the Reserve System believes
that it can be free to restrain credit to this extent under all inflationary conditions, as might be inferred if this statement were read out
of context. Reference to two statements in the joint replies to other
questions clearly illustrates this point:
During a period of emergency affecting the national security, credit policy
must consider the immediate interests of national defense as well as its primary
responsibility for a monetary policy which w i l l contribute to economic stability
(question 13).
Financing a major war Involves two conflicting objectives—adequate financial
support of the war program and avoidance of inflationary effects. * * * Deficit
financing on a large scale would be a serious obstacle to a strongly restrictive
monetary policy, as the Federal Reserve System would have to avoid interference with, and even assist in, Treasury financing of the deficit (question 16).
15. How rapidly and to what extent would you expect the volume of
bank loans to respond to measures of general credit control
under present conditions ?
Joint answer
I t is never possible to measure quantitatively the effects on the
volume of bank credit of general credit control actions. To so measure
the effects would require definite knowledge of what would have
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happened had no action been taken, and that must necessarily remain
a matter of informed opinion rather than knowledge. Nevertheless,
we would expect some response in bank extensions of credit to restrictive measures of general credit control almost immediately, with
increasing effects over a period of time.
For example, the change of open market policy by the Federal Reserve System in the spring of 1951 and the fall in prices of Government securities which ensued were reflected almost immediately in
a reduced availability of funds for mortgages other than those for
which commitments had been made previously. The market for
corporation and "municipal" securities also was affected, so that the
flotation of new issues became more difficult.
Furthermore, we are informed that the action by the Federal Reserve System had the effect of making many banks feel "loaned up,"
thus leading them to adopt a more restrictive policy with respect to
new extensions of credit. The fact that market prices of Government securities fell below par contributed to the "loaned-up" feeling,
as banks (and other lending institutions) were reluctant to take actual
losses by selling such securities as a means of obtaining additional cash
resources. We are informed that this situation has contributed materially to the success of the voluntary credit restraint program.
I n the case of use of measures of general credit control to make
credit more freely available, the response may involve some time lag,
especially if the action is taken in a period'of pronounced business
recession. I n such circumstances, potential borrowers may be more
intent upon reducing their liabilities than upon obtaining additional
funds for the purpose of extending their activities. Nevertheless,
there is reason to believe that tendencies toward credit liquidation
are likely to be relieved by the easier credit conditions brought about
by a change of general credit policy, except perhaps under conditions
of extreme depression. And when the immediate cause of more moderate business recession (such as an overextended inventory position)
has been corrected, easy credit conditions facilitate the financing of
a resumption of activities. Here again, however, it is impossible to
measure the effects of the credit action in quantitative terms.
16. Compare the applicability of general credit and monetary measures and the resultant increases in interest rates as a means of
restraining inflation (a) when the Treasury is not expected to
be a large borrower in the foreseeable future, (&) when a large
volume of Treasury refunding operations will have to be effected
in the foreseeable future, (<?) when it is expected that the Treasury will be a large net borrower during the foreseeable future,
(d) under conditions of total war.
Joint answer
A basic objective of economic policy in this country is assumed to
be the maintenance of high levels of production and employment,
free from the disruptive influences of either serious inflation or serious
deflation. I n view of this objective, we believe that in an inflationary
period both general credit and monetary policies and public-debt
management policies should be directed toward restraining inflationary pressures, whether or not the Treasury is expected to have to carry
out large borrowing or refunding operations in the foreseeable future.
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While not all inflationary pressures are directly attributable to monetary expansion, nor can be dealt with completely by monetary action,
we believe that, in most circumstances, action to check monetary expansion is an essential part of an anti-inflationary program. I n a
free market, a restricted supply of credit in the face of heavy demand
for credit will unavoidably be reflected in somewhat higher interest
rates.
I n our opinion the Treasury's borrowing operations can and should
be adjusted to the requirements of over-all economic policy. Publicdebt operations may supplement and reinforce monetary action and
may even reduce the need for strong measures in the monetary and
credit field, or they may interfere with, and hamper the effectiveness
of monetary action if they are not appropriate to the existing economic situation. For example, the Treasury surpluses of the early postwar
years and their use to retire securities held by the Federal Reserve
banks not only helped to offset the effects on the income stream of
credit expansion, but helped to offset the expansionary effect on the
banking system of gold inflows and to exert recurrent pressure on
bank reserves and thus to restrain credit expansion.
(a) A situation in which the Treasury is not expected to be a large
borrower in the foreseeable future implies that Treasury receipts are
expected at least to equal Government expenditures, and also implies
such a distribution of maturities in the public debt that frequent refunding operations are -not necessary. The presumption would be
that, at least so far as the amount of Treasury receipts and disbursements is concerned, Treasury operations were not contributing to inflationary pressures and were imposing no obstacles to the execution
of monetary measures designed to combat inflationary tendencies.
(&) The prospect of a large volume of Treasury refunding operations would in no way relieve the need for action to combat inflation.
But depending upon how well the refunding operations were adjusted
to current market conditions, that is, adjusted to meet competitive demands for credit and capital, they might facilitate an appropriate
monetary and credit policy or might interfere seriously with such a
policy.
I n an inflationary situation there are likely to be heavy demands for
capital and credit to finance industrial-plant expansion and improvement, commercial and residential construction, and, quite possibly,
State and local government projects, and to finance increased business
inventories and receivables and increased consumer spending. I f the
Treasury offers securities in its refunding operations that are competitively attractive, interest rates and risk considered, the exchange
of new securities for the maturing issues can be accomplished without
any permanent addition to commercial bank or central bank credit.
On the other hand, if Treasury operations are not competitively attractive, heavy recourse, directly or indirectly, to central bank credit
is likely to be necessary to prevent their failure. The result will be
additions' to bank reserves and the creation of a basis for multiple
expansion of bank credit and the money supply, which is likely to
accentuate the inflationary pressures and the depreciation of the
purchasing power or real value of the currency.
I f , as a result of restrictive monetary policies and heavy demands
for credit and capital, interest rates tend to rise, the Treasury may
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have to pay higher interest rates on the new securities it offers than on
maturing securities of comparable maturity, and the demand for
securities of various terms to maturity may be affected. Usually a
rise in interest rates tends to create uncertainty as to the future course
of rates and to increase the relative demand for securities of short
maturity. Since short-term rates generally have been considerably
lower than long-term rates for many years, the increased demand for
short maturities might enable the Treasury to do its refunding without
increasing materially the total interest cost on the public debt by
taking advantage of this demand. However, interest cost should be a
secondary consideration in refunding operations during an inflationary period; and both the interest rate and the length of maturity
should be selected with the primary objective of placing the refunding
issues as largely as possible with nonbank investors to avoid contributing to monetary expansion.
Even with the best of financing methods, however, some degree of
interference with an effective monetary policy is likely for the period
during which the refunding operations are carried out. A considerable amount of shifting of holdings of securities from one investor
to another always occurs in refunding operations, Government or
private. Fairly stable market conditions ordinarily are necessary
during the period of the refunding operation to facilitate the redistribution. I n the case of a large Treasury refunding operation, which
frequently runs into billions of dollars, maintenance of stable market
conditions during the refunding period may require the injection of
Federal Reserve credit into the market, temporarily at least. The
result is that additional reserve funds are made available to the banking system, on the basis of which credit can be extended. The more
frequent the refunding operations, therefore, the greater the disruptive
effect on an anti-inflationary monetary and credit policy. Consequently, well-spaced maturities in the public debt are highly desirable
if the management of the public debt and monetary policy are to work
together in combating inflation.
(c) When the Treasury is expected to be a large net borrower,
there is even greater need for measures to restrain expansion of private
credit, if inflationary tendencies are to be held in check. Such a
situation implies that an increased share of over-all production of
goods and services is to be diverted to governmental purposes, and
that there is no corresponding reduction of private spendable income
through taxes. I f Treasury borrowing operations are such as to
encourage increased savings by the public and to attract such savings
to the financing of Government expenditures, the inflationary effects
of the Government deficit financing will be mitigated, and the need
for strong measures to restrict private credit will be reduced. On the
other hand, if not enough is done in debt management operations to
divert income from the private sector to the financing of Government
expenditures, strongly restrictive measures to restrain expansion of
private credit, or even to force contraction in such credit, are likely
to be necessary if the inflationary tendencies are not to be allowed to
develop unchecked.
I n the case of large net borrowing by the Treasury, it is even more
important that the financing of the Government be done in ways that
will stimulate and attract savings and so minimize the inflationary
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effects of Government spending, even though higher interest cost on
the public debt is involved. Avoidance of such cost is likely to result
in generally higher costs for the goods and services acquired by the
Government, as the result of an accentuation of inflationary tendencies. I t has been suggested that this dilemma might be resolved by
direct limitations on private demands for credit, coupled with compulsory allocation of Treasury securities to institutions and individuals. I f inflationary tendencies are permitted to develop unchecked, the cost to the Government is likely to be many times the
interest cost of making Government securities more attractive to
investors, and there will be other costs in the form of injury to groups
who are unable to protect themselves against the inflation. Compulsory allocation of securities would almost certainly encounter strong
public resistance in circumstances short of all-out war, and, if applied,
would have a deleterious effect on the credit of the Government and on
the voluntary demand for Government securities.
I n addition to general restraints on credit expansion, the need
for supplemental use of selective credit controls, such as restrictions
on consumer credit, is likely to be intensified in periods of heavy Treasury borrowing in order4 to reduce the demand for goods in the production of which there is much use of materials and manpower needed
for governmental purposes, such as the greatly expanded national
defense program now in progress. Measures designed to direct credit
and capital into the financing of the more essential activities and
away from nonessential uses,- such as the current voluntary credit
restraint and " V loan" programs, are also helpful in these
circumstances.
(d) Experience has demonstrated that under conditions of total
war, when the existence of the Nation and all the freedoms of its
people are threatened, there must be not only economic sacrifice, but
also the sacrifice "for the duration" of some of the normal economic
freedoms of a democracy. To some extent there can be reliance upon
appeals to patriotism, but there is likely to be the necessity also of
increased recourse to compulsion in order to assure the disciplines
and the equality of sacrifice that are necessary for the winning of
war and for survival. Less reliance than in peacetime can be placed
upon the normal functioning of the market, whether for goods or
for money. Under such conditions, restrictive monetary measures
are needed to deter tendencies in the private economy which conflict
with the war effort, but the major roles in combating inflation must
be played by fiscal and debt management policies designed to keep
to a minimum monetary expansion arising out of the financing of
the war. I n addition, these policies must be supplemented by direct
controls, such as allocations of materials, inventory controls, price
and wage controls, and the rationing of consumers' goods.
Financing a major war involves two conflicting objectives—adequate financial support of the war program and avoidance of inflationary effects. A major share of the income of the public has no
counterpart in the production of peacetime goods and services, and
must be drained off through taxes or immobilized through savings
that are not returned to the private income stream if inflationary
pressures are to be kept within bounds and direct controls are to
have a reasonable chance of effective application. The choice is between making the sacrifices necessary to channel a sufficient amount
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of current income into the Treasury, through taxes or savings, to
meet its requirements, or enduring the hardships imposed by price
inflation (open or concealed) when a major part of Treasury financing
is done through the banking system.
Determination of the extent to which Government expenditures
are to be met by taxation is the responsibility of Congress, and its
action will greatly influence the feasibility of restraining inflationary monetary expansion. Deficit financing on a large scale would be
a serious obstacle to a strongly restrictive monetary policy, as the
Federal Eeserve System would have to avoid interference with, and
even assist in, Treasury financing of the deficits. To the extent that
deficits should prove unavoidable, every effort should be made to
finance them through the investment of savings. But if the Treasury
were- unable, with the best of financing methods, to raise enough funds
without recourse to bank credit, the central banking system would
have to provide the necessary reserves to enable the banks to do their
part in financing the war. I n any case, a coordinated debt management and monetary policy designed to keep monetary expansion at
a minimum would be essential, not only to minimize the inflationary
pressures during the war, but also to avoid creating the monetary
basis for serious inflation after the war when the restraints of wartime patriotic impulses no longer are effective. The alternative might
be to keep the economy in a strait-jacket of direct controls for an
indefinite period, in the effort to keep dormant inflation from becoming active inflation.
Comment of Allan Sprout, New York
[Mr. Sproul would eliminate the last sentence of the joint answer,
stating that the alternative there presented is not really possible,
practical, or desirable, given our form of society and Government.]
Comment of Ray M. Gidney, Cleveland
I am in substantial agreement with the joint reply. However, I
should like to comment on the sentence containing the following:
Compulsory allocation of securities would almost certainly encounter strong
public resistance i n circumstances short of all-out war, and, i f applied, would
have a deleterious effect on the credit of the Government and on the voluntary
demand for Government securities.
I believe that compulsory allocation of securities would be undesirable
and would encounter strong public resistance even during an all-out
war. During World War I I , there were occasional rumors that the
Government intended to take action of this kind perhaps by levying
on savings accounts. Frequent denials were made of any such intention but, even so, each new rumor caused heavy withdrawals from
banks and apparent increases in currency hoarding. I do not favor
including compulsory allocation of securities as a possible method
of financing Government needs.
I should like also to comment on the paragraph stating:
I n addition to general restraints on credit expansion, the need for supplemental
use of selective credit controls, such as restrictions on consumer credit, is likely
to be intensified in periods of heavy Treasury borrowing i n order to reduce the
demand f o r goods i n the production of which there is much use of materials
and manpower needed for governmental purposes, such as the greatlv exnanriori
national defense program now i n progress.
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I do not share the confidence in the use of selective credit controls
implied by this paragraph and shall make further reference to the
matter in discussing other questions.
The closing sentences of the joint answer state:
a coordinated debt management and monetary policy designed to keep monetary
expansion at a minimum would be essential, not only to minimize the inflationary
pressures during the war, but also to avoid creating the monetary basis for
serious inflation after the war when the restraints of wartime patriotic impulses
no longer are effective—
and—
the alternative might be to keep the economy in a strait-jacket of direct controls
for an indefinite period, i n the effort to keep dormant inflation f r o m becoming
active inflation.
I agree with these statements to the extent that they imply that
under the conditions indicated, the absence of sound, coordinated,
anti-inflationary fiscal public debt and general monetary policies
might result in ruinous inflation unless the American economy and
people were put into an effective strait-jacket of controls and regimentation. However, I do not believe that a "strait-jacket of direct
controls" could be maintained. I t would interfere with the economic
forces which, in the normal course, would be moving to bring about
a replenishment of the deficiencies remaining as a result of wartime
conditions, and would break down from weariness, cynicism, public
resistance, and spreading lack of integrity in application. I have
not shared the frequently expressed view that it was a mistake to
remove direct controls after World War I I . I believe that the freedom given to economic forces at that time was a principal reason why
the country so quickly increased production of goods that in a relatively short time we moved from a condition of undersupply to one of
balance or in some lines of oversupply. I t is essential that our powerful economic machine have freedom to function.
17. To what extent is the demand for United States Government and
other high-grade, fixed-interest-bearing securities by nonbank
investors influenced by (a) the current level of interest rates,
(&) expectations with respect to changes in interest rates, (c)
other factors ?
Joint answer
Nonbank investors are a very mixed group, including savings banks,
insurance companies, business corporations, and individuals. Their
composite demand for Government securities, or for other high-grade,
fixed-interest-bearing securities, represents a wide variety of influences, many of which are subject to continuous change. While it is
necessary in the implementation of credit policy and debt management to observe these changing influences very closely, one lesson of
that observation has been that few timeless generalizations can be made
concerning the reactions of nonbank investors. I t is only possible to
describe certain patterns of behavior that recur from time to time.
Consequently, the three sets of influences indicated in the wording of
this question, (<z), (&), and (<?), may best be discussed together, in
order to indicate some of their interactions upon one another and some
of the changes in their relative significance.
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Under any circumstances, however, changes in interest rates, the
current level of rates, and expectations with respect to market factors
that may bring about changes in rates, all play important parts in
determining the distribution of nonbank holdings among Government
securities, privately issued securities, and such other outlets for funds
as business loans, mortgages, or direct investments in businesses, as
well as in influencing the distribution between shorter- or longer-term
obligations. As a longer run matter, many nonbank investors, particularly those which are financial institutions, attempt to work within
some bench marks of diversification that are consistent with the nature
of their liabilities. Such bench marks are apparently adjustable, however, when fundamental or prolonged changes occur in interest rates
or in the composition of outstanding Government and private indebtedness.
Because United States Government securities are free from credit
risk, market forces develop differentials between the yields on Governments and those on other classes of marketable securities. The fact
that this spread generally tends to widen as credit becomes tighter
indicates that over-all demand, in which the demand of nonbank investors is a substantial part, often moves toward Government securities, on balance, when interest rates rise. Part of the explanation
lies, no doubt, in the fact that many thrift institutions (such as life
insurance companies) must give very high priority to safety of the
principal amount of their investments, and will consequently tend to
hold as many Government securities as they can consistently with
their income requirements. These income requirements, so far as they
relate to dividends on thrift accounts or actuarial yields on insurance
policies, do not change frequently. Consequently, a rise in interest
yields at a time of inflationary developments may soon dry up much
of the potential selling of Government securities by these institutions,
and encourage some to resume purchases. Meanwhile, as the obverse
of this reaction in the Government security market, the market for
other types of loans or securities will have been narrowed, and somewhat greater price reductions (yield increases) will occur as supply
and demand are brought into balance in the non-Government market.
For- comparable reasons, the yield differential between Government
securities and others tends to narrow under deflationary conditions as
credit is eased and rates decline.
Expectations have an important bearing on nonbank investor demand, sometimes adding to, and sometimes simplifying, the Treasury's
financing problems. They also serve as an important bridge between
the shorter-term and longer-term markets; and occasionally the uncertainty created by rising short-term rates, for example, creates
market responses in the longer-term segment of the market that serve
the interests of credit policy effectively without actually producing
any material change in long-term prices or yields. Moreover, expectations differ in kind, varying from a predominantly speculative
character under some circumstances to a predominantly investment
character in others, with the result that'both credit policy and debt
management must be sensitively attuned to the nature of prevailing
expectations, as well as to their intensity.
To illustrate, if large blocks of longer-term Government securities
should be lightly held, as was clearly the case through the first 2 or 3
years after the completion of the Treasury's enormous wartime financ
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ing, any vigorous attempt by the Federal Reserve to back away from
such securities when they were offered for sale would lead to expectations of a severe decline in the market and might cause a great volume
of panic selling. To avoid chaotic repercussions throughout the securities markets, and to avert a paralysis of the orderly capital
financing that is needed to sustain economic activity at high levels,
the System might be forced to step in to make substantial purchases.
I t would then have to rely upon offsetting sales of very short-term
securities to those who were nervous about long-term security prices
(or upon Treasury redemption of System-held securities if the Government should then be enjoying a cash surplus) in order to reabsorb
the Federal Reserve credit created by its purchases of longer-term
securities. But if the holders of longer-term securities should be predominantly investors concerned mainly with the long-term yields from
sustained holding (as was the case in the spring of 1951), the Federal
Reserve can readily absorb any lightly held fringe of longer-term
securities by carefully calculated scale-down purchases, can offset the
Federal Reserve credit thus created by sales of shorter-term securities
at rising yields, and can then let the market bottom out on its own.
The results of these differing forms of restraining action will follow
the general patterns outlined in the reply to question 14.
The important point to recognize is that the approach to credit
restraint must be conditioned by the state of prevailing expectations,
and often primarily the expectations of nonbank investors. Another
aspect of nonbank-investor psychology that gave strength to credit
restraint in recent months was the growing realization among many
of the larger investors that they must themselves accept an attitude
of responsibility toward the market. Holding large blocks of longerterm Governments, many of them were individually capable of producing sharp price declines if they should attempt to unload heavily
in an abrupt manner. Recognizing that, some were persuaded by the
expectation of capital losses (as a result of sales at prices which would
be lower than those currently quoted in the market) to continue their
holdings of Governments and to limit their commitments for new
credits to the volume of their own currently arising inflow of new
savings or debt repayments. Others spaced or reduced their offerings and were thus able to obtain funds through the market from other
investors without sharp repercussions on prices. The net effect was
to permit the System to hold the volume of Federal Reserve credit,
and in turn the aggregate volume of money and credit, within bounds
that were consistent with the prevailing level of prices.
From the Treasury's viewpoint, the rising interest rates associated
with credit restraint raised the problem (also alluded to under question 14) of investor reluctance to accept a given Treasury financing
offering. I n the investor's view, delay may mean a better return a
few weeks later. But a Government securities market that is on its
own will actually reflect the balanced effect of such expectations in its
current pricing. When credit demands are heavy and investors understand that Federal Reserve credit will not be supplied (through the
Government securities market) to support financing of a total demand
in excess of the economy's physical capacity valued at current prices,
the market itself will find the prices (and yields) that are consistent
both with the available credit supply and the Treasury's projected
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financing needs. And under those circumstances, although admittedly
a high degree of skill in debt management and some measures of technical—but temporary—market stabilization will be required, the
Treasury can successfully place its offerings provided they are tailored
to the market. The market mechanism, and credit restraint as well,
would only break down if the setting were reversed, and new credit
were pumped out to tailor the market to the terms chosen for a .given
Treasury offering.
Another characteristic investor reaction to rising rates may be a
general shift in preferences to shorter-term issues. That, too, will
be reflected in market prices and yields, and is likely to mean that
Treasury financing, as well as any needed System sales in the interest
of general credit restraint, may often be concentrated largely in the
shorter-term sector of the market during periods of credit tightening.
The shorter-term sector has also been increasingly strengthened in
recent years by a growing interest of business concerns in Government
securities as a suitable lodgment for funds (including their tax acruals) not immediately required in the conduct of their businesses. I t
is significant that this interest developed on an important scale after
short-term rates had risen markedly above the arbitrarily low levels
at which they had been pegged during and immediately following
World War I I .
As stressed at the beginning of the reply to this question, there is
no single or set pattern of nonbank investor demand for Government
securities and for other types of loans or investments. General business conditions as well as the condition of each individual investor
will exert a changing over-all influence upon such demand. But the
brief resume given here should serve to illustrate the manner in which
credit controls, which produce changes in interest rates, and in expectations concerning investment opportunities (including possible further changes in interest rates), also exert a strong influence upon the
investment decisions of nonbank investors. The relative importance
of actual rates, or expectations, or other factors, will vary considerably. A l l of these aspects must be kept under close observation, and
continuously tested through the price mechanism of the Government
security market, the money market, and the capital market, if credit
policy and debt management are to be effective in meeting their common
objectives.
18. What is the reason for the relatively slight use by commercial
banks of the Federal Eeserve discount and borrowing privilege!
Do you believe that greater reliance should be placed on this
privilege as a means of obtaining Federal Eeserve credit? Under what conditions, if any, would you expect to see a greater
use made of the discount privilege ?
Joint answer
The limited use by commercial banks of the privilege of borrowing
from the Federal Eeserve banks in recent years is primarily attributable to the ability of the banks to obtain adequate amounts of reserve
funds from other sources, but is partly attributable to the rather general reluctance of bank managements to rely upon borrowed funds
at least for more than very short periods. Continued indebtedness
has long been considered by most banks as an indication of an over
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extended position, and the reluctance of bank managements to show
indebtedness in their statements of condition was accentuated by the
serious banking difficulties of the early 1930's. I n their efforts to
avoid borrowing, the banks usually tend to extend credit less freely
when they are in debt to the Reserve banks.
During the depression of the 1930's, the Federal Reserve System
took action through open market operations to provide the banks with
ample reserve funds to enable them to repay any indebtedness and
to accumulate fairly sizable amounts of excess reserves so that they
would be in a position readily to supply their customers' needs for
credit. From 1934 to 1940, inclusive, the heavy inflow of gold from
abroad resulted in the accumulation of a huge volume of excess bank
reserves which became widely distributed throughout the country, and
as a result there was so little occasion for the banks to borrow that they
became unaccustomed to that method of obtaining reserve funds.
Furthermore, after the serious banking troubles of the early 1930's,
many banks feared to have it become known that they were borrowing
lest their customers interpret their indebtedness as a sign of weakness.
After the United States entered World War I I , the heavy public
demand for currency, some outflow of gold, and the large increase in
the banks' reserve requirements that accompanied the growth in their
deposits quickly depleted the banks' excess reserves. Measures were
then taken to ease the pressure on bank reserves; moderate reductions
were made in the percentage of reserve requirements of central reserve city banks whose reserves were under the heaviest pressure,
and Government deposits in the banks were exempted from reserve
requirements. Nevertheless, the banks needed large amounts of additional reserves and, despite the fact that the Federal Reserve banks
established the unprecedentedly low rate of l/ 2 percent on advances to
member banks secured by Government obligations maturing in 1 year
or less, their reluctance to borrow limited the extent to which they
took advantage of this extremely cheap sources of reserves, and the
banks obtained most of the reserve funds they needed by selling shortterm Government securities. The banks obtained reserves in part
by sales of Treasury bills to the Reserve banks at the fixed rate of %
percent which was maintained from 1942 to 1947, and in part by
sales in the market of other Treasury securities, which the Federal
Reserve System was forced to buy in order to maintain the structure
of interest rates adopted by the Treasury in 1942 for the period of
the war financing.
After the war, the gold inflow was resumed and continued virtually without interruption until the fall of 1949, reaching a total
for the postwar period of approximately $5 billion. I n addition,
there was a moderate return flow of currency to the banks after 1946,
which also added to the supply of reserve funds available to the banks.
The main problem of the Federal Reserve System during most of this
period was to prevent a plethora of reserve funds from leading to a
further inflationary growth in bank credit and the money supply,
following the very large increase during the war. Total Government
securities held by the Federal Reserve banks were reduced by more
than $6 billion in this period from the beginning of 1946 to the
autumn of 1949, which had the effect of absorbing a like amount of
reserve funds. I n the process of reducing its holdings by redemptions
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and sales, the Federal Reserve System succeeded, with the aid of
Treasury surpluses, in keeping the reserves of the commercial banking system under recurrent moderate pressure, but the tradition
against borrowing weakened only gradually. A practice that came
into more common use in that period was interbank borrowing of reserves, or Federal funds, which are traded at rates at least slightly
lower than the Federal Reserve discount rate.
During the recession of 1949, the Reserve System took action to ease
the reserve position of member banks somewhat and to make it unnecessary for the banks to borrow any considerable amount. This
policy gave way to a firmer credit policy as business recovered and
signs of inflationary tendencies reappeared. But as long as the System
maintained fixed prices of Government securities, the commercial banks
could obtain most of the reserve funds they needed as the basis for
credit expansion (or to offset gold outflows) by selling Government
securities indirectly to the Reserve banks through the market. The
only way in which the System could have forced the banks to obtain
the reserve funds by borrowing would have been to have refrained
from buying the Government securities offered for sale by banks and
other investors in the market, regardless of the effects on Government
security prices and interest rates.
W i t h the accentuation of inflationary pressures that followed the
outbreak of war in Korea and the development of a greatly expanded
national defense program, the Federal Reserve System endeavored to
restrict its extensions of Federal Reserve credit through open-market
operations in order to curb the growth in bank credit, and in March
1951, by agreement with the Treasury, withdrew its intervention in
the Government security market except to the extent necessary to maintain orderly market conditions. While borrowing by member banks
has become somewhat more frequent, most banks continue to show
reluctance to borrow for more than a few days at a time, if at all, and
continue to resort to sales of Government securities to meet other than
their temporary needs for reserve funds. But when the Reserve banks
are not buying securities freely and market prices are not assured, the
banks tend to extend credit less f reely and with greater discretion.
From this brief review of past experience, it may be concluded that
whether or not greater reliance should be placed upon member bank
borrowing from the Federal Reserve bants as a means of obtaining
Federal Reserve credit depends upon the general economic situation.
I n times of recession in business, employment, and prices, it would be
undesirable to require banks to borrow in order to obtain Federal
Reserve credit, as the banks' aversion to borrowing would discourage
them from extending readily the credit needed by their customers.
Lending by the Reserve banks at low interest rates in such periods
might reduce somewhat, but would not fully overcome, this tendency.
On the other hand, in boom periods, when credit expansion needs to
be discouraged to restrain inflationary pressures, forcing banks to
borrow to obtain Federal Reserve credit works in the right direction.
When banks borrow from the Reserve banks, they realize that they
are dependent upon Federal Reserve credit for part of their loanable
funds, whereas if they sell Government securities in the market and
the securities are absorbed by the Federal Reserve System, there is
not the same realization, if any, of dependence upon Federal Reserve
credit, and, consequently, less restraining effect. Furthermore, sales
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of securities provide permanent additions to loanable funds, while
funds obtained by borrowing are usually regarded as repayable at
an early date. The restraining influence of borrowing will be enhanced if discount rates are high enough to reduce the profitability
of using borrowed funds for the extension of credit. The lower the
discount rate, the less the effectiveness of such a policy.
We would expect greater use to be made of the discount privilege
only if the commercial banks have difficulty in obtaining the reserve
funds they need by other means. Such a situation would be most
likely to prevail if a "neutral" open-market policy were being followed
by the Federal Eeserve System and demands for credit and currency
were increasing, with no offsetting elements in the situation, or if a
strongly restrictive credit policy involving net sales of securities were
followed by the Federal Eeserve System.
19. Do you believe that there is any conflict between measures to restrain excess demand by credit control and the need for expanding the economy to meet the requirements of a continuing readiness to resist aggression and a continuing high standard of
living? I f so, how can the effects of this conflict be mitigated?
Joint answer
There is no real conflict between the use of credit controls to restrain
excess demand and an expanding physical volume of production. The
reference to "excess demand" in this question presumes a situation in
which the demands for goods and services at current prices are beyond
the current ability of the economy to supply them. Expansion of the
productive capacity of the country to meet the combined requirements
of a large national defense program and a continuing high standard of
living in such circumstances is likely to require the diversion of materials and manpower from the production of end products to the
creation of additional productive facilities. Consequently, during
the process of expanding capacity, there is likely to be an intensification of shortages of end products. For example, if more steel and
copper are used for the building and equipment of new plants, less w i l l
remain for the production of such things as automobiles, household
appliances, and homes.
The measures needed to deal with such a situation include fiscal
policies designed to reduce the disposable income of the public, monetary policies designed to discourage credit expansion that would enlarge effective demand, and other measures designed to direct the use
of resources from less essential to more essential purposes. Competitive efforts to expand in all directions at the same time would accentuate inflationary pressures and would be definitely undesirable.
Hence, credit restraints are an essential element in an appropriate
economic policy under the conditions stated, as they can play a useful
role in dampening competitive demands for scarce resources, and in
that way exert a restraining influence on inflationary pressures. There
would be no thought, however, of applying credit controls to a degree
that would prevent maintenance of the highest standards of living
practicable in the circumstances. Any reduction of living standards
would be the result of diversion of physical resources to defense purposes, not jthe results of credit controls to restrain excess demand.
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I n the circumstances stated, it may be useful, as indicated in the
reply to question 16, to supplement general credit controls with other
credit measures, such as consumer credit regulation and a voluntary
credit restraint program designed to channel credit and capital into
the financing of the more essential activities. I f needed, Government
uaranties may also be used as an additional means of assuring the
nancing of essential activities as in the case in the " V loan" procedure with respect to the financing of defense contracts. The objective
of such programs would be to supplement other controls in directing
limited resources into the most essential uses.
G
20. What do you believe to be the role of bank examination and supervision in furthering the objectives of the Employment Act? 2
Joint answer
The role of a bank examiner is essentially that of a fact finder. H e
determines whether or not the operations of the bank under examination conform appropriately to statutes and regulations, and reports
any violations noted to his superior, the supervisor. I n addition, the
examiner is charged with evaluating the assets of the bank in an effort
to inform the supervisor whether the institution is solvent, whether
its credit and investment policies are such as to endanger its solvency
and destroy its ability to serve the banking needs of the community.
The appraisal of the condition of a bank is made in the light of local
current and prospective economic conditions and the quality of the
management. The nature and degree of exposure to possible loss in
the loan, investment, and other operations of the bank are carefully
appraised in order that risks deemed disproportionate to the moderate
protection to creditors afforded by the capital funds may be reduced
and the bank enabled to serve the reasonable needs of the community
without undue jeopardy to its depositors and other creditors. The
examiner is also charged with the duty of reporting on the competence
of the management. Thus the examiner is concerned solely with the
condition of each individual bank rather than with the condition of
the banking system as a whole.
The supervisor, whether appointed under authority of the Federal
or State statute, is the official or institution charged with the administration and enforcement of the banking laws and regulations and
with the initiation and carrying out of efforts to obtain correction of
unfavorable trends as revealed by findings of the examiner. The
objective of bank supervision is threefold:
1. To see that the public is provided with adequate banking
services;
2. To enforce the banking laws of the legislative body under
which his office operates; and
3. To maintain solvent and effective banking institutions.
Ready access to deposit and checking account facilities and to a
reliable source of credit is essential to the effective functioning of free
enterprise. To the extent that bank supervision achieves its objectives it contributes to those "conditions under which there will be
2
T h e objectives of the Employment Act as set f o r t h i n sec. 1021 thereof a r e : " C r e a t i n g
and maintaining, i n a manner calculated to foster and promote free enterprise and the
general welfare, conditions under which there w i l l be afforded useful employment opportunities, including self-employment, for those able, willing, and seeking to work, and to
promote m a x i m u m employment, production, and purchasing power."
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afforded useful employment opportunities" and the other collateral
objectives of the Employment Act. Otherwise, the role of bank examination and supervision in furthering the objectives of the Employment Act is indirect and difficult to trace.
I n past periods of business recession the examiner and his superior,
the supervisor, have been accused of augmenting deflationary tendencies by bringing additional pressure for liquidation. His influence
in this direction tends to increase because the uneasiness of bankers
over prospects renders them more willing to conform to the supervisor's criticisms, just as in prosperous times bankers frequently discount the supervisor's cautions. The supervisor and his field representative, the examiner, are concerned with the soundness of the bank
assets in those periods when inflationary pressures are predominant
just as they are when deflationary pressures are predominant. One
of the important problems of examination and supervision is the establishment and maintenance of standards of appraisal of assets which
will not reflect unduly the swings of the weather vane of business
sentiment.
Comment of Rwy M. Gidney, Cleveland
I n the statements of the objectives of bank supervision, the joint
reply has as No. 1, "to see that the public is provided with adequate
banking services." I do not understand that the supervisory authorities have considered that they have a responsibility to promote the
organization of banks. I t has usually been assumed that free enterprise in banking would bring about organization of enough banks to
meet the reasonable needs of the public. I take the joint reply to mean
that the supervisory authorities, particularly those who have the right
to give or withhold bank charters, should have among their objects
the adjustment of the number of banks and banking offices, to provide
for both successful operation and good service to the public.
Comment of Hugh Leach, Richmond
The first of the three objectives of bank supervision given on
page 703 of the joint answer—"To see that the public is provided
with adequate banking services"—is interpreted as meaning that supervisory authorities give considerable weight to adequacy and availability of banking services when considering applications for permission to open new banks or to establish additional branches of
existing banks. This should not be considered as implying that supervisory authorities do or should look upon themselves as "prime
movers" in the organization of new banks or branches.
21. What do you consider to be the role of selective regulation of
consumer credit in restraining inflation under the conditions
of each of the assumptions with respect to the magnitude of
Government borrowing stated in question 16 ? What attention
should be given by the controlling authority to inventories and
price and employment changes in the particular industries afrected by the regulation? Discuss the operation of regulation
W since its revival in the fall of 1950.
Joint answer
The various selective credit regulations are a supplementary type
of control instrument which should be used as needed as an adjunct
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to general credit and monetary measures to enable the System to
achieve most effective control over the volume and use of credit. Selective credit controls are not substitutes for general credit and monetary measures, nor do they in any degree minimize the importance
of achieving effective use of general controls. I n an inflationary situation, the ability to apply restraints upon particular types of credit
may be of considerable significance in an over-all anti-inflation program, but such selective credit regulations are of necessity limited
to a few areas. They cannot do the job that must be done through
restraints upon the creation of additional bank reserves plus an adequate fiscal policy.
When general credit and monetary measures bring about a balanced
credit situation from the standpoint both of the economy as a whole
and of the various sectors of the economy in which particular types
of credit are important, the need for selective instruments of control
is either reduced, or possibly eliminated. I n the past, despite the
use of general credit and monetary measures, unsound credit developments have occurred in different sectors of the credit economy, and it
is probable that they will occur in the future. Under such circumstances, the central bank, if it has authority to use selective controls,
may be in a position to operate in certain sectors that for one reason
or another are not being effectively restricted through the use of the
general types of control. I n addition, the use of selective controls
enables the central bank to supplement general controls in influencing
to some extent changes in the velocity of money, for they offer the
possibility of more specialized control over the use of funds in some
of the particular sectors of the market in which wide variations in
velocity may be most likely to occur. I t would appear that if the
central bank should be prevented, for one reason or another, from
using general credit and monetary controls for the purpose of restraining the availability and cost of bank reserves, there would be
an even greater need for the use of selective instruments of control
as supplementary devices. Unfortunately, however, it is not practicable to apply selective credit controls except in limited areas, and
without an appropriate general credit policy, the effectiveness of any
selective measure would be greatly impaired.
Questions 21 through 25 refer to the role of various selective and
supplementary credit control instruments under differing conditions
of Treasury fiscal requirements. Inasmuch as the same principles are
involved in each of the cases raised in these various questions, a general
statement may be useful at this point.
I n general, certain basic tests might be relied upon to determine the
need for and the particular type of selective credit control that would
be most effective under the circumstances. First, how effective are
general credit and monetary measures in bringing about a balanced
credit situation in the economy ? Second, how strategic and important to the stability of the general economy are those expansive developments which might occur in a particular sector ? Third, how extensive is the use of credit in that sector of the economy, and how widely
does its volume fluctuate ? Fourth, is it administratively feasible to
exercise effective selective credit control in the particular sector of the
economy in which expansive excesses appear to be developing ?
I n line with these tests, the role of selective regulation of consumer
credit in restraining inflation at a time when the Treasury is not in
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the market as a borrower would be less important than under the other
alternative conditions indicated in the question. Even in this circumstance, however, conditions might exist or develop—wholly foreign to
Treasury financing requirements—which might make the application
of selective regulation of consumer credit desirable. I n other words,
determination of the role and need for selective control of consumer
credit or any other selective credit-control device must be measured
in terms of and in relation to all influencing conditions in the market
and not merely with regard to Treasury financing requirements.
I f the Treasury were forced to enter the market as a large borrower,
the role of consumer credit regulation might become more important,
the degree of importance depending upon the extent to which Treasury
debt management policies were coordinated with general credit and
monetary measures to limit to a minimum the development of inflationary forces. Even under this circumstance, however, all other
factors influencing the consumer credit market would need to be taken
into consideration; the judgment should not be based merely upon
Treasury financing.
Under conditions of total war, the role of selective regulation of
consumer credit would be influenced^rgely by the severity and effectiveness of noncredit direct controls. The problem of preventing an
expansion in the volume of consumer credit and an excessive demand
for consumer durable goods would be reduced in proportion to the
severity and effectiveness of direct controls covering consumer durable
items. I f consumer durable goods were effectively and severely rationed, it is questionable whether the threat of an expansion of consumer credit for the purchase of such goods would be very serious,
although such credit restrictions might help to relieve the strain upon
direct controls. I n other words, the greatest need for the application
of selective control over consumer credit will tend to occur when the
desired goods are available to consumers without direct restriction
other than that which is naturally imposed by a short supply of such
goods.
Inasmuch as inventories of consumer goods, prices of consumer
goods, and employment in the consumer goods industries reflect developments and conditions in those industries, these factors should
be given consideration in connection with the administration of consumer credit regulation. A l l other relevant factors, however, also
must be given careful consideration, and in the final analysis the ultimate test of the effectiveness and appropriateness of the regulation's
terms must be measured by their impact on credit conditions. Administration of consumer credit regulation during a period of general
inflation has as its objective the limiting of the availability of consumer credit in a manner that is most consistent with the over-all credit
policy. Therefore, inventories, prices, and employment cannot be
considered as the only test of the soundness of the regulation—or possibly even the most important test—but merely one set of conditions
which, along with others, is carefully studied to appraise the effectiveness of this particular type of credit control.
I n a free-enterprise system, "rationing" of goods and services is
accomplished through the price system. On the surface, it may appear that regulation W is more restrictive against those with lower
incomes than against those with higher incomes. However, such a
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view rests on the assumption that all demands can be satisfied without
price increases. But, with increased defense demand, some things
will have to be foregone by someone. Without higher taxes and restraints upon credit expansion, those with lower incomes and smaller
savings would be the first to be priced out of the market. I n addition,
price increases would further lessen the purchasing power of their
savings bonds, their bank accounts, and their life insurance. I t is the
man with small savings who is least able to protect his savings against
the ravages of inflation, and who most needs the additional protection
against credit-inflated prices that a selective regulation of consumer
credit affords.
Although it is never possible to single out one instrument of credit
control from many others and measure its effectiveness without regard
to the possible effects of other credit controls in operation, it would
appear to be more than mere coincidence that the increase in the
volume of consumer credit outstanding began to level off with the
application of regulation W and actually declined during the first 7
months of 1951. This same pattern prevailed with respect to installment credit and would seem to indicate that regulation W has played
a valuable part in the effort to control the total volume of credit and,
particularly, to limit excesses in the consumer credit sector of the economy. I n addition, the majority of reports received from those who
have been affected by the regulation appears to indicate that the application of this form of credit control has had a notable restraining
influence upon demand in this particular consumer goods sector of
the economy.
Comment of Ray M. Gidney, Cleveland
I agree substantially with the comment in the joint reply that—
selective credit regulations are a supplementary type of control instrument which
should be used as needed as an adjunct to general credit and monetary measures
to enable the System to achieve most effective control over the volume and use
of credit. * * * Selective credit controls are not substitutes for general credit
and monetary measures, nor do they i n any degree minimize the importance of
achieving effective use of general controls.
However, I do not consider these controls to be as useful or effective
as supplementary devices as the joint reply infers. I t is too easy in
practice to turn to selective controls as alternatives or supplements to
inadequate general policies. I n such cases either they are ineffective
or they may have to be applied so severely as to penalize unduly certain types of credit and of economic activity. To the extent that they
may be effective, their impact is felt directly by such a large number
of persons as to subject the administrative authorities and the Congress
to pressures sufficient to compel modification. Recent legislation
affecting regulations W and X is illustrative of this point. I n addition, the difficulties of administration, particularly of regulation W ,
are so great as to lead me to doubt the efficiency of this device except
when accompanied by effective general credit policy and by controls
directly affecting production and distribution of articles affected by
the selective credit controls. I n such a situation the need of selective
credit controls becomes much less apparent.
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22. What do you consider to be the role of selective regulation of realestate credit in restraining inflation under the conditions of each
of the assumptions with respect to the magnitude of Government
borrowing stated in question 16 ? Discuss the operation of selective regulation of real-estate credit during the past year.
Joint answer
Certain unique characteristics of the real-estate market are especially significant. First, because of the durability of houses and other
structures, the number of buildings in existence at any time is much
larger relative to new construction than is true of consumer durable
goods, even automobiles; thus credit restrictions in this field should
not be limited to construction. Second, price control and rationing
are not administratively applicable to houses or other structures
(except for rentals), and consequently prices of houses and other
structures are likely to rise sharply in an inflationary period and the
demand for real-estate credit may be maintained even when there are
direct restrictions of other sorts upon new construction.
Real-estate credit restrictions need not run counter to national policy
calling for aid to low-income groups through public housing or aid to
veterans through financing made possible by Government guaranties.
The extension of Government aid by whatever measures in the field
of housing clearly is a matter of congressional decision. I t should
be recognized, however, that to expand the demand for housing at a
time when the construction industry is operating virtually at capacity
(or up to the limits of available supplies of materials after meeting
the needs for war and defense) will result only in higher prices, not
more houses. These price increases in turn intensify the housing
problems of the very groups the Government is seeking to aid.
The position of the Treasury is not the sole determinant of the usefulness of selective regulation of real-estate credit in restraining inflation. Under the assumption that the Treasury will not be a borrower
in the market in the foreseeable future, selective regulation of realestate credit would.be relatively less important than when the Treasury
should be actively in the market for credit. A balanced Treasury position, such as might be expected under this assumption, would tend to
remove one strong potential inflationary force. To determine, however, whether real-estate credit regulation of a selective type would be
necessary would require thorough analysis of all factors influencing
the market. I n the event of inflationary developments, general credit
and monetary measures should be more effective if the Treasury has
no occasion to enter the market, and consequently a relatively firm
money-market condition might be maintained, thus tending to prevent
diversion of excessive amounts of credit into real estate.
I f the Treasury were to be a substantial borrower in the market and
if its debt-management policies were of such a nature as to lead to an
increase in the money supply and to inflationary pressures, the need
for selective regulation of real-estate credit would become increasingly
important; but without an effective general restraint upon credit, the
anti-inflationary effect of such a selective regulation could not be great.
Under conditions of total war, selective regulation of real-estate
credit should be a valuable aid in restraining inflation in the real-estate
market. During total war it might be assumed that construction of
new properties would be limited and that housing shortages would
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begin to appear. Moreover, if war damage should result to properties
in this country, the pressure for housing and nonresidential accommodations would increase very markedly, thus imparting an inflationary
bias in that sector of the economy. I n fact, it is virtually certain that
direct controls of a noncredit nature, in addition to selective regulation of real estate credit, would become necessary under conditions
of total war.
Selective regulation of real-estate credit has not been in effect long
enough to permit a reliable judgment concerning its effectiveness.
Moreover, during the period a number of extraneous but closely related developments have affected real-estate trends. For instance,
during the first several months of the regulation the exemption of
prior commitments resulted in a large number of units being outside
of the coverage of the regulation. Also, the very large amount of
commitments outstanding by lenders tended to restrain the full effectiveness of the regulation. I n recent months, however, there have
been indications, according to reports received from builders and
lenders, that the regulation is taking hold more effectively. Even in
this respect, however, the extent to which the increase in effectiveness
is due to the tighter conditions which have been brought about in
the money market through general credit and monetary measures, or
to the regulation itself, may be subject to question. I t is probable,
however, that the limitations that the regulation places upon realestate credit have been important in reducing the effective demand for
both residential and nonresidential properties and have been a contributing factor in reducing the amount of building construction from
the very nigh 1950 level.
During the past year no particularly difficult problems have developed in connection with the administration of the regulation. I n
fact, registrants, including builders, lenders, and contractors, have
shown a high degree of compliance and cooperation.
On the whole, this type of selective regulation seems to meet the
principles indicated in question 21 that should be considered in determining the applicability of selective instruments of control. I n
brief, the selective control of real-estate credit was delayed in its
impact because of the large number of commitments outstanding at
the time of its introduction in October 1950. After March 1951,
fgeneral credit controls probably were a greater factor than the seective control in curbing the flow of new credit into purchases of
real estate. But the selective control has undoubtedly helped to
direct the impact of restraint upon the new construction sector of the
residential real-estate market, where credit has more often been freely
f ranted. A more reliable appraisal of the role of regulation X ,
owever, probably cannot be made until more experience under the
operation of the regulation has been obtained.
Comment of Ray M. Gidney, Cleveland
I believe that control of real-estate credit as provided for under
the Defense Production Act of 1950 has been somewhat helpful in
reducing the activity in residential construction growth and consistent with the aim of reducing the use of materials used in building
more closely to the quantities available in the circumstances for that
purpose, Jlowever, I believe also that in the fourth Federal Reserve
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district the accomplishment in reducing housing construction was due
more to the tightening of the money market and the greater difficulty
in obtaining mortgage financing after the change in the open-market
policy of the Federal Reserve System than it was to the real-estate
credit controls.
23. What do you consider to be the role of selective regulation of
stock-market credit in restraining inflation under the conditions
of each of the assumptions with respect to the magnitude of
Government borrowing stated in question 16?
Joint answer
The selective regulation of stock-market credit through the authority to regulate margin requirements on loans for the purpose of purchasing securities registered on a National Securities Exchange has
proved to be an administratively feasible and valuable selective instrument of central bank credit control. Throughout the past several
years of strong inflationary forces in the general money market and
in other sectors of the economy, and excessive use of credit in the
securities markets has been prevented, and, consequently, inflationary
developments in that particular area of the economy have been kept
to a minimum.
The role of selective regulation of stock-market credit in restraining inflation would be less important when the Treasury is not faced
with the necessity of obtaining new money from the banking system
or engaging in large refunding operations. Again, all other factors,
however, which might have a bearing upon the money supply would
need to be considered fully.
I f the Treasury were in the market as a substantial borrower for
new-money purposes, the role of selective regulation of stock-market
credit would take on added importance. Under such circumstances,
inflationary pressures would tend to be aggravated and, unless offset
by wholly effective general credit and monetary measures, would lead
to additional inflation and to the development of an inflation psychology. Whenever an inflation-mindedness develops, public interest
in equities as an inflation hedge increases. As more people attempted
to protect themselves against a declining value of the dollar—real or
anticipated—speculative purchases of equities would be likely to be
stimulated, and the role of stock-market credit regulation would become more important. Regulation of stock-market credit, by affecting the demand for stock-market credit rather than the total supply
of credit available, would not tend to raise interest rates. Thus it
would tend to facilitate rather than hinder Government financing.
Price controls and rationing are not applicable to the securities
markets. Therefore the possibility of a substantial credit expansion
in that area is increased by total war or preparation for war, which
limits the supplies of consumption goods and services. Purchasing
power may well be diverted to the stock market if the fear of rising
prices increases the demand for stocks as a hedge against inflation.
A total war would lead to an increase in the money supply relative
to available goods and services; inflationary pressures would be strong
even under most effective credit, monetary, and fiscal policies; and
anticipation of a further decline in the dollar would tend to divert
credit into equity securities. I n general, the principles outlined in
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question 21 apply with equal force to the selective regulation of stockmarket credit.
24. What selective regulations, other than those over consumer credit,
real-estate credit, and stock-market credit do you consider to be
feasible? What would be their applicability under the conditions of each of the assumptions with respect to the magnitude
of Government borrowing stated in question 16 ?
Joint answer
The feasibility of selective regulations other than those applicable
to consumer credit, real-estate credit, and stock-market credit should
be judged on the basis of the four tests outlined in question 21. These
are as follows:
1. The effectiveness of general credit and monetary measures in
bringing about a balanced credit situation in the economy.
2. The strategic position and the importance to the stability of
the general economy of expansive developments which might occur
in a particular sector.
3. Extensiveness of the use of credit in that sector of the economy and the extent of its fluctuation in volume.
4. Administrative feasibility in exercising effective selective
credit control in the particular sector of the economy in which
expansive excesses appear to be developing.
Inasmuch as selective regulations are supplementary to general
credit and monetary measures, no additional selective regulations
should be undertaken unless it is evident that general credit and monetary measures need the additional reinforcement provided by such
regulations in order to achieve reasonable economic and credit stability. Every effort should be made to achieve this satisfactory degree of
stability through the general measures, for, otherwise, a multiplicity of
direct controls over credit will introduce into the financial and economic system an undersirably large amount of governmental or official
intervention, with all of the inflexibilities and inequities that would
be inherent in such a development.
I n the area of real-estate credit control, the extension of regulation
X to existing properties, that is, to houses and other structures begun
before August 3, 1950, would be administratively feasible. From the
standpoint of the anti-inflationary objectives of real-estate credit control, it is essential to include old structures as well as new. A very
substantial share of the credit in this area is, in fact, extended in connection with transactions involving such properties. The only basis
for distinction between new and old properties rests upon the objective
of facilitating the diversion of materials to the defense program.
Short of conditions of total war, no additional selective regulations
are needed, for it should be possible, assuming that there is an adequate
fiscal program and a reasonable coordination of Treasury debt management policy with general credit control objectives, to secure a satisfactory degree of economic and credit stability through general credit
and monetary measures plus the supplementary selective devices which
already have been legislated. Even under conditions of total war,
except for extending real-estate credit regulation to include existing
structures, there is some question as to whether additional selective
regulations would be needed or whether the regulation of consumer
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credit, real-estate credit, and stock-market credit, together with a
strengthening of the voluntary credit-restraint program, would not
prove adequate.
Conceivably, selective regulation of credit might be applied to the
commodity markets, to inventory and other business loans, and to
agricultural loans. I n terms of the first principle stated above, none
of these selective devices should be considered favorably unless distortions develop in these areas which cannot be reached effectively
through general means of control. I n that event, it would become
necessary to consider the feasibility and necessity of these different
types of selective control in terms of the remaining three principles
that have been previously stated.
Credit is not used extensively in futures trading in the organized
commodity markets; and, therefore, on the second principle of the
determination of the propriety of selective control, extension of selective regulation to commodity trading would not be justified. Moreover, inasmuch as the Commodity Exchange Commission already has
rather extensive authority over speculative commodity trading, this
would appear to be a matter for the Department of Agriculture's
consideration, rather than the central bank.
Selective regulation of inventory and business loans, as well as
agricultural loans, would pose such difficult administrative problems
that it would probably not be effective if inaugurated on a formalized
basis, with responsibility for the determination of proper loans resting
with a governmental agency or with the central bank. These problems
are further discussed in the replies to questions 32 and 33, below.
A n approach to the same objective that would be sought through
selective regulation of these types of credit is being obtained
under the more flexible voluntary credit-restraint program, which
establishes certain patterns of lending on a recommended basis and
permits the individual lender to carry out his operations in compliance with that pattern.
We conclude that selective regulations other than those over consumer, real-estate, and stock-market credit are neither feasible nor
desirable.
Comment of Ray M. Gidney, Cleveland
On this question the suggestion is made that—
in the area of real-estate credit control the extension of regulation X to existing
properties * * * would be administratively feasible
and—
from the standpoint of the anti-inflationary objectives of real-estate credit
control, i t is as essential to include old structures as well as new.
I agree that inclusion of existing properties probably would be administratively feasible though productive of restraints and frictions
disproportionate to the benefits to be derived from such inclusion.
I do not believe that their inclusion is essential at this time. We are
informed that in the fourth Federal Reserve district lenders are
generally conforming to the terms' of regulation X on existing properties because of their own interests and also as a part of the voluntary
credit-restraint program.
Note on reply of J. N. Peyton, Minneapolis
[Mr. Peyton's reply omits the paragraph referring to futures trading in the organized commodity markets.]
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25. Explain and evaluate the voluntary credit-restraint program
which has been developed during the past year. What are the
precautions taken to insure fair treatment of competingfirms?
What do you consider to be the role of voluntary credit restraint
under each of the assumptions with respect to the magnitude
of Government borrowing stated in question 16 ?
Joint answer
Acting under section 708 of the Defense Production Act of 1950,
the President authorized the Board of Governors of the Federal Reserve System to encourage financing institutions to enter into voluntary agreements and programs to restrain credit where such restraint
will further the objectives of the act. The program and principles
for voluntary credit restraint were worked out by representatives
of the American Bankers Association, the Life Insurance Association of America, and the Investment Bankers Association of America,
in consultation with the Board of Governors, and have as their major
objective—
loan screening by a l l financing institutions i n the United States to eliminate
loans which are not necessary to financing the defense program and are not
essential to the needs of agriculture, industry, and commerce.
Although financing institutions are urged to cooperate in carrying
out the voluntary credit-restraint program, participation is entirely
voluntary; no financing institution is required to consult with any
voluntary credit-restraint committee; the identity of the applicant
for the loan need not be disclosed; and final decision with respect to
making or refusing a loan remains with the particular financing
institution.
A national committee of 12 members was appointed by the Board
of Governors for the purpose of considering the functioning of the
program and advising the Board of Governors with respect thereto.
Due regard was given in the appointment of the committee to a fair
representation for small, medium, and large financing institutions
and for different geographical areas. Regional commercial banking,
insurance, investment banking, and savings and loan committees were
appointed by the national committee to be available for consultation
with individual financing institutions and to assist them in determining the application of the program with respect to specific loans. An
official of a Federal Reserve bank is a member of each regional
committee.
The original statement of principles of the program and the six
subsequent bulletins which have been issued identify the types of
loans that are considered as being consistent with the objectives of
the program and the types of loans which should not be made under
present circumstances. I n general, the criterion under the program
for sound lending in a period of inflationary danger is: W i l l the
loan commensurately increase or maintain production, processing, and
distribution of essential goods and services?
Types of loans that are considered as proper under the program
include—
(a) Loans for defense production, direct or indirect, including
fuel, power, and transportation.
(&) Loans for the production, processing, and orderly distribution of agricultural and other staple products, including export
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and import as well as domestic products, and of goods and services
supplying the essential day-to-day needs of the country.
(c) Loans to augment working capital where higher wages and
prices of materials make such loans necessary to sustain essential
production, processing, or distribution.
(d) Loans to security dealers in the normal conduct of their
business or to them or others incidental to the flotation and distribution of securities where the money is being raised for any
of the foregoing purposes.
(e) Loans on securities covered by regulation T or U and all
loans on securities for purchasing or carrying unlisted securities
if the amount of the credit is no more than that permitted by
regulation T or U.
( / ) Loans required for the rehabilitation of disaster areas.
Types of loans that are considered to be inconsistent with the principles of the program include—
(a) Loans to acquire or retire corporate equities in the hands
of the public, including loans for the acquisition of existing companies or plants where no over-all increase in production would
result.
(b) Loans for speculative investments or purchases. The first
test of speculation is whether the purchase is for any purpose
other than use or distribution in the normal course of the borrower's business. The second test is whether the amounts involved are disproportionate to the borrower's normal business
operations. This would include speculative expansion of realestate holdings or plant facilities, as well as speculative accumulations of inventories in expectation of resale instead of use.
(<?) Loans on existing (non-regulation X ) residential (1 to 4
units) properties which would cause the total amount of credit
outstanding to exceed the limit imposed by regulation X on new
construction, or a limit of 66% percent of the fair value of the
property, whichever is the greater.
(d) Loans on multiunit residential property, commercial property, and agricultural property which would cause the total
amount of credit outstanding to exceed 66% percent of the fair
value of the property.
(e) Long-term business-capital expenditure financing for such
purposes as the construction of facilities to improve the competitive position of a producer of nonessential goods; expansion
and modernization of concerns in distribution or services not defense-supporting ; and expansion and modernization of manufacturers of consumer goods not related to the defense effort.
( / ) State and local government borrowing for the replacement of existing facilities that can continue to perform their
function during the emergency period; soldiers' bonus payments,
and recreational and other types of facilities not recommended
by the Defense Production Administration; acquisition of sites
or rights-of-way not immediately needed; and purchase of privately owned utilities by municipalities where borrowing is required to replace equity capital.
I t is very difficult, if not impossible, to appraise statistically the effect of a single instrument of credit control, such as the voluntary
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credit-restraint program, because of the multiplicity of factors and
the cross-currents which influence the demand for bank credit and its
availability. Moreover, there is no statistical way of ascertaining
what the amount of outstanding bank credit would have been during
any given period if particular credit-control instruments had not been
in effect.
I t is true, however, that the contraseasonal increase in commercial
and industrial loans of the weekly reporting member banks came to an
end at mid-March and coincided with the beginning of the voluntary
credit-restraint program; and that the increase in bank loans during
the third quarter of this year was much less than in the same period
in 1950.
Full credit for these developments obviously cannot be fairly attributed to the voluntary credit-restraint program; but, on the other
hand, neither should the program be discounted. The voluntary
credit-restraint program has made a worth-while contribution to credit
restraint, to the reduction of speculative loans, and to the channeling
of bank credit into defense, deiense-supporting, and essential civilian
uses.
Perhaps one of the most valuable contributions of the voluntary
credit-restraint program has been the fact that it has created a
consciousness in the minds of lenders and, in fact, many borrowers of
the importance of eliminating speculative loans and restraining nonessential borrowing. The program has received very wide support
from private lenders over the country. These lenders undoubtedly are
screening their loan applications much more carefully and selectively
than they did prior to the inauguration of the program. Moreover,
the wide publicity given the program in the press, on the radio, and
in financial journals has had an important educative and sobering
effect upon many borrowers, tending to induce them to limit their
loan applications to essential requirements. Many individual oral
reports bearing out these accomplishments of the program have been
received by Eeserve System officials.
Another advantage of the program has been that it has provided
private lenders with a sort of standard or yardstick by which they
may measure the acceptability of loan applications during a period
of national defense such as now prevails. I n other words, acceptability of a loan is not now being considered by most lenders merely
on the basis of its soundness from the standpoint of the individual
bank but, instead, is being considered on the basis of financial soundness plus its appropriateness and possible effect in terms of the
national economic situation.
Finally, the absence of detailed, burdensome rules and regulations
has enabled the program to operate with a degree of flexibility and
with a lack of inequity and injustice to individual borrowers that
would not be possible under a type of direct Government loan rationing. I t has been possible under the program for private lenders to
meet the bank-credit requirements of the defense program as it has
developed and the essential requirements of the civilian economy and,
at the same time, refuse to extend credit for nonessential or speculative purposes.
The problem of assuring fair treatment to competing firms under
the voluntary credit-restraint program has been met by the national
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and regional committees through their agreement upon a uniform set
of principles and their policy of acting upon all applications referred
to them on the single basis of whether the purpose of the particular
credit conforms fully to the principles of the voluntary credit-restraint program. The question of competition as between prospective
borrowers is of no significance to the voluntary credit-restraint committees; in fact, the lending institution is requested not to disclose
the name of the prospective borrower, except in the case of municipalities. On the other hand, fair and equitable treatment to every
borrower in terms of the principles of the program is a "must" that
the committees have consciously sought to achieve. Ifc>r instance,
an application submitted to a regional committee for approval of a
loan to restore a depleted inventory to a level normal for the particular
business would be considered as falling within the classification of a
proper loan, assuming that the type of business was not inconsistent
with the objectives of the defense program. On the other hand,
an application submitted for the purpose of building inventories
above normal levels and involving speculative inventory aspects
would be considered as a type of loan not appropriate under the
program.
The voluntary credit-restraint program is another of the types of
credit control that should be considered as supplementary to the basic
general credit and monetary measures. The prefatory general comment to question 21 is applicable with respect to the voluntary creditrestraint program.
I f the Treasury is not to be a large borrower in the-market in the
foreseeable future and if other forces influencing the market are not
such as to bring about an over-all inflationary situation, it might be
assumed that general credit and monetary measures were satisfactorily
effective, and the importance of the voluntary credit-restraint program as a restrictive measure would be relatively small. Under such
conditions it could be assumed that banks were extending credit
in such a manner as not to induce inflationary or speculative developments.
I f Treasury financing operations were of an inflationary character,
and if general credit and monetary measures were exerting an effective
restraint upon the over-all availability of credit, the importance of a
voluntary credit-restraint program would be increased because it
would provide guidance to banks for the allocation of that limited
credit supply in the national interest. The applicability and the role
of the voluntary credit-restraint program cannot be tied exclusively to
Treasury financing operations but should be related to the full set of
inflationary forces influencing the market and their strength. Moreover, in view of the wholly voluntary character of this program, a
reasonably effective general credit and monetary policy probably is
necessary to assure its successful operation.
The applicability and the role of the voluntary credit-restraint
program and the organization that has been set up to administer that
program might become very important under conditions of total war.
I f under these conditions it was decided that credit rationing was
necessary, as a supplement to the general credit and monetary measures, it could be administered much more efficiently, with less inflexibility and less inequity, through existing groups such as the national
and regional voluntary credit-restraint committees than through a
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centralized governmental body, assuming that the authority granted
to the committees—appropriately supervised—and the governmental
agency was the same. I n other words, if additional authority were
given to the voluntary credit-restraint committees in the event of
total war, these committees, with such modifications and additions as
might prove necessary, should be able to serve effectively in directing
the degree of credit rationing that might feasibly be imposed on the
banking system.
Comment of Ray M. Gidney, Cleveland
I am in general agreement with the joint reply. I believe that the
voluntary credit-restraint program has made a really significant contribution to economic stability. The program is collateral to other
anti-inflationary actions and depends on voluntary and enthusiastic
support of lenders. This suggests certain limitations on its use. Lenders must be satisfied that genuine efforts by monetary, fiscal, and debtmanagement authorities in particular, and all agencies of Government generally, are being made to mitigate inflationary forces as much
as possible and to cope with them where they exist. Relying as the
program does, in large part, on enthusiasm and patriotic appeal, it
cannot be long sustained in the face of policies which do not support
the efforts of the participants.
26. Discuss the use of moral suasion as a tool of credit control. How
has this been used in the cases of member banks and of savings
institutions, including life-insurance companies ?
Joint answer
There are different concepts of the meaning of the term "moral
suasion." I n the broad sense it encompasses the everyday activities
of Reserve System officials as they meet with bankers and others whose
operations are important to the immediate credit needs of business
and industry and to the money market and hence have an influence on
monetary and credit policy, or vice versa. Across-the-desk conversations between System official representatives and bankers take place
constantly, both within commerical banks and within Reserve System
offices, and Reserve System official representatives are constantly being
asked to make speeches. A considerable proportion of these acrossthe-desk conversations and of the speeches deals with the reasons behind monetary policy. The relationship of everyday business and
banking operations to the economy as a whole, the effect of the operations of large investors such as banks and insurance companies on
the Government securities market, and the necessity to consider the
effect of business, banking, and monetary policy on the public welfare
are never lost sight of in Federal Reserve activities. When banks
borrow from their Reserve bank, channels are always open for an
exchange of ideas as to the influence of additional reserves on the
economy under conditions that prevail at the time. More or less
formalized conferences between System personnel and bankers, businessmen, and others are employed to a considerable extent in the
efforts of the System to understand what those affected by monetary
policy are thinking and doing, and to afford an opportunity for an
interchange of ideas as to underlying situations and the need for and
possible effect of a given monetary policy. These activities are all
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part of the everyday functions of the Federal Reserve System. They
are directed at the development of a more general understanding and
do not constitute an attempt to force acceptance of System thinking
in any sense of the word, as a narrower concept of moral suasion might
imply.
Moral suasion, in this broad sense, is a valuable adjunct of the instruments of credit control. Its purpose is to give bankers, other
lenders, large users of credit, and the business community generally
a better understanding of the economy as a whole and the relation
of their activities to its functioning. I n this way it aims to make the
objectives of monetary policy better understood and more acceptable
to those whose activities it affects, and hence makes monetary policy
more effective.
These activities of the System have another important aspect.
They give Federal Reserve officials information on the current business situation and the reaction of bankers, businessmen, and others to
it and to monetary policy as well. This is an aid to the System in
developing better policy.
Moral suasion may also mean the pressure exerted upon member
banks or other financial institutions by the central bank (or conceivably by the Government) through appeals to reason and consideration of the common good, as an alternative prior to consideration of
more positive action.
Late in 1947 and continuing on into 1948 when inflationary pressures in the economy were very strong and the central banking authorities had indicated^1 the possibility of more restrictive credit
controls, the American Bankers Association urged its membership to
scrutinize applications for credit very carefully, to the effect that its
use would be restricted to that which would stimulate immediate
production and would avoid increasing the pressure on consumption
except in areas of large supply. I n particular, banks were urged not
to contribute to rising prices, fictitious values, or other inflationary
developments. While this program was not officially participated in
by the Board of Governors, it was supported as a highly desirable
undertaking. A t the same time, moreover, spokesmen for the Board
indicated some skepticism regarding the full effectiveness of the program and continued to discuss the possibility of more positive
restrictive measures.
Another example of the use of moral suasion is the voluntary creditrestraint program, inasmuch as it has developed, to some extent, an
impression among lenders that if the voluntary program is not reasonably satisfactory in its results, some type of more positive and less
desirable (i. e., to the lenders) means of restriction may be imposed
by the central bank or Government. I n fact, a member of the Board
of Governors recently (October 10, 195J) stated that—
the program is, i n essence, nothing but enlistment of the collective horse sense
of a l l kinds of lenders to sort out the kinds of credit which should have p r i o r i t y
under today's conditions and i n that way avoid governmental regimentation of
credit which, at best, must be a clumsy affair.
A mild degree of moral suasion probably was exercised in the fall
of 1950 when Board and Reserve bank officials on several occasions
indicated that reserve requirements of member banks probably would
be increased unless the rapid expansion of bank credit W&S checked
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
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and indicated to insurance companies that their practice of large-scale
selling of Government securities was not in the best interest of a sound
economy. Also, on different occasions during the past few years,
there have been references to unorthodox or particularly restrictive
reserve proposals as a possible consequence of continued monetization
of Government securities by banking and nonbanking investors, which
might be considered as a form of moral suasion. Neither of these
efforts, however, met with any appreciable degree of success.
On the whole, the use of moral suasion (in this narrower and sterner
sense) as a tool of credit control has been relatively infrequent, and, in
general, it has not proved to be a particularly effective credit-control
instrument. I t has the disadvantage of swaying the conscientious and
licensing the uncooperative, thus impairing competitive relationships.
For reasons indicated in the reply to question 25, the voluntary creditrestraint program, while having made some contributions to credit
restraint, has not been fully tested; a more severe test of its independent effectiveness might be made if inflationary forces should
strengthen and if additional reserves should be made available to the
banking system in substantial amounts through open-market operations or otherwise.
Note on reply of J.N. Peyton, Minneapolis
[Mr. Peyton's reply omits the fourth and seventh paragraphs of
the joint answer.]
27. What is the function of bank reserves ? What are present reserve
requirements with respect to banks ?
Joint answer
The principal reason for requiring banks to hold reserves against
their deposits is to enable the central bank to exercise an effective
influence over the volume of such deposits and thereby over the supply of money. The volume of deposits is limited by the amount of
reserves available to banks and Jby reserve requirements—or the relationship between reserves and deposits. Unless a central bank controls reserves, it cannot impersonally and effectively control the volume
of deposits.
From the point of view of the individual commercial bank, in turn,
the primary function of its reserve is to meet its requirement to hold
reserves. An individual bank may also use its reserve in performing
routine banking operations, such as meeting adverse clearing balances
and customers' requirements for currency. I f , however, such uses reduce the bank's actual reserve below its requirement, a penalty is involved and the reserve must be restored.
We understand that the present reserve requirements for member
banks, and for nonmember banks subject to different State requirements have been summarized in the reply submitted by the Chairman
of the Board of Governors to a similar question from the subcommittee.
Comment of Ray M. Gidney, Cleveland
While I agree that probably a principal reason for requiring member banks to hold against their deposit liabilities reserves in the form
of balances with the Federal Reserve banks is to enable the Federal
Reserve System to exercise effective control over the volume of bank
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT720
deposits, I believe that the joint reply does not give adequate consideration to various other points of view governing reserves.
Member banks naturally are concerned with the necessity of maintaining reserves sufficient to meet minimum requirements. From the
viewpoint of the individual bank, reserves both primary and secondary
are also extremely important for liquidity purposes. By tradition
and experience and because of supervisory practice, the banker is reluctant to borrow or even to get into a position where he thinks he is
too dependent on the central bank. The practice has developed of
actually maintaining reserves in excess of minimum requirements in
order to have a little more room to move in, and of maintaining in addition substantial amounts of secondary reserves. Inasmuch as most,
if not all, supervisors and the thousands of individual bankers are
vitally concerned with the liquidity function of reserves and have it
in mind constantly, it is an important real function and affects banking and public policy. This is true even though, from the viewpoint
of the central bank, liquidity is provided less by primary reserves than
by the credit granting powers of the central bank.
Comment of C. S. Young, Chicago
Under the management policies of some banks, reserves perform the
additional function of providing partial assurance of the safety and
liquidity of deposits in case of abnormal drains. This "liquidity" or
"solvency" role of reserves is most important for nonmember banks,
which do not have direct access to Federal Reserve bank credit in time
of stress. Only that portion of reserve assets over and above requirements specified by State banking authorities can be freely utilized by
the individual bank for such a purpose. I n many cases, however,
the formal or informal reserve requirements set by State banking
authorities are considered to be established primarily as a safety
measure.
Comment of C. E. Ear hart, San Francisco
I n our opinion, another function of bank reserves, from the point
of view of the individual commercial bank and its depositors and
other creditors, is to provide a limited but definite amount of protection to its creditors in the event of liquidation of the bank. The
bank's required reserve should not be drawn upon, except temporarily, while the bank is a going concern, but it remains an asset of
the bank available to the bank's creditors in case of need.
28. Should nonmember banks be required to maintain the same reserves as member banks ? Why, or why not %
Joint answer
Although it is recognized that this is a highly controversial question, there are strong reasons for requiring nonmember banks to maintain the same reserves as member banks. I f a national monetary policy
is to be established, and to be effective, its burdens should be applied
to all banks and not solely to those that are members of the Federal
Reserve System. Since deposits in nonmember banks are part of the
total money supply in exactly the same way as deposits in member
banks, nonmember banks should be required to maintain the same
reserves as member banks.
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C DEBT
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Establishment of this requirement would be in keeping, with our
constitutional development. Article I , section 8, of the Constitution
provides that the Congress shall have power to coin money and regulate the value thereof. I n 1865, when bank notes represented a major
part of our money supply, the Congress exercised this power by imposing a 10-percent tax on notes issued by State banks. I n 1913, the
Congress created the Federal Eeserve System as its agent to regulate
the supply, availability, and cost of money. Today, the Congress
through the Federal Eeserve System has ultimate control over that
part of the money supply created by the Federal Eeserve banks and
the member banks, but it does not have the same direct control over
that part of the money supply created by nonmember banks. This defect in the mechanism of control over the Nation's money supply
impairs the discharge by the Congress of its Constitutional responsibility and needs correction. Furthermore, to subject only member
bank reserves to Federal Eeserve System requirements imposes an
inequitable burden on those banks relative to nonmember banks.
Establishment of this requirement would not, as it is sometimes
contended, be a move to undermine the dual banking system. On the
contrary, adequate control over the total supply of money in the national* interest is indispensable to the continued maintenance of the
dual system. The essence of that system in this country lies in the
recognized authority of the State and Federal Governments to {a)
charter banking organizations and (b) supervise those banks of their
respective creation toward the end of assuring sound, safe banking
institutions. These vital aspects of the dual banking system would not
be threatened if nonmember banks w^ere subjected to the reserve requirements of the Federal Eeserve System.
Comments of Ray M. Gidney, Cleveland
I do not believe that it is in keeping with our American ideals of
fair play to permit any competitive group to have special advantages
in a matter so vital to the national welfare as the creation of money
(bank deposits). Accordingly, as a matter of principle, I believe that
nonmember banks should be required to maintain substantially the
same amount of reserves as member banks, entirely independent of
questions of membership, chartering power and examination authority. However, nonmember banks do not now have to carry such reserves and there is question as to the necessity for changing the present
set-up at this time. ^ So long as the major part of bank deposits, about
85 percent are subject to Federal Eeserve requirements and so long
as the Federal Eeserve System is able to operate freely in the open
market and pursue general credit policies consistent with the Employment Act of 1946, I believe that the present privileged position of
nonmember banks is not likely to interfere seriously with achievement of those policy objectives. To the extent that Federal Eeserve
open-market policy is made subservient to other policies with different objectives, the use of other control devices may appear to be
more urgent. These devices might include the so-called selective credit
controls and the changing of reserve requirements. Under such circumstances, the ability of a large group of banks to avoid and perhaps
to nullify national credit policy as expressed in changes in reserve
requirements could become serious. I t is significant that Congress
98454—52—pt. 2
7
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT722
in authorizing the use of selective credit controls has made them applicable not only to member banks but also to all lenders, including
others than banks.
Comment of C. S. Young, Chicago
A t the very least, some mechanism should be established requiring
nonmember banks to conform to the increases and decreases in reserve requirements established for member banks. As a possible
remedy, division of powers over the reserve requirements of nonmember banks could logically be introduced. As I noted in my answer
to question 27, an important purpose of most of the reserve requirements with which nonmember banks now comply is the provision of
partial protection against cash shortages in case of abnormal drains.
State banking authorities would retain unimpaired power to set reserve requirements for nonmember banks at whatever levels are felt
desirable in the interests of bank solvency and liquidity. Over and
above this provision, however, the Federal Reserve System could be
given the authority to add (and later remove) supplemental reserve
requirements for nonmember banks in line with similar changes required of member banks. Without some such power to influence
changes in the 15 percent of the aggregate national money supply
provided by nonmember banks, the System will remain unable fully to
comply with its congressionally charged responsibilities to restrict
or encourage bank credit expansion in accord with national economic
trends.
Comment of C. E. Earhart, \San Francisco
We are in agreement with the position expressed in the last paragraph of the joint reply to this question that to require nonmember
banks to maintain the same reserves as member banks would not undermine the dual banking system, because it would not threaten the
recognized authority of both the State and Federal Governments
to charter and supervise banks. However, to say that adequate control over the money supply in the national interest is indispensable
to the maintenance of the dual system (second sentence of that paragraph) describes a factor applicable only indirectly to nonmember
banks, in the sense that their existence, along with that of member
banks, is dependent upon the continued functioning of the economy.
I n other words, adequate control over the total supply of money in the
national interest is of primary importance to economic stability, rather
than to the dual banking system as such.
Without the same reserve requirements applicable to member and
nonmember banks, there is not the same control over that part of the
money supply created by nonmember banks as over that created by
member banks. Also, the problem of equity as between member and
nonmember banks is a most important consideration. To have reserve
requirements the same for all banks would be the most desirable situation from the standpoint of effective credit policy, as the joint reply
indicates. I n the light of the history of legislative developments related to the American banking structure, however, it would be more
feasible, in our opinion, to relate but not necessarily equate member
and nonmember bank reserve requirements.
This could be accomplished if nonmember banks were required to
carry the same additional reserve over State requirements as member
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
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723
banks must carry over their statutory minimum requirements (except
that provision could be made to limit the total reserve required of any
nonmember bank to no more than that required of a member bank).
I n other words, were reserve requirements for country member banks
(for whom the legal minimum requirement on demand deposits is
7 percent) to be set at, say, 16 percent, a comparable nonmember bank
subject to no more than a 7-percent reserve requirement would be
required to carry on deposit with the Federal Eeserve System a reserve
of 9 percent in addition to its reserve, in whatever form, required by
State law. Should country member bank reserve requirements later
be reduced to, say, 12 percent, the additional requirement for nonmember banks should be lowered correspondingly from 9 to 5 percent.
Only if member bank reserve requirements were reduced to their legal
minimum would the additional requirement for nonmember banks
be suspended.
I n terms solely of a logical monetary and credit mechanism this
proposal is admittedly not so satisfactory as that calling for identical
reserve requirements for member and nonmember banks or for membership of all insured banks. However, it would strengthen considerably the control of the monetary authorities over the volume of bank
reserves and lessen appreciably the inequities with respect to reserve
requirements that now accompany membership in the Reserve System.
A t the same time, this proposal would not strip the States of power
over reserve requirements; it would maintain differences in minimum
reserve requirements as they now exist between State and Federal
levels and among the States, and as they might be changed in the
future for nonmember banks by State authorities and for memb^
banks by Congress. But when it became necessary, in the national
interest, to impose additional reserve requirements, the differences
between member and nonmember banks would not be aggravated.
Nonmember banks hold a relatively small part of the total deposits
of the banking system at present. Existing inequities between member and nonmember banks, although real and working against the
growth of membership, do not appear to be severe enough to cause
widespread withdrawals from Reserve System membership. Therefore, we would not be inclined to press for legislation at this time.
The situation should be resolved, however, should it become necessary
to provide the Board of Governors with authority to raise member
bank reserve requirements above existing statutory limits. A further
increase in reserve requirements of member banks alone would placft
them in such an inequitable position that they might not feel able to
retain their membership in the Reserve System. Withdrawal from
the System by any significant number of member banks would indeed
mean that control over the money supply would be seriously impaired.
I t would be vital to correct, but preferable to prevent, such a condition.
29. Discuss the advantages and disadvantages of basing reserve requirements on types of deposits irrespective of the geographical
location of banks.
Joint answer
To an individual bank its reserve is a nonearning asset. The extent to which it is required to hold such assets is a measure of its
contribution to an effective national monetary policy. The structure
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT724
of reserve requirements should be designed to distribute such contributions equitably among banks. I n addition, the structure should
be logically defensible, administratively simple, and adapted to the
American system of banking. I t should be recognized that no structure is perfect and that any new structure may disclose in operation
difficulties that are not foreseen.
The present structure, based on geographical location of banks, is
a carry-over from the national banking legislation in effect when the
Federal Reserve System was established. Higher requirements were
originally imposed for banks in Reserve and central Reserve cities
because, as their names imply, a substantial portion of the legal reserves of national banks consisted of deposits in such banks. Perhaps
the leading advantage of the present structure is that it has the virtue
of familiarity; banks have operated under it for a long time and have
adjusted themselves to its requirements.
Mere geographic location does not, however, determine the character of a bank's business. For example, many so-called country
banks hold a substantial amount of interbank deposits and carry on
a banking business similar to that done by some banks located in
Reserve cities or central Reserve cities. On the other hand, there are
Reserve city and central Reserve city banks which hold no substantial
amount of interbank deposits but simply provide banking services
for businesses and individuals in their localities. As a result, the
present system of reserves frequently involves indefensible inequities
and raises very difficult administrative problems.
Inasmuch as the purpose of reserve requirements is to enable the
central bank to control the volume of bank credit, it can be contended
with some basis that a single reserve requirement subject to variation within reasonable limits without differentiation as to bank or
type of deposit, might be effective in enabling the central bank to discharge its responsibility. However, a change from the present system
of reserves to a system involving a single reserve requirement would
be too disruptive, as large excess reserves would be created in central
Reserve city banks, while huge deficiencies would appear at country
banks. I n addition, to a considerable extent, interbank deposits have
some of the characteristics of bank reserves. While many fine shadings regarding different types of deposits might be made, from an
administrative point of view it is desirable to classify deposits for
reserve purposes as interbank deposits, other demand deposits, and
time deposits. Such a deposit classification is readily understandable
in the banking system, has the value of traditional acceptance, would
provide the basis for an equitable system of reserves, and, assuming
appropriate discretionary authority to the central bank, would enable
effective control over the limits within which expansion of the volume
of bank credit could occur.
A system of uniform reserve requirements based upon the three
major classes of deposits and involving the specific features outlined
below would reduce inequities existing under the present reserve structure, would facilitate administrative control, and would conform to
sound economic principles with respect to the control of deposits in a
dual system of private banking such as exists in this country.
1. Abolish central Reserve city and Reserve city designations
of banks.
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2. Establish reserve requirements uniform for all banks accepting deposits on the basis of type of deposits classified as interbank, other demand, and time deposits. Initial reserve requirements should be established at differential levels that would
permit the transition to the new system to be made with a minimum unfavorable impact on individual banks and which would
result in an aggregate volume of required reserves of a magnitude appropriate to the circumstances at the time of change.
The transition might be facilitated if it were undertaken at a
time when economic developments called for* a reduction in
total reserve requirements.
3. Banks should be allowed to consider vault cash as required
reserves. Since the purpose of required reserves is to influence
the volume of bank credit, it is a matter of indifference to the
central bank whether banks hold reserves in the form of central
bank currency or reserve deposits with the central bank.
4. Banks should be allowed to consider as reserve that part
of their balances due from other banks which those latter banks
are required to hold as reserves against such balances. This
provision would recognize the correspondent bank relationship
as an established part of our banking system but would relate
correspondent balances to reserves in such a way that a shift of
funds by banks into or out of "due from banks" would not affect the total volume of the banking system's excess reserves.
To assure effective control over the volume of deposits it would
be necessary under this structure, as under any other, to authorize the
Federal Eeserve System to change specific requirements within reasonably broad statutory limits.
Comment of Ray M. Gidney, Cleveland
I believe that the joint reply overrates the advantages and ignores the disadvantages of basing reserve requirements on types of
deposits irrespective of the geographical location of banks. I n my
30 years of experience with the Federal Eeserve Banks of New York
and Cleveland I have not been impressed with the administrative
difficulties of the present system, nor have I heard many complaints
of inequities except with regard to the inability of banks to count
their vault cash as reserve.
Differentation by type of deposit is difficult to attain administratively. Only two types—time and demand—are now in use and the
proposal in the joint reply would add a third by separating interbank from other demand deposits. The change would alter the impact of requirements on individual banks and might disrupt some
long-establishied practices and competitive relationships. A clear
understanding of the implications of the plan requires a further description of the reserve ratios which would apply if the plan were
adopted and I believe that they would involve changes which would
be considered by many to be too drastic to warrant serious consideration.
I believe that it would be helpful to have the subject of reserves reviewed by a group widely representative of banking and finance.
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT726
Comment of J. N. Peyton, Minneapolis
[Mr. Peyton would substitute the following for the paragraph in
the joint answer immediately preceding the numbered points: ]
To serve merely as a base for discussion, and without recommendation for its immediate adoption, a system of uniform reserve requirements is presented. This plan would base required reserve
balances upon the three major classes of deposits and would, it has
been argued, reduce inequities existing under the present reserve
structure, facilitate administrative control, and conform to sound
economic principles with respect to the control of deposits in a dual
system of private banking such as exists in this country.
Gomment of R. R. Gilbert, Dallas
The answer to this question indicates several favorable features of
the plan of basing reserve requirements on types of deposits, irrespective of the geographical location of banks, but it does not point
out certain important disadvantages of the plan. While the plan
would correct certain of the undesirable features of the existing type
of reserve structure, it has, in my opinion, certain important disadvantages and raises some difficult problems. Therefore, while I
believe that this plan, along with other approaches to the reserve
problem, should continue to receive study, I am not willing to give
my approval at this time 'to the plan as developed in the answer to
this question.
Comment of G.E. Earhart, San Francisco
The joint reply states, with respect to the proposal that reserve
requirements be based upon types of deposit without regard to bank
location, that the transition from the present method—
might be facilitated i f i t were undertaken at a time when economic developments called f o r a reduction i n total reserve requirements.
We agree and, in fact, would be more explicit; in our opinion, the
proposal outline should not be adopted under present circumstances,
and consideration of such a step should be postponed until a period
of definite credit ease develops.
30. Discuss the advantages and disadvantages of requiring additional
reserves which might be held in whole or in part in the form of
Government securities. Illustrate with a specific plan or plans.
Joint answer
Central bank control over reserves and therefore over the money
supply stems from: (1) a limited supply of bank assets which can be
counted as reserves, and (2) the ability of the central bank to control the creation and the extinction of reserves through its loans and
investments. Without the first condition, member banks would not
need to go to the Federal Reserve banks for reserves to support an
expansion of credit and deposits, and without the second the Federal
Reserve System would not have control over the volume of reserves
it created. The policy of maintaining fixed prices of Government
securities, for example, seriously impaired control over the amount
of reserves created because the volume of Government securities purchased by the System was determined by the market rather than by
the Federal Reserve.
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The supplementary reserve plan which would require banks to hold
additional reserves in whole or in part in the form of Government
securities has been suggested as a means of retaining control over
reserves while the System was also supporting the Government security market at predetermined interest rates during an inflationary
period. For purposes of illustration, let us assume that banks are
required to hold a supplementary reserve in Government securities
equal to 25 percent of their demand deposits in addition to a primary
reserve requirement of 15 percent. The higher reserve requirement
would reduce the ratio of a deposit expansion based on non-Government assets from about 6 to 1 down to 2y 2 to 1. I t would not, however, reduce the ratio of deposits to primary reserves if expansion
were based on bank acquisition of Government securities. By immobilizing a large block of the banks' existing holdings of Government securities, the supplementary reserve might make some banks
more reluctant to sell Governments as a means of obtaining reserves
for expanding loans and other investments. There might be an
effect in the opposite direction, though, as banks would be encouraged,
in effect, to purchase additional Government securities as the means
of expanding their earning assets. Any support by such action that
the banks would give to the Government security market by purchases
from nonbank investors would result in further expansion in the
money and credit supply.
For the banking system as a whole, a supplementary reserve requirement might impose little additional restraint. I n the first place,
the additional amount of required reserves would be more than offset
by the increase in bank assets eligible as reserves. Government security holdings of member banks, for example, at the end of August
1951 were about 55 percent of their total demand deposits. Secondly,
the supplemental reserve requirement would have little effect on the
ability of member banks to get reserves to support expansion as long
as the Federal Reserve banks supplied additional reserves. Most
member banks would still have free Governments which they could
sell and, if not, they could liquidate other securities or could borrow
from the Federal Reserve banks on the basis of any sound asset if the
Reserve System took no other action to restrict the availability of
reserves.
The supplemental reserve plan has the serious disadvantage of not
reducing the availability of reserves. Reducing the amount of deposits which could be created on the basis of $1 of new reserves would
not give more effective control over the money supply so long as the
central bank creates a correspondingly larger amount of reserves.
The plan would immobilize a part of member bank holdings of Government securities, but would not likely affect a sufficient portion of
the transactions in these obligations to impart any significant amount
of stability to the Government securities market. I t also has the serious disadvantage of placing no restrictions whatsoever on the liquidation of Governments by nonbank holders, and to the extent these
securities were purchased by the Federal Reserve under a policy of
supporting the price of Government securities, an equal amount would
be added to bank reserves and bank deposits. Furthermore, there is
the danger that the plan might become a device for financing Federal
deficits cheaply rather than a tool which would contribute to effective
monetary policy.
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT728
I n short, if the Federal Reserve System has effective control over
the supply of reserves under a flexible open-market policy, a supplementary reserve is unnecessary; without such control, a supplementary reserve would be ineffective.
31. Discuss the advantages and disadvantages of requiring during the
national defense emergency a supplementary reserve to be maintained against increases in either loans and investments or deposits. Illustrate with a specific plan or plans
Joint answer
The principal objective of requiring banks to keep a supplementary
reserve against increases in either loans and investments or deposits
during the national defense emergency would be to provide more effective control over credit eipansion and the money supply.
For purposes of illustration, let us assume a 100 percent reserve requirement against increases in deposits above a certain base level. By
eliminating a multiple expansion of deposits (e. g., $5 of deposits on
the basis of $1 of reserves when the reserve requirement is 20 percent),
a 100 percent reserve requirement would tend to provide more effective restraint on further deposit expansion. I t would reduce substantially the profit incentive for banks to expand their earning assets
since under present conditions banks need provide immediately only
a fractional reserve against the deposits resulting from an expansion
of their loans (and can usually count upon some time interval before
the full amount of such newly created deposits will be withdrawn).
However, it does not necessarily follow that the ability of the
banks to expand credit would be reduced. Their capability for expansion would be checked only if additional reserves were not freely
available to the banks to enable them to meet the 100 percent reserve
requirements. On the other hand, the likelihood of expansion would
probably be considerably lessened.
The effectiveness of a complete cash reserve against increases in deposits, as a restraint upon monetary expansion, would largely depend
upon whether the central bank has effective control over the volume of
reserves it creates. I f the central bank does not have effective control
over the volume of reserves, as under a policy of supporting the price
of. Government securities at some fixed level, it is unlikely that even a
100 percent supplementary reserve requirement will provide effective restraint.
The supplementary reserve requirement would not make Government securities more attractive to nonbank holders. Therefore, the
plan would neither reduce the sales of nonbank holders during periods
of inflationary pressure nor the amount the banking system as a whole
would have to absorb. Commercial banks faced with a stiff increase
in required reserves would tend to liquidate Government securities
to meet the new requirement. Unless the market for Government securities were permitted to decline markedly the Federal Reserve System would be forced to purchase a much larger volume of Government
securities than if commercial banks were required to maintain only
the primary reserve against deposit increases. I f the Government
were borrowing large amounts of new money the System would be
forced to buy large quantities under a policy of maintaining a supported market. I t is likely, therefore, that under such conditions a
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
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729
large part of the presumed effectiveness of a 100 percent supplementary reserve would be dissipated in a shift of Governments from the
commercial banks and others to the Federal Eeserve banks. This
proposal overlooks the fact that the real key to control over deposit
expansion stems from both the percentage reserve required and the
ability and the willingness of the central bank to limit the amount
of reserves it creates.
A high supplementary reserve requirement against deposit increases
has other important disadvantages. Development of our national
defense economy is likely to require large shifts of economic resources
from one region to another. A high supplementary reserve against
increases in loans and investments or deposits would tend to impair
the desired mobility of funds. Banks in rapidly growing areas would
need to expand their loans and investments to provide the funds
needed for industrial and commercial expansion. However, these are
the very banks that would be penalized by a high supplementary reserve requirement against loans and investments or deposit increases.
On the other hand, banks in declining areas would be able to meet their
credit demands more easily, thus tending to retard the shift of resources to other communities.
I t is difficult to envision a plan that would accomplish its presumed
purpose and yet be equitable and administratively feasible.
Comment of Hugh Leach, Richmond
[Mr. Leach submitted the following supplementary comments on
questions 30 and 31 of the joint answer:]
While the inequities and administrative and other difficulties inherent in these proposals are fully recognized, it is conceivable that a
situation might arise in which consideration of individual equities and
administrative feasibility should be subordinated to the immediate
national interest. I f a situation developed in which existing general
and selective controls proved inadequate, it would be necessary to explore further these and other plans tailored to the need of the specific
emergency, despite the important shortcomings of such proposals as
have been suggested. Just as we feel that additional selective credit*
controls are undesirable but might have to be considered under some
circumstances, we would not rule out the possible need for exploring
other types of reserve requirements.
32. Discuss the advantages and disadvantages generally of maintaining
bank reserves against classes of assets rather than against classes
of liabilities as at present.
Joint answer.
The primary reason for basing reserve requirements on deposits is
that deposits are money, and it is the volume of money that reserve
requirements are designed to influence. Hence this method accomplishes directly what a structure of requirements based on types of
assets would accomplish only indirectly. Linking requirements to deposits also recognizes that movements of deposits are accompanied by
shifts in reserves.
On first thought it might appear that a structure of requirements
based on classes of assets would enable the central bank to direct the
flow of funds into selected areas of the economy. I t is unlikely,
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT730
however, that the proposal would be effective in achieving that objective. Experience with selective regulation of credit indicates that
such regulations must be based on functions rather than institutions.
I f the flow of lending is to be directed effectively, it would be necessary
to regulate all lenders. Basing bank reserve requirements on classes
of assets might, of course, affect the relative attractiveness of different
classes of assets for bank lending and investing. But this could easily
result merely in offsetting changes in the loan and investment policy
of other lenders rather than influencing the flow of funds into various
channels. The wide distribution of Government securities in the hands
of lending institutions and individuals would greatly facilitate such
shifting. Other lenders could simply sell Government securities and
lend the proceeds to those borrowers whose loans and securities were
subjected to higher requirements if held by banks. The banking
system, in turn, would buy the Government securities against which
the reserve requirements presumably would be less. The net result,
however, would be that neither the total volume of deposits nor the
flow of funds would be controlled. I t should not, of course, be concluded that application of reserve requirements should be extended
from banks to all lending institutions and individuals. I t should be
understood, however, that even if this were done it would still be
necessary to control the total volume of reserves as well as the proportional requirements against classes of assets. I n other words, a
flexible central bank open-market policy would still be necessary.
The operation of a structure of reserve requirements based on classes
of assets would encounter very serious administrative difficulties. I t
should be recalled in this connection that it has taken a long time and
many decisions on individual cases to establish a clear-cut definition
of time deposits. But this problem was simple compared with the
problem of actually defining types
assets. Business firms and individuals spend for a variety of purposes, and it is a matter of indifference which particular dollars, whether those secured from sales or
from borrowing, are used for specified purposes. I f , however, different
reserve requirements were applied to loans for different purposes, it
might become important for the borrower to earmark his receipts in
such a way that the borrowed dollars could be used for purposes
against which requirements were lowest. I t is not certain that either
total spending or the direction of spending would be affected at all.
The administration of such a system, in an attempt to try to assure
the desired results, would require a large staff of highly trained persons whose decisions, in the nature of the case, would often be arbitrary.
Another difficulty is that it is not always desirable to encourage or
discourage given activities to the same degree throughout our wide
and diverse economy. At the present time, for example, it is generally desirable to limit the construction of houses, but it is also desirable to encourage their construction in certain defense areas. I t
is difficult to envision the full complexities of a structure of reserve
requirements designed to deal with such diverse objectives.
Difficulties and possible injustices would be encountered in initiating
the system. Banks that happened to have relatively more assets requiring higher reserves would be penalized. The penalized banks
might be those that had done most to help develop their own communities, including the assumption of greater risks through the exten
MONETARY POLICY AND MANAGEMENT OF PUBLIC
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731
sion of private credit. This would not be true, of course, if higher
reserves were required against Government securities than against
other earning assets. I f the new structure of requirements were to be
superimposed on the present structure and made applicable only to
future increases in types of assets, the administrative difficulties would
be greatly increased.
33. State the statutory authority for the power, if any, of the Board
of Governors, the Federal Reserve banks, or of any agency of the
United States Government to control directly or to ration the
extension of credit by individual banks. Specify the (legal)
circumstances under which such rationing could occur and the
control of the President over its operation. Under what (economic) circumstances, if any, would you recommend the use of
credit rationing ? Describe the manner in which you believe that
such a system would operate.
Joint answer
The principal provisions of law which might possibly be construed to
authorize the control or rationing of the extension of credit by individual banks are the provisions of section 5 (b) of the Trading With
the Enemy Act of 1917 (as amended) and section 4 of the Emergency
Banking Act of 1933. Section 5 (b) of the Trading With the Enemy
Act authorizes the President, through any agency that he may designate—
during the time of w a r or d u r i n g any other period of national emergency declared—
by him to—
investigate, regulate, or prohibit * * * transfers of credit or payments between, by, through, or to any banking i n s t i t u t i o n * *
During World War I I , pursuant to the authority conferred upon
the President by section 5 (b), he issued Executive Order No. 8389
designating the Secretary of the Treasury to administer the so-called
blocked accounts. Under this authority the President also issued
Executive Order No. 8843 conferring upon the Board of Governors
authority to control consumer credit.
Section 4 of the Emergency Banking Act of March 9,1933 provides
that—
* * * during such emergency period as the President of the United States
by proclamation may prescribe, no member bank of the Federal Reserve System
shall transact any banking business except to such extent and subject to such
regulations, limitations, and restrictions as may be prescribed by the Secretary
of the Treasury, w i t h the approval of the President.
The President pointed out in his memorandum of February 27,1951,
that the Secretary of the Treasury, under the authority vested in him,
subject to the President's approval, by the Bankiifg Act of March
1933—
could by regulation delegate the administration of this program to the 12 Federal
Reserve banks, each to act i n its own Federal Reserve district—
but this was not done.
The exercise of the authority conferred by Congress upon the President under section 5 (b) of the Trading W i t h the Enemy Act and the
issuance of any regulations by the Secretary of the Treasury, pursuant
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT732
to section 4 of the Emergency Banking Act of March 9, 1933, ate
predicated upon the existence of a national emergency. The national
emergency declared by the President by the banking holiday proclamations of March 6 and 9, 1933, has never formally been declared at
an end, and on December 16,1950, the President issued a proclamation
of national emergency in connection with the Korean situation. I t
is for the courts to decide whether the national emergencies as declared by these proclamations constitute a legal basis for action by the
President and the Secretary of the Treasury under the Trading With
the Enemy Act and the Emergency Banking Act of 1933 with respect
to control of extension of credit by individual banks. We believe it
would be undesirable to institute direct controls over the extension of
credit by individual banks under the provisions of these laws for purposes and under circumstances not contemplated at the time of their
enactment. I t would be preferable to have specific action by Congress
authorizing such controls, if they were to be undertaken.
The question implies that rationing of credit by banking institutions
only would be contemplated. I f that were done, the tendency would
be to shift demands for credit to nonbank lenders not subject to the
control. Even if such lenders financed their extensions of credit by
attracting the savings of the public, many of their loans and investments might be for purposes contrary to those permitted for banks.
Furthermore, it is quite likely that, in the face of heavy demands for
credit which the banks were not permitted to extend, the nonbank
lending institutions might finance a considerable part of their extensions of credit through sales of Government securities, which, if they
were absorbed by .the commercial banks or by Federal Reserve banks,
would result in indirect extensions of bank credit for unapproved purposes. To avoid such developments, not only banks, but all other
lenders, would have to be brought under the controls, if they were to
be effective, and that would involve an extremely difficult enforcement
problem.
I f a form of credit rationing were to be undertaken under conditions
short of an extreme emergency, probably the simplest approach would
be to give mandatory status to something like the current voluntary
credit restraint program. But to make such a program compulsory
would imply enforcement procedures to assure that lenders generally
conformed to the rulings of the central organization directing the program. The policing problem would be of a magnitude far beyond
anything previously experienced. Probably the most feasible arfd
manageable part of such a program would be control over capital
issues. I t is conceivable that a Government-sponsored capital issues
committee, with authority to enforce its decisions, might be needed
in the event of another full-scale war.
A possible approach to a more thoroughgoing system of credit
rationing might ^e to prohibit all extensions of credit except those
specifically authorized. Even the first step in such a procedure, however, would involve serious difficulties. For example, if credit extensions to war contractors were exempted from the general prohibition,
it would be necessary to limit the amount of credit they could obtain
to that required for the execution of their war contracts. Presumably
that would mean setting up a certification procedure which would
include not only certification of the need for credit, but also of the
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
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733
amount and perhaps the duration of the need as well. Otherwise,
some of the credit might be used for nonwar purposes, for which competitors would be unable to obtain credit. But to certify the amount
of credit required would necessitate thorough examination of such
factors as the prospective borrower's present and prospective position
with respect to current assets and liabilities and cash flow.
The certification procedure might be applied also to defense-supporting activities, but that would probably involve even more difficult
problems of ascertaining the actual needs for credit for approved
purposes. Beyond the field of war contracts and supporting activities, the classification of demands for credit, according to the degree
of essentiality and urgency of need, would become much more nebulous and correspondingly more difficult. I t might become necessary to
pass upon individual loan applications, in which case a huge staff of
men experienced in credit analysis, and competent to judge the purposes and permissibility of credit extensions in individual cases, would
be required to administer the rationing—very probably an impossible
requirement.
Even if this difficulty could be surmounted, the problem of determining the precise use of credit applied for and deciding whether or
not it was essential would be almost impossible. A large part of
business borrowing is for working capital purposes. That may include such variables as the financing of larger inventories (in physical
amount, cost, or both), larger receivables, a reduction in trade credit,
or the maturing of tax liabilities. To appraise the legitimacy of the
need for credit it would be necessary to arrive at a judgment as to the
necessity of the items giving rise to the demands for credit, the necessary level of inventory, for example. Aside from the problem of
classifying potential borrowers as to the degree of essentiality of their
activities and the extent of their actual need for credit, a credit-rationing system would encounter other difficulties. For example, the creation of a large war industry might result in an extraordinary growth
of the community where it was located and require the financing not
only of a large amount of housing construction, but also of a great
variety of servicing facilities, the financing of which in other communities might not be approved. Exemptions from the general prohibitions in such cases would need to be carefully restricted to avoid
the financing of nonessential activities or unnecessary amounts of
essential activities. To take account properly of such local variations
in credit needs and administer exceptions to the general restrictions
fairly/ in addition to more fundamental responsibilities, would be
likely to constitute an almost impossible task for the central organization.
One other aspect of the matter may deserve mention. A thorough
review of applications for credit, of the sort outlined above, would
necessarily be time-consuming. The time required to obtain approval
of loan applications and actual extensions of credit might, in a number of cases, impede essential activities.
I n summary, we have a repugnance to regulating credit transactions
on a case-by-case basis. We do not believe that the Federal Reserve
System or a governmental agency could estabish and administer standards which presumably would be substituted for the judgment of
lenders in individual transactions. Even with the best standards the
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT734
decisions of members of the large enforcement staff would necessarily
be arbitrary. Were it possible to overcome these difficulties, rationing
would be ineffective if applied to banks alone. For these reasons we
do not recommend, save possibly in catastrophic emergency, the use
of direct rationing of extensions of credit by individual banks.
Delos 0. Johns, St. Louis
[Following are Mr. Johns' comments on the joint answers to questions under section D. General Credit and Monetary Policies.]
The joint replies prepared under the direction of a special committee of the presidents of the Federal Reserve banks represent my
general opinion with respect to the questions 13 through 33, in this
section. I have no major substantive differences with these replies and
my comment is primarly supplementary and general. I n this section,
however, comment is tied more specifically to the particular questions
than it has been in the three previous sections. I n certain cases it is
included mainly to supplement the joint reply with some information
on the eighth Federal Reserve District.
Open-market operations.—With respect to questions 13 through 17,
which deal with open-market operations and their effects, I am in
complete agreement with the joint replies. I have just two supplementary comments to make. I n the joint replies to question 16 it is
pointed out that under full-scale war conditions direct controls (on
prices, wages, allocations, and rationing) are needed; an opinion in
which I concur. I wish to emphasize strongly, however, my opinion
(1) that successful application of such direct controls depends in
large measure upon monetary and fiscal policies aimed at restricting
growth in private purchasing power, and (2) that it is generally
wiser to place most dependence upon indirect controls such as monetary and fiscal policy which permit greater flexibility in the economy.
The great economic danger of the direct controls, as I see it, is the
introduction of rigidities into the economic system and the probable
resultant impairment of dynamic strength, which is the basic factor
in our productive power. The longer direct controls operate, the
greater the distortions generated by rigidities become.
Discounting and moral suasion.—I have no supplementary comment with respect to the joint replies to questions 18 and 26, which
deal with the discount function and with the use of moral suasion.
Selective-credit regulations.—The joint replies to questions 21
through 24, which deal with the selective-credit regulations? coincide
with my opinion almost exactly. I agree that these selective-credit
instruments are supplementary to general quantitative-credit regulation through action on the volume of reserves and that they cannot be
taken as a substitute for such general credit regulation. I also am in
agreement with the statement concerning the four tests to be met by a
prospective selective-credit-regulation device and with the conclusion
that the present selective-credit instruments meet those tests and are
useful. I further agree that selective regulations other than those
over consumer, real-estate, and stock-market credit are neither feasible
nor desirable, as stated in the joint replies to question 24, but I would
amend that statement mildly by including the phrase "under present
conditions and given the present institutional structure and state of
knowledge." I t is conceivable that future developments could result in
discovery of means to make selective regulation in other fields admin
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
735
istratively feasible and perhaps desirable. I n other words, I concur
in the statement as of the present, but I am inclined to be somewhat
less certain about the future.
Voluntary credit-restraint program—With
respect to question 25,
which concerns the voluntary credit-restraint program, I have two
comments. One involves a point brought out in the joint reply, the
other merely is a note on eighth-district experience with the program.
The joint reply indicates that the committee (or a similar group)
might be given certain additional powers (under adequate supervision) in the event of total war; that such action would be preferable,
from the standpoint of economic efficiency, to instituting "credit rationing" administered by Government. I question most seriously the
desirability of administered "credit rationing" whether performed
directly by Government or by groups such as the National Voluntary
Credit Restraint Committee or the regional committees. I n my
opinion the function of "credit rationing" is performed best by the
individual lender who is on the local scene and is conversant with local
conditions. This is his economic justification for being; he is expected
to channel credit to essential uses and to efficient users. Limitations
on general credit supply should be general limitations and permit the
lender to exercise his best judgment as to where his credit should flow.
I n other words, "credit rationing" by Government or an administrative body, when it is called for, should apply to the economy as a whole,
and "credit rationing" in individual cases should be left to the determination of individual lenders. By this approach the economy is kept
flexible and dynamic and hence stronger.
Furthermore, this approach seems to me most in keeping with our
basic American political philosophy. The commercial-banking system in this country is unique among financial institutions in that it
has the power to create money (bank deposits) through extension of
credit. That power has laid upon the commercial banking system
the correlative responsibility to create (in a broad sense) no more and
no less money through its credit operations than is necessary for the
smooth functioning and stable growth of the economy. The Federal
Reserve System was established to share this responsibility and does
so by making reserves more or less available and costly to the commercial banks. Thereby, it establishes a broad over-all maximum
limit and provides the basis for a minimum limit to the money supply.
Within those broad limits the commercial banking system and the
individual banks exercise their responsibilities to select the desirable
and economic users and uses of credit. I believe it would be undesirable to eliminate those responsibilities, not only on the grounds of economic efficiency as noted above but also under the general democratic
principle that responsibilities should be roughly correlative with
powers.
This comment applies also to question 33, and is my only supplementary comment on that question.
The voluntary credit-restraint program has been taken quite seriously in the eighth Federal Reserve District. The Eighth District
Commercial Banking Voluntary Credit Restraint Committee was
established at the inception of the program and originally served
banks throughout the district. Subsequently a Little Rock (Ark.)
Regional Commercial Banking Voluntary Credit Restraint Commit-
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT736
tee was established to serve banks in the Little Rock branch zone
(most of Arkansas) ; the eighth-district committee continues to serve
banks in the rest of the district. An Eighth District Savings and
Loan Voluntary Credit Restraint Committee also has been established
to serve all savings and loan associations in the district.
I n line with the point made in the joint reply, it is not possible to
measure precisely what the program has accomplished in the eighth
district. I t is noteworthy, however, that total loans at all member
banks in the district rose just $86 million from the end of May 1951
to the end of October 1951, as compared with an increase of $276
million in the like period of 1950, and a 3-year (1947-49) average
gain for the same period of $146 million.
I t is also noteworthy that the record of business-loan changes at
large district banks indicates some channeling of credit to defense
activities and away from nondefense activities. I n the 5 months
(June-November 1951) new credits for defense contracts at these
banks totaled $16 million and for defense-supporting activities totaled
$31 million. I n the same period the net increase in outstanding business loans of these banks to all nondefense activities was just $56
million (less than expected on seasonal grounds). While the defenseloan figure is not large, it should be recognized that defense contracts
in this district have lagged behind the amount that might have been
expected, given the district's proportion of national industrial
capacity.
Keserve requirements.—I concur fully in the joint replies to questions 27 to 32, inclusive, which deal with the general topic of reserve
requirements and methods for fixing such requirements. I have, however, one supplementary comment which relates to reserve requirements applying to nonmember banks.
The joint reply to question 27 indicates that the major reason for
reserve requirements is to give the central bank influence over the
total money supply. The joint reply to question 28 indicates that
nonmember banks should be made subject to the same reserve requirements as member banks. I argee, and my opinion is based on three
points, as follows:
(1) As noted in the joint reply to question 28, the nonmember-bank
deposits are part of the money supply just as are deposits in member
banks. I t would be in keeping with our constitutional development
to have the Federal Reserve System, as the agent of Congress, exercise
the same degree of direct control over that part of the money supply
held as nonmember-bank deposits as is exercised over that part held
as member-bank deposits.
(2) I n a very real sense, the legal requirement to hold reserves may
be viewed as a price paid, a contribution made, by the banks for
greater economic stability. The reserve burden should be shared
equitably by all banks.
(3) The fact that nonmember banks hold only a small part of the
Nation's bank deposits theoretically does not impair central banking
action with respect to total reserve volume and its influence on the
total money supply. However, more than half the number of banks
are nonmember banks. Practically, the fact that nonmember banks
are not subject to member-bank reserve requirements may well inhibit
central banking action at various times. The System is keenly aware
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C DEBT
737
of the problem of equity, noted in my second point, and naturally finds
it repugnant, when restrictive measures are called for, to widen further the disparity in reserve burden between member and nonmember
banks. This question of equitable treatment is very sharply outlined
in the eighth district, where two-thirds of the banks are nonmember
banks.
I should stress the fact that I am not advocating compulsory membership, but only the application of member-bank reserve requirements to nonmember banks. Membership in the Federal Reserve
System involves many more responsibilities than the keeping of reserves with the Federal Reserve bank. Generally speaking, nonmembers are not subject to the same degree of responsibilities as are
members. I n my opinion, membership should be predicated on full
appreciation of the responsibilities involved and should, for State
banks, be voluntary.
Finally, I probably should note, as does the joint reply, that making
member-bank reserve requirements apply to nonmember banks would
not break down the dual banking system, which rests basically upon
the chartering and supervisory authority of Federal and State governments.
Credit policy and cm expanding economy.—Questions 19 and 20 have
to do with credit policy and supervisory activity and their roles in an
expanding economy. The joint replies to these questions coincide
with my views. I should emphasize my belief that supervisory policy
and the bank-examination function are aimed at preservation of the
soundness of individual banks and through them a sound banking
system. Promotion of this objective should aid promotion of the
objectives of the Employment Act.
I see no basic conflict between measures to restrain excess demand
by credit control and the need for an expanding economy. As the
joint reply indicates, the way resources are used and by whom they
are used are the keys to expanding the economy. As I pointed out
earlier, the economic function of finance in general is to channel credit
to essential uses and efficient users. Credit policy aimed at restraining excess demand creates the climate for the exercise of this economic
function of finance and hence should contribute to promotion of an
expanding economy. By preserving balance between the money supply and the goods supply, credit policy helps assure that less efficient
and less essential producers cannot bid up prices and absorb resources
better used elsewhere.
E. T H E B A N K I N G STRUCTURE
34. W i l l you please submit a memorandum discussing the adequacy
of banking facilities in your district? For this purpose, taJke as
your standard of adequacy the ideal of bringing banking facilities within convenient reach of all persons having need of them,
and, so far as practicable, giving all persons the opportunity
of choosing between two or more competing banks. Distinguish
between deposit facilities and loan facilities
Answer for the First Federal Reserve District (Joseph A. Erickson,
Boston ):
The economic age, development and geographic make-up of the
first Federal Reserve District is such that we have in our opinion
98454—52—pt. 2
7
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT738
a mature and adequate banking structure. W i t h very few exceptions
banking facilities, both deposit and loan, are within convenient reach
of all persons and business firms and so far as practicable there exists
the opportunity of choosing between two or more competing banks.
This does not necessarily mean that every town and village in New
England has one or more banks located therein. I t does mean that
such facilities are available on a competitive basis within easy commuting distances. There are attached at the end of this reply a series
of scaled maps of the New England States which present in graphic
form the location of banking facilities in New England in relation
to density of county population (commercial banks exhibit A 1-6,
savings banks exhibit A 7-12).
As of December 30,1950, there were 518 commercial and 342 mutual
savings banks in New England as reflected by exhibit B. I n addition
to commercial and mutual savings banks there are 104 State-chartered
savings, building and loan associations, 175 cooperative banks, 56 Federal savings and loan associations and 13 other types of financial institutions operating in New England aside from numerous credit
unions both State and Federal and small-loan companies.
Cooperative
banks and
savings
State-chartered Federal
loan assobuilding and andciations
loan associations
Connecticut
Maine
Massachusetts. >
New Hampshire
Rhode Island
Vermont -
«.
Total
Other types
31
30
179
24
7
8
17
5
29
2
1
2
9
2
279
56
13
2
Comparative figures indicate that banking has kept pace with the
increase in population in New England over the past 10 years. I n
the following tabulation column A gives the comparative population
in 1940 and 1950 per commercial bank facility, column B the comparative population per commercial and savings bank deposit facility,
and column C the population per supervised loan and depository,
exclusive of credit unions, small loan companies, and the like.
B
A
1940
Connecticut
Maine
Massachusetts
New Hampshire
Rhode Island
Vermont
Recapitulation
12,800
6,700
13, 500
7,400
11,800
4,100
10, 700
1950
12,000
6,800
13,000
6,800
10,000
4,600
10,400
1940
8,300
5,300
7,900
4,470
9,900
3,500
7,000
C
1950
8,300
5,400
7,800
4,700
8,600
3,800
7,000
1950
7,000
4,400
5,800
3,800
8,000
3,500
5,600
Reference is made to exhibit C which shows the population per banking office by counties for the New England States.
Banks are recognized as quasi-public institutions. To warrant their
existence they must serve the community. To serve a community well
MONETARY POLICY AND MANAGEMENT
OF P U B L I C
t)EBT
739
requires that each bank as well as the entire banking structure be
sound. The extent to which expansion of present facilities is needed
and could be undertaken on a sound basis is a moot question. Need
for additional banking facilities and the ability of the area to support
new facilities is evidenced in part by the fact that only 12 applications
have been filed for new State and National commercial and savings
bank charters during the 10-year period ended December 31, 1950.
Of this number only eight charters were granted.
5
New
Hampshire
Rhode
Island
1
1
0
3
2
0
ooo
Total received
4
1
0
Massachusetts
0
2
5
0
Vermont
ooo
Granted
Declined
Withdrawn
Maine
ooo
Connecticut
0
Lack of growth prospects and of evidence that the area could support a bank were the reasons for declining four of the applications
filed.
On the other hand expansion has occurred in banking facilities
during the past 10 years, as is evidenced by the data contained in
exhibit B. Referring thereto it will be noted that although there
has been a decrease from 546 to 518 commercial banks in New England during the 10-year period ended December 30, 1950, branches
operated by such banks have increased from 243 to 371, resulting in
a net increase of 100 in commercial banking facilities. Mutual savings banks during the same period decreased from 356 to 342.
Branches of these banks, however, also showed an increase from 48
to 70, with the result that there was also a net increase in this type
of banking facility of 8. There was accordingly a net increase of
108 in these two types of banking facilities during the 10-year period.
The decrease in the number of commercial and savings banks reflected by exhibit B has been to some extent the result of mergers,
consolidations, and liquidations, with the resultant purchase of assests
and assumption of liabilities by other banks. However, the result
has been not only to expand the banking facilities of New England
but to bring better and more adequate service to the smaller communities of our region, since in the vast majority of cases the resultant
or acquiring bank has been the more progressive with better organization and broader banking services.
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT740
EXHIBIT
B.—First Federal
Reserve District—Number
Commercial and stock
savings banks 1
Mutual savings banks
of
banks
Total banks
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
Dec.
31,1940 31,1945 30,1950 31,1940 31,1945 30,1950 31,1940 31,1945 30,1950
Connecticut:2
Banks
Branches
Total banking units. _
Maine:
Banks
Branches.
Total banking units. _
Massachusetts:
Banks
Branches
Total banking units. _
New Hampshire:
Banks
Branches
Total banking units. _
Rhode Island:
Banks
Branches
Total banking units. _
Vermont:
Banks
Branches
Total banking units. _
Recapitulation,] New England:
Banks
Branches
Total banking units. _
1
2
117
16
117
16
112
50
72
1
72
0
72
5
189
17
189
16
184
55
133
133
162
73
72
77
206
205
239
68
58
64
66
63
71
32
2
32
2
32
2
100
60
96
68
95
73
126
130
' 134
34
34
34
160
164
168
201
117
192
139
182
177
192
33
190
33
189
47
393
150
382
172
371
224
318
331
359
225
223
236
543
554
595
64
2
65
3
75
2
43
1
42
1
34
1
107
3
107
4
109
3
66
68
77
44
43
35
110
111
112
23
38
25
45
16
60
9
2
9
2
8
6
32
40
34
47
24
66
61
70
76
11
11
14
72
81
90
73
12
72
9
70
11
8
9
8
9
7
9
81
21
80
18
77
20
85
81
81
17
17
16
102
98
97
546
243
535
278
518
371
356
48
353
47
342
70
902
291
888
325
860
441
789
813
889
404
400
412
1,193
1,213
1,301
Includes 9 stock savings banks located in New Hampshire.
Includes Fairfield County.
Answer for the Second Federal Reserve District (Allan Sproul, New
York)
As the wording of this question implies, there are various possible
tests for the "adequacy of banking facilities." The test upon which
this question focuses attention is the physical accessibility of banking
offices to the persons and business firms having need of them. While
there are banking facilities available within a reasonable distance and
over adequate roads for virtually all individuals or businesses located
in the second Federal Eeserve district, ready accessibility must
always be measured in relative terms, taking into account the density
of population in the area being served. A sparsely settled area obviously cannot support as many banks as a densely populated area of
similar size. A summary of the variations in the distribution of banking offices among regions within the district, in terms of population
per square mile and the number of square miles per banking office,
will consequently constitute the major portion of this reply.
I t should be noted, however, before turning to the statistical data,
that the operation of a banking office must meet the usual test con-
1
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Exhibit
M A P NO. I t 7
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98454 O - 52 - pt. 2 (Face p. 740) No. 2
Exhibit A-3
VEJRMONT
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LOCATION OF BANKING OFFICES
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LOCATION OF BANKING OFFICES
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M AP NO. 517
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LOCATION OF BANKING OFFICES
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CLEARTYPE
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CLEARTYPE
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MAP N O .
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County Population Per Square Mile
•
under 50
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BENNINGTON
LOCATION OF BANKING OFFICES
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WINDHAM
CLEARTYPE
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MAP NO. 5W
RHODE ISLAND
LOCATION OF BANKING OFFICES
Savings Institutions
CLEARTYPE
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Exhibit C
ORLEANS
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V F. R M 0 N T
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11000—14999
1 5 0 0 0 and over
SCALE
Federal Resrve Bank of Boston, Research 8 Statistics Dept., //-/- 51
98454 O - 52 - pt. 2 (Face p. 740) No. 13
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
T)EBT
743
fronting any business functioning in a private enterprise economy.
That is, the office must be able to extend its services to a group that is
sufficiently large to provide a volume of business that will cover costs
and yield a satisfactory profit. On this criterion, the evidence suggests that commercial banking facilities have for some time been extended into all regions or localities of the district where profitable
operation is a reasonable possibility. The way is always open for
enterprising individuals or groups to apply for new bank charters, or
to open new banking offices, where there appears to be room for the
successful operation of additional banks. There have been very few
requests for new bank charters in this district over the past two
decades. Banking offices have been opened as branches of existing
banks, however, in a number of instances where the shift or growth
of population opened up new opportunities for profitable banking
services. By and large, it has been our observation that the elemental
stimulus of the enterprise system—seeking out opportunities for extending services wherever there is an opportunity to function at a
profit—has assured the provision of economically adequate banking
facilities in this district. For New York State, this observation will
soon be further tested by a detailed study of the present distribution
and adequacy of banking facilities, particularly with a view to the
possibility of approving additional branch offices for savings banks,
which has recently been inaugurated by the New York State Bankers
Association, in cooperation with the Savings Banks Association, at
the request of the State Superintendent of Banks.
The statistical data which we have prepared summarizes the distribution of banking offices in the second Federal Eeserve district ar>
a whole, including the entire State of New York, the 12 northern counties of New Jersey, and Fairfield County in Connecticut. Within the
district there are 868 banks with 1,847 offices. The total number of
banks include 850 which are classified as commercial banks, 5 classified
as private banks, and 13 industrial banks (only industrial banks in
New York State are included; the 3 industrial banks in the segment
of Connecticut included within the second district have not been
listed because they are not authorized to accept demand deposits).
Among the 1,847 offices of these various banks, there are 5 offices which
operate only on a seasonal basis, and 2 which are merely paying or
receiving stations. A l l these banking offices, except the two just mentioned, offer both loan and deposit facilities. Thirteen branch offices
located on military reservations have not been included in the total of
banking offices because they are not open to the general public. The
geographical distribution of these banks and banking offices, in relation to the density of population, will be discussed further below.
While in the aggregate these banking facilities provide an adequate
network of both deposit and loan accommodation throughout the district, there are in addition a large number of other financial institutions which also provide loan facilities (and in many cases a specialized type of deposit facility also). No attempt will be made to compare their location within the district with that of commercial banks,
primarily because none of them can accept demand deposits. Nonetheless, as repositories for savings, and as sources of loanable funds,
these other institutions provide a wide range of financing facilities
that are superimposed on the commercial banking structure. The
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT742
following table lists a variety of institutions which together maintain
nearly 3,000 offices within the second district:
Some financing institutions
Type of institution
Mutual sayings banks
Savings and loan associations
Small loan companies
Commercial finance companies3
Credit unions
_
Production credit associations
National farm loan associations
Total
in the second district,
Number of
head offices
1951
Number of Total number
of offices
branches
165
544
1220
7
1,086
17
32
111
50
1325
305
24
276
594
1545
312
1,086
17
56
2,071
815
2,886
i Approximate number.
* New York State only.
I n addition, most of the life-insurance companies, some specialized
investment companies, several independent factoring concerns, and
a number of large manufacturing or sales concerns (who sell on installment terms) conduct active lending operations within the district.
Data on the number of actual offices through which these lending
activities may be conducted are not available, and, of course, many
policy loans from insurance companies are arranged through local
insurance brokers whose functions could not be considered those of
a loan office.
So far as commercial banking offices are concerned, for the district
as a whole there is an average of 1 office for each 28 square miles of
territory. The average bank serves 10,300 people within its geographical area. Any such average is, however, merely a statistical convenience ; in order to provide a better indication of regional differences
within the district, each county has been studied separately. The
shading on th,e accompanying map indicates the differences among
counties in population density (measured as the number of people per
square mile in each county). A small circle superimposed upon each
county indicates the number of square miles per banking office. By
and large, although eaqh bank generally serves a much larger area in
counties where the population is relatively thin, the actual number
of persons served by eacn bank in such counties is relatively low. Thus,
in most of the counties which have no more than 100 persons per square
mile, the population per banking office is actually less than the figure
cited above as the average for the district as a whole. This simply
means that in the thinly settled areas banks serve many fewer people
per banking office than are served by banking offices located in the
larger metropolitan centers. A t the other extreme, while the counties
representing the various boroughs of New York City include large
numbers of banking offices within a limited area, each of these banking
offices serves many more persons than the number indicated as the
average for the district as a whole.
Within New York City, the county of New York (borough of Manhattan), has a banking office located on the average within each onetenth of a square mile, while the counties of the Bronx, Kings, and
Queens have banking offices for each 0.6, 0.7, and 1.0 square miles,
respectively.
98454 O - 52 - pt. 2 (Face p.742)
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
T)EBT
7 4 3
I n the semicircle of counties immediately around New York City
and in Richmond County, which is part of the city proper, the
density of the population in each county is in excess of 1,000 persons
per square mile and the available banking facilities are correspondingly numerous. Among these counties, Hudson County, N. J., which
embraces Jersey City, has a population density of 10,800 per square
mile and the banking offices are spaced on the average at one to the
square mile. I n Essex County, N. J., which includes Newark, the
third largest city in the district, the population density is 6,900 to the
square mile and banking offices average one to every 2 square miles.
Union County, N. J., which includes the city of Elizabeth, has a population density of 3,800 per square mile and its banking offices each
serve an area of 3 square miles. I n five other counties—Richmond
County (Staten Island), Nassau and Westchester Counties in New
York State, and Bergen and Passaif Counties in New Jersey—the
population density ranges from 1,400 to 3,400 people per square mile
and the banking facilities are spaced at one for each. 5 to 7 square
miles.
I n up-State New York and in the Connecticut portion of the second
district there are 5 cities with a population in excess of 100,000, namely,
Buffalo, Rochester, Syracuse, Bridgeport, and Albany. Erie County,
in which Buffalo, the second largest city in the district, is situated,
has an over-all population density of 850 persons to the square mile.
I t contains 104 banking offices or branches, on the average, one for
each 10 square miles of territory. Monroe County includes the city of
Rochester. I t has a population density of 725 persons per square
mile and is served by 40 banking offices, 1 for each 17 square miles.
Onondaga County includes the city of Syracuse and has a population
density of 430 people to the square mile. I t contains 33 banking offices
or 1 for each 24 square miles. Albany County, with 450 people per
square mile, is largely similar to Onondaga County in population
density, and the coverage of banking facilities, 1 for each 24 square
miles, is exactly the same. Fairfield County, Conn., has the city of
Bridgeport within its boundaries and it is also relatively close to New
York, so that it receives a certain amount of New York's commuter
copulation. I t has a population density of 800 persons per square
mile and contains 48 banking offices, one for each 13 square miles of
territory.
There are four additional counties with a relatively dense popula^
tion that are about as far removed from New York City as Fairfield
County. They are Middlesex and Monmouth Counties in New Jersey,
and Suffolk and Rockland Counties in New York. The incidence of
banking facilities in these counties ranges from one office for each 14
square miles to one office for each 20 square miles.
Among the sparsely inhabited counties of the district, Hamilton
County in the heart of the Adirondack Forest Preserve is outstanding
with but one commercial bank for the entire area of 1,747 square miles.
Relative to the population, however, Hamilton County with only
4,050 all-year residents, may be considered a sufficiently "banked"
county. The other northerly counties, namely, Essex, Franklin, Lewis,
Clinton, St. Lawrence, and the northerly part of Herkimer County,
are all either part of the Adirondack Preserve or are devoted mainly
to resort areas and agriculture. The incidence of banking facilities in
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT744
these counties is naturally low and ranges from one bank for each 304
square miles of territory to one bank in each 146 square miles. The
remaining sparsely inhabited counties are those lying outside the large
concentrations of population previously mentioned. Among these
counties there are eight in which there is one bank for each 100 to
125 square miles, 15 counties where there is one bank for each 75 to
99 square miles, and 14 counties in which the average area per bank is
51 to 74 square miles. Further details concerning each county are
presented in the following table.
Banking
offices in relation to nature of economic activity, population,
bp coimties, Second Federal Reserve
District
and area,
[Banking offices as of October 1951; population, census of 1950]
Nature of county
Total of
banking
offices
Population per
office
Population per
square
mile
NEW YORK STATE
Mixed industrial, governmental, and
agricultural.
Agricultural, oil industry
Residential industrial
Industrial, agricultural
Agricultural, oil industry
Agricultural, fruit farming
Agricultural
Industrial, farming
Medical and knit goods...
Fruit farming
Agricultural
do
Dairy and agricultural
Agricultural
Industrial
Resort, agricultural
do
Glove industry
Agricultural
Resort and agricultural
Forestry
Resort, wood products
Resort, mining
Residential, industrial
Mining
Agricultural
Dairy farming, silverware
Industrial.
Agricultural
Residential, industrial
Financial, industrial
Fruit farming, industrialCopper and knit goods, dairy farming
Industrial
Fruit farming
Agricultural.
do
do
do.
Fruit and dairy
Residential
Industrial
Residential, industrial
Residential, agricultural
Mining, fruit, dairy farming
Resort and agricultural
Locomotives and electrical industriesAgricultural
do—
Fruit farming
Glassware, agricultural
Agricultural
Resort
Dairy
Industrial, dairy
6
5
13
18
104
6
7
7
8
7
1
12
15
108
7
10
8
40
9
63
288
12
19
33
10
23
4
10
13
4
87
10
12
11
19
8
11
5
4
5
16
46
12
7
5
10, 881
451
2,576
21, 989
13,193
5, 564
6,376
7,510
10, 853
3, 914
8,937
7,197
7,432
3, 417
7, 599
8,647
5,848
6,404
7,289
5,948
4,106
4,105
5,117
5,701
25, 353
3, 217
4,026
5, 777
12,191
6,622
10, 679
6,806
15,833
11, 729
10, 355
0,017
42
35,397
260
58
100
125
6,620
7,458
7, 718
3, 905
5,077
17,826
13,261
15,963
8,116
5,205
9,359
12,991
4,541
3,546
5,851
5,715
6,003
3,394
4,309
11,824
211
43
51
67
74
30
168
853
19
27
103
95
44
2
43
66
38, 566
17
63
70
725
146
2,243
89, 096
356
182
431
93
184
75
80
50
86
14,360
199
3,361
502
36
92
684
36
43
89
64
299
41
57
120
MONETARY POLICY AND MANAGEMENT
Banking
offices in relation
to nature
of economic
by counties,
Second Federal
Reserve
OF P U B L I C
t)EBT
activity,
population,
District—Continued
and
745
area,
[Banking offices as of October 1951; population, census of 1950}
County
Nature of county-
Total of
banking
Population per
office
Population per
square
mile
N E W YORK STATE—
continued
Ulster
.Warren
..
Washington.
Wayne
Westchester .
Wyoming
Yates
6,616
Resort
Resort and agricultural.
do
Fruit farming
Residential
Agricultural
Fruit farming
81
4,901
5,893
5,211
9,628
2,984
4,404
44
56
94
1,439
55
51
10,476
797
10,314
11,261
10,769
3,557
11,507
7,700
10,288
10,541
12,342
4,289
11,693
5,441
2,171
6,930
10,769
97
817
415
343
1,704
324
64
3,786
149
CONNECTICUT
Fairfield
Mixed industrial, residential.
48
N E W JERSEY
Bergen
Essex
Hudson
Hunterdon..
Middlesex...
Monmouth..
Morris
Passaic
Somerset
Union...
Warren-
Residential, shopping
Industrial
do
Agricultural
Mixed industrial and farming
Resort, agricultural
Agricultural
Mixed industrial and residential _
Agricultural
Dairy farming
Industrial
Dairy farming
The detailed analysis of data concerning banking offices located
within each county still tends to conceal, however, instances in which
articular communities may only be served by a single bank, or peraps in some instances may not contain any banking offices. There
are, of course, many smaller communities in which, by force of economic circumstances, no more than one bank can be supported. Competition is generally provided, however, through the operations of
other banks in nearby communities, as well as through other lending
institutions or agencies. To illustrate the way in which nearby banking facilities may supplement those available within a given community, an additional study has been made. The following table lists
all municipalities within the second Federal Reserve district whose
population exceeds 14,000 persons and whose local commercial banking
facility is limited to no more than one institution. I n every case, as
the table also indicates, there are additional commercial banking offices within a relatively short radius. I n most of the communities
listed, there are also offices of savings and loan associations or savings
banks—in some instances several such offices exist in the same community. However, the details presented in the table relate only to
the existence of commercial banking facilities.
E
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT746
Cities of over 14,000 with only 1 commercial bank office, Second Federal
District, 1951
Location
County
Population
Commercial banks in
nearby cities
Reserve
Approximate
distance
in miles
N E W YORK STATE
Floral Park
Nassau..
Garden City.
Valley Stream.
Hornell
do—
.do..
Steuben..
Johnson City.
Broome..
North Tonawanda.
Ogdensburg
Niagara
St. Lawrence-
Oswego
Watervliet.
Oswego.
Albany.
New Hyde Park (1)....
Franklin Square (1)
Garden City (1)
14,364 Floral Park (1)
Franklin Squate (1)
New Hydo Park (1).._ _
Hempstead (2)
Mineola (3)
West Hempstead (1)...
26,833 Lynbrook (2)
Malverne (1)
Woodmere (1)
Springfield Gardens (1)
15, 649 Canisteo (1)
Arkport (1)
18,039 Binghamton (4)
Endicott (3)
24,730 Tonawanda (2)
16,126 Heuvelton (1)
Lisbon (1)'_
22, 611 Fulton (1)
15,036 Troy (3)
14, 535
N E W JERSEY
Bergenfield Borough
Bergen..
Cliffside Park Borough
do-
East Paterson
do..
Fair Lawn
NortlfArlington Borough.
.do.
do._
Hawthorne
Passaic..
Linden..
Union..
Rahway..
_do_
Roselle Borough.
.do.
West Orange..
17, 611 Tenafiy (2)
Englewood (2)
Teaneck (2)
Dumont (1)
17,123 Edge water (2)
Fort Lee (2)
Ridgefield (1)
15,391 Paterson (6)
Garfield (2)
Fair Lawn (1)
28,865 Glen Rock (1)
Hawthorne (1)
Paterson (6)
15,977 Belleville (2)
Kearny (2)__
Newark (9)
14,828 Paterson (6)
Glen Rock (1)
Prospect Park (1)
WyckofE (1)
Ridgewood (2)
30,434 Rahway (1)
Cranford (2)
Roselle (1)
Elizabeth (4)
Carteret (2).._
21,287 Linden (1)
Carteret (2)
Woodbridge (1)
17,646 Linden (1)
Cranford (2)
Roselle Park (1)
Elizabeth (4)
28,624 Orange (4)
Montclair (2)
Livingston (1)
South Orange (2)
Maplewood (1)
Verona (1)
Answer for the Third Federal Reserve District (.Alfred H. Williams,
Philadelphia)
Banking facilities in the third Federal Reserve district appear to be
adequate both from the standpoint of depositors and borrowers. There
are 839 commercial banks and 10 mutual savings banks in the district
doing both a deposit and loan business. The commercial banks are
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
747
distributed throughout the district so that banking facilities are within
a convenient distance of all residents, except possibly for a few living
in isolated mountain areas where population and wealth are insufficient to support a bank within a radius of a few miles. I n addition,
most people have an opportunity to choose either among two or more
banks in the same town or among towns and villages each with one
bank in their general area which are readily accessible with modern
transportation facilities. I n fact, excess banking facilities, in the
sense of insufficient wealth in the community to provide all of the
existing banks with the minimum resources necessary for strong,
efficiently operated institutions, are probably a greater problem in the
third district than inadequate banking facilities.
Banks in relation to population.—One index of the adequacy of
banking facilities is the number of banks in relation to the population—their potential customers. This relationship in the third district is shown in chart I .
Of the 60 counties in the district, 15 or one-fourth have a banking
office for each 4,000 or less population. These 15 counties, 12 in Pennsylvania, 2 in Delaware, and 1 in southeastern New Jersey, are
mainly agricultural, some of them also having diversified manufacturing, mostly small scale. Most of these counties are sparsely populated as compared to the density of population for the district as a
whole and have a number of small villages with only one bank.
The largest number of counties, 27 or nearly one-half, fall in the
classification of one banking office for each 4,000 to 7,000 population.
Typically, these counties are agricultural, diversified manufacturing,
or coal mining areas with few, if any, large cities. However, in general, they are more densely populated than the counties with a banking
office for each 4,000 population or less.
There are 12 counties with a banking office for each 7,000 to 10,000
people. Four of these counties are in the soft coal region of Pennsylvania, two are in the heart of the anthracite region, each with a
medium-size city; five are close to the metropolitan area of Philadelphia, and one is in the heart of the resort area along the New Jersey
coast.
Six of the counties have a banking office for each 10,000 population
or over. These are densely populated industrial areas so that the
large number of people per banking office does not indicate any lack
of adequate banking facilities conveniently available.
Geographical distribution of hanks.—Another requirement of adequate banking facilities is that the banks be distributed so that residents of the district have convenient access to a banking office. The
distribution of the banks in the third district is shown in chart I I , the
open circle representing a single bank or branch office and the solid
dot representing towns with two or more banks.
The average number of banking offices per county is 17. There are
25 counties with 10 or fewer banking offices, and 1 county, Philadelphia, has 127 banking offices.
I t is clear from the chart that the banks tend to be concentrated in
the densely populated areas. There is, however, a good distribution
of banks in the sparsely populated counties except for a few in the
most rugged mountain regions. I n these counties there are relatively
large areas without a bank, but the primary reasons are inadequate
resources and population to support one.
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT748
Additional lending facilities.—Other lending agencies, such as savings and loan associations, insurance companies, production credit
associations, mortgage companies, finance companies, and credit
unions, supplement the credit facilities of the commercial and mutual
savings banks. Savings and loan associations, insurance companies,
and mortgage companies are very active in the real-estate loan field,
especially residential mortgages. The production credit associations
supply a substantial amount of short-term credit to farmers. Personal
and sales finance companies and credit unions specialize in credit to
the consumer, either directly or through the purchase of consumer
credit paper from stores and dealers as in the case of sales finance
companies.
Data are not available on the number and the distribution of these
various lending agencies in the third district. However, they are
numerous, and one or more of these institutions supplement the credit
facilities of the banks in nearly every community. They not only
enlarge the total credit facilities available but also provide competing
sources of funds. I n view of the wide distribution of these institutions, as well as commercial banks, there are probably very few, if any,
residents of the district who do not have access to more than one
lending institution.
THE THIRD FEDERAL RESERVE DISTRICT
POPULATION PER BANKING OFFICE (INCLUDING
HEAD-OFFICES AND I N - AND OUT-OF-TOWN BRANCHES)
POPULATION 4 , 0 0 0 OR
LESS
OVER 10,000
I
I
THE THIRD FEDERAL RESERVE DISTRICT
POPULATION
PER
SQUARE
MILE
BANKING
5 0 OR LESS
L _ J
0NE1
51 T O
[ Z 3
T W 0
250
OVER 2 5 0
ES3
B A N K
CITIES
( M A I N
QR MORE
Q R
B R a n C h )
BANKS
0
#
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT750
Answer for the Fourth Federal Reserve District {Ray M. Gidney,
Cleveland)
The accompanying maps (exhibits A, B, and C) indicate that banking facilities are within convenient reach of virtually all persons and
business firms throughout the fourth district, and that, except perhaps
in the most sparsely populated areas, ample opportunity exists for
depositors and borrowers to divert their patronage from one bank or
lender to another in response to competitive conditions.
Exhibit A shows the approximate location of each of the 1,440 banks
and branch offices in the fourth Federal Reserve district. The map
shows that the offices are more thickly located in the heavily populated
areas than in the less heavily populated areas but that they are well
distributed throughout the district and that the distances between
banking offices are not excessive, particularly when consideration is
given to the quality of our modern transportation facilities, to the
character of our highway system, and to the widespread ownership
of automobiles.
Location alone of banking offices is not a sufficient measure of adequacy of those facilities. The most important question is whether the
number of offices, the resources, and the variety of services available
are sufficient to facilitate the commerce, industry, and agriculture of
the community and to finance the reasonable growth and development
of the community and its business. We have not developed data on
the volume of business and incomes of different communities but, instead, have used density of population as our measure, and have related
banking facilities to population. Exhibit B shows how the banks
compare with population in each county. Viewed on this basis, certain
general observations can be made.
1. Banking offices and banking resources tend to concentrate
in densely populated centers with a large volume of business. I n
the fourth district these centers include such cities as Cleveland,
Cincinnati, Pittsburgh, Toledo, Dayton, Columbus, and Youngstown. These places can be located on the map by the clusters
of dots. The fact that some of the dots are small is without
significance; they have been made small in an effort to get them
crowded into a small space.
2. Because of the density of population in the larger centers,
the number of persons per banking office tends to be greater than
in the rural areas. This does not indicate less adequate facilities
in the cities; rather it reflects the fact that the facilities tend to
become larger and provide more varied services to their local
clientele.
3. I n the rural areas the banking offices tend to be pretty well
distributed geographically so that distances between offices are
not excessive.
TJrban centers.—In most of the 22 counties of the fourth district
with population of more than 100,000, there is one banking office for
each 10,000 to 20,000 population. I n five of the centers the ratio is one
banking office for each 6,000 to 10,000 population. The largest in this
latter group is Hamilton County (Cincinnati) with 83 banking facilities for 725,000 persons.
The densely populated urban areas, because of the concentration of
people, have more and generally larger banking offices for a given unit
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
751
of area but fewer offices per unit of population than do the less heavily
populated rural areas.
The banks in the larger centers tend to be larger, are generally able
to provide directly a more diversified service, and can also make larger
loans, thus serving the needs of larger business firms than can many
of the smaller banks. Furthermore, by acting as correspondent banks
the larger city banks enable the smaller rural or country banks, in
turn, to provide their local communities with a wider variety of
services than would be possible if the smaller rural banks tried to do
it all themselves. Thus, both in the large cities and in the rural areas
mere numbers, size, and location are not a sufficient test of adequacy.
Rather, the whole range of banking practices and of interbank relationships must be considered. I n my opinion, those who have a need
and use for banking facilities in the fourth district have reasonably
satisfactory access to adequate facilities.
Areas with the most numerous banking offices in proportion to population.—In nearly one-fourth (39) of the counties of the fourth district, there is one banking office for each 4,000 population or less.
These counties are shaded black on the map (exhibit B ) . Most of the
39 counties are located in western Ohio and northern Kentucky, where
almost without exception, the major economic activity is agriculture.
I n those areas the population is prosperous, relatively evenly dispersed
throughout the counties, and not concentrated in large urban communities.
The largest of the 39 counties is Wayne County in Ohio, with a
population of 59,000. There are 15 banks in the county, in 12 different
municipalities, which means that banking facilities are within easy
reach of nearly every part of the county. Most of the 15 banks have
total assets of less than $4,000,000 each, and therefore, do not provide,
in themselves, the wide range of services normally associated with
banking offices in large metropolitan centers. Throughout this
analysis, however, it should be remembered that in the broad sense
banking facilities are not necessarily a function of size or architecture.
I n the Pennsylvania portion of the fourth district, the largest county
with a large number of banking offices in proportion to the population
is Clarion with a population of 38,000, also predominantly rural. The
county has 11 banking offices, located in 9 municipalities. Here, too,
the offices are well distributed throughout the county.
I n Kentucky (fourth district portion) there are 15 counties in
which the population is less than 4,000 per banking office. The largest is Lincoln, with a population of less than 19,000 but with six banking facilities divided among four different communities.
I t might be added that the median county (of the 39 well-covered
counties) is Harrison County, Ohio, with a population of 19,000 and
six independent banks located in six different towns or villages.
Presumably only a favorable combination of circumstances will
warrant, or permit, such a relative abundance of banking facilities
as exist in the rural areas described above. These circumstances include prosperous business and high agricultural incomes, well distributed.
Areas with the fewest banking offices in proportion to population.—
I n contrast to the foregoing well-covered counties, there are 10 counties in the fourth district each of which contains only one banking
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT752
office per 20,000 persons (or more). These 10 counties do not possess
a common economic characteristic.
Menifee County (almost in center of fourth district, Kentucky),
with a population of 4,800, has had no bank since 1933. Because of
mountainous topography, farming is on only a limited scale, and
there is practically no industry in that section of the State.
Far more populous are five counties in southeastern Kentucky which
also contain relatively few banking offices. The largest of this group
is Pike County with a population of over 80,000, but with only three
banking offices. Another is Harlan County with the same number
of facilities for some 70,000 persons. I t is believed that the character of the economic resources and the relatively low economic
income per capita in these counties, from poor farm land and from
mining, are partly responsible for the scarcity of banking facilities.
The existence of many mining-company commissaries is also a factor.
Two counties at the southern tip of Ohio (Scioto and Lawrence)
likewise have a very small number of banking offices in relation to
population. The former with a population of over 80,000 has only
four banking offices, three of which are located in the county seat of
Portsmouth. Lawrence with a count of 49,000 has only two offices,
both in Ironton. I n both instances, it may be explained that the
respective county seats are the only areas of appreciable industrial
activity in those counties and that the hinterland consists of sparsely
populated and rugged terrain.
Another below-average area is Lake County in northeastern Ohio,
which has a population of around 75,000, served by only three banking offices. The relative scarcity of banking facilities in such a
built-up area can be explained in part by the fact that the population
has grown rapidly in only recent years, as a consequence of the expansion of the Cleveland metropolitan area, without a corresponding increase in number of banking offices. There has been some discussion
among local interests looking to the establishment of additional facilities in the county.
Summit County is the largest of the counties, with relatively few
banking offices in proportion to population. This reflects, in considerable part, the density of population of the city of Akron itself,
for the balance of the county seems to be in line with many other
similar areas. Akron has a population of more than 300,000 and six
banking offices with total resources of more than $300 million. The
remainder of the county is predominantly rural and its 100,000 people
appear to be well served by the six banking offices located in six communities of the county.
LENDING
FACILITIES
The incidence of banking facilities is determined not only by the
potential volume of deposits that may be available but also by the
number and character of competitive lending institutions present in
any respective area, such as building and loan associations, credit
unions, finance companies, mortgage companies, insurance company
lending offices or agencies, production credit associations, and national
farm-loan associations. The relation to population of all such lending agencies, including banks, in each county is shown in exhibit C.
The count of lending agencies, other than banks and savings and loan
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC DEBT
753
associations, used in this report is based largely on registrations under
regulations W and X .
Large metropolitan centers.—The number of lending agencies in the
metropolitan centers of the fourth district is large, competition is keen,
and there does not appear to be a shortage of facilities for those who
can qualify for their use. Under ordinary circumstances the chief
qualification for use of the facilities is demonstration of ability and
intention to repay. We are informed that, currently, lenders are denying loans to applicants in many instances because the purposes of the
loans do not meet the tests of the voluntary credit restraint program
discussed in the answer to question 25. Such a rejection is not a reflection of an absence of lending facilities but of inability of the applicant
to meet the tests of credit worthiness now being employed.
Counties with a large number of lending agencies in relation to population.—In nearly one-third of the fourth district counties, there is
one lending agency (bank or other) for each 3,000 of population (or
less). These areas are roughly coterminous with those containing a
relatively large number of banks, that is, they are predominantly rural
in character. (Compare exhibits B and C.)
As in the case of banks, most of the counties with the greatest number of lending facilities in relation to population are predominantly
agricultural. Two of the largest such counties are Wayne and Wood
(both in Ohio). Each county has a population of nearly 60,000 and is
served by 20 lending agencies, or 1 for each 3,000 persons. Nearly
40 percent of all Ohio counties have almost that many lending institutions and lending agencies in proportion to their population. The
northwestern portion of fourth district Kentucky also is relatively
well supplied with lending facilities.
Counties with a relatively small number of lending agencies per unit
of population.—In contrast to northern Kentucky, the southeastern
portion of that State represents the largest single area of relative sparsity, which for the most part is attributable to the economic situation
in that area and the resulting comparatively low per capita income.
Ohio also contains 7 counties in which there is only 1 (or less)
lending agency for each 7,000 population. The same seven counties
also ranked low in banking density. The relatively small number of
banking offices in those seven has not been offset by a corresponding
abundance of other lenders, which suggests the presence of some economic factors that may be hindering the proliferation of lending facilities. I n fact, in both exhibits B and C, tiie incidence of the various
shaded areas does not occur at random (which would be the case if
banking density were a function of personal economic power in each
locality) but follows a clearly perceptible pattern, reflecting above all
else levels of income and the type of agricultural, industrial, trading,
or mining activity carried on within each single or multicounty section.
This relationship is similar to that shown to exist between the economy of the community and the presence of business opportunities as
well as the availability of capital and credit therefor, indicated in the
answer to question 35.
Answer for the Fifth Federal Reserve District {Hugh Leach, Richmond)
The fifth Federal Reserve district, comprised of Maryland, District
of Columbia, Virginia, West Virginia (excluding the six-county pan98454—52—pt. 2
7
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT754
LOCATION OF BANKING OFFICES-FOURTH FEDERAL RESERVE DISTRICT
for the district is in large part a consequence of the large population
concentrations in three metropolitan areas: Baltimore, the District of
Columbia, and Hampton Roads. These three areas account for almost
one-fourth of the total population of the fifth district.
Almost one-fourth of the 319 counties in the district, arbitrarily
counting the District of Columbia as a county, have one banking office
for each 5,000 persons or less. This is a low ratio when compared with
13,567 for the city of Baltimore, 9,596 for the city of Richmond, and
8,378 for the city of Charlotte. The national average is, incidentally,
just over 7,000.
Four out of five counties in the fifth district have two or more banks
and branches. I n 62 percent of the counties there is one banking office
MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT
BANKING
OFFICES
IN FOURTH
755
DISTRICT
AS O^ NOVEMBER I, 1951
for each 10,000 population or less. Thirty-one percent of the counties
have a ratio of population to number of banks and branches between
10,000 and 20,000, the majority of which are found in North and South
Carolina. Only 16 counties in the entire district have only one banking office per 20,000 population or more and only 5 counties out of the
total of 319 have no banks.
I t would appear that, as indicated on the accompanying maps, banking facilities are adequately distributed throughout most of the district
to meet the needs of individuals and business enterprises. Similarly,
there is throughout most of the five-State district reasonable opportunity for depositors and borrowers to choose between two or more
banks.
I n some instances misleading impressions may arise from the presentation of data by county. Frequently people living in counties with
high ratios of population to banking offices have access to banking
facilities across county lines. This is particularly true when we con-
MONETARY
LENDING
POLICY AND MANAGEMENT
ENTERPRISES
A S
*
OF
AND
AGENCIES
N O V E M B E R
I,
O F P U B L I Ct ) E B T756
IN FOURTH
DISTRICT*
1951
Including banks, savings and loan association^ credit unions, finance companies,
mortgage companies, insurance companies, Production Credit Associations, and
National Farm Loan Associations,
sider contiguous counties comprising an area of homogenous economic
characteristics.
Less than 2 percent of the counties embraced in the fifth Federal
Reserve district are "no bank" counties—New Kent, Charles City,
King and Queen, and Cumberland Counties in Virginia, and Camden
County, North Carolina. Despite the absence of within-county banking facilities, analysis of these counties indicates that competing facilities are reasonably convenient (for the purpose of this memorandum, facilities within 20 miles are regarded as reasonably convenient)
across county lines to depositors and borrowers throughout each of the
five counties. Supporting this conclusion are the following characteristics common to all five counties: (1) sparse population; (2) no urban
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
757
areas; (3) virtually no manufacturing activity; (4) low per capita
income; (5) "shoe-string" shape (maximum width 12 miles); and (6)
reasonable proximity to competing banking facilities in adjoining
counties.
There are 54 one-bank counties in the fifth district, but only 13 of
them do not have competing banking facilities within reasonably convenient reach of all parts of the counties. These counties are Floyd in
Virginia; Calhoun, Morgan, Pendleton, and Webster in West Virginia; Allegheny, Currituck, Dare, Graham, Pender, Tyrrell, and
Washington in North Carolina; and McCormick in South Carolina.
I n every one of the 13 counties there is a low density of population
per square mile (average, 26.2; range, 12.7-39.2), and every one of
the counties has a relatively low ratio of population to banking offices
(average, 9,997; range, 5,048-18,423). I n the majority of these cases
it is extremely doubtful that the sparse population and slender economic resources could support the additional banking facilities necessary to put all portions of the counties within convenient reach of more
than one banking office. Only relatively small areas, within each
county are without reasonably convenient competing banking facilities, and in two cases the deficiency is corrected by crossing State
lines. Manufacturing activity is nil or insignificant in every county;
the average number of census-classified manufacturing establishments
for the group is 12, with a range from 2 to 25.
There are in the fifth district only 16 counties (5 percent of the total)
with ratios of population to banking offices of 20,000 or over. I n most
of these cases, however, banking facilities appear reasonably adequate
and individuals and businesses do have access to competing banks.
The basic factors considered in arriving at this conclusion were availability of banking facilities in adjacent counties, economic environment, urban concentrations, and supplementary bank-type services
such as those provided by large coal companies.
Three of these counties—Buchanan, in Virginia; Logan, in West
Virginia; and Henderson, in North Carolina—do not appear to provide individuals and businesses with a choice between two or more
competing banks. Based on population alone, Logan County, in West
Virginia, with one bank and a population of 77,000, does not appear
to have adequate banking facilities. Yet rugged topography, scattered population, and coal-mining emphasis, with company stores and
credit, seem to give a reasonably common-sense answer to the possible
query as to why there are no more banks.
Note on deposit-lending facilities.—The appended map showing
location of fifth district banks includes 23 depositories in South Carolina. These depositories accept demand deposits, but may only make
loans to the extent of their surplus or as brokers for individual
depositors.
Also included are all tellers' windows licensed as branches. These
may or may not make loans, though all accept deposits. As a general
rule, they also accept payment on loans and receive credit applications
for processing at the head office, so that in effect loan facilities are
available at many of these tellers' windows. To our knowledge, there
is only one branch in the district which handles loans but does not
accept deposits; this branch is included on the map.
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT758
Tellers' windows not licensed as branches and deposit facilities at
military installations (unless licensed as branches) are not included.
Data indicating the number of such facilities and tellers' windows are
not available.
FIFTH
FEDERAL RESERVE DISTRICT
RATIO OF POPULATION TO BANKS AND BRANCHES
POPULATION PER BANK AND BRANCH
•
•
UNDER 5 , 0 0 0
3
5,000
TO
9,999
M M
10,000
TO
19,999
CZD
20,000
AND OVER
C£3
NO
BANKS OR BRANCHES IN COUNTY
Answer for the Sixth Federal Reserve District (Malcolm Bryan, Atlanta) :
Judged on the basis of being within the convenient reach of all
persons and business firms having need of them, banking facilities
appear to be adequate in practically all parts of the sixth Federal
Reserve district. Facilities are conveniently available to residents of
most rural areas as well as to practically all urban residents. Moreover, in most urban and rural areas there is the opportunity of choosing between two or more competing banks. I n addition, other types
of lending facilities are available in large numbers.
MONETARY POLICY A N D M A N A G E M E N T OF P U B L I C
THE
FIFTH
FEDERAL
RESERVE
t)EBT
759
DISTRICT
Services to rural areas.—In practically all the area now included in
the Atlanta Federal Reserve District—Alabama, Florida, Georgia,
the southern halves of Louisiana and Mississippi, and the eastern twothirds of Tennessee—agriculture at one time was the predominant
economic activity. As a consequence, population was not concentrated in large urban centers. To meet the needs of the people, the
States were subdivided into numerous small counties. I n general, the
area of each county was such that a resident of any part o f the county
could go and return from the county seat by horse-drawn transportation and transact his business well within 1 day.
Although many areas of the district are now predominantly urban,
and although modern transportation has vastly increased the distance
that may be conveniently traveled in order to transact business, the
original county boundaries have been retained for the most part.
The existence of a bank or banks within a county, therefore, means
that for the rural resident banking facilities are as conveniently avail-
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT760
•
able as practicable. Indeed, so small are some of the sixth district
counties that the residents of many of them have a choice of several
trading and banking centers not only in their own counties, but in
adjoining counties as well. The average land area of a sixth district
county is 564 square miles. Since this means an area only 23.7 miles
square, the existence of banking facilities in the county would mean
that the distance to a bank on an average would seldom exceed 12 miles
for any rural resident.
Out of the 439 counties included in the Atlanta Federal Eeserve
District there are only 12, or 2.7 percent, with no banking facilities
whatsoever. (Banking facilities include unit banks and branch offices.) I n all but 125 counties—28 percent of the total—residents
have the opportunity of choosing between two or more banks within
the county. I n many cases, because of the small size of the county,
they have the opportunity of conveniently choosing the services of
banks outside the county if they so desire. (See exhibit A., p.t763.)
Each county in Alabama and Tennessee contains at least one banking office. Three counties in Florida have no banking facilities—
Glades, Liberty, and Wakulla. Only one of them has a population
of over 5,000. None of them contains a city of over 2,500 persons.
Per capita retail sales of $550, $557, and $217, respectively, compared
with the State average of $853 cast doubt on the possible profitable
operations of banks in these counties.
There are no cities of 2,500 or over in the five Georgia counties without banking facilities. Residents of Banks County normally do a
great part of their trading in Gainesville nearby. Dade County lies
within the Chattanooga, Tenn., trading area. Dawson County residents have ready access to the banks in Dahlonega and Cumming.
Oconee County residents are near Athens, Ga., a major trading center.
Chattahoochee County is within the Columbus, Ga., trading area, and
residents of Quitman County can be served by the banks in Eufaula,
Ala., just across the State border. Per capita retail sales range from
$75 to $222 in these counties compared with the State average of $615.
I n Louisiana, there are no banking offices in Cameron and Plaquemines Parishes. The former is within the Alexandria-Lake Charles
trading area, and Plaquemines Parish, near the mouth of the Mississippi, contains no cities of over 2,500, and is ordinarily served both in
its trading and banking activities by institutions in the New Orleans
area.
The sole county in Mississippi not served by a bank, Issaquena, has
4,958 inhabitants, and per capita retail sales of $132 compared with
$440 for that part of Mississippi within the sixth district. I t contains no city of over 2,500 persons.
Services to urban areas.—In approximately 94 cases out of 100, residents of sixth district cities with populations of 2,500 or over have
banking facilities within their own city. I n 56 cases out of every 100
they may choose between the services of competing banks. As indicated in table 1, the likelihood of such choice increases with the size
of the city. Oak Ridge, Tenn., is the one city of over 25,000 population
with only one banking office and this is a special case.
No cities of 10,000 population or over have no banking facilities
whatsoever. Eleven of the twenty cities of 2,500 to 5,000 population
with no banking facilities are located within major metropolitan areas
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C
t)EBT
761
where competing banking facilities are available. The remaining
cities of this size with only one bank are for the most part suburbs
of other cities. Both of the cities of 5,000 to 10,000 population without
banks are within a major metropolitan area.
Banking facilities in relation to population.—Because banks are
privately owned businesses, operating for a profit, private enterprise
will not knowingly open a bank unless it believes the community is
economically capable of supporting it. More banks in the community
than can be profitably supported can lead to bank failures and losses
not only to owners but to the public as well. Such a condition existed
prior to and during World War I , and it was a large factor in the
cause of a large number of bank failures during the twenties.
One factor, although not the only one, that is considered in determining the practicability of establishing a bank is the size of the
population that might be served. As a general rule, a bank may provide a more complete range of services to its customers when it is serving a population sufficiently large to compensate for the services it
renders than when the population is small.
Exhibit B., page 764, shows the variation in ratios of population to
banks by counties. I n preparing the map, data for counties with no
banking offices were combined with neighboring counties where banking transactions would normally be carried on.
Exhibit B shows that the population served by many of the banks
is relatively small, particularly in the rural areas. The addition of
more banks, therefore, might reduce the services that the banks might
offer to the residents if they were to still operate profitably and might
also make it impracticable to establish competing banks.
Loan facilities.—Loan facilities are available even more conveniently than bank facilities alone. Specialized lending institutions,
including credit unions, savings and loan associations, sales finance
companies, production credit associations, Federal farm mortgage
associations, mortgage companies, and insurance companies, increase
the opportunity of choosing between competing lenders.
The ratio of population to loan facilities by counties is shown in exhibit C, (p. 765) .3 As indicated by the map, lending facilities are even
more conveniently available throughout most of the area than banking
facilities alone. So far as numbers of lenders are concerned, loan
facilities are in convenient reach of practically all persons and businesses that have need of them.
9
The numbers of lenders were derived from registration statements filed with the
Federal Reserve bank pursuant to regulation W and regulation X. Although the list is
as reasonably complete as possible, some lenders have probably not been included. The
data used in exhibit C include the institutions listed in the preceding paragraph as well
as banks and their branches.
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT762
TABLE
1.—Banking offices in sixth
district
city
cities classified
by State and size of
Number of cities with banking
offices as specified
State and size of city
Number of
cities
2 or more
offices
1 office
None
Alabama:
2,500 to 5,000-..
5,000 to 10,000-.
10,000 to 25,000.
25,000 or over—
2,500 or over-
11
20
9
76
26
46
96
55
32
Florida:
2,500 to 5,000...
5,000 to 10,000..
10,000 to 25,000.
25,000 or over
2,500 or over-
14
Georgia:
2,500 to 5,000-.5,000 to 10,000-.
10,000 to 25,000.
25,000 or over—
34
17
14
7
21
2,500 or over-
72
Louisiana:1
2,500 to 5,000...
5,000 to 10,000..
10,000 to 25,000.
25,000 or over—
2,500 or over-
47
22
28
20
Mississippi:1
2,500 to 5,000-..
5,000 to 10,000-.
10,000 to 25,000.
25,000 or over—
2,500 or overTennessee:1
2,500 to 5,000.
5,000 to 10,000..
10,000 to 25,000.
25,000 or over—
2,500 or overDistrict:
2,500 to 5,000. . .
5,000 to 10,000-.
10,000 to 25,000.
25,000 or over
2,500 or over..
2
15
4
47
17
29
184
103
64
41
103
32
12
61
1
52
40
148
222
392
22
* That part within the sixth district.
Answer for the Seventh Federal Reserve District
(G. S. Young,
Chicago)
I n the seventh Federal Reserve district, banking service is available
to each person in the county in which he resides. Moreover, there are
two or more banking facilities from which to choose in all but six
counties, all of which have a population of less than 6,500 each.
For the district as a whole, there is an average of one banking facility for every 7,060 persons. Illinois, with 11,660 persons per facility,
has the lowest banking density relative to population of the five district
States. This reflects, of course, the concentration of population in
MONETARY POLICY AND MANAGEMENT
EXHIBIT
OF P U B L I C DEBT
763
A
BANKING OFFICES IN SIXTH FEDERAL RESERVE DISTRICT
AVAILABILITY BY COUNTIES
the Chicago area, and a higher-than-average asset size per bank. A
similar situation in Wayne County, Mich., results in a lower than average density of one facility per 9,430 persons in that State.
Banking density in most counties, therefore, is above the district
average. Of the 337 counties, one-third have a facility for every 3,000
or fewer people, and over four-fifths of the counties have a density of
one bank per 7,060 or fewer persons (the average). I n general, agricultural counties have the highest banking densities, because of their
relatively low population and the dependence of farmers on banking
services. Lowest densities occur in heavily populated industrial areas,
where competing nonbank facilities are available and many persons
are not in need of banking services, and in the piore sparsely settled
counties, where land use is marginal,
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT764
EXHIBIT
B
BANKING OFFICES IN SIXTH FEDERAL RESERVE DISTRICT
POPULATION PER BANKING OFFICE BY COUNTIES
I OFFICE PER 4 , 0 0 0 POP. (OR LESS)
11 OFFICE PER 4 , 0 0 0 - 6 , 0 0 0 POP.
I OFFICE
6 , 0 0 0 - 1 0 , 0 0 0 POP.
I OFFICE PER 10,000~ 2 0 , 0 0 0 POP
\
1 I OFFICE PER 2 0 , 0 0 0 POP. (OR MORE)
W i t h the addition of competing institutions (715 savings and loan
associations, 1,284 small loan company offices, and 311 mortgage companies and brokers), the density of lending facilities increases substantially over the district. The average coverage is increased to one
facility for every 4,050 people; here, as is the case with banking facilities, the States with lowest densities are Michigan and Illinois. Almost
two-thirds of the counties in this district have one facility per 3,000
people, and only eight have one facility per 7,060 or less (the bank
average).
I n addition, other lending facilities are widely available, including
insurance companies, production credit associations, national farm
loan associations, credit unions, and industrial loan companies. These
have not been included in the accompanying statistical tables for one or
MONETARY
POLICY AND MANAGEMENT
EXHIBIT
OF P U B L I C DEBT
765
O
LENDING OFFICES IN SIXTH FEDERAL RESERVE DISTRICT
POPULATION PER OFFICE BY COUNTIES
| I OFFICE PER 4 , 0 0 0 POP. (OR LESS)
| I OFFICE PER 4 , 0 0 0 - 6 , 0 0 0 POP.
! I OFFICE PER 6 , 0 0 0 - 1 0 , 0 0 0 POP.
[:;/•;] I OFFICE PER 1 0 , 0 0 0 - 2 0 , 0 0 0 POP.
|
| I OFFICE PER 2 0 , 0 0 0 POP. (OR MORE)
more of the following reasons: (1) They do not normally provide
credit to business, (2) their location is of no special significance, or (3)
they are too few in number to affect the density data importantly.
The existence of multiple-banking facilities in virtually all counties
strongly suggests that the district's facilities are adequate for the great
majority of persons and business firms having need of them. The
distances to be traveled in rural areas generally are not unreasonable,
and bank-by-mail services are commonly offered. I n addition, over
three-fourths of the district's population live in communities where
banking facilities are locally available.
Of the 8,112 towns of all sizes in the seventh district, over 36 percent
have a banking facility, with the range extending from less than 1 percent for towns of 1 to 99 people to 100 percent for all towns with a popu-
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I Ct ) E B T766
lation of 25,000 or more. Most of the towns without banking facilities
are very small, and consequently 91 percent of the district's town population live i n places w i t h at least one facility and 75 percent live i n
towns where two or more facilities are located.
There are 20 cities w i t h populations of 5,000 or more which do not
have banking facilities. A l l of these, however, are located near large
cities where deposit and lending facilities are centrally available.
Three of these cities, Calumet City and Brookfield, 111., and Van Dyke,
Mich., have populations of more than 15,000. They are, however, i n
the densely populated Chicago and Detroit metropolitan areas. Both
Illinois cities have savings and loan associations and Brookfield has a
small loan office as well.
Lending institutions other'than banks also are locally available to a
large proportion of the district's town population. Generally, these
institutions are located in towns where a bank is also functioning, and
thus they do not add a significant number of towns to those served
by commercial banks. They do increase the proportion of the town
population having two or more competing facilities locally available,
however, from 75 to 82 percent. I n addition, these nonbank institutions increase the density of lending facilities substantially, particularly i n the larger cities.
TABLE 1.—Seventh Federal
Reserve District—Major
deposit
and lending
Number of
facilities
Institutions:
Commercial bank facilities
Member banks
Nonmember
banks
Branches 1
Savings and loan associations 2
Small loan company offices
Mortgage brokers.
Mortgage companies
•
States:8
Seventh district..
Illinois
Indiana
Iowa
Michigan
Wisconsin
facilities
Number of
persons per
facility
3,125
7,060
1,010
1,491
624
721
1,284
200
111
21,842
14,796
35,354
30,598
17,181
110,306
198, 750
5,441
4,054
1,431
1,011
1,139
1,003
857
5,150
3,19o
2,293
5,990
3,314
i Includes paying and receiving stations. Branch banking is prohibited in Illinois, Iowa, and Wisconsin,
but certain paying and receiving stations are permitted in Iowa, and such stations or branches in Wisconsin
established before May 17,1947, may be operated as branches.
* And 6 mutual savings banks.
»Seventh district portions.
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C
TABLE 2.—Seventh Federal
Size of town
Reserve District—Commercial
size of town
Towns1
With
banking
facilities
1 deposit
facility
tanking
t)EBT
facilities,
1 bank (or
lending
2 facilities
branch)
767
by
3 or more
facilities
Number of towns
0 to 99
100 to 499
500 to 999
1,000 to 2,499....
2,500 to 4,999....
5,000 to 9,999
10,000 to 24,999..
25,000 to 49,999..
50,000 and over-
3,504
2,612
756
651
235
161
108
46
39
25
660
535
503
193
146
103
46
39
11
177
56
16
1
0
0
0
0
14
481
461
434
112
50
38
2
0
0
2
18
53
79
88
51
14
2
0
0
0
0
1
8
14
30
37
All towns.
8,112
2,250
261
1,592
307
90
Total town population (thousands)
0 to 99
100 to 499
500 to 999.
1,000 to 2,499....
2,500 to 4,999....
5,000 to 9,999....
10,000 to 24,999..
25,000 to 49,999..
50,000 and over-
175
784
567
1,139
881
1,208
1,890
1,725
9,452
1
198
401
880
724
1,103
1,803
1,725
9,452
1
53
42
28
4
0
0
0
0
1
144
346
760
420
383
666
75
0
0
1
14
93
296
660
893
525
105
0
0
0
0
4
60
245
1,125
9,347
All towns.
17,821
16,287
128
2,795
2,587
10,781
14.5
60.5
Percent of town population
All towns..
1
100.0
91.4
0.7
15.7
Includes all towns and cities listed in the 1951 edition of the Rand-McNally Commercial Atlas, whether
incorporated or unincorporated. Incorporated towns in the district number 2,918, with distribution by size
group as follows: 0 to 99, 63; 100 to 499, 1,042; 500 to 999, 689; 1,000 to 2,499, 564; 2,500 to 4,999, 212; 5,000 to
9,999, 157; 10,000 to 24,999, 106; 25,000 to 49,999, 46; 50,000 and over, 39; all towns, 2,918.
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I Ct ) E B T768
TABLE 3.—Seventh Federal
Reserve
of
Size of town
Towns»
District—Other
town
lending
facilities,
by
size
Savings and
loan
With facili- loan association Small
companyties
or mutual savoffice
ings bank
Number of towns
Oto 99....
100 to 499.
600 to 999..
1,000 to 2,499
2,500 to 4,999
5,000 to 9,999....
10,000 to 24,999..
25,000 to 49,999..
50,000 and over.
3,504
2,612
756
651
235
161
108
46
39
0
17.
30
99
111
123
90
46
39
0
16
29
87
82
101
77
40
39
0
1
4
23
62
95
81
45
39
0
0
0
2
2
6
9
16
26
All towns.
8,112
555
471
350
61
Total town population (thousands)
0 to 99
100 to 499
500 to 999
1,000 to 2,499—
2,500 to 4,999—_
5,000 to 9,999—
10,000 to 24,999..
25,000 to 49,999..
50,000 and over.
175
784
567
1,139
1,208
1,890
1,725
9,452
881
0
5
23
173
416
923
1,575
1,725
9,452
152
308
758
1,348
1,500
9,452
0
0
3
40
233
713
1,418
1,688
9,452
All towns.
17,821
14,292
13,545
13,547
0
5
22
Percent of town population
All towns..
1
See tabled, footnote 1.
100.0
80.2
76.0
76.0
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C DEBT
TABLE 4.—Seventh Federal
Size of town
Reserve District—Deposit
size of town
Towns 1
With no
facilities
and credit
3 or moie
facilities
facilities,
2 facilities
769
by
1 facility
Number of towns
0 to 99
100 to 499.
500 to 999„
1,000 to 2,499
2,500 to 4,999
5,000 to 9,999
10,000 to 24,999
25,000 to 49,999
50,000 and over
3,504
2,612
756
651
235
161
108
46
39
3,479
1,949
215
143
41
14
3
0
0
0
0
4
19
66
108
79
46
39
0
13
39
118
74
19
12
0
0
25
650
498
371
54
20
14
0
0
All towns
8,112
5,844
361
275
1,632
Total town population (thousands)
0 to 99
100 to 499.
500 to 9991,000 to 2,499
2,500 to 4,999.
5,000 to 9,999.
10,000 to 24,999
25,000 to 49,999
50,000 and over
175
784
567
1,139
881
1, 208
1,890
1,725
9. 452
174
585
161
250
154
105
52
0
0
0
0
3
33
247
810
1,382
1,725
9,452
0
4
29
207
278
143
210
0
0
1
195
374
649
203
150
246
0
0
All towns
17,821
1,481
13,652
871
1,818
4.9
10.2
All towns
100.0
i See table 2, footnote 1.
98454—52—pt. 2
10
Percent of population
i
8.3
76.6
SEVENTH FEDERAL RESERVE DISTRICT
DENSITY OF
COMMERCIAL BANKING FACILITIES*
O
K
o
H
H3
5
Hj
O
tT«
[SIus:
•
o
H
MMAt^..
2
'
raiiiir
O
- Pllll"
j
POPULATION PER FACILITY
UNDER 2 0 0 0
2 0 0 0 - 2999
M B
fnnsna
3000-4999
r ^ l
9000 - 8999
9 0 0 0 AND OVER I
I
*
INCLUDES ALL COMMERCIAL BANKS AND BRANCHES.
a
f
H-l
a
»
H
w
SEVENTH
FEDERAL RESERVE DISTRICT
DENSITY OF
DEPOSIT AND LENDING FACILITIES*
g
O
O
f
>
o
a
o
UNDER 2 0 0 0
—
2 0 0 0 - 2999
H I D
3000 - 4999
P
1
5 0 0 0 - 8999
p ^ j
9 0 0 0 AND OVER I
I
* INCLUDES COMMERCIAL BANKS AND BRANCHES, SAVINGS AND LOAN ASSOCIATIONS, MUTUAL SAVINGS BANKS SMALL LOAN
COMPANIES, AND MORTGAGE COMPANIES AND BROKERS.
t*
HH
O
o
MONETARY
POLICY AND MANAGEMENT
O F P U B L I Ct ) E B T772
Answer for the Eighth Federal Reserve District (Delos G. Johns, St.
Louis)
I believe that banking facilities i n the eighth Federal Reserve dist r i c t are generally adequate for the district, considering the standards
noted i n the question. M y opinion is based on the following facts.
1. There is no county w i t h i n the eighth Federal Reserve district not
served by at least one bank.
2. Most counties (329, or 90 percent of all district counties) have
two or more banks to choose between.
3. Of the 34 counties w i t h only one bank, virtually all (33) are below
the district average i n population and are i n areas where per capita income is substantially below the district average. I n other words, these
counties probably can support no more than one bank (table I , p. 773).
4. Each of the counties w i t h one bank is abutted by at least two
counties having more than one bank.
5. Individuals and businesses of each eighth district county have
more than $1 million of local (county) banking resources available
to them except i n five cases: Four counties i n Arkansas and one i n
Missouri.
This estimate of banking resources available to supply the needs 'of
the individuals and businesses i n each county is based upon total deposits, a very rough measure of total banking resources. On the one
hand not all deposits are available for lending to individuals and
businesses. On the other, resources available to supply a county's
credit needs are many times greater than total deposits w i t h i n the
county, i f consideration is given to (a) the ability of a particular
member-bank to rediscount its loans w i t h the Federal Reserve bank,
(&) the ability of a particular bank (member or nonmember) to call
upon the resources of its correspondent banks or the Federal Reserve
System's 13b and Y-loan programs or, i n case of some types of loans,
upon insurance company direct lending and participation programs.
6. I n terms of total district population (10,500,000), the eighth
Federal Reserve district's 1,500 banking facilities average 1 to every
7,000 persons. People-per-bank ratios range f r o m 4,200 to one bank i n
the least populous counties to 24,900 to one bank i n the most populous
counties. As shown on the map and i n table I I , one-half of the
district's population living i n the less populous counties have access to
nearly three-fourths (72 percent) of the total number of the district's
banks. More individual banks are needed, and exist, to serve a given
number of people scattered i n rural areas than are necessary where
population is concentrated as i n a city or metropolitan area.
7. I n this district i t seems generally true that each county has the
number of banks the area can support. Avenues are open to formation
of new, independent banks anywhere i n the district; the chartering
agencies i n no way prohibit applications for more banks and give
careful consideration to community needs as one of the factors i n
passing on applications. One-bank counties, almost without exception,
lie i n areas characterized by relatively low per capita income and presumably relatively low per capita holdings of liquid assets.
8. I n this district most banking facilities combine both deposit and
loan features. There are 18 tellers' windows w i t h only limited banki n g facilities i n Arkansas. Similarly there are six cooperative exchanges i n Arkansas offering only limited services. Restricted fa-
MONETARY
POLICY AND MANAGEMENT
OF PUBLIC
t)EBT
773
cilities serve seven military posts within the eighth district. Otherwise
the 1,500 banking facilities i n this district provide both loan and
deposit services.
The above relates only to regular banking facilities. There are i n
addition numerous other financial institutions, both public and private,
that provide either deposit or loan facilities or both.
TABLE I . — E i g h t h district
counties,
with
one "banking
estimates, and per capita income for
State and county
Population
1950
Per capita
income in
1950 for
general
area2
11,683
7,132
18.137
9,024
16.138
17,079
8,609
32, 614
$543
789
613
730
953
730
588
Arkansas:
Baxter
Calhoun
Conway.
Grant...
Johnson
Lincoln
Marion
Miller
Montgomery.
Nevada
Newton
Perry
Saline-..
Scott
Stone.
Van Buren
Illinois: Pope
Kentucky:
Clinton
662
650
6,680
14, 781
8,685
5, 978
23,816
10, 057
7,662
9, 687
5,779
662
588
613
802
953
543
613
684
10,605
facility,
area1
population
Per capita
in
Population income
1950 for
1950
general
area2
State and county
Kentucky—Continued
Hancock
Meade
Simpson
Spencer
Trigg...
Mississippi:
Attala..
Itawamba.
Tunica
Missouri:
Douglas
Hickory.
Knox
Ozark..
Putnam
Ripley
Stone
Wayne
6,009
9,422
11,678
6,157
9,683
976
996
659
723
616
26,652
17, 216
21, 664
554
619
696
12,6?8
5,387
7,617
8,856
9,166
11,414
9,748
10,514
627
820
1,210
627
950
508
700
508
Total population of 34 counties
Average county population of 34 counties
Average county population, eighth district
Per capita eighth district income, 1950
407,967
11,999
28,850
$1,055
* Population figures from the census; 1950 income estimates by the Federal Reserve Bank of St. Louis.
Count of banking facilities based on deposit ownership surveys by Federal Reserve Bank of St. Louis
and tabulations prepared by Board of Governors of the Federal Reserve System. Deposit ownership surveys list no within-county branches of banks.
All banking facilities listed in table are independent banks except in case of Itawamba County, Miss,
where the facility is a branch office of a bank in another county. All facilities listed provide both deposit
and loan service to their communities.
2 The Federal Reserve Bank of St. Louis has prepared annual estimates of per capita income in 97 district
areas. Each area contains one or more district counties. The general area referred to is the income area
in the particular county noted.
TABLE I I . — B a n k i n g facilities
First quartile (least populous)
Second quartile
Third quartile
Fourth quartile (most populous)
eighth
Federal
Reserve
Number
Percent People
of coun- Number of total per bank
ties in of banks number (rounded
group
of banks to nearest
hundred)
Population quartile
Total or average
and population,
-
district
Average Range in
number number
of banks of banks
per
per
county
county
206
102
49
6
619
467
309
105
41
31
21
7
4,200
5,600
8,500
24,900
3
5
6
18
363
1,500
100
7,000
4
1-8
1-11
2-18
6-^9
MONETARY
EIGHTH
POLICY AND MANAGEMENT
DISTRICT
BANKING
FACILITIES
BY COUNTIES
O F P U B L I Ct ) E B T774
AND
POPULATION
102
(467
36,000
To 185,000
^
165,000 And Ovtr
Counties k
Bank*)
20un,,iV *
(309 Banks)
6 Counties*
(105 Bank*)
CONTAINING IN THE AGGREGATE APPROXIMATELY ONE-FOURTH OF TOTAL DISTRICT
POPULATION (1950 CENSUS)
NUMERALS
FACILITIES
BRANCHES
INDICATE NUMBER OF BANKING
PER COUNTY (WITHIN-COUNTY
EXCLUDED).
Answer for the Ninth Federal Reserve District
(J. N. Peyton,
Minneapolis)
On August 31, 1951, there were 1,275 banks on which checks are
drawn and 112 branches and bank offices i n the ninth Federal Eeserve
district. The population of this district as of A p r i l 1,1950, was 5,730,908. Thus one commercial banking office existed for each 4,132 persons i n the district^
A study of banking facilities i n the district indicates that i n counties where only one or two banks exist, the population almost invariably is sparse. The accompanying maps show that i n all these areas
the population per square mile is less than 10. I n most one-bank
counties, population per square mile is less than five persons; i n several
i t is two or less.
I n these sparsely populated areas i t is very doubtful that an additional bank would be a profitable enterprise.
Available evidence and general observation lead to the conclusion
that the number of banking offices i n the ninth Federal Eeserve dist r i c t is adequate, especially i n areas where a small number of banks
exist. I n only 7 of 305 counties i n the district does the number of
persons per bank exceed 10,000. These are the more densely populated
MONETARY
POLICY AND MANAGEMENT
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t)EBT
775
areas where deposit facilities of commercial banks are w i t h i n easy
reach of all people who wish to use them, and where many types of
credit facilities other than those of commercial banks are available.
Loan facilities are available i n practically all banking offices i n
the ninth Federal Reserve district where deposit facilities are present.
I n a few very small towns served by branches or stations of banks
w i t h main offices i n other towns, loan applications must be referred
to main offices, but this procedure usually applies only to the larger
loans. I n general, loan facilities and deposit facilities are not separable banking functions.
Answer for the Tenth Federal Reserve District (H. G. Leedy, Kansas
City)
I n our judgment, banking facilities i n the tenth Federal Reserve
district are adequate, and, to the extent that i t is practicable, competing facilities generally are available. As is apparent from the
accompanying map on bank location and population density, there is
a large range in the density of population i n the district (from 0.5 to
7,169 persons per square mile on a county basis), and the number of
banks and their distribution varies according to the population density. This is the result of the differences i n the type of economic
activity found i n the various parts of the district, as the nature of the
economic activity and the size of the population have determined the
needs for banking institutions. As both loan and deposit facilities
are provided by all commercial banks and branches in the district, these
statements apply to both types of facilities. There may be isolated
points, unknown to us, where banking facilities are considered inadequate. A number of applications for bank charters have been granted
i n recent years i n this area, and i t may be that others w i l l be necessary
in the future.
The largest number of persons per bank are found generally i n the
metropolitan areas, such as Denver, Kansas City, Oklahoma City,
Omaha, Tulsa, and Wichita, but i n those locations a substantial number of competing banks are available to the public w i t h i n the immediate community. Generally speaking, banking facilities, including
competing facilities, are available w i t h i n relatively short distances
throughout the more populous eastern half of the district, including
western Missouri, and the greater part of Kansas, Nebraska, and Oklahoma. The same condition exists i n the principal population centers
of the Mountain States i n the western part of the district.
I n large portions of the western half of the district, including most
of Colorado, New Mexico, and Wyoming, population is of low density.
That also is true of western Kansas, north central and western Nebraska, and the Panhandle of Oklahoma. The counties shown i n white
on the map have an average population density of less than five persons
per square mile, ranging downward to an average of less than one
person per square mile. I n western Kansas, western Nebraska, and
the Panhandle of Oklahoma, larger wheat farms and grazing predominate ; i n fact, many of the wheat farmers live i n the towns. The
Sand H i l l s of north central Nebraska are devoted to cattle raising.
Except i n the irrigated sections i n parts of northeastern Colorado,
northwestern New Mexico, and north central Wyoming, the areas i n
Colorado, New Mexico, and Wyoming shown in white on the map are
either mountainous or devoted largely to range operations for cattle
MONETARY
POLICY AND MANAGEMENT
O F P U B L I Ct ) E B T776
and sheep, w i t h farming operations limited largely to production of
feed. Along w i t h grazing, wheat farming is important i n eastern
Colorado. The availability of improved roads and the adjustment
of the whole mode of living to greater distances helps to make banking
facilities more readily available i n these areas of sparse settlement, i n
which i t could hardly be expected that banking facilities would be as
close at hand for all people as i n the more populous areas.
Answer for the Eleventh Federal Reserve District (R. R. Gilbert,
Dallas)
On June 30, 1951, there were 1,101 commercial banks (including
branches, agencies, and facilities of parent banks) i n the 311 counties
of Arizona, Louisiana, New Mexico, Oklahoma, and Texas which comprise the eleventh Federal Reserve district. These banks serve a local
population i n excess of 9,000,000, which means that for the district
taken as a whole there are approximately 8,250 persons per bank. I n
the larger metropolitan areas where the density of population is much
greater than i n the smaller cities and towns each bank provides services, on the average, for approximately 19,600 persons. Conversely,
i n the more sparsely populated areas each bank serves a much smaller
number than the average.
O f the 311 counties i n the eleventh district, there are 12 which have
no banks and 66 i n which there is only 1 bank per county. Sixty-two
of the counties i n these two categories are i n Texas, almost entirely
i n the relatively thinly populated western half of the State. The 12
counties which have no banks account for less than one-third of 1 percent of the district's population, while the 66 counties which have only
1 bank per county account for slightly less than 5 percent. Fortyeight of these counties have populations of 7,000 or less. The absence
of a bank i n some counties and the existence of only one bank i n others
does not necessarily mean, however, that these localities are without
banking services or that they do not have the opportunity of choosing
between two competing banks. For example, the county seat of each
of those counties which have no banks lies within a radius of 35 miles
of another town or city i n which, there is one or more banks. Moreover, i n two-thirds of tnose counties having only one bank, each county
seat is also w i t h i n a radius of 35 miles of another bank. I n those relatively few counties where a second bank lies more than 50 miles away
f r o m the county seat—in New Mexico, Arizona, and the western part
of Texas—the relatively greater distances separating towns and the
sparse population are characteristic.
There are 754 towns and cities i n the district i n which there is at
least one bank. Five hundred and forty-eight of these are one-bank
towns, while two hundred and six have two or more banks. The onebank towns predominate i n localities where either personal income or
population considerations would not warrant the establishment of a
second bank. For example, about 47 percent have populations of less
than 1,000. As i n the case of one-bank counties, other banking facilities lie w i t h i n reasonable reach of all except a relatively few one-bank
towns.
Among the 1,101 commercial banking offices i n the district, there
are 41 branch banks, 5 agencies of commercial banks (all i n New
Mexico), and 24 facilities of commercial banks maintained at military
NINTH
FEDERAL
RESERVE
DISTRICT
98454 O - 52 - pt. 2 (Face p. 776)No. 1
NINTH
FEDERAL
RESERVE
DISTRICT
98454 O - 52 - pt. 2 (Face p. 776) No. 2
TENTH FEDERAL RESERVE DISTRICT
98454 O - 52 - pt. 2 (Face p. 776) No.3
MONETARY
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t)EBT
7 7 7
reservations. I n most cases, the distinction between loan facilities and
deposit facilities is significant at these institutions. A t the remaining
1,031 banks the distinction is not important, since each institution is
an entity f u l l y competent, both by law and custom, to provide the two
services. Facilities provided at military installations are primarily
for the purpose of cashing checks and providing other services not
involving the making of loans or the accepting of deposits. The cashing of checks, acceptance of deposits, and other services are provided
at branches and agencies, while loan facilities on a limited basis are
provided only at some of these offices. Branch banking facilities in
the district are relatively insignificant, except i n Arizona (20 branches)
and Louisiana (21 branches).
D u r i n g the 3 years 1948-50,19 charters for new national and State
member banks i n the eleventh district were approved by the supervisory authorities. Ten applications were either disapproved or withdrawn. I n addition, the Federal Deposit Insurance Corporation received applications for insurance coverage for 61 proposed new State
nonmember banks i n the district. Twenty-one were approved and
chartered, while 40 were rejected or withdrawn. Lack of sufficient
evidence that the establishment of a new bank was warranted was
among the reasons for the rejection or withdrawal of applications for
new charters during the 3 years.
Notwithstanding the fact that 12 counties of the district have no
banks and an additional 66 counties have only 1 bank per county, banking facilities are w i t h i n reasonable reach of all persons, except a very
small proportion of the total population. Using as a criterion, the—
ideal of bringing banking facilities within the convenient reach of all persons and business firms having need of them, and, so f a r as practicable, giving
a l l persons the opportunity of choosing between two or more competing banks—
the eleventh district has adequate banking facilities on the whole.
There is little question that the establishment of additional banks
or branches i n some counties or towns would be of considerable convenience to small numbers of people i n widely scattered areas, largely
as a result of the provision of deposit facilities. The economic justification for supplying these services, howevier, appears questionable.
Convenience to the public cannot be accepted i n every case as an
overriding principle, or always even as a major factor, i n determining
the adequacy of banking facilities. I n an economy such as ours where
commercial banks are privately owned, economic considerations must
be taken into account and must form a part of any criterion of adequacy. For example, even though 73 percent of the towns and cities
of the district i n which there is at least one bank are one-bank towns,
this fact alone is not necessarily significant as an indication of insufficient banking facilities. I t is highly significant, however, that
the range of deposits (as of December 30, 1950) at banks i n the 66
counties having only one bank was from $609,000 to $8,552,000, w i t h
average deposits amounting to $3,122,000. I t is very probable, i f not
certain, that economic factors would not support the establishment
of additional banks i n any except a very few of these counties.
Due to the fact that banking is subject to a high degree of regulation and control, the area i n which competition is permitted or is practicable is limited rather severely. The prevalence of f u l l competition
between two banks i n the same town does not guarantee the existence
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T O F P U B L I Ct ) E B T778
of more adequate banking facilities. I n fact, i n towns where two
banks are not economically justified, banking services would be improved, in all probability, by the elimination of one bank.
Answer for the Twelfth Federal Reserve District (C. E. Earhart, San
Francisco)
The t w e l f t h Federal Eeserve district includes nearly one-fourth of
the area of the Nation, but only 11 percent of the population. Because of the topography of and the climatic variations over the district, population is very unevenly distributed. That some sections are
heavily settled and others very sparsely settled is indicated i n the
following tabulation of twelfth district counties:
County population per square mile
More than 50 persons:
Metropolitan areas
Other counties
10 to 50 persons. _
Less than 10 persons
Number of
counties
20
13
76
123
Percent of district total
Population
61
6
25
8
Area
4
2
24
70
I n the more densely populated sections banking facilities are w i t h i n
convenient reach of nearly all persons and business firms having need
of them, and the majority of bank depositors and borrowers do have a
reasonable opportunity to choose between two or more competing
banks. I n some of the sparsely populated sections banking offices are
not within convenient reach, and i n others facilities are offered by only
one banking organization. I n such areas, however, the volume 01 business done is so small, as a rule, that additional banking facilities,
whether unit banks or offices of branch banks, could not adequately
be supported.
The supervisory authorities, in considering an application for the
establishment of a new banking office, must be satisfied that the establishment would be i n the public interest, which includes a reasonable
prospect for the development of a sufficient volume of business to meet
expenses and maintain a sound bank. While competition among
banking offices is highly desirable, i t is not i n the longer r u n public
interest to permit the establishment of a competing bank i n an area
where only one healthy banking facility can exist.
Where opportunities develop for new banking facilities, as they
have i n connection w i t h the marked growth of population and business
activity i n the Western States, existing branch banking organizations
are usually eager to extend their services through additional branches,
and i n certain instances some group proposes to establish a new bank.
The growth of banking offices in this district, particularly since W o r l d
W a r I I , is illustrated by the following figures: 1,640 banking offices
i n 1935; 1,653 i n 1940; 1,674 i n 1946; and 1,866 i n mid-1951.
Currently these 1,866 banking offices represent 439 banks with not
more than one branch, 63 head offices of multiple branch banks, and
1,364 branch offices of branch banks. Only 19 of the district's 502
banks are savings banks (14 stock savings banks and 5 mutual savings
banks). The fact that most commercial banks operate substantial
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ELEVENTH
FEDERAL
RESERVE
DISTRICT
POPULATION AND NUMBER OF BANKING OFFICES, BY COUNTIES
POPULATION
OVER 7 5 , 0 0 0
60,000-75,000
45,000-60,000
30,000-45,000
15,000-30,000
UNDER 15,000
98454 O - 52 - pt, 2 (Face p. 778) No. 1
•
ELEVENTH
FEDERAL
RESERVE
DISTRICT
I O F F I C E PER 2 0 , 0 0 0 PERSONS OR MORE
POPULATION PER BANKING OFFICE, BY COUNTIES
( O F F I C E PER 1 0 , 0 0 0 - 2 0 , 0 0 0 PERSONS
I O F F I C E PER 5 , 0 0 0 - 1 0 , 0 0 0
PERSONS
I O F F I C E PER 2 , 0 0 0 - 5 , 0 0 0
PERSONS
O F F I C E PER 2 , 0 0 0 PERSONS OR L E S S
NO BANKING
OFFICE
98454 O - 52 - pt, 2 (Face p. 778) No. 778
MONETARY POLICY AND M A N A G E M E N T
OF P U B L I C
t)EBT
779
savings departments is the principal reason for the relatively few
banks that are strictly savings banks.
Branch banking is more important in the twelfth district than i n
any other district. While the growth of branch banking has brought
no decline, but has probably caused an increase, i n the number and
availability of banking facilities, i t has undoubtedly resulted i n a
reduction i n the number and availability of competing banking organizations.
I t is difficult to measure in an exact sense how adequately the district's 1,866 banking offices are distributed, but the following facts
may throw some light on this question. I n the entire district there are
15 counties without banking facilities. These counties are i n relatively remote mountain and desert areas, however, and have a total
population of only 57,000 people, half of whom are i n one Arizona
county (Apache), which has a large Indian population.
Altogether there are some 130 towns in the district of 1,000 or more
population, unincorporated as well as incorporated, 4 outside of socalled urban fringe areas, without banking facilities. However, many
of these are suburbs of, or close to, smaller cities; and there are only
10 such places located more than 20 miles from the nearest banking
point (one or more banks) ; 6 of these towns are i n Utah, 3 are i n
Arizona, and 1 i n Nevada, and all are under 2,000 population.
W i t h further reference to the opportunity of choosing between 2
or more banks, there are some 640 towns w i t h only 1 banking office.
Most of these towns are i n metropolitan areas or close to other cities.
There are 171 one-bank towns located more than 20 miles from the
nearest competing bank. I n addition, nine towns without banking
facilities, that are w i t h i n 20 miles of a bank, are more than 20 miles
f r o m the next nearest bank. Altogether there are 190 towns located
more than 20 miles from at least 2 banks, but 180 of these have 1 bank
i n the town or w i t h i n 20 miles. (There is a second office of the same
branch banking organization within 20 miles of a number of these
180 towns, but such an office is not considered a second bank for the
purpose of these statistics.)
As shown on the accompanying maps, most of the 190 plapes more
than 20 miles from two or more banks are located i n thinly populated
areas. I n counties w i t h a population density of less than 10 persons
per square mile are found all 10 of the places of over 1,000 population
that have no banking facilities w i t h i n 20 miles, and 112 of the other
180 towns more than 20 miles from a second bank. V i r t u a l l y all of
the other 68 towns, located i n the more densely populated counties,
including the 10 towns located i n counties w i t h more than 50 persons
per square mile, are not i n heavily populated areas. The maps do not
reflect this situation, however, since i t was not feasible to chart population density for areas smaller than counties. A l l but 42 of the 190
towns more than 20 miles from 2 banks have less than 2,500 population,
and only 8 have a population of more than 5,000.
Many commercial banks i n the t w e l f t h district make available to
their customers not just demand deposit and commercial loan facilities
but offer savings deposit, real estate and consumer loan, and other facilities as well. For the most part these facilities are available i n
4
Not including unincorporated towns in California of from 1,000 to 2,500 population.
See note, p. 780.
MONETARY
POLICY AND MANAGEMENT
O F P U B L I Ct ) E B T780
s m a l l e r c o m m u n i t i e s as w e l l as i n l a r g e cities. W h i l e i n s u r e d c o m m e r c i a l b a n k s i n t h i s d i s t r i c t h o l d 12 p e r c e n t o f t h e t o t a l resources o f
a l l i n s u r e d c o m m e r c i a l b a n k s i n t h e U n i t e d States, 20 p e r c e n t o f t h e
t i m e d e p o s i t s , 25 p e r c e n t o f t h e r e a l - e s t a t e l o a n s , a n d 18 p e r c e n t o f t h e
consumer i n s t a l l m e n t loans o f such banks are h e l d b y banks i n the
t w e l f t h district.
Statistical note.—The lower l i m i t of 1,000 persons, w i t h respect to places w i t h
no banking facilities, was used as a reasonable l i m i t and because of ready reference to census tabulations on that basis. For California i t was necessary to use
a lower l i m i t of 2,500 w i t h respect to unincorporated places, since the more detailed census tabulation is not yet available. This should not make any appreciable change, however, i n the number of such places more than 20 miles away
f r o m two or more competing banks.
I t should also be pointed out that i n the measurement of distances between
towns i t was necessary to make estimates i n many instances. Such distances
were over rather than under estimated, however, and i n a l l cases were estimated
along available highways or roads.
I n determining whether there were two or more competing banks i n an area,
branches of the same bank were not considered to be separate banks. However,
i n some instances, the "competing" bank may be a holding-company affiliate of
the first bank, but further refinement of our classifications on this basis was not
attempted i n the time available.
L E G E N D
FOR
S T A T E
MAPS
County P o p u l a t i o n Per Square M i l e
£Z7
£Z7
Less t h a n 10
10 t o 49
50 and over
Bank P o p u l a t i o n o f Towns
X
Non bank towrf*with no bank w i t h i n 20 m i l e s
©
Non bank towr^with one bank w i t h i n 20 m i l e s b u t more
t h a n 20 m i l e s from second bank
One bank town more t h a n 20 m i l e s from second bank
O
One bank town w i t h second bank w i t h i n 20 m i l e s
Town w i t h two or more banks
* W i t h 1 ,000 or more p o p u l a t i o n (except f p r unincorporated towns
i n C a l i f o r n i a where the lower l i m i t i s 2 , 5 0 0 ) .
MONETARY
POLICY AND MANAGEMENT
Arizona
TWELFTH
DISTRICT
COUNTIES
OF P U B L I C
t)EBT
781
MONETARY
POLICY AND MANAGEMENT
O F P U B L I Ct ) E B T782
MONETARY
POLICY AND MANAGEMENT
OF P U B L I C
t)EBT
783
MONETARY
POLICY AND M A N A G E M E N T
O F P U B L I Ct ) E B T784
MONETARY
98454—52—pt. 2
POLICY AND MANAGEMENT
10
OF PUBLIC
DEBT
785
MONETARY
Utah
POLICY AND MANAGEMENT
O F P U B L I Ct ) E B T786
MONETARY POLICY AND M A N A G E M E N T
OF P U B L I C
t)EBT
787
Washinqfon
F . A V A I L A B I L I T Y OF C A P I T A L FOR S M A L L BUSINESS
35. On the basis of information available about your district, discuss
the changes which have occurred during the last 25 years i n the
ease or difficulty w i t h which small-business men have been able
to raise capital or to borrow. What i n your opinion are the
reasons for such changes as you find to have occurred ? Do you
believe that a more liberal supply of capital and credit to small
business would contribute to the diffusion of economic power
and to the dynamic character of the economy? W h a t steps
could be taken to bring about a more liberal supply of capital
and credit to small business ? Do you believe that any of these
steps would be desirable ? Distinguish between the longer-term
aspects of the problem and those of particular importance today
during the current national defense emergency.
Joint answer
The problems of financing small business are sufficiently common to
all districts to warrant a joint reply to some parts of this question. We
believe that the growth and diversification of lending facilities over
the past 25 years has increased the access of businesses of all sizes to
the types of credit accommodation suited to their economic needs. So
far as capital is concerned (as contrasted w i t h credit) i t is essential
i n a free enterprise economy that the equity interest i n a business carry
w i t h i t a measure of control commensurate w i t h the greater risks
undertaken by the stockholder. Consequently, while aware that some
businesses, and particularly smaller businesses, may at times be unable
to obtain all ox the capital funds which they would like to have to
MONETARY
POLICY
AND MANAGEMENT
O F P U B L I Ct ) E B T788
support their plans for development, we do not favor an attempt to
provide equity capital i n such cases through governmental facilities.
We do favor the encouragement of privately managed regional facilities designed to channel the funds of local investors into concerns
which have a definable economic need for added capital.
W h i l e no categorical statement can be made as to whether or not it
has become more or less difficult to finance small business, we do not
believe that difficulties i n obtaining capital and credit for small businesses, as compared w i t h other businesses, have increased sufficiently
over the past 25 years to lessen the diffusion of economic power for
that reason or to weaken the dynamic character of the economy.
One test of the adequacy of capital and credit to finance business is
the rate of business organization. Except for periods of war and business depression, the rate of formation of businesses has been maintained at a level which has produced America's dynamic and flexible
business structure—a structure which has, i n spite of cyclical fluctuations, provided more opportunity for self-employment, a higher overall standard of living, and a more widespread diffusion of income and
wealth than any other existing system. Studies by the Department
of Commerce indicate that the number of firms now i n existence is
about what would be expected on the basis of past experience i n terms
of the volume of business now being transacted. This is illustrated
graphically i n the chart at the bottom of this page (the chart has been
reproduced f r o m page 20 of the Survey of Current Business for June
1949). The dotted line labeled "calculated" indicates the number of
firms that would be expected to be i n existence each year on the basis
of the total volume of business, as measured by gross national product.
The solid line labeled "actual" shows the number of firms actually in
existence. The chart reveals that, except for the war and early postwar period, the actual number has corresponded closely w i t h the expected number. B y 1948, the wartime deficiency had been f u l l y replaced and the actual number again equaled the expected number.
MILLIONS
OF
FIRMS
ACTUAL
1
1929
/
f
L
1 1 1 1 1 1 1 1 1 1 1
1 ! 1 1 1 1 1 1 1 1 1
35
37
39
41
43
45
46
47
48
ANNUAL AVERAGE.
ENO Of QUARTER
U S DEPARTMENT OF COMMERCE, OFFICE OF BUSINESS ECONOMICS
49-196
1 1
31
/
1 1
33
F I R M S I N OPERATION, A C T U A L A N D C A L C U L A T E D
MONETARY
POLICY AND MANAGEMENT
OF P U B L I C
t)EBT
7 8 9
The number of businesses organized since W o r l d W a r I I appears to
be greater than for any comparable period, and the number m operation increased by between 700,000 and 800,000. The rates of formation
and of discontinuance of small businesses have been substantially
higher than those of larger businesses, and the net rate of additions
has also been higher for smaller businesses. Three-fourths of all firms
i n existence on March 31, 1948 had less than four employees, and 95
percent of all firms had less than 20 employees. These are high proportions, and i t would be difficult for them to be much higher. I t
would appear, therefore, that small-business men have been able to
raise enough capital or to borrow enough to sustain the rate of business
organization at levels comparable w i t h those of the past.
Notwithstanding the high rates of organization of small businesses,
as compared w i t h large businesses, and the relatively larger number
of small businesses i n operation today, there is some evidence that
the proportion of the business handled by large firms, particularly
i n manufacturing and utilities, has increased over the past 25 years.
The increasing importance of the very large firms may lessen the diffusion of economic power, although this may be arguable as a matter
of definition. I t is not evident that the dynamic character of the
economy has thereby been lessened. A number of factors have contributed to this increasing concentration, among which may be listed
the following:
1. Increasing importance of the durable goods industries, requiring large capital outlays and correspondingly large-scale
operations.
2. The increasing complexity of the business process w i t h its
more complicated equipment and products, multitudinous legal
problems involving contracts, labor practices, wages and hours,
social security, taxes and franchises, and its more detailed and
burdensome requirements of record keeping and reports. These
indirect costs can be borne more readily by larger than by smaller
businesses.
3. A general trend toward integration.
4. The effects of income and inheritance tax laws which make
i t profitable to dispose of businesses for capital gains and difficult to assure succession i n family or personal ownership i n the
event of death of the proprietor.
5. Increasing use of retained earnings as a source of capital
which gives some advantage to larger businesses because of the
magnitude of the sums involved, regardless of considerable differences i n rate of earnings.
6. Growth of successful small businesses which inevitably
marches them toward the ranks of the "bigs."
Whatever the causes of the tendency for an increasing proportion
of business to be handled by larger firms, i t does not appear to be due
to a reduction i n the relative number of small firms. Nor do we
believe i t to be attributable i n any significant degree to difficulties
encountered by small-business men i n raising capital or i n borrowing.
I t is important to distinguish between the roles of capital and of
credit i n the financing of business. Capital represents the values put
into the business on a permanent basis by the owners. Credit represents funds made available to the business on a temporary basis, the
repayment of which is contemplated, and which takes precedence over
MONETARY
POLICY AND M A N A G E M E N T
O F P U B L I Ct ) E B T790
the right of the owner to withdraw his capital. Credit may be extended on a short-term or long-term basis, but its repayment is contemplated. Capital may consist not only of money but also of goods
and ideas—the ideas of those organizing or reorganizing a business.
However, we shall confine our discussion of capital to the actual money
or plant, .machinery, and goods made available permanently to the
business.
We t u r n first to the question of the supply of credit available to
business. Credit (or borrowed funds) may be obtained from trade
sources; or through loans obtained from commercial banks, insurance
companies, savings banks, industrial banks, small-loan companies,
finance companies, commercial factors, and private individuals (including friends and relatives); or from the sale of interest-bearing
notes or securities i n the market. Although security issuance is often
not practicable for the smaller concern, the wide variety of other
sources available combine to provide an adequate source of borrowed
funds. For most smaller concerns, trade credit is generally the largest single source of outside financing. The commercial banks are next
i n importance as a source of credit for business.
A n intensive survey of loans of member banks as of November 20,
1946, revealed that three-fourths of the total number of member bank
loans then outstanding to business were extended to small business.
For the purposes of this survey, small business was defined in terms
of total assets as follows: manufacturing and mining, under $750,000;
wholesale trade, under $250,000; retail trade, service, construction,
public u t i l i t y (including transportation), and all other (including
sales finance), under $50,000. As would be expected, the proportion
of loans to small business was higher i n the smaller banks—more than
90 percent—than in the larger banks. Even i n the large banks, however, most of the loans numerically were to small business. The figures are shown i n the accompanying table. A more detailed discussion of member bank loans to small business w i l l be found i n the
Federal Reserve Bulletin for August 1947.
Inasmuch as the nonmember banks tend to be smaller on the average
than the member banks, we would expect an even larger proportion
of the loans of the nonmember banks as a whole to have been made to
small businesses.
While the data relate to November 1946, we have no reason to believe that the pattern changed significantly between that date and
the time of the outbreak of the Korean war. A n y changes i n the pattern that may have occurred since the outbreak of the Korean war,
and of this we have no evidence, would be likely to reflect the effects
of war and the defense program rather than of underlying economic
forces.
Among the difficulties that may be experienced by small business
i n obtaining credit may be listed the following: Lack of business experience and of credit history; absence of previous1 banking relationships; and improvement i n credit practices of lenders requiring
borrowers to provide more adequate financial statements and to maintain adequate records. Many small-business men do not have the time,
facilities, or talent for maintaining such records.
Even though the failure record of smaller businesses may be proportionally no worse than that of larger businesses, the greater numbers of small businesses which bring losses to creditors may tend to
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Member bank loans to small businesses, Nov. 20, 1946, as a percentage of all
business loans, by size of bank
[Estimates of outstanding loans]
Size of bank (total deposits)
Less than $2,000,000
$2,000,000 to $10,000,000
$10,000,000 to $100,000,000
$100,000,000 to $500,000,000
$500,000,000 and over
All banks 2
Number
of member
Number
banks in of loans
United
States i
Amount
of loans
As a per centage of
all busiiness loans
in each size group
Number
Amount
1,870
4,204
1,397
143
25
33,000
174,000
216,000
61,000
31,000
$74,000,000
60b, 000,000
1, 250,000,000
670,000,000
288.000.000
91.9
85.7
74.9
61.4
67.8
82.9
66.7
43.3
17.7
5.2
7, 639
514,000
2,888,000,000
76.6
21.9
1
For use in loan survey, number includes branches of certain member banks which were considered
separate lending institutions for sampling purposes and excludes some member banks with no commercial
and
industrial loans outstanding.
2
Detailed figures may not add to totals because of rounding.
Source: Federal Reserve Bulletin, August 1947, p. 965. The definition of "small business" used in this
survey is given on pp. 963 and 965.
make the latter more cautious w i t h regard to credit extensions during depression periods. Consequently, the difficulties encountered by
business generally i n obtaining credit during periods of recession
and depression may be intensified for small businesses. However,
we do not find from our experience that lenders, even during depressions, discriminate against the small businesses because they are
small.
Depression has not been the characteristic of recent years; small
businesses exist i n large numbers, are active, and show great vitality ; business loans are i n record volume and most of them are to
small businesses. We conclude, therefore, that i n recent years adequate credit facilities have been available to provide for the over-all
needs' of small business. While numerous cases undoubtedly exist
i n which businessmen have been unable to get the credit they desire,
i t is impossible in most such cases to secure agreement as to the creditworthiness of the applicants, and we do not believe that difficulties
i n borrowing have been sufficient to lessen the diffusion of economic
power or the dynamic character of the economy.
We have reason to believe that the developments i n lending practices
over the past 25 years have increased the ability of small businesses to
borrow. These lending practices include increasing use of term l^oans,
field warehouse loans, loans secured by accounts receivable or chattel
mortgages, and consumer installment loans. The increased use of
accounts receivable and consumer installment financing enables the
small-business man to transfer the financing of his customers to financial institutions and to use his own capital and credit for his own
operations.
I n addition to the private financial institutions listed earlier, a
large number of Federal lending or loan guaranty agencies have been
brought into existence or have had their activities expended. These
agencies include:
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT792
1. Reconstruction Finance Corporation
2. Federal National Mortgage Association
3. Federal Home-Loan Banks
4. Commodity Credit Corporation
5. Rural Electrification Administration
6. F a r m Security Administration
7. Federal Housing Administration
8. Defense and Administration services agencies i n guaranteeing Y-loans
9. Veterans' Administration
More than 140,000 veterans have been aided in establishing or operating businesses by loans aggregating more than $430 million guaranteed by the Veterans' Administration.
Midway between the private institutions and the wholly owned
Federal agencies are the Federal Reserve banks w i t h their authority
to extend loans directly to established business for # working capital
purposes i n cases where credit is not otherwise available on reasonable terms.
We t u r n now to consideration of the question of capital. While we
believe that i t has probably become more difficult over the past 25
years, barring temporay cyclical influences, for small businesses to
raise capital, we do not believe that the increase of difficulties for small
businesses, as compared w i t h those common to all businesses, have
been sufficient to lessen the dynamic character of the economy.
A study i n the ninth Federal Reserve district conducted by the
Federal Reserve bank of Minneapolis indicates that small-business
enterprise secures its equity capital from five sources: (1) the person organizing the business, (2) relatives and close friends, (3) other
business concerns, (4) local and nearby capitalists, and (5) the secur i t y market. Proprietors have been the most important source of
capital. The other sources have varied i n importance depending in
part on type of business and i n part on size.
Studies of the Department of Commerce indicate that for the most
part new businesses have been organized i n different regions of the
United States i n about the proportion to be expected f r o m the volume
of business and the income of the regions. This is revealed by the
chart shown at the bottom of page 793 (this chart has been reproduced f r o m page 13 of the Survey of Current Business for
December 1949). The fact that the number of firms i n operation i n each State is proportional to the total income payments
received i n the State is revealed by the straight line which slopes
upward at an approximately 45-degree angle, and by the way i n
which the dots for the individual States cluster about the line.
The chart shows clearly that, i n general, the States w i t h higher
income payments have more businesses i n operation, and those w i t h
lower income payments have fewer i n operation. The over-all limiting factor i n organization of new businesses i n the different regions
of the country, therefore, would appear to be the wealth and business opportunities of the community rather than the availability of
capital. I t should be borne i n mind, of course, that income, wealth,
business opportunities, and availability of capital are not unrelated
to each other.
Where shortages of capital exist they are primarily local problems,
and can best be dealt w i t h at the local level rather than at the national
MONETARY
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level. Local individuals and institutions are better acquainted w i t h
the persons and problems involved, and can give better consideration
to the merits of individual cases.
Lack of capital does not appear to have been a dominant cause of
business failure. The most important factor i n success or failure of a
business appears to be the quality of the management. Once a business gets into difficulty, the difficulty w i l l probably sooner or later
show up i n the capital account, and thus appear superficially to
indicate lack of capital. Increased capital or credit may temporarily
alleviate the distress, but the basic cause of the difficulty appears to
lie i n the quality of the management, its skill i n picking business opportunities, i n getting business, i n operating a plant, shop, or store,
and i n controlling expenses.
Most of the businesses which have failed had been i n existence lesy
than 5 years. I t would appear, therefore, that while some, and perhaps many, worthy and competent individuals cannot raise sufficient
capital to go into business for themselves as they might wish, enough
capital is available to permit a substantial number of incompetent
businessmen to go into business and subsequently fail. Furthermore,
sufficient capital appears to be available to permit enough persons to
go into business who are competent to keep their businesses going and
growing, i n order to contribute to the growth, vitality, and health of
the American economy.
We know of no way to assure that all worthy aspirants for independent business w i l l get the capital they need and can use effectively,
600 r
500 -
1
1 I 1I I
J. 400o
5 500 D
o
z
'
•
200 -
100
90
-- TO 50 •
40 -
•<
.5
I I t i l l !
A .5 .6 .7 4 .9 I
2
3
4 5 6 7 0 9 >0
TOTAL l*C0*C PATMCNTS, »9«8 l«AT»0 SCALC - 8«LU0*S 0f 00LLA«S»
v S OfP*0TmfmT or commtmct. Office or «1/I W H tcomomct
RELATIONSHIP BETWEEN NUMBER OF F I R M S I N OPERATION AND TOTAL
PAYMENTS, BY STATES, 1948
INCOME
MONETARY
POLICY AND MANAGEMENT
O F P U B L I Ct ) E B T794
and that those not competent to conduct a business enterprise w i l l
be denied such capital. Under our present system, those who provide capital generally do so directly and bear the corresponding risks
of the enterprise. W i t h i n the limits of their ability, their own selfinterest impels them to make the best possible choice to assure safety
and maximum return on their investment. We believe that i t would
not be in the best interests of the American enterprise system to dissociate risk bearing from the investment decision i n the organization
of new businesses.
Some complaints are made that the providers of capital, when other
than the businessman himself, insist on control of the business, thus
l i m i t i n g the freedom of action and the opportunity of the smallbusiness man. Ordinarily, control does go w i t h capital. The control
of each new business, and of each established business as well, is a
matter of negotiation and agreement among those contributing to the
business. So long as one person does not provide all of the capital of
the business, his independence is correspondingly reduced. This is a
characteristic of American business, from the smallest to the largest
enterprise, forged out of generations of experience w i t h the most
flexible, aggressive, dynamic, and productive system so far established
by man. To insist on a change i n this characteristic is to attack the
very foundations of the American system.
The following steps might bring about a more liberal supply of
capital and credit to small business, but we are by no means convinced
that a more liberal supply of capital and credit for small business
would necessarily contribute to the diffusion of economic power and
to the dynamic character of the economy.
1. Improved business practices by small-business men, particularly w i t h regard to accounts, records, and financial statements.
2. Encouragement of t h r i f t so that more savings of individuals
would be available for financing small businesses. Two possible
devices would be to provide higher returns on savings and some
tax incentive for savings. The former would require higher levels
of interest rates.
3. Maintenance of economic stability. Inflation is usually
accompanied by a high rate of organization of new businesses
and temporarily by a low rate of failures. As the forces of inflation reach their inevitable climax and as readjustment gets
under way, business failures become more numerous. The firms
that are most susceptible are the newer, less well established ones
which frequently have been instituted on a high-cost basis and
have difficulty i n adjusting their costs downward. A policy of
economic stability requires flexible monetary and fiscal policies.
4. Adjustments i n our system of taxation so that those who
invest in new business ventures would not be so severely penalized.
To offer a simple illustration, under present tax rates a single
person w i t h an income of $50,000 who invests $25,000 and gets a
10 percent return would have a net yield on his additional income
after taxes of about 2i/ 2 percent. A person w i t h an income of
$25,000 under similar conditions would have a net yield of 3y 2
percent. These returns are scarcely high enough to provide an
incentive for the risks of new enterprise by individuals who should
be best able to assume the risks of financing such enterprise.
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5. Preferential tax treatment for small and newly established
businesses.
6. Keconsideration of inheritance taxes w i t h a view to facilitating continuity of control and ownership i n successful small businessess.
?. Encouragement of local institutions to facilitate the financing of business*
8. Increased guaranties or grants of capital or credit by governmental agencies.
Every reasonable effort should be made to achieve steps 1,2,3, and 7.
They w i l l contribute to increasing the stability, prosperity, and vitality
of American business. Steps 4, 5, and 6 involve broad questions of
public policy, i n addition to those relating to small businesses, which
require careful consideration, and we are not prepared to make recommendations i n the tax field. ^ •
We believe that the establishment of additional governmental facilities on the national level to provide capital or credit, or guaranties,
for small business would not be necessary or desirable. The establishment of additional agencies to provide capital or credit, or guaranties,
for small business would, in fact, tend to be harmful i n the long run
to the American enterprise system and the public welfare for the
following reasons.
1. Such agencies are unlikely to have the intimate knowledge
of all aspects of the affairs of individual businesses that is needed
to enable them to provide the type of service, supervision, guidance, and counsel appropriate to protecting the investment and
providing management aid.
2. Those making the final decisions bear no risk and are not
penalized for their errors of judgment.
,3. There is danger of the infiltration of special influence and
corrupt practices which tend to destroy fair and impartial administration.
4. A deliberately generous granting of Government financial aid
would inevitably lead to the creation and financing of more new
businesses than the economy could support, and thus produce increasingly uneconomic competition as well as increased failures
among small businesses. Competition is the essence of the American system and i t is also the dynamic force that betrays incompetent management and causes businesses to fail. Government subsidization of uneconomic enterprises would be damaging to sound
enterprises while ultimately failing to assure the survival of the
less competent.
For these reasons we believe that additional direct Government
financing of private enterprise should not be undertaken. I f i t should
be concluded that there is sufficient evidence of a need for additional
facilities for supplying capital to promising enterprises, the first approach should be to undertake to reduce or eliminate obstacles to
private financing. I f anything further should appear to be needed,
assistance by public or semipublic institutions to privately managed
local or regional institutions organized to seek out sound opportunities
for the employment of capital i n small enterprises would be far preferable to direct Government financing.
As we have indicated earlier, we believe that difficulties i n obtaining capital and credit f o r small business as a whole have not been
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I Ct ) E B T796
sufficient to weaken the dynamic character of American business, and
we are doubtful of the extent to which they may have lessened the
diffusion of economic power. Where such difficulties may exist they
are essentially local i n character and except for tax adjustments can
best be dealt w i t h on the local rather than national level.
As i n other war periods, the problems of small business arising out
of the current national defense emergency are more those of materials,
markets, sales, and labor than of capital and credit. Credit facilities
are available for small businesses. The usual facilities serve their
ordinary needs, and the V-loan program is available for financing their
needs on defense contracts. The following tables show that a high
proportion of the number of V-loans is being made to relatively small
businesses.
Percentage
distribution
of V-loans, September
Under $25,000
$25,000 to $49,999
$50,000 to $99,999
$100,000 to $249,999....
$250,000 to $499,999....
$500,000 to $999,999. _..
$1,000,000 to $4,999,999
$5,000,000 to $9,999,999
$10,000,000 and over...
1951
Size of borrowers receiving loans
Size of guaranteed loans authorized
Dollar amount of loan
1950 to July
Percent
of total
number
of loans
4.2
4.8
12.8
19.5
20.1
15.5
17.5
2.6
3.0
Assets of borrower
Under $25,000
$25,000 to $49.999
$50,000 to $99,999
$100,000 to $249,999
$250,000 to $499,999
$500,000 to $999,999
$1,000,000 to $9,999,999—
$10,000,000 to $49,999,999.
$50,000,000 and over
Percent
of total
number
of loans
1.6
3.5
9.5
17.3
18.6
15.9
27.4
5.1
1.1
Source: Board of Governors of the Federal Reserve System, press release, Sept. 11,1951.
Supplement for First Federal Reserve District {Joseph A. Erickson,
Boston)
We believe that credit needs are being met w i t h reasonable adequacy
i n the first Federal Reserve district. A sample study of the financial
needs of small manufacturers made i n 1950 i n the Pioneer Valley,
which comprises three counties i n western Massachusetts, bears out
this conclusion. Although one out of six of the small manufacturers
interviewed had unsatisfied financial needs, the greatest need was for
permanent investment. Only 6 of the 92 firms covered by the study
reported unsatisfied requirements for short-term loans, and all 6 had
poor financial records.
Most of the complaints about the adequacy of credit i n the first
district are i n fact concerned w i t h the adequacy of capital rather than
credit. Because capital is not available i n unlimited supply and because not everyone wanting capital inspires the confidence of investors
i n his ability to employ capital profitably, there are almost always far
more projects seeking capital than can be financed. Because investment in new or small enterprises which cannot obtain capital f r o m
ordinary sources involves many elements of judgment regarding products, costs, markets, and especially management ability, most such investments are of a marginal type. Some may t u r n out i n fact to be
sound but many w i l l t u r n out to be bad. I t has yet to be demonstrated
that the gains w i l l offset the losses i n this marginal type of investment.
A number of new institutions have been set up to deal w i t h capital
or credit problems of new or small businesses. The experience of
MONETARY
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these institutions affords information of considerable value i n considering the need for additional financial aid to small business.
The industrial foundation is one type of institution which has been
widely used i n New England and elsewhere to encourage new businesses or expansions by reducing the capital requirements for such enterprises, largely by providing factory space on a rental basis. The
businesses so encouraged are usually small and medium-size concerns
which want to expand by establishing new plants. A survey published
by the Federal Reserve Bank of Boston i n J u l y 1950 disclosed that 166
plants i n New England had been made available on a lease basis by
17 New England industrial foundations. These plants were leased by
almost 200 firms, most of which were of small to moderate size.
Several additional plants have been built by such foundations since
that survey was published.
The equity capital corporation is another type of institution established to provide capital or, as a substitute i n many cases, long-term
credit, primarily to new, concerns. The outstanding example i n the
first district is the American Research & Development Corp., founded
by private investors i n 1946. I t has made 25 investments totaling
over $3,000,000 since i t was established, and is currently profitable.
Another example of an institution supplying marginal capital and
credit is the Development Credit Corp. of Maine, established i n 1949.
This corporation, and a similar one established this year i n New
Hampshire, have limited themselves to advances to manufacturing
and processing concerns which banks and other lenders w i l l not make.
F r o m its beginning i n February 1950 to the end of September 1951 the
Maine corporation has made 16 advances totaling $363,000. The advances range i n size f r o m $3,000 to $75,000. I t still has unemployed
funds at its disposal. The New Hampshire corporation is just being
organized and has not yet done any business.
F r o m the experience of these institutions certain principles can be
derived which afford valuable guidance i n this field.
1. The number of firms having an unsatisfied demand for capital
(or longer-term capital-like credit) is ordinarily large i n relation to
the number whose demand can be satisfied even by institutions specializing i n meeting their needs. For example, American Research has
had about a thousand applications per year but has found only 25
firms justifying investment of its funds. The Development Credit
Corp. of Maine screened 206 applications totaling about $2,250,000
to make 16 advances; the risks involved, particularity i n management,
caused most of the others to be turned down, although 7 loans totaling $165,000 were approved but not used by the borrowers.
2. The task of developing, screening, and appraising applicants
from the marginal group is time-consuming and expensive and can
be done most efficiently and economically by having on call the services
of a large number of people who are best aole to render the judgments
necessary. The Maine and New Hampshire corporations make use of
a large number of lending institutions and experienced businessmen
to develop and screen prospects, and the American Research & Development Corp. is assisted by a panel of consultants for appraising as
well as by a large group of stockholders and friends for developing
prospects. I n addition, these corporations usually offer continuing
assistance to the managements of the concerns to which they make
advances.
MONETARY
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3. There is available a sufficient number of reasonably good prospects to provide an adequate supply of business to institutions set up
to invest i n marginal enterprises. Whether these institutions w i l l
finally be profitable has not been finally determined, but prospects
appear so far to be favorable.
4. These specialized institutions increase the supply of capital or
marginal credit beyond that extended by the institutions themselves
because i n many cases outside sources are opened up following investigation of the applicant by the specialized institution. F o r example,
although American Research has invested $3,000,000, i t has secured
the direct investment by friends of the corporation of another $1,000,000, and the companies i t has financed initially have later been able to
secure $3,800,000 f r o m the public. The Development Credit Corp. of
Maine has secured financing for its applicants from others i n excess
of $200,000, although i t has invested only $363,000 of its own funds.
Because these institutions take a secondary or an equity position i n
the firms they finance, they make possible loans by other financing
institutions which otherwise might not be made.
5. The successful operation of these institutions calls for knowledge, organization, know-how, and judgment which cannot be obtained
i n any one man or even i n several men. So wide is the variety of
talent required for this type of operation that i t is questionable that
i t could support the cost of specialized personnel devoting f u l l time
to the job. We are led to the conclusion that i t probably could not be
performed satisfactorily by a Government agency staffed w i t h f u l l time Government employees.
I n my opinion, this function can and should be carried on by private enterprises established i n those areas and regions which are unsatisfied w i t h their current rate of growth or state of economic
development. I f development proceeded along these lines, i t would
assure that the financing facility would be located near applicants
and that local bankers and businessmen would support the enterprise
and provide the field organization and specialized knowledge and
judgment, without which the enterprise probably could not be
successful.
Supplement for Second Federal Reserve District {Allan Sproul, New
York)
There is reason to believe that the accessibility of credit to the
small-business man has widened considerably over the past 25 years
i n the second Federal Reserve district. A number of new types of
financing facilities have been developed which make i t possible for all
sizes of business to borrow more readily on specialized kinds of collateral, such as accounts receivable, warehouse merchandise, or equipment. The development of more systematic and adequate records on
individual businesses also has facilitated the extension of credit on
a sound basis. Moreover, 25 years ago almost all bank loans to business
were customarily made in short-term form. Today most banking and
financial institutions in the district extend credit for periods i n relation to the nature of the uses for which the credit is required. Popularization of the term loan and the amortization method of repayment, as well as the use of an analysis of the cash flow through an
individual business, have greatly increased the adaptability of credit
terms to the many varying needs of individual businesses.
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So far as capital is concerned, i t has been an inevitable attribute of
the American free-enterprise system that the investment of equity
funds in smaller or newer businesses must come largely from individuals or firms which participate in the actual management to some
extent. The greatest impediment to a sustained flow of new equity
capital into smaller business concerns over the past 25 years has been
the almost continuous increase in income tax rates affecting individuals
and business corporations. Nonetheless, partly because of the greater
diversity i n the methods through which credit is made available, a
vigorous community of smaller business concerns has played an active
part i n the economic development of this district over the entire period.
Adequate data concerning the business population, and the changes
occurring i n it, have only been available for the country as a whole
since W o r l d War I I . For New Y o r k State, which constitutes the
greater part of the second Federal Reserve district, data have been
available since 1939. For this later segment of the 25-year span to
which the subcommittee question refers, the data suggest three conclusions. First, the rigidities and controls made essential by the Nation's all-out effort i n W o r l d War I I resulted in a sharp decrease in
the formation of new businesses, and led to some reduction in the
business population. Second, the high levels of income and employment maintained since W o r l d War I I have provided an environment
in which the formation of new businesses (mainly small) has been at a
rapid rate and, despite numerous discontinuances, failures, or mergers,
the business population of New York State alone increased by more
than one-third from the low point in 1944 to 1950 (the latest date for
which comprehensive data are available). T h i r d , a high and growing
proportion of the net additions to the business population has occurred in lines of business activities in which the individual concern
is characteristically small—unfortunately precise data by size of business for each year are not yet available for a significant portion of the
postwar period. I n all three States of the district, new business
formation has occurred at a rate of 1 new business for every 10
existing businesses throughout that part of the postwar period for
which data are available. The new business formations have, of
course, been accompanied by the discontinuance or failure of other
businesses. The net results, appearing as the actual business population year by year, are presented i n the following table.
Business population
of S States,
1940-501
[In thousands of concerns]
New York
Year
1940
1944 (low point)
1945
1946
1947
1948
.
1949.
1950
...
-
-
467
410
423
470
527
555
571
579
New Jersey
117
120
131
143
2 143
3 2 143
()
Connecticut
(3)
46
47
54
59
2 58
>57
1 Data are available only by States; consequently, the entire States of Connecticut and New Jersey have
been included although only parts of each State lie within the second Federal Reserve district. Data for
New York, prepared by New York State Department of Commerce, are yearly averages, and are not directly comparable with data prepared by the United States Department of Commerce, as of Mar. 31 for each
year, for the other two States.
2 Preliminary.
»Not available.
MONETARY
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O F P U B L I Ct ) E B T800
Supplement for Third Federal Reserve District (Alfred B. Williams,
Philadelphia)
The supply of credit appears to be adequate to meet the needs of
small business and other borrowers i n the t h i r d district, as explained
i n more detail in the reply to question 34. Also, funds which are
available f r o m various sources, including those indicated i n the general reply to question 35, appear generally adequate to meet the capital
needs of small business i n this district. However, because of the
greater reliance of the small business on retained earnings as a source
of funds for capital expansion, some f o r m of tax adjustment would
be desirable as already recommended above.
There are three additional sources of funds which deserve special
mention. One is the 13b loans which can be made by the Federal
Reserve banks for working-capital purposes. These loans, which were
authorized i n 1934, can be made either directly or i n participation
w i t h commercial banks and other lending agencies. The Federal Reserve Bank of Philadelphia is continuing to make these loans to business firms i n the district which are unable to secure credit f r o m private
lenders on suitable terms. A t the present time this bank has 28 loans
outstanding for a total of $8,974,757 i n which its participation is
$3,575,721. These loans are primarily to small firms which represent
diversified types of business. However, the fact that on the average
only 28 applications a year were received during the period 1946 to
1950 indicates a relatively small demand for this source of credit.
A second development worthy of mention is the establishment of
special loan programs for small business by some of the larger banks.
These programs represent an effort to provide more adequate lending
facilities for meeting the credit needs of small business. Loans are
made for a variety of purposes and they include term loans of over 1
year as well as short-term loans. These banks make loans directly to
small-business firms and upon request participate w i t h local banks
i n extending such credit. Recent reports indicate that these programs
have been well received by small-business men.
Another source of funds is that supplied by community development programs. I n 1949, this bank made a comprehensive survey of
community activities i n the t h i r d district i n providing financial aid to
business. The information gained points to two major conclusions:
(1) The community's need for industrial expansion determines
whether aid w i l l be given and determines the type of financial aid to
be provided; (2) the great variety of methods employed indicates the
ingenuity of the local community i n meeting the needs of a specific
situation.
I n communities where the need for new industries is great, the
establishment of an industrial development corporation has been a
common approach to the problem. Sometimes the existence of such
a corporation stimulates lending institutions and even individuals to
extend credit to assist i n bringing i n new business. I n communities
where there is relatively less need for industrial expansion, financial
aid is usually by more informal methods. The local chamber of commerce, for example, may bring together a prospective new business
and a lending institution, thus facilitating the working out of financial arrangements. I n many cases, a small group of prominent businessmen cooperate i n extending credit to help bring i n a new business.
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The survey disclosed that there were at least 17 industrial development corporations and about as many other communities which were
helping to finance industries by other methods. The following list,
although not necessarily complete, gives the towns and communities
which reported some arrangement for providing financial aid f o r local
industrial development.
Towns w i t h corporations
Pennsylvania:
Allentown
Altoona
Bellefonte
Clearfield
Eldred
Freeland
Hazleton
Johnstown
Lansford
Tamaqua
Coaldale
Summit H i l l
Nesquehoning
Nanticoke
Pottsville
Reading
Allentown Business Extension Corp.
Altoona Enterprises, Inc.
Bellefonte I n d u s t r i a l Development Corp.
The Clearfield Foundation, Inc.
Eldred Real Estate Corp.
Freeland I n d u s t r i a l Development Corp.
Hazleton I n d u s t r i a l Development Corp.
Johnstown I n d u s t r i a l Commission, Inc.
^
I
>Panther Valley I n d u s t r i a l Association
J
Nanticoke I n d u s t r i a l Commission
Pottsville Industries, Inc.
Greater Reading Development F u n d
(Scranton Lackawanna I n d u s t r i a l B u i l d i n g
Co
Scranton I n d u s t r i a l Development Co.
Scranton P l a n Corp.
Shamokin and nine
surrounding communities
Shenandoah
Delaware: L a u r e l
Towns with
other arrangements
Pennsylvania:
Bangor
Chambersburg
Downingtown
Dushore
Lebanon
Lock Haven
Pittston
Tyrone
Shamokin Area I n d u s t r i a l Corp.
Shenandoah Chamber of Progress
( W y o m i n g Valley I n d u s t r i a l Development
Fund, Inc.
Wyoming Valley I n d u s t r i a l B u i l d i n g Fund,
Inc.
L a u r e l Industries, Inc.
to provide
for erection
of industrial
buildings
Pennsylvania—Continued
Williamsport
York
Delaware:
•
Dover
Lewes
Middletown
Smyrna
The operations of industrial development corporations vary widely.
I n many cases funds are subscribed through bond issues on which
interest is paid. I n others outright contributions may be solicited
f r o m individuals or there may be a combination of bonds and contributions. The uses to which the funds are put also vary. The corporation may make loans, but these are seldom working-capital loans. Apparently the major need is not for this type of credit. I n cases where
long-term loans are made, commercial banks individually or sometimes
as a group often participate. The most frequent type of financial
assistance is the construction of a new plant which is leased to an
industrial firm on a long-term basis. I n communities where the need
98454—52—pt. 2
10
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for new businesses is great the corporation may give the plant to the
company or at least contribute a part of its cost.
From the information gained i n this survey, i t appears that many
communities which were really in need of new businesses have found
the funds for providing financial aid. The financing nearly always
takes the form of long-term debt rather than equity financing. Financial aid has been given to both small and large businesses, but there
appears to be some tendency to seek a branch plant of a larger outside
company rather than to give aid to local firms.
A recent recheck shows that the situation now is about the same as
when the survey was made 2 years ago. I t appears that financing
activities of these community organizations have diminished somewhat, as nondefense capital expansion programs have declined and
as expansion for defense purposes has increased, since the latter is not
associated so closely w i t h local development programs.
Supplement for Fifth Federal Reserve District (Hugh Leach, Richmond)
I n considering the question of changes during the last 25 years in
the capital or credit position of small business in the fifth Federal
Reserve district, i t should be noted that adequate information is not
available to provide a categorical answer. However, i n general terms,
(a) short- and long-term credit appear to be more readily available
due principally to the leadership of commercial banks i n developing
new lending practices and techniques, but in part reflecting improvements in small-business accounting, inventory, and other operating
policies which have improved their credit position; and (&) equity
capital may be less readily accessible to small businesses, possibly
because of changes in the tax structure which have adversely affected
individual venture capital and retained earnings as sources of funds.
W i t h more specific reference to the fifth district, the following
changes relating to the ease or difficulty with which small-business
men are able to raise capital or to borrow have occurred:
1. There has been an absolute and relative growth i n the financial resources of this area, reflected in such basic factors as bank
reserves and life-insurance-company assets.
2. Banks and other financial institutions in this area have tended
increasingly to adopt new and more liberal lending techniques
which in turn adapt these resources more successfully to the credit
needs of small business.
3. The Federal Government has in some instances supplemented
existing facilities for longer-term credit to small business in this
area through credit guaranties and direct loans by the Federal
Reserve banks and the Reconstruction Finance Corporation and
other governmental lending agencies.
4. Community industrial development corporations have
emerged in scattered areas throughout the district, though their
activity has to date been limited.
Commercial-bank resources constitute one of the major sources of
short-term working-capital funds and, increasingly, of intermediateterm capital funds of small business. I n this connection, bank reserves are a significant measure of the credit potential of any given
region, since regionally, as well as nationally, bank reserves control the
expansion of earning assets by the commercial banking system. Data
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on bank reserves reveal an absolute and relative growth i n the
Federal Eeserve district during the past 25 years.
Fifth
district
803
fifth
member bank reserves as percent of United Statesf selected dates,
1925-51
Amount
(millions)
End of year:
1925
1929
1932
1939
1945.
1950
Mar. 28, 1951
June 30,1951.
$68.0
64.7
52.0
283.0
727.2
695.0
748.0
811.3
Percent of
United States
3.07
2.75
2.07
2.43
4.57
4.05
3.93
4.26
Similarly, life-insurance companies i n this area have experienced
a sharp growth i n assets over the past 25 years; a recent study on the
Economic Resources and Policies of the South by Calvin B. Hoover
and B. U. Ratchford reports:
Although southern companies are relatively quite small, they had a considerably greater growth between 1929 and 1946 than did nonsouthern companies. Southern companies increased their admitted assets by 308 percent
against 172 percent for nonsouthern companies; for insurance i n force the
figures were 153 percent and 57 percent; and for premium income southern
companies were ahead by 247 percent to 57 percent.
I n the postwar period commercial banks in the fifth district have
been actively engaged in using their expanded financial resources to
meet the short- and intermediate-term credit needs of small business.
This is reflected in the postwar growth i n fifth district bank loans
(both absolutely and relatively) and more particularly i n the socalled business loans, including term loans. I t is generally accepted
that smaller business concerns account for a substantial proportion
of such loans in this district.
From June 30,1945, to June 30,1951, total loans of all active banks
i n the district almost tripled and rose from 3.9 percent to 4.7 percent
of the United States total. Business loans (commercial and indust r i a l ) of district member banks in this same period expanded even
faster; on June 30, 1945, they accounted for 20 percent of the $1.1
billion total loans of all active banks in the district; by June 30, 1951,
they accounted for 25 percent of total loans of $3.0 billion. Although
comparative data are not available, a special survey of business loans
of fifth district member banks as of November 20, 1946, revealed that
more than 85 percent of the business borrowers on that date had total
assets of less than $250,000 and accounted for almost 45 percent of
the total commercial and industrial loans outstanding on that date.
(See table 1, p. 806.) This same survey revealed that nearly 11,000
loans, or 26 percent of the total, were outstanding to businesses formed
since 1942. These loans were made principally to unincorporated
businesses w i t h assets of less than $250,000 and amounted to $65 million, or 13 percent of the total business loans. (See table 2, p. 806.)
This recent absolute and relative growth in the extension of business credit (and, as indicated, mainly small-business credit) reflects
the increased effort of financial institutions i n this area to adapt their
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O F P U B L I Ct ) E B T804
resources to the needs of small business. Developments i n banks' lending practices i n recent years, including the increased use of term loans,
field warehouse loans, loans secured by accounts receivable or chattel
mortgages, and consumer installment loans, all appear to represent
a better adaptation of short- and intermediate-term credit facilities
to the needs of small business. Furthermore, increased availability
of accounts receivable and consumer installment financing has enabled
the small-business man to shift the financing of his customers to the
banks and therefore to utilize more f u l l y his own capital and credit
resources.
Evidence of these developments i n the f i f t h district may be found i n
the previously noted survey (November 20, 1946) of fifth district
member bank loans which revealed that term loans (defined as loans
of more than 1-year maturity) amounted to more than 20 percent of
total commercial and industrial loans outstanding on that date.
Loans of longer than 5-year maturity constituted nearlv 10 percent of
total commercial and industrial loans outstanding on tnat date. (See
table 3, p. 807.)
Additional evidence as to the efforts being made by financing institutions i n this area to develop and utilize a wide range of different
financing arrangements adapted to the special needs of prospective
business borrowers may be found i n the results of last year's poll of
V i r g i n i a banks by the Advisory Council on the V i r g i n i a Economy.
I n response to the question, "Has your bank ever handled business
loans of the following types?" answers indicated a very high proportion of banks making term loans and actually utilizing a large number
of different financing arrangements, as follows.
Types of financing offered Virginia
business "by Virginia
banks
Percent of total banks reporting
No
Has your bank ever handled business loans of the following types?
(a) Assignment of accounts receivable
(b) Pledge of notes receivable
(c) Public warehouse receipts.
(d) Field warehouse receipts.
(e) Floor plan or trust receipts
—
(/) Factor's liens
« (g) Unsecured term loans under special loan agreements
(h) Term loans against plant liens or other security
(0 Liens on machinery, motor vehicles, or other equipment
(J) Assignment of contracts
(k) Assignment of property leases.
(I) Assignment of life insurance
(m) Monthly or other regular installment payment loans
(n) Construction advances on individual or group housing
projects
(o) Subordination of existing debts owing to principals or others .
(p) Assignment of Government contracts under Assignment of
Claims Act of 1940
(q) Participations with RFC
(r) Participations with Federal Reserve bank.
(s) Loans with final maturities as long as:
2 years
5 years
10 years
No answer
42
70
37
17
41
5
50
48
99
55
39
96
98
57
29
61
81
58
91
48
50
1
44
60
3
1
1
1
2
2
1
4
2
2
0
1
1
1
1
70
20
30
77
0
3
17
37
8
81
62
88
2
1
4
80
71
65
9
18
28
11
11
7
On balance, i t appears that commercial banks i n this area, as elsewhere, have taken the initiative i n developing different forms of lending which have enabled small-business men to finance over longer
MONETARY
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805
periods necessary purchases of facilities, equipment, and machinery,
and to obtain credit on the basis of assets formerly considered unacceptable as collateral. These lending activities have been supplemented
by the direct lending and guaranteeing activities of the Federal Government and the Federal Reserve banks. The record of 13b loans i n
this district indicates that i n large part these loans and commitments
have been used to finance small, rather than large, business. Likewise,
a large proportion of V-loans currently being made may be considered
as relatively "small business." (See attached table 4.)
For the most part, then, the credit needs of small business are being
handled effectively by existing financial institutions and agencies.
Attempting to expand this over-all supply of credit would be particularly inappropriate under the current emergency; the expanding business credit is i n fact one of the major factors contributing to underlying inflationary pressures at the present time. The Federal Reserve
banks and commercial banks working together on the voluntary credit
restraint program are t r y i n g to curb extensions of business credit,
especially to new businesses not contributing commensurately to the
defense effort.
The equity capital position of small business is not as clear cut.
Claims of capital shortages undoubtedly have exaggerated the role of
capital i n the success or failure of new business. The management
factor is probably most important, and inability to obtain capital or
use i t effectively may simply be a reflection on management. F r o m the
demand-for-funds side, another factor which may superficially indicate a shortage of capital is the fact that small-business men traditionally do not like to give up the control necessarily incident to obtaining
additional capital.
I t may be that existing sources of funds do not meet all of the demands of deserving enterprisers. But, again, where shortages of capital actually do exist, our present system of taxation may be an important deterrent to availability of funds. Significantly, under present
personal income tax rates, net yields do not provide sufficient incentive for risk investment by those individuals who, i n terms of income,
are normally best able to assume such risks. Also, corporate tax laws
which do not distinguish sufficiently between small newly established
enterprises and large established concerns may reduce the possible use
of retained earnings, which i n the past has been one of the major sources
of funds for growing enterprises.
W i t h i n the last 25 years, a number of community industrial development corporations have been formed i n the fifth district for the purposes of raising money to build new plants to be leased to individual
concerns desiring to locate i n the area, providing space i n older plants,
making loans, providing capital, and making grants to encourage a
business to erect a plant i n the vicinity. One of the oldest and most
frequently cited examples of the successful community development
corporation is the Industrial Corp. of Baltimore City, originally organized i n 1915 to facilitate the making of investigations and appraisals of applicant enterprises, the maintenance of engineering and related
facilities for counseling, and arranging financing from outside sources.
Community industrial financing plans of various types have been
adopted by a number of other localities i n this district, but the aggregate amount of capital provided to small business to date has not
been significant.
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Recognizing that to the extent additional capital can be made available to meritorious small business, this would in t u r n contribute to the
already dynamic character of the economy; nevertheless, we do not
believe that the establishment of additional governmental agencies on
a national level to provide capital or loan guaranties for small business
is either necessary or desirable. I t is our view that such shortages of
capital as may exist are primarily local problems and can best be dealt
w i t h locally rather than nationally. Local individuals and institutions are better acquainted w i t h the persons and problems involved and
are i n a better position to consider the merits of these individual cases.
Across-the-board financial aid by Government subsidy could lead to
uneconomic development of new businesses w i t h consequent damage
to sound enterprises and to normal competition which is the most
dynamic force i n our economy.
To whatever extent there can be shown a real need for additional
facilities to supply capital to promising enterprises, this need should
be' met, first of all, by basic changes i n our tax structure—changes
designed to reduce or eliminate obstacles to private financing. Revision
of tax laws to encourage individual risk investment would go far toward solving any problem of capital shortage. I n addition, further
preferential treatment to small and newly established enterprises could
be considered. I f further need should then be demonstrated, assistance
by public and semipublic institutions to privately managed local or
regional institutions organized to seek out sound opportunities for the
employment of capital in small enterprises would be far preferable to
direct Government financing.
TABLE 1 . — C o m m e r c i a l and industrial
loans by size of "borrower, member
fifth Federal Reserve district,
estimated—Nov.
20,1946
Number of
loans
Total assets of borrowers
Over $5,000,000
$750,000 to $5 000 000$250 000 to $750 000
$50,000 to $250.000
Under $50,000
Unclassified
—
All borrowers
Percent of
total number
655
1,269
3,056
12,013
24,690
814
1.5
3.0
7.2
28.3
58.1
1.9
42,497
100.0
Amount of
loans
Amount of loans
Percent of
total amount
Thousands
TABLE 2 . — C o m m e r c i a l and industrial
loans to firms organized
banks, fifth Federal Reserve district, estimated—Nov.
banks,
$86.619
88, 532
92,158
144,300
74,418
10,867
17.4
17.8
18.6
29.0
15.0
2.2
496, 894
100.0
since 1942,
20,1946
member
Number of loans
Total assets of borrowers
Total
Other
Thousands Thousands Thousands
Over $5,000,000
$750,000 to $5,000,000
$250,000 to $750.000
$50,000 to $250.000
Under $50.000
Unclassified
All borrowers
Corporate
—
Total
Corporate
Other
$350
6.948
8,206
23,071
25,385
711
$350
6, 506
5,626
7, 788
5,819
552
$442
2,580
15, 283
19,566
159
14
51
202
1,390
9,079
81
14
43
80
418
1,129
12
8
122
972
7,950
69
64,671
26,641
38,030
10,817
1,696
9,121
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TABLE 3.—Commercial and industrial
loans by maturities,
member
Federal Reserve District,
estimated—Nov.
20, 1946
Maturity
t)EBT
807
banks,
Fifth
Amount
Millions
$87.1
Demand
Less than 90 days
90 days to 6 months
6 months 1 day to 9 months
9 months 1 day to 1 year
1 year 1 day to 2 years
2 years 1 day to 3 years
3 years 1 day to 4 years
4 years 1 day to 5 years
5 years 1 day to 10 years
Over 10 years
118.8
136.0
26.6
12.2
22. €
15.2
9.2
21.2
45.0
2.9
Total
496.8
TABLE 4.—Percentage distribution
of T 7 -loans. Federal Reserve Bank of
September 1950 to October 1951
Size of guaranteed loans authorized
Amount of loans
Under $25,000..
$25,000 to $49,999
$50,000 to $99,999
$100,000 to $249,999....
$250,000 to $499,999....
$500,000 to $999,999....
$1,000,000 to $4,999,999.
$5,000,000 to $9,999,999.
$10,000,000 and over...
Richmond,
Size of borrower receiving loans
Percent of
total number of loans
22.9
17.1
8.6
17.1
20.0
5.7
8.6
.0
.0
100.0
Assets of borrowers
Under $25,000
$25,000 to $49,999
$50,000 to $99,999
$100,000 to $249,999
$250,000 to $499.999
$500,000 to $999,999
$1,000,000 to $9,999,999 ..
$10,000,000 to $49,999,999.
$50,000,000 and over
Percent of
total number of loans
0.0
17.1
14.3
34.3
8.6
14.3
11.4
.0
.0
100.0
Supplement for Sixth Federal Reserve District
(Malcolm
Bryan,
Atlanta)
We believe that there are few, i f any, problems concerning the
availability of capital and credit to small business that this district
does not share w i t h other sections of the country and that these
problems are adequately discussed in the joint reply. That the growth
i n the number of sixth-district business firms in operation has been
i n accordance w i t h the national situation is indicated by the chart
presented i n the joint reply showing the relationship between the
number of firms in operation by States and to income payments.
The most recent data available, for November 1946, reveal that
small businesses are by far the most numerous borrowers at sixthdistrict member banks. Retail concerns w i t h assets of less than
$50,000 constituted 72 percent of the retail borrowers. Manufacturing concerns usually carry on their operations on a larger scale than
the retailers, and consequentlv require financing in larger amounts.
Even in this field of lending, however, the banks reported that their
loans to small manufacturing concerns were many times greater than
the number of those made to larger concerns. Manufacturing concerns having assets of less than $50,000 accounted for 45.9 percent of
the total number of loans i n this category. I n manufacturing as well
as i n retailing, the majority of the borrowers were unincorporated,
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and such unincorporated concerns accounted for 59.6 percent of the
total amount of manufacturing loans.
The problem of raising capital, as outlined i n the joint reply, is
separate f r o m the problem of securing credit. I f the district, together w i t h other parts of the South, has lacked capital i n relation
to its total resources, this condition has applied to large businesses
as well as to small ones. W i t h i n the last 25 years, however, lack of
capital has become a less acute problem because of the growing financial resources of the South. That interest rates on loans to businesses i n the sixth district were found, i n 1946, to be approximately
the same as those on loans to concerns of comparative size throughout
the country as a whole is an indication of these growing resources.
Further expansion of savings out of which additional capital financing
for small businesses as well as large w i l l come, i n our opinion, w i l l
depend upon the factors outlined i n the joint reply i n this area as
much as throughout the country as a whole.
Supplement for Seventh Federal Reserve District
(C. S. Young,
Chicago)
Although we concur i n general w i t h the views of the System committee, i t may be worth while to discuss briefly certain aspects of the
small-business problem as they have been observed i n the seventh
district. Important changes have occurred in the methods of financi n g business during the past 25 years, both i n business practices
and i n the institutional arrangements by which the needs for funds
are satisfied. Like the System committee, we are not prepared
to state categorically whether or not i t has become more difficult to
finance small business, since i t is impossible to quantify an answer.
Certain changes have tended to restrict the availability of funds,
while other developments have worked i n the opposite direction.
On balance, i t is our considered opinion that, i n this area, the supply
of capital and credit to small business is sufficiently liberal to maintain a progressive economy and prevent undue industrial concentration. Government undertakings designed to increase the flow of funds
to business may result i n less efficient use of resources. This is especially true i n a time such as the present, when available men and
materials, for the most part, are f u l l y utilized.
The magnitude of the problem.—To what extent are the legitimate
needs of small firms f o r capital and credit unsatisfied at the present
time? The problem is not easily approached statistically. For example, tabulations of the number of loans granted to small business
are of limited usefulness. This is because (1) the term "small business" has no generally accepted meaning, and (2) such data describe
the loans which were granted; they do not give information about
the firms which were unsuccessful i n their search for funds.
Small-business men who are earnestly seeking credit or capital
which they cannot obtain through the usual channels are likely to t u r n
to an organization which has been established to aid them i n meeting
these needs. Such institutions include the RFC, the Veterans' Administration, the Federal Reserve banks, or the venture-capital companies.
Many of the prospective borrowers applying to the special lending
agencies are found to be i n an impossible financial position as a result
of mismanagement or an overambitious expansion program. I n other
cases the risk is of a marginal nature which a private bank is w i l l i n g
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to undertake i f the Government agency participates i n the loan, or
agrees to come i n later upon request.
On the matter of equity investment, the organized venture-capital
companies report that only about one i n a hundred of the applications
they receive results i n actual investments. There w i l l always be a large
number of individuals seeking funds for grandiose plans which could
not find economic justification i n the eyes of qualified analysts.
Several schemes have been advanced for the creation of "capital
banks" which would lend to or invest directly i n small firms. There is
no evidence that their search for suitable new investments would be
more f r u i t f u l than those of existing private organizations of this
type.
The availability of short-term credits.—Short-term b&nk loans constitute a residual source of funds for most business firms. Such credit
is temporary by its very nature and is paid off as and i f adequate funds
become available. Assuming f a i r l y constant credit standards, and the
absence of severe cyclical disturbances, fluctuations i n the volume of
outstanding business loans of commercial banks are largely the result
of changes in demand. Most banks are anxious to grant business
loans which promise reasonable assurance of repayment on schedule.
This is because of (1) a desire to serve customers and the community,
and (2) the opportunity to increase earnings.
The relative importance of bank loans has declined i n the past
25 years. I n the twenties total loans of seventh-district member banks
amounted to about 70 percent of deposits. A t the end of W o r l d W a r
I I this ratio was less than 15 percent. I n mid-1951 i t was still less
than 30 percent. On the demand side, many businessmen who had
unfortunate experiences w i t h excessive debt i n the early thirties have
attempted to decrease their reliance on credit. Total loans of seventhdistrict member banks i n mid-1951 were only 60 percent greater than
they were i n 1929. D u r i n g the same period, total output of goods and
services i n the Nation rose by over 200 percent.
The relative decline of loans in commercial-bank portfolios is the
result of a great increase i n bank assets i n comparison to the increase
i n the demand for loans. This situation is largely traceable to the
huge increase in the Federal debt and the money supply which has
occurred i n the past 20 years. I n the thirties and during the war,
most banks became accustomed to using Government securities as an
outlet for their excess reserves, and, indeed, these were the only obligations available i n sufficient supply to satisfy the demand. I n the
twenties, banks looked to short-term commercial loans which could be
rediscounted at the Federal Reserve bank for liquidity. I n recent
years holdings of Governments have served this function.
A number of other changes i n the banking structure i n the past
quarter-century may have affected the availability of credit and capital for small business. These are (1) more careful examination of
banks, (2) broader regulatory powers of Federal and State banking
authorities, (3) the separation of commercial banking from investment banking, and (4) the decline i n the number of banks through
failures and consolidations.
B y themselves those changes have tended to restrict credit availability. Other factors, however, have worked i n the opposite direction. These include (1) the use of term loans of 3 to 5 years' maturity,
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(2) the growth of several security devices not used extensively in the
'twenties, and (3) the aggressive lending programs of certain banks
i n the larger cities which have tended to stimulate loan activity of
other institutions.
The question of whether a firm is large or small does not of itself
have much influence on decisions as to the risk involved i n granting
a bank loan. Of course, the mere fact that a firm has become large and
has been i n business for a considerable number of years suggests a
greater degree of stability than would be true in the case of the average
small firm. For a large centrally located bank, very small loans may
not be considered desirable because such credits involve a more than
proportional expenditure of time and effort.
The short-term credit system appears to rest on a firmer basis than
was true 25 years ago. I f more loan applicants are turned away than
was formerly true, i t is probable that these cases are of a doubtful
nature. Business firms have been formed and have grown when there
was a need for them. The business failure rate i n recent years has
been only about one-third of what i t was during the prosperous decade
of the twenties.
A borrower cannot expect to look to the banking system for "easy"
credit since the loan officer's first responsibility is to the bank's depositors. Many banks, however, are w i l l i n g to give special consideration to the needs of small firms which give promise of future growth
which w i l l make them more valuable customers. Part of the problem
is inadequate knowledge on the part of small-business men as to the
type and size of bank which can best serve their interest. The R F C
and the Federal Reserve banks attempt to refer bankable loans to
suitable institutions who can grant credits i n the usual manner.
Long-term credits and equity investment.—Smaller firms probably
had somewhat easier access to the capital markets 25 years ago than
today. This is true for both stocks and bonds, but since stock financing
has never been a major source of funds for small business the changing
character of the bond market is of particular importance.
I n the twenties individuals purchased substantial quantities of corporate bonds for their personal investment portfolios, or for trust
funds. Often the bonds were obligations of relatively small firms who
floated their securities with the aid of investment-banking affiliates of
local commercial banks. Today, life-insurance companies buy almost
all new corporate-bond issues. Life-insurance-company holdings of
industrial bonds rose from less than 1 percent of assets in 1926 to over
15 percent today. I n large part the insurance-company market is
geared to handle economically only large issues of substantial firms,
often through private placement.
Although most of the life-insurance money has been invested i n
f a i r l y large firms, some companies have made an effort to seek out
smaller businesses w i t h sound futures. I n this case, funds have usually been made available i n the form of term loans. The term loan
granted by either a bank or insurance company has helped to take the
place of bond financing for smaller firms i n the past 15 years. Term
loans w i t h amortized payments plus greater reliance on internal
sources of funds have contributed to the strong financial position of
business today relative to the era before the depression.
Business firms, large and small, have greater difficulty i n interesting
outside investors i n new and untried stock issues than was true i n the
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twenties. I n recent years the small investor has reentered the stock
market in larger numbers than at any time since the "crash." I n terest has centered, however, i n "blue chips"—the shares of large wellestablished firms—far more than was the case i n the late twenties.
The difficulties encountered by business in general, and smaller firms
i n particular, i n raising money through stock sales has been traced by
some observers to the existence of Securities and Exchange Commission regulations. I t is doubtful that the existence of SEC has had
much adverse effect on small-business finance. Very small firms have
never sold stock i n appreciable amounts, and when they did i t was not
listed on the organized exchanges. Small to medium-sized firms
can usually sell their shares only at a considerable expense—perhaps
20 percent of the selling price. Finally, i t was the very abuses which
the SEC legislation was intended to correct which have placed stockholdings i n an unfavorable light w i t h a large number of small
investors.
The greater reliance placed upon retained earnings and depreciation
reserves by business, generally, as sources of funds is not necessarily
an unfavorable development. The fact that a firm is able to earn
the money w i t h which to expand is in itself a justification for that exansion. On the other hand, the ability of a new or relatively small
r m to sell stock to the public is often a reflection of high-powered
merchandising rather than an indication of the economic worth of the
enterprise.
I n the northeastern part of the United States a number of venturecapital companies have been formed i n the past decade w i t h the object
of locating desirable investments i n small new firms. Such organizations have not been established in the seventh district on a formal
basis. There are, however, a number of wealthy individuals who have
created investment-research groups of their own on a private basis.
These organizations operate i n much the same manner as the venturecapital companies, but do not publicize their activities.
Possible aids to small-business finance.—Many of the proposals to
aid small business which have been advanced i n recent years have
involved modification of the corporate-income tax. On balance, i t is
probable that the postwar tax structure has tended to encourage the
formation of equity capital i n small corporations. This is because
of the differential between the capital-gains tax of 25 percent and the
high marginal rates on large personal incomes. Keeping the earnings
i n the business shields them from the individual tax. This is especially important i n the case of small, closely held corporations. Many
wealthy individuals have invested money in small firms i n recent years
without ever intending to receive dividend income. They expect to
sell out at some future date after the growth of the firm has enhanced
the value of the stock.
Small business in the defense economy.—In the present international
emergency the restrictions upon new credit extensions and allocations
of materials are serving to l i m i t expansion opportunities. These
developments may adversely affect levels of production and sales for
business firms which are unable to participate in defense work.
The Nation's business population fell by 300,000 from 1941 to
1944. A n y deepening of the present crisis would doubtless tend the
same way. Retail and service establishments would decline i n num-
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ber as their proprietors are taken into the Armed Forces or as the
commodities they sell become unobtainable. Many small processors
unable to obtain subcontracts would find their supplies of strategic
materials reduced further or cut off entirely.
A partial solution for this problem may be found i n a greater attempt by the procurement agencies to award contracts to smaller
firms, and a greater ingenuity on the part of the small-business men
themselves i n fitting their establishment into a war or semiwar environment. I n the years immediately ahead the problems created
by the defense emergency w i l l far outweight the difficulties which
small business w i l l encounter i n obtaining an adequate amount of
credit and capital.
Supplement for Eighth Federal Reserve District (Delos C. Johns,
St. Louis)
The joint reply prepared under the direction of a special committee
of the presidents of the Federal Reserve banks covers many of the
general problems of financing small business which are common to
all districts. I amj i n agreement w i t h the statements made i n that
joint reply. I have confined my own reply, therefore, mainly to
conditions and developments i n the eighth Federal Reserve district.
B y way of introduction, the following points should be recognized
for they influence my general conclusions.
(1) The financing of small business is but one of many problems
relating to the stimulation of small-business b i r t h and growth, to
the diffusion of economic power, and to the dynamic character of
the economy. I n fact, the financing problem does not seem to rank
as high on the list as do various others. Perhaps the greatest boon
small business could receive would be maintenance of general .economic stability. Changes i n tax policy to permit higher net returns
on investments and more funds available for investment and for
buying the products of small business would rank high on the list
of aids. Improvement of managerial ability would lead to fewer
failures; more widespread availability of technical and managerial
assistance would be useful. Actually, whatever financing problems
exist for small business almost certainly would be lessened i n magnitude and k i n d i f the three factors noted could be made more favorable.
(2) Programs designed to aid small business should be examined
w i t h great care to see that they really serve the purpose of contributing to the diffusion of economic power and the dynamic character of
the economy. Under our system of democratic capitalism everyone
should have equal opportunities to test his abilities as a businessman.
H e should be able to test those abilities on fair terms of competition
w i t h other businessmen. Our economic resources of manpower,
materials, and capital are limited, however, and there can be no
guaranty that everyone, regardless of ability, can command as much
of these resources as he wishes or that they should be prorated on a
per capita basis. The more efficient businessman naturally w i l l come
closer to meeting resource requirements than w i l l the less efficient.
Attempts to distribute resources on other bases would likely lead to
resource wastes, to the holding back of efficient producers, to lowered
output and hence to less dynamic strength i n the economy.
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(3) Precise and complete information w i t h respect to the specific
question of availability of capital to small business i n this district
over the past 25 years simply is not available. The difficulty encountered i n obtaining concrete statistical evidence has its roots partly
i n the lack of a clear-cut definition of "small business." I n t u r n this
leads to considerable confusion i n defining the problems and i n making
recommendations designed to aid small business. Actually much of
the public discussion about small business seems to reflect concern
about what might be better termed "intermediate sized business"—
the upper range of the so-called small business group.
Official definitions of small business use volume of employment i n
some cases, sales or assets or earnings i n other cases, and shift from
one yardstick to another depending on the nature of the study involved. B y and large, however, almost all of the official classifications
result i n making practically all business establishments, perhaps 90
to 95 percent of the total, "small business."
This situation obtains i n the eighth Federal Reserve district as well
as i n the Nation. Of the more than 225,000 businesses in this area,
somewhere between 90 and 95 percent would meet the general standards of classification as small business establishments.
(4) The eighth Federal Reserve district is a low-income region.
I t is composed of the entire State of Arkansas, the southern portions
of Illinois and Indiana, the western half of Kentucky and the western
t h i r d of Tennessee, the northern half of Mississippi, and all of Missouri except the western tier of counties. Over the past several years
the research staff of the St. Louis Bank has made fairly extensive
studies of the district income structure and of per capita income i n
small areas of the district.
I n 1950, per capita income i n the district as a whole was $1,055 or
just 73 percent of the national average. One district area ( i n western
Kentucky) had an average income of only $382 i n 1950 or less than
one-third the national average. The highest per capita income registered i n the district last year was i n the St. Louis area ($1,824).
While district income runs well below the national average, over
the past decade i t has increased relatively faster than the national
average. Between 1940 and 1950 total income i n the eighth district
rose 194 percent as compared w i t h a gain of 186 percent for the Nation as a whole. Since the district showed a smaller net population
gain than d i d the Nation as a whole, 3 percent against 15 percent, the
increase i n per capita income here as against the Nation was even
more favorable—187 percent as compared to 150 percent.
While the district can be proud of its record over the past decade,
the above figures indicate that i t is an area which has some distance
to go to catch up w i t h the rest of the Nation. That catching-up process necessarily involves continued shifts of district workers to jobs
of higher productivity. Thus i t may well mean a sustained growth
rate i n the number of business establishments i n the area.
(5) Business numbers have increased here. A study made by the
staff of this bank more than a year ago indicated that the number of
business establishments i n this district had grown from approximately
183,000 i n 1944 to 227,000 i n 1949. Further growth probably has
taken place since 1949.
The increase i n number of business establishments i n the district
ever this 5-year period was perhaps a little smaller relatively than
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growth i n the Nation as a whole. I n this connection i t is worth noti n g that for the country as a whole the ratio of the number of business
enterprises to the population has remained relatively steady since the
t u r n of the century. Also, as indicated by the chart at the bottom of
page 793 i n the joint reply to this question, there is a close relationship
between number of businesses and income in a State. The periods
of interruption from a statistical normal have been occasioned by war
and widespread depression.
The smaller growth rate i n business numbers in this district than in
the Nation apparently reflects largely the smaller than average population gain here. Actually, adjusting for relative population changes,
growth of the number of business establishments in this area compares
very favorably w i t h that for the Nation as a whole. I t also gives
indication that income growth and business growth go hand i n hand.
These five points bear on the general question of small business
growth and development i n this district. The balance of my reply
deals, as specifically as the available data and evidence permits, w i t h
the financing problems of small business. I discuss them under three
major headings: Short-term credit, intermediate and long-term credit,
and equity capital.
Bank (short-term) credit.—As noted earlier, there have been cases
over the past quarter-century where credit-worthy businesses i n this
district could not obtain short-term bank credit. Statistical measurement of the extent of this condition is not available, but i t probably
was most prevalent around the time of the great depression. Responsib i l i t y for the failure to satisfy worthy demand rested partly on the
lenders and partly on the borrowers. To the extent that failure was
due to bank shortcomings or banking system shortcomings two factors
suggest that a change for the better has taken place: Improved public
confidence i n banks and certain institutional changes that make bank
credit more readily available to small businesses.
Restored public confidence i n banks generally has lessened the strain
on each individual bank to meet daily demands w i t h i n itself, that is
f r o m cash i n vault, primary reserves above requirements, and very
short-maturity secondary reserves. Under present conditions banks
may safely carry a larger share of assets i n intermediate and longterm loans and investments than they could when public confidence i n
banks was less firmly established. Furthermore, the relatively large
proportion of the United States Government securities to total loans
and investments of all banks today compared w i t h prewar serves to give
the bankers a feeling of confidence i n their ability to meet any unusual
daily demands and, therefore, to induce i n them a greater willingness
to lend than they had in the early 1930's.
Secondly, there have been several institutional changes that have
improved the individual bank's accommodation of credit-worthy businesses. The Federal Reserve System's ability to meet currency demand is no longer hampered by a need to back the currency only w i t h
eligible paper and gold. Also the Reserve banks may now make industrial loans under section 13b. While extensive use of this additional lending power has not been made, System authority to lend helps
assure credit-worthy established industrial businesses that their bank
credit needs w i l l be filled more adequately than before 1934. ( I n fact,
assuming only proper administration of the direct lending authority,
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the relatively inconsequential use of section 13b would suggest that
industry's bank credit needs have been f a i r l y well taken care of by the
commercial banks over the past 15 years.)
The Reserve banks' V-loan guaranty program, likewise^ assures
business that the necessary bank credit for defense production w i l l
be made available.
Judgment on the adequacy of short-term bank credit to small business i n this district is that virtually no credit-worthy demand is unsatisfied today. A survey of business lending by banks, made i n 1946,
indicated widespread bank financing of all sizes of business. This
situation is not believed to have changed appreciably i n the past 5
years.
While admittedly the number and volume of loans made is no complete measure of unsatisfied demand, i t is significant that the 1946
Business Loan Survey showed some 28,870 loans by district member
banks to business outstanding at that time w i t h the average loan
being for $18,947. (Nonmember banks were not included i n this survey. While member bank resources account for the bulk of banking
resources i n the district, there are about twice as many nonmember
banks as member banks.) The bulk of the loans (number) was made
to small businesses. Almost 26,000 of the loans were to businesses with
assets of less than $250,000. Another 2,000 were to businesses w i t h
assets from $250,000 to $750,000. A t that time, the Federal Reserve
Bank of St. Louis i n summarizing the results of the survey noted:
One of the most significant results of the survey w i t h regard to asset size and
type of business borrower is the close correlation between the number of loans
going to businesses w i t h assets of less than $250,000 and the proportion of all
small businesses to total number of businesses. About 9 of every 10 business
loans made by banks i n this district went to borrowers which (in terms of asset
size) would be classed as small business. According to most widely accepted
definition, about 9 of every 10 business firms i n the United States are small
businesses. This district, representative i n so many respects of the Nation as
a whole, probably is equally representative in its proportion of small business
establishments to all business establishments. Similarly the proportion of total
dollar amount of loans to borrowers i n the two smallest classes is i n general
agreement w i t h the relative share of employment or of sales volume of small
business firms as traditionally defined. I t appears, therefore, that the banks
of this district are not neglecting the financing of small business.
Intermediate and long-term credit.—In the intermediate and longterm credit fields the statistical picture is not quite as clear. Improvement, however, has occurred in the past quarter century i n these fields,
and today small business credit needs for intermediate and long-term
borrowed funds seem to be met reasonably well.
Over the past 25 years, term lending by banks has expanded. Further, participation on the part of smaller banks w i t h their larger
correspondent banks or w i t h insurance companies has permitted the
smaller banks to accommodate individual businesses i n their communities w i t h larger credits than would be possible from their own resources and for longer terms.5 Establishment of the System's 13b
5
The Chase National Bank of New York, for example, in 1950 set up a fund of $10 million to furnish intermediate-term credit to small businesses all over the country in cooperation with its 3,700 correspondent banks (at least one in virtually every county in the
48 States). Loans are made through local banks. The Chase Bank may agree, after a
period of review, to take up to 90 percent of the loan, allowing a half of i percent to the
local bank as a service fee. Minimum rate to the Chase Bank was fixed at 4% percent;
maximum loan, $25,000. (This fund has reportedly not been used extensively to date.)
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program also helped term lending to businesses, moderately insofar as
actual extension of term credit or commitments to extend term credit
are concerned, but substantially i n setting examples for commercial
banks and small businesses to follow. Finally, the growing acceptance by commercial banks of the amortized loan principle has aided
very small businesses i n financing their intermediate-term credit needs
and has aided small or intermediate-size businesses to escape the task
of directly financing their customers, thus leaving the working capital
of the small business to serve other purposes.
I n addition to the improvement i n bank lending, a number of Federal lending or loan-guaranteeing activities have appeared i n the past
25 years or have been extended. Particularly important have been
the R F C direct lending and participation programs and the V A loan
guaranty program.
I f there is any appreciable lack i n the credit field f o r small business i n this district i t probably lies i n the long-term area (maturities
of 10 years and more). I n part, any such lack reflects an institutional
shift f r o m equity capital to long-term credit which i n t u r n reflects
a variety of factors including the preoccupation w i t h security, the
institutionalization of savings, high income-tax rates, and so on. I n
other words, the demand for long-term funds now focuses more than
i n the past on credit and less than i n the past on capital investment.
Thus part of any failure of long-term credit supply to meet demand
really reflects this shift away from equity investment.
Small firms cannot tap the organized security markets for longterm loans as easily as can larger, older and more well-known firms.
Most of the long-term credit needs of small business thus necessarily
are met by real estate mortgage credit, much of i t granted by financial institutions other than commercial banks. Traditionally the commercial banks have been only minor factors i n this long-term credit
field. I n most cases, the long-term credit needs of small business seem
to be served, but there probably is some unsatisfied, worthy long-term
credit need. The record of new business starts and business growth
i n this district over the past decade, however, would suggest that any
such unsatisfied demand was of no appreciable magnitude.
Capital.—The question concerning adequacy of equity capital for
small business is more difficult to answer than those concerning credit
adequacy. One important source of funds (relatives and friends)
shows greatly increased liquid assets and should, therefore, be more
adequate to help small-business men w i t h their equity capital problem today than a decade ago. B u t two factors apparently have offset, at least i n part, the improvement i n individuals' dollar incomes
and liquid asset holdings: (1) the increased capital requirements i n
dollars, and (2) the increased income-tax rates compared w i t h 25
years ago. The increased dollar-capital requirement is partly because
of higher average prices for buildings, machinery and equipment and
inventories, and partly because of an almost universal increase i n
technologies of production.
The question of capital for small business is partly a matter of
availability of local funds. The importance of having funds actually
w i t h i n a region is often overlooked or discounted i n the belief that
money is not regional i n character, that i t w i l l flow where i t is most
needed and most useful (that is, where i t w i l l command maximum
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return consonant w i t h risk). I n practice, despite improving communication and transportation, this flow of funds lacks the perfect
fluidity i t theoretically possesses. Established programs and traditional practices introduce impediments to free movement. Distance
and lack of personal contact tend to obscure the need of funds and to
magnify the apparent risk of advancing them. Often prospective
borrowers cannot identify prospective lenders and vice versa.
The growth i n funds held i n relatively underdeveloped regions like
the eighth district is of prime importance to small business growth.
I n this connection i t is noteworthy that the increase i n home-owned
funds i n the eighth district over the past decade has been relatively
larger than that for the Nation as a whole. For example, eighth district bank deposits have increased by about $5 billion since the end
of 1939, a gain of 220 percent as against the national average growth
of 170 percent. W i t h i n the district, deposit growth has been relatively larger at rural than at urban banks, thus further distributing
available funds geographically.
D u r i n g the war years, f r o m 1941 through 1945, the St. Louis dist r i c t ranked seventh among Reserve districts i n demand deposit
growth. I t s relative gain, however, was appreciably larger than the
national average and considerably more than that in the eastern districts. Since the end of the war, deposit growth i n this area has continued to run above the national average. A t eighth district member
banks, private demand deposits increased 32 percent f r o m December
1945 to December 1950, i n contrast w i t h a Nation-wide gain of 25
percent.
As noted, however, the growth in home-owned funds has been accompanied by larger capital requirements of business, and the tax
laws (plus the emphasis on security as against opportunity) have made
equity investment somewhat less attractive than i t was a quarter century ago.
On balance, then, i t seems likely that there is some gap, small but
important to an area like the eighth district, between supply of longterm funds and worthy need for such funds.
M y position on the problem of channeling a more liberal supply of
long-term credit and equity capital into small business i n this region
is that two lines of approach should be emphasized. I would prefer
not to foster either approach at present, partly because of the potential
inflationary dangers still confronting us and partly because I do not
see great need for such steps under the present emergency situation.
A t an approprate time, however, I would favor (1) the activation
and promotion of local and area development programs, and (2) the
establishment of pilot private investment trusts to provide mechanisms
whereby current savings could be moved into productive use by small
businesses. These trusts would generate experience from both lender
and borrower points of view on proper profitable techniques.
Supplement for Ninth Federal Reserve District (J. N. Peyton, Minneapolis)
The question is of special interest to the ninth Federal Reserve district for i t represents an economy predominantly composed of small
business firms. From east to west, the district includes the upper
peninsula of Michigan, the 26 northwest counties of Wisconsin, and
98454—52—pt. 2
10
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the States of Minnesota, North Dakota, South Dakota, and Montana.
This territory is sparsely populated. As a result, markets are small
and the average or typical business firm falls w i t h i n the category of
small business.
I n the last 25 years, a number of changes i n the structure of the
economy have had a bearing on the ease or difficulty experienced by
small-business men in raising capital or securing credit. Nevertheless,
i t is difficult to ascertain precisely how important an effect each change
may have had on the financing of small business.
The steady advance i n technology has increased the amount of
capital required to establish a business. Rapid strides made i n the
mechanization of factory operations have resulted i n the use of an
ever-increasing number of specialized machines. I n the production
of the simplest products, complicated equipment is a prerequisite.
Technological progress also has resulted i n the perfection of more
complex products. Durable consumer goods have grown rapidly i n
the last 25 years. Economical production of these items requires largescale equipment w i t h correspondingly large capital outlays.
Even i n the distribution of merchandise and services, where opportunities for mechanization have not been as great as i n production,
more fixtures and equipment now are required to display effectively
the merchandise or render efficiently the services.
A t the same time that more capital is required to establish a new
business or purchase a going concern, higher rates on income and
inheritance taxes have made i t more difficult for individuals to
accumulate sufficient amounts of capital. Individuals looking forward to the opportunity of entering business for themselves must rely
more heavily on outside sources of capital.
Offsetting these changes in the economic environment which have
added to the difficulty of financing small business, the general business
prosperity of the forties has enabled the rank and file to accumulate
small savings as never before in the last 25 years. Small business
enterprise secures its equity capital almost entirely outside of the
organized money market. A case study made by the Federal Reserve
Bank of Minneapolis i n 1948 disclosed five principal sources of equity
capital :
1. The entrepreneur himself.
2. Relatives and close friends.
3. Business concerns.
4. Local and nearby capitalists.
5. The security market.
On the basis of this case study, the individual establishing a new
business or purchasing a going concern generally had some capital of
his own to invest i n the venture. This was the case i n 89 out of 122
firms called upon i n this survey. Relatives and close friends comprised the second most frequent source of capital. I n 23 concerns,
they contributed to the original equity capital. Established business
concerns supplied the initial capital for a number of new firms.
Equity'capital was secured in relatively few instances from local or
nearby capitalists or through the security market. A number of corporations included i n the study had been reorganized and at that time
they secured capital through the sale of securities.
Although sources of equity capital for small business are almost
entirely outside of the organized money market, sources of borrowed
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capital or credit are principally the prevailing lending institutions.
There exists a wide range of private, quasi-private, and Federal lending institutions supplying credit to small business. When a firm has
acquired its essential equity capital, i t is i n a position to secure credit
by pledging some of its collateral.
Private lending institutions and Federal lending or loan guaranty
agencies have increased the supply of credit available to small business. Commercial banks have devised floor planning which enables
manufacturers and distributors to carry their stocks of merchandise
on bank credit. The term loan has grown into familiar use for the
purchase of large and complex equipment which depreciates slowly.
Installment loans are granted frequently when the creditor has only
the particular equipment to pledge as collateral.
Industrial banks, small loan companies, and finance companies are
organized for the purpose of granting small loans to individuals who
have little or no collateral to offer as security. These companies loan
to individuals for their business operations as well as for their family
needs.
I n the lending field, the Federal Reserve banks are i n between private lending institutions and Federal lending agencies. They have
authority to extend loans directly to established business firms for
working capital provided the credit is not available on reasonable
terms from private lending institutions. Experience has proven that
the demand for such credit prevails only during periods of depressed
business conditions. A f t e r this authority was granted to the Federal
Reserve System in June 1934, Federal Reserve banks received a substantial number of applications for loans. I n the early forties, the
number of such applications received by the banks tapered off sharply
and none were received during the war years, but with the slight business recession in 1949 the number of applications again rose
significantly.
Federal lending or loan guaranty agencies, which lend directly or
indirectly to business concerns, include the Reconstruction Finance
Corporation, Rural Electrification Administration, banks for cooperatives, Defense and Administration Services agencies i n guaranteeing V-loans, and Veterans' Administration. Other agencies,
such as the Federal National Mortgage Association, Federal Home
Loan Banks, Federal Housing Administration, and Commodity Credit
Corporation, loan exclusively either on residential properties or on
agricultural products.
I n the case study made by the Federal Reserve Bank of Minneapolis,
it was disclosed that small-business enterprise secured borrowed capital from numerous sources, chief of which was the commercial bank.
Banks supplied slightly over one-half of the long-term total. I n the
purchase of a going concern, proprietors frequently found previous
owners willing to leave some of their capital in the business; they
were the second most important source of long-term borrowed capital.
Other sources constituted relatives and close friends, suppliers of tools
and equipment, and capital pools created by communities for the purpose of financing new enterprise. These latter sources were seldom
used and contributed only a small amount of capital.
Commercial banks supplied most of the short-term borrowed capital, I n the firms included i n the survey, they supplied over half of
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the total. Relatives and close friends loaned a small amount. I n a
few instances, the proprietor borrowed from a close business friend
who secured i t from a bank and reloaned i t at a substantially higher
rate of interest. For short periods, personal loans were secured from
finance companies. Suppliers of tools and equipment frequently
extended credit, the proprietor making a down payment that exceeded
the depreciation on the equipment. Trade credit was generally relied
on in some measure to finance the stock of merchandise.
The rate of business organization is a measure of the amount of
capital and credit available to supply business. According to statistical information available, i t appears that more businesses were organized sinse W o r l d War I I than i n any previous period. I n the ninth
Federal Reserve district, the growth i n business establishments has
been concentrated in manufacturing. For example, between 1939 and
the first quarter of 1949, the number of manufacturing concerns i n
Minnesota increased by 1,119. A similar proportionate growth i n
such concerns occurred in other States of this district as well as i n the
entire Nation. The basic statistics are assembled i n the accompanying
table I .
D u r i n g W o r l d W a r I I , many retail and service establishments were
liquidated. I n this district where the population growth during the
decade of the forties was held to 3 percent due to the emigration of
labor to other regions, the number of retail stores and service establishments i n 1948 when the business census was taken still was noticeably less than those i n existence i n 1939.
The liquidation of these business concerns during the war was traced
to other causes rather than to a lack of capital and credit. Some proprietors entered the armed services while others were faced w i t h a
shortage of labor or found more profitable employment. The conversion of industry to the production of war materials reduced the supply
of civilian merchandise, which forced some concerns into liquidation.
Following the end of W o r l d W a r I I , the number of annual business
failures was at an all-time low. W i t h business boom conditions receding i n 1949, business failures rose significantly. Inefficient management and not lack of capital or credit appears to be the dominant cause
of these failures.
The success or failure of business ventures are not predictable w i t h
any degree of accuracy. Consequently, no technique has been devised
which w i l l assure all worthy prospective entrepreneurs the capital
and credit they need and can use effectively, and deny them to those
who are not competent to manage their business ventures successfully.
While some, and perhaps many, worthy and competent individuals
cannot raise sufficient capital to go into business for themselves as they
might wish, enough capital is available to permit a substantial number
of incompetent businessmen to go into business and subsequently fail.
I n our private enterprise system, capital is invested i n and credit
is granted to business concerns on the judgment of individuals who
bear the risk of failure of such concerns. I f we wish to retain this
highly efficient system, the risk-bearing function cannot be dissociated
f r o m the investment and credit decisions i n the initiation of new business firms.
MONETARY
TABLE
POLICY AND
MANAGEMENT
OF
PUBLIC
t)EBT
of manufacturing
establishments
in ninth district
United States from 1909 through first quarter of 1949
I.—Number
1909
Michigan
Minnesota
Montana
North Dakota
South Dakota
Wisconsin
United States
1919
1929
1939
8 2 1
and
1947
9,159
8,305
6,549
9,892
6,311
5,561
6,225
4,206
4,567
4,008
1,290
677
553
652
585
894
752
346
362
350
1,414
588
1,020
494
468
7,323
6,979
9,721 10,393
6, 717
268,491 210,959 206,663 184,230 240,881
in
First
quarter
1949
10,914
5,127
735
367
553
7,317
274,890
Source: Data from 1909 through 1947 were taken from the census of manufactures. Data for the first
quarter of 1949 were compiled from the old-age and survivors insurance program and published by U. 8.
Department of Commerce and Federal Security Agency.
TABLE
II.—Number
of retail establishments
in ninth
States in 1929,1939, and 1948
district
1929
Michigan.
Minnesota
Montana
North Dakota
South Dakota
Wisconsin
United States
1939
53,952
29,206
6,521
7,611
8,330
38,045
1,476,365
___
and in
United
1948
67,414
40, 448
8,481
8, 549
9, 817
47, 604
1,770,355
68,689
35,241
8,108
8,201
8,993
46, 500
1,769,540
Source: Census of business."
TABLE
I I I . — N u m b e r of service
establishments in ninth
States in 1939 and in 1948
Personal, business, and repair
service
Michigan
Minnesota
Montana
North Dakota
South Dakota
Wisconsin
United States
1939
1948
20,567
11,904
2,384
2,363.
2,617
11,547
570,057
21,376
10,104
1,942
1,955
2,087
10,935
559,559
Amusements
1939
1948
district
and in
Hotels
1939
1948
1,825 2,623
865 1,136
992
804
818
1,066
222
492
398
295
232
219
256
247
194
333
194
333
862
841 1,004
670
44,917 50,347 27,987 29,650
United
Tourist courts
1939
436
765
246
23
164
407
13,521
1948
1,441
1,063
392
61
224
749
25,919
Source: Census of business.
Supplement for Tenth Federal Reserve District (27. G. Leedy, Kansas
City)
The answer to this question on credit and capital availability to
small business as presented i n the joint answer of the Reserve bank
presidents is generally applicable to the situation i n this district,
w i t h i n the limits of information available. The Federal Reserve System's survey of business lending i n the f a l l of 1946, referred to i n the
joint answer, indicated that commercial bank lending in this district is
predominantly to small business. Under the classification of small
business stated i n the joint answer, small business accounted for 80
percent of the number and 35 percent of the dollar volume of business
loans extended by member banks. Subsequently, the volume of busi
MONETARY
POLICY
AND
MANAGEMENT
O F P U B L I Ct ) E B T822
ness loans has expanded very substantially, and under present circumstances the chief concern has been that the amount of credit extended
might be excessive in view of the price-inflation threat. While data of
the type obtained in the 1946 survey are not available on a current
basis, there is reason to believe that the proportion of loans and loan
volume going to small business compares favorably w i t h 1946 and
that the demands of both small and large business firms for bank
credit are currently being met in a satisfactory manner.
No comparable study of capital, or credit from sources other than
commercial banks, has been made in this district. On the basis of less
specific information, our understanding of the capital situation and
our views w i t h respect to the problem so far as this region is concerned
are essentially i n accord w i t h the presidents' joint answer to the
question.
Supplement for Eleventh Federal Reserve District (R. R. Gilbert,
Dallas)
I n my opinion, there are no changes which have developed in the
eleventh Federal Reserve district during the last 25 years that have
been peculiar to this district and have increased the difficultv of smallbusiness men to raise capital or to borrow. Such changes as have occurred i n the district during the past 25 years have i n general been
expansive and may have strengthened the ability of small-business
men to raise capital or to borrow. The strong growth factors i n the
district should make the formation of new businesses more attractive
and more promising than might be the case i n other parts of the count r y where expansive forces and growth factors have been less pronounced. I know of no statistical measure that would indisputably
establish the adequacy of capital available to small business, but, on
the other hand, i t is a fact that the economic growth and expansion in
the Southwest has been more pronounced than for the country as a
whole. I t is possible, of course, that had there been even greater
capital availability there might have been greater growth, but this
cannot be established. On the other hand, the Southwest's remarkable
economic growth is an established fact. I n my opinion, the same set
of factors and conditions which are developed in the general answer
to this question are also applicable to small business i n the eleventh
district, modified only to the extent that the more rapid economic expansion of the Southwest would tend to make this area offer more
attractive capital-investment opportunities than other areas.
Supplement for Twelfth Federal Reserve District (G. E. Earhart,
San Francisco)
I t is not surprising that no definition of small business is given i n
this question, since small business is not a concept capable of exact
measurement. To establish fixed upper limits i n terms of some quantity, such as sales, number of employees, or assets, serves no particularly useful purpose here. B y the same token, however, since an
appropriate definition depends upon the discussion at hand, i t is necessary that the use of the term "small business" be understood. W i t h
respect to the question of availability of equity capital and credit, we
assume that small business, i n a broad sense, includes all enterprises
not large enough to have recourse to security markets. However, we
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
823
assume that the question is directed, to a considerable extent, to very
small business; that is, to businesses, many of which are individual
proprietorships, which have relatively few employees, and i n which
the capabilities of one or two persons are likely to be decisive factors
in success or failure. This is the area i n which many of the complaints
regarding lack of funds originate. I t is also assumed that the question
is directed toward the relation between access to funds and the ability
to launch new small enterprises.
Growth of the business population.—In our opinion, the conclusions
i n the joint reply (pp. 787-796) regarding the financing of small business are, in general, applicable to the t w e l f t h district. Population
growth i n the district has been accompanied by vigorous and extensive
business expansion, including the formation of new businesses at an
active rate. I n December 1949, a Department of Commerce study in
the Survey of Current Business reported that the total number of
businesses i n the far West, including four of the seven t w e l f t h district
States, increased 56 percent between March 1944 and March 1949.
D u r i n g this period, the number of contract construction firms more
than tripled, wholesale firms became 83 percent more numerous, public
utilities and concerns i n transportation increased 82 percent i n number, manufacturing firms 60 percent, service establishments 53 percent,
and retail trade concerns 40 percent. This area led the Nation i n the
relative increases i n number of firms in all businesses, and i n manufacturing, transportation and utilities, retail trade, and wholesale trade.
Between 1929 and 1947, the number of manufacturing firms i n the
district w i t h less than 50 employees increased by more than 30 percent
and accounted for some 70 percent of the total numerical increase in
manufacturing firms. D u r i n g a roughly similar period, retail concerns
increased by about 50 percent or 58,000. I t is safe to assume that the
great majority of such retail firms are small businesses, w i t h only a
few employees per establishment. Our observation indicates that
many of the district's contract construction firms are realtively small,
and that many of substantial size have grown quite rapidly f r o m small
organizations.
From the evidence available as to the growth i n number of business
firms, i t appears that small businesses in this district have had reasonable access both to equity funds and to credit i n recent years. I n the
absence of generally adequate sources of funds, many of these businesses could not have come into being.
Equity capital.—Whether equity capital has become more or less
readily available to small business over the past 25 years cannot be
demonstrated conclusively. While i t may have become more difficult
f o r small businesses to raise equity capital, we should like to emphasize
that many of the difficulties that confront small businesses and that
may discourage investment i n small business would not necessarily be
corrected by a more liberal supply of credit. For example, compared
w i t h the situation 25 years ago, a man wishing to start or expand a
neighborhood grocery store may be deterred far more by the competition afforded by chain stores and supermarkets than by a lack of funds.
As has been indicated (p. 128), the most important source of equity
capital for most very small businesses is the proprietor and his relatives and friends. I n this regard, mention has been made of the
difficulty of accumulating personal funds for business investment i n
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT824
the face of rising income tax rates. Without disagreeing w i t h this
for business generally, i t should be pointed out that, i n the postwar
period, both liquid asset holdings and incomes of individuals have been
at record levels and have apparently been more equally distributed
than they were before the war. Consequently, i t may be that persons
seeking to launch very small businesses, who are usually persons of
moderate income, have been able to supply equity capital and to obtain
i t f r o m their families and friends w i t h little more difficulty since
W o r l d W a r I I than previously.
Credit.—In our opinion, credit has become more readily accessible
to small businesses over the past 25 years i n the t w e l f t h district, and
i n recent years has been adequate for their over-all needs. That district banks have been responsive to small-business demands is indicated by the loan survey made as of November 1946. A t that time, almost 78,000 out of a total of 124,000 loans to business were made to
firms w i t h capital of less than $50,000.
Loans of banks to small business i n the district include not only
short-term loans for working capital purposes but also term loans of
a year or more, w i t h the majority of such term loans on an installment basis. W i t h respect both to term loans to business and consumer
installment credit, twelfth district banks have been i n the forefront.
The November 1946 loan survey showed that, at that time, term
loans of t w e l f t h district banks accounted for nearly 30 percent of the
national total i n numbers, although for only 10 percent of the dollar
amount. The next district in terms of the number of term loans (New
Y o r k ) had ony 15 percent of the national total. I n the t w e l f t h district, one out of three of all member bank business loans was a term
loan, compared w i t h one out of four i n the next highest district (Minneapolis), and about one out of five i n the country as a whole.
On the average, outstanding term loans of banks i n this district
were considerably smaller i n amount than the average term loan for
all districts combined. The average term loan of district member
banks was also smaller i n size than the average size of all business
loans of those banks.
D u r i n g the 1930's, banks had large excess reserves and limited investment opportunities. Though some banks had already shown considerable interest i n lending to small business, i t was not u n t i l the
1930's that they entered the installment lending field to any great
extent. A large portion of the paper was acquired from retail dealers,
and many small businesses used this method of financing to acquire
equipment.
Through bank credit, business firms have been able i n recent years
to finance the acquisition of automotive equipment, tools, furniture,
fixtures, and machinery, as well as inventory. Bank purchases from
dealers of consumer installment paper have, in effect, financed accounts
receivable in substantial amounts; direct lending to consumers, while
of lesser importance, has served the same purpose indirectly.
I n recent years, some of the larger banks i n the district have developed small business departments and advisory services. These departments do more than process loans to small business; they also
supply information and advice on business conditions, legislative
developments, record keeping, and the like, that is useful to small
business. Such practices have strengthened the position of many
small firms,
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
825
That small businesses do have reasonable access to credit also eases
the problem of equity capital to some degree. First, the borrower can
extend his operations beyond the limits of his capital investment so
that he can achieve a given scale of activity w i t h a smaller equity;
second, i f the additional business supported by borrowing is profitable,
he is able to increase his equity out of retained earnings at a more rapid
rate. I n view of the extent to which credit has been made available to
small business i n this district, we believe these factors to be of significance w i t h respect to the availability of equity capital.
I n conclusion, we should like to emphasize that any discussion of
the access of small business to equity capital and credit is apt to be
inconclusive. There are always unsatisfied seekers of funds. Whether
these demands would be met i f loanable funds or funds for investment
i n equities were made more plentiful is open to question. Investors,
whether institutions or individuals, might still be reluctant to make
funds available i f there were little evidence that a sound business could
be developed. Certainly, i t is essential that new enterprises be permitted to enter the business arena, and that small businesses have an
opportunity to expand, i f we are to continue to have an expanding and
dynamic economy, but to lower standards and supply funds without
reference to reasonable prospects of successful operation would lead
to an increased number of business failures and a waste of economic
resources.
I n the twelfth district, at least, i t is our opinion that lack of access
to credit and equity capital, as a factor of and by itself, is not a barrier
to the establishment and growth of small businesses that, i n terms of
management, markets, and the other foreseeable factors relevant to
success or failure, have a reasonable chance of meeting the test of the
market, which is simply profitable operation.
36. Discuss the effects of bank examinations on the lending policies
of banks i n your district, particularly as they apply to loans to
small-business men. Distinguish i f necessary between examinations by different examining authorities.
Joint answer
The Board of Governors of the Federal Eeserve System and the
Federal Eeserve banks have endeavored to develop uniform standards
and practices i n bank examination and supervision, and a joint answer
to this question w i l l serve to describe this common basis. The answer
to this question should also be considered i n conjunction w i t h the
answer to question 20 which deals w i t h the role of bank examination
and bank supervision i n furthering the objectives of the Employment
Act.
The banker is the custodian of other people's money. H e watches
over and provides the deposit currency on which the economic life of
the community depends. Banking laws, practices, and ethics require
that loans be made only when the banker is convinced that the chances
of repayment are reasonably good.
I n a broad sense bank examinations w i t h regard to the lending
policies of banks are designed: (1) to insure the-observance by bank
managements of applicable laws and regulations relating to loans,
and (2) to encourage the making of loans of appropriate bank quality,
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT826
well diversified as to obligors, industries, collateral, etc., and under
competent administration. No supervisory authority w i t h whom we
have contact criticizes or discourages small loans or loans to smallbusiness men because of size, since supervisory authorities generally
prefer a wide distribution of loans to concentration of loans to a
few borrowers or to a limited number of industries.
A n examiner, i n appraising credits i n any bank, reviews the data
i n the bank's credit files supporting the loans and, i n addition to such
information, gives weight to the loaning officer's expressions and personal knowledge of the borrowers. He considers the invested capital
of the borrower, capacity, and character, as well as the conditions
under which the borrower is conducting his business; he reviews, of
course, the borrower's past earning record, the appraisal of "knowhow" employed i n the business, and its future prospects. Inability
of the small-business man to furnish (or of the banker to obtain)
adequate credit information may expose loans to small business to
more criticism from the bank examiner than loans to larger, better
established firms w i t h more adequate records.
A review of banker attitudes following bank examinations, particularly as they relate to the effects of bank examinations on lending
policies, indicates that officers i n the medium- and small-sized banks are
probably influenced more by examiners' appraisals and criticisms than
are the officers of the larger banks. The lending officers i n the larger
banks generally are more thoroughly schooled i n the analysis of
credits, and have more complete credit information i n their records.
For the reasons (1) that records, statements, and credit information
of small businesses are frequently less satisfactory than those of larger
businesses, (2) that loans to small businesses are more important i n
the smaller banks than in the larger banks, and (3) that officers of
smaller banks tend to be influenced more by examiners' criticisms than
do those of larger banks, the examiners' criticisms may have a stronger
influence on the extension of credit to small businesses than on extensions to larger businesses. The examiners, however, criticize loans not
because they are small, but because of adverse factors. That these
factors may happen to be more prevalent among small businesses is
not a function of size of firm but rather of the ability and experience
of the businessman. That these adverse credit elements do i n fact
exist more frequently among small businesses, particularly when they
are new, is revealed by the larger proportion of small businesses that
go out of existence each year. As we have indicated earlier, however,
examiners do not discriminate against loans to small businesses as
such. That the criticisms of the examiners, i n general, do not prevent
small businesses from getting sufficient credit to maintain the vitality
of small business i n the economy is revealed by the large number of
bank loans made to small businesses and by the record of the growth
of the business population (compare the reply to question 35).
We cannot distinguish w i t h confidence among the examining practices of the different examining authorities as those practices affect the
extension of credit, particularly to small businesses. Some differences
in practices undoubtedly exist but whether they are differences of
examining authorities or of individual examiners would be difficult
to ascertain. The appraisal of assets in an examination is a matter of
judgment.
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
827
Whatever the differences may be, we believe that bank examinations
do not interfere w i t h the extension of adequate credit by banks to businesses, large or small. Loans today are i n record volume and the
evidence indicates that the overwhelming proportion of the number of
business loans of banks is to small businesses.
Supplement for First Federal Reserve District
(J. A. Erick$on,
Boston)
Criticism of a particular loan by the examiner may result f r o m adverse available information or a lack of information. Lack of adequate information is a constant point of criticism. Such criticism,
however, is not necessarily a reflection on the quality of a particular
credit but rather a reflection on bank management i n not obtaining
information necessary to service properly the loan and to appraise the
credit.
Most criticism by examiners is aimed at bank management rather
than individual credits or types of credit. Many factors aside f r o m
the individual credit are involved in arriving at the examiner's conclusions such as the general over-all condition of the bank, the capabilities of bank management in servicing various types of credit, the
size of the total loan portfolio, concentrations of credit, proportion of
classified or marginal and long-term loans, and local and general business conditions.
There is little doubt but that a number of the smaller country
bankers i n their day-to-day consideration of loan applications reflect
to some extent the past criticism of examiners. I n years past, particularly during the 1930's, some bankers were prone to use the bank
examiner as the reason for declining applications for credit. Most
bankers today accept the responsibility for the management of their
loan portfolios and no longer use the examiner as a scapegoat since
they realize that i f quality is present and the credit adequately supported by facts their loans w i l l be favorably considered by the examiner.
That the criticisms of the examiners, i n general, do not prevent small
businesses from getting sufficient credit to maintain the vitality of
small business in the economy is revealed by the large number of bank
loans made to small businesses and by the record of the growth of the
business population (compare the reply to question 35). A further
survey of short-term commercial loans of 24 member banks i n New
England, who handle approximately 90 percent of the total commercial loans in this area, disclosed that of the new loans of this type
made during the period September 1-15, 1951, 42 percent were i n the
$1,000 to $5,000 range, 17.7 percent i n the $5,000 to $10,000 range, and
18.1 percent i n the $10,000 to $25,000 range.
Supplement for Second Federal Reserve District (Allan Sproul, New
York)
Bank examiners and supervisory authorities i n the Second Federal
Reserve District do not differentiate between loans to small business and loans to big business in their appraisal of the loan portfolios and lending practices of the banks they examine and supervise.
Consequently, no data are available to indicate directly whether or not
loans to small business have been, on the average, subject to more
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I Ct)EBT828
criticism than loans to large business. I t is the belief of our examining staff and supervisory officers that bank examinations have tended
to promote improvement in the lending policies and practices of banks
supervised w i t h respect to small and large businesses alike, so that
criticized loans are relatively few.
Tabulation of the most recent examinations of all member banks in
this district, conducted during the past year, indicates that only 1.09
percent of the total loans reviewed were classified by our examiners as
substandard, doubtful, or loss. The criticism of such a small proportion of the loans is significant evidence that bank examiners have not
been so severe in their appraisals as to cause restriction of the availability of credit to the business community where a sound basis for
credit exists. The following table summarizes the total loans and the
total "classified" (or criticized) loans of the 739 member banks i n this
district.
[In millions of dollars]
Total classified loans
Number and location of banks
Total loans
Amount
Percentage
86 large city banks
653 all other banks
$11,091
1,653
$112
27
1.01
1.61
Total
12,744
139
1.09
The percentage of loans criticized has been moderately greater i n the
653 of these member banks which are not located i n large cities w i t h i n
the district. This difference might possibly indicate that a slightly
higher proportion of small loans has been criticized, since the banks
other than the large city institutions generally have a somewhat higher
proportion of small loans i n their total portfolios. Such an inference
must be qualified, however, since no records are available from which
we can determine whether the criticized loans at these banks were proportionately greater among loans granted to small businesses. The
difference i n any event is slight, and, to the extent that i t has meaning,
probably reflects the relative ability and business experience of the
lender and the borrower, rather than the attitude of the examiner.
I t is not the practice of examiners i n this district to criticize new
loans—that is, loans made since the previous examination—unless
there is evidence of the development of material weakness i n the
position of the borrower and the safety of the loan. A loan is classified as substandard, doubtful, or loss only after the examiner has discussed i t w i t h the management of the bank and reviewed all pertinent
records, and usually has obtained the agreement of the bank's manage, ment as to the appropriateness of the classification. The examiner
does not attempt to dictate the lending policy of a bank.
We do not believe that there are any significant differences i n the
effect of the examinations made by the different examining authorities on the lending policies of the banks i n this district.
Supplement for Third Federal Reserve District (.Alfred H. 'Williams,
Philadelphia)
I n the t h i r d Federal Reserve district, bank examination policy is
also directed toward discouraging an undue expansion of the total loan
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
829
portfolio. No specific maximum ratio of loans to total assets or to
total deposits can be laid down which would be appropriate for all
banks or under all circumstances. I n all instances, the objective is to
appraise the nature and degree of risk i n the assets, including loans and
investments, and relate the total exposure to the capital account, earning power, and managerial capacity. Such a policy is considered
necessary i f examinations are to serve as the chief tool of the supervisory authorities i n their endeavor to insure the maintenance of sound
banking conditions w i t h due regard to the appropriate interests of the
depositors, other creditors, and the public.
I n some instances, a few national bank examiners i n this district
have taken the position during the past few years that a loan ratio
i n excess of 45 percent of total assets calls for a very careful examination of all pertinent factors to determine whether the total loan portfolio may be excessive. However, a careful analysis of the examiners'
report i n such cases suggests that their criticism was concerned primarily w i t h an excessive amount of substandard loans and the failure
of the bank managements to provide sound loan administration rather
than at the size of the loan portfolio.
We know of no instances i n this district where bank examinations
have served to discourage loans to small-business men i f such loans are
supported by reasonable net worth, earning capacity, and managerial
competence. Examinations do discourage loans to individuals and
businessmen, both large and small, which provide what is, in effect,
equity capital or fixed capital when inadequate credit information is
on file or i f the information available indicates a lack of earning power
or paying ability to insure the liquidation of the loans w i t h i n periods
of time appropriate to the type of credit extension. I t is felt that
equity capital and long-term capital for businesses of uncertain prospects, where justified, should be provided by organizations which are
not employing depositors' funds subject to immediate or early withdrawal and protected by relatively moderate capital accounts.
Supplement for Fifth
Federal Reserve District
(Hugh
Leach,
Richmond)
I t might be well to preface the answer to this question by mentioning
the close relationship between supervisory authorities and bankers i n
the development of credit policies and techniques. The development
of new types of loan outlets, the changing needs of commerce and
industry, and constant study by lending officers have given rise to
many changes i n lending policies during the past 15 to 20 years. As a
consequence, many loans are made now that in earlier times would have
been unsatisfactory or even unsound. I t should be emphasized that
new credit developments have evolved without restricting credit to
any class of borrower and without any line of distinction being drawn
i n bank examinations between loans, to large and small businesses or
between one type of loan and another. I n the development of these
improvements bankers and examiners have learned much from each
other, w i t h the latter serving also as a medium for the dissemination—
particularly to smaller banks—of new and improved methods of credit
extension.
I f specific faulty lending practices are observed by examiners, an
effort is made to influence the bank's lending policies by suggesting
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT830
that i t be more analytical of credits applied for and granted and adopt
sounder credit administrative policies. Some of the principal practices
urged are the following:
1. The bank should obtain borrowers' agreements to repayments
prior to credit extensions.
2. As a general policy, loans should be paid seasonally, at the
conclusion of the specific need, or reduced regularly at intervals
designated by the particular circumstances.
3. Detailed information should be obtained that w i l l disclose
the source, dependability, and adequacy of borrowers' funds available for debt retirement.
4. Risks inherent i n concentrations of credit extended to the
same or related interests should be weighed carefully; such concentrations should be avoided to the extent deemed appropriate
after thorough analysis.
Experience shows that capable bankers obtain necessary credit data
f r o m small as well as large enterprises and that failure to secure such
information is a consequence of the attitude of the bank management
rather than nonavailability of the information. I t is generally true,
however, that large businesses maintain more complete records of
operations and are.better equipped to furnish f u l l credit information
than are small concerns.
Examiners' appraisals of loans made by the great majority of member banks i n the f i f t h district do not disclose a significant number
characterized by an unwarranted degree of risk. Well-calculated risks
are taken readily, administered carefully, and i n such circumstances
the banks' exposure is not considered unduly high. Where this is the
case there is little or no need for conscious influencing of lending policies, and examinations of such banks have no particular effect i n this
respect. I n the absence of examinations of such banks, however, i t is
probable that legal regulations would not be observed as carefully as
they now are and that competitive pressures might result i n unsound
credit policies.
I n a relatively small number of banks, examinations have disclosed
substantial amounts of loans involving a very high degree of risk. Here
bank examination and supervision do have a direct impact onlending
policies i n pointing out unsound loans and i n suggesting desirable
changes i n credit policy. Frequently loans regarded as unsatisfactory
would be proper and sound i f made on suitable bases and terms. I t is
the purpose of bank examination and supervision to promote lending
policies that w i l l serve best the interests of both borrowers and lenders.
The examiner's principal concern is the quality of individual loans,
but there are times when he m,ust question the aggregate loans of a
bank i n relation to prospective demand from depositors and the
capital protection available. Instances of this sort are relatively
few and ordinarily rise i n banks whose portfolios include a high
volume of substandard credits. I n such cases, there is frequently
an excessive risk i n relation to capital protection, a general lack of
flexibility i n asset distribution, and a consequent danger of serious
loss. These conditions are usually found i n small banks whose management is not as alert, experienced, or as capable as desired. I t is
the responsibility of examinations and supervision to encourage such
banks to pursue sound lending policies, to reduce the exposure re-
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
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831
suiting from unsound credits, and to gear the total loan volume to
the ability of the bank to assume normal risks and maintain a sound
and flexible asset position.
No supervisory authority w i t h whom we have contact criticizes or
discourages a small loan or a loan to a small-business man per se.
I n fact, these authorities prefer a wide distribution of loans to concentrations of credit to a few borrowers or to a limited number of
industries.
We have not observed any differences i n the practices of the various examining authorities w i t h respect to loans to small business.
Supplement for Seventh Federal Reserve District
(C. S. Young,
Chicago)
>
I n addition to the qualitative appraisals of individual loans described i n the general answer, the several supervisory authorities operating within the seventh Federal Reserve district set rather flexible
standards for the relative quantity of loan assets. Federal Reserve
Bank of Chicago examiners place emphasis upon the ratio of capital
accounts to "risk assets" (assets other than cash and Government securities), w i t h appropriate allowance made for quality of the risk
asset portfolio. I n cases where an individual bank begins to f a l l
appreciably below the desired minimum ratio, recommendations are
made for improving the ratio. Except i n the small number of instances i n which an individual bank's capital ratio becomes very
unfavorable, however, examiner recommendations stress additions to
capital accounts rather than curtailment of loan expansion as a remedial action.
Quality and quantity standards followed by Federal Reserve Bank
of Chicago examiners i n appraising loans are designed primarily to
protect the solvency of individual banks. When bank portfolios of
earning assets contain an imprudent degree of risk, some reduction
in additional risk assumption becomes necessary i f the integrity of
deposit liabilities is to be assured. Occasionally, temporary reduction i n the availability of credit from a specific bank is part of the
price which must be paid i f the continued solvent operation of that
bank—and therefore the continued availability of its credit facilities w i t h i n the community—is to be insured over the years.
On those rather rare occasions when examiner criticism of the
size or quality of loan portfolios has appeared to induce a tightening
of lending policies, there seems little reason to believe that such
tightening has disproportionately constricted the borrowing opportunities of credit-worthy small businesses. Credit extensions to new,
untried, and undercapitalized businesses are undoubtedly among the
first types of business credit to be affected under such circumstances,
and a large portion of these firms would naturally be small i n size.
Over the years, however, the great bulk of business credit extended
by most banks i n the seventh Federal Reserve district has gone to
small concerns. Because business firms are generally considered to
be more desirable customers than individual borrowers, extensions to
reasonably well-managed and well-established businesses, both large
and small, are usually ambng the last types of loans restricted by
a bank i n any tightening of its general credit policy.
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT832
Supplement for Eighth Federal Reserve District (Delos C. Johns,
St Louis)
The joint reply covers adequately the situation i n the eighth district.
As indicated i n my reply to question 35, the growth record of district
business and district income would suggest that examination procedure i n this region has not hampered credit-worthy small business
i n obtaining credit, either short or long term. Examination procedure would have little, i f any, effect on capital investment.
{Supplement for Ninth Federal Reserve District (J. N. Peyton, Minneapolis)
Bank examinations are intended primarily to determine soundness
and solvency of banks for the protection of depositors and f o r the national economic welfare. I n making such a determination, individual
assets are appraised and criticized i f i n the judgment of the individual examiner such criticism is justified.
Examiners visit many banks during the course of a year and have
an opportunity to observe policies and practices i n effect at each of
the banks. I n the course of each examination they are able to make
suggestions based on their experience and i t is our belief such suggestions are welcomed and have a beneficial effect. This holds true
not only w i t h respect to the over-all examination, but w i t h respect to
the examination and appraisal of individual loans.
Bankers are businessmen, interested i n increasing their volume of
business and hence the volume of business i n their trade territories.
They are solicitous of the needs and welfare of small businesses as
well as large. I n actual practice, bankers spend more time and devote
more effort to the small-business man than they do to the large-business man, because the former is frequently getting started and needs
more financial help as well as more counsel i n getting his business
established. The large-business man has generally proven his abili t y and needs less guidance.
Examiners understand the bankers' point of view and recognize the
importance of developing small businesses to promote the national
economy and to develop the communities i n which the banks are located, just as f u l l y as the operating officers of the banks. Suggestions
and criticisms by examiners are made w i t h a view to helping the bankers better to perform their functions in their communities and not to
hinder them i n those efforts.
That more small businesses f a i l than large business establishments
cannot be attributed to bank examination policies. I t is our belief
that bank examinations have nq adverse effect on small businesses. On
the contrary, examiners, because of their observations of the experiences of many banks, are able to give helpful advice indirectly to smallbusiness men through bankers. Failures among small businesses are
attributable to many factors which bear no relationship to bank examinations. No bank examiner, whatever the examining authority under
which he serves, as far as we have observed i n our district, has criticized or discouraged loans to small businesses because of size of
business,
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C DEBT
Supplement for Eleventh Federal Reserve District
Dallas)
(R. R.
833
Gilbert,
I n the eleventh Federal Reserve district the Federal and State
supervisory and examining authorities have cooperated closely for the
purpose of coordinating their policies, standards, and practices to the
greatest extent practicable. I n fact, the Federal Reserve bank examiners conduct joint examinations of State member banks w i t h the
State examining authorities. I n addition, the Federal Reserve Bank
of Dallas has held an annual conference attended by supervisors and
examiners during each of the past several years for the purpose of
enabling the Federal and State supervisory and examining authorities to have the opportunity to discuss policies and practices toward
the end of achieving most satisfactory coordination. On the basis
of my observation and knowledge of practices i n effect i n this district,
I believe that such differences as may exist between the different
authorities are relatively minor i n importance. I am not aware of any
policies or practices relating to bank examination or supervision on
the part of any of the authorities that would have the effect of interfering w i t h the extension of adequate credit by banks to businesses
regardless of the size of the business unit.
Supplement for Twelfth Federal Reserve District (G. E. Earhart,
San Francisco)
Our experience in the t w e l f t h district supports the statements i n
the joint reply to question 36. However, we doubt that bank examinations i n this district have much more of an influence, so far as the
banking structure as a whole is concerned, upon loans to small businesses than to larger ones. W i t h the prevalence of branch banking,
approximately three-fourths of the loans of district banks are held by
the 15 largest banks (banks w i t h assets of $300,000,000 or more). As
a rule, the influence of examiners' comments is probably less i n the
larger banks. Moreover, the larger the bank, the higher is the minimum loan l i m i t below which examiners cannot feasibly check every
loan i n detail. Many small loans to small-business men, particularly
those which are i n the personal or installment loan categories, may not
be reviewed, unless they are past due.
While financial statements and other credit data of small businesses
tend to be less comprehensive than those of larger businesses from
the standpoint of the bank loaning officer and the bank examiner, small
business records have improved considerably i n recent years, in our
opinion. This is due i n part to the educational efforts of credit men
and their organizations, and i n part to the increasing necessity of
maintaining adequate records for tax purposes and i n order to comply
w i t h other Government regulations.
Certainly this bank's examiners do not discriminate against loans to
small businesses as such, nor are we aware of any discrimination in
terms of the size of the borrower on the part of examiners of other
supervisory agencies i n the twelfth district. A l l factors considered,
we doubt that bank examinations have a markedly greater influence
upon loans to small businesses than upon loans to larger concerns; in
any event, i t is our definite opinion that bank examinations do not
prevent small businesses from obtaining adequate bank credit i n the
t w e l f t h district.
9 8 4 5 4 — 5 2 — p t . 2—^—16
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I Ct ) E B T834
A P P E N D I X TO CHAPTER I V
Q U E S T I O N S ADDRESSED TO T H E P R E S I D E N T S OF T H E F E D E R A L RESERVE
BANKS
(The questions on this list, insofar as they refer to country-wide
practices and conditions, may be answered jointly by the presidents i f
they so prefer—each president, of course, adding such supplement or
dissent as he desires.)
A. O W N E R S H I P OF T H E FEDERAL RESERVE B A N K S A N D T H E I R R E L A T I O N S H I P
TO T H E GOVERNMENT
1. Describe the present arrangements w i t h respect to the ownership
of the stock of the Federal Reserve banks. What are the implications,
advantages, and disadvantages of this ownership as compared with
ownership by the Federal Government ?
2. Who, in your opinion, owns the surplus of the Federal Reserve
banks ?
3. Do you consider the Federal Reserve banks to be part of the
United States Government ? Part of the private economy ? I f neither,
or partly one and partly the other, discuss their status.
4. State the congressional policy directives applying to the Federal
Reserve banks, citing appropriate statutes. I n what respects, i f any,
do you believe that these directives should be altered?
B. ORGANIZATION OF T H E FEDERAL RESERVE B A N K S
5. Describe the roles of the presidents and the boards of directors of
the Federal Reserve banks and of the Board of Governors in the management of the Reserve banks.
6. State the qualifications required for election as class A and class B
directors of the Federal Reserve banks, and the method of electing such
directors. Include i n your description both qualifications and procedures prescribed by statute and those established by customary
usage, distinguishing between them when necessary.
7. Do you believe that all of the directors of the Federal Reserve
banks should be chosen as public representatives rather than as representatives of specified groups ? I f so, how should they be chosen ? I f
representation of specified groups is to be continued, do you believe
that labor should be added to the groups represented? I f so, how
should the labor representatives be chosen ?
C. D I S T R I B U T I O N W I T H I N T H E FEDERAL RESERVE SYSTEM OF A U T H O R I T Y ON
CREDIT POLICIES
8. Discuss the extent to which i t is possible to maintain regional
credit policies differing from national credit policies. Who is responsible for the formulation of such policies and what are the instrumentalities by which they can be maintained ?
9. Describe the role played by the boards of directors and the presidents of the Federal Reserve banks in the formulation of national
credit policy.
10. Trace the historical development of open-market operations
covering both their significance as instruments of monetary and credit
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C
t)EBT
835
policy, and the nature and composition of the bodies which have successively had control over them.
11. What is the rationale of the present assignment of authority
over open-market operations to a body other than the Board of Governors ? W h y should the allocation of responsibility for open-market
policy differ from the allocations w i t h respect to discount rates and
reserve requirements? Do you consider these differences desirable?
Why, or why not?
12. Can open-market policy, discount policy, and reserve requirement policy pursue different general objectives or should these various
instruments always be directed toward a common policy? When differences of viewpoint among the different policy-determining groups
must be compromised i n order to adopt a common policy, what are
the factors of strength and weakness i n the position of each of the
arties to the compromise—i. e., the Board of Governors, the Federal
SReserve Bank President Members of the Federal Open Market Committee, and the boards of directors of the Federal Reserve banks ?
D. GENERAL CREDIT AND MONETARY POLICIES
13. Analyze the effects of the rising yield upon short-term Governments between August 1950 and March 1951 from the standpoint of
(a) effect upon the volume of bank loans, (b) effect upon the level of
private interest rates and the differential between those rates and the
yield on Governments, (c) effect upon the market prices and the volume
of sales of long-term Governments, (d) effect upon the policy of the
Federal Reserve System to support the long-term Governments.
14. Describe the mechanism by which a general tightening or easing
of credit, and the changes i n interest rates which may result, is expected to counteract inflation or deflation. Discuss the impact on
borrowers and lenders i n both the short-term and long-term credit
markets and on spending and savings. Indicate the effect on each
of the broad categories of spending entering into gross national
product. What are the (actual or potential) capital losses or gains
that would be brought about by changes i n interest rates ? To what
extent is the effectiveness of a program of credit restraint affected by
or dependent upon expectations w i t h respect to subsequent changes i n
interest rates ? Distinguish i n your discussion between small changes
i n rates and large changes in rates.
15. How rapidly and to what extent would you expect the volume
of bank loans to respond to measures of general credit control under
present conditions ?
16. Compare the applicability of general credit and monetary
measures and the resultant increases in interest rates as a means of
restraining inflation (a) when the Treasury is not expected to be a
large borrower i n the foreseeable future, (b) when a large volume of
Treasury refunding operations w i l l have to be effected i n the foreseeable future, (c) when i t is expected that the Treasury w i l l be a
large net borrower during the foreseeable future, (d) under conditions
of total war.
17. To what extent is the demand for United States Government
and other high-grade, fixed-interest-bearing securities by nonbank
investors influenced by (a) the current level of interest rates, (b) ex-
M O N E T A R Y POLICY AND M A N A G E M E N T OF PUBLICt)EBT836
pectations w i t h respect to changes i n interest rates, (c) other factors?
18. What is the reason for the relatively slight use by commercial
banks of the Federal Eeserve discount and borrowing privilege? Do
you believe that greater reliance should be placed on this privilege as
a means of obtaining Federal Eeserve credit ? Under what conditions,
i f any, would you expect to see a greater use made of the discount
privilege?
19. Do you believe that there is any conflict between measures to
restrain excess demand by credit control and the need for expanding
the economy to meet the requirements of a continuing readiness to
resist aggression and a continuing high standard of living? I f so,
how can the effects of this conflict be mitigated ?
20. What do you believe to be the role of bank examination and
supervision i n furthering the objectives of the Employment Act?
21. What do you consider to be the role of selective regulation of
consumer credit i n restraining inflation under the conditions of each
of the assumptions w i t h respect to the magnitude of Government
borrowing stated i n question 16 ? What attention should be given by
the controlling authority to inventories and price and employment
changes i n the particular industries affected by the regulation ? Discuss the operation of regulation W since its revival i n the f a l l of 1950.
22. W h a t do you consider to be the role of selective regulation of
real-estate credit i n restraining inflation under the conditions of each
of the assumptions w i t h respect to the magnitude of Government
borrowing stated i n question 16 ? Discuss the operation of selective
regulation of real-estate credit during the past year.
23. What do you consider to be the role of selective regulation of
stock-market credit i n restraining inflation under the conditions of
each of the assumptions w i t h respect to the magnitude of Government
borrowing stated i n question 16 ?
24. What selective regulations, other than those over consumer
credit, real-estate credit, and stock-market credit do you consider to
be feasible ? What would be their applicability under the conditions
of each of the assumptions w i t h respect to the magnitude of Government borrowing stated i n question 16 ?
25. Explain and evaluate the Voluntary Credit Eestraint Program
which has been developed during the past year. What are the precautions taken to insure fair treatment of competing firms? What
do you consider to be the role of voluntary credit restraint under each
of the assumptions w i t h respect to the magnitude of Government borrowing stated i n question 16 ?
26. Discuss the use of moral suasion as a tool of credit control.
H o w has this been used i n the cases of member banks and of savings
institutions, including life insurance companies ?
27. What is the function of bank reserves? What are present
reserve requirements w i t h respect to banks ?
28. Should nonmember banks be required to maintain the same
reserves as member banks ? Why, or why not ?
29. Discuss the advantages and disadvantages of basing reserve
requirements on types of deposits irrespective of the geographical
location of banks.
30. Discuss the advantages and disadvantages of requiring additional reserves which might be held i n whole or i n part i n the form of
Government securities. Illustrate with a specific plan or plans.
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C
t)EBT
837
31. Discuss the advantages and disadvantages of requiring during
the national defense emergency a supplementary reserve to be maintained against increases in either loans and investments or deposits.
Illustrate w i t h a specific plan or plans.
32. Discuss the advantages and disadvantages generally of maintaining bank reserves against classes of assets rather than against
classes of liabilities as at present.
33. State the statutory authority for the power, i f any, of the Board
of Governors, the Federal Reserve banks, or of any agency of the
United States Government to control directly or to "ration" the extension of credit by individual banks. Specify the (legal) circumstances under which such rationing could occur and the control of the
president over its operation. Under what (economic) circumstances,
i f any, would you recommend the use of credit rationing? Describe
the manner i n which you believe that such a system would operate.
E. T H E B A N K I N G STRUCTURE
34. W i l l you please submit a memorandum discussing the adequacy
of banking facilities i n your district ? For this purpose, take as your
standard of adequacy the ideal of bringing banking facilities w i t h i n
convenient reach of all persons having need of them, and, so far as
practicable, giving all persons the opportunity of choosing between
two or more competing banks. Distinguish between deposit facilities
and loan facilities.
F . A V A I L A B I L I T Y OF C A P I T A L FOR S M A L L BUSINESS
35. On the basis of information available about your district, discuss
the changes which have occurred during the last 25 years i n the ease
or difficulty w i t h which small-business men have been able to raise
capital or to borrow. What in your opinion are the reasons for such
changes as you find to have occurred? Do you believe that a more
liberal supply of capital and credit to small business would contribute
to the diffusion of economic power and to the dynamic character of
the economy? What steps could be taken to bring about a more
liberal supply of capital and credit to small business ? Do you believe
that any of these steps would be desirable? Distinguish between the
longer-term aspects of the problem and those of particular importance
today during the current national defense emergency.
36. Discuss the effects of bank examinations on the lending policies •
of banks i n your district, particularly as they apply to loans to smallbusiness men. Distinguish i f necessary between examinations by
different examining authorities.
LETTER
F R O M T H E DIRECTORS OF T H E
OF B O S T O N
F E D E R A L RESERVE
BANK
I n addition to the general statements and answers to particular
questions by the Presidents of the Reserve banks, the Subcommittee
received the following communication, w i t h enclosure, signed by all
MONETARY POLICY AND MANAGEMENT OF PUBLICt)EBT838
of the members of the board of directors of the Federal Reserve Bank
of Boston:
BOSTON, MASS., December
IS,
1951.
To the Members of the Subcommittee on General Credit Control and Debt Management of the Joint Committee on the Economic Report, Washington, D. C.
GENTLEMEN: The individuals whose names appear below as signers of this
letter are a l l Directors of the Federal Reserve Bank of Boston. I n our capacity
as Directors we n a t u r a l l y have a v i t a l interest i n the forthcoming hearings
before your Committee.
I t is our hope t h a t the answers w h i c h you receive to the questionnaires w h i c h
your Committee has addressed to various groups w i l l prove of value i n the
adoption of sound measures f o r general credit control and debt management.
I t is possible t h a t the findings of your Committee w i l l recommend some changes
i n existing procedures i n connection w i t h those problems. For example, we
hope that greater, rather t h a n lesser, responsibilities may be given to the individual Boards of Directors and that System policy matters may be settled only
after some f o r m of consultation w i t h those Boards. Since the men picked as
Directors of the Federal Reserve Banks t r u l y represent the business and banking
judgment of their districts, i t would seem that their views should have real
value both to the B o a r d and to Congress which is the final control of the System's
functions.
Although we as i n d i v i d u a l Directors were not asked to submit answers to a
questionnaire, we should appreciate the opportunity to be recorded on one
fundamental point which we feel lies at the heart of any investigation such as
that which you are conducting. I t is our strong and unanimous feeling that
one of the chief essentials of a sound economy is the continued independence of
the Federal Reserve System, which i n our judgment should be free of domination
by the Executive, the Treasury, or any branch of Government other than the
Congress which created the System.
I n connection w i t h this matter of System independence we are t a k i n g the
liberty of submitting for your consideration the enclosed paper w h i c h we believe
bears directly upon the matters subject to your scrutiny. I t was w r i t t e n origi n a l l y by M r . L. Sumner Pruyne, Vice President of The F i r s t N a t i o n a l Bank of
Boston, f o r presentation to a private organization of w h i c h he is a member.
I t represents his personal views; i t was not w r i t t e n w i t h the thought of being
presented to your Committee; and no effort has been made on the p a r t of any
of the undersigned to influence or to change the views as originally expressed
by the w r i t e r .
When this paper came to our attention, i t appealed to us f o r presentation to
your Committee as pertinent background f o r the study w h i c h you are conducting. The paper outlines i n general terms w h a t has happened to our money
supply i n the years 1940 to 1950, inclusive, but i t lays chief emphasis on the
opportunities w h i c h were missed to reduce t h a t money supply, and thereby to
reduce the inflationary dangers, i n the postwar years 1946 to 1950, inclusive.
Some of us doubtless might have expressed the thoughts of this paper somew h a t differently, and some of us may feel t h a t the w r i t e r ' s criticism of the
activities of the Federal Reserve System i n the years 1946 to 1949, inclusive,
was perhaps not entirely justified. However, i n spite of these more minor
reservations as to details and as to emphasis, we are i n agreement on one point.
We believe t h a t the paper as a whole represents a f a i r and a clear sketch of
what happened i n the period i n question; t h a t i t points up the dangers inherent
i n our present situation resulting f r o m the huge increase i n our money supply
d u r i n g the w a r years and our f a i l u r e to reduce that supply i n the postwar years;
and t h a t above a l l i t emphasizes i n our minds the necessity of maintaining the
independence of a Federal Reserve System which can be free to p e r f o r m its
function of contracting credit i n the face of these inflationary dangers.
Very t r u l y yours,
FREDERICK S B L A C K A L L , J r .
LLOYD D . BRACE.
RUSSELL H . BRITTON.
K A R L T . COMPTON.
HAROLD D . HODGKINSON.
HARVEY P . HOOD.
ROY L . P A T R I C K .
EARLE W . STAMM.
A M E S STEVBNS.
MONETARY
POLICY AND
MANAGEMENT
OF PUBLIC
t)EBT
839
ENCLOSURE ACCOMPANYING LETTER
Each of us know i n a general way what inflation is and each of us is all too
conscious of the impact of inflation on our daily living. We may all feel poor
in terms of the purchasing power of our dollars, but we are conscious that there
has been a marked increase in the money supply of the country i n the past
decade. Had this increase been advertised as due to the unrestrained printing
of dollar bills by our Government, i t would be easily understandable. The increase, however, took place largely in the field of bank deposits, and since this
method of inflating the supply of money is more roundabout and less noticeable,
the means by which i t comes to pass are f a r less generally understood. To the
extent that this study adds to an understanding of what lies behind the ballooning of our money supply in the past 10 or 12 years, i t w i l l accomplish its purpose.
Inflation has been rather inelegantly described as "too many dollars chasing
too few goods." This phrase immediately indicates that there are two components involved in inflation: namely, money and goods. However, for the
purpose of this discussion we shall make only the briefest mention of the
second component by assuming that a shortage of goods was not, and is not, the
primary cause of our present inflationary dangers.
I t is perfectly true that we have had shortages of particular items at particular
times in the recent past. During the war, for example, we obviously could not
have an adequate supply of tanks simultaneously w i t h a normal supply of automobiles. Furthermore, i n the first few years after the war the factories of the
country could not suddenly supply both the normal civilian demand and the
abnormal demand resulting from wartime shortages. However, i n spite of these
particular periods when certain items were limited, there were relatively few
actual necessities of life missing from our daily living, certainly i n contrast
w i t h the rest of the world. Actually, except for a short period during the war
itself, the supply of civilian goods has been far above prewar levels. We learned,
in other words, the tremendous productive capacity of this Nation, its ability
to t u r n out both guns and butter, and its resiliency to very great obstacles. Because of our productive capacity shortages of goods have been, and seemingly w i l l
be, only temporary. On this basis the assumption appears justified that inflation in this country is far less the result of shortages of goods than the result of
an excess money supply.
When we focus our attention on the money supply, we are immediately confronted w i t h a realization that there are primarily two forms of money: currency and bank deposits. I t is true that money in circulation between the end
of 1939 and the end of 1945 quadrupled from $6 billion to $26 billion. However,
this increase cannot be regarded as too surprising in view of the intense business activity during that period, greatly increased employment, higher wages,
and higher prices. Large as was the rise i n currency i n circulation, i t was
almost dwarfed by the rise in bank deposits during that same 6-year period,
such deposits having almost tripled from $58 billion to $150 billion, for the staggering increase of $92 billion.
Up to this point we have narrowed down our line of thought from an over-all
discussion of inflation to a concentration on the increase in the money supply
and have moved from that to a further concentration on the increase i n bank
deposits. From here on the going w i l l become more rough due to the unfortunate
fact that any discussion of bank deposits requires an understanding of how the
banking system functions in the creation of deposits and particularly of the role
of the Federal Reserve banks in the over-all picture. Thus some of the succeeding discussion w i l l be of a technical nature, even though every effort w i l l be made
to phrase the discussion in language reasonably familiar to the layman.
To understand the "why" and the "how" of a change in the deposits of commercial banks, i t is necessary to go back to our college economics for a review
of the factors which cause such deposit changes. There are five major factors
which individually or collectively w i l l always be found to be primarily responsible
for any marked increase in commercial bank deposits. Each of these w i l l be
described briefly, though not necessarily in the order of their respective importance.
The first factor might be described as an inflow of gold to this country. I r respective of who the seller may be, the Government w i l l pay for the gold by
the issuance of a check to the order of the importer and when the importer
deposits that check in his own bank, the deposits of the banking system automatically are increased.
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The second factor tending to increase bank deposits is found i n a reduction of
actual currency. We previously noted that money takes the form either of
currency or of bank deposits, and since they are interchangeable, a reduction i n
currency automatically increases deposits. For example, at the end of the
Christmas season a department store w i l l find itself holding much more actual
currency than i t needs for its normal operations. When i t returns the excess
currency to its bank, its account at the bank goes up and the deposits of the
banking system have been increased by that amount.
The t h i r d factor increasing deposits of the commercial banking system is
found i n an increase of loans made by those banks. For example, the X Y Z
Corp. borrows $1,000,000 from Bank A and receives the amount of the loan in
the form of a deposit credit on the books of Bank A. Deposits have been increased $1,000,000. Even though the borrowing corporation may draw the
money out of Bank A immediately by issuing 10 checks of $100,000 each, those
checks i n t u r n may be redeposited by the recipients in 10 different banks, perhaps
located in different sections of the country. The fact remains, however, that the
original increase i n the deposits of the banking system is not extinguished u n t i l
the loan is repaid.
The fourth factor of increase is similar to the third. For the commercial bank
described as Bank A, instead of making a loan, purchases securities. For example, Bank A may buy Government bonds directly from the Government or from
one of its customers. I n either case i t pays for the bonds by crediting the seller
on the books of the bank, thereby increasing deposits. Again the seller—whether
i t be the Government, an individual, or a corporation—can check this deposit
out of Bank A, but i t w i l l reappear i n some other bank i n the system and w i l l
not be lost as an increase i n the total deposits of the system u n t i l Bank A or some
otter bank sells an equivalent amount of securities.
The fifth factor of deposit increase results from a purchase of securities by
the Federal Reserve Banks. Assume, f o r example, that the Federal Reserve,
through a dealer as an intermediary, buys $1,000,000 of Government bonds from
the ABC Insurance Co. The minute the insurance company deposits that money
i n Bank A or i n any other bank, deposits are increased correspondingly.
Having outlined the five major factors resulting i n deposit increase, i t is now
necessary to note a highly important distinction between the potential effect of
the fourth factor, i n which Bank A (i. e., the commercial banking system) purchased the securities, and the fifth factor, i n which the Federal Reserve Bank
was the purchaser. I f the purchase i n each case was $1,000,000, the actual i n i t i a l
increase i n deposits was $1,000,000, whether Bank A made the purchase or
whether i t was made by the Federal Reserve Banks. The potential effect, however, was very different.
The difference arises from the requirement that the commercial banks carry
w i t h the Federal Reserve Banks a reserve amounting to approximately 20 percent of deposits. Because of this reserve requirement, the commercial bank
described as Bank A actually would have been unable either to make a loan or
to buy securities i n an amount which would raise its deposits $1,000,000 unless
i t already had excess reserves at the Federal Reserve Bank i n an amount at
least $200,000 greater than its actual reserve requirements on the date of the
purchase. Assume, however, that the Federal Reserve Bank buys $1,000,000
of securities from a customer of Bank A. I n this case we have already seen
that the deposits of Bank A rise by $1,000,000. The more important significance,
however, of this latter transaction is the fact that when the customer deposits
i n Bank A the check on the Federal Reserve Bank, the reserves of Bank A at the
Federal are increased $1,000,000. W i t h its reserves at the Federal thus up by
$1,000,000, Bank A is potentially i n a position to make loans or to purchase
securities in amounts which w i l l result i n a total increase of deposits of $5,000,000. This is because its excess reserves at the Federal potentially can become
required reserves when needed and $1,000,000 excess reserves at the 20-percent
rate thus w i l l support a $5,000,000 increase i n deposits.
Because this distinction between the activity of Bank A (the commercial
banking system) and the activity of the Federal Reserve System is as important as i t may seem complicated, perhaps i t can be restated and summarized as
follows: On the i n i t i a l transaction a purchase of securities either by Bank A
or by the Federal Reserve is equally effective in raising deposits by the amount
of the purchase. Potentially, however, a purchase by the Federal Reserve is
five times as effective as a purchase by Bank A since the purchase by the Federal
Reserve creates excess reserves, the ultimate use of which w i l l lead to an in-
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crease in deposits five times as great as that which results when Bank A is the
purchaser.
W i t h this necessary background behind us, we can now return to our original
study of how and why the money supply as represented primarily by bank deposits has risen so drastically i n recent years. For tt^e sake of clarity the
time since the beginning of World War I I w i l l be divided into two periods. The
first period is one of 6 years, beginning at the end of 1939, when we were first
conscious of the necessity of rearming, and ending at the close of 1945 shortly
after the end of the World War. The second period is represented by the first
five postwar years beginning at the close of 1945 and ending at the close of 1950.
For any periods of this length and for any subject as complicated as that of
the money supply, one has to choose between brevity and clarity on one hand
and detailed discussion of all factors concerned on the other hand. I n what is
to follow we shall pursue the former course and attempt to h i t only the major
high spots of what has happened. We admit i n all frankness that by so doing
the discussion w i l l seem to ignore some of the more minor factors which had a
bearing on this problem and w i l l also seem to ignore shorter-term periods w i t h i n
the f u l l 11 years when trends were somewhat divergent from the main trend
which we shall follow.
First let us look at the 6-year period from the end of 1939 to the end of 1945,
which we shall refer to as the Wartime Period. During those 6 years the fact
of major interest to us is t h i s : The supply of money as represented by total
deposits plus currency i n circulation practically tripled from $64 billion to
$176 billion, a staggering increase of $112 billion. As previously mentioned, a
relatively small part of this was represented by an increase i n currency. By
f a r the largest part, however, represented an increase in bank deposits. This
increase i n bank deposits, in turn, was caused primarily by an increase of $105
billion i n the holdings of Government bonds by the banking system.
The background of this terrific increase i n bank-held Government debt is not
difficult to discern. We had a tremendously costly war to finance, so costly i n
fact that i t obviously could not be financed as a practical matter out of current taxation but had to the financed i n part by borrowing. .Everyone connected w i t h the financing effort recognized that as much of the borrowing as
possible should be accomplished through sales to individuals and institutions
outside the banking system i n order to avoid the inflationary dangers of a drastic deposit increase. A l l of us well remember the strenuous efforts made to
sell bonds to the public and to nonbanking institutions. I n spite of those efforts
more bonds had to be sold than could or would be absorbed in the nonbank field.
The balance or residue of the financing necessarily had to be placed w i t h the
banks.
Remembering our previous discussion of bank reserve requirements, the commercial banks could only buy i f they had access to increased reserves. Those reserves could only be supplied by the Federal Reserve Banks themselves, and
they were supplied through Federal Reserve purchases of part of the Government security offerings. I n view of our previous discussion i t is interesting to
find that the actual figures for this Wartime Period bear out the technique previously described. The Federal Reserve Banks absorbed approximately 20 percent of the residual financing, or $22 billion. Their purchases and the reserves
which were created thereby allowed the private banking system to absorb the
other 80 percent of the residual financing, or approximately $83 billion.
From the standpoint of our postwar and future economy, we well might wish
that i t had not been necessary to finance as much of the wartime borrowing
through the banking system as was actually the case. However, i t probably
would be difficult and unfair to assign the blame for what happened to any one
individual or group other than possibly Mr. Hitler. The main job was to w i n
the war and to the extent that money to finance i t was not available, i t was
necessary to manufacture it, not i n this case by the printing of currency but
by the printing of bonds. Tax rates were relatively high and there was a natural
and general reluctance to raise them further. Individuals as a class subscribed
to the bonds i n relatively heavy amounts both directly and through savings
banks and insurance companies. Whether they saved and subscribed to the
fullest extent possible probably varies greatly i n the case of one individual or
another, but we do know that i t was a period during which individual saving
was necessarily diminished by high taxation. The subscriptions of the commercial banks and of the Federal Reserve Banks were necessarily as large as,
but limited to, the amount of financing which could not be absorbed by other
investors.
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I t would be difficult to be dogmatic about the role of the Government during
this period of wartime financing. Considering the fact that the Government
debt during the 6 years i n question increased by a total of $231 billion, any fair
observer should give the Treasury Department and the Federal Reserve Banks
distinct commendation for an adroit job of raising this colossal sum of money.
The adroitness and their technique are particularly noteworthy when one
remembers that, during the raising of this money, rates on Government securities
were not allowed to rise from the time the wartime pattern of rates was set in
early 1942 to the end of the period i n 1945. The free-spending and easy-money
proclivities of the administration prior to the war may have had something
to do w i t h a reluctance on the part of some investors to subscribe for their
f u l l quota of securities, and the burden of debt and taxation which had been
built up i n the prewar years did not add to the ease of financing the war
itself. On balance, however, the Government should be given all due credit
both for raising the money and for their efforts to place i t outside the banking
system. Furthermore, although the yields afforded by the securities offered
during the war were relatively meager, especially after the impact of taxation,
the future interest burden of the Government was reduced thereby and i t is
questionable whether a much larger proportion of the financing would have found
its way into nonbank hands had interest rates at that time been slightly higher.
Having completed our study of what happened during the Wartime Period,
i t is interesting to visualize the situation and the problem which, at the end
of 1945, faced those charged w i t h the management of our debt and of our fiscal
affairs. Included i n that latter group are particularly the Executive Department,
the Treasury Department, Congress, and the Federal Reserve System. Any
student of our economy could hardly f a i l to be impressed w i t h the dangers
inherent i n a money supply which had practically tripled over a 6-year period as
a result of the staggering increase in that supply of $112 billion. Furthermore,
he could know w i t h certainty that, unless drastic measures were taken to offset
it, the money supply would be automatically increased by a rise in loans necessary
to finance the resumption and enlargement of our productive facilities i n order
to make up for all of the shortages of goods created by the waste of war. Even
though we are looking at this problem w i t h the benefit of hindsight, i t seems
rather obvious that certain steps were absolutely requisite i n attacking this problem. These would include immediate and continuing curtailment of unnecessary Government expenditures; a continuation of relatively high rates of taxation ; a consequent budget surplus which would allow some reduction of Government debt to decrease, at least in part, the money supply in a manner converse to
the manner in which it was increased; a willingness to see interest rates rise
by an amount necessary to attract individuals and nonbanking institutions to
purchase Government securities held by the banks; a policy on the part of the
Federal Reserve System to restrict and to contract credit to the greatest extent
possible without interfering w i t h the creation of legitimate credit for productive
purposes.
I f these were logical objectives for the Postwar Period, we are justified in
critically examining the years after the war and i n using as our criterion of
success or failure the extent to which these objectives were reached. Unfortunately, the picture which we find is not a happy one and if the Wartime Period
could be characterized as one of "necessary evils," the Postwar Period probably
should be characterized as one of "missed opportunities."
One of the objectives on which special stress was laid was a reduction of the
supply of money as represented by total deposits plus currency. I f we describe
as the Postwar Period the 5 years between the end of 1945 and the end of 1950,
i t is discouraging i n the extreme to find that the money supply not only did
not decrease at all but actually increased $4 billion. Incidentally, it should be
remembered that this particular 5-year period includes only 6 months of the
Korean War and that, although the so-called cold war had started earlier, the
5 years in question were essentially years of peace
Considering the objectives which seemed so logical for our money managers
to consider and to stress at the end of 1945, i t seems almost incredible that no
progress was made i n reducing the money supply during the next 5 years. To
seek the causes for this failure within the framework of both brevity and clarity,
again i t is necessary to concentrate entirely on the major highlights in analyzing
the happenings of that period. The two chief factors affecting the money supply
in those 5 years were represented by an incerase of loans of approximately $30
billion and a decrease of outstanding Government debt of $22 billion. Because
of the importance of these two factors, each of them w i l l be discussed briefly.
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Since the increase of loans obviously tended to hold up the total supply of
money, i t would be only natural to ask i f this loan expansion were not inflationary. Logical as the question is, i t cannot be answered categorically. The reason
is t h i s : The loans created deposits, or money, and to that extent they were inflationary.
On the other hand, there is little question but that the great bulk
of those loans were for the primary purpose of rehabilitating on enlarging our
Nation's facilities for the production and distribution of goods, and to this extent
they were antiinflationary. I t would be useless to argue and impossible to prove
the net effect of this loan increase as far as the single issue of inflation is concerned. I t is probably safe to assume, however, that on balance the largest
part of the loan increase was both desirable and almost necessary for the particular period in question.
I n view of this necessary and large expansion of loans, i t was indeed fortunate
that a large part of the deposit increase reulting from the loan expansion could
be offset during the same period by a reduction of $22 billion i n the Government, debt. Unfortunately, however, the Government cannot be given credit for
any part of that debt reduction because of one very large joker i n the situation.
I n December 1945, just before the start of this Postwar Period, the Government
borrowed about $23% billion at the time of what was called the Victory Loan
Drive. Since the war was over at that time, there has always been a question as to why the Government thought i t needed to borrow such a colossal sum,
but at least the financing was successful i n the sense of placing a large amount
of the debt outside of the banking system.
As a result of this financing the General Fund balance of the Treasury Department at the start of the Postwar Period on January 1, 1946, was over $26 billion, or perhaps $22 billion i n excess of normal cash requirements. I t became
evident quite soon that they had overborrowed in excess of their actual needs
by roughly that amount, and they started quite promptly to pay off debt. What
this joker really indicates is that i n the first five postwar years the Government
simply reduced its debt by the amount of its overborrowing i n December 1945.
Or to put i t another way, there was no real reduction i n debt during the entire
5-year period.
Here again the reason is not hard to find because in those particular five
calendar years the Government had a budget surplus of only about $1 billion. To
call this a "missed opportunity" of the first magnitude would be to put i t mildly
in view of the high state of business activity during this particular 5-year period.
The administration, for example, has always been more than willing to endorse
the philosophy of Lord Keynes that governments are justified i n operating at
deficits for the sake of stimulating the economy during a period of depression.
However, during this period of prosperity they showed all too clearly how difficult i t is for a free-spending administration to follow that part of the Keynes
philosophy which recommends the building of government surpluses during periods of high business activity. While giving lip service to economy and while
urging a higher level of taxes than Congress was willing to vote, the administration provided the poorest possible leadership in any real move to combat inflation
by its unwillingness to cut nonessential spending and by its almost eager willingness to be found on the side of higher wages and higher farm prices. Congress
also must accept its proper share of the blame during this same period for not
insisting on the budget cuts about which so much was said and written but
toward the achievement of which so little was done. I t can also be charged
w i t h the failure to keep taxes high enough to provide a real budget surplus each
year. Here again, however, Congress well knew that the voters and taxpayers
would both resent and resist increased taxes at a time when the administrative
leadership was making no real effort to control or to reduce the terrific cost of
Government operations.
I f we return to the list of logical objectives which the money managers might
have set as their goal at the end of the war, we w i l l recall that one of those objectives was to reduce the money supply by transferring debt from the hands of
the commercial banking system to the hands of individuals and other institutions.
I n other words, even if total debt were not really reduced, can we not at least
hope to find that its ownership has been transferred to less inflationary hands?
Remembering that the total debt during this postwar period was reduced $22
billion, we are at first pleased to find that holdings of Government securities by
commercial banks and by the Federal Reserve banks declined during these 5
years by almost $32 billion. Thus at first blush i t would appear that the Treasury Department had been able to effect a $10 billion transfer i n ownership by the
sale of securities to nonbank investors.
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Immediately, however, we are confronted w i t h another joker which is all too
l i t t l e understood by citizens generally. Each year the Government collects i n
special taxes, particularly the Social Security Tax, substantial sums of money
aggregating between $3 and $4 billion. These taxes are invested i n Government
bonds by the administrators of the various funds i n question and the bonds
are held against the future liabilities of the Social Security and other programs.
During the first five postwar years the investment of those various funds i n
Government bonds rose by $12 billion. Thus $12 billion of Government debt
found its way through the involuntary method of taxation into the portfolio
of these Government agencies, and we have already found that $22 billion of
debt was retired by the proceeds of overborrowing i n 1945. Since this total of
$34 billion is i n excess of the actual $32 billion reduction i n Government securities held by the banking system, i t is obvious that on balance the Treasury
Department was not able to persuade individuals and nonbanking institutions
to add a single bond to their holdings during the 5 years i n question. I n fact,
there was a net reduction i n such nonbank holdings during that period.
I f we are justified in looking upon this record as another "missed opportunity," we are also justified i n seeking the reasons therefor. Chief among
these appears to have been the reluctance of the Treasury Department during
practically a l l of this period to depart f r o m its almost stubborn fondness for
very easy money and low rates on its security offerings. Any official of the
Treasury Department can be pardoned for a natural tendency to wish to keep
down the cost of debt service. However, the colossal rise in our money supply
during the war obviously had placed a powder keg of potential inflationary dynamite under our whole economy. Under such circumstances i t would have seemed
that inflation was a considerably greater danger than a modest rise i n the cost
of borrowing. The logic of this statement becomes apparent when one considers the following three points:
(1) Any increase i n interest cost would apply not to the total debt but
only to that portion which is refunded at maturity or bv exchange offers.
(2) The Treasury Department would automatically recapture a substant i a l part of any increased interest costs through taxes levied on the income of holders of these securities.
(3) The Government is the world's largest single buyer and consumer
of goods and services. The easy money policy of the Treasury Department
following the war tended substantially to "freeze i n " the inflationary potentials which resulted from the war. Thus the Government's own policies
may well have raised the cost of everything which the Government buys
by amounts f a r i n excess of the relatively modest net cost of higher interest
on its securities.
Not only did the Treasury keep rates low, but i t insisted on confining practically all of its offerings to short maturities. For a period of 4 years—from
the end of December 1945 to December 1949—the Treasury offered to the public
no securities w i t h a maturity of over 18 months, other than savings bonds and
savings notes. Even as late as December 1949, when the potential demand for
long-term securities by nonbank investors was indicated by a price of 103%
on the long-term 2y2 percent bond, the Treasury Department, instead of
meeting that demand, offered a 4%-year 1% percent note of obviously no interest
to long-term buyers. Thus its choice of maturities served to complement its
easy-money policy i n failing to attract buyers outside of the banking system.
I n earlier sections of this study we noted the potentially sharp impact which
open-market purchases and sales of securities by the Federal Reserve System
could have upon the money supply. I t therefore becomes pertinent to examine
the role played by the Federal Reserve i n these first five postwar years. Their
operations admittedly are influenced and complicated by varying, and at times
conflicting objectives. For example, i t should be granted that the size of their
holdings was at times influenced by changes i n the rates of reserves which the
commercial banks were required to hold against deposits. During this period the
Federal Reserve System also had to consider the desirability of creating credit
conditions which would make i t possible for industry to expand its productive
facilities.
However, one would have thought i t logical for the Federal Reserve System
to consider inflation as Public Enemy No. 1 and to take as its primary objective
the reduction of the money supply at the end of the war. I n the light of that
objective i t is probably not unfair to determine what contribution, i f any, the
Reserve System made toward the attainment of that objective. We have
previously found that the total debt of the Government was reduced $22 billion
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and that an additional $12 billion of the debt was transferred to the ownership
of the various Government agencies. I f this total of $34 billion could have been
applied to the reduction of debt held by the banking system, we would normally
expect to find the holdings of the Federal Reserve Banks reduced at least by
20 percent thereof, or by $6.8 billion. Instead of that we find that the holdings
of the Federal Reserve System in the first five postwar years were reduced by
only $3% billion. Thus, even making allowance for some necessity of creating
an atmosphere favorable to productive loans, i t seems evident that the Federal
Reserve System can also be charged w i t h a "missed opportunity" through its
failure to contribute to the reduction of the money supply.
This failure on the part of the Federal Reserve System is attributable to the
one basic fact that the open-market operations of the Reserve System during
most of the 5 years in question were geared to the preservation of the easymoney rates favored by the Treasury Department. I t has already been pointed
out that during the war the Federal Reserve and the Treasury worked closely i n
cooperation w i t h the result that the colossal amount of wartime financing was
handled w i t h remarkable smoothness and at a remarkably low rate of interest.
There is good evidence to indicate that at least some prominent officials of the
Federal Reserve were not equally enthusiastic about the easy-money policy
favored by the Treasury Department after the war.
Despite their reluctance, however, the actual open-market operations of the
Reserve System u n t i l the latter part of 1950 were handled i n such a way as to
support prices of Government securities at levels designed to facilitate continued Treasury offerings at low rates i n spite of the inflationary implications.
For example, between November 1947 and November 1948 the Federal Reserve
Banks purchased approximately $7 billion of long-term Government bonds to
prevent those issues from selling below par. I n justification for this action the
fact is sometimes cited that total holdings of the Reserve System went up i n
that 1-year period by only $1 billion. This seeming inconsistency is explained
by the fact that the Treasury had a very substantial cash surplus during that
particular period. Had there been agreement that the fight against inflation was
the No. 1 objective, the cash surplus could and should have been -used to reduce
debt held by the banking system and consequently to reduce the money supply.
Instead of that, the Federal Reserve operation of supporting the Government
bond market i n effect practically used up and wasted the anti-inflationary ammunition which was available.
The illogical nature of the Federal Reserve operations during the Postwar
Period becomes evident i f we look at the primary function which has been
delegated to the Reserve System. This primary function is "to regulate the
supply, availability, and cost of money w i t h a view to contributing to the
maintenance of a high level of employment, stable values, and a rising standard
of living." Thus there seems little question that the proper function of the
Federal Reserve i n a period of inflationary pressures was to reduce the supply
of money by reducing its holdings of Government securities.
Contrast that normal and orthodox functioning of the Federal Reserve System w i t h what actually happens under a policy whereby the Federal supports
Government bonds at fixed prices. Under a fixed support policy the Federal
Reserve not only becomes a buyer on balance, instead of a seller, but loses all
initiative as to the amount of securities which i t has to purchase. I n order to
protect a fixed price level, i t must purchase f r o m all holders of Government
bonds irrespective of the use to which the proceeds are to be put. I t no longer
becomes a central bank for bankers but a residual buyer from bondholders generally, w i t h the decision as to whether the Federal w i l l buy and how much i t w i l l
buy resting not w i t h the Federal but w i t h the individual and institutional bondholders. Instead of contracting the money supply, this central bank under a
policy of fixed price support becomes potentially the most powerful factor in
increasing the supply of money.
Fortunately, the completely illogical position i n which the Federal Reserve
System found itself came, i n the latter part of 1949, under the scrutiny of a
subcommittee of Congress under the able chairmanship of Senator Paul Douglas,
of Illinois. I n January 1950 this subcommittee released a report pointing out
that the vigorous use of a restrictive monetary policy as an anti-inflationary
measure had been inhibited since the war by the policy of supporting the prices
of Government securities. The committee i n effect recommended restoring
to the Federal Reserve freedom to restrict credit as an important contribution
to the fight against inflation. I t was recognized that such credit restriction
might well involve a higher level of interest rates, some increase i n the cost of
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servicing the Government debt, and a possible abandonment of Federal Reserve
support of Government bonds at fixed prices. The recommendations of the subcommittee were never actually acted upon by Congress, but they undoubtedly
helped materially to strengthen the backbone of the Federal Reserve officials in
their continuing controversy w i t h the officials of the Treasury Department on
this v i t a l subject.
Finally, i n March 1951, announcement was made of an "accord" which had been
reached between the Federal Reserve and the Treasury Department concerning
the terms of a new bond issue carrying a higher rate than any which had been
offered since the beginning of the war. There is nothing on the record to
indicate whether the "accord" included a willingness on the part of the
Treasury Department to allow outstanding long-term bonds to sell at prices below
par. The fact remains that within a relatively short time of the announcement
just mentioned long-term Government bonds actually were allowed by the
Federal Reserve to fall below par for the first time in a decade. Thus this
particular phase of our study ends on a somewhat happier note than the other
phases. I n the 5 years ending w i t h the close of 1950, the Federal Reserve System
could be cited w i t h other agencies of Government for their failure to attack the
swollen money supply. Shortly thereafter, however, the Reserve System regained
its independence from the Treasury Department, and we can hope that i t will
continue to retain and to exercise that independence in the fight against inflation
and in the maintenance of a more stable economy.
Our study may be summed up briefly w i t h a look to the future. During the
Wartime Period our money supply was increased to a tremendous figure and no
progress was made in reducing that supply i n the first five postwar years.
I n looking at the pessimistic side of the future outlook, we find an administration which as yet has given no evidence of any constructive leadership toward
economy in even the nonessential items of Government operations. Most Members
of Congress appear interested in cutting expenses or in keeping taxes at realistic
levels only i f those economies and those taxes can be devised i n a manner to
h u r t their particular constituents the least. There likewise remains the suspicion
that the Treasury Department is less interested i n the battle against inflation
than in the maintenance of relatively easy money rates. Naturally, the most
pessimistic factor of all is the international situation as exemplified by the attitude of Russia. One might not be accused of being too cynical i f he suspected
that the Russian leaders hope by their series of warlike maneuvers and incidents
to do more harm to this country by fostering further inflation here than they
might be able to do by force of arms.
On the more optimistic side of the future outlook we can cite the regained
independence of the Federal Reserve System and particularly the tremendous
productive capacity of our country. There is a third factor which potentially
could exert a powerful influence toward high-level decisions which would put
us back on the road toward a real and sustained attack on the basic causes of
inflation. This factor would be found in a broadened understanding by the
public generally of what has really happened to our money supply, the reasons
behind it, and the cures for it. To'tbe extent that this study makes any contribution to that understanding, i t w i l l have fulfilled its purpose.
OCTOBER 1 9 5 1
L . SUMNER PRUYNE.
CHAPTER V
R E P L Y
B Y
( L E O N
R O Y
H.
T H E
C O U N C I L
K E Y S E R L I N G ,
O F
E C O N O M I C
C H A I R M A N ;
J O H N
A D V I S E R S
D.
CLARK,
1
B L O U G H )
A.
CONGRESSIONAL P O L I C Y
DIRECTIVES
1. Do you believe that the congressional declaration of policy contained i n the Employment Act of 1946 is balanced i n its emphasis
upon high-level employment and upon price stability respectively, as objectives of Federal Government policy? I f not, what
changes have you to suggest?
Two passages in the Employment Act of 1946 give the documentary
basis for commenting on this question. The act declares that i t is
the "continuing policy and responsibility of the Federal Government"
to create and maintain " i n a manner calculated to foster and promote
free competitive enterprise and the general welfare, conditions under
which there w i l l be afforded useful employment opportunities, including self-employment, for those able, willing, and seeking to work, and
to promote maximum employment, production, and purchasing
power." A t another point the act states that i t shall be the duty of
the Council of Economic Advisers "to develop and recommend to the
President national economic policies to foster and promote free competitive enterprise, to avoid economic fluctuations or to diminish the
effect thereof, and to maintain employment, production, and purchasing power."
The emphasis in the act upon the objective of high-level employment is clear. The Council is of the opinion that this emphasis is a
proper one: first, because high-level employment is a prerequisite of
the production that is necessary to raise and maintain standards of
living, to build up industrial capacity and, when the occasion demands,
to strengthen the Nation's military defenses; second, because only
when there is high-level employment can the largest number of people share to the greatest extent i n the national output, through
their own participation in its creation; and third, because the opportunity to be useful is both an individual good and a social good.
While price stability is not specifically mentioned as an objective
in the Employment Act, there is no doubt that i t is implicit i n several
of the stated objectives. "Economic fluctuations," mentioned i n the
second quoted passage, usually involve price fluctuations as an important aspect. Severe price fluctuations interfere with the maintenance
of high levels of employment and production. The objective of maximum purchasing power can scarcely be achieved unless the real purchasing power of workers and all others who take part i n production
1
Mr. Clark did not participate in the development of these answers. His separate note
in the Annual Economic Review of the Council of Economic Advisers is reprinted on p. 892.
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is safeguarded from declines i n the value of the dollar, and from the
arbitrary and inequitable redistribution of real income that accompanies inflation and deflation. Moreover, the framework of free competitive enterprise, w i t h i n which the declared objectives of the Employment Act of 1946 are to be achieved, would be threatened by w i l d
gyrations of prices. Prolonged and excessive price movements would
invite the collapse of the system of market pricing that is essential
to the functioning of a free-enterprise economy. Price stability thus
is considered not primarily as an end i n itself, but as a means to the
attainment of more fundamental economic goals.
Price stability should not, of course, be interpreted to mean price
rigidity. The process, referred to above, by which prices serve to
guide production i n a free economy, necessitates freedom of movement
for individual prices; and this flexibility of prices, coupled w i t h the
free decisions of businessmen and consumers which i t reflects, inevitably leads at times to changes i n price levels. Such general price
changes could be absolutely prevented only by setting up a system of
permanent price controls, and by taking from businessmen and consumers their freedom of choice. Such steps should be contemplated,
even as temporary measures, only i n periods of national emergency.
I f the objectives of the Employment Act of 1946 are to be achieved " i n
a manner calculated to foster and promote free competitive enterprise"
the economy must have tolerance for limited price fluctuations. Some
degree of price instability is unavoidable i f there is to be economic
growth under a free system.
Since the objective of price stability, though unnamed, seems clearly
implicit i n the language of the act, the Council does not suggest that
the Employment Act of 1946 be rewritten to include price stability
among the enumerated objectives. A n explicit statement would run
the risks of causing useless controversies over the meaning and desirable degree of price stability and of making price stability a goal
that competed w i t h the objectives of maximum employment, production, and purchasing power instead of assisting i n their achievement.
B . F O R M U L A T I O N OF F I S C A L A N D M O N E T A R Y
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2, Do you believe that, subject to the statutes and general directives
laid down by Congress, the fiscal and monetary policy of the
United States Government should be formulated under the direction of the President? I f not, what suggestions have you for the
coordination of the policies of agencies not under the direction of
the President w i t h those of agencies which are under his direction? How urgent do you consider this problem to be?
This question raises fundamental issues concerning the structure of
government and the allocation of responsibility among public bodies.
Such issues are for determination on the basis of the Constitution of
the United States by the Congress as a law-making body and by the
President as the Chief Executive. The Council ventures to respond
to the question because, quite aside from the jurisdictional aspects,
the allocation of powers referred to i n the question has great significance for the development of a comprehensive and consistent program of economic policies.
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I n answering this question i t is necessary to make a distinction between fiscal and monetary policies. Fiscal policy, as the term is used
here, is focused mainly on Federal receipts, expenditures, and debt
management, while monetary policy deals w i t h the availability and
cost of credit and the supply of money. Monetary policy, as the term
is used i n this context, does not include the regulation of the banking
business.
As far as executive responsibilities are concerned, fiscal policy
is formulated and executed under the direction of the President.
Some difference of opinion exists about the responsibilities for the
formulation of monetary policies under existing statutes. There is no
question that the Congress has delegated substantial authority to the
Federal Reserve System w i t h respect to monetary policy. The statutes, of course, also delegate certain functions to other agencies, but
this does not relieve the President of his responsibility for supervising
these activities. Nevertheless, the Federal Reserve System was so designed as to make i t clear that the Congress intended to give the
System a greater degree of independence than is implied i n the position
of most other executive departments and agencies.
Independence of the monetary authority has been supported by the
argument that the borrower and the lender—or the spender of money
and the creator of money—should not be under the same immediate
control. I t must be recognized, of course, that i t is the Congress that
determines both the amount of spending and the method of financing,
whether taxation or borrowing. Nevertheless, we do not question
the desirability of making monetary policy chiefly the responsibility
of an authority having some degree of independence f r o m all Government departments and agencies engaged i n borrowing or lending.
The fact that the President does not have the same supervisory function w i t h respect to the Federal Reserve System that he has w i t h
respect to other Government agencies should, however, not be confused w i t h the question of whether the President is ultimately responsible for monetary as well as all other fiscal and economic policies
of the Government. I t is w i t h this latter question that the Council
is concerned.
The President scarcely could discharge his general constitutional
responsibilities as Chief Executive, and certainly could not discharge
his specific responsibilities under the Employment A c t of 1946, i f
monetary policy were not regarded as one of the "functions and resources" of the Government to be coordinated and used i n promoting
maximum employment, production, and purchasing power. The Employment A c t directs the President to include i n his Economic Report
a program for carrying out the objectives of the act. I f such a program is to achieve its goal w i t h maximum effectiveness and minimum
cost, the various elements i n the program to the greatest extent possible
must be consistent w i t h each other and part of an integrated whole.
Unless this is done, one policy i n the program may i n effect contradict
other policies, thus making for impotence of policy and waste of
public funds.
Consistency and integration are needed not only i n the formulation
of recommendations to Congress, but also i n carrying out policies
adopted by Congress. This is particularly true w i t h regard to achieving economic stability where a general policy i n favor of stabilization
may require quick action to deal w i t h unstabilizing forces.
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Even i f economic stabilization were the only objective of the Government, there might exist at least the theoretical possibility that agencies
under the direct supervision of the President on the one hand and
independent agencies on the other might take contradictory actions
based on different interpretations of the economic outlook. A problem
of greater practical importance, however, is presented by the fact that
stability is only one of the objectives of the Government, and monetary
policy is only one of the methods of achieving stability. When various
objectives must be promoted simultaneously, a combination of policies
needs to be chosen that w i l l promote these different objectives without
tearing down one to build up another.
Furthermore, there is need for integration within the area of monetary policy itself. While the Federal Reserve System administers the
principal instruments by which the availability and cost of credit
and the money supply are influenced, the Treasury can significantly
affect money and credit by the way i n which i t exercises such powers
as the issuance of gold certificates, the depositing of receipts and
the investment of trust funds. Likewise, the activities of Government lending and loan-guaranteeing agencies have a bearing on the
volume and cost of certain forms of credit.
Accordingly, i t is imperative that there be effective integration i n
the adoption of various policies to meet a variety of Government objectives under changing economic conditions. The President, as Chief
Executive and head of the executive branch, is the only one person i n
the Government i n whom this power of policy coordination can be
lodged.
I n its second part, the question solicits suggestions for "the coordination of policies of agencies not under the direction of the President
w i t h those agencies which are under his direction." Our view that
monetary policy does come under the responsibility of the President
although he does not "direct" the monetary authority i n the same
manner i n which he supervises other executive agencies may seem
anomalous, but the anomaly is more apparent than real. The need to
coordinate monetary and fiscal policies w i t h the other economic policies of the Government has been generally recognized. W h a t conflict
there has been i n this area has been caused more by a clash of ideas
regarding the contribution that certain specific monetary policies
would make to the various economic objectives of Government than by
a denial of the principle that monetary policy should be coordinated
w i t h other fiscal and economic policies. Moreover, i n spite of the
independence of the Federal Reserve System as an agency, a good deal
of reconciliation among the various objectives of fiscal and monetary
policies has been brought about under the general initiative and responsibility of the President.
The point to be emphasized is that difficulties have arisen from the
complexity of various objectives and the ramifications of economic
and fiscal policies, and have been reflected only secondarily i n jurisdictional disputes. We believe that the same sorts of problems would
have arisen even i f there had been no jurisdictional question, and
even i f the most perfect machinery for coordination had existed.
We recognize, of course, that the coordination necessary for the
development of a consistent economic program is greatly facilitated
by the provision of appropriate coordinating machinery. We believe
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that one of the chief purposes of the Employment Act is to provide
such machinery w i t h i n the legislative and executive branches of Government. On the executive side, interagency committees have been
established as part of the general procedure for preparing material on
behalf of the President for the Economic Report. One of these informal committees concerns itself with fiscal and monetary matters.
I n the final stages of preparation of material for the Economic Report, the Council has consulted regularly w i t h the Secretary of the
Treasury, the Chairman of the Board of Governors of the Federal
Reserve System, and other officials concerned w i t h monetary and fiscal policies. For other purposes, other arrangements for determination of fiscal and monetary policies have been made.
The Council believes that there is room for the further development of such informal methods of coordination. Whether experience
has proved this method to be adequate, or whether effective coordination w i l l require basic changes in the structure, is, as we have said, a
fundamental policy question for the Congress to determine.
3. Discuss the rationale, advantages, and disadvantages of the present
division of authority in the Federal Reserve System over the
control of discount rates, open-market operations, and changes
in reserve requirements.
The present division of authority in the Federal Reserve System—
permitting the Reserve banks to participate in discount rate and openmarket policies, but assigning to the Board of Governors undivided authority over reserve requirements—can be characterized,
for the most part, as an historical anomaly. A t the time of the drafting of the original act, there was no developed understanding of central banking functions as we think of such functions today. The
main objectives, as stated in the act, were "to furnish an elastic currency, to afford means of rediscounting commercial paper," and "to
establish a more effective supervision of banking in the United States."
I t appeared to the Congress that these objectives could be met most
effectively by establishing a system of regional banks, which would
be relatively autonomous and able to adjust their operations to the
needs of their respective districts. This approach was also encouraged
by the widespread fear that a single Federal Reserve bank might fall
under the control of one group of bankers and become an agency of
monopoly. As attitudes changed and the country became more aware
of the importance of central banking operations in the promotion of
economic growth and stability, the autonomy of the Reserve banks in
decisions involving general credit policy was greatly reduced, at first
by nonstatutory changes and later by important amendments to the
act.
The only question of any import raised by the existing division of
authority concerns open-market operations. As already noted, cont r o l over reserve requirements of member banks is centralized i n the
Board of Governors. The Board's power over discount rates is virtually as complete as its control over reserve requirements, in spite
of the provision i n the law that the Board go through the formality
of calling on the Reserve banks to "establish" discount rates, over
which i t then has the power of "review and determination." There
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is no dispute, today, as to the Board's authority not only to approve
discount rates referred to i t by the banks, but also to initiate changes.
Open-market operations, on the other hand, are directed by the
Federal Open Market Committee, which consists of the seven governors and five members elected by the directors of the Reserve banks,
.with the different banks grouped i n order to assure fair representation. The representatives must, by law, be presidents or vice presidents of the banks. Since the Board constitutes a majority of the
Open Market Committee, i t can control the committee, provided i t is
unanimous. I f the Board is not unanimous, and i f the bank representatives do not side w i t h the majority of the Board, decisions can be
made which are not consistent w i t h actions taken by the Board w i t h
respect to discount rates and reserve requirements.
As a practical matter, however, the coordination of views is such
that there is little opportunity for a policy conflict of this sort. The
Board, as a regular practice, maintains close contact w i t h the executive
officers of the Reserve banks and gives f u l l consideration to their
views on all phases of credit policy. A n additional factor which undoubtedly makes for increased harmony of views is that the appointment of the top executive officers of the Federal Reserve banks is
subject to the approval of the Board before they can assume their
respective bank posts.
For these reasons, i t is difficult to see either important advantages
or disadvantages i n the present division of authority w i t h respect to
open-market policy, or any harm that might develop i f the division
were eliminated. The Board can obtain the benefit of the judgment of
the banks' officers, whether or not there is a formal committee w i t h
'oint Board and bank representation. I t is uncertain that the division
Las merit simply as a compromise gesture, although, i n 1935, when
the monetary control structure was last modified, there was insufficient support for legislation providing for a more complete departure
f r o m the original concept of a regional Federal Reserve System.
J
C. CREDIT AND D E B T M A N A G E M E N T
POLICY
4. Describe the mechanism by which a general tightening or easing of
credit, and the changes i n interest rates which may result, is
expected to counteract inflation or deflation. Discuss the impact
on borrowers and lenders i n both the short-term and long-term
credit markets and on spending and savings. Indicate the effect
on each of the broad categories of spending entering into gross national product. What are the (actual or potential) capital losses
or gains that would be brought about by changes i n interest rates ?
T o what extent is the effectiveness of a program of credit restraint
affected by or dependent upon expectations w i t h respect to subsequent changes i n interest rates? Distinguish i n your discussion
between small changes i n rates and large changes i n rates.
The effectiveness of the credit-control mechanism at any given time
depends, i n part, upon the exact nature and magnitude of the inflationary or deflationary pressures to be counteracted and, i n part, upon the
extent to which support is obtained f r o m other policy instruments
available to the Federal Government. For these reasons, i t is difficult
to generalize about the operation of the credit-control mechanism, or
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to discuss its effectiveness i n the abstract. A realistic appraisal of
credit control must allow for the f u l l range of contingencies as to economic setting and for the operation of other controls. I n addition,
the appraisal must take into account the uncertainty as to the exact
nature of consumer and business reactions to changes i n the availabili t y and terms of credit. The operation of credit policy is dependent
upon relatively variable psychological responses, probably to a greater
extent than, say, fiscal policy or direct controls. We have i n mind,
for example, the impact of credit policy on incentives to save or
consume, and the impact on incentives to invest or hold funds idle.
Various specific aspects of the credit-control mechanism are dealt
w i t h at other points m this questionnaire. I n this answer our attention is focused on those broader aspects which seem to be of critical
importance i n determining the over-all effectiveness of the mechanism.
The functioning of the credit mechanism.—A general tightening or
easing of credit is expected to counteract inflation or deflation by influencing the demand for goods—primarily private demand. Accordingly, to assess the contribution of credit controls i n counteracting inflation or deflation, i t is necessary to review the various ways i n which
the demands of consumers and businessmen are financed and to analyze
the manner i n which the tightening or easing of credit affects each
means of supporting private spending. Private spending and investi n g can be financed out of (1) current income, (2) existing liquid
assets, and (3) new bank credit. One of these means of payment can
often be substituted for another, as when a business draws more heavily
on its cash assets because bank credit has become less easily available.
The employment of one method of payment sometimes increases the
possibility of the use of another; for example, the spending of previously idle funds or of new bank credit increases incomes.
The functioning of the credit mechanism can be illustrated by the
expected effects of a general tightening of credit. I f bank lending
is curtailed because reserve funds are more difficult to obtain or are
more costly, or because the demand for loans has been reduced by
higher interest rates, bo£h the immediate and the future demand for
goods may be lessened. Since a bank loan adds to the present spending
of the borrower, and also to the future spending power of those who
w i l l receive higher incomes as a result of his spending, a decline i n
bank lending has a double tendency to hold down demand.
The actual results of this tendency may be large or small depending
on the circumstances. Thus, the restraint of lending is likely to have
less effect i f individuals and businesses are well supplied w i t h liquid
assets than i f they are not. I t is necessary to distinguish, of course,
between liquid assets in the form of cash, which can be spent or loaned,
and liquid assets i n the f o r m of securities, which must be sold for
cash, perhaps on an uncertain market, before spending or lending can
take place. General credit restraint cannot directly l i m i t either the
spending of available funds, or the transfer of idle funds to others to
finance an increase i n spending. However, the general tightening of
credit may impede the liquidation of marketable securities, both directly by reducing the ability of commercial banks to buy them or to
finance their purchase, and indirectly by causing a decline in the price
of the securities, thereby discouraging the security holders f r o m
selling them, i n view of the losses involved. The tightening of credit
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cannot, of course, prevent the holders of nonmarketable redeemable
securities from turning them into funds to be spent or lent.
A remaining question is whether tighter credit can counteract inflation by lowering the rate of spending out of disposable income,
that is, whether i t can l i f t the rate of saving. Tighter credit might
result i n a reduction i n the distribution of business profits, i n order
to replace borrowed funds w i t h internal financing, thus increasing the
rate of business saving. The chief effect of a restrictive credit policy
on saving is commonly believed to be brought about by the rise i n
interest rates. To the extent that higher interest rates encourage
saving, they are a part of the mechanism of counteracting inflation.
However, the available evidence gives little support to the view that
the rate of personal saving is significantly affected either by the level
of interest rates, or by changes i n that level.
Effect of credit tightening on lenders.—A general tightening of
credit can be accomplished i n different ways. For the most part, we
associate credit tightening w i t h various actions which restrict the
availability of bank reserves and, thereby, the availability of bank
credit. Changes i n bank reserve requirements accomplish a tightening
of credit i n this way, as do open-market operations and changes i n
Federal Eeserve discount rates. "Moral suasion," on the other hand,
does not operate through changes i n bank reserves, but rather through
its direct effect upon the willingness to lend.
The distinction between curtailment in lending power and curtailment in willingness to lend can be an important one. F o r example,
increases in discount rates and other preliminary evidences of a shift
to tighter credit conditions may lead to more cautious lending policies
long before any scarcity of lendable funds materializes. Similarity,
changes i n reserve requirements may bring about a more than commensurate change i n willingness to lend. I t is equally possible, however, for the reverse to happen, that is, for lenders to resist in every
possible way the efforts of the control authorities to restrict their lending power. When lenders follow such a policy, i t is not necessarily because there is a basic disagreement w i t h the monetary authorities. I t
may be rather because the desire of lenders to protect their competitive position appears to leave them little choice.
I n view of the fact that commercial banks make little use of the
rediscount privilege, the direct impact of discount rate policy on bank
lending is bound to be small. Nevertheless, discount rate policy may
accomplish a substantial credit tightening through its psychological
impact on the willingness of commercial banks and others to lend.
Increases i n reserve requirements impose a more direct restraint on
lending activities, although this restraint may not be appreciable
when, as has been true i n the postwar period, banks are able to meet
higher requirements by reducing their holdings of Federal securities
which then find their way into the Federal Reserve banks. Perhaps
the most certain way of tightening credit is through open-market
operations, although such operations must be carefully meshed w i t h
debt-management policy, as described in the answer to question 8.
We are impressed w i t h the fact that, under existing conditions, general credit tightening cannot be achieved by a simple t u r n of the screw.
For one thing, the large volume of existing funds could be used more
actively. Moreover, even when the avenue of Federal Reserve credit
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is closed to the banks, except for rediscount privileges, individual
banks can usually obtain lendable funds by permitting their holdings
of Government securities, which are largely short-term obligations, to
run off. Such action would not expand the reserves of the banking
system as a whole, except when the net result was to force the Treasury
to rely more heavily on Federal Reserve credit.
When banks are short of lendable funds, they are forced to ration
their loans. Steady customers are likely to be given preference, and
many other firms w i l l probably be disappointed. There w i l l also be a
tendency to tighten the terms of lending, including shortening of the
length of loans, raising collateral requirements, and increasing interest
rates. The banks may be guided by the economic effects of the loans
when they are requested to do so by the monetary authorities, although
such requests are generally of limited effectiveness because they are
in no way binding upon the banks. Thus, there is ordinarily no assurance that the least important loans w i l l be the ones reduced the
most as the result of a general credit tightening.
Effects of credit easing on lenders.—It is far simpler to achieve a
general easing of credit than a tightening. When reserve requirements are lowered and the Federal Reserve makes open-market purchases, the supply of lendable funds is increased and there is no real
incentive for banks to resist such developments. The problems of
achieving desired results through credit easing are serious ones, but
they do not relate to the effect on the actions of lenders, but rather to
the effect on the actions of borrowers.
Effect of credit tightening on borrowers.—Borrowers are affected
by general credit tightening measures to the extent that lenders, as a
result, grant smaller, shorter term, or more costly loans, or no loans at
all. Borrowers may take several courses of action. A t the one extreme, they may decide to abandon whatever plans they had for using
the borrowed funds, either because the terms of lending are unattractive or because they cannot obtain loans and have no alternative means
of financing. A t the other extreme, they may decide to go ahead, regardless, paying any higher interest that is required and, when possible, obtaining funds from other sources, as, for example, liquidation of
asset holdings, diversion of funds originally set aside for other purposes, and sale of equity securities. There are many in-between possibilities. Borrowers may scale down or temporarily defer their plans.
Or they may speed up their programs, acting i n the belief that credit
w i l l be even tighter i n the future and that i t would be to their advantage to arrange the necessary financing as quickly as possible and on
the best terms that can be obtained.
Which are the most likely developments ? I t would seem that, in
most cases, the net result, after sufficient time for the credit tightening
to take hold, w i l l be a lower volume of borrowing than would otherwise prevail. How much lower w i l l depend upon the extent of the
credit tightening, on the one hand, and the strength of demand pressures, on the other. When the tightening takes the form of a small
increase i n interest rates, the effect on borrowers w i l l tend to be
small. This would be generally true whether we think of borrowers of
short-term or long-term funds, or of borrowers for business or consumer purposes.
I n the case of businesses seeking short-term funds, the restriction
on their borrowing would likely be more a consequence of their inabil
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i t y to obtain funds than of their unwillingness to pay the higher
interest cost. When funds are to be used to finance inventory accumulation or other working capital requirements, interest costs are not
likely to be a major consideration. Likewise, consumer credit, which
is essentially short-term financing, would be affected by changes i n
the availability of credit, but would not react to any great extent to
interest rate changes. The mortgage market, on the other hand, seems
to be somewhat sensitive to rate changes as such, as well as to credit
availability, and this is even more true of long-term industrial
financing.
A more restrictive credit policy, which places a tight l i m i t on the
available volume of lendable funds, may have a substantial effect on
all classes of borrowers. Obviously, more funds cannot be borrowed
than financial institutions and individuals are w i l l i n g to lend. Yet
this restriction can be deceptive, since the supply of lendable funds
cannot be treated as a quantity that can be accurately controlled by
credit policy. Even i f the credit control measures are sufficiently
powerful to fix the volume of bank reserves, the supply of lendable
funds may vary depending on the completeness w i t h which all banks
exhaust their lending power, and the extent to which liquid funds i n
nonbank hands are made available for loans i n one way or another.
When the demand for loans is strong, interest rates may rise while,
at the same time, the volume of lending continues to* expand.
Effect of credit easing on borrowers.—The easing of credit, by adding to funds available for lending, permits an expansion of loans, but
such an expansion w i l l not automatically follow. I n deflationary
periods i t is not easy to induce businesses and consumers to apply for
additional loans, or lenders to grant them. Anticipations that add up
to the prospect of losses rather than profits, and further depression
rather than early recovery, are not changed merely because credit is
made more abundant and less costly. The experience of the early
thirties is so clear on this point that there is no need for any
elaboration.
Effect of credit tightening on volume of spending.—The extension
of credit permits an immediate increase i n the volume of spending and
a generally higher level i n the future. A reduction i n credit tends i n
the reverse direction, but i t should be apparent f r o m the discussion
so far that the relationship between credit tightening and the volume
of spending is not a simple one. The effects of credit tightening may
be limited by the fact that a large proportion of business investment
is internally financed and consumers also have sizable funds of their
own. However, insofar as spending is being financed by loans, and
other sources of funds are not available to replace the loans, there w i l l
be a reduction i n spending and a contraction i n the income flow.
The immediate anti-inflationary effectiveness of credit tightening
essentially depends upon the over-all size of the net reduction i n spending, yet the character and distribution of the reduction cannot be
ignored. We have already seen that the main impact of credit tightening is likely to be felt i n the long-term credit market, so that the
largest reduction can be expected i n expenditures dependent upon such
credit. Established customers for short-term credit w i l l feel the impact to a much smaller extent, but new businesses may find themselves
relatively hard hit. Larger and well-established firms w i l l fare better
than others for the additional reason that they are more likely to have
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alternative sources of funds at their disposal. Since moderately
higher interest rates do not greatly discourage consumer borrowing,
consumers may not be much affected by. credit tightening unless the
general measures are accompanied by selective credit controls. Because of the increased cost, State and local governments may abandon
certain projects which were to have been loan-financed.
Other objectives than counteracting inflation commonly are present
and these require more discriminating action than merely l i m i t i n g the
total volume of spending. I n the present defense emergency, for
example, the types of spending curtailed are of critical importance.
A credit policy which impeded the flow of investment funds into
defense industries could not be tolerated. Accordingly, a policy of
general credit tightening cannot be pursued safely without provision
being made for such requirements.
Effect of credit easing on volume of spending.—Because of the rather
loose connection between an easing of credit and an expansion of
borrowing, there is little to say under this heading. Plentiful funds
and low interest rates can help to stem a deflationary movement and to
facilitate recovery, and they are tremendously important because of
this fact, but, a business downtrend once established w i l l ordinarily be
dominated by forces which are outside the control of monetary action.
Effect of interest rate changes on capital values.—Changes i n interest rates cause a revaluation of all assets. W i t h respect to fixedinterest securities regularly traded on the large exchanges, this revaluation is quickly reached. For assets which are not being Continually
tested i n the market place, the revaluation may be submerged under
the influence of other factors affecting values. When assets are not
traded, the revaluation takes place only on paper.
The import of such changes i n capital values for credit policy lies
i n the effect on the supply of lendable funds. A credit tightening
which brings on higher interest rates may gain additional effectiveness by virtue of the resultant decline i n security prices. Financial
institutions and other potential lenders may prove reluctant to incur
a capital loss on securities which would have to be sold i n order to
obtain funds to make new loans. This reluctance would tend to persist unless interest rates on loans rose to the point where i t became
advantageous to switch into loans despite the immediate capital loss
on securities.
Influence of expectations regarding future interest rates.—The influence of expectations as to changes i n interest rates is pretty much
limited to the long-term credit market. When only short-term commitments are involved, there is little need for borrowers and lenders
to concern themselves w i t h speculations regarding the probable trend
of interest rates.
The influence of expectations w i l l vary, depending on whether there
is general agreement about the future and what this agreement is, or
whether there is widespread uncertainty. I n the latter event, both
borrowers and lenders w i l l prefer to l i m i t themselves to short-term
financing as much as possible, and activity i n the long-term market
w i l l decline. Should this uncertainty give way to, say, a general expectation of a rise i n long-term interest rates, lenders w i l l be inclined
to hold off making additional commitments, except for temporary
investments i n short-term obligations, while borrowers w i l l be in-
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clined to speed up their financing arrangements. These adjustments,
however, are not likely to have a great effect, except to hasten the rise
i n interest rates, w i t h the result that the expected higher level w i l l
come into being sooner than otherwise. When the opposite set of expectations holds, the pressures w i l l be reversed, but, again, they w i l l be
of passing importance. I n the event that the expectations prove to be
abortive, the anticipatory increases or decreases i n interest rates likely
w i l l be of temporary duration.
Large traders i n securities are, of course, highly sensitive to changes
i n interest rates and bond yields, even when such changes involve only
small fractions of a percentage point. For these traders, expectations as to interest rate changes play the same role as expectations
as to price trends i n the stock market play for the speculator i n stocks.
Such sensitivity has a direct bearing on the day-to-day market decisions of dealers i n securities, but its bearing on the trend of investment
tends to be remote and uncertain.
Summary appraisal.—This reply has been primarily concerned w i t h
the effectiveness of general credit tightening as a counter-inflationary
policy instrument. For reasons already indicated, credit easing has
been treated only briefly.
We believe that an appraisal of the credit control mechanism should
allow for the following: (a) the relationship of credit control to other
instruments of economic policy, since maximum effectiveness is possible only when several instruments are used i n carefully coordinated
fashion; (b) the obstacles to making credit tightening effective against
lenders; (c) the alternative courses of action open to potential borrowers; (d) the uncertainty over the sensitivity of different classes of
spending to credit-tightening measures; and (e) the absence of select i v i t y i n the impact of general credit-tightening measures on
spending.
B y stressing these limitations, we have attempted to call attention
to the importance of placing general credit control i n perspective i n
relation to other measures. As indicated i n our answers to subsequent questions, some of these limitations can be met by supplementing
general credit control policies w i t h selective credit measures. I n the
area of Government economic policy, there is no cure-all. The more
desirable approach is the judicious application of a family of related
instruments, w i t h the policy officials retaining the maximum practicable freedom of action to relax or tighten each control measure as
circumstances warrant.
5A. How rapidly and to what extent would you expect the volume of
bank loans to respond to measures of general credit control
under present conditions ?
The rapidity and extent to which bank loans respond to measures of
general credit control is determined i n part by the nature of the controls employed and the degree of severity w i t h which they are applied. To a considerable extent the actual or apparent effect of general credit controls is also influenced by other special factors that under
present conditions modify the impact of controls or bring about by
themselves changes i n the volume of loans.
The significance of the character and intensity of the controls used
is illustrated by some of the actions taken since June 1950. The first
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step to tighten credit generally after the Korean outbreak, other than
official requests for voluntary restraint by lenders, was an increase of
one-fourth percent in Federal Reserve discount rates. This rise in
rates could have only slight, if any, direct effect on the availability
of credit. Commercial bank borrowing from the Federal Reserve
banks was at a low level, as it had been for many years; and, even if
banks had been relying heavily on this source of lendable funds, the
increase in rate was not great enough to be a penalty on discounting.
The increase in the discount rate did serve as a traditional warning
signal that the Federal Reserve authorities viewed the rate of expansion in bank lending as excessive and were beginning a policy of restraint that, largely through the use of other measures, might be
expected to make lendable funds relatively more scarce in the future.
The warning having been served, a further rise in discount rates, even
a substantial one, would for the reasons given probably have little
impact on the volume of bank loans.
Another measure of credit policy, higher reserve requirements for
member banks, became effective in January and February 1951. The
amount of the increase was necessarily limited, since the Board had
already nearly exhausted its authority to raise reserve ratios. Most
banks had little difficulty in acquiring the additional reserves that were
needed.
The most important measure adopted after June 1950 to curb the
growth of bank credit took the form of a new open-market policy,
which the Federal Reserve System developed i n two stages. Immediately after i t announced the rise in discount rates i n August, the
Federal Reserve System initiated a policy that was intended to
reduce the sale of Government obligations to Federal Reserve banks,
which had been the largest source of new bank reserves. Since early
1942, that source had been readily available because the banks
owned large quantities of Government obligations and the Federal
Reserve System followed a policy of market support. The essential
element of the new policy was withdrawal of Federal Reserve banks as
buyers from the market for Government short-term securities at prevailing rates. The new policy resulted in higher interest rates and
yields on short-term Government obligations, which result tended to
discourage existing holders from selling such obligations and to invite
purchases by other buyers, thereby promoting the System's desire
to reduce its purchases.
I n March 1951, the new open-market policy was extended to Government long-term bonds. To achieve the goal of reduced System
purchases of such bonds, i t was desirable that the reintroduction of
price flexibility into the market for these securities be accomplished
smoothly and w i t h due regard to other objectives. Open-market operations, since they are carried out i n the market for Government securities, must be reconciled w i t h the needs of Treasury financing or
refinancing. Furthermore, much of the demand for credit was to
finance essential operations, such as expanding defense production
and increases i n productive capacity to meet long-run goals for both
military and civilian output. A drastic application of open-market
policy might have deprived business of the credit required for the
growth of production.
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Restraint i n the management of open-market policy w i l l probably
become more important during the next stage of the mobilization
period. I f , as is likely, the Treasury finds i t necessary to borrow
large sums of new money during the next few years, the objectives
of debt management may make i t inexpedient to rely heavily on this
policy instrument to l i m i t the volume of bank lending.
The rapidity and extent to which the volume of bank loans changes
after the application of general credit controls are influenced by various other factors, some of which affect the operation of the controls
and others of which have an independent impact on the volume of
loans. Because of the multiplicity of forces that alter the amount of
bank loans outstanding, i t is not possible to measure the effect of
credit controls i n themselves, much less to determine the impact of
individual controls.
The following factors are significant:
(1) Vigorous application of selective credit controls can reduce the
demand for credit, and thereby restrict the growth of bank loans.
I f selective controls are in effect at the same time as general credit
restraint, total loans outstanding w i l l naturally respond to both. Regulations W and X , and the Government-agency counterparts of the
latter, all imposed after June 1950, apply to substantial segments
of commercial banks' total lending activity. Many bank loans are
also subject to Regulation U, which sets minimum margin requirements on bank loans on stocks. Margin requirements were increased
by the Board of Governors i n January 1951.
(2) The speed w i t h which general credit policy restricts bank lendi n g is influenced by some conventions of commercial banking. Banks
commonly extend lines of credit to their regular borrowers; and,
while these agreements to extend credit do not typically take the
f o r m of contractual obligations, bankers are slow to change and reluctant to break them. I f i t were necessary to do so, banks might
be expected to sell securities at a substantial loss i n order to f u l f i l l
existing loan agreements. Even i n the absence of lines of credit, the
highly personal relationship that exists between the banker and most
of his business borrowers limits the speed and extent of the effects
of general credit restraints. The banker tries to "take care" of his
established customers, and he is more likely to adjust his investments—even at a sacrifice—to supply them w i t h funds than to adjust
his loan policy to meet new conditions i n the securities market.
(3) The volume of business loans, i n particular, is subject to seasonal change, rising during the second half of the year, f a l l i n g somewhat during the first quarter, and f a l l i n g more markedly during the
second quarter. General credit controls have the appearance of being
more quickly effective i f they coincide w i t h a seasonal decline than
i f they coincide w i t h a seasonal rise.
(4) General credit policy can be assisted i n efforts to hold down
the volume of bank loans by the effects of direct controls over prices,
wages, and materials. To the extent that direct controls serve to
halt a rise i n prices and wages, they moderate or terminate that part
of the business demand for credit that is a consequence of rising costs.
Price ceilings also help to curtail borrowing to finance speculation
i n commodities. Controls over materials reduce the demand for credit
by restricting certain kinds of production. The general price and
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wage controls imposed i n January 1951, and the growing network of
regulations governing the use or accumulation of materials have been
significant auxiliaries of credit policy because they helped to curtail
demand f o r loans at the same time that credit measures were l i m i t i n g
the supply. As direct controls over materials further retard nonessential production during the next phases of the defense period,
the business demand for credit may be held down enough to make
added measures of general credit restraint unnecessary.
(5) The rapidity of the response of the volume of bank loans to
general measures of credit restraint is slowed down by the fact that
lending activity at any period of time reflects business decisions
about spending which were made at an earlier time. This lag is likely
to be particularly great i f a rapid expansion of business plans for investment preceded, the adoption of the measures of credit restraint
since extensive plans for business spending build up a strong pressure
i n the demand for credit.
5B. Discuss recent changes i n the volume of bank loans.
Under the impetus of the surge i n private demand after Korea and
the expansion of output, outstanding loans of all commercial banks
rose $7.4 billion or nearly 17 percent during the second half of
1950. Seasonal credit needs of many industries contributed to the
upward movement. General credit restraints were applied midway
i n the t h i r d quarter, but these had to combat a powerful demand for
credit and could not be expected to halt at once an expansion largely
based on buying orders already placed and lending agreements already
entered into. General controls received almost no help from the residential mortgage regulations i n slowing down the advance of total
bank loans u n t i l well into 1951, because of the large backlog of mortgage financing commitments. The measures of general credit restraint
did receive some assistance from consumer installment credit regulations, beginning i n the fourth quarter of the year. Price and wage
controls were not yet i n effect to help check that part of the demand for
credit that arises f r o m inflation itself. Materials controls were only
just beginning to appear and were not yet significant i n holding down
the credit demands of businessmen.
D u r i n g the first quarter of 1951, bank loans expanded $2.2 billion
or about 4 percent, though i n these months some net contraction
usually occurs as a result of seasonal repayments. Several factors
were responsible for this relatively large growth. When the year
opened, private spending was rising to another crest, following the
Chinese intervention i n Korea. When buying began to subside later
i n the quarter, the credit needs of many firms continued to rise as
inventory accumulation, partly involuntary, occurred at an unprecedented rate. Loans related to defense production were emerging as
a factor i n the demand for credit, but were to be of greater importance
later i n the year. The price and wage ceilings announced i n January
could not immediately halt the rise i n business costs that were the
basis of some demand for additional credit; and the growing system
of materials controls had not yet had a great impact on business investment. Funds for lending were still relatively ample, i n spite of the increase i n reserve requirements early i n the quarter. The Federal
Reserve System's more restrictive open-market policy and the campaign
of voluntary credit restraint were not inaugurated u n t i l March. Dur
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ing the i n i t i a l stages of both the August and March open-market operations, Federal Reserve banks, in order to maintain an orderly market,
had to purchase some United States Government securities, many of
which were offered for sale by those who anticipated greater difficulties
i n selling, or greater losses, later on.
I n A p r i l , total loans remained at the March level, but during the
next 2 months they rose moderately. Instead of the usual marked
second quarter decline, loans expanded $0.4 billion or about 1 percent
in the 3-month period. Factors, i n addition to the seasonal, that
tended to reduce the volume of loans were the general and selective
credit restraints, particularly the general measures introduced i n
March, and the many other elements i n the complex of factors that
ushered i n the 1951 business lull. Factors that tended to increase
loans, and which together more than offset the opposing influences over
the second quarter, included the still rising need for inventory credit
and the gradual acceleration of defense production.
Total bank loans declined in July, but rose during August and
September, w i t h the result of a net expansion of about $1.2 billion or
2 percent during the t h i r d quarter. Much of the growth reflected the
increased demand for credit to finance defense contracts and defensesupporting activities. Seasonal factors, mainly associated w i t h the
marketing and processing of farm crops, were increasingly responsible
for the rise as the quarter progressed. I n addition, the volume of consumer installment credit, which had varied w i t h i n a narrow range for
several months, began to show signs of entering a period of moderate
expansion following the relaxation of the terms of Regulation W in
accordance w i t h the provision of the Defense Production Act Amendments of 1951.
6A. What is the reason for the relatively slight use by commercial
banks of the Federal Reserve discount and borrowing privilege ?
The chief reason for the relatively slight use of the discount privilege is that commercial banks have several other sources of reserve
funds in addition to discounts at Federal Reserve banks. I n combination, these other sources have generally been adequate, or more than
adequate, to furnish banks with lending power. Each of these alternate sources appears to banks to have some advantage over discounting. Net gold imports, which have frequently been large, furnish the
banking system w i t h new reserves without the need of any action on
the part of the individual bank. Federal Reserve bank purchases of
Government securities have been the other major source of commercial
bank lending power. D u r i n g the years of close support of the market
for Government securities when the Federal Reserve banks stood
ready to buy at pegged prices, commercial banks had i n their possession an abundant and assured means of obtaining lending power at
fixed and relatively low costs, without going into debt.
The institution of the correspondent relationship among banks
remains strong. Many member banks prefer to seek temporary financial aid from their correspondents, partly because these loan transactions are free of such regulations and considerations of credit policy
as govern Federal Reserve bank discounts. Member banks can also
borrow the surplus Federal Reserve balances of other member banks.
Another reason for the slight use of the discount privilege is the
unwillingness of commercial banks to borrow from other banks, particularly as a regular means of obtaining funds for lending. This
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reluctance to borrow had its origin in the pre-Federal Eeserve period
when banks acquired the habit of relying on their own resources i n
finding funds for lending or for paying the claims of depositors. The
habit was i n part an outgrowth of the policy of giving preference i n
lending to so-called self-liquidating, short-term commercial loans,
which were expected to help make the individual bank inherently
liquid. Moreover, most bank earning assets consisted at the time of
customer notes that did not have an open market, and could not readily
be endorsed and used to obtain funds from other institutions. The circumstances that made borrowing uncommon also made i t appear undesirable. When banks did resort to borrowing, i t was often because
they were i n financial difficulties, and borrowing naturally came to be
looked upon as evidence of unsoundness.
6B. Do you believe that greater reliance should be placed on this privilege as a means of obtaining Federal Eeserve credit?
I f i t were feasible to increase the use of this source of lending power,
i t would be desirable to do so. I f Federal Eeserve funds flowed to
banks more commonly through discounts, i t would be possible to put
a more effective control over the supply of Federal Eeserve credit than
is possible when, for example, additional reserves can be obtained
through the acquisition of Government obligations by Federal Eeserve
banks.
6C. Under what conditions, i f any, would you expect to see a greater
use made of the discount privilege?
I f banks were unable i n other ways to secure funds needed for
loan expansion, bankers i n time undoubtedly would overcome to some
extent their reluctance to discount and would make greater use of this
privilege. For example, i f the Board of Governors were granted
authority to change reserve requirements i n line with suggestions made
in the answer to question 13, i t would be possible in many situations
to offset or to curtail new lending power arising from other sources,
w i t h consequent increase i n the importance of discounting as a means
of obtaining lendable funds. Unless there is such an increase i n the
authority of the Board over reserve requirements, i t is not likely that
a condition i n which banks cannot obtain substantial quantities of lending power by other means w i l l appear for many years because of the
mass of Government securities held outside the Government trust
accounts. These securities must, of course, be held by someone, and
when outstanding obligations i n the possession of other investors are
reduced the consequent transfer of securities to Federal Eeserve banks
creates additional reserves w i t h resultant new lending power. Furthermore, gold imports may again become a large source of new lending power.
Some increase i n discounting might result from continuation of the
policy of allowing greater flexibility in the movements of prices and
yields i n the market for Government securities than prevailed during
the period of close support of the market.
The use of the discount privilege would probably be stimulated
i f there were a further relaxation of the statutes and regulations governing the duration of the several types of rediscounts and advances,
and the eligibility of bank assets for rediscounts or as collateral for
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advances. Many of the laws and regulations appear to be unnecessary from the standpoint of credit policy. The exceedingly restrictive requirements of the original Federal Reserve A c t were not conducive to use of the discount right. The liberalization of the statutes
and regulations during the 1930's made the discount privilege more
valuable, without opening i t to abuses. The elimination of a few
more technicalities might be helpful i n making discounts relatively
more desirable than at present.
7. Discuss the economic effects of the increase i n short-term interest
rates between August 1950 and March 1951, and the subsequent
increase i n long-term interest rates.
Since the answers to other questions contain the economic analyses
underlying the answer to this question, the comments here w i l l be
limited to a brief statement of conclusions.
The increase i n short-term rates contributed to a shift i n demand
f r o m long-term to short-term Government securities and greater purchases of short-term securities by nonbank investors. The increase i n
the return on short-term obligations increased their attractiveness to
investors, at least u n t i l there was a corresponding rise i n the yield on
alternative forms of investment. Anticipations that long-term rates
might also rise, which developed as a consequence of the Federal Reserve System's action on short-term rates, were also a factor i n this
shift. (The effect of anticipations w i t h respect to the demand for
Government securities is also discussed i n the answer to question
15.) The subsequent rise i n long-term rates made investors even
more uncertain about future interest rates and further increased the
desire to hold short-term securities. Another factor i n the preference for short-term obligations was the continued absence of aemand
for Government securities by financial institutions that hold a high
percent of long-term investments. For example, l i f e insurance companies rather than buying were selling to obtain funds to meet real
estate mortgage and other loan commitments. Much nonbank buying
was by nonfinancial corporations w i t h short-term funds arising from
tax accruals.
The increase i n short-term rates had little effect i n reducing lending
by commercial banks. Banks held a large quantity of short maturity
Government obligations, many of which they could redeem i n cash,
and the balance of which could be sold, i f necessary, at losses that
would be offset at least i n part by rising rates of interest on business
loans. Furthermore, relatively large market offerings of Government
securities by both banks and other investors, resulting from uncertainties about future prices and yields or from adjustments of holdings
i n response to Treasury refinancing operations, led at times to Federal
Reserve bank purchases that added to the lending power of banks.
D u r i n g the 8 weeks preceding the change i n Federal Reserve support
operations i n the market for short-term Government securities, Federal Reserve bank holdings of Government obligations rose $655 mill i o n ; i n the next 8 weeks the increase was $1.2-billion.
Partly as a result of the rise i n short-term rates, and the anticipated
and later actual rise i n long-term rates, but more largely as a result
of the other factors described above, all Treasury issues of marketable securities, i n the comparatively large refinancing and new financi n g operations of 1951, were of the short-term type.
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The increase i n market interest rates as reflected i n lower prices of
long-term Government obligations, likewise, did little to curtail lending by banks. As explained above, large holdings of short-term Government securities made banks less subject than other lenders to the
impact of lower prices of long-term securities. Insurance companies
and other nonbanking institutions w i t h relatively large investments
i n long-term Government obligations were undoubtedly restrained
from making some loans by the capital losses that would result from
sales of these obligations to secure lendable funds. As their mortgage
loan and other commitments were large, the restraint did not show up
as an immediate decline i n lending but i n reluctance to make new commitments. The higher yields on Government long-term bonds that
could be bought at below-par prices began to compare favorably w i t h
net returns on mortgages w i t h a 4 ^ or 4 percent interest ceiling. As
this group of lenders had been investing substantial sums i n resident i a l mortgage loans guaranteed or insured by the F H A or the V A , the
reluctance to enter into new commitments often took the form of a
refusal.
Neither the higher short-term interest rates nor the rise i n the longterm rates significantly reduced the demand for credit. The higher
interest rates businessmen had to pay had slight effect on their costs
compared w i t h the rise i n prices and wages. Business demand for
materials, services, and credit did not slacken, because of the anticipation of long-continued profitable markets for goods. Even the
demand for long-term loans to finance new construction, a demand that
is usually very sensitive to actual or expected changes i n interest rates,
remained strong, partly because of the urgent need for expansion of
productive capacity to support the defense effort and partly because
of the highly favorable long-run outlook for profits. The demand
for consumer and residential mortgage credit was curtailed by the
requirement of higher down payments and shorter maturities and by
a reduced supply of funds rather than by increases in interest rates.
Though the rise i n interest rates did not i n itself discourage the
growth of bank loans, the aggregate of general and selective measures
of credit restraint undoubtedly held down the total volume of loans.
The declining prices and rising yields on long-term Government
bonds were reflected by like movements i n other securities. Several
corporate and State and local government issues about to be placed on
the market at specific rates had to be withdrawn.
8. Discuss the appropriate roles of direct controls, selective credit
controls, and a generally restrictive credit policy as means of
restraining inflation (a) when the Treasury is not expected to be
a large borrower i n the foreseeable future, (6) when a large volume of Treasury refunding operations w i l l have to be effected i n
the foreseeable future, (c) when i t is expected that the Treasury
w i l l be a large net borrower during the foreseeable future, (d)
under conditions of total war.
This question has two interrelated facets. I t appears to aim first
at the broad problem of the interrelationship between governmental
programs and different methods of inflation control. The situations
(a), (&), and (c) obviously refer either to peacetime conditions or
conditions of a defense and mobilization program short of total war,
while (d) refers to conditions of total war. Direct controls such as
9 8 4 5 4 — 5 2 — p t . 2—^—16
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allocations and wage and price ceilings, selective credit controls, and'
general credit policies necessarily play different roles during these
different phases of a national emergency.
A t the beginning of the present defense program i n J u l y 1950,
when an increase of $10 billion i n military appropriations was contemplated, the Council, i n its report to the President on "The Economic
Situation at Midyear 1950," stated:
* * * we find firm ground for believing t h a t i t w i l l be possible to make
and m a i n t a i n substantial enlargement i n these ( m i l i t a r y ) expenditures w i t h o u t
resorting to a l l of the controls of a w a r economy but we must take some important
steps now. The first and most important of these is to use fiscal and credit
policies to the fullest extent feasible for the restraint of inflationary pressures.
For reasons which w i l l be discussed i n the second part of the answer
to this question, and which have been already referred to i n the answers
to other questions, the Council placed particular emphasis on higher
taxes and selective credit controls, and somewhat less emphasis on
general credit restraints. The need for control of materials was also
recognized.
Six months later, i n the Council's January 1951 Eeport to the President, i t was realized that a national security program of the general
magnitude of "much closer to 150 than 100 billion dollars for the fiscal
years 1951 and 1952 combined would be needed" (p. 67). A n antiinflation program was recommended which added direct controls over
prices and wages to the controls previously recommended (see pp. 97119 of the Annual Economic Eeview, January 1951) and emphasized
the mutually supporting character of the different types of controls.
The same emphasis was repeated i n the report on The Economic
Situation at Midyear 1951, pages 120-161.
I f the international situation should force a further substantial upward revision i n the security program, the role of direct controls, particularly allocations and limitations, probably would further expand.
I f a larger portion of productive resources were diverted to defense
purposes, measures such as allocation of materials, limitation orders,
price and wage controls, and selective credit controls would become
more dominant, and general credit controls would assume more
of a supporting role. As the diversions for defense purposes were
increasingly enlarged, a situation would be reached which, i n economic
respects, would begin to be similar to one of total war. B y stating
that i n such a phase of an emergency program general credit controls
assume a supporting role, we do not mean to suggest that this role i n
any sense would be a minor one.
The preceding remarks are intended to make clear that i f the
question aims at clarifying the changing relationship between direct
and indirect controls during various phases of a national emergency,
i t must include other aspects besides Treasury operations and the
budget outlook. Obviously there are powerful factors, i n addition to
these, which influence the course of the economy, inflationary trends,
and the selection of appropriate policies. The size and kinds of business investment, the propensity of consumers to spend or save their
incomes, the dynamics of price-wage adjustments, the anticipations of
producers and buyers concerning future economic developments, all
have powerful effects on economic trends and consequently have
important bearing on the consideration of economic policies. There-
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fore, the appropriate and respective roles of direct controls, selective
credit controls, and a general restrictive credit policy must be based
upon an analysis of all these factors and not simply upon consideration of the current position or prospective operations of the Treasury.
These other factors of importance may include not onty current
economic developments but also objectives of national economic policy.
For example, question 11 raises the issue of whether the use of monetary measures to restrain inflation may not depend i n part upon production objectives, which would mean that they could not depend
entirely, and possibly not even mainly, upon the Treasury situation.
The significance of the production objective is illustrated by the situation that developed after Korea. Defense production was then i n a
preparatory stage, and i t was desirable to use resources and manpower
to the fullest extent on types of private investment that would have
to be curtailed later as defense production expanded. Credit was being
used at the time to modernize and expand plant and equipment and to
accumulate inventories. Rigorous general credit controls aimed at
combating inflation would also have h i t production and business
investment.
Consequently, the Council of Economic Advisers has endeavored
to base its appraisal of the respective u t i l i t y of the various types of
selective and general controls, both direct and indirect, upon careful
analysis of the entire economic situation, and also upon the analysis
of our primary economic objectives in terms of the world situation.
I n this analysis, consideration of Treasury operations and the budget
outlook has occupied an important place but by no means a decisive
one.
Besides this general relationship between the use of various antiinflation measures and the phase of the national emergency, the question apparently aims more specifically at the relationship between
problems of debt management, on the one hand, and credit policy, on
the other hand.
Obviously, considerations of debt management have conditioned
the use that has been made of general credit policy. Thus, i t was
stated i n the report on credit policies, submitted to the President by
the Director of Defense Mobilization, the Secretary of the Treasury,
the Chairman of the Board of Governors of the Federal Reserve System, and the Chairman of the Council of Economic Advisers, on
May 17,1951:
I n the postwar period, Federal Reserve use of t r a d i t i o n a l instruments to
restrain credit was conditioned by the objective of maintaining a market for
(Government) securities w i t h o u t a substantial and general increase i n interest
rates. This latter objective l i m i t e d the effective use of open-market operations
for purposes of counteracting inflation.
The reasons why debt management should aim to maintain a stable
long-term bond market w i l l be set forth i n answer to question 16 below.
I n the hypothetical situation when neither deficit financing nor refunding operations were currently required or i n prospect, the maintenance
of a stable Government securities market would have relatively little
importance. B u t this is not a realistic assumption. I t is obvious that
the reasons for a stable bond market become stronger i n a period of
large Treasury refunding operations. The reasons become still
stronger when prospective budget deficits require large new Treasury
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT868
financing, since additional purchasers must be found to hold the larger
total of outstanding securities.
When, as defense production increases, expenditures of consumers
and businesses are restricted through allocations and limitations, i t
should become easier to reconcile the objectives of debt management
and credit policy. Under such conditions, business funds, pension
funds, and funds of other nonbank investors should be increasingly
available for investment i n Government securities. This would be a
situation approaching i n economic terms that of total war.
9. Discuss and evaluate the Voluntary Credit Restraint Program
which was initiated i n the spring of 1951.
I t is very difficult to evaluate i n quantitative terms the contribution
that the Voluntary Credit Restraint Program has made to the fight
against inflation, and to the achievement of at least temporary relative
stability during most of the year 1951. While the rate of increase i n
loans has been lower since the adoption of the Voluntary Credit Restraint Program than during the comparable period a year before, i t
would be impossible to measure the specific contribution made by that
Program in holding down loan expansion.
The period during which the Voluntary Credit Restraint Program
became effective was the period during which a substantial change i n
inventory accumulation took place. The first 12 months after the
Korean attack was for the most part a period of rapid inventory accumulation which slowed down substantially during the second half of
1951. What happened to bank loans during the last 6 months of 1951
was probably more the result than the cause of the change i n inventory
accumulation, in view of the softening of retail markets that developed. Nevertheless, there seems to be general agreement among
observers that the Voluntary Credit Restraint Program has made
lenders and borrowers aware of the desirability of restraint, and i t
seems to be a fair guess that without that program there would have
been greater loan expansion.
The Voluntary Credit Restraint Program is designed not only to
hold down credit expansion i n general, but i t is specifically designed to
curtail credit expansion in a selective manner, that is, to permit loan
expansion for purposes of financing defense contracts and defensesupporting and other essential activities, while holding down loans
for less essential activities.
The Federal Reserve System has instituted a reporting system
which shows changes in commercial and industrial loans on a sample
basis, broken down by the purposes for which the borrower uses the
money. For 7 months through October 31, 1951, loans for defense
contracts were expanded by about $550 million; for defense-supporting activities, by $620 million. The aggregate net increase in classified
loans extended by banks included i n the sample amounted to $1,900
million. Of this increase, approximately 29 percent was for purposes
of financing defense contracts; 32 percent for financing defense-supporting activities; 39 percent for financing nondefense activities. Net
loans extended to commodity dealers were reduced by $27 million during this period. The fact that more than one-third of the increase i n
total loans was for nondefense purposes, and that loans to commodity
dealers were again on the rise, is undoubtedly i n large part a reflection
of the normal seasonal increase i n the demand for credit and not an
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indication of the failure of the Voluntary Credit Restraint Program.
Because the figures are not conclusive, the evaluation of the Voluntary Credit Restraint Program must be based largely on general considerations. The advantages and the weaknesses of the program
obviously stem f r o m the same fact, namely, its voluntary character.
1. I n a nation i n which businessmen value highly the r i g h t of making their own decisions, voluntary controls are more acceptable than
mandatory controls. I t should, however, not be overlooked that any
collective voluntary program involves an element of coercion. Some
businessmen may prefer a clear legal mandate to a situation i n which
cooperation is enforced by the threat of social or economic ostracism.
The effectiveness of a voluntary program depends largely on the
number of institutions which have to cooperate, and on the extent
to which their activities are a matter of public knowledge. I n the
field of commercial and industrial loans, i t is possible for a firm seeking
funds to "shop around" after one bank has refused the loan. Another
bank may grant the loan, hoping that the fact does not become'known.
The situation is different when public capital issues are involved, as
the experience w i t h the Capital Issues Committee of W o r l d War I
demonstrated. I n this field, i t is more easily possible to enforce a
voluntary agreement. I n the case of proposed State loans which were
believed not i n accord w i t h the criteria established by the National
Voluntary Credit Restraint Committee, public issues were impossible
because the investment bankers refused to underwrite them.
2. The second advantage of the program is its selective character.
The main idea of the program is that under the guidance of the
mobilization agencies standards and criteria are developed which are
designed to help the individual banker distinguish between defense
and non-defense-related activities and between essential and nonessential purposes.
3. Voluntary campaigns for credit restraint have a
flexibility
difficult to achieve i n direct mandatory controls of lending, especially
i f these controls embrace all classes of lending institutions. Restraint
through the effort of private lenders is automatically adjusted to reflect conditions among the several kinds of lending institutions. Voluntary restraint of credit also has flexibility i n the sense that its
lending criteria can be quickly and easily altered to meet changing
conditions.
The weaknesses of a voluntary program can be diminished to some
extent by the way the campaign is organized and supplemented by
other measures.
1. The main weakness lies i n the fact mentioned above as an unavoidable feature of a voluntary program, namely, that there is no
assurance that all competing banks are equally w i l l i n g to cooperate.
This limits not only the effectiveness of the program, but i t also
undoubtedly creates a condition i n which some business may move
f r o m those banks which cooperate more scrupulously i n the program to those which are less cooperative or which believe they are
less i n the public eye. Moreover, the standards and criteria developed
by the Committee under the guidance of the mobilization agencies
must necessarily remain of a general nature, and leave room for considerable differences of interpretation. I f lenders are requested to
grant loans only to defense or defense-supporting industries, i t
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT870
may be found that nearly every prospective borrower can demonstrate that his activities have at least some indirect relationship to the
defense effort. The selectivity is probably most effective when certain
types of loans, for instance for speculative inventory holdings or for
certain real estate transactions, are designated as undesirable.
The effectiveness of a voluntary credit restraint campaign is increased by other measures to tighten credit. Then the main emphasis
of the voluntary effort lies i n the appeal to bankers to be guided i n
the selection of borrowers by the criteria and standards formulated i n
consultation w i t h the mobilization authorities. I t follows that the
Voluntary Credit Restraint Program should not be regarded as an
alternative to the proposals made i n response to question 13, which are
designed to enable the Federal Reserve System to exercise more effective general control over credit expansion.
2. While competitive conditions l i m i t the effectiveness of a voluntary program, there is also the danger that any attempt to "enforce"
cooperation may lead to monopolistic misuse of the voluntary campaign, or to discrimination against certain borrowers. I n order to
diminish the danger of these kinds of abuses, the Defense Production
A c t made all voluntary agreements subject to review by the Attorney
General and the Federal Trade Commission. The fact that a Federal
Reserve representative has been placed on the various voluntary credit
restraint committees gives some assurance against the possible misuse
of voluntary agreements, but the danger is not an imaginary one.
3. When the Voluntary Credit Restraint Program was initiated, fear
was expressed by many bankers that some of the lenders who were
refused credit by private bankers might obtain loans f r o m Government
lending institutions. The administration has taken determined action
to apply the same standards of selectivity to Government lending. The
Council has cooperated w i t h the Office of Defense Mobilization and the
Budget Bureau i n a review of the lending activities of Government
agencies, and the Budget Bureau, under the direction of the President,
has issued directives to these agencies for the enforcement of these
standards. We believe that this problem deserves continuing attention.
4. Every voluntary effort runs into the difficulty that i t is likely to
lose its force after some time unless i t is institutionalized i n a cartellike arrangement. I t is not easy over a long period to maintain enthusiasm i n restricting profit-making activities. I t is, of course, most
difficult to maintain enthusiasm i f i t turns out that some lenders
disregard the program and secure a great deal of new business at the
cost of those who are cooperative.
Summing up the achievements and the limitations of the Voluntary
Credit Restraint Program, we believe—although we cannot offer quantitative proof—that the program has contributed to holding down bank
loan expansion and, to some extent, to diverting funds from less essent i a l to more essential usage. But we do not believe that any voluntary
program could be heavily relied on to be sufficiently effective i f the pressures for credit expansion should assume much larger proportions over
a prolonged period. As previously indicated, the effectiveness of the
program to some extent depends on supplementary measures for more
effective general control, continuing corresponding action on Government lending, and continuing measures of mandatory selective control,
such as those related to real estate and consumer installment credit.
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While we feel i t is our duty to point out the limitations of the program, we do not wish to underrate either the patriotic spirit of cooperation w i t h which the program is being carried forward, or the present
usefulness of the program.
10A. Do you believe that under existing law any agency of the Federal Government has the power to control directly or to "ration" the extension of credit by individual banks?
While this is a question for legal interpretation, there is reason for
believing that power to control credit directly is provided by existing
statutes. The Trading W i t h the Enemy Act of October 6, 1917, as
amended, states that "during the time of war or during any other period of national emergency declared by the President, the President
may, through any agency that he may designate, or otherwise, and
under such rules and regulations as he may prescribe * * * investigate, regulate, or prohibit * * * transfers of credit or payments
between, by, through, or to any banking institution. * * * " The
Emergency Banking A c t of March 9, 1933, i n amending the act of
1917, added a section which provides that " * * * during such
emergency period as the President of the United States by proclamation may prescribe, no member bank of the Federal Reserve
System shall transact any banking business except to such extent and
subject to such regulations, limitations, and restrictions as may be
prescribed by the Secretary of the Treasury, w i t h the approval of the
President * *
.f\
The Executive Order of August 1941, in accordance w i t h the terms
of which subsequent controls were placed on consumer credit, was
based on the authority of this legislation. I t appears to us that the
statute is broad enough to permit the use, under the conditions prescribed, of other mandatory credit controls, including the imposition
of ceilings on the volume of loans that may be made by individual
banks as well as all other lending institutions. The power to impose
controls on lenders other than commercial banks is suggested by the
broad scope of the Executive Order of August 1941, which defines a
banking institution as "any person engaged as principal, agent,
broker, or otherwise i n the business of making or holding extensions
of credit."
10B. Under what economic circumstances, i f any, would you recommend the use of this authority ?
This authority should be used only when (1) the continued upward
movement of bank credit is creating severe inflationary pressure and
(2) there is serious doubt that other methods of credit control w i l l
together be adequate to control the inflationary pressure.
I n designing direct controls over bank loans i t would be necessary
to take the following into account: (1) some banks have shown more
restraint than others i n making loans; (2) bank loans are subject to
seasonal movements that vary widely in different parts of the country
and even w i t h i n the same region; (3) much of the demand for loans
from some banks is for defense and other essential purposes while the
demand for loans from other banks is more largely for purposes of low
p r i o r i t y ; (4) production in some communities is expanding because of
defense orders or other factors while i n other communities the volume
of production is stable or declining; (5) newer banks may not have
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT872
built up their loans to normally expected levels, while older institutions may have attained the maximum volume of loan expansion.
The problems involved i n the direct control of bank loans are indicated by the disadvantages of some of the bases that have been
proposed for loan ceilings. I f the total loans a bank could hold were
fixed as a percent of its capital accounts, total deposits, or total assets,
i t might be found that, because banks differ considerably i n the ratio
of outstanding loans to these other quantities, some banks could expand their loans substantially, while others would have to contract
loans. The fact that laws l i m i t i n g total real estate loans held by a
national bank to a percentage of its capital and surplus or time and
savings deposits have resulted i n no great hardships or inequities,
should not be interpreted as meaning that ceilings can be placed on
total loans w i t h equal success. Real estate loans are usually only a
relatively small part of the total loans of national banks. Moreover,
ceilings were imposed when these banks first received the authority
to make real estate loans. As the national banks were just entering
a new lending field, all could expand real estate loans under the
ceilings.
I f the loan ceilings were related to a bank's total loans outstanding
on some base date, other problems would appear. Banks that had
been holding down loan expansion would be discriminated against
compared w i t h banks that had been following less conservative policies. As the volume of bank loans changes seasonally, a moving base
might have to be used. New banks would be handicapped, compared
w i t h older institutions, i f loans were held close to existing amounts,
and a special base might have to be provided for the former institutions. Furthermore, economic development would be impeded i f
loans that could be made by banks i n growing communities were
frozen at the amounts outstanding on a given date.
A n y direct over-all control of lending has the disadvantage of being
a possible obstacle to the expansion, or even maintenance, of essential
production, military or civilian. To avoid the effect of such control,
exceptions would have to be provided for individual loans i n excess
of ceilings—and such exceptions would involve a difficult administrative problem—or needed credit would have to be supplied, i n some
cases, by Government agencies. Expansion of the lending activities
of the latter institutions under such conditions understandably would
be considered to be unfair governmental competition by private
lenders.
Despite the difficulties i n the direct control of bank lending, the
Council believes that certain circumstances may warrant use of this
method. I f bank credit expansion becomes severely inflationary, and
other means to cope w i t h the problem prove ineffective, the damage
that might be done because of the arbitrary character of loan ceilings
would be less than the damage from inflation. However, to minimize
hardships i n the event of its use, the potentialities, problems, and
means of applying this method of control should be more f u l l y explored. I t may be possible to devise an administratively feasible plan
that w i l l recognize differences among banks and avoid interference
w i t h needed production.
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11. Do you believe that there is any conflict between measures to
restrain excess demand by monetary means and the need for expanding the economy to meet the requirements of a continuing
readiness to resist aggression and a continuing high standard
of living? I f so, how can the effects of this conflict be mitigated ?
The choice of the several means employed to hold down demand,
and decisions concerning the intensity of their application, must be
made w i t h reference to two facts: (1) demand at some times is an
engine of inflation; and (2) demand at all times supplies the driving
force necessary for production. I n a free economy, private demand
is the principal determinant of the character and volume of output.
Unless demand is sustained at an adequately high level, businessmen
w i l l not make f u l l use of existing facilities and available labor to t u r n
out goods, and w i l l not add to the productive capacity of the Nation.
I f the economy is to grow, demand must be permitted to grow. I f
demand is restrained generally i n the effort to attain the stability
objective, the objective of expanding production may suffer f r o m the
impact of that restraint. I t is difficult to determine, of course, the level
of demand that would attain the desired degree of stability and at the
same time would make possible desired expansion. I t is probable that
at times demand great enough to achieve high production and expansion goals may involve inflationary pressures, since i n order to
expand output, demand must be strong enough to overcome the frictions which result from the fact that resources and labor do not have
perfect mobility.
When demand is i n excess of available supply, some demand must
be curtailed—either Government demand, or demand for plant, equipment, inventory accumulation, and housing, or consumer demand. I f
this curtailment of excess demand is not accomplished by restrictive
policies, i t w i l l be curtailed by the effect of an inflationary price rise.
I f the only objective of Government policy were to combat inflation, i t would not make much difference which k i n d of demand
was curtailed. This, however, is not the present situation. I n the
present situation, the purpose of combating inflation must be reconciled, as the question states, w i t h the purposes of economic expansion "to meet the requirements of a continuing readiness to resist
aggression and a continuing high standard of l i v i n g . " From the
viewpoint of achieving these objectives, there are higher priority
demands for goods and services that are necessary to the achievement of the objectives and lower priority demands for goods and
services that make little or no contribution to achieving the objectives.
Reconciling the fight against inflation and the pursuit of other vital
programs requires that the lower priority demands be curtailed and
the higher p r i o r i t y demands be impeded as little as possible.
Drastic general credit restrictions would possibly curtail some
speculative inventory accumulation and low priority construction,
but at the same time would possibly also curtail some vitally important expansion of defense-supporting industries, construction of
houses i n defense areas, and purchases of raw materials by munitions
producing industries. On the other hand, general credit restrictions
would not touch at all those low priority demands that are financed
not by credit but out of consumers' or businesses' own resources. The
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT874
fact that credit expansion serves as a vehicle for inflation does not
necessarily mean that i t is only credit-financed demand which should
be regarded as inflationary and should be curtailed.
I t follows that combating inflation at a time when some economic
expansion is needed cannot be accomplished by means of general
monetary or credit restrictions alone, but only by a combination of
policies. Such a combination of policies should include, of course,
some general tightening of credit, but not such a severe tightening
that high priority activities would be impaired or that over-all employment and production would be cut sharply. Such severe tightening to be sure would reduce inflationary pressures but i t would also
imperil the security and productivity of the economy. To the extent
that credit must be restrained, i t should be done i n a selective manner. This suggests the use of selective credit controls, but also the
use of programs like the Voluntary Credit Eestraint Program which
can be operated in a selective manner. More important, credit policies must be complemented by allocations, limitations, and similar
physical controls.
Because of the complex nature of the current situation, the Council
of Economic Advisers has repeatedly insisted that a wide range of
tools must be used i n workable proportion to reallocate resources and
effort, to stimulate some lines of activity, and at the same time to
contract others.
The resort to physical controls as a method of restraint is justified
only under conditions of war or a large defense program. B u t even
under more ordinary circumstances, the selection among various economic policies involves the evaluation of competing objectives. For
example, a tax policy that would be desirable i f only revenues were
to be considered may not be desirable from the viewpoint of incentives
or equity. Or, an antitrust policy which might be appropriate i f the
sole objective were to encourage small business might not be appropriate when the economy also needs many of the qualifications of big
business. While these competing objectives always exist, they are perhaps never so acute as when a defense emergency confronts the Nation
at once w i t h the imperative need to fight inflation and the imperative
need to bring about that extraordinary utilization of manpower and
other resources which i n its immediate impact may add to the inflation.
While there are no perfect guides to the correct admixture of this
wide variety of policies toward a wide variety of ends, i t is clear that
the policies can be most effective when the objectives sought are defined
as quickly and clearly as feasible. I n order to know how far a generally restrictive credit policy can be pushed without impairing necessary production, there must be some quantification of the main lines
of production which are most needed for the defense effort and for a
strong economy, set off against the lines of production which we can
afford to contract without serious impairment. This quantification,
in turn, depends upon increasing clarification of the size of primary
military objectives, stockpiling, industrial build-up, international
commitments, and satisfiable consumer demand i n the face of these
other requirements. Thus a consistent and improved programming of
available supply and competing requirements is essential to improved
decision w i t h respect to the various types of economic policy which
may be applied effectively. A t that stage i n the process where the
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875
problem of restraining total demand seems more urgent than the
problem of selective expansion, relatively greater weight can be given
to general credit contraction and heavier general taxation; where the
greater urgency seems to shift toward selective expansion, more selective control measures are needed to allocate resources rapidly i n that
direction and correspondingly to cut down the competing use of
resources.
12. What do you believe to be the role of bank examination and supervision i n furthering the objectives of the Employment Act?
I n contrast to general credit policy, which aims to prevent swings i n
the total volume of credit which would have a destabilizing influence
on the economy, bank examination and supervision policies are directed
toward maintaining the soundness of individual banks. Inasmuch as
sound banks are a basic institution of a prosperous economy, bank
examination and supervision activities further the objectives of the
Employment Act. I n addition, these activities can help reduce cyclical fluctuations and thereby aid in the maintenance of maximum levels
of employment, production, and purchasing power. For instance,
during periods of inflation, emphasis on sound banking practices may
encourage the banker to discount inflated prices, w i t h the result that
he may grant a smaller volume of loans than i f his attention were not
directed to the risks of price declines.
Bank examination and supervision should seek'to prevent general
fluctuations i n the market values of assets from having disruptive
effects on the aggregate loan volume. This objective was aided by the
decision of the F D I C and other supervisory agencies to allow banks
to carry high-grade investments in their statements at values reflecting
their ultimate worth rather than volatile market prices. The policy
of judging the soundness of a bank on a long-run basis, which is
implicit i n accepted methods of valuing securities, might find other
applications. Provided there is no threat to the interests of depositors,
temporary declines i n the book value of a bank's assets or
its liquidity, when these declines arise from general business conditions, should not serve as the basis for interfering with the bank's lending activities. ' I t may be best for the bank, the community, and the
economy to make financial aid readily available to the bank i n such
cases, in order to permit i t to continue its normal lending operations.
As a general policy, bank examination procedure should look at the
average value of assets over depression and prosperity periods and
should impose basically the same standards i n both depression and
prosperity. Flexible standards, designed to aid stabilization policy by
being made tighter i n periods of inflation and maximum employment
than i n periods of unemployment, do not appear to be administratively
feasible. Furthermore, bank confidence i n the judgment of examiners
and supervisory authorities would not be enhanced i f these officials
approved today what they had disapproved yesterday.
13A. Discuss the economic functions of bank reserve requirements.
A traditional function of bank reserve requirements is to assure a
degree of liquidity and solvency i n individual banks. The contribution that the required reserves might make to liquidity is largely
negated by the restrictions placed on their use. The bank is penalized
MONETARY POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT876
for using its legal reserves to meet the claims of its depositors, and is
made to appear to be in an unsound condition whenever its reserves f a l l
below a rather arbitrary statutory minimum. Resultant suspicions
about its ability to pay may lead to heavier withdrawals, and further
impairment of its liquidity. Moreover, the practical necessities of
banking operations would force banks to hold cash and other liquid
assets, even i f there were no legal requirements. Legal requirements
may even lead some banks to carry lower reserves than they would
otherwise, since minimum standards are frequently interpreted as
optimum standards.
Bank reserve requirements also make a contribution toward keeping
a bank solvent. Since the reserves are a fraction of total liabilities,
however, the solvency of the typical bank is much more largely determined by the quality of its loans and investments than by its legally
required reserves. Moreover, the solvency of the individual bank is
largely dependent on the general economic situation existing i n the
country. A bank reserve requirement which contributes to economic
stability is likely to be more of a protection to depositors and other
creditors of individual banks than are reserve requirements aimed
solely at the liquidity or solvency of the individual bank.
I t is for this reason that the primary economic function of bank
reserve requirements today is to serve as an instrument of controlling
the volume of credit. The principle underlying this control is that
changing the ratio of reserves to bank deposits alters the total amount
of deposits that can be supported by a given amount of reserves. Since
deposits are chiefly created by bank loans, raising reserve ratios restricts bank lending power, and lowering reserve ratios expands bank
lending power. A n increase i n cash reserve requirements can also be
used to offset increases i n lending power arising from net gold imports
or Federal Reserve bank acquisitions of Government securities.
Because of their original function of maintaining liquidity, reserve
requirements are generally related to bank deposits. However, where
reserve requirements are used as a tool of credit policy, i t is possible
to relate reserves not only to deposits but to assets. There appear to be
several advantages i n using assets as a base for reserve ratios. When
an individual bank expands its loans, its assets held i n this form necessarily rise but its deposits may not, because of shifts of deposits to
other banks. I f a bank's required reserves were increased by some percent of the rise i n the dollar value of its outstanding loans, i t might be
more effectively discouraged from expanding loans than i t would be by
an increase i n reserve requirements which are related to deposits.
Moreover, when reserve ratios are based on deposits, an increase in
required reserves affects all banks whether or not they have been expanding their loans. Relating reserves to assets would also permit reserve requirements to be applied selectively. For example, higher
reserves might be required w i t h respect to the increase of a particular
class of a bank's loans or investments.
I n recent years purchases of Government obligations by Federal
Reserve banks have been the largest source of new commercial bank
reserves. I t has become necessary to find ways either to restrain the
movement of Government securities to Federal Reserve banks, or to
l i m i t the volume of bank lending made possible by such transfers,
without at the same time interfering unduly w i t h Treasury financing
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or refinancing operations. Reserve requirements appear to be a promising means of easing the task of reconciling credit and debt
management policies. I f regulations permitted banks to carry specified earning assets i n their reserves, such as certain types of Government securities, banks would have an incentive to hold these assets.
The merit of such reserve requirements as a tool of credit policy
is that they would be useful both i n checking transfers of Government obligations to Federal Reserve banks and in offsetting resultant
increases i n bank cash reserves, w i t h a minimum of disturbance i n the
market for Government securities.
13B. What suggestions, i f any, do you have for changes i n either the
nature, applicability, or amount of existing requirements? I f
you consider that each of several proposals for change has
important elements of attraction, discuss each.
Several changes i n the authority of the Board of Governors over
reserve requirements appear to be desirable i f the potentialities of
these requirements as a tool of credit policy are to be f u l l y realized.
Flexibility and discretion seem preferable to r i g i d regulations that
leave no room for administrative judgment. A n d the substance of
reserves and the bases employed i n setting reserve ratios should be
reconsidered i n the light of the policy function. I t is not suggested
that the reserve structure be completely rebuilt i n an effort to make
reserve requirements serve solely as an aid to policy, w i t h no consideration of the liquidity objective. F o r one thing, our long tradition of
liquidity reserves would make a drastic remodeling impractical. I t
is suggested, rather, that since the policy function is the principal
one now requiring attention, the existing system of requirements be
reexamined, and modified i n a manner that would make i t a more valuable tool to control the volume and the character of bank lending.
The Council offers the following suggestions :
(1) The Board of Governors should receive an increase i n authority
over reserve requirements that would give i t considerable latitude
i n determining the amount and content of reserves, and the bases to
which reserves may be related. A n increase i n authority is very desirable because the Board has nearly exhausted its present power to
l i f t reserves, and inflationary credit expansion may again become a
threat to the economy. Latitude i n the use of such power is desirable
for many reasons. The exercise of the Board's power over other
weapons of general credit policy is not held to a narrow range by
law. Each stabilization problem w i t h which the Board must,deal
is novel, and each calls for a different combination of credit measures.
A reserve formula suitable i n one situation might be inappropriate i n
another.
So that the Board may be more f u l l y prepared to cope w i t h various
problems of control, its authority over reserves should include the
r i g h t to permit banks to carry in their legal reserves Government
securities to be specified by the Board. This device, which the Council
has frequently recommended, would be an important addition to the
means by which objectives of credit policy and debt management can
be reconciled. The Board should also be authorized to require that at
least a portion of legal reserves be related to changes i n the volume
of classes of assets to be designated by the Board.
M O N E T A R Y POLICY AND M A N A G E M E N T OF PUBLICt)EBT878
(2) The Board's discretionary authority should include the right
to classify banks and bank deposits for reserve purposes. Administrative instead of statutory determination of such matters would
make i t possible to end the present classification of member banks on
the basis of location, which is an illogical vestige of banking practices and customs that no longer exist. I t would also permit deposits
to be defined and classified i n a manner most suitable to attainment
of the purposes of reserve requirements.
(3) F o r the most effective use of reserve requirements i n credit
policy, all commercial banks should be subject to reserve requirements
comparable to those imposed by the Board of Governors. A t present
the reserves of about half of the Nation's banks cannot be regulated by the Board of Governors. This nonmember group owns only
about 15 percent of total bank resources, and the effectiveness of the
Board's reserve requirements may not seem to be greatly impaired with
this small percentage of the banking business not obliged to observe
them. B u t i t is probable that any considerable increase i n reserve
requirements for member banks would raise the number of nonmember
banks.
14. Have you any suggestions other than those implied i n the answer
to the preceding question for insulating public debt securities
from the impact of restrictive credit policies designed primarily
to discourage the growth of private debt ?
Complete insulation of public debt securities from the impact of
restrictive policies would be possible only i f we could have a debt that
consisted entirely of nonmarketable, nonredeemable obligations.
Total insulation of the debt by this means, however, is not feasible since
the demand of individuals and private institutions for this kind of
security would scarcely be substantial even at considerably higher
rates of interest than were paid on other securities. The only practical
opportunity for increasing the volume of nonmarketable, nonredeemable securities is offered by the Government trust funds which at
present are the only holders of obligations having virtually these characteristics. I f social security programs were expanded as suggested
in the answer to question 17, larger contributions would add to the
trust funds and make possible the issuance of more of the special securities i n which most Government trust funds are invested. These
issues are nonmarketable, nonredeemable i n effect, and they are affected by measures of credit restraint only insofar as these measures
lead to changes i n the average rate of interest on the public debt. The
interest rate on some of the special issues, according to law, is
determined by the average rate on the interest-bearing public debt.
Another method to withdraw more of the privately held Government debt farther away from the influence of restrictive credit policies is to place as much of the debt as possible i n long-term nonmarketable, redeemable securities. The redemption value of these securities
is not affected by movements of prices and yields i n the market for
Government obligations. However, the fact that they can be redeemed, although at a sacrifice, makes the attractiveness of holding them somewhat dependent on the financial markets. Accordingly, they are not f u l l y insulated from the effects of major credit
restrictions.
MONETARY POLICY AND M A N A G E M E N T OF P U B L I C
t)EBT
879
I t was pointed out i n the answer to question 13 that i t might be
desirable to allow commercial banks to carry some Government securities i n their required reserves. While the holding of Government
obligations in reserves would not remove those obligations from the
impact of changes i n market prices and yields resulting from measures
of credit restraint, i t would help to prevent Government securities
from shifting i n ownership i n a manner that interfered w i t h the success of credit policy. A more complete insulation of securities held
by banks could be achieved by requiring banks to hold part of their
reserves in the form of special nonmarketable, redeemable securities
made available i n limited quantities for reserve purposes only.
Selective credit controls can be used to reduce certain kinds of private loans without interfering w i t h the market for Government obligations. Priorities and allocations of materials, by restricting investment outlets, similarly may reduce or restrict private loans without
adverse effect on the Government securities market.
15. To what extent is the demand for Government securities by nonbank investors influenced by (a) the current level of interest
rates, (b) expectations w i t h respect to changes i n interest rates,
(c) other factors?
I t is doubtful i f the absolute rate of interest has much effect on the
demand for Government securities by nonbank investors, although
conceivably interest rates might reach such a low point that investors
would prefer to hold their funds in cash than to purchase securities.
The relative rate of interest offered by Government compared
w i t h rates being paid by private borrowers undoubtedly has important
effects on the demand for Government securities. The extent of these
effects depends on the alternatives available to the investor.
(1) Though individuals give less consideration to interest rates
than do institutional investors, a continuing and well publicized
opportunity to receive higher rates of return on savings placed i n
banking and similar institutions offering high degrees of safety to
funds entrusted to them, might in time substantially reduce the demand for Government obligations paying lower rates. Individuals
i n lower income classes probably respond less rapidly and to a lesser
extent than those in higher income brackets to chances of obtaining
higher interest rates from alternative forms of investment.
(2) Since there are relatively few short-term securities available
other than short-term Government obligations, nonfinancial corporations desiring to invest in short-term securities cannot move a great
volume of funds from Government to private securities, whatever the
interest rate on the latter. The demand of these nonfinancial corporations for short-term Governments might be more substantially curtailed i f interest rates on time accounts in commercial banks were
comparatively more attractive.
(3) Large individual investors and institutional investors i n longterm securities would be most likely to have competing outlets for
their funds and would accordingly be most affected by changes i n relative rates of interest.
I f interest rates were expected to rise beyond current levels, purchases of all except short-term Government securities would be discouraged. Great uncertainty about the direction of future changes
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT880
i n interest rates might likewise lead many investors to place funds i n
short-term obligations while they awaited clearer signs of future
trends. On the other hand, an expectation that long-term rates were
about to decline would stimulate the purchase of long-term Government securities.
There are many other factors besides interest rates which affect the
demand of nonbank investors for Government obligations:
(1) Both . i i v i d u a l and institutional investors may desire a high
degree of liquidity, i n the f o r m either of a stable market for salable
obligations or the right to redeem nonmarketable securities on demand,
or on very short notice. I f investors expected wirV fluctuations i n
prices and yields on long-term marketables, they m ^ i i t prefer to place
their funds i n short-term obligations paying lower rates of interest.
Likewise, the demand for nonmarketable securities that could not be
easily and quickly redeemed at the w i l l of the holder at any time
soon after their purchase, would probably not be great.
(2) Investors wTho are likely to buy Government bonds seek a
safe investment, one that is an obligation of a debtor who w i l l be financially able to pay. Individual savers i n lower income classes are especially concerned about safety because they can little afford to take
risks. Likewise they are not usually i n a position to evaluate different
degrees of risk. Investors i n this group have therefore understandably shown a decided preference for obligations of the Government,
the safety of. which no one questions. However, the development of
alternate outlets for savings that provide virtually equal assurance of
safety may i n time divert more funds of small investors f r o m Government obligations. The insurance of bank deposits and of deposits or
shares i n savings and loan associations are illustrations of measures
by which the Government increases the comparative attractiveness of
some types of private obligations.
(3) The demand for Government obligations, like that for all similar liquid assets, is influenced by inflation. Should expectations of
a chronic or uncontrollable inflation ever be allowed to become widespread, then the certainty that Government obligations w i l l be paid,
liberal redemption features, and even high interest rates might not be
sufficient to maintain the desired market for Government securities
among nonbank buyers. The demand for Government obligations by
individual investors, who are more directly concerned w i t h the buying
power of the holdings, is undoubtedly influenced more by expectations
of inflation than is the demand of institutional buyers whose obligations are of fixed dollar amounts.
(4) The demand of nonbank investors for Government securities, of
course, is influenced also by the volume of lendable funds at their disposal and by the availability of other investment outlets.
16. What advantages do you see i n a stable long-term Government
bond market? What weight should be given to the desirability
of stability i n the Government bond market i n determining
credit policy under each of the assumptions w i t h respect to the
volume of Government borrowing stated i n question 8 ?
Stability of the long-term Government bond market is a relative
term, which can be best defined by noting the different kinds or degrees
of movements i n bond prices which may take place. A t the one ex-
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C DEBT
881
treme there may be no change in the prices and market yields of longterm Government bonds because prices have been pegged. Second,
the market prices may fluctuate moderately around some level of prices.
Third, prices likewise may fluctuate moderately, but move gradually
i n either an upward or downward direction. Fourth, market prices
may fluctuate wildly.
The first of these conditions we would consider a r i g i d or absolutely
stable market i f prices were supported at the pegged level over a long
period of time; the second, we would consider a practically stable market ; the third, an orderly market; and the fourth, a disorderly market.
Of importance i n characterizing the nature of the market is not only
what actually has happened to prices but also the expectations of the
public regarding future price changes, including expectations regarding actions by the Federal Reserve or the Treasury. Ordinarily, price
behavior, both current and anticipated, is closely related to Government policy. For instance, a r i g i d market is one in which prices not
only remain unchanged, but also one i n which i t is expected that,
through a Government support policy, price changes w i l l be prevented.
I n a stable market, the public is not certain that bonds can always be
sold at a fixed price, but is assured that, i f necessary, the Federal
Reserve System or Treasury w i l l prevent major price changes. The
same applies, w i t h proper modification, to the expectation of an orderly
market. A disorderly market implies that the public does not expect
any official intervention, irrespective of what happens to prices. A
free market, of course, is not necessarily a disorderly market.
The volume of marketable long-term Government issues is large,
but i t is less than one-fifth of the Federal debt available to the public,
and, of course, a much smaller percent of the total amount of debt that
is influenced by forces spreading out from the long-term bond market.
I f we define long-term bonds to include those securities which reach
their maturity or first call date more than 5 years i n the future, there
are outstanding about $41 billion par value of marketable long-term
securities. Of these, $5 billion are bank-eligible and $36 billion are not,
although the great majority of these w i l l become bank-eligible over
the next 3 years. More than five-sixths of the bank-eligible issues are
held by commercial banks. Insurance companies and mutual savings
banks are the largest holders of the bank-restricted issues, although
nearly 40 percent are held by private investors other than the major
financial institutions and about 15 percent are held by Federal Reserve
banks and United States Government investment accounts.
The significance of conditions i n the market for long-term Government bonds is magnified by the fact that changes i n prices and yields
on these securities are interrelated w i t h changes i n prices and yields on
other securities, both public and private. The market prices of longterm Government securities eventually affect i n various ways all
other issues, including short-term marketables and nonmarketable securities. For example, a prolonged upward movement i n yields on
long-term bonds would require changes i n the terms of new issues of
nonmarketables. A n important relationship is the reciprocal one between movements i n prices and yields on long-term Government bonds
and prices and yields on corporate and State and local government
securities, a relationship that w i l l continue as long as a large part of
the public debt is not insulated against the impact of credit policy.
98454—52—pt. 2—^—16
MONETARY POLICY AND M A N A G E M E N T OF PUBLICt)EBT882
Because of this connection, support operations i n the Government
bond market are one of the factors that influence the entire structure of
interest rates, and thus affect private as well as public-investment
projects needed for economic growth.
A stable market for long-term Government bonds has important
values for f1 bt management. Bond market stability, by reducing
speculative
encourages the sale and continued ownership of
long-term Government bonds outside the banking system, and thereby
contributes to economic stability. B y reducing the risks of holding
them, a stable market adds to the attractiveness o* ]ong-term bonds
and thus permits their issuance at lower rates o^ i r erest than would
otherwise be possible. The objective of holdiu, down the rates of
interest paid on Government securities is desirable, since an increase
i n interest rates would increase the cost of Government. For example, an average increased rate of one-half percent i n the interest paid
on the Federal debt would amount to approximately $l 1 / 4 billion
a year when the increase i n rate became f u l l y effective on all debt.
A stable bond market has other advantages. I t helps to uphold the
credit of the Government, and the Government's credit has an important bearing on international relations, as well as on the success of the
Treasury i n financing operations. Furthermore, the purchasers of
Government securities are protected against substantial loss i f the
bond market is stable, which is valuable for the maintenance of internal morale. Lastly, a stable market for long-term Government
bonds has the advantage of making i t easier to assure that interest
rates on long-term loans in general w i l l remain at levels required for
economic expansion. As has been pointed out, a stable market for
Government bonds is conducive to stability i n the markets for other
securities, private as well as public. Increases i n interest rates might
give rise to speculative movements that forced interest rates still
higher, u n t i l they reached a level that interfered seriously w i t h the
future ability of the economy to produce and to expand its productive
capacity. While the increase i n interest rates might be intended as
temporary, i t would tend to be perpetuated since, after investors have
become used to higher rates, they are only gradually persuaded to
accept lower rates.
On the other hand, although stability i n the market for long-term
Government bonds is generally considered desirable, objection has
been raised to efforts to bring that stability about by support operations. These support operations can be carried out through purchases
and sales by the Federal Reserve System, and, to a limited extent,
through transactions of Government trust accounts. I t has been
argued that a policy of' price maintenance, when extended to all marketable Government securities and continued indefinitely, practically
erases the difference between long-term and short-term obligations,
and makes any considerable spread i n interest rates or yields discriminatory and costly to the Government. The buyer of long-term
bonds may receive a relatively higher rate of interest, while at the
same time his investment is virtually as liquid as cash. Under such
conditions the Government pays a long-term price for short-term
money, while the liquidity of security holders is increased.
This argument, which relates to only one factor i n the total picture,
appears to be most applicable to a r i g i d and absolutely stable market
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
t)EBT
883
with pegged prices; i t applies with leaser force to a practically stable
market, as previously defined. The moderate fluctuations of prices
i n a stable long-term Government bond market constitute an element
of risk to the investor. As distinct from a pegged market, a stable
market does not make long-term bonds the equivalent of cash. B y
offering some protection to the Government against large-scale "dumpi n g " of securities, a stable market justifies a moderate spread between
short-term and long-term yields.
I t is also argued that supports - f he bond market limits or makes
impossible Federal Reserve System a. ; alationary open-market operations. D u r i n g a period of inflationary pressures accompanied by
strong demand for private credit, the action indicated for the Federal
Reserve would be to sell Government securities on the open market and
thereby reduce bank reserves and bank lending power; or at least the
Federal Reserve should not buy Government securities and thereby
increase bank lending power. W i t h the pressure for private loans very
strong, however, banks and other lending institutions are tempted to
sell Government securities i n order to secure funds to make such loans.
I f the market for Government securities is maintained at a fixed price,
i t w i l l be necessary for the Federal Reserve to buy these securities
when they are offered. As a result, bank reserves and bank lending
power are expanded at a time when they should be contracted?
However, i f the Federal Reserve System maintains the kind of
stable market that has only moderate fluctuations but does not assure
fixed prices, some anti-inflationary use of open-market operations is
possible. I n this case, the Federal Reserve banks would probably
have to make net purchases of Government securities during periods
of strong demand for private loans, but the amount of the purchases
might be relatively small. The support methods involved i n such an
operation have not been definitively tested but i t seems probable that
relatively stable prices can be maintained without the Federal Reserve purchasing all securities offered and that the prospect of even
moderate losses keeps some prospective sellers out of the market.
Nevertheless, while Federal Reserve purchases of Government securities may be less under these conditions than when prices are pegged,
i t must be recognized that the maintenance of either k i n d of stable
market for Government securities limits, under some circumstances,
the use of open-market operations for restraining credit and combating inflation. I n view of the other factors l i m i t i n g the use of a t r u l y
flexible open-market policy for anti-inflationary purposes during the
foreseeable future, we discount extreme claims made by some economists as to the degree of importance to be attached to which of these
alternatives is followed. There is room for variance of opinion concerning their relative merits.
Support operations i n the Government securities market have a
bearing on the lending activities of banks and other financial institutions mainly because such operations influence one source of lendable
funds, but also, i n part, because they affect the liquidity of the lender.
When prices of securities are pegged and this is expected to continue,
financial institutions can maintain desired degrees of liquidity partly
by holding long-term Government obligations, since these could readily
be converted into cash without loss. W i t h stable prices that showed
some flexibility of movement, however, the liquidity of many institu-
M O N E T A R Y POLICY AND M A N A G E M E N T OF P U B L I Ct)EBT884
tions would be less than i n the previous case, since long-term Government obligations could not be looked upon as the equivalent of cash.
T o achieve desired liquidity, these institutions would need to hold
more cash and short-term securities than when the Government bond
market was pegged. The lending of the institutions accordingly
would be affected.
The argument that the support of the long-term Government bond
market inhibits the Federal Reserve System's use of its strongest instrument of general credit restraint is a matter of concern only i n
certain economic situations. Obviously, at times when inflationary
conditions do not exist, the several advantages of a stable bond market
can be sought, through support operations i f necessary, without any
conflict w i t h measures that are used to check the expansion of credit.
Again, i n the case of all-out war, the problem might actually be less
serious than under other circumstances. Conditions of all-out war
would probably mean that relatively little nonmilitary investment
was going forward. W i t h private outlets for lendable funds narrowly
restricted, the objective of maintaining a stable Government bond
market would be less complicated by the need of using open-market
operations to curb private credit expansion.
The question of the conflict between efforts to stabilize the bond
market and the employment of open-market operations to maintain
economic stability is of significance primarily i n a period i n which
inflationary pressures and private demands f o r credit are strong, and
substantial Treasury refunding or new borrowing is necessary. I n
this conjuncture, the case for a stable bond market is particularly
strong because i t is an important objective of debt management to
place firmly the largest possible quantity of long-term Government
obligations i n the holdings of individuals and institutions other than
banks. Of course, the importance of stability i n the long-term market would depend to a considerable extent on whether any long-term
funds would be seeking investment under any market conditions. The
desirability of maintaining a stable market for long-term securities
is less i f no long-term funds would be available i n any event than i f
investors held such funds and would purchase long-term bonds under
conditions of stable prices but not otherwise.
When inflationary credit expansion is taking place, the case for aii
anti-inflationary open-market policy often is strongly urged even
i f i t coincided w i t h substantial Treasury refunding or new borrowing. Those who believe that drastic credit restraint is the
most appropriate method for combating inflation, irrespective of its
cause and character, w i l l be inclined to conclude that the use of openmarket operations is indispensable for this purpose, and that other
objectives of Government should be subordinated. The Council cannot follow this reasoning. The Council believes that each inflationary
situation requires a different strategy of counteraction, and that openmarket operations, while an important instrument, are by no means
the answer i n every case of inflation. For example, i n the answer to
question 11, the Council pointed out why i t believes that under the
conditions of the defense program a drastic unselective credit restraint
could do harm to the needed expansion i n defense-related industries.
Moderation and, particularly, adaptation of credit restraints to the
specific conditions are necessary i f interference w i t h the defense program is to be avoided.
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC
DEBT
885 ^
I t should also be borne i n m i n d t h a t stability i n the price of Government bonds under many circumstances operates to keep the debt i n
private hands and to encourage private purchases of additional debt,
and to t h a t extent, the stability of bond prices is i n itself a stabilizing
factor i n the economy. The maintenance of a stable long-term bond
market may have a more quieting effect than w o u l d monetary policy
steps t h a t resulted i n a decline i n the price of long-term Government
bonds and efforts on the p a r t of the bondholders to dispose of them
before the market f e l l even f u r t h e r , since i n the process of preventing
a disorderly m a r k e t the Federal Reserve m i g h t find itself obliged to
purchase larger amounts than i f stability had been continued.
I t is also necessary to consider the effect of higher interest rates,
that w o u l d f o l l o w the employment of open-market operations to restrict private credit, on production, and on the g r o w t h of productive
capacity i n later years. Success i n curbing a current rise i n the
volume of loans m i g h t be bought at the price of a tenacious level of
higher interest rates t h a t would be an obstacle to f u t u r e economic
expansion.
I f the use of open-market operations to h o l d down lending t o private
borrowers were thought more i m p o r t a n t than the maintenance of a
stable market f o r long-term Government bonds at a time when the
Treasury was engaged i n b o r r o w i n g substantial sums of new money,
the Goverifment would be forced into an interest rate race w i t h private
borrowers. The Government m i g h t have to offer higher and higher
rates of interest to sell securities. Undoubtedly under some circumstances a small increase w o u l d be sufficient. B u t when private demand
f o r loans was strong, this competition f o r funds w o u l d be an effective
means of combating inflation over any continuing period of time only
i f the private demand f o r credit were thereby substantially reduced
or i f private lenders turned f r o m private loans, even at the loss of the
higher interest that they m i g h t receive. A s we point out i n response
to question 7, we believe t h a t a rise i n interest rates has only a l i m i t e d
effect on the private demand f o r credit. W i t h a continuation of
strong private demand f o r credit, the Government m i g h t have to pay a
disproportionately h i g h price f o r an uncertain contribution t o economic stability.
Another basic p o i n t to be borne i n m i n d is the close interrelation
between the demands f o r private credit and the stability of the Government bond market. I f , instead of achieving a restriction of p r i vate credit t h r o u g h open-market operations i n Government securities,
private credit were restrained i n other ways, any conflict between
economic stability and the stability of the Government bond market
would largely disappear. I t is f o r these reasons t h a t we have placed
stress on the increase i n reserve requirements and on other ways f o r
h o l d i n g down private credit.
I n summary, the advantages and disadvantages of m a i n t a i n i n g a
stable market f o r long-term Government bonds under inflationary
conditions when demand f o r private credit is very strong must be
judged i n the l i g h t of a l l the circumstances, including the availability
of other measures to cope w i t h the inflationary threat. D u r i n g the
defense period, when large refundings and new financing w i l l be necessary, we believe t h a t great weight should be given to the maintenance
of stability i n the Government bond market. I f other measures of
MONETARY POLICY AND M A N A G E M E N T OF P U B L I CDEBT886^
restraint are availed of, bond market stability is to a large extent consistent w i t h and even complementary t o the objective of economic
stability f o r the whole economy.
17. Under w h a t conditions, i f any, do you believe i t would be desirable
to resort to compulsory methods i n the sale of Government
securities to (a) banks, (&) other financial institutions, (e)
other corporations, (d) individuals? Discuss the philosophy
w h i c h underlies your views on this matter.
Compulsory lending has some characteristics of taxation and some
characteristics of voluntary lending. L i k e taxation, i t compels persons to surrender purchasing power. B u t the person who surrenders
the purchasing power is given a receipt i n w h i c h the Government
promises to repay at a later time. Because of the promise to repay,
compulsory lending has some characteristics of Government borrowing. I t adds to Government indebtedness either i n the f o r m of a book
credit or some k i n d of bond or note issued to the lender.
The use of compulsory lending appears to have certain advantages
over either taxation or voluntary b o r r o w i n g f r o m the p o i n t of view
of the taxpayer and the p o i n t of view of the Government. F o r the
taxpayer, i t is an obvious advantage t o be reimbursed f o r at least a
p a r t of his present payments. A s contrasted w i t h v o l u n t a r y lending,
the person who i n an emergency patriotically is w i l l i n g to forego present consumption may welcome the knowledge t h a t everybody is cont r i b u t i n g according t o some measurement of a b i l i t y to pay. Particul a r l y , some people may prefer legal compulsion to the social compulsion of a high-pressure campaign.
F o r the Government, compulsory saving has the advantage over
v o l u n t a r y saving t h a t w i t h i n l i m i t s the amount can be determined
according to requirements and does not depend on the people's volunt a r y cooperation, and also t h a t the terms of the loans can be determined by the requirements and purposes of the Government rather
than by the wishes of the buyer. F i n a l l y , the Government can cont r o l the time of repayment and thereby t r y to prevent r e t u r n of the
funds at times when they m i g h t add to inflationary spending.
I n spite of these apparant advantages of compulsory lending, we
believe t h a t as a general principle taxes should be used as a compulsory method of f u n d raising and the voluntary purchase of Government securities as a method of borrowing. The greatest possible
amount of the public's compulsory contribution should be i n the f o r m
of taxes—taxes i n the t r a d i t i o n a l sense w i t h no provision f o r repayment. A large volume of Government obligations, whether placed
i n the hands of investors by compulsory or voluntary sale, is a reservoir of purchasing power f o r f u t u r e spending. I t is sometimes urged
t h a t this w o u l d be an advantage of compulsory lending, since the
Government could support purchasing power by repaying the loans
d u r i n g periods when demand was inadequate to support a h i g h level
of employment and-business activity. One difficulty is t h a t popular
demand m i g h t force redemption d u r i n g a period of strong inflationary
pressure. I f at some f u t u r e time economic conditions should require
t h a t consumer and business demand be stimulated, there exist other
means of monetary and fiscal policy which can be used.
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC DEBT
887 ^
The use of compulsory placement of Government securities could
be justified only under very exceptional conditions of a national
emergency, namely, when existing taxes and voluntary saving combined w i l l not b r i n g about the needed absorption of purchasing power;
and i f higher taxes (a) are not feasible, or ( i ) there is reason to
believe that additional taxes w i l l have an adverse effect on production
incentives, or (c) the l i m i t has been reached beyond w h i c h a f u r t h e r
increase i n taxes w i l l result i n irresistible demands f o r compensating
wage and salary increases. The best case can be made f o r a policy
of compulsory lending i f , i n addition, there is reason to believe t h a t
the emergency is of short duration and that the problem of postemergency redemption of bonds is not likely to add to post-emergency
inflation, but rather serve to support post-emergency stabilization
policy.
These conditions are not existent at the present time. W e are not
convinced t h a t we have reached the l i m i t s of taxation. W e also
believe that voluntary lending both by individuals and nonfinancial
corporations can be increased, and t h a t the willingness to lend w i l l
p a r t i c u l a r l y increase when restrictions on the supply of consumer
durable goods and business investment l i m i t the possibility of spendi n g by individuals and enterprises. Most of all, the present emergency
may possibly be of long duration, and the character of the postemergency situation is even more uncertain than that of the situation
after a war.
I n the present and prospective situation, an expanded social sec u r i t y system appears as the only defensible f o r m of increasing
lending by other t h a n voluntary means. Contributions f o r additional social security or special annuity benefits are more acceptable
to workers than additional taxes. Such contributions w o u l d offer
l i t t l e ground f o r compensating wage demands. Moreover, there is
no conflict between increasing payments f o r social security benefits
and i n t e n s i f y i n g the campaign f o r voluntary purchase of Government securities. A s social security payments are spread out over long
periods i n total amounts not subject to abrupt changes, this method
of compulsory lending does not present the problems of debt redempt i o n and of waves of spending that exist i n the case of other forms
of compulsory loans. W e emphasize t h a t this f o r m of compulsory
surrender of purchasing power is recommended only as an addition
to and not as a substitute f o r needed taxation.
W e see no reason f o r using compulsion to sell bonds to banks or
other financial institutions. T h e i r lending power can be directed tow a r d Government bonds by measures of credit control. I n addition, the purpose of compulsory lending is not so much to raise money
f o r Government expenditures as to reduce the spending power of consumers and business firms. The compulsory sale of bonds t o banks
and other financial investors would contribute l i t t l e to t h a t objective.
I t w o u l d not add directly to i n d i v i d u a l saving out of current income,
and i t would not significantly reduce private borrowing below levels
which could be obtained f r o m the use of other measures of credit policy.
Besides these reasons, the use of compulsory placement of bonds
w i t h banks and other private financial institutions w o u l d raise even
more administrative difficulties than the compulsory sale of securities
to individuals, because separate regulations would have to be d r a w n up
f o r each of the tnany classes of lending institutions, and numerous ad-
M O N E T A R Y POLICY A N D M A N A G E M E N T OF P U B L I C DEBT888^
justments and exceptions w o u l d have to be made because of variations among institutions i n each class.
I n connection w i t h the compulsory sale of bonds to banks, i t should
be noted t h a t the recommendation f o r changes i n bank reserve requirements, discussed i n the answer to question 13, includes the proposal to
permit banks to carry Government securities as p a r t of the legal reserve. W h i l e such permission w o u l d give banks an incentive to h o l d
Government securities, i t w o u l d not provide f o r compulsory purchase.
18. Discuss the merits and demerits of the proposal f o r the issuance
of a bond, the value of w h i c h w o u l d be guaranteed i n terms of
purchasing power.
A s a means of stimulating i n d i v i d u a l saving, a proposal has recently been made t h a t the Government issue bonds w h i c h are payable
at m a t u r i t y i n a sum of dollars h a v i n g the same t o t a l purchasing
power as the money p a i d f o r the bond. Because such a bond would be
bought m a i n l y as a safeguard against inflation, the proposal was t h a t
the bond carry a low or no interest rate. I n order to prevent specul a t i o n i n such bonds they were thought of as nonmarketable, and
redeemable above face value, i n the event of higher prices, only i f
held u n t i l m a t u r i t y . The proposal also provided a l i m i t f o r the
amount of such purchasing power bonds that could be bought by any
one person.
Such bonds m i g h t have considerable attraction at a t i m e when many
investors are concerned about the future value of the dollar. They
m i g h t attract some money t h a t otherwise would compete f o r commodities in-short supply, or that m i g h t be invested i n stocks and real estate
and other inflation hedges.
I n spite of the possible attractiveness and apparent equity of a
purchasing power bond, we cannot recommend its adoption under
present and foreseeable circumstances.
The issuance of a purchasing power bond would i m p l y a defeatist
attitude t o w a r d the problem of inflation. Widespread ownership of
purchasing power bonds w o u l d add another group to those who t h i n k
themselves sheltered f r o m the effects of inflation, and would weaken
public support of a stabilization program. Instead of m a k i n g preparation f o r the consequences of defeat i n the stabilization effort, i t is
more appropriate f o r the Government to marshal and improve its
resources of policy toward achieving economic stability. I t is too
early to concede t h a t stability cannot be attained. A c t u a l l y , while
people are Tery much concerned w i t h the price rise of many essential
commodities^ there are no indications t h a t there is a widespread fear
of a general deterioration of the dollar.
Purchasing power bonds w o u l d add another escalator to the
mechanism of inflation. The dynamic process of inflation is speeded
by the existing price and wage escalators t h a t cause one price rise to
lead to increases i n other prices. T h e most effective method f o r preventing escalation is to prevent or minimize the first i n i t i a l price rise.
Once prices have risen, escalation means t h a t the f u l l impact of an
accelerated price rise w i l l f a l l on those who are not protected. T o
p e r m i t prices to rise and t o t r y then to protect everybody against
inflation must result i n more r a p i d inflation, w i t h the threat of v i r u l e n t
inflation f r o m w h i c h nobody can find refuge. The advantage of at-
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC DEBT
889 ^
t r a c t i n g some additional saving would be f a r outweighed by the
aggravation of the inflationary spiral w h i c h m i g h t result f r o m that
saving.
The proposal f o r purchasing power bonds applies the principle only
to a l i m i t e d amount of bonds. The Government w o u l d thus add an
admittedly attractive feature to one type of security offered t o the
public i n competition w i t h other Government bonds and such other
forms of assets or contracts as currency, demand, time and savings
accounts, shares i n savings and loan associations, and l i f e insurance
policies. I t is very l i k e l y that great pressure would develop to extend
the purchasing power clause also to other investments, public and
private. The greater the number of persons who considered themselves shielded f r o m inflation, the greater w o u l d be the possibility
of its occurrence.
Besides the economic deficiencies of the proposal, its alleged equity
is more apparent than real. I t would be u n f a i r discrimination to protect a few investors at the expense of a l l taxpayers.
19. Discuss the advantages and disadvantages of marketable and nonmarketable securities (a) under present circumstances, (Z>) i n
the event of the necessity f o r substantial net Government
borrowing.
I n answering this question, we find i t necessary to treat separately
three different types of nonmarketable securities (leaving aside the
special issues sold to Government trust funds) :
(a) Nonmarketable redeemable securities, w h i c h are demand obligations of the savings bond type, nontransferable but cashable by the
holder at any time after a brief w a i t i n g period. The y i e l d is ordinari l y graduated according to the length of time the security is held, thus
p r o v i d i n g incentive to h o l d the security u n t i l the m a t u r i t y date.
(Treasury savings notes also belong i n this general category.)
(&) Nonmarketable convertible securities, which are nonredeemable, but convertible at the owner's request into lower-yielding marketable securities. The only time this type has been used was i n an
exchange offering i n M a r c h 1951.
(c) Nonmarketable nonredeemable, nonconvertible securities, which
must be held u n t i l m a t u r i t y (although provision m i g h t be made f o r
redemption under special circumstances). The Federal Government
has never made use of this type i n a public offering.
The advantages and disadvantages of the different types of securities should be considered both f r o m the viewpoint of the Treasury's
immediate interests and f r o m the viewpoint of the economy as a
whole. I t is also necessary to take into account the classes of investors
t h a t are l i k e l y to have lendable funds and the types of securities
i n w h i c h these investors w i l l be most interested. I t is an academic
gesture to develop types of securities that no one wishes to buy.
I t is easy to see w h y , f r o m the Treasury's standpoint, securities of
the nonredeemable, nonconvertible type offer i m p o r t a n t advantages
over other types, first, because the Treasury w o u l d be protected against
p a y i n g out cash on demand, and, second, because such securities w o u l d
be insulated f r o m the impact of general credit restrictions. ( I n the
latter connection, see the answer to question 14.) O n the other hand,
i t is d o u b t f u l t h a t i l l i q u i d securities of this type w o u l d find much of a
MONETARY POLICY AND M A N A G E M E N T OF PUBLIC DEBT890^
market, even i f ' t h e y carried substantially higher interest rates than
are p a i d on other securities. Compulsory placement would, of course,
be unacceptable, except possibly i n an all-out war situation.
The remaining types of nonmarketable securities provide more practicable alternatives to the conventional marketable issues. Sale of
nonmarketable redeemable securities t o individuals is a particularly
advantageous f o r m of Federal borrowing, under present circumstances
as w e l l as i n a period of more substantial net additional borrowing.
Such securities are attractive to individuals because of t h e i r demand
character, yet experience has shown t h a t most individuals are quite
cautious about redeeming them. The low interest yield t h a t is typical
of these securities when redemption occurs before the m a t u r i t y date
provides an incentive to h o l d them f o r the f u l l period, and i t also
makes i t unnecessary f o r the Government to pay long-term interest
rates f o r short-term money. F i n a l l y , i t should be observed t h a t the
savings-bond type of security, being both h i g h l y l i q u i d and riskproof
(apart f r o m the r i s k associated w i t h changes i n purchasing p o w e r ) ,
is the only type w h i c h is well adapted to the needs of the millions ox
small investors who would not o r d i n a r i l y consider p u t t i n g t h e i r savings i n t o securities. F o r this reason, the savings-bond type can serve
an anti-inflationary purpose much more so than other types can.
Nonmarketable redeemable securities, which are, i n essence, interestbearing demand deposits, are not a p a r t i c u l a r l y satisfactory means
of b o r r o w i n g f r o m investors other than individuals. U n l i k e i n d i v i d u a l investors, business concerns and financial institutions w o u l d show
no hesitancy i n unloading their holdings of redeemable securities
whenever more profitable investment opportunities appeared. The
Treasury would thus be under the constant threat of a sudden d r a i n on
its cash resources. The monetary authorities, too, w o u l d be handicapped because of the weakening of their control over the money
supply.
Marketable securities have an advantage i n that the Government is
protected against the necessity of p a y i n g out cash on demand p r i o r
to the m a t u r i t y date. They have the advantage, too, of being acceptable t o investors, provided the interest rate is i n line w i t h the market.
O n the other side of the ledger is the fact that, as the volume of outstanding marketable securities increases, there is a possibility of f u r ther impairment of monetary controls. The critical significance of
this consideration is developed elsewhere i n this questionnaire. (See
question 16.)
I t is difficult to appraise nonmarketable securities of the convertible
type, because of their rather novel character and because so much depends upon the market value of the securities offered i n exchange.
T h i s type has the characteristics of a compromise plan, since they provide the Treasury w i t h the advantages of a marketable issue and the
monetary authorities w i t h the advantages of a nonmarketable issue.
I t s attractiveness to investors depends upon the rate of interest and
the value of the conversion privilege. A s this privilege is made
more attractive, however, the advantages of nonmarketability become
less. On the whole, we t h i n k i t quite possible that the convertible type
can be developed into a useful instrument of debt-management policy,
f o r example, as a means of absorbing the funds t h a t w i l l be seeking
new investment outlets as private capital outlays are curtailed.
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C DEBT
891 ^
A continual aim of policy, while the possibility of renewed inflation
remains a real one, should be to place the largest possible volume of
securities outside the banking system. This suggests a careful tailo r i n g of marketable issues to serve the needs of nonbank investors.
I n the event of the necessity f o r large-scale borrowing, there
would be greater need to encourage purchases of savings-bond type
securities and to find ways of insulating the holdings of other investors f r o m the impact of restrictive credit policies. T h i s may call f o r
new types of securities.
20. W h a t new types of securities, i f any, do you believe should be
given serious consideration f o r use \a) under present conditions,
(b) i n the event of the necessity f o r substantial net Government
borrowing?
We have pointed out i n the answer to question 19 that the greatest
possible emphasis should be on securities which are placed outside
the banking system, and w h i c h the buyer is likely to hold. T h i s is
desirable under present conditions, w i t h the need f o r considerable
refinancing and some new financing, but i t would be even more desirable i f s t i l l heavier new financing should become necessary.
W e have, however, no recommendation f o r specific new types of
securities t h a t m i g h t be issued i n f u r t h e r i n g the attainment of this
objective.
D . DEPOSIT I N S U R A N C E
21. Discuss the advantages and disadvantages of extending Federal
deposit insurance to a l l deposits i n insured banks.
One advantage of extending Federal deposit insurance to a l l deposits is that i t would be a great step toward g i v i n g all forms of money
the f u l l protection t h a t seems to be a corollary of a government's
responsibility f o r the monetary system. I t has long been recognized
that one of the major responsibilities of a central government is to
establish a monetary system. T h a t function was performed i n early
times by p r o v i d i n g the public w i t h coins f r o m the government m i n t .
B u t f o r more than a century the p r i n c i p a l forms of money have been
notes and deposits i n banks operating under v a r y i n g degrees of government control or supervision.
B e g i n n i n g w i t h the period of the C i v i l W a r , the Federal Government has prevented the issuance of State and private bank notes by
taxes and has protected the owners of bank notes issued by banks under
Federal supervision f r o m loss g r o w i n g out of bank failure. E v e r y
bank note issued since t h a t time carries, directly or indirectly, the
f u l l guaranty of the Federal Government. M u c h later, i n 1933, a
Federal system f o r protection of bank depositors was also set up,
t h r o u g h the F D I C . The insurance the F D I C affords is at present
limited, however, to $10,000 i n the case of an i n d i v i d u a l account.
W h i l e under this insurance ceiling about 99 percent of i n d i v i d u a l
accounts i n insured banks receive f u l l protection, only a l i t t l e more
than h a l f of the dollar volume of accounts i n insured banks is covered. A case can be made f o r g i v i n g the deposits not covered under
the present law the same guaranty or insurance that the Government
has applied to other bank credit money.
MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT892^
Complete insurance of bank deposits w o u l d also be an i m p o r t a n t
aid i n m a i n t a i n i n g economic stability. Widespread losses by bank
depositors disrupt the operation i n the economy and aggravate depressions, as was demonstrated i n the early thirties.
Extension of F D I C insurance to a l l deposits, regardless of size,
w o u l d eliminate a source of contention i n the present law. A s a l l banks
pay F D I C assessments on a l l deposits, less some adjustments, regardless of the aggregate dollar amount insured under the $10,000 ceiling,
many banks w i t h a h i g h percent of large accounts consider themselves
the victims of inequity.
E x t e n d i n g F D I C protection to all deposits i n insured banks would
not represent a great departure f r o m actual practice. Because of
F D I C policy of merging failed or f a i l i n g banks w i t h other institutions, whenever i t is possible to do so, instead of l i q u i d a t i n g the weak
banks, F D I C insurance has i n recent years resulted i n a v i r t u a l 100
percent protection of deposits.
O n the side of disadvantages, i t has been objected t h a t f u l l protect i o n of depositors w o u l d eliminate an important present safeguard to
sound bank management—the watchfulness of the owners of deposits
i n excess of $10,000. W h i l e we recognize that the desire of bankers to
attract and h o l d large deposits provides some incentive f o r prudent
management, the watchfulness of depositors has not i n the past prevented widespread losses.
T h e fear has also been expressed t h a t f u l l insurance w o u l d give Federal bank supervisory authorities f u r t h e r o p p o r t u n i t y f o r encroachment on the affairs of privately-owned banks. However, as has been
noted above, there can be no real question of the Government's invasion
of private r i g h t s where the monetary system is concerned. Money is a
responsibility of Government.
Moreover, f u l l coverage of deposits would increase the contingent
liabilities of the F D I C and m i g h t require an increase i n the assessments p a i d by insured banks. I t is doubtful t h a t a higher basic rate
of assessment would be feasible. On the other hand, the amount of
losses that the F D I C may be called on to pay under any level of insurance coverage is an uncertain quantity, and i t is possible t h a t the basic
rate of assessment i n the present law would be adequate t o supply the
F D I C w i t h a l l the resources needed even i f insurance were extended
to a l l deposits.
SEPARATE N O T E BY M R .
CLARK
M r . C l a r k d i d not participate i n the development of the answers
to the questions submitted to the Council by the Subcommittee. There
is here reprinted f o r the convenience of the members of the Subcommittee and of the public generally the "Separate Note by M r .
C l a r k upon Monetary and Credit Policy," which appeared on pages
142-144 of the A n n u a l Economic Review by the Council of Economic
Advisers, transmitted to the Congress on January 16,1952.
SEP ABATE NOTE BY M E . CLARK UPON MONETARY AND CREDIT POLICY
No economic theory relating to the stabilization of the economy is more
important than t h a t of general monetary policy, w h i c h many believe can o f
itself accomplish the stabilization purposes of the Employment A c t of 1946,
MONETARY POLICY AND MANAGEMENT OF PUBLIC DEBT
893 ^
but the usefulness whereof i n a strong inflationary movement has been challenged i n former reports of the Council of Economic Advisers.
E a r l y i n 1950, the Douglas committee regretfully commented t h a t "Our
monetary history gives l i t t l e indication as to how effectively we can expect
appropriate and vigorous monetary policies to promote stability, f o r we have
never really t r i e d them." T h i s is not quite accurate. Monetary policy was
used vigorously i n 1920, and the resulting "stabilization" was a disaster the
farmers have not yet forgotten. I t was used again i n 1928-29, and of t h a t
episode the B r i t i s h expert, H a w t r e y , has said, " T h e dear money policy accomplished its purpose i n the end. I t stopped speculation by stopping prosperity."
We are now able to study efforts to establish the stabilization value of
monetary policy i n our greater economy i n which the i n s t i t u t i o n of banking
has been revolutionized by a great national debt which has m u l t i p l i e d the
l i q u i d assets i n bank portfolios. The Council of Economic Advisers, which,
unlike other Government agencies, has the responsibility of considering a l l
national economic policies and their effect upon each other, must give attention
to the collateral consequences when i t studies our recent experience. I n the
l i g h t of the problems of a defense program w h i c h must be integrated, the followi n g anomalies created by monetary policy stand out.
I t has enabled the banks to increase their earnings more than enough to match
the heavy increase i n their taxes i n 1951. Nearly every other business and industry found net profits reduced as a result of Government policies under the
defense program.
A n increase of one-third i n the basic commercial interest rate of larger banks,
leading to general increases i n other bank interest rates, was hailed as a valuable
contribution to economic stability. A l l other businessmen are criticized when
they exploit a situation by raising their prices by a much smaller percentage.
When restraint must be imposed elsewhere upon the freedom of decision, the
Nation imposes positive control, as i n forcing young men into m i l i t a r y service,
i n l i m i t i n g the production of General Motors, and i n fixing prices. To l i m i t the
expanding activity of banks, we are offering them larger profits upon the existing
level of loans.
The cost of new private capital has been increased and an effort has been made
to tighten credit for industry. V i t a l defense-related industries must expand
and the Government w i l l have to finance their expansion to the extent t h a t private capital is inadequate.
The Government is spending large sums to assemble and distribute business
i n f o r m a t i o n i n order t h a t businessmen may reduce to the m i n i m u m their uncertainties about the trend of the economy and may plan more confidently. Monet a r y policy is being based upon the principle t h a t the financial w o r l d must be
kept i n great uncertainty about f u t u r e interest rates and the availability of credit.
There is general agreement that every effort should be made to place the
Government debt i n long-term bonds i n nonbank hands. The Treasury now
finds no market for long-terms and its heavy financing has to be i n the f o r m of
short-term securities eligible f o r bank portfolios.
When the size of Government expenditures is giving us deep concern, the
interest charge on the Government debt is increasing.
I f these miscarriages were the unavoidable results of a monetary policy which
is a successful instrument to stabilize the economy, they might be accepted.
I do not believe t h a t monetary policy can be successfully used f o r t h a t purpose
i n the k i n d of economy and institutions which we now have. I n recent action,
t h a t policy has had u t t e r l y perverse consequences.
The advance i n short-term interest rates i n August 1950 was followed by the
greatest expansion of business loans i n our history.
The increase i n long-term rates i n March 1951, coming after the price freeze
i n January had taken the steam out of boiling markets and when a seasonal
contraction of business borrowing was due, had no effect upon new business
investment.
The more rigorous the use of monetary policy, the more rapid was the increase
i n new investment i n plant and equipment, the very channel through which monet a r y policy, i f effective, operates on its way to the final objective of dampening
inflationary forces.
A n d to complete the topsy-turvy picture, the more rapid the growth i n money
supply, creating "more dollars chasing goods," the quieter became the consumers'
markets.
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C D E B T894^
A P P E N D I X TO CHAPTER
V
Q U E S T I O N S ADDRESSED TO T H E C O U N C I L OF E C O N O M I C ADVISERS
A. CONGRESSIONAL POLICY DIRECTIVES
1. D o you believe that the congressional declaration of policy contained i n the Employment A c t of 1946 is balanced i n its emphasis
upon high-level employment and upon price stability, respectively, as
objectives of Federal Government policy ? I f not, what changes have
you to suggest?
B. F O R M U L A T I O N OF FISCAL A N D M O N E T A R Y POLICY
2. D o you believe that, subject to the statutes and general directives
l a i d down by Congress, the fiscal and monetary policy of the U n i t e d
States Government should be formulated under the direction of the
President? I f not, what suggestions have you f o r the coordination
of the policies of agencies not under the direction of the President
w i t h those of agencies which are under his direction? H o w urgent
do you consider this problem to be?
3. Discuss the rationale, advantages, and disadvantages of the
present division of authority i n the Federal Eeserve System over the
control of discount rates, open-market operations, and changes i n
reserve requirements.
C. CREDIT A N D D E B T - M A N A G E M E N T POLICY
4. Describe the mechanism by which a general t i g h t e n i n g or easing
of credit, and the changes i n interest rates which may result, is expected
to counteract inflation or deflation. Discuss the impact on borrowers
and lenders i n both the short-term and long-term credit markets and
on spending and savings. Indicate the effect on each of the broad
categories of spending entering into gross national product. W h a t
are the (actual or potential) capital losses or gains t h a t w o u l d be
brought about by changes i n interest rates? T o w h a t extent is the
effectiveness of a program of credit restraint affected by or dependent
upon expectations w i t h respect to subsequent changes i n interest rates?
Distinguish i n your discussion between small changes i n rates and
large changes i n rates.
5. H o w r a p i d l y and to what extent would you expect the volume of
bank loans to respond to measures of general credit control under
present conditions? Discuss recent changes i n the volume of bank
loans.
6. W h a t is the reason f o r the relatively slight use by commercial
banks of the Federal Eeserve discount and b o r r o w i n g privilege ? Do
you believe t h a t greater reliance should be placed on this privilege as a
means of obtaining Federal Eeserve credit? Under what conditions,
i f any, would you expect to see a greater use made of the discount
privilege?
7. Discuss the economic effects of the increase i n short-term interest
rates between August 1950 and M a r c h 1951 and the subsequent increase
i n long-term interest rates.
8. Discuss the appropriate roles of direct controls, selective credit
controls, and a generally restrictive credit policy as means of restrain-
M O N E T A R Y P O L I C Y A N D M A N A G E M E N T OF P U B L I C DEBT
895 ^
i n g inflation (a) when the Treasury is not expected to be a large borrower i n the foreseeable future, (b) when a large volume of Treasury
r e f u n d i n g operations w i l l have to be effected i n the foreseeable future,
(c) when i t is expected that the Treasury w i l l be a large net borrower
d u r i n g the foreseeable future, ( d ) under conditions of t o t a l war.
9. Discuss and evaluate the V o l u n t a r y Credit Restraint P r o g r a m
which was i n i t i a t e d i n the spring of 1951.
10. D o you believe t h a t under existing law any agency of the Federal
Government has the power to control directly or to " r a t i o n " the
extension of credit by i n d i v i d u a l banks ? Under Tyhat economic circumstances, i f any, w o u l d you recommend the use of this authority?
11. Do you believe that there is any conflict between measures to
restrain excess demand by monetary means and the need f o r expanding
the economy to meet the requirements of a continuing readiness to
resist aggression and a continuing h i g h standard of l i v i n g ? I f so,
how can the effects of this conflict be mitigated ?
12. W h a t do you believe to be the role of bank examination and
supervision i n f u r t h e r i n g the objectives of the Employment Act?
13. Discuss the economic functions of bank reserve requirements.
W h a t suggestions, i f any, do you have f o r changes i n either the nature,
applicability, or amount of existing requirements? I f you consider
t h a t each of several proposals f o r change has i m p o r t a n t elements
of attraction, discuss each.
14. Have you any suggestions other than those implied i n the answer
to the preceding question f o r insulating public debt securities f r o m
the impact of restrictive credit policies designed p r i m a r i l y to discourage the g r o w t h of private debt ?
15. T o what extent is the demand f o r Government securities by
nonbank investors influenced by (a) the current level of interest rates,
(b) expectations w i t h respect to changes i n interest rates, (c)
other factors?
16. W h a t advantages do you see i n a stable long-term Government
bond market? W h a t weight should be given to the desirability of
stability i n the Government bond market i n determining credit policy
under each of the assumptions w i t h respect to the volume of Government borrowing stated i n question 8 ?
17. Under what conditions, i f any, do you believe i t w o u l d be desirable to resort to compulsory methods i n the sale of Government
securities to (a) banks, (b) other financial institutions, (c) other corporations, (d) individuals? Discuss the philosophy w h i c h underlies
your views on this matter.
18. Discuss the merits and demerits of the proposal f o r the issuance
of a bond, the value of w h i c h would be guaranteed i n terms of purchasi n g power.
19. Discuss the advantages and disadvantages of marketable and
nonmarketable securities (a) under present circumstances, (b) i n the
event of the necessity f o r substantial net Government borrowing.
20. W h a t new types of securities, i f any, do you believe should be
given serious consideration f o r use (a) under present conditions, (b)
i n the event of the necessity f o r substantial net Government borrowing.
D. DEPOSIT
INSURANCE
21. Discuss the advantages and disadvantages of extending Federal
deposit insurance to a l l deposits i n insured banks.
C H A P T E R
V I
REPLY BY PRESTON DELANO, COMPTROLLER OF T H E
CURRENCY
A. GENERAL PURPOSES OF OFFICE
1. Describe briefly the functions and mode of operation of your Office,
The m a i n functions of the Office of the Comptroller o f the Currency
relate to the organization, operation, expansion (branchwise or t h r o u g h
amalgamation), and liquidation of national banks. A t the present
time there are approximately 5,000 national banks ( w i t h over 2,000
branches), organized and operating i n accordance w i t h the National
B a n k A c t and other Federal legislation, w h i c h hold slightly over h a l f
of the total banking resources of the U n i t e d States.
T h e Federal statutes confer upon the Comptroller of the Currency
broad discretionary powers either to approve or reject applications
f o r the organization of new national banks, the conversion of Statechartered banks i n t o national banks, and consolidations of banks
under Federal charter. The establishment of branches w i t h i n the
U n i t e d States by national banks also is permissible only upon authorization by the Comptroller.
T h e Bureau exercises general supervision over the operations of a l l
national banks. U p o n notification by the Comptroller, each national
bank is required by law to publish a report of its current condition,
at least three times each year. National bank examiners, under the
direction of the Comptroller, are required by law to examine every
national bank not less t h a n twice annually.
I n case of deliberate violation o f law by a national bank, suit may
be brought i n the name of the Comptroller f o r the f o r f e i t u r e of the
bank's charter. I n the event of continuous violation of law or unsafe
or unsound banking practices, the Comptroller may initiate action
designed t o remove the officers and directors responsible therefor. I f
i t appears to the Comptroller t h a t a national bank is i n an insolvent
condition, he is empowered to establish a receivership to take over its
affairs. 1
T h e operations of the Bureau are performed by less than 200 persons
i n the central office i n Washington, and somewhat over 900 persons
located throughout the country.
The Washington office consists of the Comptroller of the Currency
(appointed by the President, by and w i t h the advice and consent of
the Senate, f o r a t e r m of 5 years), three Deputy Comptrollers who
p e r f o r m duties assigned to them by the Comptroller and who function
1
The Bureau is charged with comparable duties with respect to all banks and certain
credit unions in the District of Columbia. The Office also performs duties with respect
to the issuance and redemption of Federal Reserve notes.
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i n his place i n the event of his absence or inability to perform his duties,
and the f o l l o w i n g divisions:
Examining Division.—The
reports of examination, reports of
condition, and other data submitted to the Comptroller are reviewed and analyzed by this Division, consisting of the Chief
National Bank Examiner, seven Assistant Chief National Bank
Examiners, and their clerical assistants.
Organization Division.—Reviews and analyzes applications, re
ports, and other data relating to the basic corporate organization
affairs of national banks.
Statistical Division.—Compiles
statistics relating to national
banks and other banking institutions f o r the information of the
Comptroller, the Congress, and others.
Division of Insolvent National Banks.—Supervises liquidation
of the insolvent banking institutions for which the Comptroller
has appointed individual receivers.
Legal Division.—Advises
the Comptroller and his staff on legal
problems involved i n the performance of the Bureau's functions.
Federal Reserve Issue and Redemption
Division.—Performs
functions i n connection w i t h the custody, issuance, and redemption
of Federal Reserve notes.
Personnel Office and Miscellaneous Division.—Recruitment
of
employees, transfers, promotions, employee relations, retirement,
resignations, budget matters, time and leave.
Disbursing Division.—Makes
disbursements to cover payrolls,
travel expenses, and miscellaneous expenses; makes purchases
of equipment and supplies.
Auditing Division.—Maintains
a continuous internal audit of
all operations of the Bureau. The Division reports directly to
the Comptroller.
The field staff is organized into 12 geographic districts corresponding to the 12 Federal Reserve districts covering the United
States. Each district is under the supervision of a district chief national bank examiner w i t h offices i n the city i n which is located the
Federal Reserve bank. Under each district chief examiner is a staff
of examiners, assistant examiners, and clerks, who perform the required examinations and other functions w i t h respect to national banks
situated i n the district. F i e l d personnel includes slightly over 250
national bank examiners, about twice that number of assistant examiners, and approximately 125 clerical employees. National bank examiners are commissioned f r o m the ranks of assistant examiners on
the basis of experience, demonstrated ability, and w r i t t e n and oral
examination. The work of the field force is, of course, coordinated
and closely supervised by the Comptroller and his immediate staff
i n Washington.
2. Describe the nature of the supervision exercised through examinations of banks by your Office. Specify the basic purpose or purposes of examination, and the principles which guide your
examiners. Distinguish between bank examination and bank
audit, as evidenced by the methods followed by your examiners
i n their work.
Broadly speaking, the supervision exercised by our Office through
examinations of banks consists chiefly of the f o l l o w i n g :
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1. Determination of amount and nature of assets.
2. Determination of amount and nature of liabilities.
3. E v a l u a t i o n of assets; determination of estimated losses.
4. E v a l u a t i o n of management (directors and officers) and
policy.
5. Evaluation of practices and procedures.
6. Determination of nature, adequacy, and value of p l a n t and
equipment.
7. Analysis of expenses, earnings, and adequacy of capital
structure.
8. Compliance w i t h requirements of law.
9. Analysis of trends; recommendations and criticism.
The general purposes served by the examination process are to
ascertain—
(a) Whether the bank is solvent and its capital structure
satisfactory;
(b) Whether the bank is being managed competently and i n
accordance w i t h legal requirements;
(c) W h a t constructive and corrective action, i f any, is called
f o r to strengthen the i n s t i t u t i o n or to preserve or enhance its
stability and usefulness.
O u r Office has prepared, and furnishes to every examiner, a volume
of 130-odd p r i n t e d pages, entitled Instructions to National B a n k E x aminers. Even this volume does not do more than outline most of
the important principles of bank examination. A s indicated by its
Foreword, i t does not include—
a detailed and exact step by step account of the functional and physical procedures to be followed i n proving, auditing, appraising, and examining each
asset and liability account . . .
I f desired by the subcommittee, copies of the Instructions w i l l be
furnished f o r its confidential study, as w e l l as copies of the looseleaf Digest of Opinions of our Office, which is furnished to every national bank and periodically supplemented.
I n the hands of the examiners, the Instructions supplement and
give definite f o r m to the elements of judgment and knowledge of
mechanical technique which have been absorbed by the examiner
i n his w o r k as well as d u r i n g years of preparatory w o r k as an assistant examiner 2 and, p r i o r to that, as a bank employee, i n almost
a l l cases. T h i s practical experience is supplemented by university
t r a i n i n g or courses of study—sometimes quite extensive—in the A m e r i can I n s t i t u t e of B a n k i n g and the several graduate schools of banking.
I n the broadest sense, the w o r k of a national bank examiner consists of an analysis of a national bank for the purpose of determining
its soundness, the capacity and policies of its management, its methods of operation, and whether i t has complied w i t h a l l applicable laws.
The examiner must determine and report to the Comptroller of the
Currency not only upon the assets and liabilities of the bank, but also
w i t h reference to whether the management is observing and conf o r m i n g w i t h sound business conceptions, banking laws, and regulations of the Comptroller. The reports* submitted to the Comptroller
by his examiners are set up i n such f o r m as to present the examiner's
8
Assistant examiners are furnished with a book of instructions outlining their duties
and procedures in some detail.
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considered judgment as t o the status of any given national bank, its
management and policies, and to facilitate appropriate action to correct any deficiencies or delinquencies.
T h e examiner's analysis includes an examination of a l l assets, a
p r o v i n g of liabilities as reflected by the records, a determination of
sound values of assets through appraisals and the like, a review and
inspection of records and files f o r the purpose of determining their
adequacy, and a review and investigation of activities to ascertain
whether there has been a compliance w i t h legal requirements and l i m i tations. I n p e r f o r m i n g this p a r t of his work, a national bank examiner is engaged p r i m a r i l y i n fact finding. However, i f unsound
or unsatisfactory conditions or violations of law are revealed as the
result of such fact finding, the examiner has the f u r t h e r d u t y of
i n i t i a t i n g such action as may be necessary to effect correction thereof.
I n most instances these corrections can be accomplished t h r o u g h discussions w i t h the active officers or board of directors. I n other cases,
conferences are arranged between representatives of the bank and
the district chief national bank examiner of the district i n which
the bank is located, the Chief National Bank Examiner i n Washington, one of the Deputy Comptrollers, or the Comptroller, depending
upon the nature and importance of the situation. These functions
of the examiners are corrective or advisory activities, rather than
fact finding.
T h e files of this Office w i l l bear witness to the fact t h a t throughout
the years, i n instances' too numerous to mention, corrections have been
made t h r o u g h the changing or strengthening of management, revision of weak or unsound loan and investment policies, the adjustment or fortification of capital structure, and the merger of weak and
unsound banks w i t h strong competitive institutions at the instigation
of the examiner after a f u l l discussion of the facts w i t h the boards
of directors'. A l t h o u g h i t is essential t h a t examiners act i n an advisory capacity, such activities must be conducted b y examiners who
are trained to use their discretion and judgment. Under no circumstances is an examiner permitted t o give advice or recommendations to the management w i t h reference to the desirability or undesirability of m a k i n g particular loans or investments.
•
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T h e last sentence of this question calls' upon us to—
distinguish between bank examination and bank audit, as evidenced by the
methods followed by your examiners i n their work.
The p r i m a r y purpose of bank examination has been indicated i n this
and the preceding question. They are carried i n t o effect through
examination and evaluation of the assets, and p r o v i n g the liabilities
recorded i n its books.
O n the other hand, a complete audit of a bank involves, among other
things, a thoroughgoing verification of liabilities (by contacting all
k n o w n depositors and other creditors) and—unlike bank examination—has as one of its p r i m a r y purposes the detection of dishonesty
by the officers or employees.
T h i s matter of the fundamental distinction between bank examinat i o n and bank audit, and their purposes, unfortunately has been the
subject of considerable misunderstanding^ and consequently a somewhat extended discussion of the matter is justified.
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Quite often, after discovery of embezzlement, the question is raised
why every such dishonest act is not p r o m p t l y discovered d u r i n g the
next governmental examination after its occurrence. T o this there
are a number of answers. I n the first place, there are certain methods
available to a defaulter (particularly i f he is the chief executive officer
of a bank, assisted i n his dishonesty by other employees) which no
conceivable auditing technique would inevitably discover. This is not
to say there are any detection-proof embezzlement schemes; there are
none. B u t i n some circumstances the clue to. exposure must come f r o m
a source other than auditing procedures.
However, i t is true that by and large a thoroughgoing and careful
audit of a bank usually w i l l disclose any dishonest manipulations which
are taking place. I n larger banks, separate auditing departments are
maintained f o r this very purpose, and internal checks constitute a cont i n u i n g safeguard against the generality of dishonest practices. I n
some banks the services of public accountants are sometimes utilized
f o r thorough audits, either periodically or at irregular intervals. I n
addition, the board of directors of every national bank should make
or have made for them regular independent surveys which should include certain basic elements of auditing techniques designed to detect
irregularities. I n a booklet entitled Duties and Liabilities of D i rectors of National Banks," which is sent to every national bank, we
have advised directors that i n connection w i t h their annual or semiannual surveys of the bank, the individual ledger balances should be
verified i n such manner as the directors may deem advisable by calling
i n passbooks, by sending out reconcilements of certain accounts selected
by the directors, or i n some other suitable w a y ; and other suggestions
are made which, i f followed, would enable them i n most cases to
establish the authenticity of the bank's records, and the actual amount
of its assets and liabilities.
I t cannot be emphasized too strongly that bank examination does not
involve a complete audit of the institution. I t has always been understood that the p r i m a r y function of governmental bank examination is
to judge the assets and the operations of banks, and to effect improvements therein, wherever necessary, through recommendations or definite orders. National banks, like banks of the State systems, must be
operated i n accordance w i t h applicable laws and regulations, as well as
i n accordance w i t h principles of safe and sound banking practice. Accordingly, the chief duty of a national bank examiner is to ascertain
that the statutory requirements and restrictions enacted by Congress,
and administrative regulations adopted thereunder, are being complied
with, and that the lending and investment policies of the bank, and its
operating procedures, are such as to minimize the dangers to the banki n g system which are inherent i n excessive and hazardous loans, investments which are speculative or not readily marketable, obsolete or
inadequate internal practices, inefficient personnel, and the like.
I t w i l l be noted that this description does not include detection of
embezzlement or other dishonesty as one of the "primary functions of
the examiner. Generally speaking, such irregularities take place
through manipulation of the bank's l i a b i l i t y accounts, most frequently
through fictitious entries i n deposit accounts. The detection of such
dishonest practices is the function of the bank's own audit department,
directors' periodic surveys, and audits conducted by independent public
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accountants retained f o r this purpose. Bank examiners are h i g h l y
trained men whose special abilities as analysts of loans, securities, and
bank management and methods, would not be properly utilized i f they
were to devote themselves largely to the mechanical aspects of detection
of dishonesty.
I t is true that defalcations are very frequently discovered by bank
examiners through well-developed methods not amounting to complete audits, and their years of experience sometimes develop a sixth
sense which enables them to react w i t h suspicion to circumstances
which would pass unnoticed by others. Perhaps because of their
achievements along this line, many people are not aware of the distinction between an audit and an examination and erroneously believe
that an examiner's principal task is the detection of dishonest acts on
the part of bank officers and employees.
I t is unnecessary to refer to the numerous authorities i n which i t
has been explicitly recognized, at various times d u r i n g the last half
century, that bank examination does not include bank audit. Perhaps
as clear a statement as can be found w i t h respect to this subject was
made by M r . Thomas P. Kane, who was a Deputy Comptroller of
the Currency f r o m 1899 to 1923, i n a volume devoted to operations
of the Bureau:
When an examiner satisfies himself that the books of original entry are correct
and the assets fonnd i n the bank are equal i n value to the amount called for by
the books, he is bound to assume that the original individual credits which go
to make up the grand total are correct, and he cannot know otherwise except by
a complete audit of the books, unless errors or false entries are discovered by
accident or otherwise.
There is only one way of determining the absolute accuracy of an individual
ledger or a certificate of deposit register, and this is by calling i n and balancing
or otherwise verifying all of the depositors' pass books and by verifying each
individual certificate of deposit. I t would require weeks of time to do this. No
examiner could undertake such a task, and is not expected or required to perform
such services.
A n audit of a bank calls for the performance of this work and similar detail.
A n examination does not. Yet when a defalcation is disclosed, which has extended over a period of several years undiscovered by the examiner, the latter
is invariably charged w i t h incompetency or superficiality in the performance of
his duty, and i n most cases unjustly so because of the failure of the critics to
discriminate between an examination and an audit.
This essential distinction between bank examination and bank auditi n g is recognized by all Federal bank supervisory agencies as well
as the overwhelming majority, i f not all, of bank supervisory departments of the 48 States. Occasional attempts have been made to introduce a substantial element of auditing into the work of the bank
examiners. The results have not been satisfactory. No Federal bank
supervisory agency today attempts i n the course of ordinary examinations to v e r i f y the correctness of a bank's books through contacting
depositors.
I t should be borne i n mind that, over the years, embezzlement and
other dishonesty have been minor factors i n bank failures. Generally
speaking, dishonest practices are on a small scale, as compared w i t h the
total resources of the bank and the total number of bank personnel,
and, f a r f r o m jeopardizing the accounts of depositors, are rarely of
sufficient magnitude, before discovery, to cut deeply into the capital,
surplus, undivided profits, and reserves of the institution. Even i n
the exceptional case, where the embezzler is the major executive officer
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of and dominating influence i n the bank, and is assisted by a large
percentage of its employees, additional protection is afforded by the
substantial fidelity bonds upon which our office insists, and by the
responsibility of directors i n the event t h a t their negligence contributed to the magnitude of the shortage.
D u r i n g the eighty-odd-year history of the national banking system,
defalcations were a contributing factor i n only a small percentage of
national bank insolvencies. I t is clear t h a t dishonesty is f a r less of
a danger t h a n are weak or incompetent management, excessive and
ill-advised loans, speculative investments, and other major causes of
insolvency. Therefore, i t w o u l d be a disservice to the Nation's banki n g system i f examiners were t o spend less time i n the i m p o r t a n t fields
i n which their abilities enable them to render substantial assistance
to banks, and were to devote themselves instead to the extensive mechanical tasks involved i n detection of dishonesty.
I f bank examiners were to serve also as bank auditors, i t would
require governmental examining forces many times as large as those
now maintained. I t would keep our entire examining force continually occupied merely to conduct complete audits of only a few of the
largest national banks. I n our opinion such an expansion of the
size and functions of bank supervisory agencies is not advisable or
justified. I t is our belief t h a t safeguards which are recommended
by bank supervisors (such as adequate fidelity bonds, rotation of employees, compulsory vacations, audits by public accountants, establishment of an adequate internal audit system where practicable, etc.)
and w h i c h are being adopted by steadily increasing numbers of banks,
constitute a more efficient and desirable protection than w o u l d a system of governmental audit.
The supervision of national banks rests upon the National B a n k
A c t and other congressional enactments. Those statutes have never
required bank examination to be supplemented by thorough a u d i t i n g
of the affairs of each bank examined. A s f a r as we are aware, i t has
never been suggested t h a t such legislation be enacted, although i t has
been repeatedly brought out i n standard texts, reports, addresses, and
otherwise t h a t Government's functions i n this field do not include t h a t
of detailed auditing.
Undoubtedly, the Federal Government could employ some tens of
thousands of a u d i t i n g personnel, and develop auditing procedures
suitable f o r banks of various magnitudes, types of business, and geographical situations. I t is even l i k e l y that, over a period of years,
these methods could be so perfected as t o reduce s t i l l f u r t h e r the
present infrequent occurrence of serious dishonesty.
However, i t is our firm conviction, after consideration of this problem f o r many decades, t h a t the benefits of such a step would not j u s t i f y
its cost, not only i n money b u t i n the effect on certain fundamental
American principles. W e consider that the extremely small amount
of loss t h r o u g h dishonesty does not call f o r the creation and maintenance of a large Government bureau and the imposition upon A m e r i can banking of governmental control i n an additional field. W e consider i t clearly more desirable f o r thorough auditing of banks t o remain a matter of internal management, encouraged and guided by the
supervisory authorities. I n other words, we are satisfied t h a t the possible benefits to be derived f r o m legislation of the type described w o u l d
not j u s t i f y the necessarily increased governmental employment, the
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additional expense, and the consequent great expansion i n public cont r o l of private enterprise. W e would like to see the banks remain
free f r o m unnecessary governmental supervision.
3. W h a t directives, i f any, have been given to your Office by Congress
w i t h respect to the economic objectives which i t should seek to
f u r t h e r i n its operations ? Cite appropriate statutes.
The Federal laws relating directly to the national banking system
do not contain any directives w i t h respect to "economic objectives," i n
the narrow sense of that term. I t must be borne i n m i n d that the
National Bank A c t , which is the nucleus of the laws governing the
system, was enacted i n 1863-64. A t that period i n our history, i t
was not customary f o r Congress to give explicit directives w i t h respect
to economic objectives.
The scope of congressional action during the nineteenth century
w i t h respect to fundamental economic currents, including what is now
called the business cycle, was considerably narrower than i t is today.
This policy may have been due i n part to the relatively lesser significance of the business cycle in t h a t era, and also to the absence of
developed economic theory as to what could and should be done by
the Federal Government i n those circumstances.
I n any event, i t was generally understood that the economic objectives of Congress, i n most cases, were limited rather than general, and
ordinarily these purposes, although not explicit, were f a i r l y obvious
f r o m the provisions of the enacted legislation, clarified, where necessary, by the history of the legislation.
This was the case w i t h respect to the National Bank Act. I t s origi n a l purposes were p r i m a r i l y t w o f o l d : First, to provide the country
w i t h a u n i f o r m and reliable paper currency, f u l l y backed by Government bonds; and, secondly, to assist i n wartime financing through sale
of Government bonds, which were purchased by national banks to
provide the basis f o r the issuance of their currency.
A l t h o u g h these were the immediate dominant aims, they necessarily
rested upon at least one other, namely, the continued existence of
solvent individual banks constituting the national banking system.
This was the chief responsibility of the Bureau of the Comptroller of
the Currency, and has remained so during its almost 90 years of
existence.
D u r i n g the earlier decades of the Bureau's operations, i t was generally felt, i n accordance w i t h the prevailing economic philosophy,
that no considerations should be recognized i n chartering and supervising national banks other than whether a proposed bank had a reasonable chance of solvent operation for the foreseeable future, and
whether an eatisting bank was currently i n solvent condition. The
national bank examiners considered that Congress had charged them
w i t h the duty of seeing that national banks obeyed the laws applicable
to them and d i d not engage i n practices which m i g h t endanger their
financial stability and their obligations to depositors and other
creditors.
T o recapitulate: Congress has not given this Office, specifically, any
directives w i t h respect to broad economic objectives which i t should
seek to f u r t h e r i n its operations. The general tenor of banking legislation over almost a century is that our primary supervisory function
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is to maintain and further a safe, sound, and adequate system of banki n g institutions, qualified to perform the functions required of a commercial banking system under existing conditions. T o a more limited—and somewhat undefined—extent, the Comptroller of the Currency, i n exercising his discretionary powers, also takes into consideration his understanding of broad national economic policies, as exemplified by the declaration of policy i n the Employment A c t of 1946.
4. W h a t weight do you give i n the conduct of your Office to the congressional declaration of policy contained i n the Employment
A c t of 1946, where i t is stated:
The Congress hereby declares that i t is the continuing policy and responsibility of the Federal Government to use all practicable means consistent w i t h its needs and obligations and other essential considerations
of national policy, w i t h the assistance and cooperation of industry, agriculture, labor, and State and local governments, to coordinate and utilize
all its plans, functions, and resources for the purpose of creating and maintaining, i n a manner calculated to foster and promote free competitive
enterprise and the general welfare, conditions under which there w i l l
be afforded useful employment opportunities, including self-employment,
for those able, willing, and seeking to work, and to promote maximum
employment, production, and purchasing power. [Italics supplied.]
Do you believe i t would be desirable that Congress give your
Office a more specific directive that i t should govern its activities, wherever practicable, i n the l i g h t of the general objectives
of economic stability and high-level employment? I f not, are
there any other economic directives which you would consider
desirable ?
Questions 4, 5, and 6 are closely interrelated. Question 4 asks what
weight is given, i n the conduct of our Bureau, to the declaration of
policy i n the Employment A c t of 1946. Question 5 inquires as to
the role of bank examination i n furthering the objectives of that act,
and question 6 asks how we endeavor to further the objectives of
economic stabilization through means other than bcmk examination*
Since the latter two are simply segments of the operations of the
Bureau, there is necessarily some repetition i n our answers to these
three questions.
I n the formulation of its policies and procedures, the Bureau of
the Comptroller of the Currency has always been aware, of course, that
the Bureau was created, and its functions assigned, f o r the purpose
of advancing the general economic welfare of the people of the United
States. A s indicated i n answers to previous questions, one of the
p r i m a r y purposes of the National Bank A c t (1863-64) was to
strengthen the currency system of the Nation and to put an end to
the era of "wildcat banking" and note issue which had impeded the
commercial and industrial growth of the country for many years.
A f t e r the establishment of the Federal Reserve System i n 1913,
the currency functions of the national banking system became of
rapidly diminishing importance, and ended, for practical purposes, i n
1935. However, both before and since that development, the Bureau
has considered its chief duty-to be the preservation and advancement
of the national banking system as a major factor i n American commercial banking.
I t is hardly necessary to stress the fact that the industrial and commercial g r o w t h of the country during the twentieth century could not
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have taken place without the aid of the resources and facilities of
commercial banks. W i t h o u t agricultural loans, seasonal loans (to
manufacturers, wholesalers, and retailers), real-estate loans, consumer-paper loans, and many other categories, our economic progress
would at least have been seriously retarded.
The foreging suggests the character of our answer to the first sentence of question 4, asking what weight is given i n the conduct of this
Office to the congressional declaration of policy contained i n the E m ployment A c t of 1946. As i t applies to the Comptroller's Office,
that policy is one of u t i l i z i n g functions to create and maintain conditions making f o r employment opportunities, and "to promote maximum employment, production, and purchasing power." I t is the
philosophy of this office that its greatest contribution to these ends,
over the long run, can be made by bending its efforts to maintaining
and strengthening a commercial banking system which is safe and
sound, and able to meet all legitimate credit needs of individual communities and the Nation as a whole.
D u r i n g the past 20 years, since Federal governmental policy has
been directed toward energetic efforts to ameliorate cyclical economic
swings and to improve the general economic environment, the Comptroller (together w i t h all other bank supervisory authorities) has been
faced w i t h the question whether bank supervision should be directly
utilized as an additional implement i n these efforts.
Few responsible people would deny that amelioration of the business
cycle is a desirable objective. B u t i t would be a gross oversimplificat i o n to argue: "Economic stability is a desirable condition. Therefore, let us examine various possible courses of action. I f a particular course of action is likely to contribute to economic stabilization, i t
should be adopted."
Such an approach, of course, would overlook several crucial questions. Other things being equal, economic stability is a h i g h l y desirable condition, but the American people probably would feel that
a small increase i n economic stability would not be w o r t h while i f i t
were to be accompanied by great loss of individual economic and
social freedom and also would result i n a lower standard of living.
Obviously, these are not necessary concomitants to economic stability,
but they illustrate the principle that efforts toward economic stability
cannot sensibly be made i n utter disregard of the possible undesirable
"side effects."
Similar principles are applicable w i t h respect to the adoption of
means to a desired goal. A particular proposed legislative or supervisory measure m i g h t promise some gain toward economic stability, but
i t might also involve a much greater net evil i n its repression of enterprise and initiative. Furthermore, i n an economic system as complex
as ours, great care must be exercised to determine, as definitely as
possible, whether a contemplated step w i l l contribute to an objective
such as economic stability, even disregarding any unfortunate incidental results. Consequently, i t is essential not only that we evaluate
conflicting objectives, but also that we inquire whether a suggested
means w i l l contribute materially to that objective and whether such
means may give rise to evils greater than the evil we are seeking to
eradicate.
I t is undeniable that commercial bank credit is an important sector
of the economic f r o n t i n our Nation today. The stringency or easy
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availability of commercial bank credit may exaggerate or moderate
the extent of both booms and depressions. A t first glance, there is
much plausibility i n the suggestion that, since bank examiners employed by the Federal Government constitute continuing, direct, and
forceful points of contact w i t h almost the entire banking system, the
economic policies of the Federal Government i n this sphere could be
effectively advanced through the efforts of national bank examiners
and those of other Federal bank supervisory agencies.
Unquestionably, something could be achieved by this means i n the
way of tightening or loosening bank credit, i n accordance w i t h governmental economic objectives. However, we are inclined to believe
that bank examiners are not i n a position to accomplish as much in
this direction as has sometimes been supposed, and that the plan has
definite draw-backs.
When a particular extension of credit contains an important element of weakness, an examiner can persuade the banker to take steps
to strengthen the loan or to reduce or collect it, and dissuade h i m f r o m
continuing to pursue a lending policy under which similar loans would
be made. Needless to say, our examiners do exactly this every day;
i t is one of their most important functions.
The foregoing, however, is very different f r o m efforts by examiners
to convince banks that loan volume should be reduced, not because of
any credit weaknesses or doubts as to collection, but because the Federal Government believes that the economic welfare of our country
calls f o r a contraction of bank lending. Generally speaking, bankers
are quite alert to the presence or absence of an undue risk element i n
a loan, although some may occasionally depart f r o m the soundest
practices. I f an examiner criticized loans which both he and the
banker knew to be sound and collectible, i t is unlikely, i n our opinion,
that the bank's lending policy would be modified i n accordance w i t h
the examiner's suggestions; i t is more probable that the banker would
simply lose f a i t h i n the examiner.
Even greater obstacles would stand i n the way of efforts by examiners to induce a more generous lending policy i n accordance w i t h
broad governmental economic objectives. Self-interest is sufficient, i n
most cases, to induce a banker to grant every application f o r a loan
which he believes w i l l be collectible and profitable. Consequently,
the examiners could only (1) urge bankers to extend credit beyond
the l i m i t dictated by their own banking judgment, or (2) r e f r a i n f r o m
adverse criticism of loans, already made, which i n the examiner's
judgment involve an excessive degree of risk. I t is obvious that
either of these practices would involve grave hazards.
Perhaps even more fundamental than these difficulties would be
the loss of confidence on the part of bankers i n the singleness of purpose of bank examiners and their primary concern w i t h the soundness
and welfare of the particular institutions under examination, thus
destroying the principal source of strength of our organization. H o w ever, as pointed out later i n our answer to question No. 6, supervisory
action at the Washington level, while based upon factual reports received f r o m field examiners, takes into consideration prevailing economic trends and attempts the difficult task of adjusting its many
supervisory activities i n accordance w i t h those trends. This is accomplished through letters of criticism which pass f r o m the Washing-
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ton office to i n d i v i d u a l banks, f r o m conferences arranged w i t h the
management of individual banks, and f r o m pronouncements and
opinions as made to the representatives of the national bank division
of the American Bankers Association and to the banking public i n
general.
I t is of significance that the declaration of policy i n the Employment
A c t emphasized the promotion of "free competitive enterprise and
the general welfare." The point of view underlying the policies of
this Bureau are summed up, i n a general way, i n those words. A s
suggested i n the answer to a previous question, an important portion
of our operations relates to authorization of the establishment of new
national banks and branches. I n the exercise of his authority i n these
matters, the Comptroller has always placed first emphasis on whether
the management, capitalization, location, and so on, of the institution
are such that i t has a good chance of functioning successfully and
thereby aiding the economy of its community and area. Less important only i n degree, however, is the fostering of healthful competition among banking institutions.
Extremely difficult problems occasionally arise i n which the banking
facilities of an area can be strengthened only by p e r m i t t i n g a very
large institution to absorb a weaker one or to establish additional
branches, or by p e r m i t t i n g a "bank holding company" to establish
additional banking subsidiaries. I n all cases, i t is our practice to
encourage the organization of an independent locally owned institut i o n wherever that is feasible. B u t where that alternative course is
not open, a choice necessarily must be made between two goals—prov i d i n g adequate banking facilities, on the one hand, and promoting
healthful bank competition; on the other. A l t h o u g h no h a r d and fast
rule of thumb can be followed, a study of actual decisions over a period
of years reveals that, faced w i t h this choice, the office generally has
decided that its first duty is to assist i n satisfying every real need f o r
additional banking facilities.
I t has been our conviction that the Bureau can make its greatest
contribution to the general welfare, as well as to "maximum employment, production, and purchasing power," by concentrating its efforts
upon the maintenance of a system of sound and well-managed banks,
adequate i n number, location, and resources to satisfy the Nation's
needs f o r the services they perform. This attitude has been reexamined, d u r i n g the past 5 years, i n the l i g h t of the congressional
declaration of policy i n the Employment A c t of 1946, and our decision
was that the underlying purpose of the act, and the declaration of
policy, would be best'served by this office through a continuation of its
traditional approach. I n other words, our efforts are directed toward
the improvement and maintenance of a great and powerful machine
i n good condition, but we believe that, over the long r u n and i n the
broadest sense, we would injure rather than advance the general welfare i f we attempted to dictate also the manner i n which the machine
was to be utilized.
The Bureau of the Comptroller of the Currency believes that its
present policies and activities already are governed " i n the l i g h t of
the general objectives of economic stability and high-level employment." I f Congress is i n agreement w i t h our views as to the appro-
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priate role of bank supervision i n the national economy, no more specific directive is called for.
5. W h a t do you believe to be the role of bank examination i n furtheri n g the objectives of the Employment Act?
To a considerable extent, this question has been answered i n our
reply to question 4.
Insofar as the actual process of examination is concerned (that is,
the work of the examiner and his assistants on the condition of a particular institution, and his report thereon), i t is our conviction that
the objectives of the Employment A c t are most effectively to be f u r thered by factual, objective judgment. I n our opinion, to inject into
the examiner's method of operation a deliberate effort to affect future
economic trends by a " h a r d " or " s o f t " attitude would undermine, at
one stroke, the foundation on which rests much of the effectiveness
of the bank-examination procedure.
Each report of examination of a national bank serves several purposes. I t is p r i m a r i l y f o r the use of the Comptroller of the Currency
m his supervision of the bank. I n addition, those reports are also
used by the Federal Reserve System and the Federal Deposit Insurance Corporation i n the performance of their duties w i t h respect to
national banks as members of the System and of the Corporation,
respectively. I t is absolutely essential that these supervisory authorities be furnished w i t h accurate, objective reports, not only f o r the sake
of effective supervision, but also to provide, i n the aggregate, a de{>endable statistical basis f o r ascertainment of trends and the formuation of policies.
The report of examination serves another valuable purpose. A copy
of each report is furnished to the particular bank f o r its confidential
use, and study of the report by the bank's directors and officers is a
very important secondary value of the examination process. Together
w i t h the oral comments, suggestions, and criticisms made by the examiner d u r i n g the course of examination, i t provides the bank, twice
a year, w i t h the results of a painstaking examination by a disinterested expert, whose judgments are formed upon the basis of his examination of numerous banks i n the same area, and of the economic conditions existing i n the area.
The management of a bank may regard a particular examiner as a
man of exceptional or mediocre intelligence, or as a keen or a weak
judge of credits. W i t h practically no exceptions, however, national
bankers entertain no doubts regarding the integrity of the examiner
or the purpose and attitude w i t h which the examination is made. They
know that his conclusions as to whether particular loans are "substandard" or contain definite "loss" elements are based solely upon
the examiner's informed views as to the likelihood of f u l l payment of
specific loans—in the light of the credit weaknesses involved and existing conditions as he sees them.
I f the bank examiners were to serve as active direct tools i n a governmental program intended to flatten out the crests and troughs of
economic cycles, this change i n policy inevitably would become known
to bankers, and their confidence i n the trustworthiness of reports of
examination would be seriously shaken. I t is our belief that comments
i n the course of examination, i n the examination report, and i n our
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communications thereon are perhaps the greatest single influence our
office can b r i n g to bear i n keeping a bank on a desirable course or
persuading i t to abandon unsound policies. This beneficial effect of
the examination process would be lost, to a considerable extent, i f
bankers became convinced that our examiners were f o r m i n g their
judgments not on the basis of existing conditions, but rather w i t h the
deliberate purpose of affecting future conditions by encouraging banks
to adopt generous or restrictive credit policies i n accordance w i t h the
current economic program of the Federal Government.
As we have previously indicated, intelligent bank supervision makes
a very definite contribution toward economic stability and actually
does serve as a steadying force i n the economy. However, i t does not—
and i n our opinion, should not—do this by attempting, through examination practices, to control or influence bank credit policies f o r the
deliberate purpose of stimulating the Nation's economic activity duri n g recession periods and dampening that activity when i t is believed
to be excessive. B y concentrating their efforts on the preservation of
sound and serviceable individual banks, examiners can do more than
could be accomplished by using bank examination as a minor adjunct
to the numerous appropriate means f o r achieving economic stability,
such as policies i n the fields of governmental budget, debt management,
and central banking (including bank-reserve requirements and openmarket operations).
I n brief, we are satisfied that the actual and potential effect of bank
examination upon credit conditions has been exaggerated by some
persons; actually i t could be only a relatively slight force i n that direction. A n d even i f this force were used to the utmost, the resulting
perversion of the true and valuable functions of bank examination
would, i n the long run, do more to injure than to advance economic
stability and the general welfare.
The appropriate role of bank examination i n f u r t h e r i n g the economic welfare of the Nation is i n the preservation of a strong and
vigorous banking system competent to meet (1) its responsibility to
depositors, i. e., maintaining solvency and adequate l i q u i d i t y , and (2)
its responsibility to the communities served, i. e., accommodating
legitimate and meritorious credit demands. Functioning i n this way,
bank examination is calculated to foster and promote sound free competitive banking enterprise, capable of discharging its responsibilities
and being itself an affirmative force of consequence and solid strength
i n f u r t h e r i n g the objectives of the Employment A c t of 1946.
6. I n what ways, i f any, other than through bank examination, does
your Office endeavor to further the objectives of economic stabilization ?
T o a considerable extent, this question has been answered i n our
reply to question 4.
I n the performance of a number of functions not directly related
to bank examination, our Office seeks to make its maximum contribution to the objective of economic stabilization. B y virtue of the nature
and prestige of our organization, the Comptroller and other officials
of the Bureau can and do provide leadership i n developing and recommending among the Nation's bankers sound policies designed to maint a i n our economy on an even keel.
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A n example of this is our participation w i t h the Federal Beserve i n
developing and sponsoring the voluntary credit restraint program
over the past year. I n annual reports, speeches, articles, conferences,
and conversations w i t h i n d i v i d u a l bankers and others, we have emphasized that the self-interest of banking institutions, as well as the
general welfare, are best served by f o r m u l a t i n g credit policies and
allied policies w i t h a view to long-term benefits to i n d i v i d u a l customers, the community, and the Nation, rather than by having i n
m i n d only the maximum immediate dollar income. Development of
bank policy at this level calls f o r extremely delicate balancing of conflicting factors, but i t is our belief that American banking is learning
to p e r f o r m successfully this difficult art.
Another example of Qur effort to gear our activities to economic
needs, to the extent t h a t such action is feasible and appropriate, is the
policy we have adopted, and i n which the other two Federal bank
supervisory agencies have concurred, whereby we decline to give our
consent, i n the existing economic climate, to bank amalgamations i n
which the capital structure of One of the institutions is returned to
shareholders and thus becomes additional inflationary purchasing
power. Exceptions are made i n a p p l y i n g this policy to take care of
necessitous cases, but they are rare.
W e adhere to a similar principle i n passing upon applications to
invest i n banking premises amounts i n excess of the o r d i n a r y limits,
as well as applications to establish new branches or new banks which
would generate additional loans and hence create additional deposit
currency. Here again exceptions are made where the need of a comm u n i t y f o r additional banking facilities is so great as to outweigh the
inflationary aspects of the proposal.
A s previously emphasized, our day-to-day supervisory actions are
made i n the l i g h t of our concept of the basic task imposed on this
Bureau by the Congress—namely, the maintenance of a strong national banking system comprised of sound i n d i v i d u a l units, whose
operations, i n meeting the financial needs of their communities, are
directed not by Government but rather by persons who are p r i m a r i l y
concerned w i t h the advancement of the welfare of their institutions
and the public which they serve.
Nevertheless, staff members of the organization constantly bear i n
m i n d the ever-increasing importance of the objective of economic stabilization and govern their actions i n accordance therewith, to the
extent t h a t this can be accomplished without i n f r i n g i n g upon the
fundamental purpose f o r which the Bureau was established.
T h i s is accomplished, as f a r as possible, by having the field examiners
f o r m their opinions and formulate their reports on the basis of local
facts and conditions as they see them. The Comptroller and his immediate staff i n Washington act upon those reports, i n d i v i d u a l l y and i n
policy formation, w i t h a view to general Nation-wide economic conditions, trends, and needs. The moderation or intensification of supervisory action on the basis of the examiners' reports, i n the l i g h t of the
prevailing economic trends, can be done best by the Washington staff
because of the necessity f o r extremely close integration and u n i f o r m i t y
of viewpoints and actions. I t should be noted, however, that a l l actions
of this nature must be taken w i t h only one a i m : The maintenance of
each national bank i n such sound condition that i t can play its proper
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p a r t i n meeting the banking needs of its community and hence f u r t h e r
the objectives of economic stabilization.
7. W h a t use do you make of the results of economic analysis i n the
conduct of your Office ?
A t the highest policy level of our Office considerable attention is
given to the results of economic analysis, and i t affects, t o a substantial
degree, certain major activities of the Office. I n his annual report
to Congress, as well as in^public addresses and discussions w i t h i n d i v i d ual bankers and groups, the Comptroller and his deputies present their
conclusions regarding probable trends i n general economic conditions
as they impinge upon the banking structure, and their views as to the
l i k e l y course of financial conditions as a result of such forces. A s a
matter of course, the bank supervisory actions of the Comptroller and
his immediate staff must be and are geared to their concept of economic
conditions as gleaned f r o m d a i l y contact w i t h economic problems and
an analysis of economic thought and material.
A s previously indicated, this is not true, i n the same sense, w i t h
respect to our examination procedure. B a n k examining methods and
objectives are not altered on the basis of forecasts of national or w o r l d wide economic conditions. Nevertheless, our examiners are not insulated f r o m current economic t h i n k i n g , and they develop a h i g h degree
of f a m i l i a r i t y w i t h economic conditions i n their particular districts,
and w i t h respect to the m a i n agricultural, industrial, and commercial
activities therein. Consequently, examinations of i n d i v i d u a l banks,
and the resulting recommendations and criticisms, inevitably stem i n
p a r t f r o m the examiner's views w i t h respect to general economic conditions and trends i n a particular industry or geographic area.
B. R E L A T I O N S H I P TO T H E
GOVERNMENT
8. T o what extent does your Office operate under the direction of the
Secretary of the Treasury? Discuss i n the l i g h t of both the
statute and customary usage.
F r o m the o r i g i n of the national banking system, the N a t i o n a l Bank
A c t has provided t h a t the Comptroller of the Currency "shall perf o r m his duties under the general directions of the Secretary of the
Treasury," R. S. 324 (12 U . S. C. 1).
A s a matter of customary usage, the various Secretaries of the
Treasury have exercised their directory powers over the Comptroller
of the Currency only to a l i m i t e d extent. The basis of this policy, as
applied by the present Secretary, was recently expressed by h i m as
follows:
Effective governmental regulation of national banks has rested at all times
upon the exclusive preoccupation of this Bureau w i t h the well-being of the
individual banks and their performance of all the banking services called for
by a vigorous and expanding economy. W i t h very few exceptions, the individual banks of the national banking system have consistently responded
to the recommendations and suggestions of the Comptroller of the Currency,
and this has been true, to a considerable extent, because of their realization
that the Comptroller's Office is not only thoroughly and intimately acquainted
w i t h the affairs of a l l national banks but has no other purpose or function
than maintaining the soundness and progress of those banks.
I need hardly stress the value of such a relationship of trust and confidence,
built up over many years of contact through carefully worked out and consist-
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ently applied examination and supervisory procedures. By virtue of this relationship, w i t h which the directors and officers of every national bank have been
familiar throughout their banking careers, the Comptroller's Office serves as a
coordinating, steadying, and vitalizing force i n the entire banking system.
I n the course of his duties, the Comptroller of the Currency exercises a number of quasi-judicial powers of great importance. I n my judgment, i t is highly
desirable that all such functions in this field should be performed by an official
whose duties are definitely and permanently related to the national banking
system alone. I t should be borne in mind that under present law the Comptroller performs his duties "under the general directions of the Secretary of the
Treasury," and this provides an entirely adequate integration of the general
policies of the Bureau w i t h those of the Department. 8
I n some respects, the status of the Comptroller of the Currency is
unique i n t h a t he performs certain quasi-judicial functions w h i c h are
not subject even to j u d i c i a l review, i n the absence of f r a u d or caprice—
f o r example, determining whether a national bank is insolvent,
chartering new national banks, authorizing the establishment o f national bank branches, and the like.
T o reiterate, i n actual practice the Comptroller of the Currency,
operating i n accordance w i t h relatively l i m i t e d general policy directions of the Secretary of the Treasury, makes his own decisions on
matters relating t o the operations of the Bureau and the administrat i o n of the Federal laws and regulations applicable to banks under
his supervision.
9. Does your Office operate under the direction of the President except
as this direction is exercised t h r o u g h the Secretary of the
Treasury ?
The Office of the Comptroller of the Currency operates under the
direction of the President only as that direction is exercised through
the Secretary of the Treasury.
10. Describe the relationships, f r o m your point of view, among the
three Federal bank supervisory agencies. T o what extent is
there coordination of policies and procedures, and how is such
coordination brought about? T o the extent that policy conflicts arise, how are such conflicts resolved at the present time ?
Federal supervision of banks is divided chiefly among three agencies : The Comptroller of the Curency, the Federal Beserve System,
and the Federal Deposit Insurance Corporation. The Comptroller
supervises national banks and banks operating i n the D i s t r i c t of Columbia. The Federal Reserve System exercises some degree of supervision over all member banks, but examination and related activities
are conducted by the 12 Federal Beserve banks p r i m a r i l y w i t h respect
to State member banks. The F D I C has responsibilities w i t h regard
to a l l insured banks, but i t supervises actively only nonmember insured banks.
The functions of banking supervisors include: (1) Passing on applications f o r charters f o r new banks, applications f o r branch permits, proposed mergers and consolidations, and proposed changes i n
banks' capital structures; (2) liquidation of closed banks; (3) issuance of regulations, rulings, instructions to supplement or c l a r i f y
legislation; (4) periodic detailed examinations of the condition, op9
Excerpt from letter to Senator John L. McClellan, dated April 7, 1950.
98454—52—pt. 2
19
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erations, and policies of individual banks; (5) t a k i n g corrective
action; (6) counsel and advice to bankers; (7) compilation of reports
and statistical data.
The Federal banking statutes today are the product of an evolutionary process covering almost a century. They are voluminous and
complicated. Many provisions were enacted to meet emergencies,
specific situations, and competitive conditions as they developed. A l though the broad fields occupied by the three principal Federal
supervisory agencies are f a i r l y well defined, there are numerous instances i n which specific prerogatives or responsibilities of one agency,
whether utilized or not, touch or supplement the prerogatives or responsibilities of one of the other agencies. F o r example, the F D I C
under law has' authority to examine national banks and State member banks. I n actual practice such examinations have been rare and
have been made usually i n anticipation of financial assistance by the
F D I C i n a rehabilitation program, or where a member bank desires
to continue as an insured bank after ceasing to be a member of the
Federal Eeserve System. Similarly, the Federal Eeserve banks do not
examine national banks, although w i t h approval of the Board of
Governors they have the legal power to do so.
Applications f o r domestic branches of national banks are approved
or denied by the Comptroller. L i k e functions w i t h respect to foreign
branches of national banks are performed by the Board of Governors.
The banking statutes also provide machinery f o r the removal of a
director or officer of a national bank f o r continued violations of law
or continued unsafe and unsound banking practices i n the conduct of
business of the bank. W h i l e such action is initiated by the Comptroller of the Currency, the proceedings are conducted by the Board of
Governors, and i t is this body that makes the final determination as
to whether the officer or director is to be removed f r o m office.
Several interesting i n t e r t w i n i n g relationships between the supervisory agencies exist as the result of regulations issued by one agency
under a statutory grant of power. The investment securities regulation issued by the Comptroller of the Currency is applicable to
State member banks as well as national banks. W h i l e most of the
regulations issued by the Board of Governors apply to member banks,
one regulation (regulation U , relating to loans f o r the purpose of purchasing or carrying stocks registered on a national exchange) applies
to all banks. Another (regulation F , relating to trust powers of
national banks) is directed to national banks only. S t i l l another
(regulation H , which relates to State bank membership) is applicable
only to State banks. The F D I C promulgates some regulations that
are applicable only to nonmember insured banks, and others that are
applicable to a l l insured banks.
The F D I C , as the insurer of deposits i n national banks up to $10,000,
has an interest i n the soundness of these risks. Copies of reports of
examination of all national banks are made available to the Corporation by the Comptroller's Office and are carefully reviewed by that
organization. A similar procedure is followed by the Federal Eeserve
authorities w i t h respect to reports of examination of State member
banks.
The F D I C may institute proceedings f o r termination of insurance
whenever i t finds that an insured bank has not, after citation, effected
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corrections of unsafe or unsound practices or violations of law or regulations. U p o n termination of the insurance of a national bank by the
Corporation, the Comptroller is required to appoint the F D I C as
receiver f o r the institution. The F D I C also may require any insured
bank (including national banks) to provide protection and indemnity
against burglary, defalcation, and any other similar insurable losses.
Since national banks are members of the Federal Reserve System,
the condition, policies, and methods of operation of those banks are of
concern to the Federal Reserve authorities. F r o m copies of our reports of examination, furnished to them, the 12 Federal Reserve banks
are able to keep informed of the status of the national banks i n their
respective districts.
Despite these numerous interrelationships among the three agencies,
i n actual operation their basic supervisory functions—within the
framework of the governing laws and regulations—are quite separate.
National bank examination and related duties are performed by the
Comptroller's Office; State member banks ordinarily are visited by no
Federal examiners except those of the Federal Reserve System; and
nonmember insured banks look to the F D I C for this service. ( A l l
State banks, of course, are also subject to p r i m a r y supervision by the
supervisory authorities of the several States.)
Needless to say, continuing efforts are made to coordinate the policies of the three supervisory agencies. This coordination is achieved
through frequent conferences and consultations, both among the top
officials of the agencies and members of their staffs, for the purpose
of developing tentative programs and policies w i t h respect to new
subjects and problems, and changes i n policies and procedures to
meet changed conditions. I n this connection i t may be pointed out
that an important tie-in exists between the Office of the Comptroller
of the Currency and the F D I C by reason of the fact that the Comptroller is by statute an ex-officio member e f the Board of Directors of
the Corporation. Thus he is able to b r i n g to the Corporation the extensive background and long experience of his Bureau.
The following are examples of the types of coordinated action which are constantly being achieved:
1. A u n i f o r m understanding has been reached by the three
agencies w i t h respect to (a) the eligibility of securities as bank
investments, their evaluation, and the treatment of any depreciation i n their market prices; and (6) loan classification designations and definitions i n classifying loans involving v a r y i n g degrees of credit weakness.
2. Each application to organize a new national bank is investigated independently by examiners f r o m the Comptroller's Office,
the F D I C , and the Federal Reserve bank of the district. W h i l e
sole responsibility f o r chartering a new national bank rests w i t h
the Comptroller, the advice and counsel of the other two agencies
is carefully weighed.
3. A free exchange of information is had between the three
agencies w i t h respect to pending applications f o r the establishment of branches. Such a procedure serves to reduce the possib i l i t y of an overbanked situation and the fostering of unhealthy
competition.
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4. The F D I C furnishes the Comptroller's Office w i t h copies of
a l l memoranda prepared by its staff on national banks considered
to be problem cases. T h i s makes possible a ready comparison
of the views of the two organizations w i t h regard to a particular
bank and often leads to the development and consummation of a
constructive program of correction.
5. Figures derived f r o m reports of condition and reports of
earnings and dividends filed i n the Comptroller's'Office by nat i o n a l banks are made available t o the Federal Eeserve B o a r d
and the F D I C , thus making possible the assembly of u n i f o r m
statistics w i t h respect to the condition and operations of a l l commercial banks.
6. The forms of examination reports, reports of condition, and
reports of earnings and dividends have been substantially standardized f o r the three agencies, and major changes therein are
made only after thorough interagency study and exchange of
views.
A l l three Federal supervisory agencies direct t h e i r efforts to the
same broad general objective, namely, the establishment and preservat i o n of a sound banking system. I n seeking to achieve this goal, there
are almost certain to be some differences i n the standards and techniques applied. However, the area i n w h i c h such policy conflicts occur between the agencies is limited, and the disparity i n viewpoints is
usually not a broad one. Whenever a policy conflict arises, an effort
is made to resolve the matter through conference, consultation, or an
exchange of correspondence by the t o p officials of the agencies involved, and i n most cases, this procedure ultimately has provided adequate solutions. O f course, i f such procedure does not produce
agreement, each agency establishes its own policy i n the l i g h t of a f u l l
and intelligent evaluation of all of the factors involved, subject always
to congressional determination or clarification of the particular matter.
I n conclusion i t is our view that the w o r k i n g relationship presently
existing between the three Federal bank supervisory agencies rests
on a h i g h plane and serves to reduce to a m i n i m u m conflicts and potent i a l duplication of effort.
11. Does your'Office follow the practice of submitting its proposed
reports t o Congress on pending legislation to the Bureau of the
Budget to determine whether or not they are i n accordance w i t h
the program of the President? I f i t submits some, but not a l l of
such reports, what are the criteria by w h i c h those submitted
are selected ? Does the Bureau of the Budget submit proposed
reports of other agencies of the Government t o the Comptroller's
Office f o r comment ?
T h i s Office submits a l l of its proposed reports to Congress on pendi n g legislation to the Bureau of the Budget, t h r o u g h regular Treasu r y Department channels, to determine whether they are i n accordance w i t h the program of the President. T h e Bureau of the Budget
does not submit reports of other agencies directly t o this Office. H o w ever, when reports which pertain to the w o r k of our Office are subm i t t e d to the Treasury Department, they are transmitted by i t to our
Office f o r comments and recommendations.
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
DEBT
9 1 7^
12. Do you have any suggestions for legislation relative to your Office ?
I n view of the character and functions of the Joint Committee on
the Economic Eeport and of the Subcommittee on General Credit
Control and Debt Management, as reflected by the subject matter of
the several questionnaires, it is assumed that the interest of the subcommittee is primarily in suggestions which have a major bearing
upon the general purposes of our Office, its internal operations, its
relationship to other parts of the Government, and the adequacy and
soundness of that portion of the Nation's banking system which it
regulates and supervises. However, it is deemed appropriate also to
mention, although not in detail, the need for a considerable number
of legislative changes of lesser moment, ranging from moderately
significant to almost negligible.
The National Bank A c t has been amended scores of times since its
enactment almost 90 years ago. I n addition, national banks are subject to a large number of other Federal statutes ranging f r o m the
Federal Eeserve Act, the B a n k i n g Acts of 1933 and 1935, the act of
November 7, 1918, relating to bank consolidations, and other landmarks i n banking legislation, down to two- or three-line laws on
matters of no significance whatever under present conditions.
These major laws themselves have been amended on numerous
occasions.
The National Bank A c t was drafted i n the l i g h t of governmental,
banking, and legal concepts, institutions, and practices of the 1860's,
and to some extent f o r purposes which are no longer operative. As the
result, many of the laws relate or refer to the currency-issuing function of national banks, which terminated i n 1935. I n addition, i t was
perhaps inevitable, w i t h a body of laws so voluminous and complex,
that existing laws would be amended, and new laws enacted, without
making necessary accompanying changes i n related laws. As a result,
the laws relating to national banks contain numerous inconsistencies,
ambiguities, and obsolete provisions.
A few examples may illustrate these shortcomings. The r i g h t of a
national bank to use a subsidiary corporation to hold title to its banki n g premises is subject to considerable doubt, i n some situations, as
the result of conflicting provisions i n sections 23A and 24A of the
Federal Eeserve Act, as amended (12 U . S. C. 37lc and 3 7 l d ) .
E . S. 5200, as amended (12 U . S. C. 84), i n general prohibits a
national bank f r o m making advances to any one customer i n excess
of 10 percent of the bank's capital and surplus. However, there are
11 enumerated exceptions to this limitation, which permit national
banks to lend a customer i n excess of the 10 percent l i m i t i n reliance
upon obligations which meet specified standards, considered by Congress to provide exceptional strength and assurance of repayment.
These exceptions have been added piecemeal over more than 80 years,
w i t h the result that some contain terminology, the meaning of which
has changed considerably; others contain loopholes not contemplated
by the enacting Congress, as the result of changed business practices;
and inconsistencies and overlapping exist among the exceptions.
These developments make more difficult our task of interpreting and
applying the statute, because the necessary effort to harmonize the
exceptions and make them carry out the congressional purpose has
given rise to intricacies of interpretation which are not clear on the
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
D E B T918^
face of the l a w and are not readily understood and accepted by the
national banks to which they apply.
A m i n o r example of these difficulties, but one w h i c h is especially
clear, relates to R. S. 329 (12 U . S. C. 11), which has not been amended
since its enactment i n 1864. I t provides:
I t shall not be lawful for the Comptroller or the Deputy Comptroller of the
Currency, either directly or indirectly, to be interested i n any association issuing
national curre ncy under the laws of the United States.
A l t h o u g h the officials concerned have been meticulous i n observing
the s p i r i t of this enactment, i t is obvious t h a t i t does not accomplish its
purpose, viewed as a legal enactment. I t relates only to [financial]
interests i n an "association issuing national currency under the laws of
the U n i t e d States," and there are no such associations at the present
time.
E v e n i f t t i s defect were disregarded, the statute i n terms applies
only to the Comptroller and "the Deputy Comptroller of the Currency." A t the time of its enactment, there was only one Deputy Compt r o l l e r , appointed under R. S. 327 (12 U . S. C. 4 ) . Since t h a t time,
Congress has provided f o r t w o additional Deputy Comptrollers (acts
of M a r c h 4, 1909, and M a r c h 4, 1923; 12 U . S. C. 5 and 6 ) , b u t on
neither occasion was the necessary amendment made i n R. S. 329.
Consequently, t h a t statute refers only to one of the three Deputy
Comptrollers, although its principle is equally v a l i d w i t h respect t o
a l l of them.
F i n a l l y , R. S. 329 probably should be made applicable to a l l officials and employees of the Bureau. I n 1864 Congress may have considered t h a t no person i n the Bureau other than the Comptroller or
Deputy Comptroller w o u l d be likely to be financially interested i n any
national bank. Changed conditions have made stock ownership i n nat i o n a l banks much more available—to employees of the Bureau among
others—and since the underlying principle of the law appears to
cover a l l persons engaged i n the w o r k of the Bureau, its scope should
be so expanded.
The foregoing are examples of the types of statutory problems which
call f o r congressional correction f r o m time to time. Some 10 years
ago a compilation was made of many of these, but they were not subm i t t e d f o r congressional consideration d u r i n g the war years, since
i t was felt t h a t they were not of sufficient importance t o j u s t i f y expenditure of the necessary time by Congress and its committees. D u r i n g the past 5 years, w i t h their numerous exigent problems, no time
has seemed appropriate f o r extensive revision of the Federal banking
laws.
However, as particular problems become sufficiently pressing, appropriate corrective legislation is recommended, and d r a f t e d i f necessary. Thus, w i t h i n recent years certain exceptions have been added
to R. S. 5200. I m p o r t a n t new securities issues have been exempted
f r o m the ordinary requirements of R. S. 5136 (12 U . S. C. 24) w i t h
respect to e l i g i b i l i t y of securities f o r national bank investments.
Section 24 of the Federal Reserve A c t (12 U . S. C. 371) has been
amended to permit national banks to make loans secured by leasehold
interests i n some circumstances. The E i g h t y - f i r s t Congress enacted
a l a w p r o v i d i n g f o r conversion of national banks i n t o State banks
and their merger and consolidation w i t h State banks, i n order to
MONETARY
POLICY AND
MANAGEMENT
OF PUBLIC
DEBT
919^
establish the so-called two-way street between the Federal and State
sectors of the dual banking system.
A t the present time, the possible recommendation of additional
legislation is being considered. One of these ^relates to the power of
national banks to operate travel departments. Another has to do
w i t h the authority of a national bank to purchase stock (or otherwise invest) i n a corporation which w i l l provide p a r k i n g facilities i n
its area—a problem which is becoming increasingly i m p o r t a n t w i t h the
increase of traffic congestion i n our cities. A t h i r d has to do w i t h
possible reduction of unnecessarily h i g h capital requirements imposed
by statute upon national banks which desire to establish out-of-town
branches.
The foregoing w i l l indicate to the committee the types of legislative
problems w h i c h exist i n the numerous laws applied and administered
by our Bureau, and the manner i n which these problems are being
dealt w i t h . I t is believed that the Committee's studies and objectives
would not be furthered by an extensive detailing of these matters.
Consequently we are not submitting any recommendations f o r legislation i n connection w i t h this questionnaire.
C. I N C O M E A N D E X P E N S E S O F T H E C O M P T R O L L E R ' S
OFFICE
13. W h a t has been the income of your Office i n each year since 1933 ?
Classify this income i n any way which you believe w i l l be helpf u l to the committee.
(Answered together w i t h question 14.
See below.)
14. W h a t have been the expenses of your Office i n each year since 1933 ?
Classify the expenses i n any way w h i c h you believe w i l l be
h e l p f u l to the committee. Relate the administrative expenses
of the Office (i. e., express them as percentages o f ) (a) the gross
national product of the U n i t e d States; (b) the expenses of a l l
national banks.
The data i n tables I , I I , I I I , and I V (pp. 920-921) as to t o t a l income
and total expenses of the Office of the Comptroller of the Currency
for the years 1934 to 1950 exclude figures f o r the Federal Reserve
Issue and Redemption D i v i s i o n and the D i v i s i o n of Insolvent National
Banks, f o r the reason that the income and expenses of those divisions
are unrelated to the expenses of supervision of active national banks
and the total costs of operation of active national banks. However,
as a matter of information, data w i t h respect to the total income and
total expenses of those two divisions are presented i n tables V , V I , and
V I I (pp. 921-922).
MONETARY
POLICY AND
MANAGEMENT
TABLE I . — I n c o m e of the Office of the Comptroller
supervision
of active national
PUBLIC
D E B T920^
of the Currency
relating
to
banks, 1934 to 1950,Anclusive
reimAppropriated Funds
bursements Total income
funds
by banks
Years
1934
1935
1936
1937
1938
1939
1940
1941....
1942
1943
. 1944
1945
1946.
1947—
1948
1949
1950
Total
1
OF
i $241,750
» 245,546
i 231,244
» 240,811
» 225,906
i 270,689
i 273,187
i 273,993
262,752
289,813
289,805
296,918
153,245
5,392
$2,762,812
3,302,264
3,206,208
3,311,573
3,179,296
3,461,428
3,801,185
3,696,168
4, 242,110
4,184,356
4,079,458
4,603, 515
4,508,230
4,237,376
5, 241, 729
7,118,707
7,826,722
$3,004,562
3,547,810
3,437,452
3,552,384
3,405,202
3,732,117
4,074,372
3,970,161
4,504,862
4,474,169
4,369,263
4,900,433
4,661,475
4, 242,768
5,241,729
7,118,707
7,826, 722
3,301,051
72,763,137
76,064,188
Data for fiscal years ended June 30.
TABLE I I . — E x p e n s e s of the Office of the Comptroller
supervision
of active national
Salary
payments
Years
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
1950
Total
of the Currency
relating
to
banks, 1934 to 1950, inclusive
Per diem
and travel
expense
$2,058,344
2,333,946
2,268,864
2,326,941
2,448,724
2, 584, 700
2,692, 502
2, 790,466
2, 856,028
3,114, 774
2,964,846
2,924,030
3,497,576
3,964,286
4,573,551
5,050,402
5,207,891
$664,832
699,385
634,810
647.015
707,875
725, 767
699,196
730, 565
851,231
801,308
731,466
692.016
789,323
884,286
974,248
1,229,688
1,463,470
53,657,871
13,926,481
Retirement
system
costs
$99,567
175,545
187,437
194, 505
203,086
214,008
222,251
208,348
321,489
323,949
501, 517
507,064
2 2328,904
(2)
()
3,487,670
Miscellaneous
expense 1
Total
expenses
$162,671
142,879
181,580
199,615
191,728
171,007
247,255
148,830
165,324
139,892
124,203
128,315
163,724
227,002
230,293
292,392
294,463
$2,885,847
3,176,210
3,184,821
3,349,116
3,535,764
3,675,979
3,842,039
3,883,869
4,094,834
4,264,322
4,142,004
4,068,310
4,952,140
5,582,638
6,106,996
6,572,482
6,965,824
3,211,173
74,283,195
1
Includes rent, furniture and fixtures, communications, supplies, etc.
2 The retirement system of the Office of the Comptroller of the Currency was terminated effective Aug.
8, 1948, through transfer of the affairs thereof to the civil service retirement system and transfer of the
assets thereof (totaling $5,548,119) to the civil service retirement and disability fund, both pursuant to provisions of Public Law 849, 80th Cong., approved June 30, 1948 (62 Stat. 1163).
TABLE I I I . — E x p e n s e s of the Office of the Comptroller
supervision
of active national
Expenses
Expenses
paid from
appropriated reimbursed
by banks
funds
Cost classifications
Salaries
Pp,r diem and travel .
Comptroller's retirement system
Miscellaneous * _ __ _
Total
1
of the Currency
__
to
Total
expenses
$2,969,925
0
0
331,126
$50,687,946
13,926,481
3,487,670
2,880,047
$53,657,871
13,926,481
3,487,670
3,211,173
3,301,051
70,982,144
74,283,195
Includes rent, furniture and fixtures, communications, supplies, etc.
relating
banks, 1934 to 1950, inclusive
MONETARY
POLICY AND
MANAGEMENT
TABLE I V . — E x p e n s e s of the Office of the Comptroller
OF
PUBLIC
DEBT
of the Currency
9 2 1^
relating
to
supervision of active national banks, expenses of all national banks, and gross
national prodmct of the United States, with relative percentage values, 1934 to
1950, inclusive
Expenses of
Office (in
thousands)
Years
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947..
1948
1949
1950
Total
Expenses of
all national
banks (in
thousands)
Percent total expenses
of Office to—
Gross
national
product of
the United
States (in
millions)
Gross
national
Expenses of
product (in
national
thousandths
banks
of 1 percent)
$2,886
3,176
3,185
3,349
3,536
3, 676
3,842
3, 884
4,095
4,264
4,142
4,068
4,952
5,583
6,107
6, 572
6,966
$557,667
549,148
565, 013
586, 221
577, 272
581, 264
599, 444
641,648
695, 034
670, 628
725, 248
816, 688
951, 572
1,080, 740
1,184,386
1, 248,324
1,337, 068
$64,868
72,193
82, 483
90, 213
84, 683
91,339
101, 443
126,417
161, 551
194, 338
213, 688
215, 210
211,110
233, 264
259, 045
257,348
282,630
0.5175
.5783
.5637
.5712
.6125
.6324
.6409
.6053
.5891
.6358
.5711
.4981
.5204
.5165
.5156
.5264
.5210
4.449
4.399
3.861
3.712
4.175
4.024
3.787
3.072
2.534
2.194
1.938
1.890
2.345
2.393
2.357
2.553
2.465
74,283
1 13,367,365
2, 741,823
.5557
2.709
1
Exclusive of taxes on net income for years 1943 to 1950, inclusive, in amounts of from $75,806,000 in 1943
to $255,490,000 in 1950.
TABLE V.—Office of the Comptroller
Reserve Issue and Redemption
Banks, 1984 to 1950. inclusive
Years
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
1950
—
Total
1
Data forfiscalvears ended June 30.
of the Currency,
Division
income relating
and Division
of Insolvent
Federal
reserve
issue and
redemption
division
i $58, 299
i 56, 730
i 54, 243
53,352
57, 222
55,123
52,994
54,108
48, 560
56,834
41,002
45, 744
60,657
67,620
89, 512
98, 550
107,366
1,057,916
Insolvent
division
to
Federal
National
Total
$1,101,381
1,538,030
1, 761,661
1, 637,461
1,310,180
358,005
62,999
740, 265
308,861
253, 403
104, 946
76, 704
47, 582
65,067
9,482
8, 755
73, 426
$1,159,680
1, 594, 760
1,815,904
1, 690,813
1,367,402
413,128
115, 993
794,373
357,421
310, 237
145,948
122, 448
108,239
132, 687
98,994
107,305
180,792
9, 458, 208
10, 516,124
MONETARY
POLICY AND
TABLE V I . — O f f i c e of the Comptroller
MANAGEMENT
of the Currency,
Federal Reserve Issue and Redemption
Division,
_
_
..
PUBLIC
expenses
-
.
___
Total
D E B T922^
relating
to the
1934 to 1950, inclusive
Salary payments
Years
1934
1935
1936 ..
1937
1938
1939 „
1940
1941 .
1942
1943
1944...
1945
1946
1947
1948
1949
1950
OF
Miscellaneous expense 1
$57,409
55,840
53,458
52,009
56,421
54, 744
52,809
51, 778
48,527
56,913
40,159
42,385
58,972
64,092
88,965
97,836
105,752
1,038,069
Total expenses
2 $890
2 890
2 785
829
609
223
364
279
885
753
527
625
692
1,637
1,423
1,209
1,219
3 $58,299
3 56,730
3 54,243
52,838
57,030
54,967
53,173
52,057
49,412
57,666
40,686
43,010
59,664
65, 729
90,388
99,045
106,971
13,839
1,051,908
1 Includes supplies, printing, furniture and fixtures, rent, communications, etc.
2 Estimated.
3 Data for fiscal years ended June 30.
TABLE V I I . — O f f i c e of the Comptroller
Division
of Insolvent
of the Currency,
expenses relating
to the
National Banks, 1934 to 1950, inclusive
[NOTE.—All insolvent national banks were assessed on a uniform basis to cover the cost of supervision by
our Division of Insolvent National Banks. However, some services of the Washington staff which were
definitely allocable to particular receiverships were charged to, and collected from, those institutions. The
followingfiguresexclude all such special service expenses which were so recovered.]
Years
1934
1935
1936
1937
1938
1939
1940
1941 —
1942
1943
1944
1945
1946
1947
1948
1949
1950
Total
Salary pay- Per diem and Miscellaneous
Total net
ments (un- travel expense expense 1
expenses
recovered) (unrecovered) (unrecovered) (unrecovered)
$626,052
758, 450
936,300
815, 939
692, 296
627,185
552, 838
494, 276
324,043
311, 884
223, 236
239,837
242, 219
207, 978
97, 482
77, 871
58, 282
$2, 559
15, 544
18,001
10,281
1, 592
25, 884
35, 863
37, 806
210, 871
2,576
a 16,314
2,644
1,460
2 23
393
149
194
$126,688
181, 770
189,291
370, 459
281,377
238, 203
210, 237
208,352
143,397
100, 341
89,399
81, 808
70, 784
67,174
4,258
4,806
4,229
$755,299
955, 764
1,143, 592
1,196, 679
975, 265
891,272
798, 938
740, 434
456, 569
414, 801
296,321
324, 289
314, 463
275,129
102,133
82, 826
62, 705
7, 286,168
127, 738
2,372, 573
9, 786,479
1 Includes supplies, printing, furniture and fixtures, rent, communications, etc.
2 Red figure: In these years recoveries exceeded current expenditures.
15. Describe the budgetary procedure of your Office. I s its budget
reviewed by the Bureau of the Budget? A r e changes i n its
budget made by the Bureau b i n d i n g upon your office ? H o w are
its expenditures subject to congressional control? W h a t suggestions, i f any, do you have f o r changes i n any of the procedures
described i n this question ?
The funds upon which this Office operates are derived f r o m assessments against the banks (and their affiliates) w h i c h i t supervises.4
4
There is an exception : The cost of operating our Issue and Redemption Division, which
handles Federal Reserve notes, is reimbursed to us by the Federal Reserve System.
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
DEBT
9 2 3^
Congress has provided, by statute, t h a t these funds "shall not be construed to be Government funds or appropriated monies" R. S. 5240
(12 U. S. C. 481 and 482). Consequently, our budgetary procedure is
not reviewed by the Bureau of the Budget.
The rate of assessment is fixed as a percentage of the assets of the
bank examined i n accordance w i t h a f o r m u l a adopted by the Comptroller under congressional authority. T h e rate so fixed by h i m must
apply to a l l examined banks u n i f o r m l y , and the amount of the fee
determined by the application of the f o r m u l a is remitted to the Office
at the conclusion of each examination. Hence, the amount of funds
derived f r o m assessments depends upon how many banks are examined
each year, as w e l l as the amount of their resources at the t i m e of
examination. Therefore, i t is possible to know at the beginning of each
calendar year the approximate amount of the Bureau's income f o r the
year.
The rate of assessments is designed to produce enough income to
cover our expenses and to provide a modest cushion. I f the f u n d at
any time becomes too large, the rate of assessment f o r the next year is
revised downwards i n order to avoid excessive charges against the
examined banks. I f i t appears probable that, by virtue of unavoidably
increased costs of operation, the income derived f r o m assessments at
the existing rate w i l l be inadequate, the rate is revised upwards. H o w ever, i n order to provide u n i f o r m treatment f o r a l l banks examined, the
rate should not be changed except at year ends, and, as a matter of fact,
i t is altered very infrequently.
A s indicated by data presented i n answer to other questions, the
expenditures of the Bureau i n its bank-examining activities are f a i r l y
steady and predictable. B y f a r the largest element i n the Bureau's
expenditures is the item of salaries of bank examiners and assistant
examiners. The number of these employees is increased only when i t
appears that the existing corps of examiners is inadequate to p e r f o r m
the volume of work. I n such situations, the district chief examiner
submits to the Washington office his request f o r authority to increase
his force by the employment, f o r example, of t w o additional assistant
examiners. A n y such request f o r a staff increase must be accompanied
by an adequate factual justification f o r the proposal.
S i m i l a r principles govern the subject of pay increases f o r employees. Generally speaking, the Bureau's personnel receives periodic
pay increases on a basis comparable to t h a t applicable to the great
b u l k of the Federal c i v i l service. Departures f r o m this n o r m a l routine, whether on the h i g h or low side, occur i n relatively few instances
and only on the basis of exceptional reasons f o r such action.
O u r recruitment and compensation plans and programs are formulated under the direction and w i t h the approval of the Treasury Department.
O u r incentives f o r operating as economically as possible are p r i m a r i l y a sense of good government and sound administration, plus a
desire to accumulate, as afore-mentioned, a modest cushion adequate
to carry us t h r o u g h any relatively short emergencies i n which f o r any
reason examinations could not be conducted and consequently fees
could not be collected, and a desire to avoid the necessity of increasing
the rate of assessments, w h i c h naturally is unpalatable to the examined
banks.
MONETARY
POLICY AND
MANAGEMENT
OF PUBLIC
D E B T924^
These factors i n our operations, together w i t h the relatively small
size of the Bureau (1,115 persons on December 31, 1950), explain the
absence of need f o r more formal budgetary procedures. A t various
times i n the history of the Bureau, budgetary forecasts and allocations
have been used, but the results d i d not appear to j u s t i f y the time, expense, and effort. The data presented i n our answer to question 14
is evidence that the absence of formalized budgetary procedures i n the
Bureau has not resulted i n excessive expenditures.
Each year, our annual report to Congress presents a summary of
significant data, including the number of employees and their distribution as to function, the number of examinations performed, and the
aggregate expenses. Comparison of these figures f r o m year to year
would reveal any unusual increase i n relative cost of the service performed. Over the years, i t has never been suggested, to our knowledge, that the cost of operating the Bureau is disproportionate or i n
any respect uneconomical.
Perhaps because of the fact that our funds are i n a theoretical sense
unlimited, there is no incentive to use up any surplus funds. Consequently, our recruitment is designed to procure only enough trained
employees to perform the task assigned to us. The history of the
Bureau reveals that we have been able to determine w i t h f a i r accuracy
the number of employees needed f r o m time to time and that deviations f r o m the ideal have been i n the direction of understaffing rather
than an excessive number of employees.
Our employment and compensation plan was especially designed
by us to meet our particular situation; i. e., the need to obtain men
w i t h bank t r a i n i n g whose intellectual qualifications and personalities
are such as to enable them to deal on an equal basis w i t h bank officers
and directors, as well as the necessity of competing w i t h banks f o r the
services of such persons. A l t h o u g h our examining force is excepted
f r o m the competitive civil service—temporarily at least—each person
is selected on an impartial, nonpolitical, selective basis, and all examiners must have advanced through the assistant examiner stage.
We w i l l be glad to furnish a copy of our employment and compensation plan f o r the confidential information of the committee, i f i t so
desires. Our clerical staff, on the other hand, is w i t h i n the competitive
c i v i l service and is treated accordingly.
F i n a l l y , we wish to note that our organization is so small and well
integrated that the Comptroller and his staff can and do keep well
informed concerning the adequacy of the organization and quality
of individual performance, as well as the expenses incurred i n operating the Bureau. Hence much of what is ordinarily considered "budgeti n g " takes place i n our day-to-day operations and is, therefore, more
closely scrutinized than is possible i n many other organizations.
I t is our belief that the existing procedure has worked well throughout the years.
16. A r e the accounts of your Office audited by any other department
or instrumentality of the United States Government? I f so,
by whom ? A r e the powers of the auditing authority limited to
reporting or does i t have authority to disallow expenses ? To
whom are the reports of auditing authority sent ?
A l l of the accounts of this Office are audited by a special internal
auditing u n i t on a permanent and continuous basis. T h i s u n i t re
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
DEBT
9 2 5^
ports directly to the Comptroller. I t is completely independent of
the disbursing officials and i t is charged w i t h the duty of calling to the
attention of the Comptroller and his immediate staff a l l expense items
which are beyond the l i m i t s of applicable regulations or other authorization, inadequately supported, or otherwise irregular or questionable
i n any respect. The decisions as to allowance or disallowance are
made by the Comptroller or a designated deputy i n the l i g h t of those
recommendations.
A s an additional safeguard, an annual, comprehensive audit is performed f o r the Comptroller, at his request, by representatives of the
Bureau of Accounts of the Treasury Department. A l t h o u g h the B u reau of Accounts does not have authority to disallow expenses, their
reports are made directly to the Comptroller. T h i s serves as a check
on our own a u d i t i n g unit. The contents of those reports reflect favorably upon the quality of our audits.
17. L i s t and discuss any expenses which have been incurred by your
Office d u r i n g the period since 1946 f o r the purpose of influenci n g public opinion on controversial matters. Expenses f o r the,
preparation of material i n standard expository f o r m a t and f o r
the distribution or presentation of such material i n w r i t t e n or
oral f o r m to persons who m i g h t be expected to have a regular
business or professional interest i n i t may be omitted. A n y expenses d u r i n g this period f o r the preparation of motion pictures,
illustrated brochures, or any other special material should be
included, however, irrespective of your personal opinion as to
whether or not the material they contain is controversial i n character, i n order that the subcommittee may, i f i t desires, consider
them on a case-by-case basis.
Since 1946, our Bureau has not incurred any expenses of the types
referred to i n this question.
D.
THE BANKING
STRUCTURE
18. W i l l you please submit a memorandum discussing the adequacy
of banking facilities i n the U n i t e d States ? F o r this purpose,
take as your standard of adequacy the ideal of b r i n g i n g banking
facilities w i t h i n convenient reach of a l l persons having need of
them, and, so f a r as practicable, g i v i n g a l l persons the opport u n i t y of choosing between two or more competing banks. Distinguish between deposit facilities and loan facilities.
W i t h i n less than a generation, the number of commercial banks i n
the U n i t e d States has been halved, while the business transacted by
the commercial-banking system has m u l t i p l i e d many times. D u r i n g
that period, hundreds of small, r u r a l American communities have become "bankless towns", and many others are served by only one bank
i n place of the t w o or three which existed i n the 1920's.
These facts suggest superficially that the commercial b a n k i n g system has not kept pace w i t h the g r o w t h of the economy, and t h a t exi s t i n g units may be inadequate i n number and may f a i l (1) to b r i n g
banking facilities w i t h i n convenient reach of a l l persons h a v i n g need
of them, and (2) to provide the healthful conditions of competition
among banks generally considered desirable.
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
D E B T926^
Actually, there is relatively l i t t l e basis f o r the first conclusion. I t
must be remembered that i n 1920 the r u r a l population of the United
States amounted to 51 y 2 million, or 48.8 percent of the total population. D u r i n g the succeeding 30 years, the r u r a l population remained
relatively static, and the 1950 census disclosed only a small increase to
54y 2 million, or 36.3 percent of the total population. U r b a n growth, on
the other hand, was substantial between 1920 and 1950, this segment
of the population increasing f r o m 54 to 96 million, the latter representi n g 63 percent of the total population. These figures reveal there has
not been a growing need over the last 30 years for banking facilities
i n r u r a l areas. The increased need has been centered i n urban areas
able to accommodate i t through expansion of existing units or the add i t i o n of new units. There is somewhat greater foundation f o r the
allegation that the ideal level of competition is not being completely
achieved.
Our experience w i t h banking conditions throughout the country
over many decades has proved that a substantial lack of adequate and
convenient banking facilities i n communities large enough to support
them almost invariably w i l l give rise to an effective demand f o r such
facilities, usually i n the f o r m of an application for a new bank charter, either State or national, or a branch thereof where permissible.
Nevertheless, d u r i n g the past decade there have been relatively few
applications f o r national-bank charters and branch permits, as indicated i n our answer to question 20. I t is our understanding that the
experience of State supervisory authorities has been substantially
similar.
I t is not difficult to ascertain why 15,000 banks 5 can render several
times as much service as was formerly provided by 30,000 banks,6 and
can do this w i t h greater convenience to their communities and the
country at large. Many of the banks which have disappeared were
situated close to banks which are still i n operation, and the loss of their
facilities has been compensated f o r by expansion of continuing institutions and adoption of more efficient and time-saving methods by
present-day banks. This great increase i n efficiency, and the ability
of banks to handle increased volume have resulted f r o m such changes
as improved physical lay-out, increased mechanization of operations,
drive-in windows, popularization of banking by mail, creation of
more branch offices, and the like. Furthermore, i n many parts of the
country, 30 years ago, a local bank was more essential than now i n
very small towns; today our complete network of high-speed, allweather roads makes i t possible, without severe inconvenience, to do
business at the bank located i n the county seat, 5 or 10 miles away. W e
are satisfied that there are very few places i n the U n i t e d States, which
are able to support a unit bank on a profitable basis, which experience
extreme inconvenience as the result of inadequate banking facilities.
B u t there are some situations i n large cities, and many situations
5
For over 10 years the number of banks i n the country has been stabilized at somewhat
less than 15,000. On December 30. 1950, there were 14,666 unit banks w i t h 5,034
branches. A quarter century ago (June 30, 1924) there were 28,996 unit banks with
2,293
branches.
6
The disappearance of some 15,000 unit banks took place through voluntary liquidation,
receiverships, consolidations of two or more institutions, absorption of one bank by another through purchase of assets and assumption of liabilities, and so on. I n the great
majority of cases, a banking office ceased to exist as such. I n a smaller—but still significant—number of instances, the banking office was continued as a branch of another
institution.
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
DEBT
9 2 7^
i n small, bankless, r u r a l communities, where additional banking facilities would be a decided convenience to many people. I n many of these
situations a new bank is not the answer, for the amount of available
business is inadequate to permit profitable operation, and an unprofitable bank cannot long retain competent employees, and hence
it gradually deteriorates and becomes a hazard to the economic l i f e
of the community. On the other hand, these communities could, i n a
great number of instances, readily support a branch office of a sizable
institution. However, i n many cases the absence of State laws perm i t t i n g banks to have branches i n those areas precludes the use of
this corrective measure, inasmuch as national banks cannot have
branches i n States where State banks are prohibited f r o m operating
them. The problem could be solved i f national banks were authorized
to establish branches w i t h the,approval of this office, irrespective of
State laws, but such legislation m i g h t adversely affect the operation
of the dual banking system, i n which national banks and State banks
operate competitively.
There are s t i l l some communities i n this country which are served
by two or more banks, where a lesser number undoubtedly would be
more "efficient" f r o m the point of view of immediate dollars-andcents economy and resulting profit. On the other hand, there are
many communities served by one bank which could profitably support another. I n almost all these cases there is a conflict between the
pressure of business economics, on the one side, and the broader desirability of active bank competition, on the other. Since the initiative lies w i t h practical businessmen, interested p r i m a r i l y i n the net
dollar return on the dollars invested, the trend toward amalgamation
and branch banking remains strong, a trend which is away f r o m the
"ideal" of g i v i n g all persons the opportunity of choosing between two
or more competing banks.
I t is our opinion that existing deposit facilities of the banking
system are generally satisfactory and perform reasonably well their
important role i n our economic life, except w i t h respect to a very small
percentage of the total population located, for the most part, i n towns
too small to support a u n i t bank.
Not infrequently, one hears expressions of dissatisfaction, even i n
cities, regarding the number and location of banking offices, the shortness of banking hours, and so on. Needless to say, i t would be very
convenient for all of us i f there were a banking office i n every shopping
center and department store, open f r o m morning to night, 6 days a
week. However, i t must be remembered that, despite its unique character, banking is a business like any other, which must operate at a
profit as well as render service.
I n States where branch banking is not permitted, additional banki n g facilities of the type described could exist only through the establishment of new unit banks. Regardless of the added convenience i n
those situations, the banking office could not long exist without paying
its way, and banking authorities would not be justified i n authorizing
a bank w i t h poor prospects of success. Wliere branch banking is
permissible, such additional facilities doubtless could be successfully
established and maintained i n some cases. Such a development would
be attractive to some of the larger banks, which could afford to operate
such branches, as well as to the department stores which would receive
the benefit of the advertising value of those banking facilities.
MONETARY
POLICY AND
MANAGEMENT
OF PUBLIC
D E B T928^
However, extensive "cubbyhole" banking by large institutions would
be detrimental to many smaller banks, whose business wTould be jeopardized by such competition. F i n a l l y , i t is questionable whether
the public w o u l d continue to welcome this expanded banking service
when i t was eventually realized that i t must be paid for.
L o a n facilities of banks are utilized to a lesser extent by the public
t h a n are the deposit facilities, and we believe that the loan facilities
are adequate i n a quantitative sense, as well as w i t h respect to geographic availability. Whether such facilities actually are placed at
the service of a l l deserving would-be borrowers is a much argued
question. ( I n this connection, see our answers to questions 21 and 22.)
I n the opinion of this office, our commercial banking system is capable of meeting practically a l l legitimate credit needs of American
business. However, i t is our feeling that i n some situations, the availability of credit could be broadened, and its cost to American business
reduced i f a feasible means could be devised f o r achieving effective
banking competition i n all communities and areas. I t is our belief
t h a t this is a relatively minor shortcoming i n our commercial banking
system, and is an unavoidable concomitant to the s p i r i t of i n i t i a t i v e
and efficiency upon which the American economy has been built.
19. Discuss i n general your policy i n acting on applications f o r new
national banks. Stress your concept of what constitutes ample
banking facilities—especially the degree of competition w h i c h
you believe to be necessary or desirable.
P r e l i m i n a r y to action on a new bank application, the Comptroller
has before h i m f o r review and s t u d y :
(a) A detailed report of investigation made by a national
bank examiner who visits the community i n w h i c h i t is proposed
to organize the bank. Such report among other matters contains
i n f o r m a t i o n as to (1) the general character, financial responsibility, and experience of the organizers and of the proposed officers, directors, and principal stockholders, (2) the adequacy of
existing banking facilities, the need f o r f u r t h e r banking services and the competitive aspects of the proposed bank, (3) the
prospects f o r g r o w t h and development of the area i n question, (4)
the methods and banking practices of existing banking units, (5)
the local sources of income and wealth, (6) the extent of profitable
business w h i c h could be generated by the proposed new institution,
(7) the adequacy of the capital proposed f o r the new bank, and
(8) the banking history of the community, and i n case of conversion, the history of the State bank, et cetera.
( i ) A review of the investigation report by and the recommendation of staff members, including the district chief examiner,
the Chief of the Organization Division, the assistant chief examiner, chief examiner, and three Deputy Comptrollers.
(c) Reports and recommendations of the Federal Deposit I n surance Corporation and the Federal Reserve bank f o r the district
i n w h i c h the proposed bank is to be located, w i t h respect to the
factors enumerated i n (a) above.
There can be no h a r d and fast rule i n deciding upon the merits of
new bank applications because of the variety of factors w h i c h must be
considered i n i n d i v i d u a l cases, which vary greatly i n different communities. A s an example, an economically poor and static community
of 2,000 or 3,000 population m i g h t not be able to provide support f o r
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
DEBT
9 2 9
even one bank because of the inadequate volume of deposits and profitable credit outlets, whereas a t h r i v i n g and expanding community
possessing considerable wealth w i t h a similar population m i g h t need
and could amply support more than one bank. I t is therefore the
Comptroller's policy to weigh a l l pertinent i n f o r m a t i o n developed
i n relation to each i n d i v i d u a l case w i t h the view of determining
whether the needs of the community f o r , and the prospects of successf u l operation of, the proposed bank under the management selected are
such as to w a r r a n t favorable action on the application.
However, one of the fundamental tenets of our views and actions on
applications f o r charters and branches is the desirability of competition wherever possible. We believe t h a t sound and healthy competit i o n between banks redounds favorably to the public welfare t h r o u g h
increased adequacy of credit facilities, f a i r rates of interest, and the
prevention of undue concentration of monetary and economic power.
Hence, i n considering applications f o r new banking offices i n communities having only one bank, we give considerable weight to this
factor. I n communities where competition already exists, the factor
is given much less weight, f o r excessive competition can result i n such
a weakening of existing banking institutions as to b r i n g consequences
so injurious to the welfare of the community as to outweigh any benefits to be anticipated f r o m increasing the intensity of competition i n
such cases.
I n short, we believe thoroughly i n competition i n the field of banking, and endeavor to provide i t wherever possible to do so w i t h o u t
jeopardizing existing institutions. W e do not believe i n unbridled
competition—either by u n i t banks or branch banks, because of the risk
involved to depositors and to the economy of the community and the
Nation.
20. Submit a statistical analysis showing year by year f o r the past 10
years the number of applications filed f o r national bank charters, branch permits, authority to convert into a national bank,
and authority to consolidate. State the number of such applications approved, the number rejected, and the causes f o r rejection, classified by such p r i n c i p a l reasons as (a) existence of
ample banking facilities, ( i ) no prospect of successful financial
operation, (o) inadequate capital f o r the establishment of the
bank or branch, ( d ) no satisfactory evidence t h a t competent
management w o u l d be available. Submit also statistics w i t h respect to voluntary liquidations of national banks. Comment on
this analysis i n any manner which you consider appropriate.
T h e f o l l o w i n g tabulations, w i t h their explanatory notes and comments, contain the i n f o r m a t i o n called f o r by this question.
Applications
for authority
to organize national banks, 1941 to 1950, inclusive
1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 Total
Applications approved
Applications rejected.
Total
5
4
3
0
2
5
9
5
26
11
29
20
17
20
16
16
12
15
9
18
1128
114
9
3
7
14
37
49
37
32
27
27
242
i Applications approved as distinguished from charters issued.
98454—52—pt. 2
20
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
D E B T930^
Reasons for rejections
of 114 applications
for authority
to organize
national
bcmks (classified
according
to number of times each reason occurred),
1941
to 1950,
inclusive
1941 1942
Insufficient need
Unsatisfactory management
Earnings prospects unfavorable..
Inadequate capital
Control ownership of stock objectionable
Inadequate banking quarters
Poor distribution of stock
Promotion scheme
Application submitted by another group at the same time
appeared to more nearly meet
requirements and standards
for national bank
_ ..
Bank would function primarily
as savings bank
Total
Applications
by national
Reasons for rejections
1946
1947
1948
1949
1950 Total
4
4
2
1
4
4
0
0
8
8
3
3
18
14
7
1
19
0
11
0
15
2
7
0
15
0
11
0
17
0
16
0
104
33
57
6
0
0
0
0
0
0
0
0
0
0
0
0
2
0
0
0
1
1
0
0
0
3
1
0
0
0
0
1
1
0
0
0
0
0
0
0
0
0
0
0
4
4
1
1
1
0
0
0
0
0
0
0
1
0
0
0
0
0
0
0
0
0
0
0
1
1
6
0
11
10
24
44
31
26
26
34
212
authority
inclusive
to establish
branches,
1941 to 1950,
1943
1944
1945
1946
1947
1948
1949
1950 Total
29
14
19
6
12
3
22
4
57
38
85
56
108
50
108
29
100
37
159
46
699
283
43
25
15
26
95
141
158
137
137
205
982
of applications
by national
branches, 1941 to 1950,
Insufficient need
Insufficient need; future prospects unfavorable
_
Priority of another bank's application
__
Not in public interest
Inadequate capital structure
Inadequate capital structure;
unsatisfactory or unproved
management
Inadequate capital structure;
possibility of bank acquiring a
too dominant position
Insufficient need; unsatisfactory
or unproved management
Inadequate capital structure; insufficient need
..
Detrimental to another bank
New bank, needed more time to
prove that management and
policies are sound
__
Unsatisfactory management. _
Additional investment in real
estate not warranted; inadequate capital structure
Total.
1945
0
0
0
0
1941 1942
Total
1944
4
1
0
1
banks for
Branches authorized
Applications rejected
1943
banks for authority
inclusive
to
establish
1941 1942
1943
1944
1945
1946
1947
1948
1949
1
2
1
17
26
35
19
21
16
143
7
1
3
3
4
20
38
11
11
4
4
3
8
3
4
2
1
2
36
16
20
1
1
1
11
1
4
5
1
3
1
1
1
4
2
4
3
1
2
2
2
1950 Total
3
1
3
2
1
2
1
1
14
6
3
4
38
56
50
1
2
4
1
1
2
2
3
1
1
37
46
283
1
29
MONETARY
Applications
POLICY
AND
MANAGEMENT
OF
PUBLIC
DEBT
by State banks for authority to convert into national
to 1950, inclusive
Applications approved
Applications rejected
Total
9 3 1^
banks, 1941
1941
1942
1943
1944
1945
1946
1947
1948
1949
1950 Total
5
3
8
0
11
1
13
0
15
1
14
1
8
0
6
1
4
1
4
1
188
9
8
8
12
13
16
15
8
7
5
5
97
i Applications approved as distinguished from charters issued.
NOTE.—Between A u g . 17,1950, the effective date of P u b l i c L a w 706, a n d Dec. 31,1950,1 n a t i o n a l b a n k
was converted into a State bank.
Reasons for rejections of applications by State banks for authority
into national banks, 1941 to 1950, inclusive
1941
Insufficient need for banking
services in a town to which
bank proposed to move
Condition of State bank desiring
to convert only fair; earnings
poor; unsatisfactory management
- Bank had been in operation for
only 2 months. Considered it
should go through ''seasoning"
period before applying for conversion
__
Inadequate capital; failure to
work out banking house situation
Future of bank believed limited
Application for F D I C insurance
rejected _
Type of business emphasized by
State bank desiring to convert
made it appear successful operation as national bank not
possible
Total
1942
1943
1944
1945
1946
1947
1948
to convert
1949 , 1950 Total
1
1
1
1
2
1
1
1
1
1
1
1
3
0
1
0
1
1
0
1
1
1
1
2
1
1
9
Number of banks consolidated with national banks under national bank charters,
1941 to 1950, inclusive
Number of national banks
Number of State banks
Total
1941
1942
1943
1944
1945
1
3
1
0
1
1
3
6
5
2
1 10
19
12
no
15
13
5
3
4
12
37
49
4
1
2
9
7
1 19
112
18
8
16
86
1946
1947
1948
1949
1950 Total
1
I n each of the years 1946,1947, and 1948,1 consolidation program was consummated in which 1 national
bank and 1 State bank were consolidated into another (continuing) national bank.
NOTE.—As indicated by the preceding notes a total of 83 consolidation programs were consummated
during the period 1941 to 1950, inclusive.
Tentative consolidation proposals are thoroughly discussed with representatives of the consolidating
banks by field or office representatives of this office prior to the submitting of formal applications, by
national banks, to this office for approval and authority to consolidate. No tabulation of rejections can
be made, since no statistical record is maintained of proposals discussed and abandoned by the banks
before reaching the state of submitting formal applications to this office for permission to consummate the
consolidation program agreed upon.
MONETARY
Voluntary
POLICY AND
liquidations
Total
-
Reasons for national
PUBLIC
D E B T932^
1943
1944
1945
1946
1947
1948
1949
21
17
20
20
11
13
25
16
13
19
20
8
19
8
16
13
6
7
10
6
2
3
2
3
1
40
37
45
50
30
43
35
30
27
32
24
353
12
19
banks being placed in voluntary
inclusive
Uneconomic banking units;
towns overbanked; poor prospects or insufficient earning
power
Age of officers; disinclination to
continue; family differences or
necessity to realize on investment
Purchased by branch banking
system for expansion purposesShareholders' desire to liquidate
stock holdings
Asset condition
Absorbed into principal bank of
holding company
Desire to take advantage of more
liberal State laws
Unwillingness to increase common stock
Embezzlement •
Purchased for removal to another town
Reason unknown
Total
OF
of national banks, 1941 to 1950, inclusive
1941 1942
Take overs by other national
banks
Take overs by State banks
Liquidated without take-overs
by other banks
MANAGEMENT
liquidation,
1950 Total
15
8
1941 to 1950,
1941 1942
1943
1944
1945
1946
1947
1948
1949
13
22
6
10
10
3
5
4
4
12
172
141
1950 Total
89
1
5
10
4
10
10
2
6
14
9
71
1
3
4
5
6
5
9
4
12
2
51
3
4
5
15
7
2
4
3
4
5
1
2
6
36
25
2
1
1
1
4
2
2
1
1
2
2
4
1
10
2
4
1
1
5
1
1
37
45
50
30
43
35
30
1
1
9
3
20
9
1
1
3
1
13
3
12
11
1
24
27
32
24
353
E . A V A I L A B I L I T Y OF CAPITAL FOR S M A L L BUSINESS
21. Discuss the changes which have occurred d u r i n g the last 25 years
i n the ease or difficulty w i t h w h i c h small-business men have been
able to raise capital or to borrow. W h a t i n your opinion are the
reasons f o r such changes as you find to have occurred? D o you
believe t h a t a more liberal supply of capital and credit to small
business would contribute t o the diffusion of economic power
and to the dynamic character of the economy? W h a t steps
could be taken to b r i n g about a more liberal supply of capital
and credit t o small business? D o you believe t h a t any of these
steps w o u l d be desirable? Distinguish between the longerterm aspects of the problem and those of particular importance
today d u r i n g the current national defense emergency.
T h e first p o r t i o n of this question relates to—
* * * the changes which have occurred during the last 25 years i n the
ease or difficulty w i t h which small-business men have been able to raise capital
or to borrow.
I n the first instance i t seems i m p o r t a n t to us to p o i n t out t h a t there
often exists i n the public m i n d a confusion between capital (i. e.,
equity funds) and loans. A great deal has been said of late about the
difficulty of small business i n obtaining funds w i t h which to operate.
MONETARY
POLICY
AND
MANAGEMENT
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PUBLIC
DEBT
9 3 3^
There is a v i t a l point i n understanding clearly the division between
capital and debt, both of which contribute to the successful operation
of practically a l l businesses. Capital represents ownership i n the
business; debt is made up of credit obligations, including loans.
Strictly speaking, furnishing of capital is not a banking function.
The satisfying of requirements f o r debt upon sound and proper conditions is a banking function. Relative availability of capital (i. e.,
equity funds) is a matter which we are not qualified to discuss as
experts. I n our opinion, numerous factors, some of them psychological, enter into this matter.
One factor bearing upon the ease or difficulty of raising capital
f o r small enterprises is the availability of personal savings f o r this
purpose. Twenty-five years ago there was a f a i r l y h i g h level of accumulation of savings; during the depression years, national income
was down and savings were necessarily low • d u r i n g W o r l d W a r I I
years, accumulation of savings was extremely rapid but opportunities for utilization were l i m i t e d ; w i t h i n the past 5 years, personal
savings have accumulated more slowly, but the dammed-up savings of
the war years are still available to a large extent.
Obviously, the volume of funds potentially available f o r capital
investment has a powerful bearing on the ease or difficulty w i t h which
capital can be raised i n a particular period. Psychological factors
are of great significance i n this field. W h e n potential equity investors anticipate a period of recession, they are naturally less inclined
to supply capital funds, not only because of the supposed poor prospects of profitable use w i t h i n the near future, but also because a f a l l i n g
price level f o r capital goods may permit more economical use of the
funds a year or two later.
The foregoing discussion relates chiefly to the ease or difficulty of
raising capital. We do not feel qualified to' attempt a more definite
analysis of the nature of the changes which have occurred d u r i n g the
last 25 years i n this field.
I n q u i r y has been made also regarding changes d u r i n g the last 25
years i n the ease or difficulty w i t h which small-business men have been
able to borrow. Presumably, this aspect of the question has to do
chiefly w i t h bank-credit facilities open to such entrepreneurs,
I t is undoubtedly true that giant corporations w i t h large resources,
which have been long established and which have a certain dominance
i n their markets, have a better access to bank credit than the smaller
and younger enterprise, even i f there is comparable soundness. H o w ever, there are a great many small concerns, well managed and financed
and w i t h good records, which are well taken care of i n the credit field.
These concerns do not draw the national attention which is enjoyed
by the great corporations, but the flow of credit to them, except i n cases
of profound national distress, is adequate, although less spectacular
than that accorded to their b i g brothers.
D u r i n g the 1940's, particularly the war years, the bank-credit needs
of small business were satisfied almost completely, since those needs
arose either f r o m activities related to the war effort or i n connection
w i t h production for, or services to, the civilian market. To the extent
necessary, war-connected needs were satisfied through the medium of
loans supported by various f o r m of governmental guaranties. Because of general shortages of goods and services, the civilian market
MONETARY
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D E B T934^
was well-nigh insatiable, so t h a t the credit needs of small businesses
operating i n t h a t field were sound bankable risks, p a r t i c u l a r l y attract i v e i n view of the relatively small volume of loan business available
to banks d u r i n g t h a t time.
W i t h respect to national banks (and this is at least equally true of
State banks), i t must be remembered that the overwhelming m a j o r i t y
are situated i n small towns and have l i t t l e , i f any, contact w i t h the
larger concerns and their credit needs. T h e i r customers are small- or
medium-sized manufacturers, wholesalers, retailers, farmers, and other
groups, w i t h small to moderate credit needs.
I t must also be borne i n m i n d t h a t d u r i n g the past 25 years lending
techniques have been developed or enlarged to enable banks to advance,
w i t h a greater degree of safety, a more liberal measure of credit to
small businesses i n relation to their invested capital and other pertinent credit factors than f o r m e r l y was considered prudent. These
techniques include the pledging of accounts receivable, discounting of
notes receivable, pledging inventory via field warehousing, and the
t e r m loan on a regular amortization basis.
B a n k i n g institutions are operated as profit-making concerns, and
sound loans usually constitute the most profitable available use of a
bank's resources. Consequently, i n most cases, self-interest is an
i m p o r t a n t factor i n the consideration of demands f o r small-business
loans.
The same principles are applicable, i n almost equal degree, w i t h
respect to even the largest city banks. W i t h few exceptions, such
banks do not confine their lending activities to large established concerns. Not only are loans to small and new enterprises, when properly
made and serviced, a source of additional income, but the small or
new enterprise of today may be the industrial giant of the next decade.
Most banks are aware t h a t an institution which does not extend credit
to smaller customers i n all justifiable situations not only cuts itself off
f r o m presently profitable business, but, i n a l l probability, w i l l f a l l
behind its more enterprising competitors i n volume of deposits, loans,
and other major sources of bank income.
I n certain fields of industrial activity, i t is possible that proposed
enterprises of relatively small size may have difficulty obtaining bank
credit today, despite an apparently reasonable cushion of risk capital,
whereas a similar proposal m i g h t have received the needed banking
assistance 25 years ago. I t is believed that this is often due to the increased mechanization and large-scale or medium-scale character of
the most efficient industrial unit, rather than to increased reluctance
on the p a r t of bank officials to f u r n i s h credit i n appropriate cases.
F o r example, i n 1925 an electrical engineer w i t h satisfactory character
and experience, and $20,000 of capital, m i g h t be granted a short-term
loan of $10,000 to enable h i m to begin the manufacture of radio receivers. I n 1950, an application f o r a loan of the same size f o r the
manufacture of a similar product m i g h t be denied, i n the exercise
of sound banking judgment. The reason would not be t h a t the bank
is less w i l l i n g to f u r n i s h credit where i t seems justified, b u t t h a t the
loan officer doubts the possibility of designing, engineering, producing, and selling radio receivers, w i t h a reasonable prospect of profit,
on t o t a l funds of $30,000.
Question 21 also requests our opinion as to whether—
a more liberal supply of capital and credit to small business would contribute to
the diffusion of economic power and to the dynamic character of the economy.
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
DEBT
9 3 5^
I n our opinion, this i n q u i r y must be dealt w i t h i n two parts.
I t seems unquestionable that a more liberal supply of capital and
credit to small business would contribute f o r a time to the diffusion of
economic power. I n a particular field of manufacturing or merchandising, f o r example, which is presently occupied by some 10,000 concerns, 70 percent of the business m i g h t be done by 2,000 of the concerns
classified as " b i g business." I f the remaining 8,000 enterprises had
available a more liberal supply of capital and credit, many of them undoubtedly would expand. A s a result, the 8,000 "small business" concerns m i g h t substantially increase their proportion of the available
or permanent is most uncertain. F o r one thing, the answer would
constitute a "diffusion of economic power," i n that the larger concerns
i n the field would find their share reduced f r o m 70 to 60 percent,
thereby also diminishing their dominance.
Whether such a diffusion of economic power would be temporary
or permanent is most uncertain. F o r one t h i n g , the answer would
depend upon the liberality, i n both amount and terms, of the "liberal
supply of capital and credit." I f the sources were governmental, the
amount practically unlimited, and the interest and repayment terms
very generous to the borrowers, the resulting diffusion of economic
power m i g h t be extensive and long-continued, even to the extent, possibly, of intense industrial competition, leading to the distress of established concerns w i t h obligations undertaken p r i o r to the " l i b e r a l "
era.
O n the other hand, i f the increased supply of capital and credit were
advanced i n l i m i t e d volume and on ordinary business terms, the d i f fusion i n many cases w o u l d be a more temporary and l i m i t e d phenomenon, resulting w i t h i n a short time i n the insolvency of a number of
smaller m a r g i n a l concerns which came into being, or expanded unwisely, on the basis of the liberal supply of capital and credit.
The extent to which—
a more liberal supply of capital and credit to small business would contribute * * * to the dynamic character of the economy—
is a quite different question f r o m the effect on diffusion of economic
' power. The expression "dynamic character of the economy" may be
defined i n a number of ways. Presumably the subcommittee has i n
m i n d the extent to w h i c h a more liberal supply of capital and credit
to small business would contribute constructively to the energetic and
forceful nature of the economy.
Where adequate capital and other essential elements are present,
we believe that, w i t h few exceptions, there are no serious shortages
of bank credit f o r either small or large businesses. On the other
hand, as' stated above, i t may be t h a t various factors, including increasing diffculty of savings accumulation i n adequate amounts, prevent the f o r m a t i o n or obtaining of capital to launch or expand smaller
enterprises. The extent to which this is true cannot be known
accurately.
G r a n t i n g this premise, we are faced w i t h the question what can be
done about i t , and whether available means of dealing w i t h the matter
are desirable. A great deal of thought has been given to, and volumes
have been w r i t t e n about, such possibilities as1 especially favorable tax
treatment f o r small enterprises, the creation of so-called "capital
MONETARY
POLICY AND
MANAGEMENT
OF
PUBLIC
D E B T936^
banks," and the like. E x a m i n a t i o n of the capital-bank proposals inclines us to believe that much more w o r k w i l l have to be done to discover the advantages and disadvantages. W i t h respect to the alternative of especially favorable tax treatment, i t seems probable t h a t this
approach, properly utilized, m i g h t y i e l d some benefits, b u t we are not
i n the position to propose specific procedures.
T h e question asks t h a t we—
distinguish between the longer-term aspects, of the problem and those of particular
importance today during the current national defense emergency.
W e see no evidence t h a t the p r o g r a m of national defense is being
materially impeded by lack of financial assistance.
Perhaps the
reference is to an alleged tendency f o r an undue p r o p o r t i o n of national
defense production contracts' to be awarded to b i g business, to the
detriment of smaller enterprises.
I t is not clear to us how a more liberal supply of credit and capital
to small business would relieve the situation. I f defense contracts are
given to the larger concerns, i t is probably because the undertakings
are of a magnitude which could not be handled by smaller companies
except at much greater cost and w i t h considerable delay and uncertainty. I f this is correct, increased availability of funds to small
business w o u l d not be a solution—at most, they m i g h t simply enable
some small enterprises to expand into the category of b i g business.
22. Discuss the effects of bank examinations on the lending policies
of banks, p a r t i c u l a r l y as they apply to loans t o small-business
men. Distinguish i f necessary between examination by different examining authorities.
B a n k examination exercises a considerable influence on lending
policies, i n the broadest sense, t h r o u g h its insistence upon sound
standards. I n their emphasis on such standards', examiners do not
differentiate between credits advanced to large concerns or smaller
ones. The officers and directors of a national bank know t h a t by
adhering to h i g h standards, their bank w i l l avoid criticism. H o w ever, an even stronger factor i n m o l d i n g a bank's credit policies is its
management's desire to operate a safe and profitable i n s t i t u t i o n i n a
creditable manner.
W h e n a loan application is under consideration, the p r i m a r y questions are (1) the degree of certainty of repayment, and (2) whether
the bank's income f r o m the transaction w i l l be sufficient i n view of
the degree of risk, the cost of servicing the loan, the availability of
more attractive outlets f o r credit, and so on. The attitude of the bank
examiner is an i m p o r t a n t factor only when some aspect of the loan
is questionable.
I f a proposed loan is sound and f o r a legitimate purpose, and the
bank is not "overloaned" i n relation to capital structure, character
of management, and nature of the credits extended, the loan officer
knows t h a t there is no reason to anticipate adverse action by the
bank examiner. I f the i n d i v i d u a l loan is weak i n some respect, or the
bank's lending policy is unwise, such criticism can be anticipated;
and to the extent t h a t a tendency to extend unsound credits, whether
to large or small concerns, is checked i n this way, i t is a h i g h l y desirable result.
MONETARY POLICY AND MANAGEMENT
OF P U B L I C DEBT
937^
I n a relatively small number of cases a tendency of a lending officer
(o b u i l d up loan volume regardless of an excessive risk element may be
held i n check by a realization t h a t the character of his operations w i l l
come to the attention of the board of directors t h r o u g h adverse comments i n the bank examiner's report.
The notion that bank credit is withheld i n many meritorious cases
because of restraining instructions f r o m bank examiners, or fear of
adverse criticism by them, has gained currency f r o m a practice w h i c h
probably is as old as the institution of governmental bank examination. P a r t i c u l a r l y i n smaller cities and towns, some bankers are
reluctant to incur the danger of community i l l - w i l l w h i c h may follow f r o m rejection of a loan application and the resulting antagonism of the would-be borrower. This antagonism can be avoided,
i n some cases, by t e l l i n g the applicant that the rejection is not due
to any lack of confidence i n his financial or moral responsibility or
judgment, but is due to the instructions or unduly repressive attitude
of the bank examiners.
F o r this reason, a relatively small number of bankers, u n w i l l i n g to
extend credit because the loan would be a weak one f o r some reason,
prefer to t e l l the applicant that the bank w o u l d be glad to make the
loan, but t h a t i t is prevented f r o m doing so by the supervisory authorities. T h i s very human desire to s h i f t the onus, although not straightf o r w a r d or courageous, is relatively harmless, unless i t leads to unwise
legislation or other action based on the false idea t h a t bank supervision prevents American banking f r o m doing its job properly.
A s pointed out i n our answer to question 21, American banking has
developed a number of techniques w i t h i n the past 20 years which
facilitate the m a k i n g of certain classes of loans i n situations t h a t
f o r m e r l y would not have been considered suitable f o r bank credit.
Bank examiners have attempted to keep abreast of these developments,
and have rarely criticized their use i n appropriate cases. On the
other hand, our answer to question 21 also points out t h a t i n certain
fields, particularly some types of manufacturing enterprise, there is
today relatively less opportunity f o r small business than was the case
25 years ago. This condition, however, has resulted f r o m general industrial developments, rather than f r o m changes i n the purposes or
attitudes of the Nation's banks.
I n conclusion, we believe that, w i t h insignificant exceptions, whatever difficulties are being encountered by small business i n financing
itself are not due to f a i l u r e of banks to extend needed and deserved
credit or to an adverse attitude on the p a r t of bank supervisors.
A P P E N D I X TO CHAPTER
VI
Q U E S T I O N S ADDRESSED TO T H E C O M P T R O L L E R OF T H E
CURRENCY
A . G E N E R A L PURPOSES OF O F F I C E
1. Describe briefly the functions and mode of operation of your
office.
2. Describe the nature of the supervision exercised t h r o u g h examinations of banks by your office. Specify the basic purpose or purposes of examination, and the principles w h i c h guide your examiners.
MONETARY
POLICY AND
MANAGEMENT
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D E B T938^
Distinguish between bank examination and bank audit, as evidenced
by the methods followed by your examiners i n their work.
3. W h a t directives, i f any, have been given to your office by Congress w i t h respect to the economic objectives w h i c h i t should seek to
f u r t h e r i n its operations ? Cite appropriate statutes.
4. W h a t weight do you give i n the conduct of your office t o the congressional declaration of policy contained i n the E m p l o y m e n t A c t of
1946, where i t is stated:
The Congress hereby declares that i t is the continuing policy and responsibility of the Federal Government to use all practicable means consistent w i t h its
needs and obligations and other essential considerations of national policy, w i t h
the assistance and cooperation of industry, agriculture, labor, and State and local
governments, to coordinate and utilize all its plans, functions, and resources for
the purpose of creating and maintaining, i n a manner calculated to foster and
promote free competitive enterprise and the general welfare, conditions under
which there w i l l be afforded useful employment opportunities, including selfemployment, for those able, willing, and seeking to work, and to promote maximum employment, production, and purchasing power. [Italics supplied.]
D o you believe i t would be desirable t h a t Congress give your office a
more specific directive t h a t i t should govern its activities, wherever
practicable, i n the l i g h t of the general objectives of economic stability
and high-level employment? I f not, are there any other economic
directives which you would consider desirable ?
5. W h a t do you believe to be the role of bank examination i n
f u r t h e r i n g the objectives of the Employment Act?
6. I n what ways, i f any, other t h a n t h r o u g h bank examination,
does your office endeavor to f u r t h e r the objective of economic stabilization ?
7. W h a t use do you make of the results of economic analysis i n the
conduct of your office?
B. R E L A T I O N S H I P T O T H E
GOVERNMENT
8. T o what extent does your office operate under the direction of
the Secretary of the Treasury? Discuss i n the l i g h t of both the
statute and customary usage.
9. Does your office operate under the direction of the President
except as this direction is exercised t h r o u g h the Secretary of the
Treasury ?
10. Describe the relationships, f r o m your point of view, among the
three Federal bank supervisory agencies. T o what extent is there
coordination of policies and procedures, and how is such coordination
brought about? T o the extent that policy conflicts arise, how are
such conflicts resolved at the present time ?
11. Does your office f o l l o w the practice of submitting its proposed
reports to Congress on pending legislation t o the Bureau of the
Budget to determine whether or not they are i n accordance w i t h the
program of the President? I f i t submits some, b u t not a l l of such
reports, what are the criteria by which those submitted are selected?
I)oes the Bureau of the Budget submit proposed reports of other
agencies of the Government to the Comptroller's office f o r comment?
12. Do you have any suggestions f o r legislation relative to your
office?
MONETARY POLICY AND MANAGEMENT
OF P U B L I C DEBT
C. I N C O M E A N D E X P E N S E S OF T H E COMPTROLLER'S
939^
OFFICE
13. W h a t has been the income of your office i n each year since
1933? Classify this income i n any way which you believe w i l l be
h e l p f u l to the committee.
14. W h a t have been the expenses of your office i n each year since
1933? Classify the expenses i n any way which you believe w i l l be
h e l p f u l to the committee. Relate the administrative expenses of the
office to (i. e., express them as percentages o f ) :
(a) The gross national product of the U n i t e d States, and
( i ) The expenses of a l l national banks.
(The purpose of these comparisons is to "deflate" the expenses of the
office 'by factors which measure its workload i n a rough manner and
automatically reflect changes i n the price level.)
15. Describe the budgetary procedure of your office. I s its budget
reviewed by the Bureau of the Budget? A r e changes i n its budget
made by the Bureau b i n d i n g upon your office ? H o w are its expenditures subject to congressional control? W h a t suggestions, i f any, do
you have f o r changes i n any of the procedures described i n this
question ?
16. A r e the accounts of your office audited by any other department
or instrumentality of the U n i t e d States Government ? I f so, by whom ?
A r e the powers of the a u d i t i n g authority l i m i t e d to r e p o r t i n g or does
i t have authority to disallow expenses ? T o whom are the reports of
the a u d i t i n g authority sent ?
17. L i s t and discuss any expenses which have been incurred by
your office d u r i n g the period since 1946 f o r the purpose of influencing
public opinion on controversial matters. Expenses f o r the preparation
of material i n standard expository f o r m a t and f o r the distribution or
presentation of such material i n w r i t t e n or oral f o r m to persons who
m i g h t be expected to have a regular business or professional interest
i n i t may be omitted. A n y expenses d u r i n g this period f o r the preparation of motion pictures, illustrated brochures or any other special
material should be included, however, irrespective of your personal
opinion as to whether or not the material they contain is controversial
i n character, i n order that the subcommittee may, i f i t desires, consider
them on a case-by-case basis.
D. T H E B A N K I N G S T R U C T U R E
18. W i l l you please submit a memorandum discussing the adequacy
of banking facilities i n the U n i t e d States ? F o r this purpose, take as
your standard of adequacy the ideal of b r i n g i n g banking facilities
w i t h i n convenient reach of a l l persons h a v i n g need of them, and, so
f a r as practicable, g i v i n g all persons the opportunity of choosing between two or more competing banks. Distinguish between deposit
facilities and loan facilities.
19. Discuss i n general your policy i n acting on applications f o r new
national bank charters. Stress your concept of what constitutes ample
banking facilities—especially the degree of competition w h i c h you
believe to be necessary or desirable.
20. Submit a statistical analysis showing year by year f o r the past
10 years the number of applications filed f o r national-bank charters,
MONETARY
POLICY AND
MANAGEMENT
OF PUBLIC
D E B T940^
branch permits, authority to convert i n t o a national bank, and aut h o r i t y to consolidate. State the number of such applications approved, the number rejected and the causes f o r rejection, classified
by such p r i n c i p a l reasons as (a) existence of ample b a n k i n g facilities,
(6) no prospect of successful financial operation, (c) inadequate capit a l f o r the establishment of the bank or branch, { a ) no satisfactory
evidence that competent management would be available, etc. Submit
also statistics w i t h respect to voluntary liquidations of national banks.
Comment on this analysis i n any manner w h i c h you consider
appropriate.
E. A V A I L A B I L I T Y
OF
CAPITAL
FOR
SMALL
BUSINESS
21. Discuss the changes w h i c h have occurred d u r i n g the last 25
years i n the ease or difficulty w i t h which small-business men have been
able to raise capital or to borrow. W h a t i n your opinion are the reasons f o r such changes as you find to have occurred ? D o you believe
that a more liberal supply of capital and credit to small business
would contribute to the diffusion of economic power and to the dynamic
character of the economy ? W h a t steps could be taken to b r i n g about a
more liberal supply of capital and credit to small business? Do you
believe t h a t any of these steps would be desirable? Distinguish between the longer-term aspects of the problem and those of particular
importance today d u r i n g the current national defense emergency.
22. Discuss the effects of bank examinations on the lending policies
of banks, p a r t i c u l a r l y as they apply to loans to small-business men.
Distinguish i f necessary between examinations by different examining
authorities.
CHAPTER
VII
REPLY BY MAPLE T. HARL, CHAIRMAN OF THE FEDERAL
DEPOSIT INSURANCE CORPORATION
A. GENERAL PURPOSES OF T H E CORPORATION
1. Describe briefly the functions and mode of operation of your
Corporation.
The function of the Federal Deposit Insurance Corporation, as
stated i n section 1 of the Federal Deposit Insurance A c t of 1950, is
to insure the deposits of banks entitled to such benefits under the act.
T h i s law provides a m a x i m u m coverage of $10,000 f o r each depositor.
The benefits of the act are extended: (a) to a l l banks, both National
and State, that are members of the Federal Reserve System (required
to be i n s u r e d ) ; and (&) to banks of deposit incorporated under State
law, including the law of any T e r r i t o r y , Puerto Rico, the V i r g i n Islands, and the D i s t r i c t of Columbia, which are not members of the
Federal Reserve System (approved f o r insurance by the B o a r d of
Directors of the Corporation after considering factors enumerated i n
the deposit insurance l a w ) .
T h e Corporation discharges its responsibilities t h r o u g h its Board
of Directors and the appointed officers. Operations are conducted
t h r o u g h several divisions. T h e Executive D i v i s i o n consists of a
Secretary of the Corporation and special assistants to the directors,
i n c l u d i n g the necessary staff. T h e Treasurer of the Corporation
heads the D i v i s i o n of Finance and Accounts. The other divisions are
as f o l l o w s : Examination, Service, Research and Statistics, Legal,
A u d i t , Liquidation, and Personnel.
Recommendations w i t h respect to corporate action are prepared i n
the appropriate division and most of them are reviewed by committees
before presentation to the B o a r d of Directors f o r f o r m a l action.
These committees t y p i c a l l y consist of one director of the Corporation,
special assistants to the directors, and representatives of various
divisions.
The Corporation has t w o p r i n c i p a l committees: (1) The B o a r d of
Review which considers recommendations submitted by the D i v i s i o n
of E x a m i n a t i o n relative t o applications f r o m banks f o r insurance,
retirement of capital, establishment of branches, and other similar
purposes; and (2) the Committee on Liquidations, Loans, and P u r chases of Assets w h i c h considers recommendations f r o m the D i v i s i o n
of Examination relative to loans or purchases of assets f r o m banks
and recommendations f r o m the D i v i s i o n of L i q u i d a t i o n relative to
such activities. Other committees include a committee on assessments,
a committee on administration, and a special committee w h i c h considers matters that are not w i t h i n the scope of the regular committees.
941
MONETARY POLICY AND MANAGEMENT
O F P U B L I C D E B T942^
2. W h a t directives, i f any, have been given to your Corporation by
Congress w i t h respect to the economic objectives w h i c h i t should
seek to f u r t h e r i n its operations ? Cite appropriate statutes.
The purpose of the Federal Deposit Insurance A c t of 1950 is to
protect depositors i n the insured banks. The Congress has set out to
achieve this major "economic objective" by creating the Corporation
and g i v i n g i t the necessary powers and responsibilities. Since the
Federal Deposit Insurance A c t of 1950 is the only statutory directive
which the Corporation has f r o m the Congress, this act embodies all
of the directives " w i t h respect to the economic objectives w h i c h i t
should seek to f u r t h e r i n its operations."
3. W h a t weight do you give i n the conduct of your Corporation to the
congressional declaration of policy contained i n the Employment
A c t of 1946, where i t is stated:
The Congress hereby declares that i t is the continuing policy and responsibility of the Federal Government to use all practicable means consistent
w i t h its needs and obligations and other essential considerations of
national policy, w i t h the assistance and cooperation of industry, agriculture, labor, and State and local governments, to coordinate and utilize all
its plans, functions, and resources for the purpose of creating and maintaining, i n a manner calculated to foster and promote free competitive enterprise and the general welfare, conditions under which there w i l l be afforded useful employment opportunities, including self-employment, for
those able, willing, and seeking to work, and to promote maximum employment, production, and purchasing power. (Italics supplied.)
D o you believe i t w o u l d be desirable that Congress give your Corporation a more specific directive t h a t i t should govern its activities, wherever practicable, i n the l i g h t of the general objectives of
economic stability and high-level employment? I f not, are there
any other economic directives w h i c h you w o u l d consider
desirable ?
T h e p r i n c i p a l purposes of Federal deposit insurance are to protect depositors, to maintain the confidence of depositors i n banks, to
raise standards of bank management, increase the soundness of the
banking system, and to aid i n protecting the circulating medium.
T h e accomplishment of these purposes contributes t o economic and
financial stability and thus serves to f u r t h e r the purposes of the E m inent A c t of 1946.
Lasmuch as a l l the powers and duties of the Corporation are i n
conformity w i t h the declaration of policy contained i n the E m p l o y ment A c t of 1946, we do not see any advantage i n a specific directive
by the Congress that the Corporation "should govern its activities,
wherever practicable, i n the l i g h t of the general objectives of economic
stability and high-level employment." N o r is there any other economic directive which we would consider desirable f o r insertion i n
the Federal Deposit Insurance A c t .
B.
ORGANIZATION
OF
THE
CORPORATION
AND
ITS
RELATIONSHIP
TO
GOVERNMENT
4. W h a t is the responsibility of your Corporation to the President ?
The management of the Federal Deposit Insurance
@FedFRASER