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Operation of the National and Federal Reserve
Banking Systems



S. Res. 71


Printed for the use of the Committee on Banking and Currency



P E T E R NORBECK, South Dakota, Chairman
LAWRENCE C. P H I P P S , Colorado.
DUNCAN U. F L E T C H E R , Florida.
J O H N G. TOWNSEND, J E . , Delaware.
F R E D E R I C C. WALCOTT, Connecticut.
J O H N J. BLAINE, Wisconsin.
WILLIAM E. BROCK, Tennessee.
J A M E S J. DAVIS, Pennsylvania.
CAMERON MORRISON, N o r t h Carolina.
J U L I A N W. B L O U N T ,




CARTER GLASS, Virginia, Chairman
P E T E R NORBECK, South Dakota.
J O H N G. TOWNSEND, J E . , Delaware.
F R E D E R I C C. WALCOTT, Connecticut.


Washington, February 9, 1931,

United States Senate, Washington, D. C.
MY DEAR SENATOR: At the request of the subcommittee of the Banking and

Currency Committee of the Senate, of which you are the chairman, I am
inclosing for the confidential use of the committee a brief report covering a
period of about five and one-half years of the National Bank of Kentucky,
Louisville, Ky.
You will observe that the bank was closed by the directors on account of
heavy and anticipated withdrawals in order that all preferences may be
avoided and the assets preserved for all creditors alike.
I think this complies in a general way with the committee's request.
Sincerely yours,
J. W. POLE, Comptroller.
[Reported to the subcommittee as a confidential paner, and subsequently released for
inclusion in the record by sanction of Comptroller Pole.—C. G.]

The affairs of the National Bank of Kentucky took a change for the worse
in 1925. The report of an examination made in April of that year disclosed
losses of $109,000, which were written off during the course of the examination.
The slow and doubtful assets amounting to $1,860,000 and $244,000, respectively,
were criticized but no further action was taken.
The next examination of the bank was made in November, 1925, by Mr. John
3. Wood, who at that time was chief national bank examiner of the eighth
Federal reserve district, when the affairs of the bank were found to be in a
decidedly more unsatisfactory condition.
The losses aggregating $334,000, estimated at that time, were promptly
charged off, but the report of that examination contained 13 other items of
criticism, the principal ones being slow and doubtful assets of $4,466,000 and
$628,000, respectively; one loan in excess of the limit prescribed by law; large
and unwarranted lines of credit and overdrafts.
Upon receipt of the report of examination the comptroller's office wrote
a lengthy letter addressed to the board of directors covering each and every
criticism, also urging the bank to take such steps that would increase the
efficiency of the credit department of the bank as recommended by the examiner
at the time of his examination.
The bank was examined again by former Chief Examiner Wood in May, 1926.
The estimated losses amounted to $253,000 and were charged off during the
course of the examination. The management was severely criticized for slow
assets amounting to $4,360,000 and doubtful assets of $606,000; also on account
of two loans in excess of the legal limit. Large unwarranted lines were again
criticized and overdrafts, including one to the corporation in which the president of the bank was largely interested.



The examiner stated in this report that the institution was a 1-man bank
and its affairs dominated by President James Brown. At that time the
management promised the chief examiner to correct the criticisms and employ
such persons as might be necessary to bring the credit department up to the
standard required of national banks.
When this report of examination was received by the comptroller, and after
the same had been analyzed, a letter was written to the bank in regard to the
large amount of slow and doubtful assets, large lines of credit, large amount
of overdrafts, and violations of law, and special attention was directed to the
unwarranted line of credit to the Kentucky Wagon Co., requesting the management to charge off on account of this line periodically until it was reduced
to a safe liquidating value.
The next examination was made in November, 1926, by National Bank Examiner C. A. Reinholdt, who estimated losses aggregating $168,000, and was
successful in having the amount charged off during the examination.
The report of this examination showed seven other criticisms, including
doubtful assets of $498,000 and slow paper aggregating $4,220,000. This
examiner also stated in his report that President Brown dominated and
directed the policies of the institution, and that while the bank still held a
large volume of assets subject to criticisms he felt that if the present policy
of charging off unsatisfactory assets continued the present earning capacity of
the bank was so unusually large that no serious consequences would result.
He further stated that the credit department showed improvement. No
excessive loans were found in the bank at the time of this examination.
The bank was examined in April, 1927, by Examiner V. E. Sailor, and again
in October, 1927, by Chief Examiner John S. Wood. The institution was required to charge off estimated losses of $137,000 in April and $151,000 was
charged off at the time of the examination in October. The management was
again severely criticized on account of excessive loans, large and dangerous
lines of credit, slow and doubtful assets, overdrafts, and other matters less
serious were listed as criticisms. Both the examiner and chief examiner wrote
splendid reports of examinations, setting forth in considerable detail all criticisms of the bank and matter needing correction, and stated in their reports,
" The affairs of the bank are still being dominated by President James Brown."
Although it was apparent to the examiners and to the comptroller that President Brown was not a safe banker and had shown an utter disregard for the
law and regulations of the comptroller's office, and although considerable losses
were being charged off at the time of each examination, this did not seem to
shake the faith of the directors in the president of the bank.
Upon receipt of the reports of examination made in 1927, letters based on
these reports were written to the directors, which letters covered all of the
criticisms contained in the reports, requesting correction of same and urging
the directors to pursue a more conservative policy, and, as usual, they were
required to reply in detail over their individual signatures. They were also
requested to forward similar reports at 60-day intervals until the next
examination, and to forward copies of these reports to Chief Examiner John £.
Wood in St. Louis, Mo.
Letters from the comptroller to the directors advised them that it was
evident the affairs of the bank and criticisms had not been receiving sufficient
attention. They were advised that the condition of the bank was such as to
require close attention and a more conservative policy in making loans and
investments and a more vigorous action in liquidating or improving the condition of those which had been criticized. They were requested to carefully
review the report and letters from the comptroller at the time of their next
board meeting, and to take such steps as would be necessary to correct the
matters criticized and to place the affairs of the bank in a satisfactory condition. Thereafter letters were received from the directors advising that excessive loans had been reduced and reporting some progress made in other
criticized assets.
The bank was examined in March, 1928, by Examiner W. W. Kane, jr., and
in October of that year by Chief Examiner Wood. The examiners again
criticized the large amount of slow and doubtful assets, the same large lines,
excessive loans, unlawful real-estate loans, and overdrafts. The bank was
required to charge off assets amounting to $177,000 in March and also charged
off $115,000 at the time of the examination in October.
On March 28, 1928, the comptroller wrote to Chief Examiner Wood and
stated that it was evident the affairs of the bank were still being dominated



by President Brown and that it was important that every member of the
board be advised of the unsatisfactory condition, and instructed Chief Examiner Wood to ascertain whether the reports of examinations and letters
from this office were being actually and seriously considered by the board and
whether they had any definite program for improvement being carried out or
proposed to leave the situation in the hands of the active officers. On account
of the delay of the directors in replying to his letters and giving detailed
information as to the progress made, the chief examiner was instructed t o
bring the matter to the attention of the directors at the time of the next
examination of the bank.
Upon receipt of the reports of examination made in 1928, letters were written to the directors covering every criticism in the reports, requesting that
they give particular attention to the slow and doubtful assets and that certain
lines be materially reduced and others entirely eliminated from the bank's
assets with the least possible delay. Considerable pressure was being brought
upon the management of the bank with respect to unwarranted lines of credit
to the Cadet Knitting Co., Murray Rubber Co., Van Camp Packing Co., Consolidated Realty Co., and the Kentucky Wagon Co. The examiner advised the
comptroller's office that negotiations were apparently under way for the refinancing of most of these companies, which, if accomplished, would relieve
the bank of a very large amount of undesirable assets.
At the time of the examination in May, 1929, by Chief Examiner Wood, it
was found that no refinancing had been accomplished and it was necessary to
again severely criticize the management on account of an excessive loan and a
very large amount of slow assets. At this time the management seemed to
have definite plans for a consolidation of the bank with the Louisville Trust
Co. under a State charter. The chief examiner stated in his report that he
expected the bank to be functioning as a State institution within 90 days.
After- this examination the officers advised that plans were rapidly being
developed whereby the national bank would be consolidated with the Louisville
Trust Co. under a State charter.
Upon receipt of the report of examination a letter was written to the directors with respect to the criticisms and unsatisfactory condition of the bank,
but no reply was received until the comptroller had written three other letters
requesting a full detailed report of the progress made in correcting matters of
criticism listed in the report of examination. The cashier of the bank wrote
the comptroller in September, 1929, advising that a $50,000,000 corporation,
known as the Banco-Kentucky, had been formed and became operative on
September 19 and that the bank would within 10 days make application to
withdraw from the national system and would consolidate with the Louisville
Trust Co. under a State charter.
There was apparently some doubt in the mind of the chief examiner as to
whether or not the bank should be examined again in 1929 in view of the plans
of the management for withdrawing from the national system. In reply to his
letter concerning this matter the comptroller instructed the chief examiner to
make the usual semiannual examination, which was made in December, 1929,
and at that time the management was more severely criticized than at previous
The report disclosed slow assets aggregating $5,000,000, doubtful paper of
$725,000 and losses estimated aggregating $386,000. The examiner stated in
his report that President Brown continued to dominate. Loans to directors,
officers, and employees and loans to corporations in which directors were interested were criticized. Immediately after this examination the comptroller
wrote the directors calling their attention to the conditions of the bank and the
various criticisms, requesting them to carefully review the report of examination and to advise him over their individual signatures. Two other letters
were written the directors as the result of the examination in December, 1929.
At the time of the next examination in April, 1930, made by Chief Examiner
Wood, estimated losses of $139,000 were charged off and the directors promised to eliminate assets amounting to $128,000 on or before June 16, 1930,
and $976,000 on September 1, 1930. The examiner criticized assets amounting
to $5,000,000 as slow and a much larger amount as doubtful than at previous
examinations, the aggregate being $1,161,000.
At this time the bank was found to be holding a large number of loans to
various individuals, including loans to officers and employees, collateraled by
stock of the Banco-Kentucky Corporation. The examiner was instructed by
the comptroller to return to the bank on July 16 and again on September 1,



for the purpose of ascertaining whether or not the directors had kept their
promise to eliminate unsatisfactory assets amounting to $1,104,000.
On May 9, a letter was written to the board of directors based on the report
of examination and covering all matters of criticism as shown by the report
and as discussed with them in detail by the examiner at the time of his examination. It was requested that the report and the letter from the comptroller
be read by each of the directors and that at the next board meeting a letter
be forwarded to the comptroller, advising him of the action taken in connection
with each of the matters brought to their attention. The letter also called
special attention to the practice of making loans collateraled by stock of the
Banco-Kentucky and that the practice met with the disapproval of the comptroller's office. The directors were requested to make an immediate and material reduction in the volume of such loans with a minimum of delay.
The directors were also written on August 9, to which the cashier replied
on August 23, stating that the management had been working continuously on
the criticized items and had made considerable progress. The comptroller
wrote to the directors again on September 9, advising that a satisfactory reply
to his letter based on the last report of examination had not been received
and requesting that the letter be given immediate attention.
While the stock of the Banco-Kentucky, held as collateral, was entirely unsatisfactory to the examiners and to the comptroller's office, it had a definite
market value, being listed on the Louisville and Chicago exchanges. Therefore, loans collateraled by such stock could not be listed by the examiners as
The comptroller's office was informed that a deal had been consummated
whereby the Banco-Kentucky had acquired a one-half interest in Caldwell &
Co., of Nashville, Tenn., and for this interest had given 900,000 shares of its
stock. On September 12, 1930, Mr. Robert Neill, who had recently been appointed chief examiner of the eighth Federal reserve district, informed the
comptroller's office that Examiner Mooney had been to the , National Bank
of Kentucky for the purpose of ascertaining if the directors had kept their
promise to eliminate certain large objectionable items in the assets and reported
that a large number of shares of Banco-Kentucky had been substituted for part
of the objectionable assets which the directors promised to eliminate and also
stated that the bank was lending Caldwell & Co. a large amount through its
various connections.
Upon receipt of this information it was deemed that an immediate examination of the bank was essential. Chief Examiner Neill was so instructed and
began his examination of the bank on September 17, 1930.
Despite the severe criticisms of the bank and its management by the comptroller and the examiners and despite the fact that the bank had been required
to charge out of its assets large amounts at previous examinations covering a
considerable period, President Brown was allowed to continue dictating the
bank's policies and dominating its affairs. His large transactions with Caldwell & Co. proved disastrous.
The examination which was begun on September 17 by Chief Examiner Neill
was not completed until October 24, 1930. At that time the bank had capital
of $4,000,000 and surplus, undivided profits and reserve aggregating $2,849,000.
The examiner estimated losses aggregating $1,356,000, in addition to slow and
doubtful assets amounting to $4,542,000 and $686,000, respectively.
The bank was found to be carrying 100,000 shares of stock of the BancoKentucky on its books at $1,870,000, which had previously been substituted for
criticised loans. It was also found that the bank had loans to Caldwell & Co.,
Rogers Caldwell and to his affiliated companies, aggregating $2,065,000, collateraled largely by stock of the Inter-Southern Life Insurance Co.
During the course of this examination the examiner used his best 1 efforts to
have the losses eliminated. He held two meetings with the board of directors
and one with the executive committee. He succeeded in having formed an
executive committee and placing the affairs of the bank in its hands. He had
$850,000 of the most objectionable assets eliminated and the promise to correct
other matters of criticism.
Although the loan to Caldwell & Co. exceeded the limit prescribed by law, the
examiner ascertained before he left Louisville and after the executive committee had been appointed that President Brown granted another loan of
$300,000 to Caldwell & Co. without the approval or knowledge of the executive
committee or the board of directors. The examiner brought this matter to the
attention of the board of directors.



The report of examination was received from the chief examiner on October
28, accompanied by a letter signed by the directors, dated October 24, advising
of the action taken during the course of the examination with respect to the
elimination of criticised assets, confirming the creation of an executive committee and containing promises to correct various other matters criticised and
placing the responsibility for unauthorized loans to Caldwell & Co. on President
Upon receipt of the report of examination by the comptroller a letter was
written to the directors based thereon, calling special attention to the matters
of criticism and to the dangerous and unlawful loans to Caldwell & Co. The
letter requested the directors to forward frequently detailed reports over their
individual signatures, showing the progress made.
On account of President Brown's transactions with Caldwell & Co. and
Rogers Caldwell, the comptroller was in almost constant communication with
chief examiner Neill in an effort to have the Caldwell loans eliminated, to
prevent any further extension of credit and to correct other matters subject to
severe criticism.
While the loans to Caldwell & Co. and its affiliated interests were unlawful
and were believed to be a dangerous concentration, the comptroller could only
demand that they be eliminated. The examiners could not estimate them as
losses inasmuch as they were collateraled at the time of examination by stocks,
although undesirable but with a market value.
Within a short time after the failure of Caldwell & Co. it was evident that
the National Bank of Kentucky was experiencing a slow run which could not
be checked. Within a few days the bank lost several million dollars and it
was evident that the bank's cash resources were being rapidly exhausted.
A careful analysis of the situation on the evening of Saturday, November 15,
clearly showed that withdrawals had developed to such proportions that there
was nothing left to do but to close the bank and in order to preserve its resources the bank did not open for business on Monday, November 17.

Senator Norbeck submitted for the record the following letters
from independent bankers:

Castlewood, 8. Dak., February 4, 1931.


Washington, D. 0.
MY DEAB Snt: * * * I have no quarrel with the group and chain bankers,
but I do believe that there are many false and misleading statements made
about the unit bankers. When 50 unit banks fail the press heralds the fact that
50 banks have closed as a most terrible calamity. When a bank with a large
number of deposit branches fail with possibly many times the deposits, such as
the Bank of the United States in New York, it is noted in the records as only one
bank failure, but, in reality, there was in that case about 60 banking institutions
or banking offices that ceased business in that failure. You might just as well
say that 60 banks in New York City failed in one day. The only difference is
that they take it square on the nose in one day while we out here drag it out a
little longer. I noticed, too, that the press was careful to say it was one of the
smaller institutions in New York City. The American Banker daily list of New
York bank-stock quotations lists only sis large banks in New York City in the
amount of capital stock.
We here at Castlewood are competing with group bankers every day. They
have two of them at Watertown, only 16 miles from here. So far they have
not hurt us any that we know of, so that I am not writing this because I have
any grievance against them. The people do not like the group banking institutions and when they are assured of equal safety in a unit bank they prefer the
unit institutions. We have had deposits come to us because of the fact that
they are group institutions.
The statement recently made by the Comptroller of the Currency, Pole, that
good management of a small unit bank would not prevent a bank failure, I
believe, was pretty far fetched and certainly most unfair to the many good little
banks over the entire United States. There are many banks in South Dakota
that are small, but, nevertheless, weathered the storm the past few years. I
will agree that good management may not prevent an operating loss if the
territory is too small to support a bank, but certainly good management will
prevent a loss to depositors, and that is the most important part and what the



public is chiefly interested in. Good management of an unprofitable point
will not lose the assets of the bank by making poor investments, and good management would prevent the bank from continuing to operate at a loss sufficiently
long to cause any loss to depositors, as good management would close the affairs
of the bank, pay off the depositors, and return the excess to the stockholders.
I therefore believe that Mr. Pole was very unfair to the small unit bankers in
making the statement that he did, and it certainly was not one that would help
the small banks, but rather tend to undermine the confidence in the small
It seems to me that most of the evidence that has come before the investigating committee has come from the large centers, possibly many of which has
had no experience in the small communities, and no evidence has come from
the many small-unit bankers that are operating profitable small banks over the
country. In order to disprove some of the things that have been said about us
little fellows I should like to mention a few things about this bank. I believe
it is a typical small-unit bank and I believe the facts that I am about to recite
will prove that a small-unit bank properly managed can make a profit and
render real service to the community it serves both in safeguarding the deposits
of the community as well as extending the necessary credit.
As you know, Castlewood is a town of about 500 people. It is a strictly agricultural community. The territory is limited, Watertown being only 16 miles
to the north, Hayti, the county seat, 13 miles west, Estelline (banking town)
16 miles to the south, with Dempster village between us, Clear Lake (banking
town) 19 miles east, with the village of Bemis between us.
This bank opened on March 7, 1927, as a successor to the old bank here that
failed. This bank took over 50 per cent of the deposit liabilities of the old
bank, amounting to about $60,000, besides some public funds which were paid
in full. In addition the old bank trust assets have paid another 25 per cent,
so that the depositors of the old bank have received 75 per cent on the dollar,
with the prospects of at least 15 per cent more.
The bank opened with a capital of $25,000 and $2,500 surplus. The inclosed
statement now shows deposits of $188,294.60 and the capital investment has
grown to about $40,000. In addition ample reserves have been provided for all
accrued interest and expenses.
I also inclose an analysis of the profit and loss account for the period of
March 7, 1927, to December 31, 1930. The first part shows the yearly earnings,
being $3,230.60 for the short year 1927; $4,485.29 in 1928; $5,380.57 in 1929;
and $5,447.37 the last year, with a total net amount earned since the bank
opened less than four years ago amounting to $18,543.83. The total earned per
share for the period amounted to $74.17 a share,, which should look like a reasonable profit for a small-unit bank. Many New York bankers can not equal
this with their investment affiliates floating speculative bonds to sell to the
unit bankers. The next part shows the disposition of these earnings. The
policy of this bank has been to use the greater part of the net earnings for the
protection of the depositors and declaring only a nominal dividend; but even
so, the stockholders have received a fair rate of interest on their investment.
The lower part of the analysis shows the growth of the capital investment,
showing that from an original investment of $27,500 it has now grown to
$41,140.68 after paying three dividends of $4,750 to the stockholders.
I also inclose an analysis showing the average statement for the year just
closed and what each item has earned or cost. I believe that this analysis
shows what a small-unit bank can earn and still operate a conservative institution. The first column shows the average of each item of resources and liabilities. For instance, the average deposit with our bank correspondents
amounted to $28,209; United States bonds, $56,362; loans and discounts,
$99,556. The average deposits held during the year amounted to $208,290, of
which $102,744 were interest bearing and $105,546 noninterest deposits. The
second column shows these items in percentages to the resources and liabilities
of the bank. Note that the amount loaned locally amounted to only 40 per cent
of the total resources of the bank, which shows that we did not loan heavily
locally to obtain the profit we did make. The third column shows the percentages to the total deposits of the bank, taking total deposits as 100 per cent.
The fourth column shows the amount actually earned on each item. For
instance, bank balances netted us $482.70; United States bonds, $1,907.37, etc.
The lower part of this column shows the amount paid interest on our deposits.
The last column shows the amount of these earnings in percentage, showing
that our total resources earned us 5.367 per cent from interest alone, not figur-



ing exchange, commissions, and other earnings. The lower part of this column
shows the cost of our deposits in interest, showing that our total deposits cost us
1.106 per cent interest.
This bank keeps its books on the accrual or earned basis, the same method
used by all the large banks, and not on receipts and disbursements. This makes
possible very accurate computation of earnings so that the figures shown on
the inclosed statements are quite accurate. It takes a little more time daily,
but the extra effort is worth the results.
I also inclose a profit-and-loss statement for the year which explains itself
quite fully. I believe it will compare very favorably with profit-and-loss statements of large banks.
In inclosing these various statements to you, I do so to prove that a small unit
bank properly managed can be profitable arid safe. You. will note that at all
times we have had large reserves. You will also note that our investments
have been very conservative, being largely United States, State, and municipal
bonds, with only $3,000 invested at this time in other bonds. No doubt we
could have increased our profits by making a lairge number of local loans,
smaller bank: balances, Qther bonds than United States and State bonds.
Analysis of the loans and discounts for the p$st year shows that we started
the year with total loans of $89,932.60, the lowest total loans during the year
was $86,560.90; the highest was $110,922.61, arid we closed the year with
$90,575.86 in loans. On the closing day of the year we had an even 200 borrowers, making the average loan $452.87. The largest loan was less than $3,000.
We have now a loan limit of $7,000, but never approach it. Three-fourths of
our borrowers are farmers, being 151 in number. The others are business
men, or other individuals living in our community. Of the total loans, $64,808.49, or 71.7 per cent, is secured by chattel mortgages; $1,715, or 1.9 per cent,
by first real-estate mortgages; $4,930,26 by local collateral; $825.25 by conditional sales contracts; $2,567.56 by guarantor or 2-name paper; $478.60 otherwise secured, and only $15,250.70 straight 1-name paper, t>eing 16.8 per cent.
In making loans to farmers, we aim to loan only on the liquid security the
farmer holds. A farmer, like a business man, must have a little capital of his
own. If we have plenty of security, the loans pay themselves. On the other
hand, we have never refused a loan to a customer of this bank or anyone in our
community, who had ample and liquid security; and, in fact, I know that a
group or chain bank would not have loaned a dollar more here than we have
loaned. We aim to keep our loans iU such conservative amount tljat in the
event we had to call our loans, our borrowers could obtain a loan from the
Agricultural Credit Corporation or competing bank and pay us up. Our records
further show that during the year just closed we loaned $106,100.02 in gash
loans over our counter, in 862 loans. During the same period customers paid
back to this bank in cash loans amounting to $105,456.76. This turnover is not
so large as a large commercial bank, but I believe it shows that we rendered
a distinct service to the people of this community. During the year we lent
money to 328 borrowers.
As noted before, we have invested our secondary reserves largely in Government obligations. We did, however, have as high as $17,000 invested in corporation bonds at one time during the year, but during the summer were dissatisfied with the bonds sold us by the investment houses, and sold out all
excepting two bonds, the longest maturity of which is March 1, 1933. We knew
very little about buying bonds when we first commenced to buy bonds about two
years ago. We were told to select a sound investment house and rely on their
judgment as that was the only safe way to pursue. Nobody took the trouble to
inform us how to check up on the bonds we bought. We did, however, feel that
we should know more about the bond business, and subscribed for one of the
standard-rating services, showing the rating given each bond, the high and low
prices for the year, when issued and at what price, earnings, and so forth. We
also subscribed for some of the financial magazines and papers in order to know
more about this new field. We found that some of the bonds that had been
sold us by the investment houses were of such long term that any reverses would
materially affect the market price. We also found we had bought bonds of
holding companies holding nothing more than the common stocks of other companies. We also found that some of the bonds had only a limited market and
the market depended only on the market by a few investment houses. We,
therefore, sold out most of the bonds we held at a moderate, in fact, a comparatively small loss, excepting only the two short-term bonds now held. If we
had taken the recommendation of these investment houses and bought everything they offered to sell, we would, I am afraid, have our entire surplus wiped



out and possibly a serious impairment of our capital. In fact, we know of some
banks who have serious losses in their bond accounts. Some of the investment
houses have spent several dollars in telephone calls attempting to divest us oij
our United States holdings and invest our funds in their speculative bond offerings. We are going to buy other bonds again, but they will be of a higher
class, better marketability, and shorter terms. I sometimes wonder if these
investment affiliates of the large banks, defended by Pole and the chain bankers,
have not to some extent contributed to the downfall of the small unit bankers
by selling them frozen bonds, and bonds that are now selling for 50 cents on
the dollar. If a small bank closes the small banker is the goat, and the big
banker who helped to sell these long-term speculative bonds that possibly contributed to the closing of the small bank stands in the eyes of the public as a
smart banker. If a large banker gets on his hands some large corporation,
whose loans are frozen in the large bank, the investment affiliate arranges to
float a debenture or long-term bond, which they sell to the small banker on their
recommendation. The large banker certainly has this advantage and it behooves the small country banker to be informed nowadays, so he does not take
some of the frozen loans in the large bank into his own bank in.the form of a
bond or debenture. It is no wonder that the larger bankers do not want to
dispose of their investment affiliates. In fact, that was one of the big points
argued by the group bankers two years ago—that through their large number
of banks they would be independent of the New York bankers and float their
own bonds.
Personally I am not opposed to all branch banking. I believe that limited
branch banking within a large city is desirable. I believe that limited branch
banking within the county would not be so bad, as it would probably be better
than the cut-throat competition we had a few years ago in South Dakota. The
only bad feature is that if branch banking is given a start that the areas will
gradually increase. However, I do not believe we should have interstate branch
banking or group banking spread over such a large territory as we have in the
Northwest now. The worst feature is that trouble in one territory or in one
bank may spread over the entire system. We now have in the Northwest one
group chain that has a bank way out in Washington, a large bank in Omaha,
the largest bank in Iowa, the largest bank in Duluth, the largest bank in South
Dakota, the largest bank in North Dakota, and a number of banks in Montana,
and the head bank is located in Minneapolis, and its ratio of capital to its
deposits is much smaller than most of the large banks, and many of the small
ones, too. It is such a vast organization with a number of large banks in the
group, that any serious trouble in one of the large group banks might easily
spread over the entire system. The deposits of its affiliates totals much larger
than the head bank itself, and I do not think that this is a good thing. The
other group in the Northwest, I believe, is better situated. I do not think that
they are wholly in favor of group banking, but was forced into it by its competitor and they had to form a group of their own or let their competitor take
their correspondents away from them. Furthermore, in this group they have
two large banks to bear the burden. The deposits of the affiliates outside of
the two head banks are in better proportion. In other words, they are in better
position to take care of trouble in a part of their group, because the head banks
are larger in proportion to the rest of the group.
There is another feature of group banking that appears' bad to me, and that is
pyramiding of deposits. For instance: A bank at Ree Hights, S. Dak., is listed
in the Blue Book to use the bank at Miller as a correspondent. A former officer
of the Miller bank is now an officer of the bank at Huron recently organized, and
undoubtedly the Miller bank uses Huron as a correspondent; the Huron bank
will naturally use the head bank in Minneapolis as a correspondent. All these
banks are members of the same group. Now, if a farmer deposits $1,000 in the
Ree Hights bank, the Ree Hights bank may deposit this in the Miller bank, and
the Miller bank may deposit in the Huron bank, and finally the Huron bank
will deposit this in the head bank. Now, the deposits in all these banks have
increased each $1,000 from the same deposit. In a consolidated statement of all
the members of the group, the original $1,000 will show up as a $4,000 deposit in
the group total, and each bank will have increased its cash reserve $1,000, and
the group total of cash will also show as $4,000 as the result of the one deposit.
Although this may be an extreme case, it shows how deposits and cash reserves
may be pyramided by interdeposits within the group. It would therefore be
most interesting to see a consolidated statement of the group with all interdeposits, intercash, and interadvances eliminated. Surely it would greatly reduce the footings and total resources now so much advertised. In other words,



the totals are not there when intertransactions are eliminated. It shows the
possibilities of deception so that statements will not tell the true condition.
It is very encouraging, however, to note what the leading bankers of New
York say about branch and group banking on a nation-wide scale. I notice
many of them do not favor it. It is also encouraging to see what the leading
financial magazines say about it. The Financial Chronicle of New York in their
June 14th issue, page 4122, certainly did not indorse the group and branch banking, and ended up by saying " i t is a false growth—one not in accord with the
best banking and business interest." In the November 22d issue, after the failure of the Banco-Kentucky group, it stated, on page 3248, " The ease with which
trouble in one of the banks in an affiliated group extended to all the other banks
in the same chain or group is evidence that chain or group banking is no protection against disaster; rather the reverse. The reason is perfectly plain.
Suspicion or doubt with reference to one of the members naturally quickly
brings other members of the group or aflaiiation under similar doubt and suspicion. And when this is said the chief argument urged in support of collective banking disappears." The New York Journal of Commerce, on November
19 and November 20, 1930, in two editorials condemned group banking. The
American Bankers' Association Journal in their last two issues commented editorially on the fact that it was not the form of banking, whether group, chain,
or unit which was most important, but pointed out that each class has had
I hope you will pardon me for taking up so much of your time by this long
letter. We at the bank appreciate your efforts and for that reason wanted to
let you know t hat we appreciate it. My sole purpose in writing you this letter
is to present the side of the small unit banker and show that they can still
exist. I often have wondered what would have happened if the groups out of
Minneapolis had had all their members in 1919 to 1921. The story then might
have been different, I would not object so much to the group banks if there
was a way to untangle it, but once in, the one joining can not get out again.
The writer of this letter, started in the banking business in South Dakota
nearly 14 years ago as a bookkeeper. I have worked in both National and State
banks, and have always been very much interested in banking affairs and read
all information that I can obtain on banking subjects. My connection with this
bank, however, has been only since it reorganized, as I was not connected with
it before.
With kindest regard, I am, yours very truly,

Vice President.
P. S.—The opinions herein expressed are the opinion of the writer only, and
I do not wish to express the opinion of anyone else, although they may agree.
Analysis of profit and loss account of Citizens State Bank of Castlewood, 8. Dak.,
from date of opening March 9, 1921, to December SI, 1930

Gross earnings



$14, 601.21 $16,479.70 $17,570. 20

$58,947. 20


2, 889. 21
438. 50

8,936. 62

28,789. 56




40,403. 37

3,230. 60


Net profit
Earned per share



Interest paid.
General expenses


4,485. 29


5,447. 37


Net earnings since Mar. 9,1927
___ $18,543.83
Dividends paid: Jan. 10,1928,5 per cent; Jan. 7,1929, 7 per cent; Jan. 14,1930,7 per cent *
Transfer to reserve with State treasurer
Transfer to surplus fund __
Doubtful assets charged off
Undivided profits on hand Dec. 31, 1930
U, 964.03



i An 8 per cent dividend will be declared and paid on Jan. 13,1931.




Analysis of profit and loss account of Citizens State Bank of Castl&wood, S. Dak,,
from date of opening March 9, 1927, to December 31, 1930—Continued
Dec. 31,

Dec. 31,

Dec. 31,

- $25,000.00


269. 82

7, 500.00
1, 028.60

1,176. 65

27, 500.00

30,460. 78

33,342. 21


41,140. 68

Mar. 9,
Surplus fund
Undivided profits
Reserve with State treasurer

Dec. 31,

NOTE.—The above reserve with State treasurer is required under the new law of South Dakota. The
fund held by the State treasurer belongs to the stockholders of this bank and for the protection of the depositors of this bank only.

Average resources and liabilities showing earnings and cost of Citizens
Bank, Castlewood, S. Dak., year ending December 31, 1930



Average during year

Percentage of
ReDesources posits

Earnings of
each item

of earnings in






Total earning assets






Currency and coin.-.
•Ranking house and
fixtures.-Cash and transit items
Interest on earnings not collected





Bank balances
United States bonds
State and municipal bonds
Industrial bonds
Commercial paper
Loans and discounts

Nonearning assets
Total resources
Miscellaneous earnings-.-**







---. *__






Total earnings

17, 570.20
Percentage of
Average durCost of
ing year
Liabil- Depos- each item

Certificates of deposits
Savings deposits,
State deposits
County deposits,..
Superintendent of banks







105, 546. 00






208,290. 00



2, 753.91



37,494. 26
3,742. 00






5,447. 37



Interest deposits
Noninterest deposits
Total deposits


Capital investment
Expenses and depreciation—
Net profits for year
Total to balance profit account

of cost
m percentage




NOTE.—The books of this bank are kept on a strict accrual basis so that the above figures are quite accurate as to percentages. The large yield on commercial paper is due to the fact that the largest amount was
carried the first part of the year and bought the previous year during the high rates.

Profit and loss statement,


Citizens State Bank, Castlewooct, S. D., for year
ending December SI, 19SO
[Accrual or earned basis]

Gross income from all sources:
Interest earned—
Loans and discounts
Bank balances with correspondents
United States bonds
State and municipal bonds
Industrial or other bonds
Commercial paper


Exchange and collection commissions


Insurance commissions
Service charges
Bonds handled for customers
Total commissions


127. 21


Commissions received—
Farm-auction sales


177. 50
612. 27











Total interest earned

RentsHall rent, I. 0 . 0 . F . lodge
Safety deposit boxes



247. 21



General expenses, including depreciationTaxes
Repairs and upkeep (extras this year)
Depreciation, building and fixtures
Other expenses







State funds
County funds
Superintendent of banks



Interest on depositsCertificates of deposit


17, 570.20

Total rents
Gross income from all sources





Net profit for year



Santa Monica, Calif., January 22, 1981.

Senator from California, Washington, D. C.
DEAR SIR: We wish to call your attention to a matter now before the Congress of the United States—that is, proposed revisions of the national banking
act and the legislation dealing with the operation of banks and the Federal
reserve system.
The independent banker occupies a place in the community that can not
successfully be replaced by the local manager of a branch or chain organization. No other business comes so close to the vital needs of every community;
no one has better understanding of the people in a community or their particular problems than the local independent banker, who has his own funds
invested in the bank and whose prosperity must be keyed to the community'sprosperity. The one element in American life which has given this Nation
its greatness has been the individual initiative and enterprise of our independent business man. The American tradition of equal opportunity for every



boy to become what he chooses is fast perishing and will cease to exist unless
the opportunity for the individual with intelligence, integrity, and perseverence
to continue a business for himself with relatively small amounts of capital is
The Federal reserve system, if it is to be of any benefit to the majority of
these smaller independent banks, must be modified. As it operates at present
the great majority of the smaller suburban and country banks do not have
any opportunity to use the Federal reserve system. The compulsory membership in the Federal reserve system often proves an expense and drain without
compensating benefits. A change in the rules of accepting paper for rediscount
must be made if these banks are to be able to use the Federal reserve system
in the manner in which we believe the founders of the Federal reserve system
intended. Paper held by such banks which is safe and liquid sufficient to pass
an examiner's approval should be made eligible for rediscount to the Federal
reserve bank under some proper rules and regulations. Many small banks with
plenty of paper, even better secured than much of that now accepted by the
Federal reserve, have been forced to close during a run because of the refusal
of the Federal reserve to advance a dollar against these assets.
The question of safety of a bank obviously does not depend on mere size—
it is rather the relation of quick assets to deposit liabilities and the quality
of loans held by the bank. The smaller unit bank given equal opportunity to
utilize its resources, with proper supervision and management, should be, we
believe, the safest type of financial institution and certainly should not be
discriminated against by the Federal reserve in favor of large combinations
of the country's finances.
We believe this question to be of utmost importance to the welfare and
future of the country. Is business by the smaller independent concerns to be
allowed to continue and prosper, or shall the children of the great majority
have nothing to look forward to save a precarious vassalage to some giant
industrial or financial creature of the law, with an ever-diminishing opportunity for any degree of independence in the inevitable extinction of that
individual initiative and enterprise that produces a nation of leaders and
great men?
Undoubtedly you are aware of these circumstances, but the nature of the issue
is such that those whose interests lie with the ever-increasing power of the
large and monopolistic concerns are in a position to present their view before
the Congress and throughout the press, whereas those whose interests are on
the other side of this controversy (and we believe them to be the great
majority) can not have their views receive adequate publicity, nor will they
so often be presented and insisted upon. Not only as business men but as
citizens we feel so sincerely on this question that we would feel we had been
guilty of gross negligence of duty as patriotic citizens if we did not express
ourselves accordingly.
We trust you will find it in accordance with your duty to the Nation and
to your constituents to take an active part and do what you can toward safeguarding the welfare of the independent bank.
Yours very truly,

Senator Norbeck also submitted for the record the following letter:
MONTICELLO, I I I . , January 28, 1931.
Senator P. NORBECK,

Washington, D. C.
DEAR SENATOR: I have been reading with interest in the New York Times
the investigation of the Senate Committee on banking, and from reports thought
you would be the proper Senator to write to in reference to the following
I note that Comptroller Pole says that the owner of national-bank stock may
now transfer their bank stock to a holding company (a corporation) and
thereby evade the liability of assessment, which is provided by statute.
As I understand the proceeding, First National Bank stock is merely exchanged for stock in the holding concern and the latter is nonassessable and in
event of failure the holding corporation would have no assets with which to
pay the assessment. Their stock can be, and I presume usually is, paid for by
the exchange of stock for property and to simply receive the national-bank stock
and issue in exchange stock in the holding company. Under the United States



statute, as I remember, the transferor of shares in national bank is only liable
if the bank fails within 60 days after transfer.
It occurs to me that this could be amended so that if the transfer is to a
corporation at the time or subsequently at any time the transferee proves to
be unable to pay the assessment, the transferor could still be held.
Very respectfully yours,

14, 1921.


Chairman Subcommittee of the Committee on Banking and Currency,
Washington, D. C.
MY DEAB SENATOR GLASS : Many thanks for sending me copies of the hearings
in re Senate Resolution No. 71, and I assure you that I have read the same,
finishing Part IV, with a great deal of interest and pleasure.
Senator Norbeck seems to have deplored the fact that data submitted with
reference to branch banking in California covers only 10 or a dozen years,
instead of a 50-year period. I would suggest that several New York City
banks, such as Bank of Manhattan Trust, National City Bank, Chatham &
Phenix National Bank, Irving Trust Co., Corn Exchange Bank & Trust Co.,
and the Manufacturers Trust Co., who have been operating branches for a
number of years, could furnish data covering a period of from 20 to 30 years.
I think the Corn Exchange have been operating branches for something like
30 years, and the National City and the Manufacturers Trust as now constituted embrace chains taken in through consolidations and those chains run
back over a period of 20 years or more.
I may say that I have had a number of years' experience in the banking
business, prior to the organization of the Federal reserve system, but have not
been actively identified since, but have never lost interest in the subject, and
have endeavored to keep posted on the development of the banking business by
reading and other general observation. I thought I would write you on two
or three points that interested me particularly and at the same time offer one
or two suggestions, which may in themselves have no particular merit from
your viewpoint, but, I hope, will start a train of thought that might develop
something worth while in connection with the points covered.
Referring to affiliates of banks, I think the terms should be defined and might
include (1) a trust company, (2) a savings bank, (3) a safe deposit company,
(4) a real estate holding company, (5) a securities company, and (6) a holding
or operating company. Nos. 1, 2, 3, and 4 should be organized under State
laws, and Nos. 5 and 6, under national laws, being incorporated in the District
of Columbia.
Provision could be made, I think, for incorporating under the laws of District
of Columbia for operations carried on for Nos. 5 and 6, mentioned above,
because such operations are nation-wide and often overlap State lines when
not nation-wide.
All affiliates should be examined by the Comptroller of the Treasury at
the same time of the auditing of the parent bank, except where the affiliates
are under State supervision, and then, arrangements could be made with the
State Department so that the State would examine the other companies at
the same time.
Referring to banks of demand deposit, should, so far as practical, be prohibited from accepting what we consider as strictly savings and thrift
accounts, except where the banks are operating in small communities and
is necessary for the convenience of the public to handle all classes in the one
institution. We have, however, a recent development here in New York,
where the National City Bank has been extending to people entitled to same,
what is known as small personal loans, somewhat similar to the Morris plan
for personal loans. This is known, I understand, as 3-name paper, and the
borrower repays the same by opening a thrift account or savings account,
depositing therein weekly an amount sufficient to liquidate the loan in 10 or
12 months. I think this is a very desirable class of business and affords help
to many people and saves them from going to the loan brokers, who in the
past have charged very much beyond the legal rate. There is no doubt but
what in times of stress savings department depositors are the ones who get
excited and demand their money, thus drawing on the available resources



of a bank, very often when conditions do not justify them, and for this
reason I think that banks doing a demand deposit business should keep out
of the savings and thrift field as much as possible.
Statements of condition of affiliates should be published as of the same date
of the publishing of parent-bank statement. I do not think such statements
should disclose the holdings in the portfolios, as the same has -no special
interest, in my opinion, to the public, and in many cases would reveal information to the banks or the affiliates' competitors.
With reference to voting of stock in Federal reserve bank as is proposed
in the Glass bill, reference thereto being made in Part IV, page 614, referring
to paragraph 3 of the Glass bill, I think it is entirely too drastic. All banks
controlled by holding companies, by whatever name called, where the holding company has not incorporated under the laws of the District of Columbia,
as suggested above, should not have in any Federal reserve district the right
to vote for more than, say, one-sixth, instead of one-third of the Federal
bank directors. In such cases the Government should elect the other onesixth, thus giving the Government more control than as at present. Holding
companies putting their money into bank stocks should not be disfranchised
merely because they are not individuals or natural persons, but it might be
well to curb any right of such a controlled group to dominate in any Federal reserve district. The suggestion to incorporate holding companies under
the laws of the District of Columbia is made with the idea of bringing all
such companies under the supervision of both the Comptroller of the Treasury
and the Federal Reserve Board.
Some extra inducement might be offered State banks to join the Federal
reserve system by extending to those banks in the system a credit on their
taxes similar to the earned-income credit allowed individuals under the present
Federal income tax laws.
All national and other banks in the Federal reserve system should be prohibited from contributing in any manner to any guarantee for protection of
depositors. These guarantee systems are, in my opinion, an open invitation
to promoters to get into the banking game.
All banks large enough should be forced into the clearing-house association
serving their territory. Had this been done with the Bank of United States
here in New York City, that bank would have been forced to comply with the
very excellent banking methods of high standing of our Clearing-House Association, and I believe the depositors of that bank would be better off to-day
had that been done. This plan might be developed to the point where clearinghouse associations are organized to operate in one or more counties throughout the Nation, where the service to be secured from such clearing-house
associations is not available from the Federal reserve banks.
Referring to Superintendent Broderick's plan to oust bank officers who fail
to carry out superintendent's recommendations, I think entirely too drastic. To
place such absolute authority in the hands of one man is not warranted, and
in the hands of one less competent than the present superintendent one can
readily visualize the amount of damage that could be done by a superintendent
who was a political appointee rather than a practical man, and who had an
axe to grind or political debts to pay. In lieu thereof I would suggest that the
Comptroller of the Treasury, in making suggestions and recommendations that
are ignored, as in the Louisville case, referred to in the record, then the Comptroller of the Treasury should have the power, with the approval of the Secretary of the Treasury, to issue warrant of distraint against the property of the
chief executive officers and directors of such bank, the warrant of distraint
to be served as any other such document and recorded in the county where
both the bank and individuals reside and do business, all property so covered
to be held under such warrant until the comptroller's recommendations are
complied with. Such a warrant would affect the title to any property so covered. In addition thereto, the comptroller, with the approval of the Secretary
of the Treasury, could have the power to appoint one or more acting vice presidents (not necessarily bank examiners) in such bank, at the expense of the
bank and with authority to reduce the salaries of the executive officers sufficiently to cover compensation of such acting vice president. These two " clubs "
should not be given any publicity in the press, for that might start a run on the
bank, which we are trying to avoid. Any officer or director who may not think
the action of the comptroller is reasonable could apply to the courts to have the
same modified or revoked. This would put the burden on such officers and
directors of establishing to the satisfaction of the court that these acts of the



comptroller are not warranted. All such court actions to be public, the same
a s any other court proceednig.
If the two clubs referred to in the preceding paragraph are wielded by the
comptroller, I do not think he would have to close any banks, for he will thus
be enabled to force the officers and directors to improve conditions. He can
thus take charge of the situation before it gets out of hand, and the depositors
and stockholders could thus be saved from losses bound to arise when a bank
is closed. In the event the comptroller is authorized to act thus, he can clear
the records of the warrant of distraint by securing a court order of cancellation without publicity. Any publicity with respect to these two clubs should
be very severely dealt with unless such publicity is authorized by the comptroller. This in no wise restricts the freedom of the press. This plan is
devised to protect the depositors, the stockholders in the bank, whose interest
should be paramount.
With reference to bank loans to brokers on securities, would suggest that
a normal loan base be determined as follows: Take the average price over the
last 10 years between the high and the low market prices, then the average of
the high during the same period—the normal loan base should be some figure
between these two averages, which might be fixed for securities against which
banks might loan up to 50 per cent thereon. As the market price goes up
or down from this normal loan base, the loan margin should be moved accordingly by some percentage rate that would keep any loan in proper relation to
the normal loan base, i. e., if the normal loan base be taken at $100, then
a bank could loan up to $50; if the price of the security held as collateral went
up to $120, then the loan should not be over $52, or, say, 10 per cent of the
increase above the normal loan base. Some plan along this line could, I believe,
be worked out to handle this class of business and endeavor to keep the
brokerage loan business in the banks, so as to prevent, as far as possible, another run-away bull market. This is a desirable class of business and should
not be taken away from the banks. Every effort should be made to keep credit
facilities in the control of the banks and Federal reserve system.
Loans to brokers for the distribution of new securities underwritten by them
should be exempt from the provisions suggested in the preceding paragraph,
which are made with an idea of controlling market trading.
Capital going into brokers' loans direct, and not through the banks, should
be taxed the same as banks are taxed and penalized with a profit tax of 50
per cent in addition. If something of this kind is not done, then we are
going to have " bootlegging " in handling market trading.
I think the Federal income tax law might be changed with respect to the
capital gains and loss provisions, so that the tax on capital gains would be
materially reduced to, say, about 3 per cent, and no deductions allowed for
losses, unless the property has been held for a period of, say, 3 or 4 years.
I feel reasonably sure that under the present law, taxpayers have been able
to either materially reduce or dodge the payment of taxes, by deducting losses,
as now provided for under the captain gain tax provision.
Referring to Part IV of the proceedings, page 603, last paragraph, where
reference is made to the poor borrowers of country banks, would say that it
seems to me that the borrowers of these country banks might be grouped in,
say, several counties, if not a Federal reserve district, so that the banks could
be permitted to carry group insurance at their own expense to protect themselves against the losses bound to arise through the deaths of these small borrowers.
Of course, I understand that what I am saying applies, so far as you and
I are interested, to the national banking system, but I think some effort should
be made to get the various States throughout the country to cooperate with
Congress in devising a uniform banking system, so as to eliminate, as far as
possible, the differences between the National and the State systems of banking, and where one has an outstanding feature it should be incorporated in the
I think we should realize the importance of not having too much government
in business, but more business in government, and I think the laws should
endeavor to be constructive rather than restrictive, allowing the largest freedom of action, for the vast majority of our bankers are both honest and capable.
Legislation will not keep the banking system wholly free from incompetent
individuals, and so-called bad boys. I think our best course of procedure is
intelligent and well directed supervision and swift and sure punishment to
34718—31—PT 5




those who are dishonest and we should always aim to endavor to protect the
depositor and the stockholder by finding a way of punishing delinquent and
incompetent officers and directors before serious damage is done, and I have
endeavored to convey to you my thoughts along these lines, and hope that I
am not intruding by writing you a letter of this length.
Kespectfully yours,


Congress derives no power over banking from the specific language of the
Constitution. A discussion therefore of this question involves not an interpretation or construction of words and phrases in the Constitution but rather a
broad consideration of the nature of the Federal Government and the power
of Congress to realize the ends for which that Government was established.
There are certain fundamental constitutional principles which have become
so thoroughly established that they require no further discussion:
(1) The Government of the United States is a government of enumerated
powers. It is limited in scope to those powers delegated to it by the Constitution in contrast to the State governments which possess all powers of government which have not been conferred by the Constitution upon the General
(2) Although limited as to the number and character of its powers the
Government of the United States is, within its sphere of action with respect
to any given power, supreme over all State and local governments.
(3) Congress possesses the incidental power to enact legislation necessary
and proper to give effect to the powers specifically conferred by the Constitution upon the Federal Government.
(4) While Congress may by inaction suffer the States to exercise jurisdiction with reference to subjects delegated under the Constitution to the Federal
Government, Congress may whenever it sees fit enter those fields completely
with an authority that is exclusive and paramount.
(5) In making effective its constitutional powers the choice of means and
instrumentalities is a matter of congressional discretion. Congress may if it
sees fit utilize agencies created by the State governments; it may create its own
agencies and at the same time permit State agencies to continue to exist pari
passu; or it may dominate the entire field with instrumentalities of its own
creation to the exclusion and the prohibition of any similar State agencies or
It has been thoroughly established by repeated opinions of the Supreme
Court of the United States from the earliest times that Congress may under
its incidental powers create an instrumentality of finance in the form of
banking corporations; that Congress is the sole judge of the nature and extent
of the charter powers which such banking corporations may exercise; and that
no State government without the express or tacit consent of Congress may
limit the powers or impede the usefulness of such corporations. (McCulloch v.
Maryland, 4 Wheat. 425; Osborn v. Bank of United States, 9 Wheat. 738;
Farmers and Merchants National Bank v. Dearing, 91 U. S. 29; Davis v. Elmira
Savings Bank, 161 U. S. 275; Baston v. Iowa, 188 U. S. 229. 1903; First National
Bank of Bay City v. Fellows, 244 U. S. 426. 1917.)
The first Bank of the United States, the second Bank of the United States,
the national banking system, and the Federal reserve system were established
under this constitutional authority.
No particular constitutional provision can be detached and labelled as the
specific constitutional power under which Congress established the system of
national banks and later the Federal reserve system. These instrumentalities
are not exclusively related by any manner of means to the fiscal operations
of the Federal Treasury, although there appears to be no doubt that Congress
could create a banking instrumentality solely by reason of its power and
responsibility to provide for the management of the public finances of the
In discussing the basis of the power of Congress to establish the Bank of
the United States by the act of 1816, the Supreme Court held that the General



Government might require such a fiscal instrumentality as an incident to its
power to raise and support armies, to provide and maintain a navy, to regulate
commerce between the States and with foreign countries, to collect taxes
and customs duties, to borrow money and to make disbursements and transfers
of funds. (McCulloch v. Maryland, 4 Wheat. 325; Osborn v. Bank of United
States, 9 Wheat. 738.) The same constitutional sanction lay behind the creation
of the national banking system and the Federal reserve system.

The power of Congress to regulate commerce between the States was no
doubt one of the principal constitutional powers brought into play in the
enactment of the national bank act through which fiscal instrumentality there
was set up a system of operating banks under Federal charter and supervision.
The establishment of a system of currency which was uniform, national, and
sound through the means of notes issued by these banks had for one of its
primary objects the relief of interstate commerce from the mass of heterogeneous and inferior local bank-note currencies issued under State authority.
The following extract from the report of the first Comptroller of the Currency
in 1863 reflects in part some of these conditions:
"The amount of losses which the people have sustained by insolvent State
banks, and by the high rate of exchange—the result of a depreciated currency—
can hardly be estimated. That some of the new States have prospered, notwithstanding the vicious and ruinous banking systems with which they have
been scourged, is evidence of the greatness of their resources and the energy
of their people. The idea has at last become quite general among the people
that the whole system of State banking, as far as circulation is regarded, is
unfitted for a commercial country like ours. The United States is a Nation
as well as a union of States. Its vast railroad system extends from Marine
to Kansas, and will soon be extended to the Pacific Ocean. Its immense trade
is not circumscribed by State lines, nor subject to State laws. Its internal
commerce is national, and so should be its currency. At present some 1,500
State banks furnish the people with a bank-note circulation. This circulation is
not confined to the States by which it is authorized, but is carired by trade
or is forced by the banks all over the Union. People receive it and pay it
out, scarcely knowing from whence it comes or in what manner it is secured.
Banks have been organized in some States with a view to lending their circulation to the people of others. Probably not one quarter of the circulation of the
New England banks is needed or used in New England—the balance being
practically loaned to other States. The national currency system is intended
to change this state of things, not by a war upon the State banks, but by
providing a means by which the circulation which is intended for national
use shall be based upon national securities through associations organized
under a national law. The United States notes, the issue of which was
rendered necessary by the exigencies of the Government, and which it is
presumed will be withdrawn whenever this exigency ceases, have taught the
people the superiority of a national circulation over that to which they have
been accustomed. In many sections the produce of the; country can not be
purchased with bank notes, and people find it difficult traveling from State
to State without legal tenders. Everywhere the opinion is prevailing that the
circulation of local banks has about had its day, and must yield to the demands
of the people for a circulation of which the Government is the guarantor."
Although the power of Congress to establish a uniform system of currency
exists independently of its power to regulate commerce, nevertheless, in the
establishment of the new national currency through the national bank act
these two powers were combined in a joint purpose.
Independently, however, of the question of a uniform national currency, the
power of Congress to regulate commerce was directly involved in the creation
of the national banks as instrumentalities to facilitate commerce between the
States and with foreign countries. It was the purpose of Congress that the
national banks supersede the existing State institutions engaged in commercial
banking. It provided the means in the Act whereby the transition could be
made voluntarily and without any disturbance of operations. In 1866, two
years after the final revision of the national bank act, the national banks had
in fact displaced the State commercial banking corporations. Thus there
came into effect a uniform system of commercial banking operating in every
part of the national domain under the general supervision of the Comptroller



of the Currency. There was provided for those engaged in the purchase and
sale of goods and commodities moving in interstate and foreign commerce a
single type of banking facilities under the same regulations throughout the
entire country.
This result was, however, not accomplished until after Congress had exercised its power of penalty and prohibition against State institutions which
impeded at its inception the progress of the new banking system.
It may be said that the Federal reserve system is even more clearly related
to the commerce clause of the Constitution than any of the preceding Federal
fiscal instrumentalities. While it serves as an aid to the Federal Government
in many capacities in the exercise of the specific powers conferred upon that
Government by the Constitution, the Federal reserve system was designed
and has become in fact the cornerstone of our business structure. It is most
intimately related to the processes and facilities of interstate and foreign
commerce. The system of currency made possible through it has contributed
to the circulating medium the final element of value, namely, that of elasticity.
This feature of elasticity arises out of the direct relationship between the
volume of currency at any given time and the current demands of commerce
for. it. Apart from the question of currency the Federal reserve system,
through its system of reserves and its operations in the field of commercial
credit, provides a fundamental security for commercial banking and for commerce itself in all parts of the country.
While an analysis of all of the constitutional powers of Congress to establish the Federal reserve system is not necessary to support the legal sanction
for that instrumentality, since Congress could proceed under any one of those
powers if it deemed it appropriate, it would seem fair to say that if any one
clause of the Constitution was relied upon to a greater extent than any other
in the establishment of the Federal reserve system it was that empowering
Congress to regulate commerce between the States and with foreign countries.

Digressing for a moment, however, upon the theory that the commerce clause
must be relied upon in any attempt by Congress to create a single standard
of commercial banking, let us examine into the nature of commercial banking.
Modern commerce is carried on largely upon the basis of credit. Goods are
bought, sold, and transported not through the delivery of cash or specie by the
buyer to the seller but payment is made by means of certain paper facilities
evidencing the transaction and the obligation, such as drafts, checks, acceptances,
and promissory notes. Through these means funds situated at the place of the
buyer are made avalable at the place of the seller. That is to say, there is a
transfer of funds or a transfer of credit.
Banking institutions are essential to the operation of this commercial procedure. It is through the medium of a bank that these transfers are made. The
field of commercial banking is fraught with many complications and technicalities of interrelation between banks and banks, between banks and customers,
and between buyers, sellers, shippers, and carriers, but reduced to its simplest
terms commercial banking is the instrumentality through which funds are transferred from buyer to seller in the purchase, sale and transportation of goods
and commodities.
Commerce in the United States is almost entirely interstate and foreign and
all commercial banks, whether State or National, are now engaged in furnishing
facilities for the movement of interstate commerce. The Comptroller of the
Currency has in fact several times pointed out that commercial banking is now
predominantly in the hands of State chartered banks and trust companies. It
is significant that there are six trust companies, five in New York and one in
Chiacgo, with aggregate loans and discounts of approximately $3,400,000,000.
The third largest commercial bank in the country is operating under a State
charter. In all of the great commercial centers in the United States a large
share, if not a preponderant share, of interstate and foreign commerce is transacted through State-chartered institutions.
Congress could, in order to control this situation, proceed in two directions
under the commerce clause, one positive and the other negative:
(1) It could treat commercial banking as a facility of interstate and foreign
commerce and regulate it, or
(2) It could deny the facilities of interstate and foreign commerce to state
banks and trust companies.



The constitutional power of Congress over interstate and foreign commerce is
extremely broad. It extends to the articles which move in such commerce and
over the facilities furnished in aid of such commerce. The citation of a few
general principles laid down from time to time by the Supreme Court of the
United States will serve to illustrate the extent of this power.
(1) Commerce among the States is not a technical legal conception but a,
practical one drawn from the course of business. (Swift & Co. -v. U. S., 196
U. S. 375.)
(2) "Commerce" as used in the United States Constitution, Article I, paragraph 8, clause 3, includes the fact of intercourse and of traffic and the subject
matter of intercourse and traffic. The fact of intercourse and traffic embraces
sll the means, instruments., and places by and in which intercourse and traffic
are carried on, and comprehends the act of carrying them on at these places
by and with these means. The subject matter of intercourse or traffic may be
either things, goods, chattels, merchandise, or persons. (McCall v. California,
136 U. S. 104.)
(3) Commerce is a term of the largest import. It comprehends intercourse
for the purpose of trade in any and all of its terms, including the transportation, purchase, sale, and interchange of commodities between the citizens of
our country and the citizens or subjects of other countries and between the
citizens of different States. (Welton v. Missouri, 91 U. S. 275; Hopkins v.
United States, 171 U. S. 578.)
(4) Interstate commerce is not confined to transportation but comprehends
all commercial intercourse between different States and all component parts
of such intercourse, including the buying and selling of commodities for shipment from one State to another. (Federal Trade Commission v. Pacific States
Paper Trade Association, 273 U. S. 52.)
Under its authority thus to regulate Congress could require all corporations
which supply banking facilities for interstate or foreign commercial transactions to operate under a uniform national standard under the national charter.
Congresss, in its regulation of commerce between the States, may penalize
and prohibit the movement of articles in interstate commerce. Such a prohibition may be made within the discretion of Congress such as in the WebbKenyon Act as to alcoholic beverages, the white slave traffic act, the pure
foood and drugs act, the cattle inspection act, and the like. Similar prohibitions could be imposed upon drafts, checks, acceptances, commercial paper, and
securities passing in interstate commerce to or from State banks.
In concluding this phase of the discussion of the question reference should
be made to the doctrine of congressional inaction. A review of some of the
leading cases is given below:
(1) The power of Congress to regulate commerce is not exclusive where not
exercised and does not prohibit the States from legislating on subjects relating to commerce provided their statutes do not conflict with those already
enacted by Congress. (Thurlow v. Mass., 5 How. 504.)
(2) Congress by refraining from action in matters affecting interstate commerce permits common or civil law or State statutes to that extent to control.
(Hall v. De Cuir, 95 U. S. 485.)
(3) The State, in the absence of express action by Congress, may regulate
many matters which indirectly affect interstate commerce. (Missouri P. R.
Co. v. Larrabee Flour Mills Co., 211 U. S. 612.)
(4) Any power which a State may have over interstate commerce because
of congressional inaction ceases to exist from the moment that Congress exerts
its paramount authority over the subject. (Chicago, R. I. & P. R. Co. v. Hardwick Farmers Elevator Co., 226 U. S. 426.)
In reliance, therefore, solely upon its power to regulate commerce, it would
seeem clear that Congress may completely dominate the field of commercial

The power of Congress over banking, however, rests upon broader and more
comprehensive grounds. It embraces the question of the power of Congress
to preserve the fiscal instrumentalities set up by it from the encroachment of
State institutions operating competitively in the same field. This phase of.
the question we shall now proceed to examine.
(A) The practical conditions.—The occasion for this discussion arises out of
the fact that there have been brought to the attention of Congress reports



upon the banking systems which have a serious bearing upon the effectiveness
of the national banks and the Federal reserve system.
In his annual report to Congress for 1924 the Comptroller of the Currency
directed attention to the fact that in the 40-year period from 1884 to 1924
the percentage of commercial banking resources controlled by national banks
had declined from 75 to 47 per cent. That is to say, the aggregate of commercial banking resources in the hands of the State banks had increased by
the same proportions and controlled in 1924 more than one-half of the volume
of commercial banking facilities, namely, 53 per cent. He cited figures to show
the decided trend of national banks toward the relinquishment of the national
charters in favor of State charters. He called the attention of Congress to the
danger of the ultimate loss of its control over commercial banking through
this movement toward State charters. (Report of the Comptroller of the Currency, pp. 12 to 16.)
In his report for 1925 the Comptroller of the Currency again directs the attention of Congress to this situation. He cited cases of important withdrawals
from the national system. He said:
" The number of losses of national banks to the various State systems within
the past two years is formidable enough to arouse the serious attention of the
Government of the United States. Many of these banks had been in the
national system for more than 50 years * * *.
"These facts present a serious situation for the consideration of the Congress * * *. The national banking system is a time-honored Government
instrumentality. The charter powers of the individual national banks are
derived solely from Congress. Twice in the history of the United States,
namely, immediately after the Civil War and immediately preceding the World
War, the Federal Government was able to enforce a banking policy at a time
of great financial stress through its authority to use the national banking
system as an instrument for the public benefit. The individual national bank
is always ultimately able to take care of itself in meeting the competitive conditions due to more favorable State laws by giving up its national charter and
going into the State system. But the gradual loss of national banks and the
consequent decrease in relative resources of the national banking system is of
primary concern to the National Government, not only because the national
banks form the logical and permanent basis of the Federal reserve system but
also because only through the national banking system can there be maintained
throughout the United States a standardized system of banking subject to the
visitorial powers of the Federal Government and subservient at all times to
the will of Congress." (Report of the Comptroller of the Currency, 1925,
pp. 3 and 4.)
Turning to the report of the Comptroller of the Currency for 1926 we find him
laying before Congress additional figures showing important new withdrawals
from the national banking system.
" Each withdrawal constitutes the loss of a unit in the basic membership
of the Federal reserve system. These widespread desertions from the national
system are clearly indicative of the difliculty which national banks find in
operating under their present charter powers. The fact that a greater or less
number of State banks for one reason or another take out national charters
in no way compensates for the loss of national banks. The national banking
system should be adequate to meet all of the requirements for modern banking,
and no national bank ought to be put in the position of being forced to yield
its charter in order to carry on legitimate and necessary banking operations*
" My predecessor in his statement before the House Committee on Banking
and Currency, April 9, 1924, showed that in the five decades preceding 1924, the
aggregate resources of the national banks had dropped from a predominating
control over commercial banking resources to only about 48 per cent thereof.
This rate of decline has been accelerated during the past two years, the
national banks to-day holding only about 46 per cent of the total commercial
banking resources in the United States. This is true notwithstanding the fact
that there has been year by year an actual increase in the aggregate resources
of the national banks, the figure standing at the present time around
" The steady decline in the relative strength of the national banking system
is accounted for by the more rapid growth of commercial banking under State
charter, the total resources of the State commercial banks being at the present
time about $29,000,000,000. This rapid increase of State banking resources is
due primarily to the operation of State laws more favorable to' modern banking



than is the national bank act. It arises in part from accretions from the
national system but more largely from the normal banking operations. * * *








" The above statements of fact show that the Federal Government is gradually losing its positive and immediate control over the instrumentalities of
commercial credit and over the membership in the Federal reserve system. The
greater volume of commercial banking has already passed under the policy
control of the State legislatures." (Report of the Comptroller of the Currency,
pp. 2 and 3, 1926.)
In none of the above-mentioned reports did the Comptroller of the Currency
recommend setting up a national standard of banking under a national system
of banking which would embrace exclusively the field of commercial banking.
On the contrary, the remedy proposed was an approach as far as possible to
parity between the National and State systems of banks by permitting national
banks to engage in the various types of banking permitted under State
charters. In other words, it was recommended that there be brought into the
national charter those features of the State charters which were causing
boards of directors and stockholders of national banks to relinquish national
charters in favor of those of the State. The so-called McFadden Act (act of
February 25, 1927) was the outcome of these recommendations.
It appears from the comptroller's reports of 1927 and 1928 that the McFadden
Act for a time led to a relative increase of resources of the national banks
over that of the State banks. But not to any considerable extent. This increase
was caused almost solely by the conversion of several large State branch
banking systems into national banks. We find the Comptroller of the Currency,
in his annual report for 1929, again directing the attention of Congress to the
exodus of national banks from the national charter. In this respect he
abandons the theory of parity of powers between State and National banks and
advocates legislation for the national banks without reference to powers under
State charters. He said:
"Under the existing trend, with the operating advantage in favor of the
State banks, the development is in the direction of 48 separate and distinct
systems of commercial banking each under the supervision, control, and direction of a separate State government with a correspondent disappearance of
the national banks from the fiield * * *
"The announced legislative policy of the so-called McFadden bank act of
February 25, 1927, was parity between the National and State systems. The
purpose of the bill was to make the charter powers of national banks approximately equal in operating advantage to those of the State banks. Nearly three
years of operation under that act has demonstrated that it has failed of its
purpose in this respect.
" The theory of parity between the two systems of banks is, in my opinion,
economically unsound. Commerce is interstate and is recognized by the Constitution of the United States as being fundamentally a national question. One
of the primary purposes of the national bank act of 1863 was to establish a
sound and uniform system of commercial banking throughout the country in
order that commercial transactions growing out of the production, the manufacture, and the transportation of goods and commodities from one section of
the country to the other might not be hampered by local banking legislation but
should have access to a system of banks operating under Federal authority and
supervision under a single set of rules and regulations and statutory enactments in order that the free flow of commerce should not be embarrassed by a
multiplicity of restrictions having their origin in local political conditions."
(Report of the Comptroller of the Currency, 1929, pp. 5-9.)
A year later, in his report for 1930, the Comptroller of the Currency in
advocating new legislation for national banks said:
" State legislatures have conferred upon State chartered institutions, particularly upon trust companies, banking powers which national banks did not
at the time enjoy. As a consequence, the national-banking system has, within
recent years, declined in size, importance, and influence and has become thereby
relatively less effective as an instrumentality of the Federal Government.
Through the diversion of commercial banking from the National to the various
State banking systems Congress has lost control over the major portion of the
commercial banking resources in the United States.
" Upon the enactment of the McFadden bill the conversion into national banks
of several larger State branch banking institutions and the consolidation of
several State banks with national banks under the national charter gave



rise to the hope that the national-banking system would reclaim the most
important banks which had left it to operate under State charters. However,
this hope was short lived, for there soon followed through State legislative or
State judicial action new advantages for State banks, particularly with respect
to the operation of the trust business and desertions from the national charter
in favor of those offered by the States began to increase. That the disparity
between the two systems of banks is pronounced is evidenced by the fact that
whereas in 1886 the national banks held 75 per cent of the total commercial
banking resources of the country, the latest compiled figures indicate that this
proportion has now shrunk to less than 40 per cent." (Report of the Comptroller of the Currency, 1930, pp. 4, 5.)
The investigation instituted in both Houses of the Seventh-first Congress
through the respective Committees on Banking and Currency, and particularly
through the Senate committee, have brought out much additional information
with respect to the effect of the existence of the State systems of commercial
banks upon the national-banking system and the Federal reserve system. The
question has definitely been raised of the desirability of the establishment of a
single system of commercial banking under the national charter in order that
Congress may set up adequate standards of banking which can not be avoided
through an exit into a State system of competing banks. In this connection it
becomes necessary to consider the constitutional power of Congress to effect
such a purpose.
(B) The power of penalty and prohibition.—The situation now presented
to Congress with respect to the fiscal instrumentalities set up by it is strikingly similar to that which followed the establishment of the national banking system. Hugh McCulloch, the first Comptroller of the Currency, in his
second annual report to Congress, November 25, 1864, called the attention of
Congress to the fact that although the national currency and the national
banking system had been inaugurated, relatively a small number of State
banks had taken advantage of the opportunity to convert into national banks,
but that the bulk of State banks continued to use their own circulating notes
under State authority. At this time out of 1,500 State banks only 168 voluntarily became national banks. The Comptroller of the Currency, regarding
as. detrimental to the public interest the failure of the national system to supplant through voluntary action that of the State systems of banks because it
made the progress of the new banking system difficult, if not impossible,
recommended to Congress the enactment of legislation which would impose a
discriminating tax upon State bank currency for the purpose of driving it out
of existence and thereby forcing all banks of circulation to operate under
the national charter.
Following this recommendation Congress enacted the following provision
which put a tax upon State bank currency:
" Every national banking association, State bank, or State banking association, shall pay a tax of ten per centum of the amount of notes of any
person, State bank, or State banking association used for circulation, and paid
out by them after the first day of August, 1866, and such tax shall be assessed
and paid in such manner as shall be prescribed by the Commissioner of
Internal Revenue. (July 13, 1866, 14 Stat. L. 146.)
The constitutionality of this act was brought squarely before the Supreme
Court of the United States and upheld in the case of Veasie v. Fenno (8 Wall.
533). Chief Justice Chase, in delivering the opinion, said in part.
" The power to tax may be exercised oppresively upon persons, but the responsibility of the legislature is not to the courts but to the people by whom
its members are elected. So if a particular tax bears heavily on a corporation,
or a class of corporations, it can not for that reason only be pronounced
contrary to the Constitution,
" But there is another answer which vindicates equally the wisdom and
power of Congress.
" I t can not be doubted that under the Constitution the power to provide
a circulation of coin is given to Congress. Then it is settled by the uniform
practice of the Government and by repeated decisions that Congress may constitutionally authorize the emission of bills of credit. * * * There can be
no question of the power of the Government to emit them; to make them
responsible in payment of debts to itself; to fit them for use to those who see
fit to use them in all the transactions of commerce; to provide for their redemption ; to make them a currency, uniform in value and description, and
convenient and useful for circulation. These powers, until recently, were



only partially and occasionally exercised. Lately, however, they have been
called into full activity, and Congress has undertaken to supply a currency
for the entire countrty. * * * Having thus in the exercise of undisputed
constitutional powers, undertaken to provide a currency for the whole countrty, it can not be questioned that Congress may, constitutionally, secure the
benefit of it to the people by appropriate legislation. To this end, Congress
has denied the quality of legal tender to foreign coins, and has provided by
law against the importation of counterfeit and base coin on the community.
To the same end, Congress may restrain, by suitable enactments, the circulation
as money of any notes not issued under its own authority. Without this
power, indeed, its attempts to secure a sound and uniform currency for the
country must be futile."
It should be observed that the tax imposed by Congress upon the State bank
circulation was not for the purpose of raising revenue for the support of the
Federal Government but was clearly in the nature of a prohibition to prevent
the encroachment of State chartered institutions upon a Federal instrumentality. The purpose of the tax was to destroy State systems of currency and
thereby in effect to put out of commission the State commercial banks. The
report of the Comptroller of the Currency to the next session of Congress, in
1866, stated that the national system of banks had indeed supplanted the State
banks and that all of the State banks of circulation had availed themselves
of the privilege under the national bank act of converting into national banks,
thus indicating the effectiveness of the tax.
This case serves to illustrate an important constitutional principle which has
a direct bearing upon the present discussion. The constitutional powers of
Congress are not divided into separate compartments each independent of the
other. The Federal Government is a political organism and may rely upon a
number of its constitutional powers in the performance of a single act. Its
vitality depends upon its ability to use any and all of its powers to accomplish
the ends necessary and proper to its existence. Consequently, Congress may
proceed under one specific constitutional power by way of penalty and prohibition to make more effective another constitutional power. The two most
convenient forms of penalty which have heretofore been employed by Congress
have been imposed through its power to tax and through its power over articles
moving in interstate commerce.
(C) Responsibility of Congress for its own fiscal agencies.—As a background
to the power and the responsibility of Congress for the creation and the maintenance of the national banks and the Federal reserve system citations from
a few of the leading cases before the Supreme Court of the United States may
be of interest.
In Easton v. Iowa (188 U. S. 229, 1903) the court, in reversing the Supreme
Court of Iowa, directly adopted and applied the constitutional principles
enunciated in McCulloch v. Maryland (4 Wheat. 425) and in Osborn v. Bank
of United States (9 Wheat. 738). It said that the national bank act "'has in
view the erection of a system extending throughout the country, and independent, so far as powers conferred are concerned, of State legislation which
if permitted to be applicable, might impose limitations and restrictions as
various and as numerous as the States."
The court further said, " On the immediate subject of control over national
banks it was said in Farmers and Merchants National Bank v. Dearing (91
U. S. 29) 'the States can exercise no control over them (national banks), nor
in anywise affect their operations, except in so far as Congress may see proper
to permit. * * * The States have no power by taxation or otherwise to
* * * burden or in any manner control, the operation of constitutional laws
enacted by Congress to carry into execution the powers vested in the general
The court in this case also cited with approval the principles laid down in
the case of Davis v. Elmira Savings Bank (161 U. S. 375) in Which the court
had said: " ' National banks are instrumentalities of the Federal Government,
created for a public purpose, and as such necessarily subject to the paramount
authority of the United States. It follows that an attempt by a State to define
their duties or control the conduct of their affairs is absolutely void wherever
such attempted exercise of authority expressly conflicts with the laws of the
United States and either frustrates the purpose of the national legislation or
impairs the efficiency of these agencies of the Federal Government to discharge
the duties for the performance of which they were enacted. These principles
are axiomatic, and are sustained by repeated adjudications of this court \ "



The court further said: " Our conclusions, upon principle and authority, are
that Congress having power to create a system of national banks, is the judge
as to the extent of the powers which should be conferred upon such banks, and
has the sole power to regulate and control the exercise of their operations."
Are not these principles directly applicable to a situation in which the State
governments may have set up agencies or instrumentalities rival to and in competition with those set up by the Federal Government with the effect that the
Federal instrumentalities be reduced to a state of impairment in the accomplishment of their purposes?
In First National Bank of Bay City v. Fellows (244 U. S. 426, 1917) Chief
Justice White, in delivering the opinion of the court, confirmed all of the previous leading cases from the McCulloch case in 1839 clown to 1917 upholding
the constitutional power of Congress to create and maintain fiscal instrumentalities in the form of national banks, exclusive of State control or interference. This case involved the power of Congress to permit national banks to
exercise trust powers. The court said:
" That even though a business be of such a character that it is not inherently
considered susceptible of being included by Congress in the powers conferred on
national banks, that rule would cease to apply, if, by State law, State banking
corporations, trust companies, or others which, by reason of their business, are rivals, or quasi rivals of national banks, are permitted to
carry on such business. This must be, since the State may not by legislation create a condition as to a particular business which would bring
about actual or potential competition with the business of national banks, and at
the same time deny the power of Congress to meet such created condition by
legislation appropriate to avoid the injury which otherwise would be suffered
by the national agency."
In the more recent past Congress has pursued the policy of permitting the
State legislatures to take the initiative in banking legislation and from time
to time have attempted to enlarge the powers of the national banks in order
to meet the State competition.
The desirability of the establishment of a single national standard of banking has led to two principal recommendations, one, to grant to the national
banks charter powers of greater scope than can be attained by State banks in
the expectation that those engaged in banking under State charters will seek
the national charter; and the other, the complete and exclusive entry of the
Federal fiscal agencies into the field of commercial banking through the removal
of State commercial banking from the field.
The first of the above remedies has been recommended principally by the
Comptroller of the Currency and the immediate weapon he would use is the
extension of branch banking by national banks in disregard of State boundary
The second remedy, that of the enforcement of a single standard of banking
through congressional action, has several times been presented in the form of a
question at the current investigation by Senator Glass and has specifically been
advocated by Mr. Owen D. Young. It is on this question that doubt has been
expressed as to the constitutional power of Congress to proceed.

In view of the foregoing considerations I am of the opinion that Congress
clearly is possessed of the constitutional power, supported by legislative and
judicial procedents firmly established, to proceed by direct action to remove the
State banks from the field of commercial banking. This power is inherent in
the power to establish and maintain the national-banking system and the Federal reserve system. The question of law does not present an obstacle. What
remedy to adopt is a practical question of congressional policy.
If congress sees fit it may lawfully use one or more of the following methods
of producing a single standard of commercial banking under Federal control:
1. It may place a prohibitive tax upon (a) checks drawn in one State upon
a State bank in another State. That is to say, State bank checks moving in
interstate commerce; (&) other means of the transfer of funds through State
banks from one State to another.
2. The denial of the facilities of interstate and foreign commerce to State
banks and trust companies, such as (a) telephone, (ft) telegraph, (o) railroads,
(<f) aeroplanes, (e) steamships.
3. The denial of the use of the mails in connection with transactions in
interstate commerce.



The fact that the above procedure would be drastic is of no consequence since
its purpose would be to transfer a system of banking which has come into
harmful competition with the banking instrumentalities created by Congress.
Such a policy by Congress would be nothing more in principle than a repetition
of the tax act of 1866 and for the same purpose.



(Furnished to committee by Robert Warren, New York City)
The country bank is peculiarly an American institution. It has no counterpart and no equivalent in any other country. With its faults and its virtues,
is was the country bank that financed the growth of the United States over
the past century, and to-day " country banks " probably hold half the deposits
of the American people.
Yet, important as the country bank is in American economic life, country
banking as a distinct type of banking has received little attention from American economists. Indeed, they have generally failed to recognize that there
are fundamental differences between country banking and city banking almost
as wide as those which divide city-deposit banking from investment banking.
It is only recently that statistical data have been available which would permit quantitative statistical analysis of country banking as a distinct field, and
even to-day the data are not entirely adequate. It is limited to the " country
banks " of the Federal reserve system which, although they hold about onethird of the total deposits of the member banks, are a minority of the country
banks in the United States and do not probably hold half the deposits of
the country banks of the United States.
The figures in the accompanying analysis have been taken from the call
report of December 31, 1930, and refer only to member banks of the Federal
reserve system. It is believed that they are representative of country banking
in general; although, since the country member banks of the system have in
general weathered the financial storms of the past year more successfully than
nonmember country banks, it is probable that the statistics available present
a rather better picture than the complete actualities. For the purpose of
examination they are, however, satisfactory.

Any consideration of country banking must start from the premise that it
is a distinct type of banking, that its problems are not identical with those of
city banking, and that identical criteria of behavior can not apply. The fundamental characteristic of the country bank is the concentration of its field,
as contrasted with the diversification which the city bank enjoys. A country
bank is primarily dependent upon the welfare of the particular agricultural
specialty of its community, and upon a limited number of commercial and manufacturing enterprises, whose welfare in turn is closely associated with the local
type of agriculture. Now, of all human enterprise, agriculture is subjected to
three common and inevitable hazards:
1. A slow turnover, generally only once a year.
2. Wide and frequent price fluctuations,
3. Dependence for its volume of output upon a force beyond human control
or foresight; i. e., the weather.
These facts enter the problem of the country bank to an extent unknown
in city banking.
Second, the function of the country bank is essentially different from that of
the city bank. In theory at least, the function of city banking is the financing
of goods in process or in transit; the function of country banking is, to a certain
extent, to provide, through credit, the working capital of the entrepreneurs of
communities which are, generally speaking, deficient in capital.
That is, the country bank supplies a different kind of credit to a different
kind of customer, from that which the city bank supplies to its borrowers.
This fact in no way implies that one type of banking is " p u r e r " or more
" orthodox " than the other; it merely asserts that the two types are fundamentally different in character.
From these fundamental characteristics of country banking one unavoidable
consequence derives. It is the duty and the responsibility of the country bank



to serve the economic activities of its community, although the economic activities of its community are subject to inescapable hazards. The implication is
that the local loans of a country bank never do, never will, and never can
possess the " liquidity " which can and should characterize the loans of a city
bank. This is stating bluntly the basic problem of country banking. No matter
what the prudence of the banker nor the diligence and ability of his borrowers,
they can not avoid the hazards of the economic sphere in which they have cast
their lot—the fluctuations of prices and the vagaries of the weather operating
upon an industry which has only one turnover per annum. The country bank
can not shirk the responsibility of lending the greater part of its resources
locally, but it must (or should) do so in full realization that in spite of human
diligence or forethought circumstances beyond local control or prevision may
make it impossible for those loans, or at least a considerable part of them, to
be paid in full at the specified maturity. The word " impossible " is here used
to mean not so much absolute inability as inability except at such sacrifices as
will prove grievous to the community. Putting it frankly, any country bank in
any year may find its local loans in a condition varying from " slow " to " badly
frozen." When this occurs (as, for example, in 1930) it is not prima facie
evidence of bad banking. On the contrary, in certain sections of the United
States in 1930 no country banks which conscientiously and loyally was endeavoring to serve it community could avoid finding the liquidity of its local loans
gravely impaired. While 1930 was an exceptional year in several ways, in that
the affected areas were unusually widespread, this situation to a greater or
less degree is by no means infrequent. It is the ever-present hazard of country

Starting, therefore, from the premise that in any given year any country bank
in America may find the liquidity of its local loans impaired, and that in exceptionally years country banks as a group may find themselves generally in this
condition, entirely as the result of circumstances which they could neither foresee nor prevent, it is obvious that the country bank must set up defense mechanisms adequate to protect itself and its depositors. That is, since its local
loans must (or should) from its character comprise the major part of its earning assets, and since these local loans are subject to certain inevitable hazards,
it is clear that the country bank should apportion the remainder of its funds
among assets of a certain quality of liquidity and security. In this respect its
determinants are radically different from those of a city bank. Whereas the
city bank may depend more heavily upon the liquidity of its customers' loans
and may regard its investments as primarily the placement of its time deposits,
thus assimilating that part of its function to the operation of a savings bank,
a country bank must candidly recognize that at any time its local loans may
become quite unliquid and that its investments, far from being assimilable to
those of a savings bank, are its first line of defense in maintaining liquidity
and even solvency.

The available statistics indicate that country banks as a class have not clearly
grasped this essential requirement. The following tables show the distribution
of the assets of country banks (members of the reserve system) as reported in
the December 31, 1930, call; and alongside the distribution reported by the
member banks of New York City.
TABLE I.—Distribution 1 of assets December 81, 1930
[000,000 omitted]
Total loans and investments
Open-market loans
United States securities
Other securities
Loans to banks

- - -

* Source: The Federal Reserve Bulletin, February, 1931, p. 111.


New York
City member banks



There is one very important figure lacking from this table. Its absence is
negligible so far as the New York City banks are concerned, but it is badly
needed to complete the picture for the country banks—this is the figure of the
net balance due from city correspondents. On September 24, 1930, the call
showed such a net balance of $569,000,000.1 This figure can not be applied to
the table given because it includes correspondent relations outside the reserve
system and hence would not be strictly comparable to the other items in the
tabulation. This figure, whatever it is, is one of the key figures required for
any analysis of country banking in the United States, and it is herewith
suggested that its inclusion in future calls would be highly desirable.
Taking the statistics as they are, they disclose the following distribution of
customers' loans.
TABLE II.—Distribution of customers' loans December 31, 1930
[000,000 omitted]
Country New York
member City membanks ' ber banks
Collateral loans l
Loans on real estate
Other loans 2


Total customer loans



Includes loans to brokers outside New York City.
* Loans to customers exclusive of banks, otherwise secured and unsecured. Sometimes classed as "other
loans chiefly commercial." F. R. Bulletin, February, 1931, p. 111.

Reducing these items to percentages of their respective totals, the following
table is desired:
TABLE III.—Proportion to total loans and investments

Customers' loans 1
Open-market loans
United States securities
Other securities
Loans to banks


Per cent

New York
City member banks
Per cent

Acceptances, commercial paper, and " Street loans."

The first figure is interesting—a larger proportion of the resources of the
country banks is found under customers' loans, a fact by no means surprising
in view of circumstances.2 Certainly the figure can not be regarded as disproportionate—and, as a proportion close to this was reported at the end of 1928
and of 1929, we may presume that it is a sort of *' normal" figure. Whether
it holds for the nonmember country banks is unknown. We may suppose,
however, that country banks on the average place about 60 per cent, or between
60 and 70 per cent of their funds into loans with local customers.
Federal Reserve Bulletin, November, 1930, p. 756. This figure is approximate only.
It is the difference between the " net due to other banks in the United States " by country member banks, and the " n e t due from other banks in the United States." It necessarily includes items "due t o " and "due from" nonmember banks, and hence is
imperfectly comparable.
Strickly speaking the " street" loans of the New York City banks are a type of
customer loan.



The following table shows the distribution of the customer loans:
TABLE IV.—Proportion to total customer loans
. banks

Collateral loans
Real-estate loans
Other loans



Per cent

New York
City member banks
Per cent


It has already been noted that country banks put a larger proportion of
their resources into local customer loans than city banks, and this table indicates that these loans are distributed very differently from the customer loans
of New York City banks. It is not the purpose of this memorandum to criticize this distribution; its object is to emphasize that the local loans of country
banks are inherently of a type that becomes more or less unliquid in case 'the
community suffers from either general or local adversity.
The following table is a regrouping of Table III in order of availability:
TABLE V.—Grouping of assets in order of availability

New York
City member banks

Per cent

Customers loans (commercial and collateral)

Per cent


Immediately available




The " immediately available" item is composed of United States securities
and " open-market loans " ; these can be realized instantly and with assurance
of recovery of the entire principal. The " negotiable item " includes the " other
securities." It will be noted that, after their customers' loans the New York
City banks put about 45 per cent into the " market" and the country banks
about 40 per cent—again there is nothing to criticize in the distribution. But
whereas the New York banks put 32 per cent into *' first rate " placements and
only half as much into " second rate " securities, these proportions are reversed
in the country banks. And this, in spite of the fact that the customer loans of
country banks are inherently subject to hazards not common to the customers'
loans of city banks.

Country banks put approximately 27 per cent of their funds into investmentsother than United States securities, while New York City banks place only
14 per cent in such securities. This wide disparity of practice provokes attention and is open to criticism.
A " good " investment is one which answers the needs of the investor; " goodness " is not an intrinsic quality of the investment itself. A given bond may be
admirably suited to the needs of one investor and utterly unsuited to the needs
of another. The object of this memorandum is to show that from their character country banks are obliged to place very heavy dependence upon their other
than local loans to maintain Liquidity, in case of the ever threatened local adversity, and the unescapable corollary of this thesis is that only a certain kind of
security can meet the requirements of a country bank. This is a security whose
instant marketability, without serious loss of principal can be absolutely
depended upon in case of general or local adversity. Yet the statistics show
that country banks are prone to place their dependence upon a type of security
which, however " good " in itself, is not unqualifiedly suited to their specific



We may suppose that these " other investments " have certain high merits,
i. e., that all are negotiable in some organized market, that few or none are
threatened with default, etc. But these merits do not suffice for the needs
clearly indicated, unless they possess one other, namely, such recognized quality
and general desirability as will free them from wide fluctuations in price.
Bonds with limited markets, or narrow markets, or uncertain quality, or subject
to wide fluctuations, while they may be admirably suited to the portfolios of
certain persons or institutions (for example, investment trusts or, in due proportions, even city banks) are absolutely unfitted for the needs of country
banks. Yet it is a matter of common knowledge that such securities form a
large proportion of the " other securities " held by country banks.
It is perfectly true that country banks are never or rarely forced to suspend
specifically because of the depreciation of their bond portfolios. That is not
the point. The impairment of the liquidity of their local loans (forced by circumstances they can neither foresee nor prevent) drives them into dependence
upon their nonlocal assets, of which the greater part is composed of securities
other than "open market" loans or United States Government securities. If
at the same time that the liquidity of the local loans is impaired, the secondary
bond market is simultaneously depressed, country banks as a group find themselves in difficulties—difficulties ranging from absolute insolvency to technical
insolvency, or mere impairment of capital assets. It was precisely this combination of adverse circumstances which occurred in 1930—impaired liquidity
of local loans synchronized with a weak market for secondary bonds. Against
the former contingency the country bank has no protection—it is inherent in
the very character of country banking; country banking is liable to such
maladies as the individual is liable to illness, in spite of all human precautions.
But against the second and, in 1930, concomitant contingency, the country bank
possesses a defense. It could keep a larger proportion of its nonlocal assets
in absolutely first-class placements, i. e„ " open market" loans or gilt-edge
securities, and a smaller proportion in " other securities," which, whatever their
other merits lack the great essential—instant availability without serious loss
of principal. Returning again to the analogy of the individual, no person can
insure himself against illness, but he can insure himself against some of the
consequences of illness by keeping a portion of his capital at hand in his bank,
rather than having all of it either immobilized in his business or subject to the
vagaries of the security market.
There is a further consideration. A country bank, having a paper loss on
its bonds, and finding its deposits shrinking, is confronted with the alternative
of taking a loss by liquidating its bonds or bringing pressure upon its customers
to contract their loans. The temptation is to take the latter course, even though
the former might be preferable from the standpoint of general welfare. There
were distinct traces of the operation of such a force in the statistics of 1930.
The object of this memorandum has been to invite attention to the statistical
evidence that country banks place too great reliance upon their holding of
second-grade securities. That is, the proportion of second-grade securities
to other assets is large, both by comparison with the practice of New York
City banks, or by rational deductions from the inherent characteristics of
country banking. The conclusion appears unescapable that it would be highly
desirable for country banks as a class to place a greater proportion of their
assets in " open-market" loans, United States Government securities, and
other bonds of the highest grade; and a smaller proportion in second-grade
securities, which, however meritorious, lack the essential quality of instant
availability, in an organized market, at a price which assures no serious loss
of principal. Indeed, it appears to be no straining of the statistical evidence
to offer the conclusion that a large proportion of the difficulties of country
banking, leading, as they so frequently do, to insolvency, could be removed by
a systematic and thorough recasting of the investment practice of country
banks as a group.

Such a recasting coul be achieved by prescribing lists of investments for
country banks, as certain States do for savings banks. There are both advantages and disadvantages to the proposal; but to the writer it has one absolute
disadvantage. It would, in his opinion, place too great a restraint upon the
initiative and discretion of the individual banker. Although this memorandum



is critical of the investment policy of country banks as a class, the writer is too
well aware of, and has too high a regard for, the enterprise, prudence, and
financial acumen of country bankers not to wish them the greatest latitude for
the exercise of their abilities that is consistent with safety to their depositors
and to the integrity of the banking situation.
Nevertheless, having criticized the investment practices of country banking,
the writer feels under obligation to suggest a method by which these practices
could be improved. It is therefore suggested that, rather than prescribe a
fixed distribution of nonloical assets or prohibit investment in securities outside
a prescribed list, the improvement be sought indirectly.
1. It is therefore suggested that it be required that all banks make public
their statements, as of the call dates, and that in such statements the value of
their investments, in the aggregate, be entered at a figure not higher than the
market value of these investments as of the same date. In this way, an>
impairment of the " secondary reserve " would be brought forcibly to the attention of the bank's directors, and the temptation to invest in secondary reserve in
bonds of uncertain marketability and subject to extreme fluctuations, would
be automatically restrained without the necessity of arbitrary interference.
This method of reporting is already habitual with some banks of the highest
character; and it is believed that great benefits would accrue if the practice
were made universal. While it is not to be expected that the investment
portfolio of all banks will at all times show a net profit over cost, there seems
to be little justification for the publication of statements in which an item of
*' surplus and undivided profits" makes no allowances, or an inadequate
allowance, for a possibly serious depreciation an item which may comprise
nearly 30 per cent of the earning assets of the bank.
2. It is also suggested that a standard form of bank statement be devised
by the Comptroller of the Currency, or by the Federal Keserve Board, so
devised as to indicate more clearly the absolute and the relative liquidity of
the institution and that it be recommended that all banks in their published
statement follow such a form. At present, although most banks publish periodical statements, it is scarcely an exaggeration to say that no two banks present identical statements, or a form which makes possible comparison with
other banks; and that these diverse statements have only one common quality—for the most part they are presented in such a way as to fail to disclose
the liquidity or even the solvency of the bank. It is believed that the elementary
rights of the depositor entitle him to a statement which will give him a fair
impression as to the state of the institution to which he intrusts his money.
This opacity of statement is not peculiar to country banks; it is common to
city banks. The object of such a revised and standardized form of presentation
would be to indicate the relative liquidity and true worth of the assets, neither
of which are clearly shown in the present common types of statement.

The events of the past year have emphasized the facts demonstrated over a
long period of previous years: That American banking practice is subject to
certain weaknesses which lead to deplorable numbers of bank failures which,
even when individually small and scattered, are calamitous to the communities
in which they occur. It is obvious that a rather elaborate system of bank
examination and supervision, although helpful, is inadequate to give either
bank depositors or bank stockholders the protection to which they are reasonably entitled. It is believed that if the present systems of examination and
supervision were supplemented by more intelligent scrutiny by depositors and
shareholders, made possible by such modifications of the periodical publication
of bank statements as have been herein suggested, the quality of American
banking could be materially improved. Better informed public opinion would
reward the conservative and liquid bank by its patronage and bring pressure
upon the imprudent and unliquid bank to improve its practice in order to regain
competitive favor. In this way bank failures, if not obviated, could at least be
made far less frequent.






(A study by Robert D. Kent)
Section I : Vice President Hazelwood, of the First National Bank of Chicago,
on retiring from the presidency of the American Bankers Association at its
recent convention, said:
" The Federal reserve system is for our use in emergencies to carry us over
peak periods, to influence the general credit situation through its open market
operations, and to be the custodian of the country's gold supply, upon which
all credit is based. The Federal reserve system does not operate for the purpose
of adding permanently to the funds which we dispense to our customers, nor
to enable us to make an additional profit through rediscounting at a better
rate, nor to make it possible to take care of customers who desire to purchase
or hold securities after the loanable funds of our banks have been exhausted
by commercial or agricultural loans."
Mr. Hazelwood correctly states the purposes of the Federal reserve system,
but I can not, however, agree with him when he states that it does not operate
for the purpose of adding permanently to the funds which we dispense to our
customers nor to enable us to make an additional profit through rediscount at
a better rate. It should not operate to do these things, but it does actually so
In our necessity to have our currency made elastic I do not recall that anyone
advocated that the system should issue currency at wholesale rates to banks
for the latter to retail to their customers at higher rates. Old-fashioned and
conservative bankers condemn such a policy, but bankers by the thousands seek
to make the additional profit mentioned and condemned by Mr. Hazelwood.
So far has this gone that when the credit strain of the past few months grew
more acute the banks very largely found themselves with lines of accommodation so high with the Federal reserve banks and with such a limited supply of
eligible paper on hand that they could not readily apply for further assistance
and in consequence were compelled to decline to grant credit that under normal
conditions would gladly have been extended.
It has been uniformly the policy of the Bank of England to maintain its rate
somewhat above that of the street or open market. This policy results in the
law of supply and demand working automatically through the banks of the
nation, a surer index of business requirements than the judgment of the
majority of a body of 8 or 10 men.
The mistaken policy of the Federal reserve system indicated above has been
a large factor in bringing about the overextended use of credit through which
we have been passing for the past two or three years and which has resulted
in losses of hundreds of millions of dollars to our people and which, if the
reaction is not stopped, will produce much more serious results
James B. Forgan, the eminent banker, said in an address :
" In the long run commerce suffers more from periods of overabundance of
money than from those of scarcity. The origin of each recurring period of tight
money can be traced to preceding periods of easy money. "Whenever money
becomes so overabundant that bankers, in order to keep it earning something,
have to force it out at abnormally low rates of interest, the foundations are
laid for a period of stringency in the not far distant future, for then speculation
is encouraged, prices are inflated, and all sorts of securities are floated."
Doctor Anderson, the economist of the Chase National Bank, in a recent
address said that " the world's business is not a moribund invalid that needs
continuous galvanizing by an artificial stimulant. Cheap money is a stimulant.
It is also an intoxicant if the dose is large enough; a very substantial temporary effect can be brought about. But headaches follow. It is not the sound
way to do it." And he also says that " real estate, both urban and agricultural,
has been encouraged to overborrow in periods of excess funds. States and
municipalities increase their debts with great rapidity in periods of easy money.
Foreign governments, States, and municipalities borrow far more than is
necessary in such periods because it is so easy to do so."
Andrew Jay Frame, who retired from active banking service some 8 or 10
years ago after an experience of over 50 years, was 20 or more years ago
listened to with close attention when he addressed bankers' conventions and
legislative committees. In speaking of the experience of the Bank of England
34718—31—PT 5



he said that " i n 1847, 1857, and 1866 it broke the $90,000,000 limit of its
expansive power of credit and panics were immediately stayed "; but mark the
historic fact that the extra currency issued to relieve distress was without
delay reduced to normal. A member of our monetary commission lately asked
the governor of the Bank of England why this $90,000,000 limit was not
enlarged, and his answer was, " We fear overexpansion of credit."
" The idea that untaxed currency without some force to drive it home when
not needed will automatically expand and contract with our needs has no
warrant in experience.
*' I reassert that currency issues not practically covered by gold issued in the
day of stress must be penalized by an adequate tax so that it will only come
out to relieve distress, and will at once retire when stress is over, to the end
that inflation and overexpansion of credit may be averted. The whole world
has practically conceded it. This is the crux of the whole problem."
In advocating the establishment of a national reserve bank prior to the enactment of the Federal reserve act he said: " What is the true mission of a central
reserve bank?
" First. To be our servant and not our master.
" Second. By holding large cash reserves that in normal periods the independent banking system may obtain rediscounts with which to move crops and
in abnormal periods with extraordinary note-issuing powers that our banks may
obtain aid to the end that cash suspensions by banks generally with their train
of evils may be avoided."
In speaking of the central banks of foreign countries Mr. Frame says:
" The 20 great central reserve banks have restricted extraordinary currency
issuing powers to the end, like a water reservoir, that aid be given banks in any
section on the day of trouble."
Speaking of the bill which was proposed by the Aldrich commission, he
said: " Its true mission is to aid us in troublous times," and " to hold our
reserves, to allay distress in the day of pressure and none other. Banks that
in normal times can not stand practically on their own resources are like
pampered weaklings."
To those who desire to broaden their knowledge of monetary and banking
matters it is recommended that Mr. Frame's utterances be given close
Except for the inability of the banks of reserve cities to have any method of
creating new credit to help annually to move the crops and to meet any
unusual demands the old system of reserve banks gave admirable service,
Mr. Warburg, years ago, in advicating a more elastic currency, in speaking of
the annual pressure, said it was so great as to threaten the safety of the
European machinery when we were compelled to use it to its utmost capacity in
order to provide for our needs.
From this it will be seen that the expansion power was desired not for constant use but for crop moving and other unusual demands.
In providing a remedy for the vital defect in our old system, the operation
of the Federal reserve system has gone too far. The provision for expansion
has proved effective, but due regard was not given to the desirability of
restricting the expansion process to meet crop-moving necessities and other
unusual demands nor was proper provision made to retire the credit instruments when the purpose for which they were created had been served. The
low rate of which the reserve banks supplied money at any and, indeed, all
times to the banks of the country has proved the means of serious inflation.
Samuel P. Arnot, president of the Chicago Board of Trade, in an address
given recently before the Nebraska Bankers' Association, said, "An easy
money policy adopted by the Federal Reserve Board in 1927 to aid European
countries in recovering from postwar troubles was the foundation of the
tremendous bull market movement which reached its apex last summer." He
cited statistics in an endeavor to show that when the board became alarmed
at the increasing intensity of speculation months later, its policies " vacillated
to the distress of the markets."
Right or wrong, the part played by the Federal Reserve Board in the great
drama just finished on the financial stage undoubtedly will come in for most
intensive discussion during the next year.
Some 30 or more years ago one writer, in speaking of the policy of the Bank
of England in a time of severe and protracted money stringency, said that it
loaned freely and was not over particular about the collateral. Our policy
was the opposite. We loaned freely when no emergency existed, and when the
special need arose we were unable to meet it.



About every 15 or 20 years our people in all classes enter upon an era x»f
undue speculation. We have had a fever of that sort upon us for the past
three or four years, and the policy of the Federal reserve system has been to
stimulate the fever by adding the oil of cheap credit to the fire of the fever.
To extend the thought along this line, let us consider what would be thought
of the policy of a large city, which in normal times had a sufficient supply of
water, and built a reserve reservoir for possible emergencies, yet made daily
use of the contents, so that when the anticipated emergency arose the water
was found to be at a very low level and not sufficient to meet the demands of
a continued drought or conflagration. There is but one answer.
Have not our Federal reserve banks been acting on this principle? For the
past two or three years they have been inducing the member banks by low
rates to use the reserve facilities for the profitable resale of credit at higher
rates; an incentive of almost irresistible power. So far had this gone that
when since September of last year there existed a natural and great need for
accommodation on the part of the general public, the member banks found
themselves so far indebted to the Federal reserve banks and their supply
of eligible paper so low that they were nearly all of them reluctant to apply
for further accommodation. Thus, when the emergency did come, the water
or credit supply in the special reservoir was at a low level and the public could
not be accommodated as was intended when the reserve system was established.
If we had been better students of finance, we would have had regard for
several experiences which will now be specified:
First. That of the Bank of England and the central banks of Europe in keeping their rate for money above the current or street rate and coming to the
assistance of the banks when unusual demands were to be met.
Second. That of the clearing houses of the country which by the occasional
issue of clearing-house certificates in times of severe financial stress always
charged the accommodated banks full rates. These certificates admirablyserved their purpose and were then returned and canceled.
Third. The action under the operations of the Aldrich-Vreeland Act which
did, indeed, issue emergency currency at a low rate, but this rate was raised
monthly until it was higher than the outside rate. The $380,000,000 special
currency enabled us to withstand the financial shock of 1914, the most severe
in our history, and was in five or six months fully retired. The plan now
complained of is more and more being condemned by thoughtful bankers and
Years ago Bagehot, in his classic work Lombard Street, said: "The Bank
of England, until 1844, had the unlimited right to issue notes against their
portfolio and such authority was in more than one instance used with extreme
unwisdom, so that devastating panics followed hard upon the heels of the reckless speculation which the too-great facilities for borrowing had engendered."
We in the past year have found out another instance in which history repeats
Attention should be called to the statement of Mr. McGarrah when he was
about to sail for Europe to assume the presidency of the World Bank, that
application had been made to the Federal Reserve Board by the reserve
banks of New York;, Philadelphia, and Boston for some time prior to the September break, for permission to increase the rate for rediscounts but that the
requests had been refused.
The banks of the cities named were nearer the firing line and were better
judges of the proper policy to adopt than were the members of the Federal
Reserve Board. The refusal mentioned cost the peopie of the country untold
millions of dollars.
As part of the Federal reserve system we have a Federal advisory council
which is composed of 12 prominent and experienced bankers. As far as can
be learned, it does not appear that the point made by Mr. McGarrah has had
consideration by the council, although part of its duties as" defined by the
reserve act " is to make recommendations in regard to discount rates,"
It would be instructive if those who defend the practice complained of would
give the reasons for the adoption and point out its supposed benefits and inform us what financial authority advocated the policy now criticized.
While it is felt that for the benefit of the'business interests of the country
the policy of the reserve system sliduld he changed it is not advocated that it
be abruptly done, but only after careful study of the matter by a body composed
of competent authorities and a plan agreed upon as to how and when to make
the change.



It the argument which has been presented is considered sound and of sufficient importance the writer has a plan to propose which will develop the machinery by which the matter can be digested and the remedy worked out.
Section 2. Banking practice can be greatly improved if we adhere somewhat
closely to a well-known part of legal procedure. One branch of law is known
as common law. This is the outgrowth of .the law merchant. This last was
based on the common practice of merchants as they conducted their business
from day to day.
We should recognize as sound banking practice the usual and ordinary
methods of experienced bankers in meeting the proper needs of the people of
the different localities. It is the people who furnish the capital and deposits
of the banks, and the banks were organized for their convenience. Thus would
we apply the principle underlying the common law. The Federal reserve system should mobilize the reserves of the banks of the country, loaning and rediscounting when necessary, but on lines of sound banking practice as daily carried
on by properly managed banks.
With your permission I will amplify this thought. Our old system of reserve
cities and central reserve cities, our older bankers and students will recall,
served us well in all possible ways except one: No provision was made by wThich
ultimate elasticity of currency was provided, as is now done by the Federal
reserve banks. In other respects we had better service than now. Of paper
held by the member banks, it is probable that only about 15 per cent consists
of what is termed "eligible," The percentage will be somewhat greater in the
banks of large cities, but elsewhere the proportion will hold good. This statement is based upon inquiries made of banking friends. I know of two small
banks that estimated that they held about 5 per cent eligibles. It is probable
that 50 or 60 per cent of the loans held by the so-called country banks would
be acceptable to the old reserve-system banks. A considerable part of the
receivables would consist of paper made absolutely good by makers and indorsers
well known by the banks to which it was offered. Second, some of the paper
would be secured by high-grade collateral of which the market value could
readily be known and which could in case of necessity be quickly sold to make
good the loan. A third classification would be notes of counties, cities, towns,
villages, boroughs, and school districts, which are generally issued in anticipation of taxes. All of these classes of notes are ineligible at^the Federal reserve
banks, but were readily accepted by the reserve agents when offered by and
with the indorsement of the corresponding bank of whose standing they were
assured. The above classes of loans have always been regarded as proper
assets of banks but are now taboo by the Federal reserve banks.
Again it should be remembered that the banks of the country are organized
by the people of the various localities to serve the business of such localities.
These furnish the capital and the deposits and when financially responsible
should be able to borrow within proper limitations. These, however, should be
determined by the officers and directors of the banks without narrow and arbitrary regulations made by a group of men in Washington who are certainly
remote and who are inclined to be somewhat theoretical and academic.
Proper banking practice should be based upon daily and ordinary transactions
in the banking business, conducted as bankers have learned to conduct them,
to the best advantage of all concerned. But the laws, rules, and regulations as
they now exist have been made to a considerable extent by those who are not
fully familiar with the actual conditions. In particular, the small proportion
of eligible paper held by the general run of commercial banks indicates one of
two conditions—either that the banks are ignorantly and improperly conducted
or that the Federal reserve banks are too restricted in the classification. A
careful study along this line should be made and the fault corrected.
The old system of reserve banks gave immediate credit for out-of-town checks.
This practice has been improperly changed by our present system. This feature of banking is treated by the writer somewhat in detail as a separate
We will all agree that speculation often runs to excess and that every 15
or 20 years it becomes a sort of fever in which the butcher, the baker, and
the candlestick maker and their relatives and friends neglect their ordinary
vocations and try to make their living, and a good one at that, without giving
an equivalent of service. Appreciation of this fact has resulted in a discrimination against stocks and bonds as a proper basis of credit. Let us see if we
have not gone too far in this direction. The class of paper looked upon with
favor is that running not over three months and given for the sale of merchan-



dise. This is regarded as self-liquidating, as the goods will be sold and the
resulting proceeds used to pay the notes. This would apply to the sale of a
trainload of wheat, but what would that wheat be worth (if grown at all)
if it was not for the railroad to move it to the eastern market? Building and
operating a railroad means coal and iron mining, building and operating rolling
mills, building and operating lumber mills, building docks, and tunnels under
and bridges over rivers. All of these various matters are carried on by incorporated companies which must of necessity be financed by stocks and bonds.
These securities, therefore, within certain prescribed limitations, should be
honored as part of our economic and industrial life. If a man wants to buy
some stock or bonds and can contribute a fair proportion of the cost, say, 33%
per cent, and a banking house of good standing will also obligate itself and
the issuing company has a record of some prescribed standard, there certainly
should be no discrimination against the loan on the part of those whose business
it is to lend money. If paper of the class referred to is not regarded as desirable as that given for the sale of merchandise, let the interest in it be at a
higher rate. This, I understand, is the position taken by the Bank of England.
There are about 25,000 commercial banks in the country, only about one-third
of which are members of the Federal system. Numerous banks have relinquished their membership. Because of the failure of the Federal reserve banks
properly to meet the ordinary business needs of the country, the tendency is
to change to, or remain under, State supervision. Under these circumstances,
should not something be done to bring the practice of the reserve banks into
harmony with the requirements of business as it is properly conducted by the
vast majority of the banks of the country?
Mr. Owen D. Young has recently recommended that all of the commercial
banks of the country be placed under national authority. The writer wishes
unqualifiedly to indorse this proposal.
Section 3 : The Federal reserve banks were instituted for the purpose of
assisting and backing up the banks of the country in their ordinary operations,
carried on for the benefit of the general business interests of the country.
One of these activities consisted in giving immediate credit for out-of-town
checks issued by makers of supposed good standing and indorsed and deposited
by the depositors of the bank of whose financial strength and standing the
bank was well informed.
In collecting all of such checks there are two principal items of expense:
the loss of time involved and the express charges on possibly 10 per cent of
the amount which might have to be shipped in currency to balance the outgoing and incoming currency at any particular point. These charges are
inherent and must be provided for. The Federal reserve banks have seen
fit to assume the express charge mentioned, but if under obligations to assume
the one item it would seem logically to be under obligations to assume the other.
One authority states the objection to giving immediate credit is that such
a policy would/" involve inflationary consequences." This I will admit if
instead of " consequences " the word was " possibilities." It should be remembered that the principal reason for the creation of the Federal reserve banks
was that the assets in the vaults of the commercial banks of the country
which were " frozen " in the shape of unavailable receivables might be thawed
out and enter into the general flow of currency, if special demand arose.
When the banks of the country w^ere prevented by the ruling of the Reserve
banks from making daily use of their out-of-town checks as they had been accustomed to do, their assets to that extent were " frozen " and taken from general
circulation. By the immediate credit for the out-of-town check the member
banks would need to borrow just so much less from the reserve banks, therefore,
the action now advocated would only to a limited extent involve " inflationary
It is held not sound practice to give immediate credit on out-of-town checks,
the reason being that to do so would result in inflation. To a limited extent
this may be true, but a far greater amount of inflation is produced and encouraged by wholesaling credit. Federal reserve banks lending at a low rate of
interest so that banks borrow and reloan at a higher rate, pocketing the profits.
Dealing in credit on this basis is somewhat like straining at a gnat and
swallowing a camel.
If a carload of merchandise, wheat, corn, pork, potatoes, or cotton were sold
on three months credit the resulting instruments, bills payable, would be welcomed by the reserve banks, but if an instrument of credit called a check, payable on presentation, is offered for credit the member banks are refused the



accommodation, although both instruments in point of strength and purpose
for which issued are identical.
Mr. Paul M. Warburg in his recent work suggests that the reserve banks
should give immediate credit for transit items, charging, however, for the loss
of time involved.
In their work, Banking and Business, H. Parker Willis, professor of banking
of Columbia University, former secretary of the Federal Reserve Board, and
George W. Edwards, professor of banking, New York University, say: " Country
items are credited to the account of the depositors at once although their collection and ultimate payment may not take place for some time, owing to the
fact that the instruments are drawn on banks situated outside of the immediate

In an article on the subject, published in 1919, the writer said, " The out-oftown check seems to be looked upon as an excrescence on sound banking, as
something that can scarcely be got rid of, which is to be considered to a certain
extent discreditable."
As a matter of fact, checks, both local and foreign, are the lifeblood of our
business existence. They are entitled to high standing and deserve to be honored as making for greater progress and facility in business. One might almost
say that their circulation should no more be impeded in the arteries of trade
than should the circulation of the blood be impeded in the human system.
Nearly 100 years ago, Daniel Webster said, " All bills of exchange, all notes
running upon time, as well as the paper circulation of the banks, belong to the
system of commercial credit. They are parts of one great whole. We should
protect this system with increasing watchfulness, taking care, on the one hand,
to give it full and fair play, and on the other, to guard it against dangerous
In this I think all authorities on the subject will agree. If Webster was right
and his term " bill of exchange " includes the modern check it seems to me that
the logical and inevitable conclusion is that the Federal reserve system, if it
attempts to handle the out-of-town check of the country on a large scale, should
discount or buy the checks and so facilitate the business of the country.

[Filed with the subcommittee of the Committee on Banking and Currency of the United
States as an exhibit to testimony]

To the Board of Directors of the Chamber of Commerce of the United States:
By action of your board the banking and currency committee of the chamber
was authorized to study, among other questions relating to banks and banking,
the necessity for changes in the Federal reserve act, and for changes in the
policies and practices of the Federal reserve system, as well as the problem
of securing a better integration of the credit structure of the United States.
Your committee has confined its studies to the Federal reserve system. It
found this subject to be of such scope and importance as to engross all of its
attention. It is recommended that the problem of better integration of our
credit structure, including the interrelationships of the national bank act with
the Federal reserve act, be made the subject of later chamber study.
Your committee became convinced in the course of its work that its report, to
be most useful, should deal with those features of policy and of operation of
the system that are permanent. It does not undertake to develop ephemeral
phases of situations passed or passing. Proposals for changes in policy or
practice, and current conditions, have been considered fundamentally in the
light of their long-time effects upon the system and upon the economic wellbeing of the country.
The report and certain auxiliary statements are the result of committee and
staff studies conducted for more than a year. In the course of our scrutiny of
the system we have considered, so far as we are informed, every criticism of it
and every current proposal for change in its policies or practices that might



have a bearing upon its normal functioning. These include statements in the
public prints, congressional hearings, proceedings of learned societies, and
resolutions and reports of bankers' associations and of other organized groups
dealing effectively with phases of our economic life.
A number of unpublished proposals for change in the system's policies and
methods were brought to our attention. Some of these, emanating from
thoughtful men with considerable knowledge of the situation, were not put
forward with a view to their immediate applicability. Such suggestions will
require continued study. Their authors agree that no far-sweeping changes
should be made when there are serious doubts as to their suitability to a system
that, as a growing organism, must be adapted carefully to our country's needs
as those needs actually develop.
A number of factual studies were prepared, as well as reviews of studies
made under other auspices. They have served as working documents and have
not been included in our report. Much of their content has been collected in
a series of eight supplementary statements which accompany this report. The
titles of these auxiliaries 3 indicate their scope :
I. The Rediscount Operations of the Reserve Banks.
II. The Open Market Operations of the Reserve Banks.
III. Guides to Reserve Credit Policies.
IV. The Structure and Control of the Reserve System.
V. Reserve Requirements for Reserve and Member Banks.
VI. Federal Reserve Notes and Other Currency.
VII. Membership of the Reserve System.
VIII. The Reserve Banks and the Use of Bank Credit by the Security Market.
Not all of the proposals studied by the committee are discussed in the
report. Many ideas relating to the structure of the system, the number of
reserve banks, rearrangement of district lines, and the existing district organization in general, were considered. Numerous suggestions for changes of almost
every conceivable sort have been given attention. A good many of them dealt
with details which were in harmony with or opposed to some general principle
agreed upon by the committee, and so were not given specific mention.
The report is devoted in the main to problems of fundamental interest and
The committee was assisted in the preparation of this report by a supplementary group of business men, bankers, economists, representatives of agriculture and labor, and Federal reserve officials, who met in advisory conference
to consider an earlier draft. Their contribution is gratefully acknowledged.
We believe that we have been able to reduce the field of controversies to a
comparatively small area, and we are gratified to have reached agreement
upon the content of our report.

Harry A. Wheeler, chairman, vice chairman of the board, the First National
Bank of Chicago, Chicago, 111.
Nathan Adams, president American Exchange National Bank, Dallas, Tex.
M. A. Arnold, president I^irst National Bank, Seattle, Wash.
J. W. Arrington, president Union Bleachery, Greenville, S. C.
Sewell L. Avery, president United States Gypsum Co., Chicago, 111.
Julius H. Barnes, president Barnes-Ames Co., New York City.
A. J. Brosseau, president Mack Trucks (Inc.), New York City.
Walter S. Bucklin, president National Shawmut Bank, Boston, Mass.
James E. Caldwell, president Fourth and First National Bank, Nashville,
Charles S. Calwell, president Corn Exchange National Bank & Trust Co.,
Philadelphia, Pa.
E. L. Carpenter, president Shevlin, Carpenter & Clarke Co., Minneapolis, Minn.
W. L. Clause, chairman of the board, Pittsburgh Plate Glass Co., Pittsburgh, Pa.
Thornton Cooke, president Columbia National Bank, Kansas City, Mo.
These auxiliary statements, prepared at the order of the committee, are primarily of
the nature of staff studies.



Frederick H. Ecker, president Metropolitan Life Insurance Co., New York
J. H. Frost, president Frost National Bank, San Antonio, Tex.
Hunter L. Gary, Theodore Gary & Co., Kansas City, Mo.
W. F. Gephart, vice president First National Bank in St. Louis, St. Louis, Mo.
Everett G. Griggs, president St. Paul & Tacoma Lumber Co., Tacoma, Wash.
Rudolph S. Hecht, president Hibernia Bank & Trust Co., New Orleans, La.
A. L. Humphrey, president Westinghouse Air Brake Co., Pittsburgh, Pa.
C. T. Jaffray, president Minneapolis, St. Paul & Sault Ste. Marie Railway Co.,
Minneapolis, Minn.
Fred I. Kent, director Bankers Trust Co., New York City.
William A. Law, president Penn Mutual Life Insurance Co., Philadelphia, Pa.
Murray D. Lincoln, executive secretary Ohio Farm Bureau Federation, Columbus, Ohio.
Charles E. Lobdell, formerly fiscal agent Federal Land & Intermediate Credit
Banks, Washington, D. C.
John G. Lonsdale, president Mercantile-Commerce Bank & Trust Co., St.
Louis, Mo.
James R. MacColl, president Lorraine Manufacturing Co., Pawtucket, R. I.
Robert F. Maddox, chairman of the executive committee First National Bank,
Atlanta, Ga.
W. S. McLucas, chairman of the board, Commerce Trust Co., Kansas City, Mo.
John M. Miller, jr., president First & Merchants National Bank, Richmond, Va.
F. C. Rand, president International Shoe Co., St. Louis, Mo.
George A. Ranney, vice president and treasurer International Harvester Co.,
Chicago, 111.
John J. Raskob, vice president E. I. du Pont de Nemours & Co., Wilmington, Del.
R. G. Rhett, president Peoples First National Bank, Charleston, S. C.
H. M. Robinson, chairman of the board, Security-First National Bank of Los
Angeles, Los Angeles, Calif.
Levi L. Rue, chairman of the board, Philadelphia National Bank, Philadelphia, Pa.
J. T. Scott, president First National Bank, Houston, Tex.
Paul Shoup, president Southern Pacific Co., San Francisco, Calif.
Frank L. Stevens, president Stevens & Thompson Paper Co., North Hoosick,
Philip Stockton, president Old Colony Trust Co., Boston, Mass.
Henry B. Wilcox, vice chairman of the board, Merchants National Bank, Baltimore, Md.
Daniel G. Wing, chairman of the board, the First National Bank of Boston,
Boston, Mass.
Theodore Wold, vice president Northwestern National Bank, Minneapolis,
Matthew Woll, president International Photo-Engravers Union of North America, Chicago, 111.
Moorhead Wright, president Union Trust Co., Little Rock, Ark.
NOTS.—Mr. Chellis A. Austin, the late president of the Equitable Trust Co. of New
York City, Mr. Charles A. Hinseh, the late president of the Fifth-Third Union Trust Co.
of Cincinnati, Ohio, and Mr. Theodore F. Merseles, the late president of Johns-Manville
Corporation, New York City, were also members of the committee and signed the report.
Their contributions to this report are gratefully acknowledged.

The record of the Federal reserve system has so far met with public approval
as to induce legislation extending the charters of the Federal reserve banks for
an indeterminate period. This favorable public sentiment should discourage
constant legislative action with respect to the system's basic and fundamental
The Federal reserve system is not a borrowed scheme of central banking, but
a distinctive American institution wrought out of our own financial experience
and especially adapted to the business and banking requirements of the United
We express confidence in the usefulness of the system. Inaugurated at the
beginning of the World War it was called upon within a short period to deal



with situations of the utmost gravity. It met admirably the trying tests of
those times, earning a record of distinguished - service.
In the postwar peridd of tremendous credit expansion it was prevented by
the fiscal policies of our Government, reflected in the dominating influences of
the Treasury, from imposing early effective checks upon inflationary uses of
credit. Nevertheless, in the ensuing price decline of 1920 and 1921 the system
demonstrated its ability to avert the development of a threatening financial
Throughout the searching times of war and of world economic reconstruction
the system has been a bulwark of strength for the United States and a helpful
influence in the financial stabilization programs of other countries.
The system's short history can be divided into three parts. As stated, in its
early formative years—the first four—it operated under the influence of actual
hostilities, and in postwar years—the second four—it labored in the unsettled
economic situation that was the aftermath of the Great War. It is only in
recent years—the past seven—that under more normal conditions its operations
permit of accurate approximation of its utility in times of peace.
We believe the system possesses these definite values:
It provides a system of mobilized bank reserves, reinforcing the credit structure of the country and increasing the ability of banks to care for credit needs.
It supplies a sound, elastic system of currency.
It serves to avert the danger of money panics.
It safeguards gold movements; it protects the gold reserve of the country and
regulates its employment as a base for credit extension.
It increases the supply and general availability of credit for agricultural and
commercial purposes and checks extreme and frequent fluctuation in the cost of
such credit.
It improves the facilities for maintaining our banking resources in a liquid
It establishes an almost universal system of par payment of checks, increasing the usefulness of the check as our principal medium of exchange, and
practically eliminating a former heavy toll on business.
It improves our credit facilities for the orderly marketing of farm crops.
It aids in the financing of our foreign and domestic trade by developing a
discount market for acceptances and by stimulating the world use of dollar
It is helpfully related to the maintenance of the gold standard abroad, thereby
reducing trade risks from unstabilized currencies and rapidly fluctuating
It supplies the financial institutions of the country with the means of cooperating more effectively to meet future exigencies of our national interests at
home and abroad.
Prior to 1914, this country had had no recent experience in the field of central
banking. It was not then certain whether the new system would succeed in
attracting from more gainful private callings able men who would devote themselves wholeheartedly to the special problems of reserve banking.
The history of the reserve system records many instances of personal sacrifice
by men of influence and capacity who have become members of its governing
bodies. The continuation of this devotion and energetic enthusiasm is quite
as important for the future welfare of the system as any alteration in its
structure or methods of operation.
Timely modifications in the Federal reserve act and in the administrative
policies of the system, however, will continue to be necessary. With the changing requirements of our domestic business and the increasing influence of our
country in international trade and finance, new responsibilities will thrust
themselves upon the Federal Reserve Board, the regional banks, and member
The system must be subjected to periodic review by those who have an
understanding of its values and a sympathetic appreciation of the complexity
of the problems with which it deals. If friendly and constructive critics do
not devote attention to perfecting the credit structure, it will be dinicult to
meet radical proposals of a harmful nature or well-meant but mistaken efforts
to divert the system from its proper course.
The prime essential is the development by the American business public of a
sober and sympathetic spirit of criticism of the policies of the system. It is in
furtherance of this purpose that we submit our reports.



(The auxiliary statement upon Reserve Requirements for Reserve and Member Banks, No. V, and the one upon Federal Reserve Notes and Other Currency,
No. VI, develop this subject in somewhat greater detail.)
The Federal reserve system is not a central bank, yet its fundamental operations are in the field of central and not of ordinary banking. It is designed
to supplement the credit distribution activities of ordinary banks that deal
directly with the public and depend upon profits. It is charged with a primary
responsibility to which, if necessary, every other consideration should be
subordinated, viz, the maintenance of the currency and credit structure firmly
upon an adequate foundation of gold. In general, as a reserve or supplementary
credit institution, it must seek to exert a steadying influence upon the money
market and upon the course of industry.
Such an agency must be endowed with ample powers of credit and currency
expansion and contraction. The possession of such powers imposes a measure of
responsibility which can be discharged successfully only by an experienced
and politically independent management. The extent to which such powers
of a central banking agency must be hedged about by legal limitations, in contrast with those self-imposed by its management, is the first problem of legislative action.
The statutory restrictions that are imposed upon the lending powers of the
system have to do principally with the reserves required of the reserve banks
themselves, with the reserves required of member banks, and with the issue
of Federal reserve notes.
The reserve which each of our regional reserve banks is required to keep behind
its liabilities limits the total amount of reserve credit which it can supply
upon the basis of a given amount of gold or other reserve money; the reserve
which each member bank must carry with the regional reserve bank furnishes
substantially all of the cash resources of the reserve banks; and, finally, note
• issue provisions determine the extent to which currency demands may be satisfied without the issuance of the kinds of money which would reduce reserves.
Even those who advocate further restrictions upon the lending power of
the Federal reserve banks are not concerned over the first of these statutory
limitations—the reserves that the 12 regional banks must maintain against
Federal reserve notes and against deposits. In recent years these reserve
resources for the most part have been well in excess of the legal minima of
40 per cent against Federal reserve notes and 35 per cent against deposits.
Throughout this period it would have taken a rather drastic increase in the
required reserve percentage to have imposed any serious check upon the lending
powers of the reserve banks.

There are proposals, however, for changes in the legislative provisions applicable to the reserves that must be maintained by member banks and for alterations in the character of the reserves behind note issues. These have as their
purpose the restriction of the credit powers of the reserve banks. One such
recent legislative proposal provided that a member bank might keep 40 per
cent of its legal reserve in cash in its own vault instead of the present requirement that the entire legal reserve be maintained with its regional Federal
reserve bank. The proposal also would prohibit the issuance of Federal reserve
notes against gold or against acceptances purchased in the open market. It
would rescind, moreover, the provision that gold serving as collateral for
Federal reserve notes may also be counted by a reserve bank as a part of its
required reserve. Another suggestion of an even more drastic character is that
Federal reserve notes should be issued only against the collateral of paper
obtained by discount.
In general, these and somewhat similar suggestions seem to assume that it
is possible to gauge in advance the exact amount of lending power that reserve
banks may require at any time. They overlook the fact that the need for
reserve credit is subject to wide and unforeseeable variations. The reserve
banks must be provided with wide powers and large resources, and it is not
a matter of great consequence if at times these are even materially in excess
of requirements. There is no evidence in recent experience that the policies



of the reserve banks, or their effects, would have been essentially different
if a smaller volume of resources had been at their disposal.
The extent to which the Federal reserve banks' lending powers would be
lessened, by permitting member banks to keep 40 per cent of their reserves
in their own vaults, would depend upon the amounts member banks actually
would withdraw from the reserve banks. Nearly a billion dollars could be
withdrawn. Any such decrease of the lending powers of the reserve banks
would be undesirable. It is doubtful, however, whether in practice any large
amount would be withdrawn, and, therefore, whether the lending power of the
banks would be materially affected. Regardless of the effect upon the lending
powers of the reserve banks, this proposal does not recommend itself as a
matter of principle. Even if there were no material withdrawal from the
reserve banks, there nevertheless would be an expansion of the lending power
of the member banks resulting from the permission to count a considerable
portion of their cash in vault as reserve. The desirability of such an increase
in their lending power is questioned later in Section III, which deals with the
reserve requirements placed upon member banks.

The proposal that Federal reserve notes should be issued only against the
collateral of paper obtained by rediscounting is made in an effort to devise a
means whereby note issues would expand and contract automatically with the
needs of trade as evidenced by changes in holdings of discountable paper. This
proposal rests upon a misconception which has persisted from the date of the
enactment of the Federal reserve act. What bankers will do with the proceeds
of a rediscount customarily has no relation to the collateral they offer reserve
banks. Member banks borrow because of reserve deficiencies which result from
their operations of every character and because of the demand depositors make
upon their balances. Applications for additional credit by member banks may
arise because of operations which are not necessarily advantageous to the
community. The supply of eligible paper is always sufficient to permit an enormous increase in the volume of credit if it is employed as a basis of rediscount
at the reserve banks. The Federal Reserve Board can affect the supply, moreover, by the exercise of its power to define the character of paper eligible for
rediscount, within the meaning of the act.
On October 4, 1929, according to the latest estimate made by the Federal
Reserve Board, member banks held $4,598,000,000 of eligible paper. Since on
that date the Federal reserve banks' holdings of rediscounted bills amounted
to around a billion dollars, member banks, by the use of all eligible paper which
they possessed, could have increased their rediscounts about four and a half
times. It is true that the volume of eligible paper automatically increases in
periods of business activity and rising prices. So, too, does its employment by
member banks as a basis of accommodation at reserve banks. Because it is
precisely at such times that restrictions upon the use of reserve credit may
be necessary to prevent the development of unsound conditions, the eligibility
principle can not be depended upon either to impose a satisfactory limitation
upon the aggregate supply of reserve credit or to insure wise use of the credit


As a further means of restricting the powers of the reserve banks there has
been advocacy also of the proposal to eliminate as a basis of Federal reserve
note issues those bankers' acceptances that are purchased by reserve banks.
Bankers' acceptances, when acquired by the reserve banks either through rediscount or through purchase in the open market, are now legal collateral for
such note issues. The effect of the change would be to restrict the paper collateral of Federal reserve note issues to that obtained by meeting the discount
applications of member banks. This change is supported by some on the theory
that the real need for currency is better represented by member bank demands
than by reserve bank decisions to purchase or not to purchase such acceptances.



Aside from the impossibility of employing eligibility tests to control properly
the activities of the reserve banks, this proposal is objectionable because individual reserve banks on certain occasions may find themselves inadequately
supplied with rediscounted paper to secure their note issues. Reserve banks
located in the agricultural sections of the West and South are not in a position
to secure more rediscounting in their own districts by sales of bills and securities. Since these sales must be made in the larger money centers, any increase
in the volume of rediscounts that might result from sales would be in those
centers and not in their own districts. Thus the proposal would restrict the
•note-issuing powers of some interior reserve banks undesirably with respect to
those enjoyed by reserve banks operating in the money centers. The bankers'
hills, moreover, obtained by purchase are just as commercial in character as
rediscounted paper.

Another restriction that some favor wTould prohibit the issue of Federal
reserve notes in exchange for gold. The public's currency demands are to-day
served efficiently and to an important extent by issuance of Federal reserve
notes. As the proposal to restrict these notes to the amount of rediscounted
paper would reduce the volume of this form of money, it would be necessary
to make good the deficiency by the issuance of money of another form. The
effect would be to supplant about a billion of Federal reserve notes with a
billion of gold certificates. This would reduce the reserve ratio materially, and
thus decrease the lending powers of the reserve banks.
We do not believe that it is possible to insure the wise use of reserve credit
either through restricting by legislation the resources of the reserve banks or
through concentrating attention upon special regulations of Federal reserve
note issues. The precise adaptation of the volume of reserve credit to the
needs of business is the problem of administration rather than of law. No automatically operating statute can be substituted in this particular for prudent
judgment and discretion. The reserve administration is acquiring by experience an art and technique that will produce more definite and continuous
progress than prescription by the legislative body. The reserve administration
should be encouraged to build upon its experience, retaining those policies and
practices which prove successful, discarding those which are fruitless, and
thus continuously developing improvement.
This committee concludes that—
1. I t is not a matter of great consequence if the credit powers and resources
of the reserve banks are at times even materially in excess of immediate
2. As the future needs for reserve credit and currency can not be definitely
foretold, it is desirable that reserve banks possess ample powers of credit and
currency expansion to insure the largest measure of serviceability, especially
in any periods of strain.
3. The precise adaptation of the volume of reserve credit in all its forms,
including note issues, to the requirements of trade is a problem of administrative rather than of legislative control.
4. No changes should be made in the provisions of the Federal reserve act
relating to the issue of Federal reserve notes or to the reserve requirements,
pertaining to reserve banks or to member banks, solely for the purpose of
restricting the lending powers of the reserve banks.


(An auxiliary statement upon Reserve Requirements for the Reserve and
Member Banks, No. V, develops this subject in somewhat greater detail.)
An important legal restriction upon the lending powers of member banks
of the Federal reserve system is the statutory requirement of prescribed
reserves. Changes in the legal reserve requirements would affect either the
total volume of credit the member banks can extend or the relative credit
granting powers of the different classes of such banks. The desirability of
encouraging an expansion in the aggregate volume of member bank credit
by means of a general reduction in reserve requirements depends upon the
need of business for more abundant supplies of credit. No general reduction



on this account seems necessary. But rearrangement of reserve schedules as
they apply to different classes of member banks could iron out some existing
discrepancies and permit of more scientific definition of the kinds of deposits
upon which their reserves are based.
This committee does not believe that general reductions in reserve requirements, whether initiated by direct or indirect means, should be considered.The resulting increase in lending powers of member banks would not coincide,
save by accident, with any need of business for more credit. Once the country
has become adjusted to certain reserve requirements it is undesirable to subject
them to serious and sudden alteration. The extent to which such reduction
would benefit the average bank may also be questioned. The increased lending
power thereby acquired by any one bank would be offset to some extent at least
by the intensified competition of other banks whose lending powers similarly
would be increased. It should be remembered, too, that reserve percentages
are now much less than they were prior to the enactment of the Federal reserve
act. In 1913, national banks in central reserve cities and reserve cities were
required to maintain a reserve of 25 per cent against total deposits, grouping:
demand and time deposits, and " country " national banks, 15 per cent. Now,
as member banks, the requirement for these three classes of banks, are respectively, 13 per cent, 10 per cent, and 7 per cent against demand deposits, and
3 per cent against time deposits.
The committee has given consideration to a number of proposals which
have been advanced, designed to remove the inequalities which now exist
between the different classes of banks as regards reserve requirements.
Some of these proposals merit approval. Suggestions for change are not put
forward with any idea that all the present inequalities of member bank reserves
will be removed thereby. While recommending a few changes in the direction
of equalizing the burden as between different classes of banks, the committee
is convinced that a legislative revision of this section of the Federal reserve
act, based upon recommendations from within the system itself, will be found
to be desirable. In their review of needed changes, the officials of the system
should take into account such changes as those advanced by the Association
of Reserve City Bankers and others who have studied this problem.
Because this committee does not believe general reductions in reserve requirements should be made, it does not favor the proposal that vault money should
be counted as a part of the legal reserves of member banks. On December
31, 1928, the vault cash of member banks exceeded half a billion dollars, and
the counting of any considerable portion of this amount as reserve would be
likely to lead to a large and sudden increase in the volume of member bank
Nevertheless, the present method of treating vault money does not make sufficient allowance to a certain class of banks, mainly rural banks, for the larger
vault cash reserves they are obliged to carry. Banks that are remote from
Federal reserve banks or branches can not employ in obtaining currency the
" wheelbarrow " method of the more accessible banks.
It thus happens that on December 31, 1928, member banks in the reserve and
central reserve cities held as cash in vault an amount equal to less than 2 per
cent of their demand deposit liabilities, whereas on the same date all country
bank members held cash in vault to an amount equal to 5 per cent of their
demand deposit liabilities.
The practice of not counting cash in vault as reserve, dating from the amendment of June 21, 1917, has been realized upon by city banks to a much greater
extent than by those outside of reserve and central reserve cities.
To lessen this handicap upon the banks, desginated in the Federal reserve
system as " country " banks, this committee recommends that member banks
be permitted to deduct cash in vault from demand deposits in computing their
required reserves. This deduction would only reduce the aggregate required)
reserves by about $50,000,000. It would afford some relief to country banks,,
and yet would not lead to any such violent expansion in the lending powers of
member banks as would be induced by counting cash in vault as legal reserve.
There is another respect in which country banks are handicapped in the computation of reserve requirements. At the present time in determining their net
deposit liabilities requiring reserve member banks must include the net amounts
that are due to other banks. When banks have amounts due from other banks
they may subtract these amounts from those they owe to other banks. In cases,
however, where the " due from " items exceed the " due to " items there is na



way under present law by which banks can be given credit for the excess. The
class of banks which are most handicapped, namely, those which in balance with
other banks are usually creditors, is again composed mainly of country banks.

In determining net deposits requiring reserve this committee believes a bank
with a net amount due from other banks should be permitted to set off this
amount against its demand deposit liabilities. It is therefore urged that, in the
computation of net demand deposit liabilities, banks should be permitted to
deduct from gross demand deposits the net amount due on demand from other
On the other hand, there is a liability incurred by some country banks which,
in the judgment of the committee, might well be subjected to an increase in
reserve requirements. Some country banks, although this is not the usual situation, acquire large balances from other banks just as do the larger city institutions. The possession of such deposits is one of the principal reasons why
city banks have been subjected to somewhat higher reserve requirements than
those imposed upon country banks. The situation will be roughly equalized if
that portion of the liabilities of country banks that consists of net balances
" due to other banks " is subjected to a 10 per cent reserve requirement rather
than to the 7 per cent requirement now enforced against it and other demand
deposit liabilities.
1. The committee concludes that, based on the recommendations of administrative officials of the reserve system, there should be a legislative revision of
those provisions of the Federal reserve act relating to member bank reserves.
2. The committee favors revision of reserve requirements to:
a. Permit member banks to deduct cash in vault from demand deposits.
h. Permit member banks having net balances due from other banks to deduct
items " due on demand from other banks " from gross demand deposits.
c. Require country member banks to maintain a 10 per cent reserve against
net deposits due to other banks.
3. The committee is not in favor of general reductions in reserves required
of member banks:
a. Secured by permitting member banks to count cash in vault as legal
b. Intended solely for the purpose of lowering the lending powers of reserve
o. Intended solely for the purpose of increasing the lending powers of member


(An auxiliary statement upon Membership of the Reserve System, No. VII,
develops this subject in somewhat greater detail.)
There are about 26,000 banks in the United States. Approximately one-third
of them belong to the Federal reserve system, embracing all the national banks—
nearly 7,500—as compulsory members and almost 1,200 State banks as voluntary members..
Of the 17,000 or more nonmember State banks, it is estimated that about
10,000 comply with the technical requirement for membership that they possess
present or prospective capital of not less than $25,000, or somewhat larger capital if located in cities or towns with populations of more than 3,000. In order,
liowever, to become members they must also meet the test of examination and
approval by the Federal Reserve Board, which would bar some.
It is evident that in number the outside institutions that might apply for
membership in the system exceed the present membership. Many of these do
not become members because the reserve requirements of State law are frequently less burdensome than would be the reserve requirements attendant upon
membership in the Federal reserve system. It is generally agreed that it would
he necessary to make considerable modifications in present law and in methods
of reserve-bank operation in order to attract quickly into the system any large
number of nonmember banks. The essential question is the intensity of any
need for a larger membership in the system.




From the point of view of the resources of the reserve banks no additional
membership is now urgently required. Member banks possessed on June 30, 1929,
according to the latest available official figures, over 60 per cent of the capital
and surplus of all banks of the country and a like percentage of deposits and of
total resources. The approximately 1,200 State-bank members control about
two-fifths of all State-bank resources. The resources of the reserve banks are
more than sufficient to meet any demands upon them. Membership is sufficiently
distributed to enable reserve banks to furnish the needed volume of reserve
credit in every section of the country.
It is not necessary for all banks to belong to the system in order that credit
released by the reserve banks shall flow to their localities. By indirect processes,
such as by borrowing from correspondent banks and by receiving on deposit
funds emanating from other communities, nonmember banks participate in
credit extended to member banks. Despite various frictions and obstructions,
an excess of credit in one part of the country tends to flow toward localities
where there exists any intense demand.
The Federal reserve banks have clone much among their members toward
improving bank standards. Many nonmember banks undoubtedly would gain
through more direct contact with the reserve banks. Additions to membership
are desirable in so far as they would enable particular banks to serve their
communities more effectively and to the extent that they would lessen failure
hazards. While statistics of bank failures over the past few years, particularly
those relating to smaller banks, do not indicate that membership in the system
is a guaranty against failure, nevertheless the reserve system possesses great
potentialities for enhancing member-bank strength and solvency. When, and if,
these are realized to the full and the legend " Member of the Federal reserve
system" becomes all over the country an unfailing and recognized badge of
merit with real meaning, an increase in membership will follow.
Universal membership might bring gains in the better integration of the
credit structure of the country. But there is error in thinking that because
the system has merit it must be directly shared by all. The addition of small,
comparatively weak banks would injure rather than help the system. Many
institutions, however, could be inducted into membership with mutual benefit
to them and the system.
The membership problem is more serious when thought is directed to the
retention of the present number of members. Any scattered withdrawal might
seriously interfere with the ability of the reserve banks to serve various communities, and if those withdrawals should reach large proportions they would
tend to restrict the resources of the reserve banks to an undesirable extent.
The proposal which is sometimes made to place membership in the system upon
a voluntary basis for national banks does not seem advisable to this committee.
Under such an arrangement it is to be feared that the management of the
reserve banks might be subjected to undue pressure in the determination of
policies by threat of numerous withdrawals.
It is unlikely that for any long period of time membership in the reserve
system will be stationary. Either the reserve system will be adjudged to be so
necessary and salutary that its influence will increase or its prestige must
gradually weaken. A continuous, even, though slow, drift away from membership would develop anxieties on the part of the reserve administration and tend
to bring about a general lowering of standards. From this point of view it is
highly important that membership in the system should prove satisfactory to
members and serve to strengthen and render them more safe. The pass.age of
the McFadden-Pepper Act, making continuance in the national banking and
Federal reserve system more attractive to banks, was a move in the right direction. In furtherance of the purpose which that statute was designed to serve,
there should be a serious effort to clear up in a satisfactory fashion the uncertainty which has arisen in many States and is reflected in the recent decision
of the Supreme Court of the United States in a Massachusetts case concerning
the continuance by a national bank of the fiduciary relationship enjoyed by a
State bank which merges or consolidates with the national bank.
The most hopeful means, however, of preventing a serious number of withdrawals would seem to be through developing a solvency record for member
institutions that will be conspicuously superior to that of nonmember banks.



Hut even though principal reliance must be reposed in the gradual heightening
of the solvency of member banks, no sound means should be overlooked of making membership more acceptable to the banks of the country. Changes in the
law and concessions in administrative procedure should be made wherever they
would attract a larger membership and would involve no sacrifice of strength of
either the reserve or member banks. From this point of view attention is
directed to proposals t o :
a. Effect certain changes in the reserve requirements of member banks.
&. Pay interest on reserve balances.
c. Enable member banks to participate to a larger extent in the earnings of
reserve banks.

In the preceding section of this report certain changes in reserve requirements
are recommended for the purpose of removing some of the handicaps under
which some member banks labor in computing reserves.

The second proposal—namely, that interest be paid on reserve balances—
would be in accord with a practice of long standing before the system was
established. Nonmember banks to-day are permitted in most States to carry
some reserves on interest with other banks, while member banks must place
all of their required reserves with the reserve banks, which pay no interest.
No method has been proposed, however, by which interest could be safely
offered by reserve banks upon a member's balance. On January 2, 1929, member
banks' reserve accounts were nearly two and a half billions of dollars. Two
per cent interest on this sum would amount to almost $50,000,000. In 1927,
after meeting dividend and surplus requirements, the net earnings paid to the
Government as a franchise tax amounted to only $249,591 and for 1928 to only
$2,584,659. Thus it is seen that the interest which could have been paid upon
reserve balances is almost negligible. In 1928, for instance, only one-tenth of
1 per cent could have been so paid. In rejecting the interest-payment proposal
this committee calls attention to the fact that by the reserve act reserve percentages have been reduced by amounts calculated to be sufficient to offset the
loss of interest which was earned on reserve balances when carried with other

But even though the reserve banks can not safely be subjected to the obligatory charge of paying interest on balances, they might well be required to meet
the lesser obligations of sharing surplus earnings, in years when there are such,
with member banks. This committee believes that the reasons for limiting
dividends on stock holdings in reserve banks to 6 per cent are no longer
With the experience which has been gained in reserve operation, reserve banks
will not be expected to deviate from sound procedure in order merely to enlarge
earnings. The principle should be recognized, however, that such earnings as
do result from reserve bank operations should benefit the stockholding member
banks which contribute to the reserve bank capital and make the earnings possible. The system was set up to improve the ability of its members to serve
the public. From them its resources were dra.wn. It would be well if some
practicable means could be devised for distributing the net profits of reserve
banks in larger part to member banks instead of paying them, after present
dividend and surplus requirements, entirely to the Government as a franchise
tax. The committee supports this in principle and does not believe that the
adoption of some such method of distribution would result in too great an emphasis upon earnings.
It should be remembered that future reserve operations may require large
development of the reserve banks' open market dealings. Member banks which
may meet, even to a slight extent, competition on this account from reserve
banks have a right to share in the profits derived in part from these operations.



Even though the monetary return be small, the principle is thought to be important.
Consideration has been given to the " free services " which are performed by
Federal reserve banks for their members. It is our opinion that the authorities
of the system might do well to review carefully this situation, especially as it
concerns the collection of " noncash " items. It is recognized that there are
two possible viewpoints in connection with this question. Even though such a
service as the free collection of " noncash " items by the Federal reserve banks
cuts into the earnings of some member banks, it may perhaps be justified from
the angle of service to commerce and industry, and to other member banks differently situated. Generally, the committee believes that care must be exercised
in the development of any free services lest they encroach unduly upon the
proper field of activity of member banks to the eventual detriment of the system.
This committee further believes that annual meetings of stockholders, which
have been held in some districts, may well be adopted throughout the system
as a means of developing mutual understanding of reserve and member-bank
One inadvertence in the McFadden-Pepper Act, prejudicial to member State
banks, should be corrected. The language of that act denies to member State
banks the privilege of establishing branches in foreign countries and in dependencies or insular possessions of the United States. Foreign branches of national
banks are expressly exempted from the branch-banking restrictions of the act.
There should be no discrimination against State member banks in this respect.
The Federal Reserve Board has recommended that the reserve act be amended
to cover this discrepancy. This recommendation should be made effective.
The committee calls attention to one factor which has operated to keep some
State banks out of the system. Reserve requirements of State law have been
liberalized without the same justification which led to the lessening of the reserve burden upon members. The suggestion is made that the reserve percentages of State law in some of the States might well be raised, as respects nonmember banks. On the other hand, there are States in which reserve requirements are an obstacle to membership, because a State bank upon becoming a
member must still comply with the reserve requirements of the State and also
with those of the reserve system. It is desirable in all States that legislation respecting reserves should include the acceptance of reserve requirements for
member banks as complying with State standards.
As stated, the principal hope of increasing the membership of the reserve
banks must be reposed in an endeavor to establish a superior solvency and
management record for member institutions. If the percentage of member
bank failures in the last five years had been conspicuously smaller than those
of nonmember banks, similar in size and geographical location, the greater confidence of depositors would operate to bring into the system virtually every
desirable nonmember bank.
In efforts to increase membership the reserve banks could well afford to establish the policy of periodical visitation upon desirable nonmember banks by officers and staff detailed for this purpose. Similar visits to member banks would
serve to tie them closer, and develop a better cooperation and understanding.
This committee concludes that:
1. Without lowering membership standards, a larger membership in the
reserve system should be sought in order to enable the reserve banks to serve
various communities more effectively, to safeguard the reserve system against
loss of influence on account of future withdrawals, and to encourage improvements in banking standards.
2. Reserve banks should not pay interest on member banks' reserve balances.
3. The system should now be permitted to distribute its profits in larger part
to member banks instead of paying them, after present dividend and surplus
requirements, entirely to the Government as a franchise tax.
4. Free services rendered by Federal reserve banks such as the collection of
" noncash items " and safekeeping of securities should be developed with care
lest the reserve banks encroach unduly upon the province and functions of
member banks.
5. The reserve banks should exert every effort to establish a superior solvency
and management record for member banks.
34718—31—PT 5



(An auxiliary statement upon the Rediscount Operations of the Reserve
Banks, No. I, and another upon the Open Market Operations of the Reserve
Banks, No. II, develop the subject of lending operations in somewhat greater
Reserve credit may come into use either as a result of the initiative of
member banks or as a result of reserve bank discretion.
When the initiative proceeds from member banks, or other financial institutions, the operation will take the form of a rediscount or of a sale of acceptances
or in some cases of a sale of Government securities to the reserve banks. When
reserve banks are prompted by their own discretion to increase the volume of
reserve credit, there is on occasions but a single means of practical effect, viz,
the purchase of Government securities in the open market.
In any consideration of the inability of the reserve banks to depend upon
rediscount rate changes to secure the proper adjustment of the volume of
reserve credit, it will be serviceable to classify the occasions which lead member
banks to apply for rediscount accommodations. Aside from periods of general
financial strain, member banks resort to reserve banks to meet occasional deficiencies in reserve; to take care of seasonal peak requirements of somewhat
longer duration; ti relieve sporadic local difficulties such as crop failures; and
finally, in some cases, to secure enlarged resources for more or less prolonged
It is commendable that both member banks and the management of the
reserve banks regard permanent borrowing as contrary to sound banking principles, and this is one of the reasons why it is not imperative that rediscount
rates of reserve banks should be regularly above current lending rates. The
persistency and extent of the indisposition of member banks to borrow continuously is one of the unexpected developments of the system's operations. On
account of this disinclination, open market operations conducted by reserve banks
become necessary if they are to discharge responsibility for providing the
country with the amount of reserve credit that may be deemed desirable. They
can not meet this responsibility merely by the adjustment of rediscount rates.
Nor would open-market operations confined to acceptances, thus excluding
Government securities, be sufficient.
This is not to imply that reserve banks' rates on rediscounts, as well as on
acceptances, do not exercise some influence upon the general volume of credit.
When rediscount rates are low, member banks which have borrowed to restore
temporary reserve deficiencies will not be under so heavy pressure to pay off
their reserve indebtedness quickly. In similar fashion low rates on acceptances
would encourage their sale to the reserve banks. But if rates on acceptances
should be well under other rates the reserve banks would come to hold such a
large volume of these bills that holdings by member banks and other investment agencies would become unimportant. Acceptance rates well under rediscount rates would lead member banks holding acceptances and desirous of
obtaining reserve accommodation to sell acceptances to the reserve banks
instead of to rediscount. Acceptance rates persistently or far below callmoney rates would lead member banks to invest surplus funds in the callmoney market instead of in bills.
Inasmuch as one reason for introducing the bank acceptance into the
country was to provide banks with an asset based upon commercial transactions, which would become an object of general demand, and thereby facilitate
the effective mobilization of surplus bank funds, wider use by member banks
of the bankers' acceptance as an item of investment should be encouraged.
Relatively high rates on acceptances would tend to discourage their original
creation. If the reserve banks should be unwilling to purchase these bills
except on costly terms, a situation might be created in which borrowers would
find it more advantageous to rely exclusively upon direct loans as a means of
meeting their requirements. With these limitations upon acceptance and rediscount rate changes, the reserve banks on occasions have been obliged to depend
very largely upon dealings in Government securities in order to alter in the
desired manner the outstanding volume of reserve credit.
Thus far in the system's history there has been an ample supply of Government securities available at all times for purchase in the event that the
reserve banks wanted to enter the market as buyers. Within the next 5 to 10



years it may be necessary to face the situation which will develop when the
outstanding issues are greatly lessened in amount by retirement and have
come to be more closely held by investors. The dependence to be placed upon
open-market operations in regulating the total amount of reserve credit may
then become less certain. Whether or not that development will bring with it
its own adjustment or whether some other forms of securities will have to be
admitted as eligible for purchase by the reserve banks is a matter of conjecture.
A material reduction in the volume of Government securities would have its
effect upon rediscounting practice as well as upon open-market operations. A
common and convenient method for securing Federal reserve funds is for a
member bank to submit its own note collateraled by Government securities.
As such securities become less abundant or less available, it will be necessary
for member banks when borrowing to offer paper eligible for rediscount or for
purchase. This possibility has led to a renewal of the suggestion that the
definition of eligibility should be so broadened as to make rediscountable with
the reserve banks' paper collateraled by stock exchange securities of high grade.
This proposal was made during the debate in Congress on the bill creating
the Federal reserve system. So definite was the feeling against it that the
act contained a prohibition against the discounting of notes, drafts, or bills
" covering merely investments or issued or drawn for the purpose of carrying
or trading in stocks, bonds, or other investment securities, except bonds and
notes of the Government of the United States." The renewal of the suggestion
is considered by this committee as untimely and unnecessary, certainly while
the present volume of eligible paper and of Government securities is available.
It should be recalled that the Federal Reserve Board possesses considerable
power within the limitations of the act to admit to the rediscount privilege
desirable kinds of paper. When and if the requirements of industry and
commerce make necessary an added volume of eligible paper or it is deemed
desirable in the interest of the smooth working of the system, eligibility regulations can probably be sufficiently broadened without an amendment to the
Federal reserve act.


It is sometimes contended that reserve credit extended by means of rediscount
operations meets the requirements of the country much more effectively than
reserve credit released by the reserve banks* open-market purchases. This contention is based upon the fact that rediscounts are made to banks situated in
every part of the country, whereas the bulk of the open-market operations,
both those made at the initiative of member banks as well as those conducted at
the discretion of the reserve banks, must be confined to the central money
markets of the country, and mainly to New York City. But owing to the fluidity
of credit, an increase in its volume at any one point tends to furnish additional funds to those parts of the country where there are additional demands.
The determination of which particular types of earning assets, whether rediscounts, acceptances, or Government securities, most effectively may be increased
or decreased is a matter of detail. The fundamental question is whether it is
desirable that more or less reserve credit be employed.

Open-market dealings in Government securities are frequently subjected to
the special objection that they bring the reserve banks into competition with
member banks and on occasions tend to ease money rates to such an extent as
to impair the profits of member banks. But these open-market operations of the
reserve banks would not and do not exert normally more than a limited influence upon the course of the money market. Lending rates, and in turn the
profits realized by banks, are primarily determined by far more fundamental
considerations, such as the volume of current savings seeking investment and
the demand coming from the business community for credit in all its forms.
A downward tendency of rates can be accelerated through these open-market
operations, but persistently low rates during a period of active business can
only be explained as an outcome of a continuing abundance of capital seeking
investment relative to available opportunities for its employment. Certainly



this was true when reserve bank operations were confined within narrow limits
as in some recent years.
In the determination of open-market policies the reserve banks should not
allow considerations of their own earnings or those of member banks to exert
a controlling influence. The possible unfavorable effect of these operations
upon the earnings of commercial banks is clearly a factor, but not of major
importance. Whenever the policies of the reserve banks, as well as more fundamental influences, are tending to bring about a general lowering of the cost of
credit to the business community, it should be recognized that both member and
nonmember banks are warranted in adjusting themselves to the situation by
the adoption of a more elastic policy with regard to the rates of interest they
pay to depositors.
The committee concludes that:
1. Rediscount rate changes alone can not at all times be relied upon to provide
the country with the desired volume of reserve credit.
2. Open-market operations are necessary and should be continued.
3. The recognized requirements of a bill market preclude the predominance
of the system indefinitely in this market, as would be the case if open-market
operations were confined to acceptances. The volume of acceptances, readily
available for purchase, moreover, would be so small in some periods as to
hamper the system's operations.
4. Dealings in Government securities, therefore, are required to supplement
the rediscount and acceptance activities of the reserve banks in order that the
total volume of reserve credit may be adjusted properly to the country's needs.
5. It is not imperative that the rediscount rates of reserve banks should be
continuously above the current lending rates for ordinary commercial transactions.
6. The inclusion of bonds, other than those of the United States Government,
as security for notes rediscounted by the reserve banks, is considered as untimely and unnecessary, certainly while the present volume of eligible paper
and of United States Government securities is available.

(An auxiliary statement upon Guides to Reserve Credit Policy, No. I l l , and
the one upon the Structure and Control of the Reserve System, No. IV, develop
this subject in somewhat greater detail.)
In devising rules for the regulation of the credit activities of the reserve
banks, limitations upon the power and influence which they can exercise are a
factor of major importance. The reserve banks have no direct contacts with
individual borrowers and aside from the discretionary power to insist that
rediscounts will not be granted unless the member bank is in sound condition—a
power which this committee believes should be exercised with even greater
frequency than in the past—the reserve banks are in large measure powerless
to determine the uses that member banks make of credit acquired from reserve
banks. Neither do the reserve banks exercise nearly as much discretion as is
customarily believed in determining which member banks are to obtain the
use of reserve credit. It is true that applications to rediscount or offers to
sell acceptances to the reserve banks may be accepted or rejected. Unless,
however, the bank requesting rediscounts is borrowing too extensively or continuously most of its applications will be accepted as a matter of routine, and
under their acceptance policy the reserve banks for many years took all prime
bills offered and still give the market some support.
Even the denial of an application can not prevent funds which emanate from
the reserve banks from tending to flow to communities where the demand is
greatest. By means of the purchase and sale of Government securities the
reserve banks can exercise some discretion regarding the total volume of their
credit emissions. But the distribution of these funds throughout the country
is determined by the operation of economic laws and financial customs and
herein the power of the reserve banks is decidedly restricted. The reserve
banks' influence is in high degree confined to determining the volume of reserve
credit which is to be released, and there are some situations in which even
their volume powers are subject to decided limitations. One such situation
wrould be that in which funds released by purchases of Government securities
would be employed to pay off rediscount indebtedness. Even when the reserve



banks are in the most favorable position as regards regulation of the volume
of reserve credit, it must still be remembered that reserve credit released is
merely supplementary to the supply directly within the control of the member
banks, and customarily gets into use through the initiative of private financial
It is further essential to recognize that, even if the reserve banks possessed
greater powers than they actually do over the activities of member banks, they
could not be held responsible for improper uses of credit. Nor can all of our
economic ills be cured by the credit policies of individual member banks. The
demand for bank credit springs from the initiative of customers and owing to
highly competitive banking conditions the banker can not exercise complete
control over every such demand. While the reserve banks may do much to
encourage the proper use of reserve credit by member institutions, their powers
are largely of a quantitative character. In employing reserve credit to supplement that of member banks the reserve banks are highly restricted by the
-general state of business and prevailing financial practices. It should not be
expected that the reserve banks can exercise such close supervision over the
member banks as to prevent unwise extension of credit by them. With the
member banks rests the primary obligation of conservative banking, and it
would not behoove them, if they contribute to credit overextension, to object
to the officials of the system pointing to the need for curtailment. There should
be no unreasonable expectation that the most ideally administered banking
system can overcome all misdirections of business enterprise.
The reserve banks were created to supplement and in a measure to regulate
the credit operations of their members to the end that business and commerce
might be more effectively served. It is, of course, true that as supplementary
institutions the reserve banks may make mistakes in their analyses of legitimate
credit needs. But legislative restrictions can not be depended upon to any
great extent to reduce or prevent such errors. Dependence must be reposed in
the discretion of prudent management, proceeding upon the basis of admittedly
sound principles.
The reserve banks should not be operated to derive maximum earnings. The
full and regular employment of their lending powers would not leave sufficient
reserve to cope with the very emergency situations with which they were
designed to deal. Such a practice would not contribute the desired steadying
influence upon the business situation. Fortunately, the idea that reserve banks
should be operated to produce large and regular earnings- is coming to be pretty
generally discredited. There is now widespread acceptance of the idea that
the reserve banks are service institutions; that they were not created for profit
making. In the early days of the system it appeared likely that some or all of
the reserve banks might have to operate at a loss over a period of years. This
possibility was viewed with equanimity by the founders. It developed, however,
that the banks derived large earnings as an incident to the necessary expansion
of their activities during the war years and those immediately snceeding.
Substantial surplus accounts were built up and the system thus fortified for
any period of little or no earnings. There is even less reason now than formerly
for any policy of earnings for earnings' sake. There should be no disposition
to test the ability of reserve bank management by the volume of earnings.
Fixing the rate of rediscount is a policy function which attracts considerable
public attention. Changes in the rediscount rates of the regional banks are
watched carefully. There are, of course, many factors entering into decisions
by the officials of the system with reference to changes in the Federal reserve
rediscount rate. The guides which are followed are numerous and those which
are major determinants at one time may play little or no part at another.

One question of general application which has emerged with,respect to the
rediscount rate is whether or not it should be uniform throughout the country.
Because the Federal Reserve Board's jurisdiction is nation-wide, any tendency
to establish similar rediscount schedules in the different districts operates to
increase the board's rate influence. If the principle is accepted that the cost
to member banks of securing reserve credit should be the same in one district
as in another, each district directorate is put in a position wherein local needs
may have to be subordinated to presumed national requirements. It is true,



of course, that the needs of the country as a single unit could be appraised by
the cooperative counsel of different district officers, but only the Federal Reserve
Board is endowed by statute with authority to speak for the whole system.
In recent years there may have been comparatively little need of setting up
different rate schedules in the various districts. As is stated in another part
of the report, member banks, since 1920, have been generally desirous of avoiding continuous indebtedness to the reserve banks. In this situation it has not
often appeared necessary to employ rate increases as a means of imposing
serious restraints upon the volume of rediscounts.
It is not certain, however, that the disinclination to rediscount will always
be as widespread as it has been, and occasions probably will arise in some
districts which will develop a special need of utilizing rate increases to restrict
the demand for reserve accommodation. In such a situation each district bank
should be reasonably free to act with respect to its own requirements, and it
should not be obliged to delay its rate increase until the need of rate increases
is generally experienced. The continuation of low rates in a period of active
rediscount demand might thrust upon the district directorates the responsibility
of making an embarrassingly large number of direct refusals.
No defense for a uniform rate schedule can be had by appealing to European
precedent. The area of the United States is substantially similar to that of
Europe, and there are many independently administered central banks in
Europe. If the map of the United States is superimposed upon Europe, with
San Francisco upon London, New York falls in Asia. Credit requirements may
necessitate as clearly differences in rediscount rate schedules between New York
and Minneapolis as between London and Rome.
Uniformly to subordinate local needs to supposed national considerations in
the absence of clear emergency is inconsistent with the theory of the regional
system. This committee disapproves of a policy favoring a single rate of
rediscount as a principle of reserve system operation.

A second question which has been the subject of considerable discussion is
whether or not the power of initiating a rate change should properly be
exercised by the Federal Reserve Board or by a regional bank board. The
Federal reserve act specifies that the rates of rediscount shall be fixed *' with
a view of accommodating commerce and business." It gives to each Federal
reserve bank power to establish rates of rediscount, but makes them " subject
to review and determination of the Federal Reserve Board." Believing as we
do' that conditions in this country do not warrant a policy favoring a uniform
rediscount rate, and strongly supporting the fullest measure of local autonomy
among the regional banks, we are of the opinion that the initiation of rate
changes normally should be left to the district directorates, power remaining
with the Federal Reserve Board to veto changes. Only in the interest of
national coordination and in emergency situations should the board initiate
rate changes. It is to be recognized also' that the persistent refusal of the
board to permit a change in rate can be as violative of district autonomy as
the actual forcing of a rate change.
It must be admitted that each regional bank is swayed in its judgments by
the problems of its district and can not be expected to hold so impartial an
attitude as would the Federal Reserve Board representing the needs of the
whole country. District banks, therefore, if given unrestricted freedom in
the matter of rediscount rates might precipitate discrepancies and inequalities
of a disturbing nature. If the Federal Reserve Board exercises its power to
act in presumed national emergencies, the country has a right to assume that
such action will be taken only after conference with regional bank directorates
and after full consideration of the resulting influence of its act upon the
commerce and industry of the districts especially affected. The committee
does not believe the proper solution of this difficulty lies in legislative enactment.

It is sometimes suggested that the reserve ratio should be the predominant
factor in the determination of the rediscount rate. Owing particularly to the
huge influx of gold since 1920, the reserve ratio of the reserve banks has been



high, seldom sinking below 70 per cent. It can not now be employed as a
serviceable guide in determining the desirable volume of reserve credit. Even
if the reserve ratio were much lower than it is now, its changes would not
supply a satisfactory guide to policy. Changes in the ratio! may not agree
either in direction or in intensity with the country's need for more or less
credit. The volume of gold imports, and consequently the reserve ratio, is
influenced by the policies of the reserve banks. By increasing or decreasing
open market purchases money rates may be eased or hardened to some extent.
Gold imports are retarded by low money rates in the financial centers and are
encouraged by high rates. Since the reserve activities determine to some
extent changes in the gold holdings of the reserve banks, the height of the
reserve ratio does not supply a clear guide to credit policy.

There is also advocacy of dependence upon index numbers of commodity
prices as a valuable guide to reserve-credit policy. This proposal received
considerable attention during the pendency of the so-called Strong bill in
Congress. There may arise situations in which it would be generally agreed
that the movement of prices might constitute the most important single factor.
A pronounced rise of prices continuing for some time after labor was fully
employed, and when industrial output, therefore, was not being materially
increased, would indicate that bank credit was being too liberally employed
and that the volume of reserve credit should be reduced. On the other hand r
a pronounced decline in prices accompanied by rising rates in the money
market would serve to indicate credit pressure and the need of supplying more
reserve credit But the significance of moderate changes in prices, either in an
upward or downward direction, is difficult to diagnose. When the cause of
these milder fluctuations is not clear and uniform in its influence, it is not
certain whether and to what extent credit should be employed as a counteracting agent. Moderate price changes are but one, and not always the most
important, of the various factors of which account should be taken in the
determination of the lending, policies of the reserve banks.
Among the other factors are diverse fluctuations in the prices of various
groups or even of single commodities, the degree of activity in trade, the
accumulation of inventories, tendencies in the financing of industry, including
the financing of durable consumer goods, activity and conditions in the real
estate and building markets, the situation in individual commodity markets, the
course of long-time interest rates, and finally the industrial and financial position
in important foreign countries.
A variety of considerations, which will have different degrees of weight at
different times, must necessarily influence the general credit policies of the
reserve banks. In a period of business depression or inactivity it may be felt
that some stimulus to business can be given by that ease in the money market
which may be expected to follow an increase in open market purchases and
lowered rates of rediscount. Such seems to have been one of the motives impelling the reserve banks to action at times. On other occasions it would appear
that the reserve banks have given thought to the desirability of providing
themselves with a sufficient volume of securities to be able to exert a restraining influence upon the credit situation if that should become desirable. Such
purchases may be made at times when it is believed that a moderate increase in
the volume of reserve bank credit will have no pronounced influence upon the
money market.
Again, the foreign situation may bulk large. During the last few years, when
foreign countries have been stabilizing currencies and restoring the gold standard, it has been desirable in the general interest that no unnecessary pressure
upon important foreign money markets should be exerted from this side. The
accentuation of ease in the money market, if that involved no serious risk of
undesirable domestic developments, was clearly advantageous, since it would
aid in the restoration of normal monetary conditions in other countries.
Indeed, to avoid undesirable domestic developments, there may be positive
necessity to contribute to economic recovery abroad. Without stabilization of
important foreign currencies there inevitably would be a narrower market for
our exports. This would be especially serious in periods of increasing domestic production, when foreign outlets for goods are of the highest importance in



preventing that congestion in our domestic markets which would tend to lower
prices and reduce profits.
At times widespread speculative tendencies of the public, as reflected in the
course of the real estate, commodity, or security markets, may make such
demands upon the credit resources of the country as to impair their liquidity
or dislocate the supply available for undertakings involving a normal business
risk or unduly increase its cost.
Important price movements in these markets may arise from many causes
other than increase or decrease in the volume of money or credit. Questionable price movements, however, that are largely resultant from an insufficient
or overabundant money or credit supply are clearly of concern to the system,
since it possesses some power to influence the quantity and the cost of that
When price movements in any of these fields are largely the result of masses
of bank customers indulging their speculative tendencies, the system may not
wisely avoid seeking or urging such adjustments in the credit supply or in the
directions of the use of credit as will assist in restoring the proper balance
between the volume of credit used for speculative purposes and that used in
accommodation of business and industry.

The extent to which security market developments should influence reserve
policies is one of the most difficult problems of reserve administration. Events
and conditions in the security markets are per se of little concern to the reserve
banks. But possible repercussions of security market developments upon other
industry must be taken into account by the reserve banks because of their
interest in basic conditions. They must weigh indications of developments
which may later affect industry, commerce, and agriculture. Furthermore, security market uses of credit, if permitted to develop unchecked, may tend
either to deprive industry, commerce, and agriculture of credit or to increase
money rates.
Because of the rapid turnover of funds on the Street, a considerable expansion of stock market operations may take place without depriving other business of credit to any large extent. But the volume of security speculation may
increase on occasion out of proportion either to the normal growth of the
country or to the credit volume justified by sound business expansion.
The prices of securities may continue to rise in the face of the most sharp
advances in money rates, and those who purchase stocks with the purpose of
turning them quickly in an advancing market may be little deterred by higher
credit costs. The advance in money rates, applying as it does to well collateraled loans, has a powerful influence not only in pulling funds from domestic
sources but also from abroad. The international flow of gold may be affected
to such an extent as to minimize the power of any restrictive measures which
the reserve banks initiate. To the extent, furthermore, that street loans are
for the account of other than banking corporations, a situation may develop in
which a superstructure of speculation comes to be built upon funds which may
be drawn suddenly and with little warning.
Inasmuch as appeal would necessarily be made to the member banks of the
system, and even to the reserve banks, to replace funds thus withdrawn in order
to avert a general collapse of confidence, the reserve banks do have an interest
in the events which lead up to such a condition. Indeed, stock market declines
of considerable proportions occurring for almost any reason may threaten to
produce such repercussions upon industry and commerce as to require that
banking support be given to efforts to secure a more orderly security market.
Member banks and reserve banks would be well advised to anticipate the strain
which may later be thrust upon their resources and endeavor by all their
powers to prevent the emergence of important money-market dislocations.
Once well under way a condition of excessive speculation may be difficult to
correct. In recent years of widespread public indulgence in security speculation, many analysts have regarded the situation primarily as a belated manifestation of too abundant a supply of bank credit in earlier months and years.
In these earlier periods of time the superabundance of credit may not have
reported itself immediately either in rising prices or in increasing trade
activity. But the surplus supply of credit had sooner or later to find an outlet



and when it did begin to emerge in security operations a situation developed
in which immediate correction was difficult, if not impossible.
Another factor complicating the problem has been the impossibility of determining just how much credit security financing alone deserves. Security
operations may not signify an enlargement in the total credit transactions of the
country so much as merely a substitution of capital issues for bank credit
directly obtained. The net result of experience derived in late years of reverse
system operation seems to point sharply to two principles of policy. In the
first place, care should be taken to prevent the creation of an excessive supply
of credit in general, out of which speculative excesses are likely to develop. In
the second place, vigorous rather than mild measures of restraint are required
to bring the situation under control when speculation assumes unhealthy dimensions as tested by the unwillingness to heed the significance of rising money
Throughout the last five years the factors reviewed above, as well as other
considerations, doubtless have played a part in the determination of the open
market activities and the rediscount policies of the reserve banks. Similarly,
in the future a variety of influences must determine the course which reserve
banks will follow in the formulation of their general credit policies.
In conclusion it may be repeated that there is no one guide to which primary
significance must be invariably attached. The elements which create a financial
situation are constantly being combined in different proportions and it is not
possible to state in advance which offer the key to the understanding of the
problem. The determintion of desirable policy in confused and complicated
situations obviously necessitates the exercise of the most far-sighted management. The experience of recent years has been especially pointed in illustrating
the mixed elements which must be considered in determining credit policy, and
the importance which a single one of them can assume upon occasion.
Your committee concludes that:
1. In respect of the autonomous character of the district banks, the Federal
Reserve Board should not exercise its powers of initiation of rediscount rates
except after conference with regional bank directorates and after full consideration of the resulting influence of its act upon the commerce and industry of
the districts.
2. In the employment of the resources of the reserve banks no single guiding
principle is available and no specific object, such as price stability, should be
imposed by legislation as a definite duty upon the reserve board and the
reserve banks.
3. It is desirable that Federal reserve authorities take into account the course
of speculation so far as it may involve at any one time immediate or prospective
strain upon the credit operations of the reserve or member banks.
4. A policy favoring a uniform rate of rediscount as a principle of reserve
system operation should be disapproved.


(In an auxiliary statement upon The Structure and Control of the Reserve
System, No. IV, certain aspects of the management problem are treated more
In this report the committee has endeavored to stress as a factor of utmost
importance the necessity for capable management thtoughout the system. Upon
capacity for good management and its increasing efficiency, as distinguished
from legislative devices, must now rest the well-being of the system and its
ability to serve to the limit the high purposes for which it was created in the
interest of all the people.
No banking system is self-operating, no matter how perfect its structure, nor
how smooth its working parts. This is especially true of central or supplementary banking systems, and peculiarly so of the Federal reserve system.
The provisions of the Federal reserve act relating to the management of the
reserve banks and of the system as a whole are among its most important features. Certain unusual management problems ate encountered in the reserve
system. The special needs of 12, largely autonomous districts must be met,
while at the same time the policies and activities of district organizations must
be blended into a national policy conceived in the interest of long-sustained
business stability. In the direction of meeting this twofold requirement the



Federal reserve act provides for a balanced system of administration, wherein
the activities and policies of the district banks are integrated with those of the
Federal Reserve Board. The function of coordinating the activities in a national way must rest with the Federal Reserve Board.
It is obvious that the board can not concern itself in any high degree with
the minutiae of operation. The board could not acquire such knowledge of local
conditions as is required in passing upon the large number of rediscount applications which may be made by nearly 9,000 member banks. It can take
action within the district only on important matters of an interdistrict or
national character.
No matter how judiciously the board functions, however, efficient administration of the reserve system depends to an important extent upon the activities
of the district directorates and their officers. Their functions as regards the
determination of rediscount rates and open market operations are of the greatest
importance, and the large degree of autonomy wisely permitted them must be
zealously guarded in the interest of proper servicing of district situations. It
is encouraging that the district directors, representative of industry and commerce as well as of banking, are developing special knowledge and experience
in these and other system matters. In this direction lies the proper offset to
the natural tendency toward centralization noticeable at times in the conduct
of the system. As directors of the district organizations are mainly within the
selection of the member banks, a large measure of responsibility for the soundness of the system's operations rests upon the member banks. If these members,
as occasionally happens, fail to select competent men as directors, the efficiency
Of the district bank may be impaired, since the directors determine the policies
of the bank. District boards should consist uniformly of men of such recognized
ability that membership will be considered one of the highest business honors.

The responsible duties of the chairman of the board and the governor of a
regional bank make it essential that those offices be filled by men of the widest
experience in the field of financial administration. The chairman of the board
is an appointee of the Federal Reserve Board at Washington, and with it rests
the responsibility for selection of men adequately equipped to perform the duties
of the office. The governor of a Federal reserve bank is appointed by its board
of directors, thus emphasizing in operation the autonomous character of the
bank, which should be insured by the fact that six of the nine directors of each
bank are elected by the member banks of the district and form a two-thirds
majority of the board.

The emphasis upon the necessity of an efficient district administration does
not mean that an able Federal Reserve Board is not required. Although the
board's executive powers are exercised chiefly in emergency situations, its very
detachment from daily district administration and its domestic and foreign
sources of information furnish a background which should prove of great value
in judging financial trends and in exercising its persuasive, interpretative, and
harmonizing influences which are always imperative in the continuous task of
adapting the total volume of reserve credit to the requirements of the country
as a whole. This committee does not accept the opinion that even with the
most competent district management the system can be properly administered
without the service of a strong and able board.
The board is not and can not be the arbitrary dictator over credit and business conditions which it is sometimes pictured to be. The Federal reserve act,
however, does confer upon it discretionary powers of no mean degree. Federal
reserve notes are issued at the discretion of the Federal Reserve Board. I t
may grant in whole or in part, or reject entirely, applications from the regional
reserve banks for notes. It has the authority to review and determine rediscount rates which are established by regional reserve banks. It has the
power of determining or defining the character of paper eligible for discount,
within the meaning of the act. It makes regulations governing open market
transactions and other system operations. It- can order Federal reserve banks
to establish accounts in foreign countries, to appoint correspondents or establish
agencies, as well as to open accounts here for foreign banks.



The board is empowered to examine the accounts, books, and affairs of each
Federal reserve bank and of each member bank, and to require such statements
and reports as it may deem necessary. It may permit or require one Federal
reserve bank to rediscount the discounted paper of another Federal reserve
bank. It may suspend reserve requirements specified in the act. It can classify
cities as reserve or central reserve cities. It can suspend or remove any officer
or director of any Federal reserve bank. It can require the writing off of
doubtful or worthless assets upon the books of Federal reserve banks. It can
suspend the operations of a Federal reserve bank, take possession thereof, or
liquidate or reorganize it. It can authorize national banks to act in fiduciary
capacity. It is authorized to " exercise general supervision over" the reserve
A number of ideas have been considered by the committee relative to methods
of selection of the members of the Federal Reserve Board. Suggestions have
been offered that nominations be made by the Federal advisory council or by
district directors or other agencies. Proposals which received favor with some
members of the committee involved the appointment by the President of a few
"members of the board and the election of the others by district directorates.
One such plan proposed an increase in the number of board members to 9,
3 to be appointed by the President and the remaining 6 to be chosen one each
by the joint vote of the directors of Federal reserve banks in two contiguous
districts. The consensus of opinion is that no immediate necessity demands a
change from the present system of presidential appointment without any formal
machinery of nominations.
It is recognized that the selection of highly competent men presents a number
of difficulties:
a. Because the duties are supervisory, coordinating, and analytical rather
than of direct executive character.
J). Because the salary, which all too often in the public mind becomes the
measuring rod of importance of service, is so sadly out of line with the compensation paid officers of the regional banks.
o. Because the relative rank and dignity of members of the board in official
life is clouded and uncertain by the dependence upon the Treasury for its
housing and the possible interpretation of the wording of the law that the board
is merely a bureau of the Treasury Department.
It is the belief of this committee that if its recommendations can be made
effective it will become evident that no public service is of greater importance
to the whole country than the board's close contact with and understanding
of all the currents of domestic and international credit and finance; that this
function supported by the powers now reposed in the board by the Federal
reserve act will attract the services of a group of men willing to devote their
experience and ripe judgment to all of those intricate and important relations
which exist in this field.
To encourage able men to accept the sacrifice which board membership involves, every effort should be made to develop the dignity and independence of
the board and to improve its working conditions. To increase the strength of
the board we believe that the prestige of the position of its governor should be
enhanced. We are convinced that the board can not possibly be expected to
meet the anticipations of the framers of the reserve act, while it continues to
include the Secretary of the Treasury as its chairman, overshadowing the governor. Indeed, your committee is convinced of the inadvisability of including
the Secretary of the Treasury as a member of the board.4
On general principles, the exclusion of Treasury representation on the
reserve board would seem to be desirable because the Treasury is a frequent
borrower and is consequently prone to attach major importance in the determination of credit policies to the maintenance of easy conditions in the money
market that will facilitate the placing of loans at minimum rates. This consideration, as is well known, was given undue weight for a year and more
after the armistice, and, apparently, thought with less serious consequences,
on some subsequent occasions.
This proposal-—to free the reserve board from Treasury influence—it should
be clearly understood, is not urged on the ground that that influence has com4

Mr. Clause and Mr. Hecht do not agree with this view.



monly been exerted in support of unwise policies. By no means! Treasury
influence at times undoubtedly has been a factor in securing effective action
without unreasonable delay. Even so, it is evident that representation of the
Treasury on the board has not been conducive to realization of that personal
responsibility, independence of action, and freedom from administration influence which the country has the right to expect.
It is hardly going too far to say that since the establishment of the reserve
system the Treasury Department to a considerable extent has overshadowed
the board and has tended, consciously or unconsciously, to reduce the board
to the status of a departmental bureau. As members of the Cabinet, holding
an historic office of great responsibility, it is to be presumed that Secretaries
of the Treasury will be in the future, as they have been in the past, men of
wide experience and strong character, enjoying widespread public confidence.
It is precisely for this reason that, if a strong board as a whole is to be secured,
the Secretary of the Treasury should not be one of its members.
More particularly, the chairmanship of the Secretary must obviously render
the post of governor of the board less attractive to a man of executive capacity
and energetic temperament. In the judgment of your committee, the dominant personality on the board should be the governor, and he, not the Secretary of the Treasury, should be its chairman. The elimination of the Secretary
of the Treasury from membership, or at least from the chairmanship, will
surely assist in making the position of governor of the board more distinguished and influential. Enhancement of the importance of this office is necessary if men of the highest capacity are to be secured and if board membership
in general is to be more attractive. This proposal is not to be understood
to involve any reflection upon the present Secretary of the Treasury. On the
contrary, his ability and the undoubted high character of his public service
stamp his administration as one of the ablest the country has ever enjoyed.
It is because of his very incumbency that such a proposal can be made without
the restraints that would be necessary were a lesser man in office.
There should, however, be some rather close interrelationship between the
Federal Reserve Board and the Treasury Department, and it is inevitable that
in the very nature of things there would be. To be independent is not to be
less cooperative. There could exist, and undoubtedly would, a close contact
and splendid cooperation between the department and the board, without the
official connection we suggest being dissolved. There are important banks of
issue abroad which have no representatives of the Government upon their
governing boards.
The committee has reviewed current proposals that instead of the Secretary
of the Treasury being a member of the board the Under Secretary should be,
but believes that this is not a practical suggestion. The committee is convinced of the undesirability of the Secretary's membership on the board. While
we do not insist that there is an immediate and pressing need for legislation
relieving the Secretary of the Treasury from his duties as a member of the
board, we do believe that an early change in the chairmanship of the board is
This committee is further of the opinion that there should be a thoroughgoing survey of the office of the Comptroller of the Currency and its relationships to the Treasury Department and to the Federal Reserve Board to see
if it would not be feasible to make such a transfer as would bring the duties
and activities of that office under the purview of the Federal Reserve Board
rather than continue them under the Treasury. While recognizing the force
of some of the practical difficulties, the committee nevertheless feels that more
is to be said for the divorce of the office of the Comptroller of the Currency
from the Treasury Department than against that proposition.
As a further means of developing the independent status of the board, that
body should be adequately housed in a special building of its own. This building should provide adequate facilities for the board's analytical and research
work, now being done at a distance from the Treasury Building where the
board is housed.
Board salaries are now palpably inadequate and incommensurate with those
which necessarily must be paid to both the reserve agents and the governors of
the district banks. Some of the latter receive three and four times as
much as members of the Federal Reserve Board. Their compensation must
approach at least the salaries paid in the field of general banking, from whicli
Federal reserve management must be drawn. This committee recommends that



salaries be increased from the present figure of $12,000 to a minimum of $30,000
per annum for the governor of the board and $25,000 for the other members.
Objection to these salary increases should not be made on account of conditions
existing in the general governmental service. It is to be noted that salaries as
well as other expenses of the board are defrayed, as would be the cost of a
separate building, from assessments upon the reserve banks and not upon the
United States Treasury.
It is not enough that there be efficient district administration plus a strong
Federal Reserve Board, unless the two work in unison. Just as the regional
reserve banks should maintain constant and intimate contact with member
banks, so also should the Federal Reserve Board have first-hand knowledge of
situations within the regional banks and their branches. Frequent visits to
the reserve banks would assist the members of the Washington board to
familiarize themselves with the practical problems of regional administration.
By such contacts they can also assist the officers of the district banks through
discussion of the policies of the board and the reasons for their adoption.
This committee concludes that:
1. Successful management in- administration of the Federal reserve system
must always depend more upon the individual ability of its officers and governing boards to meet changing conditions than upon limitations of powers by
2. Efficient management of each district bank requires that:
a. Member banks select competent men for reserve bank directors.
&. District directors exert every effort to select able governors.
3. Provision should be made to increase the attractiveness of board membership and develop the influence and independence of the board by:
a. Enhancing the importance of the position of governor of the board by
making him chairman.
1). Housing the board in a building of its own.
c. Increasing the salaries of the governor and members of the Federal
Reserve Board to compare more favorably with the salaries paid the principal
administrative officers of the reserve banks.
4. Thoroughgoing consideration should be given to the relations of the
Treasury to the Federal Reserve Board, especially with respect to discontinuing
the membership of the secretary on the board, as well as to the desirability of
a change in the status of the office of the Comptroller of the Currency to bring
that office more directly under the purview of the board.

(In an auxiliary statement upon The Rediscount Operations of the Reserve
Banks, No. I, and another auxiliary statement upon Membership of the Reserve
System, No. VII, some of the matters referred to in this section are considered
more fully.)
While the establishment of the reserve banks has enormously improved our
banking system as a whole, it has accomplished little in the way of reducing
the number of bank failures. There has been a discreditably large number
of member as well as nonmember bank failures in the recent past. These
failures are in part a result of the inflationary methods of war finance, for
which the reserve banks were not responsible, and in part the outcome of
the acute agricultural depression which seems to have been due fundamentally
to its overdevelopment and maladjustment throughout the world. The large
number of failures is also to be attributed to an excessive number of banks
in the agricultural sections of the country—many of them of little financial
strength and managed by unskilled officers. The ability of management to
avoid failure is evidenced by the fact that conservatively operated banks,
situated in rural communities of strong banking competition, succeeded in
weathering the storm developed by the inflation.
As between member and nonmember banks, the only essential change
affected by the establishment of the Federal reserve system was to increase
the borrowing power of the member banks. Limitations on the types of assets
available for rediscount at reserve banks have not served to confine borrowings
within safe limits. They have simply served to transfer to the reserve banks
a portion of the more liquid assets of the borrowing banks. Unless the added
loans made by the member bank are as good as the paper discounted at the
reserve bank, the position of the borrowing bank is obviously changed for



the worse. Proper consideration of the interests of the depositors of member
banks places upon the reserve banks responsibility for taking account of the
general condition and character of the management of member banks, as
well as the situation in the locality in which the bank is operating, when
extending any appreciable accommodation by way of rediscount.
There are difficulties to be encountered in the execution of such a policy.
The member bank ordinarily requests reserve credit in order to restore its
reserve balance which has been depleted as a result of all its operations and
the use its depositors are making of their balances. The reserve bank is
the principal channel through which checks drawn on its members are
presented for payment. These clearing operations deplete the members'
reserves. To make up such deficiencies, the reserve bank is inclined, naturally,
when a member presents good paper, to grant the accommodation requested.
The reserve banks can not, without notice, establish new and rigid practices
in the extension of credit to member banks. On the other hand, if it is
made clear to all members that the character of their management and their
general condition will be the primary factors in the extension of accommodation, member banks will conduct their affairs with reference to these requirements. By this means the reserve banks can come to exert a steady and
powerful influence in the direction of the maintenance of sound banking
practices on the part of member banks.

Most bank failures are the outcome of unsound banking policies followed for
months and even years. There is ample time in most instances for corrective
measures to be effectively applied and it is believed that the reserve banks are
in position to exert a large influence in this direction as an incident of their
rediscounting relations with borrowing banks.
Another difficulty of basing rediscount advances upon-the condition of the
applying bank has grown out of this country's limited experience in the field
of central banking. Undoubtedly too much has been expected of the reserve
banks with regard to servicing distressed banks in emergency situations.
When an emergency is acute and general, it will no doubt be incumbent upon
the reserve banks to offer their credit more liberally. But member banks in
their relations with reserve banks should come to understand that the avoidance of a strained condition is much more important normally than the
alleviation of strain after the situation has become acute. In so far as the
reserve banks have been obliged to resort to restrictive measures in order to
maintain and improve member bank solvency, their activities should command
support from their members. If permitted thus to operate, the reserve banks
can come to exert a steady and powerful influence in the direction of the
maintenance of sound banking practices on the part of member banks.
It is gratifying to note that increasing attention is being given to this important aspect of reserve-bank operations by all of the reserve banks.
This committee concludes that the granting of rediscount accommodations
by reserve banks should depend upon the general condition of member banks
and the effect of granting the rediscount upon the safety of depositors as well
as upon the character of the paper which the applying bank tenders.


Throughout its report this committee has insisted that the efficiency of the
reserve system must depend upon wise administration. On this account it has
opposed the employment of legislative devices to restrict narrowly the powers
of the reserve banks.
The grant of liberal powers to the reserve banks necessarily requires that
there be complete recognition by them of their public responsibilities. Neither
the public in general nor Congress will be content to rely solely upon the probability that the administration will always be composed of farsighted men. The
activities of the reserve banks must be such as to insure confidence in the
system's general policies. Such confidence can not be gained unless the proper
type of criticism is stimulated.
To insure the desirable type of criticism it is essential that the public be
provided with ample information relative to the activities of the reserve banks.



The amount of valuable credit information, statistical and otherwise, supplied
by the Federal reserve system is far beyond that furnished by foreign central
banks. For this accomplishment the reserve administration is to be commended.
But in providing the country with official or semiofficial explanations of the
basic purposes of major policies much yet remains to be done.
The scheme of 12 regional banks and the division of responsibility between
the Federal Reserve Board and the district officials increase the difficulty of
supplying the public with the desired interpretations of reserve policies. It is
to be recognized that various officials may support the same measure from different points of view and that to secure agreement upon the factors to be emphasized may create discord within the system. The further fact that a certain
measure might accomplish one useful purpose, but not precisely that originally
avowed, must also serve to retard explanation.
But despite the difficulties attendant upon complete statements of intent, no
secretive policy will succeed in securing approval for the reposal in the reserve
administration of a large degree of discretionary power. An ill-informed public
will demand precise statutory limitations. Without ample knowledge public
criticism can not be intelligent and beneficial. The more abundant the information and the sharper drawn the issues, the less fertile becomes the field in which
charges of ulterior motives can be sown. When ignorance abounds the arena
belongs to the careless, the radical, and the irresponsible.
With general discussion of reserve problems lifted to a higher plane, illadvised critics will find it more difficult to secure an audience of intelligent
men. Neither should there be too great apprehension regarding the inevitability
of frequent reversals of policy. Thoughtful men understand the imponderable
character of most credit problems and they will not demand that the views of
reserve officials as stated on various occasions agree precisely.
The explanations and interpretations advanced in the Federal Reserve Bulletin and in the annual reports of the Federal Reserve Board have been highly
serviceable and beneficial. What appears to be required further is that on
irregular occasions of important decisions men who occupy prominent administrative positions in the system should seek to clarify their motives. By this it
is not meant that there should be a newspaper release on every action. But in
some recognized way, such as by addresses of the officials of the Federal Reserve
Board and of the district banks, sufficient information should be given about the
determining factors in the situation, so that intelligent men may be able to
engage in frank and friendly criticism. It would be evidently advantageous if
as a regular feature of reserve-bank practice full and detailed publicity were
given to the purposes and results of various policies after the situation with
which they were concerned had developed to such a point as would make such
a statement practicable.
This committee concludes that the grant of liberal legislative powers to thereserve board and to the reserve banks imposes upon them the responsibility
of providing the public not only with an ample amount of factual and statistical
credit information but also with the means of determining the purposes of
major policies. Much is yet to be accomplished in the way of supplying the
public with an adequate amount of interpretative material.
There is need also for greater exchange of information and clear opinion
within the system itself. The regional reserve banks should be thoroughly
familiar with the policies of the Federal Reserve Board and the reasons
therefor. Only thus can they be in a position to chart their own course and
to enlighten the member banks. Not otherwise may there be expected the
fullest comprehension of problems and solutions, with wholehearted and intelligent cooperation. There may be some justification upon occasions for not
taking the entire public into confidence; there is little for lack of frankness
between the board and the reserve banks.
Although this committee undertook its detailed investigations with no prejudgment, it is gratified to note that the post important of its affirmative
declarations require administrative rather than legislative solution. It recognizes the mechanical simplicity and structural soundness of the reserve banking
system. Future alterations of its machinery will be, of course, required. But
these should be initiated step by step out of proven experience. As we earlier
stated, the prime essential is the development by the American business public
of a sober and sympathetic spirit of criticism of the system's administrative



policies. Toward this the administration of the Federal reserve system itself
is in position to make the greatest contribution.
Nathan Adams, M. A. Arnold, J. W. Arrington, Chellis A. Austin,"
Sewell L. Avery, Julius H. Barnes, A. J. Brosseau, Walter S.
Bucklin, James E. Caldwell, Charles S. Calwell, E. L. Carpenter, W. L. Clause, Thornton Cooke, Frederick H. Ecker, J. H.
Frost, Hunter L. Gary, W. F. Gephart, Everett G. Griggs,
Rudolph S. Hecht, Charles A. Hinsch,5 A. L. Humphrey, C. T.
Jafiray, Fred I. Kent, William A. Law, Murray D. Lincoln,
Charles E. Lobdell, John G. Lonsdale, James R. MacColl, Robert
F. Maddox, W. S. McLucas, Theodore F. Merseles,6 John M.
Miller, jr., F. C. Rand, George A. Ranney, John J. Raskob,
R. G. Rhett, H. M. Robinson, Levi L. Rue, J. T. Scott, Paul
Shoup, Frank L. Stevens, Philip Stockton, Henry B. Wilcox,
Daniel G. Wing, Theodore Wold, Matthew Woll, Moorhead
Wright, Harry A. Wheeler, chairman, and John Jay O'Connor,

Special mention should be made of the assistance given the committee by Prof.
O. M. W. Sprague, of Harvard, who conferred at frequent intervals on all questions under review; Prof. Harold L. Reed, of Cornell, who assisted the committee
full time for more than a year, making valuable contributions to the committee
report and undertaking the main work of drafting the auxiliary statements;
and Prof. Ray V. Leffler, of Dartmouth, who prepared some special studies upon
currency problems.
Mr. John Jay O'Connor, manager of the finance department of the Chamber
of Commerce of the United States, as secretary of the committee, and Mr. C. B.
Upham, of the department staff, gave helpful assistance upon every phase of the
undertaking. Mr. W. W. Stewart, formerly director of research and statistics
of the Federal Reserve Board, assisted in the formative period of the committee's
To them, to the members and staff of the Federal Reserve Board, and to
directors and officers of the Federal reserve banks, and to many others who in
conferences or in correspondence aided in the work, the committee acknowledges
its indebtedness.

Following the annual meeting of the Chamber of Commerce of the United
States in May, 1925, the board of directors authorized a comprehensive study of
the Federal reserve system and its developments. During the year following
the preliminaries of the project were investigated, the general set-up was
planned, study of some of the individual problems was begun, and a canvass of
available personnel was made.
In the spring of 1926 the president of the chamber invited a group of past
presidents of the chamber and other business men who are familiar with chamber methods to consider the feasibility of organizing a Federal reserve study
to be undertaken under the auspices of the chamber. On May 8, 1926, the
following gentlemen conferred with the president of the chamber in Washington:
H. A. Wheeler, vice chairman of the board, the First National Bank of
Chicago, Chicago, 111.
Julius H. Barnes, president Barnes-Ames Co., New York, N. Y.
Fred I. Kent, director Bankers Trust Co., New York, N. Y.
John G. Lonsdale, president Mercantile-Commerce Bank & Trust Co., St.
Louis, Mo.
James R. MacCall, president Lorraine Manufacturing Co., Pawtucket, R. I.
Lewis E. Pierson, chairman of the board, Irving Trust Co., New York, N. Y.
John J. Raskob, vice president E. I. Dupont de Nemours, Wilmington, Del.
R. G. Rhett, president Peoples First National Bank, Charleston, S. C.
Following this conference the board of directors of the chamber recommended
a continuance of the investigation of important questions affecting the banking
systems of the country, particularly proposals for changes in Federal reserve




law and practice and a better integration of the credit structure of the country.
The president was authorized further to appoint the necessary committees,
arrange for the necessary conferences, and make the required budget adjustments.
During the progress of the committee study the charters of the Federal reserve
banks were extended in February, 1927, for an indeterminate period. The first
public discussion of charter renewal appeared in an article contributed by the
Secretary of the Treasury, Andrew Mellon, to the May, 1925, issue of Nation's
Business, a publication of the Chamber of Commerce of the United States. At
the time the banking and currency bill was before Congress in 1913 the national
chamber, through referendum vote of its membership, went on record as favoring the automatic continuance of the proposed banking system until superseded
by later legislation. Instead, the bill as enacted into law provided for 20-year
charters for the Federal reserve banks. In affirmation of its earlier position,
the chamber adopted a resolution at its fourteenth annual meeting in 19S6
reading as follows:
The Chamber of Commerce of the United States has a record of steadfast
support of the Federal reserve system and from the beginning has favored indeterminate or automatically renewable charters for the Federal reserve banks.
American commerce and industry have taken the system's continuance for
granted. To avoid any danger of unsettlement to business or disturbance of
public confidence, the charters of the reserve banks should be extended without
delay for an indefinite period until dissolution by act of Congress or until
forfeiture of franchise for violation of law. Extension should not be made
dependent on the adoption of other amendments, however meritorious.
The chamber campaigned vigorously for the legislation extending the charters
of the reserve banks for an indeterminate period, and that provision was written into law on February 25, 1927, as a part of the so-called McFadden-Peppef
The study was not inspired by any feeling that the Federal reserve system
was deficient in serving American business or that fundamental changes in law
or practice were needed. It was more that the system had become indispensable
to business progress and that business therefore had a vital interest in being
in position to "indorse its perpetuation, at the sanie time indicating, if possible,
ways in which even better cooperation between banking and business might bedeveloped.
As the president of the chamber stated in his letter inviting the members
of the executive committee of tlje study to serve:
" It is not the hope of the ctianiber that the inquiry will recommend modifications of the Federal reserve act, necessarily, or of the policies and practices of
the Federal reserve banks. It is rather the desire that all current suggestions
for such modifications, and all serious criticisms of the system emanating from
responsible sources, be appraised by a competent group.
" You Will readily appreciate the importance of the chamber and the business
community being placed in a position to say, in regard to any pertinent criticism
or suggestion concerning the system, that it has been the subject of special study
of business men. It is apparent from the personnel we are inviting to participate in this inquiry that a nucleus is being sought of influential persons, well
distributed over the country, to develop, as far as may be possible, a common
viewpoint as regards the values of the system. Around this nucleus may later
be summoned a national conference * * *. It is to be hoped that Congress
shortly will provide for extension of the charters of the Federal reserve banks.
The foundation will then be laid for general recognition of the Federal reserve
system as a permanent institution. We desire to build firmly on such a
In addition to the executive committee under the direction of the general
chairman of the entire project Mr. Harry A. Wheeler, three other committees
were organized. Under the chairmanship of Mr. Sewell L. Avery, committee
No. 2 was appointed to study the organization and structure of the reserve
system. Committee No. 3, under the chairmanship of Mr. John G. Lonsdale,
had for its field of study reserves and note issues. Rediscounts and openmarket operations were given attention by committee No. 4, under the chairmanship of Mr. Chellis A. Austin. The personnel of the committees will be
found below.
After each committee had made its report it was felt by the executive committee that one consolidated report should be made and placed before an
34718—31—PT 5



advisory conference, made up of bankers and other business men, journalists,
representatives of agriculture and labor, economists, and Federal reserve officials, so that the committee might have the benefit of the thought of all groups
and all sections focused upon the definite proposals made. Such a conference
was held in June, 1928.
In the light of conference discussion and of subsequent events in the credit
field, the committee report and the auxiliary statements were revised and
presented to the board of directors of the chamber, which ordered them printed
for distribution in conjunction with a referendum of the organization members
of the chamber.

Harry A, Wheeler, chairman, vice chairman of the board, First National
Bank of Chicago, Chicago, 111.
Chellis. A. Austin, chairman Committee IV, president Equitable Trust Co.,
New York, N. Y. (deceased).
Sewell L. Avery, chairman Committee II, president United States Gypsum
Co., Chicago, 111.
Julius H. Barnes, president Barnes-Ames Co., New York, N. Y.
Fred I. Kent, director Bankers Trust Co., New York, N. Y.
Murray D. Lincoln, executive secretary Ohio Farm Bureau Federation,
Columbus, Ohio.
Charles E. .Lobdell, formerly fiscal agent Federal Land and Intermediate
Credit Banks, Washington, D. C.
John G. Lonsdale, chairman Committee III, president Mercantile-Commerce
Bank & Trust Co., St. Louis, Mo.
James R. MacColl, president Lorraine Manufacturing Co., Pawtucket, R. I.
John J. Raskob, vice president E. I. du Pont de Nemours, Wilmington, Del.
R. G. Rhett, president Peoples First National Bank, Charleston, S. C.
H. M. Robinson, chairman of the board, Security-First National Bank of Los
Angeles, Los Angeles, Calif.
Matthew Woll, president International Photo-Engravers Union of North
America, Chicago, 111.

Charter and structure
Sewell L. Avery, chairman, president United States Gypsum Co., Chicago, 111.
Federal reserve district No. 1. Daniel G. Wing, chairman of the board, the
First National Bank of Boston, Boston, Mass.
Federal reserve district No. 2. Frank L. Stevens, president Stevens & Thompson Paper Co., North Hoosick, N. Y.
Federal reserve district No. 3. Levi L. Rue, chairman of the board, Philadelphia National Bank, Philadelphia, Pa.
Federal reserve district No. 4. Charles A. Hinsch, formerly president FifthThird Union Trust Co., Cincinnati, Ohio (deceased).
Federal reserve district No. 5. John W. Arrington, president Union Bleachery,
Greenville, S. C.
Federal reserve district No. 6. Robert F. Maddox, chairman of the executive
committee, First National Bank, Atlanta, Ga.
Federal reserve district No. 7. George A. Ranney, vice president and treasurer.
International Harvester Co., Chicago, 111.
Federal reserve district No. 8. F. C. Rand, president International Shoe Co.,
St. Louis, Mo.
Federal reserve district No. 9. E. L. Carpenter, president Shevlin, Carpenter
& Clarke Co., Minneapolis, Minn.
Federal reserve district No. 10. W, S. McLucas, chairman of the board, Commerce Trust Co., Kansas City, Mo.
Federal reserve district No. 11. J. T. Scott, president First National Bank,
Houston, Tex.
Federal reserve district No. 12. Paul Shoup, president Southern Pacific Co.,
San Francisco, Calif.




Reserves and note issues
John G. Lonsdale, chairman, president Mercantile-Commerce Bank & Trust
Co., St. Louis, Mo.
Federal reserve district No. 1. Walter S. Bucklin, president National Shawmut Bank, Boston, Mass.
Federal reserve district No. 2. A. J. Brosseau, president Mack Trucks (Inc.),
New York, N. Y.
Federal reserve district No. 3. William A. Law, president Penn Mutual Life
Insurance Co., Philadelphia, Pa.
Federal reserve district No. 4. A. L. Humphrey, president Westinghouse Air
Brake Co., Pittsburgh, Pa.
Federal reserve district No. 5. Henry B. Wilcox, vice chairman of the board,
Merchants National Bank, Baltimore, Md.
Federal reserve district No. 6. James E. Caldwell, president Fourth and First
National Bank, Nashville, Tenn.
Federal reserve district No. 8. Moorhead Wright, president Union Trust Co.,
Little Rock, Ark.
Federal reserve district No. 9. Theodore Wold, vice president Northwestern
National Bank, Minneapolis, Minn.
Federal reserve district No. 10. Thornton Cooke, president Columbia National
Bank, Kansas City, Mo.
Federal reserve district No. 11. J. H. Frost, president Frost National Bank,
San Antonio, Tex.
Federal reserve district No. 12. M. A. Arnold, president First National Bank*
Seattle, Wash.

Rediscounts and open-market operations
Chellis A. Austin, chairman, president Equitable-Seaboard Bank & Trust Co*,
New York, N. Y. (deceased).
Federal reserve district No. 1. Philip Stockton, president Old Colony Trust
Co., Boston, Mass.
Federal reserve district No. 2. Frederick H. Ecker, president Metropolitan
Life Insurance Co., New York, N. Y.
Federal reserve district No. 3. Charles S. Calwell, president Corn Exchange
National Bank & Trust Co., Philadelphia, Pa.
Federal reserve district No. 4. William L. Clause, chairman of the board,
Pittsburgh Plate Glass Co., Pittsburgh, Pa.
Federal reserve district No. 5. John M. Miller, jr., president First & Merchants National Bank, Richmond, Va.
Federal reserve district No. 6. Rudolph S. Hecht, president Hibernia Bank
& Trust Co., New Orleans, La.
Federal reserve district No. 7. Theodore F. Merseles, president Johns-Manville Corporation, New York, N. Y. (deceased).
Federal reserve district No. 8. W. F. Gephart, vice president First National
Bank in St. Louis, St. Louis, Mo.
Federal reserve district No. 9. C. T. Jaffray, president Minneapolis, St. Paul
& Sault Ste. Marie Railway Co., Minneapolis, Minn.
Federal reserve district No. 10. Hunter L. Gary, Theodore Gary & Co., Kansas
City, Mo.
Federal reserve district No. 11. Nathan Adams, president American Exchange
National Bank, Dallas, Tex.
Federal reserve district No. 12. Everett G. Griggs, president St. Paul &
Tacoma Lumber Co., Tacoma, Wash.

Charter and structure
I. Rechartering:
1. Duration of charter.
2. Method of securing renewal of charter:
(a) Press for renewal of charter as separate congressional measure, or



(&) Include renewal provision in congressional bill of more general nature
relative to Federal reserve.
3. Time of renewal:
(a) Press for renewal at earliest possible opportunity, or (&) pursue an
opportunist policy and urge renewal when political and other conditions seem
most propitious.
II. Districts:
1. Number of districts.
2. Boundaries of existing districts.
3. Federal reserve cities.
4. Federal reserve branches:
(a) Number of.
(&) Location of.
III. Directors:
1. Qualifications of members of the three classes.
2. Method of selection.
3. Changes in the number of members of each clags.
IV. Board:
1. Number of members.
2. Tenure of office.
3. Salaries.
4. Ex-officio membership thereon.
5. Qualifications of appointive members.
6. Method of selecting those who are not ex-officio members.
7. Should one or more members of the advisory council be members of the
Federal Reserve Board?
8. Powers of. (To be considered under the various specific heads such as discount policies, open-market operations, etc.)
V. Advisory council:
1. Method of selection.
2. Tenure of office (now one year).
3. Should it be given more power (now has only advisory power on certain
questions) ?
4. Possibility of establishing closer relationship with board.
VI. Membership:
1. National banks.
2. State banks:
(a) Is it desirable to encourage wide membership with the view of securing
a better integration of the entire national credit system; or (&) is it desirable
to limit membership to the larger State banks, aiming at financial strength,
rather than number of banks?
(c) Qualifications for admission of State banks.
(d) Is it desirable to provide for associate memberships with limited requirements for admission and limited privileges so as to increase Federal reserve resources and unify the credit system of the country?
VII. Foreign agencies and correspondents:
1. Should the foreign activities of the Federal reserve system be increased?
If so, by—
(a) Establishment of agencies, or (&) by increased use of correspondents?
VIII. Bank examination:
1. Desirability of placing bank examination under supervision of Federal Reserve Board.
2. Desirability of superseding or supplementing State examination of State
member banks by—
(a) National bank examiners supervised as at present by the Comptroller of
the Currency, or (6) examiners under the supervision of the Federal Reserve
IX. Operating functions:
1. Correspondent relationships with foreign central banks (carrying of deposits, earmarking, purchase and sale of gold, making of loans upon gold
2. Fiscal agency and depositary functions for Federal Government:
(a) Sale and delivery of Government securities.
(6) Redemption of Government securities.
(c) Exchange of Government securities.
(#) Transfers of Government securities.
(e) Security purchases for Government account.



(f) Maintenance of Government deposit accounts with designated depositaries,
(g) Custody of Government securities.
(h) Depositaries for Treasury—payment of Government checks, warrants,
and coupons.
(i) Collections of checks and noncash, items.
(;) Relations with depositary banks—telegraph transfer of funds; former
subtreasury functions; replacing, exchange and redemption of currency and
3. Research and publications:
(a) Board.
(6) Banks.

Reserves and note issues
I. Reserves:
1. Federal reserve- banks: topics for consideration:
(a) Reserves against Federal reserve notea (now not less than 40 per cent
in gold).
(&) Reserves against deposits (now 35 per cent in gold or lawful currency).
2. Member banks. Topics for consideration:
(a) Reserves against demand deposits: (1) Central reserve city banks (now
13 per cent); (2) reserve city banks (now 10*per cent) ; (3) country bantes (now
7 per cent).
(b) Against time deposits: (1) All banks (now 3 per cent).; (2) effect which
this low reserve ratio has on savings institutions; (3) incentive to convert
demand deposits into time deposits.
(o) Should some of the reserves be carried in the vaults; of the member
banks? If so, what portion? (Original act provided that one-third should be
retained by member bank.)
(d) Should interest be paid on reserves?
(e) Method of computing reserves (e. g., should reserves be held against trust
funds, Government deposits, and other special types of deposits?)4.
(f) Redesignation of central reserve city, reserve city and country banks*
(g) Should State banks be permitted to consider Federal reserve* notes as
II. Currency:
1. Federal reserve notes. Topics for consideration:
(a) Should Federal reserve notes be issuable only against commercial paper
as collateral?
(&) Should Federal reserve notes be issuable against gold and collateral of
commercial paper, Government securities, private corporation securities, or other
recognized collateral or some combination of these?
(c) Should there be a certain fixed amount of Inderal reserve notes constantly outstanding but to be supplemented as occasion demands by notes based
on gold or commercial paper?
{d) Should the class of collateral now used as basis for Federal note issues
be widened or narrowed?
(e) Changes in regulations affecting note issues in excess of the 40 per cent
2. Federal reserve bank notes:
(a) Continued as at present.
(&) Abolished.
(c) Modifications as to collateral:
3. National-bank notes:
(a) Continued as at present.
(6) Abolished.
(e) Modifications as to collateral.
4. Relation of Federal reserve currency to other currency such as nationalbank notes, silver certificates, " greenbacks," etc. Consideration of such topics
(a) Volume of currency.
(&) Elasticity of currency.
(c) Velocity.
III. Operating functions:
1. Handling of member-bank reserves.


Supplying of currency and coin.
Collection and clearance of checks.
Collection of noncash items (drafts, notes, and coupons).
Wire transfers of funds.
Safekeeping of securities for member banks.

Rediscoimts and open-market operations
I. Rediscounts:
Function of rediscounts in central regional banking:
1. European background (brief historical treatment).
2. Federal reserve policy (brief historical treatment of recent few y e a r s ) :
{a) January, 1922, to spring recession of 1923.
(o) Spring of 1923 to close of 1924.
(o) Beginning of 1925 to present time.
A. Legal status:
1. Classes of institutions permitted by act to rediscount with reserve banks.
2. Qualifications of eligible paper—
(a) As regards form of paper (promissory notes, drafts, bills of exchange,
acceptances, etc.).
(&) As regards purposes for which paper was originally drawn.
(c) As regards maturity.
3. Amounts discountable:
(a) For any member bank.
(&) By the reserve banks.
(c) Of paper bearing the signature of one party.
4. Bates:
(a) Method of fixation.
(6) Differentials between various types of paper.
B. Need of control:
1. From standpoint of banking requirements, such as—
(a) Reserve ratios.
(6) Money-market conditions.
(c) Gold movements.
(d) Foreign conditions, exchange rates, and rates of foreign central banks.
(e) Earnings of reserve banks.
2. From standpoint of other economic requirements, such as—
(a) Commodity prices.
(&) Volume of production.
(o) Inventories.
(d) Volume of speculation.
C. Methods of control:
1. Discrimination based upon nature of paper and use of proceeds.
2. Rate changes.
3. Rulings and regulations.
4. Fixing basic lines for each rediscounting institution.
5. Moral suasion.
6. Advice and warnings.
7. Exercise of right to arbitrarily refuse applications.
8. Altering volume of open market purchases and sales.
9. Altering volume of direct collateral advances to member banks.
D. Agencies of control:
1. Reserve banks.
2. Board,
3. Advisory council.
E. Difiiculties of control:
1. Lack of pertinent analogies in experience of foreign central banks.
2. Varying interest rates existing throughout the country.
3. Correspondent connections of small country banks to larger institutions in
the financial centers.
4. Statistical.
II. Open market operations:



Function of open market operations in central and regional banking:
1. European background.
2. Federal reserve policy (brief treatment of development).
A. Value of (in relation to)—
1. Individual banks.
2. Credit control under Federal reserve.
3. Development of bill market.
4. Gold flow.
5. Dollar credits.
6. Foreign credit and currency situations.
7. Earnings of system.
B. Legal status:
1. Classes of permissible purchases.
2. Institutions dealt with.
3. Rates.
4. Differentiation from rediscount operations.
C. Control:
1. Need of—
(a) From standpoint of banking requirements.
(b) From standpoint of other economic requirements.
2. Methods of—
(a) Rate changes.
Cb) Rulings and regulations.
(c) Treatment of applications.
3. Agencies of—
(a) Federal Reserve Board.
(&) District banks.
4. Difficulties attending Federal reserve participation in open market:
(a) Eligibility limitations.
(&) Foreign demands.
(o) Absorption of funds by securities market.
(d) Attitude of individual banks.
D. Special problems:
1. Do open market activities enable reserve banks to keep outstanding more
credit than would otherwise be possible?
2. Can open market sales be employed as a substitute for discount-rate increases in such a way as to avoid the unpopularity of such increases?
3. Do open-market purchases force more rapid credit expansion by member
banks than do reduction of rediscount rates?
4. Have the effects of dealings in Government securities been similar to dealings in bank acceptances?
5. Should the reserve banks continue to deal with other than member banks
in making purchases and sales?
6. Should open-market powers include different types of paper than is now
7. In general, should open-market activities be continued or abandoned?
III. Finances:
1. Gross earnings—
(a) Sources and amounts (classified).
2. Expenditures—
(a) Purposes and amounts (classified).
3. Net earnings—
(a) Analysis.
(&) Surplus account.
(c) Dividends.
(d) Franchise payments.
4. Building and equipment accounts.
IV. Gold policy:
Consideration of such topics as—
(a) Should a portion of the gold now in this country be "earmarked" and
not considered a part of the reserve fund?
(&) International movement of gold,
(o) Cooperation with foreign banks of issue.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102