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Calendar No. 604
72d C ongress
1st Session

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SENATE

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R epobt

No. 584

OPERATION OF THE NATIONAL AND F E D E R A L RESERVE
BAN K IN G SYSTEMS

A pril

22, 1932.— Ordered to be printed

Mr. G la s s , from the Committee on Banking and Currency, submitted
the following

REPORT
[Tp accompany S. 4412]

The Senate Committee on Banking and Currency has had under
consideration S. 4412, “ To provide for the safer and more effective use
of the assets of Federal reserve banks and of national banking associ­
ations, to regulate interbank control, to prevent the undue diversion
of funds into speculative operations, and for other purposes,” and
reports it back to the Senate with the recommendation that the bill be
passed.
The bill thus reported is the result of extensive hearings by a duly
authorized subcommittee of the Banking and Currency Committee
of the Senate and, more recently, hearings by the general Banking
and Currency Committee. The investigation of banking problems
was held under the terms of Senate Resolution No. 71, adopted at
the second session of the Seventy-first Congress, reading as follows:
Resolved, That in order to provide for a more effective operation of the National
and Federal reserve banking systems of the country the Committee on Banking
and Currency of the Senate, or a duly authorized subcommittee thereof, be, and
is hereby, empowered and directed to make a complete survey of the systems
and a full compilation of the essential facts and to report the result of its findings
as soon as practicable, together with such recommendations for legislation as
the committee deems advisable. The inquiry thus authorized and directed is
to comprehend specifically the administration of tliese banking systems with
respect to the use of their facilities for trading in and carrying speculative securi­
ties; the extent of call loans to brokers by member banks for such purposes; the
effect on the systems of the formation of investment and security trusts; the
desirability of chain banking; the development of branch banking as a part of
the national system, together with any related problems which the committee
may think it important to investigate.
For the purpose of this resolution the committee, or any duly authorized sub­
committee thereof, is authorized to hold hearings, to sit and act at such times
and places during the sessions and recesses of the Seventy-first and succeeding
Congresses until the final report is submitted, to employ such clerical and other




2

NATIONAL AND FEDERAL RESERVE B AN K IN G SYSTEMS

assistants, to require by subpoena or otherwise the attendance of such witnesses
and the production of such books, papers, and documents, to administer such
oaths, and to take such testimony, and make such expenditures as it deems
advisable. The cost of such stenographic services to report such hearings shall
not be in excess of 25 cents per hundred words. The expenses of the committee,
which shall not exceed $15,000, shall be paid from the contingent fund of the
Senate upon vouchers approved by the chairman.

Acting upon the authority of the foregoing resolution the Senate
Committee on Banking and Currency appointed a subcommittee to
conduct the Inquiry, which subcommittee proceeded in three ways:
1. It held hearings during the months of January and February
of the year 1931 and at these hearings interrogated numerous wit­
nesses, representing the banking, financial, and technical elements in
the community, who either indicated a desire ttf be heard or were
invited by the committee as probably possessing information that
would be valuable.
2. Inquiries were made among a select list of representative banks
by the method of questionnaires. Lists of questions were carefully
formulated by experts and transmitted to the banks; and, in nearly
all cases, replies of a full and complete description were forwarded
by the latter. These have been carefully analyzed and the result
published as appendixes to the hearings.
3. Statistical and other investigations were conducted by inves­
tigators attached to the committee; and their results reported and
published in connection with the hearings. In addition, reports on
topics of a technical nature calling for special inquiry were placed
before the committee.
In addition to the foregoing the committee carried on an extensive
correspondence and received numerous suggestions, recommendations,
and other presentations of argument or evidence. It also received
various drafts of proposed legislation, and gave due consideration to
all. It found, however, that public opinion was in an indeterminate
condition on the whole subject, and felt that immediate emergencies
were so great that it was wise to defer the preparation of a completely
comprehensive measure for the reconstruction of our banking system,
such as had been urged by some responsible men. Hence the commit­
tee resolved to construct a bill to correct manifest immediate abuses,
and to bring our banking system back into a stronger condition. Thus,
for example, it seems to be the consensus of opinion among banking
authorities that the United States will never have a complete and
strong system until such time as it shall succeed in fully harmonizing
and adjusting State and Federal laws on banking questions. This
might involve a constitutional amendment or some equally farreaching measure necessitating a long postponement of action.
The immediate measures of reform and rectification are, how­
ever, quite important. They include the correction of evils which
reached a peak of danger in 1929 and abuses which have gradually
grown up within the banking system itself. Immediate dangers and
emergencies have been of so pressing a nature as to throw into the
background many of the evils which have previously been recognized
and to divert discussion from causes to the immediate effects of what
was done in recent years. It is, therefore, needful to consider at
some length the general background of the banking conditions which
culminated in the breakdown of 1929.




NATIONAL AND FEDERAL RESERVE BAN KIN G SYSTEMS

3

IN FLATIO N OF BAN K CREDIT

There seems to be no difference of opinion with reference to the
statement that the years after 1925, and indeed to a smaller extent
those preceding that date and subsequent to 1922, were years of a
very great inflation of bank credit— as well as of commercial credit
and, especially in the later years,^of business. By inflation, in the
sense in which that word is here used, is meant the increase of bank
liabilities, usually demand liabilities, in a proportion or degree mate­
rially greater than the rate of increase indicated by the requirements
of a gradual growth of business transactions involving the produc­
tion and distribution of goods— in a degree or ratio, therefore, greater
than that in which the need for media of exchange had grown—
usually accompanied by corresponding changes in liquidity. ~By way
of demonstration or illustration of this statement m very brief form,
we may simply cite the enlargement of deposit liabilities of the banks
during the past few years prior to 1929 and the great subsequent
enlargement of investments and frozen loans. This growth was not
paralleled by any similar enlargement of the demand for means of
exchange, as is suggested by th6 various indexes reflecting the rate
of production.
Inflation was also indicated by the uses to which the credit thus
established was put and the advance in prices thereby .brought about.
It is now evident that the increase in deposit credit on the part of
the banks already described was largely used in three ways: (1) In
the carrying and inflating of the prices of securities, especially com­
mon stocks, (2) in the overdevelopment of real estate and real estate
enterprises, and (3) in the upbuilding of a large capital equipment
paid for with short-term accommodation but not funded at the time
into longer-term loans.
BEARINGS ON CREDIT EXPANSIO N

Analysis of the sources from which the excessive credit used in
the stock market during past years was drawn, is a primary factor
in determining what was really at fault in the management of bank­
ing during the years in question. This is of special interest in con­
nection with the so-called brokers’ loans.
The loans in question are divided into two main groups, the one
obtained from banks and bankers while a second represents those
obtained from “ others.” These “ others” were corporations and
other nonbanking lenders, including investment trusts and many
others having funds to spare who chose to advance them for use
in supporting securities transactions. The question is thus naturally
raised: Where did the “ others” thus spoken of obtain their funds?
They obtained them, of course, in substantial measure from the
public at large through sales of new issues, which rose steadily
through this period. In part, also, they were a result of the use of
large war-time and postwar earnings, which were retained from
stockholders instead of being paid out as dividends.
The major source of the inflation, however, was the creation of
new bank credit through large loans and investments by banks that
had substantial surplus reserves, owing to gold imports, open market
operations of the reserve banks, etc.




4

NATIONAL AND FEDERAL RESERVE BAN KIN G SYSTEMS
USE OF PROCEEDS OF N E W ISSUES OF SECURITIES

A large portion of the funds obtained by these issues of securities
from the public was unavoidably used in new construction and in
carrying out the legitimate purposes of the businesses which thug
obtained them from the investors of the country. Another large
portion was, however., left over; it was not directly required for
immediate use, the issuers of securities having overborrowed or over­
capitalized themselves, so that they were in possession of more current
funds than they needed. This surplus of funds went into the stock
market and fostered excessive speculation, although it also stimu­
lated business by being transferred to sellers of securities later on.
Where did the public which bought the securities of such corpora­
tions get the funds th€>y thus supplied? Some portion of the money
naturally came from savings and current incomes, but a larger frac­
tion was unquestionably obtained from the banks by means of the
security borrowings to which reference has been made at an earlier
point. The banks were thus lending directly in unprecedentedly
large amounts directly to brokers; but they were also lending in even
larger amounts on collateral to the general public, which was then
taking the funds so supplied and using them in large degree for the
purchase of securities whose proceeds were applied to speculative
loans in the market. The flow of funds through the hands of the
general public into those of the corporations, and from the latter
into the hands of brokers and dealers, who then re-lent the funds
to the public engaged in speculation, was thus primarily the result
of a loose banking policy which had turned from the making of loans
on commercial paper to the making of loans on security. This policy
was critically referred to by the Federal Reserve Board, which often
called attention to it in its annual reports.
THE GROW TH OF ACCEPTANCE CREDIT

The general ease and accessibility of credit under the regime
which existed prior to 1929 was accentuated by the issue of the in­
strument known as the bankers’ acceptance. In its original purpose
this form of lending was intended to include only unquestionably
liquid obligations, growing out of the actual sale of goods in foreign
trade, so that the acceptance became a short-term claim payable in
international funds, usually gold. It was this conception of the in­
strument which was originally adopted in the Federal reserve act,
and on which the use of the instrument by the Federal reserve system
was founded. Later amendments to the reserve act, adopted during
the World War, broadened the use of the acceptance and opened the
door to the application of a conception of its use which was practically
that of a finance bill— a bill drawn without reference to the immedi­
ately liquid character of a given transaction, and primarily based
upon the general power of the parties to it to see that it was liquidated
from some sourse. The use of the acceptance to supply what was
called dollar exchange, although doubtless of advantage under proper
restrictions, undoubtedly opened a door to grave abuses, which were
in some measure responsible for the credit difficulties that later made
their appearance in South American finance. These difficulties, how­
ever, were after all comparatively minor, the real dangers of the accept-




NATIONAL AND FEDERAL RESERVE BAN KIN G SYSTEMS

5

ance being exhibited in connection with the stretching of the definir
tion of various transactions so as, for instance, to include storage of
commodities as an incident to their moving abroad or moving from
one market to another so that acceptances protected by such stored
goods were regarded as acceptances made against goods actually
moving in international trade. It was easy to pass from this view
of the situation to another and more advanced view, wherein stored
goods not sold during the period of the acceptance were used as
goods properly providing a basis for renewal of the acceptance so
that revolving acceptances or acceptances growing out of revolving
credits became common, notwithstanding official warnings against
them.
From the domestic standpoint, it would seem clear that not a few
banks had fallen into the habit of supplying their customers with
funds through the issue and sale of their acceptances, without much
regard to the question whether such acceptances were called for or
not. That the large amount of reserve credit thus created prevented
effective control of security loans and investments of the banks, and
thus fostered the stock market boom, there can be little doubt.
Through these and similar means, too, a very large commitment
on the part of American banks taken on behalf of foreign banks came
into existence. Germany, in particular, proved to be a great borrower
on this score, and the total of acceptances made directly or indirectly
in order to provide funds for foreign banks grew to unprecedented
amounts. The effect of these transactions upon the German banks
themselves, in leading up to the German financial collapse of July,
1931, has been carefully traced by the international committee of
bankers which met under the chairmanship of Mr. A. H. Wiggin in
Basle, after the breakdown of Germany during the past summer, for
the purpose of discussing ways and means of dealing with the German
credit situation.
BA N K INSOLVENCIES

Every discussion of the conditions which preceded the panic of
1929 must make full allowance for the bank insolvencies which dur­
ing the years after 1924 began to grow so numerous. The following
brief tabulation furnished to another subcommittee affords the facts
regarding bank insolvencies during the year 1931, while figures for
earlier years were furnished by the Comptroller of the Currency
during the hearings of the past winter, and are computed on a some­
what different basis by the Federal Reserve Board in its monthly
bulletin. It is obvious that bank failures, whatever may be the basis
upon which they are computed, have reached an unprecedentedly
high level after a long continued growth extending over a decade.
The effect of these insolvencies prior to the panic of 1929, was two­
fold. They tended to break down the business structure of the coun­
try and particularly of the places and regions in which they were
most numerous, and they tended to bring on local hoarding over large
areas. The condition of affairs is complex, growing as it did, out of
a variety of conditions. Most of these circumstances have been out­
lined in the hearings, and there is little use in further reviewing them
at this point. For the most part they are well known.
There should, however, be no failure to recognize the important
r61e played by these insolvencies in preparing the way for the gen­
20366 0 — 5 8 ---------2 7




6

NATIONAL ANI) FEDERAL RESERVE B AN KIN G SYSTEMS

eral breakdown of 1929. The fact that they occurred more largely
among “ small banks,” as has often been urged, in no way reduces
the significance of the phenomenon. It points to a gradual disin­
tegration of banking under present conditions and it reflects the com­
munity’s way of gradually curing the evils complained of, though
a lengthy and costly process. It was this tendency to bank failure
starting 10 years ago after the depression of 1920-21 and steadily
growing more and more pronounced, except during the boom years,
until it reached the astonishing height touched in 1930 that has cul­
minated in the great total of nearly 2,300 failures occurring in this
country during the year 1931. This drift toward failure among banks
laid the foundation for extreme difficulties experienced during the lat­
ter part of 1931, and necessitated the remedial measures that were
then undertaken. Bank failures can not but be regarded as one of
the fundamental symptoms that must be given primary study in the
search for remedies to be applied to present conditions.
Bank sus pensions in 1931, preliminary figures
All banks

Num­
ber

National banks

Num­
ber

Deposits

Year 1931, total..................... 2,290 $1,759,000,000
Last quarter of 1931.............. 1,049
866,000,000
November and December,
527
1931.......................................
388.000.000
October, 1931..........................
522
478.000.000
November, 1931.....................
174!
69,000,000
December, 1931.....................
353
319.000.000

Deposits

410 $473,000,000
199 244.000.000
99 128.000.000
100 116,000,000
35 28,000,000
64 100,000,000

S T O C K -E X C H A N G E

State bank
members
Num­
ber

Deposits

Nonmember
banks
Num­
ber

Deposits

108 $302,000,000 1,772 $984,000,000
799 467.000.000
51 155.000.000
26 37.000.000
25 118.000.000
8
4,000,000
18 33.000.000

402 223.000.000
397 244.000.000
131 37,000,000
271 186.000.000

S P E C U L A T IO N

Stock-exchange speculation in excess is often spoken of by some
as the cause and by others as an unfortunate result of the business,
banking, and credit conditions which culminated in the panic of
1929. It was neither of these, but was an accompaniment or symptom
of unsound credit and banking conditions themselves. The facts as
to the expansion of such speculation are well known, and its history
requires no repetition but the major data, facts, and conclusions
may be briefly summarized as including: (1) A steady increase in
bank security loans and investments; (2) rising price resulting from
the increased resulting demand; (3) a sporadically enlarging vol­
ume of stock-exchange operations and new issues made possible by
popular enthusiasm thus engendered; and, finally (4) a violently
fluctuating course of prices on the stock exchange continuing until
the whole structure fell of its own weight, resulting in the sharp
downward movement which began in the autumn of 1929 and has
been followed by sporadic collapses at various times since.
IN F L U E N C E

OF

P U B L IC

F IN A N C E

It must be noted, in reviewing the situation which preceded the
panic of 1929, that methods then adopted in connection with public
finance had a very substantial share in bringing on the collapse of




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

7

that year. Almost all governments both here and abroad have per­
mitted themselves to overborrow on short term. When such borrow­
ing has been effected at banks, as has been the case in most instances
the result has been to add to inflation by getting the banks to carry
as credit what was really long-term capital investment. In the
United States very low money, the result of exceptionally low interest
and discount rates, rendered it possible to effect such "borrowing on
a very economical basis. The result was the extended use of the
banks for the purpose of carrying unfunded public debt, often in
the expectation that such debt would be shortly funded and could
be so funded at any time determined upon by the borrowing gov­
ernment as suitable. The growth of very large public-bond hold­
ings, including not only the obligations of the United States but of
various States and cities, operated strongly to limit the banks’ liquidity
by engaging their funds in what were really long-term investments.
From the outbreak of the panic and during the subsequent depres­
sion there was never a favorable time for refunding, and the result
has been to leave many banks with unduly large burdens of public
bonds. So far as Federal reserve banks were concerned, the fact
that the obligations of the Federal Government could always be
used to protect member-bank borrowings inevitably tended to encour­
age such members in developing frozen portfolios.
R E A L -E S T A T E

IN F L A T I O N

One element which deserves special notice in any study of pre­
panic conditions is afforded by real-estate inflation and speculation.
It is not possible to find authoritative statements of the growth of
the volume of real-estate loans and security investment in the port­
folios of the banks and elsewhere, but the general facts in the case
are clearly enough known. The immense increase in the volumes of
real-estate bond issues and of real-estate mortgages both in banks
and among the holdings of the financial institutions generally are
the subject of widespread comment. What is less well recognized
is the fact that an immense overexpansion of real-estate values was
set in motion and that in consequence the coming on of the panic
and their recognition that the country was “ overbuilt” added an
element of great difficulty to the situation. This element of difficulty
is vividly illustrated by the circumstance that many institutions now
find themselves hopelessly embarrassed by their real-estate com­
mitments and by the fact that rents and selling values have so
seriously shrunk.
PROBLEM S

OF

R ESERVE

BANKS

At times the reserve banks have held an unprecedented amount of
gold during the past two or three years and the gold stock of the
country has occasionally been well above $5,000,000,000, so that the
reserve percentage of the reserve banks has been steadily high, not­
withstanding fluctuations and a recent tendency to recede. These
high ratios, however, have much less direct bearing upon the actual
condition of the system than is generally supposed. The real prob­
lem of reserves is furnished by the relationship between the outstand­
ing deposits of the banks of the country ana the gold reserve which
the reserve banks themselves carry. This ratio or relationship has




8

NATIONAL ANI) FEDERAL RESERVE BAN KIN G SYSTEMS

until recent months shown continuous tendency to decline. The
great gold movements of the past half year and the liquidation of
many banks have somewhat changed the situation, but it has con­
tinued true that the ratio was inadequate while the tendency of a
portion of the public to hoard currency has necessitated the issue of
reserve notes in large volumes with corresponding shrinkage of the
so-called free gold available. During the three years before the col­
lapse of 1929 unduly low discount rates were a cause of danger to
reserve banks. They have been viewed by some banking authorities
as a chief cause of the difficulties which compelled Great Britain to
abandon the gold standard in the summer of 1931. The question of
reserve policy is an involved and complex one on which your com­
mittee took much testimony and also pursued an extended study
whose results are stated, in the words of the reserve banks them­
selves, in part 6 of the hearings (appendix). So fully are the facts
there reviewed and so authoritatively are they stated by the reservebank authorities that it has not been thought necessary to enlarge
more fully upon the situation in this report.
C O N D IT IO N

OF

MEMBER

BANKS

The outstanding development in the commercial banking system
.during the prepanic period was the appearance of excessive security
loans, and of overinvestment in securities of all kinds. The effects
o f this situation in changing the whole character of the banking
problem can hardly be overemphasized. National banks were never
intended to undertake investment banking business on a large scale,
but the whole tenor of legislation and administrative rulings con­
cerning them has been away from recognition of such a growth in
the direction of investment banking, as legitimate. Nevertheless
it has continued; and a very fruitful cause of bank failures, espe­
cially within the past two years, has been the fact that the funds of
various institutions have been so extensively “ tied u p ” in long-term
investments. The growth of the investment portfolio of the bank
itself has been greatly emphasized in importance by the organiza­
tion of allied or affiliated companies under State laws, through which
even more extensive advances and investments in the security market
could be madeTj This question, like that relating to the policy and
situation of reserve banks, has extensive ramifications which must
be studied statistically. In order to provide material for such a
study, the results of questionnaires addressed to a selected list of
large banks, each possessing one or more affiliates, have been assem­
bled in general tabular form with such explanation as is necessary
to enable the reader to evaluate the figures thus given. They are
presented as part 7 of the hearings (appendix).
A N A L Y S IS OF P R E S E N T B A N K IN G PR O BLE M

We have furnished thus far a merely descriptive account of the
financial and credit conditions which preceded the panic of 1929. It
now remains to consider these facts as exhibiting a distinct kind
of banking problem and to inquire in what way remedies for it may
be found. Specific conditions which stand out as requiring some
remedy are therefore, taken under consideration, as follows:




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

9

1. Bank loans and their uses.— It is evident from what has been
said that the underlying factor in the whole prepanic situation was
excessive use of bank credit. The question of “ excess” is a question
of judgment and can only be determined by noting in specific terms
the forms it has taken and the remedies to be applied to them.
(a) The excessive use of bank credit in making loans for the pur­
pose of stock speculation or, more generally stated, for the excessive
carrying of securities with borrowed money was generally admitted
before the panic of 1929, and almost universally since that time, to
have been one of the sources of major difficulty, far exceeding in its
scope any total that could be reasonably asked for as a basis for
the financing of legitimate investment business. Under this same
topic, too, must be mentioned the so-called “ brokers' loan.” These
are merely a special form of securities loan in which a bank or commerical corporation or other enterprise advances funds through an
intermediary— the broker— instead of lending direct; an excessive
volume of brokers' loans must be considered in the light of the total
volume of security loans outstanding. The category of brokers'
loans obtained from “ others” is a separate and especially difficult
aspect of this problem.
(b) It seems clear that any remedial measure of legislation should
seek to provide some check upon the abnormal growth of all security
loans at banks as well as seek to limit the loans to brokers, especially
those loans originating with “ others.” Such legislation, if success­
ful, should operate to lessen the danger of a repetition of the experi­
ence of 1929. It is often suggested that control of this form of credit
ought to be effected in some way through stock exchanges. What­
ever may be thought of that method of approaching the subject,
it is at all events certain that nothing of the kind would be likely to
succeed without adequate banking control, while on the other hand,
banking control alone may greatly ameliorate conditions in this field
of credit.
(c) The line of reasoning thus presented leads us to propose:
(1) Legislation designed to control and limit brokers' loans, partic­
ularly to limit the use of funds of the reserve banks for this purpose.
(2) Legislation designed to restrain the diversion of bank funds
to an undue degree into direct loans upon securities whether to
brokers or to others.
(3) Legislation intended to prevent, so far as legislation can,
speculative market loans by corporations engaged in industrial or
business enterprises.
2. Banking affiliates.— There seems to be no doubt anywhere that
a large factor in the overdevelopment of security loans, and in the
dangerous use of the resources of bank depositors for the purpose of
making speculative profits and incurring the danger of hazardous
losses, has been furnished by perversions of the national banking and
State banking laws, and that, as a result, machinery has been created
which tends toward danger in several directions.
(a)
The greatest of such dangers is seen in the growth of “ bank
affiliates” which devote themselves in many cases to perilous under­
writing operations, stock speculation, and maintaining a market
for the banks' own stock often largely with the resources of the par­
ent bank. This situation was never contemplated by the national
banking act, and it would, therefore, appear that the affiliate sys­




10

NATIONAL AND FEDERAL RESERVE B AN KIN G SYSTEMS

tem calls for the establishment of some legislative provisions designed
to deal with the situation. It has been suggested from many quarters
that the affiliate system be simply “ abolished.” This suggestion
has much authority behind it, but, in addition to the manifest diffi­
culty of enforcement, owing to the existence of well-known subter­
fuges to maintain control, there remains the question whether it
would be of much real service so long as State legislation permits the
growth of affiliates in connection with State banks and trust com­
panies. The committee has, therefore, determined to present pro­
posed legislation aimed at the following objects:
(1) To separate as far as possible national and member banks
from affiliates of all kinds.
(2) To limit the amount of advances or loans which can be ob­
tained by affiliates from the parent institutions with which they are
connected.
(3) To install a satisfactory examination of affiliates, working
simultaneously with the presei^t system of examination applicable
to the parent banks.
(b)
Group banking.— Closely allied in many points of similarity
with the affiliate system is the plan of group banking in operation in
some parts of the United States, working, m a few cases, on a large
scale. In this system a holding company is organized under State
law and proceeds to buy a majority of the stock of a series of banks,
operating them* thereafter through the holding company. In this
way in some districts such holding companies control the reserve
bank of the district through ownership of enough banks to carry an
election. The difference between this plan and the affiliate system
itself is that in the one banks are owned by a State-organized hold­
ing company, while in the other State-organized companies (affili­
ates) are owned by a national bank’s stockholders, or in some cases
directly by trust companies, under some form of law which amounts
to ownership by the parent bank itself. The evils of indirect control
are similar in the two cases, and they may lead to similar abuses, as
is seen when it is noted that holding companies also usually control
companies organized for security financing. THoweverJfeuch compamesTraTe ill some parts of tEe Um^d~States become well rooted,
and the difficulty of eliminating or abolishing them in any effective
w ayis similar to the difficulty of eliminating or abolishing the affiliates
of city banks. It is, therefore, thought best to attempt the control
and oversight of these companiejjbn the following terms":
(1) Since the companies are State corporations, Congress has no
control over them, except that which may be voluntarily granted.
However, since the staple of their ownership or holdings is the stock
of National and State member banks, it would seem that Congress
may control the conditions under which such stocks may be owned and
particularly voted.
(2) The affiliates of this type (holding companies) are prohibited
from voting the stocks of national banks unless they are willing to
undertake to accept examination by the Federal Reserve Board,
divest themselves of ownership of stock and bond financing con­
cerns, and comply with regulations designed to insure their own­
ership of sufficient free assets to make sure that they can satisfy
the double liability of their shareholders in case any of the banks
<
11 such a company should go into the hands of receivers or




NATIONAL AND FEDERAL RESERVE BAN KIN G SYSTEMS

11

(3)
It is thought that, in any event, holding companies should
not be allowed, except in a severely limited way, to vote at elections
of Federal reserve bank directors, since otherwise the Federal reserve
bank would become merely the creature of the holding company.
Such voting is therefore definitely restricted.
3. Insolvency oj banks.— Within the past few years, the insolvency
of banks has been a major cause of distress and business difficulty
in all parts of the country. There is no one sovereign remedy for
this condition or tendency. It grows out of the weakness of the
banking system and the way to correct it is, of course, to correct
defects in the system itself. However, we believe that this tendency
to constitutional weaknesses is to be remedied or alleviated by meas­
ures of several sorts. These we shall briefly enuoaerate as follows:
(a) Strengthening of the capital of banks.
(b) Provisions for closer and stronger supervision.
(c) More careful restriction of investments.
(d) Requirements for the truthful valuation of assets.
(e) Protection of depositors and limitation of their losses through
a liquidating corporation.
These provisions if acted upon in good faith by administrators
will do something to correct the insolvency situation, butfthere is ^
no denying the Fact that our banking system is going tnTbugh a (
period of great change and that the ultimate destination of the J
system is not yet fully clear. Because of that fact, provision for j
branch-banking powers under carefully qualified conditions with ( ^
a view to making a larger experiment with branch banking is deemed ! f %
essential and due provision for it is made. Specifically, what is J /
proposed is the grant of power to establish branches of national
banks not merely in the towns and cities in which they are located
but also outside of such limits at any point within the borders of
the State in which they exist, irrespective of State laws. Also, it
is proposed that if by reason of the proximity of a national bank to
a State boundary line the ordinary and usual business of the bank is
found to extend into an adjacent State, the Federal Reserve Board
may permit the establishment of a branch or branches in an adjacent
State but not beyond 50. miles from the place where the parent bank j
is locatedn No national bank is to be permitted, however, to establish:
a branch outside of the city, town or village in which it is local ed
unless it has a paid-in and unimpaired capital of not less than $500,000^
4. Strengthening of Federal reserve system.— TEe Federal reserveT
system has been seriously impaired of recent years and has wandered
far away from its original function. This is the result of many
complex conditions. Among these conditions has been the uncer­
tainty of policy in the matter of exercising plainly authorized control
by the central supervising authority at Washington and the tendency
to submit rather timidly to considerations of immediate expediency.
Among the reserve banks themselves there has been a decidedly
dangerous drift toward the conversion of the system into a medium
for transacting fma&cial rather than commercial business. Further,,
the establishment of understanding^
with foreign
central and other banks, and the attempt to carry out plans and
measures of a hazardous nature relating to discount rates and prob­
lems of technique, have had unfortunate results.
To reform these conditions the committee recommends:




12

NATIONAL AND FEDERAL RESERVE BAN KIN G SYSTEMS

(a) Improvement of membership, and increase of independence
of Federal Reserve Board.
(b) Restoration of the requirement that two members of the board
shall be men of experience in banking.
(c) Elimination of the Secretary of the Treasury from member­
ship.
td) Better definition of powers with respect to speculative trans­
actions, particularly as to authority over open market dealings, by
establishing a so-called “ open market committee” with designated
authority.
(e)
Definition of powers of the board in the management of foreign
affairs.
5. Protection oj bank depositors.— The great number of banks now
in the hands of receivers with assets which are said to aggregate
something like $2,500,000,000 has created a situation in which a very
large number of persons are unable to meet their obligations and
in which many business houses are embarrassed through inability to
get the use of their funds. In the natural course of events it would
be a long time before these conditions are very greatly relieved
through the liquidation of these closed banks. The continued post­
ponement of liquidation is a very heavy burden upon a large portion
o f the community. Furthermore, there is and can be no assurance
that further failures of considerable amount and number can be
avoided. They will from time to time recur even under the best
conditions. In order to provide against a repetition of the present
painful experience in which a vast sum of assets and purchasing
power is “ tied up,” we have recommended the creation of a Federal
liquidation corporation.
The proposal is that) this corporation shall have a capital stock con­
tributed by reserve banks to the extent of one-quarter of their present
surplus, or a sum of about $68,500,000, while member banks shall
subscribe to the extent of one-fourth of 1 per cent of total net out­
standing time and demand deposits or a sum of approximately
$75,000,000, so that the enterprise would have a subscribed capital
o f about $143,000,000. In addition, it is proposed that the Govern­
ment contribute $125,000,000 to the corporation as paid-in surplus,
and the corporation is empowered to issue notes, bonds, debentures,
and other such obligations in an amount equal to not more than twice
the sum of its capital and the amount appropriated out of Govern­
ment funds. The sum thus made available would be adequate to
deal with any probable failure conditions of the future. If the Govern­
ment should add to it a proportionate sum for the benefit of State non­
member banks it would be able to include their necessities along with
those of the system’s own members as a subject of treatment. The
corporation may be left free to invest its excess funds in the assets of
banks that have already failed before it came into existence and it
may thus materially help in clearing up the bad situation that has been
left as a result of the panic.
6. Emergency reliej.— Within recent months there has been a very
widespread demand for some means of furnishing emergency relief
to banks that are in difficult straits. The Federal reserve system was
intended to furnish a means of mutual aid and if properly admin­
istered was entirely adequate to the necessities of the case. However,
with conditions as they stand it is likely that some plan whereby




NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS

13

actual assistance could be furnished to banks which are willing to
stand sponsor for one another and thus enable them to clear up
danger spots in their own several communities would be helpful.
We therefore suggested such a plan as an additional means of strength­
ening and rendering useful the provisions of the Federal reserve sys­
tem. The general plan so recommended was founded upon the idea
of joint action by clearing houses or groups of banks in different lo­
calities designed for the purpose of getting accommodation on their
joint unsecured notes at reserve banks up to such amount as might be
held prudent; likewise, in exigent cases, relief was provided for indi­
vidual banks. Such emergency credit should be retired as soon as
possible, and therefore it seemed best to provide severe restrictions
upon its use and duration. This proposal was lifted from the body of
the bill as first prepared and has already been enacted into law. (See
Public No. 44, 72d Cong.)
TERMS OF BILL RECOMMENDED

Having thus outlined in general broad terms the main objects of
the new legislation, although without endeavoring to do more than
suggest the major features of the enactment, we think it best to
review the actual provisions of the accompanying measure point by
point in order to indicate the precise content of the various sections
and their main provisions:
Section 1.— Provides a shoft title for use in citation, for con­
venience in discussion, and for certainty of reference.
Section 2 .— Defines the language used in the bill and undertakes
to make the meaning definite.
Section 8 .— Places general restrictions upon the operating policy
of Federal reserve banks with the intent to limit them to the exten­
sion of credit for ordinary business purposes and to make plain that
their resources are not to be used to support speculation. The
Reserve Board is given power to oversee and direct such use of the
resources of banks.
This section also provides that where two or more member banks
are affiliated with the same holding company, they may participate
in the nomination and election of directors of the Federal reserve
bank in their district through one of the banks to be designated for
that purpose by the holding company.
Section 4 -— Amends the first paragraph of section 7 of the Federal
reserve act so as to eliminate the requirement of the payment of
a franchise tax to the United States by Federal reserve banks.
Section 5 .— Provides for reports of condition of affiliates of State
member banks and for the examination of all such affiliates by exam­
iners selected or approved by the Federal Reserve Board.
The section also subjects State member banks to the same limita­
tions and conditions with respect to the purchasing, selling, under­
writing, and holding of investment securities and stock as are appli­
cable in the case of national banks. (See sec. 14.)
It is also provided that after three years from the date of enactment
of the bill no certificate representing the stock of a State member
bank shall represent the stock of any other corporation except a
member bank nor be conditioned in any manner whatsoever upon the




14

NATIONAL ANI) FEDERAL RESERVE B AN KIN G SYSTEMS

ownership, sale, or transfer of a stock certificate of any other cor­
poration except a member bank. This corresponds to the provision
in section 16 which is applicable to national banks.
Section 6 .— Provides for eliminating the Secretary of the Treasury
as a member of the Federal Reserve Board and restores the former
requirement that two members of the board shall be men of tested
banking experience. It also readjusts the term of members of the
board so as to secure as nearly as possible the expiration of terms of
members at equal 2-year intervals.
Section 7 .— Adds a new section 12A to the Federal reserve act
providing for the creation of a Federal open-market committee of
12 members to supervise the open-market operations of the Federal
reserve banks and the relations of the Federal reserve system with
foreign banks. This :in effect legalizes and gives official recognition
to the present open-market committee.
This section also adds to the Federal reserve act a new section 12B
providing for a Federal liquidating corporation which is given power
to liquidate the assets of member banks which have been closed by
action of the Comptroller of the Currency, the appropriate State
authorities, or by vote of their directors. The management of the
corporation is vested in a board of five directors consisting of the
Comptroller of the Currency, a member of the Federal Reserve Board,
and three persons chosen annually by the governors of the 12 reserve
banks. The capitalization of the corporation has already been
referred to. (See p. 12.)
Section 8 .— Imposes certain limitations upon advances by Federal
reserve banks to member banks on their 15-day promissory notes.
It is provided that if, during the life of any such advance and despite
an official warning of the Federal reserve bank or the Federal Reserve
Board to the contrary, any member bank increases its outstanding loans
made to members of any organized stock exchange, investment house,
or dealer in securities for the purpose of purchasing or carrying stocks,
bonds, or other investment securities (except obligations of the
United States) the advance to the member bank shall be immediately
due and payable and the bank shall be ineligible as a borrower on
15-day paper for such period as the Federal Reserve Board shall
determine.
Section 9 .— Gives the Federal Reserve Board power to supervise
all relations and transactions of any kind entered into by Federal
reserve banks with foreign banks or bankers.
Section 10.— Prohibits member banks from acting as the medium
or the agent of any nonbanking corporation, partnership^ association,
business trust, or individual in making loans on the security of stocks,
bonds, and other investment securities to brokers or dealers in such
securities.
Section 11.— Imposes certain limitations upon loans or extensions
of credit by member banks to their affiliates and also limits the
amount which such banks may invest in the securities of such affili­
ates. In general, the maximum limit is 10 per cent of the capital
stock and surplus of the member bank in the case of any one affiliate
and 20 per cent of the capital stock and surplus in the case of all
such affiliates. It is also required that each such loan or extension
of credit be secured by collateral having a market value of at least 20
per cent more than the amount of the loan or extension or at least 10




NATIONAL AND FEDERAL RESERVE B AN K IN G SYSTEMS

15

per pent more than the amount of the loan or extension if it is secured
by obligations of any State or political subdivision of a State. The
provisions do not apply, however, to loans or extensions of credit
secured by obligations of the United States, the Federal intermediate
credit banks, the Federal land baiiks, or by paper eligible for rediscount
or purchase by Federal reserve banks. Certain types of affiliates
are also exempted from the application of the provisions of this
section.
Section 12.— Adds a new section 24A to the Federal reserve act
which imposes a maximum limit upon the amounts which national
banks and State member banks may invest in bank premises or in the*
stock, bonds, debentures, or other such obligations of a corporation
holding the premises of any such bank, and the amounts which such
banks may lend to any such corporation.
Section 13.— Provides that all suits of a civil nature to which any
corporation organized under the laws of the United States shall be a
party, arising out of transactions involving international or foreign
banking, shall be deemed to arise under the laws of the JJnited States,
and the district courts of the United States are given original juris­
diction of all such suits. It is also provided that a defendant in any
such suit may at any time before the trial thereof remove the suit
from a State court to a Federal district court in the same manner as
now provided by law for the removal of other suits.
Section H .— Undertakes to broaden the national banking laws by
giving national banks all powers possessed by State banks of deposit
and discount organized in the States in which such national banks are
located, except m so far as they may be prohibited by Federal legis­
lation. National banks are to be permitted to purchase and sell
investment securities for their customers to the same extent as here­
tofore, but hereafter they are to be authorized to purchase and sell
such securities for their own account only under such limitations and
restrictions as the Comptroller of the Currency may prescribe, subject
to certain definite maximum limits as to amount.
Section 15.— Provides for the amount of capital of national banks
depending upon the population of the places where they are to be
located and also prohibits the admission of a bank into the Federal
reserve system unless it possesses a paid-up unimpaired capital
sufficient to entitle it to become a national bank.
Section 16.— Provides for separating the certificates representing
ownership in national banks and ownership in affiliates other than
member banks so that in the future they will not be written upon a
single certificate of ownership. This corresponds to the provision
contained in section 5 of which is applicable to State member banks.
Section 17.— Provides for the voting of national-bank stock held by
holding companies under voting permits obtained from the Federal
Reserve Board. Certain limitations are imposed upon such holding
companies which they must agree to comply with at the time the voting
permits are obtained. These limitations relate chiefly to examina­
tions, reports of condition, reserve requirements, and ownership and
control by holding companies of organizations engaged in the issuance,
underwriting, and distribution of securities. These provisions are
also made applicable to holding companies affiliated with State
member banks. (See sec. 3.)




16

NATIONAL AND FEDERAL RESERVE BAN K IN G SYSTEMS

Section 18.— Provides for ©liminating after a period of three years
all affiliations by member banks with corporations, associations, busi­
ness trusts, or'other similar organizations engaged principally in the
issuance, underwriting, or distribution of securities.
Section 19.— Authorizes national banks to establish branches at any
place within the States in which such banks are located, and alsa
allows the establishment of branches in adjacent States under cer­
tain conditions, subject to the approval of the Federal Reserve'
Board, but not beyond 50 miles from the seat of the parent bank.
No such association is to be permitted, however, to establish a branch
outside of the city, town, or village in which it is located unless it has
k paid-in and unimpaired capital of not less than $500,000.
Section 20.— Amends the act of November 7, 1918 (relating to the
consolidation of national banks), to the extent necessary to carry
out the policy provided for in section 19.
Section 21.—Limits the interest that may be charged by a national
bank to that which may be charged by local banks in the State where
the national bank is located, or to a rate 1 per cent higher than the*
discount rate on 90-day commercial paper in effect at the Federal
reserve bank in the district where the national bank is located, which­
ever is greater. If no rate is fixed by State law, the maximum rate
the national bank may charge is limited to 7 per cent, or 1 per cent in
excess of such discount rate, whichever is greater.
Section 22.— Provides that in estimating the total amount of loans
which may be made by a national bank to a corporation, the obliga­
tions to the bank of all subsidiaries of the corporation in which it
owns or controls a majority interest are to be counted.
Section 28.— Provides for reports of condition of all types of affiliates
of national banks. This corresponds to the provisions of section 5
which are applicable to affiliates of State member banks.
Section 2%.— Relates to the examinations of affiliates of national
banks. There is a corresponding provision in section 5 relating to*
affiliates of State member banks.
Section 25.— Provides for the removal from office of directors and
officers of member banks who have continued to violate the bankinglaws or who have continued unsafe and unsound banking practices,
after being warned by a Federal reserve agent or the Comptroller
of the Currency.
Section 26.— Reserves the right to alter, amend, or repeal the act
and provides for separability of its provisions in case any part of the
act is held invalid.
The changes which are thus suggested are considered to repre­
sent essential matters called for in the interest of immediate im­
provement of present conditions and the avoidance of financial
dangers and there is none of them which can wisely be omitted.
All afford solutions that have been indicated by investigators in
many quarters as unavoidable and all are thought urgent for the
purpose of correcting or eliminating actual hazards.




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