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Calendar No. 79
73d C ongress
1st Session
)
SENATE
J
J
R eport
(
No. 77
O P E R A T IO N OF T H E N A T IO N A L A N D F E D E R A L R E SE R V E
B A N K IN G SY ST E M S
M ay
15 (calendar day, M ay 17), 1933.— Ordered to be printed
M r. G la s s , from the Committee on Banking and Currency, submitted
the following
REPORT
[To accompany S. 1631]
The Senate Committee on Banking and Currency has had under
consideration S. 1631, “ 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 certain amendments with the
recommendation that the bill be passed.
The bill thus reported is similar in its main aspects to the bill
S. 4412, which was passed by the Senate during the last session of
Congress and which was the result of extensive hearings by a duly
authorized subcommittee of the Banking and Currency Committee
of the Senate and 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 these banking systems with
respect to the use of their facilities for trading in and carrying speculative secuiities; 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
t ie national system, together with any related problems which the committee
may think it important to investigate.
2
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
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
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 deemt*
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, represeating the banking, financial, and technical elements in
the community, who either indicated a desire to 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
wer§ so great that it was wise to defer the preparation of a completer^
comprehensive measure for the reconstruction of our FanTang system,
silch 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 far-reachingjoieasure necessitating a long postponement of action. *
The immediate measures of reform aiid rectification are, how
ever, quite important. They include th» 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 disc ussion from causes to the immediate effects of what
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
3
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.
INFLATION OF BANK 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 in 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 the 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 EXPANSION
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 post-war earnings, which were retained from
stockholders instead of being paid out as dividends.
4
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
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.
USE OF PROCEEDS OF N EW 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 thus
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 they 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.
TH E GROWTH 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 instrument
known as “ the bank ed acceptance.” In its original purpose this form
of lending was intended to include only unquestionably liquid obliga
tions, 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 instrument which
was originally adopted in the Federal Reserve Act, and on which
the use of the instrument by the Federal Reserve Sj^stem 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 immediately
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 source. The use of the acceptance to supply what was called
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
5
“ 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,
however, were after all comparatively minor, the real dangers of the
acceptance being exhibited in connection with the stretching of the
definition of various transactions so as, for instance, to include storageof 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 boorti, 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, for the purpose of discussing
ways and means of dealing with the German credit situation.
BANK
IN S O L V E N C IE S
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
6
NATIONAL AND FEDERAL RESERVE BAN KIN G SYSTEMS
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
role played by these insolvencies in preparing the way for the gen
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. During the year 1932 and the first two months of
1933 nearly 1,850 additional banks suspended operations. Bank
failures cannot 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 suspensions 19S1-8S%preliminary figures
All banks
Num
ber
Deposits
Year 1931, total............ 2,290 $1,759,000,000
Last quarter of 1931... 1,049
866,000,000
478.000.000
522
October, 1931.................
November, 1931............
174
69,000,000
December, 1931............
353
319.000.000
Year 1932, total______ 1,456
715.626.000
Last quarter of 1932...
345
151.554.000
October, 1932.................
97
21.899.000
46.322.000
95
November, 1932...........
83.333.000
December, 1932..........
153
January, 1933................
142.719.000
237
February, 1933.............
72.870.000
148
National banks
Num
ber
Deposits
410 $473,000,000
199 244.000.000
100 116.000.000
35
28,000,000
64 100,000,000
276 214,150,000
58
46.932.000
20 6,603,000
19
26.475.000
19
13.854.000
43
55.921.000
20 15.881.000
State-bank
members
Num
ber
Deposits
108 $302,000,000
51 155.000.000
25 118.000.000
8 4,000,000
18
33,000,000
55
55.153.000
10 11.354.000
6
4
15
7
3.519.000
7.835.000
14.798.000
7.788.000
Nonmember
banks
Num
ber
Deposits
1,772 $984,000,000
799 467.000.000
397 244.000.000
131
37.000.000
271 186.000.000
1,125 446,323,000
277
93.268.000
15,29f, 000
77
70
16.328.000
130
61.644.000
179
72.000.000
121 49.201.000
STOCK-EXCHANGE SPECULATION
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
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
7
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.
INFLUENCE OF PUBLIC FINANCE
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
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 sub
sequent depression 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
encourage such members in developing frozen portfolios.
RE AL-ESTATE INFLATION
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 over-expansion 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.
8
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
PROBLEMS OF R E SE R V E
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, notwith
standing 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 and the gold reserve which
the Reserve banks themselves carry. This ratio or relationship has
shown continuous tendency to decline. The great gold movements
of the past year and a half and the liquidation of many banks have
somewhat changed the situation, but it has continued 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 collapse 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 stand
ard in the summer of 1931. The question of reserve policy is an
involved and complex one on which your committee took much
testimony and also pursued an extended study whose results are
stated, in the words of the Reserve banks themselves, in part 6 oi
the hearings (appendix). So fully are the facts there reviewed and
so authoritatively are they stated by the Reserve-bank authorities
that it has not been thought necessary to enlarge more fully upon
the situation in this report.
CONDITION OF M EM BER B A N K S
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
of 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,
and 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 tliree 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 ^really^ fefnphasized 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 madeT} 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
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
9
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).
ANALYSIS OF PRESENT BANKING PROBLEM
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:
1.
Bank loans and their uses.-M.t is evident from what has been
said that the underlying factor m 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.
(а) 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’ loans.” These
are merely a special form of securities loan in whfeh a bank or com
mercial 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
(^taingd frojm “.athj^s ’’ is^a separate and’ especiaily difficult aspect of
~
t&sprohlem,.......
(б) It seems clear that any remedial measure, of legislation should
seek to provide some check upon the abnormal growth of all security
ioaas. at banks as well as seek to limit the loans to brokers, especially
tho&e loans originating with “ others/’ Such legislation, if successful,
should operate to lessen the danger'of a repetition of the experience
of 1929. i i j s oftenjsugge^
of this form of credit ought
tQ .^ e^ e^ cted m 'son ^ w ^
stock exchanges?"' Whj|.tfiYer^may
be. thoji^Tit~~oF~tliat method of approaching theTsubjecF, it is at all
events certauTthat notKng of the ki&djwould be likely to succeed
witlrouT'adequaXe banking control, while on the other hand, banking
e o n tro '^ ofl^
ameliorate conditions in thia.field oTcredit.
( c )T he Kn e of reasoningTEus 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,
s p e c u l a t i v e l u y k e TToans bv"15orporations engaged nTIndustrial or
business enterprises.
* 2 . Banking affiliated.—There seems to be no doubt anywhere that
a large factor in the overdevelopment of security loans, and in the
10
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
dangerous use of the resources of bank depositors for the purpose of
malang 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
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 present 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 banlring in operation in
some parts of the United States, working, in 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. /T he evils of indirect control
are similar in the two cases, and they m aylead to similar abuses, as
is seen when it is noted that holding companies also usually control
companies organized for security financing. However, such com
panies have in some parts of the United States become well rooted,
and the difficulty of eliminating or abolishing them in any effective
way is 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 companies on 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
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
11
o f 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
owned by such a company should go into the hands of receivers or
be closed.
(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 of 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 remed3r 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 enumerate as foilows:
(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 bank deposit insurance corporationr
These provisions if acted upon in' good faith by administrators
will do something to correct the insolvency situation, but there is
no denying the fact that our banking system is going through a
period of great change and that the ultimate destination of the
system is not yet fully clear. Because of that fact, provision for
branch-banking powers under carefully qualified conditions with
a view to making a larger experiment with branch banking is deemed
essential and due provision for it is made. Specifically, what is
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, if such establishment is expressly author
ized to State banks in such State. The branches so established are
also to be subject to the restrictions as to location imposed by the
law of the State upon State banks and no national bank is to be per
mitted to establish a branch outside of the city, town, or village in
which it is located unless it has a paid-in and unimpaired capital of
not less than $500,000; except that in States with a population of less
than 1,000,000 and with no cities with a population exceeding 100,000>
the minimum capital requirement for the association is fixed at
$250,000.
4. Strengthening of Federal Reserve System.— The Federal Reserve
System has been seriously impaired of recent years and has wandered
12
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
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 financial rather than commercial business. Further,
the establishment of understandings or agreements 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:
(a) Increase of independence of Federal Reserve Board.
(b) Better definition of the powers of the Board with respect to
speculative transactions, particularly as to authority over open
market dealings, by establishing a so-called “ open market committee”
with designated authority.
(c) 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 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
of the community. In order to provide against a repetition of the
present painful experience in which a vast sum of assets and purchas
ing power is “ tied up” , we have recommended the creation of a
Federal bank-deposit insurance corporation to liquidate the assets of
closed member banks of the Federal Reserve System and, on and
after July 1, 1934, to insure the time and demand deposits of such
banks which have subscribed to stock of the corporation.
The proposal is that this corporation shall have a capital stock
contributed by the Federal Reserve banks to the extent of one-half
of their surplus on January 1, 1933, or a sum of about $175,000,000,
while each member bank shall subscribe to stock of the corporation to
the extent of one-half of 1 percent of its total deposit liabilities, or a
sum of approximately $175,000,000, so that the enterprise would
have a subscribed capital from those two sources of about $350,000,000.
In addition, it is proposed that the Government subscribe for $150,000,000 of stock of the corporation, and the corporation is to be
permitted to issue tax-exempt notes, bonds, debentures, and other
such obligations in an amount aggregating not more than twice the
amount of its capital. Payment of the net amount due a depositor in
a closed member bank which has subscribed to the stock of the cor
poration is to be made by the corporation up to 100 percent where
the net amount of the deposit does not exceed $10,000. If the net
amount of the deposit exceeds $10,000 but does not exceed $50,000,
the corporation is to pay 75 percent of the amount of the deposit
between these two limits, and if the net amount of the deposit exceeds
$50,000, the corporation is to pay 50 percent of such excess.
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
13
6.
Emergency relief.— One provision of the bill as first prepared which
was suggested as an additional means of strengthening and rendering
useful the provisions of the Federal Reserve System and of furnishing
emergency relief to banks in difficult straits, has already been enacted
into law (see Public, No. 44, 72d Cong.). The general plan recommend
ed in this provision was founded upon the idea of joint action by
clearing houses or groups of banks in different localities for the pur
pose of getting accommodation on their joint unsecured notes at the
Federal Reserve banks up to such amount as might be held prudent;
likewise, in exigent cases, relief was provided for individual 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.
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 short title for use in citation, for conven
ience 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.— Amends section 9 of the Federal Reserve Act so as to
extend the privileges of membership in the system to Morris Plan
banks and other incorporated banking institutions engaged in similar
business, and to mutual savings banks having no capital stock and
any other banking institutions the capital of which consists of segre
gated weekly or other time deposits.
Provision is also made 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. 16).
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
20366 0 — 58------ 20
14
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
bank shall represent the stock of any other corporation except a
member bank or an existing corporation engaged solely in holding
the bank premises of the bank, nor be conditioned in any manner
whatsoever upon the ownership, sale, or transfer of a stock certificate
of any other corporation except a member bank. This corresponds
to the provision in section 18 which is applicable to national banks.
Section 6.— Readjusts the term of members of the Federal Reserve
Board so as to secure as nearly as possible the expiration of terms of
members at equal 2-year intervals; and leaves to the Board the deter
mination of its own internal management policies.
Section 7.— Confers upon the Federal Reserve Board the power to
fix from time to time the percentage of individual member bank capital
and surplus which may be represented by loans secured by stock or
bond collateral.
Section 8.— 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 oi the Federal
Reserve banks and the relations of the Federal Reserve System with
foreign banks, in accordance with regulations adopted by the Federal
Reserve Board. 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 bank deposit insurance corporation which is
to insure, on and after July 1, 1934, the time and demand deposits of
all member banks and of all banks which have applied for member
ship in the system whose applications have not been acted upon.
The insurance is to extend to 100 percent of the first $10,000 of the
individual deposit, 75 percent of the next $40,000, and 50 percent of
the amount in excess of $50,000; and provision is made for the expe
ditious payment of the insurance and the winding up of the affairs
of closed banks. 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 capitaliza
tion of the corporation has already been referred to. (See p. 12.)
Section 9.— 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 imme
diately 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.
The section also repeals the provisions of existing law which
empower a national banking association located in a place having a
population of not more than 5,000 inhabitants to act as the agent
of an insurance company.
Section 10.— 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.
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
15
Section 11.— 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.
The section also prohibits the payment by any member bank of
interest on, demand deposits, and gives the Federal Reserve Board
the power to regulate the rate of interest which may be paid by mem
ber banks on time deposits. It also amends the law relating to postal
savings depositories so as to provide that all deposits in such deposi
tories shall be for a period of not less than 60 days, and that no such
deposits may be withdrawn prior to the expiration of such 60-day
period.
Section 12.— Prohibits any executive officer o|f a member bank
from borrowing from the bank of which he is such officer, prohibits
member banks from making loans to their executive officers, and
provides for the making of a written report by any executive officer
of a member bank of the amount in which he may be indebted to
any other member bank. Penalties are provided for the violation of
any of the provisions of this section.
Section 13.— 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 percent of the capital
stock and surplus of the member bank in the case of any one affiliate
and 20 percent 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
percent more than the amount of the loan or extension or at least 10
percent 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 banks, or by paper eligible for redis
count or purchase by Federal Reserve banks. Certain types of
affiliates are also exempted from the application of the provisions of
this section.
Section 14-— 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 corporal
tion holding the premises of any such bank, and the amounts which
such banks may lend to any such corporation.
Section 15.— 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 United 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.
The section also makes the same provisions with respect to juris
diction over all suits of a civil nature to which any Federal Reserve
16
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
bank shall be a party. It also prohibits the issuance of attachment
or execution against any Federal Reserve bank or its property before
final judgment in any suit, action, or proceeding in any State, county,
municipal, or United States court.
Section iff.— 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 in 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
restriction as the Comptroller of the Currency may prescribe, subject
to certain definite maximum limits as to amount. The limitations as
to dealing in investment securities are not to take effect until two
years after the approval of the act.
Section 17.— 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 18.— Provides for separating the certificates representing
ownership in national bank^ and ownership in affiliates other than
member banks or existing corporations engaged solely in holding the
bank premises of the affiliated national bank 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 which is applicable
to State member banks.
Section ./S.-^Provides for cumulative voting of shares of nationalbank stock in the election of directors and for the voting of nationalbank 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 examinations, 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. 5.)
Section 20.— Provides for eliminating after a period of two years all
affiliations by member banks with corporations, associations, business
trusts, or other similar organizations engaged principally in the
issuance, underwriting, or distribution of securities.
Section 21.— Makes it unlawful after a period of two years (1) for
any person or institution engaged principally in the issuance, under
writing, or distribution of securities, to receive deposits; and (2) for
any person or institution other than a banking institution or private
banker subject to examination and regulation under State or Federal
law, to engage in the business of receiving deposits, unless such
person or institution shall submit to examination by the Comptroller
of the Currency or by Federal Reserve bank officials, and shall make
and publish periodical reports of its condition.
Section 22.— Authorizes national banks, subject to the approval of
the Comptroller of the Currency, to establish branches at any place
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
17
within the limits of the city, town, or village, or at any point within
the State in which the national bank is situated, if the establishment
and operation are expressly authorized to State banks by the law of
the State in question, and subject to restrictions as to location im
posed by such law on State banks. 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 a paid-in and unimpaired
capital of not less than $500,000; except that in the case of an associa
tion situated in a State with a population of less than 1*000,000 and
with no cities of more than 100,000, the required capital shall be
$250,000.
Section 23.— 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 21.
The section also amends such act with respect to the property
rights and the duties and powers of consolidated national banking
institutions.
Section 24.— 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 percent higher than the
discount rate on 90-day commercial paper in effect at the Federal
Reserve bank in the district where the national bapkis 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 percent, or 1 percent in
Ipxcess of such discount rate, whichever is greater.
' Section 25.— 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 but it does not
apply to obligations held by a national bank on the effective date of
the act.
Section 26.— 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 27.— 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 28.— Permits the Comptroller of the Currency to authorize
a national bank which has been closed to resume business if the de
positors and unsecured creditors of the bank representing at least 85
percent of its total deposit and unsecured credit liabilities consent in
writing to the retention by the bank of such part of its deposits as
the Comptroller deems necessary.
Section 29.— Provides for the removal from office of directors and
officers of member banks who have continued to violate the banking
laws or who have continued unsafe and unsound banking practices
after being warned by a Federal Reserve agent or the Comptroller
of the Currency.
Section 30.— Requires every member bank to have a board of direc
tors consisting of not less than five nor more than 25 members, and
that every member of the board shall be a bona fide owner of stock of
the bank having a par value of at least $2,000.
18
NATIONAL AND FEDERAL RESERVE BANKING SYSTEMS
Section 81.— Provides that no officer or director of a member bank
shall be an officer, director, or manager of any institution engaged
primarily in the business of purchasing, selling, or negotiating secu
rities, that no member bank shall act as a correspondent bank for any
such institution, and that no individual, partnership, corporation, or
unincorporated association shall act as correspondent for any member
bank unless a permit therefor is issued by the Federal Reserve Board.
The issuance and revocation of any such permit rests with the dis
cretion of the Board.
Section 82.— Amends the Clayton Act to provide that no director,
officer, or employee of any bank, banking association, or trust com
pany organized or operating under the laws of the United States shall
be at the same time a director, officer, or employee of a corporation
or a member of a partnership which shall make loans secured by stock
or bond collateral.
Section SS.— Permits national banks to hold stock in corporations
organized by them for the purpose of liquidating such of their assets
as have been ordered liquidated by the Comptroller.
Section 84-— 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.
o
@FedFRASER