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THE WORK OF THE FEDERAL DEPOSIT INSURANCE CORPORATION By Edison H. Cramer, Chief, Division of Research and Statistics, Federal Deposit Insurance Corporation. Class in Money and Banking Department of Economics University of Colorado Boulder, Colorado May l6, 1950 THE WORK OF THE FEDERAL DEPOSIT INSURANCE CORPORATION Professor Joseph Dorfman of Columbia University is the author of a monumental Civilization." study entitled, The Economic Mind in American I would like to open my remarks today with a quotation from one of the early chapters in his first volume. Aftex summarizing the views of William Penn and several of his contemporaries on methods of providing the colonies with an adequate supply of money, Dorfman remarks. "So the seventeenth century "bequeathed to the eighteenth an enduring controversy on problems of money and trade, and around these would center, as before, all other economic issues." l/ This controversy was not settled in the eighteenth century, but was bequeathed in turn to the nineteenth, and then to the twentieth. Today, we are passing it on from the fxrst half of the twentieth century to the second. Joseph French Johnson appears to have been right when he said, in a book published in 1905* Men do not and probably never will thoroughly understand the relation between money and goods." 2/ For at least a century this problem of money has been primarily concerned with the operations of banks of deposit. banks of deposit. The obligations of The obligations of banks in the form of deposits now constitute the great bulk of the circulating medium which moves through society as the agent or carrier of trade, in much the same way that the blood stream courses through the body when the cells take in nutriments and discard their wastes. 17 Banks, as the manufacturers and purveyors of .Tnfifiph Dorfman, The Economic Mind in American Civilization, Vol. One (New York; The Viking Press, 19^&) > P* 2/ Joseph French Johnson, Money and Currency, (Boston: 1905)7 P- 165. n Gxnn and Co., 2 circulating medium, occupy as strategic a position in the economic structure of the nation as does the marrow of the bones in providing the human body ■with the corpuscles for its blood. Banks, because of this unique function in society, necessarily stand somewhat apart from other types of business enterprise, and require guidance from the governing authority of the nation. As we go back through the economic issues which have also been political issues and have aroused intense controversy throughout the country there is no other problem which has been so persistent or recurrent as the problem of what to do about tanks in order that they will provide the nation with a circulating medium suitable in quality and quantity--good enough so that it is acceptable everywhere, and always in the quantity needed for economic progress and stability, neither too much nor too little. When the banking/' system has failed disastrously to fulfill this function, Congress has per formed a surgical operation upon it, or has provided a new agency of the Government itself to assist the system in its functioning--for the purpose, of course, of avoiding a recurrence of a banking debacle. origin of the Federal Deposit Insurance Corporation. Such was the The insurance of bank deposits, in essence, is just one more device in our centuries of effort to provide a circulating medium which is always good. The principal operations of the Federal Deposit Insurance Corpo ration, as assigned to it by the Banking Acts of 1933 and 1935 and as they have developed, may conveniently be placed in four groups. The first of these is the replacement of deposits which are no longer sound because the bank which created them has failed or is in difficulty and in danger - 3 - of failure. This replacement process includes paying off the deposits of the failed bank, up to $5,000 for each depositor, or arranging for assumption of the deposits by another bank, and liquidation of the assets acquired by the Corporation in extending this protection to depositors. The second is the improvement of banking operations and the maintenance of operating banks in a condition such that failure is unlikely. The third group covers the actions of the Corporation with respect to particular banks-»those which wish to become insured or to open new branches or to retire capital or to assume the obligations of a noninsured bank. The fourth group includes studies of banking legislation, the circumstances under which bank failures have occurred in the past, and the relation of banking operations to business fluctuations. I would like to make a few comments about each of these four aspects of the operations of the Corpo ration. Payment of depositors and handling of assets of banks in difficulty During the sixteen years of operation of the Corporation, ^-11 insured banks have required its financial aid. The depositors in these banks numbered 1,350,000, and at the time when the Corporation’s aid was given, they owned deposits of more than $528 million. The Corporation’s disbursements in connection with these banks amounted to $315 million, or about three-fifths of the amount of the deposits in the banks. This ligure of disbursements includes incidental expenses incurred by the Corporation in connection with the ^-11 cases, but does not include the regular operat ing expenses of the Corporation. More than half of the banks requiring financial aid of the Corporation suspended operations and were placed in receivership. In these cases the Corporation paid the depositors the amount of their deposits, up to the limit of the insurance protection, and became entitled to a corresponding share in the dividends paid by receivers as the assets of the defunct banks were liquidated. Since 1935 the Corporation has had an alternative method of handling banks in difficulty. If the bank which is in trouble can be merged with another bank and it is estimated that -fckis will reduce or avert the loss to the Corporation, a loan to or purchase of assets from the bank may be made by the Corporation. When this is done the absorbing bank assumes the deposits of the failing bank and takes over such assets from that bank as are considered acceptable. The Federal Deposit Insurance Corporation provides cash equal to the difference between the deposits assumed and the value of the assets taken over, and by purchase or collateral acquires the assets of the failing bank which are not acceptable to the absorbing bank. this method has been used exclusively. In recent years No insured bank has been placed in receivership since May 19^* • If a bank which is placed in receivership is a national bank the law provides that the Comptroller of the Currency must appoint the Corporation as receiver. The Corporation may also accept an appointment as receiver in the case of a state bank if it is offered. In these cases the Division of Liquidation of the Corporation is responsible for liquidat ing all assets of the defunct bank and of distributing the proceeds there from to itself and to the depositors whose balances were larger than $5,000. In the merger cases the Division of Liquidation has charge of the assets which have been acquired. - 5 - In planning the disposal of assets acquired in receivership and merger cases, representatives of the Division of Liquidation examine each asset to see what is the best method of disposing of it., and as fast as is feasible prepare their recommendations. These recommendations are presented by the chief of the Division to a committee of the Corporation; consisting of one member of the Board of Directors, special assistants to members of the Board of Directors, and chiefs of the policy-making divisions. This Committee normally meets twice a week and considers a substantial number of items at each meeting. As would be expected., the Committee approves the recommendations for most of the items, but occasionally members of the Committee feel that an alternative method of handling an asset would be better. In some cases it is necessary to refer items to the Legal Division for careful study and recommendation. Items approved b;y the Committee are submitted to the Board of Directors of the Corporation for final approval. When this is given, the Division of Liquidation proceeds with the sale or other method of handling the assets. Of the $315 million that the Corporation has disbursed in the 411 banks, $287 million have been recovered from the liquidation of the assets of the banks. The assets which the Corporation now holds that have not yet been liquidated--consisting chiefly of assets acquired in the most recent cases--are appraised on the books of the Corporation at about $3 million, the amount which is expected to be recovered from them. The remainder of the amount disbursed; which is $25 million, is the loss which the Corporation has incurred on the assets of which it has disposed and expects to incur on those which it still holds. - 6 - Maintenance of Banks in a Sound Condition The protection of deposits of banks which fall into trouble is the primary responsibility placed upon the Corporation by the deposit insurance law. The maintenance of insured banks in so sound a condition that they are unlikely to fall has become the major responsibility of the Corporation in terms of its annual expenses and the time of its staff. The Corporation's policy is to examine once each year each insured bank which is not examined by the Comptroller of the Currency or a Federal Reserve bank. This means that the Corporation examines about half of the banks that are insured. Examination of these banks is the responsi bility of the Corporation’s Division of Examination, which, as you know, has twelve regional offices. In addition to the examiners which are located at these regional offices, the Division of Examination has a small staff of review examiners in Washington. The duties of the review examiners include review of the reports of examinations of insured banks made by the Comptroller and Federal Reserve banks, and also preparation oi memoranda regarding banks applying for admission to insurance or other cases on which the Board of Directors is required to take action. the end of 19^9 the personnel of the examining division was At 719 > or two-thirds of the entire personnel of the Corporation. As bankers you are familiar with the bank examining process and are probably also conversant with the efforts the Corporation has made to improve it. The process, as you know, consists largely of classiiying the assets of the bank in order to call attention to those which might lead to loss. The bulk of this work is, of course, done by the examiners - 7 themselves. However, in the case of one group of assets, that of municipal obligations, the basic work on classifying or evaluating assets is done by the staff of the Corporation located in Washington. qP The securities unit the Division of Research and Statistics is constantly surveying the status of cities, counties, and other political subdivisions in order to appraise the riskiness of obligations which have been or may be issued by those political subdivisions. These evaluations of municipal obliga tions are utilized by the examiners in their judgment regarding the suitability and quality of the assets of this type in the banks that are being examined. Another phase of the work of the Corporation, which involves a comparatively small number of banks but is an essential part of its efforts to maintain banks in a sound condition, relates to cases where banks continue to engage in unsafe or unsound practices or violation of law after appropriate warning by the examiners. Under the permanent plan of deposit insurance adopted by Congress in 1935; the Corporation has the power to terminate the insurance of any bank which continues to engage in unsafe or unsound practices or violations of law. The Corporation has taken action against 1^2 banks under this provision, which is an average of about ten cases a year. In 19^9? action was initiated in only one case. In most cases where action under this provision of the deposit insurance law becomes necessary the bank is engaged in many types of banking practice which are unsafe or unsound. These practices include operation of the bank in an insolvent condition or with inadequate or - 8 » seriously impaired capital, continued holding of assets in violation of lav or of excessive amounts of substandard assets, lax loan and invest ment procedures, and failure of bank directors and officials to properly exercise their functions. The specific practices in which the lk2 banks vere engaged which have been listed in the Annual Reports of the Corpo ration to Congress; and each Annual Report has a table shoving the dis position of the cases. Actions on Requests from Banks Since the permanent plan of deposit insurance vent into effect in 1935 the Corporation has acted on more than 1,700 applications of banks for admission to insurance. a week. This is an average of two and a half cases Of these, more than 1,500 vere approved for insurance. than 200 cases vere disapproved. Less The deposit insurance law requires an insured bank which is not a member of the Federal Reserve System to obtain the approval of the Corporation to establi-sh a branch or to reduce its capital. The Corporation has acted on nearly 1,000 applications of banks for permission to establish branches or to continue branches already in operation at the time of admission to insurance. Of these, over 900 were approved. For the most part the applications of banks for approval of retirement of capital obligations relate to retirement of capital stock or debentures purchased by the Reconstruction Finance Corporation after the banking debacle of 1933* applications from about In recent years the Corporation has considered 500 banks a year, an average of about 10 a week, for retirement of specified amounts of capital. This process is now be ginning to approach an end, since a large proportion of the banks which had such capital have retired the entire amount. - 9 - Applications from banks for these various purposes are made on forms provided by the Corporation and submitted through the supervising examiner of the district where the bank is located. The supervising examiner arranges for such examination as is necessary to provide a basis for judgment on the merits of the request, and contacts the State banking commissioner to ascertain his opinion. The recommendation of the supervising examiner is forwarded to Washington where the application is reviewed by one of the review examiners, and referred, with the recommendations of the supervising examiner and the review examiner, to a committee of the Corporation called the Board of Review. The composition of the Board of Review is similar to that of the Committee on Liquidations, and the membership of the two committees is largely, but not entirely, identical. This committee also meets twice a weekj in fact the meetings of the two committees are held at the same sessions. Studies of Banking Legislation and Banking Problems The original deposit insurance law in 1933 provided for a permanent insurance plan under which banks were expected to subscribe to the capital of the Corporation. once. This plan was not put into operation at In the meantime protection of deposits was afforded by a temporary plan of insurance. After the Corporation was established, its staff studied the legislation and concluded that the permanent plan of insurance could be substantially improved. The temporary plan was extended by Congress until the Corporation could complete preparation of its recom mendations. 10 The revised plan for permanent insurance of deposits was included in the Banking Act of 1935, and only minor changes have been made in the deposit insurance law since that time. Recently, the Corporation has reviewed the deposit insurance plan adopted at that time in the light of the experience of the intervening years and the great growth in hank deposits which occurred during the recent war. The recommendations of the Corporation were embodied in a draft of a bill which covers the entire deposit insurance law. This bill has been considered by the Banking and Currency Committee of the Senate and after some modifications by the Committee was passed by the Senate. by the House Banking and Currency Committee. It is now under consideration The chief changes in the deposit insurance law which will be made by this bill, if it is approved by the House of Representatives and signed by the President, are an increase in deposit insurance coverage from $5,000 to $10,000 per de positor, a rebate of a portion of the deposit insurance assessment if it is not needed to meet losses, a simplification of the method of calculat ing the base on which the assessment is levied, and more flexibility in the powers of the Corporation to aid an insured bank in difficulty prior to its suspension. Deposit insurance was adopted by Congress in the midst of the nation's most disastrous business depression. It was the large number of bank failures during that depression, with the repercussions of those failures on business activity, which provided the impetus ior establishment of the Federal Deposit Insurance Corporation. If the fundamental purpose of deposit insurance, the avoidance of destruction 11 - of a portion of the nation's circulating medium through bank failures, is to be achieved, we must learn how to avoid in the ¿uture such huge clusters of failures as occurred in the early years of the 1930’s. Consequently, it was appropriate and logical for the Corporation, soon gjp’-ker its establishment, to undertake studies of the conditions which preceded such periods in the past, including as detailed analysis as possible of the whole complex set of relationships between banking and the fluctuations in business activity which we have come in recent years to call business cycles. The Federal Deposit Insurance Corporation is of course only one among many agencies of the Federal Government whose duties are such that they are interested in the causes of business fluctuations and the sequence of events in the transformation of good times to bad and of bad to good. However, there has been one feature of the work of the Corpo ration in this field which differs from that carried out in other parts of the Federal Government. When our work on the relation of banking to business fluctuations was begun, we found a dearth of available factual data pertaining to the major variables involved in business iluctuations. There were no suitable statistical series of key elements in the situation. There was no index of the nation's output, or production, reasonably comprehensive in coverage; no measure of the rate of spending of business and individuals for the output of the economy; no reasonably comprehensive index of changes in the level of prices of the final products of the economy;no measure of the rate of use of money by business and individuals, that is to say, no measure of changes in the speed with which the supply 12 of money circulates through the economy in connection with its output of goods and services; no suitable measure of changes in the quantity of money or circulating medium available to business and individuals, or held by them; and no suitable measure of changes in thè quantity of bank reserves, which in most circumstances are the dominant influence on changes in the quantity of bank deposits. Despite the vast amount of time and talent spent by economists at universities, bureaus of economic research, and government agencies, there had been no development of measures of any of these things for periods sufficiently short and in forms suitable for study of their relations to each other during the ups and downs of business. In delving into this field the research staff of the Federal Deposit Insurance Corporation was not encroaching upon work which was being done, nor, so far as we could ascertain, was planned by any other government agency. We were attempting to fill a statistical vacuum. It was essenti a] to do this if we were ever to understand the origin of business fluctuations or the character of the forces which transform minor movements in business into great depressions with calamitous results on the welfare and happiness of the people. The results of our studies of the relation of banking to business fluctuations have thrown a strong light on what has hitherto been an obscure area in the course of business activity. In the years of agitation for banking reform which preceded establishment of the Federal Reserve System, great stress was laid on imperfections in our monetary system which resulted in erratic fluctuations in bank reserves. It was believed, with a large body of supporting evidence, that these - 13 - fluctuations in bank reserves were the leading factor responsible for bringing business upswings to a halt and also in making it possible for businessmen, after a downswing, to renew their operations on a normal scale. There were four specific aspects of the monetary system of the United States which produced irregularities in the volume and effectiveness of bank reserves. One of these was the restricted currency issue, under which an increased need for hand-to-hand currency pulled gold certificates or other lawful money out of bank vaults and hence out of their reserves. Another was the irregularity of receipts and expenditures of the Federal Government and the occasional impounding of lawful money by the Federal Government under the Independent Treasury System. The third was the practice of the interior banks, resulting from the reserve provisions of the National Bank Act, of sending seasonal funds to and concentrating their reserves in New York City, and the consequent practice of the New York City banks of making call loans as a type of investment which pre sumably could be recalled at a moment's notice whenever the banks of the interior drew drafts on their balances. In addition, it was recognized that irregularities in the balance of payments with foreign countries and in gold movements had undesirable repercussions on bank reserves in this country. The Federal Reserve System was established for the primary purpose of removing these forces which produced instability in the volume of bank reserves and in their distribution throughout the country. The results of our studies indicate that the basic assumption with respect to the relation of banks to business fluctuations, which underlay establishment of the Federal Reserve System, is valid. During - Ik - the quarter of a century between the two World Wars there were five downswings in business sufficiently severe to be labeled depressions or recessions by business cycle analysts; and there were, of course, an equal number of recoveries. The statistical series which we have developed show beyond any possibility of doubt, it seems to us, that each of the five turning points from business upswing to downswing was preceded by significantly large deviations in the volume of bank reserves, when adjusted for changes in percentage reserve requirements and other technical factors, from a reasonable rate of growth in line with the needs of the economy. Further, the duration and depth of the depressions were intimately related to the duration and depth of the departures in the amount of reserves from a reasonable rate of growth; and still further, the halts to the downswings and the turning of business upward occurred when the direction of change in effective bank reserves was reversed. The business-fluctuation theory which underlay establishment of the Federal Reserve System is also supported by the course of events since the close of the recent war. As you know, the volume of bank reserves and the amount of bank deposits increased rapidly during the war years as a result of the policies associated with war financing. This great increase in the money supply led to a rapid rise in prices when the wartime controls were removed. During the period of inflation in prices, particularly in the latter half of of 19^8 , 19^7 Q&d the early months various measures were taken for the purpose of preventing any further increase in the money supply. These measures impinged on bank - 15 - reserves. By the end of 19^-7 the expansion of bank reserves was halted and turned into contraction. Between that date and the end of April 19^9 > the effective amount of bank reserves was reduced by to the-normal rate of growth. 15 percent relative Bank deposits also declined substantially though not by so large a percentage. The price level stopped rising and business activity slackened in the fall of 19^8 , several months after the peak in reserves, repeating the typical sequence and lag which prevailed between the World Wars.. By the spring of 19^9 fears were arising that a serious post war depression was at hand. At this point the Federal Reserve authorities reversed their pressure on reserves. Early in May they started a series of reductions in percentage reserve requirements, thus stopping the con traction in reserves and deposits. In the summer and autumn business sentiment became more favorable, several of the leading indicators of revival appeared, and fear of a deep depression disappeared. The Federal Reserve authorities deserve a great deal of credit for the skill with which they used their powers impinging on bank reserves during the years from 19^7 to 19^9* They stopped the postwar inflation and at the same time avoided a postwar depression sufficiently deep to be a serious threat to the economy. At the present time the prospects for avoidance of a serious depression are not as hopeful as they appeared a few months ago. Since the beginning of the year another turnabout has taken place in the direction of pressure on reserves. From the first of the year to March 29 the effective volume of reserves declined over ^ percent. Since the normal growth for that length of time is a little over 1 percent, this is a - 16 decline relative to trend of more than 5 percent in less than a quarter of a year. If this rate of contraction in bank reserves should continue for a few more months the recovery from our present mild recession will not occur during 1950. Should it continue for a year, a serious depression , will be upon us. On the other hand, if the Federal Reserve authorities show the same foresight they did last year, they will reverse their pressure on bank reserves to the extent necessary to restore and maintain an adequate rate of growth of the circulating medium. This is what is needed to prevent continuation of the present recession and to permit and stimulate business to expand until it reaches a level of full employment.
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