COMMERCIAL BANKING IN THE UNITED STATES
The commercial banking system of the United States consists of several
elements which have been contributed at different periods in our
history. The most important of these are state banks, national banks,
and the independent treasury system.
_1. State Banks_
From the very beginning of our national history institutions enjoying,
among others, the privilege of commercial banking have been chartered
by our states. For several years after the adoption of our
constitution it remained an open question whether the incorporation of
such institutions was not their exclusive privilege, but in the case
of McCulloch v. Maryland, in 1819, the Supreme Court decided that the
federal government also had this right.
During the years 1791-1811, and 1816-1836, the state banks had as
competitors the first and second United States banks, and in 1863
so-called national banks entered the field, and, more recently still,
trust companies. Private banks have also existed from the beginning,
but their number and relative importance have declined in recent
years. At the present time the number of state banks exceeds that of
all other classes of banking institutions combined, but in capital and
resources they are inferior to both national banks and trust
companies.
Since each state has had a free hand in the matter of legislation
concerning the banks chartered under its auspices, uniformity in the
regulations imposed upon and in the kind and degree of supervision
exercised over this class of institutions, is lacking. In most cases,
however, as compared to national banks, the amount of capital required
is smaller; they have greater freedom in the making of loans,
especially upon real estate security; and they are not so carefully
examined and supervised by public officials. The most frequently
imposed legislative requirements are: the accumulation of a surplus
fund from earnings; double liability of stockholders; a minimum cash
reserve to be kept in the vaults, and an additional reserve on deposit
in other banks; the organization of a banking department for the
administration of the laws pertaining to them; regular reports and
examinations; and some limitation on real estate holdings and on the
amount of loans to be made on real estate security. On account of the
relatively low capital requirements imposed upon them, and the
liberality of the laws concerning them in other respects, state banks
have been able to prosper where national banks and trust companies
could not exist, and on this account in many parts of the South and
West they do most of the banking business in small towns and country
districts. They generally perform a wide range of banking functions,
including those of investment and savings as well as of commercial
banks.
_2. National Banks_
Our national banking system owes its existence to financial exigencies
of the federal government experienced during the Civil War. For a
considerable period preceding the outbreak of that struggle the
expenses of the government had exceeded its receipts. The deficit was
greatly increased as soon as the war began, and Congress did not find
it possible immediately to devise adequate new sources of revenue,
including a market for government bonds. It was, therefore, forced to
the issue of legal-tender notes under authority of an act passed
February 25, 1862.
After three issues of these notes, amounting to $400,000,000, had been
exhausted, and the value of the notes had depreciated to such an
extent that persistence in this method of financiering portended
speedy financial disaster, Congress adopted a suggestion made early in
the war by Secretary Chase, to the effect that a market for government
bonds might be created by compelling banks to purchase them as
security for their note issues. An act passed February 25, 1863,
provided for the incorporation of banks with the right to issue notes
on condition that they purchase government bonds and deposit them with
an official to be known as Comptroller of the Currency.
It was the expectation of the authors of this act that the state
banks, then numbering over one thousand, would exchange their state
for national charters and purchase bonds sufficient to secure their
circulation under the terms of the new act, but, since they showed
reluctance so to do, in 1865 force was applied in the form of a tax of
ten per cent on bank notes otherwise secured. Under this pressure most
of the state banks reorganized as national institutions, but a few
retained their state charters and formed the nucleus of the state
system of the present day. On account of the ten per cent tax,
however, the issue of notes by this remnant became unprofitable, and
the new national banks have to this day remained the sole banks of
issue in the country.
The act of 1863 has been amended several times, notably in 1864, 1870,
1874, 1875, 1882, 1887, and 1900. In its present form it permits the
organization of banks with a capitalization as low as $25,000 in towns
of 3,000 inhabitants or less, and with a capitalization as low as
$50,000 in towns of 6,000 or less. Banks organized under this act must
put ten per cent of their profits into a surplus fund until said fund
amounts to twenty per cent of the capital; must invest at least
twenty-five per cent of their capital, if it is less than $200,000,
and at least $50,000, if it is $200,000 or more, in government bonds;
and may deposit said bonds with the Comptroller of the Currency and
receive circulating notes to the amount of their par value, provided
their market value is par or above.
The rights and privileges of these banks are stated in very broad and
general terms, a fair interpretation of which permits them to engage
in both commercial and investment banking under certain specified
limitations, of which the most important are the following: they must
not invest in or hold real estate beyond their owns needs for suitable
quarters, or temporarily for the purpose of collecting debts due them;
they must not accept real estate as security for loans; they must not
loan more than ten per cent of their capital and surplus to any one
person or firm; and they must keep reserves to the amount of fifteen
per cent of their deposits, if they belong to the group known as
country banks, and to the amount of twenty-five per cent of their
deposits, if they belong to either the reserve city or the central
reserve city group.
In the case of country banks, at least two-fifths of the required
reserves, and in the case of reserve city banks, at least one-half,
must consist of specified forms of money in their own vaults. The
remainder may be balances payable on demand in approved banks in
reserve or central reserve cities in the case of country banks, and in
the central reserve cities in the case of reserve city banks. In the
case of banks in central reserve cities, the entire reserve prescribed
by law must consist of money in the vaults. These required minimum
reserves must not be infringed upon. When a bank's cash and balances
with its reserve agents fall to the prescribed minimum, discounting
must be stopped under penalty of suspension of privileges and
liquidation by the Comptroller of the Currency.
At five dates each year, selected by the Comptroller of the Currency,
national banks must make detailed reports of their condition on
prescribed blanks and publish abstracts of such reports in local
newspapers. They must also submit to examination by persons appointed
for that purpose by the Comptroller as often as this official may deem
necessary and proper.
National banks have been organized in every state of the Union, and in
Maine, Massachusetts, and Vermont they have completely supplanted the
state banks. Elsewhere they exist side by side with state banks and
compete with them. In some states they are more and in others less
numerous than state banks. In the kind of business transacted the only
important difference between the two classes of institutions consists
in the loans on real estate security, which national banks are
prohibited, and state banks allowed, to make. The latter, therefore,
share this class of business with the trust companies only, and where
it predominates have a distinct advantage in competition over the
national institutions.
_3. The Independent Treasury System_
While not a banking institution, the Treasury of the United States
handles its funds in such a manner and performs such functions with
reference to the currency that it has become an important part of the
banking system of the country.
Previous to 1840 the funds of the federal government were kept on
deposit in banking institutions, during the greater part of the time
in the First and Second United States banks. Friction between
President Jackson and the Second United States Bank resulted in their
withdrawal from that institution in 1834 and their deposit in selected
state banks, several of which failed and all of which suspended specie
payments during the crisis of 1837. The embarrassment which the
treasury experienced in consequence, combined with previous
unsatisfactory relations between the government and its depositories,
convinced President Van Buren that the Treasurer ought himself to keep
and to disburse the funds of the government. He made a recommendation
to this effect to Congress, which in accordance therewith enacted the
first independent treasury act in 1840. The revival of agitation for a
third United States Bank led to the repeal of this act the following
year, but in 1846 it was reenacted and with modifications has remained
upon our statute books to the present day.
In its original form this act provided for the acquisition of vaults
in certain cities, in which should be deposited the funds of the
government as soon as possible after they came into the hands of the
receiving officers, and out of which should be taken, upon drafts
issued by the Secretary of the Treasury, the money needed for the
payment of the government's obligations. It further provided that all
dues to the government in the future should be paid either in coin or
in currency issued exclusively by the government, and that all
expenses should be paid in the same forms of money.
Important modifications in this act were made during and after the
Civil War. In 1863 permission was granted the Secretary of the
Treasury to deposit in national banks funds accumulated in the
treasury, and derived from any source except duties on imports,
provided the banks selected for this purpose should deposit with him
government bonds for their security. Subsequently the discretionary
power of the Secretary in this direction was extended so that at the
present time he is authorized at his discretion to deposit in national
banks surplus funds derived from any source, trust funds alone
excepted, and to accept as security therefor other securities than
government bonds. Other laws have made national bank notes acceptable
for certain public dues, and have given the Secretary authority to
issue gold and silver certificates against gold coin and silver
dollars deposited in corresponding amounts, and to redeem United
States notes in gold coin and to keep on hand for that purpose a gold
reserve of $150,000,000.
In its operation, this independent treasury system affects the
reserves of the banks and through them their discounts and the
commerce of the country. Whenever the receipts of the government
exceed its expenditures, money accumulates in the treasury and the
reserves of the banks are diminished; and, under opposite conditions,
they are increased. The return of accumulated surplus funds to the
banks is possible when the Secretary of the Treasury decides that such
return is desirable or necessary and when the banks are able and
willing to supply the bonds demanded as security. In case a deposit is
agreed upon the funds go to a relatively small number of national
banks selected as depositories by the Secretary of the Treasury, the
amount allowed each depository also being determined by him.
Through its ability to issue gold and silver certificates, its
obligation to redeem United States notes in gold on demand, its
administration of the United States mints and assay offices and the
laws regulating the supply and distribution of subsidiary coin, the
United States Treasury cooperates with the banks in the supply and
distribution of the circulating medium of the country. The people
apply to the banks for the forms of money and currency desired and
these institutions meet the demand by means of the funds deposited
with them or by their exchange at the various subtreasuries, if the
forms of money deposited do not correspond with these demands.
_4. The Interrelations of These Institutions_
Under the operation of the national banking act, New York, Chicago,
and St. Louis have been designated as _central reserve_, and
forty-seven other cities as _reserve_ cities. The national banks in
these reserve cities act as reserve agents for national banks in the
cities and towns not so designated and ordinarily receive on deposit
the major part of their reserves plus surplus funds not needed for
local purposes. Banks in the central reserve cities act as reserve
agents for the banks in the reserve cities as well as for country
banks, and on account of their importance as commercial and investment
centers receive and hold in the form of bankers' balances a large part
of the reserve funds as well as the surplus investment funds of the
national banks of the entire country.
State banks and trust companies manage their reserve and surplus
investment funds in substantially the same manner as national banks,
using national banks in the reserve and central reserve cities as
their reserve agents. State laws usually allow approved state banks
and trust companies also to act as reserve agents for the banks and
trust companies under their jurisdiction, but these approved banks are
generally located in the reserve and central reserve cities, and
themselves employ the national banks there located as their reserve
agents, thus forming simply an additional conduit through which the
reserve and surplus investment funds of state banks and trust
companies reach the central money reservoirs administered by national
banks in the central reserve cities.
National banks in the reserve and central reserve cities are also
clearing centers for the enormous volume of checks and drafts which
the administration of the checking accounts of the banks and trust
companies of the country bring into existence. They act as
correspondents as well as reserve agents for these other banks and
trust companies, and in this capacity collect out-of-town checks and
drafts and conduct checking accounts for them. Within these cities, as
well as in hundreds of others, clearing house associations conduct the
local clearings and also act as agencies through which national and
state banks and trust companies cooperate in the promotion of common
interests.
The center of the entire system is in New York City. The clearing
house association of that city, consisting of over fifty national and
state banks and trust companies, includes the banks the vaults of
which constitute the central money reservoir of the country and which
constitute the center of the country's clearing system. Through the
New York subtreasury pass the greater part of the receipts and
disbursements of the government, and the chief assay office in the
country is located there. The New York stock exchange is our only
stock and bond market of national scope, and consequently the
investment center of the country.
The Associated Banks of New York City, as the members of the clearing
house association are called, hold the greater part of the reserves of
the banks and trust companies not required by law to be kept in the
local vaults, as well as the greater part of the surplus investment
funds of the entire country. It is through the operation of the New
York subtreasury on the reserves of the Associated Banks that the
chief influence of the independent treasury system on the banking
business of the country is exerted, the greater part of the
government's receipts coming directly out of those reserves, and a
large part of the expenditures going into them, and the greater part
of the money deposited in national banks by the Secretary of the
Treasury going directly or indirectly into New York institutions. Most
of the exports and imports of coin and bullion pass through New York,
and the major portion of the foreign exchanges of the entire country
are there effected. The New York Assay Office receives and distributes
the greater part of the new supplies of gold and silver bullion which
come from our mines and transforms into bullion the major part of
these metals that come to us from abroad and do not find employment as
foreign coin. The New York Stock Exchange is the medium through which
a large part of the surplus savings of the country are invested in our
industries or loaned for the use of our national, state, municipal,
and other local governmental agencies.
_5. Operation of the System_
The most noteworthy features of the working of this machinery may be
discussed under the heads: conflict of functions and laws; loan
operations; treasury operations; reserve system; absence of elasticity
in the currency.
(_a_) _Conflict of Functions and Laws._--The two classes of banking
institutions which have been described (state banks and national
banks) and trust companies, described in a subsequent chapter, exist
side by side in many communities, and in the performance of certain
services compete for the patronage of the public. As has already been
pointed out, state and national banks differ little in their functions
except in their relation to real estate loans, and in some states
trust companies perform all the functions of these institutions and
many others besides. In the performance of these common services,
however, they are rarely regulated by the same laws or subjected to
the same kind or degree of public supervision. The competition between
them, therefore, is not always on a fair basis and the temptation to
violate restraining laws and administrative regulations is strong. The
supervising officers recognize the situation as a rule and go to the
extreme limit of leniency in administering laws and regulations which
operate to the manifest disadvantage of the institutions over which
they have jurisdiction, but even then it is often impossible to render
the basis of competition fair and equitable.
This condition of affairs has resulted in the devising of ways and
means of circumventing obnoxious laws and in some cases in practices
which are pernicious in themselves. As examples may be mentioned the
widespread practice of national banks, which are prohibited by law
from making loans on real estate security, of making loans to
customers who can offer no other collateral, on the security of their
personal notes only, or of making loans secured by real estate by a
three cornered operation utilizing a director or officer or some other
third party as intermediary. All three classes of institutions
compete in soliciting the savings deposits of the community, with the
result that the trust companies and savings banks, which often have
the advantage here, sometimes force upon their state and national bank
competitors a higher rate of interest on such deposits than they ought
to pay. The differing regulations in some places in force regarding
the amount that may be loaned to a single individual or firm has also
resulted in some cases in devious and uncommendable practices.
For the remedy of these conditions the first desideratum is the
careful differentiation of the various functions performed by all
these institutions, and the devising of appropriate legal and
administrative regulations for each one. These regulations should then
be incorporated into the legislation and the administrative practices
of the federal government and of each state, and any institution which
performs any of these functions should be obliged to submit to the
regulations pertaining thereto. The difficulties in the way of
securing such a differentiation of functions and such community of
action between the federal government and our states are too obvious
to require statement, but they should not prevent the formulation of
ideal conditions, and a conscious and persistent effort to attain
them.
(_b_) _Loan Operations._--In making loans, a typical method of
procedure for a business man is to arrange with a bank for what is
technically called a "line," that is, the maximum amount he may expect
to be able to borrow under normal conditions. This "line" determined,
he borrows from time to time according to his needs, giving as
security his personal note, payable in one, two, three, four, or six
months. Sometimes an indorser is required, and sometimes the deposit
of collateral, mortgages on real estate, bonds, stocks, and warehouse
receipts being the most commonly used securities employed in such
cases. Ordinarily, when a note falls due, he expects the bank to renew
it, if its payment at the time is not convenient, the agreement on a
"line of credit" ordinarily carrying with it that implication, though
not legally, probably not morally, binding the bank so to do. Indeed,
the customer ordinarily counts the amount of his "line" as a part of
his working capital and expects to keep it in use a large part, if not
all, of the time.
In the determination of the amount of these "lines of credit," the
judgment of some one or more bank officers, assisted by a discount
committee and sometimes, though not as a rule, by a specially
organized credit department, rules. In forming these judgments, the
bankers of the United States as a class are not guided by any
universally recognized and well established principles. The best ones
require from their customers carefully prepared statements showing the
nature and volume of the business they transact, and a careful
classification of their assets and liabilities. Others, and these are
a large majority, rely upon the knowledge they already possess, gained
by general observation, and supplemented by verbal inquiries made from
time to time and by the voluntary statements of the customers
themselves.
The significance of the distinction between commercial and investment
operations in the business of banking is not generally understood, and
is consequently little regarded. The dominant question in the mind of
the average banker, both in determining the amount of a customer's
line and in making loans to him after the line is fixed, is how much
he is "good for," and on this point the total net worth, rather than
the nature of the business operations, of the customer is likely to be
decisive. Of course, the banker is also influenced by the customer's
reputation for both integrity and business ability.
This method of procedure has the advantage of rendering access of
people to the banks easy and of promoting their extensive use, but it
has the grave disadvantage of opening the doors wide to inflation of
credit. The majority of our bankers do not know whether more or less
than their savings deposits and their capital and surplus, the only
funds which can safely be invested in fixed forms, is so invested. The
promissory notes of their customers, which constitute the major part
of their assets, give no information on this point, and they have not
made the investigations necessary to determine with certainty the
destination of the funds they have loaned. They are satisfied with the
knowledge or the conviction that their loans can be collected, not at
maturity--they know very well that many, probably most, of them can
not--but ultimately. The result is that unconsciously and gradually
the banks create their demand obligations in the form of balances on
checking accounts against fixed investments in machinery, buildings,
lands, mines, etc., and, when the payment of these obligations is
demanded, the reserves fall below the danger point and they are forced
to require payment at maturity of paper which the maker had counted
upon having renewed indefinitely, and the payment of which is only
possible by the forced sale of the property in which the borrowed
funds were invested, or of some other property in his possession. If
only a single bank or a comparatively few banks find themselves in
this condition, relief may be found in the rediscount of paper with
other banks, in direct loans, or in the sale of securities on the
exchanges; but, if the condition is general, relief by these means is
impossible, and widespread forced liquidation becomes necessary. An
aggravated situation of this kind causes panic and results in a
commercial crisis.
(_c_) _Treasury Operations._--The operation of our independent
treasury system produces arbitrary fluctuations in the reserves of the
banks and prevents that degree of prevision which is essential to the
most economical and the safest practices. The funds needed for current
purposes are withdrawn from the banks and kept under lock and key in
the treasury vaults, thus diminishing reserves to the extent of their
amount. Surplus funds likewise accumulate in the vaults with the same
result, until the Secretary of the Treasury sees fit to deposit, and
the banks find it possible to receive them. Even then the depository
banks alone are directly benefited, and no one of these knows long in
advance how much it is going to receive or when funds left on deposit
will be withdrawn.
Since the volume of the business of the government is very large, the
effects produced by the movement of its funds are of such magnitude as
to give them national importance, the ability of banks to loan and to
meet obligations already incurred being profoundly affected by them.
Among these effects must also be noted the inability of the banks to
calculate these movements in advance, as they to a degree can those
produced by the operations of their commercial customers, and the
relation between them and the Secretary of the Treasury, which
results. The relation between the receipts and the disbursements of
the government vary greatly from month to month and year to year, so
that, on the basis of past experience, it is impossible to predict
when the banks will gain from or lose to the treasury. The action of
the Secretary of the Treasury regarding deposits of surplus funds is
equally uncertain and unpredictable. No fixed policy regarding this
matter has yet been established by precedent or determined by law.
Each secretary follows his own judgment and is influenced by current
events and conditions.
The uncertainty which results creates a speculative atmosphere about
the money market and renders the banks dependent upon the secretary
and the secretary influential on the money market in a manner which is
unfortunate for both. Since they cannot be indifferent to the
operations of the treasury, and cannot predict them, banks are obliged
to speculate regarding them, and, if they err, they are likely either
to over-extend their credit operations or unduly to contract them. The
former will result when they expect an increase in their reserves from
treasury sources and do not get it, and the latter when contemplated
withdrawals of funds do not occur.
The Secretary of the Treasury is not in a position properly to
exercise the power conferred upon him. He is outside the channels of
commerce and industry, and must, therefore, secure at second hand the
information necessary for intelligent action. Such sources of
information are frequently unreliable and inaccurate and their use
subjects him to the charge of favoritism and to the danger of acting
in the interest of special groups or special localities.
(_d_) _Operation of the Reserve System._--Each national bank now keeps
locked up in its vaults money to the amount of at least six to
twenty-five per cent of its deposits and a balance with banks in
reserve and central reserve cities sufficient to bring the total to at
least fifteen per cent of deposits in the case of country banks, and
twenty-five per cent of deposits in the case of reserve city banks. In
addition, it is customary for most banks to carry as a secondary
reserve high-grade bonds which can be readily sold in case of need.
The practice of state banks is practically the same as that of
national, and that of trust companies differs only in the amount of
reserves carried and in the proportion between the different items.
This system has many disadvantages. Among them the most obvious,
perhaps, is the withdrawal of enormous sums from the current use of
the agriculture, industry, and commerce of the country. That portion
of these reserve funds which is required to be kept under lock and key
in the vaults, amounting in the aggregate to a billion and a half of
dollars or more, is not available for use in ordinary times, and is
practically useless even in times of stringency, since according to
present law, when the reserves fall to the minimum prescribed by law,
banks must stop discounting, under penalty of being put in the hands
of a receiver. The other portions of these funds, namely, those
deposited with banks in reserve cities and those invested in bonds,
are likewise withdrawn from the uses of current commerce, since a
large part of the former is only available for use on the New York
Stock Exchange, and the latter are invested in railroads, mines,
factories, land, etc.
The explanation of the devotion of the redeposited portion of the
reserves to the operations of the New York Stock Exchange is to be
found in the fact that that exchange furnishes a regular market for
call loans on a large scale. Since these funds are held subject to the
call of the banks which deposited them, and interest at the rate of at
least two per cent is paid upon them, the depository banks are bound
to seek investment for them, and call loans on collateral listed on
the exchange under ordinary circumstances are best suited to their
purposes.
Another disadvantage of this reserve system is the dangerous situation
in which it places banks from time to time, and the tendency to panic
which it fosters. The demands made upon banks for both cash and credit
vary with the seasons. In the fall and spring they are much greater
than in the winter and summer. They also vary regularly through
periods of years, increasing during the up-grade of a credit cycle and
decreasing for a longer or shorter period after a crisis. Irregular
and unexpected events also cause variations. On account of the
rigidity of this reserve system and the lack of elasticity in our
currency, the means available to banks for meeting increased demands,
especially those of an irregular and unexpected character, are
inadequate, and their employment is often dangerous. These means are:
keeping in the vaults in slack times a large amount of unused cash, a
practice too expensive to be employed; keeping surplus balances with
correspondents at two or three per cent interest, not a sufficiently
remunerative practice to be employed on a sufficiently extensive
scale; rediscount with correspondents of some of their customers'
paper, or loans from them on the security of their own signatures or
on such security supplemented by collateral; and sale of bonds at such
prices as they will bring.
None of these expedients is certain at all times and under all
conditions, and some of them are precarious at all times. Surplus
balances with correspondents are most reliable, but they occasionally
fail on account of the inability of correspondents to realize upon
their call loans. When calls for the payment of balances are large and
general, it is impossible for brokers whose loans are called by one
bank to transfer them to another. The collateral deposited as security
must, therefore, be offered for sale on the stock exchange, and the
very stringency which resulted in their being so offered renders their
sale, even at slaughter prices, difficult and sometimes impossible.
The result at the best is a heavy fall in the prices of stock-market
securities, and at the worst a stock-market panic and a suspension of
payments by the banks.
Rediscounts and loans from correspondent banks cannot be depended on.
Correspondents are under no obligation to make them. They will usually
do so as a favor, if their condition warrants, otherwise not. Sales of
bonds on the stock exchange are difficult and sometimes impossible in
times of emergency, and are usually attended with loss.
On account of this uncertainty and the danger attending it, when new
and unusual conditions likely to result in increased demands upon them
arise, banks are likely to act "panicky"; to call in their balances
from correspondents; to sell bonds; to call loans; and greatly to
curtail or absolutely to cut off new discounts. This action spreads
the panicky feeling among their customers, and creates such pressure
at the reserve centers as to cause curtailment of accommodations and
panic there.
At the very best, this reserve system is accompanied by high discount
and loan rates and by speculation on the stock market. High rates
result inevitably from the hoarding of currency which it involves, the
supply of loan funds being abnormally diminished, and speculation
follows from the concentration in slack times of funds in New York
City, which can only be employed in call loans on stock-exchange
collateral. Stock brokers regularly take advantage of this situation,
speculate themselves and inspire speculation among their customers.
The mutual dependence of the stock and money markets thus produced by
this reserve system is disadvantageous to both, fluctuations in
values, uncertainty, and irregularity on both being the result.
(_e_) _Lack of Elasticity in the Currency._--The money of the United
States consists of four main elements, gold and silver coin, United
States notes, and national bank notes, and none of these fluctuate in
volume in accord with the needs of commerce.
The gold element depends primarily upon the output of our gold mines
and upon the international movement of gold, increasing when that
output increases and when our imports of gold exceed our exports, and
decreasing under opposite conditions. These fluctuations, however, are
quite independent of our commercial needs. Silver dollars, which
constitute the major part of our silver currency, for several years
have been unchanged in quantity, and the volume of United States notes
has remained at $346,681,016 since the resumption of specie payments,
January 1, 1879.
National bank notes fluctuate in volume as a result of changes in the
number of national banks and in the prices of government bonds.
Whenever a new national bank is organized, a specified portion of its
capital must be invested in government bonds, which bonds are usually
deposited with the Comptroller of the Currency in exchange for notes;
and, when the price of government bonds rises, banks holding more than
the minimum required by law frequently retire a portion of their
circulation in order to recover their bonds for sale at the enhanced
price. When the price of government bonds falls, many banks purchase
additional quantities and increase their circulation.
Changes in the price of government bonds and in the number of national
banks, however, have no connection whatever with changes in our
currency needs, and no more do the fluctuations in the volume of the
currency as a whole, made up of these various elements combined. As a
result of this condition, rates on loans and discounts fluctuate
greatly on account of wide variations between the demand and the
supply of loan funds, and commerce is hampered at certain seasons and
overstimulated at others. As was indicated above, this lack of
elasticity in our currency aggravates the defects of our reserve
system and also aids in the production of financial panics.
_6. Plans for Reform_
On account of the defects in our system of banking, there has been
long-continued agitation for reform, increasing in scope and intensity
in recent years. After the crisis of 1907, which revealed these
defects to many persons who had not observed them before, Congress
appointed a commission to make investigations and to prepare a reform
measure. In January, 1912, this committee submitted a report which
embodied a bill for the incorporation of a National Reserve
Association, to be made up of a federation of local associations of
banks and trust companies. The purpose of this association was to
supply a market for commercial paper, an elastic element in the
currency, a place for the deposit of the bank reserves of the country
and of the funds of the government, as well as proper machinery for
the administration of this market and these funds.
For various reasons, the plan of the monetary commission did not meet
with universal favor. It was condemned in particular by the Democratic
party, which was victorious at the polls in the fall elections, and
installed a new administration in Washington, March 4, 1913. A special
session of the new Congress was called to consider the tariff
question, and to it was submitted another plan for the reform of our
banking system, which was enacted into law December 23, 1913.
This law provides for the incorporation of so-called "Federal Reserve
Banks," the number to be not less than eight or more than twelve. The
country is to be divided into as many districts as there are Federal
Reserve Banks, and the national banks in each district must subscribe
six per cent and pay in three per cent of their capital and surplus to
the capital stock of the Federal Reserve Bank located in that
district. State banks and trust companies may contribute on compliance
with the same conditions as national institutions. If, in the judgment
of the organization committee, the amount of stock thus subscribed is
inadequate, the public may be asked to subscribe, and as a last resort
stock sufficient to raise the total to an adequate figure may be sold
to the Federal Government. Cooperation between these Federal Reserve
Banks and a degree of unity in their administration are provided for
through a Federal Reserve Board of seven members, two ex officio and
five to be especially appointed by the President of the United States.
For the administration of each Federal Reserve Bank, a board of
directors of nine members is provided for, six to be appointed by the
member banks and three by the Federal Reserve Board, one of those
three to be designated as Federal Reserve Agent and to be the
intermediary between the Federal Reserve Board and the bank of whose
directorate he is a member.
The proposed Federal Reserve Banks are to hold a part of the reserves
of member banks and to rediscount commercial paper, administer
exchange accounts, and conduct clearings for them. They are also to
serve as depositories for the United States government, and to issue
treasury notes obtained from the Federal Reserve Board in exchange for
rediscounted commercial bills, these notes to be redeemable on demand
by them and to be a first lien on all their assets. Their retirement,
when the need for them has passed, is provided for by the requirement
that no Federal Reserve Bank shall pay out any notes except its own,
all others being sent in to the issuing bank or to the treasury for
redemption. Against outstanding note issues a reserve of at least 40
per cent in gold must be maintained, and against deposits one of at
least 35 per cent in gold or lawful money.
This law provides remedies for the chief defects of our system;
namely, a market for commercial paper which will enable a properly
conducted bank at any time, through rediscounts, to secure notes,
legal-tender money, or checking accounts in the amounts needed; a
system of note issues which will fluctuate automatically with the
needs of commerce for hand-to-hand money; a more economical
administration of the reserve funds of the country, unattended by the
dangers of the present system, and an administration of the funds of
the federal government which is free from the evils of the independent
treasury system.