THE WEAKNESSES OF OUR BANKING SYSTEM PRIOR TO THE ESTABLISHMENT OF THE
FEDERAL RESERVE SYSTEM
CONFLICTING OPINIONS
[249]For fifty years the United States has lived rather happily under
the National Bank Act, born in the strife of the Civil War and developed
in the period of the nation's greatest expansion and growth. This act
has, by its record, earned for itself a place as a great piece of
constructive legislation; and the recognition of this fact is
responsible for the preservation of our national banking system almost
intact under the Federal Reserve Act. The National Bank Act removed the
ills of wild-cat banking, which so afflicted the country prior to the
Civil War; gave us an absolutely safe form of money which, although not
legal tender, is taken without question by everyone; and has made
possible an enormous expansion in the banking resources and facilities
of the country. In spite of the denunciation and abuse which have been
heaped upon it, the act has been reasonably satisfactory in operation.
Anyone who reviews the figures of the material growth and prosperity of
the nation and the rise of its financial power will be forced to the
conclusion that no act that was fundamentally unsound could have been an
integral part of the achievement of such a notable record.
Designed for the purpose of encouraging a system of independent banks,
the act has been responsible, directly and indirectly, for the creation
of some twenty-five thousand banking institutions in this country,
practically all of which are independent of each other. Instead of a
small banking class and an equally small group of banks, all under the
domination of one or a very few interests, we have developed a system of
banking which has sprung from the people, and which is closer to the
people than that of any other country.
[250]We have grown and prospered in spite of an imperfect, repressing,
and perilous banking and currency system. We have grown as a vine
sometimes forces its way through a crevice in a wall, our very growth
inviting disaster and death, our wonderful vitality hastening
catastrophe.... Over fifty years of growth under the old banking act has
been forced by the generosity of the soil of a new land, by the
unconquerable energy and resiliency of a virile and courageous people;
yet it has been interrupted by periods of business depression and
stagnation; our progress punctuated by panics, discreditable,
appalling--to many ruinous.... The immediate results ... have been
crashing of banks and commercial houses, the wholesale stoppage of
industries, the wiping away or cruel draining of the results of honest
thrift, denial to willing and hungry labor of the opportunity to earn
bread and shelter.
[251]A physician would probably say that what primarily ails our
currency system and causes panics and desperate stringencies is
something akin to _arteriosclerosis_. The veins and arteries of credit,
which in order to function properly ought to be elastic and contractile
like rubber, are hard and brittle as glass. When subjected to unusual
strain they can yield but little and are very liable to rupture, and
when once stretched they are apt to remain over-enlarged....
The temporary act of May 30, 1908, which relaxed the rigor of the law in
moments of critical emergency [as to note issues] by permitting
additions to the currency to be based upon other security by payment of
a heavy and increasing tax, was no real solution of the situation. It
contained no provision to render the currency responsive to ordinary
fluctuations in currency demand, and resort to its provisions in times
of great stress might easily precipitate a panic if one did not already
exist. It was only enacted for six years, and was only regarded by its
sponsors as a temporary palliative pending the preparation of a
permanent cure. _One universally recognized essential ... of a proper
banking and currency plan is provision for a more flexible and
responsive note issue_.
INFLEXIBILITY OF LEDGER BALANCES
When we turn to credit in the form of ledger balances or "deposits" and
enquire as to the causes of their inflexibility, the explanation also
rests in quite familiar facts. There are two peculiar features of our
banking system which are practically without counterpart in other
important countries, and which render ledger balances or deposit credits
in this country less flexible and responsive than such balances or
credits are elsewhere. The _first_ is the rigidity of our reserve laws,
and the _second_ is the lack of any bankers' bank or similar
institution, with ample resources and lending power, from which the
banks can replenish their own reserves when necessary.
RIGID RESERVE REQUIREMENTS
Outside of the United States I know of only one other country in which
the law requires a cash reserve to be held against deposits. That
country is Holland, and the law applies to only one institution, the
Bank of the Netherlands, and that institution does not hold enough
deposits to make it worth mentioning in this connection (less than
$3,000,000). Our national banking law, however, and the banking laws of
most of the states are unreasonably and unsoundly rigorous in this
regard. Not only must stated proportions of all deposits be held by the
banks in reserve, but these reserves, according to the law, can never
under any circumstances be used. It is very much as if the Government,
having established naval and military reserve forces in times of peace,
were to insist that these forces should not be used in time of war, in
order to maintain them intact as reserves. Whenever the cash held by a
bank has fallen to the required minimum, the bank cannot legally
continue to extend accommodation. It cannot issue more notes unless it
has additional government bonds to deposit for their security, and it
cannot enlarge its ledger balances unless it has additional reserves. No
matter what may be the stress of an emergency, or whether it is due to
war, catastrophe, or unreasoning fear, there are no legal means for
relaxing this requirement. And so, in moments of great sensitiveness and
anxiety, legal spokes are apt to be suddenly thrust into the wheels of
credit, and the whole machinery of business brought crunching to a
standstill. _A second essential then of any adequate currency plan is
some provision which will render the reserve requirements pliable and
the reserves of possible use._
NEED OF BANKERS' BANK
Our banks also have less flexibility in their power to lend ledger
balances than the banks of practically all other countries for another
reason, because of the lack of any permanent institution or institutions
which can perform for them services similar to those which they perform
for their customers. An individual bank makes the money of each and all
of its customers flexible in amount, by rendering it of mutual service,
and available to those who most need it, when they most need it, and, in
order that the money of individual banks may be similarly flexible in
amount, of mutual service to each other and available to those
institutions which most need it, when they most need it, they require in
their turn some agency which will do for them severally and jointly what
they do for the general public....
It does not matter what such an agency may be called. It may be a
discount bureau, or a rediscount bureau, a national clearing house, or a
national or regional reserve association. Out of deference to those
great financial experts who write the banking clauses of political
platforms and whose bans and edicts are blessed with sacerdotal
infallibility, when such an institution is proposed for this country,
it must not be called a central bank. Such an institution is perhaps
most plainly designated if it is called a "bankers' bank," but by
whatever name it is referred to, the need of such an institution is the
fact of primary importance in the American banking situation.
Just as an individual bank economizes and mobilizes and makes flexible
in amount the funds of individual members of a community, so a bankers'
bank mobilizes and economizes and makes flexible in amount the money of
the banks. It collects money from institutions and localities when and
where they do not need it, and lends it to others when and where they
do. In like manner the active deposits of the various banks, as they are
not all wanted simultaneously, furnish the bankers' banks with a large
surplus reserve of lending power, which in turn is an invaluable source
of flexibility to the individual banks. By its means they can, if need
be, rediscount their commercial paper, exchange their unmatured assets
for actual cash, and secure its still better known credit in place of
their own. By its means their reserves can be replenished and their
lending power made responsive to the needs of their communities. A
bankers' bank makes it possible for the money of the individual banks to
do many times the work it would do if left in the separate institutions,
and to do it far more effectively. It is the only ultimate safeguard,
the only scientific deposit guarantee, the only sound basis of
flexibility in any banking system. As some philosopher once said of
God--if such an institution did not already exist, people would
certainly have to invent one, and, as we have no such institution
permanently and legally established in America to-day, _the prime
essential of any sufficient banking plan is the equipment of our system
in some way or other with the facilities of a bankers' bank_.
THE PARCELLATION OF RESERVES
[252]If the absolute certainty of ability to pay all depositors in
money on demand be taken as the _summum bonum_ of banking, an idea which
quite generally prevails among the unthinking, it is interesting to
reckon the cost. A bank has no fairy wand with a wave of which it can
transmute into gold the amounts due it, whether represented by
borrowers' notes or balances due from other banks. Such repayments have
an element of uncertainty which pervades all human affairs. All
uncertainty could be eliminated only by having in money on hand an
amount equal to the total of liabilities to depositors. A deposit with a
bank would then be simply a warehousing transaction.
If a readjustment to such a condition were accomplished, and if we
consider only the ultimate result, and not the cataclysm of the process,
it would clearly prove such an extinguishing restriction of commerce as
would cost fabulously more than the value of the advantage gained. It
would be like preferring the constitution of a jelly-fish to that of a
human being in order to avoid the hazard of fracturing a bone.
Only by having banks which employ in loans a part of depositors' capital
lodged with them, can the best interests of the whole people be served,
even if this entails something less than an absolute certainty of power
to liquidate deposits on demand. That banking system must then be best
which combines equally the largest measure of each of two elements: the
use in commerce of funds deposited, and the certainty of paying
depositors in money on demand.
Turning now to the vast system of banks throughout the country, if the
separate reserves of all the banks were gathered into one mass,
available to meet the demands of depositors for payment in money,
whether made in Maine or Texas, New York or California, the banks of the
whole system would be able to operate with the highest degree of safety
by having a total sum of money equal to only a small percentage of the
aggregate amount owing to depositors, and consequently would be able to
lend for use in the commerce of the country the greater proportion of
the funds deposited. The total of deposits and withdrawals made
throughout the country would very nearly offset one another. Very little
of the reserve money would actually be used. A special requirement of
one section would represent only a small percentage of the total massed
reserves. The country has such vast area, and the requirements in
different parts so vary in season that a deficiency of money in some
sections would find a measurably offsetting surplus in others.
While theoretically an institution so constituted would be strongest and
most efficient, none such exists, and no one would advocate such a
system. Omniscience and omnipotence would be required for its wise
administration.
But the conclusion seems clear that only in proportion to the massing of
reserves can efficiency in lending for commerce be combined with
strength to pay depositors. The greater the proportion of the entire
reserves gathered into one mass, the greater the efficiency and strength
rendered possible. This principle is fundamental.
The fundamental defect of our banking system, then, is the parcellation
of the entire reserves among the separate self-independent banks,
necessitating either a wastefully large proportion of reserve for
assured ability to pay, with correspondingly inefficient service to
commerce, or efficient service with the hazard of unexpected exhaustion
of reserves and consequent inability to make good the contracts to pay
depositors in money on demand.
[253]If after a prolonged drought a thunderstorm threatens, what would
be the consequence if the wise mayor of a town should attempt to meet
the danger of fire by distributing the available water, giving each
house owner one pailful? When the lightning strikes, the unfortunate
householder will in vain fight the fire with his one pailful of water,
while the other citizens will all frantically hold on to their own
little supply, their only defence in the face of danger. The fire will
spread and resistance will be impossible. If, however, instead of
uselessly dividing the water, it had remained concentrated in one
reservoir with an effective system of pipes to direct it where it was
wanted for short, energetic, and efficient use, the town would have been
safe.
We have parallel conditions in our currency system, but, ridiculous as
these may appear, our true condition is even more preposterous. For not
only is the water uselessly distributed into 21,000 pails, but we are
permitted to use the water only in small portions at a time, in
proportion as the house burns down. If the structure consists of four
floors, we must keep one-fourth of the contents of our pail for each
floor. We must not try to extinguish the fire by freely using the water
in the beginning. That would not be fair to the other floors. Let the
fire spread and give each part of the house, as it burns, its equal and
inefficient proportion of water. _Pereat mundus, fiat justitia!_
REDEPOSITED OR OVERLAPPING RESERVES
[254]If we are to understand the radical change which will be worked by
the Federal Reserve Act in the reserve situation in this country it is
necessary to examine at some length the system heretofore prevailing.
Under the National Bank Act these banks were divided into three groups
or classes, referred to as the country banks, the reserve city banks and
the central reserve city banks.
There are three central reserve cities: New York, Chicago, and St.
Louis. Every national bank in these cities is a central reserve city
bank. The reserve cities are forty-seven in number and include the
larger cities of the country. Every bank not situated in any one of the
three central reserve cities or the forty-seven reserve cities is a
country bank. This last term includes all the national banks of the
smaller cities in the country, of the manufacturing towns and
communities of New England and the Middle States and thousands of
national institutions doing business in the agricultural sections.
~The Country Banks.~--The country banks, by the terms of the National Bank
Act, are required to keep a cash reserve at all times equal to 15 per
cent. of their deposits. Under the old law the country bank must keep
only 40 per cent. of this required reserve in its own vaults, while it
is allowed to deposit 60 per cent. of the required reserve on call in
such national banks in any of the reserve cities or central reserve
cities as may be approved as "reserve agents" for it by the Comptroller
of the Currency....
~The Reserve and Central Reserve Cities.~--The second class of national
banks, known as reserve city banks, includes all national banks located
in forty-seven cities of the country, which from time to time have been
designated as reserve cities. Every national bank in them is required to
keep a reserve at all times equal to at least 25 per cent. of its
deposits. It must be borne in mind that the deposits of a reserve city
bank include not only what the banker refers to as individual
deposits--the deposits of individuals, firms, partnerships, and
corporations--but also deposits which have been made with the reserve
city bank by country banks, for which it is the reserve agent.
A reserve city bank is permitted by the National Bank Act to keep
one-half of its required reserve on deposit, subject to withdrawal on
demand, in a national bank or banks in a central reserve city, approved
by the Comptroller of the Currency, as its reserve agent....
Every national bank within the central reserve cities must keep a
reserve equal in amount to at least 25 per cent. of its deposits,
including not only individual deposits but deposits by bankers for whom
it acts as reserve agent or correspondent.
~The Reasons for the System.~--This rather complicated system of reserves
was authorized by Congress because it was necessary to allow the banks
of the country districts or smaller cities to keep reserves in other
banks in the larger centres of trade in order to facilitate the
commercial exchanges of the country; and also because it was necessary
to have some means by which banks of the larger cities could finance
payments for their customers in the great centres of the country,
especially in New York, Chicago, and St. Louis....
~Its Weaknesses.~--Our system of deposited reserves has failed miserably
in times of stress, although it has worked reasonably well in ordinary
times. It is contended that it has, to a large degree, built up the
great centres, and more especially New York City, at the expense of
country districts. It has been responsible for the seasonal withdrawal
of money which was at one time a most serious embarrassment to business,
especially in New York, Chicago, and other large cities in the fall
months, but which has practically disappeared in New York City since the
panic of 1907.... It was not until the system of deposited reserves
brought about the panic of 1907 that the country at large became
convinced that this feature of the national banking system was vicious,
dangerous, and likely to produce trouble at any time. With this
conviction began the movement which finally ended in the enactment of
the Federal Reserve Act.
~Much of Our Reserve Fictitious.~--As a matter of fact, the actual
available reserves of the three classes of national banks in the country
are much less than is indicated by the percentage specified in the act
quoted above.... This condition is referred to frequently as the
pyramiding of reserves, which means, in substance, that the national
banks of this country, omitting from consideration the state banks where
the same conditions exist in an even more aggravated form, are doing
business largely upon a paper reserve, which experience has shown is
utterly useless in times of panic. The seven thousand five hundred and
nine national banks held cash and paper reserves on October 21, 1913, as
follows:
_Cash in vaults._ _Due from banks._
Country banks $294,000,000 $534,000,000
Reserve city banks. 251,000,000 258,000,000
Central reserve city banks 381,000,000
------------ ------------
$926,000,000 $792,000,000
As a matter of fact the national banks of the country held $926,000,000
in cash as against total deposits subject to reserve requirements of
$7,172,000,000, or about 12.8 per cent. of the liabilities subject to
the requirements.
~Dangers of the System.~--So conclusive are the lessons to be learned from
the experience of the last half century with the system of redeposited
reserves, that there is a practical unanimity among bankers and
financial experts that the reserves of our banks, with the exception of
the money actually held in the vaults, are, in the words of William
Ingle, vice-president of the Merchants and Mechanics National Bank of
Baltimore, "A great deal of a delusion and a snare." In every panic, the
country banks and the reserve city banks have found that it has been
impossible for them to secure the return of the portion of these
reserves which has been redeposited in New York, Chicago, and St. Louis.
At a time of great stress, when the banks have been subjected to a
drain, they have been suddenly bereft of the support which, in theory,
should have been forthcoming from their reserve agents, and have been
forced to depend upon the 6 per cent. or 12-1/2 per cent. reserve, which
was contained in their own vaults. What is even worse, the outbreak of a
panic in New York City, where every panic of the last half century has
started, was the signal for the suspension of cash payments by every
bank in the country, within a few hours.... Thus a local panic, in many
cases occurring when business conditions were exceedingly prosperous and
healthy, has completely disorganized the exchanges of the country and
brought business to a standstill.
THE PERVERSE ELASTICITY OF NATIONAL BANK NOTES
[255]... It is not quite correct to call our national bank notes
inelastic. They are decidedly elastic. The trouble is that their
elasticity is of a wrong sort; they expand when there is need of
contraction, and contract when the need is for more currency. By calling
the notes inelastic we mean that their volume does not correspond
automatically to the need for currency. This is true, and is one of the
most serious defects of the bond-secured notes....
The demand for currency depends upon the volume of business to be
transacted, and is continually in a state of fluctuation. Various causes
have only to be mentioned to explain the unequal demand at different
times. We have thus the payments of salaries, bills, etc., coming
usually, on the first of each month. Then there are the quarterly
payments of dividends, interest, etc., falling generally on the first of
January and at intervals of three months thereafter during the year.
Above all, we have in this country a regularly recurring seasonal change
in the volume of business, due to the harvesting and moving of the crops
every fall and early winter. Besides these normal fluctuations in the
demand for currency there are of course such abnormal circumstances as
business emergencies, panics, depressions, etc., which at irregular
intervals call for expansion or contraction of the currency. To meet all
these varied demands an elastic currency is a necessity.
The most serious evils of inelasticity in this country are seen in
connection with the annual handling of the crops. It may be safely said
that for this purpose the United States needs every fall at least one
hundred and fifty million dollars of extra currency. Since our monetary
system contains no really elastic element, this extra business of the
fall has to be done with little or no increase of the country's
currency. The crops must be handled by means of a shifting of currency
from one part of the country to another. In the spring and early summer
the agricultural districts are apt to have more money than they need.
Accordingly, the country banks are in the habit of depositing part of
their reserves in banks situated in the reserve cities. A large part of
these sums eventually finds its way into the money markets of New York
and other Eastern cities, where a low rate of interest is paid to
outside banks for such deposits. Now comes the harvest season, and a
demand goes up from the country banks for the return of their deposits.
Every fall the clearing-house banks of New York City alone give up about
fifty millions of "lawful money" to meet this demand.[256] Of course
this means a tight money market. In the spring and summer the funds
obtained from the country banks were loaned out or used as reserves for
deposits. Money was in excess, interest rates were low, and speculation
was encouraged. Now loans must be called in and deposits reduced. This
sudden contraction is a hard blow to all business interests. It is
especially hard on the speculators, and their desperate demands cause
the enormous rates on call loans which are witnessed every fall on the
New York money market....
It has ... been suggested that the inelasticity of the national bank
notes does not mean that their volume never changes. As a matter of
fact, the circulation has been marked by enormous fluctuations, and
these fluctuations, having no relation to the demands of business, have
simply aggravated the evils of inelasticity which have been described.
Thus, between June 1, 1880, and June 1, 1891, the total volume of bank
notes outstanding declined from $345,000,000 to $169,000,000, a decrease
of $176,000,000, or 51 per cent. This retirement of half the circulation
came during a decade marked by large growth in population and wealth,
and by remarkable industrial expansion and business activity. The reason
for this decline lies in the fact that the Government was using part of
its large surplus revenue to pay off the debt. In eleven years the
Treasury paid $1,105,000,000, reducing the debt by more than half,
something without parallel in the history of public finance. The
retirement of half the debt caused a scarcity of United States bonds,
and their prices went soaring. Four per cents of 1907 rose from 103-113
in 1880 to 125-130 in 1888. The inevitable result was the decline of
circulation. The opposite course of events has been seen in recent
years....
[The subjoined diagram (suggested by a similar one for
1902-1906, accompanying the article a part of which is here
reproduced) illustrates the comparative seasonal elasticity
of the notes of our national banks and the circulation of
the chartered banks of Canada for the period 1910-1914. The
marked expansion of national bank notes in 1914 was due to
the crisis brought on by the outbreak of the European war.
The Aldrich-Vreeland notes which were issued in that
emergency were retired in a few months and the volume of
national bank notes assumed normal proportions.
For the Canadian statistics involved the editor is indebted
to Mr. G. W. Morley, Secretary of the Canadian Bankers'
Association.]
[Illustration]
NATIONAL BANK NOTES UNSOUND AND UNSAFE
[257]... Any correct system of credit currency must be based on a
foundation of gold. Bank credit is issued in the two forms of deposits
and notes. The former are based on a reserve of gold, the latter are
not. We have here a fundamental weakness of our bank-note system. Under
proper banking methods, deposits cannot expand without a proportional
increase of the gold reserves of the banks. This furnishes the natural
and necessary check to inflation. Our bank notes, however, have no such
connecting link with the business and the monetary stock of the world.
The basis of the American bank-note currency is the government debt, a
very inferior kind of foundation. Such a system carries with it the
possibility of paper money inflation of a peculiarly dangerous kind,
because its real meaning is apt to be concealed. For example, between
January 1, 1900, and January 1, 1908, the volume of national bank notes
outstanding increased from $246,000,000 to $690,000,000, an expansion of
$444,000,000. In other words, the circulation nearly trebled in eight
years. The cause of this great increase was not the need of more
currency but the changes in the National Bank Act made in 1900, changes
which made the establishment of national banks easier and the issue of
notes more profitable.... The future is likely to witness further
expansion, unless some change is made in our system.... It is
undoubtedly the present intention to give ... to future [bond] issues
[the privilege of being used as security for notes]. Indeed, unless this
privilege is given, there will be no market for the 2 per cent. bonds.
We may expect, therefore, to see each issue made the basis of a further
increase in the volume of bank notes.
All this means inflation, and inflation by means of a circulating medium
having no connection with the gold stock of the world. To make room for
the additional currency, gold must be forced to leave the country, and
our whole monetary system, by no means too strong to-day, will be
weakened at its foundation. This is the fundamental difference between
expansion of credit by means of deposits and expansion by means of
national bank notes. The one is based on gold; the other is based on the
government debt. When deposits expand, the reserves of the banks must
increase proportionately and, if carried far enough, the result must be
to bring in gold rather than to force it out. In like manner, deposits
cannot for any considerable time be in excess of business needs. But
bank notes may be increased indefinitely, if the Government only borrows
enough, and the result will be the expulsion of gold whenever the
currency becomes redundant. That this is an actually present danger is
sufficiently demonstrated by the recent action of the Secretary of the
Treasury, who has seen fit to add to the national debt at a time when
the Treasury had a surplus of over 250 millions, for the sole purpose of
increasing the circulation of the national banks. Our currency system
can never be sound until the bank circulation is entirely divorced from
the government debt.
The danger of inflating our monetary system with bank notes having no
gold reserve back of them is all the more serious from the fact that the
notes of the national banks are used as reserves by state banks, private
banks, trust companies, etc. They are part of the "cash reserves" on
which these banks base their deposits. Thus we have a system of credit
based on credit, and any weakness in the national bank note is carried
over and multiplied in the deposits of other banks.
The complete _reductio ad absurdum_ of this multiple credit system came
when at a recent convention of the American Bankers' Association it was
seriously proposed that it be made lawful for national banks to count
their notes as "lawful money" in their own reserves. There is good
reason to believe that this is actually practised to some extent by
national banks to-day, though the practice is, of course, illegal.
The safety of the national bank notes is seldom questioned. Whenever the
evils of our currency system are pointed out and plans for asset
currency or other reforms are proposed, the reformer is apt to be met by
the reply that, at any rate, our bank notes are perfectly safe, and we
had better put up with their other shortcomings rather than launch out
on new schemes which may possibly sacrifice that safety which we now
enjoy. The foregoing discussion should already have cast some suspicion
on this complacent attitude. It will be further weakened by a closer
analysis of the basis of the national bank circulation.
National banks may issue their notes up to the amount of their paid-up
capital, and up to 100 per cent. of the par value of United States bonds
deposited with the Treasury, but never in excess of the market value of
the bonds. The notes are engraved by the Government and issued to the
banks. When signed by the proper officers of the bank, they become the
bank's promise to pay upon demand and may be issued for circulation. The
United States Treasury is also required by law to redeem on demand all
notes of national banks presented to it. For this purpose each bank must
keep with the Treasury a reserve fund equal to 5 per cent. of its
circulation. The duty of the Treasury to pay notes on demand, however,
is not limited to the amount of this reserve, but applies to all notes
properly presented. In case of the failure of a national bank, the
Treasury is required by law to immediately redeem all its notes. The
Treasury is secured against loss by the bonds deposited, by the 5 per
cent. cash reserve, by its prior lien on the assets of the banks, and by
the personal liability of the stockholders for an amount equal to their
stock investments.
It is thus seen that the popular idea that the holder of a national bank
note is secured against loss by the government bonds deposited in
Washington is not strictly correct. What protects the holder of a note
is the absolute responsibility of the Treasury to redeem all notes on
demand. The bonds are to secure the Treasury, not the individual
noteholder, against loss. The noteholder is secured so long as the
Treasury is able to meet its legal obligations.
Let us examine the character of our government bonds as security to
enable the Treasury to meet its obligations. To understand the
situation, it should be remembered that the leading purpose in the
establishment of the national banking system was not the creation of a
scientific currency system. The National Bank Act was a war measure
enacted largely for the purpose of improving the market for government
bonds during the Civil War. It was for this purpose that the circulation
of state banks was forced out of existence by a 10 per cent. tax and the
right of issue restricted to national banks on condition of the deposit
of government bonds as security. In the accomplishment of this purpose
the act has been eminently successful. United States bonds have been
given a new utility over and above their utility as an investment. From
the very beginning, this has given them an added value and enabled the
Government to borrow at lower rates of interest than it would otherwise
have had to pay. The act of March 14, 1900, made provision for the
ultimate refunding of all the United States debt into 2 per cent. bonds,
and gave an added inducement to the use of these bonds as note security
by lowering the annual tax on circulation from 1 per cent. to one-half
of 1 per cent., provided the notes were secured by the new 2 per cent.
bonds. All bonds issued since 1900 have borne 2 per cent. interest. Yet
the market value of these bonds has always stood above par....
Obviously, this value is not based on earnings. British consols paying
2-1/2 per cent. are to-day quoted in the neighborhood of 85, which makes
them yield about 3 per cent. on the investment. The French and German 3
per cent. loans are both considerably below par. United States bonds
have been given an artificial value through their use as security for
bank circulation. The national banks to-day hold for this purpose about
two-thirds of the total funded debt of the United States. Remove this
privilege from the national debt, and we should see the 2 per cent.
bonds (which compose two-thirds of the interest-bearing debt of the
United States) fall to perhaps seventy cents on the dollar, very likely
even lower.
Here we have a remarkable situation. Our national bank notes are safe
because they are secured by government bonds, and our government bonds
are valuable because they are security for national bank notes. This
looks very much like lifting oneself by one's bootstraps.
If we are to cling to the bond-secured note system, this matter of the
artificial value of government bonds will become an important practical
problem whenever it becomes necessary for the United States to make any
addition to its debt. Either the rate of interest will have to be raised
to 3 per cent. or higher, or, if that alternative is rejected, means
will have to be found to induce the banks to use the greater part of the
new loans as security for additional note issues.[258] In practical
effect, this is only a thinly disguised resort to the time-honored but
now thoroughly discredited practice of compelling the people to use the
government debt as a circulating medium.
The bearing of this matter on the safety of the national bank note is
simple. The burden of the ultimate redemption of the bank notes has been
placed on the shoulders of the Treasury, to add to its other burdens of
maintaining the value of the greenbacks and of the silver dollars. If
loss of confidence in the bank notes should ever lead people to demand
their wholesale redemption, the Treasury would have to meet the demand
in gold. But the moment it tried to sell the bonds, it would find there
was no market for them except at a discount of perhaps 30 or 40 per
cent. It is true that the Treasury would still be able to recoup itself
for this loss in the value of the bonds by exercising its prior lien on
the assets of the banks. But this leads us to the important conclusion
that the final security for our bond-secured notes rests on the assets
of the banks after all. A more striking argument for asset currency
could hardly be discovered.
It must be remembered, however, that the foreclosure by the Government
of its claim on the assets of the national banks would cut into the
wealth on which deposits are based and so have a most disastrous effect
on the deposit system. The pressure upon the Government to refrain from
such a crushing blow to credit would be overwhelming. It is almost
inconceivable that in time of panic or a national crisis the Government
would resort to such a procedure. Almost any alternative would be
preferred. It would not be too difficult a matter for the Government to
persuade itself that the wiser and safer course would be to suspend
specie payments, perhaps even declaring the bank notes a legal tender. A
more plausible case could be made out in favor of such action than was
found sufficient to justify the issue of the greenbacks of the Civil
War. Yet such action would mean the breakdown of our financial system.
This is, of course, looking into the future and anticipating a state of
disaster which may never come. But a system which bids fair to break
down in time of disaster should be remodelled before disaster comes. And
we should not rest too confidently in the notion that disaster can never
reach us. It is only thirteen years ago [1895] that the burden of
supporting its paper and silver currency brought the United States
within twenty-four hours of suspension....
SPECULATION INVOLVED IN THE ISSUE OF NOTES
[259]When a banker takes out currency he engages in two distinct
transactions and enters upon two different hazards. In one transaction
he assumes the risk and holds the expectation of greater profit for
taking out circulation. Since buying bonds and taking out circulation
most of the time shows some theoretical profit over loaning direct,
presumably if there were no other consideration, most of the time our
bankers would keep outstanding all the notes they could. In the other
transaction, however, the banker engages in a speculation in government
securities. As a matter of fact, if the price of government bonds
advances, the profit from taking out circulation declines; but our
banker is pretty likely to view with equanimity the declining
circulation profit when he considers the profit he is making in his
speculation in bonds. On the other hand, as the price of government
bonds declines, circulation grows more profitable. The banker is likely
to view this with sour satisfaction when he looks on his loss in his
bond speculation. Profit or loss in the bond speculation is likely to
outbalance loss or profit in the circulation transaction.[260]
Let us examine the situation more closely. Just what is the profit or
loss from taking out circulation? In the first place the bank gets the
regular current money rates on the loans it makes through issuing notes.
Also it gets the interest on the government bonds it buys. This, of
course, means the real interest, or income on the investment, called
basis, taking into consideration coupon interest, price paid, and date
of maturity. Excepting for the tax of 1/2 per cent. on the circulation
taken out (1 per cent. if taken out on the 3's or 4's) and for the
expenses attendant on taking out circulation, which the government
actuaries compute to average $63 on the $100,000, this interest on the
government bonds looks like clear "velvet." It would be, too, if the
banker did not have to pay more for the bonds than the amount of
circulation he can take out against them. To figure his net profit he
must deduct from the gain items just stated what he would have made if
he had loaned his funds direct instead of investing in bonds.
Expressed as an algebraic equation the situation becomes much clearer.
Let
x = current money rate;
y = basis rate at which government bonds are bought;
z = price of government bonds;
b = circulation received ($100,000 used as basis of calculation);
c = taxes, redemption, and other circulation expenses.
(As already stated, government actuaries have calculated that
circulation expenses average to cost the banks $63 on the $100,000 of
circulation taken out. Taxes depend on whether the 2's, in which case
the tax is 1/2 per cent., or the 3's or 4's, in which case the tax is 1
per cent., are bought. Taxes, then, amount to either b(.01) or b(.005).
We can take b as a constant in our calculations and base all our
computations on taking out $100,000 of circulation.)
The equation of profit or loss on taking out circulation then reads:
yz + bx - xz - c = profit or loss.
But circulation taken out (b) can never be greater than the amount of
money paid for the bonds (z).
If government bonds should be at par or at a discount, the nominal
profit would always be just the basis interest on the bonds, less the
tax and the cost of taking out circulation, or a constant advantage in
the case of the 2's of 1.437 per cent. For the purpose of this
discussion we will consider only the 2's of 1930.
In the regular case, then, the money paid for the bonds (z) is greater
than the amount of circulation received (b). With that statement in mind
we can draw certain very definite conclusions about our circulation
direct from the equation we have formed; z is greater than b.
Repeating the equation in order to have it directly before us:
yz + bx - xz - c = profit or loss.
Then as the current interest rate (x) increases, if all the other
quantities remain constant, the negative influence in the equation grows
greater, or profit from circulation decreases. We can, then, make
definitely:
STATEMENT I
_If all other circumstances remain the same, circulation grows less
profitable as the current money rate advances._
As business increases and the demand for both credit and money
increases, as reflected in the rising interest rates, taking out
circulation _caeteris paribus_, with the inexorability of a mathematical
law, becomes _less_ profitable.
Further, there is an intimate relationship between y and z. If the price
of bonds (z) declines, the basis rate (y) must advance. As a matter of
fact as z declines yz grows greater. If, then, x remains constant and z
declines the influence of the negative quantities of the equation is
growing less. Then follows:
STATEMENT II
_As the price of bonds declines, if the current interest rate remains
constant, the profit from taking out circulation increases._
That gives the absolute mathematical basis for such general statements
as that "the price of bonds is too high to make circulation profitable."
These two facts set out in Statement I and Statement II place the banker
who has taken out circulation between the devil and the deep, blue sea.
If the price of bonds remains the same and the current interest rate
rises, his circulation grows steadily less profitable. A decline in the
price of bonds affords the only offset to an increasing interest rate.
But if the price of bonds declines enough to offset the advance in the
current interest rate, the banks must mark off enough profits to cover
the loss on the capital value of the bonds.
Speculating in securities properly forms no part of a bank's business.
It is an anomalous situation that in order to fulfil a proper function
of note issue a bank should have to undertake such an improper
speculation.
THE LACK OF ADJUSTMENT BETWEEN BANK NOTES AND DEPOSITS
[261]Under our present currency system the volume of money in
circulation is perfectly flexible. It constantly expands and contracts
in automatic adjustment to the requirements of trade and the convenience
of the people. An increase in the volume of cash transactions brings
promptly an increase in the volume of currency in circulation through
the current withdrawals of money exceeding the current deposits of
money. A lessening in the volume of cash transactions promptly drives
unneeded currency out of circulation through the deposits of money
exceeding the withdrawals. No other system could provide a currency
which would adjust its volume in circulation more exactly to the needs
of trade and the preferences of the people. There is a ceaseless flow of
the money in circulation into bank reserves, and of money in bank
reserves into circulation--ceaseless except in an occasional crisis when
the natural flow of money from bank reserves into circulation is
arbitrarily stopped by banks refusing, for self-protection, to continue
paying out to the point of exhausting reserves.
While the volume of money in circulation is thus perfectly and
automatically adjusted to trade requirements, it is to be noted that
this flexibility arises from the flow back and forth, between the mass
of money in circulation and the mass in bank reserves. In this lies the
main economic defect of our present currency system. An expansion in the
volume of money in circulation entails a corresponding contraction in
the volume of bank reserves, and necessarily a corresponding contraction
in loans. A period of expanding business would naturally be attended by
both an increased volume of loans and an increased volume of cash
transactions, such as increased pay-rolls, increased retail sales.
Increased cash transactions cause a larger volume of money to flow into
circulation. But this flow is out of bank reserves, thus contracting
them and necessitating a contraction of loans depending upon them, at
the very time when loans would naturally expand. Obviously, if business
becomes very active, the effect upon bank reserves is so adverse, and
the contraction of loans depending upon reserves so important, that
embarrassment is widespread and panic ensues.
The main defect, then, of our present currency system is that the volume
of currency in circulation has its adjustment in the flow from bank
reserves into money in circulation and from money in circulation into
bank reserves, causing a contraction of bank reserves and the loans
depending on them as business expands.
A remedy would be the use of bank notes through which the volume of
currency in circulation would have its adjustment in the flow from bank
deposits into bank notes in circulation, and from bank notes in
circulation into bank deposits, thus protecting from disturbance both
bank reserves and the loans based on them.
THE COMMERCIAL PAPER SITUATION IN THE UNITED STATES
[262]... At the present time the commercial paper situation in the
United States is peculiar. "Commercial paper" in the old and strict
sense is little used in this country. "Trade paper," as it is now
called, arises in less than 3 per cent. of the credit transactions in
the United States.[263] In some lines of trade, especially where a local
wholesaler does a large business with small tradesmen, the wholesaler
will extend credit by taking the retailers' notes; but in obtaining
credit for himself the wholesaler will not surrender control of the
bundle of retailers' notes, preferring instead to give simply his own
note on a general understanding with his banker that the personal note
rests on, and is fully covered by, the retailers' notes.[264] The
wholesaler hesitates to surrender to the banker the notes that he
receives because he fears that his competitors might get some inkling of
his trade connections, etc. In general, "trade paper" is used to settle
accounts only when the credit terms are still long, that is, four months
or more.[265]
What generally passes as "commercial paper" in the United States is
single-name paper. As in the case of the wholesaler referred to above,
the borrower of bank credit in these days offers for discount simply his
own promissory note. Some of this paper, particularly corporation notes,
carries indorsements, but these are largely "accommodation"
indorsements, which may buttress the security of the paper but which
indicate nothing as to its purpose.
The wide use of single-name paper in this country is largely explained
by the fact that the prevailing terms of payment in business
transactions are net in 30 or 60 days, with a discount for payment in
cash within variously from 10 days to one month. The cash discount
allowed is usually so large that a purchaser can ill afford not to take
advantage of it. Two per cent. discount for cash within 10 days, for
example, with "60 days net" is equivalent to a return of 12 per cent.
per annum on one's capital. In actual practice the allowance is often
even more liberal. Hence where competition is at all keen the business
man is practically forced to adopt the system of cash payments,
depending upon his bank to advance to him, on his own notes, the
necessary funds. Moreover, so broadly has the custom of taking cash
discounts spread that a failure to take advantage of them is generally
regarded as an indication of weakness, and tends to undermine general
confidence in the business man's credit standing. Hence the necessity
for maintaining his credit rating, as well as competition, virtually
forces the business man into making anticipatory cash payments and thus,
more or less as a consequence, into the general practice of discounting
his personal paper.[266]
Furthermore, as business operations have grown to a larger and larger
scale, especially in the case of large corporate enterprises, the credit
needs of business have in many cases expanded beyond the capacity of the
local banks to supply them. The necessity arose, therefore, to go
elsewhere for accommodation. This was met in some cases by the opening
of bank accounts in other centers, but obvious difficulties and
restrictions attend this method of procedure. More elastic possibilities
and fewer difficulties grew out of the employment of middlemen to market
the paper over the country as a whole on the best available terms. Hence
the note-broker is to-day an important factor in the discount market. As
a result of the note-broker's activities there has come to be
established an extensive open market for commercial (single-name) paper
in this country, and the rates at which such paper is discounted are
regularly reported in the daily newspapers.
This development of a commercial-paper market reflects, of course, a
considerable development of the demand of the banks for this form of
investment.[267] "Country banks" especially have in the last few years
heavily increased their purchases in the open market, because the
necessity of writing off heavy losses due to the shrinkage of bond
values has tended to make them more timid about investing in securities,
and because they have also learned by experience that paper purchased
through a broker does not have to be renewed, as does most of the purely
local paper.[268]
This development has, of course, tended to put an increasingly heavy
responsibility on the note-broker and has brought about, at least to
some extent, a readjustment of his business methods. At first
note-brokers simply solicited paper from merchants and charged a
brokerage fee. Latterly, the custom has grown up for the broker to buy
up the paper outright.[269] This forces the broker "to stand between the
maker and the bank," and to the extent that any given piece of paper may
be left on his hands, even though he does not indorse the paper that he
sells, it compels him to be very circumspect about the paper that he
purchases. Moreover, some banks now purchase paper with an option of
return within a specified period, making it a point carefully to
inquire about the maker of the paper before the option expires. In the
last few years banks as well as brokers have established carefully
organized credit departments, the purpose of which is, through careful
inquiry into the character and standing of sellers of paper, to enable
both brokers and bankers to select paper with sounder discrimination.
This characteristically American discount system differs greatly from
that which prevails in Europe. Abroad, single-name paper is very little
used.[270] The European banker demands more than one signature, not only
as a guaranty of security, but also as an assurance of the validity of
the transaction out of which the paper offered for discount grew. When
the prospective borrower, for some sufficient reason, does not wish to
divulge the names of his clients, as would be necessary if he drew bills
on them, he may arrange with his bank for an overdraft (known as a cash
advance),[271] or by paying a small commission he may get the bank to
"accept" a bill drawn directly on it. With a bank's acceptance a bill,
even though drawn by the humblest shopkeeper, becomes a prime investment
and may be sold openly on the market at the lowest terms that
prevail.[272] On the Continent bank acceptances thus open the market
widely to all who can arrange for them, while the open market for
single-name paper in this country is restricted to large firms of
established reputations.
In view of the prevailing practice in Europe it is interesting to
inquire why in America there should have been this peculiar development
in the discount field. It has been pointed out that before the Civil War
trade paper, as it is now called, was pretty generally used, but the
exigencies growing out of the war completely changed the situation. The
excessive issue of the greenbacks and the uncertain value of credit
instruments covering any appreciable period of time led sellers to
endeavor to bring business to a cash basis. Credits were shortened to 30
or even to 10 days, and strong emphasis was placed on immediate
payment. With cash discounts alluringly liberal, merchants could ill
afford to forego them, and cash payments tended to become more and more
common. Big houses offered single-name paper to raise the needed funds,
and little by little the older system of settling by the promissory note
of the debtor was supplanted by the system of selling on open account,
with the choice given to the debtor of a liberal discount for cash or
the payment of the due amount "net" at the expiration of a relatively
short credit period.
The transition was hastened by the development of the practice of
selling goods by sample instead of by personal selection from an
accumulated stock. Under the old practice the buyer bought under the
rule of _caveat emptor_, but when purchasing by sample he had a right to
demand that the delivered goods attain the standard of the sample, and
there grew up in consequence the doctrine of "implied warranties." These
warranties have in some lines been pushed very far,[273] but in any case
the buyer would hesitate to pay for goods until he had had a chance to
inspect them, and hence he would as a rule demand that they be consigned
to him on open account. The seller, however, cannot afford to wait for
payment until his accounts become due. Too much of his capital would be
tied up. He is forced, therefore, to go to his banker and, on the basis
of his accounts receivable, to offer his own note and thus to obtain
release of the capital otherwise temporarily beyond reach....
Single-name paper virtually monopolizes the field....
NO SYSTEM OF BANK ACCEPTANCES AND THE ABSENCE OF AN OPEN DISCOUNT MARKET
[274]The weakness of our banking system as compared with the systems of
Europe may very certainly be attributed in part to the omission of the
bank act to permit bank acceptances. It is a weakness, furthermore,
which involves the country in serious economic loss. Without a national
discount market, the great majority of our merchants and manufacturers
are compelled to confine their borrowings to American capital, either
through the discounting of their paper with their local banks or through
its sale to note brokers. All but the strongest and largest are
practically excluded from the benefits of foreign competition for their
paper. Aside from the great concerns with international ramifications,
which are able to arrange their own credits abroad, our merchants and
manufacturers are not benefited by low foreign discount rates, except in
so far as note brokers, who make it a practice to borrow in Europe with
commercial paper as collateral, are better able to finance their
purchases. What is more, they receive relatively little advantage from
an accumulation of funds in New York banks. Low call loan rates have an
indirect rather than a direct effect on the rate which the mercantile
community has to pay for money. Low call rates, in other words, are an
indication more especially of stagnation in the stock market than of a
lack of demand for accommodation from merchants and manufacturers. Such
rates do not act as a stimulus to trade in general any more than high
call rates act as an immediate check to over-expansion.
It is not only in our domestic trade that the country suffers through
the want of a discount market. Without bank acceptances we are at a
distinct disadvantage in connection with our foreign trade. Our
importers, unable to open credits with their banks, as is done abroad,
are not in a position to finance their purchases upon as favorable a
basis as the importers in other countries, as English cotton spinners,
for example. The English spinner about to purchase cotton in America
arranges for his bank to accept sixty or ninety days' sight bills drawn
on it by the American shipper. The latter draws his bills on the English
bank and attaches the documents covering the shipment, such as the bills
of lading, insurance certificates, invoices, etc. He then sells them to
a New York bank, thereby receiving immediate payment for his cotton. The
New York bank forwards the bills to its London correspondent, which
presents them for acceptance to the bank upon which they are drawn. Upon
the acceptance of the bills the documents are delivered to the
accepting bank, which then turns them over to the spinner upon whatever
arrangement has previously been made. The accepted bills are discounted
by the New York bank in London and the proceeds placed to its credit
there. The New York bank can afford to pay a high rate for such bills,
as they are drawn on prime bankers, rendering certain their ultimate
payment. The purchase of the bills does not, moreover, necessitate any
outlay of money, as against the credit to be received through the
discount of the bills the New York bank can immediately sell its checks
on London.
Without such banking facilities--that is, the ability to arrange with
his bank to accept time bills drawn on it by a foreign shipper, the
American importer is compelled to finance his purchases in either one of
two ways. He may pay for the goods at once by remitting funds direct to
the shipper. This, however, ordinarily necessitates the negotiation by
the importer of a loan on his promissory note. If he is not in a
position to secure such an advance he must shift the burden of providing
funds to finance the shipment, from the time it is forwarded until it is
to be paid for, upon the foreign shipper, who is then in a position to
exact terms more favorable to himself through an adjustment of prices.
The practice in connection with this method of making payment for
foreign purchases is for the shipper to draw his draft on the American
importer and turn it over to his banker to forward for collection. Such
drafts, drawn as they are on individual importers and not on banks whose
standing is well known abroad, must be sent for collection since there
is no general market for them. Practically the only way in which a
foreign shipper can realize immediately on bills of this character is to
dispose of them to his own banker or get him to make an advance on them.
Either of these two methods of financing our imports is expensive even
when the time between the shipment and the receipt of the goods is
short. When the time is much longer, as in the case of imports from
South America and the Far East, the cost is almost prohibitive--that is,
so great that we can not compete on an even basis with foreign buyers.
In fact, we might be practically excluded from these markets if a
makeshift were not possible. Our importer gets around our lack of
banking facilities by having his bank arrange a credit with its London
correspondent. He receives an undertaking, called a commercial letter of
credit, giving the terms of the credit--that is, the name of the London
bank upon which the bills are to be drawn, the amount which may be
drawn, the character of the goods which are to be purchased, the tenor
of the bills, and the documents which must accompany them. On the
strength of such a letter of credit, the shipper in South America, for
example, is able to dispose of his bills on London and thus receive
immediate payment for his goods. The local bank which buys the bills
sends them with the documents to its London correspondent, which
presents the bills to the bank on which they are drawn--that is, the
bank with which the credit was opened. Upon the acceptance of the bills
the documents are delivered. They are then sent by the London accepting
bank to the New York bank which opened the credit and the latter
delivers them to the importer against his trust receipt. Twelve days
prior to the maturity of the bills in London the New York bank presents
a statement to the importer indicating the amount of pounds sterling
which must be remitted to London to provide for their payment at
maturity or rather a bill stated in dollars for the amount of pounds
sterling drawn under the credit. In this purchase of exchange the
importer makes payment for his goods. This method while workable is
obviously cumbersome, yet it is practically the only one which the
American importer can follow in connection with such imports. It is
expensive for the importer, for not only must he pay his bank a
commission for arranging the credit, but there is included in this
commission a charge made by the London bank for its acceptance. Further
than that the importer must take a material risk in exchange. At the
time a credit is opened the cost of remitting, say L10,000 to take up
the bills in London, might be only $48,600, or at the rate of $4.86,
whereas by the time the bills actually mature exchange may have risen
and cost him $4.87, or $48,700.
As a result of the inability of our banks to finance imports through the
acceptance of time bills, American importers are, then, made dependent
to a large extent upon London, and are required to pay London a
considerable annual tribute in the way of acceptance commissions. This
practice not only adds to the importance of London and militates against
the development of New York as a financial center, but it at the same
time works serious injury to our export trade. Since time bills can not
be drawn on our banks from foreign points against shipments of goods to
the United States, there are consequently in such foreign countries very
few bills which can be purchased for remittance to the United States in
payment for goods which have been bought here. In other words, under our
present banking system our imports do not create a supply of exchange on
New York, for example, which can be sold in foreign countries to those
who have payments to make in New York. This means that our exporters are
also, to their great disadvantage, made dependent upon London. It means
that when they are shipping goods to South America and to the Orient
they can not, when they are subject to competition, advantageously bill
them in United States dollars. They naturally do not care to value their
goods in local currency--that is, in the money of the country to which
the goods are going--so their only alternative is to value them in
francs or marks or sterling, preferably the latter, owing to the
distribution and extent of British trade, creating throughout the world,
as it does under the English banking system, a fairly constant supply of
and demand for exchange on London. When we come to bill our goods in
sterling, however, it is at once seen that our exporters are obliged to
take a risk of exchange, which is a serious handicap when competing with
British exporters. Our exporters who are to receive payment for their
goods in sterling must previously decide on what rate of exchange will
make the transaction profitable. If, in an effort to safeguard
themselves against a loss in exchange, they calculate on too low a rate
for the ultimate conversion of their sterling into dollars, their prices
become unfavorable compared to those made by British exporters and they
lose the business. If they do not calculate on a sufficiently low rate
they get the business but lose money on the transaction through a loss
in exchange.
The prohibition of bank acceptances not only acts as a hamper upon our
domestic and foreign trade, but is detrimental to our banks as well. It
is the small country bank which is chiefly affected. The business of the
country bank, so far as the employment of its funds is concerned, may be
divided into two classes--that which relates to advances to local
customers and that connected with the investment of its surplus. It is
in respect to the latter that the matter of acceptances is important.
Under the present limitations of the National Bank Act there are three
principal ways in which a country bank may render its surplus funds
productive. It may deposit them with its reserve agent. This means a low
interest return, too low in fact to permit of only a relatively small
amount being thus employed. It may invest in bonds. In this way an
increased interest return can be secured, providing a wise selection of
securities is made, but it partakes of the nature of speculation. The
third way is to buy commercial paper. Such purchases give an ample
interest return and there is no savor of speculation. Even this method
of employing a bank's funds, however, is far from satisfactory. It means
the investment in a security for the strength of which the bank must
depend on the word of note brokers, the rating of the mercantile
agencies, or the opinion of some correspondent bank. It means,
furthermore, the tying up of the bank's funds for a fixed period. If
national banks were permitted to accept time bills the country bank
could then invest its funds in paper bearing the guaranty of some great
bank with whose standing it is perfectly familiar. Risk such as now has
to be taken would be eliminated. What is vital, however, is that with a
national discount market an investment in a bank-accepted bill is one
which could be realized upon immediately. Commercial paper and bank
acceptances are both discountable. The prime difference between them, as
affecting a country bank, is that they are not both readily
rediscountable. Herein probably lies the reason for the strong prejudice
against rediscounts which exists among bankers in the United States. In
this country when a bank discounts a piece of commercial paper it is
discounting something which for its security depends solely on its
maker. Should the bank desire to realize on this paper it could do so
by rediscounting it, but such a rediscount would be practically
equivalent to a loan to the bank on the strength of its own name. In
other words, to rediscount its commercial paper would affect a bank's
credit. To ask for a rediscount is to ask for accommodation. This would
not be the case with bank-accepted bills. If such bills were discounted
by a country bank as a means of investing its surplus and it was desired
to realize on them such a rediscount would be made not on the name of
the country bank, but on the name of the accepting bank. A rediscount in
this instance would not constitute a loan to the country bank and would
have absolutely no effect on its credit. It would merely indicate that
some more profitable business had arisen in which to employ its funds or
that it was desirous of increasing its reserve.
Since the reserves of interior banks are so largely concentrated with
them and it is essential that they keep their assets in an especially
liquid condition, the prohibition of bank acceptances works injury to
the banks at the country's financial center, New York, in a different
way. It deprives them of what London banks, for example, have--that is,
a mass of the soundest securities against which to loan their money on
call or in which they may invest their funds for very brief
periods--bills of exchange, covering genuine commercial transactions,
bearing the acceptance of prime bankers. Unquestionably such securities
as a basis for loans are preferable to stock and bonds, but without them
New York banks must have recourse to day-to-day loans on the Stock
Exchange. Moreover, when the demand for such loans is limited. New York
banks are forced into the keenest kind of competition, a competition
which, as has been pointed out, is not only of little benefit to trade
but which, through the lowering of the money rate, actually stimulates
speculation. Furthermore, without a steady money rate such as exists in
countries possessing discount markets, New York banks are left with no
reasonable or satisfactory basis upon which to fix a rate of interest to
pay for the deposits of country banks. In London interest on bank
deposits is fixed at a certain percentage below the Bank of England
discount rate, usually 1-1/2 per cent.--that is, a rate which
fluctuates with the value of money and normally leaves a certain margin
of profit to the London bank. The same practice is followed in all the
great financial centers of Europe. With us, country banks receive a
fixed rate of interest for their deposits, usually 2 per cent., the year
around, regardless of fluctuations in the value of money. The
unscientific nature of such a rate is obvious. When the call loan rate
is high country banks do not receive interest in proportion to the value
of their deposits. When it is low the New York banks pay more interest
than the deposits are worth. In the latter instance the New York banks
are forced into injurious competition with one another. They are in much
the same position as competing railroads were earlier in our history,
with results similarly baneful. With the railroads it was worth while to
secure traffic even at a losing rate, as no matter what the return it
helped, if only a little, toward meeting fixed charges. Oftentimes with
the New York banks to-day any rate which they can secure for their money
whether losing or not is acceptable as helping to meet this fixed
interest charge on bank deposits. To pay 2 per cent. for deposits and to
keep a 25 per cent. reserve a bank must loan its money at 2-3/4 per
cent., to come out even, taking into consideration the actual expense of
making and recording the transaction. It is better to loan at 1-3/4 per
cent., however, than to let the money lie idle. It is better to lose 1
per cent. than to lose the entire 2-3/4 per cent., as would be done in
case no loans at all were made, clerk-hire being just as much a fixed
charge as interest. With the amendment of the National Bank Act, to
permit the acceptance of time bills, such ruinous competition would
cease. The funds of the banks would come to be principally invested in
trade paper and stock-exchange loans would be relegated to a position of
secondary importance, as in London and on the Continent. The field for
the investment of their deposits would be greatly broadened, to the
benefit both of the banks and trade in general.
To remedy this primary defect in our banking system, to make possible
the financing of our domestic and foreign trade along the lines which
have proved so advantageous in other countries, to provide negotiable
paper of a character suitable to the investment of foreign funds, paper
which can not only be discounted but rediscounted, to give trade the
advantage of bank surpluses accumulated both in the country at large and
in New York, to lessen the evils of speculation, to afford a reasonable
basis for the calculation of interest rates on bank deposits in central
reserve cities, to bring New York into the circle of those financial
centers between which funds move naturally as discount rates rise or
decline, to secure the advantage of the competition of foreign capital
for our trade paper, can be put in the way of accomplishment by the
insertion of a paragraph or two in the National Bank Act.
* * * * *
[275]The European financial system is constructed upon discounts as its
foundation; the American system is constructed upon bonds and stocks as
its foundation. Bank notes in Europe are issued mainly against bullion
and discounts; in the United States mainly against bullion and bonds.
The quick assets held by European banks against their deposits consist
of discounts or call loans, largely secured by discounts. The quick
assets of American banks ... are primarily call loans on stock and bond
collateral.
In Europe the daily plus and minus of money requirements are adjusted by
the use of the discount market--that is to say, in a final analysis, by
purchase or sale of bills. (Calling in or putting out money on call
where the loans are secured by bills amounts, in effect, to a sale or a
purchase of bills.) In a last analysis this means that in Europe
attempts to liquidate are primarily appeals to the whole nation to
liquidate its temporary commercial investments, the brunt of such
liquidation being borne by the entire community, and the pressure being
constantly subdivided, every member of the community thus contributing
his share.
As a majority of discounts represent goods in process of production or
on the way to consumption, liquidation with them primarily expresses
itself by a falling off in new production, while the consumer, on the
other hand, can not stop consuming and must therefore continue to pay.
The brunt is thus borne by the whole nation and adjustment follows
without violent convulsions.
In sharp contrast with such a system the attempts to liquidate in the
United States are directed primarily at the contractors of stock
exchange loans. This means that a comparatively limited number of
debtors are called upon to sell their securities. This they can do only
by finding new investors, who, as a rule, are at such times
comparatively rare, because when acute pressure arises it generally
originates in the inability of the investor to purchase because of lack
of funds or in his unwillingness by reason of his distrust of the
financial situation. The concomitant of this is that those forced to
sell securities at such times must offer them at sufficiently reduced
prices to bring about an entire change in the attitude of the investor.
The difficulty here is that violent reductions of prices in themselves
cause distrust, and low prices caused by distrust not only frighten away
purchasers but, in addition, unsettle the owners of securities and thus
cause them to join the ranks of the sellers. An acute convulsion,
therefore, must inevitably follow before the tide can be turned....
Of course, general liquidation in Europe includes a liquidation of
securities, just as liquidation in the United States also includes
liquidation of commercial paper as it matures. But the difference is
that in Europe bills will be the main factor and securities will play a
much more subordinate part, while with us just the reverse is true.
THE ESSENTIAL CONDITIONS FOR THE ESTABLISHMENT OF AN INTERNATIONAL
DISCOUNT MARKET
[276]The essential conditions for the establishment of an international
discount market are:
1. Every bill offered for discount should be based on a commercial
transaction where value passes. Finance or accommodation bills should
be extremely rare and capable of satisfactory explanation.
2. It follows that almost invariably the bill will arise out of a sale
of goods and will be in the form of a draft by the seller upon the
buyer, and accepted by the buyer.
3. It will thus be a two-name bill, and not an individual promissory
note. How far you can change your system in this respect and how far the
powers of your new Federal banks can be used to induce such a change, is
a question which I cannot pretend to answer, but which you will no doubt
be able to answer.
4. The bill should be drawn for a period neither too long nor too short.
The period should be sufficient to allow of a resale of the goods on
which the bill is based, thus making the bill in a sense
self-liquidating. The usual period is three months.
5. While there should be a large proportion of trade bills, there should
be a still larger proportion of acceptances by banks and finance houses,
based, of course, on collateral, which usually takes the form of
imported produce. In Germany, however, I understand that banks accept a
good many drafts arising out of internal transactions.
6. If the market is not to be merely a home market, but international:
that is, attractive to foreign bill buyers, an important and desirable
step would be the opening of American banks or branches of American
banks in foreign exchange centres, such as London, Paris, Berlin,
Amsterdam, Buenos Aires, Shanghai, and so on, and these banks should
always be prepared to encourage American bills by buying, at reasonable
rates of exchange, bills on New York, Chicago, and other American
centres, payable in dollars.
7. Your usury laws would have to be modified so as to allow discount
rates to move freely upwards if required.
8. Your Federal reserve banks which are intended to be the equivalent of
the Central banks of other countries, such as the Bank of England, Bank
of France, and the Reichsbank, should be prepared to rediscount approved
bills at all times and to any extent.
The advantages to you of such a market would be the same advantages
that we possess, namely, liquid employment for short money; power to
meet demands for money without disorganizing stock exchange prices;
power to check overtrading at home, and finally, power to check a
foreign drain of gold.
CASH STOCK EXCHANGE DEALINGS
[277]In England, France, and Germany there exist monthly or half-monthly
settlements of stock exchange transactions, and as stock exchange loans
run from one settlement to the next the amount of money employed on the
stock exchange between settlements remains stationary. If, at the
settlement, it develops that commitments on the stock exchange have
increased and that a larger amount of money is needed there, so much
additional money will under normal circumstances be withdrawn from the
bill market and go into the stock exchange. If less money is wanted on
the stock exchange, so much more will go into the bill market.
Without entering upon a discussion of the question of cash stock
exchange dealings versus stock exchange dealings per settlement (for
which, be it said in passing, a suitable method of weekly stock exchange
settlements can probably be devised for this country, combined with
provisions for proper margining in order to prevent over-stimulation to
gambling), we are, for the purposes of this article, interested only in
the effect of this method of cash dealings on the whole financial
system. An exclusive system of cash dealings brings about the
pre-ponderance of the call loan on stock exchange collateral. But for
the existence of the seducing call loan, which is one of the gravest
dangers and curses of our system, we should have been forced to develop
our bill market as a regulator of our daily money requirements. In that
case, instead of seeing the idle money of the whole nation poured into
stock exchange loans when trade is inactive--thus unduly stimulating
speculation when it should be discouraged--and again withdrawing money
from the stock exchanges in order to provide for the business of the
whole nation when trade becomes active--thus bringing about anxiety and
convulsions on the stock exchange in the face of prosperity--we should
have a system based on bills; that is to say, based on the broad
foundations consisting of the commerce and trade of the whole nation,
and we should then enjoy an almost uniform rate of interest all over the
country, gently rising and falling within moderate bounds, instead of
the violent fluctuations and unbearable conditions to which we are now
subjected.
The aggregate amount invested by a nation in trade and commerce should
be and is many times the amount invested in stock exchange loans, which
latter represent undigested securities and securities carried for
speculative investors. Our way of doing business may be illustrated by
two adjoining reservoirs, one small and one very large. The small one
represents the stock exchange and contains the call loans; the large one
represents the general business of the country, as expressed by commerce
and industry. In Europe the small reservoir is regulated by pumping
water into it from the large one or by withdrawing water from it into
the large one. In this way the outflow and inflow of the large reservoir
are scarcely perceptible, and yet there is no difficulty in regulating
the small one. With us, the reverse is done. If there is a shortage of
water in the large reservoir we draw on the small one and, in order to
increase the water in the large reservoir by perhaps an inch, we empty
the small one altogether, or else in order to decrease the amount of
water in the large reservoir by an inch, we fill the small one to
overflowing.
NO POWER TO LEND ON REAL ESTATE[278]
Most of the restrictions in the national banking law have to do with
loans, reserves, or the issue of notes. Of these the restrictions upon
loans are by far the most serious impediment in competing for business
with state banks and trust companies. For the banks outside the large
cities this is particularly true of the provision which forbids loans
upon real estate as security.
This restriction is based upon a sound banking principle, learned after
much bitter experience. But the experience which led to a complete
prohibition of real estate loans was gained amid the economic conditions
of the first half of the last century, and the principle itself is one
which is applicable only to a particular form of banking organization.
While the country was in process of settlement, with an abundance of
unoccupied fertile land, real estate was a security of most uncertain
value. Moreover, the wildest of the speculative movements which preceded
all our early crises were invariably in land. At present, land values
are far more stable, and real estate is everywhere included among the
most conservative of investments, proper for all with the one exception
of commercial banks.
For banks, all of whose obligations are payable upon demand, the real
estate loan, quite regardless of its safety, is wisely considered
unsuitable. Such loans are commonly wanted by borrowers for a
considerable period of time and, therefore, they can not readily be
reduced in amount even by an individual bank. In other words, they are
not liquid. But the importance of this quality in all its assets
disappears when a bank begins to acquire time or savings deposits, as
well as those payable on demand.... The example of the trust companies
shows that a great variety of financial business can be carried on
safely and profitably under a single management. Failures among them
have been comparatively few in number, and it would be difficult to find
a single instance of disaster which could be attributed to the variety
of business carried on.
Some of the advantages which the banks would derive if they were able to
lend on real estate are so evident that they require little more than
mere mention. It would give them more of the most profitable kind of
business, that which has its origin in the neighborhood of the bank. The
immediate return is generally greater than can be secured from the
employment of funds in the money centers or in the purchase of paper
from note brokers. Moreover, in fostering the growth of wealth and
population in its locality a bank is laying a solid foundation for the
future expansion of its own business. Finally, the ability to lend on
real estate will often enable a bank to secure valuable customers who
would otherwise go elsewhere. It has been the unpleasant experience of
many a national banker to be obliged to refuse a loan to a would-be
borrower who has nothing but real estate to offer as security and to see
him enter a neighboring state bank or trust company where there was no
legal obstacle to the transaction. Relations once established are pretty
certain to continue even after the borrower has security which falls
within the provisions of the national law.
There are then at least three distinct advantages which may be expected
to follow if the national banks are permitted to lend on real estate. It
would be profitable for the banks; it would be of advantage to the
localities served by the banks; and, finally, it would enable the banks
to compete with state institutions upon a more equal footing,[279] thus
checking to some extent the relative decline of banking under the
national law.
THE INDEPENDENT TREASURY AS A SOURCE OF WEAKNESS IN OUR BANKING
SYSTEM[280]
For many years the banks of this country have conducted a persistent
agitation for the abolition of the Independent Treasury system. It has
been their contention that the Independent Treasury was an archaic and
inefficient system of administering the finances of the nation; that it
worked serious hardship upon the banks and the business of the country,
and that any system of reform should include its abolition.
The treasury is, in reality, a central bank of deposit with branches,
run by the Government, in which the Government is the only depositor,
and from which there are no borrowers. The central office of the
Treasury is situated in Washington, while there are ten subtreasuries or
branches scattered among the various large cities of the country. The
most important subtreasury, from the standpoint of the volume of
business handled, is located in New York City....
The United States is the only large nation in the world which has a
treasury system of this sort, and this fact has been made much of in the
agitation for its abolition.
DIFFICULTIES ARISING FROM THE TREASURY SYSTEM
There is no room for dispute that many features of the Independent
Treasury have, in the past, been the source of serious difficulties.
However, we must recognize that within the last decade, and particularly
within the last two or three years, most of the glaring defects have
been eliminated through a liberalization in methods, involving, in
brief, a deposit of a very considerable amount of the Government's money
in national banks rather than carrying it locked up in the vaults of the
Treasury, through more liberal administrative regulations by which
payments to the Treasury could be made with certified checks, and
through facilitating in other ways the transactions of business men with
the Treasury Department.
CORRESPONDENCE OF TREASURY RECEIPTS AND DISBURSEMENTS
... The real criticism against the Treasury is that it causes the tying
up of money, not over a series of years, but during the months in which
the banking system of the country most needs it. This condition is the
result of the lack of correspondence between government receipts and
disbursements.
During the first four months of the year the receipts are less than in
any other period. During the month of May, the receipts sharply
increase, reaching their maximum about the first of June, and continuing
at a very high rate over that month. In July the income falls off,
reaching by the end of the month a point a little above that which
prevailed in April, after which it gradually increases during August and
September. About October first the tide turns and the receipts fall off
sharply during that month, while during December the revenue again
increases. As contrasted with this the government expenditures change
only in a general way....
EXAGGERATION OF TREASURY EVILS
It should be stated that whatever embarrassment exists because of this
condition, and which as a matter of fact has been grossly exaggerated,
is found almost entirely in New York City.
However, in order to reduce as much as possible the objections raised by
the bankers and to prevent money being taken out of circulation and
buried in the Treasury, where it would be of no service to the country,
the Secretary of the Treasury, on January 9, 1913, issued the following
order, which inaugurated a radical change in the manner of handling and
disbursing the public funds. The objects to be accomplished were
announced in the order as follows:
"For the purpose of bringing the ordinary fiscal transactions of the
Federal Government more nearly into harmony with present business
practices, it has been determined that the daily receipts of the
Government shall be placed with the national bank depositaries to the
credit of the Treasurer of the United States. Disbursements will be made
by warrant or check drawn on the Treasurer, but payable by national bank
depositaries, as well as by the Treasury and subtreasuries."
Secretary McAdoo, in his report for the fiscal year ending June 30,
1913, in speaking of this, stated that while it had caused some
embarrassment "the difficulties at first encountered are disappearing,
and the system appears to respond to the public requirements, and to be
accomplishing the purposes for which it was devised."
LACK OF CENTRAL CONTROL
[281]There is no country in the world where the volume of currency in
circulation and the demand for bank credits fluctuate more widely than
in the United States. This is due to the great expanse of our territory,
to the annual harvest requirements of the agricultural sections, to the
prevailing business activity and enterprise, and to the rapid and
unequal increase of population and wealth in different sections.
Furthermore, there is no country in the world where intelligent control
over bank credits and bank reserves is needed more than in the United
States. There are in the United States nearly seven thousand national
banks, besides twice as many state banks and trust companies. Each of
these institutions acts for its individual interest alone, independently
of the others, and the prevailing tendency of each at all times is to
expand its credits to the limit permitted by law. The country banks lend
their surplus resources in the form of deposits at interest to the banks
in the larger cities, and the banks in the principal money centres
commonly expand their credits as much as practicable by lending on call
such sums as they deem it unsafe to lend on time or by discount of
commercial paper. Each bank with a deposit in another bank assumes that,
in case of need, it can strengthen its reserve by drawing upon this
deposit; but it fails to consider that, when thus it strengthens its own
reserve, it must to the same extent weaken the reserve of the other
bank, and that the deposits of banks with other banks add no strength to
the general credit situation. Each bank that has loaned money on call
assumes that, in case of need, it can strengthen its reserve by calling
such loans; but it fails to consider that, generally, when a loan is
called the borrower is obliged to borrow the same sum from some other
bank, although a high rate of interest may be exacted, and, therefore,
that call loans affect the security of the entire bank situation
practically to the same extent as time loans.
In the United States there is no way of regulating the supply of bank
credits and of holding part of the potential supply in reserve for
periods of financial stringency. Consequently, nearly always there is
either an over-abundance of money (meaning credit which the banks are
ready to lend) or a money famine. It has been argued that the volume of
credits granted by the banks depends upon business activity and upon the
consequent demand for credit and not upon the power of the banks to
grant credits, and, therefore, that low interest rates have little
effect in causing an expansion of bank credits. Experience, however,
shows that the contrary is the case, at least in the United States. It
is true that, when there is loss of confidence and when business is
depressed, interest rates are low, because there is less currency in
circulation and more in the bank reserves, while at the same time the
demand for bank credits is diminished. It is true, also, that low
interest rates will not stimulate speculation and enterprise unless
people have confidence and are ready to speculate and to embark in new
enterprises. But we know by experience that when people are in a mood
for speculation and for business expansion low interest rates operate as
a powerful stimulus to speculation and business expansion. A leading
banker has said: "In the long run commerce suffers more from the periods
of over-abundance (of money) than from those of scarcity. The origin of
each recurring period of tight money can be traced to preceding periods
of easy money. Whenever money becomes so over-abundant that bankers, in
order to keep it earning something, have to force it out at abnormally
low rates of interest, the foundations are laid for a period of
stringency in the not far distant future, for then speculation is
encouraged, prices are inflated, and all sorts of securities are floated
until the money market is glutted with them."[282] [The need of
intelligent control over discount rates and bank credits is (was)
imperative.]
ABSENCE OF REGULATION OF RATIO OF DEPOSITS TO CAPITAL AND SURPLUS
[283]The reports of condition of the national banks, according to the
statements of September 12, 1914, to the Comptroller of the Currency,
show that, on an average, the total deposits of all national banks
amount to about four and six-tenths times their total capital and
surplus. This means that the average capital and surplus of these banks
is equal to approximately 21 per cent. of the total amount of deposits.
There are, however, national banks whose deposits amount to ten or more
times their capital and surplus, and in these cases the margin of
protection to depositors is only 10 per cent. or less of the sum total
of deposits. Usually the amount of money which a bank has invested in
loans approximates the amount of its deposits. In the case of a bank
whose loans equal its deposits, and whose deposits are approximately ten
times its capital and surplus, it is obvious that the loss of over 10
per cent. in loans would wipe out both capital and surplus and destroy
the solvency of the bank, rendering it unable to pay its depositors.
The view is held by many practical bankers and experienced economists
that it is not sound banking for an active commercial bank to be allowed
to receive deposits in excess of ten times its capital and surplus. I am
firmly impressed with the correctness of this view, and respectfully
recommend to the Congress that the national-bank act be amended so as to
provide that no national bank shall be permitted to hold deposits in
excess of ten times its unimpaired capital and surplus. Perhaps it might
be wiser to make this limitation eight times the capital and surplus.
Such a limitation need not interfere with the growth and development of
the bank. When its deposits approach an amount equal to ten times its
capital and surplus, or whatever other limitation may be fixed,
arrangements may be made to increase its capital. A bank whose deposits
amount to ten times the capital and surplus, if efficiently managed,
should be so profitable that there would be no difficulty in providing
for an increase of capital by the sale of additional stock, and when the
proposed increase shall have been authorized by two-thirds of its
stockholders and approved by the Comptroller of the Currency, it can be
made promptly effective. A commercial bank whose capital and surplus
amount to less than one-tenth of its deposits is, except possibly under
very exceptional conditions, doing business on too small a capital and
upon too narrow a margin for safety, and does not furnish its creditors
the protection to which they are entitled against unexpected losses and
contingencies which are liable to, and do, so frequently arise....
BANKING ABUSES
[284]... Among the many abuses and violations of law and regulations
with which the department has to contend are excessive loans;
overdrafts; loose and unbusinesslike methods of accounting; excessive
borrowings by the banks; investment of the bank's funds in securities
not authorized by law; charging of usurious rates of interest; unlawful
loans on real estate; excessive loans to officers, clerks, and employes
of the bank employing them; loans to a bank's officers or employes and
others through "dummies"; loaning money, directly or indirectly, upon
the bank's own stock; transaction of a brokerage or commission business
by the bank's executive officers, the commissions thus collected being
sometimes appropriated personally by the officers and sometimes going
directly or indirectly to the bank; false statements of directors as to
ownership of stock; false statements made by bank officers, such as
including as cash or cash items memoranda of moneys due from one source
or another which do not represent actual cash and can not be immediately
converted into cash; and failure or refusal when so directed to charge
off bad debts and other ascertained losses; delay on the part of
directors in taking the oath of office.
For many of the offences indicated the only penalty which can be
enforced by the Comptroller's office is the forfeiture of the bank's
charter by suit in the United States Court. This in many cases would
prove a great hardship to innocent stockholders and depositors, and can
only be resorted to with much reluctance by this office....
USURIOUS INTEREST RATES
[285]All the national banks of the country have been required in each
report of condition made to the Comptroller's office since January 1
last to state under oath the highest rate of interest they have charged
since the preceding report and the average rate of interest charged by
them on all loans since the preceding report.
The reports received at the Comptroller's office show indisputably that
in some States and sections borrowers, especially small borrowers, have
been and are being subjected to extortions and exactions which the
average man would consider impossible in this enlightened age.
One thousand and twenty banks in different sections of the country, out
of the total of 7,615 banks, admitted that they were receiving an
average of 10 per cent. or more--some an average of 18 per cent.--on all
their loans.
Those receiving an average of 10 per cent. and upwards included 2 banks
in Illinois, 6 in Minnesota, 2 in Missouri, 23 in Georgia, 6 in Florida,
21 in Alabama, 2 in Louisiana, 315 in Texas, 17 in Arkansas, 3 in
Tennessee, 90 in North Dakota, 25 in South Dakota, 18 in Nebraska, 5 in
Kansas, 38 in Montana, 14 in Wyoming, 37 in Colorado, 25 in New Mexico,
300 in Oklahoma, 12 in Washington, 10 in Oregon, 13 in California, 2 in
Utah, 1 in Nevada, and 33 banks in Idaho.
Let me illustrate the methods of some of these bankers by giving you the
facts and figures as taken from the sworn statements submitted to the
Comptroller's office by the national banks in two particular States in
the Southwest.
In one of these States there were 131 banks which reported that they
charged a maximum rate of interest ranging from 15 per cent. to 24 per
cent. per annum, 67 banks whose maximum rate ranged between 25 per cent.
and 60 per cent. per annum, 22 banks which charged between 60 per cent.
per annum and 100 per cent. per annum, 18 banks whose maximum rate was
from 100 per cent. to 200 per cent. per annum, and 8 banks which owned
up to having charged maximum rates ranging between 200 per cent. and
2,000 per cent. Most of these disgraceful and unprecedented rates were
for comparatively small loans....
These figures are not results of the rule, applied by many banks, not to
pass a loan on their books for less than a dollar.... When we find loans
made by national banks for $25, $50, $100, $200, $500, and $2,000 or
more, at 40, 50, 100, or 1,000 per cent., it is merely a hideous gamble
on how long the borrower can keep starvation from his door and live and
work. Yet I am told on good authority that in one State, largely
agricultural, reports from nearly 200 banks--lending chiefly or largely
to farmers--show losses of only a fraction of 1 per cent. on farmers'
loans, while the average interest rate in these particular banks is 12
per cent. to 15 per cent.--and the maximum rate 30 per cent. or 40 per
cent., the banks paying large dividends.
We read much of the infernos of the slums of the great cities, of
degradation and misery and squalor, of the grinding callousness of
tenement landlords and sweatshop operators. Here in the country we find
bankers, men in business that should be the most respectable, as it is
the most responsible, of all secular avocations, literally crushing the
faces of their neighbors, deliberately fastening their fangs in the very
heart of poverty....
A well thought out, carefully constructed, conservative system of rural
credits for the development of agriculture and the increase of our
wealth and resources by offering encouragement and opportunity to the
ambitious farmer will come presently. When it comes all of us will share
the splendid results....
BANKERS' VIEW OF USURIOUS INTEREST RATES
[286]On February 25 the following statement was "given out" from the
office of the Comptroller of the Currency:
The Comptroller of the Currency received to-day from the
Farmers' Grain Dealers' Association of Iowa notification of
the adoption at the convention of that association in Des
Moines, Iowa, on the 17th instant, of the following
resolution:
_Be It Resolved_, By the Farmers' Grain Dealers' Association
of Iowa, representing 40,000 members, as follows:
That we are as much opposed to bank discrimination in
interest rates as to railroad discrimination in freight
rates.
We oppose private control of the public currency.
That we strongly commend the Comptroller of the Currency for
his courageous exposure of bank usury; and we unalterably
oppose the efforts of the guilty parties to abolish his
office.
There has been no better statement of the Comptroller's position than is
here given--credit standing and variations of it must have no influence
on interest rates and anyone who wishes his office abolished is guilty
of usury; or, conversely, only those guilty of usury wish the office
abolished.
The statement is inadequate only in the failure to define what is meant
by "private control of the public currency."
FOOTNOTES:
[249] Conway and Patterson, _The Operation of the New Bank Act_, pp. 1,
2. J. B. Lippincott Company, Philadelphia, 1914.
[250] John Skelton Williams, Comptroller of the Currency, _Democracy in
Banking_, Address delivered before the annual convention of the North
Carolina Bankers' Association, Raleigh, May 13, 1914. Printed in
_Congressional Record_, 63d Congress, 2d Session, Vol. 51, pp. 10150-53.
[251] A. Piatt Andrew, _The Essential and the Unessential in Currency
Legislation_, in Questions of Public Policy, Addresses delivered in the
Page Lecture Series, 1913, before the Senior Class of the Sheffield
Scientific School, Yale University, pp. 62-70. Yale University Press,
New Haven, Connecticut, 1913.
[252] Adapted from John Perrin, _What is Wrong with Our Banking and
Currency System?, The Journal of Political Economy_, Vol. 19, No. 10,
December, 1911, pp. 856-865.
[253] Paul M. Warburg. _The Discount System in Europe_, Publications of
the National Monetary Commission, Senate Document, No. 402, 61st
Congress, 2nd Session, pp. 33, 34.
[254] Conway and Patterson, _The Operation of the New Bank Act_, pp.
203-207. J. B. Lippincott Company. Philadelphia. 1914.
[255] Fred Rogers Fairchild, _Bond-Secured Bank Notes and Elasticity_,
_The Outlook_, Vol. 88, No. 11, March 14, 1908, pp. 590-93.
[256] [As was pointed out in an earlier chapter, the autumnal demand for
currency in the agricultural sections of the country has fallen off
appreciably since 1907.]
[257] Fred Rogers Fairchild. _Fundamental Defects of the Bond-Secured
Bank Notes_, _Bankers Magazine_, Vol. LXXVI, No. 4, April, 1908, pp.
487-90.
[258] We are not considering the third alternative of issuing bonds at a
heavy discount.
[259] Adapted from W. H. Lyon, _A Gamble in Governments_, _Moody's
Magazine_, Vol. XI, No. 1, January, 1911, pp. 181-186.
[260] [In this extract the explanation of the so-called perverse
elasticity of our national bank notes is given incidentally but very
clearly.]
[261] Adapted from John Perrin, _What is Wrong with Our Banking and
Currency System?_, _The Journal of Political Economy_, Vol. 19, No. 10
December, 1911, pp. 856-865.
[262] Eugene E. Agger. _The Commercial Paper Debate. The Journal of
Political Economy_, Vol. 22, No. 7, July, 1914, pp. 663-667.
[263] _Annalist_, March 9, 1914, p. 293.
[264] _Annalist_, March 9, 1914, p. 294.
[265] J. J. Klein, _Annalist_, March 23, 1914, p. 361.
[266] _Ibid._
[267] During 1912 over $1,700,000,000 in notes were sold by reputable
brokers, and they represented in these transactions from 2,500 to 3,000
concerns. In one large eastern state over two-thirds of the state banks
and trust companies regularly invest a portion of their funds in this
class of paper (J. A. Broderick, _Finance_, October 4, 1913, p. 328). On
August 9, 1913, according to the report of the Comptroller of the
Currency, the national banks held over six billions of dollars of
commercial paper, most of which was single-name.
[268] _Financier_, June 22, 1912.
[269] J. G. Cannon, _Financial Age_, October 19, 1908.
[270] P. M. Warburg, _The Discount System in Europe_, in Report of the
National Monetary Commission.
[271] _Ibid._: see also William Jacobs, _Bank Acceptances_, in Report of
the National Monetary Commission.
[272] Warburg, _loc. cit._
[273] E. D. Page, _Annalist_, March 16, 1914, p. 324.
[274] Lawrence Merton Jacobs, _Bank Acceptances_, Publications of the
National Monetary Commission, Senate Document No. 569, 61st Congress, 2d
Session, pp. 9-19.
[275] Paul M. Warburg, _The Discount System in Europe_, Publications of
the National Monetary Commission, Senate Document, No. 402, 61st
Congress, 2nd Session, pp. 23-25.
[276] Adapted from James H. Simpson, General Manager, Bank of Liverpool,
Ltd., _Some Leading Features of the London Money and Discount Markets_,
an address delivered at the annual banquet of the bankers of the city of
New York, January 19, 1914.
[277] Paul M. Warburg, op. cit., pp. 28-30.
[278] O. W. M. Sprague, _Banking Reform in the United States_, pp.
72-75, Harvard University, 1911.
[279] The importance of real estate to the state banking institutions is
shown in the Special Report from the Banks of the United States on April
28, 1909, recently published by the National Monetary Commission. For
state banks real estate loans and mortgages amounted to $414,000,000 or
12-1/2 per cent. of total resources and for the trust companies to
$377,000,000, more than 9 per cent. of their resources.
[280] Conway and Patterson, _The Operation of the New Bank Act_, pp.
184-192. J. B. Lippincott Company. Philadelphia, 1914.
[281] Victor Morawetz, _The Banking and Currency Problem in the United
States_, pp. 47-50. North American Review Publishing Company. 1909.
[282] From an address by Mr. James B. Forgan to the Texas Bankers'
Association.
[283] Report of the Comptroller of the Currency, 1914, pp. 20, 21.
[284] _Ibid._, pp. 16, 17.
[285] John Skelton Williams, Address before the Kentucky Bankers'
Association, October 6, 1915. _The Commercial and Financial Chronicle_,
Vol. 101, No. 2624, October 9, 1915, pp. 1137, 1138.
[286] _Journal of the American Bankers' Association_, Vol. VIII, No. 9,
March, 1916, pp. 755-6.