Chapter 10

COMMERCIAL BANKING IN THE UNITED STATES

The commercial banking system of the United States consists of several elements which have been contributed at different periods in our history. The most important of these are state banks, national banks, and the independent treasury system.

_1. State Banks_

From the very beginning of our national history institutions enjoying, among others, the privilege of commercial banking have been chartered by our states. For several years after the adoption of our constitution it remained an open question whether the incorporation of such institutions was not their exclusive privilege, but in the case of McCulloch v. Maryland, in 1819, the Supreme Court decided that the federal government also had this right.

During the years 1791-1811, and 1816-1836, the state banks had as competitors the first and second United States banks, and in 1863 so-called national banks entered the field, and, more recently still, trust companies. Private banks have also existed from the beginning, but their number and relative importance have declined in recent years. At the present time the number of state banks exceeds that of all other classes of banking institutions combined, but in capital and resources they are inferior to both national banks and trust companies.

Since each state has had a free hand in the matter of legislation concerning the banks chartered under its auspices, uniformity in the regulations imposed upon and in the kind and degree of supervision exercised over this class of institutions, is lacking. In most cases, however, as compared to national banks, the amount of capital required is smaller; they have greater freedom in the making of loans, especially upon real estate security; and they are not so carefully examined and supervised by public officials. The most frequently imposed legislative requirements are: the accumulation of a surplus fund from earnings; double liability of stockholders; a minimum cash reserve to be kept in the vaults, and an additional reserve on deposit in other banks; the organization of a banking department for the administration of the laws pertaining to them; regular reports and examinations; and some limitation on real estate holdings and on the amount of loans to be made on real estate security. On account of the relatively low capital requirements imposed upon them, and the liberality of the laws concerning them in other respects, state banks have been able to prosper where national banks and trust companies could not exist, and on this account in many parts of the South and West they do most of the banking business in small towns and country districts. They generally perform a wide range of banking functions, including those of investment and savings as well as of commercial banks.

_2. National Banks_

Our national banking system owes its existence to financial exigencies of the federal government experienced during the Civil War. For a considerable period preceding the outbreak of that struggle the expenses of the government had exceeded its receipts. The deficit was greatly increased as soon as the war began, and Congress did not find it possible immediately to devise adequate new sources of revenue, including a market for government bonds. It was, therefore, forced to the issue of legal-tender notes under authority of an act passed February 25, 1862.

After three issues of these notes, amounting to $400,000,000, had been exhausted, and the value of the notes had depreciated to such an extent that persistence in this method of financiering portended speedy financial disaster, Congress adopted a suggestion made early in the war by Secretary Chase, to the effect that a market for government bonds might be created by compelling banks to purchase them as security for their note issues. An act passed February 25, 1863, provided for the incorporation of banks with the right to issue notes on condition that they purchase government bonds and deposit them with an official to be known as Comptroller of the Currency.

It was the expectation of the authors of this act that the state banks, then numbering over one thousand, would exchange their state for national charters and purchase bonds sufficient to secure their circulation under the terms of the new act, but, since they showed reluctance so to do, in 1865 force was applied in the form of a tax of ten per cent on bank notes otherwise secured. Under this pressure most of the state banks reorganized as national institutions, but a few retained their state charters and formed the nucleus of the state system of the present day. On account of the ten per cent tax, however, the issue of notes by this remnant became unprofitable, and the new national banks have to this day remained the sole banks of issue in the country.

The act of 1863 has been amended several times, notably in 1864, 1870, 1874, 1875, 1882, 1887, and 1900. In its present form it permits the organization of banks with a capitalization as low as $25,000 in towns of 3,000 inhabitants or less, and with a capitalization as low as $50,000 in towns of 6,000 or less. Banks organized under this act must put ten per cent of their profits into a surplus fund until said fund amounts to twenty per cent of the capital; must invest at least twenty-five per cent of their capital, if it is less than $200,000, and at least $50,000, if it is $200,000 or more, in government bonds; and may deposit said bonds with the Comptroller of the Currency and receive circulating notes to the amount of their par value, provided their market value is par or above.

The rights and privileges of these banks are stated in very broad and general terms, a fair interpretation of which permits them to engage in both commercial and investment banking under certain specified limitations, of which the most important are the following: they must not invest in or hold real estate beyond their owns needs for suitable quarters, or temporarily for the purpose of collecting debts due them; they must not accept real estate as security for loans; they must not loan more than ten per cent of their capital and surplus to any one person or firm; and they must keep reserves to the amount of fifteen per cent of their deposits, if they belong to the group known as country banks, and to the amount of twenty-five per cent of their deposits, if they belong to either the reserve city or the central reserve city group.

In the case of country banks, at least two-fifths of the required reserves, and in the case of reserve city banks, at least one-half, must consist of specified forms of money in their own vaults. The remainder may be balances payable on demand in approved banks in reserve or central reserve cities in the case of country banks, and in the central reserve cities in the case of reserve city banks. In the case of banks in central reserve cities, the entire reserve prescribed by law must consist of money in the vaults. These required minimum reserves must not be infringed upon. When a bank's cash and balances with its reserve agents fall to the prescribed minimum, discounting must be stopped under penalty of suspension of privileges and liquidation by the Comptroller of the Currency.

At five dates each year, selected by the Comptroller of the Currency, national banks must make detailed reports of their condition on prescribed blanks and publish abstracts of such reports in local newspapers. They must also submit to examination by persons appointed for that purpose by the Comptroller as often as this official may deem necessary and proper.

National banks have been organized in every state of the Union, and in Maine, Massachusetts, and Vermont they have completely supplanted the state banks. Elsewhere they exist side by side with state banks and compete with them. In some states they are more and in others less numerous than state banks. In the kind of business transacted the only important difference between the two classes of institutions consists in the loans on real estate security, which national banks are prohibited, and state banks allowed, to make. The latter, therefore, share this class of business with the trust companies only, and where it predominates have a distinct advantage in competition over the national institutions.

_3. The Independent Treasury System_

While not a banking institution, the Treasury of the United States handles its funds in such a manner and performs such functions with reference to the currency that it has become an important part of the banking system of the country.

Previous to 1840 the funds of the federal government were kept on deposit in banking institutions, during the greater part of the time in the First and Second United States banks. Friction between President Jackson and the Second United States Bank resulted in their withdrawal from that institution in 1834 and their deposit in selected state banks, several of which failed and all of which suspended specie payments during the crisis of 1837. The embarrassment which the treasury experienced in consequence, combined with previous unsatisfactory relations between the government and its depositories, convinced President Van Buren that the Treasurer ought himself to keep and to disburse the funds of the government. He made a recommendation to this effect to Congress, which in accordance therewith enacted the first independent treasury act in 1840. The revival of agitation for a third United States Bank led to the repeal of this act the following year, but in 1846 it was reenacted and with modifications has remained upon our statute books to the present day.

In its original form this act provided for the acquisition of vaults in certain cities, in which should be deposited the funds of the government as soon as possible after they came into the hands of the receiving officers, and out of which should be taken, upon drafts issued by the Secretary of the Treasury, the money needed for the payment of the government's obligations. It further provided that all dues to the government in the future should be paid either in coin or in currency issued exclusively by the government, and that all expenses should be paid in the same forms of money.

Important modifications in this act were made during and after the Civil War. In 1863 permission was granted the Secretary of the Treasury to deposit in national banks funds accumulated in the treasury, and derived from any source except duties on imports, provided the banks selected for this purpose should deposit with him government bonds for their security. Subsequently the discretionary power of the Secretary in this direction was extended so that at the present time he is authorized at his discretion to deposit in national banks surplus funds derived from any source, trust funds alone excepted, and to accept as security therefor other securities than government bonds. Other laws have made national bank notes acceptable for certain public dues, and have given the Secretary authority to issue gold and silver certificates against gold coin and silver dollars deposited in corresponding amounts, and to redeem United States notes in gold coin and to keep on hand for that purpose a gold reserve of $150,000,000.

In its operation, this independent treasury system affects the reserves of the banks and through them their discounts and the commerce of the country. Whenever the receipts of the government exceed its expenditures, money accumulates in the treasury and the reserves of the banks are diminished; and, under opposite conditions, they are increased. The return of accumulated surplus funds to the banks is possible when the Secretary of the Treasury decides that such return is desirable or necessary and when the banks are able and willing to supply the bonds demanded as security. In case a deposit is agreed upon the funds go to a relatively small number of national banks selected as depositories by the Secretary of the Treasury, the amount allowed each depository also being determined by him.

Through its ability to issue gold and silver certificates, its obligation to redeem United States notes in gold on demand, its administration of the United States mints and assay offices and the laws regulating the supply and distribution of subsidiary coin, the United States Treasury cooperates with the banks in the supply and distribution of the circulating medium of the country. The people apply to the banks for the forms of money and currency desired and these institutions meet the demand by means of the funds deposited with them or by their exchange at the various subtreasuries, if the forms of money deposited do not correspond with these demands.

_4. The Interrelations of These Institutions_

Under the operation of the national banking act, New York, Chicago, and St. Louis have been designated as _central reserve_, and forty-seven other cities as _reserve_ cities. The national banks in these reserve cities act as reserve agents for national banks in the cities and towns not so designated and ordinarily receive on deposit the major part of their reserves plus surplus funds not needed for local purposes. Banks in the central reserve cities act as reserve agents for the banks in the reserve cities as well as for country banks, and on account of their importance as commercial and investment centers receive and hold in the form of bankers' balances a large part of the reserve funds as well as the surplus investment funds of the national banks of the entire country.

State banks and trust companies manage their reserve and surplus investment funds in substantially the same manner as national banks, using national banks in the reserve and central reserve cities as their reserve agents. State laws usually allow approved state banks and trust companies also to act as reserve agents for the banks and trust companies under their jurisdiction, but these approved banks are generally located in the reserve and central reserve cities, and themselves employ the national banks there located as their reserve agents, thus forming simply an additional conduit through which the reserve and surplus investment funds of state banks and trust companies reach the central money reservoirs administered by national banks in the central reserve cities.

National banks in the reserve and central reserve cities are also clearing centers for the enormous volume of checks and drafts which the administration of the checking accounts of the banks and trust companies of the country bring into existence. They act as correspondents as well as reserve agents for these other banks and trust companies, and in this capacity collect out-of-town checks and drafts and conduct checking accounts for them. Within these cities, as well as in hundreds of others, clearing house associations conduct the local clearings and also act as agencies through which national and state banks and trust companies cooperate in the promotion of common interests.

The center of the entire system is in New York City. The clearing house association of that city, consisting of over fifty national and state banks and trust companies, includes the banks the vaults of which constitute the central money reservoir of the country and which constitute the center of the country's clearing system. Through the New York subtreasury pass the greater part of the receipts and disbursements of the government, and the chief assay office in the country is located there. The New York stock exchange is our only stock and bond market of national scope, and consequently the investment center of the country.

The Associated Banks of New York City, as the members of the clearing house association are called, hold the greater part of the reserves of the banks and trust companies not required by law to be kept in the local vaults, as well as the greater part of the surplus investment funds of the entire country. It is through the operation of the New York subtreasury on the reserves of the Associated Banks that the chief influence of the independent treasury system on the banking business of the country is exerted, the greater part of the government's receipts coming directly out of those reserves, and a large part of the expenditures going into them, and the greater part of the money deposited in national banks by the Secretary of the Treasury going directly or indirectly into New York institutions. Most of the exports and imports of coin and bullion pass through New York, and the major portion of the foreign exchanges of the entire country are there effected. The New York Assay Office receives and distributes the greater part of the new supplies of gold and silver bullion which come from our mines and transforms into bullion the major part of these metals that come to us from abroad and do not find employment as foreign coin. The New York Stock Exchange is the medium through which a large part of the surplus savings of the country are invested in our industries or loaned for the use of our national, state, municipal, and other local governmental agencies.

_5. Operation of the System_

The most noteworthy features of the working of this machinery may be discussed under the heads: conflict of functions and laws; loan operations; treasury operations; reserve system; absence of elasticity in the currency.

(_a_) _Conflict of Functions and Laws._--The two classes of banking institutions which have been described (state banks and national banks) and trust companies, described in a subsequent chapter, exist side by side in many communities, and in the performance of certain services compete for the patronage of the public. As has already been pointed out, state and national banks differ little in their functions except in their relation to real estate loans, and in some states trust companies perform all the functions of these institutions and many others besides. In the performance of these common services, however, they are rarely regulated by the same laws or subjected to the same kind or degree of public supervision. The competition between them, therefore, is not always on a fair basis and the temptation to violate restraining laws and administrative regulations is strong. The supervising officers recognize the situation as a rule and go to the extreme limit of leniency in administering laws and regulations which operate to the manifest disadvantage of the institutions over which they have jurisdiction, but even then it is often impossible to render the basis of competition fair and equitable.

This condition of affairs has resulted in the devising of ways and means of circumventing obnoxious laws and in some cases in practices which are pernicious in themselves. As examples may be mentioned the widespread practice of national banks, which are prohibited by law from making loans on real estate security, of making loans to customers who can offer no other collateral, on the security of their personal notes only, or of making loans secured by real estate by a three cornered operation utilizing a director or officer or some other third party as intermediary. All three classes of institutions compete in soliciting the savings deposits of the community, with the result that the trust companies and savings banks, which often have the advantage here, sometimes force upon their state and national bank competitors a higher rate of interest on such deposits than they ought to pay. The differing regulations in some places in force regarding the amount that may be loaned to a single individual or firm has also resulted in some cases in devious and uncommendable practices.

For the remedy of these conditions the first desideratum is the careful differentiation of the various functions performed by all these institutions, and the devising of appropriate legal and administrative regulations for each one. These regulations should then be incorporated into the legislation and the administrative practices of the federal government and of each state, and any institution which performs any of these functions should be obliged to submit to the regulations pertaining thereto. The difficulties in the way of securing such a differentiation of functions and such community of action between the federal government and our states are too obvious to require statement, but they should not prevent the formulation of ideal conditions, and a conscious and persistent effort to attain them.

(_b_) _Loan Operations._--In making loans, a typical method of procedure for a business man is to arrange with a bank for what is technically called a "line," that is, the maximum amount he may expect to be able to borrow under normal conditions. This "line" determined, he borrows from time to time according to his needs, giving as security his personal note, payable in one, two, three, four, or six months. Sometimes an indorser is required, and sometimes the deposit of collateral, mortgages on real estate, bonds, stocks, and warehouse receipts being the most commonly used securities employed in such cases. Ordinarily, when a note falls due, he expects the bank to renew it, if its payment at the time is not convenient, the agreement on a "line of credit" ordinarily carrying with it that implication, though not legally, probably not morally, binding the bank so to do. Indeed, the customer ordinarily counts the amount of his "line" as a part of his working capital and expects to keep it in use a large part, if not all, of the time.

In the determination of the amount of these "lines of credit," the judgment of some one or more bank officers, assisted by a discount committee and sometimes, though not as a rule, by a specially organized credit department, rules. In forming these judgments, the bankers of the United States as a class are not guided by any universally recognized and well established principles. The best ones require from their customers carefully prepared statements showing the nature and volume of the business they transact, and a careful classification of their assets and liabilities. Others, and these are a large majority, rely upon the knowledge they already possess, gained by general observation, and supplemented by verbal inquiries made from time to time and by the voluntary statements of the customers themselves.

The significance of the distinction between commercial and investment operations in the business of banking is not generally understood, and is consequently little regarded. The dominant question in the mind of the average banker, both in determining the amount of a customer's line and in making loans to him after the line is fixed, is how much he is "good for," and on this point the total net worth, rather than the nature of the business operations, of the customer is likely to be decisive. Of course, the banker is also influenced by the customer's reputation for both integrity and business ability.

This method of procedure has the advantage of rendering access of people to the banks easy and of promoting their extensive use, but it has the grave disadvantage of opening the doors wide to inflation of credit. The majority of our bankers do not know whether more or less than their savings deposits and their capital and surplus, the only funds which can safely be invested in fixed forms, is so invested. The promissory notes of their customers, which constitute the major part of their assets, give no information on this point, and they have not made the investigations necessary to determine with certainty the destination of the funds they have loaned. They are satisfied with the knowledge or the conviction that their loans can be collected, not at maturity--they know very well that many, probably most, of them can not--but ultimately. The result is that unconsciously and gradually the banks create their demand obligations in the form of balances on checking accounts against fixed investments in machinery, buildings, lands, mines, etc., and, when the payment of these obligations is demanded, the reserves fall below the danger point and they are forced to require payment at maturity of paper which the maker had counted upon having renewed indefinitely, and the payment of which is only possible by the forced sale of the property in which the borrowed funds were invested, or of some other property in his possession. If only a single bank or a comparatively few banks find themselves in this condition, relief may be found in the rediscount of paper with other banks, in direct loans, or in the sale of securities on the exchanges; but, if the condition is general, relief by these means is impossible, and widespread forced liquidation becomes necessary. An aggravated situation of this kind causes panic and results in a commercial crisis.

(_c_) _Treasury Operations._--The operation of our independent treasury system produces arbitrary fluctuations in the reserves of the banks and prevents that degree of prevision which is essential to the most economical and the safest practices. The funds needed for current purposes are withdrawn from the banks and kept under lock and key in the treasury vaults, thus diminishing reserves to the extent of their amount. Surplus funds likewise accumulate in the vaults with the same result, until the Secretary of the Treasury sees fit to deposit, and the banks find it possible to receive them. Even then the depository banks alone are directly benefited, and no one of these knows long in advance how much it is going to receive or when funds left on deposit will be withdrawn.

Since the volume of the business of the government is very large, the effects produced by the movement of its funds are of such magnitude as to give them national importance, the ability of banks to loan and to meet obligations already incurred being profoundly affected by them. Among these effects must also be noted the inability of the banks to calculate these movements in advance, as they to a degree can those produced by the operations of their commercial customers, and the relation between them and the Secretary of the Treasury, which results. The relation between the receipts and the disbursements of the government vary greatly from month to month and year to year, so that, on the basis of past experience, it is impossible to predict when the banks will gain from or lose to the treasury. The action of the Secretary of the Treasury regarding deposits of surplus funds is equally uncertain and unpredictable. No fixed policy regarding this matter has yet been established by precedent or determined by law. Each secretary follows his own judgment and is influenced by current events and conditions.

The uncertainty which results creates a speculative atmosphere about the money market and renders the banks dependent upon the secretary and the secretary influential on the money market in a manner which is unfortunate for both. Since they cannot be indifferent to the operations of the treasury, and cannot predict them, banks are obliged to speculate regarding them, and, if they err, they are likely either to over-extend their credit operations or unduly to contract them. The former will result when they expect an increase in their reserves from treasury sources and do not get it, and the latter when contemplated withdrawals of funds do not occur.

The Secretary of the Treasury is not in a position properly to exercise the power conferred upon him. He is outside the channels of commerce and industry, and must, therefore, secure at second hand the information necessary for intelligent action. Such sources of information are frequently unreliable and inaccurate and their use subjects him to the charge of favoritism and to the danger of acting in the interest of special groups or special localities.

(_d_) _Operation of the Reserve System._--Each national bank now keeps locked up in its vaults money to the amount of at least six to twenty-five per cent of its deposits and a balance with banks in reserve and central reserve cities sufficient to bring the total to at least fifteen per cent of deposits in the case of country banks, and twenty-five per cent of deposits in the case of reserve city banks. In addition, it is customary for most banks to carry as a secondary reserve high-grade bonds which can be readily sold in case of need. The practice of state banks is practically the same as that of national, and that of trust companies differs only in the amount of reserves carried and in the proportion between the different items.

This system has many disadvantages. Among them the most obvious, perhaps, is the withdrawal of enormous sums from the current use of the agriculture, industry, and commerce of the country. That portion of these reserve funds which is required to be kept under lock and key in the vaults, amounting in the aggregate to a billion and a half of dollars or more, is not available for use in ordinary times, and is practically useless even in times of stringency, since according to present law, when the reserves fall to the minimum prescribed by law, banks must stop discounting, under penalty of being put in the hands of a receiver. The other portions of these funds, namely, those deposited with banks in reserve cities and those invested in bonds, are likewise withdrawn from the uses of current commerce, since a large part of the former is only available for use on the New York Stock Exchange, and the latter are invested in railroads, mines, factories, land, etc.

The explanation of the devotion of the redeposited portion of the reserves to the operations of the New York Stock Exchange is to be found in the fact that that exchange furnishes a regular market for call loans on a large scale. Since these funds are held subject to the call of the banks which deposited them, and interest at the rate of at least two per cent is paid upon them, the depository banks are bound to seek investment for them, and call loans on collateral listed on the exchange under ordinary circumstances are best suited to their purposes.

Another disadvantage of this reserve system is the dangerous situation in which it places banks from time to time, and the tendency to panic which it fosters. The demands made upon banks for both cash and credit vary with the seasons. In the fall and spring they are much greater than in the winter and summer. They also vary regularly through periods of years, increasing during the up-grade of a credit cycle and decreasing for a longer or shorter period after a crisis. Irregular and unexpected events also cause variations. On account of the rigidity of this reserve system and the lack of elasticity in our currency, the means available to banks for meeting increased demands, especially those of an irregular and unexpected character, are inadequate, and their employment is often dangerous. These means are: keeping in the vaults in slack times a large amount of unused cash, a practice too expensive to be employed; keeping surplus balances with correspondents at two or three per cent interest, not a sufficiently remunerative practice to be employed on a sufficiently extensive scale; rediscount with correspondents of some of their customers' paper, or loans from them on the security of their own signatures or on such security supplemented by collateral; and sale of bonds at such prices as they will bring.

None of these expedients is certain at all times and under all conditions, and some of them are precarious at all times. Surplus balances with correspondents are most reliable, but they occasionally fail on account of the inability of correspondents to realize upon their call loans. When calls for the payment of balances are large and general, it is impossible for brokers whose loans are called by one bank to transfer them to another. The collateral deposited as security must, therefore, be offered for sale on the stock exchange, and the very stringency which resulted in their being so offered renders their sale, even at slaughter prices, difficult and sometimes impossible. The result at the best is a heavy fall in the prices of stock-market securities, and at the worst a stock-market panic and a suspension of payments by the banks.

Rediscounts and loans from correspondent banks cannot be depended on. Correspondents are under no obligation to make them. They will usually do so as a favor, if their condition warrants, otherwise not. Sales of bonds on the stock exchange are difficult and sometimes impossible in times of emergency, and are usually attended with loss.

On account of this uncertainty and the danger attending it, when new and unusual conditions likely to result in increased demands upon them arise, banks are likely to act "panicky"; to call in their balances from correspondents; to sell bonds; to call loans; and greatly to curtail or absolutely to cut off new discounts. This action spreads the panicky feeling among their customers, and creates such pressure at the reserve centers as to cause curtailment of accommodations and panic there.

At the very best, this reserve system is accompanied by high discount and loan rates and by speculation on the stock market. High rates result inevitably from the hoarding of currency which it involves, the supply of loan funds being abnormally diminished, and speculation follows from the concentration in slack times of funds in New York City, which can only be employed in call loans on stock-exchange collateral. Stock brokers regularly take advantage of this situation, speculate themselves and inspire speculation among their customers. The mutual dependence of the stock and money markets thus produced by this reserve system is disadvantageous to both, fluctuations in values, uncertainty, and irregularity on both being the result.

(_e_) _Lack of Elasticity in the Currency._--The money of the United States consists of four main elements, gold and silver coin, United States notes, and national bank notes, and none of these fluctuate in volume in accord with the needs of commerce.

The gold element depends primarily upon the output of our gold mines and upon the international movement of gold, increasing when that output increases and when our imports of gold exceed our exports, and decreasing under opposite conditions. These fluctuations, however, are quite independent of our commercial needs. Silver dollars, which constitute the major part of our silver currency, for several years have been unchanged in quantity, and the volume of United States notes has remained at $346,681,016 since the resumption of specie payments, January 1, 1879.

National bank notes fluctuate in volume as a result of changes in the number of national banks and in the prices of government bonds. Whenever a new national bank is organized, a specified portion of its capital must be invested in government bonds, which bonds are usually deposited with the Comptroller of the Currency in exchange for notes; and, when the price of government bonds rises, banks holding more than the minimum required by law frequently retire a portion of their circulation in order to recover their bonds for sale at the enhanced price. When the price of government bonds falls, many banks purchase additional quantities and increase their circulation.

Changes in the price of government bonds and in the number of national banks, however, have no connection whatever with changes in our currency needs, and no more do the fluctuations in the volume of the currency as a whole, made up of these various elements combined. As a result of this condition, rates on loans and discounts fluctuate greatly on account of wide variations between the demand and the supply of loan funds, and commerce is hampered at certain seasons and overstimulated at others. As was indicated above, this lack of elasticity in our currency aggravates the defects of our reserve system and also aids in the production of financial panics.

_6. Plans for Reform_

On account of the defects in our system of banking, there has been long-continued agitation for reform, increasing in scope and intensity in recent years. After the crisis of 1907, which revealed these defects to many persons who had not observed them before, Congress appointed a commission to make investigations and to prepare a reform measure. In January, 1912, this committee submitted a report which embodied a bill for the incorporation of a National Reserve Association, to be made up of a federation of local associations of banks and trust companies. The purpose of this association was to supply a market for commercial paper, an elastic element in the currency, a place for the deposit of the bank reserves of the country and of the funds of the government, as well as proper machinery for the administration of this market and these funds.

For various reasons, the plan of the monetary commission did not meet with universal favor. It was condemned in particular by the Democratic party, which was victorious at the polls in the fall elections, and installed a new administration in Washington, March 4, 1913. A special session of the new Congress was called to consider the tariff question, and to it was submitted another plan for the reform of our banking system, which was enacted into law December 23, 1913.

This law provides for the incorporation of so-called "Federal Reserve Banks," the number to be not less than eight or more than twelve. The country is to be divided into as many districts as there are Federal Reserve Banks, and the national banks in each district must subscribe six per cent and pay in three per cent of their capital and surplus to the capital stock of the Federal Reserve Bank located in that district. State banks and trust companies may contribute on compliance with the same conditions as national institutions. If, in the judgment of the organization committee, the amount of stock thus subscribed is inadequate, the public may be asked to subscribe, and as a last resort stock sufficient to raise the total to an adequate figure may be sold to the Federal Government. Cooperation between these Federal Reserve Banks and a degree of unity in their administration are provided for through a Federal Reserve Board of seven members, two ex officio and five to be especially appointed by the President of the United States. For the administration of each Federal Reserve Bank, a board of directors of nine members is provided for, six to be appointed by the member banks and three by the Federal Reserve Board, one of those three to be designated as Federal Reserve Agent and to be the intermediary between the Federal Reserve Board and the bank of whose directorate he is a member.

The proposed Federal Reserve Banks are to hold a part of the reserves of member banks and to rediscount commercial paper, administer exchange accounts, and conduct clearings for them. They are also to serve as depositories for the United States government, and to issue treasury notes obtained from the Federal Reserve Board in exchange for rediscounted commercial bills, these notes to be redeemable on demand by them and to be a first lien on all their assets. Their retirement, when the need for them has passed, is provided for by the requirement that no Federal Reserve Bank shall pay out any notes except its own, all others being sent in to the issuing bank or to the treasury for redemption. Against outstanding note issues a reserve of at least 40 per cent in gold must be maintained, and against deposits one of at least 35 per cent in gold or lawful money.

This law provides remedies for the chief defects of our system; namely, a market for commercial paper which will enable a properly conducted bank at any time, through rediscounts, to secure notes, legal-tender money, or checking accounts in the amounts needed; a system of note issues which will fluctuate automatically with the needs of commerce for hand-to-hand money; a more economical administration of the reserve funds of the country, unattended by the dangers of the present system, and an administration of the funds of the federal government which is free from the evils of the independent treasury system.