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THE ALDRICH PLAN FOR MONETARY LEGISLATION
The plan for monetary legislation suggested by Senator Aldrich contains many indications of the skilful handiwork of its experienced author. It bristles with provisions obviously designed to insure not only its passage but also its general acceptance by the people as an equitable means of banking reform. In particular, extraordinary precautions seem to have been taken both in determining the form of organization and in the limitations placed upon the lending power of the proposed bank in order to forestall objections of a political or sectional nature. Banking principles and needs have not, on this account, been overlooked, and it may be predicted with confidence that if the measure were to be adopted in its present form, a material improvement in our banking system and methods might be expected to follow. At this stage in the movement for reform, however, and notwithstanding the risk of leaving with the reader a less favorable impression than the measure deserves, it seems advisable to concentrate attention on amendments which will either facilitate its passage or render it more serviceable.
To the weight attached to political and sectional considerations may be attributed the highly complicated form of organization of the proposed bank. In the opinion of the writer practically every specific objection or fear which has been expressed on the organization side of the subject during recent discussions of the central bank problem has been successfully met a remarkable feat of constructive imagination. The resulting inevitable complexity may, however, prove in itself a serious obstacle on account of the difficulty of making the arrangement generally intelligible. If the same results could be secured by more simple means it would be a great gain. I have, however, no simpler alternative to take its place. Indeed the one modification which I would urge would add slightly to its present complexity. In addition to the six ex officio government directors and the fifteen directors, one chosen by the board of directors of each branch, the plan provides for twelve directors to be chosen by the banks on the basis of their capital and surplus and for a similar number to be chosen by the board thus constituted. In order to prevent an unduly large representation from the Northern states, east of the Mississippi, which have the bulk of the banking capital of the country, and to avoid the consequent
danger of sectional antagonism, it might be of advantage to limit the number of directors in the last two groups taken together to three from any one district and to five from adjoining districts. With this additional limitation the fear rather than the likelihood-which in any event would seem to be very remote that the management of the Bank might be so composed as to fail to give all sections of the country proper consideration should be entirely removed.
There seems indeed to be a general tendency to attach undue importance to the question of the organization of the proposed bank. Limited almost entirely to advances upon commercial paper and working always very much in the public eye there is little likelihood that under any form of organization its resources would be used for selfish purposes whether individual or sectional. The wise use of the resources of the bank in normal times and the conservative husbanding of a considerable portion of them for emergencies are far more vital matters, and they can not be entirely safeguarded by provisions relating to organization or by restrictions upon lending power. Forebodings of this nature may well be occasioned by a provision in the bill which makes it incumbent upon the Bank to lend at a uniform rate throughout the country. Provision will doubtless be made for different rates on the different kinds of loans which the Bank is authorized to grant, though no such provision appears in the bill in its present rough draft. Even though the control of the Bank might be largely in eastern hands it is certain that the bulk of its loans will be made in the West and South where lending rates are uniformly somewhat, and in many places considerably, above those in the East. On purely banking grounds much might be said against this restriction but it goes without saying that without it there would be slight chance of the passage of the measure. It will, most certainly, increase the difficulties which will have to be met by the management of the Bank. Demands for an excessive amount of accommodation from particular sections of the country can not be checked automatically by advances in rates without making it entirely unprofitable for banks in other sections to resort to the Bank for any accommodation whatever. There is a grave possibility that its entire lending activities in normal times may be confined to those sections of the country where interest rates are high and where the average quality of loans, taken as a whole, is relatively unsatisfactory as regards liquidness. No
other country presents an exactly parallel case because elsewhere. through the branches of the other banks much of the work of equalizing lending rates is performed. Here that task would devolve almost entirely upon the central bank. And its accomplishment would require not only far greater power than is possessed by any existing central bank but also, it may be added, vastly more than the proposed bank could by any possibility secure.
In these circumstances it is of the utmost importance that the management of the Bank be protected from borrowers, not so much to prevent unwise action on its part as to protect the Bank from criticism and distrust which would be certain if the management were obliged to refuse many loans out of a large number to one section of the country while making perhaps all of the limited number of loans desired in some other section. Having restricted the management to a uniform rate, thus taking away one means of defense, it is necessary to provide others to take its place. In a measure this is accomplished in the bill proposed by Senator Aldrich through certain limits placed upon the lending power of the Bank, though not to the extent which would seem to be required. Banks are to be allowed to rediscount directly with the Reserve Association only short-time commercial paper, i. e., paper maturing within twenty-eight days which shall have already been made at least thirty days before the date of rediscount. The amount of such paper taken, moreover, is not to exceed the capital of the bank applying for accommodation. Doubtless the management of the Reserve Association will raise objections if a bank were regularly to apply for rediscounts up to this limit. So far as this class of loans is concerned the restrictions would seem to be entirely adequate, and if paper of this kind should prove to be the only paper ordinarily brought to the Bank for rediscount no trouble need be feared. But elaborate provisions are found in the bill for other kinds of loans, and many bankers as well as the public are certainly likely to assume that their use is not to be confined to exceptional occasions. The passage of the measure should not be facilitated by the creation of hopes and expectations which can not be realized.
Banks are to be grouped in local associations and these associations may guarantee commercial paper having not more than four months to run. This paper may then be presented to the Reserve Association for rediscount. The amount of commercial paper which may be guaranteed by a local association for an
individual bank is not limited, although the total guarantees of the Association may not exceed the aggregate capital and surplus of its member banks.
There is a wide difference of opinion among bankers as to the extent to which banks would resort to this means of providing themselves with bankable paper. It is thought by some that most bankers would refrain from making application for guarantees from their local associations because it might be regarded as a confession of weakness. But this is a view which is most likely to prevail in the Eastern states where bank resources are ordinarily more than ample for local requirements. In those parts of the country in which there is a relative scarcity of capital of all kinds, as in Oklahoma where the normal lending rate is 8 per cent and upwards, it would seem probable that virtually all of the banks would resort to this device, thus removing any stigma from the practice.
By exacting a rate upon this guaranteed paper very much higher than that upon short-time paper the management of the Bank might succeed in checking applications for its rediscount. But it does not seem wise to place this heavy burden upon the management of the Bank. If it is believed that ordinarily the banks should not expect much accommodation on long-time paper from the Reserve Association, then it will obviously not prove disadvantageous to place further restrictions upon the amount which the local associations may guarantee. Moreover, if the Reserve Association in normal times should rediscount short-time paper for a particular bank to about the amount of its capital and in addition an equal amount of long-time paper, it would certainly seem to be a dangerous reliance upon the lending resources of the central institution. Instead, therefore, of guarantees by the local association to the extent of the entire capital and surplus of the members, I venture to suggest the advisability of limiting such guarantees to one half of the capital, or perhaps to one half the capital and surplus of the individual banks.
It might be felt, however, that this definite restriction upon the amount of paper which any single bank might rediscount would prove an obstacle in the way of needed relief in emergencies. But the plan of Senator Aldrich contains a valuable provision designed to meet such contingencies. By special vote of the executive committee and with the approval of the Secretary of the Treasury the Reserve Association may discount the notes of banks
guaranteed by the local association and secured by the deposit with it of securities taken at two thirds of their market value. Under the terms of this clause it will be possible to assist threatened banking institutions, following the precedents established by European central banks and our own clearing-houses. Finally, it may be noted that the bill permits banks to accept commercial paper drawn upon them to the amount of half their capital and surplus, and contains a further provision under which the central institution may rediscount such paper for its original purchasers. Taking account of all the various lending activities proposed for the Reserve Association it would seem clear that some further restriction upon the rediscounting of long-time paper would not hamper its lending operations or weaken its power to serve the business community.
If the Reserve Association is to serve a useful purpose it should be clearly understood by the public generally as well as by bankers that it is not to be one of its functions to contribute largely to the aggregate amount of credit regularly at the disposal of borrowers. There can be little question that the volume of bank credit in this country is already large enough considered with reference to total capital or with reference to the amount of working capital of corporations and business firms. It is desirable, however, to make commercial paper the most liquid and therefore the most attractive asset which the banks can hold. It will further the economic development of the country if the relative standing of the collateral loan and commercial paper can be reversed. It is also desirable to foster banking methods and arrangements which will tend to check not so much the concentration of surplus banking funds in New York as to facilitate their general employment throughout the country, and not as at present in collateral loans in that city. These objects can be attained without large loans by the Reserve Association through its ability at all times to make advances upon commercial paper to meet the regular seasonal requirements of the other banks and their more occasional needs during periods of financial stress.
A large volume of loans at all times by the Reserve Association is not merely unnecessary for the accomplishment of the primary functions of such an institution, but would also subject the country to very grave danger of excessive credit expansion. In the acquisition of its cash resources by the proposed bank no appreciable contraction of credit on the part of other banks would