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Banking in the United States before the Civil War.-Prior to the Civil War, the national government failed to exercise any direct supervision of the banks of the country. There grew up in each state numerous banks which were subject only to such loose supervision as the state governments wished to give. In a large part of the country, such supervision was hopelessly inadequate. Banks issued notes freely, with scant regard for ability to redeem the notes. Masses of notes remained in circulation even after the issuing banks had failed, because people had no way of knowing the fate of the issuing banks. Counterfeit notes flooded the country, and became a source of widespread loss. Notes passed at par in some communities and below par in other communities. There was no even standard of value. Note issue was chaotic. It was unsafe and it was non-uniform.

When the Civil War occurred, the federal government believed that a system of national banks could be made to provide a market for bonds to finance the war. Moreover, it hoped to combine with this advantage the gain that would come from a reformed bank note currency throughout the country. Accordingly, the National Banking Act was passed in 1863. The state banks were reluctant to join the national system until, in 1865, the law was amended to impose a tax of 10 per cent on all future notes issued by other than national banks. This prohibitive tax brought the leading banks rapidly into the system and insured the support of the new law.

The expected market for bonds did not materialize, but from a currency standpoint, the new law was an undoubted success. It aimed to put safety and uniformity into the note circulation of the country, and these two qualities were possessed in ideal degree by the national bank notes. National banks were required to buy designated government bonds, up to a certain percentage of their capital. These bonds were acceptable as backing for notes issued under the name of the national banks. The establishment of an exclusive bond secured note issue, regulated by the federal government, and circulating uniformly at par in all parts of the United States, was a great piece of financial reconstruction,

Banking in the United States from the Civil War to 1913.- In the course of time, certain shortcomings of the national banks made themselves felt. The shortcomings were twofold. On the one hand, the bank notes were inelastic, and did not readily expand and contract in accord with the needs of trade. On the other hand, bank reserves were not controlled by any central authority and therefore could not be adequately mobilized in time of emergency. The occurrence of severe panics in the '80's and '90's, culminating in the disastrous panic of 1907, aroused the country to action, and led to the passage of the Federal Reserve Act. It is important to examine briefly the two major defects of the old national law.

The inelasticity of national bank notes embarrassed the country both because of the stress at certain stages of the business cycle and because of the stress at certain months of the year. Inelasticity was both cyclical and seasonal. When a state of advanced prosperity was reached, the banks faced a need for more currency, and when a financial crisis approached the banks needed emergency currency in order to avert outright panic. After the strain had passed and business had contracted, the banks needed to be in a position where they could contract currency proportionately. This was the cyclical need for elasticity, but there was another important need, the seasonal. The farmers in the fall of the year required abnormally large amounts of currency in order to finance the harvesting and marketing of crops. When this demand appeared each year, currency had to be shipped from the East to the West, at cost, bother, and delay. Under the seasonal scarcity of funds, interest rates fluctuated abnormally. There was a pressing need for seasonal elasticity of the currency.

There were several reasons why the national bank notes failed to provide elasticity of either kind. The maximum note issue against bond backing was not to exceed the par value of the latter, and if market value was less than par, then not to exceed market value. The price of government bonds determined whether the banks could make a profit from note issue. When bonds were high, the expense of obtaining the necessary bond-backing became prohibitive. The state of the bond market was the vital factor in determining whether more notes should be issued. At times the bond market was favorable to issue although business was in a state of depression. At other times the bond market prohibited issue, although business was in a state of expansion. The result was often that banks issued notes when business least needed them, and refrained from issue when business most needed them. Notes were said to have a perverse elasticity with respect to the needs of business.

If a bank decided to issue notes, considerable delay occurred. It required about forty days for the first application to be filled, and after plates were made about twenty days. At time of panic, the emergency would be a thing of the past before new notes could be rushed into use by the banks.

The volume of note issue was limited by the amount of certain kinds of bonds in existence. If the government paid off its debt, as it did in part between 1880 and 1891, the result was a decrease in the amount of note issue. If the government arbitrarily increased the bonds eligible for note backing, the currency supply would tend to increase. Fiscal policy rather than the needs of commerce and industry determined the volume of notes that could be issued.

When business contracted, bank notes did not contract accordingly. The law limited the amount that could be retired in any one month to $9,000,000. The red tape and cost of retirement in addition to that of issue made it desirable that notes should be issued only to that amount which could be kept permanently in circulation. Retirement and reissue

would wipe out practically all possibility of profit from note issue. Consequently, note issue was unresponsive to declines in business need for money.

National banks were required to deposit with the Treasurer of the United States a sum of lawful money equal to 5 per cent of their notes outstanding. This fund aided in maintaining the redemption of the notes but it did not aid in giving them elasticity.

Although the defects of note issue were serious, they were not as menacing as the defects of the reserves of the banks. The difficulty with reserves was not that they were too small in volume but that they were too weakly organized and controlled. For reserve purposes, national banks were classified as to location. The ratios of reserves to deposits were as follows:

Banks in Towns, Smaller Cities, and Country Districts.

15 per cent, of which two-fifths or more must be in the bank's
own vaults, and three-fifths or less might be in either reserve

city banks or central reserve city banks.
Banks in Reserve Cities.

25 per cent, of which one-half or more must be in its own vaults

and one-half or less might be in central reserve city banks. Banks in Central Reserve Cities.

25 per cent, of which all must be carried in its own vaults.

That part of reserves kept in vault constituted a scattered and disorganized mass. In time of stress and strain, some banks had more reserves than were needed in their own vaults and some had less. But each bank jealously guarded its own reserves, and refused to help out other banks which were in difficulty. There was no possibility of mobilizing the scattered reserves for the benefit of those institutions which were threatened with ruin. Decentralization was the heart of the reserve problem.

But another part of the reserve suffered from the opposite evil, extreme centralization. New York City banks received deposits from the banks of the rest of the country, these deposits counting as legal reserve. About half of all the deposits of New York City banks consisted of such deposits of reserves by outlying banks. In 1912, ten of the leading banks and trust companies of New York City had 15,483 banks on the list of their depositors. The interior banks were anxious to make these deposits in central reserve cities, because they received a small rate of interest, usually about 2 per cent, on the money. If they had held the reserves in their own vaults, they would have earned no interest rate whatsoever. The New York banks used these deposits largely for call loans to finance speculation on the Stock Exchange. In ordinary times, interior banks could recover their deposits by requesting their return from the New York representatives. The New York banks were able to obtain the funds only by calling in the loans to brokers. The called loans might cause temporary flurries in call rates and in speculative markets, but the evil was not excessive, and did not directly worry the interior bankers at all. But in emergency, interior banks found it impossible to recover their reserve funds. If panic was threatened, it was disastrous to liquidate stocks on the stock market because prices were ruinously low. Hence, the central reserve city banks frequently suspended specie payments at such times. The suspension enabled the New York banks to cling to their own reserve funds, but left the interior banks to save their lives as best they could. The reserve was not available for use at the very time when it was desperately needed. The method of centralization prevented any adequate mobilization of reserves.

In spite of these dangers, the centralization was thought essential by the mass of banks. In addition to the small interest allowed on reserve deposits, there was the inducement of correspondent relations between banks. Interior banks needed a correspondent bank in New York for the purpose of making collections and handling exchange. New York banks needed interior correspondents for the same reason. This intricate system of correspondent relations connected all parts of the country, and facilitated the transfer of payments. But this undercurrent of service was more than offset by the inflexibility of reserves during periods of financial emergency.

Numerous other defects appeared in the National Banking system, but the most important of all were the two here discussed, -the inelasticity of note issue, and the inability to mobilize reserves in time of emergency. Largely because of these basic faults, the Federal Reserve Act was adopted in 1913. The new law provided elasticity of note issue through the creation of the Federal Reserve note, and provided mobilization of reserves by placing their control in the hands of Federal Reserve banks and of the Federal Reserve Board.

The Administrative Mechanism of the Federal Reserve System.At the top of the system is the Federal Reserve Board, of eight members. Six are appointed by the President with Senate approval, and are to be selected with a view to giving fair representation to agriculture, industry, finance, and other phases of economic life. The other two are the Secretary of the Treasury and the Comptroller of the Currency, who are members ex officio. The term of office of the six regular members is ten years.

Under the Federal Reserve system, the country is divided into twelve districts, each district containing a Federal Reserve bank. Many authorities favored the creation of a central bank for the whole country, modelled after the system in vogue in European countries. This idea was objectionable largely because many were afraid that a great central bank might become a tool of Wall Street or might try to dominate the government. Memory of Andrew Jackson's war with the State Bank acted as a caution in the minds of the law makers. The regional plan promised to diffuse the facilities of banking, and to adapt banking machinery to the great areas to be served in the United States. Accordingly, each of the twelve Federal Reserve banks was made practically a central bank with respect to its own district, but was federated with the other district banks through the coördinating functions of the Federal Reserve Board.

For purposes of dividing the country into sections which would be natural economic units, the following twelve cities were selected as the seats of the Federal Reserve banks :

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In addition to the twelve main banks, twenty-three branches have been established as a means of enabling the banks to serve their districts more effectively. Foreign agencies and representatives have also been established, particularly by the Federal Reserve banks of New York and of Boston.

Each Federal Reserve bank is managed by a Board of Directors of nine members, holding office for a three-year term. Three classes of directors are recognized: first, Class A, consisting of one-third of the Board, elected by the member banks of the district as their representatives; second, Class B, consisting of one-third of the Board, likewise elected by the member banks but representative of commerce, agriculture, and industry; finally, Class C, consisting of one-third of the Board, and appointed by the Federal Reserve Board in Washington. It should be noted that a majority of the board of directors is chosen by the member banks themselves, whereas only a minority is chosen by the government. The method of election is calculated also to avoid allowing the larger banks in the district to dominate the small banks. The effort has been to create bankers' banks.

The Federal Reserve banks are owned by the member banks. When a new bank becomes a member, it is required to subscribe 6 per cent of its capital and surplus to the stock of the Federal Reserve bank, half of the subscription being paid in, and the other half subject to call. The Federal Reserve banks are privately owned by the member banks. Both ownership and majority control of management rest in the hands of the members themselves. This form of organization is intended to give the frame work for local autonomy and home rule in all banking problems which peculiarly affect each individual district. It effaces the idea of paternalistic control somewhat, and gives the semblance of control from the ground up rather than from the top down.

The Reserve banks are required to pay 6 per cent cumulative dividends on paid-in capital stock. Excess earnings must be put into

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