banking system prior to 1913 was this: the banks were dependent upon one another, but such dependence was unsafe because of the lack of any machinery which would enable the banks effectively to help one another in time of stress. Several notable panics have illustrated this weakness of the old national banking system. The failure of the national banking system to meet emergency situations during the panic of 1907 is described by Professor O. M. W. Sprague in the following selection: On Wednesday, October 23 [1907], a run began on the Trust Company of America [New York City], the second of the trust companies in size, having deposits of $64,000,000. . . . The company withstood a run which continued for two weeks, during which it paid out some $34,000,000; on Wednesday and Thursday paying $12,000,000 and $9,000,000. The Trust Company of America and also the Lincoln Trust Company, upon which a run began on Thursday, were assisted . . . [chiefly] because it was clear that the foundation of the entire credit structure was endangered. The steps taken, however, were slow and the means adopted were not sufficiently clear in import to restore general confidence. During the three days of heavy runs upon the trust companies New York was threatened with a general panic, and a number of other trust companies experienced runs of varying degrees of severity. A few small mismanaged banking institutions in the outskirts of the city were forced to suspend. Depositors began to withdraw money from savings banks, and [the latter] were obliged to exercise their right to require sixty days' notice. Loans could be secured only with extreme difficulty and the fall in stock exchange prices. was alarmingly violent. . . . The strenuous efforts that were made to relieve the situation were but partially successful, because they lacked the authority and backing of the Clearing House Association. As in the case of the Trust Company of America, the relief afforded was of a piecemeal character without any certainty of its continuance. ... During the three days of heavy runs upon the trust companies the strain upon the clearing-house banks was very severe, as they had to furnish most of the money required by the trust companies, whose reserves had been deposited with them. At the same time they were shipping money to the interior banks, and they also suffered some loss from payments to their own frightened depositors. . spreads Had New York been a city with only local responsibilities it is Alarm probable that the disturbance would have gone no further; but, as throughout in 1873 and in 1893, the disasters in New York had caused alarm the country. to spread throughout the country. [There] came telegraphic demands from all over the country, including the other central reserve cities, for the calling of loans and the shipment of currency. . . . Everywhere the banks suddenly found themselves confronted with demands for money by frightened depositors; every- Outlying where, also, banks manifested a lack of confidence in each other. Country banks drew money from city banks and all the banks throughout the country demanded the return of funds deposited or on loan in New York. The evidence of lack of confidence in and between the banks is clear, and it points to a serious difficulty in carrying on banking in this country. 184. The Federal Reserve System 1 Following the panic of 1907, there was widespread agitation for the reform of our banking system. Banking systems in European countries were investigated, and the defects of our national banking system were thoroughly studied. As the result of a great deal of discussion and compromise, there was enacted on December 23, 1913, the Federal Reserve Act, which amended and strengthened our national banking system. This act marked a compromise between a centralized and a decentralized system, i.e. it allowed our banking system to remain decentralized, but it guaranteed some of the fundamental advantages of a centralized and coördinated banking system. The general organization of this new Federal Reserve System is described by Professor Sprague as follows: banks demand had de the New York banks. As a result of the panic of 1907, the Federal Reserve Act of 1913 is passed. of the Act. The primary purpose of the Federal Reserve Act of December 23, Purpose 1913, is to make certain that there will always be an available supply of money and credit in this country with which to meet unusual banking requirements. Banks of a new class, to be known as Federal Reserve Banks, are to be established, and upon these banks is to 1 From the Quarterly Journal of Economics, Vol. xxvIII. February, 1914. O. M. W. Sprague. "The Federal Reserve Act of 1913"; pp. 213-215, 223–224, 226–227. Duties and Reserve Each Federal Bank a rest the heavy responsibility of supporting the structure of credit in periods of financial strain. The new banks are expected to keep themselves in a condition of such strength in ordinary times that the other banks may safely rely upon them for all needed cash and credit in emergencies. In the past, the banks in this country, when subjected to financial pressure, have relied mainly upon loan contraction and the selling of securities. In the future it is expected that they will resort to the Federal Reserve Banks, securing additional funds from these by rediscounting commercial loans. The Federal Reserve Banks are to exercise wide powers, and would seem likely to have ample resources. The country is to be divided into not less than eight, nor more than twelve districts, in each of which a Federal Reserve Bank is to be established. All national banks are required, and qualified state banking institutions are invited, to subscribe to the capital of the Reserve Bank of their district. Subscribing banks, to be known as member banks, are required to keep a part of their reserve with their Federal Reserve Bank. . . [The Federal Reserve Banks] will provide an elastic currency, issuing notes secured by their commercial assets. They are also empowered to undertake the business of collecting and clearing checks throughout the entire country, thus providing an organization for making settlements between banks in different places, the lack of which has been one of the most serious defects in our .banking system. Each Federal Reserve Bank will be a central bank for the section of the country which it is to serve. It will have all of the responsicentral bank. bilities and most of the powers of central banks in the various European countries. Provisions of the Act with regard to member banks. The Federal Reserve Banks are to receive deposits from the government and from member banks only. Ordinarily they will lend to member banks only. . . . National banks are required, and properly qualified state banks are invited, to signify their acceptance of the terms of the act. Each national bank must subscribe to the capital of the Reserve Bank of its district an amount equal to six per cent of its capital and surplus. . . Reserve [The whole system is to be supervised and controlled by the The Federal Federal Reserve Board,] to consist of seven members; the Secre- Board. tary of the Treasury and the Comptroller of the Currency ex officio, and five members appointed by the President. . . . Of the five appointed members, at least two must be persons experienced in banking or finance. Not more than one shall be appointed from any Federal Reserve district, and due regard is to be given to the different commercial, industrial and geographical divisions of the country. The term of office of the appointed members is ten years; but those first selected are to serve one for two, one for four years, and so on, so that the term of office of one member may expire every two years. Council and its function. Organization of the system will be complete with the selection The Federal of the members of the Federal Advisory Council. This Council is Advisory to consist of as many members as there are Federal Reserve districts, the board of directors of each Federal Reserve Bank selecting one member. The function and powers of the Council are purely consultative. It is to meet regularly four times each year at Washington, and at other times there or elsewhere if deemed necessary by the Council itself. It is authorized to confer directly with the Federal Reserve Board, to call for information, and make oral or written representations concerning matters within the jurisdiction of the Federal Reserve Board. 185. Centralization under the Federal Reserve System 1 Reserve System provides for the centralization and mobility of bank At the time of the panic of 1907, the United States had the largest The Federal supply of gold of any country in the world. The difficulty was that under the old national banking system this supply of gold was ineffective, because widely scattered. A second difficulty was that our reserves were not only scattered, but were immobile. There was no effective way of quickly gathering them together and massing them at the points of financial danger. These two difficulties the Federal Reserve System overcomes by provision for, first, the centralization of bank reserves, and, second, the mobility of those reserves. The following discussion of this subject is by Dr. Kemmerer: 1 From Edwin Walter Kemmerer, The A B C of the Federal Reserve System. Princeton University Press, Princeton, N. J., 1920; pp. 36-42, 48-49. reserves. Member banks must maintain their entire legal reserve in the Federal [At the present time] every bank, banking association or trust company belonging to the Federal Reserve System [must] maintain its entire legal reserve in the form of a deposit at the Federal Reserve Bank of its district. . . . [Thus commercial banks belonging to the system no longer tie] up their legal reserve money by depositing it in the banks of our money market centers, there to be loaned out their district. at call to speculators on the stock and produce exchanges. This divorcing of the legal reserves of nearly 8,000 commercial banks from the speculative and capital loans of the stock market is one Reserve Bank of This secures the district centralization of reserves. Mobility of reserves between different Federal Reserve districts, of the big achievements of the Federal Reserve System. The Federal Reserve law, as amended, recognizes only one form of legal reserve, and that is a member bank's deposit in its Federal Reserve Bank. Member banks may keep as much or as little cash on hand for till money as they wish to. They may keep balances in other banks if it suits their convenience to do so - all that is their own affair for which their responsibility is to their stock holders and their customers - but their legal reserve, the reserve which the Government looks upon as the minimum below which the public interest demands that banks should not go, that reserve must all be kept on deposit in Federal Reserve Banks, the nation's reservoirs of reserve money. . . A corollary to the district centralization of reserves is their mobilization. Reserve money must not only be piped into a few large reservoirs, but these large reservoirs must be piped together, and there must be a pumping engine of sufficient power to force the reserves promptly and in large quantities to any place desired. The Federal Reserve System creates just this machinery. [It provides for the mobility of reserves, first, between the different districts of the system, and second, between the different member banks of any one district. Mobility of reserves between different Federal Reserve districts is provided for in a number of ways, notably as follows:] In case there is an exceptionally heavy demand for reserve money in any section of the country a demand heavier than the banks of that section can reasonably meet the reserve banks in other sections where money is more plentiful will come to the rescue, either voluntarily or under compulsion [by the Federal Reserve Board], and will rediscount the paper of the reserve bank in the |