§ 4. Defects of our banking organization before 1913. Taken altogether, the national banks in the United States between 1863 and 1913 represented great banking power and very efficient service for the community in times of normal business, as with few exceptions did also the state banks. But in several respects it long ago became apparent that our banks were operating less satisfactorily than those of several other countries. American banking organization had failed to keep pace with the increasing magnitude and difficulty of its task. Especially at the recurring periods of financial stress, such as those of 1873, 1893, 1903, and 1907, our banking machinery showed itself to be wofully unequal to the strain put upon it. Financial panics were more acute here than in any other land, and this fact clearly was traceable in large part to defects in the banking situation. In academic teaching and in public conferences of bankers, business men, publicists, and students, the subject was continually discussed after 1890. At length Congress in 1908 created a "National Monetary Commission" to inquire into and report what changes were necessary and desirable in the monetary system of the United States or in the laws relative to banking and currency. After the most extended inquiry and discussion that the subject had ever received, the commission submitted its report in January, 1912. The defects to be remedied, as enumerated in the report3 may be reduced to the following five headings: (a) Lack of system. (b) Inelasticity of credit. (c) Periodic local congestion of funds. (d)    Unequal territorial distribution of banking facilities.(e)   Lack of provision for foreign banking.

§5. Lack of system. Only in a loose sense could the banks of the United States be said (before 1914) to constitute a system at all. Both national and state laws dealt with individual banks only. It was not legal for a bank to establish branches in another city, as is done in most countries. The several national banks in one city were legally quite separate. It was only by voluntary agreement that in some of the larger cities they came together into clearing-house associations. They made possible some measure of cooperation which, small as it was, proved at times of stress to be of much service within a limited sphere for the local communities. But even with the aid of these organizations the banks were unable in times of emergency to avoid the suspension of cash payments.

There was no provision whatever for the concentration of bank revenues so that each bank would be supported by the strength of the other banks if a movement began to withdraw deposits in unusual amounts. Each bank then was compelled for self-protection to call for any sums it had deposited with other banks,4 and to keep for its own use all the reserves it might have in excess of its own immediate needs. This threw a great strain upon the banks in the reserve cities, which in normal times had become the depositories of a good part of the reserves of the banks in other places. Thus developed a spirit of panic, like the fright of theater-goers crowding toward the door at the cry of fire.

The maintenance of the government's independent treasury contributed to the difficulties by causing the irregular withdrawal of money from circulation and thus depleting bank reserves in periods of excessive government revenues and by returning these funds into circulation only in periods of deficient revenues. Efforts to modify this system by a partial distribution of the public moneys among national banks, had resulted, it was charged, in discrimination and favoritism in the treatment of different banks and of different sections of the country.

3 The expressions within quotation marks in the following sections are taken from this report.

4 See further on this in § 7 on periodical congestion of funds.

§ 6. Inelasticity of credit. Our banks, considered both separately and collectively, were unable to increase their lending powers quickly and easily to respond to business needs. The need of greater elasticity of credit was felt in the more or less regular seasonal variations within the year, and in the more irregular variations in cycles of years from periods of prosperity to those of panic and depression in business. The inelasticity was necessitated by illogical federal and state laws restricting absolutely the further extension of credit when the reserves fell below the percentage of deposits (15 or 25 per cent) fixed by law. Reserves thus could not legally be used to meet demands for cash payments at the very time when most needed. This feature has been likened to the rule of the prudent liveryman who always refused to allow the last horse to leave his stable so that he would never be without a horse when a customer called for one. The refusal of credit by the banks at such times when they still had large amounts of cash in their vaults increased the need and eagerness of the public to draw from the bank all the cash they could, and often precipitated the insolvency of the banks. Clearly, some means were needed to enable the lending power of the individual banks to be increased at such times, so that no customer with good commercial paper need fear to be refused a loan even though the rate of interest might have to be somewhat higher for a few days or weeks than the normal rate. Our bond-secured bank-notes lacked almost entirely the quality of elasticity needed to meet these changing business feeds.5 Their value being dependent primarily upon the amount and price of United States bonds, they might be most numerous just when least needed as a part of our circulating medium.

5 See above, § 3.

§ 7. Periodical local congestion of funds. In times of general confidence each bank finds it profitable, and is tempted, to extend its credit to the extreme limit permitted by the law governing the proportion of reserves to deposits. Of the 15 per cent reserves that were required in the so-called "country" banks, three fifths (9 per cent) might be kept in banks in reserve cities; and of the 25 per cent in reserve city banks, 12 1/2 per cent might be kept in central reserve cities. There it counted as part of the depositing banks' legal reserves, was a fund upon which domestic exchanges could be drawn, and earned a small rate of interest (usually 2 per cent) paid by banks in reserve and central reserve cities to their "country" correspondents. By this process of pyramiding, reserves in very large part came to be kept in New York city, where they could be lent "on call," and the largest use for call loans was in stock-exchange speculation. Thus every period of prosperity encouraged an unhealthy distribution of reserves, gave an unhealthy stimulus to rising prices, and "promoted dangerous speculation."

§ 8. Unequal territorial distribution of banking facilities. Another aspect of this concentration of surplus money and available funds in the larger cities was the comparatively ample provision of banking facilities in the cities and in the manufacturng sections, and imperfect provision in the agricultural districts. The whole financial system seemed designed to induce the poorer country districts to lend temporarily available funds at low rates of interest to be used speculatively in cities, instead of enabling the richer districts, the cities, to lend to the rural districts for productive enterprise. The rates of bank discount in different sections of our country have long been most unequal—lowest in the largest cities and highest in the rural South and West—whereas in Canada, with a different system of banking, the rates have long been much more approximately uniform in urban and agricultural districts.

Indeed, our national banking development has been predominately urban and commercial to the neglect of rural and agricultural interests. National banks were (until 1913) forbidden to make loans on real estate, and this greatly "restricted their power to serve farmers and other borrowers in rural communities." There was in the more agricultural regions, "no effective agency to meet the ordinary or unusual demands for credit or currency necessary for moving crops or for other legitimate purposes." The lack of uniform standards of regulation, examination, and publication of reports in the different sections prevented the free extension of credit where most needed. Finally, the methods and agencies for making domestic exchange of funds were, compared with other countries, imperfect and uneconomical even in normal times, and could not "prevent disastrous disruption of all such exchanges in times of serious trouble."

§ 9. Lack of provision for foreign financial operations. Not without its influence on public opinion was the consideration that we had "no American banking institutions in foreign countries." Many bankers and business men felt, as did the Commission, that the time had come when the organization of such banks was "necessary for the development of our foreign trade." Foreign banks in South America and th3 Orient, handling American trade, were believed to favor their own countrymen rather than the interests of American merchants. In contrast with the European nations with their centralized control of banking, we had "no instrumentality that" could " deal effectively with the broad questions which, from an international standpoint, affect the credit and status of the United States as one of the great financial powers of the world. In times of threatened trouble or of actual panic these questions, which involve the course of foreign exchange and the international movements of gold, are even more important to us from a national than from an international standpoint."

§10. The "Aldrich plan." The report of the National Monetary Commission represented most careful study of the whole subject, and embodied the efforts and aid of many of the best financial experts of this and other lands. The Commission in its work gave an admirable example of the right way to prepare for and undertake important economic legislation. Though it discovered nothing essential that was not known to the small group of expert economic students, it put all material into systematic and convincing form and served during several years to educate public opinion as to the needs and proper means of sound banking policy. The analysis of difficulties as outlined above has not merely a temporary but a lasting interest to the student of financial history, for it implies an ideal for the banking system of the nation.

The Commission submitted with its report a constructive plan which was known by the name of the Commission's chairman, Senator Aldrich. This plan was embodied in a bill for a National Reserve Association, a bank for banks, which bore some likeness to the great central banks of Europe. In the many details of the plan an effort was made to remedy every one of the difficulties above described and to supply all the needs indicated. The plan was favored pretty generally by bankers, but called forth many adverse opinions. In the year of a presidential election, however, Congress took no action in the matter. All parties were pledged to some kind of banking reform, but particular proposals were not discussed in the campaign.

References

National Monetary Commission, Report. 1912. In Sen. Doc. 243, 62d Cong., 2d Cess. Phillips, C. A., ed., Readings in money and banking. N. Y. Macmillan. 1916. Ch. XXX. United States Comptroller of the Currency, Annual reports. White, Horace, Money and banking illustrated bv American History.

Boat. Ginn. 1914. Bk. Ill, chs. IV, XV, XVII, XX, XXI, and appendices A and B.