The Federal Reserve Act repealed the provisions of Section 5159 of the Revised Statutes of the United States and of the Acts of 1874 and 1882, and any other provisions of existing statutes that required national banks to deposit a stated amount of bonds with the United States Treasurer before being authorized to commence banking business.

The Federal Reserve Act also provided for the retirement of the national bank circulation, and for the sale and transfer to the federal reserve banks of the United States bonds securing circulation. A member bank desiring to retire the whole or a part of its circulating notes is empowered at any time during a period of twenty years after December 23, 1915, to file with the Treasurer of the United States an application to sell for its account, at par and accrued interest, the United States bonds securing the circulation to be retired. The Treasurer is required to furnish the Federal Reserve Board, at the end of each quarterly period, with a list of such applications; and the board may in its discretion require the federal reserve banks to purchase such bonds from the banks whose applications have been filed with the Treasurer at least ten days before the end of the quarterly period at which the board may direct the purchase to be made. But the federal reserve banks cannot be required to buy an amount to exceed $25,000,000 of such bonds in any one year, this amount including all such bonds which they may have bought in the open market. The board is required to allot to each federal reserve bank such proportion of these bonds as the capital and surplus of the bank bear to the aggregate capital and surplus of all the federal reserve banks. When such sales are made the member bank assigns and transfers the bonds to the federal reserve bank purchasing them; the reserve bank pays the purchase price in lawful money to the United States Treasurer, and the Treasurer in turn pays the selling bank any balance due after deducting a sufficient sum to redeem its outstanding notes secured by such bonds. When redeemed these notes are canceled and permanently retired. The federal reserve bank purchasing such bonds is permitted to take out an amount of circulating notes equal to the par value of the bonds. These notes, known as "federal reserve bank notes," have the same tenor, qualities, basis, and method of issue and redemption as national bank notes, except that they are not limited to the amount of the capital of the federal reserve bank issuing them.

The Federal Reserve Act went further and provided for the conversion of the 2 per cent bonds bearing the circulation privilege, but not having any circulation outstanding at the time, into 3 per cent securities without the circulation privilege. Upon application of any federal reserve bank, approved by the Federal Reserve Board, the Secretary of the Treasury may issue, in exchange for the United States 2 per cent gold bonds bearing the circulation privilege but against which no circulation is outstanding, 1-year United States 3 per cent gold notes without the circulation privilege, to an amount not to exceed one-half of the 2 per cent bonds so tendered for exchange, and 30-year 3 per cent gold bonds without the circulation privilege for the remainder of the 2 per cent bonds so tendered. In obtaining the 1-year notes, however, the federal reserve bank enters into a contract with the Secretary of the Treasury to purchase, if the Secretary so requests, from the United States for gold, at the maturity of these 1-year notes, an amount of 1-year notes not to exceed those originally received from the Secretary in exchange for the 2 per cent bonds, this obligation to buy notes at each maturity of the previous issue continuing for a period not to exceed 30 years. The Treasury notes so issued are to run not longer than one year, are to be issued at par, in coupon or registered form, in denominations of $100 or multiples thereof, are to bear 3 per cent interest payable quarterly, redeemable at maturity in gold, and are exempt from payment of all taxes of the United States (except as provided by this act) and of state, municipal, or local taxes. The bonds, on the other hand, are payable in 30 years, bear 3 per cent interest, and are like the United States bonds without the circulation privilege. Upon application of any federal reserve bank, approved by the board, the Secretary may issue at par such 3 per cent bonds, to take up the 1-year gold notes. The Secretary may convert any amount of 2 per cent bonds that he deems best, and the establishment of such amount is a matter to be annually determined in accordance with the requirements of the situation.

Effect of Liberty Bond Issues on Bond Refunding and Conversion Bond refunding and conversions were well under way during 1916 and the first quarter of 1917. But the process was halted by the Liberty bond issues. Before that date the 3 per cent conversion bonds could be sold at a premium, and it was profitable to the federal reserve banks to buy the 2 per cent bonds at par, convert them into 3's, and sell at a premium. The 3 per cent notes could also be sold at a premium, but the reserve banks chose to keep them as an investment. But the issue of 3 1/2 per cent Liberty Loan bonds destroyed the market for 3 per cent conversion bonds, and sales at par were no longer possible. At this time 3 per cent conversion bonds were held by the reserve banks to the amount of $7,000,000.

To remedy this condition a proposal has been made to raise the rate on future issues of conversion bonds to 3 1/2 per cent. But the Federal Reserve Board hesitated to encourage the conversion of bonds in this or other ways, deeming it best during the war to hold the 2 per cent bonds with the circulation privilege rather than the conversion 3 per cent bonds without the privilege, so that in an emergency the volume of federal reserve bank notes might be expanded. On December 31, 1919, the aggregate holdings of the twelve federal reserve banks were $18.6 million of bonds with the note issue privilege, and $6.5 million of 3 per cent conversion bonds. From the fact that some $16 million of the privileged bonds bear but 2 per cent interest, it is evident that the federal reserve banks are not trying to make maximum earnings from this investment. In 1916 the Federal Reserve Board encouraged the federal reserve banks to buy the 2 per cent bonds, but discouraged the issue of federal reserve bank notes upon them; or, if such notes were issued to a reserve bank, the board favored the bank's holding them in its vaults against a time of stress. The policy of the Treasury has been to redeem the 1-year 3 per cent gold notes issued in connection with the conversions for the federal reserve banks.