Two months after the September meeting, Charles S. Hamlin of the Board talked about changes needed in the Federal Reserve Act. The proposed changes were modest and, Hamlin said, were considered nonpartisan by the Board and Congress. Hamlin talked about the Board’s cordial relations with Congress. He made no mention of changes in gold reserves or requirements as a restriction the Board wanted removed.
Hamlin’s speech showed no evidence of the need for stimulus. He accurately described the magnitude of the decline in industrial production and prices in the first year of recession. The decline in bank credit was the usual occurrence in a recession. He noted the reduction in bank borrowing and in the ratio of loans to deposits (Federal Reserve Bank of Boston 1928–31, 1930, 19). After discussing quantitative changes in the distribution of credit between New York and the rest of the country, Hamlin concluded by comparing 1929–30 and 1920–21. “The Federal Reserve Banks are not now, as they were then, close to the limits of their lending power. On the contrary, they have ample reserves and stand ready to finance a growing volume of business as soon as signs of recovery express themselves in an increasing demand for credit. That day cannot arrive too soon to please any of us” (21).
WATCHING AND WAITING: POLICY IN THE SECOND YEAR
By November–December 1930, a radically new element had emerged. The eruption of serious bank failures shifted the balance of relative advantage toward increased currency holdings. The risk attached to holding demand deposits increased substantially, lowering the relative inconvenience of holding currency. With Federal Reserve policy unchanged, the public’s increased demand for currency forced a further contraction in the money supply and in the banks’ demand for earning assets. But until mid-December, member bank borrowing remained virtually unchanged, and short-term interest rates did not rise, so the executive committee did not meet and made no purchases of securities for seasonal or other reasons.
Bank failures began in the Southeast after the collapse in November 1930 of Caldwell and Company, a large Tennessee investment bank (Wicker 1996). Runs on 120 banks followed the collapse, but most were small. Wicker (1996, 32) concluded that the effect of the failures did not spread beyond the region, and Calomiris and Mason (2000) support this conclusion. Since money market interest rates did not rise, the Federal Reserve took no action.
On December 11 the New York State superintendent of banking closed the Bank of the United States, a New York City member bank. More than half a million depositors found their deposits unavailable.48 The proximate reason for closing the bank was failure to merge the bank with two others—the Public National Bank and the Manufacturers’ Trust Company. Neither of the latter banks closed. All three banks had Jewish owners, and each lent to small and medium-sized clothing and textile manufacturers. None was a member of the New York clearinghouse at the time.
After two weeks of late-night meetings, a group including J. Herbert Case, chairman of the New York reserve bank, Leslie Rounds, Federal Reserve officer responsible for banking, and Mortimer Buckner, head of the New York Trust Company and chairman of the relevant clearinghouse committee, agreed to merge the three banks with Case as chairman of the new board. The agreement required the clearinghouse banks to advance $20 million: “The Public was in fine shape, the Manufacturers’ was in good shape, and the Bank of the United States was generally supposed to be in pretty poor shape” (CHFRS, Rounds, May 2, 1955, 15).
48. Two smaller banks closed also—the Chelsea Bank in New York and the Binghamton State Bank.
Rounds and Case give different explanations of the failure to merge. According to Rounds, Harrison returned from Europe just as the agreement was reached. Harrison was cool to the idea. The Manufacturers’ Trust was hesitant and would agree only if the clearinghouse banks would guarantee up to $20 million of Bank of the United States assets: “Quite a few of those representing the clearinghouse banks cooled off and George [Harrison] was not disposed to warm them up any, so it all fell through; at about 5:30 that morning it was decided to close the bank” (ibid., 16).49
Case’s version has Harrison in Europe throughout.50 Case attributed the failure of the merger to a decision by the Public National Bank to withdraw from the merger. The governor, Franklin Roosevelt, “sent Lehman down to plead that the consolidation should go through. One of the distinguished bankers [a clearinghouse member] shook his head and said ‘let it fail, draw a ring around it, so that the infection will not spread.’ Obviously any such idea was impossible” (CHFRS, Case, February 26, 1954, 7).51
To ease the burden of the closing of a medium-sized member bank and to slow the currency drain, the New York clearinghouse admitted the Manufacturers’ Trust and the Public National Bank to membership. The owners of the Manufacturers’ Trust sold controlling shares to a non-Jewish banker (CHFRS, Rounds, May 2, 1955, 21).52
49. Rounds had looked over the bank’s records for several days and nights. He claimed the bank was solvent at the time it closed. “We had discounted the doubtful items very heavily. They had a pretty good bond account, they had $35 or $40 million of capital to be exhausted before they became insolvent” (CHFRS, Rounds, May 2, 1955, 17). Friedman and Schwartz (1963, 311) report that the Bank of the United States paid out 83.5 percent of its adjusted liabilities despite declining asset prices in the following two years.
50. Case described a conversation with Harrison in Germany in which Harrison agreed that Case should be chairman of the merged bank (Case, CHFRS, February 26, 1954, 7). The conversation must have occurred earlier. Harrison was in New York on December 4 for the New York directors’ meeting.
51. The issue of Harrison’s presence or absence aside, Case’s story emphasizes a different side of a very similar story. Both the Manufacturers’ and the Public National demanded the clearinghouse guarantee. Failure to get the guarantee caused them to withdraw. One reason the clearinghouse banks were unwilling to guarantee the $20 million was that they had lost heavily when they guaranteed the Harrison National Bank. The Harrison bank went bankrupt, and stockholders lost most of their equity. Another reason, offered by Friedman and Schwartz (1963, 309–10), is that the Jewish ownership of these banks played a role in the clearinghouse decision. Earlier, Rounds denied the story in a way that suggests it was a consideration. “I don’t think anti-Jewish feeling was too important so far as the clearinghouse banks were concerned. Of course, it contributed to the feeling that they all had of doubt about how bad the situation was. . . . There was a definite feeling in the minds of the public regarding banks that was anti-Jewish. As far as the clearinghouse banks were concerned, I don’t think they thought in terms of race. . . . There was a certain amount of feeling about the Jewish banks but I don’t think it was based on race. I do think that in the public mind there was a strong aversion to Jewish banks and that many of the Jewish bankers felt that the public had made that decision” (CHFRS, Rounds, May 2, 1955, 19).
The December 1930 OMPC meeting was one of the briefest on record. The minutes cover only two pages. Harrison reported on the closing of the Bank of the United States nine days earlier and informed the conference that he had made some emergency purchases of securities from particular banks in New York after the failure. In fact, New York had purchased $100 million of securities and $75 million of acceptances between November 30 and December 17; the System’s discounts and the monetary base increased by $80 million and $250 million, respectively. Most of the increase in the base reflected the currency drain, a subject discussed at length in the preliminary memorandum prepared for the meeting and all but completely ignored by the governors.53
Borrowing, currency, and the base continued to rise to the end of the month but, contrary to the normal seasonal increase, loans at weekly reporting banks fell $500 million in two months (see table 5.9). The risk spread between higher- and lower-rated bonds rose 0.67 to 2.19 in the same period and was almost one percentage point above the August 1929 level by the end of the year.
The conference was willing to leave any decision ab
out further purchases to Harrison but stipulated that the purchases would have to remain within the $100 million limit set by the OMPC in September. It is not clear whether this was intended as a vote of confidence in New York’s ability to handle the crisis or whether the governors were aware that New York had purchased most of the $100 million for its own account before the meeting and had little remaining authority. During the week of the meeting, discounts rose more than $100 million to the highest level since the start of the year. New York sold $50 million, and at the end of the week it reduced its discount and acceptance rates. When the pressure increased in the last week of the year, New York temporarily exceeded its authority by purchasing more securities than the conference had authorized.54
52. “The feeling of the Clearinghouse was that the bank could not survive as a Jewish bank” (CHFRS, Rounds, May 2, 1955, 22).
53. Case reported that in the single week ending December 13, 1930, the New York Federal Reserve Bank supplied $170 billion in currency, 4 percent of the total stock outstanding. For the country as a whole, currency increased $300 million, about 7.5 percent of the outstanding stock. Part of the increase was seasonal (testimony of J. H. Case, Senate Committee on Banking and Currency 1931, 108–9).
54. During the week ending December 24, a fortuitous increase of $50 million in float eased the money market and offset the System’s open market sales. In the following week, float declined and the pressure on the money market increased. New York purchased more than $100 million of acceptances and $85 million in securities during the week; at $729 million in securities and $364 in acceptances, the account was more than $300 million higher than at the time of the OMPC meeting. All of the increase came in December. These figures are higher than those shown by the change in securities in table 5.9, which are based on monthly averages of daily figures. Approximately $45 million of the purchases were made (net) by New York for its own account.
Before December, most failed banks were rural nonmember banks. The Bank of the United States was a medium-sized member bank in the country’s main financial center. After calm returned to the markets, evidence of concern remained. Risk spreads between Baa and Aaa bonds remained above the levels customary before the failure, and currency outstanding continued to increase absolutely and relative to the money stock.
The background memo prepared for the December meeting painted a gloomy picture. Industrial production had declined “to the lowest level relative to normal ever reached”; factory employment had declined further; agricultural prices had fallen; the autumn expansion was below average. The memo mentions a decline from 92 to 85 between August and November in the seasonally adjusted production index and a decline in the price index from 85 to 81. Yet these facts had no apparent effect on the OMPC’s decision. Member bank borrowing remained below $500 million; on Riefler-Burgess grounds, the market did not require further support.
Once the money market disturbance subsided, the System began to sell securities and to reduce its acceptance portfolio, following the usual seasonal pattern. Bank loans had declined by almost $1 billion, nearly 6 percent, in the four months to January 31. Industrial production, prices, and the stock of money continued to decline. Currency held by the public rose from December to January, reversing the standard seasonal movement and suggesting public concern about the financial system. A new element appeared for the first time: member bank excess reserves were above $100 million, twice the average level of the preceding year.
The rise in excess reserves could have been a signal to the members of the Open Market Policy Conference or to their staffs. In their analysis, excess reserves were small and approximately constant, so the relatively large increase from December to January was inconsistent with the Riefler-Burgess framework. Miller was aware of the inconsistency. He asked why the banks were acquiring surplus reserves and how widespread the practice had become. Harrison replied that excess reserves were most likely a sign of lack of demand by borrowers and of banks’ reluctance to use funds; McDougal and Young replied that most of the banks in Chicago and Boston did not have surplus reserves but that the banks were “very liquid.” Miller pressed his point, suggesting that the “banking system might be suffering just now from excessive caution and excessive desire for liquidity.” Harrison replied that “that was one reason why our easy money policy [sic] has not proved more effective.” No one suggested that the excess reserves could be eliminated by an aggressive policy of monetary expansion or that the banks’ “desire for liquidity” should be satisfied by the System.55
Although borrowing was only $250 million, the main discussion at the meeting was not, as in September, about whether there should be sales but about how much should be sold. McDougal suggested they sell $100 million; George Seay (Richmond) suggested they sell $200 million; Harrison reported that the directors at New York wanted to sell $35 million.56 Only Meyer suggested that sales might be interpreted as a change to a more restrictive policy. And Meyer added, “The Reserve System has been accused in a number of quarters of pursuing a deflationary policy in the past year.” In the end, the governors did not decide on the amount to be sold, but they agreed unanimously that it “would be desirable to dispose of some of the System holdings of government securities.”
The tone of the minutes was more pessimistic than it had been at previous meetings. For the first time there was a lengthy discussion of gold, but the problem was an inflow, not an outflow. Harrison had returned from Europe in December. He reported that the European countries were planning to reduce imports from the United States because they could not afford to pay $600 million in gold each year. Britain, Germany, and Italy had experienced a decline in gold reserves during 1930. With the decline in exports, these countries reduced borrowing. The Smoot-Hawley Tariff had added to the decline in world trade and particularly to reduced exports and imports by the United States.
International cooperation continued. The New York bank purchased sterling bills during the fall because of the “weakness in sterling.” Harrison added that in December he had “been urged from many quarters to make a reassuring statement which might aid in quieting the banking situation,” but he had declined to do so for fear it might be contradicted by any small bank failure that occurred. McDougal noted that the recent reduction of the discount rate at Chicago had been made without any belief that it would encourage business activity.
Despite these gloomy prospects, the meeting had no recommendation or even discussion of expansive Federal Reserve action. All the members believed that policy was easy. There was only one type of evidence to support this belief at the time. Between December and January, member bank borrowing had declined and short-term interest rates had fallen to the lowest point recorded up to that time. To the governors of the Federal Reserve System, nothing was more indicative of the direction of policy and its effect.
55. Harrison’s response neglected to mention his officers’ discussion earlier in the month. At that meeting, one of the officers described the excess reserves as “a result of a period of country-wide apprehension concerning the banking situation” (Harrison Papers, Meeting of Officers Council, January 14, 1931).
56. He did not explain that he proposed selling $45 million but some of the directors objected that they should not sell (Minutes, New York Directors, January 15, 1931).
Again, an alternative view was presented and rejected. W. Randolph Burgess told the New York directors at their meeting on January 15 that selling securities meant reversing current policy and suggested that they delay the change. Two of the directors recommended that Harrison continue the “easy money policy,” but they were unable to persuade him that selling securities would have an adverse effect. However, when the sale of only $20 million was followed by a much larger decline of excess reserves, sales were suspended.
A week later, Burgess reported to the directors that Harrison suggested resumption of selling, but “a majority of the Officers Council was of the opinion that it would be better to defer further sales
.” One of the directors again urged a policy of expansion; as a compromise, they postponed further sales.
Between the end of January and the end of April, the risk spread on long-term bonds increased by 0.875 percent, but excess reserves declined and the index of industrial production rose by almost two percentage points. The minutes note the rise as early as the February 26 meeting of the New York directors.
The Federal Reserve never discussed using monetary policy to support the modest recovery. On March 5, Harrison advised “maintaining the status quo,” which at the time meant no change in the discount rate, in the buying rate on acceptances, or in open market policy. Meyer, who was present, agreed that it was unwise to take any small steps that might be interpreted as a change in policy when none was intended.
Nor did the rise in industrial production receive much attention at the OMPC meeting. The committee focused on three changes in the data for the monetary system—the continued gold inflow, the decline in the System’s acceptances, and the decline in member bank excess reserves.57 At the time of the meeting, the gold stock had increased nearly 5 percent since the previous August, and the rate of increase had quickened during the winter.
57. Much of the gold now came from France. Meyer asked why the Bank of France sold gold. Harrison responded that it probably had more than it needed. Meyer urged that the increased gold be allowed to lower interest rates and expand credit (Minutes, New York Directors, April 23, 1931).
A History of the Federal Reserve, Volume 1 Page 48
