lending functions of the federal reserve banks: a history, 1973 · 2018-11-06 · a comprehensive...

Lending FunctionsOf The

Federal Reserve Banks:A History

Board of Governors of the Federal Reserve System

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Lending JunctionsOflhu

Jederal Reserve/Banks:J[ History


Library of Congress Catalogue Card Number 73-600196

Copies of this book may be obtained from Publica- $3.00 each. Remittances should be made payabletions Services, Division of Administrative Services, to the order of the Board of Governors of theBoard of Governors of the Federal Reserve System, Federal Reserve System in a form,that is collectibleWashington, D.C. 20551. The price is $3.50 per at par in U.S. currency. (Stamps and coupons arecopy; in quantities of 10 or more sent to one address, not accepted.)


4 History,i of the' |Lending*

Foreword

This book represents a revision and updating of an unpublishedversion that was mimeographed in April 1961. The earlier versionwas prompted by a 1955 revision of the Board's Regulation A;the present version was prompted by the 1973 revision of thatregulation.

I make no apology for the length and technical nature of thebook nor for the seemingly disproportionate space given to long-forgotten matters, such as the many Board interpretations duringthe 1920's and the chapter dealing with the obsolete authority ofthe Federal Reserve Banks to make working capital loans tobusiness. This is necessary to achieve the objective of presentinga comprehensive history of the lending functions of the FederalReserve Banks.

Following tradition, I must include here a statement that, unlessotherwise indicated, any opinions expressed in this book are myown and are not to be attributed to the Board of Governors or toany member of the Board or its staff.


Historyi. of the iLending

Functions

Table of Contents

INTRODUCTION

Statement of objective 1 Distinction between Reserve Bank loans and commercial bankloans 1 Significance of Reserve Bank loans 3 Scope of this study 4

Arrangement 5

THE ORIGINAL DISCOUNT PROVISIONS

LEGISLATIVE HISTORY 7

Development of the Federal Reserve Act 7 Differences among the discount provisions ofvarious bills 8 Resolution of differences 8 The final provisions 8

BASIC PURPOSES 9

Creation of a market for commercial paper 9 Prevention of panics 10 Expansion ofbusiness 10 Benefit to country banks 10 Lessening of speculation 11

Elastic currency 11 Secondary objectives 12

GENERAL LIMITATIONS

MATURITY 13

Introduction 13 Reasons for 90-day limitation 14 Agricultural paper 14Days of grace 16 Regulations 16 Demand paper 16

AMOUNT 16

Aggregate amount 16 Paper of one borrower 17

ENDORSEMENT 22

Purpose 22 Waiver of protest 22 Regulatory provisions 22Form and effect of endorsement 22


History.fo f t h e |Lending

Table of Contents—Continued

GENERAL LIMITATIONS Continued

NEGOTIABILITY 23

Regulatory requirement 23 Exceptions 23 Meaning of negotiability 24Elimination of the requirement 24

DISCOUNT OF COMMERCIAL PAPER

MEANING OF "COMMERCIAL PAPER" 27

Intent of the original Act 27 Regulatory definition 28 Commercial purpose 30Self-liquidating nature 31 Effect of collateral security 31 Evidence of eligibility 32

Change in concept as to eligibility 33

TRADE ACCEPTANCES 33

Separate classification for rate purposes 33 Nature of transaction 34 Form 34

COMMODITY PAPER 35

PERMANENT- OR FIXED-INVESTMENT PAPER 35

Exclusion from discount 35 Evidence of compliance 36 Meaning of permanent invest-ments 36 Removal of exclusion of permanent-investment paper 36

PAPER DRAWN FOR SPECULATIVE PURPOSES 37

PAPER DRAWN FOR TRADING IN STOCKS AND BONDS 38

FINANCE PAPER 39

Original exclusion from discount 39 Modification by statute 39Reversal of Board's position 39

CONSUMER PAPER 40

CONSTRUCTION PAPER 41

vi


• History*,c of the-;|^LendingFunctions


AGRICULTURAL CREDITS

THE ORIGINAL ACT 43

AGRICULTURAL CREDITS ACT OF 1923 44

Background 44 General provisions 44 Amendments to Federal Reserve Act 45

NATURE OF AGRICULTURAL PAPER 46

Regulatory description 46 Distinguished from commercial paper 46

MATURITY 47

AMOUNT LIMITATIONS 48

SIGHT DRAFTS 48

FACTORS' PAPER 49

PAPER OF COOPERATIVE MARKETING ASSOCIATIONS 50

DISCOUNTS FOR FEDERAL INTERMEDIATE CREDIT BANKS 51

BANKERS' ACCEPTANCES

GENERAL CONSIDERATIONS 53

Purposes 53 Early encouragement by the Board 54 Definition 55 Acceptanceauthority of member banks 56 Discounting authority of Federal Reserve Banks 57

• •VH


.-History*-| of the I"•LendingFunctions


BANKERS' ACCEPTANCES Continued

IMPORTATION AND EXPORTATION OF GOODS 58

Connection with import or export 58 Contract and shipping documents 59Geographic coverage 61

DOMESTIC SHIPMENTS 61

Extension of law to cover domestic shipments 61 Purpose of financing 62Shipping documents 62 Geographic limitation 62

STORAGE OF STAPLES 63

Purpose of transaction 63 Warehouse receipts and other security 63Place of storage 64 Meaning of "readily marketable staples" 64

DOLLAR EXCHANGE 65

Nature and purpose 65 Permission to accept dollar-exchange drafts 66Designated countries 67 Question regarding present legal authority 68

MATURITIES 69

Acceptances by member banks 69 Discount by Federal Reserve Banks 70Renewals 71

AMOUNT LIMITATIONS 72

Acceptance by member banks 72 Discount by Federal Reserve Banks 74

LETTERS OF CREDIT AND SYNDICATE CREDITS 75

DIMINISHED IMPORTANCE OF ELIGIBILITY REQUIREMENTS 76

viii


History,j?of the ; |Lending*


REDISCOUNT OF WORLD WAR IVETERANS' NOTES

79

ADVANCES TO MEMBER BANKS

GENERAL CONSIDERATIONS 83

Distinction between advances and rediscounts 83 Development of authority for advances 83Original authorization 85 Limitation to paper eligible for purchase under Federal ReserveAct 85 Limitation to paper arising from commercial or agricultural transactions 86Endorsement of pledged paper 87 Maturity of advances 88 Increase of securities loans

during life of advance 88 Elimination of application forms and promissory notes 89

ADVANCES ON DIRECT OBLIGATIONS OF THE UNITED STATES 90

15-day advances 90 90-day advances 90 Limitation as to type of obligation 91Advances at par 91

ADVANCES ON OBLIGATIONS OF GOVERNMENT AGENCIES 91

Summary 91 Federal intermediate credit bank obligations 92 Farm loan bonds 93Federal Farm Mortgage Corporation bonds 94 Home Owners' Loan Corporation bonds 95

Commodity Credit Corporation certificates of interest 95 Merchant Marine bonds 96Farmers Home Administration insured notes 96 Export-Import Bank

participation certificates 96 Notes guaranteed by Small Business Administration 97Agency issues 97

TAX WARRANTS 98

THE GLASS-STEAGALL ACT: A BREAK WITH THE PAST 100

Emergency background 100 Provisions of the bill 100 General purposes 101

ix


/History*a; of the 4Lending'

Functions


ADVANCES TO MEMBER BANKS Continued

ADVANCES TO GROUPS OF MEMBER BANKS 103

Purpose and nature 103 Limitations 104 Effect 105

ADVANCES ON SATISFACTORY ASSETS 105

Original authorization 105 Extensions of time limit 106 Permanent authorization 107Emergency use vel non 108 The "sound assets" concept 109 Particular types ofsecurity 112 Maturity 113 Rate of interest 113 Proposals for liberalization 114

CREDIT FOR NONMEMBER BANKS

SUMMARY 117

CREDIT THROUGH MEDIUM OF MEMBER BANKS 118

Legislative history 118 Liberal interpretation of statute 119 Blanket authority 119

Regulatory provisions 121

EMERGENCY DISCOUNTS OF ELIGIBLE PAPER 121

ADVANCES ON GOVERNMENT OBLIGATIONS 122

TEMPORARY AUTHORITY FOR ADVANCES ON SOUND ASSETS 124


-. History,t of the |Lending*

Functions


LOANS TO INDIVIDUALS, PARTNERSHIPS,AND CORPORATIONS

LOANS ON ELIGIBLE PAPER IN EMERGENCY CIRCUMSTANCES 127

Rejection in original Act 127 1932 amendment 127 Limitations 128Board activation of authority 129 Use of authority 130

ADVANCES ON GOVERNMENT OBLIGATIONS 131

WORKING CAPITAL LOANS TO BUSINESS

ORIGIN AND PURPOSE 133

A departure from tradition 133 Need for the authority 134 Legislative history 134Reserve Banks versus RFC 135

LIMITATIONS 136

General limitations 136 Limitations on direct loans 138Limitations on commitments 138 Amount limitations 140

INDUSTRIAL ADVISORY COMMITTEES 140

SOURCE OF FUNDS 141

REGULATION S 142

TERMINATION OF AUTHORITY 144

XI


• Historyf otthe I'Lending


V LOANS

ORIGIN AND NATURE 147

Wartime background 147 Phases of the program 148

LEGAL BASIS 149

Executive Order 9112 149 VT guarantees 150 Contract Settlement Act 150Defense Production Act 151

ROLE OF THE FEDERAL RESERVE BANKS 152

As fiscal agents 152 As financing institutions 154

ROLE OF THE BOARD OF GOVERNORS 154

THE GUARANTEE AGREEMENT 155

FEES AND RATES 157

RELATED LEGAL PROBLEMS 158

Eligibility of V-loan paper for discount 158 Lending limits of national banks 159Assignment of claims under Government contracts 159

INTERDISTRICT REDISCOUNTSLegislative purpose 163 Use of the authority 164

xii


^History*s of the |Lending*

Functions


DISCOUNT RATES

STATUTORY PROVISIONS 167

OBJECTIVES OF DISCOUNT RATES 168

Uniformity of rates 168 Accommodation of commerce and business 169Implementation of credit policies 170

LEGAL BASIS AND DISCRETIONARY NATURE 170

DISTRIBUTION OF AUTHORITY 171

CLASSIFICATION OF PAPER FOR RATE PURPOSES 173

Applicability to advances 173 The class-of-paper question 174 Maturities 174Character of paper; preferential rates 174 Frequency of borrowing; progressive rates 175

Statutory basis for credit 176 Nature of borrower 177 Purpose of credit 178

TIME AND MANNER OF DETERMINATION 179

COMPUTATION 180

RELATION TO CREDIT POLICY

THE EARLY YEARS: ACCOMMODATION OF CREDIT NEEDS 181

THE 1930's: PREVENTION OF SPECULATION 182

SINCE 1951: AN INSTRUMENT OF CREDIT CONTROL 185

xill


-History^Pot the $-Lending


GENERAL PRINCIPLES: A SUMMARY

STATUTORY AND REGULATORY BASIS 189

ACCOMMODATION OF COMMERCE, INDUSTRY, AND AGRICULTURE 190

THE REAL-BILLS DOCTRINE: AN ABANDONED PRINCIPLE 191

MAINTENANCE OF SOUND CREDIT CONDITIONS 192

INAPPROPRIATE USES OF FEDERAL RESERVE CREDIT 193

Speculation or investment 193 Use for profit 193 Continuous borrowing 194Shift in emphasis 194

APPROPRIATE USES OF FEDERAL RESERVE CREDIT 195

Short-term adjustment credit 195 Seasonal credit 196 Emergency credit 196

LENDER OF LAST RESORT 197

PROTECTION OF RESERVE BANKS 197

DISCRETION OF FEDERAL RESERVE BANKS 198

Legislative intent 198 Recognition by the Board 200 Judicial confirmation 200Quasi-automatic access to Federal Reserve credit 200

THE BASIC PRINCIPLE: ECONOMIC STABILITY AND GROWTH 201

xiv


History.3 of thefLending

Functions

APPENDIXES

TEXTUAL CHANGES IN PROVISIONSOF THE FEDERAL RESERVE ACT

203

REGULATION A AS CURRENTLY IN EFFECT

237

REGULATION C AS CURRENTLY IN EFFECT

241

RIGHTS AND LIABILITIES OFFEDERAL RESERVE BANKS

WITH RESPECT TO DISCOUNTED PAPER

245

NOTES AND REFERENCES249

INDEX267

XV


Introduction

STATEMENT OF OBJECTIVEMany scholarly treatises have been written

about the Federal Reserve System. In general,they have dealt with the System's vital functionsin the field of monetary and credit policy orwith its important responsibilities in the field ofbank regulation and supervision. Writers onthe subject have, of course, referred to theprovisions of Federal law under which theSystem operates, but usually—and naturally—any such references have been only incidental,or at least secondary, to economic or bankingconsiderations. This study is based on the re-verse approach. It is not primarily concernedwith economic and banking considerations (thewriter is neither an economist nor a banker);it is concerned primarily with legal considera-tions, and any references that must be made toeconomic and banking matters are purely inci-dental and secondary.

In brief, the strictly limited objective of thisstudy is to trace the legal history of the lendingfunctions of the Federal Reserve Banks: thenature of the original statutory authority of theFederal Reserve Banks to make loans; thereasons for which that authority was given tothe Reserve Banks by Congress; how and whythe authority has been changed, expanded, or

For NOTES AND REFERENCES, see p. 249.

modified by subsequent statutes; the nature ofregulations on this subject that have been issuedby the Board of Governors of the Federal Re-serve System (generally referred to as the Fed-eral Reserve Board, or the Board); how theBoard has interpreted the law; and how the lawhas been construed and applied by the courts.

Warned by this prospectus, the non-lawyermay, forgivably, wish to read no further. Muchof what follows may be regarded as technicaland therefore dull. Perhaps only a few willshare the writer's feeling that the legal develop-ment of the lending authority of the FederalReserve Banks is in many respects an intenselyinteresting subject. In any event, it is con-ceivable that some useful purpose may beserved by this historical discussion of thestatutes, regulations, interpretations, and courtdecisions that lie behind and are directly relatedto the important part that the lending functionsof the Reserve Banks have played in the econ-omy of the Nation for some 60 years.

DISTINCTION BETWEENRESERVE BANK LOANS ANDCOMMERCIAL BANK LOANS

It is essential to preface this study with abrief indication of the differences between loansthat are made by the Federal Reserve Banksand those made by ordinary commercial banks.


2 HISTORY OF LENDING FUNCTIONS

In the first place, there are differences in themanner in which Federal Reserve Banks andcommercial banks are organized and in thepurposes for which they are operated. A com-mercial bank may be organized by a few indi-viduals either as a State bank or as a nationalbank, depending upon whether the organizerschoose to comply with the requirements of theapplicable State banking laws or with those ofthe National Bank Act, a Federal statute origi-nally enacted in 1863. Consequently, the num-ber of commercial banks is limited only by theinclination of individuals to organize them andby the willingness of the State banking authori-ties—in the case of State banks—and of theComptroller of the Currency—in the case ofnational banks—to approve their organization.Like other private ventures, the number of suchbanks is influenced by public demand for theirservices and by the forces of competition. As ofDecember 31, 1972, there were 13,928 com-mercial banks in the United States.

In contrast, the Federal Reserve Banks wereestablished by a 1913 Act of Congress knownas the Federal Reserve Act, and under that Acttheir number was limited to 12, each ReserveBank serving a geographical district of thecountry. AH national banks in the UnitedStates are required to be stockholders; banksorganized under State laws may voluntarilybecome stockholders, subject to approval bythe Board of their applications for membershipin the Federal Reserve System. As of December31, 1972, there were 5,705 commercial banksthat were members of the System; of these,4,613 were national banks and 1,092 wereState member banks.

Any individual or corporation may be astockholder of a commercial bank; the stock ofsuch banks normally is acquired for purposesof investment or control. The return on aninvestment of this kind depends in large partupon the earnings received by the bank on itsloans and investments. Stock of a FederalReserve Bank, on the other hand, is not ac-quired as an investment or for control. Theownership of such stock is merely a prerequisiteto membership in the Federal Reserve System.

The stock pays only a fixed statutory dividend,regardless of the earnings of the Reserve Bank.It does not entitle member banks to all therights that usually appertain to ownership ofstock in private corporations. If a Reserve Bankshould be liquidated, all of its assets—afterpayment of debts, accrued dividends, and theamounts paid in by member banks on theirstock subscriptions—would become the prop-erty of the United States. Moreover, althoughmember banks are authorized by the law toparticipate in the election of six of the ninedirectors of a Federal Reserve Bank, the affairsof the Reserve Bank arc administered by itsdirectors under the supervision of the Board ofGovernors of the Federal Reserve System, anindependent Government agency.

From these differences between commercialbanks and Federal Reserve Banks stems oneof the fundamental distinctions between com-mercial bank loans and Reserve Bank loans.Commercial banks make loans for profit—to allcomers and for all conceivable purposes. Al-though loans made by the Federal ReserveBanks bear interest, they arc made not forprofit but for a public purpose; in general theyarc made only to banks that arc members ofthe Federal Reserve System. It is for this reasonthat the Reserve Banks have often been calledbankers' banks.

Quite apart from differences in organizationand purpose, an important distinction betweenloans made by Reserve Banks and those madeby commercial banks is that the lending opera-tions of the Reserve Banks, often referred toas the Federal Reserve discount window, con-stitute a channel through which Federal Reservecredit policies can be implemented. When aReserve Bank makes a loan to a member bank,the result is an increase in the reserves thatthe member bank carries with its ReserveBank. Consequently, the member bank hasmore funds with which to extend credit to itsown customers. Without attempting an explana-tion here, a Reserve Bank loan to a memberbank makes possible a multiple expansion ofcredit the degree of which depends upon thepercentage of required reserves against de-


INTRODUCTION

posits prescribed by the Federal Reserve Boardat the time. It is for this reason that creditcreated by Federal Reserve action, whether ex-tended through the discount window or throughpurchases of securities in the open market, issometimes referred to as "high-powered"dollars.

As just indicated, Federal Reserve credit canbe provided to the banking system throughpurchases by the Reserve Banks of Govern-ment obligations and other securities in theopen market. Open market operations of theReserve Banks, however, are conducted atthe initiative of the Reserve Banks under the di-rection of the Federal Open Market Committee.They do not come within the scope of this studysince we are concerned here only with the creditextended by the Reserve Banks to memberbanks—and other borrowers—because of theborrower's need for credit and at the borrower'sinitiative.

The Reserve Banks also in effect extendcredit to their member banks when they givecredit to member banks for checks—in ac-cordance with the Federal Reserve Banks' timeschedule—before the amount of the checksis actually received by the collecting ReserveBank. This form of Federal Reserve credit isknown as "float." Again, however, it is notwithin the scope of this study.

SIGNIFICANCE OF RESERVEBANK LOANS

A discussion of the nature and purposes ofthe Federal Reserve System is beyond the scopeof this study. In general, as indicated in thepreamble to the Federal Reserve Act, it may besaid that the System was the outgrowth of afeeling that the country's financial system re-quired a more elastic currency, a better mobi-lization of bank reserves, and more effectivesupervision of commercial banks. It is quiteclear, however, that the so-called discount pro-visions of the Federal Reserve Act have beenregarded as among its most important provi-sions and that access to the credit facilities ofthe Reserve Banks continues to be the chief

reason for membership in the Federal ReserveSystem.

The Federal Reserve Act was based in largepart upon an intensive study of the bankingsystem made by a National Monetary Commis-sion appointed by Congress. In its final reportof January 9, 1912,1 that Commission listed17 defects in the then-existing banking system.Six of them related to the need for a widermarket for commercial paper. The Commissiondeplored the lack of adequate means availableto commercial banks for replenishing their re-serves or increasing their lending powers, the"congestion of loanable funds in great centers,"the inability of farmers and others to secure thecredit they required, and the "marked lack ofequality in credit facilities between differentsections of the country."

Congress concurred in the Commission'sopinion that the lending authority of the pro-posed Federal Reserve Banks was of paramountimportance. The House Banking and CurrencyCommittee referred to the creation of a marketfor commercial paper as one of the "essentialfeatures of reform" - and stated that the dis-count function was the "fundamental businesspurpose" of the legislation.3 The House com-mittee felt that the new legislation would "en-tirely transform the conditions under whichpaper is bought and sold, loans contractedbetween banks, and funds transferred from onepart of the country to another." 4 The SenateBanking and Currency Committee was unani-mous in its opinion that one of the fundamentalsof the legislation was "the promotion of an opendiscount market."a During the debates on thebill, one Congressman referred to the discountsection as "the most important section of thebill."6 This feeling was reflected by the factthat the preamble of the Act, as finally passed,stated that one of its purposes was "to affordmeans of rediscounting commercial paper."

The importance of the lending or discountfunctions of the Federal Reserve Banks hasvaried from time to time since 1913, dependingupon prevailing economic conditions. In theearly years of the System, these functions hadall of the significance envisaged by the framers


HISTORY OF LENDING FUNCTIONS

of the Federal Reserve Act. During the 1920'sthey were particularly important as a means ofmeeting the credit needs of agriculture; andduring the economic depression of the early1930's, they were instrumental in meeting therequirements of business enterprises. There-after, for a long period, the lending authorityof the Federal Reserve Banks dwindled inimportance. Between 1951 and 1959 there wassome increase in the use of the discount win-dow. Since 1959 member banks have madelittle use of their privilege of borrowing fromthe Reserve Banks except during periods ofunusual stringency, as in the early weeks of1973 when daily-average borrowings by mem-ber banks reached the highest level since the1920's. Nevertheless, despite such marginal andperiodic use of the discount window, it consti-tutes an ever-available source of short-termcredit to member banks that cannot always beprovided from other sources and it can still beused as an important, even though secondary,instrument for the effectuation of Federal Re-serve credit policies.

SCOPE OF THIS STUDYThe provisions of the original Federal Re-

serve Act regarding loans by the Federal Re-serve Banks were relatively brief. In a fewparagraphs, section 13 of the Act merely au-thorized the Reserve Banks to discount fortheir member banks commercial paper withmaturities of not more than 90 days, agricul-tural paper with maturities of not more than6 months, and bankers' acceptances arisingfrom import or export transactions with ma-turities of not more than 3 months. Over theyears these original provisions have been ex-panded and supplemented by numerous amend-ments to the law. In 1916, acceptances growingout of domestic shipments and the storage ofstaple goods, as well as dollar-exchange accept-ances, were made eligible for discount, and thesame act authorized the Reserve Banks to make15-day advances to member banks on their ownnotes secured by eligible paper or Governmentbonds. The Agricultural Credits Act of 1923

substantially expanded the authority of the Re-serve Banks to discount agricultural paper. In1932, Congress conferred upon the ReserveBanks new authority to make emergency dis-counts for individuals, partnerships, and cor-porations, and to make advances to memberbanks on any satisfactory security, although ata penalty rate of interest. In 1933, direct ad-vances to individuals, partnerships, and cor-porations on the security of Government obliga-tions were authorized, and the maturity ofadvances to member banks on eligible paperwas increased to 90 days. The reasons forthese and many other amendments to the dis-count provisions of the statute, as reflected incommittee reports and congressional hearingsand debates, arc one of the major subjects ofthis study.

The statutory history of the provisions of theFederal Reserve Act relating to Reserve Bankloans is embodied in Appendix A to this study.By reference to that appendix, one may deter-mine how a particular provision read in theoriginal Federal Reserve Act or when it wasadded to that Act by subsequent statute, exactlyhow the language of the provision has beenchanged, if at all, by later enactments of Con-gress, and how the provision reads today.

Along with the development of the statutoryauthority of the Reserve Banks in the lendingfield, the Federal Reserve Board, acting underauthority conferred by the law, has been calledupon to issue, modify, and revise regulationsgoverning the exercise of that authority. TheBoard's first regulation related to this subjectand, although it has been changed many times,it is still identified as Regulation A. With eachmajor change in the law, the regulation hashad to be modified in one or more respects.Sometimes the regulation has been changed toeliminate or relax certain regulatory require-ments. On a few occasions, changes have beenmade to reflect shifts in Federal Reserve policyas to the appropriate use of the discount win-dow. An account of these regulatory changesforms another part of the present study. Thetext of the Board's present Regulation A, assubstantially revised in 1973, is set forth in


INTRODUCTION

Appendix B; the related provisions of Regula-tion C, regarding bankers' acceptances, consti-tute Appendix C.

In addition to regulations, the Board fromtime to time has issued interpretations of theprovisions of the law with regard to the dis-counting authority of the Federal ReserveBanks. Most of them have been published inmonthly issues of the Federal Reserve Bulletin.Board rulings on this subject were especiallynumerous during the 1920's when extensive usewas made by member banks of the discountfacilities of the Reserve Banks. Such rulingsconstitute an important aspect of a legal historyof the lending functions of the Reserve Banks.

In a few instances the discount provisions ofthe Federal Reserve Act have been the subjectof judicial interpretation, and to that extentcourt decisions are also embraced within thescope of this history. During the early years ofthe System, the Reserve Banks were involved inlitigation growing out of questions as to thelegal rights and liabilities of parties to paperdiscounted with the Reserve Banks, and whilethese cases related chiefly to the general law ofnegotiable paper and not to the construction ofprovisions of the Federal Reserve Act, they arebriefly summarized in Appendix D.

It is with all of these phases of the legaldevelopment of the lending authority of theFederal Reserve Banks that the present study isconcerned. Obviously, they impinge upon theeconomic aspects of the subject. It would bemost unrealistic to ignore the fact that thepurposes of the Federal Reserve Act wereessentially of an economic nature and thatchanges in the law have been occasioned bychanges in economic conditions or economicthinking. For example, it was a drop in farmprices following World War I and an acutedemand for agricultural credit that led toamendments to the statute in 1923 to liberalizethe authority of the Reserve Banks to discountagricultural paper. It was a movement to pro-mote foreign trade that led to a broadeningof the authority to discount bankers' accept-ances; and it was the depression of the early1930's that prompted drastic amendments to

the law to provide Federal Reserve credit tononmember banks and business enterprises.Moreover, the fixing of discount rates has longbeen recognized as one of the three majorinstruments through which the Federal ReserveSystem effectuates national credit and monetarypolicies.

Nevertheless, as has already been indicated,it is the aim of this study to tell the story of thedevelopment of the lending functions of theFederal Reserve Banks from the lawyer's ratherthan the economist's point of view, with em-phasis upon statutory provisions and theirlegislative history, regulations, rulings of theBoard, and court decisions. If anything herewritten suggests an opinion as to economic orcredit policy, it is wholly unintentional and, inany event, incidental.

It should be borne in mind that this study isintended to be a history of the System's lendingactivities. As such, it is not limited to presentlaw and regulations; it covers all enactmentsof Congress since 1913 and all regulations andpublished rulings issued by the Board sincethat time, even though many of them werelater repealed, revoked, or superseded. Forexample, all of Chapter 11 relates to workingcapital loans to business under a section of thelaw that was added in 1934 and repealed in1959.

ARRANGEMENTA strictly chronological account of the de-

velopment of the lending functions of the Fed-eral Reserve Banks would be disconnected,complicated, and confusing. At the same time,it seems desirable to show how these functionshave gradually expanded over the years. Ac-cordingly, whether rightly or wrongly, thewriter has compromised between a chronologi-cal and a topical treatment of the subject. Eachmajor aspect of the lending authority of theReserve Banks is dealt with in a separatechapter according to the type of loan involved,although the chapter may cover the entireperiod of the System's existence, but the topicsof the various chapters are arranged roughly inthe order in which they assumed importance



chronologically. Thus, while advances on Gov-ernment bonds were authorized in 1916, itwas not until 1932 that advances to memberbanks—as distinguished from discounts ofeligible paper—attained real significance; con-sequently, the chapter dealing with such ad-vances follows those dealing with agriculturalcredits and bankers' acceptances.

In the two chapters immediately followingthis introductory chapter consideration will begiven to the general nature and purposes of thediscount provisions of the original Federal

Reserve Act and to certain general limitationsimposed on the lending authority of the FederalReserve Banks. The 10 succeeding chaptersdeal with the different categories of loans madeby the Reserve Banks, some of them no longerof great significance and some no longer evenauthorized by present law. The study concludeswith chapters covering discount rates and therelation of the discount mechanism to nationalcredit policy and, Anally, with a summary ofgeneral principles governing the extension ofFederal Reserve credit.


The Original Discount Provisions

LEGISLATIVE HISTORY

DEVELOPMENT OFTHE FEDERAL RESERVE ACT

With its final report of January 9, 1912, theNational Monetary Commission submitted adraft of proposed legislation that became knownas the "Aldrich bill," after the name of theCommission's Chairman, Nelson Aldrich. Thatbill would have provided for a National ReserveAssociation with authority to rediscount paperfor commercial banks. Although the Commis-sion's plan for a central authority was laterdiscarded in favor of a regional system of Fed-eral Reserve Banks, the essential feature of itsplan—the discounting of paper issued or drawnfor "agricultural, industrial, or commercial pur-poses"—was carried over into the Federal Re-serve Act.

The bill that was eventually enacted, thoughwith many changes, was H.R. 7837. It wasintroduced by Chairman Carter Glass of theHouse Banking and Currency Committee onAugust 29, 1913. Often referred to as the


"Glass bill," it was reported by the HouseBanking and Currency Committee on Septem-ber 9, 1913, and it was passed by the Houseon September 18.

The Senate Banking and Currency Commit-tee split into two sections. On November 22,1913, it reported two bills without recommen-dation. The Democratic section, headed byChairman Owen, reported a bill that generallyfollowed the Glass bill, although with someimportant differences. The Republican section,led by Senator Hitchcock, submitted a separatedraft that became known as the "Hitchcockbill." On December 1, a substitute bill wasoffered on the floor of the Senate by SenatorOwen. It was generally similar to the originalOwen bill, but it included some features of theGlass bill. It was passed by the Senate onDecember 19.

With some changes, the Owen substitute billwas adopted by the conference committee. Theconference report was agreed to by the Houseon December 22 and by the Senate on Decem-ber 23. On the latter date the bill became lawwith President Wilson's signature.



DIFFERENCES AMONG THEDISCOUNT PROVISIONS OFVARIOUS BILLS

Insofar as the discount provisions were con-cerned, the general objectives of all of thecompeting bills were the same. All of themauthorized the proposed Federal ReserveBanks to discount for member banks paperarising out of commercial transactions, and allprovided for the discounting of acceptancesdrawn to finance the importation or exportationof goods.

In certain respects, however, the Glass,Owen, Hitchcock, and Owen substitute billsreflected differences, some of a minor natureand some that gave rise to sharp debate andcontroversy.

The principal differences related to (1) thegeneral maturity of paper eligible for discount,(2) the kinds and maturities of bankers' ac-ceptances that might be discounted, (3)whether member banks should have a right toobtain discounts, and (4) whether advancesmight be made on any satisfactory securities.

With regard to maturity, the Glass bill fixeda maximum of 90 days, but with permissionfor the discounting of paper with maturities offrom 90 to 120 days in certain circumstances.The Owen bill prescribed a maturity of notmore than 90 days, without any exceptions.The Hitchcock bill would have allowed maturi-ties of up to 120 days, provided that not morethan half the paper discounted for any memberbank had a maturity of more than 90 daysand provided also that no member bank hadmore than $200,000 of rediscounts with ma-turities longer than 90 days.

With respect to bankers' acceptances, theGlass bill permitted only the discounting ofacceptances growing out of the importation orexportation of goods, whereas the Owen andHitchcock bills would have also covered ac-ceptances drawn to finance domestic shipmentsof goods. On the other hand, the Glass billwould have permitted 6-month maturities foracceptances, whereas the Owen bill would havelimited such maturities to 3 months and theHitchcock bill would have fixed a 6-monthmaximum for acceptances arising from the

importation or exportation of goods and a4-month maximum for those arising from do-mestic shipments.

The Hitchcock bill would have given a mem-ber bank an absolute right to obtain discountsup to the amount of its capital stock. Under theother bills, the discounting of paper was leftto the discretion of the Reserve Banks, althoughthe Owen bill contained a provision that re-quired the Reserve Banks to extend credit withdue regard "for the claims and demands ofother member banks."

The Owen and Hitchcock bills would haveauthorized advances on the direct obligationsof member banks secured by satisfactory securi-ties, and this authority was in the bill as itpassed the Senate. No such authority was con-tained in the Glass bill.

RESOLUTION OF DIFFERENCESIn one way or another, these differences

were eventually resolved. As to maturity, theconference committee adopted the flat 90-daymaximum of the Owen bill, but with an excep-tion of 6 months for agricultural paper. Au-thority to discount bankers' acceptances waslimited, as in the Glass bill, to those arisingfrom foreign shipments. The compulsory dis-count proposal and the suggestion for directadvances on satisfactory securities were bothrejected, but only after considerable debate.As will be seen later in this study, some ofthese matters were reconsidered by Congressin the years that followed. For example, theproposal to authorize bankers' acceptances cov-ering domestic shipments was adopted in 1916,and many years later, in 1932, Congress finallyauthorized direct advances to member bankssecured "to the satisfaction" of a Federal Re-serve Bank, but only with a penalty rate ofinterest.

THE FINAL PROVISIONSIn its final form, the original Federal Reserve

Act gave the Federal Reserve Banks authority:(1) to discount for their member banks paperarising out of actual commercial transactions,that is, paper issued or drawn for agricultural,industrial, or commercial purposes, with the


ORIGINAL DISCOUNT PROVISIONS

definition of such paper left to the determinationof the Federal Reserve Board; (2) to discountbankers' acceptances based on the importationor exportation of goods; and (3) to rediscountthe discounted paper of other Federal ReserveBanks if permitted or required by the FederalReserve Board.

Limitations on this authority were imposedas follows: (1) Discounted paper was requiredto be endorsed by the discounting memberbank, with a waiver of demand, notice, andprotest; (2) paper discounted was required tohave a maturity at the time of discount of notmore than 90 days, except that a maturity ofnot more than 6 months was allowed for agri-cultural paper and of not more than 3 monthsfor bankers' acceptances; and (3) the aggregateamount of paper of any one borrower dis-counted for a member bank was limited to10 per cent of the member bank's capital andsurplus.

All discounts were made subject to suchregulations, limitations, and restrictions asmight be prescribed by the Federal ReserveBoard. Discount rates were required to beestablished from time to time by each FederalReserve Bank, subject to review and determina-tion by the Board.

Incidental provisions of the Act authorizedmember banks to accept paper growing out ofthe importation or exportation of goods and

amended the National Bank Act to except fromthe limitations imposed on the aggregate in-debtedness of national banks any liabilities"incurred under the provisions of the FederalReserve Act," that is, liabilities incurred onpaper discounted with the Federal ReserveBanks.

Finally, in section 4 of the original FederalReserve Act, the board of directors of eachFederal Reserve Bank was required to adminis-ter the affairs of such Bank "fairly and im-partially and without discrimination in favorof or against any member bank" and to extendto each member bank such discounts, advance-ments, and accommodations as might be"safely and reasonably made with due regardfor the claims and demands of other memberbanks."

These were the discount provisions of theoriginal Federal Reserve Act. Essentially, theyconstitute the basis for the lending powers ofthe Reserve Banks today, except for the im-portant additions in later years of authority tomake advances to member banks on the securityof Government obligations or on any papereligible for discount or for purchase by theReserve Banks, authority to make advances tomember banks at a penalty interest rate on anysatisfactory security, and authority to extendcredit in exceptional circumstances to indi-viduals, partnerships, and corporations.

BASIC PURPOSES

CREATION OF A MARKET FORCOMMERCIAL PAPER

One of the basic purposes of the originalFederal Reserve Act, as stated in its preamble,was "to afford means of discounting commercialpaper." The National Monetary Commissionhad emphasized the need for a wider marketfor commercial paper. The House Banking andCurrency Committee, in its report on the Fed-eral Reserve bill, stated that the first funda-mental feature of reform was: *

Creation of a joint mechanism for the ex-tension of credit to banks which possess soundassets and which desire to liquidate them forthe purpose of meeting legitimate commercial,agricultural, and industrial demands on thepart of their clientele.

Similarly, the Senate Banking and CurrencyCommittee asserted that one of the chief pur-poses of the legislation was to "make availableeffective commercial credit for individuals en-gaged in manufacturing, in commerce, in



finance, and in business to the extent of theirjust deserts"; the committee also referred to thefundamental necessity of "establishing an openmarket for liquid commercial bills, by providingthrough the reserve banks a constant and un-failing market for such bills at a steady rate ofinterest." 2

PREVENTION OF PANICSWith the financial panic of 1907 still fresh

in their minds, various Congressmen repeatedlyexpressed the view that the discounting author-ity of the Federal Reserve Banks would serve toprevent the recurrence of similar panics. Thus,in the House, it was alleged that the FederalReserve bill would provide banks with "sourcesof strength" in times of stress.' In the Senate,likewise, Senator Swanson regarded the bill asone that made "impossible another panic inthis country." *

EXPANSION OF BUSINESSThe market for commercial paper provided

by the bill was considered to be not only aprophylactic against panics but also a meansof enabling banks in normal times to expandtheir business. Congressman Phelan stated: c

* * * In times of stress, when a bankneeds cash, it can obtain it by a simple processof rediscounting its paper with the Federalreserve banks. Many a bank will thus beenabled to get relief in time of serious need.Moreover, if a bank desires to expand itsbusiness, it may do so far beyond its presentcapacity by this rediscounting process. Sup-pose, for instance, a bank has $1,000,000 indeposits and $120,000 in reserves. Under suchconditions the bank can not further extendits loans because of the legal-reserve require-ments. Under such circumstances, by taking$12,000 of its paper to the Federal reservebanks and rediscounting it, it can increase itsreserves by $12,000. An increase in its re-serves of $12,000 increases its loaning powerby $100,000. By this very simple process thebank is enabled to increase its loans and ex-tend its accommodations to its patrons.

It is significant to note from this statement thatthe expansionary effect of Federal Reserve

credit was recognized. In fact, some Congress-men feared that the discount provisions of thebill would be inflationary. Chairman CarterGlass of the House Banking and CurrencyCommittee agreed, but contended that it wouldbe a "wise expansion." °

BENEFIT TO COUNTRY BANKSIt was felt that the creation of a market for

commercial paper through the rcdiscountingauthority of the Reserve Banks would particu-larly benefit the country banks. There weresome, it is true, who doubted this and believedthat country banks had very little paper thatthey could discount and that, therefore, therediscount provisions would be "valueless" tothem.7 The majority, however, were convincedthat these provisions would result in the crea-tion of a "competitive money market for thecountry banks"; such a market would eliminatethe necessity for country banks to go to NewYork for funds and thereby tend to reduceinterest rates." It was contended that the redis-count section of the bill would "come to therelief of every small bank in the United States,"that it would "break down the tyranny of themoney power in the great centers," " and thatthe small banker, having the same discountfacilities as the big bank, would "be freed fromhis dependency upon the big banks and beable to serve his customers according to hisown judgment, subject only to reasonablesupervision by the Government board." 10

It was recognized that the traditional reluc-tance of banks to borrow would need to beovercome. The House committee noted thatsuch a prejudice had "more or less artificiallysprung up." " Mr. Phelan conceded that bankswere "very much averse" to discounting theirpaper with other banks and that such redis-counting had been regarded as "a sign of weak-ness"; but he believed that with the enactmentof the Federal Reserve Act, rediscountingwould be regarded, "as it should be, as anordinary and proper part of a bank's busi-ness." >2 Similarly, Senator Norris felt that theprejudice of bankers against rediscountingpaper would pass away, and Senator Smootexpressed the view that while the change would


ORIGINAL DISCOUNT PROVISIONS I I

be gradual, the feeling about rediscountingwould be "changed materially" if the bill shouldbecome law.13

LESSENING OF SPECULATION

There was a general feeling at the time of theoriginal Federal Reserve Act that the creationof a market for commercial paper through therediscounting authority of the Federal ReserveBanks would have the incidental advantage oftending to lessen speculation. Thus, the Na-tional Monetary Commission had described oneof the defects of the banking system as fol-lows: "

The narrow character of our discount mar-ket, with its limited range of safe and profit-able investments for banks, results in sendingthe surplus money of all sections, in excess ofreserves and local demands, to New York,where it is usually loaned out on call on StockExchange securities, tending to promote dan-gerous speculation and inevitably leading toinjurious disturbances in reserves. * * *

Senator Owen explained how the absence ofa ready discount market had led to the use ofbank funds for stock speculation: ™

Mr. President, one of the most far-reachingresults which will follow will be the abate-ment of the nuisance of the national menaceof the stock-gambling operations in this coun-try, because this measure proposes to gradu-ally withdraw these reserves, which haveheretofore been pyramided in the three greatcentral reserve cities. I call the attention ofthe Senate to the peculiar situation in whicha banker in a Federal reserve city finds him-self. * * * He has no great public utilitybank in this country to which he can go forcredit. He has no open discount market inthis country. He can not convert quickly intocash his liquid commercial bills. The onlyplace that he can get his resources quicklyin cash is upon the stock market. Thereforethese men have been forced by the conditionssurrounding them to lend money by hundredsof millions upon the stock exchange. * * *

It was expected that the ability of banks toobtain credit from the Reserve Banks wouldhelp to halt the use of bank funds for specula-

tion in stocks. In addition, however, it wasdeemed desirable that the new law include anexpress prohibition against the rediscount bythe Reserve Banks of paper drawn for thepurpose of trading in stocks. All of the prin-cipal bills involved in the evolution of theFederal Reserve Act contained a provision tothe effect that paper eligible for discount shouldnot include notes or bills "issued or drawn forthe purpose of carrying or trading in stocks,bonds, or other investment securities." In theSenate, an exception was made, for obviousreasons, with respect to bonds and notes of theUnited States. With this sole exception, theinjunction against discounting paper drawn forstock investment purposes became, and hasever since remained, a qualification on the dis-count authority of the Federal Reserve Banks.

It was emphasized in the debates on theoriginal Act that this provision had the effectof "withdrawing the privilege of the act fromstock-exchange transactions." 16 The provisionwas referred to as "one of the splendid provi-sions of the bill." " It was regarded as pro-hibiting "the resources of these reserve banksbeing used for the purposes of stock specula-tion." »

ELASTIC CURRENCY

In addition to its deterrent effect on specula-tion, the creation of a market for commercialpaper was regarded as having a direct relationto another stated purpose of the Federal Re-serve Act, namely, "to furnish an elastic cur-rency." It was expected that member bankswould obtain currency from the Federal Re-serve Banks by discounting short-term commer-cial paper. As such paper was paid off, thecurrency would automatically return to theFederal Reserve Banks, thus causing theamount of currency in circulation to fluctuatewith the varying needs of business, agriculture,and commerce.

Mr. Phelan explained the relation betweenthe proposed discounting of commercial paperand the elasticity of Federal Reserve notes asfollows: I!)

Based upon commercial paper as security,these notes increase and decrease with the



demands of commerce. As more currency isneeded the want is supplied by the deposit ofmore commercial paper as security and theissuance of more notes. As all this paper isof short maturity, other commercial papermust in a short time be deposited as securityin the place of the paper which matures. Asbusiness slackens the amount of commercialpaper diminishes and Federal reserve bankswill return Federal reserve notes to be de-stroyed instead of putting up new commercialpaper as security.

At another point during the House debates,Mr. Beakes explained how the elastic qualityof a Federal Reserve note was expected tooperate: 20

* * * Its elasticity is secured in this way:It is issued to a bank needing it when theypresent as much of their current paper to berediscounted as they call for in currency. Allof the paper so discounted matures within90 days, and so within 90 days as muchmoney will be back in the reserve banks aswas issued in currency. * * * Thus is elas-ticity secured in the currency of each localcommunity and the volume of currency out-standing expands and contracts as the busi-ness needs of each community require.

A similar concept was expressed in theSenate by Senator Hollis: 21

* * * They [the Federal Reserve Banks]may rediscount for member banks promissorynotes, based on genuine commercial paper,which are payable in 90 days. * * *

Loans and rediscounts for member bankswill ordinarily be made from the funds de-posited as reserves and by the Government,but if funds are getting low any reserve bankmay apply to the reserve agent for the dis-trict for reserve notes. * * *

The Federal reserve board will pass uponthe application for reserve notes and, if itapproves the application, the reserve agentwill deliver to the reserve bank United States

reserve notes to the face of the commercialpaper put up with him as collateral.

The transaction will then stand as follows:A member bank has obtained currency

from its reserve bank by rediscounting com-mercial paper. * * *

The reserve bank has replenished its fundsby putting up with the reserve agent, say,$100,000 in amount of commercial paper,and has received $100,000 in United Statesreserve notes. These reserve notes are loanedto it by the Government, and it may holdthem, loan them, or invest them. In this waythe currency is expanded, but no faster thanthe needs of business require, as shown by theamount of commercial paper offered for re-discount.

The commercial paper put up with the re-serve agent as collateral for the reserve noteswill become due from time to time, and thepayers will transmit the funds through themember banks and the reserve banks in gold,reserve notes, or lawful money to the reserveagent. He will take the cash, surrender theparticular piece of collateral, and lock theproceeds up for future transactions.

SECONDARY OBJECTIVESWhile it is proper to say that the primary

objective of the original discount provisionswas to provide a wider market for commercialpaper that would meet the credit needs of busi-ness and at the same time tend to lessen specu-lation and contribute to an elastic currency, itshould also be borne in mind that the discountprovisions of the original Federal Reserve Acthad two secondary but important objectives.One was to afford special credit assistance tofarmers; the other was to encourage foreigntrade by establishing a market for bankers' ac-ceptances. Both of these objectives were clearlyevidenced in the committee reports and con-gressional debates on the original Act. Theywill be discussed in detail in subsequent chap-ters of this study.


General Limitations

MATURITY

INTRODUCTIONThe various types of loans made by the

Federal Reserve Banks will be considered sepa-rately in subsequent chapters, along with thespecial limitations and restrictions placed bythe law upon each type of loan. There are threegeneral limitations, however, that might be dis-cussed before dealing with specific limitationsapplicable to particular kinds of loans. In thefirst place, there are maturity limitations bothwith respect to the discounting of paper and todirect advances; second, there are limitationsas to the amount of the paper of any one personthat may be used as a basis for a FederalReserve loan; and, third, the law requires thatall discounted paper be endorsed by the dis-counting member bank. As a fourth generallimitation, all discounted paper was requireduntil 1970 to be negotiable. Unfortunately, con-sideration of these general limitations willplunge us immediately into some of the mostcomplicated and technical aspects of the lendingauthority of the Reserve Banks.

For NOTES AND REFERENCES, see pp. 249-51.

The first of the general limitations has to dowith the maturity of paper eligible for discountby the Reserve Banks. With but one exception,the original Federal Reserve Act required alldiscounted paper to have a maturity of not morethan 90 days at the time of discount. The singleexception was agricultural paper, which waspermitted to have a maturity of not more than6 months. As will be noted in a later chapter,this exception was made even more liberal in1923. Another exception was provided in 1932when the law was amended to authorize ad-vances to member banks for periods of up to4 months, but only at a penalty rate of interest.In 1934 another amendment provided for work-ing capital loans to business enterprises withmaturities as long as 5 years, but that authorityexpired in 1959.

By and large, the 90-day maturity prescribedby the original Federal Reserve Act has con-sistently been adhered to as the legal limitationon the maturity of all Federal Reserve loans—except discounts of agricultural paper—not onlywith respect to rediscounts of eligible paper butalso with respect to advances to member banks

13



on their secured notes. In actual practice, ma-turities have been even shorter. Following thegeneral principle that member bank borrowingsshould normally be only for the purpose oftemporary adjustments in their reserve posi-tions, extensions of Federal Reserve credit areusually made only for a period of a few days.

In subsequent chapters, more detailed atten-tion will be given to the maturity limitationsimposed on special types of paper. At this pointit is worthwhile to consider briefly why andhow the basic 90-day limitation was adoptedby the framers of the original Federal ReserveAct, subject to the one exception for agricul-tural paper.

REASONS FOR 90-DAYLIMITATION

That the paper to be discounted by theFederal Reserve Banks should be short-termpaper was a corollary of the premise that suchpaper should arise out of actual commercialtransactions. In its report on the original Fed-eral Reserve Act, the Owen section of theSenate Banking and Currency Committee—after observing that, according to Europeanbanking practices, paper based on commercialtransactions of short maturities was regardedas "self-liquidating" and "almost the exactequivalent of cash"—proposed that the ReserveBanks be permitted to discount "commercialbills and acceptances of the qualified liquidclass." 1

The House committee report on the originalAct stated: =

* * * The limitation of business which isproposed in the sections governing redis-counts, and the maintenance of all operationsupon a footing of relatively short time willkeep the assets of the proposed institutions ina strictly fluid and available condition, andwill insure the presence of the means of ac-commodation when banks apply for loans toenable them to extend to their clients largerdegrees of assistance in business.

In addition to enabling the Reserve Banks tomeet demands for credit, a short maturity wasconsidered desirable because the discounted

paper was expected to be the basis for an elasticcurrency. It was conceded that long-term papermight be fully as sound as short-term paper,but it was argued that long-term paper was notso suitable as a basis for an asset currency. Onthe floor of the House, Mr. Borland stated: :I

* * * The asset currency provided for in theGlass bill is secured upon current commer-cial transactions which liquidate themselveswithin a comparatively short time withoutundue pressure on the borrower. The differ-ence between short-time paper and long-timepaper is not the difference in its intrinsicsoundness, but a difference in what the bank-ers call its liquid character.

The critical question was just how shortmaturities should be in order to make the paperliquid. Based on the practice of Europeanbanks, the conclusion was reached that a ma-turity of 90 days was the most reasonable.Senator Shafroth explained: '

* * * When we look around in the historyof the world we find that there arc banks ofthis kind; that is, discount banks; and whenwe find that in England the paper must runonly 28 days, when we find that in France itruns but 26 days, when we find that in Ger-many it does not exceed 90 days, and thatthere is no bank in the world which discountspaper in excess of 90 days, does it not be-come us, in the interest of caution, to say thatuntil it is demonstrated the other way we hadbetter adhere to 90-day paper?

AGRICULTURAL PAPER

It was recognized, however, that a 90-daymaturity requirement might not be adequate inall cases, especially with respect to agriculturalpaper. Hence, in addition to 90-day maturities,the House Banking and Currency Committeeallowed a Federal Reserve Bank to discountpaper with a maturity of up to 120 days pro-vided (1) that its own cash reserve exceededone-third of its outstanding liabilities, otherthan Federal Reserve notes, by an amount fixedby the Federal Reserve Board, and (2) thatnot more than half the paper discounted for


GENERAL LIMITATIONS 15

any particular member bank had a maturityof more than 90 days. The committee felt thatthis provision would "fulfill the requirementsof portions of the country with an extremelylong term of credit." "

In explaining the bill on the floor of theHouse, Chairman Glass sought to refute thecontention that the 90-day maturity require-ment would render the discount provisions ofno use to the farmer. He stated, first, that therehad been some misapprehension as to themeaning of the 90-day provision and explainedthat it did not mean the paper had to have anoriginal maturity of not more than 90 daysbut only that it could not be discounted untilit was within 90 days of maturity; ° and, sec-ond, that even if a country bank at certain sea-sons should find its funds tied up in longer-termpaper, it could take advantage of the 120-dayprovision of the House bill and be in a posi-tion "to take six months' paper as soon as itwas two months old to a Federal Reserve bankand rediscount it."

Nevertheless, there were Congressmen fromthe farm belt who thought that the maturitiesallowed by the Glass bill were not sufficientlylong to accommodate agricultural loans.7 Mr.Norton of North Dakota introduced an amend-ment to increase the normal maturity limitfrom 90 to 120 days and the exceptionalmaturity (when the Reserve Bank would havereserves in excess of one-third of its liabilities)from 120 days to 6 months. His proposal,however, was rejected.8

In the Senate, agitation for a longer maturityfor agricultural paper met with more success.The Owen bill was severe, requiring a 90-daymaturity at the time of discount in all casesand with no exception. The Hitchcock bill,however, was more liberal. It provided that dis-counted paper should have a maturity of notmore than 180 days, with two qualifications:not more than half of the paper discounted forany member bank could have a maturity ofmore than 90 days, and in no case could amember bank have more than $200,000 ofrediscounts with a maturity longer than 90days. By way of justification, Senator Hitch-cock said:"

The six months' paper is just as legitimatelya commercial paper as is the 90-day paper ofthe East, where the processes of manufactur-ing and mercantile business are perfected in90 days, and the man who gives his note for90 days is able to pay it out of the proceedswhich come from the sale of his property, hisstock. In the West the man who buys cattle tofeed during the winter months and borrowsmoney for the purpose of buying them is notable to meet his paper in 90 days, but at theend of six months his paper is liquidated justas naturally, just as fully, and just as freelyas is the mercantile and manufacturing paperof the East. * * *

Proponents of the Owen bill defended the90-day provision of that bill. They argued thateven the country banks would always have asubstantial amount of paper maturing within90 days;10 that a maturity of 90 days had beenfound adequate in Europe;" and that under aspecial provision of the Owen bill, a bankunder certain circumstances could discount itsown 90-day obligations secured by longer-termpaper of farmers.12

These arguments failed to satisfy the farm-belt Senators. They protested that the 90-dayrequirement was discriminatory against thecountry banks and pointed to the fact that thebill allowed a maturity of 6 months in the caseof foreign acceptances."

An amendment to the Owen bill proposedby Senator Hitchcock to increase the requiredmaturity from 90 to 180 days was defeated.11

In the end, however, Senator Owen himselfoffered an amendment to his substitute bill.The amendment, while retaining the basic 90-day limitation, permitted the discounting ofpaper drawn for agricultural purposes or basedon livestock if the paper had a maturity of notmore than 6 months; the amount of such dis-counts was limited to a certain percentage of thecapital of the Federal Reserve Bank, whichpercentage was to be fixed by the FederalReserve Board. This amendment was agreed toby the Senate.15 Subsequently, it was acceptedby the conference committee and became a partof the original Act.



Thus, the net effect was adoption of the 90-day limitation as a general rule, with a moreliberal maturity requirement for agriculturalpaper.

To avoid confusion, it is important to bearin mind—as Carter Glass pointed out in thedebates—that the 90-day limitation applies tothe maturity of paper at the time of discount,not to the original maturity of the paper. Forexample, member banks are authorized to ac-cept drafts and bills with maturities of up to6 months, but bankers' acceptances not drawnfor agricultural purposes are eligible for dis-count by the Reserve Banks only if they havea maturity of not more than 90 days at the timeof discount.

DAYS OF GRACEOnly one slight change has been made in

the 90-day maturity requirement since it wasoriginally enacted. In 1916 the requirementwas modified to exclude days of grace fromthe computation of the 90-day period as well asfrom the longer-maturity requirement applica-ble to agricultural paper.10 The amendment wasmade on the recommendation of the FederalReserve Board, which had pointed out thatsome States provided for days of grace in thepayment of obligations."

REGULATIONSThe Board's discount regulations have never

done more than paraphrase the 90-day require-ment of the law itself. In 1915 the Board'sRegulation B stated simply that, to be eligiblefor discount, commercial paper "must have a

maturity at the time of discount of not morethan 90 days." '" This provision was retainedin a 1916 revision of Regulation A,IB but withan exclusion of days of grace in accordance withthe amendment to the law enacted in that year.A similar provision was contained in RegulationA, as revised in 1955,20 but a footnote statedthat advances to member banks are normallymade for periods of not more than 15 days.That footnote was eliminated in 1968.21 The1973 revision of the regulation provided thatpaper eligible for discount must have "a periodremaining to maturity of not more than 90days." It also eliminated the reference to exclu-sion of days of grace, but this was presumablyin the interest of simplicity and without intend-ing to modify the statutory exclusion of daysof grace.

DEMAND PAPERIn 1917 the Board ruled that demand paper

was not eligible for discount because, at theoption of the holder, it might be held and notpresented for payment until after 90 days.2-This ruling led to an amendment to the law in1923 making demand or sight drafts eligiblefor discount if drawn to finance shipments ofagricultural staples.

In 1966 the Board reconsidered and reversedits 1917 ruling. The Board pointed out that, asa matter of law, demand paper is due and pay-able on the day of issue. Therefore, it con-cluded that such paper satisfies the maturityrequirements of the statute and that, if it meetsother eligibility requirements, demand paper iseligible for discount and as security for ad-vances by the Reserve Banks.23

AMOUNT

AGGREGATE AMOUNTApart from special provisions with respect to

agricultural paper and bankers' acceptances,the Federal Reserve Act has never placed anylimit upon the total amount of credit that may

be extended by the Reserve Banks either to anyone member bank or to all member banks.

The National Monetary Commission hadsuggested in 1912 that, in order to provide asafeguard against possible abuses, the aggregate



amount of paper rediscounted for any bankshould be limited to the amount of its capitalstock.-1 The framers of the Federal ReserveAct, however, apparently believed that dis-counts should be limited only by the amountof short-term commercial paper available fordiscount. Mr. Glass emphatically stated thatno limitation on the aggregate amount thatcould be discounted for member banks wasintended.2'"' As a matter of fact, there weresome who felt that the volume of eligible paperavailable for rediscount might not be sufficientto support the contemplated issuance of Fed-eral Reserve notes.50

Senator Hitchcock, however, was disturbedby the lack of any limit on the amount of paperthat the Federal Reserve Banks might discount.He felt that there was a need for "some auto-matic check" on the amount of discounting andthat, without restraints, excessive discountingmight lead to inflation. He proposed, therefore,that discounts for a member bank in excess ofits capital stock should bear a higher rate ofdiscount and that in no event should a FederalReserve Bank be permitted to discount paperfor a member bank in an amount greater thantwice the amount of the member bank's capitalstock.27 His proposed amendment for this pur-pose was tabled by a close vote of 37 to 31.2"

After the Glass bill had been reported in theHouse, it was discovered that although no limi-tation on the amount of discounts had beencontemplated by the committee, the amount ofpaper that a national bank could rediscountwith a Federal Reserve Bank would neverthe-less be limited to the amount of its capital stockby virtue of the existing provisions of section5202 of the Revised Statutes. That section pro-vided that the aggregate indebtedness of a na-tional bank should not exceed its capital stock,except for certain specified kinds of liabilitiessuch as circulating notes and liabilities to stock-holders for dividends. These provisions of theNational Bank Act would therefore have effec-tively limited the amount of paper that nationalbanks could rediscount with the Federal Re-serve Banks, whereas, as pointed out by Mr.Glass, State banks that became members of theSystem would not be similarly limited. It wasnoted that, actually, national banks would not

be able to discount paper up to even 100 percent of their capital because their liability forthe unpaid part of their subscriptions to FederalReserve Bank stock and also their liability onany acceptances they might make under the newlaw would be liabilities within the meaning ofsection 5202 of the Revised Statutes.29

In order to remove this limitation on theability of national banks to rediscount paperwith the Reserve Banks, an amendment wasintroduced on the floor of the House by Mr.Bulkley ™ to except from the provisions ofsection 5202 of the Revised Statutes "liabilitiesincurred under the provisions of sections 2, 5,and 14 of the Federal Reserve Act"; and aftersome debate the amendment was adopted.31

This provision was not contained in either theOwen bill or the Hitchcock bill as reported inthe Senate; but it was incorporated in SenatorOwen's substitute bill and, with the languagemodified to refer simply to "liabilities incurredunder the provisions of the Federal ReserveAct," it was approved by the conference com-mittee. It is still to be found in existing law.

PAPER OF ONE BORROWER

While the law does not limit the total amountof discounts that may be made by the FederalReserve Banks, it has always included provi-sions restricting the amount of paper of oneobligor that may be rediscounted for any mem-ber bank. It is important to note that thisrestriction relates not to the amount borrowedfrom the Reserve Bank by the member bankitself, but to the amount borrowed from themember bank by a customer of the memberbank.

Section 13 of the original Act provided thatthe aggregate amount of notes and bills bearingthe signature or endorsement of any one person,company, firm, or corporation rediscounted forany one bank should at no time exceed 10 percent of the unimpaired capital and surplus ofthe member bank, but the restriction was madeinapplicable to bills of exchange "drawn in goodfaith against actually existing values."

This general limitation on discounts by theReserve Banks of paper of one person wasconsidered to be in harmony with the then



existing provisions of section 5200 of the Re-vised Statutes prohibiting a national bank fromlending to any one borrower more than 10 percent of the national bank's capital and surplus.However, the exception in the Federal ReserveAct provision for bills drawn against actuallyexisting values was not contained in the nationalbank provision. Describing it as a new featurethat had long been called for in the interest oflegitimate business transactions, the report ofthe House Banking and Currency Committeestated: 3Z

* * * Obviously when a bill of exchange issecured by bills of lading and other docu-ments accompanying it, it is primarily de-pendent for liquidation upon this unques-tionably marketable wealth. There is there-fore no reason for limiting the amount of thediscount to be granted by any reference tothe resources of the person applying for theaccommodation or by the capit-l and surplusof the bank granting the discount, that beingmerely a question of banking judgment, whilethe bill itself is salable and will presumablybe protected at the point where it is pre-sented.

It was soon found, however, that even thegeneral 10 per cent limitation was not in allrespects the same as the limitation imposed bysection 5200 of the Revised Statutes on loansmade by a national bank to one borrower. Sec-tion 5200 limited the amount of a customer'sliability "for money borrowed," whereas underthe Federal Reserve Act a bill otherwise eligiblefor discount was rendered ineligible by the extraor additional endorsement of some third personwho had already borrowed from the memberbank up to the statutory limit, even though theobligor on the bill had not himself borrowedup to the limit. At the Board's suggestion,33

section 13 was amended in 1916 to make thelimitation applicable to the aggregate amountof paper bearing the signature or endorsementof "any one borrower," rather than "any oneperson, company," and so forth, thus bringingit in line with the national bank limitation.31

Another discrepancy arose from the factthat under an exception contained in section5200 of the Revised Statutes, a national bank

could acquire "actually owned" commercial orbusiness paper from the same person in excessof the 10 per cent limitation, while a FederalReserve Bank under section 13 of the FederalReserve Act could not rediscount such paperunless it consisted of bills of exchange drawn"against actually existing values." ••" The Boardin 1916 suggested to Congress that this provi-sion of section 13 be amended to except actuallyowned commercial and business paper, as wellas bills of exchange drawn against actuallyexisting values.-10 This suggestion was not actedupon at that time. In 1917, however, whencertain provisions of section 9 of the Act werebeing revised to make membership of Statebanks more attractive, a new provision wasinserted in that section that conformed to theBoard's recommendation. According to thisprovision, State banks joining the System wouldretain their full charter and statutory rightsunder State law, provided in general that noFederal Reserve Bank could discount for aState member bank any paper of any personwho had borrowed from such bank an amountgreater than 10 per cent of the bank's capitaland surplus. However, there were two excep-tions: Bills drawn against actually existingvalues or against actually owned commercial orbusiness paper were not to be considered asborrowed money."

While this amendment met the Board's pointas to the exception of actually owned businessor commercial paper, it nevertheless gave riseto a conflict between the new provision insection 9—applicable only to State memberbanks—and the old provision of section 13—applicable ostensibly to all member banks butactually only to national banks—with nationalbanks gaining an unintended advantage overState member banks. This advantage arose forthe following reasons.

Under section 5200 of the Revised Statutes,a national bank could make loans to a singleborrower in excess of the general 10 per centlimit by discounting certain exceptcd types ofpaper described in that section, such as notessecured by shipping documents, warehouse re-ceipts, and other documents covering readilymarketable staples and notes secured by bonds



of the United States. Consequently, a nationalbank could have outstanding loans to a singlecustomer represented by notes of the kinds justdescribed in excess of the 10 per cent limitation,and a Federal Reserve Bank, under the provi-sion of section 13, could rediscount the paperof that customer for the national bank up to10 per cent of the national bank's capital andsurplus. On the other hand, because of thelanguage of the provision of section 9 of theAct that had been added in 1917, if a Statemember bank with the same amount of capitaland surplus had made loans to one of its cus-tomers in the same amount and represented bythe same kinds of paper, the Reserve Bankwould be prohibited from rediscounting for theState member bank any of that customer'spaper.™

To remove this inconsistency, Congress in1922 again amended the limitation in section 9to provide simply that a Reserve Bank shouldnot discount for a State member bank the paperof any one borrower who was liable for bor-rowed money to that bank "in an amountgreater than that which could be borrowed law-fully from such State bank or trust companywere it a national banking association." S9 Thismeant that thereafter a State member bank thathad made loans to one borrower in excess ofits capital and surplus but on the security of, forexample, warehouse receipts covering readilymarketable staples or notes secured by Govern-ment bonds would not be precluded from offer-ing paper of that borrower as a basis for redis-count.

Nevertheless, there were still significant dis-crepancies between the provisions of sections9 and 13. In the first place, the amount limita-tion in section 13 was subject to only one excep-tion—bills of exchange against actually existingvalues. However, the limitation in section 9 wasclearly subject to all of the exceptions providedin section 5200 with respect to loans by na-tional banks to one borrower.10 This meant,strangely enough, that paper representing loansto a single borrower that was permitted for a na-tional bank under section 5200 was eligible fordiscount if offered by a State member bank butwas not eligible if offered by a national bank.41

In the second place, both the Comptroller ofthe Currency in interpreting section 5200 andthe Federal Reserve Board in construing section13 had held that the limitations on loans to oneborrower applied only to direct liabilities suchas those of a maker or acceptor, and not toindirect liabilities such as those of a drawer,endorser, or guarantor." The McFadden Actin 1927 amended section 5200 to make itslimitations expressly applicable to the indirectliability of a drawer, endorser, or guarantor;but section 13 was not similarly changed.

Both of these inconsistencies were correctedby the Act of April 12, 1930," which amendedthe provision of section 13 so that, like the pro-vision of section 9, it referred specifically to thelimitations on loans to one borrower containedin section 5200 of the Revised Statutes. As thusamended, section 13 stated: "

The aggregate of notes, drafts, and billsupon which any person, copartnership, asso-ciation, or corporation is liable as maker,acceptor, indorser, drawer, or guarantor, re-discounted for any member bank, shall at notime exceed the amount for which such per-son, copartnership, association, or corpora-tion may lawfully become liable to a nationalbanking association under the terms of sec-tion S200 of the Revised Statutes, as amended;Provided, however, That nothing in this para-graph shall be construed to change the char-acter or class of paper now eligible forrediscount by Federal reserve banks.

This provision has not been changed since1930. Literally, it permits a member bank torediscount with a Federal Reserve Bank asmuch paper of a single borrower as a nationalbank is permitted to acquire from a singleborrower under section 5200 of the RevisedStatutes. The latter section has been amendedon a number of occasions to provide additionalexceptions to the 10 per cent limitation (thereare now 13 of them); but a discussion of theprovisions of that section is beyond the scopeof this study.

As being of historical interest, it may benoted that in March 1919 Congress amendedsection l l (m) of the Federal Reserve Act toauthorize the Federal Reserve Board, upon the



affirmative vote of five members, to permit theFederal Reserve Banks to discount for anymember bank paper of one borrower in excessof 10 per cent of its capital and surplus, but notto exceed 20 per cent, if the amount exceeding10 per cent were secured by bonds or notes, orcertificates of indebtedness of the UnitedStates.45 Presumably, this was a postwar meas-ure to encourage bank holdings of Governmentbonds. By its own terms, the provision becameinoperative after December 31, 1920.

The Board's discount regulations in generalhave paraphrased the provisions of the lawlimiting the amount of paper of any one bor-rower that may be discounted for a memberbank, with successive revisions of Regulation Areflecting changes in the statutory provisions.As revised in 1955, the regulation set forth thesubstance of the provisions of both section 13and section 9 of the Federal Reserve Act: limit-ing the aggregate amount of paper of any oneperson discounted for any member bank to theamount for which such person could lawfullybecome liable to a national bank, and for-bidding a Federal Reserve Bank to discountfor any State member bank paper of any oneborrower who is liable to such bank for bor-rowed money in an amount greater than couldbe borrowed lawfully from such bank if itwere a national bank.46

A literal reading of the law and of theseprovisions of Regulation A meant that a Re-serve Bank could discount for a national bankpaper of one borrower in an amount up to theamount that the national bank was permitted tolend to a single borrower under section 5200of the Revised Statutes, but that a ReserveBank could not discount for a State memberbank any of the paper of one borrower if theamount exceeded the amount that a nationalbank could lend to a single borrower. The ab-surdity of this distinction was recognized bythe Board in an unpublished letter to a FederalReserve Bank in 1966 when, notwithstandingthe statutory provisions, the Board held that aReserve Bank could not "discount for anymember bank, national or State, any obligationof a borrower who is liable to such memberbank in an amount greater than that which

could be borrowed lawfully from a nationalbank in the circumstances of the particularcase." This position was in effect incorporatedin Regulation A by an amendment in 1970 thatprovided that any member bank requestingReserve Bank credit shall be deemed to repre-sent and guarantee that, except as to creditgranted under section I0(b) of the FederalReserve Act, "as long as the credit is outstand-ing no obligor on paper tendered as collateralor for discount will be indebted to it in anamount exceeding the limitations in section5200 of the Revised Statutes, which for thispurpose shall be deemed to apply to State mem-ber as well as national banks." *"

Even with this amendment, the regulationcontinued to provide, inconsistently, that theaggregate amount of paper of one borrowerdiscounted for any member bank should at notime exceed the amount that such person couldborrow from a national bank under section5200 of the Revised Statutes. The general revi-sion of Regulation A adopted by the Board in1973 eliminated this inconsistent provision ofthe regulation. It did, however, continue ineffect the language of the provision added in1970 under which any member bank applyingfor credit is deemed to guarantee that no obligoron paper offered as collateral or for discountwill be indebted to it in an amount exceedingthe limitations prescribed by section 5200 ofthe Revised Statutes.

On a number of occasions the Board haspublished interpretations of the statutory limita-tions on the amount of paper of one borrowerthat may be discounted, but only a few of themore important need be mentioned here.

Before the limitations in section 13 of theFederal Reserve Act were amended in 1930 toconform to those of section 5200 of the RevisedStatutes, the only exception, as has been seen,was that with respect to bills drawn againstactually existing values. However, when section5200 was changed in 1919 to except papersecured by shipping documents and bankers'acceptances of the kinds described in section 13of the Federal Reserve Act, the Board ex-pressed the opinion that both of these kinds ofpaper might be regarded as bills drawn against



actually existing values and therefore as ex-cepted from the discount limitations of sec-tion 13.1S

Since the 1930 amendment to section 13conforming its limitations to those prescribedby section 5200 of the Revised Statutes, theBoard in applying section 13 has followed in-terpretations made by the Comptroller of theCurrency under section 5200. Thus, notes offarmers for the purchase of agricultural imple-ments, which had been interpreted by theComptroller to constitute actually owned com-mercial or business paper within the meaning ofsection 5200, were similarly held by the Boardto be exempt from the amount limitation setforth in section 13."

Although the limitation with respect to thediscounting of paper of a single borrowerliterally applies only to rediscounts for memberbanks, the Board in 1938 took the positionthat, in order to comply with the spirit of thelaw, a Federal Reserve Bank, in making ad-vances to a member bank secured by eligiblepaper as well as in discounting paper, shouldnot acquire paper upon which one person isliable in an aggregate amount in excess of the10 per cent limitation.50 At the same time, how-ever, the Board expressed the opinion thatadvances under section 10(b) of the FederalReserve Act on the security of any satisfactorycollateral should not, in view of the purposesof that section, be subject to any limitation ofthis kind. These interpretations—the applica-bility of the limitation to advances as well as torediscounts and the inapplicability of the limita-tion to advances under section 10(b)—weresubsequently incorporated in Regulation A. Thefirst interpretation was clearly justified, buttoday one might question why advances undersection 10(b) to a national bank should be per-mitted to be secured by any paper of a single

borrower in an amount greater than that whichcould be borrowed from the national bankunder section 5200 of the Revised Statutes.

In 1934 Congress amended section 9 of theFederal Reserve Act to provide that, for pur-poses of membership of any State bank in theSystem, the terms "capital" and "capital stock"should include capital notes and debenturesissued by such bank and purchased by theReconstruction Finance Corporation (RFC).01

On the theory that the RFC was authorized topurchase such capital notes and debentures inorder to provide capital funds to banks, theBoard held that, for purposes of various provi-sions of the Act, capital notes and debenturesof a bank bought and held by the RFC shouldbe treated as capital stock; and that amongthese provisions were those of sections 9 and 13of the Federal Reserve Act limiting the dis-counted paper of one borrower to 10 per centof the discounting member bank's capital stockand surplus.58

In concluding this section, it is appropriateto observe that, quite apart from the statutorylimitations on discounting paper of one bor-rower, a Federal Reserve Bank, in determiningwhether to discount paper for a particular mem-ber bank, may properly take into considerationthe total amount of paper of the same borrowerthat has been discounted for other memberbanks. In the early days of the System theBoard publicly stated that it was "both lawfuland proper" for a Reserve Bank to place anaggregate limit on the amount of the paper ofany one borrower that it would discount for allof its member banks, and that a policy ofdeclining to receive more than a certain propor-tion of the paper of a particular borrower wasnot itself a discrimination but a general andconservative policy applicable to all memberbanks alike.03



ENDORSEMENT

PURPOSEIn addition to general limitations on maturity

and amount, the Federal Reserve Act imposed athird limitation that was designed to afford theReserve Banks some protection against possibleloss on paper discounted by them—a require-ment that the paper be endorsed by the dis-counting member banks.

During the debates on the original FederalReserve Act there was evidence of some con-fusion between eligibility for discount and thesoundness of the paper discounted. In general,however, it was agreed that, even though par-ticular paper was eligible for discount, a Re-serve Bank would still have a right to determinewhether the paper was "good" and to inquireinto the solvency of the maker.54 The require-ment for endorsement by the borrowing mem-ber bank was the one statutory requirementaimed at assuring the soundness of the loan.The report of the House Banking and CurrencyCommittee stated: 05

The fundamental requirement throughoutall of the discount section of the proposed billis that antecedent to the performance of aservice by a Federal reserve bank for a mem-ber bank which applies therefor the memberbank shall indorse or guarantee the obliga-tions which it offers for rediscount.

During the House debates Mr. Phelan as-serted that discounted paper would be "gilt-edgepaper, entirely safe" because, after passing thescrutiny of the member bank that had made theoriginal loan, it must then pass the scrutiny ofthe Federal Reserve Bank and, in addition, havethe endorsement of the member bank.sa

WAIVER OF PROTESTTo further protect the Reserve Banks and to

avoid trouble and expense, Congress adopted arequirement, originally contained only in theHitchcock bill, that a member bank's endorse-ment must be accompanied by a waiver ofdemand, notice, and protest. During the de-

bates Senator Nelson explained that if theReserve Banks "were in every instance requiredto protest those notes it would cause them greatexpense, and they would have to present themfor payment and protest them at the local bankwhere they were payable." "

REGULATORY PROVISIONSThe Board's first discount regulation, in list-

ing the requirements to be met by all paperoffered for discount, stated: 5S

First. It must be indorsed by a Nationalor State bank or trust company which is amember of the Federal reserve bank to whichit is offered for rediscount.

Second. Such bank must, with its indorse-ment, waive demand, notice and protest.

A 1915 revision of the regulation providedsimply that discounted paper "must be indorsedby a member bank, accompanied by a waiverof demand, notice, and protest." 59

Among certain technical amendments madeto section 13 of the Federal Reserve Act by theAct of September 7, 1916,*° the requirementfor endorsement was changed to provide thatpaper might be discounted by a Federal ReserveBank "upon the indorsement of any of its mem-ber banks, which shall be deemed a waiver ofdemand, notice and protest by such bank as toits own indorsement exclusively." This meantthat the act of endorsement by a member bankconstituted, without more, a waiver of demand,notice, and protest as to its own endorsement.Consequently, all subsequent revisions of Regu-lation A have provided only that paper offeredfor discount must be endorsed by a memberbank, with no specific reference to waiver ofdemand, notice, and protest.

FORM AND EFFECT OFENDORSEMENT

With respect to the form of the requiredendorsement, the Board ruled that it was suffi-cient if the discounted paper bore the simple



written endorsement of the discounting memberbank;61 and that it was even permissible forthe endorsement to be on a separate but at-tached piece of paper, a so-called allonge.02

As previously indicated, the purpose of theendorsement requirement is to provide a Fed-eral Reserve Bank with a certain measure ofprotection against loss. According to the law,the member bank's mere endorsement carrieswith it a waiver by that bank of the right itwould otherwise have to deny liability in theabsence of notice, demand, and protest. Theeffect is to make the member bank primarilyliable on the paper so that the Reserve Bankdoes not have to proceed first against the makeror prior endorsers. The Reserve Bank is giventhe advantage of "a right to proceed againstthe bank that indorses the paper." °3

It is important to observe again that endorse-ment by a member bank is not an essentialprerequisite to the eligibility of paper for dis-count; it is simply a condition precedent to thediscount of eligible paper. Thus, under theauthority to make advances to member bankson their own notes secured by paper eligible for

discount or purchase by the Federal ReserveBanks, a Reserve Bank may make such ad-vances on notes secured by paper that is notendorsed by the member bank.61 In such a case,the Reserve Bank relies on the member bank'sown note; the additional endorsement of thepaper securing the note would provide nofurther protection. For many years, loans bythe Reserve Banks to member banks have beenmade not through the rediscounting of eligiblepaper, but through advances on the notes ofmember banks secured by eligible paper or byGovernment securities or other securities eli-gible for purchase by the Reserve Banks. As aresult, the endorsement requirement of the lawno longer has any great significance.

A distinction should also be made betweenendorsement as a requirement for discount andendorsement in connection with purchases ofpaper by the Reserve Banks under section 14of the Federal Reserve Act. Under the lattersection, bills of exchange and bankers' accept-ances are expressly made eligible for purchaseby the Reserve Banks with or without the en-dorsement of a member bank.

NEGOTIABILITY

REGULATORY REQUIREMENTThe law itself has never required that paper

discounted by the Federal Reserve Banks benegotiable paper. However, one of the earliestversions of the Board's discount regulations °F>

defined the terms "promissory note" and "draftor bill of exchange" in language that, under theUniform Negotiable Instruments Law, had theeffect of prescribing negotiability as a require-ment for discount; and from 1923 until 1970Regulation A specifically provided that anypaper offered for discount "must be a negotiablenote, draft, or bill of exchange."60 This meantnot only that discounted paper had to be ne-gotiable but also that any eligible paper offeredas security for direct advances to member bankslikewise had to meet the test of negotiability.

EXCEPTIONSOnly two exceptions were made to the regula-

tory requirement for negotiability before thatrequirement was eliminated. In 1942, Regula-tion A was amended to except from this re-quirement paper evidencing war productionloans guaranteed by the War and Navy Depart-ments and the Maritime Commission pursuantto the V-loan program of World War II;'"this exception was broadened in 1944 to coverloans similarly guaranteed pursuant to the Con-tract Settlement Act.OiS After the war, the excep-tion was eliminated,11" but in 1951 it was re-stored to make negotiability unnecessary forpaper representing defense production loansguaranteed by Government agencies under theDefense Production Act of 1950.™



The other exception from the negotiabilityrequirement related to notes evidencing loansmade pursuant to commodity loan programs ofthe Commodity Credit Corporation and subjectto a commitment to purchase by that Corpora-tion. An amendment to Regulation A providingfor such an exception was adopted by theBoard in 1949."

It .should be noted that, under section 10(b)of the Federal Reserve Act, the Reserve Banksmay make advances to member banks on anysatisfactory security—but at a penalty interestrate—whether paper offered as security is ne-gotiable or nonnegotiable.

MEANING OF NEGOTIABILITYIn general, an instrument is negotiable if it

evidences an unconditional promise or order topay, on demand or at a fixed or determinablefuture time, a certain sum of money to orderor bearer. In the final analysis, the questionwhether a particular note or draft is negotiableis a matter for determination by the courts inthe light of applicable provisions of State law.Negotiability is governed by Article HI of theUniform Commercial Code, which has beenadopted in all States except Louisiana.

This is not the place for a discussion of thevarious elements of negotiability. It may benoted, however, that, in administering the dis-count provisions of the Federal Reserve Act,the Board undertook during the early years ofthe System to express opinions as to whetherparticular instruments were negotiable andtherefore eligible for discount. In general, theseopinions related to whether the paper involvedwas "unconditional," or was payable at a "fixedor determinable" future time, or provided forpayment of a "certain" sum of money.

For example, the Board expressed the opin-ion that bills were not unconditional—andtherefore were nonnegotiable—if they were pay-able out of the proceeds of an import or exporttransaction; '•- but that negotiability was notaffected either by a provision authorizing theconsignee of goods to inspect the goods beforeaccepting a draft covered by a bill of lading "or by an endorsement exempting the endorserfrom responsibility for the genuineness of an

accompanying bill of lading." With respect tocertainty of time of payment, the Board ruledthat drafts payable before a specified maturitydate after 5 days' notice were negotiable; ™that a draft "payable on arrival of car" was notnegotiable;70 and that a note providing forextensions of time should not be approvedbecause of conflicting authorities as to thenegotiability of such a note.77 As to certaintyof amount, the Board ruled that a bill payablewith collection • charges is not negotiableTR

unless it is so drawn as to show that no collec-tion charges are to be included unless the billis dishonored at maturity;T0 but that nego-tiability is not affected by a provision for in-terest at a specified rate after maturity if pay-ment is delayed.80 However, because ofconflicting court decisions, the Board in 1918disapproved of trade acceptances that providedfor a fixed discount if paid at a certain timebefore maturity.81

ELIMINATION OF THEREQUIREMENT

When Regulation A was amended in 1942 toremove the negotiability requirement with re-spect to notes evidencing guaranteed V loans,the Board noted that the requirement of nego-tiability "was not a requirement of the FederalReserve Act but had been placed in RegulationA as a means of protecting the Federal ReserveBanks against certain legal disadvantages ofnonnegotiable paper."82 In April 1970, theBoard broke with tradition and eliminated thenegotiability requirement from the regulation."1

This action was taken because of the beliefthat, while negotiability of paper afforded theReserve Banks certain protection against loss inthe event of default, most loans were beingmade in the form of advances on the notes ofmember banks themselves and the ReserveBank could therefore proceed directly againstthe member bank in the event of default; thus,the importance of negotiability was diminished.In any event, it was felt that negotiability doesnot improve the underlying quality of the paperoffered as security and that the Reserve Banksshould not be precluded from accepting per-fectly sound and otherwise eligible paper as



security for advances at the regular discount regulatory requirement would not preclude arate merely because it did not meet all of the Reserve Bank in individual cases from decliningtechnical requirements for negotiability. It was to accept nonnegotiable paper for discount orunderstood, however, that elimination of the as collateral for advances.


Discount of Commercial Paper

MEANING OF "COMMERCIAL PAPER'

INTENT OF THE ORIGINAL ACTThe principal objective of the discount pro-

visions of the original Federal Reserve Act—to establish a market for commercial paper—was clearly reflected in the provision of section13 of the Act that authorized the ReserveBanks to "discount" for their member banks"notes, drafts, and bills of exchange issued ordrawn for agricultural, industrial, or commer-cial purposes, or the proceeds of which havebeen used, or are to be used, for such pur-poses." This chapter relates to discounting ofwhat has generally been referred to as "com-mercial paper." Since agricultural paper hasbeen accorded special treatment by the law, itwill be considered separately.

Despite frequent statements of their purposeto create a market for commercial paper, thetrainers of the original Act were obviously notclear, except in a very general way, as to whatwas meant by commercial paper. They wereagreed that it meant paper arising out of "actualcommercial transactions"; that it meant paper


drawn, or the proceeds of which were to beused, for "agricultural, industrial, or commer-cial purposes"; that it included paper secured by"staple agricultural products"; and that it didnot include paper drawn for the purpose oftrading in stocks and bonds. They were alsoagreed that it meant "liquid" paper and paperwith short maturities. All of these points ofagreement were written into the law. Theframers, however, made no further effort todefine commercial paper; instead, they left tothe Federal Reserve Board the authority andresponsibility for making a more specific deter-mination of the character of paper eligible fordiscount.

The report of the House Banking and Cur-rency Committee stated: x

* * * In view of the great difficulty ofdefining "commercial paper," the actual defi-nition of the same has been left to the Federalreserve board in order that it may adjust thedefinition to the practices prevailing in differ-ent parts of the country in regard to thetransaction of business and the making ofpaper. * * *

27



During the debates, Senator Weeks de-clared: z

We asked a dozen or fifteen banking mento give us a definition which could limit thekind of paper which we wanted to cover bythis definition of commercial paper, and noone of them did it. I do not know just exactlyhow the reserve board will finally conclude todefine it, but I assume they will in some form,so that there will be no question about whateligible paper is.

Perhaps the best effort to explain the meaningof commercial paper was made by Mr. Phelanin the House. After noting that it must be short-time paper, he stated: 3

* * * Just what constitutes commercialpaper it is impossible to define closely orstrictly. The whole spirit of the bill and thissection is, however, that the funds of the re-serve banks shall be applied to the activitiesof business; first, because the funds of thereserve. banks consist in large part of publicmoney and of reserves; and, second, becausethe funds of commercial banks, both from ascientific banking and a practical standpoint,should be applied to commercial purposes.The whole spirit of the bill is that the fundsof the reserve banks should be applied to theactivities of business, commerce, and agricul-ture. It is impossible to define in a specificway just what notes and bills shall be eligiblefor rediscount. It is clearly defined in the bill,however, that the funds of reserve banks shallnot be diverted from the channels of produc-tion and distribution. In order that theremight be a broad and adaptable constructionput upon the terms contained in section 14[section 13 in the Act as passed], discretion asto their interpretation, in accordance with thespirit of the bill, is given the Federal reserveboard. It is reasonable to believe that thisboard will exercise its discretion with wisdomand prudence.

There were a few members of Congress, suchas Mr. Wingo,4 who questioned the desirabilityof allowing the Federal Reserve Board to de-termine what classes of paper should be eligiblefor discount. The majority, however, appearedto agree with Senator Weeks who stated thatCongress, having required that paper arisefrom a commercial transaction, should "leave

it to the reserve board to make rules and regu-lations which will define the kind of paperwhich shall be accepted." •'•

REGULATORY DEFINITION

The Federal Reserve Banks first opened theirdoors for business on November 16, 1914. Pre-viously, the Board had decided that since it wasnot passible to formulate in advance a completeset of regulations to govern the operations ofthe Reserve Banks, it would "confine itself inthe beginning to those matters which weredeemed absolutely essential to setting the banksin motion upon a basis of reasonable ef-ficiency." " The matter of discounting com-mercial paper came first. In its first AnnualReport to Congress, the Board stated that it hadfelt "that the regulations relating to discountoperations and commercial paper in generalwere fundamental and that they should be pre-pared and issued at once." " Accordingly, ina letter sent to the Reserve Banks on November10, 1914," the Board outlined its views as toinitial discount policy and transmitted five sep-arate though brief regulations relating to thercdiscounting of notes and bills and bankers'acceptances.

In its circular letter to the Reserve Banks,the Board referred to the uncertain effects of thewar in Europe (in which the United States wasnot yet involved) and stated that the functionof the Federal Reserve Banks was of a twofoldcharacter: (1) They should extend credit fa-cilities, particularly where the prevailing ab-normal conditions had created emergencies de-manding prompt accommodation; and (2) theyshould protect the gold holdings of the countryin order that such holdings might remain ade-quate to meet demands made upon them."While credit facilities should be liberally ex-tended in some parts of the country," said theBoard, "it would appear advisable to proceedwith caution in districts not in need of imme-diate relief and to await the effect of the releaseof reserves and of the changes which the creditmechanism of the country is about to experiencebefore establishing a definite discount policy."

The Board expressed the belief that it wouldbe inadvisable to place a narrow or restrictive


DISCOUNT OF COMMERCIAL PAPER 29

interpretation upon the character of papereligible for discount. It did, however, prescribethree basic principles for the guidance of Fed-eral Reserve Banks and member banks: (1)No bill should be discounted if its proceeds wereto be applied to permanent investment; (2)maturities should be well distributed; and (3)bills should be "essentially self-liquidating." Inexplanation of the self-liquidating principle, theBoard stated that discounted paper "shouldrepresent in every case some distinct step orstage in the productive or distributive process—the progression of goods from producer to con-sumer. The more nearly these steps approachthe final consumer the smaller will be theamount involved in each transaction as rep-resented by the bill, and the more automaticallyself-liquidating will be its character."

The Board, in this first pronouncement onthe subject of discounting, also called attentionto the fact that single-name paper does not, likedouble-name paper, show on its face the char-acter of the transactions out of which it arose.For this reason, the Board felt that it was in-cumbent upon each Reserve Bank "to insistthat the character of the business and the gen-eral status of the concern supplying such papershould be carefully examined in order that thediscounting bank may be certain that no suchsingle-name paper has been issued for purposesexcluded by the act, such as investments of apermanent or speculative nature."

As to procedure, the Board's circular letterstated that while it was not deemed essentialthat a statement of condition be attached toeach bill, it was thought advisable that, afterJanuary 15, 1915, no paper should be dis-counted unless it bore on its face evidence thatit was eligible for discount; and a rubber stampfor this purpose was suggested.

Appended to the Board's circular of Novem-ber 10, 1914, was the Board's RegulationNo. 2,D which set forth in general the require-ments to which all paper offered for discountmust conform. Among other things, it was re-quired that the paper offered "shall be in theform of notes, drafts, or bills of exchange arisingout of commercial transactions; that is, notes,drafts, and bills of exchange issued or drawnfor agricultural, industrial, or commercial pur-

poses, or the proceeds of which have been usedor are to be used for such purposes." Withoutattempting to elaborate further on the statutorylanguage, the Board's regulation stated onlythat, under the law, paper drawn for the pur-pose of trading in stocks and bonds—other thanGovernment bonds—or drawn merely for in-vestment purposes was excluded from eligibility.

An effort to define more specifically the char-acter of paper eligible for discount was madeby the Board when, on January 25, 1915, itissued a new regulation, designated as Regula-tion B, relating to commercial paper.10 Thisregulation stated that, in order to be eligible,a bill must be one "the proceeds of whichhave been used or are to be used in producing,purchasing, carrying, or marketing goods inone or more of the steps of the process of pro-duction, manufacture, and distribution."

A year and a half later, in 1916, the Boardissued a new series of its regulations. Regula-tion B was changed to cover open market pur-chases. Discount operations were covered bya revised Regulation A." It embraced not onlydiscounts of commercial paper but also all otherkinds of discounts under section 13 of theFederal Reserve Act, including discounts ofagricultural paper, commodity paper, and bank-ers' acceptances that had previously been dealtwith in separate regulations. The new regula-tion, however, made no substantial change inthe general definition of commercial paper. Itfollowed the language of the 1915 RegulationB already quoted except that, in referring to theproduction, purchasing, carrying, or marketingof goods, it defined the word "goods" in a foot-note as including "goods, wares, merchandise,or agricultural products, including live stock."

The regulatory statement as to the generalcharacter of paper eligible for discount re-mained unchanged until 1920 when twochanges were made in Regulation A. It wasthen provided that the proceeds of the papermust be used "in the first instance" for thepurposes described, and it was expressly statedthat eligible paper included paper the proceedsof which were used "for the purpose of carry-ing or trading in bonds or notes of the UnitedStates." 12

Two further changes were made in 1923."



For the first time in the regulation itself, it wasrequired that the paper be negotiable. In addi-tion, it was provided that the name of a partyto the underlying transaction should appearupon the paper "as maker, drawer, acceptor,or indorser." This requirement was eliminatedwhen Regulation A was revised in 1937.14 The1937 revision also eliminated a provision ex-cluding paper the proceeds of which were usedto finance third parties and expanded the defini-tion of eligible paper to include paper theproceeds of which were used "in meeting cur-rent operating expenses of a commercial, agri-cultural or industrial business." As has beennoted earlier, the negotiability requirement wasremoved in 1970.

Further changes of a liberalizing nature weremade by the 1973 revision of Regulation A.In the first place, paper the proceeds of whichare used for the "purchase of services" as wellas for the purchase of goods was made eligiblefor discount. Of greater significance, this revi-sion eliminated the long-standing prohibitionagainst the discounting of paper the proceedsof which were used for permanent or fixed in-vestments and provided only that the proceedsmust not be used "merely for the purpose ofinvestment, speculation, or dealing in stocks,bonds, or other such securities, except directobligations of the United States." This im-portant change will be discussed in more detaillater in this chapter.

COMMERCIAL PURPOSE

The Board's regulatory definition of com-mercial paper, as indicated earlier, has beenphrased in broad and general language. Themeaning of the term can be better understoodby considering particular instances in whichthe Board by interpretation has determinedwhether the paper offered for discount wasactually drawn for a commercial purpose.

At an early date, the Board in a publishedstatement1!i pointed out the distinction between(1) paper issued or drawn for a commercialor agricultural purpose and (2) paper theproceeds of which have been or are to beused for such purposes. As to the first, a notegiven by the buyer of goods to the seller is a

note issued or drawn for a commercial purpose,since "the purchase and sale of goods of anycharacter is a commercial transaction from thestandpoint of the seller,"I0 and the note iseligible for discount as commercial paper, eventhough the goods may be in the nature ofpermanent or fixed investments. However, if thenote is not given in a purchase-and-sale trans-action, then the test of eligibility is the purposefor which the proceeds of the note are to beused.

In any case, it is the purpose of the originalnegotiation of the note that determines itseligibility. For example, a note given to afarmer in payment for grain purchased forresale is commercial paper even though thefarmer subsequently discounts the note at hisbank and uses the proceeds for an agriculturalpurpose, since the purpose of the original nego-tiation of the note was to finance the purchaseand sale of goods, a commercial transaction.17

The above principles may be illustrated byadditional particular cases. For example, notesgiven by dealers in payment for mules and cattleare commercial rather than agricultural paper.14

Similarly, the note of an irrigation company theproceeds of which arc used for payroll andother current purposes in connection with thedistribution of water to farmers constitutes com-mercial paper.19 When a railroad company, inorder to purchase supplies, accepted the draftof the seller, the Board ruled that if the draftwere discounted by the seller or a third partywith a member bank, it would be eligible for re-discount with a Federal Reserve Bank; but ifthe railroad itself discounted the draft with itsown bank, there would be a direct loan to therailroad and the draft would be eligible forrediscount only if the proceeds were used fora commercial purpose.20

It seems probable that the drafters of theoriginal Federal Reserve Act contemplated thatcommercial paper would include only papergrowing out of business transactions and wouldnot embrace ordinary day-to-day purchases ofgoods and services by individuals for their ownuse. In 1937, however, the Board took theposition that the purchase of goods, such as anautomobile or a radio, for the use of the pur-chaser himself constitutes a commercial trans-



action. The eligibility of such consumer paperwill be specifically considered in a later sectionof this chapter.

SELF-LIQUIDATING NATUREA basic concept underlying the discount pro-

visions of the Federal Reserve Act was thatcommercial paper admitted to discount shouldbe self-liquidating paper. In a published state-ment, the Board recognized this concept. Itstated that paper eligible for discount waslimited to "liquid" paper, "that is, paper whichis issued or drawn under such circumstancesthat in the normal course of business there willautomatically come into existence a fund avail-able to liquidate each piece of paper, that fundbeing the final proceeds of the transaction outof which the paper arose."ai

As an illustration, if the notes of a publicservice corporation will not be liquidated withina short time out of current assets accruingthrough ordinary earnings and the borrowingis really for capital purposes, such notes areineligible; but, if the notes are given for sup-plies necessary to enable the corporation to sellservices to the public for which the publicwill pay within 30 or 60 days, the notes areeligible for discount.22

In order to assure liquidity, the Board tookthe position that at least one of the partiesto the commercial transaction out of which thepaper arises should be obligated as maker,drawer, acceptor, or endorser.21 Unless theproceeds will ultimately come into the handsof a person who is liable as a party to thepaper, there is no assurance that the proceedsof the commercial transaction will be used toliquidate the paper. By the same token, theBoard ruled that an equitable participation ina note could not be discounted because it didnot represent a legal claim against the maker ofthe note.24

EFFECT OF COLLATERALSECURITY

In 1915, in its first comprehensive regula-tion regarding discounts of commercial paper,the Board stated that "the pledge of goods assecurity for a bill is not prohibited." 25 A more

positive statement was made in the next revi-sion of the regulation in 1916, in which it wasprovided that paper otherwise eligible "may besecured by the pledge of goods or collateral."28

In 1920 the regulation made it clear that dis-counted paper could be secured by "collateralof any nature, including paper, which is in-eligible for rediscount." "

The Board emphasized in a number of in-terpretations that eligibility of paper for dis-count does not depend upon whether it is se-cured or upon the character of any collateralsecurity, but depends upon the purpose forwhich the paper is drawn or its proceeds used.28

Thus, a note drawn for commercial purposesand otherwise eligible for discount is notrendered ineligible because it is secured by amortgage on real estate.29

At the same time, it was recognized thatthe character of the collateral could havea material bearing upon the acceptability of thepaper and its desirability as an investment.30

The Board at an early date upheld the rightof a Reserve Bank to refuse to discount papernot adequately secured.31 The courts have ju-dicially confirmed the authority of a FederalReserve Bank to require additional collateral,including collateral that would not itself beeligible for discount.32

Perhaps because the question had been raisedin the course of litigation, the Board in its 1937revision of Regulation A expressly authorizedthe Reserve Banks to require such additionalor marginal collateral as they might deem ad-visable or necessary for their protection.33 How-ever, the regulation stated that a Federal Re-serve Bank would be expected to consider thegeneral effects that its action in requiring addi-tional collateral might have on the position ofthe member bank involved, on its depositors,and on the community, and that in general aReserve Bank should limit the amount of col-lateral it required "to the minimum consistentwith safety." Moreover, if the additional col-lateral exceeded 25 per cent of the amount of anadvance, the Reserve Bank was required toexplain the circumstances to the Board. Thislatter requirement, however, was eliminatedwhen the regulation was again revised in 1955.The regulation as revised in 1973 provides



regulation '5 defining the term "trade accept-ance," and requiring that any such acceptancebe endorsed by a member bank, have a ma-turity of not more than 90 days at the timeof discount, and be accepted by the purchaserof goods sold to him by the drawer of the bill.

In 1916 a provision specifically relating to thediscounting of trade acceptances was incorpo-rated in the Board's general regulation relatingto discounts, and the term "trade acceptance"was there defined simply as "a draft or bill ofexchange drawn by the seller on the purchaserof goods sold and accepted by such pur-chaser." l0 This definition was carried intosubsequent revisions of Regulation A until 1937when specific reference to trade acceptances wasdropped.

While for a few years the discount rate setfor trade acceptances was lower than the rateon other commercial paper, it became generallythe same as that for commercial paper by 1920,and in May 1927 the practice of fixing aseparate rate for trade acceptances was dis-continued.

NATURE OF TRANSACTIONAs previously indicated, the Board's 1916

regulations defined a trade acceptance as a draftor bill drawn by the seller on the purchaser ofgoods and accepted by the purchaser. Thismeant that the underlying transaction mustinvolve a sale of goods.

To constitute a sale, it is necessary thatthere be a transfer of title. Thus, there is notrade acceptance when a draft is drawn by asupplier of building materials and acceptedby the purchaser—a building contractor—if thecontractor, under his building contract, doesnot acquire title to the materials furnished orto the building as it is being erected.41 Similarly,goods sold under a conditional sales contractcould not be made the basis for a trade ac-ceptance.48 However, if a lumber companyhad sold lumber to a sales corporation con-trolled by the lumber company, the Board heldthat the transaction was a sale upon which atrade acceptance might be based, provided thesales corporation was not merely an agent ofthe lumber company formed to evade the law.49

As to what constituted goods for this pur-

pose, the Board followed a liberal position. Itheld that a draft drawn by a publisher on thepurchaser of advertising space and acceptedby the latter was a trade acceptance on theground that the advertising space was goods.50

Likewise, it held that an accepted draft for theprice of electrical goods including their installa-tion S1 and a draft given in payment for gassold by a gas-producing company S2 were eligi-ble trade acceptances. The Board refused, how-ever, to consider a draft drawn in payment foran insurance premium ™ or drawn in paymentfor labor alone '" as covering sales of goods.

As long as there is an actual sale of goods,it does not matter whether the purchaser in-tends to resell the goods or to use them forhis own purposes. The Board held, therefore,that a bill drawn by a dealer on his customer tofinance the sale of goods to the customer wasa proper trade acceptance, even though thebill was drawn after the purchaser had failed toremit promptly on an open account. But, theBoard felt that the use of a trade acceptance asa means of liquidating an otherwise slow ac-count was contrary to the primary purpose ofthe trade-acceptance movement and that suchacceptances should not be encouraged."

FORMIn 1918 the Board had suggested the use

of certain standard forms of trade acceptances.66

In March 1927 the Supreme Court of the Stateof Texas held that a trade acceptance was ren-dered nonnegotiable by a statement therein that"the obligation of the acceptor hereof arisesout of the purchase of goods from the drawer,maturity being in conformity with the originalterms of purchase." °7 This clause, the courtruled, imported into the terms of the instru-ment an obligation arising from a collateraltransaction and thus destroyed the instrument'snegotiability. As a result of this decision, theBoard suggested in a published statement thatthe clause be changed in the prevailing standardform to provide only that the transaction givingrise to the instrument was "the purchase ofgoods by the acceptor from the drawer."68

Since that time no further statements havebeen issued by the Board with regard to theform of trade acceptances.



COMMODITY PAPER

As in the case of trade acceptances and forsimilar reasons, the Board in 1915 concludedthat so-called commodity paper should be en-couraged by preferential discount rates for suchpaper. The Board expected that "this new classof paper with its special rates will prove ofparticular efficacy in meeting the seasonal de-mands for credit facilities in the crop-producingdistricts."59

To distinguish such paper for rate purposes,the Board issued a separate regulation relatingto commodity paper.00 It defined the term"commodity paper" as "a note, draft, or bill ofexchange secured by warehouse terminal re-ceipts, or shipping documents covering ap-proved and readily marketable, nonperishablestaples properly insured." It provided that suchpaper, in order to be eligible for discount atthe special rate, not only should comply with

all the requirements of the Board's generalregulation relating to discounts but also shouldbe paper on which the rate of interest or dis-count, including commission charged the maker,did not exceed 6 per cent. In addition, it hadto comply with any requirements prescribed bythe Federal Reserve Bank as to warehouse re-ceipts, shipping documents, and insurance.

Substantially similar provisions regardingcommodity paper were incorporated in theBoard's comprehensive revision of RegulationA in 1916 B1 and were repeated in a revisionof the regulation in 1917.02 By that time, how-ever, the discount rate on such paper had be-come the same as the regular rate on othercommercial paper; consequently, when theregulation was next revised in 1920 no specialprovisions with respect to commodity paperwere included.

PERMANENT- OR FIXED-INVESTMENT PAPER

EXCLUSION FROM DISCOUNT

The original Federal Reserve Act expresslyprovided that paper eligible for discount shouldnot include paper "covering merely investmentsor issued or drawn for the purpose of carryingor trading in stocks, bonds, or other investmentsecurities, except bonds and notes of the Gov-ernment of the United States." This provisionof the law has never been changed.

In its first circular on the subject of discountsin November 1914, the Board stated as the firstguiding principle that no bill should be admittedto rediscount if the proceeds had been or wereto be applied to permanent investment. TheBoard explained in the accompanying regula-tion that the Act excluded paper coveringmerely investments and that, since any fundsemployed in agriculture, commerce, or industry

are quasi-investments, the emphasis was to belaid on the word "merely." From this point ofview, the regulation stated, there should beexcluded all paper whose proceeds were used inpermanent or fixed investments of any kind, in-cluding investments in land, plant, machinery,permanent improvements, or transactions of asimilar nature.63

This characterization of permanent invest-ments was spelled out in the Board's 1915 regu-lation regarding discounts of commercialpaper.61 The regulation provided that no billwould be eligible if its proceeds were used:

For permanent or fixed investments of anykind, such as land, buildings, machinery (in-cluding therein additions, alterations, or otherpermanent improvements, except such as areproperly to be regarded as costs of opera-tion). * * *



In 1920 the provision was expanded to excludepaper whose proceeds were used not only forfixed investments, such as land, buildings, ormachinery, but "for any other capital pur-pose." or> In 1937 this language was modified torefer to any other "fixed" capital purpose.*6

In this amended form the provision was con-tinued in the 1955 revision of Regulation A.07

EVIDENCE OF COMPLIANCEThe regulatory exclusion of permanent- or

fixed-investment paper was accompanied by aprovision to the effect that compliance of dis-counted paper in this respect might be indi-cated by a statement of the borrower thatevidences "a reasonable excess of quick assetsover current liabilities." The absence of such astatement, however, did not necessarily renderthe paper ineligible for discount; the test, ofcourse, was whether the proceeds were actuallyused for permanent- or fixed-investment pur-poses .ss

In this connection the Board ruled that anote given by the buyer to the seller of goodsin payment therefor would be eligible in thehands of the seller for discount as commercialpaper, even though the goods sold were in thenature of a permanent investment.1"1 However,if the proceeds of a note were to be used by themaker to purchase articles constituting perma-nent investments, the note would be regardedas ineligible.70

MEANING OF PERMANENTINVESTMENTS

As to what constituted permanent or fixedinvestments, it was clear that land and buildingsfell in the prohibited category, but the statusof machinery and equipment was not alwaysclear. On the one hand, the Board held thattractors used in agricultural operations 71 andagricultural implements that wear out rapidly T2

were not to be considered permanent or fixedinvestments. On the other hand, the prohibitionwas held applicable to notes given by farmersfor the purchase of silos; " notes executed bya company furnishing motor transportation toprovide funds for the purchase of motor

trucks;71 notes of a parent corporation theproceeds of which were used to purchase auto-mobiles for subsidiary "drive-it-yourself' com-panies; 7E and a note the proceeds of whichwere used by the owner of property for de-veloping or building.10

With respect to machinery, the Board in1938 held that machinery that was purchasedby a manufacturing company and that was ex-pected to last over a period of years or indefi-nitely would constitute a permanent or fixedinvestment, but that there might be machineryof a kind that, like agricultural tractors, wouldwear out rapidly and would need to be replacedwithin a comparatively short time.77 In otherwords, the question depended upon the type ofmachinery involved, as well as on other factsand circumstances of the particular case.

REMOVAL OF EXCLUSION OFPERMANENT-INVESTMENT PAPER

Despite the fact that Regulation A since theearly years of the System had prohibited thediscounting of paper drawn for permanent orfixed investments, the Board in 1973 adopted ageneral revision of the regulation that omittedthis prohibition.75

The original exclusion of permanent-invest-ment paper from eligibility for discount clearlyreflected the then-prevailing theory that alldiscounted paper should be self-liquidating,that is, the real-bills theory. Actually, however,the statute itself does not expressly and specifi-cally prohibit the discounting of paper repre-senting borrowings for fixed- or permanent-investment purposes. It provides that theReserve Banks may discount paper arising outof actual commercial transactions and that theBoard shall have the right to define the charac-ter of paper eligible for discount. The onlystatutory limitation is that no such definitionby the Board shall include paper coveringmerely investments or issued or drawn for thepurpose of carrying or trading in stocks, bonds,or other investment securities, except bonds andnotes of the Government of the United States.As noted earlier, the Board has held that anypurchase-and-sale transaction, regardless of the



nature of the goods involved, is a commercialtransaction. In this sense, the purchase of ma-chinery or of a building for a home is a com-mercial transaction. Literally, the statute seemsdesigned only to exclude paper covering merelyinvestments, that is, paper representing borrow-ings primarily for the purpose of making aprofit, such as realizing appreciation of capitalor return in the form of interest or dividends.

Repeal of the permanent-investment pro-hibition in Regulation A does not make allmortgage notes or notes given for the purchaseof machinery eligible for discount. Such noteswill still have to comply with the maturityrequirements of the law and therefore are noteligible for discount (or as collateral for ad-vances) until they are within 90 days of ma-turity. Moreover, the paper is not eligible if theproperty is purchased merely for investment—for example, for later sale at a profit.

This change in the regulation, however, hashad an important liberalizing effect becausenotes drawn to pay for permanent or fixedinvestments may now be regarded as represent-ing borrowings for an eligible purpose. As notedelsewhere in this study, the Board has takenthe position that finance paper is eligible fordiscount if the proceeds are to be re-lent toothers for eligible purposes irrespective of thematurity of such loans. Thus, in 1965 the Boardtook the position that the note of a financecompany is eligible for discount if the proceedsare to be used by the finance company to financethe purchase of consumer goods or "for other

purposes which are eligible within the meaningof the Federal Reserve Act" and that, if thereis any question as to whether the proceeds areto be used for such an eligible purpose, afinancial statement of the finance company "re-flecting an excess of notes receivable whichappear eligible for rediscount (without regardto maturity)" over total current liabilities ofthe company may be taken as an indication ofeligibility.79

Following the principle of that Board ruling,the note of a finance company or of a savingsand loan association that might be acquired bya member bank would be eligible for discountor as collateral for a Reserve Bank advance ifthat note itself had a maturity of not more than90 days and if the proceeds were to be used tomake loans for permanent or fixed investments,such as the construction of a home or the pur-chase of machinery. In addition, repeal of theregulatory prohibition makes it possible, inemergency circumstances, for a Federal ReserveBank to extend direct credit to a home mortgagelender subject to certain limitations prescribedin the law. That possibility will be referred toagain in connection with the discussion of ex-tension of Federal Reserve loans to nonmemberbanks and nonbanking enterprises.

One of the desirable side effects of the repealof the regulatory prohibition on the discountingof permanent-investment paper is removal ofthe need for technical interpretations as to whatconstitutes a permanent investment, such asthose described earlier.

PAPER DRAWN FOR SPECULATIVE PURPOSES

The statutory prohibition against the discountof paper covering "merely" investments obvi-ously excludes paper drawn only for speculativepurposes. In its 1915 discount regulation, theBoard provided that no bill should be eligiblefor discount if its proceeds were used "forinvestments of a merely speculative character,

whether made in goods or otherwise."so In1916 the language was slightly changed to pro-hibit the discount of any paper "the proceedsof which have been used or are to be used forinvestments of a purely speculative charac-ter";" and the same language (with "trans-actions" substituted for "investments") was



included in the 1955 revision of RegulationA.82 The present regulation requires that theproceeds must not be used "merely for thepurpose of investment, speculation, or dealingin stocks, bonds, or other such securities, exceptdirect obligations of the United States."

For example, it is customary for agriculturalproducts to be carried for a time in order toaccomplish orderly marketing, but the situationis different if there is a "mere speculative with-holding from the market, at a time when there

is a normal demand, in the hope ultimately ofobtaining a higher price"; and drafts drawn tofinance the growers of crops for such a purposecannot be considered as drawn for an agri-cultural purpose.81 On the other hand, when amanufacturer of pig iron gave his note, securedby pig iron already manufactured but heldpending delivery under contract for sale, thenote was held eligible for discount becausethe sale had been made and the carrying of thematerial was not for speculative purposes.*"

PAPER DRAWN FOR TRADING IN STOCKS AND BONDS

The law specifically excludes from discountany paper issued or drawn for the purpose ofcarrying or trading in stocks, bonds, or otherinvestment securities, with an exception, how-ever, in favor of bonds and notes of the Govern-ment of the United States. In its earliest dis-count regulation,85 the Board observed that thisprovision required no comment.

A provision excluding paper drawn for carry-ing or trading in stocks and bonds has appearedin all revisions of Regulation A. Since 1930,however, the regulation has made it clear thatthe exception for Government bonds and notesapplies only to direct obligations of the UnitedStates, that is, bonds, notes, Treasury bills, andcertificates of indebtedness.60

In 1918 the War Finance Corporation Act87

authorized the Reserve Banks to discount papersecured by obligations of the War FinanceCorporation. The Board ruled that paper drawn

for trading in bonds and notes of that Corpora-tion was eligible for discount,8" and in the 1924revision of Regulation A *• specific provisionswere included with respect to this matter. Theseprovisions were eliminated in 1928 when theywere no longer necessary.

Obviously, the reason why the Reserve Bankswere prohibited from extending credit on stocksand bonds was that the Banks were intendedto assist commercial banking and not invest-ment banking. Paper eligible for discount wasconfined to self-liquidating paper arising out ofcommercial rather than investment transac-tions.80

The exception for Government obligationshas been liberally construed.01 For a time, in-deed, the Board permitted the discount of notesof nonmember banks drawn for carrying ortrading in such obligations, provided the noteswere endorsed by a member bank."



FINANCE PAPER

ORIGINAL EXCLUSION FROMDISCOUNT

Generally speaking, "finance paper" is paperthe proceeds of which are loaned by the obligorto some other borrower. For many years theBoard took the position that such paper wasnot commercial paper and was therefore noteligible for discount by the Federal ReserveBanks, even though the loan made by theborrower to a third party was itself for acommercial purpose.83

Following this position, the Board ruled thatthe notes of cotton factors or cold storagecompanies were ineligible for discount whenthe proceeds were to be used by such factorsor companies for the purpose of making loansto their customers.84 The same principle wasapplied to paper of finance or credit com-panies M and to notes of Federal land banksand joint-stock land banks the proceeds ofwhich were loaned to third persons for agri-cultural purposes.84

In 1920 the principle was incorporated inRegulation A. It was expressly provided thatthe Reserve Banks could not discount paperthe proceeds of which were used "for the pur-pose of lending to some other borrower."07

MODIFICATION BY STATUTEIn two respects the Board's position regard-

ing finance paper was modified by statute in1923. The Agricultural Credits Act of that yearspecifically amended section 13 of the FederalReserve Act to provide that the paper of factors"issued as such making advances exclusively toproducers of staple agricultural products intheir raw state shall be eligible for such dis-count." 8S The same statute added to the Fed-eral Reserve Act a new section 13a that, amongother things, made eligible for discount paperof cooperative marketing associations the pro-ceeds of which were used for advances by suchassociations to their members for agriculturalpurposes. In the light of these changes in the

law, Regulation A was amended in 1923 toexcept agricultural factors' paper and paper ofcooperative marketing associations from theprohibition against the discount of financepaper."

As to other kinds of finance paper, the Boardcontinued after 1923 to exclude such paperfrom discount. Thus, it held that notes of awarehouse company engaged in a finance busi-ness used to finance its current operating ex-penses l0° and notes of an insurance agency tofinance the carrying of accounts covering pre-miums due on insurance sold by it101 were noteligible for discount.

REVERSAL OF BOARD'S POSITION

In 1937, however, the Board reversed itsposition with regard to the eligibility of financepaper. As part of a comprehensive revision ofRegulation A, the provision excluding financepaper was eliminated. The Board explained thatelimination of the provision would render eli-gible for discount "a large amount of paper ofcommission merchants and finance companies,including paper drawn to finance installmentsales of a commercial character."10S

Following this changed policy, the Boardmade it clear that if the proceeds of paperwere advanced to some other borrower, thepaper would be eligible for discount providedthe proceeds were ultimately used by such otherborrower for a commercial, agricultural, orindustrial purpose.103 Thus, a note given to abank or a finance company the proceeds ofwhich are to be used by the maker to purchasegoods for his own use is eligible paper; inholding to that effect, the Board pointed outthat, from a legal standpoint, there is no differ-ence between the discounting of a note in thehands of the seller and a direct lending by abank or finance company to the purchaser,since in either case the purpose is to finance"the final step in the distribution of goods, thesale to the consumer."1W



In a 1965 ruling the Board reaffirmed itsposition that notes of finance companies wereeligible for discount if they conformed to thematurity requirement of the law and if theproceeds were used to finance the purchase ofconsumer goods or for other purposes eligibleunder the Federal Reserve Act. Recognizingthat it is sometimes difficult to determine thepurposes for which individuals borrow fromfinance companies, the Board prescribed aformula that could be used in case of question:If a financial statement of the finance companyreflects an excess of notes receivable that ap-pear eligible for discount, without regard tomaturity, over the total current liabilities of thefinance company, this could be taken as anindication that the note of the finance companyis eligible for discount.105

This interpretation was clarified and liberal-ized in certain respects in 1972. The 1965formula for determining the eligibility of financecompany notes had referred to a financialstatement of the company reflecting an excessof notes receivable that appear eligible forrediscount "over total current liabilities (i.e.,liabilities maturing within one year)." Thisdefinition of "current liabilities" was changed to

refer to "notes due within one year" in orderto exclude a company's liabilities for suchthings as salaries and taxes.

In some instances, finance companies makewhat are known as direct consumer loans toindividuals when the purpose for which theproceeds are to be used cannot easily be de-termined. In its 1972 interpretation the Boardstated that when information is lacking as towhether such loans will be used for eligiblepurposes, it could be assumed that 50 per centof such loans would be "notes receivable whichappear eligible for rediscount."

The Board also stated that the language justquoted should be regarded as including notesgiven for the purchase of mobile homes that areacquired by a finance company from a dealer-seller of such homes. Previously, questions hadbeen raised as to whether such notes fell withinthe prohibition against the discounting of notesdrawn for permanent investments. Finally, itwas made clear that the principles of theBoard's position with respect to finance com-pany paper were applicable to the notes of afinance company engaged in making loans forbusiness and agricultural purposes as well as forconsumer loans.100

CONSUMER PAPER

Soon after the 1937 revision of Regulation A,when it first took the position that finance paperwas eligible for discount, the Board issued aninterpretation in which it made clear that aborrowing for the purpose of making a purchaseof goods is a borrowing for a commercial pur-pose whether the borrower intends to use thegoods himself or to resell them, since in sucha case the proceeds are used to finance a sale—a commercial transaction.107 Whatever mayhave been the intent of the framers of theoriginal Act with regard to limiting commercialloans to ordinary business loans, this ruling ofthe Board definitely reflected the view thatconsumer paper is to be regarded as eligible

for discount. For example, the Board's rulingreferred to the eligibility of a note given to amember bank by a householder who is to usethe proceeds to purchase household equipment,such as radios or furniture.

If the purchase of a radio by an individualconstitutes eligible consumer paper, it is diffi-cult to see why a note the proceeds of whichare used for the purchase of services, such asmedical services or travel advice, should notalso be considered a note given for a commer-.cial purpose. In the general revision of Regula-tion A adopted by the Board in 1973, a newprovision specifically makes such paper eligiblefor discount.



CONSTRUCTION PAPER

The National Housing Act of 1934 con-tained, along with provisions for the insuranceof certain housing mortgages, an amendmentto section 24 of the Federal Reserve Act thatprovided that loans made to finance the con-struction of residential or farm buildings andwith maturities not exceeding 6 months shouldnot be considered as real estate loans subject tothe restrictions of that section on real estateloans made by national banks, but should beclassified as "ordinary commercial loans." 10S

In addition, the amendment provided that notesrepresenting such loans should be eligible fordiscount as commercial paper if they wereaccompanied by a valid and binding agreement—entered into by an individual, partnership,association, or corporation acceptable to thediscounting bank—to advance the full amountof the loan upon completion of the building.

Although not entirely clear, it may be as-sumed that the condition requiring an agree-ment by a third party to advance the fullamount of the loan at maturity was intendednot only to afford protection to the lendingbank but also to make the paper self-liquidating,in keeping with the general concept that alldiscounted commercial paper should be self-liquidating in nature.

In 1955, section 24 was amended to extendthe permissible maturity of residential and farmconstruction loans from 6 months to 9months.109 The reason given for this liberalizingchange was that the prescribed 6-month periodhad proved to be unrealistically short in somecases, and it was expected that the increase to9 months might "serve to increase the avail-ability of funds for the financing of short-termresidential and farm construction work." n o

In 1959 these provisions were further liberal-ized to provide that loans made to finance theconstruction of industrial or commercial build-ings and with maturities of not more than 18months should not be considered real estateloans subject to the limitations of section 24, if

accompanied by an agreement by a financiallyresponsible lender to advance the full amountof the bank's loan upon completion of thebuilding.111 By successive amendments to sec-tion 24, the maximum maturity of constructionloans that are exempted from the limitationson real estate loans by national banks has beenincreased from time to time. At present anysuch loans, if they have maturities of not morethan 60 months—whether for the constructionof industrial or commercial buildings or for theconstruction of residential or farm buildings—are not regarded as real estate loans within themeaning of that section but as ordinary com-mercial loans.

In view of this liberalization of the provisionsof section 24, it might be assumed that all suchconstruction loans, being commercial in nature,should be regarded as eligible for discountunder section 13 of the Federal Reserve Act.This assumption is negatived, however, by thefact that section 24 provides specifically thatloans for the construction of residential or farmbuildings with maturities of not more than 9months shall be eligible for discount as com-mercial paper within the terms of the secondparagraph of section 13 but makes no similarprovision with respect to loans for the con-struction of industrial or commercial buildings.

The eligibility of residential and farm con-struction paper for discount by the ReserveBanks was specifically recognized in the Board's1937 revision of Regulation A.112 The regula-tion required that such paper (1) represent aloan to finance the construction of a residentialor farm building, whether or not secured byreal estate; (2) be endorsed by the memberbank; (3) be accompanied by an agreement bya person acceptable to the Reserve Bank toadvance the full amount of the loan upon com-pletion of construction; and (4) mature notmore than 6 months from the date the loanwas made and not more than 90 days from thedate of discount. These provisions were re-



peated without change in the January 1955revision of the regulation.113 The regulation wasnot changed to reflect the 1955 statutory in-crease in the permissible maturity of residentialand farm construction paper from 6 months to9 months until 1973, at which time the correc-tion was made in the general revision of theregulation.

As indicated, the Board's regulation requiresthat a residential or farm construction loan notonly must comply with the maturity requirementspecified in section 24 but also must have amaturity of not more than 90 days at the timeof discount. It is by no means clear that thislatter requirement is made necessary by the law.When the original provisions for constructionloans were added to section 24 in 1934, the

report of the House Banking and CurrencyCommittee stated that the Federal Reserve Actwas being amended to permit national banks tomake such temporary loans with maturities ofnot more than 6 months and to make "suchtemporary paper . . . eligible for discount ascommercial paper at the Federal ReserveBanks." 1U In view of this statement, it may beargued that—-since the intent of Congress wasto make such paper eligible for discount if ithad a maturity at the time of discount notin excess of that prescribed in section 24—tosuperimpose a further requirement that thepaper have a maturity of not more than 90 daysat the time of discount would render unneces-sary and meaningless the limitation on originalmaturity.


Agricultural Credits

THE ORIGINAL ACT

Granted that the primary objective of thediscount provisions of the original Federal Re-serve Act was the establishment of a market forcommercial paper, an important secondary ob-jective was to provide a new source of credit foragricultural purposes. In a separate section theAct authorized national banks for the first timeto make loans on farm lands. In the discountprovisions of section 13, agricultural paper wasgiven special prominence in a phrase that de-scribed commercial paper as paper issued foragricultural, industrial, or commercial purposes(a confusing description since distinctions havebeen made between commercial and agricul-tural paper). Moreover, the Act actually gavepreferential treatment to agricultural paper, atleast with respect to maturity limitations.

Clearly the framers felt that the Actwould provide substantial benefits to the agri-cultural interests of the country. In his openingstatement on the floor of the House, Mr. Glass


called particular attention to those provisionsof the bill that would bear upon "the farmerand his welfare." ' Other Congressmen stronglyendorsed the discount provisions as promisinggreat aid to agriculture.2 They felt that thepaper of farmers was fully as good as so-calledcommercial paper,3 even though agriculturalpaper might have longer maturities.1

It was recognized that agricultural loansnormally were made for a period correspondingto the crop season and that, consequently, the90-day maturity limitation generally prescribedfor paper eligible for discount would not beappropriate for such loans. The reasons forwhich agricultural paper was allowed a maxi-mum maturity of 6 months have been discussedin detail in Chapter 3 of this study; and thematurity requirements for such paper will beconsidered further in a later section of thepresent chapter.

Although, as has been noted, the original Actspecifically included paper issued for agricul-tural purposes in the description of paper eli-

43



gible for discount, it contained an additionalprovision expressly stating that nothing in theAct should be construed as prohibiting papersecured by staple agricultural products frombeing eligible for discount. This seemingly un-necessary provision apparently resulted from afeeling in some quarters that, without this pro-vision, paper drawn to finance the carrying of

agricultural products pending a higher pricemight be regarded as paper drawn for specula-tive purposes and therefore ineligible for dis-count.1 Despite this provision, it appears thatthe Board in 1922, as indicated in the previouschapter, concluded that such paper would be ofa speculative nature and not eligible for dis-count as agricultural paper.

AGRICULTURAL CREDITS ACT OF 1923

BACKGROUNDProposals for a long-range system of farm

credits reached legislative fruition in the enact-ment of the Federal Farm Loan Act in 1916.°Following the pattern of the Federal ReserveSystem, the Federal Farm Loan Act set up12 regional Federal land banks and providedfor the voluntary formation of joint-stock landbanks and national farm loan associations. Theland banks were authorized to make farm mort-gage loans with maturities of not less than 5and not more than 40 years. The whole systemwas placed under the supervision of a FederalFarm Loan Board. No change was made in thediscounting authority of the Federal ReserveBanks, but both the Reserve Banks and memberbanks of the Federal Reserve System werespecifically authorized to buy and sell farm loanbonds issued by the land banks.7

During World War I, farmers had little orno financial problems. In 1920, however, whendeflation set in, farm prices dropped; and theneed for additional agricultural credit becameacute.8

In 1921 the War Finance Corporation wasrevived, with authority, among other things, toprovide loans for agricultural purposes." ThatCorporation made a large volume of loans tofarmers, livestock companies, and cooperativemarketing associations. However, it was only anemergency agency, and there was a growingsentiment in favor of a more permanent systemof farm credits to meet the intermediate credit

needs of the farmer—loans with maturitiesshorter than the 5-year minimum maturity per-mitted by the Farm Loan Act and yet longerthan the 6-month maximum maturity prescribedfor the discount of agricultural paper by theFederal Reserve Banks. The growth of thissentiment led to the enactment of the Agricul-tural Credits Act of 1923.10

The chief advocates of the new farm creditlegislation in Congress were Senators Lenrootand Capper, and Chairman McFadden of theHouse Banking and Currency Committee.Aside from Congress, the principal impetusprobably came from Eugene Meyer, at that timeManaging Director of the War Finance Cor-poration and later Governor of the FederalReserve Board. Actually, Meyer felt stronglythat the best way to help the agricultural in-terests was to induce more country banks tobecome members of the Federal Reserve Sys-tem." However, he urged the enactment of thefarm credit bill as a means of meeting the prob-lems and difficulties that had come to the atten-tion of the War Finance Corporation in connec-tion with agricultural credits.12

GENERAL PROVISIONS

The Agricultural Credits Act set up 12 Fed-eral intermediate credit banks with authority tomake agricultural and livestock loans with ma-turities of from 6 months to 3 years. It providedalso for the voluntary organization of national


AGRICULTURAL CREDITS 45

agricultural credit corporations that, underregulations of the Comptroller of the Currency,were authorized to make loans on agriculturalpaper with a maturity of not more than 6months and on livestock paper with a maturityof up to 3 years; a further provision authorizedmember banks of the Federal Reserve Systemto purchase stock in these corporations. Suchwas the new machinery provided by the statute.In addition, certain amendments were made tothe existing farm credit provisions of the Fed-eral Farm Loan Act and to the discount pro-visions of the Federal Reserve Act; the latterare of particular interest here.

AMENDMENTS TO FEDERALRESERVE ACT

The general objective of the 1923 amend-ments to the Federal Reserve Act was to makeeligible for discount certain types of agricul-tural paper that previously had not been eligi-ble, either because of the maturity limitationsor because of other limitations of the law asthey had been interpreted by the Board. Thematurity requirements were liberalized bothfor agricultural paper in general and for bank-ers' acceptances based on agricultural transac-tions. Sight or demand drafts drawn to financedomestic shipments of agricultural productswere made eligible for discount, as were draftsof factors drawn to finance producers of stapleagricultural products. A new section—13a—was added to the Federal Reserve Act dealingspecifically with the discounting of agriculturalpaper for Federal intermediate credit banksand cooperative marketing associations. Asstated by Senator Capper, who sponsored thebill in the Senate, the purpose of these provi-sions was "to make such changes in the rulesof eligibility governing agricultural paper asseem necessary to fit the actual requirementsof the farmer." "

In the opinion of Eugene Meyer, the amend-ments to the discount provisions of the FederalReserve Act were the most important in thebill.14 His statement before the House Bankingand Currency Committee regarding adjustmentof the Federal Reserve System to meet changingconditions is worthy of quotation here because

of its applicability not only to the agriculturalcredit functions of the System but also to theSystem's functions in general: 1S

* * * The adjustments contemplated arein line with the experience of the last fewyears, and their purpose is merely to adapt theFederal reserve system, so far as agricultureis concerned, to changed conditions. Thosewho object to adjusting the eligibility rules ofthe system to the time required for theorderly marketing of agricultural productsunder present conditions seem to fear thatthe soundness of the system may be jeopar-dized. But the system suffers from friends aswell as from foes. Those who defend its everyact and policy and who stand for the immuta-bility of its present law and regulations maybe as harmful as those who are extreme intheir denunciation of the part played by itin the collapse of commodity markets andprices. The true friends of the Federal reservesystem are those who are willing to see itsmachinery adjusted along sound lines to meetchanging conditions, both in this country andabroad.

Shortly after the enactment of the Agricul-tural Credits Act of 1923, the Board in a pub-lished statement reviewed and explained theincreased farm credit facilities provided by thatact. In general, the Board said that it had "soconstrued and administered the law as to im-prove, in the highest possible degree, the creditstanding and economic position of the agricul-tural interests, placing at their disposal, throughits discounts for member banks and its open-market operations, the vast resources of theFederal reserve system to the fullest extentpermitted by the law and by the principles ofsound banking."10

Since 1923 Congress has enacted numerousstatutes to provide further credit assistance toagriculture, including, among others, the FarmCredit Acts of 1933 and 1937, the FederalFarm Mortgage Corporation Act of 1934, andthe Farm Credit Act of 1971. However, nosubstantial changes in the authority of the Fed-eral Reserve Banks to discount agriculturalpaper have been made since the liberalizingamendments made by the Agricultural CreditsAct of 1923. Amendments to the law authoriz-ing advances by the Reserve Banks to member



banks on the security of obligations of Federalintermediate credit banks and other Federallyestablished organizations to provide agricul-tural credit will be discussed later.

As discussed in Chapter 3, discounts of agri-cultural paper are subject to the general limita-tions relating to endorsement and to the amount

of paper of one borrower that may be dis-counted for any member bank. Before discuss-ing the one important difference between agri-cultural and commercial paper—the moreliberal maturity requirements applicable toagricultural paper—it is necessary to considerthe nature of agricultural paper.

NATURE OF AGRICULTURAL PAPER

REGULATORY DESCRIPTIONThe Federal Reserve Act itself did not under-

take to define agricultural paper or agriculturalpurposes, although it was clear that paper basedon livestock was intended to be covered bythese terms. More specific description was leftto the discretion of the Federal Reserve Board.

In 1915, in a separate regulation pertainingto agricultural paper,17 the Board stated merelythat paper issued or drawn for agriculturalpurposes or based on livestock meant paperthe proceeds of which had been used or wereto be used for agricultural purposes, "includingthe breeding, raising, fattening, or marketing oflive stock." After the passage of the Agricul-tural Credits Act of 1923, the Board in arevised regulation 1S more particularly referredto paper drawn for, or the proceeds of whichwere to be used for, "the production of agri-cultural products, the marketing of agriculturalproducts by the growers thereof, or the carryingof agricultural products by the growers thereofpending orderly marketing, and the breeding,raising, fattening, or marketing of live stock."The same language was used in the 1955 revi-sion of Regulation A.10 Paper of cooperativemarketing associations was specifically declaredto constitute agricultural paper if it met certainrequirements. Otherwise, the Board has neverattempted by regulation to describe agriculturalpaper in any detail, and the revision adopted in1973 omits even the general description of suchpaper indicated above.

DISTINGUISHED FROMCOMMERCIAL PAPER

In the early days of the System, the Boardfound it necessary to issue a number of inter-pretations distinguishing agricultural paperfrom commercial paper, in view of the moreliberal maturity requirements applicable to theformer type of paper. In general, these inter-pretations are still in effect.

The basic test is whether the commodity forthe purchase of which a note is given willactually be used for agricultural purposes. Eventhough the commodity itself is of an agriculturalnature, the note is not considered agriculturalpaper if the purchaser does not intend to use itfor an agricultural purpose.20 Hence, purchaseof such a commodity merely for resale is notsufficient;2I in such a case the paper must betreated as commercial rather than agriculturalpaper.22 However, as long as the commodity isactually to be used for an agricultural purposeby the purchaser, the note given by him maybe considered agricultural paper, whether dis-counted by the maker or by the seller-en-dorser.23 Thus, the Board ruled that notes givenfor commercial fertilizer,21 tractors used in agri-cultural operations,50 agricultural implements,20

and the draining and tilling of farm land"may be considered agricultural paper.

Livestock paper—that is, paper to financethe breeding, raising, fattening, and marketingof livestock—has always been regarded as agri-cultural paper.28 One of the principal purposes



of the Agricultural Credits Act of 1923 was toprovide needed credit to breeders of livestock.For this purpose, the Board held that cows,horses, and mules are livestock.29 However,notes given by dealers in cattle and mules are

commercial rather than agricultural paper,30

and the notes of a packing company given forthe purchase of livestock to be slaughtered arenot notes "based on live stock" within themeaning of the law.31

MATURITY

The original Federal Reserve Act allowed amaximum maturity of 6 months for agriculturalpaper, as contrasted with the 90-day maturityrequirement applicable to all other types ofpaper. This allowance was made with no intentto single out agricultural paper for special favorbut simply in recognition of the fact that themarketing of farm crops and livestock normallyrequires a longer period of financing than ordi-nary commercial transactions. The considera-tions that led the framers of the original Actto prescribe a more liberal maturity requirementfor agricultural paper than for commercialpaper have been noted in Chapter 3.

Even a 6-month maturity limitation soonproved to be inadequate, and the AgriculturalCredits Act of 1923 increased the maturitypermitted for agricultural paper to 9 months.

Apparently this further liberalization wasprompted largely by the contention of represen-tatives of livestock associations that the then-existing 6-month limitation was not adequate toprovide assistance to breeders, as distinguishedfrom raisers, of livestock." The Senate Bankingand Currency Committee felt that the longerperiod of maturity "would be helpful and was insome cases necessary," and that such a length-ening of the maturity of agricultural paperwould in no way impair the liquid character

essential to Federal Reserve Bank discounts.33

Congress agreed with those "in control of theFederal reserve system" that paper having amaturity of more than 9 months should not beeligible for discount because the paper redis-counted by the Reserve Banks "must be self-liquidating." 3i As a safeguard, the SenateBanking and Currency Committee inserted anew provision prohibiting the use of paper withmaturities greater than 6 months as securityfor Federal Reserve notes, unless the paper wassecured by warehouse receipts or security docu-ments or chattel mortgages on livestock.35

In addition to increasing the maximum ma-turity prescribed for the discount of agriculturalpaper, the Agricultural Credits Act of 1923increased the maturity prescribed by section 13of the Federal Reserve Act for the discount ofbankers' acceptances from 90 days to 6 monthswhen the acceptances were for agricultural pur-poses and were secured by title documents cov-ering readily marketable staples. The FederalReserve Board had previously ruled that agri-cultural acceptances with maturities of up to6 months could be purchased by the FederalReserve Banks in the open market, and Con-gress felt that there was no reason "why suchacceptances should not be given the full benefitof the rediscount privilege." M



AMOUNT LIMITATIONS

The longer maturity permitted for agricul-tural paper was a departure from the orthodoxdoctrine that only short-term paper should beeligible for discount, and Congress agreed tothis departure only with a qualification. Toprevent the discounting of long-term agricul-tural paper in excessive amounts, the originalFederal Reserve Act provided that discounts ofsuch paper should be limited to a percentageof the capital of the discounting Federal Re-serve Bank, "to be ascertained and fixed by theFederal Reserve Board."

Pursuant to this provision, the Board byregulation limited the aggregate amount ofagricultural paper with a maturity of more than3 months and less than 6 months that eachFederal Reserve Bank might discount to 25per cent of the Reserve Bank's paid-in capital.37

At the same time the Board indicated that, inthose districts in which 6-month paper wasparticularly required to carry through agricul-tural operations, the 25 per cent limit would beincreased upon request of the Reserve Banks.38

In 1916 Congress sought to make the statu-tory limitation more liberal by requiring it tobe based on a percentage of the assets, rather

than of the capital, of the discounting FederalReserve Bank.30 Still later, the AgriculturalCredits Act of 1923 authorized the Board byregulation to limit the amount of paper with amaturity ranging from 3 to 6 months and from6 to 9 months that might be rcdiscounted by aReserve Bank. Pursuant to these changesin the law, the Board in its 1923 revision ofRegulation A provided that there should be noamount limitation on the discount of paperwith a maturity of more than 3 months and lessthan 6 months, but that the aggregate amountof discounted agricultural paper with a ma-turity of between 6 and 9 months should notexceed 10 per cent of the total assets of aFederal Reserve Bank.10 Although the authorityfor such limitations is still in the law, the limitfixed by the Board in 1923 was omitted fromRegulation A in 1937, and no amount limita-tion is now in force.

One should bear in mind, however, thatagricultural paper continues to be subject tothe same limitations on the amount of paperof any one borrower that may be discounted fora member bank as those that are applicable tothe discounting of other types of paper.

SIGHT DRAFTS

Drafts payable at sight or on demand do not,of course, have any fixed maturity, and it ispossible that they may not actually be presentedfor payment within 90 days, or even within 6or 9 months. For this reason, the Board in1917 ruled that demand paper was not eligiblefor discount.41 It was the custom, however, formany member banks during crop-moving pe-riods to discount large volumes of sight draftssecured by bills of lading covering the shipmentof wheat, cotton, or other agricultural products;

these drafts, although having no fixed maturity,were usually paid with promptness and wereconsidered a liquid and desirable form of paper.Accordingly, the Board recommended to Con-gress that the law be amended to make suchdrafts eligible for rediscount by the ReserveBanks under certain conditions.42

Such an amendment was made by the Agri-cultural Credits Act of 1923.43 It extended thediscount privilege to bills of exchange payableat sight or on demand if drawn to finance the



domestic shipment of "nonperishable, readilymarketable staple agricultural products" and ifsecured by bills of lading or other shippingdocuments conveying or securing title to suchstaples. The act contained the provision, how-ever, that all such bills should be forwardedpromptly for collection and that demand forpayment should be made, with reasonablepromptness after the arrival of the staples attheir destination; and no such bill could be heldby or for the account of a Federal Reserve Bankfor more than 90 days. In discounting suchsight bills, the Reserve Banks were authorizedto compute the interest to be deducted on thebasis of the estimated life of the bill and to ad-just the discount after payment of the bill to con-form to its actual life. In 1928, the provisionwas expanded to permit the discounting of sightbills covering nonagricultural as well as agricul-tural staples and covering the exportation aswell as the domestic shipment of such staples.14

In its 1923 revision of Regulation A, theBoard followed in general the language of thelaw with respect to discounts of sight or demandbills,40 and the regulatory provisions on thissubject remained substantially the same until1973." These provisions, however, became un-necessary in 1966 when the Board ruled thatall demand notes met the maturity requirementsof the law and therefore were eligible for dis-count if they met other eligibility requirements.47

In the light of this fact, the general revisionof Regulation A adopted by the Board in 1973omitted the special regulatory provision regard-ing demand drafts.

In 1923, when the special authority for thediscount of sight or demand paper still hadsignificance, the Board stated that it did notdeem it advisable to formulate a comprehensivedefinition of the term "readily marketable non-perishable staple" and that the Reserve Banksshould exercise their discretion in the matter.48

In specific instances, however, the Board heldthat cottonseed should be,49 and cottonseed oilshould not be,50 considered readily marketablestaples for this purpose. As has been noted, thestatutory provisions were changed in 1928 tocover nonagricultural as well as agriculturalstaples. When Regulation A was revised in1937, it carried a footnote stating that, withinthe meaning of the regulation, a readily market-able staple meant "an article of commerce,agriculture, or industry of such uses as to makeit the subject of constant dealings in readymarkets with such frequent quotations of priceas to make (a) the price easily and definitelyascertainable and (b) the staple itself easy torealize upon by sale at any time."51 Thisdefinition followed a similar definition that hadpreviously been adopted by the Board for thepurpose of determining the eligibility of bank-ers' acceptances growing out of the storage ofreadily marketable staples. The scope of theterm will be considered further in the followingchapter relating to the discounting of bankers'acceptances. The definition was omitted in therevision of Regulation A adopted in 1973 since,as previously indicated, that revision did notinclude any provision relating specifically to theeligibility of sight or demand drafts.

FACTORS' PAPER

At the time of the hearings on the Agricul-tural Credits Act of 1923, Governor EugeneMeyer pointed out that, in addition to sightbills, there was another class of agricultural pa-Per that had theretofore been ineligible for dis-count because of rulings of the Federal ReserveBoard. The Board had held that finance paper

the proceeds of which were to be loaned to thirdpersons was not eligible for discount. Based onthis theory, the paper of cotton factors, whocarried the cotton for their customers until itwas sold, could not be offered for discount/1-Governor Meyer felt that this was a "hairsplit-ting" distinction.03



Congress apparently agreed with GovernorMeyer. The Agricultural Credits Act of 1923amended section 13 of the Federal Reserve Actto provide expressly that nothing in the lattershould be construed to prevent "the notes,drafts, and bills of exchange of factors issued assuch making advances exclusively to producersof staple agricultural products in their rawstate" from being eligible for discount. A para-phrase of this provision was incorporated in theBoard's 1923 revision of Regulation A,54 anda similar provision appeared in the 19SS regu-lation.55 It was omitted, however, from therevision of the regulation adopted in 1973.

This provision related only to factors' paperdrawn to finance producers of agricultural prod-ucts in their raw state. Thus, the Board heldthat if the proceeds of a cold-storage company'snotes were to be used for making advances to

producers of eggs and poultry, the notes wouldbe eligible for discount, but that butter is not anagricultural product in its raw state and thatconsequently notes covering advances to thoseengaged in the commercial production of butterfrom cream purchased from others would notbe eligible for discount.56

Some years later, as has been noted in Chap-ter 4, the Board reversed its previous positionregarding the eligibility of finance paper fordiscount. Since 1937, not only agricultural fac-tors' paper but any paper the proceeds of whichare to be loaned to third persons has beeneligible for discount if the proceeds are ulti-mately to be used for commercial, agricultural,or industrial purposes. Consequently, the gen-eral revision of the regulation adopted by theBoard in 1973 does not include any provisionrelating specifically to factors' paper.

PAPER OF COOPERATIVE MARKETING ASSOCIATIONS

By 1923 cooperative marketing associationshad assumed considerable importance as agen-cies for enabling farmers to market their cropsto better advantage.57 Normally such associa-tions were nonstock organizations whose mem-bership consisted of the producers of the par-ticular crop that the organization was designedto market and to which the members deliveredtheir crops for sale. The commodities werepooled according to grade, and after all of aparticular pool had been sold by the associationthe proceeds were distributed pro rata to theproducers who had contributed to that pool.0*

In a number of rulings prior to 1923 °9

the Board had held that in some circumstancesnotes of cooperative marketing associationswere eligible for discount as agricultural paper,but that in other circumstances such notes werenot eligible for discount or were eligible onlyas commercial paper and therefore must havea maturity of not more than 90 days. Forexample, the Board had held that notes of anassociation engaged in packing and marketing

products that it had not grown, the proceeds ofwhich were used to pay current expenses and topurchase supplies, were eligible for discountonly as commercial paper.60

The Agricultural Credits Act of 1923 recog-nized the essentially agricultural nature of co-operative marketing associations and, as statedby Eugene Meyer, "swept away" technical dis-tinctions based on the legal form in which theirpaper was issued.81 A new section—13a—added to the Federal Reserve Act provided thatnotes, drafts, and bills of exchange issued ordrawn by such associations should be "deemed"to have been issued or drawn for an agriculturalpurpose if their proceeds were (1) advanced totheir members for an agricultural purpose, (2)used to make payments to members for agri-

' cultural products delivered to the associations,or (3) used to meet expenditures incurred inconnection with grading, packing, preparingfor market, or marketing of any agriculturalproducts handled by the associations for theirmembers.



After the enactment of the AgriculturalCredits Act of 1923, the Board published arevised statement of general principles regard-ing the discount of paper of cooperative market-ing associations.62 Among other things, thisstatement made it clear that the following typesof paper would be eligible for discount as agri-cultural paper: growers' drafts accepted by theassociations and covering deliveries of crops, ifthe proceeds were used by the growers foragricultural purposes; growers' paper used tofinance the carrying of their products for areasonable period incident to orderly market-ing; and paper of the associations to financethe packing and marketing of the products oftheir members, to pay for products purchased

from their members, or to make advances totheir members for agricultural purposes.

In a revision of its Regulation A, the Boardfollowed the language of the amended law asto the eligibility of paper of cooperative mar-keting associations for discount; however, theregulation provided that such paper would notbe eligible if the proceeds were used to defrayexpenses of organizing the association, or toacquire warehouses, or to purchase or improvereal estate or other fixed or permanent invest-ments.63 The 1973 revision of Regulation Aomits the paragraph dealing specifically withpaper of cooperative marketing associations,but such paper is referred to as constitutingagricultural paper for purposes of discount.

DISCOUNTS FOR FEDERAL INTERMEDIATE CREDIT BANKS

As noted at the beginning of this chapter,the Agricultural Credits Act of 1923 set up asystem of Federal intermediate credit banks tomake loans to farmers with maturities inter-mediate between the short-term credit availablethrough the Federal Reserve Banks and thelong-term credit obtainable from the Federalland banks. The intermediate credit banks wereauthorized to discount agricultural and livestockpaper for State and national banks, agriculturalcredit corporations, livestock loan companies,and cooperative marketing associations, and tomake direct loans to cooperative marketingassociations. The maturity of all such discountsand advances was limited to a minimum of 6months and to a maximum of 3 years.

In turn, the Federal intermediate credit bankswere permitted to rediscount their paper withthe Reserve Banks on the same basis on whichagricultural paper in general could be offeredfor discount to the Reserve Banks. Thus, to beeligible for discount, such paper had to beendorsed by the intermediate credit bank andhad to have a maturity at the time of discountof not more than 9 months, exclusive of daysof grace. In addition, the Federal Reserve

Board had the right to limit the amount ofpaper with maturities of 3 to 6 months and of6 to 9 months that might be rediscounted by aFederal Reserve Bank. Furthermore, the newlaw specifically provided that no Reserve Bankshould rediscount for a Federal intermediatecredit bank any note bearing the endorsementof a nonmember State bank that was eligiblefor membership in the Federal Reserve System.This was the first instance in which the discountfacilities of the Federal Reserve Banks weremade available to any but member banks of theFederal Reserve System.

In addition to authority to discount paperfor the intermediate credit banks, the Agricul-tural Credits Act of 1923 gave the ReserveBanks authority to buy and sell debentures andother such obligations issued by the Federalintermediate credit banks or by the nationalagricultural credit corporations provided for inthe same Act, but only subject to the samelimitations as those applicable to the purchaseand sale of farm loan bonds. Farm loan bonds,under the Farm Loan Act of 1916, could bebought and sold by the Reserve Banks to thesame extent as State, county, and municipal



bonds could be purchased pursuant to section14(b) of the Federal Reserve Act, and thatsection prescribed a maturity limitation of 6months at the date of purchase. Finally, it maybe noted that the Agricultural Credits Actadded to section 14 of the Federal Reserve Acta new provision authorizing the Reserve Banksto purchase and sell in the open market ac-ceptances of the intermediate credit banks andthe national agricultural corporations wheneverthe Federal Reserve Board should declare "thatthe public interest so requires." All of theseprovisions relate to purchases by the ReserveBanks rather than to the discounting and lend-ing functions of the Banks; they are mentionedhere to indicate the extent to which Congress in1923 provided for the use of the Federal Re-serve System in facilitating the operations ofFederal intermediate credit banks and in fur-thering extensions of agricultural credit.

Discounts for the intermediate credit bankswere made subject to regulations and limitationsto be prescribed by the Federal Reserve Board.In its 1923 revision of Regulation A,C4 theBoard required each Federal Reserve Bank, indiscounting paper for any intermediate creditbank, to "give preference to the demands of itsown member banks" and to have "due regard tothe probable future needs ,of its own memberbanks." In addition, a Federal Reserve Bankwas prohibited from discounting such paperwhenever its own reserves were less than 50per cent of its aggregate liabilities for depositsand Federal Reserve notes in circulation,05 andthe total amount discounted by all FederalReserve Banks at any one time for any oneintermediate credit bank was limited to theamount of the capital and surplus of suchintermediate credit bank.

In 1928 both of these amount limitationswere made less rigid by an amendment to theregulation allowing them to be exceeded "withthe permission of the Board."68 In the 1937general revision of Regulation A,67 the limita-tion on the aggregate amount of discounts byall Reserve Banks for any one intermediatecredit bank was omitted altogether. In 1955the other limitation was also omitted, primarilybecause the reserves of all Federal ReserveBanks had for some time been less than 50

per cent of their deposit and note liabilities andthe Board's permission would therefore benecessary in all cases. It was specifically pro-vided that all discounts for intermediate creditbanks should be made only with the permissionof the Board.0" The 1973 revision of RegulationA drastically condensed the section regardingdiscounts for intermediate credit banks butwithout any change in substance.

In the meantime Congress amended thelaw to provide the Federal intermediate creditbanks with additional facilities for "acquiringfunds through the Federal reserve system."69

The Act of May 19, 1932,70 authorized the useof intermediate credit bank debentures as col-lateral for advances by the Reserve Banks tomember banks. In addition, it amended sec-tion 13a of the Federal Reserve Act to permitthe Reserve Banks to discount for the inter-mediate credit banks notes payable to suchbanks and endorsed by them if the notes hadmaturities of not more than 9 months and weresecured by paper eligible for discount by theReserve Banks. The purpose of the added au-thority to discount notes payable to the inter-mediate credit banks was simply to permit thediscounting of paper representing direct ad-vances made by such banks to agriculturalassociations and other financial institutions.As explained by Chairman Stcagall of theHouse Banking and Currency Committee, itwas "a piece of lost machinery in the inter-mediate credit banks" that the committee wasattempting to supply.

In practice, the Reserve Banks do not nowdiscount paper of Federal intermediate creditbanks. However, under present law the ReserveBanks are authorized, with the permission ofthe Board, to discount for any Federal inter-mediate credit bank (1) paper meeting theregulatory definition of agricultural paper and(2) notes payable to such intermediate creditbank that represent loans made by it and thatare secured by any paper eligible for discountby the Reserve Banks. In either case, the papermust be endorsed by the intermediate creditbank, must have a maturity of not more than9 months at the time of discount, and must notbear the endorsement of a nonmember Statebank. No amount limitation is prescribed.


Bankers'Acceptances

GENERAL CONSIDERATIONS

PURPOSESIn authorizing extensions of Federal Reserve

credit on commercial and agricultural paper,the original Federal Reserve Act sought toprovide a broader market for well-known exist-ing types of paper. In contrast, the provisionsof the Act with respect to bankers' acceptanceshad as their objective the development of amarket for what was then considered a newtype of commercial paper in the United States,and it is clear that their underlying purpose wasto stimulate U.S. foreign trade.

The unimportant role of U.S. banks in thefinancing of foreign trade had been deplored bythe National Monetary Commission in its 1912report.1 When the House Banking and CurrencyCommittee reported the Glass bill on the Fed-eral Reserve in 1913,2 it stated that in theopinion of expert bankers the "acceptance formof loan," which was very common in Europe,could "be applied in the United States to ex-cellent advantage." To remedy the situation, it


was proposed to give national banks expressauthority to accept drafts and bills of exchangeand, in addition, to authorize the FederalReserve Banks to discount such acceptances,subject in both cases to limitations on maturityand amount.

The major purpose of these provisions wasto permit the financing of foreign businessthrough U.S. markets rather than through for-eign markets, particularly the London market.Mr. Phelan said: :t

Taken in connection with the permission toestablish foreign branches it means that ourimporters and our exporters shall no longer bedependent upon London, and that they shallbe freed from the annual tribute which theyhave been required to pay London bankers.

This purpose was more fully explained bySenator Swanson:4

* * * This country, having no system ofacceptances in vogue by banks, has been com-pelled to resort to the foreign system in orderto conduct our foreign business. All of our

53Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis


transactions in exportation and importation ofgoods is thus conducted in foreign moneycenters. The bankers and their customers inthis country have to pay immense sumsannually for this accommodation. The re-serve banks, by being permitted to rediscountthe acceptances of member banks, will soondo this class of business to the great benefit ofthe banks and their customers, and result inthe saving of many millions of dollars annu-ally. * * •

The greater marketability of paper acceptedby well-known banks was emphasized by Sena-tor Weeks in referring to the acceptance pro-visions of the bill: s

* * * If the merchant made a promissorynote, he might find it necessary to pay 5 percent for that money; but if he draws on awell-known bank or a well-known banker, hemay be able to sell his paper on a 4 per centbasis. * * •

For that reason, we undoubtedly will seea lower interest rate to every man who has abroad credit as a result of this system. Thatis the kind of paper that will not only go inour own reserve banks and be available as abasis for circulation, but it is the kind ofpaper that will give our business men aworld-wide credit.

With the financing of foreign trade in mind,the Glass bill authorized national banks toaccept, and the Federal Reserve Banks to dis-count, only acceptances based upon the impor-tation or exportation of goods. Mr. Glassremarked during the debates in the House thatthis limitation had "been complained of bymany of those who believe that its extension todomestic operations would be highly advan-tageous to industry." 6 Indeed, the Senate wasopposed to the limitation; both the Owen billand the Hitchcock bill would have coveredacceptances growing out of domestic as well asforeign transactions. In the conference on thebill, however, the House conferees prevailedand the reference to domestic shipments wasomitted.

On the very day on which the Act was finallyapproved, Senator Bristow asked why the ref-erence had been cut out and why the dealer

in foreign merchandise should be "given anadvantage over the dealer in domestic mer-chandise on exactly the same kind of paper."Senator Owen replied that he had yielded with"very great reluctance" on this point, but thatthe House conferees had demanded its omissionon the ground "that small banks were apt toabuse the right of selling their credit in theway of acceptances by accepting domestic billsin default of any accommodation they couldextend at the time because of their then re-sources."7 It was not until 1916 that theacceptance provisions were broadened to coverdomestic transactions. How this came about willbe discussed later.

EARLY ENCOURAGEMENTBY THE BOARD

Recognizing the novelty of acceptances, theFederal Reserve Board proceeded cautiouslyafter the enactment of the original Federal Re-serve Act. In issuing its first comprehensiveregulation on the subject, the Board in April1915 observed: 8

* * * The acceptance is still in its infancyin the field of American banking. How rapidits development will be can not be foretold;but the development itself is certain. Oppor-tunity is given by the Federal reserve act toassist the movement in this new direction; thepresent regulations are to be regarded as afirst step and will be extended as circum-stances and a reasonable regard for the otheruses and needs of the credit facilities of theFederal reserve system may warrant.

At the same time, the Board called attentionto the highly desirable character of bankers'acceptances and stated that they would be dis-counted at a preferential rate, as follows: "

The acceptance is the standard form ofpaper in the world discount market and bothon this account and because of its acknowl-edged liquidity universally commands apreferential rate. By reason of its beingreadily marketable it is widely regarded as amost desirable paper in the secondary re-serves of banks and will help to provide aneffective substitute for the "call loan."


BANKERS' ACCEPTANCES 55

In the fall of 1915, when the Board amendedits regulations to relax provisions prohibitingthe renewal of acceptances, the Board de-clared: 10

It has been the aim of the Board to doeverything in its power to create for theAmerican acceptance, that is, dollar exchange[not to be confused with dollar exchangeacceptances authorized the following year],a dominating position in the world market.* * * In widening somewhat the facilitiesof Federal reserve banks in dealing withAmerican bankers' acceptances, the Board isattempting to give the member banks alarger opportunity for developing their sphereof usefulness in this respect.

By the latter part of 1916, the System's policyof encouraging bankers' acceptances began toshow results. The Board was able to say: "

There can be but little doubt that the lawpermitting national banks to accept draftsbased upon foreign-trade transactions hasbeen a most helpful factor in the recent move-ment of our foreign trade. Dollar acceptances[still not to be confused with dollar exchangeacceptances] are now becoming known inalmost all parts of the world, and are boundto prove a most powerful instrument in pro-moting and facilitating the commercial rela-tions between this country and our foreignmarkets, where commercial credit has to beextended by our exporters desirous to enterthese markets in competition with Europeanhouses. * * •

The movement to encourage an acceptancemarket continued despite the intervention ofWorld War I. In its Annual Report to Congressfor 1919, the Board, after noting that there wasnot in this country any broad acceptance marketsuch as existed in London, went on to say: "

* * * The development of such a marketis necessarily a slow process and the burdenof its support has fallen during the year 1919,as in previous years, upon the Federal Re-serve Banks. This condition will doubtlesscontinue until banks generally begin to investfunds temporarily idle in acceptances anduntil this method of employing funds appealsto the private investor. * * *

In the following year, the Board reported toCongress that "appreciable progress" had beenmade in the development of a market forbankers' acceptances and that the FederalReserve Banks continued to be "the greatestinfluences" in that market."

These statements by the Board are significantas indicating the attitude of the System towardbankers' acceptances during the earlier years.The System's policy of encouragement wasreflected in preferential discount rates. At thesame time, the novelty of acceptances in U.S.banking was evidenced by the numerous rulingsand interpretations issued by the Board duringthose years. In fact, a major part of the inter-pretations of the Board published in the FederalReserve Bulletin before 1924 related to bank-ers' acceptances.

After 1923, however, the emphasis placed onbankers' acceptances gradually diminished.Since then, there has been no change in thelaw on this subject. No change has been madein the Board's Regulation C relating to themaking of acceptances by member banks (seeAppendix C) since 1946, and provisions ofRegulation A regarding the discounting of ac-ceptances by the Reserve Banks were drasticallycondensed in the 1973 revision of that regula-tion. Only in recent years has interest in bank-ers' acceptances revived, with some evidenceof resurgence in the acceptance market.11

DEFINITION

An excellent nontechnical definition of abanker's acceptance is set forth in the followingexcerpt from an article that appeared in a 1955issue of the Federal Reserve Bulletin, to which,incidentally, the reader is referred for a goodsummary of the development of bankers' ac-ceptances in the United States: "

A banker's acceptance is a time bill ofexchange (frequently called a time draft)drawn on and accepted by a banking institu-tion. By accepting the draft the bank signifiesits commitment to pay the face amount atmaturity to anyone who presents it for pay-ment at that time. In this way the bankprovides its name and credit and enables its



customer, who pays a commission to the ac-cepting bank for this accommodation, tosecure financing readily and at a reasonableinterest cost. For investors, bankers' accept-ances represent short-term private paper witha maximum degree of safety and liquidity,comparable to that enjoyed by Treasury bills.

Bankers' acceptances have been utilized inthe United States and abroad in part tofinance domestic transactions but primarily intransactions related to international trade.Buyers and sellers engaged in foreign trans-actions are apt to be less well known to eachother and the shipping time is longer than isusually the case in domestic transactions.

Somewhat more legal in nature was thedefinition stated by the Board in its 1915regulations. There the term "acceptance" wasdefined as: 18

* * * a draft or bill of exchange drawn toorder, having a definite maturity, and payablein dollars, in the United States, the obligationto pay which has been accepted by anacknowledgement written or stamped andsigned across the face of the instrument bythe party on whom it is drawn; such agree-ment to be to the effect that the acceptor willpay at maturity according to the tenor of suchdraft or bill without qualifying conditions.

In a separate place, the regulation provided thatan acceptance, in order to be eligible for dis-count, must have been made by "a memberbank, nonmember bank, trust company, or bysome private banking firm, person, company,or corporation engaged in the business of ac-cepting or discounting." If it met these require-ments, the acceptance was to be considered a"banker's" acceptance.1'

The definition was simplified in the Board's1916 revision of Regulation A. There the term"banker's acceptance" was defined simply as"a draft or bill of exchange of which the ac-ceptor is a bank or trust company, or a firm,person, company, or corporation engaged in thebusiness of granting bankers' acceptancecredits." 1H

Four years later the definition was changedto make it clear that an eligible acceptancecould be payable either in the United States or

abroad and either in dollars or in some othermoney.1" This was a reversal of the positiontaken by the Board in 1915 that the instrumentmust be one payable in dollars in the UnitedStates.

The Board's present Regulation A, as dras-tically revised in 1973, omits any definition ofa banker's acceptance.

In construing its earlier regulatory definition,the Board made it clear that an acceptance mustbe made by the party upon which it is drawn.For example, a draft drawn upon a land com-pany but accepted by a bank cannot properlybe considered a banker's acceptance.80

It should be noted, however, that the defini-tion did not require that the acceptor be a bank.If the acceptor was in the habit of carrying onsome acceptance business, its acceptances quali-fied as bankers' acceptances.21 In pursuance ofthe policy of developing a U.S. acceptance busi-ness, the Board in 1918 announced that ac-ceptances of "acceptance corporations" shouldbe considered on the same basis as those ofprime private bankers and should not be dis-criminated against.22

ACCEPTANCE AUTHORITY OFMEMBER BANKS

It seems reasonably clear that the framers ofthe original Federal Reserve Act assumed thatnational banks lacked authority to accept timedrafts. The House committee report stated thatthe acceptance business was "a new form ofbusiness heretofore forbidden to nationalbanks." 21 Mr. Phelan observed in the Housethat "under our national banking laws nationalbanks are not permitted to accept drafts or billsof exchange." 2* In the Senate, Senator Swansondeclared that the bill would "open up a newfield of business for our national banks."25

Following enactment of the original Act, theFederal Reserve Board on several occasionsexpressed the view that national banks had noacceptance powers prior to 1913,26 and it ap-pears that the Comptroller of the Currency tookthe same position for many years. In 1963,however, the Comptroller sharply reversed thatposition and ruled that national banks were notlimited by the Federal Reserve Act as to the



kinds of acceptances they might make in financ-ing credit transactions; this ruling was basedlargely on the ground that the making of ac-ceptances constituted an essential part of thegeneral banking powers authorized in the Na-tional Bank Act.37

Although the provisions of the original Fed-eral Reserve Act were in terms of authorizingany member bank to make acceptances of thekinds therein described, they were obviouslynot intended to confer any new authority uponState member banks since State banks derivetheir powers from State law. Nevertheless, theprovisions could reasonably have been inter-preted as limiting State member banks, as wellas national banks, to the types of acceptancesdescribed in the Act. Although the Act ex-pressly provided that State banks joining theSystem should retain their charter and statutoryrights as State banks, this reservation was madesubject to the provisions of the Federal ReserveAct. In the form in which the bills passed bothHouses of Congress, the acceptance provisionsreferred only to national banks; but the con-ference committee changed the words "nationalbank" to "member bank." Although no ex-planation was given for this change, it seemslikely that it was intended to limit State memberbanks, as well as national banks, to the makingof acceptances of the kinds specified.

Despite these considerations, the Board'sGeneral Counsel in 1923 stated that the Boardhad "always taken the position that a Statebank becoming a member of the Federal reservesystem is not limited as to the character ofacceptances which it may make by the permis-sive provisions of section 13."2S At the sametime, that opinion stated that the quantitativelimitations of the Act with respect to bankers'acceptances—limitations on the amount of ac-ceptances for any one customer and on the,aggregate amount of acceptances—were appli-cable to State member banks as well as tonational banks.

On the assumption that the provisions ofsection 13 of the Federal Reserve Act limitingwe kinds and amounts of acceptances that couldb e .m a d e by member banks applied at least tonational banks, if not to State member banks,we Board since 1917 has had outstanding its

Regulation C, regarding the making of bankers'acceptances, in addition to Regulation A, gov-erning the discounting of acceptances by theReserve Banks. If national banks and Statemember banks are governed only by the amountlimitations of the law and not by the qualitativelimitations, it is questionable whether Regula-tion C continues to serve any useful purpose.

DISCOUNTING AUTHORITY OFFEDERAL RESERVE BANKS

Whatever may be the situation as to theauthority of national banks or of State memberbanks to make acceptances, the Federal Re-serve Banks are authorized by section 13 ofthe Federal Reserve Act to discount onlybankers' acceptances of the kinds thereinafterdescribed.29 Consequently, in order for anyacceptance to be eligible for discount, it mustmeet all the requirements of the seventh or thetwelfth paragraph of section 13 with respect tothe acceptance authority of member banks,those as to kind as well as those as to maturityand amount. In addition, it must also meet twospecial requirements for discount by the Re-serve Bank. First, it must have a maturity atthe time of discount not less than that specifiedby the statute, and this requirement as tomaturity for discount purposes must be care-fully distinguished from the maturity require-ments prescribed as a condition to the authorityof member banks to make acceptances. Second,it must be endorsed "by at least one memberbank." Until 1916, an acceptance had to com-ply with separate limitations as to amount,different from those imposed on the discount-ing authority of member banks; however, theselimitations are no longer prescribed.

Requirements as to kind, maturity, andamount will be treated in subsequent sectionsof this chapter. The requirement as to endorse-ment may appropriately be considered here inconnection with the general nature of the Re-serve Banks' discounting authority.

As to discounts of other types of paper, thelaw authorized a Federal Reserve Bank todiscount the paper if endorsed by any of "its"member banks. An acceptance, however, wasrequired by the law only to be endorsed by "at



least one member bank." Noting the difference,the Board in 1915 held that it was immaterialwhether the offering member bank was locatedin the district of the Reserve Bank making thediscount or in some other district; in otherwords, a Reserve Bank could discount bankers'acceptances for any member bank whereverlocated.30 This inconsistency prevailed until1937 when, in revising Regulation A, the Boardprovided that a banker's acceptance could bediscounted by a Federal Reserve Bank only forone of "its member banks," though the regula-tion still, rather ambiguously, required theacceptance to bear the endorsement of "amember bank."S1 The present regulation au-thorizes a Reserve Bank to discount for amember bank, which must, of course, be oneof its own members, bankers' acceptances en-dorsed by "the member bank." Thus, despitethe discrepancy in the law, a Reserve Bank nowmay discount acceptances only for its ownmember banks.

The Board's discount regulations have alwaysincluded a provision to the effect that a FederalReserve Bank must satisfy itself as to the eli-gibility of any paper offered for discount. Inthe case of bankers' acceptances, however, aspecial provision as to evidence of eligibilitywas once considered necessary. As amended in

1916, Regulation A specifically provided that ifthe bill did not itself evidence the character ofthe underlying transaction, evidence of the eli-gibility of a banker's acceptance might consistof a stamp or certificate affixed by the acceptorin a form satisfactory to the Reserve Bank."In 1937, a footnote was inserted in the regula-tion requiring the accepting bank to obtain"substantiating evidence" as to the eligibility ofthe underlying transaction in the case of accept-ances based on import or export transactions,but this requirement was omitted in 19SS, pre-sumably as unnecessary. No provisions regard-ing evidence of eligibility of bankers' accept-ances are included in the revision of the regula-tion adopted in 1973.

Even if legally eligible for discount, a bank-er's acceptance, like any other kind of eligiblepaper, does not have to be discounted by theReserve Bank to which it is offered for discount.The discount authority of the Reserve Banks isnot mandatory but discretionary. Thus, in anearly ruling the Board held that a draft drawnby an American exporter upon a foreign buyerand accepted by the buyer may be technicallyeligible for discount, but that the Reserve Bankmay nevertheless, in its discretion, decline todiscount such an acceptance on the ground thatit is not a desirable investment.33

IMPORTATION AND EXPORTATION OF GOODS

CONNECTION WITH IMPORTOR EXPORT

The original Federal Reserve Act authorizedmember banks to make, and Federal ReserveBanks to discount, only one type of banker'sacceptance: acceptances "growing out of theimportation or exportation of goods." As hasbeen indicated, the framers of the Act thoughtof the acceptance mechanism chiefly as a meansof financing foreign trade, hoping that the ac-ceptance authority, along with the authoritygiven national banks to establish foreign

branches, would serve to improve the positionof the United States in the world market.

Aside from the rather vague requirementthat acceptances should grow out of import orexport transactions, the law made no attemptto describe or limit the kinds of transactionsthat might give rise to eligible acceptances. Inits first regulation on the subject the Boardrequired only an indication (on the face of theacceptance) that the proceeds "were used or areto be used in connection with a transaction iD"volving the importation or exportation ofgoods."" In 1915, becoming a little more



specific, the Board changed the regulation torequire the draft to be drawn either by a com-mercial, industrial, or agricultural concern "di-rectly connected" with the shipment of goodsinvolved or by a banker; in the latter event the"goods" were required to be "clearly specified"in the agreement with the acceptor. If theacceptor were not a member bank, it had toagree to furnish the Reserve Bank, on request,with information as to the nature of the trans-action.311 In 1916, however, the language of theregulation was again changed, this time torequire that an accepted bill, to be eligible fordiscount, "must have been drawn under a creditopened for the purpose of conducting, orsettling accounts resulting from," one of thethree types of transactions described in thestatute.3"

The obvious intent of these early regulationswas to insure that a banker's acceptance hadsome close and direct connection with an im-port or export transaction in order for it to beconsidered as growing out of such a transac-tion. In a number of early rulings, the Boardsought to answer the recurring question of howclose and direct the connection ought to be.

Thus, the mere fact that a draft was securedby an acceptance based on an import or exporttransaction was held by the Board not to besufficient to make the draft itself eligible fordiscount." Similarly, the Board ruled that anacceptance was too remotely related to animport or export transaction if the draft wasdrawn by a domestic seller of raw materials ona domestic manufacturer who had a contract toexport the manufactured products;38 or if thedraft was drawn by a foreign manufacturer ona domestic bank to finance the manufacture ofgoods to be shipped later to the United States;3B

or if the acceptancewas intended to financeforeign retailers in selling goods exported fromthe United States."

On the other hand, if it were clear that thedraft was actually drawn to finance an exporttransaction, the Board held that the acceptanceof the draft would be eligible for discount eventhough the goods had not yet been actuallyshipped" or even though there had been adelay in shipment." As a matter of fact, theBoard went so far as to hold that, if there had

been a bona fide contract for the export ofgoods, drafts drawn to finance such export con-tinued to be eligible throughout their life asdrafts growing out of an export transactioneven though, because of freight rates and ship-ping conditions, the goods were never actuallyshipped abroad.13

Thus, although the Board adopted a liberalview with respect to acceptances made prior toshipments, it was more conservative, at least atfirst, with respect to acceptances made after theshipment was completed. In 1917, it ruled thatafter goods had been imported and they werelying on the docks, any new transaction wouldbe simply a domestic transaction.41 Similarly, in1926, the Board held that a national bank couldnot legally accept drafts after the underlyingimport or export transactions were completed.4"'In the following year, however, the Board con-cluded that these and other previous rulingswere unnecessarily strict interpretations of thelaw and that the statute was susceptible of "amore liberal interpretation which would facili-tate the financing of our foreign trade." It ruled,therefore, that acceptances might properly beconsidered as growing out of the importationor exportation of goods if they were drawn tofinance the sale and distribution on usual creditterms of imported or exported goods into thechannels of trade, whether or not the bills wereaccepted after the physical importation or ex-portation had been completed.16 This rulingopened up a broader field for the use of bankers'acceptances than had previously existed.47

CONTRACT AND SHIPPINGDOCUMENTS

The two things that normally afford the bestevidence that a banker's acceptance grows outof an import or export transaction are theexistence of a contract for the shipment ofgoods and the documents relating to theirshipment.

At an early date the Board held that theaccepted draft must have been drawn by, or atthe instance of, a person with a contract to ex-port or import goods.48 However, if the goodshad been actually shipped and shipping docu-ments were attached to the draft at the time of



its acceptance, the existence of a contract forexport was not essential.19

In a 1918 ruling the Board announced certainprinciples to be applied in determining whetheran acceptance grew out of an export transactionin the case of a dealer who was engaged in thepurchase of the same kind of goods for bothexport and- domestic use. The agreement be-tween such a dealer and the accepting bank wasrequired to show (1) that the dealer had acontract for the export of the goods, (2) thatthe amount of the drafts would not exceed theamount involved in the export transaction, and(3) that the proceeds of the drafts would beused in connection with the export transaction.In addition, it was required that the proceedsof the sale be applied in payment of the accept-ance, unless the dealer had placed the bank infunds to meet it at maturity or had secured theacceptance in the manner required for domesticacceptances, that is, by shipping documents,warehouse receipts, or similar documents secur-ing title to readily marketable staples.50

This ruling, however, was superseded 2 yearslater when the Board, in its 1920 revision ofRegulation A, undertook to specify the cir-cumstances that must be present for an accept-ance to be considered as growing out of theimportation or exportation of goods.01 Theregulation stated that it was not necessary thatshipping documents be attached or that thedrafts cover "specific goods" 5Z in existence atthe time of acceptance. But the regulation re-quired either (1) that shipping documents beattached when the draft was presented for ac-ceptance, or (2) if the goods had not beenshipped, that there be a contract for their im-port or export within a specified and reasonabletime and that the customer agree to furnish theaccepting bank in due course with shipping doc-uments covering the goods or with exchangearising out of the transaction being financed.

These requirements, as interpreted by theBoard, meant that it was no longer sufficient,as had been indicated in the 1918 ruling, forthe acceptance to be secured by documentscovering goods not intended for export; adealer engaged in both domestic and foreigntransactions was now required to furnish theaccepting bank with shipping documents cover-

ing the goods to be exported if the acceptancewas to be eligible as one growing out of anexport transaction." The regulatory provisionpermitting the dealer to furnish exchange arisingout of the transaction was meant as an alterna-tive to the furnishing of shipping documentsonly in the case of import transactions.

When the regulation was next revised in1922, the detailed provisions of the 1920 regu-lation with respect to the alternative necessityfor cither a contract or shipping documents, aswell as the other requirements as to import andexport transactions, were omitted. The Boardstated, however, that their elimination was onlyfor simplification and that the Board was notreversing or modifying any of its previous rul-ings regarding acceptances growing out of theimportation or exportation of goods insofar asthey had been interpretative of the law or hadlaid down broad general principles, which "as aresult of long experience in the field of inter-national banking, [were] recognized as essentialin the proper conduct of the acceptance busi-ness." r" Apparently, the Board felt that a regu-latory statement of these general principles wasno longer necessary. It observed:

Those American banking institutions whichhave large demands for acceptance credits inforeign transactions have by this time hadconsiderable experience in this field, and theformer detailed regulations arc no longerthought necessary. Moreover, it is believedthat the general advancement of foreigntrade, with the resulting benefit lo the agri-cultural and commercial interests which arelargely dependent upon foreign markets, canbe furthered most effectually at the presenttime by the substitution of this simpler regu-lation applicable to acceptances in export andimport transactions.

Since 1922, neither Regulation A nor Regu-lation C has contained any provisions describingor limiting the import and export transactionsthat may be made the basis for bankers' ac-ceptances, except that, until 1955, Regulation Acontinued to carry the general requirement thatan acceptance should be drawn under a creditopened for the purpose of conducting or settlingaccounts resulting from one of the three typesof transactions described in the law.



GEOGRAPHIC COVERAGE

Soon after the enactment of the original Actquestion arose as to what was meant geographi-cally by the phrase "importation or exportationof goods." In 1915 the Board's General Counselexpressed the view that it covered not onlyshipments of goods between the United Statesand foreign countries but also shipments be-tween two foreign countries and shipmentsbetween the United States and Puerto Rico, theCanal Zone, or the Philippines." However,because Hawaii was then an integrated territoryand subject to all laws of the United States, heheld that shipments between the United Statesand Hawaii were domestic shipments and couldnot, therefore, be regarded as shipments involv-ing the importation or exportation of goods.This, of course, was before the law was changed

to authorize acceptances based upon domesticshipment of goods. (It was also, of course, longbefore Hawaii became a State.)

When Regulation A was revised after theamendments made by the Act of September 7,1916, it specifically covered acceptances arisingout of transactions involving shipments betweenthe United States and any foreign country,between the United States and any of its "de-pendencies or insular possessions," or betweenforeign countries.56 In 1923 the regulation in-cluded mention of an additional category ofshipments—those between dependencies or in-sular possessions and foreign countries." Thesame four categories of shipments are coveredby the Board's regulations today, although sinceFebruary 15, 1955, they have been specificallydescribed not in Regulation A but in RegulationC, governing acceptances by member banks.58

DOMESTIC SHIPMENTS

EXTENSION OF LAW TO COVERDOMESTIC SHIPMENTS

The original Federal Reserve Act, as hasbeen noted, contained no authority for the mak-ing or discounting of bankers' acceptances cov-ering domestic shipments of goods. Some mem-bers of Congress could see no good reason forauthorizing foreign but not domestic accept-ances, but the majority apparently felt that, inview of the novelty of the acceptance device inthis country, acceptances against domestic ship-ments might be abused by the smaller banks.By 1916, however, sentiment had changed. Thestatute was amended to authorize memberbanks to accept drafts or bills "which grow outof transactions involving the domestic shipmentof goods provided shipping documents convey-ing or securing title arc attached at the time ofacceptance." •"

The amendment had been recommended bythe Board in its 1915 Annual Report00 asfollows:

The acceptance system, provision for whichis made in foreign trade operations by theFederal Reserve Act, should be extended tothe domestic trade in so far as relates todocumentary acceptances secured by shippingdocuments or warehouse receipts, coveringreadily marketable commodities or against thepledge of goods actually sold.

There can be but little question of thesafety of such acceptances, and their use willtend to equalize interest rates the countryover and help to broaden the discount market.

In explaining the purpose of the amendmentin Congress, Senator Owen stated:91

The purpose of that is to permit a limiteduse of domestic acceptances where those ac-ceptances are covered by documents convey-ing or securing title to readily marketablestaples, and then confining it further, so thatthe bank may not make acceptances to over10 per cent of its paid up and unimpairedcapital stock to any particular individual,company, firm, or corporation.* * *



The amount limitation referred to by theSenator will be discussed at a later point. Hisstatement is significant here because it reflectsa feeling of caution in extending the law topermit banks to make acceptances in domestictransactions.

PURPOSE OF FINANCING

Promptly after the 1916 amendment to thelaw authorizing domestic acceptances, theBoard revised its Regulation A to cover bank-ers' acceptances under the new authority.*2

However, the revised regulation did no morethan paraphrase the requirements of the statutethat such acceptances must grow out of thedomestic shipment of goods and that shippingdocuments must be attached at the time ofacceptance.

In some early rulings the Board took theposition that, in order to be eligible, the ac-cepted draft must have been drawn solely forthe purpose of financing the shipment and thatif the effect was merely a straight loan to thedrawer, even though secured by bills of lading,the draft could not be eligible for acceptance.83

In other rulings the Board similarly held thatacceptances covering financing for a periodlonger than the period of shipment were ac-tually designed to provide working capital andso were not eligible.64

In 1929, however, the Board held that whena 90-day bill was accepted by a bank and theproceeds were used to pay a sight draft accom-panied by a bill of lading covering a shipmentof staples, the acceptance was eligible for dis-count even though 90 days were not requiredfor completion of the shipment, provided thematurity was consistent with the "usual andcustomary" credit time prevailing in the particu-lar business.65 The Board stated that this rulingsuperseded, to the extent of any inconsistencies,previous rulings regarding the use of accept-ances to furnish working capital.

SHIPPING DOCUMENTS

As a condition both to the acceptance bymember banks of drafts growing out of domes-tic shipments and to the discounting of such

acceptances by the Federal Reserve Banks, thelaw requires that shipping documents "convey-ing or securing title" shall be "attached at thetime of acceptance." In applying this condition,the Board has held that the term "shippingdocuments" includes either an order bill oflading or a straight bill of lading, even thoughthe protection afforded by a straight bill is notabsolute; but that freight receipts or merecopies of original bills of lading arc not suffi-cient.66

Since the law requires attachment of shippingdocuments at the time of acceptance, a draftcannot be accepted before the bills of ladingcovering a shipment have been issued.87 Butphysical attachment is not necessary; it sufficesif the documents arc in the possession of theaccepting bank or its agent at the time ofacceptance.*8

Although shipping documents arc necessaryat the time of acceptance, they need not, andnormally would not, be retained by the accept-ing bank throughout the life of the acceptance.6*Obviously, such documents must be surrenderedin order for the customer to consummate thetransaction involved. However, the Board oncepointed out that when the documents have tobe released after acceptance, banking prudencerequires that the accepting bank should protectitself by obtaining cither a trust receipt or anagreement that the proceeds of the sale will bedeposited with the bank when they becomeavailable.70

GEOGRAPHIC LIMITATION

The 1916 amendment authorizing accept-ances growing out of the domestic shipmentof goods did not define what was meant bya domestic shipment, nor did the Board byregulation or ruling undertake to define theterm prior to 1946. Presumably it was under-stood that domestic was simply the oppositeof foreign and that the amendment referred toshipments within the United States. This wasconfirmed in the Board's 1946 revision of Regu-lation C, when previous language referring todomestic shipments was changed to refer tothe "shipment of goods within the UnitedStates." "



STORAGE OF STAPLES

PURPOSE OF TRANSACTIONWhen the law was amended in 1916 to

authorize acceptances growing out of the do-mestic shipment of goods, an additional typeof acceptance was also authorized, namely,acceptances "which are secured at the time ofacceptance by a warehouse receipt or othersuch document conveying or securing titlecovering readily marketable staples." The pur-pose of this third class of commercial banker'sacceptance was to facilitate the carrying ofgoods held in storage pending sale, shipment, ordistribution into the process of manufacture.

If the draft, even though secured by a ware-house receipt, was actually drawn to carrygoods for speculative purposes or for an in-definite period of time without any purposeto sell, ship, or manufacture within a reasonabletime, it was not eligible for acceptance; such adraft was regarded by the Board as merely acloak to evade the limitations of the law onthe amount which a national or a State memberbank could lawfully lend to one person."

By the same token, if the real purpose of aproposed acceptance credit based on the storageof cotton at a mill was to provide the mill withworking capital rather than to finance the saleof the cotton by a cotton broker to the mill ortemporary storage thereof pending sale, suchan acceptance was considered improper."Similarly, drafts drawn to finance a manu-facturer pending the manufacture and ultimatesale of the goods as a finished product wereheld ineligible for acceptance because the drafts,although accompanied by warehouse receipts,were not drawn to carry the goods covered bysuch receipts pending a reasonably immediatesale or distribution.'4

WAREHOUSE RECEIPTS ANDOTHER SECURITY

The statute requires that an acceptance cov-ering the storage of readily marketable staples°e "secured at the time of acceptance by a

warehouse receipt or other such document con-veying or securing title" to such staples. Byregulation and interpretation the Board has laiddown certain conditions as to the form ofthe security for such acceptances, the independ-ence of the warehouseman from die borrower,and the substitution and release of the security.

As to what constitutes a warehouse receiptor other such document, the Board by regula-tion in 1920 provided that the security for thestaples involved must take the form of a"warehouse, terminal, or other similar receipt,conveying security title to such staples, issuedby a party independent of the customer." ™For this purpose, chattel mortgages on cattlewere not considered security similar to a ware-house receipt.78 However, a receipt issued bythe custodian of buildings in which the stapleswere stored could be treated as a warehousereceipt."

The principal regulatory requirement wasthat the warehouse receipt be issued by a partycompletely independent of the borrower; other-wise the receipt would not effectively convey orsecure title to the staples. This meant that theborrower should not be in a position to exerciseany control over the goods stored and shouldnot have access to the premises,78 except accesssolely for the purpose of inspecting the goods."If these conditions were met, the staples couldbe stored on property owned by the customer ifthey were turned over, under a bona fide lease,to an independent warehouseman.80 However,in a case in which the custodians and rep-resentatives of the warehouse company wereformer employees of the lessor-borrower whoexpected to be reemployed by the latter at theclose of the storage season, the Board heldthat the requirement as to independence of thewarehouseman was not fulfilled.81 Similarly, ifthe warehouse company was organized by thecustomer, it must not have been simply a sub-terfuge to evade this requirement of the regula-tion.82

In 1928 Regulation A was amended to make



it clear that a warehouse receipt covering thestorage of readily marketable staples could beissued "by a grain elevator or warehouse com-pany duly bonded and licensed and regularlyinspected by State or Federal authorities withwhom all receipts for such staples and alltransfers thereof are registered and withoutwhose consent no staples may be withdrawn." S3

Under the statute, bankers' acceptances se-cured by warehouse receipts covering the stor-age of staples are required to be so securedonly at the time of acceptance, except that ifsuch acceptances or any other kinds of accept-ances are made by a member bank for onecustomer up to an amount exceeding 10 percent of the bank's capital stock and surplus,the acceptance must remain secured throughoutits life. In other words, the law does not requirethat acceptances within the 10 per cent limita-tion must remain secured, either with respectto the acceptance authority of member banksor the discounting authority of Federal ReserveBanks. By regulation, however, the Board pro-vided that acceptances to finance the storageof staples, in order to be eligible for discount,must continue to be secured throughout thelife of the acceptance by some form of securityin addition to the customer's general credit,whether or not the acceptance exceeded 10 percent of the member bank's capital and sur-plus.84 This requirement was first included inRegulation A in 1920.85 If the goods werewithdrawn from storage before maturity, theregulation permitted the substitution of a trustreceipt or other similar document covering thegoods, provided the substitution was condi-tioned on a reasonably prompt liquidation ofthe credit. To insure compliance, the regulationprovided that, when the original documentswere released, it should be required either (1)that the proceeds be applied within a specifiedtime to the liquidation of the acceptance credit,or (2) that a new document similar to theoriginal be substituted in a specified time.

PLACE OF STORAGE

At an early date the Board ruled that ac-ceptances secured by the storage of stapleswere eligible for discount even though the

staples were stored in a warehouse in a foreigncountry. Such acceptances involved drafts thatwere payable in dollars in the United Statesand that were drawn abroad and accepted byU.S. banks.80 In 1928 the eligibility for discountof acceptances covering the foreign storage ofstaples was expressly recognized by an amend-ment to Regulation A that inserted after theword "storage" the words "in the United Statesor in any foreign country." 8T

MEANING OF "READILYMARKETABLE STAPLES"

Shortly after the law was amended in 1916to authorize acceptances secured by the storageof staples, the Board ruled that the term"staples" included manufactured goods as wellas raw materials, provided the goods were non-perishable and had a wide ready market.88

Three years later the Board defined the term"readily marketable staple" as follows: M<

A readily marketable staple may be definedas an article of commerce, agriculture, orindustry of such uses as to make it the subjectof constant dealings in ready markets withsuch frequent quotations of prices as to make(a) the price easily and definitely ascertain-able and (b) the staple itself easy to realizeupon by sale at any time.

At the same time the Board suggested that, asa matter of prudence and protection, banksshould not consider as eligible any staple thatis so perishable as to raise doubts as to whetherits value as security can be maintained at leastfor the life of the draft drawn against it.

The definition just quoted was incorporatedin Regulation A in 1920 and, surviving theyears without any change in language, it isstill set forth in a footnote in Regulation C;however, it was omitted in the 1973 revision ofRegulation A.

In particular instances, the Board ruled thatreadily marketable staples included cattle,90

coal,91 cotton and cotton yarns,92 cottonseed,93

flour,91 potatoes,03 sugar in bond,80 and wool.97

In other cases, it held that the term did notinclude automobiles and automobile parts andtires9S or whiskey or sacramental wine inbond."



DOLLAR EXCHANGE

NATURE AND PURPOSE

In 1916 Paul M. Warburg, a member of theFederal Reserve Board, made a trip to SouthAmerica. Upon his return, he wrote a letterto Senator Robert L. Owen, then Chairman ofthe Senate Banking and Currency Committee,recommending that U.S. banks be given author-ity to accept drafts drawn by foreign bankersto furnish "dollar exchange." 10° Mr. Warburgstated that his attention had been drawn tothe fact that the means of payment employedby the South American merchant, when settlinghis obligations in Europe or in the UnitedStates, was generally not by check but by "theold established usage—a three months' draft onforeign bankers, primarily British bankers."Mr. Warburg then went on to say:

* * * If dollar exchange is to be used asfreely as sterling exchange, the foreign bank-ers in these South American countries mustbe in a position to draw a three months' drafton American bankers as easily as they candraw it on British bankers.* * *

I am fully conscious of the fact that a draftof this kind, if permitted, might be classifiedas closely approaching or being a species ofthe finance draft; but to the extent as aboveoutlined I think this draft has to be sanc-tioned in order to place our banks on a parwith the British banks and other foreignbanks operating in South and Central Amer-ica.

If Congress will trust the Federal ReserveBoard to supervise these transactions andkeep them within proper bounds, I believethat an amendment as here proposed wouldremove a great handicap now burdening theAmerican banks, while any abuse of thesefacilities could be stopped at any time by theFederal Reserve Board.

Congress followed Mr. Warburg's recom-mendations. The Act of September 7, 1916—the same act that authorized acceptances againstdomestic shipments and storage of staples-

added to section 13 of the Federal Reserve Acta new paragraph authorizing member banksto accept drafts or bills of exchange drawnupon them for the purpose of furnishing dollarexchange, subject to certain limitations. It wasrequired that the drafts or bills must have notmore than 3 months' sight to run at time ofacceptance. It was required that they be drawn,under regulations prescribed by the Board, bybanks or bankers in foreign countries or de-pendencies or insular possessions of the UnitedStates for the purpose of furnishing dollar ex-change "as required by the usages of trade"in the respective foreign countries, dependen-cies, or insular possessions. The amendmentfurther provided that such drafts and bills mightbe acquired by Federal Reserve Banks in suchamounts and subject to such regulations, re-strictions, and limitations as might be pre-scribed by the Board. Specific limitations wereplaced upon the amount of dollar-exchangedrafts that could be accepted by member banks.

In explaining the new type of acceptance inCongress, Senator Owen said: 101

At present exchange passing from the Ar-gentine to the United States passes throughLondon by sterling exchange. By this[amendment] it is proposed to permit theseexchanges to be expressed in dollars, so as inthat way to establish a direct communicationbetween the South American and other for-eign countries and the United States, and tomake it unnecessary, in transmitting credits,to transmit them through London in sterlingexchange or through other European coun-tries in terms of money of the foreign coun-try through which the exchanges are trans-mitted. The purpose is to establish the dollarexchange, so as to make the United States afinancial center for the transaction of foreignbusiness, and to make this country what it isdestined to be—the financial center of theworld.

Soon after the passage of the 1916 amend-ment, the Board noted that the custom amongforeign bankers of selling 3-month drafts in



preference to checks had originated in countries"where the mail connections were irregular andthe foreign-exchange market was a limited one,and where it would have been difficult for thedrawing banker to be certain that he could finda cover against the checks drawn by him intime to forward it by the same mail, whereas,in drawing a three months' draft, he would feelassured of being able to forward remittancesbefore his obligation fell due."102 In areaswhere these conditions did not exist, the Boardfelt that dollar-exchange acceptances were notjustified.

As observed by Mr. Warburg, dollar-ex-change drafts are in the nature of "finance"drafts. Unlike the so-called commercial accept-ances discussed in previous sections of thischapter, dollar-exchange acceptances are notdirectly based on underlying commercial trans-actions. The Board, however, has carefullysought to limit the use of these acceptances tothe particular species of finance transactioncovered by the statute. It has held, for example,that they may not be used merely for thepurpose of benefiting from the fact that dollarexchange is at a premium in the country wherethe drafts are drawn.108 In its 1946 revision ofRegulation C, the Board prescribed the follow-ing "purpose" limitation: 104

Any such dollar exchange draft or bill mustbe drawn and accepted in good faith for thepurpose of furnishing dollar exchange asrequired by the usages of trade in the coun-try, dependency, or insular possession inwhich the draft or bill is drawn. Drafts orbills drawn merely because dollar exchangeis at a premium in the place where drawn orfor any speculative purpose or drafts or billscommonly referred to as "finance bills" (i.e.,which are not drawn primarily to furnishdollar exchange) will not be deemed to meetthe requirements of this section.

In furtherance of this limitation as to pur-pose, the regulation also provided that theaggregate of drafts or bills accepted by amember bank for any one foreign bank orbanker should not exceed an amount whichthe member bank would expect the foreignbank or banker to liquidate through the pro-ceeds of export documentary bills or from other

sources "reasonably available to such foreignbank or banker arising in the normal course oftrade." 105

The principal usefulness of dollar-exchangeacceptances arose from the fact that in someforeign countries exports of goods were subjectto seasonal variations. This form of acceptanceenabled banks in such countries to providedollars to their customers to finance importsfrom the United States during seasonally lowexport periods, such acceptances to be repaidwith dollars acquired out of the proceeds oflater exports.100 Despite their usefulness forthis purpose, however, dollar-exchange accept-ances never constituted a very large proportionof the total amount of acceptances made bymember banks under the Federal Reserve Act.

PERMISSION TO ACCEPTDOLLAR-EXCHANGE DRAFTS

The statute does not specifically providethat a member bank must obtain the Board'spermission before accepting dollar-exchangedrafts or that such drafts may be acceptedonly when drawn by bankers in countriesdesignated by the Board. The law does provide,however, that dollar-exchange drafts must be"drawn under regulations to be prescribed"by the Board. Pursuant to this provision, theBoard by regulation has required that a memberbank must have the Board's prior permissionbefore it accepts any dollar-exchange draftsand also that a member bank may accept suchdrafts only for bankers in those foreign coun-tries that have been expressly designated bythe Board.

The Board's first regulation on this subjectwas issued in September 1916 as RegulationC.107 It provided simply that any member bankdesiring to accept drafts drawn by foreign banksor bankers should apply to the Board for suchauthority, setting forth the usages of trade inthe respective countries in which such banks orbankers were located; that, if the Board deter-mined that the usages of trade required, theBoard would so notify the applying bank andpublish in the Federal Reserve Bulletin thenames of the countries approved for this pur-pose; but that the Board reserved the right



to modify, or, on 90 days' notice, to revokeeither its approval as to the particular memberbank or its approval as to any foreign country.

In its contemporaneous revision of Regula-tion A,108 the Board stated that the FederalReserve Banks were authorized to discountfor member banks dollar-exchange acceptancesmade in accordance with Regulation C.

The provisions of Regulation C as first issued,treating together the authority of member banksto accept dollar-exchange drafts and their au-thority to accept for bankers in specified foreigncountries, continued unchanged until 1946.When the regulation was revised in that year,the two authorities were separated.

As to the authority of member banks tomake dollar-exchange acceptances, the 1946Regulation C provided, and continues to pro-vide, that a member bank must file with theBoard, through the Federal Reserve Bank ofits district, an application for permission toaccept dollar-exchange drafts.109 The applica-tion need not be in any particular form, but itmust show "the present and anticipated need"for the authority requested. The Board reservesthe right to rescind any such permission afternot less than 90 days' notice in writing to thebank affected.

DESIGNATED COUNTRIES

Since the law permitted dollar-exchange ac-ceptances only with respect to those countriesin which such acceptances were required bythe usages of trade, the Board felt it necessaryto assume the responsibility for determiningwhat particular countries met this requirement.As already noted, in its first regulation on thesubject the Board required any member bankaPPlying for permission to accept dollar-ex-change drafts to set forth the usages of trade inthe countries for which it desired to acceptsuch drafts, and the Board stated that it wouldPublish in the Federal Reserve Bulletin thenames of the countries approved by it for thispurpose.

Late in 1916 the Board published examples°f letters written by it to member banks ap-proving and declining to approve certain foreigncountries as eligible for dollar-exchange

drafts."0 It quoted a letter declining to approveEngland and France for this purpose, becauseit appeared that there was "no difficulty insecuring in London or Paris cable transfers orchecks on the United States." At the same time,it indicated that it had given approval to theacceptance of dollar-exchange drafts for banksor bankers in Puerto Rico, Santo Domingo,Costa Rica, Peru, Chile, Brazil, Venezuela,Argentina, and Bolivia. In 1918, Colombia,Ecuador, Nicaragua, Uruguay, and Trinidadwere added to the list.111 In 1920, the followingcountries were also added: British Guiana,British Honduras, Cuba, Dutch Guiana, FrenchGuiana, Honduras, Panama, Paraguay, andSan Salvador.112 Up to this time, only Southand Central American countries (plus Cuba)had been included in the list. In 1921, however,the Board designated Australia, New Zealand,and "other Australasian dependencies."113

Finally, in 1922, the list was expanded to in-clude the French West Indies, Guatemala, andthe Dutch East Indies.111 No countries havebeen added to the list since 1922. Also, nocountries have been removed from the list, al-though the reference to Santo Domingo nowrefers to Haiti.

It should be noted that member banks thathave been authorized to accept dollar-exchangedrafts with respect to countries designated bythe Board at the time the authority was grantedalso have authority to accept such drafts forcountries subsequently designated by the Boardwithout the necessity for any further permissionfrom the Board.115

As revised in 1946, Regulation C provided "°that member banks having authority to acceptdollar-exchange drafts might accept such draftsonly with respect to the countries specified inthe list published by the Board, but that amember bank desiring to accept for bankers incountries not specified in such list might requestthe Board to add such countries to the list upona showing that the furnishing of dollar exchangewas required by the usages of trade. The regula-tion also noted that the Board might at anytime, after 90 days' published notice, removethe name of any country from such list.

As has been observed, no countries havebeen added to or removed from the list since



1922. Extensive changes have taken place sincethat time in the usages of trade in foreigncountries affecting dollar exchange; and unlessthe law is construed as authorizing dollar-exchange acceptances for purposes broaderthan those envisaged by Mr. Warburg after his1916 trip to South America, one may questionwhether many—or any—of the countries desig-nated by the Board before 1922 as justifyingdollar-exchange drafts actually warrant thatdesignation under present conditions.

QUESTION REGARDING PRESENTLEGAL AUTHORITY

An interesting technical question has beenraised as to whether the twelfth paragraph ofsection 13 of the Federal Reserve Act—theparagraph authorizing dollar-exchange accept-ances—is still an effective part of the law.

In 1952, when the U.S. Code was revisedunder the auspices of the House JudiciaryCommittee, the revision omitted the dollar-exchange paragraph that had previously beencarried in section 373 of Title 12. A note bythe codifier stated that the provisions of thissection had been added to section 5202 of theRevised Statutes by the Act of September 7,1916, but had been omitted in the furtheramendment made to section 5202 by the Actof April 5, 1918. For the same reasons, thecodifier also omitted the eleventh paragraph ofsection 13 of the Federal Reserve Act, relatingto the right of national banks to act as insuranceagents and real estate loan brokers, which hadpreviously been carried as section 92 ofTitle 12.

Apparently, the basis for the codifier's omis-sion of these provisions was as follows:

Section 13 of the original Federal ReserveAct had amended section 5202 of the RevisedStatutes, which limited the aggregate indebted-ness of national banks, by adding an exceptionwith respect to liabilities incurred under theFederal Reserve Act; the amended section 5202had been set forth in full in section 13 of theFederal Reserve Act, although without quota-tion marks.

The Act of September 7, 1916, amendedsection 13 of the Federal Reserve Act and, in

doing so, set forth the amended section in full.However, instead of quoting the entire sectionwithin a single set of quotation marks, theamending act closed the quotation at the endof what is now the eighth paragraph of section13. The ninth paragraph, beginning withoutquotation marks, then quoted section 5202 ofthe Revised Statutes as it had been amendedby the original Federal Reserve Act and con-tinued the quotation until the end of the revisedsection 13, thus making it appear that thetenth, eleventh, and twelfth paragraphs of sec-tion 13 were a part of section 5202. Thoseparagraphs related, respectively, to the authorityof the Federal Reserve Board to regulate dis-counts by the Federal Reserve Banks, theauthority of national banks to act as insuranceagents and real estate loan brokers, and theauthority of member banks to accept dollar-exchange drafts. None of these paragraphs, ofcourse, had any relation to the matter coveredby section 5202 of the Revised Statutes—limitations on aggregate liabilities of nationalbanks.

Two years later the War Finance CorporationAct of April 5, 1918, rewrote section 5202 inorder to except liabilities incurred under thatact from the limitation on the aggregate in-debtedness of national banks. The rewrittensection—naturally enough—did not include thematerial contained in the tenth, eleventh, andtwelfth paragraphs of section 13 of the FederalReserve Act. Nevertheless, because of thepeculiar placement of quotation marks in the1916 amendment, the codifier of the 1952U.S. Code concluded that the eleventh andtwelfth paragraphs of section 13 had beenrepealed by the 1918 revision of section 5202.Rather inconsistently, he did not conclude thatthe tenth paragraph of section 13 had also beenrepealed.

When the matter came to the attention ofthe Board in 1954, Chairman Martin wrote aletter to the House Judiciary Committee inwhich, for reasons set forth in an enclosedmemorandum,117 he expressed the view that theomitted paragraphs were still effective lawand suggested that their erroneous omission becorrected. However, no action was taken forthis purpose.



In January 1958 when the proposed Finan-cial Institutions Act was being considered bythe House Banking and Currency Committee,Mr. Patman charged that a provision of thebill that purported to amend the eleventh para-graph of section 13 of the Federal ReserveAct, regarding the authority of national banksto act as insurance agents, was misleading and,indeed, was a reflection on the integrity of thewhole bill, because that paragraph had in factbeen "repealed 40 years ago." 11S This led toa heated debate that partially contributed tothe death of the entire bill in the House com-mittee.

The debate evoked legal memoranda in sup-port of the continued legal effectiveness of theeleventh paragraph of section 13 and, neces-sarily, also of the twelfth paragraph relatingto dollar-exchange acceptances. The recordof the hearing contained such memorandaprepared by counsel for the advisory com-mittee of bankers that had assisted the SenateBanking and Currency Committee in its con-sideration of the bill and by the general counselto the House Banking and Currency Com-mittee.1111 The record also included a letter fromthe Comptroller of the Currency in support of

the validity of the eleventh paragraph, and theComptroller's letter appended the memorandumthat had been submitted by the Board in1954.120 A memorandum from the LegislativeReference Section of the Library of Congress,submitted by Mr. Patman himself, lent supportto the validity of the questioned provisions ofthe law, although it expressed no definiteopinion.121

When the U.S. Code was revised in 1958,the codifier again omitted both section 373 andsection 92 of Title 12. They were omitted againin the 1970 edition of the U.S. Code.

As was pointed out in the legal memorandapreviously mentioned, repeal of these provisionswas clearly not intended by the 1918 amend-ment; court decisions since 1918 have assumedthat both provisions continued in effect; andboth the Comptroller of the Currency and theBoard have acted for over 40 years on theassumption that the provisions are still inforce. For these reasons, it seems abundantlyclear that the codifier's omission of the provi-sions from the U.S. Code (which, after all, isonly presumed to be the law) was an errorarising from a too literal regard for quotationmarks.

MATURITIES

ACCEPTANCES BY MEMBERBANKS

With respect to both maturities and amounts,the law makes a distinction between commercialbankers' acceptances and dollar-exchange ac-ceptances and also between the authority ofmember banks to accept and the authority ofReserve Banks to discount.

With respect to the acceptance authority ofmember banks, the original Federal ReserveAct provided that such banks might acceptdrafts or bills of exchange growing out of theimportation or exportation of goods only if thedrafts or bills had "not more than six months'

sight to run." When additional authority forthe acceptance of drafts and bills based ondomestic shipments of goods and the storageof staples was granted in 1916, this maturitylimitation was not changed, except to excludedays of grace from the prescribed 6-monthperiod. The limitation remains the same today:Commercial acceptances by member banksmay not have a maturity at the time of accep-tance of more than 6 months, not countingdays of grace.

In its regulations on the subject, the Boardhas merely restated the maturity requirementof the law.123 In some of its early rulings, how-ever, the Board took the position that certain



kinds of acceptances, particularly those cover-ing domestic shipments of goods, should beeven more restricted as to maturity than re-quired by the law. Thus, it held that a draftdrawn solely to finance a shipment of goodsshould not have a maturity greater than thatapproximating the period required for the ship-ment.123 However, if the draft were drawn tofinance the subsequent sale as well as the ship-ment of the goods, the Board held that thematurity of the acceptance need not be limitedto the period of the shipment.121 In a 1929ruling, the Board took the more liberal positionthat, even if the shipment itself covered onlya relatively short time, the draft drawn tofinance it was eligible for acceptance if it hada maturity consistent with the usual and cus-tomary credit time prevailing in the particularbusiness.125

With respect to the acceptance of dollar-exchange drafts by member banks, the lawfixes a maximum maturity only half as longas that fixed for commercial acceptances. Ashas been noted, the practice of South Americanbankers that had been observed by Mr. War-burg in 1916 was to draw 3-month drafts;presumably, it was this practice that led Con-gress to provide that member banks shouldaccept only dollar-exchange drafts that have"not more than three months' sight to run,exclusive of days of grace."

The Board's regulations have never imposedany additional limitations on the maturity ofdollar-exchange acceptances, nor has the Boardpublished any interpretations relating to thislimitation.

DISCOUNT BY FEDERALRESERVE BANKS

As distinguished from the 6-month maturityrequirement imposed by the original FederalReserve Act upon the authority of memberbanks to accept drafts growing out of theimportation or exportation of goods, the Actauthorized the Federal Reserve Banks to dis-count such acceptances only if they had "amaturity at the time of discount of not morethan three months." When in 1916 member

banks were also authorized to accept draftsbased on domestic shipments of goods andthe storage of staples, their eligibility for dis-count was made subject to the same maturityrequirement, although the requirement wasslightly changed at that time to refer to 3months' "sight, exclusive of days of grace."The Agricultural Credits Act of 1923, forreasons noted in a previous chapter, liberalizedthe maturity requirement as to agriculturalacceptances by permitting such acceptances, ifsecured by warehouse receipts or other suchsecurity documents, to have a maturity at thetime of discount of not more than 6 months.Otherwise, no changes have been made in theprovisions of the original Federal Reserve Acton this point. To be eligible for discount, allbankers' acceptances—dollar exchange as wellas commercial—must have a maturity of notmore than 90 days at the time of discount,except that agricultural acceptances may havematurities of up to 6 months.

Although the Board has never undertaken tolimit further by regulation the maturity limita-tions placed by the statute on the acceptanceauthority of member banks, it has done so withrespect to the maturity fixed by the law for thediscounting of bankers' acceptances. In its 1920revision of Regulation A, the Board stated thatalthough acceptances might legally be dis-counted with maturities of up to 3 months,nevertheless a Reserve Bank might decline torediscount any acceptance if its maturity "is inexcess of the usual or customary period ofcredit required to finance the underlying trans-action or * * * is in excess of that periodreasonably necessary to finance such transac-tions." 12e As has been seen, the same principlewas applied by the Board, though in publishedrulings rather than regulations, to the maturityof drafts covering domestic shipments of goodsthat were eligible for acceptance by memberbanks.1"

With respect to the discounting of accept-ances based on the storage of readily market-able staples, the Board's Regulation A, as re-vised in 1920, stated that since the purpose ofsuch acceptances is to permit their temporaryholding pending sale, shipment, or distribution,



no such acceptance offered for discount shouldhave a maturity "in excess of the time ordinarilynecessary to effect a reasonably prompt sale,

. shipment, or distribution into the process ofmanufacture or consumption."

These rules adopted in 1920 were still to befound, unchanged, in the 1955 revision ofRegulation A,Jis but they were eliminated inthe 1973 revision of the regulation.

RENEWALS

Despite the statutory limitations on maturity,nothing in the discount provisions of the Fed-eral Reserve Act precludes the renewal of adraft accepted by a member bank. However,the draft must be such as to be eligible foracceptance at the time of renewal. Thus, incertain early rulings the Board held that if adraft drawn to finance an importation or expor-tation of goods were renewed after the comple-tion of the shipment, the renewal draft couldnot be said to grow out of an import or exporttransaction and, if eligible for acceptance at all,it would have to be as a draft based on adomestic storage transaction.1111 Similarly, adraft originally secured by warehouse receiptsor bills of lading that were later released couldnot, upon its renewal, be eligible for acceptanceunless the renewal draft complied at the time ofrenewal with the requirements of the Board'sregulations.130

In one of its earliest regulations on thesubject, the Board specifically provided that awll to finance an import or export transaction"must not be drawn or renewed after the goodshave been surrendered to the purchaser or con-signee." »« A few months later, however, theB»ard amended this provision to make itslightly more liberal: An exception was addedto permit renewal after surrender of the goodsfor such reasonable period as may have been

agreed upon at the time of the opening of thewedit as a condition incidental to the importa-tion or exportation involved, provided that thebill must not contain or be subject to anycondition whereby the holder thereof is obli-gated to renew the same at maturity." " J In a

press statement at the time the Board de-clared: "-1

This broadening of the conditions uponwhich acceptances are based is intended tocomply with existing mercantile customs, andto permit the development of the businessmore freely than at present, particularlythrough the use of drafts drawn in Americancurrency.* * *

Notwithstanding this seeming liberalizationof its attitude toward renewals after the sur-render of the goods, the Board in 1919 heldgenerally that a renewal draft should not beaccepted if at that time the period required forthe completion of the transaction out of whichthe original draft arose had elapsed.131 Thisruling was incorporated in the Board's 1920revision of Regulation A as follows:135

• * * no renewal draft whether or notcontracted for in advance, can be eligible ifat the time of its acceptance the period re-quired for the conclusion of the transactionout of which the original draft was drawnshall have elapsed.

Although this statement regarding renewals waseliminated when the regulation was next revisedin 1922, the Board indicated that no change inits previous rulings was intended.

In 1927, however, a much more liberal posi-tion was reflected in a published interpretationin which the Board held that bankers' accept-ances could properly be considered as growingout of transactions involving the importationor exportation of goods when drawn to financethe sale and distribution of imported or ex-ported goods into the channels of trade, whetheror not the bills were accepted after the physicalimportation or exportation had been com-pleted."6

A member bank may not unconditionallyagree in advance to accept a renewal draft,137

nor may a Federal Reserve Bank agree in ad-vance to discount renewal acceptances."9 Eli-gibility for acceptance in the one case and fordiscount in the other must depend upon thecircumstances existing at the time of the re-newal.



AMOUNT LIMITATIONS

ACCEPTANCE BY MEMBERBANKS

As in the case of the maturity limitations,distinctions must be made (1) between limita-tions on the amount of drafts that a memberbank may accept and on the amount of ac-ceptances that a Federal Reserve Bank maydiscount, and (2) between so-called commer-cial acceptances and dollar-exchange accept-ances. In addition, a third distinction must bedrawn between acceptances for one customerand aggregate acceptances for all customers.

Beginning with the limitations on the ac-ceptance authority of member banks, it is inorder first to consider the limitations on theamount of commercial drafts that a memberbank may accept for one customer. No suchlimitations were contained in the original Act.By the Act of September 7, 1916, however,section 13 of the Federal Reserve Act wasamended to provide that no member bankshould accept, whether in a foreign or a domes-tic transaction, for any one person, company,firm, or corporation in an amount equal at anyone time in the aggregate to more than 10 percent of the bank's capital stock and surplus,unless the bank was secured "either by attacheddocuments or by some other actual securitygrowing out of the same transaction as theacceptance." 139 This limitation has never beenmodified and is still in effect.

In construing the limitation, the Board in anearly ruling held that the "person" to which itreferred was the person who had entered intoan agreement with the member bank to protectit against loss and to whom the bank had lent itscredit in the form of an acceptance, whether ornot such person was the drawer of the draft orsome other customer of the bank.110

In another early ruling the Board made itplain that the limitation did not prohibit amember bank from accepting drafts in anamount greater than 10 per cent for one person-it meant only that, if for more than 10 per cent'

the bank must hold some "actual security" asto the excess.1" Within the 10 per cent limita-tion, the bank could properly rely on the cus-tomer's general credit.

The term "actual security" was interpretedas including shipping documents and warehousereceipts,112 and also a trade acceptance ac-cepted by the drawee.113 Moreover, there wasnothing to prevent the release of the originalsecurity for the acceptance provided that, ifthe acceptance were in excess of the 10 per centlimitation, there was a substitution of someother actual security growing out of the sametransaction, such as warehouse receipts " ' ornew drafts with bills of lading covering the samegoods.113

In this connection, an oft-recurring questionwas one that related to the circumstances underwhich a trust receipt might be regarded as actualsecurity. In several published rulings the Boardestablished the principle that a trust receipt wasadequate only if it did not permit the purchaserto retain control of the goods.118 This principlewas incorporated in the Board's 1920 revisionof Regulation C. It was specifically providedthat a trust receipt that permitted the customerto have access to, or control over, the goodsinvolved would not be considered actual se-curity for purposes of the 10 per cent limitation,but that a bill-of-lading draft would constituteactual security even after the documents hadbeen released, provided the draft was acceptedby the drawee upon or before the surrender ofthe documents.117 The present Regulation CJ4S

contains a substantially similar provision to theeffect that the member bank shall be andremain secured as to the excess over 10 per centof its capital stock " • and surplus by attacheddocuments or other actual security and that atrust receipt permitting the customer to haveaccess to or control over the goods will not beconsidered actual security for this purpose.

In addition to a limitation on acceptances forany one customer, the framers of the originalFederal Reserve Act felt that a limitation on



the aggregate amount of drafts that a memberbank might accept was also desirable. The Actspecifically provided that no member bankshould accept bills in an amount equal at anytime in the aggregate to more than one-half thebank's paid-up capital stock and surplus.

Apparently, however, it was soon found thatmore leeway was needed. By an amendment ofMarch 3, 1915,150 an exception was added topermit a member bank to accept up to as muchas 100 per cent of its capital stock and surplusif granted such authority by the Federal ReserveBoard under regulations applicable to all mem-ber banks regardless of capital stock and sur-plus.

Acting under this amendment to the law, theBoard issued a new regulation151 by which itauthorized any member bank to accept up to100 per cent of its capital stock and surplusunder the following conditions: (1) The bankwas required to have an unimpaired surplus ofnot less than 20 per cent of its paid-in capital;(2) it was required to file a formal applicationwith the Federal Reserve Bank of its districtthat would report to the Board on the standingof the applicant; and (3) any such applicationhad to be approved by the Board, such approvalto be subject to rescission on 90 days' notice.

When the law was amended in 1916 toauthorize acceptances growing out of domesticshipments of goods and the storage of readilymarketable staples, the provision authorizing100 per cent acceptances with the authority ofthe Board was omitted, apparently through in-advertence. In its Annual Report to Congressfor 1916, the Board recommended an amend-ment "to restore the provision which was byerror stricken from the Act in the amendmentsof September 7, 1916, thus restoring to nationalbanks, with the approval of the Federal ReserveBoard, the right to accept up to 100 per centof their capital and surplus in transactions in-volving imports and exports." 15=

In accordance with the Board's recommenda-tion, the provision was restored by the Act ofJune 21, 1917,153 but with a new proviso to theeffect that the aggregate of acceptances growingout of domestic transactions should in no eventexceed 50 per cent of a member bank's capitalstock and surplus. In other words, while the

Board might authorize a member bank to acceptdrafts, both domestic and foreign, in an aggre-gate amount of more than 50 per cent, it couldnot in any case permit the bank to accept morethan 50 per cent in domestic transactions.154

After the provision for 100 per cent accept-ance authority was restored, the Board, in its1917 revision of Regulation C, again providedthat any bank might apply for such authority ifit had surplus equal to at least 20 per cent ofits capital; but in this revision the Federal Re-serve Bank with which the application was filedwas required to report to the Board not onlyas to the standing of the applicant bank butalso as to whether business and banking condi-tions prevailing in its district warranted thegranting of the application.155

These regulatory provisions regarding the100 per cent acceptance authority remainedsubstantially unchanged until 1946. When Reg-ulation C was revised in that year, the require-ment that the applicant's surplus be at least 20per cent of its capital was omitted. The revisedregulation also omitted the specific provisionsfor reports by the Federal Reserve Bank. How-ever, a new provision stated that while the appli-cation need not be in any particular form, itmust show "the present and anticipated need ofthe applicant bank for the authority re-quested." 15li The regulation continued, as in thepast, to reserve to the Board the right to rescindany such authority after not less than 90 days'notice in writing. As might naturally have beenexpected, only a relatively few of the largerbanks of the country have felt it necessary toobtain the Board's permission to accept draftsamounting in the aggregate to more than halftheir capital and surplus.

Two additional points should also be noted.First, a member bank's own acceptances pur-chased by it before maturity are not to becounted in determining the aggregate amountof acceptances outstanding, since by purchasingthem the bank's obligation as to such accept-ances is cancelled.157 Second, when a memberbank accepts commercial drafts or bills at therequest of another member bank that agrees toput the accepting bank in funds to meet suchacceptances at maturity, drafts and bills so ac-cepted must be considered as acceptance liabili-



ties of both the accepting bank and the request-ing bank for purposes of the aggregate-amountlimitations of the law and the Board's regula-tions.158

The authority granted member banks to ac-cept drafts drawn for the purpose of furnishingdollar exchange, like their authority to acceptcommercial drafts, is subject to limitations bothas to the amount that may be accepted for onecustomer and as to the aggregate amount forall customers. Moreover, these limitations areseparate and distinct from, and not to be in-cluded in, the amount limitations prescribed asto commercial acceptances."9

Under the law, no member bank may acceptdollar-exchange drafts for any one bank in anamount greater in the aggregate than 10 percent of the accepting bank's paid-up and unim-paired capital and surplus, unless the draft isaccompanied by documents "conveying or se-curing title or by some other adequate secur-ity." ™° In its Regulation C, the Board has madeit clear that the limitation refers to drafts drawnby foreign bankers as well as by foreign banksand that only the excess over the 10 per centlimit must remain secured by security docu-ments.161

As has been noted in connection with dollar-exchange acceptances in general, the Board byregulation has prescribed an additional limita-tion on the amount of such acceptances thatmay be made for any one foreign bank orbanker, but its primary purpose is to insure thatthe drafts accepted are actually for the purposeof furnishing dollar exchange. It requires thatthe aggregate of drafts and bills accepted forany foreign bank or banker shall not exceed anamount that the accepting member bank wouldexpect the foreign bank or banker to liquidatethrough the proceeds of documentary bills orother sources reasonably available to the foreignbank or banker arising in the normal course oftrade.182

The aggregate amount of dollar-exchangedrafts that a member bank accepts and hasoutstanding at any one time, as distinguishedfrom the amount accepted for any one foreignbank, may not exceed 50 per cent of the bank'scapital and surplus. This limit cannot be ex-ceeded, as may be done in the case of the

limitation on the aggregate amount of commer-cial acceptances, with the authority of theBoard. Moreover, the limitation on the aggre-gate amount of dollar-exchange acceptances isseparate and distinct from the aggregate limita-tion placed by the law on commercial accept-ances.

As in the case of commercial acceptances,dollar-exchange drafts accepted by one memberbank at the request of another must be con-sidered as part of the acceptance liabilities ofeach of such member banks for purposes of theamount limitations on the making of dollar-exchange acceptances.1**

DISCOUNT BY FEDERALRESERVE BANKS

Like all other paper discounted by the Fed-eral Reserve Banks, bankers' acceptances mustcomply with the general requirement that theaggregate amount of paper rcdiscountcd for anymember bank upon which any one person isliable as maker, acceptor, endorser, drawer, orguarantor shall not exceed the amount forwhich one person may become liable to a na-tional bank under section 5200 of the RevisedStatutes. This means that a draft accepted bya member bank for a particular customer can-not be eligible for discount with the ReserveBank if the total amount of acceptances madefor that customer and then outstanding exceeds10 per cent of the member bank's capital andsurplus, unless, as may well be the case, thesituation is one that falls within one of thevarious exceptions to section 5200 of the Re-vised Statutes.

In addition to this general requirement, theBoard by regulation made it a condition to thediscount of a banker's acceptance that draftsaccepted by a member bank for any one cus-tomer in excess of 10 per cent of the capitaland surplus of the accepting bank must remainactually secured throughout the life of the ac-ceptance.161 This requirement was, of course,comparable to the limitation imposed by thelaw and the Board's Regulation C on theamount of drafts that a member bank mightaccept for one customer. Supplementing thisrequirement, Regulation A provided in a foot-


note that, in the case of acceptances in excessof the 10 per cent limitation, such acceptancesmust be secured by shipping documents, ware-house receipts, or some other actual securitygrowing out of the same transaction as theacceptance, such as documentary drafts, tradeacceptances, terminal receipts, or trust re-ceipts. If trust receipts were the security forthe draft, they were required to be such asto provide an effective and lawful lien in favorof the accepting bank and they could not beconsidered actual security if they permitted thecustomer to have access to or control over thegoods.

Apart from these limitations on the amountof acceptances that may be discounted for onecustomer, neither the law nor Regulation Aimposes any limitations on the amount ofacceptances—whether commercial or dollar ex-change—that may be discounted by the FederalReserve Banks. Even the limitations with re-spect to acceptances for one customer wereomitted from the revision of the regulationadopted in 1973. In the case of dollar-exchangedrafts, the statute provides that they "may beacquired by Federal Reserve Banks in suchamounts * * * as may be prescribed by theBoard"; but the Board has never exercised thisauthority.

It should be noted, however, that the originalFederal Reserve Act limited the aggregateamount of acceptances that a Federal ReserveBank might discount for any one member bank(as distinguished from any one customer of amember bank) to one-half the capital stock andsurplus of the member bank. By an amendmentof March 3,1915, this limitation was liberalizedto permit the discount of acceptances for amember bank, with the authority of the Board,


of up to 100 per cent of the member bank'scapital stock and surplus."5 Pursuant to thisprovision, the Board by regulation gave theReserve Banks blanket authority to discountacceptances for a member bank up to theamount of its capital stock and surplus.166

At the same time—in 1915—the Board pro-vided that bills accepted by any private bankerand rediscounted by a Federal Reserve Bankshould not exceed 5 per cent of the paid-incapital stock of the discounting Reserve Bank,unless the acceptances were secured by a lienon the goods or transfer of title thereto, andthat in no event should the aggregate amountof acceptances of any private banker to berediscounted by a Reserve Bank exceed 25per cent of the Reserve Bank's paid-in capitalstock. Later in the same year these specifiedlimits on discounts of acceptances of privatebankers were omitted, leaving the percentagesto be fixed from time to time by the Board.107

When section 13 of the Act was amended bythe Act of September 7, 1916, the provisionlimiting the amount of acceptances that mightbe discounted for any member bank wasomitted. Subsequent regulations of the Boardomitted the limitations on the discounting ofacceptances of private bankers. Consequently,the only remaining amount restrictions on thediscounting of acceptances—as distinguishedfrom those imposed on the acceptance powersof member banks—were those that in generalprecluded the discounting of paper accepted bya member bank for one borrower in excess of10 per cent of such bank's capital and surplusunless the excess remained actually securedthroughout the life of the acceptance. As hasbeen noted, these restrictions were not includedin the 1973 revision of Regulation A.

LETTERS OF CREDIT AND SYNDICATE CREDITS

Although a member bank may not uncondi- with a customer to accept his drafts over ationally agree in advance to renew outstanding specified period of time, provided they areacceptances, it may enter into an agreement eligible at the time of acceptance.168 The trans-



action may take the form of a commercial letterof credit issued by a bank for its customerunder which the bank agrees to honor draftsthat may be drawn under the letter.169

Because commercial letters of credit mayfrequently be used to finance import or exporttransactions and because large city banks arebetter known abroad than small interior banks,it sometimes happens that an interior bank willappoint a large city bank as its agent for theissuance of a letter of credit and the acceptanceof drafts drawn thereunder. While a nationalbank is without authority to guarantee lettersof credit, the Board in 1921 held that undersuch an arrangement an interior national bankcould agree unconditionally to reimburse itsagent for any moneys put out by it or to putthe agent bank in funds to meet maturing ac-ceptances under such a letter of credit.170

Drafts accepted by the agent bank, under anarrangement of the kind just described, at therequest of another member bank must be re-garded as acceptance liabilities of both theaccepting bank and the requesting bank forpurposes of the aggregate amount limitationsdiscussed in a previous section of this chapter.1"However, the letter of credit itself, since it isonly an agreement to make acceptances, is notsubject to the limitation prescribed by section13 of the Federal Reserve Act on the aggregateamount of acceptances that a member bank may

have outstanding at any one time.1" Neverthe-less, the Board once cautioned member banksto exercise prudence in issuing letters of creditunder which acceptances in excess of this limi-tation might result.

At one time, in the early days of the develop-ment of acceptances, the Board apparentlybecame concerned by the growth of "syndicate"acceptance credits providing for the extensionof acceptance credits by groups of banks. Itfelt called upon to publish a statement outliningcertain principles that should be followed byaccepting banks in their own interests and inorder to avoid the necessity for issuing rigidand inflexible regulations on the subject. TheBoard urged that since acceptance transactionscall for direct contact between banks and bor-rowers, syndicate credits should be avoided.In addition, it stated that the duration of ac-ceptance credits should not normally exceed 1year and in no case 2 years; that such creditsshould relate to transactions of a legitimatecommercial nature and should not be for thepurpose of furnishing working capital; thatagreements by bankers to furnish 1-ycar or2-year credit at a definite rate of interest tofinance themselves should not be countenanced;and that, whenever syndicates were formed tofurnish acceptance credits for more than mod-erate amounts, the Federal Reserve Banksshould be consulted.1"

DIMINISHED IMPORTANCE OF ELIGIBILITY REQUIREMENTS

The numerous technical regulatory require-ments and Board interpretations with respect tothe eligibility of bankers' acceptances for dis-count by the Reserve Banks are of little signifi-cance today for all practical purposes. Briefly,this is because practically all Reserve Bankloans to member banks are now made in theform of advances rather than by the rediscount-

ing of customers' paper held by the memberbanks and because advances may be made onthe security of any paper eligible for purchaseby the Reserve Banks under the Federal Re-serve Act. Under section 14 of tnc Act, bank-ers' acceptances may be purchased by theReserve Banks even though they are not eligiblefor discount.


The first paragraph of section 14 authorizesany Reserve Bank to purchase in the openmarket "cable transfers and bankers' accept-ances and bills of exchange of the kinds andmaturities by this Act made eligible for redis-count, with or without the indorsement of amember bank." IU This language was part ofthe original Act and has never been changed.In 1923 the Board interpreted the language asmeaning that a Reserve Bank may purchase abanker's acceptance even though it is not ofthe kind or maturity made eligible for redis-count. In this connection, the Board said: ' "

At first glance, it would appear that onlybankers' acceptances of ihc kinds and ma-turities made eligible for rediscount could bepurchased in the open market, but, uponcareful consideration of the language of thissection, it will be found (hat the phrase "ofthe kinds and maturities by this act madeeligible for rediscount" qualifies only "billsof exchange" and docs not qualify "bankers'acceptances." Accordingly, bankers' accept-ances may, subject to the board's regulations,be eligible for purchase in the open marketby Federal reserve banks, even thoughnot of the kinds and maturities made eligiblefor rediscount. This construction of section14 has been adopted by the board since 1916,when the board first provided in its regula-tions that a Federal reserve bank might pur-chase in the open market bankers' accept-ances based upon the domestic storage ofgoods under contract of sale, even thoughsuch acceptances would not be eligible forrediscount by Federal reserve banks * * *.

As will be noted in a later chapter, Congressi n 1916 amended section 13 of the FederalReserve Act to authorize the Reserve Banks tomade direct advances to member banks ontheir own promissory notes for periods of up to15 days provided such notes were secured by"such notes, drafts, bills of exchange, or bank-ers' acceptances as are eligible for rediscount orfor purchase by Federal reserve banks under theProvisions of this Act." Consequently, followingthe Board's 1923 ruling that bankers' accept-ances were eligible for purchase even though


not eligible for discount, it became permissiblefor a Reserve Bank to make an advance to amember bank on the security of a banker'sacceptance that would have been ineligible forrediscount. In 1933, the law was amended topermit advances to member banks on papereligible for rediscount or for purchase by theReserve Banks for periods of up to 90 days.170

It is still conceivable, though very unlikely,that a member bank might seek to borrow fromits Reserve Bank by offering bankers' accept-ances for discount, but it is almost certain thatthe member bank would apply for an advanceon the security of such a banker's acceptance.Consequently, the technical requirements ofRegulation A with respect to the discountingof bankers' acceptances would not be appli-cable.

Despite these considerations, Regulation Acontinued until 1973 to include detailed provi-sions, both in the text and in footnotes, regard-ing requirements for the discounting of bankers'acceptances. Since, for the reasons here indi-cated, these provisions no longer served anypractical purpose, they were replaced in the1973 general revision of Regulation A by ashort paragraph that merely paraphrases, incondensed language, the provisions of section13 of the Act with respect to commercialbankers' acceptances and dollar-exchange ac-ceptances.

Although section 14 of the Act authorizesthe Reserve Banks to purchase in the openmarket bankers' acceptances that are not eli-gible for discount, the regulations of the FederalOpen Market Committee provide that the Re-serve Banks may purchase in the open marketonly acceptances of the kinds made eligible forpurchase under the Board's Regulation B.1"The Board's Regulation B, which has not beenchanged since 1923, purports to govern openmarket purchases by the Reserve Banks of billsof exchange, trade acceptances, and bankers'acceptances. One of the requirements of thatregulation is that a banker's acceptance eligiblefor purchase must also be eligible for discountunder the Board's Regulation A.IJS Conse-quently, the present technical requirements of



the law and of Regulation A still have some In any event, this docs not change the fact that,significance in that they are made applicable, under the law itself, acceptances may be pur-by virtue of the FOMC's regulations, to open chased by the Reserve Banks even though notmarket purchases of bankers' acceptances. It is eligible for discount and that, therefore, incli-questionable whether, as a matter of policy, gible acceptances may be taken as collateralsuch open market purchases of acceptances security for Reserve Bank advances to memberneed to be made subject to such requirements. banks.


Rediscount ofWorld War I Veterans'Notes

It may be a relief now to turn to a minor butinteresting development in the lending authorityof the Federal Reserve Banks. This develop-ment was significant because it represented thefirst instance in which the Reserve Banks wereauthorized to extend direct credit accommoda-tions to nonmember commercial banks. Thisauthorization was a result of the need in theearly 1920's to provide some means of enablingveterans of World War I to use their militarylife insurance policies—called adjusted servicecertificates—as a basis for obtaining loans frombanks. In order to induce banks to make suchloans, the Reserve Banks were authorized todiscount for nonmember as well as memberbanks the notes of veterans secured by suchcertificates.

Culminating several years of agitation for ash bonus or some other payment to veterans,

World War Adjusted Compensation Act of19, 1924,1 represented something of a

compromise. It provided for the issuance ofadjusted service certificates to all veterans ofWorld War I; these certificates, in effect, were20-year endowment insurance policies based in

F°r NOTES AND REFERENCES, sec p. 257.

general on years of military service. Each cer-tificate was dated as of the first day of themonth in which the veteran's application for thecertificate was filed, but in no event could acertificate be dated before January 1, 1925.The face amount of the certificate was payableafter 20 years to the veteran or, if he died inthe meantime, to his beneficiary.

A means was provided, however, by whichthe veteran could obtain cash on the basis ofhis certificate, although not immediately. Sec-tion 502(b) of the act authorized any nationalor State bank, after 2 years from the date of thecertificate, to make a loan to a veteran on hisown note secured by the certificate in an amountnot to exceed 90 per cent of the certificate'scurrent reserve value. The interest rate chargedon any such loan was limited to a rate not morethan 2 per cent above the discount rate cur-rently charged on 90-day commercial paper bythe Federal Reserve Bank of the district. Anybank making such a loan was specifically au-thorized to transfer the note to any other bank.

The provisions 2 that involved the FederalReserve Banks were patterned closely after thediscount provisions of section 13 of the FederalReserve Act. Any note representing a loan by

79



a commercial bank to a veteran on his adjustedservice certificate, if it were endorsed by a bankand were in compliance with regulations ofthe Federal Reserve Board, was made eligiblefor rediscount at the Federal Reserve Bankof the district, whether or not the bank offeringthe note was a member of the Federal ReserveSystem and whether or not such bank had madethe loan in the first instance or had acquiredit from another bank.

To be eligible for rediscount, however, thenote was required to have a maturity at the timeof discount of not more than 9 months, exclu-sive of days of grace—a requirement, it shouldbe noted, much more liberal than the maturityrequired for the discount of commercial paperin general.

The rate of discount charged by a FederalReserve Bank was required to be the same asthat charged by it in discounting 90-day com-mercial paper for its member banks. The Fed-eral Reserve Board was authorized to permit orrequire a Federal Reserve Bank to rediscountsuch veterans' notes for any other ReserveBank, and in such a case the rate of rediscountwas to be fixed by the Board. Again, the lawwas patterned after provisions of the FederalReserve Act (discussed later in this study)regarding rediscounts between Federal ReserveBanks.

If a veteran failed to pay a loan obtained onhis adjusted service certificate, the bank holdinghis note could present it to the Director of theVeterans' Bureau and the Director was author-ized to pay the bank in full. The certificatewould then be restored by the Director to theveteran upon receipt of the amount that hadbeen paid the bank, plus interest.

Since loans could not be made on the cer-tificates until at least 2 years after January 1,1925, it was not necessary for the FederalReserve System to take any immediate action.However, on December 9, 1926, the Boardissued a regulation governing the rediscount ofnotes secured by adjusted service certificates.1

At the same time, in accordance with a requestmade by the Veterans' Bureau, the Board ar-ranged for the Federal Reserve Banks to furnish

all banks with full information as to the legalrequirements for loans on such certificates andfor the rediscount of veterans' notes by theReserve Banks.

The new regulation, designated RegulationM, consisted in large part of a restatement ofthe requirements of the law. It provided, forexample, that to be eligible for discount aveteran's note must (1) arise out of a loanmade in conformity with the law on the securityof a certificate issued to the maker; (2) benegotiable and have a maturity at the time ofdiscount of not more than 9 months; (3) bearinterest at a rate not more than 2 per cent abovethe discount rate; and (4) be endorsed by theoffering bank. The Reserve Bank was requiredto satisfy itself as to the eligibility of the notefor discount. Along with the note, the offeringbank was obliged to submit an affidavit to theeffect that, in accordance with the law, it hadnot charged any fee for the loan other thaninterest and that it had notified the veteran ofthe fact that the note was being rediscountcd/

Although a Reserve Bank could rediscountsuch notes for nonmember as well as for mem-ber banks, it was permitted by the Board'sregulation to rediscount them only for bankslocated within its district. Moreover, the regula-tion provided that no rediscount should bemade for any nonmember bank unless it fur-nished such information as the Reserve Bankmight request "in order to satisfy itself as tothe condition of such bank and the advisabilityof making the rediscount for it."

In 1928, Regulation M was redesignatedRegulation G, but no change was made in itsprovisions.' In 1931, however, the AdjustedCompensation Act was amended to provide thatthe loan value of an adjusted service certificateshould in no event be less than 50 per cent ofits face value and that the interest rate on loanson such certificates should in no event exceed4Vi per cent," and Regulation G was amendedby the Board to conform to these changes inthe law.7 In 1932 the statute was furtheramended (1) to reduce the maximum interestrate on bank loans to 3Vz per cent, and (2) topermit banks to make loans on the certificates


WORLD WAR I VETERANS' NOTES 81

at any time after the date of their issuance.8

These modifications were likewise incorporatedin a revision of the Board's regulation.9

As time passed, discounts of veterans' notesbecame of less and less importance. By 1939,it appeared that the Federal Reserve Banksheld no notes secured by adjusted service cer-tificates and that no such notes had been redis-countcd for several years. Moreover, the statutehad been amended to authorize payment of suchcertificates by the Veterans' Administration atthe option of the veterans and also to authorize

the Veterans' Administration to make loans onsuch certificates. Since, for these reasons, itseemed unlikely that the Reserve Banks wouldbe called on in the future to rediscount veterans'notes, the Board on April 6, 1939, decided torepeal its Regulation G relating to this matter.10

At the same time, however, the Board an-nounced that if it should happen that any appli-cation for the discount of such a note should bereceived, it would be handled in the same man-ner as if the provisions of Regulation G werestill in effect.


Advances to Member Banks

GENERAL CONSIDERATIONS

DISTINCTION BETWEENADVANCES AND REDISCOUNTS

One of the most interesting chapters in thehistory of the lending functions of the FederalReserve Banks is that relating to advances tomember banks. For many years, virtually alllending by the Reserve Banks has taken theform of advances rather than discounts. Bothdiscounts and advances are sometimes looselyreferred to as discount operations, but the legaland procedural distinctions between the twoare clear.

In the case of a discount, credit is given by aReserve Bank to a member bank on the basisof eligible paper representing loans made by themember bank to its own customers. By eligiblepaper we mean, of course, commercial or agri-cultural paper meeting all of the technical re-quirements that have been discussed in previouschapters. Any such eligible paper that is offeredfor discount is transferred to the Reserve Bankw'th the member bank's endorsement. No noteis executed by the member bank. The bank

por NOTES AND REFERENCES, see pp. 257-60.

receives in its reserve account at the ReserveBank credit in the amount of the paper dis-counted, less the current rate of discount. Whenthe paper approaches maturity, it is returned bythe Reserve Bank to the member bank for col-lection, and at maturity the full amount of thepaper is charged to the member bank's reserveaccount.

An advance is a simpler operation. Themember bank merely executes its own note or,under procedures established in 1971, entersinto a continuing lending agreement, andpledges as security paper eligible for discountor purchase by the Reserve Banks. Interest onthe advance is paid at maturity on an accrualbasis. If the advance is not repaid at maturity,the Reserve Bank has a direct claim against themember and does not have to resort to thepaper pledged as security unless necessary tosatisfy that claim.

DEVELOPMENT OF AUTHORITYFOR ADVANCES

The original Federal Reserve Act containedno authority for advances to member banks.

83



In 1916 provision was made for 15-day ad-vances on the notes of member banks securedby Government bonds or by notes, drafts, billsof exchange, or bankers' acceptances eligible fordiscount or for purchase by the Reserve Banks.It was not until 1932, however, that the realtrend toward advances began. The immediatecause was the deteriorated banking situationand the decline in the volume of eligible paperheld by member banks. Even those banks thathad ample amounts of paper eligible for dis-count were reluctant to use such paper as abasis for borrowing from the Federal ReserveBanks.

During 1932 and 1933, in an attempt todispel fear and create an atmosphere of con-fidence, Congress enacted a series of statutesbroadening the credit facilities of the FederalReserve Banks and making such facilities avail-able not only to member banks but also tononmember banks and even to nonbankinginstitutions and individuals. The first step, in1932, was emergency authority for advances onthe security of any satisfactory assets to groupsof member banks and to individual memberbanks in cases in which the member bankshad exhausted their eligible paper—althoughthe advances were at higher rates of interest.Subsequently, the Reserve Banks were autho-rized, in unusual and exigent circumstances,to discount eligible paper for individuals,partnerships, and corporations.

At the time of the banking crisis in March1933, provision was made for direct advancesto individuals, partnerships, and corporationson the security of direct obligations of theUnited States; nonmember banks were giventhe privilege, though only for a short time, ofborrowing from the Reserve Banks on anysatisfactory assets. In June 1933, Congressextended the period for which member banksmight obtain direct advances on eligible paperfrom 15 to 90 days. The Banking Act of 1935made permanent and more liberal the author-ity of the Reserve Banks to make advancesto member banks on satisfactory security at arate of interest higher than the regular dis-count rate.

These statutory amendments in rapid succes-sion over a period of 3 years represented signifi-

cant changes in the concept of the lendingfunctions of the Federal Reserve Banks. Forone thing, they involved an extension of thecredit facilities of the System to others thanmember banks. Of more importance, theseamendments evidenced a definite departurefrom the original idea that Federal Reservecredit should be based only on self-liquidatingcommercial paper that met certain technicalrequirements as to eligibility; instead, greateremphasis was placed on the soundness of theassets offered as security, whether Governmentbonds, real estate mortgages, or consumerpaper.

Additional liberalizing changes were made inthe law in the late 1960's. In 1966 obligationsissued or guaranteed by Federal agencies weremade eligible for purchase by the ReserveBanks and therefore also eligible as collateralfor advances to member banks. In 1968 suchagency issues were made eligible as securityfor advances to individuals, partnerships, andcorporations. At the same time, a technicalchange made eligible as security for advances tomember banks not only notes, drafts, bills ofexchange, or bankers' acceptances that wereeligible for discount or purchase by the ReserveBanks but also any obligations that were eligiblefor purchase.

It is of interest to note that although dis-counting operations, as discussed in previouschapters, have involved detailed regulationsand numerous rulings on the part of the Board,advances have given rise to relatively few regu-lations or interpretations. In fact, it was notuntil 1937 that the Board's Regulation A de-voted a separate section to the subject of ad-vances as distinguished from discounts. How-ever, the predominant importance of advancesin recent years is indicated by the fact that therevision of the regulation in 1955 for the firsttime placed the section dealing with advancesahead of the detailed and technical provisionsrelating to the discount of commercial, agricul-tural, and industrial paper. The importance ofdiscounting was further downgraded by therevision of Regulation A adopted in 1973. Thisrevision condensed to a minimum the regula-tory provisions regarding eligibility of paperfor discount, and it provided that a Reserve


ADVANCES TO MEMBER BANKS 85

Bank may discount paper for a member bankif the Reserve Bank "should conclude that amember bank would be better accommodatedby the discount of paper than by an advanceon the security thereof."

ORIGINAL AUTHORIZATIONAs previously indicated, the original Federal

Reserve Act was limited to discounts; it in-cluded no provision for advances. In its AnnualReport for 1915, the Federal Reserve Boardrecommended to Congress an amendment toauthorize 15-day advances to member banks ontheir own notes secured cither by eligible paperor by Government bonds. The Board stated: 1

In order to enable member banks to obtainprompt and economical accommodations forperiods not to exceed fifteen days, the FederalReserve Banks should be permitted to makeadvances to member banks against theirpromissory notes secured by such notes,drafts, bills of exchange, and bankers' ac-ceptances as the law at present permits to berediscounted or purchased; or against thedeposit or pledge of United States Govern-ment bonds, the purchase of which is nowpermitted under the law.

The Board's recommendation was adoptedby Congress. The Act of September 7, 1916,2

among other amendments, added a new para-graph to section 13 of the Federal Reserve Act,a paragraph that will frequently be referred tohereinafter as "the eighth paragraph of section13." It authorized any Federal Reserve Bank tomake advances to its member banks on theirpromissory notes secured "by such notes, drafts,bills of exchange, or bankers' acceptances asare eligible for rediscount or for purchase byFederal reserve banks under the provisions ofwis Act, or by the deposit or pledge of bondsor notes of the United States." No such advancecould be made for a period exceeding 15 days,and rates for such advances were required to beestablished by the Reserve Banks, subject tothe review and determination of the FederalReserve Board.

The primary purpose of this amendment, as't had been stated by the Board and as it waskte stated by the Senate Banking and Cur-

rency Committee,3 was "to facilitate the con-venience of the transaction and to economizein bookkeeping." On the floor of Congress,Senator Owen referred to it simply as "anadministrative detail which makes more con-venient the operation of the bank."4 Manyyears later, when early drafts of the BankingAct of 1933 were being considered in Congress,the Board similarly stated that member banksborrowed on their 15-day notes "because of thegreater convenience both to them and to theFederal reserve bank." s

Following the adoption of the 1916 amend-ment, the Board announced that it did notconsider it necessary to promulgate "any specialruling relating to the exercise of the powersconferred" by this amendment.8 Actually, aspreviously noted, it developed that the provi-sions of the law regarding advances, unlikethose with respect to discounts, rarely gave riseto the need for rulings by the Board.

LIMITATION TO PAPERELIGIBLE FOR PURCHASE UNDERFEDERAL RESERVE ACT

Putting aside for the moment the specificauthority for the use of Government bonds ascollateral security for advances to memberbanks, it should be noted that the 1916 amend-ment required that such advances be secured"by such notes, drafts, bills of exchange, orbankers' acceptances as are eligible for redis-count or for purchase by Federal reserve banksunder the provisions of this Act," [emphasisadded] that is, under the Federal Reserve Act.In effect, this meant that all of the classes ofpaper eligible for discount under that Act, asdiscussed in previous chapters of this history,and, in addition, all paper eligible for purchaseby the Reserve Banks under that Act (with ex-ceptions hereinafter noted) became eligible ascollateral for advances.

The restriction of security for advances topaper eligible for discount or purchase underthe Federal Reserve Act, however, had theeffect of excluding two types of paper. Onewas notes secured by adjusted service certifi-cates of World War I veterans, since such noteswere made eligible for discount by provisions



of the World War Adjusted Compensation Actrather than by provisions of the Federal ReserveAct.7 The other was farm loan bonds, since theauthority of the Reserve Banks to purchasesuch bonds was contained not in the FederalReserve Act but in the Farm Loan Act of 1916.

Paper eligible for purchase by the ReserveBanks under the Federal Reserve Act is de-scribed in section 14 of that Act. It covers,in the first paragraph of that section, cabletransfers, bankers' acceptances, and bills ofexchange of the kinds and maturities eligiblefor discount. As noted in an earlier chapterrelating specifically to bankers' acceptances, theBoard has ruled that such acceptances areeligible for purchase even though they are noteligible for discount; consequently, any accept-ances are eligible as security for Reserve Bankadvances to member banks. Section 14 alsoauthorizes the purchase of direct obligations ofthe United States; obligations fully guaranteedby the United States; obligations issued or guar-anteed by any agency of the United States; andobligations issued by States and municipalitiesin anticipation of the collection of taxes andwith maturities of not more than 6 months,which are usually referred to as tax warrants.

LIMITATION TO PAPER ARISINGFROM COMMERCIAL ORAGRICULTURAL TRANSACTIONS

Not all paper made eligible for purchase bythe Reserve Banks under the Federal ReserveAct was also eligible as security for ReserveBank advances until 1968. This was becausethe Board before 1968 took the position thatthe reference in the eighth paragraph of section13, as added in 1916, to "notes, drafts, billsof exchange, * * * eligible * * * for purchaseunder the Federal Reserve Act" was intended tocover only notes arising out of commercial andagricultural transactions. Consequently, obliga-tions guaranteed by the United States, obliga-tions issued by individual Government agencies,and tax warrants of municipalities, even thoughexpressly eligible for purchase under section 14of the Federal Reserve Act, were not eligiblefor use as collateral for advances unless theireligibility for such use was specifically provided

for by Congress. The rationale of the Board'sposition before 1968 may be summarized asfollows.

Read literally, the reference to the use ofnotes eligible for purchase by the Reserve Banksthat is contained in the eighth paragraph ofsection 13 could be construed as covering anynotes, including bonds and debentures, issuedby Government agencies that were eligible forpurchase under section 14 of the Act. It seemsreasonably clear, however, that such a literalconstruction of the eighth paragraph of section13 would not have been warranted. In the firstplace, the legislative history of that paragraphindicates that the word "notes" as used thereinwas intended to cover only notes arising out ofcommercial and agricultural transactions of thekind made eligible for discount.

As originally enacted in 1916, this paragraphauthorized 15-day advances on the security of(1) notes, drafts, bills of exchange, or bankers'acceptances eligible for discount or purchase,or (2) bonds or notes of the United States.Since bonds and notes of the United States werealready eligible for purchase under section14(b), it would have been unnecessary tomention them separately in section 13 if theywere covered by the words "notes * * * eligible* * • for purchase." When the Board in its1932 Annual Report to Congress recommendedthat the maximum maturity on advances se-cured by paper eligible for discount or purchasebe increased from 15 to 90 days, it was clearthat the Board had in mind only ordinary com-mercial or agricultural paper. Thus, the Boardnoted that the Reserve Banks could rediscount"commercial or industrial paper with maturitiesup to 90 days and agricultural paper withmaturities up to 9 months" and argued that anamendment increasing the maturity on advancessecured by such paper would not "involve abroadening in the character or class of paperor securities which may be legally acquired byFederal Reserve banks and would not consti-tute in any respect a departure from the funda-mental purposes of the Federal Reserve Act."s

The Emergency Banking Act of March 9,1933, added a new paragraph to section 13authorizing 90-day advances to individuals,partnerships, or corporations if secured by


direct obligations of the United States. Underthat paragraph, the Board took the positionthat since member banks are "corporations,"advances could be made to such banks onGovernment obligations with maturities of up to90 days. This resort to the last paragraph ofsection 13 as a legal basis for 90-day advanceson Government obligations would have beenunnecessary if the word "notes" in the eighthparagraph of section 13 were broad enough toinclude notes of the United States.

Again, in 1934 Congress amended section14(b) to authorize the purchase of bonds ofthe Federal Farm Mortgage Corporation andof the Home Owners' Loan Corporation; atthe same time it also amended the eighth para-graph of section 13 to make such bonds eligibleas security for 15-day advances to memberbanks. These amendments to section 13 wouldnot have been necessary if such bonds werenotes within the meaning of section 13; theywould have automatically become eligible assecurity for 90-day advances to member banksby reason of the fact that they were madeeligible for purchase.

It appears that, presumably for the reasonsabove indicated, the Board adopted the positionthat notes of a Government agency, even thoughbacked by the credit of the United States andperhaps eligible for purchase under the Fed-eral Reserve Act, would not for that reasonalone be eligible as security for advances undersection 13. In 1960, the Board ruled that UnitedStates Government Insured Merchant MarineBonds, issued under the Merchant Marine Actof 1936, were not eligible as security for suchadvances, even though such bonds were in effectfully insured as to principal and interest by theUnited States. After quoting the provision ofsection 13 authorizing 90-day advances onpaper eligible for discount or purchase, theBoard concluded:9

* * * in the light of the language of thequoted provision, its legislative history, andthe language and scope of other provisions ofthe Federal Reserve Act, that the words"notes, drafts, bills of exchange, or bankers'acceptances" refer only to obligations arisingout of commercial or agricultural transac-tions. Since Merchant Marine Bonds [which


are based on mortgages] are not of this char-acter, they are not eligible as security foradvances by Federal Reserve Banks to mem-ber banks under the provisions of section 13of the Federal Reserve Act.

The situation was completely changed in 1968when Congress, following a recommendationmade by the Board, amended the eighth para-graph of section 13 to authorize advances tomember banks not only on the security of"notes * * * eligible * * * for purchase" butalso on the security of any obligations eligiblefor purchase under section 14 (b) of the Act.10

As a result of this amendment, all of the variousobligations made eligible for purchase undersection 14(b), including obligations fully guar-anteed by the United States, obligations issuedor guaranteed by Government agencies, and taxwarrants of municipalities, became for the firsttime eligible for use as collateral for advancesto member banks.

In the light of the 1968 amendment to thelaw, the Board amended Regulation A, effectiveNovember 13, 1968, to change the provisionsregarding advances to member banks by elimi-nating a reference to the making of suchadvances "secured by such notes, drafts, billsof exchange, or bankers' acceptances as areeligible for discount by Federal Reserve Banksunder the provisions of this Regulation or forpurchase by such banks under the provisionsof the Federal Reserve Act" and by substitutingfor this language a simple statement that "Re-serve Banks may make advances to memberbanks for not more than 90 days if securedby obligations or other paper eligible under theFederal Reserve Act for discount or purchaseby Reserve Banks." "

ENDORSEMENT OF PLEDGEDPAPER

Bills of exchange and bankers' acceptancesneed not be endorsed by a member bank inorder to be eligible for purchase under section14 of the Federal Reserve Act. Moreover, thegeneral requirement of section 13 that paperoffered for rediscount must be endorsed by theoffering member bank is not regarded as anessential prerequisite of eligibility as such. For



these reasons, the Board in an early ruling heldthat eligible paper pledged as security for ad-vances to a member bank did not have to beendorsed by the member bank, provided thepaper was negotiable in form.13 Since then, asmentioned earlier in this study, the negotiabilityrequirement has been eliminated.

MATURITY OF ADVANCESAlthough the Reserve Banks may discount

commercial paper having a maturity of up to90 days at the time of discount and agriculturalpaper with a maturity of not more than 9months, the authority for advances, as alreadynoted, was originally limited by the 1916amendment to periods of not more than 15days. When that amendment was under con-sideration in Congress, question was raised asto why the maturity was made so short; " but,until 1933, the 15-day limitation continued ineffect for advances both on eligible paper andon Government obligations. Although renewalswere not encouraged, the Board held that aFederal Reserve Bank could renew the 15-daynotes of its member banks as long as it didnot obligate itself in advance to make any suchrenewal.11

In 1932 the Board recommended to Congressthat the maturity limitation on advances beincreased from 15 to 90 days, pointing out thatsuch a liberalization "would be especially help-ful to country banks." " In accordance with thisproposal, Congress by the Banking Act of 1933amended the eighth paragraph of section 13 ofthe Federal Reserve Act to authorize advancesto member banks on their secured notes forperiods of up to 90 days, but only when thesecurity was paper eligible for rediscount orpurchase by the Reserve Banks under the Fed-eral Reserve Act. Advances on Governmentobligations were still specifically limited to15 days, even though such obligations wereeligible for purchase under section 14 of theAct. As will be noted later, however, anotherprovision of the law, which had been addedin March 1933, was construed as authorizing90-day advances to member banks on their

own notes secured by direct obligations of theUnited States.

Despite the statutory extension of the periodfor which advances might be made to memberbanks on the security of eligible paper, suchadvances have normally been extended forperiods of much less than 90 days. The principlethat member bank borrowings should ordinarilybe only for temporary periods was emphasizedwhen the Board's Regulation A was revised in1955. In a foreword to the revised regulation,it was stated that "Federal Reserve credit isgenerally extended on a short-term basis"; and,while the provision relating to advances oneligible paper followed the law in prescribinga maximum maturity of 90 days, a footnote tothis provision stated, "However, borrowings bymember banks arc generally for shortperiods." 10 This footnote was eliminated in1968; K but the statement remains accurate asa matter of practice except where advances aremade to enable member banks to meet seasonalneeds and except in unusual or emergencycircumstances.

INCREASE OF SECURITIES LOANSDURING LIFE OF ADVANCE

While Congress during the early 1930's wasseeking to instill confidence in the economy bybroadening the basis for borrowings from theReserve Banks, it was at the same time deeplyconscious of the fact that the use of bankcredit for speculative purposes had been one ofthe major causes of bank failures. Thus, whenthe Glass-Steagall bill was being debated inFebruary 1932, an amendment was offered tomake any advance to a member bank im-mediately due and payable if, during the lifeof the advance, the bank should increase itsoutstanding loans for the purpose of carryingstocks and bonds. The amendment was defeatedonly because Senator Glass gave assurance thata provision to that effect was to be included inthe omnibus banking bill then pending."

An early draft of the Glass omnibus bankingbill in March 1932 10 included not only a provi-sion, for suspending credit to member banks



that increased their securities loans but also arequirement that the rate of interest on any15-day advance to a member bank shouldbe 1 per cent higher than the current discountrate. The Board strongly opposed the suggestedpenalty rate on advances. It argued that thetheory underlying the suggestion, namely, thatadvances had a more direct connection withspeculative activities than rediscounts, was un-founded. It pointed out that if advances "wereprohibited or made more expensive, they[member banks] would merely substitute theprocedure of rcdiscounting eligible paper with-out any change in the use of the proceeds."=0

At the same time, the Board recommendedthe inclusion in section 4 of the Federal ReserveAct of a provision requiring the Reserve Banksto keep themselves informed as to the specula-tive use of bank credit by their member banksand to take such matters into consideration inmaking discounts and advances. Such a provi-sion, the Board believed, would make unneces-sary the proposed provision for making anyadvance immediately due and payable if theborrowing bank increased its loans to purchaseor carry securities.

As it turned out, both provisions were in-cluded in the final version of the Banking Actof 1933. The provision added to section 4, asrecommended by the Board, will be discussedin a later chapter. The provision added to theeighth paragraph of section 13 was to the effectthat if any member bank to which any advancehad been made under that paragraph should,during the life of such advance and despite anofficial warning from the Reserve Bank or theBoard, increase its outstanding loans col-lateraled by securities or loans to members ofstock exchanges or dealers in securities for thepurpose of purchasing or carrying stocks,bonds, or other investment securities (otherthan obligations of the United States), suchadvance should be deemed immediately dueand payable. In addition, in any such case themember bank was made ineligible to borrowagain from the Reserve Bank under this para-graph for such period as the Federal ReserveBoard should determine.

This provision remains unchanged in the lawand it has given rise to no legal problems.Following the language of the law, the Boardhas taken the position that an increase in amember bank's securities loans does not subjectit to the penalties prescribed by the provisionunless such increase takes place after the is-suance of an official warning by the ReserveBank or the Board.21 This has been the onlypublished interpretation of the provision.

ELIMINATION OF APPLICATIONFORMS AND PROMISSORYNOTES

In November 1970 the Board approvedrather drastic changes in the procedures relatingto advances to member banks: (1) eliminationof the use of formal applications for advances,and (2) provision for the use of a continuinglending agreement to be entered into by amember bank in lieu of the execution of atraditional promissory note in connection witheach borrowing.

The law had never required that memberbanks file formal application forms in requestingReserve Bank advances, but Regulation A hadincluded provisions clearly implying the needfor such applications. These provisions wereeliminated by an amendment to the regulation,effective November 23,1970.22

At the same time, the Board amended theregulation to eliminate references to the execu-tion of notes by borrowing member banks. Itappeared that the law expressly required aborrowing bank to execute a promissory note.Nevertheless, the Board concluded that theunderlying purpose of this requirement—togive a Reserve Bank a direct claim against aborrowing member bank—would be equallyserved by the execution of a lending agreementunder which the bank would be legally obligatedto repay all advances made pursuant to theagreement. Moreover, a practice had developedby which overnight advances to member bankswere frequently repaid before the receipt bythe Reserve Bank of the borrowing bank'spromissory note.



These changes in procedure were describedby the Board in a press release issued onDecember 1, 1970, as "designed to simplifyand update present practices." They went intoeffect in February 1971. Since then, continuinglending agreements have been regarded as an

acceptable substitute for formal applicationforms and promissory notes. Such agreementsinclude the essential terms previously includedin promissory notes, and a member bank isunconditionally obliged to repay all advancesreceived under such agreements.

ADVANCES ON DIRECT OBLIGATIONS OFTHE UNITED STATES

15-DAY ADVANCESThe eighth paragraph of section 13 of the

Federal Reserve Act, as added by the Act ofSeptember 7, 1916," authorized the FederalReserve Banks to make advances to memberbanks on their own notes secured not only bypaper eligible for discount or purchase but alsoby the "deposit or pledge of bonds or notes ofthe United States." The maturity of such ad-vances was limited to 15 days. By the BankingAct of 1933, this paragraph was amended topermit a maximum maturity of 90 days, insteadof 15 days, on advances secured by eligiblepaper. It did not, however, similarly liberalizethe maturity restriction with respect to advancessecured by Government obligations. Thus,under this paragraph of section 13, advanceson direct obligations of the United States withmaturities exceeding 15 days could not bemade.

90-DAY ADVANCESActually, there was no need for the Banking

Act of June 16, 1933, to increase the maturitylimitation on advances secured by Governmentobligations. About 3 months earlier, the Emer-gency Banking Act of March 9, 1933,11 hadadded to section 13 of the Federal Reserve Acta new paragraph (the thirteenth and last para-graph) that had authorized advances withmaturities of up to 90 days to individuals, part-nerships, and corporations on their promissorynotes secured by direct obligations of the

United States. Although the new paragraph didnot specifically mention member banks, it wasimmediately obvious that since member bankswere corporations, they could obtain 90-dayadvances on the security of Government obliga-tions under the provisions of this paragraph.

This was made clear by a change in Regula-tion A in 1942. Section 2(b), which previouslyhad prescribed a 15-day maturity with respectto advances to member banks on Governmentobligations, was amended to provide a maxi-mum maturity of 90 days." In a footnote it wasexplained that although the eighth paragraphof section 13 authorized advances to memberbanks on Government obligations for periodsnot exceeding 15 days, the last paragraph ofthat section authorized advances to any in-dividual, partnership, or corporation on directobligations of the United States for periods notexceeding 90 days and that the term "corpora-tion" included a member bank.

When the regulation was again revised i"February 1955, the 15-day maturity limitationon advances on Government obligations wasrestored, at least in the text of the regulation."However, it was explained in a footnote thatunder the last paragraph of section 13 of theFederal Reserve Act, a Federal Reserve Bankhad authority to make 90-day advances to fa'dividuals, partnerships, and corporations I"1'eluding member and nonmember banks) °n

their notes secured by direct obligations of the


United States, but that advances to memberbanks on the security of such obligations "arenormally for short periods of not exceedingfifteen days."

In 1968 the regulation was amended toprovide in the text for advances to memberbanks for periods of up to 90 days whensecured either by paper eligible, for discountor by paper eligible for purchase by the ReserveBanks, without any specific reference to ad-vances on direct obligations of the UnitedStates; at the same time the footnote indicatingthat advances were normally made for shorterperiods was omitted."

LIMITATION AS TO TYPEOF OBLIGATION

The eighth paragraph of section 13 of theFederal Reserve Act, as added in 1916, re-ferred to advances on bonds or notes of theUnited States. The Banking Act of 1933amended this language to refer to bonds, notes,certificates of indebtedness, or Treasury bills ofthe United States." Although the last paragraphof section 13 authorized advances on "directobligations of the United States," the Boardconstrued this phrase as likewise being limitedto bonds, notes, and certificates of indebtedness,and as not including any other types of directobligations of the United States. Thus, in 1960,the Board held that although the DefenseDepartment was directly liable on certain deedof trust notes, such notes were not direct obliga-tions of the United States within the meaningof the last paragraph of section 13. This posi-tion was based on the ground that advancesunder that paragraph were subject to suchlimitations, restrictions, and regulations as the


Board may prescribe, and that Regulation Aparenthetically defined direct obligations tomean only bonds, notes, Treasury bills, or cer-tificates of indebtedness of the United States.29

ADVANCES AT PAR

In its 1937 revision of Regulation A, theBoard included a provision requiring a FederalReserve Bank to explain to the Board the factsand circumstances of any case in which theamount of an advance on a member bank's notesecured by direct obligations of the UnitedStates or by obligations fully guaranteed by theUnited States was less than the face amountof such obligations.30 However, when WorldWar II broke out in Europe, the Board an-nounced that all advances by the ReserveBanks on Government obligations would bemade at par,31 and this announcement wasrepeated in 1941 when the United Statesentered the war.32 This provision was omittedin the 1955 revision of the regulation becauseit was considered no longer applicable andbecause its inclusion might be construed asbeing inconsistent with the System's announcedpolicy that all advances on Government obliga-tions would be made at par.

For many years commercial banks held largevolumes of Government obligations in theirportfolios, and by far the greatest part ofmember bank borrowings from the ReserveBanks during those years was through advancessecured by direct obligations of the UnitedStates. In recent years, however, the volume of"free" (that is, unpledged) Government obliga-tions held by member banks has declinedsharply, and more and more member bankborrowings have been secured by eligible paper.

ADVANCES ON OBLIGATIONS OFGOVERNMENT AGENCIES

SUMMARY obligations of the United States, as distinguishedfrom obligations of U. S. Government agencies,

Except for bonds of the War Finance Cor- were eligible as security for Reserve BankPoration during World War I,™ only direct advances prior to 1932. After 1932 amend-



ments were made from time to time to theeighth paragraph of section 13 of the FederalReserve Act for the purpose of specificallymaking obligations of certain Government agen-cies eligible as security for advances under thatparagraph. In 1968 the paragraph was amendedto permit advances to member banks on anyobligations eligible for purchase by the ReserveBanks under section 14(b) of the FederalReserve Act—which include all obligationsguaranteed by the United States and obliga-tions issued or guaranteed by agencies of theUnited States.

FEDERAL INTERMEDIATECREDIT BANK OBLIGATIONS

The Agricultural Credits Act of 1923 addedto the Federal Reserve Act a new section—13a—which, among other things, authorized theReserve Banks to discount *paper for Federalintermediate credit banks and to purchase thedebentures and other obligations of such banks.In 1932 Congress apparently felt that the inter-mediate credit banks needed additional facili-ties for acquiring funds through the FederalReserve System; the Act of May 19, 1932,"endorsed by the Farm Loan Board, the Trea-sury, and the Federal Reserve Board, wasdesigned to meet these needs. Among otherthings, that act amended the eighth paragraphof section 13 of the Federal Reserve Act so asto authorize 15-day advances by the ReserveBanks to member banks on their notes secured"by the deposit or pledge of debentures orother such obligations of Federal intermediatecredit banks which are eligible for purchase byFederal reserve banks under section 13 (a) ofthe Federal Reserve Act." 3=

In recommending the enactment of this provi-sion the House Banking and Currency Com-mittee, after pointing out that intermediatecredit bank debentures were already eligiblefor purchase by the Federal Reserve Banks,stated: 30

• * * * Such an amendment to the Federalreserve act would be of great benefit to theFederal intermediate credit banks because its

immediate effect would be to broaden themarket for ihc collateral trust debentures is-sued by the banks. These arc high-grade in-vestments, and member banks would purchasethem in greater volume if they could be usedas a basis for temporary credit with the Fed-eral reserve bank in the event of someemergency or need for funds.* * *

Significantly, the committee's report wenton to say that it was not believed that thedebentures would be used for this purpose toany great extent, but that "the fact that theycould would be very valuable in the sale ofdebentures and would greatly facilitate theoperations of the Federal intermediate creditbanks in extending credit to agriculture." Thismotive—to make the purchase and holding ofthe debentures more attractive to banks—hasobviously been behind subsequent amendmentsto the Federal Reserve Act making obligationsof other Government agencies eligible as col-lateral for Federal Reserve advances to memberbanks.

In the course of the debates on the 1932amendment, Chairman Stcagall of the HouseBanking and Currency Committee argued thatdebentures of the intermediate credit bankswere "as sound and desirable" as the commer-cial paper that the Reserve Banks were per-mitted to accept as collateral for advancesunder the existing law and that the amendmentwould make the debentures more desirable tomember banks and thus "reduce the interestwhich is paid by fanner borrowers." nr

One persistent opponent of the amendmentwas Congressman McFadden. He arguedstrongly that its enactment would weaken thesecurity behind Federal Reserve notes. His rea-sons were the same as those he had previouslyadvanced in opposing the Glass-Steagall Act,which a few months before had permitted Gov-ernment bonds to be used as collateral securityfor Federal Reserve notes. He insisted that theamendment would "repeal the liquidity provi-sion of the Federal reserve act, the main thingthat was the argument for the creation of theFederal reserve act—elasticity." He contendedthat the amendment was a reversion "to the



Government bond secured circulating medium,"and that in this instance the bonds of theintermediate credit system were being sub-stituted for Government bonds.36

Despite Mr. McFadden's objections, theamendment was passed. It became a precedentfor later enactments authorizing obligations ofcertain other Government agencies to be usedas collateral for advances by the Reserve Banksto their member banks.

The 1932 amendment authorized the pledgeof intermediate credit bank obligations as se-curity for 15-day advances to member banksonly if they were eligible for purchase by theReserve Banks under section 13a of the FederalReserve Act. That section provided for thepurchase of such obligations only "to the sameextent and subject to the same conditions" asthose under which farm loan bonds could bebought by the Reserve Banks. Under the FarmLoan Act of 1916, the Reserve Banks couldbuy farm loan bonds only to the same extentand subject to the same conditions as they couldbuy municipal bonds under section 14(b) ofthe Federal Reserve Act. Under section 14 (b)they were authorized to purchase only muni-cipal bonds having maturities of not more than6 months from the date of purchase. As theresult of this rather devious chain of references,only obligations of intermediate credit bankshaving a maturity of 6 months or less wereeligible as security for advances to memberbanks. This limitation, however, is no longerapplicable because section 14(b) of the Fed-eral Reserve Act now authorizes the ReserveBanks to purchase obligations of any agency ofthe United States—the intermediate creditbanks arc regarded as agencies of the UnitedStates—and the eighth paragraph of section 13permits any obligations eligible for purchaseunder section 14(b) to be used as collateralfor Reserve Bank advances.

Although section 13a of the Federal ReserveAct refers to the purchase of debentures issuedty "a" Federal intermediate credit bank, thelaw covers not only debentures issued individ-ually by such banks but also consolidateddebentures issued by such banks together;'"1

consequently, consolidated debentures, as wellas individual debentures, are eligible as securityfor advances to member banks.

FARM LOAN BONDS

The Federal Farm Loan Act of 1916 ex-pressly authorized any Federal Reserve Bankto buy and sell farm loan bonds issued by theFederal farm land banks to the same extent asthey were authorized to buy State, county, dis-trict, and municipal bonds under section 14 (b)of the Federal Reserve Act.40 That sectionauthorized the purchase of such bonds, that is,tax warrants, with maturities of not more than6 months. Since the new farm loan bonds wereeligible for purchase under a statute other thanthe Federal Reserve Act, they were not eligibleas collateral for advances to member banksunder the eighth paragraph of section 13 ofthat Act. Moreover, the Board's General Coun-sel in 1917 ruled that farm loan bonds couldnot be regarded as "bonds of the United States"and were therefore not eligible for use ascollateral for advances to member banks."

In the early days of March 1933, drasticsteps had been taken to maintain the solvencyof the banks of the country. As a further steptoward economic recovery, President Roosevelt,in a special message to Congress on March 16,1933, recommended the enactment of an act"to establish and maintain such a balancebetween production and consumption of agri-cultural commodities and such conditions inthe marketing of agricultural commodities aswill give to such commodities sold by farmerstheir pre-war purchasing power."42 This be-came known as the Agricultural AdjustmentAct.

As evidence of the urgency of the measure,the bill was introduced in the House on March20, reported the same day, passed by the Houseon March 22, and introduced in the Senate onMarch 23. Up to that point, it contained nothingwith respect to farm credits; it was concernedprimarily with the maintenance of the balancebetween the production and consumption ofagricultural commodities. As reported by the



Senate committee, however, the bill was ex-panded to cover extensions of additional creditthrough the farm credit system. It included aprovision for the issuance by the Federal landbanks of a special type of farm loan bonds fora limited period of 2 years in order to enablethe land banks to expand their lending facilities.These bonds, limited to an aggregate of $2 bil-lion, were to be fully guaranteed as to interestby the United States.

To insure the sale of the bonds, SenatorFrazier proposed an amendment that wouldhave given them the complete support of theFederal Reserve System: If they were not soldto the public, the Federal Reserve Board wouldhave been required to deliver to the FederalFarm Loan Board an equal amount of FederalReserve notes. A less drastic step, however, wasfinally adopted. On April 10, Senator Shipsteadintroduced an amendment to the bill to makethe new farm loan bonds eligible as collateralfor advances by Federal Reserve Banks tomember banks under section 13 of the Fed-eral Reserve Act. As finally enacted on May 12,the statute " amended section 32 of the Fed-eral Farm Loan Act of 1916 to authorize theissuance of the temporary farm loan bondsand further amended the provisions of section13 of the Federal Reserve Act relating to15-day advances to member banks so as topermit such advances to be secured "by thedeposit or pledge of bonds issued pursuant tothe paragraph added to section 32 of theFederal Farm Loan Act, as amended by section21 of the Emergency Farm Mortgage Act of1933."

Authority for the use of these bonds, as col-lateral for advances to member banks wasshort lived, however. In the following month,the Banking Act of 1933 again amended theeighth paragraph of section 13 of the FederalReserve Act and at that time the provisionfor the use of farm loan bonds as collateralfor 15-day advances was omitted.

Although the Reserve Banks were still au-thorized to purchase farm loan bonds, thatauthority was not contained in the FederalReserve Act itself; consequently, such bonds

did not come within the scope of paper eligibleas collateral for advances, that is, paper eligiblefor discount or purchase under the FederalReserve Act. However, farm loan bonds haveagain become eligible as collateral for FederalReserve advances because they arc obligationsof the Federal land banks, which arc agencies ofthe United States; the Reserve Banks areauthorized under section 14(b) of the FederalReserve Act to purchase obligations of Govern-ment agencies, and section 13 permits the useof any paper eligible for purchase under section14(b) as collateral for Federal Reserve Bankadvances.

FEDERAL FARM MORTGAGECORPORATION BONDS

The need for additional farm credit, whichthe Act of May 12, 1933, had been designed tomeet, continued into 1934. Commercial banksstill were not satisfying the demand for farmmortgage loans. The Federal Farm MortgageCorporation Act of January 31, 1934," wasintended "to supply funds for continuing onits augmented basis the land-mortgage creditsystem provided for in the Federal Farm LoanAct and the Emergency Farm Mortgage Act of1933." 45 It created a new agency, the FederalFarm Mortgage Corporation, with authority toissue bonds guaranteed by the United States.The Federal land banks were permitted to ex-change their own consolidated bonds for theGovernment-guaranteed bonds of the Corpora-tion and thus be in a position to sell the latterand use the proceeds for making additionalfarm mortgage loans.

To encourage banks to buy the bonds of thenew Corporation, the House bill would haveamended section 14 of the Federal Reserve Actto authorize the Federal Reserve Banks to buyand sell such bonds. As finally enacted, thestatute went further and amended both section14 and section 13 of the Federal Reserve Act.The Reserve Banks were authorized undersection 14 to buy and sell bonds of the FederalFarm Mortgage Corporation having maturitiesfrom the date of purchase of not more than



6 months. The eighth paragraph of section 13was amended to authorize 15-day advances tomember banks on their notes secured "by thedeposit or pledge of Federal Farm MortgageCorporation bonds issued under the FederalFarm Mortgage Corporation Act."

This authorization soon lost its significance.By the mid-1950's very few bonds of theFederal Farm Mortgage Corporation were out-standing.10 In recognition of this fact, theBoard's 1955 revision of Regulation A, whichpreviously had referred in the text to the useof such bonds as collateral for advances tomember banks, merely referred in a footnoteto the fact that "such advances may also bemade on notes secured by the deposit or pledgeof Federal Farm Mortgage Corporation bondsissued under the Federal Farm Mortgage Cor-poration Act." 17 By an Act of October 4,1961,Congress amended paragraph 8 of section 13of the Federal Reserve Act to eliminate thereference to Federal Farm Mortgage Corpora-tion bonds as collateral for Federal Reserveadvances to member banks; "• and the footnotereference to such bonds in Regulation A waseliminated in 1968.10

HOME OWNERS'LOAN CORPORATION BONDS

A few months after bonds of the FarmMortgage Corporation were made eligible ascollateral for Federal Reserve advances, bondsof the Home Owners' Loan Corporation(HOLC) were given the same privilege. Inaddition to making such bonds eligible forpurchase by the Federal Reserve Banks, theAct of April 27, 1934,50 amended the eighthparagraph of section 13 of the Federal ReserveAct to permit 15-day advances to memberbanks to be secured by "the deposit or pledgeof bonds issued under the provisions of sub-section (c) of section 4 of the Home Owners'Loan Act of 1933, as amended."

The committee reports gave no specific rea-son for this amendment. It appeared, however,that the refunding of the previously issuedHOLC bonds had been retarded because they

had not been clearly guaranteed as to principalby the United States and, being quoted belowpar, they had not been acceptable to somemortgagees at face value in exchange formortgages. To remedy the situation, the newbonds were expressly and fully guaranteed asto principal and interest by the United States."Presumably in order to make them more at-tractive investments for banks, they were alsomade available as a basis for Federal Reservecredit.

During the debates, Senator Bulkley statedthat this was simply a technical provisiondesigned to put these bonds "on the same basiswith United States bonds in this respect.* * * We are simply conforming to the Fed-eral Reserve Act in giving these bonds atechnical privilege, which they ought to havewhen guaranteed by the Treasury."os

In practice, the authority for the use ofHOLC bonds as security for section 13 ad-vances to member banks proved to be of littlesignificance. The HOLC was dissolved on Feb-ruary 3, 1954," and none of its bonds areoutstanding. The reference carried in theBoard's 1937 Regulation A to the use of suchbonds as collateral for advances was omittedwhen the regulation was revised in 1955.

COMMODITY CREDITCORPORATION CERTIFICATESOF INTEREST

By regulation in 1949, the Board permittedthe use of one type of paper as collateral forsection 13 advances even though it was notclearly eligible either for discount or for pur-chase by the Reserve Banks. As part of aneffort to encourage banks to hold notes rep-resenting loans made to producers of agricul-tural products pursuant to commodity loanprograms of the Commodity Credit Corpora-tion (CCC), the Board amended its Regula-tion A, effective February 17, 1949, to exceptsuch producers' notes from the negotiabilityrequirement of the regulation in order that theymight be eligible for rediscount. Under some ofthe CCC programs, however, the producers'



notes were bought by CCC and held in"pools," and certificates of interest in suchpools of notes were issued to banks. In 1917the Board had ruled that a certificate ofinterest in a note was not eligible for dis-count.54 Although this would suggest that cer-tificates of interest in pools of CCC notes wouldnot be eligible for discount, the Board amendedRegulation A to provide "for the use of certifi-cates of interest such as are issued by theCommodity Credit Corporation under its cottonloan program as security for advances made tomember banks." 5=

In 1969 the reference to the use of CCCparticipation certificates as collateral for ad-vances to member banks was omitted fromRegulation A, but at the same time the Boardadded to its list of agency issues eligible ascollateral for such advances "Commodity CreditCorporation certificates of interest in a price-support loan pool." 50

MERCHANT MARINEBONDS

In 1960 the Board ruled that United StatesGovernment Insured Merchant Marine bondswere not eligible as collateral for Reserve Bankadvances to member banks under section 13 ofthe Federal Reserve Act because, in the lightof the legislative history, the reference in theeighth paragraph of that section to notes, drafts,bills of exchange, or bankers' acceptances con-templated only obligations arising out of com-mercial or agricultural transactions, and Mer-chant Marine bonds were not of that char-acter.57 This interpretation was, of course,superseded by the 1968 amendment to theeighth paragraph of section 13 making eligibleas collateral for Reserve Bank advances anyobligations eligible for purchase under section14(b). On the ground that the Merchant Ma-rine bonds constituted obligations issued orguaranteed by a Government agency and thatthey were therefore eligible for purchase, theBoard in 1968 expressly revoked its 1960ruling holding such bonds to be ineligible foruse as collateral.58

FARMERSHOME ADMINISTRATIONINSURED NOTES

In 1962 the Board considered the questionwhether notes evidencing loans to farmers bymember banks that were insured by theFarmers Home Administration were eligibleas collateral for advances under the eighthparagraph of section 13 of the Federal ReserveAct. The Board concluded that, while the term"insurance" rather than the term "guarantee"was used irr connection with such loans, theywere to be considered as fully guaranteed bythe United States within the meaning of sec-tion 14(b) of the Federal Reserve Act andwere therefore eligible for purchase by theReserve Banks. In addition, the Board con-cluded that the insured notes involved in thiscase were to be distinguished from the insuredMarine bonds, which had been considered bythe Board in 1960. The latter bonds, althoughtechnically notes, were regarded as securitiesand not the kind of notes contemplated bythe eighth paragraph of section 13, whereasthe notes insured by the Farmers Home Admin-istration were not in the category of securities.Accordingly, the Board held that such insurednotes were eligible as security for Reserve Bankadvances to member banks under section 13.53

EXPORT-IMPORT BANKPARTICIPATION CERTIFICATES

The Export-Import Bank of Washington is-sued participation certificates representing in-terests in loans made by that Bank. Althoughthe law did not give the Bank express authorityto pledge the faith or credit of the United Statesto the redemption of such certificates, it didunconditionally guarantee the payment of pnn*cipal and interest on such certificates. On thebasis of an opinion of the Attorney General ofthe United States *° to the effect that a guar-antee by a Government agency is an obligationfully binding upon the United States despite theabsence of statutory language expressly pledg-ing its faith or credit to the redemption of the


guarantee, the Board in 1966 concluded thatsuch participation certificates were "fully guar-anteed by the United States as to principal andinterest" within the meaning of section 14(b)of the Federal Reserve Act and were thereforeeligible as collateral for advances to memberbanks under the eighth paragraph of section13."

NOTES GUARANTEED BYSMALL BUSINESSADMINISTRATION

A few months later in 1966, the Boardfollowed the principle stated in the Export-Import Bank case when it ruled that notesfully guaranteed by the Small Business Ad-ministration (SBA) under its Small BusinessInvestment Company Program were eligiblefor purchase by the Reserve Banks under sec-tion 14(b) of the Federal Reserve Act andwere, therefore, eligible as collateral for ad-vances under the eighth paragraph of section13.62 Again, although the Small Business In-vestment Act did not expressly pledge thefaith or credit of the United States for theredemption of the notes guaranteed by theSBA, the Board relied upon the opinion ofthe Attorney General previously mentionedto the effect that a guarantee by a Governmentagency is an obligation fully binding on theUnited States despite the absence of statutorylanguage expressly pledging the faith or creditof the Government for the redemption of theguarantee.

AGENCY ISSUES

In 1966, section ]4(b) of the Federal Re-serve Act was amended to authorize the ReserveBanks, under regulations of the Federal OpenMarket Committee, to buy and sell in the openmarket "any obligation which is a direct obliga-tion of, or fully guaranteed as to principal andinterest by, any agency of the United States."03

This authority was originally conferred for only1 year, but in 1967 it was extended for anotheryear and in 1968 it was made permanent.01


The effect of this amendment to section14(b) was to make eligible for purchase bythe Reserve Banks not only direct obligationsof the United States and obligations fully guar-anteed by the United States but also any ob-ligation issued by any agency of the UnitedStates or fully guaranteed by any such agency,even though such obligation would not be fullyguaranteed by the United States.

Although such agency issues were thus madeeligible for purchase by the Reserve Banks,they were still not eligible, under Board rulings,as collateral for Reserve Bank advances undersection 13 of the Act unless they could be re-garded as notes arising out of commercialor agricultural transactions. The situation waschanged by the 1968 amendment to the eighthparagraph of section 13 when any obligationseligible for purchase were made eligible assecurity for advances. Since 1968, any obliga-tion issued or fully guaranteed by any Govern-ment agency has been eligible as collateral forsection 13 advances to member banks.

Following the enactment of the 1968 legisla-tion, the Board issued an interpretation listingthe principal agency obligations that wereeligible as collateral for Reserve Bank advancesunder section 13. The list of agency obligationswas as follows: °5

(1) Federal Intermediate Credit Bank de-bentures

(2) Federal Home Loan Bank notes andbonds

(3) Federal Land Bank bonds(4) Bank for Cooperative debentures(5) Federal National Mortgage Association

notes, debentures, and guaranteed cer-tificates of participation

(6) Obligations of or fully guaranteed bythe Government National MortgageAssociation

(7) Merchant Marine bonds(8) Export-Import Bank notes and guaran-

teed participation certificates(9) Farmers Home Administration insured

notes(10) Notes fully guaranteed as to principal

and interest by the Small Business Ad-ministration



(11) Federal Housing Administration de-bentures

(12) District of Columbia Armory Boardbonds

(13) Tennessee Valley Authority bonds andnotes

(14) Bonds and notes of local urban renewalor public housing agencies fully sup-ported as to principal and interest bythe full faith and credit of the UnitedStates pursuant to section 302 of theHousing Act of 1961 (42 U.S.C. 1421a(c), 1452(c))

This list was supplemented in 1969 by theaddition of Commodity Credit Corporationcertificates of interest in a price-support loanpool00 and was further supplemented in 1971by the addition of notes, debentures, and guar-anteed certificates of participation of the Fed-eral Home Loan Mortgage Corporation andobligations of the United States Postal Service."In 1972, on the basis of opinions of the At-torney General to the effect that they wereobligations of the United States, the Boardtook the position that certain guaranty con-tracts entered into by the Department of Health,Education, and Welfare and certain participa-tion certificates issued under a Purchase Con-tract Program of the General Services Admin-

istration should be treated as direct obligationsof, or fully guaranteed as to principal and inter-est by, a U.S. agency and were eligible as se-curity for advances to member banks.0*

The Board's 1968 interpretation made it clearthat nothing less than a full guarantee of prin-cipal and interest by a Federal agency wouldmake an obligation eligible as collateral for anadvance. For example, mortgage loans insuredby the Federal Housing Administration arc noteligible because an insurance contract is notequivalent to an unconditional guarantee anddoes not fully cover interest payable on theloan. Moreover, obligations of international in-stitutions, such as the Intcr-Amcrican Develop-ment Bank and the International Bank forReconstruction and Development, arc noteligible as such collateral because they are notagencies of the United States.

It is interesting to note that when the Pcnn-Central Transportation Company collapsed in1971 and was placed under reorganization pur-suant to Federal law, the certificates issued bythe trustees of the company were fully guar-anteed by the Secretary of Transportation. Con-sequently, such certificates technically becameeligible as security for Reserve Bank advancesto member banks under section 13 of the Fed-eral Reserve Act.00

TAX WARRANTS

Section 14 (b) of the Federal Reserve Actauthorizes the Reserve Banks to buy and sell"bills, notes, revenue bonds, and warrantswith a maturity from date of purchase of notexceeding six months, issued in anticipation ofthe collection of taxes or in anticipation ofthe receipt of assured revenues by any State,county, district, political subdivision, ormunicipality in the continental United States,including irrigation, drainage, and reclamationdistricts, such purchases to be made in ac-cordance with rules and regulations prescribedby the Board of Governors of the Federal

Reserve System." This language was part of theoriginal Federal Reserve Act and has neverbeen changed.

Following the enactment of the 1916 amend-ment to the law authorizing advances by tneReserve Banks to member banks on papef

eligible for rediscount or purchase by the Re-serve Banks, the Board held that county &*warrants, although eligible for purchase underthe Federal Reserve Act, were not eligible*collateral for advances to member banks underthe eighth paragraph of section 13 of the Act,'presumably because tax warrants were no


regarded as notes, drafts, or bills of exchangewithin the meaning of that paragraph.

That such obligations were not regarded aseligible security for section 13 advances wasindicated during consideration of the Glass-Steagall Act of 1932, when statements weremade by Governor Meyer of the Board andby various Congressmen to the effect that thelatter act, by authorizing advances on anysatisfactory security under the new section10(b), would have the effect of permittingmunicipal bonds to be used as collateral foradvances under that section.71 When the Board'sRegulation A was revised in 1937, it providedthat advances to member banks under section13 must be secured by paper eligible for re-discount or for purchase by the Reserve Banksunder the provisions of the Board's RegulationB. That regulation dealt only with the purchaseof bills of exchange and bankers' acceptances,not with the purchase of tax obligations ofmunicipalities. Although the 1955 revision ofRegulation A changed this reference so that itreferred to paper eligible for purchase underthe Federal Reserve Act (as provided in thestatute), apparently this change was not in-tended to reflect any change in the Board'sprevious position that tax-anticipation obliga-tions of municipalities were not eligible ascollateral for advances to member banks undersection 13.

The 1968 amendment to the eighth para-graph of section 13, which has frequently beenmentioned in this chapter, had the effect ofmaking tax warrants that were eligible for pur-chase under section 14(b) also eligible as col-lateral for Reserve Bank advances to memberbanks. That change in the law was recognizedby the Board in an interpretation that notedspecifically that the kinds of tax-anticipationbonds and warrants described in section 14(b)had become eligible as collateral for advancesto member banks, but only to the extent thatsuch obligations would be eligible for purchase


under the Board's Regulation E.72 RegulationE, Purchase of Warrants, was adopted manyyears ago and is still in effect, even though itpurports to regulate the purchase and sale oftax warrants in the open market, a subject nowwithin the jurisdiction of the Federal OpenMarket Committee and no longer subject toregulation by the Board. That regulation pre-scribes detailed conditions that must be met inorder for warrants to be eligible for purchase bythe Reserve Banks.

In 1969 the Board amended its 1968 inter-pretation regarding the eligibility of tax war-rants as security for Reserve Bank advances.It eliminated the earlier requirement that inorder to be eligible as such security, warrantshad to comply with the requirements of Regula-tion E. It provided, however, that in eachcase a Reserve Bank should satisfy itself thatsufficient tax or other assured revenues ear-marked for payment of such obligations wouldbe available for that purpose at maturity, orwithin 6 months after the date of the advanceif no maturity was stated."

One final point with respect to the use oftax warrants as collateral for Reserve Bankadvances should be mentioned. The languageof section 14(b) literally limits the eligibilityof such warrants for purchase by the ReserveBanks (and therefore as collateral for ad-vances) to warrants issued by a State, county,district, political subdivision, or municipalityin the continental United States. This wouldappear to exclude warrants issued by munici-palities in the State of Hawaii. However, thefact is otherwise because, when Hawaii wasadmitted to statehood in 1959, the enablinglegislation amended section 1 of the FederalReserve Act to define the term "the continentalUnited States" as the States of the UnitedStates and the District of Columbia." Thus,although it consists of islands in the middle ofthe Pacific, Hawaii is a part of the continentalUnited States, at least for certain purposes.



THE GLASS-STEAGALL ACT: A BREAK WITH THE PAST

EMERGENCY BACKGROUNDA date of importance in the history of the

lending functions of the Federal Reserve Bankswas February 27, 1932—the date of enactmentof the Glass-Steagall Act.™ It was a brief statuteof only three sections, but one that marked adefinite change in the traditional concept of thenature of the lending functions of the ReserveBanks. Previously, emphasis had been placedon compliance with more or less formal andtechnical requirements regarding eligibility fordiscount, in particular compliance with anarbitrarily fixed, short maximum maturity anda requirement for self-liquidation out of actualcommercial or agricultural transactions; there-after, more and more emphasis was placedupon the soundness of the paper offered as abasis for credit.

The Glass-Steagall Act was essentially anemergency measure. Its purposes were to re-store confidence in the banking system, to haltbank failures, to loosen credit, and to bringcurrency out of hoarding. As stated by thebill's co-author, Congressman Steagall, thebanking and credit machinery of the countryhad "drifted into unhappy days." 7S An omni-bus banking bill, the so-called Glass bill, wasthen pending in the Senate. Designed to correctabuses that had led to the unhappy days—useof bank funds for speculative purposes andparticipation by banks in the securities business—that bill was to be enacted more than a yearlater as the Banking Act of 1933. In the mean-time, some immediate action was deemed neces-sary to dispel the prevailing atmosphere of un-certainty and apprehension.

The extreme urgency of the situation is in-dicated by the legislative progress of the Glass-Steagall bill. It was introduced in both Houseson February 11; it was reported and debated inthe Senate on Friday, February 12; on thesame day hearings were held by the HouseBanking and Currency Committee; on Monday,

the lSth, it was passed by the House; afterfurther debate in the Senate on the 18th,it was passed by that body on the followingday; and the bill was signed by the Presidenton the 27th. Indeed, some members of Con-gress complained of the shortness of time al-lowed for consideration of the bill."

PROVISIONS OF THE BILL

One of the three sections of the bill amendedsection 16 of the Federal Reserve Act to permitdirect obligations of the United States to beused as collateral for the issuance of FederalReserve notes until March 3, 1933. Previously,such notes could be issued only against gold,gold certificates, and eligible paper rcdiscountcdby the Reserve Banks. Because of the shrinkagein the amount of commercial paper offered fordiscount, Federal Reserve notes then outstand-ing were backed to the extent of nearly 80 percent by gold, although the Federal ReserveAct then required a gold reserve of only 40per cent against outstanding Federal Reservenotes." There were those who felt that permis-sion for the use of Government obligations assecurity for Federal Reserve notes would beinconsistent with the original concept of anelastic currency backed by commercial paperrather than by Government bonds.19 Themajority, however, were willing—at least as atemporary measure—to depart from the ori-ginal concept because they believed that hoard-ing would be offset by an "emergency cir-culation of Federal reserve notes secured byGovernment bonds." s o Moreover, it was feltthat this amendment would have the effect of"turning loose" about 5800,000,000 of "f«e

gold," *» and would thereby "fortify the goldstatus of the Federal reserve banks in thisperiod of extraordinary disturbance." "

But it is with the other two sections of theGlass-Steagall Act that this history isdirectly concerned. They permitted the



eral Reserve Banks for the first time, althoughonly in emergency situations, to extend creditto member banks on the basis of any satis-factory assets, whether or not technically eligiblefor rediscount. These sections added sections10(a) and 10(b) to the Federal ReserveAct. Section 10(a) authorized any ReserveBank, with the consent of at least fivemembers of the Federal Reserve Board, tomake advances to groups of five or more mem-ber banks on their promissory notes undercertain conditions, one of which was that thebank or banks in the group that received theproceeds had no adequate amounts of eligiblepaper. Section 10(b) provided authority, untilMarch 3, 1933, under which a Reserve Bankin exceptional and exigent circumstances couldmake an advance to an individual member bankon its notes secured to the satisfaction of theReserve Bank if the member bank had nofurther eligible paper, but only at a rate ofinterest at least 1 per cent higher than theregular Reserve Bank discount rate.

GENERAL PURPOSES

The principal objective of these provisionswas to reassure banks by making it clear thatin an emergency they could use long-termpaper, such as mortgages, as a basis for borrow-ing from the Reserve Banks. Actually, therewas no real shortage of eligible paper among thebanks of the country as a whole. During thehearings on the bill before the House Bankingand Currency Committee, Governor Meyer ofthe Board estimated that member banks heldfrom $8 billion to S8Vi billion of eligible paper,including Government bonds." The difficulty,Governor Meyer said, was that the banks were"timid" about borrowing. In the prevailing stateof confusion and fear, banks felt it necessary"to keep on hand enough liquid securities oreligible paper to respond to any contingencythat might arise" in order to meet possibledemands of their depositors.*' Senator Glassdescribed the situation as follows:85

* * * There is plenty of eligible assets inthe portfolios of the member banks of theFederal reserve system * • *. The member

banks of the system, the banking communityof the United States, have ceased to functionthrough abject fear and have communicatedthis fear to depositors.* * *

In other words, the purpose of the Glass-Steagall Act was largely psychological. At an-other point during the debates, Senator Glassremarked :so

* * * The chief psychological advantageof this measure—and it is perhaps a valuablepsychological advantage—is that it gives as-surance to these frightened and timid bankersthroughout the country that if they will onlyrespond to the requirements of commerce, ifthey will only help in relieving themselvesand the country from this depression and indoing so exhaust their eligible assets, thenand only then may they make use of theirineligible assets.

Similarly, Senator Fletcher felt that the billwould place banks in a position where theycould "take greater risks and make loans andaccommodate their customers to a greater ex-tent" than they had been doing.87

Some feared that by broadening the base forborrowing from the Reserve Banks, the billwould be inflationary/" The Senate committee'sreport, however, stated that the bill was "notintended nor should it be used for undue infla-tion of the currency."S9 Similarly, the Housereport expressed the belief that the bill, "with-out undue expansion," would result in easiercredit, which would aid in ending bank failuresand in improving business conditions gen-erally.90 In other words, it was felt that if thebill did cause some inflation, it would not, inthe circumstances, be an undue or improperinflation. One Congressman put it as follows:01

If by easing credit we increase confidenceand dispel fear, we shall observe a resultingflow into rediscount channels of hoarded re-discountable paper, with a resultant issuanceof Federal reserve notes. * * * There isnothing inflationary in such a program, be-cause there is no undue or unwarrantableelement in that which is normal.

There were some, indeed, who were afraid notthat banks would borrow too much under thebill but that they would borrow too little.02



In any event, it was emphasized that theprovisions of the act were to be utilized only inexceptional and emergency situations. A few,like Senator Vandenberg, suggested that com-mercial practices had changed over the years;that "Federal reserve definitions should pro-gress with the times"; and that "sound" assetsshould be eligible as a basis for Federal Re-serve credit even though they "fell outside thearbitrary limitations set up in the original Fed-eral reserve act."9S But Governor Meyer of theBoard declared that the bill was intended to beused only in "exceptional cases," s l and that itwould provide facilities to be availed of "in anemergency." 9S The act itself stated in its titlethat it was to provide means for meeting theneeds of member banks "in exceptional cir-cumstances"; and the new section 10(b), au-thorizing advances on any satisfactory assets,was limited to "exceptional and exigent cir-cumstances" and was enacted to remain inforce only until March 3,1933.

The general objectives of sections 10(a) and10(b) were summarized by the Senate Bank-ing and Currency Committee 2 months aftertheir enactment when Congress was consideringa more comprehensive banking bill. That com-mittee's report on the Glass bill, which laterbecame the Banking Act of 1933, containedthe following statement: 96

Within recent months there has been a verywidespread demand for some means of fur-nishing emergency relief to banks that are indifficult straits. The Federal reserve systemwas intended to furnish a means of mutualaid and if properly administered was en-tirely adequate to the necessities of the case.However, with conditions as they stand it islikely that some plan whereby actual assist-

ance could be furnished to banks which arewilling to stand sponsor for one another andthus enable them to clear up danger spots intheir own several communities would be help-ful. We therefore suggested such a plan as anadditional means of strengthening and render-ing useful the provisions of the Federal re-serve system. The general plan so recom-mended was founded upon the idea of jointaction by clearing houses or groups of banksin different localities designed for the purposeof getting accommodations on their joint un-secured notes at reserve banks up to suchamount as might be held prudent; likewise,in exigent cases, relief was provided for indi-vidual banks. Such emergency credit shouldbe retired as soon as possible, and thereforeit seemed best to provide severe restrictionsupon its use and duration.* * *

Although regarded in those unhappy daysof 1932 as a piece of emergency legislation,the Glass-Steagall Act marked a turning point;and, as it later developed, it proved to bemore than a temporary measure. The authorityfor the use of Government bonds as securityfor Federal Reserve notes was extended fromtime to time and was finally made permanent.Section 10(a), authorizing advances to groupsof member banks, is still on the statute books,although it is of little practical significance forreasons hereinafter indicated. Section 10(b),providing for advances on satisfactory assets, isnow permanent legislation and is no longerrestricted to emergency situations, although itstill requires that a penalty rate of interest becharged on such advances.

It is in order at this point to consider inmore detail the purposes, history, and applica-tion of these sections of the Federal ReserveAct that relate to advances to member banks.



ADVANCES TO GROUPS OF MEMBER BANKS

PURPOSE AND NATURESection 10(a) of the Federal Reserve Act,87

as added by the Glass-Steagall Act of February27, 1932, authorized any Federal Reserve Bankto make advances to groups of five or moremember banks, subject to a number of rigidrestrictions. Its purpose was to enable severalmember banks to join together in an organiza-tion like a clearing house and, as a group,borrow from a Federal Reserve Bank fundswith which to assist a weak or failing bankwithin the group.88

The report of the Senate Banking and Cur-rency Committee stated that this section was"intended to provide a permanent reserve forgroups of banks in periods of great distress." °9

Similarly, the House Banking and CurrencyCommittee described the section as affording"a means of relief to banks that find themselvesin urgent need of accommodations whenwilling to enter into joint liability." "° Duringthe House hearings, Governor Meyer of theBoard declared that if the provision had existedin the previous year it might have been used ina number of cases, since he felt that it wascertainly "to the interest of neighbors in thebanking business to save one of their number ifunliquidity is the main difficulty affecting thecondition of an important banking member ofthe community."101

In general, it was contemplated that the sec-tion would be utilized by banks in a large cityin order to prevent the imminent failure ofone of their number and thus protect them-selves from the possibility of similar disaster.As to the objection that the stronger bankswould not be willing in this manner to assist aweak bank, Senator Glass stated:102

' * * To think that as many as five banksm any considerable community may not bewilling to organize themselves in a group toavert the failure and consequent disaster ofone or more other banks in that communityis to assume that the bankers of the country

have not even an intelligent selfishness, be-cause the failure of any one of the weakerbanks in any given community has its reac-tionary effect upon the stronger banks and,it is readily conceivable, might bring disasterto them also. So we provide that there maybe this species of group banking in thepopulous centers, where it may readily beemployed and prove effective.

In effect, the section provided for FederalReserve advances of funds to a weak bank onthe security of the guarantee of the strongerbanks in the community.103 Recognizing thegeneral rule that national banks could notlegally guarantee the debts of others, the bill atfirst specifically provided that national banksshould be authorized to endorse or guaranteenotes of other member banks evidencing loansunder this section. As the hill was finally en-acted, it covered this point in broader languageapplicable to all member banks; the bill au-thorized member banks "to obligate themselvesin accordance with the provisions of thissection."101

In keeping with its basic purpose of providingaid to banks in dire, or nearly dire, circum-stances, the section imposed no limit on theamount that might be advanced by a ReserveBank103 or on the maturity of any such ad-vance. Nor was any time limit placed on theperiod during which section 10(a) should re-main in effect, although the other provisionsof the Glass-Steagall Act, relating to advancesto individual member banks and the use ofGovernment obligations as security for FederalReserve notes, were limited to a period of 1year.108 It seems clear, however, that the au-thority to make advances to groups of memberbanks was intended as an emergency measureto be utilized only in the exceptional case inwhich a member bank had exhausted its dis-countable eligible paper and other banks inthe community, were willing to come to its aidthrough the joint borrowing mechanism pro-vided by this section.



LIMITATIONS

That loans authorized by section 10(a) ofthe Federal Reserve Act would be made onlyin truly emergency circumstances was insuredby the limitations imposed by its provisions.In order for any advance to be made by aFederal Reserve Bank under this section, nineseparate requirements were required to be met:

1. The advance had to be approved by atleast five members of the Federal ReserveBoard.107

2. The advance was required to be made toa group of not less than five member banks,except that it might be made to a lesser numberif the aggregate amount of their deposit li-abilities was at least 10 per cent of the totaldeposit liabilities of the member banks in theFederal Reserve district. Originally, saidSenator Glass, the proposal had been for aminimum of 10 banks, but, "in a yieldingmood," the number had been reduced to five.108

There were some, on the other hand, who sawno reason to impose even a five-bank minimum,and the conference committee agreed to theexception stated above.109

3. A majority of the banks in the groupobtaining the advance were required to be in-dependently owned and controlled. Originally,the bill required all of the banks to be inde-pendent banks. The purpose was to preventholding companies from forming exclusivegroups of their own members.110 At SenatorGlass's suggestion, an amendment was adoptedto make the requirement applicable only to amajority of the borrowing banks.

4. The most important requirement was thatthe bank or banks receiving the proceeds ofthe advance must have no adequate amounts ofeligible and acceptable assets available to enablesuch bank or banks to obtain sufficient creditaccommodations from the Federal ReserveBank through rediscounts or advances otherthan as provided in section lO(b). The bill atfirst provided that advances could be made togroups of banks only if such banks hadexhausted their eligible assets. The languagewas changed by a Senate committee amend-

ment to make it clear that the requirementapplied only to the weak bank or banks thatactually received and used the proceeds of theadvance."1 If this requirement were met, theadvance could be secured by any satisfactoryassets, whether technically eligible for discountor not, with only one exception—foreignsecurities.

5. The liability of each bank in the borrow-ing group was limited to such proportion ofthe total amount of the advance as the amountof the deposit liabilities of that bank bore tothe aggregate deposit liabilities of alt the banksin the group. The lawmakers were not certainwhether the banks in the group would bejointly and severally liable to the Federal Re-serve Bank,111 but Senator Robinson and Sena-tor Glass felt that each bank would be soliable in proportion to its deposits.lia

6. The borrowing banks were authorized todistribute the proceeds of the advance to suchof their number and in such amounts as theymight agree upon, but the recipient banks wererequired to deposit with a suitable trustee theirindividual notes made in favor of the entiregroup and protected by such collateral as mightbe agreed upon.

7. The rate of interest charged on the ad-vance was required to be not less than 1 percent above the Reserve Bank's regular discountrate at the time of the advance.

8. Notes representing advances under thissection were not to be used as collateral securityfor Federal Reserve notes issued under section16 of the Federal Reserve Act. As previouslynoted, some Congressmen in 1932 were re-luctant to permit even Government obligationsto be used as security for Federal Reservenotes; Congress clearly was not prepared toallow notes given for emergency advances un-der section 10 (a) to be used for this purpose.

9. Finally, foreign securities—obligations offoreign governments or of foreign persons orcorporations—could not be offered as collateralsecurity for advances under this section of thelaw. The implication clearly was that any andall other types of collateral security were per-missible.


EFFECTIn view of the many limitations and require-

ments imposed with respect to group advancesunder section 10(a), it is not surprising thatthis authority proved to be of little significance.Moreover, any importance the section mightotherwise have had was all but nullified by theprovisions of section 10(b) enacted at the sametime. When the conference report on the Glass-Steagall bill was being considered in the House,Chairman Stcagall recognized that in practicaleffect there would be no use made of the au-thority available under section 10(a) by thosebanks that would be permitted to apply forloans under section 10(b) .n t

Shortly after the enactment of the Glass-Steagall Act, the Board announced that since


the advances authorized by section 10(a) wereto be made only in unusual circumstances, itdid not contemplate issuing any regulations onthe subject but would consider each requestfor its consent to such an advance in the lightof the facts of the particular case.115 Actually,no regulations ever became necessary, nor wereany rulings or interpretations issued under thissection. In short, section 10(a) was never ofany real practical significance. It would havebeen repealed by the proposed Financial In-stitutions Act, which passed the Senate in 1957but was allowed to die in the House Bankingand Currency Committee.116 Although still ineffect today, section 10(a) is virtually a deadletter, overshadowed by its sister section—sec-tion 10(b).

ADVANCES ON SATISFACTORY ASSETS

ORIGINAL AUTHORIZATIONSection 10(b) of the Federal Reserve Act,

as originally added by the Glass-Steagall Actof February 27, 1932, was intended, in thewords of Senator Glass, to provide for theneeds of the smaller country banks that were'so detached from commercial and financialcenters as to make it exceedingly inconvenient,if not actually impossible, for them either toorganize into a group or readily to join anexisting group" 11T that might obtain an advanceunder section 10(a) of the Act.

Briefly, the original section 10(b) authorizedany Federal Reserve Bank to make advancest o a member bank on its notes secured to thesatisfaction of the Reserve Bank, subject tocertain limitations. As explained by GovernorMeyer of the Board, the section was designedt 0 permit the Reserve Banks to make advances°n "adequate and safe security" in cases inwhich member banks, "because of unsatis-factory business conditions, or through unusual

withdrawal of deposits," had reached the pointwhere their remaining paper, although good,was ineligible for rediscount.118

But, as in the case of section 10(a), therestrictions imposed by section 10(b) weresomewhat severe. In the first place, authorityto make advances under section 10(b) waslimited to a period expiring March 3, 1933.Some felt that such a time limit was unneces-sary,118 and the Senate approved an amendmentoffered by Senator Thomas to extend the perioduntil March 3, 1934.iao However, the confer-ence committee agreed to go back to the 1-yearlimitation.121

Second, advances under the section were ex-pressly limited to exceptional and exigent cir-cumstances. This was a requirement that, al-though perhaps implicit in section 10(a), hadnot been specifically prescribed as a conditionto advances to groups of banks under thatsection.

Third, in order to make it clear that advancesunder section 10(b) would be for the benefit of



small country banks,122 it was provided thatthey could be made only to member bankshaving a capital of not exceeding $5,000,000.Originally, the Senate bill had fixed this capitalrequirement at $500,000; an amendment on thefloor had increased it to $2,000,000; "3 theHouse bill had prescribed no such capital limi-tation; and the conference committee, in viewof the decision to limit the period of the au-thority to 1 year instead of 2, agreed to com-promise by permitting advances to be made tobanks with a capital of up to $5,000,000."'

Fourth, each advance under the section wasrequired to have the affirmative approval of notless than five members of the Federal ReserveBoard. This corresponded to the similar re-quirement imposed upon group advances undersection 10(a).

Fifth, the borrowing bank was required tohave "no further eligible and acceptable assetsavailable to enable it to obtain adequate creditaccommodations through rediscounting at theFederal reserve bank or any other method pro-vided by this Act other than that provided bysection 10(a)." In other words, the memberbank must have exhausted its eligible paper.

Three additional limitations were similar tothose prescribed in connection with group ad-vances under section 10(a): The interest ratewas required to be not less than 1 per centhigher than the regular discount rate; notesrepresenting advances under the section couldnot be used as collateral security for FederalReserve notes; and foreign securities could notbe accepted as collateral for such advances.

In addition to all of these limitations, theFederal Reserve Board was authorized by regu-lation to limit and define the classes of assetsthat might be accepted as security for advancesto member banks under this emergency au-thority.

EXTENSIONS OF TIME LIMIT

Even while the Glass-Steagall bill was underconsideration in 1932, it was recognized thatif the banking emergency continued, the au-thority provided by section 10(b) might haveto be extended.1" The emergency not only con-tinued but became more acute.

On January 9, 1933, with banks failing atan alarming rate, Governor Meyer wrote toChairman Steagall of the House Banking andCurrency Committee: ""

• * * While demands upon the Federalreserve banks for accommodations under sec-tion I0(b) have not been large, the existenceof the authority to extend such accommoda-tions has been a helpful factor in the dis-turbed situation through which we have beenpassing and has enabled the Federal reservebanks to render service to individual memberbanks in a number of instances.

• ° • The Federal Reserve Board feelsthat the Congress might well consider theenactment of these provisions in permanentform, with whatever safeguards may bedeemed appropriate as to the exercise of theauthority granted by them, but, in any event,it is the opinion of the Board that, in view ofexisting conditions, it would be highly de-sirable to extend such authority for at leastone year beyond March 3, 1933.

One month before the section would haveexpired, Congress, by the Act of February 3,1933,1" extended the time limit to March 3,1934.

The banking crisis reached its climax onMarch 4, 1933, when all banks were closed byorder of President Roosevelt. On the day thebanking holiday ended, March 9, 1933, Con-gress rushed to enactment an Emergency Bank-ing Act •" in order, as Senator Glass said, todeal with "an extraordinary and desperate situa-tion." "»

Among other things, the Emergency BankingAct modified section 10(b) to eliminate someof its restrictions. The $5,000,000 capital limi-tation was removed, thus making advancesunder this section available to any memberbank regardless of its size. The requirement forapproval of each advance by at least five mem-bers of the Board was also omitted; instead, itwas provided that advances should be madeunder rules and regulations prescribed by theBoard. The prohibitions on the use of notesrepresenting such advances as collateral securityfor Federal Reserve notes and on the use offoreign securities as security for advances wererepealed.


The liberalized section, however, continuedto provide that advances should be made onlyin exceptional and exigent circumstances andonly when the borrowing bank had no furtherassets eligible for rediscount. It continued alsoto require that the rate of interest on suchadvances should be at least 1 per cent higherthan the regular discount rate.

The termination date of March 3, 1934, wasretained, but it was qualified to permit extensionfor such additional period of not more thanI year as the President might prescribe.

Senator Glass observed that the provisionsof the Emergency Banking Act were "so broadand so liberal that no friend of the FederalReserve System, in ordinary times, would toler-ate them for a moment" and that under the billmember banks might bring their "cats anddogs" to the Federal Reserve Banks and havethem discounted.1'" In the House, ChairmanSteagall stated, "We have provided a simplerand broader authority for loans by Federalreserve banks upon securities and collateral noteligible under the general authority of the Fed-eral Reserve Act." m

In his fireside chat of March 12, 1933,President Roosevelt said: lM

Remember that the essential accomplish-ment of the new legislation is that it makes itpossible for banks more readily to converttheir assets into cash than was the case be-fore. [More liberal provision has been madefor banks to borrow on these assets at thereserve banks and more liberal provision hasalso been made for issuing currency on thesecurity of these good assets. This currencyis not fiat currency. It is issued only on ade-quate security—and every good bank has anabundance of such security^

Less than a year later, on February 16,1934,acting under the authority conferred upon himty the statute, the President by proclamationextended the duration of section 10(b) for anadditional year—until March 3, 1935.133

PERMANENT AUTHORIZATION

From the time of the original enactment in1932, there were those individuals who felt'h the authority for advances on satisfactory


collateral under section 10(b) should not bemerely a temporary measure but should bemade a permanent part of the law. Their viewsfinally prevailed after the section expired—ac-cording to its terms—in March 1935 and theauthority was re-enacted in permanent andliberalized form by the Banking Act of 1935 onAugust 23, 1935."' It is of interest to notehow this came about.

On February 5, 1935, an omnibus bankingbill had been introduced in the House; and asimilar bill was introduced in the Senate on thefollowing day.135 Both bills contained a provi-sion that would have added a new paragraph tosection 13 of the Federal Reserve Act authoriz-ing the Federal Reserve Banks, under regula-tions of the Board, to discount for their memberbanks any commercial, agricultural, or indus-trial paper, and to make advances to their mem-ber banks on their promissory notes secured byany sound assets and without charging a penaltyrate of interest. The House adopted this provi-sion. The Senate, however, was not willing togo so far. Instead, it approved a provision re-enacting section 10(b) in the same form inwhich it had previously existed but as a perma-nent measure and with one important liberaliz-ing change—the omission of the requirementthat advances be made only in exceptional andexigent circumstances. The conference commit-tee followed the Senate version, but with twoadditional liberalizing changes: The require-ment that the borrowing bank must have ex-hausted its eligible paper was eliminated andthe penalty rate of interest was reduced from1 per cent to one-half of 1 per cent. At thesame time, the conference committee added anew requirement that maturities should notexceed 4 months.

As finally enacted on August 23, 1935, andas still in force, the revised section 10(b) pro-vides:

Any Federal Reserve bank, under rules andregulations prescribed by the Board of Gov-ernors of the Federal Reserve System, maymake advances to any member bank on itstime or demand notes having maturities ofnot more than four months and which aresecured to the satisfaction of such FederalReserve bank. Each such note shall bear



interest at a rate not less than one-half of1 per centum per annum higher than thehighest discount rate in effect at such FederalReserve bank on the date of such note.

In this form the authority for advancesunder this section today is subject to fourlimitations: (1) Advances must be made inaccordance with such rules and regulations asthe Board may prescribe; (2) maturities maynot exceed 4 months; (3) a member bank'snote must be secured to the satisfaction of theReserve Bank; and (4) the interest rate mustbe not less than one-half of 1 per cent higherthan the currently effective discount rate. Withregard to these limitations, the Board has pre-scribed no restrictive regulations; the collateralneed be satisfactory only to the Reserve Bank;and the 4-month maturity limitation is moreliberal than the 90-day maturity limitation onrediscounts. Hence, the only important re-striction now imposed by the law on advancesunder section 10(b) is the requirement for ahigher rate of interest.

EMERGENCY USE VEL NONDespite the enactment of section lO(b) as

permanent legislation and the omission of theprovision limiting advances to exceptional andexigent circumstances, some statements weremade in 1935 that suggested that the sectionwas still intended to be used only in emergen-cies.

Thus, during the House committee hearings,Reserve Board Governor Eccles observed thatbanks should have the assurance that all soundassets could be liquified at the Federal ReserveBank "in case of an emergency."136 In theHouse debates, Mr. Hancock stated that theFederal Reserve Board should be in a positionto "consider emergencies promptly." "T Mr.Hollister referred to the use of "the emergencyprovisions." 138

On the other hand, these and similar state-ments can reasonably be regarded as meaningthat section 10(b) advances would be availablein emergency situations, but not that such ad-vances could be made only in such situations.Numerous statements were made during the

committee hearings and during the debates inCongress to the effect that this section wouldenable banks to meet the needs of their com-munities for long-term as well as short-termfunds, placing emphasis on soundness ratherthan the technical form of the paper.'**

After the 1935 rc-cnactmcnt of section10(b), the Board pointed out in a publishedstatement that these provisions were a recogni-tion of the fact that the scope of the operationsof member banks had changed since 1913; thatthe amount of paper technically eligible fordiscount had become very small; and that amajor factor had been the development of largervolumes of savings deposits, which permittedbanks to put their funds into long-time invest-ments."0 In its 1937 Annual Report, the Boardstated that changes in the law made by theBanking Act of 1935 reflected a change in theintention of Congress with regard to the char-acter of assets that might be used as a basis forFederal Reserve credit accommodations andthat under the 1937 revision of Regulation Aany sound assets could be used as a basis foradvances by Federal Reserve Banks."1 Thesestatements contained no suggestion that section10(b) advances were limited to emergencysituations; on the contrary, they clearly sug-gested that it was contemplated that such ad-vances might be available at any time to mem-ber banks desiring to obtain credit on thesecurity of long-term paper not eligible fordiscount, such as real estate mortgages.

Legally, then, the use of section 10(b) isnot restricted to emergencies. As a practicalmatter, it would not normally be used exceptas a last resort, since member banks usuallywould not wish to pay the higher rate of interestprovided by this section unless they had nopaper eligible for rediscount or as security foradvances under section 13 at the lower discountrate; and, generally speaking, member bankstoday have ample amounts of Government ob-ligations that in times of need they may offer ascollateral for section 13 advances. Nevertheless,the words "normally," "usually," and "gen-erally" have been used here for good reason.There have been occasions, some in recentyears, when member banks in trouble did not



hold cither eligible paper or Government securi-ties in amounts sufficient for use as collateralfor Reserve Bank advances at the regular dis-count rate, and they were compelled to borrowunder section 10(b). In addition, there arctimes when large member banks requiring over-night adjustment credit arc willing to pay theextra rate of interest under section 10(b) ratherthan go to the trouble and expense of sortingout the paper held by them that would meetthe technical eligibility requirements prescribedby section 13.

THE "SOUND ASSETS" CONCEPTEven at the time of the enactment of the

original Federal Reserve Act there were somewho felt that the Federal Reserve Banks shouldhave authority, at least in emergencies, to makeadvances to member banks not only on eligiblepaper but on any good security.

In the Senate, both the Owen and Hitchcockbills would have authorized the Federal ReserveBanks, with the approval of the Board, to dis-count the direct obligations of member bankssecured by the pledge and deposit of "satis-factory securities," subject to limitations as toamount. The Owen bill would have limited anysuch direct advance to three-fourths of the valueof the securities pledged. The Hitchcock billimposed the same limitation and in additionprovided that the amount loaned should notexceed the amount of the member bank's capi-tal.

Senator Owen described this provision fordirect advances on any satisfactory security asan emergency provision. He said: " :

* " • this bill provides, and it rightlyprovides, that in case of an emergency theFederal reserve bank, with the approval ofthe Federal reserve board, may extend theaccommodation to a bank against its assets ofwhatever character, provided they arc a goodsecurity.* ° *

The provision was regarded as an answer tothose who contended that the 90-day maturity'imitation on discounts was too short to ac-commodate country banks in agricultural areas.Th«s, Senator Pomcrcnc noted that in order

that such banks might not be at a disadvantage,a provision had been added that would enablea member bank to discount its own notes se-cured by farmers' notes of longer maturity.1"

The provision was in the bill as it passed theSenate, but it was eliminated in conference.Three years later, in 1916, the law was amendedto authorize advances to member banks ontheir own notes secured by eligible paper orGovernment bonds. It was not until 1932, how-ever, that Congress in section 10 (b) of theAct finally provided for advances to memberbanks on any satisfactory collateral, and thenonly at a higher rate of interest.

As first enacted in temporary and emergencyform by the Glass-Steagall Act in 1932, section10(b) provided for advances to member bankson their notes "secured to the satisfaction" ofthe lending Reserve Bank; but the Board wasauthorized by regulation to "limit and definethe classes of assets" that might be acceptedas security. This was understood to mean thatthe character of assets acceptable as securitywould be left entirely to regulation by theBoard1U or, in other words, that the nature ofsuch security would be "largely decided as anadministrative matter." " s Senator Glass statedthat the security could be of "any type whichthe Federal reserve bank, with the approval ofthe Federal Reserve Board, may by regulationadmit." " '

It was understood during consideration ofthe Glass-Steagall bill that section 10(b) wouldinclude authority for advances on tax war-rants,117 and on State, county, and city bonds."8

It was also assumed that real estate mortgageswould be eligible as collateral for such ad-vances.119 In fact, as stated by Governor Meyer,the collateral could include any "good security,"with the exception of foreign securities that werespecifically barred by the statute itself."0

In the course of the debates on the Glass-Steagall bill, some Congressmen criticized thebill for not going far enough in the direction ofpermitting Federal Reserve advances on anysound assets. Mr. Williamson felt that the billfailed to recognize "a permanent change in thecharacter of paper held by national and othermember banks" resulting from the fact that



banks had found it difficult to make a profitwithout investing in long-term paper, municipalbonds, and other securities not technically eli-gible for discount.151 Senator Vandenberg simi-larly referred to the fact that "commercialpractices" had changed since the enactment ofthe Federal Reserve Act.152

The idea that a fundamental change hadtaken place in the character of paper held bycommercial banks and that, consequently, theReserve Banks should be authorized to lend onthe basis of sound assets rather than on short-term, self-liquidating eligible paper gained evengreater acceptance during consideration of thelegislation that became the Banking Act of1935.

During the House hearings on the 1935 act,Governor Eccles recommended an amendmentto section 13 to authorize advances on anysound assets, subject to regulations of theBoard. He asserted that this proposal would notopen the door to all kinds of paper regardlessof its soundness but that, on the contrary, itwas proposed "to place emphasis on soundnessrather than on the technical form of the paperthat is presented."153 He pointed out that,under the emergency provisions of section10(b), the Board had exercised caution andthat, although credit had been extended onineligible assets to the extent of $300,000,000,all but $1,500,000 had been paid back. He alsopointed out that the total volume of eligiblepaper held by member banks at that time wasonly about $2 billion, or less than 8 per centof the resources of the banks; that in periods of"timidity" banks tended to refrain from makingloans except on paper eligible for discount; andthat banks conducting business on this theorycould not serve their communities adequately."Such a bank," he said, "would confine itsoperations to the purchase of the most liquidopen-market paper, with the consequence thatit would neglect its local responsibilities andwould nevertheless find it difficult to earnenough from the low returns on such paper tocover expenses and dividends."

With respect to the traditional idea that dis-counted paper should be liquid, GovernorEccles contended that many assets that wereeligible for discount because they were con-

sidered liquid were actually less sound thanmany other assets held by banks that could nottechnically qualify for discount."* He pointedout that long-term credits had not been respon-sible for the depression and that short-termcredit is not necessarily sounder than long-termcredit.1"

As to what specific types of assets would bepermissible under his proposal. GovernorEccles stated that he would permit the ReserveBanks to lend "on any and all assets, real-estatemortgages, collateral loans, bonds, or otherassets, which they considered sound, on such abasis as they considered sound." *M

The proposal made by Governor Eccles wasnot that section 10{b) , which had expired byits terms in March 1935, should be revived, butthat the existing limitations of section 13 onpaper eligible for discount and as security foradvances to member banks be completely dis-carded in favor of broad authority to extendcredit on any sound assets, subject only to suchregulations as the Board might prescribe. Somemembers of the House committee questionedwhether, if this were the intent, the existing pro-visions of section 13 should not be repealed.The Board's General Counsel, Mr. WalterWyatt, explained, however, that the proposedbroad authority would be construed as repeal-ing by implication the provisions of the oldlaw.1'"

The House Banking and Currency Commit-tee approved the proposal. In its report on thebill, it said: 15<t

The purpose of this provision is to relax orremove stringent technical limitations on thecharacter of paper that can be used as a basisof borrowing from the Federal Reserve banks,and thus to give member banks the assurancethey need so that it will be possible for themto meet the needs of their communities forboth short-time and long-time funds. Since inpractice existing restrictions must be relaxedwhenever they become really restrictive, it is

best not to have them in the law, but to placefull regulatory responsibility on the Board,which is always in session and in a positionto take prompt action when it is required.

Changes in the country's economic litenotably in the methods of financing businessenterprise, have materially reduced the vol-


time of short-term self-liquidating paper ofthe classes to which the discount privileges ofthe Reserve Banks arc largely restricted bylaw. In times of stress, therefore, when thehelp of the Federal Reserve System has beenmost urgently needed, many banks, thoughholding sound assets in their portfolios, havebeen devoid of the particular kinds of paperavailable under the law for borrowing at theReserve banks.

This amendmeni, by removing many of thetechnical restrictions of the present law, willenable the Federal Reserve banks to renderbelter service to their member banks in timesof need. This will not only make membershipin the Federal Reserve System much moreattractive but will encourage the memberbanks to invest their savings deposits, whicharc essentially capital funds, in longer-termloans, a course that would greatly facilitatebusiness recovery.

Concluding its explanation, the committee'sreport made the following significant statement:

* * * Soundness of assets (a term which ishere for the first lime introduced into theFederal Reserve Act) is a greater safeguardto the banks than short maturity of loans or•he particular form of the underlying trans-action.

The sound-assets principle approved by theHouse committee was reiterated in the Housedebates on the bill. Chairman Stcagall assertedthat the liberal provisions for discounts andadvances would enable the Reserve Banks to beconducted upon "principles of solvency ratherthan technical requirements." 15" Mr. Hancockdeclared that "the old idea of commercialPaper or such paper as can be liquidated almostovernight" had been "the greatest curse tobusiness activity." u o

In the Senate, as has previously been noted,the Ecclcs proposal to replace the discountProvisions of section 13 by a broad and simpleauthority to make discounts and advances onany sound assets did not prevail. During theSenate hearings, Winthrop Aldrich and AdolphMiller, a veteran member of the Board, opposedthe proposai.i«i Senator Glass resisted the useof the term "sound assets" because brokers hadtestified that brokers' loans were the soundest


that could be made, and he feared that its usemight lead to the employment of Federal Re-serve credit for stock speculation.182 As a con-sequence, the Senate decided simply to restorethe provisions of section 10(b)—which hadexpired several months before—but in perma-nent form and without the restriction that ad-vances be made only in exceptional and exigentcircumstances.163 However, the charging of in-terest at a rate higher than the rate on advanceson eligible paper was still a requirement.

Nevertheless, the liberalized version of sec-tion 10(b) approved by the Senate was as mucha departure from the orthodox theory of secur-ity for Federal Reserve Bank loans as was theprovision of the House hill for advances onsound assets.184 In fact, although the conferencecommittee adopted the Senate version, therewere some who felt that the sound-asset prin-ciple had not been abandoned. When the con-ference report was considered in the House,Chairman Steagall referred to the liberalizedprovisions of section 10(b) as authorizingloans "upon any security regarded sound andsatisfactory";"! and Mr. Hollister thoughtthat the provisions would permit loans "onpractically any reasonable assets."168

The Board itself obviously regarded the newsection 10(b) as representing congressionalapproval of the sound-assets concept. In its1937 Annual Report to Congress, the Boardstated that its recent revision of Regulation A,in conformity with the changes made by theBanking Act of 1935, established rules "whichin effect permit any sound assets of memberbanks to be used as a basis for advances byFederal Reserve banks." By way of elaboration,the Board said:16t

* * * Under the original Federal ReserveAct the conception of the rediscount functionof the reserve banks was limited to providingmember banks with credit on short termpaper arising out of specific commercial, in-dustrial and agricultural transactions, particu-larly to meet seasonal requirements; whereasunder the more recent amendments to thelaw it is provided that any assets of a memberbank which are satisfactory to a reserve bankmay be used as a basis for obtaining credit.

* * «



In formulating the revised regulation, theBoard had in mind the fact recognized byCongress in the Banking Act of 1935 thatunder our banking system member bankscarry time deposits as well as demand de-posits, and, since these banks are custodiansof the funds representing the savings or capi-

. tal accumulation of the people, they properlyinvest a part of their funds in long-time paper,and consequently provision should be madefor using them in case of need as a basis foradvances from the Federal Reserve banks.Experience has demonstrated that the sol-vency of banks is better safeguarded by care-ful regard to the quality of the paper thatthey acquire than by strict observance of theform that this paper takes, and that greateremphasis on soundness and less emphasis onform is a sound banking principle.

PARTICULAR TYPES OFSECURITY

As has been noted, when section 10(b) wasfirst enacted in 1932 in its temporary form, itwas contemplated that the authority grantedby that section would permit advances to mem-ber banks on almost any type of satisfactorysecurity, including municipal bonds, tax war-rants, and long-term real estate mortgages.

As it was in force between 1932 and 1935,section 10(b) authorized the Board by regula-tion to limit and define the classes of assetsaccepted as security for advances; and, asre-enacted in permanent form by the BankingAct of 1935, the section authorized advancesunder rules and regulations prescribed by theBoard. In published rulings after 1935, theBoard made it clear that advances could bemade under this section to member banks thathad not exhausted their eligible paper and thatany such assets eligible for discount could alsobe used as security for section 10(b) ad-vances.168 In addition, the Board held thatloans insured under the National Housing Actmight be accepted as collateral for such ad-vances.169 It was not until 1937, however, whenRegulation A was revised to reflect changes inthe law, that the Board undertook to prescribeany regulations on this subject.

The 1937 regulation provided that a FederalReserve Bank might accept as security for asection 10(b) advance any of certain enu-merated classes of assets.1"1 These were:

1. Assets eligible as collateral for section 13advances, that is, eligible paper and Govern-ment obligations;

2. Paper that would be technically eligiblefor discount except for the fact that its maturitywas greater than that permitted for eligiblepaper;

3. Investment securities eligible for purchaseby member banks under section 5136 of theRevised Statutes;

4. Obligations representing loans on stocksin conformity with the Board's Regulation U;

5. Obligations insured under Titles I and IIof the National Housing Act;

6. Obligations issued by Federal Home LoanBanks or under the Federal Farm Loan Act,regardless of maturity;

7. Revenue bonds and warrants representinggeneral obligations of any State or politicalsubdivision;

8. Obligations issued or drawn to finance,refinance, or carry real estate that complied withthe standards for real estate loans set forth inan appendix to the regulation; and

9. Obligations issued or drawn to financeinstalment sales that complied with the stan-dards for instalment loans set forth in theappendix to the regulation.

These enumerated classes of assets were notintended to be exclusive. The regulation pro-vided that, in addition, a Reserve Bank mightmake advances on any other types of satisfac-tory assets if in the judgment of the ReserveBank the circumstances made it advisable todo so. However, the various types of assetsenumerated in the regulation were clearly re-garded as preferred kinds of security for section10(b) advances. In its Annual Report to Con-gress the Board stated that the regulation listed"certain preferred classes of assets which coverthe principal fields of financing" and indicatedthat the paper so described would have "firstclaim for advances." 171

In order to encourage member banks to havetheir real estate loans and instalment paper in a


form that would make them acceptable as abasis for advances,1- the Board set forth in anappendix to the 1937 revision of Regulation Acertain recommended minimum standards forobservance in making such loans, as a matterof sound banking practice.'71

When—18 years later—Regulation A wasrevised in 1955, the listing of specific types ofsecurity acceptable for section 10(b) advancesand the minimum standards for real estate andinstalment loans were both omitted, presumablybecause they were considered no longer neces-sary and possibly because, after the passage oftirtic, they might be misleading and inadequate.

MATURITYIn its temporary and emergency form, section

10(b) had prescribed no requirement as tomaturity. As revived and made permanent bythe Banking Act of 1935, the section providedthat notes representing advances should havematurities of not exceeding 4 months. In theform in which it had passed both the House andSenate, the 1935 bill had contained no suchlimitation. However, during the committee hear-ings Governor Ecclcs conceded that a 6-monthlimitation might be reasonable; K1 and the con-ference committee adopted the 4-month ma-turity restriction.

This was, of course, a somewhat more liberallimitation than the 90-day maturity require-ment imposed by section 13 with respect todiscounts and advances under that section.Moreover, it was recognized that advancesmight be subject to renewal,175 although, as intne case of any other extensions of credit, aReserve Bank could not make a prior commit-ment to renew such advances at maturity.

RATE OF INTERESTOne requirement prescribed by section 10(b)

has effectively prevented advances under thatsection from taking the place of discounts ofe'igiblc paper and advances on the security ofGovernment obligations and paper eligible fordiscount or purchase under the Federal ReserveAct- That is the requirement that any advance


made by a Federal Reserve Bank to a memberbank on its note secured by satisfactory assetsshall bear interest at a rate higher than the"highest discount rate in effect at the FederalReserve bank on the date of such note."

As originally enacted in 1932, section 10(b)required the rate on advances under that sectionto be at least 1 per cent higher than the regulardiscount rate. As re-enacted in permanent formby the Banking Act of 1935, this penalty ratewas reduced to one-half of 1 per cent.

When the section was first enacted in 1932as an emergency measure, the only discountrates then in effect were those applicable todiscounts of eligible paper for member banksunder sections 13 and 13a and advances tomember banks on the security of eligible paperand Government obligations under the eighthparagraph of section 13. Subsequently, in 1932,section 13 was amended to provide for dis-counts of eligible paper for individuals, partner-ships, and corporations; in March 1933 it wasfurther amended to authorize advances to indi-viduals, partnerships, and corporations on directobligations of the United States; and in 1934Congress enacted section 13b providing foradvances to industrial and commercial busi-nesses. Under these various special authoriza-tions designed to revive the economy during thedepression years, the Board fixed rates that werehigher than the regular rates on discounts formember banks under sections 13 and 13a. TheBoard took the position, however, that therequired differential between the rate on ad-vances under section 10(b) and the discountrate should be determined by reference to theregular discount rate on discounts and advancesunder sections 13 and 13a rather than the ratesprescribed under the other special provisionsmentioned above.1"

In accordance with this position, the 1955revision of Regulation A specifically providedthat the rate on advances under section 10(b)should be not less than one-half of 1 per centhigher "than the highest rate applicable to dis-counts for member banks under the provisionsof sections 13 and 13a of the Federal ReserveAct" in effect at the Reserve Bank making theadvance.1" As again revised in 1973, the regu-



lation meets the problem in a different man-ner: It provides that the rate on section10(b) advances to member banks shall be atleast one-half of 1 per cent higher than the rateon advances to member banks secured by obli-gations or other paper eligible for discount orpurchase by Reserve Banks.

PROPOSALSFOR LIBERALIZATION

The idea espoused by the Board in 1935 thatFederal Reserve loans should be available tomember banks on the security of any soundassets without a penalty interest rate is by nomeans dead.

In its replies to the questionnaire submittedby Senator Douglas in 1949 (Douglas Ques-tionnaire) the Board made the following recom-mendation: I r s

The provision of section I (Kb) which re-quires an interest rate higher by at least one-half percent per annum than the highest dis-count rate of the Federal Reserve Bank foradvances to member banks secured by anysatisfactory collateral other than eligible pa-per should be eliminated.

Fourteen years later, in 1963, ChairmanMartin, on behalf of the Board, again proposedthat the Reserve Banks be authorized to makeadvances to member banks on any satisfactorysecurity without charging a premium or penaltyinterest rate. In letters to the Banking and Cur-rency Committees of both Houses of Congress,he argued that the real-bills doctrine had longbeen abandoned and that the test of papereligible as security for Federal Reserve ad-vances should be its soundness rather thancompliance with outmoded technical require-ments. In this connection, he said: 1TS

Despite changes in the character of paperheld by commercial banks and the repeatedand necessary departures from the originalconcept that discounts should be based onlyon short-term, self-liquidating paper, the lawcontinues to impose unduly restrictive re-quirements as to the nature and maturity ofthe paper that may be discounted by theReserve Banks or offered as security foradvances by the Reserve Banks.

For many years, it has been generally rec-ognized that the concept of an clastic cur-rency based on short-term, self-liquidatingpaper is no longer in consonance with bankingpractice and the needs of ihc economy. It haslong been apparent that the narrow require-ments of the law regarding "eligible paper"serve no useful purpose and thai it would bepreferable to place emphasis on the soundnessof the paper offered as security for advancesand the appropriateness of the purposes forwhich member banks borrow. The onc-ycarpaper of many bank customers that is not noweligible for discount may be as satisfactorycollateral as ihc 90-day notes of other cus-tomers. Moreover, the nature of the collateralprovides no assurance that the borrowingbank will use the proceeds for an appropriatepurpose.

As long as member banks hold a largeenough volume of Government securities,they need not, of course, be particularly con-cerned as to the eligibility for discount withthe Reserve Banks of customers* paper heldby them. Since World War II, however, therehas been a sharp net decline in the aggregateholdings of Government securities by memberbanks. If any substantial increase in economicactivity should cause banks to reduce theirholdings of Government securities in order tomeet increased credit demands, many bankswould be obliged to tender oihcr kinds ofcollateral if they should seek to obtain Fed-eral Reserve credit.

If such a situation should develop, theReserve Banks could accept technically "in-eligible" paper as collateral for advances totheir member banks only under section 10(b)of the Federal Reserve Act at a rate of in-terest one-half of one per cent above theregular discount rate. However, the necessityfor distinguishing between "eligible" and "in-eligible" paper would give rise to cumbersomeadministrative procedures that arc not war-ranted by the exigencies of current bankingconditions. In order to avoid these problems,it would clearly be preferable to move in ad-vance and to revise and up-date the law soas to eliminate the existing restrictions wi*respect to "eligible paper."

Bills to implement this proposal were intro-duced in Congress."0 They would have repealed



all of the provisions of the Federal Reserve Actregarding discounts and advances and wouldhave replaced them with a new section 13Athat would have authorized the Reserve Banks,under regulations of the Board, to make ad-vances to member banks on any satisfactorysecurity. Such bills were passed by the Senatein 196S and 1967 but they never succeeded inobtaining the approval of the House Bankingand Currency Committee.

In 1971 the Board changed its approach.Instead of recommending comprehensive legis-lation like that proposed by Chairman Martin,it suggested simply an amendment to section10(b) of the Federal Reserve Act to eliminatethe requirement that advances to member banksunder that section should bear a rate of interestat least one-half of 1 per cent above the regulardiscount rate.1'1 Tactically, this approach may

be preferable to the earlier proposal to eliminatethe various provisions of the Act relating todiscounts and advances by the Reserve Banks.Technically, it would have certain disadvan-tages. For example, unlike the earlier proposal,it would not give the System complete flexibilityin fixing discount rates and it would not elimi-nate the necessity for applying the traditionaltechnical eligibility rules with respect to emer-gency extensions of credit under the third para-graph of section 13 to individuals, partnerships,and corporations—a matter to be discussed ina subsequent chapter.

In any event, the fact remains that underpresent law the Reserve Banks may makeadvances to member banks at the regular dis-count rate only on the security of paper thateither meets technical requirements for discountor is eligible for purchase by the Reserve Banks.


Credit for Nonmember Banks

SUMMARY

As of December 31, 1972, there were 14,413commercial banks and mutual savings banks inthe United States. Of this number, 4,613 werenational banks, 1,092 were State memberbanks, and 485 were mutual savings banks.Thus, there were 8,223 State banks that werenot members of the Federal Reserve System.1

In general, but with significant exceptions,nonmember banks are the smaller banks of thecountry; their total deposits comprise onlyabout 22 per cent of the total deposits of allcommercial banks. Since they have not sub-scribed to Federal Reserve Bank stock—andthus have not subjected themselves to the vari-ous requirements, restrictions, and limitations•mposed by the Federal Reserve Act—they donot directly enjoy the benefits of the System,deluding access to the credit facilities of theFederal Reserve Banks.

h a sense, however, all nonmember banks^ e «i a position to obtain the advantages of

e Svstem indirectly. Thus, in their dealings

F°r NOTES AND REFERENCES, see pp. 260-61.

with correspondent member banks they benefitfrom the services afforded by the System to suchmember banks through the collection of checksand distribution of coin and currency. In anindirect way also, nonmember banks benefitfrom extensions of Federal Reserve credit tomember banks. When the Glass-Steagall Actof 1932 authorized the Reserve Banks to makeemergency advances to member banks on anysatisfactory security, Mr. Steagall pointed outthat while a nonmember bank could not obtainsuch advances directly, it could borrow from anational bank or a State member bank andthereby have "its paper indirectly fed intothe Federal reserve bank and indirectly" getthe benefit of that legislation.2

Since the time of its original enactment, theFederal Reserve Act itself has specifically pro-vided for indirect extensions of credit to non-member banks through the medium of memberbanks if permitted by the Federal ReserveBoard. For a brief period during 1933, theReserve Banks were expressly authorized tomake direct advances to nonmember banks on

117



satisfactory security. These two provisions, onepermanent and one temporary, will be discussedin subsequent sections of this chapter.

Two other provisions of the law that au-thorize extensions of credit to individuals, part-nerships, or corporations .in limited circum-stances also afford a basis for extension ofFederal Reserve credit to nonmember banks,since such banks, of course, are corporations.These provisions will be considered generallyin the following chapter; but insofar as they

affect nonmember banks they will be discussedin subsequent sections of the present chapter.

Finally, nonmember banks for many yearshad direct access to Federal Reserve credit to alimited extent by virtue of the provisions ofsection 13b (no longer in effect), which au-thorized the Reserve Banks to extend credit tofinancing institutions on the basis of paper ofindustrial or commercial businesses. That au-thority, however, will be dealt with in a separatechapter.

CREDIT THROUGH MEDIUM OF MEMBER BANKS

LEGISLATIVE HISTORY

Section 19 of the Federal Reserve Act, whichotherwise relates to entirely different subjects,contains one sentence that affects the discount-ing functions of the Federal Reserve Banks andin particular extensions of credit to nonmemberbanks. That sentence was a part of the originalAct and has never been amended. It reads:

* * * No member bank shall act as themedium or agent of a nonmember bank inapplying for or receiving discounts from aFederal reserve bank under the provisions ofthis Act except by permission of the FederalReserve Board. [Emphasis supplied.]

Although stated in the form of a prohibition,this provision, by its exception, contemplatesindirect extensions of credit to nonmemberbanks whenever permitted by the Board. Thelegislative history of the provision is of interestas indicating the belief on the part of theframers of the Act that the benefits of the Actshould be limited to member banks, but that insome circumstances even nonmember banksshould be afforded at least indirect access tothe credit facilities of the System.

The provision was not in the Glass bill thatpassed the House in 1913 nor in the originallyreported Owen bill in the Senate. It grew out

of a provision contained in Senator Owen'ssubstitute bill that broadly prohibited any mem-ber bank from extending "directly or indirectlythe benefits of this system to a nonmemberbank, except upon written permission of theFederal reserve board, under penalty of sus-pension."

When the bill was under debate, SenatorOwen himself pointed out that while the broadprovisions in his substitute bill would preventnonmember banks "from being the beneficiariesof a system supported by others," it might gotoo far, especially in the case of small banksthat could not, under the terms of the bill, comeinto the System.1 He suggested that the provi-sion might place a "stigma of exclusion" uponevery bank that was not a member of theSystem and might, in addition, have the effectof barring such banks from all transactions withtheir correspondent member banks except bypermission of the Board. He felt that this pro-hibition would tend to build up "a monopolyin banking instead of stabilizing the bankingsystem" and would prevent thousands of banks"from continuing their business." ' In a likevein, Senator Weeks said that the provision hadbrought forth "a general protest" from all sec-tions of the country, and Senator Root referredto the provision as amounting "almost to a


CREDIT FOR NONMEMBER BANKS 119

nonintcrcoursc provision as between the banksforming a part of the new system and the Statebanks in general."s

Senator Owen asserted that no such effectwas intended and that the provision would beredrafted." On December 18, 1913 (5 daysbefore the bill was signed), he offered anamendment limiting the provision to discounts.As thus amended, the bill prohibited any mem-ber bank "from acting as the medium or agentof a nonmember bank in applying for or re-ceiving discounts." r Senator Owen explainedthat this would mean that member bankswould be "at liberty to have any transactionswhatever with the nonmember banks, but thatthey must not act as a medium for nonmemberbanks to get loans out of Federal reservebanks." s In this amended form the provisionpassed the Senate.

The conference committee adopted the pro-vision, but restored the exception permittingmember banks to act as the medium for dis-counting paper of nonmember banks "with thepermission of the Federal Reserve Board."Thus, while reflecting an intent to limit thediscounting facilities of the Reserve Banks tomembers of the System, this provision in effectgave the Board authority to determine whenand in what circumstances those facilities mightbe extended to nonmember banks indirectlythrough the medium of member banks.

LIBERAL INTERPRETATIONOF STATUTE

For some years the Board took no steps toexercise its authority to permit discounts ofnonmember bank paper through the medium°f member banks. It did, however, adopt asomewhat liberal interpretation of the prohibi-tory portion of the provision of the law inquestion. It held that if a member bank in goodfaith acquired notes from a nonmember bank'nat were eligible for discount and were held asPart of the assets of the member bank, therewas no objection to the discounting of suchPaper if the officers of the Reserve Bank weresatisfied that it was a bona fide transaction and

that the member bank was not extending ac-commodations to the nonmember bank.9

During World War I, in order to facilitatethe sale of Liberty bonds, the Board expresslyauthorized the Reserve Banks to discount fornonmember banks, with the endorsement of amember bank, notes secured by Governmentobligations if the proceeds were to be used forcarrying Treasury certificates or U. S. Govern-ment bonds." Subsequently, the Board ruledthat the Reserve Banks could discount formember banks any notes of nonmember bankssecured by Government bonds."

In 1918, still following a liberal constructionof the statutory prohibition, the Board held thatthe law did not preclude the discounting formember banks of paper bearing the signatureor endorsement of a nonmember bank 12 or ofnotes endorsed without recourse by a nonmem-ber bank."

BLANKET AUTHORITYIt was not until 1921, however, that the

Board, in a period of economic stress, gavegeneral authority to the Reserve Banks to dis-count for member banks any eligible paperacquired from nonmember banks.1*

Two years later, in 1923, that general per-mission was withdrawn on the ground that thetemporary emergency that had made it neces-sary had passed.15 At the same time, the Boardspecifically rescinded the liberal rulings previ-ously mentioned that had permitted the dis-counting of paper signed or endorsed by non-member banks. Also at the same time, theBoard undertook to set forth some general ruleson this subject:

1. No paper acquired from, or bearing thesignature or endorsement of, a nonmemberbank was to be discounted for any memberbanks except with the Board's permission,unless such paper had been bought by theoffering member bank in good faith on theopen market from some party other than thenonmember bank.

2. Applications for the Board's permissionwere required to state the facts fully and the



reason why the member bank felt justified inseeking such permission.

3. As a general rule, the Board would notgive its permission in the case of any non-member bank that was eligible for membershipin the System; the Board felt that eligible non-member banks should join the Federal ReserveSystem if they desired to participate in itsbenefits.

4. However, the Board would make excep-tions, for limited periods, to assist nonmemberbanks in emergencies, but only until the non-member'banks could qualify for membership.

Following this action in 1923, the Board insome specific cases granted temporary permis-sion for the discounting of paper of nonmemberbanks. In 1926 it expressly gave general per-mission for the discounting of paper signed orendorsed by a Federal intermediate credit bankon the ground that, since such banks were noteligible for membership in the System, suchpermission was consistent with the policy an-nounced in the Board's 1923 ruling.10

During the banking crisis of March 1933, theBoard for the second time gave blanket permis-sion for the discounting of paper acquired fromnonmember banks. This permission continuedin effect until the revision of Regulation A in1937, when it was allowed to terminate.

In the summer of 1966, there was whatbecame known as a credit crunch—a situationin which not only nonmember commercialbanks but savings and loan associations andmutual savings banks were subjected to unusualdeposit drains that made it difficult for themto meet the loan demands of their customers.To ameliorate this situation, the Board onJuly 1, 1966, advised the Reserve Banks that,as a matter of general policy, they should beprepared to provide emergency credit facilitiesto such institutions in accordance with certainguiding principles. To implement this policy,the Board, among other things, gave blanketpermission, pursuant to section 19(e) of theFederal Reserve Act, for the use of assetsacquired from nonmember banks as security forFederal Reserve advances to member banks,whether under section 13 or section 10(b)."This permission was limited to a period endingon September 1,1966.

During a similar crunch in 1969, the Board,for the fourth time, gave general permission forthe use of assets acquired from nonmemberbanks as security for advances to memberbanks. As of December 24, 1969, that per-mission was made effective for a period endingApril 1, 1970.ls After additional extensions,the permission expired on August 1, 1971.

In 1972 the Board again gave blanket per-mission for Reserve Bank loans to memberbanks for the benefit of nonmember banks butfor entirely different reasons. The Board hadamended its Regulation J, relating to the collec-tion of checks by the Reserve Banks, to requireevery bank to which checks arc sent for pay-ment by the Reserve Banks to make paymenton the day of receipt in immediately availablefunds. Previously, drawee banks had the optionof making payment for a cash letter receivedfrom its Reserve Bank by means of drafts thatwould not be collected by the Reserve Bankuntil 1 or 2 days following the receipt of thecash letter by the drawee bank; consequently,the drawee bank enjoyed the use of the fundsrepresented by the cash letter for a short periodafter its receipt, thus giving rise to what wasknown as Federal Reserve float. This amend-ment to Regulation J, which, after some delayresulting from litigation, became effective No-vember 9, 1972, in effect deprived draweebanks of such float with a resulting loss thatvaried from bank to bank. The adverse effectwas mitigated in the case of drawee memberbanks by a simultaneous amendment to theBoard's Regulation D that substantially loweredreserve requirements for most member banks;but, since nonmember banks arc not subjectto reserve requirements under the FederalReserve Act, they could not be given the sameoffsetting advantage.

Shortly before the change in Regulation Jwas originally scheduled to have gone intoeffect, the Board sought to ameliorate its impactupon nonmember drawee banks by providingfor extensions of Federal Reserve credit to suchbanks either directly or through correspondentmember banks. To facilitate indirect extensionsof credit to nonmembers, the Board grantedblanket permission to the Reserve Banks undersection 19(e) of the Federal Reserve Act to


make advances to member banks for the benefitof nonmember banks in order that FederalReserve credit could be made available to anynonmember bank if the change in Regulation Jwould "result in a significant impairment ofliquidity or impair the bank's ability to serveits community." IB

REGULATORY PROVISIONS

Not until 1928 did Regulation A include anyspecific provisions regarding loans to memberbanks for the benefit of nonmember banks.20

In ils general revision of the regulation at thattime, the Board required that a member bank'sapplication for discount be accompanied by acertificate to the effect cither that the paperoffered for discount had not been acquired froma nonmember bank or that, if so acquired, theBoard's permission had been obtained. In a newseparate section, the revised regulation providedthat, except with the Board's permission, noFederal Reserve Bank should discount paperacquired by a member bank from a nonmemberbank or bearing the signature or endorsementof a nonmember bank, unless the paper hadbeen bought by the offering bank "in good faithon the open market from some party other thanthe nonmember bank." Applications for theBoard's permission were required to state thefacts and the reasons for requesting it. Express


permission was granted for the discounting ofpaper signed or endorsed by Federal intermedi-ate credit banks. In effect, these provisions ofthe regulation merely incorporated the sub-stance of the 1923 and 1926 rulings of theBoard that have previously been mentioned.

As revised in 1937 51 and again in 1955,"Regulation A continued to include the provi-sions first incorporated in the regulation in1928: prohibition of discounting of nonmemberbank paper without the Board's permission,and specific permission to discount only paperacquired from Federal intermediate creditbanks. One change in language, however, wasmade by the 1937 revision. Whereas the regula-tion had previously excepted paper purchasedin good faith in the open market from a partyother than the nonmember bank, the 1937amendment provided more broadly that theprohibition should not apply to paper purchasedin the open market or "otherwise acquired ingood faith and not for the purpose of obtainingcredit for a nonmember bank." The revision ofRegulation A adopted in 1973 condensed theseprovisions, without intending any change ofsubstance. They now provide simply that, ex-cept with the Board's permission, no memberbank shall act as the medium or agent of anonmember bank—other than a Federal inter-mediate credit bank—in receiving credit froma Reserve Bank.23

EMERGENCY DISCOUNTS OF ELIGIBLE PAPER

Pursuant to the statutory and regulatory pro-visions just discussed, nonmember banks havebeen enabled, since the enactment of the Fed-eral Reserve Act, to obtain Federal Reservecredit indirectly through the medium of member°ariks, subject to permission granted by theBoard, it w a s n o t u n t i i i9i2, however, thathere was any statutory authority under which

°Ifect credit could be extended to nonmemberbanks by the Federal Reserve Banks—excepthe ^ c i a l authority granted in 1924 to any

banks to discount notes of veterans of WorldWar I, as discussed in Chapter 7.

The Emergency Relief and Construction Actof July 21, 1932,5' added to section 13 of theFederal Reserve Act a new paragraph, now thethird paragraph of that section, that made itpossible for the Reserve Banks, in unusual andexigent circumstances and with the affirmativeauthority of the Federal Reserve Board, todiscount eligible paper for any individual, part-nership, or corporation unable to secure ade-



quate credit accommodations from other bank-ing institutions. This authority will be discussedgenerally in the following chapter. At this pointit is sufficient merely to note that since a non-member bank is a corporation, the authority isbroad enough to encompass discounts of eli-gible paper for nonmember banks.25

Nevertheless, when the Board on July 26,1932—5 days after the enactment of theprovision—granted permission for discountsunder this authority and prescribed certain rulesto be followed, it was specifically stated thatfor this purpose the term "corporations" shouldnot be considered as including banks.16 Thus,nonmember banks were excluded from thebenefits of this authority.

As has been noted, during the credit crunchesof 1966 and 1969 the Board for temporaryperiods expressly permitted advances to mem-ber banks for the benefit of nonmember banks.At the same time, the Board also activated theauthority under the third paragraph of section13 for extensions of Federal Reserve credit onthe basis of paper eligible for discount to non-member deposit-type financial institutions, prin-cipally mutual savings banks and savings andloan associations, and also to nonmember com-mercial banks. This authorization was neveractually utilized by any nonmember bank, andsince August 1, 1971, the authority for loansunder the third paragraph of section 13 tononmember institutions has not been in effect.

ADVANCES ON GOVERNMENT OBLIGATIONS

By the Emergency Banking Act of March 9,1933," Congress added still another paragraphto section 13 of the Federal Reserve Act underwhich the Reserve Banks could extend credit tononmember banks. This paragraph, the thir-teenth and last in section 13, as amended in1968, authorizes advances to any individual,partnership, or corporation for periods of notmore than 90 days on notes secured by directobligations of the United States or by obliga-tions issued or fully guaranteed by U.S. agen-cies." Again, a discussion of this paragraphbelongs properly within the scope of the follow-ing chapter, but it needs to be mentioned herebecause the term "corporation" includes a non-member bank and nonmember banks haveused this paragraph as the basis for obtainingdirect access to the credit facilities of the Re-serve Banks in emergency circumstances.

When the Emergency Banking Act of 1933was under consideration in Congress, it wasclearly contemplated that the new thirteenthparagraph of section 13 of the Federal ReserveAct would permit nonmember banks to obtaincredit from the Federal Reserve Banks. Thus,

Senator Glass, with some reservations as tothe wisdom of the measure, stated: M

* • * It broadens—in a degree that isalmost shocking lo me—the currency andcredit facilities of the Federal Reserve Bank-ing System, and largely extends these facilitiesto State banks which arc not members of theFederal Reserve Banking System, that havenever endured one penny of the expense ofthe establishment of the system or its main-tenance, and do not do so today.

Similarly, when the bill was being debated inthe House, Chairman Steagall of the HouseBanking and Currency Committee declared thatany State bank could obtain an advance froma Reserve Bank to the amount of the face valueof U.S. Government bonds offered as security."That," he said, "is where we have gone inliberalizing credit and expansion."30

When, in 1937, Regulation A was revised toreflect changes in the law made since 1930, noprovision in the text of the regulation coveredadvances to individuals, partnerships, and cor-porations; but in a footnote attention was calledto the fact that, under the last paragraph of



section 13 of the Federal Reserve Act, theReserve Banks could make advances to indi-viduals, partnerships, or corporations "(includ-ing banks)" on the security of direct obligationsof the United States. In 1942 an amendment tothe regulation changed this footnote to stateexplicitly that the term "corporation" includedan incorporated bank;" and in the same yearthe Board published a ruling that made it dearthat, under the last paragraph of section 13,advances could be made to nonmember bankson the security of direct obligations of theUnited States." Thus, although the Board hadnot interpreted the reference to corporations inthe third paragraph of section 13 as applying tononmember banks, a similar reference in thelast paragraph of the section was explicitlyapplied to cover loans to such banks.

Except in special circumstances or duringcertain limited periods, advances to nonmemberbanks under the last paragraph of section 13have not been encouraged. In a footnote in the1955 revision of Regulation A, it was statedthat while a Reserve Bank has authority underthat paragraph to make advances on Govern-ment obligations to individuals, partnerships,and corporations, including nonmember banks,it was "not the practice to make advances toothers than member banks except in unusualor exigent circumstances." •"" In 1968 even thisreference to the legal authority for advances tononmember banks was eliminated from theregulation," so that the regulation thereaftercontained no reference whatsoever to extensionof Federal Reserve credit to nonmember banks.The revision of the regulation adopted in 1973,however, contains a section expressly referringto advances under the last paragraph of section'3 to individuals, partnerships, and corpora-

tions on the security of direct obligations ofthe United States or obligations issued or fullyguaranteed by any agency of the United States,but the wording makes it clear that any suchextensions of credit are limited to emergencycircumstances."

Discouragement of advances to nonmemberbanks under the last paragraph of section 13has been evidenced not only by provisions ofthe Board's regulation but also by the fact that,in general, the rate charged on such advanceshas been higher than the regular or basic dis-count rate for advances to member banks.From September 1939 until April 1946—just before, during, and after World War II—advances to nonmember banks were au-thorized to be made at the same rate as thatfixed for loans to member banks on eligiblepaper at the regular discount rate. Since 1946the rate on advances to nonmember banks hasbeen substantially higher than the regular dis-count rate. As previously discussed, the Boardin 1972 acted to provide credit through thediscount window to nonmember banks ad-versely affected by changes in Regulation J.At that time a special rate of 4'/i per centwas established by six Reserve Banks—butonly for a temporary period of time—for ad-vances to nonmember banks under the lastparagraph of section 13 for cases in whichnonmember banks were seriously affected bythe changes in Regulation J. This special ratewas the same as the regular rate at that timefor advances to member banks—2 per centless than the rate for advances in general underthe last paragraph of section 13.

In actual practice, Federal Reserve loans tononmember banks under the last paragraph ofsection 13 have been few and far between.



TEMPORARY AUTHORITY FOR ADVANCES ONSOUND ASSETS

In only one instance has Congress authorizeddirect extensions of Federal Reserve credit tononmember banks as such, as distinguishedfrom advances to such banks as corporationsor as financing institutions, and that authoritywas in force only for an emergency period ofone year ending March 24, 1934.

As noted in the previous chapter, the Glass-Steagall Act of 1932 authorized the FederalReserve Banks, by the addition of section10(b) of the Federal Reserve Act, to makedirect advances to member banks on any satis-factory security, though only on an emergencybasis and subject to certain restrictions. Thatauthority was somewhat liberalized by theEmergency Banking Act of March 9, 1933.About 2 weeks later, on March 24, 1933,10

Congress amended the Emergency Banking Actby adding a new section 404 under which theReserve Banks were authorized to make ad-vances to nonmember banks on the same termsas advances could be made to member banksunder section 10(b) of the Federal ReserveAct.

This new authority, however, was severelylimited. In the first place, its effectiveness wasrestricted to "the existing emergency in bank-ing" or until the authority might be terminatedby proclamation of the President, but in noevent beyond 1 year from the date of enactment.A Reserve Bank could make an advance to anonmember bank only after inspection andapproval of the collateral and a "thorough ex-amination of the applying bank or trust com-pany." " Each application was required to beaccompanied by the written approval of theappropriate State banking authority and by astatement of that authority that in its judgmentthe bank was in a sound condition. As long asit was indebted to the Reserve Bank, the bor-rowing bank was required to comply in allrespects with the provisions of the FederalReserve Act and regulations of the Board appli-cable to member State banks, except that in-

stead of subscribing to Federal Reserve Bankstock, the bank was required to maintain duringthe period of such indebtedness the reservebalance required for member banks under sec-tion 19 of the Act.

Although this authority for advances tononmember banks was a limited one of shortduration, its legislative history is of interestbecause it reflects both an intent to case thebanking crisis by affording credit to nonmemberbanks and, at the same time, an intent to adhereto the concept that Federal Reserve credit facili-ties should be limited to member banks exceptin emergencies.

The disposition of Congress to permit moreliberal extensions of credit to nonmember bankswas obviously influenced by the fact that thebars had already been lowered by the Acts ofJuly 21, 1932, and March 9, 1933." In thelight of the conditions that still prevailed, itwas felt that the bars should be lowered evenfurther to allow nonmember banks the sameaccess to Federal Reserve credit that memberbanks enjoyed under the provisions of section10(b) of the recently enacted EmergencyBanking Act. Mr. Stcagall believed that therewas no reason to discriminate against non-member banks during the emergency.13 Hedescribed the bill as permitting State nonmem-ber banks: '"

* • • to borrow temporarily of Federal Re-serve banks and to use as collateral, the sameas was provided in the legislation of last weekfor member banks of the Federal ReserveSystem, any security whether eligible or notunder the general provisions of the FederalReserve Act that may be found to be satisfac-tory to Federal Reserve officials * * *•

Similarly, Senator Robinson stated: "

* * • The bill gives supplemental rightsor opportunities to State banks and truscompanies to obtain direct loans from theFederal Reserve banks on their time anddemand notes, secured to the satisfaction o



the Federal Reserve banks. • • ° It is be-lieved that the change now proposed will tendto place the State banks nearer on a paritywith member banks.

At the same time, it was recognized that theprivilege thus afforded to nonmember bankswas exceptional and that it should be strictlylimited. When Senator Barklcy suggested thatthe requirement for approval by the State bank-ing commissioner might be too restrictive, Sena-tor Robinson replied that such approval wasnecessary because the bill would extend "arather extraordinary privilege to an outsidebank—that is, a bank that is not a member ofthe Federal Reserve System" and that it hadbeen "thought wise"' to make this require-ment.i:

An interesting sidelight on the legislativehistory of the Act of March 24, 1933, is thefact that in attempting to provide the sameaccommodations to nonmember banks as thoseprovided to member banks by section 10(b) ofthe Federal Reserve Act, the bill at first re-ferred to advances on eligible or ineligiblepaper. Mr. Bccdy felt that the term "eligibleor ineligible paper" was subject to varyinginterpretations. Mr. Stcagall explained thatit was intended to permit a nonmember bankto "tender its eligible or noncligiblc paper,and that gets all the paper it has, just as it doeswith a member bank." " He pointed out thatoriginally section 10(b) had been limited toadvances in cases in which member banks hadno further eligible paper available and that, ifadvances to nonmember banks were permitted

only on the same terms as those prescribed bysection 10(b), such banks would be enabled toborrow only on noneligible paper.41 Eventually,to make the point clear, the provision in ques-tion was omitted and, instead, there was in-cluded a proviso stating that loans might "bemade to any applying nonmember State bank ortrust company upon eligible security."

The limited and temporary authority foradvances to nonmember banks on any satis-factory security expired on March 24, 1934,and has never been revived. It may be notedthat the so-called eligible paper bill recom-mended by the Board in 1963 not only wouldhave permitted Reserve Bank advances to mem-ber banks on any satisfactory security but alsowould have authorized advances to any indi-vidual, partnership, or corporation secured tothe satisfaction of the lending Reserve Bank inexigent circumstances. This authority is notcontained in the current Board proposal"for legislation that would simply removethe penalty rate requirement from section10(b) of the Federal Reserve Act authorizingadvances to member banks on any satisfactorysecurity. If that proposal should be enacted,nonmember banks, as at present, would havedirect access to Federal Reserve credit onlyunder the last paragraph of section 13 of theFederal Reserve Act on the security of Govern-ment obligations or obligations issued or fullyguaranteed by agencies of the United States, orunder the third paragraph of section 13 on thesecurity of paper eligible for discount if thatparagraph is activated by the Board in unusualand exigent circumstances.


Loans to Individuals/Partnerships/ and Corporations

LOANS ON ELIGIBLE PAPERIN EMERGENCY CIRCUMSTANCES

REJECTION IN ORIGINAL ACTWhen the original Federal Reserve Act was

being considered in 1913, some members ofCongress argued that the Reserve Banks shouldbe permitted to discount paper for individualsas well as for member banks, on the theory thatthe System's control over discount rates wouldbe made that much more effective and also thatFederal Reserve credit would thereby be mademore widely available in emergencies.1 Thegreat majority in Congress, however, felt thatthe Federal Reserve Banks should be strictlybankers' banks, dealing only with commercialbanks and not with the general public. By thesame token, it was generally agreed that theReserve Banks should not compete with com-mercial banks by making loans to individuals.2

This concept was maintained intact until theearty 193O's when the depression created asituation that resulted in a fundamental changein the role of the Federal Government withrespect to loans to nonbanking institutions and


individuals, and the Federal Reserve Systemfelt the effects of this change. As noted in theprevious chapter, the original Federal ReserveAct provided a means for at least limited andindirect extensions of credit to nonmembercommercial banks. Some years later, authoritywas added to permit access to Federal Reservecredit by the Federal intermediate credit banks.It was not until 1932, however, that the ReserveBanks were first given authority to providecredit assistance to individuals, and that author-ity was very limited and was given with reserva-tions on the part of some members of Congress,including Carter Glass.

1932 AMENDMENTOn July 11, 1932, President Hoover vetoed

a bill to relieve unemployment through highwayconstruction projects because it also containedprovisions for loans to individuals by the Re-construction Finance Corporation. The Presi-dent felt that these provisions "would place theGovernment in private business in such fashionas to violate the very principle of public rela-

127



tions upon which we have builded our Nation,and render insecure its very foundations." Suchaction, he believed, "would make the Recon-struction Finance Corporation the greatestbanking and money-lending institution in allhistory." 3

A new bill was introduced on the day of thePresident's veto, and Senator Glass promptlyoffered an amendment to authorize the FederalReserve Banks, in unusual and exigent circum-stances, to discount eligible paper for individ-uals and corporations. A similar provision wasincluded in another bill introduced by SenatorWagner as a substitute for the highway con-struction bill vetoed by the President. Theprovision was retained in that bill when itpassed the Senate on July 12, although theduration of the authority for such discountswould have been limited to a period of 2 years.The conference committee made three changes,all of a liberalizing nature: The 2-year limita-tion was omitted, thus making the authoritypermanent legislation; the authority was ex-panded to cover discounts for partnerships aswell as corporations and individuals; and aprohibition against the use of paper discountedunder the provision as collateral security forFederal Reserve notes was omitted.

The bill became law on July 21, 1932.1

Thus, tucked away in a road constructionmeasure, authority for extension of Federal Re-serve credit to individuals, partnerships, andcorporations was incorporated in the FederalReserve Act. That authority—with one smallchange to be mentioned later—is contained inthe third paragraph of section 13 of the Act.That paragraph which is the same as originallyenacted, reads as follows: r>

In unusual and exigent circumstances, theBoard of Governors of the Federal ReserveSystem, by the affirmative vote of not lessthan five members, may authorize any Fed-eral reserve bank, during such periods as thesaid board may determine, at rates estab-lished in accordance with the provisions ofsection 14, subdivision (d), of this Act, todiscount for any individual, partnership, orcorporation, notes, drafts, and bills of ex-change of the kinds and maturities madeeligible for discount for member banks under

other provisions of this Acl when such notes,drafts, and bills of exchange arc indorsed andotherwise secured to the satisfaction of theFederal Reserve bank: Provided, That beforediscounting any such note, draft, or bill ofexchange for an individual or a partnershipor corporation the Federal reserve bank shallobtain evidence that such individual, partner-ship, or corporation is unable to secure ade-quate credit accommodations from otherbanking institutions. All such discounts forindividuals, partnerships, or corporationsshall be subject to such limitations, restric-tions, -and regulations as the Board of Gov-ernors of the Federal Reserve System mayprescribe.

LIMITATIONSAs will be observed, this authority for loans

to individuals, partnerships, and corporations isstrictly limited.

First, loans may not be made by the ReserveBanks under this authority unless the Board ofGovernors, in unusual and exigent circum-stances, authorizes them to do so. It should benoted that it is activation of the authority bythe Board that is dependent upon unusual andexigent circumstances and not the making ofindividual loans once the authority is activated.

Second, activation of the authority by theBoard must have the affirmative vote of atleast five members of the Board. This is one ofthe few instances in which the law requires thataction taken by the Board must be approvedby a greater majority than a quorum.

Third, if the authority is activated by theBoard, its duration may be limited to suchperiods as the Board may determine.

Fourth, loans under this authority may bemade only through the discounting of paper ofthe kinds and maturities made eligible for dis-count for member banks under other provisionsof the Federal Reserve Act. This is an importantlimitation. While advances may be made tomember banks under the eighth paragraph ofsection 13 on the security of any paper eligiblefor discount or purchase by the Reserve Banksor, at a higher rate of interest, on any satisfac-tory security under section 10(b) of the Act,the only paper made eligible for discount formember banks is paper arising out of actual


INDIVIDUALS, PARTNERSHIPS, AND CORPORATIONS 129

commercial transactions with a maturity of notmore than 90 days (under the second paragraphof section 13) or agricultural paper with amaturity of not more than 9 months (undersection 13a).

Nonbank financial institutions, such as sav-ings and loan associations, ordinarily do nothold customers' paper of the kind that wouldbe eligible for discount, and it is even less likelythat business enterprises would hold any sub-stanlial amounts of such paper. There are,however, certain possibilities. For one thing,the note discounted for an individual, partner-ship, or corporation need not be one of itscustomer's notes but may be its own note.Under Regulation A, a note the proceeds ofwhich arc to be used for current operatingexpenses of a business enterprise is eligible fordiscount by a member bank. Consequently, abusiness concern's own note would be eligiblefor discount under the third paragraph of sec-tion ! 3 if the proceeds were to be used by it forcurrent operating expenses. Again, if the pro-ceeds of a note executed by a financial institu-tion such as a finance company or a savings andloan association were to be used for makingloans to others for eligible purposes, that note,under rulings of the Board heretofore men-tioned, would be eligible for discount in thehands of a member bank and hence would beeligible as a basis for direct credit under thethird paragraph of section 13.* In any suchcase, however, the note of a business enterpriseo r of a financial institution must have a matur-'ty of not more than 90 days in order to be eli-gible for discount under that paragraph.

Fifth, whereas a member bank may discounteligible paper with its Reserve Bank withoutoffering any additional security, a borrowerunder the third paragraph of section 13 noton'y must present a note—its own or its cus-tomer's—that is eligible for discount but alsomust provide security or obtain an endorsementtoat is satisfactory to the lending Reserve Bank.A* originally enacted, the paragraph requiredfoat the paper offered for discount should bemdorscd and otherwise secured" to the satis-

faction of the Reserve Bank. In 1935, on theB°ard's recommendation, the word "and" wasranged to "or" so that cither an endorsement

or additional security could be accepted by theReserve Bank.T In any case, it seems clear thatit was the intent of Congress that loans shouldbe made only to creditworthy borrowers; inother words, the Reserve Bank should be satis-fied that a loan under this authority would berepaid in due course, either by the borrower orby resort to security or the endorsement of athird party.

Sixth, the lending Reserve Bank must obtainevidence that an applicant for credit under thisparagraph is unable to secure adequate creditaccommodations from other banking institu-tions. This is a significant limitation—one de-signed to assure that loans will be made only intruly unusual and exigent circumstances.

Finally, all loans under this authority aresubject to such limitations, restrictions, andregulations as the Board may prescribe and torates established in accordance with section14(d)oftheAct.

BOARD ACTIVATION OFAUTHORITY

Notwithstanding the restricted nature of theauthority, it was apparently felt in 1932 that,in the economic circumstances of the time, suchauthority would be used to provide neededcredit to business concerns and individuals. TheBoard lost no time in implementing the statute.Five days after its enactment, on July 26, 1932,the Board issued a circular granting permissionto the Reserve Banks to make discounts underthe new authority for a period of 6 monthsbeginning August 1, 1932.8 The circular statedthat since such discounts would be made onlyin unusual and exigent circumstances, the Boarddid not propose to prescribe any formal regula-tions. However, the requirements of the law andthe procedure to be followed were outlined inthe circular.

Among other things, the circular requiredthat an applicant for any discount under thenew authority must submit a statement as tothe circumstances and the purpose for whichthe proceeds would be used, describe the effortsmade by him to obtain credit from other bank-ing institutions, list each bank with which theapplicant had had banking relations during the



previous year, provide complete credit data, andagree to furnish additional credit informationwhen requested.

Upon the Federal Reserve Banks the circularimposed a duty in each case to determine thatthe applicant's financial condition and creditstanding justified the discount; that the paperoffered for discount was acceptable from acredit standpoint and eligible from a legalstandpoint; that the security was adequate; thatthere was a reasonable need; and that the appli-cant was unable to obtain adequate creditaccommodations from other banking institu-tions. The Reserve Banks were prohibited frommaking any commitments to renew creditsgranted by them, and, except with the Board'spermission, no Reserve Bank could discountfor any one individual or corporation paperaggregating more than 1 per cent of the ReserveBank's own capital stock and surplus.

The circular included one important restric-tion not prescribed by the law. Although thestatute authorized discounts for corporations,a term broad enough to include banks, theBoard's circular specifically provided that theterm should not include banks. Because of this,nonmember banks that otherwise might haveavailed themselves of this avenue of access toFederal Reserve credit were precluded fromdoing so.

The 6-month permission for discounts forindividuals, partnerships, and corporationsgranted by the Board on August 1, 1932, wasextended for successive periods of 6 monthsuntil July 31, 1936, when the permission wasallowed to terminate.9 In large part, it wasrendered unnecessary by the enactment in 1934of section 13b of the Federal Reserve Act underwhich the Reserve Banks were authorized tomake loans to business enterprises for workingcapital purposes. That authority will be dis-cussed in the next chapter.

Although the third paragraph of section 13

has not been reactivated by the Board since1932 as a means of providing Federal Reservecredit to businesses, it was activated in 1966and again in 1969 for the purpose of meetingpossible credit needs of savings and loan asso-ciations, mutual savings banks, and nonmembercommercial banks.10

USE OF AUTHORITYThe authority for discounts in exigent cir-

cumstances for individuals, partnerships, andcorporations was an emergency authority—oneof several measures undertaken in the early1930's to meet the need for credit during thedepression. It was used only for a short whileand only to a limited extent. Pursuant to theactivation of the authority in 1932, the ReserveBanks, over a period of 4 years, made loansto only 123 business enterprises aggregatingonly about SI.5 million. The largest single loanwas for S300,000.

One of the reasons for the limited use of thisauthority has already been noted—the enact-ment in 1934 of legislation authorizing workingcapital loans to business enterprises. Anotherwas the enactment in March 1933 of legislationauthorizing advances by Reserve Banks to in-dividuals, partnerships, and corporations onthe security of U. S. obligations, an authority tobe discussed in the following section. Moreover,the rate established for discounts under the1932 authority was considerably higher thanthe regular discount rate;" and, though laterreduced, the rate on emergency discounts forindividuals, partnerships, and corporations,when such discounts have been authorized,has always been substantially higher than theregular discount rate and higher also than therate on direct advances to individuals, partner-ships, and corporations on the security of Gov-ernment obligations under the thirteenth para-graph of section 13 of the Act.


INDIVIDUALS, PARTNERSHIPS, AND CORPORATIONS 131

ADVANCES ON GOVERNMENT OBLIGATIONS

The Emergency Banking Act of March 9,1933,12 signed by President Roosevelt at theheight of the most critical banking situation inthe country's history, was, as stated in its enact-ing clause, designed to remedy a "serious emer-gency." It gave legal confirmation to the drasticaction taken by the President a few days earlierin closing all banks; it provided for their re-opening under licenses from the Secretary of theTreasury; it authorized the Secretary to call inall privately held gold and gold coin; and, alongwith these and other equally drastic steps, itbriefly but explicitly authorized the Federal Re-serve Banks to make advances to individuals,partnerships, and corporations on their promis-sory notes secured by direct obligations of theUnited States. This authority was set forth in anew paragraph—the thirteenth—added at theend of section 13 of the Federal Reserve Act.

Unlike the authority granted in 1932 for thediscounting of paper of individuals, partner-ships, and corporations, this authority con-tained relatively few restrictions and limitations.It provided only that such advances should bemade for periods not exceeding 90 days; thatthey should bear interest at rates fixed by theReserve Banks subject to review and deter-mination of the Board; and that they should besubject to such limitations, restrictions, andregulations as the Board might prescribe.

Again, like the 1932 authorization for dis-counts for individuals, partnerships, and cor-porations, the provision for direct advances onGovernment obligations represented a definitedeparture from the traditional concept that theReserve Banks should act only as bankers'banks. Senator Glass observed that, under theset W o Provisions, individuals were: "

* * * permitted to do business with the Fed-eral Reserve banks, something that has neverbeen done before since they were organized,individuals who have eligible paper in theirPossession, and who can not get accommoda-

tion at the member bank, permitted to take itdirectly to the Federal Reserve banks and beaccommodated.

Chairman Steagall of the House Banking andCurrency Committee, after stating that underthe new authority an individual could obtainFederal Reserve credit to the amount of theface value of Government bonds offered assecurity, remarked: "That is where we havegone in liberalizing credit expansion." "

While the Board was authorized to prescriberestrictions and limitations, it did not do so. Incontrast to its action after the enactment of the1932 authority to discount paper for individ-uals, partnerships, and corporations, the Boarddid not exercise its regulatory authority to ex-clude banks from the scope of the term "cor-porations." On the contrary, as noted in thepreceding chapter, it became clear that incorpo-rated banks, both member and nonmember,could avail themselves of the new provisionauthorizing advances to corporations. Indeed,the thirteenth paragraph of section 13 made itpossible for advances to be made to memberbanks on U.S. Government obligations forperiods of up to 90 days, in contrast to the15-day maturity limitation on such advancesunder the eighth paragraph of that section.Since 1968, when the eighth paragraph wasamended to authorize 90-day advances to mem-ber banks on the security of any obligationseligible for purchase by the Reserve Banksunder section 14 (b) of the Act, including obli-gations of the United States, it has been un-necessary to resort to the thirteenth paragraphof section 13 as a basis for advances to memberbanks on Government obligations for periodsin excess of 15 days.

In 1968, when the temporary authority of theReserve Banks to purchase obligations issued orguaranteed by agencies of the United States wasmade permanent, the thirteenth paragraph ofsection 13 was broadened to authorize ad-vances to individuals, partnerships, and corpo-



rations not only on the security of direct obliga-tions of the United States but also on the secur-ity of such agency issues.15

It should be observed that, although con-ferred by an emergency statute, the authoritycontained in the last paragraph of section 13 ofthe Federal Reserve Act was not limited toemergency circumstances. Perhaps the authorsof the Emergency Banking Act contemplatedthat the authority would be used only underextraordinary circumstances such as those pre-vailing at that time; but they did not place anysuch limitation in the law. Legally, the provisionmakes it possible for the Reserve Banks tomake advances under this provision in ordinarytimes as well as in times of economic stress.Actually, the authority provided by the thir-teenth paragraph of section 13 has always beenregarded as being limited to unusual or excep-tional circumstances. The revision of Regula-tion A adopted in 1973 expressly provides foruse of the authority only in emergency circum-stances, and the general principles contained inthe revision contemplate advances to individ-uals, partnerships, and corporations only when,in the judgment of a Reserve Bank, credit "isnot practically available from other sources andfailure to obtain such credit would adverselyaffect the economy." 1B

One factor that tends to preclude any ex-tensive use of the last paragraph of section 13is that business enterprises—and even nonmem-ber banks—may not hold Government securi-

ties in sufficient amounts to be used as securityfor advances under that paragraph. Anotherimportant factor that militates against use ofthe paragraph is that the rate fixed for advancesunder the paragraph has usually been substan-tially higher than the regular discount rate. Forinstance, in early April 1973, the rate for suchadvances was 7'/4 per cent, whereas the regularrate for advances to member banks was 5 xh percent. As noted in the previous chapter, the ratefor advances to nonmember banks on Govern-ment securities was the same as that for similaradvances to member banks from 1939 to 1946,and in 1972 a like concession was accorded(by six of the Reserve Banks) to nonmemberbanks adversely affected by changes in theBoard's rules regarding payment of checkscollected through the Reserve Banks. No suchrate concession has ever been given to nonbankborrowers under the last paragraph of section13.

Because of these deterrents—limitation touse in emergency circumstances, the acceptanceof only Government securities as collateral foradvances, and a penalty rate of interest—veryfew loans have been made to business enter-prises under this authority. Nevertheless, it con-tinues to be the only authority, except for theeven more limited authority provided by thethird paragraph of section 13, under which theReserve Banks, as lenders of last resort, mayprovide credit directly to business enterprises orto nonmember financial institutions.


Working Capital Loans to Business

ORIGIN AND PURPOSE

A DEPARTURE FROMTRADITION

This chapter deals with a form of FederalReserve credit that is no longer authorized bythe law. Nevertheless, it should not be passedover quickly, for it represented a significantdevelopment in the history of the lending func-tions of the Federal Reserve Banks.

For more than 20 years after the enactmentof the Federal Reserve Act, the concept thatReserve Bank loans should have relativelyshort maturities was firmly entrenched. So alsowas the concept that security for Reserve Bankloans should be limited to certain types ofPaper; the only exception was for advancesunder section 10(b) in 1932 and, as has beennoted, such advances were authorized only ata Penalty rate of interest.

These concepts were drastically modified in1 9 3 4 when Congress added to the Federal Re-serve Act a new section 13b authorizing theReserve Banks to extend credit, either directly


or through commitments to financing institu-tions, to established business enterprises forworking capital purposes with permissible ma-turities of up to 5 years and without any limita-tions as to the type of security.1

This departure from tradition did not takeplace without protest. During the debates on thebill, Mr. Beedy deplored the fact that, in aneffort to stimulate business recovery, it hadbeen necessary "to bring the Federal Reservebanks into this picture." He said: s

• * • The Federal Reserve banks, 12 innumber, which were never designed to dobusiness with any individual or any person,but were banks of issue or rediscount to dealwith other banks, ought never, in my opinion,to be put into the lending business. It is a per-version of the original purpose for whichthose banks were established * * *.

Somewhat later, when the bill had been agreedto by the conference committee and 3 daysbefore it was signed by the President, Mr. Beedyagain, as he put it himself, raised his "feeblevoice * * * in this hour of the Nation's crisis"and accused the House conferees of having

133



taken "a decided step toward destroying thecharacter of the Reserve banks.":|

But the overriding mood of the day was tomake credit more freely available to businessthrough Government channels. In that atmos-phere, Congress sought to provide such busi-ness credits not only through the Reserve Banksbut also through the Reconstruction FinanceCorporation (RFC), as will be noted later.

NEED FOR THE AUTHORITYThe statute grew out of evidence that busi-

ness enterprises, particularly small businesses,were unable to obtain necessary working capitalloans from the usual sources of credit. Com-mercial banks, with painful memories of the1933 banking crisis and subject to more vigilantsurveillance by bank examiners, were not, so itwas alleged, meeting the needs of small busi-ness. Although the RFC had been empoweredin 1932 to make loans to banks and insurancecompanies with the expectation that the moneywould filter down to industry and the smallborrower, there was a feeling that this expecta-tion had not been fulfilled because the banksand other lending institutions had not done theirpart to bring the country out of the depression.4

It was said that banks were frequently unableor unwilling to extend industrial loans, due inlarge part to the fact that bank examiners hadrequired them to maintain a degree of liquidity.5

On March 19, 1934, President Rooseveltwrote to the chairmen of the Banking and Cur-rency Committees of both Houses of Congress:"I have been deeply concerned with the situa-tion in our small industries. In numberless casestheir working capital has been lost or seriouslydepleted."

The fact that not only commercial banks butalso Federal Reserve Banks were limited toshort-term loans and could not, therefore, ade-quately meet the credit needs of business wasemphasized by the Federal Reserve Board in aletter to the Senate Banking and CurrencyCommittee dated April 13, 1934:

In the judgment of the Board, there existsan undoubted need for credit facilities forindustry and commerce beyond those thatare now being supplied through the commer-

cial banks or that can be supplied throughthe ordinary operations of the Federal Re-serve System acting within the limitations ofthe Federal Reserve Act. In brief, the need isfor loans to provide working capital for com-merce and industry, and such loans neces-sarily must have a longer maturity than thoserediscountablc by Federal reserve banks.

Throughout the debates in Congress, it wasindicated repeatedly that the primary purposeof the legislation was to assist, not just business,but small business. Thus, Mr. Kopplcmanndeclaimed: "The main purpose of this bill isthe rehabilitation of small businesses and smallindustries. The small industries arc the back-bone of America.""

As will be noted later, the purpose of aidingsmall business was emphasized by provisions inthe bills under consideration that would havelimited the amount of any loan to $100,000.Although this limitation was omitted in thestatute as finally adopted, it is clear that smallenterprises were expected to be its chief bene-ficiaries.

LEGISLATIVE HISTORYAt the outset, two principal plans for provid-

ing credit to business enterprises had competedfor consideration by Congress. One was to ex-pand the existing lending powers of the RFC toinclude power to make loans to business enter-prises, and various bills for this purpose wereintroduced in Congress.1 The other was a planfor the establishment of regional credit banksfor industry under the supervision of cither theRFC or the Federal Reserve Board." Bills toauthorize the establishment by the Federal Re-serve Board of 12 credit banks for this purposewere actually prepared in the offices of theFederal Reserve Board and represented, atleast at that time, the mature conclusions of theBoard.9

Eventually, however, a third method of pro-viding business credits was incorporated in acommittee print of the Senate Banking andCurrency Committee. This proposal would havestricken provisions of the bill then under con-sideration to establish regional credit banksand, instead, would have amended section 13 of


WORKING CAPITAL LOANS TO BUSINESS 135

the Federal Reserve Act to authorize the Re-serve Banks to make working capital loans tobusiness. On April 28, 1934, Senator Glassincorporated this committee print in a new bill(S. 3487) but in the form of an addition of anew section—13b—to the Federal Reserve Actinstead of an amendment to section 13. A fewdays later, Senator Fletcher introduced anotherbill authorizing the RFC to make businessloans and, subsequently, the substance of thatbill was combined with the new Glass bill. Theresult was a bill authorizing business loans byboth the Reserve Banks and the RFC. OnMay 12, 1934. the Senate adopted a proposalto add to the Glass bill authorizing businessloans by the Reserve Banks a separate provisionfor RFC loans to business.10 As thus amended,that bill was approved by the Senate on May 14.On May 23, a new RFC bill that included alsoauthority for business loans by the ReserveBanks was passed by the House.

Insofar as the business loan authority of theReserve Banks was concerned, the bills passedby the Senate and House differed in only onemajor respect. The Senate bill authorized anddirected the Secretary of the Treasury to pay tothe Reserve Banks the sum of $139,299,557 toaid in the making of business loans, with pro-vision for repayment at a rate of at least 1 percent per annum. The House bill contained nosuch provision for payments by the Treasury.The conference committee adopted the SenateProvision, but modified it so as to permit, butnot direct, the Treasury to make payments tothe Reserve Banks and to provide for repay-ments at a rate of not less than 2 per cent perannum.

The conference report was approved in bothHouses on June 16, and the bill was signed intolaw by the President on June I 9 . u

In the course of the legislative process, theoriginal idea of establishing 12 credit banks forindustry had been abandoned because, as Sena-tor Glass said, "it was totally unnecessary tos e t up another banking system of 12 banks tod ° what might be done more readily and withgreater facility by the Federal Reserve banksthemselves." •= At the same time, the questionwhether business loans should be made by theFederal Reserve Banks or by the RFC was

resolved by giving both agencies somewhatsimilar, but not identical, authority in this field.

RESERVE BANKS VERSUS RFCThe fact that both the Federal Reserve Banks

and the RFC were given authority to makebusiness loans was not regarded as involvingany inconsistency. It was expected that suchloans would be made primarily by the ReserveBanks and that the RFC would make them onlyif they could not be obtained from a ReserveBank. Moreover, it was contemplated that theFederal Reserve authority would be permanent,whereas that of the RFC would be only tem-porary. (Members of Congress in 1934 couldnot know that the RFC, an emergency agency,would continue to function for another 23years.)

In accordance with the idea that the RFC'sauthority should be supplemental to that of theFederal Reserve Banks, the bill that passed theSenate and was reported by the House commit-tee expressly provided that business loans wereto be made by the RFC "when credit at pre-vailing bank rates for the character of loansapplied for is not otherwise available at banksor at the Federal Reserve bank of the districtin which the applicant is located." However, onMay 23, the day that the bill was passed by theHouse, a floor amendment was introduced byMr. Beedy (who had not wanted the ReserveBanks in the picture in the first place) to strikeout the words "or the Federal Reserve bankof the district in which the applicant is located."Mr. Beedy expressed the fear that "many ofthese loans will never get as far as the Recon-struction Finance Corporation if they are turneddown by the Federal Reserve bank in the firstinstance." His amendment was adopted." Soit was that, as finally enacted, the statute autho-rized business loans by the RFC when creditwas not otherwise available at banks, therebyindicating that, despite all that had been saidearlier, the RFC's authority was not to bemerely supplemental to that of the ReserveBanks.

Nevertheless, Chairman Steagall apparentlyagreed to the Beedy amendment only becausehe felt that it would not change the substance of



the previous provision, presumably on theground that the Federal Reserve Banks wouldstill be embraced by the word "banks." Hestated that he had no objection to the amend-ment because it was one "which really perfectsthe language of the section."14 ChairmanSteagall's feeling that nothing had been changedand that the RFC would make business loansonly if they were not obtainable from the Re-serve Banks was more explicitly stated when,during the House debate on the conferencereport on June 16, he answered a question asto the procedure to be followed by a businessin seeking credit. He replied: l 5

It would apply through regular channels,and if it did not obtain the money it wouldapply to the Federal Reserve Banks, and ifthe Federal Reserve Bank did not make theloan, the application would then go to theReconstruction Finance Corporation, whichin this case would be in the nature of anappellate court for loans, where applicationsmight be reviewed and reconsidered.

Whatever may have been the intent of Con-gress as to the respective roles of the FederalReserve Banks and the RFC, the fact is that the1934 statute gave both agencies coordinateauthority to make loans to commercial and in-dustrial businesses, but with certain importantdifferences in respect to limitations on theirauthority:

1. The authority of the Reserve Banks waspermanent; that of the RFC was limited induration and, by the terms of the 1934 act, wasscheduled to expire on January 31, 1935.

2. The RFC could make loans only to busi-nesses established before January 1, 1934; theReserve Banks could make loans to established

businesses, presumably including any estab-lished after January' J,1934.

3. The aggregate amount of loans made bythe RFC to any one borrower could not exceed$500,000; no such limitation was placed onloans made by the Reserve Banks.

4. The Reserve Banks could make directloans only in exceptional circumstances; theRFC was not similarly restricted.

5. The RFC was authorized in general tomake loans in cooperation with banks or otherlending institutions, including authority to pur-chase participations; the Reserve Banks werepermitted to participate with lending institutionsonly if the latter assumed at least 20 per centof the risk.

6. RFC loans were required to be adequatelysecured and could be made only if the directorswere of the opinion that the borrower wassolvent; Reserve Bank loans were required tobe made on a reasonable and sound basis.

On the basis of this comparison, and espe-cially in view of the temporary nature of theRFC's authority, it might be supposed that Mr.Steagall's expectation that the Reserve Bankswould be the primary source of business loanswould be fulfilled. Actually, time proved other-wise. Not only was the authority of the RFCextended for many years, but the limitations onits authority were gradually relaxed by subse-quent amendments, while the limitations on theauthority of the Reserve Banks remained un-changed. As a result, the RFC came to be theprincipal Federal agency for the making ofbusiness loans, while the volume of such loansmade by the Federal Reserve Banks—at firstconsiderable—eventually declined to an amountthat was almost negligible.

LIMITATIONS

GENERAL LIMITATIONS

The authority granted to the Reserve Banksby the 1934 legislation was of two different

kinds: ( i ) authority to make direct loans tobusinesses; and (2) authority to extend creditCo business ct i icmrltnt ;nri;i-n/->tK> hv mrans ot

kinds:

to business enterprises indirectly by means ofdiscounts for financing institutions of oblige



tions of business enterprises, loans to financinginstitutions on the security of such obligations,and commitments with respect to such discountsor loans. For convenience only, the first ofthese two alternate types of authority is herereferred to as authority for direct loans and thesecond as authority to make commitments.

On both types of authority the law placedcertain significant restrictions. Some were com-mon to both direct loans and commitments;others were in the nature of special limitations,some applicable only to direct loans and someapplicable only to commitments. Such speciallimitations will be discussed in subsequentsections.

In the first place, it was clearly the purposeof Congress in 1934 to provide, through boththe Reserve Banks and the RFC, credit assist-ance that would enable existing businesses toget back on their feet, not to encourage theestablishment of new businesses. In the Housedebates on the bill, Congressman Martin statedthat the legislation would "not provide for loansto a new industry," but that its purpose was "tokeep old industries functioning."iri

In furtherance of this purpose, the RFC, asnoted, was authorized to make loans only tobusinesses in existence before January 1, 1934.Although the Reserve Banks were not so strictlylimited, their loans were restricted to establishedindustrial or commercial businesses. Perhaps, inthe light of Mr. Martin's remark, this wasmeant to confine Federal Reserve loans to busi-nesses in existence on the date of the act; butit seems more reasonable to interpret the limita-tion as meaning thai a Reserve Bank couldmakc a loan only to a business establishedbefore the loan was made. Also, it seems fairlyclear that the word "established" was not usedm the sense of meaning a long-established,successful enterprise but simply in the sense ofbeing already in existence.17

To be eligible for aid under section 13b ofthe Federal Reserve Act, a business had to beJtot only an established business but also anindustrial or commercial business. There is littlem the legislative history of the legislation thatthrows any light on the intended scope of thesew°rds. No published rulings of the Boards°ught to define industrial or commercial busi-

nesses. However, in announcing the issuance ofRegulation S under the new law, the Boardindicated that it did not propose to place anyrestrictions not required by the statute upon themaking of business loans by the Federal Re-serve Banks and that consequently the termsused in the law would be liberally interpreted.The Board stated:1S

* * * Any attempt to prescribe technicaldefinitions of such terms as "working capital","established commercial or industrial busi-ness", and "financing institutions" has beenavoided, lest it have the effect of restrictingand hampering the operations of the FederalReserve banks under this statute.

A major limitation placed upon the lendingauthority of the Reserve Banks was that loansshould be made only to provide businesses with"working capital." During the Senate debateson the bill, Senator Bone proposed an amend-ment to strike out the reference to workingcapital and instead to authorize loans "for work-ing capital, for reducing and refinancing out-standing indebtedness if such refinancing isconcurrent with a substantial write-down ofsuch outstanding indebtedness, for rehabili-tating and making improvements to plants, forreopening plants not in operation on the datethis section takes effect, and for new buildingsand new machinery." " This effort to broadenthe purposes for which business loans might bemade was unsuccessful. The House was moreliberally inclined. It would have authorizedloans for the purpose of providing a businesswith capital, a term broad enough to includealmost any type of loan. The conference com-mittee, however, resolved the difference on thispoint in favor of the Senate bill, limiting boththe Federal Reserve Banks and the RFC to themaking of business loans to provide workingcapital. While the Board never undertook todefine the term "working capital," it is clearfrom its legislative history that section 13b wasnot intended to authorize the Reserve Banks tomake loans to enable businesses to refinanceoutstanding indebtedness or to build, improve,or replace plant and machinery.

Another limitation imposed by the law bothupon direct loans to businesses by the Reserve



Banks and upon commitments with respect tobusiness loans made by private financing institu-tions was that no such loans should havematurities in excess of 5 years. This, however,was a liberal limitation. Never before had theReserve Banks been authorized to extend creditfor such a long period. Prior to 1934, the maxi-mum maturity permitted had been the 9-monthmaturity authorized with respect to discounts ofagricultural paper for member banks.

LIMITATIONSON DIRECT LOANS

Subsection (a) of section 13b, relating todirect loans by the Reserve Banks, imposed thefour limitations discussed in the preceding sec-tion: They could be made only to establishedbusinesses, only to industrial and commercialbusinesses, only for working capital purposes,and only with maturities of not more than 5years. Such loans were also made subject to fouradditional limitations.

1. They could be made only in exceptionalcircumstances when it appeared to the satisfac-tion of a Federal Reserve Bank that a businesswas unable to obtain requisite financial assist-ance on a reasonable basis from the usualsources. Obviously, this limitation was designedto make it clear that the Reserve Banks shouldnot compete with commercial banks and otherprivate lending institutions. The Board so con-strued the law when, in issuing its Regulation S,it declared: "It is expected * • * that the Fed-eral Reserve banks will not compete with localbanks, but rather will assist and cooperate withthem in meeting local requirements for workingcapital." so

2. They should be made only pursuant toauthority granted by the Federal Reserve Board.It may have been contemplated that such au-thority would be granted by the Board in indi-vidual cases. However, in its Regulation S,issued shortly after enactment of the new law,the Board expressly authorized "every FederalReserve Bank, in exceptional circumstances,until such time as the Federal Reserve Boardmay revoke or modify such authority" to makedirect loans to businesses in accordance withthe provisions of the statute.11 This authority

was never revoked or modified. In explanation,the Board stated: -

• * • in order to avoid the necessity ofhaving applications for such accommodationspassed on in Washington, the Board hasgranted blanket authority to all Federal Re-serve banks to grant such accommodationsdirectly on their own responsibility withoutreference to Washington.

3. By the terms of the statute, a ReserveBank could make a direct loan only to a busi-ness located in its district. This requirement wasinterpreted broadly by the Board as coveringany business having an office or place of busi-ness in the district of the lending ReserveBank.23

4. Although the law contained no require-ment as to the security upon which loans mightbe made to business enterprises, it did providethat direct loans should be made on a reason-able and sound basis. In this connection, it maybe noted that, as in the case of their otherlending operations, the Reserve Banks were notobliged to make a business loan even though itmight meet alt the requirements of the statute;a Reserve Bank was free to turn down anyapplication if it felt, for example, that it wouldnot be a sound loan from a credit viewpoint.An effort in Congress to make such loansmandatory rather than permissive was voteddown.5*

LIMITATIONSON COMMITMENTS

Like direct loans, all indirect extensions ofcredit to businesses through financing institu-tions were made subject to the general require-ment that the underlying loan be one made toan established industrial or commercial businessfor working capital purposes with a maturity ofnot more than 5 years. The special limitationsplaced on direct loans that were discussedin the preceding section—that the loan be onemade in exceptional circumstances, that it beauthorized by the Board, that it be to a businesslocated in the Federal Reserve district of theReserve Bank involved, and that it be made ona reasonable and sound basis—were not made

applicable to commitments with respect to busi-



ness loans made by private financing institu-tions. However, discounts for and purchasesfrom financing institutions and loans made inparticipation with such institutions were madesubject to certain other special limitations.

1. The law authorized the Reserve Banks toextend indirect financing assistance to businessenterprises only through a bank, trust company,mortgage company, credit corporation for in-dustry, or other financing institution. In orderto facilitate the participation of national banksin the making of business loans under the newlaw, the Comptroller of the Currency ruled thatlimitations on national banks with respect toloans to a single customer and with respect toreal estate loans did not apply to the extentthat a loan to a business enterprise was coveredby a commitment by the RFC or a FederalReserve Bank pursuant to the new law." TheComptroller's ruling with respect to limitationson real estate loans was later incorporated inthe law by the Banking Act of 1935, and wasmade still more liberal. That act added to sec-tion 24 of the Federal Reserve Act a new para-graph exempting from the limitations of thatsection loans made by national banks to estab-lished industrial or commercial businesses thatwere in whole or in part discounted or pur-chased or loaned against as security by aFederal Reserve Bank under section 13b, orfor any part of which a commitment was madeby a Reserve Bank, or in which a Reserve Bankparticipated. Thus, not only that part of theloan subject to a commitment by a ReserveBank but the entire loan was exempted fromlimitations on real estate loans by nationalbanks.

There was no question that national banksand other commercial banks qualified as financ-ing institutions under section 13b. In addition,the Board ruled that an investment banking firmm'ght be considered a financing institution if asubstantial part of its business represented pro-vision of funds for business enterprises throughtnc underwriting, sale, and distribution of se-curities.™

2. The law provided that a Reserve Bankc»uld make discounts or purchases, loans, par-ticipations, or commitments only with respect toa financing institution operating in its district.

Following the policy of liberal construction an-nounced when Regulation S was issued, theBoard held that a Reserve Bank could discountfor a financing institution operating within itsdistrict the obligation of an industrial or com-mercial business located in another FederalReserve district." Thus, while a direct loancould be made by a Reserve Bank only to abusiness located within its district, indirect ex-tensions of credit could be made to businesseslocated in other districts, provided the financinginstitution through which the credit was ex-tended could be regarded as operating withinthe Reserve Bank's district. This ruling wasincorporated in Regulation S when the regula-tion was revised in 1942.=s

3. The final special limitation placed uponparticipations by the Reserve Banks with pri-vate financing institutions in extensions of creditto business was that in all cases the financinginstitution should bear at least 20 per cent ofany loss. If the obligation of a business wasacquired by a Reserve Bank from a financinginstitution, the latter was required to "obligateitself to the satisfaction of the Federal Reservebank for at least 20 per centum of any loss."In lieu of such an obligation, however, thefinancing institution could itself advance 20per cent of the amount of the credit, the ReserveBank advancing the other 80 per cent; in thatevent, these separate advances were to be con-sidered as one advance, with repayment to bemade pro rata under regulations prescribed bythe Board. When a Federal Reserve Bank ac-quired from a lending institution the obligationof a business enterprise, the law provided thatthe existence and amount of any loss should bedetermined in accordance with regulations ofthe Board. Pursuant to this provision, Regula-tion S provided that a Reserve Bank should bedeemed to have sustained a loss on such anobligation whenever its directors, after investi-gation, determined that the obligation or anypart of it was a loss and the Reserve Bankcharged that amount off its books. The amountof the loss would be the amount so charged off,plus unpaid interest. The financing institutionwould then be required to reimburse the Re-serve Bank for the portion of the loss for whichit had obligated itself. If there was any subse-



quent recovery, the financing institution and theReserve Bank would share pro rata in theamount recovered.20

AMOUNT LIMITATIONS

Subsection (c) of section 13b provided thatthe aggregate amount of loans, advances, dis-counts, purchases, and commitments made un-der the section by all of the Reserve Banks andoutstanding at any one time should not exceedthe combined surplus of all the Reserve Banksas of July 1, 1934, plus all amounts paid tothe Reserve Banks by the Secretary of theTreasury under authority of the section. Thecombined surplus of the 12 Federal ReserveBanks on July 1, 1934, was $138,383,000.Under subsection (e) , the Secretary of theTreasury was authorized to pay to the ReserveBanks up to a total of $139,299,557. Conse-quently, the aggregate amount of direct loans,advances in participation with private financinginstitutions, discounts for and purchases fromsuch institutions, and commitments with respectthereto that could be outstanding as of anyparticular time, could theoretically be as muchas $277,682,557. Actually, the aggregateamount of credit permitted under the new lawproved more than adequate. The greatestamount outstanding at any one time was around$60,000,000 late in 1935, when the volume ofoperations under section 13b was at its peak.

It is to be noted that the statute itself placed

only an aggregate limit on the amount of creditextended by all of the Federal Reserve Banks,without specifically limiting the amount thatcould be extended and outstanding by a par-ticular Reserve Bank. By regulation, however,the Board limited the aggregate amount ofloans, advances, discounts, purchases, and com-mitments that could be made by any ReserveBank (and outstanding at any one time) to thesurplus of that Reserve Bank as of July 1, 1934,plus amounts paid to it by the Secretary of theTreasury under subsection (c) of section 13b,unless permission to exceed that limit was givenby the Board." Thus, each Reserve Bank wasin general limited to its proportionate part ofthe over-all limit; but, if the need for businessloans was found to be greater in some districtsthan in others, it was possible under the regula-tion for the Reserve Banks of those districts,with the Board's permission, to make loans inan amount far greater than their pro rata shareof the aggregate amount allowed by the statutefor all of the Reserve Banks.

No limitation was prescribed, cither bystatute or regulation, on the amount that aFederal Reserve Bank could lend to any onebusiness enterprise, cither directly or throughprivate financing institutions. This is somewhatsurprising in view of the fact that the RFCsbusiness loan authority was made subject notonly to an aggregate limitation of S300 millionbut also to a limitation of $500,000 to any oneborrower.

INDUSTRIAL ADVISORY COMMITTEES

Apparently there was some concern in Con-gress in 1934 that the Reserve Banks wouldnot be especially inclined to make loans tobusiness. Carter Glass observed that the Presi-dent himself thought that "perhaps the FederalReserve bank boards were too bank-minded tobe as liberal as he could wish they would be intreating matters of this sort." Accordingly, saidSenator Glass, the President had suggested the

insertion of a provision for the appointment ofan "advisory committee in each Federal Re-serve district, to be composed exclusively ofactive industrialists, to advise upon suchloans." "

Such a provision was included in subsection(d) of section 13b. It provided for the estab-lishment in each Federal Reserve district of anadvisory committee, to be appointed by ">e



Reserve Bank subject to the approval andregulations of the Federal Reserve Board, andto consist of not less than three nor more thanfive members as determined by the Board.Each member was required to be actively en-gaged in some industrial pursuit within theFederal Reserve district. Every application un-der section 13b was to be submitted to thiscommittee, which, after examination of thebusiness involved, would transmit the applica-tion to the Reserve Bank with the committee'srecommendation.

Implementing this provision of the statute,the Board's Regulation S provided that eachcommittee should consist of five members fa-miliar with the problems and needs of industryand commerce in the particular district; that

before February 15 of each year the board ofdirectors of each Reserve Bank should submitto the Board the names of members selectedfor the ensuing year; that, if approved by theBoard, such members should serve for 1 yearcommencing March 1; and that the committee,after examining each application and consider-ing the necessity and advisability of granting theapplication and such other factors as it deemedappropriate, should transmit the application tothe Reserve Bank with the committee's recom-mendation."

The regulation was adopted on June 26,1934. Promptly thereafter, the names of thefirst members of the industrial advisory com-mittee in each Federal Reserve district wereannounced by the Board.™

SOURCE OF FUNDS

Though not expressly stated, the law clearlycontemplated that the Federal Reserve Bankswould use their own funds in extending creditPursuant to section 13b. However, subsection(c) provided that, in order to enable the Re-serve Banks to extend such credit, the Secretaryof the Treasury should have authority to pay'o each Federal Reserve Bank an amount not'o exceed such portion of the sum of $139,-299,557 as might be represented by the amountPaid by such Reserve Bank for stock of theFederal Deposit Insurance Corporation (FDIC).In a sense, this provision made possible thereturn to the Reserve Banks by the Treasury offunds that had once belonged to the Banks.

At the time the FDIC was established by theBanking Act of 1933, the Federal ReserveBanks were required to subscribe to stock of

c Corporation in an amount equal to one-half°f their respective surpluses as of January 1,1 9 3 3 . The total amount that they were thusSquired to turn over to the FDIC was $139,-" ' 5 5 7 ' By the 1934 enactment of section 13b,

that amount was made available again to theReserve Banks; however, all funds returned

were to be used only for business loans, andthe portions to be returned to the individualReserve Banks were to be decided by the Secre-tary of the Treasury.34

But the authority for such payments to theReserve Banks by the Treasury was subject tocertain conditions. Payment could be made toa Federal Reserve Bank only if it executed anagreement to hold its FDIC stock unencum-bered and to pay to the United States all divi-dends, payments on liquidation, and otherproceeds of such stock; and if the stock itselfwere pledged to the United States as security forthis agreement. In addition, the Reserve Bankwas required to agree that if such dividends,payments, and other proceeds from the FDICstock in any year should not be as much as2 per cent of the payments made to the Bankby the Treasury, the Reserve Bank would payto the United States such further amount, outof its earnings derived from the payment re-ceived from the Treasury, as would make upthe balance of the specified 2 per cent, andwould continue to make such payments untilthe final liquidation of the FDIC stock.



Operations under section 13b never madenecessary the payment by the Treasury to theReserve Banks of the full amounts authorizedby the law. An agreement was entered into bythe Treasury and the Reserve Banks underwhich the Treasury agreed to make paymentsequal to approximately one-half of the creditsextended by the Reserve Banks through loansand commitments under section 13b. Theamounts actually advanced by the Treasuryunder this agreement aggregated about $27,-546,000. No such advances were made by theTreasury after 1937.

Pursuant to an Act of Congress approvedAugust 5, 1947,™ the stock of the FDIC thathad been subscribed by the Federal ReserveBanks in 1933 was cancelled on October 7,1947, and the amount that had been paid forsuch stock ($139,299,557) was turned over tothe Treasury instead of being repaid to theFederal Reserve Banks. Since the 2 per centannual payments by the Reserve Banks to theTreasury—previously mentioned—were relatedto ownership of the FDIC stock, those pay-ments were discontinued after October 7, 1947.Nevertheless, there was no requirement in thelaw for repayment of the amounts advancedby the Treasury, consequently, the aggregateamounts paid by the Treasury to the ReserveBanks under section 13b ($27,546,000) con-

tinued to be carried on the books of the Re-serve Banks as "section 13b surplus" until1958 when section 13b was repealed.

Finally, a word should be said concerningthe source of the $139,299,557 that the Secre-tary of the Treasury was authorized to pay tothe Federal Reserve Banks under section 13b.The law provided that all amounts that mightbe required to be expended by the Secretaryunder this authority should come out of mis-cellaneous receipts of the Treasury created bythe increment resulting from the reduction ofthe weight of the gold dollar under the Presi-dent's proclamation of January 31, 1934, andthat such sum as should be required for thisexpenditure should be appropriated out of suchmiscellaneous receipts. Under the Gold ReserveAct of January 30, 1934, the Reserve Bankshad been required to transfer title to all goldcoin and bullion held by them to the UnitedStates in return for equivalent amounts indollars. On the next day, the President's procla-mation pursuant to the Act of May 12, 1933,reduced the weight of the gold dollar; as aconsequence, the dollar credits received by theReserve Banks for their gold resulted in asubstantial net profit to the U.S. Treasury.That profit was the increment from which pay-ments by the Treasury to the Reserve Bankswere authorized by section 13b.

REGULATION S

On June 26, 1934—7 days after the enact-ment of section 13b of the Federal Reserve Act—the Board promulgated its Regulation Sunder the new law. In doing so, the Boardstated::'°

In accordance with the policy of Congressand in order to facilitate as much as possiblethe performance of the new functions thusgranted to the Federal Reserve banks, theFederal Reserve Board's regulation leaves thebroad powers granted by Congress to theFederal Reserve banks wholly unimpairedand prescribes no restrictions beyond those

prescribed in the law itself. • • • The regu-lations • • * contain practically nothing ex-cept an analysis of the law and an outline ofthe necessary procedure.

That statement represented a fair indicationof the contents of Regulation S, which did littlemore than paraphrase the requirements of thestatute and outline the procedure to be followedby financing institutions and businesses in mak-ing applications to the Reserve Banks.

The regulation provided that each applicau"0"by a financing institution or business should be



filed with the Reserve Bank of the district inwhich the principal place of business of theapplicant was located, and that the applicationshould then be submitted by the Reserve Bankto the industrial advisory committee of the dis-trict. In determining whether to approve anysuch application, the Reserve Bank was re-quired to satisfy itself not only that all legalrequirements were met but also that the finan-cial condition and credit standing of the obligorand endorsers and the value of the securityoffered, if any, justified the granting of theaccommodation.

As to transactions with financing institutions,the regulation contained a special provisionregarding the manner of determining the exist-ence and amount of any losses. With respect todirect loans, the regulation granted blanketauthority to the Reserve Banks to make suchloans without referring them to the Board forindividual authorization. An industrial advisorycommittee of five members was required to beestablished in each Federal Reserve district.The aggregate amount of loans and commit-ments made by each Federal Reserve Bank waslimited to the Reserve Bank's proportionatepart of the over-all maximum amount fixed bythe statute, except where permission to exceedthe Reserve Bank's individual limit might begranted by the Board.

With respect to a matter not dealt with bythe statute, the regulation provided that all ratesof interest and discount established by theReserve Banks on section 13b loans, advances,discounts, and purchases should be subject tothe approval of the Board. Although a discus-sion of rates charged on section 13b loans andcommitments is not within the scope of thisstudy, it may be noted that such rates, unlikediscount rates under sections 13 and 13a ofthe Act, were not usually fixed at stated per-centages but were generally set in terms of a

maximum and a minimum. In addition, therewas greater variation among the different Fed-eral Reserve Banks."

Only once was Regulation S amended orrevised. In the spring of 1942, in connectionwith the inauguration of the so-called V-loanprogram for guaranteeing war production loans(discussed in the following chapter), the regula-tion was reissued with certain changes designedto facilitate participation by the Reserve Banksin that program.3" As stated in a foreword tothe revised regulation, the changes were largelyof a clarifying or technical character. They wereintended to make operations more flexible. Forexample, whereas the original regulation hadrequired an application by a financing institu-tion to be filed with the Reserve Bank of thedistrict in which the applicant was located, therevised regulation permitted the application tobe filed with the Reserve Bank of any districtin which the financing institution was operating;it was made clear that the business beingfinanced by the applicant could be located insome other district. Similarly, an application bya business for a direct loan was permitted to befiled with any Reserve Bank in which the busi-ness had an office or place of business insteadof only in the district in which its principal placeof business was located. Also, the previousrequirement that a Federal Reserve Bank mustsatisfy itself that the financial condition andcredit standing of the obligor and endorsers andthe value of the security offered justified thegranting of the accommodation was omittedfrom the revised regulation. Finally, the revisedregulation required that rates of interest anddiscount should be subject to review and deter-mination of the Board rather than to approvalby the Board—a change apparently made toconform to the general practice with respect todiscount rates under other provisions of theFederal Reserve Act.



TERMINATION OF AUTHORITY

For a period of about 18 months after theenactment of section 13b, loans and commit-ments by the Federal Reserve Banks were madein considerable volume. By the end of 1935,1,993 applications totaling about $ 124.5 millionhad been approved. In 1936, however, activitytapered off. Only 287 applications were ap-proved in that year and only 126 in 1937. Thisdecline in activity after such a favorable begin-ning is easily explained. The authority grantedthe RFC in 1934 to make business loans hadbeen somewhat broader than that given theFederal Reserve Banks, even though the RFCwas looked upon as a temporary agency. Notonly was the existence of the RFC continued,but in 1935 its business loan authority wasliberalized.3" It was again liberalized in 1938when maturity restrictions on RFC loans wereeliminated.10 It followed that, with less re-stricted authority, the RFC made more businessloans, and by the same token the Federal Re-serve Banks made less. In 1938, the Board ofGovernors sought to obtain some relaxation ofthe limitations imposed by section 13b, butwithout success.11 This was the beginning of along and fruitless effort to liberalize the au-thority of the Reserve Banks to make loans tobusiness enterprises.

Early in 1941, when U.S. participation inWorld War II seemed imminent, bills to liberal-ize the authority of the Federal Reserve Systemto make business loans were revived as meas-ures to finance defense production,12 but noaction was taken by Congress for that purpose.After Pearl Harbor, the urgency was too greatand the time too short to wait for legislativeaction; as will be seen in the following chapter,steps were taken promptly to provide financialassistance to business enterprises engaged inwar production. Implementation of such assist-ance was not by statute but by an Executiveorder of the President authorizing a program ofGovernment guarantees of loans to war con-tractors. Nevertheless, because of the experi-ence of the Federal Reserve Banks in making

business loans under section 13b. they werebrought actively into the now guaranteed loanprogram as agents for the war procurementagencies of the Government. In addition, urgentdemands for the financing of war productioncontracts stimulated activity under section 13b,and during 1942 the Reserve Banks approvedapplications under that section aggregating overSI28 million, the peak volume for any year inthe history of their industrial loan operations.

Near the end of the war, efforts to liberalizesection 13b were renewed. In May 1944, Sena-tor Wagner introduced a bill ' • that would haveauthorized the Reserve Banks to guarantee, ormake commitments to purchase, loans made byfinancing institutions to any business enterprise,subject only to regulations of the Board andwith no statutory restrictions. Similar bills wereconsidered in 1945, although with some limita-tions." In 1947 a new bill was introduced thatwould have repealed section 13b and wouldhave added to section 13 of the Federal ReserveAct a provision broadly authorizing the ReserveBanks to guarantee, up to 90 per cent, loansmade by financing institutions to business enter-prises, provided that such loans had maturitiesof not more than 10 years, that the aggregateamount at any one time did not exceed the com-bined surplus of the Federal Reserve Banks, andthat the aggregate amount of guaranteed loansin excess of $100,000 did not exceed half <nthe combined surplus of the Reserve Banks-'The Board supported this proposal. '* Agan>>however, this effort to liberalize the businessloan authority of the Reserve Banks was to noavail.

A sharp decline in business activity in We

1949 and early 1950 gave rise to new proposalsfor financing business enterprises, but itstill contemplated that the Federal ReserveBanks would be utilized for this purpose,though somewhat more indirectly. Active consideration was given to various bills to pr«vl

for Government insurance of business loans anfor the establishment of national investmen



companies to make long-term loans to eligiblesmall business enterprises and to invest in stockof such enterprises.'7 These bills would haverepealed section 13b of the Federal ReserveAct and provided for investment by the ReserveBanks in the capital of the proposed investmentcompanies and for regulation and supervisionof such companies by the Board. In 1951,Senator Robertson introduced a bill '" verysimilar to the 1947 bills to liberalize the au-thority of the Reserve Banks under section 13b.This time, however, instead of endorsing theproposal, the Board felt that, because of then-current inflationary tendencies, the proposalshould be deferred.

A complete shift in the Board's attitudetoward participation of the Federal ReserveSystem in the financing of small business be-came evident in 1955. In May of that year theBoard endorsed the objective of a bill l!l toestablish national investment companies tomake long-term loans to business, but it ques-tioned the wisdom of Federal Reserve participa-tion and recommended repeal of section 13b ofthe Federal Reserve Act. A similar attitude wasexpressed in February 1957, when the Boardsupported in principle a bill to set up nationalinvestment companies to make long-term loansto business, but flatly stated that the responsi-bility for supervision and regulation of suchcompanies should not be vested in the FederalReserve System. Again, in June 1957, Chair-man Martin told the Small Business Subcom-mittee of the Senate Banking and CurrencyCommittee that the primary duty of the FederalReserve System was to guide monetary andcredit policy and that, in the Board's opinion,>t would be "undesirable for the Federal Re-serve to provide the capital and participate inmanagement functions" in the proposed smallbusiness investment companies. At the same

time, Chairman Martin suggested a "freshstudy of the small business financing problem."

In the meantime, a bill to recodify andstreamline all Federal banking laws, known asthe Financial Institutions Act, which passed theSenate on March 21, 1957, would have hadthe effect of repealing section 13b of the Fed-eral Reserve Act/'0 However, because of oppo-sition to certain other provisions, the bill wasallowed to die in the House Banking and Cur-rency Committee.

In the spring of 1958, a general economicrecession gave new impetus to legislative pro-posals to provide financial assistance to businessenterprises. All such proposals contemplatedthe repeal of section 13b of the Federal ReserveAct. Finally, on August 21, 1958, the SmallBusiness Investment Company Act of 1958 wasenacted into law.11 It provided for the establish-ment of small business investment companiessubject to regulation by the Small Business Ad-ministration. Section 601 of the act repealedsection 13b of the Federal Reserve Act effectiveone year after the date of the new act, andsection 602 required the Federal ReserveBanks, within 60 days, to pay to the UnitedStates the aggregate amount theretofore paid tothe Reserve Banks by the Secretary of theTreasury under section 13b of the FederalReserve Act.l=

So it was that the departure from traditionin 1934, which for a time put the FederalReserve Banks actively into the field of busi-ness loans, was followed by a long period ofunsuccessful legislative efforts to liberalize theauthority of the Reserve Banks in that field,then by a complete reversal of policy aimed atseparation of the Federal Reserve from all par-ticipation in business financing, and finally byrepeal of the business loan authority of theFederal Reserve Banks.


V Loans

ORIGIN AND NATURE

WARTIME BACKGROUND

Strictly speaking, this chapter may not belongin a history of the lending functions of theFederal Reserve Banks, since it relates to loansmade primarily by commercial banks and onlyminimally by Reserve Banks themselves. In abroad sense, however, such a history would beincomplete without a general discussion of theactive and important part that the Federal Re-serve System has played in the program offinancing commonly known as the V-loan pro-gram.

Briefly, the V-loan program is a programunder which Government procurement agenciesguarantee loans made by banks and otherfinancial institutions to business concerns en-gaged in producing goods or furnishing servicesnecessary to the national defense both in war-time and in peacetime. Practically all of suchguarantees have been made through the FederalReserve Banks as fiscal agents of the Govern-ment.


The program was partly an outgrowth of theefforts to liberalize the business loan authorityof the Reserve Banks, which were discussed inthe preceding chapter. As indicated, all bills inCongress for that purpose failed of enactment,including those introduced early in 1941 as ameans of aiding in the financing of contractorsengaged in defense production. However, theattack on Pearl Harbor and the entry of theUnited States into the war in December 1941made the immediate financing of war contrac-tors an essential part of the war effort. Numer-ous small subcontractors, because of their sizeand financial condition, were unable to obtainfrom commercial banks the credit that was nec-essary to carry out the large volume of Govern-ment contracts awarded to them.

Time did not permit the delay involved inthe enactment of new legislation. On March 26,1942, the President by Executive order author-ized the War and Navy Departments and theU. S. Maritime Commission to make or guaran-tee loans to war production contractors throughthe agency of the Federal Reserve Banks.1 Inissuing the order, the President emphasized that

147



its purpose was "to put working capital financ-ing on a war basis" and that loans and guaran-tees would "not be made under peacetime creditrules." a

The Executive order made the operations ofthe Reserve Banks as fiscal agents subject tosupervision and regulation by the Board ofGovernors. Under this authority, the Board onApril 6, 1942, promulgated its Regulation V.~The use of the letter "V" to designate the regu-lation—a letter made popular by WinstonChurchill as a symbol of victory—was purelyfortuitous. It just so happened that among theletters of the alphabet, which the Board hascustomarily used in designating its regulations,"V" was the next unused letter. From thisderived the short name given to the whole pro-gram of guaranteeing loans to defense and warcontractors.

PHASES OF THE PROGRAM

Although it originated as a wartime measure,the V-loan program is still in effect at thiswriting. Actually, it has consisted of two dis-tinct though similar programs, one a war pro-gram that began in 1942 and the other apeacetime defense program that began in 1950.

The wartime part of the program wentthrough three different phases marked by cer-tain differences in purpose: (1) the emergencyphase from March 1942 until the fall of 1943,during which the prime objective was to financewar production; (2) the so-called VT periodfrom the fall of 1943 until the fall of 1944,when guarantees were made not only to financewar production contracts but also to enablecontractors to unfreeze their working capitalpending settlement of their termination claimsagainst the Government; and (3) the T-Ioanphase from September 1944 until about themiddle of 1946, during which the chief purposewas to finance contractors in converting topeacetime operations while awaiting settlementof their claims in connection with terminationof their war contracts.

More than 5 years after the end of the warthe V-loan program was revived by the Defense

Production Act of 1950 as a means of financingcontractors engaged in defense production. Thiswas the beginning of the peacetime part of theprogram.

Both in war and in peace, however, anddespite shifts in emphasis, guaranteed loanshave been made in essentially the same manner,that is, through the Federal Reserve Banks asfiscal agents of the Government and pursuantto general procedures outlined in the Board'sRegulation V.

The wartime period was. of course, the mostactive part of the program. From the inceptionof the program in March 1942 until the end ofSeptember 1946. the Reserve Banks processed8.771 guarantees aggregating nearly SlO'/s bil-lion. Losses were relatively small and substan-tially less than the guarantee fees collected. Asa matter of fact, the wartime program resultedin a net profit to the Government of about $23million. The gratifying success of the programwas attested by a letter addressed to ChairmanEccles of the Board by Secretary of War Ken-neth Royall on March 26, 1947. on the fifthanniversary of the program. Commenting onthe part played by the Federal Reserve Banks,Mr. Royall's letter stated: •

The underlying philosophy of (he Execu-tive order was. as you know, that in assistingwar production contractors through guaran-teed loans the War Department should usenot only the funds already in the commercialbanks of the country, but should utilize theexisting credit machinery as well. It was tothat end that the Federal Reserve banks wereappointed the fiscal agents of the War De-partment.

The universal acceptance of the principleof regulation V-loans by both the contractorsand the banks is due in no small part to thegood judgment, the skill, and the expeditionwith which they have been handled by the

Federal Reserve banks. Especially appre£1'ated were the helpful suggestions of the Re|serve banks during the liquidation phase olthe V and T programs which, in many re-spects, called for an even greater degree otfinancial management than that required mthe initial extension of credit.


V LOANS 149

You and the members of the Federal Re-serve System who participated in this pro-gram should feel a deep satisfaction in yourcontribution to this important part of the wareffort.

While not so active or exciting as the wartimeprogram, the peacetime V-loan program underthe Defense Production Act of 1950 has op-erated smoothly and successfully. Under thispart of the program, the guaranteeing agencieshad approved 1,647 applications totaling overS3.6 billion as of June 30, 1972.

A complete account of all aspects of the V-loan program would require more space than

is practicable in this study of the lending func-tions of the Federal Reserve Banks. A fulldescription of the wartime period of the pro-gram may be found in the March 1946 issueof the Federal Reserve Bulletin, beginning atpage 240. For present purposes, it will sufficeto discuss briefly those aspects of the programthat might be regarded as involving legal con-siderations: the legal basis for the program; therole of the Federal Reserve System in the pro-gram; the form of the guarantee agreement;interest rates and guarantee fees; and certainlegal problems that arose in connection withthe program.

LEGAL BASIS

EXECUTIVE ORDER 9112

Legal authority for the V-loan program wasoriginally based upon provisions of the FirstWar Powers Act of December 18, 1941." TitleII of that act gave the President power toauthorize any department of the Governmentexercising functions in connection with theconduct of the war to enter into contractswithout regard to other provisions of law,whenever the President deemed that such actionwould facilitate the prosecution of the war.

Pursuant to this broad authority, the Presi-dent on March 26, 1942, issued ExecutiveOrder 9112." authorizing the War and NavyDepartments and the Maritime Commission toenter into contracts guaranteeing any FederalReserve Bank, the RFC, or any other financinginstitution against loss on loans made by themfor the purpose of financing any contractor,subcontractor, or others engaged in any busi-ness or operation that was "deemed by the WarDepartment, Navy Department or MaritimeCommission to be necessary, appropriate orconvenient for the prosecution of the war." Theorder also authorized direct loans for the same

purposes. The Reserve Banks were authorizedto act as agents of the designated agencies incarrying out the order, and the Secretary of theTreasury was directed to designate each FederalReserve Bank as fiscal agent for this purposepursuant to provisions of section 15 of theFederal Reserve Act.

The Executive order had been approved bythe Attorney General before it was issued.7 Itsvalidity was impliedly recognized by Congressin the Supplemental National Defense Appro-priations Act of April 28, 1942,S and the In-dependent Offices Appropriation Act of June27, 1942,° which made funds available to theWar and Navy Departments and the MaritimeCommission for the purpose of carrying out theprovisions of the Executive order. Any doubtas to the legality of the order was set at rest bythe Act of June 11, 1942,10 which created theSmaller War Plants Corporation. Section 7 ofthat act specifically authorized the War andNavy Departments and the Maritime Commis-sion "to make or participate in loans, guar-anties, and commitments in accordance withExecutive Order Numbered 9112 of March 26,1942."



VT GUARANTEESIn the summer of 1943, when the prospect of

ultimate military victory began to appear likely,war contractors remembered that after the endof World War I final settlement of claims undercancelled war contracts had been delayed insome instances for more than 20 years. Fearingthat a successful conclusion of the current warmight bring wholesale contract cancellationsand similar delays in the settlement of contractclaims, some contractors raised the questionwhether they could continue to draw downfunds under a V loan after termination of theirwar contracts. Literally, it appeared that Execu-tive Order 9112 authorized guarantees only tofinance war production and not to finance con-tractors pending settlement of their cancelledcontracts.

In January 1944, the Attorney General heldthat if commitments and guarantees were madeprior to the termination of all of a borrower'swar production contracts, the Executive orderwas broad enough to permit funds to be ad-vanced under such commitments and guaranteeseven after termination of the borrower's con-tracts. However, the problem had reached acritical point before the Attorney General'sopinion was rendered; on September 1, 1943,the Board and the guaranteeing agencies hadapproved a modified form of guarantee agree-ment that, in order to avoid the legal questionof authority, had provided that funds shouldbe available under a guarantee for terminationpurposes if they were also technically availablefor current war production'purposes.

CONTRACT SETTLEMENT ACT

Meanwhile, concern as to possible delays inthe settlement of contract claims upon termi-nation of the war led to the introduction in Con-gress of various bills on this subject. Out ofthese bills came the Contract Settlement Act ofJuly 1, 1944, which became effective on July21, 1944.11 The act set up procedures designedto provide for the prompt payment of claimsagainst the Government that grew out of thecancellation of war contracts. Section 10 of theact declared it to be the policy of the Govern-

ment to provide adequate financing to all warcontractors having termination claims "within30 days after proper application therefor." Tothis end, the act provided for two methods offinancing: (1) advance or partial payments and(2) Government loans or guarantees.

As to loans and guarantees, the act specifi-cally authorized any Government contractingagency to guarantee any Federal Reserve Bankor other public or private financing institutionagainst loss on loans made to a war contractor"who is or has been engaged in performing anyoperation deemed by such contracting agency tobe connected with or related to war production,for the purpose of financing such war contractoror other person in connection with or in con-templation of the termination of one or moresuch war contracts or operations." Direct loansfor such purposes were also authorized. TheFederal Reserve Banks were expressly author-ized, subject to regulations prescribed by theBoard of Governors with the approval of theDirector of Contract Settlement, to act on behalfof the contracting agencies as fiscal agents ofthe United States in carrying out the purposes ofthe act.

On August 18, 1944, the Director of Con-tract Settlement prescribed procedures and poli-cies to be followed in the guaranteeing of termi-nation loans under the act and approved stan-dard forms of guarantee agreement and loanagreement to be used for that purpose.15 OnSeptember 11, 1944. the Board revised itsRegulation V to cover guarantees under the newprogram.11 In connection with the inaugurationof the new T loans, the Board issued a pressstatement that indicated the difference betweenthe legal basis for such loans and the legal basisfor the earlier VT loans:

The T loan program is a logical extensionof the V and VT loan programs under Execu-tive Order 9112. which provide war contrac-tors with financing necessary f o r production.VT loans, in use since September 1, '9|*3'provide both production and terminationfinancing, but have not been available aftercancellation has taken place. T loans, whichare authorized under the Contract SettlementAct, may be guaranteed after the borrower swar production contracts have been tcrmi-


V LOANS 151

nated. However, commitments for such loansmay be guaranteed in advance of cancellation.Thus ihc program affords war productioncontractors a means of insurance against thefreezing of their working capital which mightresult from sudden termination of their warcontracts.

DEFENSE PRODUCTION ACT

By 1950 the great majority of claims underwar production contracts had been settled, andthe authority for guarantees of terminationloans under the Contract Settlement Act had,for all intents and purposes, become academic.However, the V-loan program was revived inthat year as one of the measures provided bythe Defense Production Act of September 8,1950, to stimulate production for national de-fense purposes."

Unlike Executive Order 9112 and the Con-tract Settlement Act, the authority contained inthe Defense Production Act was spelled out insome detail. Section 301 of the latter act ex-pressly gave the President power to authorizethe Departments of the Army, Navy, Air Force,Commerce, and such other procurement agen-cies of the Government as he might designate,to guarantee any public or private financinginstitution (including any Federal ReserveBank) against loss on any loan made to financeany contractor, subcontractor, or other person"in connection with the performance, or in con-nection with or in contemplation of the termi-nation, of any contract or other operationdeemed by the guaranteeing agency to be neces-sary to expedite production and deliveries orservice under Government contracts for theprocurement of materials or the performance ofservices for the national defense."

As under Executive Order 9112 and the Con-tract Settlement Act, the Federal Reserve Bankswere expressly authorized to act as fiscal agentsof the United States on behalf of the guarantce-ing agencies. For the first time, however, it wasspecifically provided in the law that the fundsnecessary to carry out guarantees should besupplied by the guaranteeing agencies; that theReserve Banks as fiscal agents should have noresponsibility or accountability except as such

agents; and that the fiscal agents should bereimbursed by the guaranteeing agencies for allexpenses and losses, including attorneys' feesand expenses of litigation. It was further pro-vided that all operations of the Reserve Banksas fiscal agents should be subject to the super-vision of the President and to such regulationsas he might prescribe; that the President shouldbe authorized to prescribe rates of interest,guarantee and commitment fees, and regula-tions governing the forms and procedures to befollowed in connection with guarantees; andthat each guaranteeing agency should be author-ized to use, for the purposes of such guarantees,any funds theretofore or thereafter appropriatedor allocated to it, or becoming available to it,for such purposes or for the purpose of meeting"the necessities of the national defense."

The act did not mention the Board of Gover-nors of the Federal Reserve System. However,on the day after approval of the act, September9, 1950, the President by Executive Order No.10161 1"1 delegated to the Board his authority toprescribe regulations, interest rates and guaran-tee fees, and forms and procedures, subject to arequirement that the Board should first consultwith the guaranteeing agencies. At the sametime, the President expressly designated theFederal Reserve Banks as fiscal agents of theUnited States in carrying out under the actguarantees of loans made by private financinginstitutions. Finally, the Executive order desig-nated as guaranteeing agencies not only theArmy, Navy, Air Force, and Commerce De-partments but also the Departments of theInterior and Agriculture and the General Ser-vices Administration.

The Defense Production Act was enacted asa temporary statute. Title III, containing theV-loan authority, was originally intended toexpire on June 30, 1951. This authority, how-ever, was further extended by successive amend-ments; at this writing it is scheduled to termi-nate on June 30, 1974.10

The provisions of section 301 of the actregarding guaranteed loans were amended bythe Act of June 30,1953.'7 The amendment wasdesigned to clarify the availability of V loans tofinance contractors pending settlement of their


1S2 HISTORY OF LENDING FUNCTIONS

defense contracts. The language of the law waschanged to provide specifically that such guar-antees might be made "for the purpose of fi-nancing any contractor, subcontractor, or otherperson in connection with or in contemplationof the termination, in the interest of the UnitedStates, of any contract made for the nationaldefense." At the same time, a provision wasadded to make it clear that no small businessconcern, as defined in the act, should be ineligi-ble for a guaranteed loan by reason of alter-native sources of supply.

At the time of the financial collapse of thePenn Central Transportation Company in 1970.some consideration was given to the possibilityof governmental assistance to the company bymeans of a V loan. The idea was dropped, how-ever, and, on the contrary, Congress specificallyamended section 301 of the Defense ProductionAct for the purpose of guarding against the useof V loans as a means of preventing financialinsolvency or bankruptcy unless such an oc-currence would have an adverse effect upondefense production. A new subsection wasadded to section 301 that limited the maximumobligation of any guaranteeing agency to S20million except with the approval of Congress,

and that prohibited the use of the V-loanauthority for the purpose of preventing the fi-nancial insolvency or bankruptcy of any personunless the President certified that the insolvencyor bankruptcy would have a direct and sub-stantially adverse effect upon production. Acopy of .such certification, with a detailed justi-fication, must be transmitted to Congress atleast 10 days before any such use of theauthority.'-

Executive Order 10161 was subsequently af-fected, amended, and superseded by other Ex-ecutive orders,1' but no essential change wasmade in the authority delegated by the Presi-dent to the Board or in the scope of the au-thority given to the Federal Reserve Banks toact as fiscal agents. It should be noted, how-ever, that, as of the present writing, the desig-nated guaranteeing agencies are the Army.Navy, and Air Force Departments and the De-fense Supply Agency of the Defense Depart-ment; the Departments of Commerce. Interior,and Agriculture; the General Services Adminis-tration; the Atomic Energy Commission; andthe National Aeronautics and Space Adminis-tration.

ROLE OF THE FEDERAL RESERVE BANKS

AS FISCAL AGENTS

It must always be borne in mind that the partplayed by the Federal Reserve System in theoperation of the V-loan program was primarilythat of agent and coordinator. The principalsin the program were the procurement agenciesof the Government, chiefly the military depart-ments and—during the later defense phase ofthe program—the General Services Administra-tion and the Atomic Energy Commission. Itwas these agencies that guaranteed V loans.The Reserve Banks acted only as intermediaryagents, investigating and making recommenda-tions as to the credit aspects of applications forguarantees, processing such applications, and

servicing the loans after they were made andguaranteed.

At the outset of World War II, ExecutiveOrder 9112 had directed the Secretary of theTreasury to designate the Federal ReserveBanks as fiscal agents of the United States underprovisions of section 15 of the Federal ReserveAct. On March 31, 1942—5 days after theExecutive order was issued—the Secretary for-mally designated each Federal Reserve Bank asfiscal agent for the purpose of carrying out theorder. The Contract Settlement Act of 1944made action by the Secretary of the Treasuryunnecessary, since that act expressly authorizedthe Reserve Banks to act as fiscal agents of theUnited States in carrying out the provisions of


V LOANS 153

the act authorizing guarantees of terminationloans. Similarly, the Defense Production Act of1950 expressly authorized the Reserve Banks toact as fiscal agents of the United States onbehalf of any guaranteeing agency "when desig-nated by the President"; such designation wasmade by the President in section 302(b) ofExecutive Order 10161. It was made plainthroughout the program that no Federal Re-serve Bank should have any responsibility oraccountability except as agent for the guaran-teeing agencies and that the operations of theReserve Banks should be subject to supervisionand regulation by the Board of Governors.

Reimbursement of the Reserve Banks fortheir expenses and losses in acting as fiscalagents was provided by the original ExecutiveOrder 9112, and it was specifically stated thatsuch expenses should include attorneys' fees

, and expenses of litigation. Despite this specificprovision, a question arose in the course of thewartime V-loan program whether a guarantee-ing agency could lawfully reimburse a ReserveBank for attorneys' fees paid out in connectionwith a guaranteed loan after the loan had beenpurchased by the guaranteeing agency. TheWar Department doubted its authority to do sobecause section 314 of Title 5 of the U.S. Codeprohibited any Government agency other thanthe Department of Justice from incurring legalexpenses in protecting the interests of theUnited States. This question was eventuallysettled by the Defense Production Act, whichexpressly authorized reimbursement of the Re-serve Banks for attorneys' fees and expenses oflitigation "notwithstanding any other provisionof law."

The procedures followed by the ReserveBanks in executing guarantees and servicingguaranteed loans were prescribed in consider-able detail by the guaranteeing agencies and,from the outset of the wartime V-loan program,they were generally uniform. The Defense Pro-duction Act expressly recognized the desirability°f procedural uniformity. It provided that thePresident should prescribe regulations "govcrn-Ing the forms and procedures (which shall beuniform to the extent practicable) to be utilizedIn connection with such guarantees." As pre-

viously indicated, that authority was delegatedto the Board, to be exercised after consultationwith the heads of the guaranteeing agencies.

In accordance with this statutory injunction,Regulation V, as revised effective September27, 1950,-° for the first time undertook to out-line the procedures to be followed in guarantee-ing loans. Essentially, the prescribed procedureswere as follows:

1. A financing institution desiring a guaran-tee of a loan to an eligible borrower would sub-mit its application to the Reserve Bank of itsdistrict.

2. It would then be necessary to determinewhether the contract or other operation of theprospective borrower to be financed by the loanwas necessary to expedite defense production orservices. This determination would be made bya duly authorized certifying officer of the ap-propriate guaranteeing agency.

3. The application would then be subject toapproval either by the appropriate guaranteeingagency in Washington or, to the extent thatauthority was delegated to it, by the FederalReserve Bank acting on behalf of the guarantee-ing agency.

4. If approval from Washington were neces-sary and if the application were approved by anauthorized contracting officer of the guarantee-ing agency, that officer would authorize theReserve Bank to execute and deliver the guar-antee. If the application were one that could beapproved by the Reserve Bank under delegatedauthority, the Reserve Bank would approve andexecute the guarantee without reference to theguaranteeing agency in Washington.

Early in the wartime program, the WarDepartment stationed liaison officers at each ofthe 12 Federal Reserve Banks and also at theDetroit Branch of the Chicago Reserve Bankand the Los Angeles Branch of the San Fran-cisco Reserve Bank, with authority to certifythe eligibility of the prospective borrower for aguaranteed loan. Field representatives of theMaritime Commission similarly furnished state-ments of necessity in connection with loans tobe guaranteed by the Commission. The NavyDepartment, on the other hand, centralized itsV-loan operations in Washington and had no



such field representatives. The peacetime phaseof the program under the Defense ProductionAct did not involve the volume of applicationsor the element of urgency that characterizedthe wartime program, and since 1950 the op-erations of all guaranteeing agencies havebeen centralized in Washington, with no liaisonofficers or representatives at the Reserve Banks.

During the wartime phase of the program,the War Department and the Maritime Com-mission delegated to the Reserve Banks au-thority to approve guarantees up to certainprescribed amounts without reference to Wash-ington. No such delegations were made by theNavy Department. Under the Defense Produc-tion Act none of the guaranteeing agencies hasdelegated such authority to the Reserve Banks;all applications are required to be submitted toWashington for approval.

Although the Reserve Banks have been uti-lized by the guaranteeing agencies as field agentsfor the purpose of expediting the considerationand execution of guarantees, it should be em-phasized again that a primary role of the Re-serve Banks has been the investigation of thecreditworthiness of prospective guaranteedloans. The guaranteeing agencies have reliedheavily upon the credit experience of the Re-serve Banks and upon their recommendationsas to whether particular applications warrantedapproval from a credit standpoint.

AS FINANCING INSTITUTIONSIn addition to acting as fiscal agents of the

United States in guaranteeing V loans made byprivate financing institutions, the Federal Re-serve Banks themselves acted to some extent aslending institutions under the V-loan program.

Executive Order 9112 had authorized guar-antees of loans made not only by private financ-ing institutions but also by the Federal ReserveBanks and the RFC. It was contemplated thatthe Reserve Banks might, under section 13b ofthe Federal Reserve Act, make loans to warcontractors that would be eligible for guaran-tees. As noted in the preceding chapter, theBoard revised its Regulation S to facilitate par-ticipation by the Reserve Banks in the V-loanprogram. Actually, however, the changes madein that regulation were largely technical andclarifying in nature. The restrictions prescribedby section 13b continued, as before the war, tolimit the extent to which the Reserve Bankscould extend credit to business concerns. Con-sequently, relatively few V loans were made towar contractors by the Federal Reserve Banks,and the role of the Reserve Banks as financinginstitutions under the V-loan program was notone of any considerable significance. It has be-come nonexistent since the repeal of section 13bof the Federal Reserve Act effective August 21.1959.

ROLE OF THE BOARD OF GOVERNORS

The role of the Board of Governors in theV-loan program is fourfold in nature: (1) Itprescribes regulations governing the operationsof the Federal Reserve Banks; (2) it prescribesguarantee fees and interest rates with respect toguaranteed loans; (3) it prescribes the formsand procedures to be followed; and, finally,quite apart from any statutory authority, (4)it acts as an over-all coordinator in the deter-mination of general policies.

Throughout the program, the Board's Regu-lation V has been couched in the broadestterms. As first issued in April 1942," the regu-lation contained general statements to the effectthat the objective of the Federal Reserve Systemwould be to facilitate and expedite war produc-tion by arranging for the financing of war con-tractors and that the Board and the FederalReserve Banks would cooperate in every waypossible in carrying out the provisions of Ex"


V LOANS 155

ecutivc Order 9112. In addition, the regulationincluded brief sections relating to rates of inter-est and fees on guaranteed loans, maturities,and reports by ihc Reserve Banks. That was all.

As revised effective September 11, 1944,"Rcgulation V was, if anything, even more gen-eral in its language. Provisions as to maturitiesof guaranteed loans were omitted as unneces-sary (there were never any limitations placedupon maturity, either by statute or Executiveorder); references to the Contract SettlementAct were included; and, in accordance with thatact, a new section with regard to the responsi-bility of the Reserve Banks and reimbursementfor expenses was added.

In the third and final revision of RegulationV, effective September 27, 1950,=1 referencesto the Defense Production Act replaced previ-ous references to the Contract Settlement Act,and, as noted in the preceding section of thischapter, the regulation prescribed briefly theprocedures to be followed in guaranteeing loans.Otherwise the regulation remained substantiallythe same.

The Board's role in prescribing uniform pro-cedures has already been discussed. Its func-tions in fixing fees and interest rates and in

prescribing forms used in connection with guar-anteed loans will be considered later.

None of the applicable statutes or Executiveorders contained any reference to the Board asa coordinating agency. Yet it was in that rolethat the Board probably played its most usefulpart in the program. All applications, approvals,and other communications between the guaran-teeing agencies and the Reserve Banks werechanneled through the Board. A separate Officeof War Loans—later called the Office of De-fense Loans—was set up within the Board'sorganization to handle V-loan matters, and thatoffice was continued until 1959. It was thuspossible for the Board to assist in the formula-tion of substantially uniform procedures andforms. In addition, during the wartime phase,all important questions of policy were con-sidered and resolved at frequent meetings in theBoard's offices by a joint policy committee com-posed of representatives of the guaranteeingagencies and the Board; and, when circum-stances required, representatives of the FederalReserve Banks attended such meetings. To aconsiderable degree, the success of the V-loanprogram was attributable to the uniformity ofpolicies that resulted from these meetings.'-1

THE GUARANTEE AGREEMENT

As a legal matter, the most important aspect°f the V-loan program was the form of guaran-tee agreement that constituted the contract be-tween the guaranteeing agencies and the lendingfinancing institutions.

On April 10, 1942, just 4 days after theBoard promulgated Regulation V, the WarDepartment approved a standard form of guar-antee agreement. About a month later, on May'4, 1942, this form was superseded by a formdesigned for uniform use by the Navy Depart-ment and Maritime Commission as well as thew a r Department. During the summer of 1942,Negotiations for a guaranteed revolving credit toGeneral Motors Corporation in the amount of

SI billion, with more than 200 large banksparticipating, gave rise to numerous questionsas to the effect of the guarantee agreement; theresult was the adoption in October 1942 ofcertain special conditions, some mandatory andsome optional. On April 6, 1943, the standardform was completely revised, incorporatingsome but not all of the special conditions."When the VT program was inaugurated inSeptember 1943, a special section was added tothe agreement. In June 1944, another standardamendment was adopted. After enactment ofthe Contract Settlement Act, a new form wasapproved in September 1944 for use in connec-tion with guarantees of war production loans



and a separate T-loan form was adopted forguarantees of termination loans. When the pro-gram was reactivated by the Defense ProductionAct of 1950, a somewhat simplified form ofguarantee agreement was put into effect, andthat form has since been amended in only twominor respects.20 Despite these many revisionsand amendments, the guarantee agreement hasremained essentially the same throughout theprogram.

The basic feature of the guarantee agreementis a commitment by the guaranteeing agency topurchase a specified percentage of the guaran-teed loan. Such a purchase will be made, within10 days after demand by the financing institu-tion, at any time prior to the date of settlementbetween the guarantor and the financing institu-tion. In the early forms, the guarantor reservedthe right at its option to purchase the entireamount of the guaranteed loan, but this right ofvoluntary purchase by the guarantor later waslimited to the guaranteed portion of the loan.

The earliest standard forms provided thatlosses on the guaranteed loan and expenses inconnection therewith would be shared ratablyby the guarantor and the financing institutionin accordance with their respective interests inthe loan. Since the guarantor obtained no inter-est in the loan unless it purchased a part of theloan, the agreement to share losses meant noth-ing unless there was a purchase. In October1942, however, the agreement was amended toprovide that regardless of whether there hadbeen any purchase by the guarantor, losses andexpenses would be shared by the guarantor andthe financing institution according to the guar-anteed and the unguaranteed percentages of theloan, respectively.

A large part of the guarantee agreement re-lates to details involved in the administration ofthe guaranteed loan. In general, the agreementmakes the financing institution responsible foradministering the loan, even after a purchase bythe guarantor. However, in the event of a pur-chase, the guarantor, through the Federal Re-serve Bank, may take over possession of theobligation and become the holder of the obliga-tion. The holder of the obligation, whether thefinancing institution or the guarantor, is re-quired to transmit to the other party its pro rata

share of all payments on the loan in accordancewith that party's interest in the loan at the time.

The agreement includes detailed and complexprovisions regarding the application of the pro-ceeds of collateral and other assets of the bor-rower to payment of the guaranteed loan. Suchprovisions, including "spreader" clauses, werethe subject of much discussion in connectionwith revisions of the guarantee agreement; butthe technicalities of such discussions would ex-tend far beyond the scope of this history.

Of major importance during the war werethose provisions of the guarantee agreementthat were designed to protect both the financinginstitution and the borrower against the adverseeffects of cancellation of the borrower's warproduction contracts. In a legal sense, theseprovisions became notorious for their com-plexity.

To protect the financing institution, the agree-ment provided for an automatic increase in thestated guaranteed percentage by the ratio thatthe dollar volume of cancelled contracts of theborrower bore to his total war production con-tracts. The dollar volume of contracts cancelledafter the execution of the agreement was desig-nated as "(a) ." The dollar volume of all warcontracts held by the borrower on the date ofthe agreement plus those entered into by himafter that date, less payments received on allsuch contracts, was designated as "(b)." Theratio of (a) to (b) was then added to theoriginally specified guaranteed percentage toobtain the adjusted guaranteed percentage.Thus, if the original percentage was 90 per centand half of the borrower's contracts were can-celled, the guaranteed percentage would be in-creased by 50 per cent of the unguaranteedpercentage and the adjusted guaranteed per-centage would be 95 per cent.

The protection afforded the borrower byanother section of the agreement was basedupon the same ratio of cancelled contracts tototal contracts, but it took a different form. Theborrower was entitled, upon request, to a sus-pension of maturity and waiver of interest asto that portion of the unpaid amount of theguaranteed loan that bore the same ratio to thetotal amount of the loan as the ratio of (a) t 0

(b). At the same time, the financing institution


V LOANS 157

was protected by a provision relieving it of itsobligation to pay any guarantee fee to theguarantor for any portion of the loan on whichmaturity was suspended and interest waswaived. In addition, the guarantor was requiredto pay the financing institution interest on thesuspended portion of the loan.

When the T-Ioan and the 1944 V-loan formswere adopted after passage of the Contract

Settlement Act, all provisions regarding adjust-ment of the guaranteed percentage and suspen-sion of maturity and waiver of interest uponcancellation of the borrower's contracts wereomitted, and, as a result, the form of guaranteeagreement was substantially simplified. No suchprovisions were included in the form adoptedfor use under the Defense Production Act of1950.

FEES AND RATES

Neither the President's Executive Order 9112of March 26, 1942, nor the Contract SettlementAct of 1944 contained any provisions withregard to the rates of interest on guaranteedloans or the guarantee fees to be paid by financ-ing institutions. However, the Board's Regula-tion V, as first issued in April 1942, specificallyprovided that rates of interest, fees, and othercharges on guaranteed loans would be pre-scribed by the Board of Governors "cither spe-cifically or by maximum limits or otherwise* * * after consultation with the War Depart-ment, Navy Department or Maritime Commis-sion, and with the Federal Reserve Banks."Basically, this became the manner in which allrates and fees were fixed throughout the V-loanprogram, although under the Contract Settle-ment Act they were prescribed by the Boardwith the concurrence of the Director of Con-tract Settlement instead of after consultationwith the guaranteeing agencies. The DefenseProduction Act of 1950 conferred upon thePresident authority to prescribe V-loan ratesand fees "either specifically or by maximumlimits or otherwise"; and this authority wasdelegated by the President to the Board, to beexercised after consultation with the heads of'he guaranteeing agencies.

The first schedule of rates and fees was pre-scribed by the Board on April 9, 1942. It lim-ited the interest rate on guaranteed loans to amaximum of 5 per cent and provided for pay-ment of a guarantee fee by the financing institu-tion on a graduated scale depending upon the

percentage of guarantee. If the guaranteed per-centage was between 91 and 100 per cent, thefinancing institution paid a fee equal to 30 to 40per cent of the loan rate; if the guaranteed per-centage was between 75 and 90 per cent, thefee was 20 to 25 per cent of the loan rate; andif the guaranteed percentage was less than 75per cent, the fee ranged from 10 to 20 per centof the loan rate.

The flexibility of the original schedule ofguarantee fees led to some bargaining andtended to tempt financing institutions to ask forthe highest percentage of guarantee with thelowest applicable fee. As a consequence, theschedule was revised in December 19422r toprovide fixed guarantee fees in all cases, de-pending upon the guaranteed percentage, exceptthat flexibility was retained for cases in whichthe guaranteed percentage was 90 per cent ormore.

In May 1943 the Board set a maximum ofone-fourth of 1 per cent for any commitmentfee that might be charged a borrower by afinancing institution. When the VT phase of theprogram was inaugurated in September 1943,the maximum commitment fee was increasedto one-half of 1 per cent; but it was providedthat any such fee should be shared with theguarantor on the same basis as interest wasrequired to be shared under the schedule ofguarantee fees.

After enactment of the Contract SettlementAct, the Board on September 11,1944, reducedthe maximum interest rate to AV2 per cent and



prescribed a simpler schedule of guaranteefees.28 At the same time, the maximum commit-ment fee was fixed at one-fourth of 1 per cent,or a flat fee of not more than S50, but withoutany requirement for sharing of the fee with theguarantor.

When the V-loan program was revived by theDefense Production Act, the Board prescribed a5 per cent maximum interest rate, a one-halfof 1 per cent maximum commitment fee (to beshared with the guarantor), and a revisedschedule of guarantee fees.29 This schedule ofrates and fees remained unchanged until May15, 1957, when the Board increased the maxi-mum interest rate to 6 per cent.

Effective September 27, 1966, the Boardincreased the maximum interest rate to IVz

per cent, without making any changes in theschedule of guarantee fees or in the commit-ment fee. It was provided, however, that in anycase in which the rate of interest on the loanwould be in excess of 6 per cent, the guaranteefee should be computed as though the interestrate were 6 per cent.10 In 1970, although themaximum interest rate of 7'/i per cent was notchanged, the Board provided that a higher ratemight be charged on a particular guaranteedloan if the guaranteeing agency should deter-mine the loan to be necessary for the purpose offinancing a person in connection with the per-formance of contracts deemed by the agency tobe necessary to expedite production and de-liveries or services for the procurement of ma-terials or the performance of services for thenational defense.;l

RELATED LEGAL PROBLEMS

ELIGIBILITY OF V-LOAN PAPERFOR DISCOUNT

The V-loan program gave rise to legal ques-tions involving an interpretation of the discountprovisions of the Federal Reserve Act. Notesgiven by borrowers under V loans, particularlyunder revolving credit arrangements, ordinarilywere not negotiable; however, the Board'sRegulation A required that all paper discountedby the Reserve Banks be negotiable. This prob-lem was met by an amendment to Regulation Aeffective September 21, 1942, that made thenegotiability requirement inapplicable to notessubject to a guarantee by the War or NavyDepartments or the Maritime Commission pur-suant to Executive Order 9112.32 This exceptionwas later extended to cover paper guaranteedunder T-loan guarantees pursuant to the Con-tract Settlement Act."1 After the end of the war,the exception for V-loan paper was eliminatedfrom Regulation A;'11 but it was restored onMarch 21, 1951, to remove any doubt as to theeligibility for discount of paper acquired bymember banks in connection with V loans

under the Defense Production Act.1' In April1970 this exception was removed from theregulation as being unnecessary when the Boardeliminated the regulatory requirement concern-ing negotiability of paper offered for discount oras collateral for advances.

A further question arose from the fact that aV-loan note usually incorporated by referencethe provisions of the guarantee agreement relat-ing to suspension of maturity in the event ofcancellation of one-fourth or more of the bor-rower's war contracts. Did this fact make thenote ineligible for discount on the grounds thatit had a maturity of more than 90 days? TheBoard ruled that it did not, since the note re-mained payable at its stated maturity unlessone-fourth of the borrower's contracts werecancelled, a contingency that might neveroccur. However, any notes offered for discountafter the happening of that contingency wereheld to be ineligible for discount.1"

Under a revolving credit arrangement, thefinancing institution could be required, upon thematurity of a 90-day note, to lend the sameamount for another 90 days, and the proceeds


V LOANS 159

of the second note could be used to pay off thefirst. Again, question was raised whether a re-volving credit arrangement under which loanscould be made up to a specified maximumamount over a period of months or years wouldviolate the 90-day maturity requirement of sec-tion 13 of the Federal Reserve Act. The Boardruled that since the Reserve Bank was under nocommitment to renew such notes at maturity,notes issued under a revolving credit were notrendered ineligible for discount."

LENDING LIMITS OFNATIONAL BANKS

Early in the V-loan program, question aroseas to the extent to which national banks couldlegally participate in the making of V loansbecause of statutory limitations on the amountthat such a bank could lend to any one bor-rower. Because of the great volume of war pro-duction contracts that a war contractor usuallyheld, it was necessary in many cases for him toseek credit in equally large amounts; and, undersection 5200 of the Revised Statutes, the mosta national bank could lend him was an amountequal to 10 per cent of the bank's capital andsurplus. Sometimes this proved to be an obstacleto the necessary financing.

On April 9, 1942, the Comptroller of theCurrency ruled that if the portion of a V loanin excess of 10 per cent of a national bank'scapital and surplus was subject to a commit-ment to purchase within 10 days after demandby the War or Navy Department or the Mari-time Commission, the loan would not violatesection 5200.-1S It was made clear, however,that any part of the loan not subject to such acommitment must be within the statutory limi-tation.

% the Act of June 11, 1942," a new para-graph (10) was added to section 5200. It pro-vided that the amount limitations should notaPply to the extent that loans were secured orcovered "by guaranties, commitments or agree-ments to take over or purchase, made by anyfederal Reserve bank or by the United Statesor any department, bureau, board, commission,or establishment of the United States." Thisexception, however, was subject to one condi-tion: The guaranties, agreements, or commit-

ments were required to be unconditional andto be performed by payment of cash or itsequivalent within 60 days after demand.

The Comptroller of the Currency was au-thorized to define the terms used in the statute.On June 18, 1942, the Comptroller issued adefinition of the term "unconditional."10 Ineffect, the definition stated that in order to meetthis requirement, the protection afforded to abank by a guarantee must not be substantiallyless than it would be in the absence of anyprovisions that might be regarded as conditions.This made it necessary to determine, with re-spect to every revision or amendment of thestandard form of guarantee agreement, whetherit complied with exception (10) to section 5200and the Comptroller's definition of uncondi-tional. Thus, on successive occasions, favorablerulings as to unconditionality were obtainedfrom the Comptroller with respect to the stan-dard form of May 14, 1942,41 the special con-ditions added to the guarantee agreement inOctober 1942, the revised standard form ofApril 6, 1943,1- the so-called VT amendmentsof September 1943, and the 1944 V-loan andT-loan forms of agreement adopted in Septem-ber 1944." Similarly, the revised standard formof September 27, 1950, adopted for use underthe Defense Production Act, was held by theComptroller to comply with exception (10) tosection 5200, Revised Statutes,-14 as were alsocertain minor amendments later made to thatform.

ASSIGNMENT OF CLAIMS UNDERGOVERNMENT CONTRACTS

In general, the principal security taken byfinancing institutions as security for V loanswas an assignment of the borrower's claimsunder his war or defense production contractswith the Government. This circumstance gaverise to important and sometimes serious legalproblems. Thus, questions arose concerning thepriority of the claims of an assignee bank asagainst those of a trustee in bankruptcy in thecase of an insolvent borrower and as againstthose of a surety company on a contractor'sperformance bond in the event of default bythe contractor; these questions were the subjectof various court decisions that caused consider-



able concern to banks participating in the V-loan program. However, it was the status of anassignee bank's claims against the borrower asopposed to those of the Government itself thatgave rise to the greatest difficulty. This was aproblem that did not develop until after thereactivation of the V-loan program under theDefense Production Act; and, since the Boardof Governors played some part in its final reso-lution, a brief discussion of that problem seemsjustified here.

For many years before 1940, an old statute(Rev. Stat., sec. 3477) had prohibited theassignment of any claims against the Govern-ment. As early as 1938, the Federal AdvisoryCouncil had recommended that the Board seekan amendment to this statute to permit theassignment of claims where legitimate credithas been extended, and the Council renewedthis recommendation in the spring of 1940. InJune of that year, Chairman Eccles of the Boardurged Congress to liberalize the statute as ameans of facilitating the Government's defenseprogram.1" Meanwhile, the National DefenseAdvisory Council (with offices in the Board'sbuilding) was endeavoring to promote thefinancing of emergency plant facilities contractswith the Government by making such contracts"bankable." Working in cooperation, the De-fense Council and the Board drafted an amend-ment to the law that was enacted on October 9,1940, and designated as the Assignment ofClaims Act of 1940.'" In brief, this act expresslypermitted the assignment to a bank or otherfinancing institution of moneys due or to be-come due from the United States under con-tracts providing for payments aggregating$1,000 or more.

This act was a fortunate, ready-made aid inthe private financing of Government contractorswhen the outbreak of war in 1941 convertedthe defense program to a war production pro-gram. It was because of this act that, during thewartime period of the V-loan program, bankswere able to accept assignments of contractclaims as security for V loans.

After the war, however, certain opinionsrendered by the Comptroller General raised

questions as to the protection afforded lendingbanks by the Assignment of Claims Act. Thestatute provided that contracts entered into bythe War and Navy Departments might include"no set-off" provisions under which paymentsto an assignee would not be subject to reductionor set-off for any indebtedness of the assignor(the borrower-contractor) to the United States"arising independently of such contract." In1949, the Comptroller General held that whena contract contained a price-revision clause, anyamounts in excess of the revised contract pricecould be withheld from payments to an as-signee or. even more alarming, could be recov-ered directly from the assignee if already paid.17

Again, in 1950. the Comptroller General ruledthat claims by the Government against a con-tractor for unpaid social security contributionsand withheld income taxes were claims that didnot arise independently of the assigned contractsand were therefore not subject to the no-set-offclause."

These and similar rulings operated to deterbanks from making loans to defense contractorson the security of assignments of contractclaims, and the revived V-loan program wasseriously retarded as a result. In an effort tomeet this problem, the form of guarantee agree-ment was amended in 1950 to define the term"loss on the loan" to include any amountsreceived by a financing institution and appliedto the loan that might later be recovered fromthe financing institution by the United States."However, this amendment did little to allaythose fears of financing institutions that hadbeen engendered by the rulings of the Comp-troller General.

On February 13, 1951, the Board recom-mended to the Senate Banking and CurrencyCommittee an amendment to the Assignmentof Claims Act that was designed to remove thisimpediment to the V-loan program."" Thisamendment, with some modifications, was en-acted on May 15, 1951." In brief, its principaleffect was to make it clear that when the no-set-off clause was included in a Governmentcontract, an assignee financing institution wasprotected against set-off of any claims by the


V LOANS 161

Government against the assignor on account of limited to the War and Navy Departments, wasrenegotiation, fines, penalties, or taxes or social extended to the Department of Defense, thesecurity contributions, whether or not such General Services Administration, the Atomicclaims arose from, or independently of, the Energy Commission, and such other depart-assigncd contract. In addition, authority for ments or agencies as the President might desig-inclusion of the no-sct-off clause, previously nate.


Interdistrict Rediscounts

LEGISLATIVE PURPOSESo far in this study consideration has been

given to extensions of credit by the FederalReserve Banks to their own member banks, toFederal intermediate credit banks, to nonmem-ber banks, to individuals and corporations, tobusiness enterprises, and, as agents for theGovernment, to defense production contractors.There remains to be considered a final recipientof Federal Reserve credit—the Federal ReserveBanks themselves.

Section l l (b ) of the original Federal Re-serve Act authorized and empowered the Fed-eral Reserve Board:

To permit, or, on the affirmative vote of atleast five members of the Reserve Board torequire Federal reserve banks to rediscountthe discounted paper of other Federal reservebanks at rates to be fixed by the FederalReserve Board.

This provision has never been amended; it is•n the law today, although its presence is allbut forgotten.

The most noteworthy feature of the provisionls that it contemplates compulsory rediscounts

NOTES AND REFERENCES, see p. 264.

between Federal Reserve Banks if ordered bythe Board, a feature completely at variance withthe otherwise discretionary character of thediscounting authority of the Reserve Banks.This element of compulsion was the cause ofconsiderable controversy during the debates onthe original Federal Reserve Act.

As included in the Glass bill, the provisionwas phrased so as to be operative only in timeof emergency. The House Banking and Cur-rency Committee felt that the authority of theBoard to compel rediscounts between ReserveBanks should be subject to such restrictions aswould "unquestionably make its use sporadicand exceptional"; and Chairman Glass sug-gested that the power would "rarely, if ever" beexercised by the Board.1

The House committee compared this author-ity to compel interdistrict rediscounts to that bywhich the head office of a central bank withbranches is enabled to "employ the resourcesof one portion of the country for the advantageof other portions or for the purpose of safe-guarding them at critical times if its managersdeem such actions to be wisest." •

In further explanation of the provision'spurpose, Mr. Phelan stated: '

163



* * * Herein is provided a means where-by funds in one part of the country for whichthere is no demand may be applied to thatpart of our country which is in need. A Fed-eral reserve bank in the Southwest, for ex-ample, has a demand for the rediscounting ofpaper beyond its power to supply. At thesame time a reserve bank in the East mayhave funds for which there is no immediatedemand. Under such conditions the Federalreserve bank in the East may rediscount paperfor the reserve bank in the Southwest.* * *

The compulsory feature of the provision metwith some opposition in the House.' It was inthe Senate, however, that this feature was moststrongly opposed.

Senator Owen's bill contained no limitationson discounts by one Federal Reserve Bank foranother. It provided only that rates on suchinterdistrict rediscounts should be fixed eachweek by the Board. Senator Hitchcock's versionof the bill, however, limited the use of theauthority to times of emergency; required una-nimity of action by the Board; and provided fora special rediscount rate of not more than 3per cent above the discount rate of the accom-modated Federal Reserve Bank.

Senator Burton, the chief antagonist of thecompulsory rediscount provision, regarded it as"a frank admission of the fatal defects of theregional system" and believed that it would"accentuate the rivalry between sections for theaccumulation of reserves" and cause "unlimitedirritation and friction." 5 Worst of all, he arguedthat under this provision no Federal ReserveBank "could make calculations for the care ofits customers or the utilization of its resources,because any day it might be called upon totransfer its funds elsewhere." In addition, hecontended that the provision might seriouslyhandicap the bank that would have to "takecare of foreign exchanges" if a time shouldcome when gold exports might make it neces-sary for that bank to buy foreign bills in orderto check the outflow of gold. Finally, he visual-ized the adverse psychological effect if it shouldbecome known that one Federal Reserve Bankhad been compelled to borrow from anotherReserve Bank under this "obnoxious provi-sion." 6

Near the close of the debates in the Senate,Senator Newlands offered an amendment thatwould have added to the provision in question,as modified in the Owen substitute bill, anotherprovision authorizing the Board to require fromthe Federal Reserve Banks up to one-third oftheir member banks' reserves for the purpose ofenabling the Board to make advances to anyFederal Reserve Bank.7 The argument wasmade that in an emergency the Board shouldnot be called upon to exercise the indirectmethod of requiring one Reserve Bank torediscount paper for another, but should "havethe power itself to put these funds directly intothe reserve bank which requires aid."

Senator Burton's objections were overruledand Senator Newlands' amendment was de-feated. As finally adopted, the Board's authorityto permit or require rediscounts between Fed-eral Reserve Banks was made subject to nolimitations or qualifications, except that com-pulsory rediscounts were authorized only onthe affirmative vote of at least five members ofthe Board and except that the rates of interestwere required to be fixed by the Board.

USE OF THE AUTHORITYSenator Burton's fears proved to be without

foundation. In practice such rediscounts aswere made between the Reserve Banks wereaccomplished almost entirely on a voluntarybasis. Actually, the published record indicatesthat, except for one occasion in 1933, inter-district rediscounts were confined to the periodbetween December 1917 and late 1921.

In 1915, when it appeared that the marketingof the cotton crop might present problems offinancing and that the southern Reserve Banksmight need to seek accommodations from theother Reserve Banks, the Board contemplatedthat interdistrict rediscounting might becomenecessary. In its Annual Report for that year,the Board said: s

The Board * * * in the exercise of thepowers conferred upon it by the Federal Re-serve Act, was fully prepared to set in opera-tion, if it should become necessary, at ratesto be fixed by it, the machinery of interbankrediscounting, in order to make available forFederal Reserve Banks requiring larger re-


INTERDISTRICT REDISCOUNTS 165

sources the available funds of other reservebanks, the collective strength of the reservesystem as a whole being far in excess of anydemands that might reasonably be expectedto be brought to bear upon it at that time.

In preparation for this eventuality, the Boardon March 10, 1915, fixed rates to be chargedfor interbank rediscounts, setting them some-what lower than the regular discount rates thenprevailing.1'

Nevertheless, the first interbank rediscount-ing did not occur until December 1917. In1918 rediscount transactions between the Re-serve Banks, including voluntary purchases ofbankers' acceptances, aggregated over $660million. All such transactions were negotiatedthrough the medium of the Federal ReserveBoard, but without resort to compulsion by theBoard.1"

In 1919 interbank rediscounts and purchasestotaled $2,658 million, again on a voluntarybasis. In its Annual Report for that year, theBoard stated: n

There has * * • been such a spontaneousspirit of cooperation between the Federal Re-serve Banks that all transactions suggested bythe Federal Reserve Board have been madevoluntarily, and in no case has the Boardfound it necessary to exercise its statutoryauthority to require such operations.

On such a basis of spontaneous cooperation,interdistrict rediscounts were made in consider-able volume throughout 1920 and 1921, taper-ing off toward the end of 1921. At one time oranother all of the Federal Reserve Banks wereboth borrowers and lenders, depending upon"ie credit needs of member banks in differentdistricts and the resulting reserve ratios of theReserve Banks. The relationship between inter-district rediscounts and reserve ratios was de-scribed in the Board's 1921 Annual Report toCongress (page 4 2 ) :

Reserve ratios of Federal Reserve Banks,considered separately, arc closely related tothe rediscount transactions between FederalReserve Banks. A Federal Reserve Bank willseek rediscount accommodations from otherreserve banks at times when its own reserve•s insufficient, without declining to a pointbelow the legal minimum, to supply the credit

demands of its member banks. Reserve ratioson the basis of reserves actually owned by abank are known as "actual" reserve ratios,while reserve ratios on the basis of reservesbefore interbank borrowing or lending arereferred to as "adjusted" ratios. It is theadjusted ratio, therefore, that is an index ofthe reserve position of a Federal ReserveBank from the standpoint of its ability tomake rediscounts for other reserve banks orits need to apply for accommodation to otherreserve banks.

Fluctuations in the reserve positions of thevarious Reserve Banks, leading to interdistrictborrowings, resulted from special causes. Thus,during 1920 and 1921, the Richmond, Atlanta,St. Louis, and Dallas Districts felt the effect ofa decline in the price of cotton; the Chicago,Minneapolis, and Kansas City Districts experi-enced a decline in the price of grains, wool, andother agricultural products. Consequently, itwas the Federal Reserve Banks of these dis-tricts, under the pressure of the credit needs oftheir member banks, that were the principalborrowers from other Reserve Banks. Con-versely, the New York Reserve Bank's reserveratio increased during the latter part of 1921as a result of a large inflow of gold from abroadand a marked liquidation of advances to its ownmember banks, and thus that Reserve Bankbecame a lending rather than a borrowingbank.12 At other times, as during 1918, aconstant flow of Government funds from NewYork to the interior of the country made itnecessary for member banks in the New YorkDistrict to borrow from the Reserve Bank inorder to replenish their reserves, and the NewYork Reserve Bank had to borrow from otherFederal Reserve Banks.

Since 1921, there have been no interdistrictrediscounts, with the exception of a singleinstance in March 1933. At that time the bank-ing crisis caused an unusual flow of bank re-serves away from New York and the reserveposition of the Federal Reserve Bank of NewYork sank so low as to necessitate borrowingfrom other Reserve Banks in the amount of$210 million." This was the last occasion whensection 11 (b) of the Federal Reserve Act hadany actual significance. Through allocations ofsecurities in the System Open Market Account,



it has been possible to maintain a constantequalization of the reserve ratios of all FederalReserve Banks so that resort to interdistrict re-discounting has been unnecessary.

As a strictly legal matter, it would no longerbe necessary for any Federal Reserve Bank toborrow from another Reserve Bank in order tomaintain its reserve ratio. In 1965 provisionsof section 16 of the Federal Reserve Act re-

quiring Reserve Banks to maintain reservesagainst deposits were repealed, and in 1968reserve requirements for Federal Reserve notesas prescribed in that section were also re-pealed. It is still conceivable, however, thatoccasions may arise when, for one reason oranother, an interdistrict rediscount under sec-tion l l ( b ) of the Act might be consideredappropriate or desirable.


Discount Rates

STATUTORY PROVISIONS

In preceding chapters references have beenmade to the discount or interest rate charged onvarious types of Federal Reserve credit—a"discount" rate when the credit takes the formof a discount of paper representing loans madeby a member bank, or an "interest" rate whenthe loan is in the form of a direct advance to amember bank on its own note. The presentchapter deals with the legal history of suchdiscount and interest rates, generally referredto without distinction as discount rates. Sinceits authority to fix Federal Reserve discountrates has always been regarded as one of theSystem's major instruments of credit policy, it>s particularly necessary to emphasize again that"us history is concerned principally with the•egal aspects of the subject rather than itseconomic aspects.

The basic provision of the law with respectt 0 d'scount rates is to be found in section 14of the Federal Reserve Act. That section pur-Ports to set forth specific powers of the FederalReserve Banks, although the section is entitled

F°r NOTES AND REFERENCES, see pp. 264-65.

"Open-Market Operations." Among otherthings, the section presently provides that:1

Every Federal reserve bank shall havepower:

e * * * #

(d) To establish from time to time, subjectto review and determination of the Board ofGovernors of the Federal Reserve System,rates of discount to be charged by the Federalreserve bank for each class of paper, whichshall be fixed with a view of accommodatingcommerce and business; but each such bankshall establish such rates every fourteen days,or oftener if deemed necessary by the Board;

Except for the last clause, this provision isidentical with the provision as it appeared inthe original Federal Reserve Act. The provisionwas amended in 1920 to authorize progressivediscount rates, but that authority was repealedin 1923.

As discussed in the preceding chapter, section11 (b) of the original Act authorized the Fed-eral Reserve Board to permit or require theReserve Banks to rediscount the discounted

167



paper of other Reserve Banks. Under this pro-vision, which has never been changed, the rateof interest on such rediscounts is required to befixed by the Board.

Since 1913, various amendments to the Actauthorizing advances to or discounts for mem-ber banks and others have included provisionsrelating to the fixing of rates.

When section 13 of the Act was amended in1916 to authorize the Federal Reserve Banksto make advances to member banks on theircollateraled notes (as distinguished from dis-counts of eligible paper), it was provided thatsuch advances should be made "at rates to beestablished by such Federal reserve banks,subject to the review and determination of theFederal Reserve Board"; and this provision hasnot been substantially changed.2

In 1932 when sections 10(a) and 10(b)—authorizing emergency advances to groups ofmember banks and to individual member banks—were added to the law, it was provided thatthe rates on such advances should be not lessthan 1 per cent above the discount rate of theReserve Bank at the time of any such advance.Since that time, section 10(b) has been changedto lower the premium rate to one-half of 1per cent for advances under that section.3

When the Reserve Banks were authorized in1932 to discount paper for individuals, partner-ships, and corporations in unusual and exigentcircumstances, it was required that such dis-counts be made at rates established in accord-ance with the provisions of section 14(d) ofthe Federal Reserve Act,1 the basic discountrate provision quoted on page 167.

In 1933, when Congress added at the end ofsection 13 of the Act a paragraph authorizingadvances to individuals, partnerships, and cor-

porations on the security of direct obligationsof the United States, such advances were re-quired to bear interest "at rates fixed from timeto time by the Federal reserve bank, subject toreview and determination by the Board ofGovernors of the Federal Reserve System";5

this language paralleled that of section 14(d).The authority granted by section 13b of the

Act in 1934 for working capital loans to busi-ness enterprises contained no provision withrespect to interest rates; but, as will be noted,various rates were established by the ReserveBanks while that authority was in effect.

For the sake of completeness, two provisionsof law relating to discount rates should be men-tioned here although they arc no longer ineffect. Section 11 (c) of the original FederalReserve Act required the Board to fix a gradu-ated "tax" to be paid by the Reserve Banks ondeficiencies in gold reserves required to be heldby them against outstanding Federal Reservenotes and provided further that any ReserveBank having any such deficiency should "addan amount equal to said tax to the rates ofinterest and discount fixed by the Federal Re-serve Board." In 1933 Congress authorized theReserve Banks in certain circumstances to pur-chase obligations of the United States and pro-vided that operations under that authorityshould not require the imposition of the gradu-ated tax on reserve deficiencies or the automaticincrease in discount rales otherwise specified insection l l ( c ) of the Federal Reserve Act."In 1968 the provisions of section 16 of the Actrequiring the maintenance of reserves againstFederal Reserve notes were repealed and, asconforming amendments, the provisions of sec-tion l l ( c ) and of the 1933 legislation justmentioned were also repealed.7

OBJECTIVES OF DISCOUNT RATES

UNIFORMITY OF RATES

It is a cardinal principle of private business,established by centuries of custom, that one

who lends money is entitled to receive inter**as compensation for the borrower's use oflender's funds. Interest on loans is one of tnmajor sources of income of commercial ban


DISCOUNT RATES 169

The Federal Reserve Banks, however, asexplained in the first chapter of this study, areoperated for public purposes and not for profit.While the law makes provision for the paymentof interest on loans made by the Reserve Banks,its primary purpose is not to enable them torealize a profit from their lending activities.Although it was not so clearly defined at theoutset as it was in later years, the philosophyof the original Federal Reserve Act was thatFederal Reserve discount rates would serve asa means of stabilizing commercial interest ratesand as a safeguard against inflation.

In 1913 uniformity in discount rates through-out the country was regarded as eminentlydesirable. The National Monetary Commissionhad looked forward to "absolute uniformity"of discount rates.15 The House Banking and Cur-rency Committee regarded the "establishmentof a more nearly uniform rate of discountthroughout the United States" as one of the"essential features of reform."a The Senatecommittee's report declared that the fixing ofrates of discount "would have a steadying effectupon the interest rate throughout the UnitedStates, and will enable the banks of the countryto extend accommodation at a comparativelystable rate of interest upon a lower basis thanheretofore, because the element of hazard ofpanic and of financial stringency will be re-moved by the proposed system." 10

In its first Annual Report to Congress afterthe enactment of the statute, the Federal Re-serve Board declared that "the adoption of afairly uniform and consistent policy to be pur-sued by all the [Federal Reserve] banks wouldgo far to insure the smooth working of thesystem."» Initial discount rates were fairlyuniform. Thus, the rate on 60- to 90-day paperwas 6 per cent at seven Reserve Banks and 6ViPer cent at five Reserve Banks."

! i its Annual Report for 1915, the Boardobserved: "

* * * Beginning at the opening of thesystem with a comparatively high rate forordinary commercial paper and with more orless variation between the different districts,the reserve banks have during the yearsteadily reduced the general level of discountrates and have worked rapidly and effectively

toward uniformity for the entire country. Itmay not be practicable to maintain uniformrates throughout the twelve districts, butthey should unquestionably bear a consistentrelation one to another, while a very muchgreater adherence to uniformity than beforethe enactment of the Federal Reserve Act willundoubtedly be secured.

Uniformity in rates was generally maintainedin the early years of the System, and at the endof 1923 the rate at all Reserve Banks on allclasses of paper was Wz per cent." Althoughvariations in rates developed in subsequentyears, in recent times uniformity has againbecome the rule as the result of acceptance ofthe fact that discount rates reflect not so muchregional credit conditions as national creditpolicy.

ACCOMMODATION OFCOMMERCE AND BUSINESS

Uniformity in rates, however, was not thestated objective of the Federal Reserve Act.The original Glass bill provided that ratesshould be fixed with a view to accommodatingthe commerce of the country. In the Senate, theOwen bill referred to the accommodation ofcommerce and business, and the Hitchcock billreferred in addition to the objective of promot-ing stability in business. The final version ofthe Act followed the Owen bill, and accommo-dating commerce and business has ever sinceremained the statutory purpose of discountrates.

That purpose, indeed, has been carried overto other provisions of the statute and has be-come one of the few objectives expressly setforth in the Federal Reserve Act. In 1923, whenthe nonstatutory Federal Open Market Invest-ment Committee was created by the Board,the Board laid down the principle that "thetime, manner, character, and volume of open-market investments purchased by the Federalreserve banks be governed with primary regardto the accommodation of commerce and busi-ness and to the effect of such purchases or saleson the general credit situation." 1= When theFederal Open Market Committee was made astatutory body in 1933, essentially the same



language was used in prescribing the objectivesof open market operations.10

IMPLEMENTATION OFCREDIT POLICIES

Federal Reserve discount rates were the earli-est means by which the System sought to influ-ence general credit conditions. Along withreserve requirements and open market opera-tions, discount rates still constitute one of thethree major tools available to the System forimplementing credit and monetary policies.Indeed, changes in discount rates have gen-erally been regarded as the most dramaticsignal of shifts in System policy, and they have

had more significance in this respect since therevival of emphasis on the discounting functionsof the Federal Reserve Banks that followed theso-called Treasury-Federal Reserve accord in1951.1T

It may be noted, however, that in 1968a System committee appointed to reappraise theFederal Reserve discount mechanism recom-mended, among other things, that the discountrate should be changed more frequently inorder to maintain it at a level "reasonably closeto rates on alternative instruments of reserveadjustment." " If this recommendation shouldbe put into practice, it is likely that changes inthe discount rate would tend to lose a large partof their announcement effect.

LEGAL BASIS AND DISCRETIONARY NATURE

In a published opinion dated May 1, 1915,the Board's General Counsel, on the basis ofSupreme Court decisions relating to nationalbanks, expressed the view that Congress maydelegate to the Federal Reserve Banks and theFederal Reserve Board the power to fix dis-count rates without regard to State usury laws.10

The constitutional validity of the statutoryauthority for fixing Federal Reserve discountrates appears to be beyond question. It wasfirmly established in 1929 by the decision ofthe Circuit Court of Appeals for the SecondCircuit in the case of Raichle v. Federal ReserveBank of New York.20 In that case the NewYork Bank was charged with wrongfully spread-ing propaganda concerning an alleged moneyshortage, restricting the supply of credit throughopen market operations, arbitrarily and unrea-sonably raising discount rates, and denyingrediscounts to certain member banks pendingliquidation of collateral loans. The suit wasdismissed for failure to join the Federal ReserveBoard as an indispensable party. On the merits,however, the court upheld the Reserve Bank onall grounds. With particular reference to dis-count rates, the court said, "It is not contendedthat the provision for fixing rates of discount is

unconstitutional, nor would it seem even rea-sonable to argue that it is, * * *."

The court also held that discount rates fixedby the Reserve Bank, subject to review anddetermination of the Board, were within thediscretion of those agencies and not subject tojudicial review. The court stated: 2I

* * * It would be an unthinkable burdenupon any banking system if its open-marketsales and discount rates were to be subject tojudicial review. Indeed, the correction ofdiscount rates by judicial decree seems almostgrotesque when we remember that conditionsin the money market often change from hourto hour and the disease would ordinarily beover long before a judicial diagnosis couldbe made.

« * * » *We can sec no basis for the contention that

it is a tort for a Federal reserve bank * *to fix discount rates which arc unreasonablyhigh, or to refuse to discount eligible pap**.even though its policy may be mistaken anits judgment bad. The remedy sought woumake the courts, rather than the Federal Kjserve Board, the supervisors of the F e

reserve system and would involve aworse than the malady. The bank, under tn


DISCOUNT RATES 171

supervision of the board, must determinewhether there is danger of financial strin-gency and whether the credit available for"commerce and business" is sufficient or in-sufficient. If it proceeds in good faith through

open-market operations and control of dis-count rates to bring about a reduction ofbrokers' loans, it commits no legal wrong. Areduction of brokers' loans may best accom-modate "commerce and business."

DISTRIBUTION OF AUTHORITY

In authorizing the establishment of discountrates by the Federal Reserve Banks, subject toreview and determination of the Board, section14(d) of the original Federal Reserve Actclearly reflected the intent of Congress that theSystem should be a regional and decentralizedsystem, but at the same time a system operatingunder the general supervision of a single gov-ernmental agency with power to determinequestions of national policy. Nearly 40 yearslater, this basic concept was expressed by Chair-man Martin of the Board when, in 1952, hestated in answer to a questionnaire by the JointCommittee on the Economic Report that: -

4 4 * The law clearly contemplates thatthe establishment of discount rates shall in-volve joint action by the Federal ReserveBanks and the Board of Governors of theFederal Reserve System.* * '

In the same statement, Chairman Martin as-serted the statutory authority of the Board tomake the ultimate determination of discountrates. This position is supported by the legisla-tive history of the statute, as well as by anopinion of the Attorney General of the UnitedStates.

When the House Banking and CurrencyCommittee reported the original Federal Re-serve bill on September 9, 1913, it stated: ='

* * * The power granted in subsection(d) to fix a rate of discount is an obviousincident to the existence of reserve banks,but the power has been vested in the Fed-eral reserve board to review this rate ofdiscount when fixed by the local reservebank at its discretion. This is intended toprovide against the possibility that the local

bank might be establishing a dangerouslylow rate of interest, which the reserve board,familiar as it would be with credit conditionsthroughout the country, would deem best toraise.

In the Senate, Senator Owen declared that"the final determination of the rate is put in thehands of the Federal Reserve board,"21 andthat "the bank rate may be fixed by the Govern-ment board."so Senator Shafroth pointed outthat the Board was "vested with the power toraise or lower the rate of discount." -" In answerto arguments that the rate should be made uni-form by statute, Mr. Phelan urged that theremight be reasons for variations in the rate indifferent sections of the country, but that underthe Glass bill the Board could make the rateuniform "if ever necessary or desirable." : :

The language of the law as finally enactedcontained evidence of the intent of Congressthat final determination of rates should bevested in the Board. Section l l ( c ) included aprovision, since repealed, to the effect thatwhenever a Reserve Bank had to pay a gradu-ated tax on its deficient reserves against FederalReserve notes, it must add an amount equal tosuch tax to the rate of interest and discount"fixed by the Board of Governors of the FederalReserve System."

Clearly, the Board itself assumed that underthe original Act it possessed the final power todetermine rates. In its first Annual Report toCongress, in discussing discount rates, theBoard stated that it was satisfied that "at thestart and until the banks could get a firm footingit [the Board] should act with prudence andconservatism* * *."=N

In 1916 the legal authority of the Board to



overrule a Federal Reserve Bank and to deter-mine a discount rate was put to the test. Oneof the Reserve Banks had voted to increase itsrates. The Board, however, withheld its ap-proval because the Treasury Department feltthat such an increase would adversely affect itsprogram for marketing Liberty Bonds andVictory Notes. When the Treasury's financingprogram was completed, the proposed increasein rates was approved by the Board.20 In themeantime, the Board's General Counsel hadexpressed the view that the Board had legalauthority to fix rates different from those estab-lished by a Federal Reserve Bank. However,the then-Secretary of the Treasury, CarterGlass, requested the Attorney General of theUnited States for his opinion on the question.In making the request, Mr. Glass himselfstated that there could be "no question of theintention of Congress to give the Federal Re-serve Board complete power in the matter offixing the rate of discount."

In an opinion dated December 9, 1919, theActing Attorney General, Alex King, held thatthe Board had the "right to determine whatrates of discount should be charged from timeto time by a Federal Reserve Bank, and undertheir powers of review and supervision, torequire such rates to be put into effect by suchBank." •10 In reaching this conclusion, hepointed out that unless the Board had thispower, the words "and determination" used inthe statute would be wholly without signifi-cance.

The intent of Congress that the Board shouldhave final control over discount rates was con-firmed by the legislative history of the BankingAct of 1935. Early drafts of that bill wouldhave placed open market operations as well asdiscount rates in the hands of the Board, butwith a requirement that the Board should con-sult with a "Federal Open Market AdvisoryCommittee" before the Board made "anychanges on its own initiative in the open marketpolicy, in the rates of interest or discount to becharged by the Federal Reserve Banks, or inthe reserve balances required to be maintainedby member banks." [Emphasis added.] Whilethis provision was not adopted, there was muchdiscussion in Congress of the power of the

Board over discount rates, which clearly indi-cated the assumption in Congress that theBoard had authority under existing law to initi-ate such rates.

In its report on the Banking Act of 1935, theHouse Banking and Currency Committee statedthat it was essential that the Federal ReserveBoard be given the same "definite responsibilityand final authority" over open market opera-tions "as it already possesses with respect to thediscount rates of the Federal Reserve Banks."31

The committee gave the reasons for which suchauthority over discount rates was vested in theBoard:

* * * It has a national viewpoint and haslong been accustomed to considering mattersas they affect the country as a whole, withoutregard to the special interests of any particu-lar group or locality. It was created for thepurpose of supervising and coordinating theactivities by the 12 Federal Reserve Banks "inorder that they may pursue a banking policywhich shall be uniform and harmonious forthe country as a whole." " ° * It is for thisreason that the original Federal Reserve Actgave the Federal Reserve Board final author-ity over discount rates.

With respect to the relative authority of theBoard and the Reserve Banks over discountrates, Chairman Martin of the Board reassertedthe Board's power to initiate rates in his repliesto the 1952 Patman Questionnaire; at the sametime he explained how present procedures weredesigned to avoid any serious conflict in thisconnection. His statement is pertinent here: "

* * * Since prospective changes in ratesare ordinarily discussed in advance betweenthe Board and the Reserve Banks, it is onlyrarely that action taken by a Federal ReserveBank for the setting of discount rates is notpromptly approved by the Board. On occa-sion, however, the Board may fail to approveor defer its approval pending discussions otSystem credit and monetary policies anTreasury financing policies with the ™redents of all Federal Reserve Banks or withthe Federal Open Market Committee. Thematter is usually discussed also with t cSecretary of the Treasury. ,

Since the Board's authority is not limlt®to mere approval of rates established by


DISCOUNT RATES 173

Reserve Banks, but includes the power toreview and determine such rates, the Board,as previously noted, has legal authority toinitiate discount rates. However, methodsevolved through experience for the taking ofaction on discount rates are calculated toavoid the development of procedural issuesin this respect.

Despite Chairman Martin's statement regard-ing the avoidance of procedural issues, the Re-serve Banks and the Board of Governors haveoccasionally had different views as to what thediscount rate should be at a particular time, andprocedural issues have inevitably arisen. If theboard of directors of a Reserve Bank acts toincrease or decrease its existing discount rateand such action is not agreeable to the Board,the Board has two alternatives: (1) It can takeno action to approve the rate fixed by theReserve Bank, in which event the existing ratecontinues in effect; or (2) it can formally act todisapprove the rate proposed by the Reserve

Bank, in which event, again, the existing rateremains unchanged. The first alternative—non-action by the Board—could subject the Boardto the charge that it is failing to perform itsstatutory responsibility of reviewing and deter-mining discount rates established by the Re-serve Banks. Consequently, in such circum-stances the second alternative course of actionis usually followed, as it was on several occa-sions in 1971 and 1972.33

If, on the other hand, a Reserve Bank re-establishes its existing discount rate and theBoard feels that the rate should be raised orlowered, the Board has the legal authority todetermine a new rate despite the ReserveBank's unwillingness to act. Such an action bythe Board, however, could involve delicateproblems of relationships between the Boardand the Reserve Banks and is avoided if at allpossible. Usually, in such circumstances, thereluctant Reserve Bank eventually acts to estab-lish the new rate favored by the Board.

CLASSIFICATION OF PAPER FOR RATE PURPOSES

APPLICABILITY TO ADVANCESSection 14(d) of the Federal Reserve Act

refers to the fixing of discount rates to becharged for each class of paper. Presumably,this means that a Reserve Bank may not, likea commercial bank, establish a different rateof discount or interest for each individual loan,but must apply the same rate to all loans ofthe same class, irrespective of the credit sound-ness of the loan or the general creditworthinessof the borrower.

Two general questions arise at once: (1)section 14(d) apply not only to discounts

under the original provisions of section 13 ofthe Federal Reserve Act but also to advancesauthorized by later amendments to the Act?And (2) exactly what is meant by each classof paper?

The third paragraph of section 13, added in32, provides that discounts for individuals,

partnerships, and corporations in emergencycircumstances shall be made at rates estab-lished in accordance with section 14(d) of theAct; consequently, there can be no doubt thatthe class-of-paper requirement applies to suchdiscounts. On the other hand, paragraphs 8and 13 of section 13, relating respectively toadvances to member banks on paper eligiblefor discount or for purchase by the ReserveBanks and to advances to individuals, partner-ships, and corporations on obligations of theUnited States and Government agencies, pro-vide only that such advances shall be made atrates established or fixed by the Reserve Banks,subject to review and determination by theFederal Reserve Board; they do not, like thethird paragraph of section 13, specifically incor-porate the requirements of section 14(d).Section 10(b) of the Act requires only thatadvances to member banks on any satisfactoryassets shall be at rates at least one-half of



1 per cent above the Reserve Bank's highestdiscount rate; it contains no express provisionfor the fixing of such rates by the ReserveBanks or for their review and determination bythe Board.

Technically, it may be argued that the class-of-paper requirement in section 14(d) appliesonly to Reserve Bank loans that take the formof discounts under the second paragraph ofsection 13, or discounts of agricultural paperunder section 13(a), or discounts of paper forindividuals, partnerships, and corporations un-der the third paragraph of section 13. Such anargument, however, would seem patently ab-surd. It would make no sense to assume thatCongress intended to apply the class-of-paperrequirement only to discounts and not to ad-vances. Moreover, the requirement of section14(d) that discount rates be established atleast every 14 days has consistently been in-terpreted as applying also to the rates onadvances.

THE CLASS-OF-PAPER QUESTIONThe second and more difficult general ques-

tion relates to the meaning of the term "classof paper." Does it mean that different rates maybe fixed only on the basis of differences in thenature of the paper, for example, agriculturalor commercial paper? Does it permit the fixingof different rates on the basis of maturities,the nature of the borrower, or the purposesfor which the proceeds of the Reserve Bankloan will be used? This point will be dis-cussed in subsequent sections of this chapter.For now, it suffices to note that the Boardapparently has followed a liberal constructionof the authority to fix different rates for differ-ent classes of paper. The so-called eligiblepaper bill recommended by the Board in 1963would have removed all question on this pointby expressly permitting the establishment ofdifferent rates on any reasonable basis.

MATURITIESIn the early years of the System it was clearly

assumed that different rates could properly befixed on the basis of different maturities. Thefirst rates approved by the Board (on Novem-

ber 16, 1914) covered four maturity categoriesof paper: (1) 30 days or less; (2) 30 to 60days; (3) 60 to 90 days; and (4) over 90days.11 The fourth category necessarily coveredonly agricultural and livestock paper, since thelaw itself set a maximum maturity of 90 daysfor commercial paper.

In 1915 the Board adopted an additionalmaturity classification for paper maturingwithin iO days.1" However, after the law wasamended on September 7, 1916, to authorizeadvances to member banks on their 15-daynotes secured by eligible paper or Governmentobligations, the Board suggested that the Re-serve Banks eliminate the 10-day maturityclassification and adopt a uniform 15-day ratefor both discounts of commercial paper andadvances on secured notes of member banks.30

Since that time, different rates have never beenestablished on the basis of different maturitiesof paper offered for discount or as collateralfor advances.

CHARACTER OF PAPER;PREFERENTIAL RATES

Along with the maturity classifications, therealso developed during the early years of theSystem additional classifications of paper basedon the special nature of the paper involved.Certain kinds of paper were considered to beentitled to preferential rates, that is, rates lowerthan those charged for ordinary commercialpaper of the same maturities.

Trade acceptances with maturities of 90 daysor less and commodity paper maturing within6 months were the first classes of paper to beaccorded preferential rates.17 During WorldWar I, notes secured by Government obliga-tions were given preferential rate treatment/Bankers' acceptances, considered the mostliquid of all investments, were also determinedto be entitled to a substantial rate preference.3'

In general, such preferential rates did notlong continue. The preferred rate for com-modity paper was merged with the ordinary ratein 1917.in Nevertheless, in that year the numberof categories of paper for discount rate purposes—according to both maturities and characterof paper—had reached a total of 13. tt

April 1917 an attempt at standardization oi


DISCOUNT RATES 175

rates was made, and the number of categorieswas reduced to eight." For many years, how-ever, the structure of discount rates was compli-cated by the effort of the System to fix rates fordifferent classes of paper both according to ma-turities and according to the nature of thepaper itself.

FREQUENCY OF BORROWING;PROGRESSIVE RATES

The amount or frequency of borrowing bya particular member bank obviously does nothave any relation to the class of paper repre-senting such borrowing; consequently, excessiveborrowing alone is not a justification for ahigher discount rate. This fact was a cause forconcern to the SystoGl shortly after World WarI during a period of credit expansion whensome member banks were borrowing heavilyfrom the Reserve Banks.

The Board considered this problem in itsAnimal Report for 1919. It observed that, al-though the law imposed no specific limitationon the amount of borrowings by member banksat the Federal Reserve Bank, there was at leastan implied potential limitation in the provisionof section 4 of the Act requiring that creditaccommodations be extended "with due regardto the claims of other member banks." It wasfelt that if all member banks should seek accom-modations proportionate to those sought by afew, a Federal Reserve Bank would not be ableto meet the demands of all of its member banks.The Board noted, however, that the situationcould not be met by charging higher rates toexcessive borrowers, because section 14(d) re-quired rates to be fixed for each class of paper.^ stated that there was no authority in thelaw: 42

* * * for establishing graduated rates basedupon the total borrowings of a member bank,and consequently when it becomes necessaryto advance the discount rate in order to curbthe demands of those banks rediscountingwith the Federal Reserve Banks in very largeamounts, the same rate would have to applyto the moderate requirements of other mem-ber banks who may rediscount with the Fed-eral Reserve Banks infrequently and neverexcessively. Thus the application of rate

advances as a corrective or deterrent to cer-tain banks tends to raise the level of currentrates to all.

To meet this problem, the Board recom-mended an amendment to section 14(d) so asto permit a Reserve Bank, with the Board'sapproval, to determine by uniform rule ap-plicable to all its member banks the "normalmaximum discount line" of each member bankand to fix "graduated rates on an ascendingscale to apply equally and ratably to all itsmember banks rediscounting amounts in excessof the normal line so determined." In this waythe Board felt it would be possible to reduceexcessive borrowings without raising the basicrate.

Congress promptly adopted the Board's rec-ommendation. By an Act of April 13, 1920,43

the following language was added to section14(d) of the Federal Reserve Act immediatelyafter the original language authorizing the estab-lishment of discount rates for each class ofpaper with a view to accommodating commerceand business:

and which, subject to the approval, review,and determination of the Federal ReserveBoard, may be graduated or progressed onthe basis of the amount of the advances anddiscount accommodations extended by theFederal reserve bank to the borrowing bank.

Four Reserve Banks adopted the progressiverates." Three of them determined the basicdiscount line as being an amount equal to 2V£times a sum equal to 65 per cent of the reservebalance of a member bank, plus its paid-inFederal Reserve Bank stock; the fourth fixedthe basic line as the combined capital and sur-plus of the member bank. In all four instances,discounts in excess of the basic line were madesubject to a progressive rate of one-half of 1per cent, in addition to the normal rate, foreach 25 per cent by which the amount of thediscount exceeded the basic line.

While some beneficial results followed theadoption of the progressive rates at these fourReserve Banks, the Board conceded that theresults were not as effective as the flat 7 percent rate established by other Reserve Banksin June 1920. As a matter of fact, one of thefour progressive-rate Reserve Banks abandoned



the plan on November 1, 1920, and adoptedthe flat 7 per cent rate.15

In 1921 excessive borrowings declined sub-stantially. Whereas the ratio of total borrowingsof all member banks to their aggregate discountline was 78 per cent on May 20, 1920, theratio at the end of 1921 was only 37 per cent.1"The decline apparently resulted from large im-ports of gold, the general recession of business,and a decline in prices.

Presumably, the graduated-ratc authoritywas no longer considered necessary. It was re-pealed by the Act of March 4, 1923,17 whichrestored section 14(d) of the Federal ReserveAct to its original form. However, the enact-ment of the 1920 amendment and its repealin 1923 apparently evidenced the intent ofCongress that, in the absence of such specificstatutory authority for graduated rates, thereis no basis in the law for fixing discount ratesaccording to the extent to which a memberbank makes use of the credit facilities of theFederal Reserve Banks. Moreover, in the ab-sence of specific statutory authority, the fixingof higher discount rates for continuous bor-rowers would seem to sanction an abuse of thelending facilities of the Federal Reserve Banks.As indicated in a subsequent chapter, con-tinuous borrowing is not regarded as an appro-priate use of Federal Reserve credit.

STATUTORY BASIS FOR CREDITDuring the first few years of the System's

existence, differentiation in rates was based, ashas been noted, on maturities and nature ofpaper; for a short period in 1920 and 1921, afurther differentiation was made on the basis ofamount of borrowings. After 1921, however,the principal basis for different rates was simplythe type of credit extended, as determined by itsstatutory source; in recent years the maturity orcharacter of the paper offered as a basis forFederal Reserve credit has had little or no bear-ing on the rate of discount or interest charged.

In contrast to the 13 different rates that pre-vailed in early 1917—according to maturitiesand nature of paper—there was only one rate(4'/i per cent) for all classes and maturities ofpaper at the end of 1923.l<! A single classifica-tion for rate purposes prevailed until 1932, al-

though the rate varied to some extent at differ-ent times among the different Federal ReserveBanks. Thus, at the end of 1931, the only dis-count rate was that for commercial and agri-cultural paper under sections 13 and 13a, a rateof 3Vi per cent at 10 Reserve Banks and 4per cent at 2 Reserve Banks; by January 25,1932, a uniform rate of 3'/i per cent was ineffect at all Federal Reserve Banks.

Differences in rates, however, were the resultof the enactment of provisions for special typesof credit during the depression years of the early1930's. Thus, when section 10(b), authorizingadvances to member banks on any satisfactorysecurity, was enacted in February 1932, allFederal Reserve Banks fixed a separate rate of5Vz per cent for advances under that section.This action was made necessary by the newprovision itself, because at that time the law re-quired the rate to be at least 1 per cent higherthan the regular discount rate. In 1935, thelaw was amended to require a penalty rate of atleast one-half of 1 per cent on advances undersection 10(b). and since then the ReserveBanks have automatically established a rate forsuch advances that is one-half of 1 per centabove the regular discount rate.

In July 1932 when Congress enacted thethird paragraph of section 13 to authorize emer-gency discounts for individuals, partnerships,and corporations, a rate of 6 per cent was fixedby all of the Reserve Banks for such discounts.When authority for discounts under that para-graph was activated by the Board in 1966, theBoard indicated that if resort to the authorityshould appear imminent, the Reserve Banksmight wish to establish the same rate as thatfixed for advances under the thirteenth para-graph of section 13—a rate higher than theregular discount rate. Similarly, when the au-thority was again activated in 1969, the Boardsuggested that the rate should be the same asthat for advances under the thirteenth para-graph; but the Board went on to suggest thatthe latter rate be fixed at 7Vi per cent—a rate1 Vi per cent above the regular discount ratefor advances to member banks. Neither in 19°nor in 1969 was the third paragraph of section13 actually used as a means of extending credito individuals, partnerships, or corporations


DISCOUNT RATES 177

and so no rate was ever fixed for discountsunder that paragraph. However, it has alwaysbeen understood that if any rate should befixed, it would, as in 1932, be considerablyhigher than the regular rate for discounts andadvances for member banks under section 13.

In 1933 the addition of the last paragraphof section 13, authorizing advances on Govern-ment obligations to individuals, partnerships,and corporations, gave rise to a new rate ap-plicable to such advances, again somewhathigher than the regular discount rate. As willbe noted later, however, there have been timessince 1933 when the rate on advances underthat paragraph to nonmember banks has beenthe same as the rate for advances to memberbanks on Government obligations, that is, theregular discount rate.

In June 1934 new authority for direct andindirect extensions of credit to commercial andindustrial businesses provided by section 13b ofthe Federal Reserve Act (discussed in Chapter11) called for the establishment of five separaterates under that section: an interest rate onloans to businesses made directly or in partici-pation with financing institutions; rates on dis-counts for and purchases from financing institu-tions, one for that portion of the loan for whichthe financing institution was obligated and onefor the remaining portion of the loan; and rateson commitments to make loans to businessesand financing institutions.

During World War II a preferential rate wasestablished for advances to member banks onGovernment obligations under section 13; and,under the last paragraph of that section, a ratewas fixed for advances to nonmember banks onGovernment obligations lower than the rate setfor advances to others—nonbanking corpora-tions, individuals, and partnerships—under thatparagraph.

The result of these developments was thatduring World War II there was again a multiplerate structure, with differentials based upon thestatutory source of the credit, together with aPreference for advances on Government obliga-tions to both member and nonmember banks.Thus, at the end of 1942 there were differentrates for advances to member banks on Govern-ment obligations; discounts and advances for

member banks under sections 13 and 13a onsecurity other than Government obligations;advances to member banks under section 10 (b);advances to nonmember banks on Governmentobligations; advances to individuals, partner-ships, and corporations other than banks onGovernment obligations; and, as previouslyindicated, five different rates on loans and com-mitments under section 13b.49

After the end of the war the preferential rateon advances to member banks under section 13on the security of Government obligations waseliminated and so also was the lower ratecharged on advances to nonmember banks onGovernment obligations under the last para-graph of section 13. Effective August 21, 1959,section 13b of the Act, relating to loans andcommitments to businesses, was repealed. As aresult, only three different rates were left: thebasic or regular rate fixed for discounts andadvances for member banks under sections 13and 13a; the rate for advances to member bankson any satisfactory assets under section 10(b),automatically fixed at one-half of 1 per centabove the regular discount rate; and the rate foradvances to individuals, partnerships, and cor-porations—including nonmember banks—onthe security of Government obligations underthe last paragraph of section 13. Of these rates,which differ according to the provisions of lawunder which Reserve Bank loans are made, themost significant, of course, has always beenthe regular rate for discounts and advances formember banks under sections 13 and 13a.

NATURE OF BORROWER

Although, in general, differentiation in ratesis now based upon the statutory source of lend-ing authority, it should be noted that even forReserve Bank loans under a particular statutoryauthority there may be different rates accordingto the nature of die borrower. As has beenseen, during World War II advances to non-member banks on the security of Governmentobligations under the last paragraph of section13 were allowed to be made at a lower rate ofinterest than advances to others under the sameparagraph on the same type of security. InSeptember 1972, when the Board acted to miti-gate any possible hardships that might be suf-



fered by nonmember banks because of amend-ments to the Board's Regulation J, the Boardindicated that the Reserve Banks should beprepared to provide credit to such banks onsubstantially the same terms as those applicableto member banks. It specifically referred to thepossibility of direct extensions of credit to non-member banks under the last paragraph ofsection 13 and expressed the view that the ratepaid by a nonmember bank in such a caseshould be no higher than the rate applicable tomember banks under paragraph 8 of section 13,that is, the regular discount rate. In accordancewith this suggestion, six of the Reserve Banksestablished a special rate of 4V£ per cent forsuch advances to nonmember banks—the sameas the regular discount rate for member banksand 2 per cent less than the rate established forall other advances under the last paragraph ofsection 13.00

Although the third paragraph of section 13,relating to discounts of eligible paper for indi-viduals, partnerships, and corporations in emer-gency circumstances, has not been utilized since1936, it was activated by the Board in 1966and again in 1969 as a possible means throughwhich Reserve Bank credit might be extendedto nonmember deposit-type institutions such assavings and loan associations and mutual sav-ings banks, as well as to nonmember commer-cial banks. No rate was fixed for such discountson either of those occasions, although in 1969the Board suggested to the Reserve Banks, aspreviously noted, that if it appeared that anyloans were to be made under that paragraph,the rate should be the same as that for advancesunder the last paragraph of section 13. It isconceivable that, in certain emergency circum-stances, the System may be called upon as alender of last resort to provide credit under thethird paragraph of section 13 for business enter-prises as well as nonmember financial institu-tions. In such a situation, it is possible that theSystem might find it appropriate to charge dif-ferent rates for loans to different types of bor-rowers, for example, a higher rate for a loan to

a nonfinancial business enterprise than for aloan to a financial institution such as a savingsand loan association.

Such a differentiation in rates according tothe nature of the borrower could be regarded asnot being in conformity with the apparent intentof section 14(d) of the Act that different ratesmay be established only for different classes ofpaper. On the other hand, plausible argumentscan be made in support of the conclusion thata loan under the third paragraph of section 13to an aircraft manufacturer is essentially dif-ferent from a loan under that paragraph to asavings and loan association, even though thecollateral security may be the same.

PURPOSE OF CREDITIf a differentiation in rates according to the

nature of the borrower seems somewhat remotefrom a differentiation according to class ofpaper, one might suppose that the fixing of dif-ferent rates according to the purpose of theReserve Bank loan would be even more remote.Nevertheless, such a differentiation according topurpose of the credit was made in 1972. TheBoard anticipated possible hardships upon somenonmember banks because of changes in Regu-lation J requiring payment of checks in im-mediately available funds on the day of pre-sentation. Therefore, it suggested, and half ofthe Reserve Banks concurred in, the establish-ment of a special rate to be charged on ad-vances to nonmember banks on the security ofGovernment obligations under the last para-graph of section 13. But this rate was to beused only when the change in Regulation Jwould result in a significant impairment of theliquidity of a nonmember bank or would impairits ability to serve its community. Thus, eventhough such advances would be made on thesame type of security (Government obligations)as any other advances to other types of cor-porations, a preferential rate was given not onlyon the basis of the nature of the borrower hutalso according to the purpose of the loan.


DISCOUNT RATES 179

TIME AND MANNER OF DETERMINATION

Aside from the graduated-rates amendmentof 1920, which was repealed 3 years later, theonly amendment that has been made to section14(d) since the enactment of the Federal Re-serve Act was the addition of the followinglanguage by the Banking Act of 1935: "buteach such [Federal Reserve] bank shall estab-lish such rates every fourteen days, or oftenerif deemed necessary by the Board."01

The legislative history of this amendmentthrows no light on its intent. The amendmentwas not contained in the bill that passed theHouse on May 9, 1935. It first appeared in sec-tion 205 of the bill that was reported by theSenate Banking and Currency Committee. Thatcommittee's report stated only: °3

* * * Section 205 also amends existinglaw with respect to rates of discount to beestablished by the Federal Reserve banks,providing that such rate shall be establishedevery 14 days or oftener if deemed necessaryby the Board of Governors of the FederalReserve System.

There was no reference to the provision in theSenate debates. The conference report of Au-gust 17,1935," merely mentioned the provisionwithout explanation.

Presumably—and one is limited to presump-tions—the purpose of this amendment was toprovide assurance that the Federal ReserveBanks and the Board would give more constantand regular attention to discount rates and tothe need for changing such rates than had beenthe practice in the past. Whether so frequent areview of discount rates should be mandatory•nay be open to question; but, as the law nowstands, the board of directors of each ReserveBank must establish the discount rate every 14days and the Board must review and determinethe rate so established. Unless credit policy atthe time suggests the need for a change in therate, the practice is for each Reserve Bank toestablish the same rate as that previously estab-lished and for the Board to approve the re-establishment of the existing rate.

It may be noted that while section 14(d)literally refers only to discount rates, the pro-cedure prescribed by that section for the fixingof rates every 14 days has been applied in prac-tice not only to discount rates but also to inter-est rates established for advances to memberbanks and others under the eighth and thir-teenth paragraphs of section 13 and section10(b)oftheAct.

In his replies to the Patman Questionnairein 1952, Chairman Martin of the Board madethe following statement regarding the proce-dure that was followed in determining discountrates: "

At the present time, the procedure for thesetting of discount rates, as it has evolvedover the years, is generally as follows:

Each Friday the Board considers all actionstaken by the Federal Reserve Banks duringthe preceding week to establish discount rates,usually action to reestablish the existing rates.The possible desirability of any prospectivechange in discount rates is usually consideredin advance by the Board with the Presidentsof the Federal Reserve Banks and the FederalOpen Market Committee in the light ofchanging credit conditions, including theGovernment's financing needs and currenttrends in the economy generally. Whenever itis determined that as a matter of policy thereshould be a change in rates, action to establishsuch a ctiange usually is taken uniformly bythe boards of directors (or executive com-mittees) of the several Federal Reserve Banksat their next meetings following such deter-mination. Thus, in August 1950, after con-sultation between the Board and the FederalOpen Market Committee, as one measure forrestraining credit and monetary expansion, adiscount rate of VA percent—initially pro-posed by the Federal Reserve Bank of NewYork—Was established at all of the FederalReserve Banks and that rate prevailed at theend of 1951.

In accordance with the procedures estab-lished many years ago, as previously indi-cated, whenever discount rates are changed,



the action is announced simultaneously bythe Board and the Reserve Bank at the endof the day on which the Board acts and thenew rates are made effective on the nextbusiness day following the day of the an-nouncement.

In general, the procedure described by Mr.Martin prevails at the time of this writing. How-

ever, the Board no longer considers rates onlyon Friday of each week; normally, it acts onrates established by the Reserve Banks promptlyafter receipt of advice of a Reserve Bank'saction. In addition, changes in rates are usuallymade effective on the day after the Board'saction whether or not that happens to be a busi-ness day.

COMPUTATION

As has been noted, the Federal Reserve Actauthorizes both discounts and advances, withdiscounts subject to a discount rate and ad-vances subject to an interest rate. Until 1971,however, interest on all Reserve Bank loans,advances as well as discounts, was computedon a discount basis; that is, interest was de-ducted at the time the loan was made. If themember bank repaid a borrowing before ma-turity, it received a rebate of a portion of theinterest deducted when the loan was made.Most of the Reserve Banks computed the rebateat the rate at which the advance was made, butsome Reserve Banks followed a practice ofcomputing the rebate at the rate prevailing atthe time of the rebate if the discount rate at thattime was less than it was at the time the advancewas made.

Since February 1971 interest on advances bythe Reserve Banks has been computed on anaccrual basis and paid at the time of repaymentof the loan. In addition, any changes in thediscount rate are made immediately applicableto all outstanding borrowings." With thischange in the method of computing interest, theneed for a rebate in the event of payment beforematurity no longer exists. It should be noted inpassing that computation of interest on an ac-crual basis rather than on a discount basis re-sults in a small mathematical advantage to the

borrowing member bank. For this reason, al-though legally a member bank could still dis-count eligible paper with its Federal ReserveBank, it seems unlikely that it would ever wishto do so.

Interest on Reserve Bank loans is computedfor the period of the loan on the basis of 365days to the year." If the maturity date falls ona Sunday or a holiday, the computation followsapplicable State law relating to such cases."

In the early days of the System, when theapplicable discount rate depended upon thematurity of the paper, questions sometimesarose that would not arise under present law.For example, in 1916 when 90-day paper car-ried a higher rate than 30-day paper, questionwas raised as to the applicable rate in a casein which the paper discounted had a maturityof 90 days at the time of discount but in whichthe member bank, by a side agreement, hadagreed to repurchase the paper in 30 days. TheBoard's Counsel ruled that the 90-day rate wasnevertheless applicable/1" Again, a questionarose as to the rate of rebate in a case in whicha 90-day loan was prepaid within 30 days ofmaturity. It was held that the rebate should beat the lower rate prevailing for paper runningthe same length of time as the unexpired termrather than at the higher 90-day rate chargedwhen the loan was made.58


Relation to Credit Policy

THE EARLY YEARS: ACCOMMODATION OF CREDIT NEEDS

Although this study is not primarily con-cerned with the economic aspects of the lendingfunctions of the Federal Reserve Banks, it isnevertheless appropriate to consider briefly howthe law and the Board's regulations have re-flected changes in the concept of the role of thediscount mechanism as an instrument of creditand monetary control.

The original Federal Reserve Act containedlittle, if any, suggestion that the discount func-tion would be employed as a tool for imple-menting credit policies in the sense in which itis considered as such a tool today. There wasno mention of any such objective in the title ofthe Act. It is true that one of the stated pur-poses was to afford means of rediscounting com-mercial paper, but it appears that this purposewas related not to the control of general creditconditions but rather to the meeting of theparticular credit needs of business and com-merce.

As indicated earlier, one of the principal aims°f the Act was to create a market for short-term

por NOTES AND REFERENCES, see p. 265.

commercial paper. Section 14 (d) of the Actprovided that discount rates should be fixed"with a view of accommodating commerce andbusiness." The key word was accommodationrather than regulation of credit.

In keeping with this purpose, emphasis wasplaced in the early years of the System not uponregulation of the amount or kinds of creditextended by member banks themselves butupon the ability of the Reserve Banks to assistmember banks in meeting their credit require-ments in normal and extraordinary times. Thus,in its first Annual Report to Congress, theBoard stated that it was necessary to enlist "thehearty cooperation of all the member banks"in "the adoption of a discount policy whichwould prevent the accumulated strength of the[Federal Reserve] banks from being dissipatedand protect their resources from being used tofinance operations not calculated to add to thestrength or solidity of general banking condi-tions." ' In its 1919 Annual Report, the Boardsimilarly stated that the Federal Reserve Banksshould not encourage rediscounting for the sakeof profit, "but that their own resources should

181



be kept liquid and their reserve positionstrong." 2

Very plainly, the Board did not consider thediscounting authority of the Reserve Banks asa means of controlling the credit policies ofmember banks. In its 1921 Annual Report, theBoard emphasized that the System had "no con-trol over member bank loans" and pointed outthat there was "nothing in the Federal ReserveAct which gives either the Federal ReserveBoard or a Federal Reserve Bank any controlover the loan policy of any member bank." 3

The Board observed that there was "a verygeneral popular misconception" in this respectand that some member banks in declining loanshad used the Reserve Banks as a buffer. It wastrue, the Board said, that a Reserve Bank mighthave occasion to call the attention of certainmember banks to their "large discount lines,"but "in no case within the knowledge of theFederal Reserve Board has any Federal ReserveBank undertaken to say to a member bank whatparticular loans it should call or ask to havereduced." *

Some shift away from this concept was evi-dent in 1923 when the Board reported to Con-

gress that, "by maintaining constant, close, anddirect contact with the loan policies and opera-tions of its member banks, through examinationor otherwise, a reserve bank can do much byother means than changes in discount rates toestablish an effective supervision and control ofthe credit released by it to its member banks." '-This was an early expression of the concept ofdirect pressure that became more explicit inthe late 1920's. However, it appears that, atleast prior to 1933, the influence exercised bythe System through the discounting functionover the credit policies of member banks wasconsidered only as something "akin in manyrespects to the bank examinations function" ofthe System • rather than as a means of regu-lating national credit conditions or controllingthe lending policies of member banks. As pre-viously indicated, major emphasis was placedupon the furnishing of necessary credit assist-ance to different segments of the economy: theestablishment of a market for commercial paperin the early years; credit to agriculture andstimulation of foreign trade through discount-ing of bankers' acceptances in the 1920's; andassistance to businesses in the early 1930's.

THE 1930's: PREVENTION OF SPECULATION

The original Federal Reserve Act contem-plated that Federal Reserve credit should bebased on short-term commercial paper and noton paper drawn for investment or speculativepurposes. Section 13 specifically excluded paper"covering merely investments or issued ordrawn for the purpose of carrying or trading instocks, bonds, or other investment securities."However, the original Act contained no expressstatement that one of its purposes was to pre-vent member banks from diverting their ownfunds into speculative channels; the originalobjective was simply to limit Federal Reservediscounts to self-liquidating commercial paper,excluding paper drawn for purposes of invest-ment alone.

In 1929 both the Board and the ReserveBanks became seriously concerned about thevolume of bank credit that was being used forthe purchase of stocks and for speculative pur-poses. There was a sharp difference of opinion,however, as to how the problem should be metThe Reserve Banks, particularly the New YorkReserve Bank, favored an increase in the dis-count rate; the Board, on the other hand, in-sisted on a program of direct pressure, that is.closing the discount window to member banksthat appeared to be extending credit for specu-lative purposes. In the end, the Board agreedto a discount rate increase; but it was this crisis,according to some historians of the sys t*jn'that marked a shift of power from the New


RELATION TO CREDIT POLICY 183

York Reserve Bank to the Federal ReserveBoard.

The stock market debacle of 1929 and theensuing banking crisis of 1933 focused evengreater attention on the dangers inherent inthe investment practices of commercial banks.The Banking Act of 1933 sought to preventrecurrence of similar situations by variousamendments that were designed to restrict in-vestments by banks in stocks and other securi-ties. Thus, the 1933 act prohibited nationalbanks and State member banks of the FederalReserve System from dealing in investmentsecurities (subject to certain exceptions) orfrom purchasing any corporate stocks exceptas specifically authorized by law. The same actrequired member banks to divorce themselvesfrom securities companies and prohibited inter-locking directorates between such companiesand member banks. Member banks were pro-hibited from paying any interest on demanddeposits, a practice that had enabled large banksin New York and other financial centers toattract deposits of country banks—funds thatthe city banks had used for investment in specu-lative securities. Finally, the Banking Act of1933 added three provisions to the FederalReserve Act relating to the discount functionsof the Reserve Banks that were specificallyaimed at preventing speculative practices onthe part of member banks. These three amend-ments merit particular attention here.

One of the amendments was to subsection(m) of section 11 of the Act, a paragraph thathas had an interesting history because of thevarious different matters that have been cov-ered by it over many years.8 The 1933 amend-ment revised this paragraph to authorize theBoard to limit the amount of loans that mighthe made by member banks on the security ofstock or bond collateral. The Board was givenpower to fix, for each Federal Reserve district,the percentage of individual bank capital andsurplus that could be represented by loans onstock or bond collateral made by memberbanks, with a flat prohibition against the making°f such loans to any one borrower in excess of10 per cent of a member bank's capital andSUrplus. The Board was authorized to changethe percentage from time to time, but it was

expressly made the duty of the Board to estab-lish such percentages "with a view to preventingthe undue use of bank loans for the speculativecarrying of securities." Finally, the Board wasempowered to direct any member bank to re-frain from further increasing its loans on stockor bond collateral for any period up to 1 year"under penalty of suspension of all rediscountprivileges at Federal reserve banks."

This amendment went far beyond the originalconcept that Federal Reserve Banks should notindirectly encourage speculation by discountingpaper drawn for investment or speculative pur-poses; it attempted to restrain directly the mak-ing of speculative loans by member banks, re-gardless of the nature of the paper that might beoffered by them as a basis of rediscount by theReserve Banks. If a member bank persisted inmaking speculative loans, it was made subjectto suspension of all rediscount privileges.

This provision for curbing speculative loansby member banks is still in effect, although itwas amended by the Banking Act of 1935 tomake loans on U.S. Government obligationssubject to the more liberal percentage limita-tion prescribed by section 5200 of the RevisedStatutes rather than the 10 per cent limitationfixed for loans on other securities.8

Another amendment made by the BankingAct of 1933 added certain new provisions tothe eighth paragraph of section 13 of the Fed-eral Reserve Act relating to advances to mem-ber banks on their secured promissory notes; itwas desiped to restrain speculative loans bymember banks. The amendment *° providedthat if, during the life of any such advance andafter a warning by the Reserve Bank or theBoard, a member bank should increase itsloans secured by stocks or other securities orits loans to dealers in securities, such advanceshould become immediately due and payableand the member bank should be "ineligible as aborrower at the reserve bank" for such periodas the Board should determine. Exceptions weremade with respect to loans on Governmentobligations and temporary carrying loans tofacilitate the purchase or delivery of securitiesoffered for public subscription.

A third amendment—the most important forthe purpose of preventing speculative bank



loans—grew out of a recommendation madeby the Board in a letter to the chairman of theSenate Banking and Currency Committee,dated March 29, 1932." In that letter theBoard stated: "

Member banks as a rule do not borrow torelend, but to make up deficiencies in reservesarising from withdrawals of deposits or fromother causes. It is therefore usually impossibleto say that a loan to a member bank isgranted for this or that specific purpose. How-ever, it would be possible to determinewhether the loan and investment policies ofa bank are inconsistent with the purposes ofthe Federal reserve act, and, if so, to refuseaccommodation to such bank or in aggravatedcases to suspend it from the privilege of usingthe system's credit facilities.

To accomplish this end, the Board recom-mended an amendment to section 4 of theFederal Reserve Act, and the language sug-gested by the Board appeared in the BankingAct of 1933 as finally enacted.

The eighth paragraph of section 4, from thetime of the original enactment of the FederalReserve Act, had provided that the directors ofeach Federal Reserve Bank should administerthe affairs of the Reserve Bank fairly and im-partially and without discrimination against anymember bank or banks and that the directorsshould extend to each member bank "suchdiscounts, advancements, and accommodationsas may be safely and reasonably made withdue regard for the claims and demands of othermember banks." To this language the 1933amendment added language requiring that dueregard be given also to "the maintenance ofsound credit conditions, and the accommoda-tion of commerce, industry, and agriculture."In addition, the amendment authorized theFederal Reserve Board to prescribe regulationsfurther defining the conditions under whichdiscounts, advancements, and accommodationsmight be extended to member banks. Theamendment then added the following significantprovisions: ™

* * * Each Federal Reserve bank shallkeep itself informed of the general characterand amount of the loans and investments ofits member banks with a view to ascertaining

whether undue use is being made of bankcredit for the speculative carrying of ortrading in securities, real estate, or commodi-ties, or for any other purpose inconsistentwith the maintenance of sound credit condi-tions; and, in determining whether to grantor refuse advances, rediscounts or other creditaccommodations, the Federal reserve bankshall give consideration to such information.The chairman of the Federal reserve bankshall report to the Federal Reserve Board anysuch undue use of bank credit by any memberbank,' together with his recommendation.Whenever, in the judgment of the FederalReserve Board, any member bank is makingsuch undue use of bank credit, the Boardmay, in its discretion, after reasonable noticeand an opportunity for a hearing, suspendsuch bank from the use of the credit facilitiesof the Federal Reserve System and mayterminate such suspension or may renew itfrom time to time.

With reference to the section of the 1933 actthat added these provisions, the report of theSenate Banking and Currency Committee statedthat that section: "

* * * places general restrictions upon theoperating policy of Federal reserve bankswith the intent to limit them to the extensionof credit for ordinary business purposes andto make plain that their resources are not tobe used to support speculation. The ReserveBoard is given power to oversee and directsuch use of the resources of banks.

In explaining these provisions on the floor ofthe Senate, Senator Glass observed that someFederal Reserve Banks might be reluctant toinquire as to what member banks were doingwith funds borrowed from the Reserve Bankand that neither the Reserve Banks nor theBoard had any control over a member bankwhile it was not seeking Federal Reserve credit.He pointed out, however, that under the newprovisions "the instant a member bank wantsto recoup itself at the Federal Reserve BanK,it is the business of the Federal Reserve Bank toknow the reason why." He then stated: "

* • • in this section we require a j jreserve bank to keep itself informed and wrequire the agent of the Federal R«erV


Board at that bank to keep the FederalReserve Board informed. If at any time itshall appear that the member bank seekingthe privileges of the Federal reserve bankis inordinately extended in stock-markettransactions or unsound and unsafe loans, weempower the Federal Reserve Board, upondue notice and hearing, to suspend the facili-ties of the Federal reserve bank to thatoffending bank.

Similarly, in the House, Chairman Steagallof the Banking and Currency Committee de-clared: "

We propose to see to it that hereafter thecredit facilities of the Federal Reserve Systemshall be devoted primarily to the purposes towhich that great act was dedicated at theoutset.

* * * * *Amendment of the Federal Reserve Act is

made to provide for supervision by FederalReserve banks to see whether any memberbank is making undue use of its funds for


speculative purposes. If such is found to bethe case the Federal Reserve bank is em-powered to suspend such member bank fromthe privilege of rediscounting.

The three 1933 amendments to the FederalReserve Act—to section l l (m) , section 13,and section 4—had a common objective: toplace upon the Board and the Reserve Banks aresponsibility for seeing that member banks didnot engage in undue use of their funds forspeculative purposes, with suspension of theirrediscounting privilege as the penalty. The sig-nificance of the 1933 amendments lies in thefact that they contemplated the exercise by theFederal Reserve System of a direct influenceupon the credit policies of member banks, incontrast to the earlier concept that the lendingauthority of the Reserve Banks was intendedonly to accommodate the credit requirementsof member banks with but incidental effectupon the lending practices of the member banksthemselves.

SINCE 1951: AN INSTRUMENT OF CREDIT CONTROL

So far in this chapter it has been suggestedthat in the early years of the System, particu-larly in the 1920's, the lending functions ofthe Federal Reserve Banks were related tocredit policy primarily as a means of enablingmember banks to supply the credit needs ofcommerce and agriculture, and that in the1930's such functions were aimed primarily atthe prevention of speculative loans by memberbanks. It would be wholly inaccurate, however,to assume that there was any clear line of de-marcation between the two periods: The ideaof preventing speculative loans was not lackingduring the 1920's; and the Banking Act of1933, despite its preoccupation with speculativelending practices, did not contemplate that theReserve Banks should not still seek to accom-modate commerce and agriculture, as well asbusiness enterprises, through the exercise of'heir lending powers. It would be equally wrong

to assume from the heading of the present sec-tion that the lending functions of the ReserveBanks were regarded as a tool of credit controlonly after 1951. As in the two previous sections,the heading is meant only to indicate a shift inemphasis.

The importance of the discount powers of theReserve Banks in affecting general credit condi-tions was clearly recognized in the early yearsof the System. In its first Annual Report theBoard declared that "the question of a discountpolicy immediately became urgent."17 Eventhen, the Board contemplated that the Systemshould be prepared to exert its influence toprotect the economy against both inflation anddeflation. Thus, the Board stated:18

The ready availability of its resources is ofsupreme importance in the conduct of aReserve Bank. Only then can it become asafe and at the same time flexible instrument



of guidance and control, a regulator of in-terest rates and conditions. Only then will itconstantly carry the promise of being able toprotect business against the harmful stimulusand consequences of ill-advised expansions ofcredit on the one hand, or against the menaceof unnatural restrictions and unnecessary con-tractions on the other, with exorbitant ratesof interest and artificial stringencies.

Nevertheless, the System was mainly con-cerned in the early years with affording neces-sary credit to commerce and agriculture; andthe concern in the 1930's with prevention ofspeculative loans was not based upon the ideaof using the discount mechanism as a means ofinfluencing the money supply in general.

From the early 1930's until about 1952,member bank borrowings from the ReserveBanks were relatively small, at times almostinsignificant; consequently, the lending func-tions of the Reserve Banks had little effect uponnational credit policy during that period. Thereasons for lack of borrowings during thoseyears were set forth in the Board's reply to thePatman Questionnaire in 1952: 19 principally,the volume of excess reserves held by memberbanks as the result of a large inflow of goldand a slack demand for bank credit, the openmarket policy of the System during WorldWar II that provided the banking systemwith ample reserves, and the strong liquidityposition of member banks as a result of theirlarge holdings of Government securities.

The situation began to change after WorldWar II. The rapid expansion of private bankcredit during the postwar years brought about areduction in over-all bank liquidity, with morefrequent occasions for borrowings by memberbanks from their Federal Reserve Banks.20

The chief factor, however, in the revival ofthe importance of the discount mechanism as aninstrument of credit policy was the Treasury-Federal Reserve accord of March 1951, whenthe System ceased to purchase Governmentbonds in order to support their prices.21 Beforethat time, member banks, in view of the steadyprices of Government obligations, had beenable to adjust their reserve positions throughsales of such obligations, which they had heldin large volume since World War II; after the

accord, they frequently found it more profit-able to borrow from the Reserve Banks. Theeffect was described in the Board's 1951 An-nual Report as follows: —

The closer relationship of short-term mar-ket rates to the discount rate was an impor-tant factor in a greater use of the Federal Re-serve discount window in making temporaryadjustments of member bank reserve posi-tions. When the Federal Reserve, by refrain-ing from open market purchases of Govern-ment securities, limits the availability of re-serves through the open market, a memberbank that has temporary need for additionalreserves has a choice of borrowing from theFederal Reserve at the discount rate or sellingTreasury bills or other securities at interestrates determined in the market. Depending onthe excess reserve position of other banks,the bank may also have the choice of borrow-ing such funds through the Federal fundsmarket, at a rate determined in this market.* * * As the year progressed, increasingnumbers of member banks elected to borrowfrom the Federal Reserve in meeting short-ages of reserve funds. This development re-flected re-establishment of the discount func-tion as a complement to open marketoperations in Federal Reserve influence onmonetary and credit conditions.

The increased importance of the discountmechanism in relation to credit policy wasemphasized in the Board's reply to the PatmanQuestionnaire in 1952. The Board pointed outthat the reluctance of member banks to becontinually in debt to the Federal Reserve madethe discount mechanism a potentially powerfulinfluence in affecting general credit conditions,especially when used in conjunction with othermeasures of credit and monetary policy. De-scribing the complementary workings of openmarket operations and discount policy, theBoard stated: "

When occasion makes it desirable from thestandpoint of over-all credit and monetaryobjectives, the System can make it necessaryfor an increasing number of member banks torely temporarily on borrowing from the Re-serve Banks. It can accomplish this by de-creasing the availability of reserve funds t>ysuch means as open market sales of Govern-



ment securities or the imposition of higherreserve requirements. When such an increasein member bank recourse to borrowing oc-curs, usually accompanied by a rise in thevolume of rediscounts, the System is put in aposition to exert an additional restrictive in-fluence on the expansion of bank reserves andof bank credit generally by increasing the costof member bank borrowing, that is, by raisingthe discount rate.

Concluding its discussion of the subject, theBoard told the Patman subcommittee that the"discount mechanism is an important instru-ment of Federal Reserve policy."

Greater resort by member banks to FederalReserve discounts after the 1951 accord re-sulted in the focusing of more attention uponthe discount functions of the Reserve Banksthan had existed since the 192O's. Renewedinterest in the subject impelled the Board torevise its Regulation A in 1955. In a forewordto the revised regulation, the Board explicitlyrecognized the role of the discount mechanismas one of the three major instruments of creditpolicy. Thus, the first two paragraphs of thatforeword read: u

A principal function of the Federal Re-serve Banks under the law is to providecredit assistance to member banks, throughadvances and discounts, in order to accom-modate commerce, industry, and agriculture.This function is administered in the light ofthe basic objective which underlies all Fed-eral Reserve credit policy, i.e., the advance-ment of the public interest by contributing tothe greatest extent possible to economic sta-bility and growth.

The Federal Reserve System promotes thisobjective largely by influencing the avail-ability and cost of credit through action af-fecting the volume and cost of reserves avail-able to the member banks. Through openmarket operations and through changes inreserve requirements of member banks, theFederal Reserve may release or absorb re-serve funds in accordance with the credit andmonetary needs of the economy as a whole.An individual member bank may also obtainreserves by borrowing from its Federal Re-serve Bank at a discount rate which is raisedor lowered from time to time to adjust to thecredit and economic situation. The effects of

borrowing from the Federal Reserve Banksby individual member banks are not localized,as such borrowing adds to the supply of re-serves of the banking system as a whole.Therefore, use of the borrowing facility bymember banks has an important bearing onthe effectiveness of System credit policy.

The role of the discount function as aninstrument of monetary policy "under present-day conditions" was fully and clearly describedin the Board's Annual Report to Congress for1957." At certain periods, and for specificmember banks, the lending authority of theFederal Reserve Banks still serves the purposefor which it was originally intended—the ac-commodation of the needs of business andcommerce. It can still be used as a means ofrestraining speculative lending practices on thepart of member banks, although not so effec-tively when member banks are not borrowingextensively from the Reserve Banks. In recentyears, however, and especially since 1951, thediscount mechanism has been most importantas a complement to open market operations inthe effectuation of monetary policy.

One episode will serve to illustrate the use ofthe discount window as a tool of monetarypolicy. In the latter part of 1966, the Boardconcluded that credit-financed business spend-ing "had tended toward unsustainable levelsand had added appreciably to current inflation-ary pressures." On September 1, 1966, at theBoard's suggestion, the president of each Re-serve Bank sent a letter to each member bankin his district urging restraint in the making ofbusiness loans. The letter also said that thisobjective would be "kept in mind by the FederalReserve Banks in their extensions of credit tomember banks through the discount window."26

Here was a new form of direct pressure likethat exerted in 1929, but this time it was usednot to prevent speculative loans by memberbanks but to discourage loans to businesses.This effort was abandoned in December 1966when it was announced that, because of changesin credit conditions, the special discount ar-rangements set forth in the letter of September 1had been terminated.

The 1968 Report of a System Committeestated that discounting of paper by the ReserveBanks can "serve as an important adjunct to



open market operations in the implementation general principles, the regulation states thatof monetary policy." -7 One of the results of the effects of borrowings by member banksthat committee's recommendations was the from their Reserve Banks do not remain local-Board's adoption in 1973 of a complete revision ized but have "an important bearing on overallof its Regulation A. In a section relating to monetary and credit conditions." !S


General Principles: A Summary

STATUTORY AND REGULATORY BASIS

Throughout this study attention has beenfocused principally on legislation and on regula-tions and interpretations of the Board withrespect to various types of Reserve Bank loans.This chapter describes briefly some of the gen-eral principles that have governed the lendingoperations of the Reserve Banks. It provides,in effect, a partial summary of this history.

In the law itself, Congress has set forth some—but not very comprehensive—policy guide-lines. It has indicated that Reserve Bank loansare designed to accommodate commerce, indus-try, and agriculture; that they should be madewith due regard for the maintenance of soundcredit conditions; that ordinarily they shouldhave short maturities; that the proceeds of such


loans should not be used for speculative pur-poses; and that in exceptional or emergencycircumstances loans may be made not only tomember banks but also to nonmember banksand even to individuals, partnerships, and cor-porations.

These statutory principles have been re-flected in regulations and rulings of the Board,and from time to time the Board has articulatedadditional principles or guidelines to be fol-lowed in administration of the Federal Reservediscount window. In its 1955 revision of Regu-lation A, the Board for the first time sought tostate general principles governing Reserve Bankloans. These principles are restated, but withdifferent emphasis, in a section of the 1973revision of the regulation.

189



ACCOMMODATION OF COMMERCE, INDUSTRY,AND AGRICULTURE

As indicated in the preceding chapter, it hasalways been a fundamental though very generalprinciple that the lending authority of the Re-serve Banks is to be used for the purpose ofaccommodating commerce, industry, and agri-culture. One of the purposes of the FederalReserve Act, as stated in its title, was "to afforda means of rediscounting commercial paper."Section 13 of the original Act provided, andstill provides,1 that a Reserve Bank "may dis-count notes, drafts, and bills of exchange arisingout of actual commercial transactions; that is,notes, drafts, and bills of exchange issued ordrawn for agricultural, industrial, or commer-cial purposes, or the proceeds of which havebeen used, or are to be used, for such pur-poses." Section 14(d) of the Act provided, andstill provides,2 that discount rates "shall befixed with a view of accommodating commerceand business."

In 1933, what is now the eighth paragraph ofsection 4 of the Act 3 was amended to reflectcertain guidelines regarding Reserve Bank lend-ing to member banks. One of the guidelines wasthat Reserve Bank loans should be made "withdue regard for * * * the accommodation ofcommerce, industry, and agriculture."

In the foreword to the 1955 revision of Regu-lation A, the Board stated: *

A principal function of the Federal ReserveBanks under the law is to provide creditassistance to member banks, through ad-vances and discounts, in order to accommo-date commerce, industry, and agriculture.

The 1973 revision similarly provides: "

Extending credit to member banks to ac-commodate commerce, industry, and agricul-ture is a principal function of Reserve Banks.

In the early years of the System, the abilityof the Reserve Banks to accommodate com-merce, industry, and agriculture was limited bythe fact that the law authorized loans only tomember banks, by the Board's adherence to

the real-bills doctrine, and by narrow interpre-tations of what constituted paper drawn foragricultural, industrial, or commercial purposes.Fortunately, the real-bills doctrine was soondiscarded and both Congress and the Board inlater years acted to enable the Reserve Banks toplay a much more expanded role in accommo-dating the needs of the economy.

In the 1920's, amendments to the law gavethe Reserve Banks broader scope in providingcredit assistance to agriculture and in develop-ing a market for bankers' acceptances. Congressalso authorized advances to member banks onU.S. Government obligations as well as oncommercial paper. In the 1930's, the depressiongave rise to radical departures from the originalphilosophy of the law, as reflected by amend-ments authorizing loans to member banks onany satisfactory security (though at a higherrate) and extensions of credit to nonmemberbanks, business enterprises, and to individuals,partnerships, and corporations in general.

Within statutory limits, the Board has takenactions over the years to liberalize requirementsas to the types of paper that arc eligible fordiscount or as collateral for Federal ReserveBank advances. For example, while the framersof the original Act undoubtedly consideredcommercial paper to be only that paper arisingout of what they termed business transactions,the Board in 1937 took the position that anypurchase and sale of goods, including the pur-chase of automobiles or radios by individuals,was a commercial transaction. In addition tosuch consumer paper, the Board also held,contrary to its earlier position, that financepaper, that is, paper the proceeds of which wereto be re-lent to third persons, could likewise beregarded as eligible for discount. In its 1973revision of Regulation A, the Board has treatedeven real estate mortgages and other permanentinvestment paper as commercial paper eligiWe

for discount if it meets statutory maturity re-quirements and if the proceeds are not usedmerely for investment.


GENERAL PRINCIPLES: A SUMMARY 191

THE REAL-BILLS DOCTRINE:AN ABANDONED PRINCIPLE

The original Federal Reserve Act reflected abelief that only short-term, self-liquidatingpaper should be eligible as a basis for FederalReserve credit. It was felt that this was neces-sary to assure the liquidity of commercial banks.It was also believed that the pledging of suchpaper as security for the issuance of FederalReserve notes would guarantee an elastic cur-rency; it was expected that the volume of cur-rency would expand and contract directly inresponse to the varying credit needs of theeconomy as reflected by the volume of short-term borrowings by commercial and agriculturalenterprises. For these reasons, the Board ex-pounded the principle that all paper offered fordiscount should be essentially self-liquidating;in other words, that it "should represent inevery case some distinct step in the productionor distribution process—the progression ofgoods from producer to consumer." •

It was not long before this philosophy—thereal-bills doctrine—underwent drastic erosion.The story of the demise of the doctrine was toldin the Board's letter of August 21, 1963, toCongress recommending legislation to author-ize Reserve Bank loans on any satisfactorysecurity. That letter stated:

The principle that Federal Reserve creditshould be extended only on the basis ofshort-term, self-liquidating paper was de-parted from as early as 1916, during the FirstWorld War, when the law was amended toauthorize the Reserve Banks to make 15-dayadvances to member banks, not only on thesecurity of "eligible paper" but also on thesecurity of direct obligations of the UnitedStates. A more significant departure occurredin 1932, when Congress authorized the Re-serve Banks to make advances to memberbanks in exceptional and unusual circum-stances on any security satisfactory to theReserve Banks, although at a penalty rate ofinterest. This authority, at first temporary,was made permanent in 1935, and it is nolonger limited to exceptional and unusual

circumstances, although such advances con-tinue to carry a penalty rate of interest.

The concept that limitation of discounts toshort-term, self-liquidating paper would serveautomatically to regulate the volume of Fed-eral Reserve notes in circulation has also beenbreached by amendments to the law and hasbeen refuted by experience. In 1932, Con-gress authorized the issuance of Federal Re-serve notes on the security of Governmentobligations in addition to eligible paper andgold. This authority was originally of a tem-porary nature, but it was made permanent in1945. The volume of Federal Reserve notestoday fluctuates with the changing demandsof the economy without regard to the natureof the paper offered as collateral for FederalReserve credit or pledged as security forFederal Reserve notes.

Each of these legislative changes took placeduring a period of economic stress that servedto make clear the inadequacy of the originalframework for Federal Reserve credit exten-sion. The credit needs of American business-men, farmers, and consumers were evolvingin many ways that could not be adequatelyhandled by the old instrument of short-term,commercial-type paper; and the rapid growthof both private and Governmental economicactivity generated credit requirements far inexcess of those that could be supported by therelatively small volume of "eligible paper."

Despite changes in the character of paperheld by commercial banks and the repeatedand necessary departures from the originalconcept that discounts should be based onlyon short-term, self-liquidating paper, the lawcontinues to impose unduly restrictive re-quirements as to the nature and maturity ofthe paper that may be discounted by theReserve Banks or offered as security for ad-vances by the Reserve Banks.

For many years, it has been generally rec-ognized that the concept of an elastic cur-rency based on short-term, self-liquidatingpaper is no longer in consonance with bank-ing practice and the needs of the economy.



It has long been apparent that the narrowrequirements of the law regarding "eligiblepaper" serve no useful purpose and that itwould be preferable to place emphasis on thesoundness of the paper offered as security foradvances and the appropriateness of thepurposes for which member banks borrow.The one-year paper of many bank customersthat is not now eligible for discount may beas satisfactory collateral as the 90-day notesof other customers. Moreover, the nature ofthe collateral provides no assurance that theborrowing bank will use the proceeds for anappropriate purpose.

Despite the Board's recommendation, re-peated in subsequent years, the law has notbeen changed to repeal the vestiges of the

real-bills doctrine. The principle of that doctrinehas been rejected and it is now recognized thatthe soundness of paper offered as a basis forReserve Bank credit is more important thancompliance with maturity requirements andlimitations as to the nature of the transactionsgiving rise to the paper. The principle has beenrejected, but these requirements and limitationscontinue to inhibit the ability of the ReserveBanks to extend credit to member banks inorder to accommodate commerce, industry, andagriculture. Only if a member bank is willingor compelled by circumstances to pay a higherrate of interest may a Reserve Bank extendcredit, under section 10(b) of the Federal Re-serve Act, without regard to such requirementsand limitations.

MAINTENANCE OF SOUND CREDIT CONDITIONS

As was soon demonstrated by experienceduring the early years of the System, one of thedifficulties with the real-bills doctrine was thatthe discounting by the Reserve Banks of short-term, self-liquidating paper growing out of pro-ductive commercial transactions gave no assur-ance that the credit extended to member bankswould actually be used by them for productivepurposes.7 The Board became concerned duringthe 1920's by the apparent fact that memberbanks were using the proceeds of Reserve Bankloans for speculative purposes, and efforts weremade through direct pressure to make certainthat the proceeds of such loans were being usedfor appropriate purposes.

Thus, a new general principle emerged: Fed-eral Reserve credit, regardless of the nature ofthe paper offered for discount, should not beused in a manner inconsistent with the main-tenance of sound credit conditions. This prin-ciple was reflected in amendments made by theBanking Act of 1933 to the eighth paragraphof section 4 of the Federal Reserve Act. It wasprovided that, in extending credit to its memberbanks, each Reserve Bank should give due re-gard not only to the accommodation of com-

merce, industry, and agriculture but also to themaintenance of sound credit conditions. Inaddition, but along the same line, each ReserveBank was required to "keep itself informed ofthe general character and amount of the loansand investments of its member banks with aview to ascertaining whether undue use is beingmade of bank credit for the speculative carryingof or trading in securities, real estate, or com-modities, or for any other purpose inconsistentwith the maintenance of sound credit condi-tions." In determining whether to grant creditaccommodations, the Reserve Bank was re-quired to give consideration to such informa-tion. If the Board of Governors found that anymember bank was making undue use of bankcredit, the Board was authorized, after oppor-tunity for hearing, to suspend such bank fromuse of the credit facilities of the System."

Reflecting the intent of the 1933 amendmentsto the law, the Board in its 1955 revision ofRegulation A stated that, in determiningwhether to extend credit, a Reserve Bankshould give due regard to "the purpose of thecredit and to its probable effects upon the main-tenance of sound credit conditions, both as to



the individual institution and the economy gen-erally." As revised in 1973, the regulation notesthat the law requires every Reserve Bank tokeep itself informed of the general characterand amount of the loans and investments of itsmember banks with a view to ascertaining

whether undue use is being made of bank creditfor any purpose "inconsistent with the main-tenance of sound credit conditions" and that, indetermining whether to extend credit, the Re-serve Bank shall give consideration to suchinformation.

INAPPROPRIATE USES OF FEDERAL RESERVE CREDIT

SPECULATION OR INVESTMENTAs has been indicated, amendments to the

Federal Reserve Act in 1933 made explicit theprinciple that Federal Reserve credit should notbe used by member banks for speculative pur-poses. This principle, of course, has been recog-nized since the earliest days of the System. Forexample, in 1923, referring to the Federal Re-serve discount window, the Board stated: •

It is not a system of credit for either in-vestment or speculative purposes * * *. Theexclusion of the use of Federal reserve creditfor speculative and investment purposes andits limitation to agricultural, industrial, orcommercial purposes thus clearly indicatesthe nature of the tests which are appropriateas guides in the extension of Federal reservecredit.

Even though the proceeds of Federal ReserveBank loans are not used for purely speculativepurposes, they are not to be used merely forinvestment purposes or for the purpose oftrading in securities other than obligations ofthe United States. Section 13 of the originalFederal Reserve Act expressly provided thatwhile the Board should have the right to definethe character of paper eligible for discount, nosuch definition should include paper covering"merely investments or issued or drawn for thePurpose of carrying or trading in stocks, bonds,or other investment securities, except bonds andnotes of the Government of the United States."This provision is still in the law."

It has been noted in an earlier chapter that,as a corollary of the real-bills doctrine, theBoard until 1973 had always prohibited Reserve

Bank loans on paper drawn to cover permanentor fixed investments, such as real estate, build-ings, or machinery. This position was reversedin the revision of Regulation A adopted in 1973.Under that revision, fixed- or permanent-invest-ment paper is regarded as commercial papereligible as collateral for Federal Reserve creditprovided the proceeds are not to be used merelyfor investment purposes and provided, ofcourse, that the paper meets applicable maturityrequirements.

USE FOR PROFIT

Federal Reserve credit should not be used bya member bank in order to take advantage ofdifferential rates, for example, a difference be-tween the discount rate and the bank's ownlending rates. In 1928 the Board stated: "It isa generally recognized principle that reservebank credit should not be used for profit,* * * _ " ii

This principle was recognized by the Boardin its 1955 revision of Regulation A. The re-vised regulation provided that, in considering arequest for credit accommodation, a ReserveBank should consider whether the borrowingmember bank "is borrowing principally for thepurpose of obtaining a tax advantage or profit-ing from rate differentials." The reference toborrowing for a tax advantage grew out of asituation during the early 1950's in which mem-ber banks were borrowing from their ReserveBanks in order to avoid higher taxes under thethen-existing excess profits tax. In fact, it wasprimarily this development that prompted theBoard to revise its regulation in 1955 in order



to include a statement of principles regardingthe proper use of Federal Reserve credit.

In recent years, with the rapid developmentof the Federal funds market, it has been thepolicy of the System to discourage memberbanks from being net sellers of Federal fundswhile borrowing from a Reserve Bank. Asstated in the Report of a System Committeein July 1968, this restriction is intended "topreclude a large day-to-day retailing operationin Federal Reserve credit obtained throughthe discount window." "

CONTINUOUS BORROWINGIn an earlier chapter it was noted that in

1920 the Federal Reserve Act was amended toprovide for progressive discount rates as adeterrent to continuous borrowings by memberbanks. Although that expedient was not effec-tive and the amendment was later repealed, theSystem has consistently emphasized a policy ofdiscouraging continuous borrowings. The rea-sons for that policy were set forth in the Board's1926 Annual Report." In 1952 ChairmanMartin stated that "continuous indebtedness tothe Reserve Banks should be avoided." " WhenRegulation A was revised in 19SS, it containeda statement that, under "ordinary circum-stances, the continuous use of Federal Reservecredit by a member bank over a considerableperiod of time is not regarded as appropri-ate." 1S

One of the reasons for the policy againstcontinuous borrowing apparently has been thatit could be inconsistent with the provisions ofparagraph 8 of section 4 of the Federal ReserveAct that require the board of directors of aReserve Bank to administer the Bank's affairs"fairly and impartially and without discrimina-tion in favor of or against any member bankor banks" and, in extending credit accommoda-tions, to give due regard to "the claims anddemands of other member banks." Presumably,it was felt that continued and excessive loans toa particular member bank "would not be fairto the other member banks which may be activecompetitors of the borrowing member bank." "

Another reason for the policy against con-tinuous borrowing is that it could impair theability of the borrowing member bank in case of

insolvency to meet its obligations to depositors;in other words, it would not be consistent withprudent banking practice. Still another reasonfor the policy is that extended borrowings by amember bank from its Reserve Bank would ineffect constitute a use of Federal Reserve creditas a substitute for the member bank's capital.Thus, the 1973 revision of Regulation A states,as a general principle, that "Federal Reservecredit is not a substitute for capital and ordi-narily is not available for extended periods."

It should be noted that this principle is quali-fied by the word "ordinarily" and that, as indi-cated later, it is not intended to preclude bor-rowings for extended periods in order to meetunusually long seasonal needs of member banksor to assist member banks in emergencycircumstances.

SHIFT IN EMPHASISThe principles just discussed with respect to

inappropriate uses of Federal Reserve credit arestill being followed. Nevertheless, there hasbeen evidence in recent years of a tendency toplace less emphasis on inappropriate borrow-ings and to give greater emphasis to the use ofFederal Reserve credit for appropriate pur-poses.

When Regulation A was revised in 1955,one of the objectives was to reinforce a limiteduse of the discount window; at that time mostmember banks were in heavily liquid positions,and it was felt that banks should resort to Re-serve Bank credit only on a short-term basiswhen other sources of funds fell short of theirappropriate needs.17 Thus, although the revisionreferred briefly to extension of Federal Reservecredit on a short-term basis to enable a memberbank to adjust its asset position when necessaryand to the availability of such credit for longerperiods to meet unusual situations, it empha-sized the fact that access to the discount windowwas a privilege of membership and that continu-ous use of Federal Reserve credit, as well asborrowing to obtain a tax advantage or to profitfrom rate differentials, was inappropriate.

The 1968 Report of a System Committeeevidenced a subtle change in attitude. It beganwith a statement that the redesign of the dis-count window proposed by that committee ha



as its chief objective "increased use of thediscount window." IS In 1968 member bankswere in a much less liquid position than theyhad been in 1955, and the revision of Regula-tion A that grew out of the committee's recom-mendations included more liberal provisions

for seasonal credit for extended periods of time.In brief, the 1968 proposal, as well as the 1973revision of the regulation, reflected an intent toencourage greater use of the discount window.Further indications of this shift in policy will bementioned in later sections of this chapter.

APPROPRIATE USES OF FEDERAL RESERVE CREDIT

SHORT-TERMADJUSTMENT CREDIT

As a general principle, one of the most ap-propriate uses of Federal Reserve credit is toenable member banks to make short-term ad-justments in their reserve positions. The 1968Report of a System Committee stated that "oneof the basic functions of the Federal ReserveSystem has been to provide temporary additionsto commercial bank reserves through loans tomember banks, in order to cushion the processof adjustment within the financial mecha-nism." »

The foreword to the 1955 revision of Regu-lation A provided:

Federal Reserve credit is generally ex-tended on a short-term basis to a memberbank in order to enable it to adjust its assetposition when necessary because of develop-ments such as a sudden withdrawal of de-posits or seasonal requirements for creditbeyond those which can reasonably be metby use of the bank's own resources.

The revision of the regulation adopted in 1973contemplates that loans to member banks tomeet seasonal requirements for credit might beon a longer-term basis than ordinary adjust-ment credit loans. With respect to adjustmentcredits, the regulation provides:

Federal Reserve credit is available on ashort-term basis to a member bank, undersuch rules as may be prescribed, to suchextent as may be appropriate to assist suchbank in meeting temporary requirements forfunds or to cushion more persistent outflows

of funds pending an orderly adjustment of thebank's assets and liabilities.

Since the beginning of the System, it has beencontemplated that each Federal Reserve exten-sion of credit normally will mature over a shortperiod of time. The original Act authorized thediscounting of commercial paper for memberbanks only if it had a maturity of not more than90 days at the time of discount. Under subse-quent amendments to the Act, advances tomember banks in general may be made only forperiods of not more than 90 days. An exceptionhas been made with respect to agriculturalpaper, which, under present law, is eligible fordiscount if it has a maturity of not more than9 months at the time of discount.

It has already been noted that amendments tothe law have authorized loans to member bankson any satisfactory security for periods up to4 months, but only at a penalty interest rate.Loans with maturities of up to 5 years to com-mercial and industrial businesses were author-ized in 1934 but that authority was repealedin 1958.

In general, therefore, advances to memberbanks at the discount rate may not be madewith maturities of more than 90 days. More-over, a Reserve Bank cannot legally commititself to renew a loan at maturity althoughit may indicate that it will give sympatheticconsideration to a requested renewal in certaincircumstances.

Even though loans may be made to memberbanks for up to the maximum maturity per-mitted by the law, it has been the policy of theSystem to limit maturities according to the



individual bank's circumstances; as a matter ofgeneral practice, loans to member banks foradjustment purposes usually are made to ma-ture in less than 30 days, with renewals asnecessary. Also as a matter of practice, somemember banks, particularly the larger banks,prefer to keep the maturity of their borrowingsto 1 or 2 days in order to have flexibility inmanaging their reserve accounts.

SEASONAL CREDIT

As previously indicated, the 1955 revision ofRegulation A stated that Federal Reserve creditwould be extended on a short-term basis inorder to enable a member bank to adjust itsasset position when necessary because of de-velopments such as a sudden withdrawal ofdeposits or seasonal requirements for creditbeyond those that could reasonably be met byuse of the bank's own resources. That languagewould suggest that all Reserve Bank loans tomeet the seasonal credit requirements of mem-ber banks are for short periods of time.

In 1968, however, the System Committeestudying the discount mechanism proposed thatarrangements be permitted under which sea-sonal credit accommodations might be extendedto a member bank for such period of time aswould be necessary to enable the bank to meetsuch needs. This is another instance in whichthe Board's attitude in recent years toward useof the discount window apparently has becomemore liberal than the attitude reflected in 1955.

The recommendations of the System Com-mittee in 1968 with respect to a seasonal bor-rowing privilege were reflected in the revisionof Regulation A adopted by the Board in 1973.Under the new regulation, Federal Reservecredit is available to a member bank that "lacksreasonably reliable access to national moneymarkets" in order to assist it in meeting seasonalneeds if the credit is arranged in advance andif the Reserve Bank is satisfied that such needswill persist for at least eight consecutive weeks.The revision contemplates that, although a Re-serve Bank could not make an advance formore than 90 days, it would normally be pre-

pared to consider further credit extensions if themember bank's seasonal needs should persistbeyond that period. As a limitation upon sucha seasonal borrowing privilege, the new regula-tion limits seasonal credit in ordinary circum-stances to the amount by which the borrowingbank's seasonal needs exceed 5 per cent of itsaverage total deposits in the preceding calendaryear.

EMERGENCY CREDITIn addition to short-term adjustment credit

and longer-term seasonal credit, it is an ac-cepted principle that a Reserve Bank may ex-tend credit to a member bank in unusual oremergency situations and, if need be for thatpurpose, for extended periods of time. The1968 Report of a System Committee statedthat the Federal Reserve System "has a clearresponsibility to lend to member banks in bothisolated and widespread emergency situations"and that this constitutes one of the benefits ofFederal Reserve membership.20

The 1955 revision of Regulation A statedthat Federal Reserve credit was available "whennecessary in order to assist member banks inmeeting unusual situations, such as may resultfrom national, regional, or local difficulties orfrom exceptional circumstances involving onlyparticular member banks." Similarly, the revi-sion of the regulation adopted in 1973 statesas a general principle that "Federal Reservecredit is available to assist member banks inunusual or emergency circumstances such asmay result from national, regional, or localdifficulties or from exceptional circumstancesinvolving only a particular member bank."

It has been recognized that in most cases inwhich member banks require emergency creditfrom the Reserve Banks, the credit will berequired for a period longer than would bepermitted under the ordinary rules of the dis-count window. Even so, if the member bank sdifficulties arise from an internal problem, itmay be necessary for the Reserve Bank toarrange a daily maturity for the loan so that itmay follow the member bank's progressthroughout the borrowing span.



LENDER OF LAST RESORT

The original Federal Reserve Act contem-plated that Federal Reserve credit would beextended only to member banks, although aprovision of the Act apparently envisaged thepossibility of indirect extension of credit to anonmember bank through the medium of amember bank if approved by the Board.

Over the years, as has been noted in thisstudy, the Act has been amended to authorizethe Reserve Banks to make loans directly toindividuals, partnerships, and corporations onthe security of U.S. Government and agencyobligations or, in exigent or unusual circum-stances, on the security of paper that would beeligible for discount in the hands of a memberbank. The nature of these special authorizationshas been discussed in detail in earlier chapters.As noted, the authority to make direct loansto business enterprises and any other corpora-tions in unusual or exigent circumstances wasutilized for several years during the 193O's,although not to any great extent. In 1966 andagain in 1969, the Board took measures underwhich the Reserve Banks were placed in aposition, if it became necessary, to extend creditdirectly to nonmember banks and other de-positary-type financial institutions such as sav-ings and loan associations.

In recent years, it has become customary torefer to the Federal Reserve System as thelender of last resort to all segments of theeconomy. Thus, the 1968 System CommitteeReport stated: "

The role of the Federal Reserve as the"lender of last resort" to other financial sec-tors of the economy may, under justifiablecircumstances, require loans to institutionsother than member banks. The apparent gen-eral approval of recent instances of lendingand offering to lend to nonmember institu-tions has strengthened the belief that theSystem's ability to carry out this functionshould be readily available for use whenneeded. In contrast to the case of memberbanks, however, justification for Federal Re-serve assistance to nonmember institutionsmust be in terms of the probable impact offailure on the economy's financial structure.It would be most unusual for the failure of asingle institution or small group of institu-tions to have such significant repercussions asto justify Federal Reserve action.

The 1955 revision of Regulation A, whilereferring to extensions of credit to memberbanks in exceptional circumstances, containedno reference to the extension of emergencycredit to others. In contrast, the revision of theregulation adopted in 1973 expressly providesfor the extension of Federal Reserve credit toindividuals, partnerships, and corporations inemergency circumstances on the security ofU.S. Government obligations if, in a ReserveBank's judgment, "credit is not practicablyavailable from other sources and failure toobtain such credit would adversely affect theeconomy."

PROTECTION OF RESERVE BANKS

Although the Reserve Banks are organizedand operated for public purposes and not forprofit, their operations are nevertheless likethose of commercial banks to the extent that

they have stockholders and directors and areexpected to conduct their business on a soundbasis. Their loans are made on a businesslikebasis—with interest and with security.



The discount provisions of the original Fed-eral Reserve Act required—and still require—that paper offered by member banks for dis-count be endorsed by the borrowing memberbank, thus affording the lending Reserve Bankrecourse against the member bank.22 When thelaw was amended to authorize advances tomember banks on their own notes, such ad-vances were required to be secured, at first bypaper eligible for discount or Government obli-gations and later by any paper eligible fordiscount or for purchase by the Reserve Banks.In 1932 the Reserve Banks were authorized tomake advances to member banks on any secur-ity satisfactory to the lending Reserve Bank.Loans to individuals, partnerships, or corpora-tions must be secured by obligations of theUnited States or agencies of the United Statesif credit is extended under the thirteenth para-graph of section 13; or if, under that paragraph,emergency loans are made on eligible paper,the paper must be endorsed or otherwise se-cured to the satisfaction of the Reserve Bank.

In brief, it has always been understood thatthe Reserve Banks should make only loans thatare adequately secured. At one time the Board'sRegulation A specifically authorized the Re-serve Banks to require additional collateralwhen deemed desirable. The 1955 revision,however, stated that a Reserve Bank in generalshould limit such collateral to "the minimumconsistent with safety," and the 1973 revision

provides that a Reserve Bank should "requireonly such amount of collateral as it deems nec-essary or desirable."

The Board's regulation until recent yearsrequired that commercial or agricultural paperoffered for discount or as collateral for advancesshould be negotiable. Although some addedprotection was afforded by negotiability, thisrequirement was eliminated in 1970, partly inrecognition of the increasing practice of makinginterest on notes dependent on changes in theprime rate—a practice that made the notesnonncgotiablc in a technical sense. Shortlyafterward, the Board amended its regulation topermit advances to member banks pursuant tolending agreements already in effect without theexecution of a traditional promissory note inconnection with each advance.

From these changes in practice emerged theconcept that the Reserve Banks, while theyshould make only sound and well-secured loans,should be allowed to extend credit, in the publicinterest, without having to take all possibleprecautions to avoid loss. In some instances,it may be difficult to ascertain how far a ReserveBank should go in extending credit to memberbanks (or to others) when the borrower is ina difficult situation and the Reserve Bank wouldbe subject to possible loss. In such cases, thereis a delicate balance between avoidance of lossand the desirability of preserving the financialstability of the borrower.

DISCRETION OF FEDERAL RESERVE BANKS

LEGISLATIVE INTENT

A fundamental principle underlying the lend-ing authority of the Federal Reserve Banks isthat this authority is purely discretionary. AReserve Bank is not obliged or required toextend credit in any particular case, even thoughthe loan may be for a purpose contemplated bythe law and may be secured by eligible paper.

The Reserve Bank may refuse to make a loanif it is not satisfied as to the soundness of theloan or if it believes that the loan would resultin an improper use of Federal Reserve creditthat would be inconsistent with the generalprinciples heretofore mentioned. In the finalanalysis, the decision in each case rests in thejudgment of the Federal Reserve Bank.



So well established is the discretionary natureof the lending authority of the Reserve Banksthat it is now almost impossible to believe thatthe framers of the original Federal Reserve Actcame very close to making it mandatory. Sena-tor Hitchcock, who led the minority section ofthe Senate Banking and Currency Committee,had urged that a member bank should beentitled as of right to obtain discounts at leastup to the amount of its capital stock.23 In sup-port of this proposal, it was argued that if thelending authority were discretionary, a ReserveBank might refuse to extend credit for any ofthe plausible reasons that bankers are in thehabit of giving;:t that if a member bank wererequired to carry reserves with its Federal Re-serve Bank, it was only right that it should beentitled to discounts in time of need up to theamount of its capital stock;M and finally, thatmandatory discounting of eligible paper wouldinsure an adequate supply of the new FederalReserve currency that was expected to be issuedon the basis of such paper.26

In opposition to these arguments, the ma-jority section of the Senate committee led bySenator Owen pointed out that "many un-looked-for conditions" might arise that wouldmake it unwise to compel the Reserve Banks todiscount paper in particular cases even thoughlegally eligible for discount;27 also, that theeligibility of paper offered for discount shouldbe only the first step and that the law shouldnot take away from the directors of a ReserveBank the right to investigate the soundness ofthat paper.5" In answer to arguments that com-pulsory discounting would prevent discrimina-tion between member banks, advocates of theOwen bill pointed to the provision of that billthat required the directors of each ReserveBank to administer its affairs "fairly and im-partially and without discrimination in favor ofor against any member bank or banks." SenatorShafroth explained: *•

• • * We thought that [the compulsorydiscount provision of the Hitchcock bill] wastoo extreme a provision; it was thought wisethat there might be conditions of the bankthat would not justify the discounting of its

paper. For that reason we put in a clause,which to a large extent is advisory to them,but which, nevertheless, indicates the policythat should be pursued by them in makingthese discounts where they fairly can.

Senator Pomerene likewise felt that the pro-vision of the Owen bill would adequately pre-vent discrimination.30 He, as well as SenatorOwen, pointed out that, in view of this provi-sion, any member bank that felt it had beendiscriminated against could appeal to the Fed-eral Reserve Board. In this connection, SenatorOwen made the following succinct statementregarding the contemplated relationship be-tween the Board and the Federal ReserveBanks: "

I take it that the Federal reserve board,under its general supervisory control of thesystem, would have a right to hear such acomplaint, to call the attention of the boardof directors to the complaint, and exact ofthem fair treatment of the member bank whomight have been discriminated against; but Ido not take it that the Federal reserve boardwould pass upon the question of the securityor upon the particular transaction or take itout of the hands of the local board. It wouldonly instruct them to discharge their dutyproperly under the provisions of the bill.

In the end, Senator Hitchcock's amendmentto substitute his compulsory-discount provisionfor the Owen bill's nondiscrimination provisionwas defeated by a close vote of 37 to 31.32

The provision of the Owen bill was acceptedby the conference committee and became a partof the original Act.

In keeping with its rejection of the Hitchcockproposal for mandatory discounts, Congress hasdeliberately used permissive language in pro-visions of the Federal Reserve Act relating tothis subject. For example, the word "may" isused in those provisions that deal with discountsof commercial and agricultural paper, discountsof bankers' acceptances, advances on Govern-ment obligations, and advances under sectionlO(b) on any satisfactory security. Moreover,the Supreme Court of the United States hasstated that the word "may," as used in the Fed-eral Reserve Act, is not to be construed as



"shall," since "throughout the act the distinctionis clearly made between what the Board and thereserve banks 'shall' do and what they 'may'do." 3:i In this connection, it is significant thatwhen the eighth paragraph of section 4 of theFederal Reserve Act was amended by the Bank-ing Act of 1933, the language of that paragraphrelating to extensions of Federal Reserve creditwas rephrased to change the word "shall" to"may."

RECOGNITION BY THE BOARD

The principle that the Federal ReserveBanks must exercise their own judgment anddiscretion in deciding whether to discount paperfor member banks was recognized by the Fed-eral Reserve Board in the early years of theSystem. In 1920 the Board ruled that, eventhough paper might be legally eligible for dis-count, a Federal Reserve Bank was under noobligation to discount such paper, but mightaccept it or refuse it "in the exercise of its dis-cretionary power."31 In the same year theBoard held that, although a banker's acceptancemight be technically eligible for discount, aFederal Reserve Bank might, in its discretion,decline to discount the acceptance on the groundthat it was not a desirable investment.3'1

The Board's 1955 revision of Regulation Aspecifically referred to access to the FederalReserve discount window as "a privilege ofmembership in the Federal Reserve System"and stated that applications for credit accom-modation are considered by a Reserve Bank "inthe light of its best judgment" in conformitywith the principles stated in the regulation andwith the provisions of the law.

JUDICIAL CONFIRMATION

In 1929 the discretion of the Reserve Banksin granting discount accommodations was judi-cially confirmed by a Federal Circuit Court ofAppeals. In Raichle v. Federal Reserve Bank ofNew York,3" suit had been brought to enjointhe Reserve Bank from engaging in open mar-ket operations, declining to discount eligiblepaper, and raising the discount rate. Specifically,it was charged that the Reserve Bank had

wrongfully refused to discount paper for certainmember banks unless they liquidated loans tobrokers. The suit was dismissed because theFederal Reserve Board, as an indispensableparty, had not been joined. The court pointedout, however, that a Federal Reserve Bank "isnot under any compulsion to rediscount eligiblepaper, for the words of the act in respect torcdiscounling arc wholly permissive." With re-spect to the charge that the Reserve Bank hadwrongfully coerced member banks to call col-lateral loans by refusing to discount eligiblepaper for such banks, the court declared: "Sucha refusal was not a wrong, because no provisionof the act requires the [Federal Reserve] bankto discount unless so ordered by the Board."[Emphasis in original.] The court's use of thewords "unless so ordered by the Board" couldbe misleading. The only provision of law underwhich a Reserve Bank may be ordered by theBoard to extend credit is that contained insection 11 (b) of the Federal Reserve Act,which authorizes the Board to require a Re-serve Bank to rediscount the discounted paperof another Reserve Bank. As a matter of law,the Board cannot require any Reserve Bank tomake loans to member banks or to individuals,partnerships, and corporations.

QUASI-AUTOMATIC ACCESS TOFEDERAL RESERVE CREDIT

In July 1968 a System Committee proposed aredesign of the Federal Reserve discount win-dow, a major feature of which was a suggestionthat member banks be given a "basic borrowingprivilege." Under that proposal, a ReserveBank would extend credit on a virtually auto-matic basis to member banks within certainlimitations on amounts and frequency of bor-rowing. It was contemplated that such an ar-rangement would enable member banks to usethe discount window more readily when theyneeded funds for short-term adjustment pur-poses and that this privilege would be particu-larly attractive to the great majority of smallmember banks that were making no recourseto the discount window." This proposal, how-ever, has not been implemented by the Board.



THE BASIC PRINCIPLE:ECONOMIC STABILITY AND GROWTH

Underlying all of the general principles dis-cussed in this chapter is the basic objectiveof utilizing Federal Reserve credit facilities toassure a sound financial system and to promoteeconomic stability and growth.

Thus, the foreword to the Board's 1955 re-vision of Regulation A stated, with respect tothe discount function of the Reserve Banks,that it "is administered in the light of thebasic objective which underlies all Federal Re-serve credit policy, i.e., the advancement of thepublic interest by contributing to the greatestextent possible to economic stability andgrowth."

The revision of Regulation A adopted in1973 specifically states that the lending func-tions of the System "are conducted with dueregard to the basic objectives of the Employ-ment Act of 1946 and the maintenance of asound and orderly financial system."

To sum up, the lending functions of theReserve Banks, like all other functions of the

Federal Reserve System, are in the nature ofa public trust to be exercised always in theinterest of the general welfare. No better state-ment of this principle can be found than thatcontained in the Board's first Annual Reportto Congress, for the year 1914, when, in dis-cussing the "place and function of the FederalReserve Banks in our banking and credit sys-tem," the Board said:3S

* * * It [a Federal Reserve Bank] shouldat all times be a steadying influence, leadingwhen and where leadership is requisite, butnever allowing itself to become an instrumentfor the promotion of the selfish interest ofany private or sectional group, be their aimsand methods open or disguised. It shouldnever be lost to sight that the Reserve Banksare invested with much of the quality of apublic trust. They were created because of theexistence of certain common needs and in-terests, and they should be administered forthe common welfare—for the good of all.


Textual Changes in Provisionsof the Federal Reserve Act

EXPLANATION

The following compilation sets forth provisionsrelating to the lending functions of the FederalReserve Banks as contained in the originalFederal Reserve Act or in later amendmentsto that Act and indicates textual changes insuch provisions made by amendatory statutes.

Italics indicate new language inserted or added°y amendments; cancelled words indicate oldlanguage stricken out.

Three asterisks indicate the omission of lan-fiuage of a paragraph not changed by a particu-lar amendment; five asterisks indicate the omis-

sion of an intervening paragraph or paragraphsnot affected by an amendment.

"Original Act" means the Federal Reserve Actof December 23, 1913 (38 Stat. 251).

A bracketed number preceding a paragraph ofa section of the Act indicates the number ofthe corresponding paragraph, if any, containedin that section as of May 1, 1973.

A bracketed citation at the end of a paragraphindicates where the paragraph, if still in force,may be found in the United States Code.

203



SECTION 4

Original Act

[6] Every Federal reserve bank shall be conducted under the super-vision and control of a board of directors. (12 t'.S.C. § 3011

[7] The board of directors shall perform the duties usually apper-taining to the office of directors of banking associations and allsuch duties as are prescribed by law. [ 12 I'.S.C. § 301 ]

[8] Said board shall administer the affairs of said bank fairly andimpartially and without discrimination in favor of or against anymember bank or banks and shall, subject to the provisions of lawand the orders of the Federal Reserve Board* extend to each mem-ber bank such discounts, advancements and accommodations asmay be safely and reasonably made with due regard for the claimsand demands of other member banks.

Act of June 16,1933 (48 Stat. 162) :

[8] Said board of directors shall administer the affairs of said bankfairly and impartially and without discrimination in favor of oragainst any member bank or banks and skftH may, subject to theprovisions of law and the orders of the Federal Reserve Board,extend to each member bank such discounts, advancements, andaccommodations as may be safely and reasonably made with dueregard for the claims and demands of other member banks, themaintenance of sound credit conditions, and the accommodation ofcommerce, industry, and agriculture. The Federal Reserve Boardmay prescribe regulations further defining within the limitations ofthis Act the conditions under which discounts, advancements, andthe accommodations may be extended to member banks. Each Fed-eral reserve bank shall keep itself informed of the general characterand amount of the loans and investments of its member banks witha view to ascertaining whether undue use is being made of bankcredit for the speculative carrying of or trading in securities, realestate, or commodities, or for any other purpose inconsistent withthe maintenance of sound credit conditions; and, in determiningwhether to grant or refuse advances, rediscounts or other credit ac-commodations, the Federal reserve bank shall give consideration tosuch information. The chairman of the Federal reserve bank shallreport to the Federal Reserve Board any such undue use of bank creditby any member bank, together with his recommendation. Whenever,in the judgment of the Federal Reserve Board, any member bank ismaking such undue use of bank credit, the Board may, in its discre-tion, after reasonable notice and an opportunity for a hearing, suspendsuch bank from the use of the credit facilities of the Federal ReserveSystem and may terminate such suspension or may renew it fromtime to time. [ 12 U.S.C. § 301 ]

* The Banking Act of 1935 provided that sifter the dote of that Art the words "FederalReserve Board", wherever they formerly appeared in the Federal Reserve Act or other actsof Congress, were chanRed to read "Board of Governors of the Federal Reserve System."


FR ACT: TEXTUAL CHANGES 205

SECTION 9

Act of June 21,1917 (40 Stat. 232):

I13] * • * Subject to the provisions of this Act and to theregulations of the board made pursuant thereto, any bank becom-ing a member of the Federal Reserve System shall retain its fullcharter and statutory rights as a State bank or trust company,and may continue to exercise all corporate powers granted it bythe State in which it was created, and shall be entitled to all priv-ileges of member banks: Provided, however, That no Federal re-serve bank shall be permitted to discount for any State bank ortrust company notes, drafts, or bills of exchange of any one bor-rower who is liable for borrowed money to such State bank ortrust company in an amount greater than ten per centum of thecapital and surplus of such State bank or trust company, but thediscount of bills of exchange drawn against actually existing valueand the discount of commercial or business paper actually ownedby the person negotiating the same shall not be considered asborrowed money within the meaning of this section. The Federalreserve bank, as a condition of the discount of notes, drafts, andbills of exchange for such State bank or trust company, shall re-quire a certificate or guaranty to the effect that the borrower isnot liable to such bank in excess of the amount provided by thissection, and will not be permitted to become liable in excess of thisamount while such notes, drafts, or bills of exchange are underdiscount with the Federal reserve bank.

Act of July 1,1922 (42 Stat. 821):

[13] * * * Subject to the provisions of this Act and to the regula-tions of the board made pursuant thereto, any bank becominga member of the Federal Reserve System shall retain its fullcharter and statutory rights as a State bank or trust company,and may continue to exercise all corporate powers granted it bythe State in which it was created, and shall be entitled to allprivileges of member banks: Provided, however, That no Fed-eral reserve bank shall be permitted to discount for any Statebank or trust company notes, drafts, or bills of exchange of anyone borrower who is liable for borrowed money to such Statebank or trust company in an amount greater than tea pepeestwa el &e capital ea4 ewpte* «4 eaea State few* e* 4wetcompany, feat the diooount ef feSfe el eseaeage d*ftwa againotaetwafly exartiftg ^atee ead the diacount el commercial eg h*m-nesepapep aetnaHy ewaed by the peraee negotiating &e sameshall ae* fee conoidorod as feewewed flseaey fl4ta» the moaningel this oootion that which could be borrowed lawfully from suchState bank or trust comvanv were it a national banking associa-tion. • • • (12 U.S.C. §330]



SECTION 10(a)

Act of February 27,1932 (47 Stat. 56):

[I] Sec. 10. (a) Upon receiving the consent of not less than fivemembers of the Federal Reserve Board, any Federal reserve bankmay make advances, in such amount as the board of directors ofsuch Federal reserve bank may determine, to groups of five ormore member banks within its district, a majority of them inde-pendently owned and controlled, upon their time or demand prom-issory notes, provided the bank or banks which receive the pro-ceeds of such advances as herein provided have no adequateamounts of eligible and acceptable assets available to enable suchbank or banks to obtain sufficient credit accommodations fromthe Federal reserve bank through rediscounts or advances otherthan as provided in section 10(b). The liability of the individualbanks in each group must be limited to such proportion of thetotal amount advanced to such group as the deposit liability of therespective banks bears to the aggregate deposit liability of allbanks in such group, but such advances may be made to a lessernumber of such member banks if the aggregate amount of theirdeposit liability constitutes at least 10 per centum of the entiredeposit liability of the member banks within such district. Suchbanks shall be authorized to distribute the proceeds of such loansto such of their number and in such amount as they may agreeupon, but before so doing they shall require such recipient banksto deposit with a suitable trustee, representing the entire group,their individual notes made in favor of the group protected bysuch collateral security as may be agreed upon. Any Federalreserve bank making such advance shall charge interest or dis-count thereon at a rate not less than 1 per centum above its dis-count rate in effect at the time of making such advance. No suchnote upon which advances are made by a Federal reserve bankunder this section shall be eligible under section 16 of this Act ascollateral security for Federal reserve notes. [ 12 U.S.C. § 347a]

[2] No obligations of any foreign government, individual, partner-ship, association, or corporation organized under the laws thereofshall be eligible as collateral security for advances under thissection. [12 U.S.C. § 347a]

[3] Member banks are authorized to obligate themselves in accord-ance with the provisions of this section. [12 U.S.C. § 347a]

SECTION 10(b)

Act of February 27, 1932 (47 Stat. 56):

[1] Sec. 10. (b) Until March S, 19SS, and in exceptional and exigentcircumstances, and when any member bank, having a capital of notexceeding $5,000,000, has no further eligible and acceptable assets



available to enable it to obtain adequate credit accommodationsthrough rediscounting at the Federal reserve bank or any othermethod provided by this Act other than that provided by section10(a), any Federal reserve bank, subject in each case toaffirmative action by not less than five members of the FederalReserve Board, may make advances to such member bank on itstime or demand promissory notes secured to the satisfaction ofsuch Federal reserve bank: Provided, That (1) each such noteshall bear interest at a rate not less than 1 per centum per annumhigher than the highest discount rate in effect at such Federalreserve bank on the date of such note; (2) the Federal ReserveBoard may by regulation limit and define the classes of assetswhich may be accepted as security for advances made under au-thority of this section; and (S) no note accepted for any such ad-vance shall be eligible as collateral security for Federal reservenotes.

No obligations of any foreign government, individual, partner-ship, association, or corporation organized under the laws thereofshall be eligible as collateral security for advances under thissection.

Act of February 3,1933 (47 Stat. 794):

[1] SEC. 10. (b) Until March 3, +93* 1934, and in exceptional andexigent circumstances, and when any member bank, having acapital of not exceeding $5,000,000, has no further eligible andacceptable assets available to enable it to obtain adequate creditaccommodations through rediscounting at the Federal reservebank or any other method provided by this Act other than thatprovided by section 10 (a), any Federal reserve bank, subject ineach case to affirmative action by not less than five members ofthe Federal Reserve Board, may make advances to such memberbank on its time or demand promissory notes secured to thesatisfaction of such Federal reserve bank: Provided, That (1)each such note shall bear interest at a rate not less than 1 percentum per annum higher than the highest discount rate in effectat such Federal reserve bank on the date of such note; (2) theFederal Reserve Board may by regulation limit and define theclasses of assets which may be accepted as security for advancesmade under authority of this section; and (3) no note acceptedfor any such advance shall be eligible as collateral security forFederal reserve notes.

Act of March 9,1933 (48 Stat. 1):

[1] SEC. 10t(b). Watil March 87 WMy e»el i/n exceptional and exi-gent circumstances, and when any member bank? having «eepitel ei mi exceeding 86,000;000, has no further eligible andacceptable assets available to enable it to obtain adequate credit



accommodations through rediscounting at the Federal reservebank or any other method provided by this Act other than thatprovided by section 10(a), any Federal reserve bank, oubjcet ineaefe. ease *e affirmative action fey «e* iesa than five members efunder rules and regulations prescribed by the Federal ReserveBoard, may make advances to such member bank on its timeor demand promiooory notes secured to the satisfaction of suchFederal reserve bank*. Provided; Tfea* ft) e£ach such note shallbear interest at a rate not less than 1 per centum per annumhigher than the highest discount rate in effect at such Federalreserve bank on the date of such note-}. {3) tfee Federal Reserve.D U l t r a XIIUJr VJ* lUgUJIXlIUIt TTTTTT© TOTTX UU1IIIU LIIU LHHwUU t7T U J J L I J

which may fee accepted es occuritj' #e* advaneca made underciutfionty Or 1*1119 Qcotion j Qnu (07 1 0 fiot© ftocopt*oo IOP ftny siionadvance ahaU fee eligible ae collateral occurity fef Federal reservenotes: No advance shall be made under this section after March 3,1934, or after the expiration of such additional period not exceedingone year as the President may prescribe.

£?e obligationa ef any foreign government, individual partnerohip, aooociation, ev corporation organiacd wtder ike iwwe thereofohall fee eligible as collateral oceurit-y ley advanced wmle* tfeis

Act of August 23, 1935 (49 Stat. 684):

[1] SEC. 10(b). fe cjiccptional a»4 exigent eiroumotancca, andwhen a»y member feaRk feas «e further eiigifele a«4 acceptableaoacto available te enable k *o obtain adequate ered4* ttoeomnie-dationo through rediacounting a* -tfee Federal rencrvo bank era«y etfeef method provided fey tfeis Aet ©tfeer «^a» that f»e-yided fey ocction 4e(a)7 a^ny Federal rReserve bank, under rulesand regulations prescribed by the Federal Reoorve Board ofGovernors of the Federal Reserve System, may make advances toeaefe. any member bank on its time or demand notes havingmaturites of not more than four months and which ar,e secured tothe satisfaction of such Federal r.Reserve bank. Each such noteshall bear interest at a rate not less than one-half of 1 per centumper annum higher than the highest discount rate in effect atsuch Federal *.ffeserve bank on the date of such note. No ad-vaftee sfeatt fee made «ftdep tfeb oection afte* Marefe »y 4934r <wftfte* 4&e expiration of SMeh additional perietl «et exceeding eaeyeap as 4fee Prcoidcnt may prcoeribe. [12 U.S.C. § 317b]

SECTION 11

Original Act:

[1] SEC. 11. The Federal Reserve Board shall be authorized andempowered: f 12 U.S.C. § 248]



[3J (b) To permit, or, on the affirmative vote of at least five mem-bers of the Reserve Board to require Federal reserve banks to re-discount the discounted paper of other Federal reserve banks atrates of interest to be fixed by the Federal Reserve Board.112 u.&.C § 24S(b) ]

[4] (c) To suspend for a period not exceeding thirty days, and fromtime to time to renew such suspension for periods not exceedingfifteen days, any reserve requirements specified in this Act: Pro-vided, That it shall establish a graduated tax upon the amountsby which the reserve requirements of this Act may be permittedto fall below the level hereinafter specified: And provided further,That when the gold reserve held against Federal reserve notesfalls below forty per centum, the Federal Reserve Board shallestablish a graduated tax of not more than one per centum perannum upon such deficiency until the reserves fall to thirty-twoand one-half per centum, and when said reserve falls below thirty-two and one-half per centum, a tax at the rate increasingly of notless than one and one-half per centum per annum upon each twoand one-half per centum or fraction thereof that such reserve fallsbelow thirty-two and one-half per centum. The tax shall be paid bythe reserve bank, but the reserve bank shall add an amount equal tosaid tax to the rates of interest and discount fixed by the FederalReserve Board.

Act of September 7, 1916 (39 Stat. 752):

[14J (m) Upon the affirmative vote of not less than five of its membersthe Federal Reserve Board shall have power, from time to time, bygeneral ruling, covering all districts alike, to permit member banks tocarry in the Federal reserve banks of their respective districts any por-tion of their reserves now required by section nineteen of this Act tobe held in their own vaults.

Act of March 3, 1919 (40 Stat. 1314, 1315):

[14] (m) Upon the affirmative vote of not less than five of its mem-bers the Federal Reserve Board shall have powerr front tm*e -to-T'inftOy tjy gencftti ptningr covering ftH (HstriGt'O &iiKof to permit memher fea»k»1» eaffy 4» the- Federal reserve banks «f their respectivethetneto any portion ef time reocrvco Hew- required by section aiae-tee« ef 44MS Aet to fee heJ4 « their -ewa vaults to discount for anymember bank notes, drafts, or bills of exchange bearing the signatureor endorsement of any one borrower in excess of the amount permittedby section nine and section thirteen of this Act, but in no case to exceedtwenty per centum of the member bank's capital and surplus: Provided,however, That all such notes, drafts, or bilk of exchange discountedfor any member bank in excess of the amount permitted under suchsections shall be secured by not less than a like face amount of bonds ornotes of the United States issued since April twenty-fourth, nineteen



hundred and seventeen, or certificates of indebtedness of the UnitedStates: Provided further, That the provisions of this subsection (m)shall not be operative after December thirty-first, nineteen hundred andtwenty.

Act of February 27, 1921 (41 Stat. 1146):

[14] (m) Upon the affirmative vote of not less than five of its mem-bers, the Federal Reserve Board shall have power to permit Federalreserve banks to discount for any member bank notes, drafts, orbills of exchange bearing the signature or endorsement of any oneborrower in excess of the amount permitted by section nine 9 andsection thirteen 13 of this Act, but in no case to exceed twenty SOper centum of the member bank's capital and surplus: Provided,however, That all such notes, drafts, or bills of exchange discountedfor any member bank in excess of the amount permitted under suchsections shall be secured by not less than a like face amount ofbonds or notes of the United States issued since April twenty fourth,nineteen hundred ami oevcntecnr 24, 1917, for which the borrowershall in good faith prior to January 1, 1921, have paid or agreed topay not less than the full face amount thereof, or certificates of in-debtedness of t»e United States: Provided further, That the provi-sions of this subsection (m) shall not be operative after Decemberthirty first, maeteen IHM4I«4 wtd twenty October 31, 1921.

Act of June 16, 1933 (48 Stat. 162, 167):

[14] (m) Upon the affirmative vote of not less than -five- six of itsmembers;- the Federal Reserve Board shall have power to pepmitFederal rocorvo banks i» discount fe* any member bank notoer

«F feiite ef exchange bearing the oignoturc -BF endoraomontborrowor m oxooec of 4h«- amount permitted 4»y ocetioH-

o xn vmts a c t j irtTL tit RT9 ??U(H" V J trJttrtrCTi TBTT |TU» t t i i w u t i '

«l th»mombor-bwtj^a e«f»itol B,&4 mrplue: Provided, however, T-htA«ti Bueh aetcB, dfftfto, m feitieef exchange diiwuiintcd for any mem-her beak m oxecno «f *}»«• amount permitted under »*H4* eectionaoOftii o© OOOUPOQ &y "ftOt JC60 vtlfttl ft llKC IflCC fkniOUHb ttl tMJtlCltl OrTinf nn nf f)i/> TI^^^J G*«4.«« z ~J *±lnjnn \ nmtj\ OJ tni *? tnilUUUJ T7T uaivf C711IVUU OUllUU iWOtTCTT ENflvt? /TjTTtt £ i f x*TTTy I V* w DO PFO W C F BflQll if! ^OOu I (lit-1) pWOI*1 x©1 »7ftWUftfy xr l v c l f ftflVC

^F &EPCCu *© •pfty fto* lco& viiftn tflc lull face amount thcrcoif wtificoteo -ef mdebtcdncoe «(• the tWted Stete«« Provided farther?¥hat 4he provieiona «f *W& aubocotion (m) «kaH -nefc be operativeafter October Hj Si- fix from time to time for each Federal reservedistrict the percentage of individual bank capital and surplus whichmay be represented by loans secured by stock or bond collateral madeby member banks within such district, but no such loan shall be madeby any such bank to any person in an amount in excess of 10 per centumof the unimpaired capital and surplus of such bank. Any percentage sofixed by the Federal Reserve Board shall be subject to change fromtime to time upon ten days' notice, and it shall be the duty of the Board



to establish such percentages with a view to presenting the undue useof bank loans for the speculative carrying of securities. The FederalReserve Board shaU have power to direct any member bank to refrainfrom further increase of its loans secured by stock or bond collateral forany period up to one year under penalty of suspension of all rediscountprivileges at Federal reserve banks.

Aci of August 23, 1935 (49 Stat 684, 713):

[14] (m) Upon the affirmative vote of not less than six of its mem-bers the Federal- Rocorvo Board of Governors of the Federal ReserveSystem shall have power to fix from time to time for each Federalreserve district the percentage of individual bank capital and sur-plus which may be represented by loans secured by stock or bondcollateral made by member banks within such district, but no suchloan shall be made by any such bank to any person in an amountin excess of 10 per centum of the unimpaired capital and surplusof such bank; Provided, That with respect to loans represented byobligations in the form of notes secured by not less than a like amountof bonds or notes of the United Slates issued since April 24, 1917, cer-tificates of indebtedness of the United States, Treasury bills of theUnited Stales, or obligations fully guaranteed both as to principal andinterest by the United States, such limitation of 10 per centum on loansto any person shall not apply, but Slate member banks shall be subjectto the same limitations and conditions as are applicable in the case ofnational banks under paragraph (8) of section 6200 of the RevisedStatutes, as amended {U. S. C, Supp. VII, title 12, sec. 84). Anypercentage so fixed by the Federal Rocorvo Board of Governors ofthe Federal Reserve System shall be subject to change from timeto time upon ten days' notice, and it shall be the duty of the Boardto establish such percentages with a view to preventing the undueuse of bank loans for the speculative carrying of securities. TheFederal RoDorvo Board of Governors of the Federal Reserve Systemshall have power to direct any member bank to refrain from furtherincrease of its loans secured by stock or bond collateral for anyperiod up to one year under penalty of suspension of all rediscountprivileges at Federal reserve banks.

Act of June 12, 1945 (59 Stat. 237):

[4] (c) * * * And provided further, That when the geW- reserveheld against Federal reserve notes falls below ferty- 25 per centum,the Board of Governors of the Federal Reserve System shall estab-lish a graduated tax of not more than em / per centum per annumupon such deficiency until the reserves fall to thirty-two «ftd wte-bftif 20 per centum, and when said reserve falls below thirty• twe£^4 one half 20 per centum, a tax at the rate increasingly of notless than em «H«1 one half 1 1/2 per centum per annum upon eachtwe <H«J WU' half 2 1/2 per centum or fraction thereof that suchreserve falls below thirty twe awd one half 20 per centum. The tax



shall be paid by the *tfeserve bank, but the p/iJeserve bank shalladd an amount equal to said tax to the rates of interest and dis-count fixed by the Board of Governors of the Federal ReserveSystem.

Act of September 9, 1959 (73 Stat. 487, 488):

[14] (m) * * * Provided, That with respect to loans representedby obligations m the lf>H« «rf notcn secured by not less than a likeamount of bonds or notes of the United States issued sinceApril 24, 1917, certificates of indebtedness of the United States,Treasury bills of the United States, or obligations fully guaran-teed both as to principal and interest by the United States, suchlimitations of 10 per centum on loans to any person shall notapply, but State member banks shall be subject to the same limita-tions and conditions as arc applicable in the case of national banksunder paragraph (8) of section 5200 of the Revised Statutes, asamended (U.S.C., Supp. VII, title 12, sec. 84). * * *112 U.S.C. §248(in)]

Act of March 18, 1968 (82 Stat. 50):

[4] (c) To suspend for a period not exceeding thirty days, and fromtime to time to renew such suspension for periods not exceedingfifteen days, any reserve requirements specified in this Act-!Provided, That tt nhn.ll e.*tabli.<h ft gratkitt Uti tft* »f*m the amountsby- which the reserve requirement:* *4 44H* A<»t mny fee permittedt» f«4i below the level hereinafter rt|K'fifietl-i AH4 prowled further,l O l o i TV 11 P i t | |\pi I ' f iffcl*Vll I If1 I l\ n i f H t'-- * * TJ**JT. J I JT. . . . ^ I im, . n m i j t |W1 I Jll*

TTTTTD ^TTTCTT LI1U I L.1V.I I T5 TTnTT CICI1111'111 Jr \j\i\.t II t I X. «' I I T \.' T"**. - «™

below 3© per wntum, 44te Board *4 Governors «tf 44teTt-wcrvc Sy.ntem nhall c.<tnbli.<h ft griwhinted t«H* «f «ot more4- pev eetitum per annum upon ;Hieh defifk'iiey »»tH *4M> rc.'ci'fall to 39 pa* centum, «t«4 when ;*»H4 I't-.x-rve ftttt below 39pcntum, « tfts ft* 44w* » t e inert-tmcly »f «trt I m t4«m + 4-/3v , ^ i n u n i p C T TTTTTTTmT U j m i l I l i t 11 — T / "S J^t X I t M l l ' U f f t t 7 r I f I I I . Ll*'*«

thereof ti«rt rtm4t rcnervc fftHr» below 39 -p*** centum. ¥i*e tftx »kftHfeepftkifey 44te Itc;<crvo bank; t»trt 44wi Ue;U'fve bank s4tftH «tkl ft«amount etttial *« H«t44 ttn* +« *4*e i-tttw «>f in(oi'O;'t ft«d discountfixed fey *b« Boni'il «rf Governors «f the Federal Keocrvc System••[12 U.S.C. §24S(c)]

SECTION 13

Original Act

[2] Upon the indorsement of any of its member banks, with awaiver of demand, notice and protest by such bank, any Federalreserve bank may discount notes, drafts, and bills of exchangearising out of actual commercial transactions; that is, notes,drafts, and bills of exchange issued or drawn for agricultural, in-



dustrial, or commercial purposes, or the proceeds of which havebeen used, or are to be used, for such purposes, the Federal Re-serve Board to have the right to determine or define the charac-ter of the paper thus eligible for discount, within the meaning ofthis Act. Nothing in this Act contained shall be construed to pro-hibit such notes, drafts, and bills of exchange, secured by stapleagricultural products, or other goods, wares, or merchandise frombeing eligible for such discount; but such definition shall not in-clude notes, drafts, or bills covering merely investments or issuedor drawn for the purpose of carrying or trading in stocks, bonds, orother investment securities, except bonds and notes of the Govern-ment of the United States. Notes, drafts, and bills admitted todiscount under the terms of this paragraph must have a maturityat the time of discount of not more than ninety days: Provided,That notes, drafts, and bills drawn or issued for agricultural pur-poses or based on live stock and having a maturity not exceed-ing six months may be discounted in an amount to be limited to apercentage of the capital of the Federal reserve bank, to be ascer-tained and fixed by the Federal Reserve Board.

[6] Any Federal reserve bank may discount acceptances which arebased on the importation or exportation of goods and which havea maturity at time of discount of not more than three months, andindorsed by at least one member bank. The amount of accept-ances so discounted shall at no time exceed one-half the paid-upcapital stock and surplus of the bank for which the rediscountsare made.

[5] The aggregate of such notes and bills bearing the signature orindorsement of any one person, company, firm, or corporation re-discounted for any one bank shall at no time exceed ten percentum of the unimpaired capital and surplus of said bank; butthis restriction shall not apply to the discount of bills of exchangedrawn in good faith against actually existing values.

[7] Any member bank may accept drafts or bills of exchange drawnupon it and growing out of transactions involving the importationor exportation of goods having not more than six months sight torun; but no bank shall accept such bills to an amount equal at anytime in the aggregate to more than one-half its paid-up capitalstock and surplus.

[9] Section fifty-two hundred and two of the Revised Statutes ofthe United States is hereby amended so as to read as follows:No national banking association shall at any time be indebted,or in any way liable, to an amount exceeding the amount of itscapital stock at such time actually paid in and remaining undi-miniehed by losses or otherwise, except on account of demands ofthe nature following:

Fifth. Liabilities incurred under the provisions of the FederalReserve Act.

[10] The rediscount by any Federal reserve bank of any bills re-ceivable and of domestic and foreign bills of exchange, and of



acceptances authorized by this Act, shall be subject to such re-strictions, limitations, and regulations as may be imposed by theFederal Reserve Board.


[6] Any Federal reserve bank may discount acceptances whichare based on the importation or exportation of goods and whichhave a maturity at time of discount of not more than threemonths? and indorsed by at least one member bank. Theamount of acceptances so discounted shall at no time exceed one-half the paid up and unimpaired capital stock and surplus ofthe bank for which the rediscounts are made, except by authorityof the Federal Reserve Board, under such general regulations assaid board may prescribe, but not to exceed the capital stock andsurplus of such bank.

• • • • •

[7] Any member bank may accept drafts or bills of exchange drawnupon it and growing out of transactions involving the importa-tion or exportation of goods having not more than six months'sight to run; but no bank shall accept such bills to an amountequal at any time in the aggregate to more than one-half of itspaid-up and unimpaired capital stock and surplus, except byauthority of the Federal Reserve Board, under such general regula~tions as said board may prescribe, but not to exceed the capital stockand surplus of such bank, and such regulations shall apply to allbanks alike regardless of the amount of capital stock and surplus.

Act of September 7,1916 (39 Stat. 752):

[2] Upon the indorsement of any of its member banks, w*tfe whichshall be deemed a waiver of demand, notice and protest by suchbank as to its own indorsement exclusively, any Federal reservebank may discount notes, drafts, and bills of exchange arisingout of actual commercial transactions; that is, notes, drafts, andbills of exchange issued or drawn for agricultural, industrial, orcommercial purposes, or the proceeds of which have been used,or are to be used, for such purposes, the Federal Reserve Boardto have the right to determine or define the character of thepaper thus eligible for discount, within the meaning of this Act.Nothing in this Act contained shall be construed to prohibitsuch notes, drafts, and bills of exchange, secured by staple agri-cultural products, or other goods, wares, or merchandise frombeing eligible for such discount; but such definition shall not in-clude notes, draft*, or bills covering merely investments or issuedor drawn for the purpose of carrying or trading in stocks, bonds,or other investment securities, except bonds and notes of theGovernment of the United States. Notes, drafts, and bills ad-mitted to discount under the terms of this paragraph must have



a maturity at the time of discount of not more than ninety days,exclusive of days of grace: Provided, That notes, drafts, and billsdrawn or issued for agricultural purposes or based on live stockand having a maturity not exceeding six months, exclusive ofdays of grace, may be discounted in an amount to be limited to apercentage of the capital assets of the Federal reserve bank, tobe ascertained and fixed by the Federal Reserve Board.

[5] The aggregate of such notes, drafts, and bills bearing the sig-nature or indorsement of any one borrower, whether a person, com-pany, firm, or corporation, rediscounted for any one bank shallat no time exceed ten per centum of the unimpaired capital andsurplus of said bank; but this restriction shall not apply to thediscount of bills of exchange drawn in good faith against actuallyexisting values.

[6] Any Federal reserve bank may discount acceptances w&efeare ba3od ©a the importation er exportation el geeds &B4 of thekinds hereinafter described, which have a maturity at the timeof discount of not more than three months1 tight, exclusive ofdays of grace, and which are indorsed by at least one memberbank. 3%e amount el aeeoptaneco ae dioeountod ebaH a* aetime e*eee4 one half tfee paid-op *R4 unimpaired eapital eteekftHu dUPpiUd Or tUO DGLQEC TO¥ WulOtt Tad POulSOOUOtQ ftfO filftuOj

QTEO&DV "j UUWJwTIvJr 0 1 TlW 3r"6«Orftl TX©9©TTT5 XTQBTQJ TEXXCTGIT SuOf i

general rcgulationa as said bea*d may- preooribo, but set teexeeed the capital otoek aad- aurplua el aaeh bank.

[7] Any member bank may accept drafts or bills of exchangedrawn upon it having not more than six months' sight to run, ex-clusive of days of grace, «nd growing which grow out of transactionsinvolving the importation or exportation of goods b*vi»g setmere tbas sis montha' sight te rvm; or which grow out of transac-tions invoking the domestic shipment of goods provided skippingdocuments conveying or securing title are attached at the time ofacceptance; or which are secured at the time of acceptance by awarehouse receipt or other such document conveying or securing titlecovering readily marketable staples. No member bank shall accept,whether in a foreign or domestic transaction, for any one person,company, firm, or corporation to an amount equal at any time inthe aggregate to more than ten per cent of its paid-up and unimpairedcapital stock and surplus unless the bank is secured either by at-tached documents or by some other actual security growing out of thesame transaction as the acceptance b«t and no bank shall acceptsuch bills to an amount equal at any time in the aggregate tomore than one-half of its paid-up and unimpaired capital stockand surplus; eseept by authority el « » ftxfc*al Resewe ©ea*^

«*efe geaeffd rogulationo m said beafd- may proooribo, btttk t k b k d

g gte eseeed tfee capital etoek *ad swpk» et seek beakyrogulationa shftH apply te «B backs alike rogardlcoa ef the

el capital steek as4[8] Any Federal reserve bank may make advances to its member



banks on their promissory notes for a period not exceeding fifteendays at rates to be established by such Federal reserve banks,subject to the review and determination of the Federal ReserveBoard, provided such promissory notes are secured by such notes,drafts, bills of exchange, or bankers' acceptances as are eligiblefor rediscount or for purchase by Federal reserve banks under theprovisions of this Act, or by the deposit or pledge of bonds ornotes of the United States.

• • • • •

[10] The discount and rediscount and the purchase and sale by anyFederal reserve bank of any bills receivable and of domestic andforeign bills of exchange, and of acceptances authorized by thisAct, shall be subject to such restrictions, limitations, and regu-lations as may be imposed by the Federal Reserve Board.

[12] Any member bank may accept drafts or bills of exchangedrawn upon it having not more than three months' sight to run,exclusive of days of grace, drawn under regulations to be pre-scribed by the Federal Reserve Board by banks or bankers inforeign countries or dependencies or insular possessions of theUnited States for the purpose of furnishing dollar exchange asrequired by the usages of trade in the respective countries, de-pendencies, or insular possessions. Such drafts or bills may beacquired by Federal reserve banks in such amounts and subjectto such regulations, restrictions, and limitations as may be pre-scribed by the Federal Reserve Board: Provided, however, Thatno member bank shall accept such drafts or bills of exchange re-ferred to * this paragraph for any one bank to an amount exceed-ing in the aggregate ten per centum of the paid-up and unimpairedcapital and surplus of the accepting bank unless the draft or billof exchange is accompanied by documents conveying or securingtitle or by some other adequate security: Provided further, Thatno member bank shall accept such drafts or bills in an amountexceeding at any time the aggregate of one-half of its paid-up andunimpaired capital and surplus.

Act of June 21, 1917 (40 Stat. 232):

[7] Any member bank may accept drafts or bills of exchange drawnupon it having not more than six months* sight to run, exclusiveof days of grace, which grow out of transactions involving theimportation or exportation of goods; or which grow out of transac-tions involving the domestic shipment of goods provided shippingdocuments conveying or securing title are attached at the time ofacceptance; or which are secured at the time of acceptance by awarehouse receipt or other such document conveying or securingtitle covering readily marketable staples. No member bank shallaccept, whether in a foreign or domestic transaction, for any one



person, company, firm, or corporation to an amount equal at anytime in the aggregate to more than ten per centum of its paid-upand unimpaired capital stock and surplus, unless the bank issecured either by attached documents or by some other actualsecurity growing out of the same transaction as the acceptance;and no bank shall accept such bills to an amount equal at anytime in the aggregate to more than one-half of its paid-up andunimpaired capital stock and surplus: Provided, however, Thatthe Federal Reserve Board, under such general regulations as itmay prescribe, which shall apply to all banks alike regardless ofthe amount of capital stock and surplus, may authorize any mem-ber bank to accept such bills to an amount not exceeding at anytime in the aggregate one hundred per centum of its paid-up andunimpaired capital stock and surplus: Provided, further, That theaggregate of acceptances growing out of domestic transactionsshall in no event exceed fifty per centum of such capital stockand surplus. |12 U.S.C. §372]

Act of March 4,1923 (42 Stat. 1454) :

[2] * * * Nothing in this Act contained shall be construed to pro-hibit such notes, drafts, and bills of exchange, secured by stapleagricultural products, or other goods, wares, or merchandise frombeing eligible for such discount, and the notes, drafts, and bills ofexchange of factors issued as such making advances exclusively toproducers of staple agricultural products in their raw state shall beeligible for such discount; but such definition shall not includenotes, drafts, or bills covering merely investments or issued ordrawn for the purpose of carrying or trading in stocks, bonds,or other investment securities, except bonds and notes of theGovernment of the United States. Notes, drafts, and bills ad-mitted to discount under the terms of this paragraph must havea maturity at the time of discount of not more than ninety 90 days,exclusive of days el grace* Provided, ¥feat notes, drafts aedbiHs draw** e* iaaued for agricultural purpoooo e* baocd ea S*eeieefe aad beting a maturity ae4 exceeding s k montha, cxoluoivoet days el gffteer »H>y be diooounted m aa aBae«B* te be faa&edte a porocntttgo el 4he assets el *fee federal pesefve baafe? *» beooocrtaiaed and feted by the £ede*al Rcoorvo Beard.112 U.S.C. §343]

[4] Upon the indorsement of any of its member banks, which shaUbe deemed a waiver of demand, notice, and protest by such bankas to Us own indorsement exclusively, and subject to regulationsand limitations to be prescribed by the Federal Reserve Board,any Federal reserve bank may discount or purchase bills of ex-change payable at sight or on demand which are drawn to financethe domestic shipment of nonperishable, readily marketable stapleagricultural products and are secured by bills of lading or othershipping documents conveying or securing title to such staples:Provided, That all such bills of exchange shall be forwarded



promptly for collection, and demand for payment shall be madewith reasonable promptness after the arrival of such staples attheir destination: Provided further, That no such bill shall in anyevent be held by or for the account of a Federal reserve bank for aperiod in excess of 90 days. In discounting such bills Federalreserve banks may compute the interest to be deducted on thebasis of the estimated life of each bill and adjust the discount afterpayment of such bills to conform to the actual life thereof.

• • • • •

[6] Any Federal reserve bank may discount acceptances of thekinds hereinafter described, which have a maturity at the timeof discount of not more than three montha' 90 days' sight, exclu-sive of days of grace, and which are indorsed by at least onemember bank; Provided, That such acceptances if drawn for anagricultural purpose and secured at the time of acceptance by ware-house receipts or other such documents conveying or securing titlecovering readily marketable staples may be discounted with a ma-turity at the time of discount of not more than six months' sightexclusive of days of grace.

Act of May 29, 1928 (45 Stat. 975): 112 V.S.C. § 34G|[4] Upon the indorsement of any of its member banks, which shall

be deemed a waiver of demand, notice, and protest by such bankas to its own indorsement exclusively, and subject to regulationsand limitations to be prescribed by the Federal Reserve Board,any Federal reserve bank may discount or purchase bills ofexchange payable at sight or on demand which are drawn *efinance grow out of the domestic shipment or the exportation ofnonperishable, readily marketable otaplo agricultural produotoand other staples and are secured by bills of lading or other ship-ping documents conveying or securing title to such staples: Pro-vided, That all such bills of exchange shall be forwarded promptlyfor collection, and demand for payment shall be made with rea-sonable promptness after the arrival of such staples at theirdestination: Provided further, That no such bill shall in anyevent be held by or for the account of a Federal reserve bank fora period in excess of SO ninety days. In discounting such billsFederal reserve banks may compute the interest to be deductedon the basis of the estimated life of each bill and adjust the dis-count after payment of such bills to conform to the actual lifethereof. [12 U.S.C. §344]

Act of April 12, 1930 (46 Stat. 162):

[5] The aggregate of s«eb notes, drafts, and bills fee«4»g *fee sig-»etwe ef indorsement el e»y e»e borrower, whether tt pcroon,company, firm, er corporation upon which any person, copartner-ship, association, or corporation is liable as maker, acceptor, indorser,drawer, or guarantor, rediscounted for any ene member bank, shallat no time exceed 4e» pe* centum ef {he unimpaired capital d



p ef said bftaki fe«t *feis fe9teietie» afeftH a«* fkpply t© ^ edisown* «t feiHa ef exchange drawa m geed faith agama* aetttaHyexisting vahiea iAe amount for which such person, copartnership,association, or corporation may lawfully become liable to a nationalbanking association under the terms of section 5200 of the RevisedStatutes, as amended: Provided, however, That nothing in thisparagraph shall be construed to change the character or class ofpaper now eligible for rediscount by Federal reserve banks.112 U.S.C. §345)

Act of May 19,1932 (47 Stat. 1S9):

[8] Any Federal reserve bank may make advances to its memberbanks on their promissory notes for a period not exceeding fifteendays at rates to be established by such Federal reserve banks,subject to the review and determination of the Federal ReserveBoard, provided such promissory notes are secured by suchnotes, drafts, bills of exchange, or bankers' acceptances as areeligible for rediscount or for purchase by Federal reserve banksunder the provisions of this Act, or by the deposit or pledge ofbonds or notes of the United States, or by the deposit or pledgeof debentures or other such obligations of Federal intermediate creditbanks which are eligible for purchase by Federal reserve banksunder section ISfa) of this Act.

Act of July 21,1932 (47 Stat. 709):

[3] In unusual and exigent circumstances, the Federal ReserveBoard, by the affirmative vote of not less than five members, mayauthorize any Federal reserve bank, during such periods as thesaid board may determine, at rates established in accordance withthe provisions of section 14, subdivision (d), of this Act, to dis-count for any individual, partnership, or corporation, notes, drafts,and bills of exchange of the kinds and maturities made eligiblefor discount for member banks under other provisions of this Actwhen such notes, drafts, and bills of exchange are indorsed andotherwise secured to the satisfaction of the Federal reserve bank:Provided, That before discounting any such note, draft, or bill ofexchange for an individual or a partnership or corporation theFederal reserve bank shall obtain evidence that such individual,partnership, or corporation is unable to secure adequate credit ac-commodations from other banking institutions. All such discountsfor individuals, partnerships, or corporations shall be subject tosuch limitations, restrictions, and regulations as the Federal Re-serve Board may prescribe.


[13] Subject to such limitations, restrictions and regulations as theFederal Reserve Board may prescribe, any Federal reserve bankmay make advances to any individual, partnership or corporation



on the promissory notes of such individual, partnership or cor-poration secured by direct obligations of the United States. Suchadvances shall be made for periods not exceeding 90 days and shallbear interest at rates fixed from time to time by the Federal re-serve bank, subject to the revieiv and determination of the FederalReserve Board.

Act of May 12, 1933 (48 Stat. 31):

[8] Any Federal reserve bank may make advances to its memberbanks on their promissory notes for a period not exceeding fifteendays at rates to be established by such Federal reserve banks,subject to the review and determination of the Federal ReserveBoard, provided such promissory notes are secured by such notes,drafts, bills of exchange, or bankers' acceptances as are eligible forrediscount or for purchase by Federal reserve banks under theprovisions of this Act, or by the deposit or pledge of bonds ornotes of the United States, or by the deposit or pledge of de-bentures or other such obligations of Federal intermediate creditbanks which are eligible for purchase by Federal reserve banksunder section 13 (a) of this Act, or by the deposit or pledge ofbonds issued pursuant to the paragraph added to section 32 of theFederal Farm Loan Act, as amended by section 81 of the Emer-gency Farm Mortgage Act of 1933.

Act of June 16,1933 (48 Stat. 162):

[8] Any Federal reserve bank may make advances for periodsnot exceeding fifteen days to its member banks on their promissorynotes for a period »©tr exceeding fifteen days at rates to be eatabfehed fey saefe Federal rcacrvc banks, oubjeefe te the fewew ane*determination el the Federal Reoervc Board; provided seefepromiaoory Rotco a*e secured by sraefe notea7 drafta, feiHfl el e*-ohange, eg bankcra' accoptanoca tts are eligible lep rcdiocount erfe* purchaoc fey Federal reserve banka undop the provioiono eftfeis A«tj er fey the deposit or pledge of bonds e*, notes, certificatesof indebtedness, or Treasury bills of the United States, or by thedeposit or pledge of debentures or other such obligations ofFederal intermediate credit banks which are eligible for purchaseby Federal reserve banks under section 13(a) of this Act?; andany Federal reserve bank may make advances for periods not exceed-ing ninety days to its member banks on their promissory notessecured by such notes, drafts, bills of exchange, or bankers' ac-ceptances as are eligible for rediscount or for purchase by Fed-eral reserve banks under the provisions of this Act er by -thedopooit er pledge el bonds iooucd purouanfc te tfee paragraphadded *e acotiea S3 el tfee ¥eaera4 Fa«» kea» Aety as amendedfey section 34- el tfee Emcrgenoy £aw» Mortgage Aefc el 4083.All such advances shall be made at rates to be established by such



Federal reserve banks, such rates to be subject to the review anddetermination of the Federal Reserve Board. If any member bankto which any such advance has been made shall, during the life orcontinuance of such advance, and despite an official warning of thereserve bank of the district or of the Federal Reserve Board to thecontrary, increase its outstanding loans secured by collateral in theform of slocks, bonds, debentures, or other such obligations, or loansmade to members of any organized stock exchange, investment house,or dealer in securities, upon any obligation, note, or bill, secured orunsecured, for the purpose of purchasing and/or carrying stocks,bonds, or other investment securities (except obligations of theUnited States) such advance shall be deemed immediately due andpayable, and such member bank shall be ineligible as a borrower atthe reserve bank of the district under the provisions of this paragraphfor such period as the Federal Reserve Board shall determine: Pro-vided, That no temporary carrying or clearance loans made solelyfor the purpose of facilitating the purchase or delivery of securitiesoffered for public subscription shall be included in the loans referredto in this paragraph.

Act of January 31,1934 (48 Stat. 344):

[8] Any Federal reserve bank may make advances for periods notexceeding fifteen days to its member banks on their promissorynotes secured by the deposit or pledge of bonds, notes, certificatesof indebtedness, or Treasury bills of the United States, or by thedeposit or pledge of debentures or other such obligations of Fed-eral intermediate credit banks which are eligible for purchase byFederal reserve banks under section 13 (a) of this Act, or by thedeposit or pledge of Federal Farm Mortgage Corporation bondsissued under the Federal Farm Mortgage Corporation Act; andany Federal reserve bank may make advances for periods notexceeding ninety days to its member banks on their promissorynotes secured by such notes, drafts, bills of exchange, or bankers'acceptances as are eligible for rediscount or for purchase by Fed-eral reserve banks under the provisions of this Act. * * *

Act of April 27,1934 (48 Stat. 643):

[8] Any Federal reserve bank may make advances for periods notexceeding fifteen days to its member banks on their promissorynotes secured by the deposit or pledge of bonds, notes, certificatesof indebtedness, or Treasury bills of the United States, or by thedeposit or pledge of debentures or other such obligations of Fed-eral intermediate credit banks which are eligible for purchase byFederal reserve banks under section 13 (a) of this Act, or by thedeposit or pledge of Federal Farm Mortgage Corporation bondsissued under the Federal Farm Mortgage Corporation Act, or bythe deposit or pledge of bonds issued under the provisions of sub-



section (c) of section 4 of the Home Owners' Loan Act of 193S,as amended; and any Federal reserve bank may make advancesfor periods not exceeding ninety days to its member banks on theirpromissory notes secured by such notes, drafts, bills of exchange,or bankers' acceptances as are eligible for rediscount or for pur-chase by Federal reserve banks under the provisions of this Act.• » •

Act of June 19,1934 (48 Stat. 1105):[9] • • •

Tenth. Liabilities incurred under the proinsions of section13b of the Federal Reserve Act. [ 12 U.S.C. § S2 ]

Act of August 23,1935 (49 Stat. 684):

[3] In unusual and exigent circumstances, the Federal RcaervoBoard of Governors of the Federal Reserve System, by the affirmativevote of not less than five members, may authorize any Federalreserve bank, during euch periods as the said board may deter-mine, at rates established in accordance with the provisions of sec-tion 14, subdivision (d), of this Act, to discount for any individual,partnership, or corporation, notes, drafts, and bills of exchangeof the kinds and maturities made eligible for discount for memberbanks under other provisions of this Act when such notes,drafts, and bills of exchange are indorsed aad- or otherwise securedto the satisfaction of the Federal r.Reserve bank: Provided, Thatbefore discounting any such note, draft, or bill of exchange for anindividual or a partnership or corporation the Federal reservebank shall obtain evidence that such individual, partnership, orcorporation is unable to secure adequate credit accommodationsfrom other banking institutions. All such discounts for indi-viduals, partnerships, or corporations shall be subject to suchlimitations, restrictions, and regulations as the Federal RcoorvoBoard of Governors of the Federal Reserve System may prescribe.[12 U.S.C. §343]

Act of September 21,1968 (82 Stat 856):

[8] • • • and any Federal reserve bank may make advances forperiods not exceeding ninety days to its member banks on theirpromissory notes secured by such notes, drafts, bills of exchange, orbankers' acceptances as are eligible for rediscount or for purchaseby Federal reserve banks under the provisions of this Act, or securedby such obligations as are eligible for purchase under section H(b) ofthis Act. * * • 112 U.S.C. §347]

[13] Subject to such limitations, restrictions and regulations as theBoard of Governors of the Federal Reserve System may prescribe,any Federal reserve bank may make advances to any individual,



partnership or corporation on the promissory notes of such individ-ual, partnership or corporation secured by direct obligations of theUnited States or by any obligation which is a direct obligation of, or

fully guaranteed as to principal and interest by, any agency of theUntied States. Such advances shall be made for periods not exceeding90 days and shall bear interest at rates fixed from time to time bythe Federal reserve bank, subject to the review and determinationof the Board of Governors of the Federal Reserve System112 T.S.C. § 347c]

SECTION 13a

Act of March 4,1923 (42 Stat. 1454):

[1J Sec. 13a. Upon the indorsement of any of its member banks,which shall be deemed a waiver of demand, notice, and protest bysuch bank as to its own indorsement exclusively, any Federal re-serve bank may, subject to regulations and limitations to be pre-scribed by the Federal Reserve Board, discount notes, drafts, andbills of exchange issued or drawn for an agricultural purpose, orbased upon live stock, and having a maturity, at the time of dis-count, exclusive of days of grace, not exceeding nine months, andsuch notes, drafts, and bills of exchange may be offered as collat-eral security for the issuance of Federal reserve notes under theprovisions of section 16 of this Act: Provided, That notes, drafts,and bills of exchange with maturities in excess of six months shallnot be eligible as a basis for the issuance of Federal reserve notesunless secured by warehouse receipts or other such negotiable docu-ments conveying or securing title to readily marketable stapleagricultural products or by chattel mortgage upon live stock whichis being fattened for market. 112 U.S.C. § 348]

[2] That any Federal reserve bank may, subject to regulations andlimitations to be prescribed by the Federal Reserve Board, redis-count such notes, drafts, and bills for any Federal IntermediateCredit Bank, except that no Federal reserve bank shall rediscountfor a Federal Intermediate Credit Bank any such note or obliga-tion which bears the indorsement of a nonmember State bank ortrust company which is eligible for membership in the Federalreserve system, in accordance with section 9 of this Act.

[3] Any Federal reserve bank may also buy and sell debentures andother such obligations issued by a Federal Intermediate CreditBank or by a National Agricultural Credit Corporation, but onlyto the same extent as and subject to the same limitations as thoseupon which it may buy and sell bonds issued under Title I of theFederal Farm Loan Act. 112 U.S.C. § 350]

[4] Notes, drafts, bills of exchange or acceptances issued or drawnby cooperative marketing associations composed of producers ofagricultural products shall be deemed to have been issued or drawnfor an agricultural purpose, within the meaning of this section, if



the proceeds thereof have been or arc to be advanced by such asso-ciation to any members thereof for an agricultural purpose, orhave been or are to be used by such association in inaking pay-ments to any members thereof on account of agricultural productsdelivered by such members to the association, or if such proceedshave been or are to be used by such association to meet expendi-tures incurred or to be incurred by the association in connectionwith the grading, processing, packing, preparation for viarkct, ormarketing of any agricultural product handled by such associationfor any of its members: Provided, That the express enumerationin this paragraph of certain classes of paper of cooperative market-ing associations as eligible for rediscount shall not be construedas rendering ineligible any other class of paper of such associationswhich is now eligible for rediscount. 112 C.S.C. vj 3.">I ]

[5] The Federal Reserve Board may, by regulation, limit to a per-centage of the assets of a Federal reserve bank the amount ofnotes, drafts, acceptances, or bills having a maturity in excess ofthree months, but not exceeding six months, exclusive of daysof grace, which may be discounted by such bank, and the amountof notes, drafts, bills, or acceptances having a maturity in excess ofsix months, but not exceeding nine months, which may be rcdis-counted by such bank. |12 U.S.C. S352]

Act of May 19, 1932 (47 Stat. 159):

[2] That any Federal reserve bank may, subject to regulations andlimitations to be prescribed by the Federal Reserve Board, redis-count such notes, drafts, and bills for any Federal IntermediateCredit Bank, except that no Federal reserve bank shall rediscountfor a Federal Intermediate Credit Bank any such note or obliga-tion which bears the indorsement of a nonmember State bank ortrust company which is eligible for membership in the Federalreserve system, in accordance with section 9 of this Act. AnyFederal reserve bank may also, subject to regulations andlimitations to be prescribed by the Federal Reserve Board, dis-count notes payable to and bearing the indorsement of any Fed-eral intermediate credit bank, covering loans or advances made bysuch bank pursuant to the provisions of section 202 (a) of Title IIof the Federal Farm Loan Act, as amended (U. S. C, title 12, ch.8, sec. 1031), which have maturities at the time of discount of notmore than nine months, exclusive of days of grace, and which aresecured by notes, drafts, or bills of exchange eligible for rediscountby Federal Reserve banks. [12 U.S.C. § 349)

SECTION 13b

Act of June 19, 1934 (48 Stat. 1105):

Sec. 13b. (a) In exceptional circumstances, when it appears tothe satisfaction of a Federal Reserve bank that an establishedindustrial or commercial business located in its district is unable



to obtain requisite financial assistance on a reasonable basis fromthe usual sources, the Federal Reserve bank, pursuant to authoritygranted by the Federal Reserve Board, may make loans to, orpurchase obligations of, such business, or may make commitmentswith respect thereto, on a reasonable and sound basis, for thepurpose of providing it with working capital, but no obligationshall be acquired or commitment made hereunder with a maturityexceeding five years.

(b) Each Federal Reserve bank shall also have power to discountfor, or purchase from, any bank, trust company, mortgage com-pany, credit corporation for industry, or other financing institu-tion operating in its district, obligations having maturities notexceeding five years, entered into for the purpose of obtainingworking capital for any such established industrial or commercialbusiness; to make loans or advances direct to any such financinginstitution on the security of such obligations; and to make com-mitments with regard to such discount or purchase of obligationsor with respect to such loans or advances on the security thereof,including commitments made in advance of the actual undertakingof such obligations. Each such financing institution shall obligateitself to the satisfaction of the Federal Reserve bank for at least20 per centum of any loss which may be sustained by such bankupon any of the obligations acquired from such financing institu-tion, the existence and amount of any such loss to be determinedm accordance with regulations of the Federal Reserve Board:Provided, That in lieu of such obligation against loss any suchfinancing institution may advance at least 20 per centum of suchworking capital for any established industrial or commercial busi-ness without obligating itself to the Federal Reserve bank againstloss on the amount advanced by the Federal Reserve bank: Pro-vided, however, That such advances by the financing institutionand the Federal Reserve bank shall be considered as one advance,and repayment shall be made pro rata under such regulations asthe Federal Reserve Board may prescribe.

(c) The aggregate amount of loans, advances, and commitmentsof the Federal Reserve banks outstanding under this section atany one time, plus the amount of purchases and discounts underthis section held at the same time, shall not exceed the combinedsurplus of the Federal Reserve banks as of July 1, 1984, plus allamounts paid to the Federal Reserve banks by the Secretary ofthe Treasury under subsection (e) of this section, and all opera-tions of the Federal Reserve banks under this section shall besubject to such regulations as the Federal Reserve Board may

prescribe.(d) For the purpose of aiding the Federal Reserve banks in

carrying out the provisions of this section, there is hereby estab-lished in each Federal Reserve district an industrial advisory com-mittee, to be appointed by the Federal Reserve bank subject to theapproval and regulations of the Federal Reserve Board, and to becomposed of not less than three nor more than five members as



determined by the Federal Reserve Board. Each member of suchcommittee shall be actively engaged in some industrial pursuitwithin the Federal Reserve district in which the committee isestablished, and each such member shall serve without compen-sation but shall be entitled to receive from the Federal Reservebank of such district his necessary expenses while engaged in thebusiness of the committee, or a per diem allowance in lieu thereofto be fixed by the Federal Reserve Board. Each application forany such loan, advance, purchase, discount, or commitment shallbe submitted to the appropriate committee and, after an examina~tion by it of the business with respect to which the applicationis made, the application shall be transmitted to the Federal Re-serve bank, together with the recommendation of the committee,

(e) In order to enable the Federal Reserve banks to make theloans, discounts, advances, purchases, and commitments providedfor in this section, the Secretary of the Treasury, upon the datethis section takes effect, is authorized, under such rules and regu-lations as he shall prescribe, to pay to each Federal Reserve banknot to exceed such portion of the sum of $139,299,557 as may berepresented by the par value of the holdings of each Federal Re-serve bank of Federal Deposit Insurance Corporation stock, uponthe execution by each Federal Reserve bank of its agreement (tobe endorsed on the certificate of such stock) to hold such stockunencumbered and to pay to the United States all dividends, allpayments on liquidation, and all other proceeds of such stock, forwhich dividends, payments, and proceeds the United States shallbe secured by such stock itself up to the total amount paid to eachFederal Reserve bank by the Secretary of the Treasury under thissection. Each Federal Reserve bank, in addition, shall agree that,in the event such dividends, payments, and other proceeds in anycalendar year do not aggregate 2 per centum of the total paymentmade by the Secretary of the Treasury, under this section, it willpay to the United States in such year such further amount, if any,up to 2 per centum of the said total payment, as shall be coveredby the net earnings of the bank for that year derived from the useof the sum so paid by the Secretary of the Treasury, and that forsaid amount so due the United States shall have a first claimagainst such earnings and stock, and further that it will continuesuch payments until the final liquidation of said stock by theFederal Deposit Insurance Corporation. The sum so paid to eachFederal Reserve bank by the Secretary of the Treasury shall be-come a part of the surplus fund of such Federal Reserve bankwithin the meaning of this section. All amounts required to beexpended by the Secretary of the Treasury in order to carry outthe provisions of this section shall be paid out of the miscellaneousreceipts oj the Treasury created by the increment resulting fromthe reduction of the weight of the gold dollar under the President'sproclamation of January 31, 1934; and there is hereby appro-priated, out of such receipts, such sum as shall be required for suchpurpose.



Act of August 23,193S (49 Stat. 684):

(e) In order to enable the Federal Reserve banks to make theloans, discounts, advances, purchases, and commitments pro-vided for in this section, the Secretary of the Treasury, «pe» *feetlftte *bie section tekes effcet on and after June 19, 1934, is au-thorized, under such rules and regulations as he shall prescribe,to pay to each Federal Reserve bank not to exceed such portionof the sum of §139,299,557 as may be represented by tfee papvalue ef tbe holdings el eaefe Federal Rcocrvo fea«k ef- FederalDcpoait Insurance Corporation otock the amount paid by eachFederal Reserve bank for stock of the Federal Deposit InsuranceCorporation, upon the execution by each Federal Reserve bankof its agreement (to be endorsed on the certificate of such stock)to hold such stock unencumbered and to pay to the UnitedStates all dividends, all payments on liquidation, and all otherproceeds of such stock, for which dividends, payments, and pro-ceeds the United States shall be secured by such stock itself upto the total amount paid to each Federal Reserve bank by theSecretary of the Treasury under this section. * * *


[The above cited Act repealed section 13b of the Federal ReserveAct, effective August 21, 1959, with the stipulation that such repealwould not affect the power of any Federal Reserve bank to carryout, or protect its interest under, any agreement theretofore made ortransaction entered into in carrying on operations under thatsection.]

SECTION 14

Original Act:[1] SEC. 14. Any Federal reserve bank may, under rules and regula-

tions prescribed by the Federal Reserve Board, purchase and sellin the open market, at home or abroad, either from or to do-mestic or foreign banks, firms, corporations, or individuals, cabletransfers and bankers' acceptances and bills of exchange of thekinds and maturities by this Act made eligible for rediscount, withor without the indorsement of a member bank. [12 U.S.C. §353]

[2] Every Federal reserve bank shall have power: |12 U.S.C. §354]

[3] (b) To buy and sell, at home or abroad, bonds and notes ofthe United States, and bills, notes, revenue bonds, and warrantswith a maturity from date of purchase of not exceeding sixmonths, issued in anticipation of the collection of taxes or in an-ticipation of the receipt of assured revenues by any State, county,



district, political subdivision, or municipality in the continentalUnited States, including irrigation, drainage and reclamation dis-tricts, such purchases to be made in accordance with rules andregulations prescribed by the Federal Reserve Board;

[4] (c) To purchase from member banks and to sell, with or with-out its indorsement, bills of exchange arising out of commercialtransactions, as hereinbefore defined; 112 l.'.S.C. S 3361

[5] (d) To establish from time to time, subject to review and de-termination of the Federal Reserve Board, rates of discount to becharged by the Federal reserve bank for each class of paper,which shall be fixed with a view of accommodating commerce andbusiness;

Act of April 13, 1920 (41 Stat. 550):

[5] (d) To establish from time to time, subject to review anddetermination of the Federal Reserve Board, rates of discountto be charged by the Federal reserve bank for each class ofpaper, which shall be fixed with a view of accommodating com-merce and business-} and which, subject to the approval, review,and determination of the Federal Reserve Board, may be graduatedor progressed on the basis of the amount of the advances and dis-count accommodations extended by the Federal reserve bank tothe borrowing bank.

Act of March 4,1923 (42 Stat. 1454):

[5] (d) To establish from time to time, subject to review and de-termination of the Federal Reserve Board, rates of discount tobe charged by the Federal reserve bank for each class of paper,which shall be fixed with a view of accommodating commerceand business; a»4 which; oubjeet to the approval, review^ a*ddetermination el -the federal Reserve Board, «*ty fee graduatedee progrc33cd eft -tfee feaaia ef -tfee amount ef- +fee advancea enddiaoount acoommodationa extended by *be Federal rcoorvc bankte the borrowing bank.

* * * * *[7] ff) To purchase and sell in the open market, either from or

to domestic banks, firms, corporations, or individuals, acceptancesof Federal Intermediate Credit Banks and of National Agricul-tural Credit Corporations, whenever the Federal Reserve Boardshall declare that the public interest so requires. | 12 U.S.C. § 359]

Act of January 31,1934 (48 Stat. 344):

[3] (b) To buy and sell, at home or abroad, bonds and notes of theUnited States, bonds of the Federal Farm Mortgage Corporationhaving maturities from date of purchase of not exceeding sixmonths, and bills, notes, revenue bonds, and warrants with a ma-turity from date of purchase of not exceeding six months, issued



in anticipation of the collection of taxes or in anticipation of thereceipt of assured revenues by any State, county, district, politi-cal subdivision, or municipality in the continental United States,including irrigation, drainage and reclamation districts, such pur-chases to be made in accordance with rules and regulations pre-scribed by the Federal Reserve Board;

Act of April 27,1934 (48 Stat. 643):

[3] (b) To buy and sell, at home or abroad, bonds and notes ofthe United States, bonds of the Federal Farm Mortgage Corpo-ration having maturities from date of purchase of not exceedingsix months, bonds issued under the provisions of subsection (c)of section 4 of the Home Owners' Loan Act of 1933, as amended,and having maturities from date of purchase of not exceeding sixmonths, and bills, notes, revenue bonds, and warrants with a ma-turity from date of purchase of not exceeding six months, issued inanticipation of the collection of taxes or in anticipation of the re-ceipt of assured revenue by any State, county, district, politicalsubdivision, or municipality in the continental United States, in-cluding irrigation, drainage and reclamation districts, such pur-chases to be made in accordance with rules and regulations pre-scribed by the Federal Reserve Board;


[3] (b) To buy and sell, at home or abroad, bonds and notes ofthe United States, bonds of the Federal Farm Mortgage Corpora-tion having maturities from date of purchase of not exceeding sixmonths, bonds issued under the provisions of subsection (c) ofsection 4 of the Home Owners' Loan Act of 1933, as amended, andhaving maturities from date of purchase of not exceeding sixmonths, and bills, notes, revenue bonds, and warrants with a ma-turity from date of purchase of not exceeding six months, issuedin anticipation of the collection of taxes or in anticipation of thereceipt of assured revenues by any State, county, district, politicalsubdivision, or municipality in the continental United States, in-cluding irrigation, drainage and reclamation districts, such pur-chases to be made in accordance with rules and regulations pre-scribed by the Federal Rcacrvo Board of Governors of the FederalReserve System: Provided, That any bonds, notes, or other obliga-tions which are direct obligations of the United States or which arefully guaranteed by the United States as to principal and interestmay be bought and sold without regard to maturities but only in theopen market;

* • • • •

[5] (d) To establish from time to time, subject to review and de-termination of the federal Rooorve Board of Governors of theFederal Reserve System, rates of discount to be charged by theFederal reserve bank for each class of paper, which shall be



fixed with a view of accommodating commerce and business;but each such bank shall establish such rates every fourteen days,or oftener if deemed necessary by the Board; 112 U.S.C. § 357]

Act of March 27,1942 (56 Stat. 176):

[3] (b) * * * Provided, That any bonds, notes, or other obliga-tions which are direct obligations of the United States or whichare fully guaranteed by the United States as to principal andinterest may be bought and sold without regard to maturitiesbttfc ealy either in the open market or directly from or to the UnitedStates; but all such purchases and sales shall be made in accordancewith the provisions of section 12A of this Act and the aggregateamount of such obligations acquired directly from the United Stateswhich is held at any one time by the twelve Federal reserve banksshall not exceed 85,000,000,000.

[NOTE.—The above amendment was originally made by Title IV of the SecondWar Powers Act of March 27, 1942, to remain in force only until December 31, 1944;but the termination date of Title IV of that Act and therefore of the amendmentto section 14(b) of the Federal Reserve Act was extended by the Act of Decem-ber 20, 1944 (58 Stat. 827) until December 31, 1945, was further extended by theAct of December 28, 1945 (59 Stat. 658) until June 30, 1946, and was furtherextended by the Act of June 29, 1946 (60 Stat. 354) until March 31, 1947. On thelatter date the amendment ceased to have effect and consequently section 14 (b) ofthe Federal Reserve Act after March 31, 1947 read as it had read prior to enact-ment of the Act of March 27, 1942, until the enactment of the Act of April 28, 1947(61 Stat. 56) as set forth below.]

Act of April 28,1947 (61 Stat. 56):

[3] (b) * * * Provided, That, notwithstanding any other provisionof this Act, (1) until July 1, 1960, any bonds, notes, or other ob-ligations which are direct obligations of the United States orwhich are fully guaranteed by the United States as to principaland interest may be bought and sold without regard to maturi-ties Wt only either in the open market or directly from or to theUnited States; but all such purchases and sales shall be made inaccordance with the provisions of section 12A of this Act and theaggregate amount of such obligations acquired directly from theUnited States which is held at any one time by the twelve FederalReserve banks shall not exceed 86,000,000,000; and (8) after June30, 1950, any bonds, notes, or other obligations which are directobligations of the United Stales or which are fully guaranteed bythe United States as to principal and interest may be bought andsold without regard to maturities but only in the open market.The Board of Governors of the Federal Reserve System shall includein their annual report to Congress detailed information with respectto direct purchases and sales from or to the United States under theprovisions of the preceding proviso.

Act of June 30,1950 (64 Stat. 307):

[3] [The above-cited Act extended the authority contained in theproviso in this paragraph by substituting, in two places, referenceto the year 1952 in place of reference to the year 1950.]



Act of June 23, 1952 (66 Stat. 154):


Act of June 29, 1954 (68 Stat. 329):


Act of June 25, 1956 (70 Stat. 339):


Act of June 30, 1958 (72 Stat. 261):


Act of July 1, 1960 (74 Stat. 295):

[3] [The above-cited Act extended the authority contained in theproviso in this paragraph by substituting, in two places, referenceto the year 1962 in place of reference to the year I960.]

Act of October 4, 1961 (75 Stat. 773):

[3] (b) To buy and sell, at home or abroad, bonds and notes ofthe United States, bond;) »f 4ke Federal Farm Mortgageportttion having nmturitiet) from duto (4 purchano el wet exceeding» « months, bonds issued under the provisions of subsection (c) ofsection 4 of the Home Owners' Loan Act of 1933, as amended,and having maturities from date of purchase of not exceeding sixmonths, * * *.

Act of June 28, 1962 (76 Stat. 112):


Act of June 30, 1964 (78 Stat. 235):


Act of June 30, 1966 (80 Stat. 235):




Act of September 21, 1966 (80 Stat. 823, 82S):

made permanent.)

[3] (b) (1) To buy and sell, at home or ubroad, bonds and notes of theUnited States, bonds issued under the provisions of subsection (c)of section 4 of the Home Owners' Loan Act of 1933, as amended,and having maturities from date of purchase of not exceeding sixmonths, and bills, notes, revenue bonds, and warrants with amaturity from date of purchase of not exceeding six months, issuedin anticipation of the collection of taxes or in anticipation of thereceipt of assured revenues by any State, county, district, politicalsubdivision, or municipality in the continental United States, in-cluding irrigation, drainage and reclamation districts, such pur-chases to be made in accordance with rules and regulations pre-scribed by the Board of Governors of the Federal Reserve System:Provided, That, notwithstanding any other provision of this Act,(1) until July 1, 1968, any bonds, notes, or other obligations whichare direct obligations of the United States or which are fully guaran-teed by the United States as to principal and interest may bebought and sold without regard to maturities either in the openmarket or directly from or to the United States; but all such pur-chases and sales shall be made in accordance with the provisions ofsection 12A of this Act and the aggregate amount of such obligationsacquired directly from the United States which is held at any onetime by the twelve Federal Reserve banks shall not exceed85,000,000,000; and (2) after June 30, 1968, any bonds, notes, orother obligations which are direct obligations of the United Statesor which are fully guaranteed by the United States as to principaland interest may be bought and sold without regard to maturitiesbut only in the open market. The Board of Governors of the FederalReserve System shall include in their annual report to Congressdetailed information witli respect to direct purchnscs and sales fromor to the United States under the provisions of the preceding proviso.

(3?) To buy and sell in the open market, wider the direction andregulations of the Federal Open Market Committee, any obligationwhich is a direct obligation of, or fully guaranteed as to principal andinterest by, any agency of the United States. [12 U.S.C. § 355]

Act of May 4, 1968 (82 Stat. 113):

[3] [The above-cited Act extended the authority contained in theproviso in this paragraph by substituting, in two places, referenceto the year 1970 in place of reference to the year 1968.1

Act of July 31, 1970 (84 Stat. 668):




Act of July 2, 1971 (85 Stat. 100):

[3) [The above-cited Act extended the authority contained in theproviso in this paragraph by substituting, in two places, referenceto the year 1973 in place of reference to the year 1971.]

SECTION 19

Original Act:

[<•>] o • • No member bank shall act as the medium or agentof a nonmember bank in applying for or receiving discounts from aFederal reserve bank under the provisions of this Act except bypermission of the Federal Reserve Board. [12 U.S.C. § 374]

SECTION 24

Act of June 27, 1934 (48 Stat. 1246):

[3] Loans made to finance the construction of residential or farmbuildings and having maturities of not to exceed six months,whether or not secured by a mortgage or similar Ken on the realestate upon which the residential or farm building is being con-structed, shall not be considered as loans secured by real estatewithin the meaning of this section but shall be classed as ordinarycommercial loans: Provided, That no national banking associationshall invest in, or be liable on, any such loans in an aggregateamount in excess of 50 per centum of its actually paid-in andunimpaired capital. Notes representing such loans shall be eligiblefor discount as commercial paper within the terms of the secondparagraph of section 13 of the Federal Reserve Act, as amended,if accompanied by a valid and binding agreement to advance thefull amount of the loan upon the completion of the buildingentered into by an individual, partnership, association, or cor-poration acceptable to the discounting bank.

Act of August 11,1955 (69 Stat. 633) :

[3] Loans made to finance the construction of residential or farmbuildings and having maturities of not to exceed sis nine months,whether or not secured by a mortgage or similar lien on the realestate upon which the residential or farm building is being con-structed, shall not be considered as loans secured by real estatewithin the meaning of this section but shall be classed as ordi-nary commercial loans: * * *

Act of September 9, 1959 (73 Stat. 487) :

[3] Loans made to finance the construction of industrial or com-mercial buildings and having maturities of not to exceed eighteen



months where there is a valid and binding agreement entered intoby a financially responsible lender to advance the full amount ofthe bank's loan upon the completion of the buildings and loansmade to finance the construction of residential or farm buildingsand having maturities of not to exceed nine months, whether©j* ft©t SCCrirCu « j *• II1QrtcQfiTO Or nfnnttf TXVTT OTT tile rcftr ©HTO^Cupon which the reaidential er farm building is feeing eea-otruotcd, shall not be considered as loans secured by real estatewithin the meaning of this section but shall be classed as ordi-nary commercial loans whether or not secured by a mortgage orsimilar lien on the real estate upon which the building or build-ings are being constructed: Provided, That no national bankingassociation shall invest in, or be liable on, any such loans in anaggregate amount in excess of 59 100 per centum of its actuallypaid-in and unimpaired capital plus 100 per centum of its unim-paired surplus fund. Notes representing auoh loans made underthis section to finance the construction of residential or farm build-ings and having maturities of not to exceed nine months shall beeligible for discount as commercial paper within the terms of thesecond paragraph of section 13 of the Federal Reaerve this Acty«s amended, if accompanied by a valid and binding agreementto advance the full amount of the loan upon the completion ofthe building entered into by an individual, partnership, associa-tion, or corporation acceptable to the discounting bank.

Act of September 28,1962 (76 Stat. 662):

[3] Loans made to finance the construction of industrial or com-mercial buildings and having maturities of not to exceed eighteenmonths where there is a valid and binding agreement enteredinto by a financially responsible lender to advance the fullamount of the bank's loan upon the completion of the buildingsand loans made to finance the construction of residential orfarm buildings and having maturities of not to exceed BtMeighteen months, shall not be considered as loans secured by realestate within the meaning of this section but shall be classed asordinary commercial loans whether or not secured by a mort-gage or similar lien on the real estate upon which the buildingor buildings are being constructed: Provided, That no nationalbanking association shall invest in, or be liable on, any such loansin an aggregate amount in excess of 100 per centum of its actuallypaid-in and unimpaired capital plus 100 per centum of its unim-paired surplus fund. * * *

Act of August 10, 1965 (79 Stat 451, 465):

[3] Loans made to finance the construction of industrial or com-mercial buildings and having maturities of not to exceed eighteentwenty-four months where there is a valid and binding agreemententered into by a financially responsible lender to advance the



full amount of the bank's loan upon the completion of the build-ings and loans made to finance the construction of residential orfarm buildings and having maturities of not to exceed oightoontwenty-four months, shall not be considered as loans secured byreal estate within the meaning of this section but shall be classedas ordinary commercial loans whether or not secured by a mort-gage or similar lien on the real estate upon which the building orbuildings are being constructed: Provided, That no national bank-ing association shall invest in, or be liable on, any such loans inan aggregate amount in excess of 100 per centum of its actuallypaid-in and unimpaired capital plus 100 per centum of its unim-paired surplus fund. * * *

Act of August 1, 1968 (82 Stat. 476, 518, 609):

[3] Loans made to finance the construction of industrial or commer-cial buildings and having maturities of not to exceed twenty fourthirty-six months where there is a valid and binding agreemententered into by a financially responsible lender to advance the fullamount of the bank's loan upon the completion of the buildings andloans made to finance the construction of residential or farm build-ings and having maturities of not to exceed twenty fo«r thirty-sixmonths, shall not be considered as loans secured by real estatewithin the meaning of this section but shall be classed as ordinarycommercial loans whether or not secured by a mortgage or similarlien on the real estate upon which the building or buildings are beingconstructed: Provided, That no national banking association shallinvest in, or be liable on, any such loans in an aggregate amount inexcess of 100 per centum of its actually paid-in and unimpairedcapital plus 100 per centum of its unimpaired surplus fund. * * *

Act of July 24, 1970 (84 Stat. 450, 462):

\'A\ Loans made to finance the construction of industrial or com-mercial buildings and having maturities of not to exceed thirty aix•sixty months where there is a valid and binding agreement enteredinto by a financially responsible lender to advance the full amountof the bank's loan upon the completion of the buildings and loansmade to finance the construction of residential or farm buildingsand having maturities of not to exceed thirty aix sixty months,shall not be considered as loans secured by real estate within themeaning of this section but shall be classed as ordinary commercialloans whether or not secured by a mortgage or similar lien on thereal estate upon which the building or buildings are being con-structed: Provided, That no national banking association shallinvest in, or be liable on, any such loans in an aggregate amount inexcess of 100 per centum of its actually paid-in and unimpairedcapital plus 100 per centum of its unimpaired surplus fund. * * *[12 U.S.C. §371]


Regulation A as Currently in Effect

REGULATION A

(12 CFR 201)

As revised effective April 19, 1973, and in effect May 1, 1973

EXTENSIONS OF CREDIT BYFEDERAL RESERVE BANKS

SECTION 201.1—AUTHORITY AND SCOPE

This Part is issued under section 13 and otherprovisions of the Federal Reserve Act and relatesto extensions of credit by Federal Reserve Banks.

SECTION 201.2—GENERAL PRINCIPLES

(a) Accommodation of credit needs of indi-vidual banks. Extending credit to member banksto accommodate commerce, industry, and agricul-ture is a principal function of Reserve Banks.While open market operations and changes inmember bank reserve requirements are importantmeans of affecting the overall supply of bank re-serves, the lending function of the Reserve Banks's an effective method of supplying reserves to

meet the particular needs of individual memberbanks.

(b) Effect on overall monetary and credit con-ditions. The lending functions of the Federal Re-serve System are conducted with due regard tothe basic objectives of the Employment Act of1946 and the maintenance of a sound and orderlyfinancial system. These basic objectives are pro-moted by influencing the overall volume and costof credit through actions affecting the volume andcost of reserves to member banks. Borrowing byindividual member banks, at a rate of interestadjusted from time to time in accordance withgeneral economic and money market conditions,has a direct impact on the reserve positions of theborrowing banks and thus on their ability to meetthe needs of their customers. However, the effectsof such borrowing do not remain localized but

237



have an important bearing on overall monetaryand credit conditions.

(c) Short-term adjustment credit. Federal Re-serve credit is available on a short-term basis to amember bank, under such rules as may be pre-scribed, to such extent as may be appropriate toassist such bank in meeting temporary require-ments for funds or to cushion more persistentoutflows of funds pending an orderly adjustmentof the bank's assets and liabilities.

(d) Seasonal credit. Federal Reserve credit isavailable for longer periods to assist a memberbank that lacks reasonably reliable access to na-tional money markets in meeting seasonal needsfor funds arising from a combination of expectedpatterns of movement in its deposits and loans.Such credit will ordinarily be limited to theamount by which the member bank's seasonalneeds exceed 5 per cent of its average total de-posits in the preceding calendar year and will beavailable if (1) the member bank has arrangedin advance for such credit for the full period, asfar as possible, for which the credit is expectedto be required, and (2) the Reserve Bank issatisfied that the member bank's qualifying needfor funds is seasonal and will persist for at leasteight consecutive weeks. In making such arrange-ments for seasonal credit, a Reserve Bank mayagree to extend such credit for a period of up to90 days,1 subject to compliance with applicablerequirements of law at the time such credit isextended. However, in the event that a memberbank's seasonal needs should persist beyond suchperiod, the Reserve Bank will normally be pre-pared to entertain a request by the member bankfor further credit extensions under the seasonalcredit arrangement.

(e) Emergency credit for member banks. Fed-eral Reserve credit is available to assist memberbanks in unusual or emergency circumstances suchas may result from national, regional, or localdifficulties or from exceptional circumstances in-volving only a particular member bank.

(f) Emergency credit for others. Federal Re-serve credit is available to individuals, partner-ships, and corporations that are not memberbanks in emergency circumstances in accordance

1 As provided in the law and in this Part, the maturityof advances to member banks is limited to 90 days,except as provided in §201,3(b) of this Part.

with §201.7 of this Part if, in the judgment of theReserve Bank involved, credit is not practicablyavailable from other sources and failure to obtainsuch credit would adversely affect the economy.

(g) Credit for capital purposes. Federal Re-serve credit is not a substitute for capital andordinarily is not available for extended periods.

(h) Compliance with law and regulation. Allcredit extended pursuant to this Part must complywith applicable requirements of law and of thisPart. Among other things, the law requires eachReserve Bank (I) to keep itself informed of thegeneral character and amount of the loans andinvestments of its member banks with a view toascertaining whether undue use is being made ofbank credit for the speculative carrying of or trad-ing in securities, real estate, or commodities orfor any other purpose inconsistent with the main-tenance of sound credit conditions and (2) togive consideration to such information in deter-mining whether to extend credit.

SECTION 201.3—ADVANCES TO MEMBERBANKS

(a) Advances on obligations or eligible paper.Reserve Banks may make advances to memberbanks for not more than 90 days if secured byobligations or other paper eligible under the Fed-eral Reserve Act for discount or purchase by Re-serve Banks.

(b) Advances on other security. A ReserveBank may make advances to a member bank fornot more than four months if secured to thesatisfaction of the Reserve Bank, whether or notsecured in conformity with §201.3(a), but therate on such advances shall be at least one-halfof one per cent per annum higher than the rateapplicable to advances made under §2O1.3(a).

SECTION 201.4—DISCOUNTS FORMEMBER BANKS

If a Reserve Bank should conclude that a mem-ber bank would be better accommodated by thediscount of paper than by an advance on thesecurity thereof, it may discount for such mem-ber bank any paper endorsed by the member bankand meeting the following requirements:

(a) Commercial or agricultural paper. A note,draft, or bill of exchange issued or drawn or tne


REGULATION A 239

proceeds of which have been or are to be used(1) in producing, purchasing, carrying, or mar-keting goods in the process of production, manu-facture, or distribution, (2) for the purchase ofservices, (3) in meeting current operating ex-penses of a commercial, agricultural, or industrialbusiness, or (4) for the purpose of carrying ortrading in direct obligations of the United States;provided that (i) such paper has a period remain-ing to maturity of not more than 90 days, exceptthat agricultural paper (including paper of co-operative marketing associations) may have aperiod remaining to maturity of not more thannine months and (ii) the proceeds of such paperhave not been and are not to be used merely forthe purpose of investment, speculation, or dealingin stocks, bonds, or other such securities, exceptdirect obligations of the United States.

(b) Bankers1 acceptances. A banker's accept-ance (1) arising out of an importation or exporta-tion or domestic shipment of goods or the storageof readily marketable staples or (2) drawn by abank in a foreign country or dependency orinsular possession of the United States for thepurpose of furnishing dollar exchange; providedthat such acceptance complies with applicablerequirements of section 13 of the Federal ReserveAct.

(c) Construction paper. A note representing aloan made to finance construction of a residentialor farm building, whether or not secured by a lienupon real estate, which matures not more thannine months from the date the loan was made andhas a period remaining to maturity of not morethan 90 days, if accompanied by an agreementrequiring some person acceptable to the ReserveBank to advance the full amount of the loan uponcompletion of such construction.

SECTION 201.5—GENERALREQUIREMENTS

(a) Information. A Reserve Bank shall requiresuch information as it deems necessary to insure'hat paper tendered as collateral or for discountis acceptable and meets any pertinent eligibilityrequirements and that the credit granted is usedconsistently with this Part.

(b) Amount of collateral. A Reserve Bank shallrequire only such amount of collateral as it deemsnecessary or advisable.

(c) Indirect credit for nonmember banks. Ex-cept with the permission of the Board of Gov-ernors, no member bank shall act as the mediumor agent of a nonmember bank (other than aFederal Intermediate Credit bank) in receivingcredit from a Reserve Bank and, in the absenceof such permission, a member bank applying forcredit shall be deemed to represent and guaranteethat it is not so acting.

(d) Limitation as to one obligor. Except as tocredit granted under §201.3(b), a member bankapplying for credit shall be deemed to certify orguarantee that as long as the credit is outstandingno obligor on paper tendered as collateral or fordiscount will be indebted to it in an amount ex-ceeding the limitations in section 3200 of theRevised Statutes (12 U.S.C. §84), which for thispurpose shall be deemed to apply to State memberas well as national banks.

SECTION 201.6—FEDERALINTERMEDIATE CREDIT BANKS

A Reserve Bank may discount for any FederalIntermediate Credit bank (1) agricultural paper,or (2) notes payable to and bearing the endorse-ment of such Federal Intermediate Credit bankcovering loans or advances made under subsec-tions (a) and (b) of §2.3 of the Farm CreditAct of 1971 (12 U.S.C. §2074) which are securedby paper eligible for discount by Reserve Banks.Any paper so discounted shall not have a periodremaining to maturity of more than nine monthsor bear the endorsement of a nonmember Statebank.

SECTION 201.7—EMERGENCY CREDITFOR OTHERS

In emergency circumstances a Reserve Bankmay extend credit for periods of not more than 90days to individuals, partnerships, and corporations(other than member banks) on the security ofdirect obligations of the United States or anyobligations which are direct obligations of, orfully guaranteed as to principal and interest by,any agency of the United States, at such rate inexcess of the rate in effect at the Reserve Bankfor advances under §201.3(a) as its board ofdirectors may establish subject to review anddetermination of the Board of Governors.


Regulation C as Currently in Effect

REGULATION C(12 CFR 203)

As revised effective August 31, 1946, and in effect May 1, 1973

ACCEPTANCE BY MEMBER BANKS OF DRAFTSOR BILLS OF EXCHANGE *

SECTION 203.0-SCOPE OF PART

This part is based upon and issued pursuant to various provisions ofthe Federal Reserve Act, particularly the provisions of the seventh andtwelfth paragraphs of section 13 of such Act, the texts of which arepublished in the appendix hereto. This part relates to the acceptanceby member banks of drafts or bills of exchange. Provisions governingthe eligibility of bankers' acceptances of member banks for discount bythe Federal Reserve Banks are contained in Part 201 of this chapter;and provisions governing the purchase of bankers' acceptances by theFederal Reserve Banks are contained in Part 202 of this chapter.

• The text correspond, to the Code of Federal Regulations. Title 12. Chapter II, Part 203:cited as 12 CFR 203.

241



SECTION 203.1- ACCEPTANCE OF COMMERCIAL DRAFTS OR BILLS

(a) Authority.—Any member bank may accept drafts or bills ofexchange drawn upon it which grow out of any of the following trans-actions (referred to in this part as "commercial drafts or bills"):

(1) The importation or exportation of goods, that is, the ship-ment of goods between the United States and any foreign country,or between the United States and any of its dependencies or insularpossessions, or between dependencies or insular possessions andforeign countries, or between foreign countries; l

(2) The shipment of goods within the United States, providedshipping documents conveying or securing title are attached orare in the physical possession of the accepting bank or its agentat the time of acceptance;

(3) The storage in the United States or in any foreign countryof readily marketable staples: - Provided, That the draft or bill ofexchange is secured at the time of acceptance by a warehousereceipt or other such document conveying or securing title coveringsuch readily marketable staples.3

{b) Maturity.—No member banks shall accept any commercialdraft or bill unless -\t the date of its acceptance sucli draft or bill hasnot more than six months to run, exclusive of days of grace.

(c) Acceptances for one person.—No member bank shall acceptcommercial drafts or bills, whether in a foreign or domestic transaction,for any one person, company, firm, or corporation in an amount equalat any time in the aggregate to more than 10 per cent of its paid-upand unimpaired capital stock and surplus, unless the bank be andremain secured as to the amount in excess of such 10 per cent limita-tion by either attached documents or some other actual security grow-ing out of the same transaction as the acceptance; but a trust receiptwhich permits the customer to have access to or control over thegoods will not be considered "actual security" within the meaning ofthis paragraph.

(d) Limitation on aggregate amount.—No member bank shallaccept commercial drafts or bills in an amount equal at any time inthe aggregate to more than 50 per cent of its paid-up and unimpairedcapital stock and surplus; except that, with the permission of the Boardof Governors of the Federal Reserve System as provided in paragraph(e) of this section, any such member bank may accept such drafts or

1 A member bank accepting any commercial draft or bill growing out of a transaction of thekinds described in 5203.1 (a) (1) will be expected to obtain before acceptance and retain In Itnfiles satisfactory evidence, documentary or otherwise, showing the nature of the transactionsunderlying the credit extended.

' A readily marketable staple within the meaning of this part means an article of com-merce, agriculture, or industry, of such uses as to make it the subject of constant dealings inready markets with such frequent quotations of price as to make (o) the price easily anddefinitely ascertainsble. and (6) the staple itself easy to realize upon by sale at any time.

»It should be noted that pursuant to Part 201 and 202 of this chapter Federal Reserve Banksmay neither discount nor purchase bills arising out of the storage of readily marketablestaples unless the acceptor remains secured throughout the life of the bill.


REGULATION C 243

bills in an amount not exceeding at any time in the aggregate 100 percent of its paid-up and unimpaired capital stock and surplus (here-inafter referred to as "authority to accept commercial drafts or bills upto 100 per cent"); but in no event may the aggregate amount of suchacceptances growing out of domestic transactions exceed 50 per cent ofsuch capital and surplus. Commercial drafts or bills accepted byanother bank, whether domestic or foreign, at the request of a memberbank which agrees to put such other bank in funds to meet such ac-ceptances at maturity shall be considered as part of the acceptanceliabilities of the member bank requesting such acceptances as well asof such other bank, if a member bank, within the meaning of thelimitations prescribed in this section.

(e) Authority to accept up to 100 per cent.— (1) Any memberbank desiring authority to accept commercial drafts or bills up to 100per cent shall file with the Board of Governors, through the FederalReserve Bank of its district, an application for permission to exercisesuch authority. Such application need not be made in any particularform, but shall show the present and anticipated need of the applicantbank for the authority requested.

(2) The Board of Governors may at any time rescind any authoritygranted by it pursuant to this section after not less than 90 days'notice in writing to the bank affected.

SECTION 203.2--ACCEPTANCE OF DRAFTS OK BILLS TO FURNISHDOLLAR EXCHANGE

(a) Authority.— (1) Any member bank, after obtaining the per-mission of the Board of Governors, may accept drafts or bills of ex-change drawn upon it by banks or bankers in foreign countries ordependencies or insular possessions of the United States for the purposeof furnishing dollar exchange (referred to in this part as "dollar ex-change drafts or bills") as required by the usages of trade in the re-spective countries, dependencies, or insular possessions, subject to theconditions set forth in this section. Any member bank desiring toobtain such permission shall file with the Board of Governors throughthe Federal Reserve Bank of its district an application for such per-mission. Such application need not to be in any particular form butshall show the present and anticipated need for the authority requested.

(2) The Board of Governors may at any time rescind any permis-sion granted by it pursuant to this section after not less than 90 days'notice in writing to the bank affected.

(6) Countries with respect to which dollar exchange drafts orbills may be accepted.—(1) Any such foreign country or dependencyor insular possession of the United States must be one of those specifiedin a list published by the Board of Governors for the purposes of thispart, with respect to which the Board of Governors has found that theusages of trade are such as to justify banks or bankers therein in draw-ing on member banks for the purpose of furnishing dollar exchange.



Any member bank desiring to place itself in position to accept draftsor bills of exchange from a country, dependency, or insular possessionnot specified in such list may request the Board of Governors throughthe Federal Reserve Bank of its district to add such country, de-pendency, or insular possession to the list upon a showing that thefurnishing of dollar exchange is required by the usages of trade therein.

(2) The Board of Governors may at any time after 90 days' pub-lished notice, remove from such list the name of any country, de-pendency, or insular possession, contained therein.

(c) Purpose of transaction.— (1) Any sucli dollar-exchange draftor bill must be drawn and accepted in good faith for the purpose offurnishing dollar exchange as required by the usages of trade in thecountry, dependency, or insular possession in which the draft or billis drawn. Drafts or bills drawn merely because dollar exchange isat a premium in the place where drawn or for any speculative purposeor drafts or bills commonly referred to as "finance bills" (i.e., whichare not drawn primarily to furnish dollar exchange) will not be deemedto meet the requirements of this section.

(2) The aggregate of drafts or bills accepted by such member bankfor any one foreign bank or banker shall not exceed an amount whichthe member bank would expect such foreign bank or banker to liqui-date within the terms of the agreements under which the drafts or billswere accepted, through the proceeds of export documentary bills orfrom other sources reasonably available to such foreign bank orbanker arising in the normal course of trade.

(d) Maturity.—Such member bank shall not accept any dollarexchange draft or bill unless at the date of its acceptance it has notmore than three months to run, exclusive of days of grace.

(e) Acceptances for one hank or banker.—Such member bankshall not accept dollar exchange drafts or bills for any one bank orbanker in an amount exceeding in the aggregate 10 per cent of thepaid-up and unimpaired capital and surplus of the accepting bank,unless it be and remain secured as to the amount in excess of such10 per cent limitation by documents conveying or securing title or bysome other adequate security.

(/) Limitation on aggregate amount.—Such member bank shallnot accept dollar exchange drafts or bills in an amount exceeding atany one time in the aggregate 50 per cent of its paid-up and unim-paired capital and surplus. This limitation is separate and distinctfrom and not included in the limitations prescribed by § 203.1 {d)with respect to acceptances of commercial drafts or bills. Dollarexchange draft or bills accepted by another bank, whether domesticor foreign, at the request of a member bank which agrees to putsuch other bank in funds to meet such acceptances at maturityshall be considered as part of the acceptance liabilities of the memberbank requesting such acceptances as well as of such other bank, if amember bank, within the meaning of the limitations prescribed in thissection.


Rights and Liabilities ofFederal Reserve Banks

with Respect to Discounted Paper

In the course of the foregoing history of thedevelopment of the lending functions of theFederal Reserve Banks, mention has been madeof certain cases in which the courts have hadoccasion to construe the provisions of law andregulations relating to such functions. In addi-tion, there have been a number of court deci-sions pertaining to the right of the ReserveBanks to realize upon the paper discounted oroffered as collateral when the borrowing mem-ber bank becomes insolvent or, for otherreasons, fails to repay the loan made by theReserve Bank. These decisions have turned notupon interpretation of the law or regulationsbut on issues of general law regarding nego-tiable instruments that would be equally ap-plicable to loans by commercial banks. How-ever, for the sake of completeness, the moreimportant of these court decisions are sum-marized briefly in this appendix.

In general, litigation resulting from effortsby the Reserve Banks to realize on paper dis-counted for member banks involved questionsrelating to the validity of defenses made by theobligor on such paper, that is, the person whooriginally gave the paper to the member bankas evidence of a loan made by that bank. InChapter 3 of this study, it was noted that aborrowing member bank, by virtue of its en-

dorsement of the discounted paper, becomesprimarily liable to the Reserve Bank, thus givingthe Reserve Bank the right to proceed directlyagainst the member bank rather than againstthe obligor on the paper discounted. However,if the member bank is insolvent, the ReserveBank's right of recourse against the memberbank is of little value. It is for this reasonthat the cases hereinafter mentioned usuallyrevolved around the right of the Reserve Bankto enforce the discounted paper against theoriginal obligor.

The most obvious defense to suit by a Re-serve Bank against the obligor on discountedpaper would be the fact of payment by theobligor. In several cases, this defense was madewhen the obligor had in fact paid his note tothe member bank that had later discounted itwith the Reserve Bank. In general, however,the courts have held that this defense will notprevent recovery by the Reserve Bank, as aholder of the paper in due course, if the obligormade payment to the member bank withoutdemanding production of the paper represent-ing his loan and if the member bank did not actas agent for the Reserve Bank in receiving suchpayment.

In a 1926 Texas case, Federal Reserve Bankof Dallas v. Hanna, 287 S. W. 274, it was held

245



that there was a reasonable inference that themember bank acted as agent for the ReserveBank in receiving payment and that, therefore,the question of agency was properly submittedto a jury. Ten years later, a Federal court heldthat the question was not one for a jury, despiteevidence of a practice under which notespledged with the Reserve Bank were sent tothe borrowing member bank for collection. Inthe case of Federal Reserve Bank of Richmondv. Kalin, 81 Fed. (2) 1003 ( C C A . 4th,1936), the court concluded that since theReserve Bank and the member bank wereseparate corporate entities, "no agency existson the part of one to act in behalf of the other,except such as arises from contractual rela-tionships sufficient to establish agency betweenany other banks." This case was followed in a1937 New Jersey case, Federal Reserve Bankof Philadelphia v. Gettleman, 189 Atl. 86 (N.J.1937), in which the court stated:

Ordinarily, in the case of negotiable paper,the person answerable does not pay the origi-nal payee if he is not in possession of thenote, except at his own risk. * * * Noagency to collect arises from the fact thatpayee bank was a member of the FederalReserve Bank of Philadelphia * * *.

In the same year, however, the FederalDistrict Court for the District of New Jerseyheld, as in the Hanna case, that the facts weresufficient to imply a custom under which themember bank acted as agent for the ReserveBank in receiving payment on the discountednote and to justify submission of the agencyquestion to a jury. Federal Reserve Bank ofPhiladelphia v. Algar, 22 Fed. Supp. 168 (D.C.N.J. 1937), aff'd. 100 Fed. (2) 941 ( C C A .3d, 1939), cert, den., 307 U. S. 631 (1939).

Next to the defense of payment, the mostfrequent defense to liability on a discountednote has been that the maker had sufficientfunds on deposit with the discounting memberbank to pay the note; in other words, a defenseof set-off. In general, such a defense has beenheld not to prevail against a Federal ReserveBank that had acquired the note by way ofdiscount.

Thus, in a 1923 Washington case, the makerof the discounted note asserted a right of set-off of his deposit with a failed member bank,predicating his claim on the ground that theReserve Bank held collateral in excess of theindebtedness of the member bank and that, onthe theory of "marshalling of assets," the Re-serve Bank should have had recourse to suchcollateral first. The court, however, ruled thatthe deposit liability of the failed bank to themaker of the note could not be set off againstthe note held by the Reserve Bank. Williams v.Duke, 125 Wash. 250, 215 Pac. 372.

A similar position was taken by the UnitedStates Supreme Court in 1925 when the makerof the discounted note claimed that the ReserveBank should have presented the note for pay-ment to the bank at which it was payable andwith which the maker had a deposit sufficientto pay the note. Since the maker had expresslywaived protest, notice, and diligence in collect-ing, the Court held that the Reserve Bank wasnot bound to present the note at the bank atwhich payable. However, the Court also re-jected the theory of marshalling of assets, hold-ing that the Reserve Bank could enforce thenote without waiting to determine whetherother collateral held by it was sufficient to coverthe indebtedness of the discounting memberbank. Sowell v. Federal Reserve Bank ofDallas, 268 U. S. 449.

Despite this decision of the Supreme Court,a Mississippi court in 1934 gave recognitionto marshalling of assets in the light of the par-ticular circumstances. In this case, the ReserveBank knew of the maker's right of set-off ofhis deposit with the member bank. The courtheld that, because of principles of equity andfair dealing, the Reserve Bank should haveresorted first to collateral held by it againstwhich no defenses of set-off existed before itresorted to the defendant's notes and that, there-fore, the marshalling of assets theory shouldapply. Dilworth v. Federal Reserve Bank ofSt. Louts, 170 Miss. 373, 154 So. 535 (1934).

Nevertheless, there were still later court de-cisions that denied the right of the obligor ona note given to a member bank and later dis-


RIGHTS AND IIABHITIES OF FR BANKS 247

counted with a Federal Reserve Bank to set offhis deposit with the failed member bank againsthis liability on the note. Federal Reserve Bankof Richmond v. Duffy, 210 N. C. 598, 188S. E. 82 (1936); Federal Reserve Bank ofBoston v. Gray-United Stores, 194 N. E. 709(Mass. 1935).

In addition to efforts to set off deposits inthe discounting member bank, obligors on dis-counted paper have offered other defensesagainst suits by Federal Reserve Banks on suchpaper, which also have been in the nature ofset-off or counterclaim. In one case, for ex-ample, the maker of two discounted notesalleged that he had received no considerationfor one of the notes and that he was entitledto a counterclaim for the other note. The courtheld, however, that these defenses were notavailable against the Federal Reserve Bank as aholder of the notes in due course. FederalReserve Bank of Richmond v. Atmore, 200N.C.437, 157 S.E. 129(1931).

In another case, a note executed by a cityin renewal of a note previously given to amember bank for money borrowed to retirecity bonds was held enforceable by a FederalReserve Bank as a bona fide holder in duecourse even though the city had no authority toissue negotiable notes. Federal Reserve Bankof Atlanta v. Panama City, 87 Fed. (2) 677(CCA. 5th, 1937).

Again, when the maker of the discountednote claimed that the member bank hadevaded the usury law, it was held that this claimcould not be made against a Federal ReserveBank that took the note as a holder in duecourse. Federal Reserve Bank of Richmondv. Jones, 205 N. C. 648, 172 S. E. 185 (1934).Similarly, when the maker, a married woman,alleged that she had executed a note as suretyfor her husband's debt and that the note wasstill in possession of the member bank, it wasruled that the bank held the note only as agentof the Reserve Bank for collection and that shecould not assert her defense against the Re-serve Bank as a holder in due course. FederalReserve Bank of Atlanta v. Haynie, 46 Ga.App.522, 168 S.E. 112(1933).

In Bragg v. Federal Reserve Bank of Rich-mond, 164 Va. 30, 178 S. E. 680 (1935),Government bonds deposited with a memberbank were pledged by the latter as security fora Federal Reserve Bank loan. When the mem-ber bank later failed, the estate of the deceasedowner of the bonds brought suit against theReserve Bank for recovery of the bonds, alleg-ing that they had been deposited with themember bank for safekeeping only. The courtheld that the evidence was not sufficient toshow that the bonds had been deposited merelyfor safekeeping and that, in any event, recoverywas barred by the fact that the Reserve Bankwas a holder of the bonds in due course.

On the other hand, when a draft was sentby the seller of goods to a member bank for col-lection only and the bank discounted the draftwith a Reserve Bank and both the memberbank and the Reserve Bank knew that themember bank was insolvent, it was held thatthe Reserve Bank was not a bona fide holderin due course. Federal Reserve Bank of SanFrancisco v. Idaho Grimm Alfalfa Seed Grow-ers Association, 8 Fed. (2) 922 (CCA. 9th,1925), cert, den., 270 U. S. 646 (1926). Simi-larly, when a Reserve Bank sold certain stockthat had been pledged with it by a memberbank that later became insolvent and knew atthe time of the sale that an attorney for themember bank had a valid lien on the stock, itwas held that the Reserve Bank was guiltyof conversion and that the attorney was entitledto assert his claim. It was only because theplaintiff had not alleged with certainty thevalue of the stock and proved that he had beeninjured by its sale that a judgment for theplaintiff in the lower court was reversed. Hans-brough v. D. W. Standrod & Co., 49 Idaho216,286 Pac. 923 (1930).

In a few instances, the obligor on the dis-counted paper has set up a defense based uponan offsetting claim against the Federal ReserveBank itself rather than the discounting memberbank. Thus, the Hansbrough case last citedgave rise to further litigation in which theReserve Bank sued Hansbrough, the attorneyfor the member bank, on a mortgage note and



the attorney claimed that the Reserve Bankhad agreed to release the mortgage in con-sideration of the attorney's assignment of hisinterest in a judgment for attorney's fees againstthe member bank. The Reserve Bank con-tended that since the judgment for attorney'sfees had been modified on appeal, there wasa failure of consideration. However, the courtheld for the attorney on the ground that themodification of the judgment had not affectedthe merits and that the interest assigned to theReserve Bank was still sufficient to constitutea valuable consideration. Federal ReserveBank of San Francisco v. Hansbrough, 49Idaho 747,292 Pac. 222 (1930).

In another case, the maker of a discountednote alleged that the Reserve Bank had vio-lated its verbal agreement with respect to pas-turing cattle on the defendant's land. Despitearguments of the Reserve Bank that newlydiscovered evidence should be considered inmitigation of damages resulting from violationof the verbal agreement, judgment for the de-

fendant was affirmed. Federal Reserve Bank ofDallas v. Upton, 34 N. M. 509, 285 Pac. 494(1930).

The cases briefly mentioned here will sufficeto illustrate the nature of the questions thathave been the subject of litigation arising fromefforts of Federal Reserve Banks to enforcepayment of paper discounted by member banksor given by member banks as collateral forReserve Bank loans. The cases cited are in nosense intended to be exhaustive. Among othersthat might have been mentioned, the readeris referred to Federal Reserve Bank of Rich-mond v. Crothers, 289 Fed. 777 (CCA. 4th,1923); Federal Reserve Bank of Richmond v.Meadows, 201 N. C. 832, 160 S. E. 757(1931); Federal Reserve Bank of New Yorkv. Palin, 79 Fed. (2) 539 (CCA. 2d, 1935);Federal Reserve Bank of Philadelphia v. OceanCity, 84 Fed. (2) 657 (CCA. 3d, 1936),cert, den., 299 U. S. 584; Federal Reserve Bankof Philadelphia v. Levy, 97 Fed. (2) 50(CCA. 3d, 1938).


jiHislory.£ of the •§Lending

Notes and References

INTRODUCTION

Senate Doc. 243, 62d Cong., 2d Sess.House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,1913), p. 11./</.. p. 48.

Id., p. 51.Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.(Nov. 22, 1913), p. 7.Mr. Tribble, 50 Congressional Record 5044.

THE ORIGINAL DISCOUNT PROVISIONS

House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,1913), p. 16.Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.(Nov. 22, 1913), pp. 7, 8.50 Congressional Record 4880, 4906,4924.51 Congressional Record 430.50 Congressional Record 4678.50 Congressional Record 4802.Mr. Towner, 50 Congressional Record 4897.Mr. McKellar, 50 Congressional Record 4830.Mr. Callaway, 50 Congressional Record 4868.Mr. Kennedy, 50 Congressional Record 4929.House Rep. No. 69, Sept. 9, 1913, p. 51.50 Congressional Record 4678.51 Congressional Record 533.Report of National Monetary Commission,Senate Doc. 243, 62d Cong., 2d Sess. (Jan. 9,1912), p. 8.

50 Congressional Record 5998.Mr. Neeley, 50 Congressional Record 4844. Atanother point, Mr. Beakes said: "Speculation islargely guarded against, as these reserve bankswill not rediscount for their member banks papersecured by stocks and bonds, the usual methodof securing money for Wall Street gambling." (50Congressional Record 4906)Mr. Thompson, 50 Congressional Record 5012.Senator Swanson, 51 Congressional Record 430.50 Congressional Record 4675. To the same gen-eral effect were statements by Messrs. Wilson (50Congressional Record 4854), Saunders (50 Con-gressional Record 4880), and Stephens (50 Con-gressional Record 4923,4924).50 Congressional Record 4905.51 Congressional Record 782.

GENERAL LIMITATIONS

Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.(Nov. 22,1913), p. 26.House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,1913), p. 18. Similarly, Mr. Phelan during thedebates in the House explained that the purposeof the maturity limitation was to prevent theassets of the Reserve Banks from becoming "tiedup." (50 Congressional Record 4675)50 Congressional Record 4731.51 Congressional Record 1056. The NationalMonetary Commission, also following Europeanpractice, had recommended a maturity of 28days but with provision for the discount of paper

with maturities of up to 90 days if guaranteed bythe local national reserve association. (Report ofNational Monetary Commission, p. 22)House Rep. No. 69, Sept. 9, 1913, p. 48.50 Congressional Record 4647. Later in the de-bates, Mr. Phelan also undertook to dispel this"misapprehension." (50 Congressional Record4675)See, for example, statements by Mr. Stephens ofMississippi (50 Congressional Record 4924) andMr. Thompson of Oklahoma (50 CongressionalRecord 5007).50 Congressional Record 5053.

249


tHistory-if of thc%^Lending'

Notes and References—Continued

50 Congressional Record 6016, 6017.Senator Pomerene, 51 Congressional Record 523,1055.Senator Shafroth, 51 Congressional Record 1056.51 Congressional Record 523, 1055.51 Congressional Record 613, 1055.51 Congressional Record 1063.51 Congressional Record 1144.Act of Sept. 7, 1916 (39 Stat. 752).Letter from Board to Senate Banking and Cur-rency Committee, Mar. 10, 1916, Senate Rep. No.481, 64th Cong., 1st Sess. (May 18, 1916), p. 10.1915 Federal Reserve Bulletin 37 (hereinafterreferred to as Bulletin).Reg. A, Series of 1916, § I(a) (1916 Bulletin530).Reg. A, 1955, § 3(a)(4) (1955 Bulletin 10).Reg. A, as amended Nov. 13, 1968, § 201.2(a)(196S Bulletin 1012).1917 Bulletin 378.1966 Bulletin 506.Report of National Monetary Commission, p. 37.50 Congressional Record 5065.See statement by Senator Weeks, 51 Congres-sional Record 469. This fear was later proved tobe unfounded; banks soon found that a substan-tial portion of their paper was eligible for dis-count. (Annual Report of the Federal ReserveBoard, 1915, p. 10; hereinafter referred to asAnnual Report)51 Congressional Record 1063.51 Congressional Record 1076.50 Congressional Record 5071.50 Congressional Record 5047.50 Congressional Record 5065.House Rep. No. 69, Sept. 9, 1913, p. 52.Letter to Senate Banking and Currency Commit-tee, Mar. 10, 1916, Senate Rep. No. 481, 64thCong., 1st Sess. (May 18,1916), p. 9.Act of Sept. 7, 1916 (39 Stat. 752).1916 Bulletin 274.Letter to Senate Banking and Currency Commit-tee, Mar. 10, 1916, Senate Rep. No. 481, 64"thCong., 1st Sess. (May 18, 1916), p. 9.Act of June 21, 1917 (40 Stat. 232). In addition,the amendment provided that, as a condition ofdiscount, the Reserve Bank should require theState member bank to submit a certificate that theborrower was not liable to such bank in excess ofthe amount presented.Letter from Board to Senate Banking and Cur-rency Committee, set forth in Senate Rep. No.73, 67th Cong., 1st Sess. (May 25, 1921).Act of July 1, 1922 (42 Stat. 821).Government bonds had been excepted from the10 per cent limit of §5200 of the Act of

Sept. 24, 1918 (40 Stat. 967), and paper securedby shipping documents, bankers' acceptances, andreadily marketable staples by the Act of Oct. 22,1919 (41 Stat. 296). The section had been furtherliberalized by the McFadden Act of Feb. 25, 1927(44 Stat. 1229).House Rep. No. 753, 71st Cong., 2d Sess. (Feb.25, 1930), p. 1.Id., p. 2; 1924 Bulletin 275.46 Stat. 162.The proviso was added because a similar provi-sion had been stricken from the McFadden bill3 years earlier as the result of opposition arousedby the "unwarranted contention" that the amend-ment was intended to change the character ofpaper eligible for discount. The Banking andCurrency Committees in 1930 declared that therewas no basis for this feeling but that the provisowas added "in order to anticipate any similarobjection." (Senate Rep. No. 308, 71st Cong., 2dSess. (Apr. 2, 1930); House Rep. No. 753, 71stCong., 2d Sess. (Feb. 25, 1930))Act of Mar. 3,1919 (40 Stat. 1314).Reg. A, 1955, § 3(j) (1955 Bulletin 12).Reg. A, as amended Nov. 23, 1970, 5 201.4(a)(1970 Bulletin 940).1919 Bulletin 1055.1930 Bulletin 453.1938 Bulletin 571.Act of June 16, 1934 (48 Stat. 971).1934 Bulletin 749.1920 Bulletin 278.Senator Weeks, 51 Congressional Record 1074.House Rep. No. 69, Sept. 9, 1913, p. 48.50 Congressional Record 4675.51 Congressional Record 523.Reg. No. 2, 1914 (1914 Annual Report 59).Reg. B, Series of 1915, § I(a) (1915 Bulletin 37).39 Stat. 752.1916 Bulletin 524.1916 Bulletin 610. Although this is true in mostStates, there may be some States in which suchallonges are not considered sufficient.Federal Reserve Bank of Minneapolis v. FirstNational Bank, 277 Fed. 300 (D.C.S.D., 1921).1916/?H//<?///I685. „, ,Reg. A, Series of 1916, §§ IV(a) and V(a) (1916Bulletin 531).Reg. A, 1955, § 3(a) (1) (1955 Bulletin 10).Reg. A, 1937, as amended Sept. 28, 1942, § l(n)(1942 Bulletin 989).1944 Bulletin 879.1949 Bulletin 247.1951 Bulletin 391.1949 Bulletin 247.1915 Bulletin 21.

250


^History;#of lhe»fs'Lending-


1919 Bulletin 472.1917 Bulletin 457.1917 Bulletin 291.1915 Bulletin 219.1918 Bulletin 870.1917 Bulletin 880.

1918 flnMe/m 745.1917 J7n/to//t 200.1918 Bulletin 871.1942 Annual Report 98.1970 Bu/fe/fii 444.

DISCOUNT OF COMMERCIAL PAPER

House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,1913), p. 48.51 Congressional Record 1074.50 Congressional Record 4675.50 Congressional Record 5046.51 Congressional Record 1074.

/</.. p. 9.Circular No. 13, 1914 (set forth in 1914 AnnualReport 182).1914 Annual Report 58.1915B«//c»/i37.1916 Bulletin 531.Reg. A, Series of 1920, § H(a) (1920 Bulletin1180).Reg. A, Series of 1923, § II(a) (1923 Bulletin893).Reg. A, effective Oct. 1, 1937 (1937 Bulletin984).1920 Bulletin 1302.Many years later, in 1937, the Board adopted thebroader view that a note given by the purchaserof goods is commercial paper even in the handsof the buyer and regardless of whether the goodsare bought for resale or for use by the buyer.(1937 Bulletin 1190)1921 Bulletin 1199.1915 Bulletin 212.1920 Bulletin 949.1918 Bulletin 91 A.1921 Bulletin 1079.1917 Bulletin 949.1921 Bulletin 1079.19(7 Bulletin 949.Reg. B, Series of 1915 (1915 Bulletin 37).Reg. A, Series of 1916 (1916 Bulletin 531).Reg. A, Series of 1920 (1920 Bulletin 1180).See 1915 Bulletin 72; 1917 Bulletin 456; 1918Bulletin 108; 1921 Bulletin 1314; 1925 Bulletin737.1917 Bulletin 458.1922 Bulletin 931.

\916 Bulletin 66.Lucas v. Federal Reserve Bank of Richmond, 50Fed. (2d) 617 (CCA. 4th, 1932) (1932 Bulletin452).Reg. A, 1937 (1937 Bulletin 987).Regs. 3 and 4, 1914 (set forth in 1914 AnnualReport 60).Reg. A, Series of 1915 (1915 Bulletin 36).The Board later made it clear that its regulationdid not require a member bank to maintain aborrower's financial statement on file. (1915Bulletin 213)Reg. A, Series of 1916 (1916 Bulletin 530).1920 Bulletin 1180.Reg. A, Series of 1928, § IV(b) (1928 Bulletin64).Reg. A, 1937, §§ l(h) and 3(b) (1937 Bulletin985, 987); for similar provisions of 1955 regula-tion, see 1955 Bulletin 12, 13.1963 Annual Report 198.By a court decision it was made plain that theFederal Reserve Act had no effect upon the char-acter of a trade acceptance or the rights of theparties thereto. (Stafford v. Hill, 53 Calif. App.337, 200 Pac. 33 (1921))1917 Bulletin 116.Circular No. 16, Series of 1915 (1915 Bulletin216).Reg. P, Series of 1915 (1915 Bulletin 217).Reg. A, Series of 1916, § V(a) (1916 Bulletin531).1919 Bulletin 565.1919 Bulletin 964. This ruling was incorporated ina footnote to Regulation A in 1920, which statedthat "a consignment of goods or a conditional saleof goods can not be considered 'goods sold'."(1920 Bulletin 1180)1918 Bulletin 33.1917 Bulletin 114, 116.1918 Bulletin 310.1918 Bulletin 435.1918 Bulletin 309.

251


History;''>:• of Ihc %* Lending


1919 Bulletin 565. However, as previously indi-cated, it was permissible for the draft to includethe cost of labor in installing goods sold. (Reg. A,Series of 1920, § VI(a), footnote 1; 1920 Bulletin1180)1918 Bulletin 30.1918 Bulletin 636.Lane Company v. Crum, 291 S.W. 1084 (1927Bulletin 510).1927 Bulletin 510. Subsequently, in 1928, anotherTexas court held that a trade acceptance wasnegotiable even though it stated that the obliga-tion of the acceptor arose out of the purchaseof goods from the drawer (American ExchangeNational Bank v. Steeley, 10 S.W. (2d) 1038;1929 Bulletin 157). The court distinguished thiscase from the Lane Company case on the groundthat in the earlier case the statement on the ac-ceptance required reference to the collateraltransaction in order to determine maturity, whilein the instant case this was not necessary, theinstrument being an unqualified promise to payat a certain time.Circular No. 17, Series of 1915 (1915 Bulletin310).Reg. Q, Series of 1915 (1915 Bulletin 310).Reg. A, Series of 1916, § VII (1916 Bulletin532).Reg. A, Series of 1917, § VII (1917 Bulletin540).Reg. No. 2, 1914 (1914 Annual Report 59).Reg. B, Series of 1915, §II(b)(l) (1915 Bulletin37).Reg. A, Series of 1920, §II(b) (1920 Bulletin1180).Reg. A, 1937, 8 l(a)(2) (1937 Bulletin 984).Reg. A, 1955, § 3(a)(2) (1955 Bulletin 10).1915 Bulletin 73; 1921 Bulletin 546.1920 Bulletin 699; 1921 Bulletin 191.1920 Bulletin 1301; 1921 Bulletin 191.1918 Bulletin 309.1916 Bulletin 67.1918 Bulletin 971.1921 Bulletin 191.1926 Bulletin 585.1920 Bulletin 699.1938 Bulletin 86.Reg. A, 1973 (Appendix B).1965 Bulletin 1409.Reg. B, Series of 1915, § II(b)(2) (1915 Bulletin

Reg. A, Series of 1916, § II(c) (1916 Bulletin531).Reg. A, 1955, § 3(a)(3) (1955 Bulletin 10).1922 Bulletin 932.1915 Bulletin 127.1914 Annual Report 59.The present provision is contained in Reg A1973, § 201.4(a) (Appendix B).

ICO

101

100

110

Approved Apr. 5, 1918 (40 Stat. 506); subse-quently amended by Acts of Nov. 21, 1918,Mar. 3, 1919, and Aug. 24, 1921.1924 Bulletin 277.Reg. A, Series of 1924, §§ I(c), II(a) (1924 Bul-letin 705).See 1916 Bulletin 587.1917 Bulletin 158, 197.1918 Bulletin 743; rescinded later, see 1924 Bul-letin 81.The Board previously had only discouraged thediscount of paper of finance companies. (1915Bulletin 72) Whether particular paper was financeor commercial paper was a matter, the Boardheld, for determination by the Reserve Bank.(1919 Bulletin 1054)1919 Bulletin 1054; 1920 Bulletin 162, 1176; 1921Bulletin 308.1918 Bulletin 197.1920 Bulletin 609.Reg. A, Series of 1920, § II(c) (1920 Bulletin1180).Act of Mar. 4, 1923 (42 Stat. 1454).Reg. A, Series of 1923, 5 H(b) (1923 Bulletin893). Under the first of these provisions, theBoard held that notes of a factor the proceeds ofwhich are loaned to producers of eggs, poultry,and butter were eligible for discount. (1926 Bul-letin 251)1926 Bulletin 665.1930 Bulletin 746.1937 Annual Report 31.1917 Bulletin 1190.Ibid. See also 1938 Bulletin 86, regarding theeligibility for discount of notes of a finance com-pany. Similarly, when the proceeds of a loan bya member bank to a credit union are used by thelatter to make loans for "eligible" purposes, thenote representing the loan to the credit union iseligible for discount. (1939 Bulletin 361)1965 Bulletin 1409.1972 Bulletin 279.1937 Bulletin 1190.Act of June 27, 1934, 5 505(b) (48 Stat. 1246).Sec. 24 of the Federal Reserve Act is to befound in 12 U.S.C. § 371.Act of Aug. 11, 1955 (69 Stat. 634).House Banking and Currency Committee Rep. No.1349, 84th Cong., 1st Sess. (July 22, 1955), P- 2-See also Senate Banking and Currency CommitteeRep. No. 399, 84th Cong., 1st Sess. (May 27,

Act of Sept. 9, 1959 (Pub. Law 86-251, 86thCong.). The report of the House Banking MiaCurrency Committee (House Rep. No. 693, 86tnCong., 1st Sess., July 21, 1959) pointed out thatin such cases a national bank making such a loanrelied upon the "take-out" commitment ranerthan the underlying real estate security and tnai

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i History >^ of t h e *Lending


therefore such loans should be classed as com-mercial rather than real estate loans. The commit-tee felt that the amendment would "permit na-tional banks to make safe and desirable loans ofthis type which they may not now make, and willeliminate a competitive disadvantage which theynow have vis-a-vis State banks in many States."The amendment had been recommended in 1956by the Comptroller of the Currency for similarreasons (see Study of Banking Laws, committeeprint of Senate Banking and Currency Commit-

tee, 84th Cong., 2d Sess. (Oct. 12, 1956), pp. 49-51); and it had been included in the proposedFinancial Institutions Act, which had passed theSenate in 1957 (S. 1451, 85th Cong., 1st Sess.)but had failed to pass the House.Reg. A, 1937, § l ( c ) (1937 Bulletin 985).Reg. A, 1955, § 3(d) (1955 Bulletin 12).House Banking and Currency Committee Reporton H.R. 9620, House Rep. No. 1922, 73d Cong.,2d Sess. (June 4, 1934), p. 4.

AGRICULTURAL CREDITS

50 Congressional Record 4647.See, for example, statements by Mr. Harrison (50Congressional Record 4729), Mr. Moss (50 Con-gressional Record 4774), and Mr. Neeley (50Congressional Record 4845).50 Congressional Record 4846.51 Congressional Record 613.Mr. Tribble stated that Mr. Glass had so con-strued the bill as originally reported. (50 Congres-sional Record 5045) There were some who as-serted that the provision was approved only aftera "hard struggle" in the Democratic caucus andin the face of Class's opposition. (50 Congres-sional Record 5009, 5022, 5045)Act of July 17, 1916 (39 Stat. 360).The Reserve Banks were authorized to buy andsell such bonds to the same extent that theycould purchase and sell municipal bonds under§ 14(b) of the Federal Reserve Act. Sec. 14(b)permitted (and still permits) the purchaseand sale of municipal bonds having maturities ofnot more than 6 months. Member banks weregiven blanket authority by the Farm Loan Act tobuy and sell farm loan bonds. The provisions ofthe Farm Loan Act were superseded by the com-prehensive Farm Credit Act of Dec. 10, 1971, butthe authorities above mentioned were continued.(12U.S.C. 2158)See discussion during the congressional debates onthe Agricultural Credits Act of 1923; 64 Congres-sional Record 1742, 1746.41 Stat. 1084.Mar. 4, 1923 (42 Stat. 1454).The Banking and Currency Committees agreedthat it was desirable to encourage more countrybanks to join the System (Senate Rep. No. 998,67th Cong., 4th Sess. (Jan. 8, 1923), p. 8; HouseRep. No. 1712, 67th Cong., 4th Sess. (Feb. 24,1923), p. 19). A proposal to increase dividends

paid on Federal Reserve Bank stock was finallyabandoned as not being a substantial inducementto membership (House Rep. No. 1712, p. 19).However, the Agricultural Credits Act sought tomake membership more attractive by somewhatliberalizing capital requirements, and a joint con-gressional committee was assigned the task ofconsidering what measures might be taken toincrease membership.House hearings on S. 4280, 67th Cong., 4th Sess.(Jan. 31, Feb. 2-19, 1923), p. 1.64 Congressional Record 1758.House hearings on S. 4280, Jan. 31,1923, p. 1.Id., p. 62.1923 Bulletin 913.Reg. C, Series of 1915 (1915 Bulletin 38).Reg. A, Series of 1923, § VI(a) (1923 Bulletin893).Reg. A, 1955, § 3(e) (1955 Bulletin 12).1918 Bulletin 310.1916 Bulletin 526.1918 Bulletin 1118.1918 Bulletin 310, 312.1915 Bulletin 75.1918 Bulletin 309.1916 Bulletin 67.1918 Bulletin 743. But the note of an irrigationcompany is commercial rather than agriculturalpaper, even though all of its customers are farm-ers. (1921 Bulletin 964)1916 Bulletin 679; 1917 Bulletin 378.1916 Bulletin 112; 1915 Bulletin 72.1915 Bulletin 212.1917 Bulletin 616.Statement by Senator Capper, 64 CongressionalRecord 1757.Senate Rep. No. 998, 67th Cong., 4th Sess.(Jan. 8, 1923), p. 7.64 Congressional Record 4903.

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a» History ,=r; of the<jjLending1

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Eugene Meyer felt that this restriction was unim-portant because of the large reserves available tothe Reserve Banks. (Hearings on S. 4280, 67thCong., 3d and 4th Sess. (Apr.-May 1922 andJan.-Feb. 1923), p. 60)Senate Rep. No. 998, 67th Cong., 4th Sess. (Jan.8, 1923), p. 7.Reg. No. 5 (1914 Annual Report 61).Circular No. 13, 1914 (1914 Annual Report 184).Act of Sept. 7, 1916 (39 Stat. 752). See state-ment by Senator Owen, 53 Congressional Record11002.Reg. A, Series of 1923, § VI(e) (1923 Bulletin893).1917 Bulletin 378.1923 Bulletin 911. See statement by Senator Plattduring hearings on S. 4280, 67th Cong., 3d and4th Sess. (Apr.-May 1922 and Jan.-Feb. 1923),p. 104; also Senate Rep. No. 998, 67th Cong.,4th Sess. (Jan. 8, 1923), p. 6.Act of Mar. 4, 1923 (42 Stat. 1454).Act of May 29,1928 (45 Stat. 975).Reg. A, Series of 1923, § VII (1923 Bulletin894).Reg. A, 1955, § 3(b) (1955 Bulletin 11).1966 Bulletin 506.1924 Bulletin 276.1925 Bulletin 737.1926 Bulletin 854.Reg. A, 1937, § l(b) (1937 Bulletin 984).Hearings on S. 4280, 67th Cong., 3d and 4thSess. (Apr.-May 1922 and Jan.-Feb. 1923), p.60.Id., p. 74.

Reg. A, Series of 1923, § VIII (1923 Bulletin894).Reg. A, 1955, § 3(g) (1955 Bulletin 12).1926 Bulletin 251.1923 Bulletin 911. For statement by EugeneMeyer regarding development of such associa-tions, see hearings on S. 4280 before House Bank-ing and Currency Committee, 67th Cong., 3d and4th Sess. (Apr.-May 1922 and Jan.-Feb. 1923),p. 61.1923 Bulletin 999.See summary of such rulings in 1922 Bulletin1044.1921 Bulletin 1312.Hearings on S. 4280 before House Banking andCurrency Committee, 67th Cong., 3d and 4thSess. (Apr.-May 1922 and Jan.-Feb. 1923), p.61.1923 Bulletin 999.Reg. A, Series of 1923, § VI(b) (1923 Bulletin893). See also Reg. A, 1955, §3(f) (1955 Bul-letin 12).Reg. A, Series of 1923, § VI(d) (1923 Bulletin894).This limitation was not applicable, however,when paper of a Federal intermediate creditbank was rcdiscounted at a Federal Reserve Bankby a member bank. (1926 Bulletin 252)1928 Bulletin 777.1937 Bulletin 984.Reg. A, 1955, § 6(a) (1955 Bulletin 14).75 Congressional Record 8860.47 Stat. 159.

BANKERS' ACCEPTANCES

Report of National Monetary Commission, Sen-ate Doc. 243, 62d Cong., 2d Sess. (Jan. 9, 1912),p. 28.House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,1913), p. 49.50 Congressional Record 4678.51 Congressional Record 434.51 Congressional Record 469.50 Congressional Record 4647.51 Congressional Record 1470.Circular No. 11, Series of 1915 (1915 Bulletin44).Ibid.Press statement, Sept. 10, 1915 (1915 Bulletin312).

1916 Bulletin 591.1919 Annual Report 22.1920 Annual Report SO.See article on "Bankers' Acceptance Financing inthe United States," 1955 Bulletin 482.Ibid. See also Wilbert Ward and Henry Harfield,Bank Credits and Acceptances (4th ed.; N.Y.:Ronald Press Co., 1958), p. 88.Reg. J, Series of 1915, § I (1915 Bulletin 45).Id., § IV(b).Reg. A, Series of 1916 (1916 Bulletin 532).Reg. A, Scries of 1920 (1920 Bulletin 1180).1916 Bulletin 112.1915 Bulletin 362.1918 Bulletin 634.

254


,'Hisloryfffaf the -|^Lending'/Functions


House Rep. No. 69, Sept. 9, 1913, p. 49.50 Congressional Record 4676.51 Congressional Record 434.Sec. for example. 1921 Bulletin 547, 816.12 C.F.R. 7.7420.1923 Bulletin 319.1923 Bulletin 316-19.1915 JW/rfin98.Reg. A, 1937, § 6(b) (1937 Bulletin 988).1916 Bulletin 532. In 1928 the Board publishedsuggested forms of certificates evidencing eligibil-ity of bankers' acceptances. (1928 Bulletin 517)1920 Bulletin 386.Reg. No. 6, Nov. 10, 1914 (1914 Annual Report61).Reg. J, Scries of 1915 (1915 Bulletin 45).Reg. A, Scries of 1916 (1916 Bulletin 532).1917 Bulletin 28.1915 Bulletin 276.1918 Bulletin 976.1929 Bulletin 294,1920 Bulletin 162.1916 Bulletin 458.1916 Bulletin 12.1917 Bulletin 30.1926 Bulletin 854.1927 Bulletin 860.Sec "Bankers' Acceptance Financing in theUnited States," 1955 Bulletin 482.1915 Bulletin 276; 1918 Bulletin 435.1920 Bulletin 162; 1921 Bulletin 419. The Boardalso ruled that it was immaterial whether or notthe goods had been actually sold at the time ofacceptance, if the accepting bank was reasonablysure that the draft was drawn to finance the ship-ment and the proceeds would be used for thatpurpose. (1917 Bulletin 527)1918 Bulletin 438.Reg. A, Series of 1920, § B ( b ) ( l ) (1920 Bulletin1180).The Board had previously ruled that there was noneed for identification of the goods at the timeof acceptance (1915 Bulletin 405; 1917 Bulletin527). Nor were there any limitations on the kindsof goods that might be involved. The Board ruledthat gold bullion and gold coin were "goods" forthis purpose. (1917 Bulletin 29)1921 Bulletin 70.1922 Bulletin 433.1915B////«/n91.Reg. A, Series of 1916, § B(c) (1916 Bulletin532).Reg. A, Series of 1923, SX (1923 Bulletin 892,894).Reg. C, 1946, § l (a) (Appendix C) .Act of Sept. 7,1916 (39 Stat. 752).1915 Annual Report 22. Later, on Mar. 10, 1916,

the Board recommended the amendment to theSenate Banking and Currency Committee. SeeSenate Banking and Currency Rep. No. 481, 64thCong., lstSess. (May 18,1916), p. 9.53 Congressional Record 11001.Reg. A, Series of 1916, § B(c) (1916 Bulletin532).1917 Bulletin 380.1920 Bulletin 1301; 1921 Bulletin 1312.1929 Bulletin 811.1921 Bulletin 191. Nor is an acceptance agree-ment, which purports to assign certain collateralsecurity but does not specifically mention anysecurity as assigned, sufficient to qualify as ashipping document. (1918 Bulletin 311) '1919 Bulletin 471.1917 Bulletin 765; 1918 Bulletin 971, 972. Event-ually, this principle was incorporated in theBoard's Regulation C. See Reg. C, as revisedAug. 31, 1946, § l (a ) (2 ) (Appendix C).1918 Bulletin 634.1919 Bulletin 254.Reg. C, 1946, § l (a ) (2 ) (Appendix C). Somelawyers have questioned this interpretation,arguing that domestic shipments may properlycover shipments within a foreign country. (SeeWard and Harfield, Bank Credits and Accept-ances (1958), p. 100.)1919 Bulletin 858.1922 Bulletin 52.1920 Bulletin 66.Reg. A, Series of 1920 (1920 Bulletin 1181).1918 Bulletin 437, 871.1918 Bulletin 636.1918 Bulletin 31; 1918 Bulletin 634; 1921 Bul-letin 963.1926 Bulletin 666.1923 Bulletin 1194; 1926 Bulletin 666.1933 Bulletin 188.1918 Bulletin 31; also 1918 Bulletin 862.Reg. A, Series of 1928, as amended, §XI(3)(1928 Bulletin 777).1923 Bulletin 316.Reg. A, Series of 1920, § B(b)(3) (1920 Bulletin1181). The requirement was repeated in Reg. A,as revised effective Feb. 15, 1955, footnote 8(1955 Bulletin 11); but it was eliminated in the1973 revision.1919 Bulletin 740; 1924 Bulletin 638.Reg. A, Series of 1928, § XI(3) (1928 Bulletin66).1916 Bulletin 523.1919 Bulletin 652.1918 Bulletin 309.1923 Bulletin 1194.1917 Bulletin 30; 1916 Bulletin 523.1925 Bulletin 737.

255


i History.f-.of thc%Lending'

Functions


101

102

105

100

ICO

110

111

113

114

113

110

120

121

1*7

1ZS

1916 Bulletin 523.1917 Bulletin 614.1918 Bulletin 520.1918 Bulletin 636.1920 Bulletin 65; 1921 Bulletin 699.1920 Bulletin 494; 1921 Bulletin 419.Senate committee report on H.R. 13391, SenateRep. No. 481, 64th Cong., 1st Sess. (May 18,1916), p. 10.53 Congressional Record 11002.1916 Bulletin 666.1920 Bulletin 835.Reg. C, 1946, § 2(c) ( l ) (Appendix C)./</., §2(c)(2).See "Bankers' Acceptance Financing in the UnitedStates," 1955 Bulletin 482.1916 Bulletin 534.1916 Bulletin 532.Reg. C, 1946, § 2(a) (Appendix C).1916 Bulletin 666.1918 Bulletin 938.1920 Bulletin 1175. Obviously, "San Salvador"referred to the country of Salvador rather thanthe city of San Salvador.1921 Bulletin 188.1922 Bulletin 50, 680.1918 Bulletin 938; 1922 Bulletin 680.1946 Bulletin 997.See hearings on S. 1451 and H.R. 7026 before theHouse Committee on Banking and Currency, Part2, 85th Cong., 2d Sess. (Jan. 14-Feb. 7, 1958),p. 1036.Id., p. 989.Id., pp. 1010, 1065.Id., p. 1036.Id., p. 1063.See present Reg. C, § l(b) (Appendix C).1917 Bulletin 690; 1923 Bulletin 158.1917 Bulletin 690; 1921 Bulletin 815.1929 Bulletin 811.Reg. A, Series of 1920, SB(c)(2) (1920 Bulletin1181).1921 Bulletin 815; 1922 Bulletin 52.Reg. A, 1955, § 3(c), footnote 10 (1955 Bulletin11).1917 Bulletin 30; 1921 Bulletin 699; 1926 Bul-letin 854.1920 Bulletin 66.Reg. J, Series of 1915 (1915 Bulletin 45).Reg. R, Series of 1915 (1915 Bulletin 311).Sept. 10, 1915 (1915 Bulletin 312).1919 Bulletin 858.Reg. A, Series of 1920 (1920 Bulletin 1181).1927 Bulletin 860.1921 Bulletin 963.

1915 Bulletin 126.39Stat. 752;12U.S.C. §372.1919 Bulletin 143.1919 Bulletin 364.1917 Bulletin 286.1920 Bulletin 1065.1922 Bulletin 52.1919 Bulletin 254, 468.1917 Bulletin 286, 881; 1919 Bulletin 254; 1921Bulletin 1313.Reg- C, Series of 1920 (1920 Bulletin 1182). Thecondition as to control of the goods was strictlyapplied. Even when the customer held a trustreceipt as agent for the bank for the sole purposeof diverting the cars carrying the goods to a ware-house, it was concluded that the customer wouldhave some control of the goods. (1921 Bulletin1313)Reg.C, 1946, § l(c) (Appendix C).In 1934 the Board held that, for the purpose ofthis limitation, capital stock included capital notesand debentures legally issued by a State memberbank and purchased by the Reconstruction Fi-nance Corporation. (1934 Bulletin 749)38 Stat. 958. In its report on this amendment, theHouse Banking and Currency Committee, headedby Carter Glass, stated that the Reserve BankOrganization Committee, on its tour of thecountry, had found that there were a number ofState banks that desired to become members ofthe System but were deterred by the restrictionsof § 13 of the Federal Reserve Act and thatthey might become members if this amendmentwere approved. (House Rep. No. 1165, 63dCong., 2d Sess. (Sept. 24, 1914))Reg. K, Series of 1915 (1915 Bulletin 46).1916 Annual Report 28.40 Stat. 232.See 1918 Bulletin 1119.Reg. C, Series of 1917 (1917 Bulletin 542).Reg.C, 1946, § l(e) (Appendix C).1916 Bulletin 397.Reg. C, 1946, § l(d) (Appendix C).1917 Bulletin 528.Federal Reserve Act, § 13, «| 12; 12 U.S.C. § 373.Reg. C, 1946, § 2(e) (Appendix C).Id., §2(c)(2).W.,§2(f).Reg. A, 1955, § 2(c) (1955 Bulletin 11).38 Stat. 958.Reg. J, Series of 1915 (1915 Bulletin 45).Reg. R, Series of 1915 (1915 Bulletin 310).1915 Bulletin 269.For a discussion of the nature and form of lettersof credit, see 1921 Bulletin 158, 410, 681, 926.

256


•f History;,± of the isLending"


1921 Bulletin 547.Reg. C, 1946, § l (d) (Appendix C); also 1915Bulletin 3 1 1 .1921 Bulletin 816.1918 Bulletin 257.

12 U.S.C. § 353.1923 Bulletin 317.Act of June 16, 1933 (48 Stat. 162).12C.F.R. §270.7(b).12 C.F.R. § 202.2.

REDISCOUNT OF WORLD WAR I VETERANS' NOTES

43 Stat. 125.Set forth in 1927 Bulletin 33.Reg. M, Series of 1926 (1927 Bulletin 30).The Board held that such a note was not eligiblefor discount if the requisite notice to the veteranhad been waived. (1931 Bulletin 538)

1928 Bulletin 74.Act of Feb. 27, 1931 (46 Stat. 1429).1931 Bulletin 161.Act of July 21,1932 (47 Stat. 724).1932 Bulletin 598.1939 Bulletin 361.

ADVANCES TO MEMBER BANKS

1915 Annual Report 22. Subsequently, the Boardrecommended specific language (1916 Bulletin324), which was adopted by Congress withoutchange.39 Stat. 752.Senate Banking and Currency Committee Rep.No. 481, 64th Cong., 1st Sess., (May 18, 1916),p. 9.53 Congressional Record 11001, 11002.Letter to Senate Banking and Currency Commit-tee, Mar. 29, 1932 (1932 Bulletin 213).1916 Bulletin 513.1927 Bulletin 29.1932 Annual Report 25-31, 216.1960 Bulletin 151.Act of Sept. 21, 1968 (82 Stat. 856).1968 Bulletin 1012.1916 Bulletin 685.53 Congressional Record 11001.1917 Bulletin 765, 879.Letter to Senate Banking and Currency Commit-tee, Mar. 29, 1932 (1932 Bulletin 206).Reg. A, 1955, S2(b) (1955 Bulletin 9) .1968 Bulletin 1012.75 Congressional Record 4324.S.4115.

Letter to Senate Banking and Currency Commit-tee, Mar. 29, 1932. (1932 Bulletin 213) The Fed-eral Advisory Council also opposed the proposedpenalty rate on 15-day advances. (1932 Bulletin224)1933 Bulletin 499.1970 Bulletin 940.39 Stat. 752.48 Stat. 7.1942 Bulletin 302.1955 Bulletin 9.1968 Bulletin 1012.This change was technically unnecessary becausea 1929 amendment to the Second Liberty BondAct of 1917 had provided that, for purposes ofthe Federal Reserve Act, bonds and notes of theUnited States should be deemed to include certifi-cates of indebtedness and Treasury bills (Act ofJune 17,1929; 46 Stat. 19).1960 Bulletin 858.1937 Bulletin 987.1939 Annual Report 6.1941 Annual Report 1.War Finance Corporation Act of Apr. 5, 1918(40 Stat. 506). Reference to the use of suchbonds as collateral for Federal Reserve advances

257


• History*j ; of the §Lending'

Functions


was contained in the Board's 1920 revision ofRegulation A (1920 Bulletin 1179), but it wasomitted in the 1928 revision of the regulation.47 Stat. 159.Previously, in December 1931, a bill to permitsuch debentures to be used as collateral for § 13advances had been introduced by Senator Van-denberg but had failed to pass.House Rep. No. 1125, 72d Cong., 1st Sess.(Apr. 25, 1932), pp. 4, 5.75 Congressional Record 10368.75 Congressional Record 10369.This was made clear by a provision of the Act ofAug. 19, 1937 (50 Stat. 718; 12 U.S.C. § 1040).Act of July 17, 1916 (39 Stat. 380). The FarmLoan Act provision was superseded by a provisionof the Farm Credit Act of 1971 that specifiesthat "any Federal Reserve Bank may buy andsell" bonds, debentures, or other obligations is-sued under the authority of that act to the sameextent and subject to the same limitations placedupon the purchase and sale by such Banks ofState, county, district, and municipal bonds under§ 14(b) of the Federal Reserve Act (12 U.S.C.§2158).1918 Bulletin 33.House Committee on Agriculture Rep. No. 6,73d Cong., 1st Sess. (Mar. 20, 1933), p. 2.48 Stat. 31.48 Stat. 344.House Committee on Agriculture Rep. No. 279,73d Cong., 2d Sess. (Jan. 12, 1934), p. 1.Less than $200,000 as of June 30, 1960.Reg. A, 1955, § 2(a), footnote 2 (1955 Bulletin10).75 Stat. 773.1968 Bulletin 1012.48 Stat. 643.House Rep. No. 1075, 73d Cong., 2d Sess.(Mar. 26, 1934), p. 4.78 Congressional Record 4807.Pursuant to Act of June 30, 1953 (67 Stat. 121).1917 Bulletin 949.1949 Bulletin 247.1969 Bulletin 354.I960 Bulletin 151.1968 Bulletin 1012.1962 Bulletin 690.42 Opinions of Attorney General, No 1, ADI". 141961. v

1966 Bulletin 188.1966 Bulletin 340.Act of Sept. 21, 1966 (80 Stat. 825).Acts of Sept. 21, 1967 (81 Stat. 226) andSept. 21, 1968 (82 Stat. 856).1968 Bulletin 1012.1969 Bulletin 355.

1971 Bulletin 399.1972 Bulletin 983.1971 Bulletin 399.1916 Bulletin 609. It was pointed out that whilebonds of the United States were mentioned bothin § 13 and § 14(b), municipal tax obligationswere mentioned in the latter but not in the formersection.Thus, during the hearings on the Glass-Steagallbill. Governor Meyer stated that if § 10(b)were adopted, "banks would be freer to use theirresources to buy warrants, knowing that in case ofneed they could borrow on them under excep-tional circumstances" (Hearings on H-R. 9203,72d Cong., 1st Scss. (Feb. 12, 1932), p. 19).During the debates, Senator Kcan similarly in-dicated that the bill would permit the use ofmunicipal bonds as collateral for advances inexceptional circumstances. (75 CongressionalRecord 4310) Previously, in December 1931,Senator Vandenberg had introduced a bill (S.546) that would have made revenue bondsspecifically eligible as collateral for advances tomember banks under § 13 of the Federal ReserveAct, but that bill was never enacted.1968 Bulletin 1013.1969 Bulletin 150.Act of June 25, 1959 (73 Stat. 142).47 Stat. 56.75 Congressional Record 3963.For example, Mr. Shannon (75 CongressionalRecord 3983); Mr. McFadden (75 CongressionalRecond 3986); Senator Couzcns (75 Congres-sional Record 4053).House Committee on Banking and Currency Rep.No. 475, 72d Cong., 1st Sess. (Feb. 13, 1932),p. 2.Mr. McFadden, 75 Congressional Record 3986.Senator Robinson, 75 Congressional Record 4223.In the House, Mr. Stafford said: 'This bill couldnot be justified in normal times, because some ofthe security that is offered for Federal reservenotes, though perfectly sound, is not of liquidcharacter, such as bonds and mortgages. But hardcases require exceptional treatment. I justify thisonly as a temporary expedient ***." (75 Con-gressional Record 3981)75 Congressional Record 3966.Senate Banking and Currency Committee Rep-No. 237, 72d Cong., 1st Sess. (Feb. 12, 1932),p. 2.Hearings on H.R. 9203, Feb. 12, 1932, p. 15.Later, the Board reported that, as of Dec. 31,1931, member banks held $4,694 million of Gov-ernment bonds and $2,573 million of eligiblecommercial paper. (1932 Bulletin 142)Mr. Steagall, 75 Congressional Record 3964.75 Congressional Record 4136.

258


:• History,1 of the ILending

Functions


75 Congressional Record 4137. Senator Wolcottlikewise thought the measure would cause banksto stop "hoarding" eligible paper and make moreloans. (75 Congressional Record 4143)75 Congressional Record 4242.Mr. LaGuardia, 75 Congressional Record 3970.Senate Rep. No. 237, 72d Cong., 1st Sess.(Feb. 12, 1932).House Rep. No. 475, 72d Cong., 1st Sess.(Feb. 13, 1932).Mr. Bcedy, 75 Congressional Record 3980.See statement by Secretary of the Treasury OgdenMills during hearings on H.R. 9203, Feb. 12,1932, p. 23.75 Congressional Record 4228. Similarly, Mr.Williamson felt that a liberalization of the eligi-bility rules should be made permanent legislation.(75 Congressional Record 3972)Hearings on H.R. 9203, Feb. 12, 1932, p. 18.Id., p. 3.Senate Rep. No. 584 on S. 4412, 72d Cong., 1stSess. (Apr. 22, 1932), p. 12.12 U.S.C. « 347a.Mr. Slcagall, 75 Congressional Record 3964.Senate Rep. No. 237, 72d Cong., 1st Sess.(Feb. 12, 1932), p. 2.House Rep. No. 475, 72d Cong., 1st Sess.(Feb. 13, 1932).Hearings on H.R. 9203, Feb. 12, 1932, p. 3.75 Congressional Record 4135.Said Mr. Strong: "It will permit the banks thathave no eligible paper to get together and guaran-tee each other's paper." (75 Congressional Record3965)Sec 75 Congressional Record 4315.Senator Glass stated: "No limitation is put uponthe amount of credit that may thus be obtainedat a Federal reserve bank. That is left altogetherwithin the discretion of the directors of the re-serve bank •**." (75 Congressional Record4135)The House bill (H.R. 9203) had limited § 10(a)to a period of 1 year, like § 10(b), although someCongressmen felt that neither section should beso limited. (75 Congressional Record 3966) Onthe other hand, the Senate bill, while limitingthe duration of § 10(b), placed no time limit on5 10(a), and some Senators were unable to seewhy both sections should not be enacted for onlya temporary period. (75 Congressional Record4318)As passed by the House on Feb. 16, 1932, the billwould have required the consent of a majority ofthe Board; the Senate bill, passed on Feb. 19,required the consent of six members; the con-ference committee in effect followed the Houseversion since the Board had eight members then.

l a

123

US

130

75 Congressional Record 4134.House Rep. No. 607, 72d Cong., 1st Sess.(Feb. 25, 1932), p. 4.75 Congressional Record 4321.See 75 Congressional Record 4315. Senator Reedwas not satisfied that this change made the matterclear; he suggested that since all the banks in thegroup initially would receive the proceeds, theprovision should refer to the "recipient" bank orbanks as later mentioned in the section. (75Congressional Record 4322)See hearings on H.R. 9203, Feb. 12, 1932, p. 9;also comments by Senator Norris during the de-bates, 75 Congressional Record 4317.75 Congressional Record 4317, 4318.75 Congressional Record 4785.1932 Bulletin 180.S. 1451, 85th Cong. In its recommendation to theSenate Banking and Currency Committee regard-ing this matter, the Board stated:

"*** As far as is known, no advances wereever made by the Reserve banks under thisauthority. One reason presumably was that thesame time Congress enacted section 10(b) of theFederal Reserve Act authorizing advances to anyindividual member bank on any 'satisfactorysecurity.' In the circumstances it seems reasonablyclear that the authority contained in section10(a) serves no useful purpose and should berepealed." (Study of the Banking Laws, com-mittee print of Senate Banking and CurrencyCommittee, 84th Cong., 2d Sess. (Oct. 12, 1956),p. 90)75 Congressional Record 4135.Hearings on H.R. 9203, Feb. 12,1932, p. 3.For example, Gov. Meyer, hearings on H.R.9203, p. 9; Mr. Burtness, 75 Congressional Rec-ord 3966.75 Congressional Record 4333. Senator Glass op-posed this amendment because he felt that psy-chologically it was unwise to suggest that theemergency would last for 2 years.75 Congressional Record 4786.75 Congressional Record 4262. At an earlierpoint, a capital limitation of $2 million had beencontemplated.75 Congressional Record 4315.75 Congressional Record 4786.Mr. Strong, 75 Congressional Record 3966.House Rep. No. 1928, 72d Cong., 2d Sess.(Jan. 27,1933), p. 3.47 Stat. 794.48Stat. 1.77 Congressional Record 56.77 Congressional Record 57.77 Congressional Record 79.1933 Bulletin 122.

259


History;;"/of the 4Lcnding

Functions


ISO

151

1=2

IE3

13*

1934 Bulletin 182.49 Stat. 684.H.R. 5357; S. 1715.Hearings on H-R. 5357, Mar. 4, 1935, p. 184.79 Congressional Record 6739.79 Congressional Record 13707.For example, Gov. Eccles, House committeehearings, Mar. 4, 1935, p. 184; House Bankingand Currency Committee Rep. No. 742, 74thCong., 1st Sess. (Apr. 19, 1935), p. 11; Mr.Hancock, 79 Congressional Record 6739.1935 Bulletin 560.1937 Annual Report 206.50 Congressional Record 5999.51 Congressional Record 523.Gov. Meyer, hearings on H.R. 9203, p. 9.Mr. Busby, 75 Congressional Record 3973.75 Congressional Record 4135.Gov. Meyer, hearings on H.R. 9203, p. 19.Mr. Strong, Feb. 15, 1932, 75 Congressional Rec-ord 3965.Ibid.; also Mr. Stafford, 75 Congressional Record3981.Hearings on H.R. 9203, pp. 9, 10.75 Congressional Record 3972.75 Congressional Record 4228.Hearings on H.R. 5357, Mar. 4, 1935, p. 183.Id., p. 289.Id., p. 405.Id., p. 387.Id., p. 453.House Rep. No. 742, 74th Cong., 1st Sess.(Apr. 19, 1935), p. 11.79 Congressional Record 6718.79 Congressional Record 6736.Hearings on S. 1715, May 15, 1935, pp. 410, 701.Id., p. 296; 79 Congressional Record 11825.Senate Rep. No. 1007, 74th Cong., 1st Sess.(July 2,1935), p. 11.Senator Adams stated: "This provision consti-tutes a fundamental departure from the theoryheretofore prevailing as to the character of securi-ties acceptable by Federal Reserve Banks." (79Congressional Record 4988)

79 Congressional Record 13706.79 Congressional Record 13707.1937 Annual Report 206.1936 Bulletin 624.1936 Bulletin 548.Reg. A, 1937, § 2(d) (1937 Bulletin 986).1937 Annual Report 207.Ibid.1937 Bulletin 989, 990. As to real estate loans,the minimum standards were: a first lien on im-proved real estate; compliance with the amountand maturity requirements of § 24 of the FederalReserve Act; and maintenance by the memberbank of an appraisal of the real estate, an ade-quate description of the property, evidence oftitle, evidence of no tax delinquency, and suchother information as the circumstances mightrender advisable. As to instalment loans, thestandards were: security by a first lien in thenature of a chattel mortgage, conditional salescontract, or similar instrument; goods of such anature that in the event of resale the sum realizedwould be greater than the amount necessary toliquidate the obligation; and reasonable steps bymember banks to satisfy themselves that paymentsand other requirements would be met.Hearings on H.R. 5357, Mar. 18, 1935, pp. 387,406.Id., p. 387.1935 Bulletin 771.Reg. A, 1955, § 2(c) (1955 Bulletin 10).Joint committee print of statements submitted toSubcommittee on Monetary, Credit, and FiscalPolicies, Senate Doc. 132, 81st Cong., 2d Sess.(Nov. 7, 1949), p. 58.Letters to the chairmen of the Banking and Cur-rency Committees of the Congress, Aug. 21, 1963.(See also discussion in 1963 Bulletin 1235.)For example, S. 1559, 89th Cong., 1st Sess.(1965); S. 966, 90th Cong., 1st Sess. (1967).1971 Annual Report 211. A bill to implement theBoard's new proposal was introduced in the Sen-ate as S. 1951, 92d Cong., 1st Sess. (May 26,1971).

CREDIT FOR NONMEMBER BANKS

1972 Annual Report 254.75 Congressional Record 4786. During the Housecommittee hearings on the bill, Gov. Meyer ofthe Board stated that the bill was not intended to

provide credit to nonmember banks but that theywould benefit indirectly. (Hearings on H.R. 9203,Feb. 12, 1932, p. 7)51 Congressional Record 958.

260


History€ of the*Lending

Functions


Id., p. 1035.Id., p. 1119.Ibid.Id., p. 1145.Id., p. 1146.1915 Bulletin 213.1917 Annual Report 5.1918 Bulletin 743.1918 Bulletin 520.1918 Bulletin 745.1921 Bulletin 963.1923 Bulletin 891. The rescission was effectiveJune 26, 1923.1926 Bulletin 252.1966 Annual Report 91.I 9 6 9 * / / fSec Board press release of Oct. 24, 1972. The textof the amendment to Reg. J was published in1972 fl«//r///i 650.Reg. A, Scries of 1928, §5111(2) and IX (1928Bulletin M, 65).1937 Bulletin 987.1955 Bulletin 13.Reg. A, 1973, § 201.5(c) (see Appendix B).47 Stat. 709.A year later, both Senator Gloss and SenatorBarklcy referred to this authority as includingauthority to discount paper for State banks onthe ground that they were corporations. (77 Con-gressional Record 249, 333)1932 Bulletin 519.48 Stat. 1.12U.S.C. §347c.77 Congressional Record 56.

77 Congressional Record 79.1942 Bulletin 302.1942 Bulletin 207.1955 Bulletin 9.1968 Bulletin 1012.Reg. A, 1973, § 201.7 (see Appendix B).48 Stat. 20.The act specifically covered banks and trustcompanies not only in the States but in any terri-tory or possession of the United States or theCanal Zone. This clarification was added by theSenate Banking and Currency Committee. (Sen-ate Rep. No. 4, 73d Cong., 1st Sess. (Mar. 13,1933))Thus, Senator Glass observed that the pendingproposal had already been covered "in a largerdegree" by the Act of July 21, 1932, under whichindividuals, partnerships, and corporations, in-cluding nonmember banks, could in an emergencydiscount paper with the Reserve Banks. (77 Con-gressional Record 249) Senator Robinson pointedout that under the Act of Mar. 9, 1933, loanscould be made to nonmember banks on Govern-ment bonds. (77 Congressional Record 332)77 Congressional Record 631.77 Congressional Record 601.77 Congressional Record 332.77 Congressional Record 333. Senator Keanoffered an amendment to eliminate this require-ment, but it was rejected. (77 CongressionalRecord 335)77 Congressional Record 603.77 Congressional Record 633.1972 Annual Report 197.

LOANS TO INDIVIDUALS, PARTNERSHIPS, AND CORPORATIONS

Senator Crawford, 51 Congressional Record 612.Thus, Mr. Phelan stated that the Reserve Bankswould not compete with commercial banks andwould "make no loans and receive no depositsfrom individuals." (50 Congressional Record4673) The Glass bill as reported expressly pro-vided that the Reserve Banks would deal onlywith the Government and depositing memberbanks. (50 Congressional Record 5063) Althoughthis provision was not adopted, it was clearlyunderstood that loans to individuals would be"contrary to the whole spirit and purpose of thelaw." (50 Congressional Record 5063)For text of the veto message, see 75 Congres-sional Record 15040.47 Stat. 715.

12 U.S.C. § 343.1965 Bulletin 1409; 1972 Bulletin 279. Under the1973 revision of Reg. A, it appears that the noteof a lending institution would be eligible as col-lateral for a Reserve Bank advance if the pro-ceeds of the note were used to make home mort-gage loans regardless of their maturities.49 Stat. 684.1932 Bulletin 518.See 1933 Bulletin 95; 1934 Bulletin 485; 1935Bulletin 473; 1936 Bulletin 123.1966 Annual Report 91; 1969 Annual Report 92.For example, in May 1933, the rate was 6 percent as compared with the regular rate of 3V4 or3 per cent. (1933 Bulletin 428)48 Stat. 1.

261


iHistoryjp of the7%Lending'

Functions


u 77 Congressional Record 57.14 77 Congressional Record 79.

" Act of Sept. 21, 1968 (82 Stat. 856); 12 U.S.C.§ 347c.

" Reg. A, 1973, § 201.2(f) (Appendix B).

WORKING CAPITAL LOANS TO BUSINESS

Act of June 19, 1934 (48 Stat. 1105).78 Congressional Record 927'5.78 Congressional Record 12234.Mr. O'Connor, 78 Congressional Record 9273.Mr. Martin, 78 Congressional Record 9274.78 Congressional Record 9286.S. 2867, 73d Cong.; H.R. 8734, 73d Cong.S. 2946, 73d Cong.; S. 3101, 73d Cong.Letter from Board to Senator Fletcher, chairmanof the Senate Banking and Currency Committee,dated Apr. 13, 1934.78 Congressional Record 8718.48 Stat. 1105.78 Congressional Record 7908.78 Congressional Record 9396.78 Congressional Record 9396.78 Congressional Record 12233.78 Congressional Record 9274.Mr. Dirkscn, who questioned the need for manyof the limitations, asked rhetorically what wasmeant by an established business: "Is it one thatmakes money now under depressed conditions,or is it a business that has been actually in opera-tion for a number of years, irrespective ofwhether it is established in the sense that success-ful men so often use the word 'established'?" (78Congressional Record 9276)1934 Bulletin 489.78 Congressional Record 8718.1934 Bulletin 430.Reg. S, § III(b) (1934 Bulletin 491).1934 Bulletin 489. This statement regarding theblanket authority granted for direct loans wasreiterated in a foreword to Reg. S when it wasrevised in 1942 (1942 Bulletin 428).See Reg. S, §§ 2(a) and 2(c) (1942 Bulletin429).78 Congressional Record 9398.1934 Bulletin 752.1934 Bulletin 675.1934 Bulletin 675.1942 Bulletin 428.Reg. S, § l(c) (1942 Bulletin 428).Reg. S, S 4 (1942 Bulletin 430).78 Congressional Record 7908.Reg. S, § 3 (1942 Bulletin 430).

1934 Bulletin 510.As the bill passed the Senate, the Secretary wouldhave been "directed" to make such payments tothe Reserve Banks. The conference committeeadopted the House bill provision, which merelyauthorized the making of such payments.P.L. 363, 80th Cong. (1947 Bulletin 980).1934 Bulletin 489.The first § 13b rates were published in 1934Bulletin 618. On direct loans the rates were fixedat from 4 to 6 per cent at the Federal ReserveBanks of Boston, New York, and Philadelphia;at from 5 to 6 per cent at Chicago, Dallas, andSan Francisco; at 5>/i per cent at St. Louis; andat 6 per cent at the other Reserve Banks. Fortransactions with financing institutions, varyingrates were established on the port'0" f o r w h i c n

the financing institution was obligated and on theremaining portion. On commitments to makeadvances, the commitment charge varied fromone-half of 1 per cent to between 1 and 2 percent. These originaj rates on § 13b loans, partici-pations, and commitments were changed on num-erous occasions in subsequent years.1942 Bulletin 427.Act of Jan. 31, 1935 (49 Stat. 4) .Act of Apr. 13, 1938 (52 Stat. 212).S. 2759, introduced in July 1939, would haveeliminated restrictions in § 13b. S. 2998 mOctober 1939 would have established an Indus-trial Loan Corporation with liberal lendingauthority. Both bills were sponsored by SenatorMead.S. 877, S. 939. „.-S. 1918, 78th Cong., 2d Sess. (May 15, 1944).An identical bill in the House was H.R. 4804.S. 511, Senator Wagner, Feb. 12, 1945; H.K.591, Mr. Spence, Jan. 3, 1945. Together, thesebills were known as the Wagner-Spence bill.S. 408, Senator Tobey, Jan. 27, 1947.June 3, 1947, hearings, p. 297, et scq.The principal bills were S. 2975 (Senator Ma-honey, Feb. 2, 1950); S. 3625 (Senator Lucas >,H.R. 8565 (Mr. Spence); and H-R. 8566 (Mr.Patman). The last three were introduced onMay 19, 1950.

262


:.- History;ij?of the**'LendingFunctions


S. 1647.S.381.S. 1451, 85th Cong.72 Stat. 689; 15 U.S.C. §§ 661, el seq.1958 Bulletin 1059. The new law provided, how-

ever, that small business investment companiesmight make use, wherever practicable, of theadvisory services of the Federal Reserve System,and the Reserve Banks were authorized to act asdepositories or fiscal agents for such companies.

V LOANS

See discussion of the origin of the V-loan pro-gram in "Financing War Production and ContractTerminations under Regulation V," 1946 Bulletin240.1942 Bulletin 299.1942 Bulletin 425.The text of this letter was quoted in hearings be-fore the Senate Banking and Currency Committeein April 1947 when Chairman Eccles appearedin support of a bill to liberalize § 13 of the Fed-eral Reserve Act.55 Stat. 838.1942 Bulletin 299.1946 Bulletin 241.56 Stat. 226 (1942 Bulletin 533).56 Stat. 419 (1942 Bulletin 640).56 Stat. 355 (1942 Bulletin 635).58 Stat. 649 (1944 Bulletin 753).1944 Bulletin 876.1944 Bulletin 877.64 Stat. 800 (1950 Bulletin 1158).1950 Bulletin 1301.50 U.S.C. Appendix, § 2166(a).67 Stat. 129 (1953 Bulletin 948).Act of Aug. 15, 1970 (84 Stat. 799); 50 U.S.C.Appendix, §2091 (e).E.O. 10161 was superseded by E.O. 10480(Aug. 14, 1953). That order, as amended and aspresently in effect, is set forth in a note to 50U.S.C. Appendix, § 2153.1950 Bulletin 1307.1942 Bulletin 425.1944 Bulletin 877.1950 Bulletin 1307.

1946 Bulletin 242.This revision of the form was published in 1943Bulletin 379.One related to the meaning of the term "loss onthe loan" (1951 Bulletin 20); the other defined"defense production contract" (1951 Bulletin149).1943 Bulletin 12.1944 Bulletin 879.1950 Bulletin 1283.1966 Bulletin 1617.1970 Bulletin 517.1942 Bulletin 989.1944 Bulletin 879.1949 Bulletin 247.1951 Bulletin 391.1942 Bulletin 1079.Ibid.1942 Bulletin 534.56 Stat. 356 (1942 Bulletin 635).1942 Bulletin 640.1942 Bulletin 641.1943 Bulletin 389.1944 Bulletin 962.1950 Bulletin 1308.Hearings on S. 2998 and S. 3839, June 12 and14, 1940, p. 21.54 Stat. 1029.B-84138, May 17, 1949 (unpublished decision).B-72929, May 18, 1950 (unpublished decision).1951 Bulletin 20.Senate Banking and Currency Committee Rep.No. 217, 82d Cong., 1st Sess. (Apr. 11, 1951),p. 4.65 Stat. 41; 31 U.S.C. §203 (1951 Bulletin 508).

263


./History*Sofihe^f: Lending


INTERDISTRICT REDISCOUNTS

50 Congressional Record 4645.House Rep. No. 69, 63d Cong., 1st Sess. (Sept.9, 1913), p. 45.50 Congressional Record 4675. See also statementby Mr. Harrison, 50 Congressional Record 4729.50 Congressional Record 4818.51 Congressional Record 667.51 Congressional Record 669.

51 Congressional Record 1192.1915 Annual Report 8.1915 Annual Report 29, note.1918 Annual Report 3.1919 Annual Report 5.1921 Annual Report 42, 43.1933 Bulletin 211.

DISCOUNT RATES

12 U.S.C. § 357.See 12 U.S.C. § 347.12U.S.C. §§ 347a, 347b.12 U.S.C. § 343.12 U.S.C. § 347c.31 U.S.C. S821.Act of Mar. 18, 1968 (82 Stat. 50).Report of National Monetary Commission, Sen-ate Doc. 243, 62d Cong., 2d Sess. (Jan. 9, 1912),p. 23.House Rep. No. 69, 63d Cong., 1st Sess.(Sept. 9, 1913), p. 11.Senate Rep. No. 133, Part 2, 63d Cong., 1st Sess.(Nov. 22, 1913), p. 23.1914 Annual Report 10.1914 Annual Report 203.1915 Annual Report 5.1923 Annual Report 64.1923 Annual Report 16.Act of June 16, 1933 (48 Stat. 168); 12 U.S.C.§263.See 1957 Annual Report 8, 9. See also discussionof the effect of the accord on pages 186 and 187(Chapter XV)."Report of a System Committee," Reappraisalof the Federal Reserve Discount Mechanism,1971, Vol. 1, p. 21. (Initially prepared and pub-lished in July 1968; hereinafter referred to as1968 Report of a System Committee)1915 Bulletin 24.34 Fed. (2d) 910.34 Fed. (2d) 915."Monetary Policy and the Management of the a

Public Debt" (committee print of the Joint Com- "

mittee on the Economic Report, Senate Doc. 123,Part 1, 82d Cong., 2d Sess. (Feb. 20, 1952),p. 279; hereinafter referred to as 1952 PatmanQuestionnaire).House Rep. No. 69, 63d Cong., 1st Sess. (Sept. 9,1913), p. 53.50 Congressional Record 4996.50 Congressional Record 5995.50 Congressional Record 6024.50 Congressional Record 4673.1914 Annual Report 10.1952 Patman Questionnaire 276.32 Opinions of Attorney General, No. 81.House Banking and Currency Committee Rep.No. 742, 74th Cong., 1st Sess. (Apr. 19, 1935),p. 9.1952 Patman Questionnaire 279.See 1971 Annual Report 74, 82, 87; 1972 AnnualReport 97.1914 Annual Report 203.1915 Animal Report 27-29.1916 Bulletin 513.1915 Annual Report 27-29.1917 Annual Report 10.1918 Annual Report 19.1917 Annual Report 11.1917 Bulletin 235, 241.1919 Annual Report 71.41 Stat. 550.Kansas City (April 19), Dallas (May 21), St.Louis (May 26), and Atlanta (May 31). (1920Annual Report 58)1920 Annual Report 59.1920 Annual Report 66.

264


; History.* of theS*-Lending'Functions


42 Slat. 1454.1923 Annual Report 64. For a time after theenactment of the Agricultural Credits Act of1923, some Reserve Banks fixed a slightly higherrate for long-term agricultural paper, but thisdifferential did not long continue.1942 Bulletin 1204.Board letter to Federal Reserve Banks, Sept. 18,1972.49 Slat. 684.

Senate Rep. No. 1007, 74th Cong., 1st Sess.(July 2, 1935), p. 13.Conference Rep. No. 1822, 74th Cong., 1st Sess.(Aug. 17, 1935), p. 51.1952 Patman Questionnaire 278.Board press release, Dec. 1, 1970.1917 Bulletin 951; 1918 Bulletin 109, 744; 1924Bulletin 639.1918 Bulletin 108.1916 Bulletin 461.1915 Bulletin 308.

RELATION TO CREDIT POLICY

1914 Annual Report 7.1919 Annual Report 68.1921 Annual Report 95.1921 Annual Report 96.1923 Annual Report 3.1928 Annual Report 9.Sec, for example, Milton Friedman and AnnaJacobson Schwartz, A Monetary History of theUnited States, 1867-1960 (Princeton UniversityPress, 1963), pp. 254, 255.12 U.S. § 248(m), as amended by Act of June 16,1933 (48 Stat. 167).Act of Aug. 23, 1935 (49 Stat. 684). Sec. 5200of the Revised Statutes subjects Governmentobligations to a 15 per cent limitation (except aspermitted by the Comptroller of the Currency)in addition to the usual 10 per cent limita-tion on loans by national banks to one borrower.In 1958 the Comptroller by regulation raised thelimit on loans on Government obligations to100 per cent of a national bank's capital and sur-plus, and this limit carries over to loans by Statemember banks on Government obligations byreason of the provisions of § 11 (m) of the Fed-eral Reserve Act.Act of June 16,1933, § 9 (48 Stat. 180).See 1932 Bulletin 206.Id., p. 208.

12 U.S.C. § 301 (48 Stat. 163).Senate Rep. No. 584 on S. 4412, 72d Cong., 1stSess. (Apr. 22, 1932), p. 13. A similar statementwas contained in the Report of the Senate Bank-ing and Currency Committee on S. 1631, May 15,1933, p. 13, and also in the Report of the HouseBanking and Currency Committee, May 19, 1933.75 Congressional Record 9885.77 Congressional Record 3835, 3836. Alsoreferring to these provisions, Mr. Kopplemannstated that "one of the chief purposes" was toprevent "undue diversion of bank funds intospeculative operations." (77 Congressional Rec-ord 3907)1914 Annual Report 10.1914 Annual Report 17.1952 Patman Questionnaire 393, 394.1952 Patman Questionnaire 395.For a description of the accord, see 1951 AnnualReport 3-8.1951 Annual Report 5, 6. See also 1957 AnnualReport 9.1952 Patman Questionnaire 395.1955 Bulletin 8.1957 Annual Report 7-16.1966 Annual Report 102.1968 Report of a System Committee 6.Reg. A, 1973, § 201.2(b) (see Appendix B).

265


iHistory-;f of the^-Lending


GENERAL PRINCIPLES: A SUMMARY

12 U.S.C. § 343.12 U.S.C. § 357.12 U.S.C. § 301.Reg. A, 1955 (1955 Bulletin 8).Reg. A, 1973, § 201.2(a) (see Appendix B).Circular No. 13 (1914 Annual Report 183).Clay J. Anderson, "Evolution of the Role and theFunctioning of the Discount Mechanism," Re-appraisal of the Federal Reserve DiscountMechanism, 1971, Vol. 1, p. 136.These provisions are still in effect. (12 U.S.C.S301) The Banking Act of 1933 also containedprovisions precluding Reserve Bank advances toany member bank that, after a warning by itsReserve Bank or by the Board, had increased itsloans on securities.1923 Annual Report 33.12 U.S.C. §343.1928 Annual Report 8.1968 Report of a System Committee 13.1926 Annual Report 4.1952 Patman Questionnaire 395.Foreword to Reg. A, as revised effective Feb. 15,1955 {1955 Bulletin 9).1926 Annual Report 4.1968 Report of a System Committee 6, 8, and15.

Id., p. 1.Id., p. 7.Id., p. 17.Id., p. 18.12 U.S.C. § 343.For text of his proposal, see Senate Rep. No. 133,63d Cong., 1st Sess. (Nov. 22, 1913).51 Congressional Record 523.51 Congressional Record 529. Senator Hitchcockemphasized the fact that the paper discountedwould in all cases be "good" paper. (51 Congres-sional Record 1064)51 Congressional Record 765.50 Congressional Record 6026. See also 51 Con-gressional Record 667.51 Congressional Record 1073.51 Congressional Record 859.51 Congressional Record 525, 843.51 Congressional Record 859.51 Congressional Record 1076.Farmers and Merchants Bank v. Federal ReserveBank of Richmond, 262 U.S. 649, 663 (1923).\920 Bulletin 1303.1920 Bulletin 386.34 Fed. (2d) 910 (CCA. 2d., 1929).1968 Report of a System Committee 10.1914 Annual Report 17.

266


/History/ft of theiji' Lending'"

IndexAcceptances {See Bankers' acceptances)Adjusted service certificates, discount of notes secured

by {See Veterans' notes, discount)Advances to member banks:

Amount limitation, 21Application forms, elimination, 89Authority, general development, 83-85Eligible paper, advances secured by, 85Endorsement of pledged paper, 87Federal intermediate credit bank debentures as col-

lateral, 52Glass-Steagall Act, 100-02Government agency obligations, advances on:

Agencies of United States, obligations issued orguaranteed by, 97

Commodity Credit Corporation certificates ofinterest, 95

Export-Import Bank participation certificates, 96Farm loan bonds, 93, 94Farmers Home Administration insured notes, 96Federal Farm Mortgage Corporation bonds, 94Federal intermediate credit bank obliga-

tions, 52, 92Home Owners' Loan Corporation bonds, 95Merchant Marine bonds, 96Small Business Administration, notes guaranteed

by, 97War Finance Corporation bonds, 91

Groups of member banks:Board of Governors, approval, 104Eligible assets, requirement for lack, 104Interest rate, 104Limitations, 104Purposes, 103Use of authority, 105

Maturity limitations in general, 88Note of borrowing bank, elimination, 89Paper eligible for purchase, advances on:

Commercial and agricultural transactions, limita-tion to paper based on, 86

Federal Reserve Act, limitation to purchasesunder, 85

Obligations eligible. 87Original authorization, 85

Rediscounts, distinguished from, 83Satisfactory security, advances on:

Authority:Board of Governors, 106Extensions, 106, 107Liberalization, proposals, 114,115Original authorization, 105Permanent authorization, 107

Interest rate, 106, 113Limitations:

Emergency use, 108Exceptional and exigent circumstances, 105General, 105, 106

Maturity, 113Sound assets concept, 109Types of security, 112

Securities loans, increase during advance, 88States and municipalities, advances on

obligations, 98

Advances to member banks—ContinuedTax warrants, 98U.S. obligations, advances on:

Maturity, 90Original authorization, 90Par, advances at, 91Types of obligations, 91

Agency issues, advances on, 97Agricultural paper:

Agricultural Credits Act of 1923, 44Amount limitations, 48Commercial paper, distinguished from, 46Cooperative marketing associations, discount of

paper of, 45,46,50Definition, 46Demand drafts covering agricultural

products, 45, 48Factors' paper, 49Farm Loan Act of 1916,44Federal intermediate credit banks, discount of paper

of, 45, 51Federal Reserve Act, original, intent, 43Livestock paper, 46Maturity, 47Staple agricultural products, paper secured by, 44War Finance Corporation, agricultural loans by, 44

Amount limitations:Advances to member banks, 21Aggregate amount for single member bank, 17,21Agricultural paper, 48Bankers' acceptances {See Bankers' acceptances)Capital notes and debentures included in

determining, 21Federal intermediate credit banks, discounts

for, 51,52National banks, total indebtedness, 17One-borrower paper, S17-21Regulatory provisions, 20

Application forms, 89

Bankers' acceptances:Amount limitations:

Commercial acceptances by memberbanks, 72, 73

Discount by Reserve Banks, 74,75Dollar-exchange acceptances by member

banks, 74Definition, 55Discount by Reserve Banks:

Diminished importance, 76Eligibility requirements in general, 57Endorsement, 57Evidence of eligibility, 58

Discounting authority, purposes, 53Dollar-exchange acceptances:

Authority of member banks, 56,57Countries designated by Board, 67Legal authority, 68Member banks, permission for acceptance by, 66Purpose, 65Usage of trade, 67

267


History.; of the *•Lending

Index—Continued

Bankers* acceptances—ContinuedDomestic transactions:

Extension of law to cover, 61Federal Reserve Act, original, 54Geographic limitation, 62Purpose of financing, 62Shipping documents, 62

Encouragement by Board, 54Export and import transactions:

Connection of acceptance with transaction, 58Contract, necessity, 59, 60Federal Reserve Act, original, 54Geographic coverage, 61Shipping documents, 60

Foreign trade, objective of financing, 53Letters of credit, 75Maturity:

Commercial acceptances by member banks, 69Discount by Reserve Banks, 70Dollar-exchange acceptances by member

banks ,70Federal Reserve Act, original, 8, 9Renewals, 71

Member banks, acceptances by:National banks, authority, 56, 57State member banks, authority, 57

National Monetary Commission Report, 53Storage of staples:

Place, 64Purpose of transaction, 63Readily marketable staples, meaning, 64Security, 63Warehouse receipts, 63

Syndicate credits, 75Bankers' banks, Reserve Banks as, 2Business, loans to (See Individuals, partnerships, and

corporations; Working capital loans to busi-ness)

Commercial banks:Loans by, distinguished from Reserve Bank loans, INumber, 2

Commercial paper, discount:Agricultural paper, distinguished from, 46Collateral security, effect, 31Commercial purpose, meaning, 30Commodity paper, 35Construction paper, 41Consumer paper, 30, 40Current operating expenses, paper drawn for, 30Definition, 27, 28Eligibility, evidence, 32Finance paper (See Finance paper)Intent of original Act, 27Permanent or fixed investment paper (See Perma-

nent investment paper)Real-bills doctrine, 33Regulatory definition, 28Self-liquidating character, 29, 31Speculation, paper drawn for, 37, 182Stocks and bonds, paper drawn for trading in, 38Trade acceptances (See Trade acceptances)

Commodity Credit Corporation, advances on certifi-cates, 95

Commodity paper, 35Construction paper, 41Consumer paper, 30, 40Cooperative marketing associations, discount of

paper, 45, 46, 50Court decisions:

Discount rates, 170Discretion of Reserve Banks in extending

credit. 200Rights and liabilities of Reserve Banks as to dis-

counted paper, 245-48Trade acceptances, form, 34

Credit policy:Commerce and business, accommodation of

needs, 181Credit control generally, discounts as instrument

of, 185Direct pressure through discount window, 182, 187Member bank credit policies, relation of

discounts, 182Sound credit conditions, maintenance, 184Speculative loans, prevention. 182-85

Days of grace, 16Demand paper, discount. 16, 48Direct pressure, 182, 187Discount and interest rates:

Advances to member banks, 173Attorney General of United States, opinions, 171Class of paper, meaning, 174Classification of paper for purposes of; 173-78Commerce and business, accommodation, 169Computation, 180Constitutionality, 170Court decision upholding authority, 170Credit policies, use in implementing, 170Different rates according to:

Borrower, 177Character of paper, 174Frequency of borrowing, 175Maturity of paper, 174Purpose of credit, 178Statutory source of credit, 176

Discretionary nature, 170Distinction between, 167Distribution of authority between Reserve Banks

and Board, 171-73Eligible paper, 167Federal Reserve Banks, establishment by, 171Government obligations, preferential rate, 174Graduated rates, 175Groups of member banks, 104Individuajs, partnerships, and corporations, 168, 176Interdistrict rediscounts, 163, 168Legal basis, 170Nonmember banks, 177, 178Objectives, 168Preferential rates, 174Procedures for establishment, 179Progressive rates, 175

268


History,; of lhe?VLending

Index—Continued

Discount and interest rates—ContinuedRebates, 180Review and determination by Board, 171-73Satisfactory security, 106, 113Statutory provisions, 167Tax on deficient Reserve Bank reserves to be added

to, 168Time of establishment, 179Uniformity, 168V loans, 157Veterans' notes, 80Working capital loans to business, 143

Discount functions in general, importance, 3Dollar-exchange acceptances (See Bankers'

acceptances)

Eligible paper:Advances on (See Advances to member banks)Discount (Sec Agricultural paper; Bankers' accep-

tances*. Commercial paper, discount)Eligible paper bill, proposal by Board, 114Emergency credits:

Member banks, 108,196Nonbanking organizations, 127-32,197Nonmember banks, 117-25, 197

Endorsement:Bankers' acceptances, 57, 58Eligibility for discount, relation to, 23Form and effect, 22In general, 22, 23Purpose, 23Regulatory provisions, 22

Export-Import Bank, advances on certificates, 96

Factors' paper, 39,49Farm loan bonds, purchase by Reserve Banks, 93Farmers Home Administration, advances on insured

notes, 96Federal Farm Mortgage Corporation bonds,

advances, 94Federal intermediate credit banks:

Acceptances, purchase by Reserve Banks, 52Discount of paper, 45, 51Establishment, 44Obligations, purchase by Reserve Banks, 51

Federal Reserve Act, original:Agricultural credit, intent to provide, 43Aldrich bill, 7Amount limitations, 9Bankers' acceptances, 8, 9,12Bills, comparison, 8,9Business expansion as purpose, 10Country banks, benefit, 10Discount rates, impartial administration, 9Elastic currency as purpose, 11Farmers, purpose of assisting, 12Impartial administration of discounts, 9Market for commercial paper as purpose, 9Maturities under, 8Purposes, 9-12Rediscounts between Reserve Banks, 9

Federal Reserve Act, original—ContinuedRegulation by Board, 9Reluctance of banks to borrow, 10Satisfactory security on advances, 8Speculation, intent to lessen, 11

Federal Reserve Banks:Advances to:

Businesses (See Individuals, partnerships, andcorporations; Working capital loans to busi-ness)

Individuals, partnerships, and corporations (SeeIndividuals, partnerships, and corporations)

Member banks (See Advances to member banks)Nonmember banks (See Nonmember banks)

Discounts for:Federal intermediate credit banks (See Agricul-

tural paper)Individuals, partnerships, and corporations (Sec

Individuals, partnerships, and corporations)Member banks (See Agricultural paper; Bankers'

acceptances; Commercial paper, discount)Nonmember banks (See Nonmember banks)Other Federal Reserve Banks (See Interdistrict

rediscounts)Organization, 2

Federal Reserve credit, principles governing:Basic borrowing privilege, proposal, 200Capital, not to be used as substitute for, 194Commerce, industry, and agriculture, accommoda-

tion, 190Continuous borrowing, policy against, 194Discretion of Reserve Banks, 198-200Economic stability and growth, promotion, 201Emergency credits, 196Lender of last resort, 197Maturities, 195Privilege of membership, 200Profit, use for, 193Real-bills doctrine, 191Right to, 8, 200Seasonal credits, 196Security, adequate, requirement for, 198Short-term adjustments, use for, 195Sound credit conditions, maintenance, 192Soundness of Reserve Bank loans, 197, 198Speculation, credit not to be used for, 193

Finance company paper, 39, 40Finance paper:

Eligibility for discount, 30, 39Factors' paper, 39, 49Regulatory provisions, 39

Float, as extension of credit, 3

Glass-Steagall Act of 1932,100Government obligations, paper drawn for trading

in, 38Groups of member banks, advances to (See Advances

to member banks)

High-powered dollars, Reserve Bank credit as, 3Home Owners' Loan Corporation bonds, advances, 95

269


,-Historyjf of the |Lending*

Functions

Index—Continued

Individuals, partnerships, and corporations:Discount of eligible paper for:

Authority:Board of Governors, 128-30Use, 130

Current operating expenses, note drawn for, 129Endorsement, 129Federal Reserve Act, original, rejection by, 127Finance company note, 129Inability to obtain credit from other banks, 129Legislative history, 127, 128Limitations:

General, 128Unusual and exigent circumstances, 128

Regulation by Board, 129Savings and loan association note, 129Security satisfactory to Reserve Bank, 129

Government obligations, advances on:Agencies of United States, 131, 132Emergency circumstances, limitation, 132Interest rate, 131Legislative history, 131Maturity, 131Member banks as corporations, 131Regulation by Board, 131Use of authority, 132

Individuals, Reserve Bank loans, 127Industrial loans (See Working capital loans to

business)Interdistrict rediscounts:

Compulsory feature, 163Purpose, 163Use of authority, 164

Interest rates (See Discount and interest rates)

Lender of last resort, 197Letters of credit, 75Livestock paper, discount, 46

Maturities:Advances to member banks, 88Bankers' acceptances (See Bankers' acceptances)Discounted paper:

Agricultural paper, 14,47Days of grace, 16Demand paper, 16,4890-day limitation, reasons, 14Regulatory provisions, 16

Federal Reserve Act, original, 9General summary, 13Individuals, partnerships, and corporations, ad-

vances to, 131Merchant Marine bonds, advances, 96Municipal obligations, advances, 98

National Monetary Commission Report, 3Negotiability, 23-25Nonmember banks:

Credit through medium of member banks:Authorization by Board, 119-21Interpretation, liberal, 119Legislative history, 118Regulatory provisions, 121

Nonmember banks—ContinuedDiscount of eligible paper in emergencies:

Authorization by Board, 122Original authorization, 121

Government obligations, advances on:Emergency circumstances, limitation, 123Interest rate, 123Original authorization, 122Regulatory provisions, 123

Indirect access to Reserve Bank credit, 117Satisfactory security, temporary authority for ad-

vances on, 124Veterans' notes, rediscount with Reserve Bank (See

Veterans' notes, discount)

Open market operations of Reserve Banks, 3

Partnerships, loans to (See Individuals, partnerships,and corporations)

Permanent investment paper:Discount, eligibility, 35-37Evidence of compliance, 36Permanent investments, meaning, 36Regulatory provisions, 35-37

Protest, waiver, 22

Readily marketable staples (See Bankers' acceptances)Real-bills doctrine, 33, 191Reconstruction Finance Corporation, loans to business

by, 135Right to Federal Reserve credit, 8, 200

Securities loans, increase, while Federal Reserve ad-vance outstanding, 88

Sight drafts, 45, 48Small Business Administration, advances on notes

guaranteed by, 97Speculative purposes:

Federal Reserve Act, original, 11Paper drawn for, 37, 193

Stocks and bonds, paper drawn for trading in, 38

Trade acceptances:Definition, 34Form, 34Rate of discount, separate classification, 33Underlying transaction, nature, 34

VS. obligation, advances on {See Advances to mem-ber banks; Nonmember banks)

V loans:Assignment of Claims Act, 159-61Background, 147Board of Governors, role, 154Contract Settlement Act, 150Coordination by Board, 155Defense Production Act, 151Delegation of authority to Reserve Banks, 154Discounting of V-loan paper, 158Executive Orders:

9112,147-^910161,151

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! History;;.j of the^;

'Lending-

Index—Continued

V loans—ContinuedFees and rates;

Board of Governors, determination, 157, 158Commitment fee, 157, 158Guarantee fees, 157Interest rate, 157, 158

Financing institutions, Reserve Banks as, 154Fiscal agents, Reserve Banks as, 152Guarantee agreement:

Administration of loan, 156Cancellation of contracts, protection against, 156Collateral, application, 156Commitment to purchase, 156Losses, sharing, 156Standard form, 155-57

Guaranteeing agencies, 147, 151, 152Legal basis, 149Liaison officers, 153National banks, lending limits, 159Operations, volume, 148Phases of program, 148Procedures, 153Regulation V, 148, 153Reimbursement of Reserve Banks, 153Security, assignment of contract claims as, 159-61Settlement of contracts, loans to finance, 150VT guarantees, 150

Veterans' notes, discount:Endorsement, 80Maturity, 80

Nonmember banks, discount for, 79Rate, 80Regulation by Board, 80Termination of authority, 81World War Adjusted Compensation Act, 79

War Finance Corporation, advanceson bonds, 91

War production loans {See V loans)Warehouse receipts, 63Working capital loans to business:

Authority:Board of Governors, 138Liberalization, proposals, 144Need, 134Reconstruction Finance Corporation, compari-

son, 135,136Termination, 144Use, 144

Financing institutions, participation, 139Funds, source, 141Industrial advisory committees, 140Interest rates, 143Legislative history, 134Limitations:

Amount, 140Commitments, 138, 139Direct loans, 138Established businesses only, 137Exceptional circumstances, 138Industrial or commercial businesses, 137Maturity, 138

Location of:Business, 138Financing institution, 143

Losses, sharing by financing institution, 139Purposes, 134Regulation by Board, 142,143Security, 138Treasury Department, payments, 141,142

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lending functions of the federal reserve banks: a history, 1973 · 2018-11-06 · a comprehensive...

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