IV

THE GOVERNMENT UNDERWRITING.

One of the great instruments to our financial independence will be the Federal Reserve Act if rightly administered, because it gives the Federal Reserve Board powers to unshackle commerce and make the freest distribution of credits by the freest transfers and collections when in due time this part of the system shall have been inaugurated. To this end our commercial and manufacturing and distributing interests should welcome the establishment of regional reserve banks and their branches, so that the government may, as in Germany, minimize the expense of financial transfers and collections.

The beginning of this banking system might have been expedited had there not been Washington prejudice against financial "underwriting." Yet the United States government underwrites the new Federal Reserve System. It provides that any stock not taken by national banks, other "member" banks, or the public, shall be taken by the United States Treasury. This is in fact an underwriting by the government, but, of course, political Washington would not harbor such a Wall Street term or thought. Therefore, the act provides that the national banks "and every eligible bank" shall have 60 days from Dec. 23 to accept its terms, and when the federal reserve districts have been marked out, the banks shall be given 30 days in which to subscribe to the capital stock. Right here might come a mix-up. The directors, or officers, may in behalf of the bank accept the act, and the stockholders may decline to subscribe. There is no penalty. The national banks may accept and stay out for a year and then they will be dealt with by the Federal Reserve Board. Indeed they may not accept the provisions of the act at all and yet may be allowed to come in within the year. Suppose the state banks and trust companies elect to come in and fill up enough capital to start the regional reserve banks-$4,000,000 each—and later the national banks elect to come in. There would then be a double subscription of capital, for the state banks and trust companies are about equal in size to the national banks.

Annexed as of Oct. 21, 1913, are similar data for the 7509 national banks, placed beside the above total for the state banks and trust companies:

There is not enough money for all to come in and pay in the capital and reserves demanded without re-discounts of too large volume for "reserve" banks, but, of course, here the Federal Reserve Board has power to discriminate and it is not likely that many more state banks will come in than will take the place of those smaller national banks, which may find it to their interest to go out.

It would, however, have been better finance and better business for the government, instead of acting as underwriter, to have promptly subscribed or set aside the fifty-one million gold which it is contemplated the national banks will pay in this year as 3% upon their capital and surplus in starting the new system. Later they will be called for 3% more. There was at the time of the passage of this act one hundred and one million of free gold in the United States Treasury and the act had only to set aside fifty-one millions in Treasury vaults, subject to the call of the new Federal Reserve Board (to be put in their vaults as soon as they were built), and there would

be no uncertainty as to the inauguration of the new system. It would be started with government capital in gold and then the national banks would first be invited to subscribe; then it would have been in the discretion of the Federal Reserve Board to let in the state 1 banks and lastly the public. With the capital fully taken by others, the Treasury would be free of the stock. It may not be material in the inauguration of the system; but a little reflection here shows how much more direct and efficient are the "underwriting" methods of finance than the "underwriting" methods of the government. In finance a stock issue is underwritten and construction begun by advances against the underwriting even before the public subscriptions are invited.

The government in starting the new federal reserve banks avoids the business system and without so denominating itself becomes the underwriter but does not get the benefit of the prompt determination of the public subscription which underwriting should

secure.

At present there is no assurance or positive regulation whence will come the subscribed capital or how far the state banks or the public will participate therein. There is danger if too few national banks come in, and there is danger if too many state banks attempt to come in, and there is still further danger if the public comes in as a subscriber, and later the national banks insist upon coming in; for in the inauguration of this system there is danger ever present in the possible disturbance to capital and credits.

If the national banks alone come in they will pay in their 3%, or fifty-three million; 1% as called; another 1% within three months, and a third 1% within six months.

V

THE SECOND DANGER IN THE LAW.

As originally proposed the new federal banks were to have a capital of 10% on the entire national banking capital, or $100,000,000. This is now to be accomplished by calling for a similar amount, but as 6% on the national banking capital and surplus.

Here there is uncertainty. If the national banks like the situation and want more of the 6% cumulative stock of their regional banks they may to a considerable extent write from their $300,000,000 of undivided profits into their surplus account; or, if they do not like the situation, they may write off a considerable part of their surplus. It makes no difference with their earning power, but reduces their liability on stock subscription account.

If all the national banks and trust companies and state banks should come in there might be $200,000,000 capital subscribed and paid in on the basis of 6% of their capital and surplus and this would be further liable, as are national bank shares, to a 100% assessment.

But as before explained there is not money enough in the country to permit all the national banks, state banks and trust companies to come in as shareholders and make deposit to the extent required by the act.

Few persons realize that one of the great dangers in contraction and expansion is a fixed reserve requirement making for inelasticity. Among the wisest provisions of the act are those for suspension (under regulation) of the reserve requirements.

While under section 2 no federal reserve bank shall commence business with a subscribed capital of less than $4,000,000, what is there in the act to prevent the starting of a $4,000,000 reserve bank and the immediate withdrawal and reduction of the share capital by the member banks? For instance, after the $4,000,000 capital has been subscribed, if the outlook is not encouraging, member banks may immediately surrender their stock and take back their payments, thereby and to that extent extinguishing the capital of the bank and the "reserve" bank might be continued as a $1,000,000 bank or a $500,000 bank. Of course, such banks would have to leave the national banking system and go into liquidation.

While the primary danger in this act is inflation, the second

danger is in this loophole for contraction. State banks and trust companies, as well as national banks, would scent trouble in our reserve system possibly ahead of the Federal Reserve Board and if a few leading banks turned in their certificates and took out their capital plus 6% accumulated dividends but "not exceeding the book value," who can say how many banks would follow?

More important than the "reserve" money involved in the share capital account is that of the deposit. A bank withdrawing would naturally first check out its full deposit. This averages about four times as much as the fully paid capital. When called upon to make good its "reserve" deposit, it may respond by passing up its share certificates, for redemption at the pleasure of the Federal Board, and announcing itself as "out," "retired," 'metamorphosed," or "in liquidation."

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The first requirement as respects reserves of member banks is that they keep money in their own bank and next in the regional reserve bank; but this reserve is mobile and may be checked against.

What would a reserve system, a partnership or an underwriting be good for, where any member or partner could at the first sign of danger take his share and accumulated dividend out of the cash box and quit?

This is the individualism-socialistic character of the bill; you are individually free to do as you please so long as you please and run away with your money when you please. You are individually "it" and above all government compulsion, unless the Federal Board promptly makes rules concerning retiring banks-their shares and "reserve" deposits.

The recent marked tendency the world over towards socialism, or the expansion of general assessment for individual good, is noted in the end of the second section of this act, which appropriates $100,000 out of the Treasury to inaugurate this system; and proposes 6% cumulative dividends to the stockholders but does not assess them to repay this $100,000 cost of establishing the system. Thirty years ago or less this would have been considered the entering wedge to a monstrously socialistic system. Now it passes unnoticed and it is cited here only as an evidence that in the framing of the bill the design is to make a good "easy" banking system for the benefit of all the people at low rates. It is not even proposed to assure the Government anything for the use of its credit, and yet for every gold dollar deposited a Reserve Bank may accommodate depositors with $1.62 in Government guaranteed paper, in exchange for bank-endorsed commercial bills, and yet some more paper for a trifling fine.

In Washington even the wisest financial advisers so far as there