CHAPTER III

THE ORIGINS OF CREDIT CONTROL IN THE

UNITED STATES

an

The Idea of Credit Control Non-Existent in America. Prior to the passage of the Federal Reserve Act the concept of the Bank rate as an instrument of credit control did not exist in America, though European central bankers were aware of its use as early as the crisis of 1857. On this side of the Atlantic, however, the principles governing the inter-relations of the Bank rate, credit expansion, prices, the foreign exchanges, gold movements, and cyclic fluctuations were unknown to the great majority of the banking community. The acts chartering the First and Second Banks of the United States, by limiting the rate of interest which might be charged on loans and discounts to 6% per annum,1 immediately crippled the Bank rate as instrument of credit control, even had the directors of these institutions been fully aware of its power. The Diffused Character of the American Banking System Prevented any Pretense at Credit Control. From the dissolution of the Second Bank in 1836 to the passage of the National Banking Act in 1863, banks were chartered entirely by state law. All, subject to certain limitations, possessed the right of issuing notes. Such reserves as they maintained against note and deposit liabilities were kept either in the form of cash in their own vaults or as a deposit account with banks in important centers. Some of these banks confined their business to one locality; others, with branches, operated throughout an entire state. United or concerted action among them, regarding the amount of credit to be extended or the industries to be favored,

1 See Dewey, The Second United States Bank, p. 167. As a result of charging the same rate of interest in all parts of the country, the applications for accommodation in the less developed sections were quite heavy-in sections where 6% was relatively a low rate of interest.

For a very comprehensive treatment of the history of banking reform in the United States, see Willis, The Federal Reserve System, Books I and II.

regarding the control of the foreign exchanges or the prevention of domestic inflation was an unheard of thing. Credit was freely extended during periods of prosperity, cyclic fluctuations were greatly exaggerated. At the time of the crisis, it was quite the customary thing to suspend specie payments.

99 2

The National Banking Act recognized the diffused character of the American banking system and continued it. The act was passed originally by Congress on February 25, 1863, but in accordance with the recommendations of Mr. Hugh McCulloch, the first Comptroller of the Currency, it was completely revised and passed again on June 3, 1864. By 1913, 7431 of the 22,958 independent and presumably competitive banks, which constituted the American banking system, existed by virtue of national charter. Their deposits amounted to 84% of the combined deposits of state banks and trust companies. They were the largest single set of institutions under one jurisdiction. They were "the heart and core of the financial system of the country. Though all but one 3 carried the word "National" in its title, they were national only in name. Branches, except under certain circumstances, were forbidden, and each served a single locality. The national banking system was not a system of banking in the sense that the 7431 members coöperated with and aided one another. Such coöperation as did exist among them resulted solely from clearing house memberships or from correspondent relations and not from national incorporation. Despite its improvement over the preceding state banking systems, it was a dismal failure and was stigmatized by Andrew Carnegie before the Economic Club of New York, on February 25, 1908, as the "worst banking system in the civilized world." 4 The diffused character of the National Banking System, the lack of any but local coöperation among the members, and the scattered nature of the reserves prevented any pretense at credit control."

2 Laughlin, Banking Reform, p. 10.

3 The Bank of North America, in Philadelphia, Pa.

4 For good statements of the defects in the national banking system see the Aldrich Report, Congressional Record, Vol. 48. p. 744; Kemmerer, The A B C of the Federal Reserve System; Laughlin, Banking Reform; Scott, Banking Reform; Sprague, Banking Reform in the United States; and the Report of the Monetary Commission of the Indianapolis Convention.

5 In introducing the Federal Reserve Act in the House, Carter Glass said of the national banking system: "While we may boast that no note holder has ever lost a dollar, and that the losses of the depositors constitute an inconsiderable percentage of the total liabilities of

Cyclic fluctuations were consequently greatly sharpened and intensified. On the upward swing of the cycle, always a time when business men over-capitalize future earnings, credit was freely extended. No check was placed on the expansion. The boom periods regularly terminated in severe crises, which as regularly degenerated into panics, followed by prolonged and severe depressions. The asperities of cyclic fluctuations were much more severe in America than in England, France or Germany, where some degree of control was exercised by the central banks over credit extensions.

Efforts at Reform. It was not until the panic of 1893, the first serious crisis in America since the resumption of cash payments in 1879, that the defects in the national banking system were so magnified as to attract general attention. The members of the American Bankers Association were among the first to sponsor a definite plan of reform. At a meeting held in Baltimore, on October 10 and 11, 1894, the Association endorsed a plan, prepared by members of the Baltimore Clearing House, which was known thereafter as the Baltimore Plan.s the banks, nevertheless, the failure of the system in acute exigencies has caused wide spread business demoralization and almost universal distress. Five times within the last thirty years financial catastrophe has overtaken the country under this system; and it would be difficult to compute the enormous losses sustained by all classes of societyby the banks immediately involved; by the merchants whose credits were curtailed; by the industries whose shops were closed; by the railroads whose cars were stopped; by the farmers whose crops rotted in the fields; by the laborer who was deprived of his wage. The system literally has no reserve force. The currency based upon the Nation's debt is absolutely irresponsive to the Nation's business needs. The lack of co-operation and co-ordination among the more than 7,300 national banks produces a curtailment of facilities at all periods of exceptional demands for credit. This peculiar defect renders disaster inevitable," Congressional Record, Vol. 50, p. 4642.

6 For a good account of the crisis of 1893, see Sprague, History of Crises under the National Banking System, Chapter IV.

7 The reasons for the failure to take cognizance of the defects in the national banking system prior to 1893 were twofold; in the first place, the system had proved itself, generally speaking, so much better adapted to the needs of the country, so much safer than and superior to the systems of banking which had preceded it, that few persons were disposed to attack it seriously; and secondly, questions of a monetary nature such as Greenbackism and Bimetalism had engrossed the attention of the public to the exclusion of purely banking problems. See Willis, The Federal Reserve, pp. 25-27.

8 See Proceedings of the Twentieth Annual Convention of the American Bankers Association, pp. 69–77. Mr. Charles C, Homer. President of

Though this plan undoubtedly would have provided America with an elastic currency, it took no cognizance of the need for reserve holding agencies, of institutions whose bank rate could function as do the Bank rates in Europe, or of the need for a discount market. In his annual report on the State of the Finances for 1894, Secretary of the Treasury J. G. Carlisle submitted the outlines of a plan of currency reform which, in his opinion, would "secure within a reasonable time a safe and elastic currency and would result ultimately in the permanent retirement of United States legal-tender notes of both classes." 9 But this plan too had as its main objective the reform of the currency and not a thorough renovation of the banking system. Indeed the gradual elimination of the United States notes, the circulation and reissue of which Secretary Carlisle felt was a constant menace to the gold reserve and seriously embarrassed the administration of the finances, was the real motive inspiring the plan.

The Plan of the Indianapolis Monetary Commission. The most notable movement through this period toward a solution of the defects in the American banking system was that made by the Indianapolis Monetary Commission.10 A bill embodying the proposals of the Commission was introduced by Representative Jesse Overstreet in the Fifty-Fifth Congress, Second Session, on January 6, 1898. It is quite probable that this bill would have provoked constructive action on the part of Congress had not the Spanish-American war intervened.11 While the plan of the Commission was quite superior to the proposals endorsed by the American Bankers Association or to those made by Secretary Carlisle, the Second National Bank of Baltimore, laid the plan before the Convention. Its acceptance was moved by A. Barton Hepburn. The details of the Baltimore plan are given in the Appendix.

9 Annual Report of the Secretary of the Treasury on the State of the Finances for the year 1894, pp. lxxv and Ixxvi. The details of Carlisle's plan are given in the Appendix.

10 See Report of the Monetary Commission of the Indianapolis Convention. The University of Chicago Press, 1898. In listing the defects of the American banking system the Commission emphasized the inelasticity of the national bank note, the inequality of interest rates in various sections of the country and the vast amount of government credit currency in circulation without adequate provision for its redemption. See Report, pp. 28 and 29. The details of the proposals of the Commission may be found in the Appendix.

11 The Gold Standard Act of 1900 did embody some of the minor recommendations of the Indianapolis Monetary Commission, but in its failure to provide America with an elastic currency it cannot be said to be a constructive piece of legislation.

it failed, as did they, in providing for any agency or means of credit control. Though it would have provided America with a safe and elastic currency, it did not present a solution of the other and equally pressing defects in the national banking system, such as the immobility, rigidity and scattered nature of the reserves, the lack of a discount market and of a central control over bank rates. Emphasis was laid on the need for an elastic currency practically to the exclusion of all other needs.

Fowler's Proposals. In 1901 the Hon. Charles N. Fowler, a Representative from New Jersey, became Chairman of the Banking and Currency Committee of the House. As he was an ardent advocate of banking and currency reform, many entertained optimistic hopes that improvements would speedily occur. Though the Committee under his leadership was one of the most active in the lower House and though a series of reform measures was introduced in Congress, 12 not one of them was granted the courtesy of a debate nor received the slightest consideration from the party in power. The indifference of the Republican party toward banking reform at that time may be attributed to the hostile predisposition of its leaders, and especially to the antipathy of Senator Aldrich, Chairman of the Senate Finance Committee.

The Aldrich-Vreeland Act. The experiences of the panic of 1907 finally awakened the country to the need of banking reform. No longer was it an academic question; it had become of the greatest practical importance to all. The insistence of the public that Congress bestir itself and enact measures which would prevent the recurrence of such a disgraceful financial episode, spurred the members to action and a plethora of bills 12 The following measures were introduced by Rep. Fowler before the panic of 1907:

1. H. R., 10,289, 55th Congress, 2nd Session.

Introduced June 15, 1898, House Report, No. 1575.

2. H. R., 13,363, 57th Congress, 1st Session.

Introduced April 5, 1902, House Report, No. 1425.

3. H. R., 4831, 58th Congress, 2nd Session.

Introduced April 11, 1904. House Report, No. 2349.

4. H. R., 23,017, 59th Congress, 2nd Session.

Introduced Dec. 20, 1906. House Report, No. 5629. This bill was substantially that advocated by the American Bankers Association in 1906.

Many other plans of reform were proposed through this period; among them was one proposed by Maurice L. Mühleman and one by the New York Chamber of Commerce. See Mühleman, Monetary and Banking Systems, p. 206.