which, when rates for call loans are persistently below 2 per cent, are naturally desirous of reducing bankers' balances swollen by the receipt of idle funds from all quarters. But the redemption of the notes does not secure contraction. All the banks, more particularly the country banks and those of the smaller cities, make haste to reissue notes, thus setting free an equivalent amount of money, which in the absence of local demand is shipped to the money centres for the sake of the interest to be had from the city banks. There is a sort of endless chain, the working of which can be interrupted only by the discontinuance of the present practice of paying interest on bankers' deposits. Were that inducement removed, our bondsecured notes would prove to be susceptible of a considerable measure of contraction. Even if the banks continued to reissue their notes as regularly as at present, contraction would still take place. An equivalent amount of money would be locked up in the banks, since they would reap no advantage from sending it to the money centres. Moreover, even if it were sent thither the pressure on city banks to force a demand for loans by the offer of low rates would be removed and they would doubtless maintain a higher reserve level.

94. CLEARING-HOUSE LOAN CERTIFICATES AND EQUALIZATION OF RESERVES1

By O. M. W. SPRAGUE

In 1893 and in 1907 the clearing-house loan certificate was the only device resorted to in order to secure the adoption of a common policy by the banks. In 1873, as on earlier occasions when its use was authorized, provision was also made for the equalization of the reserves of the banks. Thus in 1873 the Clearing-House Association, in addition to the customary arrangements for the issue of loan certificates, adopted the following resolution:

That in order to accomplish the purposes set forth in this agreement the legal tenders belonging to the associated banks shall be considered and treated as a common fund, held for mutual aid and protection, and the committee appointed shall have power to equalize the same by assessment or otherwise at their discretion. For this purpose a statement shall be made to the committee of the condition of such bank on the morning of every day, before the opening of business, which shall be sent with the exchanges to the manager of the Clearing-House, specifying the following

1 Adapted from "Proposals for Strengthening the National Banking System," Quarterly Journal of Economics, XXIV (1909-10), pp. 232-39.

items:

(1) Loans and discounts. (2) Amount of loan certificates. (3) Amount of United States certificates of deposit and legal-tender notes. (4) Amount of deposits, deducting therefrom the amount of special gold deposits.

Two fairly distinct powers were given the clearing-house committee: the right to issue clearing-house certificates, and control over the currency portion of the reserves of the banks. This machinery was devised (according to tradition) after the crisis of 1857 by George S. Coe, who for more than thirty years was president of the American Exchange National Bank. The purpose of the certificate was to remove certain serious difficulties which had become generally recognized during that crisis. The banks had pursued a policy of loan contraction which ultimately led to general suspension, because it had proved impossible to secure an agreement among them. The banks which were prepared to assist the business community with loans could not do so because they would be certain to be found with unfavorable clearing-house balances in favor of the banks which followed a more selfish course. The loan certificate provided a means of payment other than cash. What was more important, it took away the temptation from any single bank to seek to strengthen itself at the expense of its fellows and rendered each bank more willing to assist the community with loans to the extent of its power.

But in addition to the arrangement for the use of loan certificates provision was also made for what was called the equalization of reserves. The individual banks were not, of course, equally strong in reserves at the times when loan certificates were authorized. From that moment they would be unable to strengthen themselves, aside from the receipt of money from depositors, except in so far as the other banks should choose to meet unfavorable balances in cash. Moreover, withdrawals of cash by depositors would not fall evenly the banks. Some would find their reserves falling away rapidly upon with no adequate means of replenishing them. The enforced suspension of individual banks would pretty certainly involve the other banks in its train. Finally, it would not be impossible for a bank to induce friendly depositors to present checks on other banks directly for cash payment, instead of depositing them for collection and probable payment in loan certificates, through the clearing-house. The arrangement for equalizing reserves therefore diminished the likelihood of the banks working at cross-purposes-a danger which the use of clearing-house certificates alone cannot entirely remove.

These arrangements had enabled the banks to pass through periods of severe strain in 1860 and in 1861 without suspension. In both instances the use of the loan certificate was followed immediately by an increase in the loans of the banks, and in a short time by an increase in their reserves. The stipulation in 1873 was more serious, and, as events proved, the reserve strength of the banks, while sufficient to carry them through the worst of the storm, was not enough to enable them to avoid the resort to suspension.

In 1884, the next occasion when clearing-house loan certificates were issued, the opposition to the provision for the equalization of reserves was so widespread that it does not appear that it was even formally considered. The ground for this opposition can be readily understood. In 1873 the practice of paying interest upon bankers' deposits was generally regarded with disfavor. Only twelve of the clearing-house banks offered this inducement to attract deposits; but by this means they had secured the bulk of the balances of outside banks. It was in meeting the requirements of these banks that the reserves of all the banks were exhausted at that time. The noninterest-paying banks entered into the arrangement by the equalization of reserves in expectation of securing a clearing-house rule against the practice of paying interest on deposits. But their efforts had resulted in failure. Some of them had employed their reserves for the common good most reluctantly in 1873, and the feeling against a similar arrangement in 1884 was naturally far stronger and more general. Moreover, the working of the pooling agreement in 1873 had occasioned heartburnings which had not entirely disappeared with the lapse of time. It was believed, and doubtless with reason, that some of the banks had evaded the obligations of the pooling agreement. It was said that some of the banks had encouraged special currency deposits so as not to be obliged to turn money into the common fund. Further, as the arrangement had not included bank notes, banks exchanged greenbacks for notes in order either to increase their holdings of cash or to secure money for payment over the counter. Here we come upon an objection to the pooling arrangement which doubtless had much weight with the specially strong banks, although it is more apparent than real. In order to supply the pressing requirements of some banks, others who believed that they would have been able to meet all the demands of their depositors were obliged to restrict payments. That such an expectation would have proved illusory later experience affords ample proof. When

a large number of the banks in any focality suspend, the others cannot escape adopting the same course. But in 1884 the erroneousness of the belief had not been made clear by recent experience.

The New York banks weathered the moderate storms of 1884 and 1890 without suspension by means of the clearing-house loan certificate alone, and in the course of time all recollection of the arrangement for the equalization of reserves seems to have faded from the memory of the banking community.

In 1893 only a small part of the balances between the banks was settled in certificates at first; but by the end of July practically all balances were settled in that way and suspension followed at once. In 1907 all the banks having unfavorable balances, with but one important exception, took out certificates on the first day that their issue was authorized, and suspension was then for the first time simultaneous with their issue.

The connection between suspension and the use of clearing-house loan certificates as the sole medium of payment between the banks is simple and direct. The bank which receives a relatively large amount of drafts and checks on other banks from its customers cannot pay out cash indefinitely if it is unable to secure any money from the banks on which they are drawn. So long as only a few banks are taking out certificates and the bulk of payments are made in money no difficulty is experienced; but as soon as all the banks make use of that medium the suspension of the banks which have large numbers of correspondents soon becomes inevitable. The clearing-house loan certificate was a device which the banks themselves had adopted, and they had failed to provide any means for preventing partial suspension as the result of its use. That the arrangement for equalizing the reserves, adopted in 1873, would have availed to prevent suspension on subsequent occasions is highly probable, indeed a practical certainty.

The reserve situation in 1893 and 1907 was by no means desperate at the time of suspension. In 1893 the New York banks were in what was for them an unusually strong condition at the beginning of the disturbance, having early in June a cash reserve exceeding 30 per cent of their net deposits. A succession of banking failures in the West and South led to heavy withdrawals from New York during the latter part of June and the beginning of July. Then followed a lull and money began to be returned to New York. During the third week of July banking failures were renewed in the West and

South and the drain was resumed. The positively unfavorable aspects of the situation were altogether similar to those of the previous month, with the one further circumstance of a reduced cash reserve in New York. On the other hand, additional means with which to meet the situation were becoming available. At the end of July gold imports in large amounts had been arranged. Foreign purchases of our securities were heavy, reflecting increasing confidence in the repeal of the silver-purchase law. Arrangements had also been made which would certainly lead to a considerable increase in the issues of bank notes during August and September. Notwithstanding all these favorable circumstances the New York banks suspended, during the first week of August, when they still held a cash reserve of $79,000,000, more than 20 per cent of their deposit liabilities.

In 1907 the New York banks restricted payments when they still held a cash reserve of more than $220,000,000 and when the reserve ratio was also above 20 per cent. Both in 1893 and in 1907 suspension was not a measure of last resort taken after the banks had entirely exhausted their reserves and when there were no means of securing additional cash resources. Moreover, after cash payments were restricted the policy of the banks was unlike that adopted in 1873 in that the banks did not make further use of their reserves; they hoarded them and added to their amount, thus unduly prolonging the period of suspension.

95. SUBSTITUTES FOR CASH IN THE PANIC OF 19071

BY A. PIATT ANDREW

Reports from the 145 largest "independent" cities show that during the disturbance of 1907 in at least 71, or nearly half, resort was made by the banks to clearing-house loan certificates, clearing-house checks, cashiers' checks payable only through the clearing-house, or other substitutes for legal money; in 20 others the larger customers of the banks were asked to mark their checks "payable only through the clearing-house"; and in at least one other, where these practices were not pursued, the size of checks that would be cashed was restricted. Roughly speaking, in two-thirds of the cities of more than 25,000 inhabitants the banks suspended cash payments to a greater or less degree.

Adapted from "Substitutes for Cash in the Panic of 1907," Quarterly Journal of Economics, XXII (1907-8), 501-16.