ANNUAL REPORT OF THE FEDERAL RESERVE BOARD.

FEDERAL RESERVE BOARD, Washington, D. C., January 15, 1915.

The SPEAKER OF THE HOUSE OF REPRESENTATIVES.

SIR: Less than six months have elapsed since the Federal Reserve Board entered upon its duties, but so much of fundamental importance and interest has taken place in the transformation of our banking system during this period that it seems advisable not to delay for a twelvemonth the report which, under the terms of section 10 of the Federal reserve act, this Board is required annually to present.

The first steps, particularly the fundamentals of the regional structure of the new system, had already been provided for by the Reserve Bank Organization Committee when the members of this Board took the oath of office on the 10th of August, 1914. The country had been divided into 12 districts and in each of these districts a city had been designated by the Reserve Bank Organization Committee as the location for a Federal Reserve Bank. Some dissatisfaction with the conclusions of this committee had been expressed by affected districts, but this Board, though fully alive to the vital bearing which the proper districting of the country would have upon the successful operation of the Federal Reserve System, thought it best to postpone a consideration of this question in order not to delay the organization of the Federal Reserve Banks. This decision was confirmed by recognition of the extraordinary conditions then obtaining throughout the country and the urgent need of bringing to the relief of the business and banking community in a time of great financial stress the facilities of the new banking system. The Board accordingly addressed itself with energy from the very beginning to the further steps to be taken in preparation for an early launching of the new system.

The difficulties of the undertaking were of course greatly aggravated by the economic disturbances occasioned by the European war which extended to every part of the country and fear was expressed by many that the new system could not safely be put into operation before the 1st of January, 1915. Nevertheless, conditions were so far controlled and steadied by the series of unusual relief measures described below, and the work of organization was so far advanced that the Board on October 26 issued notice to the member banks of the Federal Reserve System calling upon them to pay in their first installment of capital stock as of date of November 2. At about the same time the Secretary of the Treasury, acting under the authority conferred upon him by section 19 of the Federal reserve act, fixed November 16 as the date for opening the Federal Reserve Banks and for readjusting the reserves of the member banks in accordance with the new requirements established therein.

The work of the Board may therefore be divided for the purposes of review into two periods: (1) previous to November 16, covering the preliminary steps in the organization of the new system, together with such incidental, though highly important responsibilities as were assumed by the members of the Federal Reserve Board in the effort to deal with the grave situation precipitated by the European war; (2) from November 16 to date, covering the early operations of the several Federal Reserve Banks.

EARLY PROBLEMS OF BOARD.

The condition with which the Board was confronted when it began its work on the 10th of August had such a considerable bearing upon the policy pursued that it is well worthy of further notice. Seldom, if ever, has the banking and business community of the country found itself in a situation of such uncertainty and perplexity. The outbreak of hostilities in Europe led immediately to a serious rupture of international financial relationships, not only in the affected areas of Europe, but throughout the whole commercial world. The United States was directly and profoundly affected by the suspension of communication with Europe, involving as its most serious consequences the temporary breaking down of the export trade and the collapse of the financial markets, with resulting shock to the credit system. There had been extraordinary efforts on the part of European holders of American securities to realize by sales in the New York market. The securities markets were badly demoralized, prices fell with alarming rapidity, and the country was exposed to a serious and disastrous drain of gold.

The whole situation demonstrated afresh, and to a striking degree, the dependence of our banking system upon the call-loan market because of the large proportion of the country's banking reserves which were invested in call loans protected by stock-exchange collateral. Stock exchanges throughout the country closed, and call loans were thus made unavailable. Emergency currency was issued by the Secretary of the Treasury and clearing-house certificates in large volume were issued by clearing-house associations in the principal financial centers. Moreover, the tendency to hoard cash, frequently experienced in former periods of stringency, was again being manifested by country banks, some of which curtailed accommodation to an extreme degree, thereby adding greatly to the embarrassments of their customers and city correspondents. Much doubt. was expressed as to the ability of borrowers to meet their maturing obligations, securities of high grade were unmarketable, while a situation existed in the foreign-exchange market which was altogether unprecedented. The conditions thus briefly outlined created an impression of profound alarm throughout the business community and gave rise to frequent expressions of the belief that the organization of the reserve system should be deferred until the return of more normal conditions, both for the success of the system and in order that the existing situation might not be complicated and aggravated by the injection of new and incalculable elements into it.

The board immediately after taking office undertook as nearly as possible to ascertain the exact basis for this view and secured from

a great variety of sources expressions of opinion with reference to the policies that would best be pursued in the face of the situation. Fruitful and interesting as these expressions were, there was nevertheless so much diversity of opinion that the Board in the end found that it would have to be guided by its own estimate of conditions and its own judgment as to the course to be pursued. As the result of the most careful analysis that it could make, it concluded to proceed forthwith with the organization of the new banks-that is, as early as was consistent with their stability and efficiency-and with the selection of competent operating staffs. The Board was also, however, firmly of the opinion that in undertaking thus early to establish the Federal Reserve Banks it would be necessary to enlist the hearty cooperation of all the member banks in two matters which were deemed of fundamental importance: (1) payment by the member banks in gold out of their own vaults of the reserves they were required to contribute to the new banks, thus diffusing the burden of providing the cash resources of the Federal Reserve Banks; (2) the adoption of a discount policy which would prevent the accumulated strength of the banks from being dissipated and protect their resources from being used to finance operations not calculated to add to the strength or solidity of general banking conditions.

CHOICE OF DIRECTORS.

Before the banks could be set in actual operation, however, it was necessary for the Board to complete the organization prescribed in the Federal reserve act by the appointment of three Government directors in each of the several institutions. Pursuant to the requirements of law, the Reserve Bank Organization Committee, consisting of the Secretary of the Treasury, the Secretary of Agriculture, and the Comptroller of the Currency, had already taken preliminary steps, resulting in the election by the banks of six directors in each Federal reserve district, and the results of these elections were reported to the Federal Reserve Board upon its organization.

There remained to be appointed by the board three Government directors for each district, the first of whom was to be designated Federal Reserve Agent and Chairman of the board of directors, the second as Deputy Reserve Agent and Vice-Chairman. Particular importance was felt to attach to the choice of all the Government directors, and especially of the Federal Reserve Agents. The Federal reserve act specifically designates the Federal Reserve Agent as the representative of the Federal Reserve Board at the bank to which he is accredited, and invests him with very large responsibilities. It was not, in the opinion of the Board, the intent of the act to constitute the Federal Reserve Agent the operating head of the bank, but, rather, that he should be vested with the function of promoting the general interests and purposes of the system, assuring himself and this Board of the sound and impartial administration and efficient operation of the bank to which he was accredited, and giving both to the Federal Reserve Board and to the executive officers and his fellow directors of the bank, over whom he had been appointed Chairman, the benefit of his advice and knowledge. The office is undoubtedly one which calls for exceptional qualifications, and is, therefore, difficult to fill, since by the very terms of the act, "tested banking ex

perience" is made a prerequisite, while consideration for the general welfare of the bank's administration requires that the incumbent be a man of solidity, independence, and tried character.

Believing that the choice of the Government directors was a matter of fundamental importance and that errors made in their selection would produce serious consequences in the later working of the banks, the Board deemed it essential to scrutinize every name submitted for appointment or suggested from any source, with the utmost care. The process was one which required time and necessitated visits by members of the Board to various and distant parts of the country, as well as the invitation of competent advisors to Washington for consultation. As the outcome of these investigations and deliberations, the Board announced to the public at different dates early in October the three selections made for Government directors for each of the reserve banks, or 36 in all.

In Exhibit G, hereto attached, will be found a complete list of the directors of the Federal Reserve Banks.

In order to obtain persons of satisfactory banking experience, as required by law, it was found necessary to give to Federal Reserve Agents salaries commensurate with, or approximating, those prevailing in the banking community in each district for men of similar attainments, abilities, and experience. In a number of cases it was found possible to attract to the service of the Reserve Banks men of high qualifications at a rate of compensation substantially lower than they had been receiving or were in a position to obtain. The action of the appointees in accepting office on short notice and at the compensation established was the more to their credit in that in not a few cases it was necessary for them to incur substantial financial sacrifice because of the unfavorable conditions under which they were obliged to dispose of their holdings of bank stock, the Federal reserve act making it mandatory that each Federal Reserve Agent and each director of Class Cshould divest himself of ownership of this class of securities. A list of the compensation thus established for each Federal Reserve Agent, as well as a list of salaries of governors of reserve banks submitted to the Federal Reserve Board by the several member banks and approved in accordance with law, is herewith submitted as a part of Exhibit G.

As soon as the directors of the several banks had been chosen, they proceeded to select the nucleus of a suitable staff, in order that the banks might be ready to begin active operations when qualified to do so. The Board particularly enjoined upon them the choice of a suitable chief executive officer in each institution, with the suggestion that this officer be given the title of governor in order to differentiate his functions from those of the president of a member bank. A tentative plan of organization, which has been approximately conformed to in the establishment of each bank, was, moreover, suggested, and is hereto attached as part of Exhibit C.

PURCHASE OF PAPER.

Recognizing that, in view of the urgent character of the situation regarding the establishment of the banks, it was not possible to formulate in advance of their opening a complete set of regulations with reference to their conduct and operation, the Board determined to confine itself in the beginning to those matters which were

deemed absolutely essential to setting the banks in motion upon a basis of reasonable efficiency. It was felt that the regulations relating to discount operations and commercial paper in general were fundamental and that they should be prepared and issued at once. The result was the preparation of a letter addressed to all Federal Reserve Agents, sent to them under date of November 10 as Circular No. 13, in which the board set forth its views with reference to the policy deemed advisable to be followed by the banks in the beginning. It was recommended that the Federal Reserve Banks confine themselves strictly to dealings in short-term, self-liquidating paper growing out of commercial, industrial, and agricultural operations, in the restricted senses of the terms, and that particular care be taken not to discount or purchase paper which had been issued primarily for the purpose of providing capital investment for any business. In Exhibit E, hereto attached, is given a complete file of the regulations and circulars thus far issued by the Federal Reserve Board. The full text of Circular 13, aforesaid, with the accompanying regulations, will be found in its proper place in this exhibit.

As already noted, it was deemed essential that, so far as possible, the capital and reserves to be paid into the Federal Reserve Bank at the time of organization should be taken from its own vaults by each of the contributing member banks. Inasmuch as the act provided that the capital should be paid in gold or gold certificates, it was to be expected that the bulk of such payments would, in any event, be made from the vaults of the member banks. Reserves, however, might of course be paid in any form of lawful money and the act itself had expressly provided that one-half of the reserve installments might be received by the Federal reserve banks in the form of rediscounted paper. It was, therefore, thought proper to appeal to the sense of common interest and spirit of cooperation of the member banks, in order to induce them to refrain from establishing reserves through some means other than that of a direct deposit of cash from their own vaults, and to pay in, so far as possible, the sums that were due from them to the Federal Reserve Banks on reserve account in the form of gold or gold certificates. With this in mind, the Board transmitted to the member banks on October 28 a circular (No. 10) in which the banks were advised and urged to make their payments in gold or its equivalent taken from their own vaults. As a special inducement, the Federal Reserve Banks were authorized to pay the express charges upon cash amounts thus remitted to them by member banks.

There was, of course, at no time any provision of law prohibiting member banks from drawing upon their correspondent banks for the means wherewith to make these payments, but it was believed that they would be willing to forego the exercise of this right and events fully justified this belief.

On Monday, the 16th of November, the date already fixed by the Secretary of the Treasury, as above indicated, the new banks opened their doors for business. The statement issued on the following Saturday showing the condition as of the evening previous, indicates how fully the member banks had complied with the reserve suggestions that had been made to them.

The statement referred to will be found tabulated, with the succeeding weekly statements issued by the board in accordance with