The Federal Reserve Act I 1

§ 3. Federal Reserve banks. The twelve Federal Reserve banks, which opened for business November 16, 1914, are institutions of a type new in our financial history. They are "banks for banks," that is, for the "member banks" in their respective districts. Every national bank must, and any state bank or trust company may (on agreeing to comply with reserve and capital requirements for national banks and to submit to federal examination), subscribe for stock to the amount of 6 per cent of its capital and surplus, and thus be come a "member bank." The capital of each Federal Re serve bank was to be at least $4,000,000; in fact, only two of those organized (Atlanta and Minneapolis) had at their open ing less than $5,000,000 capital ; the largest (New York) had $21,000,000 ; and the average was $9,000,000. The member banks receive dividends of 6 per cent, cumulative, on their paid-in shares of capital, and (beginning 1921, by amend ment) all remaining net earnings are added to surplus until it amounts to 100 per cent of the subscribed capital ; after that 10 per cent shall be added to surplus and the rest goes to the government as a franchise tax. By the end of 1920 the total surplus of the system exceeded the subscribed cap ital, and only two of the banks (Cleveland and Dallas) had less than 100 per cent surplus.

Each reserve bank has nine directors, consisting of three classes of three men each. Classes A and B are elected by the member banks by a system of group and preferential voting designed to prevent the large banks from outvoting the smaller ones. Directors of class A are chosen by the banks to repre sent them, and are expected to be bankers; those of class B, though chosen by the banks and though they may be stock holders, shall not be officers of any bank, and shall at the time of their election be actively engaged within the district in commerce, agriculture, or some other industrial pursuit. Directors in class C are appointed by the Federal Reserve Board, one of them being designated as chairman of the board of directors and as Federal Reserve agent. They rep resent the public particularly, and may not be stockholders of any bank.

Any Federal Reserve bank may: a. Receive deposits from member banks and from the United States.

b. Discount upon the endorsement of any of its member banks negotiable papers, with maturity not more than ninety days, that have arisen out of actual business transactions, but not drawn for the purpose of trading in stock and other investment securities.

c. Purchase in the open market anywhere various kinds of negotiable paper.

d. Deal anywhere in gold coin and bullion.

e. Buy and sell anywhere bills, notes, revenue bonds, and warrants of the states and subdivisions in the continental United States.

f. Fix the rate of discount it shall charge on each class of paper (subject to review by the Federal Reserve Board).

g. Establish accounts with other Federal Reserve banks and with banks in foreign countries or establish foreign branches.

h. Apply to the Federal Reserve Board for Federal Reserve notes to be issued in the manner below indicated.

§ 4.

Federal Reserve notes. In 1914 there were outstand ing about $750,000,000 of what we may now call the old-style bank-notes (bond-secured). These were not retired by the new act ; but the law was shaped with the purpose of retir ing them at the rate of about $25,000,000 a year, so that they would all disappear from circulation in thirty s These notes were all secured by the deposit of bonds of the United States, a large share of them bearing interest at the artificially low rate of 2 per cent. Two per cent. was less than the market rate for Whenever the banks having old-style bank-notes outstanding desire to retire any of their circulating notes, the Federal Reserve banks may be required by the Federal Reserve Board to purchase the bonds in due quota (not to exceed $25,000,000 in any one year). On the deposit of these bonds with the Treasurer of the United States, the Federal Reserve banks may receive other circulating notes (essentially of the old style) called Federal Reserve bank-notes, or may receive 3 per cent bonds not bearing the circulating privilege.

The new kind of notes provided by the act are called Fed eral Reserve notes. They are not secured by the deposit of government bonds, but they are secured beyond all question in other ways. First, they are obligations of the United states receivable for all taxes, customs, and other public dues, and redeemable by the latter in gold or in lawful money (which includes greenbacks, Treasury notes, gold certificates, and silver dollars). Thirdly, their credit and prompt re demption is insured by certain elastic rules as to re serves in gold which must be kept for the redemp tion of outstanding notes. Fourthly, they are secured by collateral, consisting of notes and bills accepted for re discount from member banks, which must be deposited by a Federal Reserve bank with the Federal Reserve agent of its district, dollar for dollar for every note it receives. Fifthly, the notes become "a first and paramount lien on all the assets of the bank." This is what gives the notes their character of asset currency. It is apparent that the notes unite in a manner without example the characteristics of asset bank notes with those of political paper money' government loans, for 3 per cent bonds without this privilege sold above par. Therefore these 2 per cent bonds were held almost exclu sively by banks, and would have lost a good share of their value had the note-deposit privilege been withdrawn.