The system tended to cause temporary superabundances and temporary shortages of loanable funds in the central reserve cities. During the dull seasons in the agricultural regions, for example, the banks would have excess funds and would remit these to their reserve agents, either to add to their balances on which they received the customary 2 per cent interest, or to have the agents invest for them in brokers' loans, securities, etc., so as to take advantage of the higher money rates on the market. The plenitude of funds in the reserve cities lowered money rates and eased the way for the speculators, and at the same time inflated the prices of securities. An inflation of stock exchange operations followed. With a revival of activity in the agricultural regions the local bank would recall part or all of its balances from the reserve cities and possibly become a borrower. The result was that it became impossible to maintain the stock market, money became tight, loans were contracted, investments were liquidated, and values fell.
In case of panic these conditions were accentuated and it became impossible to recover the "reserve" funds by liquidating the securities in which they were actually invested, or practically invested through call loans, without producing so severe a shrink age of values as to cause wide-spread bankruptcy. The banks were therefore often obliged to suspend specie payments. For want of a broad discount market where such seasonally spare funds might have found investment in commercial paper, the rede posited reserve plan forced the collateral call loan system, fos tered an unsteady securities' market and money market, and confused commercial banking with financial banking. In the panic of 1907 this dependence upon the stock market was so convincingly proved to be dangerous and vicious that banks ceased to a large degree to make seasonal deposits and with drawals from New York.
Effect on Cash Carried, Exchange, and Accommodation The interest on the balances drew the funds to the reserve cities and then forced the reserve city banks to loan and invest them. The result was that the national banks as a whole kept on hand very small amounts of actual cash in excess of the minimum reserve requirements; or, stated more accurately, loans were extended as far as possible under the law. It was a case where the excess reserves were carried with reserve agents who were in competition and who were motivated primarily by the desire for profits, and who, therefore, from the pressure of com petition had to make dangerous extensions of credit on the basis of such reserve balances. Instead of the balances being, as in theory they were and ought to be, carried for exchange purposes, and carried, too, in liquid shape and payable on demand, they were made the basis of a credit structure which toppled when the balances were recalled.
One of the considerations which the depositing bank had in view in maintaining such balances was to have a dependable source of accommodation in case it needed loans; but if the re serve bank had already loaned to the limit, its ability to support its clients was nullified. In the fall months from 1902 to 1912 inclusive, the reserves of the New York banks averaged 1.4 per cent above the minimum required, which stands in wide contrast to the reserves voluntarily kept by the central banks of Europe which assume the r6le of reserve agent. The banks in the reserve cities depended upon their secondary reserves and these proved very treacherous in falling security markets, when the call loan is inconvertible except at a sacrifice.
Reserves and Stock Exchange Loans The fault here was in the system, not in any particular banks, nor in a special desire of the banks to facilitate stock exchange speculations. The banks were institutions for profit; they were competing; funds if idle were a source of loss; interest had to be paid to hold the account; investment of the funds was forced; the reserve banks had to depend upon secondary reserves which would be earning assets; since there were no facilities for redis counting commercial paper, the best secondary reserve open was the collateral stock exchange call loan. The system hurt the banks as well as the country at large. The banks would have avoided the dangers if it had been possible, but they were in the grip of a faulty system from which they could not escape.
If the balances were used as the basis of time loans the hazard to the bank was increased, for its demand liabilities were offset by time assets. The banks' relative readiness to loan on time or call varied with the ease or tightness of the money market.
In his report in 1912 the Comptroller classified the loans of the New York national banks on June 14, 1912, as follows: While the great proportion of the demand loans were collateral loans, no small part of these were loans to correspondent banks, and the security in such cases was mostly bills receivable. Some what more than a third of the time loans were also secured by collateral. Probably more than half of the collateral loans were made to others than members of the stock exchange. The situa tion, however, was not relieved much by the use of bills receivable as collateral, for no rediscount market existed.