Practical banking, with a survey of the Federal reserve act

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Preface

In putting this volume before the public, the writer has in mind at least two purposes which he hopes to fulfill : (1) to draw with certain accuracy of detail a plan of the structure — the mechanism — of the modem bank in America; (2) to reduce all this to untechnical language and yet include sufficient of exact financial information to ^ enable the "layman" who is interested in the

^ general methods of banking to grasp the subject

p. substantially without laborious and endless effort.

'^ There is no subject, not essentially fiction,

V tions as the study and practice of banking. In-

* deed, writers on the matter are more wont to use

literary imagery than are delineators of science in general. Thus, one speaks of London as "the financial Rome of civilized nations," while an- - other says that between the gold reserves on " the

^ face of the earth " there is "the same affinity as

between the blood corpuscles circulating in the organism."

The very words "Wall Street," "Lombard Street," "Threadneedle Street," "The Bourse" suggest the boimdless optimism of man, his (often) day-dreams and visions, his plans dashed to fragments or culminating in success. After all, finance is so intimate to every one of us we cannot but find an innate interest in the contemplation of it. The prosperity of nations is closely bound oo vi PREFACE

up in the success or failure of its banking system. Thus a writer, speaking of the necessity of guarding in some way the metalKc reserve required for a coimtry's own banking, says: "When a nation, carried away by the blind confidence of an already long period of easy credit and great prosperity, neglects more and more the metallic basis and the progress of other nations toward a clearing system, and thinks it can forever increase credit and exalt speculation, the crisis is at hand and will suddenly appear; then, as the penalty for ignoring the necessarily slow processes of evolution, it must submit to the humiliation of asking the world for help." ^

But, ciuiously enough, finance is blind to such considerations as patriotism and money seeks its best market, be it where it may. This levels the supply of gold in a country to what is necessary and, as Mr. Patron points out, results in an ironical situation often enough. He cites the transfer of two hundred million francs into France as the result of buying the Panama Company. This money, it seems, had largely come to the United States from Japan in payment of war material. France loaned a large part of it to Russia, and we had Japan actually furnishing gold to her enemy.

This little volimae, however, is not concerned in particular with world finance, but rather with the interior conduct of the average American bank. I have sought to make it intimate and, as far as it was interesting and profitable, to intro-

^ Maurice Patron, The Bank qf France, in the National Monetary Commission Series.

PREFACE vii

duce the reader to some of the officers and officials of the bank, acquaint him with their duties, and, in fine, describe the actual conduct of banking from the mechanistic side. There are also several chapters dealing with more general phases of banking, such as that concerning ""What is a Bank?" and the chapters on "The Clearing House," "National Bank Currency," "Foreign Exchange," and "The Federal Reserve Act."

The writer does not presume to have said the final word on banking; indeed, he only assiunes a certain originality as far as his observations and treatment are concerned. On the other hand, he has not altogether depended on his own experience, but has sought the advice of numerous practical banking men in New York and elsewhere, and has, moreover, searched the writers for confirmation of . his theories or for additional information. A working bibliography on banking is appended to this book. A number of other books, not specially consulted by the author for this book, are referred to in various places throughout the work.

Finally, the main object of this work must not be forgotten, namely, that it is intended for the student of finance who wishes a glimpse into the practical conduct of the bank or for the business man who daily has relations with the bank and yet, as is most natiu*al, is unfamiliar with the details of this most important institution of modem civilization.

The personal acknowledgments of the author in the preparation of this little labor of love are viii PREFACE

many and the obligations real. Without those whose names follow, the book would not have been possible.

To Professor John Erskine, of Columbia University, I owe most in this imdertaking. It was he who first suggested it, and his patient criticism of the structure of the book was invaluable. Mr. John H. Prye, president of the Traders' National Bank, of Birmingham, Alabama, is responsible for several years of discipline and experience, wherein I received a first practical insight into bank methods, and for inniunerable courtesies. The late J. H. McEldowney, formerly vice-president of the National City Bank of New York, was of great assistance to my book in its inception. Hon. Oscar W. Underwood assisted me with the complete report of the National Monetary Commission and valuable documents relating to the Federal Reserve Act. Mr. H. H. Powell, cashier of the Importers' and Traders' National Bank of New York, and Mr. William Scherer, manager of the New York Clearing House, furnished me with definite information in their respective fields. Mr. William E. HoUoway, banker. New York, read the manuscript and criticized it, as did Professor Charles A. Beard, of Columbia University, Mr. H. E. Davisson, formerly of the Foreign Department of the National City Bank, New York, and Mr. Olaf Olsen, assistant cashier of the First National Bank of Boston. The Librarian of Congress provided a bibliography on currency legislation. I am indebted to Mr. F. R. Macaulay, Columbia University, for suggestions. Mr. Frederic Erb, Supervisor of the Loan Division,

PREFACE ix

Columbia Univepsity Library, was untiring in his courtesies from time to time. I gratefully acknowledge the assistance of Mr. Stanley V. La Dow, New York, in reading the proofs of this volimae.

Those whose books have proven more than valuable in preparing this work are too numerous to mention and must be looked for in the bibliography. However, I will make particular mention of the following: Charles A. Conant, A HiMory of Modem Banks of Issue; Wesley C. Mitchell, Business Cycles; James G. Cannon, Clearing Houses; and articles by Paul M. Warburg.

Ralph Scott Harris.

Columbia University, October 2, 1914.

Contents

I. What is a Bank? 1

n. The Stocehoij>ebs and the Boabd of Di-

BECTOBS ^

Chapter I What Is A Bank?

When one ascends marble steps into some wonder of the American builder's art; as he moves through offices magnificently finished, seeing here a long Une of wickets, each manned by a well-kept teller, who waits on the public; behind them a vast crowd of bookkeepers, listers, watchmen, collectors, and messengers; as he sees there desk after desk occupied by suave, sharp-eyed officers and assistants; as he notes with what smoothness, what consummate ease the business is divided and handled, like some huge power-machine, made of the best metal, — he is struck with admiration for a thing so immense, so farreaching, yet so graceful and perfect. It is difficult to imagine that the science which it is practicing and developing — the science of banking and finance— had a beginning long, long ago, and that in the beginning it was a tiny, rude, imdeveloped happening, not even a definite calling.

Our task, in this chapter, will be to give, in a brief and succinct sketch, the origin and progress of banking. It is not within our province to go very deeply into the details of this theme, which itself might fill several portly volumes. But the intention is to cover generally the historical development of the bank, touching, however, only the great peaks, and to discuss the modem bank, and particularly the National Bank, in the United States.

Those principles which underlie banking or finance, as we know it, have been applied since the first day men began to cooperate with each other. ^ It is the process of obtaining some desired article for an article which can be more easily spared. In those days there was no fixed standard, like our currency, by which articles could be compared. Consequently, nothing like a regular market could be instituted; each transaction stood on its own merit. There was exchange of articles which, on accoimt of their practically equal utility to those trading, were of an equal commercial value. But this exchange was and is the basis of our banking system. As soon as you substitute the abstract for the concrete, the payment or the promise to pay in an accepted medium for actual payment with an article of a practically equal trading value, you have a modem banking system.

In the rudest and most barbarous people of whom we have any historical record, glimpses of the employment of these general laws may be had. At first, it was a very simple exchange. A man had a very desirable dog, slave, or ox which he

^ The ultrarradical would say that they had been applied, not , from the day men commenced cooperating, but from that day when the stronger began to oppress the weaker. I refrain from any comment on this distinction.

would trade for a weapon, a skin, or a woman to work for him. Gradually rare substances, because of their comparatively little bulk or weight, became the more generally accepted medium of exchange, of which gold, silver, and bronze finally became the most common. That is, instead of a man waiting imtil his heifer had become a fullgrown cow, which he might "swap" for a wife, he took an appropriate quantity of the medium, which he had obtained by digging or trading, and made the exchange.

By slow degrees — for these evolutionary processes, it must be understood, were matters of many centuries of gradual development — people came to feel the inconvenience of carrying around coin or bullion in any quantity. Doubtless this was felt to an extraordinary degree in the city where iron was declared the standard money. So, finally, but with as much tardiness and suspicion as that which attended Charles Lamb's Chinese learning to roast pig without burning down a house, they became satisfied to accept, in place of money, the written promise to pay a specified sum at a definite time and place, and they had the genesis of paper currency. This paved the way, ultimately, for the creation of the bank, the check, and the currency bill.

The function of banking which has to do with the extending of loans is spoken of in the far d^ths of history. In the early chronicles of the Hebrews are f oimd injunctions against the taking of usury. But this, undoubtedly, preceded the actual business of lending. Then it was but the occasional lending by any man so inclined to one who wished to borrow. In other words, it was not yet a definite calling.

Banking, crude but genuine, may go back as far as a thousand years before Christ. Prior to that we have no assurance. It is probable that no institutional or private banking took place before that date, for, although it is estimated that man has been in his present physical and mental stage for something like 250,000 or 300,000 years, it is only within the last 6000 or 6000 years that he has accumulated enough experience — handed down mostly by tradition — to enable him to begin cooperative institutions. Taking, then, the famiUar clock illustration, if the face represents 250,000 years, it has only been possible for banks to exist a little over a minute now, and the national bank in the United States is not quite a second old.

Assyria, as early as the seventh and even the ninth century before Christ, possessed a system of commercial instruments, which included promissory notes, bilk of exchange, and transfer checks, not unlike the modem bank check. As this system was in operation before the use of coined money, these documents usually stipulated for the payment of a given weight of silver or copper. They were not inscribed on paper, but on small clay tablets about the size of a piece of toilet soap. After the contract had been written in the soft earth, it was baked so as to render it unalterable and indestructible. Such a form of paper naturally could not be subjected to indorsement or acceptance like modem commercial paper; but this defect was supplied by the presence of witnesses, usually having a religious or legal authority. The original was placed for saf e-keqping in either the temple or the record room of the city, inclosed in a clay envelope or case, while copies went to one or both of the contracting parties.^

Banking flourished in ancient Greece and Rome, though it was not a patrician calling. It exercised nearly all the fundamental functions of later banking, except the issuance of circulating notes. Deposits, payable on demand or at a stipulated time, were received. Sometimes interest was paid on these deposits. Bankers derived most of their profits from the lending of money at a high rate. They also engaged in the exchange of foreign money for that of Athens and Rome, and in the buying and selling of bills of exchange. Many complained of the high rates of interest, but bankers declared that they had to charge high interest in self-defense, because of the defective laws,

^ Charles A. Conant, A History of Modem Banks of Issue, p. 1. Mr. Conant gives the best account of the history of banking on the market.

It is a fantastic and grotesque picture which one gets by mentally comparing the ancient Assyrian with a twentieth-century New Yorker. Say " Presto ! " and suddenly discover yourself an interested onlooker in the capital of some old potentate like Tiglath Pileser II about three thousand years ago. Go into one of the Oriental, square, stone houses and see the lender and the borrower. The lender is clothed in shabby pale-yellow robes, unfaced and, alas, unwashed. His beard is that of Shylock and of every usurer who ever lived. He stands weighing out small blocks of silver to an anxious, nervous little fellow, type of the perennial money-borrower. Now, see the skillful fingers of Shylock guiding his cuneus through the wet clay. "Put the note on in two layers for safety," suggests little Lamb, and Shylock glares. Several funereal figures in spotless white have hovered silently by all the time. See them step up, examine the tablet, verify the weight, accept a cash offering for the gods from little Lamb, and carry away the note to bake it and put it in safe-keeping. Is it possible that the priests and Shylock exchange knowing looks? No matter! Have we changed so much?

which gave debtors every facility for escaping their obligations.

Mr. Charles A. Conant^ has very interestingly pointed out that usurious rates led the plebeians to withdraw to the Sacred Mountain in 494 B.C. and to the Janiculum in 278 B.C. This, however, does not seem to have been the fault of the regular money-lenders at Rome, but of the patricians in their business intercourse with the plebeians. The evolution of banking at Rome was the same as everywhere else. "The argentarii (Roman bankers) were first money-changers, then receivers of deposits, then lenders at interest, both of their own money and of that entrusted to them, and purchasers of bills of exchange."

After the fall of the Roman Empire in the West comes a gradual retrenchment of banking poKcy. This was a natural consequence upon the upset economic and trade conditions. Banking, even as it was known then, was dependent upon commerce. Chaos followed the conquest; the arteries of trade, the magnificent Roman military roads, fell into neglect, became infested by robbers, and were Kttle frequented. Secondly, the predatory character of the unsettled and low-rumbling centuries, known as the "Dark Ages," rendered private property unstable; hence did away with credit security. These conditions inevitably drove metaUic money to shelter. Therefore, we find a financial stagnation and chaotic situation in matters of banking until about the year 1100, when, with apparent suddenness, one encounters

* Charles A. Conant, A History of Modem Banks of Issue. Mr. Conant cites Gustave Cruchon, Les Banques dans VAntiquiU.

a reawakening of interest in co5peration and institutions.

Now, when banking does revive in western Europe, it is seen undergoing the same process of evolution which took place in Assyria, Greece, and Rome. It began with the money-changers. Many people have called the famous "Bank of Venice" (1171) the first modem bank; but it exercised none of the modem bank's functions. It is thought that the word "bank" in this case simply refers to two forced public loans, which gave rise to this institution as a convenient method of repayment.^

Modem banking, however, may be more directly traced to the money-lenders of Florence, who flourished with a high reputation in the thirteenth century. In the fourteenth centiuy occurred the failure of two of Europe's greatest bankers, and for a time there was widespread distrust of the growing profession. But bankers had so far recovered lost groimd that as early as the first generation of the fifteenth century there were eighty banks in Florence, although none were under state control.

There has been a violent dispute as to the derivation of the word "bank" as we know and use it. Some have contended with much speciousness that oiur word comes from the Italian "banco" meaning "bench," and refers to the boards which the money-changers of mediaeval Florence used as counters. These show that when a money-lender failed, his bench was broken in

^ It must be noted in a moment that the Bank of England originated in a somewhat similar way.

token of hi? disgrace. Hence, from the words "banco" and "rotto," "to break," we get our word "bankrupt." Another faction contends, with perhaps even more speciousness, that they have no reference to benches, but mean "public loans," a German word having been substituted for the Italian.^

Toward the end of the sixteenth century bankers began to issue promissory notes payable to bearer, which passed from hand to hand and had a limited circulation. The institutions putting such notes into circulation earned the name of banks of issue. In comparatively recent years.

M

^ Charles A. Conant, A History of Modem Banks of Issue, p. 8: The word 'bank' is derived from the public loans, made by Italian towns, rather than from the business of banking as understood in later times. The usual Italian word for a public loan was 'monte/ meaning a joint-stock fund. The Germans, who were influential in the Venetian forced loan of 1171, had a word for joint-stock fund, 'banck,' which meant a heap or mound. This the Italians converted into 'banco * and used for an accumulation of either stock or money. The word was later adapted for English usage with the indifferent meaning of public loan or stacks of money. Benbrigge, in 1646, speaks of the 'three bankes' of Venice, meaning the three public loans or 'monti.' The issue of paper money directly by the state was spoken of as raising a ' banke ' in colonial days in Massachusetts, the word ' bank ' standing for the money rather than the institution."

Henry D. MacLeod, The Theory and Practice qf Banking, vol. I, p. 259: " It is popularly supposed (Gilbart*s Practical Treatise on Banking, vdl. i, p. 1) that the word Bank comes from the Italian word banco, a bench or table, because the mioney-dealers or money-changers kept their money piled on benches or tables, whence it is said they were called hanchieri. . . . Nevertheless, there can be no possible doubt but that this derivation is a pure illusion; for the money-changers, as such, were never called banchieri in the Middle Ages."

MacLeod quotes Blackstone as follows: "At Florence, in 1844, Government owed £60,000, and being unable to pay it, formed the principal into an aggregate sum, called, metaphorically, a Mount or Bank"

however, it has come to be more and more generally believed that the issuance of circulating notes should fall within the province of the Government, or at least of banks under state control.

Among the very earUest of these banks of issue was the Bank of Amsterdam, which in the seventeenth centiuy received deposits of gold or silver bullion, for which it ii^sued certificates or receipts. These receipts passed from person to person and served as a somewhat rude circulating medium. They were redeemable at the bank in the metal which they represented through the payment of a small premium.

This very famous bank was formed in 1609 imder the direction of the dty and was governed by a secret municipal conmiittee- It was ostensibly founded to remedy the chaos which prevailed in the city at the time on account of sharply competing money-receivers and on account of the confused coinage. Persons were forbidden, by city ordinance, to place their money in the hands of any deposit-receiver save their personal agents. All bills of exchange were required to be negotiated through the new bank. The bank professed not to lend, but to retain in its cofifers the actual money deposited, charging a small percentage for safe-keeping. These deposits were represented by receipts which were transferable. Later, the bank accepted deposits of foreign coin at their intrinsic value and issued receipts payable in "gulden." Upon this professed basis the bank had a long and prosperous career. However, it had actually violated its charter within a halfcentury after its foundation by allowing considerable overdrafts, and in the eighteenth century it extended huge loans to the Dutch East India Company. The depositors learned of this in 1790, and in 1794 discovered that it could not pay its liabilities. Its notes fell from a premium of five per cent to a discoimt of sixteen per cent. It was govemmentally dissolved in 1819, and its place was taken by the Bank of the Netherlands, founded in 1814.

Banking methods seem to have been introduced into England in the seventeenth century by London goldsmiths, who probably borrowed them from the Dutch. It is related that the goldsmiths or "new-fangled bankers," as they were called, soon gained such a foothold that they were able, at considerable profit to themselves, to supply Cromwell with f imds in advance of the revenues. At the time, one Sir Josiah Child violently attacked the new profession, though, curiously enough, he later became a banker himself, and his firm, with one other, are the only private houses still in existence which were established earlier than the Bank of England.

The Bank of England was organized in 1694 for the purpose of extending a loan of £1,200,000 to the Government for public service. The subscribers to this f imd were to receive eight per cent per annum as interest, and £4000 per year as running expenses for the bank. How this institution has developed into the greatest financial agency in the world, controlling the discoimt rates of every English banking house and setting the foreign exchange rate, will be spoken of from time to time in the following chapters.

In 1619 the Bank of Hamburg, Gennany, was formed on the same principles that the Bank of Amsterdam professed. It had good management throughout. In the different German States, banks were formed from time to time under their own peculiar laws. In 1876 the Imperial Bank of Germany (the "Reichsbank") was authorized, which is the bank of Germany to-day.

At present there are about one hundred and forty banks doing business in Germany aside from the government banks. For it must not be thought that the "Reichsbank" is the only government bank in the empire, though it is imdoubtedly the controlling financial agency. The five banks having the right of uncovered note issue, with the amounts permitted to be issued, are : —

Imperial Bank of Germany $115,000,000.00

Bank of Saxony 4,000,000.00

Bank of Bavaria 8,000,000.00

Bank of WUrttemberg 2,500,000.00

Bank of Baden g,500,000.00

$132,000,000.00

About a century after the founding of the Bank of Hamburg, — 1716, to be exact, — John Law organized the Banque G6nerale in France. It was favored by the Government and seemed to have in store a promise of financial and economic stimulation. But Law undertook to affiUate it with his gigantic "Ocddental" schemes, and in 1718 found it necessary to ask for governmental aid. The institution became known in that year as the Banque Roy ale; its notes were guaranteed by the king. But Law's "Mississippi scheme" was too much, and though advantages were oflFered to those who paid taxes in bank bills^ and though cash money was forbidden, confidence so fell that in 1721 the bank was closed, through the influence of Paris-Duvemey, Law's bitterest opponent. In 1767, under the eminent economist, Turgot, the bank was revived and existed on a pretty soimd basis till it became involved in the issuance of assignats during the Revolution and was closed by the Convention in 179S.

No financial institution was again attempted until 1800, when Napoleon founded the present Bank of Prance. A solid foundation was not secured until 1806. Its capital at first was 80,000,000 francs. It made large loans to the Provisional Government and to the city of Paris in 1848, and was near failure. But the Government came to the rescue, allowing it to stop cash payments and declaring its notes legal tender.

For nearly fifty years the Bank of Prance was only one of a number of banks having a note issue. Until 1848 departmental banks of issue existed. These, however, and the Bank of Savoy were absorbed by 1868; since then, the Bank of Prance has been supreme. Its capital at the present time is 182,500,000 francs, held by about 30,000 shareholders, of whom about 10,000 do not own more than one share. It has had a vigorous administration and is to-day one of the best regulated financial institutions in the world. It has one hundred and eighty-eight branches {comptoirs) and two hundred and seventy-nine agencies. Every class has derived benefit from this bank, but none more than have the agriculturists. This is because the bank accepts bills as low as $1

WHAT IS A BANK? IS

and loans as low as $50. In 1906, it discounted $2,600,000,000 in bills and loaned $500,000,000 on securities. Three names are usually required on bills. This bank's deposits are comparatively small, being only $175,000,000. But it has an enormous note issue — $900,000,000 in 1906. In its vaults (1906) it had $575,000,000 in gold and $200,000,000 in silver. On account^ of its large cash reserve, it can keep discount rates at a rather uniform level. From 1900 to 1906 the rate (3%) did not change. Bank of France notes are more popular as exchange than checks.

With regard to the banking history of the United States, only a few words are necessary here. Before 1776 tliere was very little attempt at banking for commercial purposes. Many crude attempts were made, but mainly for the issuance of paper money. However, in 1740, this was stamped out by the extension of the "Bubble Act" to the colonies. The first real bank was an institution organized by the citizens of Pennsylvania to supply the patriot army with rations. Its bills were not more than promissory notes, signed and warranted by the bank's founders. These were supposed to be guaranteed by government bills on American citizens abroad for $750,- 000. It is doubtful, however, if they could have been n^otiated. The attempt was not made.

In 1781, Congress authorized William Morris to organize the Bank of North America at Philadelphia. It took over the business of the Bank of Pennsylvania. There was so much doubt as to the right of Congress to carry on a banking business that the institution was incorporated under the laws of Pennsylvania, and so continued until 1863, when it became a national banking association.

In the year 1791 the Bank of the United States, with a capital of $10,000,000, was chartered by Congress.^ The United States Government bought one fifth of the stock. Notwithstanding its government patronage, a number of state banks sprang up. But by its superior capital and several branches, the Bank of the United States dominated the finances of the country. It refused deposits of notes of banks which it considered imsound, and thus tended to keep down "wild cats."

In 1811 the charter expired and no vigorous efifort was made to renew it. In 1816, however, it was renewed with a capital of $35,000,000, of which the Government took $7,000,000. President Jackson, by his veto of the second renewal charter in 1832, practically crushed the bank.

Prom that time state banks sprang up with great rapidity, so that in 1837 there were 634 of them with a capital of $291,000,000, of which $149,000,- 000 was in circulating notes and $127,000,000 in deposits. Loans and discoimts amoimted to $525,- 000,000. The enormous crop of cotton in 1836 and the subsequent fall of prices came as a beginning of the inevitable crash. In 1837 there was suspension of cash payments. By strict laws of Congress and the state legislatures, the country nearly recovered by 1844,2