94th Congress JOINT COMMITTEE PRINT THE FEDERAL RESERVE SYSTEM A STUDY PREPARED FOR TILE USE OF TIIE JOINT ECONOMIC COMMITTEE CONGRESS OF THE UNITED STATES CONDUCTED BY Hon. WRIGHT PATMIAN The Late Vice Chairman of the Joint Economic Committee JANUARY 3, 1977 Printed for the use of the Joint Economic Committee U.S. GOVERNMENT PRINTING OFFICE 77-752 WASHINGTON: 1976 For sale by the Superintendent of Documents, U.S. Government Printing Office Washington, D.C. 20402 -Price $2.25 Stock Number 052-070-03861-6 JOINT ECONOMIC COMMITTEE (Created pursuant to see. 5(a) of Public Law 304, 79th Cong.) HUBERT H. HUMPHREY, Minnesota, Chairman RICHARD BOLLING, Missouri, Vice Chairman SENATE HOUSE OF REPRESENTATIVES JOHN SPARKMAN, Alabama HENRY S. REUSS, Wisconsin WILLIAM PROXMIRE, Wisconsin WILLIAM S. MOORHEAD, Pennsylvania ABRAHAM RIBICOFF, Connecticut LEE H. HAMILTON, Indiana LLOYD M. BENTSEN, JR., Texas GILLIS W. LONG, Louisiana EDWARD M. KENNEDY, Massachusetts OTIS G. PIKE, New York JACOB K. JAVITS, New York CLARENCE J. BROWN, Ohio CHARLES H. PERCY, Illinois GARRY BROWN, Michigan ROBERT TAFT, Ja., Ohio MARGARET M. HECKLER, Massachusetts WILLIAM V. ROTHI, Ja., Delaware JOHN H. ROUSSELOT, California JOHN R. STARK, Executive Director RICHARD F. KAUFMAN, General Counsel ECONOMISTS WILLIAM R. BUECHNER ROBERT D. HAMRIN PHILIP MCMARTIN G. THOMAS CATOa SAaAH JACKSON RALPH L. SCHLOSSTEIN SLATER WILLIAM A. Cox JOHN R. KARLIK COUaTENAY M. LucY A. FALCONE L. DOUGLAS LEE GEOaGE R. TYLER ARTHUR J. KEEFFE, ProfessionalStaff Member, Subcommittee on Economic Progress MINORITY CATHERINE MILLER CHARLES H. BRADFORD GEORGE D. KaUMBHAAR, Jr. M. MARK R. POLICINSKI (II) Property of the Joint Economic Committee- Democratic Staff G-01 Dirksen Senate Office Bldg. LETTER OF TRANSMITTAL DECEMBER 28, 1976. To the Members of the Joint Economic Committee: This study of the history of the Federal Reserve System, in its way, is an epitaph to a charter member of the committee and one of the most public interest minded Members of Congress, the late Representative Wright Patman, who died March 7,1976. It is the last project in his long effort to convince the Congress and the American public that a stable, full employment economy requires meaningful reform of the Federal Reserve System and Federal bank regulatory agencies. To this end the study and the accompanying docu- ments, herewith transmitted to members of the committee, reflect his commitment to "educate" his colleagues and the people throughout the Nation about the Federal Reserve System, how and why it came to be formed, the way in which it functions, the crucial effect its activities have on our economy, and its relationship to the American banking industry and other financial institutions. In essence, the study is a final demonstration of Wright Patman's unswerving faith in our democratic system and the people of the Na- tion. He never doubted that the American public would demand change if it was armed with the facts. As a result, he devoted much of his career, both as chairman and vice chairman of the Joint Economic Committee and later as chairman of the House Banking and Currency Committee, to sustaining a public dialog concerning the intricacies of the Federal Reserve and the significance of its monetary policies to the welfare of the Nation. The core of his concern with the Federal Reserve System was the way in which its monetary policies affect the availability and cost of credit to "the common people-the little people who go out and fight for the Nation during time of war and build it up in peacetime." Many of us who served with him on the Joint Economic Committee, which was established by legislation which he cosponsored, can still hear him lecturing the Federal Reserve on the relationship between monetary policy and interest rates which "affect the price of groceries on the shelf" and all other products and services which are essential to the working people of the Nation. In this respect he was convinced that establishment of a "good. re- liable source of funds at reasonable cost" is essential to meeting the Nation's priority needs-soiving the country's chronic low- and mod- erate-income family housing problems, providing State and local gov- ernments with the resources to finance vital public works and facilities and assuring that small business achieves and sustains a position of real competitive strength in the market place. As chairman of the Subcommittee on Economic Progress of the Joint Economic Committee. Mr. Patman authorized and personally di- (QID) IV rected this detailed study of the Federal Reserve, which was conducted bv Prof. Arthur Keeffe. The project was still underway at the time of Air. Patman's death. Professor Keeffe completed the research then underway, carrying the history of the agency from its inception in 1913 through the mid-1960's. It is hoped that at some future date the coin- inittee will be able to undertake additional research which will com- plete this historical record of the Federal Reserve. Among other things the study chronicles the special session of Con- gress which adopted legislation establishing the Federal Reserve Sys- tem, how the Federal Reserve banks were organized, how the New York Bank came to occupy its prominent position in the System, the organization and operation of the Open Market Committee, the legis- lation of 1933 which altered, the structure of the System, the removal of Federal Reserve Board Chairman Marriner Eccles by President Tru.- man, and the battle between President Johnson and Federal Reserve Board chairman William McChesney Martin over monetary policy. There follows an appendix which includes correspondence and speeches by AIr. Patmnan dealing with operations of bank holding coin- panies, bank disclosure, the adequacy of bank regulation in connection with the failure and subsequent sale of the Franklin National Bank, the advisability of allowing foreign branches of U.S. banks to underwrite securities while they are prohibited from doing so domestically, the controversial Federal Reserve monetary policy actions which resulted in expanding the money supply while President Nixon was running for reelection in 1972, and the restrictive monetary policy adopted by the Federal Reserve in 1975 which ran counter to the tax reductions voted by Congress in that year. The appendix is hiighlighted by two well-known law review articles by Air. Patman, "The Federal Reserve Svstem: A Brief for Legal Reform," and, "What's Wrong WVith the Federal Reserve System and *What To Do About It." These two articles present the basic rationale articulated over the years by Mir. Patman for meaningful reform of the Federal Reserve System-proposals whiclh, thanks in large part to his determined efforts, have in some instances finally been moved to the forefront of congressional consideration. The reforms proposed by Air. Patman include: 1. Reducing the terms of Federal Reserve Board members from 14 to 5 years and making the term of Board Chairman coterminus with that of the President to help assure that monetary policy con- forms with fiscal policy. 2. Canceling all but $10 billion of the $82 billion in Federal securities held in the Federal Reserve's open market trading port- folio and requiring the System to operate on appropriated funds, thus making it totally accountable to Congress and the administra- tion for itk policies and activities. The $10 billion remaining in the portfolio would be sufficient to implement monetary policy decisions. 3. Requiring the Federal Reserve to be subject to full-scale audits conducted by the General Accounting Office. 4. Creating a single Federal bank regulatory agency to per- form the duties that are now performed by the Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insur- V ance Corporation in order to eliminate costly overlapping juris- dictions and contradictory regulatory decisions. It is in his advocacy of reform of the Federal Reserve System that Mr. Patman provided his most valuable service to the Congress and the Nation. No one had equaled the tenacity with which he has en- deavored to rivet national attention on the Federal Reserve Board and the Open Market Committee and tried to hold them accountable to the American people. His work in this field alone has proven to be of enormous importance. It is a source of both pride and pleasure for me, as chairman of the committee, to see the publication of this study. It conveys information of lasting value and it traces dramatic chapters in the congressional career of a man whose place in history as one of the Nation's most dedi- cated public interest champions is secure. Arthur John Keeffe, of the JEC staff took major responsibility for the preparation of the manuscript with the assistance of Jane D'Arista of the staff of the House Banking and Currency Committee. The fol- lowing also provided research and editorial assistance: Robert Abrams, Dennis Braddock, Madelon Campbell, John Cummins, Adele Geffen, Eric Gressman, Faith Grossnickle, Harry Jorgenson, Francine Kush- ner, Peter Lahey, William Francis Larkin, Robert Lord, Jean Danne- berg O'Malley, John D. Raffaelli, and Paul Tierney. Sincerely, HUBERT H. HiuMiuREY, Chairman,Joint Economic Committee. A CONTENTS Letter of transmittai-------------------------- THE FEDERAL RESERVE SYSTEM I. The Federal Reserve Act of 1913 becomes law-1--------- 1I. The Federal Reserve goes into operation ------------- 25 III. Postwar adjustment, 1919-21 ------------------ 37 IV. How the New York bank came to take over all open market opera- tions---------------------------- 50 V. Monetary policy, 1923-28-------------------- 61 VI. Andrew W. Mellon----------------------- 68 VII. The history of the payment of adjusted-service certificates of World WarnI------------------------ 86 VIII. The Banking Act of 1933-------------------- 96 IX. The Banking Act of 1935-------------------- 113 X. Marriner Eccles before and after F. D. R------------- 128 XI. The disagreement between President Johnson and William McChesney Martin on the Reserve Board's December 1965 decision to raise interest rates…---------------- 137 APPFNDIXES I.