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/ There are ten CHAPTERS and the original press release. Link to them here -- I • II • III • IV • V • VI • VII • VIII • IX • X • press release
CHAPTER VIII of "A Primer On Money" / continue to Chapter IX
HOW THE FEDERAL RESERVE GIVES AWAY PUBLIC
FUNDS TO THE PRIVATE BANKS
Private banks enjoy a very special relationship ‘with the Federal Government. After all, most business firms employ private capital or privately owned resources to produce a product or provide a service which can be profitably sold in the marketplace. Most business firms pay for the raw materials and services they receive, and, furthermore, in the case of most kinds of business firms, the business itself is a risk-taking venture. The firm succeeds or fails in competition with other business firms.
But the conditions under which private banks operate are very different. In the first place, one of the major functions of the private commercial banks is to create money. A large portion of bank profits come from the fact that the banks do create money. And, as we have pointed out, banks create money without cost to themselves, in the process of lending or investing in securities such as Government bonds. Bank profits come from interest on the money lent and invested, while the cost of creating money is negligible. (Banks do incur costs, of course, from bookkeeping to loan officers’ salaries.) The power to create money has been delegated, or loaned, by Congress to the private banks for their free use. There is no charge.
On the contrary, this is but one of the many ways the Government subsidizes the private banking system and protects it from competition. The Government, through the Federal Reserve System, provides a huge subsidy through the free services the System provides for member banks. “Check clearing” is one of the services; i.e., the collection and payment of funds due one bank from another because of depositors’ use of their checkbook money. The costs of this service alone runs into scores of millions of dollars.
The gross expenses of the combined Federal Reserve banks totaled $207 million in 1963, most of which was incurred as a cost of providing free services to the private banks. Other Federal agencies also receive services from the Federal Reserve. But these are not free. The System received about $20 million for “fiscal agency and other expenses” in 1963.
In addition, the Federal Government provides private banks with a large measure of protection from competition, and the hazards of failure.
For example, when a group of business people wish to enter the banking business by opening a national bank, the Federal officer in charge of such matters will not issue a charter, or license, before his office has made studies and surveys to determine whether the proposed bank meets certain “standards.” One “standard” is that the Comptroller of the Currency must be satisfied that (a) the new bank will succeed, and that (b) it is not likely to cause any already existing bank to fail, or even to “weaken” substantially any already existing bank. This means, in brief, that nobody can enter the banking business by opening a national bank, unless the proposed bank is to be located where it will not cause an inconvenient amount of competition to other banks already in business.
If a group wishing’ to enter the banking business is refused a national bank charter, the group may, of course, apply to State banking authorities for a charter to be a State bank. But State banking boards are pretty much like the Comptroller of the Currency: they tend to make sure that a new bank will not encounter strong enough competition to weaken itself or weaken the banks already in business. As a practical matter, it is almost impossible to enter the banking business and attract depositors unless the bank can obtain deposit insurance from the Federal Deposit Insurance Corporation. Not many depositors are willing to keep funds in banks without FDIC insurance. The Federal Deposit Insurance Corporation is, of course, another Federal agency. So, in practice, even where a State banking authority is willing to issue a charter for a new State bank, a Federal agency has the last word regulating “undue” competition. People who go into the grocery business, or the farming business, or almost any other kind of business, enjoy no such protection from competitors coming in and taking over a share of their market, or even squeezing them out of business.
Federal law provides the banking business with still another kind of protection from competition. This is the Federal law which makes it unlawful for most banks to pay their depositors any interest on demand deposits. Before this law was passed, commercial banks used interest payments to compete for demand deposits specially those of large accounts, and these depositors tended to move their checking accounts to the bank paying the highest interest rate. Aside from subsidies and :protection against competition, the Government nourishes the banks ill a third way, through FDIC insurance. Because of this insurance, many depositors are willing to leave funds in the bank, which they would otherwise hoard in lockboxes or in other places outside the banks. The existence of this insurance means, then, that a larger portion of the money supply at any given time is in the form of bank deposits and a smaller portion is ill the form of currency and coin than would otherwise be the case. Money in the form of currency and coin makes no profit for the bank, but money in the form of deposits does.
And then, of course, there are the indirect subsidy features of the FDIC program explained in the last chapter: insufficient premiums, free recourse to the Treasury for $3 billion and the general protective umbrella provided by the Government’s ultimate backing. Why all this direct Federal aid to the private commercial banks ~ Does this result from a self-assumed obligation to assure profits for the bank ~ Not at all. The primary purpose of the aid is to assure the general public good banking services and a good money system, both of which are recognized as indispensable to trade and commerce in a modern economic system. True, bank profits for the bankers are necessary for a good banking system. But bank profits are only a means toward furthering the general public interest.
Now the real question arises. The supply of money in existence at any particular time is created in part by the Government, and in part by the private banks. The Federal Reserve decides---within broad limits fixed by law -- what portion of a gIven money supply It WIll Itself create, and what portion it will allow the private banks to create. How the portions are divided is important -- it means billions of dollars. For whatever money the private banks create, they obtain interest bearing assets. They make their profits from this interest. The same is true of the Federal Reserve System. The larger the portion of the money supply it creates, the more. Interest-bearing assets it acquires (in the form of Government securIties) and the more interest It collects. Ultimately, this interest, over and above the Federal Reserve’s expenses, is returned to the Federal Treasury and is used to pay expenses which the taxpayer would otherwise have to pay.
The Federal Reserve, then, is faced with any number of choices about how to proceed in changing the money supply. Indeed, even without changing the money supply, the Federal Reserve is always capable of altering the percentage of the existing money supply supplied by itself and the private banking system respectively, as the example in chapter III illustrated. In other words, the Open Market Committee and the Board of Governors are continually making decisions about how they wish the earnings associated with the manufacture of money to be divided between the Treasury and the private banks. This involves billions of dollars over any reasonable period of time. (The System’s income from interest on Government bonds was $1.1 billion in 1963 alone.) And in recent years the System has, regrettably, been following a policy which has given away billions to the private banks.
Is there an example of the Federal Reserve’s allowing the private banks to create all the money needed to increase the money supply?
Yes, there are many examples. Here is one. In the early part of 1958 the Federal Reserve decided to allow the private banks to increase the money supply by approximately $10 billion. It did this by lowering reserve requirements. The stated purpose at the time was to make it possible for the banks to make more loans to business, because in that period, business was suffering from a severe recession. In fact, however, the private banks used all of this new money-creating power to acquire an additional $10 billion of Government securities. Their loans to business and consumers actually went down between the end of 1957 and the end of 1958, when their holdings of Government securities went up by $10 billion.
Why was the $10 billion giveaway in 1958 bad?
Because the Federal Reserve could have itself created the $10 billion of money by purchasing Government securities. (And by raising reserve requirements by the appropriate percentages, there would have been no further private bank-created increase in the money supply.) Since this was the only purpose for which the money creating powers were used, the general public would have been better off if the Federal Reserve had created the money and acquired this amount of Government securities. Since the interest on Government securities which the Federal Reserve already owns is more than enough to pay its operating expenses, all of the interest payments on the extra $10 billion of Government securities would have gone back into the Treasury instead of into bank profits.
Did the banks need the increased profits which they obtained from the 1958 giveaway?
No. Although almost all other kinds of business were suffering from the recession and several million families were suffering from unemployment, bank profits had gone up-not down. Under the high interest policy of the decade of the fifties, bank profits jumped higher and higher each year.
Furthermore, most of the $10 billion giveaway went to only a few very big banks, who were already enjoying extremely high profits. Almost one-fourth of the $10 billion went to 18 big banks in New York City. Only 2 percent of all the banks in the country received about three-fourths of the whole $10 billion.
Another example: The bond giveaway bill. The bond giveaway bill was introduced in Congress in 1959 to carry out a plan recommended by the American Bankers Association. The intention was to transfer $16.8 billion of Government securities from the vaults of the Federal Reserve ‘banks into the hands of private bankers. The bill was generally referred to by the bankers as the “vault cash bill.” While the bill did have something to do with vault cash, this was a very minor feature, and the term “vault cash bill” was thus very misleading.
What happened to the bond giveaway bill?
Urged by the Federal Reserve as well as the ABA, Congress passed the bill, giving the Federal Reserve the authority to do practically everything the bankers asked, including the $16.8 billion giveaway. Rut in passing the bill, several Members of Congress in charge of the legislation made statements for the record indicating that it was not the intent of Congress that the Federal Reserve use this authority to give away any large amount of Government bonds.
How was the bond giveaway to be carried out?
According to the plan recommended in a report made by the Economic Policy Commission of the American Bankers Association to the Federal Reserve System, the Federal Reserve was to lower reserve requirements of the member banks, and, simultaneously, “sell” vast quantities of the Government securities which it then owned. The proposed process was to be carried out “gradually” over a period of time, to be completed by mid-1962. By then, according to the plan, the Federal Reserve would have owned $16.8 billion less in Government securities, and the private banks would own $16.8 billion more, than would have been the case if Reserve requirements were left at their already-existing levels. In other words, reserve requirements in effect at the time this plan was advanced meant that as the Federal Reserve expanded the money supply, it would, itself, create $1 of new money for each $5 of new money created by the private banks. The American Bankers Association plan was one which would allow the private banks to create about $12 of new money for each $1 created by the Federal Reserve.
The $16.8 billion of Government securities which were to be given to the private banks consisted of two parts: one, $9.8 billion of Government securities which the Federal Reserve had already acquired and owned as of mid-1956; second, $7 billion of Government securities which the Federal Reserve would be expected to acquire, by mid-1962, to permit normal increases in the money supply, at the old l-to-5 division of the money-creating powers then prevailing. How did the bankers explain the intended effects of their proposal’! Speaking of the $9.8 billion of Government securities which the Federal Reserve already owned, the report of the ABA Economic Policy Commission said:
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If the Commission’s proposals were in effect at the present time * * * required reserve balances that member banks must maintain at the Federal Reserve banks would be $9.8 billion lower (53 percent lower) than their actual current level. (ABA’s report, p.26.)1
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Of course, if the required reserve balances maintained by member banks at the Federal Reserve for a given total of deposits outstanding are to be lowered by $9.8 billion, the Federal Reserve would have to sell $9.8 billion of Government securities to extinguish the now excess reserves. Otherwise the $9.8 billion in unneeded reserves credited to the banks would be used to increase the money supply. And, when the Federal Reserve sold these securities, the bulk would go into the hands of the private banks.
Speaking of the additional $7 billion of bonds which the Federal Reserve could be expected to acquire by mid-1962, if the bankers’ plan were not put into effect, the ABA report said:
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Looking ahead, it is clear that the needs of the public for currency and bank deposits will increase with the growth of the American economy. To meet these needs, it will be necessary to expand the reserve base of the banking system either by creating more reserves through open·market operations or by reducing reserve requirements.
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To be more specific, if past relationships between production, currency, and deposits are approximated in the future, then over the next 5 years demand deposits will increase by something like $20 billion, time deposits by about $12 billion, and currency in circulation by more than $3 billion. If such an expansion were to be met without reducing reserve requirements, it would be necessary to supply the banks with about $7 billion of additional reserve balances by means of open-market purchases of Government securities by the Reserve banks.
It would be far better to provide for this growth by lowering the reserve requirements of member banks over the coming years. (ABA’s report, pp. 12 and 14.)”
Why did the bankers want to take $16.8 billion of Government securities out of the vaults of the Federal Reserve?
The report of the American Bankers Association has this to say:
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There seems to be considerable agreement that the Federal Reserve banks should work toward a reduction of their enormous holdings of Government obligations. At the present time the Reserve banks hold about $24 billion of Governments, an amount far in excess of their needs either for earnings or for credit control.’
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• Congressional Record. July 1, 1959, p. 12507.
• Congressional Record, July 1, 1959, p. 12514.
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But who was in “considerable agreement”? And why was it “far better” to lower reserve requirements 1 And by what measure are the Reserve’s holding of Government bonds “enormous” ?
The bankers were undoubtedly in considerable agreement with each other about all these matters. Why not ~ They were proposing to fleece the other taxpayers out of $16.8 billion of their property. What did the bankers say about the effect of their plan on the taxpayers?
The ABA report had this to say:
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It is true that the Government would lose a small amount of revenue, since about 90 percent of the Reserve banks’ annual earnings after dividends are now being voluntarily paid over to the Treasury. However, the Reserve banks were never intended to be a source of revenue to the Government, and policy regarding the level of required reserves should certainly not be determined on the basis of the effect on Federal Reserve payments to the Treasury.’
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In other words, the bankers considered that several hundred million dollars per year in interest payments on this enormous Government debt is only a “small amount of revenue” for the Government (though obviously an enormous increase in profits for the banks).
What did the Federal Reserve authorities do to protect the public property against the proposed raid by the bankers?
One might think that public officials charged with the protection of public property in their custody would have locked their vaults and hollered for help when they received this report from the bankers, proposing a gigantic raid on the Federal Reserve’s vaults. Instead, however, the Board of Governors of the Federal Reserve System endorsed the bankers’ plan with slight modifications, and urged Congress to pass a bill necessary to carry out the plan. The top officials of other Federal banking agencies, including the Comptroller of the Currency, also
endorsed the plan and urged Congress to approve it.
Were the Federal Reserve officials aware of what the bankers’ plan would do?
Yes. The staff of the Federal Reserve Board made a report on the bill which the Federal Reserve urged Congress to pass, and the Board of Governors submitted this report to the Committees on Banking and Currency of the Senate and the House. This report declared that the bill would improve the earning position of banks and aid them in building up their capital positions. ... ... * (Member Bank Reserve Requirements, hearings, Apr. 7, S, 9, 1959, p. 2S.)
This report explained further that:
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To the extent necessary to avoid undue credit expansion, reserves released by any reduction in requirements could be absorbed by Federal Reserve sales of securities in the market. This would in effect shift earning assets from Federal Reserve banks to member banks. The present System portfolio is adequate to permit a substantial reduction and still leave enough to provide sufficient earnings to cover necessary expenses as well as for current purposes of policy. [Emphasis added.] In the italicized sentence the Federal Reserve leaves no doubt that it would give the bonds to the member banks.
• Congressional Record, July 1, 19119, p. 12,1)14.
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Was the bond giveaway bill passed into law?
Yes, but only after the House managers of the bill and Chairman Martin disclaimed any intention that the authority being conferred would be used to give away or otherwise transfer any of the Federal Reserve’s holdings of Government securities. The House conferees’ report of the House stated:
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• • • it is not the intent of this legislation to encourage or cause the Federal Open Market Committee to reduce the Federal Reserve System’s holdings of Government securities.
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This statement of legislative intent is directly opposed to the original purpose of the bill, as conceived by the ABA.
Does the law as it passed give away any Government securities?
Yes. The Federal Reserve now permits private banks to use $2.6 billion of vault cash as reserves. This is the same as lowering required reserves by this amount and letting the banks create money which they may use to buy bonds if they desire. On the basis of the vault cash banks create absolute $15 billion of new deposits and may buy Government securities if they desire. The expansion of the money supply that occurred from mid-1960 to date (mid-1964) was partly fueled by the use of vault cash as reserves and partly by Federal Reserve purchases of Government securities. If the law had not been passed the Federal Reserve would have had to purchase still additional securities to have increased the money supply by the amount it did.
Is it desirable to give $15 billion of bonds to private banks?
No. They already receive almost $2 billion a year in interest from the Government; a $15 billion giveaway would increase these receipts by over a half-billion more. During the Eisenhower administration, reserve requirements were reduced nine times and the banks profited greatly. Reserve requirements should now be raised, and more bonds should go to the Federal Reserve, not the private banks.
Do private banks perform a service for the Government in buying Government bonds?
No, because they create money, which, in the last analysis, is an obligation of the Government to buy Government bonds, issued on the Government’s credit. There is no risk involved. When private banks lend to private firms or individuals, they do perform a service because they are lending on the credit of an individual or firm. And they are allocating credit where it is most needed to nourish the private economy.
Could the Federal Reserve reduce its holdings of Government securities? Yes. The Federal Reserve now owns about $33 billion in Government securities, but Federal Reserve officials have testified that they could get along on substantially fewer bonds than they now have. It is reasonable to believe that $15 billion of securities would be sufficient.
How should the Federal Reserve reduce its holdings?
Fifteen billion dollars of Government securities should be transferred from the Federal Reserve to the Treasury. This debt should then be canceled. This would reduce the public debt by $15 billion and reduce annual interest on the public debt by over a half-billion dollars.