By David Liechty
On December 23, 1913, Congress passed the Federal Reserve Act (ch. 6, 38 Stat. 251) and again fundamentally changed the monetary structure of the United States, creating a mixed public and private banking structure. The Act retained the national banks created under the National Currency Acts of 1863 and 1864, but centralized control of currency issue through creation of the Federal Reserve System.
Under authority of this Act, the Federal Reserve Organizing Committee, composed of the Secretary of the Treasury, the Comptroller of the Currency, and the Secretary of Agriculture, designated twelve “Federal reserve cities”, with corresponding districts, and organized Federal Reserve banks in each of these cities (§2, pp. 251-52). National banks were required, and state banks were allowed, to become “member banks” by purchasing stock in the Federal Reserve bank located in the respective district (§§ 1, 2, 9, pp. 251-52, 259). The Act set a minimum capitalization requirement for Federal Reserve bank operation, and if this was not met through purchase of stock by member banks, sale of additional stock to other private investors was also authorized (§2, p.253). Provision was also made for the United States government to purchase stock to make up any shortfall, but this never became necessary (id.). The Federal Reserve banks were established as (and remain) private banks owned by their respective member banks and other private investors.
The 1913 Act also created a Federal Reserve Board, which included the Secretary of the Treasury, the Comptroller of the Currency, and five additional members appointed by the President of the United States with the advice and consent of the Senate (§10, p. 260). The Act created boards of directors for each of the Federal Reserve banks, also, having six directors elected by the member bank and three appointed by the Federal Reserve Board, with one of the appointed directors designated chairman of the board and “Federal Reserve agent” for the bank (§4, pp. 255-56). Additionally, a Federal Advisory Council was created, comprised of one representative chosen by each Federal Reserve bank to act in an advisory capacity to the Federal Reserve Board (§12, p. 263).
One significant change in the monetary system introduced by the 1913 Act involved the specific backing for bank notes issued into circulation. The 1863 and 1864 National Currency Acts required national banks to purchase Treasury bonds using gold and to deposit these bonds with the Treasury as security for national bank notes printed by the Comptroller of the Currency (Act of 3 June 1864, ch. 106, §§ 21, 23, 13 Stat. 99 at 105-106). The 1913 Act reassigned this mechanism for issuance of bank notes to the Federal Reserve banks and expressly stated that the notes thus obtained were obligations of the banks receiving them (§§4, 18, 38 Stat. at 254, 269). Provisions in the 1913 Act allowed national banks to retire their circulating notes by selling the Treasury bonds securing them, and the Federal Reserve Board could direct Federal Reserve banks to purchase these bonds (§18, p. 268). Federal Reserve banks could then exchange these bonds “bearing the circulation privilege” for other types of Treasury notes and bonds, facilitating a phasing-out of direct issuance of national bank notes (§18, pp. 269-70).
The Act created a second type of notes, Federal Reserve notes, which were expressly stated to be obligations of the United States, redeemable in gold at the US Treasury or in gold or “lawful money” at any Federal Reserve bank (§16, pp. 265). Federal Reserve banks were required to maintain a redemption fund in gold at the US Treasury equal to at least 5% of Federal Reserve notes issued to them, and to replenish this fund as it was used by the Treasury to redeem presented notes (§16, 266). Federal Reserve notes were to be printed by the Comptroller of the Currency, at the expense of the Federal Reserve banks, and held by the Treasury until issued (§16, p. 267). They were given quasi-legal tender status, being “receivable by all … member banks … and for all … public dues” (§16, p. 265).
Under the 1913 Act these circulating notes were obtained by the Federal Reserve banks in a two-part process. First, Federal Reserve banks were empowered to “discount” commercial paper, including US government debt, presented by member banks, at a rate controlled by the Federal Reserve Board, and to purchase this commercial paper (§§13, 14, pp. 263-65). The Federal Reserve bank then presented this discounted paper as collateral, together with an “application” for issue of Federal Reserve notes, to the bank’s Federal Reserve agent (§16, pp. 265-66). The Federal Reserve agent, acting on behalf of the Federal Reserve Board, which had full discretion, decided whether or not to approve the bank’s application, and to what extent (§16, p. 266). If the application was approved, the Board, acting through the agent, would direct delivery of Federal Reserve notes to the Federal Reserve bank (id.).
Under the 1913 Act, this issuance of Federal Reserve notes was a loan secured by the presented collateral on which the Federal Reserve bank would “pay … interest” as determined by the Federal Reserve Board, and which becomes a “first and paramount lien” on the bank’s assets (§16, pp. 266-67). The collateral presented to the Federal Reserve agent was to be “safeguarded” by the Federal Reserve agent according to regulations set forward by the Federal Reserve Board (§11(i) p. 262).
The fractional reserve nature of the banking system was maintained in the 1913 Act, with Federal Reserve banks required to hold only 35% reserves against deposits and 40% reserves in gold against Federal Reserve notes in circulation (§16, p. 266). Member banks, depending on their location with respect to reserve cities, were required to hold reserves of only 5% on time deposits and between 12% and 18% on demand deposits, a portion of which could be held as deposits with Federal Reserve banks (§19, p. 270-71).
These Federal Reserve banks were also empowered by the 1913 Act to purchase and sell commercial paper and gold on the open market, including from foreign sources, to trade in certain US, state, and municipal debt, and to contract for loans of gold (§14, pp. 264-65). The Federal Reserve banks also received deposits from the US government, and acted as its fiscal agents (§§13, 15, pp. 263, 265). Examination of the Federal Reserve banks under the 1913 Act was under the direction of the Federal Reserve Board, with examination of member banks under the direction of the Comptroller of the Currency (§21, p. 271-72).
The 1913 Act created a hybrid public/private system of bills of credit printed and backed ultimately by the United States, redeemed in practice by private banks, issued as loans secured by both private commercial and US government debt, at the discretion of a hybrid public/private board, and with interest rates set by that board. This dual public and private system of banking and money issuance was a significant departure from the arguably wholly-private banking systems of the first and second Banks of the United States, as well as the decentralized national banking system established under the National Currency Acts. It was an especially sharp contrast to the 1792 Coinage Act and that Act’s philosophical basis.
David Liechty is an attorney who is currently studying for a Phd in Constitution Studies. He is interning with Solari this summer.
See Parts (I), (II), (III), (IV),(V), (VI), (VII), (VIII) and (IX)
