Letter to George L. Harrison, Federal Reserve Board of New York, on Financial and Economic Problems.
Dear Mr. Harrison:
The request which I laid before the leading New York bankers last night for cooperation in unity of national action to assure credit security can, in the light of our discussion, be simplified to the following concrete measures:
1. They are to take the lead in immediate formulation of a national institution with a capital of $500,000,000. The function of this institution to be:
(a) The rediscount of bank assets not now eligible in the Federal Reserve System in order to assure the stability of banks throughout the country from attack by unreasoning depositors. That is to prevent bank failures.
(b) Loans against the assets of closed banks to enable them to pay some early dividend to depositors and thus revive many business activities and relieve many families from destitution.
2. It is proposed that the capital be underwritten by the banks of the United States as a national effort, possibly with the support of the industrials. New York being the financial center of the nation must of necessity assume both the initiative and the major burden. The effort should be participated in by the country at large by appropriate organization.
3. As I said last night, we are in a degenerating vicious cycle. Economic events of Europe have demoralized our farm produce and security prices. This has given rise to an unsettlement of public mind. There have been in some localities foolish alarm over the stability of our credit structure and considerable withdrawals of currency. In consequence bankers in many other parts of the country in fear of the possibility of such unreasoning demands of depositors have deemed it necessary to place their assets in such liquid form as to enable them to meet drains and runs. To do this they sell securities and restrict credit. The sale of securities demoralizes their price and jeopardizes other banks. The restriction on credit has grown greatly in the past few weeks. There are a multitude of complaints that farmers cannot secure loans for their livestock feeding or to carry their commodities until the markets improve. There are a multitude of complaints of business men that they cannot secure the usual credit to carry their operations on a normal basis and must discharge labor. There are complaints of manufacturers who use agricultural and other raw materials that they cannot secure credits beyond day to day needs with which to lay in their customary seasonal supplies. The effect of this is to thrust on the back of the farmer the load of carrying of the nation's stocks. The whole cumulative effect is today to decrease prices of commodities and securities and to spread the relations of the debtor and creditor.
4. The only real way to brake this cycle is to restore confidence in the people at large. To do this requires major unified action that will give confidence to the country. It is this that I have asked of the New York bankers.
5. I stated that if the New York banks will undertake to comply with this request, I will seek to secure assurance from the leaders of appropriate committees in Congress of both political parties to support my recommendation at the next session for
(a) The extension of rediscount eligibility in the Federal Reserve System.
(b) If necessity requires to recreate the War Finance Corporation with available funds sufficient for any emergency in our credit system.
(c) To strengthen the Federal Farm Loan Bank System.
[Hon. George Harrison, Federal Reserve Bank, New York City]
Note: George L. Harrison's response, dated October 7, 1931, follows:
Dear Mr. President:
I want very much to thank you for your letter of October 5, which was delivered to me by messenger late that afternoon. The summary which it contained of the request you made to the New York bankers who were present at the meeting in Washington Sunday night was most helpful.
Now that your proposal has been placed before the public in the morning papers, it occurs to me that you might be interested in some short review of the situation as it now stands as we see it.
Immediately after our return from Washington on Monday morning a committee of New York bankers was appointed to consider your proposal. They authorized me late Monday afternoon to tell Mr. Mills (a) that they were prepared to support your suggestion to the bankers of the United States to form a corporation of $500,000,000 for the purpose of making funds available to banks requiring accommodation upon the basis of sound banking assets not now legally eligible for rediscount at the Federal Reserve Banks; (b) that, as requested by you, they would assume the leadership in the formation of such a corporation; and (c) that the twenty four members of the New York Clearing House Association would no doubt agree by the next day to contribute their share by pledging $150,000,000, which is approximately two percent of their net demand and time deposits. This they have since done, as I informed you late yesterday afternoon. You may be interested to know that there has been quite general and enthusiastic support throughout New York to your proposal, not merely as to the formation of the $500,000,000 corporation but also as to the enlargement of the rediscount facilities of the Reserve System; the revival of some such institution as the War Finance Corporation; the strengthening of the Federal Farm Loan System, and your statement regarding a possible reconsideration of inter-governmental debts in the light of present conditions. Their agreement with your program cannot better be illustrated than by the prompt response they have made in the pledge of subscriptions to the new corporation.
You may remember that in your letter you indicated that the corporation should be organized not merely for the purpose of advancing funds to going banks on ineligible assets in order to prevent bank failures, but also to make loans against assets of closed banks. As I explained to Mr. Mills on Monday, the New York bankers' committee felt, and I agreed with them, that it would have been unwise if not impossible to have the proposed corporation undertake the task of making loans against the assets of closed banks as distinguished from the rediscounting of ineligible but sound assets in going institutions. The technical difficulties with respect to disposing of the assets of closed banks as well as the amounts involved made it seem impossible to include in the proposed new $500,000,000 corporation any provision designed to tackle this part of the program. I understood from Mr. Mills that this modification of the proposal, as outlined in your letter to me, was agreeable to you and that, to the extent that this aspect of the problem must be taken care of, it would have to be done independently of the proposed corporation.
We have also made progress in drafting a plan by which the proposed corporation may be quickly organized to function effectively. The proper and expeditious administration of a national institution of such scope may be difficult to insure, but I believe that with the cooperation of the various clearing houses as well as other voluntary associations of banks throughout the country it will be possible promptly and safely to make the funds of the corporation available in the different communities where they may be needed. Obviously, it would be impossible for one central group to determine the needs or to pass upon the merits of the applications of banks in remote sections of the country. This will probably have to be done through some sort of local association of banks which will pass upon the need for accommodation, the merits of assets to be rediscounted, and then jointly and severally guarantee the loan made by the corporation. This, you will remember, was the procedure followed in the flood pool and is somewhat similar to the procedure set up under the emergency Aldrich-Vreeland law.
I feel that your proposal to the bankers on Sunday night was a most constructive and important step in the present emergency. It will do much to provide liquidity for those banks which may need it, and there are perhaps many of them. Unfortunately, however, there are a great many banking institutions in the United States where the difficulty is not one of liquidity but of solvency, solvency which has been prejudiced by the continued depreciation in the value of the bank's assets. In this district, where I happen to be more familiar with the situation than in other sections of the country, the principal cause of bank failures has not been a lack of liquidity but rather insolvency caused by need for a drastic write-off in bond portfolios. In other districts, I understand, many banks are threatened with insolvency because of losses in real estate loans as well as bonds.
So, while the proposed corporation will do much promptly to provide liquidity for certain solvent institutions needing cash, thus avoiding the forced sale of their assets at substantially depreciated values, it will not unfortunately be able to aid materially in improving the banking situation in those districts where the principal difficulty is the threat of insolvency through depreciation of bond or real estate values. The country banks in this district, and I believe it to be the case also in the Boston and Philadelphia districts and perhaps to a lesser extent elsewhere, have their resources very largely employed in bonds. Indeed, outside of half a dozen of our larger cities, nearly fifty percent of the assets of the banks in this district are in bonds. The proposed corporation will be helpful in this situation to the extent that it relieves some of the selling pressure upon the bond market. But if the bond market is not substantially bettered very promptly the country banking situation in this district, and possibly in other districts as well, will still remain a critical problem.
I mention this now only that I might frankly emphasize what appears to be the unavoidable limitations of the proposed $500,000,000 corporation, and the real need for such other prompt action as will tend to enhance the value of assets in banks which are now threatened with insolvency on account of the drastic cut in bond and real estate values.
I have for some weeks surveyed the possibility of a bond pool. Apparently such a pool is not considered practicable or wise even if possible. I am told that it would only be a palliative which might only worsen the situation ultimately unless there is some fundamental improvement in the earning powers of the obligors of the bonds. This is especially true of the railroads. If the Interstate Commerce Commission fails to grant a rate increase it will no doubt, sentimentally at least, have a most reactionary influence upon the railroad bond market and thus largely nullify the immediately favorable response to your announcement this morning. This would no doubt be true, even though there is a growing belief in many circles that a rate increase would probably have relatively little effect upon railroad earnings at the present time. The important objective it seems to me, therefore, is to start some favorable or constructive steps before any unfavorable announcement possibly comes from the Interstate Commerce Commission.
In view of what appears to be the imperative necessity of no further reaction but rather a prompt betterment of the bond market, which is now largely influenced by the railroad bond situation, I cannot avoid the conviction that something must be done and must be done promptly. Whether this should be a rate, increase, wage reductions, or some form of banking support may raise differences of opinion. Even if you cannot take the initiative for the various reasons which you have pointed out, might it not be possible for you to talk with some of the more influential railroad presidents with a view to ascertaining more or less definitely what they think should be done. If you ask them to reach some sort of an agreement among themselves as to what they want and to formulate a program, then there might be some concerted effort on the part of the Administration and the banking community to cooperate in carrying out a program. As I see it, we are now in a deadlock on the railroad situation, and through it in the bond market, unless the railroads themselves promptly take stock and formulate their own program for submission to the necessary parties, whether governmental or financial.
The problem of those banks which have suffered large losses on mortgage loans is perhaps even more difficult of solution than that of those with large losses in their bonds. The suggestion you made on several occasions last week with reference to a possible mortgage rediscount system, if feasible, might ultimately prove of real relief in that regard. But even if the real estate problem is not capable of immediate solution, there is no reason on that account alone to delay whatever constructive steps might be taken with respect to bond values, an improvement of which would also indirectly affect the value of other bank assets.
I hope you will please forgive my bothering you with such a lengthy letter, but I feel that you have already taken such an important and helpfully constructive step looking towards the correction of a very substantial part of the problem, that I would not be frank with you if I did not point out the very real need for fundamental improvement in the condition of a great many banks now threatened with insolvency and failure because of capital impairment through the severe depreciation of their assets--whether based on bonds or real estate.
GEORGE L. HARRISON
[Hon. Herbert Hoover, The White House, Washington, D.C.]
Herbert Hoover, Letter to George L. Harrison, Federal Reserve Board of New York, on Financial and Economic Problems. Online by Gerhard Peters and John T. Woolley, The American Presidency Project https://www.presidency.ucsb.edu/node/207743