A History of the Federal Reserve, Volume 2 (39 page)

Vault
Cash

After many fruitless attempts beginning in the 1930s, the Board considered changes in the rules for reserve requirements several times in 1958. This time it reached agreement. In January 1959, it proposed legislation to (1) permit banks to count vault cash as part of required reserves, (2) reduce the range of required reserve ratios of central reserve city banks to 10 to 20 percent (instead of 13 to 26 percent), and (3) give the Board more power to permit smaller banks in central reserve and reserve cities to carry required reserves at the level specified for reserve city and country banks respectively.

As interest rates rose, the cost of System membership increased. The Board made its first proposal to increase membership by reducing the cost of membership for country banks. These banks, in the aggregate, held $1.3 billion of vault cash, about 4 percent of their net demand deposits. The balances were widely distributed.
²⁴⁶
Large banks could minimize holdings of vault cash, but it was not worth the trouble for small country banks (Memo, Board Records, January 20, 1959).

The third proposal extended the Board’s discretionary authority to reclassify banks. At the time, five governors could reclassify a bank in an outlying district of a central reserve or reserve city. The new legislation permitted the Board to reclassify banks in the center of the city.

245. Saulnier described the administration’s view of 1959–60 emphasizing uncertainty about transitory and permanent changes. Monetary policy was tight. The long steel strike made it difficult to know whether the economy had slowed or how much it had slowed. Inventories surged after the steel strike, but it was difficult to separate the effect of the end of the steel strike from a cyclical decline in spending. The Federal Reserve and the president were both concerned about the dollar, so “there was support . . . for a cautious money policy” (Hargrove and Morley, 1984, 137). Saulnier also minimized the contribution of the $13 billion swing (more than 2.5 percent of GNP) in the budget deficit to the slowdown and recession (ibid., 138). In contrast, Arthur Burns warned Vice President Nixon (and others) in February 1960 that a recession was likely if the Federal Reserve and the administration did not ease policy.

246. Years later, with the introduction of automated teller machines (ATMs), this provision eliminated the burden of required reserves for many banks, particularly city banks with large currency (vault cash) holdings in their ATMs. The 1959–60 change restored a provision of the original Federal Reserve Act. Prior to 1917, banks could count vault cash as part of reserves.

The Board did not ask for authority to eliminate the central reserve city classification, a step urged on it by the Federal Advisory Council (Board Minutes, February 17, 1959, 1–3). Martin told the bankers that the Board would oppose legislation eliminating the central reserve city classification, and it did. On April 2, he wrote to the chairman of the Banking Committee opposing that provision mainly on grounds that it would promote “undue concentration of available reserves in money market centers” (Statement of the Board of Governors in Opposition, Board Minutes, April 2, 1959). The Board cited the 1930s experience with large excess reserves to justify its claim. This was an error. With unchanged interest rates, a reduction in reserve requirement ratios for profit-maximizing central reserve city banks would change the demand for reserves and the effective supply in the same proportion. The principal monetary or credit effect would be a small change in the multiplier of bank reserves. The Board’s argument applied only if the banks’ minimum desired reserves remained below their required reserves, as happened in some recessions.
²⁴⁷

In July, Congress approved legislation granting the authority to count vault cash as part of reserves, permitting the Board to lower required ratios for individual banks in central reserve and reserve cities, changing the range for reserve requirements in central reserve and reserve cities to 10 to 22 percent, and eliminating the central reserve city classification within three years. The Board waited the full three years to make the change (Board Minutes, July 29, 1959, 8).

The Board was pleased to have authority to count vault cash as part of required reserves but reluctant to release additional reserves in the summer of 1959. Also, it had previously classified cities and banks according to the percentage of interbank deposits held. The elimination of the central reserve city class and its increased authority to classify banks were reasons to develop new standards. It considered using volume of debits, turnover ratios of deposits, proportion of excess reserves, activity in the federal funds market, and other market measures (letter, Sherman to reserve bank presidents, Board Minutes, July 31, 1959). The presidents’ response reaffirmed the use of interbank deposits as the principal measure for classification as a reserve city. They urged the Board to make a “modest start . . . in use of vault cash for reserves” (Statement of the presidents’ conference, Board
Minutes, September 23, 1959, 7). The presidents opposed increases in reserve requirement ratios to offset the effect of releasing vault cash.
²⁴⁸

247. I am indebted to David Lindsey for pointing out when the Board’s statement was correct. The Board also argued several times that reducing reserve requirements for central reserve city banks might require an increase in reserve requirements for country banks. This would alter “long-established relationships” (Board Minutes, April 13,1959, letter, Balderston to Congressman Paul Brown, 1). Congressman Patman objected to the change because it would transfer income to central reserve city banks.

Extensive discussion continued through the fall. On November 30, the Board adopted a modified version of a proposal made by Governor Robertson. Effective December 3, currency and coin at reserve city and central reserve city banks in excess of 2 percent of net demand deposits could be counted as satisfying required reserves. For country banks, effective December 1, currency and coin in excess of 4 percent of net demand deposits could be counted. The Board also changed the dates on which country banks reported reserves and deposits to biweekly from semimonthly.
²⁴⁹
Chairman Martin described his view as “not enthusiastic” but willing to experiment in view of all the discussions. But he wanted agreement to be unanimous (Board Minutes, November 30, 1959, 11). Governors Szymczak and King expressed reservations but agreed to vote for the proposal, and it passed without dissent. A year later, effective November 24, 1960, the Board restored its original rule of 1914–17 that counted all vault cash as part of reserves.
²⁵⁰

The initial release of vault cash did not bear out the conclusions of the lengthy discussion of consequences. Free reserves fell in November and rose in December to the level reached in October. Country banks increased excess and free reserves. Since the federal funds rate remained unchanged at about 4 percent through November and December, the observed changes in free reserves appear as small random movements largely unrelated to the changes in regulation D affecting vault cash.

The new legislation also increased the Board’s authority to reclassify banks in central reserve and reserve cities into categories with lower requirement ratios. Many banks, notably Chicago banks, applied for reclas
sification.
²⁵¹
The Board initially decided to have its staff develop criteria for classification, but that took months to complete. The Board spent considerable time discussing criteria, such as the type of business that the bank did, but it relied mainly on bank size measured by total deposits.
²⁵²

248. The Board regarded the release of vault cash as a major problem because it released very different amounts of reserves at different banks and required some compensating action to avoid an increase in money. Governor Robertson described the problem as “the most important and difficult administrative problem facing the System.” Chairman Martin said, “[T]he System was going to . . . start off. . . into uncharted ground” (Board Minutes, September 23, 1959, 11, 13).

249. President Allen (Chicago) raised the only objection. The 4 percent rule did not give much help to country banks. Only about 300 out of 900 non-reserve city banks in his district would benefit whereas 80 percent of the reserve and central reserve banks would benefit (Board Minutes, November 30, 1959, 11). Later, Leedy (Kansas City) reported that less than 10 percent of country banks and 20 percent of reserve city banks in his district benefited (Board Minutes, December 15, 1959, 19).

250. Federal Reserve notes were not legal tender until 1933, so they were not part of reserves at the start of the System. The decision on June 21, 1917, to exclude vault cash from reserves also reduced reserve requirement ratios, more than compensating for the exclusion of vault cash. Country banks lost relatively when the Board excluded vault cash and gained relatively in 1960 when all vault cash counted.

The statute required the Board to use “character of the business” as its criterion for classifying cities, but the Board and its staff had difficulty making the criterion operational and applicable to individual banks. Most of the governors’ concerns were about individual banks, not cities. Although they did not make their principal concern explicit, they were aware that their criteria would require some large country banks to be reclassified as reserve city banks.
²⁵³
A further concern was the probable release of additional reserves at that time.

Discussion by the governors continued throughout the year. The Board did not reach a final decision, but it established some main criteria for classification as a reserve city: (1) presence of a reserve bank or branch, (2) one or two large banks ($200 million in deposits together), and (3) $40 million of interbank deposits. The presidents remained skeptical. Several argued that the formulas seemed arbitrary and had no advantage over the existing rules (Board Minutes, September 13, 1960, 7–8). Board members did not agree on whether to base classification on demand or total deposits, how to treat deposits of branch banks, and what to do if a city qualified as a reserve city but all of the banks were below minimum size.
²⁵⁴

Board members could not agree on a formula and did not adopt one.
The Board continued to follow its existing rules. Only five cities changed classification from country to reserve city in the 1960s (Board of Governors, 1976, 609). Effective July 28, 1962, New York and Chicago changed from central reserve to reserve city status as required by law.

251. Illinois was a unit banking state and Chicago was a central reserve city, so subject to the highest ratios. Chicago had many small banks that could be reclassified under the revised law.

252. Under previous laws and regulations banks in outlying areas of a central reserve city were not subject to central reserve city requirements. Many of the small banks in outlying districts asked to be reclassified as country banks. On January 22 and February 1, 1960, the Board established de facto that banks in outlying regions, with demand deposits less than $43 million, could follow country bank reserve requirement ratios. Small banks in the central city could have country bank status also, if they asked. Banks with more than $70 million in demand deposits would not be reclassified until the Board formulated criteria. The Board treated banks between $43 and $70 million individually (Board Minutes, January 22 and February 1, 1960).

253. The discussion suggests that the Board would have to reclassify cities as reserve cities, then exempt many of the banks from the classification. “[T]here were a number of cities, not presently reserve cities, having one or more banks that would have to be classified as reserve city banks under any standard that the Board might decide upon” (Governor King, Board Minutes, March 14, 1960, 10). Woodlief Thomas reaffirmed King’s statement (ibid., 10).

254. In December, Thomas suggested basing the classification on the deposits of all banks in a city instead of the size of the largest banks (Board Minutes, December 7, 1960, 4–5). A problem with this proposal soon appeared: the Board would have to designate a home office city for branch banks. Whether the Board had that power was uncertain.

Effective August 25, 1960, central reserve and reserve city banks could count vault cash in excess of 1 percent of deposits as part of reserves. On September 1, 1960, vault cash at country banks in excess of 2.5 percent became part of reserves. On November 24, the Board removed the last restrictions; all vault cash became part of reserves.

End
of
the
Expansion

The timing of the initial release of vault cash in 1959 coincided with the seasonal demand for reserves at year-end. The FOMC did not have a firm view of what would happen after the steel strike. Some favored an easier policy. Hayes suggested that the System should seek stand-by authority to impose consumer credit controls (FOMC Minutes, November 4, 1959, 31). The committee kept policy unchanged; Mills dissented because he wanted an easier policy.

The most contentious issue at the November 4 meeting concerned the System’s response to the Treasury’s refunding offer. The Treasury offered a four-year, 4.875 percent note or a one-year 4.75 percent note in exchange for maturing securities. The System held $5 billion. Taking the four-year note would be inconsistent with bills-only. Treasury Secretary Anderson said he did not care what the System did but, in discussion with Balder- ston, he reminded Balderston that “many Congressmen of the so-called ‘liberal’ school [thought] that the Federal Reserve was doctrinaire and inflexible” (FOMC Minutes, November 4, 1959, 16).

Hayes, presiding in Martin’s absence, asked the staff for its opinion. Riefler and Thomas opposed taking any four-year notes to avoid conflict with the bills-only policy. Governor Mills thought the System would set a bad precedent if it changed policy (ibid., 15). The FOMC voted seven to four to exchange only for the one-year note. Hayes, Erickson (Boston), Shephardson, and Szymczak voted against.

The FOMC made no changes in policy for the rest of 1959. Chairman Martin described the consensus as maintaining the status quo but giving the manager discretion to adjust to market conditions. “While there were different views expressed there was no real agreement. . . . [W]hat the System did would not really make too much difference” (FOMC Minutes, December 15, 1959, 42). Mills continued to vote no.

The December 15 meeting was the last for Winfield Riefler. He resigned effective December 31. In the 1920s and the 1950s, he had shaped the
System’s policies, including bills-only, and its analysis. In January, Ralph Young became Secretary of the FOMC, Guy Noyes took responsibility for the FOMC briefing on the economy, and Woodlief Thomas became adviser to the Board.