New Rules for Bankers

For several recent weeks a Senate investigation gave the 20 partners of J. P. Morgan & Co. plenty to think about. Last week they had something far more serious on their joint minds: What they were going to do with their own business? For the Banking Act of 1933 (passed last week by accident because a Presidential blunder kept Congress in session four days longer than expected) requires private bankers to give up either their banking or their securities business.

To a great many private bankers this forced choice caused little or no worry. Kuhn, Loeb & Co.--according to the testimony of Partner Otto Kahn at a hearing a year and a half ago--are primarily wholesalers of securities. It requires no great stretch of the imagination to picture Kuhn. Loeb's senior partner, Felix Warburg, presiding at a meeting at which the firm decides without any heartburnings to give up its banking business. A like amount of imagination would serve for Goldman. Sachs. And it requires no imagination whatever to picture Dillon. Read and Lehman Brothers renouncing the banking business, for neither firm takes deposits. But the decision will not be so easy for a number of less well-known houses--and for the House of Morgan.

Three weeks ago John P. Morgan told inquisitive Senators that the bigger and more profitable part of his business was banking. Nonetheless a large part of Morgan & Co.'s profit, if not the larger part of its prestige, has been created by its securities business. To give up either part of its activities might easily deprive the other of much profit and prestige. The choice open to Morgan was enough to stump the ablest of bankers. The House of Morgan, ready with no extempore solution, appeared to face a turning point in its history.

The problems of private bankers were, however, largely their personal problems. Much bigger questions were raised by the Banking Act of 1933. On its passage Franklin Roosevelt called up Carter Glass to congratulate him as the father of "the best banking legislation" since his other law creating the Federal Reserve System 20 years ago. Within 48 hours the bid price of the stock of the three largest U. S. banks fell:

Before After Decline Chase National Bank. 35 1/4 29 3/4 15%

National City Bank. . 40 3/4 31 1/2 23%

Guaranty Trust Co. .345 296 14%

Biggest news to the banking community was the guarantee (miscalled "insurance" ) of bank deposits, popped into the bill not because Senator Glass wanted it or approved of it but because (seeing that Congress intended to pass it) he preferred to draft the guarantee scheme himself and make it as harmless as possible. The scheme was no simple compromise:

1) From Jan. 1, 1934 (unless earlier decreed by Presidential proclamation) all deposits will be guaranteed to a maximum of $2,500.

2) After July 1, 1934. deposits will be guaranteed 100%. up to $10,000, 75% from $10,000 to $50,000, and 50% above $50,000.

3) The money to pay depositors in insured banks will come from a Federal Deposit Insurance Corp. which is to start with about $500,000,000 acquired by the sale of stock.

4) The subscribers to the stock will be the Treasury ($150,000,000), the Federal Reserve banks to the extent of one half their surplus (about $150,000,000) and the insured banks to the extent of 1/2 of 1% their deposits ($150,000,000 or thereabouts).

5) Whenever the guarantee fund sinks to 1/4of 1% or less of the deposits of the insured banks, the banks will be required to contribute another 1/4of 1% of their deposits, again and again as long as they remain solvent.

6) The Deposit Insurance Corp. may also issue bonds, notes, etc. up to three times the amount of its capital against the assets of closed banks which it takes over for liquidation.

7) All banks which are members of the Federal Reserve are obliged to join the guarantee scheme.

8) Nonmember banks may have the guarantee extended to them by subscribing to stock of the Insurance Corp.. provided their solvency is approved by their State banking authorities and by the Insurance Corp. If they are to retain the guarantee they must, however, become members of the Federal Reserve by July 1936.

Senator Glass publicly admitted that this last provision was the only good thing he could see in deposit guarantee. He and many another expect that 1) once deposit guarantee is in effect, the public will withdraw its money from "uninsured"' banks, so 2) all banks will be forced to come in. therefore 3) by July 1936 all U. S. banks will belong to the Federal Reserve System.

The possible disadvantages of the guarantee are, however, a tribe in themselves. In order to pass the examination to get into the system banks may enter a new competition for liquidity by calling loans, selling securities, churning up fresh deflation. More serious, there are undoubtedly many small State banks which cannot pass the necessary examination no matter how hard they try to liquidate their assets. When the public learns that they cannot make the grade, runs may start, another crop of bank failures may develop.

The biggest objection to deposit guarantee is that it drains the strength of sound banks to save the depositors of banks already weak. Wherever it has been tried* it has been a disastrous failure. Hence few bankers are in favor of it. Last week the president of the American Bankers Association urged his members to ask President Roosevelt to veto the bill as "unsound, unscientific, unjust and dangerous."

Three days later the President signed the bill and many a good banker began to worry about the prospect of having his profits taken to pay the losses of bad bankers. Econostat, statistical weekly, calculated that if the deposit guarantee scheme had been in force from 1928 to 1932, 62% of the net profits of solvent banks would have been taken to pay the losses of closed banks. The banks of New England and the Middle Atlantic States having 61.5% of U. S. deposits would have had to pay 61.5% of all losses although only 19% of the bank failures were in their territory. The eleven biggest banks in Manhattan having 22% of all deposits of U. S. member banks will have in future to pay 22% of the amount assessed against all banks for deposit losses everywhere. They, with good reason, look on deposit guarantee as a tax on sound banking for the benefit of unsound banking.

Unless deposit guarantee produces a wave of failures among banks that cannot get into the system, thereby forcing repeal of the law, national bankers have no way of avoiding the tax except by leaving the Federal Reserve system. This some sound banks in financial centres would doubtless do except for the numerous disadvantages which nonmembership imposes. Believing that the only hope for the success of deposit guarantee is that the Federal Government may be able to force bankers to be not only good but wise, commercial bankers found themselves standing between the Devil and Deposit Guarantee.

-- Including the States of Nebraska, Oklahoma, Kansas, Mississippi, Texas, South Dakota, North Dakota, Washington.

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