Financial institutions and the Nation's economy : FINE : compendium of papers prepared for the FINE study


Material Information

Financial institutions and the Nation's economy : FINE : compendium of papers prepared for the FINE study
Physical Description:
v. : ill. ; 24 cm.
United States -- Congress. -- House. -- Committee on Banking, Currency and Housing
U.S. Govt. Print. Off.
Place of Publication:
Publication Date:


Subjects / Keywords:
Financial institutions -- United States   ( lcsh )
Federal Reserve banks   ( lcsh )
Housing -- Finance -- United States   ( lcsh )
Banks and banking, International   ( lcsh )
bibliography   ( marcgt )
federal government publication   ( marcgt )
non-fiction   ( marcgt )


Includes bibliographical references.
General Note:
4 parts in 2 volumes.
Statement of Responsibility:
Committee on Banking, Currency and Housing, House of Representatives, 94th Congress, second session ...

Record Information

Source Institution:
University of Florida
Rights Management:
All applicable rights reserved by the source institution and holding location.
Resource Identifier:
aleph - 025851803
oclc - 02383028
System ID:

Full Text
i, I,,,, [ il r Is

[COMMITTEE PR M] ~~; ~~~"""'



e~: u~l~r THE FINE STUDY i




JUNE 1976;l ."" a

Prin ed or he u e o th Com itt e o Ban ing Cu renc an Ho sin
Th rpot asno benoficaly dote b- heComite o Bnkng
Ckirenc andHouing4nd.maynottherfor neessailyrefect he iew
Of It* mem:~I

A 4 44

44 ( 4 44 44 44
~4 A4

44 44 4 4 44 A44
444~ 4

444 4 44 4~4~ A 44

4 7 (4 44
4 4 444~

44 44 444'

1 44


44 1 44

/4 r 44
4 >44 44

44 4



'4 44

4 44

44 4
~4 44





4 44 4

44 444

4 4 4444 444 4,

44 44

4~4 444 44 44



44 -

4' 4

4, 44,~

44 r

44 4

44 44 44

44 44444

44 4 44 4

444 44 44 444

4 44

44444 44~ ~ 44444 44

4 44 4' '4'

44 44 ,44< 44

444 /4 44
444 I 44

4 >4 '4 4
444 444 44

4 44 1'

4 44 4 4 4,
44 44 ~4' 4444444 /4444?
44 44 44444 444,

14 44 4
4 4444 444~,44 44 4

444 44 4 ~44 444

4 44 44 4
44 '4 44 44, ~44) 4 44 4 4 ~ 4444 44

4~4~&4> 444444 /44 4

44 :' 444 ~ ~ '44; 4444 44' 4~44 4 ~4 444/4





94th Congress, Second Session


JUNE 1976

Printed for the use of the Committee on Banking, Currency and Housing
The report has not been officially adopted by the Committee on Banking,
Currency and Housing and may not therefore necessarily reflect the views
of its members.

62-784 WASHINGTON : 1976

HENRY S. REUSS, Wisconsin, Chairman

District of Columbia MILLICENT FENWICK, New Jersey
STEPHEN L. NEAL, North Carolina
LES AuCOIN, Oregon
PAUL E. TSONGAS, Massachusetts
BUTLER DERRICK, South Carolina
NORMAN E. D'AMOURS, New Hampshire

The House Banking, (Cu>rrency and Iiousing ('Conlmittee togetler
with the Subcominittee on Financial Institutions Supervision. Iiegiu-
lation and Insurance announced on April 24. 197 )5 the und(lertaking
of a major review of the nation's financial institutiolls and their
regulation by the Federal (Government. A project was laulnche(. called
the Financial Institutions in the Nation's Econolmy (FINE) Study.
encompassing five areas: The relationship between banks and thrift
institutions, and what changes may be desirable in their borrowing,.
lending, investment and customer service activities; the adequiacy of
federal regulation, as now divided among three government agencies
for banks alone; the structure and operations of the Federal Reserve
System; the operation of U.S. banks abroad, of foreign banks in the
U.S., and of the Eurodollar market; and the operation of bank holding
A team of consultants and Committee staff, under the supervision
of Dr. James L. Pierce, principal consultant to the ('onmmittee on the
FINE Study, began an analysis of the major issues affecting our
financial institutions. Working with staff and expert consultants.
the Committee published in November 1975 a set of Discussion Pri<-
ciples which contained proposals for the restructuring of our financial
institutions. Extensive hearings followed and ultimately legislation
was proposed.
As a first step in this process, the Committee commissioned for
FINE a number of studies that were conducted by respected scholars
who had published extensively and had experience in advising the
government on policy matters in their respective fields. These studies
provided an independent perspective on financial reform. The papers
present a focused evaluation of important issues which touch on the
many facets of financial reform and are the result of careful study
by individuals who have thought deeply in their chosen area.
The papers contained in this volumne represent all of the studies
that have been commissioned for the FINE Study. Four studies that
were completed and in publishable form before the hearings began
were published in a November 1975 volume. The present volume con-
tains those four studies as well as new ones relating to international
banking, bank holding companies, credit unions and additional papers
on regulatory reform.
Besides the studies, an extensive and detailed questionnaire dealing
with the current practices and attitudes of the Federal banking regu-
latory agencies was prepared by the FINE Study Staff and several
consultants. This questionnaire was published in the earlier volume;
in the present volume the questionnaire is reprinted as well as the
replies from the Federal Reserve Board and the Comptroller of the
Chairman, Committee on Banking,
Currency and Housing.
Chairman, Subcommittee on Financial
Institutions Supervision, Regulation and Insurance.

Digitized by the Internet Archive
in 2013


(The same table or contents appears in Books I and II)
Preface ----------- ------------- --------- III
FINE Study Discussion Principles ------------------------ VII
Part 1-Depository Institutions and Housing 2-
1. "Housing and Financial Reorganization," by Dr. Craig Swan,
Associate Professor of Economics, University of Minnesota 27
2. "A Program to Protect Mortgage Lenders Against Interest Rate
Increases," by Dr. James L. Pierce, Consultant and Director of
the FINE Study ------------------------------------93
3. "Evaluations of Selected Subsidized Housing Programs," by Rich-
ard L. Wellons, Economic Analyst, Congressional Research Serv-
ice. The Library of Congress__----------------------------- 101
4. "Credit Unions as Viable Financial Intermediaries," by Dr. David I.
Fand, Professor of Economics, Wayne State University -------- 117
Part 2-Regulation of Depository Institutions ------------------------- 143
1. "The Structure of Federal Regulation of Depository Institutions,"
by Dr. Samuel B. Chase, Jr., Consultant, Washington, D.C ------ 145
2. "Opportunity and Responsibility in a Financial Institution," by
Dr. Donald D. Hester, Professor of Economics, University of
Wisconsin ------------------------------------------------ 173
3. "Financial Innovation and EFTS: Implication for Regulation," by
Dr. William L. Silber, Professor of Economics and Finance, and
Dr. Kenneth D. Garbade, Assistant Professor of Finance, New
York University -------------------- 193
4. "Bank Trust Departments and Public Policy Today," by Roy A.
Schotland, Professor of Law, Georgetown University Law
School ----------------------------------------------------211
5. "Bank Holding Companies and Public Policy Today," by Roy A.
Schotland, Professor of Law. Georgetown University Law School-- 233
6. Questionnaire: Questions on Regulation and Supervision of Banks,
submitted to the Federal Banking Agencies by the Banking, Cur-
rency and Housing Committee and the Subcommittee on Finan-
cial Institutions Supervision, Regulation and Insurance, U.S.
House of Representatives -----------------------------------285
Answer: Comptroller of the Currency --------------------301
Answer: Board of Governors of the Federal Reserve System ------ 463
Part 3-Structure and Operations of the Federal Reserve System -------- 667
1. "The Structure and Operations of the Federal Reserve System:
Some Needed Reforms," by Dr. Thomas Mayer, Professor of
Economics, University of California, Davis--------- 669f
Part 4-International Banking--------------------------------------- 727
1. "Foreign Bank Activities in the United States," by Jane D'Arista.
Professional Staff Member, Banking, Currency and Housing Com-
mittee, U.S. House of Representatives ------------------------ 731
2. "U.S. Banks Abroad," by Jane D'Arista. Professional Staff Mem-
ber, Banking, Currency and Housing Committee. U.S. House of
Representatives ----------------------------------------- 801




(By Thomas Mayer) 1

This study evaluates the Federal Reserve's structure and presents
a number of proposals for making it more consistent with its present
functions. Two main beliefs underlie these proposed reforms. One
is that to isolate the Federal Reserve from partisan political pres-
sures it needs a substantial degree of independence. However, this
independence should not extend to allowing it to select its own goals
independently of those preferred by elected officials. Second, the
Federal Reserve's independence does not require it to have, as it
does at present, a quasi-private component. It carries out extremely
important governmental functions, and should be fully a public
agency, rather than considering itself as only quasi-public. Hence,
the following changes are recommended:
1. The Federal Open Market Committee should meet with the
President once every two years (and more frequently if very special
circumstances require this) to obtain an indication of his goals. It
should then be required to accept these goals as its own unless it
appeals successfully to Congress.
2. The stock in the Federal Reserve Banks which is presently owned
by member banks should be retired.
3. The Board of Directors of the Federal Reserve Banks should be
transformed into a management and economic advisory council.
4. The presidents of the Federal Reserve Banks should increase
their contacts with a broad spectrum of the public, and should con-
sider using a formal advisory council for this purpose.
5. The presidents of the Reserve Banks should be chosen by the Presi-
dent (with the advice and consent of the Senate) from a list of three
candidates selected by a bipartisan committee.
6. Instead of having the presidents of the Reserve Banks serve in
rotation on the FOMC, they should serve on it permanently but with
fractional votes.
7. If recommendation (6) is not adopted, the Federal Reserve should
reconsider the appropriateness of having the New York Federal Re-
serve Bank permanently represented on the Federal Open Market
Committee. (And also the rotation of the Cleveland Bank on the
8. The Board of Governors should be cut to five members if its super-
visory work is reduced.
SProfessor of Economics, University of California. Davis. A paper prepared for the
FINE Study. The author is indebted for much helpful information to Governor Holland,
Chairman Wilson President Balles and Senior Vice President Sims of the San Francisco
Federal Reserve Bank, President Eastburn of the Philadelphia Federal Reserve Bank, Pro-
fessors Sherman Maisel, Willam Poole and Larry Wade, and Dr. James Pierce, none of
whom are, of course. responsible for any statements made here. He is also indebted for able
research assistance to Mr. Robert Carter.


9. The terms of the governors should be changed so that they expire
in March of odd numbered years. If a governor does not serve out his
full term his successor should be appointed only to the unexpired part
of that term. And if recormmendation (1) is not accepted, then the
terms of the governors should be cut to ten years.
10. Various steps should be undertaken to raise the prestige and
influence of the other governors relative to the chairman's.
11. The Chairman's (and the vice-chairman's) term should be made
coterminous with the President's.
12. The President should have the power to appoint, on his own,
subject to Seniate confirmation. someone as governor and chairman.
But for the a1 pp)oi lntlment of other governors he shlould be required to
choose somleone fromll a list of three candiates selected by a bipartisan
committee. The present requirements for occupational and regional
representation slioul(d be abolished.
13. The Board of Governors should consider the appointment of an
advisory council with broad public representation.
14. If a new bank regulatory agency, with adequate safeguards
against canture bv the industrvy is instituted, then the Federal Reserve
should yield its bank regulatory and supervisory functions to it. If
such an agency is not set up, then the Board of Governors should
decentralize much of its regulatory and supervisory work to the Re-
serve Banks.
15. If uniform reserve requirements are imposed on banks, then the
Federal Reserve should charge banks for check clearing.
16. Congress should commission a management consulting firm to
evaluate the Federal Reserve's policies regarding officers and em-
ployees. Until the results of such a study are available, the issue of an
audit bv the General Accounting Office should be shelved.
17. The Federal Reserve should be required to file with Congress
an Annual Report on Monetary Policy, setting out its forecasts, its
targets and its trade-offs. Hearings should be held on this report.
18. The Federal Reserve should consider cutting the five year lag
in the publication of the FOMC Minutes and making them more
19. Except in particular cases the ii cord of Policy Act;ons should
be published right away.
20. Certain specified steps should be taken to raise the efficiency of
Congress' oversight over the Federal Reserve.
The Federal Reserve was established in 1913 primarily as a coopera-
tive enterprise among banks, as a banker's bank, rather than as a cen-
tral bank in the modern sense of the term. In accordance with prevail-
ing ideas the Federal Reserve was to prevent excessive and speculative
booms, and to control the qualaity of credit. This orientation determined
the Federal Reserve's structure. Since it was a banker's bank. it could.
in large part. be placed in the hands of banks. To be sure. some gov-
ernment supervision was needed to prevent it from becoming a bank-
ing cartel, but it was certainly not thought of as an institution by
which the government tries to control money income.2 Hence. central-
2 As Harold Stein put it: "The central bankers of the nineteenth century would have
shuddered at the thonuht that they were responsible for carrying out the objectives of the
Employment Act of 1946." U.S. ConCr. Joint Economic Committee, Subcommittee on Gen-
eral Credit Control and Debt Managment, Monetary Policy and the Public Debt,
Hearings, 82nd Congr. 2nd sess., 1952, p. 759.


ized direction could be limlited; lost of the power could be held bv 12
regional Banks which would monitor the quality of loans made by the
banks iii their Districts and extend crelit to tliem. This task cou ld be
fulfilled best by bankers if their natural tendency to favor high inter-
est rates whiere checked by havin'l borrowers, as well as thle general
public, represented on the Federal Reserve Bank's Board of Directors.
But since 1913 the functions of the Federal Reserve have changed
radically. It is no longer primarily a banking agency, rather it is an
"economic stabilization agency" concerned with the standard macro-
economic goals such as full emploiymnent. It is therefore unfortunate
that the term "Federal Reserve Banks" makes many people think of
the Federal Reserve as akin to a commercial bank. It is not a bank.
Despite this radical change in the Federal Reserve's functions, its
structure has changed much less. To be sure, there las occurred a slow,
but steady, accretion of power to the Federal Reserve Board at the
expense of the Federal Reserve Banks. In addition, the Banking Act
of 1935 provided legislative recognition for the centralization of open
market operations. lBut at the same time. tllis Act was also, in another
way, a major move towards the decentralization of macroeconomic
policy since it removed the Secretary of the Treasury and the Comp-
troller of the Currency from the Federal Reserve Board, and length-
ened the terms of its members from ten to fourteen years. Hence, while
the importance of the private component of the Federal Reserve has
shrunk since 1913, its formal independence from the Administration
has grown. This is a surprising change because Federal Reserve policy
is now, unlike in 1913, conceived of as a central component of the gov-
ernment's economic policy. Here is a case where form has not followed
The fact that the Federal Reserve's structure has changed much less
than its functions does not necessarily mean that it is outdated, and
should be chanred. It may be the case that its structure-- articularly
its independence-is even more fitting to its present functions than to
its 1913 functions. Furthermore, apparently outmoded structures some-
times perform efficiently, and by their very age, provide the institution
with legitimacy.3 But at the very least, the discrepancy between the
changes in the structure and in its functions suggest that the Federal
Reserve's structure should be reevaluated.
This paper will therefore deal with the problem of whether, and if
so how, the Federal Reserve should be reorganized. Its focus is on the
issue of the Federal Reserve's independence and on its responsiveness
to national economic policy as enunciated by Congress and the Admin-
istration. Is the Federal Reserve's independence merely a holdover
from the time when the government took little responsibility for
economic conditions, or is it something that is even more necessary
now than in the days when the central bank was thought of as strictly
a "banking" institution ? And insofar as the traditional structure of
the Federal Reserve inhibits its efficient operation as a governmental
agency, how should it be changed ? This paper therefore first looks at
the question of Federal Reserve independence, and then turns to the
various components of the system. It then deals with the problem of
3 Cf. Kenneth Bouldlng. "The Legitimacy of Central Banks" in Board of Governors,
Federal Reserve System, Reappraisal of the Federal Reserve Discount Mechanism (Wash-
ington, D.C., 1971), vol. 2, pp. 3-13.


whether the Federal Reserve should supervise banks, and discusses
some other characteristics of the Federal Reserve such as its financial
structure. It concludes with some recommendations for more effective
Congressional oversight. The guiding principle of the paper is that
since the Federal Reserve carries out govetrnmental functions, it
should be a governmental institution, and not a quasi-public, quasi-
private one, which is the way the Fed's officials frequently refer to it.
Having an institution organized as partially public and partially
private is justified if this institution carries out functions some of
which are private. For example, a scientific organization that, in addi-
tion to the services it renders to its members. a'so serves as a statutory
adviser to the government can be considered quasi-private and quasi-
public. But this is not so for the Federal Reserve. Its major functions
are governmental. Any notion that it exists in part to carry out private
functions is an anachronistic residual from the days when it was
thought of as a banker's bank. Hence, this paper recommends a num-
ber of changes in the Federal Reserve's structure to turn it fully into
a governmental institution.

In a formal sense the Federal Reserve is entirely independent; there
are no official channels by which the President can enforce his will
upon it, and it is not subject to Congressional pressure through the
appropriations process. To be sure. Congress could at any time order
the Federal Reserve to take certain actions, but Congress has shown a
great reluctance to do so. However, in March 1975 in Concurrent Res-
olution 133 Congress did assert its right to tell the Fed what monetary
policy it should follow, and to require the Fed to explain its policy
targets and justify its actions. While it is frequently asserted that the
Federal Reserve is a "creature of Congress" the same is true for other
government agencies too. In actuality Congress exercises less control
over the Federal Reserve's actions than, say, over the Treasury's
But the Federal Reserve's de facto independence is severely limited
for four reasons. First, it is precarious in the sense that Congress
could at any time abolish it. And since there is some support for this
in Congress it is in a sense, "a prisoner of its freedom." While it can
act independently, it must be careful not to alienate a body of public
opinion strong enough to take this independence away. It must treat
its ability to act contrary to the wishes of the Administration and
Congress as a scarce good which has to be economized.5 Second, it
frequently asks Congress for certain legislative changes, and to obtain
these-as well as to block legislation it opposes-it has to cultivate
Congressional goodwill. And, it also has to seek the support of the
Administration in these legislative struggles.
4 See Harold Stein. op. cit.. p. 759.
5 According to Governor .Mitchell. "The measure of independence that the System has
retainOr over te years reflects its sopring use of dissent, and the care and skill with which
the Systems views have been negotiated. . ." (T.S. Congr. Joint Economic Committee.
Recent Federal Reserre Action and Economic Policy Coordination, Hearings. 89th Conir.,
1st sess 196. 24. At the same Hearing Governor Maisel testified: "Our independence
and right to act should be used nrimarily as a valuable ace in the hole. An unnecessary
use of power may dangerously weaken the System." (Ibid., p. 28.)


Third, the President's power to rea)ppoint, or not to reappoint, the
Chairman (and those members who have completed( their )predecessor's
unexpired terms) presumably gives lhim influlenlce. a os (dos his ability
to fill vacancies that occur on the Board of (Gvernors. And the Chair-
man's wish to screen potential appointees to the Board gives the Presi-
dent an additional lever over the ('hairman.6 Fourth, there is the
moral suasion which the man elected by the nation as its Chief Execu-
tive can exercise over an appointed Board. And Congress too possesses
powers of moral suasion. It is therefore not surprising that a former
member of the Board has declared :
Although no legal method exists for the President to issue a directive to the
System its independence in fact is not so great that it can use monetary policy
as a club or threat to veto Administration actions. In any showdown, no non-
representative group such as the Fed can or should be allowed to pursue its own
goals in opposition to those of elected officials. . The White House holds too
many cards in any direct showdown.
And the Hoover Commission has stated: "Ultimately, it is the Chief
Executive, who, within the limits imposed by Congress, establishes the
Government's monetary-fiscal policy. ." "
But the fact that the Administration may get its way "ultimately"
does not mean it can always do so, and certainly not right away. At
times-though perhaps not. always-it is true that as a Congressional
Staff Report has said: "Unless the administration is willing to force a
showdown it cannot change Federal Reserve policy.'" And putting
pressure on the Fed may be costly to the Administration. Once when
the White House released a statement which criticized Chairman
Burns, and suggested that the Federal Reserve be reorganized, the
stock market declined and the dollar was put under heavy pressure in
the foreign exchange market.10
Hence, we have experienced a number of incidents when the Fed-
eral Reserve adopted policies opposed by the Administration. The
most obvious one was the Fed's termination of the bond pegging
policy in 1951. Another example occurred in 1956 when the Federal
Reserve raised the discount rate despite the declared opposition of the
Administration, in what former Governor Maisel refered to as blow-
ing the whistle on the Administration." A third example is the policy
that led to the 1966 "crunch," which was strongly opposed by the
Administration. It cannot, of course, be inferred from these cases that
whenever the Federal Reserve differs strongly with the Administra-
tion it feels free to adopt a policy contrary to the Administration's.
There may well have been other cases where the Federal Reserve very
much wanted to do something the Administration opposed, and
decided for this reason not to do it.

See Edward Vane, New Congressional Restraints and Federal Reserve Independence,"
Challenge, November-December 1975, p. 38.
7 Sherman Maisel, Managing the Dollar (New York, 1973). pp. 136 & 147.
8 Commission on the Organization of the Executive Branch of the Government Task
Force Report on Regulatory Commissions (Washington. D.C.. 1949). p. 110.
U.S. Congr. House, Committee on Banking, Currency and Housing, Subcomittee on
Domest"c Finance The Federal Reserve After Fiftu Years. Proposals for the Improvement
of the Federal Reserve. . ., 88th Congr. 2nd sess.. 1964, p. 22.
10 Sherman Maisel, Managing the Dollar, op. cit., p. 147.
1 Ibid., p. 73.


The impression given may seem unclear. And this is as it should
be, since it is not clear just how independent the Federal Reserve is in
actuality. It is an issue on which opinions differ, being a matter of
intuition rather than of demonstrable evidence. Furthermore, the
Fed's independence is likely to vary from time to time depending on
whether public opinion supports the Administration or the Federal
Reserve.12 Hence, there are no hard and fast limits to this independ-
ence; rather the relationship between the Federal Reserve and other
government agencies is "delicate." 13 Most of the time the Adminis-
tration and the Federal Reserve are more or less in agreement. It is
only when they disagree that one obtains some idea of the extent to
which the Federal Reserve is actually independent.
Compared to foreign central banks, the Federal Reserve enjoys
substantial independence. This is due, in part to the American prefer-
ence for decentralizing power, and more specifically to the separation
of executive and legislative powers. In a parliamentary system the
central bank can go along with "the government," without facing the
complication of deciding who "the government" is. This is not the
case in the U1.S. when Congress and the Administration disagree.14
Hence. foreign experience does not help us in deciding how independ-
ent the Federal Reserve should be. Let us look therefore at the case
for, and then at the case against, independence.

Before starting on the case for independence it is useful to clear
away three confusions which sometimes confound this case. One is a
tendency to identify the Fed's independence with it having a private,
or quasi-private, component. Indeed, this component is usually justi-
fied by saving that the central bank should be independent. But this
argument is invalid. An institution can be entirely governmental, and
yet enjoy substantial independence from the rest of the govern-
ment, as, for example, the courts do. On the other hand, an institution
can be privately owned and be subject to government control, as is true
for example of the airlines. Hence, the Federal Reserve's quasi-private
components can be jettisoned without necessarily reducing its in-
dependence. One might. of course, argue that the quasi-private com-
ponent is necessary to justify independence to the general public. But
this argument is spurious. As a large body of Congressional criticism
shows the Fed's independence is vulnerable to criticism precisely
because it has a quasi-private component, and hence seems to involve
the delegation of public decisions and power to a quasi-private
Second, one should avoid confusing the two uses of the term "poli-
tical." It is sometimes used in the sense of "partisan politics," and at
other times to mean any decision made by the electorial, or rather the
representative, process, as opposed to decisions made by the market.
Third, there is the confusion between Federal Reserve independence
2 For example, in 1951. the Federal Reserve could defy the Treasury and withdraw its
peg of government securities because it had substantial support in Congress and in the
country at large.
13 Malsel. op. cit.. p. 134.
i" See Jacob Viner in U.S. Congr., Joint Economic Committee, Subcommittee on General
Credit Controls and Debt Management, op. cit., p. 774.


in the sense of allowing it to choose its own social goals and the trade-
offs between them, and Federal Reserve autonomy in the means it
employs to reach these goals. For example, one could order the Federal
Reserve to give priority to the enlployment goal with )ut dictating the
means to be used, e.g. raising the growth rate of the money stock to,
say 8 percent.
Although there have recently been some attempts in Congress to leg-
islate a minimum growth rate for the money stock, and a lowering of
interest rates, most of the debates about Federal Reserve independence
have dealt, not with such specifics of monetary policy, but with the
Federal Reserve's autonomy to choose its own goals. There are few
legislative restrictions on this freedom. To be sure, in a formal sense,
the Federal Reserve is bound by the Employment Act of 1946, but this
Act has been read to mandate a price stability goal as well as high
employment.15 In addition, the Federal Reserve believes that it also
has a mandate to concern itself with balance of payments problems.
And an agency that has several mandates-mandates which frequently
conflict-has in effect no mandates. It is free to choose the one that
corresponds to its own preferences.
Giving the Federal Reserve the right to select its own goals rather
than taking these from the duly elected representatives of the public
can be defended in several ways. One is to say that effective monetary
policy requires the Federal Reserve to adopt at times painful-and
hence unpopular-measures. These unpopular measures have a long
run beneficial effect, which eventually becomes visible, and hence
acceptable, to the public. But in the short run the public is unlikely to
exercise the required self-discipline of imposing these tough measures
on itself through the political process. Hence, by giving independence
to its central bank the public insures its long-run well-being. There
are, however, three troubles with this argument. First, it is merely an
assertion. Is there really any evidence that the public is unwilling to
suffer temporary losses for its long-run good ? Proponents of this argu-
ment have treated it as though its truth were self-evident, and have
not bothered to present empirical evidence for it.16 Second, it repre-
sents a fundamental distrust of the democratic process and of the
public's ability to learn. After all, monetary policy is not the only area
in which the eventual good requires temporarily painful measures.
Why not use the same argument to say that the public, and its elected
representatives should have no say about defence policy ? Third, while
the public may be unwilling to bite the bullet, the same may be true of
the central bank. For example, many economists have accused the
Federal Reserve of being unwilling to allow interest rates to rise, even
though this was necessary and inevitable in the long run. More gen-
erally, when one looks at the erratic monetary policies actually fol-
lowed by the Federal Reserve the argument that independence allows
the Fed to take the long view seems much less convincing.
16 Representative Reuss. for example, has interpreted it as containing a price stability
goal. (U.S. Congr. House, Committee on Government Operations, Amending the Employ-
ment Act of 1946 to Include Recommendations on Monetary and Credit Policies and
Proposed Wage and Price Increases, Hearings, 85th Congr. 2nd sess., 1948. p. 3.
16 It may be no more valid than the frenuent assertation that the public does not permit
tax increases in an election year. Actually, in the period 1913-1958 most tax increases
occured in election years. See the testimony of Professor Carl Shoup in U.S. Congr., Joint
Economic Committee, Review of the Report of the Commission on Money and Credit,
Hearings, 79th Congr. 1st sess., 1961, pp. 190-91.


A related argument asserts that the public is fickle, and given to
fads, thus switching irrationally between various policy goals. Federal
Reserre independence can then be looked upon as providing an aver-
aging process whose results more truly represent the long-run interests
and wishes of the public than do its temporary wishes. Like the Su-
preme Court, the Federal Reserve follows election returns, but does so
with a lag. However this argument too, is based on an assertion rather
than on empirical evidence. Does the public really switch so rapidly
from goal to goal, or do the public's desired trade-offs change only in
a longer-run fashion? If the public's preferences do change perma-
nently, rather than only temporarily, then an agency that follows
election returns with a lag would not properly represent the public's
wishes some of the time.
Perhaps the argument about the fickleness of public opinion should
be interpreted somewhat cynically as being a discrete way of saying
something else. This is that monetary policy is too technical an issue
to be entrusted to public opinion. The public sees only the benefits of
monetary ease, and does not know enough about economics to realize
that it may result in inflation. It is instructive to compare monetary
policy to fiscal policy in this regard. Fiscal policy operates in intui-
tively clear ways; public expenditures obviously create jobs, and a tax
cut obviously raises the public's expenditures. But an increase in bank
reserves, or a decrease in the Federal Funds rate operate in more
indirect and mysterious ways. The public's understanding of monetary
policy is therefore relatively limited. But is it really any less than its
understanding of, say, foreign policy ? Democracy is based on the as-
sumption that the public can, with the help of expert advice, make
difficult, as well as easy, decisions.
A third justification is more basic. It asserts that democracy is not
our supreme value, that equity is more important. It further asserts
that inflation is highly inequitable, and must therefore be avoided. And
it claims that the public, or its elected representatives, have a strong
inflationary bias. Consequently, we need a central bank which will
resist the preference for inflation shown by the public or by its rep-
resentatives, even though this is contrary to the democratic process.
While this argument which puts price stability ahead of democracy
may have been acceptable to nineteenth century central bankers, it is
contrary to the twentieth century American ethos. Furthermore, it
looks upon the Federal Reserve as run by philosopher-kings rather
than as run by fallible men who are concerned not only with equity, but
also with their private bureaucratic goals-of which more anon. Be-
sides, has the Federal Reserve really turned out to be such a good
watchdog over the dollar's value ?
Quite another approach to the defence of Federal Reserve indepen-
dence is to express skepticism, not about public opinion per se, but
rather about its representation through the political process. In other
words, monetary policy might be misused as a tool of partisan politics.
This approach observes that excessive monetary ease initially has al-
most always favorable effects; interest rates decline, credit becomes
more readily available, and employment and output rise. Although
prices may rise somewhat right away, the public is much more aware


that its income and employment are rising. The main unfavorable
effects of such a policy in terms of higher inflation rates which occur
if the economy is trying to operate above its potential, slhow uI) only
subsequently. Consequently, it would be possible for a politically con-
trolled central bank to adopt an easy money policy timed so that its
popular consequences occur before the election, and its unfavorable
effects after the election. The result of this would be inflations shortly
after most elections, with a consequent increase in the inflationary bias
of the economy.
This is indeed a serious danger with a politically controlled central
bank."1 To be sure, a similar thing might be said also about fiscal policy,
and many other policies, but here there are checks and balances. Con-
gress would have to go along with that type of partisan approach.18
Indeed, the comparison with fiscal policy is apt. One of the standard
arguments against giving the President power to modify tax rates on
his own is precisely that he might use this power to his political ad-
vantage. The same argument applies to giving the President control
over monetary policy. This argument, that we need Federal Reserve
independence to prevent (or moderate) the partisan use of monetary
policy provides a much more effective case for Federal Reserve inde-
pendence than the arguments previously considered. Indeed, it pro-
vides the main case for it.
But the danger of partisan politics is not the only valid justification
for Federal Reserve independence. Another one, already mentioned, is
that in a system of separation of powers it is not at all clear which
branch of government should have control over the Federal Reserve,
or even whether this control is to reside solely in one branch, or should
be split analogously to the split that exists for fiscal policy. And if we
do not know which branch of government should have control over the
Federal Reserve, the best thing to do may well be to leave it in its pres-
ent, rather ambiguous, position, where it is subject to influence and
pressure from both Congress and the Administration. Threats to its
independence from both branches may make the Federal Reserve more
responsive than it might be if it were under the control-and hence
the protection-of either branch.
And another valid argument is that its independence makes the Fed-
eral Reserve into an independent voice in the councils of government.19
This is badly needed.
Thus, to summarize, there are three valid justifications for Federal
Reserve independence: (1) keeping monetary policy out of partisan
politics, (2) the uncertainty about which branch of government to give
control over the Federal Reserve, and (3) the desirability of an inde-

17 For a suggestion that this has to some extent occured in recent years see Edward
Kane. "The Re-Politicization of the Fed," Journal of Financial and Quantitative Analysis,
November 1974, p. 751. To be sure, the public would eventually wake up to this trick.
but in the meantime a lot of damage colld be done. For a general discussion of this
problem see William Nordhaus. "The Political Business Cycle", Review of Economic
Studies, vol. 42. April 1975. no. 169-90.
18 See the testimony of William Kelly in U.S. Congr. House. Committee on Banking,
Currency and Housing, Subcommittee on Domestic Finance, The Federal Reserve System
After 50 Years, Hearings, 88th Coner. 2nd sess., 1964, n. 1908.
19 See Sherman Maisel. op. cit., p. 135: H. S. Gordon. "The Bank of Canada in a System
of Responsible Government," Canadian Journal of Economics and Political Science, vol. 27,
February 1961, no. 1-22; and G. L. Bach, Federal Reserve Policy-Making (New York,
1950), pp. 214-215.

62-748--76-bk. II- 2


pendent voice on monetary issues.20 Of these, the first one is the most

The most obvious argument against Federal Reserve independence is
that such independence is undemocratic. We have here a situation
where major government decisions, at times the most important ones
in the macroeconomic sphere, are made by officials who are neither
themselves elected, nor are responsible to elected officials. The public
may have firmly repudiated a President at the polls, but his appointees
on the Board will continue to make monetary policy for many years.
And the Federal Reserve Bank presidents are even further removed
than the governors from the electorial process. From this point of
view Federal Reserve independence is fundamentally undemocratic.
Independence from the electorial process is justified for agencies that
have judicial or quasi-judicial functions, but the Federal Reserve is
primarily a policy-making agency, and hence should be controlled by
elected officials.21 Furthermore, if the President can be trusted with
the authority to wage war why is he denied the authority to make
monetary policy? 22 We do not allow appointive officials with long
terms in the Defense Department or the State Department to decide
whether to go to war. Why do this for monetary policy ? As Professor
Samuelson has put it: 23
There can never be place in American life for a central bank that is like a
Supreme Court, or 1831 House of Lords-truly independent, dedicated to the
public weal but answerable for its decisions and conduct only to its own discre-
tion, and ... conscience....
Professor Strotz well summed up the situation when he said that
"democratic values . place a burden of proof upon those who ad-
vocate an independent central bank." 24
Defenders of Federal Reserve independence have answered this
argument by saying that there is nothing undemocratic in delegating
responsibilities to an agency. In one way this argument is, of course,
entirely valid. It is certainly true that the delegation of monetary
powers to the Federal Reserve has been accomplished in a democratic
manner by the Federal Reserve Act. The problem is that this delega-
tion of power, though itself democratically accomplished, does reduce
the autonomy of the public with respect to monetary policy. What
Federal Reserve independence clearly does is to reduce the responsive-
ness of monetary policy to the public's wishes. Whether or not one
wants to call this reduction in responsiveness "undemocratic" or a

2 Two other justifications are sometimes given. One is that the Federal Reserve does
not have a well defined clientel. possessing neither a powerful grass roots constituency as,
for example, the Department of Commerce does, nor does it have, like the Defense Depart-
ment, a constituency of those who sell to it. Second, it has been argued by the Commission
on Money and Credit (Money and Credit, Englewood Cliffs, N.J.. 1961, p. 86) that inde-
pendence allows the Federal Reserve to attract a better staff and be a more vigorous agency.
But it is not clear why its staff should be concerned about the Fed's indenendence.
21 Thus Representative Reuss once asked a witness who supported Federal Reserve
independence whether he also favored indeendence under a Board of Governors for the
Treasury. U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee
on Domestic Finance. The Federal Reserve After Fifty Years, Hearings, op. cit.. p. 1707.
22 It may seem that this argument is weak since certain war powers are given to the
President rather than to Congress because of the need for speedy decisions. But this answer
would be effective only if the choice were between giving control over monetary policy to
the President or to Congress, rather than to an independent agency.
23 Ibid., p. 1105.
2 Ibid., p. 1451.


"wise act of abnegation" is, to some extent, a debate about words. But
if we call any democratically arrived at delegation of power demo-
cratic we would have to call democratic a system whereby a dictator
is freely elected to wield absolute power for life.
Since delegation with respect to means is in any case likely, the
problem of Federal Reserve independence is primarily one of the dele-
gation of value judgments. To the extent that the Federal Reserve
makes the same value judgments as the public, either because the pub-
lic's value judgments correspond to its own inherent ones, or because
it believes that it has the duty to accept the public's value judgments,
Federal Reserve independence does not raise many issues.
But there is a serious question whether this is the case. Traditionally,
central banks have been substantially more concerned with inflation,
and less concerned about unemployment, than the public. Central
banks look upon themselves as the guardians of the value of money.
This is due, in part, to the fact that one of the central bank's constit-
uencies, bankers, are strongly opposed to inflation. In case of the Fed-
eral Reserve it may also result from the Federal Reserve seeing itself
as the only major government agency that protects the interests of the
fixed income groups, most government agencies having a producer,
rather than consumer, constituency. As former Governor Maisel has
put it: "It seems evident that some officials in the System and some of
its supporters saw the Fed's role as one of a counterweight to any
government tendency to seek economic goals with which the Fed
disagreed." 2' In recent years with the appointment of economists to
the Board and to the presidencies of the Federal Reserve Banks, this
tendency to focus on price level stability, rather than on employment,
has probably decreased. Thus according to Maisel "a good deal of the
System bias has been removed," t6 though there is always a danger of
it returning, since the Federal Reserve talks more frequently with
those who favor restrictive policies than to other groups. In his view,
while the Federal Reserve was more conservative than other agencies
prior to 1961, this is no longer the case."2 But in a book published in
1971 Professor G. L. Bach refers to the Federal Reserve as more con-
cerned with inflation than are the Administration or Congress, though
he too suggests that the difference is not very great.28 But in his recent
speeches Chairman Burns has again been putting great emphasis on
the need to fight inflation.
This whole topic of the Federal Reserve's attitude towards inflation,
compared to that of other government agencies, is greatly complicated
by the fact that, as discussed below, the Federal Reserve has been un-
willing to discuss its trade-offs in a serious way. Hence, outsiders can
only form rather unreliable impressions which may well be wrong.29
2 Maisel, op. cit., D. 133. See also G. L. Bach, Making Monetary and Fiscal Policy
(Washington, D.C.. 1971), p. 165.
2 Op. cit., p. 166.
SIbid., p. 165.
2 Making Monetary and Fiscal Polici. on. cit., D. 165.
29 Some attempts have been made to estimate the Federal Reserve's trade-offs statistically.
One of these has concluded that the Fed has become less hostile to inflation after Arthur
Burns sicceeded William McChesney Martin as chairman. (See Thomas Havrilesky, Robert
Sanp and Robert Schweizer, "Tests of the Federal Reserve's Reaction to the State of the
Economy: 1964-74." Social Science Quarterly. March 1975. pp. 835-52.) But such studies
are vulnerable to the criticism that changes in the variables used, or in the way they are
measured, might result in different conclusions.


But emphasis on price stability is not the only way in which the
Federal Reserve's value judgments may depart from those of the pub-
lic. A bureaucracy, like any other closely knit group, tends to develop
its conceptions into unquestioned dogma-"professionalism also means
inbreeding and the growth of dogmas . 30 And the Federal Re-
serve has not been immune from this weakness. To be sure, the Federal
Reserve is to be strongly commended for giving its staff much more
intellectual freedom than is usual for government agencies. But all
the same, it has tended to develop a certain inbred way of looking at
things. As Professor Yohe has put it: "Anyone who has ever worked
with Federal Reserve publications or personnel has doubtless sensed a
certain conformity of thought and opinion and a defensiveness of Sys-
tem policy," 31 though the Fed may well be much better this way than
other government agencies. Similarly, Professor Friedman referred
to the reluctance of an independent agency, such as the Federal Re-
serve, to admit that it has made a mistake.32 Our economy is one of
checks and balances. Private firms, when they make mistakes, are
checked by the market and forced to change. Public opinion and elec-
tions can force Congress and the Administration to change their poli-
cies. But there is no outside agency that forces the Fed to admit its
mistakes. It can indulge in the comfortable attitude of not admitting
these mistakes even to itself. Hence, it fails to learn from its errors,
and continues to make the same ones in the future.33
Furthermore, since the Federal Reserve's day-to-day contacts are
primarily with the money market, and with the banks it supervises,
it may develop money market myopia, that is, an inclination to adopt
policies that facilitate the smooth workings of the money market, even
if these policies have a significant cost in terms of overall economic
stability. The Federal Reserve has been subject to a great deal of
criticism on this score by academic economists who have made a strong
case that this is what actually occurs.34
And this is not a minor issue. The Federal Reserve has a choice of
either stabilizing the money stock or stabilizing interest rates in the
short run. This is a very important issue for stabilization policy, but
one outside the purview of this paper. However, what is relevant here
is that independence increases the Federal Reserve's ability to indulge
in a bias to stabilize interest rates, if it does have such a bias, as many
economists believe is the case. Such a bias, against short term fluctua-
tions in interest rates could be the result of the Fed's close relations
with big banks and other money market operatives who can suffer
serious losses from interest rate instability, and have a strong prefer-
ence for policies that smooth out money market fluctuations.

30 Harvey Mansfield and Myron Hale. "The Structure of the Federal Reserve System,"
reprinted in U.S. Congr. House. Committee on Currency, Banking and Housing, Subcom-
mitee on Domestic Finance. Hearings, op. cit., p. 1980.
31 "The Open Market Committee Decision Process and the 1964 Patman Hearings,"
National Ranking Review. vol. 2. 1March 19(5 p. 310.
32 U.S. Congr. House, Committee on Banking. Currency and Housing. Subcommittee on
Domestic Finance. The Federal Reserve After Fifty Years. Hearings, op. cit., pp. 1143-44.
33 There are, of course, some pressures on it. One is the oreviouslv discussed threats to
its independence if it uses it in ways disapproved of by Congress or the Administration,
another is the need to justify itself at Congressional Hearings. a third is criticism from
academic economists, and a fourth is criticism from its staff, which in recent years has
become much more professional and less bureaucraticallv oriented.
81 For the classic criticism see Karl Brnnner and Allen Meltzer. Some General Features
of the Federal Reserve Approach to Policy, P.S. Congr. House, Committee on Banking,
Currency and Housing, 88th Congr. 2nd sess., 1964.


If this is the case, it may be by far the greatest loss from Federal
Reserve independence. While the goals of the Federal Reserve and of
the Administration do not differ so very much, the choice of the in-
terest rate, or of the money stock, as the target for monetary policy
can easily decide whether monetary policy is stabilizing-or destabiliz-
ing-the economy. Obviously the difficult and vital decision about
what target variable to use should be based on the best economic anal-
ysis available, and not be influenced by such bureaucratic factors as
the Federal Reserve's close relations with the money market, or by the
fact that the Federal Reserve Banks superficially resemble commercial
banks. Outside control over the Federal Reserve might therefore be
immensely useful if it reduces money market myopia, and generally,
limits the extent to which a "banking outlook" interferes with effective
policy.5 Similarly, reducing the Board of Governors' bank regulatory
functions, and hence its contacts with banks, may help here too.
Another part of the case against Federal Reserve independence is
that the public holds the President, and not the Fed, responsible for
the state of the economy.36 And yet, at least on a formal level, he is
not given control over what may well be the most powerful tool of
general economic policy. The import of this argument is, however,
limited by two considerations. One is that, as discussed above, in-
formally the President does exercise not inconsiderable control over
the Federal Reserve. And second, monetary policy is not unique in this
way. The President's power over fiscal policy is also limited. How-
ever, with regard to fiscal policy the President can at least run against
Congress, while if he were to run against the Federal Reserve-and
do so successfully-it would probably be the end of Federal Reserve
Critics of Federal Reserve independence have also objected to it on
the ground that it inhibits the coordination of various stabilization
tools.37 Monetary policy is placed under the control of one agency,
while fiscal policy and debt management are controlled by other
agencies. Hence, it is difficult to get these tools used in a consistent
manner, and to allocate the overall stabilization task efficiently be-
tween them. For example, as Professor Samuelson has pointed out,
if we have an independent central bank that places more emphasis on
price stability than the fiscal authorities do, the resulting restrictive
monetary, and easy fiscal policies will work to reduce the saving rate
of the economy.38

8 See Harry G. Johnson. "Alternative Guidine Principles for the Use of Monetary
Policy," Fss8ays in International Finance #44 (Princeton, N.J.. 1963). np. 6-7. Professor
Friedman ("Sholld There be an Indenendent Monetary Authority?" in Leland Yeager. In
Search of a Monetary Constitution (Cambridge. Mass., 1962), p. 2.8) argues that the close
connection between central bankers and commercial bankers contributes to the Federal
Reserve's confusion of monev and credit.
6 Thus the 1952 Council of Economic Advisers argued :
The President conld scarcely discharge his general constitutional responsibilities . .
if monetary policy were not regarded as one of the "functions and resources" of the
Government. . Monetary policy does come under the responsibility of the
President . .
(TT.S. Conwr. Joint Economic Committee, Subcommittee on 'General Credit Control and Debt
Manarement. Replies to Questions . . 82nd Conrr. 2nd sess., 1952. pn. 849-F50.)
A nolitical scientist who is a s'ecialist on Federal Reserve organization. Michael Reagan.
has taken a similar nosition ("The Political Structure of the Federal Reserve System,"
American Political Rcience Review. vol. 55 March 1961 n. 73).
7 See for example, the testimonies of Professors Villard and Johnson in U.S. Congr.
House. Committee on Banking. Currency and Housing, Subcommittee on Domestic Finance,
ThF Federal Reserve After Fifty Years, Hearings, op. cit., pp. 1035-36.
38 Ibid., p. 1125.


To be sure, there are meetings between Federal Reserve and Treas-
ury officials, but there is no formal mechanism for settling their un-
resolved disputes. Furthermore, in his meetings with the Adminis-
tration the Federal Reserve Chairman is limited in the extent to which
he can commit the Federal Reserve System. Hence the Commission on
Money and Credit stated that there is a need for "closer working
relationships and greater unity of purpose and outlook." 39 A proposal
for increasing coordination is made below in connection with the
issue of Federal Reserve secrecy.
But, one should be wary of the term "coordination." It is sometimes
a cover for saying that the Federal Reserve should be subservient to
the Administration, rather than that the two should coordinate in the
sense of a mutual agreement between two equals.
In addition, despite its obvious advantages, one could question
whether the coordination of monetary and fiscal policy is really de-
sirable. Suppose that the situation is so unclear that the Administra-
tion and the Federal Reserve hold contrary views on what policies are
called for. Given so much uncertainty it may well be best that nothing
is done.
One part of the case for independence is therefore that we really do
not know enough about monetary-fiscal policy to use it effectively.
Hence, there is safety in numbers. By having two separate agencies
whose actions sometimes operate in opposite directions we avoid some
of the big policy errors that could result were they both to pull in the
same direction.
Besides, we want conflicts between government agencies to be out in
the open, rather than hidden from Congress and the general public, so
that Congress can, if necessary, adjudicate the issue.40 An example of
the beneficial effects of this are the Douglas Hearings and Patman
Hearings in the one really major case where coordination broke down,
the events leading to the Accord. This process of bringing controversial
issues out into the open would, of couse, work much more effectively if
the Federal Reserve were less secretive; if it were willing to discuss its
goals and their trade-offs more openly.
Finally, it is worth noting that in any case full coordination
between fiscal and monetary policy could not be achieved merely
by giving the President authority over monetary policy since he
lacks control over fiscal policy.41
The case for curbing the Federal Reserve's independence is generally
based on the assumption that, at present, the Federal Reserve has too
much power. But one can also advocate reducing the Fed's independ-
ence for exactly the opposite reason. In this view the Federal Reserve's
independence reduces the power it would otherwise have because it
reduces its influence over the Administration. Not only does it tend
to limit the Fed's influence to monetary policy, but also the Adminis-
tration may be less ready to honor the views--even on monetary
policy-of an independent agency, than of an agency that is a family
member of the Administration. Thus, a study by Professors Mansfield
and Hale declared that bringing the Federal Reserve into the Admin-
9 Commission on Money and Credit. op. cit., p. 86.
4o See William Kelly, on. cit., p. 1914.
41 See the testimony of Henry Walllch In U.S. Coner. Joint Economic Committee. Recent
Federal Reserve Action and Economic Policy Coordination, Hearings, op. cit., p. 320.


istration would give it more influence.42 And Professor G. L. Bach
has argued that independence has shut the Federal Reserve off from
having influence on the Administration: "Ours is a government by
negotiation and compromise." 43 Thus, "the power and influence of
the Federal Reserve in overall macroeconomic policymaking has
usually been greatest when its distance ('independence') from the
administration has been least." 4 More specifically, the Hoover Com-
mission has pointed out that the "semi-isolated legal status" of the
Chairman means that he will not be the chief adviser to the
This argument that independence reduces the Federal Reserve's
influence over the economy is hard to evaluate. To do so one would have
to know: (1) the extent to which the Fed is now really independent,
(2) the extent to which the President would make greater use of Fed
advice if it were part of the Administration, (3) the relative impor-
tance of monetary policy compared to other policies, such as fiscal
policy, over which the Federal Reserve might gain influence by being
part of the Administration, and (4) the loss of direct influence over
the public that would result from the Federal Reserve no longer being
able to act as an independent voice. Moreover, the validity of the argu-
ment may depend upon the personality of the chairman. A strong
chairman, willing to follow policies opposed by the Administration,
is likely to have more impact if he is outside the Administration, while
a more accommodating chairman could probably assert more influ-
ence if he were part of the Administration. But although the argument
is therefore hard to evaluate, it should not be brushed aside; it may
very well be of substantial importance.
To summarize, a strong case can be made against Federal Reserve
independence on the grounds that it is basically undemocratic (or, to
put it differently, it reduces the autonomy of the public), that the Fed-
eral Reserve tends to substitute its value judgments-including myopic
ones-for the public's, that coordination suffers, and possibly that the
Fed would have more influence if it were a part of the Administra-
tion. On the other hand, one argument for reducing Federal Reserve
independence, the President's responsibility for economic conditions,
seems less compelling.

Thus, both the case for, and the case against, Federal Reserve inde-
pendence contain valid points. This suggests the advisability of a
compromise that would maintain the main advantages of independ-
ence, while making the Federal Reserve more responsive to the public
will. This could be achieved by having the President lay out the goals
a U.S. Congr. House, Committee on Banking, Currency and Housing. Subcommittee on
Domestic Finance. The Federal Reserve After Fifty Years, Hearings, op. cit., n 1970.
S4 U.S. Congr. Joint Economic Committee, Monetary Policy and the Public Debt, Hearings,
op. cit., p. 751.
SG. L. Bach, Making Monetary and Fiscal Policy, op. cit., pp. 163-64. Similar opinions
have been expressed by Harold Stein and Michael Reagan. See U.S. Congr. Joint Economic
Committee, Monetary Policy and the Public Debt, Hearings, op. cit., p. 782; "The Internal
Structure of the Federal Reserve: A Political Analysis." in Commission on Money and
Credit, (ed.) Monetary Manaqement (Enzlewood Cliffs. N.J.. 1963), n 399.
5 Commission on the Organization of the Executive Branch of the Government, op. cit.,
p. 110. And the Commission on Money and Credit (op. cit., p. 86) too suggested that closer
ties to the President might increase the Fed's influence.


the Federal Reserve should follow with a proviso which, as discussed
below, would greatly reduce the danger of the partisan use of monetary
Specifically, shortly after taking office, and again shortly after the
mid-term elections, the President should meet with the Federal Open
Market Committee (FOMC) to set the goals and trade-offs for mone-
tary policy over the next two years. The Federal Reserve would then
be bound to follow these goals with one proviso. If it objects to these
goals it can reject them publicly, stating its own alternative policy.
Congress would then choose between the two by Joint Resolution,
though obviously it could legislate its own alternative. Hence, an
appeal to Congress would be risky for the Fed since it might receive
a policy directive it likes even less than the President's. But, in any
case, the Federal Reserve is not likely to appeal to Congress against
the President (particularly right after the President's election) since,
after all, it has to live with the Administration, and to seek its support
on various legislative issues.
Since, for reasons discussed below, the President would set out the
goals of monetary policy normally only once every two years he would
have to do so in a flexible and general manner. Instead of simply indi-
cating to the Federal Reserve what his trade-off's between unemploy-
ment and inflation are at the present levels of these variables, he would
have to clarify how the Fed should react to changes in these variables.
For example, he might tell the Federal Reserve that, at present, it
should place more emphasis on unemployment than on inflation, but
should the inflation rate rise above a certain percentage, or the unem-
ployment rate decline below a certain point, then it should pay more
attention to inflation.
He would have to set out his goals for a large number of alternatives,
for example, for a high inflation rate accompanied by a high unem-
ployment rate. Similarly, he should discuss how his trade-offs would
change if certain institutional changes take place; for example, if
we return to fixed exchannye rates. He would therefore not so much
give the Fed a specific "directive," as an indication of his value judg-
ments. This would reduce the danger of inflexibility. In addition, if a
completely new major problem should arise, such as the oil embargo,
then the President would meet again with the FOMC."6
Since what is suggested here is an informal discussion which pre-
sents the President's value judgments rather than a formal directive,
some confidentiality is desirable. This could be obtained by having an
informal discussion closed to the public, in which the President could
talk relatively freely about his trade-offs.47 However, a public state-
ment should then be issued which reveals the President's targets (and
40 An alternative version of this proposal would have the President give directions to the
Federal Reserve, not in terms of general goals, such as the unemployment rate, but in terms
of specific targets, e.g. a particular growth rate of the money stock. This would mean
that the President, and not the Fed, would determine how best to reach the general goals.
Perhaps these technical judgments should be left to the Fed. But, if the Fed turns out to
be dogmatic about them, and refuses to learn from its mistakes, then it should lose its
power to decide what specific target variables to use. Indeed one of the advantages of
having the President set out general goals is that the Fed would no longer be able to
rationalize its technical errors by claiming that whatever did happen is just what it was
aiming for.
47 However, even in an informal discussion the President would probably have to avoid
the type of statement that makes "good copy," lest a member of the FOMC who strongly
disagrees with it decides to "go public."


implicitly his trade-offs) at least to the same extent as is currently the
case in the Economic Report of the President.
The trouble with most proposals to give the President authority
over monetary policy is that the President may use this power to play
partisan politics: that he may institute an excessively easy monetary
policy just before the election. But the proposal presented here largely
avoids this difficulty by specifying that the President is authorized to
give instructions to the Federal Reserve only almost two years before
an election, except if a really major new problem, such as the oil em-
bargo, suddenly emerges.4s This makes it almost impossible for him
to use monetary policy for partisan purposes. at least in the sense of
instituting an excessively easy money policy just before an election.
In general partisan politics can take three forms. One is the use of
unsubstantiated charges, a second is the use of governmental powers
to punish enemies and reward friends, and the third is the adoption
prior to an election of iolicies that have initially favorable- but ulti-
mately unfavorable-effects. The first two are not a problem with re-
gard to the Federal Reserve, but the third one is. There are only
three ways it could be prevented. One would be the development of
effective sanctions against anyone who tries to influence monetary
policy for partisan advantage. Unfortunately, it is hard to imagine
how this could be done. The second way is to give the Federal Reserve
almost absolute independence, considerably more independence than
it has now. For reasons discussed above, this is undesirable. The third
way is to allow the Administration to bring pressure on the Fed. as
is the case at present, but to require that these pressures occur at a
time when their unfavorable effects are likely to show up before the
next election. Our present system of giving the Federal Reserve sub-
stantial independence, but allowing the Administration to bring some
pressure on it at all times is an inefficient compromise of the problem
of how independent the Fed should be.
Admittedly, this proposal does not provide an iron-clad guarantee
against any partisan influence on monetary policy. Thus, a President
might, for example, tell the Federal Reserve to adopt a tight money
policy now, but to switch to an expansionary policy when the unem-
ployment rate rises above a certain point, but in the expectation that
this would occur just before the election. But given the inaccuracy of
economic forecasts such a scheme does not look very promising. There
is also the danger that if the Federal Reserve accepts the President's
guidance once every two years it may accept his guidance at other times
But note that, although the proposal suggested here does not avoid
all danger of partisan politics completely, neither does the present
system. As discussed above, the President can now inform the Federal
Reserve of his wishes, and if necessary bring pressure to bear on it.
Under the proposed system the Federal Reserve would have a legisla-
tive mandate to stand up to such pressure since the law would state
specifically that the President is to issue goals to the Federal Reserve
48 Perhaps a Joint Resolution should be reauired to authorize such a snecial meeting.
4 For example, the Federal Reserve may decide to be helpful to a President prior to
an election in the hone that he would respond by giving it goal directives it likes. But
this danger seems remote, because if the Fed would play such a game it would run the risk
that the opposing candidate might win, and revenge himself.


only once every two years. Hence, there is little ground for arguing
that the proposal would make monetary policy more vulnerable to
partisan political pressures. The opposite seems more likely.
It should therefore be acceptable to those who are afraid of political
control over monetary policy. What it does is to institutionalize some
political control, but, one might hope, at the expense of the moral
suasion the President can now bring to bear on the Fed at all times.
Professor Friedman has referred to the present system as "pseudo-
independence" that is "likely to do more harm than good." 50
The proposal is, of course, open to the objection that it does not
answer one argument made for Federal Reserve Independence, that is
the uncertainty as to whether the Federal Reserve should be placed
under Congress or into the Administration. But the proposal does very
little to reduce the role of Congress. In one way it even increases it,
since in the case of open conflict between the Administration and the
Federal Reserve, it leaves it up to Congress to adjudicate the dispute.
Furthermore, if Congress ever wants to legislate a particular growth
rate for the money stock, etc. it could still do so. Admittedly, it could
no longer justify this by the argument that the goals of monetary
policy are not under democratic control. It might also face an Admin-
istration that is more protective over the Fed than is the case now.
But in any case, at present Congress does not actually exercise much
control over the Federal Reserve. Thus, a Staff Report of the Banking,
Currency and Housing Committee stated that Congress now exercises
so little control over the Federal Reserve that making it responsible to
the President would increase Congressional leverage over it.51
Turning to another valid justification for Federal Reserve inde-
pendence, the proposal would leave the Federal Reserve as an inde-
pendent voice in government; it could still protest against various
policies while carrying them out. Admittedly, it does not meet the
point that the Federal Reserve has too little influence, precisely be-
cause it is not part of the Administration.52
Another problem is that the President may well be reluctant to
reveal his value judgments and trade-offs to the Federal Reserve. He
might prefer the present situation where he can bring informal in-
fluence to bear on it, and yet blame it for what goes wrong. But the
fact that it would reduce such "game playing" is an advantage, and
not a disadvantage. of the proposal.
On the positive side what the proposal does is to make the goals of
monetary policy subject to control by an elected official. It would also
eliminate, or greatly reduce, the current anomolous position of FOMC
members. On the one hand, they are technicians making professional
judgments about such complex and narrow technical issues as the
choice between various monetary indicators and the correct monthly
50 U.S. Congr. House, Committee on Banking. Currency and Hof-sing. Subcommittee on
Domestic Finance, The Federal Reserve After 50 Years, Hearings, op. cit., p. 1147.
51 Ibid., p. 1972.
62 But it would increase the Federal Reserve's power in one way. As Professor Bach has
suggested, if the Federal Reserve had a snecific mandate it could stand un Tetter to other
government agencies. (U.S. Congr. Joint Economic Committee Subcommittee on General
Credit Control and Debt Management, Hearings. op. cit., p. 788.) Moreover, to the extent
that the President feels favorably disnosed to the Fed because he is the one who sets its
goals, he may be more ready to take its advice.


growth rate of the money stock. On the other hand, they set, to a very
significant extent, the goals of national economic policy. This latter
task should not be left to technicians; "government by experts" is in-
ferior to democracy. Originally, when the Federal Reserve was con-
sidered essentially a banker's bank, it was reasonable to assign its
operation to "experts," since the problems it dealt with were technical
problems that did not seem to involve value judgments. But this is no
longer the case. The goals of monetary policy are not indisputable ones,
such as the avoidance of bank failures. Rather, they now involve highly
controversial trade-offs on which the public should have much more
of a say than it does at present. Hence, while technical decisions should
be left to the Federal Reserve, its goals should be set from the outside.
And, as is discussed further below, they, unlike the Fed's day-to-day
operations in the money market, should be made public.
Finally, it should be noted that taking away the Federal Reserve's
ability to set its own goals is hardly a radical move. Since the early
days of the Federal Reserve System there have been attempts by Con-
gress to impose on it specific goals. For example, the House version
of the 1935 Banking Act did contain a price stabilization directive.
Furthermore, such a staunch conservative as Professor Milton Fried-
man has spoken out in favor of Congressional control over monetary

It may be useful to look at some other proposals to modify Federal
Reserve independence that are made from time to time. A very mild
one is to amend the Federal Reserve Act to include a specific reference
to the Employment Act.54 But this does not go far enough. As pre-
viously discussed, the Federal Reserve already considers itself bound
by the Employment Act, and besides, this Act gives the Fed multiple
goals, and hence is not constrictive. But, all the same, since there is
virtually no cost to amending the Federal Reserve Act in this way,
this may be worth doing-as long as one does not expect much from it.
Another set of proposals would involve the Federal Reserve more
closely with the Administration by instituting a statutory coordinat-
ing commission on monetary problems.55 However, our experience
with statutory advisory commissions has not been good.56 Moreover,
this proposal is vague. Does it mean that the Presidential appointees
on this Commission, and hence at one remove, the President himself,
can interfere with day-to-day monetary policy, or would it land up
with the Federal Reserve being politically powerful enough to treat
this Commission as though it were merely advisory ?
3 U.S. Congr. House, Committee on Banking. Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve After Fifty Years. Hearings, op. cit., p. 1147. Con-
gressional control over monetary policy is Professor Friedman's second choice. His first
preference is for a steady growth rate rule for the money stock.
An interesting question that arises in this connection is whether the Employment
Act does not already give the President the right and duty to issue directives to the Federal
6 This was recommended by the Hoover Commission (Commission on Organization of
the Executive Branch, op. cit., p. 111).
6 See the testimony of Harold Stein in U.S. Congr. Joint Economic Committee, Sub-
committee on General Credit Control and Debt Management, Hearings, op. cit., p. 760.


A more radical proposal is to require bipartisan representation on
the Board of Governors as is the case for regulatory agencies." This
proposal has a major attraction. As is discussed below, at present the
Chairman has excessive influence over the Board. Bipartisanship on
the Board would create a focus of opposition to the Chairman, thus
bringing into the open disputes about the goals and means of monetary
But at the same time, a bipartisan Board has some serious disad-
vantages. If voting crystallizes entirely along party lines, we would, in
effect, have a one-party Board, since the majority could get its way
completely.58 This could readily lead to the partisan use of monetary
policy.59 It is, of course, not certain that voting would necessarily
crystallize along party lines to a much greater extent than at present. If
decisions were made more in the open, the fear of adverse public opin-
ion could serve to inhibit it, though, on the other hand, greater public
knowledge of how governors are voting might also increase party pres-
sure on them. Another factor that might reduce party-line voting is
the wish of governors to have the swing votes with the power that ac-
companies swing voters. But there would be a built-in tendency for
party-line voting to grow over time. The party whose members on the
Board show greater party loyalty would have an advantage, and hence
there would be pressure on the members of the other party to show
more loyalty too. And the President would be tempted to select the
members of his party, not only on the basis of their ability, but
also for their party loyalty.
In addition, the proposal has a serious disadvantage even if such
extreme partisanship can be avoided. Suppose, for example, that two
members of the Board do not vote along party lines, and provide the
swing votes. This would mean. in effect, that, as far as decision-
making is concerned, we have a two man Board without corresponding
advantages of a small Board discussed below.
Some observers have proposed that the Chairman serve at the
pleasure of the President, and even that he be a member of the cabi-
net.60 Given the power of the Chairman this would mean that the
President has a substantial degree of control over the Federal Reserve,
and conseauently, unlike the proposal presented here, could easily lead
to a partisan monetary policy.
It has also been suggested that the Federal Reserve be turned into
a branch of the Treasury. This proposal has little to recommend it.
Quite apart from the danger of partisan politics, there is little reason
why the Secretary of the Treasury who already has widespread re-
sponsibilities ranging from debt management to taxation and interna-
tional finance, should also make monetary policv. Surely, monetary
policy is important enough that, if it is to be under the control of the
7 This pronosal was discussed in 1913 and In 1935. but has received little support.
(G. L. Bach. Federal Reserre Policu lfakina. on. cit.. n. 120.)
6s Presumably, the FOMC would be abolished under this proposal, so that the Reserve
Bank nresidents could not serve as a nonpartisan erolin.
6 This problem would be much more serions for the Federal Reserve than it Is for the
regulatory agencies beennse monetary policy has much more effect on elections than does
the nnlicy of. say. the ICC.
o Thus E. A. Goldenweiler has. suiestpa a three man Board with the Chairman serving
as a cabinet officer. (American Monetary Policy, New York. 1951. n. 301.) Michael Reagan
has proposed a single head for the System serving at the President's pleasure ("The
Political Structure of the Federal Reserve System," op. cit., pp. 75-76).


Administration, it should have its own cabinet officer who, of course,
would coordinate policy with the Treasury.
A more moderate version of this proposal is to appoint the Secretary
of the Treasury to the Board of Governors either as its Chairman, or
as an ordinary member. This would partially restore the situation
prior to the Banking Act of 1935 when both the Secretary of the Treas-
ury and the Comptroller of the Currency served on the Federal Re-
serve Board. However, this experience was hardly very encouraging;
the Secretary of the Treasury did not allocate enough time to his Fed-
eral Reserve duties. Admittedly, nowadays this might not happen.61
Another problem with this proposal is that we do not know how it
would work in practice; would the Secretary of the Treasury domi-
nate the Board even if he were not the Chairman? 62 The fact that we
do not know the answers to these questions suffices to rule this proposal
out, quite apart from the obvious danger that it would make monetary
policy subject to partisan politics.

Before leaving the problem of Federal Reserve independence it may
be useful to discuss briefly its quasi-private component which is fre-
quently confused with its independence. It is clearly a vestige from
the days when the Federal Reserve was thought of as a cooperative
enterprise among bankers. It is defended nowadays by the argument
that it does no harm, since the private, or semi-private, individuals
who serve as Directors or Reserve Bank presidents consider them-
selves duty-bound to act in accordance with the public interest, and not
to act as representatives of private groups. But saying that these per-
sons are devoted to the public interest does not, in and of itself, answer
the question. The problem is that everyone sees the public interest in
a way conditioned by his own background and experience; a banker
will be more apt to think that the national interest requires a profit-
able banking system, than that it requires high wages for plumbers;
and plumbers will naturally think the opposite. Hence banker influ-
ence is not eliminated even by full adherence to the injunction to act
in the "public interest." The preconceptions and biases which arise
from a person's day-to-day contacts and from his background are not
changed by formally making him a government official. Thus, a more
effective defence of the Fed's quasi-private components is to say that
their elimination would not result in any significant changes.
But clearly, what Professor Reagan has called the "quasi-private
'face' of the System" is not "in line with its public responsibilities." 63
And this may confuse not only the naive, but also sophisticated insid-
ers. Thus, in 1947 when New York Federal Reserve Bank President
1T However, Treasury Secretary Dillon did testify that he would not have enough time
available for the Federal Reserve's business. U.S. Coner. House. Committee on Banking,
Currency and Housing, Subcommittee on Domestic Finance. The Federal Reserre After
Fifty Years, Hearings, op. cit., p. 1231. In the nast. there has also been considerable
concern that the Secretary of the Treasury, as the country's biggest debtor, has a low
interest rate bias. But this is probably no longer a serious nroblem.
10 Chairman Martin stated that the Secretary of the Treasury would not necessarily
dominate the Board. (Joint Economic Committee, Subcommittee on General Credit Control
and Debt Management. Hearin(R. on. cit.. p. 95.)
6s Michael Reagan, "The Political Structure of the Federal Reserve System," op. cit.,
p. 75.


Sproul disagreed with Chairman Eccles, the latter said: "Sproul
legitimately reflected the opposition of the bankers of his district." 64
Professor Clifford in discussing this passage stated that this was in
keeping with Chairman Eccle's belief that the Board presented the
public interest which counterbalances the interests and viewpoint of
the private bankers frequently represented by the Federal Reserve
Banks.65 Admittedly, this incident occurred almost thirty years ago,
and it is doubtful that a Federal Reserve Chairman would think this
way today. But this attitude may not necessarily have disappeared
completely. For example, in 1960 Chairman Martin testified that some,
though not a sizable number, of banks believe that ownership of Fed-
eral Reserve stock gives them ownership of the Federal Reserve Sys-
tem.66 And at the same Hearing another Fed official quoted with ap-
proval a passage by former New York Bank President Sproul which
said that "the Federal Reserve Banks should function somewhere be-
tween private enterprise and the government." 67
And it should be clear from what has been said above, in connection
with independence and value judgments, that any tendency in the
System to operate monetary policy from the viewpoint of bankers
rather than the general public is highly undesirable and should be
eliminated. Furthermore, as is discussed below in connection with
stock ownership, the existence of quasi-private components may re-
sult in unwarranted opposition to restrictive monetary policies. Hence,
this paper makes some suggestions for eliminating the quasi-private
component of the System.
It is, of course, true that the elimination of the quasi-private com-
ponent would not, by itself, suffice to remove completely excessive
private influence on the Federal Reserve. As long as senior Federal
Reserve officials have close and frequent contact with bankers, banks
will have considerable influence on Federal Reserve thinking. But at
present this tendency is reinforced by the quasi-private components in
the Federal Reserve's structure. Hence, even though it will not solve
the whole problem, removal of the private components is justified be-
cause it would tend to make Federal Reserve officials more conscious
of the public nature of their positions.
Let us now leave the general issues of the independence of the Fed-
eral Reserve and its quasi-private components, and turn to the specifics
of the Federal Reserve's structure.

The Federal Reserve Banks are primarily the operating arms of the
System, but they do have some policy-making functions. What needs
discussion here is (1) their ownership, (2) the selection of their direc-
tors, (3) the functions of the Reserve Banks, and (4) the status of
their presidents.
The Federal Reserve Banks are corporations, and hence have out-
standing stock. This stock is held by the member banks who are re-
cited in A. Jerome Clifford, The Independence of the Federal Reserve System (Phila-
delphia. 1965). p. 209.
w Ibid., pp. 209-10.
w U.S. Congr. House. Committee on Banking. Currency and Housing, Slbrommittee No. 3,
Retirement of Federal Reserve Stock, Hearings, 86th Congr. 2nd sess., 1960, p. 239.
67 Ibid., p. 77.


quired to buy stock equal to 3 percent of their capital. However, this
stock does not signify ownership. Ownership consists of the right to
manage, and the right to the residual income. Neither of these condi-
tions hold for the Federal Reserve Banks, and consequently the term
"ownership" is misleading; at best it can be called a convenient facade.
Federal Reserve officials and bankers have defended private stock
ownership mainly in two ways. One is to say that the assured 6 percent
dividend which member banks earn on this stock makes it a profitable
investment, and hence it is an inducement to Federal Reserve member-
ship. The other defence is to say that private ownership generates cer-
tain intangible benefits.
But the yield on Federal Reserve stock is not a significant induce-
ment to membership. Earnings on this stock amounts to only a trivial
percentage of member bank earnings.68 Second, the 6 percent rate of
return may at one time have seemed high relative to other earning
assets, but this is not the case at present.69 Whether or not a 6 percent
yield will look like an attractive yield in the future depends on the be-
havior of interest rates. In any case, if it is desired to give the member
banks the 6 percent earnings the stock could be transformed into de-
posits bearing that rate as was proposed in a bill by Representative
Multer (H.R. 8627,1960).
Turning to the intangible benefits of stock ownership, Federal Re-
serve officials have testified that stock ownership has "a real psycho-
logical value," and helps to tie banks to the System in the sense of
inducing them to feel favorably disposed to the Fed, and to member-
ship in it.70 Elimination of the stock would be interpreted as a step
towards nationalization of the Federal Reserve Banks.71 Furthermore,
stock ownership serves as a symbol of Federal Reserve independence.72
And it also tends to justify the Federal Reserve's financial independ-
ence from Congress.7
Criticism of stock ownership has taken several forms. One is to say
that it has a deleterious effect by giving the Federal Reserve System an
undesirable "intellectual tie" to banks, and that it reinforces a "built-in
banker bias." 74 It is not at all clear, however, how it does this. The
Fed's argument that stock ownership makes banks feel favorably dis-
posed to the Fed is open to the rejoinder that what this amounts to, in
large part, is giving the banks stock ownership so that they will support

In 1974 it amounted to about three quarters of one percent of member bank net
For some banks with a slow growth rate, however, the after-tax yield on Federal
Reserve stock is high because the dividend on stock bought prior to 1942 is tax exempt.
But, in the aggregate only about 15 Dercent of the capital stock predates 1942. It is some-
times said that the 6 percent dividend should be compared with the earnings rate, not
on total bank assets, but on eouity capital. This is wrong. It seems to suggest that banks
"use their capital" to buy Federal Reserve stock. Actually. they use their general assets;
capital is just a book entry on the liability side of the balance sheet whose main purpose
is to provide a safety cushion for the FDIC and large denositors.
70 See William McChesney Martin in U.S. Congr. Joint Economic Committee, Monetary
Policy and the Management of the Public Debt, Replies to Questions. ... 82nd Congr.. 2nd
sess.. 1952, p. 262 ; Joint Reply by the Presidents in ibid., pp. 646-7 ; testimony of Karl Bopp,
in U.S. Congr. House, Committee on Banking. Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve A fter Fifty Years. Hearings, op. cit., p 424.
71 See the statement of Governors Mills. Robertson and Shepardson in i'id, p. 104.
2 See the testimonies of President Hayes and of William Kelly (of the American
Bankers Association). ibid., pp. 534 and 1916.
"7 See A. J. Clifford, op. cit., po. 369-70 and 390-91.
7, Staff Report in U.S. Congr. House. Committee on Banking, Currency and Housing.
Snbcommitee on Domestic Finance. The Federal Reserve After Fifty Years, Hearings,
op. cit., p. 1969.


the Federal Reserve politically. There is little justification for allow-
ing a government agency to obtain political support in this way.75
Another set of criticisms of stock ownership argues that it is con-
fusing to the public and provides an irrational facade with no real
significance. For example, former Governor Maisel stated that it
"makes no sense," and E. A. Goldenweiser referred to it as "essentially
a formality without corresponding powers or obligations." 76 And such
a facade can be costly. To the extent that the public takes the facade
seriously, it is less willing to accept policies that appear to result in
high interest rates. Thus some Congressmen have reported that the
seeming ownership of the Federal Reserve by banks causes some of
their constituents to believe that the Fed adopts tight money policies
to raise the income of banks rather than to stabilize prices.7 Hence,
while stock ownership by member banks may help the Fed to cement
relations with its narrow constituency, it hurts it in its relations with
the general public. And, given the widespread opposition to restrictive
monetary policies, the Federal Reserve should worry more about its
relations with the public than with banks.
It is therefore recommended, in accordance with the suggestion
of the Commission on Money and Credit, that Federal Reserve stock be
retired, and member banks be given simply a certificate of

The Board of Directors of each Federal Reserve Bank has nine
members. Three of these, the Class A directors, are officers of member
banks; three others, the Class B directors, are persons engaged in
"commerce, agriculture, or some other industrial pursuit." The three
remaining ones, the Class C directors, are appointed by the Board of
Governors. This arrangement was instituted in 1913 to provide a sys-
tem of checks and balances. The Class A directors, the bankers, are
balanced by the Class B directors who come from borrower groups,
while Class C directors serve as "neutrals." Although both borrowers
and lenders are on the Board of Directors they are supposed to repre-
sent, not the interests of their own groups, but rather, the public
interest. And Federal Reserve officials have frequently stressed that
these directors do, in fact, act as public servants, and not as representa-
tives of their interest groups.
The selection of the Class A and B directors is complicated. The law
stipulates that they be elected by t member banks. But actual practice
is different. While Class A and B directors are "elected" in a formal

SWith respect to the other intangible arguments of Chairman Martin, is there really
any evidence that stock ownership makes banks more willing to cooperate with the Fed?
As for nationalization of the Federal Reserve Banks. what is wrong with nationalizing
an agency that fulfills governmental functions? As regards stock ownership being a symbol
of Federal Reserve independence, this symbol, as discussed below, makes it more difficult
for the Federal Reserve to exercise its independence and carry out a restrictive policy.
And financial independence of the Fed is justified by the fact that this is genuinely needed
to preserve its independence, and not by a spurious reference to private ownership of
the stock. As Federal Reserve officials have made clear ownership of the stock does not
g've banks ownership of the Federal Reserve. Hence, it cannot be used to argue that the
Federal Reserve System should be financially independent of Congress since it is privately
76 Sherman Maisel. op. cit., p. 160; E. A. Goldenweiser, op. oit., p. 294.
77 Cee A. J. Clifford. on cit., p. 374.
78 Commission on Money and Credit, on. cit., p. 294. This is also suggested by Professor
Reagan, "The Political Structure of the Federal Reserve System," op. cit., p. 76.


sense, there is often only one name on the ballot." In imany Federal
Reserve Districts associations of bankers agree informally who is to
be on the ballot, while in at least one Federal Reserve I)istrict the Fed-
eral Reserve Bank president suggests a name. And it seems that Class
B directors are in many cases the choice of the Federal Reserve Bank
president. Hence, in many I)istricts it is not really true that the ma-
jority of the directors are chosen in a meaningful way by the member
banks. In these Districts it would be more accurate to say that the
Federal Reserve Banks. However, in at least one Bank, the directors
The directors, who normally serve for no more than two three-year
terms, have both administrative and policy-advisory duties. Their ad-
ministrative duty is a very important part of their job, at least in some
Federal Reserve Banks. However, in at least one Bank, the directors
spend most of their time on discussions of monetary policy.80 They
determine (within a range established by the Board of Governors) the
salaries of the Bank's top management. Since Federal Reserve Banks
are adopting a "management by objectives" system this means that a
committee of directors has to undertake an elaborate evaluation of
the president's performance. The criteria they use include his efficiency
in controlling costs, his effectiveness in public relations activities, and,
at least in some cases, also his performance on the FOMC.81 Directors
also pass on the budget, and on the audit, etc. To illustrate the admin-
istrative functions of the directors by an example, when one Federal
Reserve Bank, on the basis of an outside consultant's report, decided
to increase mechanization, and terminate the employment of more
than 10 percent of its staff, the directors advised the president on the
best way to do this. The business experience, and managerial talent of
the directors are useful to the Bank's president.
In addition, the directors also play a policy-advisory role. The
Board of Governors encourages the Banks to use their directors for
this. Thus directors, while they are not permitted to instruct the presi-
dent about his FOMC votes, do advise him.82 In addition, the directors
communicate their policy views to the Board of Governors, both in
formal joint meetings with the Board of Governors, and informally.
The Board of Governors has stated that the directors possess informa-
tion on emerging business conditions that is important and useful.83
However, at least one former governor does not share this view, and
believes that this information is worthless.84
The directors also "establish" the discount rate. But this is now a
very limited power, since the Board of Governors not only has to ap-
prove any change voted by the directors, but can also order the Banks
to change their discount rate within two weeks. Hence, the directors
79 Banks are divided into three size groups, and each group "elects" one class A and one
class B director. Since there are fewest banks in the largest size group, and most in the
smallest size group. it is not a situation of "one bank, one vote."
so According to Willis Winn, who served as director and chairman of the Philadelphia
Bank, directors spend only roughly 5 percent of their time on administrative tasks. ("The
Role of the Director: The Ideal vs. the Real." in David Eastburn (ed.), Men, Money and
Policy (Philadelphia, n.d.), p. 247.
81 The Chairman of the Board of Directors, of at least one Federal Reserve Bank,
evaluates the FOMC performance of the president by talking to various members of the
Board of Governors, as well as to FOMC staff.
8, Not only are the directors unable to instruct the president, they are not even told
what occurs at FOMC meetings until it is in the public record.
s3 Andrew F. Brimmer, "Characteristics of Federal Reserve Bank Directors," Federal
Reserve Bulletin, vol. 58, June 1972, p. 550.
84 Sherman Maisel, op. cit., p. 164.
62-748-76-bk. II- 3


have much more of an advisory, than a policy-making function, as
far as the discount rate is concerned.
Another important function of the directors, one not set out in the
law, is to generate public support for the Federal Reserve. Directors
and former directors defend the Federal Reserve's actions to their com-
munities. and they have ocncasionally been used for lobbyinlg. This
gives the Fed political strength."8
The structure of the Board of Directors can be criticized on several
grounds. One is that it is clearly outdated. It conceives of the Federal
Reserve as essentially a "banking" agency, so that it is important to
have both bankers and their customers fairly represented. But since
the Federal Reserve is not a banking agency, but is the most important
agency of macro-economic policy, this is an anachronism. And there
is no reason why bankers should elect officials of an economic stabiliza-
tion agency.
Second, the Board of Directors consists of the top echelons of the
American economy, and gives virtually no representation to other
groups. Thus Professor Keiser wrote: the Board of Directors "look
like a Who's Who of American Industry." 87 And, Professor Bach
alleged that directors tend to be conservative.88 A recent study cover-
ing the period 1950-1970 found that class B directors tended to come
predominately from large manufacturing firms: "In this 21-year pe-
riod not a single representative of a labor union, a consumer interest
organization, or a similar nonmanagerial or non-producer interest
group was a class B director.'"89 And it found the situation was not
very different for class C directors who: 90
share a narrow professional background. First, practically all class C rep-
resentatives, even those from the academic and communications sector, had
top managerial or "ownership" status . .. Second unions, consumer
groups and a variety of nonprofit organizations remain virtually unrepresented.
This narrow social and economic base of the directors has drawn a
great deal of criticism, particularly the absence of directors with a
labor union background.91 This is because, as pointed out above, the
directors do not merely administer the Federal Reserve Banks, but
also serve as policy advisers. According to one former director, they do
influence the Bank's president and "may help in the evaluation of the
weights to be assigned to different social or monetary goals. . *"
Consequently, the upper reaches of American society have here a chan-
nel to the Board of Governors and the FOMC. This should not be
interpreted as saying that the directors are concerned with the econom-
ic interests of a narrow segment of society. But while they do try to
represent the public interest, the public interest is amorphous and
looks differently to people in different circumstances.
s8 rbid., pp. 155-56.
s8 However, Maisel does not think that this helps the Fed very much, ibid., p. 137.
87 U.S. Congr. House. Committee on Banking, Currency and Housing. Subcommittee on
Domestic Finance. Compendium on Monetary Policy Guidelines and Federal Reserve
Structure, 90th Congr. 2nd sess.. 1968, p. 349.
8 Federal Reserve Policy Making, op. cit., p. 127.
89 Thomas Havrilesky. William Yohe and David Schirm, "The Economic Affiliations of
Directors of the Federal Reserve District Banks," Social Science Quarterly, vol. 54, Decem-
ber 1973. p. 611.
90W bid., p. 615.
91 However, the Federal Reserve has apparently tried to appoint labor union leaders,
and found them unwilling to serve as directors since they were afraid that such an appoint-
ment would be the "kiss of death" for them.
92 Willis J. Winn, op. cit., p. 248.


Another criticism is that the directors obtain inside information
which they can use in their business affairs. In fact, a Staff Report of
the Banking, Currency and Housing Committee has suggested that
this might be one inducement for serving on the Board of Directors."
However, the Reserve Bank presidents are supposed to avoid giving
the directors unnecessary inside information. And apparently, the use
of inside information is not a serious problem." Finally, the use of
directors, and former directors, to generate political support for the
Federal Reserve is open to criticism. Why should the Fed have this
instrument of political power? However, this is probably not a major
Thus, there are really two major problems with the present organ-
ization of the Board of Directors. One is that "election" by member
banks is archaic; the second is that the directors are not sufficiently
representative of the community. This second problem is insoluable. If
the directors are to provide useful managerial advice, and advice
about economic conditions, to the president, then they must be chosen
from the managerial class, and will necessarily be unrepresentative of
the larger community.
This inability of the directors to fulfill their two divergent roles
raises the question whether the Board of Directors should not be
abolished altogether.95 A Federal Reserve Bank is not like a usual
business corporation, and does not need directors. To a considerable
extent the Board of Governors functions as a Board of Directors since
it reviews the budget, as well as the salaries of senior management, and
generally supervises the Banks. Since the presidents find the advice
of businessmen and bankers useful in managing the Bank, they could
be given a management advisory council instead of a "Board of
Although this proposal sounds quite radical, it is not really so. To
a substantial extent the Board of Directors already functions as a
management advisory council. It differs from such a council in two
ways. One is that it does have some, albeit quite limited, influence on
monetary policy. The second is that it plays an important role in se-
lecting the president, and in fixing his salary.
Since the Board of Directors is very unrepresentative, and also gen-
,rally lacks technical expertise in monetary policy, there is no reason
fvhy it should have any influence over monetary policy.
If the directors are to function as a management advisory committee
hen there is little reason why they should participate in choosing the
resident and in fixing his salary.9 If the president were merely the
hief administrator of the Bank it might be justified. But the president
s more than that; as a participant in the FOMC he is an important
policy-maker. Hence, the presidents should be selected, and their
alaries fixed, not by the directors, but in ways described below.

3 U.S. Congr. House, Committee on Banking. Currency and Housing, Subcommittee on
omestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit., p. 317.
" See E. A. Goldenweiser. op. cit., p. 297.
5 According to Governor Robertson the use of a Board of Directors is not necessary,
iough it does have the advantage of being in accord with Federal Reserve tradition, and
'eserves a link between the Fed and member banks; it also provides the smaller banks
ith access to the Federal Reserve. (U.S. Congr. House. Committee on Banking. Currency
id Housing, Subcommittee on Domestic Finance, The Federal Reserve After Fifty Years,
earings, op. cit., p. 1361.
96 This is so particularly since there exists a rumor-which of course is hard to evaluate-
at some presidents are afraid of their Board of Directors.


Once it is decided to transform the Board of Directors into a purely
management advisory committee, there is no reason for keeping the
complicated system of class A, B and C directors. Instead, the presi-
dent could appoint his own management advisory council. It is there-
fore recommended that the Board of Directors be eliminated, and a
Management Advisory Council substituted in its place. Or, if it is
believed that keeping the term "director" would be useful in recruiting
management advisors, they might still be called "directors," but their
functions should be confined to advising the president on management
problems and on economic conditions in his District.
In addition to managerial advice the presidents should also obtain
guidance on policy trade-offs by contacts with people representative
of the general public. They should avoid a situation such as surfaced
in a Hearing, when a president stated that, while ,e had talked with
the Chamber of Commerce, he had not talked to labor organizations.7
It is therefore recommended that contact with a broad spectrum of the
public should be stressed more as one of the objectives of the presi-
dents. They should stress this part of their public relations activities
at the expense of talking before bankers and businessmen. Some presi-
dents may want to talk to various people informally, others may pre-
fer to meet with an advisory group composed of those whose views
they normally have little contact with. It would not be useful to man-
date an advisory council since no law can require someone to take ad-
vice seriously. However, the presidents should consider using a formal
advisory council.

The Federal Reserve Banks are primarily operating agencies; 95
percent of their personnel is engaged on "chore" functions, only 5
percent deal with policy."9 It is therefore reasonable to ask whether
they should not be turned entirely into operating branches of the Sys-
tem. Their major policy making and policy-advising functions con-
sist of their president's membership in the FOMC, their maintenance
of strong research staffs, and their channeling advice from their di-
rectors and from their local communities. The last of these has
already been discussed, and the membership of the presidents on the
FOMC is discussed below. This leaves the question whether they
should maintain strong research staffs.
On a superficial level it may seem desirable to have the System's
research functions centralized, rather than scattered all over the
country. But this is wrong. Not only are small organizations often
more efficient than large ones,99 but this appears to be particularly the
case with research. It seems, though this is a matter of personal im-
pression rather than anything that can be documented, that the optimal
size of economic research organizations is fairly small. Diseconomies
of scale soon occur. A research organization has to be more or less
hierarchial. But this has a serious drawback because it means that
any errors in judgment made by the senior staff can have very del-
eterious effects on the work of their subordinates. It is particularly
important in research where, after all, the sought-for product is to
7 Ibid., p. 407.
9 Willis Winn, op. cit., p. 247.
09 Sherman Maisel believes that the Federal Reserve Banks are more efficient than
,centralized government agencies. (op. cit., p. 163.)


some extent unknown, and the proper means of obtaiing it can only
be guessed at, to have a situation of freedom and independence. Onvly
this type of organization will attract first rate researchers. It is there-
fore better to have many independent centers of research than to
centralize all economic research at the Board of Governors.1
Moreover, it is easier for new ideas to penetrate one of thirteen sepa-
rate research organizations than a single large research unit. liBy lv-
ing thirteen separate research units the Federal Reserve is somewhat
less likely to be dogmatic than if it had only a single one. Furthermore,
having part of the research done outside Washington, and supervised
by twelve different presidents, rather than by the main policy-makers
in Washington, should help to prevent research from becomling sl f-
serving. There is always a danger that what is called "resclarch'! is
merely a search for justifications of positions policy-makers have taken.
Certainly, in recent years this has not been a problem at the Federal
Reserve, but even so, having part of the System's research done at the
Banks helps guard against the danger that a strong Chairman with a
like-minded Board might pervert research.
Another problem of Federal Reserve Bank organization is the posi-
tion of its president. It is anomalous. As Professor Michael Reagan has
put it, he is appointed privately, but is a public functionary. His posi-
tion is neither public nor private, but some of each.3 De jure he is a
public servant. But he is appointed by a Board of Directors which
has a majority of members at least formally elected by the private
sector, though his appointment is subject to the approval of the Board
of Governors. However, it seems that in practice the situation is osom. -
times reversed; on at least one occasion the Board of Governors has
asked a Bank to select a president from a list of candidates presented
to it.4 Having the president selected, in part, by the Board of Direc-
tors is hard to justify. The standard argument for it is that the class A
and B directors function as public officials rather than as representa-
tives of commercial banks and other private interests. But this argu-
ment does not meet the issue. What warrant is there for allowing mem-
ber banks to participate even indirectly in selecting public officials?
Do we allow, say, exporters, to decide who should be some of the senior
policy-makers in the State Department? Why do this for monetary
policy ? Surely, this is a vestige of the days when the Federal Reserve
was thought of at least partially as a cooperative enterprise of bankers.
On the other hand, it would also not be advisable to have the presi-
dents chosen by the Board of Governors. At FOMC meetings the
presidents should function as equals to the governors and as inde-
pendent voices. This is inconsistent with their appointment by the
1 And since the Federal Reserve occasionally appoints research teams from the Board
and from various banks to work jointly on particular problems, one of the potential advan-
tages of centralization, the availability of specialized personnel, already exists under the
present decentralized system, though it is not used very much.
2 See Edward Kane. "Statement" in U.S. Congr. House, Committee on Banking, Currency
and Housing, Subcommittee on Domestic Finance. Compendium on Monetary Policy Guide-
lines and Federal Reserve Structure, op. cit., pp. 343-44.
a U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit., p. 1581.
4Nowadays the presidents are professional central bankers, and the majority are
economists rather than bankers. Some presidents have been promoted from staff positions.


Professor Reagan has suggested that the presidents be appointed
like the governors by the President with the advice and consent of the
Senate.5 This would have the advantage of raising the prestige of the
presidents since they would then be appointed in a way similar to the
governors. But there is a danger here that these positions may become
subject to partisan political considerations, and that they would re-
quire clearance from the senior senator of the largest state in the
District. Both presidential appointment and senatorial consent would
place a premiumi on political contacts, and might make it difficult to
appoint an outstanding person from outside the District.
To avoid these difficulties, while keeping the principle of presi-
dential appointments the following system is recommended. When
a presidency becomes vacant the President should appoint a bi-
partisan committee charged with recommending three candidates to
him.6 lie would then select one of these candidates and submit his
name to the Senate. If tle Senate rejects this person he would suggest
his second, and if necessary his third, choices.7

One of the most controversial aspects of Federal Reserve organiza-
tion is the Federal Open Market Committee. It is indeed an anomaly
whose origin is explained by the fact that open market operations
were originally not considered a tool of monetary policy, but were
left to each Bank to use as a way of earning ing come.
The sharing of monetary powers between the Board of Governors
and the FOMC has both advantages and disadvantages. To start with
the advantages, we have first the fact that the FOMC provides
pluralism. It generates a hearing for different points of view, and
limits the unreasoned acceptance of ideas on the "that's the way we
al1 think" basis, something that is always a danger when decision-
makers talk to each other all the time. Having some members of the
FOMC whose daily contacts are outside Washington should help
to guard against the mutual infection with stale ideas which is a
danger in any bureaucracy.8
Furthermore, according to Professor Friedman:9
The Board in Washington is very much subject to a kind of political pressure
which the banks spread around the country are not. . The members of it . .
are directly connected with the political activities in the Capitol.
However, the governors, just because they do experience political
pressure more frequently, can build up some immunity to it.
In addition, there is the danger that the quality of the covernors
migh t decrease sometime in the future: that partisan political ap-
pointments may predominate. If this should occur, it may be useful
to have the presidents, with their longer terms of service, on the
Tbid., p 1 581.
6 Such a bipartisan committeo might well reflect the nartv comnosition of Connreqs.
Althoumh it is extremely unlikely. in nrinciple the Senate could reject all three candil
dates. In thifs ase the committee should select three more candidates.
8 Thus Governor Robertson pointed out that the Board members meet the same people
all the time. nnln tend to get into a rut. hIid.. p. 121.
o Tnid.. 1147.
10 James Knipe, The Federal Reserve and the American Dollar (Chapel Hill, N.C., 1965),
p. 213.


It is important to note that the effective length of service of the
presidents also softens the power of a two term President to appoint
ia majority of the Board." More generally, what the existence of tle
FOMC does is to interpose an additional barrier between the political
process and monetary policy. Not only are the governors appointed
to long terms, but they participate in appointing others who will
for many years join them in voting on monetary policy. It is there-
fore an important additional support for the Federal Reserve's
In addition the Federal Reserve has argued that the presidents
possess useful information on regional conditions, but that their ad-
vice will be really useful only if they have a vote on the FOMC, since
advice without responsibility is of little value.12 Perhaps this argu-
ment should be reinterpreted as saying that the governors would not
pay very much attention to the views of the presidents, if the presi-
dents did not vote.)
More generally, having a vote on the FOMC is needed to maintain
the presidents' interest in the FOM C, and makes it possible to recruit
qualified presidents and staff.13
However, it is not at all clear that the defenders of the FOMC are
correct in claiming that information on regional conditions is so
valuable. According to former Governor Maisel, its value is "close
to zero." 14 Furthermore, the advice given by nonvoting members of
the FOMC is in one way better than that offered by voting members.
Since FOMC members wish to minimize dissenting votes the voting
presidents are less willing than nonvoting presidents to advocate a
minority position. Hence, it is not clear that the net effect of having
the presidents vote actually does improve the quality of their advice.
Critics of the FOMC have raised a number of issues. Perhaps the
most prominent one is that the presidents are appointed by the di-
rectors, the majority of whom are elected by bankers. Hence, the
argument runs, bankers have a powerful-and entirely unwar-
rented-voice in monetary policy. However, as was pointed out above,
currently the presidents owe their jobs to the Board of Governors
as well as to the directors, and besides the class B directors are often
not really chosen by bankers. But all the same, the directors' influ-
ence in selecting the presidents is large enough for former Governor
Maisel to oppose having the presidents on the FOMC.15 However, if
the proposal made here about the appointment of presidents is ac-
cepted this would no longer be a problem.
Yet a significant issue would still remain. What is important is
not only who appoints the presidents, but who the presidents are
in daily contact with. One's contacts surely shape one's social and
political sympathies and policies. The governors, while they do make
many trips to the rest of the country, are largely in contact with the
political community in Washington. The presidents, on the other
11 See Edward Kane. "The Re-Politicization of the Fed." op. cit., p. 744.
12 See for instance the testimony of President Hayes in U.S. Coner. House. Committee
on Banking. Currency and Housing. Subcommittee on Domestic Finance, The Federal
Reserve After Fifty Years, Hearings, op cit., p. 528.
13 See the testimony of President Bryant. ibid.. p. 490. and the Statement bh Professor
Okun in U.S. Congr. House. Committee on Banking. Currency and Housing, Subcommittee
on Domestic Finance, Compendium on Monetary Policy Guidelines and Federal Reserve
Structure, op. cit., p. 82.
14 Sherman Maisel, op. cit., p. 162.
15 Ibid., p. 160.


hand, though they do talk to other groups too, have most of their
contacts with the banking and financial communnity. Hence, one would
expect the two groups to have at least somewhat different outlooks.
Furthernmore, as Professor Eckstein has pointed out, the presidents
are. selected in good part for their administrative abilities rather
than for their jud gment on monetary policy.1, Hence, one would
expect them to be less capable monetary policy makers than the
governors are.
Besides, the present system is one which splits the policy tools
between two agencies. The Board determines reserve requirements,
and has (essentially) control over the discount rate, and over various
minor tools, while it has to share control over open market operations
with the presidents on the FOMC. According to Professor Reagan
there is general agreement that this division of authority is bad.17
To be sure, the Federal Reserve has argued that there is really no
problem of coordination since the use of all tools is discussed by
the FOMC. But former Governor Maisel has pointed out that this
causes decisions on the use of all tools to be delayed until the next
FOM( mieeting, and limits their use on a continuous basis.,1
In addition, FOMC meetings are large and potentially cumber-
some. Hence, the Chairman has to keep them to a tight schedule, and
this limits discussion.19 And, rightly or wrongly, it has been asserted
that information leaks out.20
Another criticism of the FOMC is that the presidents impart a tight
money bias. According to Sherman Maisel: 21
While the range of value judgments of the presidents is as wide, its center
position is considerably more restrictive than that of the Board. There are many
possible reasons for this tilt. The selection process for the presidents emphasizes
more conventional and conservative characteristics. Perhaps the Board is too
close to the politicians in Washington or perhaps the presidents are too close to
commercial bankers in the field.
On the other hand, Congressman Reuss and Professor Bach believe
that there is little consistent difference between the Board and the
presidents.22 This disagreement is hard to resolve. A statistical study
of voting records shows that in the 1955-1959 period the presidents
favored easier policies than the governors, but in the 1960-1965 period
the opposite was the case.2" Looking at the most recent period,
January 1960-May 1975, the presidents on the average favored tighter
policies than the governors. But one has to be careful with this result.
Since dissenting votes are so rare, only a quite limited number of
cases of dissent are available. (The sheer size of the FOMC meetings,
with governors, presidents and many staff members present generates
16 "Statement" in U.S. Congr. House, Committee on Banking, Currency and Housing,
Compendium on Monetary Policy Guidelines and Federal Reserve Structure, op. cit., p. 153.
17 "The Internal Structure of the Federal Reserve : A Political Analysis," op. cit., p. 386.
s1 Sherman Maisel, op. cit., p. 160.
19 Cf. Maisel, ibid., p. 160.
20 Sanford Borins, "The Political Economy of 'The Fed,' Public Policy, 1972, p. 186;
Willis Winn, op. cit., p. 247.
1 Sherman Maisel. op. cit., p. 162.
22 G. L. Bach. Making Monetary and Fiscal Policy, op. cit., p. 179; Congressman Reuss
in T.S. Congr. House, Committee on Banking. Currency and Housing, The Federal Reserve
After Fifty Years, Hearings, op. cit., pp. 1488-89. See also C. Walker (ibid., p. 1888).
"2 See E. R. Canterbery, "A New Look at Federal Open Market Voting." Western Economic
Journal, vol. 6, December 1967, pp. 33-35. (This tabulation counts not only formal votes,
but also expressed, though unrecorded, dissents.)


a tendency towards conformity.) Hence what appears to be a pref-
erence for restrictive policies by the presidents might possibly be the
result of sampling error.
A quite different criticism is that the presidents tend to go along
with the decisions of the governors. Thus, the record shows that in the
most recent period presidents have dissented from the majority posi-
tion less frequently than governors, though this too could perhaps
just reflect the limited sample.24 Insofar as this is not a sampling acci-
dent, and presidents do dissent less frequently this could be due to a
tendency, detected by Professor Robertson, of their deferring to Board
members.25 Professors Hasting and Robertson have suggested that
since the presidents depend upon Board approval serious opposition
cannot be expected from them.2" And Professor Robertson has pointed
out that the Board would not approve unorthodox people as
Whatever the reason, in the period January 1960-May 1975 there
has never been a case where a majority of the governors were out-
voted by the presidents, though, of course, the presidents may have
had a great deal of influence on the Directive during the discussion."8
This is so particularly since there were some cases in which three
governors dissented. It is not unlikely that, had the votes been con-
fined just to the governors, the Directive would have been changed to
avoid a four to three split.
In view of these criticisms it is not surprising that many observers
believe that the FOMC should be abolished, in the sense that only the
governors should vote on open market operations. This has been advo-
cated by the Commission on Money and Credit, by the Hoover Com-
mission and by others.29
But, as pointed out above, there are a number of arguments, some
of them quite substantial, on the other side too. Probably the three
most important issues in this debate are, on the one side, the ability of
the presidents to introduce new points of view, and on the other side,
that these views are influenced by the local financial communities.
Third. there is the fact that the presidents are further removed from
the political process and control than are the governors-which ap-
peals to some people, but not to others. All in all, neither side in this
debate has succeeded in making a preponderate case, particularly, if
as recommended above, the presidents are officially appointed by the
21 See also William Yohe, "A Study of Federal Reserve Open Market Committee Voting,
1955.--64," outhern Economic Journal, vol. 32. April 1966, pp. 396-405.
25 U.S. Congr. House, Committee on Banking. Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit., pp. 1362-63.
o2 Ibid., p. 1522.
2 Ibid., p. 1363.
2 There was one case where a majority of the governors were in dissent from the
majority position. But two of them wanted an easier policy, one wanted a tighter policy,
and one objected to the way the Directive was formulated.
29 Commission on Money and Credit, Money and Credit, op. cit., p. 90: Commission on
the Organization of the Executive Branch. op. cit., p. 113; Michael Reagan, "The Political
Structure of the Federal Reserve System," on. cit., p. 72: Clark Warburton in U.S. Congr.
House. Committee on Banking, Currency and Housing. The Federal Reserve System After
Fifty Years, Hearings, op. cit., p. 1319. Professor Samuelson has suggested (ibid., p. 1109)
that at most the president of the New York Bank, and one other president (in rotation)
should be allowed to vote on open market operations.


Finally, the opinion of Dr. Arthur Okun is worth noting:30
Abolition of the FOMC would probably produce a drastic change in the char-
acter of the Federal Reserve System, with results that are rather difficult to
predict. For this reason we are hesitant to recommend abolition of the FOMC,
even though we can see some advantages in it. As an alternative . Congress
should consider making Reserve Bank presidents subject to Presidential appoint-
ment and Senate confirmation.
However, the argument that abolition of the FOMC could drasti-
cally change the Fed is open to the objection that such a drastic change
may be desirable. If one believes-as has been persuasively urged-that
the Fed has done a poor stabilization job in the past then drastic
change may indeed be welcome.
Apart from the question of whether the presidents should vote in
the FOMC(, there are three other aspects of the FOMC that should be
discussed. One is the number of votes possessed by the presidents. They
now have five votes compared to the seven for the governors. This is
not sacrosanct, and anyone who is somewhat concerned about the presi-
dents voting on the FOMC, but not concerned enough to want to
abolish the FOMC, may want to reduce their voting strength, to, say,
Another issue concerns the rotation of the presidents. Currently the
New York Bank president is a voting member every year. but most of
the other presidents vote only every third year. It is not clear that the
New York Bank should have a permanent vote. One reason given is
that it is this Bank that actually carries out the open market opera-
tions. But, while this is a good argument for having the New York
president attend all FOMC meetings, this does not entitle him to a
permanent vote. Nor is it persuasive that the New York Bank is the
largest one. A superior argument is that the New York president is
probably better informed about the financial situation than are the
other presidents since he is in close contact with the main money
market of the country. But such contact can also generate myopia. To
some extent, the permanent vote for the New York president is a resi-
dual from the days when the New York Bank was much more power-
ful than it is at present.31 The question whether or not the New York
Bank president should always be a voting member is more than just a
technical issue. Institutional factors tend to make him favor an operat-
ing strategy that places much more emphasis on interest rates than
on aggregates such as the supply of money. Since this choice of
strategy is extremely important, one's attitude towards depriving him
of his permanent vote may be heavily influenced by one's attitude on
this issue.32 It is therefore recommended that the appropriateness of
the permanent vote for the New York president be reexamined.
Since the eleven other Banks divide four FOMC votes between them,
two Banks are given a vote every second year, while the others vote
only every third year. These two Banks are the Chicago and Cleveland
Banks. Given the importance of the Chicago money market one might
3 T.S. Congr. House, Committee on Banking, Currency and Housing. Subcommittee on
Domestic Finance. Compendium on Monetary Policy Guidelines and Federal Reserve
Structure, op. cit., p. 82.
n1 Perhaps it also reflects the days when it was felt that the Committee was using funds
belonnine to each Bank, so that the largest bank deserved more influence.
32 In addition, in the postwar period the New York Bank president has typically favored
a more restrictive policy tnan the rest of the FOMC.


argue for its greater voting power in the same way as for the New
York Bank. But it is hard to see why the Cleveland Bank should have
a greater vote too, just because of its proximity to the Chicago Bank.
Surely San Francisco is a more important money market than Cleve-
land. It is therefore recommended that, if the New York Bank's
permanent vote is kept, the San Francisco Bank, rather than the
Cleveland Bank, have a rotating vote with the Chicago Federal Re-
serve Bank.
A third issue that should be reexamined is the rotation of the presi-
dents. Instead of giving most presidents a full vote every third year,
they could be given a one third vote every year instead.33 One of the
reasons the Federal Reserve gives for having the presidents vote is
that the responsibility of voting improves the advice they render on the
FOMC. But what about their advice in those years when they do not
vote ? Perhaps a one-third vote is as effective as a full vote in inducing
the presidents to prepare themselves for FOMC meetings.
Furthermore, at present, the rotation of presidents can change the
character of the FOMC. Some people in the System therefore speak of
liberal, or conservative FOMC's. Having all presidents vote would
eliminate such unwarranted shifts.
And there is also a legal issue. Representative Patman has argued
that, contrary to law, all presidents are really on the FOMC since they
all attend the meetings and partake in the discussion.34 The Federal
Reserve response to this has been that only those presidents who cur-
rently vote are members of the FOMC, and that the others attend only
in an advisory capacity. But this is questionable. Much of the im-
portant work of the FOMC does not show up in the voting process.
The FOMC usually does not function by the majority imposing its
will on the minority; rather in formulating the Directive there is an
attempt to attain as much of a consensus as possible. Dissenting votes
are rare. In formulating the consensus that becomes the Directive, the
Chairman of the Board presumably pays at least some attention to the
comments of all presidents, and not only to those that are voting mem-
bers. Insofar as this is the case all presidents have an impact on policy,
regardless of whether or not they are voting members. In fact, given
the strong tendency of the FOMC to reach for a consensus, one might
argue that participation in the discussion is as much, or more, im-
portant, than participation in the voting. Consequently, the Federal
Reserve's answer to Representative Patman is inadequate. Yet, if the
FOMC is to be preserved in its present form, there are good reasons
for having all the presidents in attendance.
It is therefore recommended that instead of most presidents voting
every third year, they should have a fractional vote every year. This
fraction could be set at one third. However, if, as recommended below,
the size of the Board of Governors is cut to five members, then (if the
New York Bank keeps its full vote) a one third vote would probably
be too large since it would give the presidents equal representation to
33 James Knipe (op. cit., p. 213) recommends giving presidents a permanent half vote.
This would give them almost as much voting power as the governors.
4 See U.S. Congr. Joint Economic Committee, Recent Federal Reserve Actions and
Economic Policy Coordination, op. cit. p. 407.


the governors.35 Hence, under these conditions they should probably
be given a one quarter vote.36


Discussions about reforming the Board of Governors have dealt
mainly with the proper size of the Board and its tenure, and with the
position of the Chairman. However, the method of appointing the
governors should also be discussed.


Very many observers have expressed an opinion about the proper
size of the Board, and generally this opinion has been that it should be
reduced. For example, the Commission on Money and Credit recom-
mended a five member Board, while the Hoover Commission preferred
a three member Board.37 A Staff Report of the Joint Economic Com-
mittee also wanted consideration given to a reduction in the Board's
size.8 And this reform has been supported by former Federal Reserve
Chairman McCabe, as well as by numerous others.39 Relatively few
people have defended a seven man Board, though they include former
Chairman Martin.40
The considerations that suggest cutting the size of the Board are
that this would raise each governor's prestige, and hence these posi-
tions would attract better qualified people. And also, with a smaller
Board fewer candidates for governorships would be needed. In addi-
tion, decisions could be made more promptly, and each governor's
contribution to the debate would carry more weight since he would
have a larger share of the total vote. On the other hand, there would be
the absence of that greater wisdom which may result from a larger
Board.41 Furthermore, the workload imposed on the governors is large,
and-unless their bank supervisory duties are cut-there would be,
given the way the board currently functions, too much work for a
smaller Board. However, this great workload results, in part, from the
fact that the Board is reluctant to delegate more authority to indi-
vidual governors. The Board could delegate more regulatory authority

3a They would actually have a slightly greater vote than the governors. If a president
cannot attend a FOMC meeting he sends his first vice president. But if a governor misses
a meeting he does not send a deputy in his place.
38 This scheme does, however, leave one problem unresolved. This is that the presidents
do not have a vote on the use of the other tools of monetary policy. But as far as discount
rate changes are concerned each president has at least some influence on the discount rate
set by his own bank. This leaves reserve requirement changes. Perhaps this tool should be
vested in the FOMC.
37 Money and Credit, op. cit., p. 87; Commission on the Reorganization of the Executive
Branch, op. cit., p. 114.
38 U.S. Congr. Joint Economic Committee, Staf Report on Employment, Growth and the
Price Level, 86th Congr., 1st sess., 1960, p. 409.
39 See A. J. Clifford, op. cit., p. 227; New York Clearing House Association, The Federal
Reserve Reexamined (New York, 1953), p. 139; E. A. Goldenweiser, op. cit., pp. 300-304:
G. L. Bach, Federal Reserve Policy Making, op. cit., p. 224; Michael Reagan, "The Political
Structure of the Federal Reserve System," op. cit., pp. 75-76. A survey of monetary
economists shows a substantial majority for reducing the size of the Board. See U.S. Congr.
House, Committee on Banking, Currency and Housing, Compendium on Monetary Policy
Guidelines and Federal Reserve Structure, op. cit., p. 26.
40 Ibid., p. 46. Presidents Hickman and Irons also opposed cutting the size of the Board.
U.S. Congr. House. Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit., pp. 137 & 845.
41 It also been argued that with a smaller Board there would sometimes not be a quorum.
But an effective chairman should be able to ensure the attendance of a sufficient number of


to individual governors so that, for example, not all governors would
have to read through the voluminous submissions on merger cases. And
it could delegate some authority to its staff-though this may require
new legislation. Moreover, it is recommended below that more au-
thority be delegated to the Reserve Banks. Another argument for a
seven member Board is that, in addition, if some governors are not
carrying their weight this is less of a problem with a large Board than
with a small one.
An additional aspect that should be considered is the impact of
cutting the Board's size on the Chairman's position. On the one hand,
it would raise his power since his vote would now represent a larger
proportion of the total vote. On the other hand, by raising the prestige
of Board membership in general, it would reduce the Chairman's
relative prestige, and hence his suasion over the Board.
While most of the arguments are plausible, none are really convine-
ing. But since apparently the great majority of observers believe that
cutting the size of the Board to five members, is desirable, this course
of action can be-with some hesitation-recommended, if the super-
visory workload of the Board is cut.
A more significant issue is the length of the governors' terms. Many
observers prefer much shorter terms.42 There seems to be substantial
majority support for this among monetary economists, and Chairman
Martin too has given a rather cautious blessing to this proposal.43 One
major advantage is that shortening the term would eliminate from the
Board those who have grown stale and inefficient.4
On the other hand, it would make governorships less attractive, and
would involve a continual replacement of governors who have learned
the job with those who have yet to learn it. Another problem is that
with a shorter term, towards the end of his term a governor might look
over his shoulder at potential business or academic employers. If reap-
pointment would be allowed, so that one potential employer would be
the President, then the Board could become more subject to the Presi-
dent's wishes. And since the President is likely to be strongly influenced
by the Chairman's evaluation of a governor, it would make the gover-
nors more dependent on the Chairman's goodwill.
And this brings us to what is a central issue in the dispute. Shorten-
ing the terms of office, even if reappointment is not permitted, would
strengthen the President's control over the Federal Reserve since each
President would appoint more governors. Obviously opinions differ on
the desirability of this. Under present circumstances it would be de-
sirable. But if the above proposal to allow the President to set the Fed's
goals every two years is accepted, then the President would have suf-
ficient control over the Fed. Giving him a further leverage by reducing
42 See, for instance, Commission on Money and Credit. op. cit., p. 87 ; Professor Paul
Samuelson in U.S. Congr. House, Committee on Banking. Currency and Housing. Sub-
committee on Domestic Finance, Hearings, op. cit., pp. 1106-109; Governors Deane and
Mitchell (ibid., pp. 1180 & 1202; Professor Ross Robertson (ibid., p. 1359) ; and Dr. Clark
Warburton (ibid., p. 1341).
43 See also the responses of economists tabulated in U.S. Congr. House. Committee on
Banking, Currency and Housing. Subcommittee on Domestic Finance. Compendium on
Monetary Policy Guidelines and Federal Reserve Structure, op. cit., p. 26: U.S.C. Congr.
Joint Economic Committee, Monetary Policy and the Management of the Public Debt,
Replies to Questions . op. cit., p. 301
4 In any organization, there is a tendency for the less effective members to be least
likely to resign, since they are less likely to receive tempting outside offers.


the terms of office would then be undesirable because of the danger of
partisan political influence.
Finally, it should be noted that this discussion is in a way unrealistic.
Very few governors serve out the current 14 year term. The average
length of service up to 1967 was seven years.45 Hence. it may seem that
a reduction to, say, six years would not be a very great change. But this
is not the case because a significant number of governors have served
much longer than seven years. 4
The fact that the average term of office is only seven years, rather
than close to the fourteen year maximum provides ammunition both for
those who want to cut the maximum length of the term, and for those
who do not. The former can argue that with a seven year average, and
a fourteen year maximum there is room for a wide variance in the
length of time which governors actually serve. Hence, one President
may be fortunate and find that he is able to make many appointments to
the Board. while another President may be much more limited in the
number of governors he appoints. There is no reason why the influence
of Presidents over the Federal Reserve should vary in this completely
arbitrary way. Cutting the maximum length of the term would reduce
the variation in the time actually served. On the other hand, opponents
of cutting the length of terms can argue that the seven year average
length of service means that, on the average, a President is able to
appoint a majority of the governors by around the start of his second
term, and that this gives him sufficient influence.
It is not easy to choose sides in this debate. The most important issue
is how much influence the President should have over the Board. If,
as recommended here, he is given the power to set its goals every two
years, then even with the present fourteen year maximum term, he
would have sufficient influence. But if this recommendation is not put
into effect, then cutting the maximum length of the term to, say, ten
years is probably justified.
There are two other aspects to the appointment of governors. At
present, the terms expire on January 31 of even numbered years. Hence,
a new President might have to wait up to a full year before a vacancy
on the Board occurs. It is therefore recommended that the terms be
changed so that they expire, say. in March of odd numbered years.47
To prevent such a system from drifting off base, it would be necessary
to require that when a governor retires prior to the expiration of his
term. the successor is appointed to the unexpired part of that term, and
not to a full term. Admittedly, this would have two disadvantages.
First. if a governor resigns shortly before his term expires it may be
difficult to find a qualified candidate to accept such a short term posi-
tion. And second, the new appointee might not serve long enough to
learn how to do his job efficiently. But these disadvantages are not
strong enough to outweigh the advantage of having the President
appoint at least one governor at the start of his term.
45 See Mary Ann Clements, "Appointive Board Members, Average Tenure," unpublished
manuscript. p. 3.
4 Suprisingly. it made virtually no difference to the length of the term actually served,
whether a governor was appointed to a full term, or to the unexpired part of his prede-
cessor's term. Ibid., p. 3.
47 See the Statement of the (1968) Council of Economic Advisers in U.S. Congr. House,
Committee on Banking. Currency and Housing, Subcommittee on Domestic Finance,
Compendium on Monetary Policy Guidelines and Federal Reserve Structure, op. cit., p. 82.



The chairman holds very substantial power over the Board. Thus,
former Governor Maisel attributes 45 percent of the influence inside
the Federal Reserve to the chairman, compared to 20 percent for all
other governors combined,48 and even this may understate the chair-
man's relative power. He attributes this power to: (1) the chairman
being the titular head and spokesman for the System, (2) his represent-
ing the System in decisions that never reach the board, (3) the inherent
powers of the chairmanship, such as setting the agenda, (4) the dele-
gation by the Board of supervisory powers over the staff to the chair-
man, and (5) the fact that the power he thus possesses serves to attract
additional votes at Board and FOMC meetings."
This concentration of power in the chairman's hands is unfortunate.
A major reason for having a seven member Board, rather than a single
individual heading the System, is to avoid concentrating so much
power. And yet, even with a seven member Board power is heavily con-
centrated.s5 The disproportion in the power and influence of the Chair-
man and of other governors is probably one reason for there being
little dissent; the other governors and the presidents "go along" with
the Chairman. As Representative Reuss put it: 51
It is a pretty monolithic board. There is no disagreement within the Board,
apparent to the public, at the time decisions are made. Yet on the outside, a great
many very respected, and by no means radical, economists and financiers may
differ very deeply with the Fed.
This probably results in insufficient consideration of alternatives,
in a reluctance to admit errors, and in inadequate public discussion.
But while it would therefore be desirable to reduce the chairman's
influence over the Board this is not easy. One possible solution would be
for the President to appoint governors who not only have strong per-
sonalities, but also hold points of view which differ sharply from the
Chairman's. In this connection it is disturbing to note that, at least the
economists among the governors seem to have fairly similar points of
view. Thus, despite the substantial importance of the monetarist school
in the economics profession, there is no monetarist on the Board. But
unfortunately, this tendency of the President to appoint governors
with views similar to the Chairman's is likely to persist. If the chair-
man is the President's own appointee, he probably reflects the Presi-
dent's views, and in appointing other governors, the President is likely
to select people who have this same viewpoint. And even if the
chairman is the appointee of a previous President, the President would
usually seek his advice in making new appointments. By giving in to
the President on some issues a Chairman can probably obtain enough
of the President's goodwill to be able to block the appointment of
governors who sharply disagree with him.
Another possible way of lowering the chairman's power would be
to institutionalize a node of opposition on the Board by mandating a
SOp. cit., p. 110.
49 Ibid., pp. 123-29.
50 Furthermore, the limited power of the other governors relative to the chairman's
makes it harder to recruit qualified governors. But, on the other hand, if the governors
have less power their qualifications are less important.
5 U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit, pp. 116-17.


bipartisan Board. But, as discussed above, this proposal has serious
weaknesses. A third possibility would be to have the chairmanship
rotate among the governors. But this proposal is open to the objection
that some governors may lack the necessary administrative and public
relations skills. Furthermore, it is far from clear that all governors
should be equal. While this would make the governor's job more at-
tractive, the attraction of the permanent chairmanship could no longer
be used to recruit an outstanding person.
Since these fundamental solutions to the problem have major draw-
backs one has to rely instead on a series of minor reforms. Three minor
changes are therefore recommended: First the other governors should
function more as the spokesmen for the System. Specifically, Congress
should resist the temptation of always wishing to confer with the "top
man," invite other governors to testify more frequently, and rely less
on the chairman's testimony. To some extent, various governors spe-
cialize on particular problems, e.g. international finance, bank regula-
tion etc., and they, rather than the chairman, should be invited to
testify on these issues. Second, fewer decisions should be made by the
chairman on his own, and more problems should be taken up by the
whole Board. This would be feasible if, as suggested below, the regula-
tory workload of the Board were reduced. Third, the Board should
consider delegating supervision over the staff to the vice-chairman, or
to a committee of governors rather than to the chairman.52
Another important issue relating to the chairman is whether his four
year term as chairman should be coterminous with that of the Presi-
dent. At present it is possible for a President to be saddled with a
chairman he opposes for virtually his whole first term. It has there-
fore been proposed by the Commission on Money and Credit and by
the Hoover Commission that the chairman's (and vice-chairman's)
terms should start shortly after the President's inauguration, and the
Hoover Commission has further recommended that the chairman serve
at the pleasure of the President.53 A survey of economists has over-
whelmingly supported making the chairman's term coterminous with
the President's.54 As Representative Windall has said "I don't think
there is too much disagreement" about this, and Sherman Maisel too
has written that "there is no debate" about it.55
However, it is not at all clear that making the chairman's term
coterminous with the President's would necessarily increase the Presi-
dent's influence over the Federal Reserve. This is so, because if the
President, shortly after the beginning of his second term reappoints, or
newly appoints, the chairman, this chairman now knows that his re-
appointment will never again be passed upon by this particular
President. On the other hand, if the President is saddled with an "old"
chairman for virtually all his first term, then when he finally does
;2 Finally, it is worth noting that the proposal to have the chairman serve at the
pleasure of the President would raise the chairman's prestige by linking him closer to the
person elected by all the people. This is a weakness of that proposal.
5: Commission on Money and Credit, op. cit., p. 87; Commission on the Organization of
the Executive Branch. op. cit., p. 112.
SU.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, Compendium on Monetary Policy Guidelines and Federal Reserve
Structure, op. cit., p. 26.
U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Pomestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit., p. 1691;
Sherman Maisel. op. cit., p. 160.


get to appoint his own chairman, this chairman has to worry about
being reappointed virtually throughout the President's second term.
But despite this uncertainty, is is probably desirable to have the cliair-
man's term coterminous, so that the chairman is someone the President
can work with easily. Similarly, to obtain a smooth working relation-
ship between the chairman and the vice-chairman it is also recom-
mended that the vice-chairman's term too be coterminous.56

Beyond these much discussed issues of size of the Board, the tenure
of governors, and the chairman's term, there is a fundamental issue
that should be taken up. This is the President's role in appointing gov-
ernors. The President, as the Chief Magistrate, should certainly have
a very substantial role in this. But there is always the danger that he
will appoint someone to repay a political debt, either to this person, or
to a group with which he is identified. Furthermore, the President
might be tempted to appoint governors who would allow partisan
political considerations to influence their policy decisions. Hence, as a
precaution, the President's power to appoint governors should be cir-
cumscribed. It is therefore recommended that, with the exception de-
scribed below, when a governorship becomes vacant, the same commit-
tee previously described in connection with the selection of a Reserve
Bank president, recommend three candidates to the President. The
President then selects one of these candidates, and submits his name
to the Senate. The exception to this relates to the chairman. To give
the President his own chairman he should be allowed to select, without
the intervention of the above committee, his choice for the first gov-
ernorship to become vacant. He could then, with the advice and con-
sent of the Senate, appoint his choice either as the chairman, or he
could select a chairman from amongst the previous governors.
Regardless of whether or not this proposal is adopted the law de-
scribing the qualifications of the governors should be changed. Cur-
rently, the President is required to give "fair representation" to "finan-
cial, agricultural, industrial and commercial interests and geographic
divisions of the country." This is an archaic remnant from the days
when the Federal Reserve was considered a "banking agency." It is
therefore recommended that this provision be abolished. If it is de-
sired, for some reason, to set out legal qualifications, they should be
framed in terms of familiarity with the problems of monetary policy
or bank regulations.57 Similarly, it is recommended that the prohibi-
tion of more than one appointment from each Federal Reserve District
be eliminated. It is unnecessarily restrictive. A President has, in any
case, a political incentive to give adequate representation to various
6 It has frequently been suggested that the President upon inauguration should be able
to appoint a new member to the Board so that in choosing a chairman he is not confined to
the current governors. The recommendation made above regarding the terms of the
governors would provide for this.
7 If the earlier recommendation that the President set the goals is accepted, then the
representativeness of the Board would not matter so much, since the President, and not
the Board, would make the major value judgments.

62-748-76-bk. II- 4


This leaves one other component of the Federal Reserve to be
discussed, the Federal Advisory Council, which consists of one banker
from each Federal Reserve District, usually an officer of a large bank.
This council is purely advisory. It was set up in 1913 as a consolation
prize to bankers, who were denied the control over the Board of
Governors which they wanted. Despite this origin it has turned out to
be a useful organization, since it gives the Board an insight into bank-
ing problems, and into business conditions in various Districts. Hence
it should be kept. One might, of course, object to it because it provides
the large banks with access to the Board.58 But the large banks would
have this in any case.
However, a number of prestigious critics, including the Commission
on Money and Credit, former Chairman Eccles and Professor Reagan,
have suggested that the Council is too narrowly constituted; that it
fails to provide access to the Federal Reserve for other groups besides
bankers that are powerfully affected by monetary policy.59 And it is
certainly true that the income of, say, builders depends more on mone-
tary policy than does the income of banks.
But, rather than change the Federal Advisory Council, it would be
better to set up an additional council, one which is representative of
various sectors of the economy. It is therefore recommended that the
Federal Reserve consider setting up such an advisory council.


Apart from its monetary policy functions the Federal Reserve is
also one of several bank supervisory and examining agencies. And its
supervisory tasks are growing. Not only has its control over holding
companies been extended in recent years, but it has also had con-
sumerist duties thrust upon it, e.g. supervising truth-in-lending regu-
lations. In general, the Federal Reserve shares bank supervisory duties
with the Comptroller of the Currency, the FDIC and state banking
authorities. Despite substantial coordination between these agencies,
the resulting picture is one of unreasonable and untidy overlapping. It
allows for "competition in laxity" as various supervisory agencies
strive to enlarge their share of the banking industry. (Whether or not
one considers this to be desirable depends primarly on whether one
thinks that banks are overregulated or underregulated at present.) In
addition, there is the possibility of conflicting standards employed by
various supervisory agencies. And, despite substantial coordination in
examining banks there still exist some costs to this overlap.60 On the
s Moreover, the Federal Advisory Council can. unfortunately, also be used for lobbying.
Professor Kane ("The Re-Politicization of the Fed," op. cit., pp. 746-47) has described
how the Fed used it to oppose an auditing bill. This may suggest that the FAC should be
abolished. Tut, as Professor Kane pointed out, bankers are in any case sensitive enough
to Federal Reserve pressure to become lobbyists for it. Since the Fed has great regulatory
power over them they have an incentive "to score points with the Fed."
59 See Commission on Money and Credit, op. cit., p. 89; Eccles in U.S. Congr. Joint
Economic Committee. Review of the Renort of the Commission on Money and Credit, Hear-
ings, op. cit., p. 44: Michael Reagan in U.S. Congr. House, Committee on Banking. Currency
and IHousing. The Federal Reserve After Fifty Years. Hearings, op. cit., p. 1579. See also
the testimony of Professor Shapiro and Nathan Goldfinger in ibid., pp. 1102 & 1480.
60 The Comptroller of the Currency regulates and examines national banks, the Federal
Reserve state member banks and the FDIC state nonmember banks. The Federal Reserve
also regulates and examines bank holding companies.


other hand, it does serve to diffuse power. In 1913 when monetary
policy was thought of primarily as "banking policy", in the sense that
policy wasna thouIh t tylVes
maintaining a sound banking system that would make the right types
of loans was of the essence of monetary policy, it was natuiral tliat
the agency charged with monetary policy was also charged with bank
supervisory functions. But nowadays we know better; we know that
monetary policy is very different from bank supervision.
It is not surprising that a number of observers have advocated that
the Federal Reserve relinquish all regulatory functions and concen-
trate on monetary policy. This has been advocated by Governor
Robertson as well as an advisory committee to the Comptroller of
the Currency.61 And Professor Whittlesey wrote that "That clear-
cut separation of monetary policy from supervision would probably
be endorsed by most observers." 62 On the other hand, Professor Bach
and the Cominission on Money and Credit recommended that all
Federal banking supervision be concentrated by housing them in the
Federal Reserve.63
One obvious advantage of eliminating the Fed's supervisory tasks
is that this would give the governors more time for their central task,
making monetary policy. Some governors have complained that they
are now inordinately busy. Since bank supervision takes up a substan-
tial amount of time, one can well argue that the elimination or reduc-
tion of supervisory chores would result in a more effective monetary
policy.64 We currently expect governors to be experts in two fields,
monetary policy and bank supervision. Given the immense amount
of material published in each of these fields, it is questionable whether
governors can "keep up" with both fields. On the other hand, former
Governor Maisel has argued that time is not a serious problem, that
he had sufficient time to devote to monetary policy."5 But this may well
be a minority position. Furthermore, the type of person whose cast
of mind makes him an effective monetary policy maker may lack the
attitudes that are needed to be an effective bank regulator."
Taking away the Federal Reserve's regulatory functions might also
make the Board work more harmoniously on monetary policy since
conflicts over regulatory matters could carry over into monetary policy
discussions.67 On the other hand, one might also argue that the oppo-
site is true, regulatory issues might give a governor a minor, and
hence relatively "safe," issue on which to assert himself, and disagree
with the Chairman.68
But apart from these rather speculative and inconclusive considera-
tions, eliminating the Federal Reserve's supervisory functions would

61 See U.S. Congr. Joint Economic Committee, Review of the Report of the Commission
on Money and Credit, op. cit., p. 69: and Committee on Financial Institutions, Report to
the President of the United States (Washington, D.C., 1963), p. 60. This Report contains
an excellent discussion of the problem of overlapping bank supervisory powers.
62 "Power and Influence in the Federal Reserve System," Economica, vol. 30, February
1963. p. 43.
63 G. L. Bach, Making Monetary and Fiscal Policy, op. cit., p. 231; Commission on
Money and Credit, op. cit.. p. 174.
See Commission on Money and Credit, op. cit., pp. 87-88; Governor Szymczak in U.S.
Congr. Joint Economic Committee, Review of the Report of the Commission on Money and
Credit, op. cit.. p. 69.
65 Sherman Maisel, op. cit., p. 140.
G Cf James Knipe, op. cit., p. 212.
67 Ibid., p. 212.
68 Professor Charles Whittlesey (op. cit., p. 43) pointed out that by giving the governors
more time, elimination of regulatory issues might induce them to challenge the chairman
,more frequently on monetary policy.


probably have three other important effects. One is that it is likely
to reduce the Fed's emphasis on the "quality" of credit. For example,
in some recessions the Federal Reserve has limited the growth of
bank reserves because it was afraid that a "sloppy money market in
which banks are flush with reserves would tempt them to make un-
sound loans. Many economists feel that such a policy is inappropriate;
the Fed should adopt an expansionary policy during a recession,
and let bank management decide what loans are sound.
Second, the Fed's supervisory functions necessarily bring it into
close contact with banks. The more it talks with banks about regu-
latory problems the greater is the danger that the attitude of private
banks will permeate Federal Reserve thinking on monetary policy
as well. Hence, elimination of the Fed's regulatory powers should
reduce banker influence over monetary policy.
Third, it would eliminate the Federal Reserve's ability to use "arm-
twisting" as a tool of monetary policy. The holding company legis-
lation has given the Fed great power to punish banks that refuse
its "requests." Apparently, the Fed has used this lever in 1973 to
induce banks to hold down the prime rate, etc.69 On general political
grounds one may well question whether the Federal Reserve, or any
other government agency, should have such covert power over private
firms when Congress has not granted it such power overtly.70
But a decision to take the Federal Reserve out of bank supervision
creates a problem. Where else is this power to be lodged? Giving it
to the FDIC may be inadvisable. As the insuring agency, the FDI(T
is oriented towards protecting its insurance fund by limiting the risks
which banks take. Hence, giving it a larger supervisory role might
reduce the ability of banks to take risks. On the other hand, if a new
Federal banking agency is set up to take over all the Federal super-
visory functions, then---unless sufficient safeguards are written into
the law--this agency is likely to experience the same fate as many
other regulatory agencies-capture by its industry. This has not
happened to the Federal Reserve, and it would therefore be unfortu-
nate to replace an effective regulatory agency with one that is more
likely to be captured.71
In addition, the Federal Reserve has argued that monetary policy
and bank supervision go well together because the information about
banks that the Fed obtains from the examination process is useful
in making monetary policy. And certainly, at times the Fed's emphasis
on the health of the banking industry is useful in inhibiting the Fed
in adopting excessively tight policies. However, at other times when
there is a need for large interest rate fluctuations, the Fed's concern
with the well-being of banks can prevent it from adopting the needed
monetary policies.
Hence, it would be desirable to pass the Federal Reserve's regula-
tory functions on to a new agency. But this should be done only if
69 Edward Kane, "The Re-Politicization of the Fed," op. cit., p. 748.
o7 For an argument that central banks like to use covert methods of control, see John
Chant and Keith Acheson, "The Choice of Monetary Instruments and the Theory of
Bureaucracy," Public Choice, vol. 12, Spring 1972, pp. 13-32.
71 One possible explanation of why the Federal Reserve has not been captured by the
banking industry is its wish to avoid giving ammunition to those who dislike its monetary
policy. Two other potential explanations are that since its main function is monetary
policy most of its staff does not have an industry background, and that the governors
are largely concerned with questions not directly relating to the welfare of their industry.


there are adequate safeguards against capture of this new banking
agency by the industry. It is therefore recommended that if such safe-
guards are provided, then the Fed should yield its regulatory func-
tions to a new agency. If so, one governor should be an ex officio
member of the Board of such an agency. This would provide the Fed
with information about the quality of bank assets.
If such an agency is not set up one can still ease the burden on the
Board while maintaining the Fed's regulatory role. This can be done
Inder existing legislation by delegating much of the work to the
Federal Reserve Banks. It is therefore recommended that, within
guidelines set out by the Board, the Banks should issue advisory
opinions to other regulatory agencies, pass on holding company cases
and charter amendments for Edge Act corporations, etc.72 This would
very substantially reduce the regulatory work of the Board. And as
long as the Banks act within guidelines set out by the Board there is
only a small danger that their closeness to the local banking com-
munity would result in their capture by the industry.

The Federal Reserve does not rely on Congressional appropriations.
Instead, it meets its expenses out of its own earnings, most of which
consist of interest on its portfolio of government securities. Its net
earnings greatly exceed its expenses. After transferring a small
amount to its surplus the Federal Reserve System turns over the bulk
of its net earnings to the U.S. Treasury.?3
The main reason for allowing the Federal Reserve to finance itself
out of earnings rather than out of Congressional appropriations is
that this is necessary to preserve its independence. The power to
appropriate is the power to harness and control! If the Federal Re-
serve were subject to the appropriations process, Congressmen who
object to its monetary policy could use the appropriations power to
induce it to change its policy. Congress certainly has-and should
have-the power to order the Federal Reserve to change policy. But
if this is to be done, it should occur openly in full public view, rather
than through the backdoor device of the appropriations process.
Moreover, it should be done through the two banking committees
rather than through the appropriations committees, who, of necessity,
have less expertise in monetary policy.
A second, much less important, justification is that the Federal
Reserve cannot estimate its future expenses accurately, and hence, if it
were subject to appropriations, would be tempted to overbudget. If so,
it would then have the further temptation to spend all the appropriated
funds even if it does not need to do so.74
Another justification which is sometimes given is that if it had to
rely on appropriations the Federal Reserve would not be able to spend
72 It may be desirable to spell out this authority to delegate in the bank holding company
73 In 1974 the Federal Reserve had gross earnings of $6,280 million: its current net
expenses amounted to only 9 percent of its gross earnings (i.e. to $548 million). After
allowing for losses on securities and foreign exchange transactions and dividend payments,
the Federal Reserve placed $51 million into its surplus and transferred $5,550 million to
the Treasury. Federal Reserve Bulletin, vol. 61, February 1975, p. A 80.
7" See the testimony of President Bopp, in U.S. Congr. House, Committee on Banking,
Currency and Housing, Subcommittee on Domestic Finance, The Federal Reserve After
Fifty Years, Hearings, op. cit., p. 423.


enough on research.'7 However, this argument assumes that more
should be spent on research than the elected representatives think is
The Fed's freedom from the appropriation process does, however,
have two disadvantages. First, government funds are spent in ways
that have not been passed on in the standard democratic process. Sec-
ond, the Federal Reserve can spend to build a political base. The Fed-
eral Reserve issues a large number of publications dealing with mone-
tary policy, and while the quality of these publications is generally
high, they are usually not known for their sharp criticism of the Fed-
eral Reserve. It is unlikely that Congress would appropriate all the
money the Federal Reserve now spends on these publications.76
Nonetheless the advantages of budgetary independence substantially
outweigh its disadvantages. It is therefore not surprising that a survey
of monetary economists showed a two to one majority in favor of the
present arrangement.77
But there is one aspect of Federal Reserve finances that is more sub-
ject to criticism. This is that the Federal Reserve clears checks free
of charge for all banks that remit at par.78 In 1974 this cost the Federal
Reserve $64 million.79 Originally, free clearing could be justified by
the desire to bring banks into the Federal Reserve clearing network,
thus eliminating the long delays in check clearing that existed under
the National Banking System.80 But this is no longer a problem. At
present the best justification is that free clearing serves to keep in the
System large city correspondent banks that clear checks for country
banks. If, as the Federal Reserve has advocated, the reserve require-
ments for member and nonmember banks are made uniform, so that
banks have much less of an incentive to leave the System, then free
clearing should be eliminated. This would not only end an unjustified
subsidy to banks, but would also allow the private sector to compete
with the Fed in check clearing. And this is particularly important
now that we may move into a system of electronic funds transfers
that may greatly increase the Federal Reserve's clearing costs. It
is therefore recommended that if a system of uniform reserve require-
ments is adopted, then the Federal Reserve should charge banks the
full cost (or at least the long run marginal cost) of check clearing.

One issue that has received a great deal of Congressional attention,
and has resulted in frequent Hearings, is the exemption of the Federal

s" See the statenents of Henry Wallich and Donald Hester in U.S. Congr. House, Com-
mittee on Banking. Currency and Housinr. Subcommittee on Domestic Finance. Comneendium
on Monetary Policf Guidelines and Federal Reserve Structure, on. cit., pp. 2,3 & 634.
7 According to Professor Harry Johnson it also provides itself with a political base
by giving various services to its clients. U.S. Congr. House. Committee on Banking,
Currency and Housing, The Federal Reserre After Fifty Years, Hearings, op. cit., p. 1041.
'" U.S. Congr. House Committee on Banking. Currency and Housing. Compendium on
Monetary Policy Guidelines and Federal Reserve Structure, p. 27.
S A few small banks (about one rercent of all !anks) do not "remit- t par"; that is,
they deduct a service charge from the payment they make on a check presented to them.
7 The 1974 figure was much higher, but this was heavily influenced by the cost of setting
up regional check processing centers.
80 Under the National Banking System banks tried to reduce the cost of check collection
by routing checks through a correspondent bank network. This delayed the presentation
of checks substantially, and hence increased the danger that by the time a check was
presented for payment it could not be paid. In addition, free clearing was denied for banks
not remitting at par to induce more banks to remit at par. At present this is only a trivial


Reserve from GAO audits. Although the Federal Reserve was origi-
nally subject to audits by other government agencies, it was exenlmpted
from such audits by the Banking Act of 1933. Such an exelmption
is usually granted only to agencies that finance themselves primarily
by fees received from the private sector, e.g. the FDIC, or the Office
of the Comptroller of the Currency. There is much opposition in Con-
gress to the Fed's exemption, and in 1975 no less than 120 Representa-
tives sponsored a bill to require a GAO audit.81 Compared to the ques-
tion of whether the Federal Reserve is following the right monetary
policy, auditing is a trivial issue. But since it has proved to be, on the
one hand, a useful stick with which to beat the Federal Reserve, and
on the other, a way in which the Federal Reserve can assert its inde-
pendence, it has, unfortunately, received a greatly disproportionate
share of Congressional attention.
Before discussing the pros and cons of a GAO audit it is necessary
to clarify what such an audit is. There are three types of GAO audits.
One is an audit just of financial accounts and reports, which tries to as-
certain whether financial transactions meet legal requirements, and
whether the financial reports are accurate. A second type of audit
extends beyond this and examines the efficiency with which personnel
and physical facilities are used. A third type of audit extends further
"to include reviews of the results of the programs and activities of
the System, including the extent to which its established objectives
are being achieved.82 This third type of audit, unlike the first two,
clearly gets into policy issues, and might examine, for example, the
Federal Reserve's policy of raising certain interest rate ceilings set
under Regulation Q.83
Proponents of a GAO audit have argued that it is needed to prevent
inefficiencies and waste. Thus, the Comptroller General has said that
in a large organization like the Federal Reserve there must be places
where the GAO can locate waste, while Professor Reagan has drawn
attention to the fact that Federal Reserve offices are much more elab-
orate than other government offices.84 And a Staff Report of the
House Banking, Currency and Housing Committee has argued that
there is no warrant for Federal Reserve expenditures which other
government agencies are not allowed to undertake. It pointed out that
at the time (1964), of the fifteen highest governmental salaries,
thirteen were in the Federal Reserve.85 Other government agencies
have objected that in various disputes the Federal Reserve has an un-
fair advantage because it can spend more on research and on public
relations than they can.8 And Congressional Hearings have brought
out a chamber of horrors of Federal Reserve expenditures, such as
81 "House Panel Derails Bill that Requires an Audit of the Fed," Wall Street Journal,
September 25, 1975, p. 20.
s2 Testimony of Comptroller Staats, U.S. Congr. House, Committee on Banking, Currency
and Housing, To Provide for an Audit of the Federal Reserve System by the General
Accounting Office, Hearings, 93rd Congr. 1st sess. 1973, p. 12.
83 However, it would probably deal more with the way in which the decision was reached
than with the decision itself. Ibid., p. 78.
4 U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve System After Fifty Years, Hearings. op. cit., p.
1578; Subcommittee on Domestic Monetary Policy, Audit of the Federal Reserve, Hearings,
94th Congr. 1st sess., 1975, p. 173.
a8 U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve System After Fifty Years, Proposals for the
Improvement of the Federal Reserve. . op. cit., pp. 91-92.
s8 See A. Jerome Clifford op. cit., p. 362.


cigars for directors, baby-sitters for the children of officers, and ping-
pong balls for employees.
Furthermore, advocates of a GAO audit have been skeptical of the
Federal Reserve's own auditing procedures, which consist of audits
both by its own auditors, as well as by CPA firms. Thus Professor
Freeman has likened the idea that internal audits (and audits by
accounting firms reporting to the Federal Reserve) are sufficient, to
the notion that "the plaintiff should rely on defense attorney for legal
advice." 87
The Federal Reserve, on the other hand, has fought bitterly against
any type of GAO audit, and, according to Professor Kane, when
threatened with an auditing bill, "perhaps the first time in System his-
tory an FRB Chairman has lobbied personally on the Hill, visiting key
members of the Houses Rules Committee.... 88
In its defense of the status quo the Federal Reserve has raised
several points. The most important is that a GAO audit would re-
duce its independence. Even an audit confined to financial reports
would, in the Fed's view, weaken its independence because, as Pres-
ident Bryant of the Atlanta Bank put it: "the power to harass is
the power to destroy." 89 Rather than drawing a sharp line between
the three types of GAO audits discussed above, the Federal Reserve
sees any GAO audit as the beginning of a process that would chip
away at its independence. Governor Mitchell put it as follows: 90
It is obvious that the opponents of a monetary authority with the independence
the Congress has long given the Federal Reserve would view this action as the
opening wedge in a series of legislative measures by which they would hope to
make monetary and credit policy responsive to short-run political and economic
Further, to be effective, the Federal Reserve needs to be able to
rally public opinion to its side in any dispute with Congress or the
Administration. But expenditures for this purpose may well be ques-
tioned by the GAO.91
Second, the Federal Reserve does not consider a GAO audit appro-
priate for a quasi-private institution such as it believes itself to be.
Thus Governor Mitchell expressed the fear that "The System's blend-
ing of public and private elements, and its balance between central
oversight and regional initiative, could be endangered if audits were
to be conducted by the GAO." 92
Third, the Federal Reserve is afraid that a GAO audit may impair
the confidentiality of the data on banks which it collects in its exami-
nation process, and also its dealings with foreign central banks. If
the GAO is auditing the Federal Reserve, foreign central banks might
find their deposits with the Fed less useful.93

U.S. Congr. House. Committee on Banking, Currency and Housing, Subcommittee
on Domestic Monetary Policy. Audit of the Federal Reserve, Hearings, op. cit., p. 270.
ss Edward Kane, "The Re-Politicization of the Fed," op. cit., p. 748.
69 Cited in A. Jerome Clifford, op. cit., p. 363.
l0 U.S. Congr. House, Committee on Banking, Currency and Housing, To Provide for an
Audit of the Federal Reserve System by the General Accounting Office, Hearings, op. cit.,
p. 100.
9s This argument is not explicit, but can be read into, the testimony of President Swan
of the San Francisco Bank (U.S. Congr. House,, Committee on Banking, Currency and
Housing, The Federal Reserve System After Fifty Years, Hearings, op. cit., p. 666).
92 U.S. Congr., Committee on Banking, Currency and Housing, To Provide for an Audit
of the Federal Reserve System by the General Accounting Office, Hearings, op. cit., p. 106.
93 U.S. Congr. House. Committee on Banking, Currency and Housing, Audit of the
Federal Reserve, Hearings, op. cit., statement of Governor Mitchell, p. 295.


Fourth, the Federal Reserve believes that a GAO aulit is not
needed, first because it already is heavily audited and second, t ,'ausi
it already exercises strict budget discipline. For example, a President
of the Cleveland Bank testified that his bank had lower labor costs
than the Federal government.9' And, as already mentioned, former
Governor Maisel wrote that the Federal Reserve Banks are nmorre effi-
cient than other government agencies. In addition, the third type of
GAO audit, an audit of policy, would duplicate the work of ('on-
gress, since the Federal Reserve already reports periodically to Con-
gress on its monetary policy. For all of these reasons a GAO audit
would be needless duplication, and hence a waste of money.
How valid are these arguments? The Fed's concern that an audit
extending to policy decisions would reduce its independence is cor-
rect, and provides a valid argument against this type of audit.'" But
why should an audit confined to financial reports significantly reduce
the Federal Reserve's independence ? In opposing such an audit the
Federal Reserve is fighting the battle at its frontier-and it is not
at all clear that this is either good public policy or good strategy.
The Fed could make a much stronger case by accepting a purely fi-
nancial audit, and opposing the two other types of audits. To be
sure, the Federal Reserve is afraid of drifting from one type to the
others, but against this "opening wedge" argument, there is the point
that its continued opposition to any GAO audit at all arouses sus-
picion.96 Thus even a very sympathetic observer, Tilford Gaines, has
remarked that the Fed's opposition to any GAO audit seems to be
carrying the principle of the camel's nose in the tent somewhat too
The second argument, that the Fed is a quasi-private institution, is
far from persuasive. Not only does the Fed fulfill governmental func-
tions, but the major part of its earnings result from a governmental
source, the provision of money.98 And it turns its excess earnings over
to the Treasury. The private components of the System are residual
appendages, and do not justify the belief that the Federal Reserve
is spending private, rather than public, funds. Nor is it clear that a
GAO audit would actually threaten the quasi-private components of
the Fed, if for some reason it is decided to keep them.
The third argument, the need to maintain confidentiality, is also
not persuasive. The GAO does audit agencies with top secret mate-
rial, e.g. the Defense Department and the Atomic Energy Commis-
sion. Besides, if necessary, one could exclude from the scope of the

9 U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Finance, The Federal Reserve After Fifty Years, Hearings, op. cit., p. 195.
s9 Such an audit has been opposed, for example, by Professors Ackley, Heller, McCracken.
Okun and Stein, all former chairmen of the Council of Economic Advisers. "House Panel
Derails Bill that Requires an Audit of the Fed," op. cit., p. 20.
6 Thus Representative Blanchard, while himself not challenging the Federal Reserve's
integrity in opposing any GAO audit, said :
I am wondering how you can keep that integrity intact, either before the opinions
of Congress or the public, if you continue to resist an audit by the GAO .... It seems
to me that you undermine the integrity of the Federal Reserve by so resisting and
opposing this bill.
U.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee on
Domestic Monetary Policy, Audit of the Federal Reserve, Hearings, op. cit., p. 364.
97 "Statement" in U.S. Congr. House. Committee on Banking, Currency and Housing.
Subcommittee on Domestic Finance, Compendium on Monetary Policy Guidelines and
Federal Reserve Structure, op. cit., p. 234.
98 Even the Fed's earnings on the reserves held by member banks can be considered
government funds because these earnings can be treated as being in effect an excise tax on
bank deposits.


audit the Fed's examination functions as well as its dealings with, and
on behalf of, foreign central banks and governments.
Fourth. it is true that the Federal Reserve Banks do try to budget
tightly (for example, using consulting firms in cost-cutting efforts),
and, as far as one can tell on a very casual and impressionistic basis.
are not wasteful. Yet it is likely that the GAO could find some places
where costs could be cut. Moreover, the cost of a GAO audit need
not not be large." Hence, as an experiment, at least a one-time audit,
as suggested by Professor Selden, would probably pay for itself.1
Thus the Federal Reserve's arguments against a financial audit-
as opposed to a policy audit-are far from convincing. But there
happens to be a very powerful argument against a financial audit by
the GAO, one which the Fed has not stressed. This is that the horror
stories brought out in various Congressional Hearings, such as the
Federal Reserve buying flowers for the families of officers, and ping-
pong balls for its employees, have nothing to do with an audit of
financial accounts per se. These expenditures do not represent cases
where officials undertook expenditures that were not legitimate under
their agency's guidelines. They were legitimate under the Fed's guide-
lines. What is at issue therefore are the Fed's expenditure guidelines
themselves. These do differ very substantially from those of other
government agencies. because the Federal Reserve follows expendi-
ture guidelines similar to those of private firms. It is this issue, whether
the Federal Reserve should spend like a private firm rather than like
government agencies, and not the question of a GAO audit, that Con-
gress should focus on.
Is the Federal Reserve's adherence to private, rather than govern-
mental, expenditure patterns justified? For reasons discussed above
the existence of a quasi-private component in the Federal Reserve's
formal structure does not provide such a justification. However, what
may justify the Federal Reserve's spending like a private firm is that
this m ay be more efficient than following the usual government ex-
penditure standards. It is a general presumption that the private
sector is more efficient than the government. Hence, acting like a
private firm and providing amenities for officers and employees may
serve to lower total labor costs. For example, providing directors
with cigars and other perquisites may help to get more work out of
them. Similarly, expenditures on recreation equipment for employees
may increase their loyalt.y and hence lower labor turnover. Spending
a modest amount of money to make employees feel wanted may be
good business.2 Furthermore, by not abiding by civil service pay-scales
the Federal Reserve saves money because it is able to pay employees
in various cities different salaries depending on local labor market
99 The Comptroller General has testified that if the GAO is given the authority to make
selective reviews, rather than to audit the whole Federal Reserve System every year. the
yearly cost of an audit would be about '$750,000. (U.S. Congr. House. Committee on Bank-
inr. Currency and Housing. Subcommittee on Domestic Monetary Policy. Audit of the
Federal Reserre Sr.stem. op. cit., pn. 170-71.) Governor Mitchell has estimated the cost of a
thoron'ihgoinz audit at $1-1.5 million (ibid., p. 360).
STbid.. p. 209.
2 For example, at a Congressional Hearing a Federal Reserve Bank was criticized for
sendine hirthdayv rifts to employees on military service leave. But this expenditure may
be well justified because it increases the probability that employees will return to the Bank
when they leave military service.


But while the Federal Reserve's tendency to spend more on em-
ployee and officer welfare than other government agencies do may be
efficient, this need not be so. For example, one reason why private firms
provide luxurious offices is to impress customers with the financial
solidity of the firm. The Federal Reserve hardly needs to do this.3
Furthermore, the fact that Federal Reserve employees obtain certain
benefits that are denied to other government employees may create
a morale problem in other agencies. Perhaps better working conditions
and benefits should be extended to all government employees, but if
this is not done why should the Fed be singled out for special treat-
ment? It may reinforce the Fed's notion that it is not a government
Obviously, what is needed here is detailed empirical study. Some
Federal Reserve Banks have had management consulting firms under-
take cost studies. But Congress need not rely on this rather limited
information. It is therefore recommended that Congress commission
a private management consulting firm to evaluate the Federal Re-
serve's policies regarding employees and officers. While the comments
of the GAO should be sought on such a study, it is probably preferable
to have it done by a private firm, because the GAO is familiar pri-
marily with government personnel practices, and not with private
One thing such a study should investigate is the salary structure
of top officials in the System. The presidents (and even some of the
first vice presidents) of the Banks receive a higher salary than the
Chairman of the Board of Governors, and for that matter than the
Secretary of State. In view of their relative responsibilities this is
an anomaly. While it could be justified in 1913 by the argument that
the Bank presidents were essentially bankers rather than government
officials, the evolution of the System's functions has turned the presi-
dents into public officials.
Until the results of such a study are available, the issue of GAO
auditing should be shelved. Not only do we lack at present the infor-
mation necessary to settle this issue, but these discussions about GAO
auditing distract Congressional attention away from the much more
pressing and important issue of whether the Federal Reserve is
following the right policy.
Before leaving the topic of a GAO audit it may be useful to raise
the question of why the Board allows the Banks to undertake expendi-
tures that provide such flagrant targets for Congressional criticism.
Is it a feeling that any expenditures which are not authorized for
other government agencies would serve equally well as a target?
Or is it the Fed's confidence that it has enough political power to
block any reforms? Or is it perhaps a feeling that Congressional
criticism is inevitable, and that it is better to be criticized for buying
9 An interesting issue here is the psychological make-up of the governmental and private
labor forces. It may be the case that government employment attracts those who find
security of employment a more important fringe benefit than good working conditions and
employer-nrovided amenities, while the opposite may be true for private industry. If so,
the ouestion arises whether Federal Reserve employees are more like private, or like gov-
ernmental, employees.
4 President Hickman of the Cleveland Bank suggested that Congress have the Federal
Reserve audited by a CPA firm. TT.S. Congr. House. C'ommitt-p on PTnkinf- Cur'encye
and Housing, Subcommittee on Domestic Finance. The Federal Reserve After Fifty Years,
Hearings, op. cit., p. 192.


ping-pong balls than for policy blunders ? Unfortunately, this question
cannot be answered.

To a limited extent, the Federal Reserve's opposition to a GAO
audit can also be explained as a natural concomitant of central bank
secrecy. By a long tradition, "the celebrants of the arcane mysteries
of central banking"5 have preserved "a certain air of charismatic
obscurity about their operations." C "Financiers, bankers and central
bankers have for a long time regarded themselves as a Pythagorean
priesthood possessing the vital mysteries whose power is diminished
if they are exposed to vulgar eyes. . It is a mythology that strikes
at the root of democratic government." 7 Secrecy is one way in which
a government agency can protect itself from criticism." Moreover, the
less the public knows about monetary policy, the more likely is it to
be apathetic about it. And the greater the public's apathy, the smaller
is the threat to Federal Reserve independence.9 Yet, while the Federal
Reserve is secretive, it should be commended, both for being less so
than most foreign central banks, and for having become much more
open in recent years.
There are several substantial advnttages to reducing Federal Re-
serve secrecy still further. One is that the democratic ethos requires
an informed electorate. A second is that economists and others could
discuss monetary policy more intelligently, and could make a greater
contribution to its formulation. Third, secretiveness enhances the
value of specialized information to money market professionals and
to investors. Those firms that can afford "Fed watchers" (who are
frequently former Federal Reserve employees) gain an advantage.
The three main issues with respect to Federal Reserve secrecy are
its unwillingness to clarify its economic goals and trade-offs, the five
year lag in the publication of the Minutes and the 45 day lag in the
publication of the FOMO Record of Policy Actions.
Although the Federal Reserve in response to House Concurrent
Resolution 133 does now reveal its money growth targets, this is done
so vaguely that there is less in this than meets the eye.10 Hence although
the biannual Monetary Oversight Hearings are a useful start they do
not go far enough. The Federal Reserve should present to Congress an
Annual Report on Monetary Policy in which it elucidates its forecasts
for the next year, its trade-offs and its targets and goals." This would
allow Congress and the public to see to what extent the Fed's value
judgements agree with their own, and (subsequently) how successful
the Fed has been in reaching its targets. Obviously, this is information
Congress and the public need to evaluate the Fed. It would also have
the advantage that the Administration would know in considerable
detail what the Fed is planning to do. This is not the case now.
5 James Knipe. or. cit., p. 214.
6 Kenneth Boulding, op. cit., p. 11.
7 H. S. Gordon, op. cit., p. 22.
s John Chant and Keith Acheson, op. cit., p. 15.
9 Since the Federal Reserve now has substantial independence, any change resulting from
an aroused public opinion is more likely to reduce, than to increase, its independencp.
10 See Edward Kane "New Congressional Restraints and Federal Reserve Independence"
op. cit., p., 42-44.
n The Federal Reserve does not do this in an acceptable fashion in its current Annual
Report. See Edward Kane, "All for the Best: The Federal Reserve Board's 60th Annual
Report," American Economic Review, vol. 64, December 1974, pp. 835-50.


Admittedly, there are some political risks in being open with the
public. But, at the very least, the Federal Reserve should be as open
about monetary policy as the Economic Report of the President is
about the Administration's plans. If the Administration can run the
political risks, surely the independent Federal Reserve can too. Such
a proposal to set out targets does, of course, face the objection that
monetary policy must be flexible. But this objection can be met by
noting two things. First, the Fed could still change its targets in mid-
year, and explain fully why it did so in the next Report. Second,
monetary policy is in any case not so flexible if one looks, not at the
speed with which policy can be changed, but at the time this policy
takes to affect income. It is therefore recommended that the Federal
Reserve submit an annual-or perhaps biannual-Report on Monetary
Policy to Congress. And Congress should then hold Hearings on it.
The second issue on secrecy concerns the Minutes of the FOMC.
The Minutes are currently published with a five year lag. This lag is
defended by the Federal Reserve on several grounds. One is that
immediate publication could be embarassing for FOMC participants,
and hence might make them reluctant to speak their minds. Someone
may be reluctant to advocate a policy that has immediate costs and
long run benefits if his position will become known before these long
run benefits appear. Furthermore, if the Minutes are to be published
immediately, there are the dangers that participants would speak for
the record, and also that the Minutes would become more limited,
particularly as participants could discuss sensitive issues prior to the
formal meeting. In addition, the FOMC sometimes discusses matters
relating to foreign central banks and governments which must be kept
confidential. And there is also the danger of providing information
to speculators.
While most of these arguments are valid, it is not clear that they
require a five year lag in publication. It is therefore recommended that
the Federal Reserve should consider cutting the publication lag to, say,
three years. Furthermore, it should consider making the Minutes com-
prehensive. What is published at present is not the verbatim record,
but a synthesis of notes taken by several participants. However, if the
Federal Reserve does publish the above discussed Report on Monetary
Policy then the time lag in the publication of the Minutes and their
comprehensiveness is no longer so important.
Turning to the Directive, the Federal Reserve has justified the 45
day delay in its publication by the argument that immediate publica-
tion would allow money market professionals-who could interpret
the Directive-to make windfall gains at the expense of other inves-
tors. This argument is questionable. At present, money market profes-
sionals have a big advantage over others because they can infer
Federal Reserve policy. It does not take them long to form a shrewd
guess about what the latest Directive contains. Secrecy thus enhances
the advantage which the professionals have, and also gives them an
incentive to spend much effort trying to unravel Federal Reserve
policy. This is a waste of resources. If the Directive were made public
right away brokers and others could quickly inform investors about
monetary policy changes, and hence the professionals would lose some
of their comparative advantage. To be sure, the small investor usually


could not himself understand the Directive, but the free market would
soon develop information channels that would explain it to him.
Admittedly, there is sometimes a serious difficulty in publishing the
Directive. This is that the Directive might give a certain range for the
Federal Funds rate for, say, the first week, and a different range for
subsequent weeks. If the market would know this, there would be a
tendency for the rate to move immediately, at least part of the way,
to the range set for later weeks. Hence, in these situations there may
be a technical problem in publishing the Directive. But it is recom-
mended that when the Directive does not take this form it should be
published right away.

One very important part of our central banking structure is Con-
gressional oversight over the Federal Reserve. The efficacy of the
Federal Reserve's monetary policy depends, in part, on the efficiency
of Congressional criticism. Congressional Hearings, from the Douglas
and Patman Hearings in the early post-war years to the recent Hear-
ings on the Federal Reserve's money stock targets, have done much,
both to elucidate-and to affect-the conduct of monetary policy. But
the Congressional oversight process does have some weaknesses. One
is that Congressmen, being of necessity generalists rather than spe-
cialists in monetary policy, are at an obvious disadvantage when
questioning a chairman who, not only is a specialist, but also has a
large staff to help him prepare his testimony. This is particularly
serious since someone selected to be chairman is likely to be highly
skilled in evading troublesome questions. Second, there are few politi-
cal incentives for a Congressman to acquire the expertise needed to
question a Fed witness effectively.
Hence, some device is needed to reduce the gap between the expertise
of Federal Reserve governors and that of the supervising Congress-
men. One possibility would be to insist that Federal Reserve witnesses
file their written statements at least 48 hours prior to the hearing.12 The
Committee staff could then contact academic and business economists
and obtain their comments on technical points in the statement. In par-
ticular, they should be asked to suggest specific questions, and to raise
quite specific issues. For example, if a chairman testifies that the con-
cept of "money" is vague because there are several definitions of money,
they might suggest that the Chairman be asked whether over the last
ten years the growth rates on all of these definitions have been highly
correlated. Admittedly, the preparation of questions on the statement
by outside specialists would not solve the problem completely because
a witness could omit material on which he might face embarassing
questions from his written statement, and bring it up during the
questioning.'3 But subjecting the written statement to outside evalua-
tion should be of some help.
1 At present, the chairman's statement is supposed to be filed with the committees weir
ahead of time. But this requirement is frequently ignored. To avoid the problem of leaks,
and of resulting windfall gains, the statement should be made public upon receipt.
13Moreover, sharp questioning while needed, might be carried too far. See Charles
Whittlesey, "Congressional Hearings and the Federal Reserve," Journal of Politicat
Economy, vol. 68, April 1959, pp. 187-93.


In addition, the banking and currency committees should hold
extensive Hearings on the Federal Reserve Report on Monetary Policy
suggested above, niuchi as the Joint Economic ('olmmittee holds I lear-
ings on the Economic Report.14 Or Congress might consider a sugges-
tion of Professor Selden and institute a formal Monetary Policy
Review Board.15
In addition, Congressmen should show greater skepticism and not
accept the Federal Reserve's statements as necessarily correct. Some-
times the emperor wears no clothes.

14 In addition, it would be useful if the Federal Reserve staff would, from time to time,
brief Congressmen and their staff on the Fed's economic forecasts, and on econometric
model simulations of various policies.
S1JU.S. Congr. House, Committee on Banking, Currency and Housing, Subcommittee
on Domestic Monetary Policy, Audit of the Federal Reserve System, Hearings, op. cit.,
p. 209.

Bach, George Lee, Federal Reserve Policy Making, New York, 1950.
Bach, George Lee, Making Monetary and Fiscal Policy, Washington, D.C., 1971.
Borins, Sanford, "The Political Economy of 'The Fed,' Public Policy, 1972,
pp. 175-97.
Boulding, Kenneth, "The Legitimacy of Central Banks" in Board of Governors,
Federal Reserve System, Reappraisal of the Federal Reserve Discount
Mechanism (Washington, D.C., 1971), vol. 2, pp. 1-13.
Brimmer, Andrew F., "Characteristics of Federal Reserve Bank Directors,"
Federal Reserve Bulletin, vol. 58, June 1972, pp. 550-59.
Brunner, Karl, and Allan Meltzer, Some General Features of the Federal Re-
scree's Approach to Policy, U.S. Congr. House, Committee on Banking, Cur-
rency and Housing, 88th Congr. 2nd sess., 1964.
Canterbery, E. Ray, "A New Look at Federal Open Market Voting," Western
Economic Journal, vol. 6, December 1967, pp. 25-38.
Chant, John, and Keith Acheson, "The Choice of Monetary Instruments and
the Theory of Bureaucracy," Public Choice, vol. 12, Spring 1972, pp. 13-32.
Clements, Mary A., "Appointive Board Members, Average Tenure," unpublished
Clifford, A. Jerome, The Independence of the Federal Reserve System,
Philadelphia, Pa., 1965.
Commission on Money and Credit, Money and Credit, Englewood Cliffs, N.J.,
Friedman, Milton, "Should there be an Independent Monetary Authority," in
Leland Yeager, In Search of a Monetary Constitution (Cambridge, Mass.,
1962), pp. 219-43.
Goldenweiser, Emanuel, A., American Monetary Policy, New York, 1951.
Gordon, HI. Scott, "The Bank of Canada in a System of Responsible Government,"
Canadian Journal of Economiics and Political Science, vol. 27, February 1961,
pp. 1-22.
Hastings, Delbert, and Ross Robertson, "The Mysterious World of the Fed," re-
printed in U.S. Congr. House, Committee on Banking, Currency and Housing,
Subcommittee on Domestic Finance, The Felleral Reserve After Fifty Years,
Hearings, 88th Congr. 2nd sess., pp. 1519-25.
Iiavrilesky, Thomas, Robert Sapp and Robert Schweizer, "Tests of the Federal
Reserve's Reaction to the State of the Economy: 1964-74," Social Science
Quarterly, March 1975, pp. S35-52.
Havrilesky, Thomas, William Yohe, and David Schirm, "The Economic Affilia-
tions of Directors of the Federal Reserve District Banks," Social Science
Quarterly, vol. 54, December 1973, pp. 608-22.
Johnson, Harry, "Alternative Guiding Principles for the Use of Monetary Policy,"
Essays in International Finance, No. 44, Princeton, N.J., 1963.
Kane, Edward, "All for the Best: The Federal Reserve Board's 60th Annual Re-
port," American Economic Review, vol. 64, December 1974, pp. 835-50.
Kane, Edward, "New Congressional Restraints and Federal Reserve Independ-
ence," Challenge, November-December 1975, pp. 37-44.
Kane, Edward, "The Re-Politicialization of the Fed," Journal of Financial and
Quantitative Analysis, vol. 8, November 1974, pp. 743-52.
Knipe, James, The Federal Reserve and the American Dollar, Chapel Hill, N.C.,
Maisel, Sherman, Managing the Dollar, New York, 1973.
Mansfield, Harvey, and Myron Hale, "The Structure of the Federal Reserve Sys-
tem," reprinted in U.S. Congr. House, Committee on Banking Currency and
Housing, Subcommittee on Domestic Finance, Hearings, vol. 3, pp. 1959-84.
New York Clearing House Association, The Federal Reserve Reexamined, New
York, 1953.
Reagan, Michael, "The Internal Structure of the Federal Reserve: A Political
Analysis," in Commission on Monday and Credit, Monetary Management,
Englewood Cliffs, N.J., 1963, pp. 361-402.


Reagan, Michael, "The Political Structure of the Federal Reserve System,"
American Political Science Review, vol. 55, March 1961, pp. 64-76.
Whittlesey, Charles, "Congressional Hearings and the Federal Reserve," Journal
of Political Economy, vol. 68, April 1959, pp. 187-93.
Whittlesey, Charles, "Power and Influence in the Federal Reserve System,"
Economica vol. 30, February 1963, pp. 33-44.
Winn, Willis, "The Role of the Director: The Ideal vs. the Real," in David East-
burn (ed.), Men, Money and Policy, Philadelphia, n.d., pp. 241-51.
Tohe, William, "The Open Market Committee Decision Process and the 1964
Patman Hearings," National Banking Review, vol. 2, March 1965, pp. 351-63.
Yohe, William, "A Study of Federal Reserve Open Market Committee Voting,
1955-64," Southern Economic Journal, vol. 32, April 1966. pp. 396-405.
U.S., Commission on the Organization of the Executive Branch of the Govern-
ment, Task Force Report on Regulatory Commissions, Washington, D.C.,
U.S., Committee on Financial Institutions, Report to the President of the United
States, Washington, D.C., 1963.
U.S. Congr., House, Committee on Banking, Currency and Housing, To Provide
for an Audit of the Federal Reserve System by the General Accounting Office,
Hearings, 93rd Congr. 1st sess., 1973.
U.S. Congr., House, Committee on Banking, Currency and Housing, Subcommit-
tee on Domestic Finance, Compendium on Monetary Policy Guidelines and
Federal Reserve Structure, 90th Cong. 2nd sess., 1968.
U.S. Congr., House, Committee on Banking, Currency and Housing, Subeom-
mittee on Domestic Finance, The Federal Reserve After Fifty Years, Hearings,
SSth Congr., 2nd sess., 1964.
U.S. Congr., House, Committee on Banking, Currency and Housing, Subcom-
mittee on Domestic Finance, The Federal Reserve After Fifty Years, Proposals
for Improvement of the Federal Reserve and Staff Report on Hearings before
the Subcommittee on Domestic Finance of the Committee on Banking and Cur-
rency, 88th Congr. 2nd sess., 1964.
'U.S. Congr., House, Committee on Banking, Currency and Housing, Subcom-
mittee on Domestic Monetary Policy, Audit of the Federal Reserve, Hearings,
94th Congr., 1st sess., 1975.
U.S. Congr., House, Committee on Banking, Currency and Housing, Subcom-
mittee No. 3, Retirement of Federal Reserve Stock, Hearings, 86th Cong. 2nd
sess., 1960.
U.S. Congr., House, Committee on Government Operations, Amending the Employ-
ment Act of 1946 to Include Recommendations on Monetary and Credit Policy
and Proposed Wage and Price Increases, Hearings, 85th Congr. 2nd sess., 1948.
U.S. Congr., Joint Economic Committee, Recent Federal Reserve Actions and
Economic Policy Coordination, Hearings, 89th Congr., 1st sess., 1966.
U.S. Congr., Joint Economic Committee, Review of the Report of the Commission
of Money and Credit, Hearings, 79th Cong. 1st sess., 1961.
U.S. Congr., Joint Economic Committee, Staff Report on Employment, Growth
and the Price Level, 86th Congr. 1st sess., 1960.
U.S. Congr., Joint Economic Committee, Subcommittee on General Credit Control
and Debt Management, Monetary Policy and the Public Debt, Hearings, 82nd
Congr. 2nd sess., 1952.
U.S. Congr., Joint Economic Committee, Subcommittee on General Credit Con-
trol and Debt Management, Replies to Questions and Other Material for the
Use of the Subcommittee on General Credit Control and Debt Management,
82nd Cong., 2nd sess., 1952.

62-748-76-bk. II--5




1. Summary and recommendations --------------------------------- 733
2. Multinational banking: An overview-_-- --_-------------------- 739
3. The foreign operations of U.S. banks and U.S. operations of foreign
banks: A brief comparison ---------------------------------_ 743
4. State laws and the structure of foreign bank activities-------------- 747
5. Competitive advantages enjoyed by foreign banks operating in the
United States ------ --------_----------------------- 751
6. Problems in regulating foreign banks----------------------------- 757
7. The problem of reciprocity------------------------------------- 761
8. Joint investments by U.S. and foreign banks_ --------------------- 765
9. The impact of foreign banks on the domestic monetary system------- 767
10. Conclusions and recommendations _---------------------------- 775
Appendix A: Tables, foreign bank operations in the United States------- 781
Appendix B: Joint investments of U.S. and foreign banks -------------- 789
Appendix C: Foreign banks with U.S. securities affiliations and their U.S.
bank partners in joint ventures ------------------------------------ 793
Appendix D: Geographic areas in which U.S. and foreign banks with
joint investments have overlapping activities ----------------------- 795

Chapter 1: Introduction ------------------------------------------ 803
Chapter 2: Overseas branches of U.S. banks -------------------------- 809
Chapter 3: Overseas investments of U.S. banks ----------------------- 839
Chapter 4: Foreign banking laws and regulations governing overseas
operations of U.S. banks ---------------------------------------- 863
Chapter 5: Supervision and regulation- ------------------------------ 867
Chapter 6: Foreign exchange--------------------------------------- 873
Chapter 7: Twelve multinational banks_ ----------------------------- 883
Chapter 8: Some special problems ----------------------------------- 899
Chapter 9: The role of the lender of last resort in international banking -- 909
Chapter 10: Some effects of the foreign lending activities of U.S. banks_- 915
Chapter 11: Conclusion- .. -.-------------------------.-- ----- 935
Appendix A: Overseas investments of U.S. banks -------------------- 939
Appendix B: Laws regulating U.S. banks overseas --------------------- 981


At the present time, the majority of foreign bank operations in
the United States are chartered and regulated at the State level,
principally by State bank supervisors in New York, California,
and Illinois. Federal regulators are involved only where the parent
foreign bank has formed or acquired a subsidiary, not when they are
operating through branches and agencies. The Bank Holding Company
Act Amendments of 1970 require that the foreign bank establishing
or acquiring a subsidiary obtain approval from the Federal Reserve
Board before obtaining a State charter for a subsidiary bank, and
conform to the provisions of that act. In most cases, foreign bank
subsidiaries accept domestic deposits, obtain deposit insurance and
submit to regulation and examination by the Federal Deposit In-
surance Corporation. Subsidiary operations constitute, however, only
about 20 percent of total foreign bank activity in the United States.
Legislation has been introduced to alter this structure by requiring
that all U.S. operations of foreign banks be chartered and regulated
at the Federal level. Those who support such a change do so because
foreign bank operations have created a number of regulatory problems.
Some of these problems relate to the fact that foreign banks contribute
substantially to short-term capital flows and thus affect both the
U.S. balance-of-payments position and the conduct of U.S. monetary
policy. Others relate to the evasion of constraints in U.S. banking
law which give foreign banks a competitive advantage over domestic
banks. The rapid growth in the number of foreign bank offices and
in their total U.S. assets in recent years has also raised concern that
there is no national policy regarding the permissible level of foreign
investment or participation in the U.S. banking system. Such concern
reflects the view that the banking system exercises a key role in
determining the well-being of the domestic economy.
Foreign banks operate in the United States through the following
kinds of offices:
U.S. branches of foreign banks are chartered only under State
law. Until recently, only New York and Massachusetts have en-
couraged their formation. In 1973, the Illinois law was liberalized to
permit foreign banks to operate a single branch in the area of the
Chicago Loop. California permits foreign bank branches, but requires
that their domestic deposits be insured by the Federal Deposit
Insurance Corporation. Presently such deposits are not eligible for
FDIC insurance and foreign bank branches are limited to States
which waive this requirement. As a substitute for Federal insurance,
New York State law requires that a branch maintain dollar assets
equivalent to at least 108 percent of all liabilities obtained within the


State. Of the additional 8 percent which, in effect, represents the
branch's capital, 5 percent must be segregated and maintained in cash
or government securities in a domestic bank within the State under a
restricted deposit agreement and is subject to withdrawal only with
the consent of the superintendent of banks.
The fact that branches of foreign banks are legally a part of the
parent bank has led the Federal Deposit Insurance Corporation to
question their eligibility for deposit insurance and to insure only the
deposits of separately capitalized subsidiaries. New York imposes a
separate entity provision on branches which requires that the deposits
of the branch be segregated from other deposits in the parent branch
network and prohibits transfers of depositors' funds through the "due
to" and "due from" accounts of the branches with their parent banks.
Reserve requirements and interest rate ceilings on deposits are the
same for branches of foreign banks in New York as for State banks,
as are examination and supervision. Limitations on loans to one bor-
rower are, however, based on parent bank capital. The major sources
of funds received by foreign branches are Certificates of Deposit (CD's),
compensating balances and interbank borrowings. Few of them
offer personal checking accounts. Funds are used to finance interna-
tional trade, for interbank lending and for commercial and industrial
loans within the United States.
Like branches, the agencies of foreign banks are chartered under
State law. The principal distinction between branches and agencies is
that branches are permitted to accept domestic deposits and agencies
are not. Because they are not, agencies are relatively free from exten-
sive examination by State banking authorities, are not subject to
regulation Q or to fractional reserve requirements, and are not limited
in the amount of loans to individual customers. They are permitted to
keep less assets against liabilities than are branches and are relatively
free from requirements relating to asset composition and the choice of
approved depositories. Agencies also are not subject to the separate-
entity concept imposed on branches of foreign banks under New York
law and are legally an integral part of the parent bank.
Agencies are permitted to make domestic loans and New York
agencies have been an important source of funds for security dealers.
Many agencies are active in buying and selling American securities
for their parent bank, its branches and customers. They also execute
a substantial volume of foreign exchange transactions for their home
office in the New York market. However, like the branches of foreign
banks, they are primarily engaged in financing international trade,
making loans to other banks and to U.S. corporations.
Foreign banks have banking subsidiaries in the United States which
are subject to State law and their deposits are insured by the FDIC.
Unlike foreign bank branches, they are engaged in the full line of bank
activities and not concentrated in international finance and commercial
and industrial lending. Foreign banks also invest directly in non-bank
U.S. businesses such as securities firms, investment banks and trusts.
This gives them a competitive advantage over U.S. banks which can-
not engage in a brokerage or underwriting business.


Representative Ofices
Of the kinds of activity permitted to foreign banks by authorities
in the various States, representative offices attract the largest number
of banks. These offices are not permitted to engage in banking activi-
ties but may receive checks for forwarding to the home office and
handle the signing of loan papers. Because they do not receive deposits
or make loans, they are not supervised and need not even be licensed
in some States. They function primarily to attract business for the
parent bank and to develop correspondent relationships with American
banks. Representative offices often serve, however, as a precursor for
other forms of activity. They are a relatively inexpensive means of
establishing a presence in a new location before opening a branch,
agency or subsidiary.
The regulatory problems relating to foreign bank operations in the
United States can be summarized as follows:
1. Because foreign banks can operate branches and agencies in the
United States without the approval of Federal authorities, they are
able to engage in the business of banking in more than one State.
Domestic banks have not been able to branch across State lines under
the McFadden Act.
2. Since the foreign parent bank obtains approval to conduct branch
and agency operations from State authorities, they can establish or
acquire interests in companies which buy and sell securities and engage
in underwriting without divesting their banking operations. Thus,
unlike domestic banks, they are not subject to the restraints of the
Glass-Steagall Act of 1933 which separate commercial banking from
investment banking and securities transactions.
3. As State chartered institutions, foreign banks' branches, agencies
and subsidiaries are not subject to the same reserve requirements as
are Federal Reserve member banks. State requirements in some of
the States in which foreign banks are active are lower than Federal
Reserve requirements. All offer advantages in terms of permitting
reserves to be held as correspondent balances in other banks, and
some permit a portion of banks' reserves to be invested in interest-
bearing government securities. But the competitors of foreign banks
in most cases are not smaller, State chartered domestic institutions
who also benefit from these advantages. The U.S. offices of foreign
banks enhance the ability of the parent bank to compete with large
U.S. banks which are active overseas, and the arena of competition
for these offices extends far beyond the confines of the State.
The large U.S. banks with whom the foreign banks compete are
members of the Federal Reserve System and subject to its reserve
requirements on domestic operations. Thus, foreign banks operate
in the United States with an advantage which U.S. banks do not have
when they operate overseas. No foreign country permits the foreign
branches and subsidiaries of U.S. banks to hold lower reserve require-
ments against domestic deposits than are required of its own banks.
4. U.S. banks invest in joint ventures with foreign banks active in
the United States, often in the same State and city in which the U.S.
bank is domiciled. This practice blunts the thrust of U.S. anti-trust
law and permits the introduction of multinational banking cartels
into the United States-allowing, in effect, U.S. banks to do indirectly
what they legally cannot do directly.

5. Agencies of foreign banks are primarily engaged in an interna-
tional banking business, but the regulatory framework of States in
'which they operate gives them substantial competitive advantages
over the international departments of U.S. banks or their Edge Act
subsidiaries.' Because they cannot accept domestic deposits, agencies
are not subject to reserve requirements nor to interest rate limitations
nor to the same degree of surveillance as are domestic banks. But they
1borrow a quarter of their liabilities from domestic banks and are
permitted to accept and solicit domestic deposits for transfer to their
parent banks.
Agencies also can keep credit balances related to international trans-
actions for their own account, and, again, have a competitive advan-
tage in attracting these domestic funds because of their freedom from
regulatory restriction. Given the limited degree of surveillance to
which the agencies of foreign banks are subject, it is difficult to
ascertain how these credit balances differ from domestic deposits or
how long funds accepted for transfer to the home office are kept by
the agencies and how they might be used.
6. Because the agencies and branches of foreign banks serve as
sources of dollars for their parent banks' operations in the Eurodollar
market and as recipients of dollar resources which the parent bank
wishes to invest in the U.S. money market, they contribute sub-
stantially to short-term capital flows and impact on the U.S. balance-
of-payments position. In February 1973, funds solicited in the United
States and lent abroad rose by $1.2 billion (from $4.5 to $5.7 billion).
This increase added to the downward pressure on the dollar overseas at
the time. Similarly, in the spring of 1974, foreign banks in the United
States reported a $3.6 billion or 25 percent increase in claims on for-
eigners between April 24 and June 30. Almost half of the increase was
listed as due from their parent banks and related institutions overseas.
This increase in claims was offset by a $2 billion (or 10.4 percent) in-
crease in liabilities to foreigners. Thus the net outflow of funds through
these banks was $1.6 billion in the two-month period. The magnitude
of such dollar transfers, especially over short periods of time, can
thwart U.S. monetary policy domestically and internationally.
7. The assets/liabilities of foreign banks in the United States rose
nearly 20 percent in the two-month period between April 24 and June
30, 1974-from $38,998 billion to $48,127 billion. Their assets rose
another $2 billion by the end of July but dropped back $2 billion the
following month. As this pattern indicates, the operations of foreign
banks are of a very volatile nature. The fact that foreign banks obtain
between 20 and 23 percent of their liabilities from commercial banks
in the United States, and loan about 17 percent of their funds to banks
in foreign countries, and that a substantial amount of their liabilities
are obtained in the Federal funds market means that they have an
impact on financial markets out of proportion to the size of their
assets. Given the significance of their operations for both domestic
and international money markets, lack of adequate information on
their activities and the inability to influence these activities by the
Federal Reserve complicates the implementation of monetary policy.
1 Edge Act Corporations are international banking and investment subsidiaries of U.S. banks. They
were authorized by an amendment to the Federal Reserve Act (section 25a) sponsored by Senator Walter
Edge in 1919. Edge Act Corporations are chartered and regulated by the Federal Reserve Board, are subject
to limitations on liabilities and on loans to one borrower. They can accept domestic deposits only if related
to international transactions.


Because the recommendations which are an outgrowth of this study
will be discussed subsequently in detail, the following brief summary is
offered here:
1. Eliminate competitive advantages enjoyed by foreign banks by
requiring that banking operations which they conduct in the United
States conform to statutes and regulations which govern the conduct
of domestic banks.
2. Impose member bank reserve requirements on foreign banks and
require that reserves be deposited with Federal Reserve banks.
3. Provide for chartering of foreign banks at the highest level of
government (i.e., the Treasury) in order to:
(a) Provide for consultation by all relevant authorities (Federal
and State banking authorities, State Department, National
Advisory Council, etc.) as needed.
(b) Establish national guidelines regarding the permissible level
of foreign investment or participation in the U.S. banking
4. Prohibit interlocks and joint investments between U.S. and for-
eign banks operating in the same banking markets in the United

A decade ago, in 1965, the Voluntary Foreign Credit Restraint
guidelines were imposed on U.S. banks in recognition of the fact that
an increasing volume of credit to foreigners from a growing number of
banks had become a major component in our payments deficit. Twelve
banks which already had branches and subsidiaries overseas expanded
their foreign operations and over the next few years a number of other
U.S. banks undertook overseas operations for the first time with the
blessing and encouragement of the regulatory authorities. The rationale
was that funds obtained overseas and loaned to foreign customers
would have no effect on American credit markets or the U.S. payments
In 1969 U.S. authorities took note that U.S. credit markets were
not so isolated from the overseas operations of U.S. banks as had been
thought. Some $14 billion Eurodollars swept into New York in a very
short period of time as banks borrowed from their foreign branches to
get around the Fed's tight money policies. The lion's share of those
funds were channeled to larger corporations and the result was that
it took longer to cool the economy. As usual during periods of tight
money, non-corporate sectors such as housing, consumers, local
governments and small business suffered disproportionately. This
time, however, their sufferings were prolonged by the continuing
infusion of Eurodollars into the treasuries of larger corporations
through the multinational banks. The U.S. economy experienced
simultaneously skyrocketing interest rates, unemployment and in-
flation-a new combination of indicators which was termed stagflation:
In addition to these concerns, the Federal Reserve also had to
contend with what would happen to the balance of payments when
U.S. interest rates dropped and that $14 billion flowed off in search
of more lucrative markets. It responded quickly by imposing reserve
requirements on new borrowings from overseas branches and by pro-
viding for reasonably gradual repayments of the $14 billion already
borrowed. Meanwhile, the 1969 experience demonstrated within the
U.S. economy as had already been demonstrated in the economies of
other developed countries, that Eurodollars could impede or even re-
verse efforts to impose appropriate domestic monetary policies.
What is a Eurodollar? Obviously it is not a piece of paper which
the German or French housewife uses interchangeably with marks or
francs to buy groceries. A Eurodollar is usually defined as a dollar
which is deposited in a bank outside the United States and Euro-
currency as any currency which is on deposit outside the country of
origin. The significant characteristic of the Eurodollar or Eurocurrency
market is that is has freed credit creation from the confines of national
capital markets and national banking systems. Assume, for example,
that Eurodollars are loaned by a bank in Nassau to a corporation in
Germany which in turn converts the dollars into marks in order to
spend the funds domestically.


These transactions present the German Central Bank with two
choices: It can passively swap marks for dollars with the corpora-
tions, thus swelling the German money supply, or it can refuse to
swap which will require that the German corporation induce private
holders of marks to trade their marks for the corporation's dollars,
thus forcing a change in the dollar-mark exchange rate. In either
case, the German economy has been affected, either the money
supply rises or the mark appreciates. Thus, the existence of the
Eurodollar market has reduced the ability of the central bank to
control domestic financial markets.
If it agrees to permit Eurodollars to flow freely across its borders,
i.e., swap to domestic currency for dollars, a central bank can only
maintain monetary control by adjusting the volume of funds which is
under its control to compensate for the inflow-outflow. This is a more
difficult task than if it were the sole creator of the money supply
and may lose some ability to allocate credit if this is one of its objec-
tives. In any event, to be successful in making adjustments to Euro-
dollar flows, a central bank needs accurate and up-to-date information.
Currently such information is not available.1
A number of devices have been used to protect the domestic money
supply in developed countries from unwelcome inflationary and
deflationary effects of Eurocurrency flows. They have had varying
degrees of success. None of them, however, has dealt with the growth
of the Eurocurrency money supply. Professor Milton Friedman ob-
served in 1969 that the fractional reserve system functions as a credit
multiplier in the Eurobanking system as in any national banking
system and that U.S. payments deficits, while responsible for initiating
the Eurodollar pool, could not account for its immense growth.2 An
increase of $20 billion in the dollar liabilities of foreign branches of
U.S. banks to foreigners in 1973-the year of the U.S. payments
surplus-is evidence of the self-generating powers of this international
money system.
There are no official figures on the size of the Eurodollar pool. A
1973 Senate Finance Committee report on multinational corporations
estimated that short-term assets in international money markets
totaled $268 billion in 1971. This was equal to nearly 60 percent of
the U.S. money stock-currency, demand deposits and time deposits
at commercial banks (excluding large CD's)-which totaled $465
billion. These private short-term assets in international money
markets were more than three times the reserves of industrial coun-
tries-$88.5 billion as defined by the IMF at the end of 1971-and
more than twice as large as total world reserves of $122 billion. Some
71 percent of these assets, $190 billion, were controlled by U.S.
multinational corporations and banks and their overseas affiliates.
The U.S. banks and their overseas branches held $74.4 billion or 28
percent of the total.
The 1973 Economic Report of the President stated that the total
volume of dollars held by foreigners as balances in both American
and European banks on December 31, 1972 was $150 billion. Morgan
Guaranty Trust Company estimates that this figure-the Euro-
dollar component of the Eurocurrency market-had grown to $255
SEfforts are only now being initiated by the IMF, OECD and others to obtain informa-
tion on specific kinds of Eurodollar loans.
2 Milton Friedman, "The Eurodollar Market: Some First Principles," Banking Markets
and Financial Institutions, Gies and Apilado, editors, Homewood, Ill., Richard D. Irwin,
Inc., 1971.


billion by the end of 1974 and that the total gross Eurocurrency
Market had risen to $310 billion. The activities of foreign branches of
U.S. banks contributed significantly to that increase. Their total
Eurodollar and foreign currency liabilities rose 29.5 percent in 1971,
30 percent in 1972 and 53 percent in 1973, and 24.6 percent in 1974.
It is estimated that foreign branches of U.S. banks hold around 40
percent of gross Eurocurrency liabilities.
The implications of this growth are read somewhat differently by
observers of the multinational scene. There are those who argue that
the creation and expansion of the Eurodollar market is responsible for
the extraordinary increase in international trade and investment and
thus for the substantial rise in world prosperity over the last decade.
Others argue that the price which has been paid for increased trade and
prosperity has been a loss of sovereignty by governments to the private
international financial sector with the result that economic events,
both domestic and international, are determined less by public policy
and more by private interests. Most recently the argument has been
made that unrestrained money creation in the Eurodollar market as
central banks attempt to stabilize the exchange rate for their domestic
currencies has contributed to world-wide inflation in the same way
that excess money creation by the Fed had fueled inflation in the U.S.
market. There would appear to be some truth in all three observations.
One of the major problems posed by this international money supply
relates to monetary control. There is no counter-cyclical mechanism in
the Eurocurrency market. Moreover, counter-cyclical measures em-
ployed within national economies act to enforce a cyclical pattern of
events when individual countries attempt to stabilize their exchange
rates. Tight money policies draw Eurocurrency funds into domestic
markets in the form of loans. Monetary ease induces an outflow of
domestic funds which become Eurocurrency deposits. In either case,
there is an addition to the Eurocurrency money supply. The growth
of the Eurocurrency money supply has contributed substantially to
world inflation on a scale which would have been unthinkable 10 years
ago. Then it was thought that we had attained a degree of monetary
sophistication which made boom-and-bust cycles a thing of the past.
Now our ability to deal with such events seems less certain.
In dealing with the problem of international inflation, it has become
necessary that policy makers focus as much on the structure and
regulation of international banking as on international monetary
reform. Floating exchange rates have solved many of the problems
relating to adjustments between nations and have curtailed a par-
ticularly virulent form of currency speculation which fueled increases
in the Eurocurrency money supply. But floating exchange rates do not
act otherwise to inhibit its rate of growth. The solution appears to lie
with the tools of monetary policy as applied to banking systems in
national economies-i.e., reserve requirements and limitations on
assets and liabilities. Central banks have attempted to limit fluctua-
tions in exchange rates and in the process have given up some degree
of control over their domestic money supplies.
In connection with such a solution the question arises as to who
will impose these monetary controls. It has been suggested that the
IMF be turned into a world central bank with precisely those powers.

62-748-76-bk. II-6


I might also be possible to do the job through the existing structure
of national central banks working cooperatively and assuming respon-
sibility both for international activities undertaken by their own
banks and for activities of international banks within their borders.
Such an approach is needed not only because of the problems which
have arisen as a result of international credit creation but because
international banking poses a threat to the structure and soundness
of domestic banking systems.
On June 30, 1975, there were 14,573 insured commercial banks in
the United States with aggregate assets of $930.7 billion. Of these
banks, 128 had overseas branches with $162.3 billion of assets. Thus,
15 percent of the combined total of foreign and domestic assets held
by insured U.S. banks were held outside the United States and outside
Federal Reserve control. Moreover, about 75 percent of these foreign
assets are held in London, Nassau, Cayman Islands and other inter-
national financial centers and are free from control by any central
bank. They are not subject to reserve requirements or time or interest
rate limitations on deposits. Branches in these locations constitute
unregulated portions of a given parent bank's operations. Neverthe-
less, foreign branches of U.S. banks are legally an integral part of the
parent bank and rely ultimately on its resources. In the event of a
liquidity crisis in the Eurodollar market, foreign branches will call on
resources of domestic parent banks who will, in turn, borrow from the
Federal Reserve as lender of last resort. Therefore, unregulated opera-
tions of U.S. banks in the Eurocurrency market must be dealt with as
an American banking problem.
Not all unregulated international banking operations take place in
London, Nassau and the Cayman Islands. They also take place in
Panama, Hong Kong, Singapore and, more important, in New
York, Chicago, Los Angeles and San Francisco. In these four U.S.
cities, agencies and branches of foreign banks controlling some $50
billion in assets conduct an international business which differs very
little from that of their parent banks' London branches or the London
or Nassau branches of U.S. banks.

Admittedly, the amount of unregulated laissez faire international
banking which takes place in the United States is small compared
with such activity world-wide. But the U.S. activities of foreign
banks do take place in the context of international banking as a
whole rather than as an isolated phenomenon, and no discussion of
international banking would be complete without acknowledgement
of the contributions of American banks to the present state of the
art. It is true that a number of foreign banks have been active inter-
nationally for a much longer period, but their activities until recently
have been confined to specific trading areas. The developments of
the last decade-the creation of international currencies and of major
financial centers in such unlikely places as the Cayman Islands,
the establishment of global banking networks and of consortia of
major banks from several countries-have either been initiated or
made possible by U.S. banks. Foreign banks were initially overtaken
by these developments and have only moved to meet the competition
very recently. But their expansion in turn has been almost as dramatic
as that of the American banks before, and the growth of international
banking within the United States as a result of the new facilities
they are establishing would seem to offer the main event on which
attention will focus in the immediate future.
At the moment, however, and in view of the extraordinary level of
activity of U.S. banks overseas, the fact that growing interest by
Americans in multinational banking should focus on foreign banks
in the United States may appear remarkable to more internationally
oriented observors in other developed nations. The most obvious
explanation for this is that these developments have occurred outside
the United States for the most part. As noted, the Voluntary Foreign
Credit Restraint program discouraged home office loans of domestic
funds to foreigners and encouraged the offshore activities of U.S.
banks. Thus, Americans who are not themselves participants in
international markets are only dimly aware of the growing importance
of multinational banks and corporations to the U.S. economy, and
the message of its importance is being brought to them on the incoming
tide-by the inflow of foreign banks and corporations into the United
States in sufficient numbers to be visible.
As Table 1 indicates, there is a substantial difference between the
branch and agency assets of foreign banks in the United States and
those of U.S. banks overseas. But these differences are only a part
of the total picture of international banking since U.S. banks have
less than half the total foreign bank assets in London and since banks
from a number of countries have branches in the Bahamas and Cayman
Islands, Panama, Singapore and Luxembourg as well as the principal
cities of other major countries. It is estimated that U.S. banks have
only about 40 percent of total business in the Eurodollar market.
Their share of total external banking activities may be less given the
historic involvement of European banks in third world countries.


Meanwhile, other differences should be noted. American banks
built up substantial branch assets in Europe before banks from
continental Europe entered the United States in sufficient numbers
or with sufficient resources to make an impact, and this is reflected
in the fact that U.S. banks have more than twice the assets in their
European branches than banks from those areas have here. But those
banks have a greater potential for growth in the United States than
do U.S. banks in Europe under current legal and regulatory climates.
Exchange controls, restrictions on sources and uses of funds and other
limitations have hampered the growth of U.S. branches in European
countries other than the United Kingdom and Luxembourg. It should
also be noted that Japanese banks have twice the assets in branches
and agencies in the United States than U.S. banks have in Japan
where entry is limited. Canadian law actually prohibits foreign banks
from establishing branches in Canada although Canadian banks have
substantial branch and agency assets in the United States, London
and elsewhere.
As these figures indicate, there is not really that much difference
between the activity of foreign banks and U.S. banks in international
markets.' Foreign banks have roughly the same level of operations in
the United States that U.S. banks have in other developed countries
except the United Kingdom-more than in some and less than in
others. The bulk of the foreign branch activity of U.S. banks is carried
on in reserve-free and unregulated banking markets in London
(44 percent), the Bahamas and the Cayman Islands (25 percent),
Luxembourg, Panama and Singapore. Aggregate assets in these
countries are $124.3 billion or 75 percent of total foreign branch assets
of U.S. banks. As this analysis suggests, the threat of retaliation
against U.S. banks by developed countries if U.S. law governing for-
eign banks is changed should not be viewed as a major issue. While
the attitude of the United Kingdom toward U.S. and other foreign
banks is and will continue to be important in shaping international
banking, the British are not likely to expel American banks because
laws are tightened when they already tolerate banks from countries
like Japan that have far tighter entry and regulatory requirements
than current U.S. proposals have suggested.
1 Assets of subsidiaries have not been included in this comparison since subsidiaries are not legally part
of the parent bank but rather part of the banking or financial system of the country in which they are located
and subject to its laws. Commercial bank and investment company subsidiaries owned by foreign banks
have total assets of $13.5 billion in the United States. Foreign subsidiaries of U.S. banks (commercial banks,
finance, leasing and other companies) have assets of approximately $23.2 billion. A breakdown of the assets
of these subsidiaries by geographic location is not available to the Committee. The assets of the numerous
affiliates of U.S. banks also are not available.


[In millions of dollarsi

banks in U.S. banks
Country United States I overseas 2

United Kingdom.-----.........--..-------. ..--- ... _--- ----------- ...---------- 3,090 72,455
Continental Europe.-...--------......---------.. ---... ----------------.----...-- 11,463 23,314
Luxembourg.................-------------------------------------------------------------... 1,424
Japan-----............ .....................-----------------------. 19,762 10,341
Canada. ...-----...-- -..--.....--......--......----...--................ 6,049 -.....-....-..
Bahamas.... -----........ --... --..--....................- ---............- .....-- ..---. ... 35,678
Cayman Islands..-----.. --...-..--- ..--- ... ...-- ........-------... .- ..---------------. 5, 595
Other countries. ---------- ---------------.------------------- 2,635 16, 677
Total ....-----...------- --- ...----.....---------. .. ......------.. 42,999 165,484

1 Data are for September 1975 for branches and agencies.
2 Data are for August 1975.
Source: Federal Reserve Board; compiled by committee staff.

Meanwhile at year-end 1974 there were 78 foreign banks engaged
in banking operations in the United States. Thirteen additional foreign
banks were engaged only in securities operations through subsidiaries
or affiliations with investment banking companies, and another 72
foreign banks had only representative offices.2 Thus, 163 foreign banks
have some form of activity or representation in the United States.
The 78 banks which are engaged in banking operations have some
180 U.S. offices and on June 30, 1975 reported total U.S. assets of
$57.3 billion. Thus, 78 foreign banks hold slightly less than 6, percent
of total domestic U.S. bank assets. This compares with a total of $7
billion of assets held by the U.S. offices of foreign banks in 1965.
As the tables in Appendix A indicate, Japanese banks hold about
66 percent of total agency assets in New York and California. In
California they have almost 80 percent of the total with banks from
other far-eastern countries accounting for less than 2 percent and
Latin America represented by only 2 banks, for less than 1 percent.
Agencies of Canadian banks are the next largest group from a single
country. In New York they hold 36 percent of total assets but are
less important in California.
In New York European banks dominate foreign branches but have
virtually ignored the agency form of operation. In California, however,
agencies of 8 European banks have aggregate assets of $874 million
or 11 percent of the total for California. European banks as a group
have almost 85 percent of the total assets of New York branches of
foreign banks. While no single country is dominant, 4 banks from
England have about a quarter of the European assets and 2 French
banks have approximately the same amount.
Among subsidiaries, the Japanese banks hold more assets than banks
from any other country with British banks second. Banks from Europe
have only 2 more subsidiaries than do the Japanese and less than
$100 million more in assets.
2 See Appendix A.


Most of the foreign bank activities in the United States are con-
ducted by very large banks. Forty-seven-or approximately three-
fifths-of the 78 banks engaged in banking activities are among the top
100 banks in the Free World by size of deposits. The fact that only 18
U.S. banks are among the top 100 gives some indication of the compet-
itive potential of these giants. Another indication is the fact that 4
U.S. subsidiaries of foreign banks-Bank of Tokyo Trust Company of
New York, Bank of Tokyo of California, European-American Banking
Corporation and Sumitomo Bank of California--were among the top
500 banks in the world at the end of 1973. In June 1975, the Bank of
Tokyo held $6.5 billion of assets in its U.S. offices. Fourteen other
foreign banks held more than $1 billion of assets in the United States
(see Table 2) and 10 other foreign banks had between $500 million
and $1 billion of U.S. assets. About 75 percent of foreign banking
operations are handled currently by these 25 banks. But there are
another 25 or so banks already active in the United States which have
the resources to become major competitors in American banking

[Where they would rank among U.S. banks if their total U.S. assets were combined]

Total U.S.
assets 1 Hypothetical
(thousands) U.S. bank2

Bank of Tokyo _____---_ -----------....... -------------_........ ------------_. $6, 510,263 20
European American Group---------...-.. --.............------ ------------------ 3,517,480 29
Credit Lyonnais, Paris..--.......-- -........-- ...-- ....... ............-------- 2,570,053 47
Royal Bank of Canada ...--- ...---- ...-- .....------__ ---_--------- ---------_ 2,111,186 50
Sumitomo Bank, Japan--.........---...----------------------..... ---- 2.061,471 51
Barclays Group, London -. ----...........---------------------..-. ----- 2,054,911 53
Lloyds Bank, Ltd., London ---..---.._ _---- -. ----- ---- ------- ------ .. ..- 1,993, 419 57
Swiss Bank Corp --.... ------------------------------------_------_. 1,990,517 58
Sanwa Bank, Osaka ......---------......- .......------------.---- 1,741,952 66
Fuji Bank, Tokyo _....-----------------..--------.. ---.---.-------. 1,636,924 71
Mitsubishi Bank, Tokyo ----- .....---- --- --------- ...--- ..-- ..----- 1,360,977 78
Dai-lchi Kangyo Bank, Tokyo ..-.----. --.--- .- ------. -------------- 1,354,942 79
Toronto Dominion Bank .-----..-------------..------------ .---- 1,274,686 86
Tokai Bank, Japan ---... .... ....-----------------.. --------..--- 1,267,100 87
Bank of Montreal ......----- ....------------- -------------- 1,053,845 112
Total assets ... ._ ..........------------------- ....- ------ 332,499,726 ...----...---

1 Assets for New York, California, and Illinois, June 30, 1975.
2 U.S. banks ranked by assets, Dec. 31, 1975.
sTotal assets of $1,000,000,000 foreign banks were $28,267,925 on June 30, 1974.
Source: State banking departments, American Banker; compiled by committee staff.


Nine States have laws permitting some form of foreign banking
activity.' Some States specifically prohibit such activitS, otIocrs io
so implicitly,2 but the majority have taken no statutory position.
Foreign banks are not specifically prohibited from owning or contro.-
ling national banks but the provisions of the National Banking Act
require that the directors of such banks be U.S. citizens and local
residents, and prescribe some limitation on lending in relation to
the amount of equity capital invested by foreign owners. As a result,
the formation or acquisition of national banks by foreign banking
institutions has not been attractive though there are several instances
of investments in national banks by foreign individuals.3 Purchase
of a controlling interest in a U.S. bank by a foreign bank requires
approval of the Federal Reserve Board and subjects the purchasing
bank to the requirements of the Bank Holding Company Act Amend-
ments of 1970. Purchase of a controlling interest by a foreign individual
is currently not covered by the Bank Holding Company Act and does
not require Federal Reserve Board approval.
The bulk of foreign banling activity is concentrated in New York,
which has approximately 60 percent of total offices and 75 percent of
total foreign banking assets. California is second in terms of both
foreign bank offices and assets and also in terms of the length of time in
which foreign banks have been active in the State. The Illinois branches
have all been established since the law was liberalized in the fall of
While there has always been some degree of foreign banking activity
in the United States, the level has been relatively unimportant until
recent times. As noted elsewhere, total assets of foreign banks were
$7 billion in 1965 and are now in excess of $60 billion. Some of the
impetus for this growth has been due to the liberalization of State laws.
Foreign banks were first permitted to establish branches in New
York in 1961 as a result of legislation supported by First National City
Bank and Chase Manhattan Bank. California also liberalized its laws
to permit foreign branches despite opposition from its banking au-
thorities, but a provision was added requiring that the branches be
approved by the FDIC for deposit insurance. Since they are not cur-
rently eligible for insurance, the California branches cannot accept
domestic deposits. Thus their activities are similar to those of the
I States with statutes dealing with permissible foreign bank activities are Alaska, California, Hawaii,
Illinois, Massachusetts, Missouri, New York, Oregon and Washington.
2 States which are closed to foreign banks are Connecticut, Florida, Georgia, Kentucky, Maryland,
Mississippi, New Jersey and Ohio. In states which limit or prohibit branching (such as Pennsylvania and
Texas) foreign bank branches are automatically excluded.
3 Michele Sindona owned 22 percent of Franklin New York Corporation, holding company for Franklin
National Bank prior to its acquisition by European-American Bank and Trust Co. in October 1974, through
a personal holding company, Fasco International, and was a director of Franklin's holding company but not
of the bank. Edmund J. Safra owns a majority of the shares of Republic National Bank of New York through
Trade Development Bank of Geneva which he controls. Mr. Safra is an honorary director of the bank.
Other examples are Adrian Khashoggi who owns a controlling interest in Security National Bank, Walnut
Creek, California and Ghaith R. Pharoan who recently purchased a controlling interest in Bank of the
Commonwealth, Detroit.


New York agencies and they are usually referred to as agencies. Cali-
fornia permits foreign banks to establish both subsidiary and agency
operations. New York also permits the establishment of either
branches or agencies (but not both) as well as subsidiaries. Canadian
banks, however, do not have this choice and must operate through
agencies and subsidiaries. Since U.S. banks are not permitted to es-
tablish branches in Canada, Canadian banks cannot meet the require-
ment for reciprocity under the New York law.
As noted above, Illinois now permits foreign banks to establish a
single branch in the area of the Chicago Loop. Subsidiaries are subject
to the prohibitions against branching under Illinois law. Foreign banks
in Oregon are not permitted to engage in fiduciary activities but are
otherwise permitted to operate on the same basis as domestic banks if
deposits are insured by the FDIC. Washington State is in the process of
liberalizing its laws to permit entry for foreign banks other than the
two which are currently operating under a grandfather clause. Mas-
sachusetts has for many years permitted foreign banks to establish
branches in the State but has only recently received its first applica-
tion. Alaska and Hawaii permit some forms of foreign bank activity
but so far Alaska has not proved attractive. Finally, Puerto Rico and
the Virgin Islands are open to branches and subsidiaries of both U.S.
and foreign banks.
Table 3 provides a geographic breakdown of foreign bank activities
in the United States by type of organization and table 4 gives a break-
down of assets by States for New York, California, and Illinois.4 As
these tables indicate, foreign bank activities are concentrated in New
York, California, and Illinois with the bulk of activity in New York.
They also indicate that the organizational form preferred by foreign
banks is the branch or agency which can operate as part of the parent
bank network. Thus one can infer that the various liberalizations of
State law since 1961 have contributed to the growth of foreign
banking activities.
4 Additional tables in Appendix A list assets by country or area in which tne home office of the foreign bank
is located and provide a breakdown of assets by type of operation and by State.


Banking subsidiaries and Securities subsidiaries and
Branches Agencies affiliates affiliates Representative offices
Affiliates Affiliates
and and Total
State Banks Branches Banks Agencies Banks subsidiaries Banks subsidiaries Banks Offices offices

California----.......-------------------........ ------31 32 12 13 ...........-------------.. 21 22 67
District of Columbia.--------..... ------.......................--------...... .-------------------------------------------------.. 4 4 4
Florida..................................................................... 1 1 .--......-----------..--------------------------- 1
Florida------------------------------------------------ 1111----------------1 ----------------------------------------1 352
Hawaii....-.................-- -------- -----............................ 1 1 1 1 ........................................................ 2
Illinois-..---... -------..... 25 19 ......-- ---..------------... 3 3 ....---... -----------....... 13 3 35
Massachusetts---..------... 1 1 .....................................---------------...----------.-- .---------------.------------... 1
New York ..----- .--------. 29 48 33 33 18 118 36 220 91 91 210
Oregon.............-------- 2 2 ......................................... .---------------------..................----------- ---....... 2
Texas --------------------........................................----------------------------.........------- --- --------- 6 6 6
U.S. Virgin Islands..-........ 3 7 ...............................................----------------- -------------------- -----------...... 7
Washington-..-----------.. 1 1 1 1 ......---------------......------------------------------------- -- -------.. 2
Total ..--------.....-------------.. 78 -----.-------. 67 .....--------. 36 .----. ...---- 20 .----.------. 136 339

1 Includes 3 New York investment companies. Source: Conference of State Bank Supervisors; American Banker. Data are for June 30, 1974, ex-
2 Several New York securities affiliates have branch offices in California, Illinois, and Massa- cept Illinois which is for Dec. 31, 1974.


Agencies Branches Banking Subsidiaries Total
Percent of Percent of Percent of Percent of
State Amount total assets Amount total assets Amount total assets Amount total assets

New York.................................... $16,887,644,000 29.5 $13,138,196,000 23.0 1 $13,051,338,000 22.8 $43,177,178,000 75. 5
California--.............. .......... 8, 285, 640, 000 14. 5 ..........-------...----.......--.. 4, 489, 007, 000 7. 8 12, 774, 647, 000 22.3
Illinois......................................................................... 1, 018, 148, 000 1. 8 225, 975, 700 .4 1,274,123,700 2. 2
Total--...----...----.......--------.... 25, 173, 284, 000 44. 0 14, 156, 344, 000 24. 7 17, 796, 320, 700 31.1 57, 225, 948, 700 100. 0

I This includes the assets of 3 New York State investment companies owned by foreign banks and and subject to Federal regulation (Federal Reserve and FDIC) total $10,517,385,000, or 21.1 percent
regulated by the New York State Banking Department outside Federal Reserve authority under the of total assets.
Bank Holding Company Act. The assets of foreign bank subsidiaries in New York which are covered
under the BHC Act total $5,772,403,000. Thus, foreign bank assets in these 3 States which are covered Source: State banking departments.

Because foreign banks are currently chartered under State law,
they have certain advantages which domestic banks operating in
the United States do not share. Foreign banks can obtain charters
to conduct full-service banking operations in more than one State.
There are now 48 foreign banks with multi-State operations. (See
table 5.) Of these, 21 are engaged in banking in 3 States, four others-
Barclays Bank, Canadian Imperial Bank of Commerce, the Hong
Kong and Shanghai Banking Corp., and Sumitomo Bank-have
banking operations in 4 States and Bank of Tokyo has operations in
5 States. Banks chartered in the United States under Federal or State
law can only operate in one State.
Foreign banks also can evade the prohibitions of Glass-Steagall
against simultaneous engaging in securities operations and commer-
cial banking if they form agencies (or branches) and do not establish
banking subsidiaries. (See table 6.) When Banco di Roma applied to
establish a subsidiary in Chicago in 1972, it was required by the
Federal Reserve Board to agree to divest its one-third interest in an
investment banking subsidiary in New York. Banco di Roma argued
that had the State of Illinois permitted foreign banks to establish
branches as do New York, California and Massachusetts, it could
have conducted the same form of banking business and retained its
securities affiliate. Subsequently, Illinois did change its law and now
permits foreign banks to open branch offices.
Currently 25 foreign banks conduct commercial banking operations
through agencies and branches while holding an interest in subsidiaries
or affiliates which deal in securities. Of these, 10 are Japanese banks
which hold less than 10 percent in investment banking affiliates
with offices in the United States. Some of the Japanese banks, how-
ever, hold a minority interest in more than one such affiliate. Further,
agencies and investment company affiliates of foreign banks are
permitted to deal in securities but not to underwrite under New York
State law. Whether these companies are substantially involved in
the securities business as well as banking is not known. But the
European banks which have investment subsidiaries as well as bank-
ing offices would be in violation of the Glass-Steagall Act if their
operations were required to conform to existing Federal laws and
The competitive advantages enjoyed by foreign banks in being
able to operate across State lines and to have interests in investment
banking, commercial banking and securities firms is responsible
for an increase in support for Federal chartering and regulation of
their activities. A few bankers have expressed the opinion that these


competitive advantages should result in similar advantages for
domestic institutions-that rather than dismantle and restrict the
multi-State operations of foreign banks, the regulatory authorities
might propose that Congress open the door for nationwide branching
by domestic banks and amend the Glass-Steagall Act to permit
commercial banks to deal in securities. But the size and scope of
foreign bank activities-aside from those of a few very large banks-
does not yet appear to rule out the consideration of divestiture as a
reasonable course of action.
Another major concern relates to the fact that the U.S. offices of
foreign banks are not subject to the same reserve requirements as are
Federal Reserve member banks and that aside from the four subsidi-
aries which are members of the System, are not required to hold their
reserves as non-interest bearing deposits with the Fed. As of March 20,
1973, reserve requirements for State chartered banks (domestic and
foreign) in New Yoik were 1 percent less than Federal Reserve re-
quirements. In California requirements are the same as those for
Federal Reserve member banks but State chartered banks may main-
tain 80 percent of their reserves against time deposits in interest
bearing U.S. securities rather than as vault cash or demand balances
in other banks. Illinois imposes no reserve requirements on either
demand or time deposits of State banks, but does require the branches
of foreign banks to maintain the same level of reserves as do State
member banks.
Given the size of the institutions of which the U.S. branches and
agencies of foreign banks are a part and the resources available to
them, having lower reserve requirements than do large domestic
banks in U.S. money markets can constitute a substantial competitive
edge. More important, however, is the fact that the absence of control
over the reserves of foreign banks' U.S. offices creates problems in
implementing monetary policy.

JUNE 30, 1975

U.S. assets
in New York,
U.S. bank operations Illinois and
Deposits World -California
Parent bank (millions) rank Branch Agency Subsidiary 1 (thousands)

Algemene Bank Nederland--....-..-.----.-------. $12,694 47 New York, Illinois.----------. California --------------------------------....... $832,923
Banca Commerciale Italiana--.. -- ------- 17,701 25 ---------------------- --------------------- 939,699
Banco di Roma----.....- ...---- ---... ------------- 12,196 52 New York --..---...........-----do-------......--------- Illinois..-..-.. --------....... 315,662
Banco do Brazil---- ..-- ..-....---...----- -------- 15,515 31 California (2).------. --------------..... ---------- 581,866
Banco Nacional de Mexico--------------.----------- 1,900 225 --.................------..--- New York, California ---------------------------------- 8,011
Banco Real, Sao Paulo--..------...-...-----..----. 609 524 New York_ --------------- California ..-- .----- ...-- ------.-----------.. 75,204
Bank Leumi le-Israel---...........------------. 5,919 96 Illinois ...- -----..------- New York--....----------- New York..-------------------. 22,313
Bank of Montreal--------.......----------------.. 16, 900 26 .............----- ..--------. New York, California ..... .. New York, California------..... 1,053,845
Bank of Nova Scotia....-----------.. ---------.. ... 12,307 51 Puerto Rico (3), Virgin Islands .---do.--------.....-------- New York.--------.. ---. ---- 910,472
Bank of Tokyo----......-------..-----------.. 15, 314 33 Oregon, Washington.---- --- New York, California (2)-....-- New York (4), California (22).._ 6,510, 263
Banque Nationale de Paris...--..--.--..--..-...-. 34, 230 4 Illinois..-. .-----------..----- California ..---..-----.-- ...California, New York-----....-- 600, 530
Barclay's Group, London---.......--- -----......- 29, 263 6 New York (2), Illinois, Massa- ...--------- New York (24), California (37)-- 2,054,911
chusetts, Virgin Islands.
Canadian Imperial Bank of Commerce-.--.--..------ 18,758 21 Oregon, Washington__--------- New York, California----....--- New York, California (19)..---. 1,005,350
Commerzbank, Duesseldorf......................... 17,338 27 New York, Illinois-------.---....................---------------------------------700,511
Companie Financiere de Suez2...................... 3,872 ----------------------------. 105,538 '
Credit Lyonnais, Paris---------....... -----------.. 28,500 8 .----------. California-.------- --------------------------------- 2,570,053
Dai-lchi Kangyo Bank, Tokyo..--.......----------. 23,046 11 ...............-------------. New York, California---.---- Illinois.-------------------- 1,354,942
Daiwa Bank, Osaka -- --------------------12,487 48 ...--- --------... ----.. -..-.--do ......----------------------- 493,131
Dresdner Bank, Frankfurt --------..-----.-- ----- 24,063 10 New York, Illinois__------.. California- ............--------------------.. 403,288
European-American Group ---------..................------...---..---- Illinois ----.......---------. California (2).__----__.-----. New York (106) New York .... 3, 517,480
Fuji Bank, Tokyo----..............------------ 20,181 17 ..............-------------. New York, California------- New York -----.-----. ----- 1,636,924
Hokkaido Takushoku Bank, Japan................... 5,904 97 -----......----- .-------.-... --do-..---...-..---... -----. ------------225,610
Hong Kong & Shanghai Banking Corp................ 7,297 77 New York, Illinois, Washington__ California....----..---....- California (9) ----------.---.- 256, 588
Industrial Bank of Japan............--------.----.. 18,136 22 Illinois.....------- ------- New York -......-----------.---.----.---------- 944,768
Korea Exchange Bank--...--------.................. ...-- ---------------..-----do----------..-...------ New York, California-------- California---.... .-------- 162,414
Kyowa Bank, Tokyo--------...... -------------- 9,820 62 ..--..........------ --....---- do...- ----------------------- 514,321
Lloyds Bank Ltd., London......---------.-------.. 19,248 19 New York, Illinois_--_----...--.------------------.--- California (94)-...----------. 1,993,419
Mitsubishi Bank, Tokyo --.---------------------- 19,058 20 .-----..........------------.. New York, California.--------. California (3) .-------.------. 1,360,977
Mitsui Bank, Tokyo- .-------....................... 13,269 42 ----....---...---------..--. .---..-do .----------------- California ...-.------------. 996,980
National Bank of Greece...---........-----------. 3,787 120 Illinois ....___-.----------- --------------------.. New York (2) ....... .---.--. 234,469
National Westminster Bank, London....--------- --. 28,900 7 New York, Illinois-..----.. --... California...---.. --------------------------------- 496,307
Philippine National Bank---.... .................... 936 389 New York ---- ...---...-- --- California, Hawaii .---...--- .....----------..------- 97, 495
Royal Bank of Canada.......--- ....-- ..---.- ...-- 20,646 15 Puerto Rico (5), Virgin Islands-- New York, California ..-...--- New York ..--.---...------- 2,111,186
Saitama Bank, Japan---.......--..--- ............ 7,311 76 .--..-.................----------do --..--..--.. ------------..-------------------326,956
Sanwa Bank, Osaka-------......... .-------------.. 18, 074 23 Illinois---..-----...-. .---..----do--.....------------. California (4)- _---_.- ..---1, 741,952
Standard & Chartered Banking Group Ltd., London.... 10,853 60 Illinois, Washington, New York ------... --...... --- California (14) .-------------. 629,172
Sumitomo Bank, Osaka ....----........---- --. 20, 359 16 Illinois--- -------------- do--------... ......--------.. California (19)-----....------ 2,061,471
See footnotes at end of table.

JUNE 30, 1975

U.S. assets
in New York,
U.S. bank operations Illinois and
Deposits World California
Parent bank (millions) rank Branch Agency Subsidiary 1 (thousands)

Swiss Bank Corp---------------................... $14,532 36 New York (2), Illinois.......... California-------------................................-... $1,990,517
Swiss Credit Bank---------------.................. 11,201 57 New York...........------------------..... do.---------------..------------..... 713, 073
Taiyo Kobe Bank, Japan --------------............. 13, 269 40 Washington---...-....---.... -New York, California....................................-----. 868, 170
Tokai Bank, Japan-----------------.............. 14, 281 38 ..................................-------------------------do....................... California -....--............. 1,267, 100
Toronto Dominion Bank--------------.............. 10, 913 59 ......-------.------------------.. do----------............. New York, California (2) ----... 1274, 686
Union Bank of Bavaria, Munich--..-- .............. 16, 158 30 New York, Illinois- ------- ... 127,966
Total, all banks------------................. 715, 362 .............. 65 branches................. 63 agencies...--..-...------ .. 30 subsidiaries---....--- ---- 46,088,513

1 Numbers in parentheses denote branches of banking subsidiaries. Paris, world rank 9, deposits 27,239; Societe Generale de Banque S.A., Brussels, world rank 53,
2 Companie Financiere de Suez is a holding companie for Banque de Suez et de I'Union des Mines deposits 11,916.
(world rank 207) and Banque de I'lndochine (world rank 233), France.
3 Owned by Amsterdam-Rotterdam Bank N.V., world rank 45, deposits 12,862; Creditanstalt- Source: Federal Reserve, State bank supervisors and "American Bankers"; Compiled by com-
Bankverein, Vienna, world rank 102, deposits 4,955; Deutsche Bank A.G., Frankfurt, world rank 5, mittee staff.
deposits 30,437; Midland Bank, Ltd., London, world rank 14, deposits 21,208; Societe Generale,

JUNE 30, 1975

Total U.S.
Deposits World bank assets
Parent bank (millions) rank U.S. securities firms Branch Agency Subsidiary (thousands)

Algemene Bank, Nederland................. $12,694 47 ABD Securities Corp.------.. ---.....--.. New York; Illinois..--.. California. -....--....---....-------... ... $832,923
Dresdner Bank, Frankfurt.................. 24,063 10 --------...- do--.....---..---.... do.. --------- ---------- 403,288
Swiss Bank Corp.......--....------..-- ... 14,532 36 Basle Securities Corp ..----- .-----.. --. New York (2); ...----...--..---.--------..--.. .- 1,990, 517
Daiwa Bank, Tokyo.-------....------... -- 12,487 48 Daiwa Securities Co., America------..............------------. New York; California ....----.....--------- 493, 131
Banco di Roma, Rome -----... .----------.. 12,196 52 Europartners Securities Corp.-...--- ....- New York .------... California...---- .---.. Illinois..---.......... 315,662
Commerzbank, Frankfurt ----.. .--------... 17, 338 27 .-- -do--..-....-------......----- New York; Illinois.----....... -- .................----------- 700, 511
Credit Lyonnais, Paris-----...... --------. 28,500 8 .---do -....----.. .----.. ----------- do ----------- California .--.........-- -..............-- 2,570,053
Westdeutsche Landesbank Gironzentrale.. 22, 801 12 RWS Securities Services----....--...... New York...-...-- ....................----------............ ....
Amsterdam-Rotterdam Bank, N.V-.......... 12,862 45 SoGen Swiss International s2------.------. Illinois---..----.. .... California (2)..----.. 1 bank and 1 invest- 3, 517, 480
ment in New York.
Societe Generale, Paris-....----.... -----.. 27, 239 9 -.......---... -- ------............. do............-- ...--. do--.....--..... -----do--....---.... 3,517,480
Societe Generale de Banque S.A. Brussels --. 11,916 53 ---....--..--. ---- do-...--.......-- 3517,480
Companie Financiere de Suez3 --......-.--- 3,872 .--.----. Suez American.....-------... ----------. New York; Chicago.----..--------...---..........----------.. 105,538
Swiss Credit Bank....----- ----- -------- 11,201 57 White, Weld & Co.,4 Swiss American Se- New York.------.-- California..........----..-----------..... 713,073
Deutsche Bank, Frankfurt-..--............. 30,437 5 UBS-DB Corp----------....... .-----.....-.-- .....................------------..................------
Union Bank of Switzerland............----. 14,402 37 ....-do.................................-------------------------------.. New York...--..--. 999, 628
Fuji Bank of Japan ....--....--....-- ..... 20,181 17 Yamaichi International (America) Inc...-------..........------- New York; California.....--do---............ 1,636,924
Industrial Bank of Japan...-----..--... --- 18,136 22 ....-do......--------.........------ ---.--.--.-----.... -----..... --... do--.--... ...... 944,768
Mitsubishi Bank....--------. ------...... 19,058 20 do.--. ..--- California (3)... .---. 1,360,977
Banca Commerciale Italiana.--..--..-----.. 17,701 25 Shields Model Roland, Inc..----..---. --.. New York; Illinois-... California-----.... ...-.--..----........- 939,699

1 Assets not available from State bank departments as of June 30, 1975. Minority interests.
2 Stockholders of European American Bank & Trust Co., New York. Assets and banking operations
listed are for that bank. America Bank Trut New York Assets and ba g opations Source: Federal Reserve, State Bank Supervisors and "American Banker"; compiled by com-
This is a holding company for Banque de Suez et de 1'Union des Mines (world rank 207) and mittee staff.
Banque de J'idonchne (world rank 233).

Some of the disadvantages of the current system of regulating
foreign banks have already been mentioned. But there are other
problems which would not be solved merely by transferring au-
thority from the State to the Federal level. The basic difficulty was
discussed in a study of foreign banking in the United States published
by the Joint Economic Committee in 1966:
Traditionally, officials have regarded branches of foreign banks to be the most
difficult to supervise. The authorities have feared that they could not adequately
protect the depositors in the branch institutions which, in effect, are appendages
of foreign banking networks. Since the parent institutions are entirely outside
the jurisdication for examination and supervision by State authorities, concern
has been expressed that any attempt to exercise effective control over foreign
branches is made illusory. It has been argued that assets of branches could be
withdrawn by the foreign parent with comparative ease, and once removed,
would be difficult to recover in suits initiated in American courts.1
In framing its law providing for the formation of foreign branches.
New York under a restricted deposit agreement and is subject to
a branch maintain dollar assets equivalent, to at least 108 percent of
all its liabilities within the State. Of the 8 percent, which, in effect,
represents the branch's capital, 5 percent must be segregated and
maintained in cash or Government securities in a domestic bank in
New York under a restricted deposit agreement and is subject to
withdrawal only with the consent of the superintendent of banks.
Moreover, New York has imposed a separate-entity concept which
requires that branches be operated as if their liabilities extended
only to branch depositors. Deposits in the New York branch must
be segregated from all other deposits in the parent bank network
and depositors funds cannot be transferred through the "due to" and
"due from" accounts of the branch with its parent and other branches
of the parent outside the United States.
New York State banking authorities think that these provisions,
together with regulation and examination at the level applicable to
domestic banks, make it possible to supervise foreign branches in-
dependently of the operations of the parent bank and its branches.
However, in 1964 when the provisions affecting foreign branches
were passed in California, the State Superintendent of Banking
argued that the control necessary to protect domestic depositors
requires that the directors of a foreign bank be local residents subject
to local civil and criminal control as well. The implications of both
this argument and of the separate-entity concept in the New York
law tend to undermine the traditional concept of branches as an in-
tegral part of the parent bank with the resources and organization
of the parent behind it. For the protection of depositors it would
seem that the subsidiary form is more consistent with U.S. standards
of regulation and control.
"Foreign Bankine in the United Stat Materials prepared for the Joint Economic Committee, 89th Congress, 2nd Session, 1966,
pp. 23-24.
62-748-76-hbk. II-7


The fact that the branches' lending limits are based on parent
bank capital is another problem which is not easily solved in the
context of domestic bank regulation, State or Federal. Thus attention
must be directed toward the parent in assessing the soundness of a
branch since a view of the parent operation as a whole is required to
ascertain how well asset/liability maturities are matched, the bank's
total of loans to a given borrower, its foreign exchange position in
relation to capital, etc. The branch is thus more vulnerable to events
within the parent bank network than if its lending limits were directly
related to its own size as mealsured by total assets'liabilities.
The problems relating to limits on loans to one borrower apply to
agencies as well-except that there are no limits on loans by agencies.
However, there are other problems which are unique to the agencies.
New York agencies of foreign banks are permitted to hold credit
balances but can only accept domestic deposits for transfer to the
parent bank. Recently, California agencies were permitted to accept
foreign deposits as well as U.S. credit balances.2 Agencies are not
constrained to match maturities of assets and liabilities, do not
carry FDIC insurance, are not subject to Federal regulation or super-
vision and are subject only to minimal regulation, supervision and
examination by State authorities because there is no need to be
concerned with protecting domestic depositors. But because super-
vision is lax, it is difficult to tell if or how credit balances held by
agencies differ from deposits. Moreover, the restriction on accepting
deposits can be evaded by agencies through issuing acceptances.
There are over $10 billion of bankers' acceptances outstanding which
were drawn to finance trade between third countries, most of it
involving Japanese exports and imports. At year-end 1975, $163
million of acceptances issued by agencies of foreign banks were held
in the portfolio of the Federal Reserve Bank of New York.
However, the relevant distinction for supervisory authorities is not
only between domestic and international but between wholesale and
retail funds. The size of individual balances held by agencies is such
that deposit insurance is irrelevant. Thus, the real focus of concern is
with the central bank which must act as lender of last resort should
problems in one of these agencies threaten the parent bank, or other
banks and corporations which have provided a sizable portion of its
Another of the regulatory problems arising as a result of increased
foreign bank participation in the U.S. banking system relates to the
separation of banking and commerce. Some countries do not require
such a separation and some foreign banks which are active in the
United States are affiliated with foreign companies which do a sub-
stantial amount of business in the United States. Questions con-
cerning the propriety of these relationships and their impact on
competition within the American economy were raised in bills pro-
posed in the California Legislature in 1973. The Federal Reserve
Board has also attempted to meet this problem by regulation within
the scope of its authority under the Bank Holding Company Act
2 The numerous representative offices of foreign banks also may receive checks for forwarding to the
home office and handle the signing of loan papers. These offices are by law prohibited from performing
banking functions of any kind but are, currently, totally unsupervised.