purposes-if they would study and assimilate the underlying principles which must guide the Board, and observe these principles voluntarily without requiring inflexible rules. Unless the [bankers] cooperate with the Board in this manner, many transactions unobjectionable as long as they are engaged in for legitimate purposes and within reasonable limits-will have to be barred because strict regulations do not admit of discrimination.

Proper regard for conservation of the strength of the Federal Reserve System requires that it must be possessed of short paper well scattered in its maturities not exceeding ninety days), that when this paper matures it can be actually ected and that the supply of new paper coming into the market can be controlled to a certain degree by an advance or decline in the rate of interest at which bankers' acceptances are bought. Higher rates will exert a restraining fluence on the producer and the dealer and will thereby reduce borrowings and bring about a certain degree of contraction.

By keeping these principles in mind-upon which the strength of our structure depends we can readily understand the hazardous conditions which would be created if, for example, $300,000,000 of acceptance credits should be opened for the purpose of financing corporations for a period of two or three years, the corporations having secured from the acceptors (directly or by a trading_process) a fixed and definite rate of interest for the entire term of the credit. This rate would necessarily be much higher than the current rate for bankers acceptances. Let us assume that $300,000,000 had been loaned to corporations at 8% for two years, plus the acceptance commissions. If during these two years the bank rate should advance to 20%, the corporations would not be affected thereby; they would renew from time to time as though money rates had remained unchanged; and consequently, the bank rate, as far as they are concerned, would lose its power to bring about contraction. Thus the acceptance would cease to serve the purpose of financing the borrower; it would be for the purpose of financing the accepting bank. It would really become an accommodation draft for the benefit of the banker, regardless of the current rate and regardless of general conditions, and whether these conditions demand contraction or expansion, the bankers would have to rediscount these acceptances, at a profit or at a oss, if their own position so required. Here, too, the bank rate would lose its lower to produce contraction because the commitment is a definite one for two

years.

Another flaw in this method of financing is that there is practically no limit to the amount of acceptances which may be created in this manner.

In addition, the rate guaranteed the corporation by the banker would likely be so high as to tempt the accepting bank (having exchanged its acceptance with another bank associated in this business) to rediscount the acceptance with the Federal Reserve bank or to sell it in the open market. For the accepting bank this transaction would not involve the invesment of money as long as the market is able to absorb the acceptances offered. The unavoidable consequence of this process must be in order to prevent an avalanche of these acceptances, the discount rate would have to be advanced so as to reduce the tempting margin and thereby lessen the supply. These syndicate or accommodation acceptances would therefore tend to raise the rate to the detriment of the legitimate business of the country-particularly the import and export business. When, three years ago, we began our campaign to establish American bankers' acceptances, our rate was 2-24% and the English rate was about 5%. Our rate has now moved up to 4-4%%% while the English rate is about 3% %. This signifies that we have reached a point where American houses find it to their advantage again to draw on English banks, as they did some years ago, rather than upon banks of the United States.

It is certain that if syndicate acceptances of this character were offered in European countries the market would at once discriminate against them and put an end to such transactions. It is the application of this rigid principle of keeping the acceptance market primarily reserved for strictly commercial uses that has kept the acceptance business in England in a sound condition and has made the English acceptance market so important an adjunct of the money market. If in the light of these considerations we seek to apply these principles to actual operations we must reach these conclusions:

There is no reason why a bank should not agree that for legitimate commercial purposes, and for transactions complying with the rules and regulations of the Federal Reserve Board, it would commit itself for [two] years to accept for a customer for importations or exportations, or for the purpose of carrying staples properly warehoused. There is no reason why a bank should not say to a tobacco manufacturer, "Whenever you have tobacco properly stored and for which you

will give me proper warehouse receipts, I am willing to accept for you and charge you a commission of -%." Whether it would be wise to make a commitment which would force the bank to accept for a customer even when convinced that the borrower is carrying too large a supply of raw material, or that the transaction is speculative, is a question of banking judgment. It would be safer, of course, if the banker could qualify his obligation to accept. But this is an instance where it would be a mistake to lay down a rule and where reliance must be placed upon the business sagacity of the banker, for in such a case the borrower would remain subject to the hazards of the money market and any advance in rate would have an effect upon his own commitments.

However, the manufacturer should not feel that in dealing with a bankers' acceptance he is taking any other risk than that of the interest rate. He should be trained and this is an important matter-to understand that he can at any time sell his acceptance, not to the acceptor but to other banks, or through brokers in the market, or to the Federal Reserve banks. It is much to be desired that the American banks and banking firms should follow the European practice of freely endorsing first-class bankers' acceptances. No drawer of bankers' acceptances in Europe, in normal times, would expect to encounter any difficulty in selling his paper. He can sell it to discount companies or to private banks, or bankers, to be rediscounted at rates a fraction above the ruling interest rate. (In England for as little as %% above the discount rate and often less.) The manufacturer, after having his bill accepted, should feel quite safe in keeping the acceptance in his portfolio, being confident that, without any further negotiation, he could sell it at any time that he would be in need of cash. Instead of forming syndicates guaranteeing the interest rate to the acceptor, banks should make agreements with manufacturing concerns to buy acceptances, from time to time, from the drawees at, say 4% in excess of whatever might be the ruling interest rate for bankers' acceptances. In this way a real discount market would be developed in this country. Federal Reserve banks will, sooner or later, have to adopt the European rule of buying only paper bearing a third name, viz, the indorsement of a bank, banker, or responsible firm.

It is true that the banks accepting in the present syndicate transactions make an additional profit in the interest rate which they guarantee to the borrower. It is suggested, however, for their consideration that it would be a sounder policy if they would charge a higher acceptance commission for domestic transactions of this kind, for larger commissions would be justified for credits extending over a considerable period. This would be sounder than to adopt a policy which, if permitted freely to develop, would undermine the safety of our acceptance system and our money market.

The principles governing the acceptance are equally applicable to single name paper. A bank may agree to carry a customer over a period of a year and to buy from time to time his single name paper. If this paper, according to the statements submitted, should be eligible in other respects, Federal Reserve banks might discount it, provided the paper is not part of a loan which has been negotiated at a fixed rate for a definite [period-a year or two, for example. A ninetyday note made under a definite] renewal agreement in this way is a camouflage for the convenience of the banker to enable him to finance himself by using the 90-day form as a mask to conceal what is, in effect, an ineligible one year note. But if the interest rate should remain open between borrower and lender subject to adjustment to the market rate, a different aspect would be presented, and the Federal Reserve banks might discount such notes within reasonable limits. When a credit is required for two years, it should be regarded as an unsound basis for commercial borrowings on 90-day paper. Without a guaranty for renewals it would be dangerous for the borrower. With such a guaranty it would be an unsound banking credit. A demand for one or two year money, except for special contracts, indicated a need for greater working capital which ought to be obtained by increase of capital or sale of obligations in the investment market.

It may be argued that there is at present no investment market, and therefore these renewal transactions are necessary. But does the abrogation of the investment market afford a reason for the destruction of the commercial paper market also? Some plan must, and will be developed to restore to a certain extent, at least, the security market. But even if this restoration can not be effected, should we not look upon credit as a commodity of which only a limited supply is available? If we have approached the limit, would it not be wise to conserve credit and apply it only in those directions where its use will nost greatly benefit the country? In case of the tobacco company if it had not secured the full

credit it sought it would in that event have bought less tobacco and possibly might have advanced its selling prices. What if it had reduced its inventories and the consumption of tobacco? Would not this have been just what is at present required? The corollary is that business must adjust itself to credit not credit to business at this time.

To recapitulate: Agreements to grant credits for an extended period by the purchase of 90-day paper or by 90-day acceptances ought to be based upon transactions connected directly with the purchase and sale of goods and the intermediate process of manufacturing. Credits so extended should relate to the resources of the borrowing concern, and should not be granted for the purpose of furnishing working capital, or for the temporary financing of permanent investments.

These transactions should be of an individual character, they call for direct contact between banker and borrower, and syndicate credits should be avoided. Agreements by bankers to furnish one or two year money at a definite rate of interest against 90-day paper or acceptances to be used to finance themselves should not be countenanced either openly or in the form of exchange of paper between bankers.

These are the principles which the Federal Reserve System must apply. [It would be inexpedient to attempt more than to establish the principles.] It would be detrimental to formulate definite regulations dealing in minute detail with the various phases of the problem. It would be far better to give some latitude to the banks in dealing with these matters. But this will depend entirely upon the wisdom and discretion of the member banks. The banks will best serve their own interests if, following the example of European institutions, they will adopt these principles as self-imposed, well tried rules of business prudence rather than by abusing their freedom of action to force the Board to tie their hands by rigid regulations.

NOTE.-Pencilled notations enclose in brackets. 2,13,18.

EXHIBIT No. 3613

[Excerpt of letter]

OCTOBER 30TH, 1916.

DEAR WARBURG:

Now about that French credit: My previous letter written before yours arrived explained what our attitude had been in discussing the earlier credits with Brown and the others. So far as our own attitude is concerned, I think it has been correct and no different from what you and the others in Washington would have had us consistently maintain. I do not, therefore, understand the necessity for any public statement, or even any telegraphic advice, to the Reserve banks, and referring specifically to the action of the Board rather than to the merits of the business, I am inclined to think that it acted hastily in sending the telegram, which implied that the Reserve banks were either committed, or, even without commitment, were liable to employ an undue amount of their funds in investments of this character. We must not forget that business of this kind Degotiated by State banks and private bankers only affects the Reserve System to the extent that we buy the bills, and that is a private matter amoung ourselves which does not justify any public announcement. I am assuming, of course, that the business is not ultra vires as to national banks.

As to the goodness of the business, I presume you still agree with me that all of these dollar credits to England, France, and Germany (if the last-named were arranging them) are intrinsically good and will be paid. You and I would both Like to see the bills drawn if possible in the good old-fashioned way, but these are war times, and a lot of old rules necessarily have been abandoned. Emergency machinery must be devised and put into operation in order to avoid continuous disorganization of the exchanges. I agree with you that it would be very nice to have these bills so drawn that we could drive them home at any maturity date, but you seem to overlook the fact that even if a rate of discount was not guaranteed, the bills would stay here just the same until the credits matured, the only difference being that if the foreign drawers were not protected by the guarantee of discount they would risk having to pay a higher rate.

If the time comes when we have very much higher discount rates for bills than at present, and higher than those on the other side, in other words when a situa

tion develops which would justify transferring the domicle of these bills from New York to Paris or London, you must admit that exchange at such a time must be adverse to this country. Under those conditions, we must rely largely upon the money market working out its own relief and it will do so if we have a large volume of all sorts of bills, by the attraction of floating foreign capital to New York for investment in these identical bills, in that way relieving pressure on our money market and on the Reserve banks. In the past, when Lombard Street has been working normally and exchange became adverse to London so that gold begins to move out of the Bank of England, the bank raises its rate. not so much in expectation that bills will not be drawn on London, but in the expectation that floating capital will be drawn to London to invest in bills. I really do not think your argument is a conclusive one that these credits should be in such form that they can be cancelled whenever our rates get high. Their maturity might be shorter and would in ordinary times. But if credits extended by American banks, whether commercial or financial, are going to be cancelled and withdrawn every time our money rates advance, we will never have a bill market. If our discount market works as it should, an advance in our rates will result, as it does in London, in postponing the drawing of a certain amount finance bills, but an advance should never be expected to dislocate our foreign commercial and financial business by causing the cancellation of foreign credits. If an advance in our discount rates is not effective in attracting money to New York for investment in bills as the chief relief our work in endeavoring to develop a discount market is literally thrown away, for that is the way relief would naturally come.

I do not agree with you at all that this is "unscientific, rotten, and dangerous" financing considering the times we are in. The real objection that I see to the method employed in handling this business was entirely in those two paragraphs in the confidential circular. The bankers were not justified in making statements in regard to the Federal Reserve banks unless they had first consulted the management of those banks, and particularly so, when this is the first 18 months credit which had been arranged, the others having been for 12 months only.

I feel now just as I did when these matters were first discussed. We must not use a foot rule such as might have been used three years ago in dealing with the affairs of the present day. We have to modify a great many things, among others, finance credits, in order to meet the requirements of a trade surpassing anything known in history.

I felt a great deal of concern over the possibility of the Federal Reserve Board making a statement which would involve the Board in any way in a criticism of the goodness of these bills or even of its being legitimate business as to form, etc. Such an attitude by the Board I believe would do infinite harm.

You say that I know you are a liberal constructionist. I think in spots in this matter of finance credits, you have been reluctantly liberal, but that it has been a difficult attitude for you to take and in violation of your many years of training and your strong convictions about the way the bill business should be conducted. This is not the time when nice theories of the way commerce should be financed can be strictly applied.

I hope very much that you and your associates will see fit to let this matter develop just as the former transactions did and then arrange with Mr. Jay or Mr. Treman to point out to Mr. Kent or whoever was responsible for the circular that they should confer before assuming themselves to state what attitude the Reserve banks will take.

EXBIBIT No. 3614

[Copy]

NOVEMBER 10, 1916.

DEAR MR. JAY: When in New York a few days ago you showed me a letter received from Governor Strong in which he took issue with the Board for having ruled adversely in the question of the application of the Mechanics & Metals National Bank for permission to accept for three months drafts drawn for the purpose of furnishing dollar exchange by banks or bankers in France or England. I told you that I had personally secured this amendment and that I felt responshie to see to it that it was not now abused. I doubt very much whether you or Governor Strong has ever read my correspondence with Senator Owen or my testimony before the Committee on Banking and Currency in this respect. If Governor Strong had, I am sure that he could not have insinuated to the Board that we should permit British and French banks, on the strength of this amendment, to go ahead and draw any kind of a finance bill, and that he would not have characterized as ridiculous the Board's ruling in this respect. If we did what Governor Strong asks us to do we would open the door wide for any kind of finance draft from Europe, and, as a matter of fact, we would have nullified all the provisions in the act which try to restrict the power of American banks to accept only for certain well specified transactions.

If I lent my hand to any such ruling, I would feel that I had broken faith with Lose who enacted the amendment. In my letter to Senator Owen, which appears on page 67 of the enclosed copy of the hearings, you will find the following paragraph:

"I am fully conscious of the fact that a draft of this kind, if permitted, might be classified as closely approaching or being a species of the finance draft; but to the extent as above outlined I think this draft has to be sanctioned in order to place our banks on a par with the British banks and other foreign banks operating in South and Central America. If Congress will trust the Federal Reserve Board to supervise these transactions and keep them within proper bounds, I believe that an amendment as here proposed would remove a great handicap now burdening the American banks, while any abuse of these facilities could be stopped at any time by the Federal Reserve Board.”

On pages 73 to 76 you will find my testimony with reference to this particular amendment, and, on page 76, you will find that I said:

"But because we realize that this is not a thing that should be done promiscuously and should not be abused we have put in both, for the accepting and for the purchasing of acceptances the power of the Board to regulate and supervise it."

Governor Strong honestly believes that it would be the best for the growth of our acceptance system if there were no restriction whatsoever-as in Englandand if our member banks could be permitted to accept according to the requirements of trade and finance, leaving it to the business judgment of the central banks and the banking community in general to regulate any abuse. That, of course, is the ideal way for the development of banking wherever such development is safe and permitted by the law. We must remain conscious, however, of the fact that we are operating under a law and that we must not exclusively be guided by what we wish but that, as citizens and, to be sure, as a government body, it is our duty to live up to the restrictions of the law. We should not be astonished to find that the member banks from time to time will try to beat the law. But if the Federal Reserve Board and the Federal Reserve banks should adopt that attitude it would be the end of the whole system.

I am sending a copy of this letter to Governor Strong.

Very truly yours,

PIERRE JAY, Esq.,

(Signed) PAUL M. WARBURG.

Federal Reserve Agent, New York.