Ellis W. Tallman Oberlin College

1. Comments on“The Promise and Performance of the Federal Reserve as a Lender of Last Resort: 1914-1933” Ellis W. Tallman Oberlin College

2. The Federal Reserve System as Lender of Last Resort • Remains an important and relevant question • Important for future progress – what went wrong? • Federal Reserve Act – • Aimed to address known flaws in the National Banking System (1863-1913) • Paper shows that the Federal Reserve Act solved a lot of those problems • But it was not enough – 1929-33 sufficient proof

3. Alternative Explanations • Flaws in the structure of the Fed System • Too decentralized, unable to coordinate policy • Required leadership that system lacked • Devotion to gold standard • Prevented expansionary policy during depression • Fed adherence to flawed policy framework • Relied on nominal interest rate and level of discount window borrowing as policy indicator

4. Why was the Fed unsuccessful as Lender of Last Resort? • Thesis in this paper: • The US banking structure was the core problem • Federal Reserve Act – • Unable to solve the flaws in the US banking system • Unable to mimic the money market conditions of the European Central banks • Intuitively plausible explanation • Challenge: to bring compelling evidence to the issue

5. Proposed thesis: How does it add to our understanding? • Flawed banking system • This idea – not extensively developed in the paper • The flawed design of the Fed • Comments will focus on this idea • Three key flaws of the Federal Reserve Act • 1) Reluctance of Fed members to borrow at discount window • 2) Limited membership of the Fed System • 3) Restricted eligibility of discount window collateral

6. Reluctance to Borrow • Was reluctance a result of “direct pressure”? • 1928-29 – Federal Reserve was exceedingly concerned about extensive credit in call loan market • Aversion to call loan market – was common among the monetary reformers circa 1910 • Huge volume of discount window borrowing 1919-20 • Something must have changed • Aversion to borrowing may have been induced rather than implicit in the Federal Reserve Act

7. Limited Fed Membership • Non-member banks suffered higher failure rates than member banks, 1929-33 • Unable to access lender of last resort liquidity • Board had Power to allow lending to non-members • Was allowed in 1921 but then rescinded in 1923 • Similar, but restricted, ability to lend to member banks to lend to non-member banks allowed during WW I • Federal Reserve Act had the capability to overcome this limitation

8. Restricted Eligibility of Discount Window Collateral • I agree completely with this idea • The restrictions on collateral for discounting • Limited pool of eligible collateral for rediscounting • Consistent with “flawed policy framework” • Can this issue help differentiate the paper’s thesis from alternative explanations?

9. Extend Analysis -- Evidence • Compare components of collateral at Fed DW • Collateral for discount window loans during 1919-20? • Was the composition so different from 1929-33? • Banker’s acceptance market never grew to the extent that Paul Warburg had hoped • Was that sufficient for failure? • Was there any alternative asset class that could have been a satisfactory substitute? • For example, expanded purchase, rediscount of gov’t debt

10. Suggestions • Current version focuses on 1929-1933 • More analysis on the earlier period for comparison • Examine closely “lender of last resort” experiences • Bring more evidence to bear on thesis • Did policy change 1923-28 relative to policies during WW I and contraction that followed? • Quantitativecomparison of liquidity provision across time • What might have worked?

11. Was it all about “acceptable” collateral? • Collateral restrictions arose from aversion to the call loan market • No way to rediscount call loans • Hope was that banker’s acceptance market would replace it • This paper rightly emphasizes the issue • Warburg - discount market for banker’s acceptances to replace call loan market as secondary liquidity source (also in Meltzer 2003, pages 254-55) • Question: why did the call loan market remain so important after the Federal Reserve Act?

12. Holy Grail of Monetary Reformers • Break the link between capital market and money market (payment system) in US • Underlies significance of reducing role of call loan market investments in NYC bank assets • Glass-Steagall Act • Separated investment from commercial banking • Benston 1990, others – no evidence that investment banking had large negative effect on bank problems • Then why separate investment, commercial banks? • Perhaps to try again to break the link above?

13. Culprit: Daily Settlement of stock exchange transactions • Paul Warburg and the call loan market • Call money market arose from demand for daily settlement at New York Stock Exchange • Combination of overnight settlement along with the lack of a central bank and ‘modern paper’ • Put the US financial market at risk for recurrent crises • Warburg wanted credit market more akin to Europe, where term settlement existed • He was aware of the flaws in the US system • President of the American Acceptance Council • Would likely agree that banking system must change

14. Summary • Challenge of paper – • Find evidence on collateral composition • Compare 1929-33 with earlier periods when restrictions were lifted, or were not binding • Why was the call loan market so active? • Much attention from Fed 1928-29 • Unusual policies to thwart lending

15. Figure 1: Federal Reserve Credit, Monthly: 1922-1929 2 1.8 1.6 1.4 Federal Reserve Credit 1.2 Billions of US $ 1 0.8 Discount Window Credit 0.6 0.4 0.2 Banker's Acceptances 0 Jul-22 Jul-23 Jul-24 Jul-25 Jul-26 Jul-27 Jul-28 Jul-29 Jan-22 Jan-23 Jan-24 Jan-25 Jan-26 Jan-27 Jan-28 Jan-29 Apr-22 Apr-23 Apr-24 Apr-25 Apr-26 Apr-27 Apr-28 Apr-29 Oct-22 Oct-23 Oct-24 Oct-25 Oct-26 Oct-27 Oct-28 Oct-29 R

16. Figure 1 Extended: Federal Reserve Credit,1917-1935 4 3.5 3 2.5 Billions of US $ 2 1.5 1 0.5 0 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22 Jan-23 Jan-24 Jan-25 Jan-26 Jan-27 Jan-28 Jan-29 Jan-30 Jan-31 Jan-32 Jan-33 Jan-34 Jan-35 Banker's Acceptances Discount Window Borrowing Government Securities Held Federal Reserve Credit q

17. Is the thesis a controversial insight? • An opinion held by various contemporaries of that period • Paul Warburg, J. Laurence Laughlin (often tied with real bills) • Numerous discussions of the flaws in the US banking structure • Warburg 1930, text from 1927 speech • “The country must have a wide and freely used bill market if it is ever to enjoy as perfect a banking system as that to which it is plainly entitled.” p. 459 • “With us, on the other hand, the banker’s acceptance does not occupy a similar position as the principal connecting link between the Reserve System and the commercial banks.” p. 464 • Laughlin 1933, page 19, quoting a letter January 1911 • “….some measure must be provided for enlarging the reserves so as to increase the lending power of a bank in time of panic. … enable the transformation of short time paper or securities into means of payment which would enlarge reserves.”

18. During WW I, Board authorized Reserve Banks to discount for non-members (prohibited in Act) • In 1921, Board authorized Reserve Banks to discount for member banks any eligible paper acquired from non-members • Authority for this activity was rescinded in 1923 • Was this quantitatively important?