Extracts from the book Citibank 1812-1970 by Harold Van B. Cleveland and Thomas F. Huertas (only have a hard copy of the book, so I don't have any links)
(emphasis mine) [my comment]
The Test of City Bank Policy
The benefits of City Bank's ready money strategy became apparent during the panics that periodically disrupted the nineteenth-century U.S. economy. Unlike Britain and France, the United States had no central bank, no institution with the power to create or destroy reserves, that could stabilize the money market and act as a lender of last resort in a crisis. In a panic, even sound firms could fail if they could not readily obtain bank credit to refinance maturing liabilities, but most banks lost deposits in a panic and could not maintain let alone expand their loans. City Bank, by virtue of its conservative policy, was consistently able to fund its customers (Taylor's companies), thereby shielding them from insolvency, and protecting itself from failure. [Wow! A bank growing as a result of its conservative policy? A bank actually being rewarded and benefiting from its conservative banking practices? It was another world back then]
Three major panics swept the U.S. banking system during the Taylor and Pyne administrations—one each in 1857, 1873, and 1884. With each, City Bank's reputation for safety grew. Knowledgeable depositors could compare the bank's portfolio with those of other banks. Its relative strength was obvious. John Moody and George Turner, the chroniclers of big business, noted that "whenever there was a panic the [City] bank grew. A panic is a time when everybody puts his money in the safest place he knows. It is the day of reckoning, the time of the survival of the fittest, in the world of business [Today in America, it is survival of the unfittest via government support]. Moses Taylor's bank was safe and strong; with every panic it grew stronger."
In each panic, pressure focused on New York City banks. Because banks across the country held a large part of their reserves in'New York in the form of bankers' balances, the New York banks' own reserves served collectively as the central reserve of the country's entire banking system. But no bank had the power to add to or reduce the reserves of the system in the aggregate, except by importing or exporting gold. Thus, the stability of the system and of the U.S. economy was vulnerable to any shock that caused the reserves of New York banks to decline suddenly...
When Stillman took over the bank in 1891, it had a long history of supporting the government in crises (see chapters 1 and 2) but no current relationship with the government. Its contacts with the government were practically limited to the comptroller of the currency's periodic examinations [This healthy separation between government and banking doesn't exist today]. Stillman soon changed this. After the panic of 1893 Stillman and the bank actively supported President Cleveland's efforts to maintain the gold standard. Stillman served as a financial adviser to the president and helped persuade other Wall Street financiers to underwrite the two bond issues of 1894. That same year National City became a government depository. In 1897 it became the largest depository, holding for a time the sums due to the government from the Union Pacific after its reorganization. At the outbreak of the Spanish-American War, National City, along with J. P. Morgan and Company, agreed to underwrite any poction of the $200 million bond issue not taken up by the public. This guaranteed the success of the issue.58
National City's status as the government's leading bank took on new importance after 1899 when Secretary of the Treasury Lyman J. Gage began to use deposits at National City as a means of preventing crises in the money market. Following the precedents established by previous secretaries, Gage purchased government bonds on the open market, prepaid the interest on the government debt, and allowed the internal revenue receipts to accumulate outside the Treasury in the form of deposits at national banks. National City Bank was appointed to receive the tax revenues and distribute them to other depositories. According to Gage, "no Treasury office is adapted to such a purpose. It was necessary, therefore, to select a bank strong enough and with a volume of securities pledged for such deposits adequate to cover the transactions from day to day. The National City Bank of New York was the only bank which met this requirement, and it was therefore accordingly directed to assume the task."9
Gage's successor, Leslie M. Shaw, took such policies to the extreme. Under Shaw the Treasury sought not merely to alleviate crises in the money market but to eliminate them entirely by stabilizing interest rates. To this end Shaw used the Treasury's surplus revenues to build up a large fund, which he could move into and out of the money market at his discretion. To heighten this fund's impact Shaw removed reserve requirements and adjusted collateral requirements on government deposits. Finally, Shaw offered banks temporary inducements to import gold from abroad. This policy helped bring on the Panic of 1907 (see below). [The Treasury mucking about in the market and creating a crisis? Seems very familiar...]
More important, Stillman's conservative portfolio policy enabled National City to meet the severest test of a bank's strength: a panic. Indeed, the banking panics of 1893 and 1907 made National City a stronger bank relative to its competitors. The 1893 crisis set the stage for National City's subsequent growth. The 1907 crisis confirmed its position as the country's leading bank and enhanced its standing as an investment banker.
The 1893 panic stemmed from uncertainty over the federal government's willingness and ability to maintain the gold standard. Stillman had seen trouble coming, and following Taylor's precept of ready money, he had prepared the bank for it. By October 1894 the combination of ready money and the solicitation of new customers had made National City Bank the largest bank in the United States, giving Stillman the banking power needed to enter investment banking on a large scale.
The Panic of 1907, as mentioned above, stemmed largely from the attempt of Treasury Secretary Shaw to stabilize interest rates. Initially, this policy was successful [does this sound familiar?], for Shaw had the resources to intervene in the market and the skill to invent new ways of increasing the Treasury's influence over the money market. But Shaw's very success induced banks, including National City, to reduce their excess reserves. This made the entire banking system more susceptible to external shocks.
In 1906 the Bank of England supplied the shock by raising its discount rate in response to the f low of gold to the United States stimulated by Shaw's subsidization of gold imports. Prior to its decision the Bank of England had called on Stillman, as president of the largest bank in the United States and the largest participant in the Treasury's gold importation program, to appeal to the Treasury to halt the program.69 Stillman did so, but the Treasury refused. In September and October 1906, the Bank of England retaliated by raising its discount rate and asking British banks not to renew American finance bills. These actions reversed the flow of gold and brought on a money crunch in the United States and a slowdown in business activity.
Panic came a year later. When the Knickerbocker Trust Company failed in October 1907, touching off a run on the city's other trust companies, the Treasury could not avert a panic. Under Morgan's leadership, Stillman and other financiers formed a pooi to support the call money market and to save the Trust Company of America, the city's second largest." But to stop the panic, the issue of Clearing House loan certificates and the restriction of cash payments to depositors became necessary.
National City again emerged from the panic a larger and stronger institution. At the start National City had higher reserve and capital ratios than its competitors, and during the panic it gained in deposits and loans relative to its competitors (Table 3.4). Stillman had anticipated and planned for this result. In response to Vanderlip's complaint in early 1907 that National City's low leverage and high reserve ratio was depressing profitability, Stillman replied: 'I have felt for sometime that the next panic and low interest rates following would straighten out a good many things that have of late years crept into banking. What impresses me as most hr portant is to go into next Autumn [usually a time of financial stringency ridiculously strong and liquid, and now is the time to begin and shape for it . . . If by able and judicious management we have money to help our dealers when trust companies have suspended, we will have all the business we want for many years.'2
The bank's performance during the panic capped a remarkable of achievement. Since 1891 Stillman had built National City from a treasury unit in the Taylor empire into the country's foremost commercial bank. Stillman had made National City a bank for big business, for Wall Street, and for banks across the country. National City offered them ready money and comprehensive financial service. No one-man bank could expect to do more.
After debate in the Senate, President Wilson signed the Federal Reserve Act into law on December 23, 1913. In the final version twelve regional reserve banks were placed under the supervision and control of a seven-member Federal Reserve Board, consisting of five presidential appointees and two ex officio members, the secretary of the treasury and the comptrollef of the currency.
This structure sharply reduced the public policy role that National City had perforce played as the leading bank in a nation without a central bank. It injected a new organization between the federal government and the banks. Although the Federal Reserve System was to be a collection of bankers' banks, it of necessity reduced the influence of any one bank, however large, on economic policy. Henceforth, the government would seek advice more often from the Federal Reserve than from the leaders of the country's largest banks. All this was in line with Vanderlip's intentions, for it freed National City to pursue new opportunities at home and abroad.
What ran counter to Vanderlip's intentions and boded ill for the future was the direct and strong involvement of the federal government in the supervision of the Federal Reserve System. This made the Federal Reserve banks not only banks for bankers but also regulators of bankers. Thus from the outset there existed a tension within the Federal Reserve System between the dual responsibilities of serving its member banks and serving what it construed to be the public interest. Ultimately the division of control over the Federal Reserve between government and the banking community would prove to be as troublesome to National City and to the nation as Vanderlip had feared.
Boom and Crash
Early in 1919 an intense boom got under way, reflecting a wave of business spending in an effort to convert from war to peacetime production. The boom was marked by rapid accumulation of inventories and commodity speculation. Commodity prices rose steeply both at home and abroad, stimulating buying for inventory. Credit to fuel the boom was provided mainly by banks, for the bond market was still glutted with Treasury issues. The Federal Reserve underpinned the rapid expansion of bank credit by keeping its discount rates substantially below market interest rates, thereby encouraging member banks to borrow at the discount window. The Federal Reserve's discount rate policy was motivated by "an alleged necessity for facilitating Treasury funding of the floating debt plus unwillingness to see a decline in the prices of government bonds."
In this heady environment, National City along with banks across the country responded readily to business customers' strong demand for credit. From a low in June 1919, the bank's business loans rose nearly 30 percent by the end of 1919. To fund the loans, National City relied increasingly on the Federal Reserve Bank of New York, whose discount rate, at 4.75 percent, was far below the rate the bank could earn. Corporate customers were bidding aggressively for loans, and by the end of the year, the average return on City Bank's loan portfolio was up to 5.6 percent, and new loans were being made at even higher rates. Plainly it was profitable to go on borrowing, and the executive managers did not hesitate to do so. By the end of 1919, borrowings from the Federal Reserve were equal to the bank's required reserves.
Meanwhile, the authorities were growing alarmed about inflation. A controversy developed about how to check the rise in bank credit, since it was generally agreed in Washington and within the Federal Reserve System, that this was causing the inflation. One group, headed by Benjamin Strong, president of the New York Reserve Bank, favored a sharp rise in the discount rate to discourage borrowing. Another group, led by Secretary of the Treasury Carter Glass and including leading members of the Federal Reserve Board, opposed raising the discount rate mainly for fear of the impact on the prices of government bonds. Glass thought the Reserve banks should deny credit to member banks that were using the funds to make "speculative" loans." (The same difference in points of view on how to control a boom was to erupt again and again in the Federal Reserve's history.) The two sides reached a compromise in January 1920 [These "compromi ses are what destroyed the dollar]. The New York Reserve Bank raised its discount rate to 6 percent, but to ease the impact on government bond prices it kept a preferential (lower) rate for member bank borrowings secured by government securities.
On December 11, 1930, the bank closed its doors for the last time. Clearing House members created a fund so that depositors could immediately withdraw 50 percent of their funds.' National City Bank was appointed liquidator, and depositors eventually got over 80 percent of their money back. But the damage had been done. Allowing the Bank of United States to fail was, as Joseph Broderick, New York superintendent of banks, had predicted before the failure, "the most colossal mistake in the banking history of New York." Because of the bank's apparently official name, its large size, and its Federal Reserve membership, the failure had a devastating effect on the public's confidence in banks. For the first time since the onset of the depression, the public began to shift significant sums from deposits into currency. This added to the decline in the money supply and deepened the slide in income and employment.
The contrast with 1907 was marked. Then, the large Wall Street banks had stopped the panic by issuing Clearing House certificates and suspending the convertibility of deposits into currency at par. This increased the effective supply of bank reserves and reduced the public's demand for currency, bringing the panic to a halt (see chapter 3). In 1930 this solution was out of the question. The existence of the Federal Reserve made it impossible for the New York banks to resort to these traditional and effective measures of panic control without appearing to challenge the central bank's authority. Yet the spectacle of a major bank being allowed to fail would not soon be forgotten. In the public's view, Wall Street banks and the Federal Reserve had had the opportunity to save the institution's depositors, but had chosen not to do so.
Quick reaction: Notice how political considerations dominated Fed and helped create the Great Depression.