The circumstances under which the first Clearing House bank examiner was appointed and the result are well set forth by James B. Forgan, President First National Bank of Chicago.
"Chicago was the pioneer in Clearing House bank examinations.
"They were inaugurated there in 1906 after the failure of a National bank and two State banks. These institutions were under the direct management of one man who was president of the three. The condition of their affairs when disclosed surprised and appalled the other Chicago bankers. The liabilities of the private ventures of the president had gradually accumulated in the three banks until they had absorbed the entire capital and surplus of all three, amounting to $3,500,000, and 44 per cent of their aggregate deposits of $27,000,000, one-third of which was public funds.
"The condition in the National bank had developed through a period of years during which the Comptroller of the Currency, through the semi-annual reports of his examiners, had been kept fully advised of what was going on. Among the assets were found nineteen fictitious loans for $90,000 each represented by so-called memorandum notes. Each memorandum note purported to be secured by $100,000 of second mortgage bonds of the Wisconsin & Michigan Railway Co. This road was controlled by the bank president, and the bonds proved worthless. The first mortgage bonds of the same road, $952,000 of which (being almost the entire issue) were also among the assets of the banks, were finally disposed of at about 23 cents on the dollar. These memorandum notes did not, on the face of them, even pretend to be the obligations of bona fide borrowers. The ostensible signatures on them, although in different names, were all in the handwriting of the clerk who filled them out and who wrote plainly in red ink across the face of each the words 'Memorandum Note.' They could not deceive anyone who saw them and they did not deceive the national bank examiners who reported to the Comptroller the facts in connection with them.
"Although cognizant of these irregularities and of the accumulating obligations in the bank of the president's private enterprises, the Comptroller apparently could not or at all events did not take measures to stop them by other means than those of expostulation and reproof until matters became so bad that they simply could not be permitted to go further.
"When at last drastic measures were decided upon the Comptroller and the State Auditor, acting together on a Saturday afternoon after the vaults of the three banks had been closed with time locks set for Monday morning, notified our Clearing House committee that unless provision were made for payment in full of the deposits none of the banks would be permitted to open for business on Monday morning and they would be put in the hands of receivers.
"Business conditions were strained and the time was therefore particularly unfavorable for permitting the failure of three prominent banks. The effects of such a calamity it was feared would have extended far beyond the confines of Chicago.
"The situation was thus protected from a general disturbance of public confidence, but it was done at the cost of a very heavy loss, foreseen at the time and since realized by the participating banks.
"The statements of the National bank made five times a year to the Comptroller's department, copies of which were rendered to the Clearing House committee and on which it had implicitly relied, failed to disclose these conditions.
"I have given you these details of this unfortunate affair because they show so clearly the limitations of governmental supervision of banks under our National banking law as it has been interpreted by the courts and by the legal advisers of the Comptroller's department.