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CQWWSmUL tot Chalraan Socle* Fro»« L* M. Piser February 23» Subjects Treasury f imaging progrta Attached is * draft of the aeworaadum that ;*m asked m to prepare on the subject of jiwir Treasury fiaaaoiag program. I m i a full agrooas©t with the program, except that (I) 1 would like to go further by substituting for tho corporate drive an offering of securities tubjoot to allotment and ( 2 ) 1 think that tho pro pot «d liai^Ltlom oik war loan $ollat«ral would haveraaaytor ions di«admntag©iu tho f l r t t dlsad^mntago of tho promoted limi^tion It that, by l»or«a«lag tho profit that i* derived from playing tho pattern of rates, It would eaoourage corporation* to eell from their e x i t i n g holdings of eertifioatei, Seoo»d, by laakiag war loan depotita uaattraotiv©, It would reduce the incentive for backers, who eonttitute a largo proportion of the sales orga&lsatioa, to push the •ale of securities to nonbank inTestore In the drive, third, since a l l of the preaeafc war loan deposits are seoured b^ reoettt issues of Government securities, xiost of whloh ssature io aore than six Months* i t would be necessary for oossaereial baiiks to shift a oonsiderable amount of their collateral In order to »#et the new requirement* although this shift might be relatively m*y lor the larger banks, which hold large amounts of these short-term securities, i t would produce difficultles in the oase of banks that hold no b i l l s and relatively snail amount* of other short-term securities. Fourth, since a l l of the mm Issues of securities included la the drive will mature in more than six st&nths* i t would limit seriously the increase in war loan deposits during the drive* War loan deposits should imreat© to sosse tfxtetst durlx$& tho drive, because otherwise tho pro@e*ds of Hew issues would be added to Treasury deposits at the Heserve Saake, whioh would snake i t necessary for the Federal Heserv* to purchase an equal aaount of aovernsaent seourlties in order to supply reserves. LWPrmhe Draft STHICtLY cOHFIBEHriAL February 2 3 . rimmim PROGRAM Objectives, the principal ob jeetive of open saarket policy and f inancing policy during the war continues to be the sale of the maximum amount of Government securities to nonbank investors. It is Important that noribank investor* purchase these securities out of their existing holdlnfs of oa«h rather than by borrowing and that they hold the aeouri* ties* the recent large oversubscriptions in the drives have been accomplished principally by nonbank sales of securities to the banking system. This developiaent not only obscures the prinoipal objective of war financinr but is undesirable in Itself because it involves speculation, free-riding, and unnecessary activity in the market* • second objective is to reduce the growth in the interest cost of the debt to the treasury, this, however* should not be a primary eb* jeetlve* If it wore, the ifreaeury ©ould avoid any cost hy financing its entire requirements by the issuance of currency. Such a policy, however, would merely add to the inflationary potentialities of war financing. This objective is rather, therefore, to reduce the interest cost to the lowest level that is compatible with maintaining strong pressure to sell securities to nonbank investors* A third objective is to reduce the growth in earnings by comereial banks* Banks earnings are now at record high levels* If they increase further# banks will be subject to criticism on the grounds of profiteering from the war financing. In order to further these objectives, the following program is reoonatendedt 1. that the Treasury increase the outstanding amount of treasury bills by 1.3 billion dollars by the end of 2, that the offerings in the Seventh War Loan, in addition to savings bonds and savings notes, comprise l/b per eent certificates, 1 l/2 per cent securities, and 2 l/U and 2 1/2 per eent restricted bonds* 3* that the maturities of the 2 \/k and 2 x/Z ft cent bonds not be extended by store than a year beyond the maturities indicated by the structure of yields as it existed at the time of the last drive and that eomnereial banks be prohibited from purchasing these bonds until five years preceding the call date. STKICTLT Gomimmuh ~2 - k* That the drive be divided into two dlstinet parts, one for individuals and the other for corporations. 5. That, after the end of the corporate drive, the treasury aake a direct offering of 3 billion dollars of certificates and 1 l/2 pvr cent securities to eewmereial banks* 6. That the treasury discontinue the offering of otherwise restricted Issues to ©onsaerelal banks on the basis of their time deposits. Treasury b i l l s . while some increase in outstanding b i l l s is desirable, because it Would provide the Federal Eeserve with securities to supply reserres at a ss&ll interest east to the Treasury, the increase should be eons icier ably less than the amount of reserve funds needed. Additional b i l l s would be purchased almost isss&edi&tely by the Federal Keserve. Some of the renerr^B created by these purchases would go to bank* not needing them, and these banks would be «n©ourag©4 to use the fuo&s to purchase longer-term securities. This would further increase bank earnings, further reduce interest rates, and expand back credit unnecessarily. On the other hand, when banks provide their own reserves by selling securities, the reserves go where they are needed when they are aeeded. Between February Ik *&4 the end of Hay, the Federal Reserve will to supply 3*1 billion dollars of reserves* This total includes 1*6 b i l lion to aeet an increase in money in circulation and 1*5 billion to meet an inerd*se In required renmrre*. About 700 million dollars of this total will be supplied by member bank borrowing, leaving 2*k billion of securities to be purchased by the Federal Beserve. If reporting aesfcer baaks reduce their holdings of b i l l s from the February 12* level of ZM billion dollars to IS billion, the level at the end of $G>ven&er> they will s e l l about 600 million to the Federal Beserve. In addition, the Federal Eeserve will purchase other securities £r<m banks that sxe In need of reserves and that do not hold b i l l s , fro» corporations that need funds with which to pay their ineome taxes on Karch 1^, and from various nenbank investors preparing for the drive. It seems likely, therefore, that the Increase should be Ifcaited to 1*3 billion dollars. Offerings In the drive. It is reooiaaended that the Treasury announce at the present tirae the prinelpftl terms of the Seventh War Loan. The offerings, in addition to savings bonds and savings notes, would comprise 7/fe p«r eent certificates, 1 l/Z per cent securities, and 2 l/U and 2 1/2 per eent restricted bonds. The maturity of the 1 l/2 per oent securities would be determined in relation to the level of the market after the announcement and at the tlsoe of the offering. STRICTLY ccmw&mui - 3 - A naxisKn rate of I l/% rather than 1 3/4* per eeist on unrestricted securities would have a number of advantages. The lower rate would reduce the interest cost of the debt and the growth In b&s& earnings. It also would reduce the temptation for commercial basks to arrange for indirect purchases and would reduce the amount of free-riding and speculation* At the same time, i t would sot be likely to reduce materially the deamnd from nonbank investors. Although In the Sixth War Loan policing eliminated »o»e of the aost flagrant abuses ©f previous driv&a, it was unsatisfactory from other points of view. Many cosheroi&l banks were reluctant to cooperate, in view of the undesirable effects on their customer relation*. Individuals complained of unfairness, because individual subscriptions for securities that were for resale shortly after the close of the drive were supposed to be rejected whereas such subscriptlens from corporations were not Questioned* In ad* dition, policing could not reach a l l eases of abuse, because aost of the individuals involved in direct arrangements with eomere-lal banks are relatively wealthy and eoulci subscribe for the issues without borrowing from banks. The policing activities greatly increased the volume of work by the Reserve Sank* in the midst of %fce regular drive volwtt ittl l»p«ire<f their relations with member banks* Any attempt to police subscriptions Is likely to produce unsatisfactory results when the t#»ipt&tion on the part cf btmks t\r*f? their customers is strong* the issuance of 1 5/ii* instead of 2s would redtaee indirect subscriptions &nd free-riding to some extent, but s t i l l would l«*veftraa^or preblesu Jt se^ae preferablef therefor©, to reduce the temptation further rather than to rely upon policing methods done. The Maturities of the 2 l/l± and 2 l/2 p&r cent bonds should not be extended by aore than a vwar beyond the raaturities indicated by the structure of yields as it existed at the tine of the last drive. An extension of maturities would not reduce the interest cost to the Treasury, and i t might create a bad mrkft situation in the ©vent of large s&lee by nonbank investors It is Hkaly that^pPiees of the existing issues of 2 l/k and 2 l/Z per cent bonds would decline to close to par on an announcement that there would be no mat©rial change in th* terms of the new issues, but i f the prices remained at a high level this would be an advantage, since i t would provide an incentive to nonbank investors to increase their purchases in the drive. It is reeoitfeended also that eamarelal banks be prohibited from purchasing these bonds until five years preceding the call date. This would be In accordance with the original practice with regard to restricted bonds* Otherwise. oonKn&reial banks could purchase these bonds when their yields were s t i l l at relatively high levels* / m jtj, *» It is especially important to include 2 l/2 per cent bonds in the drive. Otherwise, the prices of the existing 2 l/2 per cent bonds would increase further, with the result that the long-term rate would do* eline. The 2 \/2 per cent rate has been the most important rate is the entire war fin&noing program. Even at the 2 1 ^ per cent rate, however, it has boon difficult to encourage purohases of Government securities. A reduction in that rate would increase the difficulty by reducing the ixw oentive to save. These securities are la an entirely different category from unrestricted securities, because they can be held only by individual savers and by institutions that hold savings of the public and therefore cannot involve speculation or an unnecessary expansion in bask credit. Finally, if the long-term rate were reduced, it might be impossible later to restore the Z \/2 per ©eat rate if that course seemed to be desirable, beej&use it would involve permitting newly*issued 2 l/k p«r cent bonds to decline below par* Separation of the drive* It is reooomesded that the drive be divided into two distinct parts, one for individuals, partnership*, and trust accounts, and the other for corporations, the individual drive would start on April 1 or as soon afterward as is practicable trm the point of view of the selling organisation. The separation of the individual drive would overcome an important objection to the recent drives that the large totals discourage individual purchases* The quota for the individual drive would be increased to a point that would place individuals and the selling organisation under substantial, but not impossible, pressure* It is recommended, therefor©, that the total quota for individuals be placed at 7 billion dollars and the quota for Series B savings bonds at h billion* After the close of the counting period for the individual drive, there would be a drive for other nonbank investors. The quota would be decreased to 5 billion dollars* With such a small quota, there would be no nme4 for these investors to sell any of their existing holdings. The selling organisation would be instructed to discourage the making of quotas by selling from existing holdings* After the end of the corporate drive, the Treasury would sake a direct offering of 3 billion dollars of certificates and 1 1/fe per cent securities to commercial banks. Subscriptions from each bank would be limited to a proportion of its capital and surplus, designed to result in subscriptions not far in excess of 3 billion dollars* Is the past, there have been two reasons for eliminating direct offerings to eomsercial banks* First, the channeling of all offerings in the first instance through aonbank investors probably has resulted in increasing the amount of securities that are held by nonbank investors. Second, the premiums that have been quoted in the market after the drive have been some deterrent to purchases by commercial basks* STRICTLY comimmin. - 5- This device, however> probably has served Its purpose. Coasraerei&l basks have found that nmny noabaafc investors are willing to subscribe for seeixritl#c for the purpose of reselling the securities to coisaercl&l banks at l i t t l e or no premium. Banks that have followed the Treasures request, however, have- been able to purchase securities only by paying substantial premiums to speculators, In effect* therefore, the treasury, by not making direct offerings to ©ossaercial banks, aakee i t advantageous for banks not to follow the treasury's own request. In addition to putting bank purchases on a isore straightforward basis, a direet offering to banks would permit banks to purchase new securities at par rather than to pay premiums to epeculators or to stake special arrangements with aonbank investors* It also would reduoe the upward pressure on bond prices, would reduoe speculative subscriptions, and would reduoe the shifting of securities in connection with the drives. Direet bank financing should have no adverse public reaction, because those who realise that indirect bank participation has been an important part of recent drive* would recognise the advantages of the change, whereas those who do not know this fact mould be unlikely to realise that any change had teen made. The treasury would discontinue the offering of otherwise restricted issues to commercial banks en the basis of their tine deposits, the previous allotment of securities on the basis of tine deposits seems to have been used by the banks principally as a means of obtaining 2 per cent bonds at par. There is no evidence that they have used these securities in order to Increase the rates paid on savings deposits but rather that they have used them to Increase further their earnings. If these offerings are continued, however, i t is suggested that they be limited to banks that pay not less than 1 1/2 per cent on savings deposits. Another suggestion is that the Treasury require that at least 75 per cent of war loan deposits be secured by Government securities maturing in not &©r« than elx months. This provision would eliminate a l l of the incentive for banks to bid for war loan deposit accounts. It also would en* courage banks to keep a relatively large amount of short-term securities and thereby would tend to reduce the interest cost of the debt to the Treasury and the growth in bank earnings. Finally, i t would provide sufficient deasand from commercial banks to lower the yields on short-term certificates without the necessity for thefftederal Reserve to lower these yields by purchasing these securities, which would add to reserve*. I&Ptmhe
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