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February 13 j To: Chairman Eccles From* David M. Kennedy It is not difficult to pick and choose from isolated statements, out of context, in memoranda and summaries of discussions with the Treasury that might give the impression that the Federal Reserve System has favored higher short-term rates and increased costs to the Treasury. The complete record, however, shows clearly that Federal Reserve recommendations at various times for a slight increase in the "bill rate were designed to increase the attractiveness of Treasury bills and thereby widen their distribution among banks and nonbank investors, to reduce playing of the pattern of rates, and to narrow the spread between short and longer-term issues to correct difficulties encountered in maintaining the pattern of rates• These proposals were not made to increase interest rates or Treasury costs* On the contrary, the Federal Reserve System sought to reduce costs to the Treasury by making the lowest rate securities more attractive, by reducing the certificate rate, or through the substitution of a single instrument for both bills and certificates. During the spring and summer of 19l|2 the Federal Reserve System made a special effort to widen the distribution of Treasury bills. The buying rate and repurchase option were established as part of this program* Banks were encouraged to utilize their excess reserves and other investors were encouraged to invest their idle funds in bills* In June and July of I9I42, the Federal Reserve System strongly advocated an increase in the bill rate from 3/8 to l/2 per cent* The reasons advanced were that a slight increase in the bill rate would widen the distribution of bills among banks and nonbank investors. This would permit further and much needed increases in the outstanding amount of short-dated securities with correspondingly smaller increases in the longer-term higher-yielding securities, thus actually reducing rather than increasing the interest cost to the Treasury* During this period the Treasury v^as continuously recommending reductions in reserve requirements and increases in excess reserves, particularly in Hew York City, in order to assure the success of the then frequent offerings of securities. The System reduced reserve requirements in central reserve cities in successive stages to 20 per cent, but felt that the easy method of financing then being followed by the Treasury through frequent offerings of securities with large excess reserves was contrary to the major objective of selling the largest possible amount of the increasing debt to nonbank investors. By July 19^3 it was clear that the pattern of rates could not be maintained. To meet the difficulties that had developed, the System proposed to narrow the spread between shorter and longer rates by an extension of the maturity of 2 per cent bonds and through the issuance of 9-month bills at 3A- Ver cent to replace the outstanding 3-^onth bills and the one-year certificates* - 2 - It could be argued with equal force that this proposal would or that it would not increase Treasury costs. If the advantages claimed for this proposal had been achieved, it would not only have eliminated abuses in playing the pattern of rates, but it would have reduced the cost to the Treasury through a reduction in the certificate rate. Since the proposal was not adopted, we are not able to determine with certainty what the precise results would have been. Suffice it to say, the 3/8 per cent bill ceased to have a market outside of the Federal, 7/2 Ver cent certificates became the lowest-rate market issue, playing of the pattern of rates continued on an increasing scale, and pressure continued to pull the intermediate and long-term rates down* It could Y/ell be argued that failure to make the short-term bill more attractive, failure to adopt the short-term and long-term nonmarketable securities as proposed by the System, failure to tighten up on speculation in the drives, and other failures to take action to develop a program until conditions forced a change have contributed to the unnecessarily large expansion ija bank credit that has taken place during the war and may have resulted in increased costs to the Treasury as well. Attached is a copy of a memorandum prepared in January 19U5 which shows that the average coupon rate on new issues of securities continued to increase despite the fact that interest rates were tending downward. As a result of increased sales of the highest-rate securities in the Seventh and Victory Loans, the rate has increased even further• The attached excerpts from memoranda to the Treasury and of summaries of discussions with the Treasury cover fairly completely the Federal Reserve proposals for changes in bills and certificates. The quotations are rather long, but an attempt has been made to include sufficient background material to give a clear and accurate picture of the reasons underlying the Federal Reserve proposals. Attachments.
@FedFRASER