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BOARD OF GOVERNORS — : — FEDERAL RESERVE SYSTEM Office Correspondence To From Dat fec^Aft-c kout SJLjui^ulcit"^ J L X , QL> a y J s o , Subject: C QjttjJuuiJl e q^ <&.>JUCJLM 4 I P C C R F C JLJCJGli^^ I J ^ O A J ^ U U X J I JLX-^ W * Jl I U ^ CX^Jj Z7, I^ SI J S I A . BOARD OF GOVERNORS or THE FEDERAL RESERVE SYSTEM Olfice Correspondence TOL Mr. Schmidt |TfAm Miss Harris Date—wi Subject: Report on Testimony of Governor Eccles, A p r i l 27, 1951, before Senate Banking and Currency Committee considering L e g i s l a t i o n to Abolish RFC. The r o l e of Government lending and the problems of small business financing were discussed i n the cross-examination, which followed the presentation of Mr. Eccles* prepared statement on the RFC. Those present who took an active part i n the general debate with Mr. Eccles were Senators Fulbright, Robertson, and Bentham. The following points were brought out s p e c i f i c a l l y i n the crossexamination: (1) Mr. Fulbright wanted to know whether there s t i l l was a credit gap i n the area of small business financing; he wondered whether Mr. Eccles* views now were d i f f e r e n t from those present to Congress i n 19^7* when Mr. Eccles recommended l e g i s l a t i o n which would a i d i n small business financing. I n reply, Mr. Eccles requested that h i s entire testimony, made on A p r i l J , 19^7 > be placed i n the record. He explained that h i s recommendat i o n at that time was t o repeal c e r t a i n provisions under 13b of the Federal Reserve Act, which provided for d i r e c t lending by the Reserve Banks, and t o substitute Senate B i l l 4o8. This b i l l provided for a stand-by authority for guaranteed lending t o small business. A l l loans were to originate with l o c a l banks, and no Government funds were t o be used d i r e c t l y . These, Mr. Eccles said, were the p r i n c i p l e s which should always govern loan a c t i v i t i e s of the Federal Government both i n 19^7 and today. (2) Mr. Eccles emphasized that, unlike 19^7, no c r e d i t gap exists today. The present serious i n f l a t i o n a r y s i t u a t i o n indicates that too much, not too l i t t l e , credit i s available to meet the requirements of business firms and of i n d i v i d u a l s . Mr. Eccles pointed out that the most serious shortages exist i n the areas of manpower and materials, not of c r e d i t . I f additional c r e d i t were absolutely essential to the defense e f f o r t , i t should be provided through the existing V-loan mechanism. Mr. Fulbright agreed, but stated he was concerned with the d i s t r i b u t i o n of c r e d i t . He f e l t concerns i n L i t t l e Rock,' Arkansas, were not getting enough c r e d i t , and that Mr. Eccles was recommending d i s s o l u t i o n of the one agency, RFC, that would help these l i t t l e l o c a l concerns out. He quoted s t a t i s t i c s to show that the established i n d u s t r i a l centers were getting 90 per cent of the war a c t i v i t y * s business, and suggested that Mr. Eccles advocated keeping Arkansas and similar regions raw materials producing areas. — To: Mr. Schmidt - 2 - Mr. Eccles r e p l i e d , f i r s t , that there had been as excessive a growth of c r e d i t i n Arkansas as i n any other State, and that there, therefore, was as much need t o check the growth of c r e d i t there as i n any other area of the country. He pointed out, secondly, that Arkansas, p r i m a r i l y an a g r i c u l t u r a l area, had b e n e f i t t e d from the increased p r i c e s of raw materials and a g r i c u l t u r a l products. With respect t o the r e l o c a t i o n of industry, Mr. Eccles stated that p r i v a t e enterprise and the p r i v a t e commercial banking system, not the Government, should determine where the factors of production should be placed. (3) There was some further discussion about the r e l a t i v e advantages of d i r e c t and guaranteed lending. Mr. Eccles said that d i r e c t lending by the Federal Government or i t s agencies was never j u s t i f i e d . He emphasized that defense orders and subcontracts should be placed so as t o use e x i s t i n g f a c i l i t i e s , housing, and manpower t o the maximum extent p o s s i b l e . I f i t was absolutely necessary t o b u i l d a d d i t i o n a l f a c i l i t i e s , the required loan should be financed by a loan guarantee o r i g i n a t i n g with the l o c a l bank, and c a r r i e d at l e a s t i n small part by the l o c a l bank alone, under the e x i s t i n g V-loan program. Mr. Eccles stated that i f the Government had t o put up 100 per cent of the funds, the Government should then b u i l d the plant i t s e l f and should lease i t t o the appropriate defense industry. The Government would then be able t o s e l l the plant l a t e r and the taxpayers, which assumed the o r i g i n a l r i s k of l o s s , would be able t o share i n part i n the p r o f i t s . (4) Senator Robertson s a i d that he d i d not think the RFC i s or ever has been an "experiment i n socialism. n He thought that the a c t i v i t i e s of RFC are no more s o c i a l i s t i c than are the services provided by the Federal Reserve t o the member banks or the loans made by REA to farm cooperatives. There was some discussion by the group whether the commercial banking system i s not being subsidized through s p e c i a l tax and other p r i v i l e g e s as w e l l as through the a c t i v i t i e s of the Reserve Banks. Mr. Eccles ; r e p l i e d that the f a c t that "bank stocks are c u r r e n t l y underpriced on the market and that the r a t i o of bank c a p i t a l t o deposits i s low indicates that the banking system i s not i n an e s p e c i a l l y favored p o s i t i o n r e l a t i v e t o other industry groups. (5) There was some disagreement whether RFC was or was not operating i n competition with the p r i v a t e banking system. Mr. Fulbright quoted the r e s u l t s of a recent questionnaire sent out t o banks of various size groups, i n which the small banks almost uniformly favored the a c t i v i t i e s of RFC and i t s continuance. Mr. Eccles pointed out that the r e s u l t s of the survey discussed d i d not i n d i c a t e that competition d i d not e x i s t . I t was t i n e that i n i t s d i r e c t loan To: Mr. Schmidt - 2 - a c t i v i t i e s the HFC was required t o take the excess loans that no "bank wanted, so that the competition was not immediately evident. In a d d i t i o n , with an HFC guarantee or under the ""blanket p a r t i c i p a t i o n " agreement, the l o c a l hank could handle more l o c a l loans than would otherwise be p o s s i b l e with i t s e x i s t i n g assets, a desirable feature from the point of view of the l i t t l e bank. Mr. Eccles pointed out, however, that RFC loans t o the weakest of a group o f l o c a l competing concerns have not infrequently weakened the previously solvent members o f the group; t h i s often got them a l l , i n c l u d i n g the l o c a l bank who c a r r i e d the loan account of the competing firms, i n t o f i n a n c i a l d i f f i c u l t i e s . (6) Mr. Eccles 1 point that d i r e c t loan a c t i v i t i e s of the RFC are inconsistent with n a t i o n a l c r e d i t and f i s c a l p o l i c i e s , which require the r e s t r i c t i o n o f non-defense expenditures and the r e s t r a i n t o f c r e d i t , was discussed a l s o . Mr. Fulbright suggested that the c r e d i t supplied by RFC represents an " i n f i n i t e s i m a l " part of the t o t a l c r e d i t outstanding; " i f previous e f f o r t s at monetary r e s t r a i n t have been unsuccessful p r i o r t o the Treasury-Federal Reserve accord, why take i t a l l out on poor l i t t l e RFC?" Mr. Fulbright said he thought Mr. Eccles was being a " p e r f e c t i o n i s t " i n the matter. Mr. Eccles explained that RFC lending a c t i v i t i e s , although small, do put the Federal Reserve Board and i t s various c r e d i t res t r a i n t p o l i c i e s i n a most inconsistent p o s i t i o n . Already there has been much pressure on the Federal Reserve on the part of banks and others t o r e l a x Regulations X and W and i t s p o l i c i e s under the Voluntary Credit Restraint Program. Tiie immediate psychological impact upon these d i s s a t i s f i e d groups of removing a l l unnecessary and expensive sources of c r e d i t expansion i n the economy would be good. Mr. Bentham and Mr. Eccles agreed that even more important are the long-range considerations. Mr. Eccles re-explained that i f RFC cannot be abolished now, i n an i n f l a t i o n a r y period, i t i s doubtf u l that i t ever can be dissolved. The problem w i l l then be that i n a p e r i o d of recession i t s lending a c t i v i t i e s t o marginal firms, although l i m i t e d now, may expand enormously, with, serious p o l i t i c a l and s o c i a l i m p l i c a t i o n s . (7) The point was brought out i n the cross-examination that the extent of RFC f s lending a c t i v i t i e s ( i n d o l l a r volume) t o small business was exaggerated i n the p u b l i c mind, while the w i l l i n g ness of the l o c a l commercial bank t o serve the needs of the small l o c a l businessman was u s u a l l y underrated. Mr. Eccles showed that the l o c a l banker was interested p r i m a r i l y i n c r e d i t r i s k , not i n To: Mr. Schmidt - 2 - s i z e of business or s i z e of loan. Good l o c a l business customers, whatever t h e i r s i z e , would receive c r e d i t preference over the large n a t i o n a l concern with an established c r e d i t l i n e , both because of the higher i n t e r e s t return on the smaller loan and because of local interest. Mr. Fulbright asked whetherthis meant that the l o c a l banker, l i k e RFC, was subject t o l o c a l p o l i t i c a l pressures; Mr. Eccles rep l i e d that i t did, but that the l o c a l bank, u n l i k e RFC, paid f o r i t s own mistakes w i t h i t s own and not the taxpayers' money. (8) Mr. Eccles said that i f RFC i s t o be continued, however, the b i l l f o r reorganization introduced by Mr. Fulbright represents a " l o t of work" and i s well-designed. Mr. Eccles stated that he would favor administration by a single administrator assisted by an advisory committee or by a part-time, not a f u l l - t i m e , board of governors. I t was suggested a l s o that a l i m i t o f , say, $500,000 might be put on the s i z e of RFC loans to business f i r m s .
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