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TREASURY DEPARTMENT
INTER OFFICE COMMUNICATION

DATE: September

6, 1954 •

TO The Secretary of the Treasury
FROM

Mr. Eccles
Re: Suggestions designed to improve the long-term
Government bond market*
I have been giving some thought to the problems involved in finan-

cing by long-term Government bonds • Certain suggestions come to my mind
as worthy of consideration if the present orthodox methods of financing
are to be pursued with success.
In view of the large holdings of Government bonds by banks and the
apparent nervousness whenever the Government bond market takes a slump
it is probably wise that certain changes be made in order that the banks
might feel more secure against possible future losses in their holdings*
As long as the Government continues to finance its requirements in
the orthodox way it is important that careful account be taken of timing
the operations of supporting the Government market. Once momentum has
developed it is much more difficult to head off a continued slump in the
Government securities. If prompt and aggressive action is taken by the
Federal Reserve and the Treasury to support the Government bond market
fluctuations will tend to be much narrower. It seems to me to be absolutely essential that vigorous action be taken in order to provide adequate Government credit at low rates in a depression, thus taking the
power of control out of the hands of private financial interests and in
addition increasing the effectiveness of control over the monetary system
of the United States.




— £ —
In this connection it may be well to reflect that banks of the
United States are being forced more and more to invest their funds in
securities in view of the absence of demand for commercial loans and
that in the future we may expect a continuation of this trends

Thus

if we are. going to look at banks as institutions which should engage in
lending solely upon the so-called self-liquidating commercial loan we
are simply losing sight of a major change in our methods of business
financing and from which it appears there can be no significant change
as long as we have en increasing concentration of industry and trade in
the hands of large corporations which have an abundance of working
capital and a ready access under normal conditions to the organized
securities markets•
Under these conditions the Federal agency for control must think in
terms of controlling the money supply, namely, cash and demand deposits
rather than continuing to stress the liquidity of bank assets as the all
important factor in sound banking practice* When such so-called liquid
assets do not exist in sufficient quantities to supply the volume of
money necessary to carry our economic structure, Government securities
or other sound investment securities must replace this deficiency in
commercial loans in the portfolios of commercial banks if we are to
obtain a sufficient supply of money to provide an adequate price level
to enable us to maintain the present debt structure and to support an
increasing volume of business activity. Thus it is necessary that
Government securities should be regarded as the equivalent of currency
bj banks and that the banks should stand no chance of loss through
purchasing theirs In order to provide this assurance the Federal Reserve




- 5 should be required to purchase Government securities in as large quantities as necessary so as to provide a market for Government securities
at low rates thereby making funds available to mest the requirements of
a recovery program.
Perhaps for the time being the Government should rely more upon
short-term issues of say a three year maximum to provide its necessary
funds, because banks would havp much less aversion to jmrchasing this
type of issue* There would still be a large volume of long-term Government bonds outstanding with Government guaranteed new bonds being
currently issued b;r the H. 0* L. C. and the F. F. M. C. which puts
continual pressure on the market. It is highly advisable that the longterm Government market be maintained on a low yield basis as rates on
Governments exert a considerable influence upon rates throughout the
long-term investment market and certainly a revival of construction
and general business recovery depends in large degree upon the existence
of a low level of interest rates for capital financing*
In addition, to improve the immediate market for Government bonds
as bank investments and hence tend to allay the apprehension which is
now felt toward them in some quarters, I suggest that you should use your
influence to require the Federal Reserve banks to adopt a long-term
policy of loaning to their members on Government securities or those
fully guaranteed at the par value of such securities. The Federal Reserve banks should advise all member banks to this effect as well as
give appropriate publicity through the press. Such statements would
tend to relieve the banks of any fear of loss by being forced to convert
their present holdings of Government securities into cash in the future.




- 4 -

There is every reason for the Federal Reserve to adopt a policy
such as tills inasmuch as the Emergency Banking Act already permits the
Federal Reserve system to issue currency on a 100/5 backing by Government bonds, thereby in effect recognizing them as the equivalent of
currency*

While there would likely be little, if any, borrowing from

the Federal Reserve banks at the present tine in view of the great
amount of excess reserves held by banks, nevertheless the recognition
of a value equivalent to that of currency for Government securities
would have a wholesome and favorable psychological effects
It is further suggested that if the Federal Reserve banks adopt
the above policy, the Comptroller's office be then required in making
bank examinations to list Government bonds, direct and/or fully guaranteed, in bank examination reports at cost or market whichever is the
greater except that where cost is more than par then Governments would
be listed b

the reporting banks at market or par whichever is greater*

The effect of this would be that if individual banks had an appreciation in Governments it could be used to offset the depreciation on
other assets. Whereas, if there was a depreciation between the cost
price and r?rket price it would only be taken irto account down to the
par value of the bonds, becuase of the recognition of their "equivalence
to currency which is at par value.
There is a further political danger which may become more apparent
if action is not taken to improve the Government bond market and insure
ample funds to enable the Government to carry out its recovery program.
Certain Congressmen and Senators are almost sure to start agitation for




- 5 a policy of currency inflation under powers which already exist end
for legislation to create some form of monetary authority or central
bank as a substitution for the present Federal Reserve system* These
developments would entail serioi^s consequences and it would be unfortunate to have them forced upon the Administration with mandatory
provisions thet have not been carefully ?/orked out from the standpoint
of their monetary end economic effects.