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s w m m or phoposed progeah The propoged program involTOs three step* whioh are reooiiuaended for immediate potion end which are to follow each other In brief intervals* (1) fhe Board of Co^rnorg trill announce l»posltloa of an Interact charge on Inderal Bogerve notes txnder Section 16 of the fedora! Reserve Act tor the purpoge of transferring excess earnings to the Treasury, Jhe igsuing gtate&ent (Exhibit A) will point clearly to the purpose of this action whish la to transfer earnlnggf eo that there will bo no possibility of miginterpretation* involved are digougsed in Exhibit B* £rooedurog fhe aaount of earningg that would be transferred at pregent levels of earnings ig estimated at 50 million dollarsftyear* (2) the Treasury will announce that for future bill Igstteg payaent for accepted tenders saay be made la, cash or by gurrender of maturing bills* She statement issued by the Treasury (Exhibit C) will degoribe the procedures uged and will explain that thie change is Bade to germit direct exchange of Jbdersl Beserve held bills and thug te siapHiy pre gent ewfeeraooe procedure without involving direct purchase by the Systeaa from the Treaeury* the statement will algo point out that any additional Inderal Begerve holdings of billg will be purchaged in the open mrtett She details ef the procedure ere outlined in Exhibit Sw (3) the Inderal Segerve will announce that the flsad buying rate and repurchage action at 3/8 per cent will be discontinued 2 with respect to bills issued after m certain date» Jhe issuing Btatei&ent (Exhibit E) m i l point out that the present arrangement vras introduced to aeree wartime needs yrhloli no longer apply and that the new policy is adopted to again M & e the hill a market inetruiaent. This statement may be made Jointly is&th the Treasury or the Treasury may igeue a brief concurring statement* Jhe mechanics* by i»hich the refunding of bills will be handled under the new procedure is outlined in Exhibit R She general reasoning supporting these recomaenda-* tions is summarised in Exhibit G. -3 • EXHIBITS A A3© B (Sofcaprepared bjr JSr# Thurston and Hr. Sine ad) EXHIBIT 0 treasury Announcement on Aoceptance of l&tturlng Bills la Payment for Accepted fenders for Row Bills; beginning with next m k ' s bill issue the treasury will accept maturing bills in payment for new bills* In accepting tenders, purchases paid for in maturing bills will be given no preference over those paid for in cash* Cash adjustments ^ill be made for differences between the par value of natured bills offered in payment and the issuing price of new bills bought* The new procedure is adopted to facilitate weekly refunding operations in bills* Federal Reserve bill holdings now amount to 15*5 billion out of a total of 1? billion outstanding* Under current procedure, the Inderal Reserve replaces its weekly maturing bill issues by purchasing new issues from security dealers who tender for the necessary amounts* Dealers charge no cocsr&saion for this service and obtain only a nominal profit from the transaction* Under the new procedure the Federal Reserve will be in a position to tender directly with the Treasury for new issues to replace maturing issues of bills through issues* exchanging the maturing This will sixspiiiy the refunding operations for the Federal Be-* serve and will relieve the dealers of the need for handling harge refunding operations at a nominal rate of return* Any addition to fbderal Reserve holding of bills would be purchased in the open market as at present* * - 5- EXHIBIT D Procedure for Handling Direct Exchange of Bills (1) Under this plan the Treasury would offer weekly a specified amount of a new issue of Treasury bills for which bills awarded on tenders could be paid for either by cash or surrender of a like face amount of the maturing issue of Treasury bills* In oases -where the investor tendered the maturing issue for the new issue, the investor would receive payment from the treasury (through the Federal Keserve Banks) for the difference between the redemption value of the maturing issue (par) and the purchase price of the new issue. (2) The Treasury* s announcement for the invitation of tenders would be emended correspondingly. 19U7* followsi a Using press release A*291 of April 3» sample, the last sentence on page 1 would be amended to read as ^Payment of accepted tenders at the prices offered must ba made or completed at the federal K©serve bank in maturing bills* cash or other immediately available funds on April t (3) Sew issues of Treasury bills would be sold on a discount basis under competitive bidding as in the past* Ho preferential allotment would be made on tenders for which an exchange is to be made by surrender of & maturing issue. Full allotments for small amounts on a fixed price basis could be continued* as long as the buying sale and option are continued. (4) tenders for a new issue of Treasury bills may be entered by the System to the extent of its holdings ©f the maturing issue. According to an opinion by General Counsel of the Inderal Open Market Committee, awards of an amount not in excess of maturing bills held by the federal Be serve Batiks may be acquired directly from the Treasury without coming under the five billion dollar statutory limitation on direct purchases from the Treasury, provided the new bills are issued against surrender of the maturing issue of Treasury bills* (5) In order that the System may tender option account holdings of bills in exchange for new issues the federal Reserve Open ISarket Ccra&ttee should amend its direction to the Inderal Heserve Banks with rogard to the period in which the seller of bills under the option agreement xaay exercise his option to repurchase* This axnendiaent should require that the option be exercised on or before the last business day preceding the closing day on which the Treasury will accept tenders for a new issue of Treasury bills for which allotments saay be paid for by surrender of the maturing issue of Treasury bills* (6) Pending further changes in bill policy, the Bederal Heserve would continue to tender for an amount of new issues equal to the amount of maturing issues in the System end Option accounts. Also* the Federal fieserve would have an agreement with the dealers that it will purchase at the stated buying rate of p/Q per cent such mounts of the remaining new issues as are not absorbed the the mrket. After the buying rate is die* continued, the procedure would be as shown in ISxhibit F. - 7 - EXHIBIT 1 ffideral Reserve iumouncement on Elimination of PostedBuying Rate and Repurchase Option w ?he Open Earket Coms&ttee of the Federal Reserve System herewith announces termination of its policy of offering a fiaeed buying rate of 3/8 per cent and repurchase option on treasury bills* apply to bills issued on or after April the new policy will « She present policy will eon* time to apply with respect to bills issued prior to this date* The posted rate was a wartime masure designed primarily to facilitate war financing by encouraging banks to nake the fullest use of their excess reserves and to stabilise market rates for Government securities* Sine* this policy was adopted in 19l0» underlying ocaditions have changed* As confidence developed in the course of war financing that maturities could be extended with comparative safety* certificates of indebtedness which boar a higher rate than bills replaced treasury bills in the market, not only as a medium for the investeent of short^tem funds but also as a jseans for banks to adjust reserve positions* Increased mounts of Treas- ury bills were sold to the Federal Reserve System and bills gradually ceased to be a market instrument* Currently, loss than two billion of the 17 billion total of treasury bills outstanding is held outside the Federal Reserve Banks and of this amount approximately one half billion is held for foreign central banks* the treasury bill rate is 110 longer a factor in short«-tem money market rates* Moreover, the need for large scale financing has come to an end and currently the public debt Is being reduced* Consequently* there is no reason for continuing the present policy* tjhder the new policy the bill rate will be permitted to find its level in the market in proper relation to the coupon rate of 7/8 par cent on 1-year certificates* The Badera! Reserve will continue to purchase and hold Treasury bills as well as other Government securities in amounts deemed necessary to maintain an orderly market* In view of recent action taken by the Board of Governors of the federal He serve System to pay into the Treasury the bulk of its net earnings alter dividends, approximately 90 per cent of any increase in Be serve bank earnings resulting from a rise in the bill rate will be recovered by the Treasury* Since most of the Treasury bills are held by the Federal Re servo Banks, the bulk of the increaso in interest charges will thus be returned to the Treasuryn# EXHIBIT P Procedure on Bills After Discontinuation of Buying Hate (1) She Bfcderal Open Market Comittee will withdraw its direo~ tion to the ^doral Reserve Banks issued on August 7» for the fixed buying rate and repurchase option on Treasury bills issued after a specific date. (2) As bills held in the option accounts mature, •thfiy.-will be changed for n&vr bills to be held in the System Account* The option accounts •will be liquidated in the course of a 1J weeks cycle. (5) The purpose of discontinuing the fixed buying rate is to permit the bill rate to find its market level vis-e-^ris the certificate rate* After such a level has been established, ftederal Reserve tenders of new bills would be at a rate close to the market rate for bills* (h) In the transition to a nesr bill rate, federal Reserve policy will be adjusted to "foliar* the market and not accentuate any upward pressure on the bill rate that may develop in the market. In this connection, the federal Reserve xr&ght continue in the first week to tender for the amount of its maturing bills at a rate only slightly above j/8. If the discount paid in the zaarket should increase* the Ifederal Ee serve would then raise its bidding rat© in succeeding weeks* At the saaae time, the Jbderal Reserve would arrange v&th dealers to tender for an additional amount of bills at a rate which would be above that at which the market Is expected to replace its maturing bills. This would enable the market to obtain a maximum anount of bills at what might be considered reasonable -10- rates, yot at the semo time would assure th© Treasury that no part of the issue would h a w to he sold at a rate above that of the dealers' tender for the Federal Eeserve* During the early woks, there would have to be consultation between the Treasury and Rtdoral Eeserve regarding terns and amounts of weekly ^federal Reserve tenders. After a new bill rate has boon established and the volume of market-held bills has come to be adjusted to the new rate, Federalfioservepurchases of new bills would be such as to maintain an orderly bill market» Under normal conditions, fbderal Reserve bids would be at a price just slightly below that of the .market, i*©# at a rate slightly above that of the market* Market dealings of the Federal Reserve in bills would ordinarily be restricted to purchases* Increased demands for bills by the market would be reflected in additional tenders for bills at rates below the P&deral Reserve tenders. - IX EXHIBIT © Statement of Objectives of Program 1* The program helps to clear up cumbersome procedure inherited from war finance* By letting the bill rate again become a market instrument the functioning of the money market and control thereover is improved* 2* The program will serve to introduce some uncertainty in the market regarding possible changes in other rates* This will be a wholesome factor in discouraging inflationary expansion of bank credit and pre** venting further decline in interest rates* 3* Jhis action may be sufficient to accomplish these purposes without changes in other rates but conditions may develop vdiere an upward adjustment in the certificate rate may beccme necessary. Mo change in the certificate rate would bo permitted without prior discussion with the treasury aimed at reaching an agreement on such action* km Some increase in certificate rates may turn out to be necessary for these reasonss 1* Banks may resume the practice of purchasing longer term Issues of Government securities in the market while selling shorter issues to the Federal Bcserve. There will be increased pressure for such pur chases by banks because of loss of bank earnings under the retirement program and increasing costs of operation* The process of expansion will result inftirtherincrease in the money supply and renew the decline in long-term interest rates* 2* In order to increase or maintain earnings, banks may also shift from Government securities to make unsound or speculative loans* Shis will directly add to inflationary fbroes and create the danger of a subsequent deflation spiral later on* These contingencies can not be met.; by offering additional issues of long-term securities because such offerings might increase the shifting of eligible securities into the banks and sale of short-term securities into the Federalfieserve. In the absence of increased fbdera). He servo authority to control the available supply of bank reserves, an adjustment in short-term rates is the only restrictive action that may be taken*
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