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COPY THE illillERSECFIETP.RY OF THE TREASURY WASHINGTON August 3, 1923. My dea.r Governor: I take i t that thare is no immediate occasion a.t this time to consider possible advances in the discount ra.tes of the Federal Reserve Ba.nks, but it is conceivable that sorr.e such occasion may arise in the not distant future, and I am therefore writing to suggest a. method of approa.ch to the problem which it seerns to me has not been sufficiently considered in the pa.st. I refar particularly to the possibility of establishing a different rate for discounts at the Federal Reserve Banks rep:·es3nting the ordinary line of credit loans to commercial banks, a.s d).stir;E,uished from paper of prirr.e liquidity which he.s a.t the same time a recognized open market, a.s, for example, bankers acceptances and short-time Treasury certifica.tes of indebtedness. The Fe<ieral Reserve B,mks now are proceeding ge·ne rally on the basis of a. uniform discount rate for all classes of paper, wHh a. special buy:ing ra.te for ba.nkers acceptances. I take it that there is nothing sacred, however, in a uniform rate, and i t is manifest that any uniform rate necessarily fails to take into account the differences existing be tw<::en different cla.sses of paper. The m.ost funda- mental difference, which is rr.uch better recognized in England and is coming to be recognized in this country, is tha.t betvJeen paper wLich has a. recognized status in the open market, like bankers :>.ccept:mces and Trea.sury certifica.tes, and pa.per like customers' loans at a bank .. . -2- X-3807 Which ha.s no ma.rket status and cannot be readily teste~ by the open ma.rket. There is a. growing realization in the Feder.Jl Reserve System of the importance of the open rrBrket powers of the Federal Reserve Ba.nks, and with tha.t, it seems to rr.e, there nust come a. better recog.,.nition of the fa.ct that the wz,y for the Federal Reserve Banks to bring their opera.tions into relation with tlle general credit situation is through an open ma.rket policy divorced entirely from any- question of making enough ea.rnings to meet expenses and dividends. and based instead on the ma.rket 1 s need for credit. along this line. There has already been much progress For some yea.rs pc.;.st the Trea.sury has been engaged in developing an open rr.arket for Treasury certificates of indebtedness 1 a.nd there is now, and for some time ba.ck ha.s been. an active open rr.a.rket • refleeting accurately the investment values of Treasury certificates a.s liquid short-time securities a.nd a.t the same time enabling the Trea.sury to a.djust the tenns of its successive offerings to meet a.ctual marke-t conditions. The Federal Reserve Banks at the same time hove bean engaged in an effort to esta.bl ish a ma.rket for bankers a.cceptances and have achieved some success 1 though frequently the buying rate a.t the Feder.;:;l Be serve Banks ha.s been so low as to undersell the open ma.rket, leaving the Federal Reserve :Banks pra.ctica.lly the only ma.rket for a.cceptances. More could be a.ccomplished if the buying rate for a.cceptances were kept up to the ma.rke t , a.nd I understand th8 Central Corrmi t tee of Gave rnor s on open market operations ha.s been giving some study to this side of the problem. At '.my ra.te, both the Treasury and the. Federal Reserve BJnl:s have had sufficient experience with Treasury certifica.tes and bankers acceptances to know .,. ~3- X-3807 tha.t an open ll'.a.rket can be successfully developed. for both classes of securities, and that if free of artificial influences this ma.rket will constantly reflect the true position of the securities and afford free play, through purcha.ses and sales of certifica.tes a.nd a.cceptances, to changes in the credit situation. The further development of the open na.rket for certificates and acceptances offers. it seems to rr.e, the best opportunity in the world for placing the Federal :ae?erve Banks in··•omething of the same relation to the market here that the Bank of England holds to the bill ma.rket over there. lea.ving the Federal Reserve Banks to deal, like the Bank of England, with only the Inarginal demmd for credit·.. The open msrket, in other words • would act as a. kind of balance-wheel between the ba.nks and the Federal Reserve Banks. TI.::mks in the financia.l centers would hold in their portfolios reasona.ble amounts of liquid short-time securities. like T.rea.sury ce.rtifica.tes and bankers acceptances, a.nd when in need of funds would sell certificates or acceptances to the rr:a.rket before having recourse to the Federa.l Reserve :Sank~·· The market would norma.lly a.bsorb the certifica.tes or acceptances sold, proba.bly through sale thll.S to an investor o.r to another bank ha:ving."a.n excess supply of funds, but in the event of a. real lack of credit the rr.a.rke t itself could a.pply to the Federal Reserve Bank, through a sale of certificates or a.cceptances to the Federal Res a rve Bank under its open ~re.rke t powers· To some ex- tent this is already wh8t happens in the principal fina.ncial centers under the present system, but. it breaks down in a situation where Ir;ember bankS, without ha.ving recout'se to the rr:a.rke t. can get funds from the Federal Rese-rve Banks onthe san:e terms by discounting vvi th the Fed..e.;ra.l ..... , ..... • -4- X-3807 Reserve Banks customers' notes and line of credit loans which ha~e no standing in the open ma.rket. Under this system discounts of custorrers' notes a.re almost a.lwa.ys made a.t a. ra.te :.ower than the going ra.te for such paper, while sales of certificates or bills to the Federal Reserve Banks, wl:lich must be regarded for practical p1 - poses as only a.nother form of discount, will probably be rrBde at about the open rna.rket rate, unlGSS the Federal Reserve Banks therr,selves cut in under the open rrfl.rket by esta.blishing a.rtificially low buying rates for bills.. There is no real recognition given to paper enjoying an open rr.a.rket, and Vlhat has been done in the nan:e of encoura.ging the rr.arket for acceptances ha.s frequently tended to destroy it. The remedy, it seems to me, would be to establish the rate of discount on cus tamers 1 notes and line of credit loans a.t a. sufficient fi§.ure, sa.y, 1 per cent higJ::.e:>:> than the rate on Treasury certificates and bankers a.cceptances, to n:a.tch the going rate on corr.mercia.l pa.per and give a. differential in fa.vor of paper which has independent stnnding in the open rna.rket. This would encoura.ge the development of the open market and bring the banks more and more to resort to the open market for certifica.tes and a.cceptances as a. means of securing necessa.ry funds or of employing funds temporarily idle. it ~uuld .At the sa.me time tend to give an outside Check on the credit policies of the Federal li.eserve Banks and throu@:l the inevitable relations tha.t would a.rise between the banks and the rr.a.rket would keep the Fede;a1 Reserve ~anks n:ore on their mettle in the development of these policies. The suggestion offers particula.rly interesting possibilities ..• ~s- in case there should be a. situation ca.lling for an increase . in P,isof~ count ra.tes, for it would make it possible to recognize, a.s the ficia.l Federa.l Reserve ra.te, the rn.te on a.cceptances a.nd certdica.tes of indebtedness, wi ~the proviso tha.t the rate of d:\,scount on customers t notes a.nd 1 ine of c1:edi t loans would be, say, 1 per cent higher than the established ra.te, This would recognize the essentia.l di-fferences between the two classes of pa.per, would be a. perfectly . safe distinction in view of the liquidity of the pa.~er and ~e inde- pendent open rr.a,rket which it would enjoy, and would make the Federal· Reserve ra.te more nea.rly cornpa.ra.ble than it ha.s ever been before to the discount rate of the :Bank of England. Incidenta.lly, i t would ha:ve the psychological a.dvanta.ge of leaving one official ra.te a.t the rela.tively lowe-r figu:re, with a. hi@:ler ra.te applicable to discounts· of line of credit loans, which are ha.ndled ordina.rily by banks in·· pra~tically a.ll sections of the country a.t a. ra.te considera.bly'higher than the open market rate on certifica.tes a.nd a.cceptances •.. The differential. would thus accord with the fa.cts·~ Even now, for example.· with a ~per cent discount ra.te,. it is the. general pract~ce of banks · · to cha.rge around 5~ per cent to their customers·, and in many c·ases much more than this, >mather in the fqrrn of diract interest cha.rgas. or through. incidental cha.rges i~ the form of commissions t . fix8d: deposits, a.nd the like. A rec•gnition of the differences between paper e:njoying an •,I X-3807 inctependent open rnarke t, like certificates and bankers e.cceptances, and customers 1 paper or line of credit loans by banks, on t11e other hand, would give the Federal He r.erve Bonks rr:uch rr:o'::'e effective control over the gener<c1::. credit situation, would put their rates into better rela.tion with +Jtc~, g·)ing rates on the different classes of paper, and would enabJ.e them to exercise such control as might be necessary through ir"c:"easj;-",; t:1eir rates withouta.t the s:::nne time prejudicing the open markt:t which has been built up for both certifica.tes and acceptances. Federal R~serve To put it enother way, i t gives the Banks the opportunity to establish their ra.te at or a.bove the ma.rk:>.t without discriminating a.ga ins t certifica.tes and a.cceptances. The facts are r,hat there are eiifferent rates for different kinds of pnper, loacr ra !.es fry;:- a.cceptances and certifica.tes and higher ra.tes for cornnco:rdal pa.per, and unless the Federal He serve Banks a.re vvilling to .recognize these facts i t will always be impossible for them to get on top of the mark8t ·;vithout operatin5 unfairly against certificates and acceptances. At the present ti1r.e the Federal Reserve rate on line of credit loans is undoubtedly below the market and just a.s a.cceptances. cle<:n~y .An increase to a.bove the rr.arket on certificates nn:t 5-~per cent, for example, would "Lm- fa.irly penalize certificates and a.cceptances a.nd still not much more than meet the market on cus torr.ers 1 notes and linJ of cr0d it loans. Any increase in ra:~e3 large enou6h to 1~ut the Federal Ice- serve rate on top of the rracl:et rote on customers 1 notes ond line of credit loa.ns would thus opera.te most unfairly a5ainst certificates ~7- X-3807 and a,cceptances and seriously upset the IP.a.rket for these securities without giving Federal D.e serve Banks much better control over the genera.l Situat)on. If, on the other hand, the differential is reocgnized and differar:t. rates established for the different classes of pa.per, it would lie f"JS~>ihJ,;, by putting a higher discount ra.te on customers• notes and line of eredit loans, to put Federal Reserve ra.tes all a.round into d.£ ec t1ve relation with outside ra.tes and thus accomplish vVha.t the :5';-)de:ral Heserve Banks have been hop5.ng to a.ccomplish ever since their original organiza.tion. The differential betwaen the two classes of pa.per would also have a. direct bearing on our posit ion in world trade a.nd commerce, for it recognizes the ;?opular cha.ra.cter of short-time pa.per like a.cceptances at1d wot1i.d. an a.ppropria.te rate, rr:a~~e it possible to finance such pa.per a.t U..."'l]Y,·a~;;,cliGed by the higher rate that might be applicable to ordina.:-y corr.mercial pa.per. This would enable cur bankers and business rr.en to compete on rr.ore nearly an equality with the . other rr.oney mark0ts of the world, and facil i ta.te the development of . our own market for bills • .Another thing to be sa.id for the suggested differential in ra.tes is that it would keep the Federal Reserve Banks on their mettle, and require them in q.ll their operations to keep in the closest touch with the rr.arket. Both the Federal Reserve System and the Treasury would have to cxerc ise the; ut.mos t ca.re to watch any artificial influences operating in the na.rket for certificates or ,-.-..~·· -8- X-3807 acceptances • a.nd to a:void a.t all costs any a.ction on their own part tha.t would tend to put either certifico.tes or acceptances on a. false ba.sis of value. 'Ihe zna.rket itself will give a constant check on these things i f not subje1::ted to a.rtificia.l influenGes, and vvould be the best test of vvhe :·.}1:;;r the rates vvere being intelligently administered by the ]'6 deral Reserve Ba.nks. All of these s·uc;ge:; tions are, of course, more or less ten- ta.tive and would ha.ve to h>. fu-rther developed, but :r am offering them now in the light of the T;·se.s>;.ry' s experience in these ma.tters with the thought that there may soon be a. real opportunity to consider their a.pp~ ica.tion to the d.eveloprner.t of Federal Reserve policy. hope the Federal 1\ese~re Boa.ro will receive them on tha.t ba.sis, and give sorre considera.tj on t,, when a.ction will have to I bc t~1ei -r possibilities m advance of the time token. The term "Treasury certifica.tes of indebtedness", I shouln add, ought to be regarded throughcu t this letter a.s me1ming strictly w.ba.t it says 1 and not a.s including other Government securities like Liberty bonds or short-time Trea.sury notes. Generally speaking, i t seems to rra tha.t Liberty bon<i.s and 'I'rea.sury notes, not being a.t a.ll in the cla.ss of short-time Trea.sury certifica.tes or bankers a.cceptances, and not ha.ving the same kind of a. ma.rket, would ha:ve to fa.ll into the general classification a.nd not enjoy a.eydifferent ra.te of discount tha.n customers• notes and line of credit lo<ms. Sincerely yours, Hon. D. R. Crissinger, Governor, Federa.l he serve Boa.ri, Washington, D.c. (Signed) S. P. GIL~ERT, Jr., Under Secreta.ry. '""
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