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B O ARD DF G D V E R N D R S

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FEDERAL RESERVE SYSTEM
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20551

ADDRESS OrriCIAL C O R B E S P O N D tN C E
TO T H E BO A R D

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April 5, 1973

The Honorable William E. Simon
Deputy Secretary
Department of the Treasury
Washington, D. C.
20220
Dear Mr. Simon:

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The Board has considered the implications of the seven
legislative recommendations set forth in the Treasury memorandum
dated March 19, 1973. This letter conveys the present thinking of the
Board on those recommendations and related questions.

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Before presenting the BoardTs positions on each of the issues
raised in the Treasuryfs memorandum, some general principles that the
Board considers of overriding importance should be emphasized.

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First, the Board continues to believe that universal resarve r
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requirements for both demand deposits and ^0W type accounts are necessaig?
for purposes of both effective monetary policy and competitive equity. *
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Presently, the higher reserve requirements imposed on Federal Reserve
member banks, as compared to those imposed by the states on non-member
banks, discriminate against member banks competitively and are resulting
in withdrawals from membership in the Federal Reserve System. Should the
percentage of bank deposits subject to Federal Reserve reserve require­
ments continue to decline, the Federal Reserve's ability to control
monetary aggregates will be eroded.
The Board has long advocated equality of reserve requirements
for member and non-member banks, and a succession of study groups has
supported this principle.
In 1961, the Commission on Money and Credit
recommended that all insured commercial banks be required to join the
Federal Reserve System.
In 1963, the Committee on Financial Institutions
recommended equal reserve requirements for demand deposits of member and
non-member commercial banks.
In 1971, the President's Commission on
Financial Structure and Regulation (Hunt Commission) proposed that all
institutions offering demand deposits be required to belong to the
Federal Reserve System. This proposal was a crucial part of the Commission1
program for equalizing regulatory burdens among banks and thrift institution




The Honorable William E. Simon

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While the Board does not believe it is necessary to require System
membership for all of these institutions, it considers it essential that
all institutions should be subject to the same reserve requirements
on demand and NOW type accounts.
More generally, the Board believes that wide-scale structural
reform should pursue the objectives of basic equality of regulatory
treatment for all financial institutions with similar powers, not only
with respect to reserve requirements, but with respect to interest
rate ceilings and taxation as well.

Finally, any program aimed at restructuring the system of
deposit intermediation must be carefully designed to preserve and enhan<
the soundness of banks and thrift institutions.
It is against the background of these principles that the
following observations on the seven recommendations are offered.

1,

Elimination of Savings and Time Deposit Interest Ceilings
(Regulation Q. etc.)

Photocopy from Gerald R. Ford Library

In addition, any changes that would serve to,reduce materially
the long-run supply of residential mortgage credit would be a matter of
great concern to the Board and to the Congress as well.

The Board supports the general goal of eventually eliminating
interest rate ceilings on time and savings deposits, but only as the
portfolios of thrift institutions have become sufficiently adjusted
(see Issue 2) to permit chem to compete effectively for funds even
during periods of credit restraint.
In addition, some discretion in
the timing of the removal of interest ceilings is desirable, so as to
minimize disruptive shifts of funds among institutions.
In the case of
NOW accounts, discussed under Issue 3, ceilings would be needed from
the outset, albeit with the goal of gradual relaxation and eventual
elimination. Therefore, the Board recommends a controlled phase-out
of ceiling rates, rather than immediate removal at some specified date,
and also recommends that a specific terminal date should not be set for
the authority to regulate deposit rate ceilings. Termination of authority
could be left to the discretion of the Board, or alternatively, the
authority might lapse if not used over a specified period of time.
The Board also recommends*that the conditions for imposing
interest ceilings should be made more general. The proposal in the
Treasury memo would not permit imposition of.ceilings to protect the




The Honorable William E* Simon

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mortgage market or to prevent the threat of insolvency of financial
institutions,.for example, savings and loan associations. A preferable
condition for imposition of ceilings would be when uncontrolled rates
threaten to undermine the safety and soundness of depository institutions,
or conflict with other public interest considerations.
The Board opposes the proposal for a five-agency committee
to have discretionary authority to impose Regulation Q ceilings. Given
the critical role these ceilings can play in the implementation of
monetary policy, it would be desirable either to follow the Hunt
Commission recommendations, which would place authority in the Board
to set all deposit rate ceilings, or to leave the Board the powers it
.presently has to continue, suspend, modify or reimpose rate ceilings for
member banks after consultation with the FDIC and the FHLBB.

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2.

Expanded Lending and Investment Powers

The Board generally supports the degree of asset diversification
for mutual savings banks and savings and loan institutions contemplated £
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in this rec anmendation.
Broadening the lending powers of thrift
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institutions even to this degree, however, would raise some question as j
to the impact on the long-run supply of mortgage credit. This problem 3
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could be remedied by the proposed tax credit, but it is impossible to- &
evaluate the proposal until the specific rate and other conditions of
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the tax credit are spelled out (Issue 7).
The Board believes that thrift institutions should be allowed
to invest, to a limited degree, in mortgages that include some o a r t i c i D a t i o
in income and/or capital gains. Such "equity participations" should be
confined to mortgages on residential and related properties. The Board
opposes the proposal to allow thrift institutions to invest directly
in equity securities, although thrift institutions already making
equity investments could justifiably be allowed to keep those investments.
The Board endorses the proposals to liberalize restrictions
on real estate lending by commercial banks and to permit member banks to
discount any class of assets at the Federal Reserve Banks at rates to be
determined by the Federal Reserve.
In addition, the Board recommends
that commercial banks be permitted to make equity participation loans
on residential and related properties to the same extent as thrift
institutions. With respect to commercial bank underwriting of "certain
revenue bonds," the Board would like to reserve comment until the details
of this proposal are made more specific*
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The Honorable William E. Simon

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Deposits and Third-Party Transfer Systems and Reserves

The Board believes that NOW account privileges should be
extended to all depository institutions, but that the class of depositor
eligible to hold such accounts should be confined to households.
It als
believes that NOW accounts offered by all institutions should be subject
to identical interest ceilings, established by the Federal Reserve, FDIC
and FTfLBB in consultation with one another; that- NOW account deposits
of all institutions should be subject to identical reserve requirements
set by the Federal Reserve; and that reserves should be held in cash or
in deposits at the Federal Reserve.
The Board agrees with the proposal concerning demand deposits
except as it relates to reserve requirements. While the Board does not
propose required membership in the Federal Reserve, demand deposits of
all institutions should be subject to identical reserve requirements
established by the Federal Reserve, with such reserves to be held in
cash or in deposits at the Federal Reserve.
The Board endorses broadened authority for it to set reserve
I requirements for demand deposits between scne minimal figure, such as
I 5 per cent, and 22 per cent. The Board opposes the phasing out of
I reserve requirements on commercial bank savings and time deposits, since
Msuch required reserves are a potentially useful weapon for combatting
^excessive increases in commercial bank credit.
The Board would endorse
a broadened authority to set reserve requirements on time and savings
deposits between some minimal amount, such as 1 or 2 per cent, and 10
per cent. The Board believes that reserve requirements for NOW accounts
should be set somewhere between the requirements for demand deposits and
those for savings accounts.
With respect to all of the foregoing categories of reserve
requirements, the Board should have flexible authority to establish
structures of differing reserve requirements within the indicated
percentage limits, as is provided by present law.
The Board is q>posed to permitting government securities to be
used to fulfill part of total reserve requirements, since this confuses
the role Treasury securities play in providing bank liquidity and the
function of reserve requirements in monetary management.
Furthermore,
this provision could open the door to efforts to finance Federal outlays
by mandated bank purchases of government debt.




The Honorable William E. Simon

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Charters for Thrift Institutions

The Board endorses the proposals contained in the Treasury
memorandum.

5.

Credit Uniorvs

The Board concurs, in general, with the proposals for credit
unions set forth in the Treasury memorandum.

6.

The FRA Interest Ceiling; Will be Removed

The Board endorses this proposal, and assumes that it is
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meant to include interest rate ceilings on VA-guaranteed mortgage loans.3
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Taxes

The Board endorses the proposal for equal tax treatment with
respect to additions to loan loss reserves.

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The Board is not opposed to a tax credit on mortgage interest C
income. However, before it could endorse the proposal, the Board would 8
need to know the details of the recommendation, including the size of tfre
tax credit, applicability to GNMA mortgage-backed bonds, applicability
to non-residential mortgages, and its likely distribution among various
classes of individual and institutional investors.
The Board would like
to point out that one limitation of such a tax credit is that it would
have no value to investors with no tax liabilities, including pension
funds.
In the interest of brevity, this letter has not developed at
length the reasoning and analysis that underlies its conclusions.
If
you would like to explore these matters further, we suggest that you
or someone on your staff contact Mr. Sam Chase of the Board!s staff.




Sincerely yours,

fsF
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ynan Sm
ith'
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Tynan Smith
Secretary of the Board


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102