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https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  DIDC January 22, 1981 - March 31, 1981  Collection: Paul A. Volcker Papers Call Number: MC279  Box 26  Preferred Citation: Depository Institutions Deregulation Committee, 1981 January 22-March 31; Paul A. Volcker Papers, Box 26; Public Policy Papers, Department of Rare Books and Special Collections, Princeton University Library Find it online: http://findingaids.princeton.edu/collections/MC279/c169 and https://fraser.sdouisfed.org/archival/5297 The digitization ofthis collection was made possible by the Federal Reserve Bank of St. Louis. From the collections of the Seeley G. Mudd Manuscript Library, Princeton, NJ These documents can only be used for educational and research purposes ("fair use") as per United States copyright law. By accessing this file, all users agree that their use falls within fair use as defined by the copyright law of the United States. 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Mudd Manuscript Library 65 Olden Street Princeton, NJ 08540 609-258-6345 609-258-3385 (fax) mudd@princeton.edu   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE PRESS RELEASE COMPTROLLER OF THE CURRENCY FEDERAL RESERVE BOARD  FEDERAL DEPOSIT INSURANCE CORPORATION NATIONAL CREDIT UNION ADMINISTRATION  FEDERAL HOME LOAN BANK BOARD TREASURY DEPARTMENT  For immediate release  March 31, 1981  The Depository Institutions Deregulation Committee, established by Congress to bring about an orderly phase-out of interest rate ceilings on deposits, proposed taking two steps in that direction at its meeting March 26. The Committee requested comment by May 1 on the two following proposals: 1.  To remove the present 12 and 11 3/4 percent cap on the maximum interest rate ceiling that applies to Small Saver Certificates offered by thrift institutions and banks respectively. The Small Saver Certificate is a certificate of deposit with a maturity of 2 1/2 years or more. The rate ceiling on this category would continue to be tied to the 2 1/2 year yield on U.S. Treasury securities.  2.  To establish the following schedule for deregulating deposit rate ceilings generally, by eliminating rate ceilings on deposits of certain maturities: July 1, 1981 July 1, 1982 July 1, 1983 July 1, 1984 July 1, 1985 April 1, 1986  Deposits with maturities of five years or more; Deposits with maturities of four to five years; Deposits with maturities of two to four years; Deposits with maturities of one to two years; Deposits with maturities of six months to one year; Elimination of all remaining ceilings (as required by law)  The Committee said it would also consider comment concerning deregulation by means of indexing ceiling rates to market rates according to this schedule. Subjects on which the Committee would particularly like to receive comment are listed on  Pages Three and Six of the attached notice of those proposals.  In another action the Committee amended it rules to make new ceiling rates established for the six-month Money Market Certificate and the Small Saver Certificate   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  (OVER)  -2effective the day following their announcement.  At present, there is normally a two-day  delay (from announcement on Monday to the effective date on Thursday). This will work as follows: The rates announced Monday, March 30, for both the Money Market Certificate and the Small Saver Certificate remained subject to the existing rule and become effective on Thursday, April 2. The rate announced on Monday, April 6, for the MMC, will become effective Tuesday, April 7, under the new rule. The rate announced (on the bi-weekly schedule of announcements of SSC rates) for the SSC on Monday, April 13, will be effective on Tuesday, April 14, under the new rule. All rates subsequently announced for the MMC or the SSC will be effective the day after announcement. The Committee took this action to link the rates on these deposits more closely to market rates. emerged.  It said it would reconsider the matter if severe operational problems  The Committee acted after consideration of comment received on proposals,  announced last December, for changes in the Committee's rules regarding the effective date of newly announced ceiling rates for the MMC and the SSC.  The comment  received is summarized in the attached notice of the Committee's action. The Committee considered but took no action on proposals before it relating to penalty-free early withdrawal of funds from time deposits in the event of the bankruptcy of the depositor, the Committee's rule regarding the phase-out of finders fees and the ceiling rates on regular savings accounts and interest bearing transaction accounts. The Committee elected Secretary of the Treasury Donald T. Regan to succeed Federal Reserve Board Chairman Paul A. Volcker as Chairman of DIDC.  The members  of the Committee are the heads of the agencies listed at the top of Page One. The Committee will announce the date of its next meeting at a later time.  Attachment   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE [12 CFR Part 12041 (Docket No. D-0019) NOTICE OF PROPOSED RULEMAKING Deregulation of Deposit Rate Ceilings  AGENCY:  Depository Institutions Deregulation Committee.  ACTION:  Proposed rulemaking.  SUMMARY: The Depository Institutions Deregulation Committee ("Committee") is requesting public comment on two proposed actions: (1) removal of the maximum interest rate ceilings ("caps") on 2-1/2 year or more small saver certificates (SSCs) while continuing to index the interest rate limitation on SSCs to the 2-1/2 year yield on U. S. Treasury securities, and (2) establishment of a schedule for which rate ceilings on deposits would be gradually deregulated starting with longer maturities by eliminating such ceilings or, alternatively, by indexing interest rate ceilings to a market rate. The proposals are intended as steps in accomplishing the Committee's objective of an orderly phase-out and ultimate elimination of deposit interest rate ceilings. DATES:  A  Comments must be received by May 1, 1981.  ADDRESS: Interested parties are invited to submit written data, views, or arguments regarding the proposed rules to Normand R. V. Bernard, Executive Secretary, Federal Reserve Building, 20th Street and Constitution Avenue, N. W., Washington, D. C. 20551. All material submitted should include the Docket Number D-0019. Such material will be made available for inspection and copying upon request except as provided in Section 1202.5 of the Committee's Rules Regarding Availability of Information (12 CFR s 1202.5). FOR FURTHER INFORMATION CONTACT: Paul S. Pilecki, Senior Attorney, Board of Governors of the Federal Reserve System (202/452-3281), F. Douglas Birdzell, Counsel, Federal Deposit Insurance Corporation (202/3894261), Allan Schott, Attorney-Advisor, Department of the Treasury (202/5666798), Rebecca Laird, Senior Associate General Counsel, Federal Home Loan Bank Board (202/377-6446), David Ansell, Attorney, Office of the Comptroller of the Currency (202/447-1880), or Robert H. Dugger, Director, Office of Policy Analysis, National Credit Union Administration Board (202/357-1090).   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2  Deregulation SUPPLEMENTARY INFORMATION: The Depository Institutions et seq.) ("Act") 3501 Act of 1980 (Title II of P. L. 96-221; 12 U.S.C. §s ultimate eliminathe and was enacted to provide for the orderly phase-out dividends and t tion of the limitations on the maximum rates of interes In tions. institu that may be paid on deposit accounts by depository have: s ceiling adopting the Act, the Congress determined that rate ors; (3) (1) discouraged savings; (2) created inequities for deposit provided not impeded competition among depository institutions; and (4) also s an even flow of funds for home mortgage lending. The Congres savings, are found that all depositors, particularly those with modest economically entitled to receive a market rate-of-return as soon as it is feasible for institutions to pay such rates. s Under the Act, authority to administer deposit rate ceiling the to and to structure the phase-out of such ceilings has been given out rate Committee. The Act also provides that the Committee can phase ceilings by any or all of the following methods: (1)  gradually increase ceilings applicable to all account categories (however when increasing rates on all existing accounts, the DIDC may not exceed market rates);  (2)  complete elimination of limitations applicable to particular account categories (both new and existing):  (3)  creation of new account categories not subject to limits or with limits set at current market rates;  (4)  by any combination of the above methods; and  (5)  by any other method.  In accordance with its responsibilities, the Committee is to meet requesting public comment on two proposals that are intended further d to designe is l proposa the objective of the Act. The first t rate deregulation in the short run by removing the maximum interes (SSCs). cates certifi saver small more ceilings ("caps") on 2-1/2 year or ceiling the SSCs; to apply to e continu An interest rate limitation would y Treasur S. U. on yield year 2-1/2 normally would be determined by the ation deregul of m plan longer-ter securities. The second proposal is a deregulated under which deposit interest rate ceilings would be gradually alternatively, or, s ceiling the ting starting with longer maturities by elimina ee Committ The rate. by indexing interest rate ceilings to a market ation deregul of plans also is interested in receiving comments on other 1981. 1, May of interest rate limitations. Comment is reqested by   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  3  Removal of the Cap on SSCs The ceiling rate of interest payable on the SSC is tied to the average 2-1/2 year yield for United States Treasury securities as determined bi-weekly by the United States Treasury. Thrift institutions may pay interest on SSCs at the 2-1/2 year yield announced prior to the date of deposit and commercial banks may pay interest at a rate 25 basis points lower. On February 27, 1980, prior to the establishment of the Committee, the Federal regulatory agencies announced the establishment of a temporary maximum on the SSC ceiling of 12 per cent for insured savings and loan associations and mutual savings banks and 11.75 per cent for Federally insured commercial banks. This action was viewed as necessary because the agencies believed that the sudden increase in ceilings, which otherwise would have occurred in March 1980, would have been disruptive to many financial institutions, particularly those holding a high proportion of long-term fixed-rate loans. The caps have been binding continuously since November 1980. Absent the cap, the interest limitation on SSCs for the period March 19 through April 1 would be 13.55 per cent for thrift institutions and 13.30 per cent for commercial banks. There also is a minimum interest rate ceiling on SSCs of 9.50 per cent for thrift institutions and 9.25 per cent for commercial banks, although depository institutions may pay interest at rates lower than the ceiling. The minimum interest rate ceiling, which was established effective June 2, 1980, would not be affected by the proposal. The Committee believes that removing the cap on the SSC interest rate ceiling would provide a higher return to savers as well as give depository institutions flexibility in choosing their own liability structures. The more market sensitive overall yield that could be offered could improve the competitive position of depository institutions visa-vis nondeposit alternatives. Moreover, to the extent that institutions would be able to attract longer-term deposits, the flow of funds into the mortgage markets could be improved. Accordingly, the Committee requests views from the public on a proposal to remove the maximum interest rate ceiling on SSCs of 12 per cent for thrift institutions and 11.75 per cent for commercial banks so that the interest rate limitation could be higher when the average yield on 2-1/2 year Treasury securities exceeds 12 per cent. In particular, the Committee is interested in comments on the effect that this action is likely to have on the flow of funds to depository institutions, on the earnings position of institutions, and on the ratesof-return available to depositors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 0  -4  Deregulation of Deposit Rate Ceilings by Maturity Pursuant to its responsibility to phase out deposit rate ceilings, the Committee is considering a proposal to deregulate such ceilings by maturity of deposit. Under this proposal, the Committee would announce a schedule for authorizing new deposit categories with no ceilings stPrting with longer maturity deposits. As an alternative, a schedule of new deposit categories with ceilings indexed to market rates could be established. If indexed ceilings were adopted they could be established with or without a differential between commercial banks and thrift institutions. In implementing any deregulation plan, the Committee is required to take into account whether economic conditions warrant such action. In this regard, any action under a plan could be accelerated or delayed depending upon the ability of financial institutions to pay market rates as suggested by the schedule. The Committee proposes to implement this action according to the following schedule: Maturity of deposits for which rate ceilings would be eliminted Date July 1, 1981 July 1, 1982 July 1, 1983 July 1, 1984 July 1, 1985 April 1, 1986  5 years or more 4 to 5 years 2 to 4 years 1 to 2 years 6 months to 1 year no ceilings (as required by statute)  The table below presents the existing time deposit interest rate ceilings to facilitate comparisons of the proposed program to the current ceiling rate structure. If a phased indexing of ceilings were used, the ceilings at thrifts and commercial banks could be tied to the yields on U. S. Treasury securities of comparable maturities. Under this approach, ceilings on longer-maturity deposits could be below the current SSC ceiling (even with the caps) if the U. S. Treasury yield curve were downward sloping. To avoid setting ceilings that would be lower than those possible under current regulations, public comment also is requested on tying the ceilings on longer-term deposits to the rates on comparable maturity Treasury securities or the SSC ceilings, which ever was greater. In any event, were the cap to be maintained on the SSC it would not have to apply to the "deregulated" instruments. The Committee believes that the development of its intentions regarding the deregulation of interest rate ceilings is desirable in order to facilitate planning by depository institutions. The approach   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  , 4010  5 CURRENT MAXIMUM INTEREST RATES PAYABLE ON TIME DEPOSITS (per cent) Type and maturity of deposit  Commercial banks  S&Ls and MSBs  Fixed Ceiling Time Deposits 14-89 days 90 days-1 year 1-2 1/2 years2/ 2 1/2-4 yrrs-/ 4-6 yearsil/ 6-8 years-/ 2/ 8 years or more-  5-1/4 5-3/4 6 6-1/2 7-1/4 7-1/2 7-3/4  Issued to government units (all maturities)  8  8  IRA/Keogh (3 years or more)  8  8  1/ 6 6-1/2 6-3/4 7-1/2 7-/4 8  Variable-Ceiling Time Deposits 26-week MMCs 2-1/2 year or more SSC  1/  No separate account category.  Such ceilings presently are superseded by the minimum interest rate ceilings on the SSC of 9.50 per cent for thrift institutions and 9.25 per cent for commercial banks (see fn. 4).  2/  2/  Effective for all 26-week MMCs issued beginning June 5, 1981, the interest rate ceilings will be determined by the discount rate (auction average) of the most recently issued six-month Treasury bills as follows: Bill rate 8.75 and above 8.50 to 8.75 7.50 to 8.50 7.25 to 7.50 Below 7.25  Commercial bank bill rate + 1/4 bill rate + 1/4 bill rate + 1/4 7.75 7.75  ceiling per cent per cent per cent  Thrift ceiling bill rate + 1/4 per cent 9.00 bill rate + 1/2 per cent bill rate + 1/2 per cent 7.75  1/ Effective for all SSCs with maturities of 2-1/2 years or more issued beginning June 2, 1980, the ceiling rates of interest will be determined by the 2-1/2-year Treasury yield as follows: Treasury yield 12.00 and above 9.50 to 12.00 Below 9.50   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Commercial bank ceiling 11.75 Treasury yield less 114 per cent 9..ca  Thrift ceiling 12.00 Treasury yield 9.50  6  set forth above addresses the issue of providing a market rate-of-return to savers and also allows depository institutions, particularly thrift institutions, time to adjust to an environment of deregulated deposit rate ceilings. Although the asset powers of thrifts have been expanded, it will be a number of years before their asset portfolios are affected materially. In the initial stages of the phase-out savers would be encouraged to place funds in longer-term accounts, which could help correct the imbalance of asset and liability maturities at thrift institutions. In addition, to the extent that longer-term deposits are acquired, institutions may be more willing to channel the funds into the housing market. The Committee is interested in receiving comments on all aspects of this proposal, including other approaches to deregulation. However, it is particularly interested in receiving comment on the following issues: 1. The desirability of eliminating ceilings versus establishing indexed ceiling rates. 2. The appropriateness of the phase-out schedule in view of the structure of assets and liabilities at depository institutions. 3. The impact of the proposal on the flow of funds to depository institutions. 4. The implications of the proposal for providing depositors an attractive rate of return on their deposits. 5. The impact of the proposal on the earnings of depository institutions. 6. The interrelationship of this proposal with the concept of removal of the cap on the SSC. 7. Other problems or benefits that would be derived from the establishment of a schedule for phasing out interest rate ceilings. 8.  Other suggestions related to implementing a plan of deregulation.  In view of the potential benefits that could be derived from these proposed actions on the part of both depository institutions and their customers, the Committee has determined that it is appropriate to provide a thirty-day comment period on this matter. Accordingly, comments on these proposals should be submitted by May 1, 1981.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -7  By order of the Committee, March 31, 1981.  (Signed)  Normand R. V. Bernard  Normand R. V. Bernard Executive Secretary of the Committee  [SEAL]  S   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •••••••••  TITLE 12--BANKS AND BANKING CHAPTER XII--DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE [Docket No. D-0016] PART 1204--INTEREST ON DEPOSITS Effective Date of Ceiling Rates on MMCs and SSCs  AGENCY:  Depository Institutions Deregulation Committee.  ACTION:  Final rules.  SUMMARY: The Depository Institutions Deregulation Committee ("Committee") has amended its rules to reduce the period between the announcement and the effective date of the ceiling rates of interest payable on the 26-week money market certificate (MMC) and on the 2-1/2 year or more small saver certificate (SSC). Under the revised rules, the ceiling rates of interest payable on MMCs and SSCs will become effective on the day after they are announced. Ceiling rates for such deposits normally are announced on Monday and, thus, normally will be effective on Tuesday rather than on Thursday as under the present rules. This action was taken by the Committee in order to more closely link the ceiling rates of interest payable on MMCs and SSCs with current market rates. EFFECTIVE DATE:  April 7, 1981.  FOR FURTHER INFORMATION CONTACT: F. Douglas Birdzell, Counsel, Federal Deposit Insurance Corporation (202/389-4261), Paul S. Pilecki, Senior Attorney, Board of Governors of the Federal Reserve System (202/4523281), Allan Schott, Attorney-Advisor, Treasury Department (202/5666798), Rebecca Laird, Senior Associate General Counsel, Federal Home Loan Bank Board (202/377-6446), or David Ansell, Attorney, Office of the Comptroller of the Currency (202/447-1880). SUPPLEMENTARY INFORMATION: The ceiling rate of interest payable on MMCs is tied to the discount rate (auction average) on the most recently issued 26-week United States Treasury bills. Such bills normally are auctioned on Monday and, under current rules, the ceiling rate of interest based on the discount rate (auction average) i3 effective on the following Thursday, the day on which the Treasury oills normally are issued. This ceiling rate is effective until the next issuance of 26-week United States Treasury bills. The ceiling rate of interest payable on SSCs is tied to the average 2-1/2 year yield for United States Treasury securities as determined bi-weekly by the United States Treasury.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Such average yield normally is announced by Treasury on Monday (based on the average 2-1/2 year yield for the five business days ending on the day of announcement) and, under current rules, the ceiling rates based on their average 2-1/2 year yield are effective for a two-week period beginning on the following Thursday. On December 19, 1980, the Committee issued for public comment proposed rules under which the ceiling rates announced on Monday would be effective for new MMCs or SSCs issued beginning on the following Tuesday or Wednesday rather than on the following Thursday (45 Fed. Reg. 85059 (1980)). Over 400 comments from the public, including depository institutions, individuals, trade associations, and federal instrumentalities, were received by the Committee on the proposal. Comments of a majority of depository institutions and trade associations favored changing the Thursday date to either Tuesday or Wednesday, while other commentators favored retention of the Thursday effective date. Those favoring a change in the effective date cited the potential for decreasing earnings pressures on and smoothing deposit flows of financial institutions as the primary benefits of such a change. Comments in favor of retention of the Thursday date generally viewed the proposal as having potential operational problems and as disadvantageous to depositors. After consideration of all of the comments on the proposal, the Committee has determined to change the effective date of the ceiling rate of interest on MMCs and SSCs from Thursday to the day after the new ceiling rates are announced. In this regard, the new ceiling rates on MMCs and SSCs normally are announced on Monday and, therefore, such rates will be effective on Tuesday. When a holiday occurs on Monday, the new ceiling rates are announced on Friday. In those instances, the new ceiling rates will become effective on Saturday. In all cases, the ceiling rates will remain in effect from the day after the announcement of the ceiling rate until the end of the day that a new ceiling rate is announced for the particular category of deposit. As in the past, the ceiling rate applicable to outstanding deposits will not change during the life of the deposit. This action is effective for the new ceiling rate for MMCs to be announced on April 6, 1981, and for the ceiling rate to be announced for SSCs on April 13, 1981. The Committee believes that this action will benefit depository institutions by more closely linking the ceiling rates payable on MMCs and SSCs with current market rates, thereby smoothing deposit flows among depository institutions. In view of the comments received on the proposal, the Committee believes that the change should not present operational difficulties for institutions. However, the Committee noted that if the change presents unanticipated operational difficulties for depository institutions, it might reconsider the amendment at a future date. In order to provide depositors with a return on their funds invested in MMCs and SSCs that is more closely aligned to current market rates as soon as possible, the Committee finds that good cause exists for making this action effective in less than 30 days.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  3  Pursuant to its authority under Title II of Public Law 96221, 94 Stat. 142 (12 U.S.C. § 3501 et seq.), to prescribe rules governing the payment of interest and dividends on deposits of federally insured commercial banks, savings and loan associations, and mutual savings banks, effective April 7, 1981, the Committee amends Part 1204--Interest on Deposits (12 CFR Part 1204) as follows: 1.  Section 104 is revised to read as follows:  § 1204.104 -- 26-Week Money Market Time Deposits of Less than $100,000. Commercial banks, mutual savings banks, and savings and loan associations may pay interest on any nonnegotiable time deposit of $10,000 or more, with a maturity of 26 weeks at a rate not to exceed the rates set forth below. Rounding any rate to the next higher rate is not permitted and interest may not be compounded during the term of this deposit. Rate established and announced (auction average on a discount basis) for U.S. Treasury bills with maturities of 26 weeks at the auction held immediately prior to the date of deposit ("Bill Rate")  Maximum per cent  Commercial Banks 7.75  7.50 per cent or below  Bill Rate plus onequarter of one per cent  Above 7.50 per cent  Mutual Savings Banks and Savings and Loan Associations 7.25 per cent or below Above 7.25 per cent, but below 8.50 per cent 8.50 per cent, but below 8.75 per cent ,  8.75 per cent or above   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7.75 Bill Rate plus onehalf of one per cent 9  Bill Rate plus onequarter of one per cent  4  2.  Section 106 is revised to read as follows:  § 1204.106 -- Time Deposits of Less Than $100,000 With Maturities of 2-1/2 Years or More. (a) A commercial bank may pay interest on any nonnegotiable deposit with a maturity of 2-1/2 years or more at a rate not to time exceed the higher of one-quarter of one per cent below the average 21/2 year yield for United States Treasury securities as determined and announced by the United States Department of the Treasury immediately prior to the date of deposit, or 9.25 per cent. Such announcement is made by the United States Department of the Treasury every two weeks. The average 2-1/2 year yield will be rounded by the United States Department of the Treasury to the nearest 5 basis points. The rate paid on any such deposit cannot exceed the ceiling rate in effect on the date of deposit. In no event shall the rate of interest paid exceed 11.75 per cent, except as provided in 12 CFR 217.7(g) and in 12 CFR 329.6(b)(6). (b) A mutual savings bank or savings and loan association may pay interest on any nonnegotiable time deposit with a maturity of 2-1/2 years or more at a rate not to exceed the higher of the average 2-1/2 year yield for United States Treasury securities as determined and announced by the United States Department of the Treasury immediately prior to the date of deposit, or 9.50 per cent. Such announcement is made by the United States Department of the Treasury every two weeks. The average 2-1/2 year yield will be rounded by the United States Department of the Treasury to the nearest 5 basis points. The rate paid on any such deposit cannot exceed the ceiling rate in effect on the date of deposit. In no event shall the rate of interest paid exceed 12.00 per cent. By order of the Committee, March 31, 1981.  (Signed)  Normand R. V. Bernard  Normand R. V. Bernard Executive Secretary of the Board [SEAL]   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  BOARD OF GOVERNORS OF THE  FEDERAL RESERVE SYSTEM  Office Correspondence To  Chairman Volcker  From  Messrs. Furlong and Regalia  March 26, 1981  Date  Subject: Reinstating the Differential on the MMC  If the differential on the MMC were reinstated at all levels of the 6-month Treasury bill rate, deposit flows at thrifts likely would pick up, and there could be some improvement in their earnings.  The figures  below show the projected deposit flows and earnings impacts on thrifts from restoring the differential on the MMC during the remainder of 1981. These calculations are based on an assumption that thrifts can earn a 2 percent margin on new deposits. If there were no rollover privilege for banks, line 5 could be about doubled.  Thrift Deposit Flow and Earnings Impact of Reinstating the Differential on the MMC S&Ls  MSBs  CBs  Total  (1)  1981 QI MMC balances ($ Bils.)11  196.3  52.0  195.7  444.0  (2)  1981 Q4 MMC balances (no change in differential)  251.0  66.0  247.0  564.0  1981 Q4 MMC balance (differential, but rollover Frivileges for banks) 250.0  72.0  232.0  564.0  9.0  6.0  -15.0  0  6  17  n.a.  (3)  (4) Additional MMCs in 1981 ($ billions) (1)-(2) (5) 4  Marginal impact on before tax return on assets (basis points)  n.a. - Not available. 1/ Estimated.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  n.a.  BOARD OF GOVERNORS OF THE  FEDERAL RESERVE SYSTEM  Office Correspondence To From  Chairman Volcker  Date  March 26, 1981  Subject: Removing the SSC cap  Mr. Furlong  If the caps were removed from the 2-1/2 SSCs, there could be some shifting from existing SSCs.  Without the caps, the current SSC ceiling at  thrifts and commercial banks would be 13.55 percent and 13.30 percent, respectively.  At these rates it would be profitable for depositors to  incur early withdrawal penalties and to reinvest the SSCs deposited in June, July and August of last year when the thrift ceiling was 9.5 percent and the bank ceiling was 9.25 percent.  The volume of such deposits is  estimated to be $13.7 billion at S&Ls, $3.7 billion at MSBs and $9.6 billion at commercial banks.  The estimates for the cost impact on thrifts of 100  percent shifting of SSCs is shown below.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  S&Ls Deposit Shifted 1981 Early withdrawal penalties earned Additional interest expense 1/ Net gain  MBBs  ($ millions) 13,700 3,500  650.8 411.0 239.8  175.8 105.0 70.8  (Basis points) Marginal impact on before tax return on assets 1982 Additional interest expense Marginal impact on before tax return on assets (basis points) 1/  Assumes a 360/360 day year.  3.5  618.5 -8.4  4.5  157 -8.8  -2-  These figures overstate the cost impact of lifting the caps since they assume 100 percent shifting and have not been adjusted for the margin that could be earned on new deposits attracted by the higher rates. If thrifts could earn a 2 percent margin on new deposits, S&Ls would have to attract about $30.9 billion of new deposits between March 1981 and December 1982, in order to offset the additional cost incurred in 1982. This would represent a monthly new deposit flow of $1.5 billion.  Mutual  savings banks would have to attract about $7.9 billion, or a monthly new deposit flow of $374  million between now and the end of 1982.  Staff is  of the view that such monthly flows are quite modest indeed, and easily obtainable.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  DEPOSItORY INSTITUTIONS DEREGULATION COMMITTEE PRESS RELEASE COMPTROLLER OF THE CURRENCY FEDERAL RESERVE BOARD  FEDERAL DEPOSIT INSURANCE CORPORATION NATIONAL CREDIT UNION ADMINISTRATION  For immediate release  FEDERAL HOME LOAN BANK BOARD TREASURY DEPARTMENT  March 26, 1981  Secretary of the Treasury Donald T. Regan was today elected Chairman of the Depository Institutions Deregulation Committee at a regular meeting of the Committee in Washington, D. C. The Committee was created a year ago by Congress to phase out interest rate ceilings on deposits in commercial banks, mutual savings banks, savings and loans associations and credit unions. Secretary Regan took over the Committee chairmanship from Federal Reserve Board Chairman Paul A. Volcker. Secretary Regan said after the meeting: "I welcome the opportunity to lead the Committee. Deregulation will enable depository institutions to compete more effectively for funds to lend to individuals and businesses which, in turn, will use them to build new plants, equipment and housing. Most of the funds to finance new homes are provided today by depository institutions." He went on to say: "The Committee can make a significant contribution to financial market stability by better indicating what the future pace and nature of deregulation will be, thereby reducing individual and institutional uncertainties." Mr. Regan commented that the Committee's responsibility to phase out Federal deposit interest rate ceilings should benefit small savers and other depositors who will have the opportunity to earn a market rate of interest on their deposits in institutions insured and regulated by the Federal government. Other members of the Committee are the Chairmen of the Federal Home Loan Bank Board, the Federal Deposit Insurance Corporation, the National Credit Union Administration and the Comptroller of the Currency.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -0-  I1r  For release on delivery 9:30 A.M., E.S.T.  .,  Statement by  Paul A. Volcker e System Chairman, Board of Governors of the Federal Reserv before the  Committee on the Budget  House of Representatives  March  r   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  27, 1981  i  e  I am pleased to be here today to discuss our shared concerns about the interrelationships of budgetary and monetary policy.  I have the distinct impression that  there is a broad consensus about the appropriate goals for economic policy, including the priority need for a marked 4 .  reduction in inflation as a prerequisite for sustained growth in employment, productivity, and real income.  The  difficult task we have before us is to translate that general consensus into effective action.  The Administration has  provided a firm lead in its program for economic recovery. I hope that our dialogue today will further contribute to this process by enhancing  mutual understanding of our needs  and policies. In principle, it is broadly accepted that the objective of monetary policy must be to restrain growth in money and credit as part of the process of turning back inflationary forces.  Indeed, the effort to control inflation has, until  now, often seemed to rely almost exclusively on monetary poTicy.  The consequence has been higher interest rates and  greater strains on our financial fabric,and on industries particularly dependent on credit markets ,than would otherwise be necessary. P  There is also understanding that no escape from those s. financial pressures can be found in expansive monetary policie In the end, such an approach would only aggravate the very   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  111  -24  inflationary forces that underly so much of the difficulties in the economy and in financial markets.  What is necessary  is that other policies -- including most specifically the fiscal decisions that are the province of this Committee -be in harmony with the need to deal forcefully with inflation. In particular, I cannot stress too strongly the need to change the strong upward trend in Federal spending that has characterized recent years. As you are painfully aware, inflation is not yet receding.  We did avoid a further ratcheting up in the  general rate of inflation last year, despite another quantum jump in oil prices and strong wage pressures.  But that  "holding action" has been accompanied by little growth, on balance, in economic activity since 1979, and unemployment is high in important sectors of the economy. Moreover, inflationary expectations are now deeply embedded in public attitudes, as reflected in the practices and policies of individuals and economic institutions.  After  years of false starts in the effort against inflation, there is widespread skepticism about the prospects for success. Overcoming this legacy of doubt is a critical challenge that must be met in shaping -- and in carrying out -- all our policies. Changing both expectations and actual price performance will be difficult.  But it is essential if our economic future  is to be secure. Monetary policy inevitably has a crucial role in this effort.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  It must be -- and must be seen to be -- consistently  r  a  -3, directed towards curbing excessive growth in money and credit.  Such restraint is inherent in the Federal  and credit Reserve's commitment to reduce the growth of money over time until inflationary pressures subside. growth Our specific objectives for monetary and credit ng in 1981 were presented to the House and Senate Banki Committees last month.  Without going into detail here,  growth these targets point toward further reductions in the increase of money and credit as compared with the rates of in other recent years.  In the context of strong inflationary  e, as pressures, the targets are intended to be restrictiv ng down they necessarily must be if there is to be a windi of the inflationary process. virtually The need for that basic discipline is common to know, recognized all schools of economic thought and is, as you in the Administration's program for economic recovery.  The  only issue for debate is how vigorously to proceed. growth I might also note that our efforts to keep money within acceptable bounds will at times be associated with in substantial variations in short-term interest rates response to shifting credit demands, changes in economic activity, or other factors. I  Increases or declines in short-  term rates -- such as have occurred recently -- are sometimes cited as an indication that Federal Reserve "policy" is changing. But those interpretations are misleading.  Those interest  rate fluctuations typically reflect shifts in credit   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4-  demands and expectations about inflation and economic activity, which can be volatile, and should not call into question our intent to maintain firm control on monetary growth over time.  At times, with inflation strong and  the economy expanding, restraint of money and credit expansion may well be associated with high interest rates. But those high interest rates are fundamentally a reflection of the strength of inflation and excessive credit demands; they are not in themselves a policy objective.  Indeed, over  time restraint on money creation should lead to lower, not higher interest rates, as inflation subsides. It is clear that the process of reducing inflation through monetary restraint can be painful.  It implies less money and  credit than is needed to support both the current rate of inflation and sustained growth of real activity.  Obviously,  the faster that inflation subsides, the greater will be the scope for real gains in economic activity.  Monetary policy  is, of course, designed to encourage and speed this disinflationary process.  But if strong cost pressures from wage settlements,  energy prices, or other factors persist or accelerate, strains in financial markets will be greater than otherwise, and real activity is likely to remain constrained.  All of that points  4 up the importance of other aspects of economic policy and, in particular, the stance of fiscal policy, the principal concern of this Committee. The Congress and the Administration are now in the process of making a fundamental reappraisal of the conduct of economic policy.  The focus of this effort is the Administration's far-  reaching proposals for tax cuts, spending reductions, and   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -5-  regulatory reforms.  The design and success of the program  that emerges is critical to the effort to reduce inflation and increase productivity.  I personally am encouraged by  the initial Congressional reactions to the new direction proposed by the Administration.  There appears to be broad  recognition of the nature and urgency of our problems and a willingness to bring to bear a new discipline on spending. This Committee and others will be debating, as you must, the Administration's proposals.  In my view, it would be  inappropriate for me or the Federal Reserve to inject ourselves into consideration of the precise form of the budget and tax Rather, I will confine myself to some general comments  cuts.  about the overall thrust of the budget, and how it interrelates with the problems and purposes of monetary policy. In that connection, I want to emphasize that my judgments dependent about appropriate budgetary decisions are not heavily upon a particular forecast about economic activity over the next year or two.  Of course, the actual budget results for  any fiscal year are in fact sensitive to what is happening with respect to prices, unemployment, real income, and interest rates.  But our ability to forecast these variables with precision  is demonstrably limited.  The range of uncertainty is probably  increased at a time of major new policy initiatives and possible "external" shocks because past relationships may be a less reliable guide to the future.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -6-  I know you unavoidably will need, in the end, to make precise numerical assumptions in presenting the budget.  But  rather than suggesting precisely which assumptions are most plausible for fiscal 1982, I believe it more important to emphasize certain basic and longer-run considerations that seem to me valid whether or not growth or inflation turns out moderately better or worse next year than a particular forecast might suggest.  I emphasize the point because the  problems with which we are dealing are fundamental; they have arisen over a long period of years; and the solutions must be geared to the fundamentals rather than to cyclical concerns, that to a considerable degree are unpredictable in any event. Put another way, I believe we have a clear idea of where the major economic and financial risks lie, and now the task is to minimize them. Among the fundamental considerations is the desirability, from the standpoint of economic performance over time, of tax reduction.  I have little doubt that the growing level of  taxes -- relative to GNP approaching the highest level in our history, even during war -- is a factor both in slowing growth, adding to inflationary cost pressures, and distorting savings and investment decisions. There is no dispute among economists that the particular structure of taxes can have important effects on incentives to work, to save, to invest, and to bear risk.  Consequently,  to the extent taxes can prudently be reduced, it is important   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -7-  that the reductions be designed in a manner to maximize the beneficial effects on incentives.  That is why, as I  understand it, the Administration has urged that tax proposals involving other considerations be deferred. What limits our ability to reduce taxes is, of course, the potential budgetary deficits -- deficits that are already likely to be large in the period immediately ahead.  Given  restrained growth in money and credit, the sale of Treasury securities to finance a deficit curtails the availability of funds to private borrowers, potentially reducing needed productive investment.  As the deficits are larger, the threat  of extraordinary pressures and strains on interest rates and financial markets increases, and the more difficult it is to control the money supply and inflation.  The risks are increased  to the extent deficits are incurred when the economy is expanding. That is why I emphasized at the start the critical importance of cutting back as sharply as possible the inexorable rise in Federal spending.  In my judgment, that  must be the keystone in the arch of any new approach to economic policy -- a policy that can offer a real prospect of success in dealing with inflation and in laying the groundwork for lower interest rates and more vigorous growth. In approaching that job, we should bear in mind the seemingly chronic tendency for actual Federal spending to exceed official estimates for future fiscal years.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Recent  -8-  experience in that regard has been particularly disturbing. We have usually been overly optimistic in our assumptions about economic circumstances, overestimating growth in the economy or underestimating inflation.  To be sure, there will  always be errors in estimates, and in some circumstances -an unexpected recession, for example -- a temporary automatic response of expenditures to deteriorating economic conditions may be appropriate.  But not all the unanticipated expenditure  increases reflect new economic circumstances; the tendency has been to add or enlarge programs and to underestimate their expenditure requirements.  If history is any guide, spending  tends to exceed intentions as we move from initial budgetary planning to actual results, and I would suggest you appraise the risks in that light. I would also be cautious, in assessing budgetary prospects, of the view that increased business and personal savings should be looked to as a means of financing a deficit. Savings are exceptionally low today.  I share the hope and  expectation that new economic policies and declining inflation will restore a more adequate level of savings.  But those  savings, as and when they materialize, are urgently needed to finance productive investment and housing -- they should not be dissipated in financing prolonged huge budgetary deficits. For all those reasons, considerations of general economic policy suggest all the risks lie on the side of   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  i‘  -9-  cutting expenditures too little.  I am acutely aware of  the difficulties and constraints that you face -- the need to increase defense spending, to protect the truly needy, to pay interest on the national debt, and to maintain strength and continuity in other essential programs.  In  the broadest sense, those security, social, and other requirements ultimately limit what can be done to reduce spending. But looked at from the standpoint of the need to reduce inflation and encourage economic growth, you cannot, in my judgment, cut too much.  Every added dollar of spending cuts  will provide more assurance that needed tax reduction can be accomplished within a prudent budgetary framework.  Every  step toward a reduced budgetary deficit can only help head off tension in financial markets and make room for private investment. You know how difficult it has been in practice to achieve a reasonable balance between Federal outlays and receipts.  The record is clear; there has been only one  surplus in the Federal budget in the past 20 years. will not reach that objective in fiscal 1982.  We  But we  must not continue to rationalize decisions that can only have the effect of sustaining huge deficits indefinitely. In setting the 1982 budget, we can meet two crucial criteria that seem to me implicit in the Administration's thinking.  First, we can cut back the upward trend in  spending and significantly reduce the ratio of spending to   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  the GNP.  Second, we can put the budget on a path that  realistically will produce balance and move into surplus as the economy returns to levels of unemployment and capacity utilization characteristic of most recent years. You are well aware there are no easy choices before you.  But the wrong choice, it seems to me, would be to  let this opportunity pass to change the direction of Federal spending.  Then, the risk of prolonging inflation  and unsatisfactory economic performance and of great strains in financial markets would be aggravated.  Surely, there  is room for cutting if there is the will, and the Administration's proposals for specific cuts over a broad array of programs point the way. The Federal Reserve has an indispensable role to play in dealing with inflation.  To be effective, we must demon-  strate that our own commitment is strong, visible, and sustained.  That is our intention.  But the effectiveness  of our effort depends on complementary fiscal, regulatory, and other government policies.  I feel sure that we are in  fundamental agreement about those concepts.  What remains  is to confront unflinchingly the hard decisons that this effort will require.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE COMPTROI I FR OF THE CURRENCY FEDERAL RESERVE BOARD  FEDERAL DEPOSIT INSURANCE CORPORATION  FEDERAL HOME LOAN BANK BOARD  NATIONAL CREDIT UNION ADMINISTRATION  U S TREASURY DEPARTMENT  March 26, 1981  The Honorable Alan Cranston United States Senate Washington, D. C. 20510 Dear Alan: Thank you for your letter of March 25 concerning the impact of high interest rates on the earnings of thrift institutions and urging the Depository Institutions Deregulation Committee to take steps to improve the competitive position of those institutions.  This matter is  very much on my mind, and I want to assure you that my colleagues and I will give your specific suggestions very careful consideration at this afternoon's meeting of the Committee.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Sincerely,  Paul A. Volcker Chairman  JAMS CLA.PIN, IfTAN, CHAlwm AN 4 T0w171, TCX. I4tPWl. PA. '. A PR 1.15-rw0N0. COC.O. RIDJAAND G. LUGAR. IND. ALFONSE U. C AmATO. w.I. J0.141i. C.c.* F M.AwRISON S.C.mm ITT, N. b.417C.  HA wwiSON A. WILLIAMS. JR-, N.J. NILLiAm pwox MIRE. WIL ALAN CR ANSToN. C.AL.Jr. DONA;_.., W. RIEGLE. MICH. P•Ill L. LARLLANCS. WD. w irroPHE J 0000. CONN. Al-AN J. DIXON. ILL.  U. DAN., WALL STA", DIPECTOR WrAfAILD A. MI NELL. MINORITY TAPP DIRECTOR WPC, ODuNSILL  ?Artifeb Zfaics COMMITTEE ON BANKING. HOUSING. AND URBAN AFFAIRS WASHINGTON. D.C. 20510  March 25, 1981  Honorable Paul Volcker Chairman Federal Reserve Board Constitution Avenue Between 20th and 21st Streets Washington, D.C. 20551 Dear Paul, The 1980 earnings figures for the thrift industry underscores my growing concern about the current state of the industry. Given the expectation of a continued high interest rate environment, it is certain that the 1981 earnings picture for the thrift industry will be less than satisfactory. I believe that it is important for the Depository Institutions Deregulation Committee (DIDC) to turn their immediate attention to this problem. Through the enactment of the Depository Institutions Deregulation and Monetary Control Act of 1980, the Congress has set in place the framework for all financlal institutions to move to a system of open and equal competition among themselves and with non-regulated financial intermediaries such as money market funds. If you will remember the Senate debate on the Monetary Control Act, I proposed a floor amendment to address the problem of the low yielding mortgages held by the thrifts, as it was and is still my belief that until this problem is addressed, deregulation will be a long, painful process and so it has come to be. However, the Congress did not see my point of view and a White House study of the issues was substituted in place of my proposal. At the next meeting of the DIDC on March 26, I am requesting that DIDC take the necessary steps to improve the competitive position of savings and loan associations and the mutual savings banks. Some specific thoughts, not exclusive, however, that come to mind are the restoration of the interest rate differential on the 6 month money market certificate,elimination of the cap on certificates maturing in 21 / 2 years or more and elimination of minimum ceiling applicable to both 6 months and 21 / 2 year CD's. I believe that a return of the differential, in addition to the other suggestions, would greatly assist the thrifts in attracting and retaining the enormous amount of   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Honorable Paul Volcker  -2-  March 25, 1981  funds that will be maturing in the form of 6 months money market instruments in April and May of this year. When the rate differential was removed last year permitting banks to roll over MMCS between May 29 and November 30, at the thrift rate, the rationale was to assist small banks with their earning problems, surely the situation now is reversed and urgent action is needed on behalf of the thrift industry. In recommending this action, I am by no means sugaesting a reversal of the deregulation mandate given DIDC by the 1980 legislation. I am simply seeking a short term remedy to what we all hope will be a temporary departure from a pattern of steady growth and continued viability for our nation's savings institutions. Your immediate consideration of the full scope of this problem in your meeting on Thursday would be most appreciated.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Sincer 1  Alan Cranston  AGENDA DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE March 26, 1980 3:00 p.m.  LOCATION:  Board Room Board of Governors of the Federal Reserve System 20th and Constitution Avenue, N.W. Washington, D. C. 20551  OPEN MEETING 1.  Effective date for new ceiling rates on money market certificates (MMCs) and small saver certificates (SSCs).  2.  Consideration of penalty-free early withdrawals of time deposit funds in the event of bankruptcy of the depositor.  3.  Reconsideration of rule permitting a phaseout of finders fees for qualifying institutions.  4.  Ceiling rates on regular savings accounts and on interest-bearing transaction accounts.  5.  Discussion of strategies for deregulation and consideration of petitions for ceiling rate adjustments.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Election of Chairman and Vice Chairman. 7.  Any agenda items carried forward from a previously announced meeting.  r  (w-k''  qd  411  CHARTS AND TABLES FOR DIDC DEPOSIT FLOW BRIEFING  March 26, 1981  Charts and tables prepared by Federal Reserve Board staff (ft. Regalia).   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •  CHART 1 SHORT-TERM INTEREST RATES AND TOTAL SMALL-TIME AND SAVINGS DEPOSIT GROWTH RATES AT THRIFT INSTITUTIONS AND COMMERCIAL BANKS (Seasonally adjusted annual rates, monthly average data) Percent ---w 20  Treasury bill rate, 3-month  15  10  Iii 1979  1980  5  1981 Percent 15  Thrift institution small-time and savings deposits!" (S&Ls, MSBs, and CUs)  10  QIAVG •  5  0  -5 1979  1981  1980  Percent 20  Ummercial bank small-time and savings deposits!"  15  10 QIAVG •  5  0  8  1979 1/ Growth rates for March are estimates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1980  •  I  1981  -5  gok  CHART 2 MONEY MARKET MUTUAL FUNDS (Weekly, not seasonally adjusted) Percent ---- 20  17  13 111  •  •  9  — Treasury bills, 3-month'  1  1  1  1  I  I 1980  1  1  1  1  1  1  1 1981  5  Billions of dollars ---- 3600  3000 Net change in MMMF assets 2400  --- 1800  1200  600  0  -600  111111 1980 1/ Net investment yield to shareholders. 2/ Discount basis.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1  1_  I  1 1 1981  -1200  1  CHART 3 TOTAL SMALL-TIME AND SAVINGS DEPOSIT GROWTH RATES AT THRIFT INSTITUTIONSY (Month average, seasonally adjusted annual rate) Percent ----' 15 Savings and Loans 10  5  0  -5 1979  1980  1981 Percent 20  vommemol  Mutual Savings Banks   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  10  1.11111MIND  -10  -20 1  1979  1980  1981 Percent ---- 45  Credit Unions  30  anmen.1  15  0  -15  1 1979  1980  1981  CHART 4 COMPOSITION OF DEPOSIT FLOWS AT THRIFT INSTITUTIONS  Percent 60  Small-time and savings  40 Small-time 20  •  111•011  I  1  / • / ""• / • • / .... I % • / • il  I  979  -40 I I 1981  1980  1/ Net change in MMCs and SSCs (NSA)  20  SSCs 1 •  / I en. S.  •  1  -60  Billions of dollars 30  MMCO\ I • / 1  /\ •  .1  -20  • •  •/  Savings %;  0  1 1 1 1  1  10  4  1 0  -10 1979  1980  1/  1981 Billions of dollars 4  Net change in fixed ceiling small time deposits-  0  -4  -1? -16  1/  1979 19q0 Combined savings and loan and mutual savings bank deposits.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1981  CHART 5 MANAGED LIABILITIES OF SAVINGS AND LOAN ASSOCIATIONS (End-of-month, seasonally adjusted) Billions of dollars  Net change in large CDs  awealP  1 1979  I  I  i  I 1980  I  1 1981  0 _O.5  Billions of dollars ---- 2.0  Net change in other borrowings ••••••••mmitiom  - 1.0  gnu  0  I 1980  1979  -2.0  Billions of dollars 4.0  Net change in FHLB advances   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1  1981  2.0  0  1 1979  1  1980  I  1981  -2.0  CHART 6 MORTGAGE INTEREST RATES AND MORTGAGE LOAN COMMITMENTS AT SAVINGS AND LOAN ASSOCIATIONS (Monthly) Percent ---w 18 Home mortgages primary conventional/  16 % 14  • • •  0  12  WIIMENIP  11•1 OP.  giro  ONO 111.  10 Corporate bond new issue Aaa utility A8?  1980  1979  8  Billions of dollars 12  New mortgage commitments (seasonally adjusted)  10  rimme  8  6  wimmmia  4  1  1  1  1  1  )  1  — Outstanding mortgage commitments (seasonally adjusted)'  J  2  1981  1980  1979  Billions of dollars —1— 35  30  25  20  1 1979 1/ Includes loans in process.  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1 1980  I 1981  15  CHART 7 MORTGAGE LENDING AND LIQUID ASSET RATIO FOR SAVINGS AND LOAN ASSOCIATIONS (End-of-month, seasonally adjusted) $ Billions - 6  5  Net Change in mortgage loans  4  3  2  1  0  1  1  1979  1  1  1980  1  -1  1  1981 Ratio 10  ‘11/11110  Liquid asset ratio  9  41=IMIMO  8  1  1 1979  1980  7  1981  1/ Cash and other liquid assets as a percent of sayings plus borrowings payable in 1 year or less at end of month. This ratio is for insured S&Ls only.  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  CHART 8 BORROWINGS AND INVESTMENTS OF MUTUAL SAVINGS BANKS (End-of-month, seasonally adjusted)  $ Millions - 800  411011111  Net change in mortgage loans MIMI=  600  4.111111•11  400  200  0  1979  1980  -200  I I 1981  $ Millions 800 Net change in borrowings 400 11•1111=1  0  SOME  NIONO  -400  -800 1979  1980  1981 Percent 10 immalimr  1/ Liquid asset ratio-9  INNEN.  8  7  6 1979 1/  1980  1981  This ratio is defined as cash and short-term assets as a percent of deposits plus borrowings. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  CHART 9 CREDIT UNION LOANS AND LIQUID ASSET RATIO (End-of-month) Percent —  20  Loan growth (SAAR)  IMIIIII  -30 MENIMIIII  —... -40  1  1  I  I  1  1979  1 1980  1981 Rat1035  1/ Liquid asset ratio for Federal Credit Unions(NSA) .11=11  I  IIIMOmn0  30  25  20  15  i 1/  1 1979  1  1 1980  1  i  1 1 1981  10  Total cash and investments minus total notes payable as a percent of total savings.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  TABLE 1 RATIO OF NET INCOME TO AVERAGE ASSETS  FSLICInsured S&Ls 1972 1973 1974 1975 1976 1977 1978 1/ 1979-H1— H2 1980-H1 H22/ 1/ 2/  .77 .75 .54 .47 .63 .77 .82 .69 .64 .17 .10  MSBs .60 .54 .35 .38 .45 .55 .58 c.46 -.04 -.16  Figures analyzed by doubling Preliminary.  Source:  FHLBB, NAMSB   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  TABLE 2 ROLLOVER OF MMCs ($ billions)  1980  M A M J  S&L  MSBs  Subtotal  CB  Total  35.6 43.0 22.3 28.6  7.4 12.0 7.6 9.6  43.0 55.0 29.9 38.2  30.0 47.5 33.5 20.3  73.0 102.5 63.4 58.5  March 25, 1981  To:  Chairman Volcker  Thru: From:  Don Winnil Bill Mal%ta  Subject: Testimony of Alice Rivlin before the House Budget Committee and presentation of the Congressional Budget Office's analysis of the Reagan FY 92 Budget Revisions  --There were very few questions during the hearing relating to monetary policy, although the subject did come up. Largely, Dr. Rivlin defended the CBO's budget projections--which differed sharply from the Administration's--against Republican loyalists who implied, and then later charged, that Rivlin was biased and sanctioned leaks of the CB0 numbers to embarrass the new Administration. Rivlin refuted the charges, pointing out that similar complaints were voiced by the Carter Administration when CB° critically analyzed the latter's energy program. She also responded to the charges that CBO's budget projections invariably had been wrong in recent years by noting that most economic predictions had been wrong and that CBO's errors all had been on underestimating inflation rather than the reverse. So that if indeed CB° again was in error, it was probably low in estimating the inflationary impact of the Reagan proposals and related unemployment and deficit figures, Specifically, she supported the direction of the President's budget but questioned the positive economic benefits predicted by the Administration, benefits which would ameliorate inflation if they were correct but would probably deepen the budget deficit and prolong inflation if they were too optimistic. Rivlin defended the CBO's analysis on the basis of historical data and patterns. No member of the Committee asked more than one question on monetary policy. Most asked none. The questions asked were mostly general and did not hint at ingrained anti-Federal Reserve Board attitudes. No member made explicit comments on monetary policy. No member displayed an understanding of the role monetary policy plays. In fact, several times monetary policy was discussed as if it were an Administration prerogative. Although neither monetary policy nor the Fed was prominently mentioned at today's hearing, there were some comments made by the Committee members and Dr. Rivlin with regard to these subjects. Dr. Rivlin --"A relatively tight monetary policy has helped restrain the growth of inflation" but also inhibits economic development. --"Current monetary policy can only foster growth if inflation subsides."   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2-  --"Monetary policy must stay constant if the Administration's optimistic predictions are to be realized." (She also said that other budget cuts, luck and other factors had to exist simultaneously.) --"Interest rates have been swinging up and down as the Fed tries to keep control of monetary aggregates." (She also suggested that she expects fewer gyrations in the coming months as the Fed refined its handling of monetary policy.) --In response to a passing comment by Chairman Jones that the Fed did not seem to do well at meeting its monetary targets, Dr. Rivlin agreed. She further stated that a large deficit could put the Fed "in a very difficult position" if it adheres to its targets. in a non-sequitur --Rep. Del Latta (R-Ohio)/mentioned the "Fed's bad antics" before calling on the Congress to cut the indexed (social) programs. --Rep. Jack Kemp (R-N.Y.) said that the Reagan Administration wants to reduce inflation "with a sounder monetary policy" and he challenged Dr. Rivlin's comments about needing luck on your side to do so. Kemp felt that statements by Treasury Secretary Regan about "reducing the level of monetized debt" were of more hope to the nation than wishing for luck. --Dr. Rivlin said, "Drastic slowing of the monetary growth would help fight inflation but dramatically slow economic growth." --Rep. Tom Downey (D-N.Y,), admitting that he did not quite understand the velocity of money, nevertheless asked if the Administration's desired 7-1/2 per cent increase in tne velocity of money won't force inflation up. Rivlin agreed. She further stated that the only way that GNP can increase--with a slow growth in money supply--is if you have rapid velocity. cc:  Mr. Syron   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  rip  e  UNITED STATES LEAGUE of SAVINGS ASSOCIATIONS WASHINGTON OFFICE 1709 NEW YORK AVENUE, N W / WASHINGTON. D C 200 ;‘, / TEL (202) 637-8900  March 20, 1981  Mr. Normand R. V. Bernard Executive Secretary Depository Institutions Deregulation Committee Federal Reserve Building 20th & Constitution Avenue N. W. Washington, D. C. 20551 Dear Mr. Bernard: Pursuant to the provisions of 5 U.S.C. 553(e) and Section 1201.6(c) of the Depository Institutions Deregulation Committee's (DIDC) regulation (12 C.F.R. 1201.6(c)), the U. S. League of Savings Associations* hereby submits its petition which seeks reinstatement of the housing differential of, at least, one-quarter percent on the six month money market savings certificate and all other types of savings accounts for the duration of an emergency period.  The savings associations represented by the U. S. League  are subject to the rules and regulations promulgated by the DIDC with respect to interest rate ceilings under the authority of Section 203 of the Depository Institutions Deregulation and Monetary Control Act of 1980 (P.L. 96-221, Sec. 203; 12 U.S.C. 3502). The U. S. League of Savings Associations has a membership of 4,400 savings and loan associations representing over 997 of the assets of the $625 billion savings and loan business. League membership includes all types of associations -- Federal and state-chartered, stock and mutual. The principal officers are: Rollin Barnard, President, Denver, Colo.; Roy Green, Vice President, Jacksonville, Fla.; Stuart Davis, Legislative Chairman, Beverly Hills, Cal.; William O'Connell, Executive Vice President, Chicago, Ill.; Arthur Edgeworth, Director-Washington Operations; Glen Troop, Legislative Director, Washington; and Phil Gasteyer, Assoc. Director-Washington Operations. League headquarters are at 111 E. Wacker Dr., Chicago, Illinois. 60601. The Washington Office is located at 1709 New York Ave., N. W., Washington, D. C. 20006, Telephone (202) 637-8900.  THE AMERICAN HOME: THE SAFEGUARD OF AMERICAN LIBERTIES   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand R. V. Bernard  2 -  March 20, 1981  Recent declines in interest rates have added to prospects for savings losses at our nation's thrift institutions in the period immediately ahead.  In March and April, $78 billion of MMCs are  maturing at savings and loan associations and mutual savings banks. The failure of institutions to retain and rollover these funds would constitute a major problem for our system of regulated depository institutions.  A great part of this problem results from the  existence in the marketplace of uncontrolled and unregulated money market mutual funds.  The financial regulators, the Administration,  and Members of Congress must find a workable solution to this problem.  Because legislation has been introduced only recently, it  seems likely that an ultimate program with respect to the money market mutual funds is some months distant. On the other hand, it is possible, without any delay, to address the second factor threatening savings flows at thrift institutions. We refer, of course, to the absence of a housing differential on the most important source of savings now available to savings and loan associations.  Money market certificates constitute 42 percent of all  savings and loan association retail savings (excluding jumbo certificates). Yet, because there is no housing differential on that type of account at today's rate levels, there is no reason to expect that savings and loan associations will enlarge their share of the MMC   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand R. V. Bernard  - 3 -  market and experience overall savings gains.  March 20, 1981 Indeed there is every  reason to suspect that present MMC balances are vulnerable at maturity to competing investment opportunities -- such as the money market funds with their "backward look" yield advertising and lagged returns. A healthy flow of retail savings is especially important to savings and loan associations and other thrift institutions. During the savings "dry spells" of recent months, these institutions have been compelled to use Federal Home Loan Bank advances, high-cost jumbo certificates of deposit, and expensive outside sources of borrowing to replace a normal flow of retail savings to meet their withdrawal and loan commitment obligations.  This more  expensive wholesale borrowing has also been necessary for commercial banks, of course.  But the commercial banks are structurally  equipped to meet these costs because of the short-term, marketsensitive nature of their earnings portfolios. said for longer-term lenders.  The same cannot be  As earnings reports for 1980 clearly  show, the commercial banking industry is thus better able to replace potential savings losses to money market funds. Beyond the impact of money market funds and the absence of a housing differential, there is another factor that could affect savings flows at savings and loan associations: the increased attention of the news media to the condition of thrift institutions. factor, of course, is outside of the DIDC's control.  But a possible  decline in public confidence in thrift institutions would seem a   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  That  Mr. Normand R. V. Bernard  - 4 -  March 20, 1981  compelling reason to give immediate thought to taking actions that are within the DIDC's authority, such as reinstating the differential on all accounts.  Restoration of the housing differential on all  accounts -- even on an interim basis -- would go a long way toward protecting against liquidity strains which might develop from public concern about the soundness of thrift institutions. On behalf of the 4,400 savings associations represented by the U. S. League, I would appreciate your giving thorough consideration to the issues raised in this letter at the Committee's meeting next week.  Sincerely, P alLVA WL William B. O'Connell Executive Vice President  ALE:tm   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Pre5oem BOLGER, President State Bank _Henry, Illinois 60050 14Pnry  FastvicePfeyoem W. C BENNETT, Chief Executive Officer Art)ur State Bank Unit ,South Carolina 29379  Second Vice LiBERT L. McCORMICK JR., President/CEO Stillwater National Bank and Trust Company  Treaswer ROBERT H. FEARON JR., President  Stillwater, Oklahoma 74074  Oneida Valley National Bank Oneida, New York 13421  OFFICE OF THE PREcIDEN1  iidependent  BANKERS ASSOCIATION OF AMERICA n  Ft m OTTIFFI,M., HENRY, ILLINOIS 60050  March 20, 1981  Mr. Normand R.V. Bernard Executive Secretary Depository Institutions Deregulation Committee Federal Reserve Building 20th & Constitution Avenue, N.W. Washington, D.C. 20551 Dear Mr. Bernard: The National Savings and Loan League (NSLL) and the American Bankers Association (ABA) have each submitted to the Depository Institutions Deregulation Committee a proposed plan for the deregulation of interest rates, and we understand that these proposals will be included on the agenda for the Committee's March 26 meeting. The two proposals approach the deregulation process from opposite directions: the NSLL plan would phase in market rates beginning with the eight-year certificate; the ABA's plan asks for a short-term market-rate instrument to compete directly with money market mutual funds. The Independent Bankers Association of America, which represents over 7400 community banks, cannot endorse either of the plans because each focuses on only one narrow aspect of the overall rate problem rather than seeking a broader solution which will serve the best interests of all depository institutions. We certainly do not wish to downplay the seriousness of the issues underlying the two proposals. Interest rate pressures on depository institutions have indeed reached a crisis level, and are two-fold: at a time when regulated depository institutions are already facing earnings difficulties as a result of record-high interest rates, money market mutual funds are concurrently raiding billions of deposit dollars each week. These twin pressures are interrelated, and neither can be isolated and remedied with some   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand Bernard March 20, 1981 Page 2  "magic bullet" without aggravating the other. For example, increasing the rates on long-term instruments may be the least painful course for depository institutions, but a long-term instrument is not an effective tool to counteract the competition from money market mutual funds. The plan proposed by the NSLL in fact offers everything a consumer is not looking for in 1981: long-term maturity, uncompetitive rates, and no liquidity. The NSLL plan is like giving depository institutions an Edsel while the MMMF's speed off in Ferraris. On the other hand, the high-interest shortterm instrument proposed by the ABA could be an insurmountable financial blow to the thrifts, whose current earnings problem is well-publicized. Much of the depository institutions' current earnings difficulty is the result of general economic conditions which, of course, cannot be resolved by any type of new deposit instrument. In contrast to this problem which evolved rather slowly, the money market mutual funds have suddenly appeared as a new competitor offering parallel services yet unbridled by the multitude of restrictions imposed upon the regulated institutions. MMMFs are not subject to reserve requirements, deposit insurance, interest rate regulation, community reinvestment requirements, routine supervisory examination, and the host of other regulatory requirements that depository institutions face. Add the fact that they can offer checking and higher interest rates, and it is no wonder that MMMFs are draining funds from regulated institutions at a phenomenal rate. It seems eminently appropriate for the agencies represented as members of the Deregulation Committee to combine priorities with the depository institution industry in order to address the unfettered competition of money market mutual funds as perhaps the most serious obstacle to the orderly deregulation of interest rates. In establishing the Deregulation Committee, the Congress wisely determined that the phase-out of interest ceilings should only be as rapid "as economic conditions warrant" so that the fiscal integrity of financial institutions with long-term low-yielding loan assets would not be undermined. The movement of deposit funds into MMMF's which are outside the scope of the Committee is subverting this Congressional intent to the detriment of the depository institutions.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand Bernard March 20, 1981 Page 3  Until depository institutions are permitted by law and regulation to better compete, equity demands that money market mutual funds play by some of the same rules of the game. We urge the Deregulation Committee to support legislation which would (1) impose a reserve requirement on MMMFs accessible by check; (2) set a ceiling on the MMMFs' yield at the prevailing rate available to regulated depositories; (3) require advertising disclosures of the lack of federal deposit insurance, that the advertised yield is based on an average, and that the rate is not guaranteed; and, (4) impose Community Reinvestment responsibilities. As a measure until legislation can be enacted, the IBAA has asked the Justice Department for a ruling that under the authority of the Glass-Steagall Act, money market mutual funds are "deposits" and as such, a fund accessible by check would be in criminal violation of the Act (letter enclosed). Although some groups may feel that the Committee's approach to deregulation has been "ad hoc", we believe that the Congress intended for interest ceilings to be phased out with flexibility according to economic conditions. We also believe that the Committee has the responsibility to monitor and influence outside factors which undermine its ability to oversee an orderly phase-out of rates. We hope that the Committee will not yield to deregulation proposals which do not equally serve the interests of all depository institutions, but will instead focus on the underlying competitive problem of money market mutual funds which is shared by all financial institutions.  Sincerely,  _,_ rdowW Thomas F. Bolger President TFB/nls Enclosure   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ;;;.ite ciank #' • M=1( Vctienry....e.neis rtY.:50  .'0-1nur qanx ScuM Circ'ina 2)379  rrsrJent, ;;;LO (.;:.11.viater '11;icral Ban< 57,J frust Clrroany Stoloidter. C.jhornj 1:074  iiERT  . Va ev tiM.onal One;aa. !:ew vcrPc ;1.121  OFFICE OF THE 'RESICE'IT  nctependent  BANKERS ASSOCIATION OF AMERICA 3510  ELM STP.EET,  !LLINOIS 501'.0  February 26, 1981  Honorable William French Smith Attorney General Department of Justice Room 5111 - Justice Building Constitution Ave. bet. 9th & 10th Sts.,N.W. Washington, D. C. 20530 Dear Mr. Attorney General: On January 9, 1980, Philip B. Heymann, Assistant Attorney General, Criminal Division, wrote an advisory letter to Martin Lybecker, Associate Director, Division of Marketing Management of the Securities and Exchange Commission, on the issue of whether money market mutual funds were in violation of 12 U.S.C. 378(a) when they offered, as a feature of a fund, the ability to access fund participants' assets by check. The then Assistant Attorney General concluded that no violation was involved. We would like to request a review of that opinion on the grounds that it looked too much to the form and not the substance of the law. In turn, the opinion is upsetting the complex scheme of Congressional regulation of depository institutions that has been in place since the early 1930s and altering financial flows to the clear detriment of these institutions. Basically, that Congressionally mandated regulatory structure is based on a general policy of separating the functions of depository institutions from other forms of commerce, while at the same time preventing brokerage firms, underwriters and mutual funds from engaging in depository banking. One of the key statutes employed to execute this policy is Section 21 of the Glass-Steagall Act, 48 Stat. 189, 12 U.S.C. 378(a). It is a criminal   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  .1rt  •  Honorable William French Smith February 26, 1981 Page 2  statute, and its enforcement is specifically lodged in the Department of Justice. The law is divided into two clauses. The first, 12 U.S.C. 378(a)(1) fundamentally provides that any person or firm engaged in the business of issuing, underwriting, selling or distributing securities may not also engage in the business of receiving deposits subject to check. The second, (a)(2), provides that no person or firm shall engage in the business of receiving deposits subject to check unless they are chartered to engage in such business by Federal or state law. The Department's opinion of January 9, 1980, maintained that money market mutual funds in which the participants could access their assets by check were not in violation of 12 U.S.C. 378(a)(1) because the funds were not "deposits". It made no finding as to a violation of (a)(2), but the conclusion follows from the then Assistant Attorney General's opinion that since the funds do not constitute "deposits", there could be no violation of (a)(2). It is our view that this opinion errs in that it overlooks the fact that money market mutual funds subject to check are considered deposits in the minds of the public. Further, Congress has imposed a scheme of interest rate regulation on deposit instruments (including the newly authorized NOW accounts) offered by commercial banks, mutual savings banks, and savings and loan associations which is constructed in such a manner that they cannot compete with the functionally equivalent instruments offered by money market mutual funds. This is increasingly upsetting the equilibrium of the operations of commercial banks, mutual savings banks, and savings and loan associations. If the flow of funds out of these depository institutions into money market mutual funds continues apace, the very safety and soundness of some of these depository institutions will be threatened with potentially grave implications, not only for these institutions and our nation's financial structure but also for the financing of important sectors of our economy.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Honorable William French Smith February 26, 1981 Page 3  It is our belief that Congress did not intend this to occur and that 12 U.S.C. 378(a) would, if interpreted according to its substance by the Department of Justice, prevent this increasingly serious competitive imbalance. Such an interpretation by the Department of Justice would stop money market mutual funds from acting as depository institutions offering checking accounts and halt the present breaching of Congressional policy that purposefully separates depository institutions from other forms of commerce, including investment banking. Should the Department undertake a review of its previous opinion, the Independent Bankers Association would appreciate the opportunity to participate in a manner deemed appropriate by the Department. If there are any questions on this matter, the Washington staff of the Association would be glad to be of assistance. Sincerely,  Thomas F. Bolger President TFB:ks   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ROBERT McCLORY 11TH DISTRICT. ILLINOIS  A.  A  DISTRICT OFFICES: KANE Cowry's.  R00.4 2459 RAYBURN I-40uSE CFYIEE BUILDING (202) 225-5221  Congre55of tije Unite) tate5  RANKING REPUBLICAN JUDICIARY COMMITTEE  PERMANENT SELECT COMMITTEE ON INTELLIGENCE  U.S. INTERPARLIAMENTARY  R)otie of 1tpre5entatibt5 Lila5bington,  VILLAGE HALL 1200 MEADOWDALE DRIVE DARPENTERSVILLE. ILLINOIS 60110 (312) 428-4998 LAKE COUNTY COUNTY BuILDING 18 N. COUNTY STREET WAUKEGAN, ILLINOIS 60085  20315  (312) 336-4554 McHENR Y COUNTY 56 N. WILLIAMS STREET  March 3, 1981  CRYSTAL LAKE. ILLINOIS  UNION DELEGATION  60014  (815) 459-3399  The Honorable William French Smith Attorney General Department of Justice Room 5111 - Justice Building Washington, D. C. 20530 Dear Mr. Attorney General: In line with other communications which you have receiv ed, I would request your careful review of an advisory letter from former Assistant Attorney General Philip Heymann to the Securities and Exchange Commis sion (SEC) relative to money market mutual funds. In his letter, Mr. Heymann appare ntly advised that access to these funds by check would not violate the federa l law (12 U.S.C. 378(a)). The concern which has been expressed to me by variou s bankers and representatives of bankers' associations confiiia that the practices approved by Mr. Heymann's letter would seem to impinge upon the traditional and closely supervised prerogatives of commercial bankers. While I have endeavored to warn the commercial bankin g industry for many years about the inroads being made by savings and loan associations , credit unions and other financial institutions, this latest practice of broker age houses could pose the most serious threat to our commercial bankers of any which they have experienced. I would urge your thoughtful review of the opinio n of former Assistant Attorney General Heymann. As a further basis for this request, I am enclos ing a photocopy of a letter from my constituent, Thomas F. Bolger of McHenry, Illinois, who is the current president of the Independent Bankers Association of America. Mt. Bolger's letter is most convincing that Mr. Heymann's advisory opinion should be vacated or its application deferred!. Sincerely yours, /' Robert McClory Member of Congress RMcC:lr Enclosure   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  JUi  ex/.  UNITED STATES LEAGUE of SAVINGS ASSOCIATI ONS WASHINGT  OFFICE  March 17, 1981  Mr. Paul Volcker Chairman Federal Reserve Board Constitution Avenue & 20th Streets N.W. Washington, D.C. 20551 Dear Chairman Volcker: On behalf of the United States Lea gue of Savings Associations,* I wish to comment on the var ious proposals which would (1) create new short-term savings cer tificates (American Bankers Association's proposal), (2) raise the ceilings on longer-term certificates (National Savings and Loan League's proposal) and (3) raise the 30-month CD ceilin g. The severe earnings sequeeze curren tly being experienced by the nation's savings associations is now well acknowledged. The Reagan Administration, the Secret ary of the Treasury, the Chairman of the Federal Reserve Boa rd and the two national  The U. S. League of Savings Associati ons has a membership of 4,400 savings and loan associati ons representing over 997 of the assets of the $625 billion saving s and loan business. League membership includes all types of ass ociations--Federal and statechartered, stock and mutual. The principal officers are: Rollin Barnard, President, Denver, CO: Roy Green, Vice President, Jacksonville, FL; Stuart davis, Legisl ative Chairman, Beverly Hills, CA; William O'Connell, Executive Vic e President, Chicago, IL; Arthur Edgeworth, Director-Washington Operations; Glen Troop, Legislative Director, Washington; and Phi Director-Washington Operations. League l Gasteyer, Associate Headquarters are at 111 East Wacker Drive, Chicago, IL 60601. The Washington Office is located at 1709 New York Avenue N.W., Washington, D.C. 20006, Telephone: (202) 637-8900.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  C''  V .  zy :11,11.6 -2-  rating services have all commented on the impact that too-rapid deregulation and record high interest rates have had on the thrift industry.  The simple fact is that the rapid pace of the  deregulation process now threatens the viability of a number of savings associations. Because of the current conditions in the thrift industry, we feel that further actions by the Depository Institutions Deregulation Committee to raise the cost of money to thrifts would be completely irresponsible.  Rather, the Committee should seek  to slow the liability-oriented deregulation process. Any move towards authorization of new types of savings accounts should have as its goal lowering, not raising the cost of savings to depository institutions.  The Committee must realize  that such authorizations are in effect regulatory speculations on the future course of interest rates. It would make little sense to extend maturities of savings and loan obligations at what we all hope is the peak in interest rates.  Further, the added costs of additional low denomination  short-term accounts would be extremely burdensome at this point in the interest rate cycle.  The earnings impact of any or all  of the above proposals would be quite severe.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Sincerely,  ,  .  /  ,(  /(  William B. O'Connell Executive Vice President  Deregulation of Deposit Rate Ceilings by Maturity  As alternatives to the proposals submitted by the National Savings and Loan League and Citibank for deregulating by deposit maturity , the Committee may wish to review the three schedules presented below.  These  options imply a somewhat faster pace of deregulation than under the National League's proposal, but slower than under Citibank's.  Maturity of deposits for which rate ceilings would be indexed or eliminated Option 1 Option 2 Option 3  Date July 1, 1981 July 1, 1982 July 1, 1983 July 1, 1984 July 1, 1985 April 1, 1986  8 years or more 6 to 8 years 4 to 6 years 2 to 4 years 1 to 2 years no ceilings  6 years or more 4 to 6 years 2 to 4 years 1 to 2 years 6 mos. to I year no ceilings  4 Years or more 3 to 4 years 2 to 3 years 1 to 2 years 6 mos. to 1 year no ceilings  If a phased indexing of ceilings were used, the ceilings at thrifts and commercial banks could be tied to the appropriate Treasury security yield.  It should be noted that under this approach ceilings on  longer-maturity deposits could be below the current 2-1/2 year SSC ceiling (even with the caps) if the yield curve were downward sloping.  To avoid  setting ceilings that would be lower than those possible under current regulations, a rule could be adopted that tied the ceilings on longer-term deposits to the rates on comparable maturity Treasury securities or the 2-1/2 SSC ceilings, which ever was greater.  In any event, any cap maintained on  the SSC would not apply to the "deregulated" instruments.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Chart 1 DEPOSIT RATE CEILINGS FOR NMCs AND SSCs AT THRIFTS (Weekly)  Percent  18 16 14 •• 11  SSC (without a cap)  —77C (with a cap)  12 10  ••••   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  111111111111LI  1980  111111111  19B1  Chart IA Percent TITT (  1.--  T  T  1--  I  I  I  T  1  ITTrI  l'i  I  1E3  I el.....,  Is ammo  amml  1,24C  14  •••••••1  ..•  #11......11•  1" ,  1 1 1  , ,------------ SSC (with a cap) i  mmy  12  , ;  mnimil  10  ••••• •••••••••••  a..  =NM  ••••11  Im.or  I  11111_1111  18o .  1   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  B  _1_  1  1  1  1  111111111  1 281  B   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Chart 1B Percent  18 16 14 12 10  8 8 1980 1   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Chart 1C Percent  15.20  T  - 14.40 SSC (without a cap)  - 13.80  Jiff  - 12.80 10.••••  - 12.00  SSC (with a cap)  - 11.20 - 10.40  -9.50 1  1  1  1  1  1  1  1980  1  i i i 1  I  1  1  1  1  1  1  1981  1  1  1  1  ,  8.80  Chart 2 NNE CEILING LESS SSC CEILING (Weekly) I  11  II  I  Percent  6.01  f  - 4.01  A 1 (‘is MMC-SSC  . 1  (with a cap)  -- 2.101 mm.  - 0.01 MMC-SSC (without a cap)  --  _ ,   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  11111_11_111L111111IIIIII  1980  19131  1.99   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Chart 3 SSC CEILING LESS 5-YEAR TREASURY SECURITY YIELD (Weekly)  Percent  6.01  - 4.01 •••••,  - 2.01 SSC (without a cap)5 year Treasury  0.01  , SSC (with a cap) 5 year Treasury  - 1.99 4•1•1•1  11111111111111111111  1980  1981  111   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  MMC CEILING LESS 5-YEAR TREASURY SECURITY YIELD (Weekly)  NATIONAL ASSOCIATION OF MUTUAL SAVINGS BANKS 200 PARK AVENUE  NEW YORK, N.Y. 10166 TELEPHONE 212-973-5432  NAMSB Cable Address Savings, New York  March 17, 1981  Mr. Normand R. V. Bernard Executive Secretary Depository Institutions Deregulation Committee Federal Reserve Building 20th Street and Constitution Avenue, N.W. Washington, D. C. 20551 Dear Mr. Bernard: The National Association of Mutual Savings Banks has given intensive consideration to possible new deposit instruments and other changes in deposit interest rate regulations. This effort has been conducte d through NAMSB's Special Committee on Short-Run Issues and its Subcommittee on Deposit Instruments. The conclusions reached by the Special Committee and its Subcommittee were approved today by NAMSB's Board of Directors and are summarized in this letter. in the years ahead, savings banks will need a broadened array of deposit instruments throughout the maturity spectrum to meet a variety of objectives -- to promote a better balance between assets and liabilities, to reward long-term savers and to compete with largely unregulated money market funds. Introduction of such an array of deposit instruments at the present time would be impractical in view of the deteriorating earnings position of thrift institutions and the volatile condition of financial markets. Consideration should continue to be given to new deposit instruments for introduction when more favorable conditions prevail. in the meantime, certain important changes can and should be adopted now: 1. Encourage longer-term deposits and help stabilize the deposit structure by eliminating the cap on CDs maturing in 2-1/2 years or more. In addition, eliminate minimum ceilings applicable to both 6-month and 2-1/2 year CDs. Currently, ceiling rates on market-linked CDs maturing in 2-1/2 years or more are subject to a 12 per cent cap and a 9.5 per cent minimum   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand R. V. Bernard  March 17, 1981  ceiling for thrift institutions (11.75 and 9.25 per cent for commerci al banks). At the same time, ceiling rates on 6-month money market certificates are subject to a 7.75 per cent minimum ceiling for all institutions. These provisions subvert the very purpose of market-linked accounts. In practice, they reduce the ability of savings banks to compete in high interest rate periods, while artificially placing a floor under deposit interest costs in low interest rate periods. Caps and minimum ceilings on market-linked accounts should, therefore, be eliminated. If these changes were adopted, rate ceilings on certificates with maturities of 2-1/2 years or more would be free to move with market interest rates. Thrift institutions would be able to pay a rate equal to the rate on Treasury securities maturing in 2-1/2 years, while commercial banks would have a ceiling 25 basis points lower. Thus, the thrift institution differential would continue to apply to 2-1/2 year and longer-term market-linked certificates. Removal of the 12 per cent cap would improve the attractiveness of intermediate- and longer-term certificates, thereby encouraging longer deposit maturities and a better mix between assets and liabilities. This change would also be consistent with the Committee's responsibility to provide for the orderly deregulation of deposit interest rate ceilings. Thus, the proposed change would provide depository institutions with increased latitude to experiment with rates and terms on intermediate- and long-term certificates. In our judgment, removal of the 12 per cent cap would be the preferable means of freeing up the intermediate- and long-term area. It has been proposed that ceiling rates on certificates be raised to market levels according to a pre-arranged schedule, starting in 1981 with maturities of 8 years or more and proceeding to shorter maturities in subsequent years. While we support the general objective of this proposal, we believe that eliminat ion of the 12 per cent cap would be a better way of providing increased flexibility for individual institutions and achieving the objectives of the Depository Institutions Deregulation Act. 2. Restore the thrift institution differential on 6-month money market certificates. Regulatory actions in March 1979 and May 1980 all but eliminated the thrift institution differential on 6-month CDs. The most recent action was apparently designed to assist small commercial banks to roll over maturing MMCs. As we pointed out at the time, no evidence existed of a serious problem among commercial banks, while the implications for thrift institutions were clearly unfavorable. Our expectations regarding the impact of erosion of the differential have been fully realized. Disintermediation at thrift institutions has been aggravated by shifts of funds to commercial banks. Thus, the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand R. V. Bernard  - 3 -  March 17, 1981  commercial bank share of total 6-month CD growth rose from 29 per cent in 1978 to 43 per cent in 1979 and again to 52 per cent in 1980. Based on this evidence, it may be expected that restoration of the differential would reverse or retard the decline in the thrift institution share of the 6-month CD market. The full differential should be restored on 6-month CDs and maintained on all other accounts as long as Regulation Q authori ty remains on the books. To implement this change, the commercial bank ceiling should be set at the 6-month Treasury bill rate, while the thrift institu tion ceiling should be 25 basis points higher. Restoring the differential is critical now, in view of the large volume of 6-month CDs which will mature at thrift institutions in the near future. At savings banks, for example, an estimated $21 billion or , 44 per cent of total industry holdings of 6-month CDs, will reach maturit y in March and April alone. Restoring the differential would encourage rollove r of maturing certificates and help avert serious liquidity strains. 3. Permit depository institutions to disclose fully the effects of compounding interest in advertising longer-term certificates. Current regulations restrict interest rate advertising to annual percentage yields on longer-term certificates. This restriction should be amended to permit more complete disclosure of the effects of compounding. With respect to passbook savings account rate ceilings, the Depository Institutions Deregulation Act requires the DIDC to vote on whether to increase ceiling rates by at least one-quarter of one percentage point no later than September 1981 and at specified dates threafter. An increas e in passbook rate ceilings would merely raise interest costs without attracting new money. Nor would it be helpful in retaining present deposits. No change is justified at the present time, therefore, especially in view of the depressed earnings position of thrift institutions. In this regard, the savings bank industry as a whole is operating in the red and all signs point to deepening bottom-line losses in 1981. With respect to the short-term area, proposals have been advanced for a new deposit account to compete with money market funds. A preferab le course, in our judgment, would be the broader use of nondeposit liabili ty instruments -- such as consumer repurchase agreements, participation certificates and mortgage-backed securities. Increased use of nondeposit liability instruments would provide savings banks with greater flexibility since individual institutions could vary rates, maturities and other terms in line with local market conditions and the needs of the institution. Deposit accounts, by contrast, are typically offered uniformly by all institutions in a given market area, regardless of the circumstances of the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Normand R. V. Bernard  - 4 -  March 17, 1981  individual institutions. For this reason, we believe strongly that the use of nondeposit liability instruments should not be inhibited by the bank regulatory agencies. We respectfully request that these recommendations be placed on the agenda for discussion at the next meeting of the Depository Institutions Deregulation Committee.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Sincerely yours,  Albert B. Hooke Chairman  Saul B. Klaman President  • •• •  .•• of BOARD OF GOVERNORS  4  • ••0  OF THE  *IX  •  FEDERAL RESERVE SYSTEM ,  WASHINGTON, O. C. 20551  ‘n • • ' ••4'' •  tiuii .6 4  • <,^ •  RE, • • •.. • •  •L  Meeting of Thrift Institutions Advisory Council with the Board of Governors of the Federal Reserve System Thursday, March 12, 1981 10:30 a.m.  AGENDA 1. Current and immediately prospective developments in thrift institutions industry in terms of deposit flows, including experie nce with NOW accounts, home mortgage activity, earnings, and the general financial condition of various segments of the industry (e.g. S&L's, mutual savings banks, credit unions, large/small institutions, geograp hic differences). 2.  Federal Reserve Board's action plan for thrift industry survival.  3. Current recommendations of the Council for survival of the thrift industry.  , NOTE:   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  List of Thrift Institutions Advisory Council members is attached.  x. ot,tign  (01°11.4/ /44 " 47j  ea  ,i,1140)"1 ljel„,)i JAVP4°  er  2 CWell - 1, LA  91u,  ,r  THRIFT INSTITUTIONS ADVISORY COUNCIL MEMBERS  Mr. Harry Albright President Dime Savings Bank of New York New York, New York Assets Deposits  $4,643,108,574 4,109,535,378  Mr. Edwin Brooks President Security Federal Savings and Loan Association Richmond, Virginia Assets  Mr. Walter Kropp Chairman of the Board Ohio Federal Savings and Loan Association Columbus, Ohio Assets  Mr. James Montgomery President Great Western Savings and Loan Association Beverly Hills, California  over $115 million Assets  Mr. Dwyer General Manager Pentagon Federal Credit Union Box 310 Arlington, Virginia Deposits  $522 million  Mr. Robert Garver President Charlestown Savings Bank Boston, Massachusetts Assets Deposits  $821,292,546 735,701,226  Ms. Mary Gigsby President Houston First American Savings Association Houston, Texas Assets  over $911 million  Mr. Raleigh Greene Chairman of the Board and President Florida Federal Savings and Loan Association St. Petersburg, Florida Assets   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  over $245 million  over 1 1/2 billion  over 9 billion  Mr. Herbert Sandler Chairman of the Board World Savings and Loan Association Oakland, California Assets  over 5 billion  BOARD OF GOVERNORS or T  E  FEDERAL RESERVE SYSTEM  Office Correspondence To _ _Boacd JaDf Governors From_ _Nu rminci Bernard  Date  February 4, 1981  SubjeCt:Ageacla for next meeting with Thrift Institutions Advisory Council  The next meeting of the Board with the new Thrift Institutions Advisory Council is scheduled for March 12.  To give Council members an  opportunity to discuss agenda issues with their industry colleagues, we would like to circulate a tentative agenda by mid—February.  Any suggestions  you may have for the agenda would be appreciated by close of business Wednesday, February 11. For your information there are attached some materials prepared by the Council relating to the first meeting on January 9 and also a copy of the agenda for that meeting.  Attachments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  dA-Vi  THE BANK OF NEW YORK_ NEW  YORK'S  FIRST  BANK - FOUNDED  1784  BY  ALEXANDER  HAMILTON  48 WALL STREET, NEW YORK, N.Y. 10015 ROBERT ORTNER SENIOR VICE PRESIDENT AND ECONOMIST  March 5, 1981  Chairman Paul Volcker Board of Governors of the Federal Reserve System Constitution Avenue Washington, D.C. 20551 Dear Paul: I am enclosing a copy of a brief paper I wrote on some macro aspects of the Reagan program. My comment is generally supportive, especially regarding depreciation reform and spending cuts which you have been also strongly advocating. I thought you would be especially interested in the part on monetary policy because I find, as I am sure you are aware, that the monetary policy you are proposing will not accommodate the projections incorporated in the President's program. We certainly believe, however, that you are on the right track, and we continue to support strongly your own policies. I am also enclosing a summary of our own projections through 1982. You will note that we do have a minus sign for the next quarter, but I would describe that quarter as essentially flat and not "down 3%." The more interesting part is 1982 where we show not much over 1% real gain contrasted with the President's projection of 4.2%. Our relative pessimism has much to do with the expected growth in monetary aggregates that you are promising, probable velocity limits and continuing high interest rates. Please send our regards to Barbara.  With best wishes,  Sincerely,  enc.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  THE BANK OF NEW YORK NE  'T(DR A'S  FIRST  BANK - FOUNDED  1784  BY  ALEXANDER  HAMILTON  48 WALL STREET, NEW YORK, N. Y. 10015 ROBERT ORTNER stNioR 'CE PRESIDENT AND ECONOMIST  February 26, 1981  "AMERICA'S NEW BEGINNING: A PROGRAM FOR ECONOMIC RECOVERY"  Summary It's Jones-Conable and KempRoth, spending cuts, deregulation, and monetary restraint. This program is offered as a new departure in economic policy which will get the economy moving ahead and bring down both unemployment and inflation. Tax cuts are offered in two ways: the program essentially adopts the Jones-Conable bill which proposed liberalized depreciation, using the "10-5-3" guideline lives, and the Kemp-Roth bill which provides tax cuts for individuals of 10% a year for three years. To keep the Federal budget deficit from exploding and to help fight inflation, substantial spending cuts are proposed, amounting to $41 billion in fiscal 1982, and rising to 1104 billion in 1984 when, it is hoped, the budget will be brought into balance. Federal regulations will be dismantled where they are found to be unnecessary or inefficient, to reduce inflationary costs and stifling burdens on business, and monetary growth will be limited to underwrite the fight against inflation.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Our analysis finds that not all of these goals will be achieved. Budget deficits probably will remain larger than projected, and the economic growth assumed is not likely to be achieved as expansion of money and credit is reduced over this period. Nevertheless, this program deserves national support. It will begin to move the economy in the right directions, and important parts of it may still be adjusted later as necessary.  Tax Cuts - Which are Supply-Side? The overriding problem in the economy today is productivity. Its deterioration has undermined real growth and real income and has added materially to inflation. Chart 1 shows the long term slide in the growth of productivity, to the point where it has actually declined for three years in a row, its worst performance of the post-war period. This slide has been accompanied by a similar decline in real compensation per man-hour. Poor performance in productivity is the reason real income per capita is doing so  Page 2  It is also the reason that poorly. to increase real attempts labor's incomes through larger wage inA creases are doomed to failure. a without faster rise in wages producincrease in corresponding tivity results in an increase in labor costs which is passed along by The result is simply employers. faster inflation and, as shown in Chart 2, it leaves workers no better off than they were before. How do we get out of this the of One spiral? vicious President's comments provides the key. We must give our workers the tools with which to compete in world markets, and to produce the rising standards of living everyone wants. Capital spending is not the only in the complex involved factor causes affecting productivity, but the relationship between capital stock per worker and output per Chart 3 is in shown man-hour Growth in capital stock obvious. per worker began slowing in the 1960's and virtually stopped after 1970, with disastrous results on productivity. In our view the most important component of the package is depreciation reform which will enable business firms to write off assets faster, save taxes, and thereby help The new to raise capital outlays. ten years guideline schedules are: for most buildings (some fifteen and eighteen years), five years for machinery and equipment, and three years for vehicles and for equipment used for research and development. In addition, the investment tax credit was increased to 6% from 3 1/3% for the three-year category and will be 10% where applicable for the To underscore other categories. their importance, the President changes making these proposed The 1st. January to retroactive Administration projects the tax reduction from this source to amount   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  to only $2.5 billion in fiscal 1981, but to rise rapidly to $10 billion next year, and eventually to nearly These 1986. in billion $60 estimates are contained in Table 1, along with the even larger projected These cuts in personal taxes. personal tax cuts, the Kemp -Roth bill, will reduce personal tax rates 10% a year for three years, at which be time the range of rates will reduced to 10% to 50%, from the present 14% to 70%. While depreciation reform seems as accepted universally to be "supply-side," there is considerable controversy surrounding the Kemp-Roth bill as a supply-side measure. According to the "super supplysiders," Kemp-Roth is not advocated because it puts more disposable income and spending power in the pockets of consumers, but because it induce them to work harder, will save more, invest more, produce more and, as a result, reduce inflation. In economic affairs, causes and effects are always multiple and complicated, but we suspect that most of the tax cut will show up on It was, undoubtthe demand side. of edly, this characterization Kemp-Roth as strictly supply side that led Vice-President George Bush to refer to it, during last year's primaries, as "voodoo economics." A more generous characterization might be that it is Say's Law in reverse. The economist, J.B. Say, suggested almost two hundred years ago that supply creates its own demand. Perhaps with slight exaggeration, it seems that Kemp-Roth supply-siders are arguing that demand creates its own supply - and then some. The President himself has some concern over this bill, at least in terms of its current impact on the As a result, he Federal budget. proposed that it be made effective July 1st instead of January 1st as his presidential in promised  Page 3 campaign. The budgetary consideration is important. The first 10% installment will amount to a cut of $26 billion at annual rate, but delaying it until July 1st will reduce receipts in fiscal 1981 by only $6.4 billion, because it will be in effect for only one quarter of the fiscal year which ends September 30th. There are several arguments in favor of adopting the Kemp-Roth bill, as proposed by Mr. Reagan, which Mr. Bush can now support with integrity: It is part of a package which includes depreciation reform and large-scale spending cuts; it offsets tax increases that have been caused by "bracket creep," and some personal tax relief- is therefore overdue; even if it is largely spent, as it probably will be, there is slack in the economy at present, and a pickup in final demand will also help to encourage capital spending by raising operating rates; political reality requires its inclusion to achieve passage of the rest of the package; and, finally, enacting only the first 10% installment now, would permit the second and third to be postponed if the scheduled spending cuts cannot be achieved, and/or it appears final demand is overstimulated.  Spending Cuts and Budget Prospects Some Doubts While Mr. Reagan did not predicate the tax reductions on prior spending cuts, it is clear that the spending cuts are critical to the achievement of the balanced budget he is projecting in 1984. The President specifically exempted two areas from the "hit list:" national defense and the so-called safety net programs of income maintenance. (Although these will be reviewed for waste and inefficiency). And, of course, interest   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  on the national debt is a true "uncontrollable." These three categories are shown in Table 2, along with proposed outlay ceilings. All remaining spending areas are included in "other," and the table shows the extent to which "other" must be reduced to achieve the projected total spending limit. Allowing for inflation, "other" will have to be cut by nearly one-half in real terms during the next three years to achieve the spending targets. In the President's words, "If misery loves company, then everybody better love everybody else, because we didn't overlook anyone." The spending cuts are not intended only to reduce budget deficits. Combined with tax reductions they will serve to transfer the economy back to the private sector. And this process will be reinforced by regulatory reforms. Removing unnecessary regulations will reduce the inflationary costs of compliance and stop the government from stifling private initiative. The entire program has been heralded as completely a new departure in economic policy. What is new? Certainly not big personal tax cuts or even depreciation reform. What is genuinely new is the sincere effort to eliminate waste government, in reduce spending, balance the budget, and return the economy to the private sector. Are these budgetary targets achievable? Probably not. The budgetary totals are closely dependent on the Administration's economic assumptions shown in Table 3. If inflation remains higher than projected, spending and the deficit will also be correspondingly higher, although there may be some offset, as receipts would also be greater.  Page 4 The projected drop in inflation should not be rejected out of hand because it appears substantial over the next five years. Inflation dropped from 11% in 1974 to 5.7% in only two years. It could improve again, even if not that dramatically, given a little luck in food and energy prices and a bettermanaged economy.  cies proposed, therefore, may give us guns and some butter, but not guns and very many houses and cars. The obvious way out of this dilemma would be to find inflation slowing even faster than projected. Barring that, we may have to be more patient in achieving the goals of the program.  Real growth even is more important to the budget, and this looks less promising. If the economy operates below the projected trends, both receipts and outlays would adversely. be affected Receipts would be held down by slower growth in incomes, while spending would be raised because of higher unemployment costs and other necessary income maintenance. It is our opinion that the targets for economic expansion will not be realized.  Overall Assessment - Go for It!  The Economy and Monetary Policy Still in Conflict It is almost ironic that the President also encouraged the Federal Reserve Board to continue a policy monetary of restraint, thereby presenting a kind of united front. If the Board does this, monetary policy will not accommodate the projected growth shown in Table 3, nor, therefore, the dramatic improvement in the budget deficit. Chart 4 traces the path of the velocity of M2 since 1958. It is a simple ratio of GNP to the M2 monetary aggregate. Using the Administration's projections for increases of nominal GNP of 12.8% in 1982, 12.4% for 1983, etc., and either steady or slowly declining increases in M2, produces a dramatic rise in velocity, to an extent never seen before. This pattern of velocity implies high interest rates which will abort the rapid business expansion. The combination of poli   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  It should not be surprising that a program encompassing such large changes in taxing and spending would run into criticism. In Congress, there seems to be general agreement that spending cuts are desirable, but the coming negotiations over whose sacred programs will be gored may be another matter. Tax cuts are also generally applauded but there are already demands that "working people" get a larger share of the reductions. The cuts are, in fact, pretty much across the board, and this criticism misses the essential point of the program. If the program works to promote productivity real and growth, the "non-rich" will be its greatest beneficiaries through increased jobs, and rising real income and standards of living. It will now be interesting to follow the program's progress through Hopefully, it will be Congress. legislated largely as proposed, with the exception that a firm commitment not be made now as to the size and timing of the second and third installments of the personal tax cuts. In any case, the President's economic basic philosophy is correct. The source of this country's wealth is not regulation, entitlements, and income redistribution. It is output. If this program achieves part of its goals, Mr. Reagan will bequeath to the country a better economy than he inherited.  •  I Real Compensation CHART  Productivity  % ch. year ago 12  and  per Manhour 12  10  10  Productivity I. .• •• •• .• •• •  . S  4 •  • •  Real Compensation per Manhour ( private business 'sector )  6 58  59 60   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  61 62 63  64  65 66  67 68 69  70  71 72  73 74  75  76  77 78  79  80  81 82  83  CHART 2  .,  Unit Labor  % ch. yr. ago 16  Costs and  Inflation 14  Consumer Price Index _. I. 5  14  • •  12  •  12 10  10  I  Unit Labor Costs  —2 --t58  _  59 60   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  61 62 63 64 65 66  67 68 69  70 71 72  73 74 75 76  77 78 79  80 81 82  83  2  „  CHART 3 Index 1960 =100 160  Capital Stock  Productivity  and  160  Productivity ( private  sector )  .•• .•  •• •  150  150  • • • • • •  .°. • •  Capital Stock per Worker  •  • •  140  140  private sector ) • • • •  •• •  130  • • •  130  • • •  • •  120  120  • • • • • • • • •  110  110  •  100  100  1 I 1 1 1 I 1 1 1 1 1  90  60 61 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  62  63  64  65  66  67  68  69  70  71  72  73  74  75  76  77  78  79  1-90 80  Table 1  Planned Tax Cuts - Fiscal Years ($Eillions)  Current Tax Receipts Individual Income Tax Reductions Depreciation Reform Proposed User Charges Receipts with New Tax Policy  1981  1982  1983  1984  609  702  808  917  -6.4 -2.5  -44 -10 2  -81 -19 2  -118 -30 3  600  650  710  772  Table 2  Dudget Projections - Fiscal Years ($Billions) 1980 Defense 136 Interest (net) 53 Social & Welfare Programs (Safety Net) 193 Other 198 Total Outlays 580 Receipts 520 Def. (-) or Surplus -60  1981  1982  1983  1984  158 64  184E 66E  215E 67E  250 67  239 193 655 600 -55  262E 184E 696 651 -45  286F 165E 733 710 -23  313 142 772 772 0  L - estimated for 1982 and 1983  Table 3 Economic Environment - % Change Actual  Consumer Price Index Real GNP Unemployment Pre-Tax Corp. Profits Personal Income Nominal GNP  Note:  1979  1980  19S1  1982  1983  1984  1985  11.3 3.2 5.8 14.4 12.9 12.0  13.5 -.1 7.2. -4.7 11.2 8.9  12.1 1.1 7.8 -1.2 11.0 11.1  8.3 4.2 7.2 15.4 11.5 12.8  6.2 5.0 6.6 16.3 11.5 12.4  5.5 4.5 6.4 12.7 9.9 10.8  4.7 4.2 N.A. N.A. 6.0 5.6 11.3 11.4 9.3 9.2 9.8 9.3  N.A. - not available   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Projections 1986  CHART 4  Money  Velocity  and  the  Reagan  Program  2.1  2.1  Velocity with gradual reduction of M2 growth  2.0  2.0  1.9  1.9  1.8  1.8  growth e.5010 in M2  1.7  1.6  1.5  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  GNP M2  1.7  1.6  PAGE 1  THE BANK OF NEW YORK--PUBLIC SECTOR PROJECTIONS, 3/2/81  FEDERAL GOVERNMENT RECEIPTS AND EXPENDITURES ($B1LL., SEAS. ADJ. ANNUAL RATES) QUARTERS 1981:1 1981:2 1981:3 1981:4 1982:1 1982:2 1982:3 1982:4  1980:1 1980:2 1980:3 1980:4P RECEIPTS: 246.9 80.5 31.9 169.2  252.0 60.9 38.7 169.3  259.4 66.7 42.9 171.8  273.0 I 67.6E1 48.9 I 178.6 I  285.7 66.0 55.5 198.2  295.0 64.3 59.4 201.7  277.9 63.8 64.3 206.0  288.4 63.9 68.7 210.8  298.4 62.4 72.6 220.5  308.8 62.2 75.5 225.2  297.0 62.3 77.4 230.4  307.7 59.6 78.6 235.5  PURCHASES OF GOODS & SERVICES TRANSFER PAYMENTS TO PERSONS TRANSFER PAYMENTS TO FOREIGNERS GRANTS-IN-AID TO STATE & LOCAL GOVERNMENTS. NET INTEREST PAID SUBSID. LESS CURRENT SURPL. OF GOV. ENTERP. LESS: WAGE ACCRUALS LESS DISBURSEMENTS  190.0 224.4 4.5 85.5 50.3 10.1 0.0  198.7 232.2 3.8 87.2 54.4 11.0 0.0  194.9 260.4 4.9 87.7 53.5 13.7 0.0  212.1 262.6 4.9 91.4 55.3 13.1 0.0  1 I I I 1 I I  214.5 271.3 4.7 88.6 59.5 12.1 0.0  219.0 274.7 4.7 88.1 65.8 12.2 0.0  224.0 293.8 4.7 90.8 68.1 11.4 0.0  234.5 296.6 4.9 84.1 70.6 11.6 0.0  238.5 299.8 5.2 84.8 74.3 12.7 0.0  243.0 302.7 5.3 85.6 77.1 11.8 0.0  247.5 321.0 5.4 85.5 81.0 12.4 0.0  257.5 324.2 5.4 78.6 83.9 11.0 0.0  RECEIPTS ANNUAL RATE OF CHANGE  528.4 11.7  520.9 -5.6  540.8 16.2  568.1E1 21.8 I  605.5 29.0  620.4 10.2  612.0 -5.3  631.7 13.5  654.0 14.9  671.7 11.3  667.1 -2.7  681.4 8.9  EXPENDITURES ANNUAL RATE OF CHANGE  564.7 20.8  587.3 17.0  615.0 20.2  639.4 I 16.8 I  650.6 7.2  664.5 8.8  692.9 18.2  702.3 5.5  715.3 7.6  725.5 5.8  752.7 15.9  760.5 4.2  SURPLUS OR DEFICIT (-), NIA ACCOUNTS  -36.3  -66.5  -74.2  -71.3E1  -45.1  -44.1  -80.9  -70.5  -61.3  -53.8  -85.6  -79.1  PERSONAL TAX & NONTAX RECEIPTS CORPORATE PROFITS TAX ACCRUALS INDIRECT BUSINESS TAX & NONTAX ACCRUALS CONTRIBUTIONS FOR SOCIAL INSURANCE EVENDITURES:  NOTES: P- PRELIMINARY. E- ESTIMATE. ANNUAL RATES OF CHANGE ARE PERIOD-TO-PERIOD % CHANGES AT COMPOUND ANNUAL RATES.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Table 1 THE BANK OF NEW YORK--ECONOMIC PROJECTIONS, 3/2/81 YEARS  QUARTERS 1981:1 1981:2 1981:3 1981:4 1982:1 1982:2 1982:3 1982:4  1980:1 1980:2 1980:3 1980:4P  79  80  81  82  NATIONAL PRODUCT AND INCOME SUMMARY ($B1L., SEAS. ADJ. ANNUAL RATES) LINE 1 GROSS NATIONAL PRODUCT ANNUAL RATE OF CHANGE 2 3 REAL GNP (1972 DOLLARS) 4 ANNUAL RATE OF CHANGE 5 GNP DEFLATOR (1972=1.0) ANNUAL RATE OF CHANGE 6  2571.7 2564.8 2637.3 2732.3 I 2816.0 2882.5 2964.5 3043.0 3118.0 3197.0 3280.0 3356.0 9.6 10.8 10.5 11.0 10.2 11.9 9.8 12.8 11.8 15.2 I -1.1 12.6 1501.9 1463.3 1471.9 1486.5 I 1496.0 1493.9 1500.2 1501.9 1506.1 1512.4 1520.3 1522.4 0.6 1.7 2.1 1.1 -0.6 1.7 0.5 2.6 4.0 I 2.4 -9.9 3.1 1.7123 1.7528 1.7918 1.8380 I 1.8823 1.9295 1.9761 2.0261 2.0702 2.1138 2.1574 2.2044 9.0 8.7 8.5 9.0 10.4 10.0 10.5 10.0 10.7 I 9.8 9.2 9.3  2413.9 2626.5 2926.5 3237.8 10.6 11.4 12.0 8.8 1483.0 1480.9 1498.0 1515.3 1.2 -0.1 1.2 3.2 1.6276 1.7737 1.9535 2.1364 9.4 10.1 9.0 8.5  1502.8 1462.0 1476.9 1492.3 I 1498.8 1492.3 1498.3 1497.7 1505.3 1510.8 1521.1 1524.9 7 FINAL SALES (1972$) 1.0 2.8 2.0 1.5 1.6 -0.2 -1.7 1.8 4.1 4.2 I 3.1 -10.4 8 ANNUAL RATE OF CHANGE 156.8 156.3 155.5 155.2 155.5 156.0 156.6 156.3 9 BUS. FIXED INVESTMENT (1972$). 165.0 156.1 155.5 156.1 I -0.6 1.3 1.5 0.7 -0.8 -1.8 1.9 -1.5 -1.5 1.6 I 2.2 -19.9 10 ANNUAL RATE OF CHANGE  1472.9 1483.5 1496.8 1515.5 1.3 0.7 0.9 3.5 163.3 158.2 156.0 156.1 0.1 -1.4 -3.1 6.5  182.9 146.5 159.1 161.5E1 161.5 159.0 158.0 157.5 155.5 154.0 154.5 149.5 -3.1 -2.2 -5.1 -3.7 -2.5 -0.7 8.5 -4.0 I -11.7 -8.4 11.1 -11.0 1207.9 1194.9 1207.4 1220.1 I 1220.7 1217.7 1227.8 1231.3 1232.5 1235.5 1248.4 1255.9 2.4 4.2 1.0 0.4 1.1 3.3 4.3 I -1.0 -4.2 4.3 0.2 -0.4 1021.0 1008.2 1018.5 1025.8 I 1024.0 1020.1 1041.4 1042.7 1042.0 1042.9 1064.6 1069.2 1.7 8.6 0.4 -0.3 0.5 -1.5 8.6 -0.7 4.1 2.9 I 1.3 -4.9 6.2 4.7 6.1 5.0 5.7 5.5 4.7 4.5 6.1 5.2 I 6.2 4.9  167.8 162.5 159.0 153.4 -3.5 -2.2 -3.1 19.5 1197.5 1207.6 1224.4 1243.1 1.5 1.4 0.8 3.7 1011.5 1018.4 1032.1 1054.7 2.2 1.3 0.7 3.1 5.5 5.1 5.6 5.3  Iry  11 12 13 14 15 16 17  POST-TAX CORPORATE PROFITS 4-QTR. PERCENT CHANGE PERSONAL INCOME (1972$) ANNUAL RATE OF CHANGE D1SP. PERS. INCOME (1972$) ANNUAL RATE OF CHANGE PERSONAL SAVING RATE (%)  MONETARY VARIABLES 18 19 20 21 22 23 24 25  M1B-ANN. RATE OF CHANGE, S.A M2-ANN. RATE OF CHANGE, S.A C&I LOANS-L. BKS. ($B1L.,S.A.) ANNUAL RATE OF CHANGE FED FUNDS RATE-% AAA CORP. BOND RATE-%  11.3 I 15.4 5.9 -2.5 CURRENT GROWTH TARGET RANGE FOR 80-4 TO 81-4: 6% TO 8.5% 9.4 I 17.0 7.5 5.7 CURRENT GROWTH TARGET RANGE FOR 80-4 TO 81-4: 6% TO 9% 161.2 160.2 162.8 170.9 I 6.7 21.5 I -2.4 17.1 16.50 15.00 16.00 16.00 9.84 15.85 I 15.05 12.69 13.10 13.00 13.25 13.25 12.14 11.20 11.58 12.83 I  7.8  6.4  8.9  9.1 163.8 11.4 13.36 11.94  15.88 13.15  15.25 12.75  2.470 13.5 13.5 2.469 13.4 1.471 -3.6 9.1 1.303 7.1  2.752 11.4 11.4 2.739 10.9 1.525 3.7 9.0 1.313 7.6  3.004 9.2 9.2 3.002 9.6 1.548 1.5 9.2 1.400 8.3  15.00 12.75  14.00 12.25  16.00 13.00  16.00 13.00  147.1 16.4 11.19 9.63  2.911 9.0 10.1 2.909 9.5 1.530 0.5 9.3 1.350 8.2  2.974 8.9 9.1 2.972 8.9 1.544 3.7 9.5 1.400 8.3  3.035 8.5 8.9 3.033 8.5 1.559 3.9 9.3 1.450 8.3  3.098 8.6 8.7 3.095 8.4 1.558 -0.3 8.8 1.400 8.4  2.176 11.3 11.3 2.177 11.1 1.525 4.4 10.6 1.722 5.8  OTHER ECONOMIC INDICATORS (SEASONALLY ADJUSTED) 26 27 28 29 30 31 32 33 34 35  CONS. PRICE INDEX (1967=1.0)ANNUAL RATE OF CHANGE 4-QTR. PERCENT CHANGE PROD. PRICE INDEX-FG(1967=1.0) ANNUAL RATE OF CHANGE IND. PRODUCTION (1967=1.0) ANNUAL RATE OF CHANGE CAR SALES* (MIL. UNITS) HOUSING STARTS* (MIL. UNITS) UNEMPLOYMENT RATE -%  2.371 16.9 14.2 2.371 16.7 1.525 -0.1 10.8 1.234 6.2  2.448 13.7 14.4 2.431 10.5 1.446 -19.1 7.6 1.055 7.3  2.491 7.2 12.8 2.512 14.1 1.421 -6.7 8.8 1.390 7.5  2.569 13.2 12.7 2.561 8.0 1.491 21.1 9.1 1.534 7.5  I I I I I I  2.645 12.4 11.6 2.626 10.5 1.524 9.2 9.3 1.500 7.4  2.726 12.8 11.4 2.707 12.9 1.527 0.8 8.8 1.300 7.5  2.788 9.4 11.9 2.779 11.1 1.519 -2.1 9.0 1.250 7.7  2.849 9.0 10.9 2.844 9.7 1.528 2.4 9.0 1.200 8.0  NOTES: P-PRELIMINARY. E-ESTIMATE. S.A.-SEASONALLY ADJUSTED. *-AT ANNUAL RATES. ANNUAL RATES OF CHANGE ARE PERIOD TO PERIOD % CHANGES AT COMPOUND ANNUAL RATES.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  VII  4Ib  110--  HEW T!ANDUM  purpose of this memorandum is to 111 review the present plight of the thrift industry in New \York State, which has resulted in unprecedented operating' losses of nearly :7.500 million (2) describe the basis on which the State and New York City, despite these staggering operating _losses, ilapose their grossly unfair franchit;e taxes on thrift institutions, and (3) propose a legislative change in the franchiEe tax formula which is r..ential to arliorate the Or4in c.,r1 the net worth of thrift institution  caused by the  inequitable exiting tax formula.  The crisis:  Its origin and Effect  The effect of inflation and high interest rates upon assets consisting of fixed-rate mort919es and bonds has resulted in a financial crisis for the thrift industry -particularly in New York State.  Since World War II, national  and state policy hof; caused the thrift industry to concentrate its investment in mortgage lending.  In New York  State this situation was exacerbated by statute and regulation that precluded thrifts'from adjusting interest rates to the market.  Limited by low-yielding, tixed-rate  assets, mutual savings banks and saving  and loan  asrxvoii:ftiong are in an earnings and capital crisis with no historical precedent other than the early 1930's.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  POW  The esential facts confronting New York State thrift institutions are as follOws:  (1) Thritts have sustained and will continue to sk13tain unprecedented operating losses in 1980 and 1981.  (a)  New York State savings banks and savings and  loan associations experienced operating losses approximating $500 million in 1980.  (11)  These institutions are anticipated to lose  almost twice this  it. -- ()TiE! billion dollars  this  year.  DA  The, operating losses result from inflation arid national policies which are beyond the control of thrift institutions.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  t  )  In 1981, 50% of all the deposits in savings  banks will be tied to interest rates on Treasury Bills. These ratcf:, fixed by the Federal Reserve in its effort to control the Money supply, are beyond the ability Of thrifts to control.  (b)  In June 1979, one-half of the deposits in  savings banks were composed of passbook accounts paying 5- 1/2% or fixed-rate certificates in an average range of 2-1/2 years' duration.  Since then, passbook accounts  have declined by $6 billion, while time certificates ind(!xed to the Trekisury Bill rate have increased by $3 billion, with current rates in excess of 15%.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  (c) accounts.  in 1979, 401 of deposits were in passbook In 1980, 30% .ere in passbook accounts.  In  1961, it is anticipated there will be a further erosion. The consequence is that the cOSt Of money for savingF, banks continues to rise precipitously.  (a) In  the ease of six-months certificates, the  avcrage cost of these certificates over the last two and one-half years (since they were first authorized) has been 10.53% (elusive of compounding).  The average  earnings of thrift institutions during this same period has been 8.021, leaviny a negative spread of 2.51% during this period.  (e)  Massive deposit outflows hnvu continued.  The  deposit loss of thrifts, despite the high interest rates that they have been required to pay by thc pegging Of rates to the Treasury Rill rates, amounted to $5.5 billion in 1979.  In 1980, there were $3.6 billion in  depo;it outflows.  (f)  Banks losing deposits must either (1) -ose all  their cash flows resulting from amortization of mortgages or maturing bond portfolios to pay depOSitOCS who are withdrawing funds from their institutions or (2) borrow from commercial banks or the Federal Home Loan Bank (if they are members).  -13-   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  (g)  mortgages and ionds were the principal  investmentS (up until the December 1980 legislation) in which thrift  were duthorized to invel;t.  Up until 1980,  t was pot:aible (Or thrirt5 to hold invefitments until maturity, thereby avoiding any 10SSCs resulting from their sale in depreciated markcts.  It is significantly  questionable that thrifts can continue to do so now because of continued heavy deposit outflows and operating losses.  (h)  The losses sustained by thrifts must be  charged to undivided profits and surplus.  This means  that the Only aszets that are unburdened by claims of depositors have been reduced, exewertlating the earnings problems of savings banks.  SpeciEU:ally, when these  losses are taken, the erosion not only threatens the vitality of the institution's "rainy day* fund, but results in a cannibalizing of valuable tavning assets of the bank, hastening the pressure on earnings. (i)  More thrifts will be forcel?, to borrow to meet  these pressures.  But for every $100 million borrowed,  the cost is either $25 million in interest expense 0.ncauding opportunity cost in connectiOn with compensating balances kept with oommercial banks) or $30 million in losses  f invusLmenLs are sold.  A  a  (3) As a consequence, thrifts are invading net worth in order to pay, interest and divA-65as to depositors. (a)  Net worth ratios were reduced in 1980 by GO  .5,is points for all New York mutuale combined and by one full percentage point for mutuals in metropolitan New York City.  Thus, net worth ratios that hovered at  6-1/2% at the start of 1980, have been reduced to below  6% by year end.  many institutions fell way below this  level.  (b)  For many large mutual institutions in  Plnhattan and Brooklyn, the reduction in net worth ratios will result in levels below the statutory minimum -- 5% of the amount due depositors.  In order for these  institutions to pay dividends to depositors, the Superintendent of Banks, in her discretion, must authorize their Trustees to pay dividends by transferring the required :AIMS of money from net worth.  The Effect of Present Franchise Tax Laws DeL;pite. these staggering operating losses, thrift institutions will have to pay alternative minimum franchise taxes c.if $118 million for 1980 and an equal amount for 1981 ($71 nillion to the State and $47 million to New York city) unless the present lhw is changed to tax thrifts on a more   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -5_  guitable'basis.  In effect, the present franchise tax laws  will further undermine the condition of thrift institutions uince these franchise taxes will be paid out of retained (past) earnings at a time when those amounts are needed to mitigate operating losses.  Fundamental Fairness Requires that Thrifts be Taxed on a Comparable basis to Commercial Banks  Article 32 of the New 'York Tax Law imposes a franchise tax on all banking corporations, including commercial banks, savings banks and savings and loan associations. tc2x  The basic  12% of net income -- is the same for each type of  banking corporation (Tax Law, S1455(a)). Article 32, however, alto imposes an alternative minimum tax for banking institutions which have no or low income. For commercial banks, this alternative minilnum tax is based on a percentage of. their capital stock.  For thrift  institution, however, the alternative minimum tax is based on the interest and dividends credited to their depositors. This arbitrary distinction results in a grossly excessive and unfair tax on thrift institutions. For example, a typically large commercial bank with no net income (or losses) is required to pay an alternative minimum tax of about $1 million, based on its capital Stock. At the same time, a typically large thrift institution with   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -6-  no net income (or losse ) is required to pay an alternative minimum tax in excess of $5 million, based on interest and paid Its depositors -- even though its asset size is less than 204 of the large commercial bank. Not only is this result grossly excessive and inequitable, but there is no rational basis for the distinction.  Cormnurcial banks have all of the powers and  perform all of the services of thrift institutions.  Yet,  until this year, thrift institutions were unable to perform many of the e.erviccs performr0 by comneccial banks. Moreover, a tax on capital stock is sharply different from a tax on interest and dividends paid to depositors. Capital stock represents an amount invested in a commercial bank.  Interest and dividends, on the other hand, do not  present invested capital.  They represent payments made for  borrowed funds. Thrift institutions should be taxed on a basis oomparable to commercial banks.  Although thrift institutions  do not have capital stock, the nearest equivalent is 34% of the surplus fund or account required (by the State Banking Department) to be maintained by each thrift institution in for it to have adequate capitol for safe and sound operations.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Accordingly, the Tax Law should be amondvd to  -7-  •••11  provide for an alternative minimum tax bfiell on 34% of the _ ufp10% fund Qr account maintiAintr'il by thrift institutions.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ....••••••••••••••••••  .1.•••••  Deregulation of Deposit Rate Ceiling by Maturity  Three possible schedules for "deregulating" deposit rate ceilings by maturity are presented below.  The schedule in Option 1 is similar to  the one proposed by the National Savings and Loan League and the schedule in Option 3 is comparable to the Citibank proposal. The  Depository Institutions Deregulation Act of 1980  the DIDC to create new  deposit  authorizes  categories without ceilings or with ceilings  indexed to market rates; new accounts with indexed ceilings may be established with or without a differential between tutions.  commercial banks and thrift insti-  Accordingly,the maturity categories contained in each of the three  options are permissible if the DIDC acts to establish instruments with these maturity and rate characteristics as new account categories. If a phased indexing of ceilings were used, the ceilings at thrifts and commercial banks could be tied to the appropriate Treasury security yield.  It should be noted that under this approach ceilings on  longer-maturity deposits could be below the current 2-1/2 year SSC ceiling (even with the caps) if the yield curve were downward sloping.  To avoid  setting ceilings that would be lower than those possible under current regulations, a rule could be adopted that tied the ceilings on longer term deposits to the rates on comparable maturity Treasury securities or the 2-1/2 SSC ceilings, which ever was greater.  In any event, any cap  maintained on the SSC would not apply to the "deregulated" instruments.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2-  Date July 1, 1981 July 1, 1982 July 1, 1983 July 1, 1984 July 1, 1985 April 1, 1986   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Nbturity of deposits for which rate cei1ing5 would be indexed or eliminated Option 1 Option 2 Option 3 8 years or more 6 to 8 years 4 to 6 years 2 to 4 years 1 to 2 years no ceilings  5 years or more 4 to 5 years 2 to 4 years 1 to 2 years 6 months to 1 year no ceilings  3 2 1 6  years or more to 3 years to 2 years months to 1 year  no ceilings  CA(or,724k) K)/e_he_,‹ 20L/4 DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE COMPTROLLER OF THE CURRENCY FEDERAL RESERVE BOARD  FEDERAL DEPOSIT INSURANCE CORPORATION  FEDERAL HOME LOAN BANK BOARD  NATIONAL CREDIT UNION ADMINISTRATION  U S TREASURY DEPARTMENT  May 8, 1981  The Honorable Thomas P. O'Neill, Jr. Speaker of the House of Representatives Washington, D.C. 20515 Dear Mr. Speaker: Pursuant to the requirements of Section 206 of the Depository Institutions Deregulation and Monetary Control Act of 1980, I am pleased to submit my annual report on the activities of the Depository Institutions Deregulation Committee during its first year of operation and on the viability of depository institutions. Sincerely,  .2 ( 1  4 a ' (<  Paul A. Volcker Chairman  Note—Identical letters were sent to:   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Vice President Bush Chairman :yarn Chairman St Germain Senator Williams Congressman Stanton  k  May 8, 1981  REPORT OF ACTIVITIES OF THE DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE AND REPORT ON THE VIABILITY OF DEPOSITORY INSTITUTIONS BY PAUL A. VOLCKER, CHAIRMAN BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM  I. A.  ACTIONS OF THE DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE _J  Meeting of December 12, 1980 Early withdrawal penalty.  At its meeting on December 12, the DIDC  considered four amendments to the rule adopted at the May 28 meeting which had modified the penalty for early withdrawal of time deposits.  The modifica-  tion had increased the effect of the minimum penalty in the early months of a deposit's life and could have the result that a depositor who makes an early withdrawal of a deposit might receive less than had been deposited. First, the Committee voted not to permit penalty-free withdrawals from an institution in the event of termination of federal deposit insurance. The Committee members were concerned that eliminating the early withdrawal penalty could accelerate deposit outflows and thus exacerbate problems of institutions whose federal insurance had been terminated.  Since statutory  provisions relating to deposit insurance terminations allow for a two year carry-over period during which deposit insurance remains in effect, depositors continue to be protected for the carry-over period.  1/ A report on meetings prior to December 12 was included in a preliminary report to the appropriate Congressional Committees. A copy of that report, dated September 30, 1980, is attached.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2-  The Committee approved a second proposed amendment, which was to limit the required penalty for early withdrawal from an IRA or Keogh plan during the first seven days after it is opened to the amount of interest already earned, with no invasion of principal.  The amendment was adopted in order to  eliminate a conflict with IRS regulations which require that unless a disclosure statement has been given seven days prior to the opening of an IRA account, the IRA depositor must have the right to revoke the account without forfeiture of any principal for seven days after it is opened.  The amend-  ment was made effective December 15, 1980. The third proposal was to allow penalty-free early withdrawal in the event of bankruptcy of the depositor.  Although the Committee was con-  cerned about expanding exceptions to the early withdrawal penalty rule, the Committee agreed to solicit public comment on the bankruptcy issue.  The  notice of proposed rulemaking was issued on December 18, 1980, with the comment period ending February 16, 1981. The Committee took no action on the fourth proposed modification, which would have permitted exceptions to the early withdrawal penalty rule in emergency or hardship cases.  The view of the Committee was that adoption  of such exceptions could result in severe enforcement problems and that defining workable emergency and hardship circumstances would be difficult. The Committee left open the possibility that this issue might be reconsidered at a later date. Phaseout of finders fees. terms for a phaseout of finders fees.  The Committee voted to accept specific At its September 9, 1980, meeting the  Committee had adopted a rule defining finders fees as a payment of interest   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -3-  for purposes of determining compliance with interest rate ceiling regulations. However, the Committee had been concerned that application of the new rule on December 31, 1980, could seriously affect any institution that had relied heavily on finders fees to attract deposits.  Therefore, the Committee had  requested public comment on a phaseout proposal that would provide such institutions a limited time to develop replacement sources of funds.  However, the  Committee also had to consider possible detrimental effects of a phaseout on institutions not qualifying for a phaseout operating in the same market as an eligible institution. The Committee decided to permit a phaseout under the following specific terms.  To be eligible, an institution must be certified by its pri-  mary federal supervisor to have demonstrated that on average finders fees have been paid on 25 percent or more of its outstanding domestic small-denomination (under $100,000) time and savings deposits over a two and a half year period ending June 30, 1980.  Other institutions were required to eliminate finders fees  on December 31, 1980.  The length of the phaseout for institutions meeting the  test is 18 months, divided into three 6-month periods beginning January 1, 1981. The base for the phaseout is the amount of domestic small-denomination time and savings deposits outstanding on June 30, 1980, on which finders fees had been paid. The base amount may not be exceeded during the phaseout period.  The maximum  amount of small-denomination time and savings deposits that may be raised through the continued use of finders fees is limited to 85 percent of the amount of domestic small denomination time and savings deposits on which finders fees had been paid maturing in the first 6-month period, 60 percent of the amount of such deposits maturing in the second 6-month period, and 40 percent of the amount of   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4-  such deposits maturing in the third 6-month period.  Any maturing domestic  small-denomination time deposits on which a finders fee had been paid and that is renewed, whether or not a finders fee is paid upon renewal, must be included in the amount of deposits obtained through the use of finders fees for the purpose of determining compliance with the percentage limitations.  All finders  fees must be paid in cash, with the exception that an institution may use as finders fees any merchandise it owned on December 1, 1980. of finders fees during the phaseout period is prohibited.  Mass media advertising Any advertisement,  announcement, or solicitation concerning the continued availability of finders fees during the phaseout period is limited to direct contact by the institution with its depositors or former sponsors of depositors or to displays or distributions of promotional material in an institution's offices. Request to phase out prepayment of interest.  The Committee considered  a request from the Bank of Boulder (Colorado) to provide a phaseout period for institutions that would be adversely affected by the DIDC's rule prohibiting the prepayment of interest in either cash or merchandise, effective December 31, 1980.  The Committee had agreed to consider the request because of the  similarity of the issue to the phaseout of finders fees.  However, the  Committee decided not to take any action at the meeting but to collect further information on this issue from the Bank of Boulder or other affected depository institutions, and to consider the matter at a later date. Effective date for new ceiling rates on MMCs and SSCs.  The Committee  decided to request public comment on a proposal to advance the effective date on new ceiling rates for MMCs (26-week money market certificates) and SSCs (2-1/2 year or more small saver certificates).   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  The ceiling rates, which are based on  -5-  yields on Treasury securities of equivalent maturities, were announced on Mondays (or the previous Friday if Monday is a holiday) and went into effect on the following Thursday.  This  lag allowed depositors the opportunity to accelerate  deposits prior to the effective date of a lowered ceiling or to withhold deposits prior to the effective date of a higher ceiling.  Reducing the lag between the  announcement date and effective date would lessen short-term fluctuations in deposit flows but could create operational problems for depository institutions, including the difficulty of changing advertisements on short notice.  The Com-  mittee requested comments on these issues by February 16, 1981. Adjustments in terms of IRA/Keogh accounts.  At the December 12  meeting, the Committee requested public comment on five options to make IRA/Keogh deposit accounts more attractive by reducing administrative obstacles to periodic additions to such accounts and by increasing yields available to individuals who are saving for their retirement. The first option is to reduce the minimum maturity of special IRA/ Keogh accounts from three years to one year.  The change would put the minimum  maturity on a consistent basis with tax law which has been changed to permit tax-free rollovers of IRA funds from one trustee to another to occur once a year rather than once every three years. The next two options are alternative plans for establishing a new one-year notice account that would permit regular additions to the account with interest paid on these additions at the original contract rate.  The  purpose of these options is to simplify the handling of periodic routine additions to IRA and Keogh accounts.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -6—  The fourth option would increase, revise, or eliminate the interest rate ceiling for IRA/Keogh accounts.  The fifth option would create a new type  of IRA/Keogh account with no ceiling rate and a minimum 14-day maturity. The Committee believed that the proposed changes would enable depository institutions to tailor IRA/Keogh plans to market circumstances and saver needs.  Individuals would thereby be encouraged to save for their retirement,  and the competitive position of depository institutions would be improved with respect to nondepository institutions. Petitions from American Bankers Association and others.  The Com-  mittee considered petitions from the American Bankers Association and other organizations to modify previous Committee actions relating to interest rate ceilings.  Three proposals were discussed, but the Committee decided to take  no action on any of them at that time. One issue was whether a higher ceiling rate of interest should be established on savings accounts than on interest-bearing transaction accounts at commercial banks.  The Committee was concerned that the lack of a differing  ceiling rate between these accounts at commercial banks complicates the interpretation of money supply data.  They agreed that if a differential were imposed,  it should be done by raising the ceiling rate on savings accounts rather than by lowering the ceiling rate on transaction accounts.  However, it was felt  that raising the rates on savings was not appropriate at that time, given its impact on the earnings of depository institutions, but that the issue would remain under continuing review by the Committee.  On a related matter, the  Committee also agreed to take no action on a petition to apply the ceiling rate on NOW accounts to all savings accounts accessible by electronic means.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -7-  The third issue concerned the request to make permanent the temporary authority, adopted for a six-month period at the May 28 meeting, that allowed commercial banks to roll over MMCs at the ceiling rate applicable to thrift institutions.  The Committee felt that since no differential between  bank and thrift institution ceiling rates on MMCs had applied for several months and since the rollover provision had been adopted to deal with a specific problem, there was no need to make the temporary provision permanent. B.  February 26, 1981, Action Temporary amendment on premium rule.  On February 26, 1981, the  DIDC announced a temporary amendment to its rule on the use of premiums, which had become effective on December 31, 1980.  The rule had allowed depos-  itory institutions to continue to offer premiums of gifts to depositors opening a new account and had increased the dollar value of permissible premiums to $10 for deposits of less than $5,000 and $20 for deposits of $5,000 or more. The rule also provided that no more than two premiums could be given to any account within a 12-month period. After the rule became effective, the Committee became concerned that a number of institutions were engaging in promotional activities that could undermine the intent of the rule by establishing and advertising programs in which a depositor's funds would be placed in multiple accounts, thus allowing the depositor to receive multiple premiums.  The temporary rule, announced and  effective February 26, prohibits depository institutions from soliciting or otherwise promoting deposits from customers on the basis that the funds will be divided into more than one account by the institution for the purpose of providing more than two premiums within a 12-month period.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -8-  The Committee asked for public comment on the temporary amendment and alternative measures by April 1, 1981. C.  Meeting of March 26, 1981 Implementation date on variable ceiling certificates.  At the March  26 meeting the DIX voted to change the implementation date for new ceiling rates on 26-week MMCs and 2-1/2 year or more SSCs to the business day following their announcement, effective April 7, 1981.  The ceiling rates, which for the  MMCs are tied to 26-week Treasury bill rates (auction average on a discount basis) and for the SSCs are tied to the 2-1/2 year yield on Treasury securities, are generally announced on Monday and, under the rule existing at the time of the meeting, became effective the following Thursday. At its December 12, 1980, meeting the DIDC had requested public comment on the proposal to shorten the lag between the announcement and implementation of the variable ceiling rates.  A major argument in support  of an earlier implementation date was that the two-day lag provided customers with a risk-free interest rate hedge that added to the interest costs of depository institutions.  If the new rate was lower than the old rate,  depositors had two days to lock in the higher rate; if the new rate was higher than the old rate depositors could postpone their deposits until Thursday when the higher rate became available.  The major argument against an earlier  implementation date was the potential for operational problems involved in obtaining the correct new rate, disseminating the rate to the institutions' branches and advertising the rate to customers. The Committee agreed to eliminate the lag and to make the implementation date of the new ceiling rate the day following the Treasury bill auction.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -9-  However, the Committee indicated that it might reconsider the issue if severe operational problems emerged. Possible bankruptcy exception to the early withdrawal penalty rule. At the December 12 meeting the DIDC had asked for public comment on a proposal to permit depository institutions to allow withdrawal of time deposits before maturity without penalty in the event of bankruptcy of a depositor.  After con-  sideration of the comments received, the Committee voted not to make an exception to the early withdrawal penalty rule in the case of depositor bankruptcy. Reconsideration of finders fee phaseout.  The DIDC considered a  petition to reconsider its action taken at the December 12 meeting granting qualifying institutions the right to phase out the use of finders fees in the solicitation of small denomination time and savings deposits.  The petitioners  asserted that the action provided an unfair advantage to a single institution and was arrived at improperly.  The Committee determined that there was no  competitive problem at the time since no institutions were offering finders fees under the phaseout rule.  In addition, the Committee's General Counsel  gave the opinion that there had been no improper communication and that the Committee's action was supported by the public record.  Therefore, the DIDC  reaffirmed its December 12 action. Deposit rate ceilings on interest-bearing transaction accounts and savings accounts.  Concern was again expressed that the ceiling rates on  interest bearing transaction accounts and savings accounts at commercial banks are at the same level.  As a result, depositors tend to merge accounts,  and deposits accumulated for different uses are thus not distinguishable for monetary policy purposes.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  However, the DIDC did not want to create a differen-  -10-  tial by lowering ceilings on transaction accounts since that would be inconsistent with the thrust of deregulation.  On the other hand, raising the savings  rate ceiling for commercial banks would legally require a similar increase in the ceiling for thrift institutions and increase their costs at a time when their earnings already were under pressure without significantly increa sing their deposit flows.  For these reasons, the Committee decided to take no  action but to continue to review the situation and take action to establ ish different ceiling rates as soon as possible. Strategies for deregulation.  Under the DIDMCA, the Committee is  authorized to administer deposit rate ceilings and to structure the phaseo ut of the ceilings.  The Act provides that the Committee can phase out the rate  ceilings by any or all of the following methods:  (1) gradually increase ceil-  ings applicable to all account categories, without exceeding market rates; (2) eliminate ceilings applicable to particular account categories; (3) create new types of accounts with no ceiling or with ceilings set at current market rates; (4) any other method; (5) a combination of any of these methods. A number of depository institutions had requested the Commit tee to adopt a longerterm plan for deregulation of deposit rate ceilings to facilitate their planning, and several industry groups had submitted recommendations for directions such plans could take.  At the March 26 meeting, the Committee discussed longer-  term strategies for deregulation and agreed that they would like to establish a fixed schedule for a phaseout of ceilings to the extent feasib le.  They  requested public comment by May 1, 1981, on two proposals. The first was a proposal to remove the present cap on the intere st rate that can be paid on small saver certificates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  At present, the rate ceil-  -11-  ing on these 2-1/2 year or longer time deposits is tied to the 2-1/2 year yield on U.S. Treasury securities subject to a cap rate of 12 percent at thrift institutions and 11-3/4 percent at banks.  This category of deposit would  continue to be subject to a rate ceiling based on the 2-1/2 year Treasury yield. The second proposal on which the Committee requested public comment was to establish a schedule for eventually deregulating all deposit rate ceilings by eliminating rate ceilings according to maturity categories.  Deposits  with maturities of five years or more would have no ceiling rates as of July 1, 1981; ceilings for deposits with four or five year maturities would be eliminated July 1, 1982; two to four year maturities--July 1, 1983; one to two year maturities--July 1, 1984; maturities of six months to one year-July 1, 1985; all remaining ceilings--April 1, 1986, as required by law.  The  Committee also would consider comment concerning deregulation by means of indexing ceiling rates to market rates according to the above schedule or any other alternatives. The Committee also discussed the question of restoring the differential in the ceiling rates on money market certificates but decided that reimposition of the differential would be contrary to the Committee's deregulatory mandate. Election of Chairman.  The Committee elected Secretary of the Trea-  sury Donald T. Regan to succeed Federal Reserve Board Chairman Paul A. Volcker as Chairman of the DIDC, effective on the date of the next meeting. tion of the Vice Chairman was deferred until that meeting.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  The elec-  -12-  II. A.  REPORT ON THE VIABILITY OF DEPOSITORY INSTITUTIONS  Background The Depository Institutions Deregulation and Monetary Control Act  of 1980 (DIDMCA) requires that each member of the DIDC report annually to the Congress on the economic viability of depository institutions.  Six months  after enactment of the bill, the Congress also requested an interim report, and my report was sent to Congress on September 30, 1980.  In the months  since the interim report was submitted, interest rates have risen, reaching historically high levels during the period, and deposit flows have weakened, in part in response to the relatively high yields on money market mutual funds (MMMFs) since the end of 1980.  Despite the slowing of deposit flows, the  institutions' liquidity remains ample.  However, the sharp increase in inter-  est rates has put growing pressure on their earnings.  Depository institutions  have become increasingly dependent on deposits whose rates fluctuate with market interest rates while, especially for thrift institutions, their asset portfolios are heavily weighted toward fixed rate long-term mortgages acquired when interest rates were much lower. The current problems of depository institutions will be alleviated as reduced inflation results in lower interest rates, and as thrift institutions take advantage of the new asset powers permitted by the DIDMCA and new, more flexible mortgage instruments.  Over the  longer-term, removal of deposit  rate ceilings also will strengthen the ability of the financial institutions to adapt to changing financial environments.  In the interim, however, until  the institutions' assets and liabilities come into better balance, the DIDC must continue to evaluate carefully the effects of its actions on the viability of depository institutions.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  B.  Differential The Depository Institutions Deregulation and Monetary Control Act  requires that in the report each member of the DIDC assess whether removal of any differential between rates payable on deposits by banks and those payable by thrift institutions will adversely affect the housing finance market or the viability of the thrift industry. The DIDC took no action to affect differentials in rate ceilings at its last two meetings.  At present, thrifts are permitted to pay a higher rate  than banks on certain types of accounts.  These include passbook savings  accounts, fixed ceiling time accounts, small saver certificates, and--when the Treasury bill rate is within the range of 7.25 percent and 8.75 percent-money market certificates.  There is no differential on the ceiling rates on  negotiable orders of withdrawal (NOWs), government accounts, individual retirement accounts (IRAs), Keogh accounts, and MMCs at most Treasury bill rates. The differentials on ceiling rates for thrifts, which were first instituted by regulation in 1966, were designed to help thrifts compete effectively with banks.  The higher rate permitted on thrift accounts was  intended to compensate for the thrifts' lack of the "one-stop" convenience enjoyed by commercial banks. The differentials probably have benefitted thrift institutions, although for savings accounts, banks' share of the total has increased since the mid-1960s, despite the differential.  Thrift institutions gained a larger  share of time deposits, however, when they were permitted to pay a higher rate on all of these deposits.  The possible effect of the removal of the differen-  tial on thrift time deposit flows is illustrated by the experience following the March 15, 1979, elimination of the thrift differential on MMCs over certain   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  bill ranges, an action taken before the DIDC was established.  After that  action, the relative flow of MMC funds to thrifts fell, resulting in a decline in the thrift share of outstanding MMC balances to about 55 percent recently. In contrast, thrifts' share of the flow of SSCs, the other major category accounting for growth of small time deposits, has been relatively stable at close to 70 percent of the total; thrifts have been permitted to pay a higher rate than commercial banks on these accounts since they were introduced in January 1980.  While the elimination of the differential on MMCs has reduced  flows to thrifts, it has probably assisted most the small to medium-sized banks with limited access to money markets and, through these banks, it has assisted the consumers, small businesses, and agricultural borrowers that depend on their credit extensions. Moreover, it is not clear that the lack of a differential on MMCs has significantly impaired the viability of the thrifts or the flow of funds to housing.  Given the short maturity of these deposit inflows it is unlikely  that these funds would have been channeled into mortgages.  Indeed, the differen-  tial on the SSCs, which have maturities of 2-1/2 years or longer, was maintained by the DIDC in part because it was felt that flows into these accounts were more likely to be used for mortgage lending.  The additional flows to thrifts,  had the differential on MMCs been retained, would have been obtained at relatively high money market rates, essentially substituting for money market borrowing or advances from the Home Loan Bank System, and therefore would have had only a small impact on earnings. It is not the absence of deposit flows, but rather the holdings of long-term, low-yielding assets that have been responsible for the current problems of some thrift institutions as deposit costs rose.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Current difficulties  -15-  in the mortgage credit market seem to result more from the inability or unwillingness of borrowers to pay high rates rather than to the unavailability of credit. The impact of further elimination of differentials would depend on the means chosen.  If the removal were effected by placing the same binding ceiling  on all institutions, thrift flows might be reduced as occurred in the MMC experience.  However, if the differential were removed through the elimina-  tion of all ceilings, as is eventually required under D1DMCA, the effect is less clear.  During periods when thrifts operated without ceilings, such as  prior to 1966 and during the wild card certificate experiment of 1973, they generally paid higher rates than commercial banks on similar types of deposits. If ceilings were removed thrifts could again choose to offer rates higher than those at banks.  However, given the current financial conditions and the com-  position of thrift asset portfolios, that step would exacerbate the current earnings pressure on the thrift institutions, which would seem to preclude a rapid elimination of all ceilings.  As thrift institutions are able to take  advantage of their new asset powers and flexible mortgage instruments, this consideration will become less important. During the transition to the ceilingless environment required by the DIDMCA, the Committee must consider the impact of removal of the differential on deposit flows and earnings pressures at thrifts and on the availability of funds for housing.  For these reasons the Committee has moved cautiously in  raising ceilings and eliminating differentials.  These concerns, however, must  be weighed against claims for equitable treatment by commercial banks and their borrowers, including small business and agriculture.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -16-  C.  Disintermediation The DIDMCA directs each member of the DIDC to report on "findings  banks and concerning disintermediation of savings deposits from insured s paying insured thrift institutions to uninsured money market innovator market rates to savers."  The principal such innovator has been money market  to include mutual funds which have been in existence since 1972 and have grown er over 100 funds with $118 billion in assets in over 6 million sharehold accounts.  Most of the expansion has occurred in the last two years; the level  table 1). of the funds' assets has more than doubled since January 1980 (see a The main reason for the growth of the funds is that they offer requireliquid asset with a relatively high yield and a low initial investment ment.  They have seemed especially attractive when short-term rates are high  years. and exceed longer-term rates, as has frequently been the case in recent MMMFs have been appealing to institutional investors--such as bank trust funds-for whom they offer a diversified portfolio at low management costs as an alternative to direct investment in money market instruments.  It has been  estimated that 40 percent of MMMF shares are from institutional investors, but MMMFs have also attracted household investments, thus obtaining funds that would otherwise be placed in the money market directly or at depository institutions.  Because of government regulations and constraints imposed by asset  portfolios, banks and thrift institutions are handicapped in offering the public an instrument that is as attractive as MMMF shares.  Money market certif-  icates pay a relatively high rate but require a minimum deposit of $10,000 early and a minimum maturity of six months with substantial penalties for withdrawal.  Small saver certificates offer a low minimum deposit, but a longer  maturity and, currently, a lower yield than MMCs or MMMFs.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Passbook savings   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -17-  TABLE 1 MONEY MARKET MUTUAL FUNDS (Billions of dollars, not seasonally adjusted)  End of Month  Level  1980-January February March  53.0 60.3 60.5  April May June  60.7 70.0 76.2  July August September  80.6 79.3 77.4  October November December  77.5 76.5 74.4  1981-January February March  85.0 96.7 111.5 118.5  1/  As of April 29.  -18-  accounts and interest bearing transaction accounts have the liquidity and low minimum deposit characteristics but a low rate of return. Although it is impossible to determine with certainty where the flows to these funds might otherwise have been directed, the rapid growth of MMMFs has been a cause for concern for the depository institutions and their regulators.  MMMF shares lack the insurance characteristics and guaranteed  rate of return of a bank or thrift institution deposit, but in many other respects they are similar to savings accounts and to some extent, even interest-bearing transaction accounts, given the ability of shareholders to redeem their investments by a check written to a third party (usually with a relatively high mininum size requirement).  Thus, the lack of reserve requirements, inter-  est rate ceilings, and any other bank-related regulations on MMMFs has raised the question of competitive inequity with respect to banks and thrift institutions.  Moreover, to the extent that MMMFs are used as transaction accounts,  some regulation may be necessary to gain closer control of the money supply. Several possible solutions to these problems have been offered by industry sources and others; these include placing interest rate ceilings on MMMFs or placing restrictions on how they may invest their assets.  A disadvan-  tage of many of these proposals is that they would extend the scope of regulation of financial markets at a time when efforts generally are being directed to free markets from unnecessary governmental interference.  Another problem  would be that the small savers who do not have the ability to move their funds to other money market instruments would receive a lower return on their savings, perhaps discouraging some much-needed saving in the economy. An additional proposal is to place reserve requirements on MMMFs. Under DIDMCA, financial institutions eventually will be required to hold   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  reserves on transaction accounts at the rate of 3 percent on the first $25 million and 12 percent on the remainder.  Congress could place similar require-  ments on MMMFs, or at least on that portion of MMMF shares whose redemption characteristics make them functionally equivalent to transaction accounts at banks and thrifts.  Under this proposal, the return on MMMFs offering such  services would be lower, and a source of the competitive inequity might be removed.  MMMFs would then probably segregate accounts intended for transaction  purposes from those intended for longer term savings, which could improve the ability of the Federal Reserve to control and interpret movements in the monetary aggregates. However, it is not clear that a reserve requirement on MMMF transaction accounts would result in a substantial inflow to depository institutions.  Many of the shareholders, especially of institutional accounts, who  have the ability would move their funds to other money market instruments when MMMF yields declined because of reserve requirements.  Most evidence  indicates that household shareholders on average do not use their accounts as transaction balances; it seems likely, therefore, that if MMMFs were able to minimize the impact of reserve requirements by restricting access to their accounts or by setting up special transaction account funds, a reserve requirement option might have only a little impact on their ability to attract household funds. D.  Recommendations Under the DIDMCA, each member of the DIDC is asked to make recom-  mendations on measures to encourage savings, provide equitable treatment of small savers, ensure a steady and adequate flow of funds to thrift institutions and the housing market, and maintain the economic viability of depository institutions.  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -20-  In recent years, the personal savings rate in this country has declined to very low levels by historical standards.  A large part of the decline  is attributable to the rapid rate of inflation which has encouraged a "buy now" psychology.  By pushing taxpayers into higher brackets, inflation also  has reduced the real, after-tax rates of return to savers and the after-tax cost of borrowing. The most important step that can be taken to encourage savings is to reduce inflation.  In that regard, Federal Reserve monetary policy is  focussed on a staged reduction in the rate of growth of the money supply to levels consistent with a return to price stability.  This goal will be realized  more quickly and with less strain on financial markets if monetary policy is complemented by fiscal policies of the Congress and the Administration aimed at reducing Federal expenditures and the Federal deficit. Another step that could be taken to encourage savings and investment is to make changes in our tax system.  As currently structured, this system  is biased against both saving and investment, especially when inflation is strong and interest rates high.  A significant reduction in Federal spending  will set the stage for the possibility of tax reductions which could alleviate these problems.  Tax-related disincentives would be reduced to some extent by a  cut in tax rates across the board.  Other options have been mentioned that would  structure tax reductions with an eye to stimulating savings.  However, most  proposals--such as those that exclude a portion of interest income from taxation--would mainly reduce taxes for those who would save in any case, with little impact on the incentive to increase savings; at the same time, they would increase the Federal borrowing requirement as a result of the reduction in tax receipts.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Therefore, unless taxes on consumption are raised to compen-  -21-  sate for the loss in receipts, tax relief targeted to stimulate savings must be designed to encourage a large amount of new savings while having little impact on the taxation of existing savings.  It appears to he extremely diffi-  cult to structure a proposal that meets these criteria for cost-effectiveness. Deregulation of interest rates at depository institutions on both the borrowing and lending sides would also tend to encourage savings. Artificial constraints on lending rates stimulate demand for borrowing in an inflationary environment, while limits on rates paid on deposits discourage saving--especially for smaller savers with limited access to money market instruments.  Of course, one of the major purposes of the Congress in the pas-  sage of the Depository Institutions Deregulation Act was to enable small savers to receive a market rate of return on their savings, as soon as it becomes economically feasible for depository institutions to pay such a rate.  Under  the existing law, the DIDC has sufficient authority to effect an orderly phaseout of deposit rate ceilings.  Progress towards this goal, as rapidly as possible,  must be a keystone of any program to stimulate saving. The DIDC currently has proposals out for public comment on steps that could raise rates available to all savers.  First, the Committee has  requested comment on a proposal to remove the cap on the SSC and let its rate ceiling be tied at all levels to the yield on similar maturity U.S. Treasury securities.  The second proposal would eliminate rate ceilings more generally,  proceeding by maturity of deposit, with ceilings on longer maturity deposits being removed first.  Comments on both of these proposals were requested by  May 1 and will be considered at the Committee's next meeting. With a phaseout of deposit rate ceilings, it will be necessary for depository institutions, especially thrift institutions, to adjust their   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -22-  portfolios in order to be able to pay market rates of interest on deposits. As thrift institutions take advantage of the expanded asset powers permitted to them under the DIDMCA and increase their usage of innovative alternatives to conventional fixed-rate mortgages, they will be in a better position to offer market rates on deposits without severely reducing their earnings.  The  ultimate result will be more equitable treatment of small savers and a steadier flow of lending by thrifts in the mortgage market, although the total flow of funds to mortgages over time may not be appreciably larger. Although the thrift institutions have received a wide range of new powers to help them withstand the interest rate cycle, currently the major problem for the thrift industry and the housing market is a continuing high rate of inflation and the concomitant high level of interest rates.  The  best way to solve the current problems of the thrift and housing industries is to continue to make the reduction of inflation the highest priority of both fiscal and monetary policies.  The sooner policies are put into effect  to reduce significantly the Federal budget which would complement a continuing monetary policy of slowing the growth of the money supply, the sooner inflation will be reduced and the sooner the outlook for the thrift institutions will improve.  In the interim, interested regulatory agencies are studying measures  that may be desirable during the transition period to assure the continued soundness of these institutions.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  September 30, 1980 4  DEREGULATION COMMITTEE REPORT OF ACTIVITIES OF THE DEPOSITORY INSTITUTIONS AND OF DEPOSITORY INSTITUTIONS ITY VIABIL THE ON REPORT BY PAUL A. VOLCKER, CHAIRMAN  I. A.  COMMITTEE ACTIONS OF THE DEPOSITORY INSTITUTIONS DEREGULATION  Meeting of May 6 tory Institution At its organizational meeting on May 6, the Deposi  zation and Procedure, Deregulation Committee (DIDC) adopted Rules of Organi Rules Regarding Public Rules Regarding Availability of Information, and Observation of Meetings.  the The DIDC also adopted two rules concerning  payment of interest on deposits.  The first rule authorized depository insti-  any time without penalty all tutions to permit a depositor to withdraw at renewed automatically on the interest earned on a time deposit that has been st) as the original deposit. same terms (same maturity and same rate of intere l Deposit Insurance CorporaThis action conformed the rules of the Federa the Federal Home Loan Bank tion (FDIC) and Federal Reserve with those of Board (FHLBB).  utions to continue The second rule authorized depository instit Both  days after maturity. to pay interest on time deposits for up to seven depositors at all institutions of these actions were designed to allow decisions. increased flexibility in making investment B.  Meeting of May 28 the ceiling rates of At its meeting on May 28, the DIDC raised  certificate ("MMC") and on interest payable on the 26-week money market icate ("SSC"), effective for MMCs the 2-1/2 year or longer small saver certif issued beginning on June 2. issued beginning on June 5 and for SSCs  The  to enable depository institutions primary objectives of these actions were against such investment outlets as to compete more effectively for funds   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2rities, and to provide consumers money market mutual funds and Treasury secu ngs. with a higher rate of return on their savi  By allowing depository institu-  er returns, these changes were tions the flexibility to offer somewhat high s, thus enhancing credit flows expected to facilitate larger deposit flow ions. (The ceiling rates on MMCs to the markets served by depository institut and money market mutual funds and SSCs and the yields on Treasury securities e 1). over the last six months are shown in Tabl MMC:  of interest payable Under the rules adopted, the ceiling rate  percent higher than the rate on the MMC by all institutions is at least 1/4 tion average on a discount basis). established for 6-month Treasury bills (auc or higher, both commercial banks When the Treasury bill rate is 8-3/4 percent ceiling rate of 1/4 percent and thrift institutions may pay interest at a above the bill rate.  the ceiling A differential of up to 1/4 percent between  is retained when the Treasury rates payable by commercial banks and thrifts than 8-3/4 percent. bill rate is more than 7-1/4 percent but less  The rule  of 7-3/4 percent which all institutions also established a minimum ceiling rate 4 percent or below. The minimum may pay when the Treasury bill rate is 7-1/ fact that Treasury security yields ceiling was adopted in recognition of the s but usually lead declines are not only generally below other market rate in other rates available to savers.  A minimum ceiling thus puts institu-  s from market instruments at tions in a better position to attract fund ion choose to do so. lower rates of interest, should the institut  In addition,  effective, institutions would at rate levels that make the minimum ceilings tion to be able to bid for funds. be in a relatively favorable earnings posi ent of somewhat wider latitude Moreover, the experience gained in an environm   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Table 1 • Rates of Return on MNCs and Alternative Investments (percent)  -month Treasury Bill Rate 6-month InvestRate  Yield  Commercial Bank MNC Rates Old Rule New Rule Effec2/ 2/ tivenal tivenal  1980 Week Ending 2 April 9 16 23 30  15.70 14.80 14.23 13.55 11.89  18.04 16.88 16.15 15.29 13.24  7 14 21 28  10.79 9.50 8.78 8.92  11.91 10.37 9.54 9.70  4 11 18 25  7.75 8.17 6.94 6.66  8.35 8.82 7.42 7.11  8.42 7.75 7.75  July  2 9 16 23 30  7.11 8.10 8.11 8.11 7.91  7.62 8.74 8.76 8.76 8.52  Aug.  6 13 20 27  8.28 8.87 8.89 9.77  Sept.  3 10 17 24  10.25 10.25 10.23 10.88  May  .June  * Footnotes on next page.  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Thrift MMC Rates Old Rule New Rule mi- Effec- Nomi- Effec2/ tive nal tivenal 16.55 15.57 14.95 14.21 12.42  15.04 15.56 16.03 16.32 16.03  15.80 17.00 15.46 13.90  10.79 9.50 9.00 9.00  11.24 9.86 9.33 9.33  15.52 13.61 12.72 11.99  11.89 9.93 10.06 8.76  8.98 8.01 8.01  8.00 8.42 7.19 6.91  8.28 8.71 7.42 7.13  10.73 10.63 9.79 9.19  8.16 8.16 7.76 7.53  7.75 8.60 8.61 8.61 8.41  8.01 8.91 8.93 8.92 8.71  7.36 8.35 8.36 8.36 8.16  7.56 8.64 8.66 8.66 8.44  8.66 8.82 8.57 8.43 8.13  7.50 7.83 7.71 7.50 7.76  8.78 9.12 9.14 10.02  9.10 9.46 9.48 10.41  8.53 9.12 9.14 9.77  8.83 9.46 9.48 10.15  8.20 8.22 8.12 8.43  8.34 8.17 8.24 -- 6/  10.66 10.50 10.66 10.50 10.64 10.48 11.34 11.13  10.93 10.93 10.91 11.60  10.25 10.25 10.23 10.88  10.66 10.66 10.64 11.34  8.96 8.93 9.01 n.a.  16.55 15.57 14.95 14.21 12.42  10.79 9.50 8.78 8.92  11.24 9.86 9.10 9.25  8.71 8.01 8.01  7.75 8.17 6.94 6.66  8.02 8.45 7.16 .6.87  8.67 7.75 7.75  7.75 8.35 8.36 8.36 8.16  8.01 8.64 8.66 8.66 8.44  7.11 8.10 8.11 8.11 7.91  7.34 8.38 8.40 8.39 8.18  8.95 9.64 9.66 10.69  8.53 9.12 9.14 10.02  8.83 9.46 9.48 10.41  8.28 8.87 8.89 9.77  8.57 9.20 9.22 10.15  11.26 11.26 11.24 12.01  10.50 10.93 10.25 10.50 10.93 10.25 10.48 10.91 10.23 11.13 11.60 10.88  ----  1/ MMNF Average 7-day net yield First Generation Clones  15.70 14.80 14.23 13.55 11.89  15.70 14.80 14.23 13.55 11.89  •••  .11  AP AMP  --  Lk)  Table 1 (Cont'd) Rates of Return on 2-1/2 year-or-Longer Small Saver Certificates (percent) Constant Maturity 2-1/2 Year Treasury Bond  1980 Monthly January February March April May  July  Sept.  10.15 10.40 11.75 11.75 10.50  10.84 11.12 12.65 12.65 11.23  10.40 10.65 12.00 12.uU 10.75  11 12 11.40 12.94 12.94 11.51  9.05 9.00  9.25 9.25  9.83 9.83  8.30 8.30  8.78 8.78  9.50 9.50  10.11 10.11  8.55 8.55  9.06  8.60 9.05  9.25 9.25  9.83 9.83  7.85 7.85  8.28 8.28  9.50 9.50  10.11 10.11  8.10 8.10  8.56 8.56  g  _9.05 9.70  9.25 9.45  9.83 10.05  8.30 8.95  8.78 9.50  9.50 9.70  10.11 10.33  8.55 9.20  9.06 9.77  3 17  10.25 11.50  10.00 11.25  10.67 12.08  9.50 10.75  10.11 11.51  10.25 11.50  10.95 12.36  9.75 11.00  10.39 11.80  1  11.05  11.85  10.55  11.29  11.30  12.14  10.80  11.30  11.57  9 23  Oct.  1/ 2/ 3/  Old Rules Effective  IRTaTzi  10.90 11.15 14.00 14.65 11.25  2 Weeks Ending 11 June 25 •  nriftf I Comm rcial Banks a, New Rules jj a/ Old Rules New Rules 11;;171;i1 Effective Nominal Effective jNominal I Effective! 7  •  Includes any eapital gains or losses. at the same rate for another six months. The effective rate astumes reinvestment of principal and interest percent at banks are establiahed.. Minimum ceiling rates"of 9-1/2 percent at thrifts and 9-1/4 Maximum rates set in March will continue. and may pay the 2-1/2 year Treasury securities rate Between the minimum and maximum rates payable, thrifts banks may pay this rate less 1/4 of a percentage point. business based on average daily yields for the five The rate will change bi-weekly beginning Monday, June 2, following Thursday. days ending every other Monday, and will be effective the remains at banks which was set in February 1980 percent 11-3/4 The temporary cap of 12 percent at thrifts and  in effect. Treasury securities. each month, based on average 2-1/2 year yield on of day calendar first on changed ceiling Rate 4/ on the average daily the first day of the month, andime based This yield Nes announced three business days prior to yields for the preceding five business days. respectively, below the 2-1/2 3/4 and 1/2 of a percentage point, Nominal ceilings at banks and thrifts were year Treasury securities yield. day basis. 5/ The effective rate assumes continuous compounding on a 365/360 ion between clone and other MMNFs. distinct the ended ent requirem "g/ The removal of the special deposit  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -5-  in rate setting may serve the depository institutions well as we move toward wider deregulation. Under the previous rules, the maximum rate of interest payable by commercial banks on MMCs was the Treasury bill discount rate.  The maximum  rate of interest payable by thrift institutions on MMCs was 1/4 percent above the Treasury bill discount rate when that rate was less than 8-3/4 percent, 9 percent when the Treasury bill discount rate was between 8-3/4 percent and 9 percent, and the Treasury bill discount rate when that rate was above 9 percent.  Thus, under the former rules, when the Treasury bill discount  rate was 9 percent or above, there was no differential between the ceiling rates payable on MMCs by banks and thrifts. In establishing the new MMC rate ceilings, the DIDC also faced the prospect that the decline in Treasury rates then occurring would reintroduce a differential on MMCs in favor of thrifts.  In this regard, commercial banks  that are relatively large lenders in the mortgage, small business, and agricultural credit markets--and which, especially in the agricultural credit market, tend to be quite small--had a large volume of MMCs scheduled to mature in the late spring and early summer.  Such institutions could have  faced substantial deposit attrition and subsequent pressure on their ability to extend credit if the differential reemerged for a sustained period.  In  view of these concerns, while permitting the differential to reappear if market rates declined somewhat from the May levels, the D1DC also gave commercial banks the one time option of renewing maturing MMCs with the same depositor at a rate equal to the thrift ceiling rate for a period of six months (May 29 through November 30, 1980).   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1 -6-  SSC.  for the same reasons as the MMC ceiling adjustment--to increase  flows to depositors institutio ,---new SSC ceiling rates for all institutions were established that are 1/2 lercent higher than the previous ceilings.  As  in the case oi MMCs, and for the same reason, the rule also established minimum ceiling rates payable on SSCs.  These minimum ceiling rates are 9-1/4  percent for commercial banks and 9-1/2 percent for thrift institutions, regardless of the average 2-1/2 year yield for Treasury securities.  The 1/4  percent differential between the ceiling rates payable on the SSC by banks and thrift institutions was left intact because these longer-term deposits were considered particularly appropriate to the maturity structure of thrift institutions' asset portfolios and provide a more solid base and incentive for mortgage lending. Under the new rule, the ceiling rate for thrift institutions is the higher of 9-1/2 percent or the average 2-1/2 year yield for Treasury securities. The ceiling rate for commercial banks is the higher of 9-1/4 percent or the average 2-1/2 year yield for Treasury securities less 1/4 percent.  The  maximum ceilings of 12 percent (for thrift institutions) and 11-3/4 percent (for commercial banks) imposed on the SSCs by the federal financial supervisory agencies effective February 27, 1980, were retained.  In addition,  the new rule provides that the ceiling rate payable on SSCs will be determined biweekly. monthly.  Under the previous rules, the ceiling rates were determined  For thrift institutions the ceiling rate of interest on SSCs formerly  was 12 percent or 1/2 percent below the 2-1/2 year Treasury rate, whichever was lower; for commercial banks the ceiling rate formerly was 11-3/4 percent or 3/4 percent below the 2-1/2 year Treasury rate, whichever was lower.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -7-  Growth of savings and small-denomination time deposits has accelin the erated substantially at banks and thrifts since the May adjustments ceiling rates on MMCs and SSCs, as shown in Table 2.  However, much of the  of deposit growth in recent months is attributable to a tremendous influx savings deposits, the ceiling rate on which had not been adjusted.  Most  ng" of observers feel that the deposit growth reflects a temporary "parki permanent deposits by the public which will later be used to acquire more r. financial assets after the interest rate outlook becomes cleare  Although  s since the banks and thrifts have experienced net outflows of MMC balance been more than spring, such outflows have moderated most recently and have s of the 30-month offset at both banks and thrift institutions by larger inflow for thrifts on SSCs SSCs; the advantage of the 25 basis point differential s. has had the effect of larger relative inflows for thrift  Presumably, the  of institutions growth of small denomination time deposits at both sets actions of late would have been lower, or even negative, without the DIDC market yields since May--especially after taking account of the increases in •  June.  s The acceleration of total small-denomination time and saving at lower interest deposits flows, in combination with stronger loan demand ty. rates, has contributed to a pickup in mortgage activi  At S&Ls, mortgage  of decline, commitments rose slightly in June after eight straight months billion in July and a and outstanding commitments moved up a sizable $3.0 further $3.1 billion in August.  Mortgage holdings of S&Ls, which actually  g a $1.6 billion declined in May and June, began to turn up in July, postin (see Table 3). gain, and a further $3.6 billion gain in August   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Real estate  Table 2 Composition of Deposit Flaws of growth) 1/ (Seasonally adjusted, percentage annual rate All Depository Institutions Total Small Denomination Savings & Small Time Savings Time Deposits Deposits  Commercial Banks Total Small Denomination Savings & Small Time Savings Time Deposits Deposits  Savings Deposits  Thrifts Small Denomination Time Deposits  Total Savings & Small Time  1980--Jan. Feb. March  -14.1 -25.1 -33.6  9.5 17.4 29.0  0.3 1.1 5.5  -12.4 -22.5 -35.6  21.9 25.9 42.5  6.6 4.7 9.0  -15.2 -27.7 -31.7  2.3 12.5 20.8  -3.8 -1.4 3.1  April May June  -44.7 -14.6 27.8  36.1 16.5 2.7  6.9 5.6 11.3  -43.3 7.0 32.4  54.4 14.0 -2.8  14.1 5.7 10.9  -45.5 -21.3 23.7  24.9 19.0 5.2  1.8 6.3 10,8  July (prelim) 38.2 Aug. (prelim) 28.0  -3.6 1.0  10.8 10.6  39.2 25.9  -3.2 0.1  13.6 10.4  37.2 29.1  -3.9 1.8  8.9 10.5  adjusted Flows in billion of dollars, not seasonally Sum of MU and SSCs 30-month SSCs 6-month MICs Thrifts Banks Commercial Banks Thrifts Commercial Thrifts Commercial Banks Memo:  1980--April May June July August 1/  19.3 -2.7 -3.4  17.0 -5.6 -5.2  2.8 4.6 4.2  7.2 9.1 6.3  22.1 1.9 .8  -4.3 -.9  -7.7 -.8  4.5 1.5  8.4 3.1  .2  t data are average of month ends. Commercial bank data are daily average, and thrif   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  24.2 3.5 1.1 .7 2.3  , 03 '  II  &   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  - 9 _  Table 3 Net Change in Mortgage Loans at Thrift Institutions (Billions of dollars, seasonally adjusted) S&Ls  Total  .2 .3 __  2.1 2.2 1.6  2.3 2.5 1.6  April May June  .1 -.2  .6 -.5 -.3  .6 -.4 -.5  July August  -.1 n.a.  1.6 3.6  1.5 n.a.  Mutual Savings Banks 1980-January February March  -10-  a contraction lending by small commercial banks has behaved similarly, with in July and in such loans in the second quarter and renewal of expansion August (Table 4). Early withdrawal penalty:  At its May 28 meeting, the DIDC also modi-  withdrawal of fied the rule requiring the imposition of a penalty for early time deposits.  The new rule increased the minimum penalty in the early months  ent months of a deposit's life, while leaving the minimum penalty in subsequ virtually unchanged.  The new rule adopted by the DIDC requires imposition  interest on of a minimum penalty of an amount equal to three months simple deposit is three the funds withdrawn where the original maturity of the time withdrawn months to one year and six months simple interest on the funds year. where the original maturity of the time deposit is more than one months is Where a time deposit with an original maturity of less than three equal to paid before maturity, the penalty is the forfeiture of an amount withdrawn at the amount of interest that could have been earned on the funds until maturity. the simple interest rate if the funds had remained on deposit exceed the Under the previous rules, the minimum required penalty did not interest accrued or already paid on the time deposit.  Under the rule  principal adopted by the DIDC, the penalty may require a reduction in the of a sum of the deposit where funds are withdrawn in the early months a deposit's life. The penalty rule was modified in view of the DIDC's apprehension inflows to that lenders may not be willing to commit additional deposit those deposits mortgage and other credit markets because of their concern that ently rose. would be rapidly withdrawn before maturity if market rates subsequ   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -11-  Table 4 Bank Loans By Class of Banks (Billions of dollars, seasonally adjusted) Large Banks  Small Banks Real estate loans  Business loans  5.2 5.7 1.7  4.5 6.3 .8  -1.8 -.5 -.9  -3.6 -1.8  -2.4 -4.4 -3.3  -2.1 -6.5 -2.2  -.7 .6  .5 - .9  .8 0  - .9 7.3  .3 1.6 .9  April May June  -.6 -.3 -.6  July August  1.0 .3   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Total loans  3.3 2.9 .4  1.6 1.2 .4  1980 January February March  Other loans  Total loans  -12-  In the environment of rising interest rates in late 1979 and early 1980, the volume of withdrawals prior to maturity for the purpose of acquiring higher yielding deposits--often at the same institution--rose sharply because, under the former penalty rule, the amount of the penalty in the early months of a deposit's life was not sufficient to offset the gain from reinvestment. Technically, this reflected the provision that the minimum required penalty was imposed only on accrued interest and did not require a reduction in the amount of the original deposit; in the early months of a deposit's life, there was insufficient accrued interest to act as a deterrent to early withdrawal when interest rates are rising appreciably.  Under these circumstances,  depositories moved to protect earnings by investing the proceeds of MMCs and SSCs in money market instruments, rather than making loans. While the DIDC was aware that the depositor who breaks a deposit contract by withdrawing the deposit prior to maturity may be concerned upon finding the principal reduced by early withdrawal penalties, a similar situation would also occur if an investor were to liquidate a market security prior to maturity in a rising rate environment.  In the DIDC's opinion, the  revised early withdrawal penalty rule was especially appropriate in view of the growth in deposits with yields linked to market instruments.  The bene-  fit that individuals receive via the higher rates available on such deposits has to be balanced with the need to maintain flows to various credit markets. This can be facilitated by having depositors share some of the interest rate risk that traditionally has been borne by depository institutions, a risk that appeared to be limiting the willingness of the institutions to commit funds to their traditional credit markets.  Nevertheless, at the September 9  meeting, the Committee directed its staff once again to review the early   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  withdrawal penalty rule, including in particular the possiblity of defining "emergency" provisions that, in specified circumstances, might permit early withdrawal with no or minor penalty. C.  Meeting of June 25 At its meeting on June 25, the DIDC adopted a rule providing that  a penalty need not be applied to a withdrawal from an IRA or Keogh account time deposit prior to maturity if the owner is disabled or age 59-1/2 or over.  This rule conformed the rule of the Federal Home Loan Bank Board  to the rules previously adopted by the Federal Reserve and FDIC.  The  rules of the FHLBB formerly permitted exemption from the early withdrawal penalty only when withdrawal was made to effect a taxable distribution of the account. D.  Meeting of September 9 At its meeting on September 9, the DIDC adopted rules concerning  the use of premiums, finders' fees, and the prepayment of interest. comment was solicited on these rules on May  Public  6, 1980, and the comment period  expired on July 16, 1980. Premiums.  The issue of premiums offered as gifts to depositors has  been controversial, with both sides bringing cogent arguments in defense of their positions before the DIDC.  The issue arose because some depository  institutions were allocating their costs of the gifts given as premiums in such a way as to avoid the intent of the rule, viz., to permit only a de minimis gift to a depositor.  The Committee had proposed to ban premiums out-  right in view of the considerable difficulty the agencies were encountering administering their premium rules, but at its June meeting the Committee   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4  -14-  until the end announced that any implementation of a ban would be delayed suppliers could of the year, in order that thrift institutions and premium make plans for the fall season.  After reviewing the more than 5,000 public  tions to comments laceived, the DIDC decided to permit depository institu time of opening a continue to offer premiums of gifts to depositors at the . new account or adding to or renewing an existing account  However, in order  ee increased to make the premium rule effective and enforceable, the Committ deposits of less than the dollar limits of permissible premiums from $5 for $20, respectively, $5,000, and $10 for deposits of $5,000 or more to $10 and associated with the and specified that the new cost limits include all costs premium offered (shipping, handling, packaging, etc.).  In addition, deposi-  certifies compliance tory institutions are required to prepare a statement that with the new premium rule.  This statement will be reviewed in the course of  the examination process. Finders' fees.  The Committee had also proposed to treat finders'  institution fees paid to third parties who bring depositors to a depository ning comas a payment of interest to the depositor for purposes of determi pliance with deposit ceiling rate limitations.  This proposal was made in  to the depositor view of evidence suggesting that such fees were being passed on and, hence, being used to avoid deposit rate ceilings.  The Committee at its  paid in cash September meeting adopted a rule requiring that such fees be for purposes of and be regarded as the payment of interest to the depositor ions. determining compliance with deposit ceiling rate limitat  Certain incen-  were exempted tive programs for the employees of a depository institution comment on a from this rule, and the Committee also is soliciting public   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  von&  F  —15—  proposal to permit a two-year phase-out of finders' fees by those institutions that have relied heavily on such fees. The Committee also adopted a rule prohibiting the prepayment of interest in either cash or merchandise. The premium, finders' fees, and prepayment of interest rules, which apply only to deposits subject to ceiling interest rate limitations, were ely adopted to facilitate the administration of such ceilings fairly and effectiv during the phase-out period.  The rules are effective December 31, 1980.  Rate ceilings on interest-bearing transaction accounts.  The legis-  toward lative history of P.L. 96-221 indicates that the DIDC should work rate ceiling parity on transaction accounts at all institutions.  Consequently,  ceilings public comment was requested on June 25 on four options for uniform mutual savings on interest-bearing transaction accounts at commercial banks, banks, and savings and loan associations.  •  The DIDC proposed to define trans-  subject to automatic action accounts to include NOW accounts, savings accounts rized nonnegotiable transfer (ATS), telephone transfers (TTS), and preautho to third parties transfers (PNTS), and savings accounts that permit payments unit (RSU) or by means of an automated teller machine (ATM), remote service other electronic device.  In addition, the DIDC proposed to establish a  ceiling rate uniform ceiling on transaction accounts that would be below the of interest on "regular" savings accounts.  A spread would help the Federal  for the Reserve distinguish between transaction and liquid asset accounts purpose of monitoring the growth of transaction balances.  However, to achieve  a spread between both rate ceiling uniformity on transaction accounts and require either a roll-back such accounts and all regular savings accounts would or an increase in the passbook in the ceiling rate on some transaction accounts earnings. ceiling rate that could further erode thrift   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 0  -16-  DIDC decided After considering over 750 comments on its proposals, the ceiling rate of interest to take action at this time only with reference to the tions are authorized payable on NOW accounts; on December 31, 1980 all institu 5 percent ceiling to pay 5-1/4 percent on NOW accounts as compared to the Jersey. presently authorized in New England, New York, and New  The ceiling  left unchanged. rates of interest payable on all other accounts were  In  for monetary policy taking this action, the DIDC recognized the importance on transaction and of a spread between the ceiling rates of interest payable any transaction account nontransaction accounts, but did not wish to roll back should be further ceiling and did not believe that the earnings of thrifts • at this time. However, rate g ceilin k passboo the in se increa strained by an k savings ceiling rate the DIDC announced its intention to raise the passboo by law a 25 basis point as soon as feasible, hopefully in 1981; in any event, red by the DIDC no later increase in the passbook ceiling rate must be conside than September 30, 1981. Time deposits with maturities of 14-29 days.  The third action taken  a deposit ceiling rate by the DIDC at its September 9 meeting was to establish on time deposits of for banks that are members of the Federal Reserve System s) of 14 - 29 days. under $100,000 with original maturities (or notice period The rate established for such deposits is 5-1/4 percent.  The DIDC's action  shortening the minimum was prompted by the recent action of the Federal Reserve maturity of time deposits from 30 to 14 days.  The DIDC also announced that in  in the future to shorten the event the FDIC and the FHLBB take similar action institutions under their the minimum required maturity of time deposits for st payable on such time jurisdiction to 14 days, the ceiling rate of intere commercial banks and 5-1/2 deposits will be 5-1/4 percent for insured nonmember s and loan associations. percent for insured mutual savings banks and saving   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •L  -17-  II.  FINDINGS ON DISINTERMEDIATION  The Deregulation Act directs each member of the DIDC to evaluate the degree to which uninsured money market innovators paying market rates have contributed to disintermediation at depository institutions. of small investors has grown impressively in recent years.  The sophistication  Many investors  have discovered that the yield and liquidity characteristics of money market instruments, and money market mutual funds that buy them, to be superior to deposits for many purposes--an advantage that reflects to a substantial extent the ceilings applicable to deposit rates at banks and thrifts.  This increasing  familiaity with attractive alternatives to deposits has meant that changes to in relative yields have led to episodes of large diversions of deposits market instruments, probably with the most impact on the availability of t their credit at smaller institutions that have limited ability to supplemen deposits with managed liabilities. This distortion of credit flows was particularly serious when overall financial conditions were unusually taut early this year.  Substantial funds  were flowing into the central money markets where yields were highest, severely reducing the availability of credit in local markets across the country.  A  significant share of this diversion reflected the rapid growth of money market mutual funds.  In this environment, under the authority of the Credit Control  increase in the Act, a 15 percent special deposit requirement was placed on any the total assets of money market mutual funds, effective March 14, to restrain normal distrigrowth of credit through these funds and hence encourage a more bution of credit growth in local financial markets.  The deposit requirement was  d in July after the lowered two month& later to 7-1/2 percent and was eliminate became available pressures in financial markets eased sufficiently and credit interest rates. to a wide variety of borrowers at lower   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4  -18-facing There has been a relaxation of the immediate difficulties and money funds small banks and thrifts in competing with market instruments spring. since the period of extremely high interest rates in the  The raising  a better competiof the ceiling rates on MMCs and SSCs in May contributed to e in market rates tive position for depositories, as has the recent increas rates above yields which, for some short period, will raise deposit offering in portfolio available on money fund shares since the latter still have assets acquired at lower yields.  But there are obvious limitations on the  solution to the extent to which raising ceiling rates can be a short-term earnings of the problem of disintermediation, given the existing assets and institutions.  the next Even when the deregulatory process is completed over  operate under five and one-half years, depository institutions will still issuers of much more restrictive regulations than Money funds or direct onal time debt, including reserve requirements on transaction and nonpers accounts. on There are also economic limitations on placing constraints market alternatives that compete with depositories for funds.  The recent  on the money experience with the imposition of special deposit requirements s of selective funds helps to illustrate an important limitation of program restraints on money market instruments:  many investors are in a position to  lower the net returns turn to higher-yielding alternatives when new regulations of specific financial assets.  When the offering rates on the money funds  , noncompetitive declined after the special deposit requirements were applied (table 5), tenders in the weekly Treasury bill auctions surged to record levels ed debt maras investors who were able to do so bypassed the funds and purchas ket instruments directly.  To be sure, the imposition of special deposit require-  to local markets, ments on the money funds did assist in redirecting credit flows   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  - 19 -  Table 5 Selected Investment Alternatives for Small Investors (Billions of dollars, not seasonally adjusted)  Money Market Mutual Funds 1/ Change Level-  Noncompetitive Tenders in Weekly Treasury Bill Auctions (Monthly Average)  Net MMC Flows at Depository Institutions 1/ Change Level-  1980January February March  53.0 60.3 60.5  7.8 7.3 .2  1.25 1.12 1.68  291.1 307.3 342.6  25.3 16.2 35.3  April May June  60.7 70.0 76.2  .2 9.3 6.2  1.85 1.11 .88  378.9 370.6 362.0  36.3 -8.3 -8.6  July August  80.6 79.3  4.5 -1.3  1.19 1.21  350.1 348.0  -11.9 -2.1  1/ End of month   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -20for a protracted but if the special deposit requirements had remained in place tions might not period, even the immediate gains by local financial institu have been sustained. the assets Also, it must be recognized that almost one-quarter of large minimum investheld by the money funds are controlled by funds that have can meet such ment standards, and the individuals and institutions that operate freely in standards can be assumed to be sophisticated investors who to rate money and capital markets and do not think of deposits subject ceilings as an alternative.  Indeed, the average account size at all the  money funds was over $20,000 in July.  Moreover, even the smaller shareholders in  investment alternatives the money funds clearly have gained an understanding of that will lead them to seek out high-yielding financial assets. thrifts and There are partially offsetting advantages to deposits at depository institubanks, such as federal deposit insurance and the ability of location. tions to offer customers a wide variety of services in one  Neverthe-  changes in the relative less savers have become extremely sensitive to even small a diversion of yields of different financial assets, including deposits, and instruments could flows from depository institutions to money funds and market up market very well recur if a rekindling of inflationary pressures drives interest rates.  In that event, perhaps a solution can be found that is equi-  during periods table to small investors and still allows thrifts to raise funds earnings. of high and rising interest rates without wholesale damage to  One  • between approach might be to force, in effect, a choice by the money funds s on their shares. reserve requirements or not offering check-writing service ory authority I am not inclined to advocate the legislation of such regulat at this juncture, however.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  &  -21-  III.  DIFFERENTIAL BETWEEN RATES PAID ON DEPOSITS BY BANKS AND THRIFTS AND THE VIABILITY OF THE HOUSING INDUSTRY The differentials in ceiling  rates have been an important element  of the environment in which thrift institutions operate.  The Deregulation Act  requires each member of the DIDC to assess whether removal of any differential between rates paid by banks and thrifts will adversely affect the housing finance market or the viability of the housing industry. With one limited exception, interest rate differentials have been left unchanged by the DIDC.  As reviewed above, the May actions narrowed the  substantially differentials on the 6-month MMCs in some respects, but did not of interest change the rules concerning the differential in the market range recently. rates prevailing at either the time of the actions or most  The new  tial for minimum ceiling rates authorized in May have eliminated the differen al banks the six only three weeks, and the temporary provision giving commerci rates has month privilege of rolling over maturing MMCs at thrift ceiling seven weeks since eliminated the differential for maturing deposits for only authorized at the end of May.  Since early August, bill rates have been at  the new rules, levels that have removed the MMC ceiling rate differential under previous rules as well. but the levels of bill rates would have done so under the Since 1966 as inflation has accelerated, thrift institutions have s in recurrently found their returns on assets lagging behind the increase their costs of funds.  In an attempt to improve their competitive position  be demanded by the market, without paying interest rates that might otherwise s commercial banks were introduced the differentials on ceiling rates vis-a-vi by regulation in 1966.  Thrifts have come to rely on this competitive edge in  attitude must be taken toward the years since, and a justifiably cautious   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -22-  savings deposits as dismantling the structure of differentials on time and t above the average long as inflation continues to push market rates of interes return on thrift institutions' long-term assets. by the Depository The ultimate removal of ceiling rates--as required end of the differential. Institutions Deregulation Act--of course would mean the during which the ceilings The legislative history states that, through the period the Committee may increase are phased out over the next five and one-half years, differential required ceiling rates on those accounts subject to the statutory maintained. by Public Law 94-200, provided that the differential is  Beyond that,  modifications of differjudgements about the level of the ceiling rates and any will depend upon a balancing entials on new deposit classes that may be authorized ies against the claims of the special problems of the thrift and housing industr of consumers and others for equity.  Small businesses and agriculture, in parti-  and recognized claim for cular, that rely heavily on bank credit have a strong equitable treatment.  The DIDC's power to affect the distribution of credit is  Section II, that the limited, however, by the economic reality, described in to deposits. public is increasingly aware of its market alternatives  Saver  protected by unresophistication implies that depository institutions cannot be of time. alistically low ceiling rate limitations for long periods  The actions  differential may of the DIDC fully reflect concern that sudden removal of the all institutions adversely affect housing, and also reflect efforts to place in a somewhat better competitive position.  Progress in restoring a more compe-  , would appear essential titive setting for depository institutions, while gradual over time to avoid atrophy in the thrift industry. thrift instituThe phasing-in of new asset and liability powers for Monetary Control Act tions under the Depository Institutions Deregulation and   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -23ed and next year should, over time, provide opportunities for improv cyclically more stable earnings for thrifts.  Improved earnings would help  ceilings lay the groundwork for more flexible policies toward interest rate and ultimately their phase-out.  With the introduction of NOW accounts, thrift  e for houseinstitutions across the country will be in a position to compet similar terms, a hold interest-bearing transactions balances with banks on major change in the competitive landscape.  The innovations in mortgage con-  un ability of thrift tracts made over the last year will also enhance the long-r market over the interest institutions to compete with commercial banks and the rate cycle. IV. A.  RECOMMENDATIONS  recently appraised by The economic viability of thrift institutions was  lation Act of 1980. the Interagency Task Force created by the Deregu  The findings  the Federal Reserve participated-and recommendations of the Task Force--in which 1/ on June 30 of this year. were submitted to the President and the Congress interest rates were At the time of the Task Force report, declining the thrift industry. contributing to improvement in the health of  However,  -term interest rates has raised the recent increase in short- and intermediate levels prevailing at the time offering rates on MMCs and SSCs well above the S&Ls and mutual savings banks should 1. The recommendations were: 1) nonmember System, and credit unions should FHLB the give serious consideration to joining more flexible and cost-responsive mortjoin the Central Liquidity Facility; 2) the federal regulatory agencies should and gage instruments should be developed, ments, subject to adequate consumer instru these encourage more widespread use of and alter statutes that may safeguards; 3) state legislatures should review mortgages in the secondary sell to inhibit the ability of thrift institutions taxation of thrift institheir review also market; 4) state legislatures should nd serious earnings compou could that taxes tutions so as to avoid inequitable an override of state to n eratio consid s problems; 5) Congress should give seriou order to increase the in loans er consum of y ceilings on rates charged on a variet to take advantage of the expanded asset powers incentives for thrift institutions provided by the Deregulation Act.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -24e on the earnings of the Task Force's report, placing some renewed pressur margins of thrifts.  If interest rates rise further and money market mutual  from thrifts and funds reemerge as a critical element in diverting funds pressure. small banks, these institution once again may be under severe imbalances, we In looking at ways to address specific competitive fundamental problem should not lose sight of the fact that inflation is the which has led thrift institutions to their current state.  As inflation has  commensurately since increased, market interest rates have risen more or less institutions with the mid-1960s with plainly adverse consequences for thrift large portfolios of fixed rate mortgages.  The increases in short-term yields  ios at lower and lower forced thrift institutions to fund their mortgage portfol e yields has not yet been profit margins, and the relief provided by higher mortgag the slow turnover of sufficient to offset the higher costs of deposits, as ios below market long-term mortgages kept the total returns on thrift portfol rates of interest.  perverse Moreover, the higher mortgage yields have had the  mortgages. effect of slowing down the repayments of older, low rate  Thus,  ions on financial as long as inflation continues, tinkering with regulat ions will continue to intermediaries will not solve the root problem, and distort appear.  expectations are As high rates of inflation and shifts in inflationary  institutions that borrow reflected in high and volatile interest rates, thrift access to money markets for short and lend long and small banks that do not have liquidity pressures. funds will be vulnerable to recurrent earnings and  This  with inflation. central problem exemplifies the importance of dealing B. inflation.  rate of Encouraging savings will also be helped by reducing the In recent years, inflation has whittled away the returns  of  remaining returns on savers, and our tax system has cut deeply into the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -25-  investment.  Many careful investors have seen the purchasing power of their  financial capital fall, squeezed by both inflation and taxes.  The accelera-  tion of inflation in recent years has rewarded the nimble, rather than the productive, and has encouraged the accumulation of debt to purchase existing physical assets, rather than the growth of savings to build our capital stock. The causes of the decline in the savings rate are complex, however, and even with a reduction in the rate of inflation, changing savings habits will not easily be accomplished. encourage savings.  However, there are things that Congress can do to  At a minimum, the Federal government should reexamine  policies that discourage savings or divert it away from productive investment. In evaluating the factors affecting savings, it is important to underline the impact of the real after-tax rates of return earned by savers. I have not, in principle, been in favor of indexing the tax system to inflation, lest we are drawn into further patchwork solutions to inflation and away from attacking the problem head-on.  But I am nevertheless sensitive to the fact that  in inflationary periods the progressivity of the tax system can pull real aftertax rates of return on financial assets to zero and even into the negative range. The DIDC, by keeping ceiling rates at depository institutions reasonably competitive, can assist in raising nominal and after-tax returns to savers, but the forces of unanticipated inflation and the tax structure transcend the confines of the DIDC's authority.  Indeed, real rates of return even in unregulated finan-  cial markets have been extremely low and sometimes negative in recent years. It is of fundamental importance that the federal government not divert investable funds away from housing, plant, and equipment by heavy reliance on deficit financing.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Not only would smaller deficits reduce the inflationary  -26-  pressures now rampant in the economy, but they would release a larger proportion of society's savings for private investment, a point made in the 1980 Economic Report of the President with which I strongly concur. C.  Equitable treatment of small savers is a key goal of the Deregulation  Act of 1980, and the DIDC has begun to move toward improving the returns In authorizing the deregulation of deposit  available to small depositors.  rate ceilings, the Congress set a timetable of six years, and substantial progress could not be expected in just the first six months of that period. Nevertheless, the DIDC did raise the ceiling rates on MMCs and SSCs in May; the ceiling on NOW accounts will be increased at the end of this year.  And  the remarkable rise in the outstanding amount of MMCs and SSCs has already increased the returns to savers who had previously held their funds in fixedrate accounts.  The total volume of MMCs and SSCs has passed $400 billion,  with about 60 percent of these deposits held by thrift institutions and 40 percent by banks. There are, however, significant limitations on the ability of depositories, especially thrift institutions, to pay market rates of return over the interest rate cycle.  Constrained by large portfolios of fixed rate  mortgages made in periods of much lower interest rates, thrifts cannot quickly raise their offering rates on deposits without possibly grave consequences to their earnings.  With the passage of time and implementation  of the many innovations in thrift assets and liabilities, I look forward to eventual removal of the current array of ceiling rates that will permit fairer treatment of small savers.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -27-  D.  A steady and adequate flow of financing to thrift institutions and  housing has become more likely with the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980.  Together with recent regula-  tory actions, the list of innovations at thrift institutions that will help thrifts through the interest cycle is impressive:  NOW accounts, variable  rate mortgages, renegotiable rate mortgages, and, of course, MMCs and SSCs, to cite just a few.  The ultimate consequences to thrift institutions and  the housing industry of these changes will take time to become clear.  In my  judgment, thrift institutions need time to adapt to the changes already made, and I would not urge additional legislative actions now. The immediate prospects for thrift institutions and the housing industry in the months ahead will depend upon more than legislative and regulatory innovations, however.  The. persistence of intense inflationary  pressures as the economy moves out of recession raises the possibility of further upward movements of market rates of interest.  A federal tax cut  that adds to inflationary demands would heighten the risk of interest rate increases that would renew tendencies toward disintermediation and stall the incipient recovery in homebuilding.  Indeed, the recurring theme in my  recommendations must be my concern with the dislocations that inflation has wrought in the patterns of savings and investment in the United States and, in particular, in the thrift industry.  But I believe that we can lower  inflation by the patient application of carefully designed monetary and fiscal policies.  When we succeed in this task, we will have gone a long way  toward solving the pressing and important problems of housing and the thrift industry.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  DEPOSITORY INSTITUTIONS DEREGULATION COMMITTEE PRESS RELEASE COMPTROLLER OF THE CURRENCY FEDERAL RESERVE BOARD  FEDERAL DEPOSIT INSURANCE CORPORATION FEDERAL HOME LOAN BANK BOARD NATIONAL CREDIT UNION ADMINISTRATION TREASURY DEPARTMENT  For immediate release  February 26, 1981  The Depository Institutions Deregulation Committee today announced a temporary amendment to its rule on the use of premiums which will prohibit a depository institution from soliciting the opening of multiple accounts from a depositor in order to provide more than one premium at a time. The Committee adopted new rules in September on premiums, finders fees and prepayment of interest which became effective December 31, 1980.  Since  then, an increasing number of depository institutions have advertised premium programs in which a lump sum brought in by a depositor may be broken up by the institution and placed in multiple accounts, thus enabling the institution to give a premium for each account. These programs have the effect of undermining the Committee's intent by making it possible for the institution to provide more premiums than would otherwise be permitted if the funds remain in one account. The temporary rule, which becomes effective immediately, prohibits depository institutions from soliciting or otherwise promoting multiple accounts for the purpose of paying multiple premiums.  The Committee  asked for public comment by April 1, 1981 on this rule and on alternative methods that also might be adopted on a permanent basis.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  The Committee's Federal Register notice will be available shortly.  0111h  Savings Association League of New York State 700 VVtiit In Road  HI 41  Scarsdale. New York 10583 (914)472-3500  Paul A.Schosberg Prw,Orrit  Your Savings ASSOCIatiOnS A.  .•  y.)r.iary 24, 1981  Mr. Paul A. Volcker, Chairman Board of Governors of the Federal Reserve System and Chairman, Depository Institutions Deregulation Committee Federal Reserve Building 20th Street and Constitution Avenue, N.W. Washington, D.C. 20551  Dear Mr. Our request of February 2, 1981, for an outright prohibition on all premium offerings by all financial institutions has developed a totally new sense of urgency and I urge the Depository Institutions Deregulation Committee to assign the highest priority to an immediate consideration of such a ban. During the three weeks since I first wrote to you requesting consideration of a prohibition on premium offerings, banks and thrift institutions throughout the New York City metropolitan area have increasingly begun to use misleading and deceptive advertisements to promote their premium and cash offerings for savings deposits. As I predicted, a growing number of financial institutions now utilize advertisements which reflect the pre 1981 advertisements for finders' fees for new deposits. At the same time, they use multiple account openings and split deposits to open accounts and immediately add to the accounts to facilitate the giving of cash and gifts of substantially greater value than the $10 and $20 limitations intended in 12 CFR 1204.109. Now, Chase Manhattan Bank, NA of New York has heightened the cash offering competition with the introduction of its "Chase Against Inflation" campaign. It has blanketed the metropolitan area print media (see ads enclosed) with questionable advertisements offering "the biggest cash bonus of any New York bank" for new savings deposits. Chase now offers "up to $400 , The Savings Association League of New York State has a membership of 105 state and federally -chartered savings and loan associations with assets in excess of $23 billion. The principal officers are Charles C. Weyant, chairman; Paul A. Schosberg, president; Vincent R. Tortorello, vice president -administrative services and treasurer; Edward B. Kramer, vice president-public affairs; and Gerald M. Seixas, secretary. League headquarters are at 700 White Plains Road, Scarsdale, New York 10583 Telephone (914) 472-3500. WhosPmemt,,,.•''  Federal Home Lx1ri Bank System  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Mr. Paul A. Volcker  page 2  more than you will find anywhere else" by paying cash bonuses of up to $800 on 30-month deposits of $100,000 and similarly higherA)onuses on smaller deposits. Clearly, other financial institutions will move quickly to establish cash offerings that are competitive with the Chase program and we face the inevitable return to the pre -1981 situation in which the regulations governing premium offerings were routinely circumvented. To curtail these growing abuses, the Savings Association League of New York State once again urges the Depository Institutions Deregulation Committee to enact a permanent prohibition on all premium offerings by all financial institutions. The savings and loan industry of New York State first called for such a prohibition on March 26, 1980, and we predicted at that time that the situation would worsen until a total ban is enacted.  Very truly your  Paul A. Schosberg PAS:flm Enc:   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  )  j• 11 L  "r0  ,e1  1\  f\ fl7r7T 1 •  (  r1  „\r--7  r--7  71-  j  L.] L._,J  'LI LI  I  1, ............._,/).. L.  i  (LI FT romn — -71 it 1',i'\ (r --i-1 , LI _171 ,  ,  / , —; ,  if  Jri1r  777  I  ...j  ..a L......1 Lz...1  _.N.1.,a:,.....--  We know. And we're going. to show you how to get ahead in the Chase Agr..nst Inflation. • Whether your balance is $1,000 or S100,000, 00-1tUS has inflation-fighting savings certificates Chase SAY.1r,'; (1RN 'CATE SA• Cf 301,'Cril113 will give you higher interest. Just compare that the rates in this ad with the rate on your 12.26% A) 1 r;elegi° :_iDON•• 1 EFFECTI'wE Er' E. ; i passbook and you can see that your money will be worth more with us. If you want to know 11.75% 1.5.010°i° exactly how much more, come in and we'll I ., —.. . -- "=1"...nr=7"'" explain it to you. PLUS THE BIGGEST CASH BONUS 1 We'll also give you RANK. YORK NEW OF ANY start in the a head .-„, .-,= . 1:7117--:.--...`7•717...11=2='7,7:1"L2'.:1" i i . ) , Chase Against Infla- , 7: r -.4 1 3.-.... I, r.,,,•4,:-..1 , tion with the biggest '33.5781 • • 4 '8'.)0 ,aa......• 4 'F;00 cash bonus any . :..........-,,!....... 'F.,0 001 q '6-10 it '26.863! , New York bank has ;: 1 , i,n.." '(3.070 'L :......... ! 'On Cr'', . , •' „ • ..:-............,........-..) '20.1471 ' ,1'70 i , 001 a '€f) ever given. As you i' ' . 1 '4.553 001 '1'..0 il '10 1 ' .........,-..--.,.......-7.........,....,., ,.........4.........."JIMIPINIISXCIS can see on our Cash V 140 c.j1 9 1 I u3 t 1,3.(,4) I , s•:0 CO1 .1 !:12;) .e: '13,4311 1 . ‘1 ,-,L..;, 5:-.0 col d si.o ii '6.716 -4 Bonus Column, S'20.C?1 ki•'::(..) k,,you'll walk out ; . ) . 9. 3"L. ! .._ 1 1 '1',3C0', i s1fl01:: I i '15C31 .J '.i5 '1 1"9 with as much '10,091 .1.1 ..'-'''.. t v7,F5 I: =10.0.01 4 i ,) 1 '3.3581 i as $800. . -, -. , . ..a.nummer.rf:- ---.....am. '5.001 iili s.'.=7 . 2 . 1, 1 So bring —$ - . - — 1iyour passbook to Chase. • Where your 4... 77:777=-17.777"7„J savings get a fif4i.• With inflation raging in the double diclits,your chance to amount to something.For information, passbook doesn't have a chance. And that has call(212)223-5017/5018.0ut of state,call enraged. you today, 11 saving money enough (800)223-1338. It's tough 1 2% interest, but when you're only earning 5/ 1 2%or even 8%,you're losing more than or 6/ you're gaining. •:.,77777.7.7=71  FE CHASE AUANST INFLATION PLANA , ,11-.roor  p. .,Ionwormar  ,  '  •  1;7,F Z..ATE  I  7 . 7 5-"".........=2X5: --re......  I  , ) 1'. ,4!.4 f  1  ,•••.I  ,:' '• . 4  C,',..  •Itaremanomoser" -teemr.rerer t ventrestacamer.  1:zaLi , =100.000  otapaaCitoort rlimestanatrze.,  100.000 : '  '2  riararrasimrausc cSf.IGIVIWSZO .1971111W110.1 , 1', maisr-amosimetsar ,istrzsarry,.mtasieramoseI ,  mornasrmemoms'1-iricrwearrs  :•-maneenriameiron:"-ratrrirearii‘masomaanaa-  rzateamreomme.,-,mattearmet . tamaimicaarimern-r!iamaasaarsaa.meorawaemarr. ' ! 4   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ,;110111MIBMWEIr. —0111.15•WIIIIIKINCRITSIMIL.R .  i  •  I  Ferle•al rootilnlOnS pion.ba tompouncl.no of nteresl on a 6- Vonin Cer1,6c RIO 04 0,00S4 Substantal ontereSI legu.,ed IC. 0.3,1y wit,Of agmai of Tome Deposdi w,tryd,byat an ar,,,m14,11)al all, AV cash twwws...be deducted I.orn Iry aocoum4s) lo comply one. Fade,ah rogulatKols A may In nocetsary o opnn none han one ac.ounf . 4h VOW dePO4 . 4-  "  Chase reserves Ina nght fo change the Rema 04 0,4 ear at anylune.  0.031 uar•••1  CHASE  smat.  ri•vortrein rPC  ....  ;  't  1  41  • 0  lj  •  71 N 11 ") r--)  1 1 // 7  (p)(.1  Ai  L7-7/7:\ •  ,  /773 7/  •  )17  /2-E3 > <?, : irv7c,;:::?/ 1 .11 1 ^1-L  1  r-7_ Li  Li  1 rir Ir-71(rnf  ,  r  /  ti  7  it \I i •  \.1  .4 • 1 L_ 1  41  '-...  .  •  f' ' . , ./  1  .( ,,'-'-» / 7)  to Chase. We'll transfer your ; money into a h:gh savings interest • certificate.And, as you can see on our , . ' • Cash Bonus C.45;:" ccrsus. fChart, y()ti'll walk out with as much as $800.You've got a lot to gain in interest, too. Chase has infiation-fighting ' CASH tIONUS "I 30-MCN CASH PONUS 6-MONTH savings certificates that give you higher interest than your passbook. This week for instance, our t.9 6-month Savings Certificate at 15.01% gives you an annual yield of 15.80%'. And our 30-month $209 Savings Certificate at 11.75% yields an annual rate of 12 28%:* $Fr:CI 1 $‘2.r.;0 SO vihrxhcf rout baianco S WOO of "410 I s;ft0 s, mum,yora waxy vs* be%VII rtxxo wilt)us And )100112,tatraloprog Ito& miko% roam,carta 01arid 041140 les Wirl Kt&40 I ffigt004 MOM 111;"64CiftetC111 itik".4„ *AA 4,1 01010NSW* 04014:4' “tirrattalt •14401$OA WO,  We want you to get a head start in the Chase Aga'nst Inflation. And \.'.'ere making it possible with the biggest cirJ1 bonus of any New York hank. Up to $100 more than you'll find anywhere else. All you have to do is bring your pasEbook .  • r.  •  • «  WHEN YOU DEPOSIT  ' ef.:i7'1 SESTA -  san,C-DS71 .10p $1  IL.Y7  gzo,coi $1.5,C   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •  -cP  •t  •Th  ala S  ' r  .,,,,... I  lisE:$ 'moo ti  National Savings and Loan League  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1101 Fifteenth Street NW N Washington,7D0.C2O005 Cable: ATLISA n Richard S. Lawton President January 22, 1981  Mr. Normand R. V. Bernard Executive Secretary Depository Institutions Deregulation Committee Federal Reserve Board 20th and Constitution Avenue, N.W. Washington, Li.C. 20551 Dear Mr. Bernard: The National Savings and Loan League is very concerned with both the speed and direction of deposit ceiling deregulation. This concern is heightened by the difficult earnings position in which the savings and loan industry finds itself. Therefore, we would like to petition the Depository Institutions Deregulation Committee (DIDC) to change its deregulation process. The details of our petition are contained in the attachment to this letter. Without repeating entirely what is in the attachment, we are petitioning the DIDC to adopt a deposit deregulation plan which concentrates on raising to market the rate ceilings on longer term certificates first and providing for a 25 basis point differential for thrift institutions. We believe there are a number of reasons why this is a preferable strategy, and they are given in the paper. We are also providing a copy of this letter and attachment to each member of the DIDC. We would request that this petition be considered at the next meeting of the Committee. Sincerely yours,  Richard S. Lawton  t(  4   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  The National Savings and Loan League, in behalf of its member associations, hereby petitions the Depository Institutions Deregulation Committee (DIDC) to adopt a deposit deregulation strategy which would raise to market the rates paid on new classes of accounts beginning with the longest term certificates. We propose that this strategy, which is explained below in more detail, be adnpted as a substitute for the early raising and phasing out of interest rate ceilings on passbook accounts. While deregulation of deposit interest rate ceilings will be difficult for all depository institutions to adapt to, this is especially true for savings and loan associations, long characterized by asset/liability maturity imbalance and huge exposure to interest rate risk. Up to now, the major acts of deregulation by the DIDC, its predecessor (the ICC) and the Congress have been accomplished on the liability side of the balance sheet, with most of the deregulation occurring in relatively short and medium-term maturities.  The National League is concerned about the imbalance  or uneveness between asset and liability deregulation and is further concerned that deposit deregulation has not encouraged savings and loans to reduce the imbalance between the maturities of their assets and liabilities.  Discussion at the December 12  meeting of the DIDC centered on raising the rate ceiling on passbook accounts.  A recent petition from the American Bankers  Association to the DIDC recommends authorization of a new short-  a   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2-  term account to compete with mutual money market funds (MAMFs). While the National League is very much aware of the competition that MMMFs have given to all depository institutions, we are also aware that in an environment increasingly characterized by volatile interest rates, concentrating one's liabilities in short term instruments (possibly because of consumer preferences but also lack of alternatives) while being forced to make longer term loans is a prescription for an increasingly severe earnings crunch, which is exactly where the S&L industry finds itself at this time.  While the S&L industry made some progress  in reducing this imbalance in the early 1970's with longer term certificates, much of this progress has been lost since creation of the MMC.  MMC growth has been so phenomenal that $30 billion  in MMCs will roll over in January alone, with another $36 billion in March.  This has wreaked  havoc on the imbalance problem.  Consequently, the National League would like to petition the DIDC to take up the following proposal at its next meeting. The National League proposes that the DIDC cease its present deregulation strategy, which amounts to an ad hoc approach.  This ad hoc approach has caused a great deal of un-  certainty to depository institutions of all types, making it extremely difficult for managers to plan short and long term operating strategies.  Because of the uncertainty which this  present approach has caused, the Congress has expressed its displeasure with the way the DIDC has chosen to deregulate. The National League also believes that a deregulation strategy which concentrates on phasing out rate ceilings on   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -3-  passbook accounts is flawed because it does not take into account the asset/liability maturity imbalance of S41,s.  Most  deregulation of deposits has occured mainly in short and, to some extent, medium term maturities.  No conscientious  attempt has been made to encourage institutions to offer, and savers to accept, longer term instruments.  Even though the 30  month certificate can actually have a maturity of up to 10 years, with normal yield curves, there is no premium for going long. The National League proposes that the DIDC minimize this uncertainty and encourage institutions to lengthen maturities of liabilities by announcing a scheduled phaseup to market rates, beginning with longer term certificates.  This  deregulation plan is proposed as a substitute for phasing out passbook ceiling rates.  The National League would propose the  following schedule: July 1, 1981 -- raise to market the rates paid on all certificates issued or renewed after that date with an original maturity of 8 years or more July 1, 1982 -- raise to market the rates paid on all certificates issued or renewed after that date with an original maturity of 61 / 2 years or more July 1, 1983 -- raise to market the rates paid on all certificates issued or renewed after that date with an original maturity of 5 years or more July 1, 1984 -- raise to market the rates paid on all certificates issued or renewed after that date with an original maturity of 3/ 1 2 years or more   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4-  July 1, 1985  raise to market the rates paid on all certificates issued or renewed after that date with an original maturity of 2 years or more  March 31, 1986 -- Congressionally-directed end of rate decontrol process By market, we mean the appropriate Treasury rate, plus a differential of 25 basis points for thrift institutions.  On  July 1, 1981, thrifts and banks, under this proposal, would be able to pay the Treasury rate on 8-year securities for 8-year certificates or the Treasury 10-year rate on 10-year certificates, for example.  For instance, as of January 22, 1981, Treasury bonds  maturing in May of 1989 (approximately 8 years) were yielding 12.64 percent.  Under our proposal, thrifts would be able to  pay 12.89 percent and banks, 12.64 percent.  These rates would  float with the market like the small saver certificate rate.  On  July 1, 1982, all institutions would be able to not only pay market-indexed rates on the above certificates, but on any certificate 61 / 2 years or greater in maturity.  Again, the market index  would be the appropriate Treasury rate.  We would propose that  thrifts enjoy a 25 basis point differential because of their statutory commitment to mortgage finance.  A 25 basis point  differential makes the most sense on longer term certificates because it is these certificates which are best used for housing investment. Prior to each of the above dates, we would further recommend that the DIDC make an affirmative finding that the freeing up of the new shorter maturities would not be deleterious to the financial soundness of any class of depository institutions. We believe this is critical.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -5The arguments in favor of this particular proposal are as follows: o this strategy will provide certainty to all depository institutions on the course of deposit rate deregulation o this strategy will help savings and loan associations balance the maturities of their assets and liabilities since savers can be expected to shift funds toward longer term certificates as ceilings are raised to market and normally sloped yield curves reappear o this proposal gradualizes the deregulation process and, therefore, allows savings and loans to become familiar with their new powers before significant deposit deregulation is mandated o real deregulation would eventually occur as opposed to small increases in the passbook ceiling rate which, we believe, contains very few benefits to the saving public (an increase of 50 basis points on a $2,000 passbook account only yields an extra $10 per year in interest) yet, at the same time is costly to depository institutions The National League is extremely concerned that deposit deregulation has been occuring at a much faster pace than asset deregulation.  For instance, in June of 1978, the MMC was  created, and accounts at this time for over one-third of all deposits in S&Ls.  Similarly, the small saver certificate,  created in January of 1980, accounts for approximately 10 percent of all deposits.  Thus, almost SO percent of deposits are in  these two market-sensitive instruments, yet the S&L industry has not yet been given the authority to offer realistic adjustable rate mortgages.  The FHLBB's VRM regulations are useless.  Its  -6RRM regulations, while an improvement, still fall far short of what is necessary.  Changes to both of these regulations have  been proposed by the FHLBB, but they still do not provide sufficient flexibility. What the National League requests of the DIDC is to use its influence to encourage the various regulatory agencies, as well as the Congress, to provide realistic asset powers to S&Ls, especially adjustable rate mortgage authority.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  The National  League supporLs the principle of paying market rates of interest to savers, but S&Ls can only do that if they can earn market rates on their assets.  Further, S&Ls do not expect, generally,  to make abnormal profits with the new consumer lending, trust and NOW account powers provided in H.R. 4986.  While all of these  powers are necessary to compete in a deregulated world, they will not be the source of significant profits since a competitive market, generally, already exists for these services.  We do  expect these powers will help stabilize profit levels somewhat, however. Finally, the League would like to reiterate that the deregulation process has taken a strange course.  Asset dereg-  ulation should precede or occur simultaneously with liability deregulation, not follow it  The current approach, exacerbated  by the recent volatility in interest rates, has caused unprecedented earnings pressures on S&Ls.  1980 will be the worst earnings  year for S&Ls, with average aggregate earnings close to 15 basis points return on assets.  If interest rates remain at  present levels, 1981 will be worse.  Even if they fall gradually,  as we expect, 1981 will only be a repeat of 1980.  The significance  -7-  of this is that 1980 was the worst earnings year in the history of the savings and loan industry.  The previous low was 43  S.sis points in the first half of 1975, during the previous housing recession, three times the current level of profits. Therefore, we would request that the DIDC act quickly and constructively to encourage the passage of realistic asset powers for S4Ts as part of the deposit deregulation process.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis
Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102