View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

§ C&llli

IFi f

cellCC'(Ci)

March 10, 1978

Pseudo Intermediari es
Disintermediation could again become a threat to financial intermediaries in 1978, as we discussed in
our most recent Weekly Letter. With
open-market interest rates rising
above the maximum rates that banks
and thrifts can offer on savings accounts, many dollars could leave these
accounts and end up in investments
that pay the open-market rates.
Hence, funds that otherwise might be
channeled through the usual intermediaries may now be channeled instead into market instruments through
money-market funds and bond
funds - pseudo intermediaries, as it
were.
Impact of Reg Q
The growth of these new institutions
reflects the influence of the Federal Reserve's Regulation Q, which implements a section of the Banking Act of
1933 limiting the payment of interest
on commercial-bank deposits. Congress passed the Act originally to stabilize the banking industry, primarily by
limiting competition - but as is often
the case in the regulatory arena, Reg Q
has since taken on a life of its own.
Over the years, the Federal Reserve
has developed a complex array of rate
ceilings to cover deposits of different
types and maturities, and in 1966,
Congress extended similar ceilings to
savings-and-Ioan associations.
During the 1966 and 1969
crunches, the regulatory authorities
managed to curb bank and thrift-institution lending by utilizing Reg Q ceilings to restrict the flows of funds into
such institutions. To this end, the Fed
N

used rate ceilings on large certificates
of deposit (CDs) to restrict these
funds, and in 1969 also placed reserve
requirements on non-deposit sources
of funds such as Eurodollar borrowings. The combination of generally
tight credit conditions and specific controls on intermediaries resulted in rampant disintermediation.
A number of changes have occurred
since 1970 to reduce the danger of another bout of severe disintermediation. Between 1970 and 1973,
the authorities raised - and then removed - all ceiling rates on CDs over
$100,000, and they also eliminated
ceilings on some longer-term consumer deposits. Banks can now pay market rates of interest on these funds
even when rates are high. Furthermore, thrifts have more leeway now
to attract funds from large depositors
and to pay competitive rates on longer-term deposits of small savers.
However, Reg Q ceilings remain in
force on all passbook accounts and on
most small-denomination time deposits. For example, the maximum allowable rate on passbook savings is
currently 5 percent at banks and 5 1h
percent at S&Ls, while open-market
rates are signific'antly higher at 6.4
percent for 3-month Treasury bills, 6.8
percent for 90-day commercial paper,
and 6.8 percent for 90-day CDs over
$100,000. Reg Q thus represents a
on the small saver who cannot
find a way to shift from a passbooksavings account into one of these alternative investments. But Treasury bills
require a $10,000 minimum purchase

(continued on page 2)

and entail some transaction costs, either through a service charge or
through a trip to a Federal Reserve
Bank. Large CDs, and commercial paper generally, require a $100,000 investment. These instruments thus are
beyond the grasp of most individuals.
Money-market funds
For many savers, however, there are
indirect means of purchasing such instruments, through such vehicles as
money-market and bond funds. These
funds represent only a fraction of the
size of the typical financial intermediaries, but they have already exerted a significant impact on the market. For instance, their me"re existence
has helped lead to relaxed Reg Q ceilings.
Money-market funds are investment
vehicles that accept short-term savings from individuals and businesses,
and pool these savings to effect economical purchases of large-denomination Treasury bills, commercial paper,
CDs, and other short-term investments
of one-year maturity or less. (They are
also called money funds or cash management funds.) Typically, they don't
involve
(purchase) fees, but require an initial minimum purchase
amount of $1,000 and subsequent purchase amounts as small as $50. They
generally provide free checking privileges, although checks typically must
be at least $500 in amount. The saver
earns a return that is equal to the
fund's return, say about 6.6 percent today, less a management fee of roughly
0.3 percent.

2

Money-market funds are not large in
the aggregate, but they expand rapidly
whenever interest rates rise. They
grew from practically zero in 1973 to
$3.7 billion in late 1975. Then, as
open-market rates declined throughout 1976, they contracted somewhat,
only to rise sharply again in late 1977
and early 1978. According to
Donoghue's Money Fund Report, assets were up to $4.4 billion by late January and were increasing by
approximately $125 million per week.
Large corporations often invest in
money-market funds, but small
businesses and individuals can do the
same. For all such investors, moneymarket funds offer a low-cost and convenient method of investing $1,000 or
more in a diversified portfolio of Treasury bills, commercial paper, bank
CDs, and other short-term assets. And
paradoxically, although banks lose
some funds" that are subject to Reg Q
ceilings, they have the option of
buying the funds back at open-market
rates in the form of CDs of over
$1 00,000 denomination. In fact, bank
CDs constituted 50 percent of all
money-market funds' assets at the end
of 1977. Thus, to a large extent, money-market funds are simply a vehicle
for circumventing Reg Q.
Rond funds
A host of bond funds are also available to individual or business investors - indeed, they swamp the
money-market funds in aggregate size.
Bond funds do not limit themselves to
short-term investments, but instead invest in a diversified array of
government and corporate debt. Several
new bond funds invest only in stateand municipal-debt issues, paying in-

u.s.

terest that is exempt from Federal (and
some state) income taxes.
Bond funds, unlike money-market
funds, are by no means new. However, in the last few years they have taken on new characteristics that make
them similar to savings and even
checking accounts. In the past, openend bond funds normally charged
fees (initial purchase fees) of
perhaps 5 or 6 percent. The front-end
fee thus tended to make these instruments long-term investments. Recently, however, a number of funds (both
new and old) have chosen no-load
status, charging the investor only a
management fee of perhaps 0.3
percent to 0.6 percent of asset value
per year. Thus the individual can get in
and out of the funds with no transaction charge. In addition, many funds
are now offering free checking privileges, free telephone transfers, and
wire-transfer services.
N

A bond fund may invest in corporate
and
government bonds and pay
taxable interest, or it may invest in
state and municipal bonds and pay taxexempt interest. Initially, funds that
paid tax-exempt interest were required
to be limited partnerships - a restriction that created a costly paperwork
and reporting burden. But a change in
Federal law in late 1976 permitted
them to adopt the corporate form of
organization, thereby making no-load
tax-exempt funds a feasible alternative for small investors. Since that time,
at least half a dozen such funds have
appeared, totaling almost $3 billion in
the aggregate.

u.s.

For the bond fund aimed at attracting
liquid savings, there are minimum ini3

tial investments ($1,000 and up), minimum subsequent investment amounts
($50 and up), and minimum withdrawal
amounts (normally $1,000 and up). Because of the high minimum restrictions
on withdrawals, the individual who
wishes to use the checking privilege
will move funds from the bond fund
to his or her checking account, and
then write smaller checks for consumer transactions. Thus, the minimumwithdrawal restriction makeS these
funds close substitutes for saving accounts rather than for checking accounts, at least for individuals.
No-load bond funds with free checking privileges -like money-market
funds - are excellent vehicles for the
relatively small saver to obtain openmarket rates during periods of high interest rates. The funds advertise daily
in financial journals and newspapers,
and have come to be recognized by
many individual savers as a more convenient vehicle for their funds than
passbook accounts. For higher-income individuals, the tax-exempt option offers an especially appealing
combination of liquidity and ta)(-free
yield.
Money-market and bond funds will
never approximate in size such major
intermediaries as banks and savingsand-loan associations. However, they
have already carved out an important
niche among financial institutions. Furthermore, they pose but one more
threat to the already fragile viability of
Reg Q.
jack Beebe

U018u!45BM0 4Bm • uo8aJO " BpBAaN • 04BPI
!!BMBH
B!UJOllre:::> EUOZPV
1?>j5EIV
0

IO:JSpueJ:I
u-eS
lSL: 'ON
O;Vd
lS Od 's'n
1IIY"'J S\i13
S

-BANKI
NG OATA- TWE!l.fTHFEDERAL
RESERVE
DaSTllUCT
(Dollar amounts in millions)
Amount
Outstanding

Change
from

2122178

2/15178

Loans(gross,adjusted)and investments*
Loans(gross,adjusted)- total
Securityloans
Commercialand industrial
Realestate
Consumerinstalment
U.s. Treasurysecurities
Other securities
Deposits(lesscashitems)- total*
Demand deposits(adjusted)
U.s. Government deposits
Time deposits- total*
Statesand political subdivisions
Savingsdeposits
Other time depositst
LargenegotiableCD's

105,161
83,282
1,722
25,537
28,185
14,874
7,668
14,211
102,180
27,551
584
72,057
6,487
31,452
31,683
13,295

-

Weeldy Averages
of Daily Figures

Week ended
2122178

Selected Assetsand liabilities
large Commercial Banks

-

+

+
+
+

+
+
+
+

510
374
139
56
110
10
28
108
592
1,317
195
342
20
34
212
196

Changefrom
year ago
Dollar
Percent
+ 12,957
+ 12,836
166
+
+ 2,514
+ 6,191
+ 2,512
- 1,085
+ 1,206
+ 10,812
+ 2,250
270
+
+ 8,017
719
+
347
+
+ 6,460
+

Week ended
2115/78

+

+

+
+
+
+

-

+
+
+
+
+
+
+
+
+

14.05
18.22
10.67
10.92
28.15
20.32
12.40
9.27
11.83
8.89
85.99
12.52
12.47
1.12
25.61
52.96

Comparable
year-agoperiod

Member Bank Reserve Position

Excess
Reserves(+)/Deficiency
(-)
Borrowings
Net free(+)/Net borrowed (-)

6
11
5

+
+

61
2
59

+ 1,535

+ 1,949

+

716

+

+

+

67

+
+

38
22
16

+

Federal Funds-Seven Large Banks

Interbank Federalfund transactions
Net purchases )/Net sales(
(+
-)
Transactionswith U.s. security dealers
Net loans(+)/Net borrowings (-)

285

1,023

*Includesitems not shown separately.tlndividuals, partnershipsand corporations.
Editorial comments may be addressed to the editor (William Burke) or to the author •.••
Information on this and other pUblications can be obtained by calling or writing the Public Information
Section, Federal Reserve Bank of San Francisco, P.O. Box 7702,San Francisco 94120. hone (415)544-2184.
P