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December 3,1976

The Yellow Brick Road
To some observers, Congress' ef­
forts toward a legislative restructur­
ing of the nation's depository insti­
tutions evoked memories of the
difficulties faced by Dorothy and
her varied companions in following
the Yellow Brick Road to Oz. There
were, for example, the perils of the
dark forest—perils largely unseen,
but the more to be feared because
of this. Then too, there was the
constant threat of danger from the
Wicked Witch of the East, who
wanted to augment her already
formidable powers by acquiring the
magic shoes which alone protected
Dorothy from harm.
The characters in the Frank Baum
stories and the Broadway musicals
based on them quickly learned that
cooperation was essential to the
attainment of their objective. In
contrast, this year's travellers soon
parted company, variously accusing
one another of lacking courage,
heart, and even brains, of deliber­
ately setting up straw men, and of
not having any real interest in actu­
ally reaching the Emerald City— in
this case a more viable and compet­
itive financial structure.
Off to see the Wiz
As the year commenced, the pros­
pects for reform appeared fairly
good. In December the Senate had
passed the Financial Institutions
Act—a somewhat distant descend­
ant of the Hunt Commission report
of 1971. On the House side, legisla­
tive proposals evolved out of the
late-1975 FINE study (Financial Insti


tutions and the Nation's Economy).
The FINE study incorporated a set
of tentative “Principles" which, in
the view of some observers, had a
stronger pro-competitive thrust
than the Senate's bill.
The FINE Principles included the
Senate's proposals regarding uni­
form tax treatment, the payment of
interest on demand deposits, con­
sumer lending, and the extension
of third-party payment powers to
all depository institutions. But in
addition, the Principles called for
reduced restrictions on branching
and the definite termination of
Regulation Q interest-rate ceilings
after five years. In the interests of
both equity and the effective im­
plementation of monetary policy,
the FINE study also advocated the
imposition of Federal Reserve re­
serve requirements on the deposit
liabilities of all federally insured
depository institutions.
Forks in the road
In response to the clamor of the
prospective travellers, the design of
the Yellow Brick Road began to
change almost immediately. The
first mark-up of a House bill (The
Financial Reform Act of 1976) wit­
nessed the elimination of a number
of the key Principles. Some changes
were made at the insistence of
builders and the building trades,
who opposed a substantial diversifi­
cation of thrift institution powers
because they feared a possible re­
duction in the flow of funds to
housing. As a result, the removal of
(continued on page 2)

Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System,

interest-rate ceilings was again con­
ditional on circumstances existing
at the end of 51 years. The thrifts
/2
also have insisted that even with
broadened lending and deposit
powers, they still need to offer a 14percent differential over the banks'
ceiling to be able to compete for
savings, and thereby to maintain an
adequate flow of funds to housing.
For their part, commercial banks
were unhappy at the prospect of
groundrules that would confer
many of their traditional powers
upon their competitors while al­
lowing the latter the continued
protection of an interest-rate differ­
ential. In addition, many banks
(small banks in particular) became
worried about one specific
proposal—the payment of interest
on demand deposits. They felt that,
on balance, this proposal would
raise the average cost of bank funds
significantly, with an attendant in­
crease in costs to bank customers,
while lowering the average cost of
funds to the thrifts. (According to
the American Bankers Association,
a 2-percent interest rate on demand
deposits—assuming no change in
service charges—would mean a 23percent decline in earnings, which
could only be offset by a 1.2percentage point increase in either
loan rates or service charges, or by
some combination of the two.) Yet
significantly, major S&L groups, ear­
ly in the year, reversed their tradi­
tional stance in favor of checkingaccount powers. They did this part­
ly to strengthen their argument for
retaining their 14-percent differen­
tial on savings, but also in the belief



that potentially expensive accounts
were not needed so long as they
had the prospective power to offer
NOW accounts at a lower average
cost than present savings accounts.
The equity thrust of the original
FINE Principles was weakened by a
revision which would permit thrifts
to offer third-party payment serv­
ices of any type (checking accounts,
NOWS, etc.) where permitted by
state law. Also, the Principles’ po­
tential for strengthening monetary
control was weakened by a revision
which would exempt institutions
with less than $15 million in thirdparty accounts from System reserve
requirements. When the bill finally
was sent back to committee, it
looked like such Ozian characters
as the Shaggy Man and the Patch­
work Girl. Nevertheless, Chairman
Reuss of the House Banking and
Currency Committee has made it
clear that the reform proposals “are
not dead,” and that the new Con­
gress will be focusing more intently
on the problem of asymmetry be­
tween the thrifts’ asset and liability
structures. He has also noted that
the groundrules even now are be­
ing rapidly altered at the state level,
a situation that cannot be left “to
the chaotic action of the 50 states.”
Hectic activity
This spate of legislative action at the
state level has involved the confer­
ring of some form of checkingaccount authority upon thrifts in
New England, New York, Illinois,
Wisconsin and Oregon. In several
cases, these new powers have in­
cluded authority to offer overdrafts.

Activity in the area of electronic
funds transfers also is having an
impact, notwithstanding the Su­
preme Court's recent ruling that
bank electronic terminals (CBCT's)
are "branches" within the meaning
of the McFadden Act, and thereby
subject to state branching laws and
restrictions. A large California S&L
now makes it possible for its
savings-account customers to pay
for groceries with a simultaneous
electronic debiting and crediting
procedure. Such developments are
rapidly eroding the traditional dis­
tinction between different types of
accounts, and are reshaping
competition among financial insti­
tutions and also altering the link­
ages of monetary control.
Both of these forces for change—
state legislative actions and the new
EFT developments— have strong
consumer overtones, and herein
may lie the means for unraveling
the gordian knot that has tied up
the restructuring of the nation's
depository institutions. For exam­
ple, some consumer groups appear
to be increasingly disenchanted
with the view that savers should be
forced to subsidize certain borrow­
ers because of the Reg Q ceilings
on their savings deposits. Others
claim that Reg Q fails to meet its
primary social justification—
housing— because in an era of
growing consumer awareness of
investment alternatives, interestrate ceilings will become progres­
sively less effective in forestalling
future disintermediation of deposit
funds. Consumers also are becom­
ing more aware that inflation itself



is the chief enemy of housing—
contributing to a doubling of home
prices in nine years—and that
unless inflation is curbed, housing
will not be protected by any num­
ber of Dorothy's magic shoes.
Increasingly, consumers also may
demand an explicit rather than an
implicit return on their funds—
including demand deposits, whose
distinction vis-a-vis savings deposits
even now is being altered by NOW
accounts and preauthorized trans­
fers from savings deposits, as well as
proposed telephonic transfers to
demand deposits. Yet consumers
will have to realize that increases in
the cost of funds to lenders may
mean higher costs to borrowers; in
the real world there is no such thing
as a "free lunch," such as Dorothy
and the Tin Woodsman were able
to pluck from the lunch-pail tree.
In the area of EFTS, a more consis­
tent attitude on the part of consum­
ers and bankers alike may be neces­
sary towards both liberalized
branching and EFTS— including the
use of CBCT's by banks. Hostility
may be not only anti-competitive
but also self-defeating, simply be­
cause the thrifts are not subject to
the McFadden Act. In fact, EFTS
holds considerable potential for the
development of consumer and
small-business services, which
traditionally have been the stock in
trade of the small banks. If the
banks don't take advantage of this
potential, the thrifts and other com­
petitors very likely will, and small
banks in particular may be left be­
hind in Munchkin Land.
Verle Johnston

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BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks

Amount
Outstanding
11/17/76
91,218
69,258
1,569
22,557
21,166
11,640
8,865
13,095
89,773
26,048
329
61,874
4,730
28,929
26,158
10,045

Weekly Averages
of Daily Figures

W eek ended
11/17/76

Member Bank Reserve Position
Excess Reserves
Borrowings
Net free(+)/Net borrowed (-)
Federal Funds—Seven Large Banks
Interbank Federal fund transactions
Net purchases (+)/Net sales (-)
Transactions of U.S. security dealers
Net loans (+)/Net borrowings (-)

+

Change from
year ago
Dollar
Percent

+

Loans (gross, adjusted) and investments*
Loans (gross, adjusted)—total
Security loans
Com mercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
O ther securities
Deposits (less cash items)—total*
Demand deposits (adjusted)
U.S. Governm ent deposits
Time deposits—total*
States and political subdivisions
Savings deposits
O ther time deposits}:
Large negotiable C D ’s

Change
from
11/10/76

+ 4,792
+ 4,307
+ 191
333
+ 1,511
+ 1,266
+ 231
+ 254
+ 2,080
+ 1,523
146
+ 916
1,121
+ 7,208
- 3,830
- 5,546

-

+
+
+
+
+
-

+
-

-

320
371
234
64
120
20
218
473
168
21
182
218
68
206
249
74

W eek ended
11/10/76

+
+
+
+
+
+
+
+
+
+
+
-

5.54
6.63
13.86
1.45
7.69
12.20
2.68
1.98
2.37
6.21
30.74
1.50
19.16
33.18
12.77
35.57

Comparable
year-ago period
+

17
3
14

-

+

11
0
11

-

3
0
3

+

719

+

366

+ 1,531

+

307

+

706

+

+

544

"Includes items not shown separately. ^Individuals, partnerships and 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.
Phone (415) 544-2184.