Full text of Economic Policy Review (Federal Reserve Bank of New York) : February 1976, Vol. 58, No. 2

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FEDERAL RESERVE BANK OF NEW YORK

Remarks before the New York State Bankers Association
By P a u l A. V o l c k e r
President, Federal Reserve Bank of New York

I am delighted to have this opportunity to meet today
with bankers from all parts of New York State for the
first time as president of the Federal Reserve Bank of
New York. My delight, of course, is related to the nature
of the occasion— being back home and talking about
matters of common interest— not a claim that we meet
in entirely happy circumstances.
The past year has seen unparalleled strains on the
finances of our state and its leading city. There have
already been consequences for all of us and, unless
dealt with effectively, there could be national and even
international repercussions as well. Other pressures on
our banking and financial structure, building up over
several years, have become evident in the aftermath of
recession. Right in my own bailiwick, the Federal Reserve
System has been in the midst of much controversy, with
a spate of proposals for far-reaching changes introduced
in the Congress.
In a happy contrast to the beginning of last year, there
is upward momentum in economic activity. The rate of
price increase has diminished from the peaks of 1974.
But unemployment remains close to postwar peaks, with
only slow declines in prospect. Our economic prospects
remain clouded in other im portant respects. Inflation
still looms as a major threat to sustained prosperity,
and investment activity is lagging.
From our somewhat different vantage points, we will
be dealing together with all of these challenges as far
ahead as I can see. In the circumstances, I hardly knew

^Midwinter meeting held in New York City on Monday, January
26 , 1976 .

where to begin as I prepared for my remarks today.
But that problem was solved for me by the unprecedented
barrage of reports in the press these past two weeks about
conditions in the banking system and of individual banks
within it— reports that could leave in the public mind
some totally unwarranted impressions about the stability
of the system. That subject is close to my heart and mind,
and I am sure to yours as well.
Perhaps I can best approach the matter by simply
stating again my own perspectives. There is no doubt
that banks— as businesses generally— have been function
ing in a more difficult environment than at any earlier
time since the Great Depression. A long period of almost
uninterrupted growth and prosperity— accompanied by
widespread confidence that we had found the means of
preventing serious economic setbacks— had encouraged
more aggressive, highly competitive behavior by many
financial institutions in the 1960’s and the early 1970’s.
The long period of smooth sailing encouraged banks,
as others, to leverage their capital more highly, beyond
traditional standards. To many in the investment com
munity and elsewhere, aggressive liability management
and exploration of new lending areas became the hall
marks of progressive banking; indeed, those slower to
move in these directions were often less favored by the
market and chided by their customers. The more com
petitive banking environment was widely and, in impor
tant respects, rightly hailed as bringing clear benefits for
depositors, borrowers, and investors alike. Yet, it was
also true that some of the trends could not be sustained
indefinitely, and some mistakes were made. The brutal
combination of inflation and recession has now exposed
the excesses in a few areas; they need correction and
the process is under way.
None of this has been hidden from you or from any

MONTHLY REVIEW, FEBRUARY 1976

careful follower of bank reports. I know the actions and
statements of the regulatory authorities— and I can speak
directly of the Federal Reserve— have reflected their
recognition of potential points of stress for some time,
sometimes to the discomfort of bank managements. But
the danger now is that reports spread in the general
press— citing, in part, fragments of examination reports
and other internal working papers designed specifically
to ferret out and highlight problems— lend a sensation
alized air to these matters that seems to me unwarranted.
The clear positive signs of the basic health and strength
of the banking system are largely ignored, and perspec
tive is lost.
Let me cite again some simple facts that seem to me
to reflect in a more balanced way the banking situation.
Loan losses did reach a postwar high last year at a mul
tiple of the levels to which we had grown accustomed
in more settled times. Even so, for the larger New York
banks, the losses can be estimated at about 3A of 1 per
cent of loan portfolios. For the leading national and
international banks for which I have seen reports, loan
write-offs have without exception been matched by fresh
provisions to loan loss reserves, maintaining that impor
tant element of protection against future contingencies.
In fact, every large bank in New York City now has loan
loss reserves at a higher level than at the beginning of
1975 averaging almost twice last year’s actual losses.
At the same time, the basic earning power of banks
appears to have improved significantly. Preliminary indi
cations are that, after making their provisions for loan
losses, earnings for the year were maintained by the
large banks as a group— although not for every individ
ual bank— above the record levels of 1974. With growth
in loans and deposits slowing substantially and retained
earnings high in 1975, these banks have also begun to
improve their capital ratios.
It would be ironic, indeed, if that kind of broadly
favorable and distinctly reassuring information, routinely
reported in the financial pages of only a few papers, were
to be lost to readers of many newspaper stories that focus,
in the name of full disclosure, on the problem areas. The
recent publicity— leaning heavily on leaks of internal
papers protected by law from unauthorized disclosure—
does call attention to important questions about the
public’s right to know, the privacy and confidentiality
necessary to the internal work of the supervisory agencies
and the banks themselves, and even the effectiveness with
which the supervisory agencies are discharging their re
sponsibilities for the stability of our banking system. These
questions demand answers.
Accurate, adequate disclosure of material facts about

sizable business firms has long been an accepted concept
in the American business system, providing fundamental
protection for the investor and ensuring effective discipline
through market processes. Standards in that respect have
been toughened in recent years, and banks have not been
exempt. In a number of instances, banking institutions
have voluntarily moved beyond required standards, and
the standards have themselves been raised by the efforts
of the SEC, the banking authorities, and the accounting
and legal professions. Thinking is still evolving in this
area, and it seems to me possible that more can be done
to provide meaningful, consistent information, without
violating the confidentiality of customer relationships or
smothering business initiative. Information beyond the
purely financial may be relevant when sensitivity to such
matters as business ethics, employment practices and
standards, and consumer protection is understandably
high. I am also convinced that disclosure will be both
more meaningful and less burdensome to the extent banks
themselves consider, in a forward-looking way, what
should and can be done. I welcome the fact that at least a
few institutions are prepared to do just that.
These disclosure efforts, developed primarily to protect
the investor, inevitably overlap with, but can be distin
guished from, the overall responsibilities of the supervisory
authorities. The supervisor can help ensure that disclosure
standards designed primarily to help the investor are
enforced, and that the information is accurate. But the
responsibility of the bank supervisor is still broader. Our
basic job is not to serve the investment analyst or to serve
the stockholder interest, but to protect the interest of the
public generally, and the depositors directly, in the integ
rity and stability of the banking and payments system as
a whole. As part of that responsibility, we need to be
concerned with the safety and soundness of individual
banks, because it has long been recognized that failure
of a bank can have repercussions locally, nationally, or
even internationally, extending far beyond the impact on
the owners and creditors of the particular institution in
volved. Concerned as we must be with the safety of banks,
our responsibilities do not stop with meaningful disclosure
to the investor, but extend to developing and enforcing
appropriate safeguards against excessive risk.
Given these responsibilities, we are naturally concerned
with searching out problem areas. The individual examiner
is trained to probe into institutions as far as he can to
identify potential problems before they threaten the sound
ness of the bank and to bring them to the attention both
of his superiors and of the bank’s management. The exam
iner should, in the vernacular, “holler and scream” to get
his point across. And he will be more successful to the

FEDERAL RESERVE BANK OF NEW YORK

extent banks feel comfortable in volunteering free and
full access not just to their records but to their thinking,
and the examiner feels free to form judgments partly on
the basis of intangibles. All of this demands an atmo
sphere of confidentiality and mutual trust, because private
customer relationships, proprietary information, and pub
lic confidence are all deeply involved.
In the end, the measure of how well the examiner does
his job is how successfully problems can be identified and
resolved before they reach damaging proportions. We have
not always been successful— but one of the more inter
esting statistics I have learned in my new job is the very
limited number of loans classified as “substandard” or
“doubtful” that ever need to be written off in whole or
substantial part after those credits have been identified
and bank management seized of the task of following them
closely and taking the actions necessary to bolster the
credit.
A bank could always avoid mistakes, in the narrowest
sense, by drawing back to only those credits that involve
no discernible risk, by maintaining tight ceilings on interest
rates paid depositors, by maintaining high and rigid capital
standards, and by similar devices. But, carried to an ex
treme, such a course of action would hardly serve the
interest of individual institutions and their customers, or
more fundamentally, the requirements for an expanding
economy dependent on a free flow of bank credit and
risk taking. The supervisor, in the end, is not concerned
with safety alone, but also with promoting competition
and initiative. We want a variety of lending outlets for
businesses whose fortunes are never altogether certain. We
want savers to earn a reasonable reward. And we want
banks to seek out profits, because profits both measure
their effectiveness in serving their community and provide
the base for growth.
The constant challenge— the dilemma, if you will— of
the supervisor is to assure needed safety without stifling
initiative and competition. We are helped in resolving that
dilemma by the broad array of support that can be made
available through the FDIC and the Fed to protect, in the
last analysis, the stability of the banking system and the
individual depositors. But the first line of defense lies in
the soundness of the individual banks— and I frankly do
not see how we can maintain the necessary balance in that
job if the supervisor and the banks cannot work in confi
dentiality and mutual trust. Exposure in a public forum
of confidential working papers— papers designed to surface
potential problem areas— can only destroy that essential
condition.
Short of revealing sensitive, confidential information
about individual banking institutions and their customers,

I welcome considered Congressional and public inquiry
into the way we go about our job. As you know, proposals
for reorganization of the responsibilities for Federal bank
ing supervision are now being reviewed in the Congress,
with their inquiry focusing particularly on the question of
some or even complete consolidation of the overlapping
supervisory authorities of the FDIC, the Comptroller of
the Currency, and the Federal Reserve. The present ar
rangements grew out of a long period of historical
evolution, and follow no clear or obvious principle of
administrative organization. There are overlapping and
potentially confusing elements. The consequent possibility
of inconsistency, and even a competitive instinct, among
the agencies has often been cited.
But the system also has enormous strengths and histori
cal logic of its own. It reflects our national suspicion about
the danger of concentrated power. It can help encourage
a useful measure of innovation. And I suspect it also helps
protect against a certain insulation— a bureaucratic arterio
sclerosis— that may over time erode ability of a dominating
regulatory agency to distinguish between the public interest
and its institutional interest.
In responding to the Congressional concern, the Federal
Reserve and other supervisory agencies have been rethink
ing this matter. No consensus has yet emerged. One possi
bility is that, even under present law, there may well still
be areas in which a further degree of coordination— for
instance, in examination standards and procedures— could
usefully be achieved. I would not myself resist some fur
ther consolidation through legislative reorganization, pro
vided— and it is a large proviso— that the Federal Reserve
maintains a substantial role in the supervisory and regu
latory process.
The proposals sometimes made to insulate monetary
policy from supervisory policy would, in my judgment, be
a disservice to both. In particular situations, it is easy to
imagine that people concerned wholly with bank super
vision, and therefore the way particular banking institu
tions are meeting their responsibilities, might have a
different perspective and reach somewhat different con
clusions from those concerned wholly with monetary
policy, and therefore aggregate economic activity. Both
are important. But it doesn’t make sense to me to try to
resolve these different perspectives by trying to place them
in water-tight compartments.
The potential conflicts have to be reconciled. That best
can be done, in my judgment, by those who are forced
by their responsibilities to recognize the legitimacy of
both concerns.
To my mind, decisions on monetary policy will them
selves only benefit from the fact that those responsible are

MONTHLY REVIEW, FEBRUARY 1976

forced to involve themselves in the “nitty-gritty” of bank trolled by— direct, day-to-day and potentially partisan
ing— with a flow of first-hand information about lending political pressure, whether originating in the Administra
policies and trends, the condition of the credit markets, tion, with individual members of the Congress, or else
and the capacity of banks and other institutions to respond where.
That was not the view of the founders. The Federal
and adapt to policy initiatives. In other words, I am not a
Reserve
Act was a product of political genius. In going
believer in monetary policy from an ivory tower.
about
the
job of constructing a central bank, the Congress
The vague charge has often been made of regulatory
built
a
unique
institution, without precise parallel in the
agencies that they may become a captive of the industry
United
States
or
other countries. Some concepts were,
they regulate. Whether that charge has any merit in other
areas or not, I suspect this audience could testify rather of course, borrowed from earlier experience here and
eloquently that no case to that effect can be made against abroad. The genius lay in blending them together in a
the Federal Reserve. And I suspect one fundamental rea manner fitted to the vast size, the heterogeneity, and
son is that our supervisory and regulatory responsibilities, the traditions of the United States.
important as they are, are not our entire “raison d ’etre” .
The structure of the Federal Reserve defies simple
They must be performed in the context of other still larger description. It is a part of government; yet, it is not an
purposes and responsibilities.
agency like other agencies. It is firmly controlled by
It will not surprise you that I have deep concerns about public officials; yet, it has been able to draw upon a
the nature of other criticism directed at the Federal Re degree of participation and support from the private sec
serve in recent months. I am not thinking so much about tor that is perhaps unique in government. Monetary
debates on monetary policy conducted in the press, in the policy by its nature is a function of the central govern
academic community, and most importantly in the Con ment; yet, there is regional participation in policy devel
gress. Those debates are natural and even healthy when opment and implementation.
the economy is troubled. I am thinking rather of what I
The original Federal Reserve Act has been amended
can only judge as an attack on some of the underlying many times. There was a sweeping modernization in
premises of the Federal Reserve as an institution. I will
1935, and the act has been thoroughly reviewed in the
take my remaining time to talk with you about them, for Congress a number of times since. But throughout this
there are issues here that seem to me fundamental to our process, three fundamental and related elements have
economy and even to the nature of our processes of gov been retained.
ernment.
I have lost count of the number of times in recent
(1) The process of policy formulation and imple
months that one or another committee of the Congress has
mentation has been protected from partisan and
been presented with proposals for changes in the structure
short-term political control and influence. The
and organization of the Federal Reserve. What these pro
Congress, in delegating its own Constitutional
posals have in common is that, almost without exception,
authority over money, established an indepen
they seem to be designed, contrary to past intent and
dent authority free of executive domination and
tradition, to bring monetary policy much more directly
removed from the immediate pressures of the
under “political” control.
day-by-day Congressional processes. A number
In approaching this question, I do not want to be mis
of reinforcing methods have been used to assure
understood. The Federal Reserve is a public institution.
that result. Members of the Board of Gover
It is a creature of the Congress, and the Congress is free to
nors with general supervisory power over the
change it. Congressional review of our policies and our
System are appointed for long terms; they share
operations is neither new nor disturbing, even given the
certain im portant policy responsibilities with
pitch of intensity it has reached in recent years. We are,
the Federal Reserve Banks, whose officials are
after all, charged with responsibilities of great national
appointed outside the political process; and
importance. We should be— and I think we are— sensitive
the System is self-financed.
to the broad national priorities, and aware of the problems
(2 ) Policy and operating responsibility is widely
and needs of all parts of our country. In that broadest
dispersed. Washington is the center, but the
sense, we are a part of the fundamental political processes
System is nourished by roots throughout the
of the nation.
country. Awareness of, and sensitivity to, the
What is at issue seems to me something else: whether
concern of different regions and different in
the Federal Reserve should be exposed to— even con
terests have been built into the structure. Thus,

FEDERAL RESERVE BANK OF NEW YORK

operations are conducted by the twelve R e
serve Banks, under the direct supervision of
boards of directors drawn from their own
region. The Bank officials participate in the
process of policy formulation, with the presi
dents (who must be approved by the Board of
Governors) directly represented on the body
that formulates open market policies. Members
of the Board of Governors themselves are
drawn from different regions.
(3 ) As implied by the previous point, the System
has checks and balances within itself. In the
end, a single monetary policy must prevail. But
a diversity of views can be brought to the policy
table— each supported by independent research
and filtered through the differing perspectives
of different parts of the country and different
individuals, by direct contact with the market
place, with economic decision makers, and with
local opinion. A consensus must be reached
among men dependent on each other only by
the general interest in achieving coherent and
intelligent policy.
The Federal Reserve is a living institution— the precise
balance of forces within the System, and between the
System and other elements of government, is almost
always shifting at the margin as needs change and par
ticular personalities come and go. But these constants
of independence in judgment, regional participation and
decentralization, and internal checks and balances have
remained. I believe they have stood the test of time.
I cannot take the position that the Federal Reserve
should be exempt from legislative changes— that improve
ments are not possible. Some of the proposals now before
the Congress— and others made in the past— certainly
deserve careful hearing. But I do object vigorously to
the common thread that runs through many of the current
proposals.
For instance, one family of bills would bring the
Board of Governors and the individual Federal Reserve
Banks within the process of Congressional authorization
and appropriation— and with the purse goes the power.
With both the Board and Banks already carefully audited,
proposals that would subject the System to further audits
by the GAO inevitably raise the suspicion that the real
intent is to intrude into policy areas. Other bills would
drastically shorten the terms of Board members. Power
would be centralized by eliminating voting participation
of the presidents of the regional Reserve Banks from
the Open M arket Committee, by abolishing the boards

of directors of the regional Banks, and by curbing the
ability of the Reserve Banks to attract and retain the
kind of exceptionally able career officials that have not
ably marked the System from its'first days.
Taken together, or even in substantial part, these
proposals, if adopted, would mark a reversal of the
historic judgment of the Congress about the proper role
for itself and for the central bank in the conduct of m one
tary policy. The question must be asked: To what end?
The idea that the basic powers of the Federal Reserve
are to be directed toward certain basic, well-established
goals of public policy is not at issue. Those goals of
stability, growth, and employment— implicit in the Fed
eral Reserve Act and embodied in the Employment Act
of 1946— are essentially noncontroversial.
What is bound to be controversial is how best to meet
those goals through monetary policy. At best, monetary
policy is a complex and difficult mixture of science and
art. The results are never certain, and the relevant time
horizon may be relatively long.
The Congress, in delegating its ultimate authority, im
plicitly recognized that policy decisions heavily weighted
by their immediate impact and by public appreciation and
response may often be distorted and counterproductive.
By their nature, decisions on monetary policy must some
times run against the grain of the illusive hope that more
money can be equated with more production or more
real welfare. Effective policy takes a high degree of
expertise, and continuous attention. While there is a clear
need to work with the Administration of the day to the
extent possible, there are also times when their judgments
need to be sharply challenged. And these considerations
all support the continuing validity of the judgment that
the decision making should not be conducted directly
by those engaged fully in the rough and tumble of the
political arena.
The other side of the coin is that the policymaker needs
to be sensitive to the broad needs of the economy and
continuing national priorities. I have already stated my
belief that such sensitivity is built into the organization of
the Federal Reserve System. Within that general frame
work, there are still more opportunities for enlarging our
perspective— through, for instance, encouraging appoint
ment of Reserve Board members and Reserve Bank direc
tors from a wide spectrum of our national life. What I fail
to see is how narrowing the base of the System— for
instance, by abolishing the boards of directors of the Banks
or curbing the voice of the Banks themselves— would
contribute to that end. Nor do I see how it will help to
place Reserve Banks or their officials in a position to be
hostages to political fortune through the appropriations

MONTHLY REVIEW, FEBRUARY 1976

process or otherwise, or to undermine their ability to take
and defend viewpoints that may not coincide in all respects
with the current fashion in Washington. My observation,
from an earlier time than when I took my present position,
is that individual Reserve Banks have often played an
avant-garde role in prodding the System to reexamine the
premise of its policies, to explore and experiment with new
techniques, and to recognize in its policy making new cur
rents of opinion.
Finally, the proposals to reorganize the System in the
name of “responsiveness” seems to me to overlook the
effectiveness with which the Congress has learned to exer
cise its power of review and oversight. Never before have
Federal Reserve policies been scrutinized and challenged
so continuously and forcefully by the relevant committees.
It is a tough process— one that forces the policymaker to
think and rethink the premises of his actions and their con
sistency and effectiveness. A mass of information is
diligently supplied in response to the legitimate demands
of the Congress and the public to be fully informed both
as to the substance of policy and the factors bearing upon
the decisions.
Last year saw a potentially important new initiative in
this respect. After Congressional prodding, the Federal
Reserve undertook to quantify its longer range objectives
with respect to im portant monetary aggregates. I am not
one who believes that monetary policy can be reduced to
a question of maintaining a given rate of growth in the
money supply— the economy is much too complex for
that. But at least in present circumstances, when the econ
omy has been so unsettled, this discipline of quantifying

can perform an important service in both clarifying our
objectives for the public and providing a focus for in
formed Congressional debate.
The constructive elements in this process would end,
and the damage to the basic concept of the Federal
Reserve would begin, in my judgment, if the essential base
for the independent judgment of the System were to be
eroded. That is why I am concerned about the number of
proposals in the Congress that would do just that, and
why I wanted to leave these thoughts with you on my
maiden appearance today. History is, after all, replete with
the wreckage of economies that lost sight of monetary
discipline. We have had a glimpse of what that process
can mean in recent years, not just in the United States
but elsewhere.
I readily confess to a special interest in the Federal
Reserve. I know that, as we work together in the years
ahead, there can be many particular issues upon which
our views will diverge, our interests may differ, and new
approaches will be needed. Within the Federal Reserve
itself, there is ample room for debate and even dissent.
I am here today only because I firmly believe the Federal
Reserve Bank of New York has played— and can continue
to play— a constructive and even vital role in this entire
process.
That may sound parochial. But I do not think it paro
chial to assert that the chances for dealing successfully
with our troubled economy this year— and maintaining a
healthy economy and banking system through the years
ahead— will be enhanced by maintaining the independence
and vitality of the Federal Reserve System.

FEDERAL RESERVE BANK OF NEW YORK

The Business Situation

The latest monthly business statistics confirm that the
cyclical recovery in economic activity is continuing and,
indeed, suggest that it may have gained a firmer footing in
recent months. Perhaps the most striking improvements
have been reported in the figures on labor market condi
tions for December and January. The average workweek
rose significantly over this period, and there were large
additions to private nonfarm payrolls along with even
larger gains in household employment. In addition, the
overall unemployment rate plummeted 0.5 percentage
point in January to 7.8 percent, the lowest level in over
a year. Quite possibly, technical problems of seasonal
adjustment overstated the January improvement in jobless
ness, but there is little doubt that overall labor market
conditions have strengthened over the past two months.
O ther recent reports showed strong and broadly based ad
vances in industrial production and retail sales in Decem
ber, including an improvement in domestic new car sales
that was apparently extended further in January. Some
other developments, however, have suggested a more
moderate rate of expansion overall, as new orders, housing
starts, and the composite index of leading indicators all
turned in relatively lackluster performances in December.
In the fourth quarter, the rate of growth of gross na
tional product (G N P) in real terms was much lower than
in the previous one. But the third-quarter spurt, largely
attributable to a marked slowdown in the pace of inven
tory liquidation, was clearly unsustainable. Now that the
inventory situation has stabilized, the pace of the economic
recovery will be closely attuned to the rate of growth of
final demand. Hence, the fact that all major spending com
ponents contributed to the healthy fourth-quarter gain in
real final sales can be regarded as an encouraging sign.
Other recent developments, such as the extension of the
1975 tax cut and the heady advance in the stock market,
are also reassuring in that they enhance the prospect of
further increases in consumption spending in coming
months.

GNPAND RELATED DEVELOPMENTS

According to preliminary estimates prepared by the
Department of Commerce, the market value of the nation’s
output of goods and services (G N P) increased at a 12.2
percent annual rate in the fourth quarter. Adjusted for
changes in the level of prices, the gain in real GNP
amounted to a healthy 5.4 percent. This was less than half
the rate of the previous quarter, but that advance was pri
marily the result of a sharp slowdown in the rate of inven
tory liquidation. The latest GNP data indicate that the
recovery is moving ahead on schedule and that the level
of economic activity has regained much of the ground that
was lost during the steep recession. As of the fourth
quarter, real GNP stood 1.9 percent below the peak at
tained two years earlier, a vast improvement over the 6.6
percent shortfall recorded in the first quarter of the year.
Nevertheless, there is still a great deal of slack within the
economy, inasmuch as the potential productive capacity
of the economy has continued to grow over the last couple
of years. For the manufacturing sector, the Federal Reserve
Board’s index of capacity utilization stood at 70.8 percent
in the fourth quarter, up 3.8 percentage points from the
second-quarter trough but 12.5 percentage points below
the peak attained in m id-1973.
In addition to the preliminary GNP data for the fourth
quarter, the Department of Commerce also released revised
estimates of GNP for the period from 1946 to 1975. These
revisions were quite extensive and incorporate a number
of notable features. First, the revisions include the regular
updating of the estimates for 1972 to 1974 that was post
poned from July 1975. Second, they incorporate
new “bench-m ark” information based on a num ber of
recent censuses. Third, the new estimates reflect numerous
definitional and classificational changes. The most im
portant is the new estimate of economic depreciation
which is designed to measure the loss in productive ser
vices of the existing capital stock— valued in both current-

MONTHLY REVIEW, FEBRUARY 1976

dollar and constant-dollar terms. Previously, the quarterly
estimates of depreciation in the national income accounts
had been based on allowable depreciation charges as de
fined by the United States tax code and tabulated by the
Internal Revenue Service from business tax returns. As a
result, these estimates were affected anytime the tax code
was changed, and they were valued on a historical cost
basis, i.e., in terms of the prices of the capital goods pre
vailing at the time they had originally been purchased.
Fourth, improvements were made in certain statistical
estimation procedures, including the incorporation of in
formation obtained in new statistical surveys of inventory
accounting methods used by businesses in estimating inven
tories. Fifth, the base year for the constant-dollar estimates
of GNP was updated from 1958 to 1972, and additional
information has been used to improve the constant-dollar
estimates of construction, producers’ purchases of durables
equipment, and Government purchases of goods and ser
vices. These changes have had a noticeable impact on the
recorded rates of growth of real GNP in particular quar
ters, but they do not appreciably change the cyclical pat
tern of growth over the postwar period (see Chart I) .
The fourth-quarter gain in real GNP was widely distrib

uted among the spending components (see Chart II ).
Inventory spending turned positive but added little to the
momentum of the recovery. Indeed, the turnabout in
inventory spending accounted for only about 6 percent
of the total gain in real GNP, unlike the previous quarter
when its contribution had amounted to about 60 percent.
In the fourth quarter, real final expenditures— equal to
GNP less the change in business inventories— increased at
a 5 percent annual rate, slightly higher than the gains
registered in the two preceding quarters. All major spend
ing components contributed to the latest increase in final
sales, including fixed investment spending and net exports
which had posted declines in the previous quarter.
Businesses have evidently succeeded in getting out from
under the once massive inventory overhang and now seem
to be keeping an earnestly tight rein on their inventories.
For the first time in a year, businesses actually added to
their stocks of inventories in the fourth quarter, although
the increase was concentrated in the farm sector. Within
the nonfarm business sector, there was a further liquida
tion of inventories, marking the fourth consecutive quarterly
decrease. Yet, in some respects, the most recent decline
seems to be of a different ilk than the earlier ones. Accord

C h a rt I

ALTERNATIVE ESTIMATES OF THE GROWTH RATE OF REAL GROSS NATIONAL PRODUCT
Com pounded
P e rc e n t

N o te :

P e rc e n t

S h a d e d a r e a s d e s ig n a te r e c e s s io n p e r io d s , as d e te r m in e d b y th e N a t i o n a l B u re a u

o f E c o n o m ic R e s e a rc h (NBER).
S o u rc e :

T he m o s t r e c e n t re c e s s io n h a s n o t y e t b e e n d a te d .

U n ite d S ta te s D e p a r tm e n t o f C o m m e r c e , B u re a u o f E c o n o m ic A n a la y s is .

a n n u a l ra te s

FEDERAL RESERVE BANK OF NEW YORK

ing to November data, the most recent disaggregated data
available, inventories declined in the wholesale trade and
retail trade sectors as well as in durable goods manufac
turing. In previous months, both trade sectors had been
building up their inventories. This sudden turnaround,
together with strong end-of-the-quarter retail sales, sug
gests that much of the fourth-quarter rundown was unin
tended, i.e., businesses had geared their production rates
to sales expectations that turned out to be too low. In any
event, the real inventory-to-sales ratio for the nonfarm
business sector edged down further in the fourth quarter,
declining to the lowest level in two years. This is one of
the clearest signs that the inventory correction has run its
course. Thus, changes in inventory investment in the
months ahead are unlikely to have the amplifying impact
on the cyclical swings in economic activity that they have
had over the past year and a half or so.
As inventory spending takes on a more passive role in
the current cyclical upturn, consumption spending will
come to play an increasingly vital role in setting the pace
of the recovery. In the fourth quarter, consumption spend
ing increased at a less than vigorous 3.5 percent annual
rate in real terms. Most of the advance occurred in Decem
ber. In the previous months, retail sales had been flat and
this sluggishness had given way to widespread concern
over the robustness of the recovery. The December up
surge in retail sales allayed these doubts to a large extent.
Moreover, the prospects for further increases in consump
tion spending have been brightened lately by such devel
opments as the extension of the 1975 tax cut, the steady
gains in personal income, and the impressive advance
staged by the stock market. Taken together, these develop
ments not only provide consumers with the wherewithal
for stepping up their spending but also should help allay
the uncertainty and hesitancy that consumers may have
about the economic outlook.
In the fourth quarter, personal income outpaced ex
penditures and the savings rate inched up to 8.2 percent,
relatively high by historical standards. For 1975 as a
whole, the savings rate averaged 8.3 percent. In the event
that consumers do begin to feel less insecure about the
economic environment, the savings rate will probably
decline a bit. This would add even further momentum to
the recovery.
At the end of the year the residential construction sec
tor was continuing to pull out of its very severe recession,
although the recovery path was proving to be a rather
bumpy one. In real terms, residential housing expendi
tures increased at a 30 percent annual rate, off somewhat
from the previous quarter’s gain. Much of this reflected
the pickup in construction of new units. Housing starts

C h a r t II

RECENT CHANGES IN REAL GROSS NATIONAL
PRODUCT AND ITS COMPONENTS
S e a s o n a ll y

a d ju s te d

C h a n g e fro m s e c o n d q u a r t e r to

C h a n g e fro m t h ir d q u a r t e r to

t h ir d q u a r t e r 1 9 7 5

f o u r th

-5

q u a rte r 1 9 7 5

B illio n s o f c o n s ta n t ( 1 9 7 2 ) d o lla r s

S o u rc e :

U n ite d S ta te s D e p a r tm e n t o f C o m m e r c e , B u re a u o f E c o n o m ic A n a ly s is .

were running at a 1.37 million unit annual rate over the
last three months of the year, up slightly from the previous
quarter but well above the average 1.03 million rate posted
for the first six months of the year. Still, there was less
residential construction activity in 1975 than in any year
since 1946, and the industry remains in a depressed
state.
Yet housebuilders can look forward to a somewhat
better year, as conditions have lately improved in the
mortgage market. In recent months, mortgage interest
rates have come down a bit as mortgage funds have
become increasingly abundant. The inflow of deposits to
thrift institutions rebounded in 1975 from the sluggish
rates of the previous year and a half. The thrift institu
tions have used these funds, in part, to rebuild their liquidity
but have lately channeled an increased proportion into

MONTHLY REVIEW, FEBRUARY 1976

the mortgage market. As a result, growth of their mortgage
holdings accelerated between April and October, and then
stabilized in November at an annual rate of about 12
percent, the highest since June 1973. At the same time,
mortgage interest rates have also reflected the easier
conditions. In the January 26 auction, the yield on the
Federal National Mortgage Association’s insured mortgage
commitments was about 90 basis points below the October
7 peak. Mortgage rates on some multiple-family buildings
will be lowered even further as a result of a recent action
by the Administration. Thus far, construction of multiplefamily buildings has staged a very weak comeback.
Whereas single-family starts in the fourth quarter of last
year had rebounded to better than 75 percent of their
1972 rate, multiple-family starts were at the same time
running at only one third of their 1972 rate. To stimulate
this sector, the Administration agreed to release $3 billion
in funds previously authorized by the Congress— an
amount which will enable the Federal Housing Adminis
tration to issue mortgages on multifamily buildings at a

C h a rt III

REAL BUSINESS FIXED INVESTM ENT IN SIX
POSTW AR RECESSIO N S AND RECOVERIES
SPENDING AS A PERCENTAGE OF TR O U G H -Q U A R TE R L E V E L *
Percent___________________________________________________________Percent

/
>J 949
A
\ \
>- VV \

-1

/
/

PR IC ES

/
/
_

/
/

>1958

/
)-

n l 970
\
\

\ ^

197 5

*
*

\ \ \
\ \ \
\ V \

t
1954

1
—2

1
—1

fo u r th

....

q u a r t e r 1 9 4 9 , se co n d

f irs t q u a r t e r 1 9 6 1 , f o u r th
r e c e s s io n

Quarters after trough
.

_L.. ........ J
1

N o t e : T h e N a t i o n a l B u r e a u o f E c o n o m ic R e s e a r c h - d a t e d
o c c u r in

/7 A

------

Quarters before trough
—3

1961

) ............. 1___

—4

7.5 percent interest rate. This infusion of Government
funds, along with the increased deposit inflows to thrift
institutions, should add impetus to the housing recovery.
In the fourth quarter, business fixed investment spend
ing advanced in real terms, following six consecutive quar
terly declines. The gain amounted to an impressive 9
percent annual rate and reflected increased outlays for
both structures and capital equipment. This turnabout
follows a protracted and very steep contraction in capital
spending and has occurred at about the same time in the
current cyclical recovery as in earlier ones (see Chart III).
Nevertheless, there is some doubt whether the fourthquarter advances in real capital spending will be backed
up by subsequent increases in the current year. In partic
ular, the most recent (December) Department of Com
merce survey of businesses’ planned capital outlays for
1976 points to a modest increase in nominal spending but
an outright decline of about 4 percent in real terms. In
general, there has been a tendency for surveys of planned
capital spending to underestimate the actual increases in
the first full year of economic recovery. The Commerce
Departm ent’s special December survey only dates back to
1970, which means there is no long track record by which
to judge its forecasting accuracy. Since its inception, how
ever, this survey has proved to be quite accurate. Still, an
outright decline in capital spending at this stage of the
current business cycle would indeed be an unusual devel
opment. In any event, even if there were a decline in capi
tal spending in 1976, it would probably be too small to
undermine the economic recovery, though the recovery
would of course be slowed down.

1 ........ 1
3
4
r e c e s s io n

q u a rte r 1 9 5 4 , s e co n d

tr o u g h s

q u a rte r 19 58 ,

q u a r t e r 1 9 7 0 . T h e t r o u g h q u a r t e r fo r t h e la te s t

has not ye t been

b o tt o m e d o u t in t h e s e c o n d

d a te d

b y th e N B E R . In d u s t r ia l p r o d u c t io n

q u a r t e r , w h ic h

is u s e d as th e t ro u g h

q u a r t e r in t h e c h a r t .
♦ For each

re fe re n c e

c y c le th e tr o u g h - q u a r t e r le v e l e q u a ls

S o u rc e : U n it e d S ta te s D e p a r t m e n t o f C o m m e r c e .

100 p e rc e n t.

Inflationary pressures appeared to let up a bit in the
fourth quarter, although the various indicators continued
to present a mixed picture that is difficult to interpret.
According to the implicit price deflator for GNP, the
most comprehensive of the official price indexes, the
prices of final goods and services rose at a 6.5 percent
annual rate in the fourth quarter, 0.6 percentage point
below the advance of the preceding quarter. F or the year
ended in the fourth quarter, the run-up in the final goods
and services prices amounted to 6.4 percent, down from
the 11.4 percent increase recorded over 1974. For final
goods, the 1975 slowdown in inflation was rather evenly
distributed in both consumption and business fixed invest
ment goods. Still, the gap between the rates of inflation
for the two classes of goods was rather wide in 1975, as
the prices of investment goods rose almost twice as fast as
those of consumption goods. While a similar pattern has

FEDERAL RESERVE BANK OF NEW YORK

occurred during past cyclical recoveries, the difference
between the growth rates has not been nearly so large. It
could be that this unusually large discrepancy in the rates
of inflation between consumption and investment goods
has contributed in part to the weakness in the outlook for
investment spending.
In recent months, the rates of inflation of consumer
and wholesale industrial prices have moved in disparate
directions. At the retail level, the average level of prices
rose at a 6.6 percent annual rate in the fourth quarter,
after increasing at an 8.2 percent rate in the earlier three
months. On average in the fourth quarter, total consumer
prices stood 7.3 percent above a year earlier, high by
historical standards but an improvement over the 12.1
percent surge chalked up in 1974. Increases in nonfood
commodity prices continued to moderate in the fourth
quarter. The advance in retail food prices also slowed
down but remained at an unexpectedly rapid rate. At the
wholesale level, industrial prices spurted at a 9.2 percent
annual rate in the fourth quarter, more than double that
of the preceding quarter and the largest quarterly advance
of the year. On average in the fourth quarter, industrial
wholesale prices were 6 percent above a year earlier in
comparison with the 27.3 percent surge recorded over
1974. Most of the fourth-quarter speedup occurred in
October and reflected the large price hikes posted for
metals and new automobiles. According to recent news
paper accounts, however, it appears that some of these

list-price increases may have been trimmed through either
discounting or outright price reductions.
LABOR

M A R K ET

C O N DITIO N S

According to the labor market data for recent months,
the recovery in economic activity has gained a much
firmer footing than it appears to have had late last fall.
The number of workers on nonagricultural payrolls spurted
by about 360,000 in January, up from the 210,000 advance of the previous month and almost three times as
large as the average increment recorded from September to
November. The January rise was broadly based, as every
major industry grouping except mining increased the size
of its work force. At the same time, the average workweek
lengthened in both the manufacturing sector and the pri
vate nonfarm economy. This is a particularly encouraging
development, inasmuch as the average workweek has
proved to be a fairly reliable indicator of labor market
tightness. According to the separate household survey,
employment shot up by 800,000, a huge increase by his
torical standards. Whereas the gain in employment greatly
overshadowed the expansion in the civilian labor force,
the overall unemployment rate plummeted by 0.5 per
centage point in January to 7.8 percent. This was the
largest one-month drop in the jobless rate in sixteen years,
but technical problems of seasonal adjustment may have
overstated the decline.

MONTHLY REVIEW, FEBRUARY 1976

The Money and Bond Markets in January

Interest rates continued to fall sharply during the first
half of January. The declines were particularly pronounced
in short-term rates, with some rates dropping to their
lowest levels in more than three years. Forecasts of lower
interest rates in the early months of 1976, optimism about
the outlook for inflation, and a lower trading range for
Federal funds strengthened market demand. At midmonth
the rally faltered, amid signs of sustained economic re
covery and reemergence of concern over financing the
massive Federal deficit. The absence of further declines in
the Federal funds rate also prompted a more cautious
market tone. In this atmosphere, a reduction in the dis
count rate by Federal Reserve Banks at midmonth was
viewed only as a necessary adjustment to recent declines
in other short-term rates and provided only modest sup
port to the market.
Late in the month the Treasury announced its plans
for the February refunding operation. M arket reaction
was favorable, and a substantial amount of new cash was
raised. In early February the Treasury sold $9.4 billion of
securities to the public to retire $4.3 billion of maturing
notes and to raise $5.1 billion in new funds.
Preliminary estimates, which reflect recent revisions,
indicate that the narrowly defined money stock (M x) in
creased modestly in January after declining in the previous
month. At the same time, consumer-type time deposits at
commercial banks advanced at a rapid pace and, thus,
growth in the more broadly defined money stock (M 2)
accelerated sharply. A sizable decrease in the outstanding
volume of large negotiable certificates of deposit (CDs)
held the bank credit proxy to a small gain.

THE

M O N EY

M A R K ET A N D

M O N ETA R Y

THE

AGGREGATES

Interest rates on most money market instruments de
clined sharply during the first half of January, then stabi
lized at new lower levels (see Chart I) . Compared with
its average in December, the effective rate on Federal

funds fell 33 basis points in January to 4.87 percent,
its lowest monthly level since September 1972. Most other
short-term interest rates also posted substantial declines.
Over the month, the rate on 90- to 119-day dealer-placed
commercial paper dropped s/s percentage point to 5 per
cent, while the yield in the secondary market on ninety-day
CDs declined about 5/s percentage point to 5.02 percent.
Effective January 19, the Board of Governors of the
Federal Reserve System approved a reduction in the dis
count rate at eleven Federal Reserve Banks, including
New York, from 6 percent to 5Vi percent, and the
remaining Reserve Bank joined in this move on January
22. The action was intended to bring the discount rate
into closer alignment with other short-term rates. Even
with the discount rate reduction, Federal funds traded at
rates generally below the discount rate and the volume
of borrowing was modest (see Table I ) .
Commercial and industrial loans at large commercial
banks fell by $3,897 million in the four statement weeks
ended January 28. A sharp reduction in bank holdings
of bankers’ acceptances accounted for part of this decline,
however. Loans excluding acceptances showed a decrease
of $2,698 million. Over comparable periods in the pre
ceding two years, these loans excluding acceptances were
down an average of $3,153 million. Reflecting the easing
in other short-term interest rates and the continued sluggish
loan demand, most major banks reduced their prime lend
ing rate to 63A percent in two Va percentage point steps.
In January the Board of Governors announced re
vision of the money stock and related measures to
incorporate data obtained from nonmember banks in
the June and September call reports and to revise sea
sonal adjustment factors. The revisions also reflect ad
justments for certain new data relating to cash items in
the process of collection, a deduction item in the computa
tion of the demand deposits adjusted series. The “cash
items” adjustment affected the money stock measures back
to 1966. The major effect of the revisions was to lower
slightly the growth of the money stock measures in 1970

FEDERAL RESERVE BANK OF NEW YORK

Chart I

SELECTED INTEREST RATES
N ovem b er-January 1976
M O NEY MARKET RATES

BO ND MARKET YIELDS

N o v e m b er
N o te -.

D ecem ber

January

D a t a a r e s h o w n fo r b u s in e s s d a y s o n ly .

M O N E Y M A R K E T RATES Q U O T E D :

P rim e c o m m e rc ia l lo a n ra te a t m o st m a jo r banks,-

s t a n d a r d A a a - r a t e d b o n d o f a t le a s t t w e n t y y e a r s ’ m a tu rity ; d a ily a v e r a g e s o f

o f fe r in g r a te s (q u o te d in te rm s o f r a te o f d is c o u n t) on 9 0 - to 1 1 9 - d a y p rim e c o m m e r c ia l

y ie ld s on s e a s o n e d A a a - r a t e d c o r p o r a te b o n d s ; d a i ly a v e r a g e s o f y ie ld s on

p a p e r q u o te d b y t h r e e o f th e fiv e d e a le r s t h a t r e p o r t t h e ir r a te s , o r th e m id p o in t o f

lo n g -te rm G o v e r n m e n t s e c u ritie s (b o n d s d u e o r c a lla b le in ten y e a r s o r m o re )

th e r a n g e q u o te d if no co n s e n s u s is a v a i la b l e ; th e e f f e c tiv e r a t e o n F e d e r a l fu n d s

a n d on G o v e r n m e n t s e c u ritie s d u e in th re e to f iv e y e a r s , c o m p u te d on th e b a s is

(th e r a te m o st r e p r e s e n t a t iv e o f th e t r a n s a c tio n s e x e c u te d ); clo s in g b id ra te s (q u o te d
in te rm s o f r a te o f d is c o u n t) on n e w e s t o u ts t a n d in g th r e e -m o n t h T re a s u ry b ills .

y e a r t a x - e x e m p t b o n d s (c a r r y in g M o o d y ’ s ra tin g s o f A a a , A a , A , a n d B a a ).

B O N D M A R K E T YIELD S Q U O T E D :

Y ie ld s on n e w A a a - r a t e d p u b lic u t ilit y b o n d s a r e b a s e d

on p ric e s a s k e d b y u n d e r w r itin g s y n d ic a te s , a d ju s t e d to m a k e th e m e q u iv a l e n t to a

and raise slightly the growth in 1972. In addition, changes
in the seasonal adjustment factors were larger than usual,
particularly for Mi, and resulted in higher levels of the
money stock measures for January and lower levels for
June. As a consequence, monthly changes in the money
stock measures in 1975 are now somewhat smoother than
previously estimated. All money stock data in this article
reflect these revisions.
According to preliminary data, the monetary aggregates
gave a mixed picture in January, with M x showing con
tinued weakness and M 2 showing substantial strength.
Over the four-week period ended January 28, M i— private
demand deposits adjusted plus currency outside commer
cial banks— rose 2.6 percent at an annual rate from its

o f c lo s in g b id p ric e s ; T h u rs d a y a v e r a g e s o f y ie ld s on t w e n t y s e a s o n e d t w e n ty -

S o u rc e s :

F e d e r a l R e s e rv e B a n k o f N e w Y o rk , B o a rd o f G o v e r n o r s o f th e F e d e r a l

R e s e rv e S y s te m , M o o d y 's In v e s to rs S e rv ic e , In c ., a n d T h e B o n d B u y e r.

average level over the previous four weeks. This brought
the growth in M 1 from the four weeks ended thirteen weeks
earlier to 3 percent (see Chart II). M 2— Mi plus time
deposits other than large negotiable CDs— on the other
hand, benefited from the lower interest rates on money
market instruments. Both individual and corporate savers
were attracted by the relatively higher rates generally
available on small- to medium-size time and savings
deposits. As a result, the growth in M 2 accelerated to a
10.4 percent annual rate in the four-week period ended
January 28 from its level over the previous four weeks.
Over the same period, the adjusted bank credit proxy—
total member bank deposits subject to reserve require
ments plus certain nondeposit sources of funds— increased

MONTHLY REVIEW, FEBRUARY 1976

48
Table I

FACTORS T EN D IN G TO INCREASE OR DECREASE
MEMBER BA NK RESERVES, JA N U A RY 1976
In millions of dollars; (+ ) denotes increase
and (—) decrease in excess reserves

Changes in daily averages—
week ended

Net
changes

Factors
Jan.

Jan.
14

Jan.
28

Jan.
21

“ Market” factors
M e m b e r b a n k r e q u ir e d re s e rv e s
O p e ra tin g

tr a n s a c t i o n s

...................

( s u b to ta l)

..............

F e d e r a l R eserv e flo a t ......................................
T re a s u ry

o p e r a tio n s *

—

17G

— 1,209

—

359

+ 1,084

+ 3 .8 0 3

433

— 3,851

—

395

286

215

620

443

+ 2 ,5 4 5

633

— 4,256

— 1,490

—

+ 1,854

679

310

124

239

132

+ 3,498

792

— 2,767

257

- 3,515

773

+ 2 ,5 5 1

448

—

510

— 1,522

238

— 1,73S

172

......................................

854

G o ld a n d fo re ig n a c c o u n t .............................

392

............................................................

T o ta l “ m a r k e t” f a c to rs .................................

— 2,272

+ 3 .244

O th e r F e d e r a l R eserv e lia b ilitie s
a n d c a p ita l

174

Direct Federal Reserve credit
transactions
O pen m a r k e t o p e r a tio n s

(su b to ta l)

............

O u tr ig h t h o ld in g s :

R a n k e r s ’ a c c e p ta n c e s

......................................

F e d e r a l ag e n c y o b lig a tio n s

—

1
__

..........................

—

240

R e p u rc h a s e a g r e e m e n ts :
T re asu ry

s e c u ritie s

...........................................

B a n k e r s ’ a c c e p ta n c e s
F ed eral

ag e n c y

......................................

o b lig a tio n s

M e m b e r b a n k b o rro w in g s
S easonal

T o ta l

borrow ings'}-

........................

184

— 1,553

620

—

305

202

—

136

108

.................................

—

186

....................................

—

408
276

..........................................................................

Excess reservest§ .................................................

—■
—

— 3,629

840

—

131

+ 1.727

978

19S

—

199

1 1
249

+ 2 ,7 0 6
_

—
+

156
491

i
“

420

Monthly
averagesll

Daily average levels

Member bank:

T o ta l re s e rv e s , i n c lu d in g v a u lt c a s l i + § ..........

35,531

35,813

36,220

35,075

35,660

R e q u ire d

35,232

35,627

35,986

34,902

35,437

299

186

234

173

223

152

35,769

36,068

35,017

35,579

127

111

re s e rv e s

................................................

E x c e s s re s e rv e s § .......................................................
T o t a l b o rro w in g s

....................................................

S e a s o n a l b o rr o w in g s !

......................................

N o n b o rro w e d re s e rv e s ...........................................
N e t c a rry - o v e r, e x c e ss o r d e fic it ( — )fl . . .

208

N o te : B e c a u s e of ro u n d in g , fig u re s do n o t n e c e s s a r ily a d d to to ta ls .
* I n c lu d e s c h a n g e s in T r e a s u r y c u r re n c y a n d c a s h ,
t I n c lu d e d in to t a l m e m b e r b a n k b o rro w in g s.
I n c lu d e s a s s e ts d e n o m in a te d in fo r e ig n c u r re n c ie s .

§ Adjusted to include waivers of penalties for reserve deficiencies in accordance with the
R egulation D change effective November 19, 1975.
|| Average for four weeks ended January 28, 1976.
II Not reflected in data above.

at only a 1.3 percent rate, as CDs registered a substantial
decline when banks allowed rates to drop in view of con
tinued weak loan demand.
In mid-January, the Federal Reserve adopted a new
long-term target range for M x growth, left the ranges for
the broader monetary aggregates unchanged, and advanced
by one quarter the yearly period over which the ranges
apply. The
range for the period from the fourth quarter
of 1975 to the fourth quarter of 1976 was widened to
AV2 -IV 2 percent from the previous 5-1V2 percent range
for the period from the third quarter of 1974 to the third
quarter of 1975. The change was prompted by the recent
transfer of an estimated $2 billion of corporate funds
from checking to savings accounts at commercial banks.
These transfers followed the November change of banking
regulations allowing partnerships and corporations to hold
commercial savings accounts of up to $150,000.
THE G O VER N M EN T

SECU R ITIES

M ARK ET

Interest rates on United States Treasury bills continued
their recent sharp declines and ended January substantially
lower on balance. The declines followed general reduc
tions of other money market rates and continued despite
sizable additions to outstanding bills through increases in
the regular weekly auctions. Yields on coupon issues,
however, reversed course before midmonth, partly retrac
ing early-January declines. Market participants became
wary that the rally might have been overdone, especially
in view of renewed evidence that economic recovery was
well under way and of the continued heavy borrowing
needs anticipated by the Treasury. Competition from the
enlarged corporate calendar and the normal hesitancy that
precedes a refunding announcement may also have been
factors.
Prices of Treasury coupon issues rose early in January
in line with the general improvement in the tone of the
money and bond markets. However, the market accorded
an unenthusiastic reception to $4.5 billion of Treasury
notes during the second week of the month. In that financ
ing, $2 billion of 64-month notes and. $2.5 billion of
24-month notes were auctioned to replace $1.6 billion
of maturing issues and to raise $2.9 billion of new cash.
The average yields on the notes were 7.40 percent and
6.49 percent, respectively. Dealers made slow progress
distributing the new notes, and with the February refund
ing on the horizon coupon prices moved downward.
On January 27 the Treasury announced its expected
borrowing needs for the first half of 1976 and its offerings
for the February refunding operation. The Treasury ex
pects to borrow $35 billion to $40 billion in the market

FEDERAL RESERVE BANK OF NEW YORK

during the first six months of 1976, with $8.6 billion of
this new cash having been raised in January. In its Feb
ruary refunding package, the Treasury made a larger than
expected start on the balance of these funds by selling
$9.4 billion of securities to retire $4.3 billion of publicly
held notes maturing February 15 and to raise $5.1 bil
lion in new cash. In auctions on February 5, the Treasury
sold $3 billion of three-year notes at a 7.05 percent yield
and $400 million of additional 8V4 percent 29-year
3-month bonds at an 8.09 percent return. In addition,
the Treasury announced that it would accept subscriptions
for at least $3.5 billion of seven-year notes with 8 percent
coupons to be issued at par. The subscription technique,
which had not been used in the past six years, caught
the market by surprise. The response to it was favorable,
however, since the coupon rate was set at an attractive
level. Subscriptions were accepted through February 3.
The issue turned out to be heavily oversubscribed, with
requests totaling $29.2 billion. The Treasury originally an-

Chart II

GROWTH OF SELECTED MONEY STOCK MEASURES
S e a s o n a lly a d ju s t e d a n n u a l ra te s
P e rc e n t

N o te :

P e rc e n t

G ro w th ra te s a r e c o m p u te d on th e b asis of fo u r-w e e k a v e r a g e s o f d a ily

fig u res fo r p erio d s e n d e d in th e s ta te m e n t w e e k p lo tte d , 13 w e ek s e a rlie r an d
5 2 w e ek s e a r lie r . The la te st sta te m en t w e e k p lo tte d is J a n u a ry 28 , 1976.
M l = C u rren c y plus a d ju s te d d e m a n d d ep o s its h eld b y the public.
M 2 = M l plus co m m e rc ia l b a n k savin gs a n d tim e d ep o s its h eld b y the p u b lic , less
n e g o tia b le ce rtific a te s o f d e p o s it issued in d e n o m in a tio n s o f $ 1 0 0 ,0 0 0 o r m ore.
Source:

B o ard o f G o v ern o rs o f the F e d e ra l R eserve System .

nounced that all orders up to $500,000 would be fully
allotted. Because of the overwhelming response to the
issue, orders of only $200,000 were actually met in full
and subscriptions over that amount were also allotted
$200,000. Even this restrictive approach to subscriptions
resulted in an enlargement of the issue to $6 billion in
sales to the public.
Following the Treasury’s announcement, prices on out
standing coupon issues changed little, as most participants
felt that the financing package was manageable. Over the
month, the index of intermediate-term Government securi
ties declined by 14 basis points to 7.14 percent while the
index of long-term bond yields fell 13 basis points to 6.92
percent.
Treasury bill rates continued their sharp declines in
January, buoyed by easier conditions in the Federal funds
market. A t the regular weekly bill auctions, rates on
new three-month bills dropped almost steadily over the
month (see Table II). On January 26, the average issuing
rate was 4.76 percent, about 45 basis points below the
rate set at the final auction in December and the lowest
such rate since the auction of November 6, 1972. Oneyear bills were auctioned on January 7 at 5.58 percent,
down 86 basis points from the yield at the December 10
auction. Rates on most issues ended the month 40 to
50 basis points below levels at the end of December.
In January, yields on Federal agency securities moved
in a similar manner to those in the coupon market. A
combined total of $1.42 billion of Federal Land Bank
bonds was sold during the early part of the month and
encountered an excellent reception. The offering con
sisted of $400 million of 6.60 percent 21-month bonds,
$600 million of 7.35 percent 51-month bonds, and
$420 million of 7.85 percent twelve-year bonds. These
issues raised $347 million in new cash. Another series
of agency bonds, involving $1,561 million of farm
credit issues, was also sold during the month and raised
$100 million in new cash. Investor response to these
bonds was somewhat more modest. The issues were
$399 million of 5.35 percent six-month Banks for Coop
eratives (BC) bonds, $962 million of 5.65 percent ninemonth Federal Intermediate Credit Bank bonds, and $200
million of 7.75 percent nine-year eleven-month BC bonds.
On January 15, $126.1 million of 7.25 percent Govern
ment National Mortgage Association mortgage-backed
bonds due in thirty years was priced to yield 8.22 percent
on a corporate bond equivalent basis. This offering was
immediately sold and traded at a small premium. Finally,
on January 22 the Federal National Mortgage Association
raised $300 million of new cash during the month through
ten-year capital debentures yielding 8.15 percent.

MONTHLY REVIEW, FEBRUARY 1976
Table II
OTHER

SECU R ITIES

M A R K E T S

The corporate bond market continued to rally during
the first half of January. Low inventories, a slack forward
calendar, and forecasts of lower interest rates in 1976
contributed to the optimistic atmosphere. However, by mid
month, the calendar of scheduled offerings had enlarged,
massive Treasury borrowing loomed ahead, and sizable
unsold balances of certain aggressively priced issues
remained in dealer hands. Consequently, price gains
halted, as market participants concentrated on the dis
tribution of large new offerings.
A number of highly rated corporate issues came to
market in January at yields appreciably below those
available on similar issues in December. Three utilities
sold thirty-year first-mortgage bonds, with yields of
8.50 percent on a $55 million Aa-rated issue, 8.83 per
cent on a $60 million Aa-rated issue, and 8.60 percent on
a $100 million Aaa-rated issue. These yields were about
85 to 100 basis points below those on comparably rated
securities offered during the previous month. In another
major offering, $200 million of 25-year credit corporation
debentures rated Aaa by Moody’s and AA by Standard &
Poor’s was sold at a yield of 8.80 percent, about 100 basis
points below a similar issue offered in December.
In the municipal market, yields on high quality issues
also moved sharply lower over the month. Underwriters,
however, continued to be wary of tax-exempt bond issues
in view of the Federal legislation, passed the previous
June, that holds them responsible for disclosure of infor
mation on the issuer. Hence, many state and local govern
ments found it necessary to expand the data available on
their financial condition before new issues could be floated.
Over the month as a whole, The Bond Buyer index of
twenty bond yields on twenty-year tax-exempt bonds fell
44 basis points to 6.85 percent. About a third of the
decline, however, reflected a change in the composition
of the index.
Prices on New York State-related tax-exempt bonds
remained stable during the month in spite of the refinanc-

A V ERAGE ISSU IN G RATES
AT R EGULAR TREASURY BILL AUCTIONS*
In percent
Weekly auction dates— January 1 9 7 6
M a tu rity

T h r e e - m o n th

................................................

Jan.
5

Jan.
12

Jan.
19

Jan.
26

5.226

4.S26

4.783

4.763

5.521

5.066

5.046

5.052

Monthly auction dates— November 1975-January 1 9 7 6

F if ty - tw o w eeks

.........................................

Nov.
13

Dec.
10

Jan.
7

6.010

6.439

5.578

^ I n t e r e s t r a te s o n b ills a r e q u o te d in te rm s o f a 3 6 0 -d a y y e a r, w ith th e d is c o u n ts fro m
p a r a s th e r e tu r n o n th e fa c e a m o u n t of th e b ills p a y a b le a t m a t u r i t y . B o n d y ie ld
e q u iv a le n ts , r e la t e d to th e a m o u n t a c t u a l l y in v e s te d , w o u ld b e s lig h tly h ig h e r.

ing problems of certain agencies of New York State and
Massachusetts and the suspension of M oody’s rating of
three New York State agencies. In New York, four agencies
needed to raise $128 million by midmonth, mainly to
refund maturing issues. However, several New York banks
(on a rollover basis) and two state insurance reserve
funds agreed to supply the necessary funds. The difficulties
of one Massachusetts agency were overcome when the state
purchased $60 million of notes that the Housing Finance
Agency had been unable to market publicly. A possible
solution to the financial problems of New York State agen
cies in the months to come was proposed during January,
as state pension funds may consider buying “moral obliga
tion” bonds of certain state agencies, contingent upon
passage of a state constitutional amendment prohibiting
further moral obligation borrowing and agreement by
the private sector to underwrite the state’s short-term bor
rowing in the spring.

FEDERAL RESERVE BANK OF NEW YORK

Trading in Bankers’ Acceptances:
A View from the Acceptance Desk
of the Federal Reserve Bank of New York
By R a l p h T. H e l f r i c h *

The Acceptance Trading Desk at the Federal Reserve
Bank of New York is a focal point, not only for System
open market operations and foreign investment account
activity in bankers’ acceptances, but also for banks, dealers,
students, and others seeking information about the accep
tance area. As the volume of bankers’ acceptances out
standing has increased substantially in recent years, the
Acceptance Desk has been requested to provide informa
tion not readily available elsewhere. Although there is no
lack of literature on the bankers’ acceptance method of
financing or its advantages as a money market instrument,
there is a scarcity of printed information about the tech
niques and procedures followed by the Federal Reserve in
its activities in the bankers’ acceptance market. To answer
some of the more frequent questions asked by the public,
this article aims, in addition to providing general informa
tion on the acceptance market, to assemble and to put into
an easily available form the standards and guidelines used
in the daily operations of the Acceptance Desk.
DRAM ATIC GROW TH
O U TSTA N D IN G

A C C E PT A N C E S

Bankers’ acceptances are primarily negotiable time drafts
drawn to finance the export, import, shipment, or storage
of goods, and they are termed “accepted” when a bank

* Ralph T. Helfrich is chief of the Acceptance Division in Open
Market Operations and Treasury Issues. The author wishes to
acknowledge gratefully the contribution to this work made by his
colleagues at the Federal Reserve Bank of New York: Lawrence
B. Aiken, Robert L. Cooper, Edward J. Ozog, and Peter D.
Stemlight.

assumes the obligation to make payment at maturity. The
first significant use of dollar-denominated bankers’ ac
ceptances in the United States occurred after the passage
of the Federal Reserve Act of 1913. By the late 1920’s
the volume of acceptances outstanding was over $1.7 bil
lion. During the depression and World War II, acceptances
financing international trade declined sharply. There has
been, however, a considerable increase in the volume of
acceptances outstanding in the United States since World
War II. In May 1945 acceptances outstanding totaled
$104 million, and by the end of 1973 the total was $8.9
billion (see Table I) . During 1974 the amount of accep
tances outstanding more than doubled, rising by $9.6 bil
lion to $18.5 billion; a record level of $18.7 billion was
registered in March 1975. A substantial portion of the
dramatic increase during 1974, and of the postwar growth
as well, was related to the use of acceptance financing by
Japan to sustain its international trade. As a result of this
growth, the acceptance as a short-term credit instrument
has gained significance in the money market. Purchases
of acceptances by the Federal Reserve provide a supple
mentary method of conducting open market operations.
Finance bills, also known as working capital accep
tances, are not included in the data showing total dollar
acceptances outstanding (see Table I). Developed in the
late 1960’s, these bills are not related to specific trade
transactions but are accepted by some banks as a vehicle
for extending short-term credit, presumably to provide
working capital to the drawer of the draft. In m id-1973, a
record $1.5 billion of outstanding finance bills was re
ported but the imposition of reserve requirements by the
Federal Reserve at that point on funds raised through the
use of such acceptances prompted a contraction of the
market. Finance bills cannot presently be discounted or
purchased by the Federal Reserve.

MONTHLY REVIEW, FEBRUARY 1976
Table I
DOLLAR ACCEPTANCES O UTSTANDING*
In millions of dollars
Year-end

Amount

1929 ................................

1,732

1939 .................................

233

1945 .................................

154

1950 .................................

394

1955 ................................

642

1960 ................................

2,027

1965 .................................

3,392

1967 .................................

4,317

1969 ................................

5,451

1970 .................................

7,058

1971 .................................

7,889

1972 .................................

6,898

1973 .................................

8,892

1974 ................................

18,484

1975 .................................

18,727

* Includes acceptances held by Federal Reserve Banks, com m ercial
banks, and others and excludes finance bills, also known as
working capital acceptances.

A C C EPTA N C E

D E SK

O PER A TIO N S

Operations at the Federal Reserve’s Acceptance Desk
consist of two major activities: first, operations undertaken
for the System under the direction of the Federal Open
M arket Committee (FO M C ) and, second, operations to
invest funds for foreign accounts maintained at the Fed
eral Reserve Bank of New York. Acceptance transactions
related to the implementation of monetary policy are an
integral part of Federal Reserve open market opera
tions in the securities market. To supply bank reserves, the
Federal Reserve purchases United States Treasury obliga
tions, Federal agency securities, and bankers’ acceptances
either outright to provide a permanent base for monetary
growth or under repurchase agreement when there is only
a temporary need for reserves. Federal Reserve open m ar
ket operations are conducted by the Federal Reserve Bank
of New York on behalf of the entire Federal Reserve
System. As will be discussed at some length, the Desk
purchases in the market for System or foreign accounts
only prime bankers’ acceptances from established dealer
firms.

o u t r i g h t p u r c h a s e s . Acceptances are normally pur
chased each day for the Federal Reserve’s own portfolio
of outright holdings, which totaled about $725 million in
December 1975. Since acceptances are short-term instru
ments, daily maturities of acceptances from the Federal
Reserve’s holdings are sizable and the portfolio must be
continually replenished to provide its share of a steady base
for bank reserves. If there is no reason to affect bank re
serves, the Desk replaces the maturities which are sched
uled to occur during a bank reserve-accounting week by
purchasing approximately equal amounts each trading day
during the same reserve period. In each reserveaccounting period, however, the Desk may elect to pur
chase more or less than its portfolio replacement needs
either to supply or to absorb bank reserves in accord with
monetary policy objectives. Dealers with which the Desk
is authorized to transact business are usually contacted by
telephone between 10 and 10:30 each morning and told
the approximate amount of purchases the Desk will make.
Dealers soon respond with offerings by rate, and under
normal circumstances purchases are completed within an
hour. Purchases are always awarded on a best rate basis,
and most purchases are delivered and paid for on the day
of the transaction.
The Desk does not usually ask dealers to specify in
advance the names of the banks that created the accep
tances the dealer is offering, since the Desk does not
attempt to distinguish gradations of quality among the
prime bank paper it finds acceptable for purchase. Never
theless, the market has assigned slightly different values
to the money market instruments of different classes of
banks. Therefore, to avoid acquiring undue amounts of
paper that the market considers to be less attractive to
hold, the Desk instructs dealers to offer and to deliver to
the Federal Reserve’s own account a reasonable mixture
of acceptances created by large money center banks, re
gional banks, and foreign banks.
The Federal Reserve avoids acquiring an unduly large
percentage of any bank’s total outstanding acceptances
by setting limitations on the amount of any individual
bank’s acceptances which it will buy. If dealers’ deliveries
of any bank name cause the Federal Reserve’s hold
ings of that name to exceed a reasonable percentage of
that bank’s outstanding acceptances, the Acceptance Desk
will temporarily refuse to accept that name until the hold
ings are reduced below the acceptable percentage. When
a bank learns that the Federal Reserve has stopped buying
its acceptances from the dealers, it sometimes inquires as
to the reason. Ordinarily, there is no significance to the
Federal Reserve’s action other than that its holdings
of a certain bank’s acceptances have grown out of propor

FEDERAL RESERVE BANK OF NEW YORK

tion to that bank’s activity in the market. There need be
no implications regarding the credit standing of the accept
ing bank involved. It is a temporary situation that will
end when the Federal Reserve’s holdings are reduced
through maturities, normally within a month or so.
r e p u r c h a s e a g r e e m e n t s . Federal Reserve operations to
purchase bankers’ acceptances under repurchase agree
ments serve as an im portant method of supplying bank
reserves for a short time, usually one to seven days. As a
rule, dealers maintain fairly sizable inventories of accep
tances. These inventories provide opportunities for the
Federal Reserve to acquire acceptances under repurchase
agreements designed to achieve the money market condi
tions desired by the monetary authorities. When the Fed
eral Reserve observes a temporary shortage of bank re
serves, dealers are contacted by the Desk and informed of
the number of days for which the Desk will offer to
provide funds under repurchase agreements. Dealers sub
sequently offer to sell to the Desk an amount of accep
tances at specific rates. The Desk has an amount of
bank reserves it wishes to supply and, in effect, auctions
this amount to dealers at the highest rates. Dealers deliver
to the Desk acceptances which have a market value some
what greater than the dollar amount the Desk pays to
dealers, thus providing a margin of excess “collateral”.
Dealers may terminate a repurchase agreement before
maturity, in whole or in part. The repurchase operation
at the Acceptance Desk is conducted as a joint operation
with the Securities Trading Desk at the Federal Reserve
and, consequently, both acceptance dealers and Govern
ment securities dealers compete for the amount of funds
the Federal Reserve is providing on any given day.

purch ases for
c u sto m er
a c c o u n t s . In recent years
many foreign correspondents of the Federal Reserve Bank
of New York, mainly other central banks, have found
bankers’ acceptances an attractive means of employing a
portion of their dollar balances maintained in investment
accounts at the Federal Reserve. When acting for its cus
tomers, the Acceptance Desk usually contacts each dealer
at the time that it seeks offerings for the System Open
Market Account. Purchases for customer accounts are
confined to acceptances created by banks specified by the
customer and to maturity ranges specified by the customer.
Within these limits, purchases are decided on a best rate
basis.
Prior to November 8, 1974, the Federal Reserve guar
anteed the acceptances it purchased for its foreign cor
respondents. The policy of guaranteeing acceptances held
by foreign correspondents was developed in the process

of working out reciprocal correspondent relationships with
other central banks during the early years of the Federal
Reserve System. Such guarantees were at that time con
sidered useful in encouraging the development of the
bankers’ acceptance market. In part, due to the favorable
rate spread between acceptances and Treasury bills, for
eign correspondent holdings of bankers’ acceptances guar
anteed by the Federal Reserve increased rapidly during
1974 to a level of about $2 billion. Against this back
ground, officials of the Federal Reserve concluded that
there was no longer justification for extending a guarantee
favoring a particular private market instrument or a par
ticular group of investors. Customer holdings receded to
around $300 million in 1975.
AUTH O R ITY

FOR

O PER A TIO N S

Acceptance Desk operations for the Federal Reserve
System are governed by directives from the FOMC. The
Committee’s authorization for domestic open market oper
ations in acceptances stems ultimately from the Federal
Reserve Act, Section 12A, Section 13, paragraphs 6, 7,
and 12, and Section 14, paragraph 1.
At one time, System operations in acceptances were
governed by Regulations B and C of the Board of Gov
ernors of the Federal Reserve System, but these were re
voked effective April 1, 1974 in order to realign and
modernize the rules relating to open market operations.
This action recognized that responsibility for open market
operations in acceptances rests with the FOM C rather
than with the Board of Governors. The FOM C issued new
rules which broadened the scope of acceptances eligible
for purchase by the Federal Reserve, but Regulation A,
as well as the sections of the Federal Reserve Act that
define those acceptances eligible for discount at the Fed
eral Reserve, was not changed. As a result, many ques
tions arose concerning the frequently misunderstood term
“eligibility”. Prior to the revocation of Regulations B and
C, Federal Reserve Banks were, subject to certain minor
exceptions, permitted to purchase under Section 14 of the
act only bankers’ acceptances discountable under Section
13, and consequently reference to eligibility could be made
with less ambiguity. At present, use of the word eligibility
without further clarification is ambiguous since some
acceptances eligible for purchase are not eligible for dis
count and some acceptances eligible for discount are not
eligible for purchase (see Table II ).
“The new rules issued by the FOM C authorize the
Federal Reserve Bank of New York to buy (outright or
under repurchase agreement) and sell ‘prime’ bankers’
acceptances— with maturities of up to nine months at the

MONTHLY REVIEW, FEBRUARY 1976
Table II
ELIGIBILITY

PRIME BANK ER S’ ACCEPTANCES
ELIGIBILITY A N D RESERVABILITY
Eligible for
Type of bankers’ acceptance
Purchase*

Discountt

Reserves
required*

Export-im port, including shipm ents
betw een foreign countries:
Tenor— 6 m onths o r less .............................
6 m onths to 9 m onths ..................

Yes
Yes

Yes§
No

No
Yes

D om estic shipm ent, with docum ents
conveying title attached at the time
of acceptance:
T enor—6 m onths or less .............................
6 m onths to 9 m onths ..................

Yes
Yes

Yes§
No

No
Yes

D om estic shipm ent, w ithout docum ents
conveying title:
T en o r—6 m onths o r less .............................
6 m onths to 9 m onths ..................

Yes
Yes

No
No

Yes
Y es

Shipm ent within foreign countries:
T enor— any m aturity ...................................

Yes

Foreign storage, readily m arketable
staples secured by w arehouse receipt:
T en o r—6 m onths o r less .............................
6 m onths to 9 m onths ..................

No
No

Yes§
No

No
Yes

D om estic storage, readily m arketable
staples secured by w arehouse receipt:
T enor— 6 m onths or less .............................
6 months to 9 m onths ..................

Yes
Yes

Yes§
No

No
Yes

D om estic storage, any goods in the
U nited States under contract of sale or
going into channels of trade and
secured throughout its life by
w arehouse receipt:
T en o r—6 m onths or less .............................
6 m onths to 9 m onths ..................

Yes
Yes

No
No

Yes
Yes

D ollar exchange, required by usages of
trade, only in approved countries:
T enor— 3 m onths or less .............................
3 m onths to 9 m onths ..................

No
No

Yes
No

No
Yes

Finance o r working capital, not related
to any specific transaction:
Tenor— any m aturity ...................................

Yes

N ote: T enor refers to the full length of time of the acceptance from
date of inception to m aturity.
* A uthorizations announced by the Federal Open M arket C om m ittee
on A pril 1, 1974.
t In accordance with R egulation A of the F ederal R eserve A ct.
t In accordance w ith R egulation D of the F ed eral R eserve Act.
§ Providing th at the m aturity of nonagricultural bills at the tim e
of discount is not m ore than ninety days.

time of acceptance that (1 ) arise out of the current ship
ment of goods between countries or within the United
States or (2 ) arise out of the storage within the United
States of goods under contract of sale or expected to move
into the channels of trade within a reasonable time and
are secured throughout their life by a warehouse receipt
or similar document conveying title to the underlying
goods.”1

1 Quoted from Federal Reserve Bank o f New York Circular 7366
dated March 27, 1974.

As mentioned, prior to April 1, 1974, the Federal Re
serve’s eligibility requirements for the discount or outright
purchase of bankers’ acceptances were almost synonymous,
but since that date it has become very im portant for those
who work with acceptances to know for what an accep
tance is eligible. Bankers’ acceptances acquired by the
Federal Reserve through the discount of such paper or
through open market operations are methods of supplying
bank reserves. However, as a matter of practice, the Fed
eral Reserve Banks for many years have not discounted
paper for member banks. Rather, Federal Reserve Banks
will advance funds to member banks if secured by obliga
tions or other paper eligible under the Federal Reserve Act
for discount or purchase by Reserve Banks. The principal
remaining significance of eligibility for discount, from the
Federal Reserve’s standpoint, is that bankers’ acceptances
described in Section 13 of the Federal Reserve Act and
eligible for discount are not subject to reserve require
ments; i.e., a bank which is a member of the Federal R e
serve System and which creates a bankers’ acceptance that
is sold in the market and that is not described in Section 13
or not eligible for discount must maintain reserves against
such an acceptance. While an acceptance may not be
eligible for discount, it may be eligible for purchase by
the Federal Reserve Bank of New York for its open m ar
ket operations and, if so, it would also be eligible to secure
an advance from the Federal Reserve to a member bank,
i.e., secure “borrowing from the discount window” .
The FOM C’s authorizations, announced on April 1,
1974, changed the type of acceptance the Federal Reserve
could purchase, as follows:
(1 ) Maturities at time of acceptance of more than
six months and up to nine months, providing
they meet other requirements, are eligible for
purchase but not eligible for discount.
(2) Domestic shipment acceptances without at
tached documents conveying title at the time
of acceptance are eligible for purchase but not
eligible for discount. To be discountable, the
shipping documents securing title must be in the
possession of the bank or its agent at the time
of acceptance.
(3) Foreign storage acceptances are not eligible for
purchase but are eligible for discount, provided
the goods are readily marketable staples, are
stored in an independent warehouse, and are
secured at the time of acceptance by a receipt
or other documents conveying title.

FEDERAL RESERVE BANK OF NEW YORK

(4 ) Acceptances financing the domestic storage of
goods (any goods, not necessarily readily m ar
ketable staples) that are under contract of sale
or expected to move into the channels of trade
within a reasonable time and that are secured
throughout their life by a warehouse receipt or
similar documents conveying title to the under
lying goods are eligible for purchase but are not
eligible for discount. To be discountable, the
goods must be readily marketable staples and
stored in an independent warehouse or subject
to governmental control and must be secured at
the time of acceptance by a receipt or other
document conveying title.
(5 ) Dollar exchange acceptances are not eligible for
purchase but continue to be eligible for dis
count.
As can be seen, therefore, the new rules have separated
acceptances, in some instances, into those eligible for pur
chase and those eligible for discount. Table II defines
“eligibility” and “reservability” for various classifications
of acceptances.
When dealers make deliveries of the acceptances sold
to the Federal Reserve, the Acceptance Division’s clerical
staff verifies each acceptance for eligibility, acceptability,
and negotiability. The following lists some of the most
common faults that disqualify an acceptance for purchase
by the Federal Reserve even though the acceptance may
meet the broad tests of eligibilty described in Table II.

(6 )
(7 )

(8 )

(9 )

due date is described as a stated number of
days from the date of the bill of lading issued
in connection with the shipment of goods
underlying the draft. At this writing, our inter
pretation is that there may be a legal infirmity
to the practice of specifying the tenor of an
acceptance in this way. The Federal Reserve
prefers to see specific language such as “ac
cepted to mature on . . . .”
Authorized signatures missing, e.g., drawer,
acceptor, endorser.
Restrictive foreign endorsement or drafts
drawn without recourse. Example: The en
dorsement “Pay any Bank, Banker, or Trust
Co.” does not under the Uniform Commercial
Code impair negotiability among banks and
special endorsees of banks, but this result may
not follow under foreign laws.
Words and figures on drafts do not agree, or
any change casting doubt on the amount, such
as “with collection charges” or “with interest” .
Drafts payable in a nonreserve city are not
acceptable as a matter of policy.

Also, it should be noted that since July 11, 1974, when
the dealer endorsement requirement was discontinued, the
Federal Reserve buys two-name paper— i.e., the drawer
and a nonaffiliated acceptor— for its own and its cus
tomer accounts.
M A R K ET

(1 ) The face of the draft does not specify the de
tails of the underlying transaction; this infor
mation is usually presented in a standard
“eligibility” stamp.
(2 ) Incomplete description of underlying trans
action. Example: “Merchandise— various; from
— various countries to Japan.” If a broad cate
gory must be used, it should be supported on
the back of the draft or on an attachment
giving the details of the commodities, the
countries of origin and destination, and the
amount of each such transaction.
(3 ) Draft drawn to finance only freight charges or
service charges such as interest, customs, in
surance.
(4 ) Changes in the terms of the draft or the tenor
is incomplete or questionable.
(5 ) A draft drawn subject to a bill of lading date
is not acceptable, i.e., the Federal Reserve
will not purchase an acceptance on which the

PA R T IC IPA N T S

The market for bankers’ acceptances is an over-thecounter market made by perhaps ten to fifteen dealer
firms, some with nationwide branches. Most of these
firms deal in a variety of marketable obligations, with the
acceptance trading constituting one part— in some cases
a relatively modest part— of their overall activities. The
major dealers in bankers’ acceptances are located in New
York City, a natural outgrowth of the close relationship
between acceptance financing and foreign trade as well as
between acceptances and the international departments of
larger banks. Participants in the market, in addition to
dealers, are the accepting banks both domestic and for
eign, Edge Act corporations, other investors of all types
ranging from individuals to foreign central banks, and the
Federal Reserve System.
The acceptance market, until the latter part of 1969,
differed from some other short-term markets in that it
featured posted rates by dealers. The major dealers in
acceptances quoted bid and asked rates for specified ma

MONTHLY REVIEW, FEBRUARY 1976

turities and stood ready to buy or sell prime acceptances
at their posted rates. Inasmuch as these acceptance rates
changed rather infrequently prior to 1969, the relative
stability provided the investor a certain measure of pro
tection against market risks. As the market for bankers’
acceptances became more volatile, the practice of posting
rates was altered and, although some dealers continued to
post bid and asked rates for informational purposes, it
has become generally understood that trading is done on
a negotiated basis.
Movements in acceptance rates are closely aligned with
other short-term money market instruments and are also
influenced by the size of dealers’ portfolios. The differ
ence in rate between what the dealer pays for acceptances
and what he sells them for, as well as the spread on the
cost of financing his position, largely determines his profit.
The normal dealer spread between buying and selling rates
is Vs to V\ percent, but it can be 1 percent or higher in
a sharply fluctuating market. Despite the relatively costly
paper work involved with each acceptance transaction,
i.e., the verification of each bill to assure negotiability and
eligibility, some large volume dealers manage on some
what smaller spreads, providing the cost of financing their
holdings is favorable. Accepting banks utilize dealer quo
tations in establishing a discount basis for customer
acceptance financing, usually adding an acceptance fee to
the dealer bid rate.
DEALER TR AD ING
W ITH

THE

R ELA TIO N SH IP

FEDERAL

RESER V E

A dealer firm trading in bankers’ acceptances and de
siring to establish a trading relationship with the Federal
Reserve must meet certain financial, managerial, and op
erational criteria. Before the Federal Reserve trades with
a dealer firm, the officers responsible for open market
operations ask the following types of questions:
(1 ) Is the firm actively engaged on a daily basis in
trading bankers’ acceptances?
(2 ) Is the firm’s trading activity of sufficient volume
and diversification to satisfy the Federal Re
serve’s requirements that the dealer be a sig
nificant market participant?
(3 ) Does the firm maintain a portfolio of satisfac
tory size, particularly relative to the other firms
with which the Desk transacts business?
(4 ) Is the firm reputable and financially sound?
(5 ) Will the Federal Reserve’s open market opera
tions benefit from recognition of the dealer, i.e.,
from the firm’s ability to make markets and its

ability to contribute to the development of a
broader market?
(6) Is the management and staff competent?
If these questions can be answered affirmatively, with
appropriate documentation, then the dealer firm can ex
pect the Federal Reserve to establish a trading relationship
with it.
E ST A B L ISH M E N T

OF BA N K

N A M E A S

PR IM E

To qualify its acceptances for purchase by the Federal
Reserve, a bank must establish its name in the market and
its acceptances must be considered “prim e” . A bank may
m arket its acceptances in any manner it chooses, but it is
when sales are made to dealers reporting to the Accep
tance Department on a daily basis that a bank’s sales be
come known to the Federal Reserve. When a bank’s
acceptances move in the dealer market, the Federal R e
serve can more easily reach a judgment regarding the
marketability of the paper and whether it is considered
prime by the dealers. The volume and frequency of market
transactions is also a factor which the Federal Reserve
considers before it decides to add a bank’s name to the
“acceptable” list that can be purchased in the open m ar
ket. The financial condition and reputation of the bank is,
of course, an important ingredient in whether a bank’s
acceptances are considered prime.
A bank seeking to have its acceptances qualify for pur
chase by the Federal Reserve Bank also has to meet cer
tain other standard criteria in the form of documentation.
The requirements are somewhat different for agencies or
branches of foreign banks and for nonmember commercial
banks than for Edge Act corporations and member banks
of the Federal Reserve System.
Member banks of the Federal Reserve System and Edge
Act corporations governed by Federal Reserve Regulation
K have only to submit a list of authorized signatures, in
addition to the requirement that the bank’s acceptances
trade as prime in the market. When a bank indicates to
the Acceptance Department that it seeks to have its accep
tances qualify for purchase by the Federal Reserve, a
review of the bank’s most recent examination by the
Federal bank examiners is obtained from the Reserve Dis
trict in which the bank is located.
The documents to be lodged by branches or agencies
of foreign banks with the Federal Reserve Bank are:
(1 ) Certificate of resolution (in the form required
by the Federal Reserve Bank of New Y ork) of
the board of directors of the foreign bank.

FEDERAL RESERVE BANK OF NEW YORK

(2 ) Certification (in the form required by the Fed
eral Reserve Bank of New Y ork) by the prin
cipal officer or representatives of the agency or
branch of the names, titles, and specimen sig
natures of persons authorized to sign accep
tances.
(3 ) Certified copy of license to do business issued
by the state in which the office is located.
(4 ) Copy of the letter to the State Banking Depart
ment requesting and authorizing the department
to furnish the Federal Reserve Bank with copies
of all reports of examinations of the foreign
agency or branch.
(5 ) Opinion of the United States counsel to the for
eign bank as to the authority of such bank to
accept bills of exchange drawn upon it.
(6 ) Letter of transmittal from the foreign branch or
agency addressed to the Federal Reserve Bank,
accompanying the foregoing documents and
containing a written undertaking by the agency
or branch that it will inform the Federal R e
serve Bank, at its request, of the details of any
transactions underlying the acceptances.
(7 ) Whenever the principal officer or representative
is to be succeeded, certification (in the form re
quired by the Federal Reserve Bank of New
York) by the principal officer or representative
of the status and signature of his successor.
(8 ) Such financial statements as the Federal Reserve
Bank may require.
It is recommended that the United States counsel to the
foreign bank be consulted in connection with its prepara
tion of the foregoing documents and that in the course of
such preparation the counsel contact the Legal D epart
ment of the Federal Reserve Bank of New York.
A nonmember commercial bank seeking to qualify its

acceptances for possible purchase by the Federal Reserve
is required to supply similar information as follows:
(1 ) Opinion of counsel to the bank that (a ) under
its charter and the laws of the state in which it
is located the bank is empowered to accept for
payment at a future date bills of exchange
drawn upon it and (b) the officers of the bank
have been authorized by its directors to accept
such bills.
(2) Certified copy of the most recent statement of
condition of the bank.
(3 ) Most recent report of examination of the bank
by the appropriate supervisory agency of the
state.
(4 ) Copy of the letter from the bank to the State
Banking Agency, authorizing and requesting
the agency to furnish the Federal Reserve with
copies of all examinations of the bank made by
the agency.
(5) Letter of transmittal from the bank to the Fed
eral Reserve Bank accompanying the foregoing
and containing a written statement that the
bank will inform the Federal Reserve, at its re
quest, concerning the details of the transactions
underlying its acceptances.
It should be emphasized that the policy of the Federal
Reserve is to purchase in the open market only accep
tances already established as prime acceptances; the lodg
ing of the documents enumerated above with the Accep
tance Department would not in and of itself mean that the
acceptances of the Bank would be purchased immediately
by the Federal Reserve. The documents merely put the
Federal Reserve in a position to purchase the acceptances
when such purchases are consistent with Federal Reserve
policy objectives, or when Federal Reserve customer ac
counts request that such purchases be made.

Full text of Economic Policy Review (Federal Reserve Bank of New York) : February 1976, Vol. 58, No. 2

FRASER