Full text of Economic Policy Review (Federal Reserve Bank of New York) : July 1968, Vol. 50, No. 7

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JULY 1968
Contents
Euro-Dollars in the Liquidity and Reserve
Management of United States Banks .......

130

The Business Situation .....................................

139

The Money and Bond Markets in J u n e ...........

142

Recent Capital Market Developm ents...........

147

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MONTHLY REVIEW, JULY 1968

Euro-Doilars in the Liquidity and Reserve Management
of United States Banks
By F r e d H.

During the last decade, the large commercial banks in
the United States have exhibited a remarkable degree of
imagination and initiative in broadening their access to
pools of liquid funds. Their success in attracting corporate
and institutional balances through the issue of negotiable
certificates of deposit (C /D ’s) is a case in point. Other
examples are their issue of “ consumer” investment certifi­
cates and the flotation of unsecured notes and debentures
in the capital market. More recently this increased readi­
ness of banks to rely on what has become known as “lia­
bility management” in the adjustment of liquidity and re­
serve positions has been demonstrated by their large-scale
use of balances acquired through their overseas branches
in the Euro-dollar market. The overseas branches became
active in this market soon after it emerged in the late
1950’s, and have gradually become the most important
participants. But only since the midsixties have several
of the major United States banks employed large amounts
of Euro-dollar balances for adjustments of their money
positions in response to changing needs for funds, and
more and more banks have opened overseas branches to
gain access to the Euro-dollar market.
For some of the large money market banks, Euro­
dollars have now become a major source of funds for
loans and investments; in certain instances, the head
office’s dollar liabilities to overseas branches exceed or
closely approach its outstanding C /D ’s. Altogether, lia­
bilities of American banks to their overseas branches are
now in excess of $6 billion. It is true that this total in­
cludes some funds that do not originate in the Euro­
dollar market, but on the other hand the United States

♦Manager, International Research Department, Federal Reserve
Bank o f New York.




K lopstock*

banks’ use of Euro-dollar balances in the management of
their portfolios is not limited to the amounts reported
as liabilities to their branches. For example, they may
use such balances for transfers of loans to overseas
branches; or they may conserve head-ofiice resources by
referring some loan demands to their branches for financ­
ing with Euro-dollars; and those that have no branches
overseas may sell loans to foreign banks or borrow from
foreign banks directly. The following pages examine the
institutional and economic background of the practice of
using Euro-dollars in portfolio management, a practice
that has greatly increased during the last two years.
TH E EURO-DO LLAR M A R K E T A S A SO U R C E OF
F U N D S FOR U N IT E D S T A T E S B A N K S

The Euro-dollar market, which centers on London with
links in several other major financial centers in Western
Europe and elsewhere, is a telephone and telex network
through which many of the world’s major banks bid for
and employ dollar balances. By a generally accepted defini­
tion, Euro-dollars come into existence when a domestic or
foreign holder of dollar demand deposits in the United
States places them on deposit in a bank outside the United
States, but the term also applies to the dollars that banks
abroad acquire with their own or foreign currencies and
then employ for placement in the market or for loans to
customers. Compared with other markets used by Ameri­
can banks for adjusting their liabilities, the Euro-dollar
market possesses distinctive features which both add to
and detract from its usefulness as a source of funds.
By far the greatest merit of the market from the view­
point of United States banks is that it offers the possibility
of obtaining balances that are not subject to the regulatory
restrictions applicable to demand and time deposits.
Unlike United States banks, the overseas branches may

FEDERAL RESERVE BANK OF NEW YORK

pay interest on dollar call deposits and on time deposits
with maturities of less than thirty days. Thus, United
States banks can gain access, through the overseas branch
route, to sizable amounts of funds that they are precluded
by various regulations from acquiring directly from foreign
depositors. In addition, balances payable at overseas
branches are not subject to Regulation Q rate ceilings, a
factor of great significance when rates for money market
instruments in the United States or Euro-dollar rates rise
above the ceiling rates payable on deposits. And, finally,
branch balances placed in head offices are not subject to
member bank reserve requirements or to the fees of the
Federal Deposit Insurance Corporation (FDIC). Indeed,
especially during periods of tight money, the differential
between Euro-dollar rates and time deposit rates in the
United States tends to reflect this saving.
Another advantage of the market is its broad scope.
Actual and potential Euro-dollar sources are diverse and
widely dispersed geographically. They include countless
banks and corporations in many parts of the world as well
as monetary authorities and international financial institu­
tions. When conditions in some countries restrict offerings
by suppliers, conditions elsewhere typically free more re­
sources for Euro-dollar placements. Monetary authorities
and international institutions may add to their offerings
when commercial banks and corporations pull back theirs.
In short, there is a high degree of supply flexibility in the
Euro-dollar market.
It must not be thought, however, that the market is al­
ways a stable source of funds for United States banks.
On the one hand, there may be problems of oversupply—
because of relative ease in the money markets of major
supplier countries or because foreign customers’ demand
for loans has been weak or their established credit lines
have been filled. At such times the branches will quote
defensively, but even so some of them tend on occasion
to take in sizable balances from day to day, as they are
loath to refuse offerings by correspondent banks and cor­
porations among their established customers that habitu­
ally lay off temporarily excess dollar balances with them.
Several of the branches of major banks are in effect the
residual takers of foreign banks’ liquidity reserves, which
tend to converge upon them largely in the form of call
deposits. If these balances cannot immediately be em­
ployed abroad, the respective head offices tend to use
these balances as an alternative to Federal funds purchases.
Under such conditions, branch deposits in head offices may
rise above the targets set by the money-desk or portfoliomanagement departments.
On the other hand, there are occasionally supply
stringencies, notably during periods of heavy seasonal




131

pressures. Moreover, restrictive monetary policies in major
supplier countries may reduce offerings by foreign banks.
Individual branches may then be unable, at a given rate,
to replace maturing deposits. If such deposits account for
a sizable proportion of a branch’s aggregate balances, its
deposits at the head office may drop off sharply, to be built
up again when the branch has been authorized to offer
more competitive rates. Timing is often important, as
other branches and other banks abroad may absorb early
in the day major portions of the funds offered. It is true
that central banks have increasingly been prepared to sup­
ply funds to the Euro-dollar market when it is exposed to
pressures, but there are still occasions when the branches
are forced to withdraw balances placed in their head offices,
thereby forcing the latter to seek additional funds in the
United States money market.
At times, the demand for Euro-dollars for use in for­
eign money and loan markets is so pressing that rates rise
to levels that are out of line with those quoted in markets
for comparable funds in the United States, thereby in­
ducing the head offices not to renew maturing deposits.
This situation is subject to reversal, because the head
offices normally absorb so large a proportion of aggre­
gate Euro-dollar deposits that any reduction of their
takings will tend to bring rates down. In any event,
Euro-dollar rates, especially those for call money and
other short-dated funds, which are less suited than the
more distant maturities for use in commercial loan mar­
kets abroad, are highly sensitive to conditions in the
United States money market.
It is true, of course, that banks must allocate a major
part of their branches’ aggregate Euro-dollar resources to
the loan and investment transactions of the branches
themselves. The banks cannot disregard the demand for
branch loans that comes from the affiliates abroad of im­
portant head-office accounts. And the branches must ac­
commodate their own customers with whom they have
developed close deposit and loan relationships. But the
needs of the branches themselves do not appear to have
restricted head-office use of the market for its own require­
ments. The head offices can almost always obtain addi­
tional balances in the market, at a price, if they are pressed
for funds. The market has proved to be highly interest-rate
elastic, and thus, as rates escalate, offerings rise at a very
rapid pace. This was demonstrated during the credit crunch
in the summer and fall of 1966, when United States banks
by raising their bids pulled very large additional amounts
into the market. The Euro-dollar pool is not inexhaustible,
but it can be replenished by a large variety of funds held
in several types of assets and currencies. Therefore, rela­
tively small shifts from other uses within and to the Euro­

132

MONTHLY REVIEW, JULY 1968

dollar market can satisfy a rise in the demand for funds.
There are some negative aspects of the Euro-dollar mar­
ket from the viewpoint of money position management. The
market is far away, and because of the time difference
between London and New York (not to mention Chicago
or San Francisco) opportunities for immediate and direct
head-office communication with it is confined to a few
hours during the morning. Moreover, due to the settle­
ment and clearing periods involved, several days pass
before a head-office decision to take on Euro-dollars is
reflected in available funds in the banks’ reserve accounts.
Meanwhile, conditions in domestic money markets may
have changed significantly. Closely connected with the
distance factor is the problem of adequate information.
Because of the diverse conditions prevailing in the several
major areas where dollar supplies originate, it is not al­
ways easy for the branches to obtain accurate knowledge
of prospective market factors that might affect rates and
amounts offered. And, in turn, head-office money position
managers have not always found it easy to convey to their
London offices their exact needs in terms of amounts and
maturities, since their desire to draw on the market is
partly conditional on the rates at which balances in various
maturity sectors become available, and the rates change
in response to market conditions.
The large banks with overseas branches differ greatly
in their appraisal of the merits of the market as a source
of funds for head-office use. A few banks look upon the
market as one of their preferred methods of portfolio
adjustment and have made very heavy use of it almost
continuously. For most large banks, however, Euro-dollars
appear to be only a second choice. Several of these banks
have used the market on a substantial scale solely during
periods of severe reserve pressure.
By far the largest part of branch placements with head
offices is held in New York, but several banks in other
financial centers also absorb relatively sizable balances
from their branches. A few New York banks— and several
banks elsewhere that have only recently opened overseas
branches— have not yet made any large-scale use of Euro­
dollar deposits.
The banks differ substantially in the proportion of their
branches’ aggregate dollar resources that they take
into their own positions. At present, almost half of the
branches’ aggregate dollar balances, excluding interbranch
deposits, are held in head offices, but for the branches of
a few banks the figure is in excess of 60 per cent while
for others it is below 40 per cent.
The bulk of Euro-deposits taken for head-office use
is obtained through branches in London. These branches
are of course a conduit for funds from many parts of the




world. In fact, some banks have instructed their branches
in other Euro-dollar centers to redeposit excess dol­
lar balances in London offices. United States banks also
obtain sizable funds directly from their Paris branches
and, to a lesser extent, from their branches in Nassau.
Direct placements in United States head offices by branches
elsewhere are generally quite small.
M A JO R H E A D -O FFIC E U S E S O F
BRANCH BALANCES

Conceptually, the funds of overseas branches in head
offices may be separated into three main categories: (1 )
balances borrowed by the head offices on a more or less
continuous basis for the purpose of enlarging the banks’
reserves, (2) balances acquired for short-term adjust­
ments of reserve positions, and (3 ) working or operating
balances to accommodate adjustments between head-office
and branch accounts. The boundaries between the three
categories are, at least for some banks, somewhat blurred;
often the same balances serve all three functions, and
clearly, whatever their maturity or the ultimate objective
of their acquisition, they all add to the resources of the
borrowing banks. Apart from these three categories,
Euro-dollars are also used by foreign banks and overseas
branches for the purchase of loans from United States
banks and to finance loans that otherwise would have
been made directly by American banks.
C O N TIN U O U S B O R R O W IN G F O R E N L A R G IN G R E SE R V E S. The
major motive of United States banks in using Euro-dollar
funds has been to obtain balances for enlarging or main­
taining their credit potential. In their efforts to locate
and solicit additional loanable funds, the banks have be­
come increasingly attracted by the continuous availability
in the Euro-dollar market of very large amounts of funds
in a broad maturity range. Although a large part of
these funds are call and short-dated deposits, experience
has demonstrated that over extended periods even the
call component remains quite steady in the aggregate.
Thus the presence in, or availability to, the Euro-dollar
market of very large interest-rate-sensitive funds provides
the banks with an attractive alternative means of meeting
demands on their liquidity positions and adding to aggre­
gate deposit stability.
Rate advantages explain, of course, much of the heavy
use of Euro-dollar deposits. During recent years, they
have been for extended periods less expensive, or at least
not more expensive, than domestic deposits. Even when
rates in the Euro-dollar market are nominally higher than
those in the C /D market, it may be advantageous to in­
crease holdings of branch balances, relative to sales of

FEDERAL RESERVE BANK OF NEW YORK

133

C /D ’s, because of their exemption from reserve require­ corresponding maturities, there is a tendency for head
ments and FDIC fees. A further saving associated with offices to concentrate on the shorter maturities among the
the acquisition of branch balances arises from technical balances that branches tap in the Euro-dollar market.
factors. When a bank obtains Euro-dollar balances from Moreover, substantial offerings in the market generally
its branch, it may benefit from reduced reserve require­ carry short maturities. On occasion, the banks have in­
ments, while clearing the transaction, for at least one day structed their branches to reach out for rather distant
— and for more if the date of the acquisition is followed by maturities, so that the banks’ loan and investment port­
a holiday or a weekend. The reason is that the check re­ folios can be financed on a more secure basis. Sometimes,
ceived by a bank in connection with the transfer of a Euro­ the banks acquire longer term Euro-dollars from their
dollar deposit acquired by its branch increases cash items branches and invest them in liquid assets in order to
in the process of collection, which are deductible from maintain a comfortable cushion against the possibility of
demand deposits in computing reserve requirements even losing C /D money if open market rates should exceed the
though the branch balance does not add to deposits subject Regulation Q ceilings.
BORROWING TO FINANCE WEEKEND RESERVE POSITIONS.
to such requirements. This saving arises only if the Euro­
dollar deposit is repaid by a so-called “ bills payable” United States banks seldom use Euro-dollar balances for
check. Outstanding checks of this type need not be in­ specifically adjusting day-to-day cash and reserve posi­
cluded in deposits subject to reserve requirements in con­ tions except over weekends. The Euro-dollar market is
trast to checks issued by banks for purposes other than generally not suited to immediate reserve adjustment
borrowings. The initial saving would cancel out at ma­ needs. One reason is the distance factor: In the morning
turity of the funds if they were repaid with a check not hours, London time, when the branch officers would need
to obtain indications of immediate head-office needs in
exempt from reserve requirements.
As noted, the head offices may stand ready to accom­ the light of current offerings, United States banks have
modate important suppliers, even if Euro-dollars are not yet opened for business; by noon, New York time,
offered at rates somewhat above those quoted for com­ when the evolving cash needs of banks are becoming evi­
parable domestic funds. Generally, the large banks are dent, the London market is closing up shop. Of still greater
very much aware of the advantages of regular contacts significance is the fact that the normal delivery period for
and dealings in the market. Some of them have concluded Euro-dollars is two days, and even if arrangements can
that a continuous readiness to accept large amounts be made early in the morning London time to acquire dol­
irrespective of immediate needs permits the overseas lars for same-day delivery in New York, these balances
branches to improve their feel of the market and their become available as bank reserves in Federal Reserve
information on prospective trends. Moreover, if needs for accounts only the next day (see below). Moreover, banks
overseas balances are less urgent at a particular time, find it difficult to estimate changes in reserve positions for
they may well rebound in the not too distant future. Keep­ more than a few days in advance. For these reasons, banks
ing a hand in the market makes it a more reliable source generally consider the Federal funds market far su p erior
of funds. In short, a number of United States banks to the overnight sector of the Euro-dollar market for very
believe that complete withdrawal from the market when short-term adjustments of reserve positions. Yet, a few
domestic funds can easily be substituted for Euro-dollars banks appear to be quite prepared for a variety of reasons
would not serve their longer run interest, and on occasion to make continuous use of overnight deposits as a substan­
they have been quite willing to pay a price, albeit small, tial core of relatively low cost funds.
for continued participation.
An important use of the Euro-dollar market as a
The head offices issue directives to the branches con­ tool of short-term reserve management is for the financ­
cerning the amounts they wish to take and the rate limits, ing of weekend reserve positions. In fact, most of the
either for specific maturities or for a “package” of ma­ banks with branches employ overnight deposits each
turities. During periods of rapidly mounting or declining Thursday as a partial substitute for Federal funds purchases
pressures, head-office instructions to the branches regard­ on Friday. Because of New York check-clearing practices,
ing targets and rates are often changed from day to day. overnight borrowing in the Euro-dollar market valueIf money market conditions in the United States are rela­ Thursday for repayment on Friday can serve as bank re­
tively stable, the directives are issued for extended and serves for three days— from Friday through Sunday. Euro­
sometimes indefinite periods ahead. Because the rising dollar transactions are generally settled through checks on
yield curve for Euro-dollar deposits often makes the more New York banks. Unlike Federal funds transactions, which
distant maturities too expensive relative to C /D rates for are recorded in Federal Reserve accounts immediately,




134

MONTHLY REVIEW, JULY 1968

these checks must pass through the New York Clearing
House, and it is not until the following business day that
they become balances in the Federal Reserve accounts of
member banks. Thus, a check drawn on bank A and de­
posited on Friday in bank B in repayment of a Euro-dollar
deposit does not draw down A ’s reserves until Monday;
the same applies if the check is deposited on the day be­
fore a holiday.
These weekend and holiday clearing delays are reflected
in the rates that head offices must pay for Euro-dollar bal­
ances. For a one-day Euro-dollar deposit on Thursday, a
United States bank in need of funds to meet its reserve
requirements will be willing to pay a rate close to three
times the anticipated Federal funds rate on Friday; and it
will pay a corresponding multiple when the settlement date
for these overnight balances precedes any other period
when the New York money market is closed for one busi­
ness day or longer. Thursday-Friday transactions have be­
come so common that the rates have adjusted themselves
almost fully to the anticipated Federal funds rate on Fri­
day. Nevertheless, the banks continue to have their Lon­
don branches engage in these transactions on a large scale
— often for purely defensive purposes— because any bank
that does not bid for overnight dollars offered valueThursday is likely to suffer sizable losses in its Federal
Reserve account as other American banks take advantage
of the Thursday deposit offerings.
The money-desk managers of United States banks that
wish to acquire Thursday-Friday money must make their
basic decisions on amounts and rates at the end of the
preceding week, or at the latest on Monday, on the basis
of projections of supplies and rates in the Federal funds
market the following Friday. Within limits further ad­
justments can be made on Tuesday or Wednesday, but
the bulk of the available funds has been spoken for by
that time. Actual conditions on Friday may well be and
often are different from those projected. By Wednesday,
however, the money-desk manager knows the amount of
Euro-dollar overnight deposits that will be available on
Friday, and in the light of this information he can adjust
his Federal fund and dealer loan operations during the
closing days of the week.
No statistical information is extant on the volume of
Thursday-Friday transactions by the overseas branches of
United States banks. Aggregate branch balances in their
head offices tend to increase on Thursday by amounts in
the $100 million to $300 million range, depending in part
on conditions in the Federal funds market. But the overall
volume of Thursday-Friday transactions is in excess of
this range, which does not reflect balances that mature or
are called on Thursday and are placed again for one day.




There are other categories of Euro-dollar deposit trans­
actions that take advantage of the delay in the clearing of
checks in New York. For instance, a foreign bank may
accept an overnight Euro-dollar deposit on Thursday and
make arrangements to sell the resulting Federal funds on
Friday through its United States correspondent. For for­
eign banks, however, such transactions are less attrac­
tive than direct dealings with American banks’ overseas
branches, and have come into disuse with the branches’
increasing activity in the Thursday-Friday market on be­
half of their head offices.
In addition, use of the foreign exchange market to
take advantage of the United States check-clearing pro­
cedure is quite common. For instance, a foreign bank, using
a foreign currency, may purchase dollars in New York
value-Thursday for resale value-Friday. Although the dol­
lars it buys and sells are not “ good money” until the fol­
lowing business day, the foreign currency is immediately
available to the buyer for investment, because in foreign
financial centers checks deposited before a designated hour
are cleared the same day. Thus on Friday, when its Thurs­
day dollars become available as “ good money” , a foreign
bank can put them to weekend use in the Federal funds
market and also use its Friday repurchase of local ex­
change for payments needs or for investment over the
weekend in a foreign market. Of course, a bank engaging
in such a transaction forgoes earnings on Thursday. Or a
United States bank buyer of foreign exchange value-Friday
can employ the funds abroad over the weekend and also
retain its weekend use of the dollars with which it paid for
them, since the check deposited for the settlement of the
transaction is not debited against its reserve account until
Monday. These and similar operations have been reflected
in spot and forward exchange rate distortions and erratic
flows of funds from foreign money markets.
o p e r a t in g b a l a n c e s o f b r a n c h e s .
The third type of
liabilities to overseas branches consists of balances car­
ried with head offices for operating purposes. This item
has no direct relationship to the branches’ overall dollar
liabilities. Actually there may be no necessity for a branch
to carry an operating balance in its head office if it is
authorized to overdraw its account at its head office in
case of need, or if the various components of its assets
carry maturities of the same length as those of its corre­
sponding deposit liabilities. Moreover, branches are ordi­
narily able, at a price, to obtain additional balances in for­
eign currency deposit markets. But the voluntary credit
restraint program has made it undesirable for head offices
to expose themselves to sudden branch overdrafts for
meeting deposit liabilities that cannot be replaced at the
time of maturity without costly rate sacrifices. Some

FEDERAL RESERVE BANK OF NEW YORK

branches have been willing to build their asset portfolios
on deposits that carry somewhat shorter maturities than
loan and deposit placements abroad: it is not easy, and is
at times impossible, to match dollar loans to corporations
with dollar deposits of similar maturities. Branches also
need operating balances to discharge obligations under
letters of credit and to take care of a variety of payments
orders by customers, and they need contingency reserves
in view of their large outstanding loan commitments.
Dollar balances at head offices have on occasion served
also as contingency reserves for the branches’ deposit and
loan operations in sterling. Because of the swings in con­
fidence in the pound, sterling deposits have typically been
short dated. On the other hand, the branches’ commercial
loans in sterling— made both to United Kingdom firms and
to European affiliates of United States corporations— are
usually for extended periods. At times, though less so
recently, the branches have preferred to draw down and
convert their dollar balances at head offices in lieu of meet­
ing their sterling liabilities through other more costly port­
folio adjustments.

135

tained in the Euro-dollar or other foreign currency deposit
markets. It is, of course, possible that a branch would
have increased its Euro-dollar liabilities even in the ab­
sence of this particular loan demand and would have
placed additional balances in its head-office account.
It should be mentioned again that many United States
banks without branches sell substantial amounts of their
foreign loans to foreign banks under repurchase agree­
ments, primarily in order to hold their foreign claims be­
low the credit restraint program ceilings; the foreign banks
finance these loan purchases largely with Euro-dollars.
And there are indications that an increasing number of
banks without branches have made arrangements to bor­
row Euro-dollars directly from foreign banks. These two
types of transactions are analogous to, and have the same
liquidity and reserve effects as, the corresponding trans­
actions between head offices and their overseas branches.
H EA D -O FFIC E U S E O F B R A N C H
BALANCES, 1 9 6 4 - 6 8

EURO-DOLLAR FINANCING OF LOAN TRANSACTIONS. T h e r e
Before 1964, relatively few of the banks with overseas
is, finally, the special category of Euro-dollar transactions branches made much use of the Euro-dollar market for
represented by head-office loan transfers to branches. To their head-office operations. Not until the summer of that
some extent these entail the sale of outstanding loans under year did aggregate head-office liabilities to branches re­
repurchase agreements. Such sales appear to arise mainly main continuously above $1 billion. Through most of
from efforts of head offices to maintain their outstanding 1965, they were substantially below $2 billion, as shown
claims below the quota ceilings set by the voluntary credit in the chart. The majority of the banks with branches
restraint program. The sales wipe out any simultaneous apparently preferred other options for obtaining funds,
increase in branch placements in head offices that have re­ either because of cost considerations or because headsulted from branch acquisitions of deposits abroad for the office portfolio managements had not yet developed a close
specific purpose of purchasing the loans, but the head liaison with overseas branch managements.
offices obtain funds for further loans. Of course, the head
During the first half of 1966, as Federal Reserve pres­
office does not acquire additional funds if the loan is paid sures on the banks’ reserve positions mounted, borrowings
for out of existing branch deposits. In that case the head gradually increased and the aggregate due to branches
office reduces its outstanding loans and its liabilities ( “ due approached the $2 billion level. The increased resort to
to” branches) by the same amount. Its overall balance the Euro-dollar market during this period represented
sheet thus contracts.
primarily an attempt to obtain resources over and above
The large banks do not appear to have employed repur­ those available in domestic deposit markets and thereby
chase agreements with branches as a device for obtaining to lessen susceptibility to reserve pressures.
funds for additional domestic loans. Those banks that have
Toward the end of June 1966, the pace of borrowing
considerable credit leeway under the restraint program have through branches quickened even more. The large money
made several sizable sales of loans to branches. Under market banks then used the Euro-dollar market to cushion
these circumstances, however, the purpose appears to have the effects of another weapon in the Federal Reserve’s
been to enable individual branches to acquire earning armory of credit control— administration of Regulation Q.
assets with funds that they had taken in to accommodate With the Reserve System using Q as a deliberate means of
important nonbank accounts on their books.
reducing the rate of credit expansion, the banks were
Of greater importance than such sales, in terms of dol­ virtually priced out of the national C /D market. But about
lar amounts involved, are loans made by branches to meet four fifths of the loss in outstanding C /D ’s suffered dur­
loan demands on their head offices. For these loans to ing the summer and fall of 1966 by the twelve banks with
head-office customers the branches employ deposits ob­ overseas branches was offset by increased Euro-dollar tak-




MONTHLY REVIEW, JULY 1968

136

LIABILITIES OF UNITED STATES BANKS
TO THEIR FOREIGN BRANCHES
Billions of dollars

Billions of d ollars

Source: Board of Governors of the Federal Reserve System.

ings from branches. Euro-dollars at that time were in
ample supply, partly because of large-scale shifts of funds
out of sterling into dollars. By mid-December, aggregate
redeposits in head offices, which had then reached $4.3
billion, amounted to substantially more than half of the
twelve banks’ outstanding C /D ’s, compared with less than
one fifth in mid-1966.
Thus, during the summer and fall of 1966, Euro-dollar
balances played an important role in banks’ efforts to meet
loan demands and commitments, offset losses of other
resources, and reduce the need to liquidate securities
at distressingly low prices. Moreover, the banks were then
experiencing an increase in demand deposits relative to
time deposits, and the resultant effects on required reserves
were cushioned by the acquisition of balances not subject
to reserve requirements.
Late in 1966 and early in 1967, when a large move­
ment of foreign funds into the London money market co­
incided with a considerable easing of money market con­
ditions in the United States, the use of branch balances by
head offices fell rapidly, and by May 1967 it had dropped




by about $1.5 billion from the peak level reached in De­
cember 1966. The figure then began to rise, however, and
in November 1967 it began to exceed the amount out­
standing during the 1966 credit crunch. During the short
span of six months beginning in the middle of May 1967,
aggregate borrowings from branches rose by about $2
billion.
This 1967 surge of branch deposits occurred in a mar­
ket atmosphere quite different from that prevailing in the
second half of 1966. During the latter part of 1967 the de­
mand for business loans was relatively weak. The Federal
Reserve supplied bank reserves quite liberally until late in
the year, and banks were able to make considerable prog­
ress in improving their liquidity positions. There was little,
if any, need to reach out for funds in Europe to compen­
sate for shortages of funds in the United States. It appears,
therefore, that there was a fundamental change in the
banks’ attitude with respect to taking Euro-dollars from
their branches. Before the summer of 1966, several of
them approached the Euro-dollar market with some hesi­
tation, looking on it merely as a marginal source of funds.
In general, they discovered the market’s full potential only
after having been virtually forced into it. As they became
familiar with its breadth and depth, they lost their skepti­
cism and came to regard the market as another normal
source of funds to be tapped whenever the price was right.
Other factors also contributed to the surge in the use
of Euro-dollars during 1967. Foreign investors shifted
substantial amounts of their short-term sterling invest­
ments into the Euro-dollar market in response to the
Middle East crisis in June and the weakening of sterling
in the fall of 1967 prior to its devaluation. In addition,
market relationships had been established, with consider­
able effort, and the banks desired to maintain them. Sev­
eral felt that a withdrawal from the market because
domestic funds could be easily substituted for Euro-dollars
would not serve their longer run interest, even if continued
participation sometimes involved a rate sacrifice.
In the spring of 1968, as money market conditions in
the United States tightened, aggregate balances held for
overseas branches passed the $5 billion mark, and toward
the end of June they amounted to more than $6 billion.
Sizable dollar losses by the Bank of France contributed
importantly to Euro-dollar availabilities during the closing
weeks of the month.
IM PL IC A T IO N S FOR M O N ETA R Y
A N A L Y S IS A N D PO LICY

United States banks’ initiative in attracting hitherto un­
tapped liquid funds— their gradual shift from a passive to

FEDERAL RESERVE BANK OF NEW YORK

an active role in acquiring funds through incurring liabili­
ties— has raised important issues for monetary analysis
and policy. And their recently increased use of balances
obtained by the overseas branches from foreign sources
has added to both the number and the complexity of the
issues with which analysts and policy makers need be con­
cerned. The success of the banks’ efforts to acquire addi­
tional funds abroad has implications that touch on many
aspects of the financial mechanism, including the country’s
balance of payments, the distribution of bank reserves and
the banks’ response to reserve pressures, the foreign own­
ership of United States money market instruments, and
monetary policy.
One of the major consequences of the vast increase in
the intermediation of overseas branches for head-office
account has been a sizable substitution of United States
bank liabilities to their branches for foreign central bank
holdings of United States money market assets, and
with it an improvement in the United States balance-ofpayments position as defined on the official reserve trans­
actions basis. To the extent that foreign-owned dollar
balances are placed with United States banks instead of
being used in foreign deposit and loan markets, the dollar
supply offered on foreign exchange markets abroad is re­
duced, and thus also for the time being the potential
offerings of dollars to foreign monetary authorities. Those
authorities’ holdings of dollars may even decline, as for­
eigners’ demand for dollars to deposit in the Euro-dollar
market may cause central banks to supply dollars to their
exchange markets. Since foreign central banks tend to
invest the bulk of their dollar holdings in United States
Treasury securities, either a diversion of potential dollar
balances from monetary authorities or a diminution of
their existing holdings occurs largely at the expense of
foreign official investments in Treasuries. Moreover, the
retention or expansion of dollar balances in the hands of
private holders benefits the official reserve transactions
balance of the United States. However, some foreign cen­
tral banks may suffer unwelcome losses in their own re­
serves as a result of developments in the Euro-dollar mar­
ket. And if they take monetary action in an effort to reduce
the outflows of funds, rates in their own money markets
may escalate to levels that are undesirable for domestic
reasons.
These substitutions and balance-of-payments effects are
also likely to occur when central banks decide on their
own initiative for reasons of domestic or international
monetary policy either to deposit funds in the Euro-dollar
market or to enter into swap transactions with their com­
mercial banks. Especially if attractive swap rates are
available, foreign commercial banks will make substantial




137

use of such facilities and convert large amounts of
domestic-currency assets into dollar balances. Such injec­
tions of foreign official funds into the market often add
significantly to supply availabilities and tend to reduce up­
ward pressures on Euro-dollar rates or even to lower rate
levels. As a result, United States banks are likely to take
on larger Euro-dollar balances through their branches
than they would have acquired in the absence of these
official injections of funds. Thus, the monetary reserves of
foreign central banks are channeled through the Euro­
dollar market to United States banks, and this country’s
official reserve transactions balance is thereby improved.1
The transformation of demand deposits into branch bal­
ances in head offices does not change United States banks’
total reserves, but it does reduce the level of their aggre­
gate required reserves, since overseas branch balances in
head offices are not subject to reserve requirements. This
fact has to be taken into account if, as is often done,
current changes in bank credit are estimated on the basis
of changes in deposits subject to reserve requirements.
Moreover, the banking system as a whole can carry a
somewhat larger amount of earning assets on the basis of
a given amount of reserves. Since the banks that obtain
balances from their branches typically are in a net reserve
deficiency position and tend fully to employ available
funds, their additional reserves are likely to be reflected
immediately in a bank credit increase or reduced borrow­
ings from other sources rather than in larger excess re­
serves. In other words, these banks’ acquisition of re­
serves through the Euro-dollar operations of their branches
increases the utilization of the banking system’s reserve
base, as do Federal funds purchases from those banks
that are less fully invested.
The banks that have direct access to the Euro-dollar
market through their foreign branches are in a position
to increase their share in total member bank reserves.
If they were to abstain from absorbing Euro-dollar bal­
ances, most of the underlying funds would be invested
by foreign central banks in the United States money
market and would therefore be more widely dispersed
throughout the banking system. Of course, to the extent
that foreign central banks place their dollar gains in

1 Some branch funds in head offices may originate in shifts o f
private foreign investments from the New York money market to
the Euro-dollar market. In that event, the official reserve trans­
actions balance would not be improved. But the evidence indicates
that such shifts are not likely to occur when rates in the New York
money market are relatively high. And when money market rates
in this country are low in relation to Euro-dollar rates, the banks
have little incentive to increase their liabilities to their branches.

138

MONTHLY REVIEW, JULY 1968

time deposits with American banks, these balances would
be largely held with the same banks that acquire funds
through their branches. To be sure, banks without
branches may borrow Euro-dollar balances from foreign
banks, and such borrowings are also exempt from Regu­
lation Q ceilings and reserve requirements. But the branch
route to Euro-dollars is more convenient and, in the
long run, probably less expensive. Moreover, it allows
access to a much larger volume of funds than banks can
or would wish to secure through borrowings abroad. And
only the larger banks in the United States have the credit
standing that would enable them to obtain sizable dollar
balances from foreign banks.
For individual banks with overseas branches, the avail­
ability of still another liability market of great breadth pro­
vides additional elbow room for portfolio and reserve ad­
justments. Inasmuch as the Euro-dollar market is subject
to influences emanating from prevailing climates in foreign
money markets, its supply-demand balance at any one
particular point in time may differ greatly from that in the
New York money market. Money market tightness here
may be accompanied by relative ease in the Euro-dollar
market. United States banks that find it undesirable or are
unable to liquidate securities at such times, or are unable
to add to their outstanding C /D ’s because of interest rate
limitations by the Federal Reserve, may find a ready
alternative source of funds in branch balances. But, even
in the absence of pressure or regulatory interference in
domestic money markets, access to Euro-dollars offers
additional opportunities to minimize portfolio adjustment
costs— as does resort to the national C /D market. More­
over, the very knowledge that they are able to fall back
on the Euro-dollar market, and to use it in addition to or
as an alternative to other liability markets, may induce
portfolio managers to carry larger amounts of loans rela­
tive to aggregate deposits, and fewer liquid assets relative
to aggregate assets, than they would otherwise consider
prudent.
Monetary policy has had to take into account the buildup
of overseas branch deposits in United States banks, and
now continuously weighs the various implications and
consequences of current and prospective changes in these
placements. During periods of balance-of-payments pres­
sure, the effect of branch deposits in head offices on the
net demand for the dollar in foreign exchange markets is,
of course, a matter that deserves particular attention. Nor




can policy makers overlook the ways in which their deci­
sions are transmitted through branch operations in the
Euro-dollar market to foreign money markets and re­
flected in foreign monetary reserve changes, notably in
countries that are under balance-of-payments pressure
themselves. Now that banks in this country have become
a major receptacle for the liquidity reserves of foreign
commercial banks, the United States authorities have
added reason to take an interest in foreign money market
conditions. Similarly, they have additional reason to con­
cern themselves with the Euro-dollar operations of those
central banks that use the market as a major channel for
making adjustments in their own monetary reserve posi­
tions. Indeed, prospective developments in the Euro­
dollar market are now regularly discussed at the monthly
meetings of central banks at the Bank for International
Settlements (BIS) in Basle. The Federal Reserve’s inter­
est in the market is also demonstrated by the fact that Re­
serve credit has repeatedly been provided to the market
through activation of the System’s swap line with the BIS
which now amounts to $1 billion. Under this arrangement
the BIS can draw dollars from the Reserve System for
placement in the Euro-dollar market.2
On the domestic side, the Federal Reserve System must
be concerned with the redistribution of reserves arising
from the access of banks with overseas branches to bal­
ances that other banks find it difficult or impossible to
attract. It must also take into account shifts in the banks’
aggregate demand for reserves as they acquire reserveexempt balances. Furthermore, it must make allowance
for the increased ability of the money market banks— the
major source of business loans to large corporate bor­
rowers— to fall back on the Euro-dollar market whenever
the interest rate ceilings impair the banks’ ability to obtain
funds in the national market for C /D ’s. Indeed, now that
some of the major commercial banks in the United States
look beyond this country’s borders for funds with which
to make adjustments in their liquidity and reserve posi­
tions, a new and significant dimension has been added to
central banking in the United States.

2 For a description o f these operations, see Charles A. Coombs,
“ Treasury and Federal Reserve Foreign Exchange Operations” , this
Review (March 1968), pages 38-52.

FEDERAL RESERVE BANK OF NEW YORK

139

The Business Situation
Business activity was strong as the first half of 1968
drew to a close. Production and employment were at rec­
ord levels, but cost and demand pressures on prices re­
mained excessive. At the same time, the United States
balance-of-payments deficit continued to be substantial
and the international financial markets were subject to
renewed uncertainties. Against this background, the Con­
gress passed and the President signed the long-awaited
fiscal restraint package, including a 10 per cent surcharge
on personal and corporate income taxes and a reduction
in budgeted Federal spending. These measures should be­
gin to relieve the demand pressures in the economy quite
promptly. Bringing existing cost pressures under control
will, however, be a slower and more difficult matter.
Industrial production moved up sharply in May from
an April level that had been restrained in part by civil
disorders. Automobile production provided a major stim­
ulus to May output, and the assembly rate continued to
run at a high level in June. With output expanding, the
flow of income to consumers registered a sharp gain, paced
by wages and salaries in manufacturing. Retail sales also
advanced in May, as sales of automobiles and other con­
sumer durables posted good gains. Although the number
of housing units started fell sharply in May, this series is
quite erratic and building permits for new housing re­
mained at a high level. Labor market conditions remained
extremely tight, with the unemployment rate holding at its
fifteen-year low of 3.5 per cent in May. Consumer prices
advanced again at a rapid 4 per cent annual rate in May,
while wholesale prices, according to the preliminary report,
climbed at a 2 per cent rate in June.
P R O D U C T IO N , O R D E R S , A N D C O N ST R U C T IO N

Industrial output in May reached a new high. The Fed­
eral Reserve Board’s seasonally adjusted production index
rose 1.2 percentage points to a record 163.7 per cent of
the 1957-59 base (see Chart I). Auto assemblies— up
10 per cent to an annual rate of 9.4 million units— gave
the manufacturing index a substantial boost, and assem­
blies remained at a high 9.3 million unit rate in June.
Automobile production has been running ahead of sales,




as auto makers build up inventories in anticipation of a
steel strike. Output of other consumer goods also ex­
panded strongly in May. The production of industrial ma­
terials advanced sharply, since the index of iron and steel
output climbed 4.2 percentage points. A high level of op­
erations in the steel industry is expected to continue to
bolster the industrial production index in June, as pres­
sure builds to fill orders before the August strike deadline.

140

MONTHLY REVIEW, JULY 1968

The rate of materials output in May was also strengthened
by the further recovery of copper production from strikereduced levels. Equipment production edged downward
because the defense equipment component, which has been
falling since February, continued to decline. Business
equipment production, however, remained at its April
level.
The pace of inventory accumulation is providing strong
support for industrial production. In contrast to the first
quarter of 1968— when a strong rise in consumer demand
apparently held inventories below intended levels— April
saw businesses adding substantially to stocks. Total in­
ventories of manufacturing and trade firms expanded by a
seasonally adjusted $1.3 billion in April, compared with
a monthly average of only $370 million in the first quarter.
Most of the expansion was accounted for by manufactur­
ers and retailers. At the retail level, the growth in auto
dealers’ stocks was responsible for about two thirds of the
increase. While data on inventories in trade firms is not
yet available for May, manufacturers’ inventories did ex­
pand further in May but at a more moderate rate. The
April step-up in inventory investment was associated with
a modest rise in the inventory-sales ratios of retailers and
of durables manufacturers, but the slower May inventory
expansion, coupled with a sizable gain in sales, brought
the manufacturers’ ratio down to the lowest level since
1966.
The volume of new orders received by durables manu­
facturers rose 1.7 per cent in May to a seasonally ad­
justed $25.6 billion. Gains in the primary metals, machinery
and equipment, and auto industries led the advance, while
the defense-oriented industries experienced a decline.
The so-called “ defense” orders series includes all orders
received by the aircraft industry, and the strong March
increase and the subsequent sharp April and May declines
were mainly due to a heavy concentration of commer­
cial aircraft bookings in March. Excluding the defense
products industry, durables orders advanced by 5 per cent
in May. New orders excluding transportation equipment
have remained roughly on a plateau this year, somewhat
below the extraordinary December peak but significantly
above earlier months of 1967. Since durables manufac­
turers’ shipments in May exceeded the volume of new
orders, the orders backlog dropped back somewhat from
its April peak, but remained at a high $80.9 billion.
The latest Government survey of business capital spend­
ing plans indicates that 1968 outlays on plant and equip­
ment will be 6.7 per cent above last year’s level, compared
with an anticipated 5.8 per cent increase reported by the
preceding survey three months earlier. The new survey,
taken by the Department of Commerce and the Securities




and Exchange Commission in late April and early May,
shows 1968 plant and equipment expenditures at a record
$65.8 billion. The latest survey findings, as well as the solid
$2.2 billion gain registered in the first quarter, indicates
that plant and equipment spending has made a substan­
tial recovery from the pause following the 1964-66 capital
investment boom. The survey indicates outlays dipping
slightly in the second quarter to an annual rate of $64.6
billion, and then rising by $1.45 billion in each of the final
two quarters. While the planned expansion of capital out­
lays in 1968 is widespread, projected gains are largest in
nonmanufacturing industries. This concentration is un­
derstandable in view of the relatively moderate rates at
which manufacturing capacity has been utilized during the
past year.
Indicators of activity in the residential construction sec­
tor— which had shown considerable strength in the first
four months of this year— gave conflicting signals in May.
Private nonfarm housing starts, an admittedly erratic
series, fell sharply from the high April level to a seasonally
adjusted annual rate of 1.3 million units. Some decline in
housing activity might well be expected in view of the
relatively tight conditions that have been prevailing in
the mortgage market over past months. Nevertheless, the
number of building permits issued for new private housing
declined only moderately in May, suggesting that a sus­
tained sharp fall in housing starts is probably unlikely.
Moreover, private nonfarm residential construction out­
lays continued to advance in May. The recently passed tax
and spending package may relieve some of the pressures
in the capital markets and make a larger supply of funds
available to institutions specializing in mortgage lending.
E M P L O Y M E N T , IN C O M E, A N D
CONSUM ER DEM AND

The number of workers on the payrolls of nonagricultural establishments was unchanged from April to May,
as strikes in the construction and telephone industries
offset increases in wholesale and retail trade, services, and
state and local government— the three categories of em­
ployment that consistently have shown the most growth in
the last few years. While manufacturing payroll employ­
ment was virtually unchanged from the April level, the
manufacturing workweek bounced back from a sharp dip
in April which had reflected the effects of civil disturbances
and religious holidays. The workweek in manufacturing
averaged a seasonally adjusted 40.6 hours, up from 40
hours in April; overtime averaged 3.4 hours, up from 2.8
hours in April. The increases brought the workweek and
overtime back about in line with their March levels.

FEDERAL RESERVE BANK OF NEW YORK

C h art II

UNEMPLOYMENT RATES
S e a s o n a lly ad justed

141

cent a year earlier. Joblessness among nonwhites fell back
in May to the record low 6.4 per cent registered in Janu­
ary of this year, down from 6.7 per cent in April and 7.7
per cent a year ago. The fact remains, however, that the
nonwhite unemployment rate has persistently been about
twice as high as that for white workers.
Rising wage rates helped boost personal income in May
by $4.2 billion to a seasonally adjusted annual rate of
$674.0 billion. The largest advance occurred in the cate­
gory of wages and salaries that rose $2.9 billion, more
than double the April increase which had been dampened
by the telephone industry strike and by civil disturbances.
According to the Commerce Department, about half of the
May wage and salary rise was accounted for by manu­
facturers’ pay boosts. A longer workweek also contributed
to the wage and salary gain in manufacturing.
Retail sales apparently resumed their upward climb in
May with a 1.1 per cent advance to a near-record level
of $27.9 billion, seasonally adjusted, according to the
preliminary report of the Department of Commerce. The
April decline, which occurred against a background of
civil disorders, was the first since last October. The May
gain was paced by a 2 per cent advance in the automotive
group. Car sales climbed again in June to 8.8 million units
at a seasonally adjusted annual rate. Reflecting the rise in
consumer spending, consumer instalment credit in May
advanced sharply, largely as a result of a rapid increase in
automobile and personal loans.

Source: United States Bureau of Labor Statistics.

P R IC E A N D C O S T D E V E L O P M E N T S

Unemployment in May remained at 3.5 per cent of the
civilian labor force, the lowest rate since 1953. The un­
employment rate has fluctuated in the narrow range be­
tween 3.5 and 3.7 per cent for the past six months (see
Chart II). It has been nearly fifteen years since the rate
remained for so long a period at such a low level. Tighten­
ing of the labor market over the past year has been clearly
reflected in declining unemployment rates for specific
groups of workers. The rate for adult men, unchanged
in May from April’s 2.1 per cent, was at the lowest level
since June 1953; it was 2.4 per cent a year ago. The adult
women’s rate, also unchanged from April at 3.7 per cent,
was down from 4.1 per cent a year earlier. The decline
in unemployment has improved the position of some of
the groups that had been suffering rather persistent job­
lessness. The blue-collar unemployment rate of 3.7 per
cent was down from 3.9 per cent in April and 4.6 per




Prices and costs continued their upward spiral in May.
The consumer price index rose at an annual rate of 4.0
per cent— bringing the gain since May 1967 to 4.1 per cent,
the largest annual increase in sixteen years. All the major
components of the consumer price index showed large
increases in May. The nonfood commodities index ad­
vanced at an annual rate of 3 per cent, while prices of
services rose at a 4 V2 per cent annual rate, as health, hous­
ing, and recreation costs moved higher. The upturn in
wholesale food prices this year was reflected in a substantial
rise in retail food prices.
At the wholesale price level, preliminary data for June
indicate a further 2.2 per cent annual rate advance to 108.7
per cent of the 1957-59 base, with industrial wholesale
prices renewing their upward movement. After nine months
of large increases, industrial commodities prices eased in
May, as copper prices fell from strike-inflated levels. In
June, however, this index turned upward again, rising by
0.2 percentage point. Agricultural prices show a mixed
pattern in June. Farm products prices, which had jumped

142

MONTHLY REVIEW, JULY 1968

4.7 percentage points from December to May, fell back 1.3
percentage points in June, but wholesale prices of processed
foods and feeds continued to climb strongly.
Labor costs rose again in May. The combination of a
modest decline in output per man-hour and an increase
in hourly compensation, in part due to an increase in
overtime payments, pushed the index of unit labor costs

in manufacturing up 0.2 percentage point to a record
109.6 per cent of the 1957-59 average. Unit labor costs
in manufacturing have advanced at an annual rate of 5 Vi
per cent in the first five months of this year, following the
rapid 4 per cent increase in 1967. Bringing mounting labor
costs under control is a difficult but important goal of the
recently enacted fiscal restraint measures.

The Money and Bond Markets in June
Yields on long-term securities declined through most of
June from the record levels reached in late May. This
sharp decline largely reflected the credit market’s increas­
ing confidence in the likelihood of favorable Congressional
action on the proposed fiscal restraint package, which in­
cluded a 10 per cent income tax surcharge and a cut in
budgeted Federal spending for fiscal 1969. After the
House of Representatives voted its approval of the legisla­
tion on June 20, thereby assuring passage, market yields
drifted somewhat higher. Investment demand remained
light, while profit taking by dealers in United States Gov­
ernment securities was widespread. Despite the weakening
in the market toward the end of the month, however, yields
on Treasury coupon securities closed the month substan­
tially below end-of-May levels— 18 basis points in the inter­
mediate maturity area and 23 basis points in the long-term
area. By comparison with their late May peaks, average
yields on Treasury issues were about 51 and 39 basis
points lower, respectively, in the intermediate- and long­
term maturity range (see right-hand panel of chart). The
affirmative House vote on the tax legislation helped relieve
the congestion in both the corporate and tax-exempt mar­
kets, which had been restrained earlier in June by heavy
debt offerings. Toward the end of the month, however, a
degree of pressure returned to these markets, as the vol­
ume of tax-exempt offerings expanded and substantial ad­
ditions were made to the July calendar of both corporate
and tax-exempt financing.
Treasury bill rates also declined sharply in June, but
rates on most other short-term money market instruments
were unchanged to slightly higher. Bank reserve positions
were under sustained pressure during the month. The ef­
fective rate for Federal funds generally remained above the




discount rate, and this premium rose as high as 1 per cent
at times. The large New York City banks generally con­
tinued to quote Regulation Q ceiling rates on largedenomination negotiable certificates of deposit (C /D ’s).
However, other issuers of money market instruments did
not lower rates on balance over the month, so that C /D ’s
remained at a yield disadvantage relative to bankers’ ac­
ceptances, commercial paper, and finance company paper.
At midmonth, the city banks experienced a fairly large
attrition of C /D ’s as about half of such instruments matur­
ing on the quarterly tax date were not renewed. As a result
of the sharp yield declines in the Government securities
market, however, C /D ’s had achieved a yield advantage
over three-month Treasury bills by the latter part of June.
THE G O V E R N M E N T SE C U R IT IE S M ARK ET

Prices of Treasury coupon securities were marked
sharply higher on the first trading day of June in a con­
tinuation of the favorable market reaction to a speech by
President Johnson on the May 30 Memorial Day holiday.
The President had indicated that he would reluctantly
accept the recommendation of a joint Senate-House Com­
mittee for a $6 billion reduction in Federal expenditures
budgeted for fiscal 1969 in combination with a 10 per cent
tax surcharge. With a major deterrent to the passage of the
long-awaited income tax legislation thus removed, prices
rose sharply. The market enthusiasm soon wavered, how­
ever, when significant investment demand failed to appear,
and dealers embarked on profit taking. Additional down­
ward pressure on prices came from the heavy volume of
new corporate and Federal agency securities scheduled to
be marketed during the month.

143

FEDERAL RESERVE BANK OF NEW YORK

SELECTED INTEREST RATES
A p ril-Ju ne 1968

M O N E Y MARKET RATES

A pril

M ay

Ju n e

B O N D M ARKET YIELDS

A pril

M ay

Note: Data are shown for b usiness d ays only.
M O N EY MARKET RATES Q UO TED: D aily ran ge of rates posted by major New York City banks

point from underw riting syn d icate reo fferin g yield on a given issue to market yield on the

on new call loans (in Federal funds) secured by United States G overnm ent securities (a point

sam e issue im m ediately after it has been rele ased from syndicate restrictions); d aily

ind icates the ab sen ce of any ran ge); offering rates for directly p lace d finance co m p an y paper;

a v e rage s of yields on lo n g-term Governm ent securities (bonds due or ca lla b le in ten years

the effective rate on Federal funds (the rate most representative of the transactions executed);

or more) and of G overnm ent securities due in three to five ye ars, computed on the b asis of

clo sing bid rates (quoted in terms of rate of discount) on newest outstanding three- and six-month

clo sing bid prices; Thursday av e ra ge s of yields on twenty seasoned twenty-year tax -e x e mpt

T reasury b ills.
BO N D MARKET YIELDS Q UO TED: Y ie ld s on new A a a - and A a-rated p ublic utility bonds are plotted
around a line show ing d a ily a v e ra g e yie ld s on seasoned A aa-ra ted co rporate bonds (arrows

On June 6 the House Ways and Means Committee an­
nounced a postponement of the tax vote until June 19 or
20. This further delay in the long-awaited tax legislation
injected a temporary note of caution into the market which,
however, was dispelled later on the same day by a state­
ment of Committee Chairman Mills expressing confidence
that the tax-spending package would be adopted. Sub­
sequently, between June 6 and June 20, when the tax
measure was finally passed by the House, prices of Trea­
sury coupon issues drifted moderately higher. However,
activity in the market was generally light, and trading
was largely professional.
After the passage of the income tax legislation, there
was heavy swapping activity by commercial banks. Prices
of intermediate-term Treasury securities declined, largely




bonds (carrying M oody’s ratings of A a a , A a, A, and Baa).
Sources: F e d eral Reserve Bank of New York, Board of G overno rs of the Federal Reserve System,
M oody's Investors Service, and The W e e kly Bond Buyer.

in response to profit taking by market professionals while
prices of long-term issues edged irregularly higher. For
the month as a whole, prices of Treasury issues rose by
about 3/4 point in the intermediate maturity area and 2
points on long-term issues. (President Johnson signed the
fiscal restraint bill into law on June 28.)
The Treasury announced on June 26 that it would auc­
tion $4 billion of tax anticipation bills on Tuesday, July 2,
for delivery and payment on Thursday, July 11. Of the
total, half will mature on March 24, 1969 and half on
April 22, 1969. Commercial banks will be permitted to
make payment by crediting Treasury Tax and Loan Ac­
counts. The Treasury also indicated that it plans to con­
tinue adding $100 million to each weekly sale of six-month
bills, probably through the end of the current cycle which

144

MONTHLY REVIEW, JULY 1968

extends through the October 10 delivery date.
standing securities, were $279 million of a 6V4 per cent
Treasury bill rates declined sharply at the beginning of fifteen-month loan of the Federal land banks and $409
June, as a broad investment demand reinforced the market million of 6V4 per cent nine-month debentures of the
strength resulting from the President’s statement on the Federal intermediate credit banks, both priced at par. The
income tax proposal. With demand centering in the longer yield on the latter issue, offered on June 19, was 20 basis
bill issues, the rate differential between three-month and points lower than that on a similar offering by the same
one-year Treasury bills narrowed rapidly to about 6 basis agency on May 21, when capital market yields were at
points from 25 basis points near the end of May. In the record highs. Virtually all the agency offerings of the
regular weekly auction of bills on June 3, bidding was month were well received by investors.
aggressive, particularly for the longer issue, and average
issuing rates on the three- and six-month issues declined
OTHER SE C U R IT IE S M A R K E T S
to 5.649 per cent and 5.699 per cent, respectively (see
Table III), about 5 and 17 basis points below the rates
The corporate and tax-exempt bond markets shared in
in the previous auction.
the generally optimistic mood which pervaded the money
Soon after that auction, however, a somewhat nervous and capital markets at the opening of June. However, the
tone developed in the bill market. The changed market heavy calendar of new corporate offerings for the month
atmosphere was partly attributable to the announced de­ and the prospect of an upsurge in the municipal calendar
lay in the House vote on the tax measure and partly tended to counteract the favorable effect of President
to technical factors. Money market conditions had be­ Johnson’s statement regarding the pending income tax
come firmer, and dealers, whose awards of the new bills legislation. Thus, price increases on outstanding issues
auctioned on June 3 had not been fully distributed to were relatively moderate, amounting to one point or less,
investors, were apprehensive about the additional market and new bonds reoffered at yields slightly higher than
supply of bills expected around the quarterly dividend and those on comparable recent offerings made a fairly poor
tax dates. Moreover, it was widely expected that the market showing. The corporate and tax-exempt sec­
Treasury would meet its need for additional cash in July tors were also adversely affected in early June by the
through the sale of tax anticipation bills. Consequently, the postponement of voting on the income tax legislation in
issuing rates established in bidding for new bills on June the House and by the announced suspension of trading
10 were somewhat above those set a week earlier. Around on major stock exchanges on three days of the month—
the income tax date the market tone improved, and bill June 12, 19, and 26 as well as on July 5. The trading
rates entered an irregular downward trend. After mid­ suspensions forced the rescheduling of several corporate
month, there was strong demand from the Federal Reserve offerings. During the first part of the month, a few cor­
System in the course of supplying reserves and from the porate and tax-exempt bond financings were postponed
holders of tax anticipation bills who redeemed for cash on or reduced in size due to market conditions.
After midmonth, a bullish tone reappeared in the mar­
June 24 bills not tendered in payment of income tax liabili­
ties. The passage of the income tax legislation by the House, kets, reflecting both optimism over the approaching tax
as well as commercial bank buying prior to the quarterly legislation and an expansion in demand. Moreover, it
statement date, contributed further to market optimism was expected that the corporate calendar would de­
over the final week of June. At the close of the month, the cline seasonally in July. In the corporate market a $75
three- and six-month bills were bid at 5.30 per cent and million Aa-rated public utility issue, carrying five-year
5.48 per cent, respectively, down 38 and 31 basis points call protection, reoffered on June 18 to yield 6.85 per
cent, was fully distributed to investors by June 20 when
from rates at the end of May.
the
House voted its approval of the tax measure. On June
The pattern of price movements in the market for Fed­
eral agency securities during June was similar to that in 21, distribution was finally completed on a utility issue
other sectors of the capital market. Prices scored impres­ which had been in underwriters’ hands since June 5. The
sive gains over the month, despite a large increase in the issue, a $150 million Aaa-rated offering of forty-year
volume of agency flotations. Included in the month’s offer­ telephone bonds carrying five-year call protection, had
ings were two large issues to raise new cash— $500 million previously moved sluggishly at a reoffering yield of 6.75
of 65/s per cent participation certificates of the Export- per cent.
Similarly, activity revived strongly in the tax-exempt
Import Bank due in 1971 and $300 million of 6.30 per
cent one-year Federal Home Loan Bank bonds, both market with the approach of the House vote on the tax
priced at par. Other large offerings, partly to retire out­ measure. Prices of outstanding issues advanced, and a




145

FEDERAL RESERVE BANK OF NEW YORK
Table I

Table H

F A C TO R S T E N D IN G TO IN C R E A S E O R D E C R E A SE
M E M B E R B A N K R ESE RV E S, JU NE 1968

R ESE RV E POSITION S OF M A JO R R ESE RV E C IT Y B AN K S
JUNE 1968

In millions o f dollars; ( + ) denotes increase,
( —) decrease in excess reserves

In millions o f dollars
Daily averages-—week ended on
Factors affecting
basic reserve positions

Changes in daily averages—
week ended on
!

Factors
j June
[ 12

June
5

1 June
| 19

June
26

!
!

“ Market” factors
+ 11
+ 39
+ 305

Other Federal Reserve accounts (n e t)? ..

— 146
— 472
+ 286

+

__243

— 340
4 - 121 — 627
4 - 236 —
83
— 206 —
16
4 - 11 __ 151
4 - 140 4 - 245 |
— 58 — 758 j

41

— 155

4 - 36
— 36
+ 137
— 352
+ 57

— 176 | — 114 j — 122 —

Open market instruments
Outright holdings:
Government securities ............................
Bankers' acceptances ............................
Repurchase agreements:
Government securities ............................
Bankers' acceptances..............................
Federal agency obligations ..................
Member bank borrow ings..............................

— 729
—_650
+ 228
+
47
__
13
__ 439
_
473

-f
—

30

2

+

4 - 261

_

5

1 +

1

— 153 4 3 44- 2G
4 - 29 — 14 +
— 8 1 1 — 14 4 -

_

38
42

51
143

“
..........................................................

Excess reserves* ............................................

1+

23

4 - 220

— 153 | + 1 ° 6

+1,208
__
3
+
+
j

146
65
gg

+

43

!

4 - 60 +1,224

+1,527

__ 62

+

+

257

June
26*

June
19

148

23

16

35

35

75

36

93

84

72

320
1,164
844

447
1,255
808

640
1,399
759

516
1,346
830

481
1,291
810

27

— 372

-4 6 7

-6 9 8

— 565

-5 2 6

684

620

734

542

645

Thirty-eight banks outside New Y ork City

1

Other loans, discounts, and advances........
Total

Reserve excess or deficiency ( —) f ,
Less borrowings from
Reserve Banks .......................................
Less net interbank Federal funds
purchases or sales (— ) ........................
Gross purchases ..............................
Gross sales .........................................
Equals net basic reserve surplus
or deficit ( —) .........................................
Net loans to Government
securities dealers ...................................

967 j — 1,379

Direct Federal Reserve credit
transactions

June
12

Eight banks in N ew Y ork City

j
j
— 187

June
5

Net
changes

Averages of
four weeks
ended on
June 26*

Reserve excess or deficiency ( - ) f
Less borrowings from
Reserve B a n k s .......................................
Less net interbank Federal funds
purchases or sales ( —) ........................
Gross purchases ..............................
Gross sales .........................................
Equals net basic reserve surplus
o r deficit(— ) .........................................
Net loans to Government
securities d e a le r s ...................................

32

11

21

13

19

182

178

94

216

168

551
2,193
1,642

701
1,997
1,296

897
2,233
1,336

513
2,081
1,568

665
2,126
1,461

-7 0 2
151

-

869
121

-9 7 0

-

-7 1 6

127

56

814
114

N ote: Because o f rounding, figures do not necessarily add to totals.
* Estimated reserve figures have not been adjusted fo r so-called “ as o f ” debits
and credits. These items are taken into account in final data,
f Reserves held after all adjustments applicable to the reporting period less re­
quired reserves and carry-over reserve deficiencies.

Table III

Daily average levels

A V E R A G E ISS U IN G R A T E S *
A T R E G U L A R T R E A S U R Y B IL L A U C T IO N S
In per cent
Member bank:
Total reserves, including vault cash*..........
Required reserves* ............................ .............
Excess reserves* ..........................................
Borrowings ........................................................
Free ( + ) or net borrowed (— ) reserves*..
Nonborrowed reserves* ..................................

25,339
25,122
217
759
— 542
24,580

25,404
25,081
323
678
— 355
24,726

25,585
26,182
25,664
25,324
261
518
807
664
— 403 — 289
24,921
25,375

25,628§
25,298§
330 §
727§
— 397 §
24,9015

Changes in Wednesday levels

Weekly auction dates— June 196S
Maturities
June
3

June
10

June
17

June
24

Three-month,.

5.649

5.713

5.578

5.238

Six-month......

5.699

5.790

5.633

5.485

Monthly auction dates— April-June 196S
System Account holdings of Government
securities maturing in:
+ 161
4- 771
4 - 550
Less than one year ........................................
More than one y e a r ........................................
— 308
Total

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

4 - 161

4- 771

4- 242

Note: Because of rounding, figures do not necessarily add to totals.
* These figures are estimated.
§ Average of four weeks ended on June 26.
t Includes changes in Treasury currency and cash.
t Includes assets denominated in foreign currencies.




+ 248
+ 85

+1,730
—- 223

+ 333

+1,507

April
23

May
23

June
25

N ine-m onth.....................................

5.665

6.086

5.745

One-year...........................................

5.663

6.079

5.731

* Interest rates on bills are quoted in terms o f a 360-day year, with the discounts
from par as the return on the face amount o f the bills payable at maturity.
Bond yield equivalents, related to the amount actually invested, would be
slightly higher.

MONTHLY REVIEW, JULY 1968

146

substantial proportion of the new tax-exempt securities
offered during the period was successfully distributed to
investors. During the final week of June, however, in­
vestors showed increasing resistance to new offerings of
both corporate and tax-exempt bonds which were aggres­
sively priced to yield 5 to 10 basis points less than yields
available on comparable offerings in the previous week.
The weaker market tone stemmed in part from an ex­
pansion of the calendar for July. At the close of the month
the Blue List of dealers’ advertised inventories stood at
$669 million, considerably above the $513 million level at
the end of May. Over the month, The Weekly Bond
Buyers' average yield series of twenty seasoned tax-exempt
bonds (carrying ratings ranging from Aaa to Baa) fell
sharply to 4.48 per cent from 4.64 per cent at the end of
May. The average yield on Moody’s Aaa-rated seasoned
corporate bonds declined by 2 basis points over the month
to 6.27 per cent.
BANK RESERVES AN D THE
M ONEY MARKET

The underlying tone of the money market was quite
firm in June. Average net borrowed reserves of all member
banks deepened somewhat to $397 million for the four
statement weeks ended on June 26 (see Table I) from
$380 million in May. Transactions in Federal funds were
generally executed at rates well above the discount rate,
but the effective rate for these funds ranged widely, de­
clining to 5Vat per cent on one occasion and rising as
high as 6V2 per cent on others. Variations in the degree
of pressure in the money market mainly reflected the
management of reserve positions by the “ country” banks,
which alternately accumulated excess reserves and re­
leased these surpluses to the Federal funds market. On
average, the country banks carried about the same excess
reserves in June as they had in May and continued to
borrow heavily from their Reserve Banks. Average bor­
rowings of member banks, in the aggregate, were $727
million in the four statement weeks ended in June, vir­
tually unchanged from May.
Reserve positions of the major money market banks
deteriorated markedly over the first three statement weeks
of June under the impact of a sharp rise in the financing
needs of United States Government securities dealers at
the start of the month, heavy borrowing by businesses and




sales finance companies through the quarterly corporate
dividend and income tax period, and a substantial runoff
of maturing C /D ’s in the tax week itself. The city banks
continued to tap the Euro-dollar market for supplemental
funds but on a very limited scale, compared with that in
the last three weeks of May when average borrowings
from overseas branches rose about $650 million. The
average basic reserve deficit of the eight New York City
money market banks climbed to $698 million in the state­
ment week ended on June 19 (see Table II) from the
$135 million level to which it had fallen in the last May
statement week. In the final week of June, the basic re­
serve deficit shrank to $565 million as loans to Govern­
ment securities dealers contracted.
Rates posted by the major New York City banks on
call loans to Government securities dealers were adjusted
moderately higher through mid-June, as dealer borrowings
mounted and the banks were subjected to the usual taxperiod demands. Late in the month, new call loans were
generally quoted at a range of 6V2 to 6% per cent, com­
pared with 6 to 6lA per cent near the end of May. Dealer
offering rates on bankers’ acceptances and on prime com­
mercial paper were unchanged during June. In sharp con­
trast, rates on short-term Euro-dollars dropped precipi­
tously before leveling off around midmonth, while rates on
Treasury bills declined rapidly after a moderate markup
early in June.
Large New York City banks generally continued to offer
the maximum interest rates permissible under Regulation Q
on large-denomination negotiable C /D ’s during June.
In the three-month maturity area, C /D offering rates were
lower than yields on competing types of money market
instruments through midmonth, but higher than Trea­
sury bill rates in the latter half of the period. In the
longer maturity area, however, C /D ’s held a yield advan­
tage over Treasury bills throughout the month. In the
statement week ended on June 19, the large commercial
banks sustained net redemptions of $424 million of C /D ’s,
out of the approximately $825 million that matured on
the June 17 tax date. With the sharp decline in Treasury
bill rates, however, C /D ’s became more competitive, and
the reporting banks added $235 million to their outstand­
ing C /D ’s in the final week of June. Outstanding C /D ’s
declined by $279 million, net, over the four weeks ended
on June 26; total maturities for the month were estimated
at $5.4 billion.

147

FEDERAL RESERVE BANK OF NEW YORK

Recent Capital Market Developments
The nation’s capital markets were subjected to strong
pressures during the first six months of 1968, and interest
rates pushed through their 1967 peaks. It was not until
late June that the Congress enacted legislation incorpo­
rating a 10 per cent income tax surcharge on individuals
and corporations and a reduction in budgeted Federal
spending. Consequently, monetary policy had to bear the
entire burden of economic restraint throughout the first half
of the year. Evidence of greater monetary stringency was re­
flected in the deepened net borrowed reserve positions of
commercial banks, increases in the Federal Reserve dis­
count rate in March and April, and an increase of Vi per­
centage point in required reserves on member bank demand
deposits, effective in January. The impact of uncertainty
over the timing and dimensions of fiscal restraint on the
expectations and actions of both borrowers and lenders
was compounded by the ebb and flow of optimism over
negotiations for a peace settlement in Vietnam. Moreover,
the pressures on interest rates from the rapidly growing
domestic economy were reinforced by the impact of the
gold crises and rising apprehension in foreign markets con­
cerning the stability of the dollar.
While demands for funds by nonfinancial business
abated slightly from the record levels of 1967, business
needs remained high when viewed in the perspective of
earlier years. The large Federal deficit resulted in an in­
crease in outstanding Treasury indebtedness during the first
half of the year, a period normally marked by debt retire­
ment. Borrowing by state and local governments declined
slightly from the record amounts of 1967, but nevertheless
remained strong. Consumer credit rose sharply, reflecting
increased purchases of automobiles and other durable
goods. Aggregate mortgage lending, while slightly below
the pace of the second half of 1967, was maintained at
a generally high level in spite of gradually rising pressure
on the principal suppliers of these funds.

Chart I). During the same period, the major sources of
internally generated funds— retained earnings and capital
consumption allowances— declined slightly on balance.
Nevertheless, demands for external long-term financing
moderated during the quarter and, indeed, for the entire
first half of 1968. In particular, during the first six
months of 1968, corporate bond flotations (gross publicly
offered and privately placed issues) approximated $9
billion, about $2Vi billion less than the record six-month

Chart I

COMMERCIAL AND INDUSTRIAL
BUSINESS INVESTMENT AND FINANCING
Billions of dollars

Annual rates

Billions of dollars

|
„ .
, 1 ,
Privately placed
corporate bonds

Publicly offered
corporate bonds /
, r
,-v
|/
l \
/

\

\
N
V

B U S IN E S S FIN A N C E

Expenditures by nonfinancial corporations for fixed in­
vestment rose sharply during the first quarter of 1968 (see




m l r f f f i n 11 r n i j i u l i m
j m
L L i l u i
1959 1960 1961
1962 1963 1964 1965 1966 1967
Sources: Board of Governors of the Federal Reserve System and
Securities and Exchange Commission.

111
1968

148

MONTHLY REVIEW, JULY 1968

volume of the second half of 1967. While the volume of
C h art II
privately placed issues continued to trail substantially
LONG-TERM INTEREST RATES
that of publicly offered issues, some recovery of private
Per cent
per cent
placements from the depressed levels of early 1967 ap­
pears to have been registered.
The moderation in corporate demands for external
financing is attributable to a number of factors. Corpora­
tions were under less pressure to use long-term financing for
building up liquidity positions. The ratio of cash and United
States Government securities to total current liabilities— a
widely used measure of corporate liquidity— stood at 24.4
per cent at the end of the first quarter of 1968, about 1 per­
centage point above the 1967 low point reached in the
third quarter of that year. Furthermore, during the first
half of 1968, corporate income tax payments were rela­
tively low by comparison with 1967, reflecting the accel­
erated payments in that year.
The strong consumer demand evident during the first
quarter of 1968 slowed the rate of inventory accumula­
tion and thus moderated business demands for short-term
financing. Reflecting this, during the first three months of
the year business loans by commercial banks expanded
at a pace somewhat below the 8.2 per cent seasonally
adjusted annual rate of growth during the second half of
1967; however, the apparent step-up of inventory accu­
mulation during the April to June quarter may have con­
Note: F e d e ra l H o u sin g A d m in istra tio n -in su re d horns m o rtg a g e se rie s plotted
tributed to a somewhat sharper expansion of business
thro u gh A p ril, oil cfh e r se rie s plotted through Ju n e .
borrowings. In addition, the commercial paper market
So u rc e s: B o a rd o f G o v e rn o rs o f the Fe d e ra l R eserve System , First N a tio n a l C ity
B on k of N ew Y ork, a n d M o o d y ’s In vesto rs Se rvice .
continued to play a significant role in corporate financing
during the first half of this year, although the rate of
growth in outstanding paper was well below the rapid ex­
pansion during early 1967.
As a result of restrictions imposed on investments by
United States business firms in their foreign subsidiaries, standing and newly issued corporate bonds exceeded the
these subsidiaries were forced to place substantially greater peak levels reached in late 1967 (see Chart II). These
demands on foreign capital markets. During the first half movements reflected effects of both monetary tightening and
of 1968, affiliates and subsidiaries of United States com­ the heavy volume of financing by all sectors. Rates in ex­
panies issued more than $1 billion of bonds in the Euro­ cess of 7 per cent on new high-quality issues were wit­
pean markets, mostly denominated in dollars and con­ nessed, and at the higher rate levels direct purchases by
vertible into the common stock of the United States cor­ individuals became an important source of funds in the
porations. The volume of these flotations was more than market.
The flow of new equity market issues— especially from
double that for the entire year 1967 and, in large mea­
sure, represented a shift of demands for funds away from corporations making initial common stock offerings to the
public— accelerated sharply during the first six months
domestic sources.
Some of the record volume of corporate securities flota­ of 1968. Gross issues of common and preferred stocks
tions in late 1967 almost surely consisted of offerings amounted to an estimated $2 billion in the January to
accelerated in anticipation of tighter market conditions June period, compared with slightly more than $1 billion
in the early part of 1968. As the new year progressed during the same period last year.
The President’s announcement on March 31 of a limited
such expectations were realized, and interest rates were
pushed higher while uncertainty concerning the tax in­ de-escalation of the Vietnam war provided the impetus
crease legislation mounted. Indeed, yields on both out- for a sharp rise in stock prices and trading activity. Stan­




149

FEDERAL RESERVE BANK OF NEW YORK

dard and Poor’s broad-based index of 500 New York
Stock Exchange common stock prices rose more than 10
per cent to 99.58 during the second quarter, while trading
activity on this exchange averaged 14.3 million shares daily
— a rise of almost 41 per cent from the average turnover
during the first quarter of the year. Prices on the American
Stock Exchange and in the over-the-counter market in­
creased even more sharply in greatly expanded trading ac­
tivity. The pace of trading became so hectic that the major
stock exchanges and the over-the-counter market decided
to close one day a week from mid-June through the end of
July to facilitate the handling of accumulated paper work.
Concern with the rising speculation in the securities mar­
kets prompted the New York and American Stock Ex­
changes to make extensive use of special margin require­
ments in their efforts to moderate such activities. In March,
the Board of Governors of the Federal Reserve System
tightened its controls over the use of credit to finance the
purchase of securities by extending margin requirements
to convertible bonds and to stock market loans from most
previously unregulated lenders. In addition, in early June
the Board of Governors increased the minimum downpay­
ments on purchases of listed stocks and convertible bonds
by 10 percentage points to 80 per cent and 60 per cent,
respectively.

posit growth at mutual savings banks in the first five
months was only about 10 per cent lower than that during
the same period a year earlier, while at savings and loan
associations the growth was about half that of the com­
parable months of 1967. The more aggressive promotion
of premium-rate, longer maturity savings instruments,
particularly at savings and loan associations, undoubtedly
slowed outflows of funds in the face of rising market yields.
In spite of the moderation in the inflow of funds to
savings and loan associations, these institutions continued
to expand mortgage holdings at a pace comparable to the
last half of 1967. Pressure on liquidity positions eventually
emerged, however. During the January to May 1968
period, savings and loan associations obtained about $300
million in advances from Federal Home Loan Banks,
while during the last six months of 1967 the rise in bor­
rowings was only $85 million. At mutual savings banks,
in contrast, the expansion of mortgages has been weak
since mid-1967. Restrictive ceilings on mortgage interest
rates imposed by usury laws in several of the states in
which these institutions operate have induced the diver-

Chait III

INDIVIDUALS’ BORROWING PATTERNS
C O N S U M E R A N D M OR TGAGE FIN A N C E

Billions of dollars

Billions of dollars

1100

Outstanding consumer credit rose by $3.4 billion (sea­
sonally adjusted) during the first five months of 1968.
On an average monthly basis, this increase exceeded by
about 62 per cent the expansion of such credit during the
second half of 1967 (see Chart III). Clearly, the impetus
for this development was a strong surge of consumer
spending, especially for durable goods. During the first
quarter of the year, total consumer spending mounted by
a record $17 billion, about $3 billion greater than the
rise in disposable personal income.
As a result of the sharp expansion in consumer spend­
ing, the savings ratio declined to 6.6 per cent during the
first quarter of 1968, Vi percentage point below the aver­
age rate during 1967. This development plus the increased
attractiveness of credit market instruments, especially Gov­
ernment securities, resulted in a diminished flow of funds
to thrift institutions. During the first five months of this
year, total savings capital and deposits at savings and
loan associations and mutual savings banks grew at a sea­
sonally adjusted annual rate of approximately 6V2 per
cent, 4 percentage points below the growth during the
comparable period in 1967 but well above that during
the January to May period in 1966 (see Chart IV ). De­




1000
900
800
700
600

500

400

300
Per cent
15

Per cent

10

1959

1960

1961

1962

1963

1964

1965

1966

1967

1968

^ Se a so n ally adjusted.
Sources: Board of Governors of the Federal Reserve System, Federal. Reserve
Bank of New York, and United States Department of Commerce.

150

MONTHLY REVIEW, JULY 1968

G O V E R N M E N T F IN A N C E

Chart IV

SAVINGS BANKS AND SAVINGS AND LOAN ASSOCIATIONS
C h a n g e fro m three months earlier; s e a s o n a lly a d ju ste d a n n u a l rates
Per cent

Per cent

14

12

10

8

2

1965

1966

1967

1968

0

Note: Seasonally adjusted by the Federal Reserve Bank of New York.
Sources: Federal Home Loan Bank Board and the National Association of
Mutual Sa vin g s Banks.

sion of a high proportion of their new funds into corporate
bonds. However, several states have recently liberalized
these ceilings, a move which should increase the relative at­
tractiveness of mortgage lending. Furthermore, the ceiling
rate on Federally insured mortgages was raised in early May
from 6 per cent to 63A per cent, although the new rate is
currently below levels prevailing in the secondary market
for Federal Housing Administration-insured mortgages.
A notable development to improve the responsiveness
of mortgage prices in the secondary market to changes in
credit conditions was the adoption during the first half of
1968 by the Federal National Mortgage Association
(FNMA) of a system of auctioning commitments (bear­
ing maturities of three, six, and twelve months) to pur­
chase new mortgage loans. Under the former system,
which involved mortgage transactions at administratively
fixed prices, the volume of mortgages purchased by
FNMA was determined largely by the sellers, mainly
mortgage bankers. In contrast, the auction system now
permits FNMA to set the volume of mortgage purchases
and thus have greater control over the magnitude and
timing of its financing operations. In its initial weekly auc­
tion in May, FNMA invited tenders for commitments
to purchase $40 million of mortgages, and by late June
the weekly offering had risen to $90 million. The average
three-month commitment price for mortgages declined
through the third week in June, but since then prices have
recovered somewhat.




The Treasury placed strong demands on the financial
markets during the first half of the year— a period that
is ordinarily marked by some reduction of Government
debt. The Treasury’s net cash borrowing from the public—
including the banking system and the Federal Reserve— is
estimated to have reached almost $3 billion during the first
half of 1968, a sharp contrast to the net redemption of
more than $8 billion of publicly held securities in the same
period of 1967. The volume of marketable Treasury securi­
ties held by the public rose slightly during the first half of
1968, whereas during the same period of 1967 the amount
of such securities held by this sector declined by about $7
billion. Part of this increase of Treasury securities was
offset by lower sales of certificates of participation in
Federal loans. In the first half of 1968 the net increase of
public holdings of these certificates was about $700 million
less than the additions during the comparable period of
1967.
Issues of Government agencies (not directly guaran­
teed) also expanded sharply during the first half of 1968.
Net new issues of these securities totaled more than $1
billion during this period, a marked difference from the
net redemption of about the same amount of agency
securities during the first six months of 1967. One factor
in this reversal was the pattern of financing by Federal
Home Loan Banks whose borrowings amounted to about
$600 million in the first half of 1968, compared with a re­
duction of indebtedness which exceeded $2 billion a year
earlier. This in turn reflected heavy repayment of ad­
vances by savings and loan associations in the earlier
year and increased borrowings by this sector during 1968.
Yields on both newly issued and outstanding Govern­
ment securities rose to new peaks during the second quar­
ter of the year, although they moved down somewhat
after mid-May. In a May financing operation, the Treasury
issued fifteen-month and seven-year notes with a coupon
rate of 6 per cent— the highest coupon on a publicly of­
fered Treasury obligation since 1920— and during the
month the average yield on newly issued Treasury bills
rose to the highest point for any fully guaranteed Treasury
security since the Civil War. In addition, the Treasury re­
cently increased the interest rates on Series E and H
savings bonds and the “ freedom shares” in an effort to
increase the attractiveness of these securities.
New issues of state and local government securities ex­
ceeded $7 billion during the first half of 1968 and were
only about $400 million below the volume of new flota­
tions during the first half of 1967. The flow of new taxexempt securities was expanded during the early part of

FEDERAL RESERVE BANK OF NEW YORK

1968 by the accelerated flotation of many industrial rev­
enue bonds which were moved ahead in anticipation of
the just-enacted removal of the income tax exemption on
interest earned on issues of such securities exceeding $1
million in size and initiated after May 1, 1968.
The market for tax-exempt securities was quite con­
gested during much of the past six-month period, as
investors were increasingly reluctant to make new commit­
ments. In 1967 commercial banks had lent strong sup­
port to this market by purchasing almost 90 per cent of
the net increase in state and local obligations, but in the
first quarter of the year this proportion declined to 66
per cent, and commercial banks made no significant addi­
tions to their holdings of municipal securities during the
second quarter.
ROLE OF THE BAN K ING S Y ST E M

According to preliminary data, during the first quarter
of 1968 the volume of net funds raised by all nonfinancial borrowers totaled about $100 billion (seasonally
adjusted annual rate), down from $106 billion during the
second half of 1967. The commercial banking system sup­
plied 20.7 per cent of this total, a sharp decline from
the 39.5 per cent that the banks accounted for during the
second half of 1967. However, the drop in commercial
bank lending activity was accompanied by a rise in direct
unintermediated lending by the private nonfinancial sectors
— mainly households and businesses— which supplied
about 47 per cent of the net funds raised by all non­
financial borrowers.
In an environment of reserve stringency the expansion
of commercial bank credit slowed markedly during the
first six months of 1968. The net rise of approximately 6.5




151

per cent at a seasonally adjusted annual rate was sharply
below the 12.5 per cent growth registered during the last
half of 1967. The principal impact of credit restraint fell
upon commercial bank holdings of United States Govern­
ment and municipal securities, both of which grew at a
rate only about one third of the strong expansion during
the second half of last year. Net loan extensions declined
slightly from the earlier period, although the drop was
not so pronounced as that for investments. A rise in busi­
ness loan expansion early in the second quarter was ap­
parently associated with increased inventory accumulation;
consumer loan volume was strong throughout the first half
in response to a sharp increase in consumer spending,
primarily for automobiles and other durable goods; and
real estate lending maintained the 10 per cent growth rate
in evidence since mid-1967.
Reflecting the pattern of rising yields on competitive
market instruments, total daily average time and savings
deposits held by commercial banks grew at a seasonally
adjusted annual rate of 5.0 per cent during the first half
of 1968, sharply below the 12.6 per cent rise during the
preceding half-year period. The Board of Governors raised
the interest rate ceilings on time certificates of deposit
greater than $100,000 at the time of the discount rate in­
crease in April,1 and commercial bank offering rates sub­
sequently moved up to the new ceilings— which range from
5Vi to &A per cent. At the increased rates the volume of
certificates issued by large banks changed little on balance
during May and June.

1 For additional information regarding the new ceilings, see this

Review (M ay 1968), page 97.