The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
July-August 1967
LY REVIEW
Specialized Mortgage
Marketing Facilities
page 3
The Process of Federal Spending
and Economic Activity . . . • page 14
Deposit Variability
at Commercial Banks
• • • . page 27
FEDERAL R SERVE BANK
OF KANSAS UITY
11
II
Subscriptions to the
MoNTHL Y REVIEW
are avail-
able to the public without charge. Additional
copies of any issue may be obtained from the
Research Department, Federal Reserve Bank of
Kansas City, Federal Reserve Station, Kansas
City, Missouri 64198. Permission is granted to
reproduce any material in this publication.
Specialized Mortgage
Marketing Facilities
B y J. A . Cacy
needs of the Nation's populaTtion and the institutions
serv ing th sc needs
II E HOU S ING
have Ion • bee n subjects or public concern . I ,;1s t
yea r's slwrp declin' in r ·s id ntial onstruction
ac ti vity :rncl in the fl ow of mortgage fund s
served to renew and intcnsi (y public interest in
thi s sector of the economy, As in other similar
periods, the event of 1966 have generated
various proposals designed to prevent their
recurrence . Some of these proposals involve
measures intended to improve the marketability
of residential mortgages. In this connection,
man y observe rs have concluded that effi cientl y
operating speciali zed mortgage marketing faciliti es offer a partia l solution to the probJcm s
ncountcrcd by construction and mortg:1gc
market participants. Such fac ilitie , it is argued,
would allow a better allocation of credit and
real re ources between housing and other sectors of the economy and would reduce the
degree of instability in the flow of mortgage
funds and in construction activity.
This article is directed toward an examination of existing specialized mortgage marketing
faciliti es . The exa min ation begins with a general di scussion of the nature and function s of
spec ialized marketing arrangements, and proceed · to an outline of the organization of the
res idential mortgage market. Ex isting specialized mortgage marketi ng facilities are then
described, and an analy is of their adeq uacy is
presented. This is followed by an identification
Monthly Review
•
July-August 1967
of some obstac1cs preventing the further development of ex isting arra ng mcnts, and a
di sc ussio n or meas ures dcsi nccl to fos ter such
a elev lopm cnl. rinally, some brief com ments
arc offered co ncern ing the objectives of policy
with regard to the residenti al construction and
mortgage markets.
1
NATURE AND FUNCTIONS OF SPECIALIZED
MARKETING FACILITIES
In financial markets, borrowers or sellers of
assets must communicate with lenders or buyers of assets; time and resources mu st be devoted to bringing market participants toge th er.
Bccm1se thi s type of activity is subject to economics of scale, speciali zed enter pri ses have
undertaken to provide specialized marketing
fac ilities for many as ets. These firm s, which
may be referred to as marketmakers, provide
centrally located facilities which are used by
market participants to communicate, undertake
transactions, and determine asset prices and
other terms on which funds are made available.
Also, marketmakers frequently collect and disseminate inform ation useful to market participants. Tn the broad sense intended here, a
marketmaker may be either a dealer who assume positions jn assets or a broker who on ly
brings participant together. Members of the
New York stock exchange, for example, are
marketmakers a are dealers in U . S. Government securities.
3
Specialized Mortgage
Chart 1
THE ORGANIZATION OF THE MORTGAGE MARKET
l /~ '
EJ
~eal Estate
Broker
Banawe ,
'
/
Mactgag e
11
.__O_r-ig-i- a-to_r_
[ : ] ..
13 th th e in co me or th e ma rk c tmakc r and
hi s contributi n to the eco nomic well-being of
th e community de rive mainly from hi ability
to reduce th e cost of e ffecting asset transfers.
Indeed, thi s cost may be u sed as one m easure
of both the ma rketability of the assets involved
and the technical efficiency of financial markets. By reducing these costs, the marketmaker
enh ances th e marketability of assets and increases the efficiency of financial markets.
Al so, by se rving as a so urce of m a rket in fo rm atio n a nd advice, market makcr. contribute to the ffici cncy of finan c ial markets in
a more indirect manner. In these various way ,
specialized m ar ke ting facilities improve the
efficiency of the ma rket mechani sm in directing
a nd redirecting flows of fund s, and enhance
the ability of market pa rticipants to a djust to
rapidly changing economic conditions.
Specialized facilities m ay serve either primary or secondary markets . N ew assets arc
created a nd pl aced in the portfolio of initial
holde rs in primary ma rkets, whereas cxi ting
or seaso ned asset a rc bou ght and sold in
seco nd a ry m arket . To illustrate, investm ent
banking firm s provide spec ialized facilities for
th e primary co rporate sec uriti es market, while
stock exchanges are exa mpl es of secondary
m arketing facilitie
4
t
Ma,tgage
l
EJ
1
t
..
_, . . .___B_ro-ke_.-_ __,. .
Inv es tor
♦
t
THE ORGANIZATION OF THE
MORTGAGE MARKET
Some familiarization with the orga nization
of the mortgage marke t is necessa ry to understa nd the nature of th e ex isting specialized
mortgage m arke ting facilities. The institutions
operating in the market and th e communication s ch annels e mpl oyed by mortgage borrowers and lenders a rc indicated in Chart ] . The
various organizations ( o r participa nts) positioned in the co mmunica ti o ns ne two rk pr vidc
th e instituti o nal fram ewo rk which suppo rts th e
ope ration of th e primary mortgage ma rketoperations which re ·ult in the provi s ion of debt
fin a ncing for the construction and/or purchase
o f residential property, a nd dete rmine the te rms
on wh ich fund s are made available. In addition,
certain elements of thi s fr amework provide, in
a limited way, secondary m arket facilities.
The operations of the marke t r equire that
th e participants perform several function s.
There is fir t th e markctmaking or brokerage
function of providing for communication betwee n borrowe rs, lende rs,
li e r , a nd buye rs.
Second, th e mo rtgage instrum ent mu st be
originated. Originating a loa n con ists of pe rforming or coordinating the performance of
necessa ry or des irabl e se rvices that precede or
Marketing Foci lities
accompany th e creation of a mortgage instru ment, such as property inspection and apprai snl, borrower credit ratin g, and the preparation
of auxiliary lega l in struments. The result of
these activities is the crention of a nego ti abk
finnnci al nsset ow ned by th e ori ginntor . Another functi on is the provision of financing.
both ha rt- nnd long-term . Long- term or permnnent fimrncing is th holding of th e mortgnge as an in ves tment . Interim or short-te rm
fin ancing is provision or credit for construction,
or from th e time the loa n is origin;1tcd and
fund s transferred to th e borrower until th e
mortgage is acquired by ;1 long- term lender .
Th prov ision or th l: l:1tt ·r type of credit is
:tiled n1 ortg;1 r • w;1rc ho11 sin e,. 1-i11;1lly, th e 10; 111
mu st b · scrv ic ·d ; th ;1t is, rcp;1y111 cnt s of prin ·ipal ~i nd p,1y mcnt s of inlcrest mu st be co ll ected.
Some mo rtgage market participnnts perform
all functions , while oth ers speci alize. Shortter m cred it is prov ided by commercial banks,
and to a lesser ex tent by savings and Joan
associations and mortgage companies. Mortgage companies are th e mnjor originating and
servicing speciali sts. Savings and Joan associations, commercial banks, mutu al sa vings banks,
and life in sura nce co mpani es provide a major
portion of the long-term fin ancing. Also , many
Ion -term Jcndcrs originate :i nd servic the
mortgages they hold and provide th e necessary
facilities fo r co mmunica ti on wi th borrower. .
The real estate broker, the builder, th e
mortgage originato r, and the mortgnge broker
are all a part of the communications network .
As shown by Chart 1, th e ultimate mortgnge
borrower m ay deal directly with a long-term
mortgage lender or he may contact a real
estate broker or a builder. The real es tate
broker or the builder mny refer th e borrower
to a mortgage ori gin ato r or to a pcrman nt
inves tor. The originator in turn may dea l
directly with th e in ves tor or may empl oy th e
services of a mortgage broker. The broker
ordina rily will have direct co ntacts only with
originators and long-term lenders.
Monthly Review
•
July-August 1967
EXISTING SPECIALIZED MORTGAGE
MARKETING FACILITIES
The specialized originators arc important
participants in th e market, and th ese enterprises
toge th er with mortgage brokers provide specialized mortgage ma rketing facilities. Man y longterm lenders have not found the establi shment
of loca l mortg;ige-o ri ginating facilities or th e
m~1int nance of sufficient se rvicin g facilities
des irabl e. Others hnve not been c1blc to or iginate th e volume of mortgage. they des ire to
hold . In consequence, th ese per manent investors
ha ve entered into agreements with ori ginatin gse rvicin g firm s- mainl y mortgage comp nni es.
Thcs ~ co111panies o ri ~in :1tc mo rt l a 1 s, assemble
them in blo ·ks, ;ind se ll th ' Ill to long-te rm
lenders in wha t is referred to hy indu stry parti ipanls ,ind obsL: rve rs as th e sec )1H.lary mortgage mark et. The mortg<1ges ~n e th en serv iced
by th e ori gin a tor. The serv icing fee paid by
th e long-ter m lender is th e majo r so urce of
income for th e originator-servicer. Tn obtaining
outlets for mortgages, th e ori ginator-servicer
may obtain the aid of mortgage brokers. These
firm s neither originate nor se rvice mortgages;
th ey are paid a fe e by the ori gin ator based on
the value of th e mortgages pl aced. In ad dition
to th e marketing fac ilities pro vid d by private
enterprise. , th Federnl N,1t ion::i l Mo rt age A sociation bu ys and sell Governm ent-und erwritt n mo rtgages. The activities of FNMA
will be disc ussed furth er in a later section. 1
ADEQUACY OF EXISTING FACILITIES
In assessing the adequacy of existing specialized marketing facilities, there are three points
'M or tga ges arc marketed th ro ugh arra nge m ents n o t
mcntione I in the text. For exa mpl e , s:wi ngs a nd loa n
asso c iations se ll pa rti c ipa ti on s in co n ven ti o nal m o rtgage.
to o th e r assoc ia ti o ns. These tra nsact io ns o rdin a ril y are
a rranged by dire t con tac t between th e long-term lend e rs .
A l o, the M o rt ga ge Guaranty In s u ra nce Co rpora tio n , a
priv a te m ortg age ins urance firm , provides a brokerage
se rvice at n o cha rge to firms w ishin g to b uy or sell
MGIC-insured m ortgages.
5
Specialized Mortgage
th at may be di scussed : ( I ) th e nature of the
operations of the ori ginato r-se rvicer, ( 2 ) th e
extent to which th e faciliti es se rve all segments
of the market, and ( 3 ) the extent to which
perm anent in ve tors employ ex isting fa cilities
for making portfoli o adju stments.
The opera tions of th e o riginator may take
several form s. One fo rm a ri ses when a perm anent inves tor commits fund s fo r a specific project, such as a tract of houses , before co nstru cti on begins. The o ri ginator may prepare prelimin ary pl ans and submit them to the investor
for approval. lf th e in vestor find s the pl ans
accep tabl e, he ag rees to prov ide th e perm anent
fin ancing. Wh n th e projc t is co mp lc tccl, th e
houses so ld , ;ind th e lo.in s close d, th e o ri gin .1tor
tr,,nsf rs or " se ll s" th mo rtgages to th e per ma nent in v tor. Another type o r o pera ti on invo lve an allotment arrange ment. An originator
typically will mainta in se rvicin g ag reements
with several perm anent inves tors. As a part of
an agreement, an in ves tor may allot a certain
sum of money to th e o ri ginator; th at is, the
inves tor agrees to accept from th e originator,
during a certain pe ri od of time, mortgages equal
to a specified total doll ar amount. Th e type of
rnortg,1ges des ired may be indicated in the servici ng ag ree ment , and th e ori gin ator will keep
well info rm ed on th e in ves tor's requirements.
J n so me cases, mortgages arc transferred to
a regul a r co rres pondent und er an ag reement
which contains no specified commitment or
allotment. Mo rtgages arc imply offered to th e
inves tor, and may be refu sed by him at any
time. Or, an originator may sell mortgages to
an in vestor who is not a regul ar correspondent
and who has no se rvicing ag reement with the
o ri ginato r, although most of the business of
mo t ori gin ators is conducted with servicing
co rrespo ndents.
T he va ri ous o perating procedures and the
tra nsacti ons ari sing from th em may be di stingui shed o n th e ba is of th e type of contrac t
or agreement entered into by the o ri ginator and
the inves tor. Some tra nsacti ons invol ve a con6
trac t fo r the future delivery of mortgages at a
price agreed upon in th e contract, while others
involve a contract for the immedi ate delivery
of th e mortagages at the current market price.
ft is obvious th at ori ginators who sell mortgages
for immedi ate delivery mu st maintain an inve nto ry of mo rtgages, and th at they will be
subject to the ri sk of price cha nges. (When an
ori ginator enter into a contract for future
delivery, he may be sa id to be acting as a
mortgage b ro ker. When he ca rri es uncommitted
in ve ntories and sell fo r immedi ate deli ve ry, he
is a dealer in mortgages . Th e ori gin ator who
pe rfo rms th e fun cti on of a broker should not
he co nfuse I with th e firm s know n ,1s mo rtgage
bro k ' rs 111 nti o11cd ;1hove.) By 111;1int ainin g invrnto ri s for sa le, th e ori •in ato r incrc:, ses th
altern ati ves ava il able to in vestors and th ereby
enhances the va lue of hi s se rvices. He also
perfo rms the broader fun cti o n of offsetting
week-to-week o r month-to-month va ri ati ons in
the flo w of mortgage fund s between ultim ate
borrowers and lenders. Frequent ch anges in the
cost and / or avail ability of fund s to borrowers
not wa rra nted by bas ic supply and demand
conditions thu s arc prevented. Origin ator-servicer-deale rs may poss ibl y be in a pos ition to
effect longe r run cyclical flu ctu at ions in th e
mortgage marke t. Thi s wo uld require th at th ey
"specul ate" in mortgage., inc rca. in g their inve nto ri es when they believe mo rtgage ra tes arc
too hi gh and redu cing them when rates are felt
to be too low.
There is no way to determine, from avail able
data, th e relative importance of immedi ate delive ry and futu re transactions. Industry operatives have indicated th at, before 1960, most
o rigin ators prefe rred to operate with prior commitments but , durin g th e prese nt deca de, th e
trend has bee n towa rd immediate deli ve ry . Thi s
wo uld see m to rep rese nt a welco me development. T he full -fl edged dea ler is less likely to
be a mere ex tension of a pa rti cul ar perm anent
inves tor, i more likely to be a stron g independent competiti ve fo rce in th e market, and will
Marketing Facilities
be more stra tegically positioned to perform th e
functions of a specialized market ing facility.
1n co nnection with the ex tent to which existing faciliti es se rve all segments of th e market,
th e originator-servicer is very important in the
Government-u nderwritten sector, and hi s importance is grow ing. As ca n be seen from
Chart 2, th e pe rce nta ge of the total doll ar
volum e of both Federn l H ous ing Admini stration and Vetera ns- Administration origination s
attributJ ble to mo rtgage compa ni es- the major
originating-servic ing speciali sts has bee n
steadily increas ing th rougho ut th e postwar
peri od. By 1965, th ese firm s c:1cco unted for 64
per ce nt of I· HA and 68 per ce nt of VA
Chart 2
Chart 3
FHA MORTGAGE SALES AND PURCHASES
Pe r Cent
100
80
SALES
60
40
\.,
..
Commercial
..... "'"' .. -- .. ( Banks
StL,MSB,IC*
'-..
20
,-. .,
- - - .J,_,__
0
Per Cent
10
1
,
,
I
'{_ J.__j,
............... _..._
FNM A
....... ---
____ "_y-~-,,;
t
YI
I
I
I
PURCHASES
GOVERNMENT UNDERWRITTEN MORTGAGE
ORIGINATIONS
Ins uranc e Co mpanies
and Mut ual Saving s Banks
r- ....
Per Cent
100
80
I
J
FHA
I
60
Commercial
40
_J_
'55
..
20
0
l
J
Per Cent
J
l
I
I
I
I
I
I
'~---- ----l
l
I
I
I
*Savings and
l oo n
Assoc iat ions, Mutual
In surance Compan ies.
SO UR CE : Fe d e ral Ho u s in g Admini strat ion .
l
I
100
80
VA
60
40
All
Others
20
SOURCE : Fe d era l Housin g
loon Bonk Boord .
Monthly Review
Admini strati on
an d
Fede ra l
July-August 1967
'60
Home
Savings
Ba nks,
origin at ions. Furthermore, c:1s ca n be see n from
C hart 3, most of the sa les of FHA mortgages
ue made by mortgage companies.~ Chart 4
shows that mortgage companies do not hold
their originations . In each of the postwar years ,
th e difference betwee n the volume of FHA
mortgages sold by these firm s and th e volume
ori ginated has bee n quite small.
Som e commercial banks have entered the
mortgage origin at ing and se rvicing bu siness.
The ex tent of thi s ac tivi ty is difficult to determin e from availab1c data fo r severa l reaso ns.
First, so me banks operate mortgage compan ies
"Sa les data is not rea dil y ava il ab le for YA mo rt gages .
7
Specialized Mortgage
Cha rt 4
FHA MORTGAGE ORIGINATIONS AND SALES
BY MORTGAGE COMPANIES AND
COMMERCIAL BANKS
Bil lio n s of Dollars
6
5
T
MORT GAGE COMPAN IES
4
3
2
0
L_l
...l
Billions of Dollars
l
1
1
1
J
_j
j
J
j
I
1
1
I
_.1
J
'65
SOURCE :
Federa l Hou s inq
Administrati on .
as se para te entities, and their activitic arc
reflec ted in th e fi gure on mortgage companie .
Seco ndly, unlike mortgage companies, commercial banks pl ace in portfolio a significant
portion of their originations. Chart 4 shows
that, for banks , FHA originations exceeded
sales in each of the postwar years. Finally,
there i-s no way to determine the extent to
whi ch th e sale fi gures represent portfolio
red uctions by banks not in th e originatingse rvi cing busine . .
Most of th e Gove rnm ent-un de rwritten mo rtgages old by th e pccialized mortgage n g1nato rs arc purchased by in. urance companies
and mutual sav ing bank . (See Chart 3.)
1n fac t, insurance companies and mutu al sav8
ing banks acquire a large percentage of their
Governm ent-underwritten mortgages by purchase. Commercial bank s acquire so me Governm ent-underwritten mortgages by purchase,
but con iderabl y fewer than they originate.
Apparently th ose commercial bank. which do
not opera te a mortgage co mpany type oE bu ines originate most of th eir Gove rnm ent-underwritten mortgages . Savings and loa n a ociati on acq uire eve n fewer Government-underwritten loa n by purchase th an do commercial
banks , both absolutely and in relation to total
acq ui sitions. For th e mos t J art , savings and
loa n ~1ssociati on: o ri gin ,1te and scrvic th eir
Governmcnt-uncl crwritt ' 11 111ort r~1gc holdin s.
Spcc i;di zcd morl •~1 1 c 111 ;1rk ' tin, L1ciliti cs :ir ·
rn1p lnyc I I 'ss 'x lcnsive ly i11 th e co nv nti onal
th an in the ovc rnm cnt-und crwritten secto r.
Transfer and ori gin ati on data arc less readil y
ava ilable for conventional loa ns, but from
sca ttered data and knowledge of indu stry practi ces, one can conclude th at a considerabl y
large r percentage of conventional th an of Governm ent-underwritten mortgages are originated ,
held , and se rviced by th e sa me institution. It
is known , for exa mple, that mort gage com panies se rvi ce onl y a very small pcrce nt.1 ge of
co nventi onal debt outstandin g. 1n. ura nc co mpanies ~1ppe,1r to be th e onl y long-term lenders
th at ex tensive ly empl oy ori ginator-scrviccrs in
rega rd to conventional loa ns. Mutu al savings
banks apparently operate in much the sam e
manner in th e conventiona l sector as do sav ings
and loan associations and commercial banks .
Thi s is not surprising since mutual savings
banks, like many commercial banks and savings and loa n a soci ation s, have bee n subj ec t
to geographic restrictions on their conventional
lending and , consequently , do not hold conve nti onal mortgage on properties in widely
di spcr cd geog raphic areas. As pointed out
above, th e se rvice of the or igin ator- ervicer
arc tail ored to the nee ds of the national lend r.
As mutual sa vings banks take advantage of
liberalizati ons in geog raphic res triction s and
Marketing Facilities
increa ·c th eir national conventional lendin g,
the or igi nator-servicer will probably become
more important in the conventional sector.
However, it should be poi nted out that eve n
for insurance compani es-which arc nat ional
lenders in th e conventi onal as well as in the
Government-underwritten market- the importance of th e o ri ginator-se rvice r is not as grea t
with regard to th eir conventional loa ns as to
their Governm ent-underwritten holdings.
Th ere is little definite information avai lab le
to determine th e ex tent to which ex isting
specialized marketin g fo cili ti cs extend out idc
th e co nfin es of th e m,irk ct for recentl y ori ri n:1tcd 111 or t,l ,1 ) L'S ;rnd ;ire c111 ploycd hy perman nt inves tors to adj ust th eir mort r,1l
portfolios . M;1rk t particip<1nts indicate th at
transactions of thi s type ,ire infrequent. Insurance companies, mutu,il savings banks, and
saving and loan associations do sell some FHA
mortgages (sec Ch a rt 3 ), although the volumes
involved are not large . The extent to which
th ese transactions arc directly negotiated between the investors is not known. Some of th ese
sales arc arra nged by mortgngc brokers, and
in som e cases th e mort gages arc sold to mortgage compani es. As Chart 3 shows, mortgage
comp:1ni cs purchnsc a sm,ill vo lu me of FHA
mortg,i-res. These fi rm s, how vc r, arc interested
primarily in maintaining and increa sing th ir
serv icing volume, and do not appea r to be
interested in buying and selling mortgages, as
such.
REASONS FOR LIMITED DEVELOPMENT
OF EXISTING FACILITIES
Jt has been shown that exi stin g specialized
mortgage marketing fociliti cs arc co nfined primaril y to Governm ent-underwritten, newly
origin ,1ted mortgages . The foci liti s appear to
opera te adequate ly in thi sector or th e market
as a di stributive mechcinism for new mortgage
inst rum ents. There ,ire no special ized seco ndary marketing facilit ies in th e sense in whic h
such were ea rlier defi ned- th at is, faciliti es
Monthly Review
July -August 1967
which mortgage investors employ to buy and
se1l seasoned mortgages. Transactions of this
nat ure do occur, of course, and ome seasoned
mortgages pass through the ex isting specialized
marketing chan nels. Also, the Federal National
Mortgage Assoc iat ion is de ignated as a seconcbry market fac ility, and one of its tated
purposes i to upport " th e ge neral secondary
mo rtgage market. " H oweve r, FNMA's activity
is ve ry closely assoc iated with the primary
market. Most o f FNMA 's mortgage purcha cs
arc from ori ginator-se rviccrs. By buyi ng mortgages from ori ginato rs that cannot be placed
wi th perman ent in ves to rs, th e ssocia ti on helps
suppoit th e primary market :mcl reduce.· th e
ri sk involved in th ' c.lc;il c r a ·ti viti es of th e
or i 1 inato r. T he policy , usu:illy ;1dopt cl, of
rcfu sin y to purch ;_ 1sc seaso ned mortgages prevents FNMA fro m bei ng employed as a portfoli o adju sting mechanism. " T he A ssociat ion
docs sell mortgages from portfolio , and these
Th e law requires th a t FNMA res tric t p urch ases, und e r
th e seco nd a ry m a rk et o pe r a ti o n , t o mortgages which
were approv e d by th e VA for g uara nt ee or by th e FHA
fo r in surance su bsequ ent to Au g ust 2 , 1954 . Th e Assoc ia ti o n has from tim e to tim e es tab li shed m o re restri cti ve age requi rement s. Th e hi , to ry sin ce 1954 o f th ese
re quire m e nt s is a, f 11 ows:
3
Period
.· l gc J< eq11ire111 e111
ove m- Statut o ry c ut o ff (m o rt gages
a ppro ved fo r ins uranc e or
g uarant ee o n or after Au g ust 2, 1954, eli gible for
purch ase)
Nov ember 23, 19 56, to 4-month c utoff (mortgages
must b e offe red to FNMA
June 30 , 195 8
within 4 months of th e d a te
o f appro val for insuran ce or
g uarantee )
A ug ust 2, 1954, to
he r 23, 195 6
.June 10. 1958, to Se pt e mbe r 12, 1959
·e pt e mbe r 12, 1959, to
N ove mb e r 28, 1962
Nove mbe r 28, l 962, to
Janu a ry 18, 1966
Janu ary 18, 1966 , to Feb ru a ry 3, J 967
Febru a ry 3. 1967 , to present
I 2-m o nth c ut o ff
4-mo nth c ut fl'
S ta tut o ry c ut o ff
4-m o nt h c uto ff
St a tut o ry c uto ff
9
Specialized Mortgage
sales can be characterized in no other way th an
secondary transaction .
The reaso ns for th e limited development of
specialized mortgage marketing facilitie s arc
not difficult to di cover. In th e first place.
th e mortgage in strum ent is not idea l for open
market trading. Th e a ct being traded is not
homoge neo u or hi ghly stand a rdi zed.
ach
mortgage loan is uniqu e, and th e indi vidu al
mortgage is too small to be denomin ated into
homoge neo us tradin g unit s. The pro p ct ive
holder mu st ha ve detailed know ledge of th e
property a nd borrower characteristics of eac h
loa n. This usu.ill y will mea n am o n g oth er
thin gs th a t th e pro pert y mu st he ph ys ic, tll y
in ~pectcd c;1ch tim e ;1 loa n is tr,t dcd. Tr;1di ng
in mort g, t~cs is th crdorc quite costl y ,tnd thi s
di sco ura ges th e deve lopm ent of spec i,tli ze d
marketin g fa cilities.
Besides renderin g trading in mortgage costly, the heteroge neo us nature of mortgage loans
encourages market segmentation, wh ich furth er
discourages tradi ng. It is a common observation th at the home mortga ge market is highl y
segmented, but th e mea ning of the term i not
always cl ea r. In thi s paper, segmentation is
interpreted to mea n th e tendency for 111c1n y o f
th e vari LL home mo rt g,1ge m,t rk ets t be
dominated by a certain type of lender o r by
a small group of lende rs. Segmen tati on in thi s
en c res ults primarily from lend r spec iali zati on, th at is, the practice of so me lenders of
holding a certa in type of mortgage almost
exclusively. The heterogeneous nature of mortgage loans enco ura ges market segmentation by
encouraging peci alizat ion. The need to collect
and evalua te specific information on individual
loa n tends to lead lend ers to conce ntrate on
holding certa in types of homogen ous mortgages in an effor t to lowe r th eir ,1cqui siti on and
ot her co ts.
The im po rt ance of seg mentatio n from th e
pre ent perspec tive is th ,1t it li sco urage the
deve lopme nt of specia lized marketing facilitie s
bcca u c it narrows th e market for particul ar
10
mo rtg~1ge loans. M ark etin g firm s will have difficulty ge nerating a profitable volume of trading unl ess there is a broad potential demand
for each a · et in whi ch they deal. It may be
mentio ned th at th e term " cgmcntation" usually co nveys deroga t ry implicclt ions when u cd
in reference to th e mortgage market. Specializati on, howe er, is not necessa rily und es irable
since it may co ntribute to effici ency. When
sp ciali zation res ults from noneco nomi c o r
arbitrary co nstraints on a lender's po rtfoli o
cho ices and re ·ults in narrowi ng th e altern atives ,1v;1ilabl e to borrowe rs, it ma y, bes ides
cli sco ur;1~ ing th e deve lopment or marketin g
;1rr.111 1 cmcnts, I rcvc nt th e op timum ;ii loca ti on
or reso urces.
M;1rk e1 scgmcnt;1 ti on i:-- c11co 11r;111cd by th e
in stiluti on;il and le 0 al ~tru cturc under whi ch
mort g,1ge lend ers operate as we!I as by tlK
nature of the instrum ent. In th e first place,
lega l considerat ions influ ence th e ;1 mounts th e
va ri ou lender all ocate to mortgages relative
to the amounts allocate d to othe r asse ts. Aside
from regulations which direc tl y affect the perce ntage of total assets held in mo rtgages, public
poli cy encourages segme ntati on within th home
mo rtgage market. Geographi c lending res tricti o ns arc ;rn exa mpl e. Th ese res tri cti ons require a 1 ' nd cr to spec iali ze in holdin g mortg;1ges on certai n prop rti es- those ] cated
within hi s legally det rmin ed le nding area.
Other feat ure of the institutional and lega l
stru cture enco urage marke t egmcntation . For
exa mple, nonuniform restriction s on lending
terms prevent so me lenders from competing
for cer tain types of mortgages, and render
these types the province of ot her lenders.
Market segmentati on i · acco mpani ed by an
attitude on th e part of lenders toward mortgages th at further di -co ura ges th e dcve lop m nt
of speciali zed marketing fa ciliti es. M;my mark et
pa rti cipants operate on the ass umpti on that
mo rtgages, once acq uired, will be h Id and not
so ld. Thi s att itude has probably contributed to
th e differenti ati ons in the mortgage in trum nt.
Marketing Facilities
H little thought i given to reselling, th ere will
be no attempt, when origi nating mortgages, to
tailor them to meet the requirements of a large r
market. Each lender e tablishcs standards and
employs methods without reference to th e
preferences of other lender . Furthermore, loc::ll
lend rs fa miliar wi th local conditions may not
need to maintain th e record and follow th
procedure · that would pro luc the inform atio n
needed by lend ers not familiar with th e local
conditions .
There arc severa l rea on · fo r this attitude.
Of course, the absc nc of a well developed
tradin g mark et is o ne. Beyo nd this , it should
b ' re ·0~1 ni zed that nonpric · ompet1t1011 is
impo rl ~tnt in the mort :1 , market. n · f :1tur ·
or ,1 I ss th an p rfe t financial mark ' t is th
imp rtancc of the customer relation ship. One
of th reaso ns so me mortgage lenders prefe r to
hold and se rvice their mortgages is to maintnin and develop the customer relationship.
Thi s is especiall y tru e of in stitutions in which
depos it growth depends to some extent on the
mnintenancc of the cu tomer relationship. Another factor fos terin g the prevailing attitude is
th e ex istence of more convenient methods of
mnking short-r un portfolio adju tm ents, nnd
th e al sencc of nny felt need to undertake forge
adjLL tm cnts in mortg:ig portfolios. For xamplc , th e mo t important mo rtgage ]ender ,
the savings and loa n associations , have experienced rapid savi ngs infl ow durin g most of the
postwar period. Having limited inves tment outlets, these lenders have had little incentive to
sell mortgages from portfolio. Furthermore,
th ey have a convenient means of making adjustments through th e Federal Home Loan
Bnnk System.
Som thing in the nat ure of a closed circle
appear to be ope rati ve here. The nature of
th e mortgage in trurnent discourages th e development of specializ d marketing facilities
and encourages segmentati on, which is inimica l
to the development of specinl ized market facilities. Public policy supports segmentation .
1
Monthly Review
1 •
July-August 1967
Beca use specialized faci lities are poorly developed, and for other reaso ns, mortgage lenders adopt the attitude th at mortgages, once
acq uired , a rc not sold. Thi s attitude contributes
to differenti ation in the market, thereby accentuating the inherent characteri tics of the instrument.
As has been not d, thi s circle has been penetrated, to some extent, in th e Governm entund erw ritten sector. Mo rtgage insurance and
guara ntee have reduced the heterogeneous
m1turc of the instrument and the relative abse nce of res triction . with regard to Govc rnmcnt-underwritt n mort gag s has made th e
d 'vclopme nt or :1 nation ,tl 111 :t rk ct poss ibl e. In
thi s enviro nm ent , spcci ,i li zcd m:trkclin r f:tcilili 'S lrn vc cxpcri ' need .t limited development.
MEASURES FOR EXPANDING
P Cl L ZED FACI I IES
The fo regoi ng analys i provides guideposts
in considering mea ures for expa nding the
scope and improving the operations 0£ existing
facilities. These measures would need to be
directed toward reducing the costs of trading
in mortgage and reducin g the degree of market
segmentation.
Th cost f tradin g in mortgage may be
redu ced either by r du cing th e heteroge neity
of th e in. trum cnt, or by mitiga ting the effects
of heterogeneity. Mortgage in urance is one
method of eliminat ing differences among loans
that arise from differences in borrower and
property characteristics. As has been stated,
one of th e reasons for the development of
marketing fac ilities in th e Government-underwritten sector of th e market i th at mortgage
insurance and guara ntee has increa ed the
homog n ity of mortgages. 1f a block of mortgages is full y in urcd by :1 bankruptproof insurer, th e potentia l holder or . uch loa ns wi ll
not be concerned with borrower and property
charac teri stics, and will find the evaluation of
each individu nl mortgage le urge nt. The cost
of makin g mortgage tran sfers is thus reduced.
ll
Specialized Mortgage
It may be noted in pa sing th at neither FHA
nor VA mortgages arc fully insured in th e
sense th at the defa ult potential of individu al
loans is completely irreleva nt to the holder.
Such insurance may not be pos ibl e. A idc
from mortgage insurance, homoge neity could
be incrca ed by more uniform origination procedure , lending practice , and state mo rtgage
laws . Al so, a cl ass ification o r ratin g system for
uninsured mortgages, while not eliminat ing
differences among loans, mi ght reduce trading
co ts by increa ing efficiency in the use of
inform ation .
Mark t scg111rntat ion cou ld be reJuccd by
climinat in th e publi c polici s th at ·nco ur;i c
sc ,m entation. In thi s ·o nn cc t ion , sc vcr;tl thin e,s
co uld b done. Perhaps the two most important
arc: th e li berali za ti on or elimin ati on of th e
remaining geographica l res tricti ons on mortgage lenders, and th e uniform applicati on of
maximum loan-value ra tios and permiss ibl e
terms among different types of institutions.
The objective would be to remove the arbitrary
obstacles th at prevent competition amo ng mortgage lenders and di scourage th e development
of a national market in co nventional loa ns.
CONCLUDING COMMENTS
As indicated in th e int rod uct ion, th ere currently is considera ble di scu ss ion of mo rtgage
marketing fac ilities. The cstab li hing of fac iliti es under the sponsorship of th e Federa l Governm ent has been considered. It may be
pointed out that, in many cases, the type of
facilitie s under discussion are not meant to
perform the marketm aking function , which has
been stressed in thi s a rticle. R ath er, marketmak ing fac ilities arc viewed by many a. organi zation th at wo uld purcha s mortgages from
private firm · and hold th em in portfolio. A
one-way market, so to pea k, is contempl ated.
Aside from Government sponso rship, th e essential differe nce between uch orga niza tion
and presently operating priyatc long-term mortgage lender is the method of fin ancing mort12
gage holdings . Holdings wo uld be financed by
selling some sort of debenture in the capital
markets. It is argued th at in this way the
mortgage market wo uld ga in access to fund s
not now ava ilable and such fund s would be
more stabl e than present so urces. If th ese arguments are va lid, th e es tab li shment of facilitie s
of the type being di cu scd wo uld not only
inc rease the suppl y of mortgage funds , but
would tend to reduce th e degree of cyclica l
in stability of th e suppl y. However, it would
appear that the mai n goa l in c tabli hing such
facilitie s is to directly augment th e supply of
mortgage fund s.
T he fore 'O in , refere nce to rn;il s su , )csts
th e importan ce or rcco ,nizin, thill th e problems ra ced by co nstru cti on and mo rt rage market participants mu st be c nsicle recl in the co ntex t of a broader probl em- the allocat ion of
the Nation's limited resources to various uses.
From th e perspective of thi s a rticle, thi s
broader problem may be sa id to have two
dimensions. First, th ere is the long-run allocation of reso urces between hous ing and other
goods and crvices . This relates to the trends
in construction activity and in the supply of
mo rtgage fin ancing ove r a long peri od of time.
Secondl y, th ere is th probl em of con truction
and mortgage market in tab ility, whi ch rclat s
to the fluctu ati ons in constru ction and in th e
fl ow of mortgage fund arou nd th long-run
trends.
To illustrate the first dim ension of the problem, consider the 21 years from I 946 through
1966. During this period , construction was
begun on approx imately 30 million nonfarm
res identi al housing units, or an ave rage of 1.5
million per year. The adequ acy of thi s number
is the long- run iss ue. Should th ere have bee n
mo re, or poss ibl y fewer? Suppose it is held
th at housing needs were not adequ ately met
,ind th at th e v lumc of starts . hould have bee n
larger. Since th e Nation's tota l resources arc
li mited, uch a position implic th at a small er
vo lum e of reso urces should have bee n devoted
Marketing Facilities
to th e production of goods and se rvices other
th an hou sing.
As stated ea rli er, many obse rvers have concluded that efficientl y operating mortgage marketing fac ilities wo uld all ow a better allocation
of reso urces between ho u ing and other sectors
of th e eco nomy. For many obse rver , a better
allocation mea ns a shift in favor of housing;
meas ur s des igned to expa nd the operations of
ex isting mo rtgage marke ting arrangements may
have reso urce all oca ti on implications th at
would be co nsidered uncle irabl e. For exa mple,
th e removal of barri ers to co mpetition among
111o rtg~1ge lenders may res ult in th e diversion of
crtain so urces of fund s. which arc now more
or less ·;1r1n;1rked for th ' mo rt '" 1 c market,
into oth er m~1r ke ts. I nd ced, mor' competiti v
markets ma y fail to prov ide fund s to th e housing sector in quantitie that would be considered adeq uate by th o e concerned with th e
gonls of society. ln this cnse, consideration
could be give n to mea ure that would alter
the flow of funds without impairing efficiency
and th at would allow an assess ment of the
ex tent of th e alteration .
Consider now the second dim ension of th e
probl em. Suppose it is agreed that hou sing
needs were met ad qu at ly durin g the 1946-66
period. Suppo e furth er that c mpl ete stability
in constructi on activity- a meas ured by th e
number of nonfarm hou sing starts-is des irable
Monthly Review
•
July-August 1967
and th at, ideally, 1.5 million units would have
bee n started in each of th e 21 years. On these
ass umptions, the volume of starts in 1966 was
too low. By the sa me token, th e level of contruction act ivity was too hi gh during the 1963 65 period. The illustrati ve nature of thi discu sion i emph as ized. o one would argue
that complete tab ility i. des irable, eve n if
attainab le. Neverthelc , th e ana lysis reveals
cl ea rly th at o ne mu t keep in mind the distinction betwee n the Jong- run course of construction activity ~md judgments concern ing its
adequacy, on th e one hand , a nd on th e other
hand , year- to-yea r flu ctuati ons and judgment.
co nce rnin r st;1bility.
Ar um cnt s we re c it -d ea rli er to th e effect
th ;1 t spc ·i,1liz cl mortga le mark ting faci lities
would r duce th degree of in stab ility of th
flow of mo rtgage fund s and in construction
ac tivity. Most obse rver probably adhere to thi s
view. Even here, howeve r, disclaimers may be
encountered . It may be argued, for examp1c,
th at th e speculative activity th at may accompany the development of a highly organized
mortgage market may at tim es increase rather
th an reduce th e market's in stabi lity. Thi s co uld
be preve nted by recogni zing th e poss ibility and
by providing th o e go vernm ental agencies having re ponsibilities with rega rd to financi al
markets with th e neces ary auth or ity and tool s
to undertake appropr iate action.
13
The Process of
Federal Spending and
Economic Activity
/J y Cile1111 II . Miller, .Ir.
of th e cl1rono lo •y ;ind
mcc lrnni cs of th e F dcr.11 spendin g procc s and o f th e bas is on whi ch expe nditures
arc reco rded in th e variou s Federal budgets
is widely recogni zed as es pecially important
in assessing th e deg ree and th e timin g of impact of Gove rnm ent operations on the eco nomy. The purposes of thi s article arc, first , to
desc ribe th e Federal ex penditure process in
some detail , and second , to relate th at process
to econo mi c performance , illu stra tin g th e relation ship wi th indicators o f d ' kn sc ;1c ti vit y in
recent yea rs.
A
N UN 1>u tsT/\ND I NG
THE MECHANICS OF THE EXPENDITURE
PROCESS
T he openin g section of thi s ar ticle is a summary o f th e mec hanics of th e ex penditure
process within th e Federnl Gove rnm ent- from
the Pres ident's request to Congress for funds
to support hi s program, through congressional
m1thorization of progra ms and appropriation
of fund s, to the ob ligati on and ex penditure of
th e fund s by (he ope rating age ncies . In th e
United States, th e Federa l buclg t document is
the mea ns by whi ch th e Pres ident submits hi s
progr.1m for th e co min g year to Co ngress and
req uests th e spendin g auth ority to car ry it out.
There arc two sepa rate stt1ges of congress ional
dcci sionm aki ng in vo lved in th e budget process.
14
In th e fir st step, l'on •rcss cn.1c 1s k )isl,itio n
,1pp rov ing th e programs, fun cti o ns, .incl nc ti vitics for whi ch expe nditures a r to b made,
but docs not provide the spending power to
ca rry th em out. Co ngress ional auth ori za tio n
of programs precedes th e grantin g of fund s,
which is co nsidered se parately. The second
stage is congressional appr opriat io n .
Appropriation
The H ouse of Rep rese ntat ives trnditionally
initi ates ;1pprop ri ;1tions mc;1s ures. Within th e
Hou c, th e m,ijor auth o rity and power over
appropri ,1tions rest with th e var ious subco mmittees of the Appropri at ions Committee and
with the subco mmittee chairmen. Senate ac tion
on approp ri ations generally fo ll ows that of the
House. Foll owing th e compromis ing of differences in conference committee, when necessa ry,
and after being passe d by Congress, appropri at ions bills go to th e Pres ident fo r his approva l. No item veto of appropriations measures is permitted.
[t is within th e appropriations tage of the
budget pro css tha t th e termin ology becomes
so mew hat co mp! x. What th e Pres ident requests, and what th e operating agency receives
fro m Co ngress as a result of the appropr iation s process. is per1111 ss1on o r au thority to
co mmit or obliga te the U. S. Gove rnm ent for
The Process of Federal Spending and Economic Activity
Table 1
NEW OBLIGATIONAL AUTHORITY
BY FUNCTION
(In billions of dollars)
Administrat ive
Budget Funds
Function
N ationa l defense
In terna tion a l affairs a nd financ e
Space res ear ch and tec hnology
Agric ultur e and agr icultural resou rces
N a tu ra l re sources
Commerce and tra n spo rtation
Ho u sing and comm unity cf vclopm nl
H a lth , la bo r, cond w lfor
ducc, ti on
V te rans b n c fit s cond s rvic s
In tere s t
G e n e ral gov e rnment
A llo wa nces for :
Civilian and military pay increa ses
Contingencies
Total new oblig ati on a l author ity
1966
Actual
67.4
5.5
5.2
5.0
3.4
3.9
1.8
9.3
4.3
6.0
12 . l
2.5
126.4
Tru st Funds
1967
Estimate
1968
Estimate
75 .l
4 .8
5.0
5.1
4.5
4.3
2.2
11. l
4.6
13.5
2.7
77 .9
5.1
5 .0
3.1
3.6
3.3
3.0
12 .4
5.2
6.7
14.2
2.7
.2
1.0
.8
139.6
144.0
6.5
1967
Estimate
1968
Estimate
1.4
.2
2.3
1.7
.l
4.1
.7
29 .4
.2
4.5
4.6
38 .4
.2
5.8
.8
40.8
.7
.8
.8
1966
A ctual
*
*
36.7
50.8
50 .2
*Less th an $50 million.
SOURCE : The Budg et of the United States Gov ernme nt : 1968, p. 44 .
certa in expe nditures . Th is is sometimes referred to as " financial auth orizat ion," so methin g quit e di stinct f rom the " program auth ori za tion '' which precedes it. T he gra nt of permi ss ion to ;111 c1ge ncy to commi t th e Gove rnment to future ex penditures is known as obligatio11a/ authority.
At th e beginning of a given fi sca l year.
total obliga ti onal aut hority ava il able to those
divisions of th e Federal Governm ent empowered to make ex penditures is of two kinds:
existing obligational authority and new obligational authorit y (NOA ). In the budge t docu ment, th e Pres ident reco mmends th at th e Congre. s appropriat new ohliga tio11a/ Cl[{t/writy
of a ce rtain amount so that th e age ncies may
obliga te th e Governm ent to future ex penditures,
in order to perfo rm certain fun cti ons and Cttrry
out certain programs. T abl e I shows, by major
function , the total amount of new obliga ti onal
auth ority actu all y gra nted for fi ca l J 966 and
Monthly Review • July-August 1967
recomm end ed for fiscal 1967 and fi scal 1968. 1
Only data on new obliga ti onal authority arc
show n in Table I , but there arc two additi onal
sources from whi ch ex p nditure may origin ate
in a given yea r. First, co mmitments previou ly
made under ea rli er gra nts of permi ss ion may
not yet have led to final expe nditure - for
exa mple, goods may have been ordered or
co nt racted for but not yet delivered, inspected,
approved , and paid for. Second, obligational
authority originally gra nted for a period greater
than one year may not yet have bee n committed- th at is, an agency may enter a new
fi sca l yea r with un obli ga ted bala nces still at
' Reme m be r th at th ese f ig ures d o n o l s how ac tu a l or
es tim a ted Federal exp e11 d i111res fo r those years, as
measu red by any of the three familiar forms o f th e budge t
d escribed in ''The Bud get, Fisca l A c ti o n, nnd Short-Run
Eco no mic C h:rnge: P n rl 1," M o111hly R el' iew, Federa l
Rese rve Ba nk of K a nsas C it y, J a nu a ry-February 1967 ,
l~P - 4-8.
15
The Process of Federal Spending
Chart l
EXPENDITURES RELATED TO OBLIGATIONAL AUTHORITY, ADMINISTRATIVE BUDGET,
FISCAL 1968
(In billions of dollars)
To Be Used in 1968
New
Obligational
Authority
95 .7
144 .0
Total
Estimated
Ex pend itures
for 1968
135 .0
For Future Years
48 .3
r _ __ t_ ____ ,
: Total
:
: 269 .6
L- --f - __
:
J
Unspen t
Ob l igati ons
and
Unobligated
Balances
For Future Years
Un spent
Authorizations
for Expenditures
in Future Years
84 .5
132 . 8
125 .6
Expiring Authority and
lntertund Payments
I.8
SOUR CE : The Budget in Brief- Fiscal
Year 1968, p . 53 .
its di posa l for future co mmitm ent and xp nditurc. Thus, ex penditure for the yea r ahead
may come from new obligational auth ority,
from unobliga ted balances of obligational
authority from ea rlier years , and from ex isting unspent obligations.
Expenditures , as reported in any of the
three types of Federal budge t statements, are
th erefore closely dependent on, but not identical either in amount or timing to , th e amounts
of ob liga ti onal authority ( old and new) th at
make up mo t of the fin ancial substance of
th e President's budget me sag , th e budget
document, and congressional acti on on appropriation measures. The es tim ated relati onship
between ob liga ti onal autho rity and ex penditures for fi sca l 19 68 is shown in C hart I for
the ad mini strati ve budget. Total obliga ti onal
16
auth ority of $269.6 billi on wa es tim ated to
be available , co mpo eel of $ 144 billion of
NOA and $ 125 .6 billion of un spe nt obliga tions
and unobligated balance . Of th at amount,
$ 135 billion is to be spent in fi sca l 1968$9 5.7 billion from NOA and $39.3 billion
from prior authority, both encumbered and
unencumbered. After deducting $1.8 billion in
ex piring authority and interfund payments,
$ 132.8 billion of obliga tion al authority and
un, pe nt obli ga ti ons remain to be converted to
ex penditures so me time aft r th e end of fiscal
1968. The r mainder includes $48.3 billion
fro m 1968 NOA and $84.5 billion from auth ority gra nted in ea rli er year .
New ob liga ti onal authority co mes in three
forms: ordinary appropnat10 11s, contract authorizatio ns. and authorizations to spend from
and Economic Activity
Table 2
NEW OBLIGATIONAL AUTHORITY BY TYPE
(In bill ions of dollar s)
A dm inistrat ive
Bud get Fund s
Type
Authorizations requiring current
action by Congress:
Appropriation s t
Reappropri a tions
A uthorizations to sp e nd debt receipts
Contract author iza tions
Tota l authori za tions requiring
current ac tion by Congress
1966
Actual
1968
Estimate
109.0
121.2
126 .3
.8
1. 1
2.0
.7
110.9
12 .9
.2
2.3
Auth oriza tions no t req uiring current
ac tion by Congress (permanen t):
Appropriation s·!·
Authorization s to spend d eb t rece ip1s
Contract authorizations
Total authorizations not requiring
current action by
Congress (permanent)
To tal
new
obligational
authority
Trust Fu nds
1967
Estimate
1967
Estimate
1968
Estimate
0.4
0.5
0.8
.1
.2
.1
4.6
.9
123 .9
126.5
.5
5 .1
1.7
14 .6
.1
1.0
15 .2
.9
1.4
30.5
.3
5.4
39.4
4.1
2 .3
41.7
.2
6.7
1966
Actual
15.5
15.7
17.5
36.2
45.8
48 .6
126 .4
139.6
144. 0
36 .7
50.8
50 .2
* Less than $50 million.
t Excludes appr o priations lo liquidate contract authorizations: Adminis tra t ive b udget funds, 1966, $2 .5 bi ll io n; 1967, $2.3 bil lion;
1968 , $1.8 billion. Tru st funds , 1966, $4.6 bi ll ion; 1967, $5.1 bi llion; 1968, $5.4 billion .
SOURCE : The Budget of the United States Govern ment : 1968 , p . 44 .
deh t recei11ts. The fir st o f these forms- the
ordin<1ry ,1 ppropriati o n- is th ' most co mmon .
/\n appropriation a ll ows a Government
agency ( I ) to com mit th e Government by
orders , co ntracts, and so forth for spec ific
types and amo unt s of future expenditures
and (2) to make th e future expe nditure as
the commitments are fulfill ed. "
According to fi scal l 968 budget estimates,
o rdi nary appropriations were nearly 95 per
cent of total NOA req ues ted (Table 2).
The first part of the definition of an appropriation qu o ted above applies to a contract
aut/Jorizatio11; th e second docs not. That is,
a n agency receivin g a contract authorization
"U . S., Congress, Subco mmitt ee o n Econom ic St a tistics
of the J o int Economic Committee, Th e Federal 1:J11dget
as a 11 L co110111ic /) oc 11111 e11t . 87t h Co ng ., 2 nd Sess., 1962,
p . 10.
Monthly Review • July -August 1967
may obligate it elf but cannot pend to meet
the obligation until it rece ives from ongrcss
an "appropriation to liquidate co ntract authorizat ions." Since the latter perm its expenditures
on ly, and docs not author ize furth e r commitme nts, it is not included in NOA. The contract authorization form of NOA is used generall y when there will be more than a year
between the incurri ng of an obligation and the
tim e an expenditure becomes necessary.
The second relat ively minor form of N OA
is th e authorization to spend from deb t receipts.
Agencies may be pe rmitted to borrow directly
from the pub lic, or from th e Treasury 's public
debt rece ipts , in order to make commitments
and expenditures . Since many of these authori za tion s do not appear in appropriations bills
and thu s are not considered in th e Appropriations Committees as part of th e norma l budget
17
The Process of Federal Spending
process, they are sometimes referred to as
" backdoor financing ."
A s is seen from Table 2, some NOA requires current action by Congress ( th at is,
it must be granted on a yea r-by-yea r basis),
while other NOA becomes available from tim e
to time under already existing laws , or permanent authorizations ( th at is, with no furth e r
action by Congress on a year-by-year ba is).
Thus, one feature of th e authorization of
NOA is whether it is current or perm anent.
Current ap propriat ions make up a far larger
share of total NOA th an do permanent appropri ation s (Table 2) .1n either case , th e c1111 0 I1111 o r NOA granted
ma y b no t d spc ifica ll y by o ngrcss ( d efinite
approprit1tio 11s), or it may not be specified ,
with th e amount I rt to be d t rmin d by subsequ ent circumstances (indefinite appropriations) . The following examples of th e various
types of appropri ations of NOA are all drawn
from the administrative budge t.
Current definite-to the legislative branch
for compensation of the Vice President,
members of the Senate and of th e Hou se
of Representatives.
Current indefinite- to the Post Offi ce Depa rtm ent as contribution s to th e po tal
fund , in an amount dete rmin ed by th e
amount postal revenu es fa ll short of
obligations.
Permanent definite- to th e Treasury Department Bureau of Accounts, a $6 ,000
statutory award paid annually as a result
of a private relief act.
Permanent indefinite-to the Treasury
Department for payment of interest on th e
public debt.
A third feature of an o rdinary appropriation , in additi on to whether it is granted und er
current or permanent a uthorization , and
whether it is for a definite or an indefinite
amount, concerns the time limits imposed on
an agency's authority to incur obligations.
Most ordinary a ppropriations are one-year
18
appropriations, which a11ow an agency to incur
obligations during only one fiscal yea r with
the authority expiring at the end of that time.
Multiple-year appropriations a re made for a
specified period longer th an o ne year, while
no-year appropriations are ava il abl e for obliga tion until the purposes of the gra nt are acco mplished. Some appropria tions for research ,
most for co nstruction , and nea rly all trust fund
nppropriations a re of the no-year type. In
each case, obligated balances a re carri ed forward until expe nditures are m ade in payment
of the obligations. In addition to obligated
balances not yet pent, unobli ga ted balances
al so may be car ri ed forward in th e case of
multipl -y '~tr and n -year appropriations. rurth rm o re, whe re sp cific tim e periods arc
~s tab lishcd for inc urring co mmitments- th at
is, one-year and multiple-yea r appro pri ationsCongress m ay rea ppropriate th e lapsed obliga tion al authority. Such reappropriations are
counted in NOA (Table 2).
Apportionment and Allotment
After obligational authority has been granted
by Congress, the Bureau of the Budget- following review of the agencies' plans concerning
the ra te at which obligations a rc to be madeappo rtion s the obli ga tional a uthority . By setting th e rate at which spend ing agenc ies may
obliga te the Government to future expendi tures, the need for deficiency or suppl emental
appropnat1on s is lessened. A pportionrnent ,
then , is a form of administrative control exercised by the Bureau of the Budget, and, as
such , gives the executive department some
additional leverage over the obligation and
spending of funds.
With the apportionment of NOA to the
agenci es, and its allotment to th e various
o rga ni za tio nal units within th em, the Government spending process has a rrived at the point
at which direct contact with th e private sector
of the economy is first made- the incurring
of obligation s.
and Economic Activity
Such obligations include the currently acc ruing li abilities for sa laries a nd wages, certain
contractual services, a nd interes t; e nterin g
into contracts for equipment, construction ,
and la nd ; approval of agree me nts to m ake
loa ns; and other commitments requiring th e
paym e nt of money. "
At thi s stage, the private sector begins to
react to the impact of Government spending
programs- if it has not already done so on
an anticipatory ba is. Al so from this point, the
process is no longer under th e sole discretionary control of the Government, which is
now only one of two parties to the transactions.
services than for hard goods, and shorter for
goods th at can be purchased from the inventories of producers than for goods produced
on order or under special contract.
Expenditures are recorded in the administrative budget on a "checks drawn" basis and
in the cash budget on a "checks cashed" basis,
while the nation al income and product accounts (NIPA) budget includes spending on a
"goods delivered" b as is. However, the impact
of Federal program s o n th e economy dates at
lea t from the time obligation s are incurred, as
employment of resources begins and production ge ts underway.
Expenditure
Thi s p rodu c tio n in th e priva te secto r o r
g ods and serv ic s fo r sa le to th e overnmcnt is no t usuall y refl ected in P ederal
bud ge t d a ta as the produ cti o n proceeds,
des pite the fact th a t th e Government is
clea rl y a ffecting th e cconomy. 4
ash xpcnd iturc is not necessa rily concu rrent with th e in urring of an ob li gati n by an
agency. In ome instances, expe nditures may
coincide with, or very shortly follow commitments made, as in the following exa mpl es:
wages and salaries paid to Government employees; interest payments on the public debt;
purchases of existing assets; transfer payments
such as social security benefits; and grants to
state and local governments. Another kind of
Federal expenditure involves the private sector's employment of resources on the Government' behalf, and res ults in the production of
goods a nd se rvices th at eve ntu ally a re sold to
the Government. H ere the Jag between obligation a nd expenditure tend s to be con iderably
longer. It takes time for private producers and
suppliers to draw plans , obta in re ources,
negotiate subcontracts, solve technical difficulties, undertake production , and deliver the
product. The Government, like a private firm ,
generally make payment after the goods are
delivered, inspected, and approved. Thus , the
employment of resources and the production
of goods prcced s deli ve ry to, and payment by,
th e Governm ent. The lag betwee n obligation
and expenditure is shorter for soft goods and
Wh at is th e significance of the mechanics
of the Federal expenditure process for the
analy is of short-run economic activity? Answers to thi s ques tion arc not hard to find.
For exa mple, it has been noted th at the im-
:' Th e Budget of 1he U11i1 ed S1at es Go, ·en1111 e111 : 1968,
◄ Th e
p. 171.
5
Monthly Review • July-August 1967
As a result, some of th e effect of Government
purchases of goods and services on total economic activity occurs well before the expenditures show up in any of th e three Federal
budgets.
Some Government purchases, of which milita ry procurement is the most significant, are
made under a rra nge ments whereby ome payment a rc made to private firm s before fin al
delivery . Such progress pay m ents or advance
pay m ents reduce th e tim e lag between obligation and expenditure, and their use causes
''data on Government ex penditures presum ably [to] refl ect more precisely th e use of resources by the private economy. " :;
THE EXPENDITURE PROCESS AND
ECONOMIC ACTIVITY
Federal Budget as an Eco 110111 ic: Doc11111 e11 1, p . 19.
/bid ., p . 20.
19
The Process of Federal Spending
portance of Government's influence on th e
perform ance of th e economy " is du e to both
th e absolute size of th e F ederal sector and its
tendency often to fluctu ate independently of
the private economy, to be an exoge nous or
relatively independ ent va riable in any agg rega tive anal ys is."'' Poli cy as pec ts also enter th e
picture, as in th e foll owing quotati on:
The Federal G ove rnme nt exe rts a pote nt
influ e nce o n th e eco nom y not o nl y because it co nstitutes such a large segme nt o f
the tota l eco nom y, but a lso beca use of its
commitme nt to fos ter hi gh-leve l empl oyme nt a nd eco nomi c grow th . Fo r th ese
reaso ns, it beco mes c ru c ia l to pinpoi nt as
acc ur,it cly as poss ibl e whe n a nd how th e
,ovc rnm c nt 's ac ti viti es
impin ge upo n
eco no mic ac tiv it y. 7
Eco no mi sts co nce rn ed with current bu siness
developments arc es pec iall y interes ted in th e
timing of th e im pact of Federal spending ( particularly th e purcha se of goods and se rvices).
And it is here th at th e famili ar F ederal accounts are mi sleading. F ederal ex penditures in
each of th e three budge ts represe nt th e endpoint in the Governm ent spending process,
while the majo r impact of spending progra ms
on th e economy is Jik cly to have occ urred
ea rli er in th e process. Ex penditure occ urs
when produ cti on ha s bee n co mpleted, and deli ve ry and / o r pay ment made, whil e " th e pri mary impac t of governm ent proc urement on
th e level of eco nomi c acti vity occ urs in ad vance
of th e ac tu al go vernm ent ex penditure.""
T he incurring of obliga tions, especialJ y the
letting of contracts and pl acing of orders, gen"M urray L. Weide nba um , in U. S ., Co ng ress , 'rl1e Federn/
Budget as an Eco 110111ic Doc 11 111e11t , H ear in gs before t he
Su bcom mi ttee o n Econo mi c Sta tisti cs of th e .Jo in t
Econo mi c Co mmitt ee. 88 th Co n .. 1st Scss., 196\ p. 67 .
7
Jose ph Sc herer, "O n M eas uri ng 1- isca l Po licy," T /1 e
l o 11mal of Fi11a11 ce, Dece m ber 1965, p. 689 .
hM ur rny L. We idenba um , "T he Federa l Gove rn me nt
Spend in g Process," in U . S., Co ngress, S ubcomm ittee 0 11
F isca l Po li cy of th e J o in t Eco no mic omm ittec. Fe deral
Expenditure Policy for £co 110 111ic Grull'th and S tabi!it)'Papers S 11 b111 itted by Pan elist s, 85 th Cong. , 1st Scss. ,
1957, p. 500.
20
erally is accepted as th e most significant point
of impact of Governm ent procurement on
eco nomi c ac ti vity. When a Gove rnm ent agency
pl aces contracts o r orders with a private firm ,
th e latter genera Uy begins to o rd er materi als,
hire wo rk ers, and pl ace subcontr acts. In turn ,
th e c steps will inspire simil ar acti on elsewhere
in the eco nomy. As produ ction moves ahead,
the in ve ntory co mponent of gro, s national
produ ct (G NP ) increases, fo r produ cti on on
Government order appea rs as private inve ntory in vestm ent ( in both goods in process and
fini shed goods). Y ct, until th e fin al pro ducts
,ire deli ve red to the Go vernm ent .i nd pa id fo r,
none of th ' 111 as urcs of Gove rnm ent spcnclin
will rcfl ct th increase in eco nomi c <1cti vit y.
Wh n th e goods arc d -live red, the reco rd ed
increase in Gove rnm ent spending tends to ca ncel out th e red uction in pri va te in ve ntori es in
the GNP acco unts; thu s leav ing no ap parent
effect on th e Jevel of total eco nomic activity
at th at time-" the contributi on to purchas ing
powe r has been made earlier during th e contract pl ace ment and production stages." n
T he fac t th at changes in Governm ent orders,
and th e changes in eco nomi c acti vity res ulting
th erefrom, arc refl ected in chan~cs in Govern ment spe nding onl y after ,1 co nside rabl e tim e
lag has led to th e co nclu sion th at " th e Federal
purchases fig ures a rc a mi slea din g clue to th e
current impac t and th e timing o f th e cyclicZt l
impact of th e Federa l Gove rnm ent on output. ""' To ove rco me thi s pro bl em, th e Zt nalys t
needs to understand th e Federal expenditure
process, to know where th at process most
significa ntly impinges upon th e private sector
and upon economic activity as a wh ole, to
adju st his th inkin g co nce rnin g th e relevance of
th e three famili a r Federal budgets, and to
mak e use or th e data th at a rc av a il able on
such thin gs as obliga ti ons incurred, co ntracts
awa rded, and so on.
1
1
'l bid., p . 499.
10
Sc he re r, p. 684 .
and Economic Activity
Among th e things to be considered i that
advance and / or progress payments for good
that have bee n ordered wi ll show up as ex penditure in th e ad mini stra tive and cash budgets
befo re production is completed and delivery
made. Thus , "a case can be made th at the cash
budge t 'time ' the Federal impac t for purchases
of good close r to the act ual production period
.. . [Th rcforc l cash budget expend itures more
closely approx imate th e real ac tivity in the
eco nomy than a record bc1 ed o n dcliverie ." 11
However, current cc1 h budget data are publi shed in scc1sonally adjusted fo rm only for
tou1I rece ip ts and ex penditures. Month ly cas h
ex penditure fi 1 ur 's by functi n:.ll classification
,in: .1v,1il:1blc but ;1r ' not seas nall y adjust d.
h1rthermorc, :.1dv:. 1ncc :i nc.I pro rress payments
arc not shown sepa rately but arc simpl y included in the ovcr-c1 ll figures.
When there is littl e change in th e level of
Governmen t act ivity, there i less need for
concern about the timing of its impact. There
arc times, however, when Federal spending is
rising or fa lling rapid ly, and Government procurement of goods and services is a part icularl y dominant fo rce in the eco nomy. At such
times, an und ers tand ing of the Federa l spending proce ss and the timing of its impc1ct is
cspcci:.tll y important for :.1 pro p r interpreta tion and eva lu at io n of current and future
eco nomic developments.
share of total Federal purchases, and changes
in defense spending have had a significant influ ence on over-a1l economic activity, in terms
of both amount and timing of impact. Federal
pending for milita ry purposes has been especially important during th e last two fi scal
year , c1s it will probably continue to be for
some time. Furthermore, defense purcha cse pecially for procurement and resea rch- arc
particularly rcprc cntativc of the long la g that
can occur between orders and deliveries ( expenditures in the NIPA budget sense), which
give ri se to difficulties in assessing th e timing
of impact of Fede ral operations on eco nomic
act ivity.
This is particularl y true because the early
stages of th e process often show up in the
priv ate sector rat her th a n in the pub li c
sec tor, and it is important to und erstand
where the und er lying demand or igi nates. 1 ~
It may therefore be inform ative to trace the
perform ance of certain indicators of defense
orders, defense production, and defense ex penditure during the past few years, concentrating
on events since the beginning of fisc al 1966.
The eri es exam ined here are taken from
o urces that a re readily ava ilable and ge nera l
in nature, such as th e Survey of urrent Busi11 ess, the Treasury Bulle tin , the Federal R e-
Defense Spending in Recent Years
Beca use of th e state of the wo rld since the
end of Wo rld War II , dcfen , c purchase of
good and services have b en a relatively lclrgc
In a spc 'c h bcfor ' ;1 :1 ti onal Industria l
'onfer nee Board mectin -r in Oct bcr 1966,
Gardner Ackl ey noted that " ... on Jul y 28,
1965, . . . th e Pre ident req ue tcd a supplemental appropri ation for Vietnam , and it became cl ea r th at the fighting there had taken
on a new character." At about th at time a
significant change in th e rate of economic advance occurred. Increased military progra ms
and expectat ions brought about by th e awa reness of a new environment were contributing
factor s. Ri sing business cap ital outlays "both
re fl ected and r inforccd th e eco nomic impact
of th e dcfcn c step-up ,' while con um r pending, in turn , re ponded strongly to increased
dcfcn c and plant and equipment expe nditures.
ser ve Bulletin , Business Cycle D evelopm ents .
I
1
12
Sc he re r, p . 688 .
Weid enbaum, "The
Process," p. 505.
Federa l
Government
Monthly Review • July August 1967
Spend ing
a nd the Bureau of the Ccn u release on manufacturers ' orders, shipments, and inventories.
For furth er detail and refin ement on these
matte rs, one may turn to so urces such as the
21
The Process of Federal Spending
Chart 2
FEDERAL GOVERNMENT PURCHASES OF
GOODS AND SERVICES FOR NATIONAL
DEFENSE; AND CASH PAYMENTS
TO THE PUBLIC FOR NATIONAL DEFENSE,
1964-67
Billions of Dolla rs
75
Quarterly, Seasonally Adjusted Annual Rotes
70
Federal Defense
Purchases
65
NI PA Budget
60
55
o .__.._____.._ _
_.___l
Billions of Dollars
8
Cash Payments for
National Defense
7
6
5
4
0
u I,
1
I , 1 I , ,lj_ i_l_u L -Li Ll L d --'-.J_ I 1 ,
196 4
1965
1966
I , ,I ,1 I , ,f
196 7
SOURC ES : U. S. Depa rt men t of Comm e r ce, Survey of Current
Business , ond the Federal Res erve Bulletin .
Department of Defen se M o nthly R eport on
Status of Funds, th e Depa rtment of the Treasury M o nthly Statement of R eceipts and Expenditures of the United States Government,
as well as the Treasury's experimental release
on gross obligat ions incurred.
Perh aps the most fam ili a r se ri es on defense spcndin~ is Federn l purcha ses of goods
and se rvice-· for defense purposes, a ca tego ry
wit hin th e NIPA budge t show in g th e va lu e of
current output purchased by th e Federal
Governm ent for nation al defen se (Chart 2).
Since it is constructed to be consistent with th e
nation al incom e accounts fr amework , cx pendi 22
turcs are recorded upon delivery of th e items
purchased, which gives ri se to a lag between
defense ex penditures on the one hand and defense orders and production (a nd thu s th e
eco nom ic impact of military act ivity) on the
other. Defense purch ases of goods and se rvices
at a seasonall y adju sted ann ual rate declined
throu gh th e fir st 3 quarters of fi scal 1965 , then
ro c at a fa irly steady rate for th e next 5
qu arters, and increased more rapidly yet in
th e fir st 3 quarters of fi scal l 967. From these
data, it mi ght be inferred that increasing
Federal military activity did not have an
eco nomic impact until th e fourth qu arter of
fi sc,il 1965, ;ind that th e r;1tc of impact becam e
si._1 nil'ic;1ntl y grea ter in fi s al 1967.
Data on Federa l cas h p;1ymcnts to th e public
for the national defense fun cti on ar al ·o shown
in C hart 2. Th is alternative presentat ion of defe nse expenditures is not comparable to th e
purchases data, first , because it is in monthly
totals, not seasona1Iy adjusted, and second , because it is cash budget data, and therefore recorded on a payments basis rather than a delivery bas is. Progress payments on defense contracts, which range aro und 70 to 75 per cent
of a contract's total amo unt, are included in th e
cas h budget data . Though both seaso nal and
irreg ul ar flu ctu ati ons arc apparent , th e ove rall movement of cash payments for national
defense has been stea dily upwnrd since th e beginning of fi scal 1965.
Although the inclusion ot progress payments
makes th e cash budget data coincide somewhat
more closely with defense production, it does
not solve th e problem of th e lag between obliga tions and expenditures . It is still useful to
look at the available data on defen se obligati ons and military prime contract awa rd s. Obli ga tions, or commitments to purchase goods and
se rvi ces , arc rcprc cnted in Chart 3 in two
se ri es: procu remcnt obi iga ti ons and total defen se obliga tion s. Procurement includes th e
acquisiti on of equipment such a aircraft, ships,
and combat vehicles , and of ,1mmunition. Total
and Economic Activity
defense obliga tions also include resea rch and
development ac ti vities, as well as compensati on
of personnel and oth er items. Among th e
probl em invo lved in using obliga ti ons data are
doubl e-co un ting ari sing fro m such things as
cont racts betwee n th e se rvices, and th e somctim s erra tic be hav ior of the se ri es as obligati ons arc . hiftcd abo ut within a fi ca l yea r.
The data in Chart 3 arc seaso nall y adju tcd
by th e Burea u of th e Census befo re publication .
After declin ing briefly from a sharp pea k
regi tcred in Decembe r 1964, both total obligati ons and proc urement obliga ti ons ro e until
abo ut th e end of fi scal 1966. Since th at time,
th eir movement may be desc ri bed as stabl -tosli ghtl y-dcc lin in 1 • T h,tt is, co mmitments to
pur ·has ' goods ;1nd sc rvic s f r defense, including mil itary hardwa re, ap parentl y have
leveled off on a hi gh platea u.
Chart 3
TOTAL DEFENSE DEPARTMENT OBLIGATIONS,
DEFENSE DEPARTMENT PROCUREMENT
OBLIGATIONS, AND MILITARY PRIME
CONTRACT AWARDS TO U.S. BUSINESS
FIRMS, SEASONALLY ADJUSTED, 1964-67
B i lli on s of Do llar s
9
T
Se o sono 11 y Ad juste d
8
7
Total
6
5
4
3
2
Obi igotions
O '---'---'-'---'---'-J.....,._._l u.J...J...1. I , , I , 1 I ,
1964
1965
L
J.
J....-1..-'--'-L-L---O.-'-'--.._.._.._._.__.._._"---"
1966
1967
SOURCE : Bu re a u of the Cens u s, Business Cycle Developments .
Monthly Review • July-August 1967
Th e third seri es appea ring in Chart 3, mili ta ry prim e contract awa rds to U. S. bu sine s
firm s, avo ids so me of th e probl ems of th e obliga ti ons seri es mentioned above but at th e sa me
time itself has some probl ems of coverage, e.g. ,
th e absence of purchases from fo reign firm s and
dome ti c nonprofit institutions, and cont racts
or orders with U. S. pri va te bu siness excluded
from th e cri es fo r va ri ous rca, ons. In ge neral ,
th e perfo rm ance of th e cont ract awards se ri es
has bee n much li ke that of th e obliga ti ons
se ri es, wi th th e ri ing movement begi nning in
th e spring of 1965 and an appa rent le veling
off beginnin !:'; with th e fir st month s of fi sca l
1967.
Th ' Burc; 1u of th ' cnsus includ ' S ;1 d fcnsc produ cts oroupin g co nsistin r of th e aircra ft ,rn d a irc raft p;1 rts, co mmunicn ti ons e4ui pmcnt, and ordn ance industries in its monthl y
publica ti on of survey res ults conce rning manufacturers' orders, shi pments, and inve ntori es.
Since th ese se ri es arc on an indu stry bas is, th ey
include dat a for both civili an and military uses
and th erefo re do not re fl ect purely defe nse inform ati on. The seasonall y adjusted se ri es on
new orders. hipmcnts, unfill ed orders, and in ve ntori es of th e defense products industri es arc
prese nted in Ch:1 rt 4 as index s with th e first
month of fi sca l 1965 cq u,11 to 100. and in
Tabl e 3 in ac tu al doll ar amount .
In spite of th e differences in cove ra ge, th e
new ord ers seri es is ce n to ha ve pe rfo rm ed in
an over-all manner simil ar to the obli gations
and contract awards seri es since th e middle
ot fi scal 196 5. The other three series in Chart
4 have moved relat ively more smoothly th an
th e widely fluctu ating new orders series ~ind its
close relati ves in Chart 3. Tn fi scal ] 965, shipments, unfill ed orders and in ve ntori es of defense I ro ducts rose onl y modera tely. Fro m
Jul y 1964 to Jul y 1965, ·hi pmcnts increased
by 6.3 pe r cc nL unfilled orders by 7 pe r ce nt,
and in ve nto ries by 10.7 per cent . Follow ing th e
sharp change in th e military situati on in mid1965, defe nse commitments ex panded rapid23
The Process of Federal Spending
Chart 4
MANUFACTURERS' SHIPMENTS, INVENTORIES,
AND ORDERS, DEFENSE PRODUCTS
INDUSTRIES, SEASONALLY ADJUSTED , 1964-67
Index (July 1964 = 100)
190
r
'
Seasonally Adjusted
1
Table 3
,'
Inventories
17 0
/
~ I,'
il ed Ordy /
I
Uni
contracts, and new orders th at has occurred in
fi scal 1967, with shipments appea rin g to have
leveled off ea rli er th an unfill ed orders. Defe nse products inve ntories, however, have con-
VALUE OF MANUFACTURERS' SHIPMENTS,
INVENTORIES, AND ORDERS, )
DEFENSE PRODUCTS INDUSTRIES-JJANUARY 1964-APRIL 1967
(Billions of dollars)
15 0
Shipments
130
/4 '
1/
h' ~
Dote
I
/\
t
II0
90
70
1964
19 65
19 67
SOURCE : Bu re au of th e Cens u s, Current Industrial Reports .
ly . As a res ult, unfill d o rder. (producti on
back logs) al so increased sharply in fi scal 1966
(Jul y 1965 to July 1966 ) , ri sing by 31.1 per
cent. The increase in shipments did not keep
pace , although goi ng up by 24 .5 per cent ; and
inventories also rose by 25.9 per cent. (Inve ntories of the defense products industries
are made up almost wholly of materi als and
goods in process . lt has been es tim ated, for
exa mple, th at at the end of April 1967 more
than 95 per cent of th e inventori e. held by
manu fac turers in the dcfen e products indu stries were materi als and supplies o r work in
process.)
Both shipments and unfilled o rders of th e
defense products indu stries have tended to respo nd to th e leveling off of defense obligations,
24
New
Orders Shipments
Unfilled
Orders Inventories
1964- Janu ory
Febr uciry
Morch
April
Ma y
June
July
August
September
October
November
December
2.7
2.4
2.2
2.4
2.5
2.3
3.3
1.9
2.0
2.4
1.8
1.9
2.2
2.2
2.1
2.2
2.2
2.2
2.2
2.1
2.2
2.2
2.1
2.2
19 .l
19.4
19.4
19.6
19 .7
19.8
20 .6
20.3
20.l
20.4
20 .0
20 .0
5.5
5 .5
5.4
5 .4
5.4
5.4
5 .4
5.4
5.4
5.4
5.4
5 .6
1965- January
February
Morch
April
Moy
June
July
August
Sep tember
O ctobe r
Nov e mb er
Dece mber
2.4
2.4
2.5
3.2
2.5
2.6
2.6
2.8
3.4
3.3
2.6
2.5
2.2
2.2
2.3
2.2
2 .3
2.3
2.3
2.3
2.4
2.4
2.4
2.5
20.0
20.3
20.5
21.4
21.4
21.7
22 .5
25.5
24 .4
24 .6
24.6
5 .6
5.6
5.7
5.8
5.7
5 .8
6.0
6.0
6.0
6.1
6.3
6.4
1966- Jonuory
February
March
April
May
June
July
August
September
October
November
De ce mber
3.4
3.0
3.4
3.3
2.9
3.7
3.5
3.2
4.7
3.3
2.7
3.4
2.6
2.6
2.6
2.6
2.8
2.7
2.9
2.8
2.8
2.9
2.9
2.9
25.4
25.8
26 .6
27.2
27.3
28.3
28 .9
29.2
31.0
31.4
31.3
31.8
6.5
6.6
6.8
7.1
7.1
7.3
7.5
7.7
7.9
8.2
8.5
8.7
1967- Jonu o ry
Fe bruary
March
April
May
2.8
3.3
3.2
3.3
3.9
2.9
2.9
3.1
3.0
3.2
31.7
32.2
32.3
32 .6
33 .3
9.0
9.2
9.4
9.6
9.7
22 .0
* All data are seaso nally adjust e d .
t Commun ication s equipment, compl ete aircraft, aircraft par ts,
an d ordn ance.
SOURCE : Bu rea u of th e Census, Current Industrial Reports .
and Economic Activity
Chart 5
tinucd to climb tca dily through May J 967.
From July 1966 through May 1967 shipm ent
rose only 6.9 per cent, unfill ed orders 15 .2
per cent, and inventories 29 .3 per cent.
The press ure of excess demand on capacity
in the dcfen e products indu stri es, where
capacity is shared between military and civilian
output, may be exam ined by u e of th ratio f
unfill ed o rders to shipm ent . Thi ratio wa
virtu all y th e amc at th e nd of fi sca l 1965
as at its beginning. From July 1965 to July
1966, th e rntio increa ed by about 5 per cent,
while the sam e ratio f r all durable goods ro c
by ab ut 19 p r ce nt. From Jul y 1966 to
April 1967, how vcr, th e incrcas' fo r th e d' fense produ ·1s rati o (7 per ent) w.is 1-cater
than that fo r all durnblcs ( 5 per cent). But as
hart 5 shows, th rati o fo r defen e products
ha been moving sidew ise- to-downw ard inc
Sep tember 1966.
RATIO OF MANUFACTURERS' UNFILLED
ORDERS TO SHIPMENTS, DEFENSE
PRODUCTS INDUSTRIES
1964-67
Ratio
l
13
12
II
1
10
I
I
1
: LLlulu .uli. 1
1964
~l~l ~ d ,
1965
.1..wJJ
1966
1967
SUMMARY
SOURCE: Burea u of th e Censu s, Current Industrial Reports .
In rece nt year , military programs have bee n
a particularl y significant part of the tot al impact
f Federal action on the eco nomy . At th e
sa me time, th ose program arc prime exa mpl es
of th e lag between th e initial impact of a
program ~
mu it s even tual appea rance in th e
familiar mca urcs o f F dcral spe nding. Data
pr sc nted in Charts 2 throu 1 h 5 illu tratc s me
of the re lat ionships involved, c pccially for th e
period since the beginning of fi cal 1967
(Ju ly 1966). The se rie s showing commitments
to purchase- here, obligations and contract
awards in Chart 3 and new orders in Chart 4are th e first to reflect changes in program .
After reaching very high levels in the opening
month s of fi scril 1967, th ey have tended to
xh ibit sidcwisc-to-dow nw ~1rd movements since
early fa ll.
Th e next tagc in th tota l process may be
called th e production tagc, in which shipment
of output arc made. A s pressure · o n capacity
mount, backlogs of unfill ed orders increase and
the ratio of unfill ed order to hipm ents ri es.
Monthly Review • July-August 1967
But as production catches up with commitments, backlogs cease to ri se as rapidly and th e
unfill ed orders- hipments ratio tends to level
off. Aga in, data for fi sca l 1967 show unfill ed
o rders :111d shipm e nts still increasing, but at a
c mp~1ra tivcly subdued pace, and the ratio between th em howing littl e incrcas and, mo t
recently, some decline.
Even th ough new orders virtually have
stopped increa sing and unfilled orders are
growing at a slower rate, there is sti ll a sizable
amount of output in the defense products pipeline. Thus invento ri es, composed mainly of
material and goods in process, had not ( a of
May 1967) ceased th e rapid grow th of th e
prior 18 month s. In thi s respect, the behavior
of defense products inventories look · much
lik e th at of Federa l expenditures for defense
in th e rPA budget, where they ar recorded
o n a delivery basi - the end point of th e
Federal expe nditure process. Defense ·pending
so recorded (Chart 2) has co ntinu ed to ri se
25
The Process of Federal Spending and Economic Activity
trongly through the fir t 3 qu arter of fi scal
1967.
Thus, th e lack of congruence between the c
mea ures of defense <1ctivity, and the de irability of not depending on any one of th em by
it elf in current bu inc s analy is, seems well
illu trated by th eir performance in fi scal 1967.
T o put it more succinctl y : co mmitments have
leveled off , shipments and backl ogs hav redu ced th eir rate of increase, while in ve ntori es
and recorded expenditure have continued to
grow at least as rapidl y as in th e immediately
preceding year.
PO
IPT
Whil e thi s :1rti le was in rn..: p,,ration, two
es p iall y important dcvclopm nts oc urred of
26
intcrc t to those concerned with the impact on
th e economy of Federal programs, e pecially
defen se programs. The first is the publication
of Economic Effect of Vietnam Spending,
Volume I: Statements of Witnesse and Supporting Materi al Hea rin g before th e Joint
Economic Committee, a compil ation of report
and tes timony by ex perts both inside and outside th e Federal Gove rnm ent. The eco nd is
th e announcement of th e issue by th e Department of Defense of a new monthly report entitl ed Selected Defense Department Indicators.
The new report is intended to provide a regul a r
monthl y compibti on of cono mic data to
permit bett er asscss m ' nt or th impact or dcr ' nsc pro q·;i ms on th ' economy. T he first issu '
w:1s rch1scd on Jun c 30, 1967.
De osit Variability
At Commercial Banks
Ry Frederich M. S truble
Carroll
fl .
Wil/.1('rson
liquidity co nditions durin
C th e currentbankbu siness
expa nsion begun in
II ANGES I N
r
early 1962 have been difficult to as css fully.
There is no doubt about what has happened to
asset Iiquidity position s at most banks. Clearly
they have declined. R ath er th ere is uncertainty
and disagree ment over what has happened to
the variability of deposits at most banks-a
principal determinant of bank liquidity req uirement . Uncertainty ex ists primarily becau se of
differences of opi ni on abo ut th e effect that
shifts in depo. it ompos ition, which occ urred
coincidentally with th e change in asse t composition , had on th e var i,1bility of total deposits
at mo t banks.
Growth of time and savings deposits far surpassed that of dema nd deposits at banks over
this period , resulting in a marked increase in
the ratio of total time and savings depos its to
total deposits. Traditionally, this type of shift
in deposit composition has been viewed as
reducing th e variability of total depos its, since
d mand depos its h;1ve ge nerally be n thou ght
to b more v;1r iablc th a n time and sa vings de po. its. Thi s ass umpti on has neve r bee n co nclu sively es tablished empiricall y, howeve r, so
th;_it it is ope n to some question. This is particularly tru e with rega rd to the nature of the
recent growth in time and savings deposits.
Monthly Review • July-August 1967
l'or ;1 co n ·idcrnblc part of it w;_1s in the form
of time deposit - a nd at large banks in large
certificate of dcposit- rnther than savings de posits. Whether tim e deposits, as opposed to
savings deposits, a rc less variable than demand
deposits is especially in doubt. Moreover, even
if both time and savings deposits were less
variable than demand deposits at the start of
thi s period and remained so throughout, it
docs not follow necessa rily that the variability
of total dcpo. its mu st have declined. Th e
vari,1bilities of both total demand deposit.
and total tim and saving. deposits may have
trend ed upward over thi s period. In addition,
the timin g of inflows and outflows into each
of these major depos it categories may have
been altered so that they became more reinforcing-therefore contributing to greater variability-rather than offsetting. Thus it is
conceivable that the shift in deposit compositi on may have tended to reduce the variability
of total deposits, but that other developments
may have been sufficiently strong to more than
offset thi s tendency .
To date , th e mos t obviou s way to r solve
thi s uncertainty- by examining actual change
in deposit vari ability- has been essentially precluded. Data indicating th e fluctuation s in deposits at large groups of banks are unsuitable
27
Deposit Variability
for this purpose, since th ey do not refl ect
shifts in dcpo it balance among bank , an
impo rtant so urce of deposit instability at individua l banks. What is required is a measure of
deposit fluctuati ons at individual banks which
may th en be averaged in order to ga in an impress ion of th e ge neral ex peri ence of bank
with thi s problem. Avail ab le data of thi · kind
arc co nfined to that pre ented in but a f w
rece nt empirica l studies, which were all quite
limited in sco pe. Moreove r, none of th ese
studi es exa mined yea r-to-yea r changes in dcpo. it va riability.
Th e main purpose o f thi s . 1rticlc is to suppl y
a p,1rl o f th ese nee ded fact s. vidcncc indi·atin e, th e va riabilit y o r dcp sits at a lar 1 e
numb r of m mb r bank s in th Tenth F dcral
Rese rve Di strict v r th e six-yc,1r p ri d, I 96 166, is prese nted. In o rd er to point up the
nature of th e problem , howeve r, considera tion
wi ll first be given to certain theoretical iss ues
and the res ults of rece nt empirical studi es
bea rin g on these issues.
THEORETICAL ISSUES AND RECENT
EMPIRICAL EVIDENCE BEARING ON THEM
Thre assump ti ons arc implicit in th po iti on th at th e increa c in th rati of total time
and sav ings deposits to total deposits r duccd
th e variabi lit y of total dcpo its. The first of
th ese is th at the variabi lity of total time and
savings depos it wa below th at for demand
dcpo its prior to the change in deposit composition and that the difference between these
variabilities remained essentially unch anged
after th e shift in deposit composition occurred.
The second ass umption is that the vari abiliti es
of both dcpo. it ca tego ries remain ed esse nti ally
un chan ged ove r thi s period or at lea st did not
increase suffi cientl y to more th an off. ct any
effects of change in co mpos iti on. F inall y, th ere
i th e . 1ssumpti on that the relati on hip of the
timin g ,rnd direction of flu ctu ati on in the c two
major ca tego ri es- as op posed to th eir magnitude-did not change materi all y.
28
The va lidity of the first assumption is most
cruci al to thi s position , since upon it rests the
proposition th at an increase in the proportion
of time and sa vings deposits will tend to reduce
th e vari ability of total deposits. The fin al two
a sumptions, on th e other hand , are only partly
co nn ected with th e hypoth c is about the effects
of a . hift in dcpo it compo ition . Th at i , while
it is po sibl c th at th e protc s of change in depo it composition may have a con sistent effect
on th e level of va ri ab ilities of both demand and
time acco unts or on th e timin g betwee n th eir
outfl ows and infl ows, other factors may also
influ nee th ese relati nships. Therefore, it L
poss ihl th at th shift in d posit co mpos ition
ma tend to rcdu c' th ' v,1riability of total d posit s but thi s t nd ncy may n t b appa rent
beca use of coincidental changes in oth er co ndition s. Instea d, all th at may happe n is that
the level of total deposit variability is held to
a lower level than it would have been if the
change in deposit composition had not occurred.
The assumption th at demand deposits are
more variable th an time and savings deposits
ha s been ques ti oned recently on a priori
grounds. Objection has b n vo iced to the longstandin g co ntention that beca use d mand deposits have a hi gher turnover rate th ey mu st
necessa rily be ubj cct to greater degrees of
variation . It has bee n poi nted out th at th e
turnover rate of a deposit category- the ratio
of total debits over some period of time to
th e average deposit balance over this periodis but one factor determining its variability.
Eq uall y important is the relationship between
th e timing and rel ative magnitude of debits
and credits to these accounts. It is pos:iblc, for
ex ample, th at a deposit category may have a
relati ve ly high turn ove r rate and yet have a
relatively low deg ree of variability , if debits
(w ithdrawa ls) arc simultaneou Iy offset by
credits ( inflows) of approx im ately equ al magnitude. Thu , to establi h th at demand depos its
are more variable th an time and sav ings de-
at Commercial Banks
po it , it is necessa ry to examine directly the
actu al variability of the e two major deposit
categories.
Recent empirical inves ti ga tions focusing on
ac tu al flu ctuations in the two deposit categories
do tend to support the as umption th at demand
acco unts arc more variab le th an total time and
sa vings acco unts. The ev idence presented in
each of th ese studies, however, wa obtained
fro m an cx,1 mination of deposit fluctuations
for a small sa mple of ba nks over a comparatively short period of time. Co nseq uently, this
evidence must be viewed as providing tentative
rath er th ,rn conclu sive support for the a sumpli on.
Thi s is p:1rticul.irl y tru e wi th rega rd to th
qu est ion of whether va rious types of tim
d posit , ~1 s opposed to savi n . dcpo its, arc
actually le. s un tab le than dema nd dcpo its.
In the one tudy which exa mined this question
it was found th at fluctuations in time deposits
were roughly four times as great as those for
savings deposits and that large negotiable certificates of deposit fluctuated about five times
as much as savings deposits.2 In addition, the
evidence presented in thi s study indicated th at
increase in th e proportion of either cert ificates
of deposit or other types of time deposits did
not r du ce total deposit variab ility. These reults would , uggcst that, at th e very ]cast, the
recent increase in the proportion of tim e deposits in total time and savings deposits may
have increa eel the variabi lity of this category.
Assuming for th e moment th at this did occur
and th at at the same time the variability of
1
'See George R. M o rri son and Richard T. Selden,
Tim e D eposit Croll't h and tlt e E 111p /oy111e 111 of Bank
F1111ds, pub lished by the Association of Reserve City
Bankers ( hi cago, 1965), c ha p. ii;
. R a nga raj:u1,
"Deposit Variabi lity in rn dividua l Ba nk s," Th e National
Ban k ing R e ,•ie ll' , Vol. 4, No. 1 (September 1966), pp .
61- 7 J; a nd Donald R. Frase r, "A Note o n Deposit
In stabi lity," /311sin e.1·.1· R e1·i ell' of th e Federa l Rese rve
Ba nk o f Dalb s ( ·1arc h 1967). pp . 1- 7.
2
/bid ., Morriso n a nd Selde n .
Monthly Review • July-August 1967
demand deposits remained unch anged, it follows th at the effects of the increase in the proportion of total time and savings deposits on
th e variability of total deposits would have become progress ively smaller with the passage
of time.
C hanges in other condition. al ·o may have
brought about an increase in the variability of
total demand deposits as well as total time
and av ings deposits, th ereby offsetting the
tendency fo r th e variab ility of total deposits
to decl ine. For exampl e, th e more competitive
involve ment of banks in the market for fin ancia l sav ings, whi ch made possibl e the rapid
1 row th in tim
and s,1vin gs dcpo. its, 111:1y have
incr '~1scd th eir vuln cr, tbility to deposit lo. cs .
This wo uld occ ur when chan r s in oth ·r fi nancial 111,ukct increased the attractiveness
of competing fo rm s of fin ancial a ct . Moreove r, tran fcrs from demand accounts in order
to take adv antage of the enh anced ea rnings
on time accounts tend to reduce the level of
idle balances hel d in demand accounts, thereby increasi ng their variability. And apart from
the possible influence of thi s development, it
is possible th at the postwar trend tow ard econom izin g on th Jcvcl of idl e fund s may have
continued over the period.
The third ass umpti on implicit in th e pos ition
that the shift in deposit composition red uced
the variab ility of total depo its in recent yea rs
is concern ed with the relationship between
the timing and direction of changes of demand
deposits on the one hand and the timing and
direction of changes in total time and savings
deposits on the other. The variability of total
deposits at a bank need not be equ al to a
weighted average of th e variabilities of its
demand acco unts and time and savings accou nts . Indccd, it is highl y probable th at it
i'> decidedly less th an such c1 n average .
A simplifi ed exa mple will help to rnustratc
thi s point. Assu me that at the start of a year
the total depos it of a bank are divided equally
be twee n demand depos its and time deposits
29
Deposit Variability
and th at no change occurs in thi s composition
ove r th e yea r; furth er a sumc th at during thi s
yea r the average wee kl y vari ati on in total
demand deposits is 4 per cent and for total
tim e and sav ings depos its is 2 per ce nt. lf
va ri ati on in the level of eac h dcpo it catego ry coincide in eac h wee k with rega rd to
direc ti on and timin g, th en th e average we kl y
va ri nt ion in total depos its fo r th e yea r wo uld
be equ al to a we ighted ave rage of th e va ri ati on
in each depos it ca tcgo ry- i.c ., 3 per ce nt. On
th e oth er hand. if th e wee kl y va ri ati ons in each
d pos it ca tego ry co incide prec ise ly with rega rd
to timing but move in opposite direct ions.
th en th e averl1ge weck l var i<1tion in t 1ta l
d pos its wo uld be onl y 2 p ' r m t.
Thi s ex am ple docs no more th an rive an
intuiti ve under tan ling of the po int and is
fa r from reprc entati ve of ac tu al co nditions.
The actual relation. hip betwee n th e direc tion
and timing of ch anges in total demand depos its
and the direction and timing of changes in total
time and savings depo its is no doubt much
more compl ex. Th at is, the fl ows into and out
of each of the depos it catego ri es may at tim es
be reinforcing and at other tim es offsetting.
Wh at is important to recog ni ze, howe ver, is
th at the vari ability of total depos its is influenced not onl y by th e co mpos iti on of demand
and time ace unt. and their relati ve va ri abiliti es, but al. o by th relati on hip betwee n th e
timin g and magnitude o f th e flu ctu ation 111
these subc atego ri es. Thi s point leads to th e
following important conclusion: Even if tot al
time and savings deposits are subj ect to less
fluc tuati on th an total demand depos its, an
increase in th e proporti on of th e c Jess va ri able
depos its may not reduce th e vari ability of
total dcpo. it s, if co incidentall y th e flu ctu at i ns
of eac h of th ese subcatego ri es o f depos its beco me less offse ttin g. Wheth r th e sy nchro ni za ti on betwee n demand and time depos it fl ows
did change ove r th pe ri od und er co nsidera ti on.
and change in uch a way th at it tended to increase th e va ria bility of total depos its. is an
30
empirical question and must be answered by
refe rring to the fa cts.
DATA AND TECHNIQUE
In order to provide part of the empirical
in fo rm ati on needed to re olve th e e i sues,
an exa min ati on was made of depos it fluctu ati on expe ri enced by virtuall y all member
btrnk s in th T enth Federa l R e. erve Di strict
over th e six-year pe ri od, 196 1-66. " T he fi r. t
tcp in thi s in ves ti gat ion entail ed developing
a proce dure fo r obtaining a meas ure of the
,1ve r<1gc yea rl y va ri ati on in total dcpo its, to tal
demand cl ·posi ts. and tota l tim e and savings
deposit. ·. T he m ',1su 1-c was des i ned to captur
the influence o f ,di f,1ctnrs ca usin r depos its
to vary ove r a yea r cxc pt d pos it rrow th .
T hi s pr e lure was app li ed se parately to th
dcpo it data of each bank and an index of
these meas ure was then co nstructed.
Since the procedure for meas uring deposit
va ri ation at indi vidual banks differs from procedures employed in other rece nt studies of
thi s ques ti on, a more detail ed di scussion of
its characteristics is in order. The fluctu atin g
line on Chart 1 provides an exa mple of the
actu al wee k-to-week va ri ation in th e level of
a give n dl.: pos it cat ~o ry ov r one yea r. Part
of th e total va ri ati on occ urrin ov r thi s y ar
wa quite clea rl y du e to gr wth . By fittin g
a trend ( or gr wth ) line to thi data, a more
prcc i, c rcfl ecti n of th e effec t of this fac tor
on the level of depo its in any given week
ca n be gained. The differences betwee n th e
values on this growth line and the actual
deposit levels in each week can be assumed
to refl ect th at porti on of th e total va riation
over th e yea r cau sed by all fa ctors except
~row th . l n order to obtain a m as ur indica ting
th avcrag week ly flu ctu ati on in dcpo its
att ribut ab le to th ese fac tor , th e pe r c nt difference b twee n th e actu al depos it valu e and
"On ly those banks o rganized dur ing this pe ri od a n d
a few other bank s subject to u n usua l ci rcu m sta nces
were excluded .
at Commercial Banks
Chart 1
EXAMPLE OF WEEKLY DEPOSIT
FLUCTUATIONS AT AN INDIVIDUAL BANK
Week.ly A 11 eroq , s ot Doily F tQures
,a I
,, I
6t
0
:
I
,'II
I,
,'I\
I
Iii
Wi•r k-.
I
I
I
17
\{,
40
I
th e trend va lue in c;ic h wed o f th e yc;i r w. 1s
ca lcu l;i ted. T hese pe r ce nt dil'fc rences we re
then summed wi tho ut rega rd to sign and ave raged.
Since the differences be twee n actu al depos it
values and the va lues on th e grow th (trend )
line we re co mp uted in perce ntage term s rather
th an absolu te terms, thi s meas ure of va ri ability is comparable among b,rnks whose ave rage deposits over a year were dec idedl y differe nt in size. I n add itio n, climin ati on of th e
cff cts o f grow th makes th e measure mo re
co mparabl e ,1111011 y di fferent depos it ca tego ri es
ubj ect to di fferent growt h rate . T he fa ilure
to elimin ate the effec ts of grow th on depos it
vari ability wo ul d mea n, fo r exa mple, th at th e
meas ured variability of to tal time and ,wings
depos its would be subs tanti all y infl ated relative to the va ri ability of de mand depos its,
because of the much grea ter rate of grow th
in time and sav ings depos its ove r this pe ri od.
CHANGES IN DEPOSIT VARIABILITY,
1961-66
T ab le I prese nts th e in dex of meas ured
va ri ability o f to tal depo.-i ts at Di strict me mbe r
banks for each yea r from 196 1 th ro ugh 1966.
Thi s data suggests th at so me red ucti on in t he
va ri ability of to tal depo it did occ ur ove r thi s
period- th e index for 1966 was ro ughly 12
Monthly Review • July-August 1967
per cent below th at for 1961 . Moreover, it
appea rs th at th e ch ange in depos it composition
which too k pl ace ove r thi s peri od was in part
responsible fo r thi s decline. The index o f demand depos it vari ability exceeded that for time
and sav ings depos its in each yea r of thi s period,
whil e th e rati o o f demand depos its to total
depos its declin ed steadily. H owever, th e relatio nship betwee n yea r-to-ye'-1r chan ges in th e
co mpositi on of total depos its and the va ri ability of th ese depos its is not pa rticul arly
close. Mo re specifica ll y, the index of total
depos it va ri ;:ib ili ty remained un changed in th e
fo ur middl e y ,u s of th e peri od even th ough
th e rati o o f de111 ;1nd depos its to tot;d depos its
de ·I in cd in ·;1cli of th ·sc ye;u s.
T he L1ilure o f th e v;1ri .i bilit y o f tot'- d depos its
to vary sys tcnn ti ca ll y with changes in th e
co mpos iti on o f th ese depos its appea rs to be
;:i ttributablc pa rtl y to th e behav ior of demand
and time a nd savings de pos it va ri ability during
th ese yea rs. Yea r-to-yea r changes in the variability of each of th ese deposit categories tended
to reinfo rce th e effects of th e depos it compos ition shift in so me yea rs of thi s period and
to offse t th e effect o f the shift in deposit
co mpos ition in ot hers. Fo r exa mpl e, th e dro p
in dcm.ind depos it va ri ab ility in 1962 tcnclccl
to co mp le ment th ffcct o f th e change in total
d pos it co mpo ition in thi s yea r. In co ntra t,
increases in th e va ri ability of demand depos its
111 1963 and 1965 ac ted to o ffse t the effects
of th e dec line in th e proporti on of th ese acTable 1
INDEX OF DEPOSIT VARIABILITY
AND RATIO OF TOTAL DEMAND DEPOSITS
TO TOTAL DEPOSITS *
TENTH DISTRICT MEMBER BANKS, 1961-66
1961 1962 1963 1964 1965 1966
Va ri a bility:
Total De posit s
Var ia bility :
Tota l De m a nd De posits
Va riabil ity:
Tota l Ti me
De posits
De ma nd / Total De posits
3 .3
3.0
3 .0
3.0
3 .0
2.9
4.3
4 .2
4.3
4 .3
4.5
4.4
2 .5 2 .5 2 .1 1.9 2.0 2.2
74 .0 70.0 68.0 66 .0 64.0 60.0
* Indexes are averages o f ind iv idu a l ba nk me a sur es.
31
Deposit Variability
counts in total deposits. View ing the period as
a whole, it can be seen that th e variabi lities
of total demand depo its in 19 65 and 1966
we re above those in ea rli er yea rs, so that on
net balance develop ments in th e va ri ability
of demand deposits tended to modera te the
decline in total depos it var iabi lity for th e entire
peri od.
C hange in th e va ri ab ility of total tim e and
sav ings d posits also appear to have had
mixed effects o n th e va ri ab ility of total deposits
over th e per iod. It will be noted that a compmatively sharp decline occurred in the index
o f va ri ab ility o f th e. c acco unt s in 1963 and
this was foll owed by ti furth er 111ode r;1t ' decline
in 1964 . H )wev ' r, th ese two yea rs of de lin '
we re foll owed by two years of modcratL: ad va nce, so th at th e effects of th e initial d cline
in th e variability of tota l tim e and sav ings
depos its on total deposits were off et in part
by th e increases in th e va ri ab ility of total
time and sav ings deposits in the latter yea rs
of the period. For th e entire period , the variability of total time and sav ings deposits was
down about 12 per cent. Thu s th e decline in
tota l deposit variability for th e period as a
whole appears to have bee n ca used not only
by th increa e in the pr porti on of tot al time
and sav ings depos it · in total d posits but al o
by a dec line in th e variabi lity of these accou nts .
l n add itio n to th e e two facto rs, the evidence
also sugge t that the ynch ro ni za ti on of flow s
into and out of demand and time and saving
deposits did not remain unch anged over this
period. Perhaps th e cl earest indication of this
is th at the variability of total depos its did not
change betwee n 1963 and 1964 even though
the ratio of demand to total depos its dropped
from 68 per c _nt to 66 -per ce nt, the var iab ility
of total time deposits fe ll from 2. I per ce nt
to I .9 per cen t, whi le the variabil ity of total
demand deposits remai ned unchanged. Taken
together, these developments wo uld tend to
reduce the va ri abi lity of total depo it . The
fact that th e va riability of total depos its re 32
mained unch anged, th erefo re, indicates that
flow s in and out of total time and sav ings
deposits had less of a tendency to offset fluctuations in demand deposits. Or, to view the
sa me point for the period as a whole, it will
be observed th at between 196 1 and 1966 ( a)
th e ra ti o of demand to tota l depos its declined
I 9 per ce nt, (b) the variab ility of total time
and av ings deposits dropped 12 per cent, and
( c) the var iabi lity of total demand deposits
increased by just over 2 per cent. Had the
tendency of time and savings deposit fl ows to
offset demand deposit fl ows remained un chan ged over thi s period , it appel1rs th l1t th e
net err · ·t of th ese thre · deve lopments wou ld
hav · brou ght abo ut :1 •r at ' r redu cti on in
t t;tl depos it var iability th an th e 12 p r ce nt
decl in c whic h actua ll y occ urred.
Perhaps the mo t surpri ing a pect of the
find ings discu ssed above is the year-to-yea r
beh av ior of the vari ab ilities of demand deposits
and time and savings deposits. The changes
in th e variability of eac h of these deposit categories did not conform very closely to what
one would expect on th e basis of discuss ion
in an ea rli er section of thi s article. First , alth ough th e var iabi lity o f demand deposits was
hi gher in both 1965 and 1966 than in earli er
yea rs o f th e peri od, th e cliff rcnce was quite
moderate. Moreove r, the var iability of these
depos its was le s in 1966 than in 1965. Evident ly any shift of idl e demand balances int o
time and sav ings depos it which may have take n
place was either quite moderate or the influence
of this development on the variability of total
demand balances must have bee n offset by
othe r co nditions tending to reduce th e var iab ility of the e accou nts.
ve n 111 re surpri ing were the deve lopments
in the va ri ab ility of tota l time and sav ings
deposits. The variability of these de pos its was
less in 1966 th an in ei th er 196 1 or 1962 . T hi s
drop occurred even though the proportion of
savings depo its in total time and savings depo it declined from 77 p -r ce nt in 1961 to
at Commercial Banks
Table 2
VARIABILITY OF DEPOSITS AT 40 WEEKLY
REPORTING BANKS
Index of Variability
(Per Ce nt )
1965
1966
Total Deposits
2 .8
3.0
Total Demand Deposits
4 .1
4.3
Total Time and Savings Deposits
2.0
2.5
Savings
1.1
1.7
Time (excluding CD's)
6 .2
9.7
Negotiable CD's
($100,000 and over)
12 .2
11 .7
50 per ce nt in I 966. In fa ct, durin g the fouryea r pe ri od endin g in 1964, the ratio of savin gs
depos its to to tal tim e and savings d pos its
dec lined fro m 77 per ce nt to 60 per ce nt and ,
at th e s;im c tim e, th ' vari :1hilit y of total tim ,
and sav ings cl pos its fell fro m 2.5 per c nt to
1.9 p r c nt . Onl y in th e fin al two-y ar peri od
did th e change in depos it co mpositi on have
th e effects th at one would ex pect based upon
th e a sum pti on th at av ings deposits are subject to less va ri ation than time deposits.
The failure of th e vari ability of total time
and savings deposits to va ry sys tematically with
th e shift in th eir composition does not appear
to be du e to a fa ll acy in ass umptions about
th e relati ve va ri ability of th ese acco unts, however. A. menti oned ea rli er, th e findin gs of a
prcvi ou. in ve. ti ga tio n ra th er clea rl y indi ca ted
th at tim e d pos its, and
D's in particular,
were decidedl y more vari able th an savin gs
depo its. D e1 os it data pro vided by all member
banks in th e District did not brea k out the
various subcategories of total time and savings
deposits until mid-1966, and , therefore, th e
relative vari abilities of these different deposit
categories could not be e tim ated with this
data. Some attempt wa made, however, to
check th previous findin gs by exa mining th
rel ative vari abilities of th ese differ nt depo it
cat go ri es at 40 wee kl y repo rting bank in th e
Di tri ct, ince the data uppli cd by these banks
is in a form whi ch permits th ese e timations.
Th e re ults of thi s examinati on, presented in
T able 2, ugges t quite cl_ca rl y th at the va ri Monthly Review •
July-August 1967
ability of pass book sa vin gs accounts was substantia11y below th e vari ability of time deposit
( excluding lmgc certificates of deposit) in both
1965 and 1966, and th at th e vari ability of
CD's exceeded th at of oth er time depos its in
each of th ese years.
Since thi s evidence refl ects th e experi ence
of only ~1 very mall sa mpl e of banks over
but a two-yea r period , it mu st be accepted
with cauti on. P arti cularl y so, since the meaurcd va ri ability of both CD 's and oth er time
depos its appea r to be exce ptionally hi gh. Both
were sub. tanti all y above th e vari ability of total
demand depos its at thi s gro up of banks in
th s two y ,tr . . H oweve r, since th e order of
vari :1hil ity ~1111 0 11 th e three co mpon1.; 11ts or tot.ii
tim and savin s depos its not onl y conform s
with pr vi us findin gs but is also co n i t nt
with gc nernll y held opinion, it appea rs sa fe
to accept thi s evidence as indicating th e order ,
if not th e relative magnitude, o( differences
in variability among th ese deposit categories .
Since th e behavior of th e vari ability of total
time and savings deposits did not conform to
what would be ex pected on th e bas is of thi s
evidence, some consideration of th e reaso n
for thi s seems to be in order. Although th e
evidence avzi il ablc is in no way suffi cient to
permit an cntir ly co nvincing ex pl anati on, th e
followin g one docs see ms reasonable. The drop
in time and avin gs depo it va ri ability over
th e ea rly yea rs of th e period may have bee n
caused by the relaxation of th e maximum
allowable rates payable on time and savings
deposits permitted under Regulation Q and the
subsequent advances in the rates by banks.
Thi s improved competitive position of banks
may not only have brought about a substanti al
growth in time and savin gs deposits but al so
ma y have reduced th e deg r e of flu ctu ctlion
around thi s growth trend . Thu s th e dow ntrend in va ri ability betwee n 196 1 and 1964
pres um ably is expl ainable in part by th e advance in rates paid by banks on th eir time and
sa vings accounts vi s-a-vis th e rate being
33
Deposit Variability at Commercial Banks
offered on competing form s of fin ancial assets.
Ev identl y thi s condition was suffici ently predo min a nt to more than offset th e influence of
th e shift in the composition of total tim e and
savings deposits.
If this explanation is close to the mark,
then it also may help to expla in why the variability in th ese deposits began to increa e in
1965 a nd 1966. ln these two yea r , p a rtic ul a rly
1966, competition for the sav ings of bu sin esses
a nd consume rs increased sha rply, as interest
rates o n othe r forms of financial assets-especiall y those sold in the open m a rket- increased
ma rkedly . Thi s in creased competitio n may
have affec t d th e stability o f ex isting depos it
ba la nces at co mm rc ial b;inks , indu cin r many
depos ito rs t shift in and o ut of these acco unts as the co mp arat iv adv a ntages of time
a nd sa vings deposits vi s-a-vis o th e r fo rm s of
fin a nci al assets changed over the peri od. In
short, the effects of thi s development reinforced the shift in composition of depos its
from savings to time accounts in the latter
years of the period.
SUMMARY AND CONCLUSION
The ev ide nce pre e nted in thi s pape r . ugge ts that the vari ability of tota l deposits
declined a t most ba nks in the Te nth Federal
R eserve District over the six-yea r period I 961 66. Wh eth e r thi s refl ects th e expe rience of most
banks in the country is not entirely clear, howeve r. In judging how representative these findings are one should consider that the great
majority of the banks included in this study
are small, nonmoney m a rket b anks. More specifically, only 20 of the banks have depos it
holdings cxcc_eding $ J 00 millio n, and in all
probab ility only these ba nks a re subject to
th e competitive conditions expe rie nced by la rge
34
banks throughout the country. Moreover, only
thi s small numbe r of b anks issue la rge CD's.
However, since conditions affecting the variability of total deposits at most banks in the
country were a t least roughly similar to those
affecti ng the var iability of tota l deposits a t
Tenth Di strict b a nk , thi s evide nce does provide so me su ppo rt for the a se rtion th at the
var iab ility of total deposits d id decline gene rall y a t mo t banks over the pe ri od .
The ev ide nce obtained in this study also
supports th e asse rtion th a t th e recent increase
in th e ratio of total tim e and sav ings deposits
to tota l depos its wa a t Jca t pa rtly responsib1c
fo r th e d cl in e in total d pos it va ri ab ilit y. This
support is dc ri v d not o nl y fro m th e findin g
th a t th e va ria bility f tota l de posits did declin e
over thi s pe riod but also fr o m the ev ide nce
indi cating that de mand deposits were sub ject
to substanti all y more variation th an total time
and savings deposits in each year of the period.
Or to put thi s differently, the ev idence suggests
th at if all other conditions are held constant,
an increase in the proportion of total time
a nd savings deposits will reduce th e variability of total deposits.
A furth e r indicatio n of th e ev idence, howeve r, is that a lJ othe r cond iti o ns did not remain co nsta nt over thi s per iod.
ha ngcs in
these other co nditi ons affected th e va ri ab ilities
of both total de ma nd depo its a nd to tal time
a nd savings deposits as well as the synchronization of flows between the m. ln so me cases
this tended to reduce the va ri ability of total
deposits and in others to increase it. This observation has importa nt implications for future
consideration of deposit variab ility issues, for
it indica tes th at judgments abo ut cha nges in
th e variability of total deposits based o n informa tion abo ut d posit co mpositi o n alo ne ca n
eas il y be quite misleading.
@FedFRASER