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TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TINE DEPOSITS HEARINGS BEFORE THE COMMITTEE ON BANKING AND CURRENCY HOUSE OF REPRESENTATIVES EIGHTY-NINTH CONGBESS SECOND SESSION ON Hit 14026 A BILL TO PROHIBIT INSURED BANKS FROM ISSUING NEGOTIABLE INTEREST-BEARING OR DISCOUNTED NOTES, CERTIFICATES OF DEPOSIT, OR OTHER EVIDENCES OF INDEBTEDNESS MAY 0, 10, 11, 12, 19, 24, 25, 31; JUNE 1, 2, 7, 8, 9, 16, AND 23, 1966 Printed for the use of the Committee on Banking and Currency TO ELIMINATE UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS HEARINGS BEFORE THE COMMITTEE ON BANKING AND CURRENCY HOUSE OF REPRESENTATIVES EIGHTY-NINTH CONGRESS SECOND SESSION ON H.R. 14026 A BILL TO PROHIBIT INSURED BANKS FROM ISSUING NEGOTIABLE INTEREST-BEARING OR DISCOUNTED NOTES, CERTIFICATES OF DEPOSIT, OR OTHER EVIDENCES OF INDEBTEDNESS MAY 9, 10, 11, 12, 19, 24, 25, 31; JUNE 1, 2, 7, 8, 9, 16, AND 23, 1966 Printed for the use of the Committee on Banking and Currency U.S. GOVERNMENT PRINTING OFFICE 63-496 WASHINGTON : 1966 Wot safe by tfcs Bapsrintandont of Documents, U.S. Qoftnuottit Printing Offics Washington, D.C. 30402 - Fries $2.60 COMMITTEE ON BANKING AND CURRENCY WRIGHT PATMAN, Texas, Chairman WILLIAM B. WIDNALL, New Jersey ABRAHAM J. MULTER, New York PAUL A. FINO, New York WILLIAM A. BARRETT, Pennsylvania FLORENCE P. DWYER, New Jersey LEONOR K. SULLIVAN, Missouri SEYMOUR HALPBRN, New York HENRY S. REUSS, Wisconsin JAMES HARVEY, Michigan THOMAS L. ASHLEY, Ohio W. E. (BILL) BROCK, Tennessee WILLIAM S. MOORHEAD, Pennsylvania BURT L. TALCOTT, California ROBERT G. STEPHENS, J b., Georgia FERNAND J. ST GERMAIN, Rhode Island DEL CLAWSON, California ALBERT W. JOHNSON, Pennsylvania HENRY B. GONZALEZ, Texas JOSEPH G. MINISH, New Jersey J. WILLIAM STANTON, Ohio CHESTER lit MIZE, Kansas CHARLES L. WELTNER, Georgia RICHARD T. HANNA, California BERNARD F. GRABOWSKI, Connecticut COMPTON I. WHITE, J b., Idaho TOM S. GETTYS, South Carolina PAUL H. TODD, J b., Michigan RICHARD L. OTTINGER, New York THOMAS C. McGRATH, Jb., New Jersey JOHN R. HANSEN, Iowa FRANK ANNUNZIO, nilnois THOMAS M. REES, California P a u l N e l s o n , Clerk and Staff Director A lvin L e e M o b s e , Counsel Cmans A . P b i h s , Chief Investigator N o b i c a n L . H o l m e s , Couneel B e n s ? D . G e l l m a n , Investigative Counsel O r m a n S . F i n k , Minority Staff Member n C O N T E N TS H.R. 14026. A bill to prohibit insured banks from issuing negotiable interest-bearing or discounted notes, certificates of deposit, or other Page evidences of indebtedness_________________________________________ 1 Statement of— Albig, Reed H., chairman, Federal Legislative Committee, Independ ent Bankers Association of America— -------- ----------------------------573 Barr, Hon. Joseph W., Under Secretary of the Treasury___________ 440 Blackmon, Larry, president. National Association of Home Builders. _ 263 Bliss, George L., president and managing director, Council of Mutual Savings Institutions---------------------------------------------------------------563 Brimmer, Hon. Andrew F., member, Board of Governors, Federal Reserve System___________________________________________ 169, 208 Carson, Deane, professor of banking, Columbia University_________ 338 Daane, Hon. J. Dewey, member, Board of Governors, Federal Reserve System___________________________________________________ 481, 507 DuBois, Pat, president, Independent Bankers Association of America. 573 Fowler, Hon. Henry H., Secretary of the Treasury; accompanied by Peter Sternlight, Deputy Under Secretary for Monetary Affairs; and Fred B. Smith, General Counsel__________________________ 131 Horne, Hon. John E., Chairman, Federal Home Loan Bank Board; accompanied by Dr. Harry S. Schwartz, economist, FHLBB_____ 70, 97 Kirchner, W. G., president, Richfield Bank & Trust Co., Richfield, Minn.; accompanied by Carter H. Golembe, deputy manager, ABA; presenting statement of Archie K. Davis, on behalf of the American Bankers Association------------------------------------------------397 Klebaner, Benjamin J., professor of economics, the City College of the City University of New York------------------------------------------------328 Maisel, Hon. Sherman J., member, Board of Governors, Federal Reserve System------------------------------------------------------ 169, 208, 481, 507 Martin, Hon. William McChesney, Jr., Chairman, Board of Governors, Federal Reserve System; accompanied by J. L. Robertson, Vice Chairman; Charles N. Shepardson, member; George W. Mitchell, member; J. Dewey Daane, member; and Sherman Maisel, member. 481, 532 Mitchell, Hon. George W., member, Board of Governors, Federal Reserve System--------------------------- ------- ------------------ 169, 208, 481, 507 Olson, Hon. Alec G., a Representative in Congress from the State of Minnesota------------- ------- ----------------------- --------------------------------573 Randall, Hon. K. A., Chairman, Federal Deposit Insurance Corpora tion; accompanied by W. W. Sherrill, Director, FD IC ____________ 386 Robertson, Hon. J. L., Vice Chairman, Board of Governors, Federal Reserve System___________________________________ 169, 208, 481, 507 Rousseas, Stephen W., professor of economics, New York University. 300 Saxon, Hon. James J., Comptroller of the Currency______________ 258 Scanlon, Hon. Charles J., president, Federal Reserve Bank of Chicago. 169, 208 Shepardson, Hon. Charles N., member, Board of Governors, Federal Reserve System------------------------------------------------------ 169, 208, 481, 507 Sherboume, Everett C., president, City Federal Savings & Loan Association, Whippany, N.J.; accompanied by William J. Kerwin, assistant executive director, and William F. McKenna, general counsel, National League of Insured Savings Associations___ 11, 33, 56& Slipher, Stephen, staff vice president and legislative director, United States Savings & Loan League-------------------------------------------------57S Strunk, Norman, executive vice president, United States Savings & Loan League; accompanied by Stephen Slipher, staff vice president and legislative director-------------------------------------------------------- 3, 33, 56& Treiber, Hon. William F., first vice president, Federal Reserve Bank erf New Y ork......... ...................... ............ ............................... ................ 169,20$ m Additional information submitted to the committee by— Albig, Reed H., chairman, Federal Legislative Committee, Independ ent Bankers Association of America: “Swapping Savings for Stock Market,” article from the Evening page Star, June 23, 1966------------------------------------------------------583 Annunzio, Hon. Frank: “Continental Illinois Asserts Passage of Assets Bill Is Lesser of Two Evils,” article from the American Banker, May 9, 1966__ 105 “Legislation Regulating Bank Certificates of Deposit Introduced by Congressman Rees,” press release dated May 19, 1966-----161 Barr, Hon. Joseph W., Under Secretary of the Treasury: Comments on article “ ‘Operation Twist’: A Mistaken Policy?” . . 472 Number of banks closed because of financial difficulties, 1928-65, by years_____________________________________________ 447 Short-term and long-term interest rates in selected countries 479 (table)--------------- ------------------------------------------------------Blackmon, Larry, president, National Association of Home Builders: Additional remarks of____________________________________ 296 292 Additional statement of__________________________________ “Choose at Franklin National Three Different Type Savings Bonds,” advertisement from the Wall Street Journal, May 27, 1966__________________________________________ 294 “For the Smaller Saver,” article from the Washington Post, May 31, 1966___________ __________________________ 293 “Invest in 5J4 Percent Savings Bonds,” advertisement from the Wall Street Journal, May 27, 1966________________ 295 Bliss, George L., president and managing director, Council of Mutual Savings Institutions: Resolution of the Council of Mutual Savings Institutions, June 9, 1966_________________________________________________ 565 Carson, Deane, professor of banking, Columbia University: “Communications,” from the Journal of Finance, September 1965: “Is the Federal Reserve System Really Necessary?” com ment by Harmon H. Haymes________________________ 351 “Federal Reserve Membership and Discrimination,” com ment by James W. Leonard_________________________ 353 “ Is the Federal Reserve System Really Necessary?” com ment by George G. Kaufman________________________ 355 “ Is the Federal Reserve System Really Necessary?” reply by Deane Carson_________________________________ 355 “ Should Federal Reserve Float Be Abolished and Its Check Activities Curtailed?” by Irving Auerbach-____________ 358 “Auerbach's Defense of Defensive Operations,” by Karl Brunner and Allan Meltzer__________________________ 366 “Should Federal Reserve Float Be Abolished and Its Check Activities Curtailed?” reply by Deane Carson__________ 368 Fowler, Hon. Henry H., Secretary of the Treasury: Accomplishments of the Coordinating Committee_____________ 131 Data concerning savings and time deposits at all commercial banks and nonnegotiable certificates of deposit_____________ 146 Commercial bank time and savings deposits (table)_______ 147 Types of time and savings deposits, IPC, held by member banks on December 22, 1965_________________________ 147 Expenses relating to tax-exempt income_____________________ 152 Influence of negotiable certificates of deposit on Treasury bill rates__________________________________ ______________ 130 Progress report on the joint Treasury-Federal Reserve study of the U.S. Government securities market_______________________ 131 Time certificates of deposit at insured commercial banks, April 26, 1965, by size of certificate (table)___ ____________________ 164 <*ettys, Hon. Tom S.: Telegram to Hon. Richard T. Hanna from Louis B. Lundborg, chairman of the board, Bank of America N.T. & S.A., dated June 3, 1966____________ ____ ___________ ; _______ ____ _ 463 CONTENTS V Additional information submitted to the committee by—Continued Horne, Hon. John E., Chairman, Federal Home Loan Bank Board: Advances made by purposes, Federal Home Loan Bank of San Francisco (table)______________________________________ Letter to Federal home loan bank presidents, dated April 20, 1966_________________________________________________ Michigan Savings & Loan Association members of Federal Home Loan Bank System anticipated regular dividend rates for period beginning January 1, 1966 (table)________________________ Shifts in demand and inflation, statement on_________________ Klebaner, Benjamin J., professor of economics, the City College of the City University of New York: Yearend total savings (table)______________________________ McGrath, Hon. Thomas C., Jr.: “ First National City Bank Paying Interest on Its Time Deposits/* article from the New York Times, February 21, 1961___ ____ McKenna, William F., general counsel, National League of Insured Savings Associations: Statement of_______________________________ .____________ Maisel, Hon. Sherman J., member, Board of Governors, Federal Reserve System: Statement on H.R. 14026 and related bills___________________ Martin, Hon. William McC., Jr., Chairman, Board of Governors, Federal Reserve System: Draft of legislation to establish a graduated system of reserve requirements for all insured banks, to authorize Federal Reserve banks to extend credit to all insured banks, and for other purposes______________________________________________ Mitchell, Hon. George W., member, Board of Governors, Federal Reserve System: Statement of____________________________________________ Ottinger, Hon. Richard L.: “Deming Cautions on Bid for Funds,” article from the New York Times, May 10, 1966--------------------------------------------Letter from Harry P. Greep, president, and Rex G. Baker, vice president, National League of Insured Savings Associations, dated May 18, 1966_________ _______ __________________ Letter from Stephen Slipher, legislative director, United States Savings & Loan League, dated April 28, 1966______________ Memo on certificates of deposit by Norman Strunk, executive vice president, United States Savings & Loan League, June 8, 1966. Patman, Hon. Wright: “Analysts See Prime Rate Boost as ‘Bullish’ for Bank Stocks, ‘Bearish7 for Industrials,” article from the American Banker, March 11, 1966____________ _______ ________________ ______ Announcement by Federal Home Loan Bank Board in response to “minimal action taken by the Federal Reserve Board,” Federal Home Loan Bank Board release dated June 28, 1966„ Announcement of increase in required reserves against time deposits from 4 to 5 percent, Federal Reserve press release dated June 27, 1966------------------------------------------------------Announcement of results of survey of time and savings deposits a t member banks, Federal Reserve press release dated June 27, 1966____________________________________________________ Applicable tax rate and net operating earnings on common stock of 7 New York City banks and 18 banks in other centers, 196065 (table)___________________ _____________ ______________ Applicable 1965 tax rate of 50 selected commercial banks, listed in order of common capital accounts on December 31, 1965 (table)..................................................................................................... “Bank Loan Losses, Past and Present,” article from the New England Business Review, May 1966_______________________ “Bank Profits: Another Record,” article from the Monthly Review, April 1966----------------------------------------------------------“Banks Add $5 Billion of Tax-Exempts in 1965, Rise of 15.4 Percent,” article from the Daily Bond Buyer, May 19, 1966_ “Big New York Banks See N o Major Strain in June CD Expira f*A m fT ia W a l l lit Pafct 127 122 108 79 376 511 54 210 533 211 120 217 41 523 667 802 797 785 589 589 600 592 187 RQQ Additional information submitted to the committee by—Continued Patman, Hon. Wright—Continued “CD’s a Problem for the Fed,” article from Banking, February 19§0____________________________________________ - ___ 642 Correspondence between Chairman Patman and Hon. William McC. Martin, Chairman, Board of Governors, Federal Re serve System, concerning issuance of short-term promissory 605 notes________________________________________________ Correspondence concerning the application of Federal securities law to misleading bank advertisements of savings bonds (certifi cates of deposit)------------------- --------------- ---------------------610 Depositary liabilities to the public commercial banks, mutual 605 savings banks, and savings and loan associations (table)-------Editorial cartoon indicating Federal Reserve Board's weakness and indecision to bring interest rate war to immediate halt, from the Washington Star, June 29, 1966--------------------------803 Excerpt from Pratt s Letter, dated December 17, 1965------------645 “Fed Governor Would Add to Mutual Role,” article from the Washington Post, May 18, 1966------ ----------------------- -------668 Federal Reserve press release announcing actions to reinforce efforts to maintain price stability, and thus to foster balance in the economy's continued growth and strength in the dollar’s international standing, dated December 6, 1965------------------644 Federal Reserve statistics for the week ending June 15, 1966, from the Washington Post, June 17, 1966 (table)-----------------------539 “Home’s Emergency Plan—Slump in Housing Starts Anticipated by S. & L. Overseer Because of CD's,” article from the Wall Street Journal, June 13, 1966____________________________ 669 “How Banks Are Doing,” article from Bank Stock Quarterly, March 1966____________ ____ _________________________ 590 “Keep Your Family Out of the Crossfire,” advertisement of the Watertown Federal Savings & Loan Association, Watertown, Mass___- _______________ - ____________________________ 638 Legal memorandum on obligations of Government agencies eligible for purchases and as security for advances by Reserve banks, from the Legal Division, Board of Governors, Federal Reserve System, dated April 13, 1966_____________________ 486 Legislative history of provision of Banking Act of 1933 prohibiting 651 payment of interest by banks on demand deposits__________ Legislative history of 12 CFR 217.1(e)(1), 217.135 whereby banks which are members of the Federal Reserve System are precluded from accepting savings deposits tendered by com mercial corporations operating for profit___________________ 653 Letter from George Champion, president, New York Clearing House, dated June 6, 1966______________________________ 616 Letter to Hon. Edward P. Boland from Bradford R. Collins, West Springfield, Mass., dated June 6, 1966_______________ 613 Letter to Hon. Edward P. Boland from Otto A. Peterson, presi dent, Ludlow Savings Bank, Ludlow, Mass., dated June 20, 1966_____ ____ _________ _______ _____________________ 614 Letter to Hon. Thomas P. O'Neill, Jr., from Lawrence H. Martin, president, National Shawmut Bank of Boston, dated June 9, 1966___________________________________________ _____ 614 Letter to Hon. William McC. Martin, Jr., Chairman, Board of Governors, Federal Reserve System, from Grover W. Ensley, executive vice president, National Association of Mutual Sav ings Banks, dated May 10, 1966, with a bulletin from the 611 NAMSB on industry deposit trends, April 1966____ _______ Maximum interest rates payable on time and savings deposits (table)_____ - ______ __________ _______ _____ 139 Maximum rates payable on CD's under regulation Q (chart)*__ 146 “Negotiable Time Certificates of Deposit,” article from the Fed eral Reserve Bulletin, April 1963.________ ________ ______ 620 Outstanding negotiable certificates of deposit in denominations of $100,000 or greater issued by weekly reporting member banks ( t a b l e ) . ___ 137 - Outstanding negotiable time certificates of deoosit* anmiahv. ■ CONTENTS VII Additional information submitted to the committee by—Continued Patman, Hon. Wright—Continued Press release of the New York State Banking Department con- **ag« cerning the illegality of issuance of negotiable promissory notes by national banks in New York State_____________________ 609 Replies to questions submitted to various agencies and organiza tions by committee letter dated May 31, 1966: Ackley, Hon. Gardner, Chairman, Council of Economic Ad visers, dated June 2, 1966___________________________ 428 Davis, Archie K., president, American Bankers Association, dated June 3, 1966_________________________________ 435 Fowler, Hon. Henry H., Secretary of the Treasury, dated June 2, 1966______________________________________ 430 Greep, Harry P., president, National League of Insured Sav ings Associations, dated June 2, 1966_________________ 434 Horne, Hon. John E., Chairman, Federal Home Loan Bank Board, dated June 3, 1966__________________________ 433 Randall, Hon. K. A., Chairman, Federal Deposit Insurance 430 Corporation, dated June 2, 1966_____________________ Saxon, Hon. James J., Comptroller of the Currency, dated June 2, 1966______________________________________ 432 Strunk, Norman, executive vice president, United States Sav ings & Loan League, dated June 1, 1966_______________ 437 Resolution approved June 23 by Committee on Banking and Currency expressing sense of the committee that the Federal Reserve Board act within 30 days to end excessive interest rate 785 competition_____________________ ._____________________ *‘Savings Accounts Fall by $1 Billion—Survey Points to Shortage of Homebuilding Credit,” article from the New York Times, May 9, 1966__________________________________________ 20 Savings by individuals in the United States, 1963-65 (table).. 139, 648 “Should Negotiable CD’s Be Outlawed?” articles from Finance magazine, May 1966: “ Yes,” by Hon. Wright Patman, chairman, Committee on Banking and Currency_____________________________ 639 “No,” by Dr. Carter Golembe, Washington economic consul tant, American Bankers Association__________________ 641 “Significance of the 1966 Business Outlook for the Savings and Loan Industry,” address by Dr. Gordon W. McKinley, vice president-economics, McGraw-Hill, Inc____________________ 654 “Some Reflections on Interest Rates and Their Economic Impli cations,” by Warren L. Smith, professor of economics, Univer sity of Michigan_______________________________________ 659 Telegram from American Bankers Association to Mr. Pat DuBois, president, Independent Bankers Association, criticizing posi tion of IB A in support of measures to end rate war; witn reply of Independent Bankers Association to ABA criticism______ 1 784 Telegram from Pat DuBois, president, and Reed H. Albig, chair man, Federal legislative committee, Independent Bankers Association of America, favoring 4}£-percent ceiling on time deposits______________________________________________ 613 Telegram to Hon. George P. Miller from the board of directors, Alameda First National Bank, Alameda, Calif., dated June 20, 1966_________________________________________________ 615 “The Increase in the Discount Rate: Timing, Motivations, Eco nomic Effects,” article from the Conference Board Record, January 1966--------------------------------------------------------------631 “The Savings War,” editorial from the New York Times, June 15, 1966________________- ________________________________ 615 “ Time Deposit Reserve Requirements Raised To Restrain Issuance of CD’s—But Boost by Reserve Board to 5 Percent From 4 Percent Is Termed Too Mild for Much Impact,” article from the Wall Street Journal, June 28, 1966_________ 799 “Volume and Composition of Individuals’ Saving in 1965,” SEC release No. 2117, dated April 14, 1966__ ____ - ____________ 646 “ Working Capital of U.S. Corporations, December 31, 1965,” SEC release No. 2118, dated April 15, 1966------------------------649 VIII CONTENTS Additional information submitted to the committee by— -Continued Randall, Hon. K. A., Chairman, Federal Deposit Insurance Corpora tion: . , . Maximum interest rates payable on time and savings deposits m commercial banks prescribed by State laws or State banking authorities (table)--------------------------------------------------------Rees, Hon. Thomas M.: # “Block to Building—Big Outflow of Savings From S. & L /s Forces Cut in Mortgage Loans—Some Halt Lending for Now; Banks’ 5y2 Percent Rate on Time Deposits Attracts Funds—Dis appointed Homebuyers,” article from the Wall Street Journal, May 25, 1966_________________________________________ Statement of J. L. Robertson, Vice Chairman, Board of Governors, Federal Reserve System, on H.R. 15173----------------------------Reuss, Hon. Henry S.: Letter from John E. Home, Chairman, Federal Home Loan Bank Board, dated June 15, 1966, with an attachment-----------------Letter from Stephen Slipher, legislative director, United States Savings & Loan League, dated June 16, 1966, with a memo randum on CD situation------------------------------------------------Robertson, Hon. J. L., Vice Chairman, Board of Governors, Federal Reserve System: Activity in time deposits----------- --------- -------- ------------- ------Distribution of time certificates of deposit by size of certificate and size of bank, with table_____________________________ Liquid asset flows________________________________________ Negotiable CD’s, 1960-66 (chart)---------------------------------------Outstanding negotiable time certificates of deposit at weekly reporting member banks on selected dates (table)------------ — Passbook savings accounts in commercial banks, mutual savings banks, and savings and loan associations (table)-----------------Personal savings-type deposits—Commercial banks, selected areas, Seventh Federal Reserve District (table)---------------------------Reply on behalf of all Board members to questions submitted to each member of the Board of Governors, Federal Reserve System, by Hon. Burt L. Talcott_________________________ Statement on H.R. 15173_________________________________ “Time and Savings Deposits, Late 1965 and Early 1966,” article from the Federal Reserve Bulletin, April 1966______________ Time deposits—Balances at commercial banks, selected areas, Seventh Federal Reserve District (table)__________________ Rousseas, Stephen W., professor of economics, New York University: “Eurodollars: An Emerging International Money Market,” by Ernest Bloch____________________ _____________________ “Eurodollar Certificates of Deposit,” by Stephen W. Rousseas and Robert G. Hawkins, professors of economics, New York University____________________________________________ Growth, economic stability, and short-run changes in the income velocity of money______________________________________ 1 Telocity Changes and the Effectiveness of Monetary Policy, 1951-57,” article from the Review of Economics and Statistics, February 1960; and “Rejoinder,” from the Review of Economics and Statistics, November 1960___ _____________ St Germain, Hon. Fernand J.: Letter from Robert B. Perry, president, Washington Trust Co., Westerly, R.I., dated May 26, 1966_______________________ Telegram from Charles A. Post, secretary, Mutual Savings Banks Association of Rhode Island, dated May 31, 1966___________ Telegram from Clarence H. Gifford, Jr., president, Rhode Island Hospital Trust, dated June 3, 1966_______________________ Telegram from Kay Bowen, president, Old Colony Cooperative Bank, Providence, E .I., dated June 1, 1966______ _____ ____ Saxon, Hon. James J., Comptroller of the Currency: Outstanding negotiable certificates of deposit, by size of bank, May 18, 1966 (table)......................... ............................................. Real estate loans, insured commercial banks (table).__ - - ____ _ Page 425 249 209 557 558 515 219 513 172 173 247 518 192 209 220 517 677 348 320 307 671 415 530 415 284 278 CONTENTS IX Additional information submitted to the committee by—Continued Scanlon, Charles J., president, Federal Reserve Bank of Chicago: Comment concerning access to Federal Open Market Committee Page deliberations__________________________________________ 670 Stanton, Hon. J. William: “Here’s What People Say They Do About Saving and Investing Money,” advertisement from the Columbus (Ohio) CitizenJournal, May 24, 1966__________________________________ 288 Strunk, Norman, executive vice president, United States Savings & Loan League: “Housing Market Pinch Will Continue: Strunk/’ article from the American Banker, May 26, 1966_________________________ 674 Letter to Hon. William McC. Martin, Jr., Chairman, Board of 35 Governors, Federal Reserve System, dated April 11, 1966____ Memo to members of House Banking and Currency Committee on certificates of deposit, dated June 8, 1966__________________ 674 Sullivan, Hon. Leonor K.: “Bankers Must Accept Major Responsibility for Future of Present Financial System,” article from the American Banker, May 19, 1966_________________________________________ 492 “Bankers Warned To Use Caution in Promotion of CD’s,” article from the American Banker, May 13, 1966___________ 497 “Chicago Bank’s Ads H it 'Rate Race/ CD's,” article from the American Banker, May 31, 1966_________________________ 499 “Deming Cautions on Bid for Funds—Aggressive Bank Behavior in Fight for Time Deposits Assailed by U.S. Aid—Warning Flag Is Raised—Some Institutions Are Seen Overextending and Taking on Excessive Risks/’ article from the New York Times, May 10, 1966___________________________________ 498 “Deming Concerned Over CD Rates, Sees Patman Rx Too Strong/’ article from the American Banker, April 15, 1966; with Treasury Department’s comments to the article________ 143 “Plummer Urges More Restraint on CD R ates/’ article from the American Banker, March 29, 1966________________________ 495 “Treiber Warns NJBA on CD Dependence,” article from the American Banker, May 20, 1966_________________________ 496 Talcott, Hon. Burt L.: Comments by the Federal Reserve Board staff on a paper by Myron H. Ross entitled “Operation Twist: A Mistaken Policy/’ with comment by Mr. Todd______________________ 783 Questions submitted to each member of the Board of Governors, Federal Reserve System, with Mr. Robertson’s reply on behalf of all Board members___________________________________ 192 Statement of____________________________________________ 189 Todd, Hon. Paul H., Jr.: “ ‘Operation Twist’: A Mistaken Policy?” article by Myron H. Ross, from the Journal of Political Economy, April 1966------467 Report of the Committee on Financial Institutions to the Presi 711 dent of the United States, April 1963_____________________ Widnall, Hon. William B.: Letter from William F. Treiber, first vice president, Federal Reserve Bank of New York, dated May 25, 1966----------------243 x CONTENTS APPENDIX “Analysts See Prime Rate Boost as ‘Bullish’ for Bank Stocks, ‘Bearish’ for Page 667 Industrials,” article from the American Banker, March 11, 1966-.- — Announcement by Federal Home Loan Bank Board in response to “minimal action taken by the Federal Reserve Board,” Federal Home Loan Bank 802 Board release dated June 28, 1966-------------------------------------------------Announcement of increase in required reserves against time deposits from 797 4 to 5 percent, Federal Reserve press release dated June 27, 1966-------Announcement of results of survey of time and savings deposits at member 785 banks, Federal Reserve press release dated June 27, 1966--------------------Applicable tax rate and net operating earnings on common stock of 7 New 589 York City banks and 18 banks in other centers, 1960-65 (table)--------Applicable 1965 tax rate of 50 selected commercial banks, listed in order of 589 common capital accounts on December 31, 1965 (table)-------------------“Bank Loan Losses, Past and Present,” article from the New England Busi 600 ness Review, May 1966________________________________________ “Bank Profits: Another Record,” article from the Monthly Review, 592 April 1966___________________________________________________ 642 “CD’s a Problem for the Fed,” article from Banking, February 1966Comment concerning access to Federal Open Market Committee delib 670 erations_____________________________________________________ Comments by the Federal Reserve Board staff on a paper by Myron H. Ross entitled “ ‘Operation Twist’: A Mistaken Policy?” with comment 783 by Hon. Paul H. Todd, J r______________________________________ Correspondence between Chairman Patman and Hon. William McC. Martin, Chairman, Board of Governors, Federal Reserve System, con 605 cerning issuance of short-term promissory notes____________________ Correspondence concerning the application of Federal securities law to misleading bank advertisements of savings bonds (certificates of deposit) _ 610 Depositary liabilities to the public commercial banks, mutual savings 605 banks, and savings and loan associations (table)_____ ___ __________ Editorial cartoon indicating Federal Reserve Board’s weakness and in decision to bring interest rate war to immediate halt, from the Washing 803 ton Star, June 29, 1966____________________________ ____________ “Eurodollars: An Emerging International Money Market,” by Ernest Bloch______________________________ ________________ _____ ___ 677 645 Excerpt from Pratt’s Letter, dated December 17, 1965________________ “Fed Governor Would Add to Mutual Role,” article from the Washington 668 Post, May 18, 1966____________________________________________ Federal Reserve press release announcing actions to reinforce efforts to maintain price stability, and thus to foster balance in the economy’s continued growth and strength in the dollar's international standing, 644 dated December 6, 1965________________________________________ “Home's Emergency Ran—Slump in Housing Starts Anticipated by S. & L. Overseer Because of CD’s,” article from the Wall Street Journal, June 13, 1966____________ ________________________________________ 669 “Housing Market Pinch Will Continue: Strunk,” article from the Ameri 674 can Banker, May 26, 1966____________________________ *________ “How Banks Are Doing,” article from Bank Stock Quarterly, March 1966________________________________________________________ 590 “Keep Your Family Out of the Crossfire,” advertisement of the Watertown Federal Savings & Loan Association, Watertown, Mass________ _____ 638 Legislative history of provision of Banking Act of 1933 prohibiting payment of interest by banks on demand deposits_______________ ___ 651 Legislative history of 12 CFR 217.1(e)(1), 217.135 whereby banks which are members of the Federal Reserve System are precluded from accepting SaVfit^B tendered by commercial corporations operating for 653 Letter from George Champion, president, New York Clearing House, to Hon. Wright Patman, dated June 6, 1966.___________________ _____ 616 Letter from Robert B. Perry, president, Washington Trust Co., Westerly, R.I., dated May 26, 1966......................... . 671 Letter to Hon. Edward P. Boland from Bradford R. Collins, West Spring field, Mass., dated June 6, 1966__________________________________ 613 CONTEXTS Letter to Ron. Edward P. Boland from Otto A. Peterson, president, Ludlow Savings Bank, Ludlow, Mass., dated June 20, 1966_________________ Letter to Hon. Thomas P. O’Neill, Jr., from Lawrence H. Martin, presi dent, National Shawmut Bank of Boston, dated June 9, 1966________ Letter to Hon. William McC. Martin, Jr., Chairman, Board of Governors, Federal Reserve System, from Grover W. Ensley, executive vice presi dent, National Association of Mutual Savings Banks, dated May 10, 1966, with a bulletin from the NAMSB on industry deposit trends, April 1966____________________________________________________ Letter to Hon. William McC. Martin, Jr., Chairman, Board of Governors, Federal Reserve System, from Norman Strunk, executive vice president, United States Savings & Loan League, dated April 11, 1966_________ Memo to members of House Banking and Currency Committee on certifi cates of deposit, by Norman Strunk, executive vice president, United States Savings & Loan League, dated June 8, 1966__'________________ “Negotiable Time Certificates of Deposit,” article from the Federal Re serve Bulletin, April 1963_______________________________________ Press release of the New York State Banking Department concerning the illegality of issuance of negotiable promissory notes by national banks in New York State_______________________________________ Report of the Committee on Financial Institutions to the President of the United States, April 1963___________________________________ Resolution approved June 23 by Committee on Banking and Currency expressing sense of the committee that the Federal Reserve Board act within 30 days to end excessive interest rate competition_____________ “Should Negotiable CD’s Be Outlawed?” articles from Finance magazine, May 1966: “ Yes,” by Hon. Wright Patman, chairman, Committee on Banking and Currency_____________________________________________ “No,” by Dr. Carter Golembe, Washington economic consultant, American Bankers Association___ ___________________________ “Significance of the 1966 Business Outlook for the Savings and Loan Industry,” address by Dr. Gordon W. McKinley, vice presidenteconomics, McGraw-JHill, Inc___________________________________ “Some Reflections on Interest Rates and Their Economic Implications,” by Warren L. Smith, professor of economics, University of Michigan__ Telegram from American Bankers Association to Pat DuBois, president, Independent Bankers Association, criticizing position of IBA in support of measures to end rate war; with reply of Independent Bankers Associa tion to ABA criticism__________________________________________ Telegram from Pat DuBois, president, and Reed H. Albig, chairman, Federal Legislative Committee, Independent Bankers Association of America, favoring 4^-percent ceiling on time deposits_______________ Telegram to Hon. George P. Miller from the board of directors, Alameda First National Bank, Alameda, Calif., dated June 20, 1966__________ “The Increase in the Discount Rate: Timing, Motivations, Economic Effects,” article from the Conference Board Record, January 1966____ “The Savings War,” editorial from the New York Times, June 15, 1966_^ “Time Deposit Reserve Requirements Raised To Restrain Issuance of CD’s—But Boost by Reserve Board to 5 Percent From 4 Percent Is Termed Too Mild for Much Impact,” article from the Wall Street Journal, June 28, 1966--------------------------------------------------------------“Volume and Composition of Individuals’ Saving in 1965,” SEC release No. 2117, dated April 14, 1966___________________________________ “ Working Capital of U.S. Corporations, December 31, 1965,” SEC release No. 2118, dated April 15, 1966----------------------------------------------------- XI 614 614 611 672 674 620 609 711 785 639 641 654 659 784 613 615 631 615 799 646 659 TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS MONDAY, MAY 9, 1966 H C ouse of o m m it t e e o n B R e p r e s e n t a t iv e s , a n k in g an d C urren cy , Washington, D.G. The committee met, pursuant to notice, at 10:10 a.m., in room 2128, Rayburn House Office Building, Hon* Wright Patman (chairman) presiding. Present: Representatives Patman, Barrett, Ashley, Moorhead, Stephens, Gonzalez, Weltner, Gettys, Todd, Ottinger, McGrath, Han sen, Annunzio, Rees, Widnall, Harvey, Clawson, Stanton, and Mize. The C h a i r m a n . The committee will please come to order. We are meeting this morning for the purpose of considering H.R. 14026, concerning certificates of deposit and related matters. (The bill, H.R. 14026, follows:) [H.R. 14026, 89th Cong., 2d sess.Jf A BILL To prohibit insured banks from issuing negotiable interest-bearing or discounted notes, certificates of deposit, or other evidences of indebtedness Be it enacted ly the Senate and House of Representatives of the United States of America in Congress assembled, S e c t i o n 1. Section 18 of the Federal Deposit Insurance Act (12 U .S .C . 1828) is amended by adding at the end thereof the following new subsection: “ (j) The Board of Directors shall by regulation prohibit insured banks from making or issuing any negotiable certificate of deposit, note, debenture, or other negotiable obligation which is issued at a discount, or is interest bearing, or other wise yields any return.” S e c . 2. The amendment made by section 1 of this Act shall apply only with respect to obligations of insured banks incurred or issued after March 31, 1966. The C h a i r m a n . The term “negotiable certificates of deposit” is a fancy label for a piece of paper which many suspect is a vehicle for the most ordinary type of misuse and abuses. Technically speaking, a negotiable certificate of deposit is a debt security evidencing a de posit liability of the issuing bank. It is a form of time deposit and is subject to the Federal Reserve Board’s regulation Q as well as ap plicable reserve requirements. Maturities are as short as 30 days. CD’s are insured up to the $10,000 FDIC limit and in negotiable form may be quickly disposed of by the original depositor. A secondary market has developed in CD’s and CD’s trade in this market at prices reflecting the reputation of the issuing bank, maturity schedules, and, most of all, prevailing interest rates. One hundred years ago the banks were authorized to issue their own money and many of them did issue their own money. That money was very similar in purpose and effect to the CD’s of today. How 1 2 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS ever, today’s version is interest-bearing currency and could be just as prevalent over the country as the money that was issued by the banks before the War Between the States many years ago. Negotiable CD’s are a very recent innovation, having grown from virtually nothing in 1961 to over $17 billion of outstanding liabilities as of May 1966. Typically, a negotiable CD represents a large deposit by a business corporation of hundreds of thousands of dollars with a maturity of 1 year. Current posted interest rates exceed 5 percent. Smaller CD’s, both in negotiable and nonnegotiable form, are currently being promoted by commercial banks very aggressively and are being offered to savers and consumers in the form of certificates often called savings bonds. While the CD must be considered innocent until proven guilty to the satisfaction of the Congress, substantial evidence gathered over the past year or so compels us at this time to drop other important matters and consider whether or not remedial legislation is necessary. My bill, H.R. 14026, would prohibit the issuance by a federally in sured bank of any negotiable certificate of deposit, note, debenture, or other negotiable obligation yielding a return. The purpose of this bill is to curb specific abuses that may be found and not to hamper or impair the use of financial instruments for legitimate purposes. I will welcome suggestions for modification as the testimony progresses. H.R. 14026 is thus a vehicle for discussion and testimony should not be limited to its precise terms. It is not the only bill on this subject pending before the committee, and I am informed that members plan to introduce several additional bills this week. This series of hearings represents the first full-scale public airing of a new problem—the CD problem—and will necessarily be extensive with all sides and points of view to be heard. We may run 2 weeks or more. Some of the questions we will want to investigate involve the rela tionship between CD’s and— 1. Monetary policy; 2. High interest rates: 3. The thrift industry: 4. Homebuilding and the mortgage market; «> The Government securities market: *.' 6. Bank safety and liquidity; and 7. Unlawful activities. This morning our witnesses represent an important segment of the thrift industry. We will hear first Mr. Norman Strunk, of Chicago, 111., executive vice president of the United States Savings & Loan League, and then Mr. Everett C. Sherbourne, representing the National League of Insured Savings Associations. The committee will seek information from these witnesses whether the well-established public policy to encourage thrift and home©wnership is being jeopardized or in any way impaired by the phe nomenal growth of CD’s in recent years. That the thrift industry has long been recognizeiias Congress’ primary tool in mobilizing savings for home financing and home building is beyond dispute. Beginning with the act creating the Federal Home Loan Bank System in 1932, the Home Owner’s Loan Act of 1933 establishing a system of UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 3 federally chartered associations, and legislation in 1934 providing share account insurance, the savings and loan industry has carried out this congressional policy in a most satisfactory manner, and the industry has grown in assets to over $130 billion. The vast majority of associations are small, independent, locally owned institutions and it seems to me that Congress has a particular responsibility to make certain that these thrift institutions continue to effectively meet the housing needs of heir communities. Thrifty people with savings accounts are better citizens and home owners are better citizens. So we must be sure that the great goals of our thrift industry are not threatened by CD’s. Mr. Strunk, we are glad to have you, sir, and you may proceed as you wish. You may identify yourself and identify the gentleman accompanying you for the record. STATEMENT OF NORMAN STRUNK, EXECUTIVE VICE PRESIDENT, UNITED STATES SAVINGS AND LOAN LEAGUE; ACCOMPANIED BY STEPHEN SLIPHER, STAFF VICE PRESIDENT AND LEGISLA TIVE DIRECTOR, UNITED STATES SAVINGS & LOAN LEAGUE Mr. S t r u n k . Thank you, Mr. Chairman. I am Norman Strunk, of Chicago, 111., and I am executive vice presi dent of the Savings & Loan League and I have with me, Mr. Stephen. Slipher, of Washington, our legislative director. We welcome this opportunity to express our views on the general subject of certificates of deposit and to discuss generally our views on the current situation in the savings market and the availability of money for homebuying and homebuilding. We consider it most constructive that the distinguished chairman of the House Banking and Currency Committee has introduced H.R. 14026 and has called these hearings which will provide a much-needed spotlight on the spreading use of certificates of deposit within the commercial banking system—a development which appropriately may be viewed with considerable concern by the American people. It cer tainly deserves a searching inquiry by the committee of the Congress that has responsibility for legislation in the field of finance. The United States Savings & Loan League represents more than 5,000 individual savings and loan associations. We are very familiar with the flows of savings, real-estate financing, and the needs of the country with respect to mortgage credit for homebuilding and homebuying. We do not claim to be experts in monetary theory and the money markets, but we can see the effect of the increasing use of certifi cates of deposit on savings flows and the effect on the amount and cost of money available to ordinary people who buy homes. Our interest in certificates of deposit, however, is broader than the effect upon the cost of credit to individuals. This country needs a strong commercial banking system and we believe that any new devel opment in the banking field which might in any way impair the useful ness, and particularly the soundness and liquidity of commercial banking is a m a t t e r of broad public interest and should be the subject of careful inquiry. 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS We think that the sale by the large banks of negotiable certificates of deposit and the issuance of deposit certificates with definite maturi ties and long-term contractual promise to pay certain rates of interest in the ordinary savings market are practices that can threaten not only the liquidity but also the basic soundness of the commercial bank ing system. A certificate of deposit is the issuance by a commercial bank of a receipt for funds deposited with the bank for a specific length of time and bearing a specific rate of interest. Negotiable certificates of de posit began to be promoted, very actively, 5 or 6 years ago by major New York City banks. Probably no one had any idea that these cer tificates would develop in such a short time to the tremendous volume that has resulted. Certainly no one would have thought 5 or 6 years ago that negotiable certificates of deposit held by corporations would have produced the kind of liquidity crisis in the New York money markets that developed last December. In practice a negotiable certificate of deposit is very much like a Treasury bill, like the obligations issued by the various Federal agencies including the Federal Home Loan Bank System and the Federal National Mortgage Association. Certificates are very similar to commercial paper issued by finance companies and various cor porations. In the space of a very short period of time negotiable cer tificates of deposit have developed into the second most important short-term money market instrument—exceeded in dollar volume only by short-term obligations of the U.S. Treasury. The use of certificates of deposit in significant volume placed the banks, for the first time, in the contractual position of having to pay a certain rate of interest on obligations maturing on specific dates. While in fact demand deposits may be said to have 1-day maturities, the issuance of demand deposits, carefully handled, does not produce the recurring liquidity problems as can the issuance of I O U’s with definite rates of interest and definite maturities. In contrast, the typ ical passbook savings business as practiced by the commercial banks and as practiced by thrift institutions, does not impose immediate and recurring liquidity problems as does the issuance of a large volume of certificates of deposit with contractual rates of interest and matur ing on definite dates. The payment of interest on large, short-term corporate deposits of this type and making loans with this kind of “hot money” has in troduced a new element of vulnerability into the commercial banking business. This element of vulnerability is simply that during a period of ris ing interest rates, there is mounting difficulty in “rolling over” matur ing certificates of deposit. This element of vulnerability has been apparent to observers of the commercial banking business and to many bankers themselves. It also has been quite apparent to the Federal Reserve Board, and from time to time members of the Board of Gov ernors expressed some concern about the potential liquidity problems which accompanied the buildup in negotiable certificates of deposit. On October 22, 1965, George Mitchell of the Federal Reserve Board declared in a speech in Chicago that the money behind certificates of deposit is the £most vulnerable” of all bank deposits because corporations and other holders of certificates are likely to respond quickly to UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 5 relatively small increases in interest rates on other short-term cer tificates. The vulnerability of the commercial banking business to changes in interest rates at a time when a large volume of certificates may be maturing was dramatically evidenced by the certificate of deposit crisis last December. With interest rates rising and with a large amount of negotiable certificates of deposit coming in the Federal Reserve Board boosted the maximum permissible ceilings on time deposits to 51/2 percent. The Board has acknowledged that the increase in time deposit ceilings was essential if the commercial banks were to be able to renew approximately $3^ billion in negotiable certificates of deposit scheduled to mature in December. The Board also admitted before the Joint Economic Committee of Congress that if the increase had not been granted, banks would have been forced to call many outstanding loans in order to meet these maturing certificates of deposit . A number of things have concerned us about the events of last December. We believe, for example, that in view of the fact that the commercial banking business is $400 billion in size, the apparent inability of major banks in the United States to liquidate $3^/2 billion in maturing obligations should be a matter of proper concern for the Congress of the United States. Another thing that has disturbed us is that despite the great cer tificate of deposit crisis of last December, nothing much seems to have been done to avoid a repetition of this crisis. On the contrary, the amount of negotiable certificates of deposit has increased from $16.3 billion in November 1965 to $17.4 on April 20, 1966. It is well known that several commercial banks in this country have failed in great part as the result of excessive and unwarranted use of certificates of deposit. With short-term interest rates again pushing upward and with some of the largest commercial banks already paying 5y 2 on certificates of deposit, a question that must be faced is: What happens if interest rates continue to move up? Will some banks find even a 5y 2 ra^ inadequate to keep their certificates ? Will the Federal Reserve Board find itself under renewed pressure to boost these ceilings even further in order to permit the major banks to secure renewals in the coming months ? We hope that during these hearings this committee will inquire into what the regulatory bank agencies are doing to police the issuance of certificates of deposit and what steps they are taking to avert another “CD crisis.” Again, I am not a specialist in central banking or in monetary policy, but it does occur to me that the widespread use of certificates of deposit might force the Board of Governors and the Open Market Committee to do certain things just to ease the banks through maturity periods—things that the Board of Governors would not otherwise want to do or have to do. It also occurs to me that the hands of the Board of Governors should not be forced in certain directions as a result of excessive use of certificates of deposit. We have the feeling in the savings and loan business that this is a new money market instrument the effects of which are not yet fully 6 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS understood, that a new type of banking lias developed to a point where it is far greater than anyone expected it to develop and we are con cerned that deposit certificates, while viewed with some concern by the bank regulatory authorities, have not been subjected to any known controls. Possibly the banking agencies have begun to enforce some informal and unwritten rules with respect to the use of the certificates—their amount in proportion to total deposits of the bank, the spacing of various maturities, and the payment of “bounties” of this money. However, we have seen no published guidelines or regulations and we fear this new phase of commercial banking is still largely an unregu lated and unsupervised operation. While the problem of negotiable certificates is an important one and deserving of thorough study, we believe that the spread of certificates of deposit into the savings market can be equally significant. The fact that the new time deposit ceilings of 5i/2 percent are being used ex tensively by commercial banks to recruit savings-type money—the kind that always has been in the passbook type of account in the com mercial banks—may in the long run be substantially more important. Many thousands of small banks in our country appear to be just as concerned as savings and loan people. The concern on the part of many small banks was reflected in the speech of the president of the American Bankers Association on January 31 in which he warned that the “unrealistic generous rates paid on certificates of deposit threaten to siphon funds out of smaller banks and, therefore, disrupt Credit in many of ^ communities of the country.” The Federal Reserve has, in effect, lifted ceilings off of the savings market and opened the way for unrestrained competition in the savings market on the part of the commercial banks. The history is clear of what happened the last time we had competition of this type. The promotional-minded banks begin to pay unusually high rates and then m order to protect themselves, more conservative banks are forced to increase their rates to prevent their deposits from being siphoned away. Ihrough this process, the price paid for savings money has skyrocketed even though the overall pool of savings may not have increase . Then to meet these higher costs, banks are forced to reach * ■ ™ *or loans in order to secure the earnings and high ™ ier kT r c?™ Pe?fate f°r the higher deposit costs. We believe that the Board of Governors wanted to avoid rate wars m p S T Wlth SaT £ s ?f the ¥ nd that has been lodged in comstitntmr»cann Sar!n^S and the savings accounts of our intho ? eCeni^ ^ year *n ^ scussing the increase in ™te ^ in c r e a s e in the time deposit ceiling the Sent™ Federal Reserve Board made the following staterate*fo^sa^imfs ^eDos?t<TS T ?h asrPosely refrained from raising the maximum competitive relaHonSiin* 80 m or<3er to minimize the impact on savings-type money. We expressed the view at that time that UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 7 regardless of this statement of intent, unless tlie Federal Reserve took some action to restrict the use of the new time deposit ceilings to very large denomination amounts, it was inevitable that the new rates would be used extensively for savings money. The action of the Board of Governors in permitting the 5^-percent rate on CD’s may have been necessary to prevent the major corpora tions and investors from withdrawing massive sums from CD’s on maturity dates. The manner in which this problem was solved, how ever, has created a whole set of new problems. In spite of the December optimism that relatively few banks would raise rates and only in modest increments, and that other savings in stitutions would not be materially affected, we find the following ac tual developments: (1) Large numbers of banks have increased their interest rates substantially with aggressive promotion. (2) The certificate of deposit has been made to resemble an or dinary savings account by reducing the required deposit to $1,000, $100, or even less; by shortening the maturity, and by providing for automatic renewal. (3) The adverse effect on the flow of savings into savings and loan associations and savings banks has been severe and the situation is worsening monthly. Those commercial banks unable or unwilling to compete at the new rates are equally affected. It is pointless to debate where the fault lies and it is not our inten tion to dwell on who, why, or what caused things to go astray. We just recommend that everyone involved recognize the facts as they now exist and proceed to take steps that will restore balance and pre vent a recurrence of the problems of last December. At the time of the change in regulation Q last December, the United States Saving & Loan League and others predicted that the result would be an acute tightening in mortgage credit. We are rapidly arriving at this point. As this committee knows, the great bulk of funds for home mortgage lending comes from two types of institutions primarily—savings and loan associations and savings banks. Savings and loan associations located in communities throughout the country traditionally have provided from 40 to 50 percent of all the funds for home mortgage lending. Mortgage interest rates do not fluctuate widely as do the rates on Government bonds and short-term loans. For many of our institutions, rates in tlie range of 5 to 6 percent are charged year in and year out regardless of conditions in the money market. Beyond this, many State laws prohibit charging more than 6 percent or sometimes 7 percent for a mortgage loan on a home. Rates beyond this under many State laws are usurious. The earnings of savings and loan associations today and our ability to pay high rates of interest for funds of the public are limited by the fact that our money is invested in mortgage loans made when interest rates were lower—last year, 2 years ago, 5 years ago, or 10 years ago. The earnings from a long-term portfolio of mortgage loans do not increase very rapidly when money tightens and interest rates go up in the money market. It is partly to provide some offset to this in flexibility that the United States League has submitted to your Hous ing Subcommittee legislation that would permit savings and loan as 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS sociations to make limited investments in loans on household furnish ings and loans on mobile homes. The commercial banks, as short-term lenders with their funds in vested in short-term business loans and high-interest-rate consumer loans, are able to charge more in periods of high interest rates, and commercial bank loans can be adjusted to higher interest rates more readily. Bank earnings, thus, can increase very rapidly in periods of rising short-term interest rates and they can pay higher rates on savings. In many instances today, commercial banks can afford to pay inter est rates of 5 and 5% percent for the savings of the public much more easily than can savings and loan associations and savings banks. In great part because the commercial banks are bidding actively for sayings funds at rates beyond those which can be paid by institu tions investing in mortgage loans—and trying to provide economical home financing: as is our mandate from Congress—today we are not attracting savings funds for mortgage lending in a satisfactory vol ume. The first 3 months of this year our net increase in savings was about $1,300 million compared to $1,900 million last year and as high as $3 billion in the first quarter of 1963. Adverse savings flows, together with new restrictions on the avail ability of Federal home loan bank funds for mortgage lending and some decrease in loan repayments, suggests that in the last 8 months of this year our institutions will do well to make $11 billion in mort gage loans compared to $17 billion in mortgage loans in the last 8 months of 1956. At $20,000 per loan, the $6 billion drop represents 300,000 home loans that will not be made during the remainder of this year, as compared to loan value last year. This will mean for the year as a whole an overall loan volume of $18 billion as compared to a volume of $23.9 billion during 1965. The 1966 loan volume represents a huge sum of course, and means that savings and loan associations will be continuing a substantial participation in the mortgage market. Nevertheless, the lending capacity of the business will fall far short of the demands of American home buyers. This means more and more careful screening of borrowers. If you are a superb credit risk, credit will be available; however, many American families who would ordi1066 mortgage loans will probably not make the grade in Not all of this decline in the availability of funds for mortalo-e lendmg is due to the very aggressive promotion by commercial banks of 5 percent CD s packaged in denominations for easy sale to the public and m a manner designed to attract money of the kind that typically goes into passbook savings accounts. We are, naturally, suffering from s t he a ir ’ and that At this point let me make it perfectly clear that a loss in s a v i n g , or a reduction m the growth of savings, does not per se have any Averse effect on the financial condition of our business. Financial institutions go into default because of bad loans and investments, not because Z pie withdraw savings. The savings and loan business today is n a strong, safe, financial condition. The ratio of our reserves to our s a v ings is increasing; loan delinquencies and foreclosures are dropping UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 9 appraisal practices have been tightened; and associations are main taining much more complete records on the condition of their loan portfolios. Furthermore, as a result of legislation enacted in 1961, the reserve ratio of the Federal Savings and Loan Insurance Corporation has more than doubled in 5 years. The Corporation has far greater funds, absolutely and relatively, than ever before. The tiny number of savings and loans and other financial institutions which have been in difficulty has, of course, been well publicized. But there are over 6,000 strongly, well-managed savings and loan associations doing business. In short, there is nothing in the picture to cause concern to the Ameri can saver. It is the home buyer who faces problems. While savings and loan associations have been forced to reduce their mortgage lending, the fact remains that we have been more actively in the mortgage market longer this year than other lenders. The com mercial banks that made such great promises a few years ago about getting into the mortgage loan field have, in fact, virtually ignored it in the past year. The commercial banker never has been very enthusiastic about mak ing mortgage loans and he certainly does not make mortgage loans when there is a large demand for short-term, high-interest-rate loans from business and then the bank can put more and more money into loans on automobiles. A severe drought in mortgage funds will very definitely reduce the volume of homebuilding the latter part of this year. We think that not only will there be a great reduction in the volume of loans for homebuilding, but there will even be a shortage of money for the pur chase of existing homes. In all frankness, it has appeared to me that the policies of the bank ing authorities in letting the certificate of deposit business at the banks grow bigger and bigger and spread throughout the banking community seem to ignore completely the welfare of specialized sav ings institutions and the vital role of these institutions in providing a steady flow of home mortgage credit. There must be an understand ing of the fact that the typical buyer of a home and the typical homebuilder generally has weaker credit and fewer opportunities to borrow money than corporations and the sponsors of large apartment projects. Savings and loan associations were created to assure a steady source of credit for typical families for whom homeownership is a dream and, we hope, a realizable dream. The country needs a type of in stitution where home buyers can go and have their needs taken care of in a convenient manner, where interest rates are not excessive, by people who understand the home mortgage loan transaction; a place where typical home buyers can go and not have to compete for money against big corporations and business borrowers. While we share the concern of many about the practice of com mercial banks in the issuance of large negotiable certificates of de posit, our main problem is the effect on the typical home buyer aris ing from the practice of commercial banks using the certificate de vice to attract the small savers and the money that typically has gone into passbook accounts in banks ^and savings and loan associations. This relatively new development in the growth of savings certificates obviously was not anticipated when certificates of deposit first de 10 UNBOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS veloped a few years ago and it obviously was not anticipated last December when the Federal Reserve perm itted the commercial banks to pay as high as 5% percent on CD’s. Instead of the typical $50,000 or $100,000 certificates negotiated with a corporation, these new certificates are now aimed at the pass book savings market. Their increasing use “runs around the end 7 of the Federal Reserve’s prudent decision not to raise the ceiling on or dinary savings. Banks are promoting these new certificates with full page ads, with m aturities as short as 90 days, and with minimum amounts as low as a few dollars. Even those with $1,000 or $2,500 minimums are exactly in the bracket that constitutes the heart of our savings funds. This use of certificates of deposit for ordinary savings was not predicted by the Federal Reserve. In fact, the Federal Reserve Board has publicly cautioned the banks against this disruptive competition. So has the Federal Deposit Insurance Corporation. The hectic com petition has also been criticized by many leading bankers. But it continues. As a minimum program of action, we make the following recom mendations to this committee—I emphasize this is a m inim um : (1) Certificates of deposit must have a single m aturity. I t is the practice now to allow the saver to sign up for one m aturity and then permit him to take a shorter m aturity at a lower rate. This, in ef fect, gives him the best of all worlds. The fixed m aturity would emphasize th at a certificate of deposit is a distinct banking instrument and not an ordinary savings account. (2) The practice of automatic renewals of certificates of deposit be eliminated. The automatic renewable feature makes this certificate more closely resemble ordinary savings. I t puts the bank in a bind, committing it for a given rate over a longer period of time. It also contributes to some very misleading advert ising. (3) Amend the banking laws to prohibit misleading advertising and provide the Federal Reserve, the F D IC , and the Comptroller of the Currency with specific authority to require th at advertisements c a n y a true story of the services being offered. I believe the committee has in its files numerous examples of ads featuring “25-percent interest7 ’ which is, of course, for a 5-year period. I t is very confusing because interest rates traditionally are expressed on an annual basis. We would expect that with appropriate encouragement from this com mittee the banking agencies could eliminate most of these abuses with out new laws. I f these relatively minor changes can be made, the certificate of deposit will resume more of its traditional function and there will be much less disturbance in the savings market. A t the same time, it would not be such a precipitous change as to inject new problems for commercial banks. We do not consider these as antibanking sugges tions. We feel they are consistent with the recent and urgent pleas fo r moderation in banking called for by Mr. Archie Davis, the presi dent of the American Bankers Association. Unless something is done to ease this hectic rate war, savings and loan associations face retrenchment in home lending which could trigger a major recession in housing. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 11 In conclusion, let me say that the savings and loan business of over $130 billion in assets—I suspect it is a little less after the month of A pril—is and will continue to be, a vital segment of the financial community, and an important factor in the national economy. O ur leaders are responsible men. We fully recognize th at the savings and loan business does not operate in a vacuum; that it must conform to national policy; that it must be subordinated to national needs. We are not against competition for savings and mortgages. O ur con cern is th at the chain of events may have led to “over reaction” and that the pinch applied to the housing m arket may be unintendedly severe. We appreciate this opportunity to present our views and we are confident that this committee will approve appropriate and construc tive legislation. The C h a i r m a n . Thank you, Mr. Strunk. Now, if it is all right with the members of the committee, we will hear the representative of the other savings and loan associations and interrogate the two together. So without objection, you may proceed, Mr. Sherboume. You may identify yourself for the record and also identify the gentlemen who are accompanying you. STATEMENT OF EVERETT C. SHERROURNE, PRESIDENT, CITY FED ERAL SAVINGS & LOAN ASSOCIATION, WHIPPANY, N.J.; ACCOM PANIED BY WILLIAM J. KERWIN, ASSISTANT EXECUTIVE DIRECTOR, AND WILLIAM F. McKENNA, GENERAL COUNSEL, NATIONAL LEAGUE OF INSURED SAVINGS ASSOCIATIONS Mr. S h e r b o u r n e . My name is Everett C. Sherbourne and I am president of the City Federal Savings & Loan Association of W hippany, N. J., with 10 ofeces in 3 adjoining counties. I have with me here Mr. W illiam J . Kerwin, assistant executive di rector of the National League of Insured Savings Associations and Mr. W illiam F. McKenna, general counsel of that organization. Mr. Chairman, I want to express the appreciation of the National le a g u e for this opportunity to appear l>efore this distinguished com mittee of the Congress. In the past, you have done much to develop the Nation’s system of private financial institutions and, in particular, the th rift and home financing industry of the Nation. I would also like to commend the committee for this current series of hearings which we hope will lead to legislation th at will halt the widespread misuse by commercial banks of negotiable certificates of deposit and other time deposit instruments. The carte blanche given commercial banks bv the Federal Reserve Board over the last several years to buy money from every conceivable source at ever-increasing interest rates—climaxed by the increase in the permissible rate ceiKng on time deposits to 5.5 percent last De cember—has already caused unduly harsh effects on savings associa tions and the housing and mortgage m arkets of this country. To per m it continued uncontrolled use of these destabilizing money instru ments by commercial banks w ith the encouragement of the Federal Reserve B oard will, unless checked by legislation, result in a chaotic 12 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS impact upon the Nation’s thrift institutions and the entire housing market. The wisdom of your committee’s consideration of this subject at this time and the severe and rapid changes that are occurring in the savings and housing markets as a result of the December change in regulation Q is confirmed by the fact that although the Federal Re serve Board itself just released a survey of post-December rate ad justments made by commercial banks, it announced this morning a new survey because “the market for savings has been undergoing rapid change in recent months.5 I can testify that is certainly the case in ’ the State of New Jersey. It may be more than coincidence that the new survey announced today reaches the news media at the same time that this committee begins its hearings. The volume of negotiable certificates of deposit has grown, with the consent of the Federal Reserve Board, from a negligible amount in 1961 to the enormous sum of over $17.5 billion. The use of this in strument to purchase bank deposits of short duration at high rates has caused continuous liquidity crises in the commercial banking sys tem almost every 3 months because of the maturity concentrations in the quarterly periods in which corporations pay dividends and taxes. There appears to be little doubt that the volume of outstanding ne gotiable certificates of deposit constitutes a money market force which the Federal Reserve Board is unable to cope with except by increas ing the rates banks may pay for these deposits. An analysis of the Board vote in December on the discount rate increase indicated that with one exception even those members voting against the discount rate increase voted in favor of increasing regulation Q from 4.5 to 5.5 percent. The volume of maturing December negotiable certificates of deposit and the liquidity crises facing the banks using them ap parently left the Reserve Board with no other choice. That is a statement made to me bv presidents of banks in New Jersey. This situation was again repeated in March and April of this year according to the financial journals, and as a result many banks, spear headed by the largest banks in the country, went to the 5.5-percent maximum. The December action of the Federal Reserve Board not only per mitted banks to boost their rates sharply on time deposits and cer tificates of deposit but also greatly shortened the time period in which such a deposit would be eligible for the new higher rates. Prior to December 6, banks were authorized to pay up to 4 percent for time deposits and certificates of 30 to 90 days and 4.5 percent on those of 90 days or more. The December order, however, increased the rate ceiling to a flat 5.5 percent and permitted this rate on any time deposit or certificate with a maturity of 30 days or more. Thus, time deposits by the Board’s action came exceedingly close to becoming demand de posits. The pervasive influence of high interest rate and short dura tion spread to nonnegotiable deposit instruments such as savings cer tificates, savings bonds, and these are now being offered to the public by banks in most of the larger metropolitan areas of the country. Comparisons of the composition of the increase in time deposits of weekly reporting member banks for the first 4 months of 1964, 1965, and the current year illustrates dramatically the Federal Re serve Board statement in its press release today that “the market for savings has been undergoing rapid change in recent months.” UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 13 This table summarizes the composition of the increase in time de posits in the first 4 months of each year for the years 1964, 1965, and 1966: Time deposits of weekly reporting member "bcmks—Individuals, partnerships, and corporations [Dollar amounts in billions] Year Increase Amount 1964..................... ........................ 1965............................................. . 1966............................................... $1.640 2.626 4.760 Other time deposits Negotiable CD's $1,441 2.158 1.405 Percent 87.9 82.2 29.5 Amount $0.199 .468 3.355 Percent 1 .1 2 17.8 70.5 There are two substantive matters involved in this committee’s current consideration of the Federal Reserve Board’s administration of regulation Q and the annual increases in permissible interest rate ceilings paid on time deposits which the Board has authorized in each of the last 4 years. One deals directly with the liquidity of the bank ing system arising from the concentration of huge volumes of time deposits in ever-shortening maturities at the same time that bank loan-deposit ratios approach or surpass alltime highs. The second is the unduly severe and potentially chaotic impact these Board-authorized increases in interest rates have on savings institu tions and the residential housing market. The effect of these developments upon savings institutions and hous ing markets is not an exercise in theoretical possibilities; they exist right now. I attended a meeting in Atlantic Citv a few days ago and the possibility in July of withdrawals that may be created by the CD market is one which is causing such great concern that the institutions find it difficult to determine w^hat their lending programs can be for the next 6 months or even for that matter, for the next 3 months. Both savings and loan associations and savings banks experienced substantial losses in savings last month. These losses are not being recouped. And further substantial reductions in existing savings held by these institutions accompanied by massive distortions in housing credit are a certainty unless some relief is given by this committee and the Congress. In my own institution, in December, we were making some loans at 5.25 percent, a substantial portion at 5.5 and an equally substantial proportion at 5.75 and some at 6. Our institution has about $137 million in assets and is the second largest savings and loan association in the State. In the last 3 months we raised the rates progressively with the hope of cutting down on the volume of loans, the ever-increasing number of loan applications that we were receiving and at the present time we are at 6 percent flat. Never in the entire 25 years that I have been in this institution have we had such a rapid rate of increase in such a short period of time. Funds available for residential mortgage lending are the tightest in the history of my long association with the savings and loan business. Mortgage interest rates have risen abruptly as a result of the high interest rates authorized by the Federal Reserve Board, and in 14 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS my judgment will go even higher. The raid on existing savings balances held by savings institutions resulting from the rechanneling of savings funds to the commercial banks has forced most savings and loan associations to reduce sharply forward loan commitments and marshal their resources to combat an unknown and imprudent and unsound spiraling interest rate competition for a limited supply of savings funds. The Federal Reserve Board’s policy of increasing interest rates has not produced additional savings. Net additions to savings in savings and loan associations, savings banks, and commercial banks are less for the first quarter of this year than any similar period since 1961. They should have had reason to anticipate this would result because of the economic markets and economic authority that the interest rate does not have much of an effect upon the increase in additional savings. While it is recognized that the demand for credit accommodations in many sectors of the economy is strong, such demand does not warrant a deliberate policy designed to prevent savings institutions from compet ing for new savings or even holding balances they already have. The savings and loan business provides a unique service to the American public—encouraging thrift in order to provide funds on a long-term basis for housing our citizens. We are proud of our contributions to the American people, the American economy, and the American way of life. We have done this with small institutions of less than $50 million. By necessity, our mortgage loans are long-term extending over 20- and 30-year periods so that the average citizen can enjoy the benefits of homeownership when he needs the space to raise his family. Our mortgage portfolios turn over slowly, and we can not adjust earnings rapidly enough to meet the interest rate competi tion from commercial banks that enjoy lower money costs principally because they do not pay anything for demand deposits, nor are we able to compete with them because we can’t issue that kind of instru ment. Savings and loan associations are vitally interested in stable and rewarding dividends to all savers as well as stable mortgage interest rates to homebuyers. We have a great respect for the com petitive American economy and free enterprise, since we are dedicated to providing two of its major bulwarks. However, we do not believe that the rewards for our services should take the form of an abandoned ship buffeted by the churning, uncontrolled, higli-interest-rate waves produced by the money managers. I have a great deal of respect for the manner in which the Federal Reserve Board has throughout the past 5 or 6 years exercised control over the money market to give us a progressive and sound economy. But frankly, I am astounded at this particular development and in all frankness, when it was issued I didn’t have any reason to anticipate the results here today and the problem is one that requires early action. During the last period of “tight money” in 1959 it is interesting to note that the Federal Reserve Board did not change the interest rates commercial banks could pay on savings deposits. From January, 1, 1957, to January 1,1962, permissible interest rate ceilings under regu lation Q were 3 percent for savings deposits and 3 percent for time deposits of 6 months or more, 2.5 percent for deposits of 90 days to 6 months, and 1 percent for deposits of 30 to 89 days. Evidently, the UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 15 Board believed then that there was no economic sense in changing regulation Q to permit an unsound competitive interest rate war for the then limited supply of savings. Since 1962, however, the policy pursued by the Board via regulation Q has changed considerably. Permissive interest rates have been ad justed upward four times. Moreover, the period of time a deposit had to be held to qualify for higher rates was progressively shortened. The distinction between 30-day money and term money of 6 months and longer disappeared, and it would appear that the Board consist ently condoned and furthered the concept that money of any duration was suitable to support a banking business that was constantly making longer term loans and investments. As late as November 23, 1964, time deposits of 30 to 89 days were limited to an interest rate of 1 percent. Now, such short deposits can be paid 5.5 percent. It would appear that these changes in the regulation were directly related to the growth in negotiable certificates of deposit. Bates were consist ently increased to permit the volume of these certificates to increase. As the volume grew, the liquidity exposure increased. Now, the unstabilizing effects of this policy by the Board have spread to almost all forms of nonnegotiable time deposits as well. Until the rate change of last December, most of the four upward rate adjustments in regulation Q were attributed to adjustments re quired by our international balance-of-payments position; i.e., to maintain interest rate levels which would keep domestic funds at home and attract foreign investments. Nonetheless, commercial banks in creased their foreign loans and investments $1 billion in each of the years 1961-63, and m 1964, the year in which regulation Q was changed to permit banks to increase interest rates from 1 to 4 percent on 30- to 89-day deposits, and from 4 to 4.5 percent on over-90-day time de posits, the banks increased foreign loans and investments by $2.4 bil lion. The logic of increasing interest rates payable on time deposits domestically for the stated purpose of curtailing the flight of funds abroad, and then to have that money channeled into the commercial banking system which proceeded to lend it in the very same foreign markets is contradictory on its face. The record of the Federal Reserve Board’s administration of regu lation Q speaks for itself. The essence of the discretionary authority vested in the Board by the Congress is the maintenance of a sound banking system and the prevention of uncontrollable upward, spiraling interest rates whose inevitable aftermath is distorted and chaotic credit markets and massive dislocations in housing and other major industries. During the last several years, the savings and loan business has been the subject of tight regulation by the Federal Home Loan Bank Board. Among these restrictions is a Board ruling adopted August 16, 1964, sharply restricting the use of certificates of deposit by sav ings institutions for liquidity purposes, an indication of the concern that has developed in Government over the CD instrument. The Congress now has the opportunity to act to prevent further misuse of regulation Q. We would urge that consideration be given to a redefinition o f a “time deposit” t 6 give recognition to the fact that “demand” and “time” deposits are different and require a time differential o f m o r e than 30 dfcyS. A 6- to 9-month differential would 16 UNSOUND COMPETITION FOE SAVINGS AND TIME DEPOSITS be desirable. The issuance of “savings bonds” or “savings certificates” at rates higher than the rate ceiling on savings accounts should be terminated. Finally, the National League would urge this committee to take whatever action is necessary to prevent regulation Q from being used to create chaotic destructive competition in the Nation’s money mar kets and the accompanying adverse impact on home financing opera tions. We also believe that the CD problem is just one facet of a competi tive struggle between banks on one side and financial intermediaries such as thrift institutions on the other. We observe that commercial banks have been recipients of many favorable actions by Government agencies and Congress to facilitate their growth and development in recent years, while similar treatment has not been accorded the finan cial intermediaries. We believe this committee could render a major service by a well-considered study of competition between various financial institutions and ways in which these institutions—both banks and thrift institutions—can broaden their services to the Amer ican people. Thank you. The C h a i r m a n . Thank you very much. You gentlemen have each given us a good paper on the subject and we thank you very much. It has been very helpful to our committee. The basic trends behind the CD from the commercial bank stand point are not fully discussed by either one of you in your statements before the committee. I just have been wondering whether or not, under the law, they are permissible for commercial banks. Commer cial banks, of course, have a great privilege—they have the exclusive sole privilege of accepting deposits for checking account purposes. No other financial institution may offer checking accounts. They have an exclusive in that respect, which gives them a great advan tage. It is a wonderful opportunity for them to create goodwill for themselves, and they take full advantage of it, as they should. But if a person were to go to the Comptroller of the Currency and ask for a charter for a new bank on the representation that he wanted to establish a bank in a town that is already well supplied with banks, the Comptroller of the Currency would probably say, well, now, we usually establish banks where there is a need, a demand for services for banks that are not being filled at the present time. And, where are you going to get your deposits? These other banks seem to take care of all of the deposit needs of the people in the community and this person who is an applicant for the charter would state, well, we will get our money by outbidding other people all over the Nation, New York, Chicago, Detroit, Dallas, and elsewhere, and we will run our bank by outbidding all others. I do not think that would be a very good reason for a charter and I am sure that the application would be turned down. In this particular case that we are discussing, we find a similar or comparable situation. But, although they are not using this as a reason or argument to get a new charter, they are using the establish ment, having been created already, the charter issued, for just that same purpose. I just do not believe it was ever contemplated or intended under the law that CD’s would be used by commercial banks UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 17 in that way, and I think the committee would be interested in a good legal presentation along that line, and if you gentlemen, representing the savings and loan industry, which we are all very proud of, over $120 billion, and one of the greatest financial institutions in our country—if you would prepare such a paper and give legal arguments, I think our committee would like to see it. Would you give some consideration to that, Mr. Sherbourne and Mr. Strunk ? Mr. S t r u n k . Yes, sir; that is a very good idea. That particular line of approach has not been considered by us. The C h a i r m a n . The way I see this, this is a critical time. In 1932 I was here when banks would not encourage homebuilding. Their terms were too particular and interest rates too high. And Mr. Hoover at that time, representing his party, now the minority party, he thought it was so serious, he asked for passage of the Federal Home Loan Bank Act which caused the creation of all these Federal savings and loan associations. Before that time they were referred to as homebuilding associations, and building and loans and many other different kinds of names, but this concentrated the name in one phrase, savings and loan associations. Now, since that time, you people in that business have done a won derful job, just a wonderful job. You take California, for instance, it has become the State with the greatest population of any State in the Union, I think solely because of home construction in a State which was provided by the savings and loans. So I look with great disfavor on anything that is done that would retard the savings and loan associations, because they have done such a wonderful job and because they have been built up by necessity. We just had to have them. Now, then, the banks—we need banks— they are wonderful—we are greatly obligated and entitled to them for the very fine service they have rendered in time of war and in time of peace. We are not trying to destroy the banks. We want them to move ahead. But I, personally, feel that there is a place in our econ omy for both the savings and loans, the thrift institutions, and the commercial banks, without one being permitted to destroy the other. If I am any judge of this, if this goes on, something has got to give. Both of them will not go indefinitely this way. I do not see how they could do it. I am going to do my best to try and find out the answer. We have no prior commitments about it. We do not know enough about it at this time, but we know there should be an answer. I am going to try to find it in these hearings. Mr. Ashley ? Mr. A s h l e y . To what extent, in your opinion, are certificates of deposit responsible for the rising interest rates that we find through out our financial structure? Mr. S h e r b o u r n e . The table that I read during the course of my remarks indicated the extent to which the competition from these high rate CD’s has caused a tremendous increase in the time deposits of commercial banks. You remember, the rates reversed themselves and the major part of the increase in the last 4 months was other than negotiable CD’s. Now, that money came largely from savings and loan associations and savings banks. I mentioned that at this convention I attended. 18 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS There was one manager after another who spoke about tracing $50,000 and $ 100,000 deposits that a particular bank absorbed, which happens to be concentrated on advertising the high rate on these certificates of deposit. It has been a major factor in the distortion of the savings trends in the last 3 or 4 months. Mr. A s h l e y . I s the impact of CD’s on the savings and loan industry measurable? First of all, can you tell the extent to which depositors, shareholders, as the case may be, might be withdrawing funds for deposit in return for CD’s in commercial banks and to what extent do savings and loans themselves make use of CD’s ? To what extent do they put their funds into commercial banks in return for certificates of deposit ? Mr. S t r u n k . Mr. Congressman, we have some of our institutions that place their liquid funds in commercial bank CD’s in preference to buying Treasury bills, for example. I don’t have any dollar figures on that, but it is fairly small. Now, the effect of all this commercial CD competition—I think this is fairly well measured by the savings flows we had in the last 3 or 4 months—by the flows of savings in and out of our institutions. We are taking in less than we are paying out in withdrawals, more. In the first 3 months of 1965, we had a net gain in savings of $1.9 billion and in the first 3 months of this year, a net gain of $1.3 billion. Mr. A s h l e y . 1.9 in 1965 ? Mr. S t r u n k . Yes, sir; in the first 3 months. In the month of April, when this really hit us, in April of last year we had a net decrease in savings of $94 million. This year, in April we have a net decrease in savings in excess of $500 million. We don’t have any final figures yet. Now, about half of our associations pay their dividends quarterly and the other half pay them semiannually. Those that are paid in quarterly were not in the red in April, so this $500 million net savings loss in the month of April was felt by about half of our institutions, half in terms of dollar volume and we are looking forward to what we call a very red July unless something happens, when all of our institutions will pay a dividend and when all of our business will be subjected to the full brunt of high rate commercial bank CD com petition. As a result of these savings losses by half of our business in April, as a result of all the concern about July, and as a result of a lesser gain in savings in the first 3 months of this year, we are substantially re ducing our loan commitments and volume of loans that we can make. There will be quite a bit of lending going on in the next several months because we have a lot of loans in the pipeline. But our people are putting nothing new in the pipeline, which means you are going to get a drastic reduction in the amount of loans, not only for homebuilding, but also for home buying, because our people don’t know how to make any commitments as to funds available in the next 4 or 5 months. The most important thing for us, of course, is to keep meeting with drawal requests. If we have major demands on our institutions in July, we will honor those demands and we will honor loan commit ments that have been made. But we are being a little leery about making future commitments in the face of a very dismal savings picture. UNSOUND COMPETITION FOE SAVINGS AND TIME DEPOSITS 19 Mr. S t e p h e n s . Would the gentleman yield? I would like to ask you this question. Is it not true that the Federal Home Loan Bank Board has directed the boards in the regions not to make any loans before taking a careful look at commitments after that date ? Mr. S t r u n k . Yes, sir. Mr. S t e p h e n s . Am I correct in that ? Mr. S t r u n k . You are absolutely correct and this, again, has pro duced major changes in the attitudes of our people with respect to the kinds of loans they are willing to commit—now we will be able to commit for loans only amounts in relation to savings flows and loan repayments and we are, frankly, quite pessimistic about that. When ever a lender is pessimistic about his sources of cash, you can be sure he tightens up on his loans. You asked about the effect on interest rates----The C h a ir m a n . Will the gentleman yield for one suggestion, Mr. Ashley ? In this morning’s New York Times, Monday, May 9, 1966, on the front page there is an article, “Savings Accounts Fall by $1 Billion. Survey Points to Shortage of Home Building Credit.” April was the “Worst Month in History.” I ask unanimous consent to put this in the record at this point. Mr. A s h l e y . Could it be following this ? He is right in the middle of a sentence. The C h a ir m a n . At the end of your time. Without objection, so ordered. Mr. S t r u n k . Whenever lenders are short of funds, they tighten u p . Mr. A s h l e y . Obviously, the increased use of CD’s is a factor in the increasing cost of money. What you have been discussing is the dis mal picture that confronts your industry with respect to decrease in amounts of savings; is that not so ? This is not totally attributable to the increasing use of certificates of deposit—the action taken by the Federal Reserve Board with respect to increase of rediscount rates is a factor, and any number of factors that contribute to this picture; is that not correct ? Mr. S h e r b o u r n e . Well, Congressman, I think the primary impact comes from these high-rate CD’s. The level at 5% percent, many of us began to ask the question, which they didn’t answer, is that what the Board thinks is a permissible money rate ? Is it what it should be ? Will the banks go up to it? Well, gradually they did. Let me cite what happens and why we believe the impact of CD’s is primarily responsible for the substantial withdrawal and which has cut down, our net increase to a point where we are no longer able to take care of the mortgage volume that has been coming to our doors. Most of our customers are plagued—are attracted by these adver tisements that state that you can get a CD for 3 months, or 6 months, or 9 months, with a rate of 5% percent, and if you withdraw within that period, perhaps on not more than 30 days’ notice, sometimes no notice at all, you will get a basic rate of 4 percent—somewhat under what we are paying as a current rate on all our savings. Now, actually, you can see this is going to be very attractive be cause the most that they stand to lose is perhaps, a quarter of a per cent, but they may gain as much as 1 percent if they last and stay in for the full SO 60-, or 90-day periods and since most of our savings -, 20 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS and loan savers are long-term savers, they are not concerned with hav ing to withdraw before this time. I cited to you earlier the increase in time deposits during the first 4 months of 1964, and our customers would naturally go into a nonnegotiable certificate of deposit and not into a negotiable CD. They are not acquainted with that market anyway, too much. The increase in other time deposits where our money would go, if they went to a CD, was in the first 4 months of 1964, $199 million, and in the first 4 months of 1965, $468 million, and in the first 4 months of 1966, $3,055 million. The difference is so great that I submit, Congressman, it is reasonable proof of the statement we are making to you. Mr. A s h l e y . Thank you very much. (The article from the New York Times previously referred to fol lows:) [From the New York Times, May 9, 1966] S a v in g s A c c o u n ts F a l l b y $1 B i l l i o n —S u r v e y P o i n t s t o S h o r t a g e o f H o m e b u ild in g C re d it (By H. Erich Heinemann) An estimated decline of $1 billion in savings accounts at savings banks and savings and loan associations has accentuated the fear that a shortage of credit for homebuilding may develop during 1966, a survey of government and trade association economists indicated yesterday. The billion-dollar outflow in April of savings accounts from such institutions compares with an outflow of only about one-tenth as much in April 1965. The savings banks and savings and loan associations—often referred to col lectively as the thrift industry—are the principal suppliers of funds for home mortgages. WORST MONTH IN HISTORY Official statistics will not be ready for several weeks, but on the basis of initial tabulations and estimates by usually well-informed economists, it seems likely tnat the thrift industry has just weathered its worst month in history. The $1 billion drop was not taken by economic experts as any sign of lack of confidence in the thrift institutions, but rather as evidence—among several fac tors—of the impact of the upward spiral in interest rates that has gripped the economy m recent months. Paradoxically, however, major commercial banks in big cities, which have been aggressive in bidding for individual savings recently, do not appear to have been particularly successful In improving their share of the savings market. * commercial banks gains in time deposits (on which interest rates of up n ° .« h in r ree-t ar! allT e?> have been j™* about offset by S e s in their 4 pereent j deposlts <on which commercial banks may not pay more than fixtdtM r iil^ A ^ iv ,W r t ^ iC«-,the d?F°si!?r af rees t0 leave with the bank for a Period. A savings deposit, on the other hand, can generally be withdrawn at any time on presentation of the passbook s y 06 wunara" n a s is ssafirawftssS?Hi S r 5'“Fr consumer durable goods. purcnase of major appliances and other For all its massive size, the national declin* nf <ti miu™ * was heavily concentrated in two arpnZTthf bllj ion in savings accounts savings banks in New York lost Sttm i -a west COasts* Mutual and Jlvings and loaT J S 5 . K J S ^ a net loss of $400 million in their savings accounts tor recorded la r ^ V S : ^ The 15 month, for a total drop since March 29 (the first o f l “gra«days“ a ? ftf eni UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 21 of the first quarter when deposits could be withdrawn without loss of earnings) of $312 million. It seems highly unlikely that anything like this rate of decline will continue for long. Major mutual savings banks in New York City are expecting a fairly .substantial net inflow of funds during May. And in California—where there has been something of a “crisis of confidence” because of widely publicized financial troubles at a few savings and loan associations—the forecast for May is for a net inflow of funds. NOT A NORMAL OUTFLOW There is no question but that the April outflow was far beyond anything that could be attributed to “normal” withdrawals to pay taxes or of accumulated earnings. The April outflow was clearly the consequence of the broad escalation of in terest rates that has occurred in the economy in recent months. The thrift institutions, which get their income largely from investments in home mortgages, have been, in many cases, simply priced out of the market. Their mortgage portfolios turn over slowly, and when interest rates rise rapidly, as they have lately, the income of the savings banks and savings and loan as sociations cannot keep pace. This, in turn, limits their ability to compete for funds with other, alternative opportunities for investment. Federal regulatory agencies are considering changes in their policies that would allow savings and loan associations more freedom in raising dividend rates in order to meet competition. But it is lack of earnings, far more than regula tory shackles, that is likely to limit the actual dividend increases that take place. Commercial banks, for their part, generally have far greater ability to adjust their lending rates to changing market conditions, and also to adjust the rates that they pay in order to attract the money that they lend. The commercial banks have taken advantage of this flexibility, in some cases increasing the rates they pay on time deposits to 5% percent, the highest now permitted by law. Very few savings banks pay more than 4y2 percent, and 5 percent is generally the top rate at savings and loan associations, except for special, long-term accounts. Yet it is a paradox of the present situation that the big-city commercial banks which have been the most aggressive in raising rates in order to bring in new deposits, have not been particularly successful. BIG LOSS FOB BANKS During the crucial month of April, the 380-odd commercial banks that report figures to the Federal Reserve on a weekly basis—this includes the vast majority of banks with assets of more than $100 million—lost $1.7 billion in passbook savings accounts, which under the law may not yield more than 4 percent. But in the same period, these same banks gained almost $1.9 billion in time deposits, which under the law may yield up to 5% percent. Only $309 million of this $1.9 billion increase was in the form of the large-denomination ($100,000 and up) negotiable certificates of deposit that major money-market banks sell to large corporations. To many observers, this juxtaposition of loss and gain is undeniable evidence that large commercial banks, at least, have simply been shifting deposits from 4 percent passbook savings accounts to time accounts yielding 5 percent or more. Interestingly, smaller commercial banks seem to have been somewhat more successful in attracting funds than their big-city cousins. The Federal Reserve estimates that total time and savings deposits of all commercial banks increased about $2 billion during April, with about 60 percent of the increase coming in banks with assets of less than $100 million. The chances are that the bulk of the small-bank increase has been generated in local communities, rather than being pulled, en masse, from competing thrift institutions. But if major commercial hanks are just barely breaking even in their quest for funds—and smaller ones aren’t acting as a major force in the money market— then to whom, or to what, did the thrift institutions lose $1 billion during April? There are no clear-cut answers, but it is likely that many factors are involved. Personal spending is high, and people are spending an exceptionally large propor tion of their disposable income, while saving correspondingly less. 63-496—66------3 22 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS For example, the Commerce Department figures that only 4.8 percent of after tax income was saved during the first quarter, the lowest level since early 1%3, and down from 5.6 percent in the last quarter of 1965. Then, too, yields on corporate and municipal bonds are at historically high levels, and interest on U.S. Government savings bonds—on which income taxes can be deferred—has just been raised to 4.15 percent. Beyond this, mutual fund sales—including the almost $400 million raised by the Manhattan Fund—have been soaring, and some of this money has come from savings banks and savings and loans. All of these factors have undoubtedly combined to pull funds out of the thrift institutions, the traditional mainstay of finance for housing. As C. A. Duncan, Jr., president of the United States Savings & Loan League, put it earlier this week, “The housing industry could become the ‘Appalachia’ of the American economy later this year.” The C h a i r m a n . Mr. Widnall? Mr. W i d n a l l . Thank you, Mr. Chairman. Mr. Strunk, Mr. Sherbourne, we certainly welcome you before the committee today and I think you have made some very strong con structive suggestions as to how to handle certificates of deposit in the future. They unquestionably have had a very severe impact, not just on the whole building market, but on many of the other forms of activity within the economy. It behooves us to really understand what is going on, what is affected. The complete magnitude of it and what will eventually happen if allowed to go on in a similar manner in the future, unchallenged and without any form of direction by the Con gress or any other agency of the Government, is something we are in terested in. I know that the builders are terribly bothered about existing money rates. Some conversations that I had over the weekend, they ^vere worried about the fact that a lot of builders were going to go into T bankruptcy one of these days. They said that it is not just a question of loans, the terms of loans, but they also have been affected more and more by unreasonableness on the part of communities with respect to restrictions on the builders as they come in to make their developments and require so many things of them that it is almost impossible to go ahead with a building program. I think it would be very, very wise for our own committee, the Subcommittee on Housing, to go into this as well as the effects of the CD which we are now doing through the full committee. We had some testimony the other day on the participation sales program as contemplated for FNMA and Mr. Barr, who was testify ing for the Treasury, stated that they now have $33 billion in Govemment-held assets. By the end of this year, if this program did not go through, he mentioned it would be $39 billion, and within a couple of years $50 billion, and then, a few years, later, about $100 billion. It is contemplated that if this program goes into effect, that $8 billion in Government-held assets would be sold through the trustee and is suing them through sales participation to buyers throughout the country. What effect do you think FNMA extended activity in the partici pation sales at the 5%-percent yield rate, will have on your business? Mr. Sherbournb. I don’t know where the money is coming from to take care of all these demands and requirements^ Because if they sell $8 billion, they are going to dry up that much more-“-that much in funds at a time when, as we are testifying here this mornittg, we have UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 23 doubts, because of the CD competition, that our institutions can han dle the volume of loan applications that are developing at the present time. Mr. W id n a ll. Mr. Strunk, would you comment on that, please ? Mr. S t r u n k . I have been concerned that these certificates will pro vide a new kind of competition for the savings of people, particularly if they package them and market them in units of $500 to $1,000. It can provide another kind of CD competition for thrift institutions. That is my major area of concern. Mr. W i d n a l l . Is it not true that the short-term Treasury’s some times have had an impact ? Mr. S t r u n k . Yes, sir; during, particularly, 1959, I believe, when the so-called magic fives were issued, our institutions didn’t feel that as much as the savings banks did, but the savings bank people tell me that they had a lot of money withdrawn for investment into the socalled magic fives. Any time any kind of money market rate goes up and where people can buy them in convenient units, it has disrupted forces again in the savings market. Mr. W i d n a l l . Are you not bothered by the fact that a multibillion Federal long-term instrument such as FNMA’s participations is above the 414-percent statutory bond limit and will, therefore, permanently take things in a direction that will be opposed to the building industry % Mr. S t r u n k . We are concerned about it, and hope it doesn’t de velop excessively. Mr. W i d n a l l . Thank y o u . The C h a ir m a n . We want to go around first on the 5-minute rule. I feel that all members should have the privilege of asking all the questions they desire to ask about this and we are doing a lot of pi oneering here. It is an unexplored field and I think we ought to give them plenty of time. We will first take 5 minutes around. Mr. Moorhead? Mr. M o o r h e a d . Thank you, Mr. Chairman. I would like to ask you gentlemen, are there such things as nonnegotiable certificates" of deposit ? Mr. S t r u n k . Yes, sir; the typical certificate issued is a nonnegoti able CD. Mr. M o o r h e a d . What you are concerned about is the negotiable CD’s ? Is that correct ? Mr. S t r u n k . We are concerned about both of them. The n o ilnegotiable CD is the one that has the most direct effect upon the savings and loan business, but the negotiable CD is a new money market instrument, and we are concerned about the effect of that upon banking in general, and the liquidity of the banking business in general. We are concerned that it will produce another kind of CD crisis such as we had last December. That was the crisis of negotiable CD’s. But so far as we feel it in our institutions through out the country, that is a problem of nonnegotiable CD’s. Mr. S h e r b o u r n e . Congressman, if I might add something to that point. I believe the reason that the rate was raised to 5y2 percent and the reason that the banks have been coming out with nonnegotiable CD’s in $25, $50, and $100 denominations is because the negotiable CD market became a problem to them. 24 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS They anticipated that billions were maturing and the corporations would probably use them for expansion purposes, inasmuch as the tight money market was making it difficult for them to get the money they might need for the expansion programs. So, really, what is hap pening at this point, is that the nonnegotiable market is getting down to the level of the little saver and the billions produced thereby are taking care of the problem that is developing in the negotiable market. Mr. M o o r h e a d . The point that I am making is that H.R. 14026 only covers negotiable CD's. Is this sufficient in your judgment, or should the bill be broadened ? Mr. S h e r b o u r n e . In my own opinion, the bill might well b e broadened. But, may I say that when it comes to matters of this kind, this is the first time that I have ever testified in a matter relating to com mercial bank practice. As an industry, we like to take care of our own problems and simply ask your powers from Congress. Where someone goes too far you do this to another type of institution—at this point, the negotiable CD market is, in the opinion of so many money market authorities, a problem that we can safely say regulate it. But. if you want our additional opinion, it would be that you ought, at the same time, to redefine time deposits and redefine the amount of issuance for these nonnegotiable certificates, so that, in eltect, you don’t have a conflict within regulation Q, itself, where they say that the rate can be a certain amount on savings accounts, and they permit a nonnegotiable CD bearing a higher rate of interest to be issued in such small denominations that it is, in effect, another type of savings account. We think that is an area that your committee ought to consider. Mr. M o o r h e a d . I would like to ask Mr. Strunk this: I notice on page 13 of your testimony, you give us three recommendations. Is it my understanding of your testimony that you would favor legislation that enacted these three things, rather than—or in place of H.R. 14026? Mr. S tru n k . No, Mr. Congressman, we support H.R. 14026. We are really concerned about CD’s and this would solve a problem. We would prefer the word “nonnegotiable” come out and the CD’s in general be prohibited. This, certainly would solve the problem. If less sweeping measures are proposed, we would support them, too. In any case, we think that steps need to be taken to deal with the con sumer CD’s. These particular steps outlined in my testimony, we think, do not require legislation. Mr. M oorhead. I see. Mr. S tru n k . We would hope that the Board of Governors would put these into effect right away. I f the Board of Governors doesn’t, then, legislation could be enacted in this direction. These are mini mum steps as against dealing with the problem head on. as does H.R. 14026. Mr. M oorhead. Referring to page 12 of your testimony you talk about the typical $50,000 or $ 100,000 certificates. Suppose we enacted legislation which put a floor on the CD’s, let us say, $50,000 or $ 100,000. Would this either solve the problem or go a long way toward solving the problem? Mr. S tru n k . It would make the savings and loan man very happy Digitized for and go a long way to solving the problem of the savings market It FRASER UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 25 wouldn’t necessarily solve the basic problem of this new instrument, but it would go a long way to solving the problem with respect to some flows of savings. M r . M o o r h e a d . You use this term, “runs around the end” of the Federal Reserve’s decision. It seems to me that it could be very well argued that where the CD is negotiable, or where you can turn it in without notice for a lower interest rate, that it is an end run aroundthe provision prohibiting interest on demand deposits. M r . S t r u n k . And an end run around the prohibition against pay ing more than 4 percent on the passbook accounts. These certificates are very much like a passbook account. The Federal Reserve wisely prohibited bank competition in that area, but the way the banks have used the certificates, they are getting passbook money into the higher rate savings certificates, savings bonds; the variety of new instru ments that the bankers are creating. Mr. S h e r b o u r n e . Congressman, I think you must note, too, that the small savings CD is not generally issued in commercial banks in our area. In most States, I believe, the CD, the negotiable CD’s, are issued by one or two or half a dozen of the largest banks. They have not generally been used yet by the small banks—the small banks, by that, I mean $200 million, $100 million. Mr. M o o r h e a d . Thank you both very much. The C h a i r m a n . Mr. Stephens. Mr. S t e p h e n s . Thank you, Mr. Chairman. I would like to ask your opinion—both of you—of this: In 1961, when the liberalization was made of regulation Q, there was a billion dollars, estimated, to be in the certificates of deposit. About a year ago when the Bank ing and Currency Committee made a visit to Philadelphia, I think— a little over a year ago—I saw in the Wall Street Journal where the certificates of deposit- amounted to $14 billion. Now, I have observed since that time that it is somewhere between $16 billion and $18 billion. In a 5-year period, then, we have seen the deposits go from a bil lion to $17 billion. Now, all of that money had to come from some where. It has not come from savings and loans, where has it come from ? Mr. S t r u n k . I think most of this money—it comes from corpo rations. Mr. S t e p h e n s . Their earnings? Mr. S t r u n k . Their liquid funds. It may be retained earnings, it may be temporary proceeds of the sale of securities, it may be cash built up in anticipation of a dividend payment. These are liquid funds of corporations. Before the CD practice started, these funds were invested in Treasury bills, invested in obligations of the Federal Home Loan Bank System, intermediate credit banks and in commercial paper, and much of it used to be in checking accounts of commer cial banks. The commercial banks have, in effect, developed a new money market instrument in competition with the U.S. Treasuiy and with the Federal agencies and with other corporations that issued commercial paper. Mr. S t e p h e n s . In other words, I do not know whether it is still in effect now, but a corporation could not have a regular savings ac count. Has this been relaxed \ Mr. S t r u n k . It may be a little bit to get around that. The corpo ration cannot invest in a passbook account in a commercial bank. 26 UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS Smaller corporations put money into our institutions, but savings in stitutions like ourselves, frankly, don’t like to take large sums that may be quickly withdrawn. Savings institution people look with con siderable concern when you get to $50,000 or $100,000 deposits. It is not our kind of money. The negotiable CD started out with maturities of $500,000 and $1 million. This is short-term corporate liquidity. That is where the $15 billion, $16 billion buildup came. Since last December, we have a buildup in consumer CD’s, as we call it, sold to people as against the corporate treasurer. Mr. S t e p h e n s . That is where the squeeze has come in ? Mr. S t r u n k . That is right; where it is happening to us. I am satisfied that the issuance of some $15 billion of competition for U.S. Treasury obligations had something to do with squeezing the U.S. Treasury a bit. You put $15 billion of something in the short-term money market in competition with short-term Treasury obligations and in competition with Federal home loan bank obligations and it increases the short-term interest rates just as now it is increasing in terest rates in our field, which is increasing the cost to homebuyers. As Mr. Sherbourne said, we just don’t have as much money for new loans. What we do is, instead of making 85-percent loans, we make 75- or 70-percent loans. When you have less money, you not only raise the rates, but stiffen your requirements considerably. Mr. S h e r b o u r n e . Congressman, may I add one small fact to put this in focus ? In 1961, when negotiable CD’s first came out, the total amount of certificates of deposit—the total amount of time deposits, at that point, was something like $13 billion. In the intervening 6 years, the negotiable CD has gone from zero to about $17 billion, whereas, the other time deposits, the nonnegotiable type of instrument, has increased only $1 billion or $2 billion. So that you see, therefore, the negotiable CD’s are the instrument that is causing the problem today. Mr. M c K e n n a . Mr. Congressman, may I respond to your particu lar question by reading, I would say, from a neutral witness in this case? I am reading from an article in the Banking Law Journal of November 1965, which you will note was before the increase in rate ceilings in December of that year. The article is entitled “Time Deposit Banking” and it is by Herbert Prochnow, Jr., attorney, the First National Bank of Chicago. On page 951, he said: In February of 1961 commercial banks, utilizing a longstanding provision of regulation Q, began to offer time certificates of deposit to their customers. At first, these certificates were for large denominations, $1 million or more, and carried maturities ranging between 6 months and 1 year. These certificates, issued in negotiable form, attracted corporate funds which could not be accepted as “savings deposits” under the provisions of regulation Q. Competitive pressures then forced the banks to issue certificates in smaller denominations and for varying maturities. A market for these negotiable cer tificates of deposit has developed so that they can be readily sold by the holder, prior to maturity. The growth of this market has been of great significance in making time de posits an attractive liquid asset to corporations and other large investors. Recently, banks have also been increasing quantity of nonnegotiable certifi cates of deposit to individual savers, who are willing to commit their funds for long periods of time in return for the somewhat higher rates which banks are willing to pay on nonnegotiable certificates. It is entirely possible that nonnego UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 27 tiable savings certificates will, in the years to come, drastically alter individual savings account relationships as negotiable certificates of deposit have already changed and greatly expanded corporate time deposits. The C h a ir m a n . We are glad to have this information for the record. You know, in 1960, the short-term interest rate was rather low. These huge corporate funds were in the market every week for short term Government securities. I do not know who devised the plan or who was the author of it, but some person, I guess thought they could raise the interest rates on the short-term U.S. Government securities. They wanted these short-term rates raised. Well, if they could get the CD’s in a race, really, an inflationary race, as to rates, why, they would get their objective. They would get the short-term rate raised. So, these managers of huge corporate funds were induced to invest them in CD’s at 3 and 4 percent. At that time it was a big windfall to them, a big bonus. It is much more than they could get on a short term rate, ana naturally they went there awfully fast. And in the next 6 years they went to over $17 billion. They went up very rapidly and left the short-term Government market entirely. That market started up and last December there was a crisis. You know, a lot of CD’s were coming due and there was no way for the banks to renew them. They could not pay them enough interest. That was the crisis in December that caused the Federal Reserve Board to react and they had to do something and they had to do it fast. They could not increase their interest rates enough to let them keep these time de posits, these CD’s, so that is the reason they increased the rate from 4 percent to 5% percent, thus 371 percent. I f somebody else had /£ raised prices &7y2 percent, if a manufacturer of automobiles raised his rates, his prices, 37% percent, he could not sell them. But they got by in raising those CD rates 37 ^ percent. That was a race between the short-term securities, the rate there, and the CD’s that got us into this inflationary condition, and it has caused all this trouble. There was a hearing before the Joint Economic Committee, during the month of December, last year, to draw out all these points. It is not disputed that the reason they had to raise those rates so high was to take care of these few banks, and a relatively few of them, just a handful that had all these CD’s outstanding against them. They were hurting and they had to do it. Anyone who is interested can call the Joint Economic Committee and ask them to give you a copy of that hearing for your purpose and you will get it, I guarantee you that. Mr. Harvey ? Mr. H a r v e y . Thank you, Mr. Chairman. Mr. Strunk, as I under stand what you have been telling us, is that actually the savings and loans that have been living with CD’s for a good long period of time— this is not new—and actually, you are not interested in getting cor porate funds. What you are* really interested in, is the abuse of these CD markets which has come about recently; is that correct? Mr. S t r u n k . Yes, sir; I would say that is correct. We have been living with CD’s some time. We have been living with CD’s since 1961,1960, when they first developed in volume. The consumer CD’s, that is. We have been living with them since then. I distinguish them between negotiable and nonnegotiable. I call the negotiable ones cor porate CD’s. 28 UNSOUND COMPETITION FOK SAYINGS AND TIME DEPOSITS Mr. H a r v e y . What is the lowest limitation of the CD that savings and loans could live with ? $5,000 ? Mr. S t r u n k . The higher, the better. Mr. H a r v e y . Obviously. Mr. S t r u n k . $15,000 to $20,000. Mr. H a r v e y . Y o u are saying, $15,000 to $20,000. Could you supply the committee with any breakdown of information, for example, as to what percentage of the CD’s that are issued today that are in the $15,000 to $20,000—what percentage are in the $15,000 to $20,000 bracket? This would be very useful information, I would think. Mr. S t r u n k . One handicap we have is that the FDIC and the Comptroller do not collect much information in this area. The Fed eral Reserve collects information about negotiable CD’s. In Decem ber, the Fed sent out a questionnaire as to the practice in issuing CD’s. The results were published in the Federal Reserve Bulletin in the month of April or May. The Fed has now announced a new survey of practice in the CD area and we would hope the information the Fed is getting now will tell us how much of the money is in CD ’s of, say, over $15,000 and how much of the money is in the CD’s of under $15,000. My guess is that 90 percent of the money in CD’s is in amounts—in $15,000 and over. The total dollars they are attract ing in the smaller CD’s is not significant in terms of banking resources. But it is terribly significant in terms of shift of money out of the mortgage market. Do you follow me ? Mr. H a r v e y . I follow you; yes. What you are saying is that 90 percent of the CD’s consist of corporate money that you are not in terested in—in the past anyway—but the 10 percent, the $15,000 to $20,000 is money that comes in by the shift. What you are further saying is that that complete information is not readily available at the present time ? Mr. S t r u n k . It has never been available until the Fed made the December survey. I am not positive whether the Fed’s December survey gives this information. I understand that the Fed’s May survey probably will give this information. Mr. H a r v e y . On page 13 of your statement, you made several recommendations but you omitted a minimum limitation for CD’s. Could I ask why, or your reason ? Mr. S t r u n k . We were suggesting a minimum program that would not necessarily require legislation. Mr. H a r v e y . But you are telling the committee here, today, such legislation is wise; is that correct ? Mr. S t r u n k . It will be very, very helpful. I would say it would be wise; yes, sir. Mr. S h e r b o u r n e . May I add something to why we are being affected today and we weren’t back 6 or 7 months ago ? It was the practice of commercial banks in our area, and this was all banks, to issue CD’s, nonnegotiable CD’s, slightly above our savings rate. We were hit at that point, but to a manageable degree. But the shocking nature, if you want to call it, a large nature of the increase that has taken place literally, when the saver, a fellow with $ 5,000 and $10,000 ----Mr. H a r v e y . I have only 5 minutes. My point to you, Mr. Strunk, was that neither one of you as I understand it, is actually, asking this UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 29 committee to prohibit the issuance of CD’s. Now, you are asking for certain reforms, but you are not asking that they be prohibited entirely, are you, as H.R. 14026 would reportedly do, according to the way I read it? Mr. S h e r b o u r n e . We are not asking that, Congressman, because the amount of CD’s is so large in billions of dollars, so many billions, that we think you cannot cure the problem by shutting it off. Mr. H a r v e y . It would cause absolute chaos in the financial market if you were to, overnight, prohibit the sale of CD’s? I would think that would be commonsense. Mr. S h e r b o u r n e . It wouldn’t have that influence if you were to provide legislation that these nonnegotiable CD’s cannot be issued for amounts less than $10,000. Mr. H a r v e y . That is exactly the point that I was trying to make a few minutes ago. Neither one of you are asking that they be pro hibited entirely, as this bill would reportedly do. I would like to direct a question to our chairman. I wonder if the Secretary of the Treasury, Mr. Fowler, is going to appear at these hearings ? The C h a ir m a n . We expect him to ; yes. Mr. H a r v e y . Is there any time schedule ? The C h a ir m a n . Not right now. We have these witnesses, the Treasury Department—Mr. Fowler will be the one, the Federal Home Loan Bank Board, Federal Reserve Board, Federal Deposit Insurance Corporation, American Bankers Association, and others. On Wednes day, we will hear Chairman John Home of the Federal Home Loan Bank Board. Tomorrow is the Open Market Committee meeting at the Federal Reserve and they wanted a day or two after that before they came up. But they will be here. Mr. H a r v e y . Thank you, Mr. Chairman. I have no further ques tions. The C h a ir m a n . May I suggest this, Mr. Harvey. This lower in terest rate on smaller accounts—that bothers me a lot. I feel strongly about this. This is going to ruin the industry if we do not do some thing about it. We must protect the savings and loans in their efforts to build homes at reasonable prices for the long term. Mr. H a r v e y . I want to do that, too, Mr. Chairman. The C h a ir m a n . I f we pass a law here to say that all accounts under $15,000 may be paid lower rates of interest/why that would be dis criminatory against the small saver. I just cannot imagine a Con gressman voting for a bill to permit a high rate of 5i/o-percent interest onlv on large accounts. Now, I know that the object of it is good. But if you put yourself in the position of two fellows who come up to the window, one has a million dollars and yon say, “Well, we will pay you 5y2 percent,” and the little fellow with just a few dollars gets only 4 percent. Mr. H a r v e y . That is what we are doing under the participations sales bill. You have a $5,000 limitation there. The C h a ir m a n . That is different. Mr. H a r v e y . I do not see anything different there at all. The C h a ir m a n . Two wrongs do not make a right. I do not say that I would be against this if it could be done some way that would not put you in the position of telling the little man 30 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS we have fixed it so you can have only a small amount of interest. That is the part that bothers me. Mr. H a r v e y . I f the chairman will let me respond to wliat you said. My point before was that I think we have to be very practical in find ing a solution to this very serious problem and I do not think that the chairman, in this bill, which would seek to prohibit all CD's— I think this is impractical. The C h a ir m a n . My bill would prohibit only negotiable CD? s. Mr. H a r v e y . I do not think it is a practical solution, and I think what we have been talking about are much more practical steps to be taken and what the witnesses have suggested here. The C h a ir m a n . All right, would you like to procced, Mr. Gonzalez ? Mr. G o n z a le z . Yes, Mr. Chairman. My questions are brief, but I am intensely interested. First, may I point out to the good chairman that I endorsed this bill by introducing it myself. I introduced the same identical bill and I have a question of Mr. Sherbourne. You say in your statement, “mortgage interests rates have risen abruptly as a result of the high interest rates authorized by the Fed eral Reserve Board. In my judgment, it will go even higher.” Well, now, they are at 6 percent now, Mr. Sherbourne. How high do you think they would go f Mr. S h e r b o u r n e . In New Jersey, we have a statutory requirement— a statutory limit of 6 percent, and the next development involves charging a point. A t this stage, I think 1 point is being charged on most loan applications. Mr. G o n z a l e z . There is no limitation on points? Mr. S h e r b o u r n e . N o , sir. Mr. G o n z a l e z . I s it n o t a fa c t th a t up to som etim e in th e 1950*s, th ere was a s ta tu to ry lim ita tio n ? Mr. S h e r b o u r n e . On points? This is an FH A and G I loan. Mr. G o n z a l e z . Right. Mr. S h e r b o u r n e . I am talking, primarily, of conventional loans, which is the major part of our market in New Jersey, and in most States. Mr. G o n z a l e z . It is now, but it is coupled with the same questions I have been asking of Mr. Brownstein and others every chance we have when they appear here. That is, that the FH A area of activity has shrunk, where in my opinion the intent of Congress in its inception; that is, in the inception of the program, was that it would be an instrumentality by virtue of which any American family that desired to purchase a home would have a chance to do so on the assumption there would be something more attractive on tlie basis of an FHA-arranged mortgage and conventional mortgage arrangement. But that is completely reversed. Only 16 percent—and that is not even new housing, that is existing housing, and that FHA. And the reason is, that, well, you know the reason better than I do. But what I am getting at, should we not go back to the congressional limitations that we had in the fifties and up until the fifties m the Eisenhower administration? I think what Congress did then, it left the floodgate eventually open for what we are now passing through, Mr. S h e rb o u rk * . My understanding of the ordination of F H A and (tI loans was that they were intended to meet specific needs that UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 31 weren’t otherwise being met by local institutions. For example, in some States, savings and loan associations were not too active and their FH A and GI mortgage was the principal instrument. Also, shortiv after the war, in order to encourage no-down-payment loans, which no institution would normally make on its own portfolio, the GI instrument came out. I always felt that the Congress properly provided through FH A and GI loans, a medium by which needs could be met or an area could be ointed to and we could be encouraged—and, by and large, home nancing has operated primarily through the conventional mortgage and, may I say frankly, there are certain advantages to that. We can move much faster, take care of builders and the individuals much faster than when you are involved in a secondary guarantee operation. So I think it is the merger of the two that is the best. I f you say, let us then go back to provide FH A and GI loans, if there is no market for them, nobody will take them. Then, you get into direct lending in tremendous volume and at that point you face the problem of pro viding credit in a period in which governmental policy is to reduce credit, to control credit. And, also, to minimize the impact of the Government. That is another problem. E Mr. G o n z a l e z . If you did not have these limitations, the 6 -percent limitation, for example, how high do you think it would go ? Mr. S ii e r b o u r n e . In New Jersey, I don’t think it would go above 6*4 percent. In California and other areas, where money is needed, the rates are already at 6 ^ and 7, headed higher. May I say for our friends in California that it is still a fact that the mortgage needs of the expanding population in that State would not have been met if savings and loan associations were not able to pay a rate which attracted money into that area and enabled them to meet the needs. Many of our confreres in New Jersey don't like that, but I frankly feel that those institutions ought to be commended for making those kinds of loans with low downpayment to new and young families, and the lending pattern there has been quite different. What I am trying to do is to explain now that the California associations are not charg ing a higher rate because they want to, but because they have to in order to get the money to meet the mortgage demands that exist. Mr. G o n z a l e z . TheCalifomia situation is very similar to the Texas situation. As you know, the two States have been, for a few years, suffering the greatest impact from this tight money situation. From my observation and experience, frankly speaking, I feel that some of these programs, such as FH A , for the good they are doing on the basis of original intention of Congress, can easily go out of business and I do not think too many people would be hurt in the purchase of homes that need the homes and should be getting the homes, and should have the credit to give them and are not giving them unless they pay ex orbitant points and go in there to the market and get this. Any time you pay 4 points, which means $500, $600, just for the pleasure of getting somebody to handle the mortgage—I say that is highway robbery that has been legalized in this country. And some thing ought to be done about it at the State level or Congress, wherever it ought to be. And in many cases, it is at the State level, the interest of the people have been sold out to the special interests, and I think this is exactly what is happening nationally right now. 32 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS I think the trend started on this other level of governmental sub sidizing the loans when the risks unwisely removed the limitation on these points. It played right into the hands of the people who are now profiting. They are making plenty of money. They could care less whether the average American family gets a home or not. Mr. S h e r b o u r n e . Mr. Congressman, may I respectfully point out that only 6 months ago, there were not too many complaints about the availability of mortgage funds and now interest rates in our own in stitution and in most institutions were at a very low rate, and there fore, from my point of view, the condition would be met, the average American family was getting its loans at the lowest rate in recent years. All of this has changed in the last 3 or 4 months, to a major extent, because of the problem we are discussing this morning and that is the only reason we are appearing before you on what might appear to be an interbank or interfinancial institutional competitive matter, because the problem has become so severe that consideration should be given as to how to cure it. Mr. G o n z a l e z . This has not been my experience at all in my area. I have been having complaints for years, since I was in the State sen ate, and this may be unusual, abnormal, or what-have-you, or it may be that those of us who have to go in and deal from another angle, see a different picture. Of course, people who are buying—most fami lies who want a home will sacrifice a great deal and they have no defense—there is nothing they can do. They are over a barrel. If the elected representatives on either the State level or the national level sell out the people’s basic interests, there is not a thing the people can do. The C h a ir m a n . We will stand in recess until 10 o’clock in the morn ing and ask these gentlemen to be back with us. We want every member of our committee to have the privilege of interrogating you. (Whereupon, at 12 o’clock noon, the committee adjourned, to recon vene at 10 a.m., Tuesday, May 10,1966.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS TUESDAY, MAT 10, 1866 H o u se o f R e p r e s e n t a t iv e s , C o m m it t e e o n B a n k i n g a n d C u r r e n c y , Washington, D.O. The committee met, pursuant to notice, at 10:10 ajn., in room 2128, Rayburn House Office Building, Hon. Wright Patman (chairman) presiding. Present: Representatives Patman, Multer, Barrett, Reuss, Ashley, Moorhead, St Germain, Gonzalez, Weltner, Hanna, Gettys, Todd, Ottinger, McGrath, Hansen, Annunzio, Rees, Widnall, Mrs. Dwyer, Clawson, Johnson, Stanton, and Mize. The C h a ir m a n . The committee will please come to order. Yester day we had gotten down to Mr. Gettys, I believe. H e is not here so I believe that Mr. McGrath is next. STATEMENT OF NORMAN STRUNK, EXECUTIVE VICE PRESIDENT, UNITED STATES SAVINGS & LOAN LEAGUE, AND EVERETT C. SHERBOURNE, PRESIDENT, CITY EEDERAL SAVINGS & LOAN ASSOCIATION; ACCOMPANIED BY WILLIAM F. McKENNA, GEN ERAL COUNSEL, NATIONAL LEAGUE OF INSURED SAVINGS ASSO CIATIONS—Resumed Thank you, M r . Chairman. I want to welcome Mr. Sherbourne, a fellow New Jerseyite. I have a question concerning the CD’s. Suppose a citizen walks into a bank and deposits $10,000 and re ceives a certificate of deposit. Is that transaction covered by FDIC insurance? Mr. S h e r b o u r n e . To the extent of $10,000. M r . M cG r a t h . M r . M c G r a t h . I t m akes no d ifferen ce w h eth er i t is a n ego tiab le o r n onnegotiable c e rtific a te o f d epo sit, th e insurance aspects? Mr. S h e r b o u r n e . I don’t believe so. I don’t believe i t makes any difference. M r . M cG r a t h . I s th ere an y p lace in th e c o u n try w here an in d iv id u a l can w a lk in to a savings and lo an association and receive a c e rtific a te o f deposit? Mr. S h e r b o u r n e . We are not permitted to issue any instrument that guarantees a definite rate for a period of time, therefore we can not issue CD’s. Mr. M c G r a t h . That is all I have. The C h a ir m a n . Mr. Mize? Mr. M iz e . Thank you, Mr. Chairman. 34 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS What percentage of this $17 billion plus in CD's now outstanding is in negotiable and what percentage is in nonnegotiable? Mr. S h e r b o u r n e . The total amount of CD's is about $35 billion and of that $17 billion is negotiable and the other is nonnegotiable. M r. M iz e . It is about 50-50 ? Mr. S h e r b o u r n e . I th in k it is. I th in k a l i t t l e m o re th a n 50 p er c e n t is n o n n e g o tia b le . Mr. M tze. Did I understand you yesterday to say that only about 10 percent of the outstanding CD's are of concern to you; that is, the small denominations affect your area ? Mr. S h e r b o u r n e . I don? have any figure. t Mr. S t r u n k . I f I mentioned them, then I was not fully conversant with all the facts. We are concerned with the nonnegotiable CD's. M r. M iz e . Only? Mr. S t r u n k . Primarily. M r. M tze. Only 10 percent a re in denominations that affect you people ? Mr. S t r u n k . I would not say that. I really don’t have the figures. I think most of the nonnegotiable CD’s are in units of $10,000 or less. Of course, any time you get in units of $10,000 or less it is a new high rate bind of competition for your accounts. M r. M iz e . These smaller denomination CD’s are the kind that you are all disturbed about have come into existence, so to speak, only in the last 2 or 3 years. You did not anticipate that kind of thing when it got started back in 1960? Mr. S t r u n k . I think that’s correct. That is all, M r . Chairman. Thank you very much. The C h a ir m a n . Mr.Gettys. Mr. G e t t y s . Mr. Chairman. Mr. Strunk, Mr. Sherbourne, I would like first to congratulate and commend the savings and loan industry for the magnificent job that is done in helping so many individual Americans realize the dream of homeownership. I do not know of any agency that has contributed more to the stability of the family and the realization of the American Dream in that connection than the savings and loan industry. I am very concerned about the over lapping of functions that are proposed between the banking industry and the savings and loan industry, if we can call it an industry. I believe that there is a place for each of the services without over lapping. Now, did I understand, Mr. Strunk, you to say yesterday in your formal statement that interest rates do not have much effect on the amount of savings? Mr. S h e r b o u r n e . I think I said that, Mr. Congressman. That increase in the interest rate does not generally have much effect on total savings. My understanding is that most economists agree with tliat statement that an increase has some impact, but not s i g n i f i c a n t . M r. G e t t y s . I f t h a t i s a f a c t , a n d I a ssu m e i t is , m o s t la y m e n have M r . M iz e . a d iffe r e n t o p in io n . Mr. S h e r b o u r n e . Well, if I could just finish. When I s a y that economists make the statement that an increase in the interest rat® does not generally increase savings, I mean that the total savings held b y individuals is related to their consumptive habit, their desire to spend for things and services rather than to the interest rate. How UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 35 ever, the interest rate has this function, that the interest rate which savings and loans pay on their savings deposits, the commercial banks do on theirs, the rate our finance companies pay for the certificates and instruments they issue, all with respect to the total amount of savings, the rate paid in any particular field determines the extent and propor tion of total savings that shifts into that field. Mr. G e tty s . I understand. In the savings and loan field an in crease in the interest rate may affect it, but overall it may not. Mr. S h e r b o u r n e . The effect is that it affects the distribution of total savings, but the high interest rate in any particular field is not going to make much significant impact on the amount of total savings by all individuals in the country. Mr. G e tty s . Thank you, Mr. Sherbourne. Mr. Strunk, did I un derstand you correctly when I got the impression that so far as the CD problem is concerned now, as it relates to the savings and loan in dustry, it could be cured without legislation, that is, by administrative action by the Fed ? Mr. S t r u n k . Mr. Congressman, the suggestions that we have offered both to the Federal Reserve and to the committee yesterday we be lieve can be effected without legislation as we have looked at the law ourselves. And those two suggestions are, that the Fed prohibit banks from issuing CD’s which are automatically renewable, and also pro hibit banks from issuing certificates which have more than one ma turity date. For example, a typical savings bond issued by a bank has a 5-year maturity. But the saver can cash that bond in after 30 or 90 days, which is what I mean by dual maturity dates. So, if the banks issued certificates which were not automatically re newable, and had only one maturity date, this would make the cer tificate like the money market instrument I believe it was first in tended to be. It was to take on the characteristics of a Treasury bill and we believe then that this would take the certificates generally out of the savings market and put the savings business back where it always was; namely, into the passbook area. We believe that those two things can be done without legislation. Mr. G e tty s . D o you recommend that ? Mr. S t r u n k . Yes, sir, yes, sir ; we do recommend it. Mr. G e tty s . Have you had any evidence from the Federal Reserve, any clue as to its position on the subject? Mr. S t r u n k . We have no clue. We wrote a letter to Mr. Martin, Chairman of the Board of Governors last month and we had a very nice acknowledgment of our communication, but no clue as to whether the Fed would take action along this line. (The letter referred to follows:) U n it e d S t a t e s S a v in g s a n d L o a n L e a g u e , Chicago, II I, April 11, 1966. Hon. W i l l i a m M cC h e s n e y M a r t i n , Jr., Chairman, Board, of Governors, Federal Reserve Board, Washington, D.C. Deab C h a i r m a n M a r t i n : My last letter to you, dated December 13, 1965. followed receipt of the news of the change in the discount rate and the change in regulation Q. We were primarily concerned at that time, as we are now, with the change in regulation Q. In view of developments since last December, we are convinced our concern a t that time was more than justified. The decision of the Board of Governors 36 TJNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS to raise the permissible rate on commercial bank time deposits to 5y2 percent opened a Pandora’s box in the savings marketplace and has provoked a “rate war” for savings in which the financial institutions in the country are now engaged. In our view, this price war in the savings market is most regrettable and can only result in a weakening effect upon financial institutions generally. We recognize full well that decisions and policies of the Board of Governors were made in the belief that increased rates and tighter money were necessary to inhibit the development of inflationary pressures in the United States. Thus, the program of monetary restraint in high interest rates inaugurated by the Federal Reserve Board evidently has been inadequate to prevent a serious in flation threat. The threat of inflation is, in our judgment, considerably more serious today than it was early last December. On behalf of the savings and loan business, the United States Savings and Loan League is urging President Johnson and Members of Congress to take measures in the fiscal area designed to curb the inflation threat. We believe that you should be aware of these efforts and we would hope that in the interest of promoting stability in the economy the Board of Governors of the Federal Reserve Board would express itself to the White House and to the Congress on the same subject. Perhaps it is time for the Federal Reserve Board itself to acknowledge, as many now acknowledge, that heavy dependence on monetary policy in fighting inflation cannot be regarded as a complete success. As you recall, our original concern over the change of regulation Q was that it foreshadowed a serious diversion of funds away from housing and home ownership. Our forecast has been validated in recent weeks; housing starts in February were 17 percent below the same month a year ago and we would be surprised if this decline does not continue over at least the next few months. Recent monetary policy decisions have meant, in other words, that the housing industry has been affected more adversely than any other major industry. Cer tainly the Board recognizes that the housing industry has been in a depressed state for several years and has not contributed to the inflationary pressures of recent years. We urge, therefore, that the Board undertake a reconsideration of recent decisions with a view of determining whether these decisions have not imposed an unduly and unfairly heavy burden and hardship upon the homebuilding industry and the real estate business. The second part of our objection to the change in regulation Q was that the change would mean a substantial shift in funds from smaller banks and special ized financial institutions into large-money-market banks which would be able to pay the highest rates on certificates of deposit. We realize that you per sonally called for “prudence’* in the use of the new ceilings. Day by day, how ever, the evidence mounts that your warning has been disregarded by many banks. In all frankness we are not reassured by the March 21 publication of your survey of use of new time deposit ceilings as of December 22, 1965. A survey of that date must be regarded as very much out of date since many hundreds of banks have been moved to high rates since December 22. Furthermore and of even greater importance, your survey was based on the number of Federal Reserve member banks offering high-rate statistics. A more accurate analysis of the extent to which the banking business of the country has taken advan tage of the new ceilings would be gained by a survey of the extent to which the major banks of the country have undertaken promotion of these small de nomination certificates of deposit. We have undertaken such a survey of the hundred largest banks in the country which hold nearly 50 percent of all deposits of the commercial bank ing business. Our survey reported that more than three-fourths of the hun dred largest banks offer “consumer CD’s.” These 78 banks hold over 40 per cent of all commercial bank resources in the country. Very clearly, the offer ing of these consumer CD’s at rates approaching and exceeding 5 percent by the banking business is considerably greater than the survey reported by the Federal Reserve Board on March 21,1966. We urge, therefore, the Board of Governors to make a new survey to find out exactly what the banks—and particularly the large-money-market banks—are doing in promoting saving certificates. We suggest th at a survey today would reveal a substantially different picture than was reported in your survey on December 22. The change in regulation Q last December was restricted to time deposits, which indicated a hope or belief on the part of the Federal Reserve Board UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS 37 that the new time deposit ceilings would not be used primarily in competition for personal savings. Of course, the tremendous volume of newspaper adver tising announcing the availability of small denomination certificates of deposit and savings certificates makes it clear that the new ceilings are being used to an ever-increasing extent in the solicitation of personal savings. Unless some new restrictions are imposed on time deposits, therefore, there promises to be increasing disruption of the savings market. Two possible and constructive restrictions on time deposits immediately avail able to the Federal Reserve Board are (1) to prohibit the issuance of certificates with more than one maturity date, and (2) to eliminate the automatic renewability feature on certificates issued in the future. Perhaps the most ironic and bitter twist of the hectic events in the savings market since early December is that the “rate w ar” in the savings market has done so little to promote savings in financial institutions. The growth of time deposits and savings in commercial banks during the first quarter of 1960 was much lower than in the corresponding quarter in 19G5. The growth in savings accounts in mutual savings banks was lower in the first quarter of 19C6 than it was last year. The growth in savings balances at savings and loan associa tions was considerably lower in the first quarter of this year than in the first 3 months of last year. Thus, banks and financial institutions over the country are paying more for savings and time deposits and are attracting less. By any measure, this must be reckoned as a hollow and expensive victory even for the few big banks that have grown in recent months. Changing the rules under which certificates of deposit are issued, as outlined above, with respect to dual maturities and automatic renewability would be consistent, we believe, with the Board’s objectives as to savings deposits out lined in your speech in December to the Life Insurance Association of America. At that time you indicated that the Board desired to minimize the impact on competitive relationships between commercial banks and savings banks and sav ings and loan associations, which depend for their resources mainly on funds deposited by individual savers rather than by corporations. In closing, we cannot urge you too strongly to pursue with the greatest vigor at your command your efforts to police the volume and nature of commercial bank lending because this is the heart of the matter. Commercial bank loan-todeposit ratios are higher than they have been in virtually any other period in our economic history. A good part of the inflationary pressures could be checked by greater selectivity in commercial bank lending. In connection with some restraint in commercial bank lending, the Board of Governors might appropriately, we believe, ask for some voluntary restraint or reduction in the total amount of credit extended by the commercial banking system in the consumer credit area. This would urge some reduction both in the total amount of consumer credit extended by the commercial banks directly and also the extent of commercial bank financing of sales finance and other con sumer credit companies. We congratulate you most heartily on the fact that you have urged restraint and caution in commercial bank lending, and we urge further and renewed efforts along these lines. Sincerely, N orm an S tru n k , E x e c u tiv e Vice P r e s i d e n t . Mr. S t r t j n k . Now, we do know that the Fed and the FDIC are making new survey to get new facts with respect to commercial bank usages of certificates, rates paid, denominations and so forth. Now, the Fed made such a survey as of December 1 8 ,1 believe, and the results of that survey were released sometime in March or April. At the time the Fed released the results of its December survey, it was obvious those facts were completely out of date and it is quite ap propriate that the Fed get new facts, get current facts as to com mercial banking practices in this area. It may be that this survej is made somewhat in anticipation of making changes in commercial bank CD practices. Mr. G e tty s . Thank you, Mr. Strunk. It would seem to me that in matters of these kinds that if the existing agencies could take corrective 63-496—66------ i 38 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS action it would be better than having to obtain legislation because it takes so long. Mr. S h e r b o u r n e . May I add to that statement ? M r . G e t t y s . I b e lie v e m y tim e h a s e x p ir e d . The C h a ir m a n . Mr. Todd? Mr. T odd. Thank you, Mr. Chairman. Mr. Strunk and Mr. Sherbourne, I would like to associate myself with Mr. Gettys’ remarks concerning the importance of savings and loan associations. One of my close and dear friends in Kalamazoo, Mr. Paul Gray, is with the First Federal Savings and many times he has told me of die great satisfaction he has gotten out of his association with that firm because he has helped many, many people buy homes in that community. I am concerned that the savings and loans as an insti tution should not be weakened by actions of Federal agencies or other agencies and that their competitive position be maintained. Mr. Sherbourne, in your statement yesterday you submitted a table on page 4, and I am not entirely clear as to the significance of that table. In 1966 you indicate that other time deposits have amounted to 70 percent and negotiable CD’s to 9 percent of the time deposits in weekly reporting member banks. The other time deposits—are they equivalent of nonnegotiable CD’s? Mr. S h e r b o u r n e . Yes. Mr. T odd. These are not what we think of as savings deposits ? Mr. S h e r b o u r n e . These will not include savings deposits. Mr. T odd. The two together are really the ones that represent the CP' n Mby banks? Mr. T odd. The other time deposits would be the time deposits which in a sense would be those taken out of savings and loans in response to high interest rates paid by commercial banks ? Would that be an analysis of the situation? Mr. S h e r b o u r n e . Yes, although it is possible that the negotiable CD’s also have some deposits. Now, may I point out that these are increases that occur, not the total amount that exists. Mr. T odd . But the significance of that 70 percent then would be really, that this year there has been a great change in the savings pat tern and particularly among the smaller savers; is that correct? Mr. S h e r b o u r n e . Yes. Mr. T od d . This is precisely the area in which you are worried and where the impact in savings and loans has been felt ? Mr. S h e r b o u r n e . Yes, sir. Mr. T od d . F in e; that explains that to me, then. Yesterday, Mr. Strunk, in your statement you indicated that the regulation Q was changed in December by the Fed in response to a potential liquidity crisis when CD’s were coming due. A s I under stand that, there would have been a withdrawal of this money from the banks and the money would have been placed in other paper, pre sumably ; is that correct? Mr. S t r u n k . That is correct. Mr. T od d . What would the other credit instruments have been? In other words, what were the alternatives open to the corporations that had the CD’s on deposit? UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 39 Mr. S t r u n k . Treasury bills, obligations of various Federal agen cies, commercial paper issued by finance companies, and other corpora tions. Mr. T od d. At that time the interest rates on these other types of paper were higher than those which the banks were paying in CD’s ; is that correct? Mr. S t r u n k . I am not positive they were higher, but the margin was such that there would have been switches out into other money market instruments. I am not positive the Treasury bills in Decem ber were more than 4y 2 percent. When the rediscount rate went up to 41/2 percent it was inevitable that these short-term money market instruments would go to higher levels which meant that banks could not have persuaded the corporations to keep their money in these CD's, but they would have to go into other instruments. Mr. T od d . Could not the Fed have achieved the same goal through open market purchases of Government bonds ? That would have put money back into the market. Mr. S t r u n k . Yes, sir, the Fed can, of course, generally keep levels of interests at about what it wants to keep them. The particular policy being pursued at that time, however, was to raise interest rates or permit interest rates to go up in response to increasing demands for funds, and the Fed was pursuing a deliberate policy of taking it by means of higher interest rates and that is one reason they raised the discount rate. They were deliberately pursuing a high interest rate policy. Mr. T odd. Yes, and I think, of course, in terms of at least conven tional economic thinking there would be justification of that period of inflation, but that would not necessarily coincide with the liquidity prices on CD’s. It seems to me anyway. Mr. S t r u n k . Liquidity prices in CD’s resulted as a result of pursuantly high interest rates. Again, the negotiable CD is a money market instrument and corporate money goes in and out of these as corporate treasurers decide where the best place is for the short-term investment of their funds. Mr. T odd. A negotiable CD is almost the same as a debenture maturing in a year? Mr. S t r u n k . It is precisely that—a debenture connotes a longer term such as 5 or 10 years, but it is precisely the same as a Treasury bill. Short-term promise to pay. It may not be short term. It may run as long as a year. But the practice of the New York banks in first offering these certificates, negotiable certificates, was to offer them for about 6 months or a year maturity and then a market was created in a negotiable market and over-the-counter market so that the corpora tions who held them could get out of them by sale to someone else. Since the CD’s have begun to be issued for shorter time periods, 30 and 90 days, the negotiability and the making of a market for these instru ments has become less important. Now, the corporations are buying shorter maturities to coincide with the demand or the need of the corporation for cash. So, a lot of corpo rations purchase CD’s to mature on March 15 and again to mature on April 15, because they were the dates the corporations needed cash for taxes and dividend payments and so forth. Now, corporations could have put the money in the checking ac counts and have left them there, but it wouldn’t nave earned anything 40 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS on that idle cash, or they could have put it in Treasury bills to mature on those dates, or other kinds of short-term paper, including obliga tions of the FNMA and the Federal Home Loan Bank System and so forth. Mr. T od d . Thank you, my time has expired. The C h a ir m a n . Mr. Johnson? Mr. J o h n s o n . Thank you, Mr. Chairman. I notice, sir, in your testimony that there might have been a virtual crisis in December—you say the banks were faced with the necessity of liquidating $3.5 billion in maturing obligations and that is the reason that the discount rate was raised. I f there was that type of a crisis, what can you conceive of a crisis occurring if this bill were passed? Supposing this bill were to pass and the banks were denied the right to issue negotiable certificates of deposits or other evidence of indebted ness? What would the banks do with these CD’s that they have now ? Would there not be another virtual crash of our banking system? Mr. S h e r b o u r n e . Mr. Congressman, I am not an expert on central banking theory, but obviously, if the banks were not able to continue to pay a good rate on those negotiable CD’s they would be withdrawn by corporations and it would create liquidity problems for commercial banks. Therefore, I am not sure any prohibition can be made immedi ately mandatory. However, it is clear that we have a problem that developed over the course of 4 or 5 years because these negotiable CD’s which are really short-term money, began to require by Federal Board action a rate of return that in previous years had been restricted by the reserve bank to longer term investments of 6 months or more. So that, therefore, from a long-range point of view, the real problem rests before this committee as to whether these negotiable CD’s should not be eliminated or restricted to a certain proportion of banking deposits. But that is an area in which the committee, I think, would have to get the opinions of better experts on central banking theory than myself. Mr. S t r u n k . May I suggest, I think obviously there would have to be some phaseout period to phase out over a period of several years, maybe. Mr. J o h n s o n . Another question, sir. Your support of this type of legislation seems to be predicated on the fact that there is a remarkable and striking and worrisome decline in the availability of funds for mortgage lending which of course affect you people. I f you were here today, let us say, to testify with respect to the sale by FNMA of $5 billion worth of participation certificates which is the bill that the Senate passed, would you, by reason of the fact that this would be a drying up of money available, be against that type of financing? Mr. S h e r b o u r n e . I t would have an impact, Congressman, but if it is necessary for the U .S . Government to carry on that type of opera tion, then the private institutions must adjust themselves as well as they can to that problem. Mr. J o h n s o n . Y o u would live with that type of a practice, but you cannot see how you can live with the practice of issuing certificates of deposits, is that right ? Mr. S h e r b o u r n e . The reason for that is that we submit that for years, by action of the Federal Reserve Board itself, they provided for a low interest rate on this type of short-term money—you can call it hot money or it almost comes close to demand deposit. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 41 May I point out that until 1962 the rate permitted on deposits— time deposits over 30 days was only 1 percent and by 1964, even in 1964, it was only 1 percent and at that point was increased from 1 to 4 percent. The reason for that must be because the negotiable CD’s market had developed to such a degree and in such a volume, that in short-term interest rates and the Treasury market and in the financ ing market generally they were beginning to touch and exceed the rates paid on all CD’s in order to prevent the shift of bills from these CD's into other phases of the market and then the Federal Reserve Board authorized a high rate on the short-term negotiable CD’s. It therefore seems to us that the onus is not on us to establish why this should be changed, but actually, I think it is up to the Federal Reserve Board to explain why they took this action—why such a sharp departure in the course of just the last 3 or 4 years and particu larly why, in December of last year did they permit a CD rate which is so high above the rate they permitted in their own savings deposits— why did they permit such a sharp differential? They could have realized that the net result of that was going to be the cause of diver sion of substantial amounts of sums from commercial bank deposits as well as from savings and loan accounts. Mr. J o h n s o n . Did you put a figure into the record as to what the total amount of these certificates of deposits are now, nationwide? Is it a large sum of money ? Mr. S h e r b o u r n e . I have a current figure on negotiable CD’s which I think is $17.5 billion and my understanding is that the nonnegotiable CD’s amount to $15 billion or $16 billion. Mr. J o h n s o n . That is all. Thank you. The C h a ir m a n . Mr. Ottinger ? Mr. OnrxoER. Thank you, Mr. Chairman. I would like to congratulate both of the witnesses on their excellent testimony outlining the problems that have been created by the ex pansion of these negotiable and nonnegotiable CD's. I know all over the country I have been hearing from builders and savings banks people and savings and loan institutions that this is a very real prob lem. I would like to explore with you a little bit the solutions. I have a bill that is related to this subject, H.R. 14422, which the chairman has very kindly consented to consider as a germane amend ment to the pending legislation. My bill would limit these time de posits to $15,000 and higher. I would like to read from a letter wiiich I received, dated April 29, 1966, from Stephen Slipher, legislative director of the United States Savings & Loan League with respect to this legislation. With your permission I would like to have the letter included in the record. The C h a ir m a n . Without objection, so ordered. (The letter referred to follows:) U n it e d S t a t e s S a v i n g s a n d L o a n L e a g u e , Washington, D.C., April 28,1966. Hon. R i c h a r d L. O t t in g e k , Souse of Representatives, Long worth Building, Washington, D.C. D e a r C o n g r e s s m a n O t t in g e e : I appreciated your letter of April 25, regarding your bill, H.R. 14422, to prohibit time deposits in banks in amounts less than $15,000. 42 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS The United States Savings and Loan League unqualifiedly endorses this meas ure. I would imagine that every savings and loan association, every savings bank, and even a majority of the commercial banks would favor the bill. In December we wrote Chairman William McChesney Martin recommending that a $25,000 or $50,000 "floor” be established for certificates of deposit. The response was that it wasn’t legally possible to make such a distinction by regulation. We have never quarreled with the necessity of commercial banks paying an attractive rate on the huge certificates of deposit purchased by major corpora tions, but we have bitterly resented the use of CD’s for the passbook-type savings in amounts of a few hundred or a few thousand dollars. Furthermore, much of the advertising creates the impression that such certificates of deposit are ordinary savings accounts. We hope that the Congress will give early consideration to your bill and we would be happy to testify in person in support of the measure. Sincerely, S t e p h e n S l i p h e b , Legislative Director. Mr. O t ti n g e r . One possible solution to this problem has been recom mended to me by a number of commercial bankers to give the Federal Reserve bank the authority to set limits on the denomination of CD’s. We heard from Mr. Sherbourne, however, testimony in his statement that was highly and I think justly critical of the Federal Reserve Board in this matter. It would appear that the Fed has been responsible for creating this problem in large part through its permitting a 514-percent rate on the certificates of deposit. Would you be sanguine with a measure which merely gave the Federal Reserve Board the power to set such a floor? Do you think the Board could be counted on to act and act adequately ? Mr. S t r u n k . We would be very happy to have the Fed have the power. Then at least it wouldn’t have the excuse that they can’t legally do it. I don’t know whether the Fed would set a floor if it could, but at least, if legislation were passed permitting the Fed to do it, they could not retreat to a legal opinion that they can’t do it. It would be better to direct the Fed—maybe direct the Fed to set a floor or permit the Fed to set a floor no lower than $15,000 or $20,000. Mr. O t t i n g e r . Mr. Sherbourne ? Mr. S h e r b o u r n e . The situation at this point seems to be serious enough to have the Congress establish the lower limit and give the Federal Reserve Board the right to make it higher if they wish. Mr. O t t i n g e r . Y ou have no objections, I take it, to large denomina tion certificates of deposit as far as your industry is concerned ? Mr. S h e r b o u r n e . We do not, sir, because we believe most of our savings are in amounts under $10,000 and therefore the impact on us would be minimal—something that we could support, and something that wouldn’t affect the home-financing market too greatly. Mr. O t t i n g e r . I suppose one of the justifications the Federal Re serve will give, and we will be hearing them, I take it, in the course of these hearings, for raising the rates on the certificates of deposit is that it was an anti-inflationary measure. As I understand it, and cor rect me if I am wrong, the effect of the increased interest on the cer tificates of deposit has not been to restrict credit generally, but only to discriminatorily restrict credit in the field of home financing, mort gage financing. It takes money away from the savings institutions which performs that function and makes credit more readily available in the industrial sector. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 43 Mr. S h e k b o u rn e . Mr. Congressman, I want to make it clear that I am not critical of the Federal Reserve Board as I think I mentioned in my testimony. I have a great deal of respect for the manner in which they have controlled the money market in recent years. I think what happened here is that under pressure and demon strated evidence from large commercial banks, a negotiable CD market was built up and then because of the necessity of maintaining deposits here and preventing a drift of deposits abroad, the short-term rate in the Treasury market got higher and higher and finally in December the Federal Reserve Board was faced with a problem and they had to take some action. The question from this point forward is whether that problem is of such magnitude and whether there is a possibility of a recurrence such that the Congress shouldn’t help by imposing a limitation, and I hope that perhaps there would be some limitation resulting from their own volition. Mr. O t t i n g e r . Thank you very much. My time has expired. The C h a ir m a n . Mr. Stanton. Mr. S t a n t o n . Mr. Hansen. Mr. I I a n s e n . Mr. Chairman, I ’m sorry to be late. I do not want you men to get the notion that I am negative toward your position, but we are talking about a problem which I think is somewhat more deepseated and has a little history behind it that I would like to draw to the surface. I live in the Middle West and competition for money started 5 or 6 or 7 years ago and the aggressors in the case were the members of your association from the west coast. I think the things that have been going on among the banking fraternity in our area, at least, were defensive moves. Now, we are talking about the validity of these negotiable cer tificates. I understand that you have indicated, that you are ame nable to the idea of limiting these to a minimal figure thus getting them out of the category of the saver item. Well, this of course was objected to by our chairman, Mr. Patman, and I think advisedly so because this would in turn create a situation where the little fellow could not get the benefit of the higher rate. The higher rate would be made exclusively for the monied men. We are small money people in the Middle West. We do not think in the same terms that you do back in this part of the country. I am all for the little fellow, because I am one of them and I think we need the little fellows in the country to carry on the whole total load with which we are faced. Therefore, I would think that you men would, instead of fighting this thing, propose that we fix it so that the banking fraternity could share with you the same position on, we will say, in the passbook savings field, by suggesting that the rate permissible to the banks on pass book accounts be put more at a level with what you men in your in dustry are paying, and advertising, as your interest rate. I would like to have your comments on that suggestion, please. Mr. S h e k b o u rn e . The record of the Federal Reserve Board on rates that they permit on savings accounts is clear that in recent years they permitted commercial banks to be competitive on the rate, because the rate that most of them were allowed to pay was fairly close to the highest rate the savings and loan associations were then paying. It is clear, Mr. Congressman* that so long as commercial banks are advertising one-stop banking, all-service banking, and private, per- 44 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS sonal loans, equipment loans, automobile loans among everything else with which to attract customers to themselves, they also get their savings deposits and commercial deposits along with it, but the savings institutions are going to have a problem if they are not permitted to have a slightly competitive advantage—maybe like a quarter of a percent. Now, therefore, it is that area to which the Federal Reserve has effectively manipulated and controlled and permitted our institutions to get proper amount of savings. But in these negotiable CD markets and in the high rates they are permitted recently, it obviously has created great distortions and the Congress of the United States I always understood is concerned with the availability of credit and home financing. I asked my Congresswoman, Mrs. Dwyer, in my district one time why this committee and the House was so slow and cautious in per mitting us to have additional lending powers, even to the extent of permitting loans for equipment in homes, and she said to me that the Congress is most concerned that there be sufficient credit for housing. So I think by this demonstrated record of Congress, they are as much concerned with this objective as we are. Mr. O t h n g e r . Will the gentleman yield ? Is it not the small fel low who is being hurt by these CD’s because he cannot get a loan to buy his house ? Mr. S t r u n k . That will be the record; yes, sir. Come late summer and early fall he will find—the typical family man that wants to buy a house will find—he will find himself unable to get the credit for it as a result of the draining away of money out of our institutions into the CD market. Mr. O t t t n g e r . Thank you. Mr. H a n s e n . The whole point that I want to draw out here is that we cannot take a meat ax approach to this thing. On the other hand, it is a fact that in every competitive situation, in every business, one or the other of the other competitors finds himself at a tactical dis advantage he is going to back into his office, sit down and figure out all the steps necessary to cope with the situation. My notion of what happened in this case is that the banking insti tutions have done just that by developing this negotiable CD propo sition on an energetic basis. My time has expired. I f you would like to make any further com ments on this point, I ’d appreciate seeing it in the record. Thank you. Mr. S h e r b o u r n e . Mr. Chairman, may I be permitted to make a comment and charge it against my time. I want to make sure that the members of the committee understand that our testimony comes not from the sense that we want the com mittee to take this away—we would not be here if that were the case. We would submit that there are two problems of international sig nificance that exist. One is that the negotiable CD market has be come so large and so great that it represents an interference with the Treasury market and the bill market and the short-term market and to that extent has an impact on Treasury financing operation. The second is that the enormous—the torrential increase th at devel oped last December has created such a transfer problem in savings from our institutions that it now limits and inhibits our capacity to UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 45 take care of the existing volume of home financing applications that we are receiving. You find no problem in those. You find no prob lem in those two areas, then take no action. The C h a ir m a n . Mr. Stanton. Mr. S t a n t o n . Mr. Strunk, I wonder if you can clarify one point for me, please. In answer to a question from Mr. Harvey yesterday, did I understand you to say that your big problem is consumer CD? s and that this practice of consumer CD's in small amounts are primar ily issued by the large banks only ? Mr. S t r u n k . If I understand your question, we are mostly con cerned with the consumer CD. As we have seen this develop, it has developed primarily in the larger banks, in the larger cities, but it is rapidly spreading to the smaller banks throughout the country and in the small communities. Smaller banks are having to do this as a defensive matter against the big banks and you will find bank promotion of CD's now spread out over the country where in the few days after the selling went up to 51/2 percent it was primarily a phenomenon of big banks, plus some aggressive newTsmall banks, but in the main, the older, smaller banks did not get into this until recently. Mr. S t a n t o n . I want to clarify that point because it was my under standing that the practice was spreading throughout the bank in dustry. Secondly, I had the occasion over the weekend to spend some time with a commercial banker and I W ’ould presume that when they testify on this bill their big complaint will be the same as yours. It is tight money and they were crying equally as hard and as eloquently as you people have presented your case here today. I f that is the case, both the commercial banks and savings and loan institutions are in this tight money situation. Would you have any particular suggestions, if you agree with that premise, what this committee might do to help alleviate that situation ? Mr. S t r u n k . There are several ways to attack the inflation problem and I think we have tight money because of the inflation problem. If the economy is overexpanding, there are shortages of everything. Inflation problems and the problem of an overexpanded economy straining at the leash can be attacked in two ways, through monetary policy through Federal Reserve action in connection with the amount of credit available and the other is through the fiscal area—fiscal tools. There are two general types, one the general areas, the general level of Federal spending and the other area is tax policy and tax in creases have been recommended, recommended by the United States Savings & Loan League and many groups, of course, have urged an attack on the inflation problem through the other fiscal means; namely, a reduction, some reduction in Government spending. Given a reluctance to use fiscal measures, then you have tighter and tighter money and you have a greater and greater demand for money and for credit on the part of businesses who find the opportunities to make things and sell things so great. Mr. S h e r b o u r n e . May I point out that the Federal Reserve Board announcement, when they changed the interest rate ceilings in Decem ber, had two interesting sentences which indicate the nature of the problem. 46 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS They said, with respect to the action on the rediscount rate, that it is intended not to cut back on the present pace of credit flows, but to dampen mounting demands on banks for still further credit ex tensions that might add to inflationary pressures. Later on they said that the increase in the rates that member banks are permitted to pay their depositors is intended to enable the banks to attract and retain deposits of businesses and individuals and thus to make more effective the savings funds already available in the economy to finance their loan expansion. As far as inflation in a given field by corporate building is con cerned, it doesn’t make much difference where the savings comes from, or where the money comes from, whether it is created by demand deposits by a loan from the bank, or whether it is created by deposits that come into the bank and then are reloaned by the bank. The pressure on prices in that field depends only upon the loan extension. It seems to me that within the extension of the Federal Reserve Board in December, you see a little contradiction. Mr. S t a n t o n . Thank you very much. The C h a ir m a n . Mr. Annunzio. Mr. A n n u n z io . Mr. Chairman. Mr. Strunk, what rate are the Chicago banks paying on their CD’s ? Mr. S t r u n k . The larger banks are paying 4X/o percent on so-called consumer CD’s. On negotiable CD’s, they are paying considerably higher rates that would have to be competitive with the rates paid by New York City banks. As far as the consumer area, 4V2 percent with a few banks paying 5. Mr. A n n u n z io . I have talked to many of the bankers in Chicago and I was informed that they were paying 4y2 percent. Yesterday, I noted in the Wall Street Journal that the Morgan Guaranty Trust Co. is raising its rates to 5y2 percent and if that happens, do you think a lot of the Chicago money will go into New York unless the Chicago banks raise their rates? You are going to have a real tight-money situation in Chicago as far as our savings and loans are concerned. Mr. S t r u n k . Again, the 5y2 percent rate, I believe, announced by the Morgan Guaranty relates to the so-called corporate depositor— the negotiable CD. I have not yet heard in the consumer area that the New York* City banks are paying 5y2 percent for the CD’s. But so far as the New York City banks raising their rates, and CD’s generallv, it takes money out of the Chicago banks and it takes money out of the banks in Keokuk, Cedar Rapids and everywhere into the big city banks. Mr. A n n u n z io . Well, in your opinion, the crisis is here arid some thing must give or something must be done, whether it is by this com mittee or by administrative actions of the Federal Reserve Board. Mr. S t r u n k . Precisely. Mr. A n n u n z io . I want to read back your statement on page 12: This use of certificates of deposit for ordinary savings was not predicted by the Federal Reserve. In fact, the Federal Reserve Board has publicly cautioned the banks against this disruptive competition. I am concerned about a statement such as that. The Federal Reserve Board is a board composed of seven men. When it voted to increase the discount rates, the vote was 4 to 3. These are seven out> UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 47 standing economic authorities. For the Board to issue a statement cautioning banks against disruptive competition and, at the same time, not be able to predict or to forecast that this very situation was going to happen is strange indeed to me. Why were they not in a position to see that 6 months later they would be cautioning people about the very condition they created ? Mr. S t r u n k . A s a matter of fact, Mr. Congressman, Mr. Martin, the Chairman, cautioned the banks in December, 2 w^eeks after the action was taken. Xow3 whether he could have, or should have seen that many banks would immediately jump to 5U2 percent, or the 5-percent certificate, I don’t know. I would have thought that he could. But within 2 weeks he felt it appropriate to caution the banks about the use of higher rate certificates. Mr. A n n u n z io . It seems to me that he, as Chairman of the Federal Reserve Board—and he has appeared before this committee, I have a great deal of respect for his ability—could have forecast the very situation that he cautioned against. I am concerned about the Federal Reserve Board—I think the responsibility lies with them. In other words, they could have forecast this thing and have promulgated the very rules that you brought before us so that we would not be in the condition that we are in today. Do you agree with that ? Mr. S t r u n k . I heartily agree with this. In connection with these flows of funds, other lenders, in connection with mortgages, other mortgage lending institutions, the commercial banks and the insurance companies dropped out of the mortgage market at the beginning of last year and now as a result of unrestrained commercial bank competi tion for savings, it really hurts the mortgage market. We have always been in the mortgage market, year in and year out. We kept, our lending volume up in the first 3 or 4 months of this year, but now with money being drained away from us and invested by commercial banks in short-term business loans, consumer loans, buying tax-exempt securities, I think it is a question Congress has to establish some kind of priorities in the use of funds and not let it just go to whomever can pay the highest rate. Mr. A n n u n z io . Y ou do not have to be an expert in economics to understand that when young people go out to buy a home, and they have the downpayment, and if they cannot make a loan, that this is going to hurt the savings and loan. It is going to hurt the building industry, it is going to hurt many of the people who are employed in the building industry and this situation will spiral, the ball begins to get larger and larger and all of us are aware of the fact that we are in a very tight money market. I want to ask this question, pursuing the responsibilities of the Federal Reserve Board. I feel that they are the key to this particular crisis for the simple reason that they created it and having had the power to create it, it seems to me, that under the regulations they can solve it. Since they are separate from us in the Congress, they ought to be able, if 2 weeks after they issue the order they were cau tioning the bankers and now it is 5 months later, I think the Chairman of that Board should call a meeting as soon as possible to do something about alleviating the situation. They caused it, they ought to do something about solving it. 48 UNSOUND COMPETITION FOB SAVINGS AND TIME DEPOSITS Mr* S t r u n k . I am certain within their law they can. Mr. A n n u n z io . Thank you, Mr. Strunk. The C h a ir m a n . Mr. Rees. Mr. R ees. Mr. Chairman, before I ask some questions, I would like to read from a memorandum from a leading savings and loan institution in Los Angeles, to give you an idea of what we are talking about, in terms of competition, and who is investing in savings and loan accounts and who is investing in CD’s. In this institution, which approaches a billion dollars in deposits, we find that 53.7 per cent of their deposits are in deposits of $9,000 and over. This is to emphasize that the great majority of money that is in savings and loan accounts is investor-type money, of people who use this type of investment and use a fair amount of money in terms of the invest ment. This institution, in the last quarter ‘lost something like $10 million deposits and $15 million was in accounts at the $10,000 level. So we are not talking about people that have $200 or $300 accounts, we are talking about those who are invested up to $10,000 insurance levels. There were several questions that I wanted to ask. One thing that shocked me is in your testimony, Mr. Sherbourne, where you said that the banks had increased their foreign loans from an average of $1 billion to $2.4 billion, during this period. Mr. S h e r b o u r n e . That is correct. They increased them during each of the years 1961 to 1963 by a billion dollars and in 1964, the year in which regulation Q was changed, the banks increased foreign loans and investments by about $2.4 billion. Mr. R ees. I think that is shocking. We have been losing some thing like $3.4 billion a year in terms of our gold reserves. Much of that has been lost because of investments and expenditures we make in other countries. Because of that we have had to send families home that have been, in say, Europe with NATO forces. We have had to curtail a lot of things in other countries and here we find that the banks are now loaning $2.4 billion which is a direct call on our gold reserves and therefore have a direct relationship to the amount of currency in our economy. I think something should be done about that. This money is being taken out of the building market in some of our States and is being put in direct foreign investments. Does the Federal Reserve Board under the law today set limits on all CD’s in terms of the amount of CD’s? For example, could the Federal Reserve Board by rule say that all CD’s have to be, say, at least $10,000 and must have a fixed date of maturity and fixed in terest rate? Mr. S h e r b o u r n e . The general counsel informs me that he doesn't think they have that legal power, to set a minimum amount. Mr. M c K e n n a . There is a difference of opinion apparently among lawyers on this, so I don’t want to say it as a categorical answer. My own opinion is that they would need the blessing of some further statutory provisions before they could set a floor under the amount of CD’s. Mr. R ees. So we really can help the Fed if we wanted to by giving them this power? M r. M c K e n n a . Yes, you could. Mr. R ees. Have we asked for the power, Mr. Chairman ? UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS 49 The C h a ir m a n . No; we haven’t asked for the power. I do not believe that the CD’s are legal anyway. I would not be in a position to discuss that part of it, personally. They had a secret meeting this morning. We have two Govern ments here in Washington, one run secretly, involving all credit, money, interest rates, and the Congress has the rest. We think they had such a meeting. We are not even sure of that. Mr. R ees. Do you not think there is a danger in the use of CD's ? We found that in California, and I think in other parts of the country this last year or so, some banks—these are primarily new and small banks—have had to go into a forced merger because they had too many outstanding CD's and all of them matured just about the same time and therefore they were not able to pay the people that wanted to draw their savings. I think San Francisco National, Mr. Silverthorne's bank, was an example of this. Do you think it might be prudent to help the banks " I think we want to help them as much i as anybody else, that we put in a provision as to what percentage of their full deposits can be invested in CD’s. Mr. S h e r b o u r n e . I certainly do, Mr. Congressman. With respect to our business, the Congress generally can, upon the recommendation of the Federal Home Loan Bank Board. Frequently whenever you permit us to go into a new area of lending, for example, you have the requirements of not more than 2 or 3 percent in a given area. So that the CongressJiad an opportunity therefore to test the impact of that new power and precisely that is what should have happened in this area. May I emphasize again this point, that when you are paying 5*4 percent or 5 percent on 30-day money, that 30-day money is so close to demand deposits on which by law the commercial banks can pay no interest, in effect you are almost getting close to infringing a principle established by the Congress that it is unsound to permit this. But when you are paying 5Vi percent on 30-day money, you are almost doing just that. And the thing that has made it so volatile and so dangerous is that in effect corporations are getting a long-term interest rate on negotiable certificates which is almost like currency, because it is so mobile. This is an acute problem. Mr. M c K e n n a . In answer to your request, Congressman, I quoted yesterday from an article by Mr. Herbert Prochnow, Jr., attorney for the First National Bank of Chicago. It seems he has been anticipating some of the questions to be asked by this committee and he was writing in November 1065. On page 058 of the “Banking Law Journal” for November 1965, he said, “Traditional regulatory tests for capital adequacy may also be outmoded by bank issuance of capital debentures and promissory notes. The failure of some U.S. banks in part because of overreliance on certificates of deposit may indicate a need for a study of the maximum of percentage of deposits of an individual bank which should be de rived from the issuance of time certificates.” Mr. R ees. Thank you. The C h a ir m a n . Mr. Hanna. Mr. H a n n a . I was not here at the time my name was called. The C h a ir m a n . We are coming back to you right now. Mrs. Dwyer is entitled to recognition. She was not here the other day, 50 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS yesterday, and then we will start right here with Mr. Reuss and Mr. St Germain and others who have not interrogated the witnesses. Mrs. Dwyer ? Mrs. D w ter. Thank you, Mr. Chairman* I am sorry I was not here yesterday because I would have liked to have had the privilege of introducing Mr. Sherbourne to the committee. He happens to live in my district and is one of the most outstanding men in the savings and loan industry. I read your statement last night, Mr. Sherbourne, and I congratulate you on it being a very, very constructive statement. Thank you. I have no questions. The C h a ir m a n . Mr. Reuss. Mr. R eu ss. Mr. St Germain and I will yield to Mr. Hanna. Mr. H a n n a . I want to thank my colleagues. I want to thank the chairman for his courtesy. Gentlemen, I wanted to go back to a point that was made by Mr. Rees about the distinction in the money that we are talking about when we are talking about the thrift savings and when we talk about the investors’ deposits. Now, I think this is a very important distinction to be made, par ticularly as a Californian, there is a distinction to be made and I would like to make it in the light of an understanding of what- you said. Mr. Sherbourne, about the comnetitive position ordinarily as it has been historically—the banks and savings and loan institutions required that since the savings and loan does not srive all the services that the bnnk does, that it has to have some spread in what it gives depositors. That has been examined into and and has been agreed. I would like to point out one other point of spread. Tn California, because we were a State in which there was a greater demand for capi tal needs than there was capital in the State for this expansion, we became a capital importing State, therefore we had to give a little bit more than one-quarter in order to serve what our needs were and that was understood. Tn addition to that we had a very aggressive group of savings and lonr* people. So they were able to take the two percentages, the one for the bank competition, the one for the importation of capital, allowing them to aggressively advertise for deposits. They are not now looking for local money to build local neighborhood buildings. They are now nroin£ out into the money market and they have become participants in the money market of the United States. California has $26 billion of $130 billion of business and therefore "bout 20 percent of it. But during the period of time in which this importation of money was acquired, they did every year between H pud 15 percent of the building that was being done in the United States. A business that ran from $45 to $60 or $65 billion a year. We doing that in California and we needed the money to do it. Now. any financial institution, be it bank, saving and loan or any thing else, operates on liquidity for growth and if it is aroing to have new loans it has got to have new money input%Where does it get that money? It gets that money from its borrowing, from loans already made, it gets that money from its new deposits, and it gets that money from the returns from loans previously made, the paybacks. Now, this is what happened in California. We got our first—we got ours with the large, the greatest market and we got the flow of UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 51 funds in order to take care of tlie demands that were made for new loans out of all of this and we went rocking along fairly well with a few stumbling blocks in places like in 1954 and 1957 until wT readied e a period of time in which this all began and it was not in December of 1965, but it was when the insurance companies started pulling out of this picture in 1964. The red flag, as far as I was concerned, went up then. What happened there was everything had been made so fluid, that the money availability determined the building of homes and not the market needs, and so there was some overbuilding. That started the pullout. Now, at the same time, our national policy demanded for an expansion of our industrial capacity. Now, there began to be a slack off because of overbuilding in certain areas, there began to be a buildup of need for expansion of industrial potential and so a new pressure on the money market was developed and I understand that this last year, that something like $60 to $80 billion in business and industry expansion occurred. So it is understand able with this pressure on, it did not take very long to build in our country a flow of funds to banks. When the interest rate went up, this again contributed to the lack of inflow of funds. We found out in California that the demand for building is hedged upon the guy who is already in a new house—it is the moveup man that really makes the market. It is the man who is moving up in housing, and when the interest rate took his equity and ran it down again, he decided he would not sell. So the raising of the interest rate changed the payoff. The 30-year loans had an average life of 7 years. And that meant there was some body selling the house they were in to buy another house. Now, that has stopped. That has stopped. Because the man who had the house to sell found out if he sold under these new interest rates he had to take a discount on his mortgage that operated to be about a thousand to $1,200 on a $20,000 house. He decided he couldn’t afford to put that much equity down the drain and he would not sell, he would hold on to it. Now, what happens to the liquidity which was in this money that we were importing? There were no loyalties in that money. No loyalties whatsoever. This was investment money and it is looking for yield and returns. So when they found that the pressure had set up the interest rates, and the Fed with raising regulation Q opened the valve for the business expansion and provided the conduits, the CD through which that can flow, the money hit the conduits toward the banks. Then something else hit the fan for the savings and loans. And that is where we are right now and the CD’s position in this thing is that it was a conduit through which this money could flow to meet the yield and the pressure that built the yield for construction loans. That is the way I see the picture and that is the way I see the CD operating in it. I think that you can always have too much of a good thing and that is what we got in a CD, It was a good thing and we got too much of a good thing because instead of handling a reasonable relationship be tween the function it was supposed to fulfill and the fact that it starts hitting even down into the thrift level, it is even destroying the loyalty depositors, not only housing, not only lousingup the liquidity, and if I am not wrong, that is a good part of the picture as far as my own State is concerned. 52 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. S t r u n k . I might say, Mr. Congressman, you have painted a brilliant and accurate picture as far as I can tell. The C h a ir m a n . Mr. Eeuss ? M r. R eu ss. There has been much testimony both from you gentle men and from many of us here stating the effects of the Fed’s per formance on CD’s on home loans and homebuilding generally, which is the function of our savings and loan institutions. At the hearings of the Joint Economic Committee right after the December action by the Fed on regulation Q, I asked Chairman Mar tin whether prior to the drastic change in regulation Q, which the Board instituted, he had consulted with or conferred with the Federal Home Loan Bank Board and his answer was no, he had not. Do you have any judgment, Mr. Strunk, as to whether that was in the interest of good and orderly Government, to effect this kind of change in the rate of our savings institutions without such consultation ? Mr. S t r u n k . Mr. Congressman, I was quite amazed when I learned on the record that the Federal Reserve people had not talked with or consulted the Federal Home Loan Bank people and I would hope that they have opened up avenues of constant communication in the mean time because the Fed, I don’t think should be taking actions, affect ing something so vitally—something so vitally affecting the savings and loan business without talking to those people in Government who are responsible for the orderly conduct of the savings and loan business. Mr. R e u s s . Both in your testimony, Mr. Strunk, and that of Mr. Sherbourne, you have made specific suggestions for action with respect to certificates of deposit. Neither of you have, in terms, endorsed the bill, H .R . 14026, which would make illegal negotiable certificates of deposit, but both of you suggested changes be made. I myself have been greatly concerned with an aspect of CD’s which has not been touched on this morning, namely, that they bear a 4-percent reserve requirement on the bank system as opposed to the 16-percent reserve requirement for demand deposits. A negotiable CD is about as close to a demand deposit as can be imagined. Do any of you have an opinion as to whether a raising of the reserve requirements from its present 4 percent would not take some of the gloss and bloom off of CD's and make them less irresistible to the large banks, an irresisti bility which has contributed to the fact that we have now $17.5 billion worth of these pieces of paper ? Mr. S h e r b o u r n e . I think your comments are much to the point. I don’t believe that setting a reserve requirement on the short-term CD’s to be the same as on the demand deposits would cure the major problem. It would have a desirable impact because at the present time if a commercial bank were willing to let a proportion of these time deposits and negotiable certificates drift away, by remaining perhaps or taking a chance on their being converted to demand de posits, then thev are put in the position of adding 8 percent to their reserve balance in the Reserve bank and that would be a little tough on them. Mr. R e u ss. So it is your judgment that no action should be taken to increase the reserve requirements on CD’s, negotiable CD’s? Mr. S h e r b o u r n e . I don’t think it would solve the problem, but I think it would be a desirable act. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 53 Mr. S t r u n k . I would not say that the Fed should not take such action. I would hope that the Fed would. I would agree with you that this is something that—another thing that can be done about this problem. Mr. S h e r b o u r n e . It wouldn’t solve the problem as far as we are concerned. Mr. S t r u n k . N o , i t w o u ld n o t. Mr. R e u s s . Would it not, by damping down the attractiveness of CD’s contribute to the solution of your problems ? Mr. S t r u n k . It would I think contribute to the solution of it. It would not necessarily solve it. Mr. R e u s s . D o you agree, Mr. Sherbourne ? Mr. S h e r b o u r n e . The difficulty I face in answering that problem— it would affect it, but I think primarily the problem is this—if a com mercial bank is enabled to pay a very high rate on a short-term de posit, it perhaps is willing to take the chance, even if they had to put up a 12-percent reserve instead of 8—they still have a substantial amount of additional deposits which they would use. Mr. R e u s s . What you are saying is that while it would not cure the problem, it might ameliorate it somewhat ? Mr. S h e r b o u r n e . It might ameliorate it, but not sufficiently for me to say there would be no residual problem of substantial magnitude left, I think the problem would still be there, but it would be a smaller problem, but still serious. Mr. S t r u n k . The CD problem might be approached in this manner, but it also needs to be attacked head on. M r. R e u s s . C o u ld i t b e a tta c k e d in b o th w a y s ? Mr. S h e r b o u r n e . Yes. Mr* S t r u n k . It could. Mr. R e u s s . During these same hearings in December, and again in a floor speech I made last January, I urged the Federal Reserve in its annual report, which I hoped to have in my hand by February 1 in the joint committee hearings, to give us its philosophical explanation of its performance on its regulation Q and CD’s generally. Unfor tunately, the Federal Reserve’s report was not delivered to the House until 4 months after the start of the year, so that it was of no use in the Joint Economic Committee hearings this year. I have had an opportunity to look through the report and I find in it, unfortunately, no real discussion of the certificate of deposit. Have any of you gentlemen had a chance to look at it? Mr. S h e r b o u r n e . No, sir. Mr. S t r u n k . N o , I haven’t, sir. The certificate of deposit area has been so new that I think the Fed or other banking agencies have not really done much in the way of study in collection of statistics. We are handicapped constantly in looking at banks because of the in adequacy of them—in completeness of them. The Fed publishes data with respect to reporting member banks in leading cities, but that is only part of the banking system. Now, the Fed in December for the first time got some facts. Those facts were released a few weeks ago and I thmk we were in—they were in the latest Federal Reserve Bulletin. This is the only area. I don’t think the Fed has gotten enough data nor have they done enough—nor have they done much real thinking, I think, in this brand new banking area. 63-496—66------5 54 TJNSOOND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr R e c s s I would like to address a question to my colleagues in the lower tier, indicating that they are closer to the people than some of us older members. Have any of y o u gentlemen received the an nual report of the Federal Reserve System { Mr. fesa. Yes. * j Mr. T odd. I just got it. I r eceiv ed it y e ster d a y . Mr. O t t in g e r . I h a v e n o t r eceiv ed it. . Mr, E e u s s . I w o u ld lik e to ask — I h a v e n o t receiv ed it e ith e r , so this is not confined to you. The C h a ir m a n . It w ill b e fu r n ish e d to a ll th e m em b ers. Mr. E e u s s . If I may address my remarks to our friend, Bob Cardon, I think it would be a good idea if the Fed made available to each member of the Banking and Currency Committee a copy of this. The C h a irm a n . They should send each member a copy. They sent the chairman one. Mr. Bees. They send one to the chairman and the lowest member of the committee. Mr. E e u ss. Thank you, Mr. Chairman. The C h a ir m a n . Mr. St Germain. Mr. St G erm a in . I have a question for Mr. McKenna whom we all have a good deal of respect for. In your opinion, does the committee have the power to legislate in the area that Mr. Rees brought up as to the amount of CD’s that a bank can issue, in other words, to restrict the percentage of CD’s as against deposits that the banks can issue? M r. M c K e n n a . A s to the Federal Reserve Board’s existing power, we have not researched that and I would have to draw on my general knowledge of the Federal Reserve Act. It seems to me that this is in an area that would be within the cognizance of the Federal Reserve Board. It is a. matter of supervisory importance and I would think that they would have, in that area, a field they could regulate if they chose to do so. However, I would appreciate the privilege of supple menting my opinion in the record. (The following information was submitted for the record:) S t a t e m e n t o r W il l i a m F . M cK e n n a Representative St Geraain raised the question of regulatory action to control SUSSS* l““W s ,ta Sectio” o< “» ° » « ~ *» Clause 5 of the Constitution of the United States emoow- “to coin money, reflate the value“ttaSS; and*“3 a o m ^ ^ ^ o lT ^ tr te T L O T ^ ^ ^ m ^ r ^ ^ v 01111 grant of P°wer baTe mand, and backed by gold or silver SS?S S ,2S£fSt»^ ,5 iS on S !S ffSiffiSf* ‘ss 90 per cent of the par value of n a ™ m amomit equal to and deposited with the U.S. Treasury* ernmeut ^ 3fa6a P^^hased by the bank ^ n s u tn tlo n a ll^ of the tax, Chief Jnstice Chase in the a1 Oongwas may, coiurtJtntlonally, sem e the b e J * oM tto p^ s w’ tuM ier' UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 55 may restrain, by suitable enactments, the circulation as money of any notes not issued under its own authority. Without this power, indeed, its attempts to secure a sound and uniform currency for the country must be futile.” 75 t\S. ;>48-f>49. Commenting on the statute designed to force the withdrawal of State bank notes from circulation, Senator John Sherman gave voice to the truism that the volume of currency affects the price of commodities. Consequently in order to regulate the value of coin, it is appropriate for the Congress to control the volume and use of currency. Certificates of dei>osit issued by banks likewise have a relationship to the value of money that warrants Congressional control of the terms upon and amounts in which such certificates may be issued. The kinship of such certificates to money is particularly close if they are issued in negotiable form, so that they can pass from hand to hand in lieu of the deposit of money they evidence. The entire outstandings of certificates of deposit, whether negotiable or non negotiable, exert influence on the value of coin from another direction. Such certificates constitute an obligation on the issuing bank to pay the amount due on them at specified maturity dates. In our present financial system, the avail ability of deposits in financial institutions affects the supply of funds available for financial transactions through bank loans. This in turn affects the price of commodities, goods and services in the same manner as the volume of State bank notes affected the price of commodities. In extremes?, unwise overissuance of certificates of deposit could result in the inability of the issuing bank to pay the obligation incurred at maturity, leading to failure of the bank due to insolvency. While it may be a matter of degree* one need only recall the economic situation in the United States in the early 1930’s to realize that bank failures in turn affect the value of money. In 1924, Mr. Justice Holmes speaking for the U.S. Supreme Court in the case of State of Missouri v. Duncan, 265 U.S. 17, upheld the authority of the Congress to sustain the competitive ability of its creature, the national bank, vis-a-vis State-chartered financial institutions. That case overturned a Missouri probate court’s refusal to appoint a national bank as an executor under a will, even though the bank met the qualifications of a Federal law that authorized national banks to act as trust companies if like activity is carried on by State-chartered banks and trust companies. The question at issue is whether a State could impose a safeguard such as the deposit of securities to protect beneficiaries that a national bank could not meet under its enabling statute. In his decision, J ustice Holmes stated: “the State cannot lay hold of its general administration to deprive national banks of their power to compete that Congress is authorized to sustain.” 205 U.S. 24. Seven years earlier, in First National Bank v. Union Trust Company, 244 U.S. 410, the Supreme Court relied on the argument th at business practice provided a connection between banking and trust business, thus sustaining Congressional authority to permit national banks to engage in trust activity if no contravention of local law was involved. Thus the principle seems well established that the Congress can use the bridge of business practice to justify action to enable its financial creatures to remain competitive. This principle would seem easily to allay any doubt that the Con gress can take similar appropriate action to sustain the competitive ability of its creatures th at are Federal savings and loan associations, where competitive ability is drawn into the picture through the business practice of banks in issuing certificates of deposit. The foregoing brief analysis has not dipped into the possibility of using the power of the Congress to regulate commerce with foreign nations and among the several States as a foundation for appropriate Congressional action controlling the terms and amount of issuance of certificates of deposits by banks. However, the Constitutional grant of power to the Congress to regulate commerce, as it ap pears in Article I, Section 8, Clause 3, may well supply an added basis for Con gressional action with reference to certificates of deposit. In modern business practice, the actual transaction of making a bank deposit often flows across State lines, as does subsequent negotiation and transfer of a certificate of deposit is sued by a bank as the result of the deposit transaction. Let us turn now to the Question as to whether the Federal Reserve System already possesses authority to regulate the percentage of total deposits in a member bank of th at System that can be represented by certificates of deposit The Chairman of the Board o f Governors of the Federal Reserve System strongly intimated th at the System already has such authority. In his appearance 56 TJtfSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS before the Permanent Subcommittee on Investigations of the U. S. Senate Com mittee on Government Operations on March 16, 1965 in connection with an in vestigation into Federally insured banks, Chairman William McC. Martin, Jr., stated that the proportion of a bank’s certificates of deposit to its total deposits is something that the System watches all the time. (Hearings Part I, page 224). In a colloquy with Chairman McClellan of the Subcommittee, Mr. Martin described “volatile” certificates of deposit as those taken by a corporation seek ing an interest return on funds expected to be used for some corporate purpose within a short time. At the given time, the corporation either withdraws its de posit or sells its certificate of deposit if it is negotiable in form. Senator McClel lan drew a distinction between a certificate of deposit likely to be withdrawn at maturity and a savings account likely to grow in size. Mr. Martin noted that the hazards in issuing certificates of deposit are intensi fied if the issuing bank ds relatively small or newly chartered. He stated that such a bank may have a ready market for its certificates of deposit one day and none whatever the next, and unless it has maintained proper liquidity and soundness on its assets, it cannot pay its “volatile CD’s” as they fall due. Senator McClellan then stated: “If you are concerned or interested in the soundness of a bank, particularly a new one just starting, you would not take $10 million deposits for face value as sonind growth. You would go back and examine to see how many of its deposits were similar to those volatile CD’s ?” Chairman Martin replied: “Exactly.” Senator McClellan continued: haJve mim°n of deposits in that kind of deposits, and w„ d .not m?icate " " “ A growth up to the $10 million rate?” a and the Senator then agreed th a t such ^ . draim staaces might indicate a lack of a healthy situation.” Senator Curtis joined the discussion to comment ■ . J ™ 110 he quite trank about i t the CD has gotten to be almost evidence of 88C °ntmted t0thebaDk« ■ * the™stodia" o' Chairman Martin agreed with Senator Curtis’ analysis, and added t h a t w ith This is the kind of analysfcthS skills of SUch banksresponsibility of the examination dep artm m ti^ftv .i3^ ^ 7; tJ 1 18 8 continuing most of the i i i r t u i c e e T w S r a ? ? ™ ^ ? Fe<Jeral Beserve banks. In symptomatic of generally now unsound ^ the Practice ha« been bank with CD p r o b l ^ hTs n ^ v E S F S L " 1 0,6 5?nk' In other words, the lending practices. * * * When an eYaminat?mIeri,P m*' incl,ldinK unsound Stnte member bank, the Reserve bank ti. unsound conditions in a and if necessary, the d i r S ^ Cts to the ^ e c u tiv e officers bank recognize and carry out its e the M na,!em™ t of the Solution of CD problems in such casesusnaliv ^ oper?te 010 bank soundly, lems. Besides avoiding further e x m u u t a ^ n f ut i on of reIated probmust stop making unsound loans, and olatile CD s, the bank’s manageJ^ n g then any such tains S v ^ e T ^ th J ^ l ng to co llecto r bank must collect, sell, or borrow on i « L Uest extent Practicable, the CD s. in troublesome situations the Ttrnr i Deces8ary to pay off m aturing SSSI^srSSSSS5ssssrss * UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 57 “Our experience to date does not dem onstrate any clear need in my judgment for legislation providing stricter controls over th e m arketing of certificates of deposit or over transfers of bank stock. I share your concern, however, over the potentialities for trouble in these areas. The Federal Reserve System stands ready to cooperate w ith your committee and w ith the oth er bank super visory agencies in making sure th a t adequate safeguards are maintained to protect the public against unsound banking practices.” (Hearings, P a rt I, pages 228-230) I t should be kept in mind th a t since Chairm an M artin’s testimony in March 1965, certificate of deposit problems have increased, particularly in view of the December 1965 increase in permissible interest rates under Regulation Q. From the foregoing testimony, it appears th a t the Chairm an of the Federal Reserve Board views any trouble w ith certificates of deposit as a phase of unsound banking operation. He readily concedes th a t unwise activity by a bank in issuing certificates of deposit can lead to unsound operation. The proportion of a bank’s total deposits represented by certificates of deposit is an item the Federal Reserve System constantly watches, according to Chairman M artin. He agrees th a t too high a percentage may indicate unhealthy operation of the issuing bank. To date, the System seems to have relied upon the persuasive power of exam iners to convince management in any affected bank to take remedial measures w ith reference to overissuance of certificates of deposit. Chairm an M artin stated th a t as of March 16, 1963 (the date of his testim ony), the System had not found it necessary to use its “drastic remedies” of term inating a bank’s Federal Reserve System membership or term inating a bank’s deposit insurance or removing a bank's officers or directors. Chairman M artin’s discussion indicates th a t a t th a t tim e he viewed the certifi cate of deposit problem as containable under Federal Reserve watchdog pro cedures concerning unsound banking practice. He would then apparently have seen no need for singling out the certificate of deposit as the subject of a. specific regulation by the Federal Reserve Board th a t would control the dollar percentage of total deposit in a given bank th a t could be represented by certificates of deposit. Admittedly authority for such a regulation would not be well-based were it to rely on th e power granted to the Federal Reserve Board in 12 U.S.C. 371b. T hat section of the Federal Reserve Act addresses itself principally to the per missible interest rate to be borne by time and savings deposits, conditions upon payment of a tim e deposit before m aturity and w aiver of any requirem ent of notice of w ithdraw al of savings deposits. B ut the broad power of the Federal Reserve Board to tak e precautionary action to safeguard against unsound banking practices would seem to include th e authority to regulate the deposit mix represented by certificates of deposit. W hile the certificate of deposit as an instrum ent may not be evil per se, Chair man M artin’s testimony before the Senate Perm anent Subcommittee on Investi gations indicates th a t its presence in large percentages in a bank may well lead to hazards of unsound operation. The breadth of the Federal Reserve System’s general regulatory authority is borne out by the following comments of Mr. Justice Brennan in delivering the opinion of the U.S. Supreme Court in U.S. v. Philadelphia N ational Bank, 374 U.S. 321,329 (1963): “B ut perhaps the most effective weapon of federal regulation of banking is the broad visitatorial power of federal bank examiners. W henever the agencies deem it necessary, they may order ‘a thorough examination of all the affairs of the bank’, w hether it be a member of th e FRS or a nonmember insured bank. 12 U.S.C. §§ 325,481,483,1820(b) ; 12 CFR $ 42. Such exam inations are frequent and intensive. In addition, the banks are required to furnish detailed periodic reports of th e ir operations to the supervisory agencies. 12 U.S.C. §§ 161. 324, 1820(e). In this way th e agencies m aintain virtually a day-to-day surveillance of th e American banking system. And should they discover unsound banking practices, they are equipped w ith a form idable arra y of sanctions. As a result of the existence of this panoply of sanctions, recommendations by the agencies concerning banking practices tend to be followed by bankers w ithout th e necessity of form al compliance proceedings. 1 Davis, A dm inistrative Law (1958), £ 4.04.” To date, the System seems to rely on exam ination as a tool to discover and persuade correction of unsound banking involving issuance of certificates of deposit. The power o f th e Federal Reserve Board to seek to prevent unsound banking by adopting a suitable regulation controlling the percentage of deposits a particular bank may have in certificates of deposit would appear to be w ithin 58 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS the Board’s possession. Bnt the to meet the problems caused by certificates of deposit in some ban * M S t G erm ain . Can the committee, Banking and Currency Com r* mittee, legislate in this area? i Mr. M c K e n n a . The Congress has the power to regulate the value of and to coin money. I think you have plenary power m that respect. Mr. St G erm ain . The banks are actually coming money, so to speak. In going over the testimony, one point was brought out, the fact that it is difficult for the savings and loan people and savings bank people to compete with this high interest rate because a great deal of our money is being repaid, as Mr. Hanna brought out, based on much lower rates of interest returned on mortgages outstanding. Now, I wonder if you gentlemen will agree, that it is very possible that this change over this rate made back in December and the change in regulation Q could well be reversed downward or changed downward at any time by the Federal Reserve Board within 6 months, a year or 2 years if conditions so warranted. That being the case and it seems to me that this is almost inevitable within a few years are we not, in essence, hurting the young family man with one or two children who cannot find an apartment to live in and is forced at this time to go out and buy a house and take out a mortgage at whatever rate of interest that is being demanded of him ? Are not these the people, in the long run, who are going to be hurt by the action taken back in December 1965 ? I ask you to comment on that one. Mr. S t r u n k . Yes, higher interest rates have a major impact on a family buying a home and these people are hurt. We have always felt that it is one thing to raise the interest rates on major corpora- tions, who borrow for shorter periods of time, and another th in s to raise the interest rates on people who buy automobiles, and that loan is only there a short period of time. I t is quite different from the interest rate on a mortgage loan that is there for 25 years and you raise that rate, say 5 percent to 6 percent or 5% percent to 6 percent, then he pays that extra percentage point on a lot of money over a longer period of time. These are the people who are hurt the most by in creases m interest rates on home loans. M r. S herbourne . T h ere is a n o th er fa c to r . T h e in te r e st r a t* is mor* ^ * p s t0(l a y b ecau se w e are t r y in g t o c u t d o w n th e m o a - P°Lnt VV* w e c a n h a n d le w ith a v a ila b le !Q th a t <>* «H H *et i s th a t th e a sso c ia S ?a hi«hr d o w n p a y m e n t a n d a E t h e 0116 i8 h u r t th e m o s t is paym ent o n th e loan a 8® d e p o sit t o p u t a s a d o w n th e greatest e x ten t. ‘ e w th e one a ffected th e m o s t d ir e c tly a n d to £?A F e d in^TW a m K ^ T o t h e fa c t th a t th e a c tio n ta k e n b y th e UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 59 Looking at this action taken by the Fed, would it not seem justifiable that these gentlemen also be put in a position where more than a one vote majority is required on a step that is of such significance to the economy and perhaps a two-thirds plural vote, be necessary for such drastic action ? Mr. S h e r b o u r n e . That sounds like a very logical suggestion. On the other hand, there may be occasions where the failure to act could be serious. Mr. S t G e rm a in . Nothing further, Mr. Chairman. Mr. C h a ir m a n . I believe we have all had the privilege of a first go around. How many members now would like to interrogate the witnesses further. Let us go off the record. (Discussion off the record.) The C h a ir m a n . May I please call your attention to the fact that after this decision by the Federal Reserve last December in defiance of the President of the United States to increase rates 37y2 percent, the most meaningfully effective, rediscount rate from 4 to 4i/£ percent, and the time deposit interest rate from 4y2 percent to 5y2 percent. As chairman of the Joint Economic Committee, composed of Members of both the House and Senate, I called a hearing for December 13 to look into that and asked the members of the Federal Reserve Board to appear. We interrogated them, all the members of our committee. For the first time in my recollection, and I have only been around 38 years, we printed a cartoon in these hearings. It was Herblock’s cartoon that appeared in the paper that morning, showing the Presi dent on a bicycle with Chairman Martin of the Federal Reserve Board on the same bicycle, one pumping in one direction and the other pump ing in the opposite direction. That is the situation we faced at that time. In these hearings I think it was very conclusively shown that the reason these rates were raised was not for the purpose of helping the economy of the Ncttion at the time by fighting inflation real or imagined. Raising the rediscount rate one-half of 1 percent did not amount to much, although it is a signal for high interest rates all over the country. The Federal Reserve was hurting because a few banks were hurting. This sounds like a sordid story because it is a sordid story. #You know, when the monetary authorities decided that they wanted high interest rates back in 1960 and 1961, they decided that the best way to do that job would be to get these large sums held by corporate managers out of the weekly auction market for short-term Govern ment securities. The corporations were keeping the rate down. They were in there every week buying billions in Government securities and that kept the interest rate down. Well, of course, we passed a law about that time making the aver age rate on treasuries the rate that the agencies of the Government would have to pay. Well, of course, some of the money lenders did not like that because the short-term rate was low. These corporate funds bidding on the short-term securities kept the rate down. Now, if they could get them out of this bidding, then the short-term rates would have to go up. So the big banks devised the CD with the help of the Federal Reserve and started a race between short-term Gov ernment securities and CD’s. CD’s, negotiable CD’s, are nothing more than interest-tearing currency. That is all it is. O f course, whenever 60 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS they got them, they had an opportunity to buy CD'S at 4 percent with these corporate funds and if they needed to pay taxes in the near future or distant future they could always get their money out of this. And they would get this enormous amount at 4 percent at that time. It was a great windfall. It was a bonus. They gladly ran in at 4^/o percent. But their leaving the auction market caused the rate on the short-term Government securities to go up and they went up so fast that in December, when over $3 billion worth of CD’s were coming due in December, and probably twice that much in January and Feb ruary, they were hurting. They could see they could not renew the CD’s because the Treasury securities were more attractive. They would be ruined. Then of course, the banks said: “You’ve got to get us out of this. We cannot keep these CD’s at 4y2 percent,” and they had a meeting. They defied the President down at Johnson City, Tex., when they went down and told him, we have decided anyway, although you are against us, to raise the CD rate from 4 percent to oy2 and they went ahead and did it. Now, here is the trouble, folks. We are just spinning our wheels around here. We are letting the Federal Reserve run over Congress and run over the country. They are running the major part of our Government. They have taken it over. They have seized it just like Castro seized Cuba. They have taken it over. They do not have the power to do it, but they have done it anyway. And the reason they could do it is because they do not have to come to Congress for ap propriations. You see, all other important agencies of Government have to come to Congress to get their appropriations to run their or ganization. And in getting that they must make certain disclosures. What are you going to do with this money ? How are you going to handle it? In that way the Constitution contemplated that Congress elected by the people would have charge of all agencies. And of course the Federal Reserve got away from Congress because they were able to take the Federal Reserve currency and trade it for Govern ment obligations. Now, remember, they are fiscal agents of the Government and they are supposed to look after the Government’s business. I f you had a mortgage on your home of a thousand dollars and you gave your agent—we will call him a fiscal agent—a thousand-dollar check to pay that mortgage and he takes it, pays the mortgage off all right, but he has the mortgage transferred to him instead of you, and the mortgage is not canceled—he wants you to pay interest every time there is an interest payment and when it comes due he would want you to pay it again—you would not think that he was a very good fiscal agent. That is what the Federal Reserve has been doing for years. They have been taking the people’s money, trading for U.S. Govern ment bonds, keeping the bonds and requiring the U.S. Treasury to require the taxpayers to pay interest on those same bonds. They are getting a billion and a half dollars a year interest and they can spend that money any way they want to. As evidence of it they are actually joining the Ainerican Bankers Association every year. They pay tens of thousands of dollars as dues and donations to the American Bankers Association and State bankers association, ag gregating a hundred thousand dollars a year. That is public money. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 61 They are taking our public money, becoming dues paying and card carrying members of the American Bankers Association. That is what they are doing. That shows they can spend money for any pur pose. That is right. I can bring up illustrations just as ridiculous. It shows they have defied the Congress. They say they will use any part of this billion and a half dollars for any purpose, any purpose they want to and it would really shock you if I told you what they used this money for. They have defied the Congress and defied the country. They have use of this billion and a half dollars any way they want, and what is left goes into the U.S. Treasury. Any of it tliat is paid out for these purposes would otherwise go into the Treasury. I t shows that they are not looking to Congress because they do not have to get their money from Congress. Another thing, they are not audited by the General Accounting Office like other Federal agencies. So what are you goin£ to do with a bunch like that who shake their fist saying we defy the President of the United States and the Congress? How can our Government last when the elected representatives have such limited responsibility and such limited powers compared to the greatest powers exercised by a few people in the banking system who absolutely control the Federal Reserve. The Federal Reserve has a meeting down there this morn ing on Constitution Avenue. I t is a secret meeting. They have their guards around it. Hitler never guarded a building in his life as well as they guard that building down there. They keep everybody out. They do not want anybody around there except the ones they want. The truth is the Federal Reserve Open Market Committee is com posed of 12 members by law. The law says that. Seven public mem bers are supposed to be on it and five are the presidents of the Federal Reserve banks. Of course, those presidents of the 12 Federal Reserve banks are elected by the private banks. Because the private bankers select a majority of the bank directors, they are right in there and not only do the seven members of the Board come in this secret room down there so highly guarded this morning that I doubt if the U.S. Army could get in there, but they also let the five presidents come in and then they let the other seven presidents come in. When they do that they operate in violation of the law. Down in the Southwest when people operate outside of the law, we call them outlaws. I would not want to call them outlaws because I know they do not intend to go to that extent, they are not the type. They are not revolutionaries or anything like that. But in effect they are violating the law. They have some 20 to 30 or 40 staff people there and then they go back and make these decisions. You will not know their decision for 5 or 6 years. It will be 5 or 6 years before that in formation will be out. They want to keep it secret. But they go back and report to their respective Federal Reserve banks, each one has a board of directors, six of nine directors elected by private bankers with different connections over their respective districts. I estimate that at least 500 people know instantly what is happening in the secret session over the Nation. They know how to cut through this. What chance have tha others got ? They use loaded dice. They know what the score is. So that is going on right here in the United States of America in broad daylight. You would never think it would happen, 62 UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS but it is happening here; yet, we do not deal with it. Why will not Congress deal with it? They look upon monetary values as sort of sacrosanct, hallowed ground, leave it alone, let the bankers do it be cause they know all about money, when they really do not. All they do is to go out and make loans and how to collect it back, and this is necessary for the economy. But they do not know the science of money and do not claim to know. They are not looking after the public interest as you would expect them to look after their own interests. We all do it. It is perfectly natural. But as long as we are permitting this to go on, we in Congress are just spinning our wheels. We do not have the main powers. We have let them take them away from us. They are not right in this inde pendence. Because the Constitution is too plain on it. We do not have four branches of the Government. They are claiming to be the fourth branch of the Government—the legislative, executive, judicial, and Federal Reserve. Well, we do not have that in the Constitution. It is an agency just like any other agency, subject to the will of the elected representatives of the people. That is what they are. Now, how long are we going to put up with this? It is a serious question. They have the advantage of us. They got all this money, they’ve got $40 billion in the Federal Reserve Bank in New York and the people know that. It is in U.S. Government bonds, interest bearing. They belong to the people. Yet the Federal Reserve claims it belongs to them. They can do anything with this money just like they pay dues to the American Bankers Association. They spend this money any way they want to. Would that not be a huge campaign fund? That is exactly what they are doing. You could not stop them. They defy us. They are not responsive to us. They are un elected representatives of the large Wall Street banks. Now, if the elected representatives of the people were doing that they could be defeated. They could be punished. That is what the Constitution contemplates, if somebody in responsibility does this. It has gotten out of hand. What are we going to do about that? Mr. A n n u n z i o . Would the Chairman yield? You have illustrated the meeting in Johnson City, Tex., when they went down to meet the President of the United States and after the meeting with the Presi dent of the United States they still went ahead and raised the discount rate to 4% percent. So they have proven your case. The C hairm an*. To bail out a half dozen banks. I want to invite your attention to these hearing's and you can get them from the clerk. We have 200 copies. I knew this was coming up. This volume here has the testimony of all the Federal Reserve Board members and it bears out what I have said. Nobody disputes what I have said. Nobody disputes it. Volume No. 2 contains valuable in formation, too. So every one of you who wants a copv of these hear ings, just ask the clerk to let you have them. You will be astounded to know some of the things that are absolutely undisputed. Every body knows. It is like this $40 billion in bonds. We could reduce the national debt $40 billion. Why should we pay our debts twice? Nobody can answer that. I have asked Mr. Martin that, I have asked Mr. Eccles when he was Chairman—I asked the others, but I cannot get any atten UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 63 tion on things like that. But we have reached a crisis here. We have reached an impasse. We have reached a point where they are using this power to destroy the institutions that have built more homes in America than any other financial institution on earth. They are put ting you out of business. You cannot possibly survive if the Federal Reserve has its way. Now, if they have the power at all to permit CD’s, they should certainly limit them. But, in the first place, they do not have the power to do it. They know that. Therefore, they are not limiting the CD’s. They are strict ly illegal, it is wrong and something should be done about the Federal Reserve. Our Government cannot continue on indefinitely that way. Because the Wall Street bankers have charge of a principal part of our Government—the amount of money we have in circulation and the interest rates. There is a book, “Primer on Money” that shows interest rates on long-term U.S. Government bonds for 75 years. There was a period of 12 years of the roughest time in American history, from the early part of 1939 to the early part of 1951, month by month, when interest on United States bonds never went above 2y2 percent and if people wanted their money, they could get their money quickly with accrued interest and at par, no doubt about that. Now, if the Federal Reserve acting then as public servants, and I will say this for Mr. Eccles, Mr. Eccles’ monetary beliefs were very much the other way, but when he was on the Federal Reserve Board, he felt his duty as a good patriot, a good patriotic citizen to cooperate with the people’s elected officials. And he did cooperate. And during that 12 years we had unemployment up to 10, 15 million people, we had breadlines for blocks, breadlines in the principal cities of America and we would have people trying to sell homes and farms and the sheriff would be stopped by mobs saying you cannot do that to our neighbor, we had food stores being raided all over the United States, we had terrible times then. But then the war came and we had employ* ment, people saved money, they wanted to buy something with it. They could not buy automobiles, appliances, or scarce materials like that. So they had a lot of money, a lot of money pursuing a small amount of goods. That was tailormade for inflation. We were shooting a quarter of a billion dollars away on the battle fields. The most potentially inflationary time in all history. Yet, during the 12 years with all those bad debts and inflationary situa tion, the Federal Reserve Board kept the interest rate less than 2y2 percent on long-term bonds and they did it for more years than 12 and I will not go into that. I f they could do it at that time they could do it any time. I f they had done that ever since, wT would e be in a much tletter position. So we have got to do something about the Federal Reserve Board. I f interest rates had been kept at 1952 levels, instead of going up since that time, we would have saved $60 billion in interest alone and our national debt would be way down. We are in an awful mess here with two Governments in the United States, one elected and responsible to the people—but limited with powers—and with another Government run by the New York banks, unelected, responsible to no one, paying no attention to anyone, sell ing mortgages on all the property of all the people every day at their will, earning interest on it—just footloose and fancy free. How 64 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS long are we going to do that? We cannot do much about this until we do something about the Federal Reserve. Shall we have these gentlemen back in the morning to pursue the matter ? Mr. Moorhead, did you have any questions ? Mr. M o o r h e a d . I notice the testimony had to do with the liquidity crisis in December. Is there something in our economy that makes December a particularly vulnerable month ? I remember in years past it used to occur earlier in the fall about the time of the harvest. Is there something about December that we should be concerned about? Mr. S t r u n k . December is always a time of huge demand for cash. I don’t think there is anything unusual about December last year except that this was the time when the interest rates went up. The Fed did raise the rediscount rate and raising interest rates generally caused the so-called CD crisis because the banks had $3.5 billion of CD’s maturing in December. But I think the banks have billions of CD’s maturing every month. Mr. M o o r h e a d . Thank you, Mr. Chairman. The C h a ir m a n . Who is next? Mr. Todd? Mr. T odd. Thank you, Mr. Chairman. Mr. Strunk, the chairman has pointed out that negotiable CD’s are almost equivalent to interestbearing money. This bill would really stop that practice, but I do not see that it would affect your position, because your position is af fected apparently by savings deposits which are converted not into the nesrotiable, but into the nonnegotiable CD’s. I was wondering if you had any comments relevant to this problem, because it would appear that although this bill would perhaps correct one situation we should not allow to continue, it would not solve the situation with which you are faced. Mr. S t r u n k . That is correct. As we pointed out in these hear ings, there are two kinds of CD problems. One relating: to thrift institutions and one relating to the money market and banking in general. We are more directly concerned with the nonnegotiable or what we call the consumer CD. Mr. T od d . Mr. Ottinger’s proposal would address itself to a solu tion of your problem, but it would do so by really separating money into two different markets, one market for the small depositor and the other market for the large depositor who would still be able to buy the CD and you would set up essentially two different interest rates. Mr. S t r u n k . You are correct. Mr. T odd . S o we would be doing what you mentioned earlier, we would^ be passing judgement on tTie competitive positions of the financial institutions which we prefer to avoid, but under the circum stances I do not see how we can avoid it. Mr. S t r u n k . You have got to be concerned with the flows of funds in the various phases of the economy and I think there will be a great shortage of funds of mortgage money. It is in this area that you must be concerned. Mr. S h e r b o u r n e . The only concern that I have with the situation that I point out is that it was the tremendous buildup in negotiable certificates that created this problem that finally led the banks to burst over into the consumer type of CD at rates that were higher, UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 65 much higher than were paid on savings. So that if you simply con trolled the consumer CD as Mr. Ottinger suggested and did nothing about the negotiable CD, I think you would still have that problem spill over into some other area that would create a condition for our industry and problems for our industry. Mr. S t r u n k . These things are never simple. Mr. Todd. We can change the Reserve requirements against CD’s or something like this. Thank you. The C h a ir m a n . Mr. Ottinger. Mr. O t t i n g e r . Mr. Chairman, I would like to address myself to the problem that the chairman has raised, that if we put a $15,000 or some other limit on all CD’s rather than outlawing them complete ly, we would be discriminating against the small investor. He could get presumably only 4 percent, which is the limit on present passbook savings rather than the 5% percent the larger corporations are getting through CD’s. Cannot the big investor get 5y2 percent elsewhere on his money ? Mr. S h e r b o u r n e . Yes, he can. Mr. O t t i n g e r . So there will still be that discrimination regardless of the regulations that we might place on the CD’s. The large fellow with the tremendous drawing power that he has can always invest in quite a variety of different markets with different kinds of paper and get high interest rates. Mr. S t r u n k . The large investor always has advantages over the small investors for a large variety of reasons. Mr. O t t i n g e r . I s there a way of resolving this problem by either requiring the interest rate to be reduced on CD’s or requiring that the 4 percent be raised on passbook accounts ? It is feasible to estab lish a regulation that would increase the passbook accounts of 5y2Percent? Could your institutions afford to pay that kind of interest? Mr. S t r u n k . Not today, sir. After all, our money is invested in mortgages that pay a little more than 5y2 percent. You cannot get more interest out of existing mortgages. I am not sure what this would do to the financial integrity of the banking system and savings and loan system to be constantly paying higher interest rates for money. I f that were to happen we would have to charge considerably more on our new loans, you see. S o I think you have to consider just how much financial institutions can afford to pay and what are pru dent rates of interest to pay for other’s money which you invest in mortgage loans, you see. Mr. S h e r b o u r n e . I f the rate on savings accounts, the permissible rate under regulation Q, were raised to 5 or by2 percent, the drain would be even worse than we are now experiencing from the con sumer CD’s. Mr. O t t i n g e r . That is what I wanted to make clear that this was not an available solution at all. Also, that we are not discriminating against the small investor by putting a limitation on the consumer CD’s, but we are merely reflecting a situation that already exists, regardless of anything that we do. This large investor has the power in the present market to pull down his 5y2 percent regardless of whether it is in CD’s or other types of finance. By putting a floor on CD’s we would be just eliminating a particular market in which 66 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS the large investor is doing a great deal of damage. But we are not going to be creating any discrimination. That already exists. Mr. S h e r b o u r n e . May I point out that the small men with $2,000 or $3,000 can now put that money into California savings and loans and receive a return of 4.8 and 5 percent so that therefore an im mediate vehicle is already provided to take care of the small men. But you are now referring to the fact that perhaps this situation doesn’t permit commercial banks to do it, because they can only pa^ 4 percent on regular savings and this rate on negotiable CD’s, this high rate is available only to the large man. From Congress’ point of view, sav ings and loan associations provide that function, therefore you are not operating against the small man. I f you were to restrict the com mercial banks solely in the area of CD’s you wouldn’t restrict the po tential return on savings for small investors. Mr. W e l t n e r . Would the gentleman yield? Is California the only State wherein the associations are permitted to issue certificates of deposit? Mr. S t r u n k . Our institutions are permitted to issue a certificate, but it is not a certificate of deposit as practiced in commercial banking. Mr. W e l t n e r . It is the same thing, though ? Mr. S t r u n k . We promise to p a y a quarter or a half percent more than the regular rate a n d it takes on some of the characteristics of a ce r tific a te . Mr. W e l t n e r . D o you not call them CD’s ? Mr. S t r u n k . Our p e o p le d o n o t c a ll th e m CD’s. T h e y c a ll th em savings certificates. Mr. W e l t n e r . SC’s ? Mr. S t r u n k . The Federal Home Loan Bank Board in December, in response, in great part to action by the Federal Reserve Board in regulation Q, the Board permitted federally chartered associations to issue a certificate. It is what we call a long-term fixed balance bonus account which is the technical term. Now, in California, the Federal Home Loan Bank Board permits the associations there to pay as high as 5 percent on such certificates. In other parts of the country the Board’s limit is 4% percent. The savings and loan associations all over the country can offer a 1-year certificate with a rate one-quarter point or half point above the base rate, but in no event more than 4% percent, but in California, because of the higher rates there and the problem of the banks there going to 5 percent, the Board in April permitted those institutions to pay as high as 5 percent, combined rate. Mr. W e l t n e r . Are not the associations in other parts of the country petitioning the Board for authorization to issue certificates as high as 5 percent on $2,500 for 6 months ? Mr. S t r u n k . You are correct. Mr. W e l t n e r . Is not that the same thing as a CD? There is really no difference, in the mind of the public, or otherwise Mr. S h e r b o u r n e . There is one difference in the impact. A corpora tion is not going to put up $500,000 in that type of certificate. It is not going to put that kind of money in a $150 million organization, but it will put it into a $2 o r $3 billion bank because they realize the size of that institution is such that they don’t have to be co n c er n e d about the fact that only $10,000 of that is insured. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 67 Mr. W e l t n e r . But your problem is with consumer CD’s? Mr. S t r u n k . Yes, these certificates that the Federal Home Loan Bank Board has authorized to help us compete with the so-called consumer bank’s CD. Mr. W . That is the basis of the associations seeking authori zation to compete with the consumer CD’s authorized by banks? Mr. S t r u n k . Yes. Mr. S h e r b o u r n e . That is being used mainly in California because of the problem, Congressman, described and pointed out earlier. Mr. W . Thank you for yielding. The C h a ir m a n . I think I should let it be known that we will expect the Chairman of the Federal Reserve Board to appear before our committee at a time that is satisfactory. I mentioned that to Mr. Multer and he suggested that we also have the other six members of the Board and I share his view. I think we should also alert the Presidents of the Federal Reserve banks who are in charge of the 12 district banks throughout the country that they will probably be needed, too, and to be ready to testify. Do you know of any others ? Mr. W e l t n e r . Mr. Chairman, what about asking Mr. Horne? The C h a ir m a n . Yes, he will be here tomorrow. I think we should have Mr. Saxon and Mr. Randall because they also have a respon sibility. We will also hear Secretary Fowler. Any other witnesses? Mr. O . The home builders are coming in. They are already scheduled. The C h a ir m a n . Yes, they are. I am talking about the ones related to the CD’s in a governmental capacity. Mr. T od d . Mr. Chairman, I would just like to compliment the witnesses on the excellent testimony they have given. I think it is some of the best I have witnessed during my period of service on the committee. Mr. O t t i n g e r . I agree with that, Mr. Chairman. I would like to say, also, that I agree with your concern over the way the Federal Reserve handled this matter and your concern over the whole certifi cate of deposit situation, but I think we have to exercise due caution not to disrupt the entire economy. The C h a ir m a n . Certainly, we must. We do not want to do any thing that would upset things. But CD’s have had such a tremendous impact on the public that we must go into the matter thoroughly. Mr. O t t i n g e r . I think in the longer course we are going to have to do something to see that the monetary policies of the various regulatory agencies are coordinated. While we may take a more limited action with respect to the immediate CD situation, I believe the larger issues you raise are of great long-term concern. The C h a ir m a n . Who else ? Mr. Annunzio ? Mr. Rees? Mr. R e e s . I have enjoyed this testimony very much. I h o p e that this committee can do what Mr. Ottinger suggested. I think we have to eventually develop some type of coordination between these two types of institutions. This competition where at one time one institu tion is on top and then the other is on top can be destructive to our economy. e l t n e r e l t n e r t t i n g e r 68 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS The C h a ir m a n . We will recess until 10 o’clock tomorrow morning at which time we will have Mr. Home. (Whereupon, at 12:05 p.m. the committee adjourned, to reconvene at 10 a.m., Wednesday, May 11,1966.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS WEDNESDAY, MAY 11, 1966 H ouse of R epresen ta tiv es , C om m ittee on B a n k in g and C u rr en c y , Washington, D.C. The committee met, pursuant to notice, at 10:10 a.m., in room 2128, Rayburn House Office Building, Hon. Wright Patman (chairman) presiding. Present: Representatives Patman, Reuss, Ashley, Moorhead, Ste phens, St Germain, Gonzalez, Minish, Weltner, Hanna, Grabowski, Gettys, Todd, McGrath, Hansen, Annunzio, Rees, Widnall, Fino, Mrs. Dwyer, Halpern, Harvey, Clawson, and Mize. The C h a ir m a n . The committee will please come to order. This morning the committee continues hearings on H.R. 14026 and related proposals concerning certificates of deposit. Our witness is the Honorable John E. Horne, Chairman of the Federal Home Loan Bank Board. The Federal Home Loan Bank System was established by Congress in 1932 to provide reserve credits for savings and home-financing organizations. There are 12 regional Federal home loan banks located throughout the Nation in an organi zation similar to that of the Federal Reserve System. I might add his agency is a true arm of the Congress in that it is subject not only to a regular General Accounting Office audit, but also to congressional appropriation procedures. Another difference is that the Federal Re serve creates its own money while the home loan banks must go to the capital markets for their money just like a private borrower and pay whatever interest rate the market requires. The Home Owners’ Loan Act of 1933 provided for the establish ment of a system of federally chartered savings and loan associations. And in 1934, in order to further encourage and stimulate savings and investments in local thrift and home-financing institutions, Con gress created the Federal Savings and Loan Insurance Corporation. This is a wholly owned instrumentality of the Government which in sures savings in all Federal savings and loan associations and in quali fying State-chartered savings and loan associations up to $10,000 for each account. The purpose of Congress was to insure the safety of investment in these thrift and home-financing institutions and thus encourage a flow of funds for sound and economical home loans to fit the needs of the local community. The Nation’s insured savings and loan institutions must by law and regulation invest primarily all their assets in first mortgages on real estate. The people who have $130 billion invested in these thrift in stitutions thus depend upon a sound and prosperous housing market 63-496— 66------ 6 0 9 70 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS for their dividends. By the same token, homebuyers, homebuilders, and the entire housing and construction industry depend upon thrift institutions as a primary source of financing for them. Our witness this morning is not only the top Government adminis trator of the thrift industry, but as we have seen he is a top housing man also, because it is his responsibility that we have an effective flow of funds into a sound savings and loan industry and into homebuilding. John Horne is an able and dedicated public servant and we know he can help the committee in assessing the impact of CD's on the thrift industry from the standpoint of the responsible Government official. Mr. Plorne, we are glad to have you and you may proceed in your own way. You may identify for the record the gentleman accompany ing you. STATEMENT OF HON. JOHN E. HORNE, CHAIRMAN, FEDERAL HOME LOAN BANK BOARD; ACCOMPANIED BY DR. HARRY S. SCHWARTZ, ECONOMIST, FEDERAL HOME LOAN BANK BOARD Mr. H o r n e . Thank vou very much, Mr. Chairman. I do have with me for. Harry Schwartz who is the economist for the Federal Home Loan Bank Board. The C h a irm a n . Glad to have you, Dr. Schwartz. Mr. H o r n e . Mr. Chairman and members of the committee, I ap preciate the opportunity to appear to testify on H.R. 14026 and H.R. 14422. I will try to answer any questions you may have after I finish my testimony. Dur view of the certificate of deposit question reflects to a large extent our experience. As we understand the certificate of deposit, it is one of two general types of instruments which banks may issue in addition to savings pass books. Passbooks are limited to individuals and certain nonprofit charitable corporations. Typically, certificates of deposit and time deposits open account, the other nonsavings passbook instrument, were issued in large denominations to large depositors who did not qualify for a passbook. It has been reported that historically in the Midwest, some banks issued certificates in small denominations. Sometimes the certificates were issued at the savings passbook rate and at other times a little higher rate to hold medium-size deposits when the savings passbook rate was below the regulatory ceiling. Time deposits at commercial banks, that is certificates and" time de posits open account, have been in an upward trend since the close of World War II, with fluctuation in volume which were in the op posite direction from the change in rates on market instruments. Since 1061, the increase in negotiable certificates of deposit has been quite large. Banks which report weekly have had an increase in negotiable CD’s of $15 billion since the end of 1961 accounting for about 55 percent of the growth in time deposits other than savings. The widespread adoption in 1961 of negotiable certificates contributed to this upswing. The advantage of the negotiable certificate lies in the fact that the holder of the certificate can sell it. For example, a 1-year or 6-month certificate becomes, in effect, a very short-term instrument from the point of view of the depositor. Banks thought that this would permit them to compete more closely with commer cial paper, Treasury bills, and other money market securities. We UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 71 cannot tell the degree to which the growth in CD's reflects this type of development ana the extent to which it may represent a shift from demand deposits within banks or from investment in time deposits open account. In an}- event, with present rates that can be paid on nonnegotiable CD*s and time deposits open account, banks might still be able to attract a very large amount of money without issuing negotiable € D :s. In fact, this is a problem which has confronted the savings institu tions since early 1965. Because of the change in regulation Q in late 1964, it became possible for banks to pay more on CD’s than they could pay on passbook savings. Some banks began issuing nonne gotiable CD's with multiple maturity dates, that is, a 5-year CD with maturity date every 90 days. These were called savings bonds or investment certificates. They were issued to yield 4% percent while the savings passbook rate was 4 percent, and they were offered in denominations as small as $25 or even less. Almost immediately, in areas where associations and savings banks were paying less than 414 percent, there was a marked shift in the flow of savings when banks in the area offered this kind of instrument. Since last December, the problem has become particularly acute. In creasingly, in one area after another, banks have adopted either the savings bond device or a fairly short CD with automatic renewal in small denominations at rates above what thrift institutions are pav ing. We do not object to competition, but we do have some concern that the use of the certificate of deposit or even the time deposit open account device to circumvent the savings passbook rate ceilings can cause large shifts of funds from thrift institutions to banks in a way that was not intended. As a matter of fact, if I recall correctly, Chairman Martin before the Joint Economic Committee stated that the Federal Reserve Board did not raise the 4 percent on passbook savings because it did not want to disturb unduly the savings in thrift institutions, but the point that I am making is that the CD? are being used in a manner which, in a s way that circumvents the 4-percent passbook savings limit that is present and which is presently imposed on passbook savings in com mercial banks. In the first quarter, for example, net savings gained by savings and loan associations were off about 30 percent from the first quarter of 1965. In April, associations lost about $550 million in savings against a net outflow in April 1965 of less than $100 million. Interestingly enough, banks had about the same relative experience for total time and savings deposits in the first quarter as did savings associations. But in April, weekly reporting banks had a gain in time and savings deposits of $800 million, only $100 million less than April 1965. It is evident, too, that the losses experienced bv savings and loan associa tions were greatest where banks were offering CD? in denominations s of from $10,000 down to $25 with most banks engaging in these prac tices being below the $5,000 level and many at the $100 level or less. We can only assume that a good part of the loss in savings from thrift institutions in April went to banks. This year, so far, the portion of time deposits excluding negotiable CD’s of more than $100,000 has increased by more than $4 billion at weekly reporting member banks compared with a growth in large 72 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS negotiable CD’s of $1.4 billion. The nonnegotiable instruments grew more than 2.5 times as rapidly this year as last year and more than 5 times as rapidly as in 1964. Again, we are not complaining about competition. We recognize, too, that if a shift in funds is desired by the marketplace, it should be accommodated, but we cannot help wondering whether we do not have an artificial device on our hands. The CD is permitting banks to pay a high rate on a portion of their savings in the disguised form of a time deposit, while paying a relatively low rate on regular savings. In effect, the CD which, apparently, was not intended for this pur pose is being used to alter quite radically the structural relationship between thrift institutions and commercial banks. Mr. Guy Noyes, senior vice president of Morgan Guaranty Trust Co. and a former adviser to the Board of Governors of the Federal Reserve System, was quoted in last Friday’s New York Times, as saying that if interest rates continue to rise, savings and loan associations and mutual sav ings banks may face a very sharply reduced savings inflow or may be unable to hold the savings they have. This latter condition seems to be in process already. Some may argue that if banks are not permitted to pursue savings through the CD or time deposits open account device that they might be no better off than savings and loan or mutual savings banks. There fore, it may be said, all a restriction on bank issuance of CD’s would do is to reduce bank access to liquid funds and all financial institutions as a group would be no better off. This argument seems to be a bit disingenuous. First, it appears to say that if there is a liquidity squeeze on banks they should be able to correct this squeeze by drawing funds by any devices from thrift insti tutions, and that it may be better for one set of institutions to take the pressure rather than passing it around. Since thrift institution port folios liquidate fairly slowly, this places them in a very tight position and requires them to cut back very sharply on their lending with very severe effects on the mortgage market. Second, banks being short- and medium-term lenders to a very great degree, they can adjust more quickly. Indeed, they need not increase their lending quite as sharply as they could if they drain very large blocks of funds from the thrift institutions. In effect, banks are likely to cause thrift institutions to shrink so that they can expand their lending. This may not be inappropriate, if the process is clearly justified and does not threaten the structure of finan cial markets. But the instruments now being used to cause this shift raise some serious questions about justification and structural disturb ance. We, therefore, recommend that Congress grant authority to the appropriate bank regulatory agencies to set a minimum amount on certificates and on time deposits open account and we would like to emphasize both types or else a major loophole would exist. Insofar as negotiability of CD’s is involved, we think this is part of a broader question about CD’s and time deposits open account in gen eral. For example, nonnegotiable CD’s and time deposits open ac count amount to about 75 percent of the increase in time deposits held by banks so far this year compared with less than 20 percent last year. We commend the committee for opening up this area to inquiry. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 73 The CD time deposit issue has several facets. First, by use of these devices banks attract very highly interest-sensitive money. They are building a liquidity squeeze for themselves if they pursue this too far. Second, these instruments could bring about a misdirection in the flow of funds and resources. I f banks continue to attract very short term, highly volatile funds, and then generate an increased volume of credit, borrowers who typically deal with banks, such as corporations and users of consumer credit, may expand their spending exceedingly rapidly. While some resources can be transferred from sectors not receiving funds, we know very well that resources are not fully or always readily transferable. Severe bottlenecks could be generated be cause of purely temporary and perhaps speculative demand shifts, particularly in inventory accumulation and perhaps even plant and equipment. Third, the present use of certificates of quite small denomination seems to be causing a very rapid structural shift among financial institutions which could have a highly unfavorable impact on the mortgage market. We are not arguing here that the mortgage market is sacrosanct and that it should not experience any reduction in avail able funds, but a cut of 50 percent or more for the remainder of this year, which now seems likely, is not justified and may, indeed, be disturbing to our economic structure. In other words, a shift in funds can proceed too rapidly for all concerned and may contribute to sub sequent instability. We would suggest examining the extent, in relation to total de posits, to which banks may use any of these instruments, negotiable CD’s, nonnegotiable CD’s, and time deposit open account. A mini mum size limit for all these instruments and the appropriateness of multiple maturities and automatic renewal should also receive the committee’s attention. In closing I should like to make it clear that the concern we have is with the effect of the present situation on the structure of financial markets. TVTiile savings and loan associations dislike losing savings just as businessmen dislike losing sales, their soundness need not be affected thereby. The industry as a whole is sound. It is not the saver in an insured savings and loan association who needs to be concerned. He can rest easy. I want to stress this be cause sometimes the savings public may misunderstand, and I think that a difficulty in one area impairs the safety of our savings accounts. This is not the case. Those accounts that are insured by the Federal Savings Insurance Corporation are safe and the saver can go to bed at night and rest in peace as far as whether or not his money is ade quately protected. However, the present situation in savings flows promises to cut mortgage availability to perhaps intolerably low levels. Consequently, we believe that the issues before this commit tee should be explored thoroughly. The C h a ir m a n . Thank you, Mr. Horne. You have presented a very interesting statement. Are you contending that this inflow of funds from thrift institutions to commercial banks is not only harm ful to the mortgage market but that it is also inflationary? Mr. H o r n e . Well, so far as the mortgage market is concerned, Mr. Chairman, we know that during recent years the amount of homes financed by private thrift institutions, we mean primarily when we 74 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS talk about thrift institutions the savings and loan associations and the mutual savings banks. But so far as savings and loan associations themselves are concerned, they have in recent years financed in excess of 40 percent of the residential construction. Now, if the money does not flow into these associations as it has in the past, or if the money that is there flows out, then unquestionably it is going to affect the availability of money available for homebuilding purposes, unless the gap is made up by other sources. And we see no evidence today that other sources are making up the gap which inevitably has to take place under existing developments within the savings and loan industry. Insofar as inflation is concerned, if there is a rapid shift of funds from one sector to another it could cause inflation, and in the present situation, I think this is a real problem. The C h a irm a n . The fact that the Federal Reserve took this action on December 6, 1965, to raise these rates really 37*4 percent from 4 percent to 5y2 percent under the law, the Employment Act of 1946, it is the duty of the Federal Reserve to coordinate these actions with the other agencies effectively. Were you consulted prior to that announcement of the increase in rates on December 6,1965 ? Mr. H o rn e . N o, sir; I was not and the Chairman of the Federal Reserve Board as I recall, when he was asked the same question before the Joint Economic Committee, gave the same answer that I have given, that we were not consulted. The C h a irm a n . It appears to me that there is something badly wrong in our economy, particularly in our institutions, our financial institutions, when one has so much power, the power of life and death over thrift institutions to iust arbitrarily take an action, that although it will considerably benefit the commercial banks for obvious reasons, it will absolutely, it will destroy thrift institutions. Do you not think the action of the Federal Reserve really jeopardizes the security of the savings and loans and other thrift institutions of this country, M r. Home? Mr. H o r n e . Mr. Chairman, there is no question but what if the present development continues and grows in intensity, that there is definitelv going to be a danger here that I think no one wants. I would like to say, if I mav, sir, in connection with the lack of co ordination or consulation. if that is a good word to use, that was true up to the 1965 action. Since that time, a committee has been estab lished in which either the Chairman of the Federal Reserve Board participates, or the Vice Chairman participates. I don’t think that what happened in 1965 would happen again. O f course, we would have no control as evervone here knows, over whether or not the Fed eral Reserve Board raised CD ’s or did something else. But we do have now a verv close working relationship as far as keeping each other advised and informed is concerned. The C h a ir m a n . That is locking the bam door after the horse is stolen. The damage in December 1965 will be with us a long time as you know and I know that the Federal Reserve is having the Council of Economic Advisers down at the Federal Reserve Board to meet every now and then. But, of course, they are not giving up any of what they call their independence, which I think they just seized. They do not have it as a matter of law. Nobody ever gave UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 75 them independence. You will not find anything in the statute indicat ing independence. And certainly, they do not have their independ ence and they are not the fourth branch of the Government that they claim to be. They are just not. But they are going their own way and they defy the President of the United States and other agencies of the Government as well as Congress. If you will notice, when they have these meetings down at the Federal Reserve Board, they never let you stay there while they have the Open Market Committee meetings. They run you out. There is nobody there as far as the fellows who are interested in high interest rates and they are running the things like they want it and it is in secret, like yesterday. They had a secret meeting yesterday down there. There are 500 people in the United States who know exactly what happened. Nobody else knows. Of course, that gives the 500 of those people a great advantage in operating their businesses in a more profitable way because of that knowledge. That is some thing that is rather obnoxious to a democratic form of Government— a democracy or republic—that we have and it is going on right here in broad daylight m the United States of America. Do you not think, Mr. Horne, the practices that have been built up are a violation of the law about paying interest on demand deposits? Mr. H o r n e . I am not quite sure I understand your question. The C h a ir m a n . Y o u see, when Congress established the FDIC, the banks were going to have to pay insurance fees of about one-half of 1 percent. So the bankers wanted some advantage to compensate for that and it was finally agreed that we would write into the law prohibiting commercial banks from paying interest on demand deposits. Now, that immediately saved the banks billions of dollars by just paying a small sum into the FDIC fund every year. But it was put in the law and it is there right now. Since they are issuing these negotiable CD’s, although they may run for 5 years, possibly, or 1 year, they are immediately cashable because they are equal to inter est-bearing currency. They can be sold in the open market. They can get their money back quickly whereas you could not do that on true time deposits. Has it occurred to you that this would be in violation of at least the spirit, if not the letter of the law to pay interest on demand deposits? Mr. H o r n e . I should think after your explanation o f it, it is some thing that could very well be questioned. It may be a very technical difference in interpretation here and I am not a lawyer and I don’t feel qualified to answer your questions specifically that'it is a violation. But, from your citation of the law, it would indicate to me that this is a practice that if it is continued this committee has every right to look into it thoroughly and take corrective action that it deems advisable. The C h a ir m a n . I f the Federal Reserve has ever attempted to en force that act against anybody, I do not know about it. In this case it is so open and flagrant that they should be certainly called upon to explain it and why they did it and I think we shall do that. The Joint Economic Committee hearings on December 13 and 14, those hearings are available and anyone who is interested may have them. Xassume you have seen them. Mr, H o r n e . Yes, sir. (- 76 UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS The C h a ir m a n . I think they are very interesting and bring out some very important points. For instance, when Mr. Martin said that he did not raise the sav ings rate, I believe it was 4 percent, if you will notice I asked him some questions there, what would keep people from taking the sav ings out and put it in CD’s and he never could explain. I assume you noticed that. Mr. H o r n e . Yes, sir. This, Mr. Chairman—this is one point that we have raised and in my testimony made clear, I think. We still raise that question. The C h a ir m a n . Yes, sir. Now, the new tax withholding law re quires holders of large corporate funds to make a report about every 2 weeks, does it not ? Mr. H o r n e . I am not sure. The C h a ir m a n . They make payments into the Treasury. Mr. H o r n e . Yes, sir. The C h a ir m a n . Would that affect in any way these certificates of deposit accounts that they carry or would they not have less money ? Mr. H o r n e . Well, if I understand the question correctly, Mr. Chair man, I should think they would have less money. The C h a ir m a n . Like the large corporate funds. You know that when the corporations turn to CD’s, that affected seriously and quickly the short-term Government securities market. Mr. H o r n e . Yes, sir. The C h a ir m a n . For the obvious reasons. The corporations had been using these huge funds to bid on the short-term security of ferings every Monday and that kept it down. By reducing them to leave that short-term auction every Monday and going to CD’s, they immediately got a big windfall or bonus by increased interest, but it caused a race between short-term security rates and the CD rate. This is a race which could cause inflation. In fact, we are paying today for the same amount of money, $30 in interest charges for every $i interest we paid during World War II. That is the most inflationary thing of all times. Mr. Reuss ? Mr. H o r n e . Mr. Chairman, would you and the committee object if I)r. Schwartz made a comment ? The C h a ir m a n . Be glad to have Dr. Schwartz’ comments. Dr. S c h w a r tz . All I was going to say, Mr. Chairman, is that I rec ognize the merits of the position you are taking, but we have a little bit of difficulty supporting it statistically. If you look at the short term interest rates at the end of 1959 when they were at their peak at that time, they were slightly lower than short-term interest rates are now. I am talking about 3-month paper—3-month bills. If you look at the 6-month bills and the 9-month issues, they were a little higher than they are now. So the figures don’t help us very much to determine whether these CD’s are really causing the kind of pressure on the money market that I think your remarks suggested and which may indeed have occurred. Interest rates may have been lower without these negotiable CD’s. But we can’t demonstrate this statistically. The C h a ir m a n . May I comment just briefly on that. I do not think anyone can dispute that when you take $16 billion or $17 billion out of the market, the auction market that is depending UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 77 on short-term securities all the time, take that away entirely and put it in something else like CD’s and in a few banks, that would not seri ously affect on the upward side interest rates on short-term Govern ment market ? Dr. S c h w a r tz . Well, I think there is a lot of merit to what you say as I indicated before* Running CD funds through another circuit can cause market frictions which put pressure on interest rates. But the argument that is made against it to us when wtb raise the same question is, well, that money is lent out to people who w ould other wise have to go to the market and compete against securities by issuing their own paper. So we end up in the argument going around a circle and in order to try to support the point we made we went to the data and the data didn’t help us very much. That is all I am trying to say. The C h a ir m a n . I do not care what they say, the facts are evident and undisputed and can be documented and that it did seriously affect interest rates. Mr. Reuss ? Mr. R e u s s . Thank you, Mr. Chairman. On page 1 of your statement, Mr. Horne, you say: Since 1961, the increase in negotiable certificates of deposit has been quite large. Now, Webster defines “quite” in two ways—one is “rather large” and the other is “extremely large.” In fact, since 1961 negotiable CD’s have gone up in volume from practically nothing to some $17.5 billion; is that not a fast ? Mr. H o r n e . Y e s , sir . Mr. R e u s s . Therefore, you meant extremely large ? Mr. H o r n e . Extremely could very appropriately be substituted for the word “quite.” Mr. R e u s s . I w a n te d to h a v e y o u t e ll m e w h ic h o f th e tw o m e a n in g s y o u m e a n t. What this whole thing boils down to, it seems to me from your very excellent testimony, is that a large part of the Nation’s savings which, had they remained in the savings and loan associations would have gone to build homes and are instead going to banks and as you said, on page 4 of your testimony, because of the nature of bank lending, it may mean that they go into inventory loans for business and in some cases into plant expansion. Mr. H o r n e . Yes, sir. Mr. R e u s s . Now, this committee is very concerned with inflation. What do you say about the ability of the economy to respond to a demand for more homebuilding in contrast to the wisdom of the economy’s building up inventories, let us say ? Mr. H o r n e * Well, sir-----Mr. R e u s s . I want you to p u t on the hat of say the President or the Chairman of the Council of Economic Advisers rather than just your Home Loan Bank Board hat. Mr. H o r n e . Well, I want to g iv e a responsive answer to your ques tion. In some parts of the country there is presently a surplus of homes. And unquestionably there is a slack of homebuilding to some degree. I t is not necessarily harmful. We are concerned, though, about the most recent figures which I pointed out in my testimony, that from 78 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS here on out for the remainder of the year, we may have a very sharp-— too sharp in our opinion—drop in the availability of money for homes. Now, if there is a shortage of money, then this within itself could contribute to the inflationary process. With the relatively small amount that will be available far lending purposes, it is just natural that the lender, whoever he may be, is going to charge a higher price to the borrower of the money with which to buy a home. And this can also be argued as contributing to inflation. I am not an econ omist and I am not a lawyer, but I guess part of inflation is a total cost of everything that the consumer has to have and if the consumer is buying the home and he is paying more for the money he is borrow ing, this is adding to the cost of living and this is in a way inflation as far as he is concerned. Mr. R e u s s . I was looking at it in simpler terms, perhaps. If, in considerable sections of America today there are building tradesmen available to build homes, and building materials available as material, which are not now being used because of lack of mortgage money and the high price of mortgage money, and if at the same time business men are building up inventories in excess of that necessary for the reasonable flow of the economic process, then the Government, or the Banking and Currency Committee which has overall jurisdiction, is being improvident. Now, is that the situation? If, for example, inventories in business were at too low a level and if there were no more capacity to build homes than are now being built, then I would say about the only objection one could make to the Fed’s CD action was to say that it is somewhat socially inequitable to the homeowner. But, if, as I sus pect is the case, and I hope you will tell me, there is a capacity in this country to build more homes than are now being built at the cur rent short rate of mortgage money, and if business inventories are at an adequate level, then the Fed is really entering this inflationary area and this committee should come in and stop it. Mr. H o rn e . Well, I am not—I don’t have the information as to in ventories with me, but I think your analysis, Congressman, is entirely correct and we do know that there is more capacity to build homes than is presently being used. I am not so concerned about this at the immediate time, but I am concerned as we go later down the months of this year, because there can be a much greater oversupply of capacity than we presently have and there can be an undersupply of homes, even though as I have indicated in some areas, we could very well afford a slackening in homebuilding. This is a spotty situation. And so, it is true that if we are drawing money from one source, that is a very important part of our economy, we are affecting that par ticular source. I f we aren’t compensating for it someplace else, this is important. I have my doubts that without inflation if the funds can be absorbed elsewhere right now. We can, therefore, be creating difficult v in the economy as a whole. Mr. R e u s s . You see, we of the Banking and Currency C o m m itte e in a sense, and nobody else seems to b e doing it , have t o act as u m p ir e s here. We have to try to determine where the Nation’s savings can best be channeled and accordingly, file for us a n analysis by you, o f present and potential capacity in the homebuilding industry, both what it is now and what it will be later o n t h i s y e a r a n d in t h e m o n th s UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 79 to come, and also your judgment and that of your economists, and I know you have them, on whether the Nation’s inventory situation is such that businessmen desperately need the bank lending power which has been purloined from your institutions to the banks by the raising of CD interest rates. Is that not an answer to a question that we need to know ? Mr. H o r n e . Yes, sir; I think it is. As far as the inventory situation is concerned, outside the home building area you probably can get more expert information from the bank agencies themselves. However, if you should like for us to prepare a resume of our own opinion, to submit to this committee, I would be very glad to do so. Mr. R e u s s . I would like it because the banking agencies tend to be special pleaders for their clients and obviously the Federal Reserve, although we cannot gather this from their very cryptic statements, must have thought that further inventory loans were in the national interest or they would not have put banks in the possession of the power to make these loans. Mr. H o r n e . It is a tremendous problem with which the committee is struggling. I am sure, too, that people who are not on the com mittee are also struggling with the problem. What to do about the fact that there is a shortage of money is a crucial issue. What kind of process can be used, if any, to say who gets this money and then for what the money is loaned once the institution has it is another ques tion. And also, under what terms^ and conditions the institutions— banks, savings banks, and credit unions are tied in—are going to lend. How we handle this problem of allocating or using and determining where the money that is available is going to be spent is not easy. (The information referred to follows:) S t a t e m e n t o n S h if t s i n D e m a n d a n d I n f l a t io n The following statement Is made pursuant to the request of Congressman Reuss for comments on the effect of shifts in savings and credit flows which shift demand from construction to other industries. Congressman Reuss asked whether this could have an inflationary effect. Our answer is yes, and explana tion follows. The housing industry is undoubtedly operating below capacity at the present time. During the current period of economic expansion, nonfarm private hous ing starts have come close to an ahnual rate of 1.8 million units at the peak. In contrast to this, housing starts are now down to 1.5 million units. Unemploy ment in the construction industry in March 1966 was 9.9 percent, the highest of any of the major industry groups. It should be noted, however, that unemploy ment in this category has been high for some years. Nevertheless, on the basis of these facts, we believe that the capacity of the housing industry is a t least 1.8 miUion units. This is not to say that such a rate of housing activity would be desirable at the present time in terms of underlying demand. In the past few years, even at a level below 1.8 million units, housing production has resulted in the emergence of surpluses and a sub sequent reduction of housing production. The recent level of 1.5 million units is probably somewhat above a sustainable level of production, although the reduction of credit into the housing sector could well reduce housing starts signifi cantly below this and far below what is sustainable. Any estimate of the capacity of the housing industry must obviously be de pendent upon many factors. Housing does use some materials and labor utilized by other sectors of the economy. Recent increases in demands upon these have probably reduced the ability of the housing industry to expand much without resulting in somfc degree of price increases. However, the capacity to produce is above recent levels and well above prospective* levels. 80 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS On the other hand a shift in demand toward inventories or plant and equipment expenditures has contributed and is likely to continue to contribute to inflationary pressures. The reason for this lies in the very large increases in demand that have occurred in the nonhousing industries and the resulting production close to or at capacity. T hus: 1. Plant and equipment spending is expected to rise 16 percent this year. 2. The buildup in inventories by businesses continues to be rather substantial. During the first quarter there was an $8.3 billion expansion in inventories, close to the very substantial rate in 1965 and well above the rate of other recent years. 3. Manufacturers’ new orders continue to reach new peaks and are in excess of shipments. The result has been an almost continuous rise in backlogs of un filled orders. These backlogs in the durable goods industries reached $66.2 billion in March, up from $55.5 billion just a year before. 4. Overall unemployment is down to 3.7 percent as compared to a level of 4 percent normally associated with full employment and price stability. 5. Capacity utilization has risen significantly since last fall, according to data gathered by McGraw-Hill, and a number of industries are operating at levels above their preferred rates. It should be noted that not all of the resources in the construction industries are readily transferable to other sectors. Witness the high rate of unemployment in the construction industries. Thus a demand shift from construction to other industries is not fully offset by a shift in resources. The speed of increasing demand in other industries is an inflationary factor. Mr. R eu ss. One final question. Before Chairman Martin and his Board adopted their CD action early in December of 1965, did he confer or consult with you about the effects of such action on our homebuilding industry and on the Home Loan Bank Board ? Mr. H o r n e . You say, did they consult with us? No, sir; they did not. As I explained to the chairman a few moments ago, they have been meeting with us and the Comptroller and the FDIC since then very regularly, but they did not prior to taking the action of December 6 ,1D65. Mr. R euss. Thank you. The C h a irm a n . Mr. Widnall. Mr. W id n a u j . Thank you, Mr. Chairman. Mr. Horne, we certainly welcome you before the committee and we know your testimony will be very valuable. Mr. H o r n e . Thank you. Mr. W i d n a l l . As you know, I made a suggestion that the Chairman of the Federal Home Loan Bank Board be added as a member to the quadriad. I wrote to the White House in that respect and asked for serious consideration of that proposal. I have not yet received any response from the White House on that and I wondered whether or not you were aware of any response or reaction by the White House to that suggestion ? Mr. H o r n e . N o , sir; I am not, except, I believe that the Secretary of the Treasury before one of the committees was asked the question— I don’t remember on which occasion, but this is the only response of which I am aware. Mr. W i d n a l l . I still think that with the importance of the savings and loan industry and the tremendous amount of influence in the development of homes in America, that it is extremely important that a full voice be heard at the present time* Mr. H o r n e . Of course, that could be done—that could be one de vice for this to be done. It could be done other ways. I do want to say, and I believe in the long run it will be helpful, that there is more consultation, more exchange of information now. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 81 Mr. W i d n a l l . Than there has been? Mr. H o r n e . Yes, sir; by far. I think, too, sir, unquestionably, you are right when you imply that the savings and loan industry is now so large in the amount of savings involved, and the impact that it can have in the economy of the country, that it no longer can be con sidered a relatively insignificant influence as was the case perhaps 15 or 20 years ago. It is now very large and it is appropriate that action that would affect it be discussed with the Federal Home Loan Bank Board before such action is taken. Mr. W i d n a l l . On page 5 of your testimony you sa y : A minimum size limit for all these instruments and the appropriateness of multiple maturities and automatic renewal should also receive the committee’s attention. Do you have in mind any minimum size amount? Mr. H o r n e . I th in k here, Congressman, that you might want to indicate, if the legislation should be passed, giving the appropriate agencies the authority to do this, that either m the legislation or in your report, you might want to indicate some guidelines. I don’t have anything to suggest except that—off the top of my head, I would suggest $25,000. Mr. W i d n a l l . $25,000 as a m in im u m ? Mr. H o r n e . Yes, sir; as my testimony, I think indicated, there is evidence in here that the smaller the CD’s the more likely is the shift from thrift institutions. Mr. W i d n a l l * Mr. Horne, the House will probably vote tomorrow on the Participation Sales Act. In that we are talking about the sale of $8 billion of participation certificates in 2 years. This is with the very likelihood that the annual rate of sales could reach $5 to $6 billion per year within a few years. I f the Congress or FNMA saw fit to sell these certificates in denominations as low as $100, what impact might that have on savings and loans in view of the fact that yield to investors is likely to be in the 5%-percent range ? Mr. H o r n e . Well, frankly, Congressman, I haven^ analyzed this particular situation. I am sure that the people who recommended it have good reason for doing so. It is part of the administration’s pro gram, as the committee knows. I think in all frankness, I should say that I have not made an effort to study what impacts it might have on thrift institutions, but I am not aware of a $100 participation unit. M r. W i d n a l l . I h a v e a v e r y s t r o n g f e e l in g t h a t i f t h is p r o g r a m g o e s th r o u g h , t h a t i t is g o in g to f u r t h e r d a m a g e t h e m o r t g a g e m a r k e t, th e g e n e r a l m o r t g a g e m a r k e t a n d m a k e it a g r e a t d e a l m o r e d iffic u lt f o r th e tr u e m o r t g a g e b a n k e r s a n d th e s a v in g s a n d lo a n in s t it u t io n s to per* fo r m t h e ir f u n c t io n , th e ir tr u e fu n c t io n w it h r e sp e c t t o le n d in g to th e b u ild in g in d u s t r y a n d m a k e t h e ir g r e a t c o n tr ib u tio n in th e w a y th e y h a v e in t h e p a s t , in th e n e x t f e w y e a r s. It seems to me, too, that this is being used as a device to get around the 4^-percent ceiling on Government bonds to bring everything up to 51/2 percent. The impact in many segments of our economy can be great and I do not think it can be sloughed off as just putting it in the hand of private investors—assets that are held at the present time. I think that is a fiction, too, because all we are doing is transferring it into a trust and selling participation in it and the Government is still holding the assets. I do believe that it is incumbent upon you as head 82 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS of the Home Loan Bank Board and others in doing so well in trying to guide the savings and loan institutions, that you be fully aware of what it might do to the mortgage market in the future by providing an entirely new means of financing with a great deal of appeal, because of a guarantee, and it can go higher. There is absolutely no guarantee that it would not go higher. Mr. H o r n e . I must confess I have not made a study in depth of it. I realize one thing, the administration—the administration is making it possible for the private sector of the economy to take over these loans that are presently held by the Government. Now, if managed properly, the possible adverse effects on other entities could be at least considerably reduced or prevented. I think it would depend to some degree, and I am just talking in answer to your question, that if it is managed carefully and handled properly, much of the possible danger, if not all of it, might be alleviated. M r.W iDNALL. That is all. Thank y o u . The C h a ir m a n . Mr. Stephens. Mr. S t e p h e n s . Mr. Home, I am glad to have you again before our committee. It is a pleasure to have you here. Mr. H o r n e . Thank you, sir. Mr. S t e p h e n s . I want to know if I gather correctly the impression from you that so far as the negotiable certificates of deposit are con cerned, that you are not quite so concerned as far as savings and loans are concerned about whether they are negotiable or not negotiable, but what you are primarily concerned about is the smaller denomina tions that people get at the $10,000 insured level down to $25. Mr. H o r n e . Yes, sir; that is right. Mr. S t e p h e n s . As far as your testimony is concerned, that is where your chief concern is as far as your particular field is concerned ? Mr. H o r n e . Yes, sir; that is correct. Mr. S t e p h e n s . I would like to ask one or two questions in respect to some statements that you have made in answer to some questions. I am very much interested as you are and all others as far as infla tion is concerned. We would like not to have inflation. What con cerns me is the other side of the coin, and that is, a depression. We do not want that, either. Recently, the Regional Home Loan Bank Board sent to each savings and loan a letter from you saying that after the next interest is payable after the first of July, that when a savings and loan institution comes to the Board for the purpose of borrowing— which it is entitled to do and one of the greatest, assets of the system— that the Board will look very carefully at what commitments they have made and as I read it, it is going to be a little bit difficult for them to borrow money—for the institutions to borrow money—if it does not have any in the institution itself. It will have more of a difficult time borrowing the money through the savings and loan facilities. Now, that will have an effect in my section where we have a shortage of homes of cutting out a lot of building and it would not be a question of inflation as far as the building industry is concerned. But it may cause a real depression in the building sector. You are going to find no housing starts and when that happens you have got all kinds of things. People who work in those trades, like carpenters, brickmasons, and plasterers and people who have small construction o r g a n iz a t io n s and cannot hold them together, while hoping things will be alleviated, UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 83 are going to be in a depression in that kind of situation if you cannot start any homes in any reasonable amount of starts. The shortage of homes and money will make people go to other financial institutions or other places to get money where it costs them more money and all that sort of thing will not add up to inflation, it seems to me. It seems to me it is going to add up to depression because in my personal opinion, if I do not have any income and I cannot get any credit, then I cannot spend anything. Under that circum stance, it is just plain depression and that is why I am afraid of that more than the other because we might go too far. Would you like to comment on that ? Mr. H o r n e . I should be glad to. Unquestionably, if there is a drastic drop in any large and influential part or sector of our total economy, it can have an anti-inflationary effect, but it can lead to deflation, particularly in that area, if not overall. Now, no one knows at this particular time just how great the drop in homebuilding is going to be so far as total availability of funds from the savings and loan industry is concerned. It seems now to be shaping up to a decrease of some 20 to 25 percent from what it was last year, 1965. As I said a few moments ago, there are some parts of the country where this is not necessarily bad. As a matter of fact, there are some spotty areas where they might be good. But if the slack that is being experienced insofar as financing by the savings and loan industry is concerned is not absorbed by other sources, and presently we see no evidence that it is going to be absorbed by other sources, then you can have a situation in which there is too little investment or too little money available for the homebuilding part of the economy. Now, the purpose of our April 20 letter to which you referred, is to make certain that what is available would go to homes. As you know, Congress from time to time has given to the savings and loan industry an additional lending authority, and we want to make certain that as far as the money they borrow from each of our 12 banks is concerned, but this is one thing we have in mind, that we know some what for the purpose it is being borrowed. We also want to make certain that they use their own funds as wisely as possible without relying on funds from the 12 banks except in areas that are needy areas. We make loans for expansion purposes under certain condi tions, but we are primarily concerned about meeting liquidity require ments, meeting seasonal advantages and seasonal needs and things of this sort. These generally are what we had in mind in this April 20 letter. Mr. S t e p h e n s . I appreciate that explanation. Of course, I agree with what you just said, that if there is going to be anything that is going to have to be curtailed, then the savings and loans should em phasize what I think is the primary purpose and for what it was created and that is homebuilding. Mr. H o r n e . I do think Congress in the past has acted wisely in granting some additional authority to the savings and loan industry. The Federal Home Loan Bank Board is on record that there are certain other areas which we think also would be appropriate places m which to grant lending authority, so that in times when there may be an excess of money for strictly homebuilding purposes, they might 84 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS very well diversify their portfolio, and incidentally might be better able to stand strains and stresses that come in the life of any financial institution. Mr. S te p h e n s . Thank you. My time is up. The C h a ir m a n . Mr. S t Germain. Mr. S t G ek m ain . We are glad to have you with us. It occurs to me, I do not think there is any cause that is attributable to your action. The SB A ’s run out of money. Mr. H o r n e . I g u e s s I am a b a d o m en . Mr. S t G e rm a in . The experience that we have in the northeast area, the wells are just drying up in the savings and loan people and the savings bank people as far as available funds to lend out to homebuilders are concerned. You suggested some changes, Mr. Chairman, that may be made as far as the Board is concerned and the Con gress might cooperate in. However, do you not feel that the true solution here is the certificates of deposit and the drain that they are causing 011 the available and ready money ? Mr. H o rn e . Y ou are talking about certificates of deposit within banks now. You are not talking about S. & L. certificates. Well, certainly, as evidenced in my testimony, this is one area in which the small CD's are quite evidently, when they begin to pay 5, percent, drawing money from thrift institutions. I think, though, and I am sure the Federal Reserve Board would do this much better than I am prepared to do it, I think we have to keep in mind, though, that this is not the only source that is competing for funds and this is not the only source that is causing less inflow of funds into the thrift institutions than was the case a year or 2 years ago. It might also be of interest to the committee to have these figures, because they are in some degree a response to your question about money drying up in the Northeast. In 1965 the repayments into the savings and loan industry from people who had borrowed money for building and other purposes amounted to about $15,300 million. We estimate the repayments for 1966 will be about $14 billion. Net savings in 1965, and this included dividends credited to savings, amounted to $8.2 billion. The estim ate for 1966 is about $4.4 billion. This means that from these two sources the savings and loan in dustry at the present outlook will have available about $5 billion less than it had in 1965. This gets back to another figure that I used in my testimony, that seemingly, the savings and loan industry is going to have for lending purposes between 20 and 2-5 percent less than they had in 1965. This is not only evident in the Northeast, but also in other parts of the country, there is going to be less money available from the savings and loan industry than there was available in 1965. Now, this is also related to Congressman Stephens’ question as to how they make up this deficit. They can’t hope to make up this deficit by coming to the windows of the 12 district banks to borrow. They will be able to come to the banks and get what is needed so far as their own liquidity is concerned, but there will be a shortage of funds even at the bank so far as expansion is concerned. Mr. S t G e rm a in . So, to capsulize, Mr. Chairman, the time has come for very definite and effective steps to be taken in an attempt to allevi ate the situation if we intend to see to it that people who need the UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 85 fluids to buy homes and build homes can find these funds at a reason able rate of interest ? Mr. H o r n e . If some mechanism can be found whereby you can con trol to what savings institutions people’s savings go and then you could determine where this money is loaned once it gets into these in stitutions, I would say you were at the crux of the difficulty. Other wise, with the free market and also with the many other things, as I indicated a few moments ago, that people are doing with their money, other than just CD’s, it is a very difficult situation right now to deter mine exactly the manner in which to best handle it. Mr. S t G e rm a in . Thank you for your thoughts on the subiect. The C h a ir m a n . Mr. Fho? Mr. F i n o . Thank you, Mr. Chairman. Mr. Horne, do I understand from your testimony here this morning that it is your feeling that if money continues to flow out of the savings and thrift accounts into commercial banks that this would affect the mortgage market ? Mr. H o r n e . It is bound to affect the amount of money, Congress man, that is available for investment in the mortgage market unless as I say, this cutback, this necessary cutback on the part of S. & L.’s is made up elsewhere and I don’t think it is going to be made up else where. Now, we cannot tell at this particular time how severe this cutback across the board in the market, in the mortgage market will be. As I have said, there are some areas where a cutback will be healthy. But if the cutback is too great across the Nation as a whole, then peo ple are simply going to be able to buy fewer homes than they’ve bought in the past. This may not in itself create for the economy a wholly un usual, severe situation that can’t be weathered. I think the whole thing depends on how steep the cutback is. Certainly if the cutback is ex tremely deep then the people who are engaged today in the home building process, whether actually putting the bricks and lumber together or whether they are manufacturing items to go into the mak ing of the home, it will necessarily cause cutbacks in their activities which may or may not be absorbed in other parts of the economy. But all of these things are interrelated as you know. One is not separated from the other. Mr. F in o . We have two giant banks in New York: First National City Bank and the Manufacturer’s Hanover, and I assume that they are issuing CD’s. These two big banks are competing with each other and certainly against all of the savings and loan banks for mortgage money and they are giving the best interest rate and are attracting mortgage money in New York City. Now, I think the fear is not so much the loss of money from the mortgage money market than the loss of money to these banks through the issuance of CD’s. You testified recently before the Senate on some legislation affect ing savings and loans. Mr. Home, could you tell us, are the savings banks, the savings and loan associations throughout this country in serious trouble ? Mr. H o r n e . To give you the correct answer and the appropriate answer, if you take the picture as a whole, the answer is “No.” I wouldn’t want to— — Mr. F in o . I asked the question seriously. 63-496—66------ 7 86 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. H o rn e . N o, sir; as a whole there are a few that are. But the thrust of my testimony before the Senate committee and which 1 hope eventually to present to this committee has to do with 2 or 3 percent of the problem cases in which there is either incompetent management or in some cases dishonest management. This is a very, very small part of this industry. Unfortunately, when this is talked about, some times the news stories don’t stress that 97 or 98 percent of our man agers are well-intentioned, good, honest people. They stress some times more the 2 or 3 percent. I think it is very urgent and very important that we get this legislation to get at this 2 or 3 percent be cause they are unnecessarily impairing the public image of the 97 or 98 percent that are good. But this is another problem. As far as liquidity goes I think we can weather this particular storm. But I think it has to be watched. I think presently money is flowing out of S. & L.’s into banks because of CD’s in some cases. As I indicated, this is not the only competition for funds so far as the S. &L.’s are concerned. There are other things that are competing for funds, too, which are having an effect on the amount of money that flows into S. & L.’s. We may have to advance money from the 12 Federal home loan banks to the savings and loan industry to enable them to meet that liquidity problem. We may have to cut down the funds available for them to use for lending purposes. But as I also indicated, we have money flowing into the savings and loans through repayments which is going to be a great deal of help. A problem we have in the savings and loan industry is, that the moneys are invested in long-term mortgages, they can’t turn the money over the way banks turn the money over. They don’t have the flexi bility as the English system has, that when things get tight the interest that they charge on loans outstanding is immediately raised accord ingly. We don’t have that in this country. The Federal a ss o c ia tio n s have the right to put it in the contract when they loan money, but it is not exercised because of competition that is so keen from other sources, (retting back to trying to answer candidly your basic ques tion, Is the savings and loan industry as a whole in trouble *” I would say not in any trouble that we can’t meet. Not in any trouble that would cause panic. But the situation is pressing enough that we imist explore things that this committee is exploring and the Board itself must explore ways and means not only within the Board, but with other Government agencies as to how we can meet any problem that might come down the road in the weeks and months ahead. Mr. H o r n e . From issuing CD’s ? COmpetit. o1 with the commercial banks? There are i n, t the'money? SSmngS ^ loan associations is®«e CD’s and keep with'th^e savings and^oan^S^cTu^ath ^ dotnotS c(Mne^n^'r'^S “ 1 vision and jurisdiction. As a " State laws apply to them rather than Federal W C and S UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 87 The answer to your question, “Can they not do the same thing?” This is somewhat a yes-and-no answer. The one thing we have to keep in mind, and it is a fact that I made reference to a while ago in my statement, that money is tied up in long-term mortgages. The interest rates they can charge are fixed by contracts. This means that they are restrained in how much they can earn. And if they are restrained on how much they are earning they are also restrained on how much they can pay their savers. The situation is, that if the savings and loan industry took on the commercial banks in a rate war, because of the condition of their portfolio as I have explained, they simply would be the loser. And so both on their part and on our part at the Board, we have tried to practice restraint in this area. We have given them flexibility. We now have under study the granting of even more flexibility which I think we will announce either this week or the early part of next week. We have to bear in mind what they actually can afford. This might interest you to some degree—during the past 3 or 4 weeks I have, by going to what we call stockholder’s meetings in the banks, I have asked the savings and loan managers, several hundred in each case, to raise his hand who would like to have a 5-percent certificate. In one bank district five people raised their hands and in another bank district six raised their hands. In another one three or four raised their hands, and in the State of New Jersey just last week, not a single person raised his hand. One thing that they recognize is what I just said, there is a limit on how much they can earn. And consequently how much they can pay for savings. Also, they know whatever they might go to today, that banks at the 5%-percent present authority can outbid them and they simply cannot meet it. They want to get by if they can, and I think we should, without engaging in a rate war. Mr. A n n u n z io . Will the gentleman from New York yield? Mr. F in o . My time has expired. The C h a ir m a n . Mr. Gonzalez. Mr. G o n z a le z . Mr. Horne, our colleague from New York has raised an interesting point here. I am just wondering, though, he suggested New York banks are finding it possible to invest their money in mortgages at a higher rate, say 5 ^ percent. I f so, this is the most unusual situation. I did not think this was prevalent in the rest of the country. Is this the case ? Mr. H o r n e . Our evidence is, Congressman, and I think we have some figures on it for the committee—;I don’t know if we have it at our fingertips. Our evidence is that this is not the case in the country, nationally speaking. The banks did in 1964 and 1965; I think I am right about 1964. They did go into the mortgage market more than they had done previously and held that rate in 1965. But evidence that we have now shows that they are dropping out of the mortgage market as compared to last year. This is true in New York as well. I can’t answer on an individual-bank basis. Mr. G o n z a le z . It seems to me, what has really happened in our country is that we are federalizing the loan sharks. Mr. H o r n e . Doing w h a t, sir? Mr. G o n z a le z . We are federalizing the loan shark. On the State level we have this like a cancer. Back in Texas, as we say, our State 88 UNSOUND COMPETITION FOE SAVINGS AND TIME DEPOSITS is the “Loan Shark State/’—loan shark capital of the Nation and it has been very interesting to watch some of the gyrations, for instance in the last session of the legislature, both the banks as well as the savings and loan institutions pushed for approval of a law that would legalize 17%-percent interest on loans up to about $1,500 or better. Fortunately for us, the Governor vetoed that bill. Of course, a lot of us had to do a lot of pleading, asking him to do that. The reason is also quite obvious—the reason is quite obvious and that is, since the adoption of the regulatory law in Texas, a lot of loans that the banks were losing were going to the finance companies other than banks and other established institu tions. We have the U.S. Comptroller of the Currency announc ing that it is his interpretation of the law that the national banks are empowered to charge the highest rates of interest permissible under State regulatory heads. That would mean in Texas that the national bank could charge on certain types of loans up to 300 percent per annum which in certain cases is legalized in Texas. It seems to me—coming out from the boondocks in Texas, as I have, serving on the State legislative level in the senate, and then coming up here to Washington—that I readily identify the animal by his tracks. I think we have been taken over by the loan sharks whether it is in CD s—not to be confused with theDT’s. I just wonder if there is anything you can see from the standpoint of congressional action that could be done to forestall this apparently— to stop these unconscionable interest charges ? Mr. H o rn e . Well, that is such a big task, I really don’t feel ade quately competent to elaborate on it. I don’t know that, I have the information to elaborate on it. We are torn here on the one hand between a shortage of money and naturally when there is a shortage there is going to be higher charges for it. Personally, my sympathy is on your side. I wish there were some way that, the person who has to borrow money, but particularly the person who desperately needs it and can’t get along without it w o u l d n ’t have to pay exorbitant rates for it. But there is such a difference of opinion here. Some people, as everyone here knows, armie that you have to charge higher rates to cut down on the amount—people who control ling inflat hm t0 borrow and consequently through their process There is another argument on the other side that, is just as strong. W l . l u ’ n ™ 01' J anl “i s?mPil% Twith the lower charges. But. ]ust how Congress or anybody can get at that particular situation that talking about, now, I frankly don’t qualify to give all the answers to it. I do think that what I have suggested about the CD have - - a * so UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 89 Mr. G o n z a l e z . It just seems to me, and I could be wrong, but it just seems to me that one thing feeds on the other. I have seen this process, as I say, on a more localized basis and I have seen things happen here on the national level. I would hate to see the Texas tech nique nationalized. Mr. H o r n e . I certainly would agree with the Congressman on that point. Mr. G o n z a l e z . My time h a s expired. The C h a ir m a n . Mr. Minish. M r. M i n i s h . Thank you, M r. Chairman. I want to commend M r . Horne on a very fine statement. Who is affected by the abrupt outflow of funds from the thrift institutions ? Mr. H o r n e . Who w o u ld b e a ffe c te d ? M r. M i n i s h . W h o is a ffe c te d b y th e o u tflo w o f f u n d s f r o m th e t h r i f t in s tit u tio n s ? Mr. H o r n e . I guess the person who would be most immediately affected would be the home borrower, the person who wants to buy a home, and if the construction level falls to the extent that it isn’t available, which is likely, he would be affected and then the fellow who wants to borrow money on homes that are available is also going to be affected, because as you have to pay more to get money in sav ings, you are going to have to—you are going to have to charge more for it. Plus, the added fact, just the natural law of life in this country, if there is a shortage of money you are going to charge a little bit more than what you have available to lend than otherwise would be the case. The C h a ir m a n . Mr. Halpem. Mr. H a l f e r n . Yes, Mr. Chairman. Mr. Home, you talked about money being taken out of savings and loan associations. Now, under the proposed Sales Participation Act, banks will be buying these certificates at 5% percent. As it is now, this is clean money, although all they have to do is cut coupons. Is not this money being withdrawn from the mortgage market ? Mr. H o r n e . I suppose m y response here, Congressman, has to b e perhaps twofold. One is, I have not made a careful study myself and the Board has not made a careful study but does not believe there would be adverse effect on thrift institutions as regards this program. Another point is that it is primarily, at least to a great degree, a question of how it is managed. I should think that those who are in charge of managing this program, if it should be approved and if they do operate under it, are knowledgeable people and that they would keep in mind, if it is managed improperly, it could cause some difficulty. Frankly, I have confidence in the people who would manage it, and I think they would try to handle it in a way that would not cause adverse effects on other parts of the economy. I would hope and expect they would do a similar thing to what we do at the Board, for example. On occasions when we take over the assets of a disappearingsavingsatfd loan association to liquidate those assets, we keep in mind what the market conditions are in that area and not unload in a manner that would impose ft handicap on the savings and loan 90 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS associations or even on other people who deal in the mortgage market situation. The record shows that the participation program has been tailored to security buyers and not to savings account holders. Mr. F in o . Will the gentleman yield ? Mr. H a lp e r n . Yes; I yield. Mr. F in o . Mr. Horne, you are the representative of a fiscal agency of Government. Mr. H o r n e . Yes, sir. Mr. F in o . Does not the Budget Dirctor and the Treasury Depart ment call in all of the agencies concerned with the one problem and discuss it before they come out with a bill such as the Sales Participa tion Act? This bill could very well affect your part of the problem and yet you say you know nothing about it, you have not studied it. Mr. H o r n e . Let me say that I have not studied it in close detail. I am generally familiar with it and while in this case there was not a meeting held----- M F in o . You were not consulted? r. Mr. H o r n e . We were consulted through the process of the Bureau of the Budget, to inquire of appropriate agencies. To this extent we were consulted. Mr. F in o . You were consulted by the Treasury Department and the Budget Director. What was the position of the Home Loan Bank Board ? Mr. H o r n e . We raised no objection to the legislation. Mr. F in o . Y o u do not see any fear of money being taken out of the m^tgage market by these participation certificates? Mr. H o r n e . I wouldn’t want to go so far as to say that this pro gram, if not administered properly, could not take money that might not otherwise go to savings institutions, whether they be banks, fc. & L s, or thrift institutions. I am saying that this is one of the several factors and one of the several programs that in mv opinion has some merit and it would depend on how this is managed as to whether or not it would have that effect. M F in o . You express deep concern about the CD’s— r. money flow1 and yet express no concern about $4.7 billion beingtaken out of the consumer credit market ? to , th afall t l l w w ' Congressman,that th at necessarily is so, * billion is the kind of money that would flow into pl“ * B is — * ■ * “■« ™ ,d “ M F ino. It is m the thrift institutions already. r. Mr Is- s h o r t , I ask for regular order. D } aV e, *ime’M r- Chairman. the c h a £ )ian an left 1116 he»r «ig room and Mr. Ashley assumed t t p £ a n y ™ t . AS * °* aCtual fact’ y°u r 5 “ inutes are about Mr. H alfern. Thank you. Mr. A s h l e y . Mr.Hanna? t« J0 1 r:Chairman. 1 ’M P ^ l a r i y . f o r the high quality is given at a tim e of u n s o u n d c o m p e titio n f o r s a v in g s a n d tim e d e p o s its 91 It reminds me of the story told about the proper and purely innocent Englishman who got caught in a demonstration that was started by the students in the streets of Djakarta. The police had been fore warned about the demonstration and so were ready with a very large water hose. When they saw the students coming they let loose with the water hose. The Englishman was unhappily placed in front of the demonstration and caught the full brunt of it right in the brisket. He got up with the most composure that he could summon and made the following complaint to the man who was in charge of the hose. v He said, “Old boy, can’t you swing that thing about a bit? I seem to be getting the brunt of it.” It seems to me that the situation that we see here, Mr. Horne, is that we do have a crisis in liquidity and that the objection that you seem to be raising here is the fact that the brunt of the effect of the crisis of liquidity demonstrably appears to be hitting in the mortgage market and it is being affected adversely by the flow of funds to a degree that is unjustifiable. Is that not correct? Mr, H o r n e . We are concerned about the point, sir, you have ex pressed. I would want to emphasize, though, that while we are concerned about it, we think that there is going to be no real problem in meeting it. Mr. H a x n a . I hope you are correct about that. If I understand the liquidity need of savings and loans, they fall into five fields: First, the savings and loans hope to have liquidity to make new loans. Sec ond, it certainly needs liquidity to repay any advances made by the Home Loan Bank Board. Third, it needs money to meet the with drawals in the situation in which withdrawals are occurring and they are occurring at the present time, are they not, Mr. Horne? Mr. H o r n e . Yes, sir; but on that point, I think it might be helpful to the committee to point out that as far as the total inflow is con cerned, and the total outflow is concerned, the industry nationwide is about even now with what it was at the opening of the year. Mr. H a n n a . I want to talk to you about this nationwide average and then talk about the regions of the United States, because I think it is very important that we distinguish the sections. Mr. H o r n e . Yes, sir. Mr. H a n n a . If there are withdrawals that are in excess of deposits, then there is liquidity needs to meet those withdrawals, obviously. Mr. H o r n e . Y e s. Mr. H a n n a . Fourth, there is needed money for operational expense every day that the shops are open, it seems to me, and fifth, there is money needed to pay interest rates if they are claimed by the de positors, right? Mr. H o r n e . Y e s . M r. H a n n a . All right. Where does the savings and loan get its liquidity to meet the demands? No. 1, is one of the sources the payment on loans ? Mr. H o r n e . One o f the sources would be that; yes, sir. M r. H a n n a . Y o u h a v e in d ic a t e d t h a t t h a t r e p a y m e n t is g o in g to b e d o w n $ 1 .3 b illio n t h i s y e a r . Mr. H o r n e . The way things are shaping up, that is o u r estimate now. 92 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. H a n n a . N o . 2 , is another source of liquidity the sale of mort gages in the secondary market—is there any decline in the source of liquidity there, the sale of mortgages in the secondary market ? Mr. H o r n e . There is a decline there; yes, sir. Mr. H a n n a . Would you s a y a portion of decline is reflected in the FNMA decision yesterday to move from $35,000 mortgages to $15,000 mortgage purchases? Mr. H o r n e . I am trying to think that through, Congressman, to give you an appropriate answer. You see, we are mostly in the con ventional side ox lending. Mr. H a n n a . I think you know the effects of the secondary m a r k e t on the liquidity of savings and loans. It certainly has a strong effect, does it not? Mr. H o r n e . I would think it has some effect. Mr. H a n n a . Let me ask you this. Would you not agree with me that the secondary market is less salable today than it was a year ago? Mr. H o r n e . Yes, sir. Mr. H a n n a . So that is another thing? Mr. H o r n e . Yes, sir. Mr. H a n n a . No. 3 , let me ask you again, there is a source of liquidity in new deposits, is there not ? Mr. H o r n e . Yes, sir. (Mr. Patman resumed the chair.) Mr. H a n n a . If y o u looked at statistics you would find there is a net withdrawal position in 1965 up to now ? Are there sections of the country where this would be true? Mr. H o r n e . I don’t know of any. I don’t know of any. There may be. In your section, for example, the situation is about on par with what it is nationwide, that is the whole State of California. Mr. H a n n a . Y o u would be impressed by figures from any substan tial source that indicated that there was a net slide in position? Mr. H o r n e . Yes, sir, I would and I might also point out, Con gressman, and this I think buttresses the point that you are making, that during the month of April as I indicated in my testimony, we did have withdrawals that caused some concern. Mr. H a n n a . It seems to me another source of liquidity would be the fees and service charges connected with new loans. Now, if they are making less new loans than they were making a year ago, they got less liquidity from that source. * ^ are money from service charges; yes, sir. This is flexible. In some parts of the country thev are paid more charged more fees, higher fees than in other parts. Mr. H a n n a . Let us take a look at the country as a whole. Is it not true that we cannot afford to simply be satisfied with the a v e r a g e statistics when we have so many demonstrable distinctions in the region which the savings and loan industry serves? Do you not have some responsibility for statistical analysis as to what the average is? . M r- H o r n e . I agree with the Congressman that you couldn’t—that m detenninmg all policy, that you have to look at more than just the national statistics, national figures. ,? the action of the Board would indicate that it has taken this into consideration in times past and most likely will continue to do so. J UNSOUND COMPETITION FOE SAVINGS AND TIME DEPOSITS 93 Mr. H a n n a . One final question. Are you anticipating going to the -money market yourself to raise funds to operate the Home Loan Bank Board? Mr. H o r n e . We anticipate going to the market for whatever our money needs may be. For the information of the committee, no doubt you already know this, that when we and other Government agencies go to the market, we sort of operate through a traffic director, in this case, the Secretary of the Treasury. We have discussed our needs with the Secretary of the Treasury and are going to do so again in the next few days. Mr. H a n n a . In the event that you do have t o go to the market and I believe you and I both agree that you will have to go----Mr. H o r n e . Yes, sir. Mr. H a n n a . Y o u are going to have to pay the market price for money. Mr. H o r n e . This is right. Mr. H a n n a . And if I read it correctly in the Wall Street Journal yesterday, FNMA in its issue yesterday put out an issue at 5.45 percent interest and up 99.95 discount which ngures at about 5.55 overall. Dr. S c h w a r t z . That is what we expect to pay on the next issue, a coupon of about 5.5 is what we are thinking of now. A few days can make a change, but we don’t think the change will be in the downward, though. Mr. H a n n a . I am in 100-percent agreement with you. I think also this has something to bear upon the questions that Mr. Widnall, Mr.. Fino was asking, because I think that if we agree that the present programs have to be carried out, and certainly the function of the Federal Home Loan Bank Board has to be carried out to protect the $130 billion business that is involved here, you have to go somewhere for the money. And the price of the money is going to be a reality, whether it is in deposits or whether it is in borrowing, from the money market. It seems to me that it is true for all of these other programs we are talking about. If we are going to do it on the basis of direct loans, then we have to go to the money market to get the money for the Treasury to pay. I f it is going to be by sales of participation, then we are going to have to go to the same money market and we are going to have to pay whatever the realities of that market dictate. Is that not correct? M r . H o r n e . Y o u a r e c o r r e c t, sir . Mr. H a n n a . I th a n k y o u . The C h a ir m a n . Mr. Hanna, do not overlook the fact that it would be possible for our Congress to compel the Federal Reserve to make money available to the Federal Home Loan Bank Board at a rate of interest that Congress felt was reasonable. Do not overlook that possibility. Mr. Gettys? Mr. H o r n e . May I also make one further response in connection with the concern that Congressman Fino expressed and Congressman Hanna also touched on ? I think we bear in mind also, and I am not trying to be evasive in answering your question, Mr. Congressman. I am part of the administration as I am sure you recognize, sir. But I do want to emphasize the importance of management of this and I also want to 94 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS emphasize th at the amount of money th a t is affected here, I think in the first go-round is only about $4.5 billion and it will come from all sources, whereas the CD has presented a much larger figure than this p articular participation program would and I just wanted to get that point in ; th a t personally, I believe I am right, Mr. Chairm an, it would be $4.5 billion involved and before any more would be involved, the adm inistration would have to return to Congress. The C h a ir m a n . 4.7 Mr. Gettys? Mr. G e t t y s . It is a pleasure to welcome an old Capitol Hill employee who has gone downtown and made good. Mr. H o r n e . Thank y o u , sir. Mr. G e t t y s . This whole subject has to do with competition for money; does it not ? Mr. H o r n e . Y es, sir; to a great degree. Mr. G e t t y s . The fact that worries me somewhat is that the savings and loan industry is asking for authority, as I understand it, to go into other fields in addition to home loans. I f there is a shortage in the home loan field, why would it be necessary—the shortage of money for the purpose that the savings and loan industry was created, why should it go into other fields which are now reserved to the banks on appliances, mobile homes, and that sort of thing? Is this a related subject? Mr. H o r n e . Y es, I think it is. Perhaps I should answer it this way: While Congress has by law made the savings and loan industry pretty much of a specialty in what it can do, it did not at the same time see fit to say to the commercial banking industry, for example, that it stay out of the mortgage market area. So the banks have complete freedom to go into almost anything whereas the S. & L.’s are restricted. Now, as far as the immediate situation is concerned, you make a very good point. And this is a point that I was making to one of the members, Congressman Stephens, when he was commenting on the fact that we are looking very closely at money we are making avail able to some of the savings and loans through our central banking setup. We want to make certain that this money would be used for home purposes. But in the long run, I should think that it is entirely appropriate to permit the savings and loan associations, at least, to loan money on those things that go to make up a complete home and this is one of the things they are asking for. As far as mobile homes are concerned, it so happens that now, about one out of every nine people that buys what he calls a home buys a mobile home. This within itself is a home and it can justifiably, I think, be argued that if they help finance the mobile home pur chases, they are still in the home financing area. I don’t want to take all of your time, but there is one other c o m m e n t that may be appropriate. ^ I don’t know where the future is going to lead in this or any other industry, but I am rather of opinion that if Congress is going to insist that the savings and loan industry remain mortgage investment spe cialists, that Congress may very well have to provide other means for them to compete for savings. If Congress isn’t going to do that, then Congress may very well have to permit—if the industry is to remain strong and viable—a more diversified portfolio than is now the case- UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 95 Mr. G e t t y s . Thank you, sir. Although it is an old-fashioned phi losophy, are we not here asking again, either by law or by administra tive action that the Federal Government should get more into the allocation or distribution among the competitive factors in the econ omy, private enterprise, dictating to them—are we not again in this legislation asked for here, going more into the private sector, putting the tentacles of the Federal Government into business and that sort of thing ? Is that not another step in that direction ? Mr. H o r n e . To enable the S. & L.’s t o have a wider lending authority. Mr. G e t t y s . By legislative or by administrative decree, to say that this money has got to go here and this money has got to go there— that is interferring with competitive factors. Mr. H o r n e . This is a problem, Congressman. I frankly feel that Congress has already done so to a degree. It is something that can very well be defended, whichever point of view a person might have. Mr. G e t t y s . In the Old South where you and I are from, maybe the free-enterprise system is a little old fashioned, but I think we ought to consider it once in a while. Mr. T od d . Would my distinguished, old-fashioned colleague yield ? It seems to me you raised a very important point here and one which we should concern ourselves with. I wonder if what we are now discussing here is potential legislative action to offset administrative action which has already interferred in what Chairman Horne calls competitive allocation of funds. Is not this something that has al ready happened via an independent administrative agency which is charged with the responsibility of maintaining all monetary policy, the Federal Reserve Board, and are we not at this meeting simply discussing whether or not their action was wise and whether or not it took into consideration the impacts of that action on other financial agencies which Congress has established ? So that we are now reallj at this committee deciding how funds should be allocated. We are de ciding whether a decision of an independent administrative agency, wisely allocated funds in the money market. Would that be valid? Mr. H o r n e . This is certainly part o f the picture, Congressman, n o question about it. Mr. T o d d . I t h a n k th e g e n tle m a n . The C h a ir m a n . Obviously, we are not going to be able to finish today. Can you come back tomorrow, Mr. Horne ? Mr. H o r n e . I will be back whenever the chairman wants me to. The C h a ir m a n . We will commence then with the gentleman next to Mr. Halpern. We hope to finish with you tomorrow. Thank you very much. We will be in recess until 10 o’clock tomor row morning. (Whereupon at 11:58 a.m., the committee adjourned, to reconvene at 10 a.m., Thursday, May 12,1966.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS THURSDAY, MAY 12, 1966 H o u se o f R e p r e s e n t a t iv e s , C o m m it t e e o n B a n k i n g a n d C u r r e n c y , Washington, B.C. The committee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Wright Patman (chairman) presiding. Present: Representatives Patman, Reuss, Stephens, Gonzalez, Weltner, Hanna, Grabowski, Todd, Ottinger, McGrath, Hansen, Annunzio, Rees, Fino, Mrs. Dwyer, Harvey, Brock, and Clawson. STATEMENT OP HON. JOHN E. HORNE, CHAIRMAN, FEDERAL HOME LOAN BANK BOARD; ACCOMPANIED BY DR. HARRY S. SCHWARTZ, ECONOMIST, FEDERAL HOME LOAN BANK BOARD— Resumed The C h a ir m a n . The committee will please come to order. We will resume questioning of Mr. Home. Mr. Horne has kindly consented to come back this morning so all members would have an opportunity to ask questions. It is possible, Mr. Home, we will not use over an hour’s time, something like that. I am just estimating. I know that would be pleasing to you because you are very busy and I thought we might be imposing on you, asking you to come back but we must give all our members a chance to interrogate. Mr. H o r n e . I understand, Mr. Chairman, and I appreciate your consideration and I will stay here as long as the committee wants to question me. The C h a ir m a n . Mr. Brock? M r. B ro ck . N o q u e stio n s. The C h a ir m a n . Mr. Rees? Mr. Annunzio? Mr. Ottinger, have you interrogated Mr. Home ? Mr. O t t i n g e r . No; I have not, Mr. Chairman. But I read this testimony. The C h a ir m a n . You may go ahead, sir . Mr. O t t i n g e r . I read your very fine testimony and want to con gratulate you, Mr. Home. Mr. H o r n e . Thank you, sir. Mr. O t t i n g e r . Of the various approaches for resolving this prob lem, what seems the most promising from your point of view ? I sup pose you testified yesterday that you thought that the limitation of perhaps $25,000 as a floor on the deposits might be advisable. Are 97 98 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS there any other steps that you feel would be advisable to rectify the problem ? Mr. H o r n e . Congressman, on the top of page 5 o f my testimony I alluded to other possible solutions. If I may, sir, I would just like to read that brief paragraph. We would suggest examining the extent, in relation to total deposits, to which banks may use any of these instruments, negotiable CD’s, nonnegotiable CD’s, and time deposit open account. A minimum size limit for all these instruments and the appropriateness of multiple maturities and automatic renewal should also receive the commit tee’s attention. There are several points in addition to the size limit which I sug gested and which also is suggested in your bill. Although my sugges tion and yours are different, I should say that yours would certainly be helpful, even if you stop at $15,000 instead of $25,000. Mr. O t t i n g e r . What degree of impact would there be between the $15,000 and $25,000 level? Do you have any idea of the amount of money that is involved in that range ? Mr. H o r n e . N o , sir ; I do not have—I have not made an estimate as to the amount that would be involved. I should think----Dr. S c h w a r t z . I think that estimate ought to come from the Fed eral Reserve because they are collecting data on this right now. Mr. H o r n e . I was going to suggest that the Federal Reserve Board could probably give you a better lead as to the amount of money that might be involved than we could. But I must say again that I think your estimate would be helpful, extremely so. Mr. O t t i n g e r . How did you arrive then at the $ 2 5 ,0 0 0 figure rather than $ 1 0 ,0 0 0 , which is the present insured limit, or the $ 1 5 ,0 0 0 figure which I selected because it is the one that is proposed as the limit for insured deposits? Mr. H o r n e . I must admit that I had no magic formula. It is just evident to us in our experience that the lower the figure is in CD’s, the more effect it has on the thrift institutions. It just seemed to me that $25,000 or $20,000 or even $15,000 would alleviate to a great de gree the pressure that is presenty on S. & L.’s and thrift institutions because of the current lack of any size of restriction. Mr. O t t i n g e r . Y o u indicate that you would like to see a r e s tr ic tion as to the percent of the total deposits of any institution which may be held in certificates of deposit. Do you have any idea what kind of percentage that would be and if there would be great diffi" culties in trying to administer that for all different kinds of banking institutions? Mr. H o r n e . I have not tried to inventory or research what might be an appropriate figure here. I suppose that it could be a r r iv e d at by the Federal Reserve Board. The Federal Reserve Board or the FDIC would be the appropriate sources to examine the banks as to what percentages presently exist in banks, and in cases where they think it is exceedingly heavy, it could be very well reduced and some maximum set. We have done similar things in the savings and loan industry as regards, for example, the amount of CD’s that an S. & L. could hold m a commercial bank for which it would be given credit as cash We ascertained by making a study in this particular area what we thought would be an appropriate amount, looking forward to the UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 99 time of phasing it out all together. I think the Federal Reserve Board with the information that it would have on each individual bank and to what degree this practice is being carried on in each individual bank could without a great deal of difficulty come up with an appropriate suggestion. Mr. O t t i n g e r . Would y o u be sanguine about giving the Federal Reserve Board discretion in both this regard and in regard to the amount of the floor that would be set, whether it would be $15,000, $10,000, $25,000 ? The C h a ir m a n . Would you yield? Would you include in that the interest rate, too, that they would be payable ? Mr. O t t i n g e r . Yes. The C h a ir m a n . Unless you fix it so that those under $25,000 would get as much as those above it, I think we would be placed in a position of discriminating against these small people and you would entice them into a situation that developed in the San Francisco bank where they were pooling their money and bringing it in there and they had a question raised as to whether or not insurance coverage was there. I f we had something like a $25,000 floor, understand, I am all in sym pathy with these savings and loans but at the same time we do not want to place them in a discriminatory position. I f you say that below $25,000 that there would be a certain rate and that rate were below the rate on deposits over $25,000 that would help the thrift associations and the man with a lot of money, but it would be unfair to the ordinary citizen. I hope you give consideration to that in approaching this problem. Mr. O t t i n g e r . I recognize that as a problem, Mr. Chairman, though I think it is rather more reflective of the situation that actually exists in the market rather than any discrimination that we would be per petrating. I myself feel that the Federal Reserve caused this problem by permitting the CD’s to come into being and to flourish so by chang ing regulation Q and permitting 51 percent to be charged on it. I /2 have some question about giving the Federal Reserve the discretionary power to resolve the problem. I am not sure they would properly exercise that discretion. Mr. H o r n e . I f you should give them such power, as I indicated yes terday, you might very well wish at the same time to provide guide lines, either in the legislation or preferably in the report that the com mittee would make when it reported the bill. I must say if I may, sir, that I have a great deal of sympathy myself with the position just expressed by the chairman. The committee might very well decide though that while this would be an evil in a way, Mr. Chairman, that there might be a worse evil if some restraint is not imposed here. I do not know the answer to it. I do say, again, that I am in sympathy with the thought that a person with a small amount of savings should draw as much as a person with a large amount of savings and yet there may be on a temporary basis some overriding reason that would cause the committee to w ant to put up T with this sort of thing at least for a while. Mr. O t t i n g e r . I think there is a much larger question here o f im balance between the regulatory agencies and the policies with respect to deposits that we will have to get at. But I am not sure, Mr. Chair man, that we should not solve this immediate threatening problem in 1 0 0 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS a tem porary way. M r. Chairm an, can I ask one more question, even though my time is up ? The C h a ir m a n . M r. M cGrath. M r . M c G r a t h . I w ant to compliment Chairm an H orne also for his fine testimony. I t is always a pleasure for me to see him here. M r. H o r n e . T hank y o u , sir. M r . M c G r a t h . I am curious to find out, if it is readily available, w hat percentage of depositors in the savings and loan associations are also borrowers ? Is th a t statistic kept ? Dr. S c h w a r t z . N o , s i r ; t h e s t a t is t ic is n o t k e p t. M r. M c G r a t h . We will forget about it, then. Mr. H om e, is there any doubt in your m ind th at the Federal Home Loan B ank B oard and other Government agencies have sufficient resources and statutory tools to keep things on an even keel and to deal w ith all contingencies in the savings and loan industry and other financial branches of our economy ? M r. H o r n e . I am very pleased th a t you ask th at question, because I should like to try to dispel any doubt about it in the mind of anyone. There is no question in my m ind but th a t w ith the resources of the Federal home loan banks, w ith the resources of other agencies on which we by law have the rig h t to go to for assistance if need be, w ith the sympathetic understanding and concern th at has been ex pressed to the Federal Home Loan B ank B oard by appropriate of* ficials of other agencies, the help th at is being generated in case it is needed I just do not believe th a t there is any reason fo r anyone to push a panic button and fear th a t we are about to suffer a real catastrophe. W e have some try in g times th a t we are going through; yes, sir. W e have done so in the past and I am confident th a t w ith the sympathetic understanding and the proper w orking together of the congressional and executive branches of Government th a t we are going through this, too. I am pleased to say th a t I hope nobody will m istakm gly take the position th a t the savings and loan industry is not going to be able to ^weather the difficulties th a t we are in now and am SUre continue fo r some months ahead. M r. M c G r a t h . T h a n k y o u v e r y m u c h . I h a v e n o f u r t h e r q u e stio n s. The C h a ir m a n . M r. Clawson ? Mr. C l a w s o n . T hank you, M r. Chairm an. M r. H om e, in answer to a question yesterday, you indicated there was no prohibition on certificates of deposit in connection w ith the savings and loans. How ever, they have exercised, apparently under your direction, extreme caution m the use of this instrum ent as p a rt of th eir procedure. I s th at about the way you p u t it ? M r. H o r n e . We have, Congressman, w hat is called not a certificate of deposit but a certificate. W e think th a t on the whole, the savings and loans have exercised this authority w ith prudence. As a m a tter o f f a c t , i t h a s o n ly b e e n in r e c e n t m o n th s — r e la t iv e l y r e c e n t m o n th s J ™ 8 , came to the Board, since I became Chairm an, as a m atter o f fact th at we worked out a certificate program th a t would be made available to the savings and loan industry. W e have presently under study fu rth e r steps in this direction. W e hope t o have it fo r m a liz e d in a very few days. This is fo r the modification o f certificate program s th a t can be used t y the savings and loan industry. I f I understand y o u r question cor is a responsive answer. rectly, this UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 0 1 Mr. C l a w s o n . To the extent that you have explained the certificate. You indicated that they do use something comparable to the CD in the S. & L. industry. Mr. H o r n e . Yes, there are some differences. There are differences in the legislation and regulation under which banks operate and under which S. & L.’s operate. There is some difference between these two instruments. But we have felt for some time that there was a neces sity for savings and loans having, at least as a defensive measure, some such device. Several months ago, we developed such devices and as I have just said, we are now in the process of even revising these devices. Mr. C la w s o n . I recall that some 5 years ago or longer, I deposited with a savings and loan, something comparable to CD. What would that have been at that time ? Mr. H o r n e . I f r a n k ly d o n o t k n o w , sir . Mr. C l a w s o n . This was a certificate. It was not a passbook. Mr. H o r n e . I do not know that it would have been the old bonus plan that has been part of the regulations for some time. There is a bonus plan wherein S. & L /s may pay a bonus if the money is held for a period of 3 years of up to 1 percent. We modified that a few months ago because some did not want to have to pay the full half percent and we gave them flexibility so they could take an eighth, a fourth, or a half. That is what von may have in mind as far as Federal is concerned. As far as States are concerned, as you know, we have the dual system and sometimes the State permission is not exactly what the Federal regulation may be. I believe Dr. Schwartz may comment on this. Mr. C l a w s o n . I think mine was a State association certificate. Dr. S c h w a r t z . I f it was a State-chartered association, you may have a special situation. The Board does approve each certificate that is issued if it is for a fixed term or has a fixed rate. Now, there is authority in the Federal regulations and there may be in certain State regulations to issue a certificate in lieu of a passbook. There is no difference in that case. Mr. C l a w s o x . I did not know the bonuses that I received were for that purpose. Dr. S c h w a r t z . I think you got that for opening of the account. Air. R e e s . W ill the gentleman yield? I had a bill on giveaways and premiums. There are no more giveaways. Mr. C l a w s o n . In your statement on page 4, you also indicated that with the use of CD’s, by banks, they are building a liquidity squeeze for themselves if they pursue this too far. Would you want to enlarge upon that comment ? Mr. H o r n e . Well, my own reaction is that these CD's of course mature and when they mature there is a question whether they are going to be held or whether they are going to move out into other chan nels. I f too much of the bank holdings is involved in this kind of savings or deposit, it can of course, create a greater problem. I do not know, because I am not privy to all the problems that the Federal Beserve Board may have experienced last December. But my assumption is that this was part of the difficulty that the Federal Reserve Board faced even at that time. As the amount of holdings of CD ’s in a bank increases, this problem can continue to expand. 63— 496—66— — 8 1 0 2 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS M r. C l a w s o n . I wanted to ask one more question. M ay I indulge just fo r a moment? There have been statem ents made th a t the liberal and expansive attitude of the Federal Home Loan B ank B oard in the past, 5 years ago, together w ith the. dram atic grow th and expansion of the sayings and loan industry, contributed to some extent to the present situation by encouraging their liberal loaning activities. Do you w ant to comment at all on th a t ? Mr. H o r n e . I would be very glad to, Congressman. I read a story some time ago which said that the hindsight of an elementary school graduate was superior to the foresight of a Ph. D, and to some degree this perhaps is right. I would not, doubt on some occasions we may have been a little bit too generous in perm itting savings and loan associations to borrow from th eir respective Federal home loan banks. This is a problem th at we constantly face. M any of the associations think on the one hand, and perhaps erroneously so, th at they have the risrht to go to the window and borrow whatever they think they need. W e have in several very im portant ways imposed some restrictions during the past year or 18 months, and frankly it has made some of the members unhappy. B ut I think we have done wisely in imposing some restrictions. A nd it would be my intention, if I am still on the Board, to look a t this thins: even more carefullv in the months and years ahead once we get through the present situation. On the other hand. X must—in answer to your question—tell you of a bit of correspondence th at took place between the B oard and a State supervisor a few weeks ago. The State supervisor said th a t the problems of the State associations in his p articular State, th a t is their problems having to do with the scheduled items and foreclosures and delinquencies and overbuilding should really rest on the shoulders of the Federal Home Loan B ank Board because these associations have not only advertised excessively for out-of-State money w ith high rates, but that^ we have in addition perm itted them to borrow money from the district bank. And I responded by telling him th a t he may be p artially risrht in his criticism of the Board, but I should like to point out th a t he is also saying, as regards associations under his super vision. th at they are not to be trusted to determine how much money thev should get from different sources and th a t they do not know how to invest wisely the money that, they do get and this m ieht be some what of a reflection on the State supervisory functions "as well as a possible reflection on the Federal Home Loan B ank Board. Mr. C l a w s o n . Thank you. My time is up. The C t ia t r m a n . Mr. Hansen ? Mr. H a n s f .n . Thank y o u , Mr. Chairman. Mr. Horne, what percentage of the holdings in the savings and loan business are comprised of the federally insured items such as Federal housing and F H A loans? Mr. H o r n e . I will supply the exact figure on th a t just, to be certain. I believe I am rig h t in saying th a t it is around 96 or 98 percent.. Now th is is tru e savingswise. I t is not tru e numberwise. There are quite a few savings and loan associations th a t do not have th eir accounts insured, but they are usually small associations. Not always, but usually they are small associations. So between 96 and 98 percent., and I would like to—when I read my response pu t in the exact figure so as to answer your question correctly. TJNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 0 3 M r. H a n s e n . Are you talking about the mortgages they hold? M r. H o r n e . N o , s ir ; I a m t a lk in g a b o u t th e s a v in g s . Mr. H a n s e n . I am talking about mortgages in their portfolio. M r. H o r n e . Y o u a re t a lk in g a b o u t VA a n d FH A. T h is is o n ly 10 o r 11 p e r c e n t, sir . Mr. H a n s e n . Ten or eleven percent ? Mr. H o r n e . Yes, sir. Mr. H a n s e n . Someplace along the line you were drawn into some discussion about the participation sales bill in the testimony that took place yesterday, and the allegation was made, I believe, by someone, I am not sure whom, that the sale of participation certificates compete for mortgage money and therefore withdraw this money from the market. In the Wall Street Journal on May 6 there was a long article about increased activity on the part of FNMA, picking up insured mortgages from the industry. In it there is a sentence which reads as follows: “When Fannie Mae buys mortgages it provides lenders with fresh cash to reinvest in other mortgages or in new construct ion.” Now presumably these mortgages that are being sold to Fannie Mae are those that were bought or taken at a lower interest rate. To the extent that they are buying these insured mortgage loans from the private institutions and institutions such as the savings and loans they are doing some subsidizing in taking care of the difference in interest. Fannie Mae is reported to have sold $400 million worth of their debentures at 5.45 rate basis. Now, wherein is the difference between this procedure and permitting the Federal agencies to move their paper through the same route ? I know that this is not germane to the bill that we are discussing here today, but it is a question w^hich was raised. Therefore, I think, the matter should be pursued a little further. Mr. H o r n e . Well, I suppose, if I understood the mechanism cor rectly, Congressman, there is no real difference. Ever since I have been in Washington, since 1947 to be exact, Congress from time to time has enabled Fannie Mae to carry out some functions to give assistance to the homebuilding industry. I should like, if I may, sir, and I think this would be a partial response at least to your question, comment somewhat further on the participation program that Congressman Fino asked me about also yesterday. I frankly admitted that I had not studied the situation in depth, although I was generally familiar with it, But since lie asked me that question I checked further into the program and there are some comments I think that might be appro priate both to your question and to one that Congressman Hansen has just asked. After I looked more carefully into it, the participation program is not one that would greatly affect the flow of savings into the savings and loan industry or into thrift institutions. My conclu sion for this is related to the fact that the sales by the Government would amount, under existing proposals, to about $4.5 or $4. ( billion. The certificates which have been sold heretofore have been in units of not less than $5,000. I believe the Treasury in testimony has indicated, they would be willing for the amount to be higher. These sales would substitute private credit for public credit and if the Government did not sell the participation certificates it would have to sell Treasury obligations. These would have at least a sim ilar effect on the m arket th a t the participation program would have. The 1 0 4 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS Government sale of participation goes across the entire investor field, as I pointed out yesterday, w ith emphasis on large investors, and this is quite different from the great amount of money th a t is going on in small C D ’s. Investors who buy the participation instruments would be more likely to be using them as a substitute for other types o f m arket securities rath er than as a substitute for savings accounts. A nd so I have not concluded in my own m ind th a t either the par ticipation program or the Fannie Mae p a rt of it, as presently being adm inistered, would constitute any great additional strain, if any at all, on the flow of money into the savings and loan associations or the m ortgage m arket. There m ight be some, of course. I do not think anybody could say there would be nothing whatsoever. B ut I think the effect, if any, would be minimum. M r. H a n s e n . T hank you very much fo r clearing up th a t point, M r. H om e. The C h a ir m a n . M r. Annunzio ? Mr. A n n u n z i o . T hank you, M r. Chairm an, Mr. H om e, I , too, along w ith m y other colleagues, would like to commend you on your excel lent presentation. Mr. H o r n e . I appreciate that. Mr. A n n u n z i o . I would like to express our thanks for your con tribution in helping us to solve the CD problem before the committee. I would like to get back to the participation pool, because it is, as fa r as I am concerned, germane to the question before us, for the simple reason th a t we are discussing liquidity on the p a rt of our bank ing institutions and w hat effect it would have on the effect of the liquidity of the banking industry. Mr. H orne, would you not agree that, first, the shares sold in the participation pool need not cost the Government 5y2 percent since the rate depends on a num ber of factors which generally change? Mr. H o r n e . This is true, sir. Mr. A n n u n z i o . I f the pool taps funds from a num ber of sources, such as pension funds, large investors, insurance companies, and others, it need not compete w ith availability of funds fo r housing. Mr. H o r n e . Yes, sir. Mr. A n n u n z i o . W ould you say yes to th a t ? Mr. H o r n e . Yes. Mr. A n n u n z i o . W ould you not agree, just as w ith this issue of CD’s, th a t the issue before us is how CD ’s affect the savings and loan industry, depending on the size of the denominations issued by the pool ? In other words, the denominations issued by the pool m ay not m any way compete w ith flow of funds into th rift institutions. Mr. H o r n e . I agree, sir, and I also made a sim ilar point in the com ments th a t I just made with regard to your question. Mr. A n n u n z i o . I would also, M r. Chairm an, like to read one para graph of an article th a t appeared in the Am erican B anker on May 9> and then ask unanimous consent th a t it be inserted into the record. The C h a ir m a n . W ithout objection, so ordered. Mr. A n n u n z i o . I t deals w ith the Continental Illinois National Bank & T rust Co., in Chicago, which a week ago suggested th a t pas sage of the bill to sell Federal loan assets m ight unsettle the financial m arkets and over the weekend said th a t failure to pass the bill would increase the size of the budget deficit and impose even greater pressures for fiscal restraint. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 0 5 I would like to have this included in the record at this point. (The article referred to follows:) [From the American Banker, May 9, 1966] C o n t in e n t a l I l l in o is A ss e r t s P a ssa g e of A s s e t s B il l I s L e s s e e of T wo E v il s C hicag o .—Continental Illinois National Bank and Trust Co., which a week ago suggested that passage of the bill to sell Federal loan assets might unsettle the financial markets, said over the weekend that failure to pass the bill would increase the size of the budget deficit and impose even greater pressures for fiscal restraint. The measure, known as the Loan Participation Act of 1966. calls for sale of $8 billion of Federally-owned assets by June 30,1967. The bill cleared the Senate Thursday and a companion measure has been approved by the House Banking and Currency Committee. The bank pointed out in its government bond department’s weekly publication, Continental Comment, that sale of the assets is reflected on the government’s .books as a net reduction in e x p e n d it u r e s , rather than as an increase to receipts. If the bill should fail to pass, says Continental, “then pressures would develop to increase direct Treasury borrowings, raise taxes or reduce other expenditures/* Direct Treasury borrowings would be restricted to the shorter range of the market because of the 4% percent ceiling on long-term governments, the publica tion states. The tax increase alternative continues to be played down by Administration officials, while a reduction in spending faces stiff political opposition, Continental adds. “Perhaps most vulnerable to spending reduction are those programs related to the Great Society where expenditures are rising rapidly,” the bank declares. “Yet each specific area of this program already has its advocates disappointed that the cost of the war has held back funds which otherwise might have been available to them. In fact, Congress recently has restored funds to many areas where proposed reduction had been suggested. “Perhaps the simplest solution would be to have an across-the-board reduction in nondefense spending.” The bank concludes that the proposed sale of assets “has important implications for the future course of the economy,” with particular impact on the budget. Mr. A n n u n z i o . Mr. Home, also in your testimony, I recall that when the discount rate was increased, you said there was no consul tation between the Federal Reserve Board and any of the supervisory agencies in the Government like the Comptroller of the Currency and yourself? Mr. H o r n e . I do not know, Congressman, to what degree they may have consulted with other agencies of Government. But as I an swered the question yesterday, they did not consult in advance with the Federal Home Loan Bank Board. Mr. A n n u n z i o . Thank you, Mr. Horne. I also recall you stating that on January 6 a committee was formed for the purpose of discussion. Mr. H o r n e . Yes, sir. I would like to stress this point if I may. I am sure the committee members remember that in the closing months of President Kennedy’s sojourn as President, he suggested the formation of such a committee. Well, shortly after President Johnson became President he instructed the Secretary of the Treas ury to make certain that such a committee was formed. Such a com mittee has been formed. It is functioning. We do not announce to the press or give any publicity to the fact that we meet, but we meet fairly regularly. TTiere is, in my opinion more exchange of infor mation now between the regulatory Government agencies in the field of financial institutions than there has ever been in the past. In addition to fairly regular meetings of the Chairman of the Fed 1 0 6 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS eral Reserve Board or the Vice Chairman, the Chairman of the Federal Home Loan Bank Board, the Chairman of FD IC and the Comptroller of the Currency, there are special meetings on topics that would be of interest to all of us between times. So there is now consultation going on, close consultation. Mr. A n n u n z i o . Would you say this consultation has increased since December of 1965 ? Mr. H o r n e . Yes, sir; it has. I was going to say-----Mr. A n n u n z i o . I am very happy that after the horse has left the bam some of our people in the supervisory agencies have decided to talk to each other. Thank you, Mr. Chairman. The C h a ir m a n . May I suggest, Mr. Horne, that sounds mighty good, but if the President himself organized this coordinating group, then they would all be obligated to the President to make sure they did a good job and he would be the overseer. But now, then, you have a coordinating committee composed of members all in a comparable position, no one above the other, and I think that is the weakness in it. I hope the President would organize a coordinating committee himself. Do you not think that would be more effective ? Mr. H o r n e . This may partially be what you have in mind, that the President has, in effect, done this through the Secretary of the Treasury. The C h a ir m a n . I do not agree with you at all, Mr. Home. Mr. H o r n e . You may be right, Mr. Chairman. The C h a ir m a n . I f the President did it is one thing, but for him to suggest one who is in a comparable position to get everybody to gether, I think that is entirely different. I would like to see the Presi dent in charge of it. He is elected by the people and I think we should have some way of him being in charge of it. Mr. H o r n e . My only intention was, Mr. Chairman, I do not know whether or not the committee recognized that while the President has not done exactly what you are suggesting, he did ask the Secretary of the Treasury to put it together and to stay on top of it and we report regularly to the Secretary of the Treasury. The C h a ir m a n . But you still have no power and authority to oppose the Federal Reserve. They have determined to be a fourth branch of the Government. You cannot do a thing about it. Mr. H o r n e . T o give a candid answer to your question, sir, we do not have the authority to override the Chairman of the Federal Reserve Board. The C h a ir m a n . Mr. Harvey? Mr. H a r v e y . Mr. Horne, I am sorry I had to leave yesterday after your statement. You certainly have had a very distinguished career in Government and we welcome you here as a witness. Mr. H o r n e . Thank you very much. Mr. H a r v e y . I have just a couple of questions here. First of all, do you support this bill, H.R. 14026? That is the chairman’s bill which would in effect prohibit the issuance of nego tiable certificates of deposit. Mr. H o r n e . May I make two comments in response to your question, I forgot yesterday to point out that I am testifying largely on my own m that we did not have time for what I have said to be checked UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 0 7 with the Bureau of the Budget which is the customary channel for Government agencies to use. I did want to clarify that since I forgot to do so yesterday. Now as to this bill, H.R. 14026, I tried to make clear in my testi mony that, while I am not in opposition at all to H.R. 14026, it is not the negotiable CD’s alone that are causing us difficulty in the savings and loan industry. The nonnegotiable CD’s are also a problem that gives us some concern and that in very recent months, the nonnegoti able CD’s have, in quantity, outgrown the negotiable CD’s. Mr. H a r v e y . Let me ask you this next question. Would you sup port flat prohibition of negotiable certificates of deposit? Mr. H o r n e . Before giving a direct answer to that question, I would want to give a little bit more thought. I think I can say again, I have no objection to it, but I do not think it would solve the entire problem we are driving at. Mr. H a r v e y . My reason for asking that, Mr. Horne, is that I am sure some of us feel that is a very drastic approach to the problem and on page 5 of your statement you did not outline any course similar to that. My offhand reaction to it, when I saw the bill the other day is that it would cause chaos in the market. Mr. H o r n e . In deference to the Chairman—I have not discussed this with him previously—I am not convinced that this would cause chaos or that this alone would solve the problem. I think to get at the problem that is giving us difficulty now, Congress would have to go further than just deal with the negotiable CD’s. Mr. H a r v e y . Let me ask you another question in another area, which shows my ignorance ox the savings and loan industry rather than anything else. In my area in the State of Michigan, the home loans from the savings and loans are going at very high rates of interest, 6y2 and 7 percent is what they charging a home loaner for a loan. Yet, the interest being paid on deposits very frankly is still 4, 4% percent which leaves a very substantial spread between the interest paid on deposits and the interest paid by the borrower. I used to think that something like a li/2-percent spread or something like that* certainly 1% is enough to allow an ample profit. But ap parently the spread here is as much as 2y2 percent or more, 2% per cent. Does this enter into the picture at all, what the charges in the market will bear? Would vou have any comment on that? M r. H o r n e . Yes, sir. I think there are several comments that would be appropriate. In the first place, generally speaking, 1% or 1% or 2-percent spread should be adequate with a well-run savings and loan association. I do not have the latest figures as to what is happening in the State of Michigan, and if it would be of interest for you, sir, for us to get the figures as to what the savings and loans pay to savers, I would be very glad to supply them for you because we could get that in formation. I think you would find that the actions by the Board of Governors in November 1964 have to be kept in mind. I believe the 1964 action caused some upward pressures on the rates S. & L.’s pay savers. And these two steps put together, particularly that in January 1966, I believe would show that the S. & L.’s in the State of Michigan are paying more for their savings than they were paying. I think you will find that perhaps some of them now are paying 4y2 1 0 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS percent. You would also probably find that some of them—perhaps not a great number—but some of them are using the certificate plan we have in which they would pay 4.75 percent. So these are two fac tors that come into it. (The information referred to follows:) M ic h ig a n S a v in g s L o a n A s s o c ia tio n m e m b e rs o f F e d e r a l H o m e L o a n B a n k S y s t e m a n t i c i p a t e d r e g u l a r d iv i d e n d r a t e s f o r p e r i o d b e g in n in g J a n . 1 , 1 9 6 6 Num ber of Anticipated dividend rate: associations 4.50 percent_______________________________________________ _____ 4 4.26 to 4.49 percent_____________________________________________ 2 4.25 percent____________________________________________________ 39 4.01 to 4.24 percent______________________________________________ 3 4.00 percent-------------------------------------------------------------------------------17 3.50 percent______________________________________ ______________ 1 No information_________________________________________________ 2 Total________________________________________________________ 68 Mr. H a r v e y . One other question, a simple one: In your career have you ever known a rollback in interest rates? This is what frightens me about this 6y2 and 7 percent. In my memory I cannot remember these interest rates going back, rolling backward. Mr. H o r n e . Yes, sir, they have gone back. Here is what can hap pen. I was going to make one more comment, if I may. There is a shortage of money today. The S. & L.’s are under a squeeze to pay more money if they are to protect even the savings they have. In anticipation of having to increase rates again that they pay to their savers they are probably taking advantage of the fact that money is short. Consequently, they are picking and choosing carefully the loans they do make, and are charging a higher rate because they may themselves have to pay a higher rate for money in the future unless we can control the matter some other way. Now, there has been a rollback and this has happened time and time again. This will work very well in Michigan or any other place if they get out of line. Once money starts flowing into thrift institu tions and business demand for credit declines, lenders won’t be able to get what they can today. The people who are now being charged 6,6%, or 7 percent can very well come m and refinance their loans and et the lower rate, whatever the low rate at that time may be. This as been done quite frequently in this industry. So if they get much out of line, once the cost of money is less, they will be brought back into line. Incidentally, there is one thing that would be of interest to the committee. Federal associations actually have the authority today, when they make a loan, to put in the contract that they could raise their charges to the borrower along the way if they wanted to. But very seldom does one include this in the contract because there has been such competition in the home mortgage market that he hasn’t been able to impose it. If he tries to impose it the borrower can go to an insurance company or a bank or some other source and get his loan that would not have such a mathematical clause that would enable the lender to charge him a higher rate on his loan. Mr. H a r v e y . Thank you very much, Mr. Horne. The C h a ir m a n , Mr. Rees? g UNSOUND COMPETITION l O l i SAVINGS AND TIME DEPOSITS 1 0 9 Mr. R e e s . Mr. Home, I would like to look at this instrument that we call a certificate of deposit. The original use of the CD was for an investment where a corporation could use its excess funds, they would go into a CD for a specific period of time and earn interest on their excess funds which they could not do in a savings account in a bank. Was not the original CD for about a 1-year period? What worries me is not so much putting a floor on the certificate of deposit but trying to analyze what a certificate of deposit is and then deciding, is this good or bad for the banking industry? In California we have ^ had probably more trouble with banks than savings and loan institu tions. One of the problems in California, especially with newer banks, is that in an effort to build the deposits up to new records, and we like to do that in California, they went through money brokers and purchased a lot of CD’s and unfortunately these CD’s came up for payment at the same time. The bank found itself in the difficulty in terms of liquidity. We had quite a few mergers because of this. You find the CD in a way is a very dangerous instrument. They say the CD crisis in New York in December was what led to the increase by the Fed to rediscount rate and increasing the interest rate for the CD’s. I see that you have authorized the same type of gimmick, or what ever you want to call a CD, for savings and loans and so now we find two different types of concepts, one is the passbook concept and the other is the certificate of deposit. They are really the same except a few internal changes; they are really the same. Do you not think it would be better to eliminate the certificate in the savings and loan and go back to passbook and then to regulate perhaps the bank CD in terms of the use by the banks so that the CD does what it was sup posed to do originally, which was to give an interest-making haven for large funds of corporate money* therefore you would not have the suicidal competition between the banking systems? What about the approach of not outlawing them or not building a dollar limit on them but saying a bank CD must be an instrument held for at least say 1 year and the interest paid can be no higher than the interest paid, for example, on a passbook. In this way I think you would cool down this competitive race for this type of money and you would leave the CD where it was supposed to be and at the same time you could get rid, of these certificates which really are not going over very well in California. What do you think about this approach? Do you think this would have the tendency to cool this whole situation down? Mr. H o r n e . If it can be done-^as a matter of fact, the suggestion appeals to me very much, Congressman, and this may be a very good way to do it. I think you would have to weigh how long you took and under what condition you could shift into the kind of program you are talking about. Of course, possible overloading of CD s in banks is one of the reasons that in my testimony I suggest the com mittee give some consideration to the proportion of bank savings that could be in the form of CD’s. Because the problem could get out of hand ju st as you have indicated. Your solution might be a very good > solution to it. . ^ So far as the certificates in the savings and loan industry is con cerned, there is only a small similarity to what has been done and what is being done in banks. The savings and loans are much more con servative under our restraints. 1 1 0 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS It should be pointed out—I am sure they can point it out better than I, that the Federal Reserve Board is concerned about the difficulty. They have expressed concern as to what effect it might be having on thrift institutions. I have been very pleased that some of the bankers themselves are concerned about the situation. I know that the presi dent of the American Bankers Association, Mr. Davis, from North Carolina, has been very outspoken in this regard and has expressed grave concern that the present use of CD’s in unlimited quantities and unlimited denominations can cause difficulties not only to the banks but also to the thrift institutions. Mr. R e e s . They are so concerned, they are ready to cry all the way to the funeral, are they not? I think there are very serious problems in California and unfortunately it is wholly the fault of the industry as they are generally in a very sound condition in California. In terms of a long-term viewpoint, we see this problem where the decisions of another Board directly affects your industry. The direct problems that the savings and loan industry is having today, especially where there is a need for new money for mortgages is directly attributable to the December action of the Federal Reserve Board. Do you think that one of these days we might be able to look at the overall problem of the money market in the United States and have some coordination ? Why could we not make you an ex-officio member of the Board and let you veto anything that the Board comes up with and that might affect your industry and Mr. Martin could be on your Board ex officio and do the same thing? There is no use for you to swallow the ball when it is another Board that is affecting you and directly affecting you and putting you probably in the worst crisis you have had in a great many years. Mr. H o r n e . I hardly know, Congressman, how to respond to your suggestion except to say something I said yesterday. This industry has become of such magnitude and of such importance that unques tionably it is going to rightfully receive more attention than was the case 15 or 20 years ago when what might happen to it did not—could not have the impact on the economy it could today. So, some device, whether it is voluntary or otherwise, has to be used to make certain that whatever is done as regards one structure of financial entities is done in a way and in a manner that does not visit great harm on the other. Mr. Rees. Mr. Horne, my last question. The situation in California, and I do not know it in other States, and I think we would tend to jxave the same situation—in California the person who keeps money in me livings and loan institutions is primarily an investor. It is not Joe Doakes around the comer who has a couple of hundred dollars. And looking at the larger associations, and this probably is the same in the smaller ones, the average account tends to be around $9,000. If we look at the type of account that has been withdrawn and put into s or ynmwapal or other competing types of paper, we find that the ^ $10\°?° leve1’ the l^el to which you are insured. We find that this is directly affecting the homebuilding market m California. The homebuilding construction is perhaps the largest industry we have and we are already having layoffs. We find that it is a serious situation in terms of real estate as people cannot sell their houses or buy new houses because of the problems of trying to UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 1 1 find mortgage money and this is through no fault of the financial insti tutions themselves. You are the Chairman of the Board. What do you plan to do about this situation that I think is a serious one for the overall California economy ? Mr. H o r n e . Congressman, as I have indicated earlier in my remarks, we have been studying this for some weeks. I believe either tomorrow or before the end of this week, or certainly next week, we will make our announcement of some of the things we are going to do. I would not want to mislead you into believing, and I know you are not attempting to get me to do so, that through the bank window, so to speak, we are going to be able to supply money to the California associations for all homebuilding purposes. Mr. R e e s . What if they do not want to be supplied money ? What if they would like to have the competitive tools and go out in the free market? Why should they have to go back to your bank and draw down the funds? Why should the Government go out and float more loans to build up these reserves if really the whole solution might be the use of the free market in allowing these institutions to compete just the way the banks are competing today. The banks are paying five and a half percent now in California for CD’s, as little as 30-day terms, and in CD’s for less than $100. Now, you know that is not a CD. I know it is not a CD, but that is what they are doing and the Federal Reserve Board seems to say it is OK. Are you going to give the banks, the savings and loan institutions in my State and throughout this Nation the right to compete in the open market for funds? Mr. H o r x e . Let me perhaps try to respond in about two or three different ways. To alleviate in some degree the problem that you describe, Congressman, I am not sure that one needs to go as far as you have indicated. Secondly, we still have, and this is not necessarily true only of California, but we do have in certain places in California a surplus of housing. Two other things that bother me frankly, and I indicated this also yesterday, is that the S. & L.’s have their money tied up in long-term loans and there is a limit to how much they can pay across the board for their savings and at the same time earn enough money to meet all their requirements. Then we do have this situation which I think is to some degree a supervisory or regulatory agency has to keep someone in mind, and that is, whenever one association takes a move, just brings pressure on every other association to do a similar thing. It is true that some of the larger, more powerful associations can do a little more in the way of ratepaying than some of the smaller ones can. The argument can be made both ways. On the one hand, there is the argument that each association be allowed to pay whatever he desires without any regard for the adverse effect it might cause on his neighbor. On the other hand, we are sitting here with a limited amount of money in the Insurance Corpora tion—and we have to give some consideration to the adverse effect that may be visited upon a somewhat weaker, somewhat newer, a some what, younger association. Mr. R e e s . It sounds as if you wanted to use the insurance instru mentality as the main shoring up of the market in California. Do you not think what California needs is more mortgage money, and 112 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS do you not think they need some kind of competitive tool? What about some kind of competitive tool allowing them to go in the open market and do some bidding? They are 0.65'percentage point behind the banks now in terms of competition. Mr. H o r x e . I made clear one of the things we will do, will give some relief in the situation—I should point out, and I have too much respect for you, Congressman, to disagree with you----Mr. R e e s . Please. The C h a t r m a x . We have some other members who have not inter rogated the witness at all. Would you mind withholding until they have? May I make this suggestion ? I am afraid we are overlooking one important point. \ ou know, the Government has often restricted the use of money for different things like savings bonds. They used to have to restrict that to $10,000, certain types of bonds, which is perfectly all right. It is in the public interest. It protects the public. In this case, and you know, it was not permissible for corporate funds to be used on savings accounts in banks. That was a good idea, because that induced the corporate funds to be in competition with all the others and keep interest rates down for the public. A specific example of this is interest rates on short-term Treasury securities. When they were using those funds in bidding for short-term Treasury bills, the short term interest rates were held way down. But when they left that market and went into the CD’s, then the short-term rates went up and they are still way up there now. And then by inventing this CD device and letting these corporate funds be used this way, that is really like an evasion of the old policy of not permitting corporate funds to be used m savings. This money is just too volatile, too sensitive to interest rate changes. They are used in time deposits, but they had to make another step in order to be effective. They had to make them negotiable, then they had to create a market for them. That *. u 1 interest on demand deposits and it was a revolution in the banking world to the extent that it gives a few people an oppor tunity to create higher and higher interest rates for themselves because be^rT’t are °U ^ Treasury market when they ought to I am afraid that we have ignored that particular point in our own looking at the CD problem. It is a revolutionary change in the entire banking system imposing upon the public hierher and higher interest rates. Do you not see something of that, Mr. Home? Horne. I think unquestionably some of the things you have en P ^ace’ ^ r*Chairman, in the way CD’s have begun tJ m6 C h^?rs^ n -, M r*W eltner has not interrogated, neither has Mr. Todd nor M r. Grabowski. These three gentlemen have not. W e will yield to them now. Mr. W e l t n e r . T hank you, M r. Chairm an. 1 fam iliar w ith the situation in the area of A tlanta. Since the first of th e year* savings and ii^oM ^acTO m fts1 1 area suffered a loss o f about $30 million UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 1 3 This has resulted in the drying up of mortgage money and as I understand your statement on page 5, a continuation of that would bring mortgage availability to “intolerably low levels.” Does that situation hold pretty true throughout the country ? Mr. H o r n e . To a great degree; yes, sir. I want to point out some thing that I pointed out yesterday which has a bearing on this ques tion, Congressman. Taking the industry as a whole, comparing what it was on January 1, 1966, and what it is today, the net inflow and outflow of savings, that is the total amount of inflow and outflow is about even. Now, this may interest Congressman Rees. Taking the State of California as a whole, comparing what the situation was on January 1, 1966, through April 1966, the S. & L. industry is down in California by $24.5 million. (The chairman, Mr. Patman, left the hearing room and Mr. Reuss assumed the chair.) Mr. H o r n e (continuing). So we have not had quite the reduction in the flow of money within the industry since the first of the year that sometimes we think. Mr. W e l t n e r . The situation in Atlanta then is substantially more drastic than the situation elsewhere; is that correct? Mr. H o r n e . More drastic than in some places, no more than in some others. Mr. W e l t n e r . The availability o f mortgage funds are substantially adversely affected by the widespread use of certificates of deposit; are they not? Mr. H o r n e . In Atlanta, yes, sir; this is true. Mr. W e l t n e r . Those CD’s which are causing the great trouble to the availability of mortgage money are what are sometimes called consumer CD’s, $2,500, $5,000, $7,500 ? Mr. H o r n e . Yes, sir. Mr. W e l t n e r . In California you have authorized Federal savings and loans out there to issue some kind of savings certificate or some kind of instrument similar to negotiable CD, and I assume that thai was done in an effort to permit a greater degree of competition with the CD’s offered by banks. Mr. H o r n e . Yes, sir. Mr. W e l t n e r . I understand also that there is under consideration by the Home Loan Bank Board the requests from several area associa tions for similar authorization on the part of the Home Loan Bank Board. Mr. H o r n e . That is correct, sir. Mr. W e l t n e r . I think you said you had this under consideration and possibly this question could not be properly answered at this point, but would seem to be a perfectly reasonable thing as a step of equaliz ing competitive opportunity—not quite so far as a step as eliminating the issuance of CD’s by banks. Mr. H o r n e . First, we have in the past, Congressman, given the S. & L.’s defensive measures to enable them to do this. We have under consideration other defensive measures that would enable them to do this. I think the people in Atlanta will probably be satisfied once we come out with what we have in mind. I Should also like to go a step further with the fear of Congress man Hanna and Congressman Rees may be having something to say 1 1 4 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS about it and point out that it has been traditionally so that in the State of California and one or two other places in the Far West, adjacent to California, that they have always advertised in eastern markets and otherwise advertised higher rates and used more devices to draw in money. I must say in all honesty I have not always been in accord with some of the things they have done and this is part of the difficulty— this accounts for some of the difficulty that we experienced today. But even so, there is less differential between what is available in California and what is available in other parts of the country today than there was 18 months or 2 years ago. But I think for some period of time we will have to make some special allowance for the situation that has developed in the State of California as compared to the situa tion or the difference that exists in California as compared to the rest of the country. I did want to get this point in because I think it is pertinent to the entire situation. But again, specifically, as to Atlanta, I have had a great deal of correspondence as you can imagine from different sources as regards the situation in Georgia and the practices of one or two of the commercial banks—one in particular— and we have taken this into consideration in the defensive measures that we are advocating, and I think, we in effect, are proposing some T thing that will be even a little bit more defensive, more effective than your associations have recommended. Mr. W e l t n e r . Thank y o u , Mr. Horne. Thank y o u , Mr. Chairman. Mr. R e u s s . Mr. Todd? Mr. T od d . Thank you, Mr. Chairman. Mr. Horne, I appreciate your comments and we welcome them. On page 2 of your testimony yesterday you indicated that there has been a loss of about $550 million in savings from S . &L.’s against a net outflow in April 1965 of less than $100 million last year. This is an increase in the net loss this year of $450 million which I take it you attribute to the CD practices of the banks. Mr. H o r n e . T o some degree; yes, sir. Mr. T od d . T o some degree. Would 50 percent be accountable to the CD? s? Mr. H o r n e . I should think at least that. Mr. T od d . My next question— this does not appear to follow at the moment—if I deposit $100 in an S. &L., how much of that can they loan ^ ? Can they loan out $90 or $100 ? Do they have a reserve out requirement against that ? Mr. H o r n e . We have a reserve requirement in the savings and loan industry that varies from association to association, depending on certain factors. But in answer to your question, I should think you could loan the entire amount or most of the entire amount. Mr. T o d d . But they could not, as the banking system could do—the banking system as a whole could do. If I put $100 in a savings de posit, they could loan out 25 times that or $2,500. Dr. S c h w a r t z . I think you got too big a multiplier. Mr. T o d d . There is 4 percent reserve ratio required. Dr. S c h w a r t z . That is not quite the way it works. Mr. T o d d . This is an oversimplification, but as a matter of principle this would be the case in the banking system, would it not? Then my next question is, if there actually had been a $450 million withdrawal or transfer of funds from S. & L.’s to CD’s, which also UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 1 5 have a 4-percent reserve requirement, you could have an extension of roughly $11 billion in the money supply, 25 times multiplier, you see. And this could have a severe inflationary impact because you would make this much money available. Over the course of a year you could have a $44 billion expansion in your money supply by the banks if there was no leakage outside of the banking system. It would seem to me the action of the Federal Reserve would be self-defeating. They raised the interest rates as a tight money instrument, but be cause they are able to attract funds from the S. &L.’s to the banking system they actually expanded the money supply, if in this case it is 50 percent, it would be $22 billion expansion of the money supply. This expansion has an impact on the economy equivalent to a Federal deficit, so actually, their procedure instead of being deflationary was inflationary. Do you think there is substance to this argument % Mr. H o r n e . Certainly there can be, as I indicated yesterday, some very strong argument made on the side you have presented. And certainly, I do not think anyone can say there is not some substance to what you have said though there are some technical points to be cleared up. Mr. T o d d . Thank you. You would not want to estimate whether or not the high rate interest on CD’s actually is inflationary or defla tionary, would you ? M r. H o r n e , I think it could be, Congressman, depending on sev eral factors, some of which you have indicated. Mr. T o d d . I would just like to suggest to the committee that we have a problem here of some magnitude and I think we should look at it in this context, and that is, perhaps the financial institutions are competing among themselves for money. They are establishing their policies in a competitive fashion with each other rather than working together in the establishment of policies. As a newcomer to this com mittee, it reminds me of Governor Robertson’s phrase of competition in laxity, applied to the regulatory functions of the banking agencies, where they establish different rules for the banks under their juris diction. Do you think there is any of this competition existing be tween the financial agencies at the Federal level to secure funds one from the other? Mr. H o r n e . I think today, Congressman, there is competition, not only between banks and S. &L.’s and vice versa, mutual savings banks and S. &L.’s and vice versa, but also competition among the S. &L.’s themselves with one another and among the banks with one another. Now, on the one hand, I realize as a person who believes in private enterprise, that it can be argued that this is good—based on the law of supply and demand—let the management decide for itself. On the other hand, I must say I am concerned about a rate war, I am concerned about the possible adverse effects on the whole financial structure that an unlimited rate war can inflict on the economy as a whole. As much as I believe in private industry, I think the Govern ment, when it is insuring deposit and savings accounts, and when it is trying to preserve the safety of people’s funds, the safety of banks and other financial institutions, has to exercise certain functions. Mr. T o d d . Thank you very much. Thank you, Mr. Chairman. Mr. R e u s s . We will now have an opportunity for members to pursue questions on the second go around. Mr. Fino ? Mr. F i n o . Thank you, Mr. Chairman. 1 1 6 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS Mr. Horne, you have expressed great concern and great interest about the liquidity of our savings and loan banks. You have also ex pressed great fear that the issuance of CD’s might hurt or further threaten the liquidity of our savings and loans. Yet you feel, from the testimony here today and yesterday, that the enactment of the Participation Sales Act will not have much effect on the liquidity of our savings and loan banks. Now, is it not logical to assume that all depositors or most of the depositors in the savings and loan banks will withdraw their money which pays about 4i/£ percent and buy partici pation certificates which will pay 5y2 percent ? Mr. H o r n e . Well, Congressman, for the reason that I gave a few moments ago, I am candid in saying that I do not share the fear in this area that I believe you feel. One reason is that the size of purchases under the participation program is already limited and the Treasurer has indicated it will be even more limited. Mr. F i n o . Wait a minute, you are talking about the denominations. Mr. H o r n e . Yes, sir. Mr. F i n o . If the Congress, more particularly, the House will fol low my suggestion on Monday, I will offer an amendment to cut down on the denominations so that the poor people, the little people* the small guy can participate in this financing. Mr. H o r n e . That gets back to a point that I think is quite similar in position to what the chairman expressed a few moments ago, and as I indicated at that time, my inclination is to be in sympathv with the small investor. But on the other hand, I think there are times when the small in vestor can be hurt by other considerations. In addition, as far as the 5%-percent rate is concerned, I rather doubt that very many of the small investors—some of them no doubt would, if your amend ment carries-*-would go into the participation program than would be the case if ^it is kept at 5,000 or even increased. There are other savings institutions, particularly banks with CD’s that are paying a similar rate. So for a multiplicity of reasons, I do not anticipate that, so far as the $4.7 billion that gjoes across the entire soectrum, much outflow will result from any savings and loan associa tions per se. I could be wrong. Mr. F i n o . It is anticipated that there will be participation sales to the extent of $8 billion within 2 years. * telieve that if the amount should be increased the $4.7 billion figure congressional approval would have to be ob tained. I think I am right on that. ^ m ° m^ assume yes. How much longer do vou think i>i*e^fury ^e able to sell 4.5 percent Treasury bonds to the public that will have an opportunity to make 5.5 Treasurv bank participations? J^9RNE- I suppose the Treasury would be more of an authority wv 1 1™ no,t ^ y in g to evade your question. f, f - ' T lunkm g of the little guy, the little fellow, who is on the savings bond program , having a certain amount deducted every Jn < ^ p a y c h e c k ™ order to buy savings bonds, mdo you thm k th at it is fa ir th a t he should be straddled—if he is pa UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 1 7 Mr. H o r n e . A s I said?Congressman, I think that there are certain circumstances under which this will not necessarily be an unreason able situation. Now, the man who is getting 4.15 for his bonds, he can turn them in if he wants to and already he can go to a savings and loan association or to a bank and get a higher return than the 4.15. I realize a lot of us, including myself and no doubt many, many other people buy the sav ings bonds because of patriotism. I just do not see myself, and I am admitting that I can be wrong, that under the program as it is pres ently constituted and presently being explained, that there is going to be any sizable outflow in this particular area from savings and loan associations. There has not been so far. Mr. Fino. It is hard to follow your logic and reasoning because it is happening with the CD’s. Everybody is getting excited because we have an opportunity to make more money on these. Mr. H o r n e . Well, there is a fundamental difference in practice. I know that within time the participation program, if Congress should approve it, would become more widely known. It would become more widely accepted. I think it is the great amount of advertising, just every day in newspapers, radio, television, and other sources that has resulted in so many people being rate conscious between one savings and loan association and another and between savings and loan associ ations and the ability to go to banks and to buy CD’s. That is another reason then that I believe that there will not be any great influx into the participation program from the savings you are now talking about because the saver just does not have the familiarity and understanding and acquaintanceship with it. Furthermore, the typical security buyer goes into this area. Mr. F i n o . Y o u are telling us then that it is not the little guy but the fat cat that is going to benefit from all this interest rate rise? Mr. R e u s s . I would ask his question, Mr. Horne. I believe your proposed remedy for the disequilibrium we now have in banks and sav ings and loan associations, as a result of the certificates of deposit, is to make illegal or give the Federal Reserve power to make illegal, the smaller amount certificates of deposit so that those presumably would tend to stay in the savings and loan system, is that correct ? Mr. H o r n e . Yes, sir. Mr. R e u s s . I have been concerned at the extra inducement to banks to issue negotiable certificates of deposit contained in the fact that they only have a 4-percent reserve requirement as opposed to the 16percent reserve requirement generally for demand deposits. Would it be useful either by itself or as a supplement to the amend ment you suggest, to increase or direct the Federal Reserve to increase the reserve requirement of negotiable CD’s? Would this not make them less irresistibly attractive to banks, since the banks would not want to pay as high an interest rate as they now are paying, and thus leave more of the money in the savings and loans ? Mr. H o r n e . I was quite intrigued, Congressman, with that thought when you first suggested it I believe, several weeks ago. It does seem to me offhand, it would have all the effect that you anticipate it would have. Mr. R e u s s . Can you see anything wrong with that ? Mr. H o r n e . From my understanding of it, no, I do not. 63-496— 66------- 9 1 1 8 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS Mr. O t t i n g e r . Will the gentleman yield ? Mr. R e u s s . I will yield. Mr. H a n n a . I w a s a s k in g y o u t o y ie ld o n t h a t p o in t . Mr. R e u s s . I will yield to Mr. Hanna. Mr. H a n n a . I think if we bring into focus then the colloquy you just had with the gentleman and with his comments previously and then relate it to the bill, I would ask, is it not true, then, that insofar as this legislation is concerned that you would be much more readily in support of a bill which directed itself to both negotiable and non negotiable CD’s, No. 1? Mr. H o r n e . Yes, sir. Mr. H a n n a . That addressed itself to the size of those CD’s and, No. 2, in that regard, would you not say that we would be on his torically firm ground if we struck a $10,000 figure in recognition of the deposit situation and then if your answer is affirmative to that, would not No. 3 be the matter of the time of the CD’s, because if we are concerned—this may not be your concern—but if we are concerned about the point you made which was the rollover requirement of these CD’s, that the banks should not make these short term. They should not be 30 days because then that is when they have to be rolled over. That brings us to the fourth point which Mr. Reuss makes, and that is, that the reserves behind these ought to be part of our considera tion. So I think we have four points here, Mr. Chairman, that you have brought out in this hearing. That is, that w e n e e d t o consider both negotiable and n o n n e g o tia b le . We should consider the size, time, and finally, the reserves b e h in d them. Is that a fair assessment of it, or do you think—where do you think the legislation on it reasonably ought to go? Mr. H o r n e . In my opinion there is. I say this with due regard and much sympathy with the point of view that has been expressed by the chairman of this committee and by Congressman Fino. Also, I would say that what one saver or investor can or is willing to do may justify his getting more than someone who will do less. I say it reluctantly, but I also say it candidly. I should also like to suggest that if this committee should come up with such legislation, that they include in it the time deposit open account, otherwise there would be a loophole that you would not intend to permit. Mr. R e u s s . I will yield also to Mr. Ottinger. Mr. O t t i n g e r . I would like to express my agreement, Mr. Chairman, with your approach to requiring reserves behind these CD’s that are somewhat comparable to demand deposits. They are comparable to deposit mansize. I would like to ask the witness whether, if we put such a r e q u ir e ment for reserves he thinks it would be necessary, as Mr. Hanna points out, to require a time for maturity of these deposits and if so, what time he would recommend ? Mr. H o r n e . Again, I am not trying to avoid answering your q u es tion. It seems to me it could be 6 months, it could be a year. Cer tainly, it is my opinion that 30 days is too short a time. Ninety days would be questionable. Six months or a year it seems to me would be more appropriate. Mr. O t i t n g e r . I f you have a reserve requirem ent is it necessary as well to have a tim e lim itation f UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 1 9 Mr. H o r n e . The reserve would mitigate it to a degree but you may still want to impose other requirements; yes, sir. Mr. O t t i n g e r . Thank y o u , Mr. Chairman. Mr.R e u s s . Mr. Gonzalez? Mr. G o n z a l e z . I have some questions that are not exactly in point here, but they are related. They have to do with information that I would like to obtain. T hat is the picture with respect to the savings and loan movement ? V Is it growing or is it fairly static ? Has it stabilized ? Mr. H o r n e . Perhaps some figures, if I recall correctly, would an swer your question, sir. At about 1947 the savings shares, savings accounts in savings and loan associations amounted to about $8 bil lion. Today these savings amount to about $110 or $111 billion. The growth has come most rapidly, and I should be very pleased to supply this committee with the year-by-year growth in any period of time you might want it. I just do not recall them offhand. The growth has come most rapidly in the 1950’s and late 1950’s and early 1960’s and even in 1965 the net growth, if I recall correctly amounted to about $8.4 billion. It is true that so far in 1966, again, making a comparison between what the size of the industry is in January 1,1966, and today, it is just about even. So for all practical purposes in 1966 it is not growing much. We are hopeful and believe that later on this year, and particularly if there is some restraint in CD’s—I want to point out again that CD’s are not the only source competing funds as far as S. &L.’s or other thrift institutions are concerned—they will grow at a reasonable rate. Mr. G o n z a l e z . What about the number of institutions? Are new ones getting chartered ? I mean on the Federal level ? Mr. H o r n e . Here again I do not recall the exact figures, but gen erally speaking, the growth in the number of new institutions, both State and Federal I think has been quite moderate, quite conservative, and while we continue to get some applications we do not get an over whelming number and we look very carefully at the ones we do get, both as to insured accounts of newly chartered State associations and as to chartering Federal associations. Mr. G o n z a l e z . I s i t r e la t iv e ly e a s y o r m o r e d iffic u lt to c h a r te r a n e w o r g a n iz a t io n ? Mr. H o r n e . I would say it is more difficult today than it was a few years ago. Mr. G o n z a l e z . In other words, they are getting like banks. What about your advisory groups? I notice when I pick up a newspaper and find out that somebody from a district has been appointed to the Little Rock board or something—would you mind explaining the pro cedure there ? Who picks these citizens $ How do you arrive at who is going to be an adviser? Mr. H o r n e . I believe, Congressman, that you are referring to perhaps two areas. One has to do with the fact that each of the 12 banks has a board of directors. In each of these 12 banks, two-thirds of the board of directors are chosen by the savings and loan associa tions themselves and one-third, what we call public interest directors, are appointed by the Federal Home Loan Bank Board here in Wash ington, 120 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS In making our choices we carefully try to choose people who are outstanding citizens, either in the business world or in the academic world or in the professional world and we carefully try to choose people who have no conflict of interests whatsoever with the savings and loan industry. Our system in this regard is a little bit different from that of the Federal Reserve Board. In the Federal Reserve Board of Directors in each of the 12 banks, about two-thirds are non industry members. Whereas in our system about two-thirds are industry members. But this I believe answers your question in one area of advisory assistance. Now, in addition to that, we have what is by statute, what we call a National Advisory Council. On tine Council each of the 12 boards of the 12 banks select 1 member and then the Federal Home Loan Bank Board appoints 6 members. In addition to that, we get advice in every mail. Sometimes almost by the wheelbarrow loads from industry members themselves which we try to read and try to weigh carefully. Then we constantly meet with members of the industry, either at the State level or at the district bank level and then in addition to that there are trade associations and the trade associations frequently request, and are always granted an opportunity to forward to the Board and to talk with the Board and advise the Board about problems within the industry. So I think I could honestly say there is no operation in the Federal Government that gets more advice from more different sources than the Federal Home Loan Bank Board gets. Mr. G o n z a l e z . Thank you. Mr. R e tjs s . I see our distinguished colleague, the gentleman from California, Mr. Holifield, is in the hearing room and knowing of his interest in monetary policy in general ana savings and loan associa tions, we will welcome his sitting here with us and directing any ques tions he may have as a witness. Mr. H o l i f i e u ) . No questions. Mr. R e u s s . Mr. Ottinger? Mr. O t t i n g e r . I would like to insert in the record a lead article on the financial page of the New York Times, May 10,1966, concerning the warning issued by Frederick L. Deming, Under Secretary of the Treasury for Monetary Affairs about the seriousness of the situation confronting the savings and loan industry by the use of these certifi' cates of deposit. Mr. R e u s s . Without objection, it will be admitted. (The article referred to follows:) [From the New York Times, May 10, 1966] D e m in g Ca u t i o n s o n Bn* fob F u n d s — A g g ressiv e B a n k B e h a v io r i n F i g s ? fob T im e D e p o s it s A s s a il e d b y U.S. A m — W a r n in g F lag I s R a is e d — S ome I n s t it u t io n s A be S e e n O vere x t en d in g a n d T a k i n g o n E x c e s siv e R i s k s (By Edwin Ii. Dale, Jr.) May 9.—Frederick L. Deming, Under Secretary of the Treasury for Monetary Affairs, warned today against “overly aggressive behavior on the part of some banks in competing for time deposits/' Mr. Deming raised the warning flag in a speech to the Society of American Business W riters in Minneapolis. The text was made available here W a s h in g t o n , UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 2 1 He said the aggressive bidding for time deposits “may tend to distort the im pact of monetary policy, impairing the stability of particular institutions and even of some sectors of the economy.” It could also “induce some banks to overextend themselves and take on ex cessive risks” in their lending, he added. Pointing out that the “increased cost of time deposits has placed many banks under pressure to seek higher yields and more loans,” Mr. Deming continued: “Even where loans are sound, banks may get burned in their bidding for time deposits. If funds can be bid away from other institutions by a particular bank, that same bank may find itself losing deposits a t a later date to a still more aggressive institution. POSSIBLE RESULT “The result may be a bidding up of time rates—not because funds can be em ployed profitably, but because funds are needed to meet current demands or to replace funds that were bid away by other institutions. In tight financial mar kets even the liquidation of good assets can be painfully expensive,” he said. Mr. Deming also said that “other financial institutions may be more vulnerable than banks to a sudden loss of funds.” He warned banks paying high rates on time certificates of deposit running 9 months or more into the future that “interest rates on loans can go both ways, and the commitment to pay high rates for a long period may prove to be risky and unprofitable.” A “more cautious” lending policy by banks “will not only be in the public interest but in the interest of the individual banks in question,” Mr. Deming said. He cautioned also that “when financial market pressures diminish, then time deposit rates—particularly those on savings accounts—may prove to have some downside rigidity.” It may be difficult, he said, “for individual institutions to lower rates unless they have some confidence th at others are similarly mo tivated.” Mr. Deming's warning came a day after the Federal Reserve and the Federal Deposit Insurance Corporation announced a joint survey of the “rates and terms” that commerical banks are offering to pay on time and savings deposits, and on changes In the flow of savings funds. The Federal Reserve made a similar study earlier in the year, which came to the conclusion that banks have made only “moderate” use of their present ability to pay up to 5% percent interest on savings deposits. In a wide-ranging speech the Under Secretary also touched on the outlook for Treasury debt management in the period ahead. He said, “We expect to get by with a minimum of cash borrowing over the next 14 months.” Allowing for increased sales of Federal assets through “participation” and for the regular sales of securities of Federal agencies other than the Treasury, and also allowing for offsetting absorption of some Treasury securities by the Federal Reserve System and Government investment accounts, Mr. Deming said the net demand of the Federal sector on the private credit market “should be under $3 million during the present fiscal year and approach zero during fiscal 1967.** Mr. O t t i n g e r . I would like to ask y o u a few questions on a slightly di fferent tack, Mr. Chairman. You recently issued a regulation to your banks which I understand restricts very much the advance commitments which they can make. I believe it was for 4-month repayments. Is that correct f Mr. H o r n e . Y o u mean—I think you have reference to the April 20 letter in which we called attention through the bank presidents to the individual savings and loan associations that after—we try to help them take care of through the cash window, the commitments they have already made and the withdrawals they may experience, that they should go very carefully—should act very cautiously on future commitments. Mr. O t t i n g e r . Y o u suggest specific restrictions on forward commit ments. Mr. H o r n e . Yes, sir . 122 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. O t t i n g e r . Would you supply that for the record, please? Mr. H o r n e . Be g la d to . (The letter referred to follows:) F ed er a l H o m e L oan B a n k B oard, W a s h in g t o n , B .C ., A p r i l 2 0 , 1 9 6 6 . T o th e F e d e r a l H o m e L o a n B a n k P r e s id e n ts : You are all weU aware of conditions prevailing in the economy and the savings and credit markets. These conditions dictate policy responses by both the Federal Home Loan Bank System and all its member institutions. The objec tives of the System obviously remain unchanged, and the capacity of the System to achieve those objectives remains unquestioned. Nevertheless the objectives do require changes in procedures as economic conditions change. In the light of the current situation we call to your immediate attention, and request that you point out to your respective regional boards of directors, and to all your member institutions, the following major policy item s: 1. Current policies governing withdrawal advances should remain unchanged. 2. Member institutions should carefully regulate and control their outstand ing commitments, including undisbursed loan proceeds, to levels not exceeding the total of the previous calendar 4 months loan repayments plus or minus their realized savings gains or losses for the same past 4 months. Moreover, if the judgment of the board of directors of an individual member institution indi cates a probable reduction in the coming period of loan repayments, or a reduc tion in savings inflow, such judgments should promptly be reflected in a working down of such outstanding commitments. For all future commitments executed from this date forward management cannot expect the advance window to be ever open if management itself has failed to gear its commitment level at its actual cash flows. 3. Expansion advances are not to be used as permanent additions to capital. Such advances are to be utilized only for seasonal needs and to cover commit ment requirements that have been maintained a t realistic levels but where unexpected, adverse, reduced cash flows have developed. of all regional banks are expected to examine each advance application m prudent detail. Previously estabUshed lines of credit certainly do not preclude such examination, nor acceptance, rejection or modification of the , ™ s is especially true of expansion advances. ParS tL w ? glven t0 the Precise purposes of the proposed advance pflnni)nll 5 properties and transactions for which the funds are sought * vpnt^roH v® nc€s should not be employed to finance highly speculative ^h would co:ntnbute to excesses in the housing inventory; to f in a n c e morteaees onallU^ i Af other.re?Idential Property; or to refinance existing ? all types of property m substantial volume. e x D a n s io n +.Utt a rePortlng Procedure to test t h e c o n f o r m a n c e of > e x p a n s i o n advances to t h e f o r e g o i n g p r i n c i D l e s Sincerely, ' Jo h n E. Hobne, C h a i r m a n . i f u r t h e r aggravate the situation with of fm+W rLf™ ? mortgage money, because a great deal Li restraint on, the building industry’s ability to proceed, hence? ' ^ eS *n building market some 6 or 9 months t a U ^ t h ? ^ m n n n ? r t ^ ^ f SSmal!L U^1^ u e^^o n a b ^ , t h i s w o u ld s e r v e to curD u r^ s S i ^ l o t t]?a t ,COuld G a i n e d f o r h o m e b u ild in g fE L S S S £ b ai? s t h a t c ? m p o s e t h e b a n k s y s te m . B u t I throm rli th n ^ u n w is e ly i f w e a tt e m p te d t o m eet ^ f o X ^ S I,gp‘56poLt a k r unIimited m n e w d illo J h S 'u T ld ta J * 4* 8068 further * “■ i»* * > t °f UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 2 3 have now where the savings and loan institutions in my area say that they cannot make any new commitments at all with the combina tion of restraints imposed on them by the shortage of funds caused by the deposits and your new regulation. They say they are just out of business----Mr. H orne, I am just being perfectly candid in saying that I think we would be making a mistake for several reasons which perhaps you might want me to talk with you privately about, if we attempted to meet all the demands through the windows. The 4 months’ repayment is a normal level—Dr. Schwartz may want to speak more specifically on this. Mr. O t t i n g e r . I do not say that this ought to be unlimited, but I wonder if the combination of these two things together, the complete shortage of funds through the draining that is taking place as a result of these certificates of deposit, and this regulation coming on top of that, if you were not iust calling building to a halt all over the United States. Mr. H o r n e . We are weighing this and keeping in touch with it as much as we can. I am sure that you also recognize that there are other people going to the market for money, also, including the U.S. Treasury. Then, as I pointed out also-^— Mr, O t t i n g e r . Why should the building industry take the total brunt of this ? Why should not that be equitably distributed through out the economy ? Mr. H o r n e . I think it is; I think we are being treated fairly gen erously as to what we are allowed to go to the market for. Where the squeeze comes, the flow of savings is not going to the S. & L.’s themselves and this gets back to the CD problem which is one of the problems this committee is looking at and other sources that compete for funds. Sir. O t t i n g e r . H o w long a period do you contemplate that this reg ulation would remain in effect ? Mr. H o r n e . I think it will depend to some degree on how long this present tight money market continues. I think it would also depend to some degree on what the Treasury’s needs have to be. I am sure everyone recognizes that all of us, to go to the market, have a co ordinating mechanism that is used because if each of us went to the market separately and independently and willy-nilly, we can produce chaos. Mr. O t t i n g e r . I would like to express m y concern over the degree to which the building industry is required to bear the brunt for the tight money situation. I would like to see the Board reconsider the situation. Perhaps we can alleviate it through the regulation of certificates of deposit. In the meantime, the building industry itself is asked to share the burdens of tight money to a greatly disproportionate degree and that you as the supervisor over the savings and loan institutions which supply the majority of the building money ought to be partic ularly concerned about this and not get walked over. Mr. H o r n e . I a m in sympathy with what you are saying. May I make a brief remark about it? I am sure you realize it is not our policy, the Federal Home Loan Bank Board, that has brought 1 2 4 UNSOUND COMPETITION FOR SAYINGS AND TIME DEPOSITS about the squeeze. We are in sympathy with the associations in the industry and we want to be as helpful as we c a n . In trying to be helpful we also have to weigh the fact that there are other things that may have to take priorities over expansion of build ing. Then also, I think I should point out again as I pointed out yesterday, that individually, savings and loan associations are getting a quite substantial number of dollars through repayments and interest on loans outstanding. So it is not that they have no money at all. They have much less than they used to have, this is true. Just because an association—this is another point that I would like to emphasize—an association does not have money to commit for the future does not reflect on its soundness. If an association does not have the money to commit far into the future, it can be just as sound as any of Uncle Sam’s dollars. Erroneously, some people have thought that because some of the associations cannot make a commitment down the road they are in extreme financial difficulty as far as safety and security is concerned, and this is not the case at all. I know you did not ask me the question on this point, but I wanted to add this while I am answering. Mr. O t t i n g e r . The nature of the building industry, though, re quires that they have to be able to anticipate the mortgage money that is available and well in advance of the time the actual building takes place. I have had two large associations in my area say they are finished as far as the future is concerned because of the tightness of the regu lation. Mr H o r n e . Unquestionably this is one of the difficulties that the homebuildmg industry always has and that is, the peaks and valleys as to the availability of funds and this is one reason why Congress on many occasions to provide some help in t h i s area has a p p r o p r i a t e d funds to FNMA. r Mr. O t t i n g e r . I would hope that you w ’ould take a look at this be cause I do not think that the building industry should be made to disproportionately bear the burdens of the tight money policy or the requirement of the Federal Government to go out for money on the market. I think it is going to be definitely aggravated by the Par ticipation bales Act we are embarking on. That is going to make the situation more difficult for the building industry. Mr. H o r n e . Let me say again------O t t i n g e r . I do not see why we should be unreasonable about is. Ihere should be some balance there and you are the logical person to protect your area against the opportunism of the T r e a s u r y Tx administration or whatever it may be. Mr. H o r n e . I want to say finally again, we do not have the unlmited power to make up this gap and I w ’ould not want to m is le a d the committee into thinking we do have it. Mr. O t t i n g e r . I appreciate that and perhaps the real force of my comments is not directed against or toward you, Mr. Horne, but rather the people who are setting these policies. I do think a really se r io u s situation m the balance has been created here. I would hope that you would do what you can to see that this is rectified. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 2 5 Mr. H o r n e . I shall, because I spent a lot of my life doing things that I thought and I think would enable people to own their own homes. That is still my wish. Dr. S c h w a r t z . Congressman, I think the Chairman covered the point rather well when he said the Board or he did not have the final authority in any of these issues. We are confronted by the money and capital market which has just become very, very tight. The Board’s role in this is marginal. The Board does not control the flow of sav ings which has created the situation that has led many institutions to withdraw from the market—not just the savings and loan associations, but insurance companies and banks are moving away from the market, too. You have everybody moving away from the market simultane ously. In past periods, when this has happened, the market has not been so tight that the Board could not step in and lend some assistance. But in this situation, it is so tight that combined with the change in the flow of savings, the impact on the Board for funds is such that there has to be some restriction on the lending though not complete restriction. I think the letter is being misinterpreted. The basic point is that we are in a market economy and the market does impose constraints. The other side of the coin—I think it was Mr. Harvey who raised the question about mortgage rates coming down. From 1961 to most of 1965 mortgage interest rates did come down, and actually builders were in a very favorable position as far as getting commitments were concerned. Savings and loan associations, commercial banks, insur ance companies, and mutual savings banks were all flooded with liquid funds and there was not enough demand from other sectors to absorb it and the mortgage market was heavily favored. Now, we have a reversal of this situation. I would like to be able to say that it is temporary, but I think it would be a little imprudent to go that far out on a limb. Mr. O t t i n g e r . Thank y o u , Mr. Chairman. Mr. R e u s s . Mr. Annunzio ? Mr. A n n u n z i o . I yield to Mr. Rees. Mr. R e e s . Just one question, Mr. Chairman. We have a problem m California and I think in most States where savings and loan institutions are losing money. People are walking in, giving them the passbooks and say, “Please let me draw on my account,” and they get five and a half percent. In about 3 or 4 weeks they are going to buy some of the Federal Home Loan Bank deben ture notes to take care of withdrawals of institutions that are re stricted to 4.85 percent. If you issue this security you are going to have to issue a lot of them to shore up all the savings and loans throughout the Nation so that they could meet their withdrawals if they are limited to 4.85. You are going to have to go out in the open market and compete for that money. bWould it not be a lot easier to allow the savings and loan institu tions to do some competition of their own to allow them a higher interest rate? Would it not be easier to tell the institutions, you can go to 51/2 percent if you want ? Then the FHLB will not have to go 1 2 6 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS o u t in th e o p e n m a r k e t a n d s e ll se c u r itie s. O u r n a tio n a l d e b t d o e s not g o u p b y th a t a m o u n t a n d th e n y o u a re n o t c o m p e t in g a g a in s t other ty p e s o f G o v e r n m e n t se c u r itie s w h ic h see m to b e in t h e m a r k e t to d a y . Would it be a lot easier to allow a kind of restrictive free market where a lot of savings and loans go up to hy2 percent just as the banks are doing in terms of CD’s? There would be less pressure on you and you would reverse the withdrawal trend. Not only would they not be going to you for more money, but they would find that they would have more money in terms of savings coming in and there fore they would be able to save some money on the mortgages. Do you not think it would be a lot easier this way than going through all this rigamarole issuing new Government paper? M H o r n e . Let me make, if I may?sir, very respectfully, three or r. four comments to your very good question. No, 1—this is repetitious—if you compare the savings deposits in California associations at the end of April with what they were around the beginning of January, there is a $24 million decline. No. 2, W the Board did early in the year to enable them to meet ’hat the competition that the increase by banks, particularly when the Bank of America went to 5 percent, was based primarily on what many of the California associations at that time recommended. They were not in agreement as to wiiat they thought the Board should do, as to what kind of defensive mechanism they thought the Board should grant. & No. 3, since we took that move and with further exploration down the line we are now on the verge of providing more leeway than they presently enjoy. J I want to reiterate that we have to bear in mind that we must take a responsible position. Looking at the industry as a whole, that when wb allow for differences among areas we have to keep in mind what adverse effect it might possibly have-not only on some other Caliornia associations, but across the country as a whole. I am sure that Congressman Weltner’s comments did not escape your obser vations a few moments ago, and I might say in complete honesty, that •is and world!5 of criticism heaped on the Board of what Calif?™a as compared to other parts of the country. at most of the money that comes from u i r m l fi011? ^ m i ,system, goes to California associations. f! P01” ^ is not a C alifornia association today that ^ ■ l m V ? suggested, provided th at he undermonev fnr 80 couW not go to the cash window and get H W n if ?n Pu rP?ses- He can still get money to meet with h e ld ^ simply would not be able to get his money to go out and 52 h e ^ ^ 40 What he is by Paying whatever T ^ •? coimecte.d with what another Congressman— forgotten who it was—said that we were being criticized he- “ w to ^ th' B°ard “ “ rtain P,,CCSl* +, a rA H ^ K.A- W ould the gentleman yield fo r a moment? I think ^ th a t the Chairm an answered very honestly in term s of this p r o b le m , UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 2 7 but I should like to put in the record at this point to make your answer more, I think true, of the situation—the answer to this question: How much money was asked in advances to meet withdrawals in the first quarter? Mr. H o r n e . Dr. Schwartz will give you the answer to that. Dr. S c h w a r t z . For the month of April, I will answer that where we have solid figures and where my memory is better. Mr. H a n n a . Does $500 million appear to be it ? Dr. S c h w a r t z . From March 28 through the other day we have put out about $900-some-odd million. Some of that is expansion money to take care of commitments that were on the books. Mr. H a n n a . A large portion is withdrawals ? Dr. S c h w a r t z . A large portion is withdrawals. I would say two-thirds to 75 percent of that is withdrawals. We do not ask the banks to give us a purpose analysis of the advances. But we do get some indication from them when we have this size with drawal and we ask them just to give a rough summary and this is what the summary indicates. For the year as a whole, advances are up sharply. I would say they are up considerably more than they were last year at this time, and this is due to the fact that the savings inflow in the first quarter, particularly outside of California was unfavorable. In fact in Jan uary and February, the California associations, particularly in Jan uary, the California associations looked pretty good against tlie rest of the country. Mr. H a n n a . A s an a v e r a g e ? Dr. S c h w a r t z . Altogether, and I think individually with some few rare exceptions. Mr. H a n n a . Would you provide for the record the actual with drawals. the advances from withdrawals in the State of California? Dr. S c h w a r t z . We would have to get a special analysis on that. Mr. H a n n a . I want to find where it really is here. If you figure on the average it is like talking about a pool that has a 10-foot depth, but if you talk about the average you figure there is safety, sure, be cause nobody is going to drown in 6 inches of water. Dr. S c h w a r t z . Until March 28 I do not think there w a s a with drawal problem in California. Mr. H a n n a . These are figures we need to have along with the averages. Dr. S c h w a r t z . We will supply the information you request. (The information requested follows:) A d v a n c e s m a d e b y p u r p o s e s , F e d e r a l H o m e L o a n B a n lc o f S a n F r a n c i s c o Month January............. . „ ................................................. February......... .......................................................................... March. .. April.................... .......................... Total......... .............. .................................................... Percent of to ta l.............. .............................................. . Withdrawals Other purposes $ 3 3 ,3 5 2 ,6 0 0 $ 6 1 ,3 2 3 ,0 0 0 $ 9 4 ,6 7 5 ,6 0 0 6 ,0 8 7 ,5 2 8 1 0 ,1 0 5 ,0 0 0 4 7 0 ,0 2 4 ,2 0 0 5 4 ,7 8 7 ,3 5 7 1 0 6 ,9 9 2 ,0 0 0 1 0 1 ,7 1 8 , 0 0 0 6 0 ,8 7 4 ,8 8 5 1 1 7 ,0 9 7 ,0 0 0 5 7 1 , 7 4 2 ,2 0 0 5 1 9 ,5 6 9 ,3 2 8 3 2 4 ,8 2 0 ,3 5 7 8 4 4 ,3 8 9 ,6 8 5 6 1 .5 3 8 .5 1 0 0 .0 Total 1 2 8 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS M r. R e u s s . If th e r e a re n o fu r t h e r q u e stio n s w e w a n t t o t h a n k ou r w itn e s s e s f o r t h e ir p a tie n c e f o r b e in g w it h u s 2 d a y s. We will not stand in adjournment until the call of the Chair. It is anticipated there will be heard witnesses from the Treasury, the Comptroller of the Currency, Federal Deposit Insurance Corpo ration, Federal Reserve Board, National Association of Home Build ers, and the American Bankers Association. We will now stand adjourned. (Whereupon, at 12:10 p.m., the committee adjourned, to reconvene subject to the call of the Chair.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS THURSDAY, MAY 19, 1966 H o u s e o r R e p r e s e n t a t iv e s , C o m m it t e e o n B a n k i n g a n d C u r r e n c y , Washington, D .C . The committee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Wright Patman (chairman) presiding. Present: Representatives Patman, Multer, Mrs. Sullivan, Ashley, Moorhead, St Germain, Gonzalez, Minish, Weltner, Grabowski, Todd, Ottinger, McGrath, Hansen, Annunzio, Rees, Widnall, Mrs. Dwyer, Halpern, Harvey, Brock, Clawson, Johnson, Stanton, and Mize. The C h a i r m a n . The committee will please come to order. Today the committee is privileged to hear the Secretary of the Treasury, Hon. Henry H. Fowler, testify on H.R. 14026 and other measures to control the use of certificates of deposit. As the chief financial officer of the executive branch of the Govern ment, Secretary Fowler has a special responsibility for assessing new financial developments such as the negotiable certificate of deposit. This is particularly the case where there are strong reasons to conclude that the negotiable CD is adversely affecting the Treasury bill market, making more costly to the taxpayers the carrying charges on the na tional debt. Economical debt management is, of course, a primary responsibility of the Treasury Department. Only recently, the ad ministration was forced to seek an unexpected appropriation of threequarters of a billion dollars just to meet extra interest costs for fiscal 1967 over 1966. Interest rates on both long-term and short-term Treasury obligations are at near-record highs. We have a graph prepared on the basis of information furnished by Treasury which indicates a definite relationship between the ceiling that member banks may pay on time deposits—including the nego tiable CD—and the Treasury bill rate. Perhaps the Secretary will also elaborate upon a memorandum furnished the chairman by Treas ury staff last February which only indirectly answers the question of the influence of CD’s on Treasury bill rates. In this connection, it should be noted, .according to a recent Securities and Exchange Com mission report as well as from many, many unofficial sources, that there has been a substantial shift of corporate cash out of the Treasury bill market and into the negotiable CD market in New York—over $2 billion just last year. We would also appreciate a progress report on the joint TreasuryFederal Reserve study of the U.S. Government securities market, I 129 1 3 0 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS understand that one of the main purposes of this study is to investi gate the competitive impact of CD’s on Treasury securities. We are aware that very recently the interest rate on Treasury U E” bonds was increased to 4.15 percent. While deploring the rise in the cost of debt management, we are glad to know that the Depart ment has taken steps to reduce differences in rates between marketable and nonmarketable Treasury bonds which discriminate against the small saver. We are also interested in a report from the Secretary of the Treas ury on the accomplishments of the Coordinating Committee on Bank Regulation, for which Mr. Fowler is responsible to the President— the members being Chairman Martin of the Federal Reserve Board, Chairman Home of the Federal Home Loan Bank Board, Chairman Randall of the Federal Deposit Insurance Corporation, and Comp troller of the Currency Saxon. The purpose of the Coordinating Committee is to avoid serious disagreements among the various finan cial supervisory agencies. As regulation Q is essentially a bank super visory instrument, we would appreciate hearing what the role, if any, the Coordinating Committee played in the amendment raising regula tion Q last December 6. (The following material was submitted by the Treasury Depart ment:) J 1 T h e I nfl u enc e of N egotiable C e e t ific a t e s of D e p o s it on T r e a s u r y B il l R ates As Chairman Patman has indicated, the Treasury staff memorandum pre pared on an earlier occasion for the House Banking and Currency Committee did not reach definite, quantitative conclusions as to the effect on Treasury raI> development in recent years of the negotiable ^ certificate of deposit. The Treasury agrees that Chairman Patman's question is an important one, but it is also a very difficult one to answer in precise terms. For that reason, the staff memorandum was largely limited in its scope to a review of the hisn^°tiable certificate of deposit a s a m o n e y -m a rk e t instrument. Further study of this and other influences on Treasury borrowing ai t? ougl? U is doubtful that the exact influence of the i negotiable certificate of deposit can ever be isolated with great accuracy. np^ H .hir0U f*«P?ear^ * * *eason t0 thieve that the rapid growth of the negotiable certificate of deposit may have exerted some upward pressure on S T T biU “ of tbe current expansion In the absent* of the development of the negotiable certificate of deposit corporate and rfv^w ie^ip?rarily in exc?ss of current requirements would probably have m lar?e* ?“ ?unts m t 0 short-term Treasury obligations, as well as other money-market instruments. This in turn, might have contributed to some easing of short-term Treasury rates in the absence of offsetting monetary or debt management action. In addition, more U.S. funds would probably have fr ^ th e r m?rket. which r e iv e d much of its initial impetus vw S n o I i°W * deposlt rates Payable in this country. Indeed, in v i e w of the U.S. balance-of-payments situation, short-term interest r a t e s — on Treasury bills and competing market instruments—have orobablv hp*m no higher during most of the current expansion than would taveb len ^ u ired U n I S S 2 . very^w e^uU ^w it^other'flM 0 J 8. asf.I,st^ commercial banks in competing 1® enabled^anks tn ^ l?S ft‘tutl<ins for short-term funds and has -£L * ^ W t. i g o* these funds into loncer term uses In >w* ’ ,a s M r a derfrable r e S desirable results. “ rat! S°mpetition “ ““ S the commercial ^ of deposlt would necessarily lead to Recent experiences-partlcularly since about the middle of UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 3 1 196o—suggests that overly aggressive competition for a limited pool of short term funds can carry rates sharply higher. This not only tends to pull up Treasury short-term borrowing costs; it may also narrow or erase the margin that banks have made use of in borowing short and lending long, thus removing the influence of CD growth as a factor tending to hold down long rates, and possibly contributing instead to an upward influence on long rates. P rogress R eport on J o in t T r e a su r y -F ederal R eserve G o v e r n m e n t S e c u r it ie s M a r k e t the U.S. S tudy of the This study was launched on March 1, 1966, with the broad purpose of ascer taining how the dealer market for U.S. Government securities has evolved and performed in the 1960’s in light of economic developments during this period. Part of this picture involved certain innovations affecting the financial processes. They would include certificates of deposit and the greatly enlarged Federal funds market. The joint study is being carried out by staff analyses, several of which are underway and are expected to be in first draft by midsummer; through question naires to U.S. Government security dealers, which have been distributed; through questionnaires to various investors in the market, which are being prepared; and through conferences with active market participants which are to be scheduled around midyear. The steering committee for this study will draft a report analyzing this material when it bcomes available. A c c o m p l is h m e n t s of t h e C oordinating C o m m it t ee M a y 25, 1966. The Coordinating Committee, composed of the Comptroller of the Currency and the Chairman of the FDIC, FHLBB, and Federal Reserve System, has pro vided a valuable forum for discussion of supervisory problems and other matters affecting financial institutions. Meetings have been held at approximately monthly intervals since the group was established last July. Formation of the Committee followed through on the suggestions made by President Kennedy’s Committee on Financial Institutions in April 1963 and President Johnson's suggestion in March 1964 for additional exchanges of information among bank regulatory agencies. While the Coordinating Committee did not play a role in the decision to change Federal Reserve’s regulation Q last December—this was the decision of the Board of Governors of the Federal Reserve System—several meetings of the Committee have been held since the December change in regulation Q in order to appraise the effects of that change on the competition for savings and to dis cuss further actions that might be desirable in light of those developments. The C h a ir m a n . Mr. Secretary, we are very pleased to have you as our witness today and you may proceed in your own way. Do you have a prepared statement? Secretary Fotor. I do, Mr. Chairman. STATEMENT OF HON. HENRY H. FOWLER, SECRETARY OF THE TREASURY; ACCOMPANIED BY PETER STERNLIGHT, DEPUTY UNDER SECRETARY FOR MONETARY AFFAIRS; AND FRED B. SMITH, GENERAL COUNSEL Secretary F o w l e r . Mr. Chairman, in my prepared statement I have addressed myself rather narrowly to the bills before this committee which in different ways would affect the acceptance or issuance of time deposits by insured commercial banks. I will not cover in my prepared statement today other matters which are of a broader na ture or which you solicited some comment in your opening statement. 132 UNSOUND COMPETITION FOR SAYINGS AND TIM E DEPOSITS However, I would like to have the opportunity to address myself to them for the record. The C h a ir m a n . Y o u may do that. We hope all the questions will be answered for the record. Secretary F o w l e r . They will, for the record, and promptly, M r. Chairman. (Material submitted in response to the questions raised by Chair man Patman in his opening remarks will be found on pp. 130-131.) The C h a ir m a n . I hope you deal with the illegality of n e g o tia b le CD’s. Are yon dealing with that in your statement? Secretary F o w l e r . Yes; I think my comments will embrace that subject, although not in a technical way. Mr. Chairman and members of the committee, I have been asked to comment today on two bills before your committee—H.R. 14026 and H.R. 14422—which in different ways would affect the acceptance or issuance of time deposits by insured commercial banks. Before addressing myself to these two bills and making certain specific sug gestions of my own, I would like to offer a general comment on recent developments regarding the competition for time deposits. I should point out, first of all, that the Treasury does not have a direct supervisory interest regarding the rates and other terms offered on bank time deposits and on competing investment forms offered by other financial institutions. However, because of our general con cern about the state of the economy, and our particular concern with the management of Government finances, we have a continuing inter est in the maintenance of stable financial markets. Moreover, in bringing together, as your opening statement made reference to, at the request of the President, a Coordinating Committee on Bank Supervision—which includes the Comptroller of the Currency and the Chairmen of the Federal Deposit Insurance Corporation, the Fed eral Home Loan Bank Board, and the Federal Reserve Board—the Treasury has been actively interested in this question. Recent developments in the competition for savings may be traced conveniently back to 1961, when a combination of more aggressive com petitive behavior by commercial banks and a series of revisions in the Federal Reserve’s regulation Q and the FDIC’s regulation 329 resulted in a substantial increase in commercial bank time deposits and in im portant changes in the portfolio policies of banks. Between yearend 1961 and yearend 1965 commercial bank time deposits increased by about $64 billion—or more than 75 percent. This is a compounded growth rate of 15.5 percent yearly—achieved on a base that already substantial. A portion of the accelerated grow th in bank tim e deposits came from funds th a t m ight otherwise Jhave gone to savings and loan a ss o c ia tio n s and m utual savings banks; in some instances, th is m ay have r e fle c te d a return flow of funds t h a t had previously been shifted away fro m banks—fo r savings and loan associations, in particular, h a d e n jo y e d an extraordinarily rap id grow th rate in the earlier postw ar yea rs. Some of the growth in commercial bank tim e deposits reflected s h ifts by corporations and public treasurers away from competing money m arket instrum ents including T reasury bills. A nd some or t h e in crease m tune deposits probably reflected shifts from bank dem and deposits. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 3 3 More recently many banks have offered so-called savings certificates or “savings bonds,” generally in nonnegotiable form, which have made higher time deposit rates available to individual savers with accounts largely in the $2,500 to $100,000 range. In some cases, the higher rates have been made available on savings instruments ranging even smaller in size—all the way down to about $20 or even less. In contrast, nego tiable certificates of deposit—or CD’s—are typically issued and traded in size units of $100,0(X or more, serving as a liquid money market in ) strument rather than as a savings medium. The rapid inflow of funds into banks spurred more aggressive lend ing policies by banks and encouraged many banks to move into areas of lending that had received less attention earlier. Mortgage lending, consumer credit lending, and investments in obligations o f State and local governments showed particular increases among bank assets. On the whole, these shifts in bank lending and investing"practices have been desirable, contributing importantly to the unprecedented growth of credit and economic activity that we have experienced in recent years. Banking has certainly become more competitive. The mar gins between what banks pay for funds and what they earn on loans and investments has narrowed and the public has benefited. It is true that a few banks have used certificates of deposit unwisely to finance unsound loan portfolios. But such practices are not inherent to CD’s or increased time deposit competition. Bank failures during the past few years have alerted supervisory agencies to potential prob lems and alerted the general public to potential risks. As market interest rates have advanced during the past year banks have been under pressure to raise rates paid on time deposits, particu larly in order to attract and retain rate-sensitive funds. The Board of Governors of the Federal Reserve System decided last December to raise the rate ceiling on time deposits from 4% percent to 5l/o Per_ cent, enabling banks to compete at higher levels. At the same time, the Board elected to keep the 4-percent ceiling on savings deposits, in order to limit the impact of rate competition among banks and between banks and other financial institutions. In recent years many economists have favored eliminating, or plac ing on a standby basis, any interest rate ceiling on time and savings deposits. Both the Commission on Money and Credit, in 1961, and President Kennedy’s Committee on Financial Institutions, in 1963, recommended placing on a standby basis interest rate ceilings that would apply both to banks and other thrift institutions. This recog nizes that, m principle, it is hard to defend a policy that insulates banks and other financial institutions from competing among them selves. While acknowledging this point of principle, I believe the present period demonstrates that there is a need at times for the guidance that regulatory agencies can provide. I might say parenthetically that, of course, was the inference in the report of the President^ Committee on Financial Institutions in recommending that this authority be placed on a standby basis, because there was recognition at particular times that authority might be useful and desirable. At the very least, ceilings are needed in transitional periods, when financial institutions are making adjustments to a changing competi tive environment. Moreover, it is important that the authority of the fta-49*— 66----10 134 TIN SOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS supervisory agencies with respect to ceiling rates and other pertinent factors relating to time and savings deposits be available with some flexibility to distinguish among different types of deposits. Regard less of what ceiling rates or other conditions may currently exist or be proposed, the present experience should stimulate some hard thinking by all of us—in the financial markets as well as in Government—about the pros and cons of bidding for “hot money.” In seeking legislation in this area, I believe an important principle to keep in mind is the undesirability of taking an approach that would permanently inhibit healthy competition among financial institutions. It would be equally undesirable, however, to remain aloof to the point that destructive competition dealt permanent injury to our financial institutions and the sectors of our population and our economy that depend on those institutions. One of the bills before you, H.R. 14026, would prohibit banks from issuing negotiable deposits or notes. This would substantially lessen the attractiveness to investors of large denomination certificates of deposit, although it probably would not eliminate their use entirely. The possible effects of a sharp reduction in the volume of certificates of deposit are difficult to contemplate. Based on the funds they have obtained in this manner, banks have built up enormous additions to their assets—representing useful credits to many segments of the economy. It is not easy to say “where the money would go” if nego tiable certificates of deposit could not be renewed as they matured. At the least, there would very likely be severe transition problems for particular institutions and segments of borrowers that found credit flows cut off. T o so m e e x te n t , b a n k s p r o b a b ly c o u ld c o n tin u e t o o b ta in f u n d s by is s u in g n o n n e g o tia b le c e r tific a te s o f d e p o s it, b u t t h i s m i g h t req u ire h ig h e r in te r e s t r a te s th a n a r e p a id n o w . A lm o s t c e r t a in ly , b an k s w o u ld h a v e t o is su e s u c h c e r tific a te s in s h o r t e r m a t u r it ie s t h a n is the c u r r e n t p r a c tic e , t h u s f o r e s h o r t e n in g th e t im e w h e n p e r io d ic re n e w a ls m u st be arran ged . H.R. 14026 would also prohibit banks from selling negotiable deben tures. During the past few years banks have added more than $1.5 billion to their capital through the sale of debentures. If banks were able to sell debentures only in nonnegotiable form they would probably hayeto pay higher interest rates, if indeed they could sell them at all. While I would not favor H.R. 14026,1 do not mean to say that we see no problems at all in the CD area, or that we have no concern about thecurrent role CD’s seem to be playing in the interest rate structure. As beneficial as CD’s have been over the past several years, I must say ^?^ress^ bank competition to obtain these short-term funds— Te which has been the counterpart of the aggressive bank competition to extend credit in channels that benefited the economy—has worked at times to move short-term interest rates higher. When this process succeeded in generating a larger pool of funds than the banks c o u ld use m extending longer term credits, this additional pressure at the short end was tolerable. ^ Indeed it was welcome in the early years of the 1960 s m order to raise our short-term interest rates in relation to r^vs abroad, thereby averting or retarding outflows that would add to the deficits in our balance of payments. But when we rea ch UNSOUND COMPETITION FOB SAVINGS AND TIM E DEPOSITS 135 a situation where, to a considerable extent, banks are bidding against one another, or against others who m ust use the short-term money m arket, to secure more of a rather lim ited total supply of available funds, a question may be raised as to whether this useful device is perhaps being pushed too far. As I said in a speech in Phoenix, in early A p ril: I would hope, also, that there will be an accompanying disengagement from unreasoning competition for time and savings deposits that ignores the need for caution and the harm that kind of competition can do to our banking and financial system. This is a question that has been under study within the Government, particularly in the last 5 months. We do not have simple answers to offer here. I cannot conclude that a flat ban on negotiable certificates of deposit would be desirable. If, in the judgment of the committee, some action is deemed desirable, a better approach might lie in the direction of providing the appropriate monetary authorities with greater discretion to set levels of reserve requirements on large nego tiable certificates of deposit that might exceed those on other time and savings deposits. Of course, you will want to consider carefully the views of those much closer to the problem of day-to-day bank super vision on this matter. Another bill before you—H.R. 14422—would prohibit insured banks from accepting time deposits in an amount less than $15,000. This bill, along with the present regulation Q ceilings, would in effect restrict banks to the 4-percent ceilings on savings deposits for accounts of less than $15,000. While I have considerable sympathy with the apparent objectives of H.R. 14422, it does seem to me that its approach is unnecessarily rigid, and that it is unnecessarily discriminatory against smaller savers at commercial banks under the present interest rate spread. A t the same time, many of us are concerned about the considerable evidence th a t something should be done prom ptly to retard the outflow and threatened outflow of savings funds from savings and loan asso ciations and m utual savings banks. W hile none of us is in a position to evaluate just how serious this threat may be as a long-term m atter affecting these institutions, there is a genuine current concern in the Congress, in the Federal Home Loan B ank Board, and in the private economy, th at a continued sav ings outflow could place undue stress on some of these financial insti tutions, and undue constraints on the flow of money into the m ortgage m arket and homebuilding. Under the circumstances, the prudent course would seem to be to provide some simple form of insurance that could be put in effect speedily, that wouM tend to avoid drastic dislocations, and that would provide our savings institutions with an opportunity to make an orderly adjustment to new competitive situations. By placing a tem porary restraint on excessive competition in this area, it should be possible both to protect the structure of the thrift institutions and to bolster the flow of funds to the homebuilding industry. I n acting prom ptly to provide tem porary relief from the problems of excessive rate competition, I do not believe we should commit our selves to perm anent arrangements th a t would impede and com part 1 3 6 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS mentalize our financial markets. R ather the present purpose is to find agreement, along simple lines, on means fo r dealing w ith this tem porary transitional problem. W ith this background in m ind, I would like to m ake certain af firmative proposals th a t I would urge this committee to consider and act on prom ptly. Specifically, I believe it would be desirable to provide the m onetary authorities, on a tem porary basis designed to cover this transition period, w ith discretion to set a different rate ceiling on tim e deposits up to the maximum amount covered by Fed eral deposit insurance. U nder present circumstances, th is would mean th a t a maximum rate of, say, 5 percent could—and I m ight say should—be set on time deposits up to $10,000. F o r larger time de posits, the first $10,000 would be covered by a maximum rate which could be set at 5 percent, while the balance could pay interest a t rates up to those now specified in the Federal Reserve’s regulation Q. The choice of an appropriate size lim it on which to set different maximum rate levels is not an easy question to resolve in view of all the equity considerations and competitive factors involved. W e sug gest $10,000 as an appropriate lim it for tw o im portant reasons: First, tying this lim it to the maximum insurance lim it makes sense in view of the Government’s contingent liabilities on deposits up to this size. Assuming the necessity for establishing a lim it, and I believe there is such a necessity, it is logical th a t those who have the protection of Government insurance should be prepared to receive a slightly lower rate on the insured amounts. Second, based on our inform ation about the current situation, we believe th at this lim it represents a m iddle course which should alleviate the impact of destructive competition fo r savings, without seriously im pairing the ability of banks to engage in constructive in termediation. A Em it of this nature, w ith the rate set in current circumstances at a 5-percent level, should be of significant help in deterring further large drains of funds from the specialized savings institutions. Timely protective measures; undertaken now, will help in relieving the liquidity strain on these institutions, and in tu rn re lieving the strain on im portant sectors o f the economy th a t depend on an availability of funds from these institutions—notably the m ort gage m arket and the homebuilding industry. Taken overall, I believe th a t the $10,000 dividing point, tied to the present insurance lim it, makes sense from the standpoint of prudent economic policy. A higher lim it—w ith discretion fo r setting the figure given to the appropriate supervisory authorities, b u t per haps somewhere in the range of $25,000 to $100,000—m ight also m a k e good economic sense in present circumstances. I would not be o p p o se d to such a lim it, provided on a tem porary basis, and this is a point that the Congress should consider carefully, but my own preference in this tem porary authority would be fo r a link to the maximum insured account size. A gainst the background of current policies as reflected in the recent announcement of the Federal Home Loan B ank Board on Tuesday, I believe this approach could be p a rt o f a framework for sustainable competition among th rift institutions. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 3 7 F o r the foregoing reasons, I sincerely urge the committee to give serious consideration to this proposal as an alternative to other legis lative proposals before it. I have available copies o f a d ra ft of a bill which would provide tem porary authority for a 2-year period to the Federal Reserve Board and the Federal i)eposit Insurance C orpora tion to institute different rate ceilings for th at portion of tim e deposits up to the maximum amount th at may be covered by Government insurance. Finally, I would like to emphasize just as firmly as I can th a t these proposals are not a cure-all or a perm anent attem pt to deal -with the problem of competition in the financial area, Certainly, they are not intended to permanently im pair competition—which is the vital force of our economy. R ather, they would provide a measure of insurance during a period of transition. Thank you, Mr. Chairman. The C h a ir m a n . Mr. Secretary, I notice on page 2 you said these negotiable certificates of deposit V en t back to 1961. Are you not mis taken, did not CD’s commence in 1960? Secretary F o w l e r . Well, the larger sizes emerged in 1961. I think they did appear earlier in smaller proportions. I accept your statement. My impression was th at the really rapid growth caught on in 1961. The C h a ir m a n . I will place in the record a t this point the history of them from 1960 down through 1965. (The history referred to follows:) Outstanding negotiable certificates of deposit in denominations of $100,000 or greater issued by weekly reporting member banks [In millions of dollars] New York City Chicago San Fran Cleve land cisco district district district Dallas district Allother Total Dec. 31,1960................................ Dec. 30,1961............................... Dec. 5,1962................................. Dec. 31,1963....................... ........ 5 935 1,650 3,434 21 318 794 1,234 219 420 598 851 41 238 480 860 247 318 486 796 263 553 1,434 2,402 796 2,782 5,442 9,579 1964 Apr. 1................. ! ................... . July 1 „ _____ ______________ Sept. 30....................................... Dec. 30— ....... ............. ............... 3,707 4,006 4,273 4,556 1,331 1,464 1,464 1,672 1,081 1,250 1,273 1,328 905 866 820 906 903 921 923 944 2,705 3,158 H SS 3,177 10,632 11,665 11,949 12,583 1965 Mar. 31................................... June 30......................................... Sept. 29......... ....... .............. Dec. 29......................................... 5,355 6,438 6,680 6,865 1,738 1,703 1,772 1,915 1,418 1,521 1,483 1,617 1,055 1,136 1,167 1,255 974 1,010 1,061 974 3.422 3,468 3,751 3,471 13,962 15,276 15,914 16,097 1966 Apr. 20___ _______ ____ ____ 7,352 2,149 1,937 1,306 1,085 3,549 17,378 Source: Office of Debt Analysis, Jan. 25,1966. 1 3 8 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS OUTSTANDING NEGOTIABLE TIME CERTIFICATES OF DEPOSIT, ANNUALLY. 1960-1965 Billions of Dollars Scurct: Basic date tmm Fedtrof Rtservt Board UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 3 9 Maximum interest rates payable on time and savings deposits [Percent per annum] Effective date Type of deposit Savings deposits held for: 1 year or more............................. Less than 1 year....... ................... Other time deposits payable in: 1 1 year or more.......................... . 6 months to 1 year....................... 90 days to 6 months____ ______ Less than 90 days........................ Nov. 1. Feb. 1, Jan. 1, Jan. 1, Jan. 1, July 17, Nov. 24, Dec. 6, 1933 1935 1936 1957 1962 1963 1964 1965 3 3 2H 2H 2M 3 3 3 3 3 3 2M 2H 2H 2H 2H 2'A 2 1 3 3 2n i 4 m 4 3H 2H 1 4 3M 4 4 4 4 4 4 4 1 4M 4 ft 514 1 For exceptions with respect to foreign time deposits, see “Annual Reports" for 1962, p. 129, and 1965, N o t e .— Maximum rates that may be paid by member banks as established by the Board of Governors under provisions of regulation Q. Under this regulation the rate payable by a member bank may not in any event exceed the maximum rate payable by State banks or trust companies on like deposits under the laws of the State in which the member bank is located. Effective Feb. 1, 1936, maximum rates that may be paid by insured nonmember commercial banks, as established by the FDIC, have been the same as those m effect for member banks. Savings *y individual* in the United S ta te s 1 1963-65 — [Billions of dollars] Type of saving 1. Currency and defnand deposits_____ _______________ 2. Time and saving deposits____________________________ 3. Savings shares *........... ........................ ................. .............. . 1963 1964 6.8 11.6 11.7 7.0 12.3 11.3 1965 8.8 15.2 9.2 1 Securities and Exchange Commission Statistical Series Release 2118, Apr. 15,1966. 2Includes shares in savings and loan associations and shares and deposits in credit unions. o t e .— The SEC also reported that during 1965 cash and deposits of all U.S. corporations rose $2,100,000,000, but that there was an equivalent drop in their holdings of U.S. Government securities. On July 17,1963, the Federal Reserve Board reduced the minimum maturity on CD's bearing the highest rate permissible under regulation Q from 1 year to just 90 days. N The C h a i r m a n . The point th at troubles me on this m atter is the fact th at your approach is not vigorous enough and rather tim id and weak. T his is my p erso n a l opinion. I was hoping th at you would realize th a t this CD m arket has grown up here in the last- few years— negotiable CD’s only since 1960; 75—90 years ago the Congress passed a law th a t no national banking association—no national bank shall issue post notes or any other notes to be circulated. O f course, th a t was done then because banks were issuing their own money. A bank would go broke and everybody would have this money but there would be nobody to redeem it. So the law was justified. _I t occurs to me th a t we are perm itting exactly the same thing in a different way today. I n other words, we are perm itting the issuance of interest-bearing circulating notes. W henever you issue a CD, th at can be sold a t any time, and the money obtained on it, is th a t not very much like a circulating note, M r. Secretary ? Secretary F o w l e r . There are some similarities, M r. Chairm an. The C h a i r m a n . I f you had the responsibility in view of this stat ute, would you perm it CDs’ to be issued ? 1 4 0 UNSOXJND COMPETITION FOR SAVINGS AND TIME DEPOSITS Secretary F o w l e r . I would not give a quick or an unqualified an swer to th a t question. Since I do not have the responsibility, I have not studied it in depth on the legal question th a t you raise. I have indicated in my statement th a t I think this is som ething th a t exists, it is p a rt of our system today. You may characterize the absence of a drastic approach as tim id. I would characterize a drastic approach as being unwise. The C h a i r m a n . W ell, I notice you state here th a t the Federal Reserve B oard and the Federal Deposit Insurance C orporation should be given authority to do these things. I think, M r. Fow ler, in dealing with the Federal Reserve you are going to have to make it manda tory. Secretary F o w l e r . Mr. Chairm an, it is im plicit in my statement, and in the proposal for this g ran t of authority in this kind of sit uation, th a t the legislation history of such a proposal would certainly, and should, include a clear intention on the p a rt of the Congress and the regulatory authorities th at, given the statutory authority, they would impose the 5-percent lim it. The C h a i r m a n . I think they would do it. Secretary F o w l e r . I would hope th a t in the process of exchanges that m ight occur some understanding could be arrived at. The C h a i r m a n . W e have been hoping w ith them fo r a long time, Mr. Fowler. D uring th a t tim e in piling more and more Govern ment bonds they buy and pay for them w ith F ederal Reserve notes; they now have over $40 billion in the New Y ork F ederal Reserve Bank. I believe th a t this is absolutely ridiculous. I t is a reflection on Congress. I t is a reflection on anybody who represents the people, th at we have $40 billion up there. A nd they claim they can use that money fo r any purpose they w ant to. As evidence o f the fact they pay dues to the American Bankers’ Association, nearly $100,000 a year. I t is scandalous and shameful th a t they use Government lT kA nair r / \ n n J- rr lv _ _ _____ _1 ____________ • .1 * . — campaign *______________ ___ one could stop them because they do not come to th e Government for funds to operate. They have gotten out from under th e General Acconnting Office, they are not audited and they are going so f a r that I think it is tune fo r the T reasury to take some stand on this. U f course, possibly, not having the responsibility, I would want you to look over it very carefully, but I th in k all the facts in this situ ation should receive the attention of the T reasury D ep a rtm en t. i m 19.6? \ hug® corporate funds th a t now make up most of the negotiable CD m arket aggregating about $17 billion were K le ? 1 i m W y Treasui7 bil1 auction market, M eeW r. F o w le r . A s m y statem ent indicated, the funds accum u- ca«ie from various sources. Some of them were certainly in the bill m arket. Some of them would have been fu n * th a t would have ultim ately flowed into other th r if t in stitu tio n s, feome of them are funds th a t are reclaimed in a sense from the thrift institutions, and so on. th ^ lis is .not new to me- W e h ad a h e a r i n g before the J o in t Economic Committee on it and I am convinced, M r. Fowler, UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 4 1 that right here in broad daylight an awful scandal has gone on. These CD’s were commenced in 1960 by just a few banks, a handful of big banks. They say, “you come to us.” They say to the man agers, “you come to us and we will issue CD’s at 4 percent.” That was quite a bonus and windfall because the short-term securities were much less than that. But they were overlooking the fact that there was a race between interest rates on short-term Government securi ties and CD's so that when December 1965 came around, the rates had gone up so high on Government short-term securities because big bidders had been enticed out of the bill market and went to the banks that were issuing these CD’s. I think that was an awful scandal and I think it was a great detriment to the public interest that it happened. Nobody seemed to say anything about it. They just let it go. But it happened right here and we could all see it. Now, then, in December 1965, all the billions of dollars of CD’s were coming due and the banks could not get any agreement out of the Federal Reserve to make them any loans or to do anything to assist in “rolling over” their CD portfolio. So they were hurting and they got on the Federal Reserve Board right quick. You know about that. You know- that they were pressing to do something and the Federal Reserve Board finally raised the rate, not only the dis count rate—that did not mean much here—but raised the CD rate from 414 percent to 5^ percent. They defied the President of the United States who did not want it done, defied the Secretary of the Treasury who did not want it done. In other words, the Federal Reserve, being the fourth branch of Government, acting on its own because it does not come to Congress to get its expenses, because it has a billion and a half dollars interest a year on those bonds to spend any way they wanted to and because they are not audited by the General Accounting Office. They just did an arbitrary act which I think was a terrible disservice to our country. Do you not think it was a disservice at the lime, December 6, Mr. Fowler? Secretary F o w l e r . My views on that incident are so well spread over the public prints and in the hearings of congressional commit tees, including the Joint Economic Committee, I think I would be taking the time of this committee to voice them here. I will be glad to say----The C h a ir m a n . All right. Secretary F o w l e r . I will refer you to m y most recent comment on this, when addressing the Reserve city bankers in Phoenix in April, I restated my views on this particular question to that audience. My views would be the same here today. The C h a ir m a n . Are you saying, Mr. Fowler, that you are o p p o s e d to the action? I know that you were at the time, until January, but do you believe that the Federal Reserve should have a right ‘to go contrary to the administration on matters of policy like that ? Do you not think that the Federal Reserve should be brought back under the jurisdiction of the U.S. Government? Secretary F o w l e r . I think it is very important, Mr. Chairman, that fiscal, monetary, and debt management policies be coordinated. 1 4 2 TJNSOTJND COMPETITION FOR SAVINGS AND TIME DEPOSITS I think the question of the m ethod and form of th a t coordination is a question which is one between the Congress and the Federal Re serve B oard. T he C h a i r m a n . You mean the executive? Secretary F o w l e r . The President and the Secretary of the Treas u ry are going to do everything they can to make and work fo r effec tive coordination in this area under whatever ground rules fo r that coordination the Congress sees fit to establish. T he existing ones or the changed ones. B u t I do not consider th a t I have the judgment or the background, nor do I think it would be appropriate, fo r me to advise the Congress as to the particular ground rules it in its judg m ent should fix under which this coordination will carry on. W e are going to do our very best to coordinate under the ground rules, what ever they are. W e are going to try to get along and work together w ith these independent bodies which draw both th eir supervisory and th eir m onetary authority in the financial field directly from the Con gress of the U nited States. They do not take them through the President. T h at applies to the Federal Reserve B oard, the federal Deposit Insurance C orporation, the Federal Home Loan B ank Board, and to the Com ptroller o f the Currency who, fo r adm inistrative pur poses, is in the Treasury D epartm ent. The C h a i r m a n . X have this suggestion to make. You have a law here th a t is 90 years old. You adm it yourself th a t there is a great sim ilarity between this interest-bearing currency th a t they are issuing rig h t now and the notes th a t were being issued. I t was supposed to stop 90 years ago. I n addition you have the Em ploym ent A ct of 1946, ju st as clear, I think, as a law can be w ritten. A nd I think— my personal opinion-—th a t the Chief Executive should consider ser iously setting iip a coordinating committee himself. I do not person ally believe it is effective to p u t a num ber o f people who are, we will say, of the same ran k and the same category as yourself and the Fed eral Reserve B oard, Com ptroller of the Currency, F D IC —to have one of you do it—w ith all due respect to you. I do tru st you and I think you are honestly try in g to do a good job, but I do not think it is the rig h t th in g to do, to have the C oordinating Committee set up among you people who are not the top person, you are not the Chief Executive. I th in k the Chief Executive should consider s e ttin g up his own coordinating committee to where they would be responsible to him to make reports to him occasionally. I think th a t would be an effective coordinating committee. Secretary F o w l e r . M r. Chairm an, as you know, there is and has been such a body which is composed of four people: the Chairm an of the Council of Economic Advisers, the Director of the Budget, the Chairm an of the F ederal Reserve Board, and the Secretary? o f the Treasury. In popular term s it is called the quadriad. T h at body meets inform ally w ith the President quite frequently. W e have full and open discussions of the problems th a t t i e President wants to t ! x this group. There is this existing instrument. Now, as you well know, there are, of course, limitations of time on the range of problems that the Chief Executive and his financial ad viser, the Secretary of the Treasury, can be concerned with. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 4 3 I do not think that the Congress can hold the Chief Executive re sponsible for policies and operations in a field where the Congress has created an agency and declared it to be independent. The C h a ir m a n . I will challenge that right now. You show me the language in any law that Congress has ever passed that makes a dec laration that the Federal Reserve should have this. You show me in the debates of Congress, House or Senate, where it was ever expressed that it was the intent that the Federal Reserve should be independent. Secretary F o w l e r . Mr. Chairman, I am using the word “independ ent” and I think you realize that I did not infer it meant independent from the Congress, but independent in that I can find no authority under which the line of command to these agencies goes through the President of the United States or the Secretary of the Treasury. The C h a ir m a n . I would not take the time of that now. I chal lenge that statement, my dear sir, and I challenge Mr. Martin to pre sent testimony just like you have. He has not presented it yet, nor has anyone else. I will yield to Mrs. Sullivan. Mrs. S u l l i v a n . Thank you, Mr. Chairman. Mr. Secretary, ac cording to a report in the April 15 issue of the American Banker, Un der Secretary of the Treasury Deming in Houston, Tex., severely crit icized Chairman Patman’s bill to curb negotiable CD’s. Did these remarks have the official blessing of the Treasury ? Secretary F o w le r . I do not recall the remarks, Mrs. Sullivan, and I do not recall the circumstances. I would have to refresh my recollection on the text of the speech and confer with Secretary Dem ing who is out of the country at this time. Mrs. S u l l i v a n . Will you furnish an answer for our record after you have had a chance to talk with Mr. Deming ? Secretary F o w le r . Yes. (The article referred to and Secretary Fowler’s reply follow:) [From the American Banker, Apr. 15, 1966] D e m in g C oncerned O ver CD R a t e s , S ees P a t m a n R x T oo S trong (Special to the American Banker) H o u st o n .—Under Secretary of the Treasury Frederick L. Deming this week expressed concern over the ‘‘rapid buildup of rates on certificates of deposit.” But, he said, he believes the proposal of Representative Wright Patman, Demo crat, of Texas—to outlaw the certificates—is too drastic. “The real concern” Mr. Deming said in an interview, “is that banks have continued to make these rates more attractive to the public. The question is how long this money wiU stick with them.” Withdrawal of an appreciable amount of deposits upon maturing of the certifi cates, after banks have made long-term loans, would pose liquidity prob lems for the banks, said Mr. Deming, former president of the Federal Reserve Bank of Minneapolis. He said the run-up in rates on the certificates “has been greater than any one could have anticipated,” but he sees no need for going to the lengths of the proposal by Representative Patman, who is chairman, House Banking and Currency Committee. “I don’t think th at the excesses have been such that you’d want to eliminate CD’s completely,” he said. Mr. Deming said lie has no ideas as to the amount of corporate funds which may have been shifted from Treasury issues into certificates of deposit It 144 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS would be too difficult a task for the Treasury to try to ascertain the extent of such shifts, he said. The Treasury Under Secretary, who came to Houston to address a group of bankers and businessmen at a dinner preceding Thursday’s annual meeting of the boards of the Federal Reserve Bank of Dallas and the Houston branch, also sa id : He likes the general tenor of the proposed legislation, favored by Chair man J. L. Robertson of the Senate Banking and Currency Committee, to provide better scrutiny of banks and savings and loan associations. Prospects for price stability in the economy look better, but there is still some strain on the Nation’s resources that is creating inflationary pressures. Approximately $12 billion will be drained out of the economy in the Gov ernment’s fiscal 1967. starting July 1, as a result of monetary restrictions, fis cal measures, higher taxes, including those for medicare and President John son’s wage-price guideposts and call for voluntary restraints. No one expects corporations to drop all their plans for the 16-percent to 19percent increase in capital expenditures forecast for this year, but “some of it.” He declined to fix a percentage that he believes should be cut. Higher taxes could be imposed if the Vietnam spending escalates, if Congress appropriates funds beyond those stipulated in the budget, or if inflation ap pears to be getting out of hand. “I don’t think,” Mr. Deming added, “that he (President Johnson) would touch wage and price controls.” Mr. Deming said that while prices on “sensitive materials” have risen, and inflationary pressures continue, they “are nothing like during the Korean War.” Prices on farm and food products appear to have been flattening out during the past month, he said. (The ment :) f o l lo w in g statement w a s s u p p lie d by the Treasury D e p a r t Under Secretary Deming spoke informally in Houston, Tex., at the April 13 meeting of the joint board of the Federal Reserve Bank of Dallas and its branches. In his prepared remarks, no itext of which was made available, Mr. Deming made no reference to Chairman Patman’s bill, H.R. 14026. In a press conference held in conjunction with the speech, Mr. Deming was asked by a reporter what the Treasury position was with respect to H.R. 14026. Mr. Deming replied that the Treasury Department had not taken a position with respect to the b ill; however. Mr. Deming commented that he would like to make two points: First, that the Treasury Department was concerned with the certif icate of deposit question, and second, that it was his offhand impression that Chairman Patman’s bill went further than was necessary under present circum stances. Mr. Deming’s statement at the press conference in Houston is essentially the same position as that taken by Secretary Fowler in his testimony on May 191966, before the Committee on Banking and Currency when he sa id : “While I do not favor H.R. 14026, I do not mean to say that we see no problems at all in the CD area, or that we have no concern about the current role CD’s seem to be playing in the interest rate structure.” Mrs. S u l l i v a n . Also, on the same interview, Mr. Deming is q u o te d as saying that it would be too difficult a task for the Treasury to as certain the extent of shifts of funds from Treasury bills to CD s. Does this mean that the Treasury-Federal Reserve joint study of the Government securities market is really not being taken seriously by the Treasury? Secretary F o w l e r . N o , I am sure it does not carry any s u c h inference. Mrs. S u l l i v a n . Thank you. I would appreciate it if you w o u ld have a fuller answer to the first part of the question. That is all, Mr. Chairman. The C h a ir m a n . Mrs. Dwyer ? UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 4 5 Mrs. D w t e r . N o questions, Mr. Chairman. The C h a ir m a n . Mr. Moorhead ? Mr. M o o r h e a d . Thank you, Mr. Chairman. Mr. Secretary, I wonder if you could help me distinguish between negotiable CD’s and the nonnegotiable CD’s. First, when we say nonnegotiable do we mean nontransferable or do we mean they do not pass to a holder in due course like a negot iable instrument ? Are they transferable ? Secretary F o w l e r . Rather than discuss this in technical, legal terms, Congressman Moorhead, I think, as a practical matter, you might have a small CD that would be dressed up and appear for all practical purposes to be negotiable, but would not in fact be nego tiable, that is, you would run into difficulties in moving it around. The larger CD s are the ones that are really money market instru ments. So I think really the negotiability has some relationship to size as well as to the express legal terms that may be there. M r. M o o r h e a d . In the bill that you have submitted to us, do you con template the possibility of authorizing the Board and the FDIC to permit different—make greater differentials between negotiable and nonnegotiable CD’s? Secretary F o w l e r . N o , sir; we were trying to keep this just as sim ple as possible because it is addressed to a temporary transitional prob lem. Rather than deal with all the varying shapes of this problem, we have tried to keep it simple by providing authority to create a rate differential on savings, between savings up to the $10,000 mark, or the insured amount, ana everything above that. That is the one dis tinction. I think it might be of interest to you, sir, to inquire of the regula tory or supervisory authorities—the Federal Reserve Board and the FDIC—as to whether or not they already have the authority to make the distinction between the negotiable and the nonnegotiable type of CD. Where we have found in our discussions with them that they feel they lack the authority to move sharply is in terms of the amount of the instrument, and that is why this particular proposal goes specifi cally to differentials in terms of the amount of the deposit. Mr. M o o r h e a d . Mr. Secretary, I notice we have before us a table relating to the growth of negotiable certificates of deposit and up here we have a chart showing the growth of negotiable time certificates. I think it might be helpful----Secretary F o w l e r . These, I might say are not our products. They have another author, therefore I am not in a position to explain them. Mr. M o o r h e a d . Do you have tables that show the growth of non negotiable certificates of deposit ? Secretary F o w l e r . We do not have it readily available. I do not know whether it could be pulled together or not. With respect to the charts and tables you mentioned, I am informed that they did come from the Treasury Department, but they are not here as part of my statement today. Mr. M o o r h e a d . I think it would be helpful in our deliberations if we could have tables, if they were readily available, to insert in the record. I would ask you to insert them in the record, Mr. Chairman. 1 4 6 trNSOTJND COM PETITION FOR SAVINGS AND TIM E DEPOSITS (The chart referred to follows; see also pp. 137-139.) Secretary F o w le r . I will be glad to make available whatever we have. I did not bring it along because rather than going over the entire range of this problem, Congressman Moorhead, I was trying to pick out one simple point. (The following material was submitted for the record by the Treasury Department:) The request for information on the growth of nonnegotiable certificates of deposit is not readily answered, since data bearing directly on this category are not available. Data separating savings and time deposits at all commercial banks are available from semiannual caU reports, the latest applying to June 1965, but the can report data do not show nonnegotiable certificates of d e p o s it as a separate item. Only a sketchy approximation of nonnegotiable CD's is presented in the following table, derived by subtracting savings deposits, and large-size negotiable CD's at weekly reporting banks from total time and savings deposits. The resultant numbers may represent the trend in non negotiable CD’s, but the levels are overstated, and the trend itself may be somewhat distorted, since the figures obtained would include savings deposit of other than individuals, partnerships, and corporations, they would in c lu d e time deposits, open account, and they would include negotiable CD’s smaller than $100,000 or at other than weekly reporting banks. A second table, “Types of Time and Savings Deposits, IPC, Held by Member Banks on Dec. 22,1965,” was taken from the Federal Reserve Bulletin of April 1966. Using information obtained from a special study undertaken in late 1965 and early 1966, it classified time deposits of individuals, partnerships, and corporations by type of deposit UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 4 7 C o m m e r c ia l b a n k t im e a n d s a v i n g s d e p o s it s [In millions of dollars] Total time and savings deposits i December 1961_____ _______________ December 1962........................................... December 1963____ _________ _ ____ June 1964. .......... . ................................... December 1964........................................ June 1965. ________ ______ __________ Savings deposits of individuals, partnerships and corpora tions 2 82,909 98,244 111, 590 120,264 127, 539 138,399 Negotiable C D 's 3 63,858 70,967 76,303 79,327 82,922 87,317 Remainder including non*negotiable C D ’s* 2, 782 5,442 9,579 11,687 12,585 15,276 16,269 21,835 25, 708 29,250 32,032 35,806 1 Includes time deposits of States and political subdivisions, domestic banks, foreign banks and official institutions, U.S. Government and postal savings. 2 This breakdown is available for all commercial banks from call report data beginning with June 1963. The call report for December 1965 is not yet available. 3 The negotiable C D data were obtained from reports of the weekly reporting member banks and are for denominations of $100,000 or more. This category includes negotiable C D ’s held by individuals, partner ships and corporations, as well as others. ♦Derived b y subtracting 2d and 3d column from 1st column. Source: Federal Reserve and Treasury estimate. T y p e s o f t im e a n d s a v i n g s d e p o s it s f I P O , helH b y m e m b e r b a n k s , o n D e c . 2 2 , 1 9 6 5 1 Number of banks Type of deposit Savings deposits.................................................. Savings certificates........... .............................. Savings bonds....................................................... Other nonnegotiable CD’s ............................... Negotiable CD 's...................................... .......... Time deposits, open account............................... Reporting specific types 5,893 2,773 130 2,157 1,777 1,763 Total...... .................................................... Amounts held Percentage of all member 95 45 2 35 29 28 In billions of dollars 74.4 6.6 0.4 5.1 15.9 4.4 106.8 Percentage distribution 70 6 < *) 5 15 4 100 1 Tim e deposits of individuals, partnerships, and corporations. 2 Less than one-half of 1 percent. Source: Federal Reserve Bulletin, April 1966. M r. M o o r h e a d . I r e a liz e t h a t t h e b ig n e g o tia b le CD? a ls o h a v e a s r e la te d e ffe c t o n th e s m a lle r o n e s a n d I m i n k m a y b e so m e o f t h e ta b le s m ig h t b r in g t h a t o u t i f i t is tr u e . Mr. Secretary, I note on page 12 of your testimony, and then I note also in glancing at the bill that you very kindly provided, authority is given to the Federal Reserve Board and to the FDIC to control rates in these different ranges. My concern, sir, is, should not this authority be centralized in one agency—one or the other so that it would be uniform? Is it not important to have the rates for the member banks the same as the rates for the nonmember banks and do we not run a danger by dividing authority? In the banking agencies everything has not been uniform in the past. Secretary F o w l e r . Y o u do. Congressman, run such a danger and you will continue to run such a danger as long as the structure of delegation of authority to these supervisory institutions is as the 148 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS colloquy between the Chairman and I indicated. We might have a difference in emphasis here, but I think the present arrangements do place a very high premium on voluntary coordination between the various bank regulating bodies and in this particular case you would be depending upon the FDIC and the Federal Reserve Board to arrive at some meeting of minds as to the appropriate level. It was cer tainly implicit in my submitting this proposal as to the appropriate level that, in the course of these hearings, either formally or informally, this would not be left entirely to chance. Mr. M o o r h e a d . Mr. Secretary, if Congress decided that this issue that is presented by the bill that you have presented to us is essentially more of a monetary problem than it is the safety and soundness of the banking system, would it not be possible for us, if we so chose, to put all of the authority into the hands of the Fed ? Secretary F o w l e r . Well, I think you would perhaps lodge the au thority—this is something of a technical question—you could probably lodge the authority in the FDIC, but make clear, either in the com mittee report or in the language in the bill itself, that in exercising this particular authority to the nonmember banks, the FDIC would follow the pattern set by the Federal Reserve Board in dealing with member banks. M r. M o o r h e a d . Y o u s a id p u t i t in th e FDIC—I t h o u g h t a b o u t i t the o th e r W ay a r o u n d . Secretary F o w l e r . By directing the FDIC, in exercising its au thority in this particular area, to achieve conformity with whatever was set by the Federal Reserve Board. M r. M o o r h e a d . Thank y o u . The C h a ir m a n . Mr. St Germain? Mr. S t G e r m a ik . Mr. Secretary, in your testimony you make recoinmendations of 5 percent on time deposits up to $5,000. Would that, in essence, be a help to the savings and loan institutions and savings banks m view of the fact that their funds are repayments on mort gages they are now holding—many of them are 4y2~or 5-percent mortgages. How could they afford to pay 5 percent on these time d e p o s its ? secretary F o w l e r . N o w , as for tne savings and loans and mutual savings banks, of course, what they choose to pay is up to them now. I he purpose and effect of this bill, if enacted, sir, would be to p r e v e n t the commercial banks from offering beyond 5 percent to the small saver, the fellows whose deposits have gone up to as high as the $10,000 insured limit. It is my information—but this is something that the committee could inquire into—that this is about the top of the range that the savings and loan institutions could afford to pay. t M r. S t G e r m a i n . D o y o u f e e l t h e y c a n p a y th e m ? I t w o u ld h e lp so m e m o r e th a n i t w o u ld o th ers. think it would help most clearly those that are in an area where there are commercial banks already offering CD’s to the small saver at 5 percent or more. It would equalize rate competition more or less at InrM J ; rn ar?as " here that was n°t the case, and savings T and loans and mutual savings banks were still receiving deposits an d ^ growth at lesser rates, it certainly would not help institutions m that particular situation. Mr. St G e r m a in . Nothing further. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 4 9 Mr. O t t i n g e r . Would the gentleman yield for one question? The sayings and loan associations testified that they could not afford to pay higher rates, such as 5, 5% percent, because of this mortgage situation. I just wondered whether it would be a practicable solution to permit them to do so and whether they cannot, m fact, afford to do so. This is a means by which they themselves get their funds, through these mortgages. Secretary F o w l e r . I think they would have to speak for themselves on this. I have some impression that, while in this world one never gets all that one would really like to have in the way of a sure situation, there is some feeling on the part of these organizations that this would be helpful. It would retard or arrest the outflow—they said they need something to arrest the hemorrhage. Mr. O t t i n g e r . In your response to Mr. St Germain’s question there is some confusion. Did you intend that the savings and loan associa tions be allowed to charge a higher rate or did you intend that we should curb the rate of interest which the commercial banks could charge on CD’s? Secretary F o w l e r . We are dealing with what the commercial banks can do on CD’s. What the savings and loan institutions should be permitted to do is a matter for the Federal Home Loan Bank Board and I think that you would want to hear from Chairman Horne on that. Mr. O t t t n u e r . The purport of your suggestion on page 10 is that the Federal Reserve should set a lower rate of interest on small de nomination CD’s. In other words, go back to regulation Q. Is it not that the savings accounts should be allowed to go up ? Secretary F o w l e r . Not at all. The C h a ir m a n . Have the gentlemen finished ? Mr. St G e r m a in . Yes. The C h a ir m a n . Mr. Halpern? Mr. H a l p e r n . Mr. Chairman, I would like to commend the Sec retary for his analytical and perceptive and most informative presen tation here this morning. I, for one, would have to evaluate the views he offered before I make my mind up on this legislation. I am pleased to note that the Secretary thinks that the bill to ban CD’s outright is drastic action. I feel such action could well be an invitation, Mr. Chairman, to financial crisis. While I have the opportunity, Mr. Chairman, I would like to com mend the distinguished Secretary on the superb job he is doing. Mr. Secretary, in little more than a year that you have been at the helm of the Treasury Department, in my opinion and in the opinion of others, you are proving yourself to be one of the Nation’s great Secretaries of the Treasury and I wish to compliment you. S e c r e ta r y F o w ler . T h a n k y o u v e r y m u c h , s ir . Mr. H a l p e r n . That is all, sir. The C h a ir m a n . Let me get this straight about your bill, Mr. Sec retary. If I read this correctly, it will permit, not require the Fed eral Reserve to arrange these rates in a way so that up to the $10,000 insurance limit, no more than, 5 percent interest can be paid on time deposits, including negotiable CD’s, and that this is the same for sav 6&-49G—66------ 11 1 5 0 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS ings and loans. But above that they can continue to pay up to 5% percent; is that correct ? Secretary F o w le r . That is correct. The C h a ir m a n . I s that not a definite discrimination against the poor man? In other words, two people come to your window if you are a banker. One of them has $100,000 and they say we will give you 5y2 percent and the man who has only $10,000, they say we will give you only 5 percent. Secretary F o w le r . Some may view it as such, but as m y statement indicates, while it is very difficult to draw the line in any given amount and give a compelling rational justification for it, the one that we have fixed upon is that the depositor who comes to the bank and makes his deposit under the terms and conditions where there is absolutely no risk is not in the same position as the depositor who comes and puts his money with the bank and takes a risk. The C h a ir m a n . Do y o u consider there is a risk above $ 1 0 ,0 0 0 ? Secretary F o w le r . There is always a risk, Mr. Chairman. I am happy to say that I do not think that in view of the character and na ture of our financial structure and the supervisory authority that is exercised with relation to it that it is a very major risk. I think it is a very, very minor risk, indeed. But for the logic of a differentiation, I think this is just as good a logic as any. The C h a ir m a n . If you are trying to make an excuse, it is fine. Mr. Gonzalez? Mr. G o n z a l e z . Mr. Secretary, referring back to the page 10 that Mr. St Germain referred to in your first recommendation, I m ight preface my remarks by saying that last week I said, and I repeat here todav, that it looks very much to me that we are federalizing the loan sharks, that up to now they have been pretty much com partm entalized on the State level. We lost the fight on the State level and it looks to me we are losing it at the national level. You speak here of a 5-percent maximum rate on time deposits lip to $10,000. Now, just exactly how would this proposal help solve the liquidity problem of the few large banks that have the most outstand ing CD’s? Secretary F o w l e r . It is not addressed to that. It is not addressed to that in any particular. I am here concerned with what I think is the most immediate problem before this committee, the one that re quires the promptest attention, and that is something that will retard or arrest the outflow of funds from the savings and loan organizations and the mutual savings banks to those who offer 5 percent or beyond in rates of interest for so-called time and savings deposits. If I can be perfectly clear on one thing, I did not come down here today to deal with the whole range of banking problems and all of the aspects of the CD’s. I am trying to pinpoint in my testimony this one problem and suggest that this is one which the committee ought to give first priority to, if I may respectfully do so. M r. G o n z a le z . But you place this as your first recom m en d ation . This is the first one that you mention, is it not, on page 10? UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 151 Secretary F owler. T h is is the only one. I indicated th at in the last paragraph in the statem en t: Finally, I would like to emphasize just as strongly as I can that these pro posals are not a cure-all or a permanent attempt to deal with the problem of competition in the financial area. There are m any other aspects to th is problem th at the comm ittee w ill be concerned w ith. Mr. G onzalez. T h at is true. Som ebody has subm itted the prop osition th at 95 percent o f the negotiable C D ’s are in denom inations o f $100,000 or better. So then how is th is in any w ay in your specific rem edy to address you rself to the problem as you say ? Secretary F owler. I w ould like to, i f I m ay, refer you to one aspect o f the statem ent. Mr. O ttinger. W ill the gentlem an yield ? Secretary F owler. Bear w ith me just one m om ent here. Mr. O ttinger. W ill the gentleman y ield for just a comment on that ? Mr. G onzalez. L et us not perm it him to stray from this question. Secretary F owler. On page 8, sir, the only comment that I offered was t h is : I cannot conclude that a flat ban on negotiable certificates of deposit would be desirable. If. in the judgment of the Committee, some action is deemed desirable, a better approach might lie in the direction of providing the appro priate monetary authorities with greater discretion to set levels of reserve requirements on large negotiable certificates of deposit that might exceed those on other time and savings deposits. Of course, you will want to consider carefully the views of those much closer to the problem of day-to-day bank supervision. N ow , I th in k th at is the on ly part o f th e statem ent that is really responsive, sir, to you r question about how to deal w ith other phases o f the problem . T he single one we are p in p oin tin g here is the socalled sm all savin gs flow. I w anted only to voice a preference to indicate th at I thou ght a flat ban w ould be undesirable and drastic, and that m y preference w ould be to m ove in g iv in g the m onetary authorities a rig h t to vary the reserve requirements in relation to the different character and amount and m aturity o f some o f these in stru m ents. Mr. G onzalez. I realize th at you are not m aking a sort o f shotgun approach to this. I do not think it lends itse lf to it anyw ay. B u t I hate to see ourselves get into th is sort o f th in g on interest. There is no question— it is obvious that there is an aspect o f savings and loans versus banks and banks versus savings and loans and so forth. In the m eanw hile I am afraid that the overall public interest is being overlooked. T h is is w hat I am concerned w ith and your suggestion, as the C hairm an so ap tly pointed out, penalizes the sm all saver. M y tim e is up. T he C hairman . Off th e record. (D iscussion off th e record.) T he C hairman . M r.M inish ? Secretary F owler. W ith your perm ission, I w ould supplem ent m y com m ents to Congressm an Gonzalez by d irectin g h is attention to p ages 13 through 18 o f th e report o f th e Com m ittee on F in an cial In stitu tio n s 152 UNSOUND COMPETITION FOR SAYINGS AND TIM E DEPOSITS to th e P resid en t w hich w as released in A p r il 1963. I t deals w ith the question o f reserves on tim e accounts and the conclusion o f th e Com m ittee. I w ill q u o te: No. 3. The Committee with one member dissenting favors the continuation of reserve requirements on time and savings deposits at commercial banks and the introduction of a similar reserve requirement for shares of savings and loan associations and deposits of mutual savings banks. In addition Federal agencies that supervise financial institutions should be endowed with sufficient authority to assure that the institutions maintain adequate liquidity over and above cash reserve requirements. I th in k that general conclusion and the reasoning th at led up to it are pertinent to your particular question and th a t w as th e background fo r the comment th at I m ade th at I th ink th e dangers that m ay exist in term s o f large C D ’s go m ost im portantly to the question o f preserva tion o f liq uid ity and therefore, the authority o f the regulatory bodies to fix differing reserve requirements w h ich have some relationship to the liquidity. Preservation o f liq u id ity is th e heart o f th e problem. Mr. G o n z a l e z . T he F ederal R eserve System in its 1952 report, in one o f its recom m endations asks fo r an extension o f its authority over all insured banks to control reserves. S o I im agine th is w ould be in line w ith the recom m endations th a t you referred to here in th e com m ittee’s reports, or is there any sim ilarity between the tw o ? Secretary F o w l e r . I have n ot com pared th e tw o to determine whether th ey are the same or w hether there are differences, sir. Mr. G o n z a l e z . T he F ederal R eserve System said th ey had a pretty high rate o f w ithdraw als from th e System . T h is has created a bad situation and they are asking fo r ad ditional authority to cover their reserve regulatory authorities over all banks. Secretary F o w l e r . O ver nonm em ber banks. T h is is a s e p a r a t e question from th e one th at th is report is addressed to, a l t h o u g h I think the m atter is covered in another p art o f th e report. Mr. G o n z a l e z . T h ank you v ery much. T he C h a i r m a n . M r.M in ish . Mr. Mj n is h . M r. Secretary, is it la w fu l under our ta x la w s fo r com mercial banks to take m oney received from C D ’s and in vest in tax-free m unicipal bonds, ta k in g as an incom e ta x deduction th e interest paid on C D ’s to large corporations ? I s th is leg a l or is it rig h t ? T he C h a i r m a n . L et m e see i f I understand that. Secretary F o w l e r . I w ould lik e to hear th a t question again, too. T he C h a i r m a n . Y o u are ask ing w hether a bank can p a y say 5 per cent on C D ’s, th e in terest b ein g ta x deductible, and then take that money, w hich really costs them only about 2% percent considering their ta x bracket, and invest it in m un icipal bonds at say 4 percent. Of course the 4-percent returns from th a t w ould be ta x exem pt and your question is, w hether or not th a t is legal, to g et th a t w in d fa ll ? I guess it w ould be considered a w in d fa ll. Secretary F o w l e r . I w ould lik e to th in k about yo u r question a n d ou a considered answer. e fo llo w in g statem ent w as subm itted b y the T reasury D e p a r t m ent:) B xm N S E s B xL & sm o t o Taz -D s m n In c o m e A question has been raised as to whether commercial banks may use the proceeds of certificates of deposit to invent in municipal bonds, the interest on UNSOUND COMPETITION FOR SAYINGS AND TIM E DEPOSITS 153 which is exempt from Federal income taxation, and deduct the interest paid on such certificates of deposit. The Internal Revenue Code provides in section 265(2) that interest on in debtedness incurred or continued to purchase or carry obligations, the interest on which is exempt from tax, is not deductible. This provision was enacted to prevent the double benefit that would otherwise ensue from such borrowing and investment in municipal bonds. Were section 265 not the law, the exempt income would not be taxable, and in addition, the interest on obligations incurred or continued to receive tax-exempt interest would be deductible. In the light of its legislative history, the provision has been interpreted to permit commercial banks to deduct the interest on time deposits. Certificates of deposit of commercial banks, because of their similarity to time deposits, have been treated in the same manner. Of course, interest on nondeposit obliga tions of banks, such as notes and debentures, incurred or continued to carry or purchase tax-exempt obligations is not treated in the same manner as interest on deposits. Mr. M in is h . Mr. S ecretaiy, ju st recently the G overnm ent speeded up the w ithdraw al rate o f w ith h oldin g ta x paym ent. W hat have you been doin g to g et some o f th is m oney from the ta x loan accounts where I recall 4 or 5 years ago they had $5 billion? Secretary F o w ler . Secretary D illo n m ade a com plete study — I cannot remember the exact tim e—I believe I w as out o f the Govern m ent at th e tim e, but I have a recollection th at a study w as prepared listin g the relationship between the various services provided by the banks and the benefits received by the so-called tax and loan accounts arrangem ents. I w ill be glad to supply you w ith a copy o f th at report which w as m y predecessors explanation and com ment on the subject. I have not-----Mr. Min is h . I was going to ask you about that later on because at a hearing here some years ago he said that the Department was making the study but we never received it. Secretary F owler. Such a study has been prepared and has been available fo r a year or tw o. Mr. Mjn is h . Recently did you call in some funds from that ? Secretary F owler. W e are constantly draw ing them down. T h at is the w ay all the bills g et paid. Mr. M in is h . Are you going to continue to ? Secretary F owler. W ell, the balances go up and down. A s taxes are paid the ta x and loan account goes up at a particular bank, and as w e pay b ills to various contractors, or salaries o f Governm ent em ployees, tiie balances g o down. T h ey g o t dow n as low , I think as $1.5 billion on A p r il 20. Mr. M in is h . A re you going to keep it down? Secretary F owler. T h e m oney ju st keeps com ing in. Y ou cannot keep it at a g iv en level. T he ebb and flow o f these accounts is an inescapable consequence o f th e ebb and flow o f G overnm ent ou tp ay ment and G overnm ent inpaym ent. F o r exam ple, at th e four periods o f the year w hen corporations m ake th eir ta x paym ents w e have considerable am ounts o f cash. A t th e tim e w hen the quarterly p ay m ents are m ade on th e in dividu al incom e ta x w e also have a considera ble am ount. Mr. M in is h . You cannot keep it at a minimum. Secretary F o w l e r . T here is a constant effort on our p art to do so and one in w h ich a sister com m ittee to th is one, th e H ou se W a y s and M eans Canoonittee g iv es us a good g o in g over— and w ill n e x t M onday m considering th e debt-lim it legislation. 154 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS Mr. M in is h . O n p age 9 o f your sta tem en t: While none of us is in a position to evaluate just how serious this threat may be as a long-term matter affecting these institutions, there is a genuine current concern in the Congress, in the Federal Home Loan Bank Board, and in the pri vate economy, that a continued savings outflow could place undue stress on some of these financial institutions, and undue constraints on the flow of money into the mortgage market and homebuilding* I have a letter here th at shows how serious the problem is. This is a savings and loan in stitution in N ew ark, N .J ., and I received this yesterday. Permit me to present the facts from the records of our own association. Dur ing April 1966 the total sum of $2,794,963 of savings was withdrawn* Of this total we, by inspecting the endorsements of the returned withdrawal checks, have traced the use of course of $1,118,760. Of this traceable amount of $1,118,760, we find that $509,372 or 45.53 percent was delivered to one, and only one, of the commercial banks of Newark, which since last fall and persistently to the present time has advertised to the public issuance of certificates of deposit at a 5-percent yield. Secretary F o w le r . I th in k th a t is an exam ple o f w hat I fear is going on in m any other areas. Mr. M in ish . T hat is all, Mr. Chairm an. The C h airm an . Mr* H arvey. Mr. H arvey. T hank you, Mr. Chairm an. Mr. Secretary, I g et the im pression th a t back in M ichigan at the grassroots o f m y district th is is quite a critical situ a tio n ; that actu ally, it could very sharply curtail home b u ild in g and apartm ent build in g in the m onths ahead. I have the im pression, also, th a t some o f the savings and loans and other institutions such as that are acting in sort o f a psychology o f fear. In other words, even though th ey have money to lend, they do not know w hat is g o in g to happen at the end o f the next quarter because o f a sh ift in funds, and so forth, so they are not real anxious to loan those fun d s out. U p u n til now in our hearings, I w ill be honest w ith you, I have fe lt as you did, th at the chairm an’s bill would bring about financial chaos as I suggested one day. I have leaned tow ard H .R . 14422. I noticed in your testim ony th is morning that you oppose that particular b ill, but y e t I note th a t m your b ill the approach is pretty much the same, is it not ? Secretary F o w le r . A s a m atter o f fact, I th ink I said I have con siderable sym pathy w ith the apparent objectives o f H .R . 14422, and I think the tw o b ills are try in g to achieve som ew hat the same objective. B u t it did seem to me that the approach o f th a t b ill w ould be unneces sarily rig id and that it involves unnecessary discrim inatory action against sm aller savers at com m ercial banks under the present interest rate spread. Now , you w ill find a continuing em phasis in m y com ments on the tem porary transition period. I w ould hope som eday th at w e w ould back to a situation in w hich th e spread between w hat th e passbook saver gets fo r h is or her money and w hat others g et fo r larger amounts, w ould be not nearly as great as it is today. B u t under th e current cir cumstances it w ould seem to me th a t to push a ll th e savin gs back to the 4-percent level for the so-called sm all saver w ould be too drastic. (M r. A sh ley now presiding.) Mr. H arvey. I would certamly want to think your bill over and Know more about it, and how it is going to affect the various institutions UNSOUND COMPETITION FOR SAVINGS A N D TIM E DEPOSITS 155 and so forth . I personally fe e l th at it is th e a p p ro a ch to take w ith the lim ited know ledge th a t I have at th is tim e. W h ile w e have you here, Mr. Secretary, I did w an t to ask you a q u e stio n o r so in the tim e I have about the b alance-of-paym ents problem . Secretary F o w l e r . A re you g o in g to g e t in t o th a t ? Mr. H arvey. J u st tou ch on it. Secretary F owler. L et m e g e t m y-----Mr. H arvey. Y ou do n ot h a v e to get th e b r ie fc a s e out or anything. Secretary F owler. I alw ays like to g et th e briefcase out on this. Mr. H arvey. I have read in th e paper r e c e n tly since we can expect that our balance-of-paym ents deficit w ill b e som ew h at in the n eigh borhood o f $2 and $3 b illio n th is year. T h is is f a r in excess, o f course, o f what w e had expected earlier. T hen I r e c a ll reading o f the speech you m ade in P h oen ix n ot so lo n g a g o a b o u t so m e o f these voluntary restraints on oversea investm ents in bank le n d in g and you are sug gesting th at they w ould be continued fo r t h e duration o f the V ie t nam war. N ow , I th ink in a ll fa irn ess th a t we in C o n g r e ss here have been led to believe th a t these v o lu n ta ry restraints w e r e g o in g to be tem porary. Secretary F owler. T h ey are tem porary, M r . H arvey. Ju st as the war in V ietnam is tem porary. Mr. H arvey. B y tem porary you m ean t h e y are as tem porary as the w ar in V ietnam ? Secretary F owler. M y ju d gm en t at t h is tim e is that it w ould be foolhardy to abandon these v o lu n tary p r o g r a m s w hile we are at war in V ietnam . A n d in m a k in g th e sta tem en t I d id in P hoenix and I noticed som e considerable com m ent from o th e r s about that— I w ould like to be very clear th a t w e do n ot view th e s e volu n tary program s as a part o f any perm anent, lo n g -la stin g s o lu tio n o f th is particular problem. I do not see th em as part o f it . Mr. H arvey. T h ey are sem iperm anent? Secretary F owler. N o, no, le t us be clea r a b o u t this. I f you would read, and I w ould be g la d to provide y o u w it h a copy o f m y state ment yesterday on th e first quarter b a la n c e o f paym ents in detail, I think there is a general u n d erstan din g in m a n y circles, and in finan cial circles throughout th e w orld, th a t a v e r y special strain, and special difficulties, are created fo r a c o u n tr y in m aintaining equi librium , or attain in g equilibrium , in th e b a la n c e o f paym ents w hile it is carryin g on m ilita ry a ctiv ities on th e s c a le w e are. Mr. H arvey. T h at is m y n e x t question. I k n ow that the reasons you have g iv en are th e fig h tin g in V ie tn a m , b u t really, is n ot th is a classic case o f inflation w here the im p o r ts g o up and th e exports go down? Secretary F owler. T here are tw o fa c to r s t h a t m y statem ent d ev el oped yesterday. T here is th e direct co st t o o u r balance o f paym ents from expenditures in sou th east A sia. A n d I d o not g iv e any m axi mum figure to th at, b ut I s a y w e can v e r y d e fin ite ly account fo r som e th in g in th e neighborhood o f $700 to $750 m illio n o f direct outlays. Our balance o f paym ents w o u ld be r u n n in g a t an annual rate th a t much less i f th at a c tiv ity w ere n ot g o in g o n . T hen th ere is the in d irect cost. N o w t h e in d ir e c t cost is reflected in several w ays. Y o u h a v e t o ask y o u r s e lf j u s t to m ake i t sim p le, 156 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS w hat w ould the gross n ational product have been in th e first quarter under a situation in w hich there were no V ietnam % Mr. H arvey. L et m e just ask you— I have only a couple o f minutes. I w anted to touch on a couple o f things. I f our deficit exceeds th e $2 b illion figure, w hat effect do you think th is w ill have, i f any, on the negotiations to create an international un it o f m onetary exchange? Secretary F owler. I t should n ot have any at all. I did n ot say it w ould not—I said it should not have any at all. A n d I w ould hope th at those w ith whom we are n egotiatin g w ill understand. I t should not have any effect at all because th is is a contingency plannin g exercise to create a m echanical arrangem ent and an agree m ent and understanding by w hich, when additional liq u id ity needs to be provided from sources other than the deficits in our balance o f paym ents it can be done quickly and in an orderly w ay. These arrangements take years to create, as the present discussions and negotiations indicate. T herefore in m y judgm ent it w ould be very unwise to set aside or put these negotiation s on th e back burner, because the war in V ietnam w hich is the root now o f our problem in gettin g to equilibrium could end w ith out relation to any particular timetable. T his is not a prediction, th is is sim p ly th e recognition of the fact th a t it could happen. Mr. H arvey. W as not trie international n egotiations tow ard this new u n it th e reason, chiefly fo r requests fo r voluntary restraints? Secretary F owler. N o indeed. Y our tim e sequence is aw ay off* T he reason fo r the v o l u n t a i y restraint program w as because o f a very sharp upsweep in outflows in 1964— foreign bank credit w ent u p $2.5 billion m 1964. T he rate o f direct investm ent outflow w ent up very sharply and we had over a $1 b illio n deficit in the fou rth quarter o f 1964. I t w as only in J u ly o f 1965, in som e remarks th a t I m ade at a, m eeting, that the U n ited States invited, and you m igh t say initiated, the course o f m oving out o f discussion in to concrete negotiations on international m onetary affairs. A contributing factor tow ard m aking th at request, or that suggestion, one th at w ould be entertained was the clear dem onstration through th e voluntary program s th a t w e did have control o f our balance-of-paym ents situation. Mr. H arvey. I n your judgm ent, Mr. Secretary, do you consider the restraint on business investm ent abroad to have been any success? Secretary F owler. I th in k w e have received excellent cooperation from the banks and nonbank financial institutions. I th in k w e have received excellent cooperation from com panies operating a b r o a d and I do consider the volun tary program s to have been successful and to h ave substantially m oderated outflow s w hich w ould have otherwise made our deficits du ring th e period since la st F ebruary quite a differ ent order o f m agnitude. Mr. H arvey. One other question and I w ill finish. H a s you r D e partm ent m ade any decision w ith respect to tourism ? Secretary F owler. T h a t was discussed to som e extent yesterday at th e press conference. I th in k I am repeating m y self fa ir ly accurately w here w e said w e are Staying w ith th e current program . *W e h ave to in ten sify an d im prove th e effort to encourage foreign ers to tou r the U n ited St&t$s anu th e .effort to ha.ve U .S . citizens sta y a t hom e and sfcfc th eir edtinfcry; Wear© fo tg o in g any im p osition of a h e a d ta x , or UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 157 any other restrictive p olicy by Governm ent act on the righ t o f a citizen g o in g where he or she pleases. Mr. H a r v e y . T han k you very m uch, M r. Secretary. Y ou can be certain th at we w ill g ive very careful consideration to the b ill w hich you suggested here w hich w ould appear to be a very th o u g h tfu l ap proach to th e problem . Secretary F owler. T hank you, sir, Mr. A s h l e y . Mr. W eltner? Mr. W eltner. T hank you, Mr. Chairman. Mr. Secretary, I read your statem ent quite carefully and I think y ou very ap tly put it on page 10 w here you characterize the bills pending before m is com m ittee as “perm anent arrangem ents th at w ould com partm entalize our financial m arkets.5 T h ey w ould be just that. I think i f w e pass 5 these b ills it m ig h t forestall some natural change in the market where funds could come from the bank and g o back into savings and loan associations. T h en w e m ight have to come back and undo it. I think it is w ise th a t th e Congress not place rig id restraints upon tem porary conditions. N ow , it appears to me, though, th a t your recommendation o f a m axim um rate on th e m axim um insured am ount o f deposit, w ith the existing regulation rates on the excess, is not really a goal that has to be accom plished by legislation. W h y can’t the F ederal Reserve sim ply amend its present regulations to provide that? I f th at were done, if the circum stances changed, then w e do not have to come back and approve, in both H ouses o f Congress, rem edial legislation. Secretary F owler. I w ould prefer the answer to th at question to come from th e F ederal Reserve B oard spokesman. M y inform ation and im pression— arrived at b y serious m eeting and discussions in Decem ber and Jan u ary and February— is th a t the B oard’s legal ad visers consider it w ithou t authority, as they understand the current law , to fix rate differences based on the am ount o f deposit. Mr. W eltner. I f th at is the case, Mr. Secretary, then it w ould cer tain ly answ er m y question. H ow ever, it seems sort o f strange to me that w e have an agency o f Governm ent em powered to make decisions but----- Secretary F owler. W ith ou t assum ing th e role o f a law yer— I could at least read the provision o f the statute to you—th is is 12 U .S .C . 371: (b) Bate of interest to time deposits The Board of Governors of the Federal Reserve System from time to time shall limit by regulation the rate of interest which may be paid by member banks to time and savings deposits and shaU prescribe different rates for such payments to time and savings deposits, having different maturity, or subject to different con ditions respecting withdrawal or repayment or subject to different conditions by reason of different locations, or according to the varying discount rates of member banks in the several Federal Reserve districts. There is n o reference to amount. N ow , our proposal here w ould insert at th a t p oin t in th e law th is language : In addition to the above, the said Boiard may prescribe the limit on the rate # interest which may be paid on that part of any time or savings deposit that not exceed the maximum amount that may be insured by the Federal DePfmt Insurance Corporation, lower than the limit prescribed for that part of such wposifc that exceed* such amount ' 158 U SO N COMPETITION N UD TOR SAVINGS AND TIM E DEPOSITS Mr. W e l t n e r . I s n ot the character, being fu lly insured u p to $10,000, a different condition o f repaym ent ? Secretary F owler. T h is is som ething you have to pursue w ith the F ederal R eserve B oard. Mr. W eltner. Mr. Secretary, i f w e passed a b ill such as th is, is there any assurance that the F ederal Reserve B oard w ould prom ulgate a n ew order under regulation Q th a t w ould m ake that differential in the interest rate based upon the m axim um insured am ount ? Secretary F owler. T he clear inference o f m y statem ent is, in the processes o f legislation, either through open testim ony or oth er com m unications, that th e Congress w ould assure itse lf o f th at fact. Mr. W eltner. T hank you, Mr. Secretary. I have sat on th is com m ittee for alm ost 4 years now , and I have often heard our d istin guished chairman direct him self to the question o f th e response and the receptivity o f the Federal Reserve B oard to the desires and wishes o f Congress. Based upon that “con dition in g” I am n ot exactly sure, were we to adopt such a bill and have a fu ll acceptance o f yo u r pro posal, that that would indeed be im plem ented by th e F ed eral Reserve. Secretary F owler. Lacking such assurance you m ig h t w ant to make it mandatory for the first year. Mr. W eltner. A nd make a “perm anent arrangem ent” in our finan cial m arket; would we n ot ? Secretary F o w l e r . Y ou would be so involved. Mr. W eltner. T hank you, Mr. Secretary. Mr. A shley . Mr. T odd ? Mr. T odd. I wonder i f he should suggest that members o f th e com m ittee sit on the Board as far as th is regulation is concerned. Mr. W eltner. W e have one member o f th e com m ittee w ho h a s tried to sit on that Board. Mr. A shley . In his absence we need not continue th is any further. Mr. T odd. Mr. Secretary, I appreciate your com ing before u s this I have a number o f questions th a t I w ould lik e to ask. D id the C oordinating Com m ittee on B an k Supervision review your proposal and proposed b ill th at you have ? Secretary F owler. N ot as such. I have a m eeting scheduled for th is afternoon in w hich I expect to do that, but the chairm an indicated that the committee w ould not be m eeting tom orrow and since I am dedicated to the debt lim itation hearings before the W a y s and Means Committee on M onday. I had to come in today w ithout the benefit of consultation w ith the C oordinating Com m ittee as such. I have dis c u s ^ th is w ith some o f the individual members, however. * r*J 0?0, ^ wonc^ ^ there has been any discussion o f th e 5-percent er rate w hich you are proposing ? Chairm an H o m e ’s letter did n o t dis cuss t-nis and it is my im pression that th is is to o h ig h a rate fo r some savings and loans to live w ith. Secretory F owler. I d o not believe that I could add a n y th in g to the committee’s understanding o f w hat the p osition o f the F ederal H om e ljoan B ank Board, F ederal R eserve B oard, or F D I C w ou ld be o n this question. 1 ^ in k ^ is important to us if we are to establish some S w JLT® i T ““ a e r a t e knowledge of the impact of this par™ ^ loanS' M y own impression, based o» my own discussions with those at home, would be 4% -would UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 159 be about th e m axim um they could liv e w ith. I t w ould seem to m e we should have some accurate expression from th e C oordinating Com m it tee or the H om e L oan B ank Board as to th is interest rate. T h at is w hy I wondered i f you had an opportunity to discuss it w ith them. Secretary F owler. No. Mr. T odd. I t is a m atter of policy th at you are bringing up here. Secretary F owler. T here are a great m any questions about th is situ ation on w hich I w ould like to have a great m any more answers than I currently do. B u t it was som ething, as I indicated, that had to be done in fa irly short order and I subm itted it here as an approach and as a principle and as an attack. I think it is im portant that you try to keep it sim ple. Y ou are never g o in g to g et som ething that is g o in g to please everybody, and you w ant to get som ething that is goin g to help and th at you can g et through. Mr. T odd. W h a t w ould you think o f the idea o f establishing say, a 6-month m inim um fo r the m aturities o f C D ’s? W ould this assist? Secretary F owlek. I think the authority fo r that already exists and therefore th e concern o f the committee should be, w hy does not the appropriate authority exercise that ex istin g authority to amend the regulations in th a t fash ion ? Mr. T odd. I thin k your suggestion that th is authority be utilized by the F ed is an excellent suggestion. I w ould be concerned that we on the com m ittee not g et involved in m aking piecemeal decisions as far as m onetary policy is concerned. I do not think we can address ourselves to th is too w ell. I wonder i f you have any inform ation or any opinion, rather, as to whether the rate in regulation Q, the interest rate in December was prim arily in response to a liqu id ity problem or an attem pt to slow down an overheating o f the economy ? Secretary F owler. I did not engage in any discussion, nor was I aware, prior to the action, o f th e exact nature o f the action that was contem plated. M y discussions had to do w ith w hether any action should be undertaken at th at particular tim e. I was in no way aware of, nor did I have, nor can I give you any authentic background of, the purpose and m otivation. Mr. T odd. In connection w ith th is problem, I wondered i f it would also be appropriate fo r the com m ittee to discuss whether or not reserve requirements could appropriately be raised on C D ’s, th a t th is w ould make them a less expansionary influence in the economy ? Secretary F owler. I tried to raise that, and did raise it in m y state ment. I referred to it before. . On page 8 you w ill find the first fu ll paragraph suggesting, “i f m the jud gm en t o f the com m ittee some action is deem ed desirable, a better approach m ig h t lie in the direction o f p rovid in g the appropriate m onetary authorities w ith greater discretion to set levels o f reserve requirements 011 large negotiable certificates o f deposit that m ight e x ceed those on other tim e and savings deposits. O f course, you w ill those m uch closer to the probw ith th a t in any depth or w ith M y precision. B u t t th in k th is is in the lin e o f approach, certainly, that w ould appeal m ore to m e than ou tla w in g the C D ’s com pletely as th e other b ill did. 160 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS Mr. T odd. In this one, if the reserve requirement were raised, it would reduce the liquidity problems as they come due? Secretary F owler. T h at is righ t. T h a t is w hy I m ade reference to the com m entary in th e report o f -the Com m ittee on F in an cial Institu tions in A p r il 1963, w hich I thin k indicates th at one o f th e important elem ents in this entire picture is concerned w ith adequate instruments to deal w ith the liq uid ity problem . T h is is n ot true only o f the com m ercial banks. I w ould like to take this opportunity to call to your attention th e fact th at on Septem ber 2 0 ,1 9 6 5 ,1 subm itted to Congress a proposed bill to provide for an increase in th e m axim um amount of insurance coverage from $10,000 to $15,000 on deposits. In the letter o f transm ittal I m ade it very clear th e recom m endation w as m ade only on condition that a number o f steps w ould be taken to protect further the safety and the liqu idity o f the financial in stitutions w hose ability to attract funds from the public w ould be enhanced by th e increase in deposit and share insurance coverage. T he bill I subm itted c o n t a i n e d a number o f im portant provisions designed to accom plish these ob jectives. F o r exam ple, it provided adequate authority to th e Federal H om e Loan B ank B oard to insure the m aintenance o f insured associa tions. I t w ould m ake liq uid ity requirem ents applicable to the total o f withdraw able accounts and borrow ing, rather than th e w ithdraw ing alone, and would im prove accounting and enforcem ent conditions. The overall question o f liq u id ity th a t is raised has its c o u n t e r p a r t in the savings institutions. A t the conclusion o f the report o f the Committee on F in an cial In stitu tio n s to w hich I referred earlier, the uestion o f reserves fo r tim e deposits is taken up. I t goes b e y o n d ins tem porary question w e have here in v o lv in g w ith d raw als from savings and loan institutions. I t is one w hich I w ould hope th e c o m mittee could shortly turn its attention to both in the question you raise and also the pending bill th at is before th e com m ittee d ealin g w ith inc r e ^ n g t h e m axim um am ount o f insurance coverage. (Mr. T o d d subsequently subm itted the R eport o f the Com m ittee on *^nancial In stitutions, w hich m ay be found in th e appendix beginning a Mr. A s h l e y . Mr. M ize? Mr. M i z e . Mr. Secretary, w ou ld you care to conjecture on w h at the ta a n c ia l situation o f th e country w ould be and w ou ld have been had tbe * ederal R eserve not done w hat it did in D ecem ber ? k ^ ra ta ry F o w l e r . N o , I w ould n ot p articularly care to c o m m e n t on that. I think that in answ ering questions o f the chairm an I have co m m u ted on it m any tim es. I w ould only sa y th a t in p e r s p e c t i v e , I tninK th at it is fa irly clear th a t a p olicy o f m onetary and fiscal res t ^ in t w as indicated a t the tim e th e action w as taken. W e w ere in t i » tte o e s o f considering w h at com bination o f fiscal an d monetary SSEmJ d h® W e fe lt th a t th e inform ation that w ould become available in th e m onth o f Decem ber h a v in g to do with the budget figures fo r the rem ainder o f fisc a ll9 6 6 and fo r fiscal 1967 w hich w ould encompass the w hole F ederal program as fa r as w e could see it w as essential. T h e better course w ould be in th e lig h t o f that sum to ta l o f inform ation, to try to arrive togeth er in a coordinated ^ gLgggP ^ Frol** m * w d methods and choice of m«m» of fiscal wtaunt ™ad h, .pjropriM. m te tho*. I have indicated, ! "was not successful in prevailing—my advice the Board moved in the field of monetary re ■ hs not accepted and w UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 161 straint. T hen, as subsequent comments have been m ade clear, the President announced shortly thereafter, w e were goin g to accept that action as a fa c t o f life. Mr. M ize. W ell, w ould you care to conjecture on w hat you feel m ight be a situation i f th e action th at was taken by the F ederal R e serve in D ecem ber w as rescinded ? Secretary F owler. I th ink that as I have indicated before, in testi m ony before the J o in t Econom ic Committee, that th is is a tim e in which a m oderate m easure o f both fiscal and m onetary restraint is appropriate and has been appropriate to the situation for these m any months. Mr. M ize. T hank you. Mr. A shley . Mr. Annunzio? Mr. A nnunzio . T hank you, Mr. Chairman. Mr. Secretary, I w ould like to join m y colleagues in com m ending you for your very constructive and practical statem ent before the com m ittee on th e problem s th at face us— the com m ittee and the people of the country. I should also like to comment th at as a member o f th is comm ittee I have heard m any w itnesses— and I would like to use the analogy o f th e w ar in V ietnam — everybody w ants peace, but they just do not know w hat to do about b ringing peace to the world. B u t at least you came before the com m ittee w ith a b ill, a practical suggestion w hich indicates you recognize, like th e members o f th is committee, that there is a problem in the m oney market, there is com petition for money, and th a t in the public interest we m ust do som ething to stop th is bidd in g in the m oney m arket am ong th e various financial institu tions that ex ist in the country. Mr. Chairm an, before I get into m y questions, Mr. Eees, our col league from C alifornia had to leave. H e introduced a bill today regu lating bank certificates o f deposits and I w ould like to ask unanimous consent to include his press release in th e record. Mr. A shley . A t th is point? W ithout objection, so ordered. (T he press release referred to fo llo w s :) L e g is la tio n R e g u la t in g B a n e C e r t if ic a te s C on gressm an R ees, M ay of D e p o s it In tr o d u c e d by 19, 1966 Legislation restricting the use of bank certificates of deposit was today intro duced by Congressman Thomas M. Rees, Democrat of Los Angeles, Calif., a member of the House Committee on Banking and Currency. “It is my belief that the unregulated use of certificates of deposit is dangerous to the banking system of this country. Already overinvestment in certificates of deposit has caused serious problems of liquidity in banks throughout this country and, in some instances, has contributed to bank failures,” said Rees. “The unregulated use of CD's in driving interest rates up has caused a serious dislocation in the savings and loan industry. For example, in California bank certificates of deposit are being sold for amounts of even less than $100, for terms as short as 30 days, and at interest rates of up to 5*6 percent. This has caused a flow of deposits from savings and loan institutions, which were held at 4.85 per cent (prior to today’s hike to 5 percent). The result has been a slowdown of both the building and real estate industries as new mortgage money is very diffiC ir *° U continued the Congressman. If we do not develop reasonable restrictions on CD's, not only is the banking system dealing with an extremely dangerous situation in terms of liquidity, but U threatens the further development of fast-growing States such as California necessary mortgage capital,” stated Rees. The bill which I am introducing defines certificate of deposit as a deposit I year or more maturity, which can draw an interest rate no more than the **vmgs account interest rate authorized by the Federal Reserve Board. In this 162 UNBOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS way the CD would be relegated to what its original intention was— allow ^to businesses to invest their excess funds in a time account for interest revenues,” explained the Congressman. “I believe this approach is far sounder than merely placing a floor on bank CD’s,** concluded Rees. Bees hopes that his legislation on the subject of certificates of deposit can be heard during the current hearings by the House Committee on Banking and Currency. M r. A n n u n z i o . Mr. F ow ler, C ongressm an W eltner sat on th e com m ittee fo r 4 years. I have been here 15 m onths and I have heard many, m any com m ents from our chairm an on th e F ederal R e s e r v e Board. W hen I first came to C ongress and sat in one o f these m eetings, in reading, I read about th is C oordinating C om m ittee th at exists, w ith you as the Secretary o f the T reasury and th e C om ptroller o f th e Cur rency and the F ederal Reserve B oard and th e F D IC . I w ant yon to know th at I w as a m em ber o f th e cabinet o f G overnor Stevenson in the S ta te o f Illin o is. A s a m em ber o f th a t cabinet I h ad nine divisions under m y jurisdiction but th e ch iefs o f tw o o f those divisions, the c h ie f o f th e State factory inspectors and th e chairm an o f the industrial com m ission, had th eir appointm ents approved b y th e Senate o f Illin ois and natural there w as a conflict o f p o licy m atters because th ey felt th at I had no jurisdiction u n til one day I discovered th a t i f I d id not sign th e payroll sheet th a t th e ch ief inspector and chairm an o f the industrial com m ission, along w ith th eir em ployees w ou ld n ot be paid. S o one o f the p ayroll periods cam e a lo n g and the director o f labor ju st fo rg o t to s i m th e payroll sheets. B y th a t tim e th e G overnor and press and everybody else w anted to know about th e problem th a t ex isted in th e departm ent o f labor and soon I g o t th e recognition that I w as look in g for. T h a t seem s to be th e problem o f th e C oordinating C om m ittee. A ga in , I w ould lik e to em phasize th a t som etim es in these com mittees you wonder w h o w atches us, and w ho coordinates th e coordinator. S o I agree w holeheartedly^w ith th e chairm an o f th is com m ittee that i f the C oordinating C om m ittee is to coordinate these various agencies h a vin g to do w ith m onetary p olicy o f th e country, th a t direction should come from th e P resid ent, th e head o f our G overnm ent. In this w ay understanding is established and th e ground rules are laid, so that w hen one agency issues a d irective, at least th e other agency ought to h ave some know ledge o f w h at is g o in g on. M r. F ow ler, on page 3 o f your prepared statem ent you suggested all bank deposits cost the banks interest. B u t is it not true th a t approxi m ately one-half o f th e bank deposits, th e dem and deposits, cost the banks n othin g at a ll ? Secretary F o w l e r . D em and deposits do n ot bear interest. I do n o t h ave the exact proportion, b ut it is about h a lf. T h e banks have as the very basis o f th eir being, so to speak, the fu n ctio n o f i n t e r m e d i a t i o n — o f ta k in g the m oney th a t is on dem and and u sin g it again st r e s e r v e requirem ents and to loan out th e rem ainder. Mr. A n n u n z i o . M r. Secretary, m y tim e h as expired, but I w o u l d appreciate g ettin g from y o u r office a copy o f form er Secretary D i l l o n ’s report to w hich Mr. M inish referred. Secretary F o w l e r . Y es, sir. M r. A s h l e y . M r. O ttinger? UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 163 Mr. O ttinger. Mr. Chairman, considering one o f th e bills that I in troduced is subject to discussion, I wonder i f w e could not have unani mous consent to proceed som etim e after the noon hour. Mr. A shley . I th in k we w ill continue w ithin reasonable lim its to accommodate the desires o f the members. I do not intend to continue on too lo n g after 12 noon. Mr. Ottinger. Mr. Secretary, I am very interested in the proposals you have m ade. I am som ewhat concerned about areas o f possible confusion. F irst, I w ould like to have it made clear, th at your proposal is th at the F ederal B eserve B oard and the som etim e com plem entary reaction o f the F D I C w ould have, in effect, changed th e power o f regulation Q, bring dow n th e interest rates on certificates o f deposit on tim e de posits on denom inations below the $10,000 present lim it-----Secretary F owler. A lso on the first $10,000 o f any larger amount. Mr. Ottinger. Y our proposal is not, on the contrary, th at the sav ings and loan associations be perm itted to increase the rates that they charge on their am ounts— the question as far as your proposal is con cerned does not involve the ab ility o f the savings and loan associations to pay h ig h rates ? Secretary F owler. N o. I t is a proposal, however, that takes into account the actions and policies o f the F ederal H om e Loan B ank Board. Mr. Othnger . There is a difference in the restrictions as they exist on Federal savin gs and loan associations, w hat they m ay charge on th eir accounts and th e 4 percent that you referred to on page 4 as to the lim it on passbook accounts? Secretary F owler. Y es. Mr. O ttinger. T h e present lim itation on w hat savings and loan in stitutions m ay pay is 4% percent? Secretary F owler. N o, it varies around the country. I t is somewhat on a regional basis. I think the announcem ent on Tuesday, for ex am ple, w hich w as addressed to a particular situation, w ould allow sav in gs and loan associations in C aliforn ia to continue to have access to advances fo r expansion if their annual dividend rates w ould not ex ceed 5 percent as o f J u ly 1, 1966, and are com pounded not more fre quently th an quarterly. Mr. O ttinger. T h is I take it is a feature to w hich m y colleague, Mr. T odd, w as referring, th at some o f them are g o in g to have a hard tim e ta k in g advantage o f that. Secretary F owler. T h at is right. Mr. O ttinger. I w ould like to refer to a question by Mr. Gonzalez earlier, and th at is, W h a t is th e sense o f concentrating on these sm all certificates i f indeed our problem is th a t 90 percent o f them are in the larger denom inations? I t is m y understanding th at th e volum e is so great in these certificates o f deposit now , som e $17.5 b illion , th a t even the 10 percent o f the sm aller denom ination certificates are causing real problem s fo r th e m ortgage m arket and th a t is really w h y w e have to concentrate on the sm all certificates, even thou gh th ey represent a sm all percentage overall. Secretary F owler. I th in k th a t is true. I t is the b ig ones w hich m ake up a lo t o f th e volum e but th ey do not really draw th e deposits 164 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS aw ay from th e ty p ica l savin gs and loan organizations and m utual savin gs banks. Mr. O ttinger. I n m y b ill I pick $15,000 lim it on the basis th at we w ou ld even tu ally adopt the adm inistration’s proposal fo r increas in g it. Secretary F owler. I had th at in m ind, too. Mr. O ttinger. I hoped we m ight. B u t in settin g the lim itation, if it w ould becom e apparent through these hearings th at w e need to know more about where the savings and loan in stitutions lie, w ould it be possible fo r you or you in conjunction w ith the F ederal R eserve people to work up figures fo r us show ing for various denom inations o f cer tificates o f deposit and how m uch m oney at the present tim e is invested ? Secretary F owler. I thin k th at the inform ation on th at subject w ould best come from the surveys o f the F ederal R eserve Board. It has made one and I do n ot know w hether the inform ation requested w ould be w h olly responsive to your question. W e in T reasury do not have this inform ation in the form in w hich you requested. I w ill do m y best to see i f we can g et together th e inform ation th a t is available, either at the Federal R eserve Board or F D I C or other sources. (T h e inform ation referred to fo llo w s :) Time certificates of deposit at insured commercial tanks, Apr. 26, 1965, by size of certificate Sise of certificate [Amounts In thousands of dollars]i All banks $10,000 and under___________________________________________ 10,217,617 Over $10,000 to $50,000______________________________________ 4,445,881 Over $50,000 to $100,000________________________ _____________ 2,290,200 Over $100,000 to $250,000_____________________________ ________ 2, 525,378 Over $250,000 to $500,000______________________________________ 2,966,921 Over $500,000 to $1,000,000____________________________________ 7,345,464 Over $1,000,000______________________________________________ 6,250,630 Total certificates of deposit--------------------------------------------- 36,041,850 Source: Comptroller of the Currency, Federal Deposit Insurance Corporation, and the Federal Reserve Board. M r. O t t i n g e r . Y o u recommend on page 8 th a t we consider raising the reserve requirem ents behind a t least large denom inations o f certi ficates. D o y ou have legislation in m ind or could you prepare some th in g? Secretary F owler. W ell, I w as really, in a ll m odesty, expressing a preference fo r a particular approach and su g g estin g th at i f the com m ittee m oved in th is particular direction, I th in k you w ould w ant to get m uch m ore in form ation from th e supervisory authorities. Mr. O t t i n g e r . Y ou recom m end th a t w e leave discretion to th e F ed eral R eserve and F D I C in settin g interest rates and lim itations. It s till seems to m e th a t it is th e F ederal R eserve B oard th a t g o t us into th e problem th at w e are in now by perm ittin g 5 y2 percent to be paid on certificates o f deposit. I think th at there are m any o f us w ho were n ot com placent about le a v in g th a t discretion in th e F ederal Reserve B oard. I rather lik e you r suggestion, how ever, th at th is is a tem porary situ atio n and perhaps w e provide a tem porary solu tion in term s of rig h tin g w h at w e do in a period o f a year or tw o years and take another look at them . W ill you h ave an y objection, i f w e placed a lim itation o f UNSOUND COMPETITION FOE SAVINGS AND TIM E DEPOSITS 165 2 years to h a v in g a $10,000 or a $15,000— w ell, either interest rate m an dated at th a t level or a floor placed such as m y b ill does—no certificates under th e denom ination o f $15,000 ? Secretary F owler. M y own im pression is th a t the m ovem ent here to m andate regulation is not a good practice or a good precedent for the Congress to undertake, and that the delegation o f authority w ith fixing o f standards for the exercise o f th at authority is a better avenue o f approach. C onditions can change and do change very rapidly as we have found. I t is better to make allow ance for it. I would think that in th is particular field, i f the com m ittee has very strong feelings and th ey w ant to assure, i f they pass th is law , th a t it is not goin g to lie unused, that you can effect that kind o f understanding in the process o f legislation, either form ally or inform ally. Mr. Ottinger. Y et, you are w illin g to have us m andate interest rates, is th at correct, the 5-percent interest rates ? Secretary F owler. N o ; I said th at even in d ealing w ith the interest rate m atter, it is better not to m andate it in to law. I think you are dealing w ith m en w ho are sensitive to th is situation and i f there were very clear expressions o f in ten t o f Congress th a t this authority w ould not lie unused. T h is goes on in th e leg isla tiv e history. Mr. O ttinger. T h e F ederal R eserve B oard could have taken from that— the F ederal Reserve B oard could have taken some action to am eliorate its effect o f regulation Q. I t could have been directed spe cifically to some o f the problem s w e have now i f they had seen w hat w as h app enin g to the 5-percent rate and p ut it back. M aybe they could not have discrim inated in their interpretation o f the law between large and sm all denom inations. Secretary F owler. I think in all fairness to the Board, you have to recognize there is a certain chronology to th is business. There were in itial apprehensions and fears w hich I shared m yself in December and asked the C oordinating Com m ittee to study and look closely at the problem. T h ey did in January. T h e B oard sent out and m ade a survey o f the changes in rates th at were occurring early in the year. T he returns from th at survey did not indicate too much w as happening, and then the situation took a m uch sharper, and much more acute turn, during the m onth o f A p ril and it has only been in the last 2 or 3 weeks that you and I and a lo t o f others have fe lt th at some o f our earlier apprehensions were now som ewhat justified and th at w e ought to ad dress ourselves very specifically and concretely to th is problem. Mr. Ottinger. J u st one more question, Mr. Secretary. There is concern expressed in your statem ent that the chairm an’s overriding concern about your solution th at you proposed or m y solu tion, th at w e w ould be discrim inating against th e sm all investor in favor o f th e large investor. T o w hat extent do you feel that th is is a legitim ate concern, or on the contrary, th at it really reflects th e in creased purchasing power, i f y ou w ill, o f the larger in stitu tion s ? A re we really d oin g an ythin g to th e sm all investor i f w e place a lim itation on these certificates o f deposit and th e interest th ey m ay charge on the level at w hich th ey m ay be issued th at is n o t already the case? Secretary F owler. T o me, it is a th orough ly w arranted and justifi able action on several scores. N o. 1, at least in the context th a t I presented it, it is a tem porary m atter to deal w ith a transitional problem . 63-496—ee------12 166 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS N o. 2, insofar as it can, th e proposal is that each person gets the sam e rate on the first $10,000 and i f the fello w can go m ore than that, then on the larger volum e he w ould g et a better return. There is also an im portant elem ent o f risk attached to the larger amount. T here is also the fa ct th at there is in the law today in the w ay it operates a discrim ination between th e so-called passbook saver and the iello w who takes tim e, and has th e know ledge and know-how, to take off from work and to g o dow n to the bank to do w hat I am afraid I have not had the opportunity to do, and that is, to buy C D ’s. Mr. T odd. W ould the gentlem an yield ? Mr. Ottinger. Yes. Mr. T odd. In th is connection, Mr. F ow ler, I wonder i f my under standing is correct, in your d raft b ill, you w ould raise th e passbook saving rate? Secretary F o w l e r . I t w ould not affect th a t at all. Mr. T odd. I t would not affect it at a ll ? Secretary F owxer. N o, sir. Mr. T odd. Thank you. Mr. Ottinger. Thank you, Mr. Secretary. Mr. A shley. Mr. Secretary, you were very generous w ith your time and the com m ittee does appreciate it very much, th e benefit o f your counsel on th is m ost im portant m atter. I f there are no further ques tions, the committee w ill stand in recess u n til n ext T uesday m orning a t 10 o’clock. (W hereupon at 1 2 :10 p.m., the com m ittee adjourned, to reconvene at 10 a.m., Tuesday, May 24,1966.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS TUESDAY, MAY 24, 1966 H ouse of R epresentatives, Committee on B anking and Currency, Washington, D.C. T he com m ittee m et, pursuant to recess, at 10 a.m., in room 2128, R ay b u m H ouse Office B u ild in g, H on. W rig h t P atm an (chairm an) presiding. P resent: R epresentatives Patm an, B arrett, Mrs. Sullivan, Reuss, A sh ley , Stephens, Gonzalez, M inish, W eltner, Grabowski, Gettys, Todd, O ttinger, M cG rath, A nnunzio, Rees, Mrs. D w yer, H a lp em , T alcott, and M ize. T he Chairman . T he com m ittee w ill come to order. T h is m orning, the com m ittee continues public hearings on H .R . 14026 and related bills to elim inate m isuse o f certificates o f deposit and tim e deposits generally. B efore w e hear from today’s w itnesses w ho are five o f the seven m em bers o f th e F ederal Reserve Board and tw o other high officials o f the F ederal R eserve System , I w ould like to make some prelim inary remarks. “I t seem s to me th at the F ederal Reserve has made a serious m istake over the p ast several years in repeatedly raising the interest rate ceil in g on com m ercial bank tim e and savings deposits to the present very h igh lim it. T h e argum ents advanced in support o f these increases— particularly the increase o f Decem ber 1965— strike m e as weak and even illogical. I t does not seem consistent to act to restrain credit w ith one hand and to increase the flow o f deposits into the com mercial bank in g system w ith the other. T he result has been to place com peting savin gs institution s a t a serious disadvantage, to bear down w ith un equal pressure on the housing m arket, and to set in m otion a w asteful and possible dangerous scramble for deposits. I t is not reassuring to have it explain ed th a t a rise in the rate ceilin g w as necessary in order to avert a m oney m arket crisis. N or is it sensible to raise the ceilin g and then criticize bankers for g o in g to th e ceiling. B oth the theory and the practice o f regulation Q are in need o f some serious rethinking. I t is to be hoped th at the rethinking occurs before a point o f no return is reached.” In terestin g ly enough, these few sentences I have ju st read did not origin ate w ith th e chairm an o f th is com m ittee. T h ey w ere spoken verbatim on A p r il 13, 1966, by Mr. G ordon M cK inley, vice president o f M cG raw -H ill, In c., publishers o f B usiness W eek. Perhaps our w itnesses th is m ornin g w ill address them selves to M r. M cK in ley’s 167 168 XJNSOXJND COMPETITION FOR SAVINGS AND TIM E DEPOSITS charge and to con vin cin g th is com m ittee w h y C ongress should not it s e lf prescribe specific g uid elin es w ith respect to tim e deposits. T h e le g isla tiv e h istory o f th e provision o f th e B a n k in g A c t o f 1933 co n tro llin g h ig h b id d in g fo r vola tile deposits stron gly suggests that th e F ed era l R eserve B oard has sad ly fa llen dow n on th e job. B efo re w e hear the B oard ’s side o f it, le t m e quote from Senator G lass on th e Senate floor back in 1933: We confide to the Federal Reserve Board authority which it does not now possess in this connection to regulate interest on time deposits in order to put a stop to the competition between banks in payment of interest, which frequently induces banks to pay excessive interest on time deposits and has many times over again brought banks into serious trouble. N ow it seems to m e th at last D ecem ber’s liq u id ity crisis fa cin g banks in the large m oney centers due to possible w ith draw al o f $ 3 ^ b illion of corporate funds attracted in the first place by h ig h rates on negotiable certificates o f deposit is ju st w hat Mr. G lass w as w orried about. B egin n in g in 1956, tn e F ed eral B eserve B oard began successive amendm ents to regulation Q w hich the evidence indicates is the source o f this problem. T hese changes have resulted in th e present sky-high interest ceilin g on tim e deposits— in clu d in g C D ’s— and a m inim um m aturity o f only 30 d ays on such deposits, w hich is ridiculous for a tim e deposit. T hese changes w ere m ade by th e B oard at the behest o f a few large money m arket banks so th a t th ey could outbid Treasury b ills fo r liq uid balances o f large corporations. I n addition to the h ig h rate and short m aturity, n eg o tia b ility w as also a necessary feature.^ S o w h ile the B oard argues it is helpless under th e law to define tim e deposits in term s o f m inim um size, let there be no m istake th a t th e B oard does have the authority in term s o f rates and m aturities to stop the rate w ar w hich th e B oard itse lf started—th e raid in g of fu n d s out o f the Treasury b ill m arket and th e raid in g o f funds out o f th r ift institutions and hom e financing. I TTi ■ n o a ! tt ti a ^ a LJ a a J «m a __ ___ 1_1 _ i ? _^ tim e out to le g is la t e bank supervision w hich it m istakenly e n t r u s t e d to the F ederal B eserve B oard. I t is unthinkable th a t th e sam e probJem fa cm g our b anking system in 1907—illiq u id ity a n d u n s o u n d b i d d i n g fo r dep osits—w hich led to establishm ent o f th e Federal Reserve S ystem , still plagues u s today. N ot fo r 1 m inute should anyone th in k th a t th e various b ills now before th is com m ittee are intended t o dim inish com petition fo r s a v i n g s or to prohibit com m ercial banks from seeking tim e d ep osits on a s o u n d basis. T he large m oney centers seem to have spaw ned some purely banking problem s w hich w e expect tod ay’s w i t n e s s e s to c o m m e n t on in depth. G overnor R obertson, in the course o f you r testim ony, we w ould appreciate some discussion o f your 1956 dissent in the B o a r d ’s decision to raise regulation Q on D ecem ber 3 o f th at year, w hich s e e m s ave precisely predicted w hat has happened by constantly increas in g interest rates. J D o y on have th a t before you ? M r. B o b e r t s o n . Y es, I do. if rn ^ f™ ^ B B S° K’ Yes; 1 wiU P” ***! m any way you like, MrET UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 169 The C hairman . I f you w ill. I think it is so opportune and tim ely, and it occurs to me th at you predicted in 1956, 10 years ago, w hat w ould happen. Mr. Robertson. Y ou w ould lik e to have m e read the dissent in 1956 ? The Chairman . Y es, if you will, please. STATEMENT OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM; PRESENTED BY J. I. ROBERTSON, VICE CHAIRMAN; CHARLES N. SHEPARDSON, MEMBER, GEORGE W. MITCHELL, MEMBER, SHERMAN J. MAISEL, MEMBER, AND AN DREW F. BRIMMER, MEMBER; CHARLES J. SCANLON, PRESIDENT, FEDERAL RESERVE BANK OF CHICAGO; AND WILLIAM F. TREIBER, FIRST VICE PRESIDENT, FEDERAL RESERVE BANK OF NEW YORK i l r . R obertson. T h is is taken, Mr. Cliairman, from the B oard’s annual report. I have not read this in a lo n g tim e, but I am sure it m ust be righ t. T h is s a y s : Governor Robertson voted against this action for the reasons set forth in the statement beginning on the following page. A. An increase----The Chairman . T h at was on Decem ber 3, 1956, if I remember correctly ? Mr. R obertson. T h a t is right. A. An increase to 3 percent in the maximum interest rates that member banks may pay on (1) savings deposits and (2) time deposits not payable within 6 months would make it possible, it is alleged, for commercial banks to compete more effectively against other savings institutions for time deposits. Payment of such higher rates of interest might have these undesirable results: (1) I t would increase bank ojjerating costs and make it more difficult for banks to raise additional capital that they need. Since any bank offering higher rates would have to pay them on existing as well as new deposits, net profits after taxes of some member banks could be reduced by as much as 25 percent— or more in the case of country banks—and this would lower iu-t profits to below 6 percent of capital accounts, compared with an average of around 8 percent for many years. (2) To offset such additional costs, banks would be under pressure to seek higher yielding assets, which would probably be less liquid and more risky, and thus impair the liquidity and solvency of the commercial banking system. Prob ably the principal purpose of the legislation authorizing regulation of interest rates on time deposits was to prevent such a development, which was to some extent responsible for the banking difficulties of the 1930’s. Furthermore, I have some doubts as to the effectiveness of such a raising of the interest ceiling in attracting savings to banks, because competing insti tutions could always pay higher rates. Their ability to pay more is due not to this limitation on banks but to other advantages with respect to such matters as taxation and restrictions as to the nature of assets th at can be acquired. In addition, it is questionable whether generally higher rates on savings deposits would bring about a material increase in aggregate savings or would merely in fluence the form in which savings are held. It is plausibly argued that banks should be permitted to distribute to their customers as much of their earnings as they think they can afford, and that, since bank earnings are higher than they have been a t times in the past, banks should be permitted to pay higher rates of interest on savings deposits. My answer is th at Congress imposed on the Board the duty of preventing that very thing to the extent that it might jeopar dize the soundness of the whole banking system. If the ceiling should be raised whenever a few banks feel they can afford to pay higher rates, there is no point in having a ceiling. view of thoto possible undesirable consequences to the commercial banking System, and my doubt concerning the effectiveness of such an increase, I would 170 UNSOUND COMPETITION FOR SAYINGS AND TIM E DEPOSITS question the wisdom of raising the ceiling at this time and would vote to retain the present maximum rates. The number of banks which are now paying ceiUng rates is smaU and only a fractional percentage of these banks actively seeks the privilege of paying higher rates. I would not accede to the wishes of those few banks and thereby, perhaps, adversely affect the whole banking system. B. An increase in the maximum rate which can be paid by banks on time deposits payable in less than 6 months is questionable for a number of reasons: 1. Many of the funds thus held are not genuine savings but are liquid bal ances subject to withdrawal either to meet cash needs or to invest in other liquid assets whenever a rise in short-term market rates of interest makes such a shift profitable. 2. Banks would tend to treat such deposits the same as savings and determine their asset structure accordingly. This tendency is illustrated by the present situation in New York City banks which have substantial time deposits consisting of foreign central banks’ balances and other liquid funds, such as trust depart ment deposits, but have permitted their holdings of liquid assets to faU to ex ceptionally low levels. They now want to raise interest rates payable on such deposits to keep from losing them because they are so ill-prepared to meet the withdrawals. 3. Payment of high rates of interest on short-term time deposits would en courage evasion of a prohibition against the payment of interest on demand deposits. 4. Any resulting tendency to shift from demand to time deposits would reduce required reserves and thus release reserves for lending. This would not be in harmony with existing Federal Reserve credit restraint policies. 5. Liquid funds of this nature should be invested in open market paper, so that holders would have to bear the burden and risks of fluctuating rates and not shift that risk to the banking system. Finally, it should be noted that if the ceilings are raised sufficiently to be effective, they will enable commercial banks to attract funds now invested in Government securities—short term and long term. This may have a detrimen tal effect on the Government securities market and even lead to higher levels of interest rates generally, as applied to the borrowing public. I doubt the need for, and prospective benefits of, a present change in the ceiling rates on time and savings deposits are such as to warrant risking this possible consequence. N ow , Mr. Chairm an, th at w as w ritten 10 years ago, and it sounds pretty good still. T he C h a p m a n . D id it predict w hat w ould happen i f these rates continue to increase ? Mr. R ob ertson . I th in k th is is true, but I am sure som e o f m y as sociates w ould not concur in these view s. I w ould add for m y self th a t n o tw ith stan d in g th e im pressiveness o f those view s, the ceilin gs have been raised a num ber o f tim es in the interim , and as a result we have not only th a t dissent, but w e have other dissents as w e know the record discloses. B u t w e now have a situation in w hich the rules have been b u ilt into the pattern o f com petition in th is country, and consequently you sim p ly cannot back up to the situation w hich existed 10 years ago w ith ou t very destructive consequences. . I w ould suggest perhaps the w ay to lin k th is to th e present sub ject o f the hearings w ould be if I were to proceed w ith th e s t a t e m e n t w hich I w ill read in b eh alf o f th e B oard, and then perhaps the comm ittee w ould lik e to interrogate a ll the members. T he C h airm an . T h a t w ill be satisfactory. Y ou m ay proceed, sir. M r. R ob ertson . I t is m y purpose tod ay to express th e v iew s o f the B oard o f Governors on th e tw o b ills—H .R . 14026 and H .R . 1 4 4 2 2 ^ th at are the subject o f these hearings. I t m ig h t be h e lp fu l to begin w ith a sum m ary o f recent developm ents in b anking, attem p tin g to place those developm ents in historical perspective. A s th is com m ittee is w ell aw are, th e com m ercial b a n k in g system Digitized forhFRASER e m ore active in recent yea rs in seek in g lon ger term savings as becom UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 171 funds. T h is has n ot been an isolated phenom enon, but rather an in tegral part o f a m ajor change in the character o f com m ercial banking. B anks have become increasingly ready to challenge traditional or out moded practices. T hey have become more aggressive not only w ith respect to b id d in g for deposits, but also in finding w ays to p u t funds to profitable uses, in opening new facilities, in providing new services for bank customers, and in reducing costs by adopting more efficient techniques o f production, especially through autom ation. In addition, the increased activity o f banks in b id d in g for tim e deposits appears to reflect a response to the declining trend o f bank liquidity over the postw ar years. U nder the conditions o f high liquidity and lim ited loan demand that prevailed from the m id1930’s through the early years o f the postw ar period, banks showed little interest in com peting for tim e and savings deposits. A s loanto'deposit ratios advanced over the postw ar years, banks came to be increasingly concerned about their ab ility to m eet their customers’ loan demands. T h is concern increased in late 1959, when soaring credit dem ands and m onetary restraint p ut m any banks under pres sure. Shortly thereafter, banks increased their efforts to attract tim e and savings deposits, especially for corporate tim e deposits through the issuance o f n egotiable certificates o f deposit. T he em ergence o f the negotiable certificate as a money m arket instrum ent began in early 1961, when a large N ew Y ork C ity bank announced that it w ould issue certificates o f th is kind to both corporate and noncorporate cus tomers and that a large Government security dealer was establishing a secondary m arket for those instrum ents. Since 1961, outstanding negotiable certificates in denom inations o f $100,000 or more— certif icates large enough to be traded readily in the secondary market— have increased to more than $17 billion. G row th in outstandings has been relatively slow since the fa ll o f 1965, however, and it m ay be that the period o f rapid grow th o f these deposits is largely behind us. I f I m ay divert your attention fo r just a m oment, Mr. Chairm an, you w ill note on your chart, on the right-hand side, the grow th in 1965 was sharp, but th at sharpness was accentuated by grow th in the first three quarters, w ith a slow in g off in the last quarter w hich has proceeded during th is year. T he C hairman . J u st a moment. Mr. E euss . A short question on that point. T he chart there— m y old eyes have difficulty. Is that Decem ber 1,1965 ? Mr. R obertson. Decem ber 1,1965. Mr. R euss . W ell, I am under the im pression th at negotiable C D ’s have increased another b illion dollars to about-----Mr. R obertson. U p to about $17 b illion. Mr. R euss . $17y2 billion , isn ’t it, to date? . Mr. R obertson* I cannot give you the exact figure, but som ewhere in that area— 17.6. Mr. R euss . I w ould lik e to see a projection, because I , fran k ly, am a little skeptical about th is notion th at a ll is now peaceful. Mr. R o b ertso n . N o-----Mr. R euss . A n d th e negotiable certificates o f d ep osit are n o t g o in g UP* I am under th e im pression th ey have gon e up-----T he C h a irm a n . W e prepared th e charts. Mr* R euss. I t is our w a r t? 172 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS T he C hairman . A n d we w ill extend it in view o f your request. Mr. R eu ss. B efo re the hearing is over, I w ould lik e to have an accurate estim ate o f where they have gone since then. Mr. T alcott. Can you change th e chart at som eone’s request 2 M r. R obertson. I w ill furnish all the inform ation desirable. Mr. R euss . I am told that, as o f M ay 11, there were $17,571 m illion o f negotiable tim e C D ’s outstanding. Mr. R obertson. Right. M r. R euss. T h at, to m e, indicates no slack ing off o f the upward curve. Mr. M itchell. May I? Mr. R obertson. Y es, sir. Mr. M itchell. I t reached about 16.3 or 0.3, in the sum m er o f 1965, but it did not change again until ju st recently, w hen it w ent up into the 17% range. I t w as flat fo r a period o f about 6 m onths. The Chairman . M ay I suggest, G overnor R obertson, th a t you pre pare a new chart and bring it r ig h t up to date and w e w ill insert it in the record at th is point. Mr. R obertson. W e w ill be very glad to do that, sir. (T h e inform ation requested fo llo w s :) NEGOTIABLE CD's UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 173 Outstanding negotiable time certificates of deposit 1 at weekly reporting member banks on selected d a te s3 In million» of dollar« 796 Dec. 31, 1960___________________________________________________ Dec. 30, 1961------------------------------------------------------------------------------ 2, 782 Dec. 5, 1962___________________________________________________ 5.442 Dec. 31, 1963----------------------------------------------------------------------------- 9,579 1964: Mar. 25------------------------------------------------------------------------------- 10,718 June 24-------------------------------------------------------------------------------- 11 , 687 Sept. 30------------------------------------------------------------------------------ 11,955 Dec. 30----------------------------------------------- ----- -------------------------- 12,583 1965: Jan. 27____________________________________________________ 13,633 Feb. 24____________________________________________________ 13,866 Alar. 31------------------------------------------------------------------------------- 13,962 Apr. 28------------------------------------------------------------------------------- 14,741 May 26------------------------------------------------------------------------------- 15,110 June 30------------------------------------------------------------------------------ 15,342 July 28____________________________________________________ 15, 840 Aug. 25____________________________________________________ 16,177 Sept. 29___________________________________________________ 15,917 Oct. 27____________________________________________________ 16,387 Nov. 24____________________________________________________ 16,610 Dec. 29____________________________________________________ 16,097 1966: Jan. 26____________________________________________________ 16,430 Feb. 23____________________________ _______________________ 16,483 Mar. 30____________________________________________________ 17,193 Apr. 27____________________________________________________ 17,502 May 18*___________________________________________________ 17,743 *Denominations of $100,000 or greater. “Figures for 1960-62 are estimates. 3 Most recent date for which data are available. Mr. R o b ertson . Pressure on banks to find lendable funds has inten sified since 1961, as loan demands of customers have continued to out strip the growth o f deposits. Consequently, banks have become in creasingly" alert to the possibilities o f tapping new sources of funds, especially through issuance of negotiable and nonnegotiable certificates of deposit in smaller denominations, often called “savings certificates” or “savings bonds.” T he tw o b ills before the committee would cut off commercial banks from im portant sources o f funds through which they have been able to meet the rising financing needs o f businesses, consumers, home buyers, and State and local governments. T hey w ould also prohibit banking practices o f lo n g standing. T he earliest data available show in g a detailed classification o f tim e and savings deposits by typ e in d i cate that, in 1928, tim e certificates and open account tim e deposits comprised about one-fourth o f all member bank tim e and savin gs de posits held by businesses and individuals. T h is is nearly as h igh as the current proportion. The issuance o f certificates o f deposit to sm all savers has been a common practice in some M idwestern and S ou th western S tates fo r m any years. In 1928, country banks in the S t. L ouis and K ansas C ity Federal Reserve D istricts held as large an am ount o f savings under tim e certificates o f deposit as in savings accounts, su gg estin g th a t in those districts, sm all-denom ination tim e certificates were a le a d in g channel for th e placem ent o f individual savings. O ur m ost recent survey confirms th a t certificates o f deposit 174 UNSOUND COM PETITION FOR SAVINGS AND T IM E DEPOSITS in sm all denom inations are still an im portant source o f fu n d s to small banks in th e M idw est and the Southw est. I m ig h t say th at in m y hom etow n o f B roken B o w , N ebr., they still use tim e certificates instead o f sa v in g s deposits as a g en era l rule. T h e C hairman . F o r your area or the w hole cou n try % M r. R obertson. N o , n o ; ju st fo r B roken B ow on ly. T h e Chairman . T h a t’s g ood ; ju st your area. M r. R obertson. M y area. T h e n eg o tia b ility feature o f certificates o f d ep osit a lso h as substan tia l le g a l precedent. T he lan gu age used by m any b an k s in their cer tificates is patterned a fter w ord ing used in fo u r ex a m p les published b y the B oard in 1933, to p rovide guidance to m em ber banks in draw in g up tim e certificate contracts th a t w ould be con sisten t w ith Federal R eserve regu lation Q. T h e suggested lan guage w as w id e ly adopted, and m any banks presently issue certificates o f d ep o sit th a t are legally negotiable, even thou gh little use is m ade o f the n e g o tia b ility features. M any o f these certificates are in sm all d en om inations and are issued b y sm all banks, even th ou gh th e largest part o f th e d o lla r volum e of negotiable certificates consists o f certificates issued b y la rg e banks with denom inations in excess o f $100,000. T h u s, a recent F ed era l R e s e r v e survey indicated th a t three-fourths o f th e num ber o f m em ber banks w ith n egotiable certificates o f deposit outstand ing t o in d iv id u a ls and businesses on Decem ber 22,1 9 6 5 , were banks w ith less th a n $50 m illion in total deposits. T he changed attitu d e o f banks tow ard b id d in g fo r tim e d e p o s it s , together w ith th e increases in m axim um rates p a y a b le on tim e and savings deposits under regulation Q , h as altered sign fican tly the role o f th e com m ercial banks as an interm ediary ch a n n elin g funds from savers to borrowers. T h e p roportion o f to ta l cred it flow s fi nanced by expansion o f com m ercial bank deposits h a s been consider ably high er in recent years th an in m ost postw ar years. T h is increase in th e financing o f econom ic expansion throu gh th e b a n k in g system has been accom panied by som e decline in th e rela tiv e p o sitio n o f the banks’ m ajor in stitu tio n a l com petitors in th e sa v in g s field, a l t h o u g h the absolute size o f these nonbank in term ediaries h a s continued to increase rapidly. M ost recently, p articu larly in th e p e rio d since yearend, th e grow th rate o f a ll financial in stitu tio n s h a s slow ed , as more savings h ave tended to flow d irectly from savers to borrow ers rather than th rou gh financial interm ediaries, reversin g th e p a tter n o f savings flows th a t had p ersisted over th e exp ansion o f th e p re v io u s 5 years. W ith th is background in form ation in m ind, let us tu r n n o w to more specific consideration o f H .R . 14026 and H .R . 14422. T h ere is every reason fo r C ongress and th e supervisory a u th orities to rem ain alert during periods o f structural ch ange in financial flow s such as those now m process. T here is alw ays a p o ssib ility th a t ch a n ges in the com petitive position o f financial in stitu tio n s m ay be accom panied by excessively zealous efforts to g a in a short-run ad van tage, and to actions th a t m ig h t raise questions about th e liq u id ity , so lven cy, an d viab ility o f financial institutions. I n con tem p la tin g th e need fo r supervisory or leg isla tiv e action, how ever, it m ust be borne in mind that the forces of competition h a v e great potential fo r promoting the interests o f the consumer and for serving the public interest. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 175 T he tw o b ills a t issue represent, in the B o a rd ’s judgm ent, efforts to circum scribe com petitive processes in w ays th a t are harm ful to the public interest. H .R . 14026 w ould prohibit issuance o f negotiable certificates o f deposit and other sim ilar negotiable instrum ents purely on the grounds o f their negotiability. W e can see n o justification for a general prohibition o f that kind. T he legal status o f th e n ego tia b ility feature o f tim e certificates has a longstanding historical precedent. On econom ic grounds, the attribute o f n egotiab ility does not, in and o f itself, im pair the liqu idity o f th e issu in g bank nor o f the banking system as a whole. T he ab ility o f the holder to sell these certificates in secondary m arkets increases the attractiveness o f the instrum ent. B ecause the certificates bear stated m aturities, bank p ortfo lio m anagers are in a position to adapt the m aturity structure o f their assets to the scheduled m aturities o f their deposit liabilities. T he em ergence o f new financial instrum ents, and the adjustm ents in financial m arkets th at take place because o f them , have to be taken into consideration in the form ation o f m onetary policy. B u t the mere presence or absence o f negotiab ility does not im pair the ability o f the m onetary authorities to im plem ent w hatever policy is called for by the econom ic situation. H .R . 14422 w ould prohibit insured banks from accepting tim e deposits in denom inations o f less than $15,000. I t w ould deny to banks the use o f an instrum ent em ployed fo r m any years in attracting savings o f individuals. I t w ould deny to the sm all saver a form o t bank deposit to w hich he has been accustomed, but it w ould not pro h ib it the issuance o f certificates o f deposit in large denom inations to individu als o f substantial w ealth or to businesses. U nder the present structure o f ceilin g rates, sm all savers w ould obtain at most the m axi mum rate payable on passbook savings— 4 percent. Those fortunate enough to be large depositors could earn as much as 5 ^ percent. Su ch differential treatm ent o f large and sm all savers on the basis o f d ep osit size alone w ould be discrim inatory. The F ederal Reserve A ct now specifies four criteria the Board may use in settin g the m axim um rates payable on time and savings de posits : m aturity o f deposit, conditions respecting w ithdraw al or repay ment, bank location, and the discount rates in the several Federal R e serve districts. I t has been suggested by the Secretary o f the Treas ury th a t the act be am ended to give the Board tem porary authority to use an additional criterion for differentiating m axim um perm issible rates, nam ely, th e extent to w hich a tim e deposit is afforded protec tion through insurance by the Federal D ep osit Insurance Corpora tion. T he rationale underlying this proposal is th at returns on invest m ent should be scaled according to th e risk assumed by the investor. A ccordin gly, because a depositor’s risk on the insured portion o f the deposit is elim inated by the assum ption o f a contingent lia b ility by the Federal G overnm ent, the m axim um rate payable on that portion could be less than on the uninsured portion. T he B oard welcom es consideration o f measures aim ed at increased flexib ility in adm inistering ceilin g rates on tim e and savings deposits. B u t experience has tau gh t us th at th is is a com plicated field in w hich changes som etim es produce ram ifications th a t are n ot anticipated. F o r th is reason, th e im plications o f a new leg isla tiv e proposal should be thorou gh ly explored by Congress, and new pow ers should be exer 176 UNSOUND COM PETITION FOR SAYINGS AND TIM E DEPOSITS cised b y regu latory agencies o n ly a fter carefu l exp loration o f ultim ate as w ell as im m ediate effects. F o r exam ple, in ad m in istering th e proposed am endm ent, it may w e ll prove difficult to achieve at one and th e sam e tim e its stated ob jectives and equitable treatm ent as between sm all and la rg e depositors. H ow ever, w e w ish to assure y o u th a t i f th e su ggested am endm ent is enacted in to law , th e B oard w ill conscientiously assum e th e responsi b ility fo r its use, in conjunction w ith its e x istin g au th ority to regulate in terest paym ents and its other p olicy instrum ents, as th e public in terest requires. T h e am endm ent also raises questions concerning th e p rinciple o f eq u ity am ong com peting financial institutions. C onsequently, Con gress m ig h t wish to consider w hether p arallel leg isla tio n is needed to authorize the application o f a sim ilar criterion w ith respect to rates o f interest on federally insured deposits or shares a t other savings institutions. C hanges in the com petitive situation am ong financial interm ediaries m erit continuing close surveillance. T h e B oard is w a tch in g develop m ents closely fo r any ind ications th a t these com petitive developm ents m igh t be ta k in g form s th a t are harm ful to th e p u b lic interest. The B oard has ordered a new survey— w h ich is now in th e field— o f changes since early 1966 in the rates banks are p a y in g on variou s classes o f tim e and savings deposits, and in th e net flow s o f these deposits during th is period. I f regulatory actions seem to be needed, in th e lig h t o f u n fo ld in g developm ents, th e B oard w ill n o t hesitate to take w hatever action is called for. I t also w ill n ot hesitate to request n ew legislative authority i f th is should seem necessary or desirable. N ow , M r. Chairm an, I w ould be very g la d to attem p t to answ er any questions, but I know m y associates w ill w a n t to exp ress additional view s, at tim es d iffering from m ine. T h e C h a i r m a n . W e w ill feel free to interrogate each one o f them. Governor, we appreciate you r statem ent and it g iv e s u s a lo t o f inform ation w hich w e w ill need, and it certain ly w ill receive c a r e f u l consideration. I t com es from th e B oard, as I understand ? M r. R obertson. I t does. T h e C h a i r m a n . A s w ell as from y o u rself ? M r. R obertson. Y es, sir. T h e C h a i r m a n . T h e m ain question before u s r ig h t now , Governor R obertson, is th e increase o f th e rate o f 4% percent to 5% percent* Decem ber 6. N atu rally, th at h a s caused a lo t o f trouble. N ow , do you feel th a t th e B oard should g iv e consideration to lo w erin g that rate a t th is tim e, G overnor R obertson? M r. R obertson . A s you know , m y fe e lin g in D ecem ber w as th a t th is w a s n o t th e appropriate action a n a th a t dissent is a m atter o f public record. H ow ever, I feel that, now th a t the com p etitive situ a tio n has developed, m th e lig h t o f those actions, th a t w e should be v ery careful in seein g w hat th e problem is and th en g ea rin g our action to £ne problem* b u t th a t w e shou ld take action in correctin g an y developm ent that w ou ld be adverse to th e p u b lic interest. I would think that, in order to do that, we vrould want to be very sore that we know what we are doing, wheai we axe doing it, a n d that UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 7 7 it is tim ed right. T h is can be done as soon as our survey is com pleted, w hich should be by the m iddle o f June. W e should then be in a posi tion to determ ine the nature o f the problem and tailor th e rem edy to su it it. T he C h a irm a n . N ow , you state here that although you do not favor the su ggestion o f lim itin g the am ount o f, say, under $10,000, you g et 4 percent, and above $10,000, 5 y2 percent, and I share your view s on that. I th in k it is discrim inatory. I do not think the Members o f Congress w ill vote fo r it, not on th e floor o f the H ouse, because I have never know n M embers to vote to discrim inate against the poor in favor o f the rich. F or th at reason, I do not thin k they w ill do it. Y ou state th at although you are again st it, you w ill, o f course, if Congress enacts it in to law , carry out your responsibility, w hich, as I understand the law , you are charged to do. Mr. R obertson. T h at is our job. T he C hairman . A n d you do not m ind d oing it. N ow , i f Congress does not g et w hat it w ants from the B oard o f Governors— there is lots o f feelin g all over the N ation about th is th in g ; there is lots o f feelin g fo r other financial institutions, not because th ey are savin gs and loans, credit unions, m utual savings lans, but because o f w hat th is adverse action is doing to the homeu ild in g industry and th r ift institutions a ll over the country. T hey feel th at u n fa ir advantage has been taken o f them and th a t advantage is cu ttin g to th e heart in lots o f places in th is country, and the people are very strongly against it and are dem anding th at their Members o f Congress do som ething about—dem anding o f them th at som ething be done about it. I t is discrim ination at its w orst, from the standpoint o f m any o f our correspondents and m any o f our constituents. So, do not be surprised i f Congress should assume its duty o f try in g to do som e th in g about th is, either by law , or, I guess, a join t resolution would be sufficient. I f Congress passed a join t resolution tellin g the Board th a t w e w a n t you to put the interest rate at 4^2 percent, you w ould have to do t h a t ; w ould you n ot ? M r. R obertson. I am sure w e w ould be obliged to do it. T he C hairman . A n d a lo t o f us feel lik e th is 4% percent w ould really solve th is question. I f you reduce th at 5% to 4% , a ll financial institutions could live and really have h ealth y and wholesom e com petition. W e hope you w ill g iv e consideration to it, G overnor Robertson, because the situ a tion rig h t now is critical. T he reason the people feel strongly about th is is, back in 1932, under Mr. H oover, a R epublican adm inistration, there w as a lo t o f feelin g o f dissatisfaction , because the banks had n o t had any fee lin g about hom ebuilding and w ould not h elp out in the hom ebuilding m arket, and M r. H oover in itiated , o f course, th e F ederal H om e L oan B ank System , and g o t th e F ederal savin gs and loans started, because the banks w ould n ot do it. T hey ju st w ou ld n ot do it, because they were not interested in it. N ow , a fter a ll th is period o f tim e, th is $130 b illion financial in dustry has been b u ilt up, savin gs an d loans, and has b u ilt m ore Tiomes S 178 u nso und c o m p e t it io n for s a v in g s a n d t im e d e p o s it s th a n h ave ever been b u ilt in A m erica. W ith o u t savin gs and loans, w e w ou ld n o t have our fine hom es over th e N ation , or as m any. Y ou realize th at, d on ’t you, G overnor R obertson ? M r. Robertson*. V ery "much so. T h e C h a ir m a n . T herefore, w e should n o t do an y th in g so drastic and arbitrary as to p un ish those very in stitu tion s th a t really saved our country, because shelter is about one o f the m ost im portant things w e h ave fo r fa m ily lif e in th is country, and w e m ust encourage things lik e th at. A n d th a t is the reason there is so m uch resentm ent now again st it th at seems to h it the in stitu tion s th e hardest th a t have done so m uch fo r us in the la st 30 years in the w ay o f b u ild in g hom es, decent hom es, fo r people to liv e in. T h e fe e lin g o f M embers, I th in k you w ill find, is very strong in th at direction, and it is possible th ey m ig h t g et im p atien t w ith the F ed eral R eserve B oard i f som ething is n ot done to change it, and I ju st hope that the B oard w ill g iv e consideration to th a t and not even w ait u n til June, or i f th e situation begin s to w orsen, as it seems to be right now. It is ju st intolerable, w e just cannot p u t up w ith it. A n yw ay, you p led g e th at the B oard w ill g iv e consideration in these changin g tim es, to the ch an gin g situations. B u t it is real u r g e n t , G overnor Robertson. I t is pressing dow n on th e people rig h t now, and we m igh t be throw n into, or be on th e verge o f a real depression, and w e do n ot need any depression r ig h t now . Mr. R o b ertso n . I w ould lik e to say, M r. C hairm an, w e are very alert to th is, and w e are n o t w a itin g on statistics. W e are actively endeavoring to find out w h a t th e actual picture is, in order th at we can decide w hether w e w ill have m eans at our d isp osal to improve the situation. A s o f th is m om ent, there is som e doubt as to w hether th e problem is as real as som e peop le think. I t is a p ro b lem ; there is no question about it, bu t th e flow o f fu n d s from one k in d o f in stitu tio n to another k in d o f in stitu tion seem s to h ave tapered off to som e extent. There are sp otty situations, o f course, bu t a lo t o f th e problem at th e moment I m igh t say, in m y ow n view , is based on fear o f w h at is lik ely to happen rather than on any present situation , but th is is som ething that we are w atch in g verv carefu lly. T he C h a irm a n . T h is 1965 action, on D ecem ber 6, p u t th e rates up 37^/2 percent. Sup p ose autom obile m anufacturers increased their prices th a t m uch or labor had attem pted to increase th eir w age rates th at m uch— or anybody else—people w ould scream to th e h ig h heavens, and th ey could not take it at a ll. B u t here, th e m onetary authorities come along and at one stroke o f the pen ju st increase interest rates 37% percent. I occurs to m e th a t real consideration should be given to that part o f you r order im m ediately. D o you h ave in m in d any im m ediate sessions o f you r B oard ? M r. R o b e r tso n . T h is subject is raised at p ractically every session o f our B oard in som e form or another. T h e C h a irm a n . M rs. S u llivan ? M rs. S u l li v a n . T h a n k you , M r. Chairm an. G overnor, in th e testim on y before th is sam e com m ittee la st Thurs d ay, M ay 19, Secretary o f th e T reasury F o w le r stated th a t negotiable C D ’s served as a liq u id m oney m arket instrum ent rather th an as a UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 7 9 savings m edium . W hat are the dangers to com m ercial banks o f their bidding up h ig h fo r huge funds which are essentially liquid, interestbearing deposits rather than bona fide bank deposits received in the norm al course o f business ? Mr. R o b ertso n . W ell, the dangers, o f course, from m y own per sonal poin t o f view — and I m ay say th at I am perhaps more interested than m ost people in the question from a supervisory point o f view , be cause o f background in th is field— m y m ain concern about the w hole CD field goes to the point o f liqu idity o f the banks them selves. N ow , it is perfectly possible fo r banks to use tim e certificates of deposit to obtain funds safely. I t depends entirely upon w hat they put those funds into, but i f they put those fun ds into long-term obligations, and you have w ithdraw als because o f interest patterns goin g up, and you can’t roll those over, they have insufficient liq uid ity w ith w hich to meet those w ithdrawals. T his constitutes a very real danger and I thin k is one o f the things w hich have to be w atched very closely. T h is is one o f the reasons that I have pressed over the years for much more effective bank supervision than we have, and unified Federal supervision. B ut, we do not have that sort o f th ing. W e do need, it seems to me, to develop as a m atter o f governm ental p olicy, m uch better bank su pervision than we have, one that is concentrated on the problem from the point o f view o f safety, liq uid ity, solvency, and v ia b ility o f the institutions. Mrs. S u lliv a n . Governor, w h y does th e F ederal Reserve System perm it th is situation to persist after really h a vin g created it by in creasing th e interest rate ? Mr. R ob ertso n . I m ust let other members, m y associates, speak on th is subject, but I am sure that they feel and deeply feel that this is being handled in a safe manner by the banking institutions o f this country, th a t th ey are in a position to m aintain appropriate liquidity and enable them to meet these w ithdraw als. From m y p oin t o f view , there has been an attitude developed over the years w hereby banks have come to believe that whenever interest rates are pushed up to tlie ceilings, w e w ill autom atically raise those ceilings. T h is is a false premise, because I do n ot think th is B oard or any other board w ill perm it banks to p ay high er rates to attract funds unless they are convinced th at banks are h an d lin g th is in a safe and sound manner. T h is is a m atter o f j udgm ent. Mrs. S u lliv a n . W ou ld any o f the other o f your associates care to express an opinion ? Mr. R ob ertso n . I am sure they would. Mrs. S u lliv a n . Mr. M aisel? Mr. M a is e l. Mrs. Congresswom an, I th in k th e fa ir th in g to say here is th at w e are concerned w ith the efficiency o f our m onetary and credit system . M y ow n attitude in Decem ber was, first, th a t w e w ould have been better off d ela y in g the use o f m onetary p olicy at th a t tim e in the hope o f g ettin g fiscal action, and second, h a v in g decided to use m one tary restraint, th at we w ould have been better off u sin g open m arket operations rather than causing rates to g o up through a discount change, but h a v in g done it, I do n ot think th a t w e had m uch choice. The present situation results sim p ly from s a y in g : “I f w e d o n o t allow banks and other financial in stitutions to com pete w ith th e m oney m ar 180 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS ket, th ey sim p ly are n o t g o in g to have th e m oney to lend to their cus tom ers.” I th in k th is is th e question w e are concerned here with— in term ed iation, and how our banking system operates. I disagree w ith th e earlier statem ent o f G overnor Robertson, I th in k h is d issen t w as w rong. M y ow n fe e lin g is th a t a m istake was m ade b y p u ttin g price ceilin g s through regu lation Q on the amount th a t banks could p ay from th e period o f 1957 through 1963. As a resu lt o f th a t action w e had th e norm al results o f any price ceiling. F u n d s flowed too fa r into the w rong areas. A s a result, w hile savings an d loans did a very good job, tow ard th e end o f that period they had m ore m oney com ing in than they knew w hat to do w ith. T h e ways in w hich th ey used th is m oney w as rather inefficient fo r the economy. L ess and less o f th eir m oney w as g o in g into th e sin g le -fa m ily house m arket. M ore and m ore w as g o in g in to other typ es o f use. T h e concentration o f fu n d s in savin gs and loans tended to flow in to certain States. A ll o f th is, I think, w as a resu lt o f the Q ceiling w hich w as m aintained too lo n g b y th e F ed era l R eserve. T h e restric tio n on th e am ount th at banks could p ay w as too great. N ow , I th ink th is has increased the problem w e face. W e must decide w hether w e believe in th e m arket se ttin g rates. D o w e believe th a t savings should flow w here th e m arket feels th ey w ill be used most efficiently ? M y ow n b elief is th at there is a danger in com petition, ju st as there is a danger in any m arket. H ow ever, fo r th e present, un til we see how great the danger is, and w here w e are g oin g, w e ou gh t not to m ake th e m istake th a t w e m ade before. W e should n o t create addi tional problem s b y u sin g ceilings. Interest-rate ceilin g s are like wage ceilin g s o r price ceilin gs, or any other sort. T h ere are tim es w hen they are usefu l. On th e other hand, h istorically, th e w a y w e tr y to run our economy is to le t th e m arket determ ine w hat th e m ost efficient use o f resources is. W e d id n ot do th is, so th a t p art o f w hat w e are seein g now is a correction o f a p rior m aldistribution o f funds. C ertain institutions w hich w en t w ay out o f lin e and g o t too m an y fu n d s com pared to what th ey could use efficiently are now suffering slig h tly . B u t since believe in a free-m arket econom y, I th in k th a t, at least fo r the time being, w e ou ght to le t the m arket distribute th e fu n d s the w ay it can m ost efficiently. Mrs. S u lliv a n . T hank you, M r. M aisel. M y tim e h as expired. T h e C h a irm a n . M rs. D w yer? Mrs. D w y e r . N o questions. T h e C h a irm a n . M r. Reuss? Mr. R eu ss. T hank you , M r. Chairm an. F ir st, G overnor Robertson, le t m e take th is o p p ortu n ity, ir r e le v a n t to the hearin g th is m orning, to congratulate you on th is splendid job you are d o in g w ith respect to our balan ce o f paym ents and foreign bank loans. Mr. R o b ertso n . T h a n k you v ery m uch. M r. R e u ss. I th in k you, an d you r colleagues, o u g h t to be congra^ ulated fo r p ro v id in g one o f th e rela tiv ely few b rig h t h o p efu l brush strokes on our balance-of-paym ents p u n tin g . UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 181 N ow , on the subject on w hich I do not feel as chum m y, certificates o f deposit, let m e recapitulate m y view s on th is m onster w hich I pre sented last Decem ber before the J o in t E conom ic Com m ittee, w hen you and your colleagues were present. I t seems to me th at in allow ing certificates o f deposit to g o up in 5 years from zero to more than $17% billion, the F ederal Reserve System has allow ed the O ld M an o f the Sea to get on its shoulders and ride it. I am im pressed by the fact th at to the extent that the certificates o f deposit have abstracted m oney from our savings and loan associations, it has had the effect o f transferring credit from the hom ebuilding industry, where there is now a 9.9-percent unem ploym ent rate? where more economic a ctivity could be accom plished w ithout inflation, it has transferred large parts o f th is to bank in ventory loans, w hich have a very inflationary effect. In your statem ent, Governor Robertson, you refer on page 4 to the marked increase in credit flows through the commercial h an k in g sys tem, and “T h is increase in the financing o f economic expansion”— that is how you refer to it. N ow , I really question th at philosophy o f the Federal Reserve. I do not th in k th at autom atically more credit in the F ederal Reserve means econom ic expansion. Som e o f it m ay mean inflation. A nd to the extent that bank loans, particularly by the big 30— N ew YorkC hicago banks w hich hold the bulk o f these $17% billion o f certifi cates o f deposit— I have reason to believe th at some o f their lending practices are in order to build up inventories in business in excess o f th a t w hich is needed. M y objection to th e uncontrolled negotiable tim e certificate o f de p osit regim e w e now have is, first, th a t it diverts credit from those sections o f the econom y w hich could lend it in a noninflationary m an ner, as to the h ousing industry, to financial institutions, by b ig banks w hich lend in part at least in an inflationary manner. Second, I object to the discrim ination in our banking system which allow s the 30 b ig banks w hich, having bu ilt up a secondary m arket and h a v in g a good opportunity to m arket the certificates say at 5% percent, I object to the discrim ination in th eir favor and at the e x pense o f th e other 13,000 banks, not to m ention all the other financial interm ediaries. T hird, I object because, since the F ederal R eserve now has only a 4-percent reserve requirem ent on negotiable certificates o f deposit, it seems to me you therefore lose som e control w hich you ought to have over the total credit capacity o f our banking system and th u s either have to tigh ten m oney inordinately over the w hole system and squeeze the other 13,000 banks in order to control the 30, or, more probably, you have to loosen th e credit-creating capacity o f the entire system m order to n ot squeeze out the 13,000 banks w hich are not im portantly in the tim e certificate o f deposit business. I w ould lik e, therefore, fo r you and your colleagues to com m ent upon m y indictm ent, i f you w ant to call it th a t, and specifically to ask your view s on the R euss proposal w hich I have been m aking ever since Decem ber, w hich is th a t the F ederal R eserve ought to increase the reserve requirem ent on negotiable certificates o f deposit, w hich it could do tom orrow , from 4 to 6 percent— and m ore th an that— th a t it ought to h ave pow er from Congress to increase those reserve require63-496— 66----- 13 182 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS m ents on n egotiab le certificates o f deposit w ith in its discretion up to a level o f perhaps equal to th a t required fo r dem and deposits. W o u ld y o u com m ent on th e package ? Mr. R o b e r t s o n . I f I could com m ent, first, I am sure some o f my associates w ould en joy d eb ating th is issue. I hesitate to say to o m uch, because I am in sym pathy w ith th is point o f view . T here m ay be differences betw een us in som e areas, but in general I have great sym pathy w ith th is p oin t o f view . I th in k th a t in so fa r as th e drains from the savin gs and loans are concerned, th ey are n ot due to th e b ig C D . I t is the gim m ick instru m ent— the savin gs certificate or savin gs bond at a high er rate of interest— w hich has been p u llin g fu n d s out o f the savin gs and loans and, therefore, from th a t p oin t o f view any changes sh ou ld be directed to th a t field instead o f the other. I do how ever realize th at the im pact o f m onetary p olicy in a time w hen you are h av in g a tig h t p o licy ough t to be evenly distributed over the econom y, as evenly as possible. I t is intended to have a bite, but you don’t w ant to take the w hole bite in one area and no b ite in another. Furtherm ore, there are areas w here th e in flationary im pact o f loans is particularly great. F o r exam ple, in p la n t and equipm ent expan sion, the m achine tool industry is probably th e tig h e st area and is the greatest bottleneck in the w hole field, and to the exten t th a t loans are m ade in th a t area, y ou are m erely ad d in g to the dem and fo r the in adequate supplies. T herefore, I th in k it is u n fortu n ate th at at the present tim e you are h a v in g a b ig g er im pact on th e b u ild in g industry than y o u are in other areas. W ith respect to the reserve requirem ents, I happen to believe that th is is a tim e w hen w e should be raisin g reserve requirem ents on time certificates to th e extent we have pow er, and I w ould w elcom e, p e r s o n ally ? a m ore flexible, a w ider spread pow er to fix reserve requirements o n tim e deposits, because, in m y opinion, tim e deposits are m uch n e a r e r to being a part o f the m oney sup ply today than th ey were 10 years ago. A t th at tim e, you could argue w ith great certain ty, I th in k , th at they really were not, th at all you had to do w as control the dem and deposits, I no lon ger believe this. I believe th a t tim e deposits are com ing closer and closer to b eing a p art o f the m oney su pp ly. N ow , w ith those com m ents, le t m e su ggest th a t you get your re sponse, and th at is w hat you w ant, from either G overnor M itchell or G overnor M aisel or G overnor B rim m er. Mr. R e u s s . I do intend to g et it from each one o f you r c o l l e a g u e s . I note th a t m y first go-around tim e is up, b ut I do h ave tim e for a comm ent, and a question, w hich is : F ro m w h at you h ave ju st s a id , G overnor R obertson, it does appear th at y ou agree w ith me, and since you are a m em ber w ith the rig h t to vote on th e F ed , and since th e F e d is not d o in g w h at you and I th in k should be done, it is g o in g t o be my business from th is d a y forw ard to see th a t th e F ed is directed and re quired to do th a t w hich you and I hope som e o f yo u r colleagues w a n t to do but are ev id en tly prevented by b ein g out-voted from n ow doing* That is all. T h e C h a i r m a n . M r. A sh ley? M r. A s m u r . G overnor R obertson, from th e testim ony you have presented; I tak e it th a t th e F ed eral R eserve B oard n o t on ly objects to the leg isla tio n under consideration but has no recom m endation for any leg isla tio n in th a t area, a t a l l ; is th at correct, sir ? UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 8 3 Mr. R o b ertso n . T h at w ould be m y personal view , sim ply because I happen to thin k th at we have am ple powers w ith in existin g legislation to cope w ith any foreseeable problem m the im m ediate future. I see no problem arising w hich w e are not in position to cope w ith. Mr. A s h l e y . D o you see any problem w hich needs som e action d i rected to it? Mr. R ob ertson . I see a problem w hich m ay be com ing up, and soon we w ill have better inform ation to jud ge w hether we can correct it. W e m ig h t return, fo r exam ple, to a schedule w ith rates adjusted to m aturities, so th a t a depositor could earn a h igher return only by g iv in g up, fo r a lon ger span h is righ t to w ithdraw h is m oney. There are m any w ays in which this problem can be dealt w ith, but I w ould say th a t as o f th is very moment, I w ould not advocate any particular change. I w ould w ant to see the w ay in w hich the problem u nfolds before a c tin g ; but we m ust act prom ptly once w e have iden tified a problem w e can help to solve. Mr. A s h l e y . W ell, now , it is pretty w ell known that savings and loans are, in m ost parts o f the country i f they are m aking any loans at all, requiring a third down, and also that the loan be less than 10 years old. I s th is a situation that is confronting them, just the out grow th o f k ind o f a norm al increase in dem and for credit, Governor? Or is th is a rather unique situation th at is caused by a unique prob lem to w hich there should be some kind o f attention directed and, presum ably, a solution found ? Mr. R ob ertso n . A tten tion is being directed to this problem. The problem is th a t in some areas o f the country, savings and loans have suffered a loss o f savings accounts, but so have all financial institutions in the im m ediate past. There has not been the grow th in savings there was before, because o f the flow directly from savers to the markets. H ow ever, they fear that if there is another increase in the rate struc ture, the flow to them w ill be dim inished greatly, and as a result they are not m aking forw ard com m itm ents. There has also been a tendency, I understand, on the part o f bor rowers, to speed up th e use o f outstanding com m itments in order to take advantage o f low er rates, and this is adding to the difficulties that savings and loan associations face at the present tim e. B u t they fear a greater outflow, m ore than they can sustain, because o f their very low liq uidity position, and th is is not a problem w hich has just come to the fore now ; th is is a problem w hich has been developing over the years. B u t th is is n ot a problem w e are not aware o f; w e are aware o f it. Mr. A s h l e y . W ith the change in regulation Q, hasn't th is p u t in creased pressure on savin gs and loans and sim ilar institutions to re spond in kind as best they can ? D oes th is p u t pressure on them to seek m eans by w hich to pay their depositors m ore ? Mr. R ob ertso n . Oh, y e s ; absolutely. Mr. A s h l e y . A n d ju st p u t continued pressure on h igh er interest rates? Mr. R o b e r t s o n . Oh, no question about th e fa c t th a t there has been greater pressure on them . T hey are g o in g to have to p ay m ore in or der to get th e fu n d s w ith w hich to m ake th eir loans. T h is is m erely a p a rt o f the process, th e com petitive process. 184 UNSOUND COM PETITION FOR SAVINGS AND TIM E DEPOSITS M r. A s h l e y . B u t th ey are resp on d in g to a situ ation brought about b y th e F ed era l R eserve B o a r d ; is th is n ot so ? M r. R o b e r tso n . T h is is a situ ation w h ich is brought about by a tig h te r m onetary p o licy w hich, in turn, is designed to curb demand, in order th a t w e do n o t have an excessive volum e o f m oney chasing an inadequate su p p ly o f goods and services, so you have the situation----M r. A s h l e y . I t seem s to m e th at banks have enjoyed, however, a very favorab le com petitive situ ation as against th e sa vin gs and loans. I can understand the necessity fo r a tig h t m oney policy upon occa sion, but I do n ot believe, as I understand it, G overnor, th at this has been brou ght about in a m anner th at treats equally and fa irly institu tio n s’ differin g characters. O f course, the com m ercial banks, I believe, h ave been favored over th e savin gs and loans, from the evidence that has been presented to me. T h is is certain ly the conclusion I would have to reach. Mr. R o b e r t s o n . I th in k y ou ou ght to be careful about that, because over the years one kind o f savin gs in stitu tion has had no ceilings over it at a ll, w hereas the banks have had. A n d , fo r m any years, the sav in g s in stitu tion s did have a com petitive ad van tage over banks. N ow , u n fortu nately, th is particular increase w as so abrupt and so great th at it changed th at com petitive pattern to o abruptly and did create th at problem you are ta lk in g about. N o question about that in m y opinion. B u t it is a problem w hich you ju st do not turn back im m ediately, because patterns becom e established. M r. A s h l e y . V io len t actions often do beget v io len t reactions, and th is is w h y w e are here today. Mr. R o b e r t s o n . T h a t is righ t. Mr. A s h l e y . B ecause o f the violence o f th a t action. Mr. R o b e r t s o n . T h is is rig h t, b ut I m erely urge y o u to be c a r e fu l in know ing exactly w h at you r problem is. Mr. A shley . Y ou urge me to be careful, but you do not choose to exercise that care yourself. Mr. R o b e r t s o n . I w ould lik e to say w e are tr y in g to be as careful as w e can, M r. Congressm an. Mr. A s h l e y . T h at is a fter th e fa c t som ew hat, is it n ot ? Mr. M a i s e l . M ay I speak, M r. Congressm an ? Mr. A s h l e y . O f course. M r . M a i s e l . I th in k that y ou are c a llin g attention to something w hich has been w ell know n. T h is situation is not a particularly dif ferent situ ation th an at any other tim e w hen m onetary restraint has come in to th e econom y. T h is is a norm al cost o f u sin g monetary Policy-. . . . w I th in k w hat you are objectin g to— and I think th is is a p oint that has to be m ade clearly — is th e h ig h cost, in a particular sector a n d particularly in the area th at w e are ta lk in g about, housing, o f the use o f m onetary policy. I f th e Congress believes that m onetary policy should not be used because it is costly in specific areas, then th is is a proper basis upon w hich to m ake its decision. I certainly have always called attention to th is fact. T h is is w h y , in m y ow n view , fiscal p o licy , such as an increase in taxes or d o in g aw ay w ith th e investm ent credit, w ould have been a better p olicy fo r th is period. B u t I th in k , h a v in g fa iled to use fiscal p olicy in D ecem ber or Janu ary, h a v in g required th a t monetary UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 185 policy be used to attempt to curtail the excessive demand and for balance-of-payments reasons as well, then I think it is not surprising •that the use of monetary policy costs particular sectors a great deal. This is what we know about the use of monetary policy, that it has to pinch in the mortgage market and other specific sectors. Mr. A shley . May I interrupt % I t seems to m e that by g iv in g the banks -the opportunity to get a greater return fo r their CD'S, th is encourages at a tim e o f restraint, at a tim e when the B oard is seeking to restrain it, th e banks, th e com mercial banks, have opportunities to invest their now relatively easy obtainable fu nd s in short-term loans as against and distinct from — and I do n ot think that that is an econom ically w ise th in g—at a tim e when restraint is necessary, particularly when the concom itant result is that there is a relative dim inution in funds available for what in fact is a socially desirable purpose, even during a period o f restrain t; nam ely, the construction o f at least a m inim um number o f homes for an in creasing population. Mr. Maisel. I agree w ith your point entirely, except in the causal factor. In fact, I feel even more strongly than you as to w hat the problem is here. B u t I think the idea that settin g a low er regulation Q ceiling, w ould fix th is problem is incorrect. A s an exam ple, in the first quarter, w e know that the relative flow to the money market from all savings institutions, including th e commercial banks, was about even. N ow , in A p ril, the com m ercial banks did a little better. B ut I still think that the problem is that all these institutions are com peting with the money m arket and sales o f goods. A great deal o f the flow out o f savings in stitu tion s arose from the fact th at during the past 3 or 4 years they were not collecting real savings. T hey were collecting sophisticated m oney. I t seems clear th at they sought th is larger in vestor kind o f m oney from the typ e o f advertising th at has taken place in the financial press and from w hat we know o f the type o f money th a t has been attracted into savings institutions. N ow there are fa irly good indications that most o f the m oney that has been flow ing out, or a great deal o f it, is th is type o f sophisticated money. I t is not particularly flow ing in to tlie banks, it is flow ing into the money market. I have been told that fo r m any institutions, because they have in creased their rates in th e last quarter, th ey have been gettin g more small accounts than they have had previously. The problem here is that we are dealing with a question of competi tive markets on a broad scale. This is what we have to be certain that everybody understands. Setting a lower regulation Q ceiling on time certificates or savings certificates or anything of that kind would not necessarily mean that savings institutions are going to have more money. It probably would mean that there would simply be less money available to all institutions to put into mortgages and things of that sort, because more of it would go ino the money market or be spent for current consumption. Now, this flow has been attracted to the money market simply from the fact that when you use monetary restraint, interest rates have to go up. But I think that it is clear that we must differentiate. We should not accept the oversimple explanation, post hoc propter hoc, 1 8 6 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS that it is the fact that Q ceilings were raised that is taking the money out o f the savings institutions. I f Q ceilings had not been raised* the money m ight have gone out even faster, and less m oney would be avail able to the m ortgage market. Mr. M it c h e ll. Could I say just a word, Mr. Congressman, please? First, about the relative advantage o f the banking system as a result o f the Q changes. Banks are paying 5^4 or 5% f ° r large C D ’s, and lending the funds at 5%. They are not m aking much money. The advantage to them is that it enables them to take care o f their most urgent customers. In the short run it is essentially a loss operation, not a profitable operation. Now, on the second point, that banks-----Mr. A s h le y . May I ask to whom they are lending it ? Mr. M it c h e ll. To prime customers; they pay 5% percent. Now, the other point that you were m aking is th at the banks, by virtue o f the change in the C D ’s, have been able to get a larger share o f the market. Banks’ share o f total funds raised in 1965 was just under 40 per cent, and in the first quarter o f this year it is 25 percent. Banks, in fact, are getting considerably less than they got last year. A nd this ties into what Governor Maisel was saying, th at the capital markets are the gainers; these funds are not goin g into the banking system from savings and loan associations, they are going into the market. Mr. Ottinger. $l7y2 billion went into C D ’s, did it not? Mr. M it c h e ll. $17% billion, no. The level o f C D ’s outstanding last fall was $16.2 billion, and after the first o f the year this total rose to about $17% billion, so this is an increase of about $1.1 billion, but the annual rate at which additional funds are being supplied to all sectors was $88 billion in the first quarter. Mr. A shley . What was the volume, what was the amount in CD’s, in 1960 or 1961? Mr. M i t c h e l l . Zero. The large negotiable CD was introduced in 1961. Mr. A shley. What is it now? M r. M it c h e l l . $17V billion. s> Mr. A s h l e y . From zero to $17% billion ? Mr. M it c h e l l . That is right. Mr. A shley. In how long? M r . M it c h e l l . Five y e a r s , I w o u ld say. Mr. A s h l e y . Where are those dollars coming from, Governor? Mr M itc h e ll. Some of these came out of the money and capita market; some of them came out of bank demand accounts. After all; when a bank issues a CD, it is competing with its own accounts. Mr. A shley. How a.bout savings and loan associations? Mr. M itchell. Well, to the extent savings and loan associations had hot money, yes, it was attracted; but to the extent they had genu- me savers, no. J aJ?1*' P ° we to what extent it came from the various sources that you have enumerated ? Mr. M it c h e ix u Well, there is some conjecture on that. Mr. Maisel. Well, I can calculate here that for 1961 through 1965' mcrease “ savings and loan shares wag abont $50 billion? They UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 1 8 7 were 62.1 in 1960; they were 111.2 in A p ril. W hereas about 17 billion went into negotiable C D ’s during that period, th at period showed one o f the largest rates o f increase in savings and loans m history. Mr. A shley . O bviously, we are talk in g about a period o f enormous credit g r o w th ; is that not so ? Mr. Maisel. That is correct. Mr. A shley . I w ould not expect— we still are faced w ith the fact that 17 b illions o f dollars are now in certificates o f deposit that were elsewhere 4 years ago. T hat is the key point, is it not? Mr. M itchell. There are several places they could have been. T hey could have been in the com m ercial banking sy stem ; in dem and deposit accounts; in open book accounts; they coula have been in nonnegoti able C D ’s; th ey could have been in the money m a rk et; they could have been in the stock m a rk et; they could have been in the bond m ark et; and there is a billion dollars o f foreign m oney in there on which you have taken th e ceilin g off. Mr. A shley . W ell, do we know, Governor, exactly where these funds cam e from ? Mr. M itchell. W ell, no; we do not know exactly where they came from ; w e know th e sources they could have come from . Mr. Maisel. L et m e put it another w a y : D u rin g th is period the amount o f liquid assets in the U .S . economy w ent up by alm ost 200 billion. T h a t m eans th at about 8 or 9 percent o f the increase in liquid assets d uring th a t period w as in negotiable C D ’s. N ow , w hether you thin k th is is a large percent or a sm all j>ercent to be m ade up o f C D ’s depends on your point o f view . I th in k a m ajor point to be made is th at th is w as th e w ay a free m arket distributed the 200 b illion of liquid assets th a t were created during th at period. Mr. A shley . W ell, I think that a m atter o f 1 percent, depending upon the extent to w hich your economy is sophisticated, could be very m eaningful. Thank you, Mr. Chairman. ^ T he Chairman . A t th is point, I w ould lik e to place in the record a statem ent in the M ay 19, 1966, D a ily B ond B uyer entitled “Banks A dd $5 B illio n o f T a x-E xem p ts in 1965.” W ithou t objection, it is so ordered. (T he article from th e D a ily B ond B u yer fo llo w s :) [From the Daily Bond Buyer, May 19. 1966] B a n k s A dd $5 B il l io n of T a x -E x e m p t s in 1965, R is e of 15.4 P ercent May 18. —Insured commercial banks increased their holdings of state and local government bonds last year by 15.4 per cent over the previous year—a rise from $33.3 biUion to nearly $38.5 billion—Federal Deposit Insurance Corporation Chairman K. A. Randall reported today. The increase in commercial bank holdings of local government securities was slightly offset by a decline in all insured banks’ investments in state and local bonds. Mutual savings banks’ holdings dropped from $367.8 miUion in 1964 to $300.2 million as of the end of last year, a drop of about 19 per cent', Chairman Randall said. W a s h in g to n , U.S. HOLDINGS DOWN While insured commercial banks were adding to their investments in local government bonds, they were disinvestors in Federal government securities. Their holdings in this area dropped from $62.6 billion to $59.2 billion, a decline of about 5.4 per cent on a year-to-year basis. 1 8 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Total assets of insured banks, both commercial and mutual savings, rose by 8.6 per cent last year to a total of $426 billion. Deposits increased 8.1 per cent to $377 billion, while capital and surplus accounts, after a rise of $2.7 billion during the year, amounted to nearly $34 billion. TOTAL LOANS U P 1 4 .9 PERCENT Assets of insured commercial banks, totaling $375 billion on Dec. 31, 1956, rose by 8.8 per cent during the year. Total loans, less valuation reserves, ac counting at year-end for almost 54 per cent of the banks’ total assets, were 14.9 per cent higher. Continuing a strong rate of growth, commercial and industrial loans gained 18.6 per cent, while loans on real estate rose 12.9 per cent. Total consumer loans were 14.3 per cent higher, with closely similar percentage changes in in stallment and single-payment loans. For the first time banks were requested to report separately on Federal funds sold, most of which were previously included in loans to banks, total Federal funds sold as reported on December 31 amounted to slightly over $2 billion. DEPOSIT LIABILITIES Deposit liabilities of insured commercial banks totaled $332 billion on De cember 31, after an increase of 8.3 per cent during the year. Time and savings deposits of business and individuals, which rose 15.4 per cent, accounted for more than two-thirds of the expansion in deposit volume. Total capital accounts of insured commercial banks increased 9.0 per cent during the year. Almost three-fifths of the dollar gain was in capital stock, notes, and debentures. Insured mutual savings banks reported an increase of 7.3 per cent during 1965 in their total assets. Total loans of these banks, about 98 per cent of which are real estate loans, were up 10.3 per cent for the year. Deposits of insured mutual savings banks totaled almost $46 billion on De cember 31, following a gain of 7.3 per cent in 1965. Total surplus accounts rose 6.1 per cent to slightly under $4 billion. The Chairman. Mr. Talcott. Mr. T alcott. Thank you, Mr. Chairman. I have a couple of rather random comments. First, I am pleased w ith the testim ony o f the Federal Reserve Board, Mr. Robertson. I am pleasantly surprised, in a way, that you did not follow right along with the administration, because sometimes I feel that you do not show as much independence as you have a righ t to exercise. I am pleased also that you have recognized that Members of Congress some tim es get pretty panicky during an election year and want to appear to be doing a lot o f things for particular industries. W e have a national interest that we must consider at the same tim e, and so I was relieved when you indicated that you were going to exercise caution and study this problem more fu lly before you make any drastic recommendation or accede to executive or political proposals. I commend you for this good and sound approach to a very com plicated and complex problem. I was curious, Mr. Robertson, about your vote on the various in creases in the rate ceilings. Could you tell me whether you voted for the increases in the rate ceiling that you mentioned earlier in your testimony. Mr. R obertson. The answer is “I did not.” Mr. T a lc o t t . Over the whole 10-year period, you did not vote to increase-----Mr. R obertson. W ell, now, I expect I could go through th is and tell you. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 8 9 I thin k you w ill find that I did not vote— I did vote for one, I believe, when th at w as raised at the tim e we raised the discount race, we raised the ceiling on tim e certificates up to a p oin t equal to savings deposits, but I have never voted to authorize the paym ent o f a rate to a business concern higher than that w hich a bank could p ay to an in d i vidual, because I thin k Government should never be in a position of saying to a bank “Y ou cannot pay to a sm all or an individual person as much as you pay to a large one.” So, I have never done that, but I think you w ill find me on th e opposite side in m ost o f those cases. Mr. T a lc o t t . W ell, it is good to be on one side m ost o f the tim e, I suppose, and y et keep flexible so that we can vote differently at times. I think we proved this in Congress. W here it used to be pretty cer tain th at th e Congress would protect, or even w atch out for, the sm all investor, la st week I think Congress neglected the sm all investor. So even Congress can make some sudden dram atic changes in its attitude. You can no longer expect them to act the same w ay consistently. Isn ’t that righ t, Mr. Chairman ? The C h a irm a n . I appreciate your interest in a low interest rate. I think you w ill be given an opportunity to vote on that pretty soon. Mr. T a lc o t t . W e had that opportunity last week. The C h a irm a n . S till com plaining about h igh interest rates, and w ill you vote for a 4 ^ -p ercen t ceiling ? Mr. T a lc o t t . I voted for it last w eek; let’s w ait and see what I do next week. B u t, I think, sometimes, that governm ental regulation can produce m ore problem s than it solves. Mr. Chairm an, I have a short statem ent I w ould like to make i f this is an appropriate time. The C h a irm a n . I t m ay be included at th is point. (T h e statem ent subsequently subm itted by Mr. Talcott follow s:) S tatem ent of H o n . B urt L. T alcott , a R epr e se n t a t iv e t h e S t ate of C a l if o r n ia in C ongress F rom Secretary Fowler has suggested legislation that would empower the Federal Reserve Board to set maximum interest rates payable on time deposits at 5 percent for deposits up to $10,000 and 5% percent for larger deposits. This proposal is apparently the Administration’s response to the problems created by inroads of banks into the flow of savings to savings and loan asso ciations and mutual savings banks. During the first decade or so after World War II, savings and loan association deposits grew much faster than time deposits at either mutual savings banks or commercial banks. Despite their slower deposit growth, banks were able to meet customers’ loan demands largely by increasing loan deposit ratios, which were very low owing to large acquisitions of U.S. Government securities during World War II. Until the mid-1950’s, most commercial banks simply did not have to compete aggressively for savings accounts because they didn’t need additional deposits in order to serve loan customers. Things began to change in the mid-1950’s. First, commercial banks’ holdings of Government securities had fallen to more normal levels, relative to deposits and total assets. Second, commercial banks were becoming increasingly com petitive in their lending operations—especially in the fields of consumer loans and mortgages. As a result, the banks found it necessary and profitable to compete more aggressively for time deposits, and they began to pay higher rates. During the late 1950’s, the spread between rates paid by savings and loan associations and mutual savings banks, on the one hand, and commercial banks, on the other, narrowed progressively. The Fed and the FDIC had, since the 1930’s, imposed a ceiling interest rate of 2% percent on time and savings deposits. This limita tion had never before been- an effective one, since before the mid-1950,s banks had not wanted to pay more than the ceiling. When it became clear that the 190 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS ceiling was getting in the way, the maximum was raised, first in 1957, and then in 1962,1963,1964, and 1965 to give banks the elbowroom they needed to compete aggressively. Without these relaxations of the ceilings, the competition of banks for time and savings accounts would have been largely forestalled. With them, time deposits of commercial banks have increased enormously in recent years. Two separate facets of these developments must be distinguished. First, com mercial banks were able to get an increasing share of the savings deposit busi ness of households, farms, and unincorporated enterprises. This cut into the business of savings and loans and mutual savings banks. Second, commercial banks, starting in the late 1950’s, began to solicit time deposits from corporations, foreigners, State and local governments. Most dra* matically, in 1961, the big New York banks reversed their policy of not accepting corporate time deposits and began issuing negotiable CD’s, which are practically the same as Treasury bills from the holder’s point of view. In addition, these large investors have acquired substantial nonnegotiable CD’s. An important further result was a rise in short-term interest rates, including rates paid on time deposits, savings and loan shares, and money market instru ments, relative to long-term rates. The spread between short and long rates had accounted for much of the postwar profitability of the savings and loan industry. As this spread has narrowed, the industry’s situation has become more pre carious. The Federal Home Loan Bank Board put an administrative lid on in terest rates paid by savings and loans in 1964 to avert what it felt were unsound tendencies. But as banks continued their invasion of the savings market, the Board’s restriction became increasingly onerous and in consequence was relaxed last week. Now, savings and loans may pay as much as 5 percent on savings cer tificates held for 6 months or longer in areas where they face severe competition from banks. This recent Federal Home Loan Bank Board action was prompted by a large outflow of savings and loan share capital following the quarterly interest pay ment date on March 31. Their loss, I am told, was well over $500 million. Mutual savings banks also lost heavily—over $300 million. It appears that these deposit losses have created something bordering on panic in the industry, which fears a repetition after the June interest payment date passes. One result has been a drying up of mortgage loan commitments by the savings and loans (and. perhaps, the mutual savings banks). If this is so (the facts are not easy to come by for such short-term developments) mortgage markets may become very tight. Up until this spring they have been less tight than they were in late 1959-early 1960. The savings and loan industry and the building and real estate lobbies have swung into action to solicit relief. Beyond political considerations life those of economic welfare of the country. The two should be distinguished. From the point of view of the national welfare, two opposing considerations emerge. The Federal Reserve may be inhibited from pursuing an appropriate monetary policy because of the exposed position of the savings and loan associations and mutual savings banks. Monetary restriction raises interest rates, especially short term rates. The present situation permits banks to pay up to 5M percent on i time certificates of deposit. Increasingly, banks have been issuing small denomi nation certificates of deposit, paying 5 to 5% percent, to attract ‘‘small” private savers. Presently banks cannot ofTer more than 4 percent on passbook savings, and some of the sales of certificates of deposit have come out of passbook savings account*. But they have also cut severely into S&L and MSB deposits. Further pressure on interest rates resulting from a tighter monetary policy would pre sumably aggravate the situation—especially in view of the Home Loan Bank Board’s reluctance to allow savings and loans to raise their own rates to de positors. The question is whether such a policy would result in excessive restric tion of mortgage credit* or in failures of some savings and loan associations, and how serious these results might be. The Fowler proposal (or some variant of it) might make it possible to tighten money with minimum effects on the savings and loans and the building industry* The basic problem is to determine whether this is in the national interest, or simply m the interest of the savings and loan associations and the building to* The stake of the latter is clear. The nationalinterest is less clear. What the Nation stands to lose by this kind of regulation, is the benefit that comes from the kind of competition in financial markets that has developed durmg recent years. In general, we would expect this competition to attract funds UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 9 1 where they are most needed, and to see that they are channeled through those institutions or markets that can handle the job most efficiently. The results of increased competition for savings during the past several years have been, in my opinion, enormously beneficial. Despite some regulators’ con trary beliefs, free market competition in finance is an important ingredient of economic progress. It has made possible a tremendous improvement in the serv ices provided by the banking system. Today’s problem is probably more the re sult of too much regulation (S & L’s are forced to put nearly all of their money into mortgages) rather than too little. History shows that one regulation breeds another. The Fowler proposal is an example. So are the proposals embodied in H.R. 14026 and II.R. 14422. None of these proposals should be accepted without much more justification than has been provided so far. Not only should we be reluctant to grant further powers to restrict comi>etition, but we should be doubly reluctant to permit fur ther restrictions that reduce the returns to small savers and have a discriminatory effect on smaller banks. I am pleased that the Federal Reserve Board has re frained from backing the Fowler plan or either of the two bills before us today. The case for any of these measures is far from proved. Rather, the Board’s testimony suggests to me the need for a full-scale study of policies to promote, rather than hinder free competition for the saver’s dollar. The Chairman . M ay I state to the witnesses here to d a y : O bviously, we w ill not have an opportunity to interrogate you today, even i f you come back tom orrow m orning, w hich we hope that you w ill, and I just wonder if it w ill be all right, Governor Robertson, i f you w ill speak for the others, th at you w ill be glad to answer any questions that any member o f the com m ittee desires to submit to you in w riting, before you look over your transcript ? Mr. R ob ertso n . I w ould be delighted. Mr. T alcott. A nd each member has a right to propose some ques tions? The C hairman . C ertainly. Mr. T alcott. M ay I ask just a couple questions now that m ay only emphasize w hat Mr. Robertson said. Last Thursday, Secretary F ow ler advocated restriction o f rates paid on a tim e deposit up to $10,000, to 5 percent, even though larger de posits can earn 5 y2 percent. T his is hard fo r me to see, w hy the sm aller depositor should be de prived o f the sam e interest rate as the larger depositor. The Secretary m aintained that part o f his rationale was because the sm aller deposit w as covered by the F D I C insurance. I take it that you disagree w ith the Secretary on th is ? The Chairman . I believe Governor Robertson covered that in his statement. Mr. R ob ertson . I did cover it. I think you should never discrim inate between th e sm all and the large; the existence or nonexistence of insurance is a very w eak reed to hang onto in tryin g to make a d is crimination betw een the tw o, and you have problems. Suppose an in d ivid ual holds five different certificates o f deposit, each o f w hich is $15,000. N ow , one o f those, I w ould guess, the first $10,000, w ould be at the 5-percent rate, and the balance at 5V2, but how about the others ? I do not know how it w ould work in th at situation. Mr. T a lc o t t . A t least h a lf o f 1 percent w ould be a p retty h igh rate to be p a v in g fo r deposit insurance. Mr. R o b ertso n . W ell, w ould it be applied on each in d ivid u al cer tificate? 192 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Suppose the depositor has a demand deposit o f $10,000, that would exhaust his insurance; then, does the 5 rate apply to the balance ? I t is a very difficult thing to administer. Mr. T alcott. I s that not a very good reason for not follow ing the Secretary’s suggestion ? Mr. R obertson. I would personally think so. Mr. T alcott* Then, w ith regard to the small banks again, and the small depositors, too, the small banks have m ostly small depositors as you indicated, over three-quarters of all the banks w ith total deposits under $5 m illion have accounts o f less o f $10,000. Mr. Robertson. Much less. Mr. T alcott. Only one-third o f all depositors w ith the giant banks with deposits o f over $2 y> billion fall into that class. Mr. R obertson. I think that is about right. Mr. T alcott. Then, the Fow ler proposal would be, in effect, just not fair to the smaller banks. W ould you interpret it that way ? Mr. R obertson. The impact o f it would be much greater on the smaller bank than the larger ones. Mr. T alcott. Suppose the interest rates were to rise f u r t h e r and the banks began to lose their time dep osits; then, would the ceiling rates have to be raised ? Mr. R obertson. N ot with my permission. Mr. T alcott. D o you think that would be the consensus o f the Federal Reserve Board members ? Mr. R obertson. Y ou would have to take a vote—No. Mr. T alcott. You think it would not ? Mr. Robertson. I do not have any idea how they would vote on this. T his would depend on judgment, and a lot o f things— circum stances, and then again whether or not monetary policy would be more effective leaving it right there or taking it off. Mr. T alcott. D o you think you have adequate powers or authority now, or w ill new legislation be necessary in order to increase the inter est rates? Mr. R obertson. In my view, we have adequate powers now. If there is any way to make them more adequate, I would favor i t ; but I think we have enough power now. Mr. T alcott. I have some other questions that I would like to put to the members o f the Board, but my time has expired already. The C hairman. Suppose you submit them in w riting; would that be satisfactory? Mr. T alcott. T hat w ill suit me. The C hairman. A nd they may be inserted at this point in the record. (F o llo w in g are questions submitted to each member o f the Board t>f Governors, Federal Reserve System , by Mr. T alcott, w ith Mr. Robertson’s reply on behalf o f all Board m em bers:) June 3,1960. D e a r ----------------- : At the meeting of the House Committee on Banking and Currency on May 24.1966,1 was granted the privilege of asking several questions of each Member of the Board of Governors of the Federal Reserve System. For the record, may I please have your complete, Jbut succinct, answers to tbe following questions: 1. Has the pursuit of anti-inflationary monetary policy been h am p ered by fear of the effects of rising short-term interest rates on savings and lo® n associations and mutual savings banks? y2 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 193 2. Do you, as a Member of the Board of Governors, favor legislation at this time to extend the Fed's powers to limit interest paid by commercial banks on time and savings deposits ? 3. Do you, as a Member of the Board of Governors, believe that a differ ence of one-half of one per cent between the maximum rate paid on time deposits under $10,000 and the maximum rate on larger deposits is justifiable because of deposit insurance coverage of amounts up to $10,000? Your usual splendid cooperation and accommodation will be greatly appreciated. Warm personal regards. Sincerely, B xjut L. T alcott , U.S. Congressman. B oard of G overnors , F e d e r a l R e se r v e S y ste m , Washington, June 13,1966. Hon. B u r t L. T a l c o t t , House of Representatives, Washington, D.C. D e a r M r. T a l c o t t : This is in reply to your letter of June 3 ,1 9 6 6 , to each Board member in which you asked three questions regarding interest rates and thrift institutions. I am replying on behalf of all Board members. Question 1. Has the pursuit of anti-inflationary monetary policy been ham pered by fear of the effects of rising short-term interest rates on savings and loan associations and mutual savings banks ? Answer. The short answer is “No.” In formulating monetary policy we try to take into account the expected impact of various alternatives on all segments of the economy. We have during the current period of monetary constraint fol lowed with special care the impact of monetary policy on the flow of funds to selected parts and institutions in the economy. Our continued examination of the various developing relationships has not, however, deterred the System from moving toward a more restrictive monetary policy in order to combat inflationary dangers. Question 2. Do you, as a Member of the Board of Governors, favor legislation at this time to extend the Fed’s powers to limit interest paid by commercial banks on time and savings deposits? Answer. The Board believes that discretionary authority to “distinguish tem porarily between these two markets (the large negotiable CD market and that for smaller time deposits) in setting ceiling rates might in some situations facilitate actions to smooth the transitory adjustment problems of competition for savings funds in smaller amounts without disrupting flows of funds in the money and capital markets.” Question 3. Do you, as a Member of the Board of Governors, believe that a difference of one-half of one per cent between the maximum rate paid on time deposits under $10,000 and the maximum rate on large deposits is justifiable be cause of deposit insurance coverage of amounts up to $10,000? Answer. Insurance coverage is obviously valuable to the smaller depositor in that it eliminates risk to him. The precise value of insurance coverage, however, cannot be determined with exactitude. Furthermore, it seems clear that the value of insurance would be greater to depositors in some banks than in others, reflecting differences in exposure to potential loss. Sincerely yours, J. L. R o b e r t s o n . The C h a i r m a n . Mr. Stephens. Mr. S tephens . G overnor R o b e r t s o n , isn't w h at has happened so far, as the slow dow n in the b u ild in g trades and in the b u ild in g busi ness and in the inaibility o f people to borrow, exactly what the mai°rity o f the F ederal R eserve B oard intended tx> happen ? Mr. R ob ertson . E x a ctly . T hat is w h at a restrictive m onetary policy does. I t is designed to cut dow n on th e a vailab ility o f m oney. Mr. S t e p h e n s . W a s it envisaged that it w ould have s u c h a drastic effect on the h ou sin g ind ustry and th e m ortgage m oney as has d u a l l y come about? W a s it expected th a t it w ould n ot be in just 194 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS one area or tw o areas but would be a wider spread cutback than has actually happened? Mr. R obertson. Y ou never know where the im pact is going to fall the hardest. Y ou would like to have the impact even over the entire econom y; I , personally, would like to see it have its greatest impact where the greatest shortage exists, but you cannot do that w ith mone tary policy. T his is a general instrument which applies across the board. N ow , as to whether or not the impact has been greater than we expected, I would say, in general, no; we have to curb the supply of money and credit. Mr. S tep h en s. You did not think it would take effect so rapidly ? Mr. R obertson. In some areas the rapidity has been greater, per haps, than was expected. Mr. S tep h en s. W ell, I would agree w ith you, that you cannot ex pect where the im pact w ill fa ll, and, o f course, a great deal o f the impact falls on us here in the Congress. W e agree w ith the ob jectives o f the Federal Reserve, that we do not w ant to have a period o f inflation, but we also do not want to have a depression in anywise either. Mr. R obertson. I think I m ight just say that there is not a single member o f the Board who does not agree w ith you, that we cannot live with inflation. W e do not w ant to manage m onetary policy in any way which would result in inflation. A s a matter o f fact, it is our job to see to it that we do have stable prices. Mr. S tep h en s. Investors in my area, and homebuilders, and others, say that the effect has been probably more drastic there because of the expansion o f hom ebuilding in th e last few years than it would have been in some other areas, other places, where you do not have the ex pansion for homes. Take, for example, a community like Athens, Ga., where my home is. W e have had, I am delighted to say, an expansion due to Federal research programs that have been placed at the U niversity o f Georgia, the expansion o f the educational system. The new m onetary policy has brought to a h alt almost the entire activities in b uilding at a time when really, sincerely, there is need to expand, and people are hurt in g for homes under the circumstances. Is there any possibility o f having areas relieved in that type of situation ? Mr. R obertson. I t can be done by selective measures taken by Con gress, through such agencies as Fannie Mae or Federal Hom e Loan Bank loans, but you can’t do it through a general monetary policy which has, by its very nature, to apply across the N ation. Mr. S te p h e n s. I appreciate that. Another question I would like to ask is t h is : W ho advised on cutting the m ilitary construction program o f th e U nited States, the $600 m illion m ilitary construction program? I t was cited on th e floor of the House, when w e were debating another bill, as a w ay to curb inflation, and I can’t understand why that particular th in g would be selected when we were at war, and I wonder who advised the Secretary, McNamara, to cut it ? Mr. R obertson. I can only tell you that th is is a m atter that the F ederal Reserve neither can be credited w ith nor blamed for. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 195 Mr. S tephens . W ell, I appreciate that, but w ouldn’t the m onetary policy o f the U n ited S tates have som ething to do w ith that? I f you try to curb inflation, w ouldn’t th at be part o f the m onetary p olicy o f the U n ited States ? Mr. R obertson. T he m onetary p olicy o f the U n ited S tates is de veloped by the F ederal Reserve. T hat is the m onetary policy. N ow , to the extent that other agencies o f Governm ent, or the G overnm ent as a whole, do th in g s th at do tend to curb inflation, th at is welcom e, but it is their own business; not ours. W e have not been con su lted ; w e are not inform ed. Mr. S tephens . T hank you very much. The C hairman . Mr. G onzalez ? Mr. G onzalez. W ell, it appears as if the F ederal Reserve System has not provided th e com m ercial banks w ith the steady grow th o f reserves year after year to support their increased dem and deposits. T his, o f course, forces them to bid the more aggressive banks fo r C D ’s and bor rowings. In addition to C D ’s, I w onder i f you w ould please list the various instrum ents w hich the commercial banks have developed in recent years in order to borrow funds ? Mr. R obertson. W ell, I w ould m ention first the prom issory notes that some banks have been issuing. T h ey have changed the name o f a piece o f paper from a certificate o f deposit to a prom issory note and sold it, and on th at th ey have no reserve requirements, on that they have no insurance assessm ents—th is is a m eans for borrow ing funds for as short as 5 days, w hich comes very close to being demand deposits. T his is one. O ther w ays include repurchase agreem ents and purchases o f Federal funds. T h e F ederal fu n d s m arket has developed over the past 10 years. Mr. G onzalez. W ell, I notice in your last report, the 52d report, where you are recom m ending an extension o f your authority over all insured banks, n ot only the member banks, but a ll insured banks, and, apparently from the report, I gather th at one reason w as the d is turbance, from the p oin t o f view o f the report, or the rate o f w ith drawal o f banks from m em bership in the System . Is th is w ith d raw al really dangerous or does it just appear to be when you look at it over a 5-year period ? Mr. R obertson. L et me start by sayin g, from m y point o f view — and I think m y associates w ould all agree— that the burden o f carrying on a central b an k in g system for this country and h avin g a m onetary policy w hich ap p lies evenly throughout the country calls for that burden to be shared by all com m ercial banks. So, from m y p oin t o f view , every com m ercial bank should be sub jected to reserve requirements w hich are com parable to those a p p li cable to other institution s. Once you do this, those institutions should also have access to the benefits, namely, they ought to have ^access to the discount window in order to meet emergency needs for funds. I w ould a p p ly these rules straigh t through the banking system . The fa ct th a t banks are lea v in g the System now , because as nonm em bers they have m ore m oney to invest due to low er reserve requirem ents is a distu rbin g factor, but it is not a m atter o f calam itous size, because we still have about 83 percent o f the deposits o f the country in member banks. N evertheless, I do not thin k it is fa ir, m yself, that som e in sti 1 9 6 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS tutions can escape reserve requirements sim ply by m oving out of the Federal Reserve System . Mr. G o nzalez . I notice that quite some big ones have come into the System , though, lately. Mr. R o b e r t s o n . I c a n ’t t h i n k o f a n y . Mr. G onzalez . New York banks % Mr. R obertson . N o, that is switching, you see, from a State charter to a National, but that does not bring it into the System. They were members when they were a State bank. Mr. G onzalez . In view o f this seem ingly or apparently failure of the System to keep pace with banking needs-----Mr. R obertson . There has been no failure o f the System to keep pace with banking needs. Fortunately, in the past 6 or 7 years, we have pumped reserves into the banking system in order to enable them to make loans and thus to expand the economy o f th is country. I think the trouble is, at the moment we have too many funds, too many reserves, in the banking system. A s a result, we have to curtail that, because the money supply now is too large in relation to the volume of goods and services available to purchasers; so, I think no one can say we have failed in m aking funds available to banks w ith which to make loans. I f we had done more, we would have had inflation a long time ago. Mr. G o nza lez . T hat is why I couched m y question in the words or phrase “appears to,” because it seems you have this other development, unprecedented development in the tremendous growth in negotiable C D ’s and the more aggressive banks bidding for them on the terms that they have. Now, in other words, your opinion is that one is not necessarily the cause of the other, that is, your restrictions, or keeping pace with the banks’ needs for reserves, are not necessarily the cause o f the increase in the CD speculative field ? Mr. R obertson . In m y view, this does have some relationship. I think that, personally, the larger banks can obviate some o f the impact o f a restrictive monetary policy by buying funds in order to meet the demands o f their creditors. B ut, overall, i f you take the whole banking system, the extent to which we provide reserves or contract reserves is determined by whether or not we think the money supply is grow ing too slow ly or too fast to carry on the economy of this country in a noninflationary way. Mr. G o nza lez . W hy don’t the banks raise more equity capital, or do they ? Mr. R obertso n . Banks, over the years, I must say they have ra ise d equity capital but only reluctantly. In many cases, this changes the ownership o f the individual, one man loses control if he is not in position to buy new equity, and as a result of this reluctance they have sought other means o f acquiring funds. Mr. G onhalez . B ut they are pretty low in relation to their liabilities, are they not? Mr. R obertson . Low er than they have been at some tim es in the p a st; yes. Mr. G o nza le z . Thank you very much. Mr. R o bertso n . I w ant to say, however, that I do not think that, as a whole, the banking system is undercapitalized today. I do not think UNSOUND COMPETITION FOR SAYINGS AND TIM E DEPOSITS 1 9 7 that, fo r a m inute. I th in k they are p erfectly sa fe and p erfectly sound. T h is country is very fortunate to have as sound a banking system as it does have. Mr. G onzalez. T hank you very much. The Chairman . Mr. M ize? Mr. M ize. T hank you, Mr. Chairman. Governor, p art o f th e reasoning behind the raise in the rediscount rate and the raise o f the Q ceilin g in Decem ber w as to p u t dow n the pressure on the inflational d evelopm ent; is th at righ t ? Mr. R obertson. T h at is right. M r. M iz e . W e ll, i t d id n o t accom plish w h a t y o u a ll h o p e d ; is th a t rig h t ? Mr. R obertson. Because it was not done in the righ t w ay, from my point o f view . You had better ask m y associates now , as to their p oin t o f view . Mr. M ize. W ell, now, is it not true th at the prim e rate th at was being charged by th e b ig banks to their borrowers had started to firm up long before you raised your rediscount rate in December ? W h at I mean, they w ere m ore selective, because o f the shortage o f m o n ey ; is that correct ? Mr. R obertson. I thin k th at is true. M r. M ize. W h a t do you th in k the 30 b ig banks in N ew Y ork and Chicago who are u sin g the h igh rate C D ’s have done wT the funds ith they have attracted ? Mr. M itchell im plied th a t they were borrow ing at 5 y2 and loaning at 5 y2, and th a t it w as a loss operation. M aybe that should be directed to Mr. M itchell. Mr. Mitchell. W ell, th ey have been try in g to take care o f their prime custom ers. B u t th at is not the only th in g that they have done. In A p ril o f th is year, they expected a larger loan demand than m a terialized. H a v in g gotten ready for it, their alternative in that in stance, though p retty hard to pinpoint, w as S tate and local securities. B asically w h at they have done or what they are try in g to do and have been tr y in g to do m the period since last fa ll is have adequate funds available for th eir custom ers to whom they have had longstanding commitments. T h is w as the m ain objective and the reason they are paying th a t price for funds. M r. M iz e . I n o th e r w o rd s, th ey w ere su fferin g fro m th e squeeze on, or th e sh o rta g e o f fu n d s in g en eral, a n d by y o u r action, th e action of th e B o a rd , you en ab led th e m to ta p some m o re liq u id fu n d s ? Mr. M itchell. Y es, so they could do business at a loss, in effect, if they fe lt they had to. There is not much o f an incentive here. M r. M iz e . H ow in h e a v e n 's n am e could you p o ssibly conceive th a t th a t w o u ld re s u lt in less p re ssu re -----Mr. M itchell. Mr. Congressm an, it has resulted in pressure on bank custom ers because banks have been tu rn in g m any custom ers away and g e ttin g others to defer their dem ands or to postpone them , and so m ore pressure has been exerted on bank custom ers than I think is generally realized. M r. M ize. I th in k i t is u n fo rtu n a te th a t it h as affected th e sm all businessm an m o re t h a n th e b ig c o rp o ra te ones. I t h u r ts th e sm all businessm an m o re, because in te re st re p re se n ts a sig n ific an t expense 1 9 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS to him, but it represents not too much to the big borrowers, because of their higher income tax rate. Mr. M it c h e ll. I agree; this again is one of the shortcom ings of monetary restraint. On the other hand, a modest-size bank has its own prime customers that it w ill take care of, too, and they may not be very large business. M r. M ize . B u t an u p w a rd raise in the p rim e ra te in th e b ig banks causes th e sm all banks, o r gives them an o p p o rtu n ity to raise th e ir rates. Mr. M it c h e ll. They probably started with a local prime rate of 6 percent and some o f them are still there. Mr. Mize. Thank you, Mr. Chairman. The C hairm an. May I suggest that the differences between the small man and the big man and interest rates, I would consider th r e e : No. 1—the big man can deduct his interest— 50 percent writeoff, taxwise. The little man, of course, is not in such a fortunate posi tion ; he does not profit to that extent. Secondly, the big man can offer stock to the public, if interest rates are too high, but the little man cannot. Finally, retained earnings are really costless capital to the big man, and he can draw on them. I t is a great benefit. The little man has no retained earnings. So, the big man is helped greatly by high interest rates, whereas the little man is discriminated against. That is my view o f it. D o you agree with that, Mr. Mize? Mr. Mize. W ell, generally, I would like to see the rates fa ll where they may. I think the action o f the Federal Reserve in December helped the b ig man and hurt the little man. I w ill say that. The C hairm an. That is what I was saying. M r. M ize. A t the same tim e, Mr. Chairman, I regard you very highly, but I still am a great champion o f the independence o f the Federal Reserve System. The C hairm an. Independent up to a point. Mr. M in ish . Mr. Robertson, on the top o f page 6 o f your state ment, you say “negotiability does not, in and o f itself, im pair the liquidity o f the issuing bank nor o f the banking system as a whole.” Does that statem ent cover savings and loans? M r. M itch ell . N o. Mr. R obertson. I t was not designed to cover savings and loans at all. I do not know any savings and loan association that issues a negotiable tim e deposit. Mr. M in ish . I was thinking o f the banking system as a whole. Mr. R obertson. I was thinking o f the commercial banking system. Mr. M in ish . I just w ant to say that in the Newark m etropolitan area, which has a population o f roughly 18 m illion people, 1 o f the savings and loan banks had withdrawals o f over $1 m illion in 30 days, and they traced roughly 50 percent o f that money to the 1 bank in the area issuing C D ’s. Mr. R obertson. Probably, however, those C D ’s were not b ig nego tiable instruments but were the so-called gim m ick instrum ents, the savings bonds and savings certificates. Mr. M in ish . B ut it put this bank in a rather precarious position. Mr. R obertson. Yes. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 1 9 9 Mr. M in is h . In the W all Street Journal today I noticed, “N ew York B anks T o Issue D ollar C D ’s in L ondon.” D id you have an opportunity to read the article ? Mr. R ob ertso n . Y es, I saw it. Mr. M in ish . D o you have any comment on it ? Mr. R ob ertso n . W ell, it is a very interesting proposal, one that is g oin g to deserve a lo t o f study. M y first question about it was what it w ould do to the balance-ofpaym ents program , because I have a concern w ith th is and, as I get it, it w ill have no effect whatsoever. T hey borrow funds. I f they buy funds there and bring them to this country, as one o f the papers said they intended to do, th is would not im prove the balance o f p a y ments at a ll because the short-term funds are now taken into con sideration as increasing our liab ilities, but th ey are not taken in to consideration in arrivin g at balance o f paym ents. On the other hand, i f that were to move the rates up so much that holders o f A m erican bonds were to sell the bonds and invest in th e se ; then, o f course, th is w ould have an effect. B u t I really suspect that all th is w ould do is to add more funds to the E uro-dollar market. I t w ill be foreign dollars that they are b ringing in, th at they are attracting to them selves, and th ey w ill utilize those in connection w ith the loans abroad. T o the extent that th ey take care o f loans abroad that otherw ise A m erican banks here w ould m ake abroad, so much to the good. T h is has m any aspects th at I am not in position to discuss this m orning, sim ply because I do not know. Mr. M in is h . N ow , Mr. Robertson, I have been on th is committee now g o in g on 4 years, and I am privileged fo r the first tim e to have so m any members o f th e Federal R eserve B oard here. T he th in g that has bothered me fo r some tim e is the question o f the Open Market Comm ittee. Som etim es it is referred to as a secret com m ittee, isn ’t it? Mr. R obertson. I do not know w hat you m ean by a secret com m it tee. O bviously th is com m ittee’s actions affect the w hole market, and, as a result, no one attends these except the presidents o f the F ederal Reserve banks and the seven members o f the B oard and members o f the staff o f th e B oard and o f each o f these banks. B u t they are all sworn to secrecy. In fact, you do not have leaks from the Open M ar ket C om m ittee. Y ou majr have people say in g th at they have gotten a leak, but take m y w ord fo r it, they have not. Mr. M in is h . H ow m any attend ? Mr. R obertson. I would guess 40. A m I rig h t about th is ? Mr. M in is h . I w ould like the experience o f attending one o f your m eetings. I w ould like an answer from you and each o f the members. W ould you in v ite me ? Mr. R obertson. N o ; w e w ould not. Mr. M in is h . W ou ld anyone else like to com m ent on that ? I w ould like to have th eir com m ents. Mr. B rim m er ? Mr. B rimmer. I w ou ld not in vite you. Mr. M in is h . Y ou w ould not? Mr. B rimmer. I w ould not. Mr. M in is h . I w an t you to know th a t I sw ore to u phold the C on stitu tion , w hen I w as sw orn in as a M em ber o f C ongress. 200 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. R o b e rtso n . This is Mr. Scanlon, the president o f the Federal Reserve Board o f Chicago. Mr. S c a n lo n . I would not, Mr. M inish. Mr. M in is h . Mr. Shepardson ? Mr. S h e p a rd so n . N o, sir. M r.M in is h . M r.M itchell? Mr. M it c h e l l . W ell, I would like to invite you, but I do not think it would be an appropriate th in g for us to do, and I do not think it would be consistent with the direction Congress has given us. M r.M in is h . M r.M aisel? Mr. M a ise l. I think that this is true. I t would not bother me. I personally feel that the Committee ought to make a good deal more o f its deliberations public. I do not think, though, that in vitin g you or any other individual would, necessarily, be the best w ay o f doing it. That would be my only reaction. M r. M in ish . I have convinced m yself th a t it is a secret com m ittee. Thank you. The C h a irm a n . May I say this, that the Open M arket Committee is composed of 12 members-----Mr. R o b e rtso n . T hat is right. The C h a irm a n . The 7 public members o f the Federal Reserve Board, and then the 5 members chosen from among the presidents of the 12 Federal Reserve banks. Now, you have no right to bring in those other seven bank presidents. You see, the law compels the formation o f an Open Market Committee composed only o f 12 mem bers, but you are in violation o f the law when after you bring in the 7 Federal Reserve Board members and the 5 presidents of the Federal Reserve banks to this secret room, you also bring in the other 7 and allow them to participate in the discussions. They do everything but actually vote. Tney are bound to have some influence. W hy wouldn’t any member of this committee or any Members o f Congress be just as trustworthy in the public interest? W hy those seven are selected by private commercial banks. E very board o f directors is composed o f nine members, six o f them selected by the private banks. T hat makes all these presidents selected by the private banking system—they are allowed to come in, and you do not allow anybody else to come in. I think that these presidents go right back and report to their direc tors. ^Naturally, they would, because they are selected by their direc tors, and these directors are interested in all kinds o f businesses. I have estim ated, Governor Robertson, that at least 500 people in the U nited States know 10 m inutes after that m eeting is over what has gone on in there. Is that estim ate very large, in view o f the fact that the 40 you adm it are there, and these 12 presidents g o right back— and m ay even communicate by wire before they get back. D on ’t you think 500 would be a reasonable estim ate o f the number o f people that know w hat goes on at these secret m eetings % Mr. R o b e rtso n . No, Mr. Patm an, I must say I do not agree w ith you. No. 1, certainly the law requires that there be a 12-man Open M arket Committee, and I think I should say th a t we have the utm ost respect for the law. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 0 1 The C h a ir m a n . T he law says th at there sh all be 12 members. Mr. R o b e r ts o n . Y es. N ow , the question as to w hether or not it is illegal fo r us to have those who are alternate mem bers o f the O pen M arket C om m ittee in there w ith the presidents, I th in k is not debat able. I think that under the law we have the pow er and the right, the legal righ t, to have them present. B u t let m e tell you exactly for the record w hy w e have them. T his is a tra in in g operation. W e w ant to keep people as closely fam iliar w ith the operation o f that C om m ittee as possible, w ith in the group, so th a t w hen it is their turn to act as v o tin g members o f that Com m ittee, they know the operations, they know w hat is g o in g o n ; they have prepared them selves. B ut, in addition to that, we do gain real benefits from attendance by the presidents who are not v o tin g members. W hen the vote is taken, o f course they do not vote, but th ey do m ake a presentation to the O pen M arket C om m ittee, g iv in g us a picture o f the econom y in their particular districts, as it relates to, contrasts or accords w ith the picture o f the econom y as we get it on an overall basis. N ow , I doubt very m uch th at any president o f a F ederal Reserve bank re ports to h is board o f directors on th e F ederal open m arket opera tions. The C h a ir m a n . G overnor Robertson, m ay I make this observa tion there? N ow , Mr. H a y es o f N ew Y ork, gets $75,000 a year. T hat is'public money just th e same as the rest o f us g et around here, and he holds that job by reason o f the fact that six o f those banker directors vote for him. D o you thin k he is g o in g to fa il to give them all o f the inform ation th at he gets at these m eetings ? D o n ’t you think it would be unrealistic to suppose that a president under those circumstances would not d iv u lg e to h is board o f directors, to the members o f the board w ho elected him , w’hat was g o in g on ? Mr. R o b e r ts o n . I thin k it is very im probable that any president of a F ederal Reserve bank ever reports to his board o f directors on what goes on in the open market operations. Remember that every president w ho is selected must be approved by the Federal Reserve Board here. W e must approve him , or he can’t serve. The C h a ir m a n . I do not consider th at a problem . Y ou have got to approve som ebody, and whoever they p ut in there, if there is no objection, you w ould approve. Mr. R o b e r ts o n . W e have objected. T he C h a ir m a n . W ell, very seldom. I doubt, i f I asked you to bring in the ones you have objected to, that it w ould be over three— that was the C hicago bank, w asn’t it? M r. R o b e r ts o n . I w o u ld n o t w a n t to discuss it. B u t I th in k th ey do not report back, and I th in k th ey are all quite aware o f the position o f the B oard o f G overnors, th a t they should not report to th eir directors on w hat goes on in the O pen M arket Com m ittee, and I am sure that this is adhered to by every president of the-----The C h a ir m a n . Mr. G ettys ? Mr. G e t t y s . T hank y o u , Mr. Chairm an. 202 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. Robertson, the action o f the Federal Reserve Board on D e cember 6 last was intended to curb inflationary trends; is that cor rect, sir? Mr. R o b e rtso n . That is right. Mr. G e tty s . Isn ’t it true that the purpose intended has been ac complished, except that it was not predicted that the building and construction field would be hit so hard \ Mr. R o b e rtso n . I w ould say th e m ore restrictiv e m o n etary policy in being to d a y is h av in g its im pact in cu rb in g th e inflation -----Mr. G e tty s . The inten d ed im pact. Mr. R o b e rtso n . But it was not thought at the tim e that this would have the great impact on the housing industry that some people fear it is going to have. Mr. G e tty s . Now, are there other fields which have been unpredictably affected by the Q action ? Mr. R o b e rtso n . I cannot think of any. Y ou do not mean the Q action, you mean the whole operation ? Mr. G e tty s . T h e whole situ atio n , yes. Now, you stated, Governor Robertson, that you would not have taken that action at the tim e, but you had other suggestions ? Mr. R o b e rtso n . Yes. Mr. G e tty s . I f your suggestions had been adopted by the Board, what effect, as o f this time, would your suggestions have had, or what would they have been ? Mr. R o b e rtso n . I would be very glad to answer that w ith the recognition that no one can tell w hat would happen or could have happened i f some other course of action were taken. Mr. G e tty s . You still hold the same view now ? Mr. R o b e rtso n . I still hold the same view now. I f the desire at that time was to curb inflation, then the result to be achieved was to curtail the expansion o f bank credit and the money supply o f the country, and the way in which I would have suggested doing that would be to hold the ceilings on interest rates on C D ’s exactly where they were and let the banks get needed funds from the discount w in dow o f the Federal Reserve. Remember, you do not act sim ply to push interest rates, because interest rates, in m y opinion, do not have as strong an im pact in curtailing the impact on credit as many people think. A s has been pointed out here this morning, large businesses can w rite off half the charge. T he interest rate does not mean any difference in bor rowing. They need money to carry on the business, which is a profit able business, and if they do, they are going to get the m oney, andconsequently, I would have made it im possible for banks to expand their credit as fast as they did by merely raising the interest rates on C D ’s and g ettin g more funds w ith which to do it. I w ould have raised the discount rate, but I would have used open market opera tions then to reduce the availability o f funds, and th is w ould have resulted in a slower increase-----Mr. G e tty s . L onger overall tim e ? Mr. R o b e rts o n . Y ou still would have the effect o f restrictive monetary policy. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 0 3 Tlie other action w ould have follow ed : In stead o f u sing interest rates as your goal, use them fo r a signal fo r w hether your actions are right or w rong, accurate or inaccurate. Mr. G e t ty s . Y ou th in k the B oard has now th e pow er to correct and control the situation w ithout additional legislation ? Mr. R o b e r ts o n . I do. Mr. G e t t y s . I believe that is the view o f other members o f the B o a r d ; is that correct ? Mr. R o b e r ts o n . T hey are all here. Mr. M a is e l. Congressm an G ettys, I think we ought to be clear that we are discussing twT separate m atters. One has to do w ith the im pact o of tighter m oney on the hom ebuilding industry. I gave a speech on December 28, 1965, in w hich I predicted just about exactly w hat has happened. T he speech w as w ritten just after the discount rate in crease. I th ink anybody know ing the way m onetary restraints work would agree th a t they did expect w hat has happened to happen. N o one should be surprised. I am sure m ost members o f the B oard were w ell aware o f the fact that when you use an overall m onetary policy, it has a prim ary effect in the m ortgage market. Mr. G e t t y s . Y ou predicted it w ould have a selective im pact ? Mr. M a is e l. Y es, th at has been the case every tim e m onetary policy has been used. W hen you ask w hether we should or can correct the situation th e answer is not so clear. W e have the ability to do what we thin k is correct w ith respect to the com petition am ong financial institutions. W e do n ot have sim ilar pow er w ith respect to com peti tion between the m ortgage and m oney m arkets. Congress has that power. I think the traditional w ay to correct a lack o f m ortgage money is through som ething lik e F an nie Mae. I f C ongress believes that the housing m arket has suffered, it seems to m e th at it is up to Congress to see w hether they w ant to exert their legal authority through F annie Mae or in other specific areas. T h is w as th e answer o f Governor Robertson. F a n n ie M ae is set up so it can have a differential im pact in a specific m arket. A nother w ay th at th e Congress has set up to take care o f this prob lem is through advances o f the F ederal hom e loan banks. T hat is a second one. I t seem s to m e proper that in th e past Congress recog nized the im pact o f m onetary policy, in a selective fie ld ; nam ely, the m ortgage field, and found w ays to develop its ow n tools to deal w ith the problem. N ow , the F ed eral R eserve can’t solve th at problem if it is charged w ith en forcin g m onetary restraint. W e m ust be conscious o f that. I do not th ink any changes in regulation Q , in a period o f m onetary restraint, w ould do m uch tow ard so lv in g th e problem o f the m ortgage market or the housebuilding industry. Mr. G e tty s . T hank you. I w ould like to pursue that, but m y tim e is up. T he C h a irm a n . M r. H alpern. Mr. H a lp e r n . I w ould like, Mr. Chairm an, to take th is opportunity to ask an expression o f view s by th is d istin gu ish ed panel on a m ost tim ely and pertinent m atter, one th a t has a direct relationship to m onetary p olicy. 2 0 4 u n s o u n d c o m p e titio n f o r s a v in g s a n d tim e d e p o s its W ould each o f you express your opinion on this committee’s recent action in recommending that the Congress grant to the President standby controls over consumer credit ? Mr. R o b e rtso n . I w ill be g la d to give you m y answ er. Mr. H a l p e r n . I w ill be very happy to hear from you. Mr. R o b e rtso n . I th in k th a t th ere are p eriods in w hich selective controls can be effectively used an d can serve a purpose. I generally am opposed to selective controls a n d p re fe r g en eral controls because o f th e very g re a t difficulty o f a d m in iste rin g those selective controls like consum er credit, on an equitable basis. This goes not only to controls on consumer credit, but controls on real estate credit as well, such as we had under regulation X once before. A ny selective control of this kind is unfair. There are always ways to evade and avoid it, and consequently I would hope to avoid the use o f it. B ut on a standby basis I would not rule them out, because I think there are occasions when that m ay be the real thing that you need for a very short period o f tim e, and I w ould like to use it, and I think it is important for a short period— as short a period as possible. Mr. H a lp e r n . W ould you do it now ? Mr. R o b e rtso n . No, I would not. Mr. H a lp e r n . You would not now ? Mr. R o b e rtso n . No. Mr. R eu ss. W ould the gentleman yield? Let me understand the question. Mr. R o b e rtso n . I w ould n o t ap p ly th em a t th e m om ent. Mr. R euss. W ould you accept the power to have the option to apply? Mr. R o b e rtso n . On a standby basis, yes, but I would not apply it if I had the power, as o f the moment. Mr. H a l p e r n . Mr. Shepardson ? Mr. S h e p a r d s o n . I have substantially the same view as G o v e r n o r Robertson. I think, under certain conditions, they m ay be used effec tively. I t seems to me that selective controls are extrem ely difficult to use. A nationwide regulation that would fit the various situations, is so difficult to form ulate, and evasions are so great that it is o f d o u b t ful value in most circumstances. U nder the im petus of an all-out war, the readiness o f people to abide by such regulations is an e x p r e s sion really o f patriotism , and under those circumstances you may effectively use that type o f an instrument. We had selective controls before, and it did not take very long before we experienced evasions that were almost uncontrollable. I think I would agree with Governor Robertson as to their value as standby powers. I think they should be used rarely and under only the greatest pressure. Mr. H a lp e r n . Y ou do not think this would be a tim e to grant them? Mr. S h e p a rd so n . No. Mr. H a lp e r n . Mr. Brimmer? Mr. B rim m er. Mr. H a l p e r n , I share Governor Robertson’s a n d Governor Shepardson’s view s on the usefulness o f standby controls over consumer credit, however, I would add a footnote, t think at this tim e the decision by the Congress to grant such a power m ight be interpreted in a lig h t different from w hat the Congress intended. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 0 5 W hile Congress m igh t intend to provide these as em ergency measures, the public m ay interpret the action as a directive to the F ederal Reserve to apply the controls at th is tim e along w ith other general m onetary instrum ents. Therefore, I w ould not encourage the Congress, if they were to ask m y opinion, to enact such legislation at this tim e. Mr. H a lp e r n . W ould you use it currently ? Mr. B rim m er. I w ould not under current conditions. Mr. H a lp e r n . Mr. Scanlon? Mr. S c a n lo n . I share Governor R obertson’s view , Mr. H alpern. I do have great hesitation about the adm inistration o f selective con trol regulations in peacetim e periods. F rom experience, during the w artim e period, they were difficult to adm inister and I w ould have some reservations on th e adm inistration now, but I w ould give the President standby authority, though I w ould not invoke such authority presently. Mr. H a lp e r n . Mr. M itchell ? Mr. M i t c h e l l . I w ould have no objection to th e power being con ferred, but I w ould certainly feel that from the evidence before us at the present tim e there is no need for it to be conferred at this particular time, and the im plication that it ought to be used I think w ould be unfortunate unless facts change. I w ould also say th at along the line Mr. M ize was follow in g a little earlier, that th is is another place where the im pact o f monetary re straint is now being felt. A s some banks have come under increasing pressure some o f the finance com panies have had difficulty in hold ing onto th eir bank loans. M r .H a lp e r n . M r.M aisel? Mr. M a ise l. I think the standby controls should have been I'etained as a perm anent part o f the anti-inflationary pow ers o f the Government. Mr. H a lp e r n . I s that affirmative? M r. M a isel . Y es, th e y — th a t is, th e sta n d b y pow ers to use co ntrols over co n su m er c re d it in case o f need— should h av e been m ade p e rm a n e n t in ste a d o f h a v in g been allow ed to lap se in th e fifties. Mr. H a lp e r n . W ou ld you apply them now ? M r. M a is e l. N o, I w ould not. Mr. H a lp e r n . Mr. Treiber ? Mr. T reib er. I share the general view s expressed so far. I nder the present circum stances, I think that general policies— m onetary policy and fiscal p olicy— are called for to fight the inflation. I see 110 objec tion to the existence o f consumer credit standby authority, but would consider it u nfortunate i f the enactment o f that legislation at this tim e were interpreted by the public as su ggestin g th at it be used as an alter native for fiscal and m onetary policy. Mr. H a lp e r n . T hank you, Mr. Chairman. The C h a irm a n . W e w ill recess u ntil 10 o ’clock in the m orning, and we w ould lik e fo r all o f you gentlem en to be back here if possible. Mr. R ees. W ou ld th e chairm an yield? I introduced a b ill, H .R . 15173, w hich is aim ed at develop in g some type o f control over certificates o f deposit, or at least defining them . I w as w ondering i f th e B oard m igh t look at th e b ill betw een now and tom orrow m orning, at w hich tim e I w ould appreciate your com ments. 2 0 6 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS The C h a irm a n . I t is considered relevant to th is particular bill that is now under consideration, and, naturally, we want consideration given to it, i f you w ill, please. Thank you, gentlemen, very much. (W hereupon, at 12 o’clock noon, the committee adjourned to re convene at 10 a.m., W ednesday, May 25, 1966.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS WEDNESDAY, MAY 25, 1966 H ouse of R epresentatives , C om m ittee on B a n k in g and C u rrency , Washington, D.C. T he com m ittee m et, pursuant to recess, at 10 a.m., in room 2128, R ayburn H ou se Office B u ild in g, H on. W rig h t Patm an (chairm an) presiding. P resen t: R epresentatives P atm an, B arrett, Mrs. S u llivan , Reuss, M oorhead, S t G erm ain, Grabowski, G ettys, T odd, O ttinger, M cGrath, A nnunzio, R ees, W id n all, F in o, and Johnson. T he C h a ir m a n . T he com m ittee w ill please come to order. T oday th e com m ittee continues hearings on H .R . 14026 and related bills. I w a n t to take th is opportunity to briefly express m y thanks to the B oard fo r app earin g before the com m ittee, and commend them for the fo rth rig h t w ay in w hich th ey defend and argue for their various positions. A lth o u g h it is apparent th at not a ll o f the B oard members think exactly alike, you all m ust still be given fu ll credit for the sincerity and honesty o f purpose w hich you alw ays exhibit. A s w itnessed by the B oard ’s vote on the Decem ber 6 action and as w itnessed by the various p ositions taken in answ ering questions asked by members o f this com m ittee w e obviously all do not interpret facts in the same way. X m ust also take th is opportunity to deplore the fact that Chairm an M artin has refused to appear at these hearings either last week or this week, due, as he expressed it, to a conflict in schedule. T he com m ittee, o f course, w as anxious to have a ll members o f the F ederal Reserve B oard appear to assist us and the Congress in arrivin g at a solution to a problem w hich has devastated th e th r ift industry, the con struction industry, the b u ildin g trade unions, prospective hom e buyers, sm all businessm en and m any others. T his situation in m y opinion, and in th e opinion o f m any, has resulted directly from the action taken by the F ederal R eserve B oard in D ecem ber 1965. In itia lly , I understood that Mr. M artin had to attend an official intergovernm ental m eeting in Europe. I have since learned, how ever, that Chairm an M artin and Governor D aane were not atten d in g an official m eeting o f governm ents but rather a tten d in g an A m erican Bankers A ssociation international convention in Spain. A p p aren tly from the picture in th e m orning paper Chairm an M artin and G overnor Daane feel th at it is m ore im portant fo r them to attend a convention whose one purpose, at least according to th e m orning paper, seem s to 207 208 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS be more in the nature o f a fiesta rather than a work session. Many of us were somewhat disturbed over the fact that these gentlemen have placed bullfighting above the importance of arriving at solutions to the problems o f the American economy. I understand that the House w ill be meeting at 11 o’clock this morn ing. W e w ill go as far as we can with a continuation of questioning of members of the Board by the committee, and if necessary we w ill ask the Board to appear again tomorrow or at another agreeable time. Governor Robertson, this is too serious of course, for levity, but I would like to ask, does the Federal Reserve have colors of its own? Mr. R o b e rtso n . H ave what? The C h a irm a n . I notice this Governor went into the bull ring with the Federal Reserve. I wondered if the Federal Reserve had colors. M r. M aisel. Green. The C h a irm a n . Green would be better than greedy. Anyway, seriously, do you have colors ? D o you have a standard ? Mr. R o b e rtso n . N o ; we do not. The C h a irm a n . That was a mistake. That was a little levity. STATEMENT OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM; PRESENTED BY J. L. ROBERTSON, VICE CHAIRMAN; CHARLES N. SHEPARDSON, MEMBER, GEORGE W. MITCHELL, MEMBER, SHERMAN J. MAISEL, MEMBER, AND AN DREW F. BRIMMER, MEMBER; CHARLES J. SCANLON, PRESIDENT, FEDERAL RESERVE BANK OF CHICAGO; AND WILLIAM F. TREIBER, FIRST VICE PRESIDENT, FEDERAL RESERVE BANK OF NEW YORK—Resumed The C h a irm a n . Mr. Todd is here now and since it his turn to quesr°*n *5? Wltness? * call on him next, but I introduced a House Jom t Resolution No. 1148. It is short and I w ill read it. S e c t i o n 1. Notwithstanding the provisions of section 19 of the Federal R e serv e Act and section 18(g) o f the Federal Deposit Insurance Act, no bank (other th a n a mutual institution) whose deposits are insured by the Federal D e p o s it Insurance Corporation may pay any interest, discount, or other return on any time deposits, savings deposits, or borrowings at a rate in excess of 4y2 percent or such other rate as may be established by the Board of G overn ors of the Federal Reserve System with the approval of the President S e c . 2. The provisions of this resolution shall be applicable with respect to— ( 1 ) savings deposits held, and ( 2 ) b o rro w in g s an d tim e d e p o sits o b tain ed or ren ew e d d u r in g th e tw oy e a r p eriod w h ich b e g in s on th e d ay a f te r th e d a te o f en a c tm e n t o f t h is Act. Briefly, I know you gentlemen quickly interpreted this the same wav it is intended, for a 2-year period that this rate will be a limit of 4i/2 percent. During that time it may be changed with the approval of the President. How would you feel about that, Governor Robertson ? Mr. R obertson. Just of! the cuff, I think this would be a tremendous burden to pla<re on the President, to decide the rate o f interest which should be a ceiling on interest deposits. The C hairm an. W e w ant to go into this somewhat. T h is th in s is so serious. W ill you gentlem en be able to be here tomorrow m orning? Mr. Robertson. I will be able to be here tomorrow morning. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 0 9 T he C h a ir m a n . I t looks like we w ill have to come back. It does not look as if we w ill be able to finish. Som e members w ant to study these and some members have proposals o f their own. Mr. T odd, you m ay proceed. Mr. R o b ertso n . Could I just say, Mr. Chairm an, in response to the question th at w as just raised by Mr. Rees yesterday, a statem ent w ith respect to his proposal w iiich I w ould like to subm it for the record ? I do not have copies, but I w ill send those copies up today. T he C h a ir m a n . W ell-----Mr. R o b ertso n . I w ill have them here this m orning. T w o o f m y associates also have statem ents. T he C h a ir m a n . Y ou m ay insert them at this point. (T he statem ents referred to fo llo w :) S ta te m e n t o f J. L. R o b e r t s o n , V ic e C h a ir m a n , B o a r d o f G o v e r n o r s o f t h e F e d e r a l R e s e r v e S y s t e m , o n H .R . 15173 At the committee hearing yesterday. Representative Rees asked the Board to comment on H.R. 15173 at this morning’s session. From our very brief study, it appears that the bill has three main provisions. It forbids insured banks (1) to issue interest-bearing negotiable certificates of deposit or other negotiable instruments, (2) to pay interest on time deposits held for less than 1 year, and (3) to pay higher interest rates on time deposits than on savings accounts. The Board views such blanket prohibitions on competition for savings as detrimental to the public interest. They would erect legislative barriers to a free movement of funds that has great potential for increasing efficiency in financial markets. In their efforts to compete for savings of individuals, banks would be effectively limited to the acceptance of passbook savings, since few individuals would be willing to hold time deposits with a maturity of a year or more at interest rates no higher than those on savings accounts. The result of such legislation might be that the maximum rate on passbook savings would have to be raised to prevent banks from being barred from effective competition with nonbank intermediaries. The bill’s prohibition of negotiable CD’s is the same as that of H.R. 14026. Our objections to that bill thus apply to this bill also. The other two provisions of H.R. 15173 seem unwarranted. As we noted yesterday, time certificates have been used in some sections of the country for many years as a medium for the investment of savings by individuals and other small investors. These certificates frequently have a maturity of less than 1 year. Maintenance of a solvent and liquid banking system does not require that all such certificates should have a maturity of 1 year or more. Time de posits of fixed maturity permit banks to tailor their asset structure to the maturities of their liabilities. With time deposit matitrities of appropriate length, there is justification for permitting rates on time deposits to exceed those on savings accounts, which are in practice paid on demand. In the past, Congress has taken the view that considerable latitude should be provided to the regulatory authorities for adjusting ceiling rates on time and savings deposits in the light of unfolding economic developments. As we noted yesterday, the Board welcomes consideration of measures directed at increased flexibility in administering interest rate ceilings. This bill, in our judgment, moves in the wrong direction, by providing a statutory prohibition and a statu tory freezing of certain interest rate relationships on banks’ time and savings deposits. The changes in financial flows and in competitive relationships among financial institutions that seem likely to result from this bill are drastic. Such legis lative action hardly seems appropriate to a competitive situation which, though it requires careful surveillance and possibly action to avoid excesses that might unduly harm particular sectors of the economy, at the same time offers promise of substantial gains in economic efficiency and in incentives for saving. 2 1 0 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS S t a t e m e n t o f S iieb m a n J. M a is e l, M em ber, B o a rd o f G o v e r n o r s o f t h e F e d k r a l R e s e r v e S y s te m , o x II.R. 14026 a n d R e la t e d B i l l s 1. This is a proper period for the use of monetary restraint. Failure to do so without taking alternative actions might speed up inflation and aggravate a sticky balance-of-payments position. (a) The demand for goods in the economy at the moment is pressing too hard upon our physical capacity to produce and therefore is tending to generate sizable price increases. (1) Generally, I think we would be better off if the bulk of excess demand is removed by fiscal rather than monetary policy, since extremes in the application of monetary policy create large problems for the economy. The timing of monetary (rather than tax) restraints is less certain. Monetary restraint’s differential impact on parts of the economy probably is greater than that of fiscal policy, while its final incidence on subgroups in the country is probably less certain. (2) On the other hand, given the decision to rely upon monetary instead of greater fiscal restraint, I believe that monetary policy should be made as effective as possible. (b) In the current situation, higher interest rates and tighter credit avail ability in the United States will aid the balance of payments. Again, I feel other steps to correct the balance-of-payments situation are preferable, such as the use of taxes, tariffs, and other governmental policies. Since such steps have not been taken, monetary restraint and higher interest rates are necessary to aid in the adjustment process of bringing about an equilibrium balance of payments. 2. Given a decision to adopt a policy of monetary restraint, raising the ceiling of regulation Q, and not adopting a split rate, was a proper corollary to the rise in the discount rate last December. (a) I do not believe that small savers should be discriminated against in favor of large savers, corporations, or financial institutions. If Congress decides to penalize small savers. I would help to enforce such a decision, but it seems to me enforcing a lower rate of return for the savings of a selected group of citizens without considering carefully other alternatives would conflict with the best traditions of the American way of life. (b) I think the previous use of interest-rate ceilings to halt normal competition among savings institutions turned out to be unfortunate for the country. The protected position of some institutions resulted in a good deal of waste and inefficiency. Unless there is a real danger from excessive competition, or unless the period is one in which the market is acting in a destabilizing manner, one should hesitate to impose ceilings on wages, prices, interest rates, or any other good without a clear theory as to what the ceiling is to accomplish, who is to gain by it, who is to pay for it, and whether the ceiling is the most efficient form of transferring money from one group to another. While we have no exact figures yet, there are indications that some sm all savers are responding to the appeal of higher rates by increasing th e ir sa v in g s. This is exactly one of the developments that is desired as a result o f m on etary restraint. It is a major reason why the savings institutions now should have some freedom to increase rates—to stimulate, and to share in, a larger fin an cial savings flow. (c ) I doubt that a ceiling on either negotiable CD’s or on small ones w ou ld give the results some hope for. Thus far it certainly appears as if co m p etitio n among institutions has aided savers. At the same time, we have no proof that it is the major cause of the April losses in some institutions. From all ap p ear ances the main competition thus far has been between the money market and all financial institutions for sophisticated money. Imposing a ceiling of 5 percent on $100,000 CD’s might simply force money into U.S. Government agency issues at 5.5 percent or into other market instruments. Many of the major losses of funds seem to have centered in savings in sti tutions that knowingly risked this situation by departing from their normal scope of operations. It was a risk that I and most regulatory authorities de plored and called specifically to their attention in public statements. Som e simply tried to expand by attracting larger deposits. Others went further. To strive for increased profits, they sought money-market money rather than real savings and used that money for lending on more speculative properties at higher rates. The average stability in a given institution of small savings still seems to be much greater than for larger blocks of funds. Such stability should not have been expected for larger savers. Should the small thrifty family that UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 1 1 is not at fault be penalized before we hare better proof -that such action would stabilize sufficient funds to make the inequity worthwhile? 3. I should make it clear that if our survey shows that unstable conditions exist, or that a further ratcheting of interest rates without productive results appears imminent, I would vote to impose some stabilizing regulations even at some sacrifice of both fairness for the small saver and the efficiency expected from the market. But I would do so with a great deal of unwillingness, and such a decision would require a particularly careful measuring of alternatives. I am concerned with the potentially greater instability of larger CD’s. I do not, however, feel that their existence can force the Board to raise the Q ceiling, any more than their existence last December seemed to me then to lend weight to the argument for raising the discount rate. I believe that at the present, within rather broad limits, the discount rate is a price fixed by the Board and not the market. The existence of market rates against the ceil ing may lead to a particular distribution of credit which differs from that which would exist without the ceiling. The question which must be answered is whether such a distribution is desirable and for how long the pressure can be maintained given the facts that money is fungible. 4. These hearings have properly called attention to the fact that even though monetary policy is applied generally, its major impacts center in certain selective markets. These costs which result from restraints must be measured each time monetary policy is used. When, as in the current -period, a decision has been made to use monetary restraint in place of more pointed and vigorous fiscal and balance-of-payments procedures, then these particular costs will be experienced. If in the circumstances, Congress believes that selective cushioning is needed for the areas hit hardest, clearly they should consider taking special action. I have gone on record on numerous occasions over the past 10 years to the effect that Congress has properly established the special assistance program of FNMA and the advances of the FHLBB to deal with such a problem. They represent ways of putting money directly into the housebuilding market when a determination has been made that such areas are suffering too much as a result of the application of general monetary policy. If it appears that the pinch of monetary restraint is too great in particular spheres, action should be taken either to substitute other types of policy for monetary ones or aid should be given directly to the sectors where the cut backs appear to be antiproductive from the point of view of the economy as a whole. Until evidence is available to the contrary, however, I believe the most reasonable presumption is that special ceilings on all, negotiable or small, CD’s would not offer sufficient aid to the mortgage market to make worthwhile the sacrifices they would entail for savers, other institutions, and many borrowers. A Pandora’s box might be opened in which decisions now made by the market as to how to distribute savings among institutions and borrowers would have to be made by law or governmental fiat. This I am certain we would all much prefer to avoid. Sta tem en t of G eorge W . M i t c h e l l , M e m b e r , B oard F ed e r a l R e s e r v e S y s t e m of G o v ern ors of the I would like to briefly state my basic reasons for believing that the Board’s position with respect to regulation Q ceilings is appropriate at this time. In do ing so I want to make clear that I do not project this view into a future in which conditions may be changed or changing. I start with the proposition that the broad subject with which this hearing is concerned is a flesh-and-blood problem, and I would like to recall my diagnosis its potential in a speech I delivered several months ago, and has previously been referred to by Mr. Strunk. At that time I considered in what respects contemporary credit developments mi£ht, from either the overall or the structural view, become a cause for concern. My choice of something to worry about, which may yet turn out to be a real menace to our credit structure, was not that we had too much debt in the ag gregate or in broad economic sectors; nor was it the level of credit quality which could be safely serviced by an expanding economy. Rather, it was the growing business of borrowing short and lending long—the transformation of uQgid claims into long-term credits by depository intermediaries. Digitized for Back on October 22, 1965, I pointed out that; for the saver and investor these FRASER totennediaries http://fraser.stlouisfed.org/ were offering the best of all possible worlds. Thus the investor Federal Reserve Bank of St. Louis 2 1 2 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS had a highly competitive return on his funds, and yet by prevailing practice he was always instantly able to convert his deposit into direct expenditure or direct investment if market conditions open up more exciting earning opportunities. The channeling of these flows into long-term instruments has also provided more ample funds for use by corporations, individuals, and the various units of government. And financial intermediaries themselves by lengthening their port folios and broadening their range of assets have been able to live well off an in creasingly slender interest rate differential. “In surveying these uniformly pleasing results, however,” I noted, “that the question naturally arises whether they have been obtained by risking serious destabilizing repercussions in the future. Certainly while banks and other sav ings institutions have been expanding the volume of liquid claims in the hands of the public, they have been assembling in their own hands an entirely different time profile of matching assets. Not only are their loans and investments far less liquid than the claims against them as has always been true; they are far less liquid than they were 5 or 10 years ago.” I went on in that speech to point especially to the liquidity risks attaching to CD issuance, but my remarks could equally well have been punctuated by illustrative references to the risks inherent in the passbook share accounts of savings and loan associations. “In considering the vulnerability of depository institutions to savings out flows,” I said, “the potentially disruptive contingency—and the one that is most likely to create a challenge to monetary policy—lies in the possibility of rela tively sudden shifts of funds from ‘time’ deposits to direct investment in equity or credit markets. In this respect, negotiable certificates of deposit constitute the most vulnerable segment of the total since they are directly competitive with the full range of money-market instruments and are held by corporations and other institutions likely to respond quickly to relatively small shifts in yield differentials. Indeed, the most immediate and direct constraint on monetary policy posed by the new profile of bank liabilities may lie in the need to weigh carefully the impact of specific actions on such differentials. “More broadly, those charged with formulating monetary policy must recog nize that the process of transforming liquid savings into long-term instrum ents does lack some of the Automatic checks and balances inherent in a single con tract between the original saver and the ultimate borrower. A widespread shift by depositors to other forms of asset holdings—say a move by corporate holders of negotiable CD’s into market instruments or by individual savers into com mon stocks—might force readjustments in bank assets that would have serious repercussions on those credit markets in which banks are inactive and into which it may be difficult to entice other investors without significantly higher yield incentives. “This would be particularly likely in markets such as those for m unicipal bonds and mortgages where bank participation has increased sharply in recent years. It might well occur whether the readjustment undertaken by banks losing time deposits was confined to reduced takings of new issues or exten d ed to actual liquidation from existing portfolios.” These comments foretold a contingency which began to come into being with the December 1965, tightening in monetary policy and the subsequent rise in market interest rates. A major asset adjustment that would have been required of banks (and an unexpected impact on their customers) was partially eased by ® change in regulation Q. This change permitted banks to offer higher rates for what amounted to about 14 percent of their total deposits. So far as the larger banks were concerned, it enabled them to be more competitive with the security markets. So far as the smaller banks were concerned, it enabled them to be more competitive for local pools of funds. B u t in both instances the banks were also competing with each other and, more fatefully, with themselves. They had in passbook savings about $90 b ft" lion on which the ceiling was not changed. To a considerable extent they round promoting CD and open-book accounts a t 4%, 5, or 5*6 percent attracted large transfers from their own lower rate passbook savings accounts and thus only raised the price on funds they already had. This redundancy of cost had a substantial moderating influence on their competitive drive. Furthermore, even with these higher deposit rates banks have not been able to fully offset the lure of high-yield market instruments for their customers J the most that banks altogether have been able to do is to keep up a positive net inflow of time deposits, but with a growth rate far below last year—a third less i® January-April than in the comparable period of a year ago. Savings and lo& ® UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 1 3 association and mutual savings bank net inflows have also been dropping—to a rate only half that of 1965. Thus, all financial intermediaries have been feel ing the tug of higher market rates of interest. Meanwhile the share of credit demands met through direct flows of savings to the market has risen sharply as savers *bypassed banks and other intermediaries and put more of their funds directly into securities. Last year the banking system was able to accommodate two-fifths of the credit used by individuals, businesses, and governments; in the first quarter of this year, the banking system’s contribution fell to only about one-quarter of the total. What does this background of fact and principle signify for how we should approach today’s problem? I think it is clear th a t we all have a common goal of maintaining the stability of our financial institutions and of providing savers with the best yields and the greatest liquidity consistent with that stability. I would add that near-instant liquidity of time deposits at banks or savings and loan associations is a privilege that must not be too widely shared. It can hardly be shared at all with any very large number of that kind of depositors whose withdrawals are stimulated by rate incentives. A predictable, even though large, turnover in savings ac counts is one thing, and well within financial managements’ capabilities—a con centrated mass withdrawal to take advantage of rising yields is an entirely dif ferent m atter and much more difficult to deal with. This is one reason for the Federal Reserve rules that today deny passbook accounts to business corpora tions and to State and local governments, two types of depositors who are ex ceptionally sensitive to rate differentials. Today many depository institutions are recognizing the destabilizing threat of rate changes, and they are trying to stratify their depositors, according to sen sitivity to yield differentials on the one hand and to desire for liquidity on the other. Those that are sensitive to higher yields are being locked in with varying maturity arrangements; this is a major virtue of the certificate of deposit. Those th at are more liquidity conscious are being offered lower yields in pass book-type accounts. The rates, terms, and conditions offered vary widely from place to place in the Nation, reflecting the great variety of economic and financial circumstances and the differing judgments of thousands of financial managements. In the process several new mutations of deposit instruments have taken place. A few such mutations may be bad, or at least nonprofitable in the longer run, but I regard as constructive those savings contracts th at compel the holder to accept some meaningful restraints (maturity or otherwise) on his ability to demand cash from his depositary institution and then pay that holder well for his giving up otf liquidity. And for this reason, denouncing longer maturity, higher yielding CD’s just because they are of small denomination strikes me as anti thetic, not only to equity but also financial stability. In a problem as complicated as this one, it is possible to mistake surface symptoms for underlying causes of disequilibrium. The result of an erroneous analysis may be to damage our financial intermediary system, reduce the bene fits of a competitive financial system, or to thw art the effectiveness of monetary action, the major instrument of public policy being used to counter emergent inflationary pressures a t this juncture. Bank and savings and loan competition has been vigorous for several years now. But it moved into the acute stage when monetary restraint reached its current levels and it became obvious th at the aggregate of credit would not be large enough to go around. The problem, in my view, is linked directly to the way in which we are dealing with overheating, or the threat of overheating, in our economy. Were we using fiscal policy to counter these pressures, I doubt the issue we are considering today would even have arisen, greater reliance upon fiscal restraint would probably not have produced the monetary stringency we now see around us or may be expecting. Our problem is clearly worse, however, because financial intermediaries have implicitly promised more liquid ity, yield, and accommodation to their customers than they can readily deliver. Admittedly, there is room for differences of view on what, if anything, should be done now. In seeking solutions, we must keep in mind th a t there a re both short* and long-run problems involved, cyclical as well as secular developments with which to cope. In the short run, we have to quell the hysteria and break the paralysis th a t seem to be gripping some participants in and observers of the financial scene. The financial structure is essentially resilient and well Uianaged, and there exist governmental mechanisms established fo r the very Digitized forPurpose of easing adjustm ents th a t m ust come in the w ake of shifts in dem ands FRASER 'o r goods and for finnnrtqi services. While not denying th a t a problem exists http://fraser.stlouisfed.org/ 68-496 St. Louis 15 Federal Reserve Bank ofO—66 2 1 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS for all financial intermediaries—as a result of the Government’s reliance on monetary policy as the main tool of economic restraint—the situation hardly warrants the crisis atmosphere that has developed in some quarters, or the overreaction by portfolio managers which threatens to curtail housing activity unnecessarily sharply. What is important is to be sure that in dealing with the short-run problem we do not adopt solutions that in the long run will hurt more than help. I believe the best and most lasting solution lies in permitting intermediaries, savers, borrowers, and the market to work out their own salvation. Most of them are doing well enough now and others are taking constructive corrective measures. If governmental actions are needed, they should be actions designed to remove restrictions and inhibitions, rather than those which hamper adjust ment to evolving economic needs. I would like to add a postscript to my statement, with respect to the impact of monetary conditions of recent years on the smaller banks of the Nation and, by inference, on the effect of restricting their use of CD’s and open-book accounts. Unfortunately, our statistical knowledge of how small banks are faring depends upon Oall Report data which are not very current From data for June 30, 1965, the latest information we have, I think it clear that small banks w'ere holding their share of the market for demand deposits, losing out on passbook savings, gaining slightly on CD’s and open-book accounts held by State and local governments and gaining well on CD’s and open-book accounts held by individ uals, partnerships, and corporations. Using June 30, 1961, as a comparison year, defining small banks by the total of their deposits in each of these categories, and choosing deposit levels in each case to set off 75 percent of the 13,543 banks in the Nation, these are the results : (1) Banks with demand deposits otf less than $5,110,000 had 11.6 percent of the demand deposit market in 1961—11.5 percent in 1965. (2) Banks with less than $3,250,000 in passbook savings had 13.0 percent of that market in 1961—and dropped to 10.9 percent in 1965. (3) Banks with less than $1,310,000 in CD and open-book accounts to individuals, partnerships, and corporations had 7.1 percent of that market in 1961 and gained to 11.9 percent of it by June 30,1965. These data are now almost a year old and what the statistics for June 30, 1966, would show is partly a matter of conjecture—my conjecture would be the smallest 75 percent of the banks are still holding their own on demand deposits, still losing on passbook savings, and more dependent than ever on the small CD and open-book ’ ccount to hold their share of the time deposit market. a Mr. R euss. May I see the copies, now? The C h a ir m a n . The clerk will make them available to you. Mr. Todd? Mr. Todd. Thank you, M Chairman. r. I very much appreciate the opportunity of clarifying some of m y own questions with you gentlemen on the Board. One of my concerns is that as much as we talked about monetary restraint and tight m oney, I find m the May 1966 Federal Reserve Board Bank of St. Louis Be^ ^ ar^ J entitled “Monetary Expansion Continues.” lc1e Perhaps the point of view can best be expressed by reading one paragraph which is the following: “The interest rate rise since last July has been caused by swelling demands for funds rather than by monetary restrictions. The intensity of the demands for loan funds has been witnessed by very rapid expansion of the bank loans, very large offerings of corporate and municipal securities and su b s ta n tia l increase in governmental debt outstanding as well as by the in c r e a s e to interest races* I have a problem myself in reconciling the statements th a t are gen' eW made th a t we are in a period of monetary restriction, and tm?* which says we are not in a period of monetary restriction. This is Dome out to me by expansion of the money supply which has occurred since last year which is on the order of, I believe—depending on you consider the money supply, some $10 billion* m d I just wonder UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 1 5 how you gentlemen look at this. On the one hand we call it mone tary expansion and on the other hand we talk of tight money. Are we talking about the same thing, or is this just a difference of inter pretation of policy that we have now ? Mr. Robertson. I think probably it is an application—a mixture of the two, Mr. Todd. Certainly, the restrictiveness of monetary policy has meant that the money supply and bank credit have expanded more slowly than other wise would have taken place. We have not attempted to bring to a halt the expansion of credit. But certainly, we have expanded at a slower rate than would have otherwise taken place if we had not been very reluctant in providing reserves. Mr. Todd. You mean the open market operation; this is really what creates the money supply, is it not ? Mr. Robertson. It depends on how you provide your reserves, either through open market operations, or through the discount window. Either avenue is available for increasing the reserves of the banks. You are right in thinking that most of the reserve expansion is being provided through open market operations. Mr. Todd. And this has really been an expansion—an expansionary policy, has it not, in that banks have been able to meet loan demands up until recently ? Mr. Robertson. Banks who had----Mr. Toro. Without many restrictions. Mr. Robertson. Banks have been able to meet their loan demands, but less readily and with more difficulty and at higher cost since the interest levels were pushed up. Mr. Todd. I think this particular series of hearings is caused by another aspect of this, and this is the attraction of money from the savings and loans to the banking system, which appears to me to be also a means of expanding the money supply. Savings and loans are not able to create money, out banks increase by 25-fold in the money they attract from the savings and loans. And since I have limited time now, I simply want to suggest that it seems to me we have to make some decisions within 2 weeks, by the middle of June, or we are faced with the prospect of substantial withdrawals from savings and loans moving over into the banking system. Perhaps some sort of liquidity problem for savings and loans. As a consequence, it seems to me we are in the midst of an academic discussion, but we must make some de cision quickly on the basis of information available to us. I wonder how severely you consider the potential liquidity crisis the first of July and if the Board is prepared to move in this? You have mentioned that you are going to do some more studying and I think M Martin has indicated before they were going to study this situ r. ation closely, but you can study things so closely you do not act. I do not think there is much prospect of the committee, except via the chairman’s resolution, taking action quickly, yet this may be an alter native to inaction by the Board. I wonder what the position of the Board is on this? Mr. Robertson. I would respond first and the others, I am sure, would be very glad to respond. First, let me reemphasize that we are as alert to this problem as any one else could possibly be. The question is the very nature of the problem, the http://fraser.stlouisfed.org/ size of the problem, the way in which you should develop Federal Reserve Bank of St. Louis 2 1 6 UNBOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS remedies for it, if it is there and if it is real and not just fear. But, also, I think it must be borne in mind that there are limitations to what you can do with respect to monetary policy to ease the burden here. It may be that what we need to do and what should be done is to deal with this particular problem selectively through either FNMA or the Federal Home Loan Bank Board in order to provide funds, in order to see that the construction industry doesn’t bear the whole brunt of the restrictive monetary policy. On the other hand, if you were to ease monetary policy to the point where the whole interest rate structure would drop down, we would have in my view inflation in this country that no one could stand. Now, I will let the other members of the Board express their views. Governor Shepardson % M S h e p a r d s o n . Mr. Todd, I would agree completely with what r. Governor Robertson said. We are definitely alert to this problem. We do not consider it something for longtime study. We are fully aware of the possible movement of funds m early July. We are try ing to marshal our information to the point that we will be in a posi tion to take constructive action before that time. What that action might be, I think is impossible to determine at this point. I do think that it is important that we recognize this is only one of several areas that we are concerned with. If we were to take steps to lower the availability of funds to banks, which are providing the funds for busi ness, both large and small, we might very well see the problem shift from the present problem of construction and mortgage funds to a problemof small business funds. A drastic curtailment of the ability of banks to draw in funds to meet the credit needs of business could create a new and different set of problems. We would find small banks and medium-sized banks and their customers being hurt just as well as large banks. The suggestions that have been made for some limitation on the flow of funds have largely been directed toward the smaller deposits. All the suggestions that I have seen would place limits on the rates paid for the smaller amounts. Well, those are the funds that go to small business, by and large. I think that we have to be very careful that in correcting one problem, we don’t create an equally difficult problem in another area. And I would agree with Governor Robertson’s sug gestion that probably a more satisfactory or more constructive way of meeting this would be through the agencies created to assist in financ ing homes, perhaps by increasing FNMA’s authorization or that of the Home Loan Bank Board. There was some discussion yesterday about selective controls. W ell? it seems to me this is a problem that needs a selective answer through the agencies created to handle this particular area. Mr. Todd. Thank you. Mr. Chairman, my time has expired. The Chairman. We will get back to you, Mr. Todd. The Board is coming back tomorrowmorning to give us all an oppor tunity to ask further questions. Mr. Ottinger? Mr. O ttinger. Thank you, Mr. Chairman. I would like to put in the record at this point, if I could, a letter that I have received from the National League of Insured Savings Associa tions, H a rry P, Greep, president, and Rex G. Baker, J r., vice president, endorsing my bill, H.R. 14422, proposing a floor on time deposits, UNSOUND COMPETITION FOR SAVINGS A N D TIME DEPOSITS 2 1 7 prohibiting issuance in denominations of less than $15,000, but pro posing that the limitation should preferably be raised to a minimum denomination of $100,000. The C h a ir m a n . Without objection, s o ordered. (The letter referred to follows:) N ational L eague Hon. R ic h a b d L. O t t in g e r , op I n su r ed S a v in g s A ssociations , W ashingto n , D.C., Map 18, 1966. S ouse of Representatives, W ashington, B .C . D e a r C o n g r e s s m a n O t t i n g e r : In connection w ith the appearance of repre sentatives of the National League of Insured Savings Associations as witnesses before the House of Representatives’ Committee on Banking and Currency on May 9 and 10,1966, you invited an expression of the view s of the National League with reference to H.R. 14422, a .bill to prohibit insured banks from accepting time deposits in amounts less than $15,000. which you introduced on April 7,1966. At its legislative conference in February 1966 in Washington, the National League discussed the topic of certificates of deposit a n d recommended legislation toward limiting the issuance of negotiable certificates of deposit to a minimum denomination of $100,000. This position was ratified by a special meeting of the members of the National League held on May 3, 1966, at its management con ference in White Sulphur Springs, W. Va. The National League position is based on the theory th a t certificates of deposit Issued by banks should partake of the nature of money market instruments involving substantial blocks of funds, and should not impinge upon the type of deposit normally handled in savings accounts. T hat position finds support in the action of the Board of Governors of the Federal Reserve System in amending regulation Q in December 1965, since the limit fo r interest rates on savings accounts was maintained at 4 percent per annum w hile the limit for interest rates on certificates of deposit and other time deposits was permitted to rise to 5% percent per annum from a former limit of 4 p ercent on time deposits of 30 to 89 days and 4 ^ percent on time deposits of 90 d a y s or more. Subsequent experience in issuance of certificates o f deposit has shown a grow ing number of examples of their issuance in denominations so small and for terms so short as to attract the attention of investors w ho otherwise would have probably chosen a savings account in a bank or a sim ila r savings account in a savings and loan association as an investment medium. Since H.R. 14422 would alleviate this situation by placing a minimum limit of $15,000 on the issuance of nonnegotiable certificates of deposit, the National League supports the principle of the bill. I t would p re fer to have the minimum placed at a higher figure. It would also urge am endm ent of the bill to place a minimum limit of $100,000 on the issuance of negotiable certificates of deposit. The principle of fixing express dollar minimum lim its should likewise be ex tended to other types of time deposits in order to p rev ent their future adaptation to instruments competing with savings accounts. As noted J>y its principal witness, Mr. Everett C. Sherbourne, the National League also hopes that action will be taken to w ard requiring a longer time differential between a savings account and a time deposit, preferably 6 or 9 months. Sincerely, H arry P. Greep, President. R ex G. B aker , Vice P resident. Mr. O t t i n g e r . You gentlemen of the F e d e ra l Reserve Board are very complacent about the effects of your c h a n g in g regulation Q to permit 5i/>-percent interest on certificates of d ep o sit and you have said no dire effects have yet been felt. I am su re y o u are aware th a t be cause of the construction cycle it takes some tim e fo r these effects to be felt. I t will be some 8 or 9 months before th e re a l effects can be felt. The savings and loan people in my area say i t is impossible to m ake new commitments a t th is time in th e m ortgage field, and th a t means that houses th a t would have been built in the f u tu r e w ith this financing http://fraser.stlouisfed.org/ will not be St. Louis Federal Reserve Bank ofstarted. Construction workers a n d builders won*t be out 2 1 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS of work, though, until housing financed by current commitments is completed. Governor Robertson, you say that you disagreed with the action taken in December. I like very much your thinking on what should have been done. Yet you say at this time that you do not think any action is called for to correct the situation that arose against your will from what you consider a bad decision. This disturbs me. The Chairman of the Home Loan Bank Board, Mr. Horne, has suggested that you be given discretion to set a differential interest rate on the deposits under $10,000. Others have suggested that with respect to the kind of limitation on size that I proposed, you be given discretion. If you were given discretion to put a floor on the size of certificates of deposit, or to put a differential interest rate, would you use it? I would like to hear from you and the Board as to whether your present disposition would be to use it. I know you are against this as a matter of principle. M R o b e r t s o n . That would be my reaction, that this would dis r. criminate against the small man in favor of the large man and this goes against the grain as far as I amconcerned. Furthermore, I do not want you to get the impression that I think there is nothing that should be done to meet this problem. I think something should be done, but I want to see the size of the problem and the nature of the problem. I want to see the size and nature before I act. Furthermore, one of the reasons I would be disinclined to use this proposal of levels for different rates is that I think there is a m uch more equitable and much better way of doing this and that is to gear rates to maturities. Now, this is fair from many points of view. No. 1, the longer a man gives up the use of his funds, the more inter est he ought to be permitted to get for them. From the bank point of view, it is in a much better position to schedule its loans and portfolio assets to the maturities the longer it knows it is going to have the funds available. Therefore, I would prefer this sort of program. Mr. O t t i n g e r . D o you have the power to do that now ? Mr. R o b e r t s o n . Absolutely. As a matter of fact, we did it until 1964. In 1964 we moved away from this and then completely away from it in 1965. Mr. O t t i n g e r . Then why have you not taken the action% M R o b e r t s o n . Well, this is a matter of lack of unanimity of opin r. ion on the subject. I would prefer to let each of my associates speak for themselves. Mr. O t t i n g e r . I would like to have them do that. You said that the primary drawout from the savings and loan banks was c a u s e d by issuance of what you described as “gimmick certificates,” which I take it are nonnegotiable certificates of deposit in small d e n o m in a tio n s . Does the $17.5 billion in certificates of deposit you cited include these nonnegotiables? Mr. R o b e r t s o n . They are the $100,000 and more. Mr. O t t i n g e r . Do you know how much is in nonnegotiable c e r tificates of deposit? Mr. R o b e r t s o n . I can get the figure on it. This will not be an ex act figure because, in the way we figure it, some of the smalltime CD? S are in negotiable form, but they are never negotiated and it is »<* done. But the volume of time—— UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 1 9 M O t t i n g e r . Would it be possible to get the volume of time de r. posits under $25,000, $20,000, $15,000, $10,000? M M i t c h e l l . You can get time accounts for individuals, partner r. ships, and corporations with size breaks at $10,000, $10,000 to $25,000, $25,000 to $100,000, and over $100,000. These data are for Novem ber 1964, the most recent survey. Mr. O t t i n g e r . Is your current survey going to give that infor mation ? Mr. M i t c h e l l . N o. We can give you aggregates in open book and CD’s—negotiable and nonnegotiable. For individuals, partnerships, and corporations the total at the end of the year was $35 billion^ whereas, passbook savings were $92 billion and State and local govern ment time accounts totaled $12 billion. Mr. O t t i n g e r . But you do not have any knowledge as to how much in volume there are in certificates of deposit, negotiable or nonnegoti able, in denominations of $10,000 or less, which Mr. Home was talk ing about, or $15,000 or less as reflected in my bill ? Mr. Mitchell. I do not think so. N o ; we do not, I am sure. Mr. O t t i n g e r . Could you supply such information as you can get on this? Mr. R o b e r t s o n . Yes; we will get whatever information we have. (The information requested follows:) D istribution op T im e Certificates S ize of of D eposit B ank by S ize of Certificate and The attached table shows certificates o f deposit issued by insured commercial banks classified by size of bank and by size of certificate. The data, which refer to certificates outstanding on A pril 26, 1965, w ere provided by the banks in a supplementary statem ent to the regular report of condition on that date. The data cover both negotiable and nonnegotiable time certificates of deposit, including those sometimes called savings certificates o r savings bonds. Of the $36 billion in total certificates outstanding on the reporting date, more than one-fourth w ere in denominations o f $10,000 o r under. N early h a lf of the $10.2 billion of certificates in the sm allest size classification w ere issued by banks w ith less than $10 million in total deposits. A t the other end o f the size distribution, $13.6 billion—more than one-third of the total—w ere in certificates with denominations exceeding $500 million, and the bulk of these larg er denom ination certificates w ere issued by banks in the largest size class. The time certificate of deposit is thus not simply a money-market instrument whose issuance is confined to large banks. Rather, it is a type of instrument offered to a wide variety of savers and investors by banks in all size classes. Time certificates of deposit at insured commercial b<mksf A pr. 26, 1965, "by size of certificate and bank [Amounts in thousands of dollars] Size of bank (total deposits) All banks Total certificates of deposit............... 36,041,850 By size: $10,000 and under. _ 10,217,617 Over $10,000 to $60,000.......................... 4,445,881 Over $50,000 to $100,000......................... 2,290,200 Over $100,000 to $250,000..................... 2,525,378 2 ver $260,000 to $500,000....................... 2,966,921 7,345,464 .................. 6,250,630 Under $10 million $10-$100 million $100-$500 million 6,898,688 8,299,903 5,201,075 15,642,184 4,962,422 1,299,466 295,795 212,188 93,681 28,217 7,085 3,874,851 1,728,496 765,583 724,498 560,631 409,773 246,132 834,764 722,321 534,236 629,571 704,128 980,121 795,963 545,580 695,598 594,586 959,121 1,618,481 5,927,353 5,201,460 Over $500 million 220 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS [From the Federal Reserve Bulletin, April 1966, pp. 466-485] TIME AND SAVINGS DEPOSITS, LATE 1965 AND EARLY 1966 Effective December 6 , 1965, the Board of Governors increased to 5 Vi per cent per annum the maximum interest rate payable by member banks on time deposits. The pre vious ceiling had been 4 per cent for time deposits with maturities of 30-89 days and 4 Vi per cent for deposits with longer ma turities. There was no change in the 4 per cent rate payable on savings deposits. To determine the structure of interestbearing deposits at member banks and the immediate response of banks to the change in the rate ceiling, a survey of time and sav ings deposits was conducted by the Board of Governors over the year-end. All member banks were asked to report not later than January 3, 1966, interest rates applicable to each major type of deposit held by individu als, partnerships, and corporations (IPC) as of December 3, when the Board’s action was taken, and any changes made after that date or definitely planned for the near term. They were also asked to report the dollar amount of each type of deposit outstanding on December 2 2 and to supply selected in formation on the characteristics of the dif ferent types of deposits they used. Reports were received from virtually all of the 6 ,2 2 0 member banks in existence at the end of 1965. This article summarizes the results of the survey. The first part of the article relates to the deposit structure at the time of the sur vey, the second, to the initial rate increases following the change in the ceiling; and the Note.—Caroline H. Cagle of the Board’s Division of Research and Statistics prepared dm article. third, to the structure of rates and other characteristics of the deposits. Since early 1966, some member banks have increased their rates to higher levels than those they had contemplated at the time of the survey. As a result the accompanying tables understate the current level of rates and the increases since December 3. The tables also, of course, do not reflect changes in deposit structure that have occurred since the end of last year. DEPOSIT STRUCTURE Historically, savings deposits have made up the bulk of all interest-bearing deposits at member banks, They still do, but in recent years their importance has declined as banks have introduced new instruments designed to counteract specific forms of competition. Since 1961, for example, banks have developed negotiable certificates of de posit (CD’s), which are aimed at attracting funds of corporations and other large inves tors and at halting the movement of demand deposits of these groups from large commer cial banks into short-term money market paper. Other new instruments, such as sav ings certificates and savings bonds, have been aimed at retaining or attracting funds of individuals and other small investors that might flow to other savings institutions or into securities. Data on the following types of deposits were collected in the survey: savings de posits; savings certificates; savings bonds; other nonnegotiable certificates; negotiable certificates of deposit; and time deposits UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 2 1 open account. Each of these will be dis cussed below. Savings deposits, which may be held only by individuals and certain types of nonprofit organizations, are usually evidenced by a passbook. The bank must reserve the right to require at least 30 days’ written notice before withdrawal, but in general practice these de posits may be withdrawn on demand. They are particularly well suited for savers whose deposits are in small amounts or whose needs for withdrawal are irregular and un predictable. On December 22, 1965, 95 per cent of all member banks had savings de posits, and the amount outstanding was $74.4 billion, as shown in Table 1. At that time they represented 70 per cent of all interest-bearing deposits, IPC, compared with 8 8 per cent 5 years earlier. Savings certificates (sometimes called in vestment certificates), savings bonds, and other nonnegotiable time certificates are all instruments that banks have been promoting in recent years in soliciting more interestsensitive types of savings and liquid funds from smaller businesses and institutions. These instruments generally state that the bank will pay to the holder on a designated maturity date either ( 1 ) the principal T able 1 op T im e and Savings D eposits , IPC, H eld by M ember B anes on D ecem ber 22, 19651 T ypes Num ber o f banka ]>PC of deposit Savings deposits___ Savm p certificates.. jwridgs bond*.......... Otbwnonoc*oti*ble CD's. .777... Negotiable CD’* .... Tims deposits, open Account................. Amounts held Reporting Percentage In billions Percentage dis of specific o f all tribution dollars member types 74.4 70 5,893 2,773 130 95 45 6 .6 6 2 0 .4 <J> 2.1S7 1,777 35 29 5.1 15.9 5 15 1,763 28 4 .4 4 106.8 100 amount shown on the instrument plus ac crued interest at a specified rate or ( 2 ) a specified redemption value, which includes the amount originally deposited plus accrued interest. A distinguishing feature of these and other types of time deposits is that they are not redeemable prior to maturity or until the expiration of a prescribed period of notification of intent to withdraw (not less than 30 days) except in hardship circum stances, and then only at some sacrifice in interest. The instruments are far from standardized, however. Those having the same name may vary in character from bank to bank. And others, though given different designations by different banks, may be identical in character. Certain important characteristics of the various instruments are discussed in the last section of this article. Of these three types, savings certificates are the largest component. On December 2 2 , 1965, these certificates amounted to $ 6 . 6 billion, or 6 per cent of all time and savings deposits, IPC. They were issued by nearly half of the banks, but principally by small institutions. Banks in three Federal Reserve districts— Chicago, St. Louis, and Minneapolis— accounted for almost threefifths of the total.1 These instruments have been an important form of time deposits in these Reserve districts for some years. At the time of the survey 6 out of 1 0 member banks in those districts held some of these deposits. Savings bonds generally are patterned after the U.S. savings bond and typically are Total........ J Time deposits o f individuals. partnership*i, and corporations. * L m than one-ha If o f 1 per ocut. 1Appendix Tables I-VI show for savings and the various types of time deposits, the number of banks with such deposits and the amounts of 'each type of deposit at various levels of interest rates; in these tables the banks are classified by size and by Federal Reserve district. 2 2 2 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS redeemable at specified intervals according to the schedule of redemption values shown on the instrument. On December 22 only $422 million of them were outstanding, and they were held by 2 per cent of all the banks surveyed. Banks in all size groups issued them, but a few large banks in the Philadel phia and Atlanta Federal Reserve Districts accounted for the major part of the total. Other nonnegotiable time certificates totaled $5.1 billion, and they accounted for 5 per cent of all time and savings deposits, IPC. They were used by large and small banks throughout the country, but banks with total deposits of less than $500 million had two-thirds of the total. Negotiable CD’s are evidenced by a docu ment that specifies a principal amount, a maturity, and the rate at which interest will be paid. The distinguishing feature of these instruments, in contrast with those described above, is their negotiability. The bulk of the negotiable CD’s outstanding have been is sued by large money market banks to na tional corporations and other large investors in marketable denominations (generally $ 1 0 0 ,0 0 0 and over) at rates competitive with other money market instruments, and a sizable secondary market in these CD’s has developed. Some smaller banks also com pete for funds of large national corporations, while others issue negotiable CD’s in smaller nonmarketable denominations to their local and regional customers. Less than one-third of all member banks reported that they issue negotiable CD’s, but the volume outstanding on December 2 2 to IPC holders totaled $15.9 billion, the second largest category of IPC deposits. All banks with total deposits of $500 million and over had some of these deposits, and these banks accounted for nearly three-fourths of the total amount outstanding. Time deposits, open account, generally are evidenced by a written contract specify ing the terms and conditions for handling the deposit and the rate of interest to be paid. A special advantage of this type of account is that it can provide for the deposit or withdrawal of funds from time to time without the issuance of separate instruments for each transaction. These deposits, used to a considerable extent for large accounts, can be tailored to the needs of the individual customer, and they show a wider range of usage and characteristics from bank to bank than the other types described. They are also used for special types of small deposits, such as Christmas and vacation clubs, on which many banks pay no interest. Large banks account for a high propor tion of all time deposits, open account. The number of banks that use these deposits is about the same as the number that issue negotiable CD’s, However, the volume on December 2 2 , 1965— $4.4 billion—was much smaller than the amount of negotiable CD’s outstanding. RATE INCREASES AFTER DECEMBER 3 The initial changes in maximum rates paid on time deposits, IPC, in late 1965 and early 1966 affected about one-fourth of all member banks. Most of the increases amounted to one-half of a percentage point or less, as shown in Table 2. Nevertheless, the amount of deposits affected (other than savings) was substantial, because most of the banks that raised rates held relatively large amounts of deposits. As might be expected in view of the in terest-sensitive character of the major holders, rate increases were most prevalent on negotiable time certificates of deposit and on time deposits, open account. About fourfifths and two-thirds, respectively, of these UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 2 3 T able 2 N um ber of M e m b e r B a n k s a n d A m o u n t o f T i m e a n d S a v in g s D e p o s i t s , I n t e r e s t R a t e I n c r e a s e s a f t e r D e c e m b e r 3, 19651 ‘ As of the survey date, 1,450 banks, or 23 per cent o f til 1965. TT* to o l amount of time deposits affected by these Deposit figures a n as of Dec. 22, l% 5 . 1 Less than $500,000. A f f e c t e d by . banks, had raised their rate on one or more types of deposits after Dec. 3, was $22.3 trillion, or 21 per cent o f all time deposits I PC at member banks. deposits were in banks that increased their rates by one-half percentage point or less. Prior to December 6 the banks that held most of these deposits were paying the old 4 Vi per cent ceiling. Rate increases affected smaller amounts of savings certificates and bonds and other nonnegotiable certificates, types held mainly by individuals and other small investors. Between one-fifth and one-third of the banks holding these types of deposits changed their maximum rates, and the pro portion of all such deposits affected was considerably less than one-half. The proportion of banks raising their rates and the proportion of other time de posits affected by rate changes were greater for large banks than for smaller ones, as shown in Table 3. Among banks in the larg est size group (those with total deposits of $500 million and over), more than fourfifths of all negotiable and nonnegotiable certificates of deposit and time deposits, open account, were in banks that raised their maximum rates. For savings certificates the proportion was nearly half. By contrast, for IPC, N ote.—Dollar amounts may not add to totals because o f rounding. small banks (total deposits of less than $ 1 0 million), the highest proportion of deposits of any type affected by rate increases was one-fifth. Savings deposits were least influenced by rate increases, in part because there was no increase in the 4 per cent ceiling for these deposits. Only 7 per cent of all member banks had raised their rates on savings by early 1966. Most of these were small institu tions in the Middle West and South. For the most part these banks had been paying low rates, and in this move they raised their rates to 3 Vi or 4 per cent. STRUCTURE OF RATES AND OTHER CHARACTERISTICS The survey obtained information on the structure of rates on interest-bearing de posits, as shown in Tables 4-5, and on vari ous characteristics of the major types of time deposits, as shown in Tables 6 -8 . Structure of rates. On December 3 nearly three-fourths of all time and savings de posits, IPC, were in banks that were paying ceiling rates. Rates paid were highest for those instruments held mainly by large, rate 2 2 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS conscious depositors and lowest for those held principally by small savers. Nearly all negotiable CD's, savings bonds, and time deposits, open account, were in banks with a 4 Vi per cent maximum rate on December 3, as shown in Table 4; nevertheless the number of banks at this rate level represented less than one-third of all banks holding negotiable CD’s and time de posits, open account. For savings certificates and other nonnegotiable CD’s, most of the banks paid no more than 4 per cent, but those banks that had moved their rate up to 4 Vi per cent on other nonnegotiable CD’s held almost half of the deposits. With respect to savings deposits, 45 per cent of the banl^s were paying the 4 per cent ceiling on December 3, and these banks accounted for almost four-fifths of all mem ber bank savings deposits. Nearly all of the largest banks were paying the ceiling rate, but this proportion dropped as the size of bank declined—to about two-fifths for banks with total deposits of less than $ 1 0 million, as shown in Appendix Table I. Rates on most forms of other time depos its also varied with the size of bank. When banks are grouped by size of total deposits, the larger the size group, the higher the pro portion within the group that were paying the ceiling rate. Most of the time deposits in banks with total deposits of $500 million and over were in those banks with a maxi mum rate of AVi per cent on December 3, as shown in Table 5. This proportion dropped to less than one-fourth for banks in the smallest size group. There were two exceptions—savings bonds, on which most banks regardless of size paid 4Vi per cent; and savings certificates, on which few banks of any size paid as high as 4 Vz per cent. Rates also varied to some extent by geo graphic areas. They were highest in the San Francisco District where nearly all time and savings deposits were in banks paying the ceiling rate on December 3. At the other extreme, less than 6 per cent of the time and savings deposits (except negotiable CD’s and savings bonds) in the Minneapolis Federal Reserve District were in banks pay ing the ceiling rates. Reflecting the relatively small number of rate changes after December 3 on sav ings deposits, the proportion of all member banks paying the 4 per cent ceiling did in crease a little—from less than one-half to one-half—by early 1966, but the proportion of all savings deposits that they held re- T a b le 3 R elation of Size of Bank to Rate I ncreases at M ember Banks after D ecember 3, 1965 (Number and deposits of banks raising rate, ai percent*** of *11member banks with specific type of deposit, by size^oMwnk group) Number of banks Type o f deport Size of bank (total deposits, in millions of dotlan) Deposits, December 22,1965 Size o f bank (total deposits, in millions o f dollars) 10 SO asas Tim# deposits, open 1Lass than oae-halfof 1 percent 50- 100 - 100 500 6 25 8 21 24 20 30 500 and UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 2 5 T able 4 M aximum R ates P aid on V arious F orms o f T im e and Savings D eposits , IPC, o f M ember Banes on D ecember 3, 1965, and in E arly 19661 1 Time and savings deposits held on Dec. 22,1965. Excludes banks that reported no interest rate paid. maximum rale applies to maturities o f 1 year or more where available. When a bank did not report a rate for this maturity, the rate . . nex* shorter m aturity was used. 2 p ie 3Less than one-half of 1 per cent T able 5 B anks P aying O ld AYi % C e ilin g R a te o n Tim e D eposits, IPC , o n D ecem b er 3, 1965, and B anks P aying O v er 4V4 % in E a r ly 1966 (Percentage o f all member banks with specific type o f deposit, by size-of-bank group) . 2 2 6 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS mained about unchanged at four-fifths, as shown in Table 4. Few banks raised the rate on any type of time deposits above 5 per cent in the period covered by the survey. On savings certificates and savings bonds most of the rate adjust ments pushed the maximum rate paid to 4 Vi per cent; few banks raised their rates above this level. By early 1966, two-fifths of all savings certificates and four-fifths of all sav ings bonds were in banks paying a rate of AV2 per cent. Because most large banks that hold the bulk of negotiable CD’s and time deposits, open account, and a substantial volume of other nonnegotiable CD’s ad justed their maximum rate upward to 4 3 A or 5 per cent after December 3, nearly all of these deposits in the largest bank-size group (total deposits of $500 million and over) T a b le M i n i m u m D e p o s it A c c e p t e d on V a r io u s F o r m s were in banks paying over 4Vi per cent by early 1966, as shown in Table 5. Among smaller banks relatively few had raised their rate on any form of time deposit above 4 V i per cent in the period covered by the survey. Other characteristics. For each of the ma jor types of time deposits issued by banks on December 3, the survey requested infor mation as to the minimum deposit required and the minimum and the maximum matu rity; whether the agreement included a pro vision for automatic renewal or an option to redeem prior to maturity; and whether the instrument was issued only to individuals and nonprofit associations. Some instruments— even though they are designed for relatively small savers— require larger minimum deposits than apply to pass book savings accounts. The minimum de6 of T i m e D e p o s it s , I PC, on D ecem ber 3, 1965 (Percentage distribution of the number of banks in each size-of-bank group) Type of deposit, ana rise ofbank (total deposit*. is millions of dollar*) Minimum deposit accepted (in dollars) All bank* with , - 1 000 4,999 Saving* certificates; All tb e groups................ Under 10 0 ................... 100 - 500..................... 500 and over............... 100 100 100 13 9 9 32 36 37 Saving bonds: AD tile groups. , ............ 100 68 69 65 70 < * > () > 7 100 10,00099,999 10 10 Under 106................... 100 - 500..................... 500 and over......... too 100 25 23 14 13 16 2 6 “j ■ 5 Ocher noonegotiabk CD’*: AH s in groups............... 100 11 18 Under 100................... 100 - 500..................... 500 and over............... 100 100 100 11 19 100 11 5 3 11 5 1 5 8 22 18 23 19 20 33 20 Negotiable CD's: Au size groups.. . ........... Under 10 0 ................... 100 - 500.............. 500 and over__ ..... 10 0 100 10 0 Ti»dcpoH ta,< Alt s o t group Under 10 0 . 100 to o 100 3 1 1 18 (» ) 2 3 17 IS 17 It 8 3 11 8 5 5 11 3 17 21 14 6 22 19 55 34 39 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 2 7 T a ble 7 M i n im u m a n d M a x i m u m M a t u r i t i e s o n V a r i o u s F o r m s o f T i m e D e p o s i t s , I P C , o n D e c e m b e r 3 , 19 6 5 (Percentage distribution o f number of banks in each sizc-of-bank group) Type of deposit, ana size of bank (total deposits* in millions of dollars) All matur ities Savings certificates: All size groups.. - .............. Minimum maturity (months) 3 or less Maximum maturity (months) 4— 7- Over 6 12 12 100 42 33 23 (*) Under 100.................................... 100-500........................................ 500 and over................................ 100 100 100 41 52 47 34 25 26 23 20 21 (>) Strings bonds: All size groups................................ 100 62 12 Uader 100.................................... 100-500........................................ 500 and over.................... 100 100 100 60 55 90 15 5 Other nonnegotiabie C D 's: All size groups................................ 100 53 29 17 100 100 1 00 50 81 79 30 12 18 5 13 8 Under 100........................ 100-500............................ 500 and over...................... Negotiable C D’s: All size groups................ 1 2 9 12 14 g 30 No infor mation or less 6 712 " ) Over 60 No infor mation 1 3 86 10 1 <’) I 87 73 51 9 1 20 (') 4 3 7 14 33 2 5 I 12 86 1 3 ] 16 5 82 95 1 2 10 10 100 1 5 85 1 0 1360 5 3 3 73 67 3 84 2 86 9 1 8 1 24 28 too 66 22 11 (’) 1 100 100 100 61 95 93 25 4 7 13 (*) 1 Time deposits, open account : All size groups.............................. 100 61 28 8 0) 3 17 72 8 1 2 Under 1 0 0 .................................. 100^500................ 500 and over 100 1 00 100 59 78 94 29 14 5 g 1 8 C) 3 17 16 72 72 78 7 1 1 3 11 21 Under 1 0 0 ........................ 100-500................ 500 and o ver............................. 1 12 1 3 86 10 t 2 1 74 67 23 3! 1 1 1 1Less than one-half o f 1 per cent. posit required by the largest number of banks, regardless of size, .was less than $ 1 0 0 for savings bonds and less than $500 for sav ings certificates, as shown in Table 6 . Nearly half of the banks with savings bonds and one-fourth of those with savings certificates restricted the use of these instruments to in dividuals and nonprofit associations— higher proportions than for other forms of time de posits. This restriction was more common for large than for small banks. Most banks reported that savings bonds included an option for redemption prior to maturity and that savings certificates con tained a provision for automatic renewal at maturity. The latter was more common for small than for large banks, as shown in Table 8 . The largest number of banks indi cated that the usual minimum maturity was 3 months or less on both instruments, while the maximum maturity was generally 7-12 months for savings certificates and up to 5 years for saving bonds. (See Table 7.) The characteristics of other nonnegotiable certificates of deposits varied with the size of bank. In the smaller banks (total de posits of less than $ 1 0 0 million) about half of the banks had minimum deposit require ments of less than $ 1 ,0 0 0 , whereas for the largest banks (total deposits of $500 million and over) about a third reported that the minimum was $10,000 or over. As for savings certificates, the most common mini mum maturity was 3 months or less, and maximum maturity was 7-12 months. Few banks indicated these instruments were re stricted to individuals and nonprofit associ ations, and only one-third of the banks 2 2 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS T a b le R e n e w a l * R e d e m p t io n , and reported they contained a provision for automatic renewal at maturity. Negotiable CD’s and time deposits, open account, carry substantial mmimiiTn deposit requirements. In banks with total deposits of $500 million and over, where the bulk of these deposits are held, the largest number of banks reported the minimum requirement on negotiable CD’s was $100,000 or more and on time deposits, open account, it was $10,000 and over. The minimum maturity most frequently reported was 3 months or less, and the maximum maturity, 7-12 8 E l ig ib il it y C h a r a c t e r is t ic s o f V a r io u s F o r m s D e c e m b e r 3, 1965 of T im e D e p o s it s , IP C , months. The largest banks almost never re stricted these instruments to individuals and nonprofit associations, and relatively few of the instruments include a provision for auto matic renewal or an option for redemption prior to maturity. For smaller banks that held instruments of this type, the minimum deposit requirement was lower—generally less than $5,000 for banks with total de posits of under $100 million. Some banks of this size included in the agreement a pro vision for automatic renewal or an option to redeem prior to maturity. UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 2 9 APPENDIX T able I Savings D eposits : M aximum I nterest R ates P aid by M ember Banks, D ecember 3, 1965, and E arly 19661 All survey banks with deposits Group All member banks (June 30, Total 1965) Maximum rate 1 paid, early 1966 (per cent) 4 3 or less 3% Banks not raising rates Banks raising rates after Dec. 3, 1965 Total Maximum rate 1 paid, Dec. 3. 1965 (percent) Maximum rate 1 paid, early 1966 (per cent) 4 3 or less 3% 3 or less 3% Total No rate Maximum rate 2 paid, Dec. 3, 1965 (per ccnt) 4 3 or less 3% Number of banks 6,235 5,893 2,946 155 2,092 405 2*4 87 34 124 273 8 5,4*8 2,662 768 2,058 3,902 3,593 1,730 241 254 75 233 134 19 17 66 26 7 68 157 96 9 9 8 948 164 204 65 510 1,518 271 511 40 37 24 26 g 2 141 243 259 75 444 1,492 255 504 37 37 24 23 2 2 3,360 1,424 1,596 837 222 148 190 237 73 63 New York Philadelphia . Cleveland Richmond.. . . . . . . . , Atlanta. . . . 250 411 411 504 414 511 227 401 395 492 406 515 169 311 65 208 256 333 Chicago. St* Louis...................... Minneapolis.. , , , Kansas City............ Dallas____.. San hr&Dcisco 495 834 677 225 448 489 781 544 223 81 431 472 Size of bank (total deposits, in milliont of dollars): 10-50................. 50-100................... 100-500 . 500 &nd over 111 16 14 16 3 2 1 38 10 8 2 8 2 Federal Reserve district: 311 88 221 11 57 129 72 68 47 33 201 212 82 82 100 198 99 36 74 27 463 261 372 276 45 2 17 20 54 15 17 51 17 20 22 14 9 45 51 81 52 16 26 58 32 22 21 21 4 4 5 18 28 4 22 1 5 2 1 21 1 6 4 12 14 16 4 1 4 13 9 4 21 2 1 7 15 4 12 2 210 381 341 477 389 464 32 14 13 30 17 29 79 41 4 1 4 3 951 397 408 729 522 219 152 291 43 194 247 288 295 62 23 399 451 217 11 57 101 -i 1 47 33 197 212 62 77 80 99 194 87 462 248 363 272 45 22 58 26 2 Amounts (in millions of dollars) All member banks............... 74,422 60,644 7,25® 6,528 2,290 1,930 308 52 1,046 1,244 125 85 46 52 20 146 26 19 72.132 58,714 6,942 6,476 S in of baak (total deputes, briOiM * of dollars): Leu than 1 0 ................ 10-50* 50-100......................... 100-500. * 500 and over.. ........ 981 1,670 5.461 2,810 7,922 2,013 2 806 754 s ’993 4,229 1 ,0 1 0 16,817 14,181 1,519 1,117 181 33,410 31,502 1,727 336 784 436 627 137 300 358 168 ioe 191 668 390 574 108 1 119 272 292 363 217 512 143 264 108 5,125 11,957 5,557 16,190 33,303 2,619 856 1,650 7,254 1,928 2,775 3,839 964 754 13,607 1,467 1.116 31,394 1,727 181 4 63 227 208 74 73 150 165 39 96 2,284 14,093 3,452 6,804 3,623 3,471 2,027 45 12,513 771 1,379 971 4.329 1,807 2,724 641 632 2,610 121 13,901 10,642 1,665 1,594 690 218 632 1,340 65 663 68 795 88 273 2,509 2,148 2,734 36 31 8 16,926 16,918 31 Federal R aw m district: New York............ Philadelphia.......... Cleveland.. Richmond................ 2,421 14,393 3,810 6 972 3,769 3,768 212 45 2,164 809 12,814 771 1,587 1,117 1,106 4 471 1 832 660 2,849 232 643 2,893 297 Chicago............... „ St. Louis...................... Minneapolis................ Kansas City........... .. D a ll a s ................... 1 San Ftanciaco,___. . . 14,081 10,793 1,690 1,598 661 270 770 1,702 672 88 1,159 399 274 94 2,590 2 ,2 2 2 36 31 2,778 2,710 8 16,979 16,970 180 162 364 81 44 32 69 6 1 Excludes banks that reported no interest rate paid on December 3, i shown, it was included in the group paying the next higher rata. http://fraser.stlouisfed.org/ 63-496 O—66------16 Federal Reserve Bank of St. Louis 137 300 208 142 123 11 151 81 332 74 44 52 25 52 23 6 <> » 2 106 2 2 201 4 29 59 77 10 1 10 40 52 85 364 71 5 26 ,6 6 3 Less than 5500,000. N ort.—Figures may not add to totals because of rounding, 212 809 1 ,1 0 2 669 257 229 n ab le Group 5.5 5.0 4.5 4.0 Member Banks, D ecember 3, 1965, and Banks not raising rates Banks raising rates after Dec, 3, 1965 3.5 or less Maximum rate paid,* early 1966 (per cent) Total 5.5 5.0 4.5 Maximum rate paid, 2 Dec, 3, 1965 (per cent) 4.0 or less 4.5 Early 1966 3.5 or less 4.0 Total No rate Maximum rate paid,2 Dec. 3, 1965 (per cent) 4.5 4.0 3.5 or less Number of banks 2,773 6 60 852 1,715 140 532 6 60 429 37 77 352 28 75 2,241 423 1,680 138 1,747 772 95 114 45 2 2 I 1 31 19 J 3 2 452 274 38 60 28 1,165 447 50 40 13 97 30 I 10 2 283 175 25 36 13 2 2 1 1 31 19 5 3 2 227 144 17 30 11 23 10 2 2 34 23 6 6 8 191 125 11 22 3 19 6 1 2 39 21 7 6 2 1,464 597 70 78 32 225 130 21 30 17 1,144 437 48 38 13 95 30 1 10 2 15 t 5 4 8 3 22 58 135 5 17 23 14 36 92 3 5 20 F.R. district: 1 9 27 44 14 39 94 3 5 20 6 17 23 2 4 4 10 21 3 2 Cleveland . •• Richmond......... Atlanta............... f!hic4jrt............... St Louis ........... Minneapolis . • • > 298 151 269 3 2 2 32 61 135 248 76 119 15 12 13 13 25 37 3 2 2 8 20 31 2 3 4 4 I 4 7 16 25 2 2 6 6 2 285 126 232 24 41 104 246 73 115 15 12 13 571 212 414 1 5 2 95 91 117 451 105 286 23 11 9 62 82 115 1 5 2 53 76 111 7 1 2 3 7 2 43 65 106 3 2 2 13 8 5 509 130 299 42 15 6 444 104 284 23 11 9 Kansas City Dallas San Francisco. . . . 330 157 110 13 8 18 127 54 60 173 89 21 17 6 6 89 25 38 13 8 18 71 12 12 5 5 3 19 28 57 15 2 3 2 10 8 8 241 132 72 56 42 48 168 84 20 17 6 4 1 5 1 5 DEPOSITS 2 4 TIME 28 75 158 AD N 1 8 Boston New York . . . . Philadelphia . .. SAVINGS Less than 10....... 10-50.................. 50-100................. 100-500............... 500 or over FO R SiMof bonk (total de posits, In millions of dollan): COMPETITION survey banks with de- by UNSOUND Maximum rate paid,2 early 1966 230 T Savings Certificates, IPC: Maximum Interest Rates Paid UNSOUND Amounts (in millions of dollars) 4,639 1,149 3,402 88 279 553 170 431 488 . 24 40 35 26 108 252 510 130 395 380 3 3 5 1 22 252 485 108 362 1,316 1,703 500 576 545 184 362 159 255 188 1,103 1,306 338 299 357 28 35 3 22 1 s A \> ( 3> 10 17 119 309 1 59 97 15 60 186 0) (J) 26 463 67 180 6 12 3 56 34 79 41 1 2 13 32 72 360 276 60S 1,224 219 783 21 3 8 215 376 588 130 3 240 75 267 139 44 32 2 2 5 202 26 90 17 12 18 1,595 2,255 669 1,008 1,033 24 40 35 26 108 436 872 289 650 568 1,106 1,309 343 300 357 28 35 3 23 1 New York. 17 341 342 0) 10 1 270 130 15 61 186 0) Cleveland.. Richmond., Atlanta. . . 592 234 542 41 1 2 81 153 357 1,614 628 1,399 130 3 17 12 18 Lost than 10. 10-50............. 30-100......... 100-500........ 500 or over.. 62 57 69 376 112 FJt. dktrict: Chicago........ St. Louis---Minneapolis. Kansas City. . . Dallas.............. San Francisco., 399 132 322 P ) 1 ( 3) 1 1 5 £ 10 9 33 65 536 200 463 68 121 285 462 66 175 6 12 3 206 245 585 ( 3) 1 16 170 15 198 205 569 1,400 252 811 154 31 20 1,224 218 783 21 3 8 184 14 72 1 1 26 175 26 7 197 105 232 56 61 195 138 43 32 2 2 5 45 1 "3 8' a rate for this maturity was not reported, the rate applicable to the next shorter maturity was used. 3 Less than $500,000. N o t e . —Figures may not add to totals because of rounding. 231 0) o > 211 33 DEPOSITS 1 Excludes banks that reported no interest rate paid on December 3, 1965, or early 1966. Deposits are as of December 22, 1965. 2 When a bank reported a maximum rate in between those shown, rt was included in the group paying the next higher rate. In most cases the maximum rate is that applicable to maturities of 1 year or more. When 33 TIME 1,319 88 AD N 585 3,413 SAVINGS 11 2,816 FO B 1,667 234 el bank (total de posits in Millions of m COMPETITION 1,921 234 6,560 All Maximum rate paid, > early 1966 (per cent) 3.5 5.0 4.5 4.0 by 3, 1965, and E arly 1966 M em ber B anks , D ecem ber Banks raising rates after Dec. 3, 1965 3.5 or Maximum rate paid, z Dec. 3, 1965 (per cent) Maximum rate paid1 2 , early 1966 (per cent) Total 5.5 5.0 4.5 Banks not raising rates 4.0 or less 3.5 or less 4.0 4,5 Total No rate Maximum rate paid * Dec. 3,1965 (percent) 4.5 3.5 or less 4.0 Number of banks 1 7 89 32 1 42 1 7 30 4 8 7 27 88 59 29 Lett 10........ 10-50,................. 50.100................ 100-500............... 900 u d over.. .. 45 46 6 21 12 1 3 1 29 33 4 14 9 11 12 2 5 2 1 21 14 1 3 1 16 11 1 2 4 2 2 3 15 9 4 3 2 1 2 1 1 1 1 2 1 2 24 32 6 17 9 13 22 4 12 8 11 10 2 5 1 4 6 9 3 4 4 1 2 3 2 4 3 1 7 9 1 4 9 3 I 2 8 2 4 15 2 1 1 2 12 2 3 5 6 9 13 6 7 7 2 6 5 10 1 3 2 1 1 2 2 3 2 12 13 2 7 3 2 5 10 4 1 10 3 .3 8 2 3 2 1 2 I AD N FJt. Artrktt 1 2 ttirfivnrtnH Atlanta g 13 28 2 1 Chicago St* Louii Mfauittfwlii 13 16 4 I K iiu ii Citv Dallas San Francisco— IS 4 4 1 7 o 19 8 5 4 12 3 3 1 s 2 t 1 5 1 1 1 4 1 1 2 i 5 5 1 1 1 1 DEPOSITS 5 11 9 TIME Boston New Yoric Philadelphia SAVINGS 110 Stae of bank (total deM ^ taa U U o iN o f FO R All oM fetr bnki M COMPETITION Group All survey banks with de posits i IPC: M a x im u m I nterest R ates P aid 232 UNSOUND T able i n S avings B onds , UNSOUND Amounts (in millions of dollars) (3 ) 5 25 6 73 313 340 0) 3 (3 > 71 0) > (3 ) (3 ) 0) (3 ) 71 (J ) 72 346 335 11 5 23 6 40 272 3 18 5 37 272 2 5 1 3 (3) 4 25 121 75 4 24 121 0) 5 2 156 5 2 153 (3> 3 13 5 1 11 (3) 1 2 4 13 13 (Ji < 2 (3) (3) Man): Leu than 10.. 10-50............. 50-100........... 100-500.......... 500 and over.. 20 5 39 272 (3 <) 5 (3 ) FO R J ’) (3 ) VJL district: 4 24 121 Cleveland.. Richmond.. A tlanta... 5 32 161 157 Chicago....... St* Louis___ Minneapolis. 13 5 5 2 (3 ) 1 (3 ) 0) (3 ) 2 4 < 2 <) 3 (3 ) O ) (3 ) (J ) P > 0) <) 3 rate is that applicable to maturities of 1 year or more. When a rate for this maturity was not reported, the rate applicable to the next shorter maturity was used. ° 3 Less than $500,000. DEPOSITS 1 Excludes banks that reported no interest rate paid on December 3, 1965. or early 1966. Deposits are as of December 22, 1965. 2 When a bank reported a rate in between those shown, it was included in the group paying the next higher rate. In most cases the maximum 233 O ) ' (3 )' <) 3 (? TIME i City. . . Dallas.............. San Francisco., U < 3 ) 1 0) AD N 4 65 121 SAVINGS Boston......... New York... Philadelphia. COMPETITION 422 Six* of bulk (total de posit* in inlUom of 24 3 COMPETITION FO B SAVINGS AD N TIME DEPOSITS UNSOUND T able IV O ther N onneootiable C D ’s , IPC : M axim um I nterest R ates P aid by M em ber B anks, D ecember 3, 1965, and E arly 1966 UNSOUND Amounts (in millions of dollars) 4 1,758 452 9 2,890 1,149 1,695 46 252 459 275 504 344 482 718 256 231 It 19 16 5 6 153 270 111 . 340 . 1,345 26 82 32 149 ,232 124 176 79 191 113 2 1 (3) 40 103 51 219 1,345 109 162 59 121 4 5 (3) 625 1,015 458 550 242 127 282 196 313 231 479 717 256 231 11 19 16 5 6 12 262 90 18 65 171 < 3) 2 7 10 317 44 7 218 9 3 98 35 (3) 1 < 3) 9 266 8 1 49 34 (3) 2 2 28 23! 234 9 165 56 18 64 171 < 3) 2 7 140 79 39 108 86 335 122 52 121 2 2 8 168 109 164 140 79 39 27 26 117 (3) (3) 146 97 131 22 11 32 (3 ) 205 114 347 8t 60 218 122 52 121 2 2 8 32 27 1 326 142 47 530 269 118 7 8 4 114 128 41 32 27 1 82 101 40 (3) 1 0) 69 51 43 76 41 782 318 129 245 41 7 530 268 118 7 8 4 27 51 890 no 126 100 5 3 2 114 88 923 27 51 890 86 38 32 1 29 30 922 84 58 1 213 180 109 85 79 104 125 100 5 3 2 116 136 a rate for this maturity was not reported, the rate applicable to the next shorter maturity was used. 3 Less than $500,000. N ote.—Figures may not add to totals because of rounding. (3 ) (3 > 235 2 1 < 3 ) 1 (3 ) < * > < 3 > DEPOSITS 1 that reported no interest rate paid on December 3, 1965, or eariy 1966. Deposits are as of December 22, 1965. 2 When A bank reported * iiin A u u w t i a » w in between those shown, it a maximum rate »«■ * W X lC n a U U lft ................ group paying the next higher rate. In most cm s the ' * . ^ - --------- ----------was included in the m«T<miim rate is that applicable to maturities of 1 year or more. When <) 3 1 (3 ) TIME 684 AD N ,521 SAVINGS 2,220 FO R 46 7 218 9 < 3 ) (3 ) 1,699 26 82 32 149 1,232 327 269 1,032 1,833 COMPETITION 1,521 236 by Group survey banks with deposits t 5.3 5.0 4.5 4.0 V Member Banks o n D ecember 3, 1965, and Banks raising rates after Dec. 3, 1965 3.5 or less Maximum rate paid,3 early 1966 (per cent) Total 5.0 5.5 4.5 Banks not raising rates Maximum rate paid,2 Dec. 3, 1965 (per cent) 4.0 or less 4.5 Early 1966 4.0 3.3 or less Total No rate Maximum rate paid, 2 Dec. 3, 1965 (per cent) 4.5 4.0 3.5 or less FO B Number of banks 5 223 632 814 103 487 5 223 231 28 245 151 19 72 882 543 107 170 75 4 60 42 9 57 J5 261 211 58 83 19 483 264 38 29 74 26 2 1 164 140 34 90 59 4 60 42 9 57 55 86 89 21 32 3 14 9 4 1 58 47 15 66 59 54 63 12 22 8 7 3 1 20 35 6 5 13 10 44 55 20 16 57 57 36 63 38 34 51 68 4 5 11 13 8 13 40 61 19 12 21 27 20 35 6 5 13 10 17 20 9 3 7 15 3 6 4 4 1 2 23 43 7 5 5 11 7 9 6 3 9 8 26 3 5 24 33 41 60 16 31 100 111 63 128 61 64 140 120 7 14 4 14 8 2 64 19 28 58 75 63 26 5 5 24 33 41 35 13 21 34 41 16 3 1 1 25 6 6 33 27 54 16 11 19 22 39 2 1,290 401 790 99 Lcm 1 0 ........... 10-50.............................. 50.100...................... 100-500.......................... 500 u d over.................. 44 , 23 4 1 718 403 73 80 16 175 122 37 51 16 472 253 33 28 71 26 1 1 1 1 2 4 3 8 5 3 27 35 2 5 8 64 97 56 56 108 121 13 50 42 33 57 37 30 50 67 4 5 8 13 8 12 1 1 1 22 1 2 3 8 7 157 77 77 220 197 60 25 3 10 66 70 49 125 60 63 140 119 9 7 14 4 14 8 2 AD N 1,777 Slat «l bank (total deports, Ja m9Hom «f SAVINGS AH tttMbtr baato.................. COMPETITION Maximum rate oald.2 early 1966 UNSOUND T a b le N egotiable CD’s, IPC: Maximum Interest Rates Paid Ftdsral Rm h t i totiict: PUyelpbii............... Q ivdm d . . . . . . . . . . 104 158 75 68 t29 St^Louis........................ Minneapolis................... Kwntwf City Qi IJi i , ............ . San Francisco., ............1[ 221 96 105 278 272 123 148 1 4 U 1 4 i 2 1 DEPOSITS jUchmond ................... Atlintft................. .. U TIME Boston.. .. » ............... New Y o rk .................. UNSOUND 15,874 12,154 2,472 1,148 28 12,869 72 12,154 634 12,352 510 3,004 1,838 1,138 28 SS4 857 499 2,562 11,403 27 77 52 1,377 10,620 175 402 270 912 713 338 362 177 271 82 207 149 1,679 10,752 27 77 52 1,377 10,620 52 128 93 299 62 36 98 106 1,359 10,752 45 107 41 317 472 649 350 883 651 123 274 177 613 651 337 360 173 269 12 15 (3) 1 New Y ork... Philadelphia. Cleveland. . . Richmond... Atlanta........ 626 6,060 628 861 401 576 556 5,793 467 712 166 260 45 228 79 116 163 164 25 36 81 32 68 142 577 5,910 489 722 173 275 556 5,793 467 712 166 260 18 116 23 569 5,878 483 712 86 268 8 31 7 8 86 6 49 150 139 140 228 301 27 112 56 108 156 149 21 35 81 30 68 142 (*) 3 1 1 4 10 Chicago........... St. Louis......... Minneapolis. . . Kansas City. . . Dallas.............. San Francisco.. 2,260 424 344 553 1,370 1,770 1,621 184 136 219 554 1,485 386 36 52 252 1,730 85 720 272 95 241 287 704 1,551 1,621 184 136 219 554 1,485 106 27 34 67 149 64 1,614 189 213 193 600 1,547 115 22 28 93 104 4 531 212 103 266 666 219 280 9 18 143 571 208 250 201 84 120 94 11 1 2 (3 ) l (3> All 8is« of bank (total deports in “ ■ »of dollars): FO R Federal Rsaerre dktrict: 11 DEPOSITS 237 a rate for this maturity was not reported, the rate applicable to the next shorter maturity was used. 3 Less than $500,000. N o t e . —Figures may not add to totals because of rounding. i TIME i banks that reported no interest rate paid on December 3, 1965 or early 1966. Deposits are as of December 22, 1965. * when a bank reported a maximum rate in between those shown, it was included in the group paying the next higher rate. In most cMM the maximum rate is that applicable to maturities of I year or more. When 8 AD N 120 211 SAVINGS 210 202 8 7 1 5 COMPETITION Amounts (in millions of dollars) 238 VI UNSOUND COMPETITION FO B SAVINGS AD N TIME DEPOSITS T a b le T im e D eposits , O pe n A ccount , IPC : M ax im u m I nterest R ates P aid by M em ber B anks , D ecem ber 3, 1965, and E arly 1966 UNSOUND Amounts (in millions of dollars) 155 365 193 600 3,088 514 2,645 34 72 92 332 479 25 1,682 15 337 4 23 6 2,888 10 12 2,645 57 „ 174 83 92 108 51 25 219 2,582 26 1,802 25 1,682 4 23 6 14 2,804 15 218 143 315 168 382 508 31 61 75 233 392 55 169 81 91 108 56 85 12 57 7 25 1,786 31 300 183 15 221 106 10 54 43 7 24 34 231 153 115 71 84 54 148 53 24 12 16 37 276 2 2 65 (3) 141 1 2 70 1 (*> 34 96 89 18 76 80 11 13 4 5 7 5 YJL district: N«w Y ork... Philadelphia. 58 2,102 Cleveland.. Richmond. Atlanta 623 3 Kansas City. . . Dallas.............. San Francisco. 36 187 379 57 44 77 96 58 149 53 24 70 35 13 307 104 142 347 201 302 189 128 Chicago........ St. Louis. . . . Minneapolis. \n 63 23 9 393 (3 ) 2 1 56 276 1 < 3 ) 19 98 94 1 2 11 17 4 63 23 9 p> 2 91 290 12 307 1 56 276 6 4 201 68 23 9 38 1 1 23 (J ) 0) 14 2 64 289 a rate for this maturity was not reported, the rate applicable to the next shorter maturity was used. 3 Less than $500,000. N o t e . —Figures may not add to totals because of rounding. 239 1 (> * 5 DEPOSITS 1 Excludes banks that reported no interest rate paid on December 3, 1965. or early 1966. Deposits are as of December 22, 1965. 2 When a bank reported a maximum rate in between those shown, it was included in the group paying the next higher rate. In most cases the maximum rate Is that applicable to maturities of 1 year or more. When 201 210 TIME 504 AD N 791 SAVINGS l t514 4 28 15 177 2,580 118 2,494 10 219 FO R 118 2,494 « ? 222 COMPETITION 4,401 2 4 0 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS M O t t i n g e r . My time has expired. I would like each of the m r. em bers of the Board to comment on this; namely, whether if they w ere given discretionary power to act with respect to the smaller C ’s, D they would use it or not. M M i t c h e l l . I think they are better tools. I agree with G r. over nor Robertson, the maturity tool is the better one than size. I think size would be highly discriminatory, not only to the small saver, b t u also to the small bank.1 The C h a i r m a n . Each member can file their comments. That is your desire, is it not ? Mr. O t t i n g e r . Yes. The C h a i r m a n . M Widnall. r. M W i d n a l l . Governor Robertson, last week Mr. Fowler said th r. e balance of payments was further deteriorating and in my view the d efi cit will be $2.5 billion. Last week before the committee Secretary Fowler insisted that the voluntary restraint program was still only tem porary and not semipermanent as I have maintained. Last month M r. Fowler said the voluntary restraint program would continue for th e duration of the Vietnam war. I have been very critical of the program and I am pleased to note I have been joined recently by some of th e more responsible elements of our business community. I dispute th e contention that the increased deficits are directly or indirectly related primarily to the war in Vietnam. It is my contention that- the real trouble lies in the sharply decreased balance of trade surplus and that only a small portion of this decreased surplus can be attributed to Vietnam. Yesterday the Commerce Department announced figures for it an d they, too, were very disturbed. They showed a figure— they show ed a further decrease in balance of trade primarily due to the increased im ports. Since you have been primarily responsible for this program , would you care to give us your opinion as to when they might be laxed so we can begin to focus on the real problem how an increase to imports and decrease in exports ? Mr. R o b e r t s o n . N o . 1,1 cannot give you any answer as to when this temporary program—and I think it is a temporary program—can b e brought to an end. This depends entirely on what happens with re spect to the balance-of-payments deficit, and the reaction of E u ro p e a n holders of dollars—whether they want to turn them into gold or whether they do not. I would say from all the conversations I h?ve Par^m program, there is a definite u n d e r s ta n d in g that this is a temporary program and not a long-term prograrn . Also, I thmk one must recognize that Vietnam cannot be dis associated' from the problem. But certainly, a real problem from m y point of view is the outflow of funds through investments a b r o a d . T he problem is attributable largely to the decrease in our s u r p lu s in the rade balance. This is a natural consequence of prosperity in ! .lS ; country, whach diminishes exports because there is such a d e m a n d m this country for products that it is much easier to sell here than it is to * m lt 18 P^haps more profitable. v . bec^dly, m a periodsuch as this when demands are so high) ports increase and this diminishes the trade balance, so that our trade gg& SS; particular* PP- “ "r811’ UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 4 1 surplus is less and less adequate to take care of the dollar outflows through other avenues. I think that this problem is one which can be whipped, but not quickly. I have advocated standby authority to impose a tax on inter national credits and investments, which I think would do the trick. I am not in favor of selective controls of this nature any more than anyone else on this committee or anywhere else, but the problem is so serious and has been so serious that something has had to be done about it and I see no way to cope with it. Mr. W i d n a l l . Of course, as far as our exports are concerned, we would seek some credit from the sale—we have received some from the sale of airplanes which were actually a few items, each one a costly item. At the same time, with imports, we have virtually millions of items coming in that amount up to figures that compare with the export of a few airplanes. I am starting to worry about the fact that in the steel industry the imports have mounted so much that they are now over a 10-percent figure. I can recall not long ago when we first started importing steel where everybody said it would be negligible and we did not have to recognize this as competition and this could go right on without anybody thinking about it or worrying about it—that it can not affect our own business. It is clear that good steel is being manu factured in many places of the world and this can have a very serious impact on our trade balance and also affect our balance of payments. We are going to have to face up to that one of these days. Mr. R o b e r t s o n . I think this is true and as you must recognize also, businessmen in this country have not devoted the same imagination, ingenuity, and drive to the export program that businessmen abroad do in their situations. We must do everything we can to build up export business. We have to see that it is adequately financed, but we also have to see that markets are taken advantage of and we do everything we can to find the markets abroad. Mr. W i d n a l l . Does the voluntary restraint program impose a re straining influence? Mr. R o b e r t s o n . I think not. The very fact that the banking in dustry has a leeway of $800 million unused under the guidelines, indi cates there is ample financing for any exports that anyone would wish to make. I have never been able to run down any single situation where an export has been lost for lack of financing. Mr. W i d n a l l . Mr. Brimmer, you were doing some work in this area for the Commerce Department, I believe ? Mr. B r im m e r . I w a s. M W i d n a l l . I would like to have your comments and your own r. opinion as to when you feel voluntary restraints might be relaxed so we can focus on the program of increasing imports and decreasing exports. Mr. B rim m e r. I do not know that the voluntary program could, or should, be relaxed. The general comments and the reason for the program I will not repeat. But I do have an opinion of my own as to why the business community part of the program which I had a re sponsibility for in the Commerce Department ought to continue for some time into the future. First, the business community obviously has been the principal source of positive contribution to the balance of payments. You know that. The trade surplus has been adding to the balance of pay 2 4 2 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS ments close to $5 billion a year, and even the temporary decline in the trade surplus described in the news story which you quoted should not be taken as an indication that this trade surplus will disappear or even fall below $4 billion a year. It is one of the largest surpluses among leading nations in relation to the total volume of trade. But the core of the industrial company program involves voluntary re straint or modification of the outflow of funds for direct investment ahead. I think this part of the program might very well have to be continued in some form into the foreseeable future. I do not disasso ciate the Vietnam program from this. In my opinion, if the Vietnam program— Vietnam activity— the had not contributed to the deficit something in the order of some $700 million a year, which is a rough estimate at this time, it would have been possible to ease the program during* 1966. As it turned out, this is not possible. You will note that I said “ease” the program rather than abandon the program completely. I think the backlog of in vestment projects, especially in Western Europe, would probably lead to a level of plant and equipment expenditures abroad much higher than could be sustained without stimulating an outflow from the United States well over $3 billion a year. Now, it is a matter of judgment as to whether direct investment outflow of that m a g n itu d e should or should not be encouraged. My own feeling is that in 1964, when it was about $2.4 billion, it was at a high level. I think in the absence of some kind of modification, the level would probably be at least $3.5 billion, i f not higher. I think the form of the program can and should be modified as we go along. And I should say that the companies themselves have made tremendous strides to modify the out flow. They have borrowed a substantial amount of money in 1965 to modify— moderate—the outflow. I do not expect that they will to continue to make increments in that borrowing year by year on that order of magnitude. Now, I would foresee that the targets could be relaxed. In other words, rather than making quantitative suggestions, they could be encouraged to follow certain kinds of guidelines which would not put a ceiling on the outflow, but would involve a different composition of outflow* In my judgment, many companies would prefer that kind of arrangement to mandatory controls. We should be reluctant to talk about the possibility of mandatory controls, but I would think that the alternative to such controls is voluntary cooperation. I repeat, I think it would be preferable to have such moderate restraint on a voluntary basis, for some time into the future. I would be r e lu c ta n t to suggest a target date, because I think the problem is still with us and it is not likely to disappear in the near future. Mr. W i d n a l l . Thank you. Just one further question. H appreciate it if you would comment on my guess of $* 2* billion deficit in the balance of payments. Mr. B r im m e r , I would not wish to comment on it, because I reluctant to forecast. While working with the Commerce Depart' ment program I found we had great difficulty in trying to see ahead 6 months. The deficit has been running about at an annual rate in the nrst quarter of $2.3 billion, or something of that order of magnitudeThere were certain peculiar developments during that quarter because several sizable transactions were simply pushed over from 1965. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 4 3 For example, a substantial amount of foreign securities, especially Canadian issues, were postponed from 1965 into 1966. I would not expect that to continue throughout the year. I would expect the rate to be less than $2.5 billion—‘ ut I would not want to suggest a particular b figure. Mr. W i d n a l l . What more favorable factors do you see that would change this below $2.5 'billion ? Mr. B r im m e r . The first thing, as I said earlier, I would expect some further improvement in trade. The pattern of exports which we dis cussed for the last month or so will probably not persist. I also think there will be some substantial savings on direct investment outflow, especially when you take account of the funds borrowed abroad by X companies. I would expect some improvement in 1966 com J.S. pared with 1965. The tourist gap may not in fact widen as much as people have been suggesting. After all, last year it was not as much as we had forecast, so I think we will see some moderation in it. But I would not want to catalog all of the possible favorable things because I have not been working so closely with the balance of payments in the last few months as I was in the Commerce Department. I am not up to date on the details of the latest thinking of the technicians who are working on them. Mr. W i d n a l l . Thank you. My time is up. (The following information was submitted for the record:) F ederal R eserve B a n k H W illia m B. W id n a ll, on. of N ew Y ork, New York, N.Y., May 2$,1966. Committee on Banking and Currency, U.S. House o f Representatives, Washington, D.C. D ear M r. W id n a l l : At the hearings of the Committee on Banking and Cur rency this morning, you referred to the trade balance of the United States and to various other aspects of our balance-of-payments problem, and you solicited the views of the Federal Reserve representatives on these matters. I was about to make a brief comment when your “time was up” and it was the turn of another committee member to ask questions. I want to say in this letter what I would have said a t the hearing, if the clock had not intervened. Your comments on our exports and our imports highlighted, I think, the im portant role that stabiUty of prices in the United States plays with respect to our balance of payments. We have been seeing rapidly expanding business activity, increased demand for and use of credit, declining unemployment, shortages of skilled labor and in creased production bottlenecks; in such a setting pressures on prices have been mounting. With an already high utilization of resources, a high aggregate demand for goods and services is pressing on a limited supply. If we have further increases in prices a t home, it will be harder for American products to compete in foreign markets. At the same time, with high demand for goods a t home, further increases in prices in the United States will stimulate Americans to buy more imported goods. Thus it seems to me that general policies designed to slow down the growth of overall demand for goods and services at this time serve the dual purpose of pro moting price stability at home and equilibrium in our international payments. Monetary policy is now operating to slow the growth of overall demand. More fiscal restraint (in the form of increased taxes and reduced expenditures) would contribute directly to the same en d ; it would thereby lessen the need to place too great an anti-inflationary burden on monetary policy, and would reduce the inevitable pressure on interest rates. Sincerely yours, ■ 1he Chairman. Mr. McGrath. http://fraser.stlouisfed.org/ Mr. Mc of St. Louis Federal Reserve BankGrath. Thank you, Mr. Chairman. W il l ia m F . T reiber , F irst Vice President. 2 4 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS M Robertson, on December 6 of 1965 the Federal Reserve Board r. raised the maximum interest rates payable on time deposits to Sy2 per cent. Is there any upper limit beyond which the Federal Reserve Board has no authority to go ? Mr. R o b e r ts o n . None whatsoever. Mr. G e t t y s . Will the gentleman yield? Mr. McGrath. I yield. M G e t t y s . Does the State law sometime control that, Mr. Robert r. son? You cannot authorize national banks to violate a State law, can you? Mr. R o b e r ts o n . N o . A national bank must comply with ceilings established by State law. State laws may vary in this in some respects. Mr. McGrath. That is all I have, Mr. Chairman. The C h a ir m a n . Mr. Annunzio? Mr. A n n u n z io . Thank you, Mr. Chairman. Yesterday reminded me of primary day with the members selecting whether or not thev were for an independent Federal Reserve Board. Some of the members indicated they were for independency of the Board and others indicated they were not for independency of the Board. I want to state my own position. In a democracy which is a government for, of, and by the people, we cannot afford the luxury of independence. In reviewing the pages of history, we find that tnose countries which have enjoyed the luxury of independence have reverted to dictatorships, and consequently, more harm than good has come out of a system of complete independence. So I am not in favor of an independent Federal Reserve Board. I do believe it should have some independence, but not total independence from the Congress of the United States and the elected representatives of the people. I also believe strongly in the two-party system because that is the only way we can have responsibility. At least, you can hold one of the major parties responsible for action. People go to the polls to vote; it is very elementary, but it works. I was gratified to learn also, Governor Robertson of your position in which vou indicated that the action of the Federal Reserve Board in December was responsible for the problem before us and you also made a statement that we must act quickly. I want to ask you, sir, How long is “quickly”? Mr. R o b e r ts o n . Again, let me say that this depends entirely on the problem as it emerges, but we cannot afford to sit by and watch the problem get into panic proportions before we act. If you want hours or days, I cannot tell you this. This depends entirely on the Board. But I would fully expect that the problem which is foremosfc before this committee today is not one that will get out of hand by virtue of lack of action on our part. Mr. A n n u n z io . Mr. Brimmer, you are the new man on the B o a r d and I have a question. Mr. R o b e r ts o n . Could I just make one statement concerning your comments concerningthe independence of the Boardf I think I can say every member of this Board will agree with you. Every member of this Board will agree with you that the Federal Reserve is not independent of Congress. We consider ourselves to be an agent of Congress and we will willingly and wholeheartedly carry out any policy which the Congress prrejStwa. . UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 4 5 M A n n u n z i o . But you did not do that in December when Mr. r. Martin met with the President of the United States. The Board went ahead anyway and increased the discount rate. M R o b e r t s o n . Y o u have never seen a law enacted by the Congress r. that we have failed to carry out. M A n n u n z i o . I have been a member of this committee for 15 r. months and have heard the chairman refer to the Board as the fourth branch of Government. I refer to it as the fourth estate* I have before me the testimony of Norman Strunk and he says here: This relatively new development in the growth of savings certificates obvi ously was not anticipated when the certificates of deposit first developed a few years ago and it obviously was not anticipated last December when the Federal Reserve permitted the commercial banks to pay as high as 5% percent on CD's. Now, Mr. Brimmer, I want to know from you, as a member of the Board, why the Board did not anticipate the increase in certificates of deposit. Members of the Board are not naive people. They are dealing with human beings when they deal with bankers, and when you open the door a little hit for human beings they are going to open the door a little more. I would like your comments. M B rim m e r. Mr. Congressman, first of all, I appreciate your r. interest in my opinion on a matter before the Board before I joined it. I am reluctant to go back and second guess my associates as to what was on their minds at the time they took the action last December. . I would prefer to look ahead and if you will permit me, I think it will be helpful to examine somewhat more closely the question of certificates or deposit and what happens when the Board took the action last December. I assume you in fact—I assume Mr. Strunk was talking primarily about negotiable certificates of deposit. I would like to say that the question of negotiable certificates of deposit we talked about yesterday, we looked at in fact what is hap pening. In the recent period of—I respectfully suggest you ask the other members what was on their minds. I would like to intonate the growth in certificates of deposit in 1966, the period when growth was concentrated, which roughly is up to March. If you look at that and use the data available, and this is some 350 weekly reporting mem ber banks. As a matter of fact, the growth in certificates of deposit during this roughly 10-week period in 1966 has been roughly the same as it was in 1965. During the same period, the weekly reporting mem ber banks have lost $1.8Trillion from their savings accounts and this was in contrast to a growth of almost $600 million such accounts durinSJ^e same period in 1965. h e also have some breakdown by Federal Reserve districts in the 2?? ^as taken place. During the same period, these banks gained billion in time deposits other than CD's during the 10 weeks 1966. JN , it appears that the banks have been gaining in those kinds ow °i time deposits other than negotiable CD’s. There you got a rate m. re rapid than a year ago. These gains, in my opinion, are due o theJPnd sPecial devices designed for consumer-type savings, sav ings bonds, savings certificates and so on, 1 have an opinion on this, blit I would not want to go into it in any ^ w°uld say I would be surprised if the Board had not antici pated that some shift in these flows would have taken place. Again, their reasoning I think, what was on their minds http://fraser.stlouisfed.org/ 63-496—66----- 17 Federal Reserve Bank of St. Louis at that time----- 246 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS M W id n a ll. Will the gentleman yield ? r* Mr. A n n u n z io . Yes. M W id n a ll. I was very interested in your preliminary statem r. ent when you started your time. I would like to know what country or countries you feel have made greater progress than we have made w ith a different system than we have in the Federal Reserve? Mr. A n n u n z io . I was not comparing the progress the countries were making from a banking point of view. No one questions the progress that we have made from a social, economic, and political point of view . But I still feel that these agencies, whether they exist in State, city, county or national governments, should be responsible to the people and to the elected officials of the people. The C h a irm a n . Will the gentleman yield ? May I add that the so-called independence of the Federal Reserve is of recent innovation. There was no independent Federal Reserve u p until 1953. In 1951 there was a declaration of independence in a w ay, but it was never exercised until 1953, and Mr. Eisenhower was the first President to ever mark them as an agency independent of the executive branch, and, of course, we are all familiar with what has happened after they seized that independence. We had three recessions within 8 years. Industry has paid $60 billion excess interest rates. I think the record will show that the so-called independence has really been seized. It is not granted by the Government. No law grants them independence. They just seized it. Mr. Eisenhower recognized it and since that time they have asserted it even under Democratic admin istrations. Has your time expired ? Mr. A n n u n z io . Yes. The C h a irm a n . We have just a little time here. Mr. Fino and M r. Rees and Mr. Stanton, I think are the only members who have not asked questions. Suppose we finish with them, if we can. If there is no objection, we will stay so they can finish. Mr. Fino? M F i n o . Thank you, Mr. Chairman. r. The C h a ir m a n . Y o u take y o u r full 5 m in u te s. Mr. F i n o . M Robertson, there are three types o f financial institu r. tions offering passbook sayings accounts to customers: namely, the savings and loan associations, the commercial banks, and m utual savings banks. The question is this: What is the amount of passbook savings for each of these types of institutions % R obertson . M a y I g iv e y o u r o u n d fig u r e s, b e c a u se I d o not ooKn u 'n ? 1* J d o n o t c a r r y th o s e m m y m in d , b u t ju s t g u e s s in g , around *<J50 b illio n fo r th e c o m m e r c ia l b a n k s, $ 1 4 0 b illio n f o r th e s a v in g s and lo a n s - w m e w h e r e a li t t l e le s s th a n $ 5 0 b illio n f o r t h e m u tu a l savings. M r. M a ise l , N o t p a ssb o o k . Mr. F i n o . Passbook savings, M r. R o bertson . $ 9 0 f o r th e c o m m e r c ia l b a n k s, $ 5 2 f o r t h e m utual Sa^ n g l r $n ° f °r s a v in g s a n d lo a n , a t o t a l o f $ 4 4 3 . , M r. M a is e l. P r o b a b ly a lo t o f t W $ 1 1 0 b illio n in t h e s a v in g s aft” lo a n s m a y b e m s a v in g s ce r tific a te s. W e d o n o t h a v e tlie breakdow n f o r th a t. F i n o . H o w h a v e th e fig u r e s y o p g i v e n m e c o m p a r e th e fig u r e s o f a y e a r a g o f o r e a c h o f t h e t y p e s o f in s tit u tio n s ? UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 4 7 M r. R o bertso n . I d o n o t h a v e t h a t in f r o n t o f m e, b u t I w o u ld be g la d to se n d i t t o t h e c o m m itte e . M r. F i n o . I ’d a p p r e c ia te th a t. ( T h e in f o r m a tio n req u e sted f o l l o w s :) P assbook savin gs accounts in com m ercial banks, m u tu a l sa v in g s banks , and sa vin g s and loan association s Commerical bank pass book savings accounts Mutual savings bank deposits * Savings and loan share capital » Amount Percent (billions of change from previous year dollars) Amount Percent (billions of change from dollars) previous year Amount Percent (billions of change from dollars) previous year End of year: 1961................... 1962_________ 1963_________ 1964....... ........... 1965_________ 63.9 71.0 76.3 82.9 * 92.5 (* > 11.1 7.5 8.7 11.6 38.0 41.0 44.3 48.5 52.1 5.3 8.0 7.9 9.6 7.4 70.9 80.2 91.3 101.9 110.3 14.1 13.2 13.8 11.6 8 .2 1 May include certificates but breakdown unavailable. 2 Not available. 3 Estimated on basis of all insured commercial banks. Mr. F i n o . Is there any essential difference between a passbook sav ings account offered by each of these types of institutions? Mr. R o b e r t s o n . I think not. No essential difference. Mr. F i n o . I s there any good reason for differentials in rates on passbook savings accounts on these three types of institutions ? Mr. R o b e r t s o n . I think not. Mr. F i n o . If we are to impose the same ceiling rate on nonnegotiable CD’s for commercial banks and savings and loan associations, why should not the same ceiling rate apply to passbook savings accounts of these three institutions? Mr. R o b e r t s o n . I believe all these financial institutions should be operating under the same rules so that I would not argue this point at all. As to differences, I think they all ought to be subject to ceilings or they should all be free of ceilings. Mr. F i n o . Just justify if you can, in this connection, I would like to have each member of the panel respond. Justify if you can the continuance of regulation Q with a ceiling of 4 percent when the rate of 4.15 percent is being paid by the U.S. Government on U.S. savings bonds. Mr. R o b e r t s o n . Well, I would want to differentiate in my own mind the rate which the U.S. Government pays in order to finance itself from the rate which private financial institutions are either willing or are permitted to pay. I would like to confine my remarks to the desirability or nondesirability of ceilings on payments that can be made. I happen to believe that fundamentally, if we were starting from scratch, you should have no ceilings at all and rates ought to be determined by competitive forces, but I also believe that once you have ceilings you should never raise them abruptly and thus change the I think you ought to c?o it when there are no pressures whatsoever. If this had been done in 1961 or 1963 when I endeavored to get it done, 2 4 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS we would not have the sort of situation we have now, because the com etitive pattern would have grown up little by little with no pressures. > t to remove the ceilings or put them up when there are pressures, u changes your pattern completely. Your savings and loans have a portfolio of assets on which the rato of interest was fixed when the pattern was much lower and they cannot do anything about that. On the other hand, when they make real estate loans at high rates, when the economy is operating close to capacity, the situation is not quite the same because those will b e refinanced later whenever the borrower can get a new loan at a low er rate. Once having ceilings in one area, then you should be very circumspect in changing those ceilings abruptly. You ought to do it very gradually only in accordance with the absolute needs of the tim e and work toward a period when you are in the situation when there are no pressures whatsoever and then remove them. M F i n o . D o all the members of the Board agree with Mr. Robert r. son in that connection ? Mr. M i t c h e l l . I amnot---M r . M a i s e l . I think you have made a very important point, that if Congress should impose ceilings they should request us to raise the ceilings on passbooks of commercial banks up to the 5 percent being paid by savings and loan associations. I think the point is a very valid point. The reason why we have the very different rates, 5 percent for savings and loans and 4 percent for commercial banks, is partly historical. Once the current situation calms down, I agree with you, that the question of whether this large differential makes any sense or not should be reexamined. M G e t t y s . You will have a different crowd screaming, though, r. would you not ? Mr. M i t c h e l l . I would say there is a rate differential between com mercial banks and savings and loan associations, as far as p assb ook accounts are concerned, at which funds will not move. The banks can live with a rate of half of 1 percent under the S. & I* rate without losing their funds to that competition. When the differ ential gets larger than that, funds start to move one way or the other, there is no question about that. So I think there is a differential in the ceilings that would neutralize flows between these associations and the banks. M S h e p a r d s o n . I would respond to Mr. Fino, that if we are going r. to have ceilings, I think they should be the same. I agree with w hat Governor Mitchell just said as to the competitive situation in the market; the banks might be able to get funds at a little less rate because of other factors than S . & L.’s. If we are going to set m a n d a to r y ceilings, I think they should be the same and these various types or institutions should be allowed to compete on whatever basis the total market forces justify. Mr. F i n o . Mr. Brimmer? Mr. B r im m e r . The only additional comment I may add r e la te d to the narrow question which you posed initially. That is the com parison of the passbook rate paid by the commercial banks and the rates available on U.S. savings bonds. I would think that the choice of the rate is obviously up to the Treasury. But I could see a justifica tion for a slightly higher rate and my response is—it is just a little bit S UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 249 more liquid than a passbook account and a little more troublesome to get and maintain. I think this smaller degree of liquidity could justify a higher rate. Mr. F i n o . Just one other question. Is it logical to assume that maintenance of the 4-percent rate on commercial bank passbook sav ings accounts invites the transfer of funds from these accounts to bank CD's? Mr. R o b e rts o n . Very much so. And this is taking place, the sophis ticated depositor who is in search of a high rate of interest will go to a savings bond or certificate. Why should he leave his funds in ? So the man who is penalized is the one who is unsophisticated, the very one who needs protection. Mr. F in o . Thank you. The C h a ir m a n . Mr. Rees? Mr. R ees. Thank you, M Chairman. I would like to have placed r. in the record an article in the Wall Street Journal of today entitled, “Block to Building—Big Outflow of Savings From S. &L.’s Forces Cut in Mortgage Loans.” The C h a ir m a n . Without objection, it is so ordered. (The article referred to follows:) [From the Wall Street Journal, May 25, 1966]) B lo c k to B u il d in g — B ig O u t f l o w o f S a v in g s F e o m S&L’b F orces C u t i n M ortgage L o a n s — S o m e H a l t L e n d in g fo r N o w ; B a n k s ’ 5*4 P er c en t R ate on T im e D e p o s it s A tt r a c t s F u n d s — D is a p p o in t e d H o m e b u y e r s (By Donald Moffit, Staff Reporter of the Wall Street Journal) Scratch Ned Smokler’s new apartment house. The Detroit builder thought he had a mortgage loan lined up last month, but it suddenly fell through. Scratch several hundred home sales in Los Angeles, too. The buyers were told last month that they qualified for mortgages—but then the two savings and loan associations that were processing their applications suddenly stopped making any mortgage loans at all. These are no isolated incidents. Mortgage money in the last few weeks has been drying up drastically even for builders and would-be homebuyers who would easily qualify for loans in anything approaching a normal market—indeed, even for some who already had qualified. a sa v in g s h e m o r r h a g e The reason: Savings and loan associations, which finance more than 40 per cent of the Nation's home and apartment mortgages, are seeing savings flow out of their institutions much faster than new savings come in. So they are reducing mortgage lending drastically, and in some extreme cases stopping it altogether for the time being. As recently as the end of March the situation was far different. A tight-money pinch throughout the economy caused mortgage-interest rates to rise rapidly in the first quarter and prompted mortgage lenders to tighten credit standards. But this squeeze mainly hit “marginal” borrowers—those whose monthly income, in the judgment of lenders, could not quite cover the higher mortgage payments necessitated by the rising interest rates. Loans still were available to those with high credit ratings. Savings deposits in S&L’s exceeded withdrawals by $1.3 billion in the first quarter, and the S&L’s managed to increase their mortgage lending slightly, to an estimated $5 billion in the first quarter from $4.9 billion in the 1965 period. In April, though, savings withdrawals from the Nation’s S&L’s exceeded new deposits by an estimated $500 million to $700 million. That was the biggest 1month net outflow ever. While a net outflow is not unusual in April because of withdrawals for Federal income tax payments, the outflow in April 1965 amounted to only $99 million. 2 5 0 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS In May, w ith no m ore pressure on depositors to w ithdraw fu n d s to settle in* come ta x hills, S&L’s usually gain savings. B ut in d u stry sources say the sav ings outflow has continued th is month. So it is now estim ated th a t, unless funds s ta rts flowing in again heavily, S&L’s will cut th e ir m ortgage lending in the la s t 9 m onths of 1966 to $13 billion, from $19 billion in th e 1965 period. A cutback on th a t scale could crimp residential building severely in th e rest of 1966. HIGHEB WITHHOLDING, HIGH EB PRICES W hat happened? In d u stry sources generally sketch th is p ic tu re : Increased w ithholding from payrolls, for social security taxes a t th e beginning of the year and now fo r Federal income taxes as well, has reduced th e take-home pay of m any consum ers—a t the same tim e th a t rising prices have le ft th e consumers in need of m ore spendable funds. The new financial p ressu res ap p ear to have caused m any people to stop m aking new savings deposits an d to have forced some to dig into p ast savings. Some studies indicate much of th e money re cently w ithdraw n from S&L’s has gone to finance m ajor p u rch ases th a t consum ers apparently no longer can m ake o ut of income. Compounding the trouble fo r S&L’s, commercial b an k s now ap p ear to be attra c tin g a bigger share of w hat new savings deposits still a re being made, because they now are paying higher rates th a n th e S&L’s. This is quite a turnabout. C alifornia S&L’s not long ago w ere p aying th e highest rates on savings (up to 4.85 percent) in the country, ad vertising these ra te s widely in the E ast, and pulling in so much money th a t w orried F ed eral regulators were putting some downward pressure on these w estern rates. L ast December, however, th e Federal R eserve B oard increased th e rate that banks are allowed to pay on tim e deposits (those left in th e b an k fo r a specified time, such as 1 year) to 5 ^ percent from 4% percent. S&L’s officials a t first thought th is would not h u rt them. B ut as more banks have moved up to the high rates (some now pay 5Y2 percent on as little as $25) an d as savings have flowed out of the S&L’s, th e ind u stry has changed its m ind in a hurry. WASHINGTON MOVES Prodded by a pilgrim age of S&L executives to W ashington, th e industry-regu lating Federal Home Loan B ank B oard la st week moved to lif t th e u n o fficia l “ceiling” th a t lim its the ra te s S&L’s can pay on deposits. A fte r Ju ly 1, S&k’s in C alifornia and Nevada, which have been p a rticu larly pinched, can pay * percent on regular deposits, and m any have announced th e y will. F u r th e r , T reasury Secretary Fow ler la te la st week proposed to Congress th a t bank reg u l a t o r s be empowered to low er th e in terest banks can pay on tim e deposits of $10,000 or less. W hile an increase in th e rates they can pay on savings m ight help 13&L's stop fu rth e r outflows of savings, some in d u stry officials doubt it will enable the S&L’s to pull back in the money they already have lo s t “I t ’s like throwing a drow ning m an h alf a life preserver,” savs one S&L president So, fo r th e tim e being a t least, S&L’s can do little b u t c u rta il m o r tg a g e lending f a r m ore drastically th an they had expected to a few weeks a go. In D etroit, despite bank competition. S&L’s gained $23 m illion in new savings during the first q u a rte r of 1966, an d were hopeful of m ain tain in g mortgage lending a t th e $108 m illion ra te of la st year. In stead , n e t savings w it h d r a w a l s reached $21 million in A pril and “th is year we’re c u ttin g back lending to $*W million o r $35 m illio n /’ o r less tb an one-third th e 1965 volum e say s H. G eh rk e, president o f D etro it’s big F irs t F ederal Savings & Loan Association. A tlanta S&L’s a re planning to cu t th e ir m ortgage lending “betw een 50 percent and 75 percent” in May, June, and Ju ly from th e $70 m illion they loaned in thosre m onths la st year, according to E d Hiles, executive vice presid en t of Georgia Savings & Loan Association. In Elmhurst, a Chicago suburb, Elmhurst Federal Savings & Loan A sso c ia tio n announced 3 weeks ago it would no longer accept loan applications. “Our savings inflow isn’t satisfactory and hasn’t been since the first of the year,” says Theodore Wilson, president “We’re flatly turning down any and all applications. W ® think we will just coast for as long as 60 days to see if this market won’t sh*** o u t” In southern California, where most of the country's larger S&L’s nxe several associations, including those controlled by Lytton Finanetel CW*> baTe UNSOUND COMPETITION FOE SAVINGS AND TIME DEPOSITS 2 5 1 announced they a re declining tem porarily to accept new m ortgage-loan applications. The L ytton associations say they are fulfilling existing loan com m itm ents. But, says B a rt Lytton, chairm an of Lytton F in an cial in Los Angeles, “we’re not open to am endm ents, suggestions, or counter-proposals” from borrowers. “We refer all am endm ents, suggestions an d counter-proposals to those employes we have discharged/* he says jokingly. N ot so jokingly, L ytton associations have dismissed 170 employes, about one-quarter of th e ir w ork force, d u rin g th e p a st 6 m onths to keep costs in line w ith the drop in business. A few associations, to h ear builders and loan agents tell it, even have canceled com m itm ents they alread y had m ade to finance th e sale of homes. A Los Angeles loan agent contends th a t 1 S&L ordered escrow agencies to re tu rn dow npay m ents and tru s t deeds (a s m ortgages are called in C alifornia) on 400 homes, the sales of w hich w ere aw aitin g tran sfe r of loan fu n d s from th e S&L to sellers. Two weeks before th a t, th e agent says, a n o th er association backed o ut of 200 commitments. The associations he nam es deny they ever have canceled a loan comm itment. B ut they concede they stopped processing loan applications in April, including some applications fo r loans to complete sales on w hich dow npaym ents already had been p u t in escrow. On some of these, applicants already had been sent le tte rs indicating ten tativ e approval pending fo rm al action by th e S&L loan committees. A Los Angeles builder says he lost th ree home sales a few weeks ago because the S&L th a t h ad m ade a n o ra l agreem ent to finance th e purchases broke its word. “T hey asked me if I had anything in w riting. I said no, and they told me to go ahead and sue ’em then,” he says. Savings and loan executives in sist such cases are so ra re as to be insignificant and say th a t suspension of new lending by some S&L’s is only tem porary. A spokesman fo r the U.S. Savings & Loan League says th a t “this step has been taken in order to fulfill m ortgage com m itm ents previously m ade” and th a t S&L’s refusing to m ake new com m itm ents “will re tu rn to th e m ark et as soon as these existing com m itm ents have been m et.” B ut even th e optim ists don’t foresee a re tu rn to th e m ortgage lending volume of la s t year. “The lending capacity of th e business will fall fa r short of the dem ands of A m erican hom ebuyers,” says N orm an R. Strunk, executive vice president of the U.S. Savings & Loan League. H e th in k s S&L m ortgage lending fo r all 1966 m ay fa ll to about $18 billion, down nearly 25 percent from $23.9 billion la st year. The consequences fo r the building in d u stry could be severe. H ousing starts, while they have rem ained about level in an n u al ra te fo r th e la st several months, fell below th e previous y ear in both 1964 an d 1965, to co nstitute one of th e few soft spots in the economy. Now th e cutback in S&L m ortgage lending raises a new th re a t, and econom ists see little chance th a t o ther m ortgage lenders such as insurance companies, comm ercial banks, and m utual savings banks, will step in to fill even p a rt of th e gap. These in stitu tio n s do n o t concentrate on m ortgage loans to the ex ten t S&L’s do. Moreover, heavy loan dem ands from nonconstruc tion businesses have p u t a stra in on th e funds th ey have available to lend. As recently as December, th e N ational Association of Home B uilders concluded from a survev of its mem bers th a t housing s ta rts in 1966 would exceed the 1,542,000 of 1965. By M arch, however, the NAHB decided th ere would be a “slight decline,” perhaps 1 percent. Now, says Norm&n F a rq u h ar, an economist fo r the association, “i t ’s like riding a roller coaster. W e know we re going down fast, bu t we don’t know w here bottom is.” Individual builders, especially in C alifornia, long a g iant construction m ark et, are ju s t as gloomy. B en Deane, a Los Angeles area builder, originally planned to p u t up 1,500 new houses th is year. B u t now he say s: “W e’ll probably go under 1,000 because of th e an ticip ated unav ailab ility of m ortgage cred it.” “The g re a t m ajo rity o f hom ebuilders in S outhern C alifornia a re dependent on th e S&L industry, an d practically none of them (th e S&L’s) a re m aking com m itm ents to finance new homes,” says b uilder L a rry W einberg. “A lo t of the sm aller builders who don’t have com m itm ents now a re going to be out of business in very sh o rt o rd er.” F o r th e S&L’s them selves, th e situ a tio n probably spells a d ra stic slowdown, a t least fo r 1966, in th e ir super-fast grow th ra te s of recen t years. T he U.S. le a g u e say s to ta l savings in S&L’s h av e increased as much as 13 percen t a y ear in recent years, w ith some S&L’s posting gains of 15 percent or even 20 percent. 2 5 2 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS The outlook fo r th is year, m ost in dustry sources agree, is fo r much more modest grow th a t best. E arnings of the large S&L holding companies eith e r a re show ing only small gains from a y ear earlier, o r a re down sharply. L ytton F in an cial reported firstq u arter profit of $381,590, or 15 cents a share, f a r below th e $1,023,622, or 40 cents a share, earned in the 1965 period. B a rt L ytton say s cu ts in expenses and higher interest rates on mortgage loans m ay reverse th e picture for the rest of the year. B ut he ad d s: “Nobody can p roject earnings now with any degree of certainty.” Investors have ra th e r clearly soured on S&L stocks, too. T he K idder, Peabody & Co. index of S&L stock prices h as dropped to 79.40 cu rren tly , down from 119 a t the end of 1965 and a peak of 397 in November 1961. M r. We have read it. I ca n see y o u d id n o t w r ite it. I would like to explore two areas that I feel are the crux here. First, the relationship between savings institutions and banks in terms of coordination of decisions being made by both your Board an d the Federal Home Loan Bank Board; and second, wliat is a CD an d what is the effect of a CD in competition with other financial insti tutions and internally within a financial institution? In this con text, I would like to discuss the legislation I introduced this week. I am a Congressman from California, from Los Angeles, and we have, of course, a great deal of competition in that area for m one^y, both in the banks and savings and loans, because we are a fast-growing econ omy. I am reading from an analysis of a billion-dollar savings an d loan association, a Federal institution. They are well below the C ali fornia average in terms of scheduled items. The management I con sider to be among the top in the entire industry. Looking at the types of savings that they have in their institution, 79 percent of their deposits are deposits of $5,000 and more; 53.7 per cent are ^deposits of $9,000 and more. So you can see the pattern here, an investor pattern rather than a savings pattern where m om and dad put a few hundred dollars away for furniture or for future needs. I think you will find this pattern at least throughout the savings and loan industry in the State of California. It is the in vestor, not a savings pattern. R o b er tso n . M r. R e e s. I w o u ld a lso lik e to g iv e y o u th e e x p e r ie n c e o f t h is -------- M R o b e r t s o n . May I ask, are these all CD’s you are talking about, r. or ]ust regular passbook? M R e e s . They have not gone into this 3-year savings type of r. certificate. M r. R o b e r ts o n . S o th e s e a re th e a c c u m u la te d d e p o s its over the ye™ S a c c u m u la te th e ir fu n d s t o b u y h o m e s. , M R e e s * It shows it is primarily investor money. The type ot r. person who puts money in the savings and loans is the person w ho has funds for investment and part of their portfolio is this type °* demand money. Mr R o b e r t s o n . This would be more likely to be true if they were a single deposit of that volume. If they are merely the accumulate" deposits of individuals who are trying to buy a home, they inijp* not oe* M r. R e e s . These a re n o t p e o p le a c c u m u la tin g t o b u y a h om e. ^ ^ e a v e r a g e in v e s to r i s p r o b a b ly 55 y e a r s o ld a n d probably so ld a h o m e a n d h a s o th e r a ss e ts a n d se e k s t h i s a s a r e a d y money in v e s tm e n t. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 5 3 Mr. R o b e r t s o n . D o you have any percentages to show the deposits over $100,000? M R e e s . Of deposits of $2 5 ,0 0 0 and over, about 2.85. I would r. say one family could maybe have $ 3 0 ,0 0 0 or $ 4 0 ,0 0 0 in three or four insured accounts; one for the wife and one for the child and however it might be. It does show you when you draw the line; it is primarily investor money and not saver money. In terms of the first quarter of this year, in that institution, they lost deposits of $19 million. This is a great deal of money. And of that, $15 million was in those areas of deposit between $10,000 and $11,000, investor-type money, investing up to the $10,000 insured ac count limit. We find basically that there is a flow of this type of money directly into the bank CD. In California the Bank of America is giving 5 percent. It is the smaller banks that are going up to 5^ percent. It is the banks who can least digest a CD that are going up to the 5*/£percent basis. Was there any consultation with your Board and the Federal Home Loan Bank Board before the decision was made on December 6 ? M R o b e r t s o n . I think not. r. M R e e s . Do you not think this is dangerous ? r. M r. R o b e r t s o n . I th in k it w o u ld h a v e b een b e tte r i f w e h a d . Mr. R e e s . Do you think there may be a possibility in the future of restructuring both your Board and the Federal Home Loan Bank Board to see that there is some coordination among your policies? We find the situation where your decision is directly affecting the savings and loan industry. The decisions of the Federal Home Loan Bank Board do not affect what you are doing nearly as much. M R o b e r t s o n . Yes; they do, too. r. Mr. Rees. Not nearly as directly as your decision. M R o b e r t s o n . I do not want to get into the question of degree, but r. on both sides, of course, any decision which they make in raising their rates, for example, the rates that are permissible, for those that are coming to borrow from the Federal home loan banks obviously affect in particular areas the rates which savings and loans are paying in contrast to those which banks can pay. Mr. R e e s . Did you look at the potential effect of the savings and loans before you made that decision ? M R o b e r t s o n . I am sure every member of the Board had in mind r. the possible effect of raising these rates. No one—no one could over look this, it seems to me. You would not look exclusively at savings and loans. You would look at all financial institutions and this would be part of the background information which every member would want to have before he made his decision. Mr. R ees. D o you not think that we have to have some restructur ing so as to have some coordination between the two banking systems ? Mr. R o b e r t s o n . I am firmly in favor of this and I would be delighted to send you a speech I made last week in which I suggest that action should be taken so that we have more uniform rules. Mr. R e e s . I wish you would. It is my prediction that when July comes up we are going to have serious problems of liquidity in the sav ings and loan industry throughout the United States. The with 2 5 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS drawals in the first quarter was a minor withdrawal in terms of what is going to happen. There should be some differential, some parity in interest rates be tween banks and savings and loan associations. Do you think it is good in terms of competition? For example, banks have many m ore advantages than a savings and loan. Mr. R o b e r t s o n . May I answer that and then Governor M itchell, who made this suggestion, may cover it, too. From my point of view, the reason for the differential of one-half of 1 percent has been the break-even point insofar as competition is concerned between the two institutions—the banks can handle the demand deposits and perform other services for individuals and there fore have the advantage in getting funds and therefore they can pay 4 percent when savings and loans are paying 4 y2 not lose to the savings and loans. I do not think this necessarily follows for all tim e, because more and more people are getting interest conscious. Savers are becoming sophisticated and they may very well move even for less than a half of 1percent. But I would prefer to have Governor Mitchell answer that. The C h a i r m a n . If you will pardon me. You have an a m e n d m e n t, Mr. Rees, I believe. Why do you not explain what your a m e n d m e n t is so that the members will have it in the record, and so the m em b ers of the Federal Reserve Board will know about it, too ? M R e e s . Yes, Mr. Chairman, I wanted to go into that, but it looks r. like we are being called. The C h a ir m a n . Y will have 3 o r 4 minutes. Mr. R e e s . Let me explain the bill that was put in last week. The bill is an attempt to define a certificate of deposit. In the bill we define a certificate of deposit as being a nonnegotiable instrument which must be held for at least 1 year at an interest rate no greater than the passbook rate of the bank. I have here an analysis by Governor Robertson of the bill. I intro duced this bill because I felt that the certificate of deposit is poten tially a very destructive instrument. In the newer growing banks in California we have the problem of too many certificates of deposit. You even had it in N e w York banks where major CD’s all became due at a certain time, you had a serious liquidity problem. My bill is an attempt to try to equalize the rates so the small passbook holder w ould not be at a disadvantage, with the large corporate investor. The C h a ir m a n . Would you like to place that in the re c o rd ? Mr. Rees. The bill? The C h a i r m a n . Your summary and any material that you have co?^elliln^ your friM I assume you will offer that amendment. * M R e e s . Yes. r. The C h a i r m a n . Y o u may place it in the record at this point. M Rees. Thank you, Mr. Chairman. r. (The analysis on H.R. 15173 by Governor Robertson was previously inserted and may be found on p. 209.) * ^ e^ H IK A * A MN right, we will recess then until tomorrow morn' mng, Governor. We regret very much to ask you to come back. under the circumstances, we have no alternative. o u UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS 2 5 5 Mr. T r e ib e r . I have been away from the Federal Reserve bank ira New York since Monday afternoon and I have some things I think I should take care of. The C h a ir m a n . Since we have the members here, I think it will be all right to excuse you, Mr. Treiber. Mr. T r e ib e r . Certainly. The C h a ir m a n . All right, we will stand in recess until tomorrow a t 10 o’clock. (Whereupon, at 11:15 a.m., the committee adjourned to reconvene at 10 a.m., Thursday, May 26,1966. This meeting was subsequently can celed, to reconvene subject to the call of the Chair.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS TUESDAY, MAY 31, 1966 H ouse of R epresentatives , C om m ittee o x B a n k in g and C urrency , Washington, D.C. The committee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Wright Patman (chairman) presiding. Present: Representatives Patman, Reuss, Moorhead, Todd, Ot tinger, McGrath, Hansen, Annunzio, Rees, Widnall, Mrs. Dwyer, Harvey, Stanton, and Mize. The C h a ir m a n . The committee will please come to order. This morning the committee continues hearings on H.R. 14026, con cerning negotiable certificates of deposit. Our witnesses are Comptroller of the Currency James J. Saxon, supervisor of the issuance of the Nation's circulating currency as well as of national banks, and Mr. Larry Blackmon, Chicago, 111., who is president of the National Association of Home Guilders. M Black r. mon’s industry is vitally interested in the CD question because their ability to provide homes for Americans is directly related to the ques tion, “Where is all the money going—Main Street, or Wall Street?” According to the latest statistics, the modest increases in the money supply created by the Federal Reserve, as well as savings money are turning up in the hands of the customers of the large money-market banks. Of the $18 billion in outstanding negotiable CD’s, over 70 per cent were issued by just 30 banks, every one with over $1 billion in assets. Over 40 percent of the total—$7 billion—was issued by just a handful of New York City banks. So it is perfectly clear what is causing the pressure on smaller banks, thrift institutions, and homebuilding ana home buying. Mr. Saxon can tell us in detail how the money market national banks he supervises have issued CD's, debentures, notes, and loans to raise cash to finance expansion for their big corporate clients, while Mr. Blackmon, who follows Mr. Saxon as our witness, can tell us the effects of these distorted money flows on other segments of our economy. Mr. Saxon, we are delighted to have you, sir. You may proceed in your own way. If you will, summarize your statement. I assume you have a copy for each member and it has been placed in front of each member. I have mine and I am sure the other members have one. We would appreciate that very much. Then we would like to ask you questions, sir. 257 2 5 8 UNSOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS STATEM ENT O H N JAM J. SA O , C M O F O. ES X N O PTR LLER O T E F H C R Y UR ENC Mr. S ax o n . All right, Mr. Chairman. 'The C h a i r m a n . Come around, Mr. Blackmon, to the witness place if you will, please. You know Mr. Saxon. Just sit there at the microphone if you will and you will be heard after him. We have asked him to summarize his statement, and we will ask you to do the same thing. All right, Mr. Saxon. Mr. S ax o n . Mr. Chairman, in response to your suggestion, I will summarize briefly this short statement which deals primarily with regulation Q and the effects that regulation in our opinion has had on the general financial industry in this country, all segments of it, and on the commercial banking business. It is our view that regu lation Q has been and is a price-fixing mechanism which is odious to the general principles on which this economy is operated, that this regulation has been destructive of the normal flow of funds to the needs of the market as those needs should be demonstrated by com petition among various segments of industry and commerce within our economy, that for many years regulation Q was kept at rates at such low level as to deter the normal flow of funds into commer cial banks, and to increase artificially the flow of funds into the sav ings and loan industry and into the mutual savings banks. I point out that for many years there was no price regulation on rates or maturities or quantity of funds which S. & L.’s or mutuals could seek in the markets, ana even today the only restraint on rates is that which is incidental to the limited control exercised through advances from the home loan banks to the S. & L.’s, whereas today by contrast the commercial banking business is subject to acrossthe-board rate regulation. As has been pointed out, this has imperiled the proper function of the economy, has materially affected in a serious adverse way the normal allocation of funds and their most efficient uses in the economy and has benefited artificially and improperly other competing indus tries, in itself has resulted ’n the problem to the extent that a prob i lem exists in the savings and loan business which because of Q has had freedom without limit to compete for funds countrywide, with out regard to rates, maturities, or other controls. We note here today that whereas the Federal Reserve continues its restraints on the commercial banking business, the Home Loan Bank Board has just recently announced liberalization of its regu lations in terms of liquidity requirements and other r e q u ir e m e n ts, and at a time when, in my opinion^ instead of liberalizing the H orn® Loan Bank it ought to be restraining these institutions. In faC ^ it is not apparently merely a matter of maintaining the status quo in the savings and loan industry today. It appears to be a matter of providing funds for continued ex pansion on the presumed basis that these funds are necessary to sup port the housing industry, much of this of course being directed these comments primarily to small housing, although we know that large construction is one of the major interests of the housing industry and that this pressure to continue the existing rate of expansion UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 5 9 indeed to increase the expansion is contrary to the requirements of the economy as it exists today with the inflationary pressures that are in herent and apparent in it in some segments, and regulation Q itself is responsible basically, as it has been over the years, and as this problem is now aggravated by the astonishing liberalizing regulations of the Home Loan Bank Board at a time when there ought to be reasonable restraint. We would also point to the practices engaged in with the approval of the Home Loan Bank Board for excessive appraisals of loans and excessive loan rates, particularly in a period such as we now have here in this country. We do not believe either that one segment of the industry and busi ness of this country, the housing industry alone, should be protected as a privileged sanctuary, and despite the restraints being imposed on other segments of the economy, the business economy, the principle somehow seems to be developed that the housing industry as a single exception ought to be protected at any cost. This seems to be con trary to the principles which should govern the sound effective func tioning of the economy in the period m which we are now living. We believe that there ought to be some restraints exercised on the lending practices of the S. & L.’s, that there is a serious question whether there ought to be any further expansion at this time, a serious question as to whether such expansion should in any case be financed by public funds through the home loan banks, and whether overall this is not seriously harmful to the economy. As I noted, to the contrary of these principles we see liberalizing practices. Instead of a substantial expansion in required liquidity, which, as I recommended to Mr. Dillon three and a half years ago, ought to be a minimum of 15 percent of funds exclusive of home loan bank borrowings and exclusive of loan commitments on the books, we have what amounts today as a negative liquidity in the case of S. & L.’s generally. Now there are some very fine ones that operate according to sound financial principles, but instead of true liquidity we have borrowed liquidity in the main, liquidity based on borrowings from the home loan banks, and it is notable in this respect that this borrowing from and lending by the home loan banks is increasing. It is now at some $6 billion and presumably, if this policy continues, this will expand. By contrast, restraint in bank lending, it is now clear enough, indi cates approximately $600 million total advances by the Fed to the commercial banks. I am not arguing that this restraint in the case of commercial banks should be lifted at all. Perhaps it should be increased, but I do seriously question whether the current policy of the Home Loan Bank Board to liberalize at this critical period, if their own statements can be taken as indicating a critical situation, ^nd I am not sure that this exists nationally at all. I do know in California and a couple of other places there are problems, but I am not persuaded that this is of such monumental significance as to war rant the hysterical—as I would describe it—hysterical reaction I have beard and seen in a number of places. So a policy of reasonable restraint, a period during which the S. & L.’s, as some of them are now doing thankfully, would not extend their commitments but would attempt to increase their liquidity, their 2 6 0 TJNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS true liquidity, their real liquidity, as indeed they could, by using the inflow from present mortgage portfolio amortization to improve their internal situation and to reduce their reliance on the home loan banks in the country. # ^ Instead we see a reduction in liquidity requirements from t to 6 percent. This I find impossible to understand. We therefore, in conclusion, feel that there are two basic prob lems here. One, the role of regulation Q in this economy, and the artificial restraints, the odious price fixing which regulation Q rep resents. In this connection I would refer to what I believe as I recol lect was the unanimous opinion of the President’s Committee on Finan cial Institutions that regulation Q ought to be put at a minimum on a standby basis. I believe it ought to be abolished altogether. I believe if regulation Q had been permitted, had been on a standby or had been abolished during the past years, the artificial protection, the privileged sanctuary enjoyed by the savings and loan industry would not have put them in the posture which it is said they have or exist in today. They would have been used and properly used in the competition in the marketplace, and, presumably, as I noted earlier, would have exercised the proper practices that many of them now do, but unfortunately not all. In conclusion 1 would note that in the April period the $900 million of withdrawals from the S. & L. industry, that $500 million of this came out of California alone, and that |500 million was fu r n ish e d back again by the Home Loan Bank of San Francisco. This is a question o f proper policy. It seems to me g o v e r n m e n ta l policy by the Congress, Ty the administration, which such s u p p o r t is b desirable, particularly when it creates an attitude and a policy of p r o tection regardless of the proprieties and the warrants of the m oney market. I would note too that this industry has been well subsidized th ro u g h the years. The 1964 tax figures of the Treasury showed that con trary to a projected 20- to 22-percent tax rate on all mutuals, m u tu al savings banks and S. & L.’s, that the 1964 figures showed m u c h less actually paid by S. & L.’s and the mutual savings banks. In this connection I would like to note that one of the other m a j o r competitors for the available funds in the money market at any given point of time is the insurance industry. It is the one industry that initially obtains its funds free of any cost through the premium* Here too this is an industry which pays lesser taxes as its earning grow. It paid something slightly over one-half of the taxes paid by the commercial banking industry in 1964. I note this item merely to suggest that there is a serious question whether this type of privilege, this type of protection provides for the best development in an efficiently operating financial economy. That concludes my statement, Mr. Chairman. (The complete statement of Mr. Saxon follows:) S t a te m e n t o f J a m e s J . S a x o n , C o m p tr o lle r o f t h e C urrency During the past few weeks, this committee has heard testimony on several proposals which are directed towards curbing competition between savings a loan associations and commercial banks. Rather than focus my attention these proposals, I wish to address my statement to what in my opinion is fundamental issue which underlies these proposals. Whether we think that tn UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 6 1 difficulty w hich now plagues the savings an d loan in d u stry is a p erm anent prob lem, a tran sitio n al problem, o r no problem a t all, th e basic issue is still the s a m e ; Should regulation Q be used to reg u late price com petition among financial institutions. A card in al principle of o ur free en terp rise system is th a t governm ent should impose economic regulation only in those a re a s w here free m ark et forces lead to resu lts th a t are n o t in th e public in terest. W hen th e governm ent in te r venes to fix prices, ad m in istrativ e decisions a re su b stitu ted fo r those of th e m arketplace— th e decisions o f one man o r a very few men replace th e judgm ents of many. T here may be instances in w hich th is is a desirable course, b u t th e burden of proof should re st w ith those w ho w ould advocate m ore controls over competition, since com petition h as long been accepted by both scholars an d businessm en as th e driving force behind o u r system of free enterprise. Indeed, a com petitive system is a t th e roots of o u r trad itio n a l political a n d economic philosophies. A lthough several proponents of m ore control have recently ap peared before th is committee, no one to m y knowledge h as offered th e kin d of convincing evidence we should dem and before acting to increase the re s tra in ts on our th riv in g financial system. R estriction on in terest paym ents go back to the B anking Act of 1933, conceived in the m idst of our w orst financial crisis. T here w as rem arkably little discus sion of in terest paym ents on deposits when th a t a ct w as under consideration. AVhat discussion there w as rested on th e assum ption th a t the banking troubles of the 1930’s w ere the resu lt of im prudent banking practices. Such practices w ere forced upon th e comm ercial banks, so th e argum ent ran , by th e severe competi tion fo r correspondent an d o th er deposit balances. This competition, it w as argued, led to high in tere st ra te s on deposits, which compelled banks to acquire risky assets, thereby exposing them selves to th e illiquidity th a t pervaded the banking crisis of 1933. T here is no evidence, however, to support the view th a t ra te competition for tim e deposits during the 1920’s w as excessive and led banks to “reach” for un sound assets. In fact, during th is period ra tes paid on tim e deposits by member banks actu ally declined. In addition, from 1920 to 1929 commercial banks sue* cessfully m aintained th e ir holdings of governm ent bonds a t about 10 percent of to ta l earning assets, indicating th a t they did not attem p t to increase th eir e arn ings by reducing the proportion of high-quality assets in th eir portfolios. More recently, a fte r review ing th e evidence, both th e Commission on Money and C redit and the P resid en t’s Committee on F in an cial In stitu tio n s concluded th a t in terest-rate ceilings a re generally undesirable. C urrent com petitive relationships betw een comm ercial banks and savings and loan associations should be exam ined in the perspective of the whole post-W orld W ar I I period. From 1946 to 1962, comm ercial banks operated a t a serious dis advantage in competing fo r savings because of the relatively low regulation Q ceilings- F o r example, u n til 1962 banks w ere lim ited to a m axim um ra te payable of 3 percent on tim e an d savings deposits, w hile m any savings and loan associations paid 4 percent or higher a t tim es. In the 1946-61 period, com m ercial bank tim e and savings deposits increased by $44.9 billion, w hile savings a t savings and loan associations increased by $63.5 billion. T his w as nearly a ninefold increase fo r savings an d loan associations, com pared to less-than-atw ofold increase fo r comm ercial banks. D uring th e la st 4 years, on the other hand, w ith th e comm ercial banks operating u n d er less restrictiv e ra te ceilings, the grow th in com m ercial banks tim e an d savings deposits an d in savings a t savings and loan associations w as n early equal. To my knowledge, the com petitive relatio n sh ip of th e la st 4 years have n ot had any h arm ful o r destructive effects on financial in stitu tio n s. As f a r as com m ercial banks a re concerned, th e ir position is sound, w h eth er we look a t q u ality of assets, earnings, o r th e ir liquidity position. B ank earnings a re a t an alltim e high. T he quality of bank assets h as been im proving in recent m onths. An aspect of tig h t money conditions and strong loan dem and is th a t it allow s banks to im prove th e ir portfolios by w eeding o u t th e ir m arg in al loans. B ank liquidity positions a re also sound. T his is som ething we follow very closely and an analysis of our m ost recent exam ination rep o rts shows th a t th e 200 larg est banks have, on average, liquid assets equal to about 30 percent of deposits. These banks have unquestionably been th e m ost aggressive com petitors fo r tim e deposit funds. A lthough I do not have d etailed knowledge of th e savings an d loan in dustry, th ere is, in my opinion, no reason to believe th a t th e in d u stry is facing w ide spread insolvencies. I f th ere w ere any basis fo r the fe a rs th a t have been ex 63-496— 66------ 18 2 6 2 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS pressed about the industry, th e Home Loan B ank B oard w ould be tightening up ra th e r than liberalizing requirem ents fo r reserves and liquidity of member as sociations. However, recent actions of th e Board, according to its own press release, have “liberalized dividend rates, reserve requirem ents, and liquidity requirem ents of savings and loan associations/’ I t is difficult fo r me to under stand why the present situation calls fo r additional restrictio n s on commercial banks when the Home Loan B ank B oard is moving in the opposite direction and liberalizing requirem ents on savings and loan associations. I recognize, of course, th a t compared to p ast years, th e savings and loan in dustry has been experiencing slower grow th in recent m onths. Although savings and loan associations would like to re tu rn to the “good old day s” during which banks were not allowed to compete vigorously, it is unreasonable to expect a re tu rn to the distorted competitive relationships of th e 1950’s. R ath e r than re turning to the 1950Js savings and loan associations m ust face up to prospects of slower growth in the future, together w ith its corollary of low er profits and re duced tax benefits* (To some extent, as long as savings and loans grow rapidly they pay virtually no taxes. In 1964, fo r example, savings an d loan associations paid Federal taxes of only $124 million, or 17 percent of income a fte r dividends.) It is clear th a t the kind of competition fo r savings fu n d s we have witnessed in recent years has not led to “dangerous” or “destructive” com petition but rather has brought about a healthy and vigorous financial system. Moreover, not only are there no dangers in removing regulation Q, b u t th e re a re real advantages to be gained. The interest-rate rigidities imposed by regulation Q d isto rt th e allocation or resources between different types of financial in stitu tio n s as w ell as among com m ercial banks themselves. Because of g reater efficiency, some banks could pay more th a n the existing ceiling ra te w ithout engaging in im p ru d en t banking prac tices. O ther banks, which a re less efficient, find the ceiling a convenient shelter from the rigors of competition. R egulation Q, therefore, imposes price controls th a t protect the inefficient and discourage th e efficient, a re su lt which conflicts w ith the goals of our free enterprise system. Even if this inefficiency were th e sole cost of regulation Q, and it m ost definitely is not, I would regard it a s sufficient justification fo r abolishing these rate ceilings. A nother aspect th a t should be noted is th e publicity associated w ith changes in regulation Q ceilings. T h is publicity, and indeed th e publicity associated w ith these hearings, calls public attention to th e 5 ^> percent ra te allow able under regulation Q. As a result, many people feel th a t th e G overnm ent h as specified 5% percent as th e ra te th a t banks should pay and th a t they a re being cheated if th eir bank pays less. I t is not ju s t th e financially u nsophisticated w h o make this mistake. The recent Home Loan B ank B oard actions w ere reported in the A tlanta Jo u rn al as follo w s: “The Federal Home Loan B ank B oard told savings and loan associations they must pay as high as 5 percent in terest on some form s of savings acco u n ts/' T his kind of m isinterpretation seems inevitable if w e continue to have ceilings on in terest ra te s which a re subject to infrequent and highly publicized changes. In closing. I have been unable to discover any dangers w hich a re clearly asso ciated w ith ra te competition fo r savings funds, and am convinced th a t by nating regulation Q our financial stru ctu re, indeed th e en tire economy, would realize significant benefits. T he proposals now before th is com m ittee would remedy the dislocations and distortions stem m ing from reg u latio n Q by saddling our financial system w ith even m ore controls and g rea te r rigidity. I do not think th a t these proposals a re in th e in te re st of eith er th e financial community °r th e public. The C h a irm a n . Thank you, sir. Now, Mr. Blackmon, please take about 10 minutes and hit the high points of your statement and then the entire statement will be pl^ce, m*ii le re.cor< immediately after your oral statement as Mr. S a x o n s ^ w be placed after his. The committee then would like to ask the tw _ill o of you questions and bring out all the important points. If indeed ce^a[n P01*ts are not brought out at the end of pur interrogation, will be perfectly free to bring them out, and if not brought out by yourselves, you can extend your remarks in the record UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 6 3 STATEMENT OE LARRY BLACKMON, PRESIDENT, NATIONAL ASSOCIATION OF HOME BUILDERS M B la c k m o n . Thank you, M Chairman and members of the r. r* committee. I was before the Subcommittee on Housing a couple of months ago and testified on certain aspects of the housing bill, most of which we supported. There were a few items we did not support. However, in my opening remarks, I said that NAHB supported the bill but we were concerned about present monetary policy and the effect it was going to have on our industry and as being a major factor in what we could and would do this year and in years to come. M Saxon stated that special treatment was being given to the r. sayings and loan institutions, and that the housing industry had re ceived special treatment. I would say this to you gentlemen: many years ago it was determined by this body that special treatment should be given to encourage the American Nation to be a nation of homeownership. The C h a ir m a n . M Blackmon, of course we shall be glad to hear r. you any time on that, but really our question is now on the CD’s. M B la c k m o n . Yes, sir. r. The C h a ir m a n . I have an idea that your time would be used in ac cordance with my suggestion. This will be appreciated by the com mittee on that particular question. This other thing will not be over looked. You may put anything in the record which you wish to. M B la c k m o n . I was concerned, Mr. Chairman, that there was an r. attack on the savings institutions because the CD’s themselves—I was getting to that----The C h a ir m a n . That is all right. Then you use your time as you desire. Mr. B la c k m o n . Congress determined that homeownership is a great thing in this country and that it would strengthen America. There fore it established the policy of encouraging savings in institutions concentrating on residential lending. Over many years small savers have been given a higher rate of interest than others. It is only in recent years that an administrative change in policy permitted CD's to pay a larger amount than savings in savings and loans and savings banks of this country. I think this change is responsible for the present chaotic condition in the Nation’s monetary policy. When the Federal Reserve Board issued regulations relaxing regulation Q to permit CD’s to bear interest at 5y2 percent without any guidelines whatsoever, it resulted in small savings being shifted from savings institutions into commercial banks. The commercial banks are using these funds not for investment in long-term loans as they were in the savings institutions; they are being invested in items of short-term duration such as automobiles and other consumer financing. This just aggravates the overheating of the economy rather than slowing it down. One of the reasons given for the relaxation of regulation Q last fall was that banks were unable to cope with their funding of the large volume of CD’s coming due at that time. I do not see how they can hope to cope with the situation now if they could not cope with it last November and December. Banks have been encouraged to en large this problem rather than to bring it under control. 2 6 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS To get back to the basic statement I was making earlier. Shifting large amounts of money from one industry to another or from savings institutions to commercial banks results in chaotic conditions in the economy. The problem could be solved by overhauling our system and creating a super board made up of the Comptroller of the C ur rency, the Secretary of the Treasury, the Federal Reserve, the Council of Economic Advisers, the Secretary of HUD, and the Home Loan Bank Board. This Board should have formal meetings in which it takes into consideration the overall welfare of the Nation and in w hich direction we should go, rather than having one segment, such as the Federal Reserve, issuing a regulation that has a great impact on other segments of our monetary policy and of our industry. I think that this is necessary and I would like to urge this body to create such a board. Our monetary policy in this country would b e coordinated more effectively as a result. I believe, M Chairman, that is all the comment I would make at r. this time and I will be available for questions. I would at the end of this like to make one comment concerning Fannie Mae that might b e of interest to the whole committee, but which does not concern CD’s. (The complete statement of M Blackmon follows:) r. S t a t e m e n t op L arry B l a c k m o n , P r e s id e n t , N a t io n a l A s s o c ia t io n of H ome B u il d e r s Mr. C hairm an and members of the committee, approxim ately 2 months ago I appeared before the Subcommittee on Housing on the D em onstration Cities Act and related bills. A t th a t time, I said th a t th e homebuilding in d u stry ’s support for those bills w as tempered by th e fact th a t m onetary pressures on our industry were rapidly crippling our capacity to produce the kind a n d volume of homes American fam ilies require. Since then, necessary long-term credit which is the lifeblood of o u r industry has become less and less available to our customers. Consequently, all over our Nation the American homebuilding industry—one of th e N ation’s most im portant industries—is in serious distress. W ithout a vigorous homebuilding industry th e American economy cannot long rem ain healthy. The economic im portance of homebuilding is briefly described in attachm ent A. This huge, basic industry is today in danger of serious credit starvation from which it will not quickly recover, if continued much longer. ^ One m ajor cause of this critical slump is th e loss by savings an d loan institu tions and savings banks of savings deposits pulled into th e comm ercial banking system by last fall’s amendment of regulation Q, A previous w itness gave you the figures on the extent of th is drain on savings and loan deposits and the resu ltan t drastic im pairm ent of th e lending capacity of th e savings and loan system. To finance its customers, homebuilding depends on savings and loans (and savings banks which are suffering equally). We therefore believe the hearings you are conducting on th is subject are most timely. ^ I t is the considered opinion of the American homebuilding industry that the deliberate diversion of savings from long-term investm ent into short-term* high-yield commercial lending has grave im plications for th e continued vitality of the homebuilding industry, and, therefore, inevitably fo r th e en tire American economy. By raisin g the m aximum permissible in terest ra te on tim e deposits to 5Vj percent from 4 % percent and in reducing to 30 days th e ir m inim um permissible term, the Federal Reserve Board set in motion the forces w hich have produced this result. At th e tim e it w as intim ated th a t th is in terest ra te rise w as design*] to perm it banks to work out of th e aw kw ard situation in w hich they found themselves as a result of increasing use of certificates o f deposit. The action has not by any m eans reduced th e size of th a t problem. On th e contrary, it has sharply increased th e am ount of certificates outstanding. B ank funds held under certificates rose from $16.3 billion in November 1965 to $17.4 billion on April 20, 1966. I f a t th e end of the la st v ear th e banking system could wot handle th e lower am ount of m aturing certificates a t th e th en m axim um of 4% UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 6 5 percent, how will it be able, in the months to come, to refinance the larger (and growing) amount at a sharply higher interest rate? And, particularly, how can banks cope with this growing load of debt when the minimum maturity of certificates has been shortened to as little as 30 days? If the general level of interest rates does not decline prior to the maturity of large volumes of these certificates, the Federal Beserve Board may decide it is necessary to raise the permissible rate even higher than 5% percent, regard less of the serious reaction this may have on other segments of the economy. We fear—and I use that word advisedly—that the concept of certificates of deposit as a substitute for long-term savings will become permanently im bedded in the commercial banking system. Originally used sparingly as an a t traction for temporary corporate surpluses, certificates of deposit are rapidly being exploited as a device to seek long-term savings of the small saver—in short, to compete with savings institutions. I t is this fierce and unfair com petition which deprives homebuyers of credit to buy new, or to refinance exist ing, homes. I say “unfair” competition, because in an interest-rate war long term investors simply cannot compete; they cannot raise their earnings as rapidly or as flexibly as can commercial banks whose funds turn over rapidly in short-term investments. Two recent news items from the Wall Street Journal will serve to illustrate what is happening. They are attached as exhibits I and If allowed to compete for these savings practically without restraint, com mercial banks can take most of it for their own uses—which are not the uses which support homebuilding and other industries based on long-term credit. In brief, we believe the current situation gives rise to two extremely serious problems, the first a problem for the commercial banking system in coping with the large and increasing volume of certificates of deposit issued at higher interest rates and, the second, the governmental problem as to how far com mercial banks should be permitted to go in competing with savings institutions for long-term savings. We are shocked a t recent newspaper reports of a proposal advanced by no less an official than Vice Chairman of the Federal Reserve Board, which would in effect convert savings institutions into commercial banks. We find in it no indication where residential mortgage loans of the future are to come from. Ap parently this is a matter of small concern to those who set credit policies. (It is high time that the importance of residential credit be recognized. We have for some time urged that the monetary system has become too complex to be left to the unilateral action of one agency and that an overall policy board should be established to include representatives of the Home Loan Bank Board, Comptroller of the Currency, Secretary of the Treasury, Secretary of Housing and Urban Development, Council of Economic Advisers, and the Federal Reserve Board. The entire situation is aggravated by the present “tight money” crisis. In this connection, I enclose for the committee’s information an interim policy state ment (exhibit III) issued by the board of directors of our association a t its meeting in Washington last month. As set forth therein, we strongly believe monetary policy should not solely be relied upon to restrain the overall economy. It simply will not work. The major consequence of such a policy is to restrict homebuilding, small businesses, and local government without restraining spend ing by big corporations and consumer spending, both of which elements are major contributors to the current inflationary danger. If we are to avoid disastrous consequences to our country's economy, the restraints need to be shared equally and soon. It is already almost too late so far as much of the spring and summer building seasons are concerned. Mutual savings banks net inflow for the first quarter of 1966 was 36 percent less than a year ago, and savings and loan associations were down 31 percent. These are the funds necessary to maintain a reasonable level of homebuilding. Without them the situation assumes crisis proportions. Because of the long leadtime in the homebuilding business, the sharp decline which will occur later this year has not yet been recorded; most homes now starting construction are financed by mortgage commitments issued last fall. Unless the conditions on which we have very briefly touched are quickly cor rected—unless restraints are imposed on the use of certificates of deposit to recognize th at the savings pool must be preserved for long-term capital invest ment and not used up in short-term, higher yield commercial lending—irrepa rable damage to the homebuilding industry, to other business, and to the Nation could result* 266 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS [A tta c h m e n t A ] S ig n if ic a n c e op H o m e b u il d in g i n t h e A m e r ic a n E c o n o m y The im pact of new residential construction is a m ajo r force in, and spreads throughout the entire American economic structure. F o r example, last year’s 1 ^ million new dwelling units generated in construction activity alone approxi m ately $21 billion. W hen you add to this the im pact of expenditures which are directly related to the construction of new dwellings, such a s schools, community facilities, service industries, durable goods expenditures, and the like, the total directly related im pact of housing expenditures am ounts to $35 billion, or approx im ately $ 1 in every $18 of the to tal am ount of gross natio n al product activity last year. Each new home built provides about 2 man-years of employment, h alf offsite, a little more than half onsite. L ast year's housing volume th u s provided close to 3 million jobs. In addition, w hat the economists call th e m u ltiplier effect of such expenditures is also enormous. F or example, it h as been calculated that the m ultiplier effect of construction activity as it spreads through th e economy in economic terms is about double the direct dollar expenditures. The thousands of products used in new dwellings come from every area of the country and affect virtually every industry. W hat follows is an analysis of th is impact in more detailed form. SINGLE-FAMILY U N IT S C onstruction cost (stru ctu re alone ).—One million single-family homes repre sent a to tal direct construction expenditure of about $16 billion, or approximately $16,000 per house .1 In term s of labor th is m eans 3,300 m an-hours of employment per home, or approxim ately 2 million m an-years of employment in th e singlefam ily housing sector alone.® SITE IMPROVEMENT In addition to home construction th e site improvem ent costs are estimated to be $2 ,2 0 0 per home, or a contribution of $2 .2 billion to th e gross n ational product. MULTIFAMILY U N IT S Construction c o s t —The construction cost in 1964 of the m ultifam ily structures alone represents a t least an additional $5 billion contribution to th e gross na tional product. T he am ount spent on site improvements of m ultifam ily u n its approached $1 billion in 1964. COMMUNITY DEVELOPMENT The building of new homes stim ulates other types of construction activity* They m ean new or bigger schools, more churches, b etter highw ays, c o m m u n it y facilities, expansion of public utilities, etc. A conservative estim ate of these related construction activities would be $3 ,0 0 0 p er single fam ily and $1 ,0 0 0 per m ultifam ly unit, or an additional $4 billion added to the gross natio n al p r o d u c t. ADDITIONAL DIRECT EXPENDITURES Upon completion of a home and its purchase, an ad d itio n al $1,000 per unit is generated by the service industries. This would include th e commission tbe builder would pay to th e real estate broker, th e settlem ent costs th e purchaser would pay the title company, a loan placement fee which would be paid to the local lending institution, fee paid to an appraiser, lan d surveyor, and real estate tra n sfe r taxes paid to both th e local and Federal G overnm ents .5 DURABLE GOODS AND FU R NISH ING S A new unit, w hether single fam ily or an apartm ent, necessitates th e purchase of new appliances, rugs, drapes an d curtains, garden p lan ts and e q u i p s 1 1 1’ I Based on Bureau of the Census C-25 series, ’‘Sales Housing,” February 1965. a r .1 v * Bureau of Labor Statistics. “Labor and Material Requirements for Private One-Famw House Construction,” June 1964. * Housing and Home Finance Agency, 16th Annual Report, table 111-35. p. 100. Modinea to new sales price of new homes as published by the Bureau of the Census, C - 2 5 s e r i e s . „ * M. L. Colean, R. J. Saulnier, “Economic Impact of the Construction of 100,000 HousesChicago: The United States Savings & Loan League. 5 NAHB economics department estimate. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 6 7 fu rn itu re, and fo r some, m aybe even a new car. New hom eow ners also spend about $200 the first y ear on im provem ents. T he to tal expenditure is estim ated to be approxim ately $3,000 p er unit, or $3 billion ad d itio n al goods and services in our economy.* BELATED SERVICE EXPENDITURES D uring th e first y ear the average homeowner w ill spend an a d d itio n al $2,000: R eal e state tax es on the average new house being b u ilt a re approxim ately $400 a year. In te re st on an $18,000 m ortgage w ould be a n ad d itio n al $1,020. Insu ran ce fo r fire, liability, theft, etc., would be between $60 an d $100 a y ear.7 H eat and u tilities an ad ditional $360, m aintenance an d rep a ir $150.® TH E MULTIPLIER EFFECT M easuring the direct expenditures resulting from th e construction o f 1% m il lion housing u n its each year, a to ta l dem and fo r goods an d services of approxi m ately $35 billion is generated. T he em ploym ent of these goods an d services and th e w ages paid g enerate additional purchasing pow er w ith th e re su lta n t stim ulation of v irtu a lly every sector of th e economy. C onservative estim ates of th is m ultiplier fa cto r suggest th a n these billions spent on new construction itself generates a t least a n equal am ount o f o th er economic activity, th u s bringing th e to ta l economic im pact to $70 billion. H IG H LEVEL OF HOMEBUILDING ESSENTIAL TO TH E ECONOMY New housing construction g enerates not only dem and fo r on- and off-site con struction activity, th e services of local banking, insurance, and real e state agen cies, b u t th e m an u factu rer h as a larg e stak e in th e hom ebuilding m arket. Each home provides a m a rk e t fo r b e tte r th a n 3,000 different item s * Any change in new construction volume, though it m ay be slight, w ould be felt by thousands of factories, n atio n al d istrib u to rs, an d th e ir local suppliers. In addition, m illions of w orkers in th e in d u strial comm unity f a r removed from the construction site would, likewise, be affected. According to a recent study by th e B u reau of L abor Statistics, each $1,000 of single-fam ily home construction price generates a dem and fo r 72 m an-hours of employment onsite, 35 m an-hours in tran sp o rtatio n , trad e, and related services, 38 m an-hours in th e m an u factu rin g stage, an d 12 m an-hours offsite construction activity. In addition to these “p rim ary ” m an-hours, they show an additional 47 “secondary” m an-hours. T ra n sla tin g th is in to employment sta tistic s we find th a t fo r each $1,000 of construction activity, th ere a re 204 m an-hours of employ m ent generated.1 A slowdown in construction activity, therefore, would have 0 far-reaching effects on th e economy of any com m unity and, in fact, th e N ation as a whole. [From the Wall Street Journal, May 25, 1966] E x h ibit I B lo c k t o Building<—B ig O u tflo w o f S a v in g s Fbom S&L’s F o rc es C u t in M ort gage L o a n s— Some H a l t L en d in g Fob N ow ; B a n k s ’ 5V2-P eb cen t R a te on Tim e D e p o s its A t t r a c t s F u n d s— D isa p p o in ted H om ebuyers (B y Donald Mofl^tt, Staff R ep o rter of th e W all S treet Jo u rn a l) Scratch Ned Sm okler’s new ap a rtm en t house. T he D e tro it builder thought he had a m ortgage loan lined u p la s t m onth, b u t i t suddenly fell through. S cratch several h u ndred hom e sales in Los Angeles, too. T he buyers w ere told la s t m onth th a t they qualified fo r m ortgages—b u t th e n th e tw o savings and loan associations th a t w ere processing th e ir applications suddenly stopped m aking any m ortgage loans a t all. • Colean, Saulnier, op. cit.. and NAHB economics department estimate. TBased on Bureau of the Census, “Sales Housing.” C-25 series; Housing and Home ?5L Agency; American Bankers Association; U.S. Savings & Loan League. nce ■Survey of Current Business, and Bureau of the Census, C-25 series, “Upkeep and Improvements.” •Estim ate by NAHB economics department, based on Colean and Saulnier. op. cit. . 10 Bureau of Labor Statistics. “Labor and Material Requirements for Private One-Family House Construction/* Bulletin No. 1404, June 1964, p. 5. 2 6 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS These are no isolated incidents. Mortgage money in th e la st few weeks has been drying up drastically even fo r builders and would-be hom ebuyers who would easily qualify for loans in anything approaching a norm al m ark et—indeed, even for some who already had qualified. A SAVINGS HEMORRHAGE The reaso n : Savings and loan associations, which finance m ore th an 40 per cent of the N ation’s home and apartm en t mortgages, a re seeing savings flow out of their institutions much fa ster th an new savings come in. So they a re reducing mortgage lending drastically, and in some extrem e cases stopping it altogether for the time being. As recently as the end of March th e situation was f a r different. A tight-money pinch throughout the economy caused mortgage interest ra te s to rise rapidly in the first q u arter and prom pted mortgage lenders to tighten cred it standards. But this squeeze m ainly h it “m arginal” borrowers—those whose monthly income, in the judgm ent of lenders, could not quite cover th e h igher m ortgage payments necessitated by the rising interest rates. Loans still w ere available to those with high credit ratings. Savings deposits in S&L’s exceeded w ith d raw als by $1.3 bil lion in th e first quarter, and the S&L’s managed to increase th e ir mortgage lend ing slightly, to an estim ated $5 billion in the first q u a rte r from $4.9 billion in the 1965 period. In April, though, savings w ithdraw als from th e N ation’s S&L’s exceeded new deposits by an estim ated $500 million to $700 million. T h a t w as th e biggest 1-month n et outflow ever. W hile a net outflow is not unusual in A pril because of w ithdraw als fo r Federal income tax payments, th e outflow in A pril 1965 amount ed to only $99 million. In May, w ith no more pressure on depositors to w ithdraw funds to settle in come tax bills, S&L’s usually gain savings. B ut industry sources say the savings outflow has continued th is month. So it is now estim ated th at, unless funds s ta rt flowing in again heavily, S&L’s will cut th eir m ortgage lending in the last 9 months of 1966 to $13 billion, from the $19 billion in th e 1965 period. A cut back on th a t scale could crimp residential building severely in th e re st of 1966. HIGHER WITHHOLDING J HIGHER PRICES W hat happened? Industry sources generally sketch th is p ictu re: I n c r e a s e d w ithholding from payrolls, for social security taxes a t th e beginning of the y ear and now fo r Federal income taxes as well, has reduced th e take-home pay of many consumers—a t the same time th a t rising prices have le ft th e c o n s u m e r s in n e e d of more spendable funds. The new financial pressures appear to have caused many people to stop making new savings deposits and to have forced some to dig into past savings. Some studies indicate much of th e money recently w ithdraw n from S&L’s has gone to finance m ajor purchases th a t c o n s u m e r s ap parently no longer can make out of income. Compounding the trouble for S&L’s. commercial banks now appear to be at tracting a bigger share of w hat new savings deposits still a re being made, be cause they now are paying higher rates th an the S& L ’s. T h is is quite a turn about. C alifornia S&L’s not long ago were paying th e highest ra tes on savings (lip to 4.85 percent) in the country, advertising these ra te s w idely in the East, and pulling in so much money th a t worried Federal reg u lato rs were putting some downward pressure on these w estern rates. L ast December, however, th e Federal Reserve B oard increased the rate that b n n k s are allowed to pay on time deposits (those left in the bank for a sp ecified time, such as 1 year) to 5% percent from 4 y2 percent. S&L officials at first thought this would not h n rt them. B ut as more banks have moved up the rates (some now pay 5% percent o n as little as $25) and as savings have flow ed out of the S&L’s, the industry has changed its mind in a hu rry . WASHINGTON MOVES Prodded by a pilgrim age of S&L executives to W ashington, th e industryregulating Federal H ome Loan B ank B oard la st week moved to lift the un official “ceiling” th a t lim its the rates S&L’s can pay on deposits. A fter July S&L’s in C alifornia and Nevada, w hich have been p a rticu la rly pinched, can P& ? 5 percent on regular deposits, an d m any have announced they w ill. Further Treasury Secretary Fowler late last week proposed to Congress that ban* UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 6 9 reg ulators be empowered to low er the in terest banks can pay on tim e deposits of $10,000 or less. W hile an increase in the ra tes they can pay on savings m ight help S&L’s stop fu rth e r outflows of savings, some in dustry officials doubt it w ill enable th e S&L’s to pull back in th e money they already have lost. “I t ’s like throw ing a drow ning m an h a lf a life preserver,” says one S&L president. So, fo r the tim e being a t least, S&L’s can do little b ut cu rta il m ortgage lend ing f a r m ore drastically th a n they had expected to a few weeks ago. In D etroit, despite bank com petition, S&L’s gained $23 m illion in new savings during th e first q u a rte r of 1966, an d w ere hopeful o f m ain tain in g m ortgage lending a t the $108 million ra te of la st year. Instead, n e t savings w ith d raw als reached $21 m illion in A pril and “th is year w e’re cutting back lending to $30 m il lion or $35 m illion,” or less th an one-third the 1965 volume, says H. Gehrke, presi dent of D etro it’s big F irs t F ed eral Savings & Loan Association. A tlan ta S&L’s a re planning to cu t th e ir m ortgage lending “between 50 percent and 75 percen t” in May, June, an d Ju ly from the $70 m illion they loaned in those m onths la s t y ear, according to E d Hiles, executive vice president of Georgia Savings & L oan Association. In E lm hurst, a Chicago suburb, E lm h u rst F ederal Savings & Loan Association announced 3 w eeks ago it would no longer accept loan applications. “O ur sav ings inflow isn ’t satisfacto ry an d h asn ’t been since th e first of the y ear,” says Theodore W ilson, president. “W e’re flatly tu rn in g down any and all applica tions. We th in k we w ill ju s t coast for as long as 60 days to see if this m arket won’t shake o u t ” In southern C alifornia, w here m ost of th e co untry’s larg er S&L’s a re based, several associations, including those controlled by L ytton Financial Corp., have announced they a re declining tem porarily to accept new m ortgage loan applications. The L ytton associations say they are fulfilling existing loan commitments. B ut, says B a rt L ytton, chairm an of L ytton F in an cial in Los Angeles, “we‘re not open to am endm ents, suggestions, or counter-proposals” from borrowers. “We re fer all am endm ents, suggestions an d counter-proposals to those employes we have discharged,” he say jokingly. Not so jokingly, Lytton associations have dism issed 170 employes, about one-quarter of th e ir w ork force, during the past 6 m onths to keep costs in line w ith the drop in business. A few associations, to h ear builders an d loan agents tell it. even have canceled com m itm ents they already h ad m ade to finance the sale of homes. A Los Angeles loan agent contends th a t 1 S&L ordered escrow agencies to re tu rn downpayments and tr u s t deeds (as m ortgages a re called in C alifornia) on 400 homes, the sales of w hich wT ere aw aiting tra n sfe r of loan funds from the S&L to sellers. Two weeks before th a t, th e agent says, an o th er association backed out of 200 comm itments. T he associations he nam es deny they ever have canceled a loan commitment. B ut they concede they stopped processing loan applications in April, including some applications fo r loans to complete sales on w hich dow npaym ents already had been p u t in escrow. On some of these, applicants already had been sent le tte rs indicating ten tativ e approval pending form al action by th e S&L loan committees. A Los Angeles builder says he lost th ree home sales a few weeks ago because th e S&L th a t h ad m ade an o ral agreem ent to finance the p urchases broke its word. “They asked me if I had an y th in g in w riting. I said ‘N o/ an d they told me to go ahead and sue ’em then,” he says. Savings an d loan executives in sist such cases a re so ra re as to be insignificant and say th a t suspension of new lending by some S&L’s is only tem porary. A spokem an fo r th e U.S. Savings & Loan League says th a t “th is step has been taken in order to fulfill m ortgage com m itm ents previously m ade” and th a t S&L’s refusing to m ake new com m itm ents “w ill re tu rn to the m arket as soon as these existing com m itm ents have been m et.” B u t even the optim ists don’t foresee a re tu rn to th e m ortgage lending volume of la s t year. “T he lending capacity of th e business w ill fa ll fa r sh o rt of th e dem ands of A m erican hom ebuyers,” says N orm an R. S trunk, executive vice president of th e U.S. Savings & Loan League. H e th in k s S&L m ortgage lending fo r all 1966 m ay fa ll to about $18 billion, dowT n early 25 percent from $23.9 b il n lion la s t year. T he consequences fo r th e building in d u stry could be severe. H ousing sta rts, w hile they have rem ained about level in an n u al ra te for th e la st several m onths, 2 7 0 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS fell below the previous year in both 1964 and 1965, to constitute one of the few soft spots in the economy. Now the cutback in S&L mortgage lending raises a new th reat, and economists see little chance th a t other mortgage lenders such as insurance companies, commercial banks, and m utual sayings banks, will step in to fill even p a rt of the gap. These institutions do not concentrate on mortgage loans to the extent S&L's do. Moreover, heavy loan demands from nonconstruc tion businesses have put a strain on th e funds they have available to lend. As recently as December, the N ational Association of Home B uilders concluded from a survey of its members th a t housing sta rts in 1966 would exceed the 1.542.000 of 1965. By March, however, th e NAHB decided there would be a “slight decline,” perhaps 1 percent. Now, says Norman F arq u h ar, an economist for the association, “it’s like riding a roller coaster. We know we’re going down fast, but we don’t know where bottom is.” Individual builders, especially in California, long a gian t construction market, are ju st as gloomy. Ben Deane, a Los Angeles area builder, originally planned to put up 1,500 new houses this year. But now he s a y s : “W e’ll probably go under 1 .0 0 0 because of the anticipated unavailability of m ortgage cred it.” “The great m ajority of homebuilders in southern C alifornia a re dependent on the S&L industry, and practically none of them (the S&L’s) are making commit ments to finance new homes,” says builder L arry Weinberg. “A lo t of the smaller builders who don’t have commitments now are going to be out of business in very short order.” For the S&L’s themselves, the situation probably spells a d rastic slowdown, at least for 1966, in th eir super-fast grow th rate s of recent years. The U.S. League says total savings in S&L’s have increased as much as 13 percent a year in recent years, w ith some S&L’s posting gains of 15 percent or even 2 0 percent. The outlook for this year, most industry sources agree, is fo r much more modest growth a t best. Earnings of the large S&L holding companies eith er are showing only small gains from a year earlier, or are down sharply. Lytton F inancial reported firstquarter profit of $381,590, or 15 cents a share, fa r below th e $1,023,622, or 40 cents a share, earned in the 1965 period. B a rt Lytton says cuts in expenses and higher interest rates on mortgage loans may reverse th e picture fo r th e rest of the year. But he a d d s : “Nobody can project earnings now w ith any degree of certainty." Investors have rath er clearly soured on S&L stocks, too. The K idder, Peabody & Co. index of S&L stock prices has dropped to 79.40 currently, down from 119 at the end of 1965 and a peak of 397 in November 1961. [From the Wall S treet Journal, Mar, 30, 1966] E x h ib it II Several N ew Y ork City S avings U nits R eport H eavy W ithdrawals — Savebs A pparently S eeking H igher I nterest R ates on C ertificates as 3-Day “Grace P eriod” Starts (By a W all Street Jo u rn al Staff R eporter) N ew York. Several leading New York C ity savings in stitu tio n s reported heavy w ithdraw als by savers who were apparently seeking higher interest returns elsewhere. For many °f the city’s savings banks and savings and loan concerns yesterday was the first (lay of a 3-day “grace period” during which depositors may with draw funds without losing interest payments for the quarter ending tom orrow . Bowery Savings Bank, the country’s largest mutual savings bank, said net «V dayJ totall d m iulon* °P from $3.6 million a year earlier itJa* » million on December 29, the first day of grace in the last quarter of l3F e inatj tutional investors withdrew $1.4 million of the total amount: similar figures for earlier periods weren’t immediately available. V ^1I s’ p.rej. ” , the New York Bank for Savings, said incomplete day lndlcated «*at «et withdrawals would exc«rf the $8.5 million last DecembCT 2 9 ^ * 8g° W d Just about equal the $5.1 million total of i t / n ’amp association in Manhattan, which declined the useof ^ 2 s y ^ e rd a y totaled $500,000, up sharply fro® $24o,000 on the corresponding day a year earlier and $250,000 on D ecem ber 29. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 7 1 SW ITCH TO SAVINGS CERTIFICATES The heavy sw itching from savings in stitu tio n s in th e New York C ity area p re sum ably w as m ainly to larg er com m ercial banks in M etropolitan New York, m any of which a re offering savings certificates paying a re tu rn of 5 percent and even more in some cases. Most m utual savings banks and savings an d loan con cerns, by contrast, are paying 4 ^ percent on reg u lar savings accounts. M any of the comm ercial banks, w hich a re b arred from paying m ore th an the prevailing 4 percent on passbook savings, also w ere h it by a sw itching problem— m ainly by w ithdraw als from reg u lar savings accounts by custom ers who used the funds to invest in a bank’s own savings certificates w ith a higher yield. B ut in some instances comm ercial-bank savers w ith d raw funds from banks n ot offer ing higher yielding certificates to purchase those of o th er banks. Among larg er New York banks offering 5 percent savings certificates m ainly in minimum denom inations of $2,500 and for 9 m onths or more are F irs t N ational City Bank, Chase M an h attan Bank, and B ankers T ru st Co. B u t some large suburban Long Island banks a re offering an even higher retu rn , including M ea dow B rook N ational Bank, w ith ra te s as high as 5^4 percent and F ra n k lin N ational Bank, 5.10 percent. A savings and loan executive, M ichael Z arrilli, p resident of W est Side F ed eral Savings & Loan Association, said net w ith d raw als a t his concern w ere “a little heavier th an usual.” H e said custom ers m aking w ithdraw als “tell us th e money is going into eith er certificates or the stock m ark et,” an d added th a t clients are about equally divided. Some th r if t in stitu tio n officials also noted th a t first-q u arter w ith d raw als are often used to m ake income ta x paym ents due A pril 15. A savings and loan official told of a neighborhood businessm an who fo r 4 years had m aintained an account containing a t least $40,000. T he official said “the businessm an cam e to us today, said he liked us an d liked to support neighbor hood institutions, but he w as still going to w ithdraw his money an d buy certifi cates a t F irs t N ational City B a n k /’ Officials of New York City comm ercial banks said they didn’t have any immedi ate figures on any sp u rt in savings certificate sales. B u t one banker commented, “I ’m sure w e’re going to see a su b stan tial increase in new savings certificates placed w ith depositors.” At the sam e tim e th a t savings and loan associations in the New York area were experiencing heavy w ith draw als due to ra te differentials, such institutions in New York and elsew here faced tougher sledding on still a n o th er front. F ed eral home loan banks, w hich m ake loans to member savings and loans and sav ings banks to help them m eet w ithdraw als, have been raisin g th e ir lending charges in recent w eeks in line w ith increases in in terest rate s generally. A nother round of in terest-rate increases by F ed eral home loan banks w ill sta rt affecting savings and loan associations w ith th e n ext few days, in d u stry sources say. According to th e ir inform ation, a t least 8 of th e 1 2 d istrict banks w ill be post ing higher charges on loans to associations about A pril 1. W hile various banks T have separately increased charges a num ber o f tim es lately, the la te st moves are generally considered to be th e second general round so fa r th is year. B asically, th e increases a re prom pted by th e h igher rate s encountered by the System on its own m oney-m arket borrowings. In mid-M arch, th e System paid a 5.40 percent ra te on a $ 5 4 3 m illion note offer, m atching the highest it has ever paid. SOME OF TH E RAISES T he Greensboro, N.C., d istric t bank raised its ra te to 5% percent yesterday. Expected to follow suit shortly are th e Spokane and Topeka d istrict banks. The Spokane bank is cu rren tly a t 4 % percent and th e Topeka bank 5 percent. The P ittsb u rg h and Chicago banks a re moving up to 5% percent from 5*4 percent and 4% percent, respectively. The Cincinnati bank is going to a 5*4 percent rate from 5 percent, the In dianapolis bank to 5% percent from 4% percent, and the Des Moines bank to percent from 4% percent Some industry men expect the Little Rock bank to move soon to 5% percent from 5 percent, but said they couldn’t confirm this. T he Boston, New York, an d San Francisco banks a re said to be rem aining a t 5 percent. All th e ra te s apply to w hichever k in d of loan is th e m ost commonly made by each bank. In most cases, th is is a short-term secured loan. 2 7 2 UNSOUND COMPETITION FOB SAVINGS AND TIME DEPOSITS The New Xork sa v in g s in stitu tio n s’ w ithdraw als were seen as foreshadowing sim ilar sw itching expected to occur among financial in stitu tio n s in o ther parts of the country a fte r th e interest-paying period ends T hursday. Switching com mences earlier in New York because of the law s’ provision th a t lets institutions pay interest to the end of th e q u arter even though funds are w ithdraw n in the 3-day grace period th a t began yesterday. E xhibit III T he F ollowing S tatement I s a S ynopsis of the R esolutions A dopted by the B oard of D irectors of the N ational A ssociation of H ome B uilders at I ts 1966 Spring M eetin g W ith R esp ect to N a tio n a l M o n eta ry and F isca l P olicies Our deep concern fo r our country’s w elfare and the fu tu re o f th e important homebuilding industry requires th a t we summarize, in th is in terim policy state ment, th e potentially disastrous condition of our industry, arisin g from im properly balanced national fiscal and m onetary policies, and th a t we suggest the indicated remedies. W ith each day th a t passes th e situ atio n worsens. Actions taken too la te a re no better th an no action a t all. W hile virtually all other sectors of the economy are expanding, homebuilding operates under severe restraints. Homebuyers, p articu larly those of moderate means, are inordinately affected; it w ill soon be literally impossible to build for fam ilies of low o r m oderate income. Unless quickly corrected, th is could lead to irreparable dam age to th e industry, to other business, and to th e Nation. Meanwhile, w ithout visible im pairm ent, credit continues to flow freely in recordbreaking amounts, into in d u strial expansion and in to short-term and higher yielding consumer loans. The stated objective of m onetary restraint to “cool our overheated economy" is not being accom plished: in fa c t it is further feeding the fires of inflation. The homebuilding industry does not believe th e burden of restrain in g inflation should fall so heavily on our industry. We believe th a t necessary actions to prevent inflation (an objective which we h eartily endorse) m ust, to be effective, more equally restrain all segments of the economy and—perh ap s particularly— Federal, State, and local government construction and other spending, which can reasonably be deferred. Effective coordination between all Government agencies dealing w ith mone tary and fiscal policy is an essential ingredient to a stable economy and to the mortgage m a rk e t The m onetary and fiscal system of th is N ation a re too com plex to be subject to unilateral action of any one agency. T he President should establish immediately an overall policy board (including representatives of fe d e r a l Reserve Board, Home Loan Bank Board, Com ptroller of th e Currency. Secretary of th e Treasury, Secretary of H ousing and U rban Developm ent, and Council of Economic A dvisers) to consider the im pact of an y m onetary or fiscal action on all elem ents of th e economy. These actions, if taken im mediately and pursued vigorously, could avoid repeal of th e investm ent ta x credit provision o r increased income taxes. W e vigorously oppose m andatory wage and price controls, w hich prevent oper ation of a free m arket. W e recognize th a t such controls m av be imposed on the economy unless th e recommendations in this statem ent a re im m ediately and effectively implemented. To perm it F ederal N ational Mortgage Association to continue to fulfill its unction of backstopping” the mortgage m arket when o th er secondary lenders I 0- ? ! av*v \ d€J enture-issuing power, now lim ited to 10 tim es authorized capital and surplus, should be doubled. This w ill p erm it FNMA to rescind ^ en} 2 ? ,0°? m aximum loan lim itation and o ther lim itatio n s which have fu rth e r increase discounts on loans not eligible fo r FNMA purchase. Building trad es unions demands fo r wage increase have flagrantly violated the wage-pnoe guideline proposed by th e Council of Economic A dvisers as a means # inflationary labor costs in th e construction in d u stry . T here is e ^ u s e fo r recognition of increases which violate th e guideline in government**} °a p™v ,aiU?* w a«es” ™<ter the Davis-Bacon Act w hich affect* nil publicly financed c o n tra c tio n and m ultifam ily housing financed u nder the Na tional H ousing Act. F u rth e r, such m easures as th e common situ s picketing UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 7 3 bill can only strengthen the hands of those seeking fu rth e r to escalate the steep spiral of construction labor increases of recent m onths. We vigorously support ap p ro p riate action in conform ity w ith these principles. The C h a i r m a n . Thank you very much, Mr. Blackmon. Mr. Saxon, you mentioned getting rid of regulation Q, and of course, that would be unrestrained competition. Would there be any limit, any restraints, in a case like that ? Mr. S a x o n . That would depend on the good judgment of the banks themselves. The C h a i r m a n . I think you are correct, but what about the Minne sota case where a number of bankers all went in together and them selves agreed to restrain competition, did a lot of things that were not in the public interest, and then were indicted in a criminal case. It involved over a quarter of a million dollars in fines, I believe. Mr. S a x o n . Mr. Chairman, there are two different questions. The C h a i r m a n . In other words, that shows that if you leave it up to them entirely, there will be abuses. Now that was, we will say, an exception. But if you have no regulation Q, you have no limit. Mr. S a x o n . It seems to me the question involves two different prin ciples. The one, conspiracy to agree to fix prices, and secondly a question whether there should be rate control and freedom of banks, that is institution by institution, to compete as need arises and war rants for funds. I do not see any conflict in the two. The Govern ment in that case did exercise its statutory authority and responsibility to move in to question the one practice, and succeeded, but I do not think this offends the principle, in my opinion, of freedom of com petition for funds at all. The C h a i r m a n . All right. Now you state that you support free competition among our financial institutions, including, I assume savings and loan associations, credit unions, and mutual savings banks. I wonder if you would be in favor of allowing these other institutions to offer checking account services? That would be maximum com petition. Mr. S a x o n . N o , I do not think so. These institutions were created as a special type institution with particular emphasis on housing con struction. They are engaged in other activities through the open-end mortgage. Many of them do installment loan and single payment to consumer financing and engage in other types of financing, but no, I would not, because this would---The C h a i r m a n . I do not want to take up too much time. I want the other members to ask questions. Mr. W i d n a l l . Mr. Chairman. The C h a i r m a n . Yes, sir. Mr. W i d n a l l . Mr. Saxon, if the banks are permitted to have mil lions of dollars on which they pay no interest, and I am talking about checking accounts now, why should not the savings and loans have the same type of opportunity to accumulate funds ? Mr. S a x o n . Banks are engaged in an entirely different character of business, Mr. Widnall, the broad sweep of commercial, mortgage,, consumer installment, other types of financing, capital financing across the board. They are deposit institutions, and as such it is a debtor-creditor relationship, and liquidity based on demand deposits 2 7 4 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS is essential to provide the means of meeting their liquidity and their needs. I do not see that the problem here arises from a lack of capacity to engage generally in the commercial banking business* The problemto the extent that it exists—and, as I say, I believe this has been sub stantially exaggerated so far as I can determine—I am not sitting on the Home Loan Bank Board and do not know the cases one by one, but I wonder, from what I have heard, whether it is not sub stantially exaggerated—as to whether this industry, the savings and loan industry, which has done a good and useful job in this country, should not be subject, particularly in a period like this, to reasonable restraints in terms of prudent banking practices. The problems that exist in California today, exist because of highly excessive lending on large projects, housing construction, office build ing construction, large block development, much of which still over hangs the market from San Diego to San Francisco, and also into Las Vegas and Phoenix, and are not the result of any restraints on institutions which are soundly managed, but because of excesses. Institutions are 100to 110 percent loaned up, making 90-percent loans on excessive appraisals. This is the problem. The C h a ir m a n '. I have about 1 minute left, M Saxon, and I w r. ant to ask a question not entirely related to this. There is a lot of talk about balance of payments. Do you know of any other country m the world that does not control exports of its capital overseas except the United States? M S a x o n . I know offhand, M Chairman, of no major country r. r. that does not have some form, whether it is in terms of exchange re strictions---The C h a ir m a n . Yes. M S a x o n (continuing). Or restrictions on the transfer of capital r. or exports. The C h a ir m a n . That is right. M S a x o n . One formor another. r. The C h a ir m a n . That is right, fine. M Reuss? r. M R e u s s . Thank you, M Chairman. r. r. M Saxon, like other members of the committee, I have been con r. cerned by the enormous growth of negotiable CD’s from practically zero 5 years ago to $17.5 billion today. I have been concerned recently not only because of the diversion of part of that total that w ould otherwise be available to savings and loans for homebuilding m ort gages, but also because much of that money, when it gets into the banksystem, is used for making loans which have an inflationary p0' tential. I am thinking particularly of inventory loans. One of the reasons why negotiable CD’s are so irresistibly attrac tive, to the large banks which issue them is because of the fact that they, under the Federal Reserve’s rules, have a reserve r e q u ir e m e n t of only 4 percent, as against a reserve requirement on demand d ep osits of 16% percent. Yet, from the standpoint of the corporation owning the certificate of deposit, it is very like a demand deposit with th e secondary market available. They can divert that into cash very quickly. Mr. S a x o n . Yes. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 7 5 Mr. R e u s s . My own approach to this problem, which our committee is wrestling with, has been along the following lines: First, I believe that an overall coordinating board, somewhat along the lines as sug gested by Mr. Blackmon, would be in the public interest. Second, I think that the Federal Reserve should be empowered to raise reserve requirements on time deposits over the present level of 3 to 6 percent which has statutory authorization, to something perhaps equal to the level on demand deposits, giving the Fed opportunity to make what ever reasonable classifications among the different time deposit in struments it wishes. My question to you is, would it not be in the public interest for Congress to vest the monetary authorities with that Kind of authoriza tion ? Mr. S a x o n . Mr. Reuss, supposing the Federal Reserve does not have the authority now, and I do not know offhand whether they do or not----Mr. R e u s s . I t does not. The present authority is only between 3 and 6 percent on all savings. Mr. S a x o n . On savings. Mr. R e u s s . And time deposits, too. Mr. S a x o n . On the principle which premises your statement and question, whether or not the two types of deposits should not be equated so far as reserves are concerned or substantially so----Mr. R e u s s . Let me interrupt to say that I did not say they had to be equated. Mr. S a x o n . Have the power. Mr. R e u s s . I propose simply to give the Fed power to raise it to the present level of demand deposits, or anywhere in between. Mr. S a x o n . I would think selected controls of this type are and would be unfortunate, to select out one type of funds for special treat ment. I t would work harmful results. The question in my mind would be whether or not the Fed should not eliminate the reserve requirement on time and savings accounts, particularly savings accounts today. I do not know why, what justi fication there is for retaining reserve on time funds. M r. R e u s s . Let us put to one side savings, which have a 4 -p e r c e n t ceiling. Mr. S a x o n . Yes. Mr. R e u s s . They have a very modest 4-percent reserve requirement. I am talking about negotiable CD’s. Mr. S a x o n . I would think not. The CD is not as new an instrument as much of the current literature would seem to indicate. We have a record of the substantial issuance and outstanding amounts of negoti able CD's going back to the early thirties and before then. One bank in particular, was a very large issuer of CD’s in the early thirties, and there were others. This received tremendous publicity and in terest at the time City Bank opened it up on a broad scale in New York. But it is not in accord with the facts to say that the CD began 5 years ago or did not exist substantially until 5 years ago. This is not true. Now of course there has been a very substantial expansion of it, but it also was a substantial factor as much as 20 and 30 years ago. 2 7 6 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS The C h a ir m a n . Y o u mean negotiable CD’s ? Mr. S a x o n . Yes, Mr. Chairman. Mr. W i d n a l l . Will the gentleman yield ? Mr. S a x o n . Yes, Mr. Chairman. Mr. W i d n a l l . In what denominations? Mr. S a x o n . The denominations were varied. I cannot give you, Mr. Widnall, a precise figure, but the amount was substantial. Mr. W i d n a l l . I think there is a great deal of difference between denominations of $1 million or $100,000 and denominations of $250 and $500 which you can get today. M r. S ax o n . W ell, th er e is a d ifferen ce in a m o u n t, b u t th e large— Mr. W i d n a l l . I think it is important. Now they were doing this you say back in the early thirties ? Mr. S a x o n . Yes. Mr. W i d n a l l . What were the denominations they were issuing at that time? M r. S a x o n . I w o u ld h a v e to g e t so m e fig u res f o r y o u i f I can on th is, b u t th ey w ere— th e d e n o m in a tio n s w ere q u ite su b sta n tia l. The C h a ir m a n . Y o u are recognized, Mr. Widnall. Mr. W i d n a l l . Thank you, Mr. Chairman. I would like to continue to follow up on liquidity. The bank has the ability to lend you $100,000 and say, “There is one condition in con nection with this. You must retain $25,000 in a checking account in our bank and a minimum balance of $ 2 5 ,0 0 0 .” They do not pay any thing for that $25,000, do they? Mr. S a x o n . That is correct, sir. Mr. W i d n a l l . What do they do with the $ 2 5 ,0 0 0 ? Do they lend it out, make money on it? Mr. S a x o n . That is correct, sir. Mr. W i d n a l l . Does the savings and loan have the same ability? Mr. S a x o n . Either that or invest it or use it as liquidity, one or the other as the liquidity, cash liquidity. Mr. W i d n a l l . Do the savings and loans have the same ability to ^°t ^ave to pay interest on any of their money, do they Mr. S a x o n . Yes, they pay money, although they have other systems that are substitutes for this. They are very active in the points areaPoints on loans now are running from 2 to 7 around the country. Mr. W i d n a l l . Banks do the same thing, do they not? . .. Mr. S a x o n . T o the extent that this exists, it is minor, and to a lim it of 1 point. We are talking 2 to 7 points. In the case of a $1 million loan that is $20,000 to $70,000. Mr. \ \ i d n a l l . The point I am trying to make is that when you a# comparing sayings and loans with the banks, where the banks can make substantial sums, it can be done without actually having to bor row the money or pay for it. Mr. S a x o n . Yes. I think this is a traditional practice, and it been a good one, so as to assure to the maximum extent p ossib le thjj funds are available to all. This is true particularly in the case of t J larger borrowers. This is not normal, as you know, in the case o } smaller borrowers. Where the compensating account exists, it mainly for the substantial borrowers, and I think this is a good UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 7 7 proper practice to assure that while these funds are not being used but are on credit, to the extent of the compensating balance such funds shall be available for other borrowers. Mr. W i d n a l l . I just read in the paper today an ad for a bank saying that if you maintain a $500 balance, why there will be no charge against your checking account. Some have a $1,000 balance. I know that there are probably millions of dollars that banks have in checking accounts that do not freely flow because there is a guaranteed balance within them, and these are not counted in the loan area, but they do have the ability to pick up a great many millions of dollars toward their liquidity without borrowing from anybody, and without any charges at all, that have to be paid by the bank. The savings and loans of course are dependent entirely on their savings, and they have to pay interest on all of those savings, and I would agree with you that they have a problem of borrowed liquid ity at the present time. This may be true with some of the other financial institutions. But they do not count the sources of money that are available to the banks, and where the certificates of deposit have hurt, particularly in the lower denominations, has been in with drawals from the savings and loan institutions. I think they have had to borrow from the Federal Home Loan Bank in order to meet the withdrawals caused by people taking out small amounts of money and placing them in certificates of deposit. I know of a number of individual instances where this has been taking place. Mr. S a x o n . Yes, I am sure this is true. But I am not sure I see the efficacy of the point. This industry has been seeking to attract funds without rate regulation for years, has not provided internal liquidity except in terms of a minority of the institutions. They are 100 per cent loaned out. I think it is a matter of management of the institu tion on a sound financial basis, and without excessive reliance on the home loan banks. # t The commercial banks are under severe restraint in borrowing from the Federal Reserve, not only in times like these, but ordinarily. They are supposedly emergency loans. Generally after 2 to 3 weeks if a bank continues to borrow heavily from the Fed or excessively, depend ing on the size of the bank, a call is received from the Federal Reserve bank of the region or district questioning them or requiring a cessa tion of the practice, and indeed we deal with this in our own examina tion reports, every one of them, where there has been any continued borrowing—(a) continued borrowing and (b) at a level which seems disproportionate. I t seems to me this is a false infusion of funds, or it can be developed into a false reliance on an infusion of governmental funds. Mr. W i d n a l l . With respect to commercial banks, how much of a percentage of reduction has there been within the last year in money going into the mortgage field % Mr. S a x o n . I do not know the figures offhand, Mr. Widnall. I will supply these for the record. Since the Fed liberalized regulation Q, there has been a very substantial increase in commercial bank entry into the mortgage field, as you know. Now what has happened in the last few months I do not know. 03-496 O—86----- 19 2 7 8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS (The information referred to follows:) Real estate loans, insured commercial banks Date Dec. 20,1963 _______ _________ ___________________ _____ Dec. 31,1964 ................................... ............... ............................ Dec. 31,1965.____________ ______ __________ ______ ____ ______ Increase during 1964 Increase during 1965 Dollar volume (millions of dollars) $38,861 43,436 49,026 4,575 5,590 Percent of total loam 25.0 24.9 24.5 = ---------------- N ote.—B ecause of a change in the definition of real estate loans in the 1965 report of condition, figures for 1963 and 1964 are somewhat overstated relative to 1965. Mr. W i d n a l l . We do know this up in the area that I happen to represent in Congress. There certainly is a shortage of mortgage funds, a very substantial one. Do you have any comment on that, Mr. Blackmon? Mr. B la c k m o n . Yes, sir. I take issue with Mr. Saxon on the fact that the national banks are going into the mortgage business. In fact the truth of the matter is that- many of them have been selling off their portfolio of mortgages. There is a tremendous shortage of money for the financing of homes in this country as a result of this CD draining money from the savings and loans, and I might say also the savings banks, because they are in the same category as the savings and loans. But the commercial banks around the country, to my knowledge, have not been increasing their purchasing of home mortgages. I think statistics will showTthat over the last year they have unloaded a great deal of their portfolio. Mr. W i d n a l l . Thank you. My time is up. The C h a ir m a n . Yes, sir. Mr. Todd? Mr. Todd. Thank you, Mr. Chairman. Mr. Saxon, I am delighted to have you with us this morning. I notice on the first page of your prepared statement that you make strong reference to the effect of competition on our economic system, which you seem to consider to be a very important consideration in pro motmg efficiency in our financial institutions. I take it you feel that, neglecting problems of adjustment, the re moval of regulation Q and ceilings on rates that savings and loans can pay would promote competition. Mr. S a x o n . Yes, sir. Mr. Todd. I believe this w a s recommended bv the President’s Com mission on Money and Credit. Mr. S a x o n . Yes, sir. Mr. Todd. Am I correct in that statement ? Mr. S a x o n . Yes, sir. Mr. Todd Do you feel that it would be beneficial for the same reasons ingsT^0^ 6 Percen* ce^*ng that banks pay now on passbook sav' Mr. S a x o n . 1 think the answer is yes, that there is a differential dis advantage m the face of the small saver? , , i /his would thereby promote competition you feel is of substantial significance. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 7 9 Mr. S a x o n . I think banks— and this is generally my experience here—the banks have not been excessive in competing for funds gen erally throughout the country at all. As a whole as we look at the picture, particularly in the CD area in the great mass of the banks, the national banks certainly which we see, are using their competitive power quite moderately. I do not see excesses here, I think the dif ferential does raise a question, the differential between the small saver and the large saver of between 4 to 5 or 5y 2 percent as a maximum. Mr. T odd. In other words, you think, if I see your philosophy cor rectly, you think that the enhancement of competition which would result if the passbook savings rate were raised would not only increase the efficiency of the financial institutions but be in accord with our general philosophy of free competition in our economy. Mr. S a x o n . That is correct, Mr. T odd. That the regulatory agency really has the function to determine financial soundness of the institution and not to allocate the resources between them. Mr. S a x o n . Yes, sir. Mr. T odd. The competition----Mr. S a x o n . Yes, sir. Mr. T odd (continuing). Should be the one that allocates the re sources. Mr. S a x o n . Yes, sir. Mr. T odd. Then would I be correct in believing that you feel the broad public interest is promoted by competition, and that it clearly outweighs our traditional means of regulating the interest rate ceil ings, that the promotion of competition----Mr. S a x o n . The answer is yes, the most efficient mechanism of allo cating resources to their most effective use in the economy. I do not know how the Government can perform this function as efficiently. We talk about the housing industry. We project x starts. Now who can profess to say what the starts should be outside of the normal demand generated throughout the country and reflected in terms of the market forces. Mr. T odd. S o that the role of the regulatory agency then would be one of promoting financial soundness, but at the same time promot ing competition between the various agencies which are being regu lated, and this would be the primaiy public interest consideration of the agency. Mr. S a x o n . That competition ought to exist among all o f the finan cial businesses generally. Mr. T odd. Well then, would you feel that if the regulations were issued by a regulatoiy agency which had some anticompetitive effect, that this would have to be, if it were to be in the public interest, it would have to be addressed to the financial stability of the institution ? In other words, the only reason for issuing a regulation which is anti competitive would be one which would effect the financial soundness of the institution. Mr. S a x o n . I think this is correct, We attempted to meet- this roblem and did effectively in connection with the smaller national anks and their acceptance of time funds on negotiable CD issues out side of their normal market area, and we issueS an instruction to all examiners that this practice was to be proscribed. We indicated that E 280 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS any of these banks out of territory, out of trade area funds, ought to be related to the normal deposit structure of the bank and other tests of this sort. This is what I mean by using the regulatory technique to effect financial soundness and stability. Mr. T odd. The reason I bring this up—and my time is expiring— is we were to a certain extent on different sides of the bank merger bill, but I think we both, based on this colloquy, believe that competi tion is the primary function of a regulatory agency and there is a pri mary public interest involved in financial institutions, would that not be correct? Mr. S a x o n . Yes, sir. Mr. T odd. Fine. Thank you very much. The C h a ir m a n . Mr. Ottinger. Mr. O ttinger. Thank you,Mr. Chairman. I am disturbed, Mr. Saxon, by a number of your statements. I do not think they are really an accurate reflection of the way the money market works. We have a highly regulated industry in the banking industry and various credit and thrift institutions all have a relation ship to each other, changing the regulation of one necessarily sharply affects what can be done in the other. It seems to me what actually happened was quite different from what you describe with the liberalizing of regulation Q at the same time that the rediscount rate was put up. The increase of the rediscount rate was a proper attempt to restrict credit overall in the economy to curb the inflationary pressures that we had. However, at the same time the Federal Reserve Board, by increasing the rates payable on CD’s, lifted the lid on restraint applied to commercial banks so that the credit flowed from the thrift institutions into the commercial banfe and industrial credit became relatively easy. The whole burden of the inflationary curb was placed on this one segment of the economy. The Home Loan Bank Board has not liberalized its liquidity rul^ as a matter of policy because it wants to, but it has acted in desperation because it was feeling such a tight pinch on available funds attribut able to the siphoning off of its funds to CD’s. I t is not a question of the home industry being protected while other segments of the finan* cial world are restricted but it has been quite the contrary. Commer cial banks have been permitted to expand credit almost without lifl^ through the device of the high-interest-bearing CD, while the lid is on in a great many ways on the homebuilding industry and the saving® and loans and thrift institutions. I th in k th is is o n e o f th e th in g s th a t g r e a tly d is tu r b s m a n y o f us o*j th e co m m ittee. T h e se in te r r e la tio n sh ip s a r e n o t g iv e n p r o p e r regard b y th e v a r io u s r e g u la to r y a g e n c ie s a c tin g q u ite in d e p e n d e n tly o f the oth er. D o e s th a t n o t d istu r b y o u at a ll? Mr. S a x o n . I would not say that. There should be c o n s u l t a t i o n and coordination and indeed there is. We have a coordinating c o m m i t t e e which meets regularly. I think we have had seven meetings. Six 0 them were taken up primarily with discussion of the S . & L. industry and generally led by Mr. Home himself. I did not mean to sugge* that there is any l a c k ---------Mr. O t t i n g e r . The Federal Reserve Board said it did not consult the Home Loan Bank Board in making its decisions. , Mr. S a x o n . N o ; and it did not consult our office, either, as a n w # # of fact. I received the first word of the announcement of the dutfr UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 281 in regulation Q from the Monday morning newspapers, to be frank with you. I believe in coordination. We have this Committee and we have been working along with them, with the Secretary of the Treasury being involved whenever he can. But on the other hand my question goes to Q itself and I do not think the S. L. problem that exists to day would have existed if Q had not imposed the restraints it has on banks. The two types of institutions would have learned to live with com petition in the market years ago, and we would not face what resulted from the changes th at came in 1962 from Q. I do not think the Home Loan Bank Board has moved to meet these changes. Many of the in stitutions have, though. They have begun to restrain themselves, and you certainly, I am sure, read the statement of the head of the Home Loan Bank of Greensboro, N.C., in which he stated that the industry ought to retrench now for the time being and lay the basis for future growth in order to increase its liquidity. Banks today are—most of them at least—using this period of tighter money to improve their own portfolio where th at is necessary. Mr. O t t i n g e r . D o you not see any danger in bank liquidity fr o m these CD’s without any reserves behind them? Mr. S a x o n . Well, there are different types, Mr. Ottinger. In the case of many of the banks, CD’s are protected by the primary liquidity in the form of cash resources. Secondly, secondary reserves and in the reliance on prime quality of short-term paper in the banks’ port folios. B ut I would like to read the figures just taken recently of the 200 largest banks of the country. I think it would be of great interest to the committee in view of some of the statements that I read in the press. Now here are the figures. Loan deposit ratios of the 200 largest national banks of the country, 62.5 percent. Now in a period like this, this figure is certainly not excessive. Net liquid assets to total deposits, 27 percent. Net liquid assets to total deposits, 30 percent. Now these figures hardly indicate an illiquid position in the com mercial banks as a result of the CD. Indeed, many of the banks today, when they set up the CD’s they set up against the scheduled maturities of the CD, municipal bonds, or other securities which automatically provide liquidity. Indeed, in and of itself the CD is a very useful and liquid instrument, because I do not know an instrument th at pro vides for a better projection of needs by scheduled maturities, like the term loan, a very, very useful mechanism providing liquidity through amortization. The CD establishes a scheduled m aturity of funds. Mr. O t t i n g e r . I would love to go at this further with you, but my time has expired. The C h a ir m a n . All right. Mr. Harvey? Mr. H a rv ey . T hank you, Mr. Chairman. Mr. Saxon, I would like to direct your attention for a moment to the Participation Sales Act which passed the House here a week or so ago. Here this morning we are talking about the impact of approxi mately $17 billion of CD’s in the market, and yet a few weeks ago the Treasury Department testified before the Rules Committee th a t within the next 10 years there could be as many as $50 or $100 billion worth of assets in this, and further within 2 years, as I understand it, over $8 billion of assets will be sold a t interest rates of 5 percent or higher. 282 UNBOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS W hat impact will this have on private credit and the home mortgage iparket, in your judgment ? Mr. S a x o n . I t will absorb funds available for investment by the commercial banking system and other segments of the financial indus try of the country, that is, the sale of these certificates. To that extent .it would, of course, displace the use of these funds for other purposes. On the other hand, you have the question of the extent to which the Government can, given the proper circumstances, move out of direct competition with the private area, and to the extent that it accomplishes this, it would be desirable. The rate question, it seems to me, is a matter of the relative tightness. As it exists today, I think the tightness has been somewhat exaggerated. Mr. H a r v e y . Well, am I not correct, though, if I understand the first part of your statement, it is going to make the situation we are talking about here even more acute, as the Government sells more of its assets. I t is going to absorb a portion of the mortgage m arket; is that not correct? Mr. S a x o n . That is correct, sir. Mr. H a r v e y . That is correct, and that is precisely—I see Mr. Black mon nodding his head—that is why his organization so vehemently opposed the participations, because that is what they fe a r; is that correct? Mr. B la c k m o n . That is correct. Mr. S a x o n . On th e o th er h a n d , i f I m a y ta k e a m o m e n t, Mr. Harvey, w e are a la rg e c a p ita l g e n e ra tio n eco n o m y a s y o u k n o w . Capital gen era tio n y ea r b y y e a r h a s b een en orm ou s, ev en th o u g h it h a s n o t met fu lly th e n eed, th e enorm ou s n eed , fo r fu n d s in th is c o u n tr y to finance our in d u str ia l an d com m ercia l g r o w th . B u t p a r t o f th is w o u l d be tak en u p , to w h a t e x te n t n o one can sa y , b y th e n o r m a l a n d continuing in crease in th e g en era tio n o f c a p ita l. Mr. H a r v e y . Well, assuming what you say in your sta tem en t, th* theory that you set forth in your statement, to be true, then how do we in Congress go about channeling more money into the hom ebuilding market ? I t seems to me that is conspicuous by its absence in your statement. The banking industry is not doing it. The homebuilding industry is suffering very badly as a result of it. I t seems to me that in the housing bills that this Congress has passed in the years that I have been here, we have set th at forth as a matter of national intent or of congressional intent, that we wanted to en courage the homebuilding industry. Now something has got to b© done to do it. W hat suggestions do you have ? Mr. S a x o n . Mr. Harvey, rather than rely on artificial methods, such as Q or these bills before this committee, if it is the ju d g m e n t of Con gress, as it has been in past years, to give special concern to housin? needs, then it ought to be done through legislation providing f°r Fannie Mae or some other governmental agency or the use of some other governmental technique to provide directly for those needs, s o as to impose a minimum interference with the normal operation of tho financial mechanism competitively in the country. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 283 Congress, as I understand it, has done this before in past years. I do not agree with Mr. Blackmon’s statement that the housing industry is in a deplorable condition today. O f course I respect you, Mr. Blackmon. I think this industry naturally wishes to see itself expand as others do, and it is entirely dependent on individuals, institutional or the financial industry for its resources to finance building. I get enormous requests. Mr. H a r v e y . Let us be realistic about it. The money is not coming into the housing industry from the banks. I t is going into coiyorate lending. I t is going in where they can make more money on it. In fairness to Mr. Blackmon here I think that is true, and I do not think in your statement here this morning or in what you have said you have suggested any cure for it, and I think this committee is concerned about it. I can tell you just having returned from Michigan th a t in my judgment the homebuilding industry is indeed very critical up there at this time. I f you want me to name them, I can give you one project after another th at has been stopped or that has not gone for ward simply because the money is not there. Savings and loans have just about stopped lending completely. I think this is a very critical situation. Mr. Blackmon, would you care to comment on this at all ? Mr. B la c k m o n . Yes, sir. As all of us know, the homebuilding industry is one of the basic industries in this country, about the second largest industry. There fore what happens to it affects the entire economy and the Nation a great deal. Mr. Saxon, for your information, in the early 1950’s \se were pro ducing nearly 2 million units a year; we are producing less than 1,500,000 units at this time. There are markets available, but we do not have funds with which to serve these markets. We have some 4.5 million deteriorating houses in this country. We have 11.5 million substandard houses. Our market is plentiful and could be expanded. But the funds have dried up and it is the one thing that I think concerns this committee. In past years, the CD has been used as a device for corporate funds with a regular schedule of payments and payments of debt and so forth. Out of the clear blue the Federal Reserve Board changed the entire policy on CD’s to allow the CD’s to pay more than the savings institutions. I t thereby encouraged the flow into commercial banks not only of corporate funds but of all other types of funds—down to $25, on a 30-day basis. A great deal of money is being artificially channeled not into the housing authority, but into industrial plant expansion. Certainly when you get a 7-percent investment credit for plant ex pansion you can pay more for money than you can under normal conditions. The big problem is that the switch from the established procedure has brought a large amount of money into commercial banks, and they are eagerly investing it in consumer credit. This creates an inflation ary spiral and drastically tightens the money supply for the housing industry. 284 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. H a r v e y . Thank you. My time has expired, Mr. Blackmon. The C h a ir m a n . Yes, sir. Mr. McGrath? Mr. M c G r a t h . Thank you, Mr. Chairman. Mr. Saxon, I understand that there are about $17.5 billion in negotiable CD’s outstanding today. Mr. S a x o n . That is correct. M r. M cG r a th . D o y o u h a v e a n y id ea a s to w h a t p e r c e n ta g e o f that su m b e lo n g s to th e 200 la r g e s t b a n k s in th e c o u n tr y ? Mr. S a x o n . I d o n ’t h a v e th e figu res. I w ill s u p p ly th em . Mr. M c G r a th . I would be interested in seeing this. Mr. S a x o n . I w ill su p p ly th em . (The information referred to follows:) Outstanding negotiable certificates of deposit, by size of bank,1 May 18t 1966 (Amounts in millions of dollazs] Sice of bank Under $100,000,000..................................................................... $100,000,000 to $200,000,000......................................................... $300,000,000 to $600,000,000— ..................................... ............. $600,000,000 to $1,000,000,000................................................ $1,000,000,000 or more..................... ................................ Total.................................................... Percent of total Number of banks Amount of CD's out standing 65 61 41 30 $136.1 377.7 1,801.2 2*429.4 12,920.3 W2 13.7 72:8 243 17,723.7 100.0 66 LI 21 — *Weekly reporting member banks. Mr. McGrath. I would also be interested in tracing, if possible, where the great bulk of the increase in the money that lias gone into CD’s has come from since about 1962, which is the date you referred to. Mr. S a x o n . This is, of course, difficult to determine precisely, boj much of the growth has been at the expense of growth in commercial bank demana deposits. These have had very little growth in the past fewyears. M!r. McGrath. Mr. Blackmon, you stated that last year we built about 1.5 million dwelling units in this country. Do you have any idea how many dwelling units we should build each year just to keep even with the increase in families ? Mr. B la c k m o n . Of course, all your statistics will show that housing starts to a great extent are related to family formations, taking out, of course, the consideration that during the thirties when the depression was on, and the war when it stopped, and this caused a larger amount of units to be built shortly after the war than the normal fam ily formation. I think our industry today, in order to provide proper housing for the American families in this country, could easily produce 2 million units a year, and then that would go up as the family formations thrf are just b a n n in g to be created concerning the W orld W ar I I babies, th at would continue to rise. B ut with a normal year of 1.5 million units, we are down considerably, and our starts will even show * greater decline, as Congressman Harvey has brought out, as soon a8 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 8 5 those statistics start being revealed in August probably, September, October, and November. But we could usually take 1.6 million regular units and 600,000 units of these substandards to better house America very easily. We have the manpower, we have the materials available. One of the biggest problems is the money. Mr. S a x o n . I would like to comment on that. This again gets back to the question as to whether in this period, with the inflationary pressures th at exist, this one industry and this alone should be freed entirely of the normal operation of restrictions th at are being imposed on other segments of industry. I just find no basis for it, th at there must be a certain given natural increase each year in the creation of housing. Incidentally it isn’t all individual housing, although naturally this association would base it on this basis. Much of the construction we are talking about, and one of the larger uses of funds represents large substantial construction, office buildings and the rest of this. You can see it if you go through M ainland and Virginia, unused capacity here in this area, the expansion here in the District of Colum bia, the projected expansion which is very substantial. This absorbs funds. All of this is involved in the picture. I think it is misleading to accept this on the basis that you are de priving an individual family of a home alone. There are other very substantial promoters, project promoters, office buildings and other large developers which have obviously a very substantial interest in a continued expansion, and apparently without regard to the general economic condition of the country and the inflationary forces that exist, and th at today ought to be restrained. Mr. O t t i n g e r . Would the gentleman yield ? Mr. M c G r a t h . I y ie ld . Mr. O t t i n g e r . I think we are very concerned not to be pumping new money into the economy as you suggest might be a solution, by supply ing additional money through Fannie Mae into the savings bank and home loan industry. W hat we are concerned with is the fair distribution of credit to all institutions under a policy of monetary restraint. W hat we are saying is that the real pinch from our policy of mone tary restraint has been felt in the home loan business, whereas through the device of the CD’s, the commercial segment of the economy is allowed to expand in a virtually unrestrained manner. We would just like to see a restoration of some equity between these two segments of the financial economy. You don’t have a situation today where the home loan industry is going wild with credit and with funds. I t seems to me you have ]ust the reverse situation, where the funds are being let out freely to the commercial world through the instrument of the CD’s while the home loan industry is being pinched very severely through the drain of funds from the traditional source, which is the small th rift depositor. The C h a i r m a n . I suggest th a t we will have to confine our question ing to about 2'or 3 minutes in order for all the members to ask questions. 286 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS Mr. M c G r a t h . Just one more question, Mr. Chairman. The C h a ir m a n . Yes. We have Mr. Hansen and Mr. Annunzio, Mr. Bees and Mr. Mize. Mr. M c G r a t h . Mr. Saxon, do you have any figures on how many CD’s savings and loan associations themselves hold in total amount? Are they in this market as holders of CD’s, do you know ? Mr. S a x o n . Yes. M r. M c G r a t h . In a significant manner? Mr. S a x o n . They have been a very substantial factor in this, which is a critical question. As of April 26,1965, they held over $975 million in CD’s. If the funds are being used as aggressively as is being suggested for housing construction, by that I would include very large scale construction too, then how could these funds be placed so widely in commercial banking institutions ? Now the recent regulation of the Home Loan Bank Board reducing liquidity requirements from 7 to 6 percent, and withdrawing the authority to include as part of the liquidity, CD’s in commercial banks, is going to have a substantial impact. This is a critical question. The C h a ir m a n . Mr. Hansen? Mr. H a n s e n . Thank you, Mr. Chairman. Mr. Saxon, going back to the line of reasoning that was used in your discussion with Mr. Ottinger, it appears that the intent which preceded the change in regulation Q on the part of the Federal R eserve banks has not come to fruition. In other words, by way of the high interest rate on CD’s, there hasn’t been as much restraint placed on the banking industry as there has been on the building and loan industry, because of the transfer of funds. What in your opinion would have been the effect, had they let the interest rate stand and increased the reserve requirements? M r. S a x o n . I think we would have had a substantial additional interference in connection with the international balance-of-payments problem we face. Regulation Q was one of the factors primarily responsible for the creation of the Euro-dollar market. It is a serious matter. The change in Q was not alone a matter of trying to give th e banks flexibility in competing for funds. It was also to p rovide some mechanism for the banks to compete internationally in the way of retaining funds in terms of their effect on the money markets. I think it would have been unfortunate if the Fed had not moved, or had moved very late to achieve a permitting of some flexibility here. I don't believe this outflow from the savings and loans has gone all to the banks by any means, Mr. Hansen. I don’t think this can be demonstrated. A lot of this is sensitive money. A lot of this Cali fornia money came from the East; definitely hot money. A lot of it, much of it up to the $100,000 area deposited and above, has gone into the stock market, I presume, and to other financial instruments. This type of restraint that is here proposed, if it is actually adopted we would find quite naturally that this type of person, this in v e s t o r or UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 8 7 depositor, if we may characterize him as such, can put his money into Treasury securities now at 5, into agency securities at 5.5, in any other number of instrumentalities, so I don’t think the outflow has been by any means entirely to the banks. Mr. H a n s e n . In your judgment this should have been started sooner. Mr. S a x o n . I think if it had, Mr. Hansen, we would have seen a better relationship in the money market. Mr. H a n s e n . Thank you. The C h a ir m a n . If we have the executive session at 1 1 :30 which we have agreed upon, then we will have to restrict the individual ques tions to about 2 minutes each. Would it be all right, Mr. Saxon and Mr. Blackmon, for the members to submit questions in writing for you to answer when you look over your transcripts? Mr. B la c k m o n . Certainly. The C h a ir m a n . Then the witnesses may extend their remarks to ex pand on anything they desire to. Next is Mr. Stanton. Mr. S t a n t o n . Thank you, Mr. Chairman. Mr. Saxon, there is not too much you can be asked in a couple of minutes. You do a beautiful job of presenting the bank picture, and vou do a beautiful job of presenting the picture for unrestricted regu lation in this country. As Mr. Harvey said, we are interested in this particular bill, as to its effect on the homebuilding industry. Not necessarily the savings and loan industry itself. Your statement, as you said, went through a period of unfair com petition as to banks. "But in relation to this, don’t, you think we will see a phasing out of the passbook as a means of savings, if we continue the unrestricted use of CD’s ? Mr. S a x o n . S o far we don’t observe any substantial indication in this direction. In many areas, in my own area in the Middle West, in Pennsylvania, in a number of districts the CD has been the traditional reliance for the small saver, rather than the savings deposits. They have been issued for generations and generations, the nonnegotiable So apart from those areas where CD has been used in place of the savings deposit, while we may see more of a change in the future, so far we haven’t. We now have and have had for many years large amounts of nonnegotiable CD’s. I think some $18 to $20 billion are outstanding now. They have been large for a long time. Mr. S t a n t o n . Mr. Chairman, I h a v e r e fe r e n c e h e r e to th is f u ll p a g e a d sent me which appeared in a Columbus, Ohio, p a p e r r e c e n tly a d v e r tising the investors guaranteed savings bonds, and I would lik e to submit it for the record because it is a change in our p a r t o f th e c o u n tr y from the historic passbook savings, to something e n tir e ly d iffe r e n t. The C h a ir m a n . Without objection, you m a y in s e r t it in th e rec o r d a t t h is p o in t. (The advertisement referred to follows:) 288 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS [From the Columbus (Ohio) Cltizen-Journal, May 24, 1960] H e re a r e s o m e strik in g fig u r e s , lifted fro m a n ew m a rk e t stu d y c o n d u c te d b y U .S . N e w s a n d W orld R e p o r t T h e su rve y w as sp o n so re d b y L ife In su ra n c e A g e n c y M a n a g e m e n t A ss n . B u t th e re su lts a r e im p o r ta n t to e v e r y o n e w h o s a v e s o r in v e s ts money. Here’s what people say they do about saving and investing money. Investor Savrfr Bonds are proving to be Central (HiiO’s-most popular new savings plan. Here are 10 special advantages. See how you compare with other people buying life insurance. i - Earn a p w a s tw * return at I V . . • • • • • 93% have checking accounts 78% have savings accounts 39% own Government Bonds 26% are stockholders 13% have mutual funds 76% ot the people said they plan to do more savins in the next few years. • • • • • 26% would consider fife insurance 25% named common stocks 22% would buy Government Bonds 13% would include mutual funds 67% planned to put more in savings accounts Now, the point is this. Everyone is inter ested in making their money go farther, work harder, and (retting a better return on it. And good family money manage* ment requires a balance between the protection of life insurance, the poten* tial growth of stocks and bonds, and the guaranteed security and high return of bank savings. You need them all The backbone —the bedrock of making your money grow, is money in the It’s rock solid and safe. You can lay yoor l»»nds on it when you need i t And it p w s . For example: 55,000 in our 4-4% Investor Saver Bonds will grow to $6,253 in fire years. And we guarantee it ^Imst-rnibnmn-tlumwtr IS Our Investor Saver Program has becom e one of the m popular ways to save oot money at a guaranteed high rate of return. So,if yon are carefully planning your family’s future, Bank savings •hodd be the foundation. The best way to baSd that foundation is with Investor Saver 4%% Bonds. Incidentally, in the survey almost half of the people questioned said that they needed apian that forced them to save regularly. We have the answer to that, too. Stop at any officeand ask about our Investor Save-O-Matic plan. It work* 2 -3 — Bat* is gw m teed for 5* w - W eirJt starts mtnrtiattin 4 -fcsikeJkrM-fC 5 - Can be easted a t tr 90 « * - AvartaMe * pncticattf m, a rju tf ^ 7 — a 51999 'Start t 8 - totaaftte Ta paidlor 9 —Cattleassaped. usrt js lO - interest ckecli n m lta qsafttriy.« sew-weuiilii . UuttulktofvmtBbtc**xlrrtst*Sav Band em tr...tr rrsf xif Off Cta o Oo o sbs. b * SAVINGS BONDS N.Bm o ob Crt a t ____ I coo « irw I— ____ t s jo• o I- ___ nw9*,n* oo 7 — TTLJ— OA GROWTH BONDS INCOME BONDS >qqm qs-m a — r C ity N a tio n a l ir c n UNSOUND COMPETITION FOB SAVINGS AND TIME DEPOSITS 289 Mr. S ta n to n . Another question, Mr. Saxon. Do you have any knowledge, with this particular change in trend in the last couple of years, in the last 6 months in general, of a shift of request for bank charters from savings and loan industries who maybe see the hand writing on the wall, with this unrestricted competition and the desire of the savings and loans to get into the banking field, or is there a merger element? Mr. S axon . We have had one conversion, a stock charter association in Ohio, a very good institution. W e have had a number of inquiries from other institutions, stock savings and loan associations. I don’t think this is unhealthy or improper, if an institution wants to move in one way or another. So long as it is sound, I think we should give fair consideration as we did m the Ohio case. We haven’t approved any since then, but if we had an application by a good, well-rounded association who would wish to convert, we would do so. I don’t read it necessarily at this juncture at least as suggesting any general trend, but I think this type of convertibility is not unhealthy. Mr. S t a n to n . Thank you very much. The C h a irm a n . Mr. Annunzio. I am sorry we are so pressed for time. Mr. A n n u n z io . Thank you. My time is limited, Mr. Saxon. On page 1 of your testimony I was very much interested in your state ment, and I would like for you to elaborate further. When the Government intervenes to fix prices, administrative decisions are substituted for the market price. The decisions of one man or a few men replace the judgments of many. I think th at the Congress and the Congressmen have been lax in their responsibilities as fa r as the agencies are concerned, and I am happy to read your statement. The Congress should have been more responsible in regulating these agencies instead of being independent of each other, getting them more or less to work together with the elected head of our Government, the President of the United States. I would like to have you further elaborate on this statement. My time is limited, and consequently I am interested in your views, because we are all in agreement, whether it is the building industry, yourself, or the Secretary of the Treasury and even some members of the Fed eral Reserve Board, in that when the Federal Reserve Board did act in December, no one knew about it, so th a t we are all members of the same club. Mr. S a x o n . Yes. The C h airm an . Mr. Rees. Mr. A n n u n z io . Pardon me, Mr. Chairman. I wanted to get his reaction. Ju st what did you mean ? My 2 minutes are not up yet. Mr. S a xon . We are referring there to regulation Q as a prim e exam ple of price fixing. Mr. A n n u n z io . W hat did you mean by replacing the judgm ent of many? Are you agreeing with us that we should nave a lot of men at these discussions, at least the elecfted representatives of the people? 290 UNISOUND COMPETITION FOR SAVINGS AND TIM E DEPOSITS Mr. S a x o n . It would have been very helpful if we had known in advance of the change in regulation Q. M r. A n n u n z i o . T h a n k y o u . The C h a ir m a n . Mr. Rees. Mr. R e e s . Thank you, Mr. Ohainnan. Mr. Saxon, you have been talking about competition. I have dis cussed this problem with the Federal Home Loan Bank Board several weeks ago before their decision in lowering the liquidity and raising the interest rates. I am from California, which is a State that needs money. We are expanding. What would you think of changing the regulations in the Federal Home Loan Bank Board, which would increase the liquid ity as you suggested up to 15 percent, and then allowing them to com pete in terms of interest rates? Now they are, in reality, regulated. They oun’t draw down the 17 percent, if they don’t do as the Board wants them to. Mr. S a x o n . That is correct. Mr. Rees. As you know, an administrative agency can really harass an institution, if they decide they want to. This would give you competition. M r. S a x o n . Yes. It has differing effects. While it is designed to impose restraints on some, in the process very well run institutions are proscribed, limited necessarily as a result of this particular type of regulation. I am not so sure that this whole package was a very desirable pack age. Indeed in a period like this in some of the additional restraints I am posing additional restrictions on banks and holding companies in this instance, I don’ know whether this is desirable either. T h ere t are other aspects of this problem. Mr. R e e s . Mr. Blackmon suggested, and this has been suggested in these hearings, that there be established probably by statute a co ordinating group, which would coordinate the Federal Home Loan Bank Board, the Federal Reserve Board, your office, Treasury and whoever else might be affected, so that there might be at least some discussion in terms of unilateral discussions being made by any in dividual agency which would affect another agency. Mr. S a x o n . I think this is very desirable, Mr. Rees. It would carry us back to where we were in 1935 when the Secretary of the Treasury and the Comptroller of the Currency sat on the Federal Reserve Board and participated in these decisions. As it is today, on some grounds of supposed threat to independence, they are excluded. I am not speaking for the Secretary now. I aw just speaking for myself, but I think this is meritorious. , Mr. R e e s . I introduced a bill which would define a certificate ot deposit. I consider the CD to be a dangerous instrument, when used by bankers like Mr. Silverthorn of San Francisco, in terms of liquidityThe bill provides that the certificate of deposit must have at least a 1-year maturing and would not be able to draw any more interest than the passbook rate of the bank. What would you think of that type of bill, from the point of view of CD? Mr. Saxon. I think it would introduce further rigidities into an already highly complicated structure. It could well be harmful. UNSOUND COMPETITION FOB SAVINGS AND TIME DEPOSITS 291 stead of providing some protection for the savings and loans, it could well end up in providing additional difficulty for them. I think it might well give false comfort. M r. B e e s . What about the dilemma of the certificate of deposit. I think we found last December before the Board made the decision to raise rule Q that this is a rigidity, it does affect the liquidity of a bank? All of a sudden, if the CD’s were to leave, it would put many banks in receivership. Isn’t there some way that we can regulate the Cl) in terms of building up reserves behind it or by providing that you can only have so much in CD’s in terms of your total investments? This is a problem we are having in California, as you know, from a lot of smaller banks that have been forced to merge because of the problem of CD’s and liquidity. Mr. S a x o n . I think we are out of that now as far as I am aware in California. Most of these CD’s in the smaller institutions which were disproportionate to their structure have since been liquidated. We met the problem in the case of the smaller banks generally throughout the country, as I indicated in response to a question from Mr. Todd by requiring our examiners to appraise each one of these situations individually, and to limit or proscribe, any deposit from outside the immediate trade area of the small bank. In the case of the larger banks, we have got to presume as I do that large New York City and Chicago banks have? as I am sure they do have, the financial sophistication to manage their money well, ana if they can’t, we are indeed in trouble. But I know they can. I think it is a differentiation between institutions. This applies to the savings and loan industry. Many of them are careful and prudent and well-run institutions. There are some certain areas, such as California, where it is very difficult. Mr. B e e s . Thank you. The C h airm an . M r. Mize ? Mr. M iz e . Thank you, Mr. Chairman. Mr. Saxon, Mr. Mitchell of the Federal Beserve Board last week said that he felt some large New York and Chicago banks were actually using these 5.5 CD’s as a kind of a loss leader, and they were borrow ing money at 5.5 percent and lending it at 5.5 percent and actually losing money. Do your examiners find that to be the case ? M r. S a x o n . I th in k t h e r e fe r e n c e s t o th e p r e ss , in t h e u se o f su c h te r m s a s c h a s in g d o lla r s a n d t h e im p lic a tio n s t h a t th e a m o u n t o f m o n e y th a t is c h a n g in g h a n d s a n d b e in g ta k e n a t t h is r a te is la r g e , I don t t h in k th e s e c o m m e n ts a r e w e ll fo u n d e d . Mr. M iz e . Mr. Bees has described his bill. Now you know Mr. Patman’s bill would outlaw negotiable CD’s entirely. Mr. Ottinger s bill would limit the denomination size to $15,000. which of the three, bills would you accept, or do you not like all of them ? Mr. S a xo n . I w ould accept anything that Congress enacted. That is p o in t one. M r. Miz e . I know . Mr. S a x o n . T h e CD is a good and useful instrument. It has been used for many many years, both th e negotiable and the nonnegotiable CD. 292 UNBOUND COMPETITION FOR SAVIN<3S AND TIM E DEPOSITS Now abuse may occur from time to time. We have attempted to deal with that, and I think effectively, by directions to our examiners. The power is ample to do so. But the instrument itself inherently is a very sound and useful tool and has been for many, many years, and I would hate to see some action taken to cure as ephemeral a problem to the extent that such problem exists, by the adoption of rigidities and restraints which could have in the long run very seriously harmful effects. In fact, we have more than ample power to deal with any situation today where we see an excess amount, and we are doing it wherever we see it. Where we see an excessive amount of CD’s m relation to the total deposit structure, we have the authority and do cut it back, It is a uniform rule now with respect to the smaller banks, and we are using it in other areas, and we are planning more and more care and prudence in the handling of the CD’s by the larger banks too as years go on. Mr. A n n u n z io . Will the gentleman yield? Mr. Mize. If the Chairman will grant me any more time. Mr. A n n u n z io . Mr. Saxon, w ill you answer Mr. Mize’s question on the comments made by Mr. Mitchell of the Federal Reserve Board, that on these CD’s, 5.5 percent, that actually the big banks are taking this money and losing money by paying out 5.5 percent ? The C h a ir m a n . Answer it for the record, please. Mr. A n n u n z io . Answer it for the record. (The information referred to follows:) R eply of H on. J ames J. S axon, Comptroller of the Currency I would not characterize the issuance of 5.5-percent CD’s as a “loss leader.” It is true that considered as a permanent source of funds, 5.5-percent CD’s would be only, marginally profitable but two facts must be kept in mind: ( 1 ) The amount of CD’s issued at this rate is not very large. , (2) The availability of the CD instrument aUows large banks to meet liquidity needs by issuing such certificates. It is liquidity rather than earnings con siderations which are paramount. Additional Statement by L arry B lackmon, P resident, N ational or H ome B uilders A s s o c ia t io n Under the permission of the chairman to extend my remarks I am im pelled to point out that the opposition, voiced by the ComptroUer of the O orren tf saxon and others primarily interested in the commercial banking system,jo any attempt to restrict certificates of deposit leaves completely unanswered the foUowlng questions of vital interest to the American homebuilding industry'*) If the present flow of funds from savings institutions into com m ercia winks continues, where win permanent residential mortgage financing com ® mof t® ft8e financing for its customers scarcer than at any time to re«othi8tory, how can the homebuilding industry perform the job, which v# ?8ert£ned to J* and the American public expects of tt, of expanding ( m°derate-income families? a^ competition for savings" advocated by Mr. Sa*? ’ we avoid return to the pattern of 40 years ago when the majority prodTlct* was concentrated in price brackets which ontt 011 families of high income could afford? . J?* yiltaal nullification of regulation Q was antfT?l® O bi?ctive 8erv« i by diversion of billions of dollars I**1 residential mortgages into high-yield consumer financing? UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 293 The homebuilding industry does not mind curtailment to serve a national good; it objects most strenuously to being asked to bear practically the entire burden of so-called anti-inflationary moves which, insofar as we can observe, have served merely to stimulate bank lending and bank profits while failing (as history proves they must) to cool an overheated economy. I call the attention of the committee to an excellent statement of views with which we agree, contained in a letter from John E. Horne, Chairman, Federal Home Loan Bank Board, printed in the Washington Post for Tuesday, May 31, 1966 (copy attached). Attached also are two typical illustrations of the vigor with which commerical banks are seeking (unfortunately, successfully) to attract long-term savings* [F r o m th e W a s h in g to n P o s t , M a y 31, 1966] F ob the S malleb Saver Readers of your May 21 editorial “Split Levels for S&Ls” may be impressed by the fact that the article contains a number of points to which most reasonable people might subscribe. Nevertheless, the editorial may be misleading because it omits consideration of the effects of massive shifts of funds among financial institutions in a short period of time. Your editorial ignores the fact that the banking system has long maintained, by regulation, two sets of rates, one for small savers and one for large savers. For many years the small saver received the higher rate, but beginning in late 1964 banks were granted the authority to pay the large saver, usually an orga nization not eligible to hold a passbook savings account, a higher rate on the grounds that it was necessary in order to stem the flow abroad of corporate and other large deposits. Thus the holder of a certificate of deposit began to receive a rate higher than the individual who used a savings passbook. A few ingenious banks, finding that there was no explicit prohibition against issuing small certificates of deposit, began to offer certificates in small denomina tions, even as little as $25, at a rate above that for the savings passbook. Since ^December of last year they have been able to offer rates as high as 5% percent through this device to persons who would ordinarily be passbook savers. Banks had ordinarily issued certificates of deposit only in large amounts; but now that the certificate was eligible for a rate higher than the passbook, it sud denly became a consumer savings instrument. Testimony before Congress shows that the Federal Reserve did not intend to disturb the relationship among in stitutions for consumer savings accounts. Furthermore, rapid mass shifts of funds in a short period of time from a spe cialized set of financial institutions, confined to one market, to a generalized set of financial institutions can lead to quite undesirable effects. Let me make it clear that the loss of a substantial amount of funds in April from the savings and loan associations is not likely to affect their soundness. However, their ability to serve the mortgage market has been reduced far more substantially than most would consider desirable. Nor is it evident that massive shifts of funds to banks is helpful in any way. We know that not all resources are readily transferable, and sharp reductions in the use of resources in residential building is not likely to satisfy demand else where. What is more, the banks have increasingly concentrated their lending in the last year in commercial and industrial loans, which by their very nature move into inventory and plant and equipment. In both these areas there is ample evidence of overheating. „ _ _ As for the small saver, the institutions which the Federal Home Loan Bank Board regulates have offered him the best rate of return on deposit-type savings for many years. Even today, except for the certificate of deposit instrument, savings and loan associations offer a higher rate than banks in most places. In any event, the small saver should not be used as an excuse for preserving a con trivance which can seriously distort flows of funds and which makes a travesty out of the reasoning underlying the 5.5 percent rate on certificates. It would seem, therefore, that your editorial runs the riak of slavish endorse ment of what appears to be competition but really reflects an artificial device contrived because our laws are not explicit. I think it is within this frame work that Secretary Fowler’s position as well as that of others should be judged. J o h n E. H o r n e , 63-496 O— http://fraser.stlouisfed.org/ 66------ 20 Federal Reserve Bank of St. Louis Chairman, Federal Home Loan Bank Board. 294 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS CHOOSE AT FRANKLIN NATIONAL 3 Different Type Savings Bonds Th» top fivo-yoar-guormitwdroti ovailoblt in N York Stot*. ow obit ivory nintty day* of M l 4JtV annual infirejf compoumW f W * * ’ ly. Maximum purchflsi $500,001 Bw an fin throo typos you con bay* GROWTH »OND5- J lW ^ - « J * '^ j£ *l"‘fT.SW.m *«MTIL* T rlT « * All Fronklin National Bonds ore available for individuals, non-profit organizations and business firms at oil Franklin ational Offices. 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Additional amounts In* multiples of $100 • Redeemable prior to maturity upon 30 days written notice, earning 3% % for time held ACT NOW— | For Information; Phone LIMITED TIME ONLY I (212) 524*9000 Republic National Bank of New York M b r Ftdtril D Jniurattct Crp ratio / fcU b Fd ra R rv S stim tmo tpoiit oo n mtr o o l iM t y 296 TTNJSOTJND COMPETITION FOR SAVINGS AND TIM E DEPOSITS The C h a ir m a n . N o w Mr. Blackmon wants about 1 minute on a question he brought up in the beginning. Then we will have an execu tive session. Mr. Blackmon. Mr. B la c k m o n . Mr. Chairman and members of the committee, since appearing before you the last time, there has been a problem created in our industry that I would like to bring to your attention. The borrowing authority of Fannie Mae to finance its secondary market operations is presently restricted to 10 times its capitalization and sur plus. Because FNMA is purchasing loans at the rate of $40 to $50 million a week, it is quickly reaching its statutory limit. As a result, it has restricted its purchase to a $15,000 limit. This limit throws a burden on high cost areas in the country, in the West and in other parts of the country. For this reason I think some action should be taken quickly to increase Fannie Mae's borrowing authority. Our board of directors last month recommended that this authority be increased from 10 to 1 to 20 to 1. I understand you have two bills before you, one from Mr. Hanna, increasing it to 15 to 1, and one from Congressman Widnall increasing the authority of Fannie Mae on an outright basis by $1.1 billion. We believe it is a m atter for Congress to determine the more feasible approach. (The following information was submitted for the record:) A dditional Remarks of Me. B lackmon As this committee is no doubt well aware, the mortgage money crisis of recent months has highlighted the reliance of the homebuilding industry on FNMA’s private secondary market. Recently, FNMA has been purchasing mortgages at levels from $40 to $45 million per week. This heavy volume has caused consid erable drain on FNMA’s borrowing capacity—currently set at 10 times capital and surplus. At current rates of use, it is Ukely that FNMA will have exhausted its borrow ing capacity for its private secondary market operations some time this sum' mer. It should be emphasized that these operations are carried on at no cost to the U.S. taxpayer. ***** k°ai^ directors meeting 6 weeks ago our members expressed con siderable concern about this problem and what failure to meet it would do to the homebuilding industry, already operating under severe strain and disloca tion as a result of current monetary policy. After much study and discussion, our members adopted a resolution calling FNMA’s borrowing power. It was our hope and expectation that this important Federal agency could be given sufficient authority t o enable it to continue to provide the secondary market backup and flexibility which has been so important a part of the homebuilding financing machinery in recent years. . l t WJ ?® feeIin* that FNMA needs at least double its current borrowing authority, tf it is to operate without artificial restrictions, and that anything lees would result in recurrent crisis during the coming year. - * * 5 at a understand why no recommendation has been forthcoming from the executive branch to the Congress about this critical situation, flti tb A t tbe Housing Subcommittee of the House Banking Committee is considering a number of approaches that would by Increasing FNMA’s borrowing capacity without any eventual real cost to tbe U.S. taxpayer. ^ r n 2 w aPP ! ^ ^ ar ^ Congressman Hanna, that of increasing the bort n i times capital and surplus would, we have been Th0*iSSJwi ^nestions about the rights of prior debenture holders. a 7 Cong*?®nai1 Widnall, which would have the merit 0n FNMA operations, would increase the Treason ^ capacity by over $1*2 bflM of activity tMs may not last the fuU year and mi*bt regnire coming back to the Congress again for additional funds. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 2 9 7 We have e v e r y confidence both in the judgment of the subcommittee, under the able chairmanship of Congressman William Barrett, to select the most logical approach, and, in the wisdom of the Congress to legislate the soundest method. We are grateful to both Congressman Widnall and Congressman Hanna for their sincere efforts to solve this problem. It is, of course, inconceivable to us in the homebuilding industry, that appro priate steps would not be taken to allow FNMA to continue to perform, without artificial restraints, the vital functions set forth in its charter. At the present time, in order to preserve its currently limited borrowing authority, FNMA is refusing to buy mortgages valued over $15,000. This action is discrimina tory against many areas of the country, particularly the north and the west where higher labor and land costs make it difficult to provide much housing for the market under such a restriction. These are times of money crisis and shortages for essential business. FNMA’s creators envisaged that it was at just such times the agency would be of the greatest usefulness. It has been able to do so in the past, when its borrowing capacity was adequate. It would be disastrous to the small businessmen represented in the home* building industry if the agency were not again able to perform that function during the months ahead. The C hairm an . I would like to ask each one of you gentlemen this one question without further comment. There is a proposal that we permit interest on deposits of under $100,000 at a 4.5-percent rate and permit interest on deposits of $100,000 and over to be at the rate prescribed under regulation Q. Would you be inclined to favor that, Mr. Saxon, or would you be opposed to it? Mr. S axon . I would be opposed to it, Mr. Chairman. The C h airm an . H ow would you stand, Mr. Blackmon, on this question ? Mr. B lackmon . We feel that CD’s should have guidelines, and we favor any guidelines that this committee might set. The C h airm an . Y ou think this would absolutely relieve the situation ? Mr. B la c k m o n . I d o n ’t th in k it w ou ld relieve it co m p letely , but I th in k g u id e lin e s w o u ld be h e lp fu l. The C hairm an . I t would be helpful in the present situation ? Mr. B lackmon . Yes, sir. The C hairm an . Would it be more helpful in any of these bills if there was a smaller amount than that? You would like to have it as 1arge as possible, wouldn’t you ? Mr. B lackmon . Our board passed a resolution that it should not be lower than $25,000. The C hairm an . Well, would you consider a $100,000 minimum adequate? Mr. B lackmon . Certainly. The C hairm an . Thank you very much, gentlemen, for your attend ance here. We will have an executive session in 2 minutes, and shall reconvene at 10 a.m. tomorrow. (Whereupon, at 11:30 a.m., the committee adjourned, to reconvene at 10 a.m., Wednesday, June 1,1966.) TO ELIMINATE UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS W EDNESDAY, JU N E 1, 1966 H o use op R e p r e s e n t a t iv e s , C o m m it t e e o n B a n k i n g a n d C u r r e n c y , Washington, D.C. The committee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. W right Patm an (chairman) presiding. Present : Representatives Patman, S t Germain, Weltner, Gettys, Todd, Ottinger, McGrath, Hansen, Annunzio, Rees, Halpern, Johnson, and Mize. The C h a ir m a n . The committee will please come to order. This morning the committee continues hearing testimony on H.R. 14026, to correct abuses related to certificates of deposit. We are very pleased to have as our witnesses three academic econo mists to give their views on the CD problem. The large negotiable CD is a money m arket phenomenon which has been the subject of much debate since its origination in 1960. Certainly, the large negoti able CD, thoug;h containing the word deposit in its name, is not a bona fide deposit at all—on that the testimony before our committee is crystal clear. I t is a money market instrument designed to attract the extremely volatile short-term cash balances of large corporations. Nearly everyone agrees that the CD situation has gotten out of hand, not just from the standpoint of competition, but as a problem for the banks themselves as they attem pt to keep this hot money. But no one has come up with a precise diagnosis and a course of treatm ent for these giant financial patients of ours. So we are hopeful Doctors Rousseas, Klebaner, and Carson will all contribute valuable suggestions as well as analysis. I assume each of you gentlemen has a prepared statement. In any case, I suggest th at in the course of your testimony you all touch on the very interesting remark by Comptroller of the Currency Saxon on May 25, in A tlantic City, that the large money market national banks depend on renewing these large C B ’s, that otherwise serious liquidity problems will result. This is a veiy disturbing rem ark and all members of this committee have a special responsibility to be con cerned and to find out all we can about this shocking state of affairs m our banking system* Mr. Rousseas, would you take about 10 minutes and summarize your statement, and then Mr. Klebaner and Mr. Carson. Then the members of the committee would like to ask you questions. AH right, M r, Rousseas. 299 300 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS STATEMENT OP STEPHEN W. ROTTSSEAS, PROFESSOR OP ECONOMICS, NEW YORK UNIVERSITY Mr. R o u ssea s. Mr. Chairman, I will summarize the statement that I have submitted in writing to this committee. The C h a irm a n . We will put all three statements in the record after each one’s oral statement. Mr. R ou sseas. In my testimony, I will not attempt to disentangle the claims and counterclaims of CD’s with respect to thrift institu tions. My own interest lies in the implications of CD’s for monetary policy, and with the Federal Reserve Board’s actions in that con nection. One of my concerns has been in the postwar short-run changes in duced in the income velocity of money and their bearing on the effec tiveness of monetary policy. It seems to me CD’s are a very unique money market instrument. Not only are they high-priced money, they are the only money market instrument which is issued directly by the commercial banks them selves. Without going into any detailed balance-sheet analysis I have tried to indicate, m my written testimony, that shifts from demand to time deposits within the commercial banking system results in an increase in velocity, given the differences in reserve requirements for these different types of deposits. This very same phenomenon would occur if funds were to drift from passbook and time deposits of savings banks and loan associations into commercial bank time deposits, since by and large these thrift institutions do keep a significant part of their reserves in the form of demand deposits with the commercial banking system. I have also tried to indicate that when nonbank c o r p o ra tio n s-which hold about 70 percent of the negotiable CD’s—switch out of Treasury bills and into CD’s, this also, results in increase in the income velocity of money assuming that the Treasury will not retire any debt. In my statement I refer to the Federal Reserve Bank of New York s claim that they are the ones who invented and thought of the idea of CD’s; that a former vice president of the Federal Reserve Bank of New York made the first public statement on CD’s and that the First National City Bank of New York first issued them in 1961 and arranged at the same time, for a secondary market in neg o tia b le CD s. The C h airm an . I do not understand how this would be correct when they had over a billion dollars of CD’s outstanding in 1960. Mr. R ou sseas. My understanding is th at certificates of deposit had existed in the Southwest and in California, but they were not negoti able and that consequently there was no secondary market for. CDs* lm a y be wrong on this. But my understanding is th at negotiable CD’s began m 1961, about February of 1961. Certificates of deposit had, of course, existed earlier than that but we are now talking about CD’s as a new kind of money market instru ment. And I think this dates back to about January or February oi 1961. The First National City Bank of New York was the innovator and arranged with a dealer in Government securities for the simul taneous creation of a secondary market for CD’s of a very high de nomination, in the million dollar category, I believe. UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 3 0 1 My own position is that Federal Reserve Bank of New York is involved in a slight inconsistency. I t takes pride in having fathered CD’s and then, says that if excess reserves and velocity changes are generated (given the differences in reserve requirements between de mand and time deposits), it can undertake the necessary counteracting open market operations. I want to focus my testimony on this particular aspect of the Federal Reserve’s position. I t should be pointed out that in the early 1950’s the Federal Reserve Bank of New York, under the distinguished leadership of Allan Sproul and Robert V. Roosa, was the major supporter of what is now called the “new” monetary policy. This “new” monetary policy shifted the emphasis of monetary control over to the supply side and argued that with the emergence of the very large public debt, as a result of the Second World War, large, yield-conscious, conservative, nonbank financial intermediaries could easily be locked into it by very small changes in interest rates via the open market operations of the Federal Reserve System. Now, it seems to me that in the postwar period, and especially since 1955 when monetary policy has really been applied in the modem sense, the range of interest rate variation has been very large indeed. And velocity changes have also been extraordinarily large. As a matter of fact, I think many economists are rather perplexed as to whether a velocity maximum exists at all. Empirical data indicates we have not yet reached it. I think the last calculation for velocity in the first quarter of 1966 would bring us to a slightly over 4.2 rate of turnover of the money supply. The problem, as I see it. is th is: if the Federal Reserve System takes pride m having fathered CD’s and CD’s result in velocity changes, then the counteracting open market operations of the central bank, contrary to the “new’”monetary policy, will have to become progres sively larger and larger. I cannot, in the time allotted to me, get into any detailed analysis of these velocity changes. There is considerable disagreement about them from a policy point of view and I have submitted to the staff of this committee some supporting material which will present my own views on this issue. With respect to the bills now before this conmiittee, I would like to pay special attention to section 1 of Mr. Rees’ bill, H.R. 15173, which would prohibit insured banks from issuing negotiable CD’s and un secured notes. I favor this part of Mr. Rees’ bill. I find, however, that I do not understand the reasoning behind section 2 of H.R. 15173 since I do feel that some spread in interest rates is justified between passbook savings and nonnegotiable time deposits. Apparently, most of the bills now before this committee are con cerned with the impact cf CD’s on thrift institutions. My own con cern, however, is with the monetary policy implications of negotiable CD’s and high-cost time deposits. From this point of view, I would suggest abolishing the distinction between city and country banks and requiring a uniform legal reserve ratio for all demand and time deposits. This would strengthen monetary policy by severely limiting the power of the banks to generate excess reserves through a reduction of their total required reserves. 3 0 2 UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS I should like to point out that the unique characteristic of CD’s is that they increase excess reserves by reducing the required reserves of the commercial banking system. The proposal which I am now making would also serve to lessen the pressure on th rift institutions, for commercial banks would not be willing to encourage the inflow of high-cost money if their excess re serves were not affected. Perhaps, this approach is to be preferred even to section 1 of H.R. 15173. I t would achieve the same ends while at the same time contributing to the effectiveness of monetary policy. As for the velocity changes attributable to the dumping of Treasury bills by the banks, a standby supplementary reserve requirement ad ministered by the Federal Reserve System would also be in order* I would like to conclude my comments by saying that I would regard the committee’s bills and my own proposal as a patchwork approach to a serious problem. I think it is time we took a good look at commer cial banks and their relation to the Federal Reserve System. We might also consider at the same time how we might improve upon the Federal Reserve System so as to increase its power and authority to regulate the flow of credit and decrease the influence of the commercial banking system on its actions. With regard to this last part of my statement, I have in mind the accommodating changes in regulation Q by the Board o f Governors every time the commercial banking system finds itself in a liquidity squeeze, and I am raising the question as to whether the Federal Reserve System has not to some appreciable degree lost its initiative in determining monetary policy. Thank you, Mr. Chairman. (In a letter to the committee, dated June 15, 1966, Professor Rous^ seas submitted the following information:) It has come to my attention that the Board of Governors was on the phone the next day to the Federal Reserve Bank of New York demanding to know if my testimony was correct that the New York bank had taken credit for “invent ing” CD’s. The public information officer of the New York bank explained that President Hayes had made such a claim, but before a closed meeting of the American Banking Association in Atlantic City. The fact, h o w e v e r , that the New York bank subsequently circulated a copy of President Haye’s r e m a r k s in mimeographed form did constitute a public disclosure. (The complete statement of Professor Rousseas follows:) S t a t e m e n t of S t e p h e n * n X n fmm<* W . R o u s s e a s , P r o fesso r of U n iv e r s it y E c o n o m ic s , N ew Y ork 1 ha7 e read some of the testimony given before this committee 1)8611 fairly presented and clearly joined. I shall not H ? e cla™s and counterclaims that have been made concerning of. deP°sit with regard to interbank c o m p e t i t i o n , their tif institutions or, for that matter, on the earnings and liquidity definSi v ta h ^ commercial banking system. Nor shall I burden you with an> m ir d f l a“alyS1 of the Phenomenal rise in negotiable CD’s as a mone i FHnk i f x w v!?t Sl£°* ^ eir lntroduetion in 1961 by the First National Cit! fs ^ owl(rlge of these developments will be taken for g ra n ted Ipm nm w STLm m regulation Q which are at the bottom of the V ^ with ? y- f eommittee. My testimony will be concerned, i * fv th5 broader implications of this new money market instrument ° f l ley of monetary policy and the short-run changes induced snnnlv^ L n v^ l'• i e - in the average rate of turnover of the naonW den^nd d e ^ it" defined in terms of currency in circulation plus adjusted UNSOUND COMPETITION FOR SAVINGS AND TIME DEPOSITS 3 0 3 CD’s, as is well known, a re high-priced money. B ut a p a rt from th is they are a unique money m ark et instrum ent. U nlike T reasu ry bills and open m ark et commercial paper, CD’s a re issued by the com m ercial banking system itself. F or example, nonbank transactio n s in T reasu ry bills involve an exchange of dem and d ep osits; they do not affect the reserve position of th e com m ercial banking sys tem as a whole. B ut banks a re p a rt of all p rim ary tran sactio n s in CD’s, and the uniqueness of CD’s lies in the fa c t th a t they involve a sw itch from dem and to time deposits w ithin th e comm ercial banking system. In all of this discussion it m ust be kept firmly in m ind th a t o f th e m any types of financial interm ediaries, com m ercial banks alone have the pow er to create money under a fra c tio n a l reserve banking system. The im portance of CD’s can perhaps best be understood by com paring them w ith T reasu ry bills. E ver since the T reasury-F ederal R eserve accord of M arch 1951, banks have resisted pressure on th eir reserve positions. D uring tight-m oney periods, they have been allowed to convert a su b stan tial p a rt of th e ir holdings of short-term G overnment debt instrum ents into cash and to use the resu ltin g excess reserves to m eet the pressure of the F ed w hile a t th e sam e tim e expanding th e ir loans, alb eit a t a slower ra te than would otherw ise have been possible. In th e absence of any requirem ent fo r the banks to hold a supplem entary reserve ag ain st th e ir deposit liabilities in the form of G overnm ent debt obligations, th e banks have been able to sell th e ir T reasury bills to nonbank investors an d to refuse th e refunding operations of the T reasury fo r m atu rin g issues. Comm ercial banks have th u s been able to increase the income velocity of money by activ atin g idle balances w ithin the banking sy stem ; th a t is, though the in te rn al tra n sfe r of dem and deposits does n o t affect the to tal money supply, its ra te of utilizatio n is affected. R equired reserves, in the final equilibrium position, a re u n altered and th e velocity increase represents a conversion, on th e asse t side, from investm ents to loans. By w ay of contrast, CD’s p erm it the expansion of bank loans via a drop in required reserves. And w ith the overly perm issive cooperation of th e F ed eral R eserve System in chang ing regulation Q to su it th e needs of th e comm ercial banking system, the banks have been able to bid aggressively fo r CD’s and control th e am ounts issued by paying the a p p ro p riate in tere st rates. For purposes of illu stra tin g th e effects of CD’s, I w ill assum e th e follow ing: (1) T h a t all banks a re totally loaned up and w ill continue to be so; (2) th a t the public’s subjective preferences a re such th a t CD’s and dem and deposits are considered to be very close su b stitu te s; (3) th a t in terest ra te s on tim e deposits are not a t the m axim um ceilings set by regulation Q ; and (4) th a t th e T reasury bill ra te on new issues is a t least 25 basis points below th e CD ra te on comparable m aturities. U nder these assum ptions, the com m ercial banking system w ill bid for tim e deposits by raisin g the in te re st ra te s payable on such deposits. As a result funds w ill quickly sw itch from dem and to tim e deposits w ithin th e com mercial banking system . Given th e lower reserve ra tio required on tim e deposits, excess reserves w ill be generated by v irtu e of the drop in to tal required reserves. The banking system as a whole w ill therefore be able to expand loans an d sec ondary deposits by some m ultiple of the newly created excess reserves. The initial drop in th e money supply induced by th e sw itch out of dem and deposits will th u s be p a rtia lly offset. The n et resu lt w ill be a less th an proportionate fall in dem and deposits (an d hence in the money supply) and an increase in income velocity th ro u g h th e activ atio n of idle balances. The very fa c t th a t we assum ed zero excess reserves before the sw itch can be taken to indicate a tight-m oney situ atio n brought about by ap p ro p riate F ederal Reserve open m ark et operations. The increase in velocity resu ltin g from the switch can th erefo re be seen as a p a rtia l offset to th e effectiveness of m onetary policy as a contracyclical tool. P rio r to the emergence of CD’s, velocity increases were, as we have seen, largely th e resu lt of banks an d nonbank corporations moving out of T reasu ry bills. CD’s a re m erely th e la te st innovation in the postw ar a ssau lt on m onetary policy, w ith banks now in the “fo rtu n a te ” position of being able to increase th e ir lending capacity by sim ultaneously converting investm ents into loans (dum ping T reasu ry bills) and by decreasing required reserves (issuing CD’s ) —th u s speeding up even m ore th e p o ten tial ra te of change in the velocity of circulation. In one sense, however, CD’s are an improvement over Treasury bills from the banks’ point of view. They allow the generation of excess reserves without reducing unduly the secondary reserves of the commercial banking system. Indeed, a senior vice president of the First National City Bank of New York was moved to observe a few months ago that “banks became financial inter mediaries between corporate treasurers and those seeking credit; we funneled 304 UNSOUND COMPETITION FOR HAVINGS AND TIME DEPOSITS short-term funds to loans, and our loan expansion has been in large measure accommodated by CD’s” (Dun’s Review, Feb. 18,1966). I should point out that the same results would occur if, for example, funds were to shift from the passbook and time deposits of savings banks and savings and loan associations to commercial bank time deposits. This follows from the fact that such thrift institutions keep their reserve balances in the form of com mercial bank demand deposits. A simple analysis of bank T-accounts would bear this out Similarly, a switch by corporations from Treasury bills to CD’s would have an identical effect if we make the more than reasonable assumption that the Treasury does not retire any debt In all of these cases, there will be an increase in the velocity of circulation which will act as a partial offset to monetary policy. I cannot, within the time allotted to me, get into any detailed analysis of velocity changes and their impact on the effectiveness of monetary policy. This is an area in which there has been much disagreement. I have, however, ap pended to this statement two studies which represent my own views on this issue. One Is a reprint of an earlier article published in the Review of Eco nomics and Statistics in 1960, and the other a typescript which brings the data up to date and challenges the view that velocity changes strengthen monetary policy by providing a safety valve against excessive and unintended