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The Federal Funds Market-A Study by a Federal Reserve System Committee

JOHN J. BALLES
NORMAN N. BOWSHER
HARRY BRANDT
D. R. CAWTHORNE
GERALD M. CONKLING
J. DEWEY DAANE
LEWIS N. DEMBITZ
DOUGLAS R. HELLWEG
BERTRAM F. LEVIN
SPENCER S. MARSH, JR.
SEYMOUR H. MILLER
DOROTHY M. NICHOLS
PARKER B. WILLIS

J. ANDERSON, Chairman
PETER M. KEIR, Secretary
CLAY

Board of Governors
of the Federal Reserve System
Washington




Published May 1959

Library of Congress Catalog Card Number 59-60040




Preface

This study was originally made by a special committee at the request of the Conference of Presidents and the Board of Governors
of the Federal Reserve System. The report was submitted in December 1957. The primary purpose of the study was to obtain
information on the structure of the market for Federal funds, the
volume of operations, and the use of the market by banks and
others—to give a cross-section view of the structure and operation
of the market rather than to determine its behavior over a period
of time.
The study was based primarily on data collected in November
1956, and information obtained from interviews with officials of
banks and other institutions active in the Federal funds market.
The data collected in November and information obtained in the
interviews revealed conditions in the Federal funds market during
a part of the period of credit restraint which prevailed until the
latter part of 1957. Federal funds data available in some Federal
Reserve districts and interviews indicate that some changes occurred in the Federal funds market under the easy-money conditions which began in the latter part of 1957. Recognition has been
given at appropriate places to the more significant of these changes.
Information developed in the study shows that the Federal funds
market has become an important segment of the short-term money
market. Since the focus of the study was on fact finding covering
a limited period, no attempt has been made to draw broad conclusions concerning the efficiency of the Federal funds market as a
means of redistributing the supply of bank reserve funds, the effect
of the market on the loan and investment policies of the institutions
that use it most frequently, or the implication of Federal funds
transactions for credit regulation. Nevertheless, much of the material is of general interest and is unavailable elsewhere.
The Committee desires to express its appreciation to the banks,
iii



PREFACE

dealers, and others for their willing cooperation in supplying data
and other information about the Federal funds market and its operation. The Committee also wishes to acknowledge the assistance
received from members of the staffs of the Board of Governors and
the Federal Reserve Banks through the various stages of the study.
It is especially indebted to a technical review committee consisting
of Harold V. Roelse, Vice President and Economic Adviser of the
Federal Reserve Bank of New York, Donald S. Thompson, First
Vice President of the Federal Reserve Bank of Cleveland, and
Albert R. Koch, Associate Adviser of the Division of Research and
Statistics of the Board of Governors for many valuable suggestions.
The Committee expresses its appreciation to Marie Butler, Chief of
Economic Editing of the Board's Division of Research and Statistics, for many helpful suggestions in preparing the manuscript for
publication.
CLAY J. ANDERSON,

Chairman.

iv




Contents

Page
PREFACE
I. SUMMARY

Origin and Growth of Federal Funds Market
Structure of the Market
Mechanics of Operation
Regional Pattern of Transactions
Use of Market by Banks
Determination and Significance of the Rate
Functions of the Market

II. BACKGROUND AND SCOPE OF STUDY

Media for Adjusting Reserve Positions
Definition and Uses of Federal Funds
Purposes and Scope of the Study
Sources of Information
Limitations of the Data

III. GROWTH OF FEDERAL FUNDS MARKET

Beginnings and Early Development
Market in the 1930's and World War II
Postwar Market
Factors Influencing Postwar Growth
Rulings on Federal Funds Transactions

IV. STRUCTURE OF FEDERAL FUNDS MARKET

Participants in the Market
Mechanics of the Market




iii
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7
8
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29
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34
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50
v

CONTENTS

Page
V. BANK USE OF FEDERAL FUNDS MARKET

Decisions to Use the Market
Use of Market in November 1956
VI.

T H E FEDERAL FUNDS RATE

67

68
78
92

Process of Establishing a Rate
92
Analysis of Rate Behavior
95
Rate as an Indicator of Money Market Conditions... 104
TECHNICAL N O T E : DISCREPANCIES IN SURVEY DATA

106

BIBLIOGRAPHY

110

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Tables

1.
2.
3.
4.
5.

Money Market Instruments Outstanding, 1925 and 1956.
Transactions in Federal Funds, Selected Periods
Size of Banks Surveyed in November 1956
Purchases and Sales of Federal Funds by Survey Banks.
Federal Funds Activity of Accommodating and Adjusting Banks
6. Federal Funds Activity in Relation to Size of Bank and
Required Reserves
7. Net Surplus or Deficit Reserve Positions of Survey Banks.
8. Comparison of Federal Funds Purchases with Borrowing from Federal Reserve Banks
9. Federal Funds Transactions of Adjusting Banks—Frequency and Relation to Required Reserves
10. Rates on Purchases and Sales of Federal Funds, November 1956
11. Rates on Purchases and Sales of Federal Funds, San
Francisco District and New York City Survey Banks,
November 1956
Purchases of Federal Funds Reported by Survey Banks and
Dealers, November 1956
Sales of Federal Funds Reported by Survey Banks and Dealers, November 1956
Purchases of Federal Funds Reported by Survey Banks and
Dealers, by Federal Reserve District
Sales of Federal Funds Reported by Survey Banks and Dealers, by Federal Reserve District




Page
31
33
44
66
82
83
85
86
88
96
97
108
108
109
109

vii




I. Summary

The Federal funds market refers to the borrowing and lending of a
special kind of money—deposit balances in the Federal Reserve
Banks—at a specified rate of interest. Such transactions are commonly referred to in the financial markets as purchases and sales of
Federal funds. As ordinarily used, the term does not include borrowing from the Reserve Banks.
The need for readily available media for adjusting cash and reserve positions is especially important for commercial banks which
are required by law to maintain certain minimum reserves against
their deposits. A multitude of business and financial transactions
are constantly shifting funds among the upwards of 13,000 independent banks, so that some have excess reserves and others have
deficiencies. The larger banks in financial centers are especially
subject to wide day-to-day swings in their reserve positions. For
these larger banks particularly, the Federal funds market is an important method of making adjustments for these daily changes.
ORIGIN AND GROWTH OF FEDERAL FUNDS MARKET

The Federal funds market is not a recent development. It originated in New York City in the early twenties. Several conditions
contributed to the emergence of the market at that time. The postWorld War I depression resulted in sharp disparities in the reserve
positions of New York City banks, some having substantial excesses
and others having to borrow at the Reserve Bank. At times the
discount rate was above some short-term market rates, providing an
additional incentive for deficit banks to borrow excess reserves of
other banks. Officials of some of the New York City banks talked
things over and began buying and selling excess reserves to adjust
their reserve positions. The transfer was usually accomplished by
an exchange of checks—the lender's check being drawn on its reserve balance at the Federal Reserve Bank and presented for clear-




1

FEDERAL FUNDS MARKET

ance the same day, that of the borrower being drawn on itself and
payable through the clearing house the next day.
Although member banks were the first to buy and sell Federal
funds, New York City acceptance houses soon became active in the
market. The acceptance houses, in their dealings with the Federal
Reserve Bank of New York as well as in other transactions, received and paid out Federal funds in the normal course of their
operations. Dealers with more Federal funds than needed in settling
their own transactions began selling them in the market. Gradually,
the acceptance dealers began to shop among the banks for funds,
getting daily information about the demand and the available supply. Soon the dealers began to buy and sell Federal funds at a 1/4
per cent spread and later, as interdistrict transactions developed, the
spread sometimes reached 1 per cent because of discount rate differentials among the Reserve Banks. Usually, only small amounts
were purchased outright, large amounts being acquired on an option
basis.
New York City dominated the early Federal funds market, both
in terms of volume of transactions and number of institutions participating. Local markets also developed in other financial centers,
such as Chicago, Boston, Philadelphia, and San Francisco, but the
volume of trading was much smaller than in New York City. There
were some interdistrict transactions in Federal funds, but the volume was relatively small. New York City acceptance houses with
branches in the principal cities, discount rate differentials which
were common among the Reserve Banks, and the differences in
time between East and West all contributed to the development of
interdistrict trading in Federal funds.
There was little activity in the Federal funds market in the thirties. In the early thirties, doubt about the financial position of borrowing banks was a limiting factor. Later there was little need to
borrow because of the large volume of excess reserves. During
World War II and immediately following, member banks had ready
access to Reserve Bank credit through sales of Government securities at pegged rates, and banks held such large amounts of these
securities that there was little demand for Federal funds.
Several developments set the stage for a revival of the Federal
funds market following World War II. As a result of a change in
2




SUMMARY

character, the call-loan market no longer served as a significant
medium for adjusting bank reserve positions. Growth of the Treasury bill market provided a suitable means for most temporary adjustments but not for those expected to last for only one day or a
few days. Activity in Federal funds was limited, however, as long
as banks had ready access to reserves at low cost under the System's
policy of supporting the prices of Government securities.
Following the Federal Reserve-Treasury "accord," monetary policy became more flexible. In periods of credit restraint, member
banks were forced to rely more frequently on borrowing to obtain
needed reserves. The tendency was to increase the demand for
Federal funds, and the rise in market rates made it more profitable
to sell such funds. Dealers in Government securities often found it
both expensive and difficult in periods of tight money to meet their
financing needs by borrowing from New York City banks. In seeking outsidefinancing,dealers extended their contacts in the Federal
funds market.
Several technical factors also contributed to the growth of the
Federal funds market. The reduction in the deferred availability
schedule in the collection of checks resulted in a substantial rise in
float. Even though the impact of float on total reserves could be
largely offset by System actions, periodic fluctuations in the reserve
positions of individual banks tended to encourage adjustments in
the Federal funds market. Other factors that encouraged the use
of Federal funds were an improvement in wire-transfer facilities and
bank competition, particularly with respect to accommodating correspondent banks.
STRUCTURE OF THE MARKET

The Federal funds market, although national in scope, is loosely
organized. Unlike the securities market, there are no dealers who
maintain a position in Federal funds and stand ready to buy or sell
at quoted prices.
The Federal funds market is predominantly a bank market. This
was clearly revealed by interviews and daily reports of Federal
funds transactions received from a sample of banks and dealers
during November 1956. At that time, about 150 banks—mostly
the larger ones in financial centers—were active participants in the




3

FEDERAL FUNDS MARKET

market. In addition, a number of smaller though still sizable banks,
occasionally entered the market—usually as sellers of funds. Banks
accounted for approximately 80 to 90 per cent of the total dollar
volume of Federal funds transactions reported in the November
survey.
Government securities dealers have become active participants
in the Federal funds market in recent years. Dealers have been
drawn into the market by the practice, which has grown rather
rapidly in recent years, of settling Government securities transactions in Federal funds. The bulk of the transactions in short-term
issues and some of those in long-term issues are settled in Federal
funds. As a result of this practice, dealers receive and pay out
Federal funds in the ordinary course of their operations.
In recent years, dealers have also developed out-of-town sources
of financing, both advances and repayments usually being made by
wire transfer and consequently in Federal funds. Dealers, however,
account for only a small part of total transactions—well below
10 per cent in the November 1956 survey. Other participants include foreign banks and their agencies in New York City, which
are usually suppliers of Federal funds; and a few savings banks
which occasionally participate in the market indirectly by asking
their commercial banks to buy or sell Federal funds for them. This
"other" group is relatively unimportant, supplying less than 8 per
cent of the banks' purchases and accounting for less than 1 per cent
of their sales of Federal funds in the November survey.
A stock brokerage firm in New York City, which is a member of
the New York Stock Exchange, and the correspondent banking
system play leading roles in bringing buyers and sellers of Federal
funds together. The stock exchange firm operates purely as a
broker, mostly with banks and on a national scale.1
Beginning early and continuing throughout most of the day,
banks report their needs and offers of Federal funds to this brokerage firm, which attempts to put the two sides together as quickly
as possible. The firm is often given considerable discretion, par1

Two other New York institutions recently instituted a brokerage service in
Federal funds; however, the description of the activities of the broker who has
been in this business for several years continues to be typical of the brokerage
function in the Federal funds market.

4




SUMMARY

ticularly by potential buyers, in arranging transactions. Sellers of
funds are typically more discriminating, the most important limitation placed on the broker being a list of approved banks to which
they are willing to sell Federal funds. The brokerage firm does not
make a specific charge for its services. Most banks compensate the
firm by giving it some of their stock brokerage business. A small
percentage of the banks prefer to pay a flat fee, usually a commission of1/16of 1 per cent.
Correspondent banks also play a significant role in facilitating
funds transactions. A large part of the total volume of transactions
is among these banks. A few of the large city banks "accommodate"
their correspondents—by buying from and selling Federal funds to
them—even when the transactions run against their own reserve
positions. A larger number buy and sell with correspondents only
as needed in adjusting their own reserve positions. The large city
correspondents are also sources of information on potential buyers
and sellers of Federal funds, and the "going" rate; and the correspondent account is an important medium for handling interest
payments on funds transactions.
MECHANICS OF OPERATION

The daily volume of bank purchases of Federal funds in November
1956 ranged from a low of $600 million to a high of $1.1 billion.
Transactions in Federal funds fall into two general categories.
About three-fourths of the dollar volume in November was in the
form of overnight, unsecured loans. The remainder involved the
transfer of securities either in the form of repurchase agreements or
buybacks, the securities usually being run through a bank's books
as an outright purchase or sale.
Under a repurchase agreement, the lender of funds buys securities, mostly short-term Government securities, and the seller agrees
to repurchase them within a stated time at an agreed price and rate
of interest. In the case of a buyback, the lender enters into two
contracts at the same time: one, to buy securities, usually Treasury
bills, for delivery and payment the same day; the other, to sell the
same issue of securities for delivery and payment the following day.
In both contracts, settlement is in Federal funds. The securities are
bought and sold at agreed prices, or rates of discount in the case of




5

FEDERAL FUNDS MARKET

Treasury bills. The difference in prices or rates of discount represents the interest cost to the borrower of the Federal funds. It is
significant that in both repurchase agreements and buybacks the
risk of price change is eliminated. In this respect, repurchase agreements and buybacks differ from outright purchases and sales of
securities.
The attitude of bank officials toward the "straight" overnight,
unsecured transaction as compared to the repurchase agreement or
buyback varies rather widely. The fact that the straight Federal
funds transaction accounted for approximately three-fourths of the
total volume in November 1956 is evidence of its general popularity. Most bankers regarded this type of transaction as more convenient, involving less bookkeeping and no handling of securities.
On the other hand, the repurchase agreement and buyback do have
certain advantages. The lender incurs less risk; legal limitations on
sales of Federal funds to a single borrower are more liberal even
under the recent ruling that such transactions are to be classified
as loans; and sometimes the rate is more favorable to the lender
than the rate on straight transactions. The repurchase agreement
and buyback were most popular in the Richmond, Kansas City,
Cleveland, and Dallas Federal Reserve Districts, where they accounted for more than one-half of total sales. They also accounted
for nearly one-half of total purchases in the Kansas City District,
and for a substantial amount of purchases in the New York and
San Francisco Districts.
Transactions in Federal funds are typically negotiated by telephone and later confirmed by wire or letter. In transactions between
banks in different Federal Reserve districts, the funds are advanced
and repaid by wire transfer. The payment of interest, however, is
usually by credit to a correspondent bank account. The mechanics
of handling intracity transactions vary. Transactions among New
York City banks are still settled by an exchange of checks—the
lender giving a check on its reserve balance, and the borrowing
bank giving its own check payable through the clearing house the
next day. In cities other than New York, local transactions are
usually negotiated by telephone and, upon instructions by draft or
letter, settlement is by debits and credits to the reserve accounts.
Federal funds are typically traded in units of $1 million or more,
6




SUMMARY

but transactions for smaller amounts frequently occur. Some of
the larger banks, as a matter of policy, buy and sell smaller amounts
to accommodate their correspondents. When reserve positions are
tight, banks may also be willing to deal in smaller units in order to
meet their needs.
REGIONAL PATTERN OF TRANSACTIONS

The Federal funds market is nationwide. The number of banks in
each Federal Reserve district participating in the November 1956
survey ranged from a low of 5 to a high of 23. Purchases of Federal funds in November 1956 were concentrated in three districts—
New York, San Francisco, and Chicago. These three districts, in
which most of the larger money market banks are located, accounted for more than four-fifths of total purchases. New York,
primarily New York City, was by far the most important buyer
with more than 60 per cent of the total; San Francisco was next
with 12 per cent, followed by Chicago with 9 per cent. Sales were
much more evenly distributed. The New York District was the
largest seller, accounting for more than one-third of the total.
Other districts in the order of their importance were San Francisco
with 18 per cent; Cleveland, 11 per cent; Boston, 7 per cent; and
Chicago, 6 per cent.
Banks in the New York District were the largest net buyers of
Federal funds, their total purchases being more than double their
total sales. Banks in the Chicago District purchased substantially
more than they sold; the Atlanta and Dallas Districts also had net
purchases, but too small to be significant. In the remainder of the
districts, sales exceeded purchases. Thus, out of a network of
transactions crisscrossing the United States, the net result appeared
to be an inflow of Federal funds to New York City and, to a lesser
extent, Chicago.
New York City, as the nation's financial center, is clearly the hub
of the Federal funds market. In addition to the inflow of funds from
outside, there is a sizable local market in New York City. Practically all of the transactions in Federal funds in the Federal Reserve District of New York were accounted for by New York City
banks, and nearly one-half of total purchases and one-half of total
sales were made locally. Other local markets of less importance




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FEDERAL FUNDS MARKET

center around San Francisco and Chicago. In the San Francisco
District, over one-half of total purchases and 38 per cent of total
sales were made within the district. About one-fourth of the purchases and over one-third of the sales reported for the Chicago
District were among district banks. In the other districts, transactions were principally with New York and secondarily with other
parts of the country. Only small amounts were within the district.
USE OF MARKET BY BANKS

In recent years, most of the larger banks, in order to keep fully
invested, have followed a policy of daily or at least very short-term
adjustments in their reserve positions. Such a policy frequently
requires quick turnarounds in the market; a bank may be a lender
of excess reserves one day, a borrower to meet a deficiency the next.
The Federal funds market is more suitable than the short-term
securities market for these adjustments. A bank can lend excess
reserves in the Federal funds market without incurring any risk of
loss from a price change or without absorbing any cost from a
spread between buying and selling prices. Call loans formerly had
the same advantages, but in recent years they have taken on more
of the characteristics of customer loans. Consequently, banks rarely
ask immediate payment of call loans.
The Federal funds market is used by only a small percentage of
the member banks, the more active participants being the larger
banks in financial centers. In the latter part of 1956, about 150
banks were active participants in the market; others used the market
infrequently. Available information indicates that the number of
participating banks has increased, particularly since the shift to an
easy-money policy in the latter part of 1957. Smaller banks, regardless of their attitude toward the market, are handicapped because of the legal limit on loans to a single borrower and because
the amounts of their excesses and deficiencies of reserves are well
below the unit in which Federal funds are customarily traded.
Interviews with officials of banks active in the Federal funds
market revealed rather wide variation in attitudes toward this
method of adjusting reserve positions. On the basis of motives for
using the market, banks may be classified into two broad groups—
8




SUMMARY

adjusting and accommodating banks. These groupings, however,
are not mutually exclusive.
Most of the bank participants use the Federal funds market only
in adjusting their own reserve positions—to dispose of an excess or
to meet a deficiency. These banks seldom lend and borrow on the
same day. They may do so occasionally when the morning estimates
of their reserve positions prove to be inaccurate.
"Adjusting banks" may be subdivided into three groups. The
largest consists of banks trying to balance out the reserve week
without either an excess or a deficiency. These banks shift between
lending and borrowing, as necessary, to dispose of an excess or to
cover a deficiency in reserves. Another group, consisting mostly of
the smaller banks active in the Federal funds market, follows a
policy of keeping a cushion of excess reserves. These banks are
typically sellers, rarely buyers. A third but small group of banks
appears to use the Federal funds market, in part at least, to meet
persistent reserve deficiencies. These banks are typically buyers of
funds or, if both buyers and sellers, net buyers on balance.
Federal funds data for selected banks were available at the Reserve Banks of New York and Chicago for longer periods than at
other Reserve Banks, and afforded a comparison of borrowings
from the Reserve Banks with Federal funds transactions by the same
banks. It appeared that the more or less continuous borrowers preferred the Federal funds market. Few of the banks, however, were
able to meet all of their needs in the Federal funds market, and most
of them had to resort occasionally to the discount window as well.
"Accommodating" banks use the Federal funds market for two
purposes: to adjust their own reserve positions, and to accommodate their correspondents and other customers. These banks, relatively few in number, commonly buy and sell Federal funds the
same day. They are two-way traders, often engaging in accommodation transactions which are contrary to their own reserve
positions.
The attitude of the larger banks toward buying and selling Federal funds to accommodate correspondents varies widely. A few
banks pursue a policy of accommodation purchases and sales as a
service to correspondents and as a means of broadening their contacts so that Federal funds will become a more reliable source of




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FEDERAL FUNDS MARKET

reserves. Other larger banks are opposed to such a policy. Important reasons given were the expense and inconvenience of handling a growing volume of small transactions, the dilemma of
making unsecured loans to all correspondents or of incurring the
ill will likely to be provoked by selectivity, and apprehension that
in the long run accommodation purchases and sales might tend to
reduce correspondent balances. Even though opposed in principle
to accommodation purchases and sales, some large correspondent
banks engage in such transactions when necessary to meet competition.
The extent to which banks use the Federal funds market in
adjusting their reserve positions depends on several factors. Relative cost of alternative sources is an important but not necessarily
a dominant consideration. The fact that the prevailing Federal
funds rate does not rise above the discount rate, however, is evidence that preferences for the Federal funds market are normally
not strong enough to induce banks to pay more than the cost of
borrowing from a Reserve Bank.
Expectation as to the length of time a reserve excess or deficiency
is likely to continue is another factor having a significant influence
on choice of a reserve adjustment medium. The spread between
bid and asked quotations and the risk of price change make the
Treasury bill and other short-term securities unsuitable for very
short-term reserve adjustments. On the other hand, short-dated securities are more suitable than Federal funds as a medium of adjustment for an excess or a deficiency expected to persist over a period
of time. Inasmuch as Federal funds and the Treasury bill are used
for largely different types of reserve adjustment, the Federal funds
rate is not tied so closely to the bill rate as to the discount rate.
A third important influence on use of the Federal funds market
is the attitude of bank officials toward borrowing from the Reserve
Bank. Traditional reluctance toward borrowing from a Reserve
Bank manifests itself in different ways. Some banks have a strong
preference for the Federal funds market, using the Reserve Bank
as a source of last resort. The majority of banks participating in
the Federal funds market appear, however, to be willing to borrow
at the Reserve Banks as well as in the market. Some prefer to
borrow from a Reserve Bank to meet deficiencies, and to use the
Federal funds market only to dispose of excess reserves.
10



SUMMARY

Bank use of the Federal funds market is influenced by the attitude
of officials toward such things as the convenience of using the Federal funds market and its reliability as a source of funds as compared to alternative adjusting media. Availability of Federal funds
also affects the use of the market by banks. The supply available
may be quite limited at times because excess reserves are held
largely by banks which do not participate in the market.
DETERMINATION AND SIGNIFICANCE OF THE RATE

A New York City brokerage firm and correspondent banks play
significant roles in bringing buyers and sellers together. As bids
and offers begin coming in early in the morning, the broker attempts
to match them and establish an opening rate. This opening rate is
widely quoted as large banks and dealers call in to check on the
rate. Some banks call their correspondent bank and Government
securities dealers to check on the rate.
The New York City rate tends to set a pattern for the rest of the
country. The November 1956 survey revealed only minor regional
variations in the Federal funds rate. Such differences become more
significant, however, during periods when the discount rates of the
Reserve Banks are not uniform.
The Federal funds rate is inherently a sensitive indicator of bank
reserve positions. Banks use the market primarily to adjust their
reserve positions, and they account for the bulk of all transactions.
The rate's significance as a money market indicator, however, is
limited in three important respects. First, it reflects conditions in
only a segment of the money market—the ebb and flow of reserve
funds among the larger banks, Government securities dealers, and
a few other institutions. Second, the Federal funds market is used
primarily for very short-term reserve adjustments. It does not directly reflect the impact of longer term adjustments made through
the securities market. Third, in periods of credit restraint the Federal funds rate tends to move up to the discount rate and remain
there for extended periods. Under these circumstances, the Federal
funds rate fails to register any intensification—or possibly any
moderate easing—of pressures on bank reserve positions. In periods
of credit ease, the large supply of excess reserves relative to the
demand for them may push the Federal funds rate well below the
discount rate. In this event, the Federal funds rate tends to reflect




11

FEDERAL FUNDS MARKET

day-to-day changes in the availability of reserves in the Federal
funds market.
FUNCTIONS OF THE MARKET

The Federal funds market has become a significant means of adjusting the reserve positions of the large banks in financial centers.
The market is particularly suited to day-to-day reserve adjustments
because it does not involve the risk of price change or the cost of a
spread between bid and asked prices as does the securities market.
Directly, the Federal funds market increases the mobility but not
the total volume of reserve balances. Through the market's facilities, banks with deficiencies purchase the excess reserves of other
banks. The effect, therefore, is to make the excess reserves of one
area or group of banks available to meet the reserve pressures which
may converge on others. Indirectly, the operation of the Federal
funds market, by increasing the availability of excess reserves,
probably results in a somewhat lower level of total reserves than
would exist otherwise. In borrowing Federal funds, banks draw
on existing reserves to meet their deficiencies. In the absence of a
Federal funds market, it is unlikely that deficiencies would be met
without some addition to total reserves. Borrowing from a Reserve
Bank would result in a corresponding increase in total reserves.
Selling securities, unless purchased by banks with excess reserves
or by nonbank buyers drawing checks on banks with excess reserves,
would pass along the reserve deficiencies to other banks. In the
subsequent process of adjusting reserves, banks with deficiencies
would probably borrow from the Reserve Banks, thereby adding to
the total volume of reserves. Thus the Federal funds market, by
facilitating use of existing reserves, tends to reduce the level of
reserves which otherwise would be outstanding under a given set of
circumstances and to minimize repercussions from the temporary
shifting of reserve funds among banks.

12




II. Background and Scope of Study

Commercial banks in the United States have a particular need for
some readily available means for adjusting reserve positions. In a
unit banking system with more than 13,000 independent banks,
excess reserves are not so readily transferred among banks as are
excess funds among the branch offices of a single bank. An independent bank faced with a reserve deficiency must turn to some external source for the needed funds—another commercial bank, a
Reserve Bank, or the money market—either by direct borrowing
or a disposal of assets.
Numerous financial and business transactions—most of them unpredictable—affect a bank's reserve position. Such factors as currency flows, wire transfers, Treasury operations, daily check clearings, and Federal Reserve System purchases and sales of securities
are continually altering a bank's reserve balance and the volume of
deposits against which it is required to hold a reserve. As a result,
the reserve balance may be in excess of the legal requirement one
day and deficient the next. Seasonal or other recurring periodic
shifts may result in a persistent drain on reserves in one period, a
rather steady inflow of funds in another.
The reserve position of the large city bank is likely to be more
volatile from day to day or week to week than that of the small bank
located in a rural area, although the latter may experience relatively
wider seasonal swings. Many of the large banks hold correspondent
balances and deposits of large business firms, the operations of
which are regional or national in scope in contrast to the local
operations of most small firms. Adjustments of reserve and cash
positions thus tend to converge on large banks in the financial
centers.
Most of the large banks strive to maintain an average reserve
balance just sufficient to meet the legal minimum for the reserve
computation period. (The computation period is weekly for central




13

FEDERAL FUNDS MARKET

reserve and reserve city member banks, and semimonthly for all
other member banks.) Excess reserves in a Reserve Bank earn no
income; a reserve deficiency subjects a bank to a penalty. Many
small banks, however, prefer to maintain cushions of excess reserves
so that they need not be concerned about their reserve balances
falling below the legal minimum. The extent to which a bank may
achieve a goal of keeping "fully invested" depends in part on the
facilities available for adjusting its reserve position.
MEDIA FOR ADJUSTING RESERVE POSITIONS

The system of correspondent banks has long played a prominent
role in providing facilities for the adjustment of bank reserve positions. In earlier years, it was common practice for smaller banks
to deposit temporary excess funds with larger correspondent banks
in financial centers. Such balances, and borrowing from correspondent banks, were important sources of funds for meeting deficiencies in reserves. Correspondent banks in regional financial
centers, in turn, redeposited balances with the large money market
banks, principally in New York City. For the money market banks,
call loans to brokers and dealers were an important outlet for temporary excess funds, and such loans were frequently called when
funds were needed to meet deficiencies. The money market banks
also placed call loans for the accounts of correspondent banks and
others. Thus correspondent balances, borrowing from correspondents, and the call-loan market were important media for adjusting
bank reserve positions.
The Federal Reserve Banks, authorized by the Federal Reserve
Act of 1913, also provided facilities for adjusting reserve positions.
Member banks could borrow from the Reserve Banks to meet temporary deficiencies, using subsequent temporary excesses to repay
the indebtedness. Member banks were still dependent on other
outlets, however, for the investment of temporary surpluses in
earning assets. Correspondent balances and call loans continued
to be widely used as reserve adjustment media.
As a result of legislation in the early thirties that prohibited the
payment of interest on demand deposits and regulated brokers'
loans, as well as of institutional changes, correspondent balances
and call loans became less attractive for reserve adjustment pur14




BACKGROUND OF STUDY

poses. Correspondent balances earned no interest, and the call
loan became similar to a customer loan. In recent years, money
market banks have restricted new loans to brokers and dealers
when funds were tight but have rarely called such loans when
funds were needed. Call loans and interbank loans are typically made in clearing-house funds and have the disadvantage of
not affecting the borrowing bank's reserve position until the following day. It is much more difficult to estimate accurately the factors
that will affect a bank's reserve position tomorrow than those that
will affect it today. Although not so important as in earlier years,
many banks still adjust their reserve positions, in part, by borrowing
from correspondents and by transferring deposits from correspondents to Reserve Banks and vice versa.
An important medium for adjusting bank reserve positions is the
market for short-term paper and securities. This is predominantly
an institutional market. Prior to the thirties, open market commercial paper and bankers' acceptances were the principal money
market instruments other than call loans. Government deficits in
the thirties and particularly in World War II resulted in marked
increases in the supply of 91-day Treasury bills and other shortterm Treasury obligations. As commercial bank holdings increased
and the market for these securities broadened, short-term Treasury
securities became an important outlet for excess reserves as well as
a source of funds for meeting deficiencies. In recent years, a growing number of large business corporations and other nonbank institutions have adopted the policy of investing their temporary
excess balances in Treasury bills and other short-term Government
securities. Thus, through the purchase and sale of short-term paper
and securities, the temporary excess funds of some institutions are
made available to meet the short-term deficiencies of others.
Short-term paper and securities are not well suited, however, for
day-to-day adjustments in bank reserve positions. Changes in a
bank's reserve position cannot be estimated accurately even a few
days in advance. Consequently, most of the large banks make
estimates each morning of their reserve positions for the day. Actions are then taken to adjust reserve positions—to lend an estimated excess or to borrow to cover an estimated deficiency. Daily
adjustment, however, often requires quick turnarounds—borrowing




15

FEDERAL FUNDS MARKET

one day, lending the next, or even a turnaround within the day. For
this purpose, even the highest quality short-term paper and securities have the disadvantages of possible price fluctuation and a spread
between the buying and the selling price. A Treasury bill, for
example, unless held for at least two or three days, is usually an
unprofitable investment.
For day-to-day adjustments in reserve positions, a medium is
needed which does not involve a spread between buying and selling
prices or a risk of price change. The Federal funds market—the
borrowing and lending of balances in a Reserve Bank—overcomes
these disadvantages. This is an important reason why the Federal
funds market has become an important method of making daily
reserve adjustments, particularly for the larger banks in financial
centers which are subject to wider day-to-day fluctuations in reserve
positions than are most other banks.
DEFINITION AND USES OF FEDERAL FUNDS

Federal funds refer to deposit balances in the Reserve Banks and
claims against such balances. Federal funds transactions represent
the borrowing or lending of reserve balances, typically for one day,
at a specified rate of interest. In the market, however, such transactions are commonly referred to as purchases or sales of Federal
funds—the terms generally used in this study.
Federal Reserve balances have two unique qualities not possessed
by commercial bank deposits. First, the legal reserve of a member
bank must be held in the form of a deposit balance in a Reserve
Bank. Second, Reserve Bank balances, including checks and
drafts drawn on them, are immediately available funds—the depositing bank receiving an immediate credit and the drawee bank
an immediate debit to their reserve accounts—in contrast to checks
drawn on a commercial bank which give the holder available funds
at a Reserve Bank only after one or two days, depending on the
time schedule for crediting reserve balances for checks in the
process of collection.
The principal uses of Federal funds derive from these qualities
of Reserve Bank balances. Member banks, primarily the larger
ones, are active participants in the Federal funds market and account for a large part of the total volume of transactions. Most of
16




BACKGROUND OF STUDY

the banks use the market to make short-term adjustments in their
reserve positions. A very small percentage of the banks active in
the Federal funds market use it not only to adjust their own reserve
positions but also to accommodate others, principally their correspondent banks.
Immediate availability of Federal funds, in contrast to the delayed availability of clearing-house funds, has given rise to other
uses. A large part of all transactions in Treasury bills and other
short-term Government securities is settled in Federal funds. Purchases and sales for the Open Market Account of the Federal
Reserve System are also settled in Federal funds. The practice of
settling a substantial part of Government securities transactions in
Federal funds, which has become increasingly widespread, has
drawn others than member banks into the market. Government
securities dealers, as market intermediaries, have become important
participants. Dealers in financing their positions often use repurchase agreements and buybacks to tap out-of-town money, and
settlement is made in Federal funds, transmitted through the Federal Reserve leased-wire system. Other corporations, largely because of their securities transactions, find themselves in possession
of or in need of Federal funds. They sometimes enter the market as
buyers and sellers, usually indirectly by having their commercial
bank act for them.
Federal funds transactions vary rather widely in form.1 Most of
them are overnight, unsecured loans, often referred to as straight
Federal funds transactions. Sometimes the transaction takes another
form, such as a repurchase agreement in which the buyer of funds
sells securities under an agreement to repurchase them within a
certain period, at a specified price. The buyer also agrees to pay a
certain rate of interest for the Federal funds so obtained. These
agreements may have a maturity of one day, several days, or, infrequently, several weeks. Similar to the repurchase transaction
but varying slightly in form is the so-called buyback or simultaneous
purchase and sale—one transaction for immediate delivery and
payment, and the other for delivery and payment the next day—
with the price adjusted for the interest differential.
1

Types of transactions are discussed more fully in Chap. IV.




17

FEDERAL FUNDS MARKET
PURPOSES AND SCOPE OF THE STUDY

The scope of this study was limited.2 The primary purpose was to
set forth the facts about the Federal funds market. Specifically, the
study was directed toward the following objectives:
1. Development of data on Federal funds transactions to give a comprehensive cross-section view of the market.
2. A brief review of the origin and growth of the market in so far as
available data permit.
3. Determination of the present structure of the market, including local,
regional, and interregional arrangements for trading in Federal funds; principal borrowers and lenders; and the geographic pattern of funds transactions.
4. Analysis of the use of the market by banks and the attitude of banks
toward Federal funds as compared to other reserve adjustment media.
5. Analysis of the factors determining the Federal funds rate, regionally
and nationally, and the significance of the rate as a money market indicator.

The study was directed primarily toward the buying and selling
of Federal funds for one day, whether by means of a direct, unsecured loan or by transferring securities under repurchase agreement or buyback. One-day transactions account for the bulk of all
trading in Federal funds. Although not limited to banks, the
emphasis was on bank participation in the Federal funds market
for purposes of reserve adjustment. Dealer financing as such was
not included but account was taken of dealer participation in the
market. To include all dealer transactions involving transfers of
Federal funds would get into the whole field of dealer financing—a
subject too broad in scope to incorporate in the study.
Even though the study was focused on bank participation in the
market for one-day funds, other aspects were considered at appropriate places. Data were collected for both one-day and over-oneday transactions to determine the relative importance of each. Data
were also obtained to show the relative importance of banks,
dealers, and others in the market. In analyzing the forces which determine the Federal funds rate, all relevant factors were considered.
SOURCES OF INFORMATION

The factual information was derived mainly from two sources.
First, a daily report of purchases and sales of Federal funds, to2

As explained in the Preface, the study was originally made at the request of
and was submitted as a report to the Board of Governors and the Conference of
Presidents of the Federal Reserve Banks.

18



BACKGROUND OF STUDY

gether with the rate paid or received, was obtained from a nationwide sample of banks and a sample of Government securities
dealers during the month of November 1956. The reports provided
for a breakdown of purchases and sales by regions and by banks,
dealers, and others. The bank sample—selected on the basis of a
preliminary investigation—included all member banks which appeared to make active use of the Federal funds market. Banks
which used the market only infrequently were not asked to report.
Reports were received from 150 banks, including banks in each
Federal Reserve district. Five banks included in the sample on the
basis of the preliminary investigation reported no transactions during the survey month. Daily reports were also received from eight
Government securities dealers in New York City which were active
in the Federal funds market.
A second important source of information was personal interviews. Officials responsible for managing the money position in
each of the sample banks were interviewed to get information on
questions such as the following:
1. How does the bank manage its money position, particularly with
respect to the role of Federal funds as compared to other reserve adjustment
media?
2. What are the attitudes toward buying or selling Federal funds?
3. What factors are considered in deciding whether to use Federal funds
or some other reserve adjustment media, such as borrowing from the Reserve
Bank?

Government securities dealers were interviewed to determine
their role in the Federal funds market. Others especially conversant
with Federal funds were interviewed to get additional information
on the development of the market, its present structure, and current
practices.
Other less important sources of information were used. A few
of the Reserve Banks had Federal funds data for a sample of banks
over a more extended period. Borrowings from the Reserve Banks
and from "others" (borrowings from the latter representing mostly
Federal funds) by weekly reporting member banks provided another clue to recent trends in the use of the Federal funds market
by banks.




19

FEDERAL FUNDS MARKET
LIMITATIONS OF THE DATA

Certain limitations of the November 1956 data should be noted.
First, although a period of one month was considered sufficient to
give a good cross-section view of the structure and current operations of the Federal funds market, it was inadequate to reveal seasonal and other behavior characteristics over time. For these latter
purposes, data for a more extended period would have been required, and their collection would have caused a prolonged delay
in completion of the study. Second, tabulation of the November
data revealed a discrepancy between total purchases and total sales.
The fact that total reported purchases exceeded total reported sales
on all except two business days indicated that the discrepancy did
not result from reporting errors alone. The principal source of the
discrepancy was that reports from Government securities dealers
and the sample of reporting banks represented a more complete
coverage of purchases than of sales. Institutions other than member
banks (mostly in New York) such as foreign banks and their agencies and a few of the large savings banks participate in the market
at times, principally as sellers of funds. The small banks, usually
not active in the market and therefore not included in the November
survey, when in the market are typically sellers rather than buyers
of funds. Reasons for the discrepancy between purchases and sales
are explained more fully in the Technical Note on pages 106-07.
It is believed that the nature of the discrepancy does not impair the
validity of the data for the purposes for which they are used.
It should be noted that bank use of the Federal funds market is
probably influenced significantly by monetary policy and conditions
existing in the money and credit markets. The data should be
interpreted in relation to the banking and credit environment which
prevailed in November 1956. Consequently, monetary policy and
credit conditions during the period are briefly summarized where
such information is considered important in interpreting the data.

20




III. Growth of Federal Funds Market1

The Federal funds market is a specialized product of American
financial organization. Prior to the formation of the Federal Reserve System, the principal instruments in the short-term money
market were commercial paper and call and time loans on security
collateral at the New York Stock Exchange. These instruments
continued to account for most of the activity in the money market
even after 1914, but they were eventually superseded in importance
by new instruments.
The financing of World War I inaugurated a market for shortterm United States Government securities. The basic framework
of the acceptance market had been completed by 1918, and further
development was encouraged and supported by the Federal Reserve
System. The market for Federal funds emerged as a byproduct of
the organization of the Federal Reserve System, and in the early
twenties became a "new market" within that group of institutions
known as the money market.
The Federal funds market has experienced two marked periods
of development—the 1920's and the 1950's. A change in the
functional role of the market between these two periods prevents
strict comparisons. Throughout the twenties, banks participated in
the Federal funds market almost exclusively in order to adjust
reserve positions. While this original function remained the primary one in the later period, Federal funds acquired increased
importance, directly or indirectly, in connection with dealer financing and the settlement of transactions in short-term Government
securities.
1

This chapter, developed as a part of the Committee's study, was published in
essentially its present form by the Federal Reserve Bank of Boston in 1957.




21

FEDERAL FUNDS MARKET
BEGINNINGS AND EARLY DEVELOPMENT

The Federal funds market originated in New York City.2 The first
transactions were among several of the leading city banks in the
early summer of 1921. By mid-1923 a fairly active market had
developed which the city banks used frequently in adjusting reserve
positions. A few of the banks, however, did not participate as a
matter of policy until later. As the decade of the 1920's progressed,
trading within New York City broadened and transactions among
Federal Reserve districts developed on a limited scale. Before
1925, local markets appeared in such cities as Boston, Philadelphia,
Chicago, and San Francisco.
In the late spring and early summer of 1921, depressed conditions had diverse effects on the large New York City banks. Some
had substantial excess reserves; others were borrowing at the Federal Reserve Bank of New York. Banks with surplus funds had
trouble finding investment outlets in the usual channels. Activity
in the money markets diminished, and open market money rates
declined steadily from the 1920 peak, some falling close to and
others below the average discount rate in all Federal Reserve districts after mid-1921. This situation was discussed informally by
the officers of several leading banks. As a result, banks which were
borrowing from the Reserve Bank began purchasing balances from
banks with excess reserves. The lending banks were able to realize
a return on their excess reserves until they could be placed in loans,
investments, or other outlets in the money market. The banks with
insufficient reserves were able to reduce their borrowings from the
Reserve Bank.
Federal funds transactions involved the transfer of reserve balances from the lending to the borrowing bank on the books of the
New York Federal Reserve Bank, generally by an exchange of
checks. Initially, the practice was for both the lender and the borrower to make their checks payable immediately. But in order to
forestall the possibility of an early deposit of the borrower's check,
2
Information and data on the early Federal funds market and its later growth
and development were obtained from the following sources: (1) interviews with
officials reputed to be familiar with and who participated in the market during
its early period of development; (2) information in the files of the Federal Reserve Bank of New York; and (3) published sources such as The New York
Money Market, edited by Benjamin H. Beckhart, Columbia University Press,
New York, 1932.

22



GROWTH OF MARKET

it became customary for the borrowing bank to draw the check on
itself, payable through the clearing house the next business day.
The typical unit of Federal funds traded in the twenties was
$1 million, but transactions of $500,000 appeared frequently, and
$100,000 was not uncommon when the money market was tight.
During the first year of operation of the Federal funds market, the
volume of transactions was reported as probably rarely exceeding
$20 million a day. Prior to 1925 the volume on an average day was
reported to have ranged between $40 million and $80 million. Beginning in 1925, the volume was estimated at about $100 million
for an average day but at times ranged up to $250 million. The
volume tended to approach the upper limit of the range on reserve
settlement days in New York because the greatest demand arose
from banks wishing to adjust their reserve positions.8 Some 30 to
40 banks and about 10 acceptance houses accounted for the bulk
of the trading. Agencies of foreign banks located in New York City
were also important sources of Federal funds at times.
Role of acceptance houses in the 1920's.

Although member banks

in New York City were the first buyers and sellers of Federal funds,
the discount or acceptance houses played a leading role in the development of the market in the 1920's and 1930's. Some of these
firms conducted business in Government securities, commercial
paper, and other investments as well as in acceptances. Moreover,
the Federal Reserve System during the 1920's conducted a substantial volume of open market operations in acceptances as well as in
Government securities. The Federal Reserve Bank of New York
purchased from banks properly endorsed acceptances when they
were offered, but a substantial part of its market transactions was
with acceptance dealers. From about 1924 on, the Bank dealt with
about 10 recognized dealers when buying acceptances and Government securities for its own account and for the accounts of its foreign correspondents. Such recognized dealers were also permitted
to sell acceptances and Government securities to the Bank under
repurchase agreements.4
At least one of the leading acceptance houses maintained a non3
Prior to 1928 the reserve computation period was one week, and settlement
was on Friday; from January 1928 to March 1942 it was semiweekly, and settlement days were Tuesday and Friday.
4
The policy of dealing only with recognized dealers was abandoned in 1953.




23

FEDERAL FUNDS MARKET

member clearing account at the Federal Reserve Bank of New
York, as did several American foreign banking corporations which
were active in the acceptance market. These accounts had been
opened as early as 1919, partly as a convenience to the New York
Reserve Bank in handling transactions in acceptances and Government securities. Thus, having these accounts, the firms were in a
position to sell their own checks on the Federal Reserve Bank. In
some cases, the deposit accounts of these firms were built up through
sales of acceptances and Government securities direct or under repurchase agreement to the New York Reserve Bank. In other cases,
the firms acquired title to reserve balances in settling transactions
with the Reserve Bank before such funds reached the commercial
banks. Dealers also acquired title to Federal funds from several
other sources: outright purchases, conversion of deposit balances
in excess of the customary amounts carried with commercial banks,
proceeds of the sale of acceptances and securities to out-of-town
banks received through the Federal Reserve Bank, payments received in redemption of United States Government securities and
interest coupons, and maturing acceptances.
Acceptance houses used Federal funds in settling their own transactions, and also sold funds in the market. In the former case,
Federal funds were used (1) in payment of acceptances and United
States securities when the terms so specified, and (2) in payment
of calls on war loan deposits if such accounts were maintained.
Alternatively, surplus funds were sold in the market, and when
demand was insufficient to absorb the surplus the balance was deposited in the New York clearing-house banks.
Federal funds deposited by a dealer in his regular account at a
commercial bank drew only the rate then paid on demand deposits.
When, however, dealers requested Federal funds in making withdrawals from their accounts, the commercial banks usually charged
the call-loan rate or more, depending upon their reserve positions.
A bank with excess reserves, however, might be willing to supply
the dealer with its check on the Reserve Bank at or below the discount rate. Gradually the dealers began to shop among the banks
for Federal funds, and found that regular purchases and sales could
be accomplished. The leading dealers eventually developed a systematic daily telephone canvass of possible buyers and sellers, thus
24




GROWTH OF MARKET

collecting daily information about the demand and supply of Federal funds, and they soon began to buy and sell Federal funds on a
quarter-point spread. Later, as interdistrict trading developed, the
spread ran as high as one percentage point at times because of discount rate differentials. The dealers usually purchased only small
amounts of Federal funds outright but customarily acquired large
blocks on an option basis. They also performed the service of combining small purchases into usual-size trading units, and at times
split large blocks for retailing.
Money brokers. Money brokers found that the status of a bank's
reserve position was important in relation to the call-money market.
Lending banks with excess reserves were less likely to call their
loans than banks which were short of reserves. Therefore, brokers
arranged to supply Federal funds to banks with insufficient reserves,
obtaining the funds from banks with excess reserves. Brokers considered this service an important adjunct to their call-money operations as it led to procurement of blocks of call and time money on
which they received a commission from the borrower.
Regional developments. Acceptance houses having branches in
the principal cities, particularly Chicago, Boston, Philadelphia, and
San Francisco, developed a considerable volume of interdistrict
transactions in Federal funds and formed the focal point of local
markets in some of these cities. Local markets in the 1920's were
generally limited to centers where financial activity was most concentrated. Atlanta, Dallas, Minneapolis, Richmond, and St. Louis
had only small amounts of transactions in Federal funds among
local banks. Some of these cities, however, at times sold Federal
funds to New York, Philadelphia, and San Francisco.
As might be expected, the New York City market was the largest,
both in terms of volume and in the number of participating banks.
Most of the transactions were between New York City buyers and
sellers and, to a lesser extent, between New York City banks and
out-of-town institutions. Banks which bought and sold Federal
funds were able to match needs locally to a larger extent in the early
years of the market than they were in the 1950's. If excess funds remained, they were offered to buyers in New York or in other cities.
Certain New York City banks, however, pursued a policy during the
1920's of not dealing in Federal funds with out-of-town correspond-




25

FEDERAL FUNDS MARKET

exits, and thereby discouraged extension of the market. For these
reasons, the volume of interdistrict transactions was probably relatively smaller than at present, while the volume of intracity trading
in financial centers like Boston, Chicago, and Philadelphia was
substantially larger.
Interdistrict trading. The differentials in discount rates among Federal Reserve Banks which characterized the 1920's encouraged
transactions across Federal Reserve district lines. During the latter
part of the 1920's a relatively active interdistrict market developed
with participants along the West Coast. Advantages in supplying
this market were found not only in the differential in discount rates
but also in time-zone differentials. When New York banks closed
at 3 p.m., San Francisco banks were still open for business since
it was only noon on the Coast. (When New York is on daylight
saving time and San Francisco is not, a four-hour differential exists.)
This time differential enabled Eastern banks to estimate their reserve positions and, if in excess, to sell Federal funds to banks in
the West before the wires closed about 2:30 p.m. The funds were
usually returned to the East early the following day.
The amount of Federal funds offered depended not only on time
differences but upon correspondent relationships. For example,
two large San Francisco banks depended on their wholly owned
Eastern affiliates as important sources of Federal funds. These
affiliates acted as agents in procuring funds when they had none of
their own. Certain San Francisco banks solicited Federal funds
from banks in many parts of the country and were willing to receive
such funds up to certain limits at all times and without notice, agreement as to rates being understood. Under one such agreement,
Federal funds were received but were paid for only at the demand
deposit rate unless the bank could actually profit from their use.
Many of the transactions in San Francisco were at flat rates, the
rates having little relationship to rates in New York City. In general, Federal funds were received from most of the large cities.
New York, Boston, and Philadelphia supplied the bulk, followed
by Chicago, Detroit, Atlanta, New Orleans, St. Louis, Kansas City,
and Dallas. In other cases, however, Federal funds from the East
were sent to banks in the Middle West and forwarded from there
to San Francisco.
26




GROWTH OF MARKET

Relation to other markets. The volume of Federal funds transactions in the 1920's was small compared to the volumes in other
segments of the money market; it was also small compared to the
present volume of Federal funds transactions. In part, this position
of the Federal funds market probably reflected the somewhat narrower function which it performed in the 1920's compared to
today.
Throughout the 1920's, the concentration of both primary and
secondary commercial bank reserves in New York City was significant, although somewhat smaller in relative volume than under the
old national banking system. New York correspondents placed
funds for the interior banks in call and time loans on the New York
Stock Exchange, short-term commercial paper, acceptances, and
securities, and in addition held some funds on deposit. Call loans
during the 1920's were considered the safest and most liquid available use for temporary surplus funds of banks and others. The
call-loan market was the most centralized market and normally
commanded higher rates than were paid on demand deposits. Interior banks shifted from balances with New York City correspondents to brokers' loans and vice versa, depending on the call-loan
rate. New York City banks followed the tradition of placing loans
for correspondents before their own.
Table 1 on page 31 shows the amounts of the various instruments
outstanding in the money market in 1925. The daily volume of
Federal funds transactions reportedly ranged from about $100 million to $175 million. The market for commercial paper was broadest during most of the twenties in the sense that it was used by the
greatest number of banks. The Federal funds market was probably
the narrowest but was an important segment of the money market.
The chief function of the Federal funds market was to facilitate
short-term adjustments in bank reserve positions. It served as a
medium for mobilizing the excess reserves of some banks and made
them available to other banks with reserve deficiencies. Federal
funds were also used at times in settling securities and other transactions by bank customers. The Federal funds market was used
as an investment medium by relatively few banks. Alternative
markets were generally more profitable and offered a wider range
of choice. Today, Federal funds provide a partial substitute for




27

FEDERAL FUNDS MARKET

several classes of money market instruments which were available
in the late twenties and early thirties.
Rate relationships in the twenties. The Federal funds rate in the
twenties, as now, tended to be limited by the discount rate of the
Federal Reserve Banks, but not so closely.
When the call-loan rate was close to the Federal funds rate in
New York City, the interior banks with surplus funds which participated in the Federal funds market usually sold Federal funds to
avoid the 1/2 of 1 per cent commission charged by correspondents
in placing call loans. Federal funds also had the advantage of immediate availability in contrast to call loans, which were in clearinghouse funds and therefore not immediately available. The banks
also used the Federal funds market as a last-minute outlet for surplus funds not needed as reserves or for call loans.
The Federal funds and call-loan rates at times tended to fluctuate
in opposite directions. When rising call rates attracted a substantial
volume of funds from outside areas to New York City, the transfers
were effected over Federal Reserve Bank wires in Federal funds,
thus creating a surplus of such funds in New York City. At other
times, when Federal funds were demanded in the interior and callloan rates were low, the demand for Federal funds to make wire
transfers drove the rate above the discount rate on occasion. Regardless of other factors, the Federal funds rate tended to be strong
on reserve settlement days.
During 1928, the Federal funds rate frequently stood above the
discount rate, and in 1929 the spread at times reached 3/4 to 1 per
cent. Some banks lacked eligible paper for rediscount; others with
a large volume of call loans preferred to borrow reserves in the
Federal funds market rather than risk criticism by borrowing at the
Reserve Bank. After the stock market collapse in October 1929
the Federal funds rate dropped sharply, partly because of the heavy
inflow of funds to New York in meeting margin calls, and partly
because of Federal Reserve action to relieve strains in the money
market. In 1931 and 1932—except late in 1931 when discount
rates were raised because of the crisis abroad which resulted in the
suspension of gold payments by the United Kingdom and an outflow
of gold from the United States—pursuit of an easy-money policy
28




GROWTH OF MARKET

THE FEDERAL FUNDS RATE, DISCOUNT RATE,
AND BORROWINGS-NEW YORK CITY 1928-1932

NOTE.—Average weekly rate on Federal funds, and the discount rate of the Federal Reserve Bank of
New York. Borrowings from Federal Reserve Bank of New York by New York City weekly reporting
member banks.

by the Federal Reserve System and gold inflows caused the Federal
funds rate frequently to drop as low as1/4to1/8of 1 per cent.
MARKET IN THE 1930'S AND WORLD WAR II

The Federal funds market dried up during the Great Depression.
Banks became very cautious about arranging these unsecured loans
as uncertainty developed about bank solvency. Many banks adopted
the policy of operating with large cash cushions. The volume of
transactions began to decline, especially interdistrict transactions,
as the number of bank failures increased. Sporadic trading, however, continued where correspondent relationships were strong, and
sometimes Government securities were pledged if a series of transactions was contemplated.
Later in the 1930's, as gold flowed in from abroad, banks accumulated huge excess reserves and there were few occasions when
banks needed to borrow. At times, however, moderate trading was
resumed as increases in required reserves in 1936 and 1937 and
29



FEDERAL FUNDS MARKET

expanding loan and investment portfolios temporarily absorbed
some of the overhang of excess reserves.
Early in 1941, as markets began to tighten in response to financial pressures resulting from World War II, Federal funds transactions became more frequent, principally in New York but also
in several other large cities. At least one money broker stood ready
to provide clearing facilities for transactions in New York City.
The volume of transactions was smaller than in the late 1920's and
probably averaged $75 million to $125 million a day. Many banks
still had excess reserves. The volume tended to increase toward the
close of the war. The market, however, continued to be local or
regional in character throughout the war years.
During the war and early postwar periods, banks made most of
their reserve adjustments in the Treasury bill market rather than in
the Federal funds market. Under the directive of the Federal Open
Market Committee, banks could sell Treasury bills to the Reserve
Banks at a discount of 3/8 of 1 per cent with the option of repurchasing a like amount of bills of the same maturity at the same rate of
discount. Thus, reserves were readily available to member banks
at a rate of 3/8 of 1 per cent. This policy also affected the yields of
other Treasury securities of similar maturity which were originally
issued for longer terms and at higher rates. Thus, it was profitable
for banks to buy longer maturities and sell them as they approached
maturity.
POSTWAR MARKET

Changes which developed in the banking system as a result of the
Great Depression, easy-money conditions in the late 1930's, legislation, financing of World War II, and the increase of bank mergers
and branch systems provided a different structural setting for the
money market when the postwar period opened. The rapid growth
of production, population, and income expanded the demand for
banking services, while growth in the average size of business units
created a demand for bigger banks with more capital funds to permit larger loans to a single borrower. Significant shifts in the distribution of population and income also had a marked impact on
commercial banking.
The greater diffusion of deposits throughout the United States,
30




GROWTH OF MARKET

the relatively small volume of commercial paper and acceptances,
and the growth of the market for United States Government securities altered the character of the money market. Market shifts, as
well as legislation, changed significantly the character of the callloan market even before formal closing of the money desk on the
Stock Exchange in 1946. These changes resulted in new money
market arrangements, and altered the relative importance of money
market instruments, as indicated in Table 1.
TABLE 1
MONEY MARKET INSTRUMENTS OUTSTANDING, 1925 AND 19561
[In millions of dollars]
Instruments
Brokers' loans
Commercial paper
Acceptances
U. S. short-term securities
1

1925

1956

2,000-3,000
600- 800
600- 800
2,500-3,000

500800
475 550
625 700
58,000-60,000

Approximate range in amounts outstanding during the year.

The most striking change was the marked increase in short-term
Treasury securities. The daily volume of Federal funds transactions
also increased from an estimated range of $100 million to $175
million in 1925 to $600 million to $1.2 billion in 1956. On the
other hand, brokers loans, commercial paper, and acceptances were
relatively much less important than in the 1920's.
Legislation in the early thirties contributed to these changes. The
prohibition of member banks acting as agents for nonbank lenders
in the placement of securities loans, the elimination of payment of
interest on demand deposits, and the establishment of margin requirements were some of the important features affecting the money
market. The volume of call loans declined, and such loans came to
involve customer relationships so that, in actual practice, banks
rarely called them to meet reserve deficiencies.
The large increase in size and marked change in composition of
the public debt as well as its broadening and shifting ownership
provided a new sensitive medium in which financial institutions and
others could adjust their cash positions. Federal Reserve credit
policy, especially after early 1951, was reflected in higher rates for




31

FEDERAL FUNDS MARKET

Government securities and a greater reliance on borrowing from
the Reserve Banks for reserve adjustment.
With the increase in breadth and activity in the Government
securities market as short-term rates rose, the competitive search
for Federal funds became more intense. Moreover, negotiation over
the form of settlement—clearing-house or Federal funds—became
a factor in many financial transactions, including payment for new
long-term capital issues. To a large extent, dealer transactions had
always been settled in Federal funds, but insistence by customers
on such settlement made a substantial addition to demands. Consequently, securities dealers found it necessary to become active
participants in the Federal funds market both as intermediaries and
as principals.
Before World War II, Government securities dealers borrowed
largely from the New York City banks to finance their positions.
This continued to be the situation during the period of relatively
easy money in the early postwar period—until 1952. New York
banks were again a major source of dealer financing during the
period of ease in 1954. During recent periods of tight money, however, dealers in Government securities had difficulty in obtaining
adequate financing from the New York City banks at favorable
rates in relation to yields on securities in their portfolios. As a
consequence, dealers sought financing outside the city. Through
the use of repurchase agreements, they were able to tap the temporary funds of a variety of financial and nonfinancial institutions.
Banks in large centers have found that purchases of Federal
funds offer a partial substitute for the demand deposit balances
which they acquired in the 1920's when interest payments on these
balances were permitted. On the other hand, sales of Federal funds,
in a significant sense, now fill the position formerly occupied by
the old call-loan market as an outlet for secondary reserves. The
current role of banks, dealers, and others in the Federal funds
market will be explained more fully in the next chapter.
Growth in volume and participants. The volume of transactions in
the Federal funds market on an average day has increased significantly since the mid-1920's, as Table 2 shows. The number of
banks participating in the market has also increased, especially
since 1950. Banks actively participating in 1957 numbered about
150, and other banks participated less frequently.
32




GROWTH OF MARKET
TABLE 2
TRANSACTIONS IN FEDERAL FUNDS, SELECTED PERIODS

Number of participants
Period

Average daily volume
of transactions
(In millions of dollars)

1925-32
1950-53
1955-57
1

100- 250
350- 450
800-1,100

Banks1

Dealers in
acceptances and
Govt. securities

3 0 - 40
75-100
125 - 200

10
14
18

Includes foreign agencies.

In relation to required reserves, Federal funds transactions have
shown little, if any, growth. On an average day, the volume of
transactions in the 1920's ranged from about 4 to 10 per cent of the
required reserves of member banks. In mid-1957 it ranged from
about 4.5 to 7 per cent. By this measure, bank use of Federal funds
at the present time is of no greater relative importance than in the
earlier period. It should be noted, however, that in 1957 required
reserves as a percentage of deposits were approximately double
those in the 1920's. While the volume of Federal funds transactions
as a percentage of required reserves was about the same, in absolute
terms it was probably five to eight times larger in 1957.
With daily average borrowing from the Reserve Banks added to
Federal funds transactions, the total at times reached some 50 per
cent of total required reserves in the 1920's in contrast to about
10 per cent in recent periods—an indication of the substantially
larger borrowed reserve base under the credit structure of the
1920's.
Growth in the volume of bank transactions in Federal funds is
also indicated by borrowings of weekly reporting member banks.
Since 1953, borrowings from the Reserve Banks and borrowings
from "others" have been reported separately. A comparison of
borrowings from others (than the Reserve Banks) with Federal
funds data available at some of the Reserve Banks shows that onehalf to two-thirds of such borrowings of weekly reporting member
banks represented Federal funds. Data on borrowings from others
than the Reserve Banks indicate that the volume of Federal funds
transactions almost doubled over the three-year period 1953-55.




33

FEDERAL FUNDS MARKET

Borrowing from the Reserve Banks in 1956, however, did not reach
the levels attained in late 1952 and early 1953.
Some differences in the prewar and postwar markets. The basic func-

tions of the Federal funds market have changed relatively little over
the years. It has been used mainly by the large banks in making
day-to-day adjustments in their reserve positions. The scope of the
Federal funds market is considerably broader than in the prewar
period. Today, it is common practice for banks to sell Federal
funds to or buy funds from banks in New York and other cities.
Changes in the operating policies of many New York banks with
their correspondents, the clearing facility offered by a New York
stock brokerage firm, and services provided by correspondent banks
facilitate intercity and interdistrict transactions.
Differences in size and character of business among banks in one
city result in varying reserve needs which frequently cannot be completely adjusted in the local Federal funds market. Similarly, intercity trading within districts occurs in greater volume currently
because of the more rapid growth of banks outside the traditional
money centers and because a different pattern of financial settlement developed as these banks extended the scope of their activities.
Currently, some banks "follow the clock," buying or selling Federal funds successively in New York, Chicago, occasionally in St.
Louis or Kansas City, and finally in San Francisco or Los Angeles.
Banks in Denver rarely make overnight, unsecured purchases or
sales with other banks, but on occasion sell funds through buybacks
with Government securities dealers. Other banks in the Mountain
Time Zone, for example in Phoenix, participate actively in overnight, unsecured transactions either as buyers or sellers.
The core of the market, as in the 1920's, is still the large money
market banks, but today their number is greater and they are more
widely distributed over the nation. In recent years, however, a
substantial number of somewhat smaller banks have participated
actively either in unsecured transactions or in repurchase agreements and buybacks.
FACTORS INFLUENCING POSTWAR GROWTH

The chief factors influencing the postwar growth of the Federal
funds market were the alteration of the institutional framework of
34




GROWTH OF MARKET

the money market and related changes in institutional practice,
generally described earlier. There were other factors, however,
which influenced directly or indirectly development of the market.
Services of intermediaries. Federal funds transactions began to
grow in volume as well as frequency in 1947 and 1948. Interdistrict
dealings with New York City and other centers increased slowly
when they were resumed after the close of the war, and were
handled almost entirely by correspondent banks.
Growth of the Federal funds market, especially in the 1950's,
was encouraged by improvement in the facilities for bringing buyers
and sellers together. A New York City brokerage firm, a member
of the New York Stock Exchange, which earlier had acted as a
clearing center locally for potential buyers and sellers of Federal
funds, initiated its service on an interdistrict basis about 1949, with
the result that an increasing number of banks arranged transactions
through the firm. Data supplied by the broker show that the
volume of Federal funds transactions handled by the firm has grown
substantially since 1949. The average daily volume of transactions
ranged from $350 million to $400 million in 1956, compared to
$100 million to $150 million in 1949. The number of participating
banks also increased significantly. Although the proportion of the
total volume of transactions handled by the firm may well have
varied, the data indicate substantial growth in the Federal funds
market.
In recent years, some of the New York City banks have developed
an accommodating business—in effect performing a brokerage
function among their correspondents. These accommodating banks
buy and sell Federal funds as a service for their correspondents, as
well as to adjust their own reserve positions.5 This service has also
attracted a number of newcomers to the market, mostly relatively
small banks with close correspondent relationships, or banks which
for some reason prefer not to deal through the broker. The ability
of the accommodating banks to serve their customers was dependent, in part, on the services of the broker in facilitating contacts or
furnishing information.
5
For a more complete description of accommodating banks and their activities,
see Chap. V, pp. 85-87, 90-91.




35

FEDERAL FUNDS MARKET

Federal Reserve operating practices. Certain technical modifications in Federal Reserve operating practices probably contributed,
at least indirectly, to growth in the Federal funds market. Changes
related to computation of required reserves provided more leeway
for using Federal funds in the reserve adjustment process. Beginning in March 1942, member banks located in central reserve and
reserve cities were permitted to average reserves for weekly periods
rather than semiweekly. In October 1949, all member banks were
permitted to offset a deficiency in one reserve computation period
with an excess in the subsequent reserve period, provided the deficiency carryover did not exceed 2 per cent of the required reserve.
In one respect, the longer period and the privilege of carrying over
a deficiency might have tended to reduce the need for reserve adjustment because of the greater probability that a deficit for one day
or a few days would be offset by surpluses on other days. Most of
the large banks in financial centers, however, make daily reserve
adjustments on the basis of early morning estimates of their reserve
positions. The longer period for averaging reserves and the privilege
of carrying over a deficiency facilitate management of a bank's
reserve position and fuller use of its available funds.
Reduction in the check collection time schedule, to the extent
that it resulted in increases in float and wider temporary swings in
reserve positions, perhaps contributed to an increased volume of
Federal funds transactions. The maximum in the time schedule was
reduced from eight days to three days in 1939 and to two days in
1951. Banks which watch their money positions closely allow
specifically for the effect of float on their day-to-day reserve positions, particularly as the level and amplitude of swings have increased in recent years.
Improvement in wire-transfer facilities, making possible more
rapid transfers of funds, facilitated and probably encouraged bank
use of the Federal funds market. Since the close of the war, the
System's wire-transfer facilities have been steadily improved. The
transmission time of instructions over the wire has been reduced,
and the volume of messages handled has increased. The inauguration of the "bank wire" by commercial banks in 1950 substantially
improved communication among banks. The wire now links more
than 200 banks in 60 principal cities.
36




GROWTH OF MARKET

Easy and tight money conditions. Available data indicate that the
years of most rapid growth in the volume of Federal funds transactions were 1950, 1951, and 1954, with increases of 80, 36, and
18 per cent, respectively. These were years in which, for the most
part, money market conditions reflected some degree of ease. It
should be noted, however, that credit conditions were not so easy
during the latter part of 1950 and 1951, and that the volume of
Federal funds transactions in 1950 was influenced by a relatively
large number of new entrants into the market. Available data also
indicate an increase in the volume of Federal funds transactions
following the shift to easier money conditions in the fall of 1957.
The volume of Federal funds transactions also increased during
periods of credit stringency, but at a much diminished rate as compared to periods of ease. From 1952 to 1953, the volume of Federal funds traded through the New York brokerage firm increased
only 3 per cent, and in a substantially broader market the increase
from 1955 to 1956 was about 11 per cent. Data for a number of
individual banks in New York City and Chicago, as well as for
some outside those areas, reveal the same tendencies.
There are good reasons why the volume of Federal funds transactions might well increase more rapidly in periods of easy money.
During periods of ease, Federal funds are generally more readily
available in the market. More of the banks active in the Federal
funds market are likely to develop excess reserve positions in
periods of easy money than in periods of tight money; and these
banks are likely to be more willing to sell temporary excesses. If
estimates prove to be wrong and reserves are subsequently needed,
Federal funds can often be purchased at the same or possibly a
lower rate.
Sustained demands for Federal funds during periods of ease come
from several sources. Borrowings by Government securities dealers
tend to be larger when money market conditions are easier, reflecting the greater opportunities for profitable positions in securities
when rates are falling than when rising. Larger borrowing by dealers in 1954 and in 1958, for example, supported a part of the
demand for Federal funds by banks particularly active in financing
the dealers. New York City banks were able to buy large amounts
of Federal funds which, to some extent, influenced their willingness




37

FEDERAL FUNDS MARKET

to lend to dealers. The fact that the Federal funds rate is frequently
below the discount rate of the Reserve Banks during periods of
monetary ease also tends to strengthen the demand for Federal
funds. The rate differential is an inducement for banks with temporary reserve deficiencies to purchase Federal funds rather than to
borrow at the discount window.
During periods of tight money, there is a tendency for the supply
of Federal funds offered in the market to diminish. Excess reserves
are less prevalent among banks, particularly among larger banks,
which participate actively in the Federal funds market. Moreover,
banks may be somewhat more reluctant to sell temporary excesses
because of a more continuous need for funds to meet customer loan
demands and because they may not be able to buy adequate
amounts of Federal funds later if needed. Some banks also adhere
more closely to certain rules, such as dealing only with banks with
which they have established credit lines. Demand for Federal funds,
however, tends to intensify as reserve deficiencies recur more frequently and in larger amounts. Thus, in periods of tight money the
volume of transactions is likely to increase at a slower rate than in
periods of ease because the supply of Federal funds tends to be
more limited. Furthermore, in periods of tight money the Federal
funds rate is usually equal to the discount rate much of the time.
When such rate equality prevails, purchasing Federal funds is no
cheaper than borrowing at the discount window.
It is difficult, however, to establish from experience in the 1950's
a functional relationship between the volume of Federal funds transactions and conditions of ease or tightness in the money market. In
the first place, complete data on the volume of Federal funds transactions during the period are not available. Second, it is impossible
to isolate the extent to which changes in the volume of transactions
resulted from changes in credit conditions or from other influences.
For example, the structure of the Federal funds market changed
somewhat from one period to another as more banks became aware
of and began to use the market. Despite the significance of these
factors, however, it appears that periods of ease are more favorable
to growth in the volume of Federal funds transactions than periods
of restraint.
Other factors. The marked increase in Government securities
transactions probably contributed to an expansion in Federal funds
38




GROWTH OF MARKET

activity inasmuch as transactions in short-term Government securities are typically settled in Federal funds. Deficit financing in
World War II resulted in a tremendous rise in Government securities outstanding, including short-term issues. At the end of the
war, commercial banks, other financial institutions, and large corporations had large holdings. As private demand for credit increased with the postwar expansion in business activity, lending
institutions disposed of some of their Government securities to
obtain funds for loans. In the earlier postwar years, playing the
pattern of rates probably tended to expand the volume of transactions in Government securities.
The excess profits tax may have induced some additional trading
in Federal funds during the period 1951 to 1953. In 1951, the
Bureau of Internal Revenue ruled that purchases of Federal funds,
like other forms of borrowing, could be included in the "capital
base" in calculating excess profits tax liabilities. There is no concrete evidence that banks generally increased their purchases of
Federal funds for the express purpose of reducing their tax liability,
although it is not unlikely that some may have done so. Perhaps a
few large banks may have bid aggressively for Federal funds during
that period and supplemented their borrowing at the Reserve Banks
to establish a larger capital base. For the most part, however, the
inclusion of Federal funds purchases in the capital base was a
collateral benefit, and the basic forces stimulating expansion of the
market lay elsewhere.
Differences in discount rates among the Reserve Banks which at
times have existed for short periods tend to stimulate transactions
in Federal funds. Available data show that banks in districts where
the discount rate is higher rely less on borrowing from the Reserve
Banks and meet a larger proportion of their reserve needs by buying
Federal funds from banks in districts where the discount rate is
lower.
RULINGS ON FEDERAL FUNDS TRANSACTIONS

The Federal Reserve Act, Section 19, reads in part:
The required balance carried by a member bank with a Federal Reserve
Bank may, under the regulations and subject to such penalties as may be
prescribed by the Federal Reserve Board, be checked against and withdrawn
by such member banks for the purpose of meeting existing liabilities. . . .




39

FEDERAL FUNDS MARKET

This provision makes possible borrowing and lending of excess
reserve balances or, in other words, the purchase and sale of Federal funds.
The market in Federal funds has been subject to several rulings
by the Federal Reserve Board and the Comptroller of the Currency.
These rulings arose from uncertainty and lack of uniformity in
reporting Federal funds purchases and sales.
Board ruling of September 1928. In September 1928 the Federal
Reserve Board ruled that a bank purchasing Federal funds should
carry the amount on its books as a liability. Such purchases outstanding were to be reported as "bills payable and rediscounts"
rather than as a deposit liability.
Board ruling of January 1930. As the practice of using book entries and wire transfers in settling transactions became widespread
toward the end of the 1920's, the Federal Reserve Board ruled that
all such transactions should be classified in accordance with the
purpose to be effected and the principles involved rather than in
accordance with the mechanics. On every such transaction, whether
effected by check, book entry, wire transfer, or otherwise, and
regardless of the method of repayment, the purchasing bank was
required to show its resulting liability to the selling bank as money
borrowed, and the selling bank was required to treat the transaction
as a loan.
In directing the banks to treat Federal funds sales as loans, sales
by a member bank were thus made subject to the limitations imposed by Federal and most State statutes on loans to a single borrower. The effect was to limit unsecured sales of Federal funds to
a single borrower to 10 per cent of the selling bank's capital and
surplus. Purchases were subject to the legal restriction that aggregate borrowings could not exceed capital stock.
Until recently, repurchase agreements and buybacks were generally considered and treated as investments. They were not regarded as being subject to the legal limitations on loans.
Recent rulings by the Comptroller. In September 1956, the Comptroller of the Currency instructed his examiners that repurchase
agreements and similar transactions should be treated as loans.
Thus, repurchases involving Government securities were subject to
the limitation that loans to a single borrower so secured could not
40




GROWTH OF MARKET

exceed 25 per cent of a bank's capital and surplus. In January
1957, it was held that the limitation did not apply to transactions
between a bank and a Government securities dealer or broker.
The Comptroller issued a regulation, effective August 16, 1957,
which had the effect of raising the limit on loans to a single borrower, secured by direct obligations of the United States maturing
within 18 months, to an amount equal to the lending bank's capital
and surplus. Loans to a single borrower backed by Government
securities maturing in over 18 months and by agency obligations
were limited to 25 per cent of a bank's capital and surplus. Under
provisions of the Federal Reserve Act, the regulation was also applicable to State member banks.
As a result of this regulation, the amount of Federal funds a
member bank could sell to a single borrower through repurchase
agreements was limited to 100 per cent of the bank's capital and
surplus if direct obligations of the United States maturing within
18 months were involved, to 25 per cent if Government securities
maturing in over 18 months and agency obligations, and to 10 per
cent in the case of municipal securities. The limit on unsecured
sales of Federal funds to a single borrower continued to be 10
per cent.
The effect of the ruling that made repurchase agreements subject
to loan limitations was mixed, according to reports received in
January 1958. Repurchase agreements are an important source of
financing for Government securities dealers. Opinion among dealers
seemed to be that the supply of funds available through repurchase
agreements was reduced. The impact was spotty, however, as banks
in certain areas were influenced more than in others. Some banks
were influenced by the restrictive effects of the loan limitation;
others by the necessity for treating repurchases as loans in published
statements. Despite the raising of the limit on transactions covering
shorter issues to 100 per cent of capital and surplus, the effect was
still to restrict the amount of repurchases made by a number of
banks.
The Comptroller of the Currency issued another regulation,
effective April 18, 1958, removing the limitation on loans to a
single borrower collateraled by direct obligations of the United
States maturing within 18 months. The effect was largely to remove




41

FEDERAL FUNDS MARKET

the limitation on the amount of repurchase agreements to a single
borrower, inasmuch as most repurchase transactions involve shortterm Government securities. From the standpoint of a borrowing
member bank, however, both unsecured purchases of Federal funds
and repurchases are subject to the regulation limiting total borrowings, except from a Federal Reserve Bank, to the amount of its
capital. The effects of this ruling are not clear because, under the
easier money conditions which have generally prevailed since the
latter part of 1957, dealers experience less difficulty in obtaining
financing at larger banks where limitations on loans to a single
borrower are a less important factor.

42




IV. Structure of Federal Funds Market

This chapter examines the structure of the market in which Federal funds are bought and sold. The first section deals with major
groups of participants in the market—commercial banks, Government securities dealers, and a miscellaneous group including corporations and agencies of foreign banks. The second section is
devoted to the mechanics of the market, including such matters as
types of contracts and the facilities for bringing buyers and sellers
together. The final section describes the regional and interregional
patterns of trading as revealed by the survey data.
The ensuing analysis is based partly on interviews with the various participant banks and partly on the data collected in November
1956. The volume and pattern of transactions revealed in the
November 1956 data reflected in part the considerable pressure
then existing in the money market. In addition to the usual year-end
pressures on bank reserves, stemming chiefly from currency outflow
and seasonal credit needs, there were continuing uncertainties over
the Suez crisis, a heavier atmosphere in the capital markets, and
two Treasury financing operations involving short-term securities.
Treasury bill yields rose almost steadily during the month, and
there were persistent rumors of an increase in the discount rate.
Although net borrowed reserves were not particularly high for the
country as a whole—indeed, the banking system held positive free
reserves on eight days in the latter half of the month—the pressure
on money market banks in New York City was quite pronounced
until the end of the period. The geographical pattern of reserve
pressures was an influence in the interregional flow of Federal funds.
PARTICIPANTS IN THE MARKET

Commercial banks have dominated the volume of trading in Federal
funds in recent years, although other institutions have made steady
if less important use of the market. The mechanics of trading




43

FEDERAL FUNDS MARKET

have been shaped to some extent by the needs of these nonbank
participants.
Member banks. The immediate availability of reserves provided
by the Federal funds market makes possible a closer adjustment in
bank reserve positions and a much greater flexibility in the management of bank assets.
Member banks accounted for 80 to 90 per cent of total purchases
of Federal funds and for roughly 85 to 95 per cent of total sales
reported in November 1956. 1 The role of dealers was significant,
but their purchases and sales represented less than 10 per cent of
the total. Moreover, most of their transactions were with banks.
Transactions with banks accounted, on the average, for 70 per cent
of total dealer purchases, and about 90 per cent of dealer sales.
Transactions of "others"—foreign bank agencies, corporations,
commercial banks not belonging to the Federal Reserve System,
and savings banks—were of about the same total magnitude as
dealer operations.
Bank participation in the market, although widespread geographically, is limited principally to the larger banks. Table 3
shows the number of banks reporting in November 1956 by size
groups.
TABLE 3
SIZE OF BANKS SURVEYED IN NOVEMBER

Total assets, in millions of dollars
(A)
(B)
(C)
(D)

Number of banks

Over 1,000
500-1,000
250-500
Under 250
Total

1956

21
27
50
52
1

150

1
Five of the 150 banks reported no transactions in Federal funds in November 1956. All five were in
Group D, the smallest size category.

1

All references to reporting banks, unless otherwise noted, refer to the 150
banks which reported in the November 1956 survey. Data from the survey relate
to gross purchases and sales reported by each respondent. Some banks, mostly
large New York City banks, frequently made purchases and sales on the same day.
If net purchases or sales were used, the preponderance of buyers on certain days
would be smaller, as would also purchases of some of the larger banks.

44




STRUCTURE OF MARKET

Of the 150 banks covered, five reported no transactions during
that particular month. All of the banks reporting no transactions
were in the smallest size classification—Group D. Nearly all of the
member banks in the A, B, and C size groups were included in the
survey. Consequently, virtually all of the larger banks were familiar
with and used the Federal funds market. A number of banks of
smaller size than those included in the reporting sample used the
market occasionally.
Information obtained since November 1956 indicates a further
increase in the number of banks participating in the Federal funds
market. The increase has reflected in part growing familiarity with
the market among a larger number of banks and a desire to utilize
excess reserves which became more prevalent under the easy-money
conditions which developed in the latter part of 1957.
Government securities dealers. As pointed out previously, Government securities dealers were drawn into the Federal funds market
because of needs related to securities transactions. Banks, the
principal customers of the dealers, insisted that securities transactions be settled in Federal funds. Today, practically all transactions in short-term Government securities and many in longterm issues are settled in Federal funds.
Dealer financing with corporations and banks outside New York
City led to extensive use of the wire-transfer mechanism in shifting
funds and securities. All such transactions require payment in Federal funds. Finally, all transactions with the System Open Market
Account, as well as repurchase agreements with the Federal Reserve
Banks, are payable in Federal funds, although in the case of transactions for "regular" delivery, settlement is made on the following day.
As the practice of settling transactions in Federal funds spread,
others than dealers found it to their advantage to use this method
of payment. Corporations, for example, were under pressure to
follow suit because of their trading activities in the short-term
Government securities market. Corporation procurement of Federal funds, however, is largely a matter of bank-customer relationship, as discussed in a subsequent section on nonbank participation
in the Federal funds market.
Dealer activity in the Federal funds market is largely centered




45

FEDERAL FUNDS MARKET

in one commercial bank in New York City which clears a substantial amount of the transactions in United States Government securities for nonbank dealers. A "clearing charge" is paid for this
service. The bank makes or receives payment for transactions
settled in Federal funds for its dealer customers in the form of
debits or credits to its reserve account at the Federal Reserve Bank
of New York. The bank keeps a tabulation of debits and credits
for each dealer during the day and, at the close, arrives at a net
balance of Federal funds either "due to" or "due from" the dealer.
A charge or credit for these funds is then computed at the current
Federal funds rate and is carried on a memorandum basis from
day to day. It is expected that these charges or credits will "wash
out" over a period of time, but if not the dealer settles with the
bank at regular intervals.
In the case of the larger, more active dealers, the amounts involved in daily activities with the clearing bank are so large that
these dealers will, if necessary and possible, buy Federal funds in
the market before the close of the day to cover a substantial deficit
accumulated with the clearing bank. If these dealers accumulate
an excess of Federal funds with the clearing bank, they may sell the
excess in the market toward the close of the day. Ordinarily, dealers
make purchases and sales fairly late in the day, but they may act
earlier if they are sure of their Federal funds position. In any
case, the larger dealers try to come out as nearly even as possible
with the clearing bank each day, leaving relatively small debits or
credits to be carried over. Their reliance on the clearing bank as a
residual supplier of Federal funds is for small amounts on most
days. The clearing bank prefers it this way as the dealer transactions affect its reserve position.
Smaller dealers, on the other hand, normally rely to a much
greater extent on the clearing bank for Federal funds and rarely
buy or sell Federal funds in the market. When large amounts of
Federal funds have to be supplied to the dealers—for example,
when dealers are taking up new issues of United States Government
securities at the Federal Reserve Bank—both large and small
dealers may have to rely on the clearing bank, especially under
tight-money conditions. The clearing bank frequently attempts to
offset a dealer shortage or excess of Federal funds through purchase
46




STRUCTURE OF MARKET

or sale of Federal funds in the market for its own or for dealer
account. The clearing bank will borrow from the Federal Reserve
Bank if necessary in order to meet dealer needs for Federal funds.
One large dealer clears all of its Government securities transactions through its own facilities. This dealer buys and sells Federal
funds in the market to meet its general needs, and has special arrangements with two of the largest banks in New York City to
provide Federal funds to meet its residual needs. The two banks
furnish Federal funds at the current rate, taking turns for a week
at a time.
Dealers go into the Federal funds market only to satisfy their own
needs. They never act as broker for Federal funds, as does the New
York City stock exchange firm that brings together a considerable
number of buyers and sellers. Most dealer transactions in one-day
Federal funds are with the large banks in New York City; some are
arranged through the New York City broker.
Dealers, however, have extensive contacts with banks throughout
the country as sources of financing for their positions. When the
dealers borrow from or make repurchase agreements or buybacks
with out-of-town banks or nonbank sources they automatically receive Federal funds. Rates on dealer repurchase agreements are
more closely related to rates on alternative sources of financing
available to dealers than to the rate on straight Federal funds
transactions.
New York City banks make dealer loans available, with only a
few exceptions, in clearing-house funds. The rate charged by New
York City banks on dealer loans is frequently higher than the cost
of financing in other cities; it is also often above the yield on the
dealers' portfolio, especially in periods of tight money. Thus,
dealers are often under pressure to borrow out of town or from
nonbank sources, both to obtain lower rates and to acquire Federal
funds to pay for the securities against which they are borrowing.
If they borrow from the New York City banks, dealers are required
to pay the current rate of interest on the loan plus the cost of the
Federal funds for one day or for three days if they borrow on
Friday. When money is tight in other parts of the country, dealers
rely more heavily on the New York City banks, thus exerting direct
pressure on the New York Federal funds market. In such instances,




47

FEDERAL FUNDS MARKET

Federal funds are supplied by the clearing bank and by other New
York City banks, even though borrowing from the Federal Reserve
Bank is necessary.
When dealers encounter difficulty in obtaining financing out of
town, it is usually late in the day before they turn to the clearing
bank and other New York City banks. The result is often unforeseen swings mainly in the reserve position of the clearing bank, but
also in other New York City banks which supply Federal funds to
the dealers. Thus, dealer financing needs at times place special
burdens on the New York money market with repercussions on the
Federal funds market. It is for this reason that Federal funds are
often very tight on Thursdays when dealers pay for the unsold portions of their awards of new Treasury bills. In some instances, the
situation is relieved by Federal Reserve open market operations in
extending repurchase agreements to the dealers; however, until the
dealers learn, usually after noon, whether the Federal Reserve will
make funds available, they attempt to locate funds elsewhere.
In the normal course of trading in Government securities, the
flow of Federal funds tends to balance itself out. The biggest problems arise when dealers acquire securities which they pay for in
Federal funds and then hold unsold in their portfolios. Similar
effects are produced when dealers buy blocks of securities for payment in Federal funds and sell them the same day for payment in
clearing-house funds. Most situations of this kind arise from transactions with nonbank investors.
On the other hand, dealers sometimes acquire excess Federal
funds when they buy securities for clearing-house funds and sell
them for Federal funds. When dealers have to borrow in clearinghouse funds, repayment is made in clearing-house funds. If in the
meantime the underlying securities have been sold for Federal
funds, as is frequently the case, these funds can be sold in the
Federal funds market. Thus, dealers may offset the cost of Federal
funds purchased when they borrow in clearing-house funds unless
the Federal funds rate declines in the meantime. Such imbalances
in availability of Federal funds to dealers are normally only moderate in amount but occasionally can become quite important.
The analysis above is more descriptive of dealer activities in
Federal funds under tight-money conditions, such as prevailed in
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STRUCTURE OF MARKET

1956 and most of 1957. Under conditions of easy money, dealer
trading and financing needs can usually be satisfied with less difficulty and with less concentrated pressures as Federal funds are
generally available on a country-wide basis at relatively attractive
rates. As a result, there is usually much less borrowing at the
Federal Reserve Bank of New York by the clearing bank and other
New York banks arising from dealer needs.
Otherfinancialinstitutions. Agencies of foreign banks licensed by
the New York State Banking Department, foreign banking corporations chartered under New York State law, and savings banks
located in the New York area have been active sellers of Federal
funds in the New York market. A few nonmember banks, by
utilizing their correspondent balances with member banks, also sell
Federal funds. Savings banks are probably less active sellers than
the other institutions, their transactions apparently being more
closely related to their operations in Government securities.
Sales by these institutions reportedly were substantial in 19561957, aggregating well over $50 million on some days. Practically
all sales are made to banks and dealers in New York City. These
"other" participants rarely purchase Federal funds.
Corporations. Corporations engage in repurchase agreements or
similar transactions with Government securities dealers. These
transactions are frequently made for payment in Federal funds to
meet dealer needs for financing short-term securities which ordinarily require settlement in Federal funds. From the standpoint of
the corporations, these transactions are effected as a means of pinpointing a short-term investment for a particular maturity date, and
are usually for more than one day. To the dealer it is a source of
financing. The volume of dealer activity in the Federal funds
market may be strongly influenced by the ebb and flow of financing
available to dealers from corporations.
Direct participation in the Federal funds market by nonfinancial
corporations appears to be nominal. Large corporations use Federal funds for various purposes and have access to such funds
through their commercial banks. Corporations needing to make
payments in Federal funds usually turn to their banks. The general
practice of banks is not to make an extra charge for the Federal
funds. In effect, the bank handles the payment for its customer and
the corporation does not acquire title to the Federal funds.




49

FEDERAL FUNDS MARKET

In special cases, where the activity in Federal funds for a corporate customer is exceptionally large, the bank may keep a record
of the inflow and outflow to ascertain whether a fair balance is
maintained between the two. If there is a continuing net drain of
Federal funds in meeting the corporation's needs, the bank may
make a charge for this facility.
Corporations occasionally sell Federal funds acquired from the
sale of Government securities. Normally, however, the proceeds are
handled in the same way as receipts from other transactions. In
practice, most corporations instruct a bank to take delivery of securities purchased, make payment in Federal funds against debit
to the corporation's deposit account, and place the securities in
custody for its account. In case of sales of securities, the procedure
is reversed.
MECHANICS OF THE MARKET

Estimating reserve positions. In order to meet the legal reserve requirement and to keep fully invested, many of the larger banks
attempt to estimate their current and prospective reserve positions.
Usually, the forecasting techniques are relatively simple. Indeed,
existence of the Federal funds market allows the individual bank
such a degree offlexibilitythat quite simple projections can be used.
If the projections turn out wrong, actions taken earlier in the day
can later be reversed, generally at little or no extra cost. It is only
natural, then, that Federal funds operations at most banks seem to
be focused chiefly on deficiencies and surpluses that are expected
on the same day, or have already developed at the time of the
purchase or sale.
Accordingly, forecasts used as a basis for transactions in Federal
funds generally have a very short range—the end of the day or
occasionally the end of the current reserve week. If a shortage or
overage persists, a more fundamental adjustment is likely to be
made through shifts in securities or other assets. Assuming, however, that the imbalance is to be only temporary, the sale or purchase of Federal funds is usually geared to the current day's reserve
position or to the pattern for the reserve period as it then appears.
Under these circumstances, forecasting a bank's reserve position
includes more or less standard information such as debits and
50




STRUCTURE OF MARKET

credits in the local clearing house, large changes in deposit balances,
debits and credits through wire transfers during the day, required
reserves, deferred availability figures on the books of the Reserve
Banks, and adjustments designed to bring balances with correspondent banks up or down to some normal working level. Most
banks apparently prefer, at least under tight-money conditions, to
get into the Federal funds market as early as possible to meet their
needs in case the supply turns out to be inadequate. Some of the
large money market banks often commit themselves even before
they have learned their opening positions, implying a forecast from
the previous day's data. At the other extreme, while many banks
attempt to project reserve positions for the remainder of the reserve
accounting period, few of them make a practice of buying or selling
Federal funds against prospective deficits or surpluses later in the
reserve period. Under easy-money conditions, however, banks, in
planning their reserve operations, tend to rely more on the Federal
funds market to provide reserves for longer periods. Federal funds
are more readily available and frequently at advantageous rates.
Types of contracts or transactions. Emphasis on the use of Federal

funds for very short-term reserve adjustments quite naturally carries
over into the specific form of the contracts. The November 1956
data show that Federal funds transactions are predominately for
one business day. Over-one-day transactions were reported on
almost every business day during the month, but the amount was
never more than 5 per cent of total transactions, and for the month
as a whole accounted for only 1.5 per cent of total purchases and
2.2 per cent of sales. Extensive interviews with banks also revealed
that a high percentage of bank transactions is for one day only.
As to type of contract, Federal funds transactions fall into two
major classes—straight, unsecured one-day loans, and repurchases
and similar agreements. A modification of the straight one-day
transaction has emerged, however, as a result of the April 1958
ruling of the Comptroller of the Currency which removed the limitation on loans to a single borrower if secured by Government securities maturing within 18 months. The limit is 10 per cent for
an unsecured loan. The buyer of Federal funds advises the seller
that the transaction is secured by the pledge of securities, usually
maturing within 18 months, held in custody for the account of the
51



FEDERAL FUNDS MARKET

seller. Otherwise the transaction is the same as a straight one-day
loan. Recently, New York City banks have been making frequent
use of the secured one-day loan when buying Federal funds from
out-of-town banks.
"Straight" Federal funds transactions. A straight Federal funds
transaction may be executed in any one of several ways. If both
buyer and seller are in close geographical proximity in the same
Federal Reserve district, the transfer—after the two parties have
settled on the terms, usually by telephone—is ordinarily handled by
telephone request to the Reserve Bank followed by written confirmation, by a direct letter of instruction to the Reserve Bank or,
as in New York City, by an exchange of checks.
The transfer of reserve balances typically takes place after a
telephone request to the Reserve Bank, although such request must
be followed by written confirmation. In the Boston District, for
example, even Federal funds transactions involving banks in cities
outside of Boston are sometimes initiated by a telephone call to the
Reserve Bank, followed by letter of confirmation. In the case of
direct letters of instruction, the lending bank transmits a letter on
the first day, and the borrowing bank a similar document the next
day. These letters simply request the shift of reserves from one
account to the other and then back again. An exchange of checks
is confined largely to New York City. The lending or "selling" bank
writes a draft on its balance at the Reserve Bank, which is of course
available immediately. In exchange the lender receives from the
borrowing or "purchasing" bank a check written on itself, for an
equal or slightly larger amount, depending on how the interest payment is to be handled. This check, however, must go through the
local clearing house, so that it does not become an immediate claim
on reserves until the following day.
When the two parties to a Federal funds transaction are located
in different Federal Reserve districts, the buyer and seller usually
work out the details by the "bank wire" or by long-distance telephone with formal confirmation following by either wire or letter.
The actual transfer of Federal funds is accomplished through the
system of leased-wire facilities connecting the Federal Reserve
Banks into a national network. The selling bank instructs the Reserve Bank in its district to make a wire transfer of a specified
52




STRUCTURE OF MARKET

amount to the buying bank, which means that the proceeds will be
credited to the reserve account of the buying bank. On the next
day, the purchaser repays by carrying out the reverse procedure.
The interest charge may be included in the remittance but when the
banks have a correspondent relationship it is generally credited to
the account of the lending bank or paid by separate check.
A step-by-step description of the execution of a typical straight
Federal funds transaction between banks in different Federal Reserve districts is as follows:
Bank A located in Columbus, Ohio, arranges—by direct telephone, through the New York stock broker, or by bank wire—to
sell $5 million of Federal funds at 3 per cent to Bank B in Chicago.
If by telephone, the arrangement is confirmed by bank wire or by
letter. Bank A then instructs the Federal Reserve Bank of Cleveland to make a wire transfer of $5 million to Bank B through the
Federal Reserve Bank of Chicago. This transfer, of course, results
in a debit of $5 million to the reserve account of Bank A at the
Federal Reserve Bank of Cleveland and a credit of $5 million to
the reserve account of Bank B on the books of the Federal Reserve
Bank of Chicago. The following day, Bank B instructs the Federal
Reserve Bank of Chicago to make a wire transfer to Bank A of at
least $5 million, the principal. Bank B might also remit the interest
of $416.65 in the same wire transfer but, since the Federal Reserve
Banks levy a charge on wires involving odd amounts, interest is
more frequently paid by check or, where a correspondent relationship exists, by credit to the correspondent account.
"Other" Federal funds transactions. Federal funds transactions
falling into the "other" category are even less uniform than straight
transactions. Their distinguishing feature, as noted above, is the
transfer of securities, which makes possible a greater variety of
techniques. For one thing, a rather extensive range of securities is
used, including issues of the United States Treasury, municipal
bonds, and securities issued by such agencies as public housing
authorities. The specific form of the transaction may differ, too,
although most of the variants can be classed under the general
headings repurchase agreements and buybacks.
The difference between these two forms is, however, more legal
than economic. In the repurchase agreement, the lender of Federal




53

FEDERAL FUNDS MARKET

funds buys a security at a certain price, actually taking title to it.
But at the same time and in the same contract, he receives from the
seller of the security (who is, in effect, borrowing Federal funds) a
commitment to repurchase the same security on a specified future
date at a specified price, generally the same as the sales price plus
interest at a specified rate for the life of the contract. Both the
initial purchase and the repurchase are paid for in Federal funds.
Thus, in a single contract the two parties have agreed to a transfer
and return of Federal funds, to be accompanied by a movement in
the opposite direction of an equivalent dollar amount of securities.
The buyback, as the term is commonly used in the market, consists of two separate contracts made at the same time—one for the
sale (or purchase) of securities for immediate delivery and payment; the other for the purchase (or sale) of securities for delivery
and payment the following day or at a later date. Most of these
transactions are in Treasury bills, and the bills are sold to the lender
of Federal funds at an annual rate of discount and bought back
generally at the same rate, so that the lender earns the discount for
the number of days the contract is outstanding. Buybacks in interestbearing securities are less frequent because of the capital gains and
losses affecting tax positions if these securities are sold and bought
back at different prices, and because of the difficulty in setting prices
that would result in the desired effective yield for the period of the
contract. The situation is different in the case of tax-exempt securities or of Treasury bills, in which capital gains and losses are not
treated as such for tax purposes. Practices with respect to pricing,
however, vary widely.
The purchase of Federal funds under a repurchase agreement may
be described as follows:
Assume that Bank A in New York City arranges directly by telephone to sell Bank B in Dallas, Texas, $5 million (par value) of
31/4per cent certificates of indebtedness due October 1, 1957, at a
price of $100 (par) and agrees to buy back the same certificates on
the next day at par, plus interest for one day at 3 per cent, both
transactions for payment in Federal funds and delivery in New York.
The arrangement provides that Bank A will deliver the certificates
to Bank C in New York City against payment of $5 million, Bank C
to hold the securities in custody for the account of Bank B. All
terms of the transactions are confirmed by bank wire.
54




STRUCTURE OF MARKET

Bank B then instructs the Federal Reserve Bank of Dallas to
transfer $5 million to Bank C in New York City and wires Bank C
instructions to pay the $5 million to Bank A against delivery of the
certificates of indebtedness and to hold the certificates in custody.
Bank A then delivers the certificates to Bank C, receiving a draft for
$5 million drawn on the Federal Reserve Bank of New York, which
it deposits at the Reserve Bank for credit to its reserve account.
Alternatively, Bank B might instruct Bank C to advise by wire when
the certificates are received in custody, whereupon Bank B would
wire transfer the $5 million direct to Bank A.
The following day the foregoing procedure is reversed as Bank A
delivers to Bank C its check for $5 million on its reserve account
against release of the certificates, whereupon Bank C wire transfers
the $5 million to Bank B in Dallas through the Federal Reserve Bank
of New York. The interest of $416.65 is credited by Bank A to
Bank B's correspondent account, or it may be remitted with the wire
transfer of the principal or by separate check.
There are many variations of the above-described technique, especially as to the prices specified in the agreement, as the price is
important from the standpoint of capital gains taxes. In the example
above, the purchase and sale prices are the same and there is no tax
effect.
To illustrate a buyback, suppose that on June 19, 1957 Bank A
in New York City agrees to sell Bank B in Richmond $5 million of
Treasury bills due September 5, 1957 at a discount rate of 3.20 per
cent, for delivery the same day against payment in Federal funds.
Simultaneously, but in a separate contract, Bank A agrees to buy
from Bank B $5 million of the same issue of Treasury bills at the
same rate of 3.20 per cent discount for New York delivery and
payment on the following day in Federal funds.
The steps involved in the execution of these commitments are
generally as follows:
Bank B instructs Bank A to deliver the Treasury bills to Bank C
in New York against payment of the proceeds of the sale amounting
to $4,965,333.33 (78-day bills at 3.20 per cent discount). Bank B
then instructs the Federal Reserve Bank of Richmond to transfer that
amount to Bank C, and wires Bank C instructions to pay it to
Bank A against delivery of the Treasury bills. Bank A then delivers
the Treasury bills to Bank C and receives a draft for the proceeds




55

FEDERAL FUNDS MARKET

drawn on the Federal Reserve Bank of New York which it deposits
at the Reserve Bank for credit to its reserve account. Alternatively,
Bank B might wire the proceeds of the sale direct to Bank A upon
advice from Bank C that the Treasury bills had been received in
custody.
On the following day, Bank A delivers to Bank C a Federal funds
check for $4,965,777.78 (77-day bills at 3.20 per cent discount)
against release of the Treasury bills, which funds Bank C wire
transfers to Bank B through the Federal Reserve Bank of New
York. This wire transfer, of course, results in a credit to Bank B's
reserve account with the Federal Reserve Bank of Richmond.
Bank A thus pays Bank B 3.20 per cent or $444.45 for the use of
the funds for one day.
In the foregoing buyback transaction, the wire transfers between
Federal Reserve districts would generally be made in round amounts
to avoid an extra wire charge, and the odd amounts arising from
the pricing of the bills would be a charge or credit to correspondent
accounts in the same way as the interest charges involved in other
types of transactions.
In both the repurchase and buyback transactions, ownership of
the securities is transferred. In perhaps the majority of cases this is
accomplished through the transfer of the securities by the borrowing
bank from its investment account to a custody account in its trust
department for account of the lending bank. In other cases the
securities may be delivered to another bank to be held in custody
for account of the lending bank as described in the example above.
When the borrower is a Government securities dealer, the collateral
usually remains in safekeeping with one of the local banks in New
York City and the Federal funds are transferred to that bank for
account of the dealer against delivery of the securities into custody.
In a few cases the transfer of securities may be effected by wire.
This is done through the wire-transfer facilities of the Commissioner
of Public Debt, which make it possible to present Government
securities to a Federal Reserve Bank or branch and have them
reissued at any other Reserve Bank or branch against payment in
Federal funds.
Relative advantages of different types of transactions.

There is con-

siderable regional variation in the relative importance of repurchase
56




STRUCTURE OF MARKET

agreements and buybacks as compared to straight Federal funds
transactions. According to the November 1956 data, the repurchase agreement and buyback were most popular in the Kansas
City District, these types of transactions accounting for nearly 70
per cent of the sales and 45 per cent of the purchases of reporting
banks during the month. In the Richmond, Cleveland, and Dallas
Districts, they accounted for 80 per cent, 63 per cent, and 52 per
cent, respectively, of the sales but only a very small fraction of the
purchases. In the San Francisco District, about 30 per cent of
the purchases and slightly less than one-fifth of the sales were in the
form of repurchase transactions. In New York, they accounted for
about 30 per cent of the purchases but only a small percentage of
the sales. The straight transaction was predominant in the other
districts. A good part of the sales via repurchase agreements represented transactions with Government securities dealers in New
York City.
Many New York City banks do not make repurchase agreements
with dealers, but do make them with some frequency with out-oftown banks. A few New York City banks make repurchases with
dealers on bills but not on other securities. Repurchases between
dealers and out-of-town banks, however, are widely used.
These regional variations reflect, in part, legal limitations and
differences in attitudes as to the relative merits of each type of
transaction. Interviews with commercial bankers active in the
Federal funds market indicated that the principal appeal of repurchases and buybacks was the more liberal legal limits on loans to a
single borrower than on straight sales of Federal funds. As explained in Chapter III, the legal limit on repurchases involving
Government securities is more liberal than on unsecured transactions. This feature gives repurchases considerable appeal, especially
to relatively small banks. Although somewhat more bookkeeping
is required than in the case of straight Federal funds, a real advantage is the greater ease in finding a buyer if Federal funds can
be offered in a larger block, thus avoiding the expense and inconvenience of trying to sell a number of smaller parcels.
Other lesser advantages are also claimed for repurchase agreements and buybacks. From the standpoint of the lending bank, the
interest rate, especially when the transaction is with a Government




57

FEDERAL FUNDS MARKET

securities dealer, is often higher than the rate on straight Federal
funds. The risk is also less than for an unsecured loan. On the
other hand, a bank may sometimes be able to obtain funds at a
lower rate under a repurchase agreement than a straight unsecured
purchase. In order to be in a position to benefit from these rate
differentials when they arise, some banks are active in both types
of transactions, even when the rates are equivalent. Rates on repurchase agreements are subject to much more negotiation than those
on straight Federal funds transactions.
Despite these apparent advantages, however, the greater part of
Federal funds trading is in the form of straight, that is, overnight,
unsecured transactions. The chief reason given in the interviews
was the greater convenience of the straight transaction. Many
bankers think one-day repurchase agreements are too much trouble.
The bookkeeping is more extensive and the securities involved must
be physically transferred. Moreover, a transaction between a dealer
in New York and a bank outside involves the performance of various functions by the bank's New York correspondent—acquiring
the securities possibly with clearing costs, issuing a trust receipt,
remitting Federal funds to the dealer, and then reversing the whole
process the following morning. For these reasons, many lending
bankers consider repurchase transactions unprofitable unless they
run for three or four days.
Some bankers apparently avoided repurchases and buybacks prior
to the recent rulings of the Comptroller of the Currency because of
uncertainty as to whether they were subject to the limitations on
loans. Some also indicated that repurchase agreements with dealers
should be held to a minimum in order to maintain the impersonal
nature of the Federal funds market, and to avoid the development of
a situation in which dealers might rely unduly on this form of bank
financing.
Finally, most repurchase or buyback transactions for more than
one day are between corporations and banks outside New York City
and Government securities dealers. New York banks do not favor
longer term transactions, preferring to lend to dealers only on collateral loans in clearing-house funds.
Units of trading and limits on transactions. The typical unit of trading in the Federal funds market is $ 1 million. The minimum amount
58




STRUCTURE OF MARKET

is also generally $1 million, although banks which rely heavily on
the Federal funds market to cover deficiencies often make exceptions
in a tight-money market. Transactions in smaller units are also
made as an accommodation to small correspondent banks whose
legal limits make it impossible for them to deal in larger units. Although trades of as little as $50,000 have occasionally been reported, few banks are willing to make transactions for less than
$200,000.
On the upper side, the size of Federal funds transactions is limited
by the legal restriction on loans to a single borrower. As a matter
of policy, however, many banks prefer not to lend the legal maximum to a given bank, even though within the borrower's legal limit.
The policy of some banks is to lend only part of the legal maximum
to any borrower; others set a specific maximum for each borrowing
bank on the basis of creditworthiness and perhaps also on the closeness of the correspondent relationship.
Handling of interest payment. Interest payments on repurchase
agreements and buybacks are usually included in the repurchase
price, but in most straight Federal funds transactions the interest is
remitted separately. As indicated before, the most common method
is simply to debit or credit correspondent balances. Then from
time to time the bank owning such balances will transfer additional
funds into or out of the account in order to maintain it at a normal
working level. Where no correspondent relation exists, interest payments are generally made by a treasurer's or cashier's check. Infrequently, interest will be transferred by wire, but the high charges on
small amounts have generally discouraged this means of payment.
At the local level, the interest is sometimes included with the
principal and sometimes not. In Chicago, for example, even local
transactions are executed by wire transfer and the interest is usually
included in the return payment wire. Similarly, where transactions
are carried out by an exchange of checks (one a draft on Reserve
Bank balances and the other a clearing-house check), the borrower's check is frequently written to cover both interest and principal. On the other hand, when the transfer is made by a letter of
instruction to the Reserve Bank, interest is often handled separately by a treasurer's check.
Facilities for bringing buyers and sellers together. While the Federal




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FEDERAL FUNDS MARKET

funds market is clearly national in scope, it is not highly organized
at either the national or the regional level. It is much less formal,
for example, than the stock exchanges, where the price and volume
of each trade are recorded and immediately published. It is also
a looser organism than the Government securities market, in
which dealers take positions in the "commodity" to be traded, and
compete directly with one another through the posting of firm
quotations of both bid and offered prices. The Federal funds market
has no group of recognized traders of this sort, and rates are arrived
at, for the most part, by direct negotiation and then reported only
informally, if at all, to other parties in the market.
Nevertheless, the activities of several institutions serve to register
the shifting relationship between demand and supply, as well as
actually to bring together an important number of buyers and
sellers of Federal funds. At the national level, these functions are
performed by the stock exchange firm in New York City, which
acts as a broker in Federal funds, and by two or three large New
York City banks that, within limits, "make markets." To a less
marked degree, the network of correspondent relationships among
banks all over the country fulfills a similar role. Formal arrangements in local and regional markets for putting buyers and sellers
in touch with each other have practically disappeared as both facilities and trading have developed on a national basis.
The stock exchange firm in New York City which is active in
the Federal funds market acts purely as a broker, merely serving
the function of putting potential buyers and sellers in touch with
each other. The firm operates on a national scale and works mostly
with banks. Transactions are occasionally handled for dealers and
even for corporations. Mostly this broker handles straight Federal
funds transactions, but occasionally puts together repurchase agreements or buybacks, which sometimes run for more than one day,
especially if the parties concerned are a dealer and a bank.
Throughout each day, buyers and sellers report their needs to
the broker who attempts to put the two sides together as quickly
as possible. In some cases the broker is given discretion as to rate
and amount; in other cases limits may be imposed, the limit on
amount being related to bank legal loan limits or to the amount of
unsecured credit the selling bank is willing to extend to other banks.
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STRUCTURE OF MARKET

Reimbursement for the broker's services in most cases is through
stock and bond business given the firm, although a few customers
prefer to pay a commission on Federal funds transactions.
The data collected in November 1956 indicated that the New
York broker arranged Federal funds transactions for banks in all
parts of the country. There was considerable regional variation,
however. In some Federal Reserve districts, banks used the broker
mainly when purchasing Federal funds; in others, the firm was used
for both purchases and sales, and in one district banks turned to
the broker principally when selling Federal funds.
A slightly different but also important role is played by one of
the large banks in New York City. Each day this bank undertakes
to make a two-way market which serves both buyers and sellers of
Federal funds. One or two other banks perform a similar role from
time to time, but in recent years only the one New York City bank
has "made" markets almost daily. Its coverage of banks throughout
the country is extensive. Generally speaking, this bank will purchase Federal funds in appropriate amounts from any bank—but
its sales of Federal funds are confined to banks for which appropriate loan lines have been determined. The bank does not normally
buy from or sell to other New York City banks directly but deals
with them through brokers.
Closely related to the Federal funds market is this same bank's
practice of making one-day loans to Government securities dealers
at a preferential rate. These loans, collateraled by Treasury bills,
are extended and repaid in Federal funds. They are normally made
only when the bank has Federal funds available on balance. The
preferential rate on such loans is usually slightly above the Federal
funds rate but below the rates on other dealer loans secured by
Government securities.
The correspondent banking system also plays a significant role
in the Federal funds market. Some of the larger banks, including
six of the major banks in New York City, buy and sell Federal funds
not only to meet their own reserve needs but also as a service to
customers. These banks try to fit the two objectives together, but
unless their reserve positions are extreme, they stand ready to trade
with an established customer even if it costs them to do so. In fact,
one of the largest advised its correspondents in writing that as long




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FEDERAL FUNDS MARKET

as its own position is not badly unbalanced, it will meet any request
or absorb any offer for Federal funds.
At the regional level, a large California bank has to some extent
established itself as a clearing center for West Coast banks. This
may stem, however, from the time lag which leaves only an hour or
so between the beginning of business hours in the Pacific Zone and
the close of Federal funds trading in New York City. Once this
period has passed, the West Coast banks apparently turn to trading
among themselves, thus enlarging the potential role that can be
played by a bank willing to trade on both sides of the Federal funds
market.
The attitude of the larger banks toward buying and selling Federal funds as a service to their smaller correspondents varies rather
widely. At one extreme is the relatively small number of large
banks, described above, which are willing to accommodate correspondents even if it means entering into transactions contrary to
their own reserve needs. A more moderate position, which probably
includes a larger number of banks, is one in which a bank is willing
to enter into transactions with its correspondents only when it needs
to adjust its own reserve position. At the other extreme is a group
of banks which are quite reluctant to start the practice of buying
and selling Federal funds as a service to their correspondents, and
do so only when forced to by competition. Their reluctance stems
from the burden of handling a large number of transactions for
small amounts, and a desire to avoid either the risk of making unsecured loans to all small correspondents, or the ill will that would
probably result from a policy of selectivity on the basis of creditworthiness. Also, some banks prefer making secured loans to their
smaller correspondents to the uncertainty involved in selling them
Federal funds at fluctuating rates.
The correspondent system facilitates the functioning of the Federal funds market in other ways. Although data are not available
on this point, interviews left the impression that a substantial part
of the volume of transactions is among banks having a correspondent relationship. Smaller banks often contact their correspondent
for information about banks offering or bidding for Federal funds,
and to check on the "going" funds rate. Nonmembers occasionally
buy or sell Federal funds through their accounts with correspond62




STRUCTURE OF MARKET

ents that are members of the Federal Reserve System. As already
mentioned, correspondent balances are also an important medium
for the payment of interest on Federal funds transactions.
On the strictly local level, there have been some relatively formal
clearing centers in the past, but these have now largely faded away.
There has been a tendency for regional facilities to wane as national
facilities developed and as the market broadened. Some banks
turned from the local to the national market because they were
frequently unable to meet all of their requirements in the local
market. Local banks are often ranged on the same side of the
market—all sellers and no buyers, or vice versa. In addition, the
development of outside alternatives lured away some banks that
prefer not to disclose their positions to local competitors. In some
cases, time differences may cause banks to prefer the national
instead of a local market. Some banks do not get a clear estimate
of their reserve positions until an hour or two before the market
closes in New York. There is a tendency for such banks to turn
directly to the national market instead of wasting valuable time
contacting local banks which may be unable to meet their needs.
Regional and interregional pattern of transactions. The most strik-

ing feature of the regional pattern of Federal funds activity is, as
might be expected, the dominant position of New York City. Although the large proportion of transactions in New York City in
November 1956 may have been attributable in part to the concentration of reserve pressures on the New York banks, there is no
doubt that New York City is normally the hub of a nationwide
market in Federal funds. In the November survey, banks or dealers
in New York City were parties to the overwhelming mass of Federal
funds transactions—transactions which generated a sizable net flow
of funds into New York City from the rest of the country. Furthermore, through the facilities of the New York broker an additional
undetermined quantity of transactions was arranged through New
York City without involving New York banks or dealers. The
correspondent relationships of some New York City banks also
served a clearing function, connecting out-of-town banks with one
another through New York.
The importance of New York was confirmed by the November




63

FEDERAL FUNDS MARKET

data.2 Banks in the New York District accounted for 62 per cent
of total purchases and 35 per cent of total sales of reporting banks
for the month. Banks in this district, however, had only about onefourth of the total assets of all member banks. Reporting banks in
the San Francisco District accounted for 18 per cent of total sales
and 12 per cent of the purchases. Banks in the Cleveland District
were important sellers, contributing 11 per cent of total sales. Sales
were considerably more evenly distributed among the Federal Reserve districts than were purchases. Three districts accounted for
more than four-fifths of the total purchases in November—New
York 62 per cent, San Francisco 12, and Chicago 9.
There was a substantial amount of Federal funds trading within
New York City. Such transactions in November 1956 accounted
for more than 20 per cent of the total volume of transactions in
Federal funds. The large volume of trading within the city reflected
not only the transfer of Federal funds between banks, and banks and
dealers, but also purchases from agencies of foreign banks, savings
banks, and others not included in the survey. The latter confine
their Federal funds transactions almost entirely to New York City.
All reporting New York City banks and dealers, however, bought
and sold Federal funds outside as well as within the city. Out-ofdistrict purchases of New York City banks in November ranged
between two-fifths and four-fifths of their total purchases, the average being considerably more than one-half. Sales showed a similar
pattern. On a few days, all sales of New York City banks were to
out-of-town buyers.
The pattern of New York dealer transactions was similar to that
of the banks. The rest of the country provided generally about
one-fifth or more of total dealer purchases of Federal funds. The
portion of dealer sales taken by the rest of the country varied quite
widely, with 100 per cent of such sales being absorbed by out-oftown buyers on one day. Generally, however, most of the Federal
funds disposed of by dealers went to banks and other dealers within
the city, and on three days during the period their entire sales were
made to New York City buyers.
The transactions of banks and dealers together served, on bal2
Data on purchases and sales used in this section were adjusted to include
weekends and holidays. Thus, transactions made on a Friday or on a day preceding a holiday run until the next business day.

64



STRUCTURE OF MARKET

ance, to shift Federal funds into New York City during most of
November 1956. The New York District was a net purchaser of
Federal funds from the rest of the country on 17 days—all but two
of the business days during the period. On 15 days when New York
was absorbing funds from the rest of the country, the net inflow
represented well over one-half of the total net interdistrict flow of
funds, with the proportion usually ranging around 70 to 80 per cent
of the total.
The only other local markets of importance are San Francisco
and, to a lesser extent, Chicago. Except for these relatively small
local markets, a large part of the flow of Federal funds is to and, to
a lesser extent, from New York City.
In November 1956, each of the other districts was a net supplier
of Federal funds to New York City on at least 9 of the 19 days on
which New York banks were open for business. For six Federal
Reserve districts, there was a net flow of funds to New York City
on at least four out of five days. The districts with the largest percentages of total sales going to New York City were: Cleveland 92,
Richmond 92, Kansas City 65, St. Louis 62, Dallas 61, Boston 60,
Atlanta 60, Philadelphia 57, and Minneapolis 56. Table 4 on the
following page shows a distribution of Federal funds purchases and
sales by survey banks according to the location of the seller or
buyer.
On a number of days, other districts than New York also bought
more Federal funds than they sold. Next to New York, which was
a net buyer on 17 of the 19 business days, were the Chicago and
Dallas Districts with 15 and 12 days, respectively; the Kansas City
and Atlanta Districts, 10 days each; and Philadelphia, 9 days. The
remaining six districts were net buyers on less than one-third of
the days.
Atlanta, Richmond, and Cleveland District reporting banks, in
the order listed, acquired the largest percentages of their total purchases from New York City. Other district banks which obtained
over one-half of their total purchases from New York City were
Kansas City, St. Louis, Minneapolis, Dallas, and Boston.
In summary, a substantial part of Federal funds trading was done
locally in only three Federal Reserve districts. In New York, nearly
one-half of the purchases and sales were within the district, mainly
within New York City. Banks in the San Francisco District also
65



FEDERAL FUNDS MARKET
TABLE 4
PURCHASES AND SALES OF FEDERAL FUNDS BY SURVEY BANKS
NOVEMBER 1956
[Monthly totals for Federal Reserve districts. Dollar items in millions]
As a percentage of purchases or sales
Federal Reserve district
Purchases

Total 1

$

New York
Philadelphia
Cleveland
Richmond
Atlanta...
St. Louis
Kansas City..
Dallas
San Francisco

557
14,056
698
264
374
169
2,103
519
164
542
687
2,654

Within district New York City
12
10
20
6
24
29
2
11
6
53

Elsewhere

52
35
35
71
81
83
29
60
57
66
54
27

37
55
45
24
19
17
47
11
41
23
40
20

60
39
57
92
92
60
45
62
56
65
61
44

36
52
31
8
7
40
17
36
43
19
33
19

Sales
New York. .
Philadelphia
Cleveland..
Atlanta....
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
San Francisco

. .

1,344
6,672
949
2,069
788
146
1,150
699
384
681
632
3,317

4
9
12
(2)

37
2
1
16
6
38

1
2

Purchases and sales adjusted to include weekends and holidays.
Less than one-half of 1 per cent.
NOTE. — Details may not add to totals because of rounding.

did a substantial amount of trading with each other, over one-half
of total purchases and nearly two-fifths of the sales being within the
District. In Chicago, too, over one-third of the sales and nearly
one-fourth of the purchases were among District banks. Thus,
sizable local markets have developed only around the two largest
financial centers, and in San Francisco, where the wide time differential is an important stimulant to local trading.
Data on the Federal funds transactions of the large New York
City banks, which are available since November 1956, indicate
that their purchases of Federal funds continued in about the same
volume under conditions of easy money. Their sales, however, increased somewhat, as well as the number of days they were net
sellers. Data available for banks in some of the Reserve districts
also indicated an increase in the volume of Federal funds transactions and in the number of participating banks following the development of easier money conditions in the fall of 1957. The increase in volume probably reflects in part the greater availability of
Federal funds in a period of easy money.
66



V. Bank Use of Federal Funds Market

The significant role played by Federal funds in the short-term adjustment of member bank reserve positions emerged clearly from
the data collected in November 1956. Purchases of Federal funds
by the 150 banks reporting in the survey averaged $760 million
daily as compared to daily average borrowings from the Reserve
Banks of $555 million. Indeed, although reporting banks accounted
for less than three-fifths of the total assets of all member banks, their
purchases of Federal funds were greater than average daily borrowings of all member banks from the Reserve Banks. Average daily
purchases of Federal funds by reporting banks were equivalent to
more than 6 per cent of their required reserves.
This chapter is devoted mainly to why and how banks which were
active in the Federal funds market used the market as compared to
alternative reserve adjustment media. For banks with excess reserves, such alternatives consist mainly of the purchase of Treasury
bills or other short-term investments; for those with a reserve deficiency, the principal alternatives are the sale of Treasury bills or
other securities, and borrowing from the Reserve Banks.1
The principal reasons for bank preference for adjustment in the
Federal funds market have already been indicated in preceding
chapters. The market makes possible a closer adjustment to daily
variations in reserve positions and, correspondingly, greater flexibility in the management of bank assets. There is, however, a great
deal of variation in the extent to which participating banks use the
Federal funds market and in their attitudes toward its use. Wide variations in attitude prevail as to the extent to which buying or selling
Federal funds is considered advantageous and the conditions under
which such operations appear to be more or less attractive. Some
banks participating in the market only sell Federal funds; others are
1

Other alternatives and their limitations are discussed in Chap. II, pp. 13-16.




67

FEDERAL FUNDS MARKET

principally buyers; and some stand ready to buy or sell at any time.
Some banks engage only in straight Federal funds transactions (unsecured, overnight loans); others use only repurchase agreements
or buybacks overnight or for longer periods.
Bank attitudes toward, and uses of, the Federal funds market
presented in this chapter are based largely on interviews with officials responsible for managing the money positions of the banks
which reported in the November 1956 survey, together with whatever statistical support was provided by the survey data. Any appraisal of attitudes reflected in the interviews as to relative emphasis
on the various factors involved must of necessity be a subjective
process. The statistical data, while illustrative of use of the market
for a short period, are not a reliable measure of any "typical" behavior of individual banks or groups of banks. Also, the attitudes
of the banks interviewed may be subject to bias in that they are
representative of the banks which were active participants in the
Federal funds market. It is to be expected that such banks would
look favorably on this market as a means of reserve adjustment.
DECISIONS TO USE THE MARKET

The principal elements entering into bank decisions to use the
Federal funds market rather than alternative media may be reviewed
from the standpoint of (a) bank preference for selling Federal
funds, and (b) bank preference for buying Federal funds.
Why banks prefer to sell Federal funds. Why does a bank sell Federal funds in preference to using other short-term outlets for temporary surpluses, such as the purchase of Treasury bills, acceptances,
and commercial paper, or the extension of overnight loans to securities dealers? The answer to this question is explored primarily in
terms of the alternative use of the Federal funds market or the
Treasury bill market, as bills are by far the most widely used and
easily available form of short-term instrument. The larger banks,
mostly in New York City and Chicago, use loans to Government
securities dealers at times as a limited alternative. In recent years,
however, dealers have relied less on such loans for their financing
as the New York rates on dealer loans have not been fully competitive with the cost of financing from other sources. Important among
68




BANK USE OF MARKET

these other sources are repurchase agreements with out-of-town
banks and large business corporations.
Interviews with bankers indicated that the major considerations
in choosing among alternatives were: (1) flexibility and convenience, (2) rate of return, and (3) promotion of the market.
Flexibility and convenience. The most important advantage of
the Federal funds market is its flexibility. It enables a bank to
maintain a more closely balanced position each day—with a minimum of risk—than any other money market instrument. Ease of
processing encourages participation in the Federal funds market,
and affects the form of Federal funds transactions used—straight
Federal funds, repurchase, or buyback.
In short, most of the banks interviewed indicated that the fullest
employment of their resources is a major objective of reserve management; and that the Federal funds market is a flexible and convenient outlet for temporary surpluses.
Banks which operate actively in Federal funds make a daily
analysis of their money positions. Typically, the participating banks
try to keep their reserve positions in balance day by day over the
reserve week, or at least to limit any cumulated deficit early in the
week to an amount expected to be covered by an inflow of funds
between Monday and Wednesday. The pressure to keep fully invested prompts banks that manage their reserve positions closely to
sell today's excess in the market unless they are fairly certain of a
deficit position tomorrow. Because of the spread between bid and
asked prices and rate fluctuations, and the more complicated bookkeeping and processing involved, Treasury bills and other shortterm paper and securities are not considered a real alternative to
Federal funds for use of strictly one-day money. Banks which have
large but unpredictable swings in cash positions thus tend to regard
the Federal funds market as the more suitable medium for disposal
of a temporary surplus.
The longer an excess is expected to continue, the more willing
the banks are to place all or at least a part of it in Treasury bills or
other short-term paper, relying on the Federal funds market to
absorb fluctuating amounts above what they are fairly sure to have
available for at least a few days. Even banks which normally carry
an excess day after day, however, often prefer to sell Federal funds.
69



FEDERAL FUNDS MARKET

The Federal funds market enables them to employ varying amounts
as excess reserves fluctuate from day to day. In addition, most
Federal funds transactions normally involve less effort and clerical
cost than bill transactions.
In a sense, buyback and repurchase arrangements combine the
features of bill purchases and Federal funds sales. They eliminate
the risk of market fluctuations in bill rates and the risk inherent in
an unsecured loan. On the other hand, such arrangements are less
convenient for the large banks, which often regard them as not
worthwhile for just one day.2
Rate of return. The relative rate of return is another factor
influencing willingness to dispose of excess reserves in the Federal
funds market. A major function of reserve management is the
maximization of bank earnings. Earnings, in turn, reflect not only
interest rates but market losses and high operating and processing
costs. Many of the banks contacted in the fall of 1956 indicated
that a better rate on Federal funds than on bills, and fluctuations in
bill rates which resulted in an uncertain return, were major influences in their choice of the Federal funds market for the disposition of excess reserves.
The incentive to sell Federal funds is naturally greater when the
rate is high than when it is nominal. In fact, numerous banks expressed unwillingness to sell Federal funds when the rate drops
below 1/2 of 1 per cent because costs absorb most of the return.
Despite this reluctance, however, the volume of transactions at
rates below 1/2 per cent is sometimes substantial in periods of easy
money. Only a small return is needed to cover "out-of-pocket"
expenses.
Timing of sales is often influenced by fluctuations in the Federal
funds rate. Instead of selling their surpluses on Wednesday when
the rate is likely to be lower, some of the country banks, having a semimonthly reserve computation period, often wait until
Thursday when dealers' needs, reflecting payment for their awards
of the weekly Treasury bill offering, normally exert upward pressure on rates. A few banks indicated they might broaden their list
of approved borrowers in case of a decline in the Federal funds rate,
2

See Chap. IV, pp. 56-58.

70




BANK USE OF MARKET

but this is not the common practice. There is a tendency, however,
for sellers to try to dispose of Federal funds as early as possible in
the day, unless the opening rate is low, in case the rate weakens as
trading progresses.
Irrespective of the level and range of fluctuations in the Federal funds rate, money-position managers can be expected to measure the rate against the returns available on alternative uses of
excess reserves. As the Treasury bill is the principal alternative for
most of these banks, the Federal funds and Treasury bill rates are
compared. When the bill rate is below the Federal funds rate, there
is an inducement to sell Federal funds instead of buying bills. Some
banks surveyed in November 1956 became active sellers of Federal
funds when such conditions prevailed.
On the other hand, when the bill rate is above the Federal funds
rate, especially if this relationship occurs frequently or is for an
extended period, banks tend to shift back to bills. Such shifts, however, are mostly by banks with consistent surpluses, or at least with
excesses expected to be available for more than just a day or two.
Regardless of rate advantages, most banks do not consider purchases of bills or other short-term Government securities appropriate for day-to-day reserve adjustments because of the spread
between bid and asked prices.
The increased fluctuation in bill rates in recent years has probably
been more important than the comparative levels of rates in influencing choice between the bill and Federal funds markets. With
day-to-day fluctuations in bill rates, a "misguessed market" trend
can lead to a principal loss on a quick bill turnaround—a loss which
management can readily observe. An analogous error in the Federal funds market would simply mean a smaller return. In periods
of tight money, the Federal funds rate usually stays close to the
discount rate and is likely to be more stable than the bill rate; in
periods of easy money, the Federal funds rate fluctuates more
widely, often declining to a nominal rate of Vs of 1 per cent. At this
rate, the supply tends to dry up as the return hardly justifies the
effort and expense of locating a buyer.
Promotion of the market. Many banks, recognizing the longer
run value to them of the function performed by the Federal funds
market, are inclined to give it continuous support. By promoting




71

FEDERAL FUNDS MARKET

development of a broad market, the banks help to make Federal
funds a more dependable medium for meeting reserve deficiencies
when they occur. This is probably of more vital concern to banks
which not only buy and sell to meet their own reserve needs but
also provide or absorb Federal funds as a service to correspondent
customers. A broad Federal funds market is especially useful to
these "accommodating" banks, as will be explained in a subsequent
section of this chapter.
Most banks which use the market primarily for adjusting their
own reserve accounts are also cognizant of the advantages of a broad
market and of maintaining close contact with the market. A bank
may therefore choose to fulfill another bank's need for Federal
funds, even though alternative uses are slightly more profitable immediately, in anticipation of a return favor at a time when reserve
conditions are reversed. More important are the indirect gains in
terms of improved correspondent relations, larger correspondent
balances, and a better working knowledge of money and economic
conditions fostered by regular contacts and dealings in the Federal
funds market. The fact that some banks in financial centers expressed a willingness to sell Federal funds at nominal rates toward
the end of the day, often to a neighboring bank, indicates the importance attached to promotion of this market, as well as the absence of a really practical alternative use of overnight money.
Why banks prefer to buy Federal funds. Why does a bank purchase
Federal funds in preference to utilizing other sources in meeting a
temporary reserve deficit? In meeting such a deficit, the principal
alternatives to the purchase of Federal funds are the sale of Treasury bills and other short-term securities or use of the Federal Reserve discount window. Small country banks may draw on correspondent balances or borrow from city correspondents for longer
periods. The larger banks, mainly in New York City, which make
loans to Government securities dealers presumably have the additional alternative of reducing their dealer loans which are subject to
call. In practice, however, such loans are rarely called for immediate
payment. Moreover, such calls would not be an alternative for New
York City banks desiring to obtain reserves the same day since most
call loans are made and repaid in clearing-house funds. Dealer loans
by banks in other cities, such as Chicago, normally would be repaid
72




BANK USE OF MARKET

in Federal funds sent from New York by wire transfer. Banks are
generally reluctant, however, to call dealer loans on short notice,
preferring instead to raise the rate on renewals, which often results
in repayment. In any event, dealer loans are currently a ready
alternative for only the few banks which make such loans in significant amount.
For the larger banks, then, the principal sources of funds for
meeting a temporary deficit remain the purchase of Federal funds,
the liquidation of short-term securities, or borrowing from the Federal Reserve Bank. Choice among these media is largely dependent
upon such considerations as (1) bank attitudes—how banks view
the differing sources, (2) the availability of the various sources, and
(3) their relative costs.
Bank attitudes toward the differing sources. A bank's own appraisal of the advantages and disadvantages of utilizing the discount
window, the Federal funds market, or liquidating bills (assuming
availability) is a major factor influencing immediate decisions. In
part, this appraisal revolves around a bank's basic attitude toward
borrowing—with particular reference to borrowing from the Federal Reserve; in part it reflects more pragmatic considerations such
as convenience and relative costs.
Bank willingness to use the discount window is, in many instances, a primary factor affecting the choice among sources of
funds. Interviews with bankers confirmed the reality of bank "reluctance to borrow" from the Reserve Bank, at least in terms of
expressed banker attitudes. Most banks expressed a definite preference for use of the Federal funds market. In contrast, however, a
minority indicated they prefer the Federal Reserve as a source of
borrowed funds, although they use the Federal funds market regularly to dispose of funds. Between these extremes were various
shadings of view, depending on the frequency and magnitude of
reserve deficiencies, individual bank policies toward indebtedness,
and differing interpretations of System discount policy.
Some of the banks interviewed apparently have no hesitancy
about borrowing from a Reserve Bank and prefer the discount
window to the Federal funds market, or to liquidating securities,
particularly in a declining market. In this group are banks which
never buy Federal funds and banks which buy them only when there




73

FEDERAL FUNDS MARKET

is a rate advantage. The advantages in using the Federal Reserve
discount window cited by this minority group of banks included:
Convenience. Notes can be prepared in advance and collateral is already
in safekeeping. Thus, borrowing from the Reserve Bank is easier than
trying to locate Federal funds, particularly when they are scarce.
Timing. Can borrow from the Reserve Bank later in the day. Time
differences between New York and the banks in Western districts make this
particularly important in certain cases.
Dependability. A more dependable source and can borrow the exact
amount needed, which may be in excess of the legal limit that can be borrowed in the market.
Cost. Even when the Federal funds rate and the discount rate are
nominally the same, borrowing at a Reserve Bank is slightly cheaper because
interest is figured on a 365-day basis instead of 360 days as in the case of
borrowing Federal funds.

As indicated, however, both the data and the individual bank
interviews revealed that the majority of the banks surveyed are
reluctant to borrow at the discount window; if funds are needed
they take advantage of every opportunity to obtain them in the
market and come to the Federal Reserve discount window only as
a last resort.
The principal reasons expressed by the majority of banks which
favored purchasing Federal funds were:
Convenience. Funds can be located in the course of ordinary telephone
contacts.
Relationship with Federal Reserve. This includes avoidance of "red tape"
in borrowing, and a desire to reserve the discounting privilege for emergencies.
Cost. Federal funds are cheaper at times, and continuous contact with
the market makes it possible to take advantage of the rate differential.
Promotion of correspondent relationships. The Federal funds market
provides an opportunity to accommodate customers and attract new ones.

Apart from the basic attitudes of banks toward borrowing from
the Federal Reserve, convenience and cost are seemingly the most
important practical factors. It is obvious from the above that the
"convenience" of the discount window and of the Federal funds
market is appraised differently among bankers. For example, in
one major city each of two large banks operating directly across
from one another—one normally utilizing the discount window,
74




BANK USE OF MARKET

and the other purchasing Federal funds to adjust—gave as the principal reason that it was "mechanically easier."
Availability of alternative sources. The availability of alternative
sources of funds to meet a deficit is another major factor influencing
choice, particularly with respect to the possible use of Treasury bill
sales. Bill portfolios may be so low as to limit the practical usefulness of this alternative, especially in the case of the largest banks.
In 1956 and most of 1957, for example, such banks held relatively
few bills, and occasionally the bill rate was above the discount rate.
Thus liquidating bills was not an advantageous method of meeting
reserve deficiencies. Following the change to easy-money conditions in the latter part of 1957, however, these banks acquired
more bills and reserve adjustments through the sale of bills became
more frequent.
Availability of Federal funds is influenced by several factors. As
discussed previously, it depends in part on the amount and distribution of excess reserves, as well as upon the contacts of a particular
bank. Availability tends to be less in periods of tight money and
greater in periods of ease. The magnitude of the deficit to be covered is another factor limiting recourse to the Federal funds market
under certain conditions. Frequently, banks may not know their
reserve needs until too late in the day to obtain Federal funds. As
a result, banks may be forced to turn to the discount window, at
least for residual needs. Another factor limiting the "availability"
of Federal funds is that of borrowing limits which, again, may not
permit a bank to cover its entire deficit in the Federal funds market.
Finally, willingness to use the discount window may vary, depending upon a bank's borrowing record, that is, whether a bank
has been a continuous borrower at the discount window. The Federal Reserve System considers continuous borrowing an inappropriate use of the discount window and a matter for discount administration by the Reserve Bank. As a result, Federal funds may be
particularly attractive to a bank which, for various reasons, may
need to borrow frequently.
In practice, many banks which are heavy purchasers of Federal
funds are also fairly regular customers of the discount window.
Practical considerations related to availability influence the use of
one source as opposed to the other or a combination of both at any
75




FEDERAL FUNDS MARKET

given time. These include the time of day the deficiency arises, that
is, whether Federal funds are still available, the size and expected
duration of the deficit, and the bank's recent record of borrowing
from the Federal Reserve.
To meet small deficits, the discount window is preferred by some
banks, especially if they do not have a record of continuous borrowing. If a large amount of funds is needed, banks which normally
buy Federal funds obtain as much as possible in the market (up to
their borrowing limits), and then turn to the Federal Reserve for
the remainder. If Federal funds are available only in limited
amounts, particularly among established contacts with lending
limits large enough to be of help, borrowing at the discount window
may be preferable. A bank which has been a large and continuous
user of the discount window, however, may deem it worthwhile to
execute a good many small Federal funds transactions if by so doing
it can "get out of the Fed" for a while.
Banks, when almost continuously in need of funds, are likely to
take advantage of any weakening in the Federal funds rate and thus
benefit both by a cost saving and a chance to pay off indebtedness
to the Reserve Banks, at least temporarily. Although none of the
banks interviewed was an express advocate of continuous borrowing, a few were, in practice, continuous borrowers, including both
borrowings in the Federal funds market and from the Federal Reserve. Banks with more or less chronic deficits return to the Federal funds market day after day to meet their needs, whereas banks
with more balanced reserve positions and thus needing to borrow
infrequently, often prefer discounting to take care of deficits which
are expected to last more than a day or so. There are, of course,
endless combinations of conditions which affect decisions at any
particular time, but they do not alter the basic policies or attitudes
of banks.
The extent to which banks can and do substitute Federal funds
for discounting cannot be discerned from the survey data which
covered only the month of November 1956. Some information on
this practice was obtained from data on borrowings of individual
banks in New York and Chicago for which Federal funds data were
available over a longer period. Examination of the borrowing pat76




BANK USE OF MARKET

terns of the banks in these centers which actively used both sources
of borrowings indicated that:
(1) Few banks were continuous borrowers.
(2) Continuous borrowers preferred Federal funds. For the few banks
which were in debt much of the time, borrowing from the Reserve Banks
appeared to be supplemental to purchases of Federal funds. When needs
were small they tapped only the Federal funds market.
(3) Despite a preference for borrowing from the Federal funds market,
few "continuously" indebted banks could obtain all the funds needed in the
market. These banks usually had to resort to the Federal Reserve discount
window as well.
(4) Finally, examination of the records of Federal Reserve borrowings
and net Federal funds transactions of money market banks showed relatively few instances where banks were able to break up extended periods
of "continuous borrowing" from the Federal Reserve by substitution of
Federal funds. Continuous borrowers (consecutive reserve periods) at the
Federal Reserve were at the same time frequently net purchasers of Federal
funds. Chicago banks were rarely able to meet all of their reserve needs
in the Federal funds market. There were relatively more cases in which
New York City banks were able to obtain sufficient Federal funds to meet
their deficiencies for a number of weeks during a more or less extended
period of indebtedness. However, most of them resorted to the discount
window as well from time to time.

Relative costs. Although all of the banks included in the study
were acutely cost conscious, the majority indicated that relative cost
is only one of the considerations involved in deciding among alternative sources of funds. Experience indicates, however, that relative cost is at times an important reason for shifts in borrowing
sources. During periods of differentials in discount rates among the
Reserve Banks, banks in the districts where the discount rate is
higher turn to the Federal funds market for a large part of their
reserve needs to take advantage of a lower Federal funds rate.
Theoretically, when the highest yield bills are below the discount
and Federal funds rates there is an inducement to sell bills rather
than to borrow, either in the funds market or from the Reserve
Bank. In practice, a bank which has a sufficient bill portfolio will
probably choose to liquidate bills. Among the banks surveyed, several with relatively large bill portfolios indicated they would prefer
to obtain funds by selling bills if the rate were lower than the dis-




77

FEDERAL FUNDS MARKET

count and Federal funds rates. A few banks indicated that they
would sell bills, or possibly longer investments, at a loss rather than
borrow from the Federal Reserve.
The actual range of variation in the Federal funds rate substantiates the view that for some borrowing banks, rate considerations are
secondary within certain limits. The hard core of discount-window
users normally do not switch to Federal funds when there is a rate
advantage. Nevertheless, market quotations for Federal funds, as
well as conversations with bankers, indicate that few banks will pay
more than the discount rate for Federal funds and few are totally
indifferent to relative cost considerations.
USE OF MARKET IN NOVEMBER 1956 3

Bank use of the Federal funds market is directly related to bank
reserve positions. If reserve pressures are spread fairly evenly
among banks participating in the Federal funds market, there will
be less activity than when both excesses and deficits exist in sizable
volume. Moreover, the volume of trading is influenced by the distribution of excesses and deficits. Banks needing funds may not
have established contacts with potential sellers, or much of the excess may be concentrated in banks which do not participate in the
market or which have selling limits too small to be of much help to
banks needing large blocks of funds. Thus the volume of transactions is likely to be relatively small when excess reserves are concentrated in country banks and reserve deficiencies in central reserve or reserve city banks. Country banks, especially the smaller
ones, tend to "freeze" excess reserves. For various reasons, such as
the relatively small amount held by an individual bank and lack of
established contacts, these banks are less likely to dispose of excess
reserves in either the Federal funds market or the bill market.
Interpretation of the November 1956 data requires consideration of the conditions then prevailing with respect to bank reserves
and the money market.4 Furthermore, the November data are inadequate for determining the relative use by banks of Federal funds
compared to other reserve adjustment media. Data were obtained
3
All data on Federal funds used in the tables in the remainder of this chapter
were adjusted to include weekends and holidays. Thus, a purchase or sale on
a Friday or on a day preceding a holiday runs until the next business day.
4
See Chap. IV, p. 43.

78




BANK USE OF MARKET

on banks' Federal funds transactions but data on their transactions
in Treasury bills and other instruments were not available. As a result, the data could not be directly related to uses of alternative
media except for a comparison of Federal funds purchases and
borrowing from the Reserve Banks.
The preceding discussion of factors affecting bank use of Federal
funds focused primarily on the attitudes revealed in interviews with
officers in charge of managing the money position of the banks
which participate actively in the Federal funds market. The next
section is based on the data collected in November 1956. It shows
the frequency of bank use of the Federal funds market during the
month and examines the patterns of use by banks with basically
different motives—those which use the market only to adjust their
reserve positions and those which use the market not only to adjust
their reserve positions but to accommodate other banks as well.
Frequency of transactions among banks. Frequency of purchases in
November 1956 tended to vary directly with size of bank. The
average number of days that banks bought funds was 21 in Group A
(assets over $1 billion), 11 in Group B (assets of $500 million to
$1,000 million), 7 in Group C (assets of $250 million to $500
million), and 3 in Group D (assets under $250 million). All five
of the banks that made purchases every business day during the
month were from the two largest size groups. On the other hand,
only one Group A bank and four Group B banks made no purchases during the month, as compared to one-third of the banks in
each of the two smaller size groups.
The tendency toward more frequent purchases by the larger
banks reflected, in part, the activity of the big New York City
banks. These banks are frequent buyers of Federal funds. In November, the number of days Federal funds were purchased by the
eight Group A banks in New York City averaged 28, compared to
17 for the thirteen Group A banks in other cities. Similarly, the
number of days the four Group B banks in New York City made
purchases averaged 18, compared to about 10 for the twenty-two
Group B banks in other cities. No Group C bank and only one
Group D bank from New York City was included in the study;
however, even outside of New York City there was a marked tendency for the large banks to be more frequent buyers on balance
79



FEDERAL FUNDS MARKET

than banks in the smaller size groups. For outside banks, the average number of days purchases were made was 17 for Group A,
10 for Group B, 7 for Group C, and 3 for Group D.
The larger banks not only purchased Federal funds more frequently but also in larger amounts. Group A banks and two of the
Group B banks in New York City accounted for 84 per cent of total
Federal funds purchases in November 1956. In fact, the concentration of buying at the large banks was more than merely proportional to their size. Total monthly purchases of Federal funds as a
percentage of total assets amounted to 25 per cent for Group A
and 31 per cent for Group B banks as compared to 11 per cent for
Group C and 7 per cent for Group D banks. Much of this difference between the two larger and the two smaller size groups resulted from the concentration of buying in the large New York City
banks. In particular, the relatively large purchases in Group B
reflected mainly the activity of two New York City banks which accounted for nearly four-fifths of the total purchases of all Group B
banks. Total monthly purchases of reporting New York City banks
amounted to 32 per cent of total assets in Group A, and 157 per
cent in Group B. For banks outside New York City, the correspondingfigureswere 18 and 7 per cent, respectively.
Unlike purchases, frequency of Federal funds sales did not reveal any clear trend by size of bank. The average number of days
during November 1956 that Federal funds were sold was 11 for
banks in Group A, 15 in Group B, 10 in Group C, and 10 in
Group D. Frequency of sales among these size groups reflected
two conflicting influences. On the one hand, of the banks participating in the Federal funds market, the larger banks are generally
more active than the smaller banks. On the other hand, the smaller
banks, when in the market, are more often sellers than buyers.
Although the larger banks tended to sell greater dollar amounts
of Federal funds than the smaller banks, the difference was much
less than on the buying side. Indeed, in proportion to size the
smaller banks were the heaviest sellers. Total sales during the
month expressed as a percentage of total assets were 9 per cent in
Group A, 36 per cent in Group B, 22 per cent in Group C, and 39
per cent in Group D.
Adjusting and accommodating banks. Classification of survey banks
80




BANK USE OF MARKET

according to basic motives in reserve management is perhaps more
significant than classification by size. On this basis, the banks may
be divided into two broad categories, namely, "adjusting banks"
and "accommodating banks." The former buy and sell Federal
funds only to adjust their own reserve positions; the latter in addition buy and sell as a service to their correspondents.
The term adjusting banks refers to banks which purchase or
sell Federal funds almost exclusively as a means of making temporary adjustments in their own reserve positions. Of the 145
banks reporting Federal funds transactions in November, 133 can
be regarded as adjusting banks.5
The adjusting group is divided into three separate subgroups.
Group 1 consists of banks which reported only purchases of Federal funds in November 1956. These banks appeared to have more
or less chronic reserve deficiencies and were typically buyers of
Federal funds on balance. Group 2 banks—the majority—aim to
maintain a balanced reserve position with neither persistent excesses nor deficiencies. Sometimes these banks are in the Federal
funds market as buyers; sometimes as sellers. Group 3 consists of
banks that sold but did not purchase Federal funds during the
month. Some of the participating banks, especially the smaller institutions, aim to maintain a surplus position most if not all of the
time. These banks, when in the market, are typically sellers of
Federal funds.
These three subgroups of adjusting banks are not mutually exclusive, and even banks in the third subgroup occasionally experience
a reserve drain of sufficient magnitude to result in a temporary
deficit. Furthermore, individual banks may shift from one subgroup
to another as conditions change or as management alters its policy.
Nevertheless, the attitude of an adjusting bank toward alternative
reserve adjustment media appears to be conditioned, at least in
part, by the status of its reserve management policy and its reserve
position over time.
Accommodating banks not only buy and sell to meet their own
reserve needs but, in addition, provide or absorb Federal funds as
5
Five banks included in the November 1956 survey reported no transactions,
as previously indicated.




81

FEDERAL FUNDS MARKET

a service to their correspondents. There are relatively few accommodating banks—about a half-dozen in New York City and a few
in other parts of the country. Of the 145 banks, only 12 clearly
fell into the accommodating category; this classification was substantiated by information obtained in the interviews.
Table 5 shows the daily average volume of Federal funds transactions accounted for by the accommodating and adjusting banks
during November 1956. It also shows the average number of days
TABLE 5
FEDERAL FUNDS ACTIVITY OF ACCOMMODATING AND ADJUSTING BANKS
NOVEMBER 1956
[Dollar amounts in millions]

Class of bank

Accommodating
Adjusting
(1) Purchases only..
(2) Purchases and
sales
(3) Sales only
Total
1
2

Number
of
banks

Purchases
Average
amount 1

12
133

$441
317

Sales

Percentage Average2
of total frequency
58
42

29

19

144

19

173

23

8

145

$758

100

Percentage Average 2
of total frequency

$212
400

35
65

21

252
148

41
24
100

11
15

14

71
43

Average
amount 1

$612

Total of daily averages for banks in each group.
Average number of days purchasing or selling in 30-day period.

Federal funds were purchased and sold by the banks in each classification. The 12 accommodating banks are conspicuous in the data
because of their almost continuous operation on both sides of the
market.6
Of the 133 adjusting banks, 43 were sellers only and are classified as Group 3 (surplus banks). The 19 Group 1 banks—purchases only—represent largely the banks which in that period at
least experienced recurring reserve deficiencies. Group 2 includes
the largest number, 71, and consists of banks which shifted from
one side of the market to the other within the month. This is, of
course, a less homogeneous group than the others.
Accommodating banks accounted for more than one-half of total
6
There were, of course, some borderline cases where more or less arbitrary
decisions had to be made in classifying banks. For instance, a few banks which
reported very small purchases or sales against their own reserve positions were
excluded from the "accommodating" category.

82



BANK USE OF MARKET

purchases and approximately one-third of total sales. On the average, they purchased Federal funds much more frequently than
banks in the other groups, including those adjusting banks which
made purchases only. The accommodating banks were also more
frequent sellers of funds.
The variation in activity reflected, in part, the relative size of the
accommodating and adjusting banks. As pointed out previously,
the large banks made more extensive and continuous use of Federal funds than did the smaller banks. In fact, 10 banks accounted
for 70 per cent of the average daily amounts of purchases in November. Moreover, there was a tendency for the large banks to be
net purchasers of Federal funds and for the smaller banks to be
net sellers.
Federal funds activity in relation to size of bank and required
reserves is shown in Table 6.7 In relating variation in activity to
TABLE 6
FEDERAL FUNDS ACTIVITY IN RELATION TO SIZE OF BANK AND REQUIRED RESERVES
NOVEMBER 1956

Class and size of bank

1

Number
of
banks

Sales2

Purchases2
Percentage
of required
reserves

Average
frequency3

Percentage
of required
reserves

Average
frequency3

Accommodating

12

11.5

29

5.5

21

Over 1,000
500 - 1 000
250-500

7
4
1

8.2
42.3
15.0

29
30
26

3.2
2.8
20.8

18
27
26

19
4
3
8
4

6.2
5.9
8.5
7.3
2.5

—

Over 1,000
500-1,000
250-500
Under 250

71
9
16
23
23

4.0
5.6
1.8
3.9
4.0

14
25
20
11
2
8
16
7
8
7

(3) Sales only
Over 1,000
500-1,000
250-500
Under 250

43
1
4
17
21

—

—

—

—

133

Adjusting
( 7 ) P u r c h a s e s only
Over 1,000
500- 1,000
250-500
Under 250

1
2
3

.

. . . .

—
5.8
3.6
7.5
5.8
9.7

11
10
16
8
12

9.8
2.1
6.2
10.1
19.8

75
5
14
15
15

Size in terms of assets, in millions of dollars, as of Dec. 31, 1956.
Daily average for banks in each group.
Average number of days purchasing or selling in 30-day period.

7
As pointed out previously, practically all of the member banks in the three
larger size groups were included in the survey.




83

FEDERAL FUNDS MARKET

size, however, it should be remembered that the Federal funds
mechanism is fundamentally a large-bank device and that all participating banks are "large" compared to the majority of banks in
the United States. Only 10 of the participating banks had assets of
less than $100 million. Also, it is significant that there are banks of
all degrees of "bigness" in each of the adjusting groups.
In analyzing use of the funds market by individual banks, activity
in relation to required reserves and size is more important than activity alone. Within each group the large banks tend to purchase
more in proportion to size than the small banks; however, small
banks tend to sell more than the large banks. This corroborates
information obtained in the bank interviews. Despite these marked
tendencies, there are variations. Of the fifteen banks with purchases averaging more than 10 per cent of required reserves, three
had assets of more than $1 billion; four, $500 million to $1,000
million; six, $250 million to $500 million; and two, less than $250
million. The averages conceal the fact that for a good many of
these banks the volume of transactions in Federal funds was small.
For 40 per cent of the 102 banks reporting purchases in November,
the average daily amount was less than 2 per cent of their required
reserves; similarly, average daily sales were less than 2 per cent of
required reserves for one-fourth of the 126 banks which sold Federal funds.
Use of Federal funds and borrowings. Of the 145 banks reporting
Federal funds transactions in November 1956, 87 banks, or 60 per
cent, were in debt to the Federal Reserve Banks some time during
the month. Most of the reporting banks also purchased Federal
funds.
As one would expect, buying Federal funds and borrowing from
the Reserve Banks were closely related to the banks' reserve positions during the month. Table 7 shows that all of the Group 1
banks which only purchased Federal funds had a net deficit position for the month; that the number of Group 2 banks was fairly
evenly divided between net surplus and net deficit positions; and
that most of the Group 3 banks with sales only had net surplus
reserve positions.
A comparison of the extent to which reporting banks used bor84




BANK USE OF MARKET
TABLE 7
NET SURPLUS OR DEFICIT RESERVE POSITIONS OF SURVEY BANKS
[Based on daily averages for November 1956]

Adjusting banks
Surplus or deficit

Number of banks:
Net surplus or deficit
1

Net surplus
Net deficit2

Percentage ratio of net deficit to
required reserves of deficit banks:
Under 5
5-9.9
10-25
Over 25
1
2

Accommodating
banks

(1)
(2)
Purchases Purchases
only
and sales

(3)
Sales
only

12

19

71

43

5
7

19

39
32

36
7

2
2
1
2

2
2
11
4

13
10
9
0

4
1
2
0

Sales of Federal funds exceeded purchases plus borrowing from Federal Reserve.
Purchases of Federal funds plus borrowing from Federal Reserve exceeded sales.

rowing from a Reserve Bank and purchases of Federal funds is
shown in Table 8 on the following page.
The data reveal a striking contrast in the use of Federal funds
and Federal Reserve borrowings by the accommodating and adjusting banks. The accommodating banks relied much less on borrowings from the Federal Reserve than did the adjusting banks in
Groups 1 and 2—those which purchased Federal funds. Only onehalf of the accommodating banks borrowed at any time during November, and the largest daily average amount borrowed by any
one of them was 6 per cent of its required reserve. On an average
daily basis, each of the accommodating banks purchased larger
amounts of Federal funds and purchased more consistently than it
borrowed from the Federal Reserve.
Accommodating banks also relied much less on Federal Reserve
borrowings than the adjusting banks (Group 1) which purchased
but did not sell Federal funds. Possible explanations for this difference are: the attitude of management toward borrowing as compared to buying Federal funds; the probability that the two-way
trading activities of accommodating banks afforded them access to
85




FEDERAL F U N D S MARKET
TABLE 8
COMPARISON OF FEDERAL FUNDS PURCHASES WITH BORROWING FROM
FEDERAL RESERVE BANKS
NOVEMBER 1956
Adjusting banks
Survey banks and borrowing banks

Accommodating
banks

(1)

Purchases
only
Total number of survey banks
Number of survey banks borrowing from F.R. B a n k s . . .
All survey banks
Daily average purchases:
In millions of dollars
As average percentage of required reserves
Daily average borrowings from F.R. Banks:
In millions of dollars
As average percentage of required reserves
Average frequency:
Purchasing Federal funds—
Days 1
Borrowing from F.R. Banks—
Days 1
Reserve weeks
Borrowing banks
Daily average purchases:
In millions of dollars
As average percentage of required reserves
Daily average borrowings from F.R. Banks:
In millions of dollars
As average percentage of required reserves
Average frequency:
Purchasing Federal f u n d s Days 1
Reserve weeks
Borrowing from F.R. Banks—
Days 1
Reserve weeks
Total daily average borrowings (F.R. Banks and Federal
funds):
In millions of dollars
As average percentage of required reserves
1

(2)
Purchases
and sales

(3)
only
43
15

12
6

19
19

71
46

441
11.5

144
6.2

173
4.0

84
2.2

311
13.4

120
2.7

20
1.4

29
4

14
3

8
2

0
0

4
1

15
3

5
1

2
1

212
8.9

144
6.2

112
3.7

84
3.5

311
13.4

120
4.0

20
3.2

29
4

14
3

9
2

0
0

8
2

15
3

7
2

7
2

296
12.4

455
19.6

232
7.7

20
3.2

Number of days in 30-day period.

a better supply of Federal funds; and the easier basic reserve positions of the accommodating banks (see Table 7).
Borrowing from the Federal Reserve Banks was greatest among
the adjusting banks, which also relied most on purchasing Federal
funds. It was least among the banks which did not buy Federal
funds at all. This apparently reflected differences in basic reserve
positions more than preference for, or prejudice against, borrowing
from the Reserve Banks. Daily average borrowings from the Federal Reserve by Group 1 banks, which purchased but did not sell
Federal funds, were more than double their Federal funds purchases and accounted for nearly 60 per cent of the combined average daily borrowings of all survey banks. Over 80 per cent of
86




BANK USE OF MARKET

the borrowings of Group 1 banks was accounted for by three of
the largest banks in the country, located in New York City and
Chicago. These three banks also accounted for more than twothirds of the Federal funds bought by the 19 Group 1 banks.
The adjusting banks which both bought and sold Federal funds
during the month acquired more of their reserves from the funds
market than from the Federal Reserve Banks, and 25 of these banks
did not borrow at all. In Group 2, banks which made use of both
sources, Federal funds purchases exceeded borrowings for about
one-half of the banks. Because of greater use of the discount window by some of the larger banks, however, Group 2 banks which
borrowed from the Federal Reserve borrowed more on balance
than their purchases of Federal funds.
These data on purchases of Federal funds and borrowing from
the Reserve Banks during November, combined with the information acquired through the interviews, point to the following conclusions:
1. Accommodating banks relied less on the discount window than adjusting banks.
2. Adjusting banks (Group 1), which purchased but did not sell Federal
funds, were the most active users of the discount window. Banks almost
continuously in a deficit position cannot always obtain sufficient funds from
the market to satisfy their needs. These banks usually purchased Federal
funds before turning to the Federal Reserve, but actually covered the largest
portion of their deficits by borrowing.
3. Adjusting banks which needed funds infrequently tended to borrow
from the Federal Reserve.
4. Adjusting banks which were part-time buyers of Federal funds sometimes resorted to the discount window but could usually get a large part
of their needs in the Federal funds market.

There is no evidence that banks deliberately borrowed from the
Federal Reserve in order to sell Federal funds. Only seven banks
reported sales of Federal funds in November on days they were in
debt to their Reserve Banks, and 10 of the 25 instances were on
Wednesdays—the last day of the reserve computation period. This
timing, as well as information obtained in the interviews, suggests
that a sudden shift in reserve position was responsible.
Adjusting banks' use of the market. Although use of the market by
adjusting banks was covered in general terms in the preceding dis-




87

FEDERAL FUNDS MARKET

cussion of alternative uses by adjusting and accommodating banks,
some additional detail on purchases and sales of Federal funds by
groups of adjusting banks may be useful. Table 9 shows frequency
of Federal funds transactions of adjusting banks and daily average
purchases and sales in relation to required reserves.
TABLE 9
FEDERAL FUNDS TRANSACTIONS OF ADJUSTING BANKS
FREQUENCY AND RELATION TO REQUIRED RESERVES, NOVEMBER

1956

Number of banks
Frequency and relation to required reserves

Survey banks reporting transactions
Purchases of Federal funds:
Frequency:1
Over 20
11-20
5-10
Under 5
Daily average purchases as percentage of
required reserves:
Over 25
10-25
5-9.9
Under 5
Sales of Federal funds:
Frequency:1
Over 20
11-20
5-10
Under 5
Daily average sales as percentage of required
reserves:
Over 25
10-25
5-9.9
Under 5
1

(2)
(1)
With
With
purchases
purchases
only
and sales
19

71

6
3
6
4

10
12
11
38

3
10
6

(3)
With
sales
only

1
7
11
52

43

11
24
18
18

12
16
10
5

2
21
15
33

7
12
10
14

Number of days in 30-day period.

Purchase of Federal funds. Ninety-one adjusting banks reported
purchases of Federal funds in the November survey—71 Group 2
banks (purchases and sales) and 19 Group 1 banks (purchases
only). The behavior of these two groups of banks reflected mainly
differences in reserve positions. If reserve pressure during the
month had been more severe, probably additional banks would have
88



BANK USE OF MARKET

been pushed into Group 1; with less pressure there would have
been more banks in Group 2. All of the Group 1 banks also borrowed from the Federal Reserve during November. Nine of these
banks bought Federal funds in all four of the reserve weeks covered,
and all but three were in debt to other banks, to the Federal Reserve, or to both, in all four weeks. The Group 1 banks averaged
larger in size than the Group 2 banks that were net purchasers of
Federal funds, primarily because of two large banks which were in
the Group 1 category.
The average number of days Group 1 banks made purchases was
14 as compared to 8 for Group 2. Average purchases were 6 per
cent of required reserves for Group 1 banks, and 4 per cent for
Group 2.
Sales of Federal funds. As compared to 71 banks which bought
and sold Federal funds, 43 banks were sellers only. As a group, the
latter consisted of smaller banks and tended to sell Federal funds
more frequently and in larger amounts in proportion to their size
than Group 2 banks. About one-half of the "sell only" banks in
Group 3 had less than $250 million in assets, as compared to about
one-third of the "buy and sell" banks. Variations in the relative
selling activity of these two groups are shown in Table 9.
Group 2 accounted for a much larger proportion of the total
dollar volume of sales than Group 3 because it included more banks
and a higher percentage of large banks. About one-half of the
Group 3 banks sold Federal funds in all four reserve periods. The
average number of days on which sales were made was 15, and the
average amount sold was about 10 per cent of required reserves.
Group 3 banks apparently normally aim to maintain a surplus
position. They did not buy Federal funds in November, and they
borrowed infrequently from the Federal Reserve Banks. Only 15
of the 43 banks borrowed during the month, and 6 of those banks
were in debt during only one of the four reserve weeks covered.
Furthermore, the relative amounts borrowed were small.
Most of the Group 2 banks were net sellers of Federal funds.
Daily average sales were only 4 per cent of their combined reserve
requirements and, on the average, those banks supplied funds 11
days out of the 30-day period. For two-thirds of the banks in this
group, average daily sales in November exceeded purchases, and
89



FEDERAL FUNDS MARKET

sales were also more frequent. Frequency of purchases and sales
among Group 2 banks varied widely. Thirty-eight of the 71 banks
purchased Federal funds on 5 days or less during the 30-day
period; however, 23 of these banks were sellers on 11 or more days.
On the other hand, the 22 banks which made purchases on 11 or
more days were infrequent sellers.
Accommodating banks' use of market. An adjusting bank may shift
from seller to buyer during the day because of an unexpected
change in its reserve position, and occasionally may execute a transaction against its own reserve needs to accommodate a customer.
But only a few banks stand ready to trade on both sides of the
market at the same time in any volume. The distinguishing feature
of accommodating banks—two-way trading banks—is their willingness to buy or sell Federal funds against their own reserve positions
unless the latter are extreme. Within this group, however, there are
variations in the degree to which individual banks are willing to
buy or sell against their reserve positions.
Although similar factors influence the decisions of accommodating and adjusting banks, they are weighted differently. All of the
accommodating banks do a large correspondent business, and look
upon Federal funds trading as a means of maintaining and expanding that business.8 The accommodating motive, however, cannot
be divorced from that of tapping the Federal funds market to satisfy
their own needs, which are frequently intensified by their operations
in servicing customers. The stake of these banks in an active national market in Federal funds is intensified by their willingness to
engage in accommodation transactions for their correspondents.
Thus motivated, most of the two-way trading banks give less
weight than other banks to immediate cost or profit differences and
more to the longer run objective of promoting and maintaining a
nationwide market for Federal funds. These banks do not make
direct profits from two-way trading except incidentally—to the extent that rates may vary during the day. Some are willing to sell
Federal funds even if they may have to borrow from the Reserve
Banks to cover their own positions toward the close of the day.
8

It may be noted that some of the big New York City correspondent banks
are not in this group.

90




BANK USE OF MARKET

There are differences within this group, however, in long-run reserve policies and in attitudes toward the use of the discount window. The more persistent the deficit positions the more reluctant
they are to borrow from the Reserve Banks, and the more important for them to develop large numbers of contacts to insure adequate sources of Federal funds when needed. On the whole, the
Federal funds market probably reduces the amounts these banks
borrow from the Reserve Banks.
Data from the November survey on the use of Federal funds by
the accommodating banks have been included in previous tables.
The data indicate that accommodating banks were in the market
more often and made larger purchases in proportion to required reserves than did other banks. Although sales relative to size were
less than for other selling banks, they were more frequent. Still,
sales were both smaller in amount and less frequent than purchases.
Of the twelve accommodating banks, seven were net buyers and
five net sellers of Federal funds. All except three of the banks making net purchases also borrowed from the Reserve Banks. The five
banks which sold more than they purchased had net surplus reserve
positions for the month. Three did not borrow from the Reserve
Banks, and the other two borrowed in only one reserve week.
Two-way trading banks constituted only a small minority of the
banks active in the Federal funds market, but they accounted for
a large percentage of the total volume of transactions. The willingness of these banks both to buy and sell broadens the market, thus
making it a more reliable and convenient reserve adjustment
mechanism for other banks. More significantly, perhaps, a broader
market facilitates shifting the excess reserves of some banks to meet
the pressures converging on others.




91

VI. The Federal Funds Rate

Analysis of how the rate on Federal funds is established is approached in two ways. First, the network of communication among
potential buyers and sellers and the mechanics of establishing a rate
are described. Second, available quantitative information is utilized
to ascertain more basic factors influencing the Federal funds rate.
The significance of the Federal funds rate as a money market indicator is also considered.
PROCESS OF ESTABLISHING A RATE

The wide geographical area through which buyers and sellers of
Federal funds are distributed and the large number of institutions
which participate in the market create the need for facilities through
which bids and offers of funds can be communicated. Banks in the
money market centers of New York and Chicago through their
widespread correspondent relationships, a brokerage firm in New
York City, and, to a lesser extent, Government securities dealers
are instrumental in disseminating information on the Federal funds
rate and in bringing buyers and sellers together.1
Role of a New York City broken The New York City firm which
has been acting as a Federal funds broker for several years plays
an important role in putting potential buyers and sellers of Federal
funds in touch with each other, and in providing information on the
Federal funds rate. Early in the morning, bids, offers, and inquiries
begin flowing in to this firm. Starting with the first bid or offer received, an attempt is made to consummate an opening trade at a
rate satisfactory to both parties. If the bids and offers cannot be
matched, bid and asked prices are quoted, and transactions are ef1
The two institutions that recently began to offer brokerage services in Federal
funds have not been operating long enough for their influence in determining the
rate to be assessed.

92




THE MARKET RATE

fected as customers revise their original ideas as to rates. In the
absence of sizable, firm bids or offerings, advice to an inquiring
customer as to an appropriate rate may be based principally on the
"feel of the situation" as obtained from conversations rather than
from actual bids or offerings.
Many of the banks dealing through this brokerage firm do not
submit bids and offers at fixed rates. Instead, they give the firm
some discretion. Some banks are willing for the firm to arrange
transactions at a reasonable rate; others give authority to arrange
transactions within specific rate limits. In the absence of such limits,
the firm often checks back with the party concerned to ascertain
whether a given rate is acceptable. The firm also checks with banks
which have indicated an interest if the rate moves sufficiently.
Banks generally are interested in learning this brokerage firm's
rate quotation early in the day since it serves as a guide in determining rates on Federal funds transactions between correspondent banks
and also as an indicator of the state of the money market. The firm's
rate on Federal funds is widely quoted as the market rate. It is from
this source, for example, that the New York Times, the New York
Herald Tribune, and the Dow-Jones service get quotations on the
opening, high, low, and closing rates for the day.
The firm works mostly with banks, although transactions are occasionally arranged for dealers and even for corporations. Relatively few of its transactions are in the form of buybacks. The firm
does not quote a rate on repurchases and usually suggests such transactions only when an alternative to a straight transaction is needed.
Other factors in the rate establishment process.

As

explained

in

Chapter IV, correspondent banks also play a significant part in the
Federal funds market by providing information on potential buyers
and sellers and on the Federal funds rate. In providing rate information, the banks often take into consideration the rate quoted
by the New York City broker.
In addition to providing information, the policies and practices
of the large correspondent banks, especially the major money
market banks in New York City, are factors in rate behavior. Banks
with Federal funds to sell may try to dispose of them early in the
day, particularly if the rate is at or near the discount rate; and buyers may tend to hold off in the hope of taking advantage of any
93



FEDERAL FUNDS MARKET

possible weakening in the rate. When there is a spread between
bid and asked quotations, several of the banks tend to consummate
transactions toward the bid side (lower rate) when their own reserve positions are easy, and toward the offered side when their
positions are tight. These banks are generally accommodating
banks, which means that a substantial volume of their transactions
is initiated by the other party but at rates set by the accommodating
bank. Only one of the banks surveyed buys at the lower and sells
at the higher rate. Another accommodating bank will sell to its
correspondents at the discount rate, but will buy only at 1/8 of 1 per
cent below that rate. The accommodating bank most active in making a two-way market frequently makes one-day loans to Government securities dealers against Treasury bills as collateral at a
preferential rate slightly above the prevailing rate on Federal funds.
Banks outside New York City generally accept the prevailing
rate obtained directly from the New York broker, a New York City
correspondent, or dealers. Some banks, however, check the rate with
more than one of these sources. The majority of the banks receive
information on the rate throughout the day and consequently are
informed of any change. Isolated instances were reported of rates
being adjusted retroactively when the effective rate—the rate on the
largest volume of transactions—varied from the quoted rate. On
the other hand, cases were reported of banks simply wiring funds to
correspondents, to be disposed of at the prevailing rate as determined
by the correspondents.
Interviews with banks outside New York City revealed, however,
that passive acceptance of the prevailing rate may easily be overstated. In disposing of funds, many banks do "shop around" for a
better rate—contacting dealers first in the hope of executing a repurchase agreement or buyback at rates slightly above the prevailing
Federal funds rate. In addition to the advantage of more liberal
lending limits, many banks indicated a preference for repurchases
and buybacks because of a possible rate advantage. Scattered cases
were reported of banks making local trades at rates nominally below
the prevailing rate when the market is inactive.
Differing bank attitudes toward the discount window and the Federal funds market, outlined in the previous chapter, are reflected in
the establishment of the rate. To the extent that banks prefer to bor94




THE MARKET RATE

row at the Federal Reserve when the Federal funds rate is equal to
the discount rate, demand is withdrawn from the Federal funds
market and upward pressure on the rate is reduced. On the other
side, banks preferring to avoid Reserve Bank borrowing may take
advantage of any weakening of the Federal funds rate, thus reducing
the downward pressure on the funds rate.
Although the Federal funds market is national in scope, there is
a tendency toward segmentation. A large segment consists of transactions arranged through the New York City broker. This firm, as
mentioned previously, deals primarily with banks and in straight
Federal funds transactions. Another segment is transactions arranged through correspondent banks, including accommodation
purchases and sales. There are also local markets of some significance, particularly in San Francisco and Chicago.
Even though there is a close interrelationship among the segments of the market, it is unlikely that all transactions at a given
time will be at a uniform rate. Potential buyers and sellers do not
have information on all offer and bid quotations. In some transactions, particularly those made to accommodate correspondents, rate
may be a secondary consideration. Time differentials alter the
scope of the market during the day. Rates for straight transactions
usually differ from rates for repurchases, especially those for more
than one day. For various reasons, therefore, a small margin of
transactions is likely to be consummated at rates above or below the
prevailing rate.
ANALYSIS OF RATE BEHAVIOR

Two sources of information were available for study of the behavior
of the Federal funds rate. Data collected in the November 1956
survey made possible a number of comparisons which are useful in
establishing the positions of the several participants in the market
and in understanding the relationships of various rates. For the
inspection of rates over a longer period, it was necessary to rely
upon broader statistical series available in various internal and
external sources.
Buying and selling rates in November 1956. The daily rates reported
on Federal funds transactions by banks included in the November
survey are shown in Table 10. Transactions were consummated
95



FEDERAL FUNDS MARKET

each day at rates that varied from the so-called effective rate, that
is, the rate prevailing on the bulk of purchase and sale transactions as obtained by the Federal Reserve Bank of New York. The
rates reported indicate a wider range of variation from the effective rate on the selling side than on the buying side. An important
reason for the wider range in rates on sales than on purchases on
TABLE 10
RATES ON PURCHASES AND SALES OF FEDERAL FUNDS
NOVEMBER 1956
[Per cent, as reported by survey banks]
Day
Nov. 1
2
.
3 (Saturday)
4 (Sunday)
6 (holiday)1. . . .
8
9
10 (Saturday).
11(Sunday 2
12 (holiday)
14
15
16
17 (Saturday)
18 (Sunday)
19
20
21
22 (holiday)
23
24 (Saturday)
25 (Sunday)...
26
27
28
29
30

Effective rate
.

.

.

Range on purchases

3
3

3 - 2 3/4
31/2-21/2

3
3
3

3
3
3
3

Range on sales
31/8 - l 1/2

3 -2 1/2

3

3 -1 3/4
3 -1 3/4
31/4-13/4
3 -1 3/4
3.1-2

-2 1/2
-2 3/4
-2
-2 3/4

3.1 - 2
3 -2 3/4
3 - 1 3/4

3 -2 3/4

2 7/8

3

3 -2 1/4

31/4-l3/4
31/4-21/4

3
2 15/16

3 -2

2 7/8
3

31/4-27/8

3 14 - 1 3/4
/
3

3 - l 7/8
31/8- 1 3/4

3 -2 3/4
3
2 1/4

1
2 7/8

3

- 2 1/2

3 -2 1/2
3 - less than 1
3 -2 1/2
3 - 2 3/4

31/8- l 3/4
3 -less than 1
3 1/4 - 1
3 -1%

1
Holiday in New York and St. Louis Federal Reserve Districts. No effective rate quoted.
2
Holiday except in the Richmond, Atlanta, Minneapolis, Dallas, and San Francisco Federal Reserve
Districts, and the Memphis Branch of the St. Louis District. No effective rate quoted.
3
Plus $6 million at unspecified rate or rates.

most days is that some banks make repurchases in municipal securities with dealers at the same rate as the yield on the securities.
The rates on some of these transactions were considerably below the
straight Federal funds rate.
Occasionally, the highest rate reported on sales of Federal funds
was slightly above the highest rate on purchases for the same day
and vice versa. These discrepancies result from incomplete coverage
96




THE MARKET RATE

of all participants in the Federal funds market. It is interesting to
note that on four days of November 1956 banks reported purchases
at rates above the discount rate.
Frictions in the market and changes in the demand-supply situation during the day are also clearly revealed; for example, even on
days when transactions were reported at rates above the 3 per cent
discount rate, other transactions were reported at rates as low as 1
per cent. Again, when the funds rate was moving away from the
discount rate ceiling on the down side near the end of the month,
transactions were reported at or above that ceiling.
Regional rates. The data obtained in November 1956 do not permit a direct comparison of the rates on transactions in New York
City with those outside. The San Francisco Federal Reserve District had the largest intradistrict market outside New York City
—53 per cent of the purchases and 37 per cent of the sales of the
district's survey banks were within the district. Thus, comparing
rates on purchase and sale transactions in the San Francisco District
with those of New York City banks provides a reasonably good
indication of regional rate behavior. Table 11 shows daily average
TABLE 11
RATES ON PURCHASES AND SALES OF FEDERAL FUNDS
SAN FRANCISCO DISTRICT AND NEW YORK CITY SURVEY BANKS
NOVEMBER 1956
[Weighted arithmetic averages of daily rates]
Purchases
Day

San
Francisco New York
District
City
2.99
2.99
3.00
2.92
2.92

2.99
2.99
2.99
2.99
2.98

2.96
2.99
2.90
2.92
2.89

2.99
2.99
2.98
2.81
2.99

16
19..
20
21
23

3.00
2.99
2.85
2.90
2.99

3.00
2.99
2.91
2.85
2.99

26..
27
28
29..
30
1

1
2
5
7 .
8
9
12 .
13
14..
15

Nov

2.98
2.29
1.83
2.53
2.98

2.97
2.11
1.39
2.57
2.94

Sales
Excess1

San
Francisco New York
District
City

Excess1

3.00
3.00
3 00
3.00
2.99

3.00
3.00
3 00
3.00
3.01

-.02

2.99
2.99
2.99
2.93
2.98

3.00
3.00
3.00
2.80
3.00

-.01
-.01
-.01
.13
-.02

3.00
3.00
2.93
2.89
3.00

3 01
3.00
2.93
2.91
3 00

— 01

-.06
.05
.01
.18
.44
-.04
.04

2.99
2.15
1.30
2.50
2.98

2.98
2.14
1.46
2.70
2.96

.01
.01
-.16
-.20
.02

—
.01
-.07
-.06
-.03
-.08
.11
-.10

-.02

San Francisco District over New York City.




97

FEDERAL FUNDS MARKET

rates on purchases and sales of Federal funds for survey banks in
New York City and in the San Francisco District.
One of the most significant points revealed by the data was the
close correspondence between Federal funds rates in the San Francisco District and in New York City. Average rates on purchases in
the San Francisco District were above and below those in New York
City on an equal number of days—seven each. Rates on sales, however, were below those in New York City on nine days and above
them on four days during the month. These rate differentials were
usually quite small. One important reason for a disparity in rates
is the difference in time. In the afternoon, when the Eastern banks
are closed, the rate along the Pacific Coast is governed by the local
supply of and demand for Federal funds. Regional differences in
rates may also reflect regional preferences for different types of Federal funds transactions, for example, repurchases and straight transactions, as explained in Chapter IV (pp. 56-58). Repurchase agreements are negotiated sometimes at rates below but perhaps more
frequently somewhat above the prevailing rate on straight Federal
funds transactions.
Data for a longer period might reveal a different pattern of regional differences in rates. Available data, however, indicate that
the New York City rate reflects the state of the national market
with reasonable accuracy.
Relationship of the Federal funds and discount rates. It is clear that
no member bank would normally pay a higher rate for Federal
funds than the discount rate despite the widely prevalent reluctance
to borrow from the Federal Reserve. A bank not only has the option of borrowing from a Reserve Bank; it can also carry a deficiency forward in the same reserve period or as much as 2 per
cent of its required reserve into the next reserve period. Consequently, the purchase of Federal funds at a rate above the discount
rate is likely to occur only when, because of some particular situation, a bank is unable or is extremely reluctant to borrow from a
Reserve Bank. It was noted in Chapter III that the Federal funds
rate was above the discount rate for an extended period during
1928-29, presumably because a number of banks did not possess
paper eligible for discount, or because they were making a large
volume of call loans and feared criticism or actual refusal if they
tried to borrow from a Reserve Bank.
98




THE MARKET RATE

Recent periods of monetary stringency were marked by a comparatively high level of borrowing from the Reserve Banks. Under
these conditions, it seems that excess reserves offered in the market
at rates below the discount rate would be quickly absorbed by banks
with current reserve deficiencies or with indebtedness at the Reserve
Banks. If the Federal funds rate falls below the discount rate, banks
indebted to a Reserve Bank have a cheaper source of funds and an
opportunity to reduce the number of consecutive days of borrowing
from a Reserve Bank. The Federal funds rate occasionally deviates
from the discount rate, however, even under conditions of stringency. Variations in the reserve positions of banks which adjust via
the Federal funds market occur as reserves shift from country to
city banks or vice versa, and as the aggregate reserve position is
affected by such factors as float and Treasury operations.
Under conditions of monetary ease, borrowings from the Reserve Banks are at a low level, and the Federal funds rate may be
well below the discount rate for extended periods. When market
rates are low, banks with excess reserves have a number of options
and their choices depend upon their expectations as to the future
course of interest rates and loan demands. Excess reserves may be
used to purchase long-, intermediate-, or short-term securities. For
money market banks, dealer loans may be an alternative. Rates on
Federal funds and short-dated bills tend to equate under these conditions since the two are close substitutes.
These generalizations, in so far as they apply to a period of credit
stringency, were confirmed broadly by statistical data for 1956—
a year in which the prevailing rate on Federal funds did not deviate
from the discount rate in 23 weekly reserve periods. Inasmuch as
the Federal funds market and borrowing from the Reserve Banks
are alternative methods of adjusting reserves, the frequency with
which the two rates were equal indicated that preferences for a particular source were not strong enough to induce banks to pay a
higher rate. In 18 reserve periods, the Federal funds rate dropped
below the discount rate on Wednesday, the last day of the reserve
period. The deviation on Wednesday reflected the fact that excess
reserves on that day cannot be carried into the succeeding reserve
period; hence, banks were willing to sell Federal funds at a lower
rate, if necessary, rather than hold them idle. Moreover, since the
required reserve for Wednesday is based on deposit balances as of




99

FEDERAL FUNDS MARKET

the opening of business on Wednesday, one of the unknowns in
estimating a bank's reserve needs for that day is removed. Average
required reserve balances are a known quantity and accumulated
excesses or deficits in reserve positions can be corrected on the
basis of reserve gains or losses during the day.
While the concentration of deviations on Wednesdays is understandable, such differences are more difficult to explain when borrowings from the Reserve Banks are at a comparatively high level.
The lower Federal funds rate affords banks a profit incentive to buy
Federal funds and reduce their indebtedness to the Reserve Banks.
Comparison of daily changes in discounts of central reserve and
reserve city banks with deviations in the Federal funds rate showed
that reductions in the Federal funds rate occurred at the same time
as reductions in indebtedness to the Reserve Banks in about 60 per
cent of the cases. In 40 per cent, however, discounts increased on
days when the Federal funds rate decreased.
A number of conditions probably accounted for the failure of
borrowing at the Reserve Banks to respond fully to the reduced cost
of Federal funds. First, a large proportion of member banks do not
participate in the Federal funds market; therefore, shifts of reserves
which impair or improve the positions of these banks may be reflected in their discounts. Such banks, as a group, may be losing
reserves and increasing their discounts at the same time that other
banks which do trade in the Federal funds market have excesses
which they are willing to sell at a rate below the discount rate.
Second, legal restrictions on the amount a bank is allowed to borrow in the market may prevent some banks from taking greater
advantage of the opportunity to purchase Federal funds to reduce
borrowing costs. Third, some of the deviations in rates were quite
small, so that the rate differential offered only a small inducement
to shift to Federal funds. Fourth, owing to the different time zones,
banks which otherwise would take advantage of the rate differential
may not receive the information in time to act upon it. In this
connection, it is of interest that the New York central reserve city
banks' response to rate deviations conformed much more closely to
expected behavior than did that of all central reserve and reserve
city banks, although there were eight instances during 1956 and
the first two months of 1957 when borrowings by the New York
100




THE MARKET RATE

central reserve city banks from the Reserve Bank increased as the
Federal funds rate declined. Only on a few days, however, were the
amounts involved of significant size.
Interrelationship with discount and Treasury bill rates. Inasmuch as

the Treasury bill market, the Federal funds market, and borrowing
from the Reserve Banks are to some extent alternative media for
adjusting reserve positions, some interrelationship among movements in the bill rate, the Federal funds rate, and the discount rate
is to be expected. The accompanying chart shows the relative

RATES ON SHORTEST TREASURY BILL, FEDERAL FUNDS
AND THE DISCOUNT RATE

* Rate on shortest outstanding Treasury bill.

movements in the rates on the shortest outstanding Treasury bill, the
discount rate, and the effective rate on Federal funds from January
1956 to February 1957. Of the Treasury bill issues outstanding, the
shortest dated bill is the nearest substitute for Federal funds to adjust reserve positions although, as previously explained, it is far from
a perfect substitute. The discount rate and Federal Reserve policy,
of course, have an important influence not only on bill rates and the
Federal funds rate but on the entire structure of market rates.
If the rates on outstanding bills are above the discount rate and
the Federal funds rate, there is an incentive for banks with other
than strictly one-day excess funds to invest in bills. The supply of
101



FEDERAL FUNDS MARKET

Federal funds available in the Federal funds market tends to be reduced. On the other hand, if bill rates are below the Federal funds
rate, there is an inducement to put excess reserves into the Federal
funds market instead of into bills. If, however, banks with excess
reserves have a fairly strong preference for either of these two reserve adjustment media, the differential between the two rates could
become large without any important switching of funds between the
two markets.
There are several reasons for the differential that usually prevails
between the Federal funds rate and the shorter term bill rates. As
pointed out previously, Treasury bills are not really a good substitute for Federal funds because the latter are used primarily for oneday adjustments often involving quick turnarounds. Purchases of
Federal funds and borrowing from a Reserve Bank are better substitutes—a primary reason for the closer relation between the discount rate and the Federal funds rate.
A second reason why a spread between bill rates and the Federal
funds rate may persist is that both the bill market and the Federal
funds market may not be available at times to a sufficient number
of banks to permit shifts between these media to bring the rates together. As previously pointed out, only a small percentage of member banks use the Federal funds market. Many of the banks which
use the Federal funds market may have exhausted their bill holdings
or reduced them to what they regard to be a desirable minimum,
especially after a prolonged period of credit restraint.
Finally, banks with low loan limits compared to their estimated
liquidity needs may have to make numerous sales of Federal funds
to invest the proceeds from bill sales. If the margin between bill
and Federal funds rates should become sufficiently wide, however,
this inconvenience and cost might be overcome. Various subjective
factors such as convenience and bankers' attitudes toward the two
markets also influence willingness to shift from Federal funds to
bills and vice versa.
Efforts to confirm this rationale of reserve adjustments and rate
relationships by reference to the statistical record lead to inconclusive results. In part, this is caused by inadequacies in the available
information. The statement of condition of weekly reporting member banks does not segregate bill holdings according to maturity.
102




THE MARKET RATE

As already mentioned, however, the shorter bills are a more suitable
alternative to the sale of Federal funds, particularly when bill rates
are above the discount rate. A more fundamental difficulty is that
changes in bank holdings of bills are often the result of a combination of factors. It is not possible to segregate the effect of a rate
advantage from the effects of other factors.

RATES ON FEDERAL FUNDS, TREASURY BILLS,
AND TREASURY BILL HOLDINGS
OF WEEKLY REPORTING MEMBER BANKS

In November 1956, for example, an easing of the reserve positions of member banks was accompanied by a decline in the Federal funds rate and an increase in bill holdings of weekly reporting
member banks. Even though the rate on the longest outstanding
bill was above the discount rate and the Federal funds rate during
much of this period, it was impossible to determine whether bank
purchases of bills were a response to the rate differential, to easier
reserve positions, to favorable treatment of banks in the Treasury's
sale of special bills, or to a combination of these conditions.
The accompanying chart shows changes in the effective rate on
Federal funds, the three-month Treasury bill rate, and bill holdings
of weekly reporting member banks in 1956 and early 1957. There
is some evidence, although by no means conclusive, that relative
changes in bill and Federal funds rates affected reporting bank
103



FEDERAL FUNDS MARKET

holdings of Treasury bills. In the first quarter of 1956, when bill
rates were generally below the Federal funds rate, banks reduced
their bill holdings. In the latter part of the year, reporting banks increased their bill holdings as bill rates, especially the rates on threemonth bills, rose well above the Federal funds rate, and in early
1957 they reduced their holdings as the spread between bill and
Federal funds rates narrowed substantially. On the other hand,
there was little change in bill holdings from May through July 1956
when bill rates were considerably below the Federal funds rate.
There were other factors than rate differentials influencing bank
holdings of bills during the period. Bank reserve positions tightened
considerably in the first part of 1956 and 1957. Treasury financing
was also an important factor. In mid-December 1955, the Treasury
sold $1.5 billion of tax anticipation bills maturing in March 1956.
In mid-October and mid-November 1956, the Treasury had special
bill offerings amounting to $1.6 billion and $1.8 billion, respectively. These issues matured in January and February 1957. The
Treasury also sold $1 billion of tax anticipation bills in mid-December 1956 which matured in March 1957.
RATE AS AN INDICATOR OF MONEY MARKET CONDITIONS

The Federal funds rate indicates supply-demand relationships in
only one segment of the money market—primarily the market for
one-day funds. Short-term adjustment of reserve positions may take
the form of discounting or retiring debts at Reserve Banks, buying
or selling bills, as well as transactions in the Federal funds market;
consequently, the Federal funds rate directly reflects only one part
of the whole process.
Perhaps the chief statistical weakness of the Federal funds rate
as a money market indicator is its limited range of fluctuations in a
period of tight money. In a period of credit restraint, such as in
1956 and most of 1957, the rate remains at the discount rate for
extended periods. Thus, when the Federal funds rate is equal to the
discount rate, any further intensification of reserve pressures is not
registered. Furthermore, deviations from the discount rate at such
times are usually ascribable to specific, known events, such as fortuitous behavior of float, an unexpected decline in the United States
Treasury's deposits in the Reserve Banks, or the ready availability
of Federal funds on the last day of the reserve week.
104



THE MARKET RATE

In periods of credit ease, on the other hand, the Federal funds
rate is a more sensitive indicator. It is usually below the discount
rate, and fluctuations in the Federal funds rate reflect rather accurately day-to-day changes in the reserve positions of the large
banks in financial centers. Recently, however, there has been some
tendency toward less uniformity in Federal funds rates, some of the
larger banks being able to buy sizable amounts of Federal funds
direct from correspondents at rates somewhat more favorable than
those generally quoted in the market.
The basic limitations of the Federal funds rate as an indicator of
market conditions derive from the function of the Federal funds
market. The market serves primarily as a medium for one-day reserve adjustments. More fundamental adjustments of banks made
in response to pressure for loans and other longer term factors are
not directly reflected in the behavior of the Federal funds rate.
Despite these limitations, the Federal funds rate is a useful indicator of conditions in a segment of the money market that has
grown in importance. It reflects the demand for and supply of existing reserve balances for very short-term reserve adjustment purposes, and thus provides information of value in interpreting
changing conditions in the money market.




105

Technical Note: Discrepancies in Survey Data

Total purchases of Federal funds reported in the November 1956
survey exceeded total sales on 19 of the 21 business days covered,
as shown by the tables on page 108. On about one-third of these
days, sales fell short of purchases by 20 per cent or more, while in
absolute terms the discrepancies ran as high as $250 million. By
contrast, the excesses of total sales over total purchases on November 28 and 30 were relatively minor—less than 3 per cent of total
sales. An investigation of these discrepancies indicates that they
stemmed largely from three sources.
Net sales by "others" not included in reporting sample. The
banks and dealers reporting Federal funds transactions were net
purchasers from the nonreporting "other" group on each day during the period. The "other" group included such net sellers as savings banks, agencies of foreign banks, and corporations. Hence,
these net purchases were not offset in the total figures by net sales
that the "other" transactors would have reported had they been included in the sample. Almost all of these transactions took place
within New York City. Incomplete coverage was the most important item accounting for the discrepancy.
Net sales to New York City banks and dealers by nonreporting
banks outside New York City. For the most part, banks and dealers in New York City reported larger net transactions with member
banks in the rest of the country than the out-of-town banks reported with New York City. Some part of this discrepancy may
have resulted from reporting errors. A number of member banks
outside New York, however, are net sellers in New York City on
a sufficiently small scale and with so little regularity that they would
not be considered active in the market and thus were not included
in the reporting sample.
New York City banks and dealers reported net purchases from
the rest of the country on 17 of the days for which nationwide pur106




TECHNICAL NOTE

chases exceeded nationwide sales; on the remaining 2 days there
were net sales, both by New York City banks and nationally.1
Similarly, the data for banks outside New York City showed net
inflows to New York City for 16 of the 17 business days on which
more purchases than sales were reported. Furthermore, a comparison of net inflows as reported by New York City banks and
dealers with data submitted by out-of-town banks showed smaller
net inflows to New York City except on five days. Of these five, two
were days on which both groups reported net outflows from New
York City, and the remaining three days were at the beginning of
the month when reporting errors were more likely to have occurred.
Clearing operations. On about half of the days, Government
securities dealers reported larger net purchases from New York
City banks than these banks reported selling to dealers. These discrepancies probably resulted in part from the clearing operations of
the New York City bank which renders this service for its dealer
customers. As explained in Chapter IV, this bank keeps a record
of Federal funds receipts and payments from securities transactions
handled for each of its dealer customers. The bank absorbs net
receipts or provides Federal funds to meet net deficiences[deficiencies].Such net
receipts and payments were not reported in the November survey.
1
November 6 and 12 were bank holidays in some Reserve districts, including
New York. Thus there were only 19 trading days for New York City banks.




107

FEDERAL FUNDS MARKET
PURCHASES OF FEDERAL FUNDS, NOVEMBER 1956
Reported by Survey Banks and Dealers
[In millions of dollars]
Type of transaction
Total
amount

Day

1-day
unsecured

Other
1-day

Over
1-day

Nov. 1
2
5
6
7

692
705
640
617
838

529
462
424
415
530

163
240
193
202
263

3
23

8
9
12
13
14

617
697
662
1,130
1,014

376
494
474
830
795

218
202
187
244
219

15
16
19
20
21

1,100
740
814
1,090
953

801
499
569
851
737

23
26
27
28
29
30

921
1,144
887
791
882
827
17,761

Total

Location of seller

Purchased from:

Banks

Dealers Others Within
district

New
York
City

Elsewhere

597
607
500
494
704

21
33
73
56
58

74
65
67
67
76

76
103
85
100
106

243
235
249
225
297

373
367
306
292
435

23
1
1
56

500
564
535
969
928

54
59
53
95
17

63
74
74
66
69

116
135
126
196
204

214
233
208
313
405

287
329
328
621
405

290
217
215
229
214

9
24
30
10
2

976
603
668
936
818

38
44
53
54
45

86
93
93
100
90

235
128
141
119
102

416
295
292
415
409

449
317
381
556
442

690
895
733
627
748
687

224
249
154
164
125
136

7

9
4

752
1,047
813
672
751
734

62
18
11
52
65
41

107
79
63
67
66
52

145
146
87
52
99
77

424
574
415
437
455
533

352
424
385
302
328
217

13,167

4,347

247

15,168

1,003

1,590

2 577

7,287

7,897

45

NOTE.—See footnote below.

SALES OF FEDERAL FUNDS, NOVEMBER 1956
Reported by Survey Banks and Dealers
[In millions of dollars]
Type of transaction
Total

Day

Other
1-day

601
606
490
481
715

427
439
365
371
499

174
155
95
85
216

12
13 ....
14

493
556
424
898
888

291
416
340
689
712

182
125
72
209
176

15
16
19
20
21

Nov

1-day
unsecured

844
616
630
900
821

673
416
475
713
665

725
1,030
828
794
792
850
14,983

1
2
5
6
7

..

8

9

23
26
27
28.
29
30
Total

Over
1-day

Location of purchaser

Sold to:

Banks

New
York
City

Elsewhere

57
131
58
69
81

373
312
308
266
448

171
163
124
146
186

67
106
79
117
160

302
328
227
430
433

124
122
118
351
295

538
446
436
549
476

204
127
131
311
286

Dealers Others Within
district

533
552
440
437
672

67
54
45
39
36

20
15
12

411
520
391
831
841

125
183
155
186
130

46
17

730
493
540
818
735

58
29
26
63
42
111
98
83
82
70

24
7
7
4
5
3
25
7
16

102
43
63
40
59

567
828
717
695
636
710

146
189
103
82
156
133

12
13
8
17
7

638
938
773
737
724
807

77
89
52
45
47
40

10
3
3
12
21
3

65
92
82
83
57
63

477
632
358
300
430
428

183
306
388
411
305
359

11,645

3,078

260

13,562

1,253

168

1,675

8,497

4,811

12
30
25

1
26

1
5
5
7

NOTE. — Totals of transactions made on business days. Data not adjusted for weekends and holidays.
Details may not add to totals because of rounding.

108



TECHNICAL NOTE

PURCHASES OF FEDERAL FUNDS, BY FEDERAL RESERVE DISTRICT
Reported by Survey Banks and Dealers, November 1956
[In millions of dollars]
Type of transaction
Location
of purchaser

Total
amount

Purchased from:

1-day
unsecured

Other
1-day

Over Banks
1-day
247

15,168

1,003

30

425
9,010
512
243

6
728
9

2
62

286
148
1,532
374

All F.R. districts...

17,761

13,167

4,347

Boston
New York
Philadelphia
Cleveland

431
11,261
521
243

402
7,669
491
242

29
3,592

Richmond
Atlanta
Chicago .
St. Louis

286
148
1,599
374

260
146
1,506
368

26

Kansas City
Dallas
San Francisco

83
409
499
1,906

83
239
491
1,269

1

31
6
170
8
484

153

83
372
499
1,683

Dealers

Location of seller

New
Others Within York
district City

Elsewhere

1,590

2,577

7,287

7,897

1,523

36
921
87
11

240
4,518
171
171

155
5,822
263
61

344
99

242
124
482
224

44
24
773
51

3
40
40
997

49
272
258
535

31
97
201
374

1

67

37
223

NOTE.—See footnotes below.

SALES OF FEDERAL FUNDS, BY FEDERAL RESERVE DISTRICT
Reported by Survey Banks and Dealers, November 1956
[In millions of dollars]
Type of transaction
Location
of seller

All F.R. districts...
Boston....
New York
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas..
San Francisco

Total
amount

1-day
Other Over
unsecured 1-day 1-day

Location of purchaser

Sold t o :

Banks

Dealers

New
Others Within York
district City

14,983

11,645

3,078

260

13,562

1,253

168

1,675

1,003
6,334
648
1,401

884
5,769
508
521

107
565
140
727

12

63
305
143
464

22
136

1

153

918
5,893
505
937

543
90
872
506

146
39
775
485

396
39
79
11

1
12
18
10

491
90
788
496

74
10

273
475
500
2,337

252
150
205
1,911

21
302
295
395

23

252
448
458
2,285

21
27
42
52

31

Elsewhere

8,497 4,811

10

579
3,318
367
1,281

392
2,759
195
114

1

52

32
257
86
6

304
10

497
47
415
300

45
43
153
196

3
74
25
877

151
313
283
946

119
88
192
514

1
Outside New York City, but within New York Federal Reserve District.
NOTE. —Totals of transactions made on business days. Data not adjusted for weekends and holidays.
Details may not add to totals because of rounding.




109

Bibliography

BOOKS AND PAMPHLETS
Beckhart, B. H., and James G. Smith, The New York Money Market,
Vol. II, Sources and Movement of Funds, pp. 40-48. New York: Columbia University Press, 1932.
Board of Governors of the Federal Reserve System, The Federal Reserve
System: Purposes and Functions (3d ed.), pp. 36-37. Washington:
Board of Governors, 1954.
Carr, H. C , "Federal Funds," Money Market Essays. New York: Federal
Reserve Bank of New York, March 1952.
Clark, Lawrence E., Central Banking under the Federal Reserve System,
pp. 107-08, 189. New York: Macmillan Co., 1935.
Madden, John T., and Marcus Nadler, The International Money Markets,
pp. 169-71. New York: Prentice-Hall, Inc., 1935.
Roosa, Robert V., Federal Reserve Operations in the Money and Government Securities Markets, pp. 11, 20-22, 24-25, 30, 46-52. New York:
Federal Reserve Bank of New York, July 1956.
Turner, B. C , The Federal Funds Market. New York: Prentice-Hall, Inc.,
1931.
Westerfield, Ray B., Money, Credit and Banking (rev. ed.), pp. 625-26. New
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PUBLIC DOCUMENT
U. S. Congress, Senate, Committee on Banking and Currency, Operation of
the National and Federal Reserve Banking Systems (Hearings pursuant
to S. Res. 71, 71st Cong., 3d sess.), Pt. 1, p. 96; Appendix, Pt. 6,
pp. 725-26. Washington: Government Printing Office, 1931.
ARTICLES
Bachert, William E., "Reserve Position and the Use of Federal Funds,"
The Commercial Bank Money Position, pp. 30-32, 45-46, 56-59. New
York: Bank of New York and Fifth Avenue Bank, 1950. Quoted in
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New York: Norton, 1952.
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Tribune, Feb. 25, 1951.

110




BIBLIOGRAPHY

"Federal Funds," Monthly Review of Credit and Business Conditions, March
1950. New York: Federal Reserve Bank of New York.
Minsky, H. P., "Central Banking and Money Market Change," Quarterly
Journal of Economics, May 1957, pp. 188-205.
Olsen, Lief H., "From Bank to Bank," New York Times, Sept. 23, 1956.
Tyng, Ed., "Federal Funds Deals Rise," Journal of Commerce, Sept. 7, 1951.
Wilson, J. S. G., "America's Changing Banking Scene: III The Money
Market," The Banker, June 1957, pp. 394-401. London.
THESES

Calvert, E. Parker, Federal Funds and Their Relation to Interbank Transfers
and Payments. Graduate School of Banking, American Bankers Association, Rutgers University, June 1952.
Martens, Edward J., Federal Funds—A Money Market Device. Pacific Coast
Banking School, Western States Bankers Association, University of
Washington, April 1958.
Shertzer, Richard R., San Francisco Banks and the Federal Funds Market
(Master's Thesis), University of California, February 1957.




111