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The

Federal Funds

Market
ITS

ORIGIN

AND DEVELOPMENT

Parker B. Willis

Published by
The Federal Reserve Bank of Boston

1970

First Edition, 1957
Second Edition, 1964
Third Edition, 1968

Fourth Edition, 1970
Fifth Edition, 1972

PREFACE

Since its first publication in 1957, The Federal Funds Market Its Origin and Development has been reprinted on several occasions
to meet the requests of teachers, students, and money market
participants thoughout the Nation.

Because the Federal Funds market has shown such remarkable
growth and development and because public interest in the topic
continues to increase, we are pleased to present this revised, updated,
and expanded treatment.
The Federal Funds market evolved in the early 1920’s as an
informal by-product of the organization of the Federal Reserve
System. It began with the trading of reserves by several of the
System’s New York City member banks as a means of adjusting their
reserve positions.
In 1957, average daily purchases were slightly more than $1
billion. Currently — on some days — these purchases are estimated at
between 810 and $15 billion. Some 350 banks are now regular
participants in the market, while close to 3,500 banks buy or sell
Federal Funds at least once a year, more than twice the number in
1960. The market during the last ten years has experienced
considerable change in both structure and institutional practice. In
addition to serving its original purpose, the Funds market has long
been well established as a major outlet for short-term investment of
secondary reserves, and it continues to finance, both directly and
indirectly, much of the operations of Government security dealers.
Although it is growing, the body of literature concerning this
important facet of our Nation’s financial structure remains relatively
small. This study is designed to increase general knowledge of the
Federal Funds market, to clarify its relation to other money market
instruments, and to illustrate its contribution to the smooth
functioning of the American economy.

iii

We hope this revised edition will lead to a broader understand
ing of the American money market and will continue to stimulate
interest in its successful operation.

FRANK E. MORRIS, President
Federal Reserve Bank of Boston

November, 1970

CONTENTS

Introduction..................................................................................... 1
Beginnings of the Funds Market .................................................... 3
Role of Acceptance Houses in the 1920’s....................................... 6
Money Brokers................................................
8
Areas of Market Development ........................................................ 8
Relationship of Funds to Other Markets in the 1920’s.................
10
Rate of Relationships in the 1920’s..............................................
13
The Market in the 1930’s and World War II .................................
14
Some Differences in the Market in the 1950’s and 1960’s .... 16
Funds Market After World War II.................................................
19
Development of the Repurchase Agreement by Government
Securities Dealers ................................................................
21
Funds Transactions by Banks........................................................ 27
The Funds Rate ...........................................................................
29
Some Factors Influencing the Funds Rate- .................................
32
Money Market Instruments 1950-1969 and Some Funds
Relationships ....................................................................... 36
Funds and Treasury Bill Market..........................................
37
Dealer Loans ........................................................................
38
Commercial Paper.................................................................
39
Bankers Acceptances ........................................................... 43
Certificates of Deposit ................................................... . 46
Other Market Instruments....................................................
50
Structure of the Market and Interbank Trading..........................
51
Brokers and Accommodating Banks ..........................................
54
Funds Trading Patterns.................................................................
58
Federal Funds vs. Borrowing at Reserve Banks
.......................
61
Market Growth Reflected in “Borrowing from Others”.............
62
Factors Influencing Volume of Funds Trading ..........................
65
Computation of Reserves....................................................
66
Reductions in Levels of Required Reserves .......................
67
Profits in Rate Differentials.................................................
69
The Lag Accounting Reserve Plan.......................................
70
Trends and Fluctuations in Interest Rates..........................
72
Excess Profits Tax, 1951-1953
75
Interbank Competition.......................................................
76
v

Debt Management and Treasury Operations.......................
76
System Operating Policy .....................................................
77
Reduction in Federal Reserve Deferred
Availability Schedule....................................................
78
Improvement of Wire Transfer Facilities..............................
79
Federal Reserve Policy ........................................................
80
a. Monetary Restriction — 1952-1953, 1955-1957,
and 1958-1960
82
b. Monetary Restriction — 1965-1966 and
1968-1969 ................................................................
83
c. Monetary Ease-1953-1954 and 1957-1958 .............
87
d. Monetary Ease — 1960-1965 .......................................
88
e. Monetary Ease — 1966-1967 .......................................
91
Summary and Comparisons of Funds with Money
Markets Abroad....................................................................
92
Appendix A — Official Rulings Affecting the
Funds Market .......................................................................
99
Appendix B — Some Definitions and the Mechanics
of Transactions in Federal Funds..........................................
110
Acknowledgements .....................................................................
119
Bibliography...................................................................................... 121

CHARTS AND TABLES
CHART I
CHART II
CHART III

CHART IV
CHART V
CHART VI
CHART VII
CHART VIII
CHART IX
CHAR T X

TABLE I
TABLED
TABLE III
TABLE IV

The Rate on Federal Funds — New York,
1928-1932 .................................
14
Borrowings of Nonbank Dealers and Dealer
Loans by New York City Banks, 1951-1957 . .
Selected New York City Money Rates,
1951-1957 ................................. 25
Rate on Federal Funds and Federal Reserve
Bank of New York Discount Rate, 1961-1969 .
Daily Rate for Federal Funds and Federal
Reserve Bank of New York Discount Rate,
June-August, 1969 ....................
33
Money Market Instruments, 1950-1969 ....
Treasury Bill Holdings and
Borrowings, 1953-1969 ....................................
Excess Reserves, as a Percent of
Required Reserves 1950-1969 ..........................
Selected Short-term Money Market Rates,
1963-1969 .................................
74
Federal Funds and Call Euro-Dollar
Deposit Rates, 1965-1969 .......
96
Money Market Instruments, 1922, 1925,
and 1928 ....................................
12
Trading in Federal Funds.....................................
Purchases of Federal Funds Through Brokers . .
Yields on Short-term Money Market
Investing, 1961 and 1969 ..........
73

64
68

53
56

vii

The Federal Funds Market
ITS ORIGIN AND DEVELOPMENT

INTRODUCTION

The Federal Funds market is a specialized product of American
financial organization. Prior to the formation of the Federal Reserve
System, the American short-term money market included only
commercial paper and call and time loans on security collateral at the
New York Stock Exchange. Large correspondent banks in New York
City and elsewhere were substantial lenders on security collateral.
The smaller banks, on the other hand, traditionally placed the bulk
of their short-term liquid funds in the open market for commercial
paper or on deposit with the New York banks. Interbank deposits
served as an important auxiliary to these markets, and to the extent
that interest was paid on the deposits, they served as a direct means
of investment by the depositing bank as well as a channel through
which the ultimate investment was made. For a number of banks,
they served, in part, some of the purposes that sales of Federal Funds
later came to serve. Although these sectors continued to dominate
money market activity even after 1914 — retaining their traditionally
broad character — new instruments were introduced that would
eventually supersede them in importance.

The financing of World War I inaugurated a market for
short-term U.S. Government securities. As the Reserve System
developed, it encouraged and supported the organization of an
acceptance market, which by 1918 had completed its basic
framework. Now almost 50 years old, the market for Federal Funds
emerged as a by-product of the Reserve System organization imposed
on the unit banking structure. At the beginning of the 1920’s, it
became a “new market” within that group of institutions known as
the money market.
Federal Funds are immediately available Federal Reserve Funds
and are essentially titles to reserve balances of member banks at
Federal Reserve banks. Initially, the term, as generally used, referred
to the amount of reserve balances that member banks held in excess
of legal requirements and were willing to lend to banks having reserve
deficiencies. Currently, however, the term more accurately means
simply reserve balances borrowed or loaned.

The Federal Funds Market

Today, some banks will deliberately run “short” on their
reserve positions by lending reserve balances to other banks, thus
causing or sometimes even increasing a daily deficiency that they
expect to cover later in the reserve period. Usually, Funds
transactions arc for overnight, and the rate of interest is negotiated
or determined by the demand and supply of funds in the market. On
the other hand, some banks depend on this market as a source of
funds for carrying an overinvested position for varying lengths of
time.

In substance, Funds transactions are borrowings or loans of
reserve balances. In practice, they are described as purchases or sales.
The market cannot increase or decrease total member bank reserves
but only redistributes them, providing a fuller use of bank reserves
and resources.
Roughly similar in concept to the very early Funds market is
the arrangement found at the Boston Clearing House between 1880
and 1910. During this period, the custom developed of borrowing
and lending balances at the morning exchanges and settling these
balances the same day by orders on the clearing house. This practice
was a unique feature of the Boston clearing system and became an
important part of the clearing arrangements. Before adoption of the
practice, debtor banks that found their balances at the morning
exchanges too large for convenient settlement with cash but who
could easily call in the necessary amount later in the day, sent their
representatives through the streets to borrow from neighboring
banks. Because of the inconvenience and risk involved, the officers of
the banks began to meet at the clearing house, and then, after the
exchanges had taken place, to borrow and loan their balances. At one
time some 60 percent of total balances were settled in that way. The
rate of interest on these loans corresponded very closely with the
rate on call loans — one of the principal methods of adjusting
operating positions.

The Federal Funds market has experienced two distinct periods
of development — the 1920’s and the 1950’s. Its development of the
1950’s carried into the 1960’s, confirming and sharpening the
structural outline of the market and increasing the dimensions. A
change in the functional role of the market between these two
periods prevents strict comparisons.
2

Beginnings of the Funds Market
Throughout the 1920’s, banks participated in Funds trading
almost exclusively as a method of adjusting reserve positions. While
retaining this original function in the 1950’s, Funds acquired
increased importance both as an outlet for short-term investment of
secondary reserves and, directly or indirectly, in connection with
Government securities dealer financing. In the 1960’s as well, an
increasing number of banks sought Funds to support loans and
investments.
After World War II, the practice evolved of making payment in
Funds for an increasing number and variety of financial transactions.
This practice was developed initially by banks when trading with
dealers in U.S. Government securities. Funds payment provided
banks with immediate adjustment in reserve position or portfolio
arrangement. It subsequently became more convenient for the dealer
to finance by the same method. Later, other customers of dealers
and banks demanded settlement in Funds because it shortened the
turnaround time and, consequently, the loss of interest between the
sale and effective date of the new purchase by the investor.
Similarly, as business corporate structures became more fully
integrated, financial officers developed methods of speeding the
proceeds of collections from local and regional banks to those in
major financial centers for disbursement or investment. There are
now plans for automatic daily remittance in Federal Funds to the
major money market banks of all balances in excess of a certain
amount held outside the principal money centers.

Trading or exchanging Funds is today a more important part of
the complex of interbank relationships which ties the units in the
American structure into a system and provides an efficient means of
distributing the volume of excess reserves according to need. Other
settlements in Funds have moved financial markets toward unity in
payment and away from the use of clearing house funds.
BEGINNINGS OF THE FUNDS MARKET

The Federal Funds market originated in New York City. The
first trades were made among several of the leading city banks in the
early summer of 1921.

The Federal Funds Market

In the late spring and early summer of 1921, depressed
conditions had a diverse effect on the large New York City banks.
While some of these member banks found that their reserves at the
Federal Reserve Bank of New York had risen to considerable
proportions, others were borrowing at the discount window. Banks
with surplus funds had trouble finding outlets for reinvestment in the
usual channels. Activity in the money market diminished, and open
market money rates declined steadily from a 1920 peak, finally
falling close to or below the average discount rate in all Federal
Reserve districts after mid-1921.
This situation was discussed informally by several leading banks.
As a result, the banks that were borrowing from the Reserve bank
began purchasing the balances of those reporting excess reserves.
These dealings involved the transfer of reserve balances on the books
of the New York Reserve Bank from the reserve account of the
lending bank to that of the borrowing bank, generally by an
exchange of checks. In the beginning, it was the practice for both the
lender and borrower to make their checks payable immediately. But
to forestall the possibility of an early deposit of the borrower’s
check, it became customary for the borrowing bank to draw the
check on itself, payable through the clearing house the next business
day.1
In this way, the bank with excess reserves was able to realize a
return on these reserves until they could be placed in loans,
investments, or other outlets in the money market; and the bank
with insufficient reserves was able to reduce its borrowing at the
Federal Reserve bank. The banks also found that by buying Funds
they avoided the trouble and expense of assembling collateral of
customers’ paper eligible for discount and of arranging a loan at the
Reserve bank.
By mid-1923, a fairly active market in Funds had developed
which the city banks used frequently in adjusting reserves among
themselves. A few of the banks, however, did not participate until

^Officers* checks may no longer be used to return Funds to the selling bank by the buyer.
Transfers are now made by entries on the books of the Reserve banks. See Board of Governors’
Ruling, April, 1970, Appendix A and the discussion in Appendix B.

Beginnings of the Funds Market
later in the period as a matter of policy. Nor did the Federal Reserve
Bank of New York encourage the development of the market. It was
argued that in contrast to Funds transactions, which affect reserves
immediately, settlement in clearing house money enabled the Open
Market Committee of the Reserve banks to take account of the net
effect of transactions entering clearings. The Committee could thus
make a better estimate of the factors affecting the volume of reserves
of the money center banks the next day. As the decade of the 1920’s
progressed, trading within New York City broadened, and
interdistrict trading of Funds on a limited scale developed. Before
1925, local markets also appeared in such cities as Boston,
Philadelphia, Chicago, and San Francisco.

The typical block of Funds traded in the 1920’s was $1 million,
but blocks of $500 thousand appeared frequently — smaller blocks
of $100 thousand were not uncommon in the early years and at
various times since then when the market was tight. Although the
typical unit traded is still $1 million, with the growth of
correspondent bank trading arrangements, transactions as small as
$50,000 have been common.
During the first year of the market, the volume traded rarely
exceeded $20 million a day. Until 1925, the volume traded on an
average day ran between $40 and $80 million. Trades were arranged
by a succession of telephone calls from one bank to another. No
facilities existed, as they do presently, for centralized market
information.
From about 1925 on, normal daily trading increased further
and ranged upward from $100 million, reaching $250 million at
times during the latter part of the 1920’s. The volume tended to
approach the upper limit of the range on reserve settlement days1 in
New York because the greatest demand arose from banks making last
minute adjustments in their reserve positions. Some 30 to 40 banks
and 8 or 10 acceptance dealers accounted for most of the trading.
Agencies of foreign banks located in New York were also important
sources of Funds at times.
Reserve settlement days were Friday until January 3, 1928, and Tuesdays and Fridays
until March 19, 1942. Since then, settlement day has been Wednesday.

The Federal Funds Market
ROLE OF THE ACCEPTANCE HOUSES IN THE 1920'S

Although the member banks in New York City were the first
buyers or sellers of Funds, the market of the 1920’s and 1930’s was
brought to its full development largely by the discount or acceptance
houses in the course of their normal operations. Some of these firms
conducted business in U.S. Government securities, commercial paper,
acceptances, and other investments. 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.
Transactions in acceptances were primarily used to meet seasonal
variation in reserve needs, while transactions in U.S. Government
securities generally were used to effect major credit policy shifts. The
substantial part of these market transactions was with the discount
houses, although the Reserve banks would buy properly endorsed
acceptances from member banks when they were offered.

From about 1924 on, the System dealt with a list of recognized
dealers — about 10 in number — when buying acceptances or
Government securities for policy purposes or for the accounts of its
foreign correspondents. Such recognized dealers were also permitted
to sell acceptances and Government securities to the System under
repurchase agreements. The Federal Reserve Bank of New York,
because of its location in the Nation’s financial center, accounted for
the largest proportion of both outright purchases and transactions
under resale agreements. When they conducted transactions in
acceptances within their district, several other acceptance houses
were recognized by one or more of the Federal Reserve banks. Those
dealers in acceptances whose own endorsements were not approved
by the Reserve System purchased endorsements from recognized
dealers or from banks.
At least one of the leading acceptance houses maintained a
nonmember clearing account at the Federal Reserve Bank of New
York, as did several American foreign banking corporations that 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 Reserve bank. In some cases, the deposit accounts
of these firms were built up through sales of acceptances or
6

Role of the Acceptance Houses in the 192O’s

Government securities outright or under repurchase agreements to
the New York Reserve Bank. In other cases, the acceptance houses
and those firms which dealt in acceptances or Government securities,
in settling transactions with the New York and other Reserve banks,
acquired title to Reserve bank Funds before such Funds reached the
commercial banks. In addition to their transactions with the Federal
Reserve banks, dealers acquired title to Funds from several other
sources: outright purchases and conversion of balances in excess of
the customary balance carried with their commercial bank; proceeds
of the sale of acceptances or securities to out-of-town banks received
through the Reserve bank; payments received in redemption of U.S.
Government securities and interest coupons; and maturing accep
tances.

The dealers used Funds partly in settling their own transactions
and partly in trading them. In the former case, Funds were used as
payment for acceptances and U.S. Government securities when the
terms so specified, as payment of calls on war loan deposits
(predecessor of today’s tax and loan accounts) where such accounts
were maintained, and as payment for U.S. Government securities
when payment was not made by war loan account. Alternatively,
surplus Funds were sold in the market, and if there was insufficient
demand, the balance was deposited in the New York Clearing House
banks.
Funds deposited by a dealer in his regular account at a
commercial bank drew only the rate then paid on demand deposits.
However, when the dealers requested Funds in making withdrawals
from their accounts, the commercial banks, if under pressure,
charged them the call loan rate or more, depending upon their
reserve position. On the other hand, a bank with a surplus of Funds
might be willing to supply the dealer with its check on the Reserve
bank at the discount rate or lower. Gradually the acceptance dealers
began to shop the banks for 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 in the market, collecting information about the demand
and supply of Funds. They soon began to buy and sell 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 between the East Coast and West Coast.
7

The Federal Funds Market

The dealers usually purchased only small amounts of Funds outright
but customarily acquired large blocks on an option basis for short
periods. They also performed the service of combining small
purchases into usual size trading blocks and at times would split large
blocks for retailing.

MONEY BROKERS

As the market grew, some banks and several of the money
brokers became market factors. The brokers found that the status of
a bank’s reserve position was important in relation to the call money
market. The brokers viewed a lending bank with excess reserves as
having “good money” — money which would be available overnight
and could be used to reduce day loans, security deliveries, and
overhead burden. Therefore, the brokers arranged to supply Funds
daily for those banks with insufficient reserves, securing them from
banks running an excess. The brokers considered this service an
important adjunct to their call money operations since it led to
procurement of blocks of call and time money on which they
received a commission from the borrower. One of these firms was
Faber, Garvin and Company — forerunner of The Garvin Ban tel
Corp.,1 currently one of the four Federal Funds brokers in the market.

AREAS OF MARKET DEVELOPMENT

The acceptance houses and those American foreign banking
corporations having branches in principal cities — particularly
Chicago, Boston, Philadelphia, Cleveland, and San Francisco —
developed a considerable volume of interdistrict trading and formed
the focal point for local markets in some of these cities. In the late
1920’s, a fairly active market had developed which was centered in
Boston and included the larger banks in several major cities in central
New England. Local markets in the 1920’s were generally limited to
those areas where financial activity was most concentrated. Atlanta,
Dallas, Minneapolis, Richmond, and St. Louis reported only small

1 The corporate title was adopted on June 1, 1966. The firm was previously known as
Garvin, Bantel & Co.

Areas of Market Development
amounts of trading among local banks. Some of these cities,
however, at times supplied Funds to New York, Philadelphia, and
San Francisco.

As might be expected, the New York City market for Funds
was the largest both in terms of volume and in the number of banks
participating. Trading consisted, for the most part, of transactions
between city buyers and sellers and, to a lesser extent, of
transactions between city banks and out-of-town institutions. In
contrast to the 1950’s and 1960’s, bank size in most financial centers
outside New York tended to be more nearly equal, and the banks
that traded Funds were able to match off needs locally to a
considerable extent. If excess Funds remained, they were offered to
New York or to other cities. However, during the 1920’s, certain
New York City banks pursued a policy of not dealing in Funds with
out-of-town correspondents and thereby discouraged the extension
of the market. For these reasons then, the volume of interdistrict
trading in the Nation was relatively smaller than at present, while the
volume of intracity trading in the leading financial centers was
substantially larger. The Funds market of this period was essentially
local or regional in character.

The differentials in discount rates between most Federal
Reserve districts which characterized the 1920’s encouraged trading
across district lines. During the late 1920’s, an active interdistrict
market developed with the West Coast. Advantages in supplying this
market were found not only in discount rate differentials between
certain eastern points and the Coast 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. This enabled eastern banks to estimate Funds in excess or
deficit of legally required reserves and, if in excess, to sell balances in
the West before the wires closed in the East about 2:30 p.m.
Reaching the Coast about noon, Funds trading commenced
immediately for the purpose of adjusting reserves. The Funds were
usually returned to the East early the following day. The amount of
excess Funds offered depended not only on time differences but also
on correspondent relationships. For example, two large San
Francisco branch banks depended on their wholly-owned eastern
affiliates as important sources of Funds. These affiliates acted as
agents for procuring Funds when they had no excess of their own.
9

The Federal Funds Market

Certain San Francisco banks solicited Funds from banks in many
parts of the country and stood ready to receive them, up to certain
limits, at all times and without notice, the agreements as to rates
being understood. Under one such agreement, Coast banks received
Funds if sent but did not pay for them except at the demand deposit
rate, unless they could actually profit by their use. Others did not
solicit or encourage forwarding of balances but would accept limited
amounts. Since much of the trading in San Francisco was at agreed
rates, or at the best price available, rates there bore little relationship
to the Funds rate in New York City. In general, Federal Funds were
received from most large cities in the United States — New York,
Boston, and Philadelphia supplied the bulk, followed by Chicago,
Detroit, Atlanta, New Orleans, St. Louis, Kansas City, and Dallas. In
other cases, eastern Funds were sent to banks in the Midwest and
forwarded from there to San Francisco. Funds from Dallas were
frequently transferred to Los Angeles and thence to San Francisco
through correspondents.
RELATIONSHIP OF
1920'S

FUNDS TO OTHER MARKETS IN THE

The Federal Funds market of the 1920’s was probably
developed to the fullest extent possible within the framework of
financial institutions of the period. Although it was an important
market, the volume of Funds passing through it was small compared
with either present volume or other sections of the money market in
the 1920’s. This position of the Funds market is explained in part by
the narrower function it performed in the 1920’s compared with
today.
The short-term money market had come to include four
principal markets centered in New York City — call and time loans
on the Stock Exchange (generally called brokers’ loans), commercial
paper, bankers’ acceptances, and U.S. Government securities. The
New York banks placed funds for the interior banks in these markets
but continued to hold some funds on deposit. During the 1920’s,
there was a marked increase in the investments made in brokers’
loans for the account of outside banks by their correspondents. This
practice became quite significant after 1924 when the volume of
liquid funds available for investment was plentiful and the volume of

Relationship of Funds to Other Markets in the 1920’s
commercial paper, the customary outlet for outside banks, was
declining. City banks followed the tradition of placing funds for
correspondents before their own.
Call loans, which accounted for about three-quarters of brokers’
loans during the 1920’s, were considered among the safest and most
liquid available use for temporary surplus funds of banks and others.
Ihe call loan market also normally commanded higher rates than
those paid on demand deposits — generally the New York City banks
paid only 2 percent on these. Interior banks shifted from balances
with New York City correspondents to brokers’ loans, and vice versa,
depending largely on the call loan rate. That portion of call loans
which depended upon bankers’ balances varied and represented the
marginal supply of funds and thus linked the call loan rate closely
with reserves of the city banks. Interbank balances, although
relatively less important than earlier, became more and more a
channel through which investments were made.

The several divisions of the short-term money market were well
integrated and highly competitive. Fluctuations of any one rate
usually caused sympathetic response in the other short-term rates,
and the rates in the several markets generally changed in the same
direction with a trend toward more uniformity. Competition existed
to a greater extent among lenders than borrowers because lenders,
principally the banks, operated in all of the markets, entering and
withdrawing in the process of adjusting their money positions in
response to operating needs in meeting customer demands. They
moved from one market to another on the basis of both preference
for and yield of particular money market assets at any given time.
These shifting investor preferences were important in connecting the
markets. The borrowers, on the other hand, represented distinct
groups which did not have the same freedom of movement because
they were generally more limited by peculiar or particular needs.

Table I shows the amounts of the various instruments
outstanding in the money market during typical years in the 1920’s
and outlines the changes which occurred during the period. In
addition to its dominance, the call loan market was the most
centralized since loans were arranged through the money desk of the
Stock Exchange. The commercial paper market, however, continued
to be broadest during most of the period because it was used by the
11

The Federal Funds Market

greatest number of banks, accounting for 90 percent or more of
purchases of the paper offered by the dealers. As noted, the
operations of the System Account were conducted in the acceptance
and Government securities markets. Consequently, the commercial
banks considered these investments major liquidity instruments.

TABLE I
MONEY MARKET INSTRUMENTS 1922, 1925, 1928

Approximate Amounts Outstanding in Millions of Dollars
Partly Estimated)

Brokers' Loans
Call
Time

1922

1925

1928

$1,000-1,600

$2,000-3,000
1,400-2,100

$3,900-5,100

800-1,200

3,510-3,980

200-400

600-900

390-1,120

800-940

1,100-1,200

800-1,200

Bankers' Balances
(Due to banks by
N.Y.C. banks)
Commercial Paper

600-800

Acceptances

500-600

600-800

480-525
1,100-1,284

1,000-1,216

2,500-3,000

40-70

100-175

100-250

U.S. Government

Short term Securities
Federal Funds Purchases

(Average daily volume)

SOURCES: Federal Reserve Bulletin and Banking and Monetary Statistics, Board of
Governors of the Federal Reserve System and Annual Report of the Secretary
of the Treasury for the years indicated. Federal Funds were reported in
interviews with retired bank officials.

The chief function of the Funds market was refining the reserve
adjustment process of the unit banking system, thereby effecting
mobilization of reserves for more continuous use in the money
market or for customers’ loans at the bank counter. It improved the
fluidity of the money market by bringing demand and supply into
more rapid adjustment. Beyond this, Funds were used at times in
settling security and other transactions by banks’ customers. The
Funds market was used as an important investment medium by
12

Rate Relationships in the 1920’s
relatively few of the banks. Alternative markets were generally more
profitable, offering a wider range of choice with a good distribution
of the volume of paper in each market. Funds today provide a
substitute for several classes of money market instruments available
in the 1920’s and early 1930’s.
RATE RELATIONSHIPS IN THE 1920'S

The Funds rate during most of the 1920’s and the early 1930’s
tended to be limited by the discount rate. In comparison with other
money market rates, the rate was more sensitive and tended to
anticipate changes in bank reserve positions and factors affecting
them because the use of Funds offered an alternative to borrowing at
the Reserve banks. When the call Ioan rate was close to the discount
rate in New York City, the interior banks with surplus Funds usually
sold them in the Funds market to avoid the fee charged by
correspondents in placing call loans, a fee that ranged as high as
one-half of 1 percent. At other times, the banks used the Funds
market as a last minute emergency outlet in placing surplus Funds
not needed as reserves or loaned on call.

Funds were usually traded during the 1920’s on a quarter-point
spread, and even in periods of temporary ease, transactions did not
take place on one-eighth of a percentage point spread. This was
accomplished at times, however, by compromise — sale of same-size
blocks at different rates, for example, one block at 314 percent and
the other at 3% percent. The rate generally kept in touch with the
discount rate and the lower limit was determined to considerable
extent by the rate paid on demand balances. The dealers would not
sell at rates below those paid on balances by the commercial banks.
The Funds rate and the call rate at times tended to lluctuate in
opposite directions, particularly when rising call rates attracted
Funds over Reserve System wires from areas outside New York City,
thus creating a surplus in the city. At other times, when Funds were
demanded in the interior and call rates were low, the demand for
Funds drove the rate up on occasion above the discount rate.
Regardless of other factors, the Funds rate tended to be strong on
many reserve settlement days.
13

The Federal Funds Market
CHART I
THE RATE ON FEDERAL FUNDS - NEW YORK

SOURCE:

N. Y. Herald Tribune and Federal Reserve Bank of New York. Funds rate data
not available in series form prior to April, 1928.

During 1928 and 1929, the Funds rate frequently stood above
the discount rate, reaching a spread of three-quarters of 1 percent to
1 percent at times. Certain banks lacked eligible paper for rediscount
while others that were lending heavily on call loans preferred to
secure reserves in the Funds market rather than risk criticism at the
Reserve bank by borrowing. After the panic of October, 1929, the
Funds rate dropped sharply, partly because of the heavy inflow of
Funds over Reserve System wires to New York to meet margin calls.
Except for the period in late 1931 and early 1932 — when discount
rates were raised because of the crisis abroad resulting in suspension
of gold payments by Britain — institution of an easy money policy
and gold inflows caused the rate on Funds to drop as low as
one-quarter to one-eighth of 1 percent with some frequency in both
these years.
THE MARKET IN THE 1930'S AND WORLD WAR II

The Funds market dried up during the Great Depression. Banks
became very cautious about arranging trades because of the
14

The Market in the 1930's and World War II

uncertainty of each other’s condition. Many banks adopted the
policy of operating with large cash cushions. The volume of trading
began to decline, particularly on an interdistrict basis, as the rate of
bank failures increased. Sporadic trading, however, continued in
those cases where correspondent relationships were strong, and
sometimes Government securities were pledged if a series of trades
was contemplated.
Later in the 1930’s, as loans fell and gold moved in volume to
the United States from abroad, banks accumulated huge excess
reserves (particularly from 1934 to 1937), and there were practically
no occasions when there were borrowers in need. Toward the close
of the 1930’s, moderate trading was resumed on occasion. Increases
m required reserves ordered by the Federal Reserve System in 1936
and 1937 and expanding loan and investment portfolios 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, Funds trading
became more frequent, principally in New York but also in several
other large cities. At least one money broker stood ready to provide
facilities for matching the demand and supply of Funds in New York
City. Volumes traded were small relative to those of the last half of
the 1920’s but larger than in the 1930’s, probably averaging $75 to
$125 million a day. The volume tended to increase toward the close
of the war. Many banks ran excess reserve positions. The market,
however, continued to be local or regional in character throughout
the war years.
During the war, U.S. Government security prices were
pegged,” resulting in a yield curve which rose from three-eighths of
1 percent for Treasury bills to 2’/2 percent for the longest term bonds.
The lower end of the curve was established April 30, 1942, when the
Reserve banks announced they would purchase all Treasury bills
offered at three-eighths of 1 percent. In August, the Federal Open
Market Committee instructed the Reserve banks to replace such
purchases with sales of a like amount of Treasury bills with the same
maturity at the same rate of discount, if requested by the seller
before maturity. Consequently, the banks made most of their reserve
adjustments through “puts and calls” on Treasury bills rather than in
the Funds market.
15

The Federal Funds Market

SOME DIFFERENCES IN THE MARKET IN THE 1950'S AND
1960'S1

Today it is common practice for banks to offer excess Funds to,
or secure Funds directly from, New York or other cities. Changes in
operating policies with correspondents of many New York banks and
the facilities for matching the demand and supply of Funds offered
by the Funds brokers and by “accommodating banks” in various
cities support this practice and make the market national in scope.
As late as 1967, about one-half of all Funds transactions originated
in or were accomplished through New York City. San Francisco and
Chicago followed in trading volume, each accounting for about 15 to
18 percent of total Funds activity. During the last two years,
however, as regional trading arrangements expanded, New York’s
relative position declined and the city’s banks now account for
between 35 and 40 percent of trading. Chicago’s and San Francisco’s
relative positions have become more important, accounting for 17 to
20 percent of gross purchases.
Size differences between banks in one city, as well as distinct
contrasts — local, regional, and national — in the character of various
1During the postwar period the Federal Reserve has collected data on Federal Funds
transactions on several occasions. In 1955, the Federal Reserve Bank of New York began
collecting data on daily purchases and sales by the large New York City banks.
Late in 1956, the System conducted a one-month survey of Funds transactions from
major banks in each district. Some Federal Reserve banks collected historical data where
available.
A three-year survey of Funds transactions at about 250 banks was carried out by the
Federal Reserve beginning in September, 1959. Transactions included all loans and borrowings
by banks for which payment was made in Funds. (See Dorothy M. Nichols, Trading in Federal
Funds—Findings of a Three-Year Survey, Board of Governors of the Federal Reserve System,
Washington, D. C., September, 1965.)
The 46 bank series was inititated by the System in 1964. This series comprises 8 New
York City banks, 5 Chicago banks, and 33 other banks, and emphasizes interbank trades. (See
“New Series on Federal Funds,” Federal Reserve Bulletin, August, 1964, pp. 944-53.)
Data for gross sales and purchases of Funds have been reported for member and
nonmember insured banks on Call Reports as separate asset and liability items since December
31, 1965.
Most Federal Reserve banks during the last two years have been collecting daily data on
Funds transactions from all member banks. Definitions of Funds may differ from district to
district, including or omitting repurchase agreements, and time periods may differ.
Beginning in July, 1969, the Weekly Reporting Banks report Funds purchased and sold on
Wednesdays. The captions include repurchase agreements (see Federal Reserve Bulletin,
August, 1969, pp. 642-46).
Data used in discussions in this booklet draw on all these sources. Many observers think
that representativeness of the 46 bank series has diminished in the last two years as the market
underwent rapid expansion.

Some Differences in the Market in the 1950’s and 1960’s

banks’ loan business, result in payment flows which prohibit
complete adjustment locally. Similarly, intercity trading within most
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. The highest proportion of
intradistrict trading occurs on the Pacific Coast and accounts on the
average for about a third of that district’s Funds activity.
The late 1950’s and 1960’s witnessed further change in trading
patterns and market structure. The development of trading within
regions centered in large correspondents, while related to such
trading in the 1920’s, has distinct differences. Trading is more
extensive and generally conducted at a uniform national rate. It
involves a larger number of banks, and trading units are as small as
$50,000 and sometimes lower. This kind of trading pattern has
developed to meet the competition offered in regional market areas
by the large central money market banks.
Perhaps more importantly it reflects competition among larger
banks in interior parts of the United States to improve the flexibility
of their own reserve positions, thus helping to retain and improve
their position in influence and size. Competition among the regional
banks, soliciting business over wider areas than previously, forced
local competitors to establish facilities for their own correspondents?
The post-World War II Funds market, in contrast to that of the
late 1920’s, developed without nonbank intermediaries quoting a
spread in rates. Nonmember clearing accounts at Reserve banks,
which were extended to several dealers in the earlier period, are no
°nger available. Thus, these nonbanks do not have the same access
to facilities which would make dealing possible. Beyond this, the
present market reflects the identity of reciprocal needs to the buying
arid selling bank along with wider and more continuous bank
participation and the rapid and inclusive wire transfer systems for
transmission of balances. The Funds broker through whom trades

For example, Funds trading by the large Dallas banks in 1965-66 forced city banks in
Oklahoma to offer trading services to country banks more willingly, and this resulted in
extensive trading by Oklahoma banks.

The Federal Funds Market

may be arranged now is usually compensated for his service in
indirect ways, the accommodating banks facilitate their own
operations, and the bank which deals directly with another bank
enjoys a mutual advantage.

Until the recent periods of severe credit restraint, many of the
larger banks that deal on both sides of the market generally
accomplished transactions at the same rate. During 1969, a number
of these banks bought Funds at the bid rate and, after covering their
basic deficiency in reserves, sold Funds to correspondents at the
offering rate; usually this spread was one-eighth to one-quarter of 1
percent. At times when market rates developed rapid changes, the
spread widened to one-half percent or more to protect against loss.
Smaller city banks in regional centers that buy Funds from
correspondents and pass on amounts not needed, however, usually
operated on a spread of one-half percent. Their transactions are in
relatively small units, and the banks are not in the market as
continuously as the larger ones and therefore are exposed to a greater
risk in rate fluctuation.
Currently, some banks at times “follow the clock,” buying or
selling Funds successively in New York and Chicago, occasionally in
St. Louis or Kansas City, and finally in San Francisco or Los Angeles.
Interdistrict trading is no longer influenced by differentials in
Federal Reserve bank discount rates, except for very short periods
caused by the normal lag as each of the Reserve banks acts to change
its rate. The movement of the preponderant share of short-term
Funds through a national market in effect precludes anything more
than temporary differentials among districts. Trading “westward”
has become significant for Mountain Time banks and those in
contiguous territory in the Central Time Zone. Although these banks
use the eastern market, an excess or deficit in the reserve position of
a Dallas, Denver, or Phoenix bank can be corrected by transactions
with the San Francisco district after the eastern banks are closed.
Even Dallas at times makes as much as 40 percent or more of its
purchases from San Francisco. The prevalence of branch banking on
the Coast has facilitated Funds trading through fewer but larger
banking systems with central management of money positions. The
district is frequently a net supplier to other regions.

As was true in the 1920’s, the core of the market is still the
large banks, but today there are a greater number (between 60 and

Funds Market After World War 11

70), and they are more widely distributed over the Nation. In
addition, the market over the last 10 years has become characterized
by a substantial number of relatively smaller banks which participate
actively in interbank transactions on an unsecured basis. Even banks
whose capital and surplus were not of sufficient size to enable them
to undertake unsecured transactions were brought into the market
occasionally in the 1950’s through the use of techniques using several
forms of collateral.
bunds transactions arc important to a larger number of banks,
and the volume traded continues to grow. At the same time, the
banking system is better integrated. Its population is about one-half
that of the 1920’s, and the typical unit is larger in size. Funds
transactions are considered by many observers as one of the effective
instruments in redistributing reserve funds and in helping to effect
greater uniformity of credit conditions throughout the Nation. Along
with discounting, Funds transactions supplement reserve averaging.
Efficient and more intensive utilization of available Funds permits
the money market to function on a minimum of excess reserves and
helps make the banking system more responsive to the credit control
measures of the System.

funds market after world WAR II
The changes which developed in the banking system as a result
(>f the Great Depression - easy money conditions during most of the
1930’s, legislation, financing of World War II, and the increase of
bank mergers and branch systems — provided a different structural
setting lor the money market when the postwar period opened. The
lapid growth of production and population expanded the demand
lor banking services, while the growth in the size of business units
bleated a demand for bigger banks and large capital accounts to
permit an increase in the size of individual loans.
Ihe rise in population and incomes and significant shills in their
distribution within the economy began to exert a marked impact on
•he pattern of bank assets. The greater diffusion ol deposits
throughout the United States, shrinkage of business borrowing in the
form of commercial paper, decline in acceptance volume, and the
tremendous growth of the market for U.S. Government securities

The Federal Funds Market

altered the character of the money market. The market shifts, as well
as legislation, brought the call loan market to an end before the
formal closing of the money desk on the Exchange in 1946. These
changes inevitably resulted in new money market arrangements, and
in the new setting, the Funds market began to develop a strong
national character.
Legislation which interacted on this situation included the
Banking Acts of 1933 and 1935. The prohibition of member banks’
role as agents for nonbank lenders in the placement of security loans,
as well as the suspension of interest payments on demand deposits by
the Banking Act of 1933 and the establishment of margin require
ments under the Securities Exchange Act of 1934, were some of the
important features of this legislation.

As the postwar period progressed, a more fully integrated
structure of markets and institutions emerged. Financial institutions
— both banks and nonbanks — became more closely interconnected.
Mechanical arrangements for communication and the transfer of
money market instruments followed rapid technological advance.
Correspondent relationships among the banks were broadened and
increased in scope. Specialization developed further to meet the
particular needs of various lenders and borrowers, and transactions
are now effected rapidly and at low cost. Knowledge of markets
became more widely diffused, and linkage between the short-term
money market and the long-term capital market strengthened as
more financial and nonfinancial institutions began to conduct
transactions in more than one market. Thus, influences operating in
one market or affecting a group of institutions, have tended to be
transmitted more rapidly to other related markets, or a group of
institutions, with the result that differentials in rates substantially
diminished. To the extent that regional markets remain, they have
become more closely tied to the national market centered in New
York.

The significant increase in size, marked change in composition,
and the broadening and shifting ownership made the marketable
portion of public debt a new sensitive medium for adjusting cash
positions of financial institutions and others. The marketable debt
also came to serve as a more permanent and continuing investment
20

Development of the Repurchase Agreement

outlet. The development of Reserve System credit policy in the
postwar period was reflected in higher rates for Government
securities and a greater reliance on borrowing for reserve adjustment
by individual banks. Bank reserves ultimately were placed under
pressure.

With the increase in breadth and activity in the Government
securities market as short-term rates rose, the competitive search for
Funds became more intense. Government security dealers found it
necessary to become active participants in the Funds market both as
intermediaries and, in some instances, as principals. Dealers’ se
curities transactions to a great extent have always been settled in
Funds, but insistence by customers on this form of settlement made
a substantial addition to demands.
All transactions between New York dealers and out-of-town
customers are completed in Funds. Until early 1969, however,
transactions within New York or other local areas involving
maturities of one year or more were settled in clearing house funds.
These trades in all maturities in both round and odd lots are now
settled in Funds. Moreover, negotiation over the form of settlement
(clearing house money or Funds) has become a factor in most
financial transactions. Money market instruments — bankers’ accep
tances, commercial paper, certificates of deposit, as well as new
long-term corporate and municipal capital issues — usually specify
payment in Funds.

development of the repurchase agreement by
government securities dealers
Before World War II, the nonbank Government securities
dealers borrowed to finance their positions largely from New York
City banks, and the proceeds were almost without exception in
clearing house money. 1 This continued to be the general situation
during the period of relatively easy money from soon after World
War II until 1952. New York banks were again a major source of
dealer financing during the 1954 and 1958 periods of monetary ease.

Dealer banks financed their position through allocation of “own bank funds” to dealer
departments.

The Federal Funds Market
During these periods, the rates that the bank charged the dealers ran,
as a rule, above the yields on short-dated securities and above the
discount rate — except when credit was quite “easy.” Nevertheless,
the dealers could generally accomplish profitable “carries” because
yields on the intermediate and longer term securities were higher.

During restrictive phases of System policy (1953, 1955-1957,
and 1959), dealers in Governments frequently found difficulty in
obtaining adequate financing from the New York City banks at rates
corresponding to yields on securities in their inventories. Charges to
dealers by the major banks fluctuated from 3'/2and 3%to 4 percent.
Very few U.S. Government securities carried rates as high as 3*4and
35/spercent. As a consequence, the dealers sought financing outside
the city with a yield margin in their favor.1 A variety of business
corporations, state treasurers, and widely scattered banks were
already investors, and dealers encouraged many of these investors to
become lenders through repurchase agreements or “buy back’
transactions as an alternative to direct investments in securities.

The proceeds on repurchase transactions are available in Funds,
in contrast to dealer loans by New York City banks which, until the
early 1960’s, were largely in clearing house money and required
conversion to Funds. Also, the net cost to the dealer is generally
lower than at the bank counter, and adequate amounts of credit are
more dependable, particularly as participation by nonbanks and
banks has widened. New York City banks do not make repurchase
agreements with nonbank dealers because these agreements carry a
lower rate than can be obtained from dealer loans.

^See A Study of the Dealer Market for Federal Government Securities, Joint Economic
Committee, 1960, pp. 87-89, and Treasury-Federal Reserve Study of the Government
Securities Market, Vol. II, 1959, 120-21, for discussion of costs of dealer borrowing in the
1950’s; and Louise Freeman, “The Financing of Government Security Dealers,” Monthly
Review, Federal Reserve Bank of New York, June, 1964, pp. 110-15, for a discussion of costs
in the 1960’s.

.
Commercial banks used repurchases in interbank borrowing to a considerable extent in
the old national banking system. As noted previously, the repurchase agreement was also used
in the acceptance and U.S. Government securities market during the 1920’s. In the 1950’s and
1960*s, the instrument was adapted to a new setting, and its current use reflects such
refinements as automatic renewal of agreement, lending at flat prices, and automatic
adjustment of rates to the market. Securities used in repurchase agreements arc mostly U.S.
Governments. They may, however, be mixed—certificates of deposit, securities issued by U.S.
Government agencies, and acceptances.

Development of the Repurchase Agreement
CHART II
BORROWINGS OF NONBANK DEALERS AND DEALER
LOANS BY NEW YORK CITY BANKS

SOURCE:

Borrowings of nonbank dealers based on information supplied by sample of
nonbank dealers. Dealer loans by New York City banks are from weekly
condition reports. Data are for last Wednesday in the month.

The rate on repurchase agreements is determined by money
market conditions at the time of negotiation. It is principally related
to the rate on Funds, dealer loans, and to a lesser extent, Treasury
bills. Availability of collateral may also be a determinant. Until the
tight money of the last two years, the repurchase agreement made
for overnight commonly carried a rate slightly above the Funds rate
but below the dealer loan rate.
During the tight money market of 1969, however, dealers at
times were able to make repurchases with certain nonbanks at a level
below the Funds rate, usually at or just below the rate on com
mercial paper. A complex of factors accounted for this development.
Among them were shortage of collateral or desire to conserve
holdings of U.S. securities on the part of banks, dealer willingness
and need to carry inventory, and investor convenience. Whether the
transaction was initiated by the investor or the dealer also influenced
the rate. Repurchases made for a longer term than overnight may
23

The Federal Funds Market
carry a rate below the Funds rate — how much will depend on the
degree of tightness or ease in the market and the outlook for rates.
One large dealer began developing repurchase agreements as
early as 1948, and the practice was slowly followed by others. As
early as 1955, a leading dealer interested in the development of
repurchases had 105 accounts including 77 banks and 15 large non
financial corporations. The balance was distributed among insurance
companies, savings banks, and funds of state treasurers. These ac
counts were scattered through 57 cities in 38 states, and the volume
for the year aggregated $36.5 billion, an average of $100 million a
day. This was 88 percent of this dealer’s total financing.
The development of sources of financing outside New York was
virtually completed early in the 1960’s, and since then the pro
portion of Funds secured from sources other than the New York
City banks has tended to stabilize. Even the dealer banks in recent
years have used repurchases to finance a substantial part of their
dealer positions.

This development of new sources of financing reflected the
changing structure of the postwar money market — the passage from
one with an overhang of surplus reserves to one of relative reserve
scarcity in which reserve use carried increasing premiums of costs.
Also, a new generation of officials in charge of corporate
treasuries and in bank and dealer money positions — stimulated by
larger cash flows, rising interest rates, and other costs — established
imaginative new relationships, thus breaking tradition.
Since 1960, New York City banks have become more liberal in
making call loans to nonbank dealers, particularly when markets have
been relatively easy. Responding to competition with the outside
banks and nonbanks, they began to make a substantial proportion of
the loan proceeds available in Funds. Beginning in 1965, the total of
these proceeds was generally made available in Funds. Their com
petitive positions improved moderately as reflected in a narrowing of
the spread between the dealer loan rate and the repurchase rate when
compared with earlier periods. Narrowing of the spread was caused
chiefly by a tendency for the rate on repurchases to increase relative
to other rates as the instrument became more widely used. Except in

CHART III

Development of the Repurchase Agreement

ro
tn

SOURCE:

U.S. Government Security Yields and Discount Rate from Federal Reserve Bulletin; Federal Funds Rate and Dealer Loan RateNew and Renewal from the Federal Reserve Bank of New York; and Average Rate Paid on Loans from Other Banks and Other
Lenders based on information supplied by several dealers from selected dates. See also A Study of the Dealer Market for Federal
Government Securities, Joint Economic Committee, 1960, pp. 87-89.

The Federal Funds Market
periods of strain, the New York banks account for about a quarter of
dealer financing1 — a significant share, and moderately more than
presently supplied by banks outside New York. Dealers, however,
continue to view New York banks as a marginal source of Funds. The
rates are almost always the highest for both new money and re
newals, ranging generally one-quarter to three-quarters of 1 percent
above the Funds rate.

The repurchase allows a lender to invest without the risk of
fluctuating security prices and to tailor maturities to his needs. At
times, the repurchase may include a larger amount than a comparable
issue of specific maturity or term. The investor can thus make lull
employment of available money up to the date when it must be used
for other purposes. The rates may be somewhat lower than yields on
most alternative short-term investments, but the advantages cited
offset this.

The nonbanks enter into repurchases with security dealers lor
varying periods running as long as several months2 and still supply
about one-half of dealer financing. To the financial officers of these
organizations, the collected portion — good money — of their com
mercial bank account is considered available in Funds. Thus, they
request their bank to pay Funds to the dealer against delivery of U.S.
Government securities to be held in custody.3 Although most of the
Funds involved are used to finance dealers’ inventories ol U.S.
Government securities, even the longer term financing arrangements
have a definite effect on the trading market. The Funds come from
the banks’ position and may cause them to leave the market on the
supply side or enter on the demand side on the particular day on
which the transaction occurs. The dealers, on the other hand, at

Sec Louise Freeman, op. cit., pp. 107-08, for a discussion of amounts of dealer financing
from various sources. See also Report of the Joint Treasury-Federal Reserve Study of the U.S.
Government Securities Market, Washington, D. C., April, 1969.
2

Long-term repurchase agreements (16 days or more) are viewed by many dealers as sales
of securities out of their inventory, since the contract matures usually only a day or two before
the maturity of the security.
3
...
A transfer of bank balances that is accomplished by entries on the books of a Reserve
bank in the reserve account of a member bank and is available on the same day is a Funds
transactions. Thus, Funds are in effect sold to dealers.

Funds Transactions by Banks
times have a balance which is offered for sale. Although these trans
actions are usually quite moderate in size, they have some influence
on the trading market.

It should also be noted that from time to time in order to ease
conditions in the money market or increase availability of reserves,
the manager of the System Open Market Account at the Federal
Reserve Bank of New York may make repurchase agreements with
nonbank dealers against Treasury and Federal agency securities and
bankers’ acceptances usually at the discount rate? They are generally
made for overnight or 2 or 3 days but at most within 15 days. These
transactions aid in financing dealers and supplement open market
operations. Repurchases are not made with bank dealers because
they have access to a greater variety of financing sources than do
nonbank dealers.2

To improve flexibility of its operations, the Open Market
Account Desk introduced the matched sale-purchase-contract in
July, 1966, as a means of absorbing reserves temporarily or for a
varying period of time (normally one to seven days). These
transactions consist of sales by the Desk of specific issues of Treasury
bills at a specified price for cash delivery and simultaneously a
commitment to purchase the same bills for later delivery. In contrast
to repurchases these agreements are made with both bank and
nonbank dealers. The transactions may be used to affect the Funds
rate with little or no impact on the Treasury bill rate.

funds TRANSACTIONS BY BANKS
Banks most frequently employ their Funds on a short-term
basis by making direct, unsecured sales to other banks. These trans
actions are flanked by several varieties of secured transactions
including common forms of repurchases. The great bulk of interbank
trades, however, are for overnight and are unsecured.
Transactions have been made at rates above and below the discount rate. In the late
1950’s and early 1960’s, the System made repurchases at less than the discount rate, generally
at the Treasury bill rate. In recent years, some purchases have been made above the discount
rate when money market rates were higher than the discount rate.
2
Such sources include the Federal Reserve discount window, direct participation in the
Funds market, and payment for some new Treasury issues with tax and loan account credit.

The Federal Funds Market

Until the Comptroller’s ruling in June, 1963,1 which freed
transactions by national banks from lending and borrowing limits,
secured transactions, when used, were generally considered a
function of the size of either the seller or the buyer, or both. Secured
transactions permitted exemption from the lending and borrowing
limits of the National Bank Act and continue to do so lor state
member banks where corresponding rulings have not been made by
state banking commissioners or by statutes. The collateral involved —
some form of collateral loan agreement or repurchase — usually
represented the most conveneient mechanical arrangement, although
for some borrowers credit standing was a factor.
Secured transactions in interbank trades are more generally a
characteristic of trades between banks outside New York, although
they are often used by outside banks when selling to New York, and
on occasion, when borrowing. While there has been some decrease in
the volume of secured transactions since the Comptroller’s ruling,
banks continue to observe the broad limits and rules in dealing with
one another which have been part of the practice of the market.
Banks similarly continue to appraise each other’s credit standing, and
collateral is still frequently required of smaller banks and as a matter
of policy in other cases. More emphasis may be placed on collateral if
certain banks want to exceed previously agreed limits.

A number of banks in large centers have found that purchases
of 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. They have come to use substantial amounts
of Funds in their operating positions. The pattern of trading varies
among the banks; some accommodate others, both buying and selling
the same day; some are net sellers or net buyers; and others run
balanced positions. On the selling side, the Funds market now
significantly fills the position formerly occupied by the old call loan
market as a secondary reserve investment market. Many banks which
previously adjusted their positions in Treasury bills now largely use
Funds transactions. The market has also become a major source of
financing for Government securities dealers. Banks in principal cities
throughout the Nation now frequently supply more dealer financing
through overnight repurchase agreements than banks in New York
and Chicago — historically the largest source of dealer borrowing.
1 See Appendix A for more detail.

The Funds Rate

the funds rate
Funds transactions between banks are now quoted in terms of
the effective rate or prevailing rate — the level at which the great
hulk of transactions are accomplished. The quote is considered
representative of the entire market, New York City and elsewhere.
During most of the postwar period the quotes have usually changed
by one-quarter of a percentage point; more recently (since late
1962), as in other markets, the quote change has frequently been
one-eighth of a percentage point, reflecting the increased breadth of
competition within this market and in relation to alternative
markets. Quotes of one-quarter of a percentage point were also
typical in the 1920’s.

During most of the 1920’s and the postwar period, the Funds
rate generally fluctuated between the discount rate and a lower limit
°f one-half or one-eighth of 1 percent — a point where most banks
can recover costs. This reflected a close association of member bank
borrowing from the Federal Reserve and the discount rate, which
was generally in touch with market rates. Thus, having access to the
discount window at the Reserve bank, member banks were usually
unwilling to pay more than the discount rate for Funds.1
Over a substantial period in 1928 and 1929 (see Chart I) and
since March, 1965, the Funds rate has almost continuously been
above the discount rate. The premium bid on many days in the
1920’s reached spreads ranging between one-eighth of a percent and
•^ percent above the discount rate. Willingness to pay this premium
was attributed to lack of eligible paper and fear of criticism by the
Reserve bank because of the large portfolios of loans to the stock
market held by member banks.
The premium bid in the mid-1960’s developed initially from the
efforts of several of the New York City banks to secure a larger
volume of reserves for lending and investing as well as the fear of

Market observers, however, reported several instances in 1959 and one in May and one in
wrly August, 1964, where one-eighth of 1 percent more than the discount rate was paid. In
October, 1964, and during the rest of the fall, the Funds brokers reported some transactions in
size on a number of trading days at one-eighth of 1 percent premium. The effective rate,
owever, did not exceed the discount rate.

The Federal Funds Market
Reserve bank criticism if their borrowings from the Federal Reserve
were used for extended or continuous periods to support extensions
of credit. Other reasons for premium rates included a shortage of
Government security collateral to serve as the basis for advances at
the Reserve bank and awkwardness in the use of eligible paper.
CHART IV
RATE ON FEDERAL FUNDS AND FEDERAL RESERVE BANK

From March, 1965, to the present time, the effective Funds rate
has almost continuously been above the discount rate. The increasing
size of the premiums developed from exceptionally strong bids by
the larger banks as their loan and investment volume expanded in
response to customer demand. During this period, the discount rate
was used sparingly and lost touch with market rates particularly

Some Factors Influencing the Funds Rate

when they were rising during the restrictive policies in 1966 and
1969. The Federal Reserve Board was reluctant to approve or initiate
increases in the discount rate. It was feared, among other things, that
the “announcement effect” of even a modest change might be
exaggerated and thus stimulate still higher levels of market rates.1
The premium at times was 2 to 3 percentage points. In a sense, the
Funds rate became a discount rate. Discipline exercised at the
window, however, insured that the Federal Reserve advances were
not a steady and continuous source of supply for any given bank.
This development reflected the changed attitude of the banks
which had come to view purchases of Funds as one of the primary
sources for covering deficits in cash flows or rebuilding excess
reserves and sales as a principal secondary reserve asset. It also
reflected the widespread acceptance of liability management by
banks to gain liquidity by varying liabilities instead of assets. In this
context, certificates of deposit, Euro-dollars, and bank related
commercial paper were increasingly relied upon. Payment of a rate
for Funds by the large banks competitive with other market rates
made the Funds market quite dependable even in periods of credit
restraint.
Banks continued to pay a premium for Funds as System policy
gradually eased during 1970. The size of the premium decreased,
owever, and by October the Funds rate was closely aligned with the
rscount rate. The premium amounted to about one-eighth to
one-quarter of 1 percent on the average. Volume traded remained

QAnmiol Report of the Board of Governors of the Federal Reserve System, 1966, pp.
94-96;1969,pp.70j77.

The relative level of the Funds rate and the discount rate does have some influence on
orrowing at the Reserve banks. A differential of a full point or more between the two rates
^ enc°urage the banks to seek the cheaper discount accommodation. Under these
conditions, it is expected that administration of the discount window would be more
arching. The impact on borrowings of differentials in these rates is less certain if they are no
at°tl>e ^an one'half °f 1 percent. Country banks’ decisions of whether to buy Funds or borrow
sh 1 ^eserve banks are typically more sensitive to smaller rate margins than the city banks. It
ould be noted that borrowings in the Funds market are not identical with those from the
scount window since in the latter case they must meet purpose constraints as outlined in
egulation A. Banks, however, whose borrowings meet such purposes may make their reserve
a Justments by using the cheaper source—the discount window. It is not expected that a bank
routinely use the window as just one of several alternative sources of funds such as
Uro-dollars or CD’s, thereby exploiting the rate differential.

The Federal Funds Market
SOME FACTORS INFLUENCING THE FUNDS RATE

During the credit squeeze in 19661 and the period of intensive
credit restraint in 1969, banks showed a strong preference for the
Funds market in making reserve adjustments. This was a factor
contributing to increases in the rate on transactions and the volume
of Funds traded. The intensity of demand was reflected in the
increasing spread of the Funds rate above the discount rate. In fact,
the preference for Funds over borrowing at the window has
continued to the present time.
Paying more than the discount rate for Funds reflects the
elasticity of the demand for them. The market may be said to
represent a marginal demand and supply schedule in which increases
of demand and supply quickly result in changed rates — in contrast
to some other markets where competition is less perfect. The Funds
rate acts as a sensitive indicator of shifting pressures in the banking
system, particularly when related to who is supplying the Funds, the
volume of the flows, and the depth of the demand. The huge flow of
Funds during the last five years and widespread participation of both
city and country banks of all sizes underscore this characterization of
the market.

Currently, Funds are bought and sold by banks at several points
in each Federal Reserve district. Each local selling point is a market,
but New York City still predominates as the central market. About
half the transactions originate in or move through New York City,
and the brokers and principal accommodating banks are located
there.

Local selling points are intimately connected with the central
market and with one another. They are “linked” in the sense that
price differences can bring transactions from one market to another,
and some of the competing buyers and competing sellers complete
transactions in more than one market within a district or in several
districts. In a real sense the market is national.
1A letter from the Federal Reserve System dated September 1, 1966, requesting the
cooperation of member banks in curtailing loans to business, stated that member banks
experiencing deposit losses would be extended credit for a longer period than usual if they
made efforts to slow loan growth instead of cutting further into holdings of securities,
especially municipals. The banks did not take advantage of the offer to any extent.

Some Factors Influencing the Funds Rate
CHART V

daily rate for federal funds and federal reserve

SOURCE:

Federal Reserve Bank of New York.

Transactions are accomplished rapidly and at low cost in
increasing volume for increasing numbers of banks at nearly uniform
33

The Federal Funds Markel

rates. This reflects a high degree of adjustment between demand and
supply and price and quantity exchanged. In each local market, the
same general forces determine the rate which may exist at any given
time, although the magnitude of these forces may vary from market
to market.

These rates are not unrelated to each other but are distinct
prices, and the departures from the effective rate merely indicate a
range of quotations on a given day.1 Lack of perfect adjustment and
a uniform rate arise from institutional friction, absence of complete
knowledge of the market as a whole, and use of Federal Funds by
nonbanks and others.
The growth in unity and breadth and the increase in efficiency
of the Federal Funds market during the 1960’s have strengthened the
connections between the various divisions of the money market and
between those of the money market and the longer term credit
markets. A given volume of Federal Funds now moves through the
market with less change in rates than before, and market participants
may move back and forth from one sector of the money market to
another in response to shifting rate differentials without causing
disruptive price changes.

Although longer run influences, such as shifts in System policy,
affect the Funds rate, it is also influenced by a shift of reserves
among money market and country banks and the ebb and flow
resulting from banking and other financial transactions. A persistent
tendency for the rate to rise indicates a greater demand for reserves
relative to supply, and a persistent tendency for the rate to fall
suggests a smaller demand relative to the supply of reserves. Aside
from temporary problems arising from the geographical distribution
of reserves, distribution among money market banks, or unusual
short-term demands, such as Treasury financing, the Funds rate
shows a consistent and generally stable relationship to net borrowed
reserves. Longer run shifts in the relationship, however, may occur
under certain conditions. The Funds rate has risen relative to net
See Chapter 4 by Dorothy M. Nichols, op. cit., for a detailed discussion of determination
of rates and rate structure. This study provides a detailed analysis of Funds transactions by
about 250 banks that reported to the System between September, 1959, and September, 1963.

Some Factors Influencing the Funds Rate

orrowed reserves when deposit drains become cumulatively large
and bank liquidity becomes strained. The credit squeeze in 1966 and
t e intense credit restraint in 1969 are cases in point. Demand for
unds to make reserve adjustments increases under these cir
cumstances. The Funds rate during much of the postwar period has
een considered a key variable, along with net borrowed reserves, by
e Open Market Account in maintaining the desired money market
conditions.
As a general rule, the Funds rate shows quite a distinct weekly
Pattern. The rate tends to be firmer on Thursdays and Fridays and to
soften on Tuesdays and Wednesdays. The softening is usually most
pronounced on Wednesday, the last day of the statement week. This
change within the week reflects the operating practices of
institutions in the market, such as those followed by different banks
>n determining their reserve positions. Some buyers and sellers come
to the market at different times. Firmness on Thursday and Friday
reflects the opening of the reserve week for all member banks.
Thursday is the payment day for weekly Treasury bills, and banks
most active in financing the dealers absorb Funds. Many banks
usually like to develop a cushion of excess reserves which can be
drawn down later in the period to meet shifts in deposits or other
Pressures. The position must also be established for the weekend on
nday, since these transactions carry over until Monday.

The softness of rates at the end of the statement week
Principally reflects lessened demand factors. Available data do not
show that supplies of Funds are larger on those days. In the opinion
°f most market observers, lessening of demand may be attributable
to several factors.
Reserve requirements have been satisfied and those country
anks which do not trade Funds shift excesses to city correspondents
requently. The widening use of Funds during recent years has
caused country banks to compute requirements more accurately and
sell excesses to city banks. When these flows from country to city
anks coincide with periods of sufficiencies for Reserve city banks,
the market tends to fade away.

Efforts have been made to adjust for anticipated volumes. Some
anks have sold estimated excesses, and others have bought to cover
35

The Federal Funds Market
estimated deficiencies a day or two prior to settlement dates. The
results, however, have not always matched expectations.1

It should be noted that excess Funds may appear with resulting
downward pressure on rates during periods of scarcity. This has
happened occasionally in the past if member banks borrow in excess
of their needs prior to a long weekend or when float or other
operating factors produce sizable amounts of Funds in excess of
estimates.
MONEY MARKET INSTRUMENTS
FUNDS RELATIONSHIPS

1950-1969 AND SOME

Chart VI traces the continuous growth and change which have
occurred during the postwar period in the composition of money
market instruments. This change reflects an effort to improve the
flexibility of the various institutions within the market itself and to
maximize the usefulness of the existing volume of money market
funds in making final adjustment between demand and supply of
credit. Special techniques have been developed by both borrowers
and lenders which facilitate flows between markets. Knowledge of
the market also has become more widespread and internal diversity
reduced, particularly since the mid-1950’s.

Business corporations have become important suppliers and
users of money market funds, both directly and indirectly. The
activity of nonbank participants has increased partly because
interest is no longer paid on demand deposits. Deposits have been
redistributed in the banking system to the extent that corporate
treasurers have shifted from demand deposits to money market
investments, and these treasurers have become increasingly active in
shifting from one market to another. This activity has also been a

See also the discussion of the effect of the introduction of and experience to date with
the Lagged Accounting Reserve Plan on pp. 70—72. At the present time, the Open Market
Committee is re-examining its own processes for agreeing on policy objectives and its strategy
for accomplishing them. Monetary aggregates, such as the money supply and bank credit, are
currently being given more weight. Emphasizing a quantitative target may result in more
amplitude of fluctuation in the sensitive rates and net borrowed reserves from time to time
than when money market conditions were used as a major policy objective.

Money Market Instruments 1950 — 1969

factor in slowing deposit growth at the large money market banks
and increasing the velocity of money. As all sectors of the market
increased in competitiveness, the range of fluctuations in rates has
been reduced except during the recent periods of severe monetary
restraint. Considerable variability in money market conditions seems
to inevitably accompany such a policy. In some markets in 1969,
spread between bid and asked rates was frequently widened from the
characteristic one-eighth percent, to one-quarter percent, and on
occasion to three-eighths percent.

Maturing instruments in the several sectors of the money
market are now generally paid off in Funds as opposed to clearing
house checks. Currently, unless agreed otherwise, money market
instruments bought and sold in the secondary market are usually
deliverable in New York the next business day following the date of
the transactions, and settlements are in Funds. Banks in New York
and Chicago frequently act as issuing agent and alternate paying
agent when such service is required to reduce deliveries and
collection expense. Banks in other principal money centers may also
Perform these services. U.S. securities and the majority of Federal
agency securities are payable at Federal Reserve banks.
Funds and Treasury Bill Markets

The Funds market and Treasury bill market are today the
dominant sectors of the short-term money market and reflect
business conducted for a widened variety of customers in sub
stantially increased volume. Over two-thirds of all trading volume in
U.S. securities in 1969 was conducted in Treasury bills. At the same
time, Federal agency securities, up to two years in maturity, have
become important in trading.

These are the markets in which the banks complete most of
their reserve adjustments, and virtually all open market operations of
the System Account are conducted in the U.S. Government securities
market. These operations have an immediate impact on the supply of
Funds and spread the effects of System monetary policy throughout
the financial markets. Correspondingly, large money market banks
and Government security dealers are the major participants other
than the Federal Reserve. Because of different uses, the relative
37

The Federal Funds Market

importance of each market to borrowers and lenders cannot be
compared on the basis of absolute magnitudes.
Beyond the Funds and Treasury bill markets, other sections of
the money market, some old and some new, are important not only
for reserve adjustment but also for lodgement of short-term funds,
and the participants link these markets to others. Some markets have
changed in both function and character compared with past periods.
An example of this is the brokers’ loan market. Although these loans
have shown a large increase in outstandings during the last several
years, they are now of relatively small significance in adjusting bank
reserve positions. The market is more generally used by the larger
banks as a secondary reserve investment. As such, its character is
considerably different from the 1920’s, when working capital
balances of corporations were placed in call and time loans to
brokers through the agency of New York City banks.
Dealer Loans

The market in dealer loans with U.S. Government securities as
collateral1 developed during the postwar period, accompanying the
rise in trading in Governments. It is highly specialized and closely
related to both the Funds and Treasury bill markets. These loans are
made on call or overnight by several of the leading New York City
banks, and they help to balance out residual reserve needs in the
money market as a whole.2 In effect, the banks act as lenders of last
resort for the Government security dealers. Daily volume may range
from $100 million to over $1.5 billion.
This market has some aspects of a customer loan market in that
most of the banks do not feel free to terminate loans without regard
to the individual borrower’s position. Generally the banks influence
the volume of outstanding loans by making daily changes in the
“posted” loan rates on new loans and renewals — announced each
day after the bank has initially determined its reserve position. By
varying their rates and administering the volume of loans within the

1 Collateral may also include certificates of deposit, securities issued by U.S. Government
agencies, acceptances, and commercial paper.
2

One or two Chicago banks are also important sources of these loans.

Money Market Instruments 1950 — 1969

framework of posted rates, these banks use dealer loans to adjust
their reserve positions to reflect changes within the market itself as
well as broader changes affecting the money market as a whole.
Dealer loans are thus considered an important money market
instrument for New York City banks.1 The rates on the loans are
established below the call rate on other security loans, but generally
one-quarter to three-quarters of 1 percent above the Funds rate and
frequently above the yield to dealers on the securities in their
inventories.

Aside from the influence of normal operating factors, an
atmosphere of ease or tightness in the general money market stems
rom the strength of the demand for Funds, the intensity of reserve
use, bank reserve adjustments through net purchase or sale of
treasury bills, and the willingness of the banks to make dealer loans.
Geographical distribution of reserves — whether concentrated in
financial centers or country areas at any given time — may be a
short-run underlying influence. In the final analysis, however, the
degree of restraint or ease in the money market is reflected in the
volume of member bank borrowing at the Reserve banks.
Commercial Paper

In the older markets, dealer commercial paper still serves a
respectable cross section of industry. Along with the enlarged dollar
volume of recent years, issuers have also increased, numbering about
00 in 1969. Although banks remain major purchasers, they now
old only one-third of outstandings. Nonfinancial corporations
account for most of the balance. Agreements by the dealer to

Y v S°me analysts view repurchase agreements made with dealers by banks outside New
ork as being more closely related to collateral loans than to interbank trades because a
number of the outside banks feel an obligation to renew such agreements even if it necessitates
orrowing Funds to support the loans. In other instances, the bank merely follows an
unpersonal attitude—makes the loan if it fits its reserve position because the rate frequently is
actionally higher than a Funds transaction. The loan is considered similar to a direct trade of
unds with another bank. The element of customer relationship in repurchases with banks
sh^ York is more likely to be found in the Midwest and West. Whether repurchases
°uld be classified as collateral loans to dealers depends upon whether interest centers upon
e er accommodation or some other aspect of the market. In any event, there is an extremely
c ose relationship between the direct Funds and collateral loan markets. Lines of distinction
‘Ue not clear-cut. For further discussion of this point, see “New Series on Federal Funds,” op.
^- This article also develops the concept of “basic reserve position” for 46 major Reserve city

The Federal Funds Market

repurchase the paper from the buyer do not usually occur, but for
good customers in an emergency, the dealer may try to resell the
paper on a “best efforts basis.”
More recent money market instruments include directly placed
sales of finance company paper, and in early 1969, bank related
commercial paper1 began to grow in volume. This latter paper first
appeared in small volume during the credit squeeze of 1966 and
provided banks with an additional nondeposit source of Funds,
enabling them to meet some of their loan demand. Both dealer and
directly placed paper have maturities of three days to nine months
with most carrying maturities of less than 90 days. The nine-month
maximum maturity exempts commercial paper from registration
with the Securities and Exchange Commission, and the exemption
requires that the proceeds of these notes be used for “current
transactions.”

Sales finance company paper, first issued in some volume in the
1920’s, was not handled by dealers and was ineligible at the Reserve
bank discount windows. Only modest amounts were held by banks.
The rise of finance companies to a predominant position in the
market accompanied the growth of consumer credit. The credit
record of the paper established it as prime quality, and by the late
1930’s dealers began handling it. Dealers continue to place the paper
of some finance companies, but most is now placed by the issuer.
The expansion in economic activity after World War II forced finance
companies to seek short-term credit in amounts beyond the ability or
willingness of banks to service them either through direct lending or
purchase.

The market for finance paper broadened to include non financial
corporate treasurers and a variety of other investors. Corporate
treasurers currently account for close to 60 percent of the volume of
purchases of this paper, and since the advent of the master note
toward the end of the 1950’s, it is estimated that bank trust
departments have come to account for about 20 percent of the
purchases. The master note is a device for pooling temporarily

'Bank related paper is commercial paper issued by bank holding companies, affiliates of
bank holding companies, or affiliates of banks.

Money Market Instruments 1950 — 1969
uninvested funds of a number of investors (typically the beneficiaries
uf trusts) under a single agreement. Bank holdings, on the other
hand, are relatively small, accounting for less than 10 percent.

If need arises on the part of the buyer, the issuer
placed paper will generally repurchase the outstandings,
rate adjustments, however. Since the close of the war,
function—locating buyers and suiting terms to needs—has
ly been performed by the finance companies.

of directly
often with
the dealer
increasing

About 85 percent of bank related paper outstanding has been
Placed directly with corporate customers, and the balance sold
through dealers. All kinds of commercial paper have increased signifi
cantly in volume—fourfold—since 1965, reaching a peak of $40 billion
ln June, 1970. Excluding bank related paper, the market has recently
supplied about 25 percent of the credit represented by the combined
total of commercial loans at large banks and commercial paper.
The increase reflects the extreme tightness of bank credit in
1966 and 1969, attempts to rebuild corporate liquidity in 1967, and
the congestion and high cost in the long-term capital market. A
number of utility companies used the market until the time when
short debt could be funded at lower rates. In addition, since 1963,
when permission was granted, certain utilities have financed current
needs and accounts receivable in the market. Of particular interest is
the use made of the market by non financial corporations during the
last several years in supplementing internal sources of funds and in
providing an alternative and supplement to bank lines of credit. The
market expanded so rapidly and the demand for credit was so intense
during recent years in an atmosphere of general euphoria that some
Paper did not receive the customary scrutiny as exemplified by the
bankruptcy of the Penn Central Transportation Company in June,
1970. About $87 million of this paper sold through dealers and rated
Prime by the National Credit Office was held by investors.1
Commercial paper, however, will undoubtedly remain a popular
alternative to bank financing. The market will be influenced by
quality preference and show more caution for anything other than
top rated paper. Some decline in outstandings may result.

Wall Street Journal, August 13, 1970, pp. 1, 16.

The Federal Funds Market

Aggressive banks used the market through their affiliates to help
hold their competitive positions. Proceeds from the sale ol com
mercial paper by a bank holding company, its affiliate, or a bank
subsidiary were generally used to supply funds to the bank through
the purchase of existing loans from the bank or to finance the
activities of the affiliate or subsidiary, such as mortgage servicing or
factoring. In this way, the bank could make new loans, thereby
accommodating its customers, or pressure on the parent bank’s
resources was eased.1

A relatively small amount of the paper known as “documented
discount notes” has also been used to accommodate customers and
avoid pressure on the bank’s resources. The bank customer’s note is
sold by the dealer accompanied by a guarantee or irrevocable letter
of credit issued by the customer’s bank.

Bank related commercial paper amounted to about $4.5 billion
at the end of 1969. By midyear 1970, outstandings had increased
further to a level a little over $7*/2 billion.2 At this level it comprised
a significant share of total commercial paper. Considering the

'in line with its restrictive credit policy, the Board of Governors proposed in October,
1969, that if the proceeds of the sale of bank holding company paper or that of one of its
affiliates were used to supply funds to the bank, the sales would be subject to Regulation Q. At
the same time, it ruled that such paper issued by subsidiaries of banks was already subject to
Regulations Q and D. However, the Board suspended interest rate ceilings and waived
reserve-requirement penalties on the later paper to the extent that volume did not exceed the
amounts outstanding on October 29. As well, it took no final action on holding company
paper.
Using the authority in the Act of December 23, 1969, the Board, in January, 1970,
proposed a 10 percent reserve requirement for bank related paper. Subsequently, after further
discussion, the Board announced on August 17, that effective September 17, 1970, a reserve
requirement of 5 percent would be imposed on a member bank affiliate’s paper with a maturity
of 30 days or more. Maturities of less than 30 days would be subject to the requirements on
demand deposits. The authority of the Reserve banks to waive penalties for deficiencies in
reserves resulting from the issue of such paper by subsidiaries was withdrawn. Simultaneously,
required reserves on all time deposits in excess of $5 million were reduced one percentage, r
effective on the same date. The combined action was expected to release about $350 million of I
reserves net. This result was suited to continued moderation of the System’s restraint policy
inaugurated at the beginning of the year. In June, the interest rate ceiling on CD’s of 30-89 day
maturities was suspended. Since most commercial paper is issued in denominations of $100
thousand or more, the imposition of reserve requirements on bank related paper places
instruments of this kind on practically an equal basis in terms of reserves with negotiable CD’s.

This class of paper will decline in anticipation of reserves to be required against it.

Money Market Instruments 1950 — 1969

commercial paper market as a whole, corporate treasurers have
succeeded the banks as major paper buyers, and the market has cut
substantially into the loan business of commercial banks with finance
companies.
Businessmen’s and finance companies’ cost of borrowing in this
market was less than at the bank counter, even at the advanced rates
reached after 1965 after allowance was made for compensating
balances. Similarly, bank holding companies and affiliates found it a
cheaper source when measured against the cost of Euro-dollars and
other nondeposit funds to their bank affiliates.1

Business and finance company commercial paper market
borrowers feel that the market has provided them with an alternative
source of funds which is usually easily accessible and offers both
flexibility in amount and terms of borrowing as well as a dependable
availability of funds.

During the first half of 1969, the banks also procured additional
reserves by selling over $1 billion from their portfolios under
repurchase agreements to corporate customers. Such repurchases
'vere limited to transactions between banks by a Federal Reserve
Board ruling on July 25, 1969.2 Since that date, a repurchase made
by a bank with a corporate customer can be made only with U.S.
Government or agency securities as collateral.
Bankers' Acceptances

Since 1958, the volume of bankers’ acceptances has almost
quadrupled, reaching $5.5 billion at the end of 1969. This reflects
increasing reliance of domestic importers and exporters on accep
tances as well as the rise in financing of foreign storage and shipment
°f goods. Acceptances for these purposes account for about 50 and 40
percent of outstandings, respectively. It is estimated that about half
°f the borrowing for foreign storage and shipment is undertaken to

See pages 94-98 for detail on the Euro-dollar market.
2,
The Board stated that the proceeds of such repurchase agreements were indistinguish
able from deposit transactions except on a formalistic basis. See Appendix A for more detail.

The Federal Funds Market
finance Japanese trade with other nations. Acceptances arc also used
to cover domestic storage and shipment and to some extent to create
dollar exchange. Acceptances for all purposes except dollar exchange
may have maturities up to six months. Dollar exchange acceptances,
however, are limited to a maturity of not more than three months.

The severe credit restraint in 1969 and the limiting effect ol the
Regulation Q ceiling even led some banks to create and sell “working
capital” acceptances in order to continue their loan expansion. These
acceptances were ineligible for purchase or discount by the Federal
Reserve because they were not trade related. The volume did not
exceed $200 million at year end, but by midsummer 1970, it was
estimated to have doubled.
Trading in acceptances focuses on six dealers, four of whom
also trade Government securities. This market has become somewhat
broader than it was in the first half of the 1950’s. In part, this
broadening reflects both more acceptance financing by a larger
number of banks and the increasing interest of corporate and
institutional treasurers in all short-term investment outlets. Foreign
buyers — both commercial and central banks — although important,
arc today less significant participants than formerly. Domestic
commercial banks and large savings banks remain the major
purchasers. In 1969, acceptance rates rose to record levels and
became increasingly competitive with other short-term investments.
Even the small denominated bill of less than $100 thousand,
heretofore considered a nuisance, was easily sold and attracted
institutional odd lot buyers and even individuals. Banks sold most of
the “ineligible” acceptances to their customers in 1969, and in 1970,
there was a limited amount of trading by one or two dealers.
In contrast to the 192O’s, the market is now considerably larger
in absolute size but much smaller and less important in relation to
the total volumes of money market instruments. The Federal Reserve
now buys only limited amounts of acceptances for its own account.
Some banks continue the practice of holding their own bills for
investment or accomplish transactions through dealers on a “swap”
basis. Some banks sell to their correspondents and other customers
from their own supply. At times, a bank will enter the market as an
agent on behalf of its customers. Similarly, banks will bid for
acceptances if the holder wishes to sell. These practices, however,

Money Market Instruments 1950 — 1969
CHART VI
MONEY MARKET INSTRUMENTS 1950-1969

Approximate Amounts Outstanding (Billions of Dollars)

SOURCE:

Federal Reserve Bulletin except Federal Funds. Funds data based on report of
250-275 banks September, 1959 — September, 1962, and 46 large banks since
then. Data on Federal Funds and certificates of deposit partly estimated for
some years. Brokers’ loan data for 1969 are June 30. All other data are
year-end figures.

The Federal Funds Market

appear to be decreasing or stabilizing, with more trading through
dealers.
'Fhe acceptance market, along with the market lor dealer and
directly placed commercial paper, provides an important tie between
the short-term money market and the bank counter. This occurs as
borrowers switch from these markets to the bank counter in meeting
needs. The prime rate on commercial loans has become an important
part of the structure of money rates. Linkage with the long-term
capital market is also provided through the bank counter as
borrowers fund bank loans, depending in part upon the relationship
of capital market rates to the prime rate.
Certificates of Deposit1

Although certificates of deposit have been issued in negotiable
form for many years in parts of the Nation, they have become a
significant money market instrument only since 1961. Earlier issuers
did not expect their certificates to be traded. In fact,there was no
organized secondary market.

In order to combat both the instability and shrinkage of their
deposits which had been in process during the 1950’s, the New York
City banks announced that they would issue CD’s to domestic
business corporations, public bodies, and foreign sources. Issuance
was expected to attract short-term corporate funds lodged elsewhere
in the banking system and also provide an instrument to compete for
corporate balances which were being invested in a variety of money
market instruments, principally in Treasury bills. These CD’s are
usually issued in large denomination with minimum face value ol
$100,000, and maturities range from 30 days to one year or longer.
Most maturities, however, are concentrated in the short-term area.
In late February, 1961, the First National City Bank of New
York began to issue CD’s. Two major innovations were introduced.
The certificates were made negotiable, and the Discount Corporation
of New York announced that it would make a market for
certificates, thus broadening appeal. Competitive forces led banks in
other centers to follow suit. Outstanding amounts have grown
rapidly and include a variety of maturities but with considerable
concentration in the short-term area.
Negotiable CD’s are issued and traded on yield to maturity basis.

Money Market Instruments 1950 — 1969

Issuers are widespread geographically and by size of bank.
Increases in outstandings have typically occurred during periods of
relative ease or stability in the markets. Since rates paid are governed
^7 Regulation Q, banks are forced to withdraw from the issue
market as money market conditions firm, offering rates reach
Regulation Q ceilings, and such ceilings remain unchanged. Under
these conditions, market short-term rates rise relative to the
Regulation’s ceiling, and certificates become noncompetitive with
other instruments. The rise of open market rates (not subject to the
constraint of regulation) above — or their fall below — existing rate
ceilings leads to the retardation or acceleration of issues as interest
sensitive investors move to obtain the highest possible yields. As the
market evolved, a number of the leading banks adopted the practice
of varying the rate offered on certificates and, by this method, used
certificates to adjust their reserve position.
Toward the end of 1968, a record high of $24 billion of
outstandings was reported. Subsequently, the intensification of the
System’s restrictive credit policy which began to develop at the year
end lifted market rates well above Regulation Q ceilings. Out
standings by the end of 1969 had dropped to about $10 billion
because of net runoffs — about five times the size of the decline
during the restrictive credit period in 1966. The move to a restrictive
credit policy in the first half of 1969 was accompanied by a decision
to leave Regulation Q ceilings on time deposits unchanged and thus
below marker rates. This was the first time that Regulation Q had
been used by the Federal Reserve with the direct intention of
restraining bank credit expansion. In 1966, market rates did not
pierce the Regulation Q ceilings until midsummer, and the net runoff
m CD’s occurred in August and September toward the end of the
restrictive period. The regulation was used at that time to sup
plement other policy instruments. The decision not to change time
deposit rates and the reduced availability of bank reserves interacted
°n the demand for bank credit throughout the year in 1969, as it had
after mid-1966. Banks were forced to seek nondeposit sources of
unds — such as Euro-dollars and commercial paper — and to use the
unds market more intensively as a source of funds to accommodate
customers’ credit demands. Prior to 1966, Regulation Q ceilings were
generally accommodated to market rates.
To the holder, at least of better known names, the secondary
Jacket, centered in the principal U.S. Government security dealers,

The Federal Funds Market

provides reasonable liquidity except during periods of tight money,
such as occurred in 1968 and 1969. The mere existence ol the
market has broadened the acceptance of all issues by facilitating sales
to third parties before maturity for most certificates. Trading volume
has ranged in “good markets” from $40 to $125 million daily
average, while dealer positions have ranged from $150 to over $600
million. In “poor markets,” such as occurred in 1966 and 1969,
dealers substantially cut their positions, as supply and consequently
trading volume dried up. In 1969, both the dealer positions and
trading volume were nominal, falling as low as $1 to $2 million at
times. Some distress selling occurred at times of sharp rate change.

The most active periods of the secondary market have occurred
when dealers expected profits could be made. Until 1965, Regulation
Q ceilings on the shorter maturities were somewhat below market
rates for long periods, and the ceiling provided a cushion against
market loss as holdings approached maturity. The yield curve
descended as maturity shortened, permitting original holders to offer
their CD’s at lower rates (higher prices) than when acquired. In this
way, they established a profit over and above the interest earned
during the period held. With the establishment of a single rate for all
maturities (December, 1965, to April, 1968), dealers acquired
positions only when the rate outlook was stable or they expected
rates to decline. They were exposed to undercutting, as issuers could
make unexpected changes in rates. When the ceilings were raised in
April, 1968, step rates based on maturities again provided a cushion
against market loss when market rates were below ceilings, and for
several months dealers were again able to acquire large positions on a
favorable “carry” either with repurchases or dealer loans. By the end
of the year, market rates and issue rates had climbed well above the
ceilings and remained there throughout 1969, severely curtailing
dealer activities.

Expansion of economic activity slowed during 1969, came to a
halt near the year end, and declined during the first half of 1970.
System policy accordingly became less restrictive, and moderate but
progressive growth in the money supply and other financial
aggregates was resumed. Reflecting these developments and as
adjustment in business continued, pressures in the financial markets

Money Market Instruments 1950 — 1969
eased gradually as 1970 progressed. Short-term interest rates declined
on balance as a consequence. In this context the Board of Governors
liberalized the Regulation Q ceilings toward the end of January,
raising the rates for each maturity. In June, the ceiling on the 30 to
89 day maturity range was suspended indefinitely, effective June 24.
As a result of the January action, as market rates adjusted, banks
were able to add CD’s in moderate volume in the following months.
The June action was undertaken partly in recognition of possible
heavy demands on commercial banks for short-term credit resulting
from uncertainties in the commercial paper market arising from the
bankruptcy of the Penn Central Railroad Company and partly to
support the easier credit policy. The System also used the discount
Window and open market operations to forestall liquidity pressures.
Freed from the constraint of rate ceilings in this maturity, the banks
aggressively sought short-term CD’s to accommodate borrowers who
could not obtain funds in the paper market. Banks received a
substantial inflow of funds in response to offering rates of about 8
Percent.

By late fall, the outstanding volume of CD’s had reached $24
billion up from about $10 billion in early February. Dealers’ inven
tories rose steadily and averaged over $400 million by the end of
September. Trading in the secondary market became more active
returning to earlier levels. Dealers were for the most part able to
finance their inventories at favorable “carries” largely on the basis of
Federal Funds.
The June action is the first suspension of the rate ceiling which
has occurred. If ceilings should eventually be discarded, the rate paid
by individual banks offering CD’s would become increasingly a
function of the average rate prevailing in the market, the volume of
CD’s outstanding, and the amount of new issues proposed. This
development could lead to a more even flow of marketing of issues
and better balance of factors in the secondary market.
As a short-term investment, certificates of deposit compete
Principally with three-month Treasury bills and commercial paper,
both dealer and directly placed. They are held mainly by cor
porations and other businesses, although state and local governments
and foreign entities also hold significant amounts. Generally, banks
do not frequently buy other banks’ certificates. Unlike other money

The Federal Funds Market
market instruments, variation in amounts of CD’s outstanding may
influence the reserve position of banks because of the lower reserve
required for time deposits. Issuing rates reflect the increased
competitiveness of the CD’s with other sectors of the money market.
As the market has developed, changes in issuing rates have declined
from one-quarter of 1 percent to one-eighth of 1 percent.
Other Market Instruments

Strong competition in the money market, charcteristic of the
past decade, was clearly reflected by the offering of straight,
unsecured short-term notes by the First National Bank of Boston in
early September, 1964. A dozen or more large banks scattered over
the Nation followed suit. These notes were directly placed by issuers
in multiples of $1 million at rates that competed with finance
company paper, negotiable CD’s, and other money market instru
ments. A limited trading market centered with major U.S. security
dealers subsequently developed. Only about $600 million of these
notes were outstanding at any one time. In contrast to the CD’s, they
required no reserves or insurance and were not subject to rate and
maturity restrictions imposed by Regulation Q. On the other hand,
the issuance utilized some of the bank’s capacity to borrow.
Effective September 1, 1966, however, bank issues of short-term
notes of less than 2 years in maturity were brought within the
provision of Regulations D and Q, being defined as deposits in the
interests of equity.

The variety of competition and money market participants’
willingness to try to improve the flexibility of the institutions within
the market itself have also been reflected in the issuance of
short-term notes by the Federal National Mortgage Association
inaugurated in April, 1960. In the private sector, the Savings Bank
Trust Company also began issues of short-term notes in October,
1962

The FNMA notes are issued at a discount and are unsecured,
with maturities designated by lenders ranging from 30 to 270 days
with a wide choice of denominations. The FNMA has placed
increasing reliance on these notes, and along with the Federal Home
Loan Bank, has during the last three years increased the number of
issues with maturities up to 2 years. This use of Federal agencies as
50

Structure of the Market and Interbank Trading

intermediaries has provided significant amounts of money for the
real estate mortgage market. The Savings Bank Trust Company has
an issue of three year notes outstanding, and both these and its
short-term securities are largely secured by FHA and VA real estate
m°rtgages. Like the Federal agencies, the Trust Company uses a
dealer in placing its notes. The outstanding volume of the Trust
Company notes, however, is relatively small as are the amounts
which are likely to be issued.
STRUCTURE OF THE MARKET AND INTERBANK TRADING

The Federal Funds market is primarily an interbank market.1 In
the early 1960’s, on an average day about $3.5 to $4 billion of Funds
was shifted from bank to bank, but on many days in the latter part
°f the 1960’s, the total probably averaged close to $10 billion and
fell to $3 to $4 billion only on occasion. These transactions2
represent more than a fivefold increase in the volume since the late
1950’s These are gross figures and include some double counting
which occurs as funds are shifted front ultimate suppliers to final
users.
On the average, only about 10 percent of total activity is with
other than a commercial bank—chiefly U.S. Government security
dealers, savings banks,3 and corporations. At times, however,

The discussion in this section emphasizes interbank trades of Funds. References are
^de, however, to transactions between banks and nonbanks. Many banks use these
transactions for the same purpose as interbank trades. Effective February, 1970, the Board of
'-•overnors narrowed the category of Funds transactions permitted member banks by bringing
'Wthin the coverage of Regulations D and Q such transactions “with any person other than a
ank and its subsidiaries, various governmental institutions, or a securities dealer in certain
cases.” The term bank was also defined. See Appendix A, pages 103-04.
2 .
Available data for member banks classifying transactions as purchases and sales generally
show an excess of purchases over sales. This reflects transactions with nonbanks and
nonmember banks and a number of small banks for which reports are not currently available.

Legislation particularly in New York (April, 1969) and Massachusetts (August, 1969)
Permitting or clarifying the authority of savings banks to make unsecured sales of Funds
resulted in a considerable increase in their activity. Savings and loan associations also make use
°f the market but frequently with repurchase agreements. Cooperative banks in Massachusetts
since February, 1970, may make unsecured transactions.

The Federal Funds Market
transactions with these institutions may comprise as much as a
quarter of total transactions.1 Member banks, however, are always
involved as a buyer, seller, or intermediary.
Some 350 member banks2 are presently regular participants in
the market, buying and selling Funds on from one to several
occasions in almost every reserve period. These banks hold about 60
percent of total commercial bank deposits and include practically all
banks with $100 million or more of deposits. The most active
participants are found in Reserve cities, but some 60 to 70 larger
country banks have substantial regular dealings, and another 400
trade less frequently — perhaps as often as 25 times a year. Estimates
place the total number of participants as high as 3,500 banks, more
than double the number five years ago. Many of these banks will
have only several transactions at one time or another during the year
and include those that range down to less than $1 million in deposit
size. Usually the transactions of the smaller banks are sales made
possible by excess reserves arising from seasonal or temporary forces.

Nonbank dealers generally clear their securities transactions through one or more banks,
and the clearing banks maintain a record of Funds paid out for, or received on account of, the
dealer’s transactions. These Funds frequently approximate $100 to $200 million per day and
are charged and credited to the dealer at the going rate. Settlement is made periodically—week
ly or monthly—on a net basis. One large dealer, however, still performs his own clearing in
everything except Treasury bills and short-term Federal agencies and acquires and disposes of
some Funds directly.
On the average over a period of time, a balance will generally prevail between the amount
of Funds that a nonbank dealer may have had to pay for securities (or to repay a Funds loan)
and the amount of Funds that he has received on the sale of securities (or from a Funds loan). If
any large discrepancy arising from differences in the Funds rate exists at the end of an
accounting period, the expense borne by the bank on account of Funds payments is settled
between the bank and the dealer. Because of this, dealers seek to capitalize on excesses of
Funds which they may have at particular times in order to offset some later charge by their
clearing bank. Such transactions in Funds are accomplished only among the New York City
banks and are not included in the interbank trading figures.
2
,
A number of the larger nonmember banks and the agencies of foreign banks are
frequently important sources of Funds. They sell excess balances in member bank
correspondent accounts as Funds. The sales may be made to third banks with appropriate
entries in the member banks’ deposit accounts at the Reserve banks, but in many cases the
transaction is accomplished on the member bank’s own books by transfers from the deposit
account to “money borrowed” or similar account on their own books. Currently the agencies
restrict most of their sales to New York City banks. Frequently the agencies will sell Funds
through repurchase agreements with Government securities dealers.

Structure of the Market and Interbank Trading
TABLE II
PURCHASES OF INTERBANK FEDERAL FUNDS
Number

Daily-average gross purchases

Period

of banks

(in millions of dollars)*

1925-32
1951-53
1955-57
1960-63
1963-66
1966-70

30-40
75-100
125-200
175-275
180-350
225-400

100-250
350-450
800-1,200
1,500-2,000
2,000-3,500
3,500-9,000

* Amounts are partially estimated and approximate and include only active traders. Lower
limits refer to earlier parts of designated periods. Based principally on the “46 Bank Series”
beginning in 1960.

The Reserve city banks as a group, as well as the large country
banks, minimize excess reserves throughout the computation period.
Others accumulate excess reserves and sell only toward the end of
the period. Since the reduction in the size of the trading units in
many accommodating banks’ trading arrangements, however, more
°f the smaller country banks have begun trading continuously
throughout the reserve period. Still others make a closely calculated
use of borrowed Funds in carrying a basically overinvested position.
The last practice has tended to assume increased importance for a
number of large banks in recent years. Some of the smaller country
banks, on the other hand, still do not customarily make full
utilization of their excess reserves and as a group maintain sizable
balances throughout the reserve period. In two midwestern districts
where there are large numbers of very small banks, about half the
number do not participate.

These differences in policy and in administration of assets, as
Well as variation in depth of market knowledge, account in large part
for differences in trading patterns. Funds transactions are still
affected by “rules” observed by correspondent systems which limit
transactions outside the group. Some banks also will submit to
brokers lists of other banks with which they will or will not trade.
53

The Federal Funds Market
This type of friction has diminished in recent years but is responsible
in part for indirect routing of trades and occasional inelasticities.

Funds transactions began to grow in volume as well as in
frequency in 1947 and 1948. This reflected the increasing pressures
in the money market and the upward movement of interest rates as
the banking system began to adjust to the postwar period.
Interdistrict dealings in Funds with New York and other centers —
which began to resume at the close of the war — increased slowly
during the early postwar years and were handled almost entirely by
correspondents. Further, the growth of the Funds market since the
1940’s has been encouraged by Funds brokers, whose facilities form
an important part of the national market.

Through the early 1950’s, the structure of the market changed
somewhat, shifting from a direct exchange of Funds between banks
to an exchange through an intermediary or broker. The development
of facilities for matching the demand and supply of Funds through a
broker was accompanied by even faster growth in the activity of
accommodating banks. At the same time, the market changed from
one primarily regional and local to one strongly national in character,
with its center in New York. With the growth of the accommodators
outside New York since 1960 and the matching of transactions
within correspondent groups, the national market now more largely
clears the significant part of residual needs. The transactions are
accomplished at minimum cost.
BROKERS AND ACCOMMODATING BANKS

Until December, 1958, when the Irving Trust Company
established its Funds desk,1 The Garvin Bantel Corp., a member of
the New York Stock Exchange, was the only Funds broker in the
market, and there were as few as 7 or 8 accommodating banks, most
of them in New York City.

The Garvin Bantel Corp, initiated its interdistrict business in
1948 and encouraged the participation of out-of-town banks. This

1The Funds desk is run separately from Irving’s transactions in Funds for its own account

or accommodation of correspondent banks.

Brokers and Accommodating Banks

business began to become significant at the beginning of the 1950’s
as increasing numbers of banks began to direct transactions through
the firm. Garvin Bantel estimates that close to 80 percent of total
Funds traded were channeled through the firm until about 1953.
With the expansion of the accommodating banks, this percentage
dropped to 50 percent by 1957 and subsequently fell to about
one-quarter to one-third. Since the entry of Mabon, Nugent and
Co.,1 also a member of the New York Stock Exchange, in the fall of
1963 and George Palumbo & Co., Inc., a money broker, in
November, 1964, four firms have shared the market volume moving
through brokers. The increased volume of transactions handled by
brokers, shown in Table III, reflects new entrants since 1950, but
more significantly it is the result of increased trading by the larger
banks.

These firms act merely as agents in bringing buyers and sellers
together through regular daily telephone contact with market
participants. In addition, there are eight banks in New York City and
another 30 or more commercial banks in other parts of the Nation —
at least two in each of the Federal Reserve districts — that perform
an accommodating business for correspondents. They differ from
brokers in that they generally deal as principals and frequently trade
°n both sides of the market. These are the major accommodators,
and during the last four years, some 40 more have offered this service
m limited degree. The increase in the number of accommodators in
the Midwest, Southwest, and West during the last 5 years was
S1gnificant. With the exception of San Francisco and Chicago, most
°f the important accommodators are in New York, and, with the
brokers, they form the largest focal point of the market. The
accommodators outside these three cities generally service cor
espondents on a regional basis and may cross district lines to a
limited extent.
The position of brokers in the market, however, has an
'uiportance beyond the volume figures. Various market participants
Use them as sources of information when seeking impersonal deals

^Before its merger with Nugent & Co. on February 15, 1965, Mabon & Co. conducted the
funds brokerage.

The Federal Funds Market
TABLE III

PURCHASES OF FEDERAL FUNDS
THROUGH BROKERS

Year

Number
of Banks
(Estimated)

Amounts (in millions of dollars)

Total

Daily Average

1949

15-20

$22,000

1950

30-40

39,000

$100-150
150-200

1951

35-45

53,000

210-250

1952

45-50

68,000

260-320

1953

50-75

70,000

280-340

1954

75-85

83,000

1955

85-100

79,000

330-360
320-350

1956

115-130

86,000

350-400

1957

130-145

87,000

310-340

1958

135-155

115,000

350-400

1959

140-160

94,000

330-360

1960

160-175

132,000

375-425

1961

180-210

158,000

450-510

1962

180-220

185,000

535-600

1963

185-225

160,000

430-540

1964

190-230

185,000

415-610

1965

200-240

281,000

650-887

1966

225-250

442,000

1,050-1,330

1967
1968
1969

230-255
240-270

465,000

1,155-1,400
1,200-2,100

SOURCE:

240-275

512,000
816,000

1,700-2,800

Data 1949-1962 supplied by The Garvin Bantel Corp. — the only broker then
in the market. Volume data 1963-1969 based on reports of three brokers to
the Federal Reserve Bank of New York.

An accurate percentage of Funds transactions cleared through the brokers in
relation to total activity cannot be computed because of double counting. Not
only does the activity of the accommodating banks overstate the net
movement of Funds from ultimate supplier to ultimate user within a given day,
but the activity of the brokers will include some of the same transactions
reported by the accommodators. Hence, in a movement of Funds from Bank X
to Bank Y, two purchases may be reported — the purchase by the
accommodating bank from Bank X and the purchase by Bank Y. They may be
identical. The Funds may ultimately move to Y from the accommodating bank
through one of the brokers.

Brokers and Accommodating Banks
other banks as well as for general information about the market,
he ability of the accommodating banks to serve their customer
anks is also dependent, in part, on the service of brokers in
acihtating contacts or furnishing information, particularly when the
supply of Funds is fluid.

The brokers, along with the correspondent banks, play a
S1gnificant role in bringing buyers and sellers together. As bids and
° ers of Funds begin coming in early in the morning, the brokers
attempt to match them and establish an opening rate for the market,
ach broker works independently but is aware of what the others are
O|ng through information received indirectly. The opening rate
established in New York is widely quoted as large banks and U.S.
securities dealers call in to check the rate, and it tends to set the
Pattern for the rest of the country.
New entrants into the Funds market during the last few years
■nclude many relatively small banks whose correspondent rela
tionships are close or who, for one reason or another, prefer not to
deal through the brokers. In other cases, neither their unit
transactions nor their volume is large enough to warrant participation
In the money market except through their correspondents. A number
°t banks have also been encouraged to trade through regional
accommodating arrangements.
Some accommodators — two-way trading banks — are net
buyers, while others run balanced positions. Although all of the
two-way traders are large banks, not all large banks conduct two-way
trading. There are also differences in the use of the market within a
g^en area, including New York. Thus many banks are referred to as
adjusting banks, appearing as net buyers or net sellers or running a
balanced position.

The variety of facilities for accomplishing Funds transactions is
Product of the last 10 years. It reflects the growth of the market,
lightened competition among large as well as many smaller banks,
c anges in practice and policies of participants, and more widely
1 fused knowledge of the market.

$'nte 1965, the greatest growth in participation has been among
e banks in the $10 to $50 million deposit grouping. During the last
Wo years, however, the participation rate of banks with less than
,

The Federal Funds Market
$10 million of deposits has increased substantially. In general,
activity is related to bank size with the proportion of banks that
trade increasing with each size class up to $50 million in deposits. As
noted, the reduced size of the trading units in correspondent trading
arrangements has not only encouraged small banks to enter but has
increased the frequency of their trades. In recent years, the upward
movement of interest rates and to a lesser extent rising costs led
many banks to find it reasonable and logical to participate
continuously in the Funds market even foregoing investments in
other markets.

Country bank participation now includes about 60 to 95
percent of this class of member banks in a number of districts.
Among these are New York, Philadelphia, Cleveland, Richmond,
Boston, San Francisco, and Chicago. In the Minneapolis and Kansas
City districts, the participation rate of the country banks, which was
only about 20 percent as late as 1967, has increased significantly
during the last several years. At least 45 to 50 percent of the country
member banks were in the market at one time or another by the end
of 1969 in these districts. The market now provides a way for all but
the smallest banks to maintain a more fully invested position.
Evidence shows, however, that a number of these banks are still
unaware of the market and others have no desire to participate.
FUNDS TRADING PATTERNS1

Several of the largest accommodating banks — six in New York
City and one on the West Coast — account at times for as much as 50
percent of total activity. They account for about one-half of gross
purchases and 40 percent of sales. Their volume sharply outlines
their pivotal position in the markets — moving Funds from supplying
banks to using banks. Several accommodators actually make markets,
since they are willing to trade Funds either way at quoted rates
where close correspondent relations exist, regardless of their own

1The figures in this section covering the early 1960’s are based on the study by Dorothy
M. Nichols covering the period September, 1959 - September, 1963, cited on page 16. The
figures for the last half of the 1960’s are based on the “46 Bank Series” published in the Federal
Reserve Bulletin. These data are supplemented by the call reports and other data collected by
the System. Some estimates have also been made.

Funds Trading Patterns
money position. Average daily two-way trading in Funds purchased
ar>d resold by individual banks on the same day ranged between $200
and $500 million at these banks in the early 1960’s, and on balance,
they absorbed $300 million net in their own positions. Two-way
trading by accommodators located in other Federal Reserve districts
ranged between $80 and $240 million on a daily average basis, but
these banks generally balanced out in position. They were usually
nonborrowers and accommodated by supplying Funds during periods
°f tightness and absorbing Funds during periods of ease. Two-way
trading by both groups of accommodating banks approximated 25 to
^0 percent of all Funds activity in the first half of the 1960’s.
Substantial increases in the volume of Funds traded by
accommodating banks have occurred during recent years. By the
close of the 1960’s, two-way trading at the several largest banks cited
above had more than doubled, ranging between $800 million and
$1-5 billion on the average. Fivefold increases in volume were
reported at the banks outside New York. Two-way trading on an
average day reached a level of $1 to $1.7 billion. The increase reflects
not only more trading by the banks but an increase in the numbers
doing an accommodating business. There was also a marked increase
ln the number of outside banks making net purchases. This volume
averaged between $2 and $3 billion with five Chicago banks
accounting for one-third to one-half of the increase.

Most of the Funds trading continues to be concentrated in a
relatively small number of banks. About 45 large banks, a third of
which have deposits of $1 billion or over, account for close to
tWo-thirds of all transactions. It is these banks that have the greatest
jmpact on the money market. (Some lessening of concentration has
"Cen noted in the last few years as regional trading has been
eveloped by more correspondent systems.) Although the average
°llar volume of the transactions of most of the other banks, in
aggregate, is relatively small and does not have a substantial impact
die general money market, their operations play a continuous role
hat is at least marginally important to the reserve management of
most of the 350-odd regular participants. These large banks each
accomplish daily average purchases and sales of $10 million or over,
epending upon the tightness or ease of the market, while the large
majority of participants each purchase or sell an average of less than
♦2 million a day.

The Federal Funds Market

The importance of the New York banks as intermediaries is
reflected in the fact that about 40 percent of the transactions of all
out-of-town banks are with banks in the city. The volume of trading
among New York City banks is relatively small — usually less than 20
percent of their total transactions. Interbank purchases of Funds
within New York City normally average about $150 million a day
and are roughly comparable to the amount purchased by them from
nonbanks in the city. Transactions with banks outside the city
comprise the largest share of New York City activity—about 75 to 80
percent of both purchases and sales. New York banks in the early
1960’s sold only small amounts of Funds to nonbanks, but this
practice showed a marked increase during the past several years.
Outside banks, on the other hand, have at times been substantial
sellers to nonbanks, and the volume of such transactions rises to
peaks at times of heavy dealer financing needs.
In the districts outside New York City,1 Funds traded locally
within the same Federal Reserve district range on the average
between 20 and 30 percent of total activity. The San Francisco and
Chicago districts, however, as noted earlier, may report somewhat
larger percentages of local trades, and in several districts — Atlanta,
Kansas City, and Minneapolis — trades within the district usually
represent only a modest percentage of the total. Many of the banks
outside New York still tend to rely fairly heavily on New York banks
both as a source for and disposal of Funds. Nevertheless, in some
cases, there is a fair proportion of trading across district lines to
points other than New York City.2 The reliance on New York has
tended to diminish during the last two years to the extent that
accommodators outside the city have balanced more purchases and
sales in their trading areas. Smaller correspondents who deal with
accommodators report some cost savings in transactions, as
compared with previous arrangements.

Interdistrict trading patterns emerging with the development of
the Funds market reflect the usual contrasts. The New York,
1 For details of trading in the various districts, see Bibliography.
One large holding company in the Minneapolis district arranges purchases and sales for
its members through the Bank of America with appropriate entries to reserve accounts at the
Federal Reserve Bank of Minneapolis. A substantial number of the trading banks in the district
are members of the holding company.

Federal Funds VS. Borrowing at Reserve Banks
Chicago, and San Francisco districts absorb and supply the largest
amount of Funds. For long periods of time, New York and Chicago
have been net borrowers and San Francisco a net supplier. The New
York City banks have purchased net as much as $1.6 billion on an
average day in recent years.

The Chicago and San Francisco districts generally do not report
a net position (+ or -) of more than $600 million. Most of the other
districts report either a net inflow or outflow that averages up to
$150 million a day in most statement weeks. Whether these districts
are users or suppliers depends largely upon seasonal forces and
payment flows throughout the year. At times, however, it may
reflect changing policies of large banks in particular districts. During
the last two years, heavy net purchases of the largest banks in the
Minneapolis district have changed the district from a net seller to a
net buyer.

The net Funds position of a district depends to some extent on
a district’s banking structure since large banks tend to be net buyers
and small banks net sellers, or exclusively sellers. In the New York
and San Francisco districts, a relatively large percentage of total
deposits is held by very large banks while in Kansas City and Atlanta,
the larger banks account for a relatively small proportion of total
deposits. The size and continuity of the market depend to a
considerable extent on the relatively large number of small banks
that sell funds to a relatively small number of large banks.1
FEDERAL FUNDS VS. BORROWING AT RESERVE BANKS

On an average day in the late 1920’s, Federal Funds traded for
all member banks ranged from about 4 to 10 percent of required
reserves. During the 1960’s this ratio averaged about 12 percent in
the early years and 27 percent toward the end of the decade. By this
measure, trading in Funds has become of substantially greater
relative importance than in earlier periods. At the same time the
reserve requirement level is about 20 percent higher than in the

^J. A. Cacy, “Tenth District Banks in the Federal Funds Market,” Monthly Review,
Federal Reserve Bank of Kansas City, November, 1969, pp. 10-20.

The Federal Funds Market
If the daily average volume of discounts and of trading in
Federal Funds are combined, the total in the 1920’s reached at times
about 50 percent of required reserves in contrast to about 12 percent
on heavy trading days in the 1950’s, and 35 percent in the late
1960’s. This indicates that borrowings from the Reserve banks made
up a substantially larger part of the reserve base in the credit
superstructure of the 1920’s.

It should also be noted that borrowings from the Reserve banks
during periods of expansion in the 1950’s and 1960’s averaged about
$100 million less than in the late 1920’s. However, the composition
of total borrowing as suggested by the figures above was reversed; the
ratio of Federal Funds to borrowings in the 1920’s was about one to
four; and now it is eight to ten to one. It may be said that in the
1920’s Federal Funds were considered a supplement to discounting,
but that in the 1960’s discounting had become a supplement to
trading in Federal Funds. Although transactions in Federal Funds
relieve the individual bank from use of the discount window, they do
not relieve the banking system as a whole from reliance on the
Federal Reserve.
MARKET GROWTH REFLECTED IN "BORROWING
OTHERS"

FROM

The Weekly Condition Report of Large Commercial Banks1 on
Wednesday dates shows their borrowings from Federal Reserve banks
and their borrowings from others separately from 1953 to July, 1969
(See Chart VII), when the series was revised.2 “Borrowings from
Others” during this period included largely commercial bank sources
in most districts. In some, however, it reflected varying amounts
borrowed from nonbanks.
A comparison of these borrowings with Funds purchases
reported by weekly reporting banks suggests that Funds purchases
1This series included only member banks until 1966. After that date, nonmember
commercial banks of comparable size arc included.
2

»♦

The weekly reporting banks now report a new liability item “ Federal Funds Purchased.
This caption also includes securities sold under repurchase agreement. No breakdown is
supplied. The new caption when combined with “Borrowings from Others” is not comparable
with the old series. Some components are reported on a different basis. See Federal Reserve
Bulletin, August, 1969, pp. 642-46.

Market Growth Reflected in “Borrowing from Others”

on Wednesdays from 1953 until 1966 ranged from 50 to 100
percent of the total borrowed from sources other than the Federal
Reserve.1 The identity of Funds purchases and borrowings from
others was consistently reasonably close in all Federal Reserve
districts except New York and Chicago, and transactions were largely
interbank. The substantial differences between Funds purchases and
Borrowings from Others,” reported with frequency by the New
York City banks and in more limited amounts on occasion by banks
m some other districts, reflect borrowings from corporations and
other nonbank sources.2 This borrowing generally took the form of a
repurchase agreement with a maturity of more than one day and was
accomplished in Funds.3
After 1965, amounts reported under this caption, while
reflecting substantial increases in interbank Funds transactions,
comprised an increased variety of other types of borrowings from
banks and nonbanks, the proceeds of which were available in Funds.
The transactions were also more widely distributed among Federal
Reserve districts and are another reflection of the growing accep
tance of liability management. These borrowings included securities
and loans sold under repurchase agreement, Euro-dollars borrowed,
directly or through brokers, from banks abroad, and liabilities to
banks’ own branches in U.S. territories and possessions. Increased use
Was also made of the traditional correspondent bank loan. Estimates
place the amount of the transactions close to $6 billion on many
days during 1969. Interbank Funds transactions accounted for the
balance of about $9 billion.
Since 1955, Funds purchases derived from the caption have
represented an increasing proportion of the total amount of all
member bank borrowing in all Federal Reserve districts. Between

A comparison of loans to commercial banks plus loans to brokers and dealers on U.S.
Government securities with Funds sales by the weekly reporting banks shows similar results for
years for which comparable data are available within this period.
2

Computed from Funds reports and weekly reporting member bank statements.

^These transactions were not reported in the regular Funds reports except on the first
day. In the revised weekly reporting series, continuing contracts are reported on each reporting
date.

The Federal Funds Market
1953 and 1958, the amount borrowed in the form of Funds1 on
Wednesday dates doubled, almost tripled from 1963 to 1968,
doubling again by mid-1969. The rise may be overstated because
prior to the Comptroller’s ruling in 1956, which classified Funds
purchases as borrowings, many banks classified as investments those
Funds transactions accomplished with underlying collateral.

CHART

TREASURY

BILL

HOLDINGS
WEEKLY

Monthly

AND

REP0RTIN6

Averogai

Partly estimated for some of the years shown.

VII

BORROWING

MEMBER

BANKS

Wednesday

Dotas

1953-1969

Factors Influencing Volume of Funds Trading
Also, double counting may be a factor. Meanwhile, although
borrowing from the Reserve banks rose in response to credit restraint
during the cyclical upturns, it did not reach levels attained in the first
half of 1953 until 1969. This development underscores greater
continuing reliance by an increasing number of member banks on
Funds transactions in preference to borrowing at the Reserve banks,
and/or reliance on various other forms of borrowings, particularly
during periods of credit restraint. It also shows the marked decline in
relative importance of the use of Treasury bills after 1965 in
adjusting reserve positions.
FACTORS INFLUENCING VOLUME OF FUNDS TRADING

The chief factor influencing the postwar growth of the Funds
market has been the alteration of the institutional framework of the
money market and the related changes in institutional practice
generally described earlier.
In addition, certain technical modifications affecting bank
operating practice, like those relating to the computation of required
reserves and the net reductions in the level of required reserves,
should be cited. These actions have made possible a larger volume of
Funds transactions by the banking system as a whole without
resorting to a larger volume of borrowing at the Reserve banks than
occurred during the immediate postwar period.
Other technical factors affecting the market include the excess
profits tax, arbitrage, and changes in check collection schedules. The
two latter factors have been responsible for fluctuations in the
volume of trading at various times.

A number of general factors have also been important in the
market’s growth. These include Federal Reserve policy, trends and
fluctuations in interest rates, interbank competition, Treasury
operations, variations in the level of float, and improvement in the
System’s and the commercial banks’ wire transfer facilities. It is not
possible, however, to assess the relative importance of either
technical or general factors in furthering growth or development of
breadth in the market.
65

The Federal Funds Market
Computation of Reserves

Beginning in March, 1942, banks located in central Reserve or
Reserve cities were allowed to average reserves for weekly periods
rather than semiweekly, a regulation in effect since the end of 1927.
In July, 1942, the Board amended Regulation D, relating to
member banks’ reserves, under the authority of an Act of Congress
which became effective July 7.1 The Federal Reserve Act (see
Appendix A) permitted reserves of member banks to be checked
against and withdrawn to meet existing liabilities. Observers believed
that this provision was nullified to some extent by a proviso in
Paragraph 9 of Section 19, which prohibited making new loans or
paying dividends while reserves were deficient. A number of banks
were hesitant about utilizing any portion of their required reserves
even for a day unless they refrained from making new loans. This
policy arose from bank directors’ fear of personal liability for
possible loss on loans. Many banks, because of the wide daily
fluctuations in reserves, followed a practice of maintaining at all
times a large volume of excess reserves. The amended law by
eliminating the proviso permitted banks more flexibility in managing
their reserves and loans and investments.

In October, 1949, all Reserve System member banks were
permitted to offset a deficiency in one reserve computation period
with excess in the next reserve period, provided that the deficiency
carry-over did not exceed 2 percent of the required reserves of the
first period. The provision for a longer period for averaging reserves
and the privilege of carrying deficiencies from one period to the next
facilitate the management of the reserve balances of member banks
and the fuller use of the banks’ available funds.
While these technical changes affecting reserve use or reserve
computation made it easier for banks to make their own adjustments
without borrowing in the Funds market or at the discount window,
they also provided — along with other methods of adjusting bank
reserves — a broader base for accomplishing Funds transactions, or
using Funds during periods of continuing credit demands. To this
extent these changes have been a factor in providing favorable

1 Public Law 656 (Section 3) 77th Cong., 2d Sess., Chapter 488.

Reductions in Levels of Reserves
conditions for greater breadth of the Funds market in the 1950’s.
The change to a biweekly instead of a semimonthly reserve
computation period for country banks in 1959, which led to a
“double settlement” every other Wednesday, had little measurable
effect on total activity.
Reductions in Levels of Required Reserves

Since the Accord, net reductions in reserves required against
demand and time deposits and the inclusion of vault cash in the
computation of reserves allowed since 1960 have jointly released a
substantial volume of reserves for investment. The reductions in
required reserves, usually complementing open market operations,
have been made to initiate or develop more fully a policy of ease,
provide for growth needs, diminish inequities in position of city and
country banks, and, on occasion, to meet seasonal needs. The results
in both level and structure of reserve requirements have provided a
more flexible framework for credit expansion, in contrast to those of
the historically high levels of the 1930’s and early postwar periods,
which had been designed to absorb the excess reserves associated
with the Depression and World War II.

Against the basically strong aggregate demand for bank credit,
which has generally been characteristic of the period following the
reduction in reserves, the actions have had more than a transitory
effect upon the volumes of Funds activity. They have contributed to
increasing the dimensions of the Funds market.

The immediate result of a reduction in required reserves is to
increase the effective supply of Funds available for trading. Given a
continued broad demand for bank credit, the money market banks
rapidly use the reserves released to repay Reserve bank borrowings
and to consolidate and expand their operating positions. The less
aggressive banks, on the other hand, retain their excess reserves for a
somewhat longer period and expand their loans and investments only
gradually. While money market banks soon become net buyers of
Funds once more, the smaller banks are in a better position to meet
these demands. As a result, Funds trading increases.
In recent years, one reflection of this enlarged activity is that
Funds have become a significant feature of the secondary reserves of

The Federal Funds Market
many banks. The growth in sales has been greater than the decline in
excess reserves. The decline in excess reserves since 1951, as outlined
in Chart VIII, has paralleled the expansion and changing structure of
the Funds market.

The movement toward lower levels of excess reserves has been
generally steady.1 Although other factors have also influenced the
administration of excess reserves, the Funds market has enabled the
banks to make more rapid adjustments in their money positions.
With the access that the market provides for the disposal and use of
discretionary reserves, banks have become more confident in holding
smaller amounts. The tendency to utilize reserves more fully in each

CHART VIII
EXCESS RESERVES AS A PERCENT OF REQUIRED RESERVES
(Averages of Daily Figures)

SOURCE:

Federal Reserve Bulletin

1 The ratio of demand balances due from banks to total deposits also declined, suggesting
that the decline in excess reserves is real and not simply a transfer of funds from one nonearning
asset to another. The decline in the correspondent balances, however, is not as large as the
volume of Funds sold.

Profits in Kate Differentials

succeeding cycle has contributed to increasing supplies of Funds even
during periods of restraint. In part, this is a reflection of the increase
in the average size of member banks and of the increasing
participation in straight Funds transactions or repurchases with
dealers by smaller country banks which have characteristically held
most of the excess reserves.

Participation now includes significant percentages of banks with
deposits between $10 and $50 million. In some districts, a high
percentage of banks with less than $10 million in deposits currently
trade Funds. The typical movement of Funds runs from the smaller
country banks and smaller city banks to the large banks in the
Nation’s financial centers. Some of these smaller banks, however,
have now become more fully invested, expecting to support their
positions by securing Funds from accommodating banks. In 1951,
average deposit size of member banks had increased more than
fivefold, reaching $58 million, and 454 banks held deposits of $100
million or more. As size increases, management of money position
tends to become sharper. Banks in this size group account for close
to 90 percent of the volume of both gross and net Funds purchases.
Profits in Rate Differentials

As the market developed in the postwar period, it has at times
offered short-term profit opportunities to participants, stimulating
Funds transactions as some banks take long or short positions in
contemplation of rate movements. When there is considerable daily
fluctuation in rate patterns, some of the larger Reserve city banks
and country banks conduct transactions to capture rate profits.
Funds are purchased when the rate softens in anticipation of selling
them in the next day or two at firmer rates. Alternatively, banks
have permitted limited cumulative deficits to develop, covering the
deficit when the rate softens. In some cases, cheaply acquired Funds
are resold in the form of repurchase agreements with Government
security dealers to maximize rate profits.

According to some market participants, a part of the expansion
of the Funds market (particularly during the years from the close of
69

The Federal Funds Market
the war to the Treasury-Federal Reserve Accord) was brought about
by using Funds to play the pattern of rates established when the
Government securities market was pegged. Some banks in recent
periods have conducted similar operations when they anticipated a
policy shift by the Reserve System or when new cash offerings of
securities or market conditions provided appropriate opportunities,
such as the “split discount rates’’ of 1955, 1956, and 1957.

Reserve settlement dates have also provided profit opportunities
for aggressive country banks. Until 1959, country banks had
midmonth and month end reserve settlement dates and the city
banks settled each Wednesday. Only seldom did a midmonth or
month end settlement date coincide with a Wednesday settlement
date. Thus, opportunities were afforded country banks to acquire
Funds at favorable rates when rate softening accompanied Reserve
city settlements. Cheaply acquired Funds could be used to maintain
an invested position, to cover a reserve deficit, or accumulate a
surplus when country banks expected the Funds rate to firm during
the ensuing reserve period for city banks.
From late 1959 to September 12, 1968, country banks settled
on two-week periods which coincided every other Wednesday with
the Reserve city banks, and rate softness appeared on the all-bank, or
double settlement, Wednesdays. Opportunities to capture rate profits
were thus diminished.
The steadier and firmer market on many single settlement
Wednesdays for Reserve city banks during this period resulted in
large part from country banks buying Funds on these days. Similarly,
actions of the country banks contributed to rate softness that
appeared on double settlement dates, and at times, Funds were
without a bid.

The Lag Accounting Reserve Plan

After considerable discussion, the so-called lagged method for
computing required reserves was introduced with the statement week
beginning September 12, 1968. Since that date, computation of

The Lag Accounting Reserve Plan
reserve requirements has been based on:

1. Establishment of coincident one-week reserve computation
periods for Reserve city banks and so-called “country banks”;

2. Calculation of weekly average required reserves based upon
average deposits two weeks earlier;
3. Calculation of weekly average reserves based upon average
vault cash held two weeks earlier, along with the current
week’s balance at the Reserve banks; and
4. Provision for carrying forward to the next reserve week of
either excesses or deficiencies averaging up to 2 percent of
required reserves.
It was expected that these changes would reduce uncertainties, both
for member banks and the Federal Reserve, about the amount of
reserves required during the course of any reserve period. The
automatic 2 percent carry-forward was expected to moderate
pressures for reserve adjustments that developed, on occasion, near
the close of a reserve period, causing sharp fluctuations in availability
of day-to-day Funds and the Funds rate. Defensive open market
operations would also be reduced.

Although the plan has helped reduce average excess reserves and
has moderated the biweekly swings in reserves at country banks, the
hopes have not been fully realized and some new problems have
arisen. This was partly the result of caution on the part of many
banks and partly because of unexpected money market develop
ments as credit tightened in 1968 and 1969. Given the privilege of
carrying over excesses as well as deficiencies, Reserve city banks with
some frequency now operate with alternate deficit and surplus
positions. In addition, these banks have tended to accumulate large
amounts of excess reserves early in the statement week, thus
tightening the Funds market. The market eases at the end of the
same week as unutilized excess reserves are released. Such practices
cause a rise of the Funds rate as the statement week opens and a fall
near the end.(See Chart V.) When a number of the larger banks act
together, these swings are exaggerated. Lagging required reserves two

The Federal Funds Market

weeks behind deposits has also affected the course of intramonth
deposit flows. This pattern usually ranges from a high at the
beginning of the month to a low in the middle and rises again at
month’s end. Pressure on reserves is thus intensified at midmonth,
and excessive ease arises at the close of the month unless offset by
System operations. The lag plan to date has consequently placed
greater demands on the Funds market as well as tending to increase
the need for defensive open market operations within most state
ment weeks and at other times during a month.
It is quite possible that in the future each week’s unutilized
deficit and surplus carryovers may tend to become more equal,
reducing the amplitude in the excess reserve swings and, conse
quently, reducing fluctuations in the Funds rate.1

Related to change in reserve computation are the recom
mendations of the lengthy and exhaustive study by the Committee
for the Reappraisal of the Discount Mechanism, some of which
liberalized the use of the discount window. An appreciably larger
volume of Federal Reserve credit supplied through discounting may
reduce the demand for Funds except in periods of restraint. During
periods of neutrality and ease the Funds rate may fall below the
discount rate with the same frequency as it did prior to 1964. More
banks may make their reserve adjustments at the Federal Reserve
bank than in the Funds market.
Final conclusions about the implications for changes in the
Funds market resulting from new procedures in calculating reserves
must await more experience. Similarly, conclusions about the market
implications of possible changes in the discount mechanism including
rate policy must await final decisions as well as experience.
Trends and Fluctuations in Interest Rates

Since the close of World War II, interest rates have fluctuated
over a wide range, and the absolute levels have moved higher. The

1Some observers, however, believe that the adoption of coincident one-week reserve
periods for all banks may simply make more frequent the exaggerated swings in the Funds
market that in the past have been common on the old double settlement dates. See “The New
Settlement Arrangements for Member Banks,” The Morgan Guaranty Survey, May, 1968, pp.
3-5.

Trends and Fluctuations in Interest Rates
increases have been reflected in yields of all classes of money market
instruments. In the late 1960’s, rates either reached peaks which had
not been achieved since 1921 or set new record highs. The bulk of
the movement occurred in the last half of the 1960’s.

TABLE IV

YIELDS ON SHORT-TERM MONEY MARKET INVESTMENTS

Type of Investment

(3-Month Maturities except Federal Funds)

Yields Percent Averages of
Daily Offering Rates

1961

1969

Treasury Bills

2.36

6.64

Commercial Paper

2.97

7.83

Finance Paper

.2.68

7.16

Bankers' Acceptances

2.81

7.61

Deposit* (Secondary Market)

3.07

8.05

Federal Funds (Effective Rate)

1.96

8.22

Certificates of

*C.D. yields are for April-December, 1962, when the series was initiated, and 1969 data
are averages of representative weekly offering rates based on the Salomon Brothers’ &
Hutzler series. All other data: Federal Reserve Bulletin.

To the extent that they have been influenced by changes in
interest rates, Funds transactions have been affected more by the
erratic behavior of the Treasury bill rates (arising in some years
partly because of significant increases in nonbank demand) than by
changes in their levels. Thus, more country banks have shifted to the
Funds market from Treasury bills to avoid the cost of selling and
subsequently repurchasing, the risk of exposure to market loss, and

The Federal Funds Market
the inconvenience when adjusting reserve positions within the
settlement period (two weeks until September 12, 1968). Re
purchase agreements with nonbank dealers have also been used to an
increasing extent by many banks outside New York. Rates on these
transactions are usually more profitable for the seller than straight
Funds sales. Changes in levels of rates, however, seem to be of some
importance in inducing smaller banks to enter or withdraw from the
Funds market. On the other hand, the spread between Treasury bill
yields and the Funds rate is frequently a significant factor in
attracting investment to one or the other instrument. In part, the
demand for Funds by many banks had arisen from the pressure on
their deposits as corporation treasurers and local government units
drew down their balances and invested them in Treasury bills or
arranged repurchases with dealers or even sold their balances “as
Funds” as interest rates rose. There has been a growing diversity in
both the number and the type of investor participating in the money
market.
CHART IX
SELECTED SHORT TERM MONEY MARKET RATES

Excess Profits Tax, 1951 — 1953
Investment in open market commercial paper and acceptances
by the banks as alternatives has been relatively less popular (despite
the recent increases in outstandings and market activity) because of
the changed character of those markets compared with previous
periods, as noted earlier. These developments also underscore the
shifting toward Funds as an investment medium in preference to
Treasury bills or other money market instruments when surplus
funds become available.

Excess Profits Tax, 1951-1953

In 1951, the Bureau of Internal Revenue ruled that Funds
purchases, like other forms of borrowing, could be included by the
buying banks in their “capital base” when calculating their excess
profits tax liabilities. There is no concrete evidence that banks
increased their volume of Funds transactions relative to other forms
of borrowing, or entered the market for the first time for the express
purpose of reducing their tax liability or avoiding payment of the
tax. Trading in Funds, however, provided an easy method and, at
times, was used in conjunction with other steps as a profitable
method of avoiding the tax. Perhaps a few large banks bid
aggressively for Funds during this period and supplemented their
borrowing at the Reserve banks to establish a larger “capital base.”
However, the inclusion of Funds purchases in the “capital base” was
largely a collateral benefit, and the basic forces stimulating expansion
of the market lie elsewhere.

Inasmuch as the amount of excess reserves is relatively small,
the purchase and sale of Funds do not relieve the banking system,
however much they may relieve the individual bank, of borrowing
from Reserve banks, particularly during periods of credit restraint.
One reflection of System policy, which was in a restrictive phase
during much of the excess profits tax period, was an increased
amount of borrowing from the Reserve banks. This was also a period
of bank and business expansion. Available data do not indicate that
Funds purchases grew more rapidly in volume than borrowing from
the Reserve banks or correspondents during the excess profits tax
period.

The Federal Funds Market
Interbank Competition

Strong competition among the money banks to improve their
relative position or to maintain their size and prestige in the postwar
period has furthered the expansion of the Funds market. Also, this
competition has contributed to the change in the structure of the
market. An increasing number of these banks have developed
outright a limited trading position in Funds to enable them to
provide services (including supplying or buying Funds) to their
correspondent banks or business customers. More recently, some of
these banks have aggressively sold their Funds service, viewing it as a
“new business service” and, in some cases, a feature of operations
where volume alone is a matter of pride. Mergers and consolidations
among some of the money market banks have sharpened the
competition by aiding the development of larger Funds positions.

Gross purchases by the accommodating banks as a group during
the last two years averaged between $5 and $8 billion daily in many
statement weeks, an amount which substantially exceeds the activity
of this group in the early 1950’s. As the banking system of the early
postwar period changed from investor to lender, the need for
liquidity increased. More banks came to rely on the Funds market to
supply this need. These banks, along with others, use part of the
resources of other banks (in the form of Funds) in servicing certain
customers to a greater or lesser degree at various times. Disparities in
the relative size of individual banks were greater in the 195O’s than
during the 1920’s and became even more pronounced in the early
1960’s. The shifting temporary strains which develop under such
conditions and which tend to be offset by Funds transactions are a
natural consequence of unit banking.
Debt Management and Treasury Operations

The observation is frequently made that the U.S. Treasury is the
largest and most active single borrower in financial markets. As such,
debt management decisions, no matter how carefully made and how
well executed, cannot avoid creation of market uncertainty and some
“churning” during the adjustment and absorption period of Treasury
operations at particular times. Treasury bill rates tend to be quite
sensitive to the reflex effect.
76

System Operating Policy
At various times throughout the postwar years, the bill rate has
behaved with some degree of arbitrariness, reflecting the varying
strength of nonbank demand, the reinvestment demand for bills at
times of large refundings and the substantial variation in supplies of
bills — more recently the use of strip bills — and the introduction of
new bill cycles. Since its introduction in 1961, the negotiable
certificate of deposit, along with the increased variety of shorter
term Federal agency paper, has been added to the group of money
market instruments which compete with Treasury bills for cash
balances of nonbank and other investors and has resulted in some
variable upward pressure on short-term rates. In contrast, the rate on
Funds during these periods has exhibited greater stability and has
frequently been relatively more attractive, encouraging the use of
Funds as an outlet. The expanded volume of debt operations, as well
as a larger volume of trading, has increased the demand for Funds.
Part of the growth in total Funds activity stems from these
influences.

Improved administration of Treasury balances at commercial
banks and Reserve banks has generally provided a better distribution
of balances in depositaries and has relieved the intensity of pressures
which formerly was concentrated in a relatively small group of
banks. The introduction of the “C” depositories in 1955 made a
marked improvement. Increased flows of Government funds over the
last ten years, arising from debt operations and from regular
disbursements and receipts, however, have subjected a fairly broad
group of banks to moderate pressures or provided them with excess
reserves. Thus, Treasury operations may be considered another factor
which contributed to participation in the Funds market. During
certain years, the frequency and amplitude of the swings in Treasury
deposits have been a special factor in increasing the volume of Funds
traded.
System Operating Policy

Another factor that has had some influence on the development
ami growth of the Funds market has resulted from the centralization
of open market operations of the System Account in New York,
along with the growing use and volume of open market operations in
Government securities as the dominant policy instrument. Centraliza
tion of open market operations in New York has been in process
77

The Federal Funds Market

since 1922, when the Federal Open Market Committee emerged as an
informal arrangement. The Banking Act of 1935 merely gave final
legal status to its development. This, along with the gravitational
pull of the financial and business center, which had been developing
in New York since the mid-1800’s, gave further impetus to the
location and expansion of Government securities and acceptance
dealers in New York. Thus, all facilities existing outside New York
for trading Governments have come to be based on the New York
market in respect both to quotations and breadth. Except for the
relatively small amount of orders that is matched off by bank and
investment firms in local or regional markets, trading is done
ultimately with or through offices or branches of Government
securities dealers and dealer banks in New York City, Chicago, and
one in Los Angeles.

As a reSult, a wider group of investors has been encouraged to
use Funds for settlement of transactions. These Funds have, in many
instances, come from an interdistrict source. The unwillingness or the
inability of the New York banks to meet all of the dealers’ financing
needs forced them to develop a network of Funds supplies outside
New York City.
Reduction in Federal Reserve Deferred Availability Schedule

The Federal Reserve check collection time schedule was
reduced from a maximum of up to eight days to a maximum of three
days in 1939, and to two days in 1951. These reductions have been
an important factor in the rise of the average level of float from one
of $500 to $600 million in 1950, to one of $2 to $2.5 billion in the
last five years. The amplitude of the swings in float has also
increased, and monthly averages in recent years have moved between
lows of $1.3 billion and highs of $3.4 billion. These short-run
fluctuations have considerable impact at times on member bank
reserves. Frequently float is unevenly distributed, so that there is
little relationship between the float change at a particular bank and
the national pattern. Thus, no bank can regularly expect with any
certainty any sharing in total float swings. Even those who attempt
to estimate the change may experience unexpected reserves or a need
for reserves and must resort to the Funds market and other
adjustment methods to balance out positions. The general impor
tance of Funds in this connection is substantiated by patterns of
78

Improvement of Wire Transfer Facilities

Funds traded, which tend to show with some frequency a marked
intramonthly rise and fall in positive association with float peaks and
troughs. Thus, from one point of view, Funds transactions can be
considered a refinement of the clearing process.
In periods of the year when the average monthly float shows
wide changes that result in a general surplus or shortage of reserves
among the smaller banks, they have historically used surplus funds to
retire borrowings at the Reserve banks or to increase correspondent
balances in money centers. During the last several years, however, a
number of these banks have sharpened their practices and have
utilized Funds sales to dispose of excess reserves. Thus, the flow of
banking balances, which moved to New York in some volume at
midmonth during certain periods of the year, has shown a tendency
to diminish. Much less frequently these banks will borrow Funds in
relatively small amounts, usually preferring to use the discount
window to cover deficits.
Regularly recurring fluctuations in float seem to be well
integrated in money market operations, and the impact of such
fluctuations is cushioned by transactions in the Funds market.
Federal Reserve offsets are made when feasible. Serious distortions
can and do occur, however, from unexpected fluctuations in float.
Through the nature of the float process, most of the unanticipated
fluctuations produce larger magnitudes than expected. This is usually
caused by weather variations and delivery delays resulting from
strikes or other causes. More frequently than not, an unexpectedly
large increase will be followed by an unusually large decrease. The
sale of Funds or the purchase of Treasury bills, if the surplus of
reserves persists, accounts for some of the sharp drops in rates and
the appearance of market ease that occurs at times. As float
disappears, a sharp tightening of the market occurs, resulting in an
atmosphere of greater firmness than had originally prevailed as banks
readjust their positions.

Improvement of Wire Transfer Facilities

Since the close of the war, the Federal Reserve’s wire transfer
facilities have been steadily improved. The transmission time over the
wire was reduced and the volume of messages which could be
handled were increased. A high speed data transmission system
79

The Federal Funds Market

utilizing a computer switch began operation September I, 1970. This
system, currently several times Faster than the old wire system, has
virtually unlimited potentials For volume and speed.
The inauguration oF the “bank wire” in 1950 by commercial
banks has substantially improved communication between banks.
The wire now links more than 250 banks in 69 principal cities. These
developments have Facilitated and encouraged the use oF the Funds
market, making possible rapid transfers to pomts of use and enlarging
the Framework of the money market.
Federal Reserve Policy

The 1950’s and 1960’s were periods of substantial year-to-year
growth in the volume and scope of transactions in the Funds market.
This growth, the attendant spread of knowledge about the market,
the attractiveness of long periods of rising interest rates, and a large
number of new entrants have tended to blur the cyclical pattern.
With the unpegging of the Government securities market in March,
1951, System credit policy became more Flexible and since that date
has shilled between restraint and ease in response to developments in
business.

Shifts in System credit policy influence the volume of Funds
traded in the market. At the same time, these shifts influence other
methods of reserve adjustment, and banks switch activities from one
market to another in response to the interaction of changing rate
relationships and the availability of reserves in terms of loan demand
or investment opportunities. Available data fail to suggest that mere
shifts from restraint to case or the reverse have encouraged the use of
Funds as an alternative to other methods of adjustment over the
period as a whole. Aside from the years 1965, 1966, and 1969,
Funds activity has been highest when the market is in a neutral
position, neither very tight nor very easy. This reflects chiefly rate
relationships which suggest no material profit advantage in alterna
tive outlets.
The data showing the volume of transactions accomplished
through the brokers ('Fable III), as well as data for a number of
individual banks, indicate that the years of most rapid growth in the
Funds market as its national emphasis developed were 1950 (80

Federal lieserve Policy
percent higher than the previous year), 1951 (36 percent higher), and
1954 (18 percent higher). These were years when System policy lor
the most part re fleeted some phase of ease.
The year-to-year changes in the volume of Funds traded during
periods of restrictive policy also show growth, but at a much
diminished rate (except 1966 and 1969) compared with periods of
ease. During 1952-1953, the volume of Funds traded through Garvin
Bantel increased only 3 percent from one year to the next and in the
substantially broader market of 1955-1957 about 10 percent.
Activity decreased during the early phase of restraint in 1955 but
remained substantially above the level of 1952-1953. Data available
for a number of individual banks in New York City and Chicago, as
well as for banks outside those areas, show the same general patterns.

'Transactions data available since 1957 for a comprehensive
sample of banks indicate that trading volume has increased about
tenfold, and that the periods of case — 1958, 1960-1965, and 1967
— produced record levels of Funds activity. The period of restraint in
1959 brought about a drop in the average level of trading compared
with case in 1958, but the level, like that in 1955, remained
substantially above that in any preceding period.
The severely restrictive credit policy in 1966 and 1969 are
exceptions and produced new record levels of transactions, large
additions to the numbers of banks using the market, and steady
premium bids for Funds. 'The brokers’ data also follow this pattern,
but the increases arc larger, reflecting in part more double counting
— a characteristic of both bank and broker figures as two-way trading
expanded in recent years.
For several reasons, it is difficult to see a direct functional
relationship between Funds trading and credit policy in both the
1950’s and the 1960’s. Although there have been periods of case
since the Accord about which generalizations can be made, it is not
possible to distinguish accurately the increase that came about
primarily because of a growing awareness of the Funds market on the
part of country banks from the increase due to expanded trading in
Funds by all banks.

Also, the influence of the widened demand for Funds by
nonbanks and corporate participants cannot be isolated satisfacto81

The Federal Funds Market

rily. In other words, the structure of the market changed somewhat
from one period to another (including both ease and restraint) as did
the practices and policies of institutions participating in the market.
Considering these qualifications, however, the impression remains
and data suggest that Funds trading developed at a faster rate during
the periods of ease than it did during periods of restraint. Both the
trough and peak of the cycles which may be accompanied by
extremely easy or quite tight markets, respectively, are excepted.
This behavior of the market can most readily be explained in a
review of the principal supply and demand factors and the structural
changes which characterized the market during these periods.

a. MONETARY RESTRICTION: 1952-1953, 1955-1957,
and 1958-1960.1 Money market reaction to restrictive credit policies
was generally the same in each of these periods. Open market
operations, as is customary, were used to work down the supply of
excess reserves, and reserves to meet the increased demand for loans
and investments became less readily available and more costly.
Reserves continued to be available at a price as restrictive policy in
the postwar period has generally been designed to limit credit
growth, not to bring about a net reduction.
Greater use was made of borrowings at the Reserve banks, and
borrowing tended to involve a large but shifting number of banks.
Borrowings outstanding, on the average, ranged from moderate to
substantial amounts, and there was frequently no rate advantage in
using Funds in preference to the discount window.
Banks tended to conserve their reserves and employed them
more continuously to serve their lending areas. They tended to be
reluctant Funds sellers, afraid that they could not buy Funds if
needed. The banks also operated within their rules and dealt only
with those with whom they had established lines. However, some
increase in the supply occurred as more banks used the market as an
outlet for excess reserves.

March, 1952 —June, 1953;January, 1955— November, 1957;August, 1958—January,
1960. See Annual Report of Board of Governors of the Federal Reserve System for each of
these years for a description of these periods.

Federal Reserve Policy
In contrast to periods of case, the demand for Funds tended to
intensify, while the supply became smaller and less fluid. An increase
in the volume of Funds traded occurred, but at a slower rate, since
expansion in the volume of Funds traded during these periods was
dependent indirectly upon borrowings at the Reserve banks and since
for considerable periods Funds were no cheaper than borrowings at
the discount window.

During restrictive periods, the demand for Funds has resulted
from a substantial increase in the demand for loans and investments
by a greater variety of users and from some need by aggressive banks
to operate on a borrowed reserve base to sustain expansion or to
hold their competitive positions. Seasonal pressures in a period of
rising business activity also place added strain on the adjustment of
bank reserves at particular times.

As credit policy becomes more restrictive, alternative money
market outlets may become more attractive than Funds. Toward the
close of restrictive periods until those in 1966 and 1969, rates of
other money market instruments frequently exceeded the Funds rate
and absorbed some reserves that otherwise would have been sold in
the market.
b. MONETARY RESTRICTION:
1965-1966 and
1968-1969.1 These restraint periods are distinguished from their
predecessors in several respects, all of which influence activity in the
market. First, credit policy was pursued with more severity for a
longer period than previously. This is particularly true of the latter
period. Second, the discount rate was used sparingly and was below
other market rates most of the time. Third, Regulation Q was used in
addition to other policy instruments to prevent acquisition or force

December, 1965 — November, 1966; January, 1968 — December, 1969. See Annual
Report of the Board of Governors of the Federal Reserve System for these years for a
description of these periods.
In late June, 1968, the Federal Open Market Committee directed that open market
operations be conducted with a view to accommodating tendencies for short-term interest
rates to decline and for somewhat less firm money market conditions to develop in connection
with enactment of fiscal restraint legislation and to facilitate adjustment to reduction of
Federal Reserve bank discount rates (in mid-August) with provision for modification
depending on the course of bank credit developments. From then until mid-December, the
account supported prevailing money market conditions.

The Federal Funds Market

runoffs in CD’s. Fourth, the banks were more innovative in devising
methods of cushioning the impact of policy. Federal Funds
transactions, Euro-dollar borrowing, commercial paper sales, and
loan repurchase agreements experienced major growth in the banks’
search for reserves. Finally, since fiscal policy in 1966 continued to
be stimulative on balance and was at best neutral in 1969, a greater
burden was placed on monetary policy in restraining economic
activity.
Trading, contrary to patterns during restraint in the past,
accelerated, and the volume of Funds transactions reached new high
levels in each period. There was aggressive bidding for Funds at
progressively higher rates. The intense pressure for credit and the
changing relationship among short-run investment or borrowing
alternatives forced a further rapid, although evolutionary, expansion
of the market.

Exceptionally heavy corporate and state and local borrowing in
capital markets and a particularly sharp increase in business loans at
commercial banks characterized both periods. Associated with the
demand for credit, short- and long-term rates rose sharply and almost
continuously. The advance in rates was more rapid as monetary
restraint intensified and reinforced the upward pressures arising from
heavy credit demands. Curbing inflationary expectations was a
problem in both periods, but their perseverance in 1969 was
unusually stubborn.
To slow bank credit expansion, open market operations were
used to contract bank reserves. Regulation Q ceilings which were
below market rates on competitive instruments at the beginning of
1969 were not changed. Pressure on CD runoffs increased as market
rates rose with the intensification of the restrictive policy. In (his
instance, the Regulation was used directly to restrain credit
expansion in contrast to 1966 when it was used as a supplement to
other policy instruments. Market rates then did not pierce the
ceilings until near the end of the period. Prior to 1966 Regulation Q
rates were generally accommodated to market rates.
The System also used selective measures. In July and Septem
ber, 1966, it increased reserves on time deposits in excess of $5
million. Strong moral suasion was reflected in a letter dated

Federal Reserve Policy

September 1, 1966, in which the System requested member banks to
reduce business loan expansion instead of cutting further into
holdings of securities. At the same time, it was noted that discount
accommodation was available to support deposit shrinkage and
prevent severe market stringency. Few banks took advantage of the
offer. Most banks continued to show a strong preference for making
adjustments with Federal Funds. In 1969, the System imposed
reserves on Euro-dollars, narrowed bank use of repurchase agree
ments with nonbanks, announced proposals to make bank related
commercial paper sales subject to Regulations D and Q, and
narrowed the scope of Funds transactions.
Many interest rates, both short- and long-term, rose to the
highest levels in this century. Sensitive rates, such as three-month
Treasury bills, peaked at 8.12 percent, commercial paper at 9.25
percent, and bankers’ acceptances at 9.00 percent in December,
1969. The effective rate on Funds was 9 to 9 '/a percent on many
days during the last half of the year, and 3 to 3 Vi percentage points
above the effective rate in 1966. At the bank counter, the rate on
prime loans in June stood at 8 '/a percent, 2 percentage points above
April, 1968. In the capital market, new long-term corporate Aaa
bond yields reached 8.85 percent, and state and local bonds, 6.90
percent toward the end of the year. At the same time, outstanding
3-, 5-, and 10-year U.S. Treasury coupon securities sold to yield 8.51
percent, 8.33 percent, and 7.77 percent, respectively—the highest
rates since the Civil War for these issues.
In this atmosphere the demand for Funds intensified, and the
consistently high rate levels and yield advantage over Treasury bills
induced many banks to sell larger amounts and encouraged addi
tional banks to enter the market for the first time. There was also a
significant increase in the number and variety of nonbanks in the
market. Competition became very aggressive among city correspon
dents in developing Funds trading arrangements for their smaller
correspondents. These arrangements increased the accessibility of the
market to more banks, while higher rates and rising costs forced
development of more efficient management of reserves, thus stimu
lating activity in the Funds market. The volume of interbank Funds
transactions amounted to about $5 billion a day with some
frequency in 1966 and probably $10 billion-on many days in 1969.
An increasing number of banks became net purchasers, especially in
85

The Federal Funds Market

1969. As noted earlier, Euro-dollar purchases and sales of bank
related commercial paper to nonbanks reduced required reserves and
increased velocity of deposits, thus helping support a larger volume
of Funds trading.

The opportunity cost to the bank of meeting reserve needs—
essentially the Funds rate and the amount of administrative pres
sure at the discount window—was higher in 1969 than in any
other postwar year. The level of net borrowed reserves may be used
as a rough index of these costs. In this measure the level of member
bank borrowing from the Reserve banks generally reflects the degree
of administrative pressure at the discount window. Net borrowed
reserves stood at J872 million on a daily average basis. Daily
borrowing from the Federal Reserve averaged $1,101 million, and
excess reserves only $229 million. The average annual rate on Funds
was 8.22 percent.

Prior to 1965, the Funds market operated largely as an
alternative to Federal Reserve credit for borrowers and as an
alternative to holding excess reserves or Treasury bills for lenders.
During recent years, it has been used intensively for reserve
adjustments to cover deficits in cash flows or to replenish excess
reserves. In response to high and rising interest rates, more and more
member and nonmember banks came to use the market as a
secondary' reserve investment, even substituting them not only for
excess reserves but for short-term investment securities or in some
cases lower levels of loans.

Rapid growth of the Funds market, which began after 1965,
probably began to approach culmination in 1969. The high rates
attracted more participants as sellers, thus increasing the depend
ability of the market as a source of borrowed money in a period of
restraint. Flows through the market are now at record high levels; at
least half of the member banks are participants along with the larger
nonmembers. There remain many small banks which lack under
standing of the market. As familiarity with the market develops, they
may become participants. Funds volume, however, cannot be
expected to grow as it has in recent years.
86

Federal Reserve Policy

c. MONETARY EASE: 1953-1954 and 1957-1958.1 During
these periods of monetary ease, substantial amounts of reserves were
made available to the banking system through open market opera
tions and through reductions in required reserves. Borrowing at the
Reserve banks was intermittent and limited to individual bank
situations, with only a small amount outstanding on an average basis.
In addition to the increase in volume, the supply of excess reserves
was also more fluid. Some of the most sensitive interest rates —
Funds and Treasury bills — were continuously below the discount
rate.
Unlike earlier periods, in which recession policies of ease had
merely diminished the disposition of banks to curtail credit, the
banks in these periods were so liquid that they aggressively sought
opportunities to employ idle balances at the Reserve banks. Under
these conditions, many banks regularly offering Funds in the market
relaxed their rules and dealt with banks with which they had no
established lines, allowing the broker to arrange transactions on a
“submit” or “show me” basis. In addition, throughout much of 1954
and in 1958, the Funds rate remained above the rate on three-month
Treasury bills (as it frequently had during restrictive policy phases)
and thus provided a further incentive on the supply side for trading
in Funds. During periods of case, a smooth How of Funds at “good”
rates — rates above minimum rates necessary to recover costs — tends
to stimulate trading. Selling banks are willing to accommodate
buyers because Funds are more readily available. Should the Funds
be sold and subsequently be needed by the selling bank, they can
usually be bought at the same or possibly a lower rate.

Sustained demands for Funds during the periods of ease Have
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 ih
securities when rates are falling than when rising. The larger
borrowing by dealers in 1954, for example, supported a part of the
demands for Funds by those banks particularly active in financing
them. Nonbank dealer borrowings in 1954 and 1958 rarely fell below

June, 1958 —January, 1955; November, 1957 —July, 1958. See Annual Report of the
Board of Governors of Federal Reserve System for each of these years for a description of these
periods.

1'he Federal Funds Market

$600 million and reached over $1.2 billion — two of the highest
points up to that time in the postwar period. A large proportion of
the borrowings was in Funds resulting from overnight or short-term
“buy backs,” arranged with banks outside New York. New York
banks took substantial amounts of Funds into their operating
positions, and this, to some extent, influenced their willingness to
lend to dealers.
In addition, those banks that found themselves with temporary
reserve deficiencies tended to turn to the Funds market rather than
to the discount window because of the rate differential which existed
during these periods of ease.

d. MONETARY EASE: 1960-1965.1 In earlier periods of
case, credit policy was designed to a large extent with domestic
considerations in mind. More recent periods, however, have required
protection of the international position of the dollar in addition to
encouragement of domestic recovery and expansion of economic
activity. In previous recovery and expansionary periods, the System
began to reduce monetary case within four months of the business
trough, but in the upturn — February, 1961, through November,
1965 — it was carried through 58 months of economic expansion.
Although modified slightly in December, 1962, and to a greater
degree in July, 1963, and November, 1964, when discount rates were
raised and reserve availability lessened, monetary policy continued to
be basically easy.
Monetary ease previously had been accompanied by low levels
of the sensitive interest rates — Funds, Treasury bills, dealer loans,
acceptances, commercial paper, and CD’s. During most of the period,
however, policy actions were designed to avoid downward pressures
on the key short-term rates, which otherwise might have been forced
to levels that would encourage short-term capital flows to foreign
money centers, intensifying the balance of payments problem. After
1961, bill rates were pushed upward, on occasion, to diminish
^The shift toward monetary ease began in late February, 1960. Monetary ease was
established by midsummer 1960. Ease was modified moderately in June, 1962, December,
1962, July, 1963, and November, 1964. See Annual Report of the Board of Governors of the
Federal Reserve System for each of these years for a description of these periods.

Federal Reserve Policy
spreads between rates in U.S. and foreign money centers, and
fluctuations from week to week narrowed substantially. Open
market operations in February, 1961, were broadened to include
transactions in U.S. Government securities in the maturity range
beyond one year. Reserve requirements were reduced at appropriate
times to meet longer run growth needs and, at other times, to meet
seasonal needs for reserves. Although long-term rates fluctuated in a
narrow range, they declined moderately, on balance, from
1960 to 1964, despite the expansion of business. Downward pressure
on these rates was influenced by the heavy flow of savings. Inflows
of savings were encouraged by the increase in maximum rates
permitted by Regulation Q on time and savings deposits and CD’s.
Both short- and long-term rates remained consistently above levels
characteristic of previous periods of ease.

Money and financial flows have set new records since 1960. The
relationship which developed between market rates and deposit
interest rates from 1960 to 1965 influenced consumers to take a
substantial share of increased holdings of financial assets in the form
of time and savings deposits or share accounts. In earlier periods of
expansion, increases in holdings of financial assets by individuals
took the form of direct acquisitions of securities. In response to
these developments, the composition of commercial bank assets
changed rapidly, resulting in increased holdings of higher yield assets,
such as mortgages and state and local government securities.
Loan-deposit ratios moved higher, and banks on the whole developed
more fully invested positions. Liquid asset ratios as conventionally
defined fell. The increased individual bank need for liquidity under
these conditions was met increasingly through the Funds market.
The volume of Funds activity rose sharply and reached new
high levels of trading as the money market eased during the first half
of 1960. As in earlier periods, the greater availability of reserves
enabled the banks to purchase Funds to retire borrowings at the
Reserve banks, and the demand for Funds for this and other
purposes kept the rate at the ceiling for several months after yields
on short-term Treasury bills had fallen somewhat below the discount
rate. Trading tapered off moderately after mid-1960 but continued
active, exhibiting larger short-run swings. Trading volume resumed its
increase toward the close of 1961. Over the whole period 1960-1965,
the volume of transactions tripled and all regions shared in the
89

The Federal Funds Market

growth. The spread between the Funds rate and Treasury bill rate
was generally favorable to Funds, and at the same time, the Funds
rate frequently exhibited more stability than the bill rate, even
though bill rate fluctuation narrowed substantially. The banks’ need
for liquidity was affected by new patterns of time and savings
deposit liabilities and by growth in demand deposits.

Another factor which influenced the volume of trading in
Funds was the policy adopted by some New York City banks in
making substantial proportions of nonbank dealer loans available in
the form of Funds. This policy was introduced about March, 1961,
and became more liberal in 1962 as the banks became confident that
an atmosphere of ease would continue. In 1965, all of the proceeds
were generally made available in Funds. The change in policy was
designed, in part, to expand dealer Ioan volume, which was more
profitable under conditions of monetary ease, and also to meet
increasing competition from lenders outside New York. Dealer
positions were also heavier, and total borrowing needs expanded,
reaching peaks of borrowing from New York City banks of over $1.5
billion on several dates. Dealer borrowings from corporations under
repurchase agreements were also increased, and expansion in dealer
transactions added further to the demand. New York City banks,
under these conditions, were continuous demanders of Funds. Rates
on Funds more clearly tended to move directly with the volume of
net purchases by New York City banks — a factor holding the Funds
rate above levels of earlier periods of ease.

Demand for Funds intensified in 1964 and 1965 in response to
continued expansion in bank credit and other financial flows. In the
fall of 1964, several aggressive banks willingly bid more than the
discount rate on a number of occasions, establishing the premium bid
as a feature of the market. Perhaps these banks preferred to make
their adjustments in the Funds market rather than the discount
window because they felt the Funds market afforded more privacy
or because they had a shortage of convenient collateral. After March,
1965, it became increasingly common for banks to bid a premium
for Funds. This and other sensitive short-term rates reached new high
levels. The Funds rate almost continuously exceeded the Treasury
bill rate by a significant margin, as it had (except in 1964) since the
first half of 1962. The spread induced more banks to become sellers
90

Federal Reserve Policy

and increased trading. New entrants and a greater number of
accommodators also stimulated large flows of Funds.

e. MONETARY EASE: 1966-1967.1 An expansive policy
was initiated again in late 1966 and was carried into the fourth
quarter of 1967. Strong demand for bank loans resumed in the first
quarter and remained relatively steady.
Throughout the period, banks rebuilt liquidity which they had
drawn down sharply in 1966. Capital market calendars remained very
heavy, and corporations also turned to the commercial paper market
for larger amounts of Funds than previously. Athough both
short-term and long-term rates receded from their peaks reached in
the previous fall, long-term rates remained relatively high. Long-term
rates resumed their rise in late winter, and during the spring they led
short-term rates — for the first time in 20 years — back toward levels
reached the previous year. The rise was spectacular. System policy
depressed short-term rates for only a few months but failed to
depress a continuous rise in long-term rates.

As credit ease was established, the Funds rate and the
three-month Treasury bill rate dropped sharply and continued to
decline until midyear 1967. Although the spread tended to narrow,
the Funds rate remained above the Treasury bill rate. This reflected
not only the demand to replenish liquidity positions but also the
sizable contraction of market supplies of Treasury bills as taxes were
paid and as the System Account bought securities in the open market
to supply reserves. At midyear, the Funds rate leveled off at about
3.75 percent and Treasury bills at 3.50 percent.
During the second half of the year, the spread was reversed, and
the bill rate exceeded the Funds rate. Reflecting Treasury needs, bill
supplies were increased substantially while monetary policy remained
easy. Banks used Funds to arbitrage Treasury bills, taking advantage
of the large spread. Banks also continued to prefer to make their
adjustments in the Funds market and at times paid a premium above
the discount rate, although borrowing from the Reserve banks was
generally cheaper.
'the shift toward case began in November, 1966, and continued to early December,
1967. See the Annual Report of the Board of Governors of the Federal Reserve System, 1966
and 1967, for a description of this period.

The Federal Funds Market
As has been noted, the Funds rate remained continuously above
the discount rate until April, 1967, and over the balance of the year,
it exceeded the discount rate on a number of occasions. The
stimulative policy was continued despite the high and rising levels of
economic activity. As a carry-over from late fall 1966, the expansive
policy in the first quarter was based on fear of a recession and was
later justified as an aid to housing markets as well as an attempt to
avoid intensifying problems in the British pound sterling.

High rate levels persisting throughout the year and ample credit
availability, together with strong demands, provided an impetus to
Funds transactions.
SUMMARY AND COMPARISONS OF FUNDS WITH MONEY
MARKETS ABROAD

The Funds market has become a major part of the short-term
money market in the United States. The origin was spontaneous, and
development occurred in response to competitive forces in the
private sector. Its organizational structure merely reflects the
characteristics of this Nation’s institutional environment. Thus, the
market is a function of the unit banking system and a federation of
the units by the Federal Reserve.

The Funds market satisfies the criteria of a money market.
Supplies of temporarily idle cash that member banks seek to invest in
earning assets are matched with the demand for such balances by
banks and other financial insitutions who wish to adjust their
liquidity position. The supply of Funds revolves, enabling the
participants to rely on outside sources with confidence when
adjusting positions and to avoid maintaining higher cash ratios than
needed. Profit and price are the main considerations that direct flows
through the market.
The Funds market contributes significantly to the integration of
the unit banking system. It supplements reserve averaging, refines the
clearing process, and makes the unit system more flexible and
responsive to the broad range of domestic and foreign economic
needs. Stated another way, the market gives the unit structure some
of the advantages of branch banking. At the same time, it contributes
to sharpening competition among the units.

Summary and Comparisons of Funds with Money Markets Abroad

Access to the Funds market makes banks more willing lenders
in situations involving new investment. The unified nature of the
market and its links with other divisions of the money market make
possible more rapid transmission — to all parts of the financial
community — of the interest rate responses and the changes in the
availability of credit that flow from Federal Reserve policy actions.
The Funds market may also be said to support more predictable
behavior by the banks since use of the market tends to fall into
patterns.
Short-term money markets abroad perform the same purposes
as the Funds market but reflect different institutional structures. In
the London market — the oldest — the clearing banks, which provide
nearly all the bank credit, do not borrow from each other but
compensate for fluctuations in their cash ratios by lending more or
less to the discount houses. These, in turn, have access to the Bank of
England. The cash reserves of the clearing banks are maintained at a
customary 8 percent. About half of these reserves is “till money”
and the other half is “bankers’ deposits” — credits at the central
bank. There is no margin of excess reserves in the system. Surpluses
are absorbed by the Bank of England, and if additional funds are
needed, it adds to its assets.

Professor Sayers, in commenting upon the London market,1 has
stated that if dealing in balances at the Bank of England were
permissible, “and this is what the Federal Funds market comes to,”
the discount houses could be viewed as unnecessary. In further
comment, Professor Sayers questions, “If a market of the Federal
Funds type can take care of any redistribution of cash reserves
required by the commercial banks, what is there left for a money
market of the old type — a bill market — to do?” He states that a
London dealer would point to two other functions now performed
by him and his counterparts elsewhere. Sayers adds that the answer is
also relevant to New York dealers, with proper qualification. The
dealer would continue his earlier function in connection with
acceptances but with reduced volume. With more accepting under
taken by the banks, his work is less significant. On the other hand,

'see R. S. Sayers Central Banking after Bagehot, Chapter 10, “The New York Money
Market Through London Eyes,” Oxford, 1957.

The Federal Funds Market
the function of making a market in “short-term government paper,”
which has grown during the last thirty years, is of much increased
importance; and the dealers are valuable primarily because “they are
buffers in the market for government paper.” Their functions as
intermediaries “dealing in bank cash is less vital though it does,
incidentally, strengthen the markets for securities.”

The Euro-dollar market, the newest short-term money market,
provides the facilities for matching the demand for and the supply of
dollar deposits in Europe. It is somewhat similar in concept to the
Funds market and came into being without official initiative. The
market is large — multibillion in size — and active. Several hundred
banks — 50 percent of which are in Western Europe, Canada, and
Japan — account for the bulk of the business. London is the focal
point for transactions and the most prominent market center. In a
sense, the market’s growth is the result of controls imposed on
currencies or credit systems by one or another government.
Euro-dollars are deposits of U.S. dollars in banks outside the
United States, including overseas branches of American banks.
Euro-dollars come into existence when an American or foreign owner
of a deposit with a bank in the United States transfers funds to a
foreign bank or a foreign branch of an American bank. The
transaction transfers ownership of the deposit in the United States to
a bank abroad and is offset by the institution’s assumption of a
liability payable in United States dollars. Total bank deposits in the
United States remain unchanged, but an additional dollar deposit has
been created abroad.

Additional Euro-dollars may be created if the foreign banking
institution deposits the funds with another foreign bank — the
original dollar deposit in the United States changing hands in the
process. After making allowances for double counting, the Bank for
International Settlements estimated a total of about $37.5 billion of
such deposits denominated in dollars at year end 1969.
Normally, funds are placed in the Euro-dollar market because
higher rates of interest can be earned there than on domestic time
deposits or through other short-term investment outlets. Fully
integrated and active foreign exchange markets permit banks to take
in deposits denominated in foreign currencies, swap them into

Summary and Comparisons of Funds with Money Markets Abroad
dollars, and then use the dollars in the Euro-dollar market. These
transactions are hedged against adverse exchange fluctuations. This
market, like the Funds market domestically, is of course only a part
of the international market for short-term funds.1
During the last several years the market has increasingly been
used as a source of borrowing short-term funds by large American
banks to help meet domestic credit demands. Euro-dollars have also
been used to adjust reserve positions as an alternative to purchasing
Federal Funds particularly over weekends.
About 20 percent of Euro-dollar deposits in foreign branches of
U.S. banks are currently overnight or call maturity. This percentage
varies with the policy of individual banks and the availability of
Euro-dollars. The percentage has been higher at times. The average
maturity of such deposits is about two months. Borrowers anticipate
the use of overnight or call money so that the proceeds are available
in Funds on the day that they are needed.2

Even when Euro-dollars have been the highest-marginal-cost
source of funds as they were consistently in 1969, many banks
willingly paid the differential to help insure maintenance of their
competitive position. Resources obtained in this market have helped
cushion reserve pressures during restrictive periods of credit policy.

Until late 1964 liabilities to their overseas branches never
exceeded $1 billion and until 1966 were held well below $2 billion.
With the “credit crunch” in 1966 borrowings rose sharply to about
1See: J. G. Kvasnicka, “Eurodollars—An Important Source of Funds for American
Banks,’’ Business Conditions, Federal Reserve Bank of Chicago, June, 1969; Fred R.
Klopstock, “Euro-dollars in the Liquidity and Reserve Management of U.S. Banks,” Monthly
Review, Federal Reserve Bank of New York, July, 1968; The Financing of Business with
Euro-Dollars, Morgan Guaranty Trust Company, International Banking Division, September,
1967; Norris Johnson, Euro-dollars in the New International Money Market, First National
City Bank, July, 1964;andRoy L. Reierson, The Euro-Dollar Market, Bankers Trust Co., July,
1964.
2

International payments currently accomplished by cable transfer, as well as the dollar
side of foreign exchange transactions, are now settled in clearing house funds. Proposals
have been made to change the practice to settlement in Federal Funds. This change would
make a substantial increase in the demand for Funds.

The Federal Funds Market
CHART X
FEDERAL FUNDS AND CALL EURO-DOLLAR
DEPOSIT RATES 1965-1969

^r^M^IWM
1 1 1 1 1 1 1 1 1 1 1

1965

SOURCE:

EURO-DOL LAR OVER FEDER AL FUNDS

1 1 1 1 1 1 1 1 1 1 1 111 11 111 1111 I 1 1 1 1 1 1 1 1 1 1 1

1966

1967

1968

_LJ 1 1 1 I 1 1 1 1 1

1969

Board of Governors of the Federal Reserve System.

$4.3 billion. Accompanying the increasing credit demands and
intensification of monetary restraint in late 1968, the level fluctu
ated around $15 billion throughout the fall of 1969, despite the
imposition of reserve requirements against these liabilities in July and
96

Summary and Comparisons of Funds with Money Markets Abroad
October.1 A number of banks without branches borrowed directly
from overseas correspondents or through several of the U.S. security
dealers who acted as brokers.
The Federal Reserve’s easier monetary policy which had pre
vailed since early 1970 brought about a substantially lower level of
money market rates. Since early summer, commercial banks had
been able to issue a substantial volume of negotiable CD’s and at the
same time repay Euro-dollar borrowings. By mid-October some
banks had reduced their reserve-free base, reflecting increasing confi
dence in the availability of money elsewhere at more favorable rates.
Repayment of Euro-dollars resulted in excess holdings by foreign
banks and accumulation of these dollars at foreign Central Banks.

In late November the System announced steps2 to temper the
repayment of Euro-dollars while avoiding penalty to banks that oper
ate so as to retain their bases. The action was designed to restrict the
size of the balance of payments deficit on official settlements basis.

Effective July 31 member banks were required to count outstanding drafts or checks
arising out of Euro-dollar transactions as demand deposits subject to reserve requirements.
Euro-dollars were made more expensive when a 10 percent reserve requirement was imposed
October 16 on any increase in liabilities to foreign branches over the daily average
outstanding amounts in the four weeks ending May 28, 1969 (reserve-free base). The techni
cal distinction between “deposits” and “due to branch” transformed Euro-dollar borrowing
from a deposit liability subject to reserves into a reserve free liability until the imposition of
reserves. Reserves were also imposed upon member bank borrowings from foreign corre
spondents. See Regulation D. For the banking system as a whole required reserves were
reduced, excess reserves increased, and total reserves remained the same, although they
supported a larger volume of earning assets.
2The Board raised from 10 to 20 percent the reserves required from member banks

against Euro-dollar borrowings that exceed amounts that the banks are allowed as a reservefree base. The higher requirement becomes effective in the four-week reserve computation
period ending December 23.
To assure that banks that currently have Euro-dollar liabilities above their reserve-free
bases are not penalized, the Board made the marginal reserve requirement applicable to
borrowings above either (1) the minimum base equal to a percentage of deposits, or (2) the
average level in the reserve computation period ended November 25, whichever is higher.
The Board also discouraged repayment of Euro-dollar liabilities by those banks that
operate under a minimum base equal to 3 percent of their overall deposits subject to reserve
requirements. The amendment will apply the automatic downward adjustment to reservefree bases of the latter kind as well as of the former. This amendment becomes effective
with the reserve computation period ending J anuary 20, 1971.
The Board stated that this action was “deliberately made of modest scale.” At the
same time it was announced that other measures were being reviewed that might moderate
repayment of Euro-dollars and avoid penalty to banks that retain their reserve-free bases.

The Federal Funds Market
As it has developed, the Euro-dollar market has contributed to
fuller integration of money markets throughout Europe, as well as in
Japan and the United States. It has also provided financing for
expansion of world trade and investment. On the other hand, like
other money markets but perhaps to a greater degree, the succession
of short-term claims imposes risks. The liquidity of each participant
is dependent to some extent upon the ability of ultimate borrowers
to meet their obligations.
In contrast to these short-term money markets, which have
evolved without official assistance, are those in Canada, Australia,
South Africa, and India, which are developing with differing degrees
of official encouragement and support.1 They are designed to meet
the needs of the particular institutional framework. But the purpose
is the same — to achieve a more fully integrated financial system.

See J. S. G. Wilson, “The New Money Markets,” Lloyds Bank Review, No. 64, April,
1962.

Appendix A

Official Rulings Affecting the Funds Market

RULINGS OF THE BOARD OF GOVERNORS

Section 19 of the Federal Reserve Act makes possible bor
rowing and lending of excess member bank reserve balances or the
purchases and sales of Funds. It 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 Board of Governors of the
Federal Reserve System, be checked against and withdrawn by such
member banks for the purpose of meeting existing liabilities.. .”(12
U.S.C. 464.)

The market in Funds which grew out of this provision of the
Act has been subject to several rulings-by the Board. Two of these
arose over the uncertainty and lack of uniformity in reporting Funds
purchases and sales. The third involved sales of Funds between bank
subsidiaries of a holding company. The fourth concerns a procedure
for accomplishing sales of Funds by a member bank for a
correspondent at its request through a transfer on the member bank’s
books from the deposit account of the correspondent to a bills
payable or similar account. The transaction is carried out at the
current rate for Funds. A fifth ruling concerned the scope of Funds
trading by foreign banking corporations operating under the provi
sions of Regulation K, and the sixth restricted the use of repurchase
agreements by banks with nonbanks.
Early in 1970, the Board issued amendments to its regulations
which narrowed the category of Funds transactions which member
banks may conduct and which may be classified as nondeposit
borrowings rather than as deposits and consequently not subject to
Regulations D and Q. It also harmonized regulations and interpreta
tions concerning methods of effecting trades.

I. THE BOARD RULING OF SEPTEMBER, 1928. This ruling
established that when a bank purchasing Funds gave its cashier’s

The Federal Funds Market
check or authorized the selling bank to clear a ticket through the
clearing house settlement on the day agreed upon, the liability
created should be carried on the books of the bank buying Funds as
“money borrowed.” The amounts involved were to be reported
under the account caption “Bills Payable and Rediscounts,” rather
than as a “Deposit Liability.” The effect of this ruling was to exempt
banks from including official checks used to return Funds in gross
demand deposits in computing required reserves. These checks are
commonly known as “bills payable checks.” (1928 Bulletin, 656.)
This ruling was withdrawn April, 1970 (See page 104.)

2. THE BOARD RULING OF JANUARY, 1930. When the
practice of using book entries and wire transfers in settling
transactions became widespread toward the end of the 1920’s, the
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 using the Board’s Form 105 for
report of condition, the purchasing member bank should show the
liability incurred in any such transaction under “Bills Payable and
Rediscounts,” and the selling bank should enter the amounts under
“Loans and Discounts.” (1930 Bulletin, 81.)

By directing the banks to treat Funds sales as loans, the ruling
limited the amount of Funds that national or state member banks
could sell to individual borrowers, since Federal and most state
statutes limit loans to a percentage of unimpaired capital and surplus.
The provision that aggregate borrowing cannot exceed unimpaired
capital and 50 percent of surplus imposed on national banks and
similar requirements for many state banks were also limiting factors
for purchases.
3. THE BOARD RULING OF JANUARY, 1959. As Funds
trading became more widespread and holding company systems grew,
the question arose whether “sales” of Funds at current rates of
interest, “between bank subsidiaries of a holding company would
constitute extensions of credit to a bank holding company of which
100

Appendix A
it is a subsidiary or to any other subsidiary of such bank holding
company.”
In reply, the Board stated that in accordance with its earlier
ruling in 1930 and that of other supervisory authorities, such a
“sale” would constitute a prohibited loan or extension of credit. It
was also the Board’s view that “sales” of Funds are not exempted
from the prohibitions of Section 6(a) of the Bank Holding Company
Act by the following provision of the last paragraph of that
subsection: “Non-interest bearing deposits to the credit of a bank
shall not be deemed to be a loan or advance to the bank of
deposit... .’’The 1930 ruling had clearly indicated that funds
transferred through the Funds market are not deposits in the
“purchasing” bank. (12 CFR 222.110; 1959 Bulletin, 7.)

This 1959 ruling, however, was withdrawn by the Board upon
the repeal by Congress, on July 1, 1966, of Section 6 of the Bank
Holding Company Act. The change in the law, in effect, permitted
the subsidiary banks of a bank holding company to deal with each
other at arm’s length. They are currently as free to trade Funds as are
any other banks, within the limits and collateral requirements of
Section 23A of the Federal Reserve Act.
4. THE BOARD RULING OF JULY, 1964. On July 27, 1964,
the Board replied to an inquiry from a member bank regarding the
procedure whereby a bank requests its correspondent to “invest for a
certain period of time” — overnight or for a few days or weeks — a
specified portion of the bank’s deposit balance with the correspon
dent, and the correspondent itself agrees to “borrow these funds.. .at
the Federal Funds rate.” The Board stated that the specified amount
could be transferred on the books of the correspondent from the
deposit account to “Bills Payable” and interest paid at the rate
currently paid for Federal Funds. (12 CFR 217.137; 1964 Bulletin,
1000; Published Interpretations, Paragraph 3261.)
It was pointed out that the right of a member bank to
“purchase” (borrow) Federal Funds from other banks has never been
questioned, and the seller of such Funds may be either a member or
nonmember that is in a position to arrange for Funds to be
transferred to the “purchaser” from a member bank’s Federal
Reserve deposit account.
101

The Federal Funds Market

The Board stated that it was unable to find any basis on which
to distinguish similar transactions when the Funds to be borrowed
are on deposit in the “purchasing” bank. If such a distinction were
drawn, the “selling” bank could readily have the Funds transferrred
to its account in a third bank and then have the same amount
transferred back to the borrowing bank by entries on the books of
the Federal Reserve bank.
It was further stated that the prohibitions of Section 19 of the
Federal Reserve Act and those of Regulation Q relate only to the
payment of interest on demand deposits. It does not prohibit the
payment of interest on “borrowed money” by member banks in
circumstances as outlined in the ruling.

A ruling effective February 12, 1970, amended this interpreta
tion so that nonbank intrabank transfers from deposit account to
borrowed money account and payment of interest thereon were
prohibited. (19 7 0 Bulletin, 3 8-39; and also see p.103, Board Ruling
No. 7.) Such transactions for the banks’ corporate customers had
increased significantly after the 1964 ruling and were not considered
good banking practice.
5. THE BOARD RULING OF NOVEMBER, 1964. This ruling
permitted foreign banking corporations operating under the provi
sions of Regulation K to purchase or sell Funds to adjust their
reserve balances at Federal Reserve banks. Transactions for regular
investment were not allowed. Funds sold by the corporation must be
included in loans subject to the limitations and restrictions in section
211.9(b) of Regulation K. Funds bought must be treated as liabilities
for borrowed money. (12 CFR 211.101; 1964 Bulletin, 1414;
Published Interpretations, Paragraph 5700.)

The revision of Regulation K in 1957 was followed by a
renewed interest in foreign banking corporations, and as internation
al trade expanded, a number of these corporations have been
chartered.

6. THE BOARD RULING OF JULY, 1969. For some time,
market observers had felt that repurchase agreements offered
member banks a major loophole for evading regulations concerning
deposits and, in particular, payment of interest on demand deposits.
102

Appendix A

A number of banks were using such instruments with U.S. securities,
Ioans, municipal securities, and CD’s as collateral in connection with
funds transactions with nonbanks and also to procure funds for
longer periods. Consequently, the Board decided to restrain their use.

Beginning August 28, 1969, every bank liability on a repurchase
agreement entered into on or after July 25, 1969, with a person
other than a bank and involving assets other than direct obligations
of the United States or its agencies (and obligations guaranteed by
them) was ruled to be a deposit. Repurchase agreements collateraled
with U.S. securities and agencies made by banks with nonbanks were
excepted from classification as deposits largely to permit dealer
banks to help finance inventories of U.S. securities.
A repurchase agreement with a person other than a bank with
respect to a part interest in any obligation or obligations, including
U.S. Government securities, was also prohibited. An amendment
effective August 15, 1969, however, continued to permit transac
tions involving a part interest in an obligation eligible for Federal
Reserve purchase and to classify the liability thereon as a nondeposit
borrowing. (12 CFR 204.1(f); 1969 Bulletin, 655, 736.)
7. THE BOARD RULING OF FEBRUARY, 1970. This ruling
effective February 12, 1970, narrowed the category of Funds
transactions permitted member banks. Its chief objective was to
prohibit transactions by member banks with certain nonbanks. The
term bank is defined in this ruling to include a member bank, a
nonmember commercial bank, a savings bank, a building or savings
and loan association, a cooperative bank, the Export-Import Bank of
the United States, or a foreign bank. It also included bank
subsidiaries that engage in business in which the parents are
authorized to engage and subsidiaries the stock of which is by statute
explicitly eligible for purchases by national banks. Foreign banking
corporations operating under the provisions of Regulation K are such
a class of corporation.

Currently four classes of Funds purchases and other short-term
borrowings by member banks are considered nondeposit funds and
arc excluded from the provisions of Regulations D and Q.

103

The Federal Funds Market

1. Borrowings from other banks. These transactions are consid
ered necessary for the efficient functioning of the Funds
market, which is believed to be useful in effecting monetary
policy.
2. Repurchase transactions in U.S. securities and Federal agency
securities eligible for Federal Reserve purchase.
3. Funds borrowings from security dealers arising from the clear
ance of securities. This type of transaction, in conjunction
with No. 2, aids the effective function of U.S. financial
markets.

4. Borrowings by member banks from various governmental
institutions.
In order to assure that the exemption for liabilities to banks is
not used as a means by which nonbanks may arrange to sell Funds to
a member bank, obligations within the exception must be issued to
another bank for its own account. Consequently, banks should take
action necessary to ascertain the character of the seller in order to
justify the classification of its liability for the transaction as Funds
purchased rather than as a deposit. (12 CFR 204.1(f); 1970 Bulletin,
37-38.)

On July 1, 1970, the Board denied a request from a trust
company engaged solely in trust business to modify Regulations D
and Q so that it would be permitted to sell Funds to a member bank.
The Board stated that expansion of the interbank liability to permit
a member bank to purchase Funds from a trust company would be
inconsistent with the policy on access to the market. It was argued
that even if a trust company were considered a “bank,” sales of
Funds by it are not for its own account but rather for the account of
beneficiaries of the trusts, a category that includes invididuals and
corporations.

8. THE BOARD RULING OF APRIL, 1970. The 1928 ruling
in effect exempted a bank from the requirement that all officers’
checks issued by a member bank be included in its gross demand
deposits for reserve purposes. The receiving bank could, of course,
deduct all cash items in the process of collection from its gross
104

Appendix A
demand deposits in establishing its reserve requirements. Permitting
both the issuing and receiving banks an exclusion from their
respective deposit liabilities was considered to be inconsistent with
the basis of the provision for cash-item deductions, which was
instituted to avoid situations in which two member banks maintain
reserves against the same funds. Instead, such a deduction would
result in neither bank maintaining reserves against such funds. It is
understood that it was never general practice for banks engaging in
Federal Funds transactions to deduct checks received in payment
from their deposits in reserve computation, despite the consistency
of such a deduction with the language of the regulation.

A survey by the Reserve System in early 1970 found that
almost all Funds transactions are currently handled through entries
on the books of the Reserve banks. Accordingly, the 1928 ruling was
withdrawn on April 2, 1970. Henceforth, Funds transactions
between banks will be settled by book entry at the Federal Reserve
banks in lieu of officers’ checks. (1970 Bulletin, 280.)
RULINGS OF THE COMPTROLLER OF THE CURRENCY

Until September, 1956, “repurchase agreements” were viewed
as not being subject to the legal loan or borrowing limits of national
or state member banks. In general, they were treated as investments.
The securities involved in the transactions included U.S. Government
securities, certain agency issues, such as public housing authority
bonds, and at times, municipal bonds. Most frequently, the U.S.
Government securities underlying the transactions were short-term,
but on occasion, intermediate and longer term issues were involved.
In recent years, however, the Comptroller of the Currency has issued
rulings which required these transactions to be regarded as loans or
borrowings, set certain limits on the amounts of individual transac
tions, and which specified the underlying securities.

1. THE COMPTROLLER’S RULINGS, 1956 and 1957. On
September 14, 1956, the Comptroller issued a ruling that had a
limiting effect on sales or purchases of Funds when accomplished
through repurchase agreements. These transactions, defined as Ioans
or borrowings, were brought within the scope of Sections 5200 and
5202, U.S.R.S. Sales of Funds in this form were limited to 25
105

The Federal Funds Market

percent of capital and surplus of a member bank. After some
discussion and consideration of the nature and purpose of these
transactions, the Comptroller held the limitation was inapplicable if
the transactions occurred between a member bank and a Government
securities dealer or broker. This ruling was issued on January 28,
1957. One of the effects of this ruling was to place nonbank
Government securities dealers in a preferred position in accomplish
ing repurchase agreements or buy backs, compared with transactions
between national or state member banks.
After further consideration of the use of repurchase agreements
and related types of transactions in financing Government securities
dealers or in exchanging Funds, the Comptroller ruled that effective
August 16, 1957, the obligations of any member bank in the form
notes of any person, co-partnership, association, or corporation,
secured by not less than a like amount of direct obligations of the
United States, which will mature in a period not exceeding 18
months from the date of such obligations to such member bank, shall
be limited to the amount of capital and surplus of the member bank.
This ruling eliminated the use of longer term U.S. Government
securities and agency issues in transactions involving the maximum
limit for such types of Funds transactions.
U.S. Government securities maturing in over 18 months and
agency obligations involved in an individual transaction were subject
to the limit of 25 percent of a member bank’s capital and surplus.
Repurchase agreements involving municipal securities were subject to
the 10 percent limit on individual loans.
After the effective date of the regulations, member banks in
reporting repurchase transactions on the Call Reports showed them
as loans for the purpose of purchasing or carrying securities, rather
than being included with securities owned. The selling (borrowing)
bank continued to report such transactions as borrowings and
continued to report the securities as owned. Borrowing limits were
not changed by these rulings.

Subsequently, as the market became aware of the rulings, a
number of protests were made by both nonbank Government
security dealers and banking institutions. In summary, they con
tended that the rulings made it more costly and difficult for

106

Appendix A
Government security dealers to finance portfolios, hindering the
dealers in attempting to make the broadest markets; banks outside
New York City found it more difficult to invest temporary funds
readily and efficiently. The banks also complained about the
necessity for entering into arrangements with several borrowers or
buyers instead of one because of the added accounting detail and
increase in overhead costs. The effects were reported to be felt more
keenly in periods of tight money. Others pointed out that repurchase
agreements involved less risk to the purchaser than did outright
acquisitions, and, thus, there was no reason to limit them in amount
beyond the requirements of Section 5136 of the Revised Statutes. It
was further argued that repurchase agreements also made it possible
for short-term investors to acquire desired maturities not otherwise
available in the market.

From the point of view of the Federal Reserve, repurchases
were an important money market instrument for effecting policy.
They helped to facilitate the mobilization and distribution of
available reserves through the Government securities market.

The Comptroller was unwilling to recognize the argument for
treating repurchases as investment securities transactions under
Section 5136 of the Revised Statutes. He also dismissed the
suggestion of some market participants that repurchases involving
securities not exceeding 18 months in maturity be exempted from
the loan category and that, as a matter of supervisory jurisdiction,
such transactions be reported separately under such definition as the
Comptroller, by regulation, may describe.

2. THE COMPTROLLER’S RULING, 1958. A new regula
tion, effective April 18, 1958, reflected a compromise. It exempted
from the limitations based upon capital and surplus of national
banking associations, obligations to any such associations secured by
not less than a like amount of “direct obligations of the United
States which will mature in not exceeding 18 months from the date
of entering such obligations to such national banking associations.”
The exception provided by this ruling dispelled the confusion
existing in the market, and the volume of activity expanded further.
3. THE COMPTROLLER’S RULING, 1963. On June 1, 1963,
a new Manual for National Banks containing a series of rulings

107

The Federal Funds Market
concerning bank practice was published by the Comptroller. Among
the interpretations dealing with obligations subject to lending limits
was Paragraph 1130 of the rulings concerning Federal Funds:

“When a bank purchases federal reserve Funds from another
bank, the transaction ordinarily takes the form of a transfer from a
seller’s account in a Federal Reserve Bank to the buyer’s account
therein, payment to be made by the purchaser, usually with a
specified fee. The transaction does not create on the part of the
buyer an obligation subject to 12 U.S.C. 84 or a borrowing subject to
12 U.S.C. 82, but is to be considered a purchase and sale of such
funds.”
The ruling reversed the previous position of the Comptroller’s
office and held that such transactions by national banks do not
constitute loans within the limitations of Section 5200 or borrowings
within the limitations of Section 5202 of the Revised Statutes. No
reasons have been given for the ruling. Several state banking officials
were reported as stating that the ruling is another effort by the
Comptroller to give national banks an advantage over state banks.
Other observers criticized the ruling as a lowering of the “reasonable
ness and good sense of bank supervision.”
On September 9, 1963, the Board of Governors stated that it
continued to be its position that, for purposes of provisions of law
administered by the Board, a transaction in Federal Funds involves a
loan on the part of the selling bank and a borrowing on the part of
the purchasing bank.
The Board reaffirmed its earlier position that for the purposes
of Section 23A of the Federal Reserve Act, which had been added by
the Banking Act of 1933, a sale of Federal Funds by a member bank,
whether state or national, to an affiliate of the member bank, is
subject to the limitations prescribed in that section. Similarly, the
Board reaffirmed a January, 1959, ruling that a sale of Federal Funds
by a banking subsidiary or bank in the same holding company system
would result in a criminal violation of the provisions of Section 6 of
the Bank Holding Company Act of 1956 (repealed, June, 1966; see
page 101.)

4. THE COMPTROLLER’S RULING, 1964. On March 31,
1964, the Comptroller in effect rescinded his earlier ruling on
108

Appendix A
repurchase agreements. Paragraph 1131 was added to the list of
interpretations in the Manual for National Banks as follows:

“The purchase or sale of securities by a bank, under an
agreement to resell or repurchase at the end of a stated period, is not
a borrowing subject to 12 U.S.C. 82 nor an obligation subject to the
lending limit of 12 U.S.C. 84.”

This ruling places repurchase agreements on the same basis as
direct Funds transactions. Since the Comptroller’s rulings, some
national banks have been reported as more willing to enter into
transactions of a modestly larger size, particularly on the selling side.
However, observers state that there has been little overall change in
total Funds activity that can be attributed to the ruling. The major
change reported is a reduction in the use of securities to collateralize
Funds purchased from banks with relatively small lending limits.
Perhaps more than half of the transactions that were previously
required to be secured have been freed or the amount of collateral
reduced. Accommodating banks, in dealing with correspondents,
have generally continued to trade within previously agreed lines, and,
in those instances where limits are increased, they have taken a closer
look at the credit standing of the correspondent. Departure from the
old limits, when it occurs, is generally on the sales side. A number of
smaller banks, however, have been encouraged to enter the market.
Borrowing proportions continue generally as before, with an occa
sional report of a bank attempting to exploit several lenders.
These rulings have probably resulted in encouraging a modest
increase in total Funds activity and helped to further concentration
in trading activity in the large banks on the demand side. Most banks
have generally observed or remained close to conventional limits.

In compliance with these rulings, national banks will report
Funds purchases and sales under a caption so designated on the Call
Report.
Some state supervisors have given informal approval to state
banks, when permissible under prevailing statutes, to trade on the
same basis as national banks. In those states where the law was more
restrictive and needed amendment, the state banks may have been
placed in an unfair competitive position.

109

The Federal Funds Market

Appendix B

Some Definitions and the Mechanics of Transactions
in Federal Funds

FEDERAL FUNDS

This term is shorthand for “immediately available Federal
Reserve Funds” and means, essentially, title to reserve balances (of
member banks) at Federal Reserve banks. In earlier periods of the
market, the principal means of transferring titles to reserve balances
was checks. The selling bank issued a check drawn on the Federal
Reserve, and the buying bank returned the Funds with an official
clearing house check. The Federal Reserve check was collectible
upon presentation at the Reserve bank in immediately availableFunds. The check on a clearing house bank was collectible in Funds
available at the Reserve bank the next day when clearing balances
were settled on the books of the Reserve bank.
Since April 2, 1970, clearing house checks cannot be used by
the member bank buyer to return Funds to the seller (see p. 104 ,
Board Ruling No. 8, April, 1970). Transfers are now made by entries
on the books of the Reserve banks in response to telephone,
teletypewriter, or telegraph instruction of the selling and buying
bank.
Title to Federal Funds may also be acquired through checks
issued by the U.S. Treasury, certain clearing nonmember banks,
foreign official banks when drawn against their balances at the
Reserve banks, and by Reserve System disbursing officers.

Using the Federal Reserve wire transfer facilities, a bank may
wire Federal Funds to other banks in different localities for their
own use or that of their customers. Funds for wire transmission
come from the sending bank’s reserve account, and the proceeds at
the other end flow into the receiving bank’s reserve account.
110

Appendix B
No interest is paid by the Reserve banks on balances held with
them. Consideration of profit dictates that member banks continu
ously employ any surplus reserves in interest-earning outlets. Thus,
Federal Funds sales is one of several alternatives in the money
market for investment of temporary excess reserves. A conventional
Funds sale of $1 million for one day (overnight lending) would
return the seller $166,667 if Funds are trading at 6 percent. The
Funds rate is determined by the day’s trading and is figured on a
360-day basis. If sold on Friday—over the weekend—the return
would be $500.00 since the next clearing is three days away.
UNITS OF TRADING AND TYPES OF TRANSACTIONS

The common unit of trading is $1 million, although at times
transactions are accomplished in blocks of $200,000 or large
multiples under $1 million. Some liberalization of trading units has
developed in recent years as a result of competition among the
accommodating banks. Minimum trades in accommodating arrange
ments range in size from $200,000 down to $25,000 and even
$10,000, on occasion, in some districts. Most frequently, however,
the trading unit is between $50,000 and $200,000 in size.
Until the ruling of the Comptroller in 1963, Funds sales were
considered unsecured loans made by one bank to another. They
came under the single borrower limitation for unsecured loans in the
National Bank Act, and individual transactions were limited to 10
percent of capital and surplus. There are similar limitations in many
state statutes. The provision imposed on national banks and many
state banks stipulating that aggregate borrowings cannot exceed
capital stock and a percentage of surplus also limited purchases.

Thus, direct trades of Funds in size were generally confined to
the larger banks. During the 1950’s, however, the smaller banks
developed the practice of using repurchase agreements, buy backs, or
general U.S. Government short-term security collateral transactions
to enter the Funds market on the selling side. The common unit for
accomplishing these transactions is also $1 million.

Until 1957, these secured transactions were carried in the
bank’s investment account and were considered investment transac
tions to avoid the loan limits. Rulings of the Comptroller in 1957
111

The Federal Funds Market

and 1958 required such transactions to be classified as loans by
national banks and permitted certain exceptions from the limits
when secured by U.S. Government securities. State member banks
met similar conditions. The ruling of the Comptroller in June, 1963,
however, freed all Funds transactions of national banks from lending
and borrowing limits. Market practice, however, generally continues
to observe the old regulations in amount of transactions, but there
has been a reduction in the number of collateral transactions,
especially in tight markets.

REPURCHASE AGREEMENTS, OR BUY BACKS,
WITH DEALERS

These terms are practically synonymous and in their more
technical usage are applied to transactions by which a bank makes a
firm purchase of Government securities for delivery and payment in
Federal Funds the same day. Concurrently, the bank makes a firm
sale with the same dealer of the same amount of the same issue of
Government securities for delivery and payment in Federal Funds on
the following business day at an agreed price.

The transaction prices are usually at or below the bid side of the
market. Most commonly the dealer sells the securities to the
customer at an agreed price, flat, and buys them back at the same
price, flat. The customer receives a rate of interest on the contract
based on par value or one related to the market.
In other instances, the securities are sold to the customer at an
agreed rate of intest and repurchased at the same rate, or, the dealer
may sell them to the customer at market and accrued interest and
buy them back at a price which will provide an agreed yield. Written
confirmations of the sale and purchase are delivered, and the
payments in Federal Funds are made on the respective settlement
dates. Less frequently, banks may borrow Funds from banks or
dealers in an analogous transaction known as a “reverse repurchase.”
The volume of these transactions, however, is usually relatively small.

During the severely restrictive periods of credit restraint in 1966
and 1969, however, the banks became quite active in making reverse
repurchases in order to conserve their holdings of U.S. securities. By
entering into these agreements with dealers, the securities are used as
112

Appendix B

a basis for borrowing from the dealer. The dealer finds the money
from nonbank sources by entering into a repurchase with a nonbank.
The two transactions ordinarily have the same maturity and are equal
in amount, thus canceling out. Market estimates place the volume of
transactions at about $1 billion daily during much of 1969. Dealers
are generally compensated for their services with a one-quarter to
three-eighths of a point spread depending in some degree on
maturity. These transactions may also be undertaken to satisfy a
corporate customer who needs cash but does not wish to disturb his
portfolio.

Repurchase agreements are generally made for overnight, but
they may be “open,” particularly when they arise between a dealer
and a bank and run for two or three days; the exact period being
indeterminate when initiated. Some provide automatic renewal until
terminated. The parties to the transaction usually agree to ignore the
coupon rate on the securities and the yield to maturity. The specified
rate is related to the going rate on Federal Funds, the dealer loan rate
in New York, and, to a lesser extent, the Treasury bill rate. If the
transaction is “open,” the rate is set from day to day as noted earlier.
During the tight money market of 1969, however, dealers at times
were able to make repurchases with certain nonbanks at a level
between the Funds rate and discount rate. Usually it was close to the
commercial paper rate. Shortage of collateral or desire to conserve
holdings of U.S. securities on the part of banks and dealer willingness
and need to carry inventory were among the factors responsible for
this development.
Repurchases may provide automatic adjustment of the rate to
the market, and some agreements may permit substitution of
collateral. The use of these transactions between banks, and between
banks and dealers, varies. Overnight transactions between dealers and
banks outside New York City have been widespread and also occur
between dealer banks in New York and out-of-town banks. More
generally, secured interbank Funds transactions do not involve the
precise pricing of securities as is characteristic of repurchases with
dealers.

If the transactions originate between a bank and a dealer’s
office outside New York, the tickets are billed to the local office, but
settlement is made in New York for their accounts. Virtually all of
I 13

The Federal Funds Market
these transactions outside New York arc accomplished by wire
transfer, with debits and credits of Federal Funds to correspondent
account balances maintained in New York City. The instructions to
pay the Funds to the borrower against delivery of the securities flow
over the “bank wire.” The securities involved in the transaction are
held in safekeeping accounts in New York.
ACCOMMODATING BANKS AND CORRESPONDENT
TRADING ARRANGEMENTS

Accommodating banks buy and sell Funds to meet their own
reserve needs but, in addition, provide or absorb Funds as a service to
correspondent banks and others.
Some lead correspondents have taken an aggessive approach in
developing outright limited trading positions in Funds to enable
them to provide a “new business service,” selling or buying Funds to
or from their correspondents, while others encourage only sales.
Reluctant to improve the familiarity of smaller banks with the
market, a few have adopted a passive attitude by offering a service of
buying or selling only upon request from the smaller banks. The
largest accommodating banks usually operate on both sides of the
market during the same day.

In providing or absorbing Funds as a service to correspondents,
the accommodator generally will:

1. match — on its own books, to the extent possible — buy and
sell orders from correspondent or customer banks;

2. care for the correspondent’s needs out of its owrn position
when its reserve position is the reverse of its correspondent’s;
3. try its best to cover a correspondent’s needs in the national
market when it can’t accomplish transactions by (1) or (2).
At times, the accommodator may borrow from the Federal
Reserve bank. In other cases, the lead correspondent acts only as
agent, pooling sales of a customer’s bank with his own. Purchases by
smaller banks come from the lead bank’s position.
114

Appendix B
All of the accommodating or corresponent arrangements do not
provide the same degree of service, and some may limit their service
at certain times during the year or depending on conditions in the
market. In some cases, a collateral loan agreement may be required
of the correspondent. When the service provides for purchases by the
smaller banks, the lead bank usually sets up an informal “line of
Funds.” If the correspondent wants to borrow more, the request is
referred to an officer in charge of the money position or the
representative who regularly calls upon the particular bank.
Correspondent charges on purchases and sales vary. Some
accommodators may make a charge on purchases but sell at the
prevailing rate regardless of the amount. Others will make a charge
on sales. Charges usually vary with the size of the trade. On amounts
under SI million, the spread may be one-half of 1 percent and over
SI million, one-eighth to one-quarter of 1 percent. The spread
between buying and selling, however, widened at times in many city
and regional trading arrangements as rates became more volatile in
the 1969 money market. The widened spread offered more protec
tion against loss. If acting as agent or if sales are combined with those
of the accommodator, the correspondent receives the rate on the
combined transaction. Few if any of the large banks view Funds as a
direct source of profits.
A very small profit or loss in their purchases from and sales to
customers may arise from rate fluctuations during the day. In some
banks the Funds are traded even (a good 8 percent market would
mean a bid in size at 8 percent and an offering in size at 8 percent).
More banks may return to “even trades” as the hyperactivity of
recent markets moderates. Profits in this instance may come from
differences in rates during the reserve period, selling at 8 percent
early in the period in hope of buying them at a lower rate at the end
of the period.

Probably 85 percent of the transactions are for overnight, and
the rest range from three days to two weeks, with the rate fixed from
day to day. In some instances, Funds remain at the bank’s disposal
until either party terminates the arrangement or until the rate
changes. There has been a tendency to increase the length of
transactions with smaller banks.
115

The Federal Funds Market

In contrast to the accommodating banks, the other regular
participants usually come into the market on only one side, either
borrowing or selling, on a particular day unless their money position
undergoes a market swing during the day. Over time, they tend to be
net buyers or net sellers.
The number of banks involved in these arrangements range from
five or six to several hundred. To a considerable extent these
networks are mutually exclusive.
MARKET RULES

Selling banks may impose their own limits on borrowing banks
and may restrict their transactions to banks on an approved list.
Some banks which view the market on an impersonal basis may
develop their lists without reference to correspondent relationships
but will honor direct requests from correspondents for purchases if
Funds are available in their position. The list of banks with which
another bank may deal may be more closely observed in tight
markets than when they are easier.
MECHANICS OF ACCOMPLISHING TRANSACTIONS

1. INTRACITY. Among banks within a city, transactions in
buying or selling Funds are made by telephone between borrowing
and lending banks and may be initiated by either one. The lending
bank then telephones the Federal Reserve bank to charge its account
and credit the borrowing bank. The call to the Reserve bank is
followed by letter or teletypewriter instructions to the Reserve bank,
and the buyer makes written confirmation to the seller. The entries
are reversed the next day by the buying bank. Interest is handled
separately by a charge or credit to correspondent accounts or by
treasurer’s or cashier’s check.
In a few cities until the spring of 1970, local transactions were
still accomplished by the selling bank’s check on the Federal Reserve
bank, and the transaction was discharged by the borrower’s clearing
house check plus one day’s interest at an agreed rate. Until 1961, this
was also the practice in New York. Under an agreement by the New
York Clearing House banks in 1966, the issuance of the clearing
house check by the buyer was enough acknowledgment, and the

116

Appendix II

seller no longer issued a check but merely instructed the Reserve
bank by telephone to charge its account and credit the buyer. Gener
ally, the New York City banks do not arrange transactions directly
with one another; instead they use the brokers as intermediaries.

2. INTRADISTRICT. Transactions arranged between banks in
different cities within a district arc usually accomplished by
telephone instruction to the Reserve bank, both in opening and
closing. The transaction may be arranged by a broker or through
direct communication from one bank to another by telephone or the
commercial bank wire. Letter or teletypewriter instruction follow
the telephone calls to the Reserve bank, and the transaction is
confirmed in writing to the seller by the buyer. Interest is charged or
credited to correspondent accounts or settled by an official check.
3. INTERDISTRICT. The lending bank instructs the Federal
Reserve by telephone, or teletypewriter to wire Funds to the
borrowing bank in another district for immediate payment, and the
borrower repays the loan with a return wire of Funds on the
following business day. The buying bank normally confirms the
transaction to the seller by both telegram and letter. Interest is
settled by credit or charge to correspondent accounts or flows back
by draft or check if no correspondent relationship is involved. This
practice is usually followed because the Federal Reserve charges for
wires involving odd sums.
FUNDS BROKERS

Two member firms of the New York Stock Exchange, The
Garvin Ban tel Corp, and Mahon, Nugent & Co.; a New York
commercial bank, Irving Trust Company; and an institutional money
broker, George Palumbo & Co., Inc., maintain desks in regular daily
contact with both buyers and sellers of Funds. None of these
organizations deal as principals. They match purchases and sales
orders received from banks desiring to use their services.

For its services, The Garvin Bantel Corp, is compensated by
stock exchange business which it may receive. The firm also offers
the banks a broker’s Ioan facility when it suits the banks’ loan needs.
117

The Federal Funds Market

At the request of a bank, a commission of one-sixteenth of 1 percent
may be charged.

Mabon, Nugent & Co. may charge the banks a one-sixteenth of
1 percent commission in return for its services. As an alternative, the
firm may receive stock exchange business.
The Funds brokerage service offered by Irving Trust Company
is separate and independent of any other transactions which the bank
may conduct in Funds. The service is supplied at no charge, but the
bank may, through the offer of this service, receive other business
from the customer banks.

George Palumbo & Co., Inc., in return for its services, may
charge the banks a one-sixteenth of 1 percent commission. As an
alternative, the firm may be compensated indirectly through referral
of stock exchange business to member firms. A broker’s loan service
is offered as well.

118

J CKNOWLEDGMENTS
In the preparation of the first edition of this booklet,
acknowledgment was made to persons who supplied information or
discussed various parts of the paper. The author is particularly
indebted to Herbert Repp and Robert Coon, Discount Corporation;
L. M. Maxson, The First Boston Corporation; Girard Spencer,
Salomon Brothers & Hutzler; Henry J. Schuler, The Bank of New
York; George Garvin, The Garvin Ban tel Corp.; Sumner Pruyne, The
First National Bank of Boston; James Arrington, The National
Shawmut Bank of Boston; and Randolph Flather, Industrial National
Bank of Rhode Island, all now retired. Also, Richard Youndahl,
Aubrey G. Lanston and Co., Inc.; Ralph DePaola, Mabon, Nugent &
Co.; James Wilson and John Benson, The National Shawmut Bank of
Boston; and John J. Cummings, Jr., Industrial National Bank of
Rhode Island. A number of these same persons were also helpful
with materials incorporated in the revised editions.

In the preparation of later editions, however, the author is
indebted to Marshall Montgomery, Aubrey G. Lanston and Co., Inc.;
Frederick Gidge (retired), Manufacturers Hanover Trust Company;
Richard J. Chouinard, Irving Trust Company; Richard C. Fieldhouse,
The Garvin Bantel Corp.; Lewis N. Dembitz, Carter H. Golembe
Associates; John J. Arena, Loomis-Sayles & Company; Professor
Donald R. Hodgman, University of Illinois; Irving Auerbach, Federal
Reserve Bank of New York; Clay Anderson (retired), Federal Reserve
Bank of Philadelphia; and Paul S. Anderson, Federal Reserve Bank of
Boston.

The author alone is responsible for statements of fact and the
conclusions in the text.

119

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128