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FEDERAL RESERVE ACT AMENDMENTS HEARING BEFORE THE SUBCOMMITTEE ON DOMESTIC MONETARY POLICY OF THE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS HOUSE OE REPRESENTATIVES N IN E T Y -F IF T H CO N G RESS SECOND SESSION ON H.R. 12621 A BILL TO EXPAND THE CLASS OF COLLATERAL ELIGIBLE FOR USE AS SECURITY FOR FEDERAL RESERVE NOfTES H.R. 13148 A BILL TO INCREASE THE NUMBER OF CLASS C DIRECTORS OF FEDERAL RESERVE BANKS JULY 14, 1978 Printed for the use of the Committee on Banking, Finance and Urban Affairs U.S. GOVERNMENT PRINTING OFFICE 31-321 o WASHINGTON : 1978 HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS HENRY S. REUSS, Wisconsin, Chairman THOMAS L. ASHLEY, Ohio WILLIAM S. MOORHEAD, Pennsylvania FERNAND J. ST GERMAIN, Rhode Island HENRY B. GONZALEZ, Texas JOSEPH G. MINISH, New Jersey FRANK ANNUNZIO, Illinois JAMES M. HANLEY, New York PARREN J. MITCHELL, Maryland WALTER E. FAUNTROY, District of Columbia STEPHEN L. NEAL, North Carolina JERRY M. PATTERSON, California JAMES J. BLANCHARD, Michigan CARROLL HUBBARD, Jr ., Kentucky JOHN J. La FALCE, New York GLADYS NOON SPELLMAN, Maryland LESS AuCOIN, Oregon PAUL E. TSONGAS, Massachusetts BUTLER DERRICK, South Carolina MARK W. HANNAFORD, California DAVID W. EVANS, Indiana NORMAN E. D’AMOURS, New Hampshire STANLEY N. LUNDINE, New York EDWARD W. PATTISON, New York JOHN J. CAVANAUGH, Nebraska MARY ROSE OAKAR, Ohio JIM MATTOX, Texas BRUCE F. VENTO, Minnesota DOUG BARNARD, Georgia WES WATKINS, Oklahoma ROBERT GARCIA, New York J. WILLIAM STANTON, Ohio GARRY BROWN, Michigan CHALMERS P. WYLIE, Ohio JOHN H. ROUSSELOT, California STEWART B. McKINNEY, Connecticut GEORGE HANSEN, Idaho HENRY J. HYDE, Illinois RICHARD KELLY, Florida CHARLES E. GRASSLEY, Iowa MILLICENT FENWICK, New Jersey JIM LEACH, Iowa NEWTON I. STEERS, Jr ., Maryland THOMAS B. EVANS, JR., Delaware BRUCE F. CAPUTO, New York HAROLD C. HOLLENBECK, New Jersey S. WILLIAM GREEN, New York P a u l N e l s o n , Clerk and S ta ff Director M i c h a e l P. F l a h e r t y , Counsel G r a s t y C r e w s II, Counsel M e r c e r L. J a c k s o n , Minority S ta ff Director G r a h a m T. N o r t h u p , Deputy Minority S ta ff Director S u b c o m m it t e e on D o m e s t ic M onetary P o l ic y PARREN J. MITCHELL, Maryland, Chairman STEPHEN L. NEAL, North Carolina NORMAN E. D’AMOURS, New Hampshire DOUG BARNARD, Georgia WES WATKINS, Oklahoma BUTLER DERRICK, South Carolina MARK W. HANNAFORD, California GEORGE HANSEN, Idaho HAROLD C. HOLLENBECK, New Jersey BRUCE F. CAPUTO, New York (II) CONTENTS Page Text of— H.R. 12621.................................................................................................................. H.R. 13148.................................................................................................................. State m e n t of Partee, Hon. J. Charles, member, Board of Governors, Federal Reserve System.. A d d it io n a l I n f o r m a t io n S u b m it t e d for th e 5 R ecord Partee, Hon. J. Charles: Condensed balance sheet of the Federal Reserve banks................................. Letter dated July 21, 1978, with attached record of policy actions taken by the Federal Open Market Committee, June 20, 1978, with emphasis in the discussion of “Operations in Federal Agency Securities” .................... Treasury Department, letter dated August 3, 1978, in regard to H.R. 12621..... (H i) 2 3 6 17 40 FEDERAL RESERVE ACT AMENDMENTS FRIDAY, JULY 14, 1978 H o u se of R e p r e s e n t a t iv e s , S u b c o m m i t t e e o n D o m e s t ic M o n e t a r y P o l i c y o f t h e C o m m it t e e o n B a n k i n g , F i n a n c e a n d U r b a n A f f a i r s , Washington, D.C. The subcommittee met, pursuant to notice, at 8:34 a.m., in room 2220, Rayburn House Office Building, Hon. Parren J. Mitchell (chairman of the subcommittee) presiding. Present: Representatives Mitchell, Neal, Watkins, Hannaford, and Hansen. Chairman M i t c h e l l . The hearing will come to order. It is now 8:34. It was called for 8:30. We are 4 minutes late. This morning, the Subcommittee on Domestic Monetary Policy meets to consider H.R. 12621, a bill to expand the class of collateral eligible for use as security for Federal Reserve notes, and H.R. 13148, a bill to increase the number of class C directors of Federal Reserve banks from 3 to 6, which would increase the total number of directors from 9 to 12. The first of these two bills would correct a small deficiency in current law regarding eligible collateral. The latter would help the Federal Reserve implement the spirit of the Federal Reserve Reform Act of 1977. In this legislation, Congress calls upon the Federal Reserve to expand both public and minority participation in Federal Reserve bank affairs. [The texts of H.R. 12621 and H.R. 13148 follow:] (l) 2 2’s““ H. R. 12621 95t h c o n g r e ss v v 4 IN THE HOUSE OF REPRESENTATIVES M a t 9,1978 Mr. of Maryland introduced the following bill; which was referred to the Committee on Banking, Finance and Urban Affairs M itc h e ll A BILL To expand the class of collateral eligible for use as security for Federal Reserve notes. 1 Be it enacted by the Senate and House of Representa- 2 tives of the United States of America in Congress assembled, 3 That the third sentence of the second paragraph of section 4 16 of the Federal Reserve Act (12 U.S.C. 412) is amended 5 by striking the words “direct obligations of the United 6 States” and inserting in lieu thereof the words “any obliga7 tions which are direct obligations of, or are fully guaranteed 8 as to principal and interest by, the United States or any 9 agency thereof”. I 3 h. 95t h CONGRESS W T R. 13148 1 r k <« A f\ IN THE HOUSE OF REPRESENTATIVES J u n e 1 5 ,1 9 7 8 Mr. (by req u est) ( f o r h im s e lf, Mr. M i t c h e l l o f Maryland, Mr. A n n t j n z i o , Mr. P a t t e r s o n o f California, Mr. L u n d i n e , Mrs. S p e l l m a n , Mr. P a t t i s o n o f New Y o r k , and M r . V e n t o ) introduced the f o llo w in g b i l l ; w h ich w as refe rre d to the Committee on Banking, Finance and Urban Affairs R eu ss A BILL To increase the number of class C directors of Federal Reserve banks. 1 Be it enacted by the Senate and House of Representa- 2 tives of the United States of America in Congress assembled, 3 SHORT TITLE 4 S e c t io n 1. This Act may be cited as the “Federal Re- 5 serve Bank Public Directors Act”. 6 BOARDS OF DIRECTORS OF FEDERAL RESERVE BANKS 7 S e c . 2. (a) The ninth paragraph of section 4 of the 8 Federal Reserve Act (12 U.S.C. 302) is amended by 9 striking out “nine” and inserting in lieu thereof “twelve”. 10 (b) The twelfth paragraph of section 4 of the Federal 11 Reserve Act (12 U.S.C. 302) is amended as follows: I 4 2 (1) by striking out “three” in the first sentence 1 2 and inserting in lieu thereof “six”. 3 (2) by adding at the end thereof the following: 4 “Of the three new class C members appointed by the 5 Board of Governors of the Federal Reserve System after 6 the date of enactment of the Federal Reserve Bank 7 Public Directors Act, initially one shall be designated to 8 serve for a term ending December 31, 1979, one for a 9 term ending December 31, 1980, and one for a term 10 ending December 31, 1981, and thereafter each member 11 so appointed shall serve for a term of three years as 12 provided in paragraph 9 of section 4 of this Act (12 13 U.S.C. 302).”. 14 (c) The last sentence of the twentieth paragraph of 15 section 4 of the Federal Reserve Act (12 U.S.C. 305) is 16 amended by striking out “third class C director” and insert 17 ing in lieu thereof “class C director designated by the chairman”. 5 Chairman M it c h e l l . This morning we have as our witness Gov. J. Charles Partee of the Federal Reserve Board, who is certainly no stranger to us, because of his frequent appearances before this subcommittee. As always, Governor, we are delighted to have you here, and we welcome you to the hearing. I want to thank you for an early-morning awakening, an early-morning departure from your house, and a prompt arrival at the subcommittee hearings. STATEMENT OF HON. J. CHARLES PARTEE, MEMBER, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Governor P a r t e e . Thank you, Mr. Chairman. I am pleased to have the opportunity to present to the subcommittee the views of the Board of Governors of the Federal Reserve System on H.R. 12621 and H.R. 13148. The Board appreciates particularly your timely consideration of these two amendments that we have pro posed to the Federal Reserve Act. Let me begin with H.R. 12621, a proposal to expand the class of collateral eligible to secure Federal Reserve notes. As this subcom mittee is aware, the currency of the United States consists almost entirely of Federal Reserve notes, which are liabilities of the Feder al Reserve banks. By law, these notes must be collateralized dollarfor-dollar by assets of the Federal Reserve, and only those assets specified in section 16 of the Federal Reserve Act are eligible as collateral. At present, the list of eligible assets is restricted to gold certificates and Special Drawing Rights certificates, direct obliga tions of the United States, bankers acceptances and other paper eligible for discount, and certain loans to member banks. H.R. 12621 would add the obligations of Federal agencies to the class of assets eligible to secure Federal Reserve notes. A brief review of the balance sheet that follows of the Federal Reserve banks may help to illustrate the increasing need for the expansion of eligible assets. The major liabilities are member bank reserve balances, the deposits of the Treasury, and Federal Reserve notes. By far the largest and fastest growing item is the liability for currency outstanding, which represented 72 percent of total liabilities and capital of the Federal Reserve banks at the end of 1977, compared with about 59 percent of the total 10 years ago. Since total assets must by definition equal liabilities and capital accounts, this means the proportion of our assets pledged to secure Federal Reserve notes has also been growing significantly. [The balance sheet referred to by Governor Partee follows:] 6 CONDENSED BALANCE SHEET OF THE FEDERAL RESERVE BANKS In millions of dollars ASSETS Gold certificates--------------------------------------- December 31 1967 1977 11 ,480 11,719 Special Drawing Rights Certificates--------------------- 0 1,250 Loans to member banks secured by eligible paper---------- 143 262 Acceptances-------------------------------------------- 164 954 U.S. government securities------------------------- ---- 49,112 102,819 Federal agency obligations------------------------------ 38 8,455 Other Assets------------------------------------------- 14,393 14,267 Total assets------------ 75,331 139,726 Federal Reserve Notes: Outstanding (issued to Reserve Banks)----------------Less: Held by Reserve Banks-------------------------- 44,311 1,940 100,535 7,382 Federal Reserve notes, net-------------------------- 42,370 93,154 Member bank reserve accounts---- ----------------------- 21,000 26,709 U.S. Treasury deposits---------------------------------- 1 ,123 7,164 Other deposits----------------------------------------- 797 1 ,514 Other liabilities-------------------------------------- 8,841 9,126 Capital accounts--------------------------------------- 1 ,200 2,058 Total liabilities and capital accounts--------------- 75,331 139,726 LIABILITIES AND CAPITAL ACCOUNTS Details may not sum to totals due to rounding. Governor P a r t e e . Among the items on the asset side of the Federal Reserved balance sheet are gold certificates, Special Draw ing Rights certificates, U.S. Government and Federal agency secu rities, banker's acceptances, loans to member banks, and other miscellaneous assets. The largest single entry is, of course, the System's holdings of U.S. Government securities, which represent ed about 74 percent of total assets at the end of 1977. Virtually all of the increase in the assets of the Federal Reserve over the past decade is accounted for by net acquisitions of U.S. Government and agency issues. In recent years, we have been able to conduct limited open market operations in the growing secondary market for agency issues, so that our holdings of such obligations— which under existing law are not eligible to secure Federal Reserve notes—now total about $8.5 billion, compared with only $38 million 7 a decade ago. The net result is that, over the last decade, while Federal Reserve notes outstanding have increased at an 8y2-percent annual rate on average, eligible collateral has grown only at a 6%-percent annual rate. In the past few years, moreover, growth in the currency needs of the economy appears to have accelerated to an annual rate of about 10 percent on average. Experience has shown that the econo my’s currency requirements tend to be a fairly stable proportion of GNP. Thus, if nominal GNP—which reflects inflation as well as real growth— continues to rise at its recent rate of 10 to 11 percent per year, and if eligible assets grow at the 7-percent rate of recent years, it can be projected that the Federal Reserve’s stock of eligi ble collateral will be completely pledged in 3 to 4 years, other things being equal. A shortage of collateral is thus a very real possibility. Indeed, over the past IV2 years, the excess of eligible assets above collateral requirements has declined sharply. Excess Reserve note collateral averaged more than $20 billion at yearend for the years 1970-76. It averaged only $11 billion in the first half of this year. And with the introduction of the new note option to the Treasury’s tax and loan account program at depositary institutions, expected to become effective this fall, excess Federal Reserve note collateral is likely to decline considerably further. This will result from a reduction in the System’s portfolio of Government securities associated with the transfer of Treasury balances from the Reserve banks to commer cial banks and other depositary institutions. If agency issues were to be made eligible to secure Federal Reserve notes, the more ample excess collateral cushion would permit greater operating flexibility during this transition. It should be emphasized that the Federal Reserve holds assets far in excess of its notes outstanding. However, with a diminished level of excess eligible collateral, some technical operating difficulties can arise. For example, since each Reserve bank must individually secure its notes outstanding, the recent sharp decline in excess collateral has meant that, on occasion, a Reserve bank runs short of eligible assets. In such an event, that bank has had to borrow Government securities from another Reserve bank in order to meet collateral requirements. The System’s operational flexibility would be enhanced by the passage of H.R. 12621, as the proposed expan sion of collateral assets would likely eliminate the need for these loans between Reserve banks. On occasion also, excess collateral can be reduced sharply by the need to offset sudden and unexpected increases in Federal Reserve float. Such an episode occurred this past January, when harsh winter weather conditions interrupted the transport of checks through the clearing process. As a result, float rose by about $10 billion above its average level in a matter of just a few days. In such a situation, open market operations are automatically under taken to offset the reserve effect of the increase in float. With the excess collateral cushion shrinking, there is growing danger that such smoothing operations might have to be constrained at times in order to avoid a corresponding reduction of assets eligible to secure Federal Reserve notes. 8 If the authorization to secure Federal Reserve notes with agency obligations is not enacted, we will have no alternative other than to take measures necessary to insure compliance with the law. The inventory of currency at Federal Reserve banks may have to be cut back, thereby reducing flexibility to meet unanticipated increases in the public’s demand for cash. A developing shortage of eligible collateral could well force the System to cease purchases of Federal agency issues for the open market account, and to replace agency securities with other assets eligible as collateral. Since the volume of agency obligations has been increasing rapidly of late, it would not seem desirable, as a matter of public policy, to substantially curtail the Federal Reserve’s participation in this active and grow ing secondary market. And in the extreme case, if all eligible collateral were to be pledged, the System would find itself unable to issue additional currency in response to the public’s need, since the issuance of notes without collateral is unlawful. The Board urges that H.R. 12621 receive the prompt attention of the Congress in order to avoid the unnecessary potential difficulties related to currency issuance that I have outlined. Passage of this bill will remove the inconsistencies in treatment that now exist in the Federal Reserve Act so that all securities eligible for open market operations would also be eligible to secure Federal Reserve notes. Moreover, it will correct the current anomalous situation whereby loans to member banks that are secured by agency obliga tions are eligible collateral for Federal Reserve notes, but direct System holdings of the agency securities are not. Let me turn now to H.R. 13148, a bill to expand the number of class C directors of Federal Reserve banks from three to six. Each of the 12 regional Federal Reserve banks has a board consisting of 9 directors who are to be chosen without discrimina tion on the basis of race, creed, color, sex, or national origin. The three class A directors are elected by, and must by law be, “repre sentative o f’ the member banks of the district. The three class B directors, who represent the public, are also elected by member banks with due, but not exclusive, consideration to the interests of agriculture, commerce, industry, services, labor, and consumers. Class C directors are appointed by the Board of Governors to represent the public and are chosen with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers. All Reserve bank directors are elected for 3-year terms. By statute, class C directors must have been residents of their Federal Reserve district for 2 years, and cannot be officers, direc tors, employees or stockholders in any bank. Beyond these statuto ry guidelines, the Board of Governors typically seeks other attri butes in candidates for class C directors. Each of the bank boards need members with experience in managing an organization, since directors must oversee the operations of their respective Reserve banks. Other important responsibilities include voting on changes in the discount rate, reviewing loans and discounts to member banks in their respective districts, and providing important, timely, and valuable intelligence about economic conditions in their re gions of the country. The Board believes it highly desirable to 9 select directors who will contribute to the fulfillment of these responsibilities. The chairman of the board of each Reserve bank, as well as the deputy chairman, who serves in the chairman’s absence, must be designated by the Board of Governors from among the class C directors. Thus, at present, most or all of the class C directors must assume— or have the potential for assuming—one of these roles. Under these circumstances, it is of particular importance that class C directors bring to the Federal Reserve a record of managerial capacity that is essential to the effective supervision of an oper ation as large and complex as a Federal Reserve bank. The Board is keenly aware of the additional criteria for class C director selection specified by the Federal Reserve Reform Act of 1977. We fully support the intent of the Congress to broaden the representation of interests on Reserve bank boards. But in practice, we have come to recognize that it is difficult to provide representa tion of a wide diversity of interests among only three class C directors. Moreover, since the directors serve staggered terms, only one class C vacancy occurs each year at each Reserve bank. And be cause the complexity of the bank’s business has given special value to on-the-job experience, Board-appointed directors are typically reappointed to a second 3-year term. Thus, throughout the System only about six new class C directors are chosen in any given year. The Board’s commitment to broader representation can be achieved only very gradually with such a limited number of new appointments. O f course, the class B director appointments also may well include persons of diverse backgrounds and interests, but their selection is a process over which the Board of Governors has no direct control. In the interest of promoting broader representation of agricul ture, labor, services, consumers and other groups among Reserve bank directors, the Board of Governors recommends the passage of H.R. 13148. The increase from 3 to 6 class C directors at each Federal Reserve bank will provide 36 immediate openings for which the Board can consider individuals with a variety of back grounds and interests. And with the greater number of class C directors at each Reserve bank, it will be more feasible to carry out the provisions of the Federal Reserve Act that call for both broader representation among, and selection of the chairman and deputy chairman from, the class C directors. In summary, I want to convey the Board’s recommendation for prompt passage of these two bills. If enacted, the first of these proposals will enhance greatly the Federal Reserve’s flexibility in meeting the collateral requirements for Federal Reserve notes, and the second will be of substantial benefit in helping to broaden promptly the diversity of backgrounds and interests represented on the boards of directors of our regional Federal Reserve banks. Thank you, Mr. Chairman. Chairman M it c h e l l . Thank you very much, Governor Partee. Just one quick question on H.R. 12621. I assume there has been consultation between the Federal Reserve and the Treasury on this. I know of no problems that Treasury has with it. Governor P a r t e e . I know of no problems either, Mr. Chairman. 10 Chairman M it c h e l l . Has there been consultation with Treasury? Governor P a r t e e . I just cannot recall. I will have to check that. Chairman M it c h e l l . I think for the sake of the record we ought to have correspondence from Treasury inserted. I know that the Treasury has no problems with the bill. Governor P a r t e e . I see no difficulty for the Treasury. But I just cannot recall specifically that the issue has been discussed in terms that can be referred to as consultation, Mr. Chairman. Chairman Mitchell. For the matter of the record of the subcom mittee, we will direct correspondence to the Treasury and ask that they reply for the record. (See page 40.) Now, with reference to our second bill, H.R. 13148, I am encour aged by the statement you made this morning, and I must say it offsets a great deal of discouragement that I experienced earlier this year. I think the Congress was quite sincere when it said it wanted greater diversity of representation. Governor P a r t e e . Yes. Chairman M it c h e l l . At the beginning of 1977, I thought we had an excellent opportunity to increase the diversification of the Fed eral Reserve bank's boards of directors. Some selections were made for openings. But in my opinion, the selections that were made fell far short of the expectations of the Congress in terms of the kind of balance we hoped would follow passage of the Federal Reserve Reform Act of 1977. If you will recall January 1 of this year, the 12 Federal Reserve banks had 37 directorships vacant; 12 were in class A, 12 in class B, and 13 in class C; 21 have been filled by new persons, 7 in each class. One class A directorship and one class B directorship are still vacant. Governor P a r t e e . Yes. Chairman M it c h e l l . What was so very discouraging to me, and seemed on its face to be in contradiction to what the Congress sought, was that there was no increased diversification at all in the class A directors. Governor P a r t e e . No. Chairman M it c h e l l . The information I have is that all seven selections—they have to be bankers—were white males. Governor P a r t e e . I am not aware of any women or minorities. Chairman M it c h e l l . That flies in the face of diversification. We also had an opportunity to diversify in class B director level. How ever, of the seven persons newly elected this year, there was only one woman. Governor P a r t e e . Yes. Chairman M it c h e l l . In that class B group, there were no blacks, no Hispanics, or any other minority elected. I am not at all sure that the present composition at that class B level can legitimately be said to represent the interests of services, labor, and consumers. Finally, of the seven persons newly appointed as class C directors by the Board this year, only one is a woman. She also can be termed a consumer representative. But even at that level as of this year there are no blacks, no Hispanics, no other minorities. I suppose only one can be said to represent labor. Now, I do not intend to lecture you, but it seems to me that that kind of selection process at least violates the spirit of section 203; 11 certainly, in terms of appearance, it seems to violate it. Let us hope that if we can move expeditiously to pass H.R. 13148— now that we have your full support for it. Let us hope we can begin to redress these kinds of inequities that I alluded to among the class A, class B, and class C directors. Governor P a r t e e . Mr. Chairman, I agree with what you have said. In defense of the record, I would point out that the Federal Reserve Reform Act was not passed until November 1977, at which time the representation for class B directors was expanded. You see, before then, effectively they all had to be businessmen. And the selection process for this year's director vacancies was pretty well completed by last November because of this process of the bankers voting for the class B members. Therefore, there was not a great deal of opportunity to turn around the situation in that class B group. In class C, as I say, we are certainly doing everything we can to find good, eligible candidates representing a wide variety of inter ests in the country. But the difficulty, as I pointed out, is that we have only those three spots; and we have to have a chairman and a deputy chairman among the three designated, for which we think managerial experience is important. So we feel so constrained that it is difficult to move significantly in the direction of broader representation. Now, if we had these 36 new positions, I think we could bring about quite quickly a very considerable change in the composition of the directorships, while still paying very careful attention to the quality of people and the quality of advice we would likely be getting from the group. Chairman M it c h e l l . I think we ought to make the record clear that class B directors, in your interpretation, have in effect to be businessmen. Governor P a r t e e . Commerce, agriculture, and industry, I be lieve. Mr. H a n s e n . Men or persons? Governor P a r t e e . Persons. Chairman M it c h e l l . If I may recapture my time, I am trying to use the language that the Governor used. He said “must in effect be businessmen.” I merely wanted to make the record very clear that even the present language does not make it so narrow, that persons in business, agriculture, services, labor, and others were included. Governor P a r t e e . That is right. Agriculture was included. Chairman M it c h e l l . M r . Hansen, any questions? Mr. H a n s e n . Thank you, Mr. Chairman. Governor Partee, I think that we need to have balanced repre sentation so that we get1the proper input, to serve any given area in the best way possible. I guess I am wondering where you really achieve balance. Can you have representation and balance at the same time without including the total population? What I am getting to is, take any example, the National Collegiate Athletic Association or anything else. They have boards. Fans are affected, just like the consumers. But how far can you go to gain a balance before you take the operation away from the pros in the business, so to speak? How far do you go to gain a balance before you end up with that so-called balance having people appointed arbitrarily 12 from Washington and have your institutions, your local representa tives and your local situations outnumbered and hanging? Where does balance end and manipulation begin when you are appointing members to these boards? Is there not perhaps some merit to increasing each category by one person or something like this? Are you going to give away professionalism for tokenism or for a num bers game? I think there are some answers that we have to come up with here before we arbitrarily change what has been a fairly workable situation right now. Maybe you would like to address yourself to that. Governor Partee. I think, Mr. Hansen, that we do have to pay careful attention to seeing that class C directors have the kind of managerial record that will make it possible for these boards to work effectively in overseeing the operations of the Reserve banks. That is a first requirement that we have for our director groups. I think it is also important that the group of directors be prepared to discuss intelligently and with some experience the question of proper discount rate setting, to discuss economic conditions in their region as they are developing and are likely to develop in the future, and in that way to be able to provide advice to their presidents and also—when they communicate on discount rates— to the Board of Governors. But I think that these functions can be performed with a more diverse group of people than we typically have had on many of the Reserve bank boards. Mr. Hansen. Forgive my interruption, but can we not also make some efforts toward insisting that maybe they broaden the variety of people in categories A and B? It seems to me that to load it with category C may not be as wise as to insist that maybe we do a better job in some of the other categories. I know some areas have pretty good representation of women, others don't. I just wonder if we are loading it too much in one category in an area of weakness where you do not have your expertise and overloading the exper tise area of your board in order to achieve the so-called racial, ethnic or whatever balance we are talking about? Governor Partee. I would not particularly favor an increase in class A, because those directors are bankers and I think we ought to keep it restricted to bankers. That is, those are the people who use in the first instance the services of the Reserve banks. I think that ought to be a banker group. Directors could be as easily added to class B as class C, but class C seemed the most reasonable thing to increase. We took this up with the presidents of the Reserve banks, and they approved this initiative. And, of course, you do recognize that as a practical matter there is involvement by the Reserve banks in proposing names for class C. Mr. Hansen. Are the member banks pretty much in accord with this? Governor Partee. I really do not know about the views of the member banks? Mr. Hansen. All you know about is the Reserve banks? Governor Partee. The presidents of the Federal Reserve banks, that is right. Mr. Hansen. Don't you think they are engaging in a little token ism in this effort in category C in order just to kind of wave away a problem instead of really, again, as I say, doing the job of trying to 13 encourage a broader representation of races and ethnics, Mr. Chairman? By this, I mean in category B, as you mentioned, Gover nor Partee, or even category A? They are developing more exper tise in category A across the country now, more people are moving into those areas, as we have insisted that they do so. I am wonder ing if, in a sense, this emphasis in category C is a copout. Chairman Mitchell. W ill the gentleman yield to me just before the Governor responds? Mr. Hansen. Please. Chairman Mitchell. Thank you. I thought about this problem, too. Quite frankly, the Chair's opinion, and I would hope the opin ion of the subcommittee and the full committee, would be to go further and expand the other classes at a later date. I look on this bill as the first step, the beginning of some impetus to show by model demonstration what can be accomplished at the C director ship level. Also, I asked the gentleman to yield because we have problems with words; semantic difficulties are frequently present. But I think rather than use the word “balance, ’ what we are looking for is diversification. That is the term that we are really seeking. Because in the Chair’s humble opinion, there is a differ ence between balance and diversification. I just wanted the record to be clear on that, that we are going for diversification. I thank the gentleman for yielding. Governor Partee. I was only going to say in response to Mr. Hansen that with class A, there is a limit on the variety of things to be represented. Typically, we expect the three class A directors, who represent the member banks, to represent large banks, medium-size banks, and small banks. As a matter of fact, in most districts one class A director is elected by each of those member bank size groups. The size groupings are determined by the Federal Reserve— that is, what constitutes large, medium, or small banks. It is pretty hard to also get broader diversity, while also achieving that kind of a size distribution. I would anticipate in class B we will have more diversity. For example, just yesterday we received word that Chairman Miller’s position on the Boston Reserve Bank board, which was a class B directorship, has been filled by vote of the member banks with a woman who is a businesswoman in New England. We have many other cases where class B directors are coming to represent more broadly various groups. But I think it somewhat unlikely that we would have many class B directors at the banks who, say, represented consumer groups or other organizations of that kind. So I would think that we would just have more latitude to see that we get a better diversity if more directors were to be added to class C. I might also say, Mr. Hansen, as to the matter of tokenism—you used the term—we expect everyone that we appoint to the Reserve banks to do a full, responsible, experienced job; to make a contribu tion to the work of the boards of directors. Mr. Hansen. I do not think, Governor Partee, that is the kind of tokenism I was talking about. I am talking about the tokenism of numbers that goes on in this country. We have gone to a system questioned by the Bakke case in some of these things, where we see the controversiality and the problems that are involved in playing 31-321 0 - 78 -3 14 numbers games. What we really want is the full spirit of the law and the full spirit of participation. Mr. Chairman, to respectfully take issue with you, you mentioned that balance was not the word, that diversification was. W ell, I see here, in a sense, still lingering the game of balance. We expand one general category in order to get more minority people there, and you get a balance—though only token balance. If you really want diversification, it seems to me we must get minorities into the areas of expertise where you really can get the input you want, rather than only in the area of category C, which is weak as far as expertise is concerned. And I guess every one of us may be in the majority in some ways and in the minority in other ways. There are some minorities, because of the emphasis of the law and the times and so forth, that get more attention than others. But we all experience situations where we are in the minor ity. Maybe it is from size. I can only shop in one men s store out of 10,000 because of the problem of size. People say go on, we can't do anything for you. It is just one of those things. Everybody has this kind of an experience in one way or another. I think we all have to be sensitive of the problems and situations of others, I think we have to be sensitive to including others. Fighting this battle is a struggle, Mr. Chairman, and as a leader here in the Congress to try to get things evened out, I know you recognize that. However, I think that sometimes because of this constant effort that many have to go through, that maybe there are times when you accept too little when you could take more, where you could move farther and faster. I guess my only concern here is that this may be one of those times where you are taking a pat on the head, in a sense, when we really could be addressing ourselves effectively to solving the prob lem in this situation, which is to include minority people in the area of expertise as well as the general category so they can participate properly and get the banking situation properly broad ened. We are talking about minority bank inclusion, the input of women, the input of ethnic groups. With this dwelling on category C, I am sure we are getting this done properly. I am hoping we can look at this legislation in broader perspective as we consider it and see if there is not a possibility to put emphasis on some of these other categories without getting into the problem of allocations addressed by the court so we can get this problem solved or at least on track, once and for all. Chairman Mitchell. W ill the gentleman yield? Mr. Hansen. Yes. Chairman Mitchell. The Chair tried to state his position in relatively diplomatic terms. Mr. Hansen. Y ou usually do. Chairman Mitchell. The Chair will try to be a bit more specific. Let me speak to two issues. First, the matter of balance and diver sification. You took issue with my use of the word “diversification,” giving that a higher preference. Although the House of Representa tives is certainly not analogous to the situation that we are con fronted with here, I think you would agree that there is not a balance in terms of the population of women in this country, as 15 represented in the House, nor blacks, nor Hispanics. Certainly, hopefully we are moving in that direction. Meanwhile, while moving in that direction, I think we seek diversification in repre sentation rather than attempting to achieve the rigid balance which could only be accomplished by somehow changing the meth ods by which people are elected to the House of Representatives. I said earlier that I tried to couch my response in very diplomat ic terms. Let me assure the distinguished gentleman, Mr. Hansen, that for as long as at least one member of this subcommittee stays in the Congress, there will be a continuous push from at least one Member, that is this Member, to do something about class C, class B, and class A. I think my record is very clear that I will not countenance nor be a party to any part of tokenism, nor continu ous exclusionary practice, and remain silent on it. I thank the gentleman for yielding. Mr. Hansen. I think my time is about up. Chairman Mitchell. Yes. Mr. Hansen. I might just make one statement, Mr. Chairman, that is, I do not think it is a healthy game to get into numbers, because there are certain types of people who by various patterns in this country have developed in ways where to include them by a numbers game in certain areas, whether it is banking or something else, still will not necessarily provide equitable or proper diversifi cation. So I think it is a problem to rigidly call for quotas or whatever, because this does not allow for the flexibility of the system that ought to be there. But I do think that somehow we need to encourage areas where it has been rather stifled to move, without the force of law necessarily, more into the area of diversifi cation, if that is the word, in representation on the various levels. My point is whatever we do here—and I don’t believe loading the one area is the answer—but whatever we do, I think we ought to be saying this is not the end—we want the job of inclusiveness carried out successfully. Mr. Chairman, I would not expect you to be one who would sit back on this vital matter so I think we as a committee ought to be saying we want you to be working more in these other areas to gain full diversification. I know there are current efforts but some times they get sidetracked and do not work as fast as if they were more conscious of these things. I would like to see that the empha sis remains on the front burner. Chairman Mitchell. Thank you. Mr. Hannaford. Mr. Hannaford. Mr. Chairman, I am a newcomer to this bill, so if I could ask a question: The legislation we are talking about is H.R. 13148 and its purpose is to expand the Federal Reserve bank boards to 12, allowing for 6 instead of 3 class C directors? Governor Partee. That is right. Mr. Hannaford. The present legislation requires class C be cate gorized as consumer—what is the category? Governor Partee. It is a wide variety. It is a broad list. Mr. Hannaford. Including minorities, women, consumers, so on? Governor Partee. Service organizations and labor as well. Mr. Hannaford. Well, I might comment on the difference be tween balance and diversification. I guess if you diversify with 16 precision it would be balanced, maybe. I do think that this is an important element to have. And I think, as to the chairman’s concern, it is a fact that probably a black woman could understand the world of banking very well, but perhaps a white male banker could not understand the problems in the world of being a black woman. I think we could have a balanced board with all the diversification that the legislation calls for and still have it quite competent to deal with problems that the Board must deal with. I regret that I was not here for your testimony. I have no further questions, Mr. Chairman. Chairman Mitchell. Thank you, Mr. Hannaford. Governor Partee, we will move expeditiously to mark up both of these bills. I am unable to set a time today for their markup. However, I can assure the members of the subcommittee that the markup will not be on a Friday, because we will have not sufficient membership here, apparently, to mark up the Solar Bank Act bill. But we will move expeditiously on them. Thank you very much for being here. Governor Partee. Thank you. Chairman Mitchell. If I may have the attention of the members of the subcommittee for just a moment. On close checking, it ap pears that none of the Republican members of the subcommittee can be here for the markup. Though I might want to try to do it with all of them being absent, I do not think I could do it under the rules of the House. Anyway, I think there is a general consensus that we are moving in the right direction on the solar bill. Howev er, in light of the fact that a quorum of the members are not present, I do not believe we can mark up the solar bill today. We will reschedule the markup for next Thursday, July 20, 1978, at 10 a.m. Thank you very much. The hearing is now adjourned. [Whereupon, at 9:15 a.m., the subcommittee was adjourned, to reconvene upon the call of the Chair.] [The following letter with attached record of policy actions taken by the Federal Open Market Committee at its meeting on June 20, 1978, with emphasis in the discussion of “Operations in Federal Agency Securities” on pages 16 and 17, was submitted by Governor Partee for inclusion in the record:] 17 BO A R D OF G O V E R N O R S O F THE FEDERAL RESERVE SYSTEM W A S H IN G T O N J. C H AR LES PARTEE M E M B E R OF TH E BOARD July 21, 1978 The Honorable Parren J. Mitchell Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs U. S. House of Representatives Washington, D. C. 20515 Dear Mr. Chairman: You will recall that in my statement on H.R. 12621 before your Committee last week, I indicated that defensive actions might need to be taken by the Federal Reserve because of the recent marked decline in the "cushion" of excess collateral eligible to secure Federal Reserve notes. Among other measures necessary to ensure compliance with the law, I mentioned that the System might well be forced to cease purchases of Federal agency issues for the Open Market Account, and to replace agency securities with other assets eligible as collateral. In this connection, you may be interested in the discussion of open market operations in Federal agency securities that appears on pages 16 and 17 of the enclosed record of policy actions of the June meeting of the Federal Open Market Committee. The need to de-emphasize open market operations in the secondary market for Federal agency issues would not have arisen if such obligations were eligible to secure Federal Reserve notes. I want to express again the Board's appreciation for your Committee's prompt attention to this matter, Sincerely, Enclosure V 18 FEDERAL RESERVE July 21, 1978 The Board o f Governors o f the Federal Reserve System and the Federal Open Market Committee today released the attached record o f p o lic y action s taken by the Federal Open Market Committee at it s meeting on June 20, 1978. Such records fo r each meeting o f the Committee are made ava ila b le a few days a fte r the next reg u larly scheduled meeting and are published in the Federal Reserve B u lletin and the Board's Annual Report. The sumnary d escrip tio n s o f economic and fin a n cia l condition s they contain are based s o le ly on the inform ation that was a v a ila b le to the Committee at the time o f the meeting. Attachment 19 July 21, 1978 RECORD OF POLICY ACTIONS OF THE FEDERAL OPEN MARKET COMMITTEE Meeting held on June 20. 1978 1• Domestic policy directive The information reviewed at th is meeting suggested that output of goods and services had expanded rapidly on the average in the second quarter, re fle c tin g the economy's rebound in la te winter and early spring from the e ffe c ts of the unusually severe winter weather and the lengthy coal s tr ik e . More recently, however, the rate of expansion appeared to have slowed. The rise in average p r ic e s--a s measured by the fixed-weighted price index for gross domestic business product--accelerated markedly in the second quarter, due in large measure to substantial increases in food p rice s. S ta ff projections continued to suggest moderate expan sion in output over the year ahead. The anticipated rate of growth was slig h tly lower than that projected a month e a r lie r , mainly because the assumptions regarding f is c a l p olicy were modified to r e fle c t the adm inistration's decision to delay the proposed tax cut from October 1 to January 1 and to reduce i t s s iz e . The pro jected rate of price advance had been raised s lig h tly from that of a month e a r lie r , but i t was s t i l l well below the rate in the second quarter. The projections also suggested that the unemployment rate would decline a b it further over the coming year. 20 6/20/78 -2- Growth in production and employment moderated in May from the rapid rates of preceding months. Thus, the industrial pro duction index increased 0 .6 per cent, compared with gains of 1 .2 and 1 .4 per cent in March and A p ril, resp ectiv ely; and the rise in nonfarm payroll employment in May was le ss than one-half the average increase e a rlier in the year. In manufacturing, the gain in employ ment was re la tiv ely small and the average workweek declined. The labor force continued to grow substan tially and the unemployment rate edged up to 6 .1 per cent from 6 .0 per cent in A p ril. Total r e ta il sales were about unchanged in May, following 3 months of exceptionally large gains. Unit sales of new auto mobiles rose slig h tly further to a new high for the current expan sion . I t appeared that some consumers were buying new cars in anticipation of further price increases. The la te st Department of Commerce survey of business spend ing plans, taken in la te A pril and May, suggested that outlays for plant and equipment would expand 11.2 per cent in 1978; this rate was marginally above that reported in the February survey. Other indicators of capital spending plans, such as manufacturers’ capital appropriations, contracts for commercial and industrial buildings, and new orders for nondefense capital goods, appeared generally consistent with continued moderate expansion in investment outlays. The index of average hourly earnings for private nonfarm production workers rose at an annual rate of about 3 per cent in 21 6/20/78 -3- Hay, following increases averaging close to 10 per cent in e a rlier months of 1978. For the f i r s t 5 months o f the year the index had increased at a somewhat faster rate than i t had on the average in 1977. The advance in the wholesale price index for a l l commodities also slowed in May, re fle c tin g smaller increases in prices of farm and food products as of the time of the survey. Later in the month, however, prices of a number of farm products advanced. In April the consumer price index for a l l urban consumers rose at an accel erated annual rate of nearly 11 per cent, owing to further large increases in food prices and to higher service co sts, especially those relating to home ownership. In general, prices had increased considerably faster in early 1978 than during the year 1977. In foreign exchange markets the trade-weighted value of the d ollar reached a peak for 1978 in la te May. Subsequently the dollar declined by about 2 per cent, but i t remained above the low for the year that had been recorded in early A p ril. The renewed downward pressure on the dollar appeared to r e fle c t market concern about the high rate of in fla tio n in the United States re la tiv e to rates in other industrial countries and about the continuation of large d e fic its in U.S. foreign trade and surpluses in the trade of Germany and Japan. The d e fic it in April was about the same as that in March but lower than the high le v e l of the f i r s t quarter. A p r il. Both exports and imports rose considerably in 22 6/20/78 -4- The rate of expansion in to ta l bank c re d it, which had accelerated sharply in A p ril, slackened somewhat in May but remained above the average for other recent months. Bank holdings of secur it ie s changed li t t le ,b u t to ta l loans, led by a surge in business loans, grew at an exceptional pace. Outstanding commercial paper of nonfinancial businesses declined s lig h tly in May. Growth in the narrowly defined money supply (M-l) moder ated in May to an annual rate of about 6 -1 /2 per cent from the extraordinarily rapid 19 per cent in A p r il. Growth in M-2 and M-3 also slowed in May, reflectin g the deceleration in M -l. Inflows of the interest-bearing deposits included in M-2 generally were greater than in April as commercial banks issued a substantial volume of large-denomination time deposits to finance the sharp increase in business loans. However, inflows of funds into savings deposits and small-denomination time deposits remained slow both at banks and at th r ift in s titu tio n s . Preliminary data for the f i r s t part of June suggested that growth in M-l and M-2 would accelerate in that month. At it s meeting on May 16 the Committee had decided that the ranges of tolerance for the annual rates of growth in M-l and M-2 during the May-June period should be 3 to 8 per cent and 4 to 9 per cent, respectively, and i t had judged that such growth rates were lik e ly to be associated with a wedcly-average Federal funds rate slig h tly above the level of 7 -1 /4 to 7 -3 /8 per cent prevailing 23 6/20/78 -5- at that time. The Committee had agreed that i f growth rates in the aggregates over the 2-month period appeared to be deviating sig n ific a n tly from the midpoints of the indicated ranges, the operational objective for the weekly-average Federal funds rate should be modified in an orderly fashion within a range of 7 -1 /4 to 7 -3 /4 per cent. In accordance with the Committee's decision, the Manager of the System Open Market Account began a fte r the May meeting to seek bank reserve conditions consistent with a firming of the Federal funds rate to around 7 -1 /2 per cent. Incoming data throughout most of the inter-meeting period suggested that growth in the monetary aggregates would be well within the ranges specified by the Committee, and the Manager continued to seek conditions consistent with a Federal funds rate of 7 -1 /2 per cent. Data that became available a few days before this meeting suggested that M-l would grow in the May-June period at an annual rate of about 7 -1 /2 per cent, close to the upper lim it of it s range. M-2 also was projected to grow in the 2-month period at a 7 -1 /2 per cent ra te, in the upper half of the range specified for that aggre gate. These data suggested the need for Committee consultation, and on June 16, in view of the proximity of the meeting scheduled for June 20, the Committee voted to direct the Manager to continue for the time being to aim for a Federal funds rate of 7 -1 /2 per cent. 24 6/20/78 -6- Other market in terest rates had risen further in recent weeks. R eflecting not only the r ise in the funds rate but a lso substantial business credit demands, market rates on short term secu rities had increased from 30 to 60 basis points since mid-May, and conmercial banks had raised the rate on loans to prime business borrowers in two steps from 8 -1 /4 to 8 -3 /4 per cent. Y ields on long-term se cu ritie s rose 5 to 20 basis points over the same period, apparently in response to the ris e in short-term rates and investor concerns about the prospects for in fla tio n . Conditions in mortgage markets had continued to tighten recently as strong demands for credit pressed against reduced a v a il a b ility of funds at lending in stitu tio n s. At savings and loan asso c ia tio n s, net mortgage lending a c tiv ity in A p ril— the la te st month for which data were availab le—was close to i t s reduced rate in the weather-affected f i r s t quarter, and mortgage conznitments outstanding declined further. During the inter-meeting period there were further increases in in terest rates on new commitments for con ventional home loans at the associations and, in most regions, a tightening of nonrate terms as w e ll. Yields in the secondary market for home mortgages also had generally increased in recent weeks. In the Conmittee's discussion of the economic situation and outlook, the members generally agreed that the growth in real output of goods and services over the coming three quarters would be substantially slower on the average than i t had been in the unusually 25 6/20/78 -7- strong quarter ju st ending. However, they s t i l l expected real GNP to grow at a moderate average rate during the year ending with the second quarter of 1979. While some members thought that average growth for that period would probably be at or a l i t t l e below the rate projected by the s t a f f , others expected somewhat faster growth, A majority feared that the r ise in prices would be greater than the s t a f f anticipated. Most members thought that the unemployment rate a t.th e end of the period would be l i t t l e changed from the rates recently prevailing. With respect to the months immediately ahead, a majority of the Committee members thought that the economy was lik e ly to show more strength than the s t a f f projection suggested. These members noted that both consumer and business sentiment appeared to be strong, and they interpreted the la te s t data on consumer behavior as evidence that many households were adopting a speculative approach to spending— anticipating needs for housing and other durables, and in the process adding w illin g ly to already heavy debt burdens. While these members acknowledged that national economic data did not yet suggest sim ilar anticipatory spending on the part of businesses, several noted that many businessmen appeared to be optim istic about the prospects for their own firms and industries and that such optimism might soon be reflected in a step-up in o v e r-a ll business inventory accumulation and investment outlays. 31-321 0 - 78 -2 A number of these members expressed 26 6/20/78 -8- concern about the indications that in flationary expectations were strengthening and that both business and labor were in tensifying their e ffo r ts to protect themselves through price and wage increases. Two of the members who anticipated re la tiv e ly strong growth in the near term thought that the economy was lik e ly to generate suf fic ie n t momentum to maintain a favorable rate of expansion beyond mid-1979. Others in this group were concerned, however, that insofar as near-term spending of consumers and businesses embodied specula tive tendencies, the resulting economic distortion s might lead to sig n ific a n tly slower growth in 1979. Of the Committee members who anticipated le s s near-term strength in the economy, some suggested that current business optimism might w ell r e fle c t an overemphasis on the sharp rebound that had occurred in recent months rather than a considered assessment by busi nessmen of prospects for the future. These members thought i t unlikely that growth in consumer outlays would continue at the recent ra te, and they saw no obvious source of o ffse ttin g strength. They expected outlays for housing to slacken; they noted that surveys o f business investment plans did not r e fle c t much ebullience; and they thought businessmen would follow a cautious approach to inventory expansion. F in a lly , they noted that Federal fis c a l policy would be le s s stimula tive than anticipated e a rlier in the year. 27 6/20/78 -9- Several members of the Committee observed that re la tiv e ly slow economic growth would tend to dampen in flation ary pressures and to bolster the position of the dollar in foreign exchange markets. One of these members noted that economic a c tiv ity in major industrial countries abroad was expected to strengthen, and that such a develop ment would help to lim it any deceleration in the U .S. expansion. He added that a fa ilu re of a c tiv ity abroad to strengthen as expected would increase the chances of unsatisfactory growth in the United States and would create additional problems with respect to the U.S. current account. At i t s meeting in April the Committee had agreed that from the f i r s t quarter of 1978 to the f i r s t quarter o f 1979 average rates of growth in the monetary aggregates within the following ranges appeared to be consistent with broad economic aims: M -l, 4 to 6 -1 /2 per cent; M-2, 6 -1 /2 to 9 per cent; and M-3, 7 -1 /2 to 10 per cent. The associated range for the rate of growth in commercial bank credit was 7 -1 /2 to 1 0 -1 /2 per cent. I t had also been agreed that the longer-run ranges, as well as the particular aggregates for which such ranges were sp ecified , would be subject to review and modifica tion at subsequent meetings. At this meeting, in discussing policy for the period immediately ahead, Committee members expressed considerable concern about recent rates of growth in the monetary aggregates, particularly in lig h t of the continuing strength of in flationary pressures and 28 6/20/78 expectations. -10- The members agreed that open market operations in the inter-meeting period should be directed i n i t i a lly toward achieving slig h tly firmer money market conditions, and that la te r in the period the objectives of operations should depend on incoming data for M-l and M-2. As at the preceding meeting, there were differences of view with respect to the degree of firming that might be undertaken. These differences were reflected in opinions on such issues as the magnitude and speed of the in i t i a l move toward firmer money market conditions and the amount of leew ay--in terms of the inter-meeting range specified for the Federal funds r a t e --fo r further firming la te r in the period. As to the in i t i a l move, most members favored seeking an increase in the Federal funds rate to 7 -3 /4 per cent from the prevailing le v e l of 7 -1 /2 per cent within a few days a fter this meeting.. However, one member suggested that th is quarter-point increase be achieved over a somewhat longer period, and another pro posed that the in i t i a l increase be lim ited to one-eighth of a p oin t. With respect to the inter-meeting range for the Federal funds ra te , most members favored 7 -1 /2 to 8 per cent, but a number preferred 7 -1 /2 to 8 -1 /4 per cent. There was greater d iv e rsity of views with respect to the ranges of tolerance to be specified for the annual rates of growth in M-l and M-2 in the June-July period. Of the ranges 29 6/20/78 -11- suggested for M -l, the lowest was 3 -1 /2 to 8 -1 /2 per cent, and the highest was 6 -1 /2 to 1 0 -1 /2 per cent; for M-2 the suggestions covered a sim ilar span. I t was noted during the discussion that i f the mone tary aggregates accelerated in June, as suggested by the early data, growth over the June-July period at rates near the midpoints of some of the lower ranges proposed could be achieved only i f there were to be a sharp slowing in July. Some members, who were inclined to stress the risks to the economy of rapid firming of money market conditions, saw this circumstance as an argument for specifying re la tiv e ly high 2-month ranges for M-l and M-2. Other members, who placed more stress on the importance at this time of lim itin g growth in the aggregates for the sake of moderating in flationary pressures and expectations, thought such firming would be called for i f the growth in the aggregates did not in fact slow sharply. At the conclusion of the discussion the Committee decided that the ranges of tolerance for the annual rates of growth over the June-July period should be 5 to 10 per cent for M-l and 6 to 10 per cent for M-2. The Committee agreed that during the coming inter-meeting period operations should be directed in it i a lly toward a Federal funds rate of 7 -3 /4 per cent, s lig h tly above the prevailing le ve l of 7 -1 /2 per cent. Subsequently, i f the 2-month growth rates of M-l and M-2 appeared to be sig n ific a n tly above or below the midpoints of the indicated ranges, the objective for the funds rate was to be raised or lowered in an orderly fashion within 30 6/20/78 -12- a range of 7 -1 /2 to 8 per cent. I t was understood that in assess ing the behavior of the aggregates the Manager should continue to give approximately equal weight to the behavior of M-l and M-2. I t was also understood that the Chairman might c a ll upon the Committee to consider the need for supplementary instructions i f the rates of growth in the aggregates appeared to be above the upper lim it or below the lower lim it of the indicated ranges at a time when the objective for the funds rate had already been moved to the corresponding lim it of it s range. At this meeting the Committee considered certain proposed modifications in the language customarily employed in the concluding paragraphs of the domestic policy d ir e c tiv e . I t was noted that, perhaps because of the manner in which the d ire ctiv e was worded, the 2-month ranges of tolerance for M-l and M-2 were subject to m isinter pretation as embodying the Committee's short-run targets for these aggregates, intended to be achieved by appropriate changes in the Federal funds ra te . In f a c t, however, the Manager could not be expected regularly to achieve 2-month growth rates in M-l and M-2 within the specified ranges for various reasons--Including the lag between changes in the Federal funds rate and changes in these growth ra te s, and the brevity of the period to which the operational para graphs of any sin gle d irective applied. I t was noted in the discussion that the Committee's objectives for the monetary aggregates were embodied in the 1-year 31 6/20/78 -13- ranges established at quarterly in te rv a ls, and that the adjustments made from time to time in the Federal funds rate were intended to increase the likelihood that the longer-run growth rates would f a l l within these ranges. The purpose of the 2-month ranges was to pro vide the Manager with an indicator for determining when changes in the funds rate were appropriate; s p e c ific a lly , the Manager was expected to adjust the funds rate within it s range when the la te st projections of 2-month growth rates in M-l and M-2 deviated s ig n if i cantly from the midpoints of their ranges (o r, i f the Committee so indicated in the d ire ctiv e , when the projections for the aggregates approached or moved beyond the lim its of their ranges). At the May meeting, following a preliminary discussion of th is matter, the Committee had deleted one p o te n tia lly misleading phrase from the language previously employed, to the e ffe c t that the Committee "exp ects" the 2-month growth rates to be within the indi cated ranges. At this meeting the Committee agreed upon a more thorough revision of the customary language, in an e ffo r t to reduce the chances of m isinterpretations. The following domestic policy d irective was issued to the Federal Reserve Bank of New York: The information reviewed at this meeting suggests that real output of goods and services has grown rapidly on the average in the current quarter as a c tiv ity rebounded from the e ffe c ts of the unusually severe winter weather and the lengthy coal strik e , but the rate of advance most recently appears to be slowing. Following substantial gains in March and A p r il, increases in in dustrial production and nonfarm 32 6/20/78 -14- payroll employment moderated in May and r e ta il sales changed l i t t l e . The unemployment rate edged up from 6 .0 to 6 .1 per cent in association with a large increase in the c iv ilia n labor force . Average whole sale prices rose somewhat le ss rapidly in May than earlier in 1978, re fle c tin g smaller reported increases in farm products and processed foods. So far this year prices have increased at a considerably faster rate than they had on average during 1977. The index of average hourly earnings also has increased at a somewhat faster pace so far in 1978 than during 1977. Since the end of May the trade-weighted value of the dollar against major foreign currencies has declined about 2 per cent, but i t remains above i t s early-A p ril low. The trade d e fic it in April was down somewhat from i t s very high first-q u a rte r ra te . Growth in M-l moderated in May from the extra ordinarily rapid pace in A p ril, and as a resu lt growth in M-2 and M-3 a lso slowed. Inflows of the in te re stbearing deposits included in M-2 picked up somewhat as commercial banks increased their reliance on largedenomination time deposits to finance an unusually sharp increase in business loans. Market in terest rates have risen somewhat further in recent weeks. In lig h t of the foregoing developments, i t is the policy of the Federal Open Market Committee to foster monetary and financial conditions that w ill r e s is t in flationary pressures while encouraging continued moderate economic expansion and contributing to a sus tainable pattern of international transactions. At i t s meeting on A pril 18, 1978, the Committee agreed that these objectives would be furthered by growth of M -l, M-2, and M-3 fron the f i r s t quarter o f 1978 to the f i r s t quarter of 1979 at rates within ranges of 4 to 6 -1 /2 per cent, 6 -1 /2 to 9 per cent, and 7 -1 /2 to 10 per cent, resp ectiv ely. The associated range for bank credit is 7 -1 /2 to 1 0 -1 /2 per cent. These ranges are subject to reconsideration at any time as conditions warrant. In the short run, the Committee sedcs to achieve bank reserve and money market conditions that are broadly consistent with the longer-run ranges for monetary aggregates cited above, while giving due 33 6/20/78 -15regard to developing conditions in fin an cial markets more generally. During the period u n til the next regular meeting, System open market operations shall be directed i n i t i a l l y at attaining a weekly-average Federal funds rate s lig h tly a ove the current le v e l. Subsequently, operations sh a ll be directed at maintain ing the weekly Federal funds rate within the range of 7 -1 /2 to 8 per cent. In deciding on his s p e c ific objec tiv e for the Federal funds rate the Manager sh a ll be guided mainly by the relationship between the la te s t estimates of annual rates of growth in the June-July period of M-l and M-2 and the following ranges of tolerance: 5 to 10 per cent for M-l and 6 to 10 per cent for M-2. I f , giving approximately equal weight to M-l and M-2, their rates o f growth appear to be sig n ific a n tly above or below the midpoints of the indicated ranges, the objective for the funds rate sh a ll be raised or lowered in an orderly fashion within i t s range. I f the rates of growth in the aggregates appear to be above the upper lim it or below the lower lim it o f the indicated ranges at a time when the objective for the funds rate has already been moved to the corresponding lim it of i t s range, the Manager is promptly to n o tify the Chairman who w ill then decide whether the situ ation c a lls for supplementary instruc tions from the Committee. Votes for this action: Messrs. M ille r , Volcker, Baughman, Coldwell, Eastburn, Gardner, Jackson, Partee, and W allich. Votes against this action: Messrs. W ille s and Winn. Messrs. W ille s and Winn dissented from this action because they favored more vigorous measures to curb the rate of growth in the monetary aggregates. Both preferred ranges of to le r ance for the 2-month growth rates in M-l and M-2 lower than those approved by the m ajority; in addition, Mr. W illes favored an upper lim it for the funds rate range of 8 -1 /4 per cent. 34 6/20/78 -16- Mr. W ille s , c itin g strong consumer and business credit demands at prevailing in terest ra te s, f e lt that a further rise in short-term in terest rates would not sig n ific a n tly damage economic prospects and that, to the extent that such a ris e tended to moderate in flationary expectations, i t would have a p ositiv e impact on the economy. Mr. Winn f e l t that i f the Committee did not act now to assure a reduction in the rates of growth of the aggregates, an excessively r e str ic tiv e policy would be required la te r on i f the Committee's longer-range objectives were to be achieved. 2. Operations in Federal agency securities At this meeting the Committee discussed i t s procedures with respect to open market operations in Federal agency s e c u ritie s. The discussion arose because of a potential problem posed by a sta tutory requirement that Federal Reserve note l i a b i l i t i e s be c o lla teralized by e lig ib le a sse ts, which included direct obligations of the Treasury but not Federal agency issu e s. At times recently, the margin of actual c ollate ral over that required had been re la tiv e ly sm all. The Board of Governors had proposed le g is la tio n that would make Federal agency issues e lig ib le as c o lla te r a l, but Congress had not yet acted on the proposal. I t was noted that the problem of maintaining su ffic ie n t c o lla te ra l for Federal Reserve notes could become c r it ic a l at seme point before the enactment of such le g isla tio n i f , for example, a need arose to s e ll a substantial volume of Treasury se cu rities to absorb redundant member bank reserves. I t was a lso noted that the 35 6/20/78 -17- problem would be mitigated by some slowing of the rate of growth in System holdings of agency secu rities and a correspondingly larger increase in holdings of Treasury se c u ritie s. Paragraph 1(a) of the Committee's authorization for domestic open market operations authorizes the Federal Reserve Bank of New York to s e l l , as well as to buy, Federal agency securities for the System Open Market Account. H isto r ic a lly , however, sales of such secu rities have been quite infrequent. I t was the sense of the Committee that modest sales of agency issues would be appropriate from time to time, but only when market circumstances permitted and when sales of secu rities were consistent with the objectives of open market operations. I t was noted in the discussion that, even apart from the problem of co lla te ra l requirements, occasional sales of agency issues would help enhance the f le x i b i li t y o f open market operations. The Committee also agreed that the Desk should reduce somewhat the volume of agency issues i t purchased when supplying reserves, and that occasionally, when there was a need to absorb reserves, i t should redeem maturing agency issues for cash rather than routinely exchange them for new issu e s. 3. Authorization for foreign currency operations At this meeting the Committee approved a technical amendment to paragraph ID of the authorization for foreign currency operations, under which the de fin ition contained in the second sen tence o f that paragraph of "o v e r -a ll open position in a l l foreign 36 6/20/78 -18- currencies" is given as "th e sum (disregarding signs) of net positions in individual currencies" rather than as "th e sum (disregarding signs) o f open positions in each currency." This change was approved in the in terest of c la r ity , and to make the language of this paragraph con form to certain new language concurrently introduced in the procedural instructions governing foreign currency operations, as described below. With this amendment, paragraph ID read as follow s: To maintain an o v e r-a ll open position in a l l foreign currencies not exceeding $ 1 .0 b illio n , unless a larger position is expressly authorized by the Committee. For this purpose, the o v e r-a ll open position in a l l foreign currencies is defined as the sum (disregarding signs) of net positions in individual currencies. The net position in a single foreign currency is defined as holdings of balances in that currency, plus outstanding contracts for future receip t, minus outstanding contracts for future delivery of that currency, i . e . , as the sum of these e le ments with due regard to sign. Votes for this action: Messrs. M ille r, Volcker, Baughman, Coldwell, Eastburn, Jackson, Partee, W allich, W ille s, and Winn. Votes against this action: None. Absent and not voting: Mr. Gardner. Under the f i r s t sentence of paragraph ID, which was not affected by the foregoing amendment, the Federal Reserve Bank of New York is authorized, for System Open Market Account, to maintain an o v e r-a ll open position in a l l foreign currencies not exceeding $ 1.0 b i l l i o n , unless a larger position i s expressly authorized by the Com m ittee. On March 21, 1978, the Committee had authorized an open position of $2.25 b illio n in view o f the scale of recent and poten t i a l System operations in foreign currencies. On May 16, 1978, the 37 6/20/78 -19- Committee had reduced this lim it to $2 .0 b illio n , in lig h t of decreases in the System's open p ositio n . Against the background of further decreases in the open p ositio n , the Committee reduced the lim it to $ 1 .5 b illio n at this meeting. Votes for th is action: Messrs. M ille r, Volcker, Baughman, Coldwell, Eastburn, Jackson, Partee, W allich, W ille s, and Winn. Votes against this action: None. Absent and not voting: Mr. Gardner. 4. Procedural instructions with respect to operations under the foreign currency documents In December 1976 the Committee had adopted certain procedural instructions for the purpose of c larifyin g the respec tiv e roles of the Committee, the Foreign Currency Subcommittee designated in paragraph 6 of the authorization for foreign currency operations, and the Chairman in providing guidance to the Manager of the System Open Market Account with respect to proposed or on going foreign currency operations under the authorization and the foreign currency d ire ctiv e . Paragraph IB of the instructions called for clearance of any transactions that would result in gross trans actions in a sin gle foreign currency exceeding $100 m illion on any day or $300 m illion since the most recent regular meeting of the Com m ittee. At it s meeting in March 1978 the Committee amended paragraph IB to increase these d ollar lim its , which had occasionally hampered ongoing operations, and to remove an ambiguity in the language. 38 6/20/78 -20- At this meeting the Committee decided to discontinue the use of the concept of gross transactions in the procedural in structions. In i t s stead i t introduced (a) a clearance require ment formulated in terms of daily and inter-meeting changes in the System's net position in a single foreign currency and (b) a require ment for clearance of any operation that might generate a substan t i a l volume of trading in a particular currency by the System, regardless of the e ffe c t on the System's net position in that cur rency. The purpose of these changes was to improve the e ffe c tiv e ness of the consultation procedure. In addition, for the sake of c la r ity the word ’'transaction" was replaced by the word "operation" wherever the former had occurred in the in structions. The two new provisions were iden tified as paragraphs IB and 1C. Paragraph 1A, which refers to d aily and inter-meeting changes in the System's ov e r-a ll open position in foreign currencies, was retained, and the paragraph previously designated 1C, which re la te s to swap drawings by foreign central banks, was redesignated ID. With these changes, the procedural instructions read as follow s: In conducting operations pursuant to the authorization and direction of the Federal Open Market Comnittee as set forth in the Authorization for Foreign Currency Operations and the Foreign Currency D irective, the Federal Reserve Bank of New York, through the Manager of the System Open Market Account, shall be guided by the following procedural understandings with respect to consultations and clearance with the Committee, the Foreign Currency Subcommittee, and the Chairman of the Committee. A ll operations undertaken pursuant to such clearances sh all be reported promptly to the Committee. 39 6/20/78 -21- 1 . The Manager sh all cle a r with the Subcommittee (o r with the Chairman, i f the Chairman b e lie v e s that con su lta tion with the Subcommittee is not fe a s ib le in the time a v a ila b le ): A . Any operation which would re su lt in a change in the System’ s o v e r-a ll open p ositio n in foreign cur rencies exceeding $100 m illion on any day or $300 m illion since the most recent regular meeting of the Conmittee. B. Any operation which would re su lt in a change in the System1s net position in a sin gle foreign cur rency exceeding $100 m illion on any day or $300 m il lio n since the most recent regular meeting o f the Committee. C. Any operation which might generate a substan tial volume of trading in a particular currency by the System, even though the change in the System* s net positio n in that currency might be le s s than the lim its specified in IB. D. Any swap drawing proposed by a foreign bank not exceeding the larger of ( i ) $200 m illion or ( i i ) 15 per cent of the size of the swap arrangement. 2 . The Manager shall clear with the Coranittee (or with the Subcommittee, i f the Subcommittee b elieves that consultation with the f u ll Conmittee is not fe a sib le in the time a v a ila b le , or with the Chairman, i f the Chairman believes that consultation with the Subcommittee is not fe a sib le in the time availab le) : A . Any operation which would re su lt in a change in the System's ov e r-a ll open p ositio n in foreign cur rencies exceeding $500 m illion since the most recent regular meeting of the Committee. B. Any swap drawing proposed by a foreign bank exceeding the larger of ( i ) $200 m illion or ( i i ) 15 per cent o f the size of the swap arrangement. 3* The Manager sh all also consult with the Subcommittee or the Chairman about proposed swap drawings by the System, and about any operations that are not of a routine character. Votes for this action : Messrs. M ille r , Volcker, Baughman, Coldwell, Eastburn, Jackson, Partee, W allich, W ille s , and Winn. Votes against this action : None. Absent and not voting: Mr. Gardner. 40 [The following letter was received from the Department of the Treasury in regard to H.R. 12621. See also page 10 of the Hearing.] DEPARTM ENT O F TH E TREASURY O F F IC E O F T H E G E N E R A L C O U N S E L W A S H IN G T O N . D .C . 20220 AUG 3 1978 Dear Mr. Chairman: Reference is made to your request for the views of the Department of the Treasury concerning H.R. 12621, a bill "To expand the class of collateral eligible for use as security for Federal Reserve notes." Under the second paragraph of section 16 of the Federal Reserve Act (12 U.S.C. 412) a Federal Reserve Bank applying for Federal Reserve notes must post collateral in an amount equal to the Federal Reserve notes applied for and issued. The collateral may consist of, among other things, "direct obligations of the United States." H.R, 12621 would amend that paragraph to expand the list of eligible collateral to include any obligations which are fully guaranteed as to principal and interest by the United States or any agency thereof. This Department has no objection to the enactment of H.R. 12621. The Office of Management and Budget has advised that there is no objection from the standpoint of the Administration's program to the submission of this report to your Committee. S in c e r e ly y o u rs , Deputy General Counsel The Honorable Parren Mitchell, Chairman Subcommittee on Domestic Monetary Policy House of Representatives Washington, D. C. 20515 o