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91ST CONGRESS 1
1st Session
OTTMATP
J
FEDERAL
/
SENATE
RESERVE
SYSTEM
{
DISCOUNT
PROPOSALS
FOR
REPORT
NO_ 91 _G
MECHANISM:
CHANGE
R E P O R T
OF THE
JOINT
ECONOMIC
CONGRESS
OF
THE
COMMITTEE
UNITED
STATES
TOGETHER WITH
SUPPLEMENTARY VIEWS
FEBRUARY 6, 1969.—Ordered to be printed
Filed under authority of the order of the Senate of February 4, 1969
U.S. GOVERNMENT PRINTING OFFICE
98-010 O
WASHINGTON : 1969
For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.C. 20402 - Price 10 cents
JOINT E C O N O M I C
COMMITTEE
[Created pursuant to sec. 5(a) of Public Law 304, 79th Cong.]
WEIGHT PATMAN, Texas, Chairman
WILLIAM PROXMIRE, Wisconsin, Vice Chairman
HOUSE OF REPRESENTATIVES
RICHARD BOLLING, Missouri
HALE BO GGS, Louisiana
H E N R Y S. REUSS, Wisconsin
MARTHA W. GRIFFITHS, Michigan
WILLIAM S. MOORHEAD, Pennsylvania
WILLIAM B. WIDNALL, New Jersey
DON ALB RUMSFELD, Illinois
W. E. BROCK, 3D, Tennessee
BARBER B. CON ABLE, Jr., New York
SENATE
JOHN SPARKMAN, Alabama
J. W. FULBRIGHT, Arkansas
HERMAN E. TALMADGE, Georgia
STUART SYMINGTON, Missouri
ABRAHAM RIBICOFF, Connecticut
JACOB K. JAVITS, New York
JACK MILLER, Iowa
LEN B. JORDAN, Idaho
CHARLES H . P E R C Y , Illinois
JOHN R . STABK, Executive
Director
JAMES W. KNOWLES, Director of Research
ECONOMISTS
RICHARD F . KAUFMAN
FBAZIEB KELLOGG
ROBEBT H . HAVEMAN
JOHN R .
KARUK
DOUGLAS C . FEECHTLINO (Minority)
( M E M B E R S H I P OF C O M M I T T E E , 90TH CONG., 2 D SESS.)
JOINT E C O N O M I C C O M M I T T E E
[Created pursuant to sec. 5(a) of Public Law 304,79th Cong.]
WILLIAM PROXMIRE, Wisconsin, Chairman
WRIGHT PATMAN, Texas, Vice Chairman
SENATE
JOHN SPARKMAN, Alabama
J. W. FULB RIGHT, Arkansas
HERMAN E. TALMADGE, Georgia
STUART SYMINGTON, Missouri
ABRAHAM RIBICOFF, Connecticut
JACOB K. JAVITS, New York
JACK MILLER, Iowa
LEN B. JORDAN, Idaho
CHARLES H. PERCY, Illinois
HOUSE OF REPRESENTATIVES
RICHARD BOLLING, Missouri
HALE BOGGS, Louisiana
H E N R Y S. REUSS, Wisconsin
MARTHA W. GRIFFITHS, Michigan
WILLIAM S. MOORHEAD, Pennsylvania
THOMAS B. CURTIS, Missouri
WILLIAM B. WIDNALL, New Jersey
DONALD RUMSFELD, Illinois
W. E. BROCK 3D, Tennessee
JOHN R . STABK, Executive
Director
JAMES W. KNOWLES, Director of Research
ECONOMISTS
WILLIAM H . MOOBE
ROBEET H . HAVEMAN
FBAZIEB KELLOGG
RICHARD F . KAUFMAN
JOHN R . K A R U K
DOUGLAS C . FRECHTLING
(H)
(Minority)
C O N T E N T S
Page
Introduction
1
I.
II.
III.
IV.
V.
2
2
3
4
4
Uses of the discount mechanism
The discount mechanism as a tool of monetary policy
The discount rate as a tool of monetary policy
The discount mechanism as an aid to individual banks
The discount mechanism in national financial emergencies
Supplementary views of Representative Patman
(Hi)
7
91ST CONGRESS
1st Session
)
SENATE
J
J
j
REPORT
No. 91-8
FEDERAL RESERVE DISCOUNT MECHANISM:
SYSTEM PROPOSALS FOR CHANGE
FEBBUABT 6,1969.—Ordered to be printed
Filed, under authority of the order of the Senate of February 4,1969
Mr.
from the Joint Economic Committee,
submitted the following
PROXMIRE,
REPORT
together with
SUPPLEMENTARY VIEWS
INTRODUCTION
. Current proposals by a Federal Reserve intra-System Committee
calling for redesign of the discount window—the device by which the
Fed lends to member banks seeking to enlarge their reserves—are
likely to strike many people as essentially technical questions of interest only to the member banks themselves. They are, after all, the ones
who come to " the window," or at least have access to it, and hence are
directly affected by lending policies, procedures, and attitudes which
confront them there. The brief hearings which the Joint Economic
Committee held on September 11 and 17, 1968, dealing with the
System Committee's proposals—involving the first major overhaul of
the discount mechanism in well over a decade—amply demonstrated
that a great deal more is involved in the regulations governing advances
and discounts than the parochial concern of member banks alone.
Just how much more is involved is suggested by the range of expert
testimony received by our committee. On the one hand, there was
recommendation that any overhaul had best provide no window at all,
calling for complete elimination of the discounting apparatus as an
"anachronistic" and "disturbing element" in the monetary system.
[NOTE.—Senator Symington states: "Because of other committee assignments,
I was not able to participate fully in the hearings on which this report is based;
therefore, I wish to reserve judgment on the conclusions and recommendations
contained herein."]
m
2
This position was matched at the other extreme by recommendation
for a more venturesome experiment calling for removal of existing
regulatory constraints in order to provide a window with a substantially enlarged outlook "freely open during business hours at a
posted rate or rates."
The limited hearing which we had, convinced the members of this
committee who were able to participate that the proposals for redesign
call for further study by the Banking and Currency Committees of
Congress before being put into effect by administrative order of the
Board of Governors.
The proposed redesign of the discount window should be an occasion
for congressional reexamination of other related parts of the structure.
Going beyond the proposed detailed procedural changes, consideration
should be given to the place of discounts and advances in a modern
central bank and their impact, through the interest rate pattern, on
mortgage-oriented thrift institutions. Especially worthy of consideration, in depth, is the present statutory policy which limits direct
access to the discount mechanism to member banks—less than half
of the commercial banks of the country, albeit large ones—and provides effective contact for the rest of the Nation's financial system
scarcely at all.
Perhaps the best way to expose the issues is to ask: What should
be the functions of the discount mechanism? What useful public and
private services should be expected of it?
I. Uses of the Discount Mechanism
The rationale and appraisal of the discount mechanism can best
proceed by distinguishing its possible service to at least three different
objectives. First is its role as an instrument of monetary policy affecting
the reserve position of the banking system and thereby controlling
the money supply and promoting economic stabilization. Second is
its role in providing a source of credit to individual member banks
enabling them to adjust reserves to meet short-term, seasonal and
emergency, needs. Finally is its role as a backstop to widespread
financial disturbance serving as a "lender of last resort"—an institution charged with the sovereign responsibilities to create money and
provide liquidity when and as required by the national interest.
II. The Discount Mechanism as a Tool of Monetary Policy
Although often cited, along with open market operations and changes
in member bank reserve requirements, as one of the available instruments
for monetary regulation} the discounting mechanism, unlike the others,
depends too much upon the initiative of the private member banks to be
rated high as a tool for monetary management or control of the money
stock. The role of the monetary managers in "discounting" is largely
passive, limited to posting a rate to be charged on advances and then
approving or disapproving loan applications put forward by would-be
borrowers. The monetary policy impact of advances granted to individual banks may either be accommodated or offset in terms of the
Nation's monetary aggregates with a considerable degree of precision
by other actions taken at the option of the monetaiy authorities.
3
The minor role of the discount window in the service of monetary
management or controlling the money stock was underscored at our
recent hearings. The report of the System Committee emphasizes that
its proposals are expected to have little significance to overall monetary supply in saying:
* * * These changes look forward to a generally higher level
of borrowing being done by a rotating sample of member
banks. However, such a higher level of T>orrowing would not
mean a corresponding increase in total reserves, since increased borrowing would be expected to be about offset by
correspondingly smaller net System purchases of securities
in the open market.
Another factor which tends to downgrade the role of the discount
mechanism in monetary policy is the attractive alternative channels
which are available to banks as sources for needed reserves. There is,
first, a well-organized, active and resilient market for purchase and
sale of reserves, the so-called Federal Funds market, bv which available reserves may be passed about and better mobilized among member banks without recourse to the regional Reserve bank or adding to
the aggregate of available reserves in the System. There is also an
effective Euro-dollar market through which banks with foreign
branches may draw upon foreign sources. During the "credit crunch"
in the last half of 1966, U.S. banks actually decreased their borrowing through the Federal Reserve discount window by several
hundred million dollars while increasing their liabilities to foreign
branches by over $2 billion. Currently, although borrowings at the
Federal Reserve are sizable by historical standards, they amount to
only one-tenth the amounts supplied by European sources.
Whatever else may be said about discounting, one would have to
say that any instrument which (1) depends for its use initially upon
the actions of the private commercial bankers; (2) can have its effect
offset or sterilized at will by the monetary managers; and (3) may
be so easily and satisfactorily bypassed, hardly merits description or
concern as a tool of general monetary policy.
III. The Discount Rate as a Tool of Monetary Policy
In keeping with the concept of a more automatic, predictable discount
window and this committee's earlier recommendation for more precise
guidelines governing growth in the money stock, we approve the intraSystem proposals which would minimize the so-called announcement
effect of discount rate change.
Although the discounting mechanism itself can be dismissed as a
significant monetary tool, the discount rate—the rate of interest
charged borrowing banks—has often been characterized as a useful
symbolic device supporting and pointing the way of monetary policy.
One difficulty with the widespread supposition that the Fed is trying
to say something through sporadic and infrequent changes in the discount rate—there have been only eight changes in the past 8 years—
is that the message comes through ambiguous and unclear. Is the Fed
leading the market and initiating a new phase in monetary policy or is
it simply adjusting to or moving in tandem with market rates?
Even more serious than the risk of misinterpretation is evidence in
published reports of Open Market Committee meetings that from time
to time the Federal Reserve seems to have done things it ought not to
have done, or left undone those things which it ought to have done,
because it has been afraid of the unpredictable announcement effects.
The move to link the discount rate to market rates through more
frequent change and by relatively small increments should achieve a
better and more active pattern of communication within the System
and the financial community. When the Fed wants to announce something it should do it in plain English, and say what it means, and not
talk mystique through the discount rate.
IV. The Discount Mechanism as an Aid to Individual Banks
Policies and procedures at the discount window should provide clear-cut
access for member banks to Federal Reserve lending facilities on objectively defined terms and conditions with the minimum opportunity for
differences in administration from one borrowing member to another and
from one regional Reserve bank to another. To the extent that the proosals of the intra-System Committee promote this end, they are to
Ee commended.
Rules governing monetary processes should be as clear, consistent,
and unambiguous as possible. The Joint Economic Committee has
long urged this principle. At a broader policy level than the discount
window itself, this recommendation for predetermined standards and
guidelines lies behind the committee's insistence upon some rule—
specifically a rule keyed to the rate of economic growth—in governing
expansion of the money supply. Obscurity and mystique have too
long characterized operations of central banks.
V. The Discount Mechanism in National Financial Emergencies
The ultimate source of liquidity for the Nation's economy—the ability
to meet financial obligations promptly when they come due—rests on the
constitutional power to create and regulate the value of money. The
federal Reserve System, to which this power over money has been delegated,
may consequently be required on occasion to lend to financial institutions
other than member banks. In this role, the System is often referred to as
a lender of last resort" although the responsibility should more accurately
emphasize its role as "supplier of liquidity" than its lender aspect
It is in this area of emergency assistance that the current functioning
ot the discount mechanism seems most in need of rethinking to eliminate ambiguities and possible inadequacies. The System Committee
sets up a set of qualifications for lending or offering to lend to nonmember institutions indicating that the responsibility for carrying
LLNS\TCZ^ITREET;S
E K T E D
^
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^
In contrast to the case of member banks, however, justincation for Federal Reserve assistance to nonmember institutions must be in terms of the probable impact of failure
on the economy's financial structure. It would be most
unusual for the failure of a single institution or small group
' W ® 8 ! £ h a V 6 Suc.h significant repercussions as to
justify Federal Reserve action.
^
5
These restrictions effectively rule out emergency aid, direct or
indirect, to small or parochial nonmember banks or institutions.
Only distress of the very largest, more pervasive national institutions
is likely to have significant impact, under the formula, on the financial
structure of the country as a whole. Let there be no misunderstanding;
the smaller banks, nonbank institutions, and even whole sectors of
the economy it would seem, must look elsewhere for their "lender of
last resort" and they would continue having to do so under the proposed revision of discount facilities. This they have, in part, in the
Federal home loan banks, which are authorized to provide credit
reserve for their 5,000 savings and loan, building and loan, and
insurance company member institutions. During "the great depression" emergency "lenders of last resort" were established in the
Reconstruction Finance Corporation, the Home Owners* Loan Corporation, and Federal Farm Mortgage Corporation. In ordinary times
such emergency agencies are, of course, not available. For those institutions who do not have access to established or emergency "windows,"
aid must come through the conduit provided by correspondents or
member banks.
The competitive position of nonbank financial institutions could
be threatened, and particularly mortgage-oriented thrift institutions
which are the keystone to the Nation's housing industry. Given present
access and, under the proposals, even more ready access to the discount mechanism as a source of liquidity, the commercial banks are
in a far better position to weather credit stringency such as that
which faced the economy in 1966. At that time the housing industiy
was badly pinched by high rates and the unavailability of loanable
funds while other businesses managed to carry on with internal funds
and commercial bank loans. It is a questionable monetary policy which
makes the housing industry bear the brunt of restrictive credit policy.
For this reason the Banking and Currency Committees will want
to examine thoroughly the discount window proposals and their
implications to the thrift institutions.*
The compatibility of the activities expected of the Federal Reserve
System (1) as manager of the Nation's money supply, (2) as a source
of needed liquidity for individual member banks, and (3) as a source
of emergency aid to institutions which lend at long term and have not
themselves accepted the obligation of membership in the Federal Reserve System, is a major issue which needs further examination. Congress should certainly leave no room for misunderstanding of the
System's responsibility for the performance of each of these several
functions.
One school of thought presented to our committee was that the
Federal Reserve should be expected to make no commitment to support any individual sector of the economy. This school of thought
would keep the Federal Reserve relatively pure as an instrument in
monetary policy, charged with supplying reserves, focusing its energies
upon money supply and the problems of inflation, deflation, and national economic health.
•Governor Mitchell In his testimony noted that " T h e Federal Reserve Act authorizes direct advances
to nonmembers, but only if collateralized by U.S. Government securities. Since most nonmember institutions of the types apt to require em°rgency credit assistance do not have sizable holdings of this asset, credit
would normally be extended through a conduit arrangement with a member bank."
6
On the other hand, there is substantial support for the view, both in
Congress and elsewhere, that the Federal Reserve System may properly De charged, for example, with supporting the long-term versus the
short-term market for credit. Participants in more recent discussions
have urged Federal Reserve purchase of obligations of intermediate
financial institutions.
The choice between these two concepts of the proper role of a central bank's "discount window" calls for further study and action by
the Congress, leading to legislative directives, removing all doubt as
to the meaning of "lender of last resort" in the context of the Federal
Reserve authorities.
SUPPLEMENTARY VIEWS OF REPRESENTATIVE PATMAN
While I agree with the views expressed by my colleagues in this
report, I believe that one facet of the Federal Reserve Board's planned
redesign of the discount mechanism merits considerably greater
attention.
In recognition of the great pressure placed on nonbank financial
intermediaries by restrictive monetary policies, the Federal Reserve
proposes to implement its role as "lender of last resort" for these
institutions, under certain conditions. These conditions are so restrictive, however, as to make access to the discount window all but
impossible for the thrift institutions. On the other hand, the ease with
which commercial banks will be able to avail themselves of the discount facilities provides them with an additional competitive advantage over the other financial intermediaries, an advantage which
I feel is unwarranted and unsound in terms of public policy.
The "credit crunch" of 1966 presented us with clear evidence
that it is the nonbank financial intermediaries—the savings and loan
associations, mutual savings banks, and credit unions—far more than
the commercial banks, that are in greatest need of a safety valve in
tight-money periods. The Federal Reserve proposals will^ aggravate,
rather than ease, the inequitable burden placed on these institutions
by stringent monetaiy policy.
What is needed to redress this imbalance between the commercial
and thrift institutions is some action to give the latter meaningful
access to the discount window in times of financial difficulties. I
believe that the provisions of the bill, H.R. 19417, which I introduced
in the House this past September, would accomplish this goal.
In times of credit scarcity, the commercial banks have several
sources from which they can obtain the liquidity needed by their
business customers. They can sell holdings of Government securities;
they can attract funds by raising the interest offered on certificates
of deposit; they can borrow on the Euro-dollar market. As a result
of the suggested redesign of the Federal Reserve discount window,
they would have an extra easy source of credit.
The thrift institutions have none of these options. When credit
gets tight, they suffer a loss of funds to the more powerful investment
opportunities. The major casualties of this loss of liquidity are the
housing industry and home-mortgage seekers.
The Federal Reserve now proposes to act as lender of last resort
to the nonbank financial intermediaries; however, this would be
limited to emergency situations of major economic significance.
Moreover, it would employ commercial banks as a conduit, and require
that the financial intermediaries pay a rate higher than the basic
discount rate paid by the commercial banks. All of these restrictions
effectively nullify any benefits which the Fed appears to be offering
nonmember financial institutions, and they would weigh the competitive balance further in favor of commercial banks.
(7)
8
The commercial banks will be able to avail themselves of the discount window at any time they find it necessary. Restricting the use
of these facilities by the thrift institutions to times of emergency
places them at a severe disadvantage. The further stipulation of the
Board that "failure of the troubled institutions * * * [must] have
significant impact on the economy's financial structure" before they
are granted relief effectively removes this source of aid from all but the
major nonbank financial intermediaries. What will happen to the
small, local savings and loan association which is experiencing dimculties in supplying its local customers with mortgage credit?
The use of commercial banks as the conduit through which Federal
Reserve funds are to flow to the thrift institutions seems a highly
unrealistic proposal. In the first place, the commercial banks are
competitors of the savings and loan associations and mutual savings
banks, and it is unreasonable to provide the commercial banks with
control over the ability of their competitors to do business. Furthermore, in times of credit scarcity, it is to be expected that the banks will
prefer to satisfy the needs of their regular, major business customers
rather than those of a competitive organization.
The higher interest rate that would be required of the nonbank
financial intermediaries for this indirect discount window credit is
also inequitable. The housing and home-financing industries are highly
sensitive to changing interest rates. By forcing the thrift institutions
to pay higher rates to obtain funds, and thus to pass these higher
rates on to their customers, the housing sector pays the double
penalty of credit being both scarce and more expensive than in other
sectors of the economy.
One means of preventing these undesirable consequences of the
Federal Reserve's redesign proposals is contained in the bill I submitted to the House, providing for direct use of the discount window
facilities by thrift institutions. By extending these facilities on a
regular basis to the thrift institutions, and by broadening the definition of "eligible paper" which the Federal Reserve can discount or
accept as collateral to include home mortgages and consumer finance
paper, this bill would extend to the nonbank financial intermediaries
the same outlet in periods of financial difficulty enjoyed by the
commercial banks.
Prior to these Joint Economic Committee hearings on the Federal
Reserve discount window proposals, I wrote a letter to Governor
George W. Mitchell of the Federal Reserve Board, requesting his
views on the measure I had introduced in the House.
The letter is printed below with Governor Mitchell's reply :
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C., September 5,1968.
H o n . GEORGE W . MITCHELL,
Member, Board of Governors, Federal Reserve System, Washington, D.CD E A R GOVERNOR MITCHELL: It is my understanding that you will
appear before the Joint Economic Committee on September 11 at
10 a.m., to discuss the changes proposed in the Federal Reserve
System's discount window operations* Due to a prior commitment it
will be impossible for me to attend this session which, as you know,
is on a subject in which I have a great deal of interest.
9
You may be aware of the fact that oil September 4 I introduced
a bill, H.R. 19417, copy enclosed, which would amend the Federal
Reserve Act to broaden the eligibility for use of the discount privilege.
This bill has as its singular objective allowing institutions insured by
the Federal Savings and Loan Insurance Corporation, mutual savings
banks, and Federal Credit Unions to make direct use of the discount
window facilities.
It would be appreciated if you would supply for the record when
you appear before the Joint Economic Committee your views on this
matter and if possible the views of the rest of the members of the
Federal Reserve Board on this legislation.
Your cooperation in this matter will be greatly appreciated.
Sincerely yours,
WRIGHT PATMAN, Chairman.
BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM,
Washington,
H o n . WRIGHT PATMAN,
October 9, 1968.
Chairman, Committee on Banking and Currency,
House of Representativesj Washington, B.C.
D E A R M R . CHAIRMAN: This is in response to your letter of September 5 in which you requested my views on a bill, H.R. 19417.1 believe
that my colleagues on the Board generally concur with the following.
This bill would amend the first sentence of the second paragraph of
section 13 of the Federal Reserve Act (12 U.S.C. 343), pertaining to
discount of commercial, agricultural, and industrial paper. It would,
as we interpret it, change the System's authority in this area in two
wa^s. First, it would extend the discount privilege on a regular basis
to institutions other than member banks—i.e., federally insured
savings and loan associations, mutual savings banks, and Federal
credit unions. Secondly, it would expand the present definition of socalled eligible paper to include home mortgages and consumer finance
paper.
The bill would, however, apparently not change the last sentence of
the second paragraph of section 13, which states that "notes, drafts,
and bills admitted to discount under the terms of this paragraph
must have a maturity at the time of discount of not more than 90
days, exclusive of grace." In view of this, it seems doubtful that this
bill would result in any large increase in the amount of paper actually
eligible for rediscount, since most home mortgage ana consumer
paper could not meet this maturity requirement.
The more significant aspect of H.R. 19417 is clearly the first change
referred to; namely, the extension of the discount privilege on a regular
basis to institutions other than member banks. As a general principle,
the Board is opposed to extending discount window access on a
regular basis to financial institutions other than those that maintain
specified levels of required reserves and related day-to-day reporting
ties with the Reserve banks.
These reserve requirements serve a fundamental purpose of monetary policy, imposing a finite limit on the expansion of bank credit
which can result from a given base. Without this kind of control
10
monetary policy would lose a key element in its ability to influence
economic activity, and reserve requirements therefore have a public
benefit reaching far beyond that of the subject institutions. In addition, the requirement that institutions maintain these reserves on a
week-by-week basis is one of the major factors creating needs for
credit assistance of a kind that can be met at the discount window.
In addition to fulfilling reserve requirements, member banks, the
only institutions now meeting the above conditions, are subject to
day-to-day scrutiny by the System through daily reporting of reserve
operations in their clearing accounts. These reports are augmented by
reports of condition and other regular statistical reports submitted by
the banks as well as by periodic examinations. In addition, Federal
Reserve banks hold in custody significant amounts of the most marketable assets owned by member banks. As a result of these relationships, the Reserve banks make loans to member banks with a substantial awareness of the current circumstances of the borrowing bank.
Such would not be the case with otherfinancialinstitutions, and only
by maintaining a direct day-to-day reporting relationship with institutions can the System stay adequately informed to undertake a
day-to-day lending relationship.
This should not be taken to imply that the System does not recognize the possible need to lend to other institutions under emergency
conditions. As this committee is aware, section 13, paragraph 13 of the
Federal Reserve Act, authorizes lending to "any individual, partnership or corporation," Such action was seriously contemplated in the
summer of 1966 in the case of mutual savings banks, and, in fact,
specific arrangements were set up to carry out such an operation.
While use of these arrangements did not then prove necessary, the
recently published report of the System committee on redesign of the
discount mechanism articulated and reaffirmed these arrangements
as being the appropriate way to deal with emergency conditions when
Federal Reserve action becomes necessary for any class of nonmember
financial institutions.
Under the current statute, this kind of credit extension must in
most cases be done indirectly, using a member bank or, where appropriate, the responsible Government agency as a conduit, since direct
loans must be secured by U.S. Government or agency securities, and
those latter assets are not held in any sizable volume by most nonmember institutions. The conduit procedure, whereby the Federal
Reserve would lend funds to a cooperating member bank which would,
in turn and by prior agreement, make loans to the nonmember institutions, is a workable and logical extension of established business
practices. This procedure could be used in emergencies without great
difficulties.
With regard to the other principal provision of H.R. 19417, the
inclusion in the eligible paper definition of home mortgages and consumer finance paper, the Board would question the efficacy of this
type of "piecemeal" broadening of eligibility requirements. As this
committee is aware, the Board is concerned about the current narrow
restrictions on the types of paper which may be acceptetl from member
banks for discount or as collateral for advances. Shortages of bank
holdings of these types of paper as well as of U.S. Government and
agency securities not otherwise pledged can needlessly complicate the
lending operation and could at times have serious implications for the
11
operation of the discount window, forcing member bank borrowings
to be done under section 10(b) at a penalty rate of interest. In addition,
the eligibility concept is based on an outmoded and disproven theory—
that the legitimate needs of the economy for bank credit would always be exactly reflected in the volume of these short-term, selfliquidating loans—and causes unnecessary administrative burdens for
both the member banks and the Reserve banks.
The possibility of a serious shortage of eligible paper is of course
lessened to a degree by any broadening of the restrictions, even one
so slight as we feel would in fact result from H.R. 19417. However,
the Board feels that a far more practical approach in the long run
would be the complete elimination of the eligibility concept, to be
replaced by a provision that would permit loans collateralized by any
asset acceptable to the Reserve bank. Such a change is embodied in
the Senate-passed bill, S. 966, now pending in the House. The Board
would favor the broader provision of that bill on the issue of eligibility
requirements and strongly urges its passage.
As noted earlier, an even narrower restriction—limitation to U.S.
Government and agency securities—is imposed by paragraph 13 of
section 13 on the kinds of collateral which may be accepted from nonmember institutions borrowing directly from the Federal Reserve
under the emergency provisions. The conduit arrangement which
would generally be necessitated by this restriction is viewed as workable, as has also been noted. However, speaking for myself, I would
favor a broadening of this requirement also to any acceptable asset,
paralleling that recommended for member banks. It would seem likely
that such a change would at least in some cases simplify the procedures of emergency lending for all those concerned, and there
appears to be no strong logical reason for the current requirement
which would offset the benefits that might be gained by liberalizing it.
On a purely technical matter, we might note that H.R. 19417 would
allow advances on the security of the enumerated kinds of paper to
member banks, but would limit other institutions to the rediscount
procedure. (See sec. 13, par. 8.) This presumably would not be an
insuperable obstacle, but over the years member banks have come to
rely almost exclusively on the advance route, and it is the nearunanimous view of those involved that this is far more workable than
rediscounting.
In sum, with regard to the major issue involved in H.R. 19417, the
Board cannot endorse the principle of regular lending to institutions
which bear none of the costs of System membership and with which
the System has no direct day-to-day relationship. Rather it feels that
the normal credit needs of these institutions should continue to be met
through established channels, where a regular business relationship
already exists. Most types of nonbank financial institutions have
borrowing relationships with commercial banks as a matter of course,
and it would seem that in most cases these should prove adequate to
meet normal credit needs. In addition, in some areas, an appropriate
central lending agency exists. The Federal Reserve would, of course,
continue, in its role as lender of last resort to all sectors of the economy, to backstop commercial banks, central lending agencies, and
where necessary the institutions themselves to forestall any major
economic disruption.
Sincerely yours,
GEORGE MITCHELL.
12
In his response, Governor Mitchell admits that the present eligibility requirements are too narrow. However, he questions what he
terms the "piecemeal" approach to broadening these requirements
that he sees m my bill, and he objects to the extension of the Federal
Reserve System's discount facilities to nonmember institutions which
do not fulfill all the requirements of member banks, particularly those
pertaining to reserves.
I do not agree. The question of reserve requirements for nonbank
financial intermediaries is one which can be resolved. More important,
however, is the fact that there are far more compelling reasons for
commercial banks to hold reserves since, under our fractional reserve
system, they have the enormously influential power to create money
in our economy.
As to the question of methods of broadening eligibility requirements,
Governor Mitchell completely bypassed the major point of this entire
issue: the responsibility of the Federal Reserve as a public agency
should be to make public credit available to all institutions.
Recent crises have proven that the thrift institutions in our financial
sector are subject to great pressure from changing monetary conditions.
The Federal Reserve System is responsible for guiding the monetary
system in the interests of the Nation as a whole, not in those of the
commercial banking system in particular. We must therefore develop
the means of responding to the needs of the total economy, with no
discrimination in favor of an individual sector at the expense of the
remainder of the Nation.
O
WRIGHT PATMAN.
@FedFRASER