Full text of Federal Reserve Notes : August 1977

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Federal Reserve Notes
FEDERAL RESERVE BANK OF SAN FRANCISCO

•

AUGUST 1977

Serving Alaska, Arizona, California, Hawaii, Idaho, Nevada, Oregon, Utah & Washington

of San Francisco

SEP 1 1977
FED IMPROVES REVIEW

LIBRARY^

OF BANK APPLICATIONS
The Federal Reserve System has
taken steps to speed up its review of
bank and bank holding-company ap
plications, following procedures out
lined by Governor J. Charles Partee in
a letter to Reserve Bank Presidents.

Henceforth, Reserve Banks must act

on an application within 12 business

days, either by accepting the applica
tion for processing or notifying the
applicant that additional information

is needed. This action helps alleviate
confusion as to when actual process
ing of an application would begin.
Partee emphasized, however, that
about 80 percent of the acquisition
and merger applications filed by
banks and bank holding companies
already are processed in less than 90
days. "I believe that much criticism is
the result of lack of understanding on
the part of applicants as to the rea
sons for delays," he contended.

Displaying currency residue for visitors from the Bank of Canada is Assistant Vice
President M. C. Petersen of the Bank's Portland Branch. The guests are (from left) M.
Morin, Auditor; Ft. H. Osborne, Chief of Administrative Operations; and S. V. Suggett,
Assistant Chief of Operations.

PORTLAND DESTRUCTION PROCESS WINS PRAISE
Representatives from the Bank of
Canada—Canada's central

bank-

recently
inspected
the
model
currency-destruction equipment at

stroys millions of dollars in unfit cur
rency each month. The branch had
previously relied on an incinerator,

but found that process to be too cost
ly in terms of rising fuel prices, and

As a rule, applications are first sent to
the appropriate Reserve Bank for
review. Before the applications can

the Federal Reserve Bank of San
Francisco's Portland Branch. The vis

undesirable also from

be acted on, the documents must be

itors included R. H. Osborne, Chief of

mental standpoint.

complete in all respects. Delays can
occur because of such things as

the Department of Administrative Op
erations, S. V. Suggett, Assistant

insufficient current financial data. Ob

Chief, and M. A. Morin, the Bank's

jections from various sources—other
banking institutions, supervisory au
thorities, Federal agencies and the

Auditor. Osborne is responsible for
currency destruction throughout
Canada.

public—as well as court proceedings
can delay final action.

When applications involve the expan
sion of the list of permissible bank
holding-company
activities,
the
Board is required to make extensive
staff studies. Public comments may
be called for, and sometimes formal
(continued on page 2)

"We were especially impressed by
the efficiency and environmental im
provements incorporated in the Port
land system," Osborne said. "It is
good to see success first hand."

The Portland disintegrator, which be
came operational in mid-1976, de

an environ

With the disintegrator system, curren
cy is mechanically shredded into a
residue resembling confetti, and au
tomatically compressed into a re
ceptacle for disposal with normal
waste paper. This process sharply
reduces fuel costs. Maintenance ex

penses are also slashed, since the
disintegrator features a self-feeder,
which permits currency to be destroy

ed without continual monitoring. ^

FED WORKS TO SIMPLIFY
TRUTH-IN-LENDING

WALLICH VIEWS BANK CAPITAL ADEQUACY

Both consumers and creditors stand

New ways to insure the soundness of
banks should be studied in light of the
impact of inflation on bank earnings
and capital, Federal Reserve Gover
nor Henry C. Wallich recently told the
Twelfth Annual Banking Law Institute.

to benefit from proposed revisions
which would make Truth-in-Lending
disclosure forms less complex and
easier to

understand, Federal Re

serve Governor Philip C. Jackson, Jr.,
told a Congressional subcommittee
last month.

The Fed official outlined a draft bill,
phrased in simple English, that would

cut nearly in half the number of disclo
sures required of creditors in credit
statements. "We believe that clarity is
better served if only the most impor
tant terms are emphasized on the
disclosure statement," Jackson com

IN LIGHT OF INCREASED INFLATION

The Fed official said that adequate
capital remains the first line of de
fense in protecting the financial sys
tem, but he argued that inflation has
severely reduced the true income of
banks. He said that this situation

raises fundamental questions about
the ability of the banking system to

generate sufficient earnings in order

mented. "The rest will be in the con

to maintain capital ratios, or to sell
enough new stock to achieve that

tract, just as now."

purpose.

According to the draft bill, the form
would be written in plain English, so
that consumers could immediately
recognize such basic items as the
amount being financed, the finance
charge and the total and monthly pay
ments.

Despite the substantial amount of
litigation developing around Truth-inLending regulations, such lawsuits
still represent only two percent of the
civil case load nationally. The Fed
proposals would serve to reduce
such litigation even more by limiting
the civil liability to seven types of
disclosure violations, instead of over

a dozen. It would also eliminate litiga
tion resulting from purely technical

He

noted

that

the

substantial

in

creases reported in bank capital
practically had disappeared after ad
justments were made for this dec
ade's inflationary upsurge. Inflationadjusted capital, stated in constant
dollars, increased only from $75.4
billion in 1972 to $80.5 billion in 1975.

"It should not be surprising to find that
bank capital tends to shrink during
inflation," Wallich said. "Bank capital
is essentially money, and money
loses value through inflation. To
maintain the real value of their capital
during inflation, and its normal growth
from retentions, banks would have to
earn a rate that, after taxes, would
cover the rate of inflation in addition to

violations. at

providing a normal return."

FED IMPROVES REVIEW

The Fed official stated that the norm

(continued from page 1)

hearings are necessary. Staff investi
gation is required when there may be
possible violations of the Bank Hold
ing Company Act, when commit
ments have been made in past appli
cations, or when conditions have

for long-term earnings growth for
banks has been about 10 percent.
With recent rates of inflation, how

ever, banks' rate of return (after taxes)
would have to be half again as great
as that norm to maintain capital in real

terms and keep it growing through

been imposed by the Board.

retentions.

Partee said that the application proc
ess goes relatively smoothly despite

"I very much doubt that either bank
ers, or the public, or legislators would
regard such a rate of return on bank
capital as at all appropriate," he com

these unavoidable complicating fac
tors, and that changes now being
implemented will further streamline
the process. He added that the Sys

tem is paying special attention to the
way applications are processed and
supplemental information is obtained.

mented. "The area of bank earnings
and capital seems to be one of the last
bastions of money illusion."
Wallich said this situation makes it

very difficult to maintain an adequate
level of bank capital. The obvious
answer is to stop inflation, but until
that happens the maintenance of
adequate capital ratios becomes very
difficult. He said that it would not be

appropriate to limit the growth of bank
credit and the money supply through
more stringent capital requirements
for banks. Such a course of action

might cause a larger proportion of the
total flow of credit to move outside the

banking system.
Because of these conditions, he said

regulators should look for alternative
means of ensuring the soundness
and safety of the banking system.
One alternative might be the exten
sion of the principle of pooled insur
ance, as first implemented by the
Federal Deposit Insurance Corpora
tion. He admitted that banking author
ities have been cautious in moving in
this direction, because this form of
insurance tends to reduce the disci

pline imposed by the market upon the
banking system. Nevertheless, he
said that the further extension of this

principle could provide depositors
with greater safety while still leaving
some degree of risk.
Another

alternative

he

cited

was

graduated insurance premiums for
those banks with high-risk portfolios.
This approach could help impose a
form of discipline over bank risktaking.
"There exist several routes toward

the achievement of safety and sound
ness of the banking system," Wallich
concluded. "Adequate capital has
been the traditional major safeguard.
But if inflation makes it difficult for

banks to maintain adequate capital
ratios out of earnings, and simultane
ously makes it very costly (if not
impossible) to raise capital through
new issues, there are alternatives.

These would require very careful
study before anything decisive can be
said. But that study should be under
taken before we either accept a re
sumption of the trend toward lower
capital ratios or seek to maintain
these ratios by uneconomic means."

FED REVIEWS MERRILL LYNCH PLAN
FOR CREDIT AND INVESTMENT
A new credit and investment plan
known as a Cash Management Ac
count (CMA)—which combines ele
ments of credit cards, margin loans
and money-market funds—does not
violate any Federal Reserve regula
tions or statutes, according to a re
cent communication from the Board

of Governors. However, the Board is

still studying CMAs to determine any
possible adverse effect on monetary
policy and banking operations.
Under the plan developed by Merrill
Lynch, Pierce, Fenner and Smith, Inc.,
qualified customers could open a
CMA account by leaving securities in
a margin account. Idle funds in the

17V. Poole

POOLE NAMED
VISITING SCHOLAR

account would be invested automati

balances in the economy. The Board
will be studying these issues further,
and perhaps may want to consider
legislation or regulatory action to deal
with such issues."

The Board did not express any view
as to the legality of the CMA program
under

visions.

ics at Brown University, has been
appointed to serve the summer term
as a Visiting Scholar at the Federal

fund, and dividends would be earned

Reserve Bank of San Francisco.

receive

economists. Scholars from Stanford,

of

the

Glass-

In addition, the Board did not com

cally once a week in a money-market

Ohio State, the University of Oregon,
the University of Washington, and the
University of Chicago have held such
appointments with the bank. One of
the most recent Visiting Scholars was

21

ment on the possible implications of
CMA regarding Truth-in-Lending pro

William Poole, Professor of Econom

The Visiting Scholar position was
inaugurated at the San Francisco Fed
to encourage creative research and
the interchange of ideas by practicing

Section

Steagall Act, which deals with the
separation of commercial banking
from the brokerage business. The
Department of Justice is responsible
for enforcing Glass-Steagall, and Al
lison suggested that Merrill Lynch
should take up this issue with Justice.

daily

at

money-market

Merrill Lynch plans to implement
CMA plans on a pilot basis next month

rates.

CMA customers would also

in Atlanta, Columbus and Denver, if

prevailing
bank

checks and a

bank

credit card issued by City National

no objections are raised by the Jus
tice Department or bank regulatory

Bank of Columbus, Ohio. Card hold

authorities.^

ers could use the credit card to obtain

goods and services from merchants
as well as cash advances from par
ticipating banks.

FED STAFF STUDIES
PRIVATE PLACEMENT
A staff study by the Federal Reserve
Board of Governors concluded re

A customer's checking and card
transactions also would be backed by

cently that private placements of se

a direct line of credit based on the

curities for corporate clients are
"within the scope of permissible ac

Milton Friedman, the 1976 Nobel Lau

margin value of the securities in his
account. By borrowing on such an

tivities for commercial banks." How

reate in Economics.

account, he could obtain a substan

ever, the study added that this area is

After receiving his B.A. degree from
Swarthmore College, Dr. Poole
earned an M.B.A. and Ph.D. from the

University of Chicago. He has taught
at the Johns Hopkins University,
American University, George Wash
ington University, Georgetown Uni
versity, Harvard University, and also
at

the

Massachusetts

Institute

of

Technology.
Dr. Poole has served as a

Senior

Economist at the Board of Governors

of the Federal Reserve System in
Washington, D.C., and in addition, as
an Advisor at the Federal Reserve
Bank of Boston.

He is

a

member of the American

Economic Association, the American
Finance Association, and the West-

tially lower interest rate—about 6V2 to
8 percent—than the 12-to-18 percent
rate available with

credit cards or

instalment-loan plans.

Theodore E. Allison, Secretary to the
Fed's Board of Governors, said in a

letter to Merrill Lynch, "The Board is
concerned that the CMA plan and
other similar programs could have
adverse effects on the quality of
stock-market margin credit, could
lead to unregulated banking, and
could reduce effective monetary con
trol over the growth of transaction
ern Economics Association. In addi

tion, he is an Associate Editor of the

Journal of Money, Credit and Banking
and a Senior Advisor to the Brookings

Panel on Economic Activity. ^

"not free from doubt."

Chairman Henry S. Reuss of the
House Banking Committee requested
the study in order to evaluate attacks
on the practice by securities-industry
spokesmen. Some charge that com
mercial bankers have an unfair ad

vantage over investment bankers in
arranging private placements, and
others contend that this activity may
pose a conflict of interest for commer
cial banks.

The Fed staff study found that the

legal aspects governing this activity
were subject to differing interpretation
under the Glass-Steagall Act. (GlassSteagall provides for the separation of
commercial banking and investment
banking.) "The stronger case would
support a conclusion that assistance
(continued on page 4)

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BOOK-ENTRY PLAN

A limited number of Treasury bills still

Chairman

CONTINUES TO GROW

are offered to institutional investors

Congressman Reuss that the Fed
would be willing to work with the
House committee to develop legisla
tive proposals in this field, although it
has nothing specific in mind at the
present time.

required by law or regulation to hold
securities in "definitive" (paper) form.

Millions of potential paper certificates
became computer entries instead, as
the second phase of the book-entry
plan for Treasury securities was im
plemented this summer by theTreas-

$100,000 will be available to such

ury Department and the Federal Re
serve System.

As a public service to bankers and

Under the book-entry system, Treas
ury securities are recorded in the

of San Francisco has designated a
book-entry phone line to answer
questions about the new program.

accounts of banks or other financial

institutions acting as custodians for
investors. Instead of an engraved
certificate, the purchaser is given a
receipt as evidence of purchase.
The program was begun last Decem
ber with the offering of 52-week Tbills in book-entry form, and was con
tinued in the second phase with
26-week bills. The final phase will
occur next month as 13-week bills are

converted, marking the final transition

of bill issues to the new book-entry
system.

When fully implemented, the program
promises to save the government and
taxpayers millions of dollars from re

duced handling of paper certificates.
Investors too can save money be
cause the program eliminates the
possibility of lost securities, which
have amounted recently to about $1
million a month.

Definitive issues in denominations of

investors for all issues through De
cember 1978.

investors, the Federal Reserve Bank

Calls can be made to the Fiscal De

partment

at

any

of

the

Bank's

branches, or to (415) 544-2477 in San
Francisco.

More information is available through
films and slides that explain the oper
ation of the book-entry program. A12minute film provides a general de
scription of the program and the
procedures involved, and a lengthier
two-part slide show (with audio
cassette) provides more detailed in

Arthur

F.

Burns

wrote

In its study, the Fed staff surveyed six
large New York and Chicago banks
and separately analyzed the findings
of a Securities and Exchange Com
mission (SEC) survey of 256 banks. It
found that commercial banks were

involved in 94 private placements in
1976, amounting to $1.3 billion. The
great majority of these were made by
the large money-center banks. How
ever, no bank ranked in the top ten
firms in terms of value of placements.
In a separate report, the SEC dis
closed that 26 banks formally offer
private-placement advisory serv
ices. This compares with 272 regis
tered

broker-dealers active

in

this

particular field.

formation. Films and slides can be
obtained from the Bank Relations unit

at the nearest Fed office, iflp

Banks have informally provided
private-placement services for years.
Yet because of the small number of

PRIVATE PLACEMENT
(continued from page 3)

of private placements is not prohibit
ed by the act, and is within the scope
of permissible activities for commer
cial banks." Following completion of
the staff study, Federal Reserve

banks involved, the Fed staff con

cluded that significant economic or
financial concentration was unlikely
in the foreseeable future. Moreover,
Fed examiners found no evidence of

alleged abuses during their examina
tions of commercial banks' private-

placement activities. ~^pi