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9 Minutes for To: Members of the Board From: Office of the Secretary February 15, 1966 Attached is a copy of the minutes of the Board of Governors of the Federal Reserve System on the above date. 1/ It is not proposed to include a statement with respect to any of the entries in this set of minutes in the record of policy actions required to be maintained pursuant to section 10 of the Federal Reserve Act. Should you have any question with regard to the minutes, it will be appreciated if you will advise the Secretary's Office. Otherwise, please initial below. If you were present at the meeting, your initials will indicate approval of the minutes. If you were not present, your initials will indicate only that you have seen the minutes. Chm. Martin Gov. Robertson Gov. Balderston Gov. Shepardson Gov. Mitchell Gov. Daane Gov. Maisel Meeting with the Federal Advisory Council. 572 A meeting of the Board of Governors of the Federal Reserve System with the Federal Advisory Council was held in the Board Room of the Federal Reserve Building in Washington, D. C., at 10:30 a.m. on Tuesday, February 15, 1966. PRESENT: Mr. Mr. Mr. Mr. Mr. Mr. Mr. Martin, Chairman Balderston, Vice Chairman Robertson Shepardson Mitchell Daane Maisel Mr. Sherman, Secretary Mr. Kenyon, Assistant Secretary Messrs. Simmen, Moore, Stoner, Watlington, Fleming, Bodman, Brinkley, Moorhead, Knight, Stewart, and Cook, Members of the Federal Advisory Council from the First, Second, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth, Eleventh, and Twelfth Federal Reserve Districts, respectively Mr. Petersen, representing the Third Federal Reserve District Mr. Prochnow, Secretary of the Council Mr. Korsvik, Assistant Secretary of the Council The following officers had been elected by the Federal Advisory Council to serve for the year 1966: President Vice President Secretary Assistant Secretary John A. Moorhead Ransom M. Cook Herbert V. Prochnow William J. Korsvik The following had been elected members of the Executive ComMittee to serve with the President (Mr. Moorhead) and Vice President (Mr. Cook): William L. Day, John F. Watlington, Jr., and Sam M. Fleming. The following members of the Council had begun their service as such at the beginning of 1966 and were attending their first meeting 0f the Council: 573 2/15/66 -2- John Simmen, President, Industrial National Bank of Rhode Island, Providence, Rhode Island Henry T. Bodman, Chairman of the Board, National Bank of Detroit, Detroit, Michigan A. M. Brinkley, Jr., Chairman of the Board and Chief Executive Officer, Citizens Fidelity Bank and Trust Company, Louisville, Kentucky Robert H. Stewart, III, Chairman of the Board, First National Bank in Dallas, Dallas, Texas Howard C. Petersen, President of Fidelity-Philadelphia Trust Company, Philadelphia, Pennsylvania, represented the Third District at this meeting in the absence of William L. Day, member of the Council from that District. There had been distributed a memorandum listing the topics to be discussed at this meeting, together with the statement of the Council on each. The topics, the Council's statement on each topic, and a summary of the discussion at this meeting follow. 1. Economic conditions and prospects. A. How does the Council appraise prospects for economic activity and for industrial prices during the first half of 1966? The Council anticipates a further rise in the level of economic activity during the first half of 1966. This will reflect 1) a larger volume of consumer spending as incomes continue upward; 2) an expansion in capital investment as businessmen strive to accommodate growing demands; 3) an increase in outlays by State and local governments; and 4) a growth in expenditures by the Federal Government for domestic programs and for military needs in Southeast Asia. As these aggregate demands are likely to tax the productive resources of the U.S. economy, upward pressures on industrial prices seem certain to intensify. President Moorhead said that the foregoing statement seemed to reflect a uniform impression throughout all the Districts. 574 2/15/66 -3Mr. Cook commented that there was continued upward pressure on real estate prices. Wages in the construction industry were pushing upward vigorously because labor was already fully occupied in that industry, and the Viet Nam situation had added to the load. There was a certain amount of price push going on in anticipation of possible restrictive measures. While this did not show up too much in the statistics, people were saying in conversations that prices had better be gotten up now because of the possibility of controls coming into the picture. The spreading of such an attitude could generate Pressure for the accumulation of larger inventories. Price increases were coming along a little at a time, although most of them were rather hard to identify except in the service areas. Mr. Moore confirmed that more and more people were commenting about the price push. While it was difficult to tick off each and every item, there was a feeling that, in addition to the price increases in basic commodities that had hit the newspapers, increases were also taking place in other areas. There was some concern about the possi- bility of inflationary hedging, and more concern about the lack of Skilled labor and the pressures this would create. B. Have Council members observed any significant changes in business plans for additions to capacity or to inventories in response to the generally more buoyant expectations now prevalent? Though it is difficult accurately to appraise and quantify the change in business plans, the members of the Council believe that businessmen generally are attempting 575 2/15/66 to enlarge and modernize capacity as rapidly as possible. In general, inventories appear to be reasonably well balanced. However, because of rising order backlogs and lengthening delivery schedules, businessmen may seek to build inventories more aggressively. President Moorhead said there was very little difference of Opinion among the members of the Council on the foregoing statement. 2. Banking developments. A. What does the Council anticipate as to nearterm business demands for bank credit in relation to usual seasonal needs? Is it anticipated that an unusually large proportion of these demands will be in the form of term loans? The Council anticipates strong near-term business demands for bank credit in excess of the usual seasonal needs. These demands are expected to cover all types of business borrowings, including term loans. There is some evidence that the tightness of credit in the major money centers is tending to shift loans to banks in other areas. B. How much tightening of bank lending policies has taken place since last fall? To what extent has such tightening extended to reductions in amounts of loans granted or to actual turndowns or deferrals of loan applications? Most members of the Council report a moderate tightening of bank lending policies since last fall. The continued growth of bank reserves tended to lessen the pressure to restrain bank credit expansion. By and large, the tightening of credit is occurring on a selective basis and some loans are being turned down. C. How have recent developments affected the ability and willingness of banks to attract funds in the CD market? Recent developments have caused banks in the major money centers to be even more aggressive in seeking funds in the CD market. This competition for funds has forced rates higher in the last sixty days. Despite the level 576 2/15/66 -5- of rates, the total outstanding has grown only moderately. Moreover, as many suppliers of these funds anticipate a further rise in interest rates, they presently are reluctant to place them in CDs with long maturities. Mr. Petersen commented on a tendency of borrowers to try to obtain medium-term bank money at current rate levels in order to avoid going into the capital market, which market would probably fit their business needs better. A heavy demand for loans was being seen in Philadelphia, but loan-deposit ratios in the Third District were not nearly as high as in New York and Chicago and on the West Coast. Mr. Petersen observed that one of the external disciplines that normally guided banks in their lending policies had to some extent been removed through the use of negotiable certificates of deposit. This tended to enable banks to avoid selling Government securities and incurring a loss. If money continued to tighten, as he thought it would, the usual kind of difficult decision on whether such losses were warranted in order to expand loans might be avoided to some extent by buying more funds, even though the differential between the rates at which the money was paid for and lent out might not be great. Mr. Fleming said that banks in his area were now receiving frequent telephone inquiries about participating in large credits to corporations, presumably because it was at present more difficult to arrange the entire credit in the major money centers. Chairman Martin couunented, with respect to term loans, that some requests from corporations allegedly were being dressed up as 577 2/15/66 -6- term loans because the corporations could deal better with the banks than in the capital market. Mr. Moore noted that just last week a major rubber company Preparing to do an underwriting had been advised to withdraw from the market and instead came to the banking system for a $100 million, 10-year loan. This was clearly a loan of the type to which Chairman Martin had referred. Other cases were occurring, although they might not be quite so obvious. Mr. Stoner said that term loans were being sought to hedge against the possibility of higher interest rates and also the rationing of credit, to which President Moorhead added that corporate treasurers had more leverage in dealing with banks than insurance companies or the public markets. Mr. Bodman observed that this kind of financing was sought particularly if corporate treasurers felt that they might want to prepay, for in the case of bank loans this could usually be done without difficulty. Mr. Petersen commented that in his area banks did a fair amount of financing for utilities. When interest rates were going higher, water companies wanted to hang on to bank loans on a renewable basis against the possibility that capital market rates might improve in the future. Chairman Martin inquired whether members of the Council had suggestions, and President Moorhead replied that bank rates were still bargains despite the recent upward movement. There were also the other factors to which members of the Council had referred, such as the privilege 578 2/15/66 -7- of prepayment. Mr. Watlington expressed the view that very recently banks were becoming more objective and that the bargain aspects of their loans were now not as common as a few months ago. Chairman Martin then commented about remarks being made to him concerning the need to find some way of "making bankers become bankers again and ration credit." Some people in Government, he said, would like to have statements issued along this line from time to time. While the Board had issued a general appeal for banking prudence, he doubted whether such appeals were generally speaking too effective a device. However, in a situation where rates on CDs were currently being ratcheted upward without generating any substantial amounts of additional funds, he would be interested in any ideas the Council members might have. Representatives of the Federal Reserve made speeches from time to time, the Chairman added, but the tendency on the part of the System had been to resist the issuance of statements. Nevertheless, the banks must try to be selective in their lending at some point, even though rationing was not easy. Mr. Moore referred to a recent speech by First Vice President Treiber of the New York Reserve Bank and said it was the kind of thing he thought could be helpful. While a good deal was heard about the need for continued economic expansion, the banks could play only a certain role in that expansion, and it was helpful to have responsible officials remind them of that. This should also help to educate bank customers. When the voluntary credit restraint program was in effect during the 579 2/15/66 -8- Korean War period, customers stopped seeking certain types of loans because they realized that such loans were contrary to the principles of that program. When customers became less aggressive, there was less chance of the banks being divided and conquered on a competitive basis. Chairman Martin observed that a replay of the Korean War period was occurring to a certain extent. As he had said, suggestions were being made that it might be wise for the banking agencies to issue some kind of statement. It had always been the Board's position that bank supervision should not be used as a substitute for monetary policy, but question had arisen whether there might not be some purpose in a general statement calling for prudence and selectivity in the making of loans. According to another school of thought, this might simply galvanize the banks into more active competition for CDs. Nevertheless, this was the type of question that tended to arise as people faced up to the fact that this was an inflationary period. Mr. Fleming said that the current tightness was causing banks to be more aggressive in weeding out their portfolios. Banks were now not so worried that a prospective customer, if turned down, could go across the street and obtain the desired loan from a competitor. He did not think that a general statement calling for prudence would mean very much. However, a guideline statement on types of loans that should be given priority and those that should be guarded against might Prove helpful. 580 2/15/66 -9Mr. Watlington said it was hard for banks to realize that the situation had changed as much as it had. A statement along the lines Mr. Fleming had suggested, particularly if it described types of loans that should be avoided, would not only educate the public but might also be of help to bank personnel. President Moorhead expressed the view that bankers would not become bankers again until told how to do so in some such fashion. Chairman Martin repeated, however, that a statement of this kind could be construed as a substitute for rather than a supplement to monetary policy, and it was difficult to judge what impact it might have on the markets. Mr. Brinkley said he was concerned about the same point. Public Psychology was sensitive, and the carrying on of a scare campaign could create quite a problem. He had the feeling that many bankers through- out the country had been shaken into an awareness of the seriousness of the situation and that they were beginning to exercise restraint and becoming more selective. He would find it difficult to draw up guide- lines for his own bank and tell the officers that they should not make certain types of loans, because there were lots of reasons entering into the decision on making a loan. He thought, however, that in the eighth District the chief lending officers were becoming more selective and were beginning to hold the line fairly well. The point had been reached where bankers were not so fearful that would-be borrowers would gO across the street and obtain loans if they were turned down. 581 2/15/66 -10Mr. Cook said the Council's discussion yesterday left him with the impression that in the past 30 days there may have been quite a change. Banks were finding CD money hard to come by, and the offering of higher rates did not seem to be generating any significant volume of additional funds. Further, the rates being paid for money were getting close to the lending rates. The feeling no longer existed that the Federal Reserve would continue to make more reserves available, and banks were beginning to take a more realistic look at the situation. He found confusing the continuing statements from Administration sources that funds could be supplied for both guns and butter; only recently had the Administration indicated any concern about inflation. It would be helpful to get away from the idea that funds could be provided for everything, and he believed this trend of thinking had already started. Governor Balderston suggested that there may have been a subtle Change since about the week ended January 5. He had been deeply con- cerned over the past year, he said, about the fact that the economy was surfeited with liquidity, and the System had been a contributor to this. However, if a change had recently occurred, perhaps a jawbone effort should be withheld pending the availability of more knowledge about the true situation. Governor Balderston noted that over the past five years bank credit had risen at an annual rate of 8.6 per cent while GNP rose at an annual rate of 5.5 per cent in constant dollars. The resulting 582 2/15/66 -11- liquidity had found its way into the banking system by the CD route. However, the money supply had decreased from $169.6 billion on January 5 to $168 billion on February 9. In January the bank credit proxy increased at the rate of 9 per cent, but thus far in February only 3.3 per cent. Net borrowed reserves rose in January at an annual rate of 6 per cent, but this figure was down to 4.2 per cent in February on the basis of Partially estimated figures. If something was going on that would later be confirmed by valid figures, then a statement of the type that had been suggested might develop to have been issued at just the wrong time. President Moorhead said he thought there had been some change, but that he was a little less sanguine. Accordingly, he was inclined to feel that the issuance of guidelines for the banks was in order. Mr. Cook referred to developments in the stock market and inquired whether they suggested some adjustment in margin requirements as a signal that the movement of funds into the stock market in undue quantity was undesirable. Chairman Martin replied that it must be recognized that the Board did not have a great deal of leeway. If it moved margin require- ments to 80 or 90 per cent, all the usual problems would be likely to arise, such as extensions of credit by unregulated lenders. The ques- tion was one of timing and whether the remaining ammunition should be used at this point. It must be borne in mind, of course, that the margin requirements were established to deal with stock market credit rather than stock prices. 583 2/15/66 -12In a further discussion of CD rates, Mr. Cook said it was his impression that the large money market banks were going to keep bidding for funds despite the rate they had to pay, because they would rather do that than sell securities. However, many other banks were taking a look at the possibility of letting money go to the money centers and trying to back away from some of the pressures through the sale of real estate loans and perhaps securities. Public funds were also of concern to some banks due to the collateral requirements. The rates on public funds would go up along with CD rates, and there would be a squeeze. As to lending rates, he rather thought they were going to stiffen, and there were some indications that rates on longer-term Governments were going to rise further. For illustration, the Export-Import Bank par- ticipation certificates, carrying a rate of 5-1/2 per cent, would be a ttractive at this time to banks that were heavily loaned. Another matter of concern related to repurchase deals, which created an exposure to the banking system of unknown quantity. All of these factors entered into the problem for the banks in deciding whether to buy money and what to do with the money if it was obtained. Mr. Petersen referred to the shortening of CD maturities. first offered, the bulk of them were for six months or a year. When But corporate treasurers, anticipating further rate increases, now did not want to commit their money for long periods, with the result that high rates were being paid for very short-term money. 584 2/15/66 -13Mr. Moore expressed the view that in certain instances there was going to be both selling of securities and bidding for certificates. These were not mutually exclusive alternatives, at least as far as some New York banks were concerned. Last year, he noted, the tax-exempt market started to become sloppy, and it looked as though this would continue. Everyone had the feeling that there was a lot more on the shelf waiting to be taken off. His bank had just finished a survey of intentions to buy tax-exempt securities this year. Rather surprisingly, 52 respondent banks expected to buy as many, if not more than last year, but 65, principally larger banks, expected to buy less. Thus it appeared that there would be no net increase in holdings of tax exempts by the banking system. However, it also appeared that the New York City banks would continue to bid for CDs, not particularly to obtain additional funds but to keep what they already had. Mr. Bodman referred to a review by his bank of the size of passbook savings accounts, which survey disclosed that a substantial number of the accounts were in quite large amounts. bility This suggested the possi- of a rather substantial movement from savings to time deposits. He did not know whether this situation prevailed generally throughout the banking system, nor did he know why people had not moved out of savings deposits more than they had. Perhaps some of the more cautious customers did not care to switch into time deposits even at higher rates because they wanted to be able to obtain their funds immediately for Other uses. 585 2/15/66 -14D. Do members of the Council have any comments regarding the proposed amendments to Regulations D and Q announced by the Board on January 20, 1966, that would in effect define "deposits" for the purposes of those regulations as including promissory notes and certain other forms of indebtedness of member banks? The Council appreciates the problems which are involved in the issuance of promissory notes, especially of very short maturity. The many aspects of this matter preclude adequate discussion within the limitations of this memorandum. Members of the Council may express their views orally or communicate in writing with the Board. President Moorhead said that while several different viewpoints were expressed, he thought the majority of the Council members were in sYmpathy with the objective of the proposed amendments. However, there were some comments to the effect that the proposal was not specific enough in its definition. Mr. Moore referred the Board to a letter that had been sent to the Board by the New York Clearing House Association. Generally speaking, the letter indicated a sympathetic attitude toward doing something about the Promissory note situation. the However, it also reflected concern about definition of deposits because it could be interpreted in such a way as to apply to certain usual banking transactions that had never been considered to involve deposits. If so interpreted, it would be unduly res trictive. Mr. Fleming noted that in Tennessee and certain other States, the law prohibited payment of interest at rates over 4 per cent on savings 581; 2/15/66 -15- accounts and time deposits. The banks had been able to retain some funds by offering a combination of CDs at 4 per cent and promissory notes at a higher rate, but that possibility would now be foreclosed. He would much Prefer a restriction on short-term maturities and a requirement that Promissory notes be charged against the issuing bank's borrowing limit. This would yield much the same result, but banks in a State like Tennessee could retain a certain volume of time money that otherwise would be taken out of the State. President Moorhead said the point had been raised in a letter to a Council member that banks were in competition with finance companies to obtain funds for instalment lending. The finance companies could borrow without the necessity of maintaining reserves, and the question was why the banks should not be able to do likewise. Governor Mitchell asked whether market factors would limit the use of promissory notes if they were required to be subordinated to d eposits, and comments by Council members indicated that this probably would not exert a particularly restrictive influence. It did not appear to have been a restrictive influence on the sale of long-term capital notes and debentures. Chairman Martin noted that there had been some suggestions in the C ongress recently for an increase in reserve requirements against time deposits, and he asked the Council's judgment concerning the impact of an increase to the maximum requirement of 6 per cent. 587 2/15/66 Mr. Fleming said that this would have no impact on the bidding for time money, would simply make it more difficult for banks to operate Profitably, and would reduce the amounts available for lending. President Moorhead agreed that the bidding for CDs would be just as aggressive. Mr. Petersen pointed out that an increase from 4 to 6 per cent would increase the cost of time money only marginally. He concurred in the view that it would not deter aggressive bidding for CDs. 3. Balance of payments. A. How does the Council appraise the strength of foreign demand for U.S. bank funds? The Council believes there is evidence of increasing strength of foreign demand for U.S. bank funds. This demand is likely to grow stronger the longer the voluntary foreign credit restraint program continues in force. B. Have the Council's views on the effectiveness of the voluntary foreign credit restraint program changed materially since the Council met with the Board in November? In the Council's judgment, the effectiveness of the voluntary foreign credit restraint program has not changed materially since the Council met with the Board in November. However, the program is effective only as a temporary measure and not a solution to the basic problem. President Moorhead said that while the Council could not discern much change as yet in the effectiveness of the program, everyone felt that it was bound to become less effective as time went on. The point in time at which any significant change would occur was problematical. Mr. Simmen reported that bankers in the First District believed the program was not in the best long-term interests of the United States. 58S 2/15/66 -17- A reduction in the volume of dollars placed abroad meant a reduction in the amount that would eventually return. The banks were bearing the brunt of the restraint effort, in the face of a strong foreign demand for funds, and it seemed fair to assume that other steps would be necessary to correct the balance of payments. Question was raised whether the announced stockholder suit against directors of Standard Oil for borrowing money abroad at higher rates than available in this country would be likely to create any reaction from the standpoint of influencing other companies that might be giving consideration to borrowing abroad. Governor Robertson commented that this was, of course, under the Commerce Department's program, but it was his feeling that the suit probably would not have any great effect. Chairman Martin asked for views about balance of payments prospects over the year ahead, and Mr. Petersen commented that the report presented to the Council yesterday by the Board's staff seemed rather disheartening. Re had gotten the impression that some retrogression might be in prospect, Particularly in the trade account. view. Mr. Petersen said that he shared this He noted that he had urged--and the Council had urged also--that reliance not be placed solely on the voluntary program to correct the balance of payments, and he felt there was still a need to look at the Problem in terms of all types of spending abroad. Foreign exchange require- Inenta must of necessity be increased because of the Viet Nam situation, With no apparent disposition to reduce troop commitments on the continent Or to make substantial aid cuts. Further, there seemed little likelihood 589 2/15/66 -18- that the bulge of exports over imports would continue. However, there was one pleasing development, in that the use of monetary policy to deal With the domestic situation could have some considerable effect on the balance of payments. The narrowing of rate differentials might induce a substantial influx of foreign capital. If U.S. rates continued to move up, as he thought they would, there could be some real balance of payments benefits. Mr. Moore reported a rapidly increasing credit demand on the part of foreigners, so it appeared that the leeway available under the voluntary program target might be used up rather quickly. Banks were getting more and more inquiries every day, particularly from Europe, to say nothing of the ever present demands from the underdeveloped countries, and there was some evidence that the Japanese economy might be starting to accelerate, with a resulting increase in credit demands from that source. In response to a question about the Euro-dollar market, members of the Council cited reasons to believe that the market was tightening. 4. What are the Council's views on monetary and credit policy under current circumstances? In the last ninety days, the resources of the nation have neared maximum utilization. Despite continuing additions to plant capacity, output is pressing on capacity in many important industries, and there are increasing reports of tight labor situations, particularly of skilled workers. These developments reflect also the nation's growing involvement in Southeast Asia. As a consequence, aggregate demands are taxing the nation's productive capabilities with accelerating inflationary pressures. Unless there is a willingness 590 2/15/66 -19- to risk a serious inflation, or the imposition of controls, aggregate demands must be moderated. To accomplish this objective and thus lessen the threat to price stability, the Council believes that monetary policy must be employed. To be specific, the availability of reserves should be gradually reduced to more modest proportions through open market operations. In all likelihood it may also be necessary to increase the discount rate again. The Council recognizes that monetary policy alone may not be adequate to meet present economic pressures. Fiscal policy involving a reduction in governmental expenditures is required, and an eventual increase in tax rates may also be necessary. President Moorhead commented that this rather strong statement reflected the Council's general concern about the present situation. Governor Balderston noted that some difference of opinion had been indicated concerning the effectiveness of a jawbone approach. He inquired how much tightening of nonborrowed reserves, supplied at the initiative of the Federal Reserve, would be required in order to cause bank lending to become selective and differentiate between things that were constructive and those that were speculative. President Moorhead recalled that total reserves of the banking System increased around 8 per cent last year. If a lesser percentage, eaY 6 per cent, were added this year, he felt that would have a distinct effect on lending policies. He believed that the jawbone approach also should be employed, but there was a difference of opinion on that score. Governor Daane inquired whether President Moorhead would distinguish between a general statement and one that laid down specific guidelines. 591 2/15/66 -20President Moorhead replied that he felt the problem should be attacked from all sides, both through a definite tightening of the reserve situation and through the issuance of guidelines telling banks what, under present circumstances, was the proper type of loan to be made and what was the more inflationary type. He recalled that in the Korean War period the desirable and undesirable types of credits were fairly well defined under the voluntary credit restraint program. In general, loans for Productive purposes were sanctioned and those for speculative purposes were not. While he did not like to admit that bankers themselves could not make the proper distinctions, he felt that this was the case. As to the voluntary credit restraint program, adherence to it was admittedly not perfect, but it had been fairly good. It had strengthened the bankers in their dealings with customers, and it had educated the customer. Mr. Moore said that he would be rather concerned about a proposal to issue guidelines. He would prefer statements of the kind included in the recent speech by Mr. Treiber, who had reminded the banking system of factors that should be considered in the present circumstances. Discus- sions of this kind were welcomed by the banking system, as contrasted With statements that it should be possible to finance everything and also Pay for the war. tO be financed. No one knew what the war would really cost, but it had It was time to start allocating funds to useful purposes, and discussions of the problem by responsible officials would be helpful. Governor Robertson noted the likelihood of differences of opinion as to what were useful loans, and Mr. Moore said that was why he would 592 2/15/66 -21- not like to see specific guidelines issued. On the other hand, speeches like that of Mr. Treiber were helpful in reminding people of what was Involved in the current situation. Governor Maisel commented that various types of loans ordinarily considered useful were not necessarily useful at the moment; for example, loans to build inventories. The problem lay in the fact that loans nor- mally defined as productive, such as loans to finance plant and equipment, were in great demand, and this was the sector that might be squeezed if war expenditures were to be fitted in. Mr. Moore commented that many dollars could be involved in a relatively few loans of the kind that were unnecessary, such as loans to effect changes in the ownership of businesses. Governor Balderston noted that a member of the Board's staff had s uggested to him that one of the worrisome areas right now was the "financing of financing"; that is, take-over ventures. Mr. Cook recalled that there had been at times in the past various sorts of voluntary aids, including an understanding that it was not cons tructive to finance mergers, take-overs, and changes of ownership. At °ne time there was an understanding that banks should give priority to loans that created jobs. There was less interest in that feature now, in view of the large amount of buying power in the hands of the public. The increase in employees in the consumer goods areas reflected this buying power. The higher ticket prices on a good bit of merchandise indicated that the average individual had a good deal of money to spend. 2/15/66 -22Governor Robertson inquired whether the members of the Council would go so far as to favor selective control of consumer credit, and the replies were in the negative. Chairman Martin commented that in the Korean War period things reached a point where every type of control was needed, including general controls, selective controls, and voluntary programs. Mr. Fleming said some people felt things were not too far from that point now, and Chairman Martin replied that this was a matter of judgment. However, this was why questions were being raised about the need for a voluntary-type program. Mr. Fleming noted that the whole situation could escalate rapidly in the four-month period between now and the next meeting of the Board and the Council. Without doubt there was inflationary pressure. Also, there seemed to be little question but that a smaller amount of reserves was going to be made available to the banking system. Therefore, some rationing of credit would be necessary, and the question was what channels the available funds should go into. The banks would be called upon for financing in many areas, and the regulatory agencies should know what Was best for the country as far as bank loans were concerned. If some guidelines were made available, this would help in dealing with loan requests. The guidelines would not be completely effective, but they would provide a good talking point. a n educational process. There would, of course, have to be However, if the banks in the major centers took the lead, compliance should flow rapidly to other sections. E94 2/15/66 -23Mr. Petersen said there had been too much talk about guidelines to suit him. He agreed with the view that the jawbone appioach was sometimes a substitute for action. He would not object to the making of speeches on appropriate occasions, for they tended to keep before the financial community the problems that were being faced, but he would Shy away from saying what the banks should or should not do. not yet a period when direct controls were needed. This was While the full impact of Viet Nam could not yet be measured fully, in relation to GNP it was of a much different magnitude than the Korean episode. in much different shape. The economy was The Council's statement favored a strengthening of indirect controls and appraising the success of these measures as time went on. This would be simpler than a guideline approach. Chairman Martin then commented that there was another point he Would like to explore. If a situation developed where there was no alternative to raising the discount rate, what should be done about the maximum permissible rate on time deposits? Mr. Petersen replied that he thought the Board would have to go to 6 per cent, while Mr. Fleming said he would rather see the ceiling removed entirely than changed to 6 per cent, for there was always a tendency to work toward the ceiling. Mr. Petersen said he understood that Without a change in the law the Board could not remove the ceilings e ntirely, and this was verified. Governor Robertson noted, however, that there was the possibility of fixing the ceiling at a rate clearly beyond the effective range. 2/15/66 -24Governor Maisel inquired whether the Council felt that the max- imum rate for savings accounts would have to be raised if the maximum rate for time deposits was increased. President Moorhead indicated that he would not be too concerned about widening the gap further. Chairman Martin noted that the Board was being criticized in some quarters on the basis that it should have raised the time deposit maximum only to 5 per cent, it being asserted that in such event there would not have been a ratcheting upward of CD rates without additional funds being created. Mr. Moore commented that one important question related to the measurement of corporate liquidity at the present time. There was the question whether corporate funds would flow, say from Treasury bills to CDs, depending on the rate, or whether they would be absorbed in capital improvement programs during the year. nothing much seemed to happen. When banks raised the rate on CDs, The bank that raised the rate first might attract some funds for a short time, but this seemed to be about all. President Moorhead observed that someone had commented that it had not yet been determined what monetary policy could really do. If, as an extreme possibility, the rate on savings was increased to 10 per cent, that would make saving more attractive. money at a price. He was sure there was The banks had never gone to such an extreme, but it Was possible that if their rates really went up, this would draw money cut and cut down on consumer spending. G 2/15/66 -25Mr. Stewart commented that savings accounts were going down in his area and that the money was not going into certificates at higher rates. Instead, it was going out. He did not know whether it was going into Treasury bills, the stock market, or some place else, but it was moving. Mr. Watlington said it was remarkable, however, that in his area savings accounts continued to stay with the banks to the degree they had. Many people seemed to like savings accounts because the money was there When they wanted it. Mr. Moore said that the shift in savings funds in his area was from the commercial banks to the mutual savings banks on the basis of rate differential. Chairman Martin asked whether the banks represented by the Council members had any dollar limit on savings accounts, and the replies heard were in the negative. Mr. Watlington suggested that the banks be allowed to compound interest more frequently than quarterly. The daily interest approach had seemed to have quite a psychological effect. When his bank shifted t° daily interest, the effect was gratifying. Mr. Brinkley commented that there seemed to be a real difference between the passbook savings account holder and the CD investor. The former was saving for a purpose on a consistent, continuing basis. When his bank offered 4-1/2 per cent on time certificates, there was some 2/15/66 -26- erc,sion of passbook savings. Since that adjustment, however, passbook savings continued to increase on a 4 per cent rate basis, even against 44/2 per cent. Governor Maisel suggested that a learning process might be involved and that it would take a while for depositors to become acquainted With the time certificate. President Moorhead said he thought that was right. He had observed that larger depositors moved into certificates in many cases. Mr. Watlington suggested that the factor of convenience tended to offset the rate differential to some degree, perhaps up to 1/2 of 1 Per cent. Mr. Fleming felt that the availability of branch bank systems tended to exert an influence. He did not think that deposits up to $10,000 would be affected too much, but above that figure he was not so sure. Mr. Cook said that in his area, if the CD were to rise to higher rates than now prevailed, there would probably be a substantial movement of savings to CDs. He felt that the present spread was fairly sustain- able, but the learning process certainly would go on. This could have a significant effect on the savings and loan associations. This created concern, at least on the West Coast, for it was to be hoped that nothing serious would happen to the savings and loans. He inquired whether it Would not be possible to raise the discount rate and to maintain the m aximum rate on time deposits. '98 2/15/66 -27Chairman Martin noted that this was the point he had been try- ing to develop. Export-Import Bank participation certificates were being offered at 5-1/2 per cent, the FHA rate had been raised to 5-1/2 per cent, and the Regulation Q limit was 5-1/2 per cent. It was at least debatable whether the Regulation Q ceiling should be raised. Mr. Moore commented that if everyone became convinced that reserves were not going to be supplied to the banking system at the same rate as in the past, something would happen. In fact, perhaps, it was happening in the last week or so. Chairman Martin said he thought it was happening, and Mr. Moore repeated that if it was known as a fact--or as nearly a fact as possible-that reserves would not be supplied so freely, the question was what would happen next. It might be well, he thought, to see what the market was going to do before considering any change in the Regulation Q maximum rates. Chairman Martin commented that at least there was not the pressure for a Regulation Q change at the moment that there had been some time ago. This concluded the discussion of the items on the agenda for this meeting. Absorption of exchange charges. Governor Robertson inquired what had happened, if anything, in regard to absorption of exchange charges, to which President Moorhead replied that nothing had changed and that in his area he thought the Federal Reserve ruling was being observed. Governor Robertson then requested the Council's reaction to the Possibility of altering the Board's position so that absorption of exchange 599 2/15/66 -28- charges would no longer be regarded as payment of interest on demand deposits, and some Council members stated that they would be unalterably opposed. Mr. Watlington said that admittedly the Board's ruling was not being enforced by the Comptroller to the same extent as by the Federal Reserve. However, the situation had settled down, customers understood the circumstances, and they were convinced that they ought to pay the exchange. time. His bank had not lost an account for this reason in a long It took the position that it was refusing to absorb exchange Charges because it was abiding by the Board's ruling. were changed, the bank would have to absorb. If that ruling The net result would be simply an added cost to the bank. Governor Robertson then asked for views about a proposal to recommend that the Congress enact a law stating that no insured bank could charge exchange. Mr. Watlington replied that this would be political dynamite, and President Moorhead agreed. The latter added that unless such a law was passed, he hoped the Board would continue its present ruling. The number of nonpar banks was dwindling in his area, although very slowly. Re estimated that absorption of exchange would cost his bank around $1 rnillion a year. Mr. Watlington estimated that absorption of exchange would cost his bank more than $1/2 million a year, and its principal competitor roughly the same amount. 600 2/15/66 -29Governor Robertson suggested that this factor might bring about more complete adherence to a policy of not absorbing exchange if the Board changed its position, but President Moorhead replied that competitive factors would force a bank such as his to absorb. A Chicago bank, for example, might approach his bank's larger customers and offer to absorb exchange if the customer would establish a deposit relationship. Mr. Watlington agreed with this observation. Mr. Fleming commented that the problem would be cured if the Federal Deposit Insurance Corporation would adopt the same position as the Federal Reserve. He suggested that the subject might be discussed Within the interagency Coordinating Committee on Bank Regulation. Governor Shepardson noted that time and again the Board had been assured by banking groups that they were going to get something done, and Mr. Fleming replied that the American Bankers Association had tried for many years to get the Federal Deposit Insurance Corporation to change its position. Governor Shepardson then remarked that a number of member bankers continued to write to the Board complaining about the inequity of the s ituation, and President Moorhead replied that the Board's ruling was the law as far as his bank was concerned. customers that it was "obeying the law." The bank could say to its But if the Board changed its ruling, the bank would have to start absorbing exchange for competitive reasons. 601 -30- 2/15/66 Mr. Fleming expressed the view that a change in the Board's Position to allow the absorption of exchange would inevitably lead to an increase in the number of nonpar banks. Governor Shepardson asked why support should not be given to a law that would require par banking, and Mr. Fleming commented that the effort might be worth a try. However, Mr. Watlington observed that if his bank supported such a proposal strongly its small nonpar correspondent banks would object strenuously. Mr. Watlington said he considered the Federal Deposit Insurance Corporation's position erroneous, and he urged the Federal Reserve not to shift over and join the Corporation. A lot of national banks were abiding by the Board's ruling even in the absence of strict enforcement by the Comptroller, in view of adherence to the ruling on the part of their State member bank competitors. If the Board's ruling were changed, the whole question of absorption would erupt violently. The reduction in the number of nonpar banks, even though gradual, reflected the fact that member banks had not been absorbing exchange and had been passing the charges on. In this manner, pressure was exerted on the nonpar bank through the customer. If exchange could be absorbed, the customer no longer would have an interest and this would encourage nonpar banking. Legislation was admittedly the proper way to effect a solution, but the nonpar banks would be so vocal that he doubted whether an attempt to Obtain legislation would be sucessful. 602 2/15/66 -31It was agreed that the next meeting of the Council would be held June 20-21, 1966. The meeting then adjourned. AA WU,"
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