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233 A meeting of the Board of Governors of the Federal Reserve SYsteril with the Federal Advisory Council was held in the offices of the Board of Governors in Washington, D. C., on Monday, February 18, 1946, at 10:50 a.m. PRESENT: Mr. Mr. Mr. Mr. Mr. Eccles, Chairman Ransom, Vice Chairman Szymczak Draper Evans Mr. Carpenter, Secretary Mr. Hammond, Assistant Secretary Mr. Connell, General Assistant, Office of the Secretary Mr. Morrill, Special Adviser Mr. Smead, Director of the Division of Bank Operations Mr. Parry, Director of the Division of Security Loans Mr. Thomas, Director of the Division of Research and Statistics Mr. Vest, General Attorney Mr. Bethea, Director of the Division of Administrative Services Mr. Wyatt, General Counsel Mr. Brown, Assistant Director of the Division of Security Loans Messrs. Spencer, Traphagen, Williams, McCoy, Wiggins, Strickland, Brown, Penick, Baird, Bradshaw, Winton, and Odlin, Members of the Federal Advisory Council from the First, Second, Third, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth, Eleventh, and Twelfth Federal Reserve Districts, respectively Mr. Prochnow, Acting Secretary of the Federal Advisory Council the 11'1". Brown reported that at the meeting of the Council yesterday O11 'Yu-rig officers, and members of the executive committee, were 234 2/18V46 -2- aPP(Anted to serve during the current year: Officers E. E. Brown, President Chas. E. Spencer, Vice President Executive Committee John H. McCoy John C. Traphagen A. L. M. Wiggins David E. Williams Edward E. Brown, ex officio Chas. E. Spencer, ex officio In response to an inquiry by Mr. Brown whether the Board had 4r .aformation with respect to plans for consolidating Government agencies under the authority of the Reorganization Act of 1945) Mr. 4cles stated that so far as he knew nothing had been done under the Act that would affect banking, that agencies and departments of the alterr.,„ —,,Liftt had been requested to submit their suggestions to the Bureau ct the .„ Tk -uuget by January 25, 1946, but that the Board had submitted 40thin g. In this connection, he called attention to the fact that the B °ard had gone on record as favoring the consolidation of the Fedbar,L. --, supervisory agencies and that it did not seek any exemption trora ,, 'Ile Reorganization Act. He added that it might be necessary for the Board to take up some of the questions involved with other agencies. Mr. Ransom asked if the members of the Council had any in41teti aft on the matter and Mr. Brown replied in the negative. Answering a second inquiry by Mr. Brown as to the status of 235 2/18/46 —3- BarikHolding Company legislation, Mr. Eccles said that members of the Board's staff had had several conferences with representatives of the C omptroller of the Currency, the Federal Deposit Insurance CorPoration, and the Department of Justice, that there remained t170 or three important points on which there was a difference, and that it was expected that a decision would be made within the next two or three weeks whether to present the bill to Congress. He ' e cicled that there was a lot of support for a decision to do nothing 841d the longer a decision was delayed the more likely it was that 11°th g would be done. Mr- Brown asked what had been done with the proposed amendrjt„ggested by the Board to the Kefauver Bill (H. R. 2357) and Ifr-Ecel_ e said that the amendment was not in the bill as it was rePorted — vitt, and that apparently the Committee felt it could not get thebill approved with the amendment and therefore was not willing to allPPort it. the Mr- Ransom commented that while there was no opposition to alitenclinent it was his impression that the attitude of the banks rna'jor factor in influencing the House Committee to drop it. Mr- Brown then made substantially the following statement: The principal thing the Council wishes to discuss With the Board and about which the members of the Council i,,t4ed for about five hours yesterday is the question of rest rates and Government financing. With one exception, 236 2/18/46 -4- the members of the Council strongly favor doing away with the preferential discount rate, which we understand the Board wants but which the Treasury has more or less opPosed up to this time. We also favor the abolition of the option rate on Treasury bills. We think open market operations should be handled in such a way as to keep certificates from going below par, but that the market On the short term securities should not be supported and excess reserves put into the market as freely as has been the case in the past. We are glad to see the War Loan .-ecounts pulled down and we would like to see them reQuced very much more than the Treasury has indicated would be done. We do not know whether there has been any arrangebetween the Board and the Treasury, as to March 1 March 15 maturities, by which the Federal Reserve las agreed to buy in the market, at approximately current ,_svels, short term securities to replace the holdings of t.he Reserve Banks, but we think it is ridiculous in the Present situation for the Treasury to continue to carry t balance anything like $25 billion. We feel it should !around $10 billion. We also think that the Treasury 8 c"cluld issue to bona fide investors long term bonds which 1 d not find their may directly or indirectly into the 13°, , 1"1-ng system. That would mean that they would not only Ineligible to the banks but also ineligible as collateral :, 1°ans. Such a security might take the form of a 20 b;1 5-year "G" bond. There is probably only six or seven e lorl a year available for long term investment in Gavmtlment bonds, but to the extent that that investment deti, 11d exists we think that it ought to be satisfied by someWaythat would not find its way into the banks. In that You would gradually check the monetization of the pub1lc _ debt that is going on. At the present time insurance 'e?mpanies are purchasing real estate and the laws of sev: i r;a1 of the States are being amended to allow them to ! ti est in stocks. If the rate on Government bonds conoVues to be forced down, the insurance companies and meuer investors will try to find other forms of investtint,.although they would much prefer Government securies if they could get something like a 2i per cent rate. an tmen th e If the Board thinks it would be desirable to have embody its views in a resolution, we would 237 2/18/46 -5- 1?e glad to do so, but we do not know what the situation is between the Treasury and the Board, nor do we know Whether the submission of such a resolution would be helpful at this time. We would like to know what the Board can tell us about the situation, and how far our conclusions differ from those of the Board's. ReAying to Mr. Brown's statement, Mr. Eccles commented sub3.1:a.'lltially as follows: .,_ With reference to the size of the Treasury balance, the Board has felt for a long while that the Treasury maintained unnecessarily large balances. he never were .able to persuade the Treasury that it did not need a min-unull balance of $10 billion, or that the Reserve System could create all the credit the Treasury might need to fleet an emergency. They seemed to feel a sense of security ?.8 long as they had big balances, and when Mr. Vinson came la he did not undertake to make any change. Some of the flea at the Treasury felt that last fall was the time to make a Victory Drive right after the end of the war, the c2eumption being that they should capitalize on the psyitlogY of the people at that time and that they could no 4. t get all they needed later on. We took the position '41,at there should be no drive and that they could get a-dclitional funds when they needed them. The best we Could do was to get them to put the drive off until the of November, and cut down the amount to be raised “xra $14 to $11 billion. T After the drive, there was an effort to get the ti .:!asurY to announce that the 24's and 2i's would con4-"ue to be available for investment funds. However, we thoUght it would have been a mistake for the Treasury k? ),have made such an announcement. They already had.a ;lc-) billion balance and to have announced that the 2A's 13°1411 , 4 continue to be available would have served only to oi'td up the balances still further and increase the cost ,financing ._ Until you could block the banks off and b-1"rol the amount of securities they could buy, it would e foolish to try to satisfy the investment market demand 2‘)8 2/18/46 by Putting putting 2A's on tap. It now appears that instead of the volume of outstandare gobe increased. During the month of January right after the drive, and with all the strikes and unemployment, there was no great amount of cashing, and there is every lndlcation that the Treasury is going to have a larger defor the E F and G's than the Treasury will need to sell. l-ng EtoF and G bonds being reduced on balance, they The executive committee of the Open Market Committee Presented a program to the Treasury last week with respect t° the use of a portion of the Treasury cash balance to Fetire securities that are due or callable through June 1. 946. I spent two hours with the Treasury people discusillg.the matter and the Secretary has accepted the program. l_think it is a good program as the first move. As you Z" )w, it takes out about $500 million of the 3-3/41 s; : 4.'300 million of the 1% notes; $1,036 million of the 3's; 4g.319 million of the 3-1/8's and $1 billion of the $4,147 fl certificates which fall due March 1st. That should have, if anything, a tightening effect. Of + 0,,vhe total amount to be redeemed in March, approximately v.)00 million is held by the Federal Reserve Banks. What happen is that war loan accounts will be reduced by ; 2.8 billion, so that the banks will lose that amount. heY will not get back the $360 million held by the Rerve Banks, and therefore, will have to sell $360 million their holdings to offset that loss. In addition, there T11 e2550 million that will be redeemed by nonbank investors. "a6 money will go back into the banks and increase rered reserves. In the operation, the banks will lose ;4e income on about $2 billion of securities, and to offset ,iat w loss of income there may be some tendency on their Part, to sell some of the short terms and replace them with terms. In any event they will have to sell about $460 :1-11ion to the System and if they undertake to replace shorts longer term issues the purchases of the System will a,,that much larger. We did not propose any more than we ;4.c1 because a $2.8 billion refunding job is a fair size Trration and we felt we would like to see how it works. The SYstem will support the certificate market and we think T 2/18/46 -7- it will be handled very smoothly. We will not let the yield 9/1 short terms go up and will support the market at whatever level seems necessary to assure a smooth and successful op- eration. There are about $4.8 billion maturities in April and bout 31.6 billion in May, so I would think that there should be a further retirement of certificates in April. I would not suggest a partial retirement in May. In June there wall be a big operation, $4.8 billion in certificates and about $1.8 billion of the 3's and 3-1/8's. A billion of certificates and both issues of bonds should be paid off. As long as the E F and G's are available, they will take care of the investment demand except for corporations, , , eanngs banks, etc., and therefore there is no reason to out a long term market issue. I think I express the 'ews of the Board and possibly the Federal Open Market Committee when I say that any increase in long term Treasury nlarketable bonds would be a mistake. The nonmarket issues t able will take c.!.-re of all investors except corporaOne savings banks, and large institutional investors. w°uld think that of the long term securities now outstand!Ig about three or four billion would be purchased by t'le insurance companies and others if you could prevent bank irohases of eligible securities from putting pressure on le long term market. In November and December the banks jeated about $11 billion of new credit; they bought $7 mlllicn of securities; they loaned 3 billion on GovernThes and $1 billion on other loans and investments. 2refore, A10 billion of credit was pumped into the Governnt security market which helped to drive the rates down. se ess we can prevent further purchases by the banks, I mae n° vay to keep the long term rate from falling and it .t, S7 go as low as 1-3/4 or 1-1/2. It would be a question then of whether certificates could be held at 7/8 or whether 7 w°uld go down to 3/4. There are two ways of stopping t1,7 oS trend, but only one practical way. The orthodox way .Lc1cling it is to increase the short term rate. That is St 'not practicable. The banks will be extremely fortunate g.LettheY can hold the 7/8's rate. There is pressure to that down to 3/4, especially in view of the bank earnc;ge Picture. In my opinion, there is no chance of ineasing the short term rate. That is the only power T: 7 240 2/18/46 -8- the System has at the present time to deal with the problem. If the public debt were what it was when the System's Powers were given, the situation would be entirely different than at present, when two-thirds of the outstandng credit is Government credit. The discount rate could be used then, but when an increase in the rate increases t the cost of supporting the public debt, the burden on the , axPaYer, and further increases bank earnings, it could be ',one only over the vigorous opposition of the Treasury and at he expense of vigorous public denouncement of the banks and the Federal Reserve System. That situation would be very difficult to defend or explain. If there is any other way t, it would be disastrous to the banks and the Reserve 6Vera to take the position, in opposition to the Treasury, at short term rates should be increased. r A problem with respect to the preferential discount 'ate is whether it should be eliminated in the face of the e°ntemplated program for the retirement of public debt. The whole matter will be discussed by the Federal °Pen Market Committee at the end of this month. In the ensuing discussion of ways in which the problem of 13°1igY might be met, Mr. Traphagen suggested that elimination the Preferential discount rate would create uncertainty in the airldts Of the bankers about the trend of long term rates, and that the b 44ks would then stop hying the intermediate bonds and be more illelined to purchase certificates. °Dmmenting upon Mr. Traphagen's suggestion, Mr. Eccles said that i4 'tight be unwise to do anything that would create uncertainty Illtheminds of the bankers, as that might result in the smaller banks 4-tig Gov ernments, and that the Treasury did not want to do anything that w cIlld "rock the boat". Instead of banks increasing their holdIlles of Government securities, Mr. Eccles said, they should be forced 241 2/18/46 to —9— 8ell about 4l5 or ,(20 billion, which could be done only by legislation. He added that if the Board were given the authority to determine the extent to which demand deposits of banks should be invested in Or paper or less, the fact that that authority existed would at°13 the banks from buying the intermediate and long term bonds if the, 4 already had as many as they could hold if the authority were exercised. He thought that in that situation the banks would sell interillediate and long term bonds and instead of the bill and certificate Market having to be supported by the Reserve Banks, the support would eon.* from the banks themselves. Mr. Wiggins suggested that another way to meet the problem wa's t° sell the securities to the nonbank investor and Chairmen Eccles 4eked holy that could be done as long as banks were free to purchase Iles in the market. lir. Williams asked if it would be possible to remove the limit °II the purchase of G bonds and Chairman Eccles expressed the opinion tile"t that should be done. r. tat7 Strickland asked whether the Board felt that present mone- conditions would accelerate inflationary tendencies and, after an 4trirMative answer by Chairman Eccles, suggested that there was justitle4ti°r1 for action by Government to control the situation. orl all 15r. Eccles concurred and said that the problem should be met r ' l°nts including price and wage controls, etc. 242 -10Mr. Strickland said the System's authority was only in the "It field and it should do what it could even if such action as the elimination of the short term rate did result in a stiffening of the short term rate. Chairman Eccles said that the present situation as reflected exist4 __ yields on securities was a reflection of the monetization of the Public debt and not of the supply of what could be cal7ed real "ngs funds in relation to the demand. He thought that an arbitragy 114g term rate could not be determined until that process was reversed to 8 °Ille extent, and that when that was done, if the long term rates continued to decline it would be because the amount of savings exceeded the investment demand. He pointed out that if people spent their income on consumption, the savings rate would likely stay higher than "People were inclined to save and put their savings in banks and inzixrance companies, in which event the supply of funds would force the long term rate down still further. During a further discussion of legislation to require banks to invest a portion of their deposits in short term securities, Mr. klaialto 4qicen suggested that action need not wait on legislation but that could be taken to eliminate the preferential rate and the bv- 341g rate on bills, to continue reduction of Treasury balances, and 1)"8i4lY G extending the limit on G bonds or the issuance of a new type bond to supplY the bona fide investment demand. 243 2/1e/46 -11- Chairman Eccles said he was sure the Treasury would oppose 4111Y action which would increase the cost of the public debt. Following a discussion of the possibility of further infla- t1°114r.7 pressures, the characteristics of a period of inflation, and the question whether Congress would be willing to give the System the "411-tY to require the investment by banks of a stated portion of their deposits in short term securities, Mr. Eccles stated that the lloard as an agency of Congress was under obligation to report to the Congress the situation which confronts the System, to point out that the powers of the System are not sufficient or adequate to deal with the Present situation, and to suggest ways in which the problem c°41d be met. At this point Mr. Winton said that he was the member of the 001incia. who agreed wit h the Treasury's viewpoint that the preferential rate should not be discontinued at this time, and that, in 48 On; ' ' 111-c)n, it would be unfortunate to do anything which might create %lee as to the future of interest rates. To take such steps, Illinton said, would be premature and unwise as the action might be taken as an indication that the System was getting ready to stiffen rate and might have an adverse effect particularly as regards purchazer 8 of E P and G bonds. 111'. Eccles inquired whether it was the view of the Council that th e Preferential rate should be discontinued and Mr. Brown req that 11 of the members of the Council were of that opinion. 244 -12Chairman Eccles said that the Board felt the preferential discount rate as well as the bill buying rate should have been discontinued 1°14g ago, that the reasons for which they were put into effect no longer eletecly that it was necessary and desirable now to discourage banks fl ' °14. further buying of Government securities, and that these steps a°111o1 be taken without increasing the cost to the Treasury. F ollowing comments as to possible changes in the volume of currelic Y outstanding and other factors affecting the reserves of member banks ) Chairman Eccles referred to the fact that the continued downPressure on rates was resulting in a situation that might involve danger ill that refunding of outstanding issues of private securities Were being refunded at very low rates, and that this was extending into ae°°11d grpde securities and in term loans as low as 2%. Some members 01* the Council indicated that term loans were being made at rates as 1°W 48 1-3/4%. the banks in Chairman Eccles added that such rates did not justify assuming any amount of risk and that unless the situation Were changed it could have dangerous results. In response to an inquiry as to the possibility of loans to tor,si 811 countries, Mr. Eccles said that aside from the British loan thet.e. -Wa8 little inclination on the part of the Government to ask °°11er es8 to authorize loans to other countries, and that, pending theor ganization of the International Bank, any credits extended to 245 2/18/46 -13- tcrsign countries would be financed through the Export-Import Bank. Re Pointed out that foreign countries had assets in this country amountto about $10 billion which would be spent as soon as they could get gccds, and that any credit extended would mean a further demand on the g°°cle available in this country. He stated that it was important that the British loan be approved as it was spread over a period of five ear8, was not related to the purchase of goods here as would be the case with loans to other countries, but was to enable sterling exchange to be free_ y I convertible into other currencies and to put England on a cash basis so that she could start trading with the rest of the world, Ur. Brown then asked whether the Board desired the Council to dra wU a resolution stating its position as referred to earlier in this 'fleeting, and Mr. Eccles said that such a statement might be help• Brown stated that the Council would submit a resolution to be 4-'eased to the press or used in such other way as the Board saw Mr. Brown made the further statement that although the Council had on if --s agenda for discussion at this meeting questions with respect tob 04 ation U, selling price of real estate, and control of rents c °nStrUCtiOn, it had been decided that they were not of suf- cisilt I • mportance to warrant discussions with the Board at this tbri. 246 2/18/46 Thereupon the meeting adjourned
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