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Minutes for February 18, 1964 To: Members of the Board From: Office of the Secretary 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. Mills Gov. Robertson Gov. Balderston Gov. Shepardson / P .V. 4 Atise Gov. Mitchell rr ,LJ Gov. Daane Meeting with the Federal Advisory Council. 542 A meeting of the Board of Governors of the Federal Reserve SYstem with the Federal Advisory Council was held in the offices of the Board of Governors in Washington, D. C., on Tuesday, February 18, 1964, at 10:30 a.m. PRESENT: Mr. Mr. Mr. Mr. Mr. Mr. Martin, Chairman Balderston, Vice Chairman Mills Robertson Shepardson Daane Mr. Sherman, Secretary Mr. Kenyon, Assistant Secretary Messrs. Martin, Moore, Day, Stoner, Watlington, McRae, Smith, Hickok, Moorhead, Breidenthal, Aston, and Cook, 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, Secretary of the Federal Advisory Council Mr. Korsvik, Assistant Secretary of the Federal Advisory Council The Board had been advised of the election by the Council of the "alowing persons to serve in the capacities indicated for the Year 1964' John A. Moorhead, President James W. Aston, Vice President John A. Moorhead, James W. Aston, Lawrence H. Martin, J. Finley McRae, and M. L. Breidenthal, Members of the Executive Committee Herbert V. Prochnow, Secretary William J. Korsvik, Assistant Secretary -2- 2/18/64 Before this meeting the Council had submitted a memorandum setting forth its views on the subjects suggested for discussion, The topics, the Council's views, and a summary of the discussion of each topic follow. 1. Domestic economic conditions and prospects, A. What are the views of the Council as to the economic outlook for the remainder of this year? To what extent are these views influenced by the tax legislation now under consideration in Congress? B. What effect does the Council expect the forces of supply and demand in the markets for funds to have on interest rates during the rest of 1964? A. The members of the Council believe that the level of economic activity will continue to rise during the remainder of this year. This view of the economic outlook reflects the expectation of a reduction in Federal taxes on personal income and corporate profits. Consumer spending, which has been strong, is likely to be further stimulated as a result of the reduction in taxes. The resulting demand and its impact °I1 production and the percentage of capacity being utilized should give a further impetus to capital spending, as well as to inventory accumulation and investment. Several members of the Council expressed concern about the added stimulus of a tax cut during a period of good business. Inflationary forces could develop which would intensify wage demands, accelerate inventory accumulation, and increase the upward pressure on prices, B. While most members of the Council expect that the demand for funds will rise during the rest of 1964, the flow of corporate cash, as well as personal savings, will also expand. In these circumstances, the Council anticipates that interest rates will be fairly stable in the months immediately ahead. However, changes in interest rates in foreign money markets might force our rate structure higher. With the advent of Fall and the customary seasonal rises in credit demands, and with the stimulus to economic activity provided by a possible tax cut, upward pressure on interest rates may develop. 2/18/64 -3Chairman Martin commented that it would be helpful to have anY views Council members might care to express on the likely impact of the prospective tax cut on employment and unemployment. that there were two schools of thought: He noted (1) assuming the tax cut 140u1d be stimulative, that it would nevertheless have little effect On the unemployment problem as it currently existed; (2) that the P°ssibilities of inventory build-up and plant investment were being underestimated, and therefore that there might be a substantial decline in the rate of unemployment in the second half of the year. Mr. Martin stated that in the First District there was little e'1180t1 to change the views expressed three or six months ago concernthe generally favorable economic outlook. However, persons in he District were putting emphasis on certain caveats. First, there /les the possibility of over-stimulation of consumer demand, with the e°11leequence that industries might take advantage of this and raise Pticea, had Second, while the relationship between inventories and sales been good in recent months, the vagaries of demand forces might ellEmge this relationship. Third, with a prosperous year in 1963, III'h4b1Y to be followed by another such year in 1964, it seemed untealistic to think that the labor unions would not take advantage of situation to make strong wage demands. If those demands were Nnted) upward pressure on prices might be expected; if they were not %tali ted, there might be some disruption of business° 2/18/64 -4Mr. Martin also said that the kinds of industries prominent in the First District--electronics, for example--were suffering from the change in defense production philosophy. The trend of manufactur- ng employment in the First District was not as good as nationally, Particularly in Massachusetts, and the trend could be expected to e°ntinue. Also, the impact of automation was beginning to be felt in the white collar area. These factors would tend to offset any stimulative effects on employment resulting from a tax cut. President Moorhead noted that the Council had seen charts Presented by the Board's staff yesterday that were on the discouraging aide with respect to the employment outlook. In a business expansion, he Observed, there usually comes a point at which employment begins to .iae rapidly. With the stimulative effects of a tax cut superimposed "the present rate of expansion, employment could rise markedly. each In succeeding period of post-war expansion, however, the rate of lillerVloyment had failed to reach as low a level as in the preceding e%Psnsion. Mr. Day noted a development of concern in the Philadelphia area; namely, that the cut in defense spending had changed the mix electronics work from emphasis on hardware to emphasis on research 44d Prototypes. At various plants, there had been heavy lay-offs of *Itkers as a result. Mr. Day also expressed some concern, from the 1) 6er run standpoint, that the impact of a reduction in tax withholdrates might be concentrated primarily in the year 1964. 2/18/64 -5Watlington felt that a tax cut could have some effect on emPloyment in the Fifth District because so many of the things manufactured in that District were consumer goods. If a tax cut stimulated the purchase of consumer goods, such as textiles and furniture, it could have an invigorating effect on employment in those industries. In commenting on the tobacco situation, he indicated that the longer run impact of the recent Government report on the harmful effects of the use of tobacco remained to be seen. The industry was not presently t00 dismayed, having in mind that following a similar report in England. tobacco consumption increased after a relatively brief decline. Mr. Smith said that, assuming the tax cut impact was stimulating, it seemed likely to help the unemployment situation in the Seventh kstrict because of the variety of industries represented in the District. Eusiness sentiment at the moment was bullish. Retail sales were up str"gly in Detroit and Chicago, and the auto industry was strong, with Production above the year-ago level in January and thus far in February. The machinery industry was hard to appraise as a unit but seemed to be 4°418 well, with order backlogs up considerably. The construction induetr_ y appeared to be the most unfavorably situated. In Chicago, e°48tructi0n had been lagging behind the national average since 1959, P4tticularly in the category of single-unit residences. Apartment but ' ling had picked up considerably, however. The stage of overbuildill& had not been reached yet, although there were some signs of such 4 Pattern developing. Construction of office buildings was active, with 40 84 'gns of overbuilding as yet. 2/18/64 -6Mr. Moorhead commented that it seemed fair to say that there Should be more jobs available with the stimulus of a tax cut. However whether they would be available in sufficient quantity to outpace increases in the labor force was questionable, particularly in light of the inflow from the high schools into the labor force. Mr. Day referred to a massive retraining program that had been Planned in the Philadelphia area, it having been noted that there were various types of jobs available if people could be trained for them, Unfortunately, organized labor killed the appropriation from the Govern' neat that had been counted upon to support the program, which was now completely stalled, Chairman Martin referred to unemployment as the major problem Of the domestic economy at this time. he ll) could be given. The question remained as to how There was debate as to whether the problem was Ptilmarily cyclical or structural, and as to the impact of a tax cut, Mere was further the question whether monetary policy could be used effectively in restraining price movements in present circumstances. The Council's statement implied a view that in the event of inflationpressures a less easy monetary policy would be warranted. Generally 8Pe4king, bankers seemed to take the view that this would be effective, nonbankers tended to be skeptical. The Chairman inquired whether it was felt that the availability Of rn °IleY was about right at present, from the standpoint of the relation- ship of supply and demand. He also referred to the current discussion 2/18/64 -7- about the possibility of Federal Reserve monetary policy negating the stimulative effects of a tax cut. He happened to feel, he said, that any deficit resulting from the tax cut should be financed primarily through nonbank sources, but such a position was currently under attack. President Moorhead commented that the leading question seemed to be how much further the economy could expand without any significant addition to the employed labor force. It appeared that there was still rnota for considerable expansion without putting any appreciable dent ba unemployment. Chairman Martin replied that he thought a case could be made that if a strong capital spending expansion should occur, there might be a considerable decline in unemployment. Mr. Stoner said he did not think that the impact of a tax cut increase employment too much in the Fourth District, where the Steel and automobile industries were already operating at such high t'ates. Mx. Aston reported that the Eleventh District had been gaining defense contracts, which would increase employment. Business in the District was strong, and he thought that a tax cut had been fairly discounted so far as nondefense-type work was concerned. " 14 still an abundance of capital for construction needs. There However, the District was still generating more job -seekers than jobs to be filled. The District had been enjoying less than average rates of 411"01°Yment, but it was difficult to see where too many new jobs would be created. 2/18/64 -8Mr. Aston said he detected some concern that there was an element of softness in the economy. There was some feeling that this was a time for caution. The buoyant sentiment resulting from recent economic conditions and tax-cut psychology might lead to an inflationary situation beginning in 1965 that could be harmful and d angerous. Governor Balderston referred to an analysis made by the Atlanta Reserve Bank of changes in job opportunities in various lines of work. It was rather surprising to see which parts of the White collar area were providing jobs strongly and which were not. Retailing had declined comparatively as a provider of jobs, while State local government jobs up markedly. Financial insti- tutions and service occupations fewer. ions had been providing more jobs, wertu there had been a general feeling that the white collar area was the Plate where high school graduates should seek employment, but this aPPeared to depend on what part of this area one had in mind. Turning to the second part of the topic, Mr. Moore commented that a lot of factors were contriving to exert upward pressure on interest rates. In New York City there was a deep awareness of the balance of payments problem, and strong competition for money from ther international markets was seen continually. As to long-term atee, there would be a good deal more State and local spending. At the moment, loans were running off seasonally and demands were rather light There is typically not so much talk of interest rate upswings 2/18/64 -9- at this time of year as later on in the year. Looking forward to the second half of this year, if there was the stimulus that apparently Would came from the tax cut, activity should start to move ahead in some areas. In his opinion, there was likely to be significant credit expansion this year. One factor, of course, in the thinking about interest rates was what the nature of Federal Reserve policy might be. In general, it was his feeling that it would be hard to push ' interest rates down and that they were more likely to push upward. Re was not advocating higher rates, but the pressure would be in that d irection. Chairman Martin inquired whether the Council members were willing to accept the optimistic forecasts currently being made about the balance of payments or whether they were skeptical. Mr. Cook indicated that he was skeptical. A good deal of What had taken place to achieve the current improvement did not "ern to him to have sufficient depth to correct major ills. Among Other things, it was necessary to keep watching the European situation to see what might develop in that area. Apparently, the Western Eur°Pean countries were feeling considerable pressure on prices and "Sts. The Japanese situation was still rather tense, and the Japanese were seeking loans actively. Part of the improvement in the balance of payments was obviously attributable to the introduction of the interest equalization tax proposal, but this was an unnatural ait uation. It was not known whether a bill was going to be enacted 2/18/64 -10- or what might happen if such a bill should be enacted. The threat of legislation might be exerting a stronger influence than would the legislation itself. There seemed to be some feeling abroad that if the U.S. did strike a payments balance, that would contribute to a depression in certain other countries. Chairman Martin inquired what if any effect the Council members felt that the increase in the Federal Reserve discount rate last summer had had on the balance of payments problem, Mr. Cook said he thought it had exerted a generally favorable e ffect, but he could not say how this might be precisely evaluated. Mr. Moore agreed that it had had a good psychological effect. Mr. Day commented that the short-term interest rate differential had grown so small that there was not much incentive for short-term funds to flow °ut of this country. Chairman Martin noted that there was a good deal of discussion currently as to whether the discount rate move had exerted anything 111°re than a psychological effect. If it had been separated from the interest equalization tax proposal, there would have been a better 1148is of measurement. The two steps were taken together, however. There was some body of opinion that the discount rate move had no effect on the balance of payments, while an easier monetary policy rrlight have had a more stimulating effect domestically. .2/18/64 -11President Moorhead commented that the discount rate increase apparently had had no adverse effect on domestic business, and Mr, 1400re noted that in any event there had been a credit expansion of record proportions last year. d iscount President Moorhead agreed that the rate move had not curtailed the lending activity of banks. Mr. Moore said he felt reasonably sure that a lot of funds had been kept in New York by the very fact that a sign was given to short-term investors that the interest rate mechanism would be used. Previously, there had been much nervousness on the part of foreign short-term investors. This again was in the psychological area, but nevertheless the talk died down and the money stayed in this country. 2, Banking developments. A. What is the Council's judgment regarding the demand for commercial and industrial loans over the next six months? B. What is the Council's judgment with regard to the demand for mortgage loans over the same period? C. Have Council members observed any recent change in the willingness of banks to continue to add to their portfolios of longer term tax-exempt securities? Do Council members believe that the ability of many banks to issue negotiable time certificates of deposit is being restricted by the current interest rate ceilings under Regulation Q? E. Have Council members observed any changes in the standards banks are employing in judging their own liquidity positions? 2/18/64 -12F. What is the attitude of Council members toward the proposal sometimes made that regulation of interest rates on time and savings deposits be put on a standby basis? A, The Council believes that the demand for commercial and industrial loans over the next six months will rise moderately, reflecting the probable expansion in business activity, B. The large volume of construction activity, as well as the level of contract awards, indicates that the demand for mortgage loans over the next six months will expand further. C„ The members of the Council believe that banks are less willing now to add to their portfolios of longer term, tax-exempt securities, D. Most members of the Council do not believe that the interest rate ceilings under Regulation Q are limiting the ability of major banks to issue negotiable time certificates of deposit, However, certain banks are finding it necessary to shorten maturities and pay slightly higher rates in order to attract funds. The Council is concerned about the effect on the volume of negotiable time certificates of deposit if the interest rate structure should rise and the yields on Treasury bills should approach 4 per cent. E. The statistics on the banking system indicate that many bankers are accepting lower liquidity standards than heretofore. The pressure of increasing costs, especially the sharp rise in the amount of interest paid, has led many bankers to hold a larger volume of less marketable, longer term assets in the portfolios of their banks. F. The Council is unanimous in its opinion that bankers generally would not favor the proposal that the regulation of interest rates on time and savings deposits be put on a standby basis, but would prefer the present arrangement, If conditions in the money market should warrant an increase in the maximum Permissible interest rate paid on time and savings deposits, the members of the Council believe that any increase should be well above the then current rate. This would tend to preclude the maximum rate becoming the prevailing rate paid. On commercial and industrial loans, President Moorhead said the Couti . ell had not attempted to specify any particular expected rate of t 2/18/64 -13- increase. 4 range A rate of 3 per cent had been mentioned in one instance, and of 2 to 5 per cent in another. Mr. Hickok said that Eighth District banks were not looking for- Ward to any particular increase in loan demand over the next six months. Demand appeared to have just about leveled off. Mr. Day reported a feel- in* in 4 0 the Third District that there might be anything from a flat curve t° around a 3 per cent increase for the year, which involved looking a little further ahead than the next six months. Mr. Watlington said that in the Fifth District it was thought that loan demand would be stronger, With an increase of from 2 to 5 per cent over the comparable period in 1963. President Moorhead commented that Ninth District loans were off 414410nally since the first of the year, but that the volume was ahead of 4 Year ago at this time. It was expected that demand might increase a tle more than normally in the second half of the year. Mr. McRae 4Ported that in an informal survey 14 bankers in the Sixth District felt that loans would increase, while four expected no change and one the- 'ght that perhaps the volume would slip off a little. The majority °Pim-°n was, therefore, that there would be at least a moderate increase, 4411(1am/ends were now strong. Mr. Smith indicated that in the Seventh net no increase was expected for the first six months. Governor Balderston noted that it was said that the flow of `P°rate internal funds might be sufficient to take care of plant and 2/18/64 -14- Ntapment additions. He asked whether this was true of any increase in inventories that might be ahead. President Moorhead replied that it was the Council's conclusion that the situation was very spotty. There were large cash flows in the large corporations, but in many smaller corporations any substantial inventory accumulation would require bank financing. Mr. Moore commented that there were a lot of "haves" and a lot of "have nots." had The "haves" s great number of dollars, but their suppliers might not have them. As to mortgage loan prospects, President Moorhead said the C°uncil had discussed the apartment and office building situation at considerable length. Charts seen by the Council yesterday indicated that apartment building was growing at a substantial annual rate, and it vould seem doubtful whether this rate of increase could be sustained 14/definitely. All of the Council members knew of instances where apart- builders were in trouble, but there was an incentive to keep going because of the abundance of mortgage funds available. Mortgage rates hseibly could soften because there was more money pushing on the mort%Ette market than that market could absorb. Mr. Aston recalled expressing the view as long ago as the SePt ember 1963 meeting of the Council and the Board that there was a aituat.4 --on of oversupply in the Eleventh District, particularly of highapartments. There was still a tendency to build, if the money ec41141 be obtained, without regard to need. Some slowing down of activity viaa s een on the part of institutional investors and insurance companies, 557 2/18/64 -15- h0 Were not rushing to make commitments in the same way as six months The availability of funds, however, was still more than sufficient Se shading of rates, and of terms and conditions, was seen in order to et this money working. Mr. Smith reported a general feeling in the Seventh District that there would be no change in demand for a while. In checking with lietional building companies, however, he sensed a feeling that there Iles going to be certainly no less demand for mortgages because it was felt that nonfarm starts would continue at about the same level or possiblY a little higher, with an increased demand for public buildings of ell types. There could be less desire to take these mortgages. Savings 44(1 loan associations were not growing as fast as they had been earlier, 111(s with savings departments were having the same experience, and 41.rtgage companies were quite well loaded up. interest in seeking mortgages. Thus, there might be less A steadying of rates could develop, or P°88iblY some increase, depending on what happened to the economy aerleraiiy. Mr, Stoner repeated a comment he had made at the November 1963 tirl.g that if there was trouble ahead the mortgage and real estate 1141'ket would be likely to trigger it, to which President Moorhead added tli4t 411 of the Council members had the feeling that this was a potential (irler spot. On bank acquisition of longer term tax-exempt securities, klY . that throughout the Third District there was widespread Mr. 2/18/64 -16- anticipation of more attractive rates on tax-exempt securities, and thus await-and-see attitude. There was a fairly substantial latent demand municipals that might became active, particularly if any feeling should develop that rates were going to stabilize. Third District banks Iftte not bearish; they were more or less sitting on the sidelines. Mr. Watlington observed that after the last Regulation Q 41dei0n there had been a marked upward surge in holdings of municipals. Re thought that that was now pretty well taken care of, and he did not 411ticipate any significant further change. Mr. Moore foresaw some increase in holdings of tax-exempt 4e4rities in the Second District. had taken a He went on to say that his bank survey of 111 banks over the country, asking them about their plans for purchases of tax-exempt securities in 1964. About half 84id they planned to purchase as many as in 1963, 31 intended to buy 111°1 ) and the others intended to buy less. Comparing the results with 84 'rnilar survey taken a year earlier, his bank came to the conclusion that commercial bank buying of tax-exempts would be less in 1964 than irk 19 63) unless there should be changes in yields. Mr. smith commented that the big change was in the last half of 19 62 and in 1963, and he felt that the banks were now quite well Mr. Hickok suggested that many banks had acquired the amount of 4418 they thought justified for their particular situation, and thelp Were not willing to go into municipals further. On the other hand, 559 2/18/64 -17- °ther banks had not thus far utilized the municipal market to the same e(tent o Mr. Martin noted that in the closing days of 1963 and the opendays of 1964 there was clear evidence of liquidation on the part of the larger banks, in contrast to slight increases a year earlier ° There 4Ppeared to have been some change in philosophy toward an attitude of stand._ , g 4r1 still and reappraising the situation. This related to the cluestion of time money and certificates of deposit, A careful reappraisal evidently was taking place as to how much further the certificate of de Posit movement should go. There was evidence that banks that had not u8" municipals historically were now using them effectively, while some '" had gone overboard, so the outlook was fairly mixed. Turning to negotiable certificates of deposit, President Moorhead 84ill it was his feeling that some banks were being restricted because eel'tificate of deposit rates were so close to the 4 per cent ceiling° tarks whose certificates might not sell quite as well as those of the rQ4jor banks could have difficulty in attracting funds even though they Ilee Willing to pay the maximum rate for short-term certificates, How- ever' most Council members felt that the smaller banks, meaning the $100 _ $500 million banks outside New York, Chicago, and the West Coast, n°t particularly interested. Mr. Cook commented that banks that had gone into municipals hg 1Y would be faced at some stage with a decision, given the anticincrease in loan demand, whether to sell tax-exempt securities-- k 2/18/64 -18- Probably at reduced prices--or borrow from the Federal Reserve or go into the certificate of deposit market. to adjust. It might not be easy fqr them Certificate of deposit money, he noted, was close to demand This raised the question of possibly trying to extend some of 111°IlLeY. the maturities. A test of the stability of certificate of deposit 111°11eY would be afforded by offering a somewhat higher rate for longer term certificates, thus determining whether people depositing this 111°IleY really meant to leave it there or whether the money was as hot a ome were inclined to think. Mr. Moore commented that everyone was trying to gauge how hot the money in the certificate of deposit market actually was. He felt that ilew — York banks were influenced in a peculiar way because they 11e17e trying to compete with both foreign and domestic money rates. thej 'certificates were somewhat easier to handle than those of lesserflames, but otherwise he would agree with what Mr. Cook had said. There might be a problem soon if certificate rates moved up to the ceilfl 4 and the Treasury bill and commercial paper rates advanced. Certifi- cEttes of deposit were going to look a little thin. Mr. Watlington said that Fifth District banks were not in I)etition with the money center banks to any substantial degree bee Use they were willing to let them have the certificate of deposit t4(311 Y. The 4 per cent ceiling was therefore not a matter of great con- 4 to Fifth District banks, and he did not think they would like to _ '( change. The smaller banks had a tendency to make the maximum rate 2/18/64 -19- the minimum, and some might go to the new maximum almost automatically. raised a question as to what the banks would do with the money in order to make a profit on it. Banks must make money or they would not be sound banks. President Moorhead noted that some banks were finding it difficult already, and others would find it difficult soon. Chairman Martin mentioned that a party had raised the question I him whether there was a possibility that negotiable certificates " (3 dePosit could be forged, and he presented this question to the It was indicated that the possibility had not been given too r4uch thought. Mr. Watlington commented that when banks formerly in- vested in savings and loan shares, a number of instances developed where 41411 banks held certificates that were forged. Mr. Smith commented that he Possibility of forgery would apply to a lot of other things handled "anks as well as negotiable certificates of deposit Mr. Breidenthal expressed the view that a lot of questions tied 4fto the answer that might be given on Regulation Q. Practices with Peet to investments in tax-exempt securities and longer term business loati 8 were linked directly to the question of what the banks did on their 41te rest rate on negotiable certificates of deposit. 4r8t came When the certificates into prominence, there was talk of $4 billion of them, then 4billion, then $8 billion, and now $10 billion. A lot of funds had been 2/18/64 -20- Nit into this category, and he thought the banking system was now ' l Illnerable. If the rate should go up, this would have a definite further effect on the liquidity position of the banks. The legislation commended by the Board to change the character of assets eligible for discounting at the Reserve Banks might be needed badly if the current lovement should go much further because banks would be loaded with certain types of assets not presently eligible. Perhaps with a Large 440unt of short-term foreign credits in this country, it was going to be n ecessary to have a more flexible rule to enable the banks that were the field of handling those credits to be able to meet any rate probleal, but this did not apply to the domestic situation. While mention had been made of standby controls over maximum interest rates, he did 11°t know exactly what this implied. One of the largest banks in the country 1413 advocating a 5 per cent ceiling, but if this ceiling was in effect thrcwghout the country he did not believe the banks could invest their fund 8 in such manner as to safeguard their assets in the way they should be ' afeguarded. He thought the banks had about reached the limit, unless 411 interest rates were going to be much higher than at present. 14184 One saY that if the ceiling was fixed at 5 per cent, or Regulation Q Vas placed on a standby basis, the problem could be left to the judgment °f t he banks themselves. It could be argued that the establishment of 4 hi 8her maximum rate did not mean that banks generally had to go to the ttlxim -urn. But he felt competition would take care of that. Corporate tre asurers were shopping for as little as 1/8 of a per cent. In his 2118/64 -21- °Pini0n the banking system was vulnerable with $10 billion of negotiable 4ttificates outstanding. He felt sure those funds would drain out of the banking system just as rapidly as the owners could find a more profit4hle use for them. Mr. Watlington said he thought Mr. Breidenthal was correct. A laqs sophisticated bank possibly could do something useful with such funds. However, people would go to their local bank and insist on the sarrls treatment. The unsophisticated smaller banks would accommodate them Wi thout studying the results; then they would wake up and find that they 714's running into a disastrous situation. This would undermine the soluldness of many units in the banking structure. On liquidity standards, President Moorhead said the Council Inernbers agreed that there had been a change in the make-up of bank assets. The 'volume of time money had inevitably led to lower liquidity standards. Mr. Day said corporate treasurers had become so efficient in 11441ing their money that they had gotten demand balances almost to an iteducible minimum. The base was a real one now, with few excess alld funds. President Moorhead observed that in present circumstances demand might really be more stable than time deposits. Reverting to the question of negotiable certificates, Governor kobe l'tson said that assuming the present interest rate ceiling was not at ' e Moment a limiting factor on the very large banks, he wondered "t the effect on the $200 - $500 million banks. Were they losing 564 2/18/64 -22- their time certificates? Was the money they had heretofore taken away ftota the major banks by offering higher rates now being pulled back? President Moorhead said that, while he had no statistics, he 8'PPosed some of this was occurring. already happened. the money. Mr. Watlington said it had Consequently, the smaller banks were doing without To get it back they would have to pay more attractive rates, but he thought there was no great pressure to get it back. The smaller banks would rather let it go than to have to pay higher rates to get it back. President Moorhead commented that something depended on how the 114311eY was invested. His bank, for example, would have been hard pressed to teet all the demands upon it except for the certificate of deposit rri°11eY) and it had pulled this money away from the major centers. If it 11°144 go out rapidly, the situation would tighten quite quickly. Governor Robertson noted that the Council expected commercial 4"industrial loans to rise moderately, and mortgage loans to expand Where were the banks going to get more funds? Mr. McRae said that in the Sixth District there were many banks that did not care to compete for certificate of deposit money at rates 'able at New York and Chicago. 4bout However, several banks that he knew ere very aggressive in wanting time money at 3-1/2 per cent. Mr. Cook said his bank had concluded at the end of the year that the rate differential was a sufficient deterrent to justify moving away the certificate of deposit business. This meant that the bank would 2118/64 -23- 11°t be in the tax-exempt market in the near future. It felt that certificate of deposit money was too hot to lend on a long-term basis. Was thought that perhaps half of the certificate money could be put in portfolio, but the rest must be used in terms of matching maturities. Other banks of about the same size had also started to back away from the certificate business. Mr. Watlington noted that his bank experiences a seasonal 4eline in deposits from this time of year until September. To offset tilat, the bank decided it wanted a fairly substantial amount of certifieatemoney. It went into the market and got it, at only a slightly higher atla than the New York banks were paying. The bank was able to get the " r eY from the same people who were giving it to the New York banks, one Naon being that national companies feel some obligation toward the 10e, ca banks in return for various favors that are done for them. Mr. Moore suggested that the outstanding certificates, in the 4111°114t of over $10 billion, might represent a good deal of money that a back in the banking system after having been elsewhere. The banks 114 'a finding that many parties other than banks, including corporations, 14A 411 the business of financing many things. It was his feeling that the b anks would have to bid for deposits and pay for them from here on that this would be the only way to finance a general expansion of 10448. Chairman Martin inquired whether any members of the Council were favor of paying interest on demand deposits, and there was no indication to 8 ' 101 effect. 2/18/64 Mr. Day commented that with demand deposits almost static and loan demands rising, banks were practically pushed into the area of time money to stay in business. Governor Robertson inquired about the reported practice of Paying a finder's fee for negotiable certificates. Mr. Martin replied that he had heard the practice was developand that he would like to know more about it. Mr. Moore said he 41410 had heard of it, but he did not know of any larger banks that had tesorted to the practice. Governor Robertson inquired about the percentage of the $10 billion of negotiable certificates outstanding that might be regarded quite stable, and one of the members of the Council expressed the 'vi ew that 25 per cent might be a fairly good guess. Other estimates l'a4ged higher or lower. Governor Robertson commented that there were banks in the Tenth 14strict that were now losing funds. Originally they took money from the No r banks by paying a higher rate on certificates. Now the major banks moved their rates up, so these Tenth District banks were losing funds. Mr. Breidenthal replied that he did not believe there was a bank (1 significance in the leading cities of the District that was not going 4fter certificates of deposit and paying 4 per cent. If the ceiling were 418ed to 5 per cent, he expected that some of them would attempt to l'et4in those funds by meeting the competition. 2/18/64 -25Governor Mills asked whether it was not a rather generally accepted proposition that the funds attracted by issuing negotiable certificates could be employed at a profit only by going into mortgages. President Moorhead commented, on this point, that he did not believe banks should go after time money merely to employ those funds IlaYs in which they would not ordinarily put their funds to use, sounder approach was to try to attract the money to meet ordinary 4)411 demand. Mr. Watlington inquired as to the purpose of putting the tabueY on the books if there was not a worthwhile result from it. Mr. /34:Y said that his bank was budgeting substantial expansion in the e°11aumer credit area. There was a logical basis for paying 4 per cent fut funds to be used in this manner. Reverting to the question as to how much of the negotiable eetificates actually represented savings, Mr. Moore said that he did 4Qt think his bank would consider a dollar of its certificates as such, 4411 Mr. Smith agreed. Mr. Hickok commented that if the certificate business had become an accepted way of life--one that had to be maintained at a price--the banks had gotten themselves into a bad situation. Aston said he thought it was indeed a way of life, but obviously not at a Price. The profitability was taken out of it if banks paid beyond a -ertain price. But they had to react defensively to keep their Istftera; if it were not for the availability of certificates of deposit, 4 bank might lose customers. 8le competitive unit. The whole banking business of today was a His bank was calling on customers over the 2/18/64 -26- country, and so were the New York banks. tive, although not at any price. qualification was important. His bank must remain competi- Mr. Breidenthal commented that the The cost of the time money had to be kept under control. On the question of putting the regulation of interest rates on 4 standby basis, Mr. Day expressed the view that if any standby arrangeWas put into effect, that should be done at a time when there was substantial pressure on rates. abroad Any significant upgrading of rates might force similar action in this country, and he did not think ' rederal Reserve could afford to keep the present ceiling in effect 4 negotiable certficates actually started to flow out of the banks taPidlY, for there would be a terrible competitive scramble. President Moorhead expressed apprehension that if the maximum "were inched up, the new maximum would become the prevailing rate. rat the other hand, bankers had not shown much ability thus far to run their ovn iives. it the If the ceiling rate was 6 per cent, somebody conceivably Offer 6 per cent on a certificate of deposit. That was the dilemma council found itself confronted with in endeavoring to answer this question. Governor Balderston commented that if a large proportion of the g gable certificates outstanding should be lost, the impact on the Cipal market no doubt would be severe. that He suggested the possibility the maximum rate on certificates now held by the banks might be 4ieed to some higher level, for example, 4-1/4 per cent, with a 4 per 5f 2/18/64 -27- cent maximum rate retained on any new funds obtained through the issuance °f negotiable certificates. Mr. Moore asked whether this implied that other interest rates 1(3111(1 not move at the same time. He would hate to think that banks would riot be able to bid for any new money as it came along. Governor Mills suggested that if there was a run-off of negotiable certificates, the money might not leave the banking system in the bsence of a general contraction of credit, and instead merely be reallocated among the banks. It might be that some who had taken on certi- fie ates would feel a pinch and have to resort to emergency credit to earrY them through. But whoever cashed in the negotiable certificates 1.101 "have funds that would come on the market for investment. One could riot know where the pressure would be felt, but if it was on the mortgage field, for example, mortgage lenders presumably would be compelled to the rates they were offering. The whole rate structure would then aqten to a degree that at some point would affect the rates being paid 4 negOtiable tti fc certificates. If it were possible to work through those the situation might be solved whereas it would be aggravated if rates went on up on a competitive basis. Referring to Governor Balderston's suggestion, President Moorhead tight out that at some point the outstanding negotiable certificates Ikuld at h mature. It might be that the holders would not want to renew them, e did not see how the banking system could retain the present $10 ion. Mr. Day added that if the short-term rate in England, for example, 2/18/64 -28- Was sufficiently attractive, money could leave the American banking system rather quickly. Chairman Martin commented that this was a point of concern to the Board. The Board did not want to encourage the negotiable certifi- cate market unduly, but the question was how to get out of the bind. Governor Mills inquired whether domestic funds were not moving lato Europe in substantial volume through the channel of credits extended by the same banks that were attempting to attract European time money through ability to pay a higher rate. The banks guilty of stimulating the outward movement were the same ones complaining about inability to hold funds in this country. Mr. Day commented, on this point, that the corporate treasurer /1°41d take money wherever he got the best rate and the funds did not 41waY8 cross. Governor Robertson asked the Council to suppose that the banks had to put the rate up to keep funds from moving out of the country. keecIrding to the Council's statement, it was anticipated that the demand att'uoture would pretty much tend toward stability. He suggested that the il/tarest rate ceiling might be raised for a percentage of each bank's t°t41 savings deposits, or total deposits. On that portion of total (14/sits, a bank could pay whatever it wanted to pay. te But the maximum 011 the remainder would be held dawn. President Moorhead said he thought the suggestion had merit, not 0411, from the monetary standpoint but from the standpoint of the banks. 2/18/64 -29- Watlington felt that it would be relatively easy to understand and erlf°rce. If the banks could have a certain percentage of total deposits in certificates, it was reasonable to believe that they could invest 811c4 funds profitably. However, if they got too much into negotiable cettificates, that could affect their profitability. Governor Balderston then stated that he thought Governor 4ber tson's suggestion for enabling baaks to defend themselves, as (31/143sed to seeking additional funds aggressively, was more feasible acilrlinistratively than his own suggestion. It would permit some further e l/ansion of the $10 billion outstanding. Those banks that were not up to4 certain percentage of total deposits could bid for and take on more eertif .-icate money, whereas those already at that level would be estopped. 3. Foreign lending by U. S. banks. A.. What is the current situation with respect to foreign demand for loans from U. S. banks? B. What does the Council anticipate with respect to such demands in coming months? A. The Council reports a strong foreign demand for loans fr°th U. S. banks. B. The Council anticipates that the demand for such f°reign loans will continue strong in the coming months. However, nould the domestic demand for credit expand as the level of "siness activity rises, the resulting pressure on bank reserves rIlaY make banks in the United States less willing to expand their f°reign loans. Mr. Cook said that in the case of certain foreign countries the they banks in the habit of lending to them had now lent about as much as elt they should. The Japanese, however, were going through the 2118/64 -30- c01111trY soliciting loans even from banks that were not customarily foreign lenders e At some point, such banks might say that the foreign loans did tle't suit their purposes, and other banks must stand by and protect the N30sure of the American banks. This was a reason why a well-entrenched barlk should hold back on more foreign loans; it should have a little re— to pick up the slack that might develop later on, Mr. Day said that the interest equalization tax proposal had had the effect of putting pressure on two-year, eleven-month bank credit d-ve loped countries. The Japanese, in particular, were trying to 41/ance longer term expansion through the banks to avoid the tax. On the matter of rates moving up abroad and inducing an outflow 0 unds from this country, Governor Mills suggested that a firming of rates by fo reign authorities presumably would reflect inflationary or distressed 44cial conditions in the particular countries. Would American businesses 480 interested in a rate differential that they would take the risk that in dicated? President Moorhead replied that he thought they could protect 4terilselves against a cheapening of the foreign currency and therefore they 41illt be interested. Mr, Day said that if they could hedge their money, they Would be happy to put money in all European countries if they could °btain a rate differential. Chairman Martin inquired whether, if rates went up I per cent in thgla 4d, it was felt that American funds would be likely to go into England 11,111e. i tl0 t 2/18/64 -31Mr. Martin replied that this would suggest the necessity for a rlale in the Federal Reserve discount rate. If European countries had lillbstantial further increases in their rates, a chain of circumstances I1°1114 be set up, thus placing before the Federal Reserve the question of 44 iftediate increase in the U.S. discount rate. The whole situation, the Regulation Q question, would be back where it was a number °f months ago. Mr. Cook suggested that there would be no objection on the part Of uanks if interest rates paid increased provided interest rates earned 44° increased, and Mr. Martin observed that it was a one-sided proposition. 'n the consequences of an increase of 1/2 per cent in the short-term rate structure did not affect bank lending rates much at all. Governor Robertson inquired whether anyone felt that the balance "Pa Yments situation was so serious that steps should be taken to teat rlet bank loans to meet foreign demands, and Mr. Cook observed that 81'01 1A -ans did not upset the balance of payments as much as one might think. They might have that effect temporarily, but the situation would adlust be -tself. Governor Daane observed, however, that if there should si mPlY a substitution of bank loans for long-term credit from the U.S. Pit -- market, obviously there would be no net gain through the imposition °f the interest equalization tax. 11r. Moore suggested that there might be a lot of two or three-year loans with a balloon at the end of the final year. Asked whether the twoYear, e leven-month loans were taking that form, Mr. Moore said he had not 2/18/64 -32- aeen too many yet, but he thought the tendency was strongly in that 4tection, He felt the banks had to be careful on that score. It was hard to pick out what was a loan and what was not. Mr. Martin commented on the volume of credit extended to Germany 1)4°r to 1931 with inadequate knowledge of developments on the part of the lenders. The situation today seemed somewhat similar, with in- 44(Inate knowledge as to what was being done in terms of bank loans to fc'teigners. In situations like that of Japan, American banks were elqendi-g n credit to a country when they had no idea of its total 14thilities. 1111 There were pieces of information, but no valid understand- 48 to the course of events in Japan. Banks were seeking income, 4" (3n the theory that the Japanese economy was prosperous, they were 8(lina ahead and extending large loans. He wondered whether something 4411d not be done to provide better information. Governor Daane observed that there were two questions involved itlsr. Martin's comments. The first related to the possibility of develQPing more information on the total liabilities of particular f°te4a countries. The second related to obtaining data on the volume Cl:edit extensions by U.S. banks. On the latter, the Treasury was develoPing a reporting program in response to a request from Congress in "(q1 ef.4 e--ton with consideration of the interest equalization tax proposal. 4edid not know the precise status of this program at the moment. Ntit, In any however, these data would not provide an answer to the first tion. 575 2/18/64 -334. Monetary policy. What are the Council's views regarding the effectiveness of recent monetary and credit policy? The Council believes that recent monetary and credit policy has been effective. Domestic business activity continues to rise while our balance of payments situation has been maintained since mid-1963. However, should the anticipated tax cut strongly sttmulate business activity and create inflationary pressures, a Policy of credit restraint would be warranted. There was no discussion of this topic, it being noted that eral aspects of it had been covered in the discussion of the preceding toPies, Absorytion of exchanu. Chairman Martin and Governor Balderston ref", 'rred to the position advanced vigorously to the Board over recent 4511ths by a State member banker that the Board's present position on al)9°113tion of exchange charges served to place State member banks at an 41equitable competitive disadvantage, not only in relation to nonmember but also in relation to national banks because of the lack of enrotc "erlaent on the part of the national bank examiners. President Moorhead inquired whether there had been opportunity 4Yet to discuss the problem with the new Chairman of the Federal Deposit /.44ce Corporation, and it was indicated that this would be done in dtte course, Mr. Watlington said that from recent conversations it was his "ion that despite the existing situation, including the lack of tofo_ reement efforts applicable to national banks, a great majority of hatike rs in the Fifth District felt strongly that the Board should not 2/18/64 576 -34- change its present position, primarily for two reasons. First, member balliks had an opportunity to say that they were not allowed to absorb echange, and as a consequence many corporate treasurers understood the situation and continued to do business with those banks. Second, if kaller banks were allowed to absorb exchange, the additional expense vould place a substantial hardship on them. It was interesting that ' of the larger correspondent national banks were adhering to the tule on their own accord, although the Comptroller was not enforcing it. The general situation, he thought, was better than a year ago, with the tiliber of nonpar banks generally being reduced. If the Board were to cha, 'Lge its position, he felt that the situation would retrogress. Member 11411k8 had been working under this competitive hardship for many years. It would be a greater hardship to go back and start all over again, and the c°ntinuation of the Boards present position offered hope for the ' 41 elimination of nonpar banking. seern feasible. A legislative approach did not Mr. Martin reported on current discussions within the ranks of the --terican Bankers Association and the Association. of Reserve City Ilatikers. He reported that a group from the former Association was plan111'4 to call upon the Chairman of the Federal Deposit Insurance Corporation. It " 14 understood also that the incoming President of the Association of to th ve city Bankers was going to try to get that Association to face up e problem this spring. 577 2/18/64 _35 Eligible paper. Chairman Martin commented that the Board would PPrsciate any support that the Council members might feel was warranted for the proposed legislation to broaden the base of Reserve Bank lending to eMber banks. It was agreed that the next meeting of the Federal Advisory Co until would be held on April 22-23 The meeting then adjourned. 1964.
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