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Minutes of actions taken by the Board of Governors of the Nler Reserve System on Tuesday, March 28, 1950. PRESENT: Mr. Szymczak, Chairman pro tem. Mr. Draper Mr. Carpenter, Secretary Mr. Sherman, Assistant Secretary Mr. Kenyon, Assistant Secretary Memorandum dated March 27, 1950, from Mr. Young, Director or the Division of Research and Statistics, recommending the ap— tl°111t°1ent of Richard W. Lindholm as an economist in that Division, basic salary at the rate of $8,000 per annum, effective as of the uate upon which he enters upon the performance of his duties ettr. having passed the usual physical examination. Approved unanimously. Letter to Mr. Sproul, President of the Federal Reserve Bank Of Ne York, reading as follows: "The Board concurs in the action of your Bank's ulrectors, as related in Mr. Clarke's letter of March 23, authorizing the acceptance of an invitation extended to A • John H. Williams to spend the first two weeks of 'Pril in Paris as an adviser to the Organization for Eu— !?Psan Economic Cooperation in connection with current 141scu8si0ns of the European payments union. It is noted 6hat this invitation has been approved also by officials °f the Economic Cooperation Administration in Paris." Approved unanimously. Letter to Mr. Parten, Chairman of the Federal Reserve Bank or tai 48, reading as follows: "This refers to your letter of March 10, 1950, t° the Board and your letter of March 13, 1950, to 3/28/50 "Chairman McCabe. "With respect to the cases involving shortages and irregular handling of money and securities which were discussed in the report of examination of the Federal Reserve Bank of Dallas made as of November 3, 1949, by the Board's examiners, the Board is glad to have the informatlon you submitted regarding the corrective actions taken or to be taken and the measures adopted to prevent similar occurrences in the future. It is noted that a further communication may be expected from you with respect to the Proposal for strengthening the Auditing Department of Your Bank mentioned in your letter of March 13. Approved unanimously. Letter to Mr. Lunding, Chairman of the Board of the Federal Rese I've Bank of Chicago, reading as follows: "Reference is made to your letter of March 20, 1950, , regarding the recommendations of your Executive Committee adjustments in the salaries of officers of the Federal !serve Bank of Chicago as submitted in Mr. Young's letter of February 6, 1950. "As you will recall, at the time consideration was bei . ng given to officers' salaries last year, you were advised that it was the view of the Board that in the absence °I further inflationary developments it could not be exPected to approve what may be regarded as cost of living increases in salaries of officers of Reserve Banks and that increase would be justified only when the officer's ies were changed or there were other special circum'ances which justified an increase. In connection with t11e proposal for salaries of officers for the period begint'ng April 1, 1950, your letter refers to Governor Szymczak's ,?lePhone conversation with you on March 15, 1950, at which he suggested that the salaries of officers be recon6rldered and that any increases be based upon (1) increased ,!sPonsibility due to changes in duties or (2) recognition ;1i outstanding competence and ability to assume higher ofciel positions. "Your letter indicates that your Executive Committee r 4eviewed the salaries of officers on the basis suggested '..aogether with two additional tests and that original recurnmendations were then reaffirmed. X 3/28/50 "The Board has given full and careful consideration to the views of your Executive Committee and, in view of the comments in your letter, hesitates to suggest further consideration of the matter by your directors. However, the Board cannot escape the conclusion that all of the Proposed increases are not justified at the present time evea if the basis for increases as referred to above is amplified by the two additional tests to which your letter refers. The Board is Influenced also by the fact that there have been no recent increases in the cost of living Ithich would justify general salary increases; in fact, there have been some decreases. "In suggesting that salary increases be based on increased responsibilities, the Board had in mind those cases where the officer had been given substantial additional responsibilities which previously had been performed bY an officer who had left the Bank or which had been asSigned to the officer under consideration as a result of a rearrangetnent of assignments. In referring to recognition cf outstanding competence and ability to assume higher official positions, the Board had in mind men who had demonstrated capacity for growth which had or would qualify them for senior positions in the Bank, rather than merely flexibility in handling assignments. This policy is essential, because of the desirability of developing talent In the Banks so that it will be prepared as fully as possible to fill from within any vacancy that might occur in the official ranks, including the senior positions. "From the information available to the Board, not all of the officers for which increases have been proposed /113uld meet these requirements. Therefore, the Board would gr:eatly appreciate it if your directors would review the 1 8t again in the light of the broader statement of the 4Juardt3 policy as set forth above and resubmit those cases whlch clearly fall within the limits of that policy. ,. "The Board will also be glad if you will assure your V-rectors that it appreciates very much the time and atrntion they have given to this matter. As you have in'icated, the dollar aggregate of the proposed increases is not large, and the Board has asked that the list be re'Jelled again only because it feels it to be important that 2 E 1e.r7 increases be limited to cases that can be justified ' en considered on the basis suggested by the Board." Approved unanimously, Messrs. McCabe and Vardaman having stated 3/28/50 -4over the telephone that they would approve if they were present. Letter to Mr. Roger W. Jones, Assistant Director in charge qLegislativP Reference, Bureau of the Budget, Washington, D. C., Nared in accordance with the discussion at the meeting on March 1950, and in response to Mr. Jones' letter of March 22, 1950, l'I"1ng as follows: "This refers to your letter of March 22, 1950, requesting an expression of views on a draft bill entitled 'The Small Business Act of 1950.' "In addition to a declaration of policy, the draft contains six titles. Title I would provide for the insurance of loans for small business by the Department Of Commerce, Title II would authorize the Commerce DePartment to charter certain investment companies--capital banks--to provide intermediate and long-term credit kid equity capital for small business enterprises, Title would amend certain provisions of the Reconstruction l'inance Corporation Act, Title IV would terminate sec13b of the Federal Reserve Act, Title V would procertain technical and managerial aids through the Impartment of Commerce, and Title VI contains miscella12e°11e provisions, including authority for the President 40 reduce business loan programs of the Government when ! 4 0essary or desirable for coordinating such functions wlth the Government's general economic and fiscal policies. "The Board is strongly in sympathy with the obective of providing adequate facilities for meeting he longer-term credit and equity needs of small busi°ss and also of providing greater assistance in the I'm of technical aids to small business. "The Board has long been concerned with the difficUlties faced by small business, particularly growing ! 8 61.11 business with demonstrated earning capacity, in taming access either to longer-term credit or to equitY capital. Section 13b of the Federal Reserve Act as 11°I.r drafted is not suited to this purpose. If a more !"°mising substitute were developed, the Board would faa provision such as Title IV of the draft which would te rminate section 13b. i r f'tS9 3/28/50 -5- "The Board feels that Titles I and II of the bill Present especially difficult questions that deserve discussion in some detail. "The problem of providing longer-term credit and equity financing for small business is complicated by the higher risk involved but is in large part one of administrative cost. The record demonstrates that minimum costs °f flotation and distribution of debt obligations or stocks in the public market are sufficiently great to constitute an almost insurmountable barrier to relatively small issues This difficulty clearly points to the need for some type of Specialized financial institution as a medium for providing long-term credit and equity capital to small business. Such institutions themselves, however, would also face a formidable problem of administrative cost. "It is this consideration of high administrative cost that accounts largely for the failure of capital banks to develop in the past to meet the longer-term credit and eq11_11tY financing needs of small business. Meanwhile, the need nas become more acute, particularly because of the incidence °f higher taxes, partly because the progressive standardization in commercial bank credit analysis procedures, though Tainently desirable, has nevertheless had the effect of lim'ting the volume of certain types of risk loan advances, and Partly because of the growing institutionalization of sav14g8 through insurance companies, investment trusts, and the like. "The suggestion has been advanced that local small siness development corporations, sponsored by local public sPirited citizens might play a useful role in the mobiliation of local aids to small business and in finding long1 ;erm loan and equity capital for them. We regard these (3cs1 corporations as a promising development. Strong local community support has always been a bulwark of small busitess in this country. Local Chambers of Commerce have been Particularly aggressive in promoting the establishment of new 4terprises in their vicinity, in securing sites on which ;aeY could operate, and frequently, in arranging exemption oin local taxation during the period in which they were getsing started. They have also at times arranged to tap local 4,!vings to finance the new enterprises. We believe that e proposed program should utilize these agencies to the el111. They will be particularly useful in the promotional to awaken the community to the financing and techCal needs of small business and in the efforts that will eed to be made to remove local impediments to small busi+.ess expansion. We believe it would be a mistake, however, base a structure of capital banks designed to fill the igil,"ing gap in the availability of long-term credit or eq1 V funds to small business primarily on the local develop- j 3/28/50 -6- H ment organizations. The making of credit advances and the Provision of equity financing requires exceptional finan— cial skill and judgment which are not ordinarily available to such small organizations. We are enclosing for your confidential information a copy of a report which we have recently received in another connection and believe to be objective on the present status of The Development Credit Corporation of Maine. There are probably other local development corporations in a less precarious position. Nevertheless, we believe it would be hazardous in the extreme to rest the success of the President's small business financing program on a base so untried, fragile and fraught with problems as is indicated in the enclosed report. "Recently, the suggestion also has been advanced that sPecialized capital banks, specifically established to make longer-term capital loans and to advance equity capital funds ° small business might be launched successfully: (1) if leY were able to moderate their administrative costs by ueing geared closely in their operations to our widespread network of unit commercial banks, which would normally have !la their credit files and operating contacts, much of the Information which a capital bank would need in judging small business applications; and (2) if the capital of these capital banks were originally subscribed by the Federal Re, , 8erve Bank, and subsequently sold to the community, once it been demonstrated that capital banks for small business 2°111d be operated on a remunerative and self-supporting ue-sis. Admittedly this approach has promise, but would reire active cooperation and sympathetic understanding on ge part of the financial community. "The implementation of the approach as it is embodied in the draft bill does not seem to us to be practicable. Under the plan of the draft bill the Federal Reserve Banks would be authorized to provide initial capital for the pronew investment companies, but after the launching, the 111vestment company program would move forward under other !Ponsorship. We believe that such a plan would be unrealand inconsistent with the need for securing the wholeearted cooperation of the financial community in making he Undertaking a success. The financial community generally /st°uld feel that the arrangement failed to reflect a proper Understanding and appreciation of the problem involved. "The Board feels that the Bimson plan for the insurance Of relatively small business loans has much promise. Howelrer, because of the high administrative costs of the capi- 1 e Z 3/28/50 -7_ "tal banks as referred to above, they would need all available sources of income and contacts with prospective customers in order to reduce as much as possible the initial and servicing expenses incident to funds advanced. The proPosal to set up the loan insurance program separately, as outlined in Title I, might well deprive the companies of badly needed sources of revenue and essential points of contact. For that reason, the Board would suggest that provision be made for transferring the loan insurance function to the investment companies as promptly as practicable when these companies prove themselves reasonably equipped to do the job. This would have the support of the financial comInunity and would be in accord with the sound principle that Government financial policies should endeavor to invigorate the regular financial machinery rather than replace it. "One feature of Title II raises a particularly serious question, namely, the use of Government guaranteed or insured debentures by the proposed investment companies. The idea of setting up investment companies in the very risky field of venture capital for small business to operate on the basis of Government liability for their debentures Poses a far-reaching question of public policy. The device of raising funds in the market through the issue of Govern11,0ent guaranteed or insured debentures, even in its use by alovernment or quasi-Government financing corporations operating under statutory safeguards, is unsound in general 121'inciple and the Board has consistently opposed it. In instance, the privilege of using the Government-backed .1,ebenture would be granted to private investment companies. f°11 private, profit-seeking financing institutions to be ie to borrow in the open market on debentures backed as r principal and interest by the Federal Government would be a radical departure from the basic principles of prudent 4usiness financing. The close relationship of such deben'lures to Government obligations cannot fail to be a source °f concern to the Federal Reserve in carrying out its re8P°11sibilities with respect to the Government securities :11Irkets. We are convinced that the incorporation of this .r'cured debenture device in the proposed bill would not be 6uPported by responsible opinion within the financial comInunity. "The question of the most suitable tax provisions to 11. 1121=4 to the proposed investment companies is very complex. goes without saying that no unfair concession should be g4 ' veh. On the other hand, the problems faced by these cornWould in many ways be unique. Tax provisions that re Perfectly proper in other fields may not be appropriate n 2 3/28/50 -8- "here. The draft attempts to adjust the provisions of the Internal Revenue Code (Sec. 361 et seq.) relating to 'regulated investment companies' so that they will be more nearly adapted to the particular needs of this case, but we believe it would be advisable to give further consideration to the question whether the needs have been met as adequately as may be desirable. For example, the two-year Waiver of the diversification requirements may not be sufficient, the 25 per cent limit on the accumulation of reserves may not be high enough or may not be calculated against the most desirable base, the loss carry-over provisions may not cover a long enough period of time, and it nlaY be undesirable to require or even encourage the distribution of earnings by this particular type of corporation. "We would also like to comment on certain other Titles of the bill. "The draft bill would reiterate the existing directive to the Reconstruction Finance Corporation to limit ts financing to cases in which the financial assistance ls not available on reasonable terms from other sources, and it also would amend the directive to make specific reference to the proposed investment companies as such a source of other financing. We believe it is wise to emPhasize in this way that the Reconstruction Finance Cor?oration should act only as a supplement to the estabished financial machinery and should not engage in un"sirable competition with regular financial institutions. "The Board also favors a provision such as that contained in section 602 of the bill authorizing the Presi.c1,4?nt to reduce business loan or loan guarantee programs of ' 416 Government when necessary or desirable for coordinating functions with the Government's general economic and '-isoal policies. "The Board has long been cognizant of the valuable and useful informational services provided to business, and esto small business by the Department of Commerce. stle V of the proposed bill, which clarifies and expands 41 Department's responsibilities in providing technical z.e nd managerial aids to small business, is an important for, 1ard step. Any additional facilities along these lines aurnished by the Department of Commerce will be helpful to 11 business enterprises as well as to small business. "In spite of the negative comments herein set forth wi+1. respect to Titles I and II of the draft bill, the Board I j 1 Q93 3/28/50 -9- "is aware of the broad sympathy which exists at all levels Of community leadership for the financing and technical and managerial aid problems of small business. If a construc— tive Government program for helping to solve these problems can be evolved, it can be expected to meet with a very fa— yorable public response. It is equally true, however, that lf a program is advanced which impresses important leader— ship as of doubtful efficacy and unlikely to succeed, a sPlrit of skepticism will be created which will hamper the Program, to say the least. The Board sincerely hopes that a program can be evolved which will hold out reasonable Prospects of achieving the desired objectives and will avoid the shortcomings to which we have felt in fairness that we Should invite attention." Approved unanimously.
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